DECEMBER 2012

THE FINANCIAL

COVER STORY: INFLATION VS GROWTH

The Financial December 2012

FROM THE EDITORS DESK

Dear Readers, Coexistence. This is what the world is all about. Good cannot exist without evil. The cover page, Yin Yang, signifies the same. Therefore, for the world to work smoothly, there has to be a balance between the coexisting entities. Similarly, inflation and growth coexist; for any economy to develop, there has to be a perfect balance between them. This issue of The Financial tries to instigate a similar line of thought. The Financial continues to evolve and it has received an overwhelming response this time. We are happy to bring to you, with this issue, a magazine with several new sections that will grow into a repository of original content and opinion from the Finance Cell at NMIMS. Keeping with this theme of change, The Financial, in this issue, explores the highs and lows that the economy seems to have confronted in its journey. In this issue, we have delved into the issue of Growth versus Inflation. The perspectives put forward by the budding managers from across the B-schools are sure to give a new dimension and importance to this issue. We have also tried to enlighten the readers about the implications of the fiscal cliff. In addition, the issue also captures many other financial goodies for you to discover! The process of evolution of The Financial will see a deliberate attempt from Finomenon, the finance cell to involve the readers as much as possible. The aim this time is not to have an article end with its last word in the magazine but to take it beyond through comments and discussions. Feel free to contact the writers of each article and discuss their views or to even dispute them! Let us keep it interesting this way. As always, I hope you enjoy this issue! Let us know how you feel about the content. Feel free to contact anyone from the Finance Cell regarding any aspect about the magazine and I promise we will get back to you. Critics, suggestions, requests, and jokes, they are all more than welcome. We thank one and all for their valuable contributions to this magazine and hope you enjoy the articles and also, write back to us. The Financial an interactive magazine and, beyond just a magazine, a two way interactive channel. As we exchange ideas we will evolve and grow to greater heights. So until we meet again next time and while you wait to see what is in store for the next issue, take care and enjoy reading! Komal Poddar

Senior Team Komal Poddar Achal Mittal

Creative and Design Srijan Srivastava Prakash Nishtala Junior Team Akshay Goyal Anirudh Kowtha Debottama Sharma Ellina Rath

Finomenon NMIMS Mumbai All design and artwork are copyright work of Finomenon NMIMS Mumbai

Table of contents
Cover Story: The Growth-Inflation Paradox Revisited GrowthGovernment of India and RBI: An Evolving Relationship Does the 'Buy and Hold' strategy really work amid the current high volatility in equity markets? Expert Speak: Analysis of Fiscal Cliff Quantitative Easing- Not That Easy..!! EasingFaculty Speak: Impact of India -ASEAN Free Trade IndiaSensex in 2013 Due Diligence and the Foreign Corrupt Practices Act Fiscal Cliff Demystified Indian Reforms: Real vs. Reel Growth The Year In Images and Words Prolonged Recession Due to Reduction of Risk Appetite After the 2008 Financial Crisis Implications of FDI in insurance 1 4 8 12 14 18 21 25 29 32 34 36 40

The Growth-Inflation Paradox Revisited

BY DEBOTTAMA SHARMA AND AKSHAY GOYAL, NMIMS MUMBAI
The controversial inflation-growth trade-off has been widely researched upon, both theoretically and empirically since the conception of the Phillips Curve elucidating the negative relation between inflation and the level of unemployment. This was one of the raging debates between the structuralists and monetarists. While the structuralists believed that inflation was a harmless accompaniment of growth, the monetarists saw inflation as a deterrent of economic progress and well-being of a country. The subsequent hypothesis by Friedman and Phelps asserted the absence of a long run Phillips curve relation between the two variables under consideration-growth and inflation. In the present Indian scenario the Inflation Vs Growth debate has assumed renewed importance and significance. In light of the events in the recent past and the visible difference in opinion between the government and the central bank it has become important to take another look at this age old debate. Traditionally, growth has been facilitated by an amalgamation of rising consumption and increasing fiscal deficit. Needless to reiterate, containing the inflation resulting from rising consumption and income levels is one of the main challenges the government is facing today. The first quarter of the year saw the Reserve bank hike interest rates to curb investments thereby temporarily curbing inflation. However this move by the RBI has dampened growth projections for the year 2012-13.More importantly in an economy experiencing a downswing induced by global recessionary factors, the relevance of employment cannot be superseded. According to various sources every percentage fall in economic growth reduces the number of new jobs created by ten million. The severe consequence of this is unemployment of a large section of skilled, educated and trained youth. The socio-political repercussions of such a scenario may be comprehended with further understanding of the social structure established by the constitution of the country. Since the constitution of India asserts the ideology of democratic government and the establishment of a country characterized by the significance of the individuals voice, these repercussions cannot be ignored. The global recession though little late did have a severe impact on the Indian economy, particularly in the then booming information Debottama Das Sharma is a 1st year student of NMIMS,Mumbai (MBA Banking Management). She has graduated in Economics Honours from St.Xaviers college, Kolkata in the year 2012. Email ID: debottama@gmail.com

C O V E R S T O R Y

Akshay Goyal is a 1st year MBA student at NMIMS. He has an engineering background and loves to write and sketch in his free time. Email ID: akshaygoyalonline@gma il.com

technology sector which operated majorly in collaboration with giant Multinational Corporations headquartered in the Western countries. The feedback effect of this situation was a huge number of lay-offs and a decline in the pay-rolls of the employees. A large section of unsatisfied youth may prove to be a deterrent in the social well-being of a country. Internal security problems triggered by the preponderance of a Maoist ideology may be a matter of concern in such a scenario. The thriving of antigovernment entities may be a probable consequence that the government would want to avoid at any cost. Even for the well being of the country the possibility of civil strife should be completely mitigated. The concept of inflation has traditionally been assumed as a major reason for instability in a countrys economy. The plausible reason behind this is the further disparity it creates in the purchasing power of goods. The relevance of this issue is heightened in an economy like that of India which is characterized by widespread economic inequity and disparity. The worst sufferers in an economy characterized by high inflation are the poorest in the society. The twelfth five year plan has stressed the importance of inclusive growth in the present scenario. In such a backdrop the costs of inflation seem to be magnified further. Allowing rising inflation would be hypocritical on part of the government post the endorsement of the idea of financial inclusion. The RBIs recent step of keeping the reserve ratios and interest rates largely unchanged indicates the Central Banks concern to curb inflation. The decision was received with skepticism by the finance ministry and the banks as it wouldnt help the investment climate in any way. The reasons for this can be easily comprehended. The Indian economy has suffered recently due to the Euro crisis and the downswing in the American economy curbing exports and inflow of capital for investments. The encouragement of growth has therefore assumed great relevance at this point. The difficulty remains in solving the paradox where growth can be facilitated with minimum rise in inflation. The financial reforms implemented in the early 1990s introduced the idea of growth stemmed from

trade liberalization. The change in the FDI policies created a thriving environment for growth. More importantly, the experience of that period showed that the resultant effect on inflation was minimal as compared to growth triggered from increased consumption or investment. The exhibit indicates that growth and lowering of inflation took place hand in hand post the implementation of the reforms in the early nineties. Paul Krugman, in an influential paper in 1990 stressed the relevance of trade liberalization for developing countries like India, Bangladesh and Sri Lanka. Firstly, developing countries have production patterns that are skewed towards labor intensive service, agriculture and manufacturing. People have low per capita incomes and markets in such countries are usually small. A liberalized trade regime allows low-cost producers to expand their output well beyond that demanded in the domestic market. Secondly, the open trade regime permits enjoyment of constant returns to scale over a much wider range and finally import substitution regimes normally give bureaucrats considerable discretion either in determining which industries should be encouraged or in allocating scarce foreign exchange in a regime of quantitative restrictions, leading to serious efficiency losses. Another important effect is the stabilization of prices according to the demand of products in the world markets. This is one of the main reasons why growth triggered from an increase in net ex-

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ports actually results in a lower rise in inflation. Understanding the requirements of the present

situation and the consequences of rising inflation, export liberalization is probably going to be one of the best inducers of growth. Encouragement to policies like welcoming of foreign investment in Multi brand retail is going to assist growth with a lower inflationary impact. The present scenario necessitates the encouragement of growth of the economy initiated by immediate reform measures introduced by the government. It is important to minimize the inflationary repercussions resulting from the growth. The government of India has recently thought of a new measure to deal with the problem of increased economic disparity as a result of inflation. It has conceptualized the idea of direct cash transfers to the lowest strata of the economy. This would enable the benefits of growth to undergo what is popularly known in economic terminology as the trickle-down effect where the positive impact of economic growth is transferred to the grassroots of the economy. The facilitation of such a measure will be a challenge to the government given the infrastructural requirements that are brought forward by such a policy. Also, the faults in the Indian administrative setup will be a major barrier to such a policy. The idea of direct cash transfers being carried out without leakages stemmed from corruption is Utopian indeed. The political backlash that may result from unsuccessful or faulty implementation of such a policy is unwarranted. Comprehending the primary focus of the government in the twelfth five year plan as financial inclusion and lowered social and economic inequity, the social implications of inflation should be clearly understood. The impact of inflation is most on the low-

est strata of the society thus defeating the basic idea of financial inclusion. In this regard it becomes important to focus on the significance of mobilization of financial resources at every level of society. This brings us to the widely discussed concept of microfinance. A study conducted in Pakistan in the year 2009(when the country was grappling under inflationary pressure) indicated that inflation could actually prove to be beneficial if there was a sound and strong micro financial structure in place. According to the survey, when the funds obtained from microfinance institutions are used for business or profit making purposes, inflation could actually be used positively by the economically downtrodden. The small scale farmers, manufacturers seem to be the biggest gainers. The small scale handicrafts industries, although may be adversely affected in a situation characterized by high inflation as they cannot fully benefit from the advantages of price rise. Apart from that fast-tracking of infrastructure projects and pending regulatory clearances, with a focus on removing supply-side bottlenecks in areas such as power, transportation and agriculture would boost the growth potential of the Indian economy and contribute towards easing inflationary pressures. The government should ideally focus on the holistic growth and development of the country and allow the Central Bank to take its course of action in terms of monetary policies. It may try and work in harmony with the Central Bank to understand the ideal mix of fiscal and monetary policies that would result in all encompassing growth.

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Government of India and RBI: An Evolving Relationship

BY ASHISH KHARE AND DEEPENDRA KUMAR, MDI

Introduction The nature of functions discharged by the central bank and their relation with the functions discharged by the central government has been debated for a long time. Together the central bank and the central government of a country are responsible for putting the economy on the path of prosperity and success. However, due to the complex nature of the relations between the functions performed by these two entities, there could be instances when central bank and the government are at odds against each other. Since the time India gained freedom, socialist ideas were promoted and the role of government and RBI was to guide the stressed economy. The objective was to promote balanced growth in general and also to take initiatives for the welfare of the people. However, it was not until 1991 that effective economic reforms were introduced in the country which placed India on the path of high economic growth. It is since then that the role of the central bank, that is, the Reserve Bank of India has widened in scope. It is in the light of the developments in the Indian economy after 1991 economic reforms and the major economic events such as the 2008 recession and the Euro zone crisis that we will analyze the relationship of the Reserve Bank of

India with the central government with a focus on their existing relationship. Role of Government The role of government in the economy is to maintain growth and generate employment for the citizens of the country. The government in order to achieve its objectives tries to mould the overall pace of economic activity by maintaining steady growth, high levels of employment and price stability. Role of Central Bank In developing countries central banks play a very important role in not only regulation but also development. RBI in addition to performing the traditional roles of central bank also plays a very important role of development of the country by manipulating monetary policies. The central bank of the country establishes a suitable interest rate structure to manage the investment in the country. The rates also decide the money supply in the market so by changing the rates the central bank manages inflation and growth. Conflict of Monetary policy and Fiscal Policy The conflict between monetary policy and fiscal policy arises because

Deependra Kumar is a first year PGPM student at MDI Gurgaon. He holds a B.E degree in EEE from BIT Mesra and has worked with Oracle India for three years. Email ID: pg12deependra_k@mand evian.com

Ashish Khare is a first year PGPM student at MDI Gurgaon. He is a fresher and holds a B.E degree in ECE from Delhi College of Engineering. Email ID: pg12ashish_k@mandevia n.com

of difference in the goal of Government and the central bank. While the aim of Government is high growth and low unemployment, the main aim of the central bank is economic and price stability. The core issue of the conflict of interest between monetary policy and public debt management lies in the fact that while the objective of minimizing market borrowing cost for the Government generates pressures for keeping interest rates low, compulsions of monetary policy amidst rising inflation expectations may necessitate a tighter monetary policy stance. Therefore, the argument in favour of separating debt management from monetary policy rests on the availability of effective autonomy of the central bank, so that it is able to conduct a completely independent monetary policy even in the face of an expansionary fiscal stance of the government. Sometimes the conflict between the two also arises on using the foreign reserve of the country. While the Government intends to use the reserve to finance its projects, the central bank wants to keep it for the reserve purpose to improve the safety and liquidity. Relation of RBI and Government of India: History Post Independence The role of government after the independence was to guide the economy which was highly stressed. The function of RBI also became diversified as it had to take part in national building. Post independence government triggered the economic growth through large public investment which was facilitated by accommodative monetary and conducive debt management policies. RBI played a crucial role of financing the government debt by monetising and maintaining interest rates artificially low levels so that the cost of borrowing for government remains cheap. By the end of the 1980s a fiscal-monetary-inflation nexus was increasingly becoming evident whereby excessive monetary expansion on account of monetization of fiscal deficit fuelled inflation. Post 1991

After 1991 despite the fact that fiscal compression was on its way and efforts were made by RBI in moderating money supply during the early part of the1990, the continuance of the ad hoc Treasury bill implied that there could not be an immediate check on the monetized deficit. In order to keep check on the unbridled monetisation of fiscal deficit, the first supplement argument between RBI and the Government of India was started in 1994 to set out a system of limit for creation of ad hoc Treasury bill during three years. Later the second supplemental agreement was done in 1997 to completely phase out the treasury ad hoc bills. By 2006, under the provision of FRBM, participation of RBI in primary auctions of government has also been stopped. Post 2008 Recession the relationship Post 2008 recession, Indian economy struggled to keep inflation low, and there were fears that the current high levels of inflation may become the new normal for the Indian economy. To deal with the inflationary pressures, the RBI raised the repo rate by 375 basis points and the CRR ratio by 100 basis points between 2010 and 2011.

Figure 1- Inflation and repo rate trend Despite these actions the inflation continued to remain high. Analysis of the sector composition of growth reveals that the growth moderation during 2008-12 has been driven largely by manufacturing and agriculture sectors. The sources of inflation

during post-crisis period suggest that the increase in inflation was contributed by more than doubling of food price inflation to 11.8 per cent during 2008-12. A major factor from the demand side contributing to the persistence of food price inflation, which caused generalization of inflation and fuelled inflationary expectations, was the sharp increase in rural wages. While RBI was trying to tame the inflation, government on the other hand was trying to prevent the country from recession by giving many benefits to the mass to increase consumption and hence increase the growth. The difference in the goal of the two entities has recently become public when Government asked RBI to reduce the interest rates so that the growth is not hampered due to the monetary policy. Figure 2- Growth and repo rate trend

fiscal policy is more effective during such times because government doesnt need to promise anything past the crisis but it becomes difficult for the government to sell such an idea. There are limitations to both kind of policies and hence it became all the more important for both government and central bank to hold hand in hand. The strategy best suited was to campaign on both the fronts of the policies and that is what is implemented in US. While the government is ensuring that austerity is bad, the fed is ensuring the investors that the rates will not be hiked until they see high level of inflation. Conclusion As much as we try to blame cost push being the prime factor behind this persistent inflation , there is a growing need to realize the fact that a sound fiscal situation ensures that inflation is contained . A country which has strong fiscal fundamentals hardly finds itself struggling to keep inflation low. What also needs to be realized that even if the monetary policy framed by the Reserve bank of India is set to keep the current levels of inflation low and the fiscal policy aims to reduce revenue collection from people through reduced tax collections, money financing will eventually be required by the central government. This will mean a dependence on borrowing and hence an upward push on the borrowing costs for the government leading to higher inflation once again. Hence it is of great importance for the both the monetary and fiscal policy to be in tandem with each other. It is in this context today that the RBI and the central government are in a conflict with each other. There are concerns about the lower expected GDP growth rate by the GOI and the RBI is concerned about the persistently higher inflation. An important area of focus today thus has been the containment of the fiscal deficit. If we look at the RBI claims, it wants the government to reduce its expenses on subsidies rather than increasing the taxes so as to contain the fiscal deficit. A deteriorating fiscal situation has also posed dangers of credit rating downgrade from the credit rating agencies. This will have direct implications on the investor
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A look at the US Economy: Relation of Government and Federal Reserve The low growth in USA is the major concern for both government and the central bank. The grave problem of liquidity trap is on the verge and a good mix of fiscal and monetary policy is what is needed in this case. While the central bank has kept the interest rates low the growth targets are still not achieved. Central bank needs to ensure that the rate will be kept low past the crisis. On the other hand

confidence and will pose a big threat to putting the economy back on the trajectory of higher growth. The government has responded to this situation by showing firm resolve to improve the fiscal situation through a number of policy initiatives. However the government blames RBI for playing it safe by not reducing the lending rates and only altering the CRR rate in the some of the recent monetary policy reviews. However, RBI has its own problems which have forced it to maintain a tighter monetary policy. The depreciating rupee, euro zone crisis, rising oil prices have forced RBI to keep the interest rates high. As much as it appears that It will help to contain the inflation we see that the food inflation has remained more or less the same level. This is because of the fact that RBI is trying to control inflation by focusing on demand push inflation whereas the current inflation levels have a lot to do with the cost push inflation. Thus RBI policy is going wrong here and hence needs corrective actions. However the fact

that the rupee has undergone serious devaluation over the course of past one year and the oil prices have remained stubbornly high, lowering interest rates poses risks of worsening this situation. It is thus important for both the RBI and the central government to work in accordance with each other. Rule based fiscal policy by the central government will become increasingly important to afford the space for monetary policy to contribute to macroeconomic stability. Fiscal prudence by the central government to alleviate resource constraints by boosting domestic saving will be crucial for raising domestic investment rate. In addition to this RBI will also have to take certain strong measures to infuse more liquidity into the system by lowering the interest rates keeping in mind the fact that the major cause for high inflation has not been the demand push inflation. The quicker this important realization occurs to both the central and the Reserve Bank of India; quicker will be the improvement in the Indias growth prospects and between the relationships of the central government with the RBI.

Courtesy: Akshay Goyal NMIMS, Mumbai

Does the 'Buy and Hold' strategy really work amid the current high volatility in equity markets?
BY CHAITANYA GANDHI, JBIMS MUMBAI
Higher the Risk, Higher the Return has been the motto of all the business across the globe since time immemorial. The Equity Markets have been the personified version of this motto. Various strategies have been developed by the most elite and erudite of the investors to succeed in this high risk avenue. The most popular and well accepted is the Buy and Hold strategy or the Long-term Investment Strategy. Choosing a good company for the portfolio will make a difference to the profits but holding the same for decades shall make the profits mammoth sized as compared to trading it every day. Even the uncrowned emperor of stock markets, Warren Buffett relies on a Buy and Hold strategy for investments and it can be said that as an investment strategy, its one of the most optimum options one has for increasing the wealth over the long term, in almost every situation. Warren Buffett is listed on the Forbes 2012 Worlds Billionaire List as the third -richest man in the entire world. However, as per John Melloy in his blog at CNBC, the Buy and Hold Strategy has taken a fair amount of beating in the recent times. As per the blog, it is the mainly the high frequency traders that make the money in the world. As per the analyst Alan Newmans Crosscurrents newsletter, the average holding period of stocks has fallen from four years in the period 1926 1999 to 3.2 months now and the same for S&P 500 SPDR (SPY), the ETF which tracks the benchmark for U.S. stocks, is less than five days! Given recent average volume, the SPY trades its entire capitalization and then some each and every week, wrote the analyst. Does anyone really wish to argue where valuation m i g ht enter the picture in this scenario? Va lu e does not matter in t h e slightest. This dissertat ion aims to have an expression on whether the annulment of the Buy and Hold Strategy has really taken place? It is done vide: 1. Understanding the Buy and Hold Strategy, its advantages and disadvantages. 2. Analysing the top indices across the world for the last ten years
Chaitanya Gandhi is a finance enthusiast. Along with working at Ernst and Young, he has completed his Masters in Commerce from Mumbai University and is a qualified Chartered Accountant. He is currently pursuing his first year of MMS at JBIMS. Email ID: chaitanyagandhi14@jbims. edu

3. Concluding on the invalidity of the long term investment strategy in such volatile times or otherwise. What is Buy and Hold? Investment Strategies are the various rules, behaviours or procedures designed and used by various investors for stock selection and forming a portfolio. The investors design strategies as per their risk appetite and try to achieve a risk-return trade-off. Buy and Hold is a long-term investment strategy based on the view that in the long run, financial markets give a good rate of return irrespective of periods of volatility or decline. Also, it advocates that shortterm market timing, i.e. the phenomenon that one can enter the market on the lows and exit on the highs, doesnt work. Moreover, attempting market timing gives adverse results, at least for small-sized or unsophisticated investors. Hence, it is far better for them to follow the Buy and Hold Strategy. The theory behind the Buy and Hold strategy is It's impossible to consistently achieve above average returns, on a risk-adjusted basis, according to the efficient market hypothesis (EMH). Investors have access to information that will fairly value a security at all times. Therefore, it is pointless to make decisions that might result in the active trading of a security. Hence the disciples of Buy and Hold find no reason to trade in stocks on a day-to-day basis. The only area of focus is that the long term trend in the market should be a positive. The antithesis of buyand-hold is the concept of intra-day trading, in which money can be made in the short-term taking advantage of greater volatility. Choosing good companies makes a difference to your profits, but holding stock for decades will offer better results on an average rather than attempting to day trade without in-depth knowledge and analysis of the market. There are several advantages of Buy and Hold Strategy: 1. Easily Comprehendible and Implementable 2. Supported by Investment Theory 3. Reinforces the Minimum Emotions Maximum Discipline approach 4. Outperformance of the Passive Investing over Active Investing 5. Cost-Effective as compared to Active Trading

The disadvantages of Buy and Hold Strategy: 1. No upper limit to losses 2. Test of Risk Appetite Investors may lose if they dont have sufficient risk appetite 3. Buy and Hold Approach may not provide Maximum Possible Returns as much as in Minute to Minute approach Performance of various indices across world The best way to take a call on the effectiveness of the strategy is to look at the historical results. For this, a sample of the top ten indices of the world is taken into consideration. Following are the performances of the various top indices of the world.

As can be seen from the above chart, most of the top indices have shown a low return over the ten year period with spikes in between. In fact the Tokyo Index - Nikkei 225 has given a negative return of 17%, which means that a person invested in Nikkei keeping a Buy and Hold Strategy in mind for ten years would have lost 17% of his investment instead of gaining anything. The mean return (arithmetic mean) and standard deviation of the yearly returns achieved by these indices are shows in the adjacent table. The mean returns of the samples taken into consideration show that the average yearly return is below 10% in most of the cases. Also, the high rate of standard deviation shows that there is a lot of volatility in the market and this makes the investments high on risk factor as well. Table 2 enlists the five-year and ten-year returns of the indices. As can be seen from the table, there is a disparity in the performance of the indices. Some of the indices have given exceptional returns over the years as high as 534% over ten years, whereas others

have others have given a return of around 20% for the same period. The negative returns in the fiveyear period 2007-Nov, 2012 has offset the gains earned in the five-year period 2001-2006 due to which the ten-year returns are not very impressive (other than BSE 30 Index and Mexican IPC Index). To gain a better understanding of the long-term returns, the year on year returns for the period 2001 to November, 2012 (current) need to be analysed. Table 3 shows that the returns on various indices of the world have been more or less on a positive trend; the only exceptions are the massive fall in the years 2002, 2008 and 2011. Conclusion As can be inferred from the above chart and tables, there is a consistent amount of returns offered by indices over a period of time which is subject to certain steep falls owing to occurrence of certain big ticket events. As can be seen, there has been a fall in 2002 (Dot-Com Bubble Burst), 2008 (Sub-Prime

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Crisis) and 2011 (Curb of Quantitative Easing). Barring these years, the indices have earned a good return of investment considerably higher than the giltedged investments. This proves that the Buy and Hold strategy still holds true provided its tweaked a little. One needs to decide the period for which the investments need to be held as the Long in the long-term investments is not a thumb rule figure. For this it is suggested to introduce periodic review of investments along with the strategy. The review need not be on a daily basis which makes it as good as trading but over a longer period sufficient to detect any event which is affecting or may affect the investment in a hugely adverse way. The periodicity of review is basically dependant on the risk of the portfolio. Higher the risk, more often should it be reviewed. There are two types of risks, namely the systematic risk and the unsystematic risks. An unsystematic risk is a company specific risk and it is inherent in every different investment at a varying level. It is a company specific risk and hence can be minimised using proper diversification,

whereas the systematic risks cannot be reduced in the same way. The systematic risks are the ones external to the company like inflation, high unemployment, political turmoil, wars, natural disasters, and so on. The systematic risks are the events which can cause excessive volatility in the markets and hence the investor should keep a keen watch on them. Systematic risks are measured using the Beta Factor (CAPM Theory) for a particular investment. This factor is available in various investment journals. Portfolio beta must be used in order to determine the periodicity of monitoring the investment while following this strategy. This will ensure that the investor assesses the investment as and when required and take a sound strategic decision when the time demands. The traditional Buy and Hold strategy has traditionally given returns shall hold for the years to come, but as time progresses and volatility increases newer ways shall have to be discovered to keep tweaking the strategy to the right curve so that the investor profitability continues.

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ANALYSIS OF FISCAL CLIFF

BY AVIRAL GUPTA, INDIABULLS FUNDS MANAGER
Hundreds of billions in tax increases and automatic spending cuts come into effect in the United States as soon as the final moments of 2012 tick away. Lawmakers in the US are scrambling to reach an accord on this 'fiscal cliff', which if doesn't happen is expected to drag the world's largest economy into recession, taking along with it several other major economies around the world. Tonight, on December 28, US President Barack Obama and Congressional leaders will be meeting for the first time since November with no sign of progress in resolving their differences. Will the US go over the fiscal cliff? That's the big question staring at economists even as the stock markets around the world trade with caution on cues from the US Congress. Here are five facts on what 'fiscal cliff' means for the US and the world economy, and how it can be averted: 1. The low tax rate regime enacted under Republican President George W Bush on a temporary basis and extended in 2010 under the Obama administration expires starting January 1. This will have an impact on ordinary working Americans who will have to pay about 2 per cent more in income tax. The taxes on an individual's investment will also get increased, which includes capital gains and dividends. The New Year will see the return of caps on personal exemptions and itemized deductions for upper-income taxpayers. All this had come to an end during Bush era. 2. More than two million unemployed Americans won't be receiving the US government's unemployment insurance. Figures suggest that about two lakhs of these unemployed reside in New York. The US unemployment rate stood at 7.7 per cent in November, according to Labor Department figures, and if the economy slips into a recession, the rate is expected to stand at a very worrying 9.1 per cent. 3. Avoiding a fiscal cliff will mean extending the Bush-era tax cuts. Mr. Obama is not expected to budge on this as far as imposing of higher taxes on rich Americans is concerned. Even if the rich are taxed more, fiscal can be avoided by just extending Bushera tax cuts for some months, if not all through 2013. 4. Americans blame the Republicans, who are the opposition in the US Congress, more than Democrats (led by President Barack Obama) for the "fiscal cliff" crisis, a recent Reuters poll has shown. When asked who they believed to be more responsible for the fiscal cliff situation, 27 per cent blamed Republicans in Congress, 16 per cent blamed Mr. Aviral Gupta has over 10 years of extensive performance oriented experience in funds management & equity research for Indian Equity Markets with domestic as well as foreign institutional investors. Besides, he has also set up domestic as well as offshore investment s truc tu re s a nd mandates for Indian Equities. Mr. Aviral Gupta is currently the fund manager of Indiabulls Mutual Fund. He is a B.E from IIT Kanpur and a CFA.

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Obama and 6 per cent pointed to Democrats in Congress. The largest percentage - 31 per cent - blamed "all of the above". On the posi -tive side, 67 per cent of Americans polled in the online survey said the impending fiscal cliff was not affecting their holiday spending. 5. Lawmakers are now looking at the period immediately after the December 31 deadline to come

up with a retroactive fix to alleviate the impact of the return to higher tax regime. If Friday's meeting fails to arrive at a deal, lawmakers would come back in January and take a more politically palatable vote on cutting some of the tax rates.

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Quantitative Easing- Not That Easy!

BY VIBHU GANGAL, SCMHRD PUNE
With growing inability of traditional monetary tools, QE has been a preferred weapon to fight out dry economies. However, whether pouring in billions of dollars into the market via indirect measures spurs the economy in desired direction in long run is indeed a billion dollar question! Is it sufficient just to have more money into the system? Isnt it also necessary for the central-banks to route money so that it gets utilized for the intended purposes specifically? The critique looks at scenarios, frequency, ways and the aftereffects when QE has been implemented in different economies. Since the use of these unconventional monetary tools has been recent and infrequent, not many instances proving the degree of effectiveness of QE are available. However, in consonance with the past consequences of easing events and recent economic developments, the exposition tries to extrapolate the implications of easing process to accomplish a stand on whether QE is a boon or a curse for an economy. The prime reason behind enforcing easing is to make the institutions and banks available with sufficient liquid money which can be used for lending purposes, thereby prompting more investments and a higher growth in production eventually. drilling the concept down to its root, observe that under QE, no new money is printed here. This means that easing is a means just to divert the flow of liquid money in the economy from one destination to the other. Thus, the main concern here is to decide: 1. What is the current base of this liquid money from where it needs to be hived off? 2. Where this money needs to be routed to? 3. How shall the diversion of this money be carried out? A miss on any of the three tabs is capable enough to ruin the whole plot of digressing money to the right front. For instance, if the idea is to divert the investment of money from risk less assets like government/ treasury bonds to risky assets like shares then the central bank credits the bond holders account with equivalent money for the bonds purchased. The investors who sell securities to the central bank then take the proceeds and buy other assets, raising their prices. Lower bond yields encourage borrowing; higher equity prices raise consumption; both help investment and boost demand. Depending on the degree that investors
Vibhu Gangal student of SCMHRD, Pune and has been writing many analytical articles, related to Macroeconomics, exchange rates and fina nc ia l s ta temen t analyses of different companies, published in va r ious fina nce magazines. Email ID: vibhu_gangal@scmhrd.edu

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add foreign assets, portfolio rebalancing also weakens the domestic currency, helping exports to generate more returns. Unfortunately the timing of this sort of easing in India has not been escorted with changes which could make the most of the easing effect. For example, given the fact that about 70% of Indian exports is un-hedged, OMOs in India could be scheduled around the time when seasonal exports are at peak and foreign assets appear attractive to investors than risky assets in India. Finding a juncture of these three events is not a rare event in present time. This shall serve two purposes at the same time - narrowing down the current account deficit (though temporarily), and the main purpose of diverting money away from the risk-less securities. These consequences, even if have a hideous negative; shall not impact the economy in long run since the laws of demand and supply shall take effect and bring it back to its original state. Another rationale behind Quantitative easing might be the requirement to boost investment by lowering the interest rates especially when credit channels are bunged. This, as the Federal Reserve was doing as a part of its earlier rounds of Quantitative easing, comprised of purchasing mortgage-backed securities, demand for which had weakened sharply during the financial crisis. To meet the reduced demand with reduced supply, increasing prices and lowering interest rates was a short-term technique, which found no relevance in present times since the credit channels have eased to quite an extent. If the idea is to route the liquid money to productive assets and long term investments then an anticipated spoke in the wheel and a major challenge is the glittering yellow metal which has seen substantial increases whenever QE has been launched. In the course of the first round of quantitative easing in the US, which ran from November 2008 to March 2010, gold prices rallied by a third. During QE2, between November 2010 and March 2011, they rose by another 17 percent. With a high volatility in currency markets, investors are likely to seek shelter in gold. This effect, if seen in India, shall be devastating for imports as India being the largest importer of Gold, will experience the worst of the implications related to rupee depreciation. In light of this important concern of routing the money released to an appropriate base, its interesting

to see what US and India have been doing for the past few months at different deemed necessary levels. This is mainly due to two highlights of the QE process: First and foremost, in case of India where the WPI (whole sale price index) is at 7.55%, CPI (consumer price index) at 10.36% and entrench spraying monetary gasoline on an incipient inflation fire. This is because; the added one-year forward inflation expectations at 12.5%, OMOs or quantitative easing is akin to additional money influx in the economy should flow to quench investment demand rather than fuelling consumer spending. So, how does the central bank ensure that the water in the village is used in the farms and not for domestic house-hold usage? Secondly, an observation worth noting is that in India, during 2011-12, of the Rs 1,27,000crore bonds purchased Rs 1,02,000 crore was of 7-13 year maturity. In FY 2012-13, of the Rs 55,000 crore of bonds purchased Rs 42,000 crore is in the 7-13 year maturity. If the reason for buying these bonds is to create primary liquidity the same could have been met through buying bonds of short maturity or conducting term repos of 3-6 month maturity with the market. Then why is it that the government is infusing liquidity only through long term securities? The answer to these two questions lies in the third round of QE by the US. This phase comprises of two parts. Under the first part, the government shall continue to purchase mortgage backed securities for $40 billion per month with no clear timeline when it will end. As discussed, this shall most probably cause prices to inflate. The current inflation rate in the US is around 2%. Just as a higher inflation rate indicates problems for an economy, a lower inflation rate can also be a sign of danger because if the inflation if primarily demand driven and not the one pushed by costs, an excessively stumped inflation indicates a drought of demand, i.e. a low purchasing power which in turn means a narrowed scope for growth. Why would not the Fed in US want this equation to

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invert? As it appears to me, this leg of the third round of QE corresponds to routing more money towards consumption demand than it is right now. Under the second part, famously known as operation twist, is an initiative of buying longer-term treasuries and simultaneously selling some of the shorter-dated issues the central bank already holds in order to bring down long-term interest rates. The idea is that by purchasing longer-term bonds, the Fed can help drive prices up and yields down (since prices and yields move in opposite directions). At the same time, selling shorter-term bonds should cause their yields to go up (since their prices would fall). The program gets its name from the fact that in combination, these two actions twist the shape of the yield curve. A same phenomenon is apparent in the Indian case too. The fact that the government has been infusing liquidity only through long term securities is evident from this figure of Yield curve. Observe that in the figure, the 10 year bond yields have lowered by about 2%. The rationSource: ET ale behind doing this is that lower longer-term yields would goose the economy by making loans less expensive for those looking to

investment demands. A point to be noted here is that India, on the other hand cannot go for the first part of the QE program since inflation in India is high and secondly is mainly pushed by costs. So, at its own deemed necessary level, India plays the game only with the second leg of QE, i.e. a program on similar lines of operation twist, though not exactly same as that. Having seen the different implications and various ways in which QE can be executed, the billion dollar question is that does pouring in billions of dollars into the market via these indirect measures really spurs the economy in the desired direction in long run? How long can we bank upon these ancillary measures? The need of the hour in both Indian and the American economies is to overcome the structural deficiencies impeding investments. By easing credits, one can push investments only when the fundamental platform for investing is paved with a strong foundation. Bureaucratic hurdles in India, a dense spiral of corruption and long sanctioning procedures are faced by an aspirant businessman before he/she raises money. So, how much ever low are the interest rates, if a person is entangled in these steeplechases, how does it make investments easy? How does it create jobs? And how does it prompt growth? So, the answer to the question, whether quantitative easing is a key step to an economys success is a bit difficult to be answered up-front. Quantitative easing is surely a blessing, a boon when the structure in the economy is at place. It can create leverage effects where a gentle turn-around of just a few purchases of bonds can makeover the face of the economy. However, easing in isolation, not being completed

buy homes purchase cars finance projects.

This leg of the QE phase three in US is to route the money to satisfy the investment demand of the economy. Together this two-pronged strategy has been framed by the Fed to fortify the flow of money to the pillar components of economy i.e. consumption and

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with appropriate channels to settle the money diverted shall end the whole effort in smoke. Easing is not a means to create additional money, easing is not a means to absorb; easing is just a means to re-route the money from one base to the

other, and so along with this re-routing, if the economy is architecturally and structurally incapable to create money and operationally incompetent to absorb money at the right time, easing alone cannot create wonders.

crossword

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Impact of India-ASEAN Free Trade Agreement

BY DR. CHANDRIMA SIKDAR, ASSOCIATE PROFESSOR AT NMIMS
While India at present has been talking ad infinitum about FDI in various sectors, another event of utmost importance, the 1oth ASEAN-India summit held on November 19, 2012, failed to catch attention of hoi polloi. In the wake of such a time, Team Finomenon makes an attempt to bring forth this hugely forgotten phenomenon through our Faculty Speaks section. The following is a summarized version of the research paper published by Dr. Chandrima Sikdar, Associate Professor, NMIMS, Mumbai along with Dr. Biswajit Nag, Associate Professor, IIFT Delhi. India announced its Look East policy in 1991 in an attempt to increase its engagement with the East Asian countries. Consequently, in 1992, it became a sectoral dialogue partner of the Association of Southeast Asian Nations (ASEAN). ASEAN, which is a geo-political and economic organization with 10 member countries, was formed in August 1967 by Indonesia, Malaysia, the Philippines, Singapore and Thailand. Since then, the membership has expanded to include Brunei, Darussalam, Cambodia, the Lao Peoples Democratic Republic, Myanmar and Vietnam. ASEANs objectives are to accelerate economic growth, social progress and cultural development among its members, protect the peace and stability of the region, and provide opportunities for the member countries to discuss their differences peacefully. Negotiations on a trade in goods agreement between India and ASEAN were started in March 2004. The negotiations continued for six years and finally the India-ASEAN Free Trade Agreement (AIFTA) was signed on 13 August 2009 in Bangkok. AIFTA promises to boost bilateral trade between the two regions. ASEAN is a major trading partner of India. The FTA will lead to the elimination of tariffs on some 4,000 products including electronics, chemicals, machinery and textiles. Of these 4,000 products, 3,200 products will have duties reduced by the end of 2013, while duties on the remaining 800 products will be lowered to zero or almost zero by the end of 2016. The net effect of the trade agreement crucially depends on the ability of the Government of India to redistribute some of the increased wealth gained from this trade agreement to those industries negatively affected by the agreement.
An M. Phil & PhD in Economics from Jadavpur University, Kolkata, she started her career as a faculty (Economics) with BES college under Calcutta University. She has been faculty with reputed business schools across India since 2004. Alongside teaching she has been a full time researcher. She is expert in trade modeling and has b e e n w or ki n g o n international trade issues since 1997. Dr. Sikdar completed several studies on behalf of Ministry of Commerce, Govt. of India and for United Nations Asia- Pacific Research and Training Network on Trade (ARTNeT).

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Impact on select macroeconomic and trade variables of India and ASEAN region As far as the selected macroeconomic indicators of GDP, employment and average prices are concerned, Indias gains are virtually none whether there is complete tariff elimination (full liberalization) or tariff changes as per tariff commitments of the countries (as in the current or ultimate scenarios). Under full liberalization, Malaysia, Singapore, Thailand and the rest of ASEAN are better off. Singapore and Malaysia gain the maximum benefit. Among the smaller countries, Cambodia is the most adversely affected while Myanmar, Vietnam and Indonesia experience considerable positive impact. In the current scenario, the same three ASEAN countries benefit substantially, with Singapore and Malaysia gaining the most. In the ultimate scenario, Singapore still gains notably among all the ASEAN countries. Welfare implications of the FTA for India and the ASEAN region FTA implementation under both the current and ultimate scenarios will result in India and some of the smaller ASEAN countries (i.e., Cambodia, the Lao Peoples Democratic Republic and the Philippines) incurring welfare losses. While the loss for India is due to negative terms of trade, for Cambodia and the Lao Peoples Democratic Republic the loss is due to both allocative inefficiency and the negative terms of trade effect. The Philippines experiences some gain from increased allocative efficiency but the negative terms of trade effect is relatively stronger. For other ASEAN countries, the terms of trade effect is positive and stronger, resulting in large welfare gains. For India, the welfare position improves with the expansion of the trade liberalization process, both with regard to the number of ASEAN countries with which its trade is liberalized as well as the number of products for which tariffs are lowered or eliminated. However, although total welfare improves, the terms of trade for India continue to be negative, resulting in the lowering of its GDP in all three trade liberalization scenarios. Therefore, the import and export prices of India following FTA implementation need to be given more attention.

Impact on bilateral trade between India and ASEAN In summary, following implementation of the FTA, bilateral trade between India and ASEAN increases phenomenally. While Cambodia, Indonesia, the Lao Peoples Democratic Republic, the Philippines and Viet Nam provide additional markets for almost all Indian exports, Malaysia, Singapore and Thailand provide markets for some of the fastest growing exports from India. Malaysia, Thailand and Viet Nam become major importers of Indian goods in terms of total exports by that country to ASEAN. They also provide markets for the fastest growing items exported by India. In particular, Thailand consistently provides a large market for Indian products under all three scenarios. The increase in Indias imports from ASEAN is due to increased exports by Indonesia, Malaysia, the Philippines, Singapore, Thailand and Viet Nam, plus the rest of ASEAN. These countries also supply the items that register the largest increases in Indias imports from ASEAN following the implementation of the FTA. Impact on India Indias welfare gain appears to be negative at the initial stage due to both negative allocative efficiency and negative terms of trade. The loss in allocative efficiency is due to a loss of import tax resulting from tariff reduction/elimination, while the negative terms of trade is explained by a larger fall in Indias export prices relative to its import prices. However, the country's welfare improves as liberalization expands and the markets of the rest of ASEAN open up substantially. Impact on ASEAN countries Malaysia, Singapore and Thailand experience positive welfare gains, with the largest gain accruing to Singapore. This is due to the fact that Singapores schedule of tariff commitments only comprises six items; as such, the FTA is tantamount to a unilateral liberalization by India for Singapore. These countries gain substantial market access in India, with Thailand experiencing the largest increase. Malaysia enjoys the largest welfare gain if there is full liberalization. The other countries, except Cambodia, the Lao Peoples Democratic Republic and the Philippines, enjoy positive welfare. The gains accruing to
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all these countries are due to large positive terms of trade gain. This is because the prices of their exports to India fall much less than Indias export prices to their markets. This is explained by their relatively smaller market sizes compared to the Indian market. The welfare losses experienced by Cambodia, the the Lao Peoples Democratic Republic and the Philippines are also due to large negative terms of trade. Trade impact on other countries of the world In general, the India-ASEAN FTA is likely to provide many of the desired results for the countries involved, i.e., improved welfare for most of the countries, increased trade engagement, better market access in the partner country and, to a large extent, trade diversion in the India-ASEAN region. However, the relatively larger ASEAN members will derive more benefits in terms of GDP and welfare growth. India is expected to enjoy higher benefits only when the agreement has been fully implemented. Indias exports to smaller ASEAN markets

are expected to grow faster as the agreement enters its final stage. ASEAN members will gain from a higher Terms-ofTrade (ToT) effect while Indias gain will mainly be from resource reallocation and change in domestic production activities reflected through allocative efficiency. Indias import demand for several intermediate goods will remain high and ASEAN will have the advantage of supplying such goods at higher prices that are still lower than the average prevailing import prices in India. (This article is an excerpt of the original research paper Impact of India-ASEAN Free Trade Agreement: A cross-country analysis using applied general equilibrium modelling by Dr. Chandrima Sikdar and Dr. Biswajit Nag. This research paper is Asia-Pacific research & training Network on Trade and Finance ARTNet Working paper series No. 107, November 2011.)

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Sensex in 2013
BY VISHAL PINGALE AND TUSHAR SHARMA, IFMR CHENNAI
"In The Business World, The Rearview Mirror Is Always Clearer Than The Windshield." - Warren Buffett Predicting the movements of stock market has never been easy. As much as we try to analyze and theorize to understand and predict where it is heading, we are always beaten by the vagaries of the game. This is particularly true in Indian context, where the financial markets are more chaotic and the investors come from extremely varied rational and intellectual backgrounds. Nevertheless, an informed observation of the historic trends and the prevailing macroeconomic environment can help in gauging how the Sensex can shape up in the coming year 2013. The SENSEX is an acronym for Sensitivity Index. It was compiled in 1986and is based on the 'Market Capitalization-Weighted' method. It comprises of 30 stocks representing large, well-established and financially sound companies across varied key sectors. The base year of SENSEX is 1978-79 and its base value is set at 100 as on April 1, 1978. Owing to its scientific design, it widely accepted and published barometer of the health of Indian financial markets. Over the past one year, the Sensex has been operating in the 16,000 19,000 range. The year has been characterized by 2 small-term bull runs with a correction thrown in the middle. As on Dec 10,2012 the Sensex is passing through the second upswing which appears in a mood to take the Index above 20,000. In the coming year, we can bet on the Sensex to breach its all-time peak of 21,078 (which it made on Jan 08, 2008). Whether it happens as part of the current Bull Run or the subsequent one is debatable. All the indicators that we consider are pointing towards a bullish year ahead for the Sensex. Some of the key factors which are contributing towards this bullish outlook are: A newfound Political will in the Government to push through reforms. Increased cases of CDRs passing through. Percolating effects of QE3 A major contributing factor to the feel-good factor of Sensex is the investor sentiment. And the investor sentiment is now on a high with hopes that the reforms agenda will finally see the much needed push from the political masters. These reforms saw an inception sometime in September, 2012 in the form of proposals to allow foreign Vishal Pingale is a first year student of PGDM at Institute for Financial Management & Re s e a rc h (IFMR) , Chennai. Email ID: vishal.pingale@ifmr.ac. in

Tushar Sharma is a first year student of PGDM-FE at Institute for Financial Management & Re s e a rc h (IFMR) , Chennai. Email ID: tushar.sharma@ifmr.ac. in

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participation in retail, aviation and broadcast together with some fiscal tightening measures such as reducing fuel subsidies. The spate of restructuring of debts of SECs and waiver of import duties on broadcast together with some fiscal tightening measures such as reducing fuel subsidies. The spate of restructuring of debts of SECs and waiver of import duties on import of machinery for power generation will doubtlessly have a positive impact on power sector a crucial but troubled supply side ingredient of the Indian economy. But concerns still remain over the workability and consistency of the Power Purchase Agreements. Already there have been concerns over another major component of the mix fuel. With mining sector passing through regulatory hurdles, many power plants are facing an artificial fuel shortage. The long gestation periods for Power plants and subsequent delays pose a challenge for the sector as these only make the sector more unviable. The reforms in Pensions and Insurance sectors will increase the liquidity in the markets thus contributing positively to the growth in the coming year. The troubled sectors remain the Airlines, PSU Banks and Real Estate/Infrastructure sectors. With eroding asset qualities and increasing exposure to troubled sectors, PSU banks will face tremendous stress on their operations. Debt restructuring will constantly keep the banks on the run for their money. However, the silver line remains their strong fundamentals and strong adherence to tight regulatory mechanisms, which will ensure no crisis, breaks out in the sector. The allowing of FDI in Airlines sector is still being debated if it will do any good. Intense competition and low margins means that the sector remains low on the radar for global players and foreign investors and with existing players burdened already, the outlook remains bleak for the sector. It is expected however, that the Land Acquisition Bill passed this year will contribute to removing the one biggest bottle-neck associated with the sector and hopefully provide an impetus to fresh investment in the sector. In spite of being a NOT SO BAD YEAR for the markets, a lot of pessimism has still prevailed in the atmosphere. This has been due to:

Threats and instances of credit rating downgrades Poor monsoons Ballooning fiscal deficit Weak IIP growth numbers Global pessimism Uncertainty about FDI in retail

There is now a growing realization among investors that the worst phase of Indian economy is over and economic growth, which had slowed down to a low of 5.5% this year, has started to bottom out. Economies are slowly limping to normalcy globally and there is an expected pick-up in external demand in 2013. With a weakened Rupee Dollar exchange regime, the exports would be perked up. Another major sector, IT, which depends greatly on exports of its services, would be buoyed by such a scenario. There is increasing pressure on Reserve Bank of India (RBI) to cut rates next year, which would go a long way in stimulating economic growth and consumption. Credit Suisse has predicted that a 125 bps cut in interest rates by the RBI will likely push India's growth rate above 7 percent by late-2013.

Fig1. FII Inflows in India Data Source: Hindu Business Line Dt. Nov 30, 2012

Analysts believe that a confluence of liquidity, sentiment, reforms, global cues and geopolitical situation in the Middle East will drive the Sensex further up in the coming year. Indian equities and currency both got a boost from recent measures. The rupee, which had plunged to an all-time low of more than

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57 vis a vis the U.S. dollar on June 22, has since recovered by more than 8 percent, helped partly by these initiated reforms. Also, if everything goes well with the Euro zone, its possible to see the Sensex above 23,000 as compared to the movement shown in 2011. The Index line touches the uptrend line at several points confirming the long term uptrend in the Index. Due to all these reasons, it can be technically inferred that if Sensex continues to move at the same pace we can see the Sensex breaching at least the 22,500 mark if not the target of 23,069 set by Morgan Stanley in their recent report. The lines shown in orange color show the supports and resistances that the Index may have in the near future. The earlier support levels will act as very strong supports in the future. In the near term the market will get a support at 18,200 and a very strong support at 17,300.The chances of the market going below 17,300 (without any economic adversity) are very marginal. On the other hand, the upside potential of the Index is to climb over23,000. Therefore, the downside risk is just of 1,800 to 2,000 points as compared to 3,500-3,700 points of upside potential. The market may face resistances at the earlier resistance levels of 2011 i.e. at levels of 19,800 and 20,550.Once these resistances are broken, these resistance levels will act as supports to the Index. However, there could be a few stumbling blocks ahead too. With disappointing FY13 numbers seen in top-line growth of companies in the BSE, a carryover of weakened earnings in the next year can im-

pede any growth of Sensex. The biggest stumbling block could still be the supply side constraints plaguing the Indian economy, which are holding back India from unleashing its true potential. Problems like a rickety infrastructure, delays in clearances for crucial projects, delays in land acquisition and power and supply-chain woes have had a very bad effect on the companies often affecting their bottom lines too. Any amount of upswing in consumer demand will be unable to perk up the Indian economy unless these constraints are not tided over. Nearing of elections in year 2014 could also tempt the Government to increase its spending on subsidies and finance its other populist measures. These steps can put pressure on the Sensex and bring it back to square one a classic case of one step forwards, and two steps backwards. Many other things still need to be done to assuage the investor sentiment and fire up the Animal Spirits. The reforms so far are just the beginning of a long and painful process. Economic growth, which has slowed to around 5.5% this year, is not going to return to the 9% growth rate experienced a few years back. But the long-term India story stays intact, as long as politics doesnt trump economics. The below figure shows the FII investments into the Indian markets since 2008. FIIs have the financial muscle to move the markets. We saw a recession in 2008, when the FII outflows (coupled with DII and retail investor panic) were to the tune of Rs. 41,216 cr. This was the time when the Sensex tasted levels of 8,000. But, just after experiencing few sluggish

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months in 2009, the Index fired up to reach back to levels of 17,500 by Dec 2009.This was backed by an influx from the FIIs to the tune of RS. 83,424. In the next year i.e. in 2010, the 94,335 cr. investment by the FIIs pulled the Index above the 21,000 level. 2011 saw the Sensex slithering to 15500 levels, when the FII investment was merely Rs. 225 Cr. And, in 2012 the Index has again grasped 19400 levels with a very high cash inflow to the tune of Rs. 101316 cr. (till Nov 30) from the FIIs. This is the second highest inflow since 1993, when India opened the doors to this class of investors. This shows the confidence of the FIIs into the Indian economy, even when the Indian experts werent confident about our economy. FIIs usually invest for long term. So it can be anticipated that the money that has come in will stay in, for at least one more year i.e. until 2013.Also, if the economy does well assisted with the reforms recently initiated by the Indian Government, we can expect the foreign inflows to continue. So, there are very high chances of Sensex breaching 23,000 levels in 2013. We will now have a look at the Index from the technical perspective. From the historical chart of Sensex (in the previous page) ranging from Jan 2011 to December 2012, we can find two strong trends emerging in the Index. The first trend was a downtrend which had started in Jan 11 and lasted for the entire year. During the month of December 2011, just when the markets were at the lowest point of the year, the stock market experts were self-confidently predicting that the markets would fall further to 13,500-14,000. But, fortunately this didnt happen. The Index then picked up in a dramatic fashion backed by the huge FII investment pouring into India in the months of January, February and March. The green color uptrend line shown in the graph makes it pretty evident that the Bull Run of Sensex has started with very strong supports. This uptrend is steered by the huge FII investments coming into the Indian markets. Also, the behavior of the Index in this uptrend is pretty simple without much volatility as compared to the movement shown in 2011. The Index line touches the uptrend line at several points confirming the long term uptrend in the Index. Due to all these reasons, we can infer that if Sensex con-

tinues to move at the same pace we can see the Sensex breaching at least the 22,500 mark if not the target of 23,069 set by Morgan Stanley in their recent report. The lines shown in orange color show the supports and resistances that the Index may have in the near future. The earlier support levels will act as very strong supports in the future. In the near term the market will get a support at 18,200 and a very strong support at 17,300.The chances of the market going below 17,300 (without any economic adversity) are very marginal. On the other hand, the upside potential of the Index is to climb over23,000. Therefore, the downside risk is just of 1,800 to 2,000 points as compared to 3,500-3,700 points of upside potential. The market may face resistances at the earlier resistance levels of 2011 i.e. at levels of 19,800 and 20,550.Once these resistances are broken, these resistance levels will act as supports to the Index. However, there could be a few stumbling blocks ahead too. With disappointing FY13 numbers seen in top-line growth of companies in the BSE, a carryover of weakened earnings in the next year can impede any growth of Sensex. The biggest stumbling block could still be the supply side constraints plaguing the Indian economy, which are holding back India from unleashing its true potential. Problems like a rickety infrastructure, delays in clearances for crucial projects, delays in land acquisition and power and supply-chain woes have had a very bad effect on the companies often affecting their bottom lines too. Any amount of upswing in consumer demand will be unable to perk up the Indian economy unless these constraints are not tided over. Nearing of elections in year 2014 could also tempt the Government to increase its spending on subsidies and finance its other populist measures. These steps can put pressure on the Sensex and bring it back to square one a classic case of one step forwards, and two steps backwards. Many other things still need to be done to assuage the investor sentiment and fire up the Animal Spirits. The reforms so far are just the beginning of a long and painful process. But the long-term India story stays intact, as long as politics doesnt trump economics.

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Due Diligence and the Foreign Corrupt Practices Act

BY ELLINA RATH & PRAKASH NISHTALA, NMIMS MUMBAI
A term that loosely signifies a voluntary investigation refers to an audit carried out of a potential investment. In other words, it is a way of assessing a business opportunity. The very notion behind it is to save any unnecessary harm to both parties involved in a transaction by examining all material aspects to a sale. This includes an examination of the past record, present and a forecast of the business in consideration. In the era of globalization, every Business strives to position itself strategically. This is done through either cross border alliances or mergers & acquisitions. In order to tackle the indispensable uncertainties arising in business, as companies make an attempt to diversify their risks, functionally as well as globally, informed decision becomes an imperative. Peeking into the background, it has its origin in the United States Securities Act of 1933 that followed the Stock market crash of 1929. The law aimed at regulating the sale and offer of securities. Section 11 of the law referred to a clause of Due Diligence that could be referred to in a situation where broker dealers did not practise adequate disclosure of relevant information to the investors or purchasers of securities. Originally practised only for the equity investments through public offerings by broker dealers, it is associated with practically all forums of investment for a business. These range from disinvestments, private equity fund investments, mergers and acquisitions as well as listing of securities in overseas markets. The Process of Due diligence is a multidimensional exercise based broadly on three parameters: Evaluation, Interpretation and Communication. The evaluation and interpretation is not an analysis of accounting nature but a business oriented analysis i.e. includes information on tax, legal and other business aspects of the issuer. This comprises understanding the industry of the target, the business and the environment it operates in. IT also attempts to locate the deal destroyer defects and aim to find mitigating options to them. It can be carried out as per the specifications of the party interested in the information. The classification of the due diligence types can be broadly on two bases. It is largely dependent on the nature of the Transaction and what the entire process of Due Diligence aims to achieve. Nature of Client according to the specifications of the investor or the seller. Nature Of work Limited Scope Vs Full scale i.e. either strictly deals with the part of Ellina Rath is currently a first year student of MBA at SBM,NMIMS. She is a graduate in Economics from Miranda House, Delhi University. She has also completed a PG diploma in International Trade Law from the Indian Law Institute, New Delhi. Email ID: rath.ellina@gmail.com

F I N K N O W L E D G E

Prakash Nishtala is a first year student of MBA at SBM, NMIMS, Mumbai. He holds a B.Tech degree and has 2 ye ars of wo r k experience in IT and Stock Exchange (F & O Segment) Email ID : prnishtala@gmail.com

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the business concerned in the transaction or a comprehensive study of the entire business is undertaken. Process The process of Due Diligence broadly covers the following steps: Presentation/background information by the issuer Sending the issuer a questionnaire Organizing a due diligence team Issuer to create a data room (virtual or physical) Review of documentation/ discussion with management Bring down due diligence questionnaires/calls prior to closing of the transaction Due Diligence in India Due Diligence in India has been brought by the foreign investors and advisers only after the economic reforms took place in 1999. Hence the practice of Due Diligence investigation is relatively recent. However, SEBI guidelines mandate certain parties to carry out Due Diligence when it comes to issuance of securities by a company. Some of the major regulation in the context of Due Diligence is: Regulation 64 of chapter VI of the ICDR regulations The Book running Lead manager ( BRLM) to exercise due diligence in the pre issue of securities and can also call upon the issuer to oblige as per the disclosure made by the latter in the offer document. Regulation 65 -the BRLM is required to submit the post issue document to SEBI along with a due diligence certificate along the prescribed format. Regulation 83- a qualified institutions placement is to be managed by BRLMs registered with SEBI who shall exercise Due Diligence. A Due Diligence certificate by the BRLM is to be furnished to each stock exchange the securities is listed on to certify that the securities are eligible for issue under Qualified Issuers placement. A greater degree of caution is practised and extensive review of compliances is undertaken in case of the listed companies in India. The provisions of SEBI (Prohibition of Insider Trading) Regulations 1992 are applicable in case of the listed company.

This is in regard to the care that has to be taken to avoid any violation of insider trading regulations while practising due diligence. Due Diligence Vs Audit There are some fundamental differences between the practice of due diligence and Audit. While the scope and procedures of Due diligence are agreed upon by the Client, that of the latter is often specific to the GAAS defines procedures in each country. Due diligence does not test the underlying accuracy of the information and includes forecasting about the business. It uses the Audit output and limited access along with a time constraint. The material aspects have to be accordingly taken into account as per the Clients needs. Audit however is backward looking and does not cover the future. It is a financial statement focuses approach and the report is prepared as per the GAAP. It has scheduled time tables and at the same time tests the accuracy of the information given. There are some limitations inherent in the Due Diligence Practice when compared to Auditing. Since it is not an examination of internal controls and is not attested as per the ICAI standards. As is apparent, it has dependency on the target Company in terms of the information and documents provided being genuine. While it seems to be a process that is negative i n approach i.e. raising hurdles to transactions, on the contrary it facilitates transactions by identifying problems and risks associated. It also devises solutions that help in mitigating risks and manage the problems in investments. With the increasing number of penalties being imposed on companies, it becomes imperative for businesses to look at Due Diligence with substantial seriousness. The lack of due diligence by many institutions can lead to transactions that are perceived to be violating the compliance requirements of certain legislations. The Foreign Corrupt Practices Act is one such legislation that needs to be understood as due diligence is closely associated with it.

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Foreign Corrupt Practices Act The Foreign Corrupt Practices Act of 1977 (FCPA) is a United States federal law known primarily for two of its main provisions, one that addresses accounting transparency requirements under the Securities Exchange Act of 1934 and another concerning bribery of foreign officials. The Act is implemented into two parts. The first is generally enforced by the Department of Justice (DOJ) which prohibits U.S. citizens and U.S. firms, or those listed on a U.S. stock exchange, from making and offering to make payments to foreign government officials to obtain, or retain, business or a business advantage. The second is enforced by the Securities and Exchange Commission (SEC) that requires that companies maintain accurate books and records. There is practically no threshold limit to the amount of infractions and even a small bribe monetarily can be termed as a big crime, especially if FCPA problems are systemic. The FCPA makes an attempt to unearth the systemic flaws and often the depth or breadth to which corruption is prevalent within a company is more pertinent under FCPA. Backdrop The U.S. Securities and Exchange Commission carried out investigations in the mid-1970s which resulted in admittance of making questionable or illegal payments in excess of $300 million to foreign government officials, politicians, and political parties by over 400 U.S. companies. The ambit of abuses ranged from bribery of foreign officials to secure favorable action by a foreign government to facilitating payments that were made to ensure that government functionaries discharged certain ministerial or clerical duties. Lockheed scandal was such a case in point in which officials of Lockheed, an aerospace company, bribed foreign officials to promote their company's products. Next in line was the Bananagate scandal in which Chiquita

Brands bribed the President of Honduras to lower taxes. FCPA was enacted to bring a full stop to the bribery of foreign officials and to restore public trust and belief in the integrity of the business system in US. On December 19, 1977, FCPA was signed into law by President Jimmy Carter and amended in 1998 by the International Anti-Bribery Act of 1998 which was designed to implement the anti-bribery conventions of the Organization for Economic Co-operation and Development. India & FCPA India has never been more attractive as a land of business opportunities as it is now. For businesses eager to enter India, compliance with the Foreign Corrupt Practices Act (FCPA) becomes an increasingly important priority as corruption in the country continues to rise and government doing a little to curb the corruption. Moreover, it has now become a regulatory prerequisite to set up businesses in India. Indias propensity for corruption is unmistakable as measured by Transparency Internationals (TI) Corruption Perceptions Index (CPI), which ranks countries from highly clean (10) to highly corrupt (0). Indias 3.4 score makes it prime territory for FCPA violations, not much safer than Russia (2.1) or Nigeria (2.7). When it comes to India, clearly the risk is higher which means that special care should be taken. Indias vast, poorly paid government bureaucracy appears to leverage its power over granting licenses and permits by demanding bribes from those seeking to speed up what can be a long and drawn out process. FCPA Violations in India US company: Dow Chemical Company Indian affiliate- De-Nocil Corporation

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Offence: Paid Indian government officials $200,000 (Rs 1 crore) between 1996 and 2001; one particular officer was given $39,700 (Rs 19.85 lakh) through contractors working for the company who got the extra cash via fictitious bills. Penalty: Dow Chemical was found guilty of violating book-keeping norms related to the above in 2007; Dow agreed to a penalty of $325,000 (Rs 1.62 crore). US company: AT Kearney Indian affiliate: AT Kearney India (ATKI) Offence: Between 2001 and 2003 ATKI paid $720,000 (Rs 3.6 crore) to Indian governmentowned companies on directions of founding President Chandramouli Srinivasan. Penalty: In 2007, ATKI parent EDS was fined $490,902 and Srinivasan $70,000 after the SEC brought in prosecution against them for violating the FCPA. US company: Xerox Corporation Indian affiliate: Xerox Modi Corp (now Xerox India) Offence: Xerox voluntarily disclosed in 2003 improper payments (related to sales to government customers of the companys products) made by Xerox Modi Corp Ltd to Indian government officials. Penalty: Not known US company: Wal-Mart Indian affiliate: Bharti Walmart

Offence: A new set of allegations surfaced against the Indian subsidiarys operations as recent as in November 2012. Way Forward for Companies Operating In India: Clearly, multinational companies preparing to do business in India should be rigorous when it comes to fighting corruption. This can include instituting a culture of FCPA compliance across Indian subsidiaries, affiliates, and alliances by focusing on creating strong due diligence, internal audit departments, and training programs as well as clear policies and procedures. While avoiding FCPA violations can be difficult, for companies doing business in corruption-rich India it can be even more challenging. To be successful in steering clear of potential FCPA violations, companies should implement a firm-wide culture of compliance with effective due diligence, internal audit practices, training and education, and clear policies and procedures along with setting the right culture and tone from the top. Encouraging corporations in the public sector to sign an integrity pact before bidding on government contracts in which all participants including the government, agree not to take or offer bribes or suffer penalties if they do could prove to be a relevant step to curb corruption. Presently, 24 companies, mainly oil and gas, iron and steel, coal and telecom companies have signed such a contract.

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FISCAL CLIFF DEMYSTIFIED

BY SRISHTI SAHU, HINDU COLLEGE, DELHI UNIVERSITY
The Fiscal Cliff is a term which is used to refer to the effect of a number of laws (if unchanged) which could result in an increase in taxes and cuts in spending resulting in a reduction of U.S. Budget Deficit beginning in 2013. It is expected that the budget deficit would roughly reduce to half its value in 2013 if the laws remained unchanged. This sharp reduction in the deficit is the cliff. According to the Congressional Budget Office (CBO), this sudden reduction would probably lead to a recession in early 2013 with the pace of economic activity picking up after 2013. The laws which could lead to fiscal cliff include the expiration of Bush Tax Cuts and planned spending cuts under the Budget Control Act of 2011. The Budget Control Act of 2011 was enacted as a compromise to resolve a dispute regarding the public debt ceiling. Let us begin by explaining what are these Bush Tax Cuts, the Budget Control Act of 2011 and the debt ceiling crisis. The Economic Growth and Tax Rel ie f R eco nc i l i at io n Act o f 2001 (EGTRRA) and the Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA) are together known as the "Bush tax cuts. The Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 is based on a twoyear extension of provisions of these laws. If the Congress had not passed this law, then Income Taxes would have returned to Clinton administration-era rates in 2011. The Act also extends some provisions from the American Recovery and Reinvestment Act of 2009 (ARRA or 'the Stimulus'). The Budget Control Act of 2011 is a federal statute in the United States that was signed into law by the President Barrack Obama. The Act had brought conclusion to the 2011 United States debt ceiling crisis which had threatened United States to lead to sovereign default. The debt ceiling is the maximum amount of borrowing that the United States government should be allowed to undertake. It usually remains the same but the government changes it whenever it is close to hitting it. Hitting the debt ceiling would mean defaulting on interest payments to creditors. The United States debt ceiling crises was a financial crisis in 2011 started as a debate in the United States Congress about increasing the debt ceiling. The crises came to an end when a complex deal was reached which raised the debt ceiling and reduced proposed increases to future government spending. Having understood what the fiscal cliff means, the next big question is Srishti Sahu is currently pursuing undergraduate in Economics at Hindu College, Delhi University. She is very intrigued by the world of finance and likes to make every effort to enhance her domain knowledge by participating in various competitions. Email ID: srishtisahu1993@gmail. com

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 why is everybody so concerned about it and what are its possible effects? The oncoming fiscal cliff is of concern for investors because the highly partisan nature of the current political environment could make the compromise difficult to reach. This is not a new problem since the policymakers had three years to address this issue but Congress had largely put off the search for a solution rather than trying to solve the problem directly. Republicans want to cut spending and avoid raising taxes while Democrats are looking for a solution which is a combination of both spending cuts and tax increases. Although both parties want to avoid the fiscal cliff, a compromise has not been reached yet particularly because of the elections. Due to this indecision, there is already an adverse effect on the economy. As estimated by the CBO, a lack of resolution has caused households and businesses to begin changing their spending in anticipation of the changes, possible reducing GDP before 2012 is even over. Having said this, it's important to keep in mind that while the term cliff indicates an immediate disaster at the beginning of 2013, the impact of the changes - while destructive over a full year - will be gradual at first. What's more, Congress can act to change laws retroactively after the deadline. As a result, the fiscal cliff won't necessarily be an impediment to growth even if Congress doesn't address the issue until after 2013 has already begun. Coming to the effects of the fiscal cliff, lets look at some of the statistics which show its grave impact on the US economy, if it eventually goes down the fiscal cliff:

points in 2013, sending the economy into a recession (i.e., negative growth). At the same time, it also predicts that unemployment would rise by almost a full percentage point, with a loss of about two million jobs. Allowing the middle-class tax rates to rise and failing to patch the Alternative Minimum Tax (AMT) could cut the growth of real consumer spending by 1.7 percentage points in 2013. The growth of real GDP could slow by 1.4 percentage points because of this sharp rise in middleclass taxes and the resulting decline in consumption. Faced with these tax hikes, the CEA estimates that consumers could spend nearly $200 billion less than they otherwise would have in 2013 just because of higher taxes. This reduction of $200 billion is approximately four times the total amount that 226 million shoppers spent on Black Friday weekend last year. This $200 billion reduction would likely be spread across all areas of consumer spending. American consumers are the bedrock of U.S. economy, driving more than two-thirds of the overall rise in real GDP over 13 consecutive quarters of economic recovery since the middle of 2009. And as we approach the holiday season, which accounts for close to one-fifth of industry sales, retailers can't afford the threat of tax increases on middle-class families.

Ok, it impacts the US economy! What about India? How badly would India be affected? According to one of the research of World Bank, the impact on India would be modest. Economic growth in South Asia would fall by 0.2 percentage points while the current account deficit would improve by 0.1 percentage points of gross domestic product. But the central bank of India seems worried enough to say that a sharp fiscal contraction may have a deleterious impact on global growth. There will be two factors at play. A weaker global economy will likely

While the combination of higher taxes and spending cuts would reduce the deficit by an estimated $560 billion, it is estimated the CBO that the policies set to go into effect would cut gross domestic product (GDP) by four percentage

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hurt domestic growth further while lower crude oil prices could ease some of the current pressure on the balance of payments (BoP). The more important issue is likely to be how Indiaboth the government and the private sector manages to negotiate the volatility that will accompany every twist and turn in US fiscal politics. The most likely outcome is another set of stop-gap

measures that would delay a more permanent policy change until 2013 or later. Still, the non-partisan Congressional Budget Office (CBO) estimates that if Congress extends the Bush-era tax cuts but cancels the automatic spending cuts then the result, in the short term, would be modest growth but no major economic hit.

Courtesy: Akshay Goyal NMIMS, Mumbai

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Indian Reforms: Real vs Reel Growth

BY HEMANT GODHWANI AND SUMEET GUPTA NMIMS MUMBAI
To reform means to shatter one form and to create another; but the two sides of this act are not always equally intended nor equally successful. George Santayana The reforms introduced by the Indian Government in September 2012 were in response to the precarious situation the Indian economy found itself in. The year on year increase in GDP in first 3 months of calendar year was 5.2% as compared to 9.2% a year earlier. The growth forecast for the financial year 2012 had been slashed by IMF from 7.2% in April to 6.5% in July. With the declining currency and increasing cost of fuel imports, Governments fuel subsidy bill had reached exorbitantly high levels of $35 billion. Moreover, rating agencies had threatened to downgrade India to non-investment grade and S&P had changed the outlook on Indias BBB rating from stable to negative. Truly, the Indian growth story seemed to be faltering. The policy paralysis at the centre and the inability of the government to take unpopular decisions became the major talking points in all business circles. The government realized that it had no other option but to take the risks of introducing unpopular reforms. The first step that the government took was to reduce the diesel subsidies by increasing the cost of diesel at the pump by about 14%. This step was aimed at reducing the ballooning fiscal deficit and reducing the spending on diesel subsidy, which as proclaimed by Dr. Manmohan Singh himself, was more than the spending of the government on healthcare and education combined. Another reform which was announced to control fiscal deficit was divesting the part government stake in the state run firms Hindustan Copper Ltd, National Aluminium Company Ltd, MMTC Ltd. and Oil India Ltd. which at market prices would fetch around $2.6 billion. The next steps were to allow FDI up to 51% in multi-brand supermarkets, up to 49% in aviation, up to 71% in broadcasting and up to 49% in the power industry. These steps were launched to attract foreign investors (and foreign currency) and arrest the fall in Rupee. Opening the multi brand retail to FDI will lead to modernization of Indias agri-retail marketplace and increased efficiencies in supply chain infrastructure. FDI in aviation is expected to benefit the industry in the medium to long term. FDI in broadcasting will help stepup the process of digitization where investments are required to be made by the cable industry. This will enable the TV distribution industry to meet the deadline of mandatory digitization as pronounced by the Government. FDI in power sector will help inject capital and Hemant Godhwani is currently pursuing MBA in Finance from NMIMS, Mumbai (2011-13 batch). He has worked at Crisil Limited (Intern). Email ID : hemantgodhwani@gmail .com

Sumeet Gupta is currently pursuing MBA in Finance from NMIMS, Mumbai (2011-13 batch). He has worked at Reserve Bank of India (Intern). Email ID: mailto.sumeetgupta@g mail.com

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bring global practices in the vital interface between buyers and sellers of electricity, and make the market more competitive. The government also unveiled a scheme to restructure over $35 billion in debt owed by loss making state electricity distribution companies. The reforms were welcomed by the industry and businesses. The stock market took a bullish turn, rupee recovered some of the lost ground and there was enthusiasm among industry leaders. Anand Mahindra, Chairman and MD of Mahindra & Mahindra tweeted, From a famine of policy action we have moved to a feast. The government has got back its gumption. We cheer and urge that they stay the course. And indeed Anand Mahindra is absolutely right. The governments move to take unpopular decisions less than two years before general elections indicates that Indias economic fortunes can indeed be a turning point as significant as in 1991. However, there are three main concerns going forward which must be catered to by the government. First, the reforms announced must be implemented. In 2011, the decision to allow FDI in multi brand retail was reversed following opposition from the coalition politicians, opposition politicians and shopkeepers. This time around the Government has maintained its stance in spite of opposition from Trinamool Congress and some more allies. It needs to stand firm in-spite of the opposition. Second, the reforms introduced are only a fraction of the reforms needed to ensure robust economic growth. That is, it is a good first step only if there is step 2, step 3 and step 4 to come in the near future. Third, the opening up of certain sectors to foreign investment is not an alternative to addressing the root problems in the Indian economy. Most of the reforms will bring advantages in the short run, but to sustain these advantages in the medium to long run, government will have to address

the structural problems in the Indian economy. The structural problems in Indian economy are manifolds. Firstly, majority of the people live in utter poverty and deprivation. They have very little access to potable water, roads, hospitals, education and employment. These people have to bear the brunt of the increased diesel prices and will receive little or no benefits from the reforms. Secondly, 60% of the population of India is still dependent on agriculture. Majority of the reforms are directed towards the services sector. Then, there are the rigid labor laws which discourage companies from hiring, obsolete land acquisition rules that make setting up of industrial projects difficult and the infrastructure from roads to power is old and insufficient. Also, subsidies on everything from fuel to fertilizers have caused the expenditure to greatly overshoot the budget. Divesting the stake in state run companies is just a temporary measure to reduce the gap between the expenditure and budget. Even after the reforms were introduced, IMF lowered the growth forecast of Indian economy in financial year 2012 to 4.9%. Hence, we can say that the reforms introduced by the government are an encouraging step towards sustaining the growth story of India. The determination showed by the government to push the reforms in spite of opposition from all corners is applaudable. However, the government should not sit back and consider its job done. These reforms can be a part of the real growth story of India only if the government takes further steps to reform the economy. The reforms introduced will undoubtedly benefit the economy in the short run. However, in the long run, government has to address the aforementioned structural problems to keep the growth rate of India sustainable. If the government fails to tackle these issues, then the reforms will fail to serve their purpose and will only contribute to the reel growth of India.

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THE YEAR IN IMAGES AND WORDS

In times like these when the global and domestic scenarios do not give us much to cheer about we could use some comic relief. This section captures some of the main events of the year in cartoons, coupled with some of the insightful and sometimes humorous quotes from some of the most powerful men and women who have occupied or are still occupying a position of power.

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F I N F U N

Compiled by: Anirudh Kowtha, MBA I Year, NMIMS, Mumbai

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Prolonged Recession Due to Reduction of Risk Appetite After the 2008 Financial Crisis
BY AKSHAY GOYAL & SOUMYAJIT DATTA, NMIMS MUMBAI
Introduction The analysis of the change in attitude post the financial crisis of 2008 necessitates a brief discussion about the real cause behind the crisis. The financial crisis of 2008 brought the once galloping US economy on its knees. With almost every other country linked directly or indirectly with the worlds largest economy, it was much obvious for the ripples to be felt all over. The real cause of the crisis is attributed to a lot many factors. But as analysts believe it was amalgamation of all the factors that resulted in the failure so big. The existence of large global imbalances during the 2000s, which was an outcome of extremely loose monetary policy followed by some of the developed world economies, was a major contributor of crisis (Taylor, 2008). There was a significant increase in current account deficit of the US, accompanied by a significant increase in the surplus in Asia (Lane, 2009). Such global imbalances along with the flaws in financial markets paved the way for the crisis. The monetary policy of the developed countries, particularly the US, had its own share of loopholes. The policy rate reached as low as 1 percent in June 2003 and stayed there for a considerable time (FRED, 2009). As a result there was easy money available during the period which boosted consumption and asset prices. Such low short-term rates led to the credit boom. With lax regulation and supervision, loans were easily given at sub-prime rates. There was overvaluation of sub-prime mortgages with the anticipation that the asset prices will continue to rise. When these sub-prime mortgage defaults started accelerating since 2006, it busted the housing bubble. The credit froze and money markets in the US and Europe tumbled. There was huge liquidity crunch and because of lack of trust, the banks refused to lend to one another. Despite the tension and uncertainty looming large over the financial sector, the emerging economies, such as Brazil, Russia, India and China (BRICS), continued to show good growth initially. Even the economies dependent on commodities, such as the Gulf States, Latin America and Africa, resisted the crisis. However, some of the events, which were beyond the wildest possible imagination of any economist, shock the entire world. The failure of major financial institutes in the US and Europe was an Akshay Goyal is a first year MBA student at NMIMS. He has an engineering background and loves to write and sketch during his free time. Email ID: akshaygoyalonline@gma il.com

Soumyajit Datta is pursuing MBA Banking from NMIMS. He has done B.Tech and has a background in IT field. He likes to write poems in his leisure time. Email ID: soumya621@gmail.com

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indicator of the disaster in waiting which hurt the sentiments of the investors. The bankruptcy of Bears Stearns and the buyout of Freddie Mac and Fannie Mae by the US government raised some eyebrows. The last bit of the existing confidence in the financial market went through the drain with the collapse of Lehman Brothers, which was one of the big-four Wall Street Investment Banks. All this led to a serious shift in attitude post the financial crisis of 2008, which hampered the economies world over. Against the backdrop of this financial crisis and the subsequent uncertainty prevailing world-over, the dissertation attempts to explain the ill-effects of reduction in risk appetite affecting the global economy to emerge out of the crisis. 2. Effects of the Financial Crisis 2.1 Declines in foreign exchange reserves Because of the falling investors appetite, the capital flows to emerging economies which were rising constantly since 2006 experienced a sharp decline after 2008. FIIs, in large amount, withdrew their investments because of the fear that emerging economies will collapse as well. As a result, foreign exchange reserve of emerging economies faced a sharp reduction (figure 1). According to the Institute of International Finance an increase in international reserves (a net addition to stocks) held by emerging market economies halved, from more than US$1 trillion in 2007 to US$571 billion in 2008.

Such sharp decline in foreign reserves led to depreciation of currency of the emerging economies. It also affected the exchange rates, creating problems for the importers and exporters. Businesses are affected because of the reduced liquidity at their disposal and in turn affect the industrial production. 2.2 Currency depreciation and tumbling of stock market Currencies of emerging market economies experienced a sharp depreciation against the US dollar in the immediate aftermath of the crisis. Currency depreciation was a source of misery for the emerging economies like India which is a trade-deficit country. The manufacturing industry like the textiles, automobiles and also the jewelry industry experienced falling operating margins because of the increase in prices of the imported raw materials due to the native currency depreciation. The depreciation in currency was a result of extreme risk aversion followed by the investors. Portfolio investors grew wary of the risk involved in the credit and marketwide systematic risk. They were apprehensive as they felt that the recession in the US will ultimately hit the emerging economies and in order to prevent losses, they pulled out a lot of money from these markets. The stock market also took a hit. As measured by the Morgan Stanley

Figure 1 Changes in foreign exchange reserves by main emerging market economies Source: Institute of International Finance

Composite Index (MSCI) the emerging market stock market fell by more than 60 per cent between midSeptember and mid-November 2008 (figure 2). The corporate is finding it difficult to raise finance

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from the stock market and have to keep expansionary plans in wait. Also the governments of the countries are facing a lot of problems in raising debts from the market because of the diminishing faith. It has become a double edged sword for the governments as on one hand they have to design bailout packages for big financial institutes in order to prevent a catastrophic situation and on the other hand they are finding difficult to borrow money from the markets. The spreads on sovereign bonds rose by more than 700 basis points and that on commercial debt papers by more than 1000 basis points. A number of economies which were highly indebted and were dependent on short-term debt finances were hit badly by the risk aversion tactics followed by the investors. 20 developing countries experienced severe distress due to lack of investors and funds (World Bank, 2009). 2.3 Cascading Effect on commodities markets The major takers for the commodities have been the developed nations or the emerging economies like India and China. As the industrial production took a hit in these countries, the prices of commodities plummeted. Amidst pessimism, which has been ruling since the financial crisis, the demand for oil declined. The prices of oil which were more than US$140 in early July fell below US$50 in November-December 2008 and reached US$35-45 in February, 2009 (World Bank, 2009). Even the prices of a number of metals, such as zinc, nickel and copper, fell drastically due to the anticipated decline in world demand, particularly because of the anticipated deterioration in global prospects for the construction and automobile industries. This was a reflection of the expected shift in demand-supply fundamentals. The demand was weakened much because of anticipation and risk aversion as financial crisis inflicted the economy. Even the investors who had a long position in futures market in commodities liquidated that fearing risk. The reduced prices of the commodities initially helped countries like India to check inflation and fiscal deficit as large amount of money is spend in the form of subsidies on commodities in such countries. But soon the positive effects of reduced food and fuel prices were nullified

in the countries importing them because of the currency depreciation against the US dollar as discussed earlier. 2.4 Lack of investments and falling industrial production With deteriorating growth prospects for the global economy and subsequent decline in export demand, the real GDP of developed and emerging economies have contracted. The effect of the fear immediately after the period of crisis is revealed by IMFs data which show that the real GDP of developed and emerging economies contracted 7.5 per cent and 4 per cent, respectively, on an annual basis in the last quarter of 2008. Both developed and developing economies suffered a contraction because of the financial and trade linkages. There has been a severe financial squeeze and continuously weakening export demand. The world trade has also suffered a lot. It has contracted by nearly 30 per cent on an annual basis (IMF, 2009). There has been a drastic fall in the import and export demands in both developed and developing economies. The disruption in financial services, mainly the lack of finances due to the prevalent apprehensions, and deteriorating global economic outlook has inflicted the industrial production as well.

When increase in economic activity was the last resort left to emerge out of the crisis, the industrial production plummeted and investments dried. The

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confidence of the investors has taken a hit and they are too cautious to invest their money. The investment cost rose sharply courtesy risk aversion. The corporate bonds have become very expensive in such a negative scenario, making it all the more difficult for corporate to borrow money. There is lack of long-term investments which is required for infrastructure-building due to lack of funds at the disposal of governments (majorly because of lack of interest of investors in sovereign bonds due to rising risk). With unavailability of infrastructure it has become tough for developing nations to compete with the developed ones as the industry looks for the best available technological and infrastructural facilities for their production. As countries like India, Brazil, Philippines etc. witnessed huge capital outflows, they responded by tight monetary policy. This worsened the domestic credit creation and further dampened the investment demand. Declining consumer demand accompanied by lack of investments due to fear of risk involved has severely contracted the industrial production. Thus, because of credit disruption and decreasing confidence as well as increasing anxiety of consumers and investors the demand for investment goods and consumer durables have been hit particularly hard. In fact, the aggregate industrial production index of India posted a negative growth rate of 2.3 per cent on an annual basis in the first quarter of 2009. Thus, due to a decline in corporate profits as well as reduced availability and higher cost of finance at the time of the severe credit crunches both internal and external financial sources have increasingly dried up (UNCTAD, 2009).

Concluding remarks We witnessed that the most severe effect of the financial crisis has been the loss in confidence in the market. People grew apprehensive and their appetite for the risk reached a new low. People switched from the equity market and started looking towards safer investment options. Even the earlier considered safe investment options such as commercial papers and money market funds were shunned by the investors as unsafe. Also the banks, after already being the center of the financial turmoil, are treading the path in a much more cautious manner. Risk-averse foreign direct investors, hedge funds, private equity, and international companies, pulled funds out of emerging economies. The crisis has led to a credit crunch. Also, countries are finding it difficult to raise long-term finances for infrastructure development. All this has hampered the industrial production. As a result, reduction in risk appetite has damaged the very nerve needed to revive the world out of recession. The crisis exposed the market failures prevalent in the global economy and incapability or inefficiency of the current financial system. The governments of various countries are doing every bit possible to protect their country by providing huge fiscal stimulus packages. Also international financial institutes, such as IMF, World Bank Group, are doing their best by fast-tracking their lending facility and enlarging the financial resources. But the urgent requirement in order to revive the global economy is to instill back the confidence. We need to show people light at the end of this dark tunnel and motivate them to believe that they will reach there. Till then there is no escape from this crisis.

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Implications of FDI in insurance

BY SANOOP SREEDHAR, FMS DELHI
The central government approval to permit 49% of FDI, up from 26%, in the Insurance segment has been on the headlines for quite some time. What could be the possible implications of such a move is a point that is very important from the economic as well as social point of view of the nation. Before delving deep into the implications of FDI in Insurance sector, it becomes essential to discuss the conditions that existed in the insurance segment that made the government to take decision of increasing the limit of FDI. History of the Insurance Segment in India The insurance business (specifically life insurance) started in India by the setting up of the Oriental Life Insurance Company in 1818 at Calcutta while the first general insurance company to be setup was the Triton Insurance Co Ltd in 1850 at Calcutta. The British Insurance Act was enacted in1870, boosting up insurance business in India, though dominated by foreign players like Albert Life Insurance ,Royal Insurance, etc. Regulation in the life business was brought about by the enactment of the Indian Life Insurance Companies Act, 1912. Allegations of unfair trade practices in the insurance segment led to the nationalization of the life insurance sector, leading to the establishment if the Life Insurance Corporation of India (LIC). The LIC comprised of 245 insurers in all (154 Indian, 16 non-Indian & 75 provident societies). The General Insurance Business (nationalization) Act, 1972 led to the nationalization of the general insurance business. All the insurers were amalgamated into 4 companies-the Oriental Insurance Co., National Insurance Co. Ltd, the New India Assurance Co. Ltd & the United India Insurance Co. Ltd. The opening up of the insurance sector to the private players in the 1990s threatened the monopoly of LIC to some extent. The Insurance Regulatory & Development Authority (IRDA) was setup in 1999, following recommendations of the Malhotra Committee Report. The function of IRDA is to regulate and develop the insurance sector. It became a statutory body in 2000. In the same year, IRDA opened up the insurance market allowing foreign

Sanoop Sreedhar is currently a student of second year of MBA at Faculty of Management Studies, Delhi. He has a prior working experience of 12 months in Banking and IT. Email ID: sanoop.s13@fms.edu

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companies an ownership limit of 26%. Current scenario of the Indian Insurance Sector The current size of the Indian Insurance market is estimated to be US$41 billion, the fifth largest among the emerging market economies. The contribution of this segment to the GDP of the nation is about 4.5%. There is a huge potential lying in this

There are more than 22 players in the life insurance segment. Their respective market shares are shown in the graph. As evident from the graph, the major player in the Insurance market is the Life Insurance Corporation of India, with more than 50% of the market share. The players in the insurance segment are earlier adopters of technology, thereby availing to customer better services and products at lower costs. The ever

segment. This claim is verified by the fact that India ranks first in terms of life insurance density, which is the ratio of premium to total population of a country. There are 48 insurance companies operating in India, comprising of 23 life insurers, 24 non-life insurers and 1 reinsurer. The broad division of the insurance sector is shown below.

increasing reach of the internet is a major factor that has contributed to the growth of the insurance segment in India. In spite of the lucrativeness of the industry, the insurance segment is afflicted by a variety of problems. Some of them are:

Questions have been raised about the confidentiality of the customer data Risk Management has been difficult in the aftermath of the global economic meltdown The low interest rate environment has been deepening the worry of the insurance companies. The Merger & Acquisitions environment has not been favorable for the companies thereby significantly reducing expansion plans for the companies Though a lucrative segment, the economic crisis of 2008 has severely impacted the insurance segment. The current loss of the industry, non-life segment, stands at Rs.1,018 crores with public sector incurring a loss of Rs.161crores. The life insurance segment, however, reported

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a profit of Rs.2,657 crores. Amendments to the FDI policy in Insurance The Government has increased the cap on FDI in the insurance sector from 26% to 49%. The government along with performing this act has also cleared certain other amendments aimed at improving the transparency in the functioning of the Insurance companies as well increasing the investment flowing into the sector. The government expects a cash flow of about Rs.30,000 crores in the next 5 years, as a result of this move. This move has been carried out by amending the Insurance Laws (Amendment), Bill, 2008, which has been pending in the Rajya Sabha. Now, foreign re-insurers would come under the ambit of Section 27E, which prevents the insurer from investing directly or indirectly outside India the funds of a policy holder. They would be able to open branches for re-insurance business only. The entry barrier in case of priority sectors like healthcare is reduced. This has been done by reducing the capital requirement for a company thereby encouraging health insurance in India. Provisions relating to coverage of sickness benefits as a result of domestic or international travel have also been included. Also, the public sector general insurance companies will be allowed to raise capital from market so as to meet their future requirements. Effects of the hike in FDI limit in the Insurance Sector The increase in the FDI limit to 49% will definitely be disadvantageous for the public sector companies like Life Insurance Corporation of India as there will

be an increase inflow of funds from global insurers resulting in cut throat competition. The market share of the Public sector insurers will decline further. The market share of LIC (in its core life segment) has already declined from 98.65% in 2001-02 to 71.40% in 2011-12. This will decrease further with the enhanced competition from the private players as a result of the increase in the FDI limit. The high inflow of funds has to be regulated by the government in order to have a check on the inflation. The Insurance density in India in 2010 stood at $64.4 while the Insurance penetration stood at 5.10%. Both of these are bound to rise with increase in competition in the segment. As a result, this can be seen advantageous to the Indian populace, specifically the rural population. This will be especially useful in the unbanked segment where the Insurance penetration is almost 0%. The foreign participation can help to increase the growth of this sector to about 11-12% per annum. This will lead to the reduction in the investments in gold and land as the insurance companies will be able to reach a larger part of the population with better services. However, there are possibilities of the loss of economic independence of the nation, as foreign players would be handling the domestic savings of the country. This can prove to be disastrous to the economy of India if a repetition of the 2008 economic crisis happens in the future. As far as the floating of IPOs of Insurance companies in the share market is concerned, there are several conditions put forward by SEBI. An essential condition is that a firm qualifies to float an IPO only if it has been in existence for 10years, making a profit for the last 3 years. This condition would

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eliminate many firms from the IPO rush. However, there will be participation of FIIs in the IPOs with ease in limit of FDI. the increase in limit of FDI. This will result in a huge cash flow into the Insurance segment in addition to the better analyzing abilities of FIIs. A very important factor in the life insurance segment is the grievance resolution by the insurance companies. Currently the value of the % resolved during a year stands at 97% for the industry. This will increase to about 99-100% with the increase in competition in the market. The increase in the number of the market players will also result in the creation of jobs. The success of any policy drafted depends upon the implementation aspect of it. The same applies to the Insurance industry as well. There will definitely be

an increase in the number of people insured in the country. The existing policy holders will also seek to increase their coverage. The entry of FIIs into the insurance segment will be a reality with the increase in the limit of FDI. This will enable in the better analysis of Insurance company financials, something which the Indian investors have little knowledge of. The SME segment in India will witness a substantial growth due to the reduced cost of borrowing. A fact that holds is that the Public Sector Insurance companies will improve their services so as to survive the onslaught of the foreign insurers resulting in faster grievance redressal mechanisms. And that is exactly what the common man wants.

Solution to the Crossword

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"Money was never a big motivation for me, except as a way to keep score. The real excitement is playing the game." - Donald Trump

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