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Niveshak From Editor's DesK
Volume II
April 2009

may have always been blamed of being pessimistic for sharing all bad financial
news and outlook with you through Niveshak since the collapse of Wall Street.
Together we have tried to find the bull among the ruins of the Sub Prime. But
Editor we were chased by bears in all the financial markets from Kospi to Nasdaq. We were also
overwhelmed by negative corporate financial results and unhealthy Macroeconomic reports
Biswadeep Parida
in all the countries across continents.

Team Niveshak But this time we have got some good news for a change. Markets are recovering. Yes,
the bull is back, picking momentum and means serious business this time. All the major
Amit Choudhary share markets have shown green figures on most occasions since 9th of March 2009. After
Nilesh Bhaiya writing off billions of dollars of toxic debt to US Treasury in the past quarters, some of the
Sareet Mishra major US financial institutions are back in profits this quarter.
Sarvesh Chowdhury India has gone a step further in giving positive data. When Kospi, Dow Jones
Sujal Kumar Industrial Average, S&P 500, Nasdaq composite index , Euronext etc have grown by 15 to
Tripurari Prasad 25%, our very own Bombay Stock Exchange has shot up by 35% since 9th of March 2009.
Most of India Inc’s financial results are out and all seem to have shown profits whereas
some of their counterparts in the west have struggled. This may be the first signs of decou-
pling of the Indian Economy from the West but we may be far away from that.
This may be the first signs of recovery but it is too early to predict. The devasta-
tion we have seen till now may be just the tip of the Sub Prime iceberg. We are still not
clear. We shall wait for more good news and positive data for a few more quarters to cel-
ebrate good placement seasons next February.
In the present issue we shall try to focus on another Institution which has been or
at least seemed virtually unscathed from the financial crisis – Microfinance. We will try
to study its growth over the years and evaluate its future prospects in rural India. As we
begin to assume the departure of the crisis, we take a look at the impact the global slowdown
had on Indian Private Equity players and its implications on India Inc. We shall try to
understand the current recession under Minksy’s Hypothesis. This hypothesis states that
bubbles and slowdowns are just a part of the economic boom and bust cycle.
In the current crisis, US and European crisis were the worst sufferers. BRIC econo-
mies were also devastated to same proportions. This crisis may see these powerful economies
loose the reigns of economic growth to the N-11 countries. How true are these assumptions?
We may have an answer. We will also try to substantiate this study with an article on the
Investment opportunities in Nigeria, one of these N-11 countries. This is the account of one
of our friends who undertook his winter internship in Lagos, Nigeria.
World Leaders met at the London G-20 conference and took a few steps to see the
world out of crisis while the International Monetary Fund decided to float it reserve cur-
rency – Special Drawing Rights worth $250bn. Though the move is expected to help emerg-
ing economies with their Liquidity problems, some economists also feel that the allocation
would add to the Inflation-related woes. We shall also try to analyse these news items and
their implications.
I also have some good news from Team Niveshak. In a bid to connect with our stake-
holders, we have launched a blog for Niveshak. This blog will carry latest news from the
world of finance along with all the archive files of Niveshak. You are cordially invited to
All Images and artwork discuss on the latest news and also provide you suggestions and reviews to make your Nive-
are copyright of IIM shak better.
Shillong Finance Club Happy Blogging.

-biswadeep Parida
©Finance Club
Indian Institute (Editor- Niveshak)
of Management, Shillong

Disclaimer: The views presented are the opinion/work of the individual
author and The Finance Club of IIM Shillong bears no responsibility whatsover.

In The News
Ways and Means Advances(4)
G-20 London Summit(4)
Special Drawing Rights(5)

Next 11 Economies(6)

Cover Story

Article of the Month
Was Suprime Predictable(17)

Behavioural Finance(18)

Global Slowdown & Indian PE Players(21)

Food for thought
Fixed Income Markets in India(23)

Investment oppurtunities in Nigeria(26)


© The Finance Club, Indian Institute of Management, Shillong
I n the newS

Ways and Means Advances to the Government
of India for the Financial Year 2009-2010

W ays and Means advances(WMA) are the tem-
porary advances extended by RBI to the gov-
ernment of India to bridge the gap between expenditure
a) Ways and Means Advances : Repo Rate
b) Overdraft: Two percent above the Repo Rate
The minimum balance required to be maintained
and receipts. It started on March 26, 1997, when Govt. of by the Government of India with the Reserve Bank of
India and RBI signed an agreement putting the ad hoc India will not be less than Rs.100 crore on Fridays, on the
T-bills system to end w.e.f April 1, 1997. WMA are not a date of closure of Government of India’s financial year
sources of finance but are meant to provide support to and on June 30, and not less than Rs.10 crore on other
government on account of mismatch in revenue or other days. When 75 per cent of the limit of WMA is utilised by
receipts for meeting the government liabilities. Limits on the Government, the RBI may trigger fresh floatation of
WMA are fixed at the beginning of the fiscal year by RBI. market loans.
For the financial year 2009-10 the limit for WMA is The government borrows through this facility for
decided to be Rs.20,000 crore for the first half of the year 90 days. The advantage of WMA route is that it does not
and Rs.10,000 crore for the second half of the year. The impact market liquidity conditions and helps keeping the
same for the financial year 2008-09 was Rs. 20,000 crore government’s cash flows intact.
for the first half and Rs 6,000 crore for the second half.
-Amit Chowdhary
The interest rate on WMA/overdraft is decided as under:

G-20 London Summit 2009 –
T he Group of Twenty Ministers and Central Bank
Governors (commonly known as G-20), com-
prises of representatives from world’ 19 largest national
parency in financial regulations, to increase cross border
co-ordination and to boost world trade for attaining sta-
bility in the global market.
economies, and an additional representation from Euro- The summit resulted in certain financial commit-
pean Union. Together, they represent 85% of the world’s ments to be met in near future despite the apparent dif-
output. On April 2, 2009 the G-20 summit was held in Lon- ferences among the economies. France demanded
don, the agenda being the revival of the Financial Markets stricter financial regulations and even
and the World Economy. threatened to walk out of
The summit was the continuation of the summit. Germany also
the 2008 Washington sum- had an opinion for stricter
mit where the mem- regulations. However, US
bers agreed to the needs and UK wanted a large
of a new international stimulus package. The end
approach to handle the result was a global deal
challenges to the finan- to provide $1.1 trillion to
cial markets and world tackle global financial
economy. The cause of the crisis. This includes $750
summit was the unexpect- billion for IMF to help
ed global crisis and the need distressed countries,
for immediate steps to curb $250 billion to boost
recession globally. world trade, and $100
The main objectives billion of additional
of the London summit 2009 lending by multilateral de-
were to decide on the mon- velopment banks. An important aspect of
etary and fiscal policy to in- the agreement is the plan for IMF to issue SDRs (Special
crease demand, to protect and support the Drawing Rights) worth $250 billion.
emerging and developing economies and ensuring that Though the agreements have been made to boost
IMF (International Monetary Fund) has enough resources the global demand and increase the money supply
and instruments, to restore confidence, increase trans- through IMF, the actual implementation of these tools
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Niveshak Volume 2 Issue 3 April 2009
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remains a question mark. The poor countries won’t be But, the major outcome of the summit is the grow-
getting the major share of the stimulus package. Only ing power of IMF, and decreased influence of US. Also,
$50 billion from the $250 billion of trade finance will go regular meeting of G-20 in future, to monitor progress in
to poor countries and from the $250 billion of free money the financial market is a positive sign. This may lead to a
from IMF, their share is expected to be only $19 billion. So, completely different outlook to the world economy and
though a lot of promises were made during the summit, financial system in future and is a positive step towards
the effects of these promises seem to be limited. Most of attaining stability.
the countries will rely on their own financial system to
boost the demand. -Nilesh Bhaiya

Special Drawing Rights

C ountries participating in world trade initially
used mainly two kinds of reserve assets – Gold
and the US Dollar. These were traded between nations in
– US Dollar, Euro, Japanese Yen and Pound Sterling. The
weight of each currency is reviewed every five years by
the IMF based on the relative importance of each cur-
order to control their exchange rates and maintain equi- rency. However, the currency value of SDR is updated on
librium in the Foreign Exchange market. But as the Inter- a daily basis based on the day’s exchange rate values of
national trade and financial development was growing the ‘basket’ currencies in terms of US Dollars.
at a rapid pace in 1960s, it became difficult to physically Each member country is allotted a quota which pri-
move gold across nations and moreover, it was necessary marily depends upon its relative size and contribution
to avoid the disproportionate rise in value of US currency to the world economy. SDR is the denomination used
in relation to other reserve assets. And then the world for the quota. The allocation to each member determines
woke up to the need for a new in- its financial obligation to IMF, its ac-
ternational reserve asset. Special cess to financing by IMF and also its
Drawing Right (SDR) was then cre- decision making power. The General
ated in 1969 by the IMF in order Quota decisions are also taken every
to supplement the existing official five years; there have been two gen-
reserves of the 185 member coun- eral quota announcements so far,
tries. The use of SDR by countries both in the 1970s.
to manage their exchange rates can A third allocation of US $250
be explained using a small example: billion is currently under consider-
For instance, if the value of British ation by the IMF after its approval
Pound falls considerably as com- by the G20 nations recently in April
pared to the US Dollar on account 2009. Though the move is being
of heavy inflow in US from British hoped as one which will help emerg-
Institutions, the US Treasury can ing economies with their Liquid-
use its SDR reserves to purchase UK ity problems, some sections of the
pounds from the Forex market in order to increase its de- world of Finance also feel that the allocation would add
mand, thereby increasing the value of remaining British to the Inflation-related woes. Nevertheless, the pros of
pounds. The SDR is also used by the IMF and few other the much needed influx of money seems to weigh over
important international organizations for their internal the few cons, as the additional allocation will reduce the
accounting purposes members’ reliance on other expensive debt instruments
Initially, when SDR was introduced, it was equiva- for building reserves.
lent to US $1. But, as floating exchange rates were adopt-
ed by countries in 1973, SDRs began to be defined in terms -Mohit Khemka
of a “basket” of major currencies of the world, which
have the most significant contribution in World Trade
and Finance. Currently, SDR comprises of four currencies
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© The Finance Club, Indian Institute of Management, Shillong

Looking Beyond the BRICs

W e have heard a lot about the BRIC economies
of late. But have we ever given a thought to
the other economies apart from these BRIC economies?
Economic Growth: The economic growth has gen-
erally been positive and has increased over the years. Re-
cent growth performance has been quite stable, and the
Where do they stand? Have they got the potential to be dispersion in growth is the lowest in 20 years. Though
able to make an impact? With this thought emerged the Vietnam is the only nation amongst N-11 that has grown
concept of N-11, the Next Eleven. in comparison to BRICs, but five others have also aver-
The Next Eleven (or N-11) are the eleven countries aged 5%-plus growth over the last five years.
identified by the Investment Bank Goldman Sachs as hav-
ing the high potential of becoming the world’s largest
economies in the 21st century along with the BRICs. These
nations are Bangladesh, Egypt, Indonesia, Iran, Mexico,
Nigeria, Pakistan, Philippines, South Korea, Turkey, and
Vietnam. The list includes some economies, which are
very well known to the investors like Korea and Mexico,
and some which are very new to them such as Nigeria,
Vietnam, Pakistan and Bangladesh. The reason for their
selection was that they were the next set of large-popula-
tion countries beyond the BRICs.
Goldman Sachs used macroeconomic stability, polit-
ical maturity, openness of trade and investment policies,
and the quality of education as the criteria.

The N-11 Economies
The three major kinds of economies in N-11 are:
a) High income and development levels are in rela-
tively good shape. The biggest challenge is to be able to Market Performance: The market performance has
sustain the growth so that the economies can compete been varied for these nations. Some of them has seen
with the richest ones in the world. Some such economies good growth while others still are very risky in terms of
are Korea, Mexico and Turkey. the market operations. 5 of the N-11 have observed mar-
b) Traditional emerging economies like Indonesia ket gains of more than 300% since 2003, with Vietnam up
and the Philippines where the growth has been strong a spectacular 500% since 2003.
formerly and the attention on growth has been high pre- Openness in the market: The market in these econ-
viously. The challenge here is to move firmly back onto a omies have started opening up for trades over the past
strong growth track. few years, particularly in Vietnam, Egypt and Turkey.
c) Economies which has generally not been on the
growth track recently but have thought-provoking pros- Growth Prospects of the N-11
pects like Egypt, Nigeria, Pakistan, Bangladesh, Iran and GDP Growth: As per the calculations, the N-11 econ-
Vietnam. This group needs the proper investor focus. omies’ aggregate GDP is expected to be about two-thirds
Vietnam currently has the highest growth potential and of the size of the G7 by 2050. All of the N-11 economies
the best chance of delivering it. have an expected growth rate of 4% or more over the
next 20 years, if they can continue with the stable growth
Recent Performance of the N-11 conditions. Even with the solid growth, only Korea and
Global Trade: The overall weight of the N-11’s has Mexico (and perhaps Turkey) are likely to have a reason-
been increasing over the past years and over the past few able chance of catching up with the developed country
years the global growth has increased by around 9%. income levels over the next few decades.
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Increased Demand: The demand from the N-11 is ex- Growth condition and Potential in N-11
pected to increase continuously and they could overtake Growth Conditions: N-11 economies vary greatly in
the G7 in around 25 years and would be twice that of G7 terms of the growth potential. While Korea rates higher
by 2050.Thus their growth contribution will continue to than most developed countries, including the US on one
rise at a fast pace. hand, Bangladesh, Nigeria and Pakistan rank in the low-
est third of all countries. Also, only Korea and Mexico
seemingly have got conditions favorable to make it able
to rival the current major economies. Being a member
of OECD, it has better growth conditions as compared to
the other N-11 nations. Bangladesh, Pakistan and Nigeria
have broad and systematic issues across a range of areas
and other economies have certain specific areas of weak-

Potential: Most of the N-11 governments have off
late been keen on improving their growth conditions.
But, there is a considerable difference amongst the N-11
nations themselves. While Vietnam is the closest to Best
in Class, Nigeria is the furthest away.

While the BRICs dream focuses on the overall shift
in the pattern of global activity, the N-11’s influence might
grow but not to the level of becoming a global story on
that level. While there is no doubt that some of the N-11
economies could join the world’s largest economies, sev-
Rising Income levels: N-11 economies are expected eral more might become large regional economies and
to have large income raise over the next twenty years, some of them (like Vietnam) do seem to have the po-
especially Vietnam, which can possibly have more than tential of showing sustained and structural high-growth
fivefold increase in the next 25 years. The ranking of in- path as has already been displayed by China and India.
come levels is less likely to change than the ranking of As a group, these N-11 nations are already somewhat
economic size. richer and more integrated into the world economy than
Current Market Shift: There has been a shift to- what the BRICs are now. It goes on to suggest that the
wards current developing economies mainly driven by impact of their integration with the global economy is
the BRIC economies, which will help the N-11’s to grow likely to be less dramatic.
at a fast pace.
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© The Finance Club, Indian Institute of Management, Shillong

Because of the potentially large and fast growing structural improvement and the second is how much
markets and with rising incomes and activity, N-11 na- the current environment has inflated artificially, the per-
tions have the potential to become an important source formance of such groupings like N-11 and other similar
of growth and opportunity that can be leveraged by both groups.
the companies and investors over the next two decades As with the BRICs, the goal of the N-11 dream has
or so. If the N- 11 economies can begin to deliver on some been to explore the frontiers of what might be possible in
of their increasingly stated desires to improve growth the world economy in the days to come. This can help us
conditions, they might end up proving to be amongst the be better prepared for the challenges on the road ahead.

By Amit Agarwal
more interesting investment stories of the next few de-
cades. But there are still some questions that are unan-
swered. The first is whether the economic environment
can be turned into broader gains in growth conditions XLRI Jamshedpur
that will lead to an increase in the chances of significant

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icro-lending refers to ex- to traditional credit. However, in recent
tension of very small loans years, this population at ‘The Bottom of
to the people living in the Pyramid’ is considered as a business
poverty who are not considered bank- opportunity rather than a burden on the
able. These people lack collateral, steady society. They are now starting to grab the
employment and a verifiable credit his- attention of social entrepreneurs as well
tory and therefore cannot meet even the as private equity firms.
most minimal qualifications to gain access
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© The Finance Club, Indian Institute of Management, Shillong
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Interest rates
The interest rates on microfinance loans in India
range from 22% - 32%. While this may seem high, they are
still half the rate charged by local moneylender. The high
cost of funds for the MFIs can be explained as follows:
the MFIs get the funds from the bank at 12%, the cost of
credit delivery and collection of payments adds 5% each,
while the cost of provisioning for bad debts and capital
adequacy requirements add another 1%-3% each. Howev-
er, some changes in the regulatory framework enabling
the MFIs to take deposits will enable the MFIs to reduce
their lending rates by about 5%-6%.

Healthy Deposit-Loan Ratio
Fig:The world Economic Pyramid The Challenge for Microfinance Institutions is to
provide affordable services to the poor and at the same
time earn a decent return on capital for the investors and
According to the UN World Development Reports,
become sustainable business opportunities. Maintaining
‘Fortune at the Bottom of the Pyramid’ refers to the poor-
a healthy deposit – loan ratio is critical for this. Collect-
est but largest socio-economic group. Globally, this group
ing deposits from clients has become an integral part
encapsulates about 4 Billion people around the World
of various Microfinance models in various parts of the
mostly in developing countries
world, most notably Indonesia, Bangladesh and also the
SHG-Bank Linkage model, because of a variety of reasons.
Evolution of Micro-lending
Firstly, Savings deposits provide a cheap source of funds
The poor usually suffer from a permanent poverty to the microfinance institutions. These funds can then be
syndrome. They do not have sufficient capital to invest in used for lending to the people who are in need of loans.
productive activities. Low capital leads to low productiv- In fact, the mobilization of savings deposit can go a long
ity, low income and low savings which in turn lead to a way in ensuring the financial sustainability of the micro-
weak capital base. finance institution because the institution will no longer
have to depend on external funds or aids for its opera-
This vicious cycle perpetuates a permanent poverty tions. A live example of this is the model followed by
syndrome. It is believed that the poor will be able to break Bank Rakyat Indonesia. Bank Rakyat Indonesia has been
the most successful in mobilizing savings deposits from
out of this vicious cycle of poverty if they have access to
its clients by offering various savings products and giving
proper and affordable credit. It is not the lack of skills
a thrust on savings mobilization. As a result of this, the
but the lack of access to proper and affordable credit that
program has about 30 million active savers compared to
prevents the poor from coming out of the poverty. This
about 3.1 million active borrowers. The deposit to loan
fact was recognized by Prof. Yunus of Bangladesh who
ratio in 2004 was about 225%. As a result of this sav-
pioneered a Microfinance revolution through Grameen
ings mobilization, the bank branches had access to cheap
source of funds and did not have to depend on external
Micro-lending to Micro-finance funds and also helped them post a profit of $153 million.
Secondly, Savings provide a kind of insurance against any
What started as Micro-lending has, in recent years, chance of default. This is because in case of compulsory
evolved into a wider concept called Micro-finance. Micro- deposits, the borrower has to maintain some savings de-
finance encompasses micro-lending and also includes oth- posit with the microfinance institution which gets for-
er services like deposit services, fund transfers, insurance feited in case of default.
and other financial services to the low income groups.
Microfinance aims at delivering the financial services on Priority Sector Lending
a sustainable basis so that the poor can break out of the
In 2000, the Reserve Bank of India, allowed lending
poverty cycle and raise their income levels. When some
to MFIs by commercial banks to be classified as priority
institutions started micro-lending to the poor, they felt
sector lending. This released large amounts of commer-
the need to offer a gamut of other services, most notably,
cial bank financing for MFIs and allowed them to scale
deposit services and insurance to the poor. This widened
their lending operations rapidly. A number of commercial
the scope of micro-lending.
banks recognized the opportunity provided to partner
with MFIs to expand in rural areas. ICICI Bank pioneered
a Partnership Model with various MFIs which enabled
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them to keep the debt on the Bank’s balance sheet and Banks: This will enable the NGOs to mobilize savings of
enjoy financial leverage to grow their client base. their clients. This model of acting as business correspon-
Global private equity players and domestic banks are dents can incorporate extensive use of technology in the
now chasing MFIs to take a stake or to extend term loans delivery of financial services. The NGOs can accept the
if the industry trends are any indication to go by. Private deposits and make the entry through a hand-held com-
equity funds raise capital from financial institutions and puting device. This will be useful in introducing the con-
banks and lend it to micro finance companies, mostly cept of ‘branchless banking’ in remote areas.
for equity. Venture Capitalists have set up Microfinance 3. Use of Technology in Delivery of Services: Trans-
Funds aimed at funding the needs of new entrepreneurs actions Costs form a major portion of the overall costs
in the industry. This is a quite recent phenomenon and it of the MFIs and push up the cost of delivering financial
will go a long way in ensuring the sustainability of prof- services to the poor. Use of technology, especially mobile
itable MFIs which run on private investor money rather services, can play a major role in lowering the transac-
than donor aid tion costs as well as administrative costs of the MFIs.
IBM in collaboration with FINO, a technology solutions
Indian Scenario: Suggestions provider has introduced the use of multi-purpose smart
cards already reaching out to half a million people. Such
1. Allowing NBFC – MFIs to accept demand deposits:
transaction by a smart card costs one tenth that of a tra-
As stated earlier, in India, a lot of work is being done by
ditional bank transaction. With the right market condi-
NGO – MFIs. These MFIs usually have the legal form of a
tions, mobile banking could help reducing the costs and
NBFC. However, in India, NBFCs are not allowed to accept
reach large numbers of poor people who are outside the
demand deposits. NBFCs are allowed to accept only time
formal financial system.
deposits only after meeting capital requirements. Since
these MFIs are not allowed to accept demand deposits,
The road ahead
they do not have access to a cheap source of funds. This
pushes up their cost of funds and affects their profitabil- Micro-lending has enabled individuals to set up
ity. Some regulatory changes can be made to allow MFIs successful micro enterprises and create assets from the
to accept demand deposits. micro loans availed by them. Micro-finance has the ca-
2. Following changes can be made to allow MFIs to pability to enable them to move up the value chain and
accept deposits: graduate from group-based borrowing to individual bor-
a. Change in Regulation: A change in the regulation rowing based on collateral and a proper credit history.
can be made allowing NBFC-MFIs who meet specified cri- This will enable their inclusion into the formal banking
teria to mobilize deposits. The specified criteria can be in system thus enabling the MFIs to move on to serve other
the form of minimum duration of operation of the MFI, areas as out of the 300 million people in need of microfi-
the number of clients, the size of the portfolio etc. nance services only 40 million have been served till now.
b. MFI – Bank Linkage: The MFIs can adopt a model

By Kushal Agarwal & Surya Ravi
where they can be linked to the banks such that the de-
posits of the clients of the MFI can be maintained in the
banks. The MFI will get a credit facility of an amount
based on aggregate deposit of the clients of the NGO. MDI Gurgaon
c. MFIs can act as Business Correspondents of the

Microfinance in India: A new model
Demand of microfinance in India savings account, most of them use the deposit facility as
a means for safekeeping and find little or no use for vari-
In India, nearly 35% of the population is at the bot-
ous payment services.
tom of the pyramid and the potential for microfinance
services is around 350 million and so far only 40 million • Credit: Though the increase in indebtedness. Yet
is being catered. Out of these, 74% of them live in the only a small portion of the population utilises the formal
rural areas. loan services. The formal loan taken is generally used
for land or machine purchases. Working capital or social
Various indicators of demand:
loans are generally taken from informal source mainly
• Savings or Deposits: Around 59% of the rural because of the collateral.
population does not have a savings account. This could
• Insurance: Access to insurance is very limited and
be attributed to the lack of need for such deposits or
the demand for the product appears to exceed its supply.
lack of knowledge.
• Payment Services: Of the 41% rural people having
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but a point to note would be that the growth has been
region specific and they service very few clients as com-
pared to Grameen bank. Each MFI in India services on an
average 6,500 clients whereas each MFI in Bangladesh
services over 1 million clients. The Indian MFIs are limited
by scope due to regulatory reasons and most of the MFIs
are not supposed to take deposits. The following aspects
in India are hindering the growth of MFIs
• Indian legal and regulatory framework and Cost
Source: RFAS 2003
of funds for Indian MFIs.
Though there has been a significant increase in formal • Capacity & skill constraints and inadequate sup-
rural deposits and credit from 1972 to 2001, yet a large por- port systems
tion of the population still do not have access to proper • Most Indian MFIs lend to SHGs thus all the draw-
formal finance facilities which can be seen in the below backs of an SHG also apply in this case too.
figure. Service Provider Model this has been piloted by pri-
vate banks like ICICI Bank. The current exposure to mi-
crofinance through this model is very small, however
new and innovative approaches are being pursued.
Kisan Credit Card is a new approach to provide cred-
it to the agricultural credit. This model has been conve-
nient for most people considering the ease of disbursal of
credit. However, a cause of concern is the uneven growth
in its distribution across various states. Also 20% of the
large farmers are reported to avail this scheme whereas
Source: RFAS 2003 only 2% of marginal farmers use it.
More such products and services are available like
Rural Finance Providers
Micro insurance, Weather Insurance, Portfolio Securitiza-
India has a range of rural financial service providers, tion of microloans, Commodity price insurance, etc.
including the formal sector financial institutions at one
end of the spectrum, informal providers (mostly money- Constraints
lenders) at the other end of the spectrum, and between Supply Side Constraints
these two extremes, a number of semi-formal/microfi- Banks are reluctant to lend in the rural market be-
nance providers. cause of the following reasons
• Formal providers: Commercial banks, Regional • Uncertainty and Default Risk
rural Banks, Cooperative Banks, Post Office Systems and
• Lack of Credit Information
Insurance companies with limited reach
• Weak Legal and Regulatory Framework and Gov-
• Semi Formal/Microfinance providers: Microfi-
ernment Policy
nance Institutions, Self Help Groups bank linkage pro-
grams • Collateral Issue and Transaction costs
• Informal Providers: Moneylenders, Trade Credi- Demand Side Constraints
tors, Local Shopkeepers From the perspective of a rural borrower, the fol-
lowing reasons make formal/semi-form rural finance an
Existing Products and Services unattractive option
• Absence of Flexible products and services
A few of the most important products and services
along with their current status in India are given below • Collateral Issue and Transaction costs
SHG-Bank Linkage Approach has been the most suc-
cessful format in the recent years. A New Model
The model has its own share of concerns in the form From our perspective, a new model could be set
of up that would successfully overcome most of the issues
• Scale of operations of the SHG program and high faced by the existing products and services. This model
cost of group formation. would require the creation of a new entity, say a Micro-
finance Entity (ME), for the sole purpose of promoting
• Lack of capacity to promote and maintain groups
microfinance activity. Following are the characteristics
to ensure quality
of the new model
Microfinance Institutions have grown over the years
• It would be an extension of the existing SHG
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Niveshak Volume 2 Issue 3 April 2009
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format and also combines the Grameen methodology. It ey is being used and how effectively it is being used, it
would introduce the idea on the lines of a Social Stock would attract donors to participate
Exchange (SSE) • With the possibility of making profits, though
• The new entity created would have as its cli- not as much as in the normal capital markets, it would
ents the following three types of groups: attract more number of the socially conscious
(1)The normal Self Help Groups, (2) people
Individuals who do not have the op- • The units bought through this
portunity to form a self help group route could also be considered as a part
of their own, (3)Groups which need of the banks obligation to lend money to
financing for a project in which each the priority sector, which would be more
group member has a stake. attractive to banks considering possible
This model is based on the returns from the project
SHG format because of its success • This route would be more attrac-
in India and to capitalise on the vast tive for a borrower as it would be cheaper
network of rural banks in India. The as compared to a loan. The unique point of
model would require each rural this model is that if the project is successful the in-
bank to create an Micro Enterprise. vestors as well as the farmers would be benefited,
These MEs could fall under the regula- however if the project fails the farmer would just
tory framework of NABARD. These MEs be affected by the loss of the project but not by
would have the following characteris- the burden of paying any interest which would
tics: have been the case if the farmer had taken a loan.
• These MEs would have subsi- This might also induce entrepreneurial spirit
dised financing from NABARD • The MEs would benefit by the commis-
• Lending by all banks to MEs sion charged and could collaborate with NGOs
would be considered towards the bank’s to make people aware of such opportunities
legal obligation to direct a fraction of their However the above model could have the
loans to the poor. This would also induce following disadvantages
the private banks to participate in the pro- • With increased attractiveness of
cess. As the ME is a part of the rural bank, commercial loans, there could be a de-
it would be able to accept deposits. crease in lending of social loans
The ME would also include the • In the case of loans chan-
Grameen methodology of microfinanc- nelled through a normal SHG, the
ing as an SHG method might exclude same constraints would apply in this
individuals who are among poorest of model as well. The same applies for
the poor because of their relatively lower loans given through the Grameen
economic status. The ME would pool such methodology.
individuals and ask them to form groups
Yet this model would help them
and the rest would follow the Grameen
model. For those groups whose members want to to prove the situation considering the following
be partners for a common project, the ME would advantages
tap the market to fund their projects. These • The stock exchange route would ensure better
projects are first evaluated for feasibility by the quality of the groups formed
ME as well as the track records of each member • Cost of the groups formed would be low in the
would be considered and if successful, the details of the case of commercial borrowings
project would be put up on the proposed stock exchange • With better quality of groups formed, the model
for the market to be a part of it. The investors would buy has better financial sustainability
the units related to the project and be benefited with divi- • The MEs formed would also provide borrow-
dends once the project is successful. The investors could ers with deposit facilities as they are a part of the rural
also trade their units on the stock exchange depending on banks. Also cost of funds in the case of commercial bor-
their perception of the success of the project. With the rowings would be low.
introduction of the stock exchange the following advan-

By Akshay Sathya & Hitesh Parikh
tages could be realised
• A facility to tap the market, especially the socially
conscious market. It would also provide means to regu- MDI, Gurgaon
late the microfinance market.
• It would create a conduit for donated money. As
this would give a clear picture of where a donors mon-
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© The Finance Club, Indian Institute of Management, Shillong
Cover stor Y

Commercial Microfinance: Process and Challenges
While micro-lending dates back hundreds of years, varied as the investment management institutions they
perhaps thousands, modern microfinance can trace its put their money in. Those institutions range from banks
roots to nearly simultaneous initiatives in Bangladesh and and funds to offshore and onshore investment compa-
Bolivia in the mid-1970s. The Grameen Bank in Bangladesh nies and a hodgepodge of other creatively organized and
has had enormous success over the years in taking its alternatively financed institutions. The microfinance in-
peer-group-based model to rural clients throughout Ban- stitutions (MFIs) that dole out the loans and other finan-
gladesh, and has exported that model to several other cial products are an assortment of credit unions, cooper-
countries, where it has been repeatedly copied and modi- atives, NGOs, commercial and private banks, government
fied by other Microfinance Institutions (MFIs). agencies and a myriad of derivatives of these institutions
Commercial microfinance, on the other hand, is rela- – every bit as varied as the rural peasants, urban mothers,
tively new. It wasn’t until the early 1990s that a conflu- roadside traders, Arctic fishermen and Slavic seamstress-
ence of supply and demand factors drove the provision es who borrow their money. Collectively, however, all of
of some micro-lending into a profit-focused model with a these players have managed to achieve social agendas
double bottom line – a return to investors and a socially such as poverty reduction and economic development,
responsible agenda. On the demand side, many MFIs had and it can be – when managed properly – profitable. For
finally reached a level of efficiency where subsidized loans investors, microfinance is a new and exciting asset class
were not only no longer necessary, but in some cases were that is already a growing parts of the portfolios of some
a disincentive to the efficient management of commer- institutional and individual investors the world over.
cial microfinance and an obstruction to the social goals In commercial microfinance, the process begins on
of economic development and self-sustainability. Mean- the supply side with an investment into any number of
while, the size of the microfinance industry worldwide microfinance -oriented funds, investment companies, co-
had hit a point where subsidized funds from government operatives or partnerships. The investment might be a
agencies and multilateral institutions like the World Bank securitized or non-securitized share in a fund, an equity
were no longer sufficient to cover demand. Global politi- share in a company or partnership, or a share in a coop-
cal and economic changes contributed to the growth in erative. In many cases, commercial microfinance funds
demand, as rapid democratization in Eastern Europe and will take a combination of public and private funds, in-
the former Soviet Republics, along with capitalist reforms cluding subsidized loans from multilateral institutions or
sweeping many Latin American and African countries, left commercial microfinance loans that are guaranteed by
hundreds of thousands of rural peasants suddenly depen- quasi-government agencies – such as the U.S. Overseas
dent on no one but themselves. Private Investment Corp. (OPIC).
While the demand was escalating, the supply side of
microfinance was undergoing its own renaissance. Mean- Process of commercial micro finance
while, there was a surge in the amount of private sec- Commercial microfinance is a “work in progress.”
tor funds looking for alternative investments. Emerging The institutions that administer and manage microfi-
market investing hit its heyday in the early 1990s. Around nance funds are constantly evolving to address the needs
the same time, socially responsible investors such as Amy both of the credit clients they serve and of private inves-
Domini and mutual fund groups such as Calvert and Pax tors. Increasingly, oversight authorities are being estab-
raised the level of awareness of socially responsible in- lished and standardized guidelines are being developed
vesting, and began to show investors that it isn’t all about that are improving disclosure and reducing the potential
charity – that investors can help make the world better for corruption and mismanagement – which in recent
while still earning a return on their investment. During years have plagued other sectors of global finance, in-
early 2000s, when the dot-com bust, ensuing economic cluding the investment banking and mutual fund indus-
and stock market downturns in the U.S. and other de- tries. Already, most of the MFIs that do receive commer-
veloped countries sent some investors out of the stock cial microfinance funding are required to pass through
market in search of new, alternative places to put their formal, third-party audits and to meet certain reporting
money. and accounting guidelines. And recently, the MicroCapi-
tal Institute implemented a service to provide ratings on
Commercial aspects
the microfinance funds and investment companies them-
Microfinance is undoubtedly one of the most diverse selves, which should help to boost disclosure and adher-
sectors of global finance, so it comes as no surprise that ence to international standards. Increasing competition
there is no single model that covers the institutions that will continue to drive the efficiencies, costs and perfor-
manage commercial microfinance. mance of all parties involved with microfinance, from the
Microfinance investors are a mixed breed – they span investment managers to the MFIs.
continents and classes, genders and races, and they are as
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Niveshak Volume 2 Issue 3 April 2009
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Challenges practice of microfinance by small and big players is also a chal-
Microfinance, at large, has been practiced by small lend- lenge. To nurture the development of micro finance in way
ers especially in rural areas to mitigate the poverty. Sometimes to suit the small financial requirements of poor population a
borrowers either fail to repay the loan either because of their proper plan of action has to be comprehended by policy makers
tardiness or due to failure of their low scale business. This situ- of economy.
ation leaves individual lender hapless. Here comes need of suf-
ficiently managed body of lenders and borrowers. Groups of Regulation on MFIs
people come together and make dedicated group called self help
The need for regulation and supervision of MFIs arises
group (SHG) to carry out small lender-borrower relationship.
from several considerations. While all types of financial institu-
Other challenge is to mitigate incentive problems that make it
tions irrespective of their origin and mode of registration and
difficult for providers and (potential) users of financial services
incorporation have to report statutorily to RBI, National Bank
to come together in the market place, and to create incentives
for Agriculture and Rural Development (NABARD) or to some
that make it economically rational for them to do business with
specified agency like SEBI or National Housing Bank, the NGOs
each other. In this context it is necessary to distinguish between
engaged in providing microfinance services do not have to com-
three levels of incentive problems, and thus also between three
ply with any statutory requirement in this regard. These agen-
levels of institutional design.
cies mainly purvey small sized credit to their clients besides, in
some cases, mobilizing small savings from them.
Regulation and supervision of the formal banking institu-
tions is well organized under various Acts, viz. B R Act, Regional
Rural Banks (RRB) Act, Cooperative Societies Acts and RBI Act.
While RBI supervises commercial and urban cooperative banks
and NBFCs, NABARD has been authorized to supervise RRBs and
cooperative banks on behalf of RBI. Regulation is, however, al-
most entirely attended to by the RBI. As regards MFIs, none
except those registered as NBFCs and cooperatives are presently
treated as part of the financial sector. As most of them are
registered as societies or trusts, the question of their supervi-
sion and regulation from the financial angle had not arisen.
Figure 1: Various level of incentive relationship involved in MFIs
Except submission of annual accounts and a report on their
The first level consists of the lending operation, and hence operations to the authorities under the Acts of their registra-
the relationship between lenders and borrowers and the market tion, these agencies are not under any statutory compulsion to
for small and micro loans. A borrower who conforms to the con- comply with specified norms or instructions in respect of their
cept of human nature assumed by economists “naturally” does microfinance activities encompassing mobilization of savings
not want to pay back a loan that has already been disbursed and granting of loans.
to him/her. In many developing countries and transition econo-
mies, it is very difficult to use the legal system to enforce con-
tractual obligations to make interest and principal payments.
That is the reason why microfinance institutions (MFIs) have to Microfinance, no doubt, has opened a new avenue for
be able to find methods of persuading their borrowers to pay business focus for financial institutions. A large portion of
back their loans, with interest, on time and in full which are not world population is still to be tapped for financial services. This
only effective and inexpensive, but also socially acceptable. in turn, gives a paradigm shift for financial firms, which have
The second level refers to the internal structure and oper- experienced ups and downs in their regular financial practices.
ating methods of MFIs. The objective here is to develop strong Micro finance provides an opportunity to go rural and complete
incentives for employees, and especially loan officers, which in- the human-organization financial relation at large scale. Many
duce them to issue a large number of small loans and also to banks and financial firms have lined up to create a consortium
see to it that they are repaid. Incentives are also needed for staff which focuses on microfinance. Having solidified microfinance’s
in management positions to ensure that, despite the presumed reputation as a valuable development tool, the next generation
higher cost of issuing small loans, they do not stop serving small of MFIs must now demonstrate poverty alleviation. Extensive
and micro entrepreneurs, who constitute a particularly impor- new funding sources are necessary. MFIs must pursue new cap-
tant target group from the point of view of development policy, ital sources by aligning the core qualities that distinguish them
yet at the same time focus on maintaining the financial sustain- from funding competitors.
ability and soundness of the institutions they manage.

By Md Manauwar Alam
The third level of incentive problems concerns the inter-
action of three groups: (1) those who manage an MFI, (2) those
who provide its equity, and (3) those who offer funds for techni-
cal assistance.
NMIMS, Mumbai
At this level, the problem of the ownership structure and
corporate governance of an MFI is posed– a problem which
tends to be particularly acute when the institution in question
is financially successful. It is the way in which this problem is
addressed, more than any other factor, that determines whether
an institution of this kind remains viable in the long term, and
also whether it remains relevant as an instrument of develop-
ment policy in the long term. Government regulation on the
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© The Finance Club, Indian Institute of Management, Shillong
Team Niveshak
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Article of the montH

WAS Predicatble?
M insky’s Financial Instability Hypothesis (MFIH)
talks about the natural cycle of boom and
bust in financial markets of expanding economies. Ac-
Subprime Crisis Explained by MFIH
A variety of complex factors contributed to the sub-
cording to Minsky, the cycle starts in boom period when prime crisis which the world’s most successful nation is
the overall feeling about the economy is optimistic. This witnessing today. Innovative securitizations, credit sup-
optimism leads to overestimation of future expected re- ply without gauzing the risks associated with it, inability
turns from the investments made in the current period. of the subprime borrowers to pay back their debts and
In order to make these investments, debts are guaranteed the fall in asset prices led to the first financial crisis of
with very little margin of safety. Due to the speculation, the 21st century.
the equation between debt and risk changes and the fi- With mortgage based securities (MBS) and Collater-
nancial value of the assets rise. al Debt Obligations (CDO), the credit risk of the subprime
Minsky defined three different types of income debt borrowers was repackaged into attractive mortgage in-
relations. These are: struments and sold to third party
• Hedge Financing: Firms investors. These third party inves-
which can fund their debt tors had the right to cash flows
through their cash flows. obtained as a result of the yearly
• Speculative Financing: payments of the loans. Consum-
Firms which can fund their inter- erism boom was at its peak in
est only through their cash flows. USA during 2005 and as a result
the asset prices were the highest.
• Ponzi Financing: Firms
This wave of consumerism led
which have negative cash flows
the public to buy real estate at
and cannot even fund their inter-
Hyman P. Minsky astronomically high prices with
the loans advanced by mortgage
Minsky suggested that in institutions.
a booming economy, the mar- Ph.D. (September 23, 1919, Chica-
If we analyze this situation
ket will be dominated by hedge go, Illinois – October 24, 1996), was an
in USA at that time using MFIH,
financing. Debt would be raised Economics professor at Washington
we can conclude that the over-
from the market at very high risk University in St Louis. His research
all sentiments of the public were
due to the speculation about fu- focused on understanding and expla-
good and the estimated returns
ture benefits. But over a period nation of financial crises. He was a
of these asset-purchases by the
of time the weight of speculative Keynesian who believed in the Gov-
public and the loan advancement
and Ponzi financing tend to in- ernment’s intervention in financial
by the companies were consid-
crease in the overall debt. This markets.
ered high. As a result the debts
happens because the change in
market was booming and the
the balance between debt and risk leads to fragility in the
institutions gave subprime loans without assessing the
market. The market finds out that the estimation about
risks associated with the loans. This changed the debt-
the future benefits was highly eschewed. At this instant,
risk equation as mentioned by Minsky and was the chief
the hedge financing converts into speculative financing.
architect of the subprime crisis.
This trigger leads to a financial crisis during which major-
ity of the financing converts to Ponzi financing. The graph shown below compares the real assets
prices in Y axis and time in X axis where t denotes the
Page 11

© The Finance Club, Indian Institute of Management, Shillong
Article of the montH

year when the crisis started. It shows that in all crises,
the asset prices boom because of the over expectation of Big 5 crises include Spain
future returns from the assets. In case of USA it has sur- (1977), Norway (1987), Finland
(1991), Sweden (1991) and
passed the other crises average by a huge margin and has Japan (1992).

also started falling as an aftermath of the crisis, similar
to others.

Big 5 crises include Spain
(1977), Norway (1987),
Finland (1991), Sweden (1991)
and Japan (1992).

In the graph above, t in the X axis denotes the year
in which the crisis started and index in the Y axis denotes
the public debt. We can conclude that the hallmark for
any financial crisis has been the high levels of debt in-
curred by the public. The same case is followed in US as
The borrowers who had borrowed huge debts to fi- well where the debts have been rising since the last few
nance their purchases gradually started defaulting by the years. This increase in debt during the boom period with
early 2007 when the interest rates began to rise. Simulta- no consideration for the risks leads to an imbalance in
neously, the real estate market began to crash. These two the economy. This in turn results into a financial crisis as
events combined together brought about the subprime suggested by Minsky.
crisis which we are witnessing today. Borrowers could We can safely conclude that financial crises oc-
not pay back their loans and the mortgage institutions cur because of the imbalances in the debt-risk equation
could not recover their loans by selling off the proper- which takes place in an economy. Minsky suggested that
ties as these prices had crashed. This had a catastrophic boom and bust in an economy follows a natural cycle
effect on the third parties which had bought the MBS as which is inherent in a capitalist economy. The real rea-
they could not get back the payments guaranteed. This son for the onset of a crisis is the fallout in the debt-
mortgage default payments and mortgage asset devalu- risk equation which is more probable to happen in a
ation forced the financial institutions to write off huge booming economy. This is what happened during the pre
amounts of debt. subprime crisis days from 2002 onwards till 2006 during
All these events triggered a sharp credit crunch in which debt was given to borrowers without considering
the market and companies all over the world are find- the risks involved.
ing it difficult to raise money from the market. Credit
crunch has also instigated a slowdown in the consumer-
ism which is having a cascading impact on the industrial

By Mayank Sinha & Girish Rathor
IIM, Kozhikode
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Niveshak Volume 2 Issue 3 April 2009

a l F i n a n c e
B e h a v i o u r
E ver wondered why the stocks in which you in-
vest always plummet down while those that
you choose not to put your money in always seem to
ing the principle of representativeness when he believes
that the small sample he observed is more representative
of the population than it really is. Extending the same
do well? Most of us have faced this question quite often principle to real financial markets leads to bubbles often
and ended up cursing our luck for an answer. But in real- when the short term trends in one sector are extrapo-
ity, there fortunately exists some logical explanation for lated to the entire market. What the investors faced after
the illogical decisions that investors make and the subse- the market crash in Jan 2008 was an example of repre-
quent effect on markets. sentativeness. This “law of small numbers’ emphasizes
Behavioural Finance, also termed as ‘open minded that people tend to put too much weight on recent expe-
finance’ is a study of the influence of psychology on the rience. As we saw, when equity returns were high for a
behavior of financial practitioners and aims at explaining long time, many people began to believe that high equity
why and how people make seemingly irrational decisions returns were normal. Two common mistakes investors
and systematic errors when they spend, invest, save, and make are excessive trading and the tendency to dispro-
borrow money. portionately holding on to losing investments while sell-
Financial markets have been subject to speculations ing winners. These systematic biases are believed to have
and inefficiencies. It is believed that market efficiency their origins in human psychology like overconfidence,
is based on three conditions; rationality, independent herding instinct, limited investor attention or the human
deviations from rationality and arbitrage. Behavioral fi- desire to avoid regrets. Sometimes people’s preferences
nance questions all these assumptions in an attempt to also create distortions. For instance, a relatively higher
understand the behavioral explanations of overall market gain might make some feel better by as much as a small-
outcomes. Are investors really rational? A gambler often er loss makes them feel worse.
bets based on past trends knowing fully well that rou- Mullainathan and Thaler point out three important
lette tables have no memory. Why does he put so much ways in which humans deviate from the standard eco-
at stake in a risky gamble at roulette table, with a faulty nomic model. Bounded rationality reflects the limited
strategy and a negative expected return? Similarly, many cognitive abilities that constrain human problem solving.
investors do not achieve the degree of diversification that Bounded willpower captures the fact that people some-
they should. Others trade frequently without keeping tax times make choices that are not in their long-run inter-
minimization in mind and paying huge amount as com- est. Bounded self-interest incorporates the comforting
missions. Many are more likely to sell their winners than fact that humans are often willing to sacrifice their own
their losers, a strategy leading to high tax payments. interests to help others.
Furthermore, deviations from rationality are often Behavioral finance also shows what managers of
systematic. Behavioral finance attempts to incorporate firms, other institutions and financial players might do to
these human departures from rationality into standard take advantage of market inefficiencies. This falls under
models of financial markets. Our gambler above is follow- arbitrage behaviour where sophisticated players stand
Page 11

© The Finance Club, Indian Institute of Management, Shillong

ready to capitalize on the mistakes of the naive. to ‘Gambler fallacy’ heuristics, which develops by living
The tools generally used for studying people’s deci- in a make believe world where the investors expect a
sion making behavior in financial markets are simulation low price stock to recover, just because of its long range
models, empirical analysis and forecasting. The behavior- average price. Others use the average price to earnings
al principles come mainly from psychology, sociology and method and believe that a stock is undervalued simply
anthropology. Some of the commonly observed principles because it has a lower price to earnings than that of the
include heuristics and framing. Heuristics makes decision industry average. What investors fail to understand is
making easier but can sometimes lead to biases. Many that they should have the temperament to control the
investors tend to equally divide their funds into various urges which can get them into trouble due to investing.
avenues which may not necessarily be the optimal alloca-
tion. On the other hand, overconfidence can also lead to …Silver light
too little diversification, because of a tendency to invest Greed and fear can be called the real protagonist in
too much in familiar areas. Men tend to be more con- the stock market. The Prospect Theory coined by Kahne-
fident than women, and this has clear implications on man and Tversky in 1979 throws light on some investor
their respective trading behaviors. The conservatism bias reactions and decision making under conditions of risk
contradicting the representative bias, states that people and uncertainties. Loss of aversion is what binds most
tend to be slow to pick up on the changes and thus might of investors. Studies point that people feel pain of loss
underreact. twice than pleasure of gain and hence they try to hold on
losses with the hope that tomorrow will be a better day.
Rules Of The Game Another aspect is regret aversion.
“If one goes by simple law of logic, one plus one will Though there are clouds of grey that loom over, but
be equal to two but when you talk about emotions one investors are getting wiser with time. The traditional old
plus one could be anything”, was opined by Parag Parikh, players do accept their mistakes and quickly learn from
the author of the famous book Stock to Riches. them and move on. They maintain a ‘book of profits’ and
The field of behavioral finance cannot be termed reduce losses by selling off.
new as psychology has been considered to play a key role Hence it’s all about means to realize the end. And
in determining the behavior of market for long. However, the end can be made beautiful by quietly observing and
in recent times it has been taken up much more seriously bringing out the rationale behind the fallacies. By careful
especially in relation to decision making by pioneers like observation of behavioral patterns of oneself and those
Paul Slovic. prevalent in market, investors can get an edge over the
In broader terms, behavioral finance can be grouped basic fundamental tools that form the maxims of the
into two segments; illusions due to heuristic decision market.
processes and illusions caused by the adoption of mental Apparently, not all the number players are the rich-
frames. est people around.

By Swati Goel & Tripurari Prasad
Heuristics refer to rule of thumb. It’s the same as
what we use in uncertain conditions or complex environ-
ments. When using heuristics one doesn’t stick to ratio-
nal decision making process, taking a 360o approach and IIM, Shillong
evaluating all the relevant information objectively, rather
takes mental ‘short cuts’ in the process, as one would say
“the easy way out”.
Heuristics can be dangerous as they can spring up
FinQ March’09 Issue Answers
anomalies like ‘representatives’. This arises due to the
tendency of investors to create stereotypes. This can lead 1. Western Union Money Transfer
to wild goose chase of some of the hot stocks with glam- 2. Metlife
orous past data and avoidance of stocks which have per- 3. Amar Bose
formed poorly in the recent past. 4. London Stock Exchange
Another anomaly that investor gets into is labeling 5. Union Bank of Switzerland
companies and writing them off even before analyzing 6. Vatican City
their worth. In India for instance, multinational firms get 7. Money Laundering
higher rating while public firms receive a lower rating, 8. Bangalored
even though the payouts are handsome. This is termed as
9. Sunil Bharti Mittal, Bharti Group, Bharti Tele-
“Anchoring” by behavioral science experts.
Another one is overconfidence heuristic where
overestimation of skill leads investors to making mis- 10. Shell Bank/Direct Bank
takes. Often the investors find themselves in a soup due
Page 22

Niveshak Volume 2 Issue 3 April 2009

Global Slowdown
Impact on Indian private equity
I ndia witnessed a booming private equity activ-
ity in the recent years, with the growth of lo-
cal funds and the arrival of global players. The particular
situation in India — characterised by family-owned com-
panies, a huge listed sector, and yet a relative lack of li-
quidity in the market enabled the private equity firms to
position themselves as partners in order to become the
preferred source of investment capital.
However the scenario has changed drastically in the
past few months: stock markets are at a two-year low. size. Almost three fourths of the investments during 2008
The US and European markets are in a turmoil, and the were in the sub $25 million category, with the maximum
global economy is feared to be moving into a recession. number of investments falling in the $5-10 million range.
There is a liquidity crunch so much so that even banks Another noteworthy point is that a majority of invest-
are borrowing at exorbitant rates. The major challenges ments were seen in the first quarter of the calendar year
for PE firms right now are: the cash crunch, convincing 2008 whereas the last quarter was a poor performer both
the management about valuations and delays in profit in terms of number of deals (66) and the total money
bookings. Although the number of deals may have come invested (USD 1.1bn)
down; but they are indeed happening. The growth is
driven by anticipated huge private sector participation in
attractively growing sectors like infrastructure, banking
Pre-Crisis Period
and finance, IT, telecom, pharmaceuticals and healthcare The Indian economy had been enjoying a period of
sustained growth at around 8 percent a year. Favourable
market scenario and some spectacular and well docu-
Indian Private Equity Scenario
mented exits attracted the attention of private equity
In India, private equity is reasonably young, dating houses who had been participating in an unprecedented
back to the mid-1990s. In the past few years, there has number of investment deals. PE firms both local and in-
been an increase in number of private equity players, ternational started looking at wide range of sectors from
with India’s stock markets booming and sectors like the pharmaceutical, automotive, engineering, real estate to
life sciences, infrastructure and real estate being growth financial services, media, telecom, insurance, informa-
stories for the future. Global firms such as Warburg Pin- tion technology.
cus, KKR, Blackstone and the Carlyle Group have a pres-
Favourable market scenario and other complimen-
ence in India while Indian players like ICICI Venture, Ko-
tary prospects of the Indian markets resulted in exponen-
tak Group, Motilal Oswal and ChrysCapital are planning
tial increase in the number of deals, average deal size and
to expand further.
total investment. The table given below depicts the above
The Indian PE market seemed attractive to these mentioned trends.
international players for many reasons: its entrepreneur-
ial status; an investment base that truly understands the
multiple opportunities for PE; and a developing infra-
structure with strong underlying economic growth.

Private Equity Transactions in 2008 & 2007
The total number of private equity transactions in
India in 2008 was 399 amounting to ~USD 10bn. As can be
seen from the following table, a majority of investments
were done in the Late Stage. The year also saw significant
number of PIPE deals as the listed companies were avail-
able at unbelievable prices
However, 2008 saw a decline in the average deal
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© The Finance Club, Indian Institute of Management, Shillong

Crisis Period and beyond ation of the companies. The current market scenario is not re-
After riding on a boom and witnessing stupendous flective of the true valuation of the target and the PE firms have
growth year-on-year, PE players such as Baring Private Equity difficulty in ascertaining the metrics against which to value a
Partners, ChrysCapital and Kotak Group among others have in- company.
dicated that they will soon take a conservative approach to- • Due Diligence Issues
wards investments. The slowdown has resulted in making the With the recent Satyam fiasco, the private equity firms
availability of funds difficult and putting pressure of exits on have to go in for even more careful due diligence with respect
marginal players. to the target. The confidence and trust in auditors has got af-
In 2006 and the 2007(H1), a bubble had developed in the fected.
PE market; the debt and acquisition multiples rose above his- • Problem with Exits
torical norms. However as the crisis hit, the LBO debt could not Year 2008 witnessed very few exits. The money that was
be syndicated. This led to pulling out of many deals and renego- invested 2-3 years ago is now tied up till the markets recover as
tiations of others. Globally, the average deal size has decreased there are negligible exit opportunities available to the investors.
from USD 519 mm in the second quarter of 2007 to less than
USD 200 mm in the subsequent quarters. New Emerging Sub Sectors
Recent Trends The global slowdown has affected almost sectors of In-
dian economy severely and in such distressed times Private
1. Debt vs. Equity Equity players need to target the new untapped sectors. After
It is not just the volumes and sizes that have decreased; analyzing various sectors we suggest the following three sec-
there is a change in the structuring as well. Private equity deals tors that hold the potential for future growth.
now involve more equity and less of debt than during the pre- 1. Airlines Maintenance and Certification Companies
crisis period. Whatever the debt portion is there, it is on less
• Currently there are 430 airplanes that fly domesti
favourable terms. The average spread of the Leveraged buyout
loans vs. The LIBOR has also increased. cally, expected to grow to 750 by 2010
2. Partnerships • Airplane maintenance market projected to be US $2
There is a growing trend towards private equity investors billion in 2010
partnering with corporate for joint acquisition. There are thus • Hardly any airline maintenance companies
more Co-Investment Opportunities. currently
3. Increase in Holding Periods • This work is currently largely outsourced to US and
PE firms are witnessing slower and negative valuation European companies
multiple growth. This has increased the holding period to en- 2. Wine Companies
sure a good return. Another reason for increase in holding peri- • With the rise in the disposable income and greater
ods is that private equity firms are spending more time improv-
awareness, wine is gaining popularity in India and
ing portfolio companies’ operational performance.
wine consumption is growing at 40-50% per year
The above trends and changes in the Indian Private Eq-
uity sector has resulted in a lot of restructuring which might • Wine industry is expected to grow at CAGR of 25%
give way to major changes in the working of the whole sector. over the next 5 years( more than any other sector)
The course of future changes will depend on how the following 3. Automotive Training Companies
critical issues are addressed. • Indian automotive industry is likely to face a short
• Will the governments intensify the regulation of the age of 2.5 million skilled personnel by 2016.
private equity industry?
• E-learning company named Adayana has partnered
• Will tax rates on private equity distributions rise?
with 38 auto firms to create curriculum to train over
• How will the industry’s public image evolve?
a million workers
• Can the basic private equity business model still
work? Future trends
Future challenges After analyzing the portfolio, market conditions, availabil-
ity of capital , attractiveness of different sectors we can predict
This could well turn out to be private equity’s finest hour. the following trends in the Private Equity domain for the com-
if the industry moves carefully and skilfully to help with the ing few years.
global economic turnaround, partnering at times with corpora-
• Private equity activity may moderate but will remain
tions, sovereign wealth funds, and governments. Various chal-
lenges that confront the PE players at present are as follows:
• Demand for investment capital from companies in the
• The Debt Problem
region will rise
The main problem in today’s scenario is that the debt is
• Local private equity firms will be the most active inves-
not available cheaply. In India, there has hardly been any his-
tory of LBO deals. And with the current financial crisis, the LBO
• Minority state transactions will predominate

By Abhinav Chugh & Nidhi Kai cker
model seems to be getting extinct.
• The Evaluation Problem
Another issue that the PE firms are facing is that of evalu-
FMS, Delhi
Page 22

Niveshak Volume 2 Issue 3 April 2009
Food for thoughT

The past, the present and the opportunities in future

The Past players entered the market increasing the competition
leading to efficient pricing of financial instruments. Inno-
W ith Commercial Banks forming the foundation
of the Indian financial system till the 1990s
and money lending having dug its roots deep, it took
vative Financial Instruments such as Zero Coupon Bonds
and Capital Indexed Bonds were introduced. This did not
however receive a good response due to the lack of so-
a considerable amount of time for the Capital markets
phistication in the markets during the 1990’s. The system
to carve its position in the Indian financial system. The
of Primary Dealers was introduced in 1995 and a majority
foundation stone for the equity markets was laid in 1875.
of the GOI bonds are handled by them. A number of re-
Increasing activity was seen in the stock markets with
strictions on Foreign Investments in Debt Securities were
the coming up of the BSE, India’s oldest stock exchange
removed, e.g. FIIs with 100% Debt Schemes were allowed
in 1965, the inception of NSE and the setting up of SEBI in
to invest in GOI Securities and T-Bills while other FIIs
1992 to bring in a uniform enforceable code of conduct in
were allowed 30% investment in these instruments.NSE
equity market (in wake of the events such as the Harshad
also set up its Wholesale Debt Market (WDM) segment.
Mehta scams), along with the liberalization wave of the
These measures increased the transparency and liquidity
1990’s and the conversion to electronic trading, led to the
in the system and hence there was a broadening of the
huge surge in the stock market activity and the subse-
market and ten-fold increase in the Primary market for
quent stock market boom in the recent times.
G-Secs between 1990-91 and 1998-99.
Despite the boom in the stock markets the debt
The debt markets however still faced a number of
markets in India have remained sluggish as opposed to
inefficiencies such as:
the developed countries like the United States, where
• Lacking market breadth due to dominance of a
bond markets are more popular than equity markets.
few players
Some reasons for this include firstly the Government
regulated interest rates. The government had intention- • Lacking Market depth due to the strategy of
ally kept the interest rates low for a long time to ensure holding to maturity by leading players
a low cost of funds for the government leading to poor • Poor retail participation due to incomplete and
interest among investors towards debt instruments. Sec- slow communication of information.
ondly, there were regulatory limits on investments from
foreign investors. Thirdly, lack of transparency loomed Corporate Bond Market: Domestic savings mobi-
the financial system. This along with the lack of liquidity lized by financial institutions was the major source of
due to non-tradability of GOI bonds on an exchange (only credit for companies till a decade back. The factors which
bilateral negotiation between dealers was done, leading led to the poor situation of corporate debt markets in
to inefficient pricing), led to lack of interest for fixed in- India include firstly the higher attractiveness of equity
come instruments among Indian investors. issue for corporate due to the abolishment of the office
of the Controller of Capital Issues (CCI), which allowed
The Present companies to price their equity issues as per the market
The Indian debt market has transformed itself into appetite. Secondly, the domestic debt market declined
a much more vibrant trading field for debt instruments due to offshore issuance of debt. Thirdly, increasing pri-
from the rudimentary market about a decade ago. The vate placement of debt which has grown 6.23 times to
credit for this goes to the liberalization of the Indian Rs. 62461.80 crores in 2000-2001 since 1995-96, has lead
economy in the 1990s and the changes brought about to a decline in liquidity in the corporate debt market.
by the Narasimhan Committee appointed in 1991 whose The corresponding increase in public issues of debt has
broad goal was to increase the role of markets in resource been merely 40.95 percent from the 1995-96 levels. All
allocation. This was achieved through a shift from admin- these have caused PSU’s to dominate the corporate debt
istrative control of credit, and government controls on market.
prices of securities such as shares or bonds. Interest rates The Future
were deregulated and controlled by market forces of de-
mand and supply. Auction system was introduced for sale With highly liquid debt markets in US, Europe and
of dated government securities in June1992. Many new other developed countries, the focus is now shifting to
Page 22

© The Finance Club, Indian Institute of Management, Shillong
Food for thoughT

the Asian Countries. Japan currently leads the lot with trading desks in India to maximize returns by betting on
the biggest debt market in terms of size, liquidity and the direction of interest rate. (ref. Chart3).
turnover. In the AXJ (Asia-ex–Japan) region, China, Korea
and India currently seem to be the top three debt mar-
kets. The following factors indicate a very promising fu-
ture for fixed income (debt) markets in India
Some of the major factors which make India the
next best destination for setting up fixed income division
within the AXJ space include:
1) Bond Market Size (Local Currency): India’s debt
market is the fourth largest Debt Market in Asia with a
Debt Market Capitalization of INR 20 trn (USD 505bn).
Further, India’s Government Bond market is one of the
largest after Korea and China. (ref. chart1)

Chart 3: Returns and volatility of local currency bonds (Source: HSBC AXJ Guide 2007)

4) Maturity profile of Government Bonds: This is an
indicator of Market depth. India has a longer average ma-
turity profile than other AXJ countries and a well devel-
oped yield curve up to 20 years .The Indian FI market is
deep and liquid in longer dated bonds which can extend
up to 20 yrs. India thus has a deep market in Government

Chart 1: Chart 1: Local Currency Bond Market Size (Source: HSBC AXJ Guide 2007)

2) Bond Market Growth: Growing at a CAGR of
18.56%, it is the fourth fastest growing bond market
among AXJ countries after China, Thailand and Vietnam
(over the last three years) Thus we can see a tremendous
growth potential in Indian markets as opposed to many
other countries in the AXJ space.(ref.Chart2)

Chart 4: Maturity profile of Government Bonds (Source: HSBC AXJ Guide 2007, CCIL
data 2007), Reuters

5) Other Factors :
• Market for Corporate Bonds: Even though the
corporate bond market in India is not too big, it has the
third largest corporate bond market among AXJ space af-
ter China and Korea with total corporate bonds outstand-
ing of USD 5 bn. There exists a huge potential for devel-
opment in this space given that liquidity for these bonds
is improved in the secondary market. The regulators are
Chart 2: Bond Market Growth (Source: HSBC AXJ Guide 2007) thus focused on improving the depth and liquidity in this
3) Returns and Volatility: India ranks highest in market and credit derivatives have been introduced in
terms of average Annual Return from local currency the Indian Market.(ref. Chart5)
bonds (10.64%) in AXJ space making it an attractive in-
vestment option to investors. The Indian bond market
also has maximum volatility in the AXJ space allowing
Page 22

Niveshak Volume 2 Issue 3 April 2009
Food for thoughT

potential for growth in the near future and banks may engage
in profitable domestic bond trading in India in the near future.
There are a number of macroeconomic factors which in-
dicate a bright future for the Indian debt market in the future.
The story of Equity growth has become questionable with the
SENSEX declining by more than half from the all time high in
Jan 2008 and the impact of the global financial crisis on the
markets. Secondly, events like the Blockbuster IPO of Reli-
ance Power which was oversubscribed 72 times, now trading
at much lower than issue price and cancellation of several
IPO’s has added to the skepticism towards equity investment.
Thirdly, overseas borrowing has become very expensive owing
to credit crisis and RBI. Finally, the government’s requirement
of long term financing for Infrastructure is not fulfilled by the
equity markets. Moreover with the global credit crisis, the gov-
Chart 5: Corporate Bonds Outstanding (Source: HSBC AXJ Guide 2007, CCIL data 2007, ernment must turn to the domestic bond markets for funds.
• High potential for Convertible Bond market: India’s The way ahead
equity market is the third largest in terms of equity market The above factors indicate a very high potential for the
capitalization after China, Korea in the AXJ space and fourth growth of Indian debt markets. A few large Indian names al-
largest in terms of annual equity turnover after Korea, China ready active in off-shore bond market-ICICI, Reliance, Bank of
and Taiwan. This indicates the high potential for Convertible India, Canara Bank, SBI, Vedanta, IDBI. However a number of
bond market in India. (ref. Chart6) gaps need to be filled before the dream of a strong debt mar-
ket could come true. The three key features that an investor
looks in any investment are: Return, Risk & Liquidity. The in-
vestment must be favorable to the investor in at least two of
the above aspects. Thus for the Indian debt market to reach its
full potential, some of the below listed measures may need to
be implemented:
• Increasing investor awareness about Government se-
curities as an option for investment and improving liquidity in
the secondary market that will provide them with an exit route
• Incentivizing and encouraging infrastructure projects
to raise funds through the debt route. This will help deepen the
market ( due to longer maturity periods of these bonds)
• Improving Transparency by trading bonds on the ex-
change rather than OTC, leading to higher competition, better
price discovery and better supervision and enforcement of trad-
Chart 6: Equity Market Size and Turnover (Source: S&P Fact Book 2007, ISMR Journal ing norms.
(NSE) 2007) • Leveraging existing equity trading Infrastructure can
• Interest Rate Swap Market: India has the third highest be modified to work for debt trading.
IRS market daily turnover of USD 4bn. among the AXJ countries • Disintermediation and removal of the system opera-
after Korea and Singapore. (ref. Chart7) tor: Introduction of IT in the system to reduce the number of
middle parties like primary dealers to reduce cost inefficiencies.
Thus among the AXJ countries India is one of the most at-
tractive destinations to set up a fixed income division. In wake
of the recent sub-prime issue and its impact on the Indian mar-
kets, current investments in the debt market (especially deriva-
tive instruments and structured products) may be have been
surrounded by a lot of questioning and skepticism. But in the
longer run given all the above stated factors like high returns
and volatility and a deep government bond market, trading in
fixed income instruments in India will be profitable. The need
of the hour is to implement the necessary measures to increase
transparency and generate awareness about the debt market
among Indian investors. Once these are implemented, and the
macroeconomic conditions return to a slightly more normal
Chart 7: Interest Rate Swap Market Turnover (Source: HSBC AXJ Guide 2007, CCIL data condition, it is not too difficult to foresee a bright future for the
2007, Reuters) Dalal Street in the Debt Segment

By Anuradha S
If we look at all the above factors we can notice that India
seems to be consistently among the top three- four among the
AXJ countries right after China and Korea on most of the factors. IIM, Bangalore
Thus it is evident that the bond markets in India have a high
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© The Finance Club, Indian Institute of Management, Shillong

A World of oppurutunities

T he country Nigeria is associated only with oil, fight,
killing… and its only these bad things that come to
mind (at least that’s what came to my mind when I heard about
a chance to go to Nigeria). But after landing there I got a differ-
ent perspective altogether. The people are very happy, friendly,
warm and kind. Did you know that they are the happiest people
on earth!(2003 survey conducted by New Scientist) No doubt
the country is ransacked, even by the government but the peo-
ple here live with a hope that things will turn around and for
the better. Almost 80% of the revenues coming from oil go to
the government and it has done little to improve the livelihood
of the people. Some of the interesting things I noted are,
• They greet everyone and if you don’t greet back they
think that you are rude
• ‘Okada’(bikes) is a mode of public travel – mostly the banks are posting continues two digit growth and they are
Bajaj CT100 all in expansion spree.
• They spend more and try to live their life to the fullest Oil continues to be the sector which contributes to ma-
jority of the export revenue. According to Oil and Gas Jour-
• Most middle class families own a car
nal (OGJ), Nigeria had 36.2 billion barrels of proven oil reserves
(mostly second hand) as of January 2007. The Nigerian government plans to expand
• There is no railroad service its proven reserves to 40 billion barrels by 2010. Nigeria is the
• Almost the entire country runs on generator world’s eighth largest exporter of crude oil and the country is a
(hence diesel is costlier than petrol) major oil exporter to the United States. In 2006, Nigeria’s total
If you look closer at it, Nigeria itself is three countries by oil exports reached an estimated 2.15 million bbl/d. Security is
demography and two by religion. The main religions are Chris- of major concern for the expats working in the Oil companies
tians and Muslims, and since this country is primarily import (especially in Port Harcourt). But still companies continue to
driven the cost of living is on the higher side. The expats should invest, primarily because it the world’s 8th largest producer of
go around with caution as some see them as moving banks! One the black gold.
of my friend told me that he was robbed at gun point and when Telecomm is one of the fastest growing sectors in Nigeria.
he went the next day to the police station to complain, he saw Major telecom companies like MTN, Glo, Starcomms are widely
the same there as a cop!!! But the good news is that they don’t present. Almost everyone has two connections! One CDMA (like
hurt you if you just give them what you have. MTN) and other is the GSM (like Glo). The primary reason being
Then where are the opportunities? With high risk comes the communication across network is not good and it’s also
a high return. Majority business here is NOT matured and there costly. You don’t need to give any documents/proof to get a
is a lot of scope for growth. There is also room for mistakes connection, all you need is 300 Naira’s (around $2) and you have
unlike country like India. The government is planning a lot to a connection that works! Internet is quietly picking up. VOIP
ensure that Nigeria is on top 20 Nations by 2020, and there are is the happening thing in the corporate communications and
some steps taken towards the fulfilment of it. The economy companies are slowly moving towards it.
of Nigeria is one of the fastest growing in the world with the All in all the next phase of growth will be seen in devel-
International Monetary Fund projecting a growth of 9% in 2008 oping and underdeveloped country so pack your backs and see
and 8.3% in 2009. Doing business in Nigeria (rank 108 in 2008) is you in Nigeria!
easier than India! (120 in the same period), according to “Doing (The author of this article did his Winter Internship with To-
business database”. laram Group and was posted in Lagos, Nigeria for two months This
Banking is the most booming sector with 15 of the top 20 article is his view on the economy of Nigeria.)
scrip’s( in terms of market capitalization) are banks and these

By PNV Kannan
command almost 50% of the total market capitalization. About
21 companies got listed in the year 2008. In 2006 Nigeria’s bank-
ing sector successfully completed a consolidation program un- IIM, Shillong
der the supervision of the Central Bank of Nigeria. In 2007 Ni-
gerian banks such as Intercontinental Bank and Guaranty Trust
were the beneficiaries of significant foreign investment. Most of
Page 22

Niveshak Volume 2 Issue 3 April 2009

1. Who am I????

a) I fled Nazi Germany to settle in America. During late 1970’s I served as the vice chairman of the board of American Stock
exchange. My core competency was hedge funds which is my pioneering concept.
b) I was proposed by Mr. John Maynard Keynes in 1944, but I never came into being. I am still being mentioned whenever there is
a meeting of IMF related to inflation. Can you please mention my origin place?
c) d)

e) I founded a bank (Indian Bank) which completed its 100 years in 2006. The bank founded by me nationalized in 1969. It also has
the reputation of being the first bank to be conferred with ISO 9002 certification. Please name my bank also.
f) I came into being under the rule of Philip the Good in Belgium. I was burned down in 1858. You can call me great great grand
father of Wall Street.

g) I am the first first private sector mutual fund of India. I got merged to Franklin Templeton.

2. What is common between Sir Benegal Rama Rau, K. G. Ambegaokar , H V R Ienga and Dr Manmohan Singh.
All of them differ slightly from Sir Osborne Smith, Sir James Braid Taylor, Chintaman Dwarkanath Deshmukh.
What is the difference?

3. Which was the first public sector mutual fund to be set up after the Unit Trust of India and which year?

All Enteries should be mailed at by 10th May 2009 23:59 hours
One lucky winner will receive cash prize of Rs 500/-
Page 22

© The Finance Club, Indian Institute of Management, Shillong
Team niveshaK

The article of the month for March 2009 goes to Mr. Mayank Sinha and
Mr. Girish Rathor of IIM Kozhikode. They recieve a cash prize of Rs.1000/-.

Fin-Q Winner for Last issue
Mr. Shyam Krishna of IIM Shillong. He receives a cash prize of Rs.500/-.

The team Niveshak invites article from B Schools all across India. We are
looking for original articles related to finance & economics. Students can
also contribute puzzles and jokes related to finance & economics. Refer-
ences should be cited wherever necessary. The best article will be featured as
the “Article of the Month.” and would be awarded cash prize of Rs.1000/-

Please send your articles before 10th May 2009 to Do
mention your name, institute name and batch with your article.
Format: Font:- Times New Roman, Size:- 12, Length <= 5 Pages in word doc/docx.
Please DO NOT send PDF files and Kindly stick to the format.
Number of authors 2 at max.

Drop a mail at

Team Niveshak
Page 22

Niveshak Volume 2 Issue 3 April 2009
Finance Club
Indian Institute of Management, Shillong
Mayurbhanj Complex,Nongthymmai
Shillong- 793014