Editorial Preamble

1 REGULATORY INDEPENDENCE
Misunderstood & muddled

In a democratic mode of governance no agency is independent. If one is independent, it cannot be a part

of any system. A system delivers best only if all its parts have harmonious co-existence and no part seeks
independence of others. In fact, dependence on one another is a strength, rather than weakness. Besides,
vigilance by others keeps one always on toes and prevents its failure.

To some, independence is a misnomer. It certainly does not mean independence from the laws of the land.
Nor does it mean independence from standard checks and balances evolved over time for the exercise of
powers. As much as one may wish, a public agency has to discharge its responsibilities within the frame
of the law and be accountable for its performance. Hence accountability and independence go hand in
hand and the mechanism to ensure this need to be provided together.

Independence is not free of cost: it has to be earned. In a system, only those who can shoulder
accountability deserve to be independent. A related issue would be credibility. An organisation created
cannot legitimately achieve the credibility overnight to claim real independence. Even central banking
independence the world over has been earned over decades.

Even after a few decades of experimenting with ‘independent’ regulators, the debate on regulatory
independence is far from over. It has rather engulfed the independence of ‘neo-government’, the
institutions created by government for governance (customer protection, development and regulation) of
markets on its behalf. To protagonists of the regulatory mode of governance believe that neo-governments
need to be independent to enable them to discharge their responsibilities professionally.

The neo-governments seek functional independence in respect of regulatory activities to facilitate

objective decisions without being encumbered by socio-political legacy constraints. Efficiency and speed
of decision making are the watch words which no political decision making process could dispense.
Independence in this functional sense means adequate powers, enough resources and capacity to carry on
regulatory activities.

However, the neo-governments discharge non-regulatory functions as well where perhaps the degree of
independence sought is different. Here, the neo- governments are just one of the players (government may
have multiple arms performing these tasks) while in the regulatory space they are the umpires. The
umpires must be independent but armed with knowledge; including the knowledge that their
independence is restricted to the game on the field. Non-regulatory activities are not the exclusive
prerogative of the neo-governments.

Discharging the responsibilities of the neo-governments requires legislative, executive and judicial
measures – a reason why their powers, including the self-image, sometimes get magnifies. But given the
exalted position of legislature and judiciary in the Indian Constitution, independence is not sought in
respect of legislative and judicial activities. It is considered normal if the regulations/orders of neo-
governments are modified/set aside by the legislature/judiciary. Thus, independence of neo-governments
essentially boils down to independence from the executive branch of the State.

The Constitution assigns a particular subject to the government. The business allocation rules assign it to
an executive unit. However, the legislature, by a statute, has assigned regulation, development and
customer protection matters related to the subject to a neo-government, without actually curtailing the
responsibilities of the executives. The said statute, however, empowers the executive to constitute the
neo-government and supersede if it is failing to discharge its duties to its satisfaction. It also empowers
the executive to give direction on policy matters to neo-government. The executive places the activity
reports – annual report, the annual accounts, regulations, etc. – of neo-governments before the legislature
for scrutiny. It responds to legislature on all matters relating to the subject for and on behalf of the neo-
government. This is de facto an agency mode of governance. Further, the executive is accountable to
people through legislature on all matters relating to the subject. In exercise of these responsibilities, the
executive engages in constant interaction with the neo-government. The interaction, if not properly
calibrated, is construed as interference.

Let us look at regulatory domain of a neo-government. Under the statute, a neo-government makes
subordinate legislation dealing with market related matters. It issues various kinds of directions in the
interest of market and/or customers. It determines and initiates enforcement action appropriate in the
circumstances. It has powers to raise resources to support its regulatory functions. Its staff enjoys
immunity from suit, prosecution or other legal proceedings in respect of actions taken by them in good
faith. Once appointed, the chairman and members of the neo-government cannot be removed, except
under extreme circumstances. These statutory provisions promote independence of neo-governments and
hardly leave any scope for the executive to interfere in the regulatory arena. Viewed in this context, every
neo-government in India is independent.

There are few agencies within government who need independence for their effectiveness. These include
the Election Commission, Comptroller and Auditor General of India and Union Public Service
Commission. All of them respond to Parliament through the executive. They are subject to legislative and
judicial scrutiny. They do not enjoy any higher level of independence than the neo-governments do. They
are rather worse off in certain respects. For example, none of them has an independent source of finance.
Even the Supreme Court, which is independent in every sense, does not have its own source of funding.

There are general regulators and special regulators. While one deal with a particular market, another deal
with one aspect of every market. For example, the Competition Commissioner of India deals with
competition issues in all markets while Sebi deals with all aspects of securities market. Both these
regulators may wish to have independence to determine competitive structure of securities markets. Does
such determination by one amount to interference in the domain of the others?

There are comparable bodies in other countries. A case in point is the Securities and Exchange
Commission in the USA. It appears twice before the Congress in a year and gives testimony before
congressional oversight committees as often as required. The fees levied by it are turned over to general
treasury. The Congress approves its budgets as well as important rules proposed by it. It is required to
hold its proceedings in public. Its programmes and expenditure are studied by the government
accountability office. It seeks administrative sanction from an administrative law judge. It refers the
matter to the justice department for launching prosecution before the district criminal court. Viewed in
this context, the neo-governments in India appear comparatively more independent.

Governance through neo-governments is still evolving. The Constitution of India does not explicitly
recognise neo-governments as recognised mechanism for delivering of governance. When governance
through panchayats was considered necessary, the Constitution was amended to explicitly recognise them
and specify their responsibilities, including their autonomy and accountability arrangements. So, it may
be appropriate that a clear Constitutional provision be made to explicitly recognise neo-governments and
provide for an appropriate autonomy-accountability framework for them. While deciding their space in
the constitution schema, it would be ideal to define the autonomy arrangements of the neo-governments to
the three organs of the State – legislative, judiciary and executive. This is necessary to remove both
conceptual ambiguity and the cobweb on the practical aspects of independence.
2.1 SECURITY MARKET
Stay flexible, open minded and skeptical

Volatility is an inherent part of stock market investing and investors need to keep in mind that market
gyrations tend to be more pronounced over the short-term. Thus, during times of negative sentiments,
often quality asset prices are available at attractive bargains and you can benefit from them.

“There is an important lesson – never adopt permanently any type of asset or any selection method. Always
try to stay flexible, open minded and skeptical. Long-term top results are achieved only by changing from
popular to unpopular types of securities you favour and your methods of selection.”

The starting point of investing is to have a point of view of the future of economy and then the sector and
then the company; or it can be individual stock picking if there are compelling reasons. In this changing
world the view of the future can change rapidly and the original assumptions of investment may undergo
a change. It is crucial to have an open mind about being wrong and to do course correction.

1st week of July ‘08 – Sensex closed flat

Daily review 30/06/08 01/07/2008 01/07/08 02/07/08 03/07/08 04/07/08

Sensex 13,461.60 12,961.68 (499.92) 702.94 (570.51) 359.89
Nifty 4040.55 3896.75 (143.80) 196.60 (167.60) 90.25

Weekly review 30/06/08 04/07/08 Points Percentage

Sensex 13,461.60 13,454.00 (7.60) (0.06%)
Nifty 4040.55 4,016.00 (24.55) (0.61%)

At these levels, the market is facing an acid test - the toughest since the start of the bull-run. The Nifty
levels of 3890-3870 will prove to be a very important support level for the market. In past few trading
session, the Nifty breached 3890-3870, but never gave closing below the 3890-mark. Recent market
conditions have certainly tested the patience of many investors. The most frustrating part is that the
market has been drifting steadily lower and intra-day moves have been choppy and sudden, making it
hard to chase trades. We are not seeing smooth moves followed by small pullbacks that offer multiple
chances, but rather quick whooshes followed by complete reversals on a dime.

2nd week of July ‘08 – Sensex closed flat again

Daily review 04/07/08 07/07/08 08/07/08 09/07/08 10/07/08 11/07/08

Sensex 13,454.00 71.99 (176.34) 614.61 (38.02) (456.39)
Nifty 4,016.00 14.00 (41.45) 168.55 5.10 (113.20)

Weekly review 04/07/08 11/07/08 Points Percentage

Sensex 13,454.00 13,469.85 15.85 0.12%
Nifty 4,016.00 4.049.00 33.00 0.82%
 SECURITY MARKET

The stock market managed to snap seven week long losing streak as both the indices Sensex and Nifty
ended the week in the green amid a host of negative factors. Abysmal industrial data, spiraling inflation as
well as global crude oil prices and muted business outlook indicated by Infosys Tech weighed on the
market sentiments on the Friday, wiping out major part of the week’s gains. The BSE 30-share barometer
crossed 14K-mark at mid-week, but failed to maintain the level due to fluid political conditions.

3rd week of July ‘08 – Sensex in a recovery mode, closed up by 1%

Daily review 11/07/08 14/07/08 15/07/08 16/07/08 17/07/08 18/07/08

Sensex 13,469.85 (139.34) (654.32) (100.39) 536.05 523.55
Nifty 4.049.00 (9.30) (178.60) (44.40) 130.50 145.05

Weekly review 11/07/08 18/07/08 Points Percentage

Sensex 13,469.85 13,635.40 165.55 1.23%
Nifty 4.049.00 4,092.25 43.25 1.06%

The markets seem to be consolidating around 3,800 levels of Nifty; however negative developments
on political front may change the market scenario completely. On the political front, the ground is finally
set for the UPA to face a vote of confidence in parliament on July 22. This event will be watched with
great interest by the markets and will decide the direction, as any negative surprise can give a nasty jolt to
the markets once again. On the positive side if the UPA cruises comfortably the markets will definitely
witness a big spurt which coupled with the nuke deal will physiologically boost the market sentiments.
This may confirm the bottom formation for near term.

4th week of July ‘08 – Sensex up 5%

Daily review 18/07/08 21/07/08 22/07/08 23/07/08 24/07/08 25/07/08

Sensex 13,635.40 214.64 254.16 838.08 (165.27) (502.07)
Nifty 4,092.25 67.25 80.60 236.70 (43.25) (121.70)

Market gives thumbs up to UPA government

Weekly review 18/07/08 25/07/08 Points Percentage

Sensex 13,635.40 14,274.94 639.54 4.69%
Nifty 4,092.25 4,311.85 219.60 5.36%

5th week of July ‘08 – Sensex up 3%

Daily review 25/07/08 28/07/08 29/07/08 30/07/08 31/07/08 01/08/08

Sensex 14,274.94 74.17 (557.57) 495.67 68.54 300.94
Nifty 4,311.85 20.25 (142.25) 123.70 19.40 80.60
 SECURITY MARKET

Weekly review 25/07/08 01/08/08 Points Percentage

Sensex 14,274.94 14,656.69 381.75 2.67%
Nifty 4,311.85 4,413.55 101.70 2.36%

Market gains despite RBI’s hawkish policy: The markets showed greater resilience despite the RBI’s
hawkish monetary policy and extended their weekly winning streak. According to analysts, the markets
drew support largely from high expectation that the reforms process would get a boost following a
statement by Finance Minister P Chidambaram. Investor’s morale was also uplifted as the government on
Friday introduced norms for 3G mobile services, an indication of its willingness to put reforms on a fast
track. They said there are positive factors ruling in the market fueled by easing of crude oil prices, which
stayed around $ 123 a barrel mark. The inflation, which almost touched the 12% mark seems to be
discounted by market conditions.

Monthly review

Month March ‘08 April ‘08 May ‘08 June ‘08 July ‘08

Date 31.03.08 30.04.08 30.05.08 30.06.08 31/07//08

Sensex 15,644.44 17,287.31 16,415.57 13,461.60 14,355.75

Points Base 1,642.87 (871.74) (2,953.97) 894.15

Percentage Base 10.50% (5.04%) (18.00%) 6.23%

Going ahead, the market are expected to hold the recent lows, although there could be further global
shocks since most of the negatives in the domestic arena have been fully discounted in the market prices.
F&O data suggests that the August ’08 series is starting on a lighter note which is the lowest since
December ’07 series. This leaves less room for any further downside. The recent lows on Nifty of 3,800 is
likely to hold for the near term and in short term, the markets may see further extension of gains. Any
positive move from the government on market liberalisation may provide necessary impetus for a rally.
 SECURITY MARKET
JUST CHILL
Is the choppy stock market making your heart skip a beat or two?
Put your fear aside…

Greed (bull) and fear (bear); these are two words investors often here and think of, but are unable to
control their emotions when it comes to investing. In fact, when stock markets are north-bound, their
confidence in buying increases considerably. They buy stocks irrespective of their high P/E ratio and are
sure to make good money. If, the markets enter a bearish phase, their confidence goes down, leaving them
wondering where did they go wrong? The chaotic bear market environment then sets the stage for fear to
creep into their minds, thus impacting investment decisions. To make sure that you successfully weather
the market storms, here are ways to drive out your fears of losing money in a bear market.

Stay calm and act prudently

Easy to say than follow; It is true that bear markets spread panic among investors, often causing them to
sell all the stocks they hold. But a smart investor is one who gets on with the job of picking up value
stocks, notwithstanding where the tide of the market is moving. Such an investor is rightly rewarded with
great profits once the market turns. Since we fail to control our emotions, we forget that investment in
equity is not for short term. So for long-term benefits, it is important to stay calm and act prudently.

Review your stock rationally

You may have earlier doubled your money in a short span, by investing in a particular stock during a bull
run, but you must remember that stock investing is not about speculating or making easy money. It is an
art and science of buying good businesses at cheaper valuations. It is important to set realistic goals for
your portfolio’s long term return, and buy only good companies with strong fundamentals and good
management. To nip your fears in a bearish market, you should avoid selling just because stock prices
have dropped. You must review your stock portfolio rationally. Then only you should arrive at a decision
to sell losers whose future prospects look weak, and hold on to winners with prospects that remain solid.

Avoid tracking the market

Another way you can calm your nerves in a bear market is by not following the stock markets on a daily
basis. Every investor knows that you should buy low and sell high. Bull markets provide you a chance to
sell high. Bear markets, however, offer you a chance to buy low. Unfortunately, too many investors are
lulled into complacency during bull markets and scared out of their wits in bear markets. So they do just
the opposite, buying high and selling low. “Thus you should avoid tracking the stock markets daily during
a bearish phase. This way you will save yourself from unnecessary anxiety and fear.

Set aside emergency funds

Investors have the tendency to over-invest during a bull run, which becomes a reason for fear when the
markets turn choppy. To counter such a situation, you should have sufficient liquidity in hand for
emergencies. This will make sure that you aren’t forced to sell equity holdings before the time and price
are right. To emerge as a winner, all you need to do is recognise the fact that your portfolio will decline
from time to time, but take solace in knowing that short-term pain is required for long-term gain.
 SECURITY MARKET

See the positive side

To make money in equities, it is important to be rational, not emotional. You should always try to look at
the positive side in a bad market. A bear market provides an excellent opportunity to buy strong
businesses at rock bottom prices. And no one can tell you when the next bull market will begin, how long
will it last, or how high the market will ultimately go. That should be the key point to drive out your fears
in the bear market. So even if the markets are down, you should be convinced that your business is
making money. The stock price may not generate great returns due to the bearish phase, but in the long-
term, your portfolio’s returns will be unmatchable.

Study behavioural finance

Last but not the least; you can study behavioural finance to calm your fears in a bear market. For the
uninitiated, behavioural finance pairs emotions with investments and shows how emotions and cognitive
errors can cause disasters in investing decisions. Individual behaviour, temperament and psychology play
an important role in determining investment success.

Even experienced investors are susceptible to making judgment errors identified by behavioural finance
research. It can help you to be watchful of your behaviour and, in turn, avoid mistakes that will decrease
your personal wealth. It provides a platform to learn from people’s mistakes, to modify and improve your
overall investment strategies and actually profit from identifying these mistakes. As for the bottomline,
just as it is important to know when to exercise caution, the same way it is important to comprehend when
to abstain from fear. Happy investing!
2.2 INDIAN ECONOMY
Left pullout may help push economic reforms

The decision of Left parties to withdraw support to the government could give lease of life to a large
number measures including disinvestment and reforms in the banking, insurance and pension sectors. The
SamaijJwadi Party (SP), which has come to the rescue of the UPA government, is not expected to have
such reservations. The trust motion moved by Prime Minister Manmohan Singh in the Lok Sabha on
Monday, 21st July 2008 was just a sideshow. The trust motion’s fate was settled not over the weight of the
arguments put forth by either side during the two-day debate, but by the outcome of the intense and
brazen bargaining outside Parliament.

After a day of high drama, backstage deals and frayed nerves, the Manmohan Singh government on
Tuesday, 22nd July 2008 evening won the trust vote in Lok Sabha. The government won comfortably –
275 against 256 votes. Looking forward, the principal concern of the Congress will be to aid Mr
Manmohan Singh quest for legacy. The Leftists were consistently frustrating his effort on the nuclear deal
front. Mr Singh has made the nuclear agreement an issue of personal prestige. But a forward movement
on policy issues will dependent on the support from new allies.

The Left parties were also vehemently opposed to raising the FDI limit in insurance to 49% from the
present 26%. On banking side, Banking Regulation (Amendment) Bill, 2005 that proposed to make the
voting rights of shareholders in private sector banks equal to their voting shares, did not find favour with
the Left. Currently, voting rights of the shareholders are capped at 10%, irrespective of their actual
holding. The Pension Fund Regulatory and Development Authority (PFRDA) Bill, 2005, was also held up
preventing reform in the pension sector. The government also wanted to bring changes in LIC Act of
1956 in order to raise resources. The proposal, however, got halted because of the Left’s opposition.

With the coming in of SP, there’s some hope for these key measures besides some crucial disinvestment
decisions. Divestment of 10% each in BHEL and BSNL could see green light. Further, the Department of
disinvestment is already, in the process of carrying due diligence on the listing of about two dozen
companies and the process is likely to get accelerated in the present political circumstances. The
government plans to piggyback on IPOs of these companies to offload up to 5% of its own stake.

Instant punditry concludes that the Left’s separation from the UPA is good news for reforms. But those
familiar with the reflexes of the parties that would sustain the government in power for another few
months are not so sanguine. This assessment is not off the mark for two reasons. Firstly, with price rise
and related issues, the new alliance would like the government to fix these problems first rather than
trying out any ambitious economic agenda. Secondly, the government just does not have the comfort-
level to put contentious piece of legislation such as pension reform or higher FDI in the insurance sector
on the policy table. In any case, the Congress will also not like the government to take up issues that
would complicate inter-party relations at this juncture.

Chidambaram puts reforms on fast track

The UPA government is gearing up to fast-forward economic liberalisation with finance minister top
priority to reforms in banking, pension sector and capital markets, besides streamlining the commodities
market and merger of SBI’s subsidiaries with the parent bank. Disinvestment and hike in FDI ceiling in
the insurance sector are other areas shortlisted by the FM. Apart from financial sector reforms; the
Manmohan Singh government is also likely to take up labour reforms. Liberalisation of labour norms is a
long-standing demand of India Inc.
 INDIAN ECONOMY

Among the areas of focus identified by Mr Chidambaram include: The Pension Fund Regulatory &
Development Authority (PFRDA) Bill; The Forward Contracts (Regulation) Amendment Bill; Banking
Regulation (Amendment) Bill, and SBI (Amendment) Bill.

A parliamentary committee has vetted the PFRDA legislation and it might be easy to get Parliament’s
approval for the Bill with the support of UPA’s new allies. In case of Forward Contracts (Regulation)
Amendment Bill, which seeks to streamline the commodities market, the government has already issued
an Ordinance. Now, the UPA regime has to obtain approval from the Parliament to effect these changes.

Cabinet approval for merger of SBS with SBI

Proposed merger of SBI received a go ahead from the Cabinet. The move would make way for the merger
of other six associate banks of SBI with itself. The Union Cabinet has also approved the proposal to
redefine powers of the RBI nominee director on the board of SBI. Centre is now expected to bring in
legislation in the monsoon session to effect the merger.

The word ‘disinvestment’ be replaced by ‘listing’

Since the UPA came to power in 2004, the disinvestment ministry has been functioning with out a full-
fledged minister. The department now comes under the finance minister. The Prime Minister is looking at
the coming eight months to carry out economic reforms. With the backing of new allies, the UPA
government would push through PSU disinvestments to improve the fiscal health of the country. It can’t
be possible unless a full-fledged minister overseas the process.

Meanwhile, minister of state for commerce, industry and power Jairam Ramesh has been lobbying that
the word ‘disinvestment’ be replaced by ‘listing’ and all PSUs be listed on the bourses. “Investment” is a
positive word, but disinvestment is not. We should junk the word disinvestment and call it listing. What
we need now is to list all our PSUs in stock market. The process will not only unlock value but will bring
in a corporate mind-set to our public sector undertakings.

The government may now undertake the process of diluting stakes of many PSUs through initial public
offerings (IPOs) because unlike many other reforms, listing in the market does not require any approval of
the Parliament. Mr Ramesh said some power PSUs such as NHPC, North Eastern Electric Power
Corporation (NEEPCO) and Tehri Hydro Development Corporation should be taken up for divestment.
We should list all these PSUs. We should not debate on whether we should list a particular PSU or not.
The debate should be on how much we should offload. Should it be 5%, 10% or 15%. In fact, we cannot
rule out the importance of PSUs in sectors such as power, coal, oil etc. But until they are listed, our
political system will not allow them to function as corporate entities.
2.3 INDIA INC
Redefining the reform agenda

The post-mortem of the trust vote has been a rush of commentaries that economic reform – issues pending
– can and must be addressed. Sadly, only a very limited agenda has been listed: FDI liberalisation in
banking, insurance and retail – plus financial sector reforms. These are, of course, important but there is
much else pending to be completed. There are 10 reforms issues which are pending and which could raise
growth as well as help contain inflation. These are the public sector, urban development, highways,
power, water, sanitation, housing, transport, rural infrastructure and food/agriculture.

The public sector needs priority attention. It is rich in assets, physical and human resources but is
hamstrung by procedures. Autonomy non-existent: CEO travel needs to be cleared by government and the
boards of directors are subservient to government. Government controls emoluments. Investment
decisions and pricing policies are subject to government approval. If government were to free the public
sector, it could add 1% of GDP growth. One way is certainly to continue the stalled disinvestment
process. It will automatically help free PSUs, especially if government shareholding is below 50%. The
only issue at this point of time is the decline in share prices in the stock market. But freedom for PSUs
will help government coffers in the medium and long term.

Second, urban development; Today’s congested and crowded cities need to be redeveloped, redesigned,
reconstructed; And new cities need to be built with simple, good quality infrastructure. Urban
development reform, which extends from legal changes to procedures becoming transparent, could also
add 1% to GDP, concurrently addressing major concerns regarding corruption, a cancer in the system.

Third, highways; they have a transformational role both for development and growth. But construction
of highways is moving at a slow speed; far, far slower than the country can afford. Allocation of resources
exists. Plan exists. There are no real policy issues. Only implementation is lacking. A push for fastest
highway construction could do great benefit to India. A part of this land is land acquisition reform.

Fourth, power – the last frontier of infrastructure reform. We are slowly, painfully, moving from a
national culture and belief that ‘power’ is ‘free’ to a new paradigm where people have to pay for power.
NTPC excels as a PSU of quality and, gradually, private sector power projects are happening, but, all too
slowly. The use of renewables needs to be speeded up as well as the use of local resources to generate
power in a decentralised manner. India’s power needs a mix of policies and practices – large plants, small
units, traditional technologies, and newer technologies. Power shortages can be resolved even in the short
term. And conservation and saving can be a powerful vehicle. Today, power is a huge cost pusher and its
shortage is surely reducing GDP growth.

Fifth, water; Real reform is yet to happen. Water supply, generally, is a huge problem. Drinking water
supply is a bigger challenge. Water conservation methods are only slowly gaining attention. If the
problem of water management and conservation is addressed, it could make a huge difference to the
people. A nation-wide creative initiative is needed. Water reform is critical to quality of life.

Sixth, sanitation; It is a major issue in India, urban, semi-urban and rural. Perhaps, a PSU corporation or
Authority with funds to work in a PPP mode and implement one million sanitation facilities – 650,000 in
the villages and 350,000 in urban centres – is the need of the hour. It is simple to do. It can be done. There
is no great innovation needed - Only simple, clean construction and maintenance arrangements.
 INDIA INC

Seventh, housing; the country needs economic housing in the millions to provide shelter, to enhance
quality of life, to provide security and stability, to raise productivity and also for so many other reasons. It
is a national need. It is a national priority. It can be done in a variety of ways - through a combination of
central initiative and decentralised implementation. Technology exists to get things done very quickly.

Eighth, transport; Public transport; More and better buses; Also small aircraft for short distances to
carry food grains, fruit, vegetables, speedily, from small rural airports to urban market centres. It will cut
down the huge waste of food, fruits and vegetables, and add productivity and efficiency. A simple system
of road and air transportation can transform the food and agriculture industry.

Ninth, rural infrastructure - All weather roads to be completed; small kuccha airports to be built; IT
connectivity to be completed; and TV and telecom connections to be provided. Even if some of these are
taken care of quickly, the 600 million people living in the rural areas will experience dramatic
improvement in their living standards.

Finally, the food and agriculture, which is still beset with controls and restrictions. What are needed are
specific strategies for specific products and different approaches for different geographical areas. A grand
vision combined with a deeply autonomous, decentralised approach and action plan is a must to achieve
another Green Revolution.

India’s reform agenda has to be broad, wide and deep. It’s mostly about management, organisation and
implementation. It’s not the “what”. It’s the “how”. The next few six months should and can take the
reform agenda ahead. A critical element will be a strong, clear, communication plan, which sets out the
steps being taken, the rationale and reasons, the benefits, the risks (if any) so that the public understands
what the reform agenda aims to do and achieve. Without this, actions can be seen as ad hoc. This will be a
real challenge because governments are best known for poor communication!

Too often, ‘economic reforms’ are related to ‘opening the economy’ in terms of trade and investment or
tax cuts. This limited coverage may well suit some other countries, but not India. ‘Economic reform’ in
India has to extend too many other areas, some of which have been covered here. There is a need for new
thought leadership to redefine ‘economic reform’ as it is applicable to India. And the sooner action is
taken, the faster will India be able to sustain 10% GDP growth per annum.
2.4 INDIANS
India to have 737m mobile users by 2012

Global consultancy and research firm Gartner said in a report: “The revenues of Indian cellular operators
will grow at compound annual growth rate (CAGR) of 18% to the tune of $ 37 billion by 2012. And India
will continue to hold its position as world’s second-largest wireless market after China in terms of mobile
connections during this period. Gartner has also predicted that the Indian mobile subscriber base is likely
to grow at a CAGR of 21% to reach 737-million connections by 2012. India currently has about 280
million mobile customers.

India telecommunication sector is witnessing an explosive growth, as falling tariffs and rising incomes are
bringing mobile phones within the reach of millions of new customers. With the urban mobile services
market reaching its saturation, operators are training their eyes on the rural market.

The Indian telecom industry is expected to see some level of M&A activity in 2009. Given the high level
of competition different business models will emerge that could push tariffs further down, with India
mobile service consumers set to emerge as the biggest beneficiaries.

The Gartner report also predicts that the cellular market penetration will increase by 40.9% to reach
60.7% in 2012 compared to 19.8% in 2007. Gartner analysts attributed the growth to the increasing focus
on the rural market, and lower handset prices, as operators would continue to focus on sub- $ 25 handsets
to increase their market share. According to the study, Indian mobile market will continue to be
dominated by prepaid subscriber. Prepaid connections in the country are expected to grow to more than
92% by 2012 compared to 89% in 2007.

The next big mobile wave

Indian mobile industry is poised for the next big wave, thanks to Trai’s recent initiative on releasing a
consultation paper recently on value-added services (VAS). VAS adds value to services, enabling the
mobile phone for a host of purposes such as messaging, playing games, listening to music, getting
news/sports and other host of information, getting location-based information, seeing real-time video and
so on. The VAS providers are neither regulated nor licensed as of now and they mainly act as channel
partners to mobile network operators (MNOs).

The VAS market is still in its nascent stages in India with revenue contribution of less than 15%.
However, it is expected that it will boom in to a substantial business in the coming years. Though we see
new models of handsets with functionalities such as global positioning system, rich media capabilities,
enhances email and search engines, being released by handset vendors every day, these can be of use to
subscribers only if services using these functionalities are made available. This requires active
collaboration between MNOs and VAS providers. Hope our regulatory reforms pave way for a better
future for VAS in the country.

As indicated in Trai’s consultation paper there is non-transparency in payment settlement, selling prices,
and sharing of management information between MNOs and VAS providers. To enforce transparency,
accounting separation for VAS service shall be implemented at MNOs. The VAS providers, especially
content aggregators also should have revenue-sharing arrangements with the content authors, content
owners and application developers who are at the end of the VAS value chain. This shall augur well for
growth of VAS in the country by fostering healthy and fair competition.
 INDIANS

Mobile learning opens a new chapter in education

If you find classroom teaching boring or computer session a little too tiring then it’s time to break the
mould and switch over to learning on the go! Now, you can take lessons in maths, English and science
and also do your training on your mobile and PDAs. And what more, you can also take your preparatory
tests, such as CAT and IIT-JEE, on your handset. Some firms, such as EnableM, Tata Interactive, 24X7
Learning, Airtel, IMS and NIIT, are working overtime to make this possible. While companies are
offering small training modules for employees, coaching and content development institutes in the
education space are tying up with mobile operators to offer such services.

India is witnessing rapid growth in mobile and Internet penetration. Analysts believe convergence of
mobile, internet, and TV services on a single gadget will lead to increased awareness and popularity of
this form of education in the next few years. Such a medium has multiple benefits. One, it offers an
interactive learning experience; two, accessibility of mobile device in remote areas. The platform can be
used anywhere, anytime, including schools, home or when in transit.

Bharti net rises 34% in Q1, adds 7.5 m users

Bharti Airtel, India’s largest wireless operator, beat street forecasts and posted a 34% jump in net profit to
Rs 2,025 crore for the quarter ended June 30, 2008, against Rs 1,512 crore in corresponding period last
year. Robust subscriber growth coupled with expansion of network to remote areas and lower tariffs saw
the company’s revenue surge 44% to Rs 8,483 crore.

Bharti added a record 7.5 million subscribers during the period – the highest by any telco in any quarter.
This improved the company’s market share in the country’s fiercely competitive wireless subscriber’s
space to 24.2% as on June 30, 2008, compared to 23.1% in the year-ago period. Bharti also accounted for
close to 30% of the country’s wireless subscriber additions during the period. EBITDA climbed 44% to
Rs 3,522 crore. The Q1 net profit also factors in a forex loss of Rs 148 crore.

But there were some blips too:

• Bharti’s net income margin dropped to 23.9% in Q1, from 25.6% in the same period last year,
following cut in tariffs.

• The margins for the mobile business declined to 30.7% compared to 35.4% in the in the quarter
ended March.

• Average revenue per user (ARPU) too fell 2% (Q-o-Q) to Rs 350 from Rs 357 in January-March
’08. On a year-on-year basis ARPU shrank 10%.

The Bharti management was upbeat about the Q1 performance and was confident the telco could sustain
the growth momentum. “The slowdown in some sectors has had no impact on us – telecom is immune to
this. We only see the situation improving as we expand our operations. We are close to rolling out our
DTH operations. The launch of our GSM services in Sri Lanka will also happen by before the year-end.”
2.5 FOREIGN INSTITUTIONAL INVESTORS
Re-ordering of the league tables within BRIC economies

In 2000, when Goldman Sachs clubbed Brazil and Russia together with India and China as the BRIC
economies they collectively represented the emerging world economic order, China and India were
clearly the poster boys. Brazil and Russia were seen as also-rans. Both had a history of economic
instability, and in the case of Russia at least, dodgy politics.

Today things could not be more different. While the broad picture presented by Goldman Sachs, that the
BRIC economies will together be more than half the size of the G6 economies (US, Japan, UK, France,
Germany and Canada) by 2025 and overtake them by 2040 is unchanged, there has been a re-ordering of
the league tables within BRIC economies.

The Asian tigers have lost their allure. And while growth in both China and India is still expected to be
among the highest in the world, the sharp decline in their stock markets – China has fallen a whopping
41% since December 2007 with India a close second at 38% - is a measure of the seachange. Once the
darling of investors worldwide, they have now been forsaken for more attractive alternatives. In contrast
Brazil and Russia have come from almost nowhere to become the new poster boys. True, their growth
rates of 5.8% and 8.5%, respectively, for the first quarter of 2008 may still trail Chindia’s (as China and
India are often referred to collectively). But even as stock markets around the world have collapsed, both
Russia and Brazil are up in dollar terms – Russia by 1% and Brazil by almost 15% during the period
December 2007 to June 25, 2008.

What has changed? The world’s unsatiable appetite for commodities and the vantage position of these two
economies as major commodity producers - while Russia’s energy resources – both oil and gas – put it in
an enviable position in a world where energy has become the lynchpin in which everything else revolves.

Brazil with its unique dominance in both food as well as energy is even better placed. And though
inflation stood at 5.6% in May 2008, above central bank target of 4%, most of this was food inflation and
should not pose a problem for a country that is among the world’s largest exporters of wheat and soya. As
for energy, if initial reports are correct, Brazil may well be sitting on reserves of between 40bn and 50bn
barrels of oil in recently discovered field off its coast in South Atlantic. If proven these could transform
Brazil from a minor player in the global industry into one of the world’s big oil powers.

It’s much a same story with Russia, but with one vital difference. Unlike Brazil where democracy seems
firmly entrenched, Russian democracy is still suspect. Nonetheless, on the economic front, the picture is
as rosy. The country’s reserves of oil, gas (it supplies a quarter of Western Europe’s natural gas),
industrial metals and potash means it is safely riding the global commodity price boom. Russia now has
the third largest forex reserves in the world and runs both budget as well as current account surplus.

But anyone, who has tracked commodity markets will tell you, these tend to be highly cyclical nature. Once
supply catches up with demand or demand shrinks in response to higher prices, the commodity cycle will
reverse. Today, with oil almost pushing $ 150 a barrel and food prices remaining high, that might seem
wishful thinking. But ten years ago a sharp fall in commodity prices – oil fell $ 13 a barrel – had seen growth
in these same countries plummet. GDP actually declined in both Brazil and Russia even as the Russian
financial crisis saw the ruble collapse. The bottom line, then, is that it is too early for new BRIC stars to
celebrate or for Chindia to be despondent. As the Goldman Sachs report points out, growth is never linear.
The only constant is change. The final pecking order will depend on which country manages to smoothen
out the peak and trough (since peaks are invariably followed by trough) through sound economic policies.
2.6 WARNING SIGNALS
IMF chief gloomy on growth

International Monetary Fund’s managing director Dominique Strauss- Kahn said: It is hard to know how
far the global financial crisis still has to run, with the extent of further credit losses hinging on what
happens to the US hosing sector.” With sky-high food and oil prices adding to the economic pain caused
by financial strains, he said the IMF was fairly pessimistic about global growth prospects this year and,
especially, in 2009. But he told softening growth was less of a threat than inflation, which he said was
rampant in some countries. In emerging countries and some low-income countries, in some of them at
least, inflation is out of control. He added that the lesson from 1970s and 1980s was that inflation can last
for years, or over decades, if central banks and government choose the wrong policy settings. That’s why
it’s very important today, and that’s what the IMF is doing, to draw attention to this question.

Doom’s here: Houses in US still overvalued

The downward spiral of the US housing prices still has a way to go and homes were overvalued by
between 8% and 20% in the first quarter of this year, according to research by International Monetary
Fund (IMF). In his report “What goes up must come down? House price dynamics in the US,” IMF
economist Vladimir Klyuev used several economic techniques to determine by how much US home
prices are overvalued. His research showed that home prices become considerably overvalued from 2001
and while the housing market has started to correct itself, there is still a long way to go. US policy-maker
are now trying to guide the housing market into a soft-landing after a five-year run-up in home values that
ended in 2006. The report said that it is likely that the home prices will swing well below their
equilibrium level before that start to recover.

US economy needs time to recovery: Henry Paulson

Treasury secretary Henry Paulson said: “The US economy needs months to recover from its slowdown,
but the banking system remains sound despite a home mortgage crisis that could cause more problems. I
am optimistic that Congress would approve the Bush Administration’s request for authority to shore up
the troubled mortgage giants Fannie Mae and Freddie Mac. He added high-energy prices would prolong
the slowdown, but the key to recovery was stablising the housing market”.

He said that US banking problems were manageable despite this month’s highly publicised failure of
mortgage lender IndyMac bank. The list of troubled would grow. But “this is a very manageable
situation… our regulators are focused on it.” Our banking system is a safe and sound one. Only 5 US
banks have failed this year, compared with an annual average of about 250 during the US saving-and-loan
industry crisis in the 1980s. He added: about 99% of the 8,500 US banks fell into the highest category of
capitalisation, a measure of financial health.

Ensuring confidence in US financial markets was crucial to reviving the housing industry and the broader
economy. To that end it was essential that Congress approve the stability plan for Fannie Mae and Freddie
Mac, which are responsible for 70% of US home loans. Treasury asked Congress for unlimited authority
to lend money to troubled mortgage companies and to buy their stock if necessary to inject fresh capital.
Some Republican lawmakers have walked at the prospect of a blank check that could cost US taxpayers
billions of dollars. But Paulson was very optimistic we’re going get what we need from Congress.
 WARNING SIGNALS
Private profits, public losses

Market economics is a big casualty in times of crisis. One tenet that has taken a beating in recent months
is that inefficient firms must be allowed to fail and shareholders must bear the loss. Banks, especially
large banks have always an exception to the tenet because the failure of banks imposes huge costs in the
economy. So, when the British government rescued Northern Rock, it was not a big surprise.

The subprime crisis has thrown up newer exceptions. The Fed stepped into present’s failure of an
investment bank. It not only organised the sale of Bear Sterns to JP Morgan but went so far as to take a
big slice of its assets on its own book. The Fed then went further. It offered liquiditory support to other
investment banks. And the new development that really takes the cake is the US government’s decision to
issue a blank cheque in favour of two private home loan institutions.

Fannie Mae and Freddie Mac (both short name), together hold or guarantee home loans worth $ 5-trillion
or more than half the national debt of the US. They are both in the trouble consequent to the debacle in
the US housing market over the past year. A failure of the two institutions is unthinkable – it would spell
disaster for the US economy. So, the US Treasury has found itself obliged to throw these two private
institutions a lifeline. It has sought approval from the US Congress for an increase in the credit line to the
two companies and for injection of equity capital if needed. The Fed has allowed them to borrow from its
discount window, a facility meant only for banks and primary dealers.

Fannie Mae and Freddie Mac are secondary market vehicles for home loans. They buy loans from
lenders, keep some on their books and sell the rest by packaging them into mortgage-backed securities.
The rationale for such vehicles is simple enough. Banks have largely short-term liabilities, so they have a
problem making home loans with maturities of as long as 30 years. In the jargon, home loans expose
banks to both interest rate and liquidity risks. But we need banks to make home loans so that large
numbers of people can buy houses. The American answer to this problem in 1938 was to create Fannie
Mac as a federal agency. With government support, Fannie Mae could issue securities at lower-than
market yields. This funding advantage was passed on to consumers. So, home loans became more
affordable, banks could get some of their home loan off their books and Fannie Mae itself was viable.

In 1968, the US government decided to privatise Fannie Mae so that its debt would not be recorded as
part of government debt. Fannie Mae continued as a “government supported institution (GSE)”, subject to
various special dispensations. To prevent a private monopoly, another GSE was promoted in 1970,
Freddie Mac. The crisis Fannie Mae and Freddie Mac face today can be directly ascribed to the original
sin of privatisation. Two highly leveraged institutions operated under government support, without
adequate regulation and with all the pressures to reward executives and shareholders that go with private
ownership. At the end of the first quarter of ‘08, their leverage (including guaranteed liabilities) was
estimated at 65 times of regulatory capital. Fannie Mae and Freddie Mac illustrate the perils that go with
“public-private partnership”: profits are private; losses are public.

How do we prevent this dichotomy in the financial sector?

Well, if a subsidy is required or if other social objectives are to be met, it is best done through public
institutions, adequately capitalised and regulated. The argument against public ownership has been that it
is inefficient. There is political interference and hence a higher proneness to failure; less management
accountability because of the absence of private shareholder pressure; poor risk management because of
the inability to attract managerial talent; and, very often, monopoly and bigness, with all its dangers.
Every one of these contentions has been shown to be hollow in the subprime crisis. Failure is not the
prerogative of public ownership. Private monopolies can be as bad as public monopolies.
3.1 MUTUAL FUND INDUSTRY
Borderline products

In recent months, the mutual fund (MF) industry has become increasingly vocal about its distress over
insurance companies stepping into their turf with unit-linked insurance plans (Ulips). The MF industry
blames high commissions and the lack of transparency in Ulips for their dominance.

However, the charge, cannot take credit away from the life companies for building a nationwide
distribution network. They set up thousands of branches and employ over two million agents. The money
flowing into Ulips is not coming from metros alone, but also from tier II and tier III cities.

Besides, insurers are quick to point out that commission on single premium policies match those paid on
MFs. They add that the seemingly high commissions are quite low when amortised over the term of the
policy. Indeed, the commissions are low when compared to what insurers pay worldwide.

But what life insurance companies fail to mention is that there is mis-selling happening where regular
premium policies (where commission rates are up to 35% in one year) are mis-sold as single premium
policies. The mis-selling is negative both for the insured and the industry. The insured fails to renew the
policy and loses half his investment on account of high year charges. For the company, it is not good as
the policy lapses and does not really bring them income. In the past two years, exceptional returns in
equity have helped cover up hidden charges and mis-selling. But with the tide turning in the equity
markets, some of the mis-sold policies may come home to roost for insurers.

Mutual Funds have been around much longer than Ulips. If the mutual fund industry has not been able to
achieve the level of retail penetration managed by life insurers, it is because they do not own a dedicated
distribution network similar to insurance companies. Even after nearly two decades of their existence,
Mutual Funds rely on new fund offerings to generate retail interest.

The tussle between MF industry and the life insurers is a bit peculiar to India. Indeed it is peculiar that
such a dispute should exist. Every insurer has an associated company in the mutual fund business and
vice-versa. So while there is Reliance Mutual Funds selling units, its sister firm Reliance Life sells Ulips.
Similar sibling rivalry exists among companies by ICICI Prudential, HDFC Standard Life, Birla Sun Life
and State Bank of India.

Elsewhere, such duplications are considered rare and even wasteful. Most insurance groups hand over
their funds to a group asset management company. In India, the regulation does not allow such
outsourcing out of suspicion of thinly capitalised fund managers.

While the regulations may be well intended, it goes against the universal truth – insurance is always a
domestic business while fund management is becoming increasingly global.

For instance: Retirement funds of senior citizens in developed markets, which are mobilised by local
insurers, get invested in emerging markets by global fund management companies.

While consolidation of fund management may be inevitable in future, India offers immense opportunities
both in accumulating and investing savings. A decade ago, mutual funds made a feeble attempt to tap
retail investors through small-ticket investments of as low as Rs 500. Such schemes were unfeasible then
because of the inefficiencies of the system. Now, with advances in cash management and fund transfers it
is possible for both mutual funds and insurers to reach out to the smallest investor.
3.2 GOLD ETFs
It’s the glitter of the yellow metal on paper

Gold ETFs have made an entry into Indian mutual fund market only for about two years or so. Only five
fund houses have offered this product and going by the assets under management (AUM) of these fund
houses in terms of absolute values, these products are not yet popular.

But there can be little doubt these products are destined to come into their own. All five gold ETFs in
India showed a rise in collections with the total corpus up by over 10% compared to April 2008. The total
gold collection was 4.57 tonnes at May-end, boosted by Akshaya Tritiya.

Are gold ETFs investments in gold?

In the traditional sense: No. An investor in ETF is neither entitled to receive gold nor does he sell ETFs to
get gold, nor can he exchange ETFs for gold. The investor merely has a paper investment in the
‘equivalent’ of gold. They are listed on the NSE and can be purchased and sold on the NSE as though you
are dealing in the gold bullion market, but without trading physically in gold. The fund house would buy
gold in the bullion market to the extent of his investment at the spot price and when he sells it would sell
that quantity in the bullion market and give him the proceeds calculated at the spot price. Therefore, the
investor invests indirectly in gold but never gets to possess the metal physically. Because he never gets to
have it physically, the hassles of physical possession are not there.

Gold ETF buyer are pure ‘investor’ who seek a return out of their investment without any other motivation
such as beautification or social status or love of possessing physical gold.

It is as specialised an investment as an investment in sectoral mutual funds such as in Infotech. In fact, it

is even more specialised because an investor in Infotech holds a basket of investments in different IT
companies and is driven by the desire to invest in the ‘IT industry.

In case of gold ETFs, the investor is not only, not in the industry, it is not in a basket of products; it is only in
one single product – gold. The commodity gold is the ‘standard’ gold bullion 0.995-purity.

Taken as a pure investment instrument, what would the investment objective for the investor be?

The returns from investing in gold have been considered for a period of 10-years (Jan 1998 to May 2008)
and are based on the daily London prices. These are then compared with the Sensex. Daily returns have
been taken using continuous compounding. Gold Annualised return (%) comes to 16.4 as compared to
22.6% of Sensex. Next, the volatility as measured by standard deviation for gold is 1.05% as compared
with Sensex of 1.70%. The gold has fairly high volatility, but it is less than the Sensex.

There are, however, points uniquely in favour of Gold ETFs - Tracking errors are expected to be low.
Another special reason: How gold units score over physical gold is from the wealth tax angle. If you have
‘wealth’ in excess of Rs 15 lakh, you are liable to wealth tax. Gold held in physical form is counted
towards this figure. But when you hold it as units of mutual funds, you are outside the ambit of wealth
tax. Capital gain on units sold of such MFs, if held for more than a year, being of long-term nature is
exempt. The same exemption applies to gold only if you hold for three years. This adds to the uniqueness
for MFs. Further, STT will not be leviable on sale as this is classified as a non-equity scheme.
3.3 COMMODITY MARKRT
Shattering the myths behind commodity trading

The commodity market has emerged as an asset class providing opportunities for investors to diversify
their investments. Many investors are, however, reluctant to trade commodities due to variety of myths or
misconceptions by the general public. These myths were created by frustrated, losing commodity traders
or by those who view commodities as too difficult of an investment to understand. We do hear people
saying things like commodities are too volatile or you will have a truckload of sugar dumped on your
house if you trade commodities. Many unsuccessful traders even say “Nobody can make money from
trading commodities”. Well, obviously people do make money-trading commodities and you could be one
of them by keeping a disciplined approach to investing.

Myth 1: Commodity trading increases speculation

Though portrayed by physical traders as a can of worms, commodity’ trading serves the economic
objective of making the field of agriculture liberalised by reducing government intervention/government
dependence to a large extent. Commodity exchanges provide a platform where traders and investors from
various parts of the country can participate in the price discovery of any listed commodity. Commodity
futures prices go up when market participants think that the supply of the commodity would not be able to
meet the demand in future. On the other hand, if the expectations for a surplus production or reduced
demand exist in the market, future prices of the commodity tend to decline.

As in the case of all financial markets, commodity price is also a function of demand, supply and market
sentiments. The futures markets provide estimates of the demand/supply situation of a particular
commodity in the near future. This information is very important for policy makers as it enables them to
take appropriate action so that demand – supply gap can be filled in time. The case of wheat is an ideal
example to highlight the importance of futures market and the need for policy making. The third quarter
of 2006 saw futures prices of wheat firm up, signaling that the country may face a supply shortage in the
coming crop season. The policy makers had more than eight months to take corrective action on this front,
by importing wheat to meet the anticipated shortfall and thereby lowering the price.

Myth 2: Too much volatility

Many investors consider volatility as the biggest problem when investing in commodities. Normally, one
has to put up about 4 - 10% of the total value of a commodity futures contract in margin; this is far less
than the required amount of margin for stock futures. Also, many new commodity traders don’t know the
way to handle the new-found gift of incredible leverage. In reality, commodities are no more volatile than
stocks as an asset class if we remove the leverage factor.

The problem with many investors is that they tend to overtrade. They might buy the maximum number of
futures contracts that they can buy from their money as margin. Therefore, if the prices move up a little in
value, they even end up doubling their investment but if the commodities move down a little in value,
their investment is wiped out.

To be successful, one should not trade more than half the number of contracts that what the margin
requirements allow. This removes the extreme leverage factor that gets so many new commodities
traders in trouble.
 COMMODITY MARKRT

Myth 3: Delivery of commodities

This is something that gives nightmares to many investors but you really don’t need to worry about it.
Only the commodity players are involved in taking and making delivery on commodities. If you close
your futures contract before the first delivery notice day, which usually occurs a five-six days before the
contract expires, you should have absolutely no worries about this. If for some reason you forget about the
first notice day, your broker will certainly monitor it and contact you, preventing you from entering
delivery process.

Myth 4: Not enough money

You do not need fortunes to enter commodity trading, it can be started with a bare minimum amount of
Rs 1,000 also which you can trade in gold guinea (8 gms gold coin). This money should be risk capital as
commodities can be a risky investment. The problem with accounts of this size is that investors take on
too much risk for their account size. They tend to roll the dice and bet it all on one trade. Don’t fall into
that trap. If you are looking for a respectable return of 25 percent a year, you will do much letter in the
long run as opposed to trying to hit a home run.

Myth 5: Nobody makes money

The fact is that many people do lose when trading commodities. However, the losers are usually ill
prepared investors who jump into the commodity markets and lose within six months, never to return
again. Others get addicted to the markets, while trying again and again to make a killing with the same
strategies and just keep losing.

So, who makes all the money?

It is normally the professional commodity traders and money managers that consistently make money
year after year. Also, disciplined commodity traders learn how to trade commodities properly and they
follow a strict trading discipline, which most losing traders never adopt. Even you can make money from
trading commodities whether you are a novice or very experienced investor. We will not say it is easy, but
if you do your research and use a good trading strategy with sound money management skills, you stand a
much better chance of success.

So, mind the gaps before investing in commodities –

An investor should be properly equipped with modern tools before entering the market arena. In all
probability, an investor not having proper skillsets to play with fire will burn his fingers. If, however, he
sharpens his skillsets, he can tame the fire and use it to his advantage. Trading with proper strategies not
only results in wealth creation, but also helps the market to grow on a sustained basis.

In the absence of successful trading skills, there is widespread value erosion for most of the participants,
which results in more people deserting the market after operating for a few months and damaging the
market sustenance in the long run. Hence, in order to ensure their own long-term survival, the markets are
duty-bound to impart knowledge among the participants, caution them against possible pitfalls and help
them mature in their trading skills.
 COMMODITY MARKRT

Such a requirement is particularly significant in commodity exchanges, which attract millions of traders
and investors. However, in order to sustain the pace of growth in the year to come, it is important to study
the nature of trades, identify deficiencies in strategies which cause loss of capital, and suggest possible
solutions to such matters.

Volatility factor of a commodity

Interestingly, a survey of some small traders in commodity exchanges has found that many traders/
speculators still do not analyse the volatility factor of a commodity while planning their strategies.
Volatility can be defined as the range within which the price of a commodity generally moves during a
given period of time. When we say average volatility, we should not consider the extreme volatility
exhibited by different commodities at certain points of time due to certain special events. The volatility in
different commodities is a function of:

Historic price behaviour

Liquidity of the commodity: Volatility tends to be lower if a commodity has a high liquidity and the
impact cost of putting in a position is lower. It will be higher if the liquidity is low.

The number and nature of participants in the commodity: Usually volatility in the price of a
commodity is lower if a large number of people from different backgrounds participate in trading for
different objectives. For instance, if a large number of speculators trade in a commodity, it will be
more volatile. But if investors, jobbers, arbitrageurs, hedgers, physical market traders, short and long
term position traders and others mainly do the trading, it will be less volatile.

It is important for you to understand this aspect while determining the size of the position you should put in.
The common mistake many people do is to determine the position size based on the margin requirement of
the commodity exchange. In fact, two different commodities may attract the same margin, but the risk
involved may not be same vis-à-vis the same position value. Therefore, it is important that you understand
the inherent volatility of each commodity and accordingly determine the position size. In an ideal situation, a
trader should:

Take smaller positions in those commodities, which have got higher volatility – so that he can allow the
commodity price to oscillate over a larger span of price movement.

Take bigger bets in those commodities, which have lower volatility – so that he can take advantage of
smaller movements and lock-in the profit.
 COMMODITY MARKRT
CRUDE OIL PRICES
There’s more to oil spike than speculation

The world seems to be perplexed as to why crude oil prices are cruising upwards. The global leaders also
failed to come to a conclusion in their meet in Jeddah on June 22 as to how to tame the galloping price-
baby back to its cradle. Interestingly, albeit rather unfortunately, the influx of speculative element in oil
prices and a slump in dollar rate have been used as excuses by Opec to shrug off its stake in oil price
determination. But is that the real reason that OPEC has lost its control on crude oil prices?

Let me just go back to the fundamental economic principle that simply the equilibrating market forces of
supply and demand determine the global crude oil prices.

Call on OPEC

There are two suppliers – OPEC and non-OPEC. Let me toe the line of conventional energy modeling
system as followed by International Energy Agency (IEA), Paris and Department of Energy (DOE), USA
where OPEC is assumed to perform the function of a ‘residual supplier’ in order to equilibrate the
demand and supply in the world crude oil market. Thus, OPEC is supposed to supply precisely the
shortfall in world demand (often referred to as Call on OPEC) after accounting for supply from non-
OPEC and adjusting for stocks of crude oil being held by the importing countries.

However, if one goes by the history of OPEC’s response to the Call, it could be observed that it seldom
complied with what had actually been demanded from it, especially when oil was dearer, although it
repeatedly claimed to have consistently oversupplied. So, at the first instance, it claim should be accepted
with a pinch of salt. OPEC has been defending its inadequate supply in response to ‘Call’ by mentioning
that it has lost its excess crude capacity buffer owing to abnormal rise in demand and persistent
inadequate investment in capacity enhancement on account of financial and geopolitical uncertainty. But
does this argument hold good uniformly for all the member of OPEC?

Among the 13-member cartel, Saudi Arabia has the highest daily production capacity of nearly 8.80
million barrels/day (b/d); Kuwait and UAE, each with 2.50 million b/d; Venezuela 2.34 million b/d; and
Nigeria 2.25 million b/d. However, with the exception of Saudi Arabia, that has promised to pump in
more crude’s if need be, other producers, especially, Iran, Iraq, Libya and Venezuela, are fully content
with the spikes in crude prices and are opposing any increase in their crude output. The reason is –
abnormal windfall profit and not lack of spare capacity.

Clearly, the moot question at this juncture is – is it actually profitable and rational for them to increase
production and comply with the ‘Call on OPEC” when they can silently continue to enjoy the windfall
gains from spiraling crude prices for some more time? The outright rejection by OPEC of restoring the
mechanism of ‘price-band’ suggested by the Indian Finance Minister during the Jeddah meet, such
intention becomes crystal clear.

Thus, contrary to its claim of lack of control, OPEC as a whole still has perceptible monopolistic
influence on world crude oil prices and it is exercising the same at this crucial hour through a ‘wait and
watch’ policy when the entire world is reeling under the dual bout of oil price shock and rising inflation.
So, it may not be wise to pass the buck entirely on speculation and slump in dollar rate. It deserves to be
underscored that these monopolistic rational producers are consistent self-interest maximisers, even if we
account for the uncertainties shrouded in geopolitical element that often seem to be OPEC’s escape route.
 COMMODITY MARKRT
COMMODITY TRADE
Has the bubble popped?

If you were long silver, wheat and base metals at the start of 2008, you have my deepest sympathy. All
these counters have become substantially cheaper in the last three months. Any bets you placed last year
would have certainly made you richer. But things haven’t been quite simple from 2008 onwards. With
crude oil hogging the headlines, one tends to forget that metals have been especially pathetic performers
in the last three months. Natural gas has fallen more than twice the distance that oil has. Wheat is 7%
cheaper than 2007. The unusual price signals last year have stimulated an equally amazing supply
response. Wheat is bearish due to record global production and wide availability of high quality wheat.

Now, the big question is has the commodity bubble deflated? And most important, who do you blame for
your pain? The answer lies mired in a confusing slush of demand-supply fundamentals, market sentiments
and threats from regulators.

The threats of investigation, tighter rules, and a very public hounding of so-called speculators by US
sarkari busybodies and Commodity Futures Trading Commission (CFTC) have scared off the larger
hedge funds and index traders. The House of Representatives voted 402 to 19 to approve legislation
directing to curb immediately what was termed excessive speculation in energy markets. The bill has to
go the Senate before it becomes law.

Independent Senator Joe Lieberman, chairman of the Homeland Security and Government Affairs
Committee, wants greater regulation of pension funds investment. He has proposed prohibiting private
and public pension funds with more than $ 500m in assets from picking up agriculture and energy
commodities traded on a US exchange, foreign exchange or over-the-counter. Second, the CFTC would
have the right to set limits on the market share that speculator can hold in any one commodity. Plus, he
wants to close the swaps loophole which allows individual speculator limits to be exceeded by swap
dealers (who tend to be acting on behalf of investment funds linked to commodity indices). If his
proposals are implemented, commodity investment would be dead in the water.

Crude oil prices:

They are finally falls in line with market fundamentals

Higher oil prices are their own enemy: demand destruction caused by spiking energy costs will fell global
crude prices. Crude oil prices, which are now on down trend, may soften further unless spooked by a
disruptive geopolitical development. Increased OPEC production, led by Saudi Arabia, coupled with a
decline in demand in the developed world, especially the US, is set to ease the tight demand-supply
equation in the global oil market. Demand is also expected to moderate in developing economies like
Chins, India and Thailand, among others because of lower subsidies and some moderation in economic
activities. This year thus expected to see prices soften as the tight market condition ease.
4. FINANCIAL SECTOR: TRANSFORMING TOMORROW
Regulatory overlap in the financial sector

The haphazard pace at which new financial products are being launched is constantly adding new
dimensions to the issue of regulatory overlap in the financial sector. Some of the new/exotic products,
because of their hybrid or borderline character, make a case for being treated under different regulatory
jurisdictions. Though the issue has a global nature, it has become more multifarious in India due to the
lackadaisical approach to finding expedient solutions. The ground realty is that this policy deficit is
increasingly creating problems (and losses) for the investors and taxpayers.

The other view is that India’s retail financial products market is still rather immature with very low
customer penetration level, and so regulatory convergence is not an immediate issue to be addressed.

1. FINANCIAL ADVISORS:
Weigh impact on investors

Borderline products

Unit linked insurance plans and mutual fund products which directly compete (as both offer securities
market-linked investment avenues); even while under different regulatory jurisdictions (Ulips under Irda
and MFs under Sebi) have co-existence in the market. Being under different regulatory domains, the
sellers of these products get disparate rewards for their services. (What asset management companies are
allowed by Sebi to give as commission to the distributors appears minuscule when compared with what
insurance companies offer to agents for selling Ulips). So there is obviously a lack of level playing field
here. A related issue is that the extra incentive is practically a lure for the insurance agents to mis-sell (it
is alleged that many Ulip buyers bought it without fully understanding its risk profile).

Another possibility of regulatory tussle has come to be noticed in the area of gold exchange traded funds.
Sebi regulates these funds even as gold, being a commodity, is under Forward Contracts Regulation Act
(FCRA) and so, under the regulatory purview of Forward Markets Commission (FMC).

It may be recalled that RBI and Sebi had been at variance over the regulation of corporate bonds market,
before the latter virtually took over the regulation of this growing, high-potential segment.

2. FINANCIAL PLANNERS
Value unlocking for all stakeholders

Harmonised regulations

The proposal for harmonised regulation of securities and commodity derivatives market has also been
hanging fire. An inter-ministerial task force headed by Wajahat Habibullah had proposed that at least
FMC and SEBI could embark on a programme of closer co-ordination of their activities. Again, no
concrete action has been taken.

Besides, the development of commodity derivatives market is impeded by existing market-distortion

policies related to cash market such as minimum support price, monopoly procurement scheme,
differential rates of taxes, APMC Act etc., the task force had proposed corrective policies. This, again, is
not being acted upon.
 FINANCIAL SECTOR: TRANSFORMING TOMORROW

3. CREDIT COUNSELORS
Resolve convertibility and recompensation issue

Multiple tasks

For quite some time, policymakers and their advisors in India have been discussing handling of public
debt, with the central question being who should do it – the central bank or the government? Though, the
point that central bank will be somewhat distracted from its core function (managing a key short-term
base rate to maintain price stability) as it is given multiple tasks is fairly acknowledged, no earnest
attempts is being made to fix the issue.

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

Regulatory convergence

It is true that even globally; regulatory convergence in the financial sector is not perfect. But many
countries, especially UK, Australia, New Zealand and Singapore have traversed some distance in the
direction of harmonisation. FSA, financial watchdog of UK, does almost all the financial regulation
(including regulatory part of debt management) in that country. Only the function of monetary
management is left with Bank of England.

In the US, the SEC regulates the spot market for securities but CFTC regulates all derivatives markets
including the commodity derivatives market. So, one agency regulates the equity spot market and another
one, the equity derivatives market. Similarly, the spot market regulator would regulate the bond market,
but derivatives market regulator would regulate interest rate futures. SEC and CFTC have joint
jurisdiction for single stock futures and narrow stock indices.

5 TECH SAVVY PROFESSIONALS

Take first step to ensure efficient and reliable system

An informed and alert system

According to some analysts, the more pertinent issue than absence of regulatory convergence in India is
that not only customers but also even other stakeholders here are clueless about the hidden risks of many
financial products and this leads to mis-selling.

It’s important all stakeholders – regulators, entities in financial business like banks, insurance companies,
AMCs, bond houses, distributors, and customers – are fully aware of the risks involved in particular
products and possible remedial actions they can take.

It may be recalled that even leading banks mis-sold complex derivative products to corporates and the
issue was mainly of lack of adequate information. So, it is an essential prerequisite for ensuring that the
whole system is sufficiently informed and alert.
 FINANCIAL SECTOR: TRANSFORMING TOMORROW

6. MICRO-FINANCE PROFESSIONALS
Developing alternative credit delivery models

Investor protection

Recently, the head of India’s securities market regulator C B Bhave made it clear to the mutual fund
industry that when it comes to upholding the mandate of Sebi, he would place protection of investors
ahead of development of the market. His remarks appear to have jolted the industry which had made a
pitch to him seeking approval for offering higher incentives to take on the insurance industry who’s Ulips
compete in a way with their offerings.

The Sebi chief’s message is important for two reasons.

• One, it signals to the mutual fund companies that if they have to grow their assets, they cannot do it by
fattening themselves at the expense of the investor. India mutual fund industry which has had an
impressive growth over the last three years now manages assets of over Rs 6,00,000 crore. But the
bulk of these assets have been built through investments made by individuals in the metros and a few
top tier towns.

• Bhave’s remark also helps draw attention to another regulator Irda, which has the mandate for
oversight of the insurance industry.

“The Acts that govern almost all regulators mandate them to protect the interests of investors and foster
competition and help develop the market.”

IRDA is a relatively new regulator in the financial sector, compared to the RBI and SEBI. But it does
merit the question as to whether the insurance watchdog is perceived as protecting the interests of
investors. The insurance industry has had a good run over the last few years, especially by selling Ulips.
Mis-selling has been a big issue and sharp practices prevail among a few players but the regulator’s
ability to protect may be constrained due to the limited staff it has to supervise the industry.

Ashwin Parekh, national leader, financial services, of consulting firm E&Y, who has watched the industry
for long says that the first five years of opening up of the industry was good but in the next phase when
consolidation and stability was called for, there were hardly any reforms. The time is opportune for
carrying out changes in areas such as reinsurance, intermediaries like broking besides beefing up
supervisory capacity. Ensuring level playing field also ought to be on the agenda.

“The Financial Services Authority (FSA), which regulates the financial services industry in the UK says in its
charter that its aim besides promoting orderly, efficient and fair markets is to help retail financial service
consumers get a fair deal. The FSA does provide links to help consumers compare the feature and cost of
products and helpline numbers. The Indian insurance regulator can perhaps take a cue. Otherwise it does
run the risk of encouraging the perception that player’s protection counts more than investor protection”.
 FINANCIAL SECTOR: TRANSFORMING TOMORROW

7. WEALTH MANAGERS
Map out the details to translate into benefits

Currency futures

Currency futures are once more the flavour of the season. They are needed to enable price discovery for
hedging operations, as there are a large number of players involved who would be looking at them. More
so because the rupee, which was appreciating sometime back creating problems of monetisation for RBI
has suddenly started depreciating. The outlook continues to be hazy as is the case with all markets. The
presence of OTC set-up, though efficient, is opaque. But, there is an alternative that exists.

Besides, there is another thought, which has to be addressed in the light of the Abhijit Sen Committee
report on futures trading in commodities. The report provokes further debate on whether futures trading
can be effective in a commodity where there is a lot of government intervention. In case of commodities,
the reference was to wheat where the minimum support price (MSP) causes a distortion. If one looks at
the forex market, then traces of familiarity can be seen in the behaviour of the RBI.

“Today, market forces determine the exchange rate, but there is substantial intervention by the RBI as
prudential monetary policy also entails keeping an eye on the exchange rate”.

This means that the market principles guiding price movements is susceptible to intervention by
regulatory authority. Hence, as in the case with the commodity market, when there is a MSP or its
equivalent of a maximum tolerable change in exchange rate, which is notionally held by RBI, there,
would tend to be distortions in prices.

“The players would have to conjecture what the RBI has in mind when bidding on the future rate. But, unlike
the MSP, the RBI’s vision is a variable that changes more frequently – 4 times a year when the monetary
policy is announced and also an equivalent number of times in between. But, the task becomes tedious, as
RBI is known to intervene even on a daily basis in case of large swings in the exchange rate”.

Therefore, one solution that could be advocated here is that the RBI will have to be actively involved in
the contract design and also specify its level of comfort with currency rate swings, which should be taken
as the daily price band beyond which the market could also expect intervention from RBI. But, this is not
efficient. Besides, the RBI can never tell what would be the tolerable limit and when it would intervene.
Therefore, there would always be an issue of regulatory intervention making the market jittery. Besides
conjecturing moves of the Fed and ECB, market layers have to continuously read the RBI’s mind – which
is not an easy job to do.

Currency trades set get a future in India:

A clutch of banks – from both public and private sectors – are planning to join hands to float a new
exchange for trading exclusively in currency futures. The Chicago Mercantile Exchange (CME), the
world’s largest diversified financial derivatives exchange, has approached some of the banks involved in
the venture to partner them. The group, which plans to promote a new exchange, includes large public
sector banks such as SBI, UBI, and Canara Bank, besides leading private banks Axis and HDFC Bank.
SEBI and RBI are working on the regulations and the norms for potential players. Trading in currency
futures is expected to be kicked off a couple of months down the line. The NSE is reckoned to be a strong
candidate for offering a trading platform in currency futures.
 FINANCIAL SECTOR: TRANSFORMING TOMORROW

8. INCLUSIVE CEOs
Innovative responses to problems

Shift currency-risk to foreign investors

The finance ministry has made out a case for a major revision in the policy on foreign borrowings to
allow an investment of over $ 15 billion by foreign portfolio investors in rupee-denominated bonds issued
by Indian corporates. The finance ministry has sounded out the RBI on the proposal. The finmin has
argued that allowing higher investment by foreign portfolio investors in local corporate bonds would
make better economic sense rather than repeatedly raising the limit for Indian firms to borrow overseas.
Increasing the allocation for investment in local corporate bonds and cutting down on the entitlements for
Indian firms to borrow abroad would mean shifting the currency-risk to foreign investors.

The ministry has suggested that instead of an annual ceiling of over $ 20 billion for borrowings abroad,
foreign portfolio investors should be allowed to invest $ 15-20 billion in corporate bonds in India. This
would mean carving out a substantial share for investment in local corporate bonds from the annual
ceiling on overseas borrowings, while paring the limit for foreign currency borrowings. The ministry has
also suggested the bonds ought to be traded on domestic exchange and that they may be of an average
maturity of five to seven years to allay concerns on short-term debt. The finance ministry and RBI jointly
fix the annual limit for Indian corporates to raise debt abroad. The cap has progressively been raised, and
during last fiscal, local firms are reckoned to have raised over $ 20 billion.

9. RISK MANAGEMENT CONSULTANTS

Educate – Engineer and Enforce

Credit derivatives

Credit derivatives are financial instruments whose value is derived from the creditworthiness of a third
party. The RBI had serious reservations about credit derivatives. After issuing draft guidelines in March
2003, it decided the time was not appropriate to take the plunge. Subsequently, as part of the process of
financial sector liberalisation in India, it decided to introduce credit derivatives in a phased manner and
issued modified draft guidelines on credit default swaps in May 2007.

These guidelines were again revised based on the feedback received and a second draft was issued in
October 2007 for further discussion. But with the subprime crisis hitting the financial world and the role
of derivatives under intense scrutiny of regulators globally, there is now little pressure even from foreign
and private banks to introduce these products in India. The central bank has, therefore, seized this
opportunity to reassert its traditional suspicion of innovation and keep credit derivatives on hold.

The decision fits in with the RBI’s ‘slow and steady’ approach to financial sector liberalisation. Having
said “the time is not considered opportune to introduce the credit derivatives in India” should not be taken
as an excuse to defer derivatives indefinitely.

Innovation is an integral part of business, be it banking or anything else. What is important is not to frown
upon it because it poses risks but to frame suitable prudential guidelines and back this with competent
supervision and market intelligence so that misdeeds are promptly bought to light.
 FINANCIAL SECTOR: TRANSFORMING TOMORROW

10. CONTINUING LEARNING CENTRES

Take informed decisions

Assessing Customers’ Role in Derivatives

There has been quite a deal of excitement on the derivatives front in the last few months. Banks and
customers are busy pointing fingers at each other and things have gone to the extent where some
customers have taken banks to court.

Unfortunately, most of the criticism is aimed at banks, labeling them the guilty party who operated with
the sole motive of ripping off their customers, in an unscrupulous effort to make huge amounts of money.
In fact, some customers naively believe that their loss is the banks’ gain. This is far from the truth, as
banks’ profits are actually only the spreads they make on these transactions.

In the melee, the role customers have played in this sorry mess has been totally forgotten. Granted, some
companies have less than the minimum knowledge needed to handle sophisticated products. Having no
clue whatsoever about cross-currency movements and attendant risks, they chose to buy these products,
often carried away by the excitement of entering into derivatives contract “just like the big boys”.

“How did companies that are so careful and conservative in other aspects of their business became so
adventurous when it came to derivatives? We know that common sense is not so common but the naïve way
some people have entered into these transactions makes one wonder”.

While we can forgive innocence in a small-town small company, we cannot do so to those professionals
with qualifications and experience manning the finance department. They read the financial journals and
attend seminars and training where, over the years, derivatives have been discussed at great length.

“Did they buy such products with inadequate knowledge or did they ignore the small voice inside their heads
telling them not to touch what they do not understand. Or was it their egos that did not allow them to admit
that they did not know what they are buying?”

One reason that comes to mind is the desire to cover oneself with glory by masking money apparently out
of thin air. The possibility of a bonus probably helped to blind some of them to the risks. It is a bit like a
batsman stepping out to hit the ball for six; while his ears can already hear the applause; he ignores the
possibility of the ball landing in a fielder’s hands. And when he is out caught, all he can do is blame the
bowler, the umpire and everyone else but himself.

Banks would have assumed that their sophisticated customers had the skills and knowledge to understand
these transactions. When a company executes documents while taking a loan, the bank people do not
make presentations explaining what happens to the collateral in case of default. The bank expects the
finance executives to know the implications without things being specifically explained to them.

“Greed, as Gordon Gecko reminded us is good, but I would think that crying about the after effects of greed
is not so good! If people thought they were in with a chance of making big money, why did they not consider
the risk involved and the possibility of loss? Were they not aware that market rates could move against them
as well as move in their favour? Most bizarre are those companies who, while making gains from the same
products in the past, completely understood the complexities as well as the risks involved. The moment they
lost money, the understanding suddenly vanished!”
 FINANCIAL SECTOR: TRANSFORMING TOMORROW

11. GLOBAL OUTLOOK

Is globalisation leading to unstable global economy?

We’ve been having the wrong discussion about globalisation. For years, we’ve argued over whether this
or that industry and the workers might suffer from imports and whether the social costs were worth the
economic gains from foreign products, technologies and investments. By and large, the answer has been
YES. But the harder question, lie elsewhere.

“Is an increasing interconnected world economy basically stable? Or does it generate periodic crisis that
harm everyone and spawn international conflict?”

The present US economic slowdown – maybe already a recession – stems mostly from familiar domestic
causes, dominated by the housing bubble burst. Still, global factors, notably high oil and food prices, have
aggravated the slump.

“The line between what’s local and what’s global seems increasingly blurred; and there is a general anxiety
that we are in the grip of mysterious worldwide forces.”

The good that globalisation has done is hard to dispute. Trade-driven economic growth and technology
transfer have alleviated much human misery. If present economic trends continue, the worldwide middle
class will expand by an additional 2 billion by 2030, estimates a Goldman Sachs study (Goldman’s
definition of middle class: people with incomes from $ 6000 to $ 30,000). But a disorderly global
economy could reverse these advances. By disorderly, we mean an economy plagued by financial crises,
interruption of crucial supplies (oil obviously), trade wars or violent business cycles.

“This is globalisation’s Achilles’ heel. Connections among countries have deepened and become more
contradictory. Take oil producers; on one hand, high oil prices hurt advanced countries; but on the other, oil
countries have an interest in keeping advanced countries prosperous because that’s where much surplus oil
wealth is invested.”

Although economic globalisation enabled unprecedented levels of prosperity around the world and has
been a boon to hundreds of millions of poor workers in Asia, it rests on shaky pillars. Unlike national
markets, which tend to be supported by domestic regulatory and political institutions, global markets are
only weakly embedded.

“There is no global anti-trust authority, no global lender of last resort, no global regulator, no global safety
nets, and, of course, no global democracy. They suffer from weak governance, and therefore have weak
popular legitimacy”.

However, this doesn’t mean that globalisation needs reversal. What is required is to create new
institutions and compensation mechanisms – at home or internationally – that will render globalisation
more effective, fairer, and more sustainable. One such glaring gap exists in the area of economic
forecasting both at national and international level.

“Globally, the people today are suffering from poverty of predictions. The lesson in all this is too careful of
predictions. Half the time they are made without sufficient research and so go horribly wrong. At other times,
people miss discontinuities that will make the future very unlike the past.”
 FINANCIAL SECTOR: TRANSFORMING TOMORROW
12. ISSUES OF THE PRESENT
Freedom to get & fail in the system of free enterprise

The end of New-Liberalism

The world has not been kind to neo-liberalism, that grab-bag of ideas on the fundamentalist notion that
markets are self-correcting, allocate resources efficiently, and serve the public interests well.

It was this market fundamentalism that underlay Thatcherism, Reaganomics, and the so-called
Washington Consensus in favour of privatisation, liberalisation, and independent central banks focusing
single-mindedly on inflation.

For the quarter-century, there has been a contest among developing countries, and the losers are clear:
Countries that pursued neo-liberal policies not only lost the growth sweepstakes; and when they did grow,
the benefits accrued disproportionately to those at the top”. Though neo-liberals do not want to admit it,
their ideology also failed another test. No one can claim that financial markets did a stellar job in
allocating resources.

In the late 1990s, with 97% of investments in fibre optics taking years to see any light; but at least that
mistake had an unintended benefit: as costs of communication were driven down, India and China became
more integrated into the global economy. But it is hard to see such benefits to the massive misallocation
of resources to housing. The newly constructed homes built for families that could not afford them get
trashed and gutted as millions of families are forced out of their home. Even those who have been model
citizens, borrowing prudently, now find that markets have driven down the value of their homes beyond
their worst nightmares. To be sure there were some short-term benefits from the excess investment in real
estate: some Americans (perhaps only for a few months) enjoyed the pleasures of home ownership than
they otherwise would have. But at what a cost to themselves and the world economy! Millions will lose
their life savings as they lose their homes. And the housing foreclosures have precipitated a global
slowdown. There is an increasing consensus that downturn will be prolonged and widespread.

Nor did markets prepare us well for soaring oil and food prices. Of course, neither sector is an example of
free-market economics, but that is partly the point: free-market rhetoric has been used selectively –
embraced when it serves special interests and discarded when it does not.

The mixture of free-market rhetoric and government interventions has worked particularly badly for
developing countries. They were told to stop intervening in agriculture, thereby exposing their farmers to
competition from the United States and Europe. Their farmers might have been able to compete with
American and European farmers, but they could not compete with US and European Union subsidies. Not
surprisingly, investments in agriculture in developing countries faded, and a food gap widened.

In the world of plenty, millions in the developing world still cannot afford the minimum nutritional
requirements. Increase in food and energy prices will have a devastating effect on the poor, because these
items constitute a large share of their expenditures. The anger around the world is palpable. The
speculators argue: we are simply engaged in “price discovery”. In other words: discovering – a little late
to do much about the problem this year – that there is, scarcity. Today, there is a mismatch between social
and private returns. Unless they are closely aligned, the market system cannot work well. Neo-liberal
market fundamentalism was always a political doctrine serving certain interests. It was never supported
by economic theory. Nor, it should now be clear, is it supported by historical experience. Learning this
lesson may be the silver lining in the cloud now hanging over global economy.
5. BANKING SECTOR
Crisis is not yet over

Anshu Jain, head of global markets at Deutsche Bank, said the contagion triggered by the US subprime
mortgage collapse has erased more than a fifth of the banking industry’s value and is “by no means over.”
The crisis “has wiped out $ 200-billion or about 22% of US banks’ so-called tangible equity.

That impact is similar to the combined effect on the insurance industry of the Hurricane Andrew,
September 11 attacks and Hurricane Katrina. Tangible equity refers to common equity, such as share
capital and retained earnings, minus intangible assets.

This crisis is really at a point where it equals the three biggest crises faced by the insurance industry. It’s
by no means over. Banks and securities firms have turned to investors for $ 322 billion to replenish
reserves after $ 403 billion of write-downs and credit losses ties to the collapse of the US subprime
market [data compiled by Bloomberg].

Jain declined to predict when the crisis will end. He described the US Federal Reserve’s decision to
provide a “liquidity backstop” for securities firms as a critical step.

The main difficulty banks are currently grappling with has to do with solvency rather than ready access to
cash. Banks continue to need and raise equity capital, and the proportion of equity capital, which is
required, is directly driven by further drop in assets they own.

One of the assets, which continue to be in free fall, is US house price. If US house prices stopped
dropping for two to three consecutive months, then very quickly we will start to find the bottom to the
current crisis. The US housing slowdown started in mid-2005 when sales of new and existing homes
began to fall, bringing a 5-year boom to a close.

UK hedge fund quietly stocks select bank shares

UK-based hedge fund The Children’s Investment (TCI) Funds, known to have forced management
changes in a few well known firms in the West, has quietly acquired a large chunk of shares in select
Indian banks.

Christopher Cooper Hohn runs the hedge fund, founded in 2003. It donates part of its gains to children’s
Investment Fund Foundation, which is run by his wife.

Over the last six months, despite the battering of stocks, the fund has built up holding in three state-owned
banks – PNB (9.85%), IOB (9.24%) and Vijaya Bank (9.62%). This is a tad lower than the 10% limit
imposed on foreign institutional investments in banks. Towards June end, the fund had also bought into
some other banks such as BOB (4%) and UBI (4.47%).

Incidentally, the hedge fund has increased its exposure in the banking sector at a time when other foreign
portfolio investors have been looking to exit. The BSE banking index, which tracks the movement of
bank shares, has fallen by 93% from January to June 30. BSE data show that TCI either did not hold any
bank shares or it held less than 1% in 2007.

Banking industry sources say the fund has communicated to the bank’s management that they are long-
term investors. The fund appears to be very bullish about the Indian banks and the Indian economy. This
is because typically economic sentiments often reflect on the performance of bank stocks.
6.1 TAX UPDATES

Third-party info may help track excise evasion

Transporters, banks and power utilities may have to share information about their corporate clientele with
excise department. The Central Board of Excise and Customs (CBEC) is formulating a third-party
information system to tackle rampant evasion in indirect taxes like excise duty. The proposal was also
discussed at the annual meeting of the chief commissioners of excise, customs and service tax last month.
The objective of such a system is to track evasion, particularly in excise duty, which has seen dismal
growth in collections.

Companies that avail cash-credit facility from banks have to submit details of opening and closing stock
balance to the banks. The declaration submitted by such companies may have to be shared with the
revenue authorities. Similarly, information on transport charges paid by a company and its electricity bills
could give the department an idea about its actual production and dispatches.

The information collected from third-party sources would be compared with details filed by the assessee
to verify if taxes have been paid fully.

The third-party information system is being designed on the lines of the annual information return (AIR)
model for direct taxes. The AIR system devised by CBDT has been successful and has been cited as one
of the factors responsible for growth in direct tax collection in the last few years. According to the
proposal being fine-tuned, requisite information will have to be divulged mandatorily. CBEC plans to
seek necessary changes in laws for put this system in place. Official now collect information from various
sources like state tax departments informally. After creation of formal system, this information will flow
to the revenue department regularly.

MF investments come under I-T scanner

Tax authorities have started putting to good use of the tax information network to zero-in on evasion and
bolster collections. Taxmen have now trained their sights on several investors who had invested a few
lakhs of rupees in mutual fund schemes and then switched between these schemes. Switching schemes
does not violate any norms, but investors have to pay a short-term capital gains tax if they sell their MF
units or stocks before a year. The tax department will also seek an explanation on the source of funds used
to finance these investments.

Stripping EOU status of RPL’s refinery

Since the tax holiday given to the refinery on the basis of it being an infrastructure project was running
out; the RPL’s refinery at Jamnagar was given 100% EOU status last year by the government to continue
getting tax sops. The commerce ministry has started examining the possibility of stripping the RPL
refinery of its 100% export-oriented unit status. However, Denotifying an EOU is not an easy process as it
is a legal entity and laid down procedures needs to be followed.

The government has to first identify the basis on which it sought to denotify the EOU and send a show
cause notice to the unit stating the charges against it. The unit then has to be given an opportunity to
defend it. After following the procedure, if the government decides that it should go ahead with the
denotification, the unit, which is stripped of benefits, can go to the court. Withdrawal of the status would
make the 27 million tonne Jamnagar refinery ineligible for tax sops, which EOUs get.
6.2 SECURITY LAWS UPDATES

Debenture Trustee-Entities

A lack of due diligence to see through the financial un-worthiness of the debt-issuing companies can lead
debenture trustee-entities like banks that oversee such issuance into trouble. In what would call for greater
accountability for debenture trustees, the National Consumer Dispute Redressal Commission (NCDRC)
has held that failure by such trustees to ensure that the debt issuers maintain their asset adequacy in
respect to the debts issued was a deficiency of service on their part. The order empowers the investors to
drag debenture trustees to consumer courts for quick redressal of their grievances, rather than take a costly
and time-consuming regular litigation route.

The apex consumer panel was hearing six petitions filed by the Central Bank of India challenging
separate decisions by state consumer commissions that held the bank guilty of deficient service. In all the
cases, it was alleged that the bank in its capacity as debenture trustees had failed to ensure due diligence
towards protecting the investor’s interests.

A three-member bench of NCDRC headed by its president M B Shah said: “The petitioner ought to have
discharged its duty as a professional corporate trustee and if the loss was caused to the debenture holders
due to its deficiency in not taking special care and in not exercising its special expertise as a corporate
trustee, which it professes, then it is liable for its deficiency in service.” The order is based on the premise
that in case where debenture trustees fail to confirm to their legal obligation as specified under the
company law and Sebi regulations, they shall be held guilty of deficiency in services. According to Sebi
provisions, trustees are required to ensure that the company, which issues debentures, has sufficient funds
and property to repay the redemption amounts of the debts securities and payment of interest.

Employee Code of Conduct

The competition regulator has called upon companies to incorporate a compliance code in their human
resource policy to ensure that their employees do not resort to unfair means while soliciting business. The
Competition Commissioner of India’s (CCI) recommendation is likely to prompt companies to ask their
marketing executives to periodically declare that they do not resort to anti-competitive practices while
trying to meet business targets.

The idea behind CCI’s suggestion is to introduce an employee code of conduct and ensure that executives
refrain from breaching competition law. Adoption of compliance code and making it part of the human
resource policy may go a long way in ensuring discipline among employees. The proposed code, which is
also directed at checking collusion among competing companies, contends that an organizational
compliance mechanism can gain effectiveness only if it is linked to its human resource and disciplinary
policy. While such a mechanism would prompt employees to be serious on compliance issues, the CCI
also feels that it would help the company display its seriousness in compliance to competition law.

With an objective to ensure that an organisation’s adherence to competition law gains more teeth, the
regulator also suggests steps to integrate its compliance mechanism with the existing staff appraisal
procedures. It is believed that asking the employees to regularly sign a form to confirm that they are not
aware of any breach of competition will ensure that anti-competitive practices are traced at an early stage.
Such an organizational check will ensure that companies are not faced to bear the cost for their
employee’s breach of compliance code.
7. NEW INFLATION
An indecisive Fed risks fuelling inflation

US: Forget the housing collapse, the credit crunch and – in isolation – higher oil prices. The real economic
menace may be resurgent inflation, which is the broad rise of most prices. To understand why, some
history helps. The government’s worst domestic blunder since World War II was the unleashing of high
inflation: in 1960, annual inflation was 1.4%; by 1979, it was 13.3%. This terrified Americans, who
feared falling living standards. It also destabilised the economy, causing harsher recession that culminated
with 10.8% unemployment in 1982.

Inflation crept from negligible levels of 3.5% in 1966 and 6.2% in 1969. There are eerie parallels now.
From 1997 to 2003, inflation averaged more than 2%. Now it’s 4%; some economists soon expect 5%.

To be sure, differences abound. Then, we had a classic wage-price spiral. Strong consumer demand
allowed businesses to raise prices, which spurred demands for higher wages that companies paid because
they needed the workers and could, recovers the costs through higher prices. In 1959, labour costs rose
4%; firms could offset most of that through efficiencies (aka productivity). By 1068, labour costs were up
a less forgiving 8%. By contrast, today there’s not yet wage-price spiral. Inflationary pressures seem to
originate mostly in rising raw materials prices. In 2002, oil was $ 25 a barrel; now it’s $ 135. Corn was
$ 2.30 a bushel; now it exceeds $ 7. Copper was 70 cents a pound; now it’s $ 3.80.

Meanwhile, a powerful anti-inflationary force – cheaper manufactured imports – is declining. The weaker
dollar and higher transportation costs have raised import prices. In the past year, prices for imported
consumer goods (excluding autos) are up 3.6%. We seem to be hostage to global forces. Economists call
this the ‘new inflation’, because it’s not easily squelched by domestic policies. Up to a point, that’s true.
Although the Fed influences interest rates, it doesn’t own oilrigs or cornfields. Long-term price relief for oil
involves switching to more fuel-efficient vehicles and increasing worldwide, including American oil
production. Removing subsidies for corn-based ethanol would reduce food price pressures.

Still, all large inflations involve “too much money chasing too few goods,” as economists often noted, and
this episode is no exception. The Fed’s easy money policies have global effects.

One antidote of rising raw material prices is for the Fed to reverse its easy money policies. Combating
inflation is rarely popular or easy, because it involves slowing the economy – even inducing a recession –
to relieve pressure on prices and wages. Unemployment rises. Housing remains in disarray. More loan
defaults could increase bank losses.

Perhaps inflation will spontaneously subside (as some Fed officials hope) because the economy is already
weak. But similar arguments for delay were made in the 1960s with disastrous results. The resulting
inflationary psychology made inflation harder to extinguish. The initial unwillingness to take a modest
slowdown or recession led to deeper subsequent recessions. There are now signs that we are at similar
juncture. Surveys show that people’s ‘inflationary expectations’ after years of stability, are rising. The
Fed is holding its key interest rate at 2%, well below prevailing inflation. In the 1970s, this condition
stoked inflation. An indecisive Fed risks repeating its previous blunder!

Relieving signals from US Fed

In a signal that inflation has moved up its list of priorities, the US Federal Reserve held rates unchanged
at 2% this time on Wednesday, the 26th of June 2008. The move ends a series of steady rate cuts over a
period of almost a year as the Fed fought to save the US financial system and the economy from
consequences of subprime crisis.
 NEW INFLATION

The rest of the world has reason to be thankful that the prolonged period of monetary easing in the US has
ended. In a world, where capital is mobile, a loose monetary policy in the US has serious implications for
developing countries like India, where the exchange rate regime is a managed, rather than a free float. Fed
reiterated its expectation that inflation will moderate “later this year,” though it cautioned against
believing that the worst is over saying uncertainty about the inflation outlook remain high.

IIP for the May decelerated to 3.8%

Growth in industrial production decelerated to 3.8% in May 2008, the lowest in six years, triggering fears
of a sharper-than-expected slowdown. Adding to the gloom was the downward revision in industrial
production growth for April to 6.2% from the previous figure of 7%. The cumulative industrial growth, as
measured by the Index of Industrial Production (IIP), in the first two months of the current financial year
stood at 5% against 10.9% in the same period last fiscal.

High interest rates play spoiler to growth: The high interest rate regime seems to have taken a toll on
the manufacturing sector, which has almost two-thirds weightage in the IIP. It grew by a meager 3.9% in
May 2008 compared to 11.3% in May 2007. The capital goods sector, which is largely seen as a lead
indicator of investment activity, grew at a dismal rate of 2.5% as against a whopping 22.4% in May 2007.
Economists feel “Investment sentiments are weakening and some growth will have to be sacrificed to
tame inflation. I think the downtrend will continue because of an overall contraction in the economy.
However, it must be noted that last year capital goods growth was very high, so there could be some
amount of base effect also.

Inflation surges to 11.89% on costlier food

Inflation, already at a 13-year peak, shows no signs of cooling down, dashing hopes of the central bank
softening interest rates to boost slackening industrial output. Annual inflation based on the wholesale
price index (WPI) climbed to 11.89% in the week ended June 28, outpacing the previous week’s 11.63%
and 4.42% during the corresponding week of the previous year. The government has also revised the
inflation figure for the week ended May 3 by a whopping 0.9% to 8.73% as compared to the provisional
data of 7.83%. This suggests that inflation may be currently close to 13%. Any marginal increase at the
current level would be highly uncomfortable and unwelcome.

Role of Inflationary expectations’ in causing inflation

To understand this better: Suppose employees expect inflation to be high, would demand an increase in
wage to protect their interest in such a scenario. So, manufacturers are likely to be faced with the demand
for increase in wage which they will factor in the form of increase in product prices from their customers.
Thus, each segment of the economy will modify their behaviour to factor in the expected inflation. Sooner
than later, this expectation will lead to a self-fulfilling prophecy and inflation will actually shoot up. In its
worst form, the ‘inflationary expectations’ can lead to an ‘inflationary spiral’.

The monetarist solution to break the inflationary expectoration is for a central bank/ monetary authority to
build strong credibility that they would not let inflation to rise. Building specific inflation targets for
central bankers and ensuring independence of central bankers typically do this. One of the key reasons for
a fairly long period of low inflation in the world (prior to the current boom) was the strong credibility
built by central bankers over the years.
 NEW INFLATION

Fire and ice of high inflation, low growth

The Global economy is teetering between “the ice of recession and the fire of inflation” as policy-makers
struggle to battle rising prices without choking off growth. US economic figures showed sentiments
among consumer remained near 28-year lows, with vast majority convinced that the country is in
recession that is only getting worse. They also expect inflation to rise further.

Consumer confidence has also slumped in Japan, where a government’s confidence survey showed it
hitting its lowest since the survey began in 1982. Germans are gloomier about their own economic
outlook than at any time since reunification in 1990 because of rising prices, a poll showed. In Spain,
inflation hit a 13-year high in June and analysts saw it rising further, deepening a severe economic
slowdown there and pressing consumer prices in the wider euro zone.

Role of central bank in controlling inflation

An interesting point was made on the sidelines of the G-8 summit in Hokkaido, Japan, regarding the role
of any nation’s central bank in controlling inflation in today’s globalised and open world. As global trade/
GDP ratios rise sharply, the price of tradable goods is increasingly determined by international, rather
than domestic, demand and supply. Most of the inflation in tradable goods over the past year has been in
oil, other non-agri commodities and food – marked by global demand-supply imbalances.

Prices of most other tradable goods are still relatively stable on account of the efficiency effects of
globalisation. While the world economy taken together can be seen as closed, the role of nation-based
monetary policy is becoming increasingly marginal in impacting domestic consumer price inflation.

However, the central banks of developing economies do have a role in correcting the internal imbalances.
International oil prices rises should be passed on to the consumer as soon as possible and in as graduated
manner as feasible so as to avoid shocks. If everybody expects oil prices to reign high in the foreseeable
future, it is best for the consumer to feel the pinch and curb consumption. Then over time, all economic
agents will veer round to a less energy-intensive regime.

Inflation inches higher to 11.91%

Inflation rose marginally to 11.91% for the week ended July 5. Inching closer to 12% inflation moved up
marginally by 0.02% to a 13-year high of 11.91%. In the comparable period last year, the rate of price rise
was 4.61%. Describing the increase in inflation ‘very marginal’ the finance ministry in a statement said
“the annual inflation rate for the group of 30 essential commodities has declined to 5.74% from 5.98%
reported to week ending June 28, 2008.” It further said the prices of essential commodities like food
grains, pulses, edible oils, vegetables, dairy products and some other commodities including kerosene,
soap and safety matches have more or less stabilised.

Inflation cools down to 11.89%

For the first time since May, inflation eased by 0.02% to touch 11.89%, mainly due to moderation in
prices of certain food items like sea fish, tea and edible oil. During the week ended July 12, inflation came
down by 0.02% from 11.91% in the previous week. It was 4.76% during the corresponding week a year
ago. According to finance ministry statement, of the 98 primary articles, prices of 10 have shown a
decline while 54 showed no increase.
 NEW INFLATION

Reddy pinches pockets to keep inflation on leash

Repo Rate hiked by 50 Bps, CRR by 25 Bps

On Tuesday, 29th July 2008, RBI governor YV Reddy has not only raised the benchmark repo rate – the
rate at which banks borrow from it – from 8.5% to 9% with immediate effect, but has also hiked the cash
reserve ratio for banks by 25 bps, which will drain Rs 9,000 crore from banking system.

RBI is pulling out all stops to ensure that inflation, which at 11.89% is at a 13-year high, can be lowered
to 7% towards the end of this fiscal. More importantly, Mr Reddy wants to douse inflationary
expectations. The policy tools, which is put to use while unveiling the first quarter review of the monetary
policy, may well strain household budgets and force company managements to rework their numbers. But
the RBI governor, who is at the fag end of his term, is still upbeat about the economy logging a growth of
8% in 2008-09. Even if GDP growth was to temper at 8% in 08-09, India would still be the second-fastest
growing economy in the world after China.

Tough days ahead?

Absolutely, Home loan EMI will be up by Rs 17-34 for every Rs 1-lakh loan. Interest on auto loans,
credit cards and personal loans will rise 25-50 basis points. Companies with poor cash flow may skip
salary hikes & bonuses.

Will property prices drop?

Yes, even in some sticky markets like Mumbai’s western suburbs, prices may dip sharply if Diwali sales
flop. Sadly, your loan EMI will also rise. There could be distress sale and defaults by builders who have
borrowed recklessly.

What’s YV Reddy trying to achieve?

The RBI governor has no control on oil prices. So, he’s forcing individuals and businesses to spend less to
control inflation. A 50 bps hike in repo rate will make money costlier and soften demand.

Did Mr Reddy overreact?

Clearly, there is panic over rising prices. More so, with elections are less than a year away. Banks are
slow in hiking rates as it shrinks their loan books. So, RBI has slammed the breaks.

Was the CRR hike necessary?

Yes, with money supply still growing at over 20%. Mr Reddy had no choice. CRR is the slice of customer
deposits that banks keep with RBI as cash. A higher CRR means banks are left with less money to lend.

Is the Indian Story running out of stream?

Slowdown is a given. Markets will be choppy. Erratic monsoon could worsen things. For investors, cash
is king. Inflation is the biggest worry and growth can take a backseat. Sectors like banks, real estate, auto
and brokerages will suffer. Infrastructure projects, with low return on capital, may not find backers.
 NEW INFLATION

Inflation inches up to 11.98% on costlier food

Inflation rose by 0.09% on account of an increase in the prices of pulses, fruit and spices, among other
things. Inflation stood 11.98% for the week ending July 19 compared to 4.65% for the same period a year
ago. Commenting on inflation figure, a finance ministry statement said, “Out of 98 articles, 15 items have
shown a decline as compared to previous week while of another 58 articles remained stable.” It however,
admitted that inflation for a group of 30 essential commodities went to 6.67% from 5.82% in the previous
week. Analysts said the RBI’s measure to curtail demand through increase in interest rates would take
some time to bring down prices.

Inflation up to 12.01% on costlier fuel, food

Annual Inflation based on wholesale prices raced past the 12% mark in the week ended, July 26, fuelled
by costlier manufacturing products, fuels and food items other than vegetables. Vegetable prices showed a
decline of 8% from the year-ago period. Prices rose 0.1% from the week ended July 19.

Prime Minister’s economic advisory council member Saumitra Chaudhary said: “Inflation may peak in
November-December and slip into single digit by March 2009. There may be another round of monetary
tightening, going by the current market situation. The fastest price gains since 1995 have prompted the
central bank to press the monetary breaks very hard to reduce consumer spending.

Auto companies signal caution, go real slow

The slowdown is beginning to hit auto industry’s biggest players as car plants start working below
capacity. In the last week July, car market leader Maruti Suzuki closed one of its plants for two days
while other volume players like Tata Motors and Mahindra & Mahindra are talking about adjusting
production to demand to tide over the lean season. According to industry insiders, car production is
expected to reduce 10-15% in the current quarter.

Oil producers may’ve to give up earnings above $ 75/bbl

The government may impose a cap on the revenues of oil producing companies like ONGC, OIL,
Reliance Industries, British Gas and Cairn if the recommendations of the BK Chaturvedi committee are
accepted. According to the proposal, any incremental revenues earned beyond $ 75 a barrel would have to
be given to the government as part of subsidy sharing in the oil sector.

The B K Chaturvedi committee had been set up to look into the pricing policy in the oil sector which has
remained largely controlled despite the administered prices being decontrolled in 2002. As of now, the
upstream oil producing PSUs have to bear one third of the total subsidies every year as part of the subsidy
sharing mechanism. The subsidies are given by the oil companies in the form of discount on crude oil
prices to the downstream oil companies like IOC, HPCL and BPCL. However, the subsidy share changes
from quarter to quarter depending on the global crude oil prices and losses of the oil companies.
8.1 MISCELLANEOUS UPDATES
Knowledge is wealth, says India Inc

Teach India: Let’s learn to teach

It’s not just business. Education is very much in the agenda for India Inc. A number of corporates in India
have taken initiatives to uplift the state of education in the country, especially at the school level. These
not only include large conglomerates like the Tatas, Birlas and Ambanis, but also firms like Bharti, Intel
India, Microsoft, Wipro Technologies and Hero Honda, to name a few.

For instance, Bharti Foundation, the corporate social responsibility (CSR) arm of Bharti Airtel
Enterprises, kicked off their Satya Bharti school program in 2006. Based on a PPP model, the initiative
aims at adopting a number of government primary schools to provide quality education to the
underprivileged children, especially girl children. With more than 160 primary schools under its gamut
already, the program aims to benefit over 200,000 children through more than 500 schools and 50
vocational institutions across India. The company’s promoters and its associates have committed more
than Rs 200 crore in the initiative.

Bharti Enterprises vice chairman Rakesh Bharti Mittal said “With more than 300 million illiterate
children in India in the age group of 7 years and above, providing access to quality education is a major
challenge for the country. We believe that this initiative will provide an opportunity to thousands of
underprivileged children to be a part of mainstream education and offer them with a platform to
participate in the nation’s economic growth. 15000 children will pass out every year having gained
experience in vocational training, which will make them employable.

IT companies like Wipro, Intel and Microsoft have also done their bit in primary education. The Azim
Premji Foundation, for example, has carried a series of initiatives which includes the learning guarantee
program, the child friendly school program, technology initiatives and education management
programming at making school education more child friendly by using various innovative learning
methods. The foundation has also partnered with the Karnataka government and surveyed over 500 school
development monitoring committees (parent-teacher) across the state to research and recommend steps
fore more effective composition in education.

Microsoft, on the other hand, has Project Shiksha, under the ‘Partners in Learning Initiative’. Announced
in June 2008, the ‘Partners in Learning 2.0’ is planned with an investment of $ 20 million in India. The
company plans to partner with governments, education institutions and other government schools to
address the national educational priorities over the next five years. “The vision Microsoft has for
education in India is driven by the shared belief that the use of technology in education can help remove
limitations, foster innovation, and enable students and teachers to achieve their fullest potential. Through
Partners in Learning, Microsoft seeks to use IT as the catalyst enables a knowledge-driven society in India
where technology is an integrated part of the learning experience.”

Intel too has also invested over $ 1-billion for education globally. According to the company, Intel’s
employees have put over two million hours to improve education in over 50 countries across the world.
Through its Intel Tech program, the company has trained millions of teachers in schools across the
country to pass on computer education to their students.
8.2 REALTY SECTOR

Price Rigging

One reason why developers are refusing to lower prices is that they stand to lose much more than their
profit margins. According to lenders, most real estate companies have raised finances on the basis of the
value of their land banks. Selling houses at a discount would sharply bring down the value of these land
banks. In some cases where developers have provided real estate as security, they would have to bring in
more funds or additional security should the market value of property drop. As a result, developers are
willing to provide discount through ‘marketing schemes’, but are unwilling to lower prices.

EWS reservation

Builders would face hefty fines if they do not set aside 15% space in their housing projects for
economically weaker sections (EWS). The ministry of housing has asked states to crack down on
developers who violate EWS reservation. Repeated failure to implement the policy may also result in
government taking back land allocated for such projects. According to the policy, at least 15% of land in
housing projects or 20% floor area ratio (FAR) – whichever is greater – has to be reserved for EWS/LIG
housing. The Centre has taken seriously to instances in states such as Karnataka, Delhi and UP where
builders have flouted EWS norms. Therefore, it has directed states to enforce the reservation strictly.

Securitised debt

The slowdown in the real estate has started impacting the securitisation of loans to the industry. The
demand for such securities has dried up as debt mutual funds – the biggest buyer of such products – turn
wary and cut exposure to these securities. In fact, there is no large scale real estate loan securitisation
now. The market for loan securitisation was Rs 31k crore, of which real estate loan securitisation
accounted for 20% as on March 2008. It is allowed to a bank or a NBFC to sell the loan as a securitised
paper. Following the securitisation, loan disappears from the balance sheet of the banks or NBFCs, who in
turn communicate to the borrowers that their loan has been sold to an investor. Borrowers then keep
repaying to the Special Purpose Vehicle (SPV) where such paper is parked instead of the bank or NBFC.

MNC Assets

Lack of provisions in the country’s bankruptcy laws to deal with cross-border insolvency may force
Western investment companies by global credit crunch to sell off their assets in the country at throwaway
prices. Since Indian courts do not recognise decisions of insolvency courts in other countries, bankrupt
foreign investment companies would be forced to rush for a domestic buyer before their local assets get
into never-ending insolvency proceedings here. Investors would prefer finding a buyer quickly for the
Indian asset even at a loss rather than letting it lose its value further in lengthy litigation.

Many overseas funds that have invested in Indian companies are owned by holding companies in the US
and UK, and are in deep financial trouble. More and more such companies are expected to put their Indian
business on the block. It is crucial for the funds to sell their local assets quickly as the fund flow to the
entity executing the projects in India keep drying up and chances of defaulting on payments due to lenders
or material suppliers here are high. Once this happens, the local lender or material suppliers could take
recourse to recovering the money by invoking the Securitisation & Reconstruction of Financial Assets
and Enforcement of Security Interest Act, under which they could take recovery proceedings within 60
days of issuing a notice to the company. They could also move the Company Law Board. The steps would
drag the anemic company to decades of litigation and erosion of asset value.
8.3 POWER SECTOR
Powering India: The Road to 2017

The McKinsey report released recently jointly by the Planning Commission and the power ministry is
neat and extensive. What are proposed are continued reforms in the vexed power sector so as to rev up
capacity addition, cut down on utility losses and, generally speaking, improve efficiencies pan-India?
There is also a broad consensus on what the contours of a proactive policy ought to be, now that the issues
have been debated for over a decade and more.

The power report estimates that the demand for electricity “is likely to soar” from about 120 gigawatt
(GW) at present to 315-335 GW by 2017. It adds that the figure is 100 GW higher than most current
projections. Next, to fulfill the increased power requirement, the suggested generation capacity is put at
415-440 GW. What it implies is a tripling of the current installed capacity of about 140 GW. It follows
that the annual capacity addition required to meet the heightened demand is in the range of 20-40 GW.
But the fact remains that in the last ten years or so, the annual capacity addition has been just about 4 GW.
So, there needs to be a five to ten fold increase in the very pace of capacity addition in power.

The study has chalked out the multi-point programme to cope and overcome the panoply of rigidities in
power. The report identified four issues that “plague” progress: a lack of viability, and market risks; the
slow pace of capacity addition; inadequate fuel supplies; and operational inefficiencies to boot.

The reform programme outlined calls for reducing aggregate technical and commercial losses of utilities
to no more than 15% by 2017. Currently, it’s over twice that. It’s the reason, in the main, why power
losses continue to mount in absolute terms (more than Rs 20,000 crore). What’s rightly suggested is
implementation of a “series of distribution reform,” including that of separating feeders for agriculture
supply. The idea is to clearly identify non-agriculture heads and do away with gross open-ended subsidies
and give-aways in power distribution.

Currently, what’s proposed is lowering of industrial tariffs with “open access”, so that efficient power
producers can seek custom by supplying at competitive rates. The fact is that power tariffs for industrial
consumers tend to be way too high and distorted. Although the cost of electricity supply for high-tension
users is verily the least, the price tends to be the highest. It clearly needs to be quite otherwise, even after
factoring in the ability to pay principle. It’s populism which makes electricity economics stand on its
head. Hence the real need to build genuine consensus on “loss-reduction measures.”

The report goes to outline specific policy initiatives that would lead to a functional market for power, and
“strengthen governance.” What’s suggested is creating a “deep and well-functioning wholesale electricity
market.” Also proposed are time-of-day-tariffs. Dearer power during the peak-hour loads would make
economic sense. The study adds that peaking plants are “vital,” as India is expected to have a peak deficit
of up to 70 GW by 2017. What’s emphasised is that given the “magnitude of the task,” piecemeal
measures just will not do.

What may well fast forward reforms are clear-cut, time-bound norms to list state power utilities at the
bourses for transparency, openness and to unlock shareholder value. Sure, this would warrant multi-year
loss reduction targets, to meet capital-market requirements. But it may not really be a tall order, if the
powers that be focus on shoring up stock capitalisation of the utilities. They can emerge as a new asset
class. Both debts and equity in the power sector ought to be listed, for added gains. And the time may be
opportune too. Infrastructure economics does imply that the highest productivity of investments is
reached when a network is reasonably developed, but nowhere near fully ‘achieved.’ The power sector
here seems to have reached such a threshold.
9.1 KNOWLEDGE RESOURCE
Ambani legal feuds not helping anyone

RCom - MTN alliance

Exit Bharti Airtel. Enter RCom. South Africa’s MTN and the Anil Ambani-owned company may shortly
announce that they are in exploratory talks for an alliance. MTN has offered RCom a structure similar to
the one that Bharti turned down. It is believed that one of the proposals under consideration is for ADAG
to transfer its 66% shareholding in RCom to MTN and in exchange become the largest shareholder in
MTN with 34% stake. This scenario will also involve making RCom a subsidiary of MTN.

In the case of now aborted Bharti-MTN deal, the Mittal family and SingTel had been offered a 51% stake
in MTN for exchange of their shares to the South African telco as Bharti’s market capitalisation is larger
than RCom. Sources said the 74% FDI cap would have made it difficult for MTN to merge into Bharti.
Unlike Bharti, where direct and indirect foreign holding is around 74%, foreign shareholding in RCom is
just over 10%. This gives RCom much more leeway to explore merger-related structures.

RCom is India’s largest CDMA operator with a subscriber base of over 40 million. While its presence in
the GSM space so far is confined to only eight circles with just over seven million subscribers, it has
ambitions of aggressively expanding in the GSM segment and has secured licenses to roll out operations
on a pan-India basis.

Reverse merger

RCom and MTN are engaged in reverse-merger talks, which, if successful, would help Anil Ambani to
emerge as the single largest shareholder of the Johannesburg-based company while RCom will become
the subsidiary on MTN. However, the exact details of the proposed deal are yet to be finalised.

Under the reverse merger route, MTN would have made an open offer for RCom followed by a share
swap between Reliance ADAG – promoters of RCom – and MTN. ADAG would then have emerged as the
single-largest shareholder of MTN while RCom would become subsidiary of MTN.

RCom announced that it has begun ‘exclusive’ talks with MTN, in what could result in the creation of
world’s fourth-largest wireless telephone operators with a subscriber base of over 116 million in 23
countries. The proposed deal between RCom and MTN may involve an open offer by African telco to
RCom shareholders. Under the Indian law, any acquisition of 51% stake triggers a mandatory 20% open
offer for minority shareholders.

In the two-step structure being discussed, MTN will be the holding company of RCom. But Mr Ambani
will have a direct one-third equity stake in MTN and an indirect holding of nearly 20% in RCom. In
effect, the R-ADAG will be the largest shareholder of the combined entity, likely to christened MTN
Reliance. His holding in RCom will go up marginally if the follow-on open offer succeeds. There is
however, no certainty regarding any of this given the regulatory complexities involved. The deal would
need regulatory approval from the Indian and South African authorities as well as from 21 other countries
where MTN is present.

RIL claims first right of first refusal (RoFR)

It’s Ambani vs. Ambani once again. While RCom negotiations with South African telecom operator MTN
was entering a decisive phase, elder brother Mukesh Ambani has entered the fray, claiming his flagship
Reliance Industries enjoys the right of first refusal in the event of RCom’s sale.
 AMBANI LEGAL FEUDS NOT HELPING ANYONE

Anil strikes back at Mukesh

Anil Ambani RCom sent a strong letter – worded to Mukesh Ambani’s flagship RIL threatening to claim
costs and damages from RIL if it takes any legal action to enforce its claimed first right of refusal. The
tone of the letter clearly indicates that it is part of a mala fide design, with no substance, to simply try and
disrupt talks between RCom and MTN, by raising the false bogey of litigation and damages. RCom also
said: “It is surprising that without knowing the contours of a possible transaction between RCom and
MTN, RIL has jumped to a baseless conclusion that the same is covered by the alleged PACT dated
January 12, 2006, which in any case was unilaterally signed only by RIL’s officials.

The Ambani brothers parted ways in June 2005 after one of the prolonged and bitterest battles in the
history of Corporate India. The January 2006 PACT was to implement the demerger of businesses
between the brothers. However, Anil Ambani challenged parts of the PACT on the plea that the
companies, which had signed the pact, were under the control of Mukesh and therefore the agreement
was untenable. The matter is still sub-judice.

From aviation to gas, there is no stopping the dispute between the Ambani brothers. It is apparent that
neither Mukesh nor Anil is in any perceptible hurry to smoke the peace pipe. Interestingly, the issues that
have become contentious have been varied and not necessarily restricted to their existing lines of
businesses. By all counts, the most contentious issue has been the sale of gas by Mukesh Ambani’s RIL
from the Krishna Godavari basin to fuel brother Anil’s proposed 7,450 mw power plant in Dadri, UP.

Settle out of court

The episodic battle of legal claims and counterclaims between the Ambani brothers is beginning to
become a bit monotonous even for the most ardent watchers of the two warring groups. The ordinary
investors are left wondering why two of the country’s richest entrepreneurs, with great global ambitions,
cannot get on with their respective businesses peacefully after they formally divided up the combined
Reliance group companies among themselves in July 2005 as per family agreement.

Be that as it may, we are now only concerned with the impact that the mounting legal disputes between
the two warring parties might have on the larger body of smaller shareholders on both sides. It is best, that
the two brothers resolve this and other outstanding dispute out of court in the interest of millions of
ordinary shareholders. They need to show some grace now.

ADAG moves HC to stop RIL from blocking MTN deal

RCom and AAA Communications filed the caveat in the Bombay High Court, asking the court not to
issue any ex-parte order in case Mukesh Ambani’s flagship RIL asks for the same on the MTN deal.
ADAG’s investment arm, AAA COM, holds 63% stake out of the group’s 66% stake in RCom.

RCom eyes 40% in MTN directly

The merger talks may have changed gears, RCom, it is learnt may buy a large equity stake in MTN,
emerging as the single-largest shareholders. This is to avoid legal disputes that may arise from Reliance
Industries’ claims of right of first refusal (RoFR). A Middle-East based sovereign wealth fund is expected
to join hands with RCom for the acquisition of the controlling stake in MTN.
 AMBANI LEGAL FEUDS NOT HELPING ANYONE

South African stock exchange rules require any acquirer to launch a tender offer if it’s holding crosses
35% in a company. RCom intents to acquire a shade lower than the threshold limit. Subsequently, RCom
is looking at a ‘whitewash’ procedure under which MTN’s shareholders will be asked to vote to waive
their right to a tender offer. If the shareholders agree, RCom will scale up its stake to 40% in MTN.
Otherwise, it will hold just under 35%. However, RCom will emerge the single-largest shareholder by far
with its 35% stake.

RCom may raise $ 12 billion from banks to finance MTN acquisition

RCom is in talks to raise $ 10-12 billion from banks to part finance its planned acquisition of the South
African telco MTN. RCom intends to leverage its balance sheet and pledge the shares of the MTN to raise
the funds. Deustsche Bank, HSBC and Barclays, among others, are putting in place short term financing
for RCom to finance the deal. A few Indian Banks and a host of European Banks have also offered an
underlying commitment to lend money for the transaction. RCom will have to repay this debt in a year or
so by raising long term funding.

The entire transaction is expected to rout through a special purpose vehicle (SPV). In addition to RCom,
other partners could also pick up equity in this SPV. RCom is learnt to have been in talks with a Middle
East-based sovereign wealth fund and a couple of private equity players to offer stake in the SPV. The
other equity holders of the SPV are expected to chip in around $ 4-5 billion. Given MTN’s valuation of
nearly $ 30 billion, a deal is expected to be done at $ 35-40 billion. This means, RCom may need to pay $
12-14 billion for a 35% stake. The acquisition cost will go up if RCom is allowed to hike its stake further
to 40%. Both the parties are yet to arrive at the exact deal size.

The new structure is a sharp departure from the reverse merger route. The new structure ensures RCom
would buy the controlling stake in MTN directly. But RCom cannot leverage the balance sheet of MTN to
finance the transaction as a 35-40% stake in the foreign company would not allow it to do so. MTN will
not be part of the consolidated balance sheet of RCom. Bankers said funding a big ticket deal could
become a problem in the wake of tight liquidity conditions across the globe. Spreads of Indian papers
have moved up by around 28 to 30 basis points in the past couple of weeks. The six-month Libor is
currently at around 3.13%. The credit default swaps for RCom is now at around 325 bps.

RCom & MTN extend deadline for talks to July 21

RCom and MTN have agreed to continue their negotiations in relation to such potential business
combination, and have extended the period of exclusivity until July 21. Earlier, MTN and RCom have
been locked in exclusive merger negotiations for 45 days that ended on Tuesday, the 8th of July 2008.

RIL kicks off arbitration against RCom

RIL started arbitration proceedings against RCom. RCom sources dismissed RIL’s move, saying
arbitration can only happen when both parties refer the dispute to a person outside the court. According to
RCom, there was no scope for arbitration as there was neither any dispute nor any occasion for any
conciliation process.
 AMBANI LEGAL FEUDS NOT HELPING ANYONE

End of the talk

RCom and MTN on Friday the 18th July 2008 announced that merger talks between the two telcos have
ended. RCom has become the second Indian telco to fail in pulling merger with MTN. Bharti Airtel and
MTN were close to a merger in May but the Indian telco called off the talks after the two companies
failed to agree on the corporate structure of the combined entity. “Owing to certain legal and regulatory
issues, the parties are presently unable to conclude a transaction. Accordingly, it has been mutually
decided to allow the exclusivity agreement to lapse.”

Many a slip…

February 11 last year was Super Sunday for India Inc. Two deals were announced on that day for a total
value of $ 17-billon. After several rounds of negotiations; British telecommunication giant Vodafone
bought Hutchison Telecommunication International’s 52% stake in Hutchison Essar for an impressive $
10.9-billion. The other big one for the day was AV Birla Group Company, Hindalco’s decision to acquire
the Toronto-headquartered aluminium major Novelis for close to $ 6-billion. If one deal confirmed the
strength of India’s wireless story and its unabated growth, the other was all about corporate India’s
outbound acquisition story.

This year has been markedly different. The deals have been a little slow to come by and the common
consensus is that the global slowdown is slowly having its effect on India. On the face of it, there have
been hugely important transactions like Tata Motor’s buying over the Jaguar-Land Rover (JRL) business
from Ford for over $ 2-billion. This was preceded by another Tata group company, Tata Chemicals
acquiring US’ General Chemical Industrial Products for just over $ 1-billion. In July, GMR Infrastructure
picked up a 50% stake in American power company, Intergen for $ 1.1-billion. The most rudimentary
observation will state that the billion dollar deal flow is underway for 2008 as well.

Quite right at face value except that a lot of large and decisive deals are in an uncertain situation and in
more than one case, a big ticket deal has just not gone through. Interestingly, the reason in each case is
unique and to that extent, there is no common thread running. However, there is no denying the fact that it
has today become a wee bit tougher to seal a deal. India Inc’s global M&A ambitions are increasingly
running into legal, environmental and cultural complexities. And the tightening of the global financial
markets is just adding to the bother. How, it negotiates this labyrinth will be fascinating to watch. Indian
companies, according to most observers, are entering the next phase of M&A activity where execution of
deals will meet with many complexities.
 SELFISH MOTIVES
www.mi7safe.org

Alka Agarwal
Promoter of Mi7 & SAFE

Financial Literacy Mission

A crash course of literacy

Missions Seven Charitable Trust

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

E-mail at: safe@mi7safe.org

Safe Financial Advisor Practice Journal: August 2008