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THE INVESTOR VOLUME 4 ISSUE 10 October 2011

OCCUPY

WALLSTREET

ENTRY OF PRIVATE SECTOR

PLAYERS IN INDIAN BANKING Pg. 14

iNFRASTRUCTURE FINANCING IN INDIA - EX-

PLORING ALTERNATIVES Pg. 19


2/26Disclaimer: The views presented are the opinion/work of the individual author and The Finance Club of IIM Shillong bearsno responsibility whatsoever.

F R O M E D I T O R S D E S K

NiveshakVolume IV

ISSUE X

October 2011

Faculty Mentor

Prof. N. Sivasankaran

Editor

Rajat Sethia

Sub-Editors

Alok Agrawal

Deep Mehta

Jayant Kejriwal

Mrityunjay Choudhary

Sawan Singamsetty

Shashank Jain

Tejas Vijay Pradhan

Creative Team

Vishal Goel

Vivek Priyadarshi

All images, design and artworkare copyright of

IIM Shillong Finance Club

Finance Club

Indian Institute of Management

Shillong

www.iims-niveshak.com

THE TEAM

Dear Niveshaks,

The curent nancial crisis has illustated how the world marketshave moved closer to each other and have become so interconnected that ev-er move in ever economy is now being catapulted to the global arena. Ev-er piece of inforation is being analysed for sigs of economic conditions.In fact, if we go by what is being wrien in press, right om high ination,dismal gowth numbers, hiring eeze and poor earing gidance by cor-

porates, we can fall into a false sense of belief that our economy is alreadyin midst of a recession. The Indian economy today is seen as so intercon-

nected and dependent on the wester economy that any problem in the west-er economy is automatically seen as touble for the Indian economy as well.

However, if we analyse the sitation careflly, the Indian economy is surelyslowing down, but is not in the same mess as developed economies. The ResereBank of India has forecast a GDP gowth rate of 7.7 per cent in FY 2011 while theUNCTAD has pegged the gre a shade lower at 7.6 per cent and the broad con-sensus among most economists is that it is unlikely to be lower than 7 per cent.Four years ago, if anyone had said the count would gow at 7 per cent, we wouldhave taken it with glee, but three years of 9 per cent gowth and talk of touchingdouble-digit exansion had spoilt us. The fact of the maer, that Indian gowthstor is still intact and what we are seeing now is probably only a temporar phe-

nomenon. The ination rate is declining; overall domestic demand is gowing,though not at the feverish pace of the last ve years and jobs are being created,albeit at a slower pace than before though cost pressures have increased. Underthe circumstances, the mood of despondency that has set in is unwaranted.

The curency space around us is on the verge of major tansforation.The last time something big happened in curency space was in 1971, when the

gold standard was abandoned by the then US President Richard Nixon. The move resulted in huge tade imbalances and a massive build-up of foreigcurency reseres by counties like China. Something big is all set to happenagain in the curency space with the new proposed curency bill by US. The billis essentially a for of tade protectionism that intends to penalize China forkeeping its curency at aricially low levels to boost its exors. The bill notonly in violates a series WTO rles, but would also potentially dampen the

global economic activit and increase the probabilit of a double dip recession.

This issue brings to you some more interesting and insightfl top-ics. The cover stor this month focuses on the Occupy Wall Steet Protestand its implications for the US as well as global economy. The issue also fea-tres an aricle on the Private Equit Indust in India and the road ahead

for it. Other aricles in this issue focus on inastctre nancing and entof private players in the Indian banking sector. The Classroom this monthexlains various tes of Fixed Income Securities. We would like to thank allthose who have contibuted aricles to this issue and sent enties for Fin Q.

Hope you nd this issue an interesting read.

Stay invested.

Rajat Sethia(Editor - Niveshak)


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C O N T E N T S

Niveshak Times

04The Month That Was

Article of the month

08 Prot Equity: Shackled?

Cover Story

11Occupy Wall Street

Perspective

17 Where is infation in Indiaheaded?

19 Inrastructure nancing inIndia - Exploring alternatives

Finsight

14 Entry o private sectorplayers in Indian banking

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Mining bill approved by cabinet

The union cabinet has given its nod to the newmining bill which requires the coal miners to share26% of their profit and also proposes to double theroyalty burden for non coal miners. This would gen-erate INR 10000 crore annually which will be used

for the social welfare and development activities in60 tribal dominated districts in Jharkhand, Chhat-tisgarh, Orissa, Madhya Pradesh and Karnataka. In

addition to the royalty being paid by the non coalminers they may also have to make an equal con-tribution to an infrastructure development fund.This effectively doubles the royalty payment for thenon coal miners placing on them an additional bur-den of INR 4500 crore. Implementation of this billwill raise the effective tax incidence on coal andiron ore to 61% and 55% respectively. Coal Indiawill be worst hit by this new mining bill as it willrequired to shell out INR 1000 crore annually underthe proposed profit sharing scheme. The bill alsoentails the setting up of a regulator that will havethe powers to investigate and prosecute the offend-ers. The new mining bill would simplify the landacquisition problems being faced by miners as landowners now will be more willing to give up theirland in exchange for the recurring revenue sourceassured by the new bill.

SBI subjected to downgrade by Moody

Global rating agency Moody downgraded StateBank of India (SBI)s Bank Financial Strength Rating

(BFSR) by one notch from C- to D+ on account oflow Tier I capital ratio and deteriorating asset qual-ity. As per Moodys, a D rating suggest

modest intrinsic financialstrength, potentially requir-ing some outside supportat times, while a C rat-ing denotes adequate in-trinsic financial strength.

Moody explained expecta-tions of increase in non-per-

forming assets (NPAs) of SBI due to risinginterest rates and slower economic growth as oneof the major reasons behind the downgrade. Indiahas expressed its displeasure over the downgrade

and has pointed out that the agency has failed toaccount for the government backing of the publicsector banks while arriving at its downgrade deci-sion. Government officials also quoted substantiat-ing facts that at the end of June 2011 SBIs grossNPAs were to the tune of 3.5% of its assets while itscapital adequacy ratio was 11.6%, both parameterssatisfying regulatory requirements.

Goldman Sachs shocked by USD 428 million

losses

Goldman Sachs reported a loss of $428 million in thethird quarter, the second instance in the bankingbehemoths history since going public in 1999. This

event has raised questions about a temporary ora more fundamental erosion of the much admiredearning power of Goldman Sachs. Chief Executive,Lloyd Blankfein expressed his disappointment overthe reporting of quarterly losses and attributed thisanomaly to lowerconfidence amongcorporate clientsand investors anddownward pressureon asset prices around the world. The majority ofthese losses were incurred by the lending and in-vestment business as revenues plunged from $8.9billion in the third quarter last year to $3.6 billionfor the corresponding quarter this year. The busi-ness model of Goldman Sachs has been hit by theVolcker Rule that bans proprietary trading to new

restrictions on derivatives trading.Draft National Telecomm policy unveiled bythe government

The draft telecomm policy framed by the govern-ment envisaged a one nation one tariff regime forthe country with a proposal to do away with roam-ing charges and introduce free inter-circle MNP. Thisproposal if and when put into practice will dissolvethe distinction between local and STD calls. As apart of this policy the telecomm operators will berequired to maintain just one license for all the cir-

cles in which they are operating as opposed to thecurrent requirement of separate licenses for differ-ent circles. The absolution of roaming charges willcause the telecomm operators to suffer losses of

The Niveshak Times


IIM, Shillong

Team NIVESHAK

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USD 400 million. Currently GSM and CDMA operatorsgenerate 9% and 5% of their revenues from roamingcharges respectively. Further Spectrum occupied byexisting government agencies will be vacated and aroadmap for providing additional spectrum will bereviewed every five years.

NRIs allowed holding accounts in any fullyconvertible currency

RBI has allowed Indians withnonresident accounts in In-dia to hold to hold them inany fully convertible cur-rency. This move will provide

flexibility to NRIs in holding ac-

counts and reduce their exposureto fluctuations in major currencies. Previously FCNRaccounts could only be held in certain currencieslike Pound Sterling, US dollar, Japanese yen, Euro,Canadian dollar and Australian dollar. Moreover thecentral bank has also permitted any citizen whowas earlier residing in a foreign country to own ortransfer property or other assets in that nation ifit was acquired during the time of his residencethere.

INR 900 crore relief package for exporters

The government has decided to provide INR 900 crorerelief package to the exporters to combat the slug-gish demand in developed markets and escalation

in input costs. Engineering goods, pharmaceuticalsand chemicals, apparels are some of the expectedmajor beneficiaries from this succor. The Commerceministry also introduced a special market focus

scheme to help diversify the countrys exports tonew markets. Under the scheme, an additional 1%duty credit would be provided to exporters, whoship their goods to markets in Latin America, Af-rica and CIS countries. Another move is to providea special bonus of additional 1% of export valuebetween October and March in the current fiscalyear to fifty products in engineering, pharmaceuti-cals and chemicals. The government expected therelief package to help it in achieving its $300 millionexport target for financial year 2011-12.

Yield on 10 year gilts at a 3 year peak

The yields on 10 year government bonds attained a3 year peak at 8.82% per annum owing to oversup-

ply and lack of appetite. Limited buyer interest byalso observed for 7 year government securities. Thesubdued investor demand resulted in a develop-ment as around 40% of the INR 10000 core put upfor auction left with primary dealers. The uptrendin interest rates on government securities has beenattributed to market expectations of another policyrate hike by RBI. Rise in freight rates and unsea-sonal rains are expected to stroke inflation furtherputting upward pressure on interest rates.

Chinas GDP down to a two year low

China registered a GDP growth rate of 9.1% y-o-y inthe third quarter of 2011, the slowest growth ratesince the third quarter of 2009. The GDP growth rate

slowed down from 9.5% in second quarter and 9.7%in first quarter of 2011. The overall GDP growth ratefor the first nine months of this year is 9.4% y-o-y.The slowing down of growth rate may be attributedto the macroeconomic policy regulation of Chinesegovernment which is making continuous efforts tokeep soaring property prices and inflation undercheck.

8 billion euro lifeline given to Greece

The Euro zone finance ministers have agreed togive another lifeline to Greece giving their approvalto 8 billion euro loan tranche that the debt lad-en country may need next month to pay its bills.However the troika of IMF, ECB and EU presented

an overall gloomy picture of economic scenario inGreece expressing serious concerns over the coun-try ability to repay sovereign debt. The most posi-tive scenario analyzed by the trio

involved reducing the debtlevel of Greece to 110% ofGDP which is still consideredvery high by global levels.However this will requireprivate bondholders to acceptup to 60% of haircuts which is ahighly unlikely scenario. The assess-ment also revealed that the debt level may furtherrise to 186% of GDP up from 160% currently. The 8billion euro tranche the sixth installment in the 110

billion bailout fund will be released in first week ofNovember this year.

The Niveshak Times

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MARKET CAP (IN RS. CR)BSE Mkt. Cap 62,64,794

Index Full Mkt. Cap 29,40,420

Index Free Float Mkt. Cap 1,463,899

CURRENCY RATESINR / 1 USD 48.82

INR / 1 Euro 69.28

INR / 100 Jap. YEN 64.36INR / 1 Pound Sterling 78.56

POLICY RATESBank Rate 6%

Repo rate 8.50%

Reverse Repo rate 7.50%

Market Snapshot


RESERVE RATIOSCRR 6%

SLR 24%

LENDING / DEPOSIT RATESBase rate 10%-10.75%

Savings Bank rate 4.00%

Deposit rate 8.5% - 9.25%

Source: www.bseindia.comwww.nseindia.com

Source: www.bseindia.com

Source: www.bseindia.com3rd to 28th October 2011

Data as on 28th October 2011

MarketSnapshot


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MarketSnapshot

BSEIndex Open Close % changeSensex 16,256 17,805 9.53

MIDCAP 6,128 6,275 2.39

Smallcap 6,879 6,960 1.17

AUTO 8,469 9,571 13.02

BANKEX 10,739 11,372 5.90

CD 6,361 6,633 4.28

CG 10,628 11,036 3.83

FMCG 3,888 4,153 6.82

Healthcare 5,851 6,171 5.47

IT 5,195 5,830 12.23

METAL 10,887 12,143 11.54

OIL&GAS 8,397 9,179 9.31

POWER 2,105 2,217 5.35

PSU 7,361 7,616 3.47

REALTY 1,751 1,923 9.81

TECk 3,212 3,522 9.65


Market Snapshot


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Introduction

India is riding high on its expanding corporatesector and has also witnessed unprecedentedincrease in entrepreneurial activities across thecountry. 64,990 limited companies with autho-rised capital of Rs. 47,161.75 Crore were regis-tered under the Companies Act, 1956 during theperiod from 1st April, 2010 to 31st December,2010. Out of these, 36 were Government com-panies with authorized capital of Rs. 23,697.22Crore and 64,954 were Non Government com-panies with authorized capital of Rs. 23,464.53Crore.

This growth wave is supported by the emergenceof new ventures in the form of Medium and SmallScale Industries. Traditional financing resourceshave failed to keep pace with increasing demandfor capital. These new ventures require exten-sive capital infusion especially from the private

sector. No wonder corporate houses have startedscouting for unconventional financing options.This has helped private equity culture to takeroots in India. Also, over the time promoters inIndia have realized the importance of private eq-uity capital and are willing to give stake in theirbusinesses.

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nmims, mumbaiPrateek Ahuja, Varun Salwan

PRIVATE EQUITY: SHACKLED?

Fig 1: Number of PE Investments (Source: Venture Intelligence) Figure 2: Value of PE Investments (In million USD)

(Source: Venture Intelligence)

The uptrend in PE investmentis in sharp contrast to the slug-

gish stock markets.



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Although the number of PE investments was re-duced post the 2008 financial crisis, it is againshowing signs of growth. The PE industry in 2011has witnessed 44 deals till June, which is about70% of total deals struck in full calendar year2010.

The amount invested by PE investors till Junethis year had already crossed last years figuresfor the whole calendar year. According to GrantThorntons Dealtracker Oct11 report, privateequity investment in India touched $1.91 billionin July-September this year, which was 18 per-cent higher than that in the same period lastyear. The uptrend in PE investment is in sharpcontrast to the sluggish stock markets. In com-parison to $1.91 billion of PE investments in thethird quarter this year, the capital raised through

the initial public offer route during the periodstood at $455.92 million through 11 IPOs, the re-port said. Under performance of capital marketsglobally as well as in India, is expected to giverise to interesting deal making in PE.

Dawn of a new era: SEBI Guidelines on Al-ternate Investment Funds

SEBI has come up with a draft proposal for Al-ternate Investment Funds on August 01, 2011,which has the potential to dramatically alter thescenario of PE industry in India. SEBI in its draftguidelines has proposed regulations on highersponsor contributions, caps on investments andrestrictions on the use of funds among otherthings to reduce systematic risk and channelizeprivate equity investments in specified sectors.

Current Framework

The current SEBI (Venture Capital Funds) regula-tions of 1996 were framed to promote start ups/early stage ventures by VCFs (Venture CapitalFunds), but there are no separate regulations for

PE Funds. VCF regulations are being used as aone point solution for all private investments.The rationale behind a VCF and a PE Fund is verydifferent; while VCFs are set up with an aim toprovide private capital to start up/early stageventures, PE is used to provide private capital toventures in their later stages. Concessions andsops given to VCFs are not needed for PE invest-

ments and similarly restrictions put on VCFs arenot required for latter.

Investors in a VCF or a PEF are either institu-tions or HNIs (High Net worth Individuals). Theseare very sophisticated and well informed inves-tors and bring good governance along with good

quality money. If everything is so hunky dory,then one might wonder-Do we really need strin-gent regulations for private funds? Lessons fromthe recent financial turmoil in the western coun-tries coupled with the exponential growth of theprivate fund industry domestically and their in-fluence on the stability of the financial marketshave impelled regulators to formulate stringentregulations for private equity funds.

Draft Guidelines on AIFs

Mandatory Registration

Under the current regulations it is not mandatoryfor VFCs or PE Funds to register with SEBI, but thenew proposal makes it mandatory for every pri-vate investment fund to be registered with SEBI.This mandate is proposed to give a level playingfield to similar funds. This proposal also seeks torecognize Alternate Investment Funds such asPE or VCF as different asset class from promoterholdings, creditors and public holdings. SEBI hasproposed to categorise private equity into nine

formats, such as venture capital funds (VCF), pri-vate investment in public equity, or PIPE funds,private equity funds, infrastructure equity funds,debt funds, small and medium enterprise funds,social venture funds and strategy funds. Also theproposed regulations are confusing and conflict-ing in nature. Multiple registrations are requiredfor fund managers who are involved in manag-ing different vehicles. Multiple regulations meanmultiple compliance this would only harm theprospects of PE industry in India.

Investment Caps

The proposed regulations put restrictions on theinvestments that a VC or a PE fund can make.The regulator has proposed that investmentsshould be largely based on the funds theme. Soa VCF, set up to promote businesses using newtechnology at an early stage, would be requiredto invest 66.66% of its corpus in the specified

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SEBIs rules adversely affects

the growth prospects of PE rmsas well as businesses that are

seeking capital for growth and

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category only. Similarly, a debt fund should in-vest the entire corpus in unlisted debt instru-ments, while a PIPE fund should invest in sharesof small-sized listed firms. It prohibits PE fundsfrom investing more than half their corpus in apre-IPO company. It also stipulates that 50 per

cent of their corpus should be invested in un-listed companies. Although, the motive behindthe draft proposal by SEBI is commendable (Tochannelize PE funds to specific sectors), it doescurtail the flexibility of PE and VC funds. Flex-ibility is the key to survival of this industry, op-tion to invest in a mix of ventures in their earlystages and some in their later stages is whatattracts these investors. PE Investors look to di-versify their portfolio; such restrictions can driveaway potential investors as the risk cannot be

minimised with diversification. Ambiguity Regarding Foreign Funds

In PE investment almost 80% capital is foreigncapital hence government needs to form favour-able rules to promote foreign investment. Theproposed regulations are also not clear on for-eign private funds with foreign investors and for-eign fund managers. It is not clear whether ornot they will have to register as an AIF.

Takeover Regulations

Capital markets regulator, Securities ExchangeBoard of India came up with a new set of take-over regulations in the month of July, 2011 to al-ter Indias mergers and acquisitions scenario. Thechange in the regulations was on cards from July,2010 when Takeover Regulation Advisory Com-mittee (TRAC) headed by Mr. C. Achuthan pro-posed revamping of the then existing TakeoverRegulations. The new takeover rules have differ-ent entails for diversified class of stakeholders.For institutional investors, mainly private equity

firms these new rules ring a favourable bell asthey will now be able to acquire up to 24.99%stake in a company without triggering an openoffer. Retail participantsd will also gain as the

non-compete fees is removed and they will getexposed to a larger share during an open offer.

SEBI has amended the 13 year old takeover rulesand augmented the first trigger limit for an openoffer to 25% which was earlier at 15%. The offersize too is increased to 26% which was at 20%

earlier providing an exit option for more inves-tors.

The change has aligned Indian M&A landscapecloser to the global platform. The first triggerpoint for an open offer while acquiring a com-pany in UK is 30%, similarly in Japan it is 33.33%and in South Africa it is 35%. Fig shows first trig-ger limit for different countries.

The increased threshold limit and effort to bein line with the global best practices will pro-

vide an additional flexibility to organizations toraise capital by exploiting PE firms which on theother hand is an opportunity for PE investors toincrease their investment base . The fact is thatin eighties also the open offer trigger limit was25% as per the listing agreement. Later, it wastrimmed down to 10% and then increased to 15%.

Since 1998, PE funds have invested around $11billion in listed firms. According to the experts ifa PE firm acquires 24.99% which is usually more

than 25% of public present and voting at an Ex-traordinary or Annual General Meeting, it canhave substantial control over important mattersof special resolution and better minority protec-tion rights and hence can create an efficient im-pel against poorly run and mismanaged compa-nies.

Conclusion

Though it is essential to rein in the financial sys-tem in order to avoid the repeat of 2008 finan-

cial turmoil, we feel that considering the growthstage India is in, it is essential to provide theaccess to capital in order to promote the busi-nesses in India. At one hand SEBI has provid-ed flexibility through New Takeover Regulationswhile on the other hand it has put in stringentmeasures through Alternative Investment Funds.Our analysis shows that SEBI needs to reconsiderthe classification of investment funds and speci-fied minimum investment limits. It adversely af-fects the growth prospects of PE firms as well as

businesses that are seeking capital for growthand expansion.

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Figure 3: First Trigger Limit (Source: www.indiape.com)



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test spread across the world. In fact, by the 3ndweek of October, similar protests were being

held in around 900 cities worldwide, all beingmodelled according to the original OWS protest.

What is the Revolution all about?

As mentioned earlier, the protests are aimedat the growing economic inequality betweenthe 99% (ordinary citizens of US) and the top1% (who run Wall Street). The increasing greedand corruption by the top 1% has led them totake a share of more than 20% of the total USincome in 2007-08 as compared to a share of

less that 10% in the 1980s (Figure2). The movement intends to bringabout a real change in the societyfrom the bottom up by empower-ing the 99%, minimizing the influ-ence of top 1% (big corporates) onthe US laws and policies and thusreducing the inequality in the dis-tribution of wealth. However, a lotof people classify the protests asa revolution against capitalism.

In short, the primary demand ofOWS is that Barack Obama ordaina Presidential Commission taskedwith ending the influence money

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Team niveshak

Sawan Singamsetty & Shashank Jain

The Occupy Wall Street (OWS) protests are in-tended and aimed at drawing attention towards

the economic disparity, injustice and politicalcorruption. The slogan We are 99% being usedby the protesters to refer to the difference inwealth between them, i.e. common citizens ofUS and top 1%, who supposedly run the Wallstreet. The protests come in the wake of intoler-ance towards the greed and corruption of top1%.

A Revolution Begins!

The protest began on a small scale when Ad-

busters, a Canadian based anticonsumerist magazine, initi-ated a peaceful occupation ofWall Street to protest against theinfluence of corporates on de-mocracy and the absence of anymechanisms post the global eco-nomic crisis. The protest was fur-ther promoted with the famousposter of a dance over the WallStreets Bull (Figure1).

The revolution started on Septem-ber 17 with more than thousandprotesters marching through thestreets and eventually the pro-

Figure 1

Occupy Wall Street


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decline in sales and had to go in for discounts toclear the stock from the shelves.

New York alone contributes nearly 33% of the $65Billion luxury retail market of United States. Anysign of deepening protests will definitively affectthis market. This protest is also coupled with jobcuts that were announced by Bank of America,JPMorgan Chase , UBS AG and Goldman, which willagain put a curb on demand of these products.Goldman which registered its 2nd loss from thetime of going public has also commented on put-

ting 59% less money towards the compensation ofemployees in the 3rd Quarter.

The Funding behind the Protest

Lately there have been many speculations recent-ly as to who is actually behind the funding ofthe Occupy Wall-Street Protests. One name thatcomes into picture while talking about the sameis George Soros, the name that appeared in thelist of wealthiest 10 Americans. Conservative saythat this movement is a Trojan Horse for the Soros

Agenda.One possible link is the indirect financial rela-tionship of George Soros and Adbusters, an anti-capitalist group in Canada. This group started theprotests with inventive marketing strategies.

Second reason is that George Soros was againstthe 2008 bailout and also government repurchas-es of the toxic sub-mortgaged assets that wereinvolved in property bubble.

Vox Populi

For many casual observers and news consumers,the fledgling Occupy Wall Street movement ap-pears to have come out of nowhere-a spontane-ous, loosely knit gathering of protesters who feeldisaffection and anger over the financial crisis and

has over our representatives in Washington.Who constitute the top 1%?

A fundamental question that has been raised allalong this time during protests was that who con-stitute the top 1%? who are seemingly greedy,corrupt and are responsible for the economicdisparity in the United States. While the gener-al opinion is that, majority of them are the WallStreet Executives or top corporate honchos, it isnot actually completely true. Following is the dis-tribution of the occupation of the taxpayers in top

1% of the income (Figure 3).

Will India join this Movement?

We believe it is very unlikely that India will joinin this protest. India happens to be a developingnation wherein the aspiring middle class seldomrelate themselves to the urban working class andurban working class to the rural India. Hence,there is a lot of disconnect between such strata ofthe society unlike the West where they are digi-tally connected among each other.

However, this doesnt mean that the middle classor the common man is not fighting for its growth.A point to be observed in the Indian scenario isthat the root cause for the hindrance of growthis corruption and the major culprit is The CentralGovernment. And, as we all know, thousands ofIndians have recently protested against corruptionthrough the Anna Hazare Movement that was aneye opener for the Indian Government

Effect of crisis on the Luxury Market

Luxury store owners as well as real estate agentsare having a Jaundice eye effect when it comes toevaluating the business prospect of their industry.Even in the year 2008 various luxury market prod-ucts suffered a hit. Eg: Saks saw a double digit

Figure 2



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End to these protests

The protestors, in actuality, have not mentionedtheir end goals or anything that would allow themto declare victory and end their protests. Giventhis, it is of paramount importance that the politi-cians and leaders start tacking the larger prob-lems and causes that lead to these protests. Pro-viding a feasible, long term sustainable solutionto the euro crisis problem would surely impressthe protesters to some extent. Further, focus on

taking steps and actions and developing policiesthat would boost economic growth in respectiveeconomies would add to the betterment of themasses. Rather than going for austerity, makingthe top 1% or the rich pay their taxes in an appro-priate manner, boosting the taxes for the wealthywould lead to better solutions that make econom-ic sense.

The other major steps that can be taken by allthe leading economies, one of them being is tomaintain transparency. Lack of transparency hasalways led to major problems in several nations,especially this being a major reason for Greece cri-sis. Further, identifying the correct reasons for theglobal turndown in 2008 and building or develop-ing suitable mechanisms to tackle such problemsin future would assure the protestors of somesafety or security in future.

Announcement of such measures or steps by thegovernments may not lead to end of these pro-tests on an immediate basis. However, this would

lead to slow realisation among the protestors thatthe leaders are truly worried about the conditionof the economy and the 99% which would eventu-ally culminate to a slow die-down of the protests.

dismay over the outlook for the American middleclass. Much of the criticism against these protestshas come in the form that they are leaderless andthat the demands and goals are unclear.

During a hearing before the Joint Economic Com-mittee October 4, 2011, the Federal Reserve Chair-man Ben Bernanke empathised with the protestsstating that People are quite unhappy with thestate of the economy and whats happening. Theyblame, with some justification, the problems in

the financial sector for getting us into this mess,and theyre dissatisfied with the policy responsehere in Washington and at some level, I cantblame them. Certainly, 9% unemployment andvery slow growth is not a good situation.

Former Soviet president Mikael Gorbachev statedthat the reasons of protest seem justified and sig-nificant. Further, he also stated that though herespected the movement he feared that it mightget diluted or affected due to some extremist ele-ments. He also went on to compare this move-ment with perestroika, the period of reform inthe 1980s he ushered in that culminated in thecollapse of the communist superpower and endof the Cold War.

The protests may be leaderless or without anyproper goals. But one thing for sure is that thishas been a wakeup call for the leaders of all ma-jor economies. It has made them realise that theycannot be complacent in any way possible andthat the growth of 99% is of paramount impor-

tance when it comes to the overall growth of thecountry or economy.

Figure 3


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The minimum capital requirement of Rs 500crore is laid down such that the capital requirementis not significantly high or not meager. A very lowminimum capital requirement (of Rs 200 crore) couldattract non-serious entities without inadequate fi-nancial resources to seek for licenses. On such smallscale, there is always a risk of an early wiping off ofthe initial capital. Such small scale banks would alsonot be able to invest in technology. While a low mini-mum capital requirement has these disadvantages,a very high minimum cap requirement (say Rs 1000crore) would evince only those with high funds. Suchentities would be profit oriented and could divertfunds to big-ticket corporates thereby diluting thepurpose of financial inclusion. Thus the requirementof high enough entry capital can be fulfilled only byentities with large surplus of funds that are readilyavailable with the industrial houses. It could also actas contingent capital for banks in case of financialshocks.

The creation of an NOHC would enable in sepa-rating the activities of each of the subsidiary com-panies from another and help in greater regulationby separate regulators in each of the segmentedspheres. The NOHC will only act as a vehicle to holdthe investments on behalf of the promoter/promotergroup and will not be allowed to accept deposits.This would cause a fall in the Return on Assets (RoA)

and Return on Equities (RoE) of the NBFCs.Excepting promoters/promoter groups that gen-

erate more than 10% of revenues or have more than10% of assets in real estate or broking services, allprivate sector players are eligible to promote banks.The exposure of the bank to any entity in the pro-moter group shall not exceed 10 per cent and theaggregate exposure to all the entities in the groupshall not exceed 20 per cent of the paid-up capitaland reserves of the bank.

A clear NO to the businesses in broking services

comes from lessons from international experience.The recent financial crises have led to closure of notonly the broking companies but also the bankingcompany associated with them. The crises have also

Banking industry is the backbone of anyeconomy and hence has always attracted the at-tention of policy makers, industrialists as well asof academicians. It acts as a catalyst to build theeconomy. Historically, banking industry in Indiahas been dominated by a handful of public sectorbanks. Post-independence Government has tried toincrease the reach of banks through measures likenationalization initially and later on through liber-alization but unfortunately banking industry hasremained concentrated only in urban areas leav-ing poor people outside the system. Almost 65%of population does not have access to the bankingsystem.

The present government in its election mani-festo had promised to increase the pace of finan-cial inclusion and since then has taken measures

like the Unique Identification Number (UID) initia-tive, which would do away with the hassles of KYC(Know Your Customers) norms. RBI has also takena crucial step to achieve this objective. It has comeup with a proposal of issuing banking licenses tobig industrial houses in India. It intends to providean opportunity not only to the NBFCs but also, forvery first time, to industrial houses to participatein banking sector.

RBI has been extremely cautious, taking morethan a year in carving out guidelines which would

provide directions for selection or rejection of aparticular private player for assigning banking li-cense.

KEY GUIDELINES AND RATIONALE

The following are the major guidelines issuedby RBI (September 2011) for new banking licensesfollowed by the rationale for each: (as per RBIsdraft on guidelines for banking licenses)

It is proposed that the initial minimum paid-up capital for a new bank shall be Rs 500 crore andthat a wholly-owned non-operative holding compa-ny (NOHC) will hold the existing businesses and thenewly created bank within itself. Only non-financialcompanies can have a shareholding in the NOHC.



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shown that banking industry was not completelyshielded from real estate businesses. This rela-

tion could be attributed to fact that the recentcrisis was due to asset bubbles in the real es-tate sector. However, because the cause has beenspecific to a particular industry (in this case, realestate) the lessons from recent past cannot beundermined. The cap on the holding limit of 10%by banks in the promoter group company is toprevent the sub-version of Chinese wall betweenthe bank and the rest of the group.

Groups with diversified ownership, soundcredentials and integrity that have a successful

track record for at least 10 years shall be eligibleto promote banks and RBI may seek feedbackon applicants from other regulators and agencieslike Income Tax, CBI, Enforcement Directorate,etc. This, in effect, rules out a first-generationentrepreneur setting up a new bank. The newlyformed banks must have 25 % of their branchesin unbanked rural areas. This is mainly so as toensure financial inclusion.

Major considerations for Allowing/Disal-lowing Industry houses to run banking

services are:

SELF-DEALING:Self-dealing means that the par-ent industrial company that set up the bank canroute funds to its own purposes not consideringthe depositors interests. There exists a possibil-ity that a bank affiliated to a commercial firmmay deny loans to its competitors.

CONNECTED LENDING: Also, the risk of connect-ed lending to companies or suppliers within thegroup cannot be ruled out. Such rotation of funds

among related parties can make it difficult forthe regulator to trace sources and utilization offunds.

However when the existing NBFCs of indus-trial houses and their clients were questionedabout the financing services by their corporatehouses, it was revealed that the loans that weresanctioned to the existing customers, vendors,channel partners- dealers and distributors- ofthe industrial unit were processed 40-45% times

faster than that done by the banks. The improvedturnaround times of sanctioning and disbursing

loans was made possible because of quicker due-diligence of the clients through information avail-able with the group firm that had business linksto the borrower. Not only that, another advantagecould be that the existing industrial houses canextend their management expertise and strategicdirection of their existing experience in the non-banking and financial services domain to theiraffiliated banks.

Analysis of the major companies planningto apply for the banking license:

LIC HOUSING FINANCE:The company has 21 yearsof work experience in Financial Services and hasmore than 200 offices across the country. It pro-vides long term finance to individuals for pur-chase, construction, repair and renovation of new/ existing flats / houses, on existing propertyfor business / personal needs and gives loansto professionals for purchase / construction ofClinics / Nursing Homes / Diagnostic Centers andalso for purchase of equipments, thus having adiversified business. It has robust financials in

terms of substantial cash balances and low NetNon-Performig Assets but its exposure to real es-tate loans as on January 2011 was 10-11% whichcould be a red signal to the license issuers. Alsoit has future prospects of launching venture capi-tal fund to invest in real estate in upcoming 3-4months. This could again increase its exposure tothe prohibited sector.

Probable Outcome: Its exposure to realty sec-tor could hinder its chance in bagging the license.

IFCI:The company has 63 years of experience inFinancial Services. It is involved in a diversifiedindustrial portfolio comprising of Public SectorUndertakings, Manufacturing industry, Infrastruc-ture projects, NBFCs, Participation in Private Eq-uity and Promoter funding. It is currently facinga litigation wherein Supreme Court has issued anotice to the company questioning its appoint-ment of IES officer Atul Kumar Rai as CEO andMD of the IFCI in breach of all norms. Apart from

LIC Housing Finance

Shareholding Pattern Key Financials

Promoter FII DII Others N/W R&S Cash CAR NNPA

36.54% 39.86% 7.81% 15.79% 4169Cr 4074.11Cr 415.41Cr 15% 0.12%

IFCI


FII DII Others N/W R&S Cash CAR NNPA

19.45% 29.31% 51.23% 5000 cr 4000 cr 500 cr 17.9%


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this IFCI has been accused of behaving as an in-dependent company, over which the governmenthas no control, in spite of the center bailing themout with a package of Rs. 5220 crore. IFCI alsodeclares itself to be out of the purview of the RTIAct.

Probable Outcome: Despite a few litigationsIFCI has a fair chance of bagging the licensemainly due to its enormous experience and itsexposure to RBIs favourite sector.

MAHINDRA & MAHINDRA FINANCIAL SERVICES

LIMITED: The companys major revenue driver isthe business of financing (for vehicles) since 1993through its NBFC. It is also into fixed deposits,personal loans, mutual funds and insurance busi-ness. It shows a diversified business by financingutility vehicles, tractors and cars, focusing on the

rural and semi-urban sector. Thus it has a hugepresence in the rural areas as financial services.It has around 540 branches and majority of themare in rural areas where it has set a strong foot-hold. Also its CAR is quite high thus depicting athick cushion for economic downturns.

Probable Outcome: High chances of baggingthe license mainly because of their rural pres-ence.

RELIANCE CAPITAL: The company has 25 years ofexperience in Financial Services. It has diversi-

fied holdings into life insurance, mutual funds,general insurance, securities and commercial fi-nance. The company however belongs to Reliance

ADAG promoter group, top officials of which are asuspect in the 2G Scam. Reliance capital recentlycompleted the 26% stake sale of Reliance to NIP-PON Life in Reliance Life Insurance. Its key finan-cials seem quite appropriate i.e. huge amount ofcash and bank balances, high net worth etc.

Probable Outcome: High chances because itsatisfies all the criteria. Promoters track recordis questionable only after he is proved guilty bycourt.

SHRIRAM GROUP:The company, since 1974, hasdiversified its business in Commercial vehiclesFinancing, Consumer & Enterprise Finance, Re-tail Stock Broking, Life Insurance, Chit Funds andDistribution of Investment & Insurance Products,EPC and Real Estate. The company underwent acapital infusion of Rs 67 crore Investments for ex-

panding their operations in - Shriram Fortune andShriram Insight. ShriRam Fortune in Insuranceand ShriRam Insight in Broking. This infusion ofcapital might increase revenues from brokingbusiness in excess of 10%. Also the FII stake ishuge (42.41%) thus introducing uncertainty andfinancial instabity. The company currently has asubstantial presence in financial services busi-ness and is known for sound track record of itspromoters.

Probable Outcome: It would be difficult to

come to any fair conclusion based on the givendata. If the revenue structure of the companyremains under the limits as mentioned in the

Mahindra & Mahindra Financial Services Limited



57.44% 34.49% 3.54% 4.53% 2490 cr 2385.56 cr 297.62 cr 20.3% 1%

Reliance Capital



54.14% 21.48% 4.86% 18.52% 7027.69 cr 6781.53 cr 1171.16 cr N.A. N.A.

Shriram Group



41.28% 42.41% 2.18% 14.13% 4904.39 cr 4674.66 cr 914.26 cr 24.85% 0.4%

SREIShareholding Pattern Key Financials


46.22% 14.17% 0.26% 39.35% 2553.13 cr 2049.89cr 1.71 cr 29.36% 0.6%


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guidelines the company might have a chance to get

a license.SREI: This Infrastructure Financing Company hasbeen in existence since the last 20 years. Theyhave a well-established rural presence in the formof SREI Sahaj e-village. They have been setting upIT centers under e-governance, e-commerce and e-learning in those villages. They already have 16000centers and are planning to set up 30000 more. Analarming figure is their low cash balances. Also thepromoters of the company are accused of misap-propriating funds of around Rs. 300 crore to some

private institutions.Probable Outcome: Its chances of winning thelicense are bleak.

L&T FINANCE:L&T Finance Holdings is into the busi-ness of lending to infrastructure projects, sellinginsurance, financing small and medium business-es, among other financial services. The companyscombined asset base grew to Rs 188 billion at theend of the financial year 2010-11, up 57% from ayear ago. L&T Finance has a tie up with NationalCollateral Management Services (NCMSL) to provide

receipt financing, which involves collateral manage-ment and warehousing services, to farmers andsmall businesses. The major objective is to assistindustrialists, traders and farmers in financing theirworking capital requirements at all stages of thesupply chain, right from pre-harvest to marketingand export. NCMSL plans to build its own warehous-es at 40 locations across 12 states, and this partner-ship will facilitate secured post-harvest lending onlarge scale to farmers , processors and other agri-business clients.

Probable Outcome: Based on their reach in rural ar-eas the company has fair chances of bagging thelicense.

ADITYA BIRLA GROUP:Aditya Birla Group has a high-ly diversified business structure. It is involved intoapparels, agri business, cement, carbon black, in-sulators, textiles, viscose filament yarn, BPO and ITservices, telecom and financial services. It reachesacross 3000 villages. The group is known for its cor-porate governance. Its initiative of Center for Com-

munity Initiatives and Rural Development focuseson the complete development of the communitiesaround the plants of this group usually located inremote rural areas and tribal belts.

Probable Outcome: The group has a bright

chance of securing the license owing to its ruralreach, corporate governance and sound manage-ment

BAJAJ FINSERV:Bajaj Finserv has a 20 year oldexperience in financial services namely life insur-ance; general insurance and consumer finance(mainly auto finance) businesses. Apart fromfinancial services, Bajaj Finserv Service is alsoinvolved in wind-energy generation. They havean option of either converting their NBFC BajajFinance into a bank or can have a wholly owned

subsidiary under Bajaj Finserv. They have a re-cord of age old sound management.

Probable Outcome: With their experience andexcellent promoter track record they have a fairchance of bagging the banking license.

TATA GROUP:The Tata group is involved with ITservices, chemicals, consumer goods, automo-biles, energy, telecom, steel and engineeringproducts. Tata group has taken several initiativeslike Tata Chemicals Society for Rural Develop-ment, Rallilove ACTS, and Voltas for Women etc.for social reforms, rural welfare and womens de-velopment.

Probable Outcome: Tatas like Birlas with theirhighly diversified business and sound promotertrack stand a good chance of securing the bank-ing license.

Some other companies like India Bulls arecompletely out of the race of receiving the bank-ing licenses owing to their major revenue contri-bution by brokerage. Religare enterprises might

still stand a chance if its promoters plan to applyfor the license since the revenue contribution ofReligare Enterprises might be less than 10 %.

Conclusion:

The guidelines incorporate a lot of sub-jectivity in terms of diversified ownership,soundtrack record of promoters. This suggeststhat the guidelines are merely a signpost for is-suance of the banking licenses; the final say stillrests at the discretion of RBI. The detailed studyof the guidelines and of the various companies

applying for the banking licenses indicates thatthis step would be instrumental towards achiev-ing Financial Inclusion, provided appropriate reg-ulations are in place.

Finsight

L&T Finance



82.64% 2.62% 2.64% 12.10% NA NA NA NA NA


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Introduction

While the rest of the world is in awe of Indias sta-bility during the turbulent times of 2008s recessionand while the international press is abuzz with spec-

ulation of Indias high growth rate and its chancesof overtaking China, there has been one problemplaguing India all the while, runaway Inflation. Un-

til the early nineties, Inflation was primarily causedby domestic factors (supply usually was unable to

meet demand, resulting in the classical definition ofinflation of too much money chasing too few goods),

today the situation has changed significantly.

Inflation today is caused by an amalgam of globaland domestic factors. Naturally, as the Indian econ-omy undergoes structural changes, the causes of in-

flation too have undergone tectonic changes. Todaya trident of higher inflation, interest rates and slowergrowth is now plunging deep into Indias economy.

As of August 2011, Inflation rate was at 8.99 %. Al-though inflation today is much lower compared to

the first quarter of 2010, it is still at a level thatwould leave the people at the lower income level inan uncomfortable position.

Factors driving infation

India has struggled to maintain control over risingconsumer good prices while stagnated developedcountries are facing low inflation rates. A large por-tion of the consumers income is spent on food in

poorer countries. Inflation in India stems from Foodinflation which is basically a supply side issue. Indiafor example spends 46% of its income on food. Im-

proper irrigation facilities lead to over dependencyon an uncertain monsoon. What actually compoundsthe problem for India is the fact that lower harvestworldwide, specifically in Australia and Brazil, has

led to an increase in the price being offered for In-dian agricultural produce. Not so recently there wasa situation where the price of one kilo of onions was

more expensive than the price of one litre of petrolor a bottle of beer.

As per recent reports, Food inflation has reached

10.6% for the week ending October 8th 2011. Infla-tion has been largely driven by soaring vegetable in-

flation (17.6%) and fruit inflation (12%). In additionpeople have started consuming more protein richfood which in turn has driven up the price of protein

food products.

Also, other commodity prices have been increasingcontinuously further adding to the inflation. Globalcrude oil prices have stagnated over the $100/bar-rel psychological level. Continued de-subsidization

has resulted in continuous price hikes in Petrol and

Diesel prices. There is speculation that LPG priceswill be increased as well. The rise in crude oil pricestrickles down to an increase in the price of all other

commodities.

Lately, the rupee has been constantly depreciatingagainst the dollar, reaching its lowest value sinceApril 2009 (50.32 rupees per dollar). As a result our

exports are fetching more money than usual. Thishas led to an increase in the wages of the peoplewhich in turn has boosted the buying power and af-fordability of the middle class and upper class.

Ination has been largely driven by

soaring vegetable ination and fruit

ination.

iim shillong

G.S.N. Aditya



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Lastly, housing prices have also been rising con-

stantly raising the cost of living.

What RBI is doing

As it can be seen from the chart, RBI has resorted tocontinuous hikes in interest rates in an attempt tocurb inflation. It has raised interest rates 11 times

in the last 18 months. It has primarily controlled theRepo and reverse repo rate as a means to controlthe money in circulation which in turn would controlthe demand.

By increasing the Repo rate and bank rates, the

banks would have to pay a higher interest rate tothe RBI to borrow money. This increase in interest istransferred completely or partially to the end con-sumer. As the interest that the consumer now has to

pay has increased, it is believed that the consumerwould spend lesser than normal, thereby curbing hisbuying potential which in turn would bring down de-mand and curb inflation. However, Inflation is largely

due to food inflation where most of the commodi-ties are essential and the consumer is forced to buythem even at exorbitant prices. Hence, the demand

for food products falls gradually as compared to oth-er luxury products.

Why is it failing?

RBI can only control the monetary policy. But thecrux of the problem lies on the supply side. We arent

supplying enough to meet our demand. And suppli-ers in our country are inclined towards exportingtheir produce to other countries due to the greater

margins being offered. Although the government hasbeen taking steps to discourage exports by imposingheavier duties and by restricting export of certain

commodities, the policies are still not holistic andcomprehensive in nature.

Hence just merely raising the Interest rates will not

be enough as interest rate hikes will only help totemporarily curb demand. Also, there will be cer-tain essential goods like petrol and rice grains wherepeople will have to pay the high prices being de-

manded. Therefore to curb inflation we will also

need certain policies and measures in place to elimi-nate the supply side problems and increase produc-tion in general.

Where is infation heading

Analysts predict that inflation would dip to 7.5 to 8% by the second quarter of 2012.

The current measures in place would ensure thatinflation is contained at least temporarily. Food in-flation is projected to stabilize and decline over the

near future given a good healthy monsoon and thepolicies in place to encourage imports and discour-age exports.

However the reason to worry now is that the lat-

est hike in inflation has been led by manufacturing

products. Manufacturing products form the largestweightage in the Wholesale Price Index (WPI). Withprice hikes of fuels such as diesel being very much

in the offing in the near future, the pressure willonly get worse.

With price hikes of fuels such as

diesel being very much in the ofng inthe near future, the pressure will only

get worse


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Read on to understandthe challenges involvedin carrying out one ofthe most important func-tion that directly impactslarge number of devel-opmental projects in ourcountry - InfrastructureFinancing. The articlealso gives a diverse setof alternatives to makefinance easily availableand overcome the ob-stacles

easy financing for infra projects in India

1. SAVINGS NOT CHANNELIZED: AlthoughIndias saving rate may be as high as37%, almost one-third of savings are inphysical assets. Also, financial savingsare not properly channelized towards in-fra due to lack of long term savings inform of pension and insurance.

2. ASSET-LIABILITY MISMATCH: Mostof the banks face this issue due to long

term nature of infra loans and short termnature of deposits.

3. REGULATED EARNINGS: Earnings fromprojects like power and toll (annuity)may be regulated leading to limited lu-crative options for private sector anddifficulty for lenders. Also, any increasein input cost over the operational life isvery difficult to pass on to customers dueto political pressures.

4. LIMITED BUDGETARY RESOURCES:With widening fiscal deficit and pass-ing of FRBM act, government has limitedresources left to meet the gap in infrafinancing. Rest of funds have to be metby equity / debt financing from privateparties and PSUs.

5. UNDERDEVELOPED DEBT MARKETS:Indian debt market is largely comprisedof Government securities, short term andlong term bank papers and corporatebonds. The government securities are thelargest market and it has expanded to agreat amount since 1991. However, thepolicymakers face many challenges interms of development of debt markets.

Infrastructure

It is the backbone of economic activityin any country, but unfortunately, In-dia suffers from osteoporosis. Time andagain various policy measures havebeen taken to boost infrastructure, butno major progress has taken place bar-ring on telecom infrastructure front. Tofuel Indias ambitious growth rate andmeet distant targets, a major restruc-

turing is required on governance, legal,administrative and financial front. Ac-cording to Global Competitiveness Re-port (GCR) 2009-10, India ranks verylow at 76 in infrastructure domain. AlsoIndia spends only about 6-7% of its GDPon infrastructure.

Financing is one of the most basic re-quirements for carrying out infrastruc-ture projects, which are capital inten-sive and are in risky domains. The low

levels of public investment have madeIndias physical infrastructure incom-patible with large increases in growth.Any further growth will be moderatewithout adequate investment in social,urban and physical infrastructure.

In 11th 5 Yr plan, 30% of total infra in-vestment is expected to be from privatesector & 48.1% of total infra investmentis expected to be from Debt sources.It emphasises the need for availability

of cheap and easy finance options forprivate sector.

Challenges in Infra Financing

There a lot of hindrances in achieving

INFRASTRUCTURE FINANCING IN

INDIA - EXPLORING ALTERNATIVES

mDi gurgaon

Ankur Bhardwaj & Sounak Debnath


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Effective market mechanism

Robust trading platform

Simple listing norms of corporate bonds

Development of market for debt securitization

6. RISK CONCENTRATION: In India, many lendershave reached their exposure limits for sector lend-ing and lending to single borrower (15% of capitalfunds). This mandates need for better risk diversifi-cation and distribution

7. REGULATORY CONSTRAINTS: There are lot of expo-sure norms on pension funds, insurance funds andPF funds while investing in infrastructure sector inform of debt or equity. Their traditional preference isto invest in public sector of government securities.

AlternativesTo overcome these challenges and find a way foreasy availability of funds for infra financing, we canexplore following alternatives:

1. DEVELOPING DOMESTIC BOND MARKET, CREDIT

DEFAULT SWAPS & DERIVATIVES

India receives substantial amount of FII investmentin debt instruments. But most of this investmentis concentrated in government securities and corpo-rate bonds

FII investment limit in infrastructure bonds has beenincreased from USD 5 billion to USD 25 billion. How-ever, investments of only USD 109 million material-ized till August, 2011. This deficit in target invest-ment levels need to be reduced.

Just like a well-developed equity market, India needsefficient bond market so that long term debt instru-ments are available for infrastructure. Currently,FIIs can trade Infra bonds only among themselves.Also, if credit derivatives are allowed, then FIIs willbe encouraged to invest more in these infrastruc-

ture bonds due to the presence of credit insuranceand better management of credit risk. RBI is in theprocess of introducing CDS on corporate bonds andunlisted rated infrastructure bonds by Oct 24 2011.

However, much progress is sought is this domainlike minimizing multiplicity of regulators, removingTDS on corporate bonds, stamp duty uniformity, etc.

2. PRIORITY SECTOR STATUS TO INFRA

Hitherto, infrastructure financing doesnt come un-

der the ambit of priority sector like agriculture, smallscale industries, education, etc. For every Rs 100 lentto non-priority sectors, banks have to lend Rs 140 topriority sectors. Giving priority status will help banksto lend more to this sector.

3. TAKE OUT FINANCING AND LOAN BUYOUTS

One major problem faced by banks while disbursingloans to infrastructure projects is the asset liabilitymismatch inherent with these projects. Therefore,many such projects are denied financing by banks.

One way out from this predicament will be the tak-ing over of loans by institutions like IDFC after themedium term. This will allow banks to finance theseprojects for a medium term by sharing some of therisks with institutions like IDFC. This reduced riskexposure will allow banks to increase their financingof infrastructure projects.

4. RATIONALIZING THE CAP ON INSTITUTIONAL IN-

VESTORS

Rationalizing the cap on investment in infra bonds byinstitutional investors like pension funds, PF funds

and life insurance companies will lead to more in-vestment in this sector. Currently, insurance compa-nies face a cap of 10% of their investible funds forinfra sector.

5. TAX FREE INFRASTRUCTURE BONDS BY BANKS

Currently only NBFCs can float tax free infrastruc-ture bonds. If banks are also allowed to float thesebonds, they can raise long-term resources for infra-structure projects, thus reducing the asset liabilitymismatch.

6. FISCAL RECOMMENDATIONS

The following fiscal policy medications can allowmore funding of infrastructure projects.



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i. Reducing withholding tax

Currently, foreign investors pay withholding tax ashigh as 20% depending on the kind of tax treaty.It increases borrowing cost as the current marketpractice is to gross up the withholding tax. So, thisrecommendation would reduce the borrowing cost.

ii.Tax treatment on unlisted equity sharesUnlisted equity shares attract larger capital gainstax than listed ones. Currently, capital gains onunlisted equity shares are taxed at 20% instead of10% for listed equity shares. Most private players inthe infrastructure sector are not able to raise capi-tal through public issues. Therefore, for these play-ers unlisted equity will be their dominant source of

equity capital. They are adversely affected becauseof the tax treatment meted out to unlisted equityshares. Hence, special consideration should be givento private players in the infrastructure sector to en-courage investments.

7. FOREIGN BORROWINGS

With respect to foreign borrowings, several optionsare there like increasing the cap rate for longer ten-ure loans, relaxing refinancing criteria for existingECBs/FCCBs; allow Indian banks for credit enhance

ECBs (which is currently allowed only for foreignbanks), etc.

8. UTILISING FOREIGN EXCHANGE RESERVES

Indias foreign exchange reserves stand at USD 311.5bn (Sep 2011).

These reserves are primarily meant to provide a buf-fer against adverse external developments. But theydo not add value to any real sector as they are in-vested in foreign currency assets such as govern-ment bonds. So, the returns on these reserves arequite small.

The Deepak Parekh committee on infra financing isalso in favour of allocating a small fraction of totalreserves for infra purpose. This method of fundingis already being used in some Asian countries like

Singapore. After accounting for liquidity purposes,external shocks, high rate of domestic monetary ex-pansion & real risks of disruptive reversals of capital

flows; some of funds can be used for infra.

9. FUTURE CASH FLOWS AS TANGIBLE SECURITY

The loans given to infrastructure project consortiumsby banks are not secured & fall under the unsecuredloans asset class for banks. Currently, RBI mandatesthat provisioning of such unsecured loans is keptat 15% (additional 10% for substandard unsecuredloans). Therefore, total amount of loans to infra-structure projects are constrained because of thesubstandard unsecured nature of these loans.

The primary source of repayment of these loans is

the future cash flows accrued from the project oncethey are completed and ready for public use. Thesecash flows can act as a security under certain condi-tions and debt covenants. For instance, in case ofroad/highway development projects, RBI passed anorder that a) annuities under build-operate-transfer(BOT) model and b) toll collection rights where thereare provisions to compensate the project sponsor ifa certain level of traffic is not achieved, be treatedas tangible securities

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Sir, we have heard a lot about bondsor fixed income securities and yield. Butthey are very confusing. Could you pleaseexplain them properly?

Yes, an important topic indeed. Bond isa debt instrument in which an investor lendsmoney to an entity (corporate or governmen-tal) that borrows funds for a defined period

of time at a fixed interest rate. This rate is also calledthe coupon rate, and is usually paid semi-annually.

So, is the interest rate and the periodalways fixed?

Not always. Interest rate for floating

rate securities is variable and may dependon the market interest rates or the inter-est rates of bank treasuries. Also one caneasily exit investments in bonds by sellingthem in the open market. Then there is a

class of bonds, called Zero-coupon Bonds which do notpay any interest. They are sold at a discount and areredeemed at par when they mature. The difference inprice is the profit on the investment.

Sir, could you explain what factorslead to different interest rates being offered

by different bonds?There are several factors, risk being

the primary one. Different firms have varyingrisks based on the industry it operates in, le-verage on its balance sheet, its managementetc. Also the rates reflect the ratings that thebond gets when they are introduced. Usually

higher the risk higher is the interest rate offered. Alsothere are other factors like Callable options, which givethe issuer the right to call back the bond in case mar-ket interest rates reduce, and hence they offer a higherreturn compared to normal bond. Similarly in Puttablebonds the bondholder has the right to sell the bond tothe issuer at a specified price prior to maturity. They doso if the interest rates rise or the credit worthiness ofthe issuer deteriorates. Hence, they offer lower interest

rates as compared to normal bonds, which do notcarry such options.

Sir, what is the difference betweenyield and interest rates or coupon rates?

Yield is a return on investment. Itis a function of the market value of thebond, whereas coupon rates are alwayscalculated on the face value.

Sir, I am not getting. Market Value!

Face Value! How is market value calcu-lated, and how does it change with inter-est rates?

Always remember that bond pricesand interest rates are inversely propor-tional. If the interest rates in the marketare above the coupon rate of the bond,the bond would trade at a discount, and

if the coupon rate offered is above market rates ofsimilar securities, the bond would trade at a pre-mium. Hence, the yield would vary accordingly. The

market value of a bond is calculated by discountingthe future cash flows from the investment at themarket interest rate at that time.

Sir, can we do this with an example.

Sure. Suppose XYZ Company issuesa 2 year bond with a face value of Rs.100and a coupon rate of 8% annually. The

market interest rate for a similar secu-rity is 6.5%. Hence the market value of the bondwould be calculated as: 8/1.065 + 108/ (1.065^2) =Rs.102.73/-

Sir, could you talk about one of themost important risk which is the Rein-vestment Risk.

Yes. Reinvestment risk is associ-ated with the redeployment of capital ob-tained as interest or principle from fixed-

income securities. If market interest ratesreduce, these funds need to be invested

at lower interest rates. Risk usually increases withcall or prepayment feature or if the coupon is higher.

CLASSROOM

FinFundaof theMonth

BondsIIM Shillong

jayant kejriwal

Classroom


24/26OctOber 2011

2424

F I N - Q

1. Which type of Bond Auction is followed by Government in India?

2. When a stock market seems highly oversold and there is a sudden spike thenext day as people cover positions, this is called a _______

3. What will be the effect on interest rate given the tax collected by Govt. ex-ceeds the expectation?

4. Which type of risk is involved while trading Govt. Bond?

5. You are a trader. The stock market is going up and you figured out that FIIsare buying stocks. What should be your trading strategy in Forex in terms of Dollar?

6. Spot Date: Jul 7, Spot - 46.70/73, Sp Jul - 18/21.A customer wants to sell dol-lars forward for July15, 2011. What will be the rate if the bank charges a 2 paisamargin?

7. A floating rate bond where the principal is repaid over time is called_______

8. Given that the closing Market Price of Wipro is Rs 400, if Wipro were to an-nounce a bonus of 1:1, what will be the stock price of Wipro in the market, all otherfactors remaining constant?

9. Which part of the office (back, middle or front) is concerned with giving buyor sell recommendations?

10. Monitoring the corporate actions and collecting results of the same is theactivity done by Custodians. (True or False)

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