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Learn, unlearn and relearn

Mi7 Financial literacy mission second publication

Revised 2008 Edition Original publication: September 2007

Revised 2008 Edition Original publication: September 2007 The Securities Academy & Faculty of e-Education Promoted
Revised 2008 Edition Original publication: September 2007 The Securities Academy & Faculty of e-Education Promoted
Revised 2008 Edition Original publication: September 2007 The Securities Academy & Faculty of e-Education Promoted
Revised 2008 Edition Original publication: September 2007 The Securities Academy & Faculty of e-Education Promoted
Revised 2008 Edition Original publication: September 2007 The Securities Academy & Faculty of e-Education Promoted
Revised 2008 Edition Original publication: September 2007 The Securities Academy & Faculty of e-Education Promoted

The Securities Academy & Faculty of e-Education

Promoted by

Missions Seven Charitable Trust

(Education is not a business)





Financial advisors

Weigh impact on investors

Are you getting the right advice? Are you getting any advice at all? You wish your account to earn as much as possible as quickly as possible, but at the same time you can’t afford to take risks. The inherent conflict between these two investing goals is pretty hard to handle on your own. Its one reason more investors are hiring outside advisers to help them manage their funds.

The financial advisors offer much more customised attention than the interactive web sites, 24-hour help lines, and even third-party consultants such as Financial Engines and Morningstar. Still, you should be willing to learn about the investment choices available. To gain the returns you need and keep risk low, you want to be spread out among 12 or 13 asset classes. Smart asset allocation and consistent rebalancing are the main investing strategies that can make your dream a reality.

Advice is the only commodity in the market where, it is said, the supply always exceeds the demand.

2. Wealth managers

Map out details to translate into benefits

Wealth managers spot winners early. They don’t believe in wasting time and energy in the daily frenzy of stock markets but grow wealth by spending qualitative time in seeking out future stars. They look out for unexploited opportunities in sunrise industries, the virtue of patience comes naturally to them and they don’t fear giving a miss to frontliners. They welcome to the world of emerging stocks where valuations may kiss the sky once they come into their own. They have insight how to identify them, create an ideal portfolio allocation and returns you can expect.

3. Financial planners

Value unlocking for investors

In order to identify emerging stocks, financial planners understand the macro-factors that could work in favour of the company and its standing within the sector. They also intensively review parameters such as the management‘s track records, quality and qualification, its ability to walk through challenging situations and build operating efficiencies within reasonable time frames. Valuation would then dictate the overall investment picture and returns that could be had over a reasonable time frame.

Let’s understand this in detail. For instance, Unitech and Educomp Solutions were trading at low valuations when listed, but both were parts of budding industries – real estate and education – in India. In the time that followed, both the industries boomed and had a dream run on the bourses. As an investor, if you had picked up these stocks three and two years back, respectively, you would have made more than 2500% and 450% annualised returns.

4. Risk management consultants


Educate, engineer and enforce

It is emerging sectors that give rise to emerging stocks and there are many examples in India that would fit into the definition of an emerging sector.

Risk management consultants recognise aviation, gas distribution, insurance, retail and media as the industries of the future where the markets are under-penetrated. There exists a huge potential as the products/services offered by many companies in these sectors are yet to be utilised by a majority of the population, thus ensuring the players of a long and sustained growth story. The risk-consultants try and understand the challenges in store and the risk of failure that are existent.

5. Inclusive CEOs

Innovative responses to problems

Inclusive CEOs hold the view that in the initial few years, successful companies grow at scorching growth rates and their valuations tend to challenge every conventional manner that is considered while valuing companies. But since they tread in uncharted territories, these stocks are also high risk in nature.

There are ample examples in history where patience has given exponential returns to investors in select stocks. However, one also has to be ready for those misses in one’s portfolio. Nonetheless, if held for over longer periods of time, considering the high-risk nature of investing in emerging stocks, the returns also may be higher than those earned from routine stock market investing.

6. Tech savvy professionals

Take first step to ensure efficient and reliable system

Tech savvy professionals recommend that you could look to allocate 15-70% of your portfolio to emerging stocks. However, your risk appetite is of great significance here and accordingly the allotment could vary. You can expect a return of 25% to 35% with a time horizon of two to three years in these stocks. However, it is important that you should be continuously abreast about the developments of companies as well as changing macro parameters.

Tech savvy professionals recommend healthcare space, more specifically contract research companies, companies in the renewable energy sector (water, solar, bio fuels), shipping (offshore and dredging companies), NBFCs catering to housing and infrastructure and oil and exploration service providers are good buys in this space.

There is, however, a word of caution for investors who are looking to make quick returns from these stocks. Emerging stories typically take years and the return on investment from these, therefore, is earned only over a period of time, which could sometimes even take 7-10 years. This is primarily because the companies in these sectors are either in high investment mode – the fruits of which are borne in years to come – warranting a long term investment period.

7. Credit counselors


Resolve convertibility and recompensation issue

Myths are created like every other myth

Credit counselor pointed out that the financial markets have turned out to be a modern-day factory for the manufacture of myths. In the stock markets, myths are created like every other myth – real events that gat overblown and are gilded with symbolism over time. Then, there are some other myths that are created to keep a section of society happy.

The small investor is one such myth. It is the product of some fertile imagination harnessed to keep society lulled in the belief that there is great concern for the small investor, or the retail investor. Every statement, every directive, every measure is made to read like it’s been designed exclusively for the retail buy. Nothing could be further from the truth.

The unpleasant truth is: the system abhors smallness. Take the example of mutual funds. Despite the lip service that most funds pay to retail investors, the structure is actually loaded against the retail investor till recently, with over 60% of subscriptions still coming from corporates.

Typically, the small investor had to pay a cost, called entry load, to invest in mutual funds, but it’s free for investments over Rs 5 crore. Therefore, it is only natural that the big investors dominate the mutual fund industry. And they churn the portfolio very frequently as part of their treasury management.

8. Microfinance professionals

Developing alternative credit delivery models

Moneylenders in rural India

RBI has proposed a solution that no country has ever tried; the idea is to get all village moneylenders to register themselves with state governments and give cheaper loans to rural households.

While some will criticise this as a move to institutionalise moneylenders, the intention is possibly to bring the faceless, exploitative moneylenders under the purview of financial regulation through a sustainable business model.

Moneylenders cannot be banished even if you want to. So why not regulate them? Banks can also treat such loans as priority sector lending. Besides, no bank can reach where the moneylender can.

Over 27% of the loans taken by rural households are from moneylenders; the figure has gone up from 19% since ’91. The interest that farmers pay varies from 24% to an unbelievable 1000%. The state government will fix a cap on the loan interest rate charged by registered moneylenders.

9. Continuing learning centres


Take informed decisions

Crash course in business etiquette

Welcome to the global business arena devoid of geographical barriers, with boardroom negotiations, transporting the Indian corporate to far-flung corners of the globe in search of that multi-million dollar contract or deal. CEOs now doing their homework not just on the turnover and assets of their competitors abroad but also take a crash course on the unique aspects of foreign culture, because even a killer proposal will not save the day if cultural sensibilities are overlooked.

Every country has a unique culture that plays a pivotal role in the negotiations process, which cannot be ignored if you want to succeed. For instance, broaching the topic of business too quickly in Japan is considered rude whilst in America, if the cards were not laid on the table, immediately would put them off. Japanese are absolute killers in their negotiation skills. The finesse and class with which they go about it are worth noting down and emulating. Don’t expect stormy discussions or face-to-face confrontation, no one ever raises his voice even in the tense situation

In contrast, Indian corporates doing business with the Russians must be prepared for stormy walk outs ant outbursts which are part and parcel of the game. Russians, like Indians, are extremely warm and hospitable. Therefore, a lot of similarities exist between the two cultures, which make conducting business in this icy land seem quite familiar. To a certain extent, the Russian is very impressionable and would rather conduct business with a person who understands his culture and tradition. Similarly, whether you wish to do business in France or Finland, certain lessons are universal. Be polite. Eat what you’re served, if not in great quantities, at least with enthusiasm. And treat people with patience and empathy.

10. One-stop-shops

Dedicated to offer related services under a roof

Sebi Institute for securities market education and research

The National Institute of Securities Markets (NISM) aimed at encouraging securities market education and research is being modeled on the lines of an IIM. The institute aims at ushering in a new era in financial education for thousands of investors and stock market professionals in India. Sebi chairman M Damodaran said that the institute would work at educating investors. It would hire 60% of the staff from India and tying up with some specialised persons from the US and United Kingdom. The institute would have different academic programme, including Ph D on capital market. Sebi is employing all its resources in content development and getting in new professionals for its teaching activities.

As a first step in the process of sowing the seeds of financial literacy in the country, the institute is planning to introduce basic financial education courses among secondary and higher secondary students in schools. The institute is in final stage of introducing financial literacy courses for around 1 lakh higher secondary students as a pilot project in 250 schools around New Bombay, Delhi and Southern India. The course would involve basic concepts about banking and savings. However introducing courses on investment will take sometime and will likely be at senior college level. The institute recently took control of management of the Indian Institute of Capital Markets (IICM), New Bombay. IICM will work in the areas of executive education – while NISM will focus on investor education, market research and increasing standards of corporate governance in Indian stock markets.

11. Global outlook


World is a village

Indian SWF

21 st century capitalism is witnessing sovereign funds run by state agencies, investing in various asset classes across the developed and developing world. Economies like Abu Dhabi, China, South Korea and Singapore have created SWF running into trillions of dollars to enhance the returns on their ever-bulging forex reserves. This has prompted India, with its forex reserves crossing $ 300-billion mark.

The pressure on India will increase if the rate at which reserves are growing – over $ 100 billion in 2007- 08 – continues over the next few years. The RBI will then be forced to curtail its losses arising from its current investment pattern – it gets a very low yield by investing the its reserves in US treasury bills but has to pay a much higher interest rate on domestic bonds released into the market to suck excess liquidity.

SWF is a bit like putting a small portion of one’s savings in a full-fledged growth mutual fund. This option may look tempting but there are some risks. Dr Reddy has pointed out that the SWFs of, say, China and Abu Dhabi are built entirely from massive current account surpluses they earn annually from exports. India has a current account deficit and large portions of its reserves are constituted by liabilities on the capital account. Dollars accumulated on account of net FII investment, external debts, etc., are returnable. So India has to be more cautious. But the idea may be worth exploring.

Sovereign wealth funds have their uses

The RBI had long opposed any dilution in its control over the country’s forex reserves, fearing, quite rightly, that risks may not be commensurate with the rewards. Also because our serves buildup comes from capital flows, rather than current account surpluses in the country’s balance of payments, making them more vulnerable to sudden shifts in global sentiments.

RBI now inclined to support setting up a $ 5 billion sovereign wealth fund. There are two possible explanations for the apparent shift in the RBI’s position. One, forex reserves are now over $ 300 billion and with the return on US Treasury bills falling steadily, the RBI is, perhaps, more willing to look at alternative avenues of investment to improve earnings from forex reserves. More so when rising domestic interest rates widens the gap between the interest paid on monetary stabilization scheme (MSS) bonds and earnings on forex assets.

The IMF estimates that SWFs will rise from $ 2-3 trillion today to about $ 6-10 trillion within five years, with China, Kuwait, Norway, Russia, Saudi Arabia, Singapore, and the United Arab Emirates becoming sizeable players. Clearly, India cannot be left out of the race. Especially since SWFs can be deployed to protect and project the country’s strategic interests – China, for instance, has successfully used its SWFs to improve the country’s access to natural resources such as minerals and oil by picking up stakes in companies in Africa. Indeed, it is this aspect of SWFs that has been a source of discomfiture of recipient countries; so much so that the International Monetary Fund (IMF) is presently formulating a code of best practices for SWFs. With India and China keenly competing for the same resources it is only fitting that we take care of our interest, if necessary by setting up a SWF of our own.

12. Issue of the present


Freedom to get & fail in the system of free enterprise

Need of Journals of finance (JoF)

The knowledge spillovers of journals should not to be underestimated. The dynamism of finance and capital markets in the US is due to the rigour and depth of finance journals. The modern portfolio theory of asset management and the key theorems in corporate finance were all outlined first in finance journals in the last few decades.

Finance is certainly one of the great success stories of quantitative economics. Till recently, finance theory was not much more than a collection of baseless premises, thumb rules and manipulations of accounting data. It was following the regular publication of the Journal of Finance that rigorous economic theories were developed for the financial markets.

Note that the 1952 paper ‘Portfolio Selection’ published in the JoF first formalised the notion that risk and the return in fact linked together through a trade-off. And today, much of the modern practice of finance can be traced back to that 14-page paper that set the ball rolling, as it were. By 1990, the risk versus returns trade-off idea and the capital asset pricing model (CAP-M) had come to be so internalised in finance circles that its profounder was – albeit belatedly – awarded the Nobel.

Since the seventies, two other high-impact finance journals have come to be published in the US, the Journal of Financial Economics and the Review of Financial Studies. It is a fact that there has been much financial innovation subsequently, notably in new security design, in derivatives and in risk management generally. Also, 1992 paper, the ‘Cross-Section of Expected Stock Returns,’ in the JoF showed, valuation indicators and business size were actually more closely related to stock returns.

It is thanks to top-notch research outlets such as the JoF that the practice of finance has much benefited in terms of knowledge and insight. Finance of course is now global, with the equity and debt markets the world over much influenced by capital flows. But researchers in Indian academe are not frequently cited in the trio of top finance journals. They would continue to have little or no impact in theory or practice. In the old days the lack of influence would have been quite understandable given our thoroughly under- developed financial markets. But as our capital markets acquire depth and breadth, researchers here surely need to access and target the new, high-impact journals for proper impact.




Access, affordability, adoption and applications (4-As)

At a recent workshop on financial inclusion were arrayed across the table an anthropologist, two economists, a member of the policy think-tank, representatives of a philanthropic agency and a few consultants. This disparate group was brought together to create a practical roadmap to usher the estimated four billion unbanked individuals across the world into the realm of formal financial services.

The viewpoints were varied. The debate was intense. Right through the discussion we were hounded by the disconcerting feeling that while each of us was correct, none of us was right. There was an elephant in the room, and we were the blind men trying to make sense of the whole through our grasp of the parts. We weren’t making much headway. Until we experienced an epiphany when somebody strode up to the white-board and put down four large A’s – for access, affordability, adoption and application.

Across emerging markets over a billion consumers are waiting to be ushered into formal markets, eager to forsake the sub-standard products and usurious rates they are forced to contend with in informal channels. These consumers, we refer to them as the nest billion, are currently excluded not because they lack purchasing power. In aggregate they are already spending almost a trillion dollars each year, and over a third of it is on non-essentials. Yet commercial enterprises and governments is far not devised ways to reach and serve them profitably.

Economic inclusion is a matter of importance to both nations and companies. Successful forays must address all four As. While much of the public debate, policy thrust and business innovation has centered on providing access and enhancing affordability, spurring adoption and informing application have received short shrift.

Access and affordability:

There is an inherent compromise between access and affordability. The extensive distribution network required to reach the next billion consumers in smaller towns and villages imposes a high cost and renders them unprofitable. To break this compromise, companies must build scale and embrace new technologies.

Where individual companies find it hard to justify the investment, collaborative approaches hold the key. Centralisation of back office operations within a bank could pave the way for a shared back office utility across banks. Telecom operators discovered they had an attractive business case in rural India once they were required to share common passive infrastructure. Partnerships between banks and microfinance institutions help aggregate demand and mitigate risk.

Rapid advancement in technology are creating new opportunities to surmount the barriers to access whilst simultaneously boosted affordability. Mobile phones are already more prevalent among the next billion than bank accounts. And they are growing more rapidly. Mobile technologies allow banks to offer very small sizes of payments, remittances, savings and loans at an affordable transaction cost. Smart card models build on the same advantages. Taken together, the effect of scale and the advent of new technologies promise to dramatically reduce the cost to serve the next billion consumers.


There is a mistaken belief, however, that once access and affordability is taken; care of adoption automatically follows. In fact, it often doesn’t. Access and affordability at best alleviate supply constraints. They do little to spur demand. For that we need to specifically address adoption and application.

Adoption and application:

Financial services, telecommunications and healthcare have large multiplier effects on economic activity and human capital. It is estimated, for example, that a 10% increase in teledensity in a developing country lifts GDP growth by as much as 0.6%. While the macro-economic evidence is compelling, it is the micro- economic impact on individual livelihoods that really matters to consumers. Unfortunately consumers don’t experience these benefits until they actually adopt the product and put it to the right application. Therein lies the challenge.

Aadmi phone lata hai tarakki karne ke liya (a man buys a mobile phone to progress in life) was the clarion call. Indeed the promise, in one of the advertisements by a mobile operator a few years ago when it launched a new tariff plan targeted at the next rung of consumers. Delivering against this promise requires carefully constructed products that deliver tangible near-term benefits. Farmers are seeking real- time advice from agricultural scientist by sending photographs of their crop taken on their mobile phone through MMS. We have all read the stories of fishermen in Kerala using mobile phones to gather pricing information from nearby markets. A recent study by a Harvard economist found that variation in fish prices in Kerala fell from 70% to 15%, and the spoilage of daily catch fell from around 5% to almost zero after widespread adoption of mobile phones. Fishermen’s profit rose by 8% even as the consumer price fell by 4%.

To induce customers to adopt these products, marketing programmes must be equal parts education and sales. After all, these are first-time consumers. Unlike more affluent consumers who learn about the benefits and right application of the products through experience, the next billion have no margin for error. One bad experience or an unfulfilled promise will turn them away. Banks have realised that merely providing access to credit at low interest rates is not enough. Customers need to be counseled on how to use and service the credit; on the distinction between consumption loans and productive loans. Microfinance institutions create small groups of customers that get together for weekly meetings where new information is imparted and experiences shared.

Government can, and must, play a role in educating new customers. Expecting market forces to fill this gap of the missing ‘4 - As’ has proven to be costly and laborious. Regulators often limit themselves to ensuring access, holding short of playing a role in channeling how these products might be used to maximise benefits. Those that take the extra step will meet with grater success.

In most card games, ‘four-As’ is a winning hand. Winning the next billion consumers demands no less.



Back to school


survey of 2,000 respondents across 106 districts by Invest India Economic Foundation a Delhi-based

think tank – revealed some startling findings:

Less than a third of the respondents viewed central government bonds as a risk-free form of investment.

Majority of the respondents felt investments in equity shares were safer than those in corporate bonds or company deposits.

These findings of low level of financial literacy is a bit surprising considering that a large part of household savings have been finding their way into financial instruments over the last couple of years.

Against this background, a recent CII report has suggested that awareness about stock markets be included as a part of the school curriculum. Experts discussed point on length and highlighted the need for greater awareness, investor education and financial literacy. “Catch them young” should be the approach”. Introduction of basic financial courses at school level should certainly be considered.


such courses become reality, India certainly would not be the first country to do so. In developing

countries like UK and Australia, financial literacy is a part of the school curriculum itself. In some countries such as New Zealand financial education is voluntary, and has to complete with other extra-

curricular options in school.

Can India follow the global practice of inculcating financial literacy as part of the school curriculum?

Experts say that it’s a difficult proposition when spread of basic awareness among adults is also very slow. Moreover, there are wide disparities in the education system at the primary and secondary education level. At school level, even today students are educated about savings through piggy bank concept. So introducing financial literacy on stock markets at a very young age could be a far-fetched concept. It is more viable to introduce financial literacy module at college level. As the concept gains ground, it could


moved to initial years of education in a phased manner.

However, the urgent need for financial literacy cannot be disputed. Today an individual starts working from the age of 22. At this stage an individual sees a shift in his money flow from mere Rs 500 of the pocket money to a standard income of Rs 15,000 – 20,000. So typically he looks to save and multiply his money at this stage. It’s the proper time to take a financial literacy course.


Back to school



1. Basic tips

You are new to stock markets and want to be part of it. But how do you get started? Here are few simple basic tips to help you make the first move in stock market.

1. A paperless world

We are moving to a paperless world. Many broking firms will chase you if they come to know you are a prospective customer. And even you can place your order yourself by logging in from your home. You may need a financial advisor to help at every stage.

2. Start investing early

As a general rule, the shorter your time horizon, the more careful you should be. If you start investing early, you give more time for your money to grow, get more time to cover up for losses, if any, and also let the power of compounding work for far-away horizon.

3. Determine your aim of investing

It is exploring a way to have an extra source of earning for financial security, earning more to improve your lifestyle, just parking your excess money, planning to retire early or is it for financial stability post- retirement? Whatever is it? Knowing and defining this helps to determine how much risk you are capable of taking. Once you know your category, it becomes clear where to put a ‘stop loss’ and when to sell your stock to lock in profit.

4. Determine your risk profile

This is the building block for making a sound investment decision. Your investments should match your risk profile, which depends on your age, personal liabilities, investible surplus and stage in life. We all have heard of the maxim ‘more risk, more gain’. Equities are certainly riskier, keeping in mind the volatile nature of markets, the gains certainly match the risk.

5. Invest with knowledge

Remember that there’s no such thing as ‘one formula fits all’. No two stocks are the same and therefore, your strategy will vary, at least to some extent, for different stocks. Still there’s an element of uncertainty. While understanding of stock does help in playing the game safe and having the fundamentals right, it’s no guarantee that there will be no downside. No one can predict what cues will emerge in days to come, what news, in general, will have a bearing on the stock market and do what extent and what direction the global markets will take the affect our stocks. Hence, one should be prepared for volatile times.

6. Stock picking: whether value stock or growth stock

Both are quite popular stock picking used by fund managers as well as retail investors. A value investor ‘values’ stocks trading lower than its actual worth but strong fundamentals with the idea that the stock will bounce back by virtue of its intrinsic worth.


On the other hand, a growth investor is not concerned with the current trading price but banks on the future growth potential. For this, investors are ready to pay a premium, which leads to its high price-to- earnings ratios of such stocks. In an ideal situation, one must have a blend of both to minimise risk, as different economic cycles tend to favour a particular type of stock at time.

7. Event risks always remain

Like life, the equity stock market will always remain a mystery. The markets always present opportunities albeit attendant risks at every stage. Currently corporate earnings, price earning ratios and liquidity (interest rates and inflation) drive the market. Corporate profits have grown and there are enough indications that there won’t be negative surprises in earnings growth. P/E ratios are not cheap, but definitely not too high. The Indian market has seen P/E of 40 to 60 during 1992-93. P/Es of tech companies had crossed 100 during 2000-01. Coming to the liquidity angle, currently both interest rates and inflation are benign. However, event risks always remain.

8. What about that ‘hot tip’

You just got an expert advice from a friend who has been investing in stocks for years and now you too want to put it to test before the ‘opportunity’ slips out of your hand. But wait a minute. Did you do the fundamental checks yourself? Once you start investing and take interest in the stock market, it becomes part of your daily discussion, just like we discuss politics, climate and the news of interest. One must be vary of investing on these hot tips. Stock investing is serious business, unlike the notion that it runs on tips from your friends, relatives or colleagues.

9. Set a stop loss

Although this may be the last thing in this piece and also in people’s mind, setting a ‘stop loss’ for your stocks is crucial for consistent returns and minimising risk. A ‘stop loss’ is set to sell a stock when it reaches a certain price level. This is done to limit your losses. In other words, setting a stop-loss order for 10% below the price you paid for the stock would limit your loss to 10%. It also helps to use a ‘stop order’ before you leave for vocation or are in a situation in which you will be unable to monitor your stocks for a period of time.

10. Track your stocks regularly

As far as tracking stocks is concerned, apart from conventional means of stock pages, newspapers and business channel, a very handy way is to create a portfolio tracker on your own on the Internet. Here, all you need to do is to register at the website and enter the details of your investments. This gives you the facility to update details of your stocks giving you exact figures of profit/losses incurred on your investment and researching your stocks.

11. Stick to your target

This is a key to successful stock market investing. Booking profit when your investments reach your target is crucial to convert deemed profit on paper to actual profit in hand – just like hitting the iron when it is hot. Old saying teach us a lot, doesn’t it?


2. That’s myth


Index stocks are best stock

Most indices are collection of stocks with highest market cap. Take for e.g. Sensex. Companies comprising Sensex are some of the largest and highly traded stocks in the country. This is a myth that index stocks are the best stocks. If this were true, most investors would safely park their money here to book maximum profit without looking out for other stocks. The risk is certainly less in index stocks as they are well researched and leaders in their sector, but again margins may not be very high. On the other hand, investor in companies with evolving business models may give you better returns over the same period. So it’s better to keep eyes open to other stocks too. Who knows, you might be investing in the index stock of tomorrow!


Mid-caps offer more than large caps

The mid-caps, by definition, are able to show faster growth rate because of the base effect. They are not necessarily well researched and there are gems to be found. This, definitely, can yield more than proportionate rewards, compared to large-caps. However, by the same token, risks are also proportionately higher. Market volatility has a snowball effect on the mid and small-cap stocks – the scrips that rise like trajectories also plummet with the same speed at the slightest hint of an adverse environment. A prudent investor will balance the portfolio with a judicious mix of the large and mid-cap stocks, governed by individual risk appetite.


Stocks trading below their book value are cheap

Book value is the actual worth of a stock as in a company’s book (read balance sheet). It often bears little resemblance to the current share price. Shares of industries that are capital intensive have higher book value and vice versa. Also, in companies with large intangible assets, book value doesn’t tell you much about the price. So keeping in mind that the effect of book value varies across industries and businesses, it can’t be the sole criteria to value stock. In stock markets it’s very difficult to generalise things, as everything is stock specific. The same is true even for book value.


Stocks with low P/Es are cheap

Investors usually think price to earning ratio of a stock as a single reflection of how cheaper or expensive a stock is because of simplicity of the strategy. P/E alone doesn’t tell much about the pricing of a stock and should be seen with other fundamentals like the risk factor involved, company’s performance and growth potential. The idea behind dividing price to earning is to create a level playing field where some kind of comparison can be made between high and low-priced stocks. Since, P/E ratios vary across sectors, with growth stocks consistently trading at higher P/E, one can only compare the P/E ratio of a stock to the average P/E ratio of the stocks in that sector to make a judgment.


Penny stocks make good fortunes

Penny stocks by nature are low-priced, speculative and risky because of their limited liquidity, following and disclosure. If it were easy to invest in penny stocks – as here you shell out much less money per share than you would require for a blue-chip firm. Chances are you make a high fortune from these, but you should also be prepared to lose all the money parked in.


Just because they come cheap, you can’t pick penny stocks. As they have high volatility and risk factor. It’s a wrong notion that penny stocks make good investment. This is the biggest myth in the stock markets in India. In fact, investing in penny stocks is a very high-risk strategy.

History has shown that most investors would have only lost money by investing in penny stocks. Investment in equity market is an art and a science and it is not as easy as it may seem to make money in this market. And it is least by way of investing in penny stocks.


The worst is over or market has peaked

Timing the market is a common strategy among investors. However, there is no ideal way of smart investing by which one can time the market. Timing the market means forecasting and that that should better be left for tarot readers. One should concentrate on timing the stock than timing the market. If you have done your valuation studies, you shouldn’t worry about the timing of market. In June-end 2004, who knew that Sensex, that was trading at 4,800-level, would cross 14,000-mark in December 2006?


Diversification is the key to investment

Well, diversification does help, but in falling markets, most often than not, almost all stocks will take a hit. Diversification is a virtue but if it’s done only for the sake of it, and then it may become a vice. In fact, if you are not sure, it’s still better to focus on a few companies in which you are comfortable irrespective of what sector they belong to. You can do this by taking into account the fundamentals, past performance and future outlook of the company as well as its sector. It is easier to study and keep a track on them. Diversification helps only when it is done without compromising on the attractiveness of the stock being selected. Also, diversification does not ensure return on your investment.


Volatility is the culprit

Investors unfortunately focus too much on the index movements as a whole and index movements also impact their sentiment. Investments should not be made on the scrip’s share price movements. To try and predict the price movements on a daily basis and time their entry-exit transactions is almost equivalent of trying to win a lottery everyday. Corrections are inevitable. There is nothing like a straight-line upward graph. What is important is to view the corrections as opportunities to consolidate positions in the market. There are always some excellent opportunities in a volatile market. How can one possibly make profit in a stable market? What is needed is the understanding of the situation. Down- trending markets shift money rapidly to new sectors, which may be tomorrow’s big thing.


Financial markets are efficient

The theory claims: the financial markets are efficient. And it’s not possible to outperform the market. However, this is not always true. Most mutual funds constantly aim to beat the benchmark index, and are able to do so. In fact, many individual investors too outperform the market.


3. Exit plan

People love to buy, hate to be sold. Indeed, selling is an art. That’s because you not may exactly remember why you sold a particular stock at any point of time. Probably, it could be experience, gut feeling or simply a better understanding of the dynamics of the stock market, which helped you plan your exit. Here’re seven reasons that help you bid adieu to a stock in your portfolio.

Consistent under-performance If the company has reported poor results in the previous two-three quarters and the stock price not shown any upward trend, analysts recommend you should exit a stock. Analysts cite a case study of the mid-cap stocks in the recent stock market fall during the first quarter of 2008. They faired badly and were not able to perform even in the pull back rallies.

Over valuation You should closely look valuation while selling a stock. Many a time, it happens that valuation is on higher side of the range, which is not supported by visibility of earnings and ownership. Analysts cite example of small realty players, which they feel, are over valued and find it difficult to execute bigger projects as they may fail to raise working capital.

Rising input cost Analysts say you should closely monitor raw material costs of the companies in which you have shares. For example, in case of auto and capital goods sector, the prices of major raw materials such as metal and alloys have gone up but the prices of finished products can’t be increased in the same proportion because of intense competition in the sector. This is the main culprit behind the recent fall in the stock prices of auto sector and capital goods companies.

Costly acquisition Any value destructive acquisition, according to analysts can lead to a three-four quarter effect on the stock price of a company. Thus, you should look to exit the stock for time being. Tata Motors stock is classic example. Since March 26, 2008, the day when Tata Motors signed an agreement to buy brands – Land Rover and Jaguar – the stock has lost more than one-fourth of its value on the bourses.

Global market conditions Analysts say you should also keep a check on the global cues, especially, if the company shares have a majority of the sales overseas or its performance is linked to smooth functioning of operations in a foreign country. A case in point is IT companies, which were exposed to US operations, and were substantially left high and dry on Dalal Street. Auto majors involved in exports too suffered.

Passive management Keeping a close eye on the management practices may provide you the cue for a planned exit. Analyst feel that sometimes it so happens that the management turns selfish and is involved in unfair practices such as regular insider trading and exorbitant compensations. You must always review the depth in the management from time to time.

Financial Model Analysts point out that you should evaluate the financial model of a company on a quarterly basis. It will serve not only as a guide to the current performance of the company, but also what its future goals are and how is it working towards it. You must assess the fundamentals of a company to set yourself new targets and re-adjust the asset allocation from time to time.


4. Best or worst time

Often one hears people say – I should have invested when the markets were in the 15,000 levels or I should have sold out when the market was at its peak at 21,000. The fact is that you get to know the best or worst times only in hindsight. Let us ask a simple question: How many people that you know successfully timed the Sensex at the beginning of a bull run or escaped a bear hug?

Investors tend to move in crowds that by nature are driven by herd instincts and a desire for instant wealth. It is difficult tom predict the direction of the market and one can be lucky once in a while, not always.

Investing in stocks with an open mind will always yield good results. Timing the markets limits investing opportunities. People who try to time the market always think it could be the wrong time and hence tend to invest less. At the recent 15,000 levels they thought the index has not bottomed out and did not invest and at 17,000 levels are hopeful that the markets will head back to 15,000 levels from them to enter.

Don’t dabble with timing if trading and investing is not ones full-time job. A fundamental principle of investing is to ascertain an apt asset allocation that divides portfolio among major asset categories such as bonds, stocks or cash, usually to balance risk and create diversification. This allocation should be done keeping in mind various factors such as risk, profile, return expectation, investment horizon, financial goals etc. and staying steadfast to the same through changing markets.

The probability of attaining financial goals is much higher through asset allocation, rather than much by trying to juggle around with investments and time market cycles. Try following an easy thumb-rule for investing – allocate your investible surplus between debt and equity as per your age. 100 minus age should be allocated to equity and the rest to debt. For example, a 35-year-old man can allocate 65% of corpus in equity and 35% into safer return instruments. One needs to periodically monitor the investment and as exposure to a particular asset class increases, rejig the portfolio to the prescribed level. The mantra to wealth creation in a stock market is to:

Start early and save regularly, Invest in a systematic manner – the intention is to capitalise on the volatility in equity markets by lowering the average purchase cost and is one of the best tools to inculcate discipline in investing, Investing in good quality companies – ones with visionary management, leadership in their industries, stock cash generation capabilities and strong balance sheets, Have patience and stay away from market rumours and hot tips, Review your portfolio periodically and make course corrections whenever there is a significant change in your situation or the market realities.

However, as markets go through their cycles and as we go ahead in life, we tend to overlook the basics, getting carried away by the moment – be it on account of a windfall gain, a hot investment tip or sharp movement in the markets, ending up taking a bad decision. Investors should take a decision on buying into or selling out keeping in mind their long-term financial goals rather than based on short-term market movements. That holds the key to success.

The Indian stock market is rightly meant for long-term investors. With the long-term India growth story looking very positive and upbeat, there is immense sunshine left for investors to earn profits from hereon. Keep emotions out while investing and remember that you can always generate good returns over a long- term. Investing is like a marathon race, not a 100 m dash!


5. Range-bound market

A range-bound market is always on the move, but going nowhere! The ‘buy and hold’ will just eat away returns and may not even deliver return equal to say a fixed deposit. Therefore, it is frustrating for a long- term investor since it eats into real returns. It is also frustrating for an arbitrageur since volumes generally drift lower and the bid offer of price makes it difficult to make money. Then, there are day traders, who still have work to do since their horizon is short.

However, sideways movements generally are preceded and succeeded by large bouts of volatility, which invariably take a toll on some large leveraged players. This leads to some active players withdrawing from the market leading to further liquidity squeeze. However, all is not lost!

Let we attempt to outline the investment strategies in a range-bound market for a normal average investor, a large savvy investor, day traders and introduce a new breed called ‘swing traders’.

The first dimension is the psychological one and here are some ground rules in this market. Firstly, in a range bound market, buying any stock, going on a holiday and coming back to see your stock double or triple is not going to happen. Secondly, a good money management will help accumulate more returns systematically than anything else. Thirdly, for investors – who do not have current investment and have no compulsion to jump in without homework – the markets are not running away anywhere. Lastly, investors, who are already invested, doing nothing and just hopping will not stand to gain either.

For the normal average investors, who are infrequent, it is best to watch stocks which are fundamentally good in Sensex or Nifty. Then watch the movement and buy near the 52-week low, wait for exit at say 10% profit or even lower if it starts turning. One needs to book the losses if they start extending to say 5% below 52-week low. One has to be patient and buy only when there are signs of stability at the lows but must never take eye off the scrip. A ‘buy and hold’ strategy is not recommended.

To reiterate, good money management is critical in these times. For large savvy investors, usage of options can come handier. To give you an example, let’s say an investor is holding a large concentrated holding. A good way to generate yields is to sell out of money calls. You can pick up close to 1.5% return for a month and if that price is a hit, you get out at profits plus the premium and re-enter when the stock drifts down again.

Due to low liquidity and momentum, however, it become hard for jobbers (who buy and sell for a small movement) to make large money. It is better that they continue to stick with the large liquidity stocks. The velocity of trades does come down. It is important to guard against compulsively putting trades on account of habit.

We emphasise that it is critical to review the portfolio in which one is already invested. The way to repair a portfolio is either through use of derivatives (if one understands the risks of the same) or simply a sector rotation. Then move into large cap defensive and play the swing game. The trick is to pick up every available opportunity to add returns bit by bit.

The key is awareness that there are times to go on the offensive and then be defensive at other time. In range-bound markets, it’s time to be defensive, look at the risk levels you are running at an overall portfolio level across the full savings and make every penny work. Small returns will add up to a tidy sum.



Learn from crisis

Each new financial crisis is an opportunity to shift myth from reality. Provided we do that and learn the right lessons. During the East-Asian crisis, it was our lack of openness that saved us; this time it is because our banking system, which is less, integrated with the global financial system. But in a global world, isolation is not an answer. Take a quick recap of what led to the subprime crisis. On paper, a brilliant piece of financial engineering – securitisation – in reality, a failure to realise its limits. The method is simple. Bundle a number of loans together, issue securities against them and sell them to investors. This has two consequences –

The first consequence is that it frees bank funds for more lending and. Also, it takes risk off banks’ balance sheets; it leaves them with very little incentive to do the kind of careful pre-sanction appraisal/post-sanction follow up of loans that was customary in the past. The result is the loans to borrowers to whom banks might not have lent in the past. The second consequence is that the risk for each investor becomes much less as it spreads risk among a much large group. This encourages them to take on more and more risk. It is not that people were unaware of the risk. But it had been going for so long without any problem that many joined in. Given the nature of markets, it is only a question of time before they recover. But if we do not want to see a repeat of the mayhem witnessed, we need to separate myth from reality and arrive at a few key takeaways. So what are these?

Dispersal of risk insures against financial meltdown In reality spreading risk more widely does not eliminate it altogether. The risk may often be taken by entities least able to comprehend it or bear the loss when things go wrong. And when risk is dispersed globally it becomes more difficult to assess the extent of loss.

Rating agencies do not need to be regulated Rating agencies should be well regulated. In the instant case, flawed ratings to subprime mortgages encouraged a huge superstructure of derivatives to be built on shaky foundations.

Qualified Institution Buyers and investment banks know better The buyers and even sophisticated investors often do not know better. For instance, when two Bear Stearns hedge funds went down, the funds were unable to determine the extent of loss.

Mathematical tools can come up with the perfect hedge Complex mathematical models can supplement other tools when it comes to assessing credit risk, but cannot replace them. As far as banks are concerned, there is no substitute for the old-fashioned technique of doing a proper due diligence of the ultimate borrower.

Central banks can and must avoid moral hazard The moral hazard is the risk that coming to the rescue of banks in trouble. It encourages more risk-taking in future. Banks are at the centre of the payment system of a modern economy. Infusion of liquidity will keep the music playing for some time. But eventually the band will tire out and flop down.

Central banks with their overly loose monetary policy are responsible for derivative crisis In reality loose monetary policy certainly played a part, but financial players are not without blame. Just as the availability of an alcohol does not turn everyone into an alcoholic, the availability of cheap money is no excuse for throwing prudence out of the window.


Learn from crises



1. India: the bird of gold

IMF has revised upward its growth forecast for India saying that the domestic economy will grow faster than what was envisaged in April. IMF has revised upwards, India’s growth projection for 2007 by 60 basis points from 8.4% made in April’07 to 9%.

Emerging market countries will expand robustly With India, China and Russia expected to turn out better-than-expected growth. Emerging market countries have continued to expand robustly, led by rapid growth in China, India and Russia. We continue to see improved fundamentals in emerging market countries and positive developments in their local capital markets, although financial vulnerabilities persist in some countries.

Global economy expected to grow by 5.2% – IMF has also revised upward its global growth forecast despite a lowering of growth estimates for the US. Global economy is expected to grow by 5.2% as against an earlier projection of 4.9%. Growth projection for Japan and the euro area, particularly Japan has been revised upwards on the revival of domestic demand in these economies.

US economy growth revised downwards – But growth projection for US has been revised downwards. The clearest area in which risks have risen is credit risk, where the weakening of credit discipline has resulted in rising difficulties in the US sub-prime market and leveraged loan market. Delinquencies, defaults, and foreclosures have continued to rise.

Inflation remains generally well contained – Globally, inflation remains generally well contained despite strong global growth, although some emerging market and developing countries faced rising inflation pressures, especially from energy and food prices. Oil prices have risen back toward record highs against the backdrop of limited spare production capacity, while food prices have been boosted by supply shortages and increased use of biofuels.

New engines of world economic growth – China and India are the new engines of world economic growth, replacing the United States and other developed countries, IMF MD Rodrigo Rato said. He said China overtook the United States this year to become the biggest contributor to the world economic growth. Looking ahead, we expect this pattern of growth to continue… we expect China – and increasingly India – to grow in importance as engines of global growth. Prospects in Europe and Japan remain good. The outlook of the global economy is generally good and the economic prospects of most countries in emerging Asia are also good.

Oil market and capital flows will be the major concern – While the global economy had easily shrugged off the high oil prices driven by increased demand, a supply shock could be much more damaging to global growth. Inflows of capital to emerging economies could complicate macro-economic management and expose the countries that receive them to an abrupt reversal of flows when sudden shocks occur.

Danger of a backlash against globalisation – Rato said there is a danger of backlash against globalisation as many people felt mainly benefited the wealthy and educated. He said the best way to address this inequality is to increase investment in education and technology and give the poor more access to infrastructure, utilities and financial services so they could also benefit from globalisation.


2. Indian: Play safe with money

After acquiring a home, Indians with a high disposable income are now taking advantage of the relatively high returns offered by bank deposits. However, they are still very cautious about investing in equities, and have shifted loyalties from small savings to insurance schemes.

According to the preliminary estimates released in RBI’s latest annual report, we are witnessing a structural shift in the saving pattern by Indian households. Fear appears to be playing a bigger role than greed in their saving pattern. Mutual funds are more preferred than shares. Bank deposits are attracting more interest than small saving schemes. In longer-term savings, insurance funds are increasing their share over provident and pension funds.

Indian saved a total of Rs 7, 58,751 crore in FY’07. On a gross basis, this amounts to 18.4%of the country’s GDP as against 16.7% in FY’06 and 13.9% in FY’05. Though the breakup between physical and financial assets is not available for FY’07, average share of physical assets between FY’00 and FY’06 was 11.3% of GDP while that of financial assets for the same period was 10.7%.

In a year that saw foreign investors pumping in billions of dollars into stock, Indian entrusted their money to bank deposits. This was also partly because deposit-starved banks offered returns of up to 10% per annum after years of very low returns. This marks a reversal in trend seen from the 90s, when bank deposits began losing share to debentures and even small saving schemes.

Thanks to the runaway growth in loans for the last three years, banks were forced to raise deposit rates to attract more funds. Besides, the central bank also signaled higher rates to control inflation. As a result, bank deposits have become so attractive that savings parked in government administered small savings schemes have started shifting to banks.

Though equity culture has caught on in the last decade, particularly among the young, MFs appear to have caught on investors’ fancy even more than stocks. Many MF schemes incorporate safety features and stable returns because of which even the risk-averse investor does not fear to trend on the newly emerged avenue. Besides, MFs are now structuring schemes for a variety of sectors that could satisfy all kinds of risk appetites.

Meanwhile, competition and product innovation in the life industry has resulted in life insurance savings growing faster than provident funds. This is largely because the insurance sector has opened up to more players who are coming with a variety of structures in addition to the higher awareness among savers.

Fear appears to be playing a bigger role than greed in their saving pattern


3. Indian Inc: In search of greener pastures

STEP OUT. The world is getting flat, at least for Indian companies spotting targets abroad. Call it an offshoot of globalisation, or a tool to gain technology and customers, or to mere necessity to counter peer pressure – India Inc may continue to engage in inorganic growth in the years to come.

The trend so far has been crystal clear. Indian companies, both big and small, from across sectors have been jumping into the game of acquisition. And the size is getting bigger. The role of RBI is accommodative for Indian firms to acquire overseas companies. The success of Indian companies in striking acquisition deals abroad has proved that India is now an industrially efficient country.

Why the Indian firms suddenly hunting for foreign assets? The two most plausible reasons put forward are, first that in economies that have opened recently, like in East Europe, Central Asia and China, it makes long term strategic sense to try and achieve first mover advantages. Second, Indian firms have now nearly closed the technological gap relative to global industry leaders and any further advance can be made either by indigenous R&D, that in most cases will have to start from scratch, or by acquiring firms that are ahead on the technology curve. The shorter way forward on the technology ladder is clearly through acquisition.

Could it be the return on capital employed is higher abroad than in India? Sounds rather improbable; yet consider in other way. This may be the push factor arising from the still unfriendly investment environment in the country. Complicated procedures and processes and problems associated with the land acquisition and in securing necessary clearances make investment a rather stressful activity. This is especially true if you a first timer.

Despite the liberalisation, we are still struggling to make a significant change in the investment environment. And so in our country to persist as an investor continues to required courage, patience, a degree of sub-servience and firm belief in God because of the pure uncertainty that is associated with any investment activity. May be, just may be some of our younger entrepreneurs and corporate managers have decided to improve their quality of life and earnings to boot by moving their operations overseas!

Grab & Grow

For the first time, acquisitions are set to play a dominant role in companies’ growth plans. There’s no limit on the number of acquisitions and the amount that it would pay as long as they add value to the portfolio.

For instance, PepsiCo Inc chairman has told the India team to push hard for buyouts in milk-based beverages, juices and convenience food this year to build the wellness portfolio. The company has already built its’ health and wellness portfolio by acquiring Quaker Oats as well as Tropicana juices. Since there aren’t any mega food & beverage companies to be bought in India, Pepsi India and its snack food sister company Frito-Lay are looking for ‘tuck-in-acquisitions’.

This essentially means buying individual brands – which could be region-specific or national – with strong brand equity and reach. The company is also looking milk co-operatives to jointly explore milk- based drinks, such as cold coffee, lassi and milk shakes. The M&A strategies are in line with what PepsiCo is doing in other markets to cater to shifting consumer choice.

Grow & Consolidate


Flush with cash, stockbrokers are taking the inorganic path to exploit the huge potential in broking space and consolidate their position in the industry. Major players have already initiated the trend by acquiring medium and small sized brokers and many others are believed to be on the lookout for suitable targets. Currently there are 700-odd brokers registered with the Bombay Stock Exchange, most of who are also members of the National Stock Exchange. The number is expected to fall as top brokers will try to consolidate their position in securities trading.

Empower individuals

The global business is on the road to new era, where we are moving towards the full realisation of strategic globalisation. India is the world’s largest democracy and free market, offering a large talent pool of skilled, English-speaking talent. Its competence lies in R&D, design and services. With one of the fastest growing young populations, government focus on economic development, India’s culture of tolerance, diversity and partnership present investors with a strong growth proposition. It’s the time to empower individuals to collaborate freely and compete globally.

They are the flavour of the PE, VC funds

If global private equity (PE) and venture capital (VC) funds are queuing up to invest in India, it’s not only because the country offers compelling investment opportunity. It is also because most of the funds have Indians at the top. According to independent estimates, as much as 15-20% of the team members of some of the global funds are Indians.

We are not talking the usual top names like Ram Sriram, Vinod Dham, Promod Haque and Vinod Khosla, who are counted among the top VCs. We are talking of a new crop of professionals who occupy senior roles in firms like Blackstone, Carlyle, General Atlantic Partners, Warburg Pincus, and Bessemer Venture Partners.

Take the US-based buyout fund Blackstone, the world largest PE house has about 11 Indians in its team of 148-odd members. Some of the top names who serve as senior managing directors of Blackstone include AJ Agarwal, Akhil Gupta, Punita Sinha, Prakash Melwani and Manish Mittal. Similarly, in Bessemer Venture Partners (BVP), the oldest venture capital practice in the United States, 10 out of the total 47 member team are of Indian origin while 6 out of the total 16 partners are Indians.

It’s no surprise that there are more Indians in early stage VC and PE funds. They look for people with a technical background, great business understanding and excellent operating experience in large and small companies. After all, their role is to help entrepreneurs get over their hurdle. On the PE side, strategy consulting or investment banking background helps a lot. Thus, we see a large number of Indians penetrating these roles over the last five years.

There is not a top tier VC firm today without a couple of successful partners of Indian origins – KPCB, Sequoia, Matrix, Norwest, NEA, DFJ, etc – the list is endless. If there is one common factor between the Indians in the top PE and VC firms, it is their higher education pedigree. Almost all of them have a management or higher engineering degree from one of the top US College.


4. Foreign Institutional Investors:

Ensure that 1997 never happens again

JULY 2 marked the tenth anniversary of the Asian financial crisis, which flattered most Asian economies in 1997-99; China and India suffered, but survived intact. Today, Asian countries adopted new policies – discussed below – to ensure that 1997 never happens again. Some of these are wise; others are unwarranted overreactions.

Do not run large current account deficit of 7% – 8% of GDP Most Asian countries ran big deficit for long periods. But 19997 exposed the catastrophic risk involved. India was always prudent: its current account deficit was only 1.5% of GDP in 1997-98.

Discourage short-term foreign loans

In early 1997, short-term loans were ballooning in every crises country with nobody taking notice. When short-term lenders refused to roll over their loans, the consequent dollar outflow emptied many Asian treasuries. India and China had very limited short-term loans in 1997, and were not discomfited.

Institute strong bank oversight

Thailand’s banks in the mid 90s borrowed massively from abroad at low interest rates to lend at higher rates locally. This financed a housing bubble, which burst just as the forex reserves were crashing. The Thai baht fell, raising the local value of foreign loans, so banks that had borrowed abroad went technically bust. Indian banks in 1997 could not indulge in foreign adventures: they were bound hand and foot by RBI red tape.

Discourage high corporate leverage

In Korea, the chaebol became giant conglomerates using huge debt-equity ratios. Leverage turned into catastrophe in 1997 because many chaebols now had large foreign loans, whose local value skyrocketed after devaluation. Daewoo, the second biggest chaebol, went bust. Indian companies also had high-equity ratios in 997 but very little in foreign loans. Today, thanks to Sebi, prudent bank lending, and the thumbs down given by the stock market to high leverage, excessive debt-equity ratios have largely disappeared in India.

Improve corporate governance

In 1997, many Asian countries went bust without warning because their books had been cooked for so long that only the owners knew the truth. Indian balance sheets were also regarded as dubious in 1997, but less so than in Southeast Asia. Since 1997, Sebi and financial markets have greatly improved corporate governance and balance sheet credibility in India.

Avoid fixed exchange rates

Many Asian countries in 1997 pegged their currencies to the dollar. This tended to make their currencies overvalued, exacerbating trade deficits. It insured foreign lenders against currency risk, and so encouraged excessive inflows in search of high interest rates.


Today, virtually all-Asian countries have managed floats. Even China is devaluing slowly. In India, the RBI intervenes often but fitfully to prevent excessive rupee appreciation. This has created enough uncertainty to encourage traders and financiers hedge their forex risks.

Run current account surpluses: This new policy of most Asian countries is an overreaction to 1997, not a sound policy. Developing countries should invest more than they save, and hence run a modest deficit. India gets high marks on this score; its current account deficit is only 1.1% of GDP.

Build huge foreign exchange reserve for safety: This again is an overreaction to 1997, not good policy. Countries need prudential reserves. But China’s forex reserves are approaching $ 1.5 trillion, and other developing countries have as much again. This far exceeds any reasonable prudential limit. The counterpart of Asian surpluses is a huge US trade deficit. This paradoxical pattern is sustainable for some time, but one day the dollar with crash, wiping out a good chunk of Third World forex reserves. India should go slow on further forex accumulation.

Discourage high inflows of foreign capital: After 1997, Asian worry that large inflows raise the risk of large subsequent outflows. This was one reason why Thailand imposed capital controls on inflows this year. China curbs inflows into its stock markets. In fact, countries should distinguish between four sorts of inflows -

Foreign direct investment in the form of factories poses no risk of capital flight: factories cannot leave during a panic.

Foreign portfolio investment in stocks and bonds is widely but wrongly thought to be volatile. In theory, foreign institutional investors (FIIs) can exit only by selling at ridiculously depressed prices, so they would rather stay put. This explains why FII portfolio inflows into India remained positive right through the Asian crisis, except for a small outflow in 1998. Lesson: encourage rather than fear FII inflows.

The third category of inflows is long-term loans. These cannot suddenly flow out in a panic, but can mean a steady outflow to the extent old loans mature and are not rolled over.

Finally, we have short-term loans, which will indeed flow out fast during panic. Lesson: discourage short-term loan, but encourage FDI and FII inflows.

Trust foreigners over Indians

Focus capital controls on citizens rather than foreigners

India gave total freedom of exit to FDI and FII during the Asian financial crises, but few exited. However, India did not allow its own citizens to exit from rupees into dollars. That policy was a success. Foreign exchange reserves can cushion capital flight by foreigners during panic. But no amount of reserves can protect against citizens trying to convert their entire liquid savings into dollars. That will bust any treasury. Today, the RBI is easing capital controls on Indians and encouraging them to invest abroad, to ease the pressure on rising reserves. But this policy can and should be reversed if another crises strike. The great lesson of 1997 was that you could trust FIIs to stay put in a panic, but not your citizens. The hottest of the hot money is not that of foreigners, but of citizens.

to stay put in a panic, but not your citizens. The hottest of the hot money



Mutual fund industry

Mutual fund industry has come a long way since the first stone was laid in 1964 with the establishment of Unit Trust of India. Forty-four years down the line, more than 34-players operate in the industry, and most of them belong to the private sector.

Moreover, the number of players is increasing at a rapid pace with many new ones, both from India and abroad, seeking approval to join the bandwagon. It is not just in terms of the number of players, but the industry has also expanded in terms of assets that it manages as well as the type of products that it has to offer to the investors. As far as the size is concerned, the industry has grown rapidly, especially in the last couple of years and is currently managing over Rs 6 lakh crore of investor money. While this sum may appear huge, it is miniscule when compared to the sector’s global peers.

Dramatic changes have been witnessed in the type of products offered by the industry. Starting with plain vanilla equity schemes, the industry today has a variety of products that include thematic funds, arbitrage funds, quant based funds and even exchange traded funds. However, despite the large basket, the need to expand the reach to global markets has often been felt.

Though India first saw the emergence of global products in 1986 in terms of allowing foreign players to invest in the country, it was only in 2003 that the Indian investors got a chance to invest overseas through mutual funds. But it was not until year 2007 that the country registered active participation from various asset management companies in encouraging investors to look beyond domestic shores. The policymakers have also supported their cause by increasing the limit to invest abroad from $ 4 billion to $ 7 billion in just about a year’s time.

So, today, the industry managers have crossed the domestic boundaries and made an entry into the international arena either directly or through foreign funds. The opportunities foregone in the Indian markets are being captured at the international platform. If overseas investors can make the most of the opportunities in India, Indians have a right to get an equal opportunity to take advantage of their resources too. While a beginning in this direction has rightly been made, the scope for expansion is huge.

The whole world in your hands

India had covered a long journey in terms of evaluating investment opportunities abroad. The mindset of the Indian policymakers has undergone a radical change since the time India became a member of the International community. The overseas investment limit has gone up from $ 25,000 to $ 200,000 over a period of time and may be raised further as the market move forward, which is the absorption of inflows into India. Investing overseas has assumed even greater importance.

The Raghuram Rajan committee report on the financial sector reforms in India has also recognised the active participation of Indian investors in the overseas markets as one of the methods that could help manage the excessive flow of funds into the country.


As a measure to allow retail participation in the overseas market, mutual fund industry was permitted to offer products that invest certain portion of their assets in overseas markets. For several decades, the Indian mutual fund industry remained in-house. It was only in 1986 that the road to the world was opened, but it was in 2007 that this road actually widened.

When certain quantitative limits of the amount that can be invested overseas by each individual fund house as well as the industry as a whole do exist, today, the country is in a position to raise these limits if there is a demand for these products. The policymakers today have recognised the need for diversification, including diversification across boundaries. The tax concessions were extended to the domestic funds with the objective to promote the growth of the Indian markets by making it lucrative for the Indian investors. In the light of the current scenario, the Indian investors could look beyond domestic shores. After five years of generating fantastic returns, Indian markets are beginning to face a slowdown. It is now time to invest globally.

Demand for infrastructure investment in emerging markets globally is like never before. Valuations in these economies are also lower than those of the developed economies. Even Indian investors looking at fixed income instrument should consider investing abroad. Indian investors can expect a lot of development in the overseas investment space in the coming days, both in terms of products as well as reach. However, while many have been heard extolling the benefits of investing abroad, most investors and advisors who subscribe to this ‘go global’ theory are unable to find an answer to the fundamental question: Where to invest and why?

The Asian economies, especially those of India and China, have, over a period of time, emerged as two of the strongest emerging economies of the world. But there do exist opportunities even beyond the great wall. If India has been highly rated for its strong domestic consumption and China for its rapid strides in infrastructure development, Brazil and Russia stand out for their power play in the commodities segment. With commodity prices, especially those of oil, these two economies have more to gain than lose. Similarly, Latin American countries, especially México have gained on account of low vulnerability to the US recession. Also, these economies have now begun to see a surge in the infrastructure investment as well as in private consumption.

Russia, on the other hand, boasts of strong balance sheet with over $ 400 billion in forex reserves, over $ 150 billion in the oil stabilization fund and almost no outstanding debt. The country was also expected to see heavy investment in the infrastructure space and surge of domestic demand in the under-penetrated consumer sector. Like Latin America, Russia is also sheltered from global economic weakness given its low correlation with the US economy.

Investment tactics lie in the ability to invest across economies and asset classes that have a low correlation. Analysts say the importance of tactical asset allocation – not just in various economies, but also in variety of asset classes like property, fixed interest instruments and cash.


Systematic Investment Plans: Slow & Steady

You’d sure want your money to grow fast and wouldn’t hesitate to explore different avenues. While some of you track market moves, other keep abreast of the bullion market or skip through reams of information on mutual funds. But the basic principle of a sound investment doesn’t lie in picking up the best product. It lies in making regular investments. Systematic Investment Plans (SIP) is one such route which helps not only in developing a financial discipline but also minimise your losses when the markets turn choppy. Here’s a pocket guide on what to keep in mind before you start your journey on the SIP route.

First things first

So what is a SIP? In simple words, it is a disciplined way of investments, where you allocate fixed amounts at a regular frequency. According to financial planners, this time-tested investment approach indicates a flair for regular investments and also helps you to navigate through the narrow lanes on Dalal Street. It is like saving coins in a piggy bank and one fine day when you open it, you find it has more than what you expected. SIP works in the same manner, just that it adds the acceleration gear. “The Power of Equity” to it and within years your expectations are surpassed.

Analyst hold the view that SIPs are one of the best tried and tested formulas to make a fortune regardless of market conditions. They help create wealth in a regimented manner over a longer period of time and acts as a buffer against all investment-related injuries.

Riding market fluctuations

Although SIPs generally apply to mutual funds, you could use this method to buy stocks directly or make regular investment in other instruments such as PF and insurance. It is often used as a method of riding the market fluctuations effectively. For instance, if you buy an equity mutual fund at a regular investment, say Rs 1,000 per month for a year, if the markets go up during this period, you will get less units. However, if the market is down, you will end up buying more units, hence over the long-term, you can ride away the risk of short-term fluctuations.

This method is also called ‘rupee cost averaging’. This ensures that you don’t try to time the market and generate consistent returns on an equity portfolio through investing across market cycles.

Analysts believe that you should focus on building a portfolio of investments suited for the medium to long term instead of trying to latch on to the latest market trend. You can always look at the SIP route to take exposure to equities in order to reduce the impact of volatility on your portfolio. This not only helps you stride through choppy markets but also enables you to buy into the market at a lower average price through a consistent, long term investment approach


Personal finance experts believe that the choice of investing weekly or monthly depends entirely upon the risk-taking ability, quantum of amount you are willing to shell out and fund selection.


It is important to choose a fund that has a long-term track record, and has a proven performance over a significant period of time and across market uncertainties.

Factors can also differ according to time frames. For example, a small and mid-cap fund could be a rewarding SIP investment though a weekly SIP plan in a volatile market, as it helps capture the aggressive gains in mid-cap stocks, while a monthly SIP in a large cap fund may be advisable in a market that is steadier in nature.

Analysts caution that you should not get carried away by short-term returns and look for funds with established performance track record across market cycles. It’s also noteworthy that you should have asset allocation plan after a thorough analysis of your financial goals, time horizon and tolerance for risk.

Watch out

Financial planners believe that it is necessary to invest in well-diversified funds, and ensure that the commitment towards the SIP is carried out over the entire length of the investment. Since an SIP investment works through cost averaging investments across a period of time, there may be times when deep correction in the market may merit larger investments at a specified point of time, which you may miss out due to specific SIP intervals.

There is a theory that SIP investment works best when it is conjunction with other lump sum investments. Also, you should remember that an SIP investment only generates consistent returns if the investment plan is adhered to. However in the event of missing out on a payment, you can buy in through a lump sum investment and carry on investing through SIPs across the remaining investment horizons. The key factor in an SIP is to stick to a regular investment plan and lower your average cost of buying in the markets. And a well-crafted financial plan will not only maximise your returns but also help you in volatile times.


Gold is a portfolio and risk diversifier

It cannot be compared to stocks in terms of value proposition. The reasons for investing in gold go beyond returns. Gold, as a portfolio and risk diversifier, is still irreplaceable. In fact, all the major investors worldwide always have 3 – 15 % of their portfolio in gold – for the right reasons. Gold is many things that stocks can never be: gold is a global currency. It is a hedge against inflation. It is a commodity as well as a monetary asset, and finally its value, unlike stocks or currency, cannot be debased. It is still the single most globally accepted form of payment. Therefore, gold is not just an investment; it is security.

And, if you are keen on investing in the yellow metal, you can certainly look beyond the traditional methods. There’s no right time for investing in gold jewellery and today there are a variety of options available. Most common among them is buying gold bars. Buying in futures and taking demat delivery is another option worth trying. But investing in rare coins is a fantastic idea. Due to its rarity and limited availability, they can fetch you far better returns than any other option.

The strength or weakness of the dollar is a significant factor in determining the price of the gold (inverse co-relation). According to experts, in the long-term, gold will probably beat inflation. Well, equity over the long-term can’t usually go wrong, but diversifying your portfolio with the right investments in gold will not only add some weight but also bring some sheen.

Why gold buyers bank on jewellers

Buying gold could have never been easier. Today, to acquire a gram of the precious metal, one need not go all the way to the jeweller. The nearest branch of your bank is a good alternative source. Over the last couple of years, several banks – public and private – have been active in this segment. Gold Exchange Traded Funds (ETFs) are the most convenient way to buy a few grams of the precious metal. Fund houses offering gold ETFs today are the Benchmark MF, UTI Asset Management and Kotak Asset Management.

Though gold ETFs are the most convenient way to buy gold and get the best value for money, they have by far failed to attract many investors. Blame it on the regulations or the fact that it is mandatory to have a demat account for transacting in ETFs. And to have a demat account a PAN card is must. Banks and jewellers provide a hassle-free trade. No demat accounts, no bank accounts and no mandate for PANs. If you thought this applies to purchases from jewellers alone, you are in a surprise. Even banks are offering such hassle-free trade. Banks are ready to offer you a PAN-free purchase irrespective of the amount involved. While there are a plethora of guidelines and norms regulating many finer aspects and operations of commercial banks, sale of gold coins by banks seems to be outside the ambit of these rules. Thus, it hardly makes any difference whether the gold coins are procured from banks or jewellers, expect for the price and confidence of purity.

Gold is a portfolio and risk diversifier



Participate in the growth story

The unprecedented boom in commodity trading, which has multiplied by a whooping 28 times in just three years, has also opened a vast new job market. Commodities market is opening fresh avenues not only to investors but also to other participants at all levels. This fast growing market finds itself at sea at times due to shortage of trained staff – be it at trading firms, brokerage houses, exchanges, local mandies, warehouses or export houses. With the industry expecting a significant part of the growth yet to come, the need for right talent would only intensify going forward. There is a huge shortage of experienced analysts in the industry due to which attrition level is also increasing in most research firms. On an average, 15-20 analysts are required in research firms. However, in most of the firms, there are hardly 5-6 member teams with each member handling a group of commodities not linked with one another.

Globally, the commodity business is ten times higher than the stock market volumes, while the ratio is relatively much smaller in India. It indicates the growth potential of the market. Demand of professionals is so much that there is need of short-term training programmes to attract the people to participate in the growth of commodity market. Realising the demand for talented skills, top-end business schools like IIM Ahmedabad, Management Development Institutes (MDT), and Institute of Management Technology (IMT) have prioritised commodity trading in their syllabus. However, the need of the hour is to realise the sudden spurt in demand for a vast talent pool when FIIs and banks enter the commodities market and also when options trading is allowed in futures.

Market needs checks but trading must go on

The aberrations in commodity futures should be corrected but there should be no clamp down on trading, according to an interim report prepared by IIM Bangalore. The B-school was appointed by commodity market regulator Forward Markets Commission (FMC) to study the impact of futures trading on prices of agricultural commodities and other aspects of future market. Commenting on the findings of the interim report, professor Gopal Naik of IIM Bangalore said that certain aberrations exist in some contracts; these can be corrected through a joint effort of the exchanges and FMC. “Future trading is quite recent… it will take some time to mature, but there is not a situation which calls for halt in trading.”

Currency future trading

The government has told the central bank to quickly put in place building blocks for enabling the launch of exchange traded currency futures to obviate the risk of the local markets being exported. With the appreciation in the Indian currency for well over a year now and the growing investor appetite for the local currency in many overseas financial markets, an active market for the Indian rupee now exists outside the country. The government feels that there is an urgent needs to unveil exchange traded currency products. India now has an over the counter currency futures market dominated by a clutch of banks. It lacks efficiency, price transparency and access that an exchange traded currency product offers. Recently, the report on Mumbai as an International Financial Centre had highlightened as to how a turnover of $ 1 billion a day of derivatives trading-on Indian currency and Indian interest rates were taking place outside India. The losers in the process were Indian players.


Financial & market inclusive growth

Need for a healthy cocktail of financial and market inclusion

Globally economists measure growth as the percentage by which a nation’s output (GDP) has changed over a period of time and view development as a ‘qualitative phenomenon’ to find if the benefits of growth of an economy have reached its stakeholders.

UN organisations such as UNDP, World Bank, and UNCTAD measures aspects of development through measures such as Human Development Index, World Development Indicators, Human Capital Index, etc. However, till today there is no one holistic measure.

In effect, this means that while we can measure a statistical sum of aspects of the status of stakeholders

and their economic wellbeing, but measuring the individual universe, i.e., their total wellbeing, is an issue that still continues to dog development economists. Ignoring development leads to socio-economic

disparities, underproductive labour, increase in unproductive investments (subsidies, market support, etc.), and social unrest and so on. Let’s apply this to the Indian context.

A dipstick on the 9% growth could be rural economic development. Unfortunately the signals from the

rural economy (in terms of common economic denominators, i.e., income/employment/investment) do not augur well. The recently released World Development Report, 2008 attributed this to market and state failures characterised by insufficient and unequal access to information/ imperfect competition/ high

transaction and supply chain costs, etc.

It is important to note that while financial inclusion provides access to financial products; it would be of

no avail until they make efficient production decisions and sell their products at prices reflective of supply and demand. This necessitates that rural areas need market-inclusive growth and an important catalyst that can enable this is telephony.

The imperative answer to all these hurdles in rural economic development is sound policies promoting ‘financial’ and ‘market’ inclusive growth. While financially inclusive policies take the financial products closer to the rural masses, market inclusive policies would take markets nearer to them and alchemise the financial inclusion. The tie-up between MCX and Tata Indicom to deliver this facility to provide market signals on a toll-free platform to the agricultural commodity value chain is an example of the ‘marriage of convenience’ which would soon become ‘marriage of choice’ given the commercial challenges and opportunities that envelop it.

To strengthen the efficiency of the prices discovered on the exchanges, it’s imperative that the price discovery process be a two-way communication process wherein farmers respond to market signals and also pass on signals back to the markets. If markets provide the right impetus to the rural areas, they would earn enough to save. In tern, they would invest more to ensure a safe, healthy, and secure livelihood than to remain a burden on the exchequers. It shall lead to the development of appropriate financial products as also various delivery models making financial inclusion a viable proposition than to make it a financial burden on the treasuries. A healthy cocktail of financial inclusion and market inclusion with an appropriate dose of required policy changes would do wonders not only foe economic growth but also economic development.

Financial & market inclusive growth



1. Greater opening up post 2009

India’s public sector banks (PSBs) have emerged financially stronger after a decade and a half of reforms. The boom in the economy has helped but improved operations and governance too have contributed. Credit appraisal is sounder today. Management of non-performing assets (NPAs) is a lot better. Intermediation costs have fallen. Overall, the return on assets for PSBs of 0.82% in 2006 does not compare unfavourably with that of the better performing banking systems in the world.

So far so good; But is it good enough? Are PSBs equipped for greater opening up of the banking sector, post 2009? The wisdom in vogue today is that they do not have the necessary size and must consolidate in order to cope with competition from foreign banks. Consolidation, it is said, will confer scale economies and the ability to cater to large corporates. Opportunities are there in abundance. However, PSBs are unable to grasp these because they lack the leadership and depth of management to do so.

The priority must, therefore, be a focus on human resource development (HRD), not consolidation. Indeed, consolidation can only sap the energies of PSBs by creating fresh HRD problems on top of the unresolved ones. It is said that PSBs cannot retain or attract talent because they cannot pay well enough. PSBs are worse off because there has been a complete neglect of the basics of HRD.

The biggest failure is lack of succession planning and continuity in management. Bank chairmen last for two years or so. A chairman does well at a small bank and oversees a successful IPO. In the course of the issue, he unveils a glorious vision to prospective investors. The issue done, the chairman moves on to a larger bank; where he makes a new set of rosy promises – and duly retires. At both the banks, the humdrum task of making the promises happen is left to the successor. Executive directors who do well are similarly rewarded – by being moved to the top job at another bank, not the one that they have got to understand well. This is not management; it is a charade and a disgrace. It happens only in the banking sector because the finance ministry, in its wisdom, has thought it fit to reduce top management at PSBs to a game of musical chairs. This game must end forthwith if at all PSBs are to have any hope of coping with competition.

In almost any organisation, talent is available and waiting to be taped. The first HRD challenge for PSBs is to identify such talent and systematically groom people for top positions. The second challenge is to hire fresh recruits, something that had virtually stopped at PSBs for years. It means career planning for new recruits with job rotation and periodic training. The third challenge is bringing in people for specialised roles. This can be done through contractual or advisory appointments. A fourth challenge is to develop a marketing orientation throughout the organisation. This again requires training as well as the induction of young people to leverage the banks’ customer relationships for wealth management and other products. One could go on.

None of this is novel nor does it require fancy footwork. But it is hard work and it requires systematic thinking through at the highest levels of the ministry as well as banks. The RBI has been careful in letting in foreign competition but pressures to open up further cannot be resisted for long. If the government and the banks cannot get their acts together, they risk destroying the value laboriously created in the post- reform period.


2. Brand & reputational risk

Internal capital adequacy assessment process

For Indian banks, it is a bit of a rude awakening. Having been used to addressing traditional risks relating mainly to operational areas, they have been oblivious to reputational and legal risks that most prudent firms address.

All that is set to change, the RBI now wants local banks to recognise and manage risks posed by actions that could have an impact on the bank’s reputation or brand besides legal risks, which could arise from contracts that may not be enforceable and in the forms of adverse judgments. What this would mean is that banks will have to set aside more capital to factor in such risks on the lines of what their counterparts in other markets have done.

Banks in India have so far focused on just three basic risks – operational, capital and market risks – pillar one of the Basel II accords that will kick off from March 2008. Now after the banking regulator has stepped in, banks here are busy analysing the various types of risks that are not captured in pillar one. These could include:

Legal risk,

Policy risk,

Environmental risk,

Regulatory risk,

Compliance risk, and

Brand & reputation risk.

It could also include risks such as technology getting obsolete and a rise in the number of ageing employees in the bank.

RBI has told that since these risks may differ from one bank to another, each institution will have to identify the risk, fix a tolerable level and assign capital on it if the limit is breached. If during the annual inspection, the RBI is not satisfied with the capital that a bank has assigned it can direct the bank to provide higher capital. The entire process, known as internal capital adequacy assessment process (ICAAP) is the second pillar of the Basel II accord.

The additional capital required for meeting ICAAP may vary from fifty to 100 basis point for different banks. The additional capital required to meeting credit risk itself is pegged at about Rs 15,000 – 20,000 crore for all domestic banks. Incidentally very few state owned banks have finalised this policy. Banks are exposed to a host of risks and everyday a new sort of risk emanate. Thus banks need to ensure that these risks are covered and additional capital is set-aside for this.


3. Build robust system to manage risks

The financial world has now got used to regular announcements of write downs (write-offs in our parlance) worth billions of dollars by banking majors across the world in the wake of the subprime crisis. It’s, therefore, no surprise that the news of one of the largest financial frauds in banking history has failed to evoke much excitement and debate.

Societe Generale, the French banking major, recently reported $ 7.2 billion in trading losses due to unauthorised trades in European futures market by a single trader. The losses forced the bank to go in for a right issue to shore up its equity.

The event once again brings to focus the risk management systems prevalent in bank treasuries. If one looks at the history of derivative trading in banks, it can be seen that this incident is not an isolated one.

The most spectacular of all derivative trading mishaps occurred at the England’s Barings Bank. A 200- year-old institution, the Barings Bank collapsed in 1995 when the bank ran up losses worth about Euro 850 million due to the illegal trading activities of a trader.

In 2002, Allied Irish Bank reported losses of $ 690 million owing to fraudulent trading activities of a trader in one of its subsidiaries.

In 2004, National Australia Bank reported trading losses of around $ 360 million caused by unauthorised currency option deals. Australia’s banking regulator, the Australian Prudential Regulatory Authority (APRA), has put in the public domain its detailed investigation report on the causes of the trading losses, which makes very interesting reading and offers insight into the significant failings contributing to the bank’s failure to detect the unauthorised trading activities.

There are unerring similarities in all the episodes described above. The losses were large, they were caused by one or few traders running unauthorised/undetected positions and existing control systems in the respective organisations were unable to detect the activities early enough to limit the damage.

In each of the above mentioned episodes, the rogue trader(s) managed to conceal their positions not for days or weeks, but for months and years. And these have happened in organisations that are supposed to have very robust risk management system!

The large losses in derivative transactions also highlight the power of leverage, i.e., the ability to take up large positions with little upfront investment.

The advantage is potential to rack in large profits (and large bonuses for the staff too!) if the bets prove successful. However, if the values of underlying assets move in the opposite direction, the losses can be quite large and, as in the case of Baring Bank, they can even pull down an institution.

Clearly, the type of internal control systems that banks are accustomed to, to take care the risks in accepting deposits and lending is quite inadequate to monitor risks in treasury activities.


Here is an illustrative list of key control systems applicable to treasury activities of banks:

Functional separation of front office (which takes positions) and back office (which does the settlement and reconciliations)

Strict adherence to various risk limits laid down; such limits include stop-loss limits, counter-party limits, open position limits, value at risk (VaR) limits, etc.

Robust system of reporting limit excesses and transactions of an exceptional nature to higher authorities

Clear and unambiguous reporting lines

Clear understanding of products (especially derivative products) at all levels, particularly at senior levels

Appropriately skilled and truly independent internal audit system

To conclude, the events over the years have proved that risk management is not just about fancy technical jargons and complex mathematical models.

It’s time that the world of banking revisited the basics of risk management.

The moment at which risk management becomes subservient to business goals, an unscrupulous employee in the treasury is all it takes to bring an institution to grief and sometimes, as in the case of Barings, to bring down an institution.

It is also worth remembering that when banks around the world are implementing Basel II framework, having a capital cushion is no substitute for having in place robust risk management systems.

An illustrative list of key control systems applicable to treasury activities of banks



Tax evaders

There is an increased focus on scrutiny as it the core function of department. Field formations may be asked to increase scrutiny in line with the hiked target of 2.5% of total returns. At present, only 2% of returns are selected for scrutiny. It may be noted that the Parliamentary Standing Committee on finance had asked the CBDT to intensify scrutiny as it helps in detecting tax evasion. The income tax department now uses details of transactions revealed in the annual information returns in carrying out scrutiny.

1. Biometric PAN with enhanced security features

All the new Income-Tax payers in the country will soon begin to get biometric permanent account number cards with enhanced security features like fingerprints or retinal scans, aimed at checking duplicate cards and better tax compliance. The process of eliminating about 13 lakh duplicate PAN cards is in last mile. Once that process is completed, a date is fixed, after which all new PAN cards will only biometric.

2. Financial profile of all financial information

The finance ministry has clarified that when there is information about large financial deals that are unreported or huge tax evasion, an attempt is made to bring together all financial information about the person from sources such as AIR, BCTT, STT, income tax and Wealth-tax returns. The object is to construct a financial profile of the person. I-T profiling is a standard device adopted as an anti-tax evasion measure.

3. A million individuals earns Rs 10 lakh or more

The tax department rustles up, with great difficulty, 110,000 individuals reporting of Rs 10 lakh per year or more. However, the country has at least a million people who earns that much in the age group 18-59, finds the IIMS Dataworks’ countrywide research, covering over a million households and followed up with in-depth interviews with over 100,000 working individuals for its Invest India Incomes & Saving Survey (IIISS), 2007.

It is not just the taxman who has failed to strike an acquaintance with the millionaires: mutual funds and stock markets too are yet to discover them. Though an overwhelming majority, 90%, of the rupee millionaires have a life insurance cover, just over a third invest in mutual funds and merely a fifth directly into equities. Yet, the survey finds that Indians are beginning to buy into the great Indian growth story

Over 1.76 million Indians in the paid workforce will make fresh investments in mutual funds within the next year, one million of which would be new mutual fund investors. Currently, there are 5.3 million mutual fund investors. Of the 3.5 million equity investors, over 80%, or 2.85 million, have put fresh investments in stocks in 12 months, and another 1.26 million new equity investors will come into the market in 12 months.

4. Stock market


The income-tax department is planning to scrutinise tax returns of the NSE 500 and BSE’s A-group,

comprising over 100 companies. This is a part of action plan sent out to field formations for 2007-08 to

The Central Board of Direct Taxes has prepared an elaborate action plan for the

year and there is an increased focus on scrutiny. Scrutiny of income-tax returns helps the income-tax department unearth hidden incomes and raise more way by tax.

increase tax

Fresh capital infusion Similarly, the action plan says that all corporate entities, which witnessed a fresh capital infusion of more than Rs 50 lakh, could find the department looking more closely at their books.

Amalgamation & merger Besides, companies, which claim tax benefits under section 72A of the Income Tax Act, also need to make sure they’ve paid their taxes honestly. Section 72A allows companies which have undergone an amalgamation or merger to set off their losses against their profits and lower their total tax liability,

Multi-national companies The guidelines also make it clear that the finance ministry seeks to closely monitor the multi-national companies operating in India. The CBDT procedure says all cross-border transactions worth Rs 15 crore or more will be compulsory scrutinised.

Non-banking financial corporations All non-banking finance corporations or investment companies having a paid-up capital of more than Rs 10 crore are also set to come under the department’s lens.

Stockbrokers Stock and commodity brokerages as well as their sub brokers with earning of Rs 1 crore or more a year will be compulsorily scrutinised by the income tax department. Further, the CBDT has also said that even stock and commodity brokers and their sub brokers with a bad debt claim of Rs 5 lakh or more come under scrutiny. This decision to probe the returns of brokers with Rs 1-crore brokerage has been taken in the backdrop of market that has been growing incessantly for the past three years.

Tax authorities apprehend that only a slice of the gains made in the stock as well as commodity markets eventually gets taxed. The searches carried out by the I-T department in the course of the last few years has convinced the revenue authorities that a substantial part of the income generated in the market go untaxed, for example, sources in the department said that more than Rs 10,000 crore may have been laundered through manipulation penny stocks alone.

Equity investors If you have bought a large quantity of shares in a blue-chip company, better get your account right; the government may soon use the security transaction tax (STT) data to track cases of income tax evasion. The CBDT has already set up a committee to find out how best the STT data, linked to PAN numbers of individual investors, can be used for I-T purposes. The idea behind analysing the STT data would be to find out how these information can be loaded into individual’ PAN Ledger Account, which like a bank account, would reflect his or her financial transactions.

5. Importers


It’s not just the currency trader or the exporters who keep a sharp eye on upward movement of the rupee. The taxman does it too. The income tax department has asked its field formations to figure out if the favourable impact of rupee appreciation was being reflected in the bottom lines and tax payments of import-incentives and FMGC companies. A strong rupee means lower rupee prices for the imported inputs. These lower costs can either be passed on to the consumer or used to increase profit margins. The CBDT’s view is that most companies seldom on the benefits to consumers. Since the rupee appreciation has been very sharp and spread over a long period this time, it would certainly have pushed up profitability margins of the companies.

6. Private education shops

Education institutes having exorbitant fee structures have caught the attention of taxmen. The income-tax department has decided to scrutinise cases of all private educational institutions, schools and universities which have an annual gross receipts of more than Rs 10 crore or more in big cities and Rs 5 crore in small cities. The receipts would also include donations received by these institutions. A large number of the private schools both pre-primary and higher education institutes mushroomed in the country in last few years. Most of these institutes claiming to have with foreign institutions have outrageous fee tags even in the pre-primary segment. In fact, some of these institutions have a tendency to take part payment of admission charges in cash. The intelligence wing of the department had recently collected information like fee structures, number of students, about some of the private institutes in select cities. The data collected will be passed on to field formations that could use it in their assessment and keep a tab on evasion.

7. Realty players

With the realty sector prone to heavy tax evasion, the income-tax department is likely to scrutinise tax returns of all real estate players – be it a property dealer or a builder – with annual turnover of Rs 5 crore in the current fiscal. A decision in this regard was taken as part of annual action plan of the department to take measures for meeting direct tax collection target of Rs 267,490 crore and unearth black money in the sector. It may be pointed that tax collection from builders has gone up after the department conducted raids on some of them in the last fiscal. Also, those who show a loss from house property of more than 2.5 lakh could also come under the scanner. The department is likely to scrutinise all cases where refunds are more than Rs 25 lakh in a year.



The competition Amendment Bill

The Lok Sabha passed the Competition Amendment Bill on 7 th of September’07, paving the way for establishment of a powerful competition regulator. The Bill seeks to provide statutory powers to the Competition Commissioner of India (CCI).

Corporate affairs minister Prem Chand Gupta told the Lok Sabha that the changes were brought about considering the recommendations of a parliamentary panel and the legal challenges to some provisions of the existing law. We are trying to have the CCI to be fully operational by mid-2008. Now, we will have one of the most important pieces of legislation in a free-market economy. With the passage of the Bill, we will soon see a fully empowered CCI replace the existing toothless Commission as well as the virtually defunct Monopolies and Restrictive Trade Practices Commission of India.

Under the new law, it would be mandatory to notify regulator about all mergers and acquisitions – including between two overseas companies – if the combined entity meets a specified threshold. Government has also introduced nexus – minimum presence in India for any two globally merging companies – to seek CCI’s blessings. Another key change is power to imprison and fine. Violation of CCI’s orders would be a criminal offence from the second instance. Contravention of the order in the first instance will be a civil offence with monetary penalty.

Strong competition legislation promotes and sustains competition, protects the interests of consumers and, most important, prevents anti-competitive practice. Now that both Houses of the Parliament endorsed the relevant Bill, the Competition Commissioner of India would assume a lot of powers necessary for performing its key function of prohibiting anti-competitive agreements and abuse of dominant position for the sake of fair play of market forces.

BCCI’s Anti-Competitive Practices

The country’s fair trade regulator has asked its investigation wing to probe into the anti-competitive practices allegedly adopted by the highest governing body of India cricket towards a rebel league. The Monopolies and Restrictive Trade-Practices Commission (MRTP) ordered a probe into certain key aspects of the Board of Control for Cricket in India’s (BCCI) reported attempts to resist competition from the Indian Cricket League (ICL). The director general of investigation and registration (DGIR) will prove into allegations that BCCI has threatened players with life-term ban on joining the Subhash Chandra- promoted league.

The DGIR would also prove into allegations that BCCI does not share infrastructure with ICL despite stadiums and machinery being national assets. The DGIR will have 90 days to complete the investigation. The Commission has also directed the DGIR to look into the expulsion of some former cricket players by the BCCI on joining ICL. BCCI has also sacked cricket legend Kapil Dev as Chairman National Cricket Academy. Such behaviour amounts to restrictive trade practices, not allowed under the MRTP Act. If found guilty, the Commission can ask BCCI to stop these practices; and if the body does not comply, the Commission could proceed against it for contempt of court.

B-school under MRTP radar for unethical teaching practices


Business schools that promise the moon to students without having adequate capabilities are in for a crackdown. The county’s monopoly watchdog has launched a nationwide probe into the flourishing business education sector. The probe will check if students actually get what they pay for.

Based on the directives from the MRTP Commission, its investigation wing has issued notices to more than 100 institutions for details about the fee, periodicity of payment, faculty, tie-ups with institutions for placement services, history of placement and whether the institute is part of a larger corporate group. The wing will probe whether these institutes are offering unapproved courses and admitting more students than permitted by the country’s technical education regulator, the All India Council for Technical Education (AICTE).

Education being in the concurrent list, both the central and state government can make laws to regulate the sector. The DGIR, attached to the judicial body, may also look into the gaps in regulation between central and state agencies. “State government’s technical education boards, universities and AICTE have a role in regulating them. AICTE is responsible for technical education only at graduate and post- graduate levels. It gives a three-year letter of intent for opening an institute. However, without permission from the concerned state government and affiliation from a university, the institute cannot admit students.

Shipping conferences are cartels

Shipping conferences are associations of shipping firms operating on the same route that are engaged in fixing freight rates and regulating capacity. Some of these conferences coordinate sailing schedules or create exclusive territories. However, some resort to a ‘pool’ mechanism whereby each shipping firm is assigned a percentage of the total business.

Shipping conferences were once justified on the ground that competition is not sustainable but destructive, and it would drive down rates to un-remunerative levels and throw firms into bankruptcy or leave only a monopoly which would be worse than the cartel itself. On this ground, shipping conference gained conditional immunity from competition laws in US, UK, EU and Japan.

One of the oldest shipping conferences in the world is the India Pakistan Bangladesh Ceylon Conference (IPBCC) that operates on the routes between India and Europe, controlling about 75% of the traffic. It has 18 members, the vast majority being foreign shipping lines. Shipping Corporation of India is also a member. It is alleged that IPBCC fixes freight rates and other charges like terminal handling charges, bunker adjustment factor and currency adjustment factor; the effect of which on prices is substantial. Under a rate restoration initiative, the conference increases rates from time to time. It increased freight rate effective from May 1, July 1 and September 1, 2007. Given the market power of IPBCC, its rates are said to be the standard for non-conference members also.

Given the fact that 95% of India’s global trade by volume and 70% by value is seaborne, the impact of cartel type activity by IPBCC on the competitiveness of Indian exports and the cost of India’s imports can be huge. India’s new competition law, the Competition Act, 2002, provides for no exemption for the shipping conferences. It regards cartels as a serious violation, which is ‘presumed’ to be anticompetitive. The Competition Commissioner of India has drawn the attention of the shipping conferences to the new law and urged them to discontinue cartel practices.


Implications of competition regulations

Industry needs to actively consider the impact of Competition Act, 2002 as amended by the Competition (Amendment) Act, 2007. Before discussing the impact of the Act, it will be useful to give basic features of this legislation.

Like other comprehensive competition law regimes, the Act mainly deals with three areas, viz:

prohibition of anti-competitive agreements; prohibition of abuse of dominant position; and regulation of combinations (Broadly, combination includes acquisition, mergers and amalgamations exceeding the thresholds specified in the Act in terms of assets or turnover).

For the purposes of the Act, the Competition Commission of India has been established. In terms of the Act, it is the duty of the Commission to eliminate practices having adverse effect on competition, promote and sustain competition, protect the interest of customers, and ensure freedom of trade carried on by other participants, in the markets in India. Thus, the Commission has a pivotal role to play under the Act.

In addition, the Act gives the Commission the responsibility of undertaking competition advocacy.

It is important to note that the Act empowers the Commission to inquire into agreement, dominant position, combination which has, or is likely to have, an appreciable adverse effect on competition in the relevant market in India. The Commission is undertaking ground work that will be required to commence the inquiry and regulatory work.

Besides the Merger & Acquisition, commercial agreements may also be looked into by the Commission in case such agreements raise competition concerns under the Act.

But, the Act expressly recognises that the provisions relating to anti-competitive agreements shall not restrict the right of any person to restrain any infringement of, or to impose reasonable conditions, as may be necessary for protecting any of his rights which have been or may be conferred upon him under various Intellectual Property Rights (IPR) statutes mentioned under the Act. However, we can say that unreasonable conditions incorporated under the IPR agreements do not fall outside the jurisdiction of the Commission.

In these circumstances, compliance with the Act is important. Further, the consequences of non- compliance may be serious for any business in terms of significant financial penalties; agreements being declared void; adverse impact on M&A deal including directions by the Commission that the combination shall not take effect or directions that the parties to such combination to carry out necessary modifications to the Combination; and loss of reputation and goodwill.

It is therefore, important for the industry to assess the impact of the Act on its business operations by way of reviewing their commercial agreements from competition angles. Similarly, enterprises enjoying dominant position must be cautious in their approach while conducting their business operations so that there is no abuse of dominant position in terms of the Act. Further in case of M&A deals, industrial players need to access the deal from the competition angle at the earliest opportunity in the deal negotiation process.

Implications of competition regulations




An analysis of some real estate booms and busts

The subprime crisis in the US, which has affected banks and markets across the world, has again highlighted the relationship between real estate and bank credit and the ramifications it has for the economy. An analysis of some of the real estate booms and busts of the past century exposes a strong correlation between banking activity and the real estate. The two are remarkably correlated in a number of instances. The speculative real estate booms followed by sudden bursts were due to banks lending on liberal terms and underestimation of the risk profile of borrowers.

1920s’ Florida land bust

The 1920s was one of the most prolific economic periods of American prosperity. The chain store movement revolutionised retailing and consumer products became affordable for the masses. Cars became the symbol of a new consumer culture. Easy availability of credit for automobiles spurred sales by 300% in a decade. Banks started to offer mortgage loans and their easy availability – often on liberal terms – resulted in frenzied real estate activity in Florida, pushing up property prices to unprecedented levels.

It all came crashing down on September 18, 1926 when a powerful hurricane slammed high winds and surging floodwaters. The huge task of rebuilding and the financial losses inflicted by the hurricane caused thousands of residents to abandon their new homes and return to northern cities. Thus, the Florida land boom cooled. Florida entered the Great Depression in 1926, three years earlier than the rest of America with the Florida land bust and did not recover until 1941.

1980s and the S&L debacle

In the late 70s, when the US witnessed double-digit inflation rates, real estate was viewed as a hedge against inflation. It was also around this time that the savings and loan (S&L) industry was deregulated and it began lending to commercial real estate, an area where the industry did not have sufficient experience. The industry lent too many third and fourth tier developers who built poorly-conceived projects.

According to the IMF study, the federal income tax code was also revised in 1981, which strongly favoured real estate investment from the tax shelter perspective. Soon after Paul Volcker took over as Federal Reserve chairman in 1979, he went for monetary tightening to control inflation, which pushed up interest rates. The Federal income tax code was again changed in 1986, severely limiting the tax shelter aspect of real estate. Many developers and investors could not repay their loans to the S&L industry. A combination of rising interest rates, deregulation, and real estate volatility, lack of regulatory oversight, mismanagement and overt fraud cases led to the crisis. The result of the 1980s building boom and the subsequent bust was the S&L crisis, which finally led to a bailout by the federal government in 1989.

Japanese bubble burst

Japan faced its worst banking and real estate crisis in the early nineties. Six trillion yen worth of loans by housing lenders who had borrowed heavily from banks and agriculture co-operatives turned bad. Seven of the eight mortgage companies slipped into insolvency.


In the 1980s, when Japanese economy soared due to its export incomes, the country deregulated its financial system. Faced with new competition, lenders turned to real estate developers, who were willing to pay higher rates than individuals. The market crashed in 1990 after the government put curbs on loans to developers. After peaking in December 1989, the Japanese stock market plunged over the next nine months to nearly half its value. As Japan entered its worst recession in decades, commercial real estate, lost nearly half value. Japan slipped into a decade-long recession.

Realty and the Asian crisis

More recently, in 1997, real estate speculation compounded the Asian currency crisis. Experience shows that financial liberalisation, through potentially beneficial, can be risky if undertaken in a fragile financial environment. For instance, a developer who borrows to invest in real estate and pledges land for collateral would put the lender at double the risk if property prices witness a sudden collapse. An underdeveloped Asian market made it easy to conceal unreasonably high property valuations and borrowers gained greater leverage by mortgaging properties at inflated assessed values.

The proceeds of these transactions were invested heavily in new businesses as well as expansions in the existing lines of business. By the mid 1990s, the size of the real estate sector was huge, relative to the size of these emerging economies. It was estimated that in 1997, the value of real estate in the Bangkok metropolitan region was almost half as large as the GNP of the entire economy of Thailand. Lending institutions operated under implicit guarantees, which created a moral hazard. Poor management within financial institutions too was a major source of fragility. Thus, the absence of effective market discipline and inadequate prudential regulations led to poor quality of bank’s asset portfolios.

US subprime crisis

The initial trigger for the US subprime crisis was increasing delinquencies in the US mortgage market. Highly leveraged lending against rapidly rising house prices boosted the crisis. As house prices slumped in 2006, delinquencies and defaults on subprime mortgages soared, despite a benign economic backdrop. When housing price rose, borrowers with poor credit history had the option to sell their property and square off their loans.

But when prices slumped and interest rate rose, many borrowers defaulted. This had a cascading effect on banks and hedge funds, which had mortgage-backed securities and collateralised debt obligations. Hedge funds specialising in subprime mortgage-backed securities took huge losses.

Although real estate comes across as a solid security, experience shows that real estate prices are prone to cyclic phenomena. Moreover, in countries where lending has been liberalised recently, lenders do not have the ability to assess the risk profiles of borrowers. This makes the financial system very fragile, as lending is not made on the basis of risk.


Residex: Realty needs indices similar to equity market

The real estate industry in India has been growing by leaps and bounds in the past few years. However, the country still lacks a credible way to cross-check the price swings (real or reported) in the sector. For example, recent reports of residential prices cooling off in major cities of the country could not be verified. There was no authentic data to indicate such a trend. Thus, property buyers remain confused, not knowing, for instance, whether Mumbai property prices fell more than that of Delhi?

The same does not happen with equity investors. If, at the end of the day, anyone wants to know the day’s market trend, he could visit BSE/NSE website or see next day’s newspaper to know the exact rise or fall of Sensex or Nifty. And nobody questions the authenticity of Sensex or Nifty as a barometer of market sentiments. With years of index publishing, a sort of credibility and association has been built with the equity investors by these financial institutions.

Could National Housing Bank (NHB) replicate the same with various real estate stakeholders – government and policymakers, builders, individuals and housing finance industry? Could it start making its real estate index figures (Residex) public, say every three months?

NHB made a beginning in this direction in 2005 when it launched a project for preparation of the real estate price indices for the residential housing segment. NHB-Residex. To start with, the project envisaged compiling the indices for 10 cities – Greater Mumbai, Kolkata, Delhi, Chennai, Bangalore, Hyderabad, Ahmedabad, Kanpur, Jaipur and Patna. It also gave price appreciation figures for major cities at the time of the launch of the Index.

However, getting data from NHB has been tough for analysts.

With various mutual funds planning to soon launch real estate funds, it is imperative that a reliable index data, preferably from a government body like NHB, is made available to act as a benchmark.

Capturing real estate prices in India has its own challenges. Thanks to different types of housing that are made available by builders, there are large variations in property price in a single locality. It is difficult to put a single price to a locality which has difficult class of houses, say premium as well as low cost.

However, NHB with its wealth of information on loan disbursements and other crucial figures could do a lot for the industry. Since most financiers would have data on a citywise basis, it could be shared with NHB for internal index calculation purposes. If NHB cracks the same, it could be one big step towards making the industry more competitive.

Residex: Realty needs indices similar to equity market



How you can beat inflation

Someone has aptly said that inflation is “taxation without legislation”. Inflation is manifested by increase in price of goods and services. Assuming a fixed income, an increase in price of goods and services that are consumed by us in our-daily lives reduces our purchasing power, forcing us to adjust our living standards and spending pattern accordingly. It is the fixed income earners, for example, retired individuals, living on their pension and other annuities, who get most severely impacted by inflation and rising prices as they are unable to raise their incomes in tandem with rising prices.

Wage earners are comparatively better off since they can expect some level of wage increase to compensate for rising prices. However wage earners have to consider the long term impact on the savings they need to accumulate over their working lives, to be able to enjoy comfortable post-retirement life. People say that the current inflation is a temporary phenomenon and the government is taking various measures to control it. However, we should take a few steps to combat the price rise.

Cut the avoidable expenses We love spending money and most of our purchases are impulsive – a shirt spotted in a shop window, an interesting coffee table book…the list is endless. However, we should curtail some of these or the periodicity of such expenditure. We know we have to keep our monthly spend constant. It can be done without making too many sacrifices, with a bit of discipline and smart spending. We now look for bargains, defer expenses that are not necessary and just a bit more conscious of what we are spending our money on.

Don’t let the savings idle We are prone to having a cash-heavy saving account which earns nominal interest, not enough to beat inflation. We should start putting our savings into fixed deposits which gives us a higher return. We can also opt to put some part of our savings into 12 months fixed maturity plans (FMPs) as they generally give a return higher than fixed deposits and are relatively safe investments.

Invest in equity Generally, the returns from equity have beaten inflation. While the state of the stock market does not generate too much confidence, we may consider going in for a systematic investment plan (SIP) and divert a small portion of our savings into equities.

Review savings & retirement plans Most investment plans pertaining to retirement assume a certain rate of inflation to arrive at how much to invest on a current basis to arrive at the target income stream after retirement. We should speak our financial planner to see if the current inflation rates necessitate an increase in how much we put aside today to live comfortable tomorrow.

People could tell us that the inflation will soon be under control and one need not to press any panic button as yet. But we should not be so sure. We should rather tighten our belts now than repent later for not taking remedial measures at an appropriate time. As an old saying goes, “a stitch in time save nine”.


Rising rupee: Need of innovation driven processes

The appreciating rupee is posing a unique set of challenge for the Indian economy. The impact would not be limited to the macro-economy alone but moves down to the level of firms. To counter the challenges, the government needs to rework its economic policy and the firms their business models and strategies for success. The initial success story of India was clearly built on labour arbitrage i.e., the ability of India to provide low-cost labour in comparison to other countries across the globe.

India – a factor-driven economy: A factor-driven economy is one whose competitiveness is primarily its low-cost labour and exports. One of the unique features of firms operating within factor-driven economies is that they produce products that are designed and conceptualised in advanced countries. The strategy at the genetic level for firms is to compete globally to provide significant price advantages. In addition, the firms focus on labour-intensive manufacturing and processes. An economy at this stage of development is sensitive to global business cycles and most importantly exchange rate fluctuations.

The success of firms in IT and KPO is significant, though the companies operate at the low end of the value chain. Now, IT companies are changing their work culture. The changes range from longer working hours per day, six-day working week and reduction in the percentage of salary hikes. With a sudden spike in the rupee, the operating margins have drastically reduced by around 14% in the last year alone.

India’s growth story is co-terminus with the rise of services sector that shifted gears to a high growth momentum in the year 2001. The rupee appreciation shaved off a large portion of the operating margins. This can also have a significant impact on the status of India remaining a low-cost destination for outsourcing. There is an imminent danger of foreign companies shifting work to other emerging locations that are willing to provide low-cost labour and other cost advantages.

The challenge that the Indian economy faces is not that of an economic bubble burst but of moving on to the next growth trajectory and economic development. India has to embark on a journey that will take the country to an investment-driven stage (efficiency driven) from the factor-driven stage (input cost) and sowing the seeds for catapulting India into an innovation-driven economy (unique value).

To be an investment-driven economy, India will have to significantly invest in infrastructure, improve the skill sets of its workforce and make investments that translate into tangible productivity across the board. Only those firms that have the capability to improve technology and move higher up in the value chain would weather the demands of this stage.

India will have to definitely accelerate its reform processes and start working to become an innovation- driven economy, as that would determine whether the country would become a developed nation by the year 2020. The focus should be on building processes that would be driven by innovation; this would make the economy resistant to external shocks and vagaries of economic cycles and currency fluctuations. The bottom line is: our policies should concentrate on enhancing our capability in manufacturing, promote entrepreneurship, and provide incentives for innovation. Last, but not the least, if economic growth has to be sustained, authorities should facilitate infrastructural expansions.

Rising rupee: Need of innovation driven processes



1. Conservative slant

The Indian insurance industry has truly come a long way. From being providers of tax planning instruments to introducing concepts of retirement planning, wealth creation etc, customers are strengthening their ties with this industry every passing day. Today life insurance is among the fastest growing industries in India.

Life insurance companies are fundamentally mobilising small savings for either retirement or other goals. Today, life insurance has earned the valuable tag of being the destination of funds for important goals. To ensure this, insurance companies adopted a conservative slant, while planning these investments and will always go for steady increments than bold risky swings in their fund values.

Hence, when making investment decisions for the portfolio, the idea is not to maximise potential gains by assuming any level of risk, but to seek best returns after adhering to some pre-defined norms on risk.

The customer buys the product when he wants to systematically provide towards a specific important goal, be it for their child’s education, accumulating a retirement kitty, or wealth creation. Hence, the majority of them regularly take money out of their monthly or annual income to make contributions towards the goal, over an extended period of time. It’s a product that they do not interact with frequently, but yet hold for 15-20 years.

In a nutshell, life insurance is usually the hedge in a customer’s portfolio, promising a goal for a passive, low-ticket investment that stays invested for a long time.

Keeping in mind the customer behaviour of making small savings, insurance companies focus on asset allocation rather than market timing or asset selection. The reason is simple, while returns in any single year from a specific asset class can be superior to other asset classes, but over a longer period, the average returns are primarily determined by asset mix in the portfolio. We all know that market timing is not very rewarding for the cost we incur in trying to do it. The orientation then is not whether you should have equity this year and debt the next, but to develop and adhere to an optimal asset mix.

For any long-term passive, regular, small-saver, the smartest thing to do is also the simplest. Stick to a pre- defined asset mix that reflects one’s risk tolerance, rather than switching between asset-classes.

The most critical norm insurance investment managers follow is that the whole investment management has to be process driven with adequate stress on risk management. Investment policies of life companies are designed to enable policyholders meet their respective financial goals, while ensuring that the government is adequately funded for long-term projects. When it comes to long term systematic investing, patience and sticking to methods are the more important tools.


2. Insurance regulator

Complex unit-linked products

Insurance regulator IRDA has banned sales of complex unit-linked products, which involve actuarially funded units. Actuarially-funded units or capital units have a sophisticated structure, where the insurance company allocates significant sums to the policyholder’s account in the first year. However, these initial allocations are notional i.e. in the form of actuarial units, which convert into real money only in the future. IRDA chairman CS Rao said, “There is lack of transparency in these actuarially funded products, and we are concerned that policyholders may suffer. These units are not totally backed by actual investments, and hence, actual expenses are loaded at a later stage of the policy.”

The ban will adversely affect the country’s second-largest private insurer Bajaj Allianz Life Insurance which generated most of its premium through sales of such products. And Bajaj Allianz Life Insurance had managed significant profits because of this product. It will also affect Aviva Life Insurance, the only other company to have similar products. Both the company insist that over a period of time, there is no disadvantage to the policyholder vis-à-vis regular unit-linked policies.

Following complaints from rival companies, the regulator decided to have these products re-examined by a committee of actuaries. The committee found that the level of transparency in this product was low while its complexity was high and decided that such products do not suit the Indian market. The regulator has decided to go along with the recommendations of the committee of actuaries.

IRDA sources said one reason why the regulator chose to ban the product rather than insist on better disclosure norms was concerns over rampant mis-selling. With over two million agents now selling insurance, the regulator has decided to standardise terms to make it easier for policyholders to understand costs and risks. Actuarially funded policies increase the complexity.

Insurance companies’ brass must pass IRDA lens

Chief executive officers (CEOs), managing directors (MDs) and whole-time directors of insurance companies – both private and public sector – will now need prior consent of the IRDA if they wish to quit. And that’s not all! IRDA wants to ensure that insurers hire “able person” at the helm to run such companies. This means insurers will need IRDA approval to recruit whole-time directors, MDs and CEOS.

IRDA chairman said: “We want to make sure that executives being recruited are fit to ably run insurance companies. In case of recruitment, we will conduct the due-diligence while in the case of a resignation; we would like to know why a person is leaving and if there are any other aspects.”

The Insurance Act of 1938 provides for such prior clearance from the regulator and is practised in the banking and mutual fund industry. But, I guess, the clause was not being followed in true sprit in the insurance sector. In case IRDA does not clear, an appointment, re-appointment or termination of appointment of CEO, whole-time directors and managing directors in any insurance company will be considered invalid.


Death bond: life settlement-backed security

The anaemic US housing market has hurt various industries and players in finance reporting their top lines have been bruised by the slowdown. As the subprime mortgage market was cracking many of the biggest players in finance, they gathered at a conference in New York to talk about the next exotic investment coming down the pike: death bonds. They were there to learn about new and imaginative ways to profit from people dying.

It’s an investment concept as Wall Street has ever cooked up. Some 90 million American own life insurance, but many of them find the premiums too expensive; others would simply prefer to cash in early.

Life settlements are arrangements that offer people the chance to sell their policies to investors, who keep paying the premiums until the sellers die and then collect the payout. For the investors it’s a ghoulish actuarial gamble: The quicker the death, the more profit is reaped.

Small local firms called life settlement providers, which in the past have typically sold the policies to hedge funds, do most of the transactions. Now, Wall Street sees huge profits in buying policies, throwing them into a pool, dividing the pool into bonds, and selling the bonds to pension funds, college endowments, and other professional investors. If the market develops as Wall Street expects, ordinary mutual funds will soon be able to get in on the action, too.

But the investment banks are wading into murky waters. The life settlement industry increasingly finds itself in the grip of dubious characters devising audacious and in some cases illegal schemes to make money. Many are targeting elderly people with deceptive sales pitches – so many that the National Association of Securities Dealers has issued a warning about abusive practices. Others are promising investors unrealistic returns or misleading them about the risks. Some are doing both.

However, that didn’t discourage the high-powered guests at the New York conference. Wall Street firms know that death bond is an asset class. There is a big potential. Firms say death bonds should return around 8% a year, right between the expected returns of stocks and Treasury bonds. Moreover, they’re ‘uncorrelated assets,’ meaning their performance isn’t tied to what’s happening in other markets. Uncorrelated assets like these are highly prized in an increasingly connected global financial system.

It all sounds great, except that many of the life settlements fall into categories ranging from sketchy to toxic. And they are creating a very risky product. Many life settlement providers, for example, are trying to lure people who don’t hold insurance. In this tail-wagging- the dog scenario, speculators take out policies on the individual’ behalf, pay them something up front, cover the premiums, and then wait for the people to die so they can collect.

The eight-year-old industry certainly has an ignominious history. It grew in 90s amid allegations of fraudulent dealing with AIDS patient and other terminally ill people. As AIDS spread during 1980s, patients turned to this market to unlock insurance money to pay for care. But advances in medicine in the 1990s extended patients’ lives, making it less profitable for buyers. At the same time, the industry was rife with abusive sales practices that drew the attention of prosecutors. By 1999, business had almost dried up.

Death bond: life settlement-backed security