1.

ILL-CONCEIVED STATEMENTS
Something missing

US President George Bush’s statement that rising food consumption in fast-growing India and China is a
major cause of the rapid increase in world food prices is both ill-timed and ill-conceived. The statement
comes at a time when there is a need for food-production and cooperation in easing global supply and
distribution of food.

Currently many food-producing economies have gone somewhat into a panic mode and are putting curbs
on grain exports. It is a problem that needs a rational global response. The US could have played a
positive role in this. Bush’s statement will not help the cause at all. On the contrary, it may provoke some
food-producing countries to put further restrictions on trading of agricultural items.

Bush’s statement lacks the rigour of facts. The United Nations data released by Food and Agriculture
Organisation (FAO) reveals that American cereal consumption has grown close to 12% since 2006
compared to less than 2.5% increase in cereal intake by India and China, the world average being 2.6%.
So, cereal consumption in the US is way higher than the world average, largely because it has been
encouraging diversion of large quantities of grains like maize, into bio-fuel production.

The classic theory of demand, the foundation on which other principles of economics are built, states that
prices are determined, other things being equal, by the demand and supply forces in the market. The
current spiralling of agricultural commodity prices is also by and large ‘justified’ on the same logic.
However a look at the supply-demand data of agricultural commodities reveals a different picture: the
global scenario has not changed that drastically to warrant such spiralling prices.

There have been umpteen columns analysing the effects of substitution, diversion of food crops for bio-
fuel, etc. on prices. Still something was missing in the whole casual loop till the subprime crisis in the US,
and the recent sharp fall of sensex. These events bought out the definitive link between the financial
market and the commodity market and provided the missing plank. The link is the speculators, whose
needs are simple: just need to make money. So when the financial sector is in the mood of embrace them
in its bearish hug, they deftly move away and sit on the bull riding high in the commodity market! And
they are not disappointed.

However, what is important is the impact of their games on the real economy. As players in the financial
market, their activities do not impact the real economy much; in fact everybody is happy when the sensex
is northward bound. The same activity in the commodity market, however, brings cheer to only those
players. This is because the underlying is a commodity that is very much ‘real’. Add to this the impact of
substitute. For example, crude prices breached the $ 135 per barrel mark mainly due to speculators. This
led to a greater demand for its substitute, namely bio-fuel products, which in turn increased their raw
material prices and fuelled more speculative activity in the now booming commodity market.

Earlier it is said that unlike the real sector, the financial sector is global and shocks are felt immediately.
However, the recent experience in both the financial and the commodity markets prove otherwise. The
shocks felt at CBOT or BURSA gets transmitted, in real time, across the globe, whereas the shocks of the
US subprime crisis is being dissipated with a definite delay. So, the impacts of commodity shocks are far
reaching and fast. What is needed is to develop the immune systems in order to provide a protective shield
against the ‘vagaries’ of markets; a sort of decoupling of the real and financial sectors domestically, at
least. Our immune system lies in the development of the real sector. Growth led by growth in financial
sector will certainly boost the overall GDP, but may not sustain without growth in the real sector.
 ILL-CONCEIVED STATEMENTS

US official adds fuel to Bush fire

The perpetually outraged in the political spectrum got fresh ammunition for their anti-US rhetoric when
the White House faulted India and China for the surge in oil prices. The statement comes on Tuesday, 6th
of May ’08 – three days after politicians here interpreted a statement of President Bush – growing
prosperity and increased consumption in India and China was one of the factors contributing to the food
shortage – as a US diktat to eat less.

White House deputy spokesman Scott Stanzel said to calm the frayed nerves over President Bush’s
remarks saying the US saw “higher living standards” of people in India as a “good thing”. Three days
ago, President Bush had referred the case of Indian middle class to argue that its demand for better
nutrition was a factor in pushing the global food prices up. “There are 350 million people in India who are
classified as middle class. That’s bigger than America. Their middle class is larger than our entire
population. And when you start getting wealth, you start demanding better nutrition and better food, and,
so demand is high, and that causes the price to go up.”

Clarifying President Bush’s remarks on Indian’s food habits, Mr Stanzel added: “We think that it is a
good thing that countries are developing; that more and more people have higher and higher standards of
living. The point that I think was to be made is that as you increase your standard of living, the food that
you eat can venture more into meats that require more commodities to feed the livestock which, you
know, uses more of those commodities, whether it’s corn, or wheat, or other commodities and it drives up
the price. So that is just a function of how those food prices that we’ve seen spike around the world.”

IMF blames India, China for rising commodity prices

After the US President George Bush and White House deputy secretary Scott Stanzel, it now the turn of
the International Monetary Fund (IMF) to blame India and China for rising global commodity prices.

Warning that the recent pickup in inflation rates around the world in part reflected the impact of higher
energy and commodity prices, IMF first deputy managing director John Lipsky said that the demand for
commodities has remained robust because of strong growth in emerging and developing economies, led
by China and India. These economies’ growth is more energy- and commodity-intensive than that of more
developed economies.

In fact, emerging and developing economies as a group have accounted for about 95% of the growth in
demand for oil since 2003. As spare capacity and inventories have dwindled, the oil market has become
highly sensitive to news of supply disruption and geopolitical events. This has pushed oil prices all-time
highs in real terms, surpassing their 1979 peak.

The IMF also forecasts that food prices will remain high. “With only temporary relief likely, we expect
that agricultural prices will remain high for the foreseeable future, as supply responses may require both
new investment and policy reforms. This will take time”.

Hopefully, the inflationary impulse from higher food prices will wane, even if prices do not retreat
significantly. However, this also indicates that the humanitarian challenges of higher food prices will not
disappear anytime soon.
 ILL-CONCEIVED STATEMENTS

Lipsky warned that the recent pickup in inflation rates around the world in part reflected the impact of
higher energy and commodity prices. “This inflation speed-up must be taken seriously as it creates
potentially significant challenges to economic stability that could undermine prospects for resorting the
combination of solid growth and low inflation that prevailed earlier in the decade”. To put the issue
starkly, inflation risks have reemerged as a global challenge following a long absence.

He called on governments to initiate steps to encourage investment in energy, reduce biofuel subsidies
and improve agricultural policies. He said the IMF was also working to help developing countries that
have been worst affected by the commodities hikes and to develop strategies that can be adopted by
member countries. Lipsky said that, in the IMF’s view, policies will need to adjust both to the reality of
permanent relative price shifts and, in some cases, to a broader resurgence in inflation.

BRIC meeting scheduled to find solution

At a time when the US and EU are blaming food and oil shortages on countries like India and China,
foreign minister of India, Brazil, Russia and China will be meeting soon in a small town in Russia to
discuss the issue of biofuel, energy security, food security, global financial trends, and impact of the
slowdown of the US economy.

Food security and increasing prices were bought into the international limelight when food riots broke out
in some parts of the world. The developing countries have argued at the WTO that the fault lies with
industrialised countries which are using agriculture subsidies to undercut the agriculture output of other
countries leading to reduced food production.

India is likely to argue that one country cannot be held responsible for the rise in food prices and there is a
need for a global approach to resolve the issue. In this scenario, the meeting of the BRIC countries comes
at an opportune time and is being seen as an opportunity for the four countries to provide their own
assessment of key economic issues facing the world.

Plan, Preserve or Parish

We are watching the death of just-in-time (JIT) school of inventory management. Since the beginning of
agriculture, farmers have recognised the need to manage stocks of grains to prevent starvation in times of
scarcity. In the Hebrew Bible, the Egyptians were directed to stockpile seven years of harvests in
preparation for seven years of famine.

We hadn’t come too far from that. To ensure food security, many countries stockpiled strategic gain
reserves. Grains are an easy-to-store and nutritious way to provide the basic needs of a population facing
a food emergency until alternative food supplies can be arranged. But in the late Eighties, management
Gurus began chiding companies for locking up resources in inventories. The guiding principle was don’t
waste time, energy and cash in stockpiling inputs when you can get suppliers to deliver at the precise
moment your factory needs them.
 ILL-CONCEIVED STATEMENTS

To be fair, JIT did appear to make sense 10 years ago. With rapid developments in IT, freight handling,
shipping and ample supply; it was the sensible thing to do. At around the same time, IMF and the World
Bank began preaching the wisdom of liberalised agriculture trade. So governments in the world’s top
grain consuming and exporting nations brought into the JIT-argument.

The US dismantled its strategic grain reserves with the 1996 Farm Bill. By year 2000, China had
discarded its low-quality, low-value grain reserves. India reduced its buffer stock norms in 2004. The EU
had intervention stocks of 16.5 million tonne at the start of 2005-06. By April 2008, they were whittled
down to only 236,000 tonne corn held in Hungaria. Overall, the EU grain ending stocks in 2007-08 will
be down to 27.1 mt compared to 46.1 mt just two years earlier, all of this in commercial hands.

For the private sector, the cost of holding stocks, use of JIT and years of readily available global supplies
provided incentives to reduce stock holding. Over the last decade, the shift toward more liberalised trade
reduced trade barriers and facilitated trade, which in turn reduced the need for individual countries to hold
stocks. Since 1999, the global stock-to-use ratio for the aggregate of grains and oilseeds declined from
about 30% to less than 15% currently.

But it took only 24 months, a bull run in crude oil and a couple of bad harvests to bring votaries of JIT to
their knees. Any policy maker today, banking on just-in-time delivery of food or raw materials can only
appear quixotic. It’s simply too dangerous. The global aggregate stock-to-use ratio for grains and annual
oilseeds is the lowest since 1970. Stocks in major exporting countries are particularly low. Obviously,
importing countries are anxious because they now have fewer sources. Even a relatively small import
order from Egypt makes CBoT jump. This has scared importing countries into buying additional supplies,
even at record high prices.

In Asia, the World Bank constantly assured the Philippines, even as recently as last year, that self-
sufficiency in rice was unnecessary, and that the world market would take care of its needs. Now the
government is in a desperate plight: Its domestic supply of subsidised rice is nearly exhausted and it
cannot import all it needs because traders’ asking prices are too high.

When there is no guarantee of how oil prices, weather, politics or hedge funds will move tomorrow, how
do you feed your population? The answer is suddenly staring at us in the face.

Across the world government are junking JIT. Stocking up is the new mantra. There is a clamour to
increase strategic grain reserves in the US, China, Russia, Indonesia and India, to name a few.

As, Dennis Olson from the Institute for Agriculture and Trade Policy says: “Strategic reserves would help
reduce the dangerous volatility that can harm everyone”. Simultaneously, the market is slowly realising
that it needs to pay people to hold stocks to be consumed in future. Traders are showing a willingness to
pay carrying cost in grains such as wheat to help build up inventories. You can see that in the way price
of far month contracts is slowly rising above expected future spot prices.
 ILL-CONCEIVED STATEMENTS

Crude prices at record high

The inflation is the name of the game. The fires of oil prices surges sweep across the globe and nobody
will come out unscathed. But there will be winners and losers. Crude oil at $ 135 per barrel – this is the
stuff of fantasy for the commodity punter and a nightmare for the rest. The explanation put forward for
why price of oil has been going up so much can be categorised into: rising demand from India and China;
fear of supply disruption, i.e., geopolitical risk; fall in the US dollar; and thin supply cushions because
inadequate investments were made in the nineties when oil prices were falling.

However, these arguments do not explain why oil prices are where they are. Global demand for oil
between 1980 and 2003 grew by 1.3% to 1.6% per annum. In 2004 it soared 3.9%, mostly because
Chinese consumption jumped and partly because US consumption rose. In 2005 world demand growth
was more again modest at 1.7%. In the course of these two years, crude oil prices doubled. In US dollar,
this at the end of 2005 was $ 61. In 2006 world demand grew by 1.1% and in 2007 by just 0.9%. But price
today has touched $ 135/bbl. Thus while world oil demand rose by just 1% p.a. crude prices shot up more
than double in US dollar terms over the past two years.

So, first, oil demand at the aggregate level has not been blowing. Second, the geopolitical risk, there were
tensions and conflicts aplenty in the past several years; thus there is a kind of plausibility in the argument.
Till November 2007 there was a risk of something happening about Iran and this was offered up the
reason for oil rising past $ 90/bbl. Since the US National Intelligence Estimate cleared the air on that, and
with conditions in Iraq clearly improved, there is no current crisis that can be used to explain ‘geo-
political premiums’. There is some substance to the argument that investments lagged in the nineties, but
hardly adequate to explain why output cannot keep pace with demand rising at 1% annually.

The answer lies elsewhere. To reverse the decline in oil prices in the fall of 2006, after the Lebanon war,
OPEC cut its production quota by 1.2 mb/d in November 2006 and by another 0.5 mb/d in February 2007.
That is a total of 1.7 mb/d, taking 2% of global output off the market. Normal market forces thus have
nothing to do with this calculating and adept leveraging of monopolistic powers in a market where the
negotiating powers of the consumer nations are depressed. Oil exporters have discovered that the inept
consumers of today can live with $ 100 plus /bbl. The waters have been thoroughly tested at $ 60, $ 70, $
80 and now $ 100, $ 110, $ 120, $ 130 plus per barrel.

The whole idea thrives on scarcity : When we speak of ‘future trading’ in commodities, we may be
referring to a situation in which traders and hoarders buy out the produces cheaply and then raise prices
by creating false scarcity. The most appropriate, and therefore the worst, example of this has been the
astronomical rise in the price of crude oil. A US senate panel has not only conducted an enquiry but also
has come to the definite conclusion that the uncontrollable surge in crude prices is without doubt the
outcome of Hedge funds having taken bets worth $ 12 trillion and more on oil futures. That this could
raise the price of crude to over $ 200 a barrel in the next four to five months seems no longer an
implausible or impossible proposition.

An April 24 report on the Dow Jones online Financial News notes that oil speculators have offered to buy
more than the producers can produce, and even artificially raising prices among themselves. This spike,
clearly, has nothing whatsoever to do with the actual scarcity or not of a commodity. Commodities are
being traded on in this profligate manner because stocks and shares have failed to deliver.

Crude prices at record high

2.1 SECURITY MARKET
“Great returns are invariably made by investing amid panic and pessimism”

Equities have traditionally outperformed all assets classes over a longer period of time. In a growing
economy like India, exposure to equities is essential in the overall asset allocation of every investor. Of
course, many investors know this. But there are still many others, who haven’t joined the ‘ring’ as yet,
waiting for an opportune time. In fact, the recent correction from the heady level of 21,000 is an
opportunity that first-timers need to capitalise on.

Yes, the times are uncertain and markets have been highly volatile. But remember most successful
investors have made money by investing in uncertain times. That’s because perceived risk and actual risk
seldom go hand in hand. At 21,000 Sensex level, the actual risk was much higher but optimism was at its
peak. Similarly, at around 15,000-16,000 levels (with a correction of close to 25% in the benchmark index
and that of around 30-40% in many fundamentally sound stocks), the actual risk was far lower but
pessimism was written all over. Clearly, sentiments tend to overshoot fundamentals in both the directions.

Notwithstanding the recent correction and continued volatility, the long-term bullish outlook on equities
in India remains intact. Fundamentally, even after factoring in the recent deterioration in the macro-
economic environment domestically, India would continue to be among the fastest growing economies
with a growth of around 8% in 2008-09. The GDP growth would be supported by the continued upturn in
the investment cycle, spending on infrastructure and industrial capital expenditure. On the other hand, the
demand push will be aided by boosting consumption through a lower personal tax and the implementation
of the Sixth Pay Commission’s generous recommendations.

The reasonably decent Q4 results and expectations of a normal monsoon this year should provide the
required trigger for bringing about a change in the overall market sentiment. Consequently,
notwithstanding the volatility in the short term, we believe that Indian equity markets will provide
handsome returns and outperform the other asset classes in the longer term. Keep the faith.

APRIL 2008:
Inflation fails to dent market mood

The Indian stock markets seem to be outperforming even as inflation is hitting new highs. India
outperformed the emerging and Asia Pacific markets in April ‘08 after three successive months of
underperformance finished the month as the sixth best performing emerging market.

However, India has been among the worst performing emerging markets since the beginning of the year
and despite the strong performance in April, year to date, India ranks twenty third out of 25 emerging
markets, according to Morgan Stanley.

According to the Morgan Stanley, FII flows in the future market remained strong in April ’08 for the
fourth month running. Domestic institutions turned into marginal buyers after large scale selling in
March. FIIs have bought $ 6.5 billion worth of stocks and derivatives since the start of 2008 (12% higher
than the corresponding period last year) whereas domestic institutions have bought $ 1.6 billion.

In April, cash trading volume (number of shares) rose 8% month on month (MoM), after falling for three
successive months, although it is still off 40% from its December 2007 peak. Trading volumes in value
also rose by 3% MoM, but they are still 44% below is January 2008 peak. Market breadth gained a further
27% MoM in April but remains 27% below its January high.
 SEURITY MARKET

1st week of May ‘08 – trade on single day out of two – Sensex shoots up 313 points to 17,600

Inflation fully discounted again: Inflation rose yet again – to scorching 7.57% for the week ended April 19
– registering a 42-month high. However, there are some signs that the rise in the price index is
moderating. Strong procurement of wheat to the tune of 154 lakh tonnes for the government’s buffer stock
is likely to dampen inflationary expectations somewhat. Reacting to inflation numbers, Finance Minister
provided hope by saying current inflation is likely to be contained.

It may appear that above a certain point, inflation is actually a good thing for the stock market. Even as
inflation climbed to a 42-month high; Sensex shot up 313 points on Friday. Markets again discounted
inflation concerns with global markets showing signs of stability. On 30th April, the Reserve Bank’s
surprise decision to keep the key lending rates steady in its annual monetary policy had cheered the
market. Another major development was the Federal Reserve’s meeting on 30th April. The Fed’s rate cut
by 25 basis point taking it to 2% from 2.25% earlier followed by a surprise decline in US jobless rate only
showed positive signs for economy after several months of stagnation.

Daily review 30/04/08 01/05/08 02/05/08

Sensex 17,287.31 0 312.81
Nifty 5,165.90 0 62.30

Weekly review 30/04/08 02/05/08 Points Percentage

Sensex 17,287.31 17,600.12 312.81 1.77%
Nifty 5,165.90 5,228.20 62.30 1.19%

WEEK AHEAD:
The test’s over, now wait for reaction

Last week there were two economic events lined up – the RBI credit policy on 29th April and the US Fed
meeting on 30th April, which were keenly awaited by the markets. Both these events passed off smoothly.
Both these factors had a positive impact on our markets which saw both the Sensex and Nifty cruise in
positive territory.

Moving ahead, the markets now seem to be in a more vibrant mood considering that two key macro
economic events are through smoothly and corporate results are by and large positive, although profit
margins in select sectors have been impacted by higher input and interest costs. Nevertheless, the sense is
that despite competitive pressures, earnings growth for Sensex companies would still be in the range of
15-16% annually for FY09E which is attractive.

With the corporate results season getting more or less completed, the market focus would now hereon be
on the forthcoming monsoons and how quickly the government reins in inflationary trends in the
economy. However, inflation levels are likely to remain high for the next two to three weeks before we
see some noticeable improvement. Also, currently the market sentiment is edgy and slightly cautious
towards equities from all market participants such as FIIs, domestic mutual funds and HNIs. The retail
investors may find opportunity to buy in to fundamentally strong companies that have lost ground
significantly along with the market.
 SEURITY MARKET

2nd week of May ‘08 – Sensex down 4.90%

Daily review 02/05/08 05/05/08 06/05/08 07/05/08 08/05/08 09/05/08

Sensex 17,600.12 (109.22) (117.89) (33.70) (258.66) (343.58)
Nifty 5,228.20 (35.95) (47.60) (9.15) (53.80) (99.10)

Weekly review 02/05/08 09/05/08 Points Percentage

Sensex 17,600.12 16,737.07 (863.05) (4.90%)
Nifty 5,228.20 4982.60 (245.60) (4.72%)

The capital market during the week mirrored the weak US market trends and closed on a negative note.
Clearly, two events which impacted market sentiments were the unrelenting sharp rise in crude oil prices
– touching a record high level of $ 124 a barrel – and the rupee falling sharply by 3% in a span of just
four days from 40.61 per $ to 41.74 per $ during the week.

Rising crude prices coupled with a weakening rupee, are definitely not good signs for India as these
would lead to higher trade deficit since the country still imports 70% of its crude oil requirement.
Already, Indian oil PSUs are losing around Rs 450 crore daily on account of under recoveries. Several
user industry segments such as aviation, automotives, fertilisers, FMGC and pharmaceuticals are expected
to bear the burnt of higher inputs costs as they go ahead.

Nevertheless, despite the short term pains, India still remains a strong economy and is now structurally in
a much stronger position, leading the people to believe that the GDP growth will still average around 9%
during 2008 – which is not bad as compared to other Asia-Pacific countries. Interestingly a recent
research study by Barclays Wealth UK has indicated that India would become the eighth wealthiest nation
by 2017 in terms of a significantly large number of Indians becoming dollar millionaires over the next
decade with the entire wealth held by these households likely to total an estimated $ 1.7 trillion. A major
composition of these assets is likely to find its way into financial assets, especially in Indian equities,
which puts India in a sweetspot when compared to global peers.

WEEK AHEAD:
Markets attain normalcy as volatility subsides

The renewed stability in markets is here to stay, after months of turmoil, if indicators in the futures and
options segment are any thing to go by. The volatility index or VIX on the NSE – an indicator of
investors’ perception of future volatility – has sustained below the 30 levels for over a week now, for the
first time since the crash that happened mid-January. The VIX is a measure of the amount by which an
underlying Index is expected to fluctuate, in the near term, based on the order book of the underlying
index options. India VIX is based on option prices of components on the Nifty 50 Index.

Usually, when market volatility is high, volatility index tends to rise. As volatility subsides, option prices
tend to decline, which in turn causes volatility index to decline. Traders prefer options to futures in
volatility times, as losses are limited in case of option buyers. In the beginning of this year, before the
market crashed, Index was at 25-28 levels. The index thereafter jumped to over 50 levels in the last week
of January and subsequently traded in 40s, with the benchmark Nifty melting roughly 30% from its high.
On Friday, the volatility indicator closed at 27.53 points.
 SEURITY MARKET

3rd week of May ‘08 – Sensex up 4.17%

Daily review 09/05/08 12/05/08 13/05/08 14/05/08 15/05/08 16/05/08

Sensex 16,737.07 123.83 (108.04) 225.49 375.19 81.40
Nifty 4982.60 30.05 (54.85) 53.95 103.50 42.45

Weekly review 09/05/08 16/05/08 Points Percentage

Sensex 16,737.07 17,434.94 697.87 4.17%
Nifty 4982.60 5157.70 175.10 3.51%

The rally during the week has cheered the bulls. However, the time gap between the market recoveries
this time after correction has given them a reason to rethink if the rally will continue.

Past analysis has shown that the recovery time after the market corrects (nearly 15%) from their peak has
been going down steadily. Market participants say this time around, the correction was quite steep and
local and global sentiments were badly affected. Even if there is not much bad news that comes, it might
take a while before the market touches its new peak.

WEEK AHEAD:
Momentum-driven rally

The Indian capital markets witnessed a typical momentum-driven rally last week with indices closing in
positive territory. A large part of this momentum was triggered due to the continued depreciation of the
Indian rupee during this week, taking the rupee to a low of $ 42.92 and finally closing at $ 42.53 by the
end of the week.

The other soothing factor for the markets was the cooling-off effect from higher crude prices which, after
touching a high of $ 126 a barrel, came off by 2% during the week to close at around $ 124 a barrel.

Both these developments were strong enough for the markets to overshadow the steep fall in IIP numbers
declared, to 3% during March 2008, with annualised IIP numbers growing slower at 8.1% in fiscal 2007-
08 from 11.6% last year.

Experts estimate that Indian GDP growth is likely to slow down. On the positive side, however, they still
maintains that India’s external fundamentals continue to remain robust enough to withstand a wide range
of potential shocks, especially from sudden reversals in short term capital flows and any sharp global
slowdowns.

On the domestic macro front also, expectations of a record wheat crop during the current year and arrival
of normal monsoons a week ahead before the June 1, 2008, deadline are all positive indications that
inflationary levels are likely to cool off in the near term.

However, the market rise during the last week was not supported by healthy volumes both from the FIIs
and domestic mutual funds. Domestic institutional support is yet to be seen at current levels and FII flows
are also not expected to rise significantly in the near term. So, during the week ahead, the markets are
likely to move in a narrow range and continue to display edging in the absence of any new triggers.
 SEURITY MARKET

4th week of May ‘08 – Sensex down 4.50%

Daily review 16/05/08 19/05/08 20/05/08 21/05/08 22/05/08 23/05/08

Sensex 17,434.94 0 (204.76) 12.98 (336.05) (257.47)
Nifty 5157.70 0 (52.75) 12.70 (92.20) (78.90)

Weekly review 16/05/08 23/05/08 Points Percentage

Sensex 17,434.94 16,649.64 (785.30) (4.50%)
Nifty 5157.70 4,946.55 (211.15) (4.09%)

With crude oil prices touching a high of $ 135 a barrel and the US Fed comments indicating slower
economic growth with higher inflationary trends likely in 2008, the market agony is being tested to the
limits. Incidentally, crude prices which came off by 2% last week, saw a spurt of almost 8% this week
from previous week level, on news reports that US inventories of crude had depleted sharply.

Rising crude oil and food prices are proving to be a deadly combination for the US economy – increasing
fears of a longer recession. Mirroring these fears, the US Markets displayed a high degree of nervousness
and negativity during the week. The Indian markets last week continued to remain edgy and displayed a
narrow range bound movement during this week with the indices closing in negative territory.

WEEK AHEAD:
Looking for triggers

Clearly, the present market mood indicates that everyone is keenly awaiting key positive triggers like
good monsoons and lower inflation numbers to boost the present sentiment which has been impacted by a
series of negative news flows coming in from rising crude prices, increased rupee depreciation and
weaker US markets.

On the domestic macro front, the monsoons are bow keenly being awaited by the market as this remains
the only big positive trigger in the short term. Also, with a higher agriculture growth expected this year,
hopefully the rising trend in food prices, which has contributed largely to the sharp spike in inflationary
levels, would get arrested. However, we may have to wait for at least a couple of months before we see
some noticeable improvement here.

While valuations of most large cap stocks have turned reasonable of late, the short term upside potential
has also been capped. This is also one of the key reasons that money flows – both from domestic mutual
funds and FIIs – are lacking in a big way and this is apparent from the shrinking volumes both in the cash
and derivative segments.

Trading in such shallow markets is extremely risky, with the risk reward ratio completely against market
players and more so in a market which is extremely hungry for positive news flows at this point of time.

The Indian capital markets are likely to remain in indecisive mode and continue moving in a narrow range
in the coming week until there is more clarity on near term domestic news triggers such as monsoons,
inflation numbers and the rupee movement.
 SEURITY MARKET

5th week of May ‘08 – Sensex down 1.41%

Daily review 23/05/08 26/05/08 27/05/08 28/05/08 29/05/08 30/05/08

Sensex 16,649.64 (301.14) (72.91) 249.78 (209.11) 99.31
Nifty 4,946.55 (71.50) (15.25) 58.55 (83.05) 34.80

Weekly review 23/05/08 30/05/08 Points Percentage

Sensex 16,649.64 16,415.57 (234.07) (1.41%)
Nifty 4,946.55 4,870.10 (76.45) (1.55%)

The Indian markets continued to remain volatile and directionless during the week with the indices
closing in negative territory. More importantly, the market movement was driven significantly by
domestic issues such as the quantum of oil price hike expected from the government, impact of rising
petrol and diesel prices on existing high inflationary levels and increased volatility coming in the form of
May F&O series which concluded on last Friday.

The US markets, however, remained moderately positive during the week consequent upon the Fed’s
announcement of the Q1FY08 GDP growth being much batter at 0.90% from the earlier estimated 0.60%
levels during April ’08. Also US home sale data during April ’08 for the first time saw a rise of 3.3%
which has turned positive after a span of six months since October last year. Both these events had a
positive impact on markets which saw the Dow closing the week on a positive note.

There is also good news on domestic economic front. The fourth quarter GDP growth for fiscal 2007-08
came in at a healthy 8.8%, taking the GDP growth rate for the year as a whole to 9%. First time since
independence, the economy has grown at an average of 9.3% over a period of three years. Also, the RBI
in a recent move has liberalised the ECB norms for inflow of external debt capital, clearly signaling the
intent to rein the softening rupee and providing adequate liquidity to corporates to sustain growth in the
current business environment.

The week ahead is a crucial period ahead for the markets while markets have largely discounted the high
inflationary levels, the oil price hike is expected to be moderate and may not be very harsh on consumers.

MONTHLY REVIEW

Month March ‘08 April ‘08 May ‘08

Date 31.03.08 30.04.08 30.05.08
Sensex 15,644.44 17,287.31 16,415.57
Points Base 1,642.87 (871.74)
Percentage Base 10.50% (5.04%)
2.2 INDIAN ECONOMY
Sill on roll: GDP scores a hat-trick with 9% growth in FY08

The Indian grew at the rate of 9% in 2007-08, faster than the advance estimate of 8.7%, according to
Central Statistical Organisation (CSO). The economic growth was 8.8% in the fourth quarter ending
March 31, 2008, though interest rates at six year highs hit consumer demand and investment. The
economy grew 9.7% in Q4 of 2006-07.

With this, the compound annual growth rate for the last four year has touched 8.9%. Growth averaged
9.3% over the last three years. The economy grew 9.6% in 2006-07 and 9.4% in 2005-06. These are
historic figures and prompted finance minister P Chidambaram to confidently assert a GDP growth rate of
8.5% in the current fiscal. He also promised to take corrective measures to address the slowdown in
manufacturing.

The total value of goods and services produced in the economy – this is what GDP measures – at current
market prices stood at Rs 47.13 lakh crore. The population in 2007-08 stood at 113.8 crore, which yields a
per capita GDP of Rs 41,416. At constant prices (1999-2000), the per capita income moved up to Rs
24,321, representing an increase of 7.8% during 2007-08.

Mr Chidambaram said: “It is matter of great satisfaction that 2007-08 has returned a growth rate of 9%.
As the year progressed, doubts were expressed on whether we would complete the year with a growth of
9%. I had said on many occasions that the economy would grow at close to 9%. Now, it has turned out to
be 9% and this improves the UPA’s average for four years at 8.9%.”

Economists feel that the strategy now being followed was not strictly a trade-off between inflation and
growth. The external commercial borrowing norms have been eased a bit with rupee being in the comfort
zone. The growth numbers are on the expected lines and matches the Plan panel’s and RBI’s forecast. The
view now seems to be to drive growth while containing inflation. However, the current financial year is
more difficult. Agriculture has grown by 4.6% to 4.7% in 2007-08. It would be difficult to grow on such a
high base. Investment is going to continue to pose some problem of financing and some projects may get
delayed. The ECB easing has been done to primarily address this. So we will grow, but needs to be seen
at what rate as mood is not so upbeat.

Mr Chidambaram said: “the gross fixed capital formation in 2003-04 was 28% and 32.2% in 2004-05.
This grew to 35.5% in 2005-06 and to 35.9% in 2006-07. Investment as a proportion of GDP has gone up
by 9.3% in four years. This has never happened before in India’s history.” The minister said this growth
coupled with rise in per capita means that more is available in the hands of people.

Reliance Energy finishes fifth of buyback

The Anil Dhirubhai Ambani-controlled Reliance Energy has completed a fifth of its total targeted share
buyback at a cost of Rs 400 crore. The promoters’ belief that shares were undervalued after the January
crash in the stock market had prompted them to announce the buyback. Before January crash in the stock
market, shares reached a high of Rs 2632. The company intends to buy back equity shares worth Rs 2,000
crore from the open market. As per earlier estimates, the transaction was to enable promoters to hike
their stake by close to 2%. Since the commencement of the buyback on March 25, 2008, Reliance Energy
has so far bought back 30 lakh equity shares. When a company buys back its shares from the open
market, those shares are ‘extinguished’ and subsequently the shareholding of the promoters increases.
2.3 INDIA INC: EXPENDING HORIZONS
Billion-dollar club

It’s the first time the two stars of the new economy, telecom and IT, have managed to enter what was until
now an exclusive preserve of the old economy. The fantastic four of new age India Inc – Bharti Airtel,
Reliance Communications, TCS and Infosys – have finally made it to corporate India’s ‘Ivy League’. A
league where the only way to gain admission is to post profits of over a billion dollars.

All four companies figure in list of 10 companies that generated more than $ 1 billion in net profit (PAT)
during FY08 based on available results. Last year, a mere six companies managed to make the cut. With
only 1,000 companies having declared results, there is a good chance that this time the list could see many
more new entrants.

A detailed comparison between telecom and IT throws up some interesting facts about how these two new
economy bellwethers got to the billion-dollar club. Though the two sectors have entered the list
simultaneously, this mammoth milestone was achieved much faster by the two telecom Moghuls, Bharti
and RCom, than it was by their IT counterparts, Infosys and TCS. This reflects the breathtaking speed
with which the telecom revolution has taken place, given that it was software and not telecom that has
been at the helm of the new age economy for much of the last two decades.

Bharti, which was incorporated in 1995, took 13 years to reach the mark, while RCom took just about
four years after its separation from Reliance Group in 2004. Even if we consider the year 2001 when the
Reliance Group decided to venture into the telecom space, RCom has taken just over seven years to post a
billion dollars in profit.

In contrast for the IT industry it has been a long march. TCS which was incorporated in 1968 has taken
over four decades while Infosys though faster still took a quarter of a century plus to reach the milestone.

However, in the euphoria following the success of the new economy, it would be unwise to forget that the
list is still dominated by the old economy bellwethers. Reliance Industries, India’s biggest private sector
company, is right there on top of the list with $ 4.8 billion and is followed by the country’s largest bank
State Bank of India, which clocked $ 2.2 billion in profits.

Anil Agarwal’s Vedanta group has put up an impressive showing with both group companies, Sterlite and
Hindustan Zinc, having broken into this listing. Among the 10 companies on the list, DLF, the real estate
giant that was listed last year, saw the sharpest jump in its profits with RCom taking second place.

REC conferred Navratna status

The government granted Navratna status to Rural Electrification Corp (REC), giving it financial and
administrative autonomy. The department of public enterprises (DPE) has issued the order for giving the
coveted status to REC, which will now be able to expand its electricity business in the rural areas. REC is
working throughout the country with big network. It is a pioneer in the area of rural electrification. REC
is the 16th PSU to have been named as the Navratna firm. The company can now take decisions of
investing up to Rs 1,000 crore or 15% of its net worth independently.
2.4 INDIANS > NETIZENS
49- million Indians logon to internet in 2008

Call it the democratisation of internet in India. Every one in 10 urban Indians (12%) is now net connected;
over two-third (70%) of all internet users reside outside metros; and across urban and rural India. Internet
using population is evenly spread across all socio-economic classes (SEC). What’s more, over 70%
internet users prefer to access the net in Indian languages, with English users at just 28% down from 41%
in 2007. The number of urban net users has increased by 33% in the last one year, 30 million to 40
million.

There are over 49-million internet users in the country. Urban users account for the bulk of it, 40 million,
with rural net users numbering 9 million. Regular net users, defined as anyone accessing the net at least
once a month, number around 35 million (30-million urban and 5-million rural). Internet penetration (as
% of population) has crossed double-digit in urban India at 12%, up 3% from 9% last year, and rural
penetration stands at 4.5% according to online research & advisory firm JuxtConsult’s ‘India Online
2008’ - an offline survey of over 12,500 households across 40 cities and 160 villages countrywide to
gauge the online behaviour of Indians.

Surprisingly women account for less than a fifth, just 17.6%, of the 49-million odd Indian netizens. The
females’ net representation is just marginally higher for urban India at 18.2%.

What explains this adverse female skew in internet usage? A seemingly unrelated figure in the survey
may perhaps hold some clues. The survey says that over half of all net users (51%) in the country are
salaries employees in the corporate world. Is internet’s low traction among Indian women a result of their
lower representation in corporate jobs compared to men?

CA ads may create new category

In months to come, your tax consultant’s name might carry more snob value than the Louis Vuitton in
your wardrobe. Courtesy the new advertising permissions by profession governing body, the friendly
neighbourhood chartered accountant can now choose to morph into super brand.

India-based finance professionals including the CAs, and company secretary (CS), who have been
allowed to advertise services and areas of expertise, are set to evolve as a new category in the advertising
industry – one that is led by an individual as a brand. The decision by the Institute of Chartered
Accountants of India to let their member advertise might unwittingly shift the advertising focus to
individuals. If an individual can support large-scale advertising, it could emerge as a new category.

There will be significant impact when professionals advertise. Financial industry is one industry which is
depends to a great extent on individual expertise. Also, financial product is one category where the
common man requires huge amount to help in saving and planning investments. The guidance aspect is
increasingly becoming important and hence the advertising around it is likely to evolve. People would
want to know of a specialist who is ready to offer guidance services. Amarjit Chopra, chairman,
accounting standards board said that advertising enables ICAI members to project themselves on a bigger
platform rather than create a marketing blitz. “Initially, only mid-sized accounting and auditing firms are
likely to capitalise on this (change of law). Small firms may not come forward aggressively since ICAI
might allow advertisement only in print medium, which is very expensive.
2.5 FOREIGN INSTITUTIONAL INVESTORS
PE turns to open market as valuation tumble

With primary deals slowing down, private equity (PE) firms are tapping the secondary market route to
pick stakes in listed companies. The PE firms are picking small stakes from the open market to either
enter a new firm or increase their exposure in existing portfolio companies. In some cases, this strategy
could be linked to bringing down the average cost of acquisition given that the PE funds originally
invested in the respective companies when valuations were sky-high.

Some of the recent cases include buyout firm Apax Partners picking shares from the open market in
healthcare services provider Apollo Hospitals, Standard Chartered Private Equity buying additional shares
of M&M Financial Services and New Vernon in recently listed Shriram EPC. This apart, UK-based
Promethean has picked shares from the open market in EIH, which operates the Oberoi Group’s hotels.

A strategy to pick shares from the open market is more commonly used by foreign institutional investors
who are typically stock traders and get in and out of a stock frequently. As against, this PE funds have an
investment period ranging from 3-10 years and usually invest in a listed firm through a preferential
allotment of fresh shares or other convertibles like warrants. The difference between the two routes of
investment is that in the latter the shareholding pattern changes as the total number of shares increases.
This could result in decrease in promoter holding unless they issue shares to themselves as well.

In case of Apollo Hospitals, Apex Partners picked 1.87% stake last month to take its total holding to
14.52%. It had originally picked 11.41% in Apollo Hospitals through a preferential allotment in October
2007. Apex had acquired this stake at a price of Rs 605/share in a deal worth Rs 426 crore. In contrast, its
secondary market deals were struck at a price between Rs 505 and Rs 550 per share.

Blackstone is also believed to have taken the secondary route to hike stake in Gokaldas Exports.
Blackstone, which had acquired a majority stake in the textile firm as a part of its buyout from the local
promoters, had come up with an open offer for additional 20% stake. While it had acquired a 67.89%
stake in total including the shares mopped up during the open offer, it added another 0.39% stake in April
to take the cumulative holding to 68.28% according to market disclosures.

The PE firms have taken the secondary market route not just to add stake but also to enter a new
company. Last year, Promethean had picked a 8.5% stake in Nitco Tiles through open market purchases
and had even secured a board seat in the firm. Moreover, sometime back the firm had also picked a
minority stake in leading listed hospitality company EIH.

In some cases funds which sealed pre IPO deals also picked stake in the company after it went public. For
instance, New Vernon Private Equity upped its shareholding in the Chennai based engineering and
construction company Shriram EPC, post-IPO. Before the IPO, New Vernon held 4.62% in Shriram EPC
which had come down to 4.08% during the public offer. The PE firm picked another 1.06% on the date of
listing of Shriram EPC.

Family businesses invite PEs as strategic partner

Tight liquidity conditions may have dented private equity investments in large corporates, but closely-
held family businesses in India are increasingly bringing in PE firms as strategic partners. Volume of PE
deals in mid-sized family businesses has been growing sharply. Since, such businesses are more
professional now. In India, PE funds have emerged as a growing option for funds as the young generation
in business families are open to bringing in PE funds as strategic partners.
2.6 WARNING SIGNALS
Industrial growth slumps to 6-year low in March

The sharp drop in industrial production in March’08 to a six-year low of 3% may have triggered fears of a
slowdown but economists are still holding onto an 8%-plus growth projection for 2008-09. The optimism
among policymakers and economists, however, is not shared by industry players, who believe that high
interest rates and rising input costs have started impacting demand.

High inflation, however, rules out any possibility of rate cuts to stimulate growth. Industrial production,
as measured by the Index of Industrial Production (IIP), grew at a disappointing 3% in March 2008
compared to 14.4% in March 2007. As a result, industrial production growth slipped to 8.1% in 2007-08
from 11.6 in 2006-07.

The industrial slowdown is largely because of the sharp drop in manufacturing, which has a high weight
in IIP. Manufacturing grew 2.9% in March 2008 against 16% in March 2007. Even electricity (3.7%) and
mining (3.8%)

The industrial growth for March 2008 is the lowest since February 2002. But the government has very
little leverage to boost growth. Crisil principal economist DK Joshi says: “In view of high inflation as
well as inflationary expectations looming over the economy due to spiraling crude and commodity prices
along with the depreciating rupee, maintaining price stability will be difficult task for the central bank.
Thus, expecting any kind of rate cut is completely out of question.”

There is a silver lining, though, in that part of the drop appears to be because of the base effect – industrial
growth in March 2007, the base for calculating growth in March 2008, was unusually high.

Rising inputs costs threaten growth

Despite apparent moderation in macroeconomic activity, corporate topline growth appears to be holding
firm. Rising costs and higher extraordinary expenses have taken a toll on profitability though. An ET
intelligence Group analysis of January- March 2008 quarter results of 799 companies’ shows net sales
growth at 21.6% y-o-y, which is marginally higher than the topline growth in the previous two quarters,
but lower than the 25.5% growth in the April-June 2007 quarter. Net profit growth has, however, fallen
sharply in the January- March 2008 quarter to 18.8% against 40% in the previous quarter.

As expected, sharp increase in expenses, namely raw material costs, have caused operating profit growth
(profit before depreciation, interest and extraordinary items) to fall sharply to 26.16% from more than
40% in the previous quarter. And unlike in the previous quarters where strong growth in other income
provided support to earnings, in this quarter, growth in other income was a lot lower at 27.9%. The
extraordinary expenses (read derivative losses) further ravaged the earnings. These charges on profit grew
130% to Rs 1,262 crore for these 799 companies.

Citigroup aims to sell $ 400-billion assets

Citigroup, the largest US bank, said it aims to shed $ 400 billion of assets over the next two or three
years, in a drive to become more efficient. Citi, hit hard by subprime mortgage meltdown and ensuing
turmoil, said it has about $ 500 billion of “legacy assets”. It said it expects to reduce this amount to less
than $ 100 billion within two to three years. Although Citi said previously it plan to shed assets to boost
its capital position, the magnitude of sales worries analysts and is likely to prompt fresh speculation of a
break-up of the Wall Street giant.
3.1 MUTUAL FUND
Fund houses are reiterating their positive outlook for the future

What goes up must come down. That’s the law of gravity for you. Investors in the stock market will be
able to empathise with this maxim, given that at all that was earned in the last six months of ’07 was
washed off with the first tsunami of ’08. The period from January to March ’08 can be described as
‘brutal’, with the Sensex and Nifty losing over 20% each since close on New Year’s Eve.

A bad quarter for the market justifies a bad quarter for the mutual fund industry as well. Almost all the
mutual fund schemes have registered dizzying falls and posted negative returns in each of the three
months of the quarter. Equity diversified or balanced funds, contrarian or sector themes, index funds or
mid-caps – schemes across the board faced the wrath of a falling market. The falls have been pretty sharp,
with net asset values of most schemes being eroded by 20-30%. However, monthly income plans (MIPs)
and income schemes, which have little or no correlation with the equity market, have offered some
respite. MIPs registered a marginal fall of 1-2% and income funds, though positive in the first two months
of the quarter, disappointed in March. The damage, however, was not severe, with the fall in most
schemes being less than a percent.

The market slowdown has hit the MF industry not only in terms of returns, but also in terms of asset
collections. Through fund houses did not witness heavy redemptions, investor reluctance for fresh
investments, both for existing and new schemes, was evident. The industry’s assets under management
(AUM), at Rs 505,152 crore for March ’08, are the lowest in the past six months. But this setback has not
dampened the spirits of the MF players. And there is more than one reason to justify this sentiment.

Despite low collections by the new schemes launched during January-March’08, the industry remains
upbeat about launching new products. So, while ICICI Prudential launched its Focused Equity Funds,
Sundaram has come out with theme funds, which target the banking and financial services sector, as well
as the entertainment industry. Giving due consideration to the slowdown in the equity market and taking
advantage of rising gold prices, AIG investment launched its World Gold Fund, which invest in stocks of
gold mining companies across the globe. Reliance Quant plus Fund was also launched after the market
crashed. It won’t be correct to call this a new launch since Reliance is converting its index fund into a
quant fund. Quant uses mathematical models to select stocks, thereby reducing the sentimental risks of
stock-picking. For those who trust machines over men to manage their money, these funds are just
another step in the ladder of innovation in the MF sector.

So, be it bears or bulls, the MF industry seems unperturbed. MF industry’s confidence is reflected not
only in the variety and number of products, but also in terms of the new players seeking entry into this
business. Just 15 years ago, this industry was the oligopoly of a few public sector companies, the most
prominent among them being UTI. Privatisation made headway only in 1993, with Kothari Pioneer being
the first private sector fund house.

Today, we already have 33 MF players, which include well-known global asset management brands. And
this number is still increasing. While Mirae Asset Management made its debut early this year, nearly a
dozen new fund houses are set to launch their products in due course. These include Bharti-AXA,
Religare-Aegon, Edelweiss, DLF-Prudential and Bajaj Finserv.

We’ve come far, but there’s still a long way to go. Even after 55 years of MF history, India lags global
peers in terms of AUM and number of players. But the industry has many opportunities, which are
waiting to be explored. Where on the one hand, there are many potential customers to be tapped, on the
other, billions of rupees locked in pension funds are waiting to see the light of the stock market via MFs.
With such opportunities on the horizons, the future’s bright for this industry.
3.2 COMMODITY MARKET
Futures ban no panacea for inflation: Assocham

The government’s decision to expand the ban on futures trading to cover potatoes, soyabean oil,
chickpeas and rubber would not help in bringing inflation down, feel Indian Inc. The real culprit is virtual
stagnation in food production since 1999, says a study by Assocham. The study says that rather than
banning futures trading, the government should ensure high volumes and strong liquidity in the futures
market to stabilise prices. The study comes close on the heels of a study by Planning Commission
member Abhijeet Sen which has not recommended scrapping of the ban on futures trading in key
commodities. After the report was submitted, the government expanded the ban on potatoes, chickpeas,
soyabean oil and rubber.

“The ban on futures trading in rice and wheat has not helped. Prices of these foodgrains have only
increased.” Assocham president Venugopal Dhoot said, “When experience shows results to the contrary,
how can we expect the ban on items like potatoes and soyabean oil to help in reducing inflation.”

Without speculation, there is no opportunity for risk management. The chamber feels that “too much
regulation” is hampering the functioning of the commodity futures market and this was highlighted in the
case of urad and tur. Rumours of ban in trading drove away market-makers and this resulted in low
volumes and wide price swings. “It is important to realise that futures market and physical markets are
influenced by a common set of factors – supply and demand. An efficient futures market is merely a
reflection of the future spot markets. Hence the ban on futures trading is devoid of economic logic.”
While population is growing at 1.9% per annum, foodgrain production is stagnating. “Hence consumption
of cereals has declined from a peak of 468 gm per capita per day in 1990-91 to 412 gm per capita per day
in 2005-06, indicating a decline of 13%. In other words, the writing was on the wall and efforts should
have been made to improve production and supply.

Is it a premature start?

Futures’ trading was reintroduced in India as part of financial liberalisation policy, which has been
pursued since 1992. Being the last mile in the road to financial liberalisation, after all the other segments
such as banking, capital markets, insurance, NBFCs and so on were opened up; the logical corollary was
to extend the same to the commodity sphere. The response of the market has been quite remarkable as
seen by the enthusiasm shown in all the commodity segments. The challenge has really been to take the
benefits to the farmer’s level so that they can gain from futures trading. We have seen a fair participation
of end-users in areas such as pulses, edible oils, cereals and spices, where processors and dealers are
participating on the exchanges.

Farmers in some areas are gradually getting aware of future’s prices, which are being disseminated by the
exchanges. This is an important step before direct participation, which is the final goal. Further, the
exchanges have made some significant advances in the creation of infrastructure like warehousing,
grading and assaying, which is in the short supply in the country. However, while the progress has been
satisfactory, the absence of integration with the disparate spot markets is a challenge to overcome.

The important point here is that in any venture, especially as complex as commodities, there would
always be problems in terms of misconceptions, absence of market integration, efficient price discovery
and so. It is also true that in the capital market, the spot market developed before the derivatives market,
which made things easier. In the commodity space, the derivatives have come before the so called
‘integrated spot market’. The route is different and probably difficult, but, a start has to be made some
time. Therefore, no time is premature on the road of innovation.
4. FINANCIAL SECTOR: TRANSFORMING TOMORROW
Market mechanics

1. FINANCIAL ADVISORS:
Weigh impact on investors

A zero sum game

There are no free lunches and money-making is never a simple task. Investment needs patience and
discipline. One has to give time for the stocks to perform, as the share price is only a proxy of the
financial health of the company, which unfolds gradually.

There is no reason why someone else should tell one to buy a stock. If by telling some one to buy the
stock, share price moving up, it is to the advantage of the person giving the tips. The tipper is always
interested to increase his share prices where he has some financial interest, or else he is distributing the
shares. A broker makes money by either through buying and selling stocks. Following blindly the tips
thus is a sure way to move to pits of doom.

When a retail investor buys a television or refrigerator, he checks three shops to get the lowest price.
Similarly the retail investor needs to check why he is buying a stock, what that share represents. The
effort to know the company does not mean the investor must know the financial performance of the
company, but at least he must know if the company actually exists, whether they are profitable or not. The
information is available easily through internet.

In summary, any investors in the stock market must understand that there is risk in the market to earn
superior return. To judge the risk, he needs to be informed: he has to do the due diligence as he does to
acquire any other assets. If he only follows tips, he is at the mercy of market, which is a zero sum game.
Sooner he is going to lose, because someone at this cost has made the quick buck.

2. FINANCIAL PLANNERS
Value unlocking for all stakeholders

Retail shareholding shrinking

The share of individual investors in Indian companies has been shrinking steadily so much that the
average individual shareholding in private sector companies has dipped to around 13% and public sector
companies, about 2%. According to a study of top BSE 200 Indian companies, among private sector
companies, Bharti Airtel (1.2%), GVK Power (2%), Educomp Solutions (2.1%), Sobha Developers
(2.1%) and Tata Communication (2.2%) are languishing at rock-bottom levels with regards to individual
shareholders. In the PSU list, National Aluminium, Hindustan Zinc, Neyveli Lignite, ONGC and SAIL
have 0.7%, 1.5%, 1.5%, 1.7% and 1.8% respectively as public shareholding.

Policy changes over the years have played a major role in edging out small investors from the market. The
concept of public listed companies has been hugely diluted. Public offer as a % of a company’s equity
capital has been bought down from 75 to 25% and in some cases to just 10%. Taking a view on dwindling
share of minority stakeholders, the Finance Ministry has floated a concept note, seeking public comment
with regards to mandatory raising public shareholding (including institutional investors) from 10% to
25%. The move is expected to increase public participation, transparency and overall governance in the
market. Currently, only 7 out top 200 Indian firms have public shareholding in excess of 25%.
 MARKET MECHANICS
3. WEALTH MANAGERS
Map out the details to translate into benefits

Minimum required public float

The concept note had proposed that if for any reason, public holding reduces below 25%; the promoters,
management and the company may be jointly and severally be liable to bring it to 25% within three
months or face action including delisting.

The government now feels that three months is too short a time. It is now evolving a phase out schedule
which is more workable and may not lead to sudden fall in share valuations due to offloading of promoter
stake in one go. The stock exchange data show that despite reservation of 35% for retail at the public
issue stage, the public hold about 13% of the capital. Therefore, if the government finally decides on 25%
minimum floating shares, then a further dilution of 12% on an average has to be made. For this, the
finance ministry is likely to grant around three to five years. The exact percentage to be diluted in a year
would be finalised only after the government decides the minimum required public float.

Private placement, ESOP won’t count as public: The government also proposes to tighten the definition of
public holding in a listed company. Promoters who disguise their stake by making preferential allotments
to closely-linked companies, which are now classified as public holding, may soon lose this flexibility and
may have to offload such stake in favour of the public. The new norms that the government is working
may also strip employee stock options of the status of public holding as employees are closer to the
company than the public. This would ensure that promoter and other entities closer to the promoter and
enjoying greater rights than the public cannot eat into the public’s share in a listed company. The idea is
to infuse more liquidity into the market and reduce volatility due to concentration of shares in few hands.

4. INCLUSIVE CEOs
Innovative responses to problems

Apply now, pay later

As part of its efforts to narrow the time between the allocation of shares in a public issue and their listing,
the Sebi gave an ‘in principal’ nod to marking lien on bank account as an alternative mode of payment in
public and right issues.

What this means is that the application money will remain in the bank account of the applicant till the
allotment is finalised; thus eliminating the cumbersome process of refunds for the unallotted portion.
Until the allotment of shares, the investor cannot use those funds even though no physical transfer of
money has taken place at the time of application (of shares). Once the allotment is made, the registrar can
instruct the bank to transfer funds, based on the number of shares that has been assigned to an investor,
and remove the lock on the funds.

Sebi hope to eliminate the movement of instruments both ways – as application money and refund, thus
hastening the whole IPO process. Sebi chairman CB Bhave, had said that he wants to kick off the primary
market reform process exercise by cutting down the time between a company’s public issue and its listing
from 21 days to seven days. The approval to marking lien on bank account should be seen as the first step
in that direction. There have been innumerable instances of delayed refunds in the past, even in the public
issues of reputed corporates. At times, the issue could be genuine, while often, the companies delay the
refund process so that they can earn interest on those funds for some time.
 MARKET MECHANICS
Cross-margining

In a move that will help stock market investors and brokers use their margin funds efficiently, the Sebi
gave approval to cross-margining across the cash and derivatives segments.

What this means is that if an investor is buying a stock in which he already has a short position in the
futures segment, he will not have to pay margin twice over. In its circular, the capital market regulator has
said that for positions in the cash market that have corresponding offsetting positions in the stock futures,
value at risk (VaR) margin shall not be levied on the cash market position. However, it will be only to the
extent of the off-setting stock futures market positions.

For instance, assume that an investor wants to buy 1200 shares of ACC. He is already holding a short
position of 1000 ACC shares in the futures segment. Any losses due an intra-day fall in the price of ACC
shares will be neutralised by gains on the corresponding short-positions held by the investor in the ACC
stock futures. This means that is the value of the transaction, that faces potential volatility risk, is of only
those 200 shares (1200 shares minus 1000 futures) that do not have a corresponding short position.
Accordingly, the exchange will levy the VaR margin only on two hundred shares.

5. TECH SAVVY PROFESSIONALS

Take first step to ensure efficient and reliable system

Fraud detection system

Call it a red alert for companies indulging in fraudulent practices. As part of its Gen-next e-governance
initiative, the government is developing a system which will provide early warning signals on corporate
frauds. The system will look for possible trends of fraudulent practices using company data filed with the
ministry of corporate affairs.

According to estimates, India is losing a whopping $ 40 bn per year because of corporate frauds, which is
more than 4% of the country’s gross domestic product. The early warning system, which is going to be
mechanised in nature, will help ministry to detect frauds at early stages.

The ministry has begun working on the system after the successful launch of the MCA 21 initiative which
provides both citizens and corporate an easy and secure on-line access to service including filing and
registration. The ministry said: “As we have all the data in an on-line format, it won’t be difficult to
analyse those and detect frauds at early stages”.

The frauds include those committed for the country, and those against the company such as embezzlement
of funds and payroll frauds which, in turn, affect the bottom-line of a company. The proposed early fraud
detection system would check the books of accounts to find out whether any company is resorting to
fraudulent practices which will adversely affect interest of shareholders, employees and others.

At present, various government agencies including intelligence bureau under the ministry of home affairs,
and Central economic intelligence bureau and financial intelligence unit, both under the finance ministry,
detect frauds in financial sector. According to the initial concept, if the early warning system detects
evidences or any trends indicating frauds or cheating, the ministry will have the right to initiate an
inspection under the provisions of Companies Act, 1956. The data on frauds will also be passes over to
various Central government agencies dealing with money laundering, auditing and other financial frauds.
 MARKET MECHANICS

6. CREDIT COUNSELORS
Resolve convertibility and recompensation issue

Manipulation of shares on the first day of listing

Few investors had heard about the stock, fewer still took notice when it delisted from stock exchanges
seven years ago. But on 21st May 2008, when the share of ‘Royal Finance’ listed under a new name ‘KGN
Industries’, it gained instant fame, and notoriety.

In what will go down as an outrageous to manipulate a low-priced stock, shares of KGN Industries
(formerly known as Royal Finance) opened at Rs 72 and went on to touch an incredible Rs 55,000 within
two hours on the first day of relisting; All this, with just 827 shares changing hands.

This wild swing in share price immediately caught the attention of the stock exchange surveillance
department which suspended trading in the stock at 12.20pm. Surveillance officials then met in the
evening to discuss the issue and made enquiries with the promoters about the price rise. Late in the
evening, BSE issued a release saying further investigations will be carried out, but trading in the stock
will resume on next day at an adjusted price of Rs 5,216.30.

The incidence has once again put the spotlight on the manipulation of shares on the first day of listing
since the intra-day circuit filters are relaxed to enable better price realisation.

However, manipulators often use the opportunity to ramp up stock prices. Last year, capital market
regulator Sebi had proposed to introduce a 20% circuit filter on the first day of relisting for companies
that had undergone corporate restructuring. But the regulator is yet to take a final view on it.

Z group belongs to a list of violators

It appears to be a busy season for stock manipulators. On 21st May, KGN Industries shares soared to an
unbelievable Rs 55,000 on relisting after nearly seven years. A day later, another obscure firm, Sylph
Technologies, which last traded at Rs 0.80 a share at the time of its delisting five years ago, climbed to an
intra-day high of Rs 800 on relisting, before setting at Rs 200.

The common thread running across these cases in that both stocks figure in Z group of the BSE – the
exchange’s hall of shame for firms violating listing norms – and both companies have no fundamentals
worth mentioning.

While these two Z group stocks made headlines because of the bizarre levels to which they rose, brokers
claim that price fixing is also routine in quite a few stocks in the T group – in which only delivery-based
transactions are allowed – because of lack of liquidity.

In many stocks, the shareholding pattern disclosed to the stock exchanges is not what it appears to be.
Shares held under the heading of corporate bodies are usually indirectly controlled by the promoters -
either through own holding companies or those owned by close relatives. As a result, actual public
holdings are very low, making the stocks an easy target for price rigging.
 MARKET MECHANICS

7. MICRO-FINANCE PROFESSIONALS
Developing alternative credit delivery models

Portfolio management services

Sebi has enhanced the net worth requirements for entities providing portfolio management services. Now,
an entity seeking to register as a portfolio manager will need to have a net worth of Rs 2 crore, four times
the previously stipulated level of Rs 50 lakh.

Existing portfolio managers with a net worth of less than Rs 2 crore at present, will have to increase it to
at least Rs 1 crore within a period of six months and thereafter to the prescribed net worth of Rs 2 crore in
the next six months.

Also, portfolio managers have also been barred from pooling the resources of their clients and floating a
scheme on the lines of a mutual fund. They would be required to keep assets of each client separately and
not in a pooled manner. The portfolio managers have been given six months time to convert their
operations managed on a pool basis to individual basis.

The portfolio management services (PMS) schemes are generally pooled in nature today due to the
operational conveniences. The small ticket size like retail type are pooled and given the benefit of large
size with diversification and economical way of handling. It facilitates buying and selling at ease in bulk
providing the benefit of size, cost and time. The brokerage incurred on such large pool will be on
wholesale basis, and therefore cheaper than retail brokerage. The purchases of shares are allotted pro-rata
on the same day to all the clients. This also ensures minimum documentation and facilitates easy
operations for the portfolio managers. Sebi’s new norm banning the pooling of clients assets by portfolio
managers under their portfolio management services (PMS) has flustered most players who have cited
increase in costs as well paperwork as key negatives to the move.

However, Sebi’s new norm has many positives to it:

For PMS clients, it clearly means more transparency. They will be able to track and trace trades and
ensure there is no manipulation in their account. India’s capital market in the past two decades has many
instances of the flagrant violation of regulatory norms for PMS by various market participants.

The new norms are also welcome at a time when the number of high worth individuals (HNIs) in India is
sharply going up and the need for PMS is on the rise.

In a non-pool system, it would be very difficult for anybody to mask proprietary trades as client trades or
proprietary losses as client losses.

Moreover, clients with higher portfolio values could now expect to get some level of customisation rather
than get bunched up with the rest.

Also, due to the recent stock market boom, a number of small outfits have propped up providing PMS
services, many of which followed lax reporting practices.

The new non-pool system automatically raises reporting standards.

 MARKET MECHANICS

8. RISK MANAGEMENT CONSULTANTS

Educate – Engineer and Enforce

INDIA VIX

In a milestone for Indian stock markets, the National Stock Exchange recently launched the country’s first
volatile index – India VIX. The index, also known as ‘investor fear gauge’ and ‘fear index’ reflects
investors’ best prediction of near term market volatility. Till now, there was no indicator to predict market
volatility or gauge the extent of uncertainty. But with the launch of VIX, this void has been filled. Here’s
a lowdown on the intricacies of this index, and why you should follow it to gain that elusive insight.

VIX value provides the expected fluctuation perceived by the market over the next 30 calendar days. In
India, it is calculated using the methodology adopted by Chicago Board Options Exchange (CBOE).
CBOE offers volatility indices based on S&P 500, Dow Jones S&P 100, NASDAQ, and Russell 2000.

From the near and mid-month options bid and offer prices of Nifty 50 index options, a volatility figure is
calculated which denotes the expected volatility in the near term. Typically a high VIX (increased
volatility) is taken as an indicator that investor fear has increased, whereas a low value is interpreted that
investors are being complacent.

The volatility index starts rising during times of financial stress and lessens as investors become
complacent. In fact, during period of market turmoil, the VIX spikes higher, largely reflecting the panic
demand for puts as a hedge against further declines in stock portfolios. During bullish periods, there is
less fear and therefore less need for portfolio managers to buy puts. Currently, VIX index is not tradable
in the Indian market and its rates are provided at the end of the day.

Why track?

Market moves are a function of sentiment and one of the indicators of sentiment is volatility. Increase and
decrease in volatility are always a signal of the extent of fear within the sentiment.

For instance, when the fear is high, volatility is always high in the stock markets. India VIX indicates how
traders and investors feel about the immediate future.

As a retail investor, you can plan effective entry and exit in stocks.

The volatility index is more relevant for short-term investors and traders, who are reliant on market
sentiment to a large extent. However for a long-term investor, the underlying fundamentals are more
important from a medium to long-term perspective.

An investor can utilise the volatility index for multiple purposes. It depicts the consensus of the market on
the expected volatility and is helpful in predicting market uncertainty. An investor can balance his risk
taking help of VIX. Further, you can use it for identifying mis-priced options. For instance, if VIX rises
sharply, you can avoid taking long position in derivative products. You can also use it as guiding
instrument for hedging portfolio, by buying options.

However, cautions using it as a sole indicator to predict the market direction. VIX is only one of the
sentiment indicators that guides in market direction.
 MARKET MECHANICS
9. CONTINUING LEARNING CENTRES
Take informed decisions

Pyramiding:

Portfolio leveraging is a method of raising loans where investors leverage on their own fund portfolio to
raise a loan that will be reinvested in the market, either in mutual funds or stocks.

Super portfolio leveraging is leveraging again on an already-leveraged portfolio, also called pyramiding
are done by investors who have high return funds, stocks and gilted instruments. The investor is safe till
the time the portfolio yields decent returns – more than the interest payable on the leveraged portion.

The more money you have, the more debt you take is an old adage that is coming into play in portfolio
leveraging. According to analysts, investors had pledged their fund portfolios when the market and the
NAV of the portfolio were at the peak. Investors had taken loans from NBFCs attached to their
brokerages to extend their presence in the market.

According to fund managers, bulge-bracketed investors pledged their mutual fund portfolios – often run
into crores of rupees – to reinvest in mutual funds and stocks. With mutual funds logging huge losses and
equities maintaining a downturn, big-ticket investors have become willing victims to MF leveraging.

Adding to their woes, MFs have logged their worst quarterly returns in over a decade. The entire spectrum
of equity mutual funds has seen erosion in returns of 20-55% over three months. When the NBFCs see the
value of underlying asset depleting, they ask the investor to meet the differential in hard cash. If the
investor fails to do so within the deadline, the NBFC asks its broking arm to redeem the entire portfolio.

10. ONE-STOP-SHOPS
Dedicated to offer related services under a roof

PO small saving rates may be on par with banks

There’s good news for those investing in post office small savings schemes. The government is
considering an increase in interest rates offered by these schemes to bring them on a par with fixed
deposit schemes of commercial banks. Interest rates offered by post office small savings schemes range
from 3.5% to 7%, depending upon the term of deposit, while banks offer about 8.5% interest on similar
schemes. Only term deposits for more than six years earn 8% in the case of post office while comparable
schemes of banks offer 9.5% to 10%.

There has been a sharp fall in the post office small saving schemes, particularly in the term deposits,
monthly income account and senior citizen saving schemes continuously for the past three years. Unless
interest rates of small saving schemes are revised upwards, there may not be any change in the present
situation due to which post office small saving schemes will keep losing their attractiveness rapidly.

The government has recently taken some steps to make postal savings attractive and this includes a 5%
bonus on monthly income scheme (MIS) and tax exemption on investment in 5-year term deposit and
senior citizen schemes. These measures, however, have not proved sufficient to bring the shine back on
post office small savings. Very few people in rural areas come within the income tax net and tax benefit
does not appeal to them, it is felt.
 MARKET MECHANICS

11. GLOBAL OUTLOOK

World is a village

Black money in grab of FDI

Many Indian businessmen have discovered that the neatest way to bring back money stashed abroad is to
show it as foreign direct investment (FDI) in a small unlisted firm that few would notice. It involves a
string of transactions that not only escapes the regulatory radar but also has a touch of legitimacy. But just
when they seemed to have perfected the practice, small change in banking rules could complicate matters
for such money laundering.

The laundering trail, honed by experts in tax and foreign money laws, begins with a simple overseas
investment allowed by the Reserve Bank of India under its liberalised remittance scheme. The investment,
which can be up to $ 200,000, is made to float a shell company in Dubai’s Free Trade Zone. That’s the
first step. Owning such a company is no big deal – no tax is paid, regulations are simple, and hundreds of
professionals are available to tell you how to go about it.

Once done, the undisclosed money lying with banks in the tax havens in other parts of the world is
brought into the Dubai Company, which just holds it in a bank account. The next step is to bring the
money back home. And here lies the shady ingenuity of the transaction.

To make this happen, the protagonist of the story, whose money is now lying with a Dubai company, sets
up a firm anywhere in India or uses one of its existing unlisted firms to get the money back. The way this
happens is that the Dubai Company buys the shares of the Indian firm at a hefty premium. A high
premium allows you to bring in as much as money as possible, and also ensures the firm’s capital post-
transaction is within the authorised capital, so that no extra charge is paid to the local authorities.

The money that comes in is the form of FDI through the automatic route, where the inflow is not
scrutinized by the government agency or the Foreign Investment Promotion Board. With this, the Dubai
Company becomes the predominant shareholder of the firm. The final step is buying out the shareholding
of the Dubai Company. This happens after a year to avoid suspicion. However, when the Indian firm buys
out the Dubai Company – a transaction that restores control back to the local shareholders – it pays only a
small fraction of the price it received a year ago.

12. ISSUES OF THE PRESENT

Freedom to get & fail in the system of free enterprise

ILLIQUID securities

The Home Trade scam that rocked the bond market in 2002: besides reaffirming the banker-broker nexus
in a chain of deals, exposed co-operative banks as the financial system’s weakest link. Six year later, the
rules of the game have changed; cooperative banks have cut new deals while the same tribes of brokers
have found ways to mask their identities and the smarter ones have spotted smaller banks to dump illiquid
securities. The latest mischief has drawn the RBI’s attention.

Since April ’08, a team of RBI auditors has been inspecting the investment books of co-op banks in
Gujarat to trace irregular transactions between brokers and entities controlled by the intermediaries.
 MARKET MECHANICS

The move followed a tip-off from Nabard, the apex institution for rural credit that Orissa State Co-op
Bank has taken Rs 30-crore hit after buying ‘deep discount bonds’ at prices way above the market price.

Further enquiries by Nabard revealed that state co-op banks of Himachal Pradesh and Karnataka have cut
similar deals, though their sizes were smaller. These co-op banks have bought zero-coupon deep discount
bonds from brokers at off-market rates. These are long-dated papers (10-20 years) issued and traded at a
big discount from par value. Paying Rs 70 for a bond that on maturity will give Rs 100 may appear as a
profitable deal, but it isn’t. The fair value – which can be calculated in standard excel sheet formats – can
actually be Rs 60. The broker or its front entity may be buying the paper at Rs 60 or below only to palm it
off to a co-op bank at Rs 70. Here, the bank takes a mark-to-market hit of Rs 10. Indirectly, the co-op
bank ends up funding the broker.

Z-security syndrome

The recent abnormal price movement in a couple of stocks that relisted after a gap of many years again
underscores the need for more firmness in dealing with the ‘Z’ group stocks of the Bombay Stock
Exchange. Ii is time Sebi and the stock exchanges came up with an equitable strategy of cleaning the ‘Z’
group – it houses thousands of companies that are in default of the listing agreement or are perceived to
be risky because of their weak fundamentals – that sees frequent price manipulations.

KGN Industries stock recently relisted after nearly seven years at a price of Rs 72 and subsequently
soared to Rs 55,000 on thin volumes. Sylph Technologies, last traded at Rs 0.80 a share five years ago,
climbed to an intra-day high of Rs 800 on relisting. Clearly, something is amiss here; fundamentals do not
justify these prices. KGN Industries reported a profit of Rs 1.5 crore for 2007-08 while Sylph had a
turnover of Rs 15.8 lakh for quarter ended March 2008. Obviously, low floating stock, because of fewer
dematerialised shares available, has made manipulation easier. BSE is investigating the case. It should not
allow trading in such stocks where floating stock is limited, even if temporary.
5.1 BANKING PRACTICES

ICICI loan paper

ICICI Bank-originated securitised paper has been downgraded by rating agency Crisil, following higher-
than-expected defaults. The rating agency said that it has downgraded the securitised paper issued by
largest private bank ICICI Bank, which comprised personal loan and car loan. According to sources, a
large chunk of these securities are currently held by mutual funds.

The two series of pass-through certificates – A13 and A14 – in the asset back securities (ABS) pool were
issued by ICICI Bank in March 2007 have been downgraded from ‘AAA’ to ‘AA’. The outstanding
amount in the series A13 was Rs 105.73 crore and it has a residual maturity of 33 months while that in
case of A14 was Rs 98.23 crore with a residual maturity of 43 months. Meanwhile, rating to 16 other
PTCs in the ABS pool has been reaffirmed to ‘AAA’.

In a statement to media, Crisil has said, “Delinquency levels for the pool in the 12 months since
securitisation have been higher than expected, with collections significantly below expectations. This has
led to the rating revision on series A13 and A14, which have longer tenors than the other rated PTCs.
However, at ‘AA (so)’, the PTCs continue to enjoy a high degree of credit protection.”

In its recent reports on retail assets, Crisil had noted that delinquencies, across all retail asset categories,
have gone up and is likely to further increase in 2008-09. It said that housing loans constitute over half of
the total retail loans in India. Gross NPAs in home loans increased to 2.2% in March 2007 from 1.8% in
2005, while Crisil expects these to increase to 2.7% in 2008-09. Car and commercial vehicle asset
segments comprise of one-third of total retail loans. Crisil has estimated that gross NPAs in these
segments in 2008-09 would be around 3% for car loans and 5.5% for commercial vehicles.

RBI pulls up ICICI over I-Venture investments

The Reserve Bank of India has taken a tough approach to the largest bank ICICI’s investments in ICICI
Venture – the country’s biggest private equity fund. The regulator feels ICICI may be using its venture
capital arm to make investments that could have been difficult to fund from the bank’s book. Besides,
owning I-Venture, ICICI Bank also invests in some of the funds managed by the fund. Just as in mutual
funds, a string of financial investors subscribe to such funds where the bank also join in. RBI told ICICI
Bank to include its investment in the PE fund in fulfilling the exposure limits that the bank has to stick to.

Under the prudential norms, the maximum exposure a bank can have to a company or a business group is
linked to its capital. Earlier banks used to float non-banking finance companies (NBFCs) to sidestep this
regulation and lend to corporates. This was stopped last year, when RBI asked banks to treat lending by
their NBFCs as part of the consolidated financial statement. RBI’s argument was that an NBFC owned by
the bank should not be used to do business which the bank can’t.

But in case of I-Venture (which manages assets of $ 2 billion), RBI is taking a stricter stance. A fund
which manages third-party money is not an NBFC. It’s more akin to an asset management company of a
fund house. Nonetheless, RBI has spelt out its stand in meetings with senior officials of the ICICI group.

Crisil lowers rating for ICICI CV loan: Credit rating agency Crisil has downgraded the commercial vehicle
loan receivables originated and serviced by the country’s second largest bank, ICICI Bank. The rating
have been downgraded by four notches to BBB+(so) from AA-(so). The lowered rating indicates a
moderate degree of certainty regarding timely payment of financial obligations on the instruments.
 BANKING PRACTICES

Derivatives deals set to become tougher for banks

Banks will have to organise more capital and make higher provisioning (that could lower their earnings)
for off-balance sheet exposures like currency, interest rate swaps and options they enter with corporate
clients. Derivative losses announced by a string of corporates and their refusal to pay has led the Reserve
Bank of India to propose accounting changes that would protect banks’ books in the long run.

According to the draft guidelines issued on 30 May, 2008, banks will also have to treat overdue
receivables under derivative positions just as they treat bad loans, better known as non-performing assets.

The combined impact of the guidelines would be that the same derivative position would require five
times as much capital as it did earlier. Also profits of banks, whose clients are delaying derivative related
payments, will take a hit as they will now have to provide for the overdues.

Forex derivatives are contracts that allow borrowers to take a position in a currency. Although the purpose
of derivatives was to insure against forex risks, some corporates increasingly used them to take currency
bets. When the bets went wrong the corporates ended up owing money to banks. This money due will
now have to be treated as a loan falling due.

Classification of the overdues as bad loans will hurt the borrowers as fresh loans will be denied to them
and they risk debt recovery proceedings.

Bankers said that institutions following Basel II norms will only be marginally affected as they already
adhere to the stricter exposure norms. Internationally active banks such as State Bank of India, ICICI
Bank, Bank of Baroda, Axis Bank and Bank of India are among those already following Basel II norms.
However, even these banks would require additional standard asset provisioning that is prescribed for all
derivative exposures.

Bank differ on pension hit

Banks are divided over ways to provide pension liabilities according to new accounting norms that
mandate disclosure. While some bib banks have dipped into reserves and taken a one-third hit, the others
have decided it over five years. Experts are of the opinion that given greater capital adequacy requirement
of banks, a one-time hit may not be preferable. State Bank of India, Union Bank, Canara Bank, Punjab
National Bank and others took a one-time hit on reserves while adopting the new AS-15 norms, others
such as Bank of India and Bank of Baroda have been amortising the hit over five years.

Analysts feel, “Since banks have stringent capital adequacy set under Basel II, a sudden hit on their
reserves was not preferable and, in some cases, would probably have meant falling foul of their capital
adequacy requirements. However, some top bankers said, “There is no point in being over-capitalised. We
can afford to dip into our reserves and take a one-time hit. Going forward, we will only need to make
provisions for the current year.

For banks, the revised accounting standard for employee benefits is set to impose a huge burden. Their
existing liability is estimated at a staggering Rs 26,000 crore. Because of AS -15 accounting methods the
new standard necessitates, this liability is likely to go up by another Rs 14,000 crore.
 BANKING PRACTICES

Prior to the revised norms, banks were not mandated to provide for their pension liabilities and disclose it
in their balance sheets. Therefore, banks were under no compulsion to regularly fund their pension
liabilities. This would have ultimately resulted in huge unfunded pension obligations which banks might
have found difficult to honour.

When a company first adopts the accounting standard AS -15 (revised 2005), it is likely that the net asset
or liability recognised on the balance sheet under this revised standard is different to that recognised on
the balance sheet under the old AS-15 (1995) standard. This is called the transitional asset/liability and is
to be adjusted against the Company reserves.

A transitional asset must be recognised against reserves immediately. Some banks have therefore used the
limited revision to the AS-15 (revised 2005) standard and have spread the hit on their reserves to be
recognised over 5 years. Any transitional liability not recognised against the reserves is still required to be
disclosed as an unrecognized liability.

For example, Punjab National Bank has dipped into reserves for Rs 1,600 crore to provide for new
accounting norms for pension liabilities, instead of staggering it over a period of 5 years. Despite this, its
capital adequacy ratio as per Basel II norms stands at 13.46$%. Going forward, the bank only needs to
provide for the current year’s pension liability.

Bank of Baroda made a provision of Rs 180 crore against its profits for employee benefits under AS-15
and also made a provision of Rs 100 crore for salary arrears.
6.1 TAX UPDATES

TDS on rental income: Taxpayers need not deduct tax at source on service tax component of rental income.
In a move that is expected to reduce tax liability of a large number of taxpayers, the CBDT has said TDS
would be required to be made on the amount of rent payable without including service tax. The recent
circular issued by the CBDT says: “Service tax paid by the tenant doesn’t partake the nature of income of
the landlord. The landlord only acts as a collecting agency for government for collection of service tax.
Therefore, it has been decided that the TDS u/s 194-I of the Income Tax Act would be required to be
made on the amount of rent paid/payable without including the service tax”.

Service tax on forex trade:

The foreign exchange business was in a tizzy on 16th of May ’08 as a service tax on forex broking
services came into effect. For retail customers, the levy makes buying and selling forex more expensive as
most banks have hiked rates on transactions. The notification issued by CBSE says both ends of the forex
transaction, buying and selling, would be taxed, on the lines of the securities transaction tax – a
transaction tax applicable on trades in the stock market.

Wholesale dealers of forex like banks and full-fledged money changers (FFMC) say, this would make the
business unviable and complex. “Margins on large forex transactions are wafer-thin, between 0.35% and
0.75%, and if 0.25% of this is paid as tax, there is nothing left. Small forex outfit, called restricted money
changers in the RBI classification, have begun charging customers at either 0.25% of the transaction cost
or a flat processing fee plus 12.36% of the fee as a service fee. The fixed fee varies between Rs 100 to Rs
500 depending on the size of the transaction.

Service tax notices on BCCI: It’s double trouble for the Board of Control for Cricket in India (BCCI). The
service tax department has issued summons to the premier cricket body seeking information about the
services rendered by the body as event management, advertising and details of its franchisee
arrangements. Summons are primarily issued to extract information from an assessee and is legally
binding unlike the show cause notice. BCCI had come under the scanner of the service tax department
soon after the IPL auction.

Industry chambers liable to pay service tax: CBEC: Industry and business chambers are liable to pay
service tax. The Central Board OF Excise and Customs clarified that the trade association falls within the
scope for ‘clubs and association services’. The board said that the services provided by these associations
are not of charitable, religious or political in nature. They collect membership fees and other charges from
their members and they work for the interest of trade and industries. Therefore, they do not have
objectives which could be categorised as public services.

Service received from Group Company must trigger tax payment: Companies that source services from
associate companies will now have to pay service tax even before they make adjustments of the payments
in their books. This follows an amendment in Finance Act, 2008. The amendment provides that service
tax liability has to be discharged where the service is provided to an associate enterprise even if no
payment is received, provided the amount for such service is credited in the books of the service provider.

Reforms on track: CST reduced to 2% from June

Ending uncertainties over the major tax reform initiative, the central government notified reduction in
Central Sales Tax (CST) to 2% from June 1 as compared to the current 3%. CST, which was reduced
from 4% to 3% on April 1, 2007, was to be slashed to 2% from April 1, 2008. The reduction could not be
carried out with both central and state government falling to agree on the compensation package.
6.2 INTERNATIONAL ACCOUNTING STANDARDS

In a major step to avoid any hardship to nearly 200 Indian firm listed on European bourses due to
‘differences’ in Indian and EU accounting norms, the government on late Saturday, 10th of May 2008
announced its decision to adopt international accounting norms.

This salvages these firms that have raised capital from EU investors from any tough action that EU might
have taken for lack of compliance with globally accepted accounting standards. Non-compliance would
have forced these Indian firms to either get their securities de-listed from EU exchanges or get their book
re-audited by audit firm in Europe. This would have added compliance cost manifold for Indian firms,
which are the largest non-EU companies that have raised capital from the trading block.

EU had announced it would examine the equivalence of accounting standards followed by non-EU
countries during 2008 and would spare companies from any tough action only if their home countries
adopt a convergence programme.

The statement by ministry of corporate affair is aimed at assuring the EU of India’s plans to converge
with international financial reporting standards (IFRS) by 2011. These standards issued by the
International Accounting Standards Board (IASB) are adopted by about 100 nations.

Since India has already adopted a programme of convergence with IFRS, a public confirmation of the
approach leading to convergence with IFRS would enable EU to determine equivalence of Indian
accounting standards, the ministry stated.

Global accounting standards help M&A

The judiciary may soon have a lesser role in dictating the way corporate houses show valuation of
companies they acquire. Come April 2011, the country is all set to adopt global accounting standards
making it easier for India Inc to get large valuation M&A deals executed without the court breathing
down their necks.

The present rules put the courts at a higher pedestal over the prevalent accounting standards. The ministry
of corporate affairs along with the apex accounting body ICAI is working on harmonising the legal and
other regulatory requirements with the International Financial Reporting Standards (IFRS). IFRS does not
recognise the judiciary prescribing accounting policies which are highly technical in nature.

Under the present regulatory mechanism, the companies which intend to enter into M&A agreements first
apply before the concerned High Courts seeking permission to hold a shareholder meeting and
subsequently to execute the deal. The process could drag for several months before the courts approve
such M&A agreements as it involves considering the interests of all stakeholders including lenders and
minority shareholders.

Even as the courts have been given wide powers to examine the procedural formalities as well as for
evaluating the financial position of the companies, on several occasions courts have taken view divergent
to the prevailing accounting standards. Now, the scenario wherein the existing accounting standards had
to make way for judiciary prescribed accounting treatment is soon to change. IFRS has laid down
extensive accounting regulations relating to business combinations including amalgamations and
acquisitions.
 INTERNATIONAL ACCOUNTING STANDARDS

In India, it is generally believed that law overrides accounting standards. Therefore, accounting is
done based on treatment stipulated by the High Court in its approval, even though it may not be in
accordance with Accounting Standards. The harmonisation of IFRS with Indian Accounting Standards is
at a deliberative phase wherein ICAI is formulating a work plan to ensure that the regulatory provisions of
the globally accepted accounting norms are adopted in India from April 1, 2011.

Disclosure norms for derivatives

Companies will soon need to disclose the nature and extent of risks arising from the financial instruments
they hold and the steps taken to manage such risks. In a step which is likely to give shareholders a clearer
picture of the health of the company they own, accounting regulator ICAI on 16th of May ’08 approved a
new accounting standard on disclosure of all sorts of financial instruments. It would also keep investors
abreast of the steps taken by the companies to guard against potential financial losses.

Companies are recommended to disclose these details from the beginning of next fiscal. The accounting
standard AS-32 pertaining to disclosure of financial information will become mandatory from April 1,
2011. These norms are based on international financial reporting standards, which India has formally
decided to adopt. Compliance to these standards would become compulsory from 2011. Disclosure of the
‘financial engineering’ of companies allows shareholders to make informed decisions.

AS-32 follows two other accounting standards (AS-30 and AS-31), wherein the regulator had laid down
rules pertaining to recognition and measurement and presentation of financial instruments by companies.
ICAI president Ved Jain says “AS-32 will bring greater transparency in disclosures related to financial
instruments such as derivatives and how the entity manages risks associated with such a portfolio”. He
also expressed hope that the new norms would be a step towards empowering the citizens.

Prudent reporting builds confidence

Much has been written and debated about the recent announcement by Institute of Chartered Accountants
of India (ICAI) that encourages early adoption of accounting standards on recognition and measurement
of financial instruments (AS 30).

The announcement further mandates that those companies which do not adopt AS30 should measure and
recognise unrealised losses on financial instruments using the principles of prudence, as explained in
accounting standard on disclosure of accounting policies (AS 1).

AS1 states that in view of the uncertainty attached to future events, profits are not anticipated but
recognised only when realised, though not necessarily in cash. Provision is made for all known liabilities
and losses even though the amount cannot be determined with certainty and represents only a best
estimate in the light of available information.

Therefore, as per principle of prudence, corporates with outstanding financial instruments, and which
have not adopted AS 30, will need to measure unrealised gains/losses on financial instruments and record
unrealised losses while ignoring unrealised gains.

Companies recognise uncertainties that inevitably surround many events and circumstances by disclosing
their nature and extent and by exercising prudence in preparation of financial statements.
 INTERNATIONAL ACCOUNTING STANDARDS

Prudence is the extent of caution used in making estimates, required under conditions of uncertainty, such
that assets or income are not overstated and liabilities or expenses are not understated.

However, the exercise of the prudence does not allow creation of hidden reserves or excessive provisions
or deliberate understatement of assets or income or deliberate overstatement of liabilities or expenses.

Frequently, assets and liabilities are measured in a context of significant uncertainties. Determining a loss
or liability using prudence does not imply absolute certainty or precision. Sometimes, a range of an
estimate could convey information more reliably than can a single estimate. Taken as a whole, financial
statement users prefer that possible errors in measurement be in the direction of understatement rather
than overstatement of net income and net assets.

All accounting frameworks recognise that a difference between an estimate and an accurate measurement
may be material in one context and not material in another. Consequently, what constitutes a significant
loss or gain may vary and thereby, may be impacted by the precision of estimate of losses and liabilities.

When evolving times, the convention of prudence, which was once commonly expressed in the
admonition to “anticipate no profit, but anticipate all losses”, too has evolved. For instance, who are the
principal external users of financial statements, understatement for its own sake is widely considered to be
desirable, since greater the understatement of assets, greater the margin of safety the asset provided as
collateral. However, with periodic reporting it is evident that understated assets frequently lead to
overstated income in later periods.

ICAI’s announcement requires companies, using the principles of prudence, to record unrealised losses on
derivatives, whilst ignoring unrealised gains. However, accounting standard on foreign exchange (AS 11)
allows recognition of unrealised gains on certain foreign currency items. Similarly, AS 30 also allows
recognition of unrealised gains on assets available for sale or held for trading. Therefore, conceptually this
would insinuate that the principles of prudence and recognition of unrealised gains are not meant to be
mutually exclusive.

To conclude, in uncertain times the best way to avoid the injury to investors that imprudent reporting
creates is to try and ensure that what is reported represents what it purports to represent. The reliability of
financial statements is enhanced by accounting and/or disclosing the nature and extent of the uncertainty
surrounding events and transactions reported.

In assessing the prospects that as yet incomplete transactions, such as outstanding derivatives, will be
concluded successfully, a degree of scepticism is warranted. The aim must be to put the users of financial
statements in the best possible position to form their own opinion of the probable outcome of the events
reported.

Prudent reporting based on a healthy scepticism builds confidence in the results and, in the long run, best
serve all the divergent interests of different constituents.
6.3 RELAXED CAPITAL CURBS

Easier access to foreign investor: Listed foreign companies with an asset of not less than $ 2 billion and a
profitability record, and foreign individuals with a minimum net worth of $ 50 million can now trade in
local stocks. They can operate as sub-accounts, where FIIs registered in India manage the investments.
Sections in the market, however, feel that the $ 2 billion floor may be a little too high. The changes
introduced by capital market regulator Sebi would also enable more overseas entities to invest as sub-
account of FIIs, foreign portfolio managers take to collective investment schemes like art funds, and FIIs
to issue participatory notes (PNs) to entities like some hedge funds.

Till now, sub-accounts, on whose behalf investments are made in India by an FII, had to be primarily
broad-based. This meant sub-accounts had to have at least 20 investors, each with 10% ownership. Now,
a sub-account investor can have as much 49% stake, which would make it possible for just 3 investors to
form a sub-account – two with 49% stake each and one with 2%. This is over and above any foreign
individual or corporate setting up a sub-account where it is the sole member. Significantly, the new
regulations will also allow NRIs to set up their own advisory companies and get the funds registered as
FIIs with Sebi. Here, the NRI acts as the fund manager while the investors are foreign nationals and
corporates. Sebi has received several applications from such entities.

“Relaxed Sebi norms for FII investment would enable more overseas entities to invest in Indian stocks
through sub-accounts. The change would allow NRIs to register as FII and manage funds, enable FIIs to
issue PNs even to some hedge funds and permit foreign portfolio managers to invest in collective schemes
such as art fund.”

External Commercial Borrowings: Resource constraints infrastructure companies and corporate houses can
now raise more low-cost funds abroad and repatriate them for domestic spending. The finance ministry
eased the ceilings on ECBs by companies. From now on, infrastructure companies could raise ECBs up to
$100 million for domestic expenditure in rupee, up from the existing cap of $20 million. Other companies
will be able to bring into India up to $50 million, up from $20 million.

“The increase in limit on overseas borrowing for rupee expenditure from $ 20 million to $ 50 million ($
100 million for infrastructure) together with 50 basis point higher interest ceiling of 200-basis point over
Libor makes borrowing easier, particularly for smaller companies. But given the global credit crisis and
the uncertainties in the Indian economy, it is unlikely that easier norms foe ECB and FIIs would make
overseas borrowing easier for Indian companies or cause portfolio inflows to accelerate. Credit market
conditions have deteriorated in the US and other major market, which means funds, may not be easily
available even at higher permitted interest rates”.

Government and corporate bonds: The government also raised the ceiling on foreign investments into
government and corporate bonds, in a bid to deepen the band market. The idea is to enhance volumes in
the debt market and evolve it as a reliable means of raising resources, particularly to improve
infrastructure and sustain economic growth.

“The increase in FII investment limit in corporate bonds ($ 3 billion from $ 1.5 billion) and government
securities ($ 5 billion from $ 3.2 billion) is unlikely to have an impact in the near term. The rising current
account deficit due to increasingly expensive oil imports and weak portfolio investments would keep up
pressure on rupee. Since currency risk is with the FIIs in case of bond investments, the outlook on rupee
makes such investment unattractive. Added to this is the increasingly uncertain business climate given
rising inflation, which could cause corporate growth to slowdown. To top it all, real short-term interest
rates are negative in India”.
7.1 LIVING WITH INFLATION
Desperate measures!

The current inflation scenario is a global phenomenon, being spurred by a host of factors, such as
escalating commodity prices and buoyant demand amidst slowdown in some countries. Governments
around the world are doing many things to rein it in. The measures include using trade policies, fiscal
actions and what not. India too is struggling to tame the beast, with looming elections guiding some of the
pronouncements and short-term measures. But what is lacking is a long-term view of an effective
regulatory framework, which can curb anti-competitive practices, hoarding and black marketing.

Government plans to come hard on inflation

The government decided to adopt a carrot and stick approach to combat inflation and discipline the
industry. The finance minister declared tax concessions, duty cuts and export disincentives. The minister
also extended tax waiver for refineries and export oriented IT enterprise and exempted all categories of
electric vehicles from excise duty.

The fiscal package included export duties on select steel items and basmati rice, which seek to make
export costly and augment domestic supplies. At the same time, custom duties have been cut on steel,
ferro alloys, coking coal, zinc, skimmed milk and butter oil to ease supply crunch and soften prices. The
import duty on newsprint, too, has been cut from 5% to 3%.

These anti-inflation measures primarily target steel, which contributes a fifth of the current spurt in prices.
The Prime Minister warned industry to show restraint and to hold the price line rather than going for a
quick buck. Finance Minister Mr P Chidambaram followed it up and said the government would also
consider adopting ‘administrative measures, to discipline sections of the industry taking undue advantage
of short-term shortages.

Futures ban in soya oil hots up spot market

The ban on commodity futures has fired up spot markets as refiners and traders use lack of transparent
price discovery gaps in information to make a killing. All vegetable oils flared on 8th of May ’08, as the
ban on futures trading in soya oil takes effect. Soyabean oil has gone up by a sharp Rs 1/kg immediately
in Indore after the ban was announced on 7th of May ’08. What’s more; oilseeds’ trading has become
highly active as a proxy for soyabean oil.

To make matters worse, edible oil importers may shy away from contracting large soya and crude palm
oil volumes overseas with no avenue left to hedge their risk in the domestic market. That would further
raise prices in the country by depleting the supply pipeline.

As soya oil is the basis on which all vegetable oils are priced in India. It pulled up the entire edible oil
table. Market watchers said, India would also end up importing inflation faster. “Refiners are now free to
charge the higher edible oil prices prevailing overseas because there is no local price discovery
mechanism left to act as a counterbalance.

Pig iron export by PSUs banned

In yet another move to check spiraling steel prices, the government has imposed a temporary ban on
export of pig iron by public-sector companies, Steel Authority of India (SAIL), Rashtriya Ispat Nigam
(RINL) and MMTC-controlled Neelachal Ispat Nigam (NINL).
The Centre is planning to hold an auction for the pig iron produced by the PSUs for domestic buyers at
their existing prices. Domestic buyers will get 10 days to make purchases, following which PSUs will be
allowed to export the left-over metal. The move is aimed at supporting the export-oriented foundry and
casting units that have been complaining about steep rise in prices of pig iron and supply constraints.
Since prices of PSUs are much lower than those maintained by private companies, giving first preference
to domestic buyers will ensure that the foundry and casting units will have access to more supplies from
them than before. This may also encourage other private sector players to reduce prices and look for
opportunities in the domestic market itself.

Inflation shows signs of peaking, hits another 3 ½ - year high at 7.61%

The annual inflation rate rose yet again, to a fresh three-and-a-half-year high of 7.61% for the week ended
April 26 ’08. The Inflation was a ted lower at 7.57% in the previous week. For the moment, it looks the
worst in year-on-year basis. However, what’s heartening is the week-on-week rise that has definitely
cooled down. From the week ended April 19 to the week ended April 26, price have risen much slower by
0.08%, compared to the 0.8% week-on-week rise in early March.

Inflation shows signs of peaking, hits another 44-month high at 7.83%

The annual inflation rate rose yet again, to a fresh 44-month high of 7.83% for the week ended May 3 ‘08.
The last time inflation hit a high was in September 2004, when it touched 7.86%. Despite the high base
effect and slew of fiscal and monetary measures initiated recently, inflation accelerated from 7.61% for
the week ended April 26, suggesting the government may have to initiate more steps to hold the price
line. The worrying factor this time is rise in price index across all categories, including primary articles,
manufacturing and fuel and lubricants, in both y-o-y and m-o-m terms. What are worse are the revised
figures for WPI for the week ended March 8, which has been revised to 7.78% from the provisional
estimate of 5.92%. Going by this trend, the actual inflation for the week ended May 3 may be over 8%.

FM says have patience

Finance Minister P Chidambaram said high inflation, which scaled a fresh 44-month peak of 7.83%, was
indeed worrying, but the government would wait to see the impact of price cuts in cement and steel
sectors in the cost of living index before taking further administrative steps. “Our expectation is that
inflation will moderate. We are waiting for the roll-back in steel and cement prices to come into force.
You have to be patient.”

Major steel makers had decided to reduce prices by Rs 4,000 a tonne after meeting Prime Minister
Manmohan Singh on May 7, while some cement companies have announced a reduction of Rs 3 to Rs 7
per bag in prices. Steel and cement sectors together contribute about 12% to overall inflation. These are
very difficult times; inflation moving up from 7.61% to 7.83% is indeed worrying. But even amid dark
clouds, there is a silver line. Inflation rates of a number of primary articles have declined. Inflation of
many food items have come down.

The rise in the wholesale price index is because of inflation in two other groups – the fuel, power and
light group, and the manufactured products group. Products in fuel group may not decline unless global
crude oil prices decline. In the fuel, power and light group category, every item is linked to crude oil. In
this class, lignite has shown a very sharp rise of 16.3% because of overall high fuel prices. In the
manufactured products group, aluminium, sulphate, synthetic yarn and agricultural implements have
shown a sharp rise, pushing up inflation.
Spike in crude prices may significantly dampen market rebound: IMF

The International Monetary Fund’s chief economist Simon Johnson said; “Rising global oil prices could
significantly dampen progress that has been made so far in calming financial markets. The banks that
suffered losses as a result of a US originated mortgage lending crisis have had greater-than-expected
success in raising new money but he worried that progress could be undone by soaring energy costs.”
Johnson said the rise in stock markets reflected success by banks in raising capital. Still, the US Federal
Reserve’s senior officers’ survey indicates banks may be tightening or reluctant to lend too many
customers. Johnson said the large increase in oil prices since March, from about $ 100 a barrel to $ 125,
not only hurt consumers but also has effected inflation expectations and makes policy harder to run.

Wheat buy set to cross record levels

With the political cost of spiraling prices bearing high on the minds of the government leaders, Union
food and agriculture minister Sharad Pawar would have some confronting news when the briefs the
cabinet about the food situation in the country. Mr Pawar is expected to apprise his cabinet colleagues
about wheat procurement across the country. The Food Corporation of India had, as of 21st of May 2008,
procured 203-lakh tonnes of wheat, well above the targeted of 150-lakh tonnes. Going by the present
trend, the procurement figures may touch an all-time high of 210 lakh tonnes by the end of the season.
The record till now had been 206.3 lakh tonnes, attained in 2001-02.

With the FCI going on an over drive to procure wheat from the farmers, it was only natural that the
private players, and as a corollary, the availability of the food grains in the market, would be affected
adversely. This, fortunately, has not happened, and the wholesale and retail prices of wheat, as also rice,
have remained stable in the main markets across the country.

While the government could afford to breathe a sigh of relief on the food front, it is the actually the prices
of other commodities, including cement, edible oil, petrol, pulses, steel and other metals which are
pushing the prices to newer highs every week. It is the global prices of these items which are determining
inflation-rates. And the government can do very little to rein them in.

Inflation loses momentum at 7.82%

The government, which has been trying every possible way to keep commodities prices under check,
seems to have got temporary relief. Data for the week ended May 10 saw inflation rate at 7.82% steady at
the previous week’s level of 7.83%. The bad news is that revised figures for March 15 showed that
inflation rate scaled 8.02%, triggering fears that the latest figure too may be an understatement.

Inflation at 45-month high of 8.1%

The wholesale price index for the week ended May 17 crossed the 8% mark and rose to a record level of
8.1%, the highest in 45 months. The unrelenting increase in the price index has put the government in a
spot as it is not left with too many options to rein in prices. According to finance minister P
Chidambaram, inflation is unlikely to decline unless global crude oil prices fall. The minister said even
though food inflation may moderate because of record procurement of wheat and rice, the global crude
and commodity prices would continue to play a crucial role in bringing the overall prices down.
Meanwhile, the government would continue to take steps to contain, moderate and, to some extent,
reverse the headline inflation.
7.2 DOWNWARD TRAIL
Rupee slips to 13-month low of 43/dollar

The outlook of the rupee has changed dramatically suddenly. The currency, which was in the news in
2007 for being one of the best performing Asian unit, is now back in the limelight for its downward trail
versus the greenback. The rupee, which recently fell, to the 41-mark against the US-dollar in the last week
of May, is now turning towards the 43-mark. On 14th of May ’08, the rupee fell a 13-month low of 42.67
per dollar, almost 6.8% lower from the levels of 39.95/96 seen in April.

Exporters, who suffered due to RBI’s non-intervention last year, are now holding back from selling dollar
holdings aggressively in the hope the rupee could fall further. On the other hand, rising crude prices have
petrified oil companies to such an extent that they have been on a massive dollar mop-up spree over the
past few weeks. Put together, this has led to a severe mismatch in demand and supply in the forex market.

Is rupee depreciation in line with fundamentals?

The recent depreciation of the rupee against dollar has been sizeable but orderly, packed within a short
time, and caught almost all off-guard. Interestingly, the RBI has not intervened in the foreign exchange
market. There are four key factors behind the recent depreciation:

1. Recovery of the US dollar;

2. Higher global crude oil prices, which widen the current account deficit and also increase dollar
buying by oil companies;

3. Slowdown in capital inflows, which decreases the supply of dollars;

4. Unwinding of positions that were betting on rupee appreciation to check inflation.

Analysing the evolving balance of payments dynamics is crucial for figuring out where the rupee is
headed. Surging crude oil import bill, continued strength in domestic demand, and expectations of
moderating export growth suggest that the current account deficit will worsen this fiscal year, probably to
slightly more than 2% of GDP. A $ 10/bbl increase in crude oil prices increases the merchandise trade
deficit by around $ 6.5-7.0 billion.

Firms that have raised external commercial borrowings (ECBs) and happily kept the proceeds unhedged
assuming super-optimistic scenarios for the rupee should be losing some sleep. Admittedly, a weaker
rupee will increase the subsidy bill for the government but the impact will be marginal on a situation that
is already on an unsustainable path for reasons that have nothing to do with the RBI. In particular, the
government should not rush into easing the restrictions on ECBs. It is somewhat amusing that many of the
analysts who argued for no RBI intervention when there was pressure on the rupee to appreciate are now
making the case for intervention to avoid depreciation.

The rupee could weaken further against the US dollar, unless either global crude oil prices ease or there is
a sharp improvement in global risk appetite that increases capital inflows into India. Further delays by
exporters in converting their export earnings will increase the mismatch between dollar supply and
demand, thus strengthening the case for further rupee weakness.

It is an important lesson for all, especially by uninitiated: even currencies that are expected to appreciate
sometimes go off-course. Get used to flexible exchange rates, and manage risk in a better manner.
New day, New challenges

India’s policymakers have been confronted with a new set of challenges this fiscal, brought about due to
sudden reversal in the country’s economic fundamentals. Until a few months ago, most indicators seemed
to suggest that the India story was strong. Prior to the hiccups now, the major tasks which policymakers
had to deal with was to tackle inflationary expectations and strong currency.

But in the course of last two months, policy challenges have altered. Besides high inflation and rising
food and commodity prices, the external sector is now showing some wobbly signs with the rupee
weakening against the dollar. Industries output growth too had decelerated, indicating a general slowdown
in the economy. While there were some signs of consumption slowdown since last year, there are signs of
brakes being applied on investments as well.

Policymakers, including Planning Commission deputy chairman Montek Singh Ahluwalia and RBI
governor Y V Reddy, are saying that both the IIP and inflation numbers might not be reflecting ground
realities; Which means that the inflation rate which is closing in on the 8% mark may actually be higher
while the drop in IIP may be far more serious than what the current figures show.

The government, it may be recalled, had tightened foreign borrowing norms in August last year and
imposed some end-use restriction to stem the appreciation of the rupee. While the policy seemed to have
served the purpose to some extent, it seems to have had an adverse impact on industrial output. Given that
it is a pre-election year, policymakers will have to clearly spell out their trade-off. Arguably inflation is
expected to take precedence over growth. With crude prices hovering close to $ 135 a barrel and with the
political compulsion of not forcing a pass through on a majority of petroleum products, there could be a
severe impact on the fiscal deficit as the government will have to bear the burden of servicing the oil
bonds subscribed by oil companies.

In addition, other fiscal measures to rein in prices could well upset crucial development projects on
account of the FRBM compulsions to rein in fiscal deficit. High oil prices have also led to the rupee
weakening against the dollar. A weak rupee could further impact imports and indirectly add to the
inflation of imported goods.

In this scenario, economists are still not willing to write off the growth story completely. According to D
K Joshi, principal economist, Crisil, a lot will depend on how oil prices move. “We expect oil prices to
stabilise in a few months and given that the RBI’s target of 5.5% is likely to be achieved. Food inflation
too could come down on a good harvest and expectations of normal monsoon. We have revised our
growth target to 8.1% from 8.5% for the year.”
8. MISCELLANEOUS UPDATES

BIG CINEMA
Process of rebranding

In line with the rebranding of Reliance Entertainment to Reliance Big Entertainment, the media and
entertainment arm of the Anil Dhirubhai Ambani Group (ADAG) is now in the process of rebranding its
Adlabs multiplex business. The Adlabs brand name will slowly be phased out and will be replaced by Big
Cinema. The rebranding is in line with its aim of ensuring one brand name across all its entertainment
verticals, such as Big FM, Big TV, its DTH services and Big Pictures etc.

The company will also start screening Indian films across 200 theatres in the US under the Big brand
franchise. Called the ‘Big cinema’ chain, it will screen Hindi and regional languages films from India as
well as movies from Asian sub-continent to cater to the growing Indian diaspora in the US.

However, ADAG is not changing the company’s name – Adlabs Films – at the moment. But eventually, a
name change is also on the cards for Adlabs Films, which will encompass the ‘Big’ brand name – in
tandem with the other entertainment brands of the group. Adlabs Cinemas has presence across 43 cities at
54 locations with 158 screens. Last year Adlabs launched 100 screens. The company is also building a
vertically-integrated studio under the ‘Big’ brand.

GSM HANDSETS
Big splash into handset retailing

Anil Ambani’s Reliance Communications (RCom) is readying itself for a big splash into the Rs 20,000-
crore GSM handset retailing. It will enter into the new avenue by selling GSM handsets in the existing
eight circles of Reliance Telecom, a part of RCom. It has signed agreements with major handset vendors,
including LG, Samsung, Motorola, Sony Ericsson, Spice, Fly Mobile and HTC. It is expected to sign a
similar agreement with Nokia shortly.

The company plans to sell GSM handset in all of its 2,500 retail outlets. RCom has been distributing
cutting edge and affordable CDMA handsets at the entry price of Rs 777, the cheapest handset in the
world. RCom has also launched colour handsets at Rs 999. RCom has built significant capabilities in
CDMA handset retail business, which can be readily utilised to channelise a diverse suite of consumer
electronic gadgets. RCom has always believed in giving better than the best quality and price to the many
million Indian consumers, and the same philosophy is the guiding force whenever the company plans to
evaluate opportunities for portfolio expansion. RCom is the second largest handset distributor. It sold over
15-16 million CDMA handsets last year.

According to sources, the foray into the GSM handset retailing is part of the company’s nationwide
launch of GSM business by the end of this year. RCom aims to grab a pie of the GSM handset market.
Also, it plans to use its bulk buying capability to offer the best GSM handset bargain and aims to tap the
new subscribers coming on mobile networks. Over 27 million subscribers were added on the country’s
telecom networks between January-March 2008, out of which 10 million subscribers were added in
March alone. At this rate, the new subscribers during the current fiscal are estimated to cross the 100-
million mark. For the launch of GSM business, RCom has placed equipment order of $ 1 billion. It
doesn’t need to spend additional money for passive infrastructure and other associated expenditure like
any other typical green field Foray. Industry sources said the entry of Reliance in this segment may lead
to consolidation of the handset retail sector.
RPL Jamnagar Refinery
World slips on oil mess as demand outpaces supply

India could play a vital role in softening the pressure on the global fuel market as Reliance Petroleum
(RPL) Jamnagar refinery readies for commercial production by the third quarter this fiscal. RPL’s 60-
million-tonne export-oriented Jamnagar refinery will pump fuel to world markets including the US and
Europe and ease supply crunch.

This should come as a relief to oil-guzzling economies as they struggle to keep their oil import bills in
check. Even as crude oil prices held firm at over $ 128 a barrel, prices of petrol and diesel scaled new
heights at $ 138 per barrel and $ 170 per barrel respectively.

Analysts said, “RPL will bring in significant volumes in the market and this should lead to softening of
petroleum product prices. High fuel bills have hit consumers across the world. While Londoners have
taken to street riots over fuel price hikes, pump dealers in the US are beginning to protest as prices reach
all-time highs. Most developing economics are taking a huge fiscal burden by heavily subsiding fuel.

So, while Thailand is contemplating emergency measures to regulate refining margins and keep prices
under control, the Indian government has taken over direct control of fuel pricing and is doling out bonds
to compensate the oil companies. Neighbouring countries like Sri Lanka, Pakistan and even Bangladesh
have increased retail prices, but India is still debating when and how much the increase should be.

The ethnic strife in Nigeria, which has disrupted petroleum exports from the country, has led to a supply
crunch in petroleum products. Added to this is the shutdown of two major refineries in Japan and South
Korea with an estimated refining capacity of 29 million tonnes. The breakdown of the Ceyhan Turkey
pipeline that feeds European markets has added the supply constraints. And even as fuel supplies are hit,
demand for some products like gasoline is set to rise in the coming months. The advent of the holiday
season in the northern hemisphere countries like the US during the summer months leads to a spurt in
gasoline demand. Low inventories in the US have added a premium to the price.

The blundering explorer

ONGC, our main oil & gas producer is clearly in the dock now that third-party audit has reportedly
revealed considerable laxity in its operations. The public sector major has, according to an ongoing
review, by petroleum consulting firm DeGolyer and McNaughton missed hydrocarbon leads in at least 20
wells drilled during 2002-05. The missteps and lapses seem particularly galling given that private sector
majors have had a much better record of striking petroleum during the same period, and in the same
sedimentary basins.

The point is that ONGC’s lackluster finding record seems essentially to have systemic causes. The ONGC
brass, like Brutus, needs to mull over the fact that the fault is not in their stars, but in themselves. The
domestic major surely needs to take sustained proactive action, if it is to substantially improve on its
rather drab finding record. Note that its last major find was over two decades ago. Since then it has
practically been sitting on its laurels. Such a business-as-usual approach will just not do. ONGC would
need to revamp strategy for key operations like drilling, logging and data management. And, ONGC
would need to shore up its expertise and ability to strike oil.
LAND DEALS
Losing stream in prime location

The soaring land deals in prime location of metro cities, which had scaled astronomical levels in the past
few years, seem to be losing steam. The deals being struck this year are at an increasingly lower price
than the ones last year. Parsvnath Developers has bought 1.18 acre land, jointly owned by Mahajan
Industries and Videocon group in Connaught Place for Rs 200 crore, compared to hotel major Leela
group’s acquisition of 3 acres in Chanakyapuri last year for Rs 611 crore. Parsvnath land deal has come at
a discount of almost 17% at Rs 169 crore per acre.

Parsvnath plans to develop retail and office space, while Leela is building a hotel. Real estate experts say
Connaught Place and Chanakyapuri are comparable locations in the capital and should fetch similar rates
if transactions happen at the same line. In addition, the FAR (the ratio of developable space to total land)
for both retail/office and hotels are the same at 1.5, according to Delhi’s new master plan.

Real estate experts argue: “We have come to the end of one property cycle. Speculators have existed the
market and we are seeing a softening in the housing market. This will now spread to the commercial
market and then finally impact land prices. So with borrowing cost going up, and prices softening, the
euphoria towards land acquisition has certainly died down.” They, however, caution that there may still
be several takers for prime properties such as those in Connaught Place in Delhi and Nariman Point in
Mumbai. “The land deals in prime city locations are very few and far between. So the prices, although,
reflect the market sentiments, do not give you a trend.”

Realty does reality check, prices fall 15-20% in Q1

If high prices have been holding you from buying your dream house all these years, here’s something to
cheer about. In the first quarter of this year, there has been a 15-20% price correction in markets across
the country. In fact, in many markets, the levels of transactions have gone down drastically, which has
resulted in this dip. This is also because residential capital values in some micro markets in the metros
have shown negative growth in the first one quarter.

Real estate markets have observed high growth levels in the recent past. A large number of supply is in
offering indicates that there are not many buyers for the prices quoted for various real estate typologies at
this point of time. The exceedingly high price points and spiraling interest rates have contributed to a
reduction in interest from speculative investors due to decrease in holding power, resulting in a clear shift
to a largely end-users-led demand. Realty developers feel that the biggest risk to growth in this sector is
sales to speculators. Of course, how this inventory build-up will affect prices going forward remains to be
seen. Further, the developers’ tendency to divert money from one project to another – rather than to keep
a financial cushion – can lead to a chain reaction.

Slowdown, falling market demolish real estate stocks

The uncertainty in the capital market has hit realty stocks hardest. The BSE realty index is the worst
performer this year, having shed 51% of its 52-week peak reached in January. With increasing evidence
of a slowdown in the realty sector, rising input costs and little chances of interest rate softening, realty
stocks may see further dip in valuations. Real estate sector is seeing a major slowdown in the sales
volume in most markets of the country. The speculators have exited the market and Mumbai and NCR, the
biggest real estate markets in the country, are seeing subdued sales. In Gurgaon and Noida, which had
seen prices almost treble in four years, sales are down 70%, leading to a price correction of 10-20%.
Experts believe if the negative news flow continues for the realty sector, the scrips may see a further dip
9. INSURANCE
Money back policies

Money back insurance policies rank high on the popularity chart. And for good reason: they offer dual
benefits of insurance and redemption of money at regular intervals. But little do people realise that they
pay more towards premium amount in comparison to term policy. Here’s a lowdown on what it takes to
buy a money back policy and the issues involved.

First things first

Money back policies fit perfectly in the scheme of things of traditional investors who seek financial
instruments that provide insurance and investment, with a low risk element and guaranteed returns. In
other words, the plan is meant for individuals who require money at certain intervals in their lifetime to
meet fixed long and short-term financial needs (buying a house or car, vacations abroad).

Unlike ordinary endowment insurance plans where the survival benefits are payable only at the end of the
endowment period, it provides for periodic payments of partial survival benefits during the term of the
policy, of course as long as the policy holder is alive. What makes these products even more attractive is
that in the event of death of the policyholder at any time during the policy term, the death benefit is the
full sum assured without deducting any of the survival benefit amounts, which may have already been
paid as money-back components. Similarly, the bonus is also calculated on the full sum assured.

Read the fineprint

Before buying a money back plan, insurance advisors recommend that you should carefully check out the
actual amount allocated towards the premium, how much of it going to be accumulated and how much is
the insurance company’s charges. The most crucial aspect, they believe, is reading the terms and
conditions thoroughly and understanding each clause well.

Also, you should make sure that the periodic payouts are sound enough to meet your anticipated needs. It
is also beneficial to analyse the past performance in terms of declared bonuses. Though the past is not
necessarily an indication of future performance, it gives a fair idea of the insurance company’s
commitment to its policyholders.

The flipside

One of the primary disadvantages, insurance advisors feel, with money back policies is its low rate of
return, when compared to market-linked insurance-cum-investment products. Also, while on the one
hand, payout intervals are fixed and helpful for crucial lifestage planning, on the other, you don’t have the
flexibility to increase or decrease premiums and have a choice of sum assured to suit growing incomes
and lifestyle.

You don’t have the freedom to change the payout intervals. In case of surrender as well, it offers low
paid-up value. For those who like to ascertain the charges of their investment products, it may not be right
choice as it is not disclosed to the policyholder.