Compendium

MONETRIX
The Finance and Economics club of

MDI, Gurgaon

Monetrix is the Finance and Economics Club of

Management Development Institute (MDI), Gurgaon.
As one of the most active clubs in the campus,
Monetrix continuously strives to contribute to the
financial and economic knowledge of the MDI
community by holding events and conducting
knowledge sessions and other interactions.

Finance is the science of managing money, i.e., how institutions generate

and manage their wealth. A degree in finance prepares future professionals
to guide corporations through uncertainties, short and long term planning.
Finance majors in various business firms evaluate their market positions,
profitability and economic policies that have implications for their
businesses.
Despite the increased prominence of other MBA specializations since the
2008 crisis, finance still remains to be a sought after major by many MBA
students. Not only has finance continued to be a core area, its significance
as a part of MBA program has been growing over the years. Moreover, its
not purely the financial services sector that employs MBA graduates wellversed in finance but organizations outside of the sector also require
leaders with an in-depth financial know-how, and as the global economy
evolves this need is growing more than ever.
Majoring in Finance involves learning about commercial and investment
banking, forecasting, budgeting, asset and liability management, stocks,
bonds, how markets function, portfolio management, risk management, etc.
Hence it would give an opportunity to enter into numerous career paths,
some of which are listed below.

Career Prospects:
1.
2.
3.
4.
5.
6.

Consumer Banking
Investment Banking
Institutional Finance
Merchant Banking
Corporate Finance
International Finance

Career Options:

1. Credit analyst
2. Financial Analyst
3. Investment Banker
4. Loan officer
5. Risk and Insurance managers
6. Investment advisor
7. Financial Planner
8. Corporate Controller
9. Trader
10. Treasury officer
11. Management Consultant

Accounting: Accountants primary function is to develop and provide data

measuring the performance of the firm, assessing its financial position, and
paying taxes. The accountant is responsible for preparing financial
statements such as the income statement, balance sheets, and cash flows.
It is normally passive work, in the sense that, the work has a very
independent nature to it such as preparing forms and financial statements.
Finance: The financial manager or consultant places primary emphasis on
decision-making. It uses the financial statements prepared by accountants
to make decisions about the firms financial condition and to advise others
about possible losses and profits. In some cases, finance is more a type of
leadership position. A financial manager has to deal not only with finance,
but also with economics, accounting, statistics, math, and management. For
example, people working with stocks and bonds have to understand and
analyze how the underlying companies are performing. How a given
company is going to perform during recession? Should they sell or buy
stocks or bonds? Finance also deals a lot with risk.
Thus, Accounting is the process of creating and managing financial
statements, which record the day-to-day transactions of the business.
Finance has a broader scope and is responsible for initiating transactions to
aid in cash, investment and other working capital management.
3

Economics can be broadly classified into Microeconomics and

Macroeconomics. While microeconomics deals with demand and supply of
an individual and a firm, macroeconomics deals with aggregate demand and
supply of industries and economy as a whole. There are two main school of
macroeconomic thought: Classical and Keynesian. Adam Smith proposed
the Classical theory through his book Wealth of Nations with the concept of
invisible hand.
The concept states that if individuals in a free market carry out their
economic affairs for their own benefit then they will be led by the invisible
hand to maximize the welfare of the economy. So, if an individual pursues
his self-interest, he contributes to the welfare of society at large. The central
idea of this theory is that free markets are self-regulated. For instance, if
demand for a commodity exceeds its supply, then the price rises to bring the
demand to match with the supply.
John Maynard Keynes proposed the Keynesian theory through his book
The General Theory of Employment, Interest and Money published in 1936
when the classical theory failed to solve the problems presented by the
Great Depression. Keynes proposed a greater government intervention in
the markets to solve issues related to unemployment. Purchase of goods
and services by the government will lead to increased demand, which will be
met by employing more people leading to higher production.

LAW OF DEMAND
defines the relationship
between the demand
and price of a product.

LAW
OF SUPPLY
defines the relationship
between the supply
and price of a product.

The demand for a

particular product is
inversely proportional
to its price, other
factors like income,
price of substitute,
taste and preferences,
remaining same.

The supply of a
particular product is
directly proportional to
its price, other factors
like income, price of
substitute, taste and
preferences, remaining
same.

As the price of good

decreases, the quantity
demanded increases.

As the price of good

increases, the quantity
supplied increases so
as to maximize profits.

Equilibrium refers to a situation in which the price has reached the level
where the quantity supplied equals the quantity demanded. As you can see
on the chart, equilibrium price and quantity are determined by the
intersection of demand & supply curves. At this point, the price of the goods
will be P* and the quantity will be Q*. This point is referred to as equilibrium

Economics deals with choosing one alternative among various alternatives.

The decision process begins with ranking all alternatives on priority basis,
and then choosing the alternative, which is on the top of the priority list. This
choice implies sacrifice of other alternatives; hence cost of this choice will be
evaluated in terms of the sacrificed alternatives. The cost of this choice is
the benefit of the next best alternative foregone. This is called opportunity
cost. Therefore, opportunity cost is the highest valued benefit that must be
sacrificed as a result of choosing alternative.

Macroeconomics is the study of the aggregate economy. It addresses many

topical issues like: Why does the cost of living keep rising? Why are millions
of people unemployed, even when the economy is booming? What causes
recession? More specifically it is a study of national economies and the
determination of national income.
A variety of measures of national income and output are used in economies
to estimate total economic activity in a country or region.

Gross Domestic Product

It is the monetary value of all the finished goods and services produced
within a country's borders in a specific time period. GDP is commonly used
as an indicator of the economic health of a country, as well as to gauge a
country's standard of living. Critics of using GDP as an economic measure
say the statistic does not take into account the underground economy transactions that, for whatever reason, are not reported to the government.
Others say that GDP is not intended to gauge material well-being, but
serves as a measure of a nation's productivity, which is unrelated. .
The expenditure method of calculating GDP:
GDP = private consumption + gross investment + government spending +
(exports imports), or
GDP = C + I + G + (X M)
Gross National Product
It is an economic statistic that includes GDP, plus any income earned by
residents from overseas investments, minus income earned within the
domestic economy by overseas residents.
GNP is a measure of a country's economic performance, or what its citizens
produced (i.e. goods and services) and whether they produced these items
within its borders.
Gross National Product (GNP) is the market value of all products and
services produced in one year by labor and property supplied by the
residents of a country.
Fiscal & Monetary Policy
The government exerts its control over the nations economy using two
distinct set of policies. One is the monetary policy (the central bank
manages this on behalf of the government) and secondly the fiscal policy.
Fiscal policy is the use of government expenditure and revenue collection
through taxation to influence the economic activity. With the help of
monetary policy the Reserve Bank of India (RBI) attempts to stabilize the
economy by controlling interest rates and spending. Monetary policy
comprises of various policy rates and reserve ratios.
Bank Rate - Bank Rate is the interest rate that is charged by a
countrys central or federal bank on loans and advances to control
money supply in the economy and the banking sector. In India, the
bank rate is the rate at which the Reserve Bank of India lends to
commercial banks and other financial institutions for meeting
shortfalls in their reserve requirements, for long-term purposes. A
change in bank rates affects customers as it influences prime interest
rates for personal loans. The bank rate signals the central banks
long-term outlook on interest rates. If the bank rate moves up, longterm interest rates also tend to move up, and vice-versa. In India, the
bank rate is 9.00% (w.e.f. 28/01/2014)

Repo Rate Repo rate is the rate at which the central bank of a
country (Reserve Bank of India in case of India) lends money to
commercial banks in the event of any shortfall of funds. Repo rate is
used by monetary authorities to control inflation. In India, the repo
rate is 8.00% (w.e.f. 28/01/2014)
6

Reverse Repo Rate The rate at which RBI borrows money from
the banks (or banks lend money to the RBI) is termed the reverse
repo rate. Reverse repo rate signifies the rate at which the central
bank absorbs liquidity from the banks, while repo signifies the rate at
which liquidity is injected. The RBI uses this tool when it feels there is
too much money floating in the banking system. In India, the reverse
repo rate is 7.00% (w.e.f. 28/01/2014)

Cash Reserve Ratio (CRR) The portion (expressed as a percent)

of depositors' balances banks must have on hand as cash. This is a
requirement determined by the country's central bank, which in the
U.S. is the Federal Reserve and in India is reserve bank. The reserve
ratio affects the money supply in a country. In India, the CRR is
4.00% (w.e.f. 9/02/2013)
This means all banks must have 11% of their depositors money on
reserve in the bank. So, if a bank has deposits of INR 1 crore, it is
required to have 4 lakhs on reserve.

Statutory Liquidity Ratio (SLR) SLR indicates the minimum

percentage of deposits that the bank has to maintain in the form of
gold, cash or other approved securities like treasury bills. It regulates
the credit growth in India. In India, the SLR is 23% (w.e.f. 11/08/2012)

Inflation
Inflation is a rise in the general level of prices of goods and services in an
economy over a period of time. Consequently, inflation also reflects erosion
in the purchasing power of money a loss of real value in the internal
medium of exchange and unit of account in the economy.
Inflation rate = (this years price index last year price index) / last years
price index
The consumer price index (CPI) is the best know indicator of inflation. In
India, Food Inflation is a significant indicator since food expense is the major
expense for most of the people in India.
RBIs desired level of inflation is 4-5 %, above which it becomes hawkish to
check inflation.
Severe form of Inflation is called hyperinflation.
Currently, Indias Consumer price index is 8.79%, Wholesale Price Index is
5.05%, and Food Inflation is 8.80% approximately.

Deflation
Deflation is a decrease in the general price level of goods and services.
Deflation occurs when the inflation rate falls below 0% (a negative inflation
rate). Inflation reduces the real value of money over time; conversely,
deflation increases the real value of money the currency of a national or
regional economy. This allows one to buy more goods with the same
amount of money over time. Deflation is correlated with depressions.
Deflation results in a lower level of demand in the economy due to lower
production capability requirements of industry and this further leads to
increased unemployment.

Stagflation
Stagflation is a situation in which the inflation rate is high and the economic
growth rate is low.
FDI & FII
Foreign Direct Investment (FDI) refers to the investment by foreign investors
in projects in the country. This type of investment is more involved with the
management, technology transfer and other field expertise and knowhow in
the project. FII refers to Foreign Institutional Investors. These investors
invest in the country indirectly by purchasing stocks of the companies listed
on the stock exchanges. The FII money inflows or outflows are also called
hot money flows.

Types of industry
1. Monopoly - It exists when a specific individual or an enterprise has
sufficient control over a particular product or service to determine
significantly the terms on which other individuals shall have access to
it. Monopolies are thus characterized by the ability of a firm to raise
price without losing all its sales. Monopolies often arise as a result of
barriers to entry.
2. Perfect Competition It describes markets such that no participants
are large enough to have the market power to set the price of a
homogeneous product. A perfectly competitive market has the
following characteristics like there are many buyers & sellers in the
market, the goods offered by the various sellers are largely the same
and firms can freely enter or exit the market. A competitive market
has many buyers and sellers trading identical products so that each
buyer and seller is a price taker. Buyers and sellers must accept the
price determined by the market. Perfect competition serves as a
benchmark against which to measure real-life and imperfectly
competitive markets.
3. Oligopoly - An oligopoly is a market form in which a market or
industry is dominated by a small number of sellers. Only only a few
sellers characterize it, each offering a similar or identical product to
the others. Because of the few sellers, the key feature of oligopoly is
the issue between cooperation and self-interest. At least some firm
have large market shares and thus can influence the price of the
product.

4. Monopsony- It is a market similar to a monopoly except that a large

buyer not seller controls a large proportion of the market and drives
the prices down. It is sometimes referred to as the buyer's monopoly.

Financial Markets
It is a broad term describing any marketplace where buyers and sellers
participate in the trade of assets such as equities, bonds, currencies and
derivatives. They are broadly of three types:
CAPITAL MARKETS
They deal with longer maturity financial assets and claims. Capital market
includes trading in the financial instruments such as shares (equity as well
as preference), public sector bonds and units of mutual funds. In case of
capital market even a small individual investor can deal by sale/purchase of
shares, debentures or mutual fund units.
The capital market includes the stock market (equity securities) and the
bond market (debt).
In primary markets, new stock or bond issues are sold to investors for the
first time.
In the secondary markets, existing securities are sold and bought among
investors or traders, usually on a securities exchange, over-the-counter, or
elsewhere.
MONEY MARKETS
Short-term instruments maturing within a period of one year are traded in
money market such as inter-corporate deposits, certificate of deposits,
treasury bonds, commercial papers, commercial bills, etc. Money market is
a wholesale market and the participants in money market are large
institutional investors, commercial banks, mutual funds, and corporate
bodies.
COMMODITIES MARKETS
A commodity market is a market that trades in primary rather than
manufactured products. Soft commodities are agricultural products such
as wheat, coffee, cocoa and sugar. Hard commodities are mined, such as
(gold, rubber and oil). Investors access about 50 major commodity markets
worldwide with purely financial transactions increasingly outnumbering
physical trades in which goods are delivered.

A balance sheet is prepared to find out the financial position or financial

health of a business i.e. to know what the business owes and what it owns
on a certain date. A Balance sheet is only a statement of assets and
liabilities. On the left hand side, the liabilities of the business are shown
whereas; on the right hand side the assets of the business are shown. The
two sides of the Balance Sheet (i.e. Assets and Liabilities) must have the
same totals. If it is not, then there is some error in the accounts. A Balance
Sheet is prepared as on a particular date and not for a period.
TERMS ASSOCIATED
Liability: It is any source of money for the company. This represents the
amount the company owes to external sources.
a. Shareholders Equity: It is the amount of money that the
shareholders of the company have in the company. The
shareholders could be the owners of the company (as in the case
of a private company) or can be the general public who has
shares of a company (as In the case of a public company). It
constitutes the following:
i. Share Capital: This is the money that has been invested in
the company by the shareholders. In the case of a public
company, there are 2 kinds of shares namely common
shares and preference shares.
ii. Reserves and Surplus: Every year the company makes
some profit. But not all profit made is distributed to the
shareholders and a part of it is retained by the company for
future use within it to expand operations etc.
b. Current Liabilities: All the funds that the company has received
which have to be repaid within 1 year are called current liabilities.
i. Short-term Loans: loans, taken by the company from
banks, which have to be repaid within the year.
ii. Advances: These are payments received by the
company for which it has not given the service or product.
iii. Provision for Tax: Any item with the word provision
represents a liability as the company anticipates that
much amount will have to be paid for a particular activity.
In this case that activity is tax payment.
c. Long-term Liabilities: All funds that the company has to repay
after 1 year are called long-term liabilities. Ex. Long-term debts
10

Assets: Any item or way in which the company has utilized the funds
available with it is called as asset.
a. Current Assets: All assets of the company that will not remain
with it for more than a year.
i. Cash and Bank Balance: It is the amount of cash the
company holds with it or in a bank that can be redeemed
immediately.
ii. Account Receivables: This is the amount of money that
the company is yet to receive.
iii. Inventory: These are the assets that the company holds
which are ready or will be ready in the future for sale but
havent been sold off yet. The inventory is of types:
Raw Material Inventory
Stocks in progress
Finished Goods Inventory
b. Fixed Assets: Any asset in which the company puts its money for
more than 1 year is fixed in nature.
Depreciation: A method of allocating the cost of a tangible asset over its
useful life. Businesses depreciate long-term assets for both tax and
accounting purposes. For example, if a company buys a machine for Rs.100
and estimates that it would be useful for 10 years, then it keeps charging
Rs.10 as depreciation every year signifying the useful life of machine that has
been utilized.

This statement is indicative of how the cash was consumed and spent over
the time period in question (a month, quarter or a year).

Income Statement is the statement that covers the incomes and expenditures
over a period of time (a month, a quarter, a financial year).
The Income Statement, the Cash Flow Statement and the
Balance Sheet together are analyzed to get a complete picture for
the firm. Whether you want to make a decision on buying some
shares of the company or the whole company (from an investment
banks perspective), you need to analyze these three statements
to get a sense of how the company has been doing.
11

With the ascent of Shinzo Abe as the prime minister of Japan for a second
term, a set of economic policies aimed at bringing Japan out of recession
have come to be known as Abenomics. The policies rely on the three
arrows of fiscal stimulus, monetary easing and structural reforms and intend
to bring Japan out of its slumber by focussing on increasing inflation to a
level of 2%, setting negative interest rates and inducing demand through
government spending/public investment.
The first arrow of monetary easing came when Haruhiko Kurod, Bank of
Japans new governor, pledged to end inflation by pumping vast quantities
of money into the system. The excess money supply is supposed to fuel
inflation.
The second package was the fiscal stimulus package worth $116 billion
which would go towards infrastructure projects with a focus on building
bridges, tunnels, and earthquake-resistant roads. Around a third of the
package, which is Japan's second-largest ever, was earmarked to stimulate
private investment, including steps to promote clean energy.. This has
raised concern however, because of Japans huge debt.
Japans
government already has a debt of 230% of GDP and unless the public
investment is made in productive infrastructure linking it to the global
market, it can accelerate Japans path to bankruptcy.
While monetary and fiscal policies will do most of the heavy lifting in the
short term, structural reforms, which the BOJ has argued are long overdue,
will be the long-term lynchpin of Abe's plans. Japan's troubling demographic
landscapethe population of Japanese workers between ages fifteen and
sixty-four has contracted by 6 percent in the past decadehas been one of
the largest culprits in hampering growth. Initiatives to counteract this trend
include encouraging greater female participation in the workforce by
adopting more comprehensive childcare support policies. Abe's government
has also laid out specific initiatives to overhaul regulations in key sectors like
energy, environment, and health care. In October 2013, Japan's parliament
began debating the "third arrow" of its economic plan, although some topics,
including Japan's labour laws and medical insurance, will likely be left off the
table.
But one of the most high-profile elements of Abe's structural reform plans
includes his decision to join the Trans-Pacific Partnership (TPP), a proposed
regional free trade agreement being negotiated between the United States
and eleven other countries in Asia and the Americas. On March 15, 2013,
Abe announced that Japanwhich accounted for 14 percent, or $146
billion, of U.S. goods trade with TPP partners in 2012would seek to
participate in the TPP negotiations.
The partnership remains a controversial topic, however, as some industries
with significant political clout has vehemently protested against Japan's
participation. The agriculture industry, for instance, has argued that the
sector would take a hit from foreign competition due to the removal of high
tariffs and other protective measures on imports. Some health providers
have

12

have also complained that Japan's national health insurance system would
be adversely affected, as the TPP would force Japanese citizens to buy
foreign-produced pharmaceuticals and medical devices. Despite these
domestic sensitivities, Abe nonetheless insisted that Japan needed to take
advantage of the "last chance" it had to remain an economic power in Asia.

National Spot Exchange (NSEL) is a Commodities exchange in India, and is

a joint venture of Financial Technologies (India) Ltd. (FTIL) and National
Agricultural Cooperative Marketing Federation of India (NAFED). On 15
October 2008, NSEL began trading in pre-certified cotton bales for Mumbai
delivery and imported gold and silver bars for Ahmedabad delivery, and has
been adding commodities since then.
The fraud became public when NSEL failed to pay out its investors in
commodity pair contracts after 31 July 2013. On investigation, it was found
out that most of the commodities that were traded never existed and buying
and selling of commodities like Steel, Paddy, Sugar, Ferrochrome, etc. was
being conducted only on paper.
Among the questionable transactions that emerged were a set of arbitrage
transactions involving investors buying a commodity on the basis of a T+2
contract and simultaneously selling it under a T+25 contract. The investor in
a T+2 contracted is expected to advance 10 per cent of the cost of the
commodity bought on the trading day and the entire purchase value on
settlement day, which is two days later. But settlement here is only the
acquisition of the relevant warehouse receipt, which is held till the T+25 sale
is executed. This amounts to the investor meeting the transaction charges
for transportation and warehousing, insurance etc. for the period between
purchase and sale. But it transpires that despite incurring these costs
investors were reportedly earning a return of around 14 per cent, because of
the difference in price between the T+2 purchase and the T+25 sale. Why
such a large price difference existed is not at all clear. But, the presumption
was that physical goods in the warehouses matching the warehouse
receipts backed all such trades. This, it appears was not true. are also
suspicions that trades were being conducted against what were fake
warehouse receipts, permitting traders to indulge in short selling, or the
sale of commodities that the seller did not own or possess at the time of
signing the contract, in the hope that they would be able to acquire the
required stocks at a lower price before the delivery date.
It appears now that the government was not unaware that the NSEL was
engaging in transactions that were in the nature of futures and, therefore,
illegal. But since the promotion of successful commodity exchanges was a
key element of the liberalization agenda, it chose to ignore this for long. Till,
of course, it became clear that the volume of transactions in the exchange
implied that some of the so-called spot contracts were naked contracts in
the sense that they were not backed by actual commodities.
This appears to have occurred because there were a web of companies (N
K Proteins, ARK Imports, P D Agroprocessors, Mohan India, Yathuri
Associates, Lotus Refineries and Juggernaut Projects among them), which
presumably were acting on behalf of NSEL and brokering contracts with
warehouse
13

warehouse receipts and collecting their fees and commissions, without

being statutorily responsible for backing the contracts with physical stocks
and financial guarantees. Payouts to investors reaching their sell dates were
possibly being made from investors putting in money into new trades. If true
this was nothing more than a Ponzi scheme.

Inflation Indexed National Savings Securities-Cumulative (IINSS-C) Bonds

Inflation is the key driver of investment performance. It can erode common
mans purchasing power. Inflation reduces the real return generated by any
asset. Inflation Indexed Bonds (IIBs) are financial instrument to protect
investors from inflation. The principal and interest payments of IIBs rise and
fall with inflation as these payments are based on Consumer Price Index
(CPI)

Face value of bonds = 5000 Rs.

Minimum investment = 5000 Rs.

Maximum investment = 500000 per annum per applicant

Rate of Interest = Real interest rate (Fixed rate) + Inflation rate

Real interest rate = 1.5% per annum
This rate of interest will be compounded half yearly.

Tenure = 10 years

Inflation: Final combined CPI with a lag of 3 months will be used. For
instance final combined CPI for September 2013 would be reference CPI
for all days of December. In case of base year change for inflation
implying that if inflation till this point is calculated on the basis of base
year 2004 and in 2016 base year for inflation calculation changes to
2012, an econometric tool known as base splicing method will be used
for calculation of Inflation rate in the above formula.

Early redemption: This will be allowed after one year for senior citizens
(> 65 years of age) and 3 years for all others. A penalty has to be paid at
the rate of 50% of the last coupon payable for early redemption.

This bond comes with a lock-in period of 1 year and 3 years for senior
citizens and others respectively. So, if the last CPI inflation for which
interest rate was calculated and interest paid was 10%, 50% deduction
might mean 50% of (10 + 1.5) % deduction of the total amount invested.
Although this might be a small amount, still it is not desirable. Also, there
is no provision for regular payment of interest rate.

14

Over the last two decades, the RBI licensed twelve banks in the private
sector in two phases. Ten banks were licensed on the basis of guidelines
issued in January 1993. The guidelines were revised in January 2001 based
on the experience gained from the functioning of these banks, and fresh
applications were invited and two more licenses were issued (Yes Bank and
Kotak Mahindra Bank). The Union Finance Minister in his budget speech for
2010-11 announced that the RBI was considering giving some additional
banking licenses to private sector players and even Non-Banking Financial
Companies could also be considered, if they meet the RBIs eligibility
criteria. The draft guidelines on Licensing of New Banks in the Private
Sector were framed taking into account the experience gained from the
functioning of the banks licensed under the guidelines of 1993 and 2001 and
important amendments in December 2012 to the Banking Regulation Act,
1949. Following are the mandated norms that are to be followed:

Entities from both private and public sector shall be able to setup a bank
through a wholly- owned non-operative financial holding company
(NOFHC).

The NOFHC shall be registered as a non-banking financial entity

(NBFC), regulated and governed by a separate set of directions issued
by RBI.

The NOFHC shall hold the bank as well as all the other financial services
entities of the group.

Entities should have a past record of sound credentials, integrity and

should be financially sound with a track record of 10 years.

Banks require a minimum paid up equity capital of Rs. 5 billion.

During the start of operations, NOFHC should hold a minimum of 40%

equity capital of the bank with a lock in period of 5 years which can later
brought down to 15% within 5 per cent within 12 years

The bank shall get its shares listed on the stock exchanges within three
years of the commencement of business by the bank.

Foreign ownership( Non-resident shareholding) of the bank shall be

limited to 49% in the first five years and later it shall as per the policy
prevailing then

At least 25% of the branches shall be opened in unbanked rural centers

(population up to 9,999 as per the latest census) and this is to promote
financial inclusion.

The existing priority sector lending targets and sub-targets as applicable

to the new banks.

Existing NBFCs, if considered eligible, may be permitted to promote a

new bank or convert themselves into banks.

The NOFHC and the bank shall not have any exposure to the Promoter
Group. The bank shall not invest in the equity / debt capital instruments
of any financial entities held by the NOFHC.
15

Indian currency has depreciated around 20% in the last four months, going
low to as much as 29% in three months.

The Causes
US Feds decision to reduce Quantitative Easing (QE): The Federal
Open Market Committee (FOMC) pumps $85 billion per month in the US
market as its bond-buying program. In recent times, it has announced its
intention to taper this by bringing it down to $65 billion later this year and
wrap up by mid-20141. Any tapering of QE will reduce the amount flowing
into the country, bringing down the demand of rupee and hence the
depreciation. This strengthening of US dollars will affect all emerging
economies.
Price of Crude Oil: We have to import bulk of our oil requirements to satisfy
local demand. With rising prices, mainly due to Syrian Crises, increases the
demand of dollars and depreciates the rupee.
Poor Current Account Deficit: With 4.8% of CAD in the previous fiscal
year, and projected as 5.3% for this year, the government has played a
major role in the downfall of rupee. As the CAD increases, we have to
depend on foreign inflows, in the form of FII, to finance our CAD and hence
increasing the demand of dollars.
Low Forex Reserves: As the rupee depreciates the value of the foreign
exchange reserves comes down without doing anything. Currently, India has
forex reserves just enough to cover 7 months of imports. The RBI also sells
forex reserves to control the rupee which is another reason of falling
reserves.

The Effects
Inflation: Rupee depreciation has a direct impact on inflation. With rupee
going down, India has to pay more for importing the same value of goods.
Even if global prices fall, Indians may not benefit as depreciation will negate
the effect. Thus as the cost of import increases, inflation increases, directly
impacting the middle-class.
Slowdown and job loss: Falling rupee will dry up the foreign investments
as returns are diminished. This will create a huge difference between
investment required for growth and what is actually made. This is a medium
term problem but is a serious one, and hence cannot be ruled out.
Education Abroad: Students studying outside India, especially USA, will
have to shell out more on tuition fees and also their travelling cost will
increase as they will become expensive.
Gain for Exporters specially IT sector: IT sector which generates around
80-90% of their revenues from foreign markets, and the falling rupee will
help them increase the actual realization of revenue in rupee terms.
Similarly, other exporters will also gain. But, this gain is not sustainable in
the long run, because as the rupee depreciates the cost of importing the raw
materials increases. And hence, the cost of the items to be exported
increases, making this model very unsustainable.
Remittances: The relatives will get more rupees for the same of dollars
deposited to bank.
16

Measures Undertaken
Introducing limits on Capital Outflows (Capital controls)
The amount of dollars taken out of the country by an individual Indian has
been reduced to US $75,000 from an earlier limit of US $2,00,000 in a year.
At the same time any Indian firm can only invest an amount equivalent to its
Net Worth abroad. If they wish to invest any amount greater than this, they
need to seek permission from RBI. Earlier this limit was to the tune of 4x the
Net Worth.
A point of note here is that this restriction on Outflow is only and only for
Indians and Indian firms investing abroad; however this has hurt the investor
confidence considerably. Even the ex-RBI governor had to give a
clarification that it was a temporary measure and would rolled-back soon.
Revision of FCNR rates
The new RBI governor in his first actions allowed banks to offer higher rate
of returns to FCNR deposits. FCNR stands for Foreign Currency Non
Resident deposits. These are deposits by NRIs made to Indian banks in US
dollar terms. These are fully recoverable as in no forex loss or gain is
charged on these deposits. There are 2 components to this, 1st INR at the
end of the deposit period. The loss incurred due to the difference in prices of
dollar are the Mark-to-Market losses for the bank. Secondly the banks have
a limit of 50% of their Tier-I capital, that they can raise through FCNR, so as
to hedge against any risk of repayment. To solve the first problem the RBI is
offering a 100 basis point or 1% discount on swap of INR and US$. Thus
reducing their cost of funds raised. For the second issue, the RBI has
allowed the banks to raise funds equal to its 100% of Tier-I capital. The
banks will be able to raise US $10 billion from the same. This will also give
them headroom to raise another US $ 38 billion in the short run.
Increase in FDI
The FDI in sectors like Telecom have been raised to 100%, more than 26%
in Defense sector (case to case basis). At the same time many sectors have
been given 49% FDI through automatic, route. The basic purpose of this is
to fill in the CAD. The effective inflow of FDI in India for the 1st increased
from US $ 5 billion to US $9 billion, year-on-year.
Credit Swap Window for Oil Companies and ECBs
RBI has setup a separate window for the oil companies and will provide
dollars directly to Oil Marketing Companies. The OMCs face the brunt of the
rising cost of dollar as their Gross Under-recoveries on Oil and Gas go
through the roof, they have a need of about US $400-500 million dollars
every day to foot this bill. It is like an interest-free loan given by RBI to the
OMCs, thus the RBI provides them with dollars, which the OMCs will repay
to the RBI in rupees within a fixed period but with 0% interest. Also, PSU oil
companies have been mandated to raise additional US$4 bn through ECB.
RBI Bond Sale
The government has attempted to sell bonds to the tune of Rs 22000 crores
on every Monday. The idea was to reduce volatility from the forex markets
by sucking up some of the excess liquidity. However this has led to a sharp
increase in short term interest rates.
17

Import Duty on Gold

The duty on gold and silver was raised to 10% so as to curb imports. Also
the government has implemented an 80:20 ratio rule, where 1/5 of the total
import of gold has to be exported. At the same time they have raised the
cost of credit for gold imports.

The assets of a bank majorly comprise of the loans which the bank gives to
borrowers. Assets on which recovery is swift (payment of principal and
interest is on time) are known as standard assets. However, on some loans
banks face recovery issues (payment pending for more than 90 days); such
loans are termed as non-performing assets (NPAs). Of late, the banks have
been facing NPA issues.
Public sector banks, which have a overall loan book of about than 75
percent of the total loan book of commercial banks, have been severely
affected by NPAs. This has had a direct impact on the liquidity with the
banks and thereby also affecting the profit of the banks; also time and efforts
of management is another indirect cost which the banks have to bear due to
NPAs and it is also likely that the share price of the banks with a high NPA
get a hit in anticipation of loss to the banks in future.
As per a statement released by RBI, the system wide gross NPA is
expected to rise from 3.42 percent in FY13 to 4.40 percent in FY14. The
major reason attributed for this rise in expectation is further slowdown in the
economy being expected.
In 2012-13 banks restructured Rs. 75000Cr of loans under the CDR
mechanism, which was almost double of what it did in 2011-12. It is also
estimated that between 20-25% of such restructured loans turn bad.

The Balance of Payments of an economy is an accounting record of all

transactions of a country with the rest of the world. It has two components:
current account and capital account. The current account is further
subdivided into three components:
1. Balance of trade, which is the difference between the value of
goods and services, exported from the country and the value of
goods and services imported into the country.
2. Transfer payments
3. Net income such as interests and dividends
The current account balance is one of the two indicators of a countrys
foreign trade balance. The largest component of current account is the trade
balance; a surplus in the current account implies that the country is earning
more foreign exchange from exporting goods and services than it is
spending on importing goods and services. Therefore, this positive net sales
abroad leads to creation of foreign assets in the domestic economy. A
current account deficit, on the other hand, depletes the countrys foreign
resource base by extracting more foreign exchange than it injects.
18

What is the Current Status?

The Fed is in the midst of tapering its simulative quantitative easing policy.
On December 18, the Fed decided to taper its quantitative easing policy by
$10 billion per month, to $75 billion. Chairman Ben Bernanke expects the
program to wind down steadily through 2014 and conclude by year-end,
assuming the economy remains healthy. On January 29, the Fed
announced that it would taper quantitative easing by another $10 billion per
month to $65 billion.

What is Fed Tapering?

Tapering is a term that exploded into the financial lexicon on May 22, when
U.S. Federal Reserve Chairman Ben Bernanke stated in testimony before
Congress that that Fed may taper - or reduce - the size of the bond-buying
program known as quantitative easing (QE). The program, which is
designed to stimulate the economy, has served the secondary purpose of
supporting financial market performance in recent years.
While Bernanke's surprising pronouncement led to substantial turmoil in the
financial markets during the second quarter, the Fed did not officially
announce its first reduction in QE until December 18, 2013, at which point it
reduced the program to $75 billion per month from its original level of $85
billion. The reason for this move was that the economy had become strong
enough for the Fed to feel confident in reducing the level of stimulus. The
tapering continued on January 29, with the Fed announcing that the
continued improvement in economic conditions warranted a reduction in QE.
Currently, the consensus estimate is that the Fed will continue to reduce the
size of its QE program through 2014 and ultimately wind it up by the end of
the year. However, this isn't necessarily a guarantee given that 1) the
program is data-dependant and 2) both the Fed chairmanship the several
board positions will change early next year. As a result, both the timing and
extent of the QE withdrawal remains uncertain.
How Will a Tapering Look?
Tapering isnt an immediate, dramatic event. Instead, it is likely to take place
gradually throughout 2014 so as to create minimal market disruption. Also, it
is going to remain dependent on economic conditions. The Fed may pull
back slightly if the economy continues to strengthen, but it could also
increase the program again if the economy slowed or the financial markets
were shocked by an unforeseen crisis.
Market Reaction to Tapering
While Bernankes tapering statement didnt represent an immediate shift, it
nonetheless frightened the markets. In the recovery that has followed the
2008 financial crisis, both stocks and bonds have produced outstanding
returns despite economic growth that is well below historical norms. The
general consensus, which is likely accurate, is that Fed policy is the reason
for this disconnect. Once the Fed begins to pull back on it stimulus, the
markets may begin to perform more in line with economic fundamentals
which means weaker performance. Bonds indeed sold off sharply in the
19

wake of Bernanke's first mention of tapering, while stocks began to exhibit

higher volatility than they had previously. The markets subsequently
stabilized through the second half of 2013, as investors gradually grew more
comfortable with the idea of a reduction in QE.

The Company law, 2013 has brought about many changes from the 1956
version of the law. The new Bill has 29 Chapters, 470 sections and 7
schedules. Following are some of the changes being implemented:
Changes in Number of Members The maximum number of people that could
be members at the time of incorporation were restricted to 50, this has now
been extended to 200. This will allow companies to access more capital
without having to go public.
Incorporation of 1 Person Company Earlier minimum 2 people were required
as members to create a company; with this law a 1- person company can be
incorporated. This allows an individual to create a corporate and to behave
as an organization. This will result in simplifying corporate structures.
However there is a fear that the same will be misused to create a maze of
organization to hide tax and black money
Dormant Company This is a new concept and introduced for the first time in
this law. A dormant company can be setup to hold some assets such as IPR
or as a SPV for a future Project. The features of such a company are that, it
is inactive and is exempted from any compliance.
Cross Border Mergers Earlier only foreign companies were allowed to
merge into Indian companies, as in the overall control was kept with the
Indian company. However in the new law, Indian companies can be merged
into foreign companies under certain conditions. This move will allow global
firms to consolidate their operations and assets on Indian shores.
Corporate Social Responsibility Earlier there were no rules governing
corporate social responsibility. Now each company must formulate a CSR
policy and Invest 2% of Average Net Profits of the preceding 3 years to
CSR. This rule applies only to companies with more than Rs 1000 Crore
Turnover.
Rotation of Auditors In the new law, all listed companies must change their
auditors every 5 years and their auditing firm every 10 years. This
mandatory rotation of auditors was not there before. This will help enhance
trust and auditors independence.
Declaration of Interim Dividend Interim Dividends can only be paid from the
surplus in the Profit and Loss account of the company and present year
profits. This will allow companies greater flexibility in dividend declaration.
Earlier the company could declare dividends even for the profits that were
not yet realized.
Rights Issue At the time of Rights Issues, all shareholders are given option
to get more shares, however employees of the company holding ESOPs did
not receive any such benefit. To remove this discrepancy a provision in the
new law was created to offer Rights Issue to employees holding the ESOPs
as well. This brings ESOP holders on par with shareholders.
Exit Opportunity for dissenting shareholders In terms of the bill, a company
cannot change its object in the prospects or vary the terms of the contracts
referred in the prospectus after raising money form public unless the
20

promoters or controlling shareholder provide an exit opportunity to the

dissenting shareholders.
This new provision will particularly benefit the retail investors. By giving
more power to the shareholders, this provision will enhance the sense of
responsibility of the companies.
Governance Aspects
The Bill incorporates the lessons learnt from the Satyam fiasco and aims to
protect the interests of minority shareholders while expanding the
responsibility on auditors who will face criminal liability if they fail to report
corporate fraud.
Acceptance of Deposits Earlier any company could raise deposits from
Public, given they followed proper procedure such as full disclosures, etc.
However in the light of Sahara and Shradha Chit fund case, the Central
government has demarcated category of companies that can raise money
from the public. The central government has setup more stringent rules and
greater over-sight. This will help increase accountability and reduce chances
of disaster like Sahara.

21

Management Development Institute

Mehrauli Road, Sukhrali
Gurgaon, Haryana - 122007
Connect with us
http://www.facebook.com/monetrix.mdi

http://www.mdi.ac.in