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NIVESHAK

THE INVESTOR VOLUME 2 ISSUE 2 MARCH 2009

Islamic Finance
Niveshak From Editor's DesK
Volume II
ISSUE 2
March 2009

I
t has often been seen that the world of finance reinvents it-
self once every decade. During the last five years we saw the
world of high street finance pass through one of its highest
Editor peaks building a regime of unimaginable optimism before disgraceful-
Biswadeep Parida ly fading into the oblivion. We saw the emergence of new economies,
evolution of new structured financial products, unprecedented rise of
stock markets into stratospheric levels, rise of commodity prices, high
Team Niveshak growth of international trade and most importantly an air of positive
Amit Choudhary sentiments prevailed all over the world. This fairy tale ended with
Nilesh Bhaiya a catastrophe wiping out the most formidable names of the BFSI
Sareet Mishra sector. In the mean time, the Islamic banking industry was being
redefined and reinvented as banks, the world over. Assets of finan-
Sarvesh Chowdhury cial institutions offering Islamic products and services have soared
Sujal Kumar by almost 25% year-on-year over the past decade, to about USD 300
Tripurari Prasad billion today and projected to reach USD 1 trillion by 2013. Govern-
ments and central banks have taken a lead in supervising Islamic
banks, encouraging their growth and have passed Islamic banking
and insurance laws in their countries.
In our last edition we had covered the emergence of such a new fi-
nancial institution – The Sovereign Wealth Funds. The current cover
story aims to provide a comprehensive overview of the fundamentals
on which Islamic Banking works, issues & concerns surrounding it
and try to find if it can respond to the opportunities presented by
the current downturn with its range of Shariah-compliant products.
Today, conventional banks in non-Muslim countries too cannot af-
ford to ignore the growing demand for Shariah-compliant products.
We shall try to answer if it will be beneficial to leverage the wis-
dom of Shariah scholars who have identified financial solutions that
conform to Islamic ethics, and the contractual mechanisms that bind
them.
Apart from this we shall also cover an issue that threatened the
credibility of corporate India not so long ago- The Satyam Fiasco.
We will try to understand and appreciate the role of Debt financing
in corporate structures, leveraged buyouts as well as in running an
economy as huge as India at such a fast pace. Our articles will ad-
dress issues concerning Debt Deflation, the future of leveraged buy-
outs owing to the current recession and the difficulties faced for the
institutionalization of the World Trade Organization.
As the world is struggling to find tools & techniques for in-
vesting in the current times, we see this as a golden opportunity for
picking up gems at throwaway prices. We present to you-“Value In-
vesting”, the tool that has largely been responsible in making Warren
Buffet the “Oracle of Omaha” and the most respected investor of the
era. Introduced by Prof. Benjamin Graham in the book “The Intel-
ligent Investor” in 1948, the concept of “Value Investing” is, till
All Images and artwork today, the most successful tool in long term investing.
are copyright of IIM Hope you find this a useful issue. Happy Investing.
- Biswadeep Parida
Shillong Finance Club

(Editor- Niveshak)
©Finance Club
Indian Institute
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.
ContentS

Debt Deflation
Liquidation defeats itself- Page 4

Corporate Governance
The Satyam fiasco- Page 5

Article of the month
Value investing- Page 8
Cover Story
Islamic finance- Page 11

Change Economics
Obama regime- Page 17

Leverage & Investments
Global Recession- Page 18

Institutions
WTO- Page 21

Food for thought
India’s growth story- Page 23

Perspective
Page 24
Finlounge
FinToon- Page 7
FinQ- Page 26

© The Finance Club, Indian Institute of Management, Shillong
Debt DeflatioN

««««««««««

»»»»»»»»»»
T
here are various reasons and explanations Does the debt deflation theory have any relevance
cited for the financial mess that the US in the current economic crisis? It is very much relevant.
economy has turned into. The core of every In fact what we are seeing in US housing market seems
explanation points to the fact that the US borrowed too a classic microcosm of debt deflation. Mortgage debt has
much. Now, there are only four ways to wriggle out of spiralled out of control and debt deflation made espe-
this debt: cially ugly by the fact that key financial players are highly
1. Grow out of debt leveraged — their assets were mainly bought with bor-
2. Inflate the debt away rowed money. Just about every financial institution has
3. Default on the debt been trying to reduce its leverage — but the plunge in
asset values has nonetheless left these institutions with
4. Socialize the debt
more debt relative to their assets than before.
Debt deflation is #3 and this apparently what the
The cure of debt deflation is hazy, nobody knows it.
situation seems to be heading towards, if left to itself.
The debt deflation of 1930’s was cured with World War
This is what is happening. The US government on the
II (if you call that a ‘cure’). Japan’s bout with deflation in
other hand, is attempting to switch it to solution #4.
the 1990’s was never really cured. Although three solu-
In many ways, 2008 has been an odd year. For exam- tions have been proposed by various economists:
ple, the year began with inflation being the biggest global
1. Fisher’s solution is simply reflation i.e. an eco-
headache. However, the evil of inflation was replaced
nomic policy whereby a government uses fiscal or mon-
with demon of deflation by the time the year ended.
etary stimulus in order to expand a country’s output. This
Deflation as we all know refers to persistent and is what the Fed is currently implementing.
generalised fall in prices. Some might argue that lower
2. Keynes advocated massive debt-funded public
prices should be good for consumers as they increase
works projects: The General Theory of Employment, In-
their purchasing power. But the situation changes if the
terest and Money (1936). Build pyramids, or bury mon-
falling prices are associated with falling wages, rising un-
ey in bottles for people to dig up — it does not matter
employment and falling asset prices. In the current envi-
what.
ronment deflation could cause serious problems because
household debt levels are high in many countries. Sus- 3. Dropping money from helicopters, as described
tained deflation would increase the real value of debt at by Nobel-laureate Milton Friedman in The Optimum
a time when asset prices are falling and nominal incomes Quantity of Money (1969).
are weakening. If individuals attempt to reduce their debt 4. The U.S. government has a technology, called a
burden by cutting spending (which only intensifies defla- printing press, that allows it to produce as many U.S. dol-
tionary pressures) and selling assets (causing further falls lars as it wishes at essentially no cost says Bernanke.
in asset prices), the risk is that a vicious “debt deflation” With all that being said it remains to be seen that
spiral may take hold. will any of it work. Fisher wrote his paper in 1933 and
Debt deflation was coined by the economist Irving thought that his country was emerging from the Depres-
Fisher way back in 1933. He observed that when highly sion then but it took a few more years. There are many
indebted individuals and businesses get into financial years of excesses to be wrung out and there is still a lot of
trouble, they usually sell assets and use the proceeds to pain to come for the global economy in the near term.
pay down their debt. Fisher pointed out, however, that

By KaranParmanandka & RajatBrar
such selloffs are self-defeating when everyone does it: if
everyone tries to sell assets at the same time, the result-
ing plunge in market prices undermines debtors’ financial
positions faster than debt can be paid off. So deflation in XLRI Jamshedpur
asset prices can turn into a vicious circle. And one con-
sequence of what he called a “stampede to liquidate” is a
severe economic slump.
Page 4

Niveshak Volume 2 Issue 2 March 2009
Corporate governancE

««««««««««
* in IT: The Satyam Fiasco
Corporate Governance
»»»»»»»»»»
W
here the country is already facing econom- companies (Maytas Properties and Maytas Infra) owned
ic crisis, one more bad news came from by Raju’s sons at extortionate price of $1.6 bn. It is dif-
a very high-profile IT company, Satyam ficult to comprehend that the accounts have received
Computer Services Limited (hereinafter referred as ‘Sa- clean audit reports from auditor (Pricewaterhouse) when
tyam’). Satyam fraud is the latest that has shaken India’s assets have been fictitiously included in the accounts.
financial foundation by its sheer audacity, tenure and These incidences put question mark over the corporate
magnitude. Satyam has succumbed to the temptation of practices of companies in India and also on the credibility
stretching earnings to maintain a quarterly growth trend of auditors.
to please short-term investors, resulting in compromis-
ing governance norms. The company is out of indices like Key Events
Sensex, Nifty, Dow Jones as well as derivatives segment. 16 Dec.: Satyam announces plan to buy two build-
Important learning from this episode is that, in busi- ing firms part-owned by the outsourcer’s founders for
ness, survival requires deep commitment to ethics and $1.6 billion. It does a rapid U-turn, killing the deal just
corporate governance. The Satyam episode has done a lot 12 hours later following a 55% plunge in the company’s
of damage to the reputation of India Inc. and it has al- share price in a day of hectic US trading.
ready resulted in greater due diligence from customers as 17 Dec.: Ramalinga Raju says the about-turn reflect-
they seek higher level of disclosures from their outsourc- ed negative investor reaction. Satyam shares continue to
ing partners and invest more in contingency planning. It slide, falling by a third on concerns about corporate gov-
may not be surprising if bodies like the Asian Corporate ernance.
Governance Association, which had put India third out 23 Dec: Satyam barred from business with the
of 11 Asian countries on corporate governance in 2007, World Bank for eight years for providing Bank staff with
downgrade India. Add to this Satyam has received the “improper benefits”. Its shares fall another 14% to their
World Council for Corporate Governance’s Golden Pea- lowest in more than 4-years.
cock Award for excellence in corporate governance not 26 Dec.: Mangalam Srinivasan, an independent di-
once but twice. It is a strong case for the World Council rector, resigns.
for Corporate Governance to consider its own method-
29 Dec.: Three more directors quit, but Satyam
ology in selecting the winners for their Golden Peacock
shares rise on hopes for moves to improve shareholder
awards. It requires deeper scrutiny.
value and corporate governance.
The Great Fall of Satyam 30 Dec.: Shares extend gains on talk of private eq-
uity interest and a management change. One of Satyam’s
Ramalinga Raju resigned as chairman on Jan. 7, re-
largest investors says it could sell its stake.
vealing profits had been overstated for years and that
02 Jan.: Satyam says its founder’s stake fell by a third
$1 bn of cash and bank
to 5.13%. Analysts say this means the company is a more
balances on the com-
attractive bid target.
pany’s books did not
exist. Satyam fraud is a 05 Jan.: Shares tumble 9% on concerns of corporate
microcosm of the greed governance issues.
that has infected the 06 Jan.: Shares rise more than 7% on a newspaper
world financial system report Satyam had been approached by smaller rivals
and is the real cause of Tech Mahindra for an all-share merger.
the current meltdown. 07 Jan.: CEO and Founder B. Ramalinga Raju resigns.
The world would never Shares plunged by 77%.
have known about the (Sources: Reuters)
fraud had a few share- Raju’s predicament has occurred despite Satyam ob-
holder activists not serving all the norms of governance. Evidently it is not
been persistent in op- rules alone that matter but their implementation. While
posing the unanimous- India Inc. aspires to be benchmarked against world class
ly approved resolution bodies, it cannot achieve this without streamlining its
of December 16, 2008, regulatory process or enhancing its disciplinary provi-
acquiring two property sions.
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© The Finance Club, Indian Institute of Management, Shillong
Corporate governancE

Regulatory Loopholes in India must be done by external auditors for listed companies.
a) Clause 49 Following are some important actions taken:
In the Listing Agreement between a company and a a) Share-pledges to be disclosed
stock exchange, Clause 49 protects the interests of inves- SEBI has made it mandatory for promoters of com-
tors by ensuring good governance practices and disclo- panies to disclose details of shares pledged by them. The
sures. Here are the provisions of the clause: details of disclosure should be made in two stages: event-
»» Executive and non-executive directors should based and periodical. Details of pledge of shares should
make up the board of directors. At least 50% of the board be made to the company and the company should in
must comprise non-executive directors. turn inform the same to the public through the stock
»» Independent directors should comprise at least exchanges
50% of the board if the chairman is an executive director. b) Peer Review
If not, the figure should be at least 33%. To boost investor’s confidence SEBI Committee on
»» A qualified and independent audit panel should be Disclosures and Accounting Standards (SCODA) has rec-
set up with at least three members. All should be non-ex- ommended the peer review of audit of accounts of large
ecutive directors, with the majority being independent. companies. Review would be in relation to the last quar-
»» The clause defines the responsibilities of the audit terly results and the last audited annual financial results
panel in all matters of financial reporting and enhances and for this purpose, a panel of auditors would be pre-
the accountability of top management, especially CEO & pared by SEBI.
CFO. c) Restatement of accounts
»» The revised Clause 49 clarifies the standards of A company could reopen and revise its accounts
independence for directors by defining ‘independent’ and even after their adoption in the annual general meeting
excluding any relatives of promoters, senior management, and filing with the Registrar of Companies in order to
former auditors or consultants. comply with technical requirements of any other law to
Drawback: Sebi does not have the teeth to penalize achieve the object of exhibiting true and fair view. The
firms not complying with its provisions. revised annual accounts would be required to be adopted
Result: Clause 49 is practiced in letter, not in spirit. either in the extraordinary general meeting or in the sub-
sequent annual general meeting and filed with the Regis-
b) ICAI Accounting Standards trar of Companies.
Indian accounting standards were to be aligned d) Open-Offer Rule
with the International Financial Reporting Standards by According to SEBI’s current regulation, an investor
2008. However, Indian company law must be amended, who acquires 15 per cent of a company needs to make
and full convergence can happen only by 2011. an open offer for another 20 per cent at a price, which
Drawback: ICAI is lenient towards erring auditors. is not less than the average share price of the previous
Result: Action against faulting members often gets six months. But in Satyam’s case, the largest shareholder
delayed. The Global Trust Bank case is still pending. L&T holds 12 per cent and the six-month rule means that
the buyer, who already has acquired 15 per cent stake
c) SEBI would have to make an open offer at a much higher price
than its current market price. Recognizing the abnormal
Since 1992 Sebi has introduced several stock market
situation, SEBI has decided to amend the regulation.
reforms, but it has been slow to react on many issues.
e) Corporate Governance issues
Drawback: The body is not proactive.
SEBI is likely to come out with a concept paper on
Result: Scams every few years; the Ketan Parekh fi-
revamping Clause 49 of the corporate listing agreement
asco in 2001, the IPO scandal of 2005-6.
to give independent directors more powers and strength-
Steps Taken en disclosure norms.
f) Dividends declaration
Government named a three-member board, includ-
ing Kiran Karnik, Deepak Parikh and C. Achuthan, to over- Listed companies must declare dividends on per
see the functioning of scam-tainted Satyam. Larsen & share basis instead of percentage basis as different prac-
Toubro (L&T), Essar, Spice and the Hindujas have shown tices of declaring dividends create confusion in the minds
their willingness to take over the whole or part of Sa- of investors.
tyam. A S Murty, a Satyam veteran of 15 years was named The Way Forward: Opportunities in Threat
the new CEO of satyam on Feb 5. Company has received
bank sanctions for Rs 600 crore as a planned fund infu- This crisis can be used as an opportunity to learn
sion towards its working capital requirements. and implement practices of good governance to add
Bitten by the Satyam fraud, SEBI is finally waking long-term value to an organization. Market has become
up to a more proactive role in ensuring corporate gover- extremely savvy. The good news is that the market has
nance. Internal audits have been made mandatory and it first time acknowledged the gains from good corporate
governance. While some companies lost almost 25% due
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Niveshak Volume 2 Issue 2 March 2009
Corporate governancE

to Satyam fall out, a number of companies with good crime will help us put into place new regulatory mecha-
governance like Tatas, Wipro, Infosys either gained or suf- nisms that will prevent such acts of shame and disparage
fered marginal loss. It is an opportunity for India Inc. to in future. This incidence should not color the contribution
enhance transparency, efficient allocation of resources of the Indian IT industry, which has been a role model for
and maximizing stakeholders’ value. Company’s board setting standards in corporate ethics and governance for
should adopt the accounting standards as stipulated by the country and has also pioneered the fundamentals of
the ICAI, a duty to maintain proper books of accounts, meritocracy. This episode may be a good opportunity for
prepare final statements that conform to acceptable stan- all of us: governments, private sectors and individuals, to
dards and to exercise due diligence before signing the self-reflect and continue to probe deeper internally about
report. Listed companies must comply with RTI Act. Com- our business depth, governance culture, and sanctity of
pany’s board should frequently assess and monitor risk business.
across the organization. Corporate need to define and

By Ni lofar
implement properly well defined process of recruitment
of independent directors. It should be possible to provide
detailed information on accounts including the ledger ac-
IIM Shillong
counts with individual details of debtors, creditors, Bank
accounts, inventory, etc in e-form. Rating agencies and
Bankers can do independent analysis of the accounts and
the type of frauds that were possible in Satyam can be
avoided.
Let us hope that the Satyam fraud was a derange-
ment and that the lessons learnt from this pusillanimous

FIN TOON

Page 7

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

««««««««««
»»»»»»»»»» Past Trends and Current Opportunities in India
at a big enough discount rate to allow some room for error
in your estimation of value. However, this does not imply
that value investments are low-risk, low-return ventures. In
fact, value investors believe that low risk investments actu-
ally result in high returns. This is well demonstrated by the
success of value investors like Warren Buffet. In this article,
this statement will be tested by evaluating the performance
of some value stocks in the Indian market during the previ-
ous stock-market boom.
Value Investing in Current Scenario
The current slowdown has brought about an interest-
ing scenario for stock markets around the world. The stock
market is under a strong hold of the bears and investors
are wary of putting their money into stocks. The financial
sector crisis in the US has seen stocks around the world
What is value investing tumble to levels, which were unthinkable less than a couple

V
alue investing is an investment paradigm which of years ago. Most people would thus argue that the best
is based on the ideas of Benjamin Graham & strategy to play the stock market right now is to stay away
David Dodd. The ideas of this theory developed from it. Value investors, however, differ from this view. The
with Graham and Dodd’s teachings at Columbia Business value investing philosophy suggests that the current condi-
School, USA, in late 1920’s. The ideas were presented by Gra- tion provides an excellent opportunity to pick up shares at
ham in his books; “Security analysis” and “The intelligent very cheap prices. Talking in Graham’s language, this could
investor”. The theory is based on the philosophy of investing be one of the times when the market is unjustifiably pessi-
in securities which trade at a deep discount to their intrin- mistic on a large number of stocks. This however, does not
sic value. Warren Buffet is the most imply that we should start picking
famous follower of the principles of up each and every stock just because
value investing in the modern world. “The less prudence with which others it is trading at way below its bull-run
The core principles of value invest- conduct their affairs, highs. What this does suggest is that
ing are the following: in every bear run, although there
• A stock, or any other secu- are stocks which fall due to genuine
rity for that matter, has an intrinsic
The greater the prudence with which falls in their values, there are many
value, and this underlying value does we should conduct our own affairs.” which decline simply because of the
not depend upon the market price. widespread pessimism among inves-
• The market, at times, as- tors. Obviously, the intrinsic value of
signs prices to certain stocks which
-Warren buffett the company does not swing with
may be unjustifiably low or high. the mood of the investors. A large
• An intelligent investor buys number of stocks consequently end
when the market price is unjustifiably low and sells when up taking a huge beating without any
it is unjustifiably high. This is best captured by Buffet’s phi- rational reason and hence trading at huge discounts to their
losophy of being “Greedy when others are fearful and fearful intrinsic value. Thus, every bearish phase brings about some
when others are greedy”. excellent opportunities for the value investor to capitalize
upon. In the later part of this article, performance of op-
• Investors should be prepared for long-term invest-
portunities provided at the end of the dot-com bust, over
ments in a stock. Value investing is not concerned with and
the subsequent boom in the Indian stock markets have been
cannot predict the short-term movements of the market or
evaluated. Some stocks which are good value buys in the
of a stock. However, a stock which is genuinely underpriced
current bear market and should yield excellent returns in
will yield significant results in the long run
the long run have been evaluated and presented.
Value investing as an investment method, is focused
on the curtailment of risk in investments. Value investors Value Investment Themes
focus on how not to lose money, rather than how to make
The major challenge in value investing is to determine
huge amounts of money. In this respect, Benjamin Graham
the intrinsic value of the company and hence of its shares,
talked about introducing a ‘Margin of Safety’ in the analysis
relative to the prevalent market price. Value investing works
to minimize the downside risk. This just means that you buy
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Niveshak Volume 2 Issue 2 March 2009
Article of the montH

on various ratios and themes to determine if a stock is un- ity is estimated using the PBIT figure in the company’s last
der-valued. Some of these ratios are the price-to-earnings annual result. It has been estimated that a company can
ratio (P/E), price-to-book value (P/B) etc. The principles of comfortably raise loans which would keep its interest cover
value investing have been demonstrated with the use of the ratio above 5. This has been used to estimate the amount
following themes: any company can safely pay as an annual interest expense.
• Cash Bargains: A cash bargain arises when the mar- The interest rate has been taken to be at 14 per cent for the
ket value of a company goes below the amount of cash and calculation of the debt raised which will result in the inter-
other liquid assets in its possession, net of all current li- est expense calculated above. Both these assumptions are
abilities and debt. In effect, the market is not giving any pretty conservative according to the actual conditions faced
valuation to the fixed assets, to the inventories, and to the by Indian companies to raise debt from the market and thus
receivables. allow for a margin of safety.
• Debt capacity bargains: The value of a debt free »» P/E ratio: A stock with P/E ratio of below 2 has
company has to be substantially more than the amount of been considered to be a value stock. This translates to an
debt it can comfortably service. Thus, a company is highly earnings yield of 50%, which is much higher than that avail-
under-valued if its market capitalisation is less than its debt- able on bonds.
raising capacity. It’s a principle which was first laid out by »» P/B ratio: All stocks with P/B of less than 0.3 were
Ben Graham in Security Analysis. selected.
• Price-to-earnings ratio (P/E ratio): This is the ratio of »» Dividend Yield: All stocks with dividend yield of
the company’s market capitalisation and the net profit. Ac- 9% or more were selected.
cording to Benjamin Graham’s principles, the earnings yield • Based on each of the above value investment themes,
of a value pick should be very high, or equivalently, its P/E I have come up with portfolios of stocks which were highly
ratio should be very low. Graham said that a stock with an undervalued in March 2003. I have evaluated the returns
earnings yield of twice the yield on AAA bonds is a safe value obtained on each of these portfolios and compared it with
bet the average performance of the market or the index itself.
• Price-to-book value ratio (P/B ratio): The P/B ratio All stocks in a portfolio were given equal weights.
is a ratio of the market capitalisation of a company and its • The return was calculated for each of these port-
book value. Theoretically, a P/B of less than 1 shows that the folios for the period starting from 31st March 2003 to 1st of
market has valued a company below the book value of its as- January 2008.
sets, adjusted for all liabilities. However, in accordance with • For the same period, the return of the Nifty was
the margin of safety concept, value investment requires the calculated and was compared with the portfolios’ return.
P/B ratio to be much lower.
• Dividend yield: The dividend yield is a ratio of the Conclusion
dividend paid by a company to its market capitalisation. To The value stocks thus identified were observed to gen-
an investor, it signifies the annualised return (in terms of erate returns which were much superior to those generated
dividend) he can achieve by investing at the current market by the stock markets in general. Some of these stocks pro-
price, assuming that the dividend remains constant over the duced absolutely staggering results. For example, Videocon
years. A high dividend yield shows that a stock is under- Industries which traded at a P/E of 0.14 and P/B of 0.01 in
valued. Graham has used this parameter extensively in The March 2003 moved from Rs. 12.80 in March 2003 to Rs. 811.50
Intelligent Investor. (as on 1st Jan 2008). This stock was a part of 3 of the 5 value
investing portfolios. Walchandnagar Industries, which was a
Performance evaluation of Value Investing part of 2 portfolios shot up from Rs. 2.73 to Rs. 863.20 over
In this section, I have made an attempt to evaluate the the same period. The returns obtained by the different port-
performance of the value investing approach over the previ- folios and the returns of the Nifty are tabulated below.
ous bull phase in the stock markets and compare it with the
market’s performance in general. Using this comparison, I Table 1. Comparative returns of the portfolios and the Nifty
aim to test if the results yielded by the value investing ap-
Return Dividend P/E P/B Cash Debt Index
proach are truly superior to other approaches. This evalua-
Yield Portfolio Portfolio Bargain Capacity (Nifty)
tion consisted of the following steps: Portfolio Portfolio Portfolio
• Audited financial results of the companies compris-
Average 4976.55 10713.82 19932.96 14600.87 2283.65 523.65
ing S&P 500 was obtained from CMIE database Prowess for
Return
the year ending March 2003 (beginning of the Bull Run) and (in %)
March 2008.
Average 49.77 107.14 199.33 146.01 22.84 5.24
• Various Price ratios and price data for the similar Return
periods was also obtained.
• Stocks worth purchasing in 2003 were identified us- Annual- 2.18 2.55 2.88 2.71 1.87 1.39
ized
ing various value investing criteria. These criteria are: Return
»» Cash Bargain: Stocks were identified as value
Annual- 118.47 154.68 188.35 170.94 86.95 39.25
stocks, based upon the cash bargain theme if their cash +
ized
market value of their investments was more than their mar- Return
ket capitalization and outsider’s Liabilities. All the stocks (in%)
that satisfied the criteria were selected
»» Debt Capacity Bargain: The debt-raising capac-
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© The Finance Club, Indian Institute of Management, Shillong
Article of the montH

As can be seen from the above, supernormal returns Since it has been established that the value investing
can be obtained by following the value investing approach. themes discussed in this article can help generate superior
Nifty provided an annualized yield of 39.25%, from Mar 2003 returns, I have identified some value stocks based on these
to Jan 2008, which is less than half of the minimum return themes in the current market and thus present below stocks
provided by any of the portfolios (Debt capacity portfolio which are expected to produce excellent returns in the fu-
provided 86.95%). Therefore, it is observed that the returns ture, based on each of the value themes.
obtained upon value investment are much higher than those
offered by the market in general.

Table 2. Value stocks at current valuations based on different themes
Theme Stocks to look out for
Cash Bargain Reliance Infrastructure , Hindalco Industries , Aditya Birla Nuvo ,Bajaj Holdings &Invst. , Tata Invest-
ment Corpn. , Jai Corp, Jindal South West Holdings, PTC India, Shaw Wallace& Co., Patni Computer Sys-
tems, Cairn India, Subex, JM Financial, Hinduja Ventures, Aftek, Mascon Global, Hexaware Technologies,
Kolte Patil Developers, BSEL Infrastructure Realty, IL&FS Investmart, Pheonix Mills, Mahindra Lifespace
Developers, Country Club (India), Balaji Telefilms, Sasken Communication Technologies, Tanla Solutions,
GSS America Infotech
Debt Capacity Bargain JM Financial, LIC Housing Finance, DCM Shriram Consolidated, Alok Industries, Orbit Corporation, JK
Lakshmi Cement, India Glycols, SREI Infrastructure Finance, Vakrangee Softwares
P/E Ratio Aftek, Amtek India, Vakrangee Softwares, Prajay Engineers Syndicate, Lok Housing & Constructions, JM
Financial, Prithvi Information Solutions, IVR Prime Urban Developers, JK Lakshmi Cement, Orbit Cor-
poration, Kolte Patil Developers, JK Cement, Marg, Sujana Towers, Chennai Petroleum Corpn, Kesoram
Industries, Mysore Cements, Country Club (India), India Glycols, Bharati Shipyard, Alok Industries, HDIL,
Gujarat State Fertilizers & Chemicals Ltd, KLG Systel, Ruchi Soya Inds, Orient Paper & Inds, Gujarat Fluo-
rochemicals, Nava Bharat Ventures, Kei Industries, Ajmera Realty & Infra India, Unity Infraprojects
P/B Ratio Aftek, Prajay Engineers Syndicate, Country Club (India), Subex, Prithvi Information Solutions, Amtek In-
dia, Mascon Global, Vakrangee Softwares, Alok Industries, Bajaj Auto Finance, IVR Prime Urban Develop-
ers, Lok Housing & Constructions, Arvind Ltd, Megasoft, Mukund Ltd, Ansal Properties & Infrastructure,
Gitanjali Gems, BSEL Infrastructure Realty, Sujana Towers, Kolte Patil Developers, Sasken Communica-
tion Technologies, Bharati Shipyard, JSL Ltd, Kei Industries, Ganesh Housing Corpn, JK Lakshmi Cement,
Marg, Ruchi Soya Inds
Dividend Yield Indiabulls Securities, Monsanto India, Chennai Petroleum Corpn, Prajay Engineers Syndicate, SRF Ltd,
Indiabulls Real Estate, JK Cement, IVR Prime Urban Developers, Varun Shipping Co, NIIT Technologies,
Bongaigaon Refinery & Petrochemicals, Tata Motors, Ganesh Housing Corpn, Graphite India, Finolex
Industries, Ashok Leyland, HCL Infosystems, Deccan Chronicle Holdings, Indiabulls Financial Services,
Kalyani Steels, Sasken Communication Technologies, Orbit Corporation

By Ankur Khaitan
MDI Gurgaon
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««««««««««
...Islamic Finance...
»»»»»»»»»»
I
slamic finance refers to a system of financial Features of Islamic Financial Instruments
activity that is consistent with the principles
of Islamic law (Shariah). Shariah prohibits the In order to be considered Halal all the transactions
payment of interest or usury, as well as investing in busi- and instruments must meet some minimum criteria. All
nesses that provide goods or services considered contrary financial instruments and transactions must be free of at
to its principles (Haraam). Islamic banking is becoming least the following five items:
increasingly popular, having reached $800 billion by mid- Riba literally translates to usury is more commonly
2007 and growing annually at a rate of more than 15 per- referred to as the charging of interest. Riba can
cent. This has grabbed the attention of governments as be in
they look to fuel their liquidity-strapped economies with different forms and is prohibited in all its
money and deposits from the Islamic world. Wall Street forms. For example, Riba can also occur when
now features an Islamic index and an Islamic mutual fund. one gets a positive return
without taking any risk.
In these cash-strapped times Islamic Banking presents an-
other alternative for raising money. The rapid develop- Rishwah It translates to corruption in any form
ment in the use of Islamic finance over the last few years Maysir It has been taken to mean unnecessary risk,
is partly due to the enormous wealth and accordingly deception or intentionally induced uncertainty.
liquidity amongst investors in Islamic countries, who In the context of financial transactions, gharar
want to structure their investments in a Shariah com- could be thought of as looseness of the under-
pliant manner, which is becoming a major movement, lying contract such that one or both parties are
as Western banks and investors are seeking wealth from uncertain about possible
outcomes. Alternatively that the contract could
oil profits in the Middle East. The stampede into Islamic
be read in a number of ways such that one
finance is mostly an effort to tap an estimated $1.5 trillion party could easily deceive
of funds floating around the Middle East, largely from (deception) the other party
higher oil prices. The system of Islamic Finance is also
Gharar from a financial instrument viewpoint would
being looked towards as an alternative to the existing
be one where the outcome is purely dependent
system so that the crises like the one financial market are on chance alone- as in gambling
currently experiencing can be avoided. As a consequence,
Jahl It refers to ignorance. From a financial transac-
a lot of firms are looking at creating Shariah-compliant
tion viewpoint, it
products to attract the cash-rich Islamic investor’s com- would be unacceptable if one party to the
munity, as well as other non-Islamic investors looking for transactions gains because of the other par-
less-risky alternatives. ties’s ignorance.
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The Islamic Financial Instruments options that trigger when the underlying asset’s price
exceeds certain bounds. The contract is complex in that
Currently, Islamic finance offers basic products and it involves a combination of
services but is developing quickly, with some forays into options, average prices and
project finance, securitization and private equity. Muharabah or cost plus fi-
»» Derivative Instruments nancing. It involves two par-
Among the contracts available within the Islamic ties, buyer which could be a
Framework, two contracts that could be considered a ba- company seeking financing to
sis for derivative contracts are: purchase the underlying asset
and a financial institution. A
• Bai Salam: Salam is essentially a transaction
typical Istijrar transaction
where two parties agree to carry out a sale/purchase of
could be as follows:
an underlying asset at a predetermined future date but at
ɶɶ A company looking
a price determined today. The seller agrees to deliver the
for short term working capi-
asset in the agreed quantity and quality to the buyer at
tal to finance the purchase of
the predetermined future date. By definition Bai Salam is
a commodity approaches a
pretty close to a conventional forward contract in terms
bank.
of structure. However the two majorly differ in that in
a Bai Salam sale, the buyer is required to pay the en- ɶɶ The bank purchases
tire amount in cash at the time the contract is initiated. the commodity at a current
The premise, on which this concept of prepayment has price (P0), and resells it to
been built, has to do with the fact that the objective in the company for payment to
a Bai Salam contract is to help needy farmers and small be made at a mutually agreed
businesses with working capital financing. The buyer in upon date in the future, let
a contract therefore is often an Islamic financial insti- us say 2 months. The price
tution. A Salam sale thus, is beneficial to the seller. In at which settlement occurs
case of Bai Salam, the predetermined price is normally on maturity is dependent on
lower than the prevailing spot price, unlike normal for- the underlying assets’ price
ward contracts, where the forwards prices are typically movement from t0 to t60
higher than the spot price by the amount of the carrying where t0 is the day the con-
cost. The lower Bai Salam price compared to spot can tract was initiated and t60
be explained to be the “compensation” by the seller to maturity day.
the buyer for the privilege given to him. The underlying »» Bond Instruments
asset, in case of a Bai Salam contract must be standard- In the Islamic financial
izable, easily quantifiable and of determinate quality. It system usury and interest are the first elements to be
cannot be based on a uniquely identified underlying as- avoided. This however does not mean that the door of
set. The underlying asset cannot be based on commodity debt financing or the possibility of bonds issuance and
from a particular farm/field etc as by definition such an trading is closed to Islamic finance. Bond instruments
underlying asset would not be standardizable. The Quan- that fit with the framework of Islamic finance are:
tity, quality, maturity date and place of delivery must be
• Ijarah Bonds: Ijarah is a contract according to
clearly mentioned in the Salam agreement. The underly-
which a party purchases and leases out equipment re-
ing asset or commodity should be available and traded
quired by the client for a rental fee. The duration of the
in the markets throughout the period of contract. The
rental and the fee are agreed in advance and ownership
forward contracts being Over-the-Counter products in-
of the asset remains with the lessor. Hence, the relation-
herently carry the counterparty risk. This risk exists with
ship between the parties differs from that of a debtor-
Bai Salam contracts as well. However, there is a slight dif-
creditor relationship since it is based on buyer-seller of
ference here as the counterparty risk would be one sided.
an asset.
Since the buyer has fully paid it is only the buyer who
faces the sellers default rink unlike forwards/futures. In Ijarah bonds are securities of equal denomination
order to overcome the threat of default on the part of of each issue, representing physical durable assets that
the seller, the Shariah allows for the buyer to require are tied to an Ijarah contract as defined by Shariah. The
security. This security may be in the form of a guaran- basic feature of Ijarah bonds is that they represent leased
tee or mortgage. The contract could also form the basis assets, i.e. without relating the bonds holders to any com-
for the provision of working capital financing by Islamic mon organisation, company or institution. For instance,
financial institutions. Since financial institutions would a machine leased to a company can be represented in
not want possession of the underlying commodity, paral- bonds and owned by a thousand different bondholders,
lel contracts may be used. each of them, individually and independently, present-
ing his bonds to the company and collecting the peri-
• Istijrar Contract: This contract has embedded
odic rent without having to have any relation with other
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Niveshak Volume 2 Issue 2 March 2009
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bondholders(similar to dividend). In other words, the revenue generated by the metro facility can be used to
Ijarah bondholders are not owners of a share in a com- service the revenue bonds. If the metro service generates
pany that owns the leased machine, but simply a sharing enough revenue to pay off the bonds, then bondholders
owner, who only owns one thousandth or more of the receive their interest and principal in full and on time.
asset itself. However, if the metro service does not generate enough
revenue, bondholders either receive their interest and
• Muqaradah or Mudaraba Bonds: Mudaraba or
principal later or nothing at all. Similarly, the muqaradah
Muqaradah means an accord between two parties ac-
bonds give its owner the right to receive his capital at the
cording to which one of the two parties provides the
time the bonds are surrendered, and an annual propor-
capital for the other to work with on the condition that
tion of the realised profits as mentioned in the issuance
the profit is to be shared between them according to a
publication.
decided ratio. Muqaradah is thus regarded as an Islam-
ic way of financing completely different from the Riba • Musharakah Bonds: Musharakah bonds based
mode of financing which is based on a predetermined on the musharakah contract are relatively similar to
rate of interest. It is the norm in Islamic financial theory muqaradah bonds. The only major difference is that the
of contract that whatever is allowable for an individual intermediary-party will be a partner of the group of sub-
contacting party is also for a group of people not nec- scribers represented by a body of musharakah bondhold-
essarily identified by their number or specified by their ers in a way similar to a joint stock company while in
qualities. Muqaradah bonds on the other hand are based mudarabah the capital is only from one party. It should
on the conclusion of a lawful Mudaraba contract with be noted that almost all the criteria applied to mudara-
the capital provided by one party and labour by the other, bah bonds are also applicable to the circulation of mush-
while the shares of profit are determined beforehand by arakah bonds.
a definite proportion of the total. It should be noted that In the wake of the financial crisis that has gripped
Mudaraba bond bears close resemblance to revenue bond the world and the questionable performance of the cur-
financing in the conventional system. For example a city rent financial products; the Shariah compliant products
wants to build a metro railway facility, believing that the provide alternate solutions. The opportunity for growth
new service will provide an alternate means of convey- in the Islamic finance market is dependent on the abil-
ance to the people. The local government issues revenue ity of practitioners to develop new products which fall
bonds in order to finance the construction of the facil- within what is permissible under Islamic law.

By Ajay Jain, & Saurav D utta
ity. The money for the periodic dividend payment and
retirement of the bonds come from ticket sales and other
revenue associated with the service. In other words, only
IIM Bangalore

»»»»»»»»»» Islamic banking: Indian way ««««««««««
According to an expert, there are over Rs. 40 bil- nity which boasts 50% self-employment much of which
lion of funds to be invested by Indian Muslims, who ac- has very few avenues for financing and loans, which in-
count for 15% of the total nation’s population, annually. turn affects their ability to compete and grow.
Indian Muslims annually lose around Rs. 66,700 crores be- Indians working in Middle East and Middle East-
cause Muslims have a credit deposit ratio of 47% against ern companies flush with petrodollars can also be a good
national average of 74%. This loss can be avoided by the source of financial resources for Indian financial institu-
provision of Shariah compliant finance products. Besides, tions offering islamically permissible financial services.
there are billions worth properties lying in the form of
Awqaf. Zakat potential of the Indian Muslims still largely Porter’s five forces analysis
remains untapped and underutilized. In light of the above Porter’s five forces analysis of the Islamic Finance
mentioned facts this story aims to provide a sneak peek Industry In India
into the attractive upcoming industry.
1) Threat of New Entrants-High
Market potential in India »» More and more companies are planning to en-
ter the market due to slowdown in the western markets
The mutual funds, venture capital and a number
»» General optimism with regards to relaxation of
of likely instruments based on equity financing are con-
banking regulations for opening up the banking sector
sidered to be identical to Islamic principles of profit and
to Islamic Banking
loss sharing. Also, 61% of the companies listed on the NSE
as well as the BSE, the major indices in India, are Shariah 2) Competitive rivalry within Industry- Low
compliant, thus capable of inducing high investments. »» Enough space to accommodate several players,
Add to that, the need for business financing in a commu- low rivalry at least for now.
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© The Finance Club, Indian Institute of Management, Shillong
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3) Bargaining power of Buyers/customers automobile finance
»» Till date there is no single company in India »» Offering venture finance on Mudarabha basis as
which offers a complete range of Islamic finance prod- well as on Musharaka
ucts, as such one can say that the products offered are
Indian Legal System on Shariah Compliant Finance
differentiated to quite an extent
»» There are high switching costs involved. Indian banks are governed under the Banking
4) Bargaining power Of Suppliers-Medium Regulation Act 1949, Reserve Bank of India Act 1934, Ne-
»» There are few players gotiating Instruments Act and Co-Operative Society Act.
»» High number of depositors Islamic Banking cannot enter the Indian market as a full
»» Likelihood of the relaxation of banking regula- fledged bank because many banking services like that of
tions could bring in Islamic banking which could later Al Wadiah, Mudarabah, Musharakah, Ijarah and Istisna
on prove to be an enhancer of the bargaining power of cannot be provided as they go against the above men-
suppliers. tioned acts.
5) Threat Of substitutes-Low The BR Act even disallows an Indian bank from
floating a subsidiary abroad to launch such products, or
»» As the people who opt for these services are
offering these through a special window. Thus, it is am-
those bound by religion to invest as per the Shariah
ply evident that there is no chance of opening an Islamic
guidelines, and any return is better than no return. As
bank in India in the conventional sense of the way. Thus
such the offerings of a conventional bank or NBFC can
that leaves us with the option of tapping the potential
never pose as a threat.
market in the form of an NBFC.
Existing Players ISLAMIC BANKS (NON-BANKING FINANCING
• There are several Baitul Mals working in cities COMPANIES) IN INDIA AND RBI REGULATIONS
as well as in villages, deposits of about Rs. 75 crores. Cater- Islamic Banks (Non-Banking Financing Compa-
ing to the local population mostly, their sources of funds nies) in India and RBI Regulations Islamic banks in India
are limited and as a result operate on a small scale. do not function under banking regulations. They are li-
• Idafa Investment Private Ltd, caters to over censed under Non Banking Finance Companies Reserve
800 clients Bank Directives 1997 RBI (Amendment) Act 1997, and oper-
• Ahmadabad based, Parsoli Corporation, Cor- ate on profit and loss based on Islamic principles.
porate Member of the BSE and NSE and a DP with the In so far as accepting public deposits are con-
CSDL cerned, NBFCs are akin to banks, except that NBFCs can-
• Bearys Properties and Development’s Islamic not accept deposits payable on demand. But it needs to
finance arm, Bearys Amanah Investments be recognized that as public deposits are unsecured, the
accepted global practice is that only banks which are
• Reliance Money presently offers portfolio man-
regulated and supervised should be the main institutions
agement to the Muslim HNI; plans to launch an entire
that could be permitted to seek public deposits. This is
spectrum of financial services the Shariah way.
the underlying element of the regulatory regime pres-
Potential Players ently being put in place in respect of NBFCs in India.
Al Wadiah (for saving bank account):
»» Shariah compliant Mutual Funds
• Section 21 of the Banking Regulation Act (BR
• Reliance Mutual Fund
Act) requires payment of interest on such deposits; thus,
• UTI Asset Management
interest-free deposit and a simple charging of premium
• Way2Wealth or Hiba is not permissible.
• Edelweiss Mutual Fund Mudarabah (for term deposit or investment):
»» Consumer and Home loan Segment • Section 21 of the BR Act disallows such prod-
• Doha Brokerage and Financial Services Ltd is ucts where the bank can invest the money in equity
all set to enter NBFC operations. funds (in India, equity exposure is determined by a sepa-
»» Suite of Islamic financing solutions rate set of rules), and the client has complete freedom in
• Mumbai-based Taqwa Advisory and Shariah the management.
Investment Solutions is in discussions with a UAE-based Musharakah (for project finance and SME credit):
Shariah advisory firm to offer such services • Sections 5, 6 of the BR Act indicate the forms
Viable Product Mix of business a banking company can undertake, and does
not allow any kind of profit-sharing and partnership con-
»» Provision of equity investment opportunities tract the basis of Islamic banking
»» Mutual Funds based on Shariah guidelines Ijarah (for home finance):
»» Invest in property development • As against Islamic banking where the banks
»» Portfolio Management services to Muslim HNIs owns the asset and hold the title, Section 9 of the BR Act
»» Provision of Consumer loans, housing loans and prevents the bank from any sort of immovable property
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Niveshak Volume 2 Issue 2 March 2009
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other than private use. in the form of an NBFC to reap the benefits of the bustling
Istisna (leasing, buyback): Indian economy and be in a better position to capture a fur-
• Besides the usual curbs on acquiring immovable ther share of the possible benefits if and when the banking
property, offering Islamic banking products many not are regulations are further relaxed

By Kirat Rawel, &Ramanvir Sarao
bankable due to stamp duty, central sales tax and state tax
laws that will apply depending on the nature of the trans-
fer.
FMS Delhi
Thus, having analyzed the existing situation in In-
dia, I feel that it would be best to enter the Indian market

»»»»»»»»»» Islamic banking: THE Future ««««««««««
The immense potential of Islamic banking in India nel for investments from the Gulf Cooperation Council (GCC)
can be judged through its vast Muslim population of about Countries not investing under credit method of banking
150 million which accounts for 13% of total population. How- thereby attracting trillion dollars of equity finance. Accord-
ever, 80% are financially excluded owing to unavailability of ing to Global Investment House, GCC countries have invested
interest free banking. Sachar committee claims that Indian around $406.3 million in India which constitutes around 1%
Muslims have a share of 7.4% in saving deposits while they of India’s total FDI. With the advent of Islamic banks in India,
get only 4.7% in credit. According to RBI annual report for this number is expected to improve considerably. Companies
2007-08, Indian Muslims annually loose around Rs. 63,700 like Kuwait Finance House, Abu Dhabi Investment Company
crores which is 27% of their deposits. The total amount of and Qatar investment authority are willing to invest $50-70
interest lying suspended is a whopping Rs. 40,000crore. million in Indian companies. McKinsey Quarterly Report-July
Muslims avail just 4% and 0.48% credits from NABARD and 06 estimates $1.5 trillion investment from Middle-East owing
SIDBI respectively. Islamic banking will provide a channel for to rising oil prices and is expected to rise to $9 trillion by
Muslim investors to be a part of the financial sector. As per 2020. It highlights the transition of about $80 billion from
Mr. Raqeeb, ICIF even if 15% of the Indian Muslim population US and Europe towards other regions and shift in asset al-
invest through Islamic Bank, the amount of Investments location to Asia by 10-30%. McKinsey also estimates the total
generated would be Rs 4000 crores which are enormous. funds available for investment in Asian countries involved
India also has a large proportion of poor population having with Islamic banking over the next five years at $250 billion.
no access to financial services. As per economic census-2005 Average investment per year comes to $50 billion. If India is
there were 51 million non-agricultural enterprises in India able to acquire at least 15% of this amount by adoption of
which required amounts varying from Rs. 25,000 to Rs. 1 mil- Islamic banking, contribution by them to total FDI Inflow
lion which is too small for most lenders. Only 4.2% of the will be $7.5 billion which is about 30% of the total FDI Inflow
poor sections had credit from formal institutions. There is in India for fiscal year 2008-09 and 22% of the $35 billion
desperate shortage of financing for micro and small enter- target for 2008-09. This will greatly aid in reducing current
prises and less than 3% of net bank credit goes to them. account deficit of the country. Besides these, after 9/11, tril-
The growth of Indian economy at 9% (Economic Advisory lions of petro-dollars are waiting to be invested in India by
Council) also highlights large requirement of capital by In- Islamic Banks. Private equity players predict investment op-
dia. The infrastructure capital requirement is estimated at portunity of $6 billion petro-dollars in India. Thus, Islamic
8.5% for 2007-08 by EAC. The increase in disposable income Banking holds immense potential for attracting huge invest-
of an average Indian household to Rs 1.2 lakh in 2005 and ments from Gulf countries which is highly important in the
growth rate of 5.3% has increased credit and discretionary light of current global financial crisis when India is looking
spending. This has increased the requirement of housing & for alternative sources of capital. Significant investments are
other loans and investment capital. There is also a surge of also expected from countries involved with Islamic banking
new ventures. This large requirement of capital dictates a like U.K, Singapore, China, Malaysia and Japan.
strong growth potential for Islamic banks.
Stability to Financial markets
Contribution of Islamic Banks to Indian Economy The strict obligations of Islamic banks prevent the
Islamic Banking has the potential to tame liquid- financial and economic enterprises from bankruptcy. The
ity and inflation problems, and promote inclusive growth. Islamic banking mechanism also strengthens the credit rat-
Increase in interest component of GDP over past years with ing system to provide security of funds for depositors and
public-debt/GDP ratio of 79.5% for March 2006 has increased investors. The credit rating under Islamic banking evaluates
inflation to about 11%. However, equity finance if extended real term business potential and growth trends, instead of
with far lower costs of credit has potential to restrict infla- manipulated asset values responsible for latest financial tur-
tion. Simultaneously the dividend shared by depositors on moil. The very fact that Islamic banks do not compete for
equity finance helps equitable distribution of income gener- extra credit shares, provides stability in the financial market.
ated by financial sector. The principle of Islamic prohibits transfer of public deposits
to other banks without the permission of depositors. Thus
Increased Inflow of Funds
there is no scope for a liquidity crisis to occur. The insulation
Islamic Banking will establish an alternative chan- of Islamic Banks from the existing financial turmoil justifies
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© The Finance Club, Indian Institute of Management, Shillong
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the stability of Islamic Banking. This has been acknowledged Islamic Banking, The road ahead…
by the fact that Islamic banks have grown by 20% in the Concept of Islamic bank-
year 2007. ing in India is still in a very na-
Overall, Islamic Banks are less risky than conven- scent stage. There are many
tional banks. roadblocks towards their develop-
Inclusive growth of population ment. Following are some of the
immediate measures that need to
India’s significant growth of about 9% in the recent be undertaken.
years cannot be termed equitable. Major part of the pop-
ulation has remained unexposed from organized financial BANKING FOR ALL: Islamic bank-
products. With low collateral strength, farmers and poor ing has been misunderstood in
workers lack access to loans and credits. Islamic Banking India as a religious charitable
has the potential to provide the desired capital to these venture restricted to country’s
sections through its unique method of microfinance called economically downtrodden Mus-
ijara-wa-iktina and morabaha. These schemes do not trans- lim community. It is essential to shed these inhibitions
fer the total interest risk onto the borrowers but risks are about Islamic Banking which has more economic rational-
shared. For example, Islamic Bank provides capital to a farm- ity compared to religious rigor. Moreover, there are strong
er who provides labour to achieve the output. Profits are possibilities of Islamic banking becoming a political agenda
then equally shared between the two parties. Islamic banks thereby losing its significance. It is necessary to execute ap-
strongly judge the credibility of borrower based upon the propriate awareness campaign to convey the purpose and
potential of their business proposals and thus promote ra- importance of Islamic banking for Indian economy and
tional, sound businesses backed by strong fundamentals. In- highlight growth of Islamic banking in non-Muslim coun-
troduction of Islamic banking will aid inclusion of Muslims tries like Britain, Thailand and Singapore. Islamic banks of
in financial sector. With 31% Muslims living below poverty Malaysia and Britain have registered non-Muslim customers
line and 40% Muslim workers as own account workers, the ranging from 10-40%.
financial exclusion is apparently a serious economic disad-
vantage. Islamic banks will enable them to work with other PARALLEL TRACK BANKING AND COLLABORATION WITH
community members cooperatively towards development of OTHER BANKS: Government should look forward to imple-
economy. mentation of the successful Malaysian model of parallel-
Growth of SMEs track banking which ensures Islamic banks and traditional
banks to work in tandem. A feasible option would be to
As per International Trade Centre, lending to SMEs operate Islamic Banks in India through established public
is limited because of the relatively high transaction costs sector institutions like SBI, Bank of Baroda, etc. Many private
and perceived risks. RBI has acknowledged decline in SME sector banks like HDFC, HSBC, and Citibank have also shown
credit from 15.1% in 1990-91 to 6.5% in 2006-07. Islamic bank- an interest towards such an initiative. Government should
ing through its scheme of Mudaraba can provide the desired also invite the foreign Islamic banks which have gained suf-
funding to SMEs and also share their financial risk, leaving ficient expertise to invest in India.
them with only operational risk. This will ensure sustain- Islamic Banking is a powerful economic instrument
able growth of SME’s which is essential for the economic capable of creating multi-sectoral impacts and should there-
growth of country given the fact that SMEs constitute 80% fore be invited in India. It will contribute to greater financial
of the total industrial enterprises and have a 40% share in stabilization, help real economy significantly, provide signifi-
industrial output. cant funds for expansion and more than anything act as a
Growth of Capital markets and Corporate Sector powerful antidote to poverty sans huge subsidies and grants
that are making a big dent in our fiscal framework. It would
Equity financing being the chief investment tool of open the doors for financial inclusion faster and quicker.
Islamic bank, stock market will be the most preferred ave- There is vast evidence to support this from across the globe.
nue for investments by future Islamic banks of India. Parsoli Today, Islamic banking is the buzzword in the global finan-
Investments estimate that about 50% of Indian stocks are cial world with all the essential ingredients of modern day
Shariah compliant. Thus trading activity on the stock mar- banking. Its credibility has been timely acclaimed by various
kets will boom with Islamic banks. All the listed companies research sources like McKinsey, KPMG, BCG and it has en-
will get additional potential investors who genuinely sub- joyed the recommendations from various imminent person-
scribe their shares instead of indulging in speculator trading. alities. The latest recommendation from Raghuram Rajan
This increased growth opportunities to the corporate sector committee Sept 08 including Mr. R Ravi Mohan, MD&CEO
will further fuel the economic growth. CRISIL as a member strongly supports establishment of Is-
Countering Money Laundering lamic banking in India. India has already paid a price for
being late in catching the globalization bus in 90’s. It should
Stringent anti-money laundering measures through not repeat the same with Islamic Banking and develop a
Islamic banks have been established in countries like Ma- quick and agile strategy towards its adoption.

By Riyaz Vohra
laysia, Britain and China. The critical managerial control of
the fund desired by Islamic banks may not be available with
debt finance under interest-based banking. The universal
nature of banking through Islamic Banks prevents surrepti- Great Lakes, Chennai
tious routes for investments and mutual funds.
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Niveshak Volume 2 Issue 2 March 2009
Change economicS

««««««««««
Protectionist Policy
of Obama’s Regime
»»»»»»»»»»
S
o, people are comforting themselves think- direct correlation between an economic downturn and
ing that this economic recession can’t be as the tariff levels. But it was too late to realize this. In
bad as the great depression. They might be response to this act, many European companies had al-
bracing themselves for a salary cut but they are kind of ready introduced similar tariffs on US goods and the US
confident that it won’t go as far as losing their jobs. Just industry was dying a slow death. In the Great Depression
a small rider to people getting this feeling. If they are US GDP had declined by nearly 30%, Industrial output by
thinking that the worst of the financial crisis is over, then 45% and there was deflation. The biggest downfall was of
well, going by US President Barack Obama’s policy, it just the export industry which was in deep trouble.
might well be on it’s way. There is nothing wrong in trying to help one’s own
We all think that Smooth – Hawley tariff act was industrial sector. In these times of desperation, every
draconian. (The Smoot-Hawley Tariff was an act signed country has taken out packages to help some particular
into law on June 17, 1930, that raised U.S. tariffs on over sector or the whole of economy. But in recreating the
20,000 imported goods to record levels).It worsened the conditions that led to the Bretton Woods agreement
economic condition of the US general population. Unem- would make no sense.
ployment in the US was at 7.8% in 1930 when the Smoot- One might argue that effect of this stimulus pack-
Hawley tariff was passed, but it jumped to 16.3% in 1931, age with the ‘protection’ clause would result in the mul-
24.9% in 1932, and 25.1% in 1933. But refusal to learn from tiplier effect and hence would stimulate the whole US
history is an essential ingredient of politics. Obama is al- economy and thus creating approximately 5 million jobs.
ready facing pressure from protectionists over the stimu- But the effect it would have on export industry would
lus package. The congress is arguing about a clause in the not very different from what happened during the great
stimulus package through which only American materi- depression era. Maybe now the US economy is not under
als can be used in public works. If this clause is included a very severe problem of overcapacity but by killing com-
then even the Detroit carmakers may have to follow this petition the problems of overcapacity will be created and
clause. this would lead to deflation. I am sure the US would not
The ‘Buy American’ clause might prove to be a very want to have its own ‘lost’ decade, the way Japan had in
costly affair for the US. It’s only natural that following the 1990’s!!!
this many European and Asian nations will opt for such One can’t overemphasize the effect this would have
clauses in their economic policies. Already in Britain and on the developing nations which work on outsourcing
France, politicians are demanding that whatever money contracts from US giants like Dell, Nike etc. The export
is poured to the ailing banks should be lent at home sector would be crippled and the economy would be af-
only. China is continuously alleged with manipulating fected drastically. And even these US firms would lose
its currency. And this is where we again come back to their cost advantage which would lead further cooling of
the conditions that led to the great depression. When- the economy.
ever politicians are involved in setting economic policies,
Barack Obama’s honeymoon with the presidency is
practicalities take a backseat and it’s only the short term
over .It’s time for him to think hard over these matters
goals that are looked at.
and veto any ‘protectionist’ clause which might jeopar-
During the great depression it was the extremely- dize the US in the long term.
high-throughput, continuous-flow mass production and,
in agriculture, the widespread efficiency gains brought

By Yogender Chhibber
on by the use of farm tractors that led to the passing of
Smoot – Hawley act. But it was realized later that this
was only an illusion because although the rated capac- SIMS Pune
ity had increased tremendously, actual output, income,
and expenditure had not. Their intention was to increase
the market share of the American companies. When the
crisis deepened, only then it was realized that there is no
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© The Finance Club, Indian Institute of Management, Shillong
Leverage &investmentS

««««««««««
GLOBAL RECESSION
»»»»»»»»»» What is LBO?
Is this the end oF LBO model?

A
leveraged buyout, or LBO, is the acquisition tal structure of an LBO is summarized as below:
of a company or division of a company with
a substantial portion of borrowed funds. It
started becoming more popular since 1980’s, with LBO
funds raised over around $385 billion till 2000. As increas-
ing amounts of capital competed for the same number of
deals, it became more and more difficult for LBO firms to
acquire businesses at attractive prices. In addition, senior
lenders have become increasingly wary of highly levered
transactions, forcing LBO firms to increase the level of
equity. In the beginning, the average equity contribution
to leveraged buyouts was 9.7% while it reached around
40% in the beginning of 21st century. As a result of these
developments, generating target returns (typically 25% to
30%) have become more difficult. Where once they could (Source : Centre for PE -Tuck school of business)
rely on leverage to generate returns, LBO firms today are This structure varies from company-to-company and
seeking to build value in acquired companies also between industries in most of the cases. To deter-
»» By improving profitability mine the optimal debt capacity for a potential Leverage
»» Pursuing growth including roll-up strategies (in Buyout target, factors like the outlook for the company’s
which an acquired company serves as a “platform” for industry and the economy as a whole, seasonality, expan-
additional acquisitions of related businesses to achieve sion rates, market swings and sustainability of operating
critical mass and generate economies of scale). margins should all be considered.
»» Improving corporate governance to better align There are many advantages for using leverage in
management incentives with those of shareholders. acquisitions which can be discussed as below:
LBO funds generally use the following two methods • Large interest and principal payments can guide
for the valuation of established companies that can be management to improve performance and operating ef-
targeted for acquisition: ficiency. This “discipline of debt” can cause
»» Market Comparisons: These are management to focus on certain initia-
metrics such as multiples of revenue, net tives such as
earnings and EBITDA which can be com- »» Divesting non-core businesses,
pared among the private and public com- »» Downsizing, cost cutting or in-
panies. Usually a discount of 10% to 40% vesting in technological upgrades that
is applied to private companies due to might otherwise be postponed or re-
the lack of liquidity in their shares. jected outright.
»» Discounted cash flow (DCF) In this manner, the use of
analysis: This is based on the con- debt serves not just as a financ-
cept that the value of a company is ing technique, but also as a tool
based on cashflows that can be pro- to force changes in manage-
duced in future. An appropriate discount rial behavior and focus of com-
rate should be used to find out net present pany towards various opera-
value. tional activities.
Transaction structure of LBO

The major part of an LBO consists of Debt com-
ponent with the debt-to-equity ratio of around 2:1. So,
in order to meet the huge requirement of debt, an LBO
will often have more than one type of Debt. The capi-
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Niveshak Volume 2 Issue 2 March 2009
Leverage &investmentS

Effects of recession on various debt component ing Mezzanine funding will demand extra premium in
To finance their transaction, the LBO private equity terms of high interest rate and also beneficial Warrants
company makes use of tranches of debt. In reality, the to convert the debt to equivalent equity shares. Both of
LBO transaction is financed mainly by two tranches – Se- these factors are unfavorable for the PE firm using LBO
nior & Junior. Now we will analyze the effect of Reces- model.
sion on these financial components.
Scene of LBO in India
1. Bank Debt: It is usually provided by the Commer-
cial bank. In case of defaults or liquidation of the compa- DIFFICULTIES DUE TO RESTRICTIONS ON FOREIGN
ny, Banks have the most senior claim in the business cash INVESTMENTS IN INDIA
flows. Bank debt usually comprised of two components: Only 2 routes for Foreign Capital to be directed to-
a) Revolving credit facility: It serves as a line of credit wards India:
that allows the firm to make certain capital investments, a) Foreign Institutional Investors (FII): They have
deal with unforeseen costs, thus providing a lot of flex- the ability to buy and sell securities freely on a stock
ibility to the bought-out firm. In the period of recession exchange. However, their investments in an Indian Com-
the credit policies are very strict and even if loan inter- pany cannot exceed more than 24% of the total paid up
ests are relaxed, there is a big uncertainty regarding the capital. Moreover, they are heavily regulated by SEBI with
availability of the Credit. Hence to finance their transac- cumbersome registration processes and are not permit-
tion, private equity players make use of other costly debt ted to hold more than 10% of the share capital of any
instruments. publicly listed company.
b) Term Debt: It is often secured by the assets of the b) Foreign Direct Investors (FDI): FDI route is used
bought-out firm, is also provided by the banks and insur- when the foreign investment is more than 10%. Off-mar-
ance companies in the form of private placement invest- ket or Non-stock exchange purchases can be executed
ments. It is usually priced with a spread above treasury through FDI and it is the only route available for invest-
notes and has maturities of five to ten years. In the pe- ing in unlisted companies in India. However, the restric-
riod of recession, the initial amount of Term Debt from tions include FDI sector caps in different sectors as set by
the bank will not be sufficient for the deal. Term debt the Govt. Of India.
amount and rate depends upon the Interest coverage ra-
tio & stable cash flow of the firm over the loan period.
During recession, stable cash flows & profits are not very UNDERDEVELOPED CORPORATE DEBT MARKET
lucrative so the banks will be reluctant to give loan. India still has a bank-dominated financial system,
2. Mezannine Financing: It is junior to the bank with bank-dominated loans measuring 36% proportion-
debt incurred in financing the leveraged buyout and can ate to GDP and corporate debt only 4%.State-owned
take the form of subordinated notes from the private public sector undertakings (‘PSU’) which started issuing
placement market or high-yield bonds from the public bonds in financial year 1985-86 account for nearly 80%
markets, depending on the size and attractiveness of the of the primary market. Compared with the government
deal. During the recession phase, the availability of cheap securities market, the growth of the corporate debt mar-
debt funding is not easy. Moreover the company provid- ket has been much less. Also, a bulk of the debt has been
Page 11

© The Finance Club, Indian Institute of Management, Shillong
Leverage &investmentS

raised through private placements. vestor. Most of the equity returns are generated from
growth by scaling and ramping up the operations of the
portfolio company through hiring and training employ-
ees, expanding capacity and adding additional customer
contracts. This sort of rapid scaling up of operations re-
quires high quality management talent, robust internal
processes and a large pool of skilled human resources.
(Source : KPMG India. 2007. “India Budget 2007 Highlights)

FUTURE OF LBO IN INDIA
The overwhelming dominance of private placements can
be attributed to the following factors: The Future of LBO in India depends on a large num-
a) Ease of issuance ber of Factors. There is no dearth of companies that can
b) Cost efficiency, and
be acquired, with the service-sector booming, but until
the regulations by SEBI are relaxed, it will be very difficult
c) Primarily Institutional demand.
for the LBO funds to source the money to acquire their
targets. The risks that come along with the high-growth
FOCUS AREAS companies have to be kept in consideration, as also the
The Service-Sector companies are the most sought- risks involved in giving more allowances to FII’s and FDI’s
after for LBO in India, with the outsourcing and high- by SEBI. On the whole, the prospect looks bright if all the
technology companies leading the pack. Recent acqui- factors fall in place.
sitions of Flextronics Software Systems and GECIS are

By Arpit So lanki
prime examples. These companies are labor-intensive and
their costs are globally competitive due to a low-cost,

Avik Roy
highly educated English workforce in India. With a phase

Ankit Agar w al
of consolidation looming large in these sectors, there is
a very good chance of these companies changing owner-
ship through LBO in recent future.
IIM Kozhikode
HIGH GDP GROWTH IN INDIA
With the Indian economy registering a consistent
over 9% growth rate during 2005-07 and an expected
creditable 7.5% in FY08, the Indian companies have a huge
chance to grow. This makes them all the more attractive
to the LBO funds as they can get the acquired company’s
revenues pay for the debt taken by the LBO funds. Indian
companies face large capital requirements and despite the
ample availability of capital in the international markets
and in India for portfolio investments, there is a shortage
of capital for funding operations and growth.
The NASSCOM-McKinsey report estimates that
the offshore business process outsourcing industry will
grow at a 37.0% compound annual growth rate, from $11.4
billion in fiscal 2005 to $55.0 billion in fiscal 2010. The
NASSCOM-McKinsey report estimates that India-based
players accounted for 46% of offshore business process
outsourcing revenue in fiscal 2005 and India will retain
its dominant position as the most favored offshore busi-
ness process outsourcing destination for the foreseeable
future. Also, retail banking, insurance, travel and hospital-
ity and automobile manufacturing have been identified
as the industries with the greatest promise for offshore
outsourcing and being targeted by LBO.

RISK FROM HIGH-GROWTH CHARACTERISTICS
The High-Growth characteristics of Indian Com-
panies bring with them a greater execution risk for the
management of the target company and the financial in-
Page 22

Niveshak Volume 2 Issue 2 March 2009
InstitutionS

««««««««««
Concerns with
»»»»»»»»»» current world eco-

I
n the last two editions of this series we nomic crisis to try
have seen the role that needs to be played t o obtain final closure of
by International Monetary Fund (IMF) and the Doha round. It is unfortunate that
World Bank in the current crisis. The third in the series the Doha closure was postponed recently mainly
is the role that can be played by World Trade Organiza- because of a rather silly US stand on what import
tion (WTO). surge in agriculture constitutes a reasonable trigger
for safeguard action by developing countries. Again,
The World Trade Organization is a major player the recent draft which brings in sectoral level negotia-
in the field of global governance. Since its creation in tions in NAMA is likely to muddy the waters.
January 1995, it has expanded the reach of trade rules
deep into the regulatory structure of almost 150 sover- That trade and global commerce is the first casu-
eign states, affecting the daily lives of all citizens. As a alty of world recessions is well known. As unemploy-
result, it has found itself at the centre of controversy ment drops in countries there are increasing political
in areas that are well outside the domain of traditional demands (more so in democracies) to ‘keep jobs at
trade policy. The ree trade policy is found to be ben- home’. The US which had taken the lead role in lib-
efitting the developed countries more than the devel- eralization through the 1980’s and 1990’s has taken a
oping countries. U-turn in its policy. One has already seen this in some
of Barack Obama’s statements in the US. The bill to
The financial crisis in the US is now converting tax outsourcing heavily is already underway. Obama’s
into a contraction in real demand for goods and ser- intent to insert labor and environmental standards
vices globally. This is mainly because the US by itself into the NAFTA Treaty is seen as more mercantile, to
accounts for about 30 percent of world demand. The America’s benefit, than favoring global free trade.
latest International Monetary Fund (IMF) forecast sees
world trade contracting by 2.8 percent this year after One of the emerging trends of this recession is
growing 4.1 percent in 2008 and 7.2 percent in 2007, a the emerging protectionism. Although the exact de-
particularly worrying trend as slowing trade growth tails of the measures taken by various countries are
is now the main depressing factor on world output. not available, there is clearly a move in that direction.
Although this recession is the worst since 1930s, there Erecting trade barriers to defend jobs may deepen the
is a crucial difference: the level of coordination among global recession by making it harder for other coun-
countries in financial and other markets is quite sig- tries to sell their goods abroad, as occurred during the
nificant today. Lack of this coordination (both domes- 1930s Great Depression.
tically and internationally) was a major lacuna in the World bodies must ensure multilateralism as uni-
1930s. The main problem with this lack of coordination lateral actions, in such circumstances, are irrational.
is that the required demand corrections rely entirely The WTO has shown its resilience by keeping markets
on markets which are typically known (a la Keynes) to open during periods of financial and external payments
fail in such times. The main difference today as com- crisis, the multilateral trading system has shown that
pared to the 1930s is the existence of international co- it can give a chance to crisis-stricken countries to re-
ordinating institutions. For trade we today have the cover through trade. However, to do so, access to trade
WTO, which coordinates tariff concessions between finance at affordable rates must be
countries. maintained in such critical times
However, the failure to close the Doha round of to ensure that international trade
trade negotiations during the past seven years or so can continue to play its shock-
has made many observers doubt the efficacy of the absorbing role.
WTO in fairly regulating world trade. Yet, paradoxi- The global financial crisis
cally, the role of the WTO is far more critical today in has put pressure on the system
preventing tariff wars. of trade credit that underpins
It is, therefore, essential for the WTO to use the world trade, making exporters and
Page 22

© The Finance Club, Indian Institute of Management, Shillong
InstitutionS

importers pay far higher prices for the loans that al- vestment restrictions) in coming months. WTO mem-
low them to transport goods globally. Important play- bers could agree to a new system of surveillance that
ers like banks either lack funds or are too risk-averse would track and report all new national trade restric-
to extend export credit in times of economic uncer- tions.
tainty.
The WTO must also shift focus from the tradi-
The primary role of the WTO at this moment is tional role of reducing trade barriers at the borders,
to serve as an insurance policy against protectionism; such as tariffs and quotas and more recently regional
especially for developing countries, whose expansion and bilateral free trade agreements. The challenges of
relies very much on trade. Many developing countries the current times call for a more up-to-date under-
rely on trade finance - loans tied directly to cross-bor- standing in an interdependent world. In areas such as
der trade transactions - to help fund their participa- climate change, the challenge is to coordinate or rec-
tion in the global market. But with many banks short oncile domestic policies to promote a common global
on cash, such loans are now hard to come by. Afford- objective while also avoiding trade barriers.
able access to trade financing in such crises is crucial
The WTO should also move beyond the straitjack-
to ensure that international trade can help absorb the
et of the “grand bargain” negotiating round, in which
shock of a global economic crisis.
progress cannot be achieved unless all countries reach
However the point in favor of trade financing is agreement on all subjects. Instead, certain negotiating
that trade finance is widely considered one of the most subjects could proceed separately or in clusters, expe-
secure modes of finance. The loans have a short matu- diting agreement and making the WTO more respon-
rity, their execution is relatively routine, and the traded sive to rapid changes in the global economy.
goods themselves can serve as collaterals. The priority
The challenge is not to rebuild the WTO from
task is to enhance capacity to mitigate the effects of
scratch, but to rethink how the WTO can better ad-
the increased perception of risks and to provide the
dress emerging global issues.
market with earmarked liquidity for trade finance.

By Manjunath M
The stimulus package and the financial bailouts
are also seen as a more insidious form of protectionism
because they favor domestic producers and poor coun- IIM Shillong
tries cannot afford the cash. They are also expected to
distort the competition between the institutions.
A drastic action is needed in the immediate future
to revive the fortunes of the WTO and the multilateral
system. WTO trade ministers should formally agree to
a “stand still” pact, by which all member states would
pledge not to introduce new protectionist measures
(increased tariff rates, a surge of safeguard actions, in-
Page 22

Niveshak Volume 2 Issue 2 March 2009
Food for thoughT

««««««««««
Is India’s growth story mostly debt driven?
»»»»»»»»»»
General definition of GDP is :- nal finance. The Indian consumption story has also been
debt driven rather than earnings driven. It’s just that the
GDP = C + I + E + G
individuals are not saddled with big debt, but big corpo-
where, rate houses and government are. And to that extent I also
C - Consumption think that the so called domestic consumption story was
I - Investment overestimated and is now unraveling. (As can be seen
E -Exports over Imports from falling vehicle sales and even falling consumer non-
G - Government Spending durables!!!). In fact I think it will be quite a while before
we are able to sell 1.4 mn passenger vehicles again in a

L
year.
et us first take the “E” part of it. Given that In-
It is always argued that India’s internal domestic
dia has a trade deficit, this should be a nega-
structure will ensure minimal impact of external envi-
tive contributor to the equation but let’s have
ronment. But as we have seen above, exports have a huge
a look at the following: Over the last 5 years the imports
part to play in the growth seen in the period and conse-
have risen by around $180 bn. But about $115 bn dollars
quently we would see a more than marginal impact of
of these imports were supported by incremental external
the deteriorating global environment. It was ironical but
debt taken during the same time. During this time frame,
for a country with a current account deficit, we were
fertilizer imports jumped from $6 bn to $54 bn. I think it
piling on forex reserves. But as we saw above, it was ma-
is fair to assume that this has been exclusively financed
jorly driven by debt and not earnings. Of course, FII and
by government through additional debt issuance. Petro-
FDI money also came in hoping to cash in on the “India
leum imports have jumped from $17 bn dollars to $80 bn.
growth story”. Since exports are now de-growing and
Some part of it is financed by the government. If we add
domestic consumption also tapering off, I would think
up all these, all the incremental imports in the country in
capex would come to a grinding halt. What happens next
the last 5 years have been financed by debt, mostly exter-
year, given that oil prices have collapsed and there would
nal. Thus essentially all the earnings from exports ended
be much lesser pressure on the current account. Given
up supporting incremental consumption/capex/savings in
the exports are falling, how much help would be given
the country, since our import liabilities were handled by
is a question mark. We might even end up having small
debt. (This is on a overall balance sheet basis, not one-
current account surplus next year, but that is at the cost
to-one correspondence between imports and debt) Thus,
of huge slowdown in growth. I am not sure if it is a posi-
even though the “E” part in the above equation was nega-
tive signal.
tive, still the debt driven financing gave a big boost to the
“C” and “I” part of the equation. Given that the exports To conclude while adding roughly $300bn to GDP
have gone up by $105 bn in this time, that is the amount in the last 5 years, our external debt has gone up by $ 110
of stimulus the economy would have received and these bn dollars and Central government’s debt has gone up
numbers do not include the software exports or the re- by around 13.5 lac cr (roughly $250bn, excluding govern-
mittances. To put that into context, in the last 5 years ment’s share of external debt). Is India’s growth mostly
the GDP has roughly gone up from $700 bn to $1000 bn debt driven?
@ around 8.5% p.a. Thus a big chunk of the incremental I don’t think this is sustainable kind of a growth
$300bn GDP was from export earnings coming through as model...then how do we build one?

By P uja Kasat
consumption and capex.
If the above theory is reasonably sound then - the
savings rate (%) of the country is inflated. We should FMS Delhi
probably subtract the incremental external debt
for the year before coming to the num-
ber. (The savings in the country is
like taking loan from Bank A and
keeping it in Bank B and
calling it savings). And
if this conclusion is cor-
rect, savings rate should
fall this year given the
problems in getting exter-
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© The Finance Club, Indian Institute of Management, Shillong
PerspectivE

««««««««««
A Different Perspective!
»»»»»»»»»»
T
he year 2008 was an unprecedented year Asian banks and
in many ways. As a consequence of the fi- financial institutions—on t h e
nancial crisis and the number of external whole—are in better shape. Bloomberg
shocks financial markets had to deal with, extreme vola- produced a nice chart showing the superior relative
tility, record high risk aversion, and a wave of de-leverag- performance of stocks of Asian financial institutions in
ing that caused a deflationary shock, 2008 will certainly the Morgan Stanley Asian financial index, compared with
get its place in the history books. Also with the funda- those in the indices for American and European financials.
mentals of companies facing dire crises all over the world The contrast has been more noticeable since the collapse
and fundamental accounting standards going for a toss of Lehman Brothers in mid-September last year. This is
with the Satyam fiasco, let us look towards history and grounded in fundamentals. Fifty-six per cent of the global
statistics to provide us with a fresh and rational perspec- write-offs and write-downs by financial institutions have
tive. If we look back over the past year, with a -38.4% come from the US, 36% from Europe and only 8% from
the S&P-500 posted its 3rd worst year since 1800 and the Asia. And these are very encouraging statistics. Perhaps
sensex shed a whopping 52.86 % (source: Bloomberg). But Chinese banks are slightly more vulnerable, for the coun-
next if we look at the market reflexes after such an ex- try was high on confidence, had institutional structure
tremely negative year, we had in most cases substantial that facilitated directed lending and had enough global
bounces if not even the start of a new bull market in the cheerleaders to take them down that path. Korean in-
following year. stitutions and households are genetically hardcoded to
Since 1800, the S&P-500 experienced 20 years with assume leverage of Western proportions. Indian banks
a loss of 15% and higher. The record down year was 1931, would have walked down that path gladly but the RBI ef-
where the US market lost 47% of its value. In 14 out of fectively forbade them from doing so. So, Asian banks are
20 cases the market managed a bullish following year in considerably better shape. Their credit intermediation
with an average performance of some 22.3%. So, one key has been disrupted not by the state of (ill) health of their
message for this year is that from a statistical standpoint and their clients’ balance sheets, but by the economic
alone we have a 70% likelihood that 2009 will end up as cycle.
a positive year for the markets. And if there is a positive Further, a survey conducted by the Duke University
bias in the chance of developed markets ending the year on the cash levels of financially constrained and uncon-
in green, then it is safe to say that the chances of emerg- strained non-financial firms, their credit availability and
ing markets giving substantially higher gains is much their investment plans for the future shows that Asian
more. firms are much better placed than their Western coun-
Now that we have probability on our side and lit- terparts. Also according to another study, India fares bet-
tle optimism behind our backs, let’s move on to a term ter than some developed countries in terms of M&As. The
which has been literally ignored since after the market size of “completed” M&A deals for India had declined by
crash last January: Decoupling. Decoupling was what 25%, according to an 9 October Thomson Reuters report—
was rumored to happen between the developed and the exactly in line with the global average and significantly
developing economies before Wall Street debacles took better than a 28% decline for the US, 57% for France and
down the world with it. Let’s now look at it again in a 32% for the UK.
new light. This suggests that economic growth will be both
The world is one leveraged bet on the US consumer. relatively and absolutely better in Asia. A few days ago
But as the US consumer cuts back on his spending, export Merrill Lynch and Co.’s North American economist, David
growth of Asian countries plumbs new depths. So, in this Rosenberg gave the following advice to investors: “Inves-
cycle, there is no decoupling, or there was no decoupling. tors looking for growth should look beyond the American
What about future cycles? There is scope for hope. consumer and housing market. These areas of the econo-
Page 22

Niveshak Volume 2 Issue 2 March 2009
PerspectivE

my, even after they stabilize, are unlikely to be the lead-
ers in the next economic expansion or bull market. Inves- FinQ January’09 Issue Answers
tors are advised to seek out the countries, most of them
in the emerging market world, which have the cash, the 1. Bretton Woods Institutions-
surpluses and the savings rates that can liberate consum- (1) Bretton Woods Hotel,
ers on the other side of the ocean. The global economy
(2) Logo of International Bank of
has relied for far too long on the American consumer
Reconstruction & Development
for growth, but that well has run dry—and this time, for
(IBRD) and
good.”
(3) Logo of The International Monetary
There are two points that emerge from this quote Fund (IMF) .
— one, the decline of the US; and the second is the rise of
2. X- Franco Modigliani
the emerging markets.
Y- Merton Miller
American state at present continues to be the Z-M & M theorem
big hope, not only for its citizens, but for international 3. (1) Business Week Cover Page – 21st
capital. But if, as more and more voices are arguing, the September’ 1998: After the LTCM
outcome of the crisis is a depression and if it leads to a
collapse
fundamental change in the way the global economy has
(2) Price Waterhouse LLP- Auditors
been arranged for the last quarter of a century, there
for LTCM
could be huge tensions building up within the US. The
(3) When Genius Failed: The Rise and
impact has been one where Wall Street makes huge prof-
Fall of Long-Term Capital Manage
its from financial activities, its companies increasingly
ment by Roger Lowenstein
offshore their operations in places such as China and In-
(4) Myron Scholes-Member of Board of
dia, while Main Street prosperity is fuelled by debt and
Directors at LTCM; Nobel Price
rising asset values. This system revived growth, but also
had the added advantage of disciplining labor, as a result
Economics Winner in 1997
of which the share of labor in national income in the US
(5). Robert Merton-Member of Board of
went down strikingly. Directors at LTCM; Nobel Price
Economics Winner in 1997
The problem is that it is not possible to get back to
4. Carol Bartz, New CEO of Yahoo!
the world of the 1950s, a world in which there was no
global production system. As for investors putting their
5. Life Insurance Corporation of India, ICICI
money in emerging markets, it would be best to sum
Prudential, Unit Trust of India, General
up by quoting investment guru Jeremy Grantham’s word Insurance Corporation of India and Asian
“We’re simply getting more mature, and all the other de- Development Bank.Connect: Credit Rat
veloped countries are doing the same thing. But emerging ing and Information Services of India
has not fallen off its trend line, and has a lot of people Limited (CRISIL) was established by UTI,
coming into the workforce and a huge savings rate. I ICICI, LIC, GIC and the Asian Develop
think it will do very well. Put it this way, it will appeal to ment Bank in January 1988.
investors. It may not make any more earnings per share, 6. Nick Leeson
in other words. I’m not talking about true fundamental 7. Syndicate Bank
value. I’m talking about how people buy stocks. They love 8. Rothschild Family
top line growth. If they’re going to grow at four-and-a- 9. Phenomenon is known as the “Mark
half and we’re going to slow down to two-and-a-half, it’s Twain Effect” or “October Effect”. The
going to look like a no-brainer. So, I think the next big quote is by Mark Twain in his book
event in emerging will be that they will sell it at a big P/E titled, “Pudd’nhead Wilson”.
(price to earnings) premium over us developed countries, 10. Diners Club Credit Card.
who are suffering from a terminal case of middle-aged

By Subhada
spread, I think.”

NMIMS, Mumbai
Page 22

© The Finance Club, Indian Institute of Management, Shillong
FinloungE

FinQ
1. Identify the advertisement of the institution which moves your money from there to here.

2. Identify the Company?

3. He used to earn money by repairing toy trains at the age of 13. After escaping from
British Police, his father landed in USA in 1920 with $20 in his pocket and later married an American school teacher
and settled in Philadelphia. His corporate headquarters is known as “The Mountain”. Identify him.

4. Identify this Coat of Arms

5. Identify the logo.

6. In which country’s coins you can see the following lines imprinted, ‘This is the root of all
evils’.

7. What term became popular after the newspaper report of Watergate Scandal in the year 1973?

8. What term in Oxford Advanced learner’s Dictionary latest edition describes “a person who lost his job owing to
heavy outsourcing in his company”

9. X laid the foundations of the New Delhi based Y Group in the 1970s with a small bicycle-parts business. In 1985, he
entered the telecom business by establishing Z that manufactured telephonic equipment. In the same year, Z entered
into technical collaboration with Siemens AG (Germany) for manufacturing electronic push button telephones. Z also
signed an agreement with Takacom Corporation (Japan) for manufacturing telephone answering machines. Identify
X, Y and Z

10. What is the name given to banks that have no physical presence and conducts business over the phone, through
the mail, by fax, or over the Internet.

All Enteries should be mailed at niveshak.iims@gmail.com by 30th March 23:59 hours
One lucky winner will receive cash prize of Rs 500/-
Page 22

Niveshak Volume 2 Issue 2 March 2009
Team niveshaK

ARTICLE OF THE MONTH
The article of the month for March 2009 goes to Mr. Ankur Khaitan of MDI Gur-
gaon. He recieves a cash prize of Rs.1000/-. CONGRATULATIONS!!

Fin-Q Winner for Last issue
Mr. Manas Jain of NMIMS University, Mumbai. He receives a cash prize of
Rs.500/-. CONGRATULATIONS!!

All Are INVITED!!
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 31st March 2009 to niveshak.iims@gmail.com. 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 3 at max.

SUBSCRIBE!!
Get YOUR OWN COPY DELIVERED TO INBOX
Drop a mail at niveshak.iims@gmail.com

Thanks
Team Niveshak
Page 22

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