Niveshak - The Investment Report
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Niveshak - The Investment Report

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Welingkars students write a report upon everything related to investment via the Niveshak Times!

Welingkars students write a report upon everything related to investment via the Niveshak Times!

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    Niveshak - The Investment Report Niveshak - The Investment Report Document Transcript

    • NiveshakTHE INVESTOR VOLUME 3 ISSUE 11 November 2010 ! The Good, The Bad and The Ugly Q2 Results RALLYING STOCK MARKETS DUE THE IMPACT OF RISE IN CRUDE OIL PRICES to HOT MONEY INFLOWS PG.08 ON THE INDIAN ECONOMY pg.20
    • FROM EDITOR’S DESK Dear Niveshaks I wonder when we are going to see this vicious circle coming to an Niveshak end. The whole world witnessed the global downturn in 2008 followed by Volume III debt crisis in Dubai and Greece. And now we see Ireland joining the league. ISSUE XI While the US economy faced the repercussions due to reckless securitising November 2010 of subprime mortgages and Greece collapsed under the burden of mis- represented government spending, the Irish took an easier path to ruin: by taking out enormous, unregulated loans. While the Irish government Faculty Mentor might have underestimated the severity of the crisis in the last two years Prof. N. Sivasankaran and have still not asked for assistance, but, given the kind of interconnected framework i.e. Euro Zone in which they operate, its neighbouring countries might not let this continue for a longer period of time. Although European countries don’t affect our economy directly but they do affect sentiments, THE TEAM capital flows, gold prices, and commodity prices and so on. Thus, it makes Editor all the more important for a recovering economy like ours to maintain the Bhavit Sharma growth momentum through timely and appropriate reforms. The waves of concerns that Ireland and few other countries of Europe Sub-Editors may find it difficult to meet their debt commitments couldn’t prevent them- Durgesh Nandini Mohanty selves from reaching Indian bourses and dragged it below the psychologi- Hitesh Gulati cal levels of 20,000 and 6,000, of Sensex and Nifty respectively. This really Sumit Kedia makes me (and many of us) believe that we are truly an integral part of so Tanvi Arora called Global village. Moving forward we can expect to see more down- Upasna Agarwal side movement owing to the slowly building Asian cues specifically on con- cerns that China may further tighten their monetary policy to curb inflation. New Team But with the strong capital inflows from FIIs looking for greater returns and Alok Agrawal sound Indian economy backed by solid fundamentals, our benchmark in- Deep Mehta dices can surprise us by breaking its greatest achieved heights by the end Jayant Kejriwal of this year. Mrityunjay Choudhary Rajat Sethia Last month’s cover story gave you a detailed analysis of the Coal In- Sawan Singamsetty dia’s IPO and its future outlook. The stock, when listed on 4th November Shashank Jain 2010, actually met all its expectations and got listed at Rs. 314 which was at Tejas Vijay Pradhan approximately 30% above of what investors had paid. Truly a windfall for all investors. I so wish I too had invested in it. In this month’s cover story, we are Creative Team going to look, analyse and understand the second quarter results of differ- Bhavya Aggarwal ent key sectors operating in India and their implications. At a time when In- Swarnabha Mukherjee dian Financial services landscape is undergoing big time consolidation with Vishal Goel the likes of Axis-Enam deal, we, in this edition, also present to you an article on mergers and acquisitions. We are pleased to inform you that we have Vivek Priyadarshi introduced a new section in Niveshak called “Classroom” for your reading pleasure. In this section, we will explain and elaborate a financial term with the help of a conversation. We hope that this endeavour of ours will proveAll images, design and artwork to be an interesting read for our readers and will help them understand are copyright of new terms in a much easier way with fun. Looking forward to your valuable IIM Shillong Finance Club feedback and suggestions. ©Finance Club Stay Invested.Indian Institute of Management Shillong Bhavit Sharma www.iims-niveshak.com (Editor -Niveshak)Disclaimer: The views presented are the opinion/work of the individual author and The Finance Club of IIM Shillong bearsno responsibility whatsoever.
    • CONTENTSNiveshak Times Fingyaan04 The Month That Was 16 Mergers and Acquisitions in a Recession finsight Cover Story 19 Axis Enam Merger11 Q2 Results – The Good, the Bad and the Ugly! CLASSROOM 23 Arbitrage Article of the month 08 Rallying Stock Markets due to Hot Money InflowsPERSPECTIVE20 The Impact Of Rise In Crude Oil Prices On The Indian Economy FINLOUNGE 24 Crossword
    • www.iims-niveshak.com The Niveshak Times IRELAND TO SEEK EU-LED BAILOUT AS FINANCE MINISTER BRIAN LENIHAN WORKS TO AVERT BANK COLLAPSE TEAM NIVESHAK IIM, Shillong DOMESTIC BUSINESS erty loans above Rs. 75 lakhs, IDBI also increased its Power Grid FPO garners 14.88 times oversub- interest rate for same by 25 basis points. scription SEBI raises retail investor cap to Rs. 2 lakhs The FPO offer from Power Grid Corporation of SEBI has doubled the upper limit for retail in- India for its 84.17 crore shares in the price band vestment in public offers from Rs. 1 lakhs to Rs. of Rs. 85-90 per share attracted a 14.88 times over- 2 lakhs to encourage greater investor participation subscription of 1252.96 crore shares. The oversub- in share market through retail route. Now an inves- scription reflects the continuing investor enthusiasm tor applying for shares up to Rs. 2 lakhs in an IPO in stocks of state run entities which or FPO will be treated as retail investor which will was also evident during the big- make him/her eligible for 5% discount on subscrip- gest Indian IPO by Coal India Lim- tion’s face value. It is relatively easier to buy shares ited. This FPO, which is estimated through retail investment due to relatively lower to generate about Rs.7500 crore, share subscription by this category as compared to is a part of the government plan HNI and institutional investor community. The total to raise Rs. 40,000 crores in the shares at the disposal of retail investors shares in a current fiscal year through stake public offer has remained unchanged at 35% and the sale in state owned firms. After this FPO, the gov- corresponding allotments for HNI and institutionalThe MonTh ThaT Was ernment’s stake in Power Grid will come down from investors has also remain fixed at 15% and 50% re- 86.36% to 69.40%. spectively. RBI hikes interest rates by 25 basis points India and China ranked higher in IMF’s quo- To tame the rising inflation, RBI pushed up its ta interest rates by 25 basis points with repo and re- G-20‘s decision to increase the quota for emerg- verse repo rate being 6.25% and 5.25% respectively. ing economies by 6% in its meeting in South Korea Though the WPI based inflation fell down marginally has resulted in India and China being elevated to 8th from 8.62% in September to 8.58% in October, the and 3rd positions in quota status respectively. Now latter figure is still considered to be above “comfort India’s quota in this 187 nation body has increased level” by central bank, thus triggering its decision to from earlier 2.44% to 2.75% signaling its emergence continue with its trend of increasing lending rates. as a major player in It also tightened its norms on high value property new world econom- loans as it increased the risk weight on property ic order. Emerging loans exceeding Rs. 75 lakhs from 100% to 125% ir- economies contrib- respective of its LTV (Loan to Asset Value) which also ute about 47.5% to has been subjected to an upper limit of 80%. This world economy in is likely to increase the difficulty of access to these terms of PPP (Pur- loans as the banks are likely to reciprocate with a chasing Power Par- hike in lending rates for such loans. ity) whereas their IDBI goes for a rise in interest rates corresponding share in IMF prior to this decision stood at 39.5%. In view of policy rate hike by RBI, public sector bank IDBI pushed up its interest rates by 50 basis India and Malaysia sign a free trade pact for points. The benchmark prime lending rate has been next year raised by 25 basis points to 13.50% with effect from India and Malaysia finalized a Comprehensive 4th November. It also raised its retail term deposit Economic Co-operation Agreement, CECA that is like- rates by 10-50 basis points for its various maturity ly to increase annual bilateral trade to $15 billion by schemes. With RBI increasing risk weight for prop- year 2015. Malaysia exports electrical and electronic 4 NIVESHAK VOLUME 3 ISSUE 11 november 2010
    • www.iims-niveshak.com The Niveshak Times THE BIGGEST OPPORTUNITY FOR US IS NOT NECESSARILY TO DO MORE THINGS, BUT TO BE GOLDMAN SACHS IN MORE PLACES: LLOYD BLANKFEINproducts, crude petroleum, palm oil and chemi- INTERNATIONAL BUSINESScal goods to India. Further, India has also invested US to go for second round of Quantitativearound $1.11 billion in nearly 100 manufacturing Easing:projects in Malaysia. The deal expected to promote Federal Reserve of US has announced its sec-free movement of goods, services and investment ond round of Quantitative Easing (QE) of $600 bil-will be signed by leaders of both the countries by lion to provide succor to languish-31st January, 2011. This deal is more comprehen- ing US economy. QE 2 actionsive than India-ASEAN one which came into effect plan involves buying of trea-at beginning of this year as it also covers services, sury bonds of $75 billioninvestment and technical barriers to trade and other per month over the next 8areas. months to infuse $600 bil-Cross Border Mergers embroiled in capital lion into the economy. Thegains tax tangle objective is to increase the Two cross border mergers, one involving tele- excess reserves with the bank-com giant Vodafone’s acquisition of Hutchison and ing system so as to keep the inter- The MonTh ThaT Wasthe other involving major drug maker, Sanofi –Aven- est rates low and thereby stimulate borrow-tis’ pick up of majority stake in Shanta Biotechnics, ing and spending activities in the economy.have come under the scanner of IT department for AIA’s $17.9 billion IPO is the 3rd biggest inpayment of capital gains tax. In Vodafone’s case, it worldhas been asked by a three judge bench of Supreme The Hong Kong IPO of AIA, the Asian insuranceCourt headed by chief justice S.H. Kapadia to de- unit of AIG was a huge hit among investors lookingposit Rs. 2500 crore by first week of December and to invest in one of world’s most attractive financiala bank guarantee of Rs. 8500 crore by second week markets as it amassed $17.9 billion to become theof January,2011. The total sum of Rs. 11ooo crore is third biggest IPO in the world. A part of the proceedsthe capital gain tax which Vodafone has to pay for will be used by AIG to pay back a portion of theits acquisition of Hutchison shares. In other case, $182.3 billion bailout that it received from US.Sanofi-Aventis has been asked by IT department topay Rs. 700 crore as capital gain tax for its buying of Steve Ballmer sells $1.3 billion shares of Mi-majority stake in Hyderabad based pharmaceutical crosoftfirm, Shanta Biotechnics valued at Rs. 3770 crore. Microsoft CEO, Steve Ballmer has laid off $1.3Mutual Funds to go for quarterly basis dis- billion worth of shares in the company, a first inclosure of assets his tenure of seven years with the company. After this sale the CEO still holds 350 million shares in Association of Mutual Funds in India (AMFI) company valued athas decided to end the practice of monthly disclo- $9 billion approxi-sure of Assets Under Management (AUM) for mutual mately. To avoid anyfunds in India from October and adopt a quarterly negative specula-basis disclosure for period thereafter.”The average tion that this chunkAUM (AAUM) for each quarter (90-day average) will sale of shares by thebe computed and uploaded on the Amfi website on CEO may trigger, thethe first working day of the following month of every company issued a statement on Steve’s behalf inquarter, effective from quarter ending December 31, which personal investment diversification and bet-2010,” Amfi said. The move is an attempt to placate ter year end tax planning were given as the reasonsprevalent feeling among mutual fund companies behind his move.about monthly disclosure of AUM putting too muchpressure on business. © FINANCE CLUB, INDIAN INSTITUTE OF MANAGEMENT SHILLONG 5
    • www.iims-niveshak.com Market Snapshot FII, DII Net activity (in Rs. Crores) BSEAoM MonTh T Perspective Source: www.bseindia.com www.nseindia.comTheFinGyaan haT Was MARKET CAP (IN RS. CR) BSE Mkt. Cap 72,21,148.40 BSE Index Full Mkt. Cap 29,13,700.51 Index Open Close % Change Index Free Float Mkt. Cap 15,45,165.99 SENSEX 20,272.49 19585.44 -3.39 Source: www.bseindia.com MIDCAP 8302.56 8077.36 -2.71 SMALLCAP 10597.59 10237.29 -3.40 CURRENCY RATES AUTO 9964.35 9940.93 -0.24 INR / 1 USD 45.26 BANKEX          14165.91 13705.09 -3.25 INR / 1 Euro 61.78 Consumer Durables 6544.48 6455.92 -1.35 INR / 100 Jap. YEN 54.25 Capital Goods 15889.74 15625.49 -1.66 FinSight INR / 1 Pound Sterling 72.60 FMCG 3620.89 3595.08 -0.71 Healthcare 6462.61 6579.76 1.81 IT 6023.54 5889.87 -2.22 Metal 16923.31 16461.15 -2.73 OIL & GAS 11137.96 10227.47 -8.17 POWER 3138.99 2981.36 -5.02 PSU 10199.39 9647.79 -5.41 REALTY 3653.32 3173.57 -13.13 TECk 3702.60 3617.55 -2.30 Source: www.bseindia.com 1st to 19th November 2010 Data as on 19th November 2010 6 NIVESHAK VOLUME 3 ISSUE 11 NOVEMBER 2010
    • www.iims-niveshak.com Market Snapshot KEY INDICES RESERVE RATIOS CPI (Sep. 2010) 9.81% CRR 6% WPI 8.58% SLR 25% IIP (Sep. 2010) 4.4% Source: www.rbi.org.in Source: www.mospi.gov.in AoMLENDING / DEPOSIT RATES POLICY RATESBase rate 7.5% - 8% Bank rate 6%Savings Bank rate 3.50% Repo rate 6.25%Deposit rate 6% - 7.5% Reverse Repo rate 5.25% Source: www.rbi.org.in Source: www.rbi.org.in Perspective GLOBAL INFLATION RATES The American inflation CPI 1.17 % Oct-10 English inflation CPI 3.13% Oct-10 MonTh ThaT Was Dutch inflation CPI 1.56% Oct-10 German inflation CPI 1.31% Oct-10 FinGyaan Japanese inflation CPI 0.60% Sep-10 Source: www.global-rates.com GLOBAL INTEREST RATES Name of Interest Rate Current Rate Previous Rate Last Date of Change  American interest rate FED 0.25 % 1.00% 16-Dec-08  Brazilian interest rate BACEN 10.75 % 10.25% 21-Jul-10 FinSight  British interest rate BoE 0.50 % 1.00% 5-Mar-09  Canadian interest rate BOC 1.00% 0.75% 8-Sep-10  Chinese interest rate PBC 5.56% 5.31% 19-Oct-10  European interest rate ECB 1.00% 1.25% 7-May-09  Indian interest rate RBI 6.25% 6.00% 2-Nov-10  Japanese interest rate BoJ 0.10% 0.10% 5-Oct-10  Russian interest rate CBR 7.75% 8.00% 31-May-10  South African interest rate SARB 5.50% 6.00% 19-Nov-10  Swedish interest rate Riksbank 1.00% 0.75% 26-Oct-10  Swiss interest rate SNB 0.25% 0.50% 12-Mar-09 Source: www.global-rates.com Data as on 19th November 2010 © FINANCE CLUB, INDIAN INSTITUTE OF MANAGEMENT SHILLONG 7
    • Rallying stock markets due to HOT money Inflows Akash Agarwal & Abhishek Dassani XLRI Jamshedpur Since January of this year, there in nearly $4.3 billion into the In- The Indian stock has been a surge in equity value dian markets in November and al- market has been on across almost all the emerging mar- most $28.64 billion since the start of the rise on account kets and India is no exception. Last this year. The domestic institutions of the “hot money” month, the Bombay Stock Exchange have been a net seller which has (BSE) Index (Sensex) closed at over helped in meeting the FII demands. inflows from the 20000 points, while National Stock ”Hot money” refers to funds FIIs. Currently, a lot Exchange’s index, the Nifty, closed at that are controlled by investors whoAoM of investments are over 6000. Sensex jumped over 15 per actively seek short-term returns happening in the cent since January, due to huge capi- (mostly FII’s). These investors scan tal inflows, making the Indian stock the market for short-term, high inter- emerging econo- market as one of the best performers. est rate investment opportunities and mies. While FIIs have move their money from one invest- Where did the capital inflows certain positive im- ment asset to another very quickly. come from? pacts on the econ- Usually, the capital inflows Higher FII inflows to India may omy, on the other be attributed to the unclear growth come from both the retail domestic prospects in the west (US has slowed hand they can also investors and the off shore investors down while Germany and UK are up- affect the economy in the form of foreign Institutional beat) and unchanged interest rates Investments (FII’s) and Foreign Di- in a negative man- rect Investments (FDI’s). This had signifying lower returns with the Fed- ner if they are in eral Reserve, European Central Bank been the case earlier during the mar- (ECB), Bank of England (BOE) keep- excess. ket rise of 2007 or before, but this ing rates unchanged. Funds seeking time it’s different. One of the major better returns moved to the Asian concerns that India is facing is that emerging markets and in particular, this ‘hot money’ is going into the India has received stock market rather than new proj- large por- ects and startup companies in the tion of form of long term fund- ing. the in- The investment in the vestment. stock market has more than doubled this year, Overall Impact of foreign direct invest- hot money inflows ment (FDI) into FIIs are usually India fell more not concerned about than 25 per- the issues of devel- cent, com- opment of the developing pared to the economies, whether or not this is same period ethical is another debate. Though a year earlier. there are obvious positive out- So far, FIIs comes for an economy due to the have poured incoming FIIs, these are also accom- So far, FIIs have poured in nearly $4.3 billion into the Indian markets in November and almost $28.64 billion since the start of this year 8 NIVESHAK VOLUME 3 ISSUE 11 NOVEMBER 2010
    • panied with a host of other negative aspects. The outcome of losing competitiveness in exports is thatonly reason for an FII to invest in a company is the it would force the organizations to become more in-motive of profit. FIIs are usually very selective in novative and increase the productivity and quality.their investment. They select companies that showgood results or have potential for future profitabil- Effect of Foreign institutional investors onity thus raising these companies’ stock prices and other emerging economieshence their market capitalization. The firm, now FIIs have had many positive affects in otherwith financial clout can even acquire other firms countries too like in OECD countries, where institu-and grow even more. Apart from that, another posi- tional investors have contributed significantly to thetive impact of FIIs is that it leads to a competition development of their financial markets and overallamong firms, all of them vying for the attention of economic growth. In China, for instance, when thethe FIIs which leads to greater efficiency, higher Qualified Foreign Institutional Investor (QFII) schemetransparency and improved corporate governance. came into effect (it essentially allowed licensed for- eign investors to buy and sell yuan denominated “A” AoMMacroeconomic impact shares in China’s stock exchanges which was closed Due to these capital inflows, enormous inflows to foreign investors till then), the domestic marketsof foreign exchange occur, which exerts an upward was opened up for the foreign investment. This strat-pressure on the Rupee. It soared up 9 percent against egy of QFIIs was also implemented in other places likethe dollar in the last 16 months. The appreciation Taiwan to ensure a stable flow of currency so that theof the Rupee will obviously make the imports com- economic stability of the economy was maintained.ing into India cheap and exports more expensive. In Mexico too, significant changes in its eco-Thus, importers stand to gain from cheaper imports, nomic and political scenario have taken placewhich in turn, lead to lower prices of these imported making it a preferred investment destination.goods in the country leading to a deflationary trend. Negative effects of excess FIIs in markets The Foreign Institutional Investors usually bring with them a lot more volatility into the fi- nancial markets of the country than what may have been experienced before. According to some Indian analysts, the increasing bullishness in the developing nations is leading the stocks in these countries to become overvalued that may not be justified even under country’s high growth rate. There are also fears that some of the lessons from Fig 1: Monthly Trade deficit in million dollars the recent financial crisis have been forgotten. On the flip side, the appreciation of the Ru- According to Eswar S Prasad, Professor of Eco-pee makes Indian exports less competitive in the nomics at Cornell University, there can be fairlyinternational markets. The major commodities that serious risks associated with the escalating equityare exported are gems and jewelry, chemical and market if the hot money keeps pouring in India.related products, engineering goods and textiles He fears that this might just be the boom phaseamong others. If the Rupee appreciates, these sec- of a boom-bust cycle, with all the given risks.tors would become less competitive due to exports Mr. Prasad worries that one day or the oth-becoming expensive and thus possibly would expe- er most of the FIIs could suddenly withdraw theirrience a slowdown in growth. Earlier, exports would invested money, as was done in early 2008, ifhave led to the growth of these sectors. Thus, with they saw any signs of a slow down in the In-the fall in exports the possibilities of layoffs and dian economy. The outflow of money from theslower growth rates in these highly labor intensive market could then decrease the real economicsectors have increased. On the other side, a positive growth in India, and hurt it tremendously, by de- Funds seeking better returns have moved to the Asian emerging markets and in particular, India has received large portion of the investment © FINANCE CLUB, INDIAN INSTITUTE OF MANAGEMENT SHILLONG 9
    • priving the country of the short term capital. For example, in 2008 India was growing at the rate of 9.2% but its growth fell to 6.7 percent, partly because the foreign investors took out bil- CROSSWORD SOLUTIONS lions of dollars from Indian stock and the bonds market. The decreased supply of capital severely OCTOBER 2010 hit the companies with large capital requirements. Thus, when the economy opens to the short term capital in the form of ‘hot mon- Across ey’ by the FII, the risk of the capital sud- denly moving out of the country increases. 4. Petrobras Conclusion It will not be wrong however, if we say that FIIs 5. CDOAoM have played a big role in the formation of capital in the country. Some academicians even say that 6. CBOT the overall liquidity in the capital market can be at- tributed to the hot money poured in the country by institutional investors. The surge in the rupee 7. Cairn due to steady flow of dollars in the country also has its own implications for the economy. However, on the downside there are some severe implications 9. Peter Lynch in terms of increased volatility in financial markets. This volatility significantly impacts the small local investors in these markets. If we look at the over- all trend in the stock market today, many Indians have become wary of the stock market. Individual Down investors, for instance, did not jump at the recent IPO of SKS Microfinance. The Coal India offering was 1. Revenue Recognition also subscribed only 2.1 X times by the retail in- vestors in contrast to the overall subscription of 15.3 times. In early 2008, however they clamored 2. Sarbox to buy public offerings such as Reliance Power. Another significant development that has 3. UTI AMC been observed is that the Indian markets are now no longer insulated from the world mar- kets due to the international flow of goods 4. Plowback and services and international flow of capital. 8. BVP “There can be fairly seri- ous risks associated with the escalating equity market if the hot money keeps pouring in India” - Eswar S Prasad, Professor of Economics,Cornell University10 NIVESHAK VOLUME 3 ISSUE 11 NOVEMBER 2010
    • eG ood,Th Cover Story Badthe and gly!t he U Jayant kejriwal & deep mehta Team Niveshak Results With the economy growing at 8-9%, and robust de- ance was on account of higher-than-expected mand of goods and services, the quarterly results of Q2 increase in raw material costs which were up FY-11 were mostly in line with estimates. The Sensex hit 150bps Q-o-Q, after having risen 400bps in Q1FY11. an all-time closing high of 21004.96 points on 5th No- Going forward, the major concerns are like- vember 2010, mainly fuelled by FII inflows. The average lihood of a split in the joint venture of Hero and growth of capital goods production remains healthy at Honda, with Hero group to acquire Honda’s 26% over 28% in 2010-11, though the growth of IIP index in stake, around Rs. 9000 Crore at current mar- September at 4.4% fell short of expectations. Data for ket prices. Also the Production at the Haridwar the first six months of the fiscal year presents a trend plant is 1.4 million units annually which can be of declining growth of capital goods over the course of stretched to 1.8 million. Hence, the possibil- both Q1 and Q2 of 2010-11. The pace of growth of con- ity of further benefits from this plant is limited. sumer durables, although healthy at 10.9% in September Mahindra and Mahindra (M&M) reported a 2010, was considerably slower than the growth rates in excess of 20% registered since April 2010. The healthy growth in the production of consumer durables during the previous months may have partly reflected building up of inventory prior to the festival season in India. With interest rates expected to climb following the lagged transmission of monetary tightening, and the US Federal Reserve announcing the second round of quantitative easing (QE2) of USD 600 billion, it would be interesting to see how the economy unfolds in the coming months. Auto The top-line performance in Q2FY11 for the in- dustry, on the whole, has either been in line with the estimates or has exceeded the estimates. The industry strong set of results in Q2FY11 with revenues of is expected to grow at a CAGR of 13-15% for FY10-12E the automotive segment growing 23.7% YoY driven aided by boisterous economic activity, favourable demo- by strong volume growth of three wheeler/small graphics and higher income levels. The major concerns, trucks. Also, the segment’s revenues were boost- however, are steep raw material prices and untoward ed by robust exports volume growth. The PAT grew forex volatility, which could cause serious concern to by 7.9% YoY to Rs 758 crore further supported by the whole of the value chain, going forward, as margins lower interest expenses. Since the successful in- and bottom-line, could shrink to a certain extent. How- troduction of Gio and Maximo the company is ag- ever, commodity prices could see some slowdown from gressively planning to expand its product portfolio Q4FY11 with the easing of the demand-supply mismatch. in the Heavy Commercial Vehicle segment (~25- 50 tonnes category) with the Navistar vehicles. Hero Honda Motors’ Q2FY11 net profit, down 15% Y-o-Y, was below market expectations. The vari- M&M with its proposed buy-out of South-Korea © FINANCE CLUB, INDIAN INSTITUTE OF MANAGEMENT SHILLONG 11
    • based SUV maker, SsangYong Motor Co (SMC) can lever- ONGC’s Q2 net profit was up 5.87% YoY and age SMC’s strong R&D capabilities and global footprint. net sales were up 20.64% YoY, mainly due to in- Tata Motors Q2FY11 net sales were up 36% crease in crude oil sales volume by 11.3% and lower subsidies(Due to increase in retail price ofCover Story YoY led by strong performance from core busi- ness and significantly better performance from auto fuels, overall subsidies declined as a result Jaguar Land Rover. Luxury car demand remains ro- subsidy burden shared by the ONGC fell 45% QoQ bust particularly in China, Russia and the US. This to Rs 1480 crore). Gas business revenues improved was on the back of a strong response to the newly 41%. Other income almost doubled QoQ to Rs 906 launched Indigo Manza. The latest launch of Aria in crore, mainly on account of dividend income from the mid-premium UV segment is expected to fur- subsidiaries and higher interest income. Miscella- ther improve market share in this growing segment. neous also accounted for a large part of the rise. Maruti Suzuki for 2QFY2011 registered 27% OMCs: Post the deregulation of petrol prices yoy growth in net sales while net profit at 598cr re- in June 2010 and price increases in LPG/ kerosene, corded a 5% yoy jump. The production capacity has the three oil marketing companies (OMCs; IOC, BPCL been increased to 1.3mn units (from 1.2mn) through and HPCL) have delivered significant outperfor- de-bottlenecking exercise. The current production rate is 110,000units/month. In October’2010 with sales of 1, 18,908 units the company crossed the one-lakh mark in domestic sales for the first time. Company Revenue Net Profit EPS Hero Honda 4551.95 505.6 25.32 M&M 5434.36 758.49 13.36 Tata Motors 28782 2222.99 38.91 Maruti Suzuki 9147.27 598.24 20.71 Revenue and Net Profit in Rs. Crores mance (14-23%) against the Sensex since July 2010. Oil & Gas IOC net sales for Q2FY11 increased 26.8% Oil and gas industry in India is almost US$110 YoY due to higher crude prices and strong refin- billion and oil accounts for almost 44% of India’s ing margin of US$6.6/bbl compared with US$2.7/ primary energy consumption. Demand for oil and bbl for HPCL and US$2.8/bbl for BPCL. With com- gas is likely to increase from 186 million tonnes pensation of Rs. 7220 Crore from the govern- of oil equivalent (mmtoe) to 233 (mmtoe) in the ment its net profit stood at Rs. 5293.95 crore. year 2011-12. India is net importer of oil and its HPCL’s revenue increased 25.3% YoY dependence on imports is 80% which is likely to primarily due to higher subsidy pay out go up in near future which might also bring do- of Rs.2830 crore from the government. mestic oil price equivalent to international price. BPCL reported impressive earnings of RIL’s Q2 FY11 net profit was up 27.80 % YoY Rs.2142.22 crore supported by government subsidy largely driven by high operating rates and improved of Rs.2950 crore and forex gain of Rs. 300 crore. refining margins at US$ 7.9 per barrel as against US$ Company Revenue Net Profit EPS 6 per barrel in the corresponding period of the previ- RIL 57479 4923 15.05 ous year. Its net sales were up 22.69% (YoY) helped by higher gas output from its KG D6 block where it ONGC 18430 5388.77 25.19 aims to reach peak gas output of 80 million stan- IOC 77335.75 5293.95 21.8 dard cubic metres. Growth in the refining segment HPCL 30870.23 2089.61 61.71 was driven by the increase in throughput and high- BPCL 35434.77 2142.22 59.25 er oil prices. The company has struck three shale- Revenue and Net Profit in Rs. Crores gas joint ventures with US firms so far this year. With Chinese and Irish con- cerns along with US Federal Reserve’s QE2, it would be interesting to see how the economy unfolds in the coming months 12 NIVESHAK VOLUME 3 ISSUE 11 NOVEMBER 2010
    • IT bottom-line due to lesser realization of dollars. IT sector companies reported stron- Company Revenue Net Profit EPS Cover Storygest quarter in the last four years. The growth TCS 7267.45 1812.65 9.24was visible across all segments and verticals. Infosys 6425 1641 28.59 TCS, the largest software exporter from India, Wipro 6556.9 1172.1 4.81showed Q2 US GAAP consolidated net profit up 14% Revenue and Net Profit in Rs. Croresat Rs 1813 crore. The stock markets reacted posi-tively with share price touching a 52-week high of BankingRs 1030.5. 53.7% of the revenue comes from North Banking sector showed very good growth inAmerica, with UK and India contributing 15.3%, this quarter with increase in focus on CASA (Current9.9% resp. BFSI contributes to 44% of its revenue, and Savings Account) which reduces the cost of de-followed by Telecom (12.8%) and Retail and Distri- posits (interest on savings account=3.5%,interest onbution (10.9%).The streamlining in operations dur- current account=0%,lending rate= approx. 10%) anding slowdown was the major reason for expanded helps banks to increase NIM (Net Interest Margin).margins. TCS added 19,923 employees in the quar-ter which was the largest ever. The superior per-formance was driven by volume growth of 11%. For Infosys, 16% QoQ PAT growth was assist-ed by addition of 27 clients in the quarter. NorthAmerica is even more significant with 65.8% con-tribution. Europe with 21.8% and India just 2.1%.Onsite revenues contributed 50.2% for this quarter.Company was conservative on its guidance and sostock prices took a minor beating. On the innovationfront, Infosys applied for 18 patent applications inIndia and US taking the aggregate to 256 and it has SBI, the country’s leading lender, showed abeen granted 15 by US Patent and trademark office. 22% decline in consolidated profit on YoY basis, and The third biggie Wipro announced IT services a marginal 0.5% growth YoY on a standalone basis.revenue growth of 5.7% QoQ. Volume growth of It was a 14.2% decline QoQ. Probable reason could6.6% was highest in 12 quarters. Strength of the ru- be higher provisions for bad loans which were partlypee did cause margin squeeze by 2.5%. Americas due to acquisition of State Bank of Indore in August.with 56% contribution, Europe with 27% and India Bank’s loan portfolio is well diversified with9% formed the revenue dynamics for the quarter. no segment accounting for more than 21% of theFinancial services and Technology, Telecom and Me- loan book. There was a healthy growth in Non-dia contribute 27%, 25% resp. to the revenue. Wipro Interest income on account of growth in loan pro- cessing, cross selling, commission from increase in government business. Higher slippages impacted the asset quality of the bank. Mainly this was due to defaults in Dubai and Agri-loan waiver scheme. ICICI Bank, top private sector lender, showed results that beat street estimates that were driven by good credit growth and drop in provisions for bad loans. Here, Net slippages were lower and NPA’s declined. A concern was increase in operating expenses, which will increase due to integration of Bank of Rajasthan.announced a decrease in margins due to salaryhikes. It won a key project from the UID authority For HDFC Bank, 33% rise in Net profit (YoY) wasfor the critical enrolment process for 2 states in In- driven by increase in NII (Net Investment Income - dif-dia. It was particularly a disappointing quarter for ference between interest earned and paid). Again, theWipro, when its peers showed double digit growth. growth was due to stable margins, robust loan growth and good CASA ratio. Retail loans which constitute Overall, expect the volume growth to con- 52% of the total, grows when GDP slows down. Depos-tinue on account of stable pricing through- its increased by 30%, out of which half are low cost.out the industry. Attrition remains a major con-cern due to increase in demand of the laterals. Andhra and Axis bank showed 27%, 26%Also, currency fluctuations can take a toll on the growth on the basis of interest earned due to good loan approval and disbursement. © FINANCE CLUB, INDIAN INSTITUTE OF MANAGEMENT SHILLONG 13
    • With economy expected to grow robustly ics grew by 28%. This was boosted by acquisition of and good monsoons, it looks good for the bank- Derma Rx in May 2010. Rise in copra prices by 26% ing industry with credit growth bound to improve. attributed to 100bps reduction in EBITDA. Volume But, with RBI planning to give licence to NBFC’s growth has been good. So, due to rising costs, vol-Cover Story to open banks, competition will increase and de- ume growth may be prioritized over margin growth. celerate the pace of expansion. Also, focus on le- Moving onto Dabur, margins expanded by veraging branches, promotional activities to at- 29bps to 22.4% despite increased inflation and tax- tract customers will be the broad theme so as to ation. Hair care, its largest category grew at 5.8%. increase market share. Also, rising NPA’s will also Reduction in employee costs (% of sales) and ef- be a challenge, especially in retail and SME seg- ficient operations were main reasons for increase ment where loans are provided without adequate in margins. But, on the negative was 2nd succes- securities. RBI’s recent increase in Repo, Reverse sive quarter of de-growth in Shampoo business. Repo rates will influence the banks other income. ITC showed good performance in ciga- Company Revenue Net Profit EPS rettes despite hike in prices. For its FMCG space, margins have improved with person- SBI 19808.09 2501.37 39.39 al-care products and biscuits gaining stability. ICICI 6309.1 1236.27 10.91 Overall, high inflation will prevent companies HDFC 4810 912.14 19.8 from raising prices significantly in order to preserve Axis 3624.25 735.14 18.01 market share. But, good monsoons augur well for the Revenue and Net Profit in Rs. Crores FMCG sector. While competitive intensity will remain high, focus will be on cost and cash management. FMCG Talking of the FMCG sector, it was a mixed Company Revenue Net Profit EPS bag. It has been a story of declining margins due HUL 4764.67 566.12 2.59 to rising raw materials cost across the sector. MARICO 540 59.66 0.98 DABUR 800.5 126.18 0.72 ITC 5147.18 1246.74 1.63 Revenue and Net Profit in Rs. Crores Conclusion India Inc. is set forth for a good second half going by the Q2 numbers. But it remains to be seen if they can reduce the impact of higher input costs. Also, with increasing recruitment, salary costs will also tend to reduce margins.With selling pres- Hindustan Unilever Ltd. reported Q2FY11 sure seen in domestic markets due to Chinese and net profit of Rs. 566.12 crores versus Rs. Irish concerns, it will be interesting to see the impact 420 crores in Q2FY10 i.e. gain of 34.76% YoY. it will have on different sectors.Good demand was After adjustments, PAT stood at Rs.533.65 vs. seen in Auto and IT sectors, but 2G spectrum scam 499 crores i.e. a growth of 6.8%. All the three ma- will definitely impact telecom companies which are jor segments viz. soaps and detergents, personal already struggling due to competitive pressures. For products, and beverages showed growths of 6.3%, banking, second half of the year usually sees an in- 14.7% and 9.3% resp. But again, due to increasing crese in credit growth - which is good news. FMCG ad-spend the EBIT margins have slipped, by 190bp, space will continue to see rising product costs as the 330bp and 160bp respectively. Costs of basic raw companies will pass on the load to customers so as materials like palm oil, benzene have increased by to protect margins. Also, incresing participation by 46% and 100% resp. Company had to hike prices FMCG companies in international territories is some- in certain products so as to protect margins. Pre- thing to look forward to. With promising recruitment launch of brands like Rin, Lifebuoy did help to im- figures from Wipro, TCS and Infosys and good growth prove the bottom-line. It was 6th successive quarter guidance from HCL, IT is likely to take off. So, overall of double digit growth for personal care products. India Inc, looks set to continue their growth story and For Marico, there was a volume growth across tackle the competetive dynamics and international businesses with PAT growing 15% over Q2FY10. The pressures so that we continue to report many such main contributor was Parachute Coconut oil at 10%, success stories in the issues ahead. Saffola Oil at 18%. Revenues from Kaya Skin Clin- 14 NIVESHAK VOLUME 3 ISSUE 11 NOVEMBER 2010
    • Mergers and Acquisitions in a Ankit Sinha IIM Bangalore Introduction firms, as well as external factors While M&A may Mergers and Acquisitions such as global economic environ- seem a natural (M&A) are an important activity for ment and government regulations. the growth of any organization. M&A The major positive effects can mode of expansion be increased market share and lower activity can have significant ramifi- in a booming econ- cations for the management as well cost of operations due to economies omy, the reasons as the investors. While this may of scale. The emerging company may for pursuing M&A seem a natural mode of expansion be more competitive, with improved in a booming economy, the reasons profitability and enhanced EPS. Also, activity in recession- for pursuing M&A activity in reces- there can be an increase in the indus- ary times may not be sionary times may not be apparent. try knowledge of the organizations. apparent as pursu- Pursuing deals in recession seems On the other hand, the con- ing deals in reces- risky and impractical. Credit markets cerned companies may face signifi- sion seems risky and and equity markets are depressed. cant legal expenses and takeover Historically, M&A’s have eroded costs, both tangible and intan- impractical. How- shareholder value rather than cre- gible. There can be potential de- ever, strategic M&As ating it. However, strategic M&As in valuation of equity and lowered in recession can add recession can add value leading to industry innovation. The merger value leading to sig- significant advantage for companies. of two large firms can also sup- press competition, and may lead nificant advantage Pros and Cons of M&A Activity to increased costs to customers. for companies. The pros and cons are primar- Whether a merger or an acqui- ily decided by taking into account sition is successful depends on how the short term and long term ef- the positive and negative effects fects of M&As. This depends on weigh against each other. This is internal factors like nature and highly subjective to individual M&As. strategic outlook of concerned Name Period Characteristics Outcome Sources of Financing Wave 1890s-1903 Horizontal Mergers Formation of Cash 1 Monopolies Wave 1910s-1929 Vertical Mergers Formation of EquityFinGyaan 2 Oligopolies Wave 1950s-1973 Conglomerate Growth through Equity 3 Mergers diversification Wave 1981-1989 Hostile Takeovers, Elimination of Debt Financed/ 4 Corporate Raiding inefficiencies Cash Paid Wave 1993-2001 Cross Borders Adjustment to Equity 5 Mergers globalization processes .. “Going downhill, everybody picks up speed.”-Business Proverb 16 NIVESHAK VOLUME 3 ISSUE 11 NOVEMBER 2010
    • M&A Waves and their common characteris- strong markets, remained strong in first 3 quarterstics of 2008 ($50 bn a quarter). M&A activity has been historically clustered in • PE Activity has bottomed out and is likely todistinct waves. The waves have been summarized in rise in future. The volumes of PE deals fell by 72%the above table. from 2007 levels and there was negligible PE activity The waves comprise of some common charac- in megadealsteristics. They originate in periods marked by eco- • Proportion of overpaid deals rose to 61%.nomic recovery. Wave 2 started during economicrecovery after market crash and First World War.Similarly, Wave 3 started after economic recoveryafter Second World War. The waves also occur inperiods of rapid credit expansion and burgeoningcredit markets. Industrial and technological shocksoften precede takeover waves. For example, Wave1 was preceded by development of trading on NYSEwhile wave 4 was preceded by development of junkbonds and technological innovations in electronics.Changes in regulatory mechanisms also lead to take-overs. This is illustrated by the fact that changes inantitrust policy and deregulation of financial sector Exhibit 2: Share of global M&A by geography of targetpreceded Wave 4. M&A Activity in 2009M&A Activity in recent years M&A activity was stable in 2009. Corporate M&A activity was in line with 2008 levels. PE accounted In the aftermath of the worldwide cri- for just 4% of global M&A, compared to 20% in 2006sis, M&A activity took a sharp hit. This is evi- and 2007. Also, there was a significant decrease indent from Exhibit 1. Both the number of deals cross border activity as a share of total M&A value. Itand deal value decreased greatly after 2007. experienced a 10% decrease from total 41% in 2007. However, M&A activity spread around the globe with companies in Asia-Pacific accounting for 26% of global M&A in 2009. In 2008, this share was only 19%. (Exhibit 2) More value was created for targets as compared to acquirers. Total deal value added was just below the long term average. (Exhibit 3) FinGyaan Exhibit 1: Deal Value, $ billion and volume Year 2008 saw a reversal of trends in previ-ous years. Some of the key changes observed were: • Cross border M&A activity decreased from41% in 2007 to 35% in 2008. • There was a shift in focus from megadeals (>$10 bn). Exhibit 3: Average annual deal value added • Hostile activity, generally resulting from M&A activity has been his- torically clustered in distinct waves originating in periods marked by economic recovery. © FINANCE CLUB, INDIAN INSTITUTE OF MANAGEMENT SHILLONG 17
    • Exhibit 4: Average acquirer excess return during various years Advantages of M&A in recession ers. Several strategies can help the companies to Contrary to the popular beliefs, M&A activ- successfully carry out M&A activity in recessions. ity in recessionary times can lead to significant Firstly, organizations should define a corporate benefits. Companies that are strategically and fi- strategy which is at the core of the company and nancially superior will find rare opportunities in allows it to invest with a clear thesis. Danaher Cor- recession to improve their competitive position. poration can be a suitable example in this regard. For buyers, strong companies with short term It engages in M&A to strengthen its base of real as- risk may be available cheaply. For sellers, reces- sets. It made 10 acquisitions in last downturn, in- sion provides opportunity for strategic divestures cluding Gilbarco. Gilbarco turned out to be the part and portfolio rebalancing. As seen from exhibit 4, of the third most profitable product line in 2008. Acquisitions completed during and right after the Secondly, companies should also buy and di- last recession (2001-02) generated almost triple vest frequently and consistently through cycles. the excess returns (“Excess returns” is defined as They should always keep in mind a list of po- shareholder returns from four weeks before to four tential targets. For example, Cintas maintains a weeks after the deal, compared to peers) of ac- pipeline of priority targets and cultivates strong quisitions made during the preceding boom years. relationships with them. Thus, it can often ap- According to Bob Filek, partner with PwC Transac- proach a target long before other acquirers. Cin- tion Services, “M&A activity in 2010 will be driv- tas has sustained its sales growth for 39 years. en by strategic buyers who have access to capi- Thirdly, companies should tailor merger in-FinGyaan tal and the strategic vision to capitalize on some tegration efforts to deal thesis and the sources of the best values we have seen in recent times.” of value. This can be accomplished by increased due diligence from the M&A team. Often, buyers Strategies for M&As during recession in the same industry overlook the details as they From the previous discussion, it can be in- believe that they know the industry. They con- ferred that M&A activity in recession can lead to duct cursory reviews of the target company and significant benefits, and separate the leaders from are often surprised to find out the actual valua- the laggards. Organizations that proceed carefully tions to be much cheaper than they anticipated. can generate significant returns for their sharehold- Companies that are strategi- cally and financially superior will find rare opportunities in recession to improve their competitive position. 18 NIVESHAK VOLUME 3 ISSUE 11 NOVEMBER 2010
    • EN X IS AM merger A Rajat Sethia Team Niveshak Axis Bank Ltd., India’s top- underwriting business while in M&A,ranked lending institution, strength- Axis isn’t in the top 20. Axis is top Weeks after lead-ened its equity underwriting op- ranked in the debt sales and loan managing theerations by merging with Enam syndication business. The mergerSecurities Pvt. Ltd in a transaction will help Axis to gain significant successful Rsvalued at $455 million. The trans- presence even in the equities and 15,000-crore Coalaction would combine Axis’s invest- M&A advisory business. India IPO, Enamment bank with Enam’s advisory ser- Securities sold off itsvice, as well as its institutional and Comparison with other dealsretail equities units. It won’t include The Axis Enam transaction is investment banking,Enam’s portfolio management ser- the second-largest involving India’s corporate advisoryvice and asset management units. investment banks and securities and equity distri-The acquired businesses of Enam firms. bution divisions tocomplement the strong corporate Merrill Lynch & Co. spent $500banking and debt capital market million in December 2005 to buy con- India’s fourth-largestfranchise of Axis Bank. Macquarie trol of its Indian venture DSP Merrill bank, Axis Bank. TheGroup acted as the advisor to Axis Lynch Ltd. from its local partners, deal will combineBank on the transaction. valuing that business at $1 billion. capital at Axis bank Axis will swap 5.7 shares for Morgan Stanley paid $445 mil-each one of closely held Enam. Enam with the clients and lion in February 2007 for Mumbai-shareholders will get a 3.3 percent based JM Financial Ltd.’s stake in a distribution networkstake in Axis following the transac- business that traded in stocks for managed by Enam.tion, and Enam’s Manish Chokhani, local and foreign institutions. At thewill act as the CEO and MD of the same time, JM Financial paid $20entity to be created by the combi- million to buy out Morgan Stanley’snation. Axis’s first financial-services share of that venture’s investment-acquisition will combine capital at bank, fixed-income and retail units.India’s fourth-largest bank with the Axis Bank’s rivals have madeclients and distribution network acquisitions in recent years to addmanaged by Enam. The deal is a win- clients and outlets. ICICI Bank Ltd.,win for both Axis and Enam. While ranked No. 2 among the nation’sAxis gets the back-end distribution lenders, bought smaller rival Bank ofwhich will bolster its front-end bank- Rajasthan Ltd., based in northwest FinSighting segment, Enam will be able to India, in August through a sharebuild its balance-sheet using a bank swap in a transaction worth as muchbase. Rankings as 23 billion rupees. Enam Securities is ranked third HDFC Bank Ltd. bought regionalamong equity-underwriters in India, lender Centurion Bank of Punjab Ltd.with equity sales of Rs. 1.02 tril- in July 2008 for 71.2 billion rupees inlion rupees this year. In M&A space, India’s biggest banking acquisition.Enam Securities is ranked No. 9. Axisis ranked at No. 16 in the equity “For us to build a balance- sheet, we thought that combin- ing forces would be an extraor- dinary opportunity.” Vallabh Bhansali, co- founder and chairman of Enam © FINANCE CLUB, INDIAN INSTITUTE OF MANAGEMENT SHILLONG 19
    • THE IMPACT OF RISE IN CRUDE OIL PRICES ON THE INDIAN ECONOMY AMITKUMAR RAJANI Welingkar Institute of Management, Mumbai INDIA’S CRUDE OIL REQUIRE- needs. The Energy Information Ad- Crude oil is one of MENTS ministration (EIA) expects India to the most essential become the 4th largest net importer India is emerging as an eco- commodity. A slight nomic powerhouse of the 21st cen- of oil in the world by 2025, behind fluctuation in crude tury & a large consumer of energy the United States, China, and Japan. oil prices can have resources. Despite the global finan- OIL UNDER-RECOVERIES both direct and cial crisis, India’s demand for energy The dependence on crude oil continues to rise. But India still faces indirect influence tremendous challenges in meeting imports is chronic for a developing country like India as the current re- on Indian economy, its energy requirements. In order source utilisation pattern does not and will continue to to sustain the rate of growth, In- contain alternatives to imported dia needs to develop a reliable pool affect, considering of energy resources which can be crude oil. Further, in a situation of the fact that India is unabated rise in oil prices the prob- tapped in the long run. lem tends to get compounded. 6th largest importerPerspective Government Owned Oil Market- of oil in the world. ing Companies (OMCs) in India sell petroleum products (excluding Pet- rol) at a subsidized rate. The losses incurred by these companies are called “Under Recoveries”. The Gov- ernment of India compensates the OMCs for these under recoveries ei- ther through cash payment or issue Oil meets about 24% of India’s of bonds. commercial energy requirements. In 2009, with a consumption of 3 mil- Under recoveries of OMCs for lion barrels per day, India was the FY 2008-09 were Rs. 1,03,292 Crores. 4th largest oil consumer in the world The Government issued oil bonds to after the United States, China, and the tune of Rs. 71,292 Crores whereas Japan. the remaining burden of Rs. 32,000 Crores was shared by Upstream Oil India’s proven reserves of Companies. crude oil and oil production have not witnessed any significant improve- ECONOMIC IMPACT OF RISE IN ment in the last few decades. As OIL PRICES a result, India largely relies on im- India’s huge dependence on ported crude oil to meet its energy Imported Crude Oil makes it vulner- requirements. able to the shocks & disruptions In 2009, India was the 6th larg- in the Global Oil Market. Any sharp est net importer of oil in the world, spike in oil prices in the global mar- importing nearly 2.1 million barrels ket results in an unfavorable eco- per day, or about 70 %, of its oil nomic situation in India. The reasons In 2009, with a consumption of 3 million barrels per day, India was the 4th largest oil consumer in the world after the United States, China, and Japan 20 NIVESHAK VOLUME 3 ISSUE 11 NOVEMBER 2010
    • for the same are outlined below. e) WORSENING FISCAL DEFICIT: India’s Fiscal a) RISE IN COST OF IMPORTS: The first victim of Deficit for 2009-10 stood at 6.6 % of Gross Domesticrise in crude oil prices is the state exchequer. Ev- Product (GDP). Rise in crude oil prices would worsenery increase of $1 per barrel in Indian crude basket the situation as Government has to shell out moreprices pushes up the annual oil import bill by $1.2 money in the form of fuel subsidy to OMCs.billion. It also leads to a faster depletion of India’s f) REDUCED AMOUNT FOR INFRASTRUCTURE IN-Foreign Exchange (FOREX) Reserves. VESTMENT: India aims to invest $1 Trillion in infra- b) WIDENING OF TRADE DEFICIT: India’s trade structure development during the 12th Five Yeardeficit for 2009-10 was $117.3 billion. The steep in- Plan (2012-17). High prices of crude oil (leading tocrease in imports due to high oil prices leads to a higher fuel subsidy & increase in fiscal deficit) have Perspectivefurther widening of the trade deficit. the potential to derail the government’s plans as they eat into the amount of disbursal available with c) INCREASE IN OIL UNDER RECOVERIES: As the the government for infrastructure & social develop-pricing of Diesel, LPG & Kerosene is still under gov- ment schemes.ernment control, any rise in international oil pricesis not reflected in the domestic market. The inability A continuous rise in the subsidy bill & worsen-of OMCs to sell fuel at the market defined rate re- ing fiscal deficit has forced the federal governmentsults in higher under recoveries. to deregulate the petrol prices in the domestic mar- ket while in-principle approval has been given for d) MOUNTING FUEL SUBSIDY BURDEN: Any hike deregulation of diesel prices.in price of imported crude oil is absorbed by theOMCs along with the Upstream Oil Companies & IMPACT OF HIKE IN FUEL PRICES IN THE DO-the federal government. The fuel subsidy bill has MESTIC MARKETwitnessed a continuous rise for the past few years. The hike in fuel prices in the domestic marketFrom FY 2005-06 to FY 2008-09, Government’s fuel has a cascading effect on the Indian Economy. Thesubsidy bill amounts to Rs. 1,42,203 Crores. same is explained below. a) INFLATION: Rise in fuel prices has a direct impact on the prevailing inflation rate in the econ- omy. Higher fuel prices (in particular Diesel) lead to increase in transportation costs across the coun- try. As a result, the price of essential commodi- ties (such as food items, cement etc) shoots up. An inflationary expectation among traders leads to hoarding which pushes the spiraling inflation rate further up. b) EROSION OF PROFIT MARGINS: Rise in infla- tion rate in turn leads to erosion of profit margins of business enterprises as the key inputs for busi- ness become costlier & consumers reduce their The dependence on crude oil imports is chronic for a devel- oping country like India as the current resource utilization pattern does not contain alter- natives to imported crude oil. © FINANCE CLUB, INDIAN INSTITUTE OF MANAGEMENT SHILLONG 21
    • spending budget. Inevitably, the earnings growth of setback. corporate India slows down. g) SLOWDOWN IN ECONOMIC GROWTH: A sus- c) HIKE IN INTEREST RATES: The Reserve Bank tained rise in interest rates in the economy begins of India (RBI) is entrusted with the responsibility of to hurt the economic growth. Reduced investment, containing inflation in the Indian economy through lower spending on infrastructure & fall in domestic periodic Monetary Policy review. It does so by in- consumption of goods & services puts a brake on creasing the Cash Reserve Ratio (a portion of depos- the fast rate of growth of the economy. its which banks have to keep with the RBI), Repo Rate (the rate at which banks borrow funds from IMPACT ON KEY SECTORS the RBI) & Reverse Repo Rate (the rate at which RBI The performance of business enterprises across borrows money from the banks). As a consequence India is adversely affected due to increase in fuel of rise in these key rates, banks are left with prices in the domestic economy. But some sectors lesser funds to lend to their customers suffer a greater loss as compared to the others. thereby sucking out the excess liquidity They include the Automobile Industry (dear- from the system. Banks are forced to fol- er personal loans leading to fall in sales), FMCG low suit & increase the cost of loans Sector (erosion of profit mar- to their customers. gins due to rise in cost of raw d) CAPEX POSTPONEMENT: Cor- materials), Banking Industry porate India largely relies on bor- (slow down in credit growth), rowings from banks for business ex- Civil Aviation Industry (rise in pansion. In view of inflationary trends price of Aviation Turbine Fuel), OilPerspective & dearer cost of funds, corporate India Refining Industry (higher under recoveries), puts it Capital Expenditure (CAPEX) plans Paint Industry (crude oil is a major input in the cold storage. The idea is to wait for for solvent based paints) and many others. the inflation & interest rates to come down NEED FOR REFORMS before initiating any new projects. It is imperative that the Indian government e) REDUCTION IN CREDIT GROWTH: A reduced brings about the necessary reforms to strengthen level of investment in the economy due to increase the domestic oil market. The key reforms include: in interest rates leads to a slowdown in the credit growth of banks, the lubricant of every economy. 1) Rational pricing of petroleum products f) FALL IN EMPLOYMENT OPPORTUNITIES: As 2) Reducing the rate of taxes levied on petro- business activity in the economy takes a hit, gen- leum products eration of employment opportunity also suffers a 3) Tapping alternative sources of revenue to compensate the loss due to reduced taxation. As the Indian Economy treads the path of growth, its appetite for crude oil as a crucial source of energy will only increase. Given India’s chronic dependence on imported crude oil, the Indian Econ- omy will continue to remain vulnerable & sensitive to fluctuations in world oil prices. The fuel subsidy bill has witnessed a continuous rise for the past few years. From FY 2005-06 to FY 2008-09, Government’s fuel subsidy bill amounts to Rs. 1,42,203 Crores 22 NIVESHAK VOLUME 3 ISSUE 11 NOVEMBER 2010
    • CLASSROOM FinFunda of the Month Arbitrage Its risk free... Rajat Sethia Team Niveshak Sir, but isn’t it true that with ad- vent of algorithmic trading, it is difficult for people not equipped with computer It is said that risk and return go trading system to actually spot arbitrage hand in hand. But there are fleeting mo- opportunities. ments, when high return can be achieved with low risks. Welcome to the world of Arbitrage. Well, it has definitely become dif- ficult for manual arbitrageurs to make money in developed markets, but in the That sounds interesting. But isn’t fledgling markets like the commodity it contrary to what we read in finance markets of India, one can find a lot of that higher risk leads to higher return? arbitraging opportunities even without computers. It is not unusual to spot price differences on similar First of all, higher risk doesn’t lead contracts on MCX and NCDEX. This is because vol- to higher return. There is only a possi- umes at NCDEX are not that high and prices react bility of higher return just as there is a sharply on trades made by few buyers and sellers. Classroom possibility of higher returns with lower risk which is what happens in the case From what you are saying, it of arbitrage. Arbitrage involves buying seems that arbitrage can make youand selling of same or closely related securities money without any risk, only you needat the same time. Buying and selling correlated or to spot the right opportunity.same assets at same time creates a natural hedgeand hence the risk is less. I wish it were that simple. In real life situation, there is always some risk and Sir, I have watched a movie called so even in arbitrage. There are various the “Rogue Trader” in which the pro- risks involved in arbitrage transactions tagonist makes millions arbitraging the viz. execution risk, counterparty risk and Nikkei Index between the Singapore liquidity risk. While counterparty and liquidity risks and UK exchanges. are rare, the execution risk is more common and one should be wary of execution failures while closing a Yes, that’s a nice movie which inci- large transaction. dentally made arbitrage famous. In that movie, the arbitrageur takes advantage Having discussed the very basics of price differences between interna- of arbitrage trading, as a closing com- tional markets to make huge money. In a ment, I would like to point out thatsimilar manner, arbitrageur can also take advantage some of the most exciting things inof price differences between two national exchanges finance such as options arbitrage andwhere similar securities are traded. Lastly, the price calendar spread arbitrage happen todifferences between the spot and futures market be related to arbitrage. We will discuss more oncan also be tapped to make money. these in the coming lectures. © FINANCE CLUB, INDIAN INSTITUTE OF MANAGEMENT SHILLONG 23
    • CROSSWORD Down 1. The process of monitoring managers and aligning their interests and incentives with shareholders is called 2. A leading security Firm which acted as the Lead manager for Coal India Limited in its IPO and was acquired by a famous bank recently is 3. What is black scholes formu- la used for? 5. Graph representing a set of portfolios that maximize ex- pected return at each level of portfolio risk is called 8. The excess of purchase price over the sum of the fair market values of the individuals assets acquired (Note: All the clues given refer to Financial terms and not personalities unless explicitly mentioned)FinLounge Across 4. Who is the Chief Economic adviser to Government of India? (person) 6. Retirement income paid by the company is called 7. The total amount of credit issued to the user determined by the credit card company is called 9. The basic measure of risk is 10. The Japan Stock Market Index is called All entries should be mailed at niveshak.iims@gmail.com by 7th December,2010 23:59 hrs One lucky winner will receive cash prize of Rs. 500/- 24 NIVESHAK VOLUME 3 ISSUE 11 NOVEMBER 2010
    • ANNOUNCEMENTS ARTICLE OF THE MONTH The Article of the Month winners for November 2010 are Akash Agarwal and Abhishek Dassani of XLRI, Jamshedpur They receive a cash prize of Rs.1000/- Crossword Winner The Crossword Winner for the month October 2010 is Ankit Bansal of SJMSOM, IIT Bombay He receives a cash prize of Rs.500/- CONGRATULATIONS!! ALL ARE INVITEDTeam Niveshak invite articles from B-Schools all across India. We are lookingfor original articles related to finance & economics. Students can also contrib-ute puzzles and jokes related to finance & economics. References should becited wherever necessary. The best article will be featured as the “Article of theMonth” and would be awarded cash prize of Rs.1000/-Instructions» Please email your article with the file name and the subject as <Title of theArticle>_<Institute Name>_<Author’s name/Group’s name> by 07 December 2010.» Article must be sent in Microsoft Word Document (doc/docx), Font: Times NewRoman, Font Size: 12, Line spacing: 1.5» Please ensure that the entire document has maximum 1500 words» The cover page of the article should only contain the Title of the Article, theAuthor’s Name and the Institute’s Name» Mention your e-mail id/ blog if you want the readers to contact you for furtherdiscussion» Also certain entries which could not make the cut to the Niveshak will getfigured on our Blog in the ‘Specials’ section SUBSCRIBE!! Get your OWN COPY delivered to inbox Drop a mail at niveshak.iims@gmail.comThanksTeam Niveshakwww.iims-niveshak.com
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