A project report on construction of balanced portfolio comprising of equity and debt at scm


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A project report on construction of balanced portfolio comprising of equity and debt at scm

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A project report on construction of balanced portfolio comprising of equity and debt at scm

  1. 1. Construction of Balanced Portfolio comprising of Equity and Debt EXECUTIVE SUMMARY 1 Babasabpatilfreepptmba.com
  2. 2. Construction of Balanced Portfolio comprising of Equity and DebtA stock market is a market for the trading of publicly held company stock and associatedfinancial instruments.The stock market in India is very volatile and many investors are in a dilemma to invest in thesecurities. Not surprisingly, recent market developments have once more focused attention onthe volatility that has come to characterise India’s stock markets. In volatile markets, domesticspeculators too attempt to manipulate markets in periods of unusually high prices.Keeping in view the above observation about the Indian stock market, a project “Constructionof Balanced Portfolio of Equity and Debt”, with the problem statement being “To test thesignificance of excess return to beta and find out whether one can construct a portfolio whosebeta is equal to market beta (beta =1), with returns greater than market returns.”.Ten sectors were picked randomly consisting of 6 companies I Cement and 4 Companies ineach sector. Also the 10 corporate bonds along with 5 govt. securities are taken. With the helpof all, the statistical measures were calculated and a TRI was constructed. Then again anotherportfolio was constructed using a particular sector stocks and this portfolio was compared withthe returns on the index to look at the performance at different combinations.The Project was carried out at SMC Solutions, stock broking firm situated in Hubli.Analysis of cement sector and steel sector give an immense insight to invest in these thesestocks. The Report describes the analysis being carried out in project and results obtained.At the last, the portfolio was constructed with higher returns thanindex returns with systematic risk of 1 2 Babasabpatilfreepptmba.com
  3. 3. Construction of Balanced Portfolio comprising of Equity and Debt THEORETICAL BACKGROUND 3 Babasabpatilfreepptmba.com
  4. 4. Construction of Balanced Portfolio comprising of Equity and DebtFundamental AnalysisThe earnings of the company, the growth rate, and risk exposure of the company have a directbearing on the price of the share. These factors in turn rely on the host of other factors likeeconomic environment in which they function, the industry which they belong to, and finallythe companies’ own performance. The fundamental analysis school of thought appraises theintrinsic value of shares through:  Economic Analysis  Industry Analysis  Company AnalysisEconomic AnalysisThe level of economic activity has an impact on investment in many ways. If the economygrows rapidly, the industry can also be expected to show rapid growth and vice-versa. When thelevel of economic activity is low, stock prices are low, and when the level of economic activityis high, stock prices are high reflecting the prosperous outlook for sales and profits of the firms.The analysis of macro economic environment is essential to understand the behaviour of thestock prices. The commonly analyzed macro economic factors are as follows:  Gross Domestic Product: GDP indicates the rate of growth of the economy. GDP represents the aggregate value of the goods and services produced in the economy. GDP consists of personal consumption expenditure, gross private domestic investment and government expenditure on goods and services and net export of goods and services. The growth rate of economy points out the prospects for the industrial sector and return investors can expect from investment in shares. The higher growth rate is more favourable to the stock market.  Savings and investment: It is obvious that growth requires investment which in turn requires substantial amount of domestic savings. Stock market is a channel through which the savings of the investors are made available to corporate bodies. Savings are distributed over various assets like equity shares, deposits, mutual fund units, real estate and bullion. The saving and investment patterns of the public affect the stock to a great extent. 4 Babasabpatilfreepptmba.com
  5. 5. Construction of Balanced Portfolio comprising of Equity and Debt  Inflation: Along with the growth of GDP, if inflation also increases, then the real rate of growth would be very little. The demand in the consumer product industry is significantly affected. If there is a mid level of inflation, it is good to the stock market but high rate of inflation is harmful to the stock market.  Interest rates: The interest rate affects the cost of financing to the firms. A decrease in interest rate implies lower cost of finance for firms and more profitability. More money is available at a lower interest rate for the brokers who are doing business with borrowed money. Availability of cheap fund, encourages speculation and rise in price of shares.  Budget: The budget draft provides an elaborate account of the government revenues and expenditures. A deficit budget may lead to high rate of inflation and adversely affect the cost of production. Surplus budget may result in deflation. Hence, balanced budget is highly favorable to the stock market.  The tax structure: Concessions and incentives given to a certain industry encourages investment in that particular industry. Tax relief’s given to savings encourage savings. The type of tax exemption has an impact on the profitability of the industries.  The Balance of payment: The balance of payment is the record of a country’s money receipts from and payments abroad. The difference between receipts and payments may be surplus or deficit. BOP is the measure of the strength of rupee on external account. If the deficit increases, the rupee may depreciate against other currencies, thereby, affecting the cost of imports. The volatility of the foreign exchange rate affects the investment of the foreign institutional investors in the Indian Stock Market. A favorable balance of payment renders a positive effect on the stock market.  Infrastructure facilities: Infrastructure facilities are essential for the growth of industrial and agricultural sector. A wide network of communication system is a must for the growth of the economy. Regular supply of power without any power cut would boost the production. Banking and financial sectors should also be sound enough to provide adequate support to industry and agriculture.  Demographic factors: The demographic data provides details about the population by age, occupation, literacy and geographic location. This is needed to forecast the demand for the consumer goods. The population by age indicates the availability of able work force. Population, by providing labour and demand for products, affects the industry and stock market. 5 Babasabpatilfreepptmba.com
  6. 6. Construction of Balanced Portfolio comprising of Equity and DebtIndustry analysisIndustry analysis is a type of business research that focuses on the status of an industry or anindustrial sector (a broad industry classification, like "manufacturing"). A complete industrialanalysis usually includes a review of an industrys recent performance, its current status, and theoutlook for the future. Many analyses include a combination of text and statistical data.Five Forces Affecting Competitive StrategyPorter identifies five forces that drive competition within an industry:  The threat of entry by new competitors.  The intensity of rivalry among existing competitors.  Pressure from substitute products.  The bargaining power of buyers.  The bargaining power of suppliers.Industry Life Cycle ModelThis model is a useful tool for analyzing the effects of an industrys evolution on competitiveforces. Using the industry life cycle model, we can identify five industry environments, eachlinked to a distinct stage of an industrys evolution:  An embryonic industry environment  A growth industry environment  A shakeout industry environment  A mature industry environment  A declining industry environmentCompany AnalysisIn the company analysis the investor assimilates the several bit of information related to thecompany and evaluates the present and future value of stock. The risk and return associatedwith the purchase of the stock is analyzed to take better investment decision.The present and future are affected by a number of factors. They are:- 6 Babasabpatilfreepptmba.com
  7. 7. Construction of Balanced Portfolio comprising of Equity and Debt Factors Share values Competitive edge Historic price of stock Earnings P/E ratio Capital structure Economic condition Management Stock market condition Operating efficiency Financial performance Present price Future priceThe competitive edge of the company:- The competitive edge of the company can be studiedwith the help of:- The market share The growth of annual sales The stability of annual salesThe market shares:- The market share of the annual sales helps to determine a company’srelative competitive position within the industry. If the market share is high the company wouldbe able to meet the competition successfully.Growth of sales:- The company would be the leading company, but if the growth of sales iscomparatively lower than another company, it indicates the possibility of the company losing 7 Babasabpatilfreepptmba.com
  8. 8. Construction of Balanced Portfolio comprising of Equity and Debtthe leadership. The rapid growth in sales would keep the shareholder in a better position thanone with a stagnant rapid growth.Stability of sales: - If a firm has stable sales revenue, other things being remaining constant will have more stable earnings. Wide variation in sales leads to variation incapacity utilization, financial planning and dividend.Earnings of the company:- Sales alone do not increase the sales the earnings but the costs and expenses of the company also influence the earnings of the company. Further, earnings do not always increase with the increase in sales. The company’s sales might have increased but its per share may decline due to the rise in costs.Capital structure: - The equity holders’ return can be increased manifold with the help offinancial leverage, i.e. using debt financing along with equity financing. The effect of financialleverage is measured by computing leverage ratios. The debt ratio indicates the positions oflong term and short terms debts in the company finance. The debt may be in the form ofdebentures and term loans from financial institutions.Management: - Good and capable management generates profit to the investors. Themanagement of the firm should efficiently plan, organize, actuate and control the activities ofthe company. The basic objective of management is to attain the stated objectives of thecompany for the good of the equity share holders, the public and the employers. The goodmanagement depends on the quality of the manager.The following are special traits of an able manager:-  Ability to get along with people  Leadership  Analytical competence  Industry  Judgment  Ability to get things doneOperating efficiency: - The operating efficiency of a company directly affects the earnings of acompany. An expanding company that maintains high operating efficiency with a low break-even point earns more than the company with high break-even points. If a firm has stableoperating ratio, the revenue will also be stable. Efficient use of fixed assets with a rawmaterials, labour and management would lead to more income from sales. This leads to internal 8 Babasabpatilfreepptmba.com
  9. 9. Construction of Balanced Portfolio comprising of Equity and Debtfund generation for the expansion of the firm. A growing company should have low operatingratio to meet the growing demand for its product.Financial analysis:- the best source of financial information about a company is its ownfinancial statements. This is a primary source of information for evaluating the investmentsprospect in the particular company’s stock. Financial statement analysis is the study of acompany’s financial statement from various viewpoints. The statement gives the historical andcurrent information about the company’s operations. Historical financial statements help topredict the future. The current information aids to analyse the present status of the company.The two main statements used in analysis are:-  Balance sheet  Profit and loss accountDebt valuation techniques and conceptsIn their simplest form bonds are pretty straightforward. After all, just about anybody cancomprehend the borrowing and lending of money. However, like many securities, bondsinvolve some more complicated underlying concepts as they are traded and analyzed in themarket.Bond PricingIt is important for prospective bond buyers to know how to determine the price of a bondbecause it will indicate the yield received should the bond be purchased. Bonds can be priced ata premium, discount, or at par. If the bond’s price is higher than its par value, it would sell at apremium because its interest rate is higher than current prevailing rates. If the bond’s price islower than its par value, the bond would sell at a discount because its interest rate is lower thancurrent prevailing.Bondholders Expected Rate of Return (Yield to Maturity)The bondholders expected rate of return is the rate the investor will earn if the bond is held tomaturity, provided, of course, that the company issuing the bond does not default on thepayments.Computing Yield-to-Maturity on a Bond (YTM) 9 Babasabpatilfreepptmba.com
  10. 10. Construction of Balanced Portfolio comprising of Equity and Debt  1    1 − (1 + r ) n    MP = C  +I  1 n   r  (1 + r )           Solving the equation for r gives the YTM.1) If the investors required return is greater than the YTM, the investor should not buy the bond2) If the investors required return is less than the YTM, the investor should buy the bondThree Important RelationshipsFirst relationshipA decrease in interest rates (required rates of return) will cause the value of a bond to increase;an interest rate increase will cause a decrease in value. The change in value caused by changinginterest rates is called interest rate risk.Second relationship1. If the bondholders required rate of return (current interest rate) equals the coupon interestrate, the bond will sell at par, or maturity value.2. If the current interest rate exceeds the bonds coupon rate, the bond will sell below par valueor at a "discount."3. If the current interest rate is less than the bonds coupon rate, the bond will sell above parvalue or at a "premium."Third relationshipA bondholder owning a long-term bond is exposed to greater interest rate risk than whenowning a short-term bonds.Relationships on the YTMSince the bonds coupon rate, kc, is fixed for the life of bond, the followingYTM/bond price relationship is created:  If YTM is > r, the bond sells at Discount.  If YTM is < r, the bond sells at Premium  If YTM is = r, the bond sells at par.The Term Structure of Interest Rates 10 Babasabpatilfreepptmba.com
  11. 11. Construction of Balanced Portfolio comprising of Equity and Debt The term structure of interest rates, also known as the yield curve, is a very common bond valuation method. Constructed by graphing the yield to maturities and the respective maturity dates of benchmark fixed-income securities, the yield curve is a measure of the markets expectations of future interest rates given the current market conditions. Treasuries, issued by the central government, are considered risk-free, and as such, their yields are often used as the benchmarks for fixed-income securities with the same maturities. The term structure of interest rates is graphed as though each coupon payment of a non-callable fixed-income security were a zero-coupon bond that “matures” on the coupon payment date. The exact shape of the curve can be different at any point in time. So if the normal yield curve changes shape, it tells investors that they may need to change their outlook on the economy.DurationThe term “duration,” having a special meaning in the context of bonds, is a measurement ofhow long in years it takes for the price of a bond to be repaid by its internal cash flows. It is animportant measure for investors to consider, as bonds with higher durations are more risky andhave higher price volatility than bonds with lower durations.Factors affecting DurationBesides the movement of time and the payment of coupons, there are other factors that affect abonds duration: the coupon rate and its yield. Bonds with high coupon rates and in turn highyields will tend to have lower durations than bonds that pay low coupon rates, or offer a lowyield. This makes empirical sense, since when a bond pays a higher coupon rate, or has a highyield, the holder of the security receives repayment for the security at a faster rate. The diagrambelow summarizes how duration changes with coupon rate and yield.Types of Duration 11 Babasabpatilfreepptmba.com
  12. 12. Construction of Balanced Portfolio comprising of Equity and DebtThere are four main types of duration calculations, each of which differ in the way they accountfor factors such as interest rate changes and the bonds embedded options or redemptionfeatures. The four types of durations are Macaulay duration, modified duration, effectiveduration, and key-rate duration.Macaulay DurationMacaulay duration is calculated by adding the results of multiplying the present value of eachcash flow by the time it is received, and dividing by the total price of the security. The formulafor Macaulay duration is as follows: n t *c n*M ∑ (1 + i) t −1 t + (1 + i ) n Mac Dur = Pn = number of cash flowst = time to maturityC = cash flowi = required yieldM = maturity (par) valueP = bond price  1    1−    MP =C  (1 +r ) n  +I  1  .  r  (1 +r ) n           So the following is an expanded version of Macaulay duration: n t *c n*M t− ∑(1 + i )(1 + i ) n n + Mac Dur = 1   1  1 −  n  C * (1 + i )   + M  i  (1 + i ) n       12 Babasabpatilfreepptmba.com
  13. 13. Construction of Balanced Portfolio comprising of Equity and DebtModified DurationModified duration is a modified version of the Macaulay model that accounts for changinginterest rates. Because they affect yield, fluctuating interest rates will affect duration, so thismodified formula shows how much the duration changes for each percentage change in yield.For bonds without any embedded features, bond price and interest rate move in oppositedirections, so there is an inverse relationship between modified duration and an approximateone-percentage change in yield. Because the modified duration formula shows how a bondsduration changes in relation to interest rate movements, the formula is appropriate for investorswishing to measure the volatility of a particular bond. Modified duration is calculated as thefollowing:    macaulaydurartion  Modified Duraton =  + YTM   . 1   No of Cpn Periods  Total Return IndexNifty is a price index and hence reflects the returns one would earn if investment is made in the indeportfolio. However, a price index does not consider the returns arising from dividend receipts. Onlcapital gains arising due to price movements of constituent stocks are indicated in a price indexTherefore, to get a true picture of returns, the dividends received from the constituent stocks also need tbe factored in the index values. Such an index, which includes the dividends received, is called the TotaReturns Index.Total Returns Index reflects the returns on the index arising from (a) constituent stock price movementand (b) dividend receipts from constituent index stocks.Methodology for Total Returns Index (TR) is as follows:The following information is a prerequisite for calculation of TR Index: 1. Price Index close 2. Price Index returns 3. Dividend payouts in Rupees 4. Index Base capitalisation on ex-dividend dateDividend payouts as they occur are indexed on ex-date. 13 Babasabpatilfreepptmba.com
  14. 14. Construction of Balanced Portfolio comprising of Equity and Debt DividendPayout ( rs ) IndexedDividend = ×1000 BaseCapofindex( rs )Indexed dividends are then reinvested in the index to give TR Index.Total Return Index = [Prev. TR Index + (Prev. TR Index * Index returns)] + [Indexed dividends + (Indexed dividends * Index returns)]The base for both the Price index close and TR index close will be the same.An investor in index stocks should benchmark his investments against the Total Returns indexinstead of the price index to determine the actual returns vis-à-vis the index.Operational DefinitionsBond: A debt instrument sold by a company or government to raise money. One who buys abond is a creditor of the company, but not an owner, as a stockholder would be.Par: The value of a bond assigned by the issuer; also called face value.Original issue discount: A bond with an offering price that is below par value.Coupon: A bonds interest rate.Premium: The amount by which a security sells above its par value.Maturity: The length of time before the principal amount of a bond is due to the bondholders.It is the time until a bond may be surrendered to its issuer, called as term-to-maturity.Maturity date: The date on which a bond is to be redeemed and its principal and interestreturned to the owner.Callability: The feature of some bonds whereby the issuer can redeem it before it matures.Issuers often call their bonds when interest rates are falling and they want to replace high- 14 Babasabpatilfreepptmba.com
  15. 15. Construction of Balanced Portfolio comprising of Equity and Debtyielding bonds with lower-yielding bonds. Call provisions must be made clear before a bond issold. A bond with this feature is a callable bond.Debenture: A bond backed by the issuers general credit and ability to repay and not by anasset or collateral.Investment-grade: A classification of the ability of a bond issuer to repay a bond.Discount bond: A bond that sells at a discounted value of its face value. If a bond has a Rs1000 par value but sells for Rs 900, it is "sold at a discount" of Rs100. Adverse marketconditions and reductions in interest rates can convince sellers to discount the bonds they sell.Premium bond: A bond selling for more than its stated value. If a bond is Rs1000 par but sellsfor Rs1100, it is "sold at a premium" of Rs100. Market conditions and increases in interest ratescan convince sellers to raise the prices of the bonds they sell.Yield: The rate of return on an investment, described as a percentage of the amount of theinvestment. For example, a bond purchased for Rs1,000 with a 7% yield would pay out 7% ofRs1,000, or Rs70.Yield to maturity: The fully compounded annual rate of return paid out over a bonds life,from purchase date to maturity, including appreciation/depreciation and earnings. It is the mostcomprehensive measure of yield.Accrued interest: The interest that has been accumulating on a bond since the last time interestwas paid on it.Current yield: The expected rate of return calculated by dividing the most recent annualizeddistribution by the selling price. For example, a Rs.2,000 par bond that pays Rs140 but isbought for Rs1600 has a current yield of 8 3/4 percent. The formula for deriving current yield isannual income divided by current price. 15 Babasabpatilfreepptmba.com
  16. 16. Construction of Balanced Portfolio comprising of Equity and DebtCoupon rate: The interest as a percent of par paid by a bond. It is called a coupon rate becausehistorically bonds included attached coupons that were clipped and surrendered for cash.Today, most bonds come without the attached coupons.Duration: The change in value of a bond (expressed in years) caused by a change in theprevailing interest rates.Floating-interest rate: A variable interest rate, one that changes periodically.Floating-interest bond. A bond with an interest rate that changes each quarter to reflecteconomic conditions.Fixed-interest bond. A bond with an interest rate that stays the same over its life span iscorporate bond. A bond issued by a corporation and backed by the companys credit and/or itsassets.Mortgage bond. A secured corporate bond that is backed by real estate. Because mortgagebond collateral provides a clear claim on a companys assets, these bonds are considered secureand high-grade.Junk bond. Refers to the quality of bond that is a speculative, high yielding, and issued by acompany that typically finances its growth and operations with debt. Ratings companies usuallyassign low grades to these bonds.Revenue bond. A bond sold by a municipality to finance projects such as bridges, hospitals,power plants and other local services. Also called limited obligation bonds, revenue bonds aresecured by the revenue generated by those projects.Government bond. A bond sold by the. Government. Government bonds are rated the highestof all bonds. They are used to finance federal projects.Treasury bond (T-bond). A bond issued by the Treasury to meet the governments financialneeds. Treasury bonds are considered the safest bonds and are very popular with investors.They have maturities lasting from ten to thirty years. 16 Babasabpatilfreepptmba.com
  17. 17. Construction of Balanced Portfolio comprising of Equity and DebtTreasury note (T-note). An intermediate-term federal government debt, similar to a T-bondbut maturing in one to ten years.Zero-coupon bond. A bond sold at discount and paying no interest, but instead paying theholder the face value at maturity. A zero-coupon bond stated at 1000 but sold for 600 wouldyield the holder a total of 1000 at maturity. The extra 400 the investor makes would be treatedas interest.Fundamental Analysis: A method of evaluating a stock by attempting to measure its intrinsicvalue. Fundamental analysts study everything from the overall economy and industryconditions, to the financial condition and management of companies.Intrinsic value: the economic value of a company or its common stock based on internally-generated cash returns. Intrinsic value can be thought of as the discounted stream of net cashflows attributable to an investment asset.Terminal value: Terminal value refers to the value of the firm (or equity) at the end of the highgrowth period. Terminal Value in year n= Cash Flow in year n+1/(r - g) .This approach requiresthe assumption that growth is constant forever, and that the cost of capital will not change overtime.Total Return Index: An index that calculates the performance of a group of stocks assumingthat all dividends and distributions are reinvested. This method is usually considered a moreaccurate measure of actual performance than if dividends and distributions were ignored.Beta: Statistically, beta is the measure of systematic risk in the CAPM and is the ratio of two covariances: the individual security divided by a proxy for the market as a whole or the so-calledmarket portfolio. The beta factor is the expected change in the securitys rate of return dividedby the accompanying change in the rate of return to the market portfolio. 17 Babasabpatilfreepptmba.com
  18. 18. Construction of Balanced Portfolio comprising of Equity and Debt DESIGN OF THE STUDY 18 Babasabpatilfreepptmba.com
  19. 19. Construction of Balanced Portfolio comprising of Equity and DebtTitle :“Construction of Balanced Portfolio comprising of Equity and Debt”Statement of Problem:To test the significance of excess return to beta and find out whether one can construct aportfolio whose beta is equal to market beta (beta =1), with returns greater than market returns.Objectives of the research: • To analyze the performance of the shares of co’s in the steel and cement sector in Indian stock market in light of the growth in infrastructure in India. • To study the factors influencing the share price of the company. • To analyze the companies based on Fundamental Analysis and TRI model • To construct a Portfolio (Balanced Fund) of Equities and Debt. The construction would be based on Fundamental Analysis Model.Research MethodologyType of researchThe study is a descriptive research, describing the construction of portfolios.Tools for data collection:The study involves collection of data from secondary sources and collected from internet,magazines, news paper, and research reports.Sampling:Type of sampling: Non-probabilistic judgment sampling.Sample size: Four stocks from the steel sector and six stocks from the cement sector; 10 company’s Corporate debt; ten Government securities; and 364 day-T-bills 19 Babasabpatilfreepptmba.com
  20. 20. Construction of Balanced Portfolio comprising of Equity and DebtPlan Of AnalysisAfter collecting financial data related to the entities, i.e. the sample selected from the selectedsectors, the various valuation ratios and other financial calculations which will help in thecompany valuation will be calculated. A portfolio will be constructed on the basis offundamental analysis and on the basis of risk-return analysis with different combinations ofdebt and equity to maximize the returns and minimize the risk (beta).Limitations of the Study• The study was confined only to the selected sectors.• The study was more confined with secondary data.• The study assumes no changes in the tax rates in the country.• As the scope is defined by the researcher, it restricts the number of variables which influence the industry.• Sales growth were assumed on the basis of change in sales of yr 2007 and 2006 20 Babasabpatilfreepptmba.com
  21. 21. Construction of Balanced Portfolio comprising of Equity and Debt EIC ANALYSIS 21 Babasabpatilfreepptmba.com
  22. 22. Construction of Balanced Portfolio comprising of Equity and DebtECONOMY ANALYSISEconomic growth includes a raft of supply side policies that have helped to increase competitiveness and productivity. For example financial markets have become more deregulated, allowing more flexible loans. These have helped to increase investment which has led to increased capacity and competitiveness. There has also been increased focus put on training and education of at least part of the population. Despite the rapid economic growth so far the Indian economy has managed to maintain relatively stable prices, with inflationary pressures remaining subdued.The success of the Indian economy shares several parallels with the Chinese economy. LikeChina the Indian economy has a plentiful supply of cheap labour. This has enabled low labourcosts for firms which have made them particularly competitive in labour intensive industries.This has often been at the expense of Western manufacturing sectors. For example recentlyDyson’s announced it would switch production of vacuum cleaners from the UK to Indianwhere labour costs are cheaper.The Indian economy has also benefited from the process of globalisation and improvedtechnology. A good example of this is in call centres, which benefit from the low labour costs.Due to the internet and cheap telephone calls many Western companies have found it profitableto switch their call centres to places in India where labour costs are significantly lower. India isat a particular advantage for this growing market because compared to other developingcountries English is spoken to a reasonable standard by a high share of the population. TheIndian economy has also been able to diversify from its primarily agricultural roots. Mumbaihas emerged as one of the leading financial centres in Asia. India is also increasingly benefitingfrom foreign investment into a variety of industries.Strengths of Indian Economy.After several decades of sluggish growth the Indian economy is now amongst the fastestgrowing economy in the world. Economic growth is currently 8-9%, second only to China. 22 Babasabpatilfreepptmba.com
  23. 23. Construction of Balanced Portfolio comprising of Equity and DebtDespite several problems facing the Indian economy many economists point to potentialstrengths of the Indian economy which could enable it to continue to benefit from high levels ofeconomic growth in the future.1. Demographics of India are favourable. India still has a positive birth rate meaning that the size of the workforce will continue to grow for the foreseeable future. (unlike India) A rising workforce helps to increase saving and investment. It also enables increased productivity.2. There is much scope for increases in efficiency. The infrastructure of India is so bad in places that even moderate improvements could lead to significant improvements in the productive capacity of the economy.3. India is well placed to benefit from globalization and outsourcing. A legacy of the British Empire is that India has one of the largest English speaking populations in the world. For labour intensive industries like call centres India is an obvious target for outsourcing. This is an economic development likely to continue in the future.4. Positive Growth Forecasts A recent study from Goldman Sachs, forecast that India could growth at a sustainable rate of 8% growth until 2020.However it is worth noting that this assumed Indian would make several supply side policies such as labour market deregulation and improvements in education and training. 23 Babasabpatilfreepptmba.com
  24. 24. Construction of Balanced Portfolio comprising of Equity and DebtProblems Facing Indian Economy1. Inflation.Fuelled by rising wages, property prices and food prices inflation in India is an increasingproblem. Inflation is currently between 6-7%. A record 98% of Indian firms report operatingclose to full capacity .With economic growth of 9.2% per annum inflationary pressures arelikely to increase, especially with supply side constraints such as infrastructure. The wholesale-price index (WPI), rose to an annualized 6.6% in Janu 20072. Poor educational standards.Although India has benefited from a high % of English speakers. (important for call centreindustry) there is still high levels of illiteracy amongst the population. It is worse in rural areasand amongst women. Over 50% of Indian women are illiterate3. Poor Infrastructure.Many Indians lack basic amenities lack access to running water. Indian public services arecreaking under the strain of bureaucracy and inefficiency. Over 40% of Indian fruit rots beforeit reaches the market; this is one example of the supply constraints and inefficiency’s facing theIndian economy.4. Balance of Payments deterioration.Although India has built up large amounts of foreign currency reserves the current accountdeficit has deteriorate in recent months. This deterioration is a result of the overheating of theeconomy. Aggregate Supply cannot meet Aggregate demand so consumers are sucking inimports. Excluding workers remittances India’s current account deficit is approaching 5% ofGD5. High levels of debt.Buoyed by a property boom the amount of lending in India has grown by 30% in the past year.However there are concerns about the risk of such loans. If they are dependent on risingproperty prices it could be problematic. Furthermore if inflation increases further it may force 24 Babasabpatilfreepptmba.com
  25. 25. Construction of Balanced Portfolio comprising of Equity and Debtthe RBI to increase interest rates. If interest rates rise substantially it will leave those indebtedfacing rising interest payments and potentially reducing consumer spending in the future6. Inequality has risen rather than decreased.It is hoped that economic growth would help drag the Indian poor above the poverty line.However so far economic growth has been highly uneven benefiting the skilled and wealthydisproportionately. Many of India’s rural poor are yet to receive any tangible benefit from theIndia’s economic growth. More than 78 million homes do not have electricity. 33%(268million) of the population live on less than $1 per day. Furthermore with the spread oftelevision in Indian villages the poor are increasingly aware of the disparity between rich andpoor.7. Large Budget Deficit.India has one of the largest budget deficits in the developing world. Excluding subsidies itamounts to nearly 8% of GDP. Although it is fallen a little in the past year. It still allows littlescope for increasing investment in public services like health and education.8. Rigid labour Laws.As an example Firms employing more than 100 people cannot fire workers without governmentpermission. The effect of this is to discourage firms from expanding to over 100 people. It alsodiscourages foreign investment. Trades Unions have an important political power base andgovernments often shy away from tackling potentially politically sensitive labour laws.CURRENT STATE OF AN INDIAN ECONOMYThe economy of India, when measured in USD exchange-rate terms, is the tenth largest in theworld, with a GDP of US $1.50 trillion (2008). It is the third largest in terms of purchasingpower parity. India is the second fastest growing major economy in the world, with a GDPgrowth rate of 9.4% for the fiscal year 2006–2007. However, Indias huge population has a percapita income of $4,542 at PPP and $1,089 in nominal terms (revised 2007 estimate). TheWorld Bank classifies India as a low-income economy. 25 Babasabpatilfreepptmba.com
  26. 26. Construction of Balanced Portfolio comprising of Equity and DebtIndias economy is diverse, encompassing agriculture, handicrafts, textile, manufacturing, and amultitude of services. Although two-thirds of the Indian workforce still earn their livelihooddirectly or indirectly through agriculture, services are a growing sector and play an increasinglyimportant role of Indias economy. The advent of the digital age, and the large number of youngand educated populace fluent in English, is gradually transforming India as an important backoffice destination for global outsourcing of customer services and technical support. India is amajor exporter of highly-skilled workers in software and financial services, and softwareengineering. Other sectors like manufacturing, pharmaceuticals, biotechnology,nanotechnology, telecommunication, shipbuilding, aviation , tourism and retailing are showingstrong potentials with higher growth rates.India followed a socialist-inspired approach for most of its independent history, with strictgovernment control over private sector participation, foreign trade, and foreign directinvestment. However, since the early 1990s, India has gradually opened up its markets througheconomic reforms by reducing government controls on foreign trade and investment. Theprivatisation of publicly owned industries and the opening up of certain sectors to private andforeign interests has proceeded slowly amid political debate.India faces a fast-growing population and the challenge of reducing economic and socialinequality. Poverty remains a serious problem, although it has declined significantly sinceindependence. Official surveys estimated that in the year 2004-2005, 27% of Indians were poor.SOME IMPORTANT FACTS ABOUT INDIAN ECONOMYPublic expenditureIndias public expenditure is classified as development expenditure, comprising central planexpenditure and central assistance and non-development expenditures; these categories caneach be divided into capital expenditure and revenue expenditure. Central plan expenditure isallocated to development schemes outlined in the plans of the central government and publicsector undertakings; central assistance refers to financial assistance and developmental loansgiven for plans of the state governments and union territories. Non-development capitalexpenditure comprises capital defense expenditure, loans to public enterprises, states and unionterritories and foreign governments, while non-development revenue expenditure comprises 26 Babasabpatilfreepptmba.com
  27. 27. Construction of Balanced Portfolio comprising of Equity and Debtrevenue defence expenditure, administrative expenditure, subsidies, debt relief to farmers,postal deficit, pensions, social and economic services (education, health, agriculture, scienceand technology), grants to states and union territories and foreign governments.Headquarters of Indias central bank, the Reserve Bank of India, in Mumbai (Its the tallbuilding in the background. The building in the foreground is the Asiatic Library)Indias non-development revenue expenditure has increased nearly fivefold in 2003–04 since1990–91 and more than tenfold since 1985–1986. Interest payments are the single largest itemof expenditure and accounted for more than 40% of the total non development expenditure inthe 2003–04 budget. Defence expenditure increased fourfold during the same period and hasbeen increasing due to growing tensions in the region, the expensive dispute with Pakistan overJammu and Kashmir and an effort to modernise the military. Administrative expenses arecompounded by a large salary and pension bill, which rises periodically due to revisions inwages, dearness allowance etc. subsidies on food, fertilizers, education and petroleum and othermerit and non-merit subsidies account are not only continuously rising, especially because ofrising crude oil and food prices, but are also harder to rein in, because of political compulsions.Public receiptsIndia has a three-tier tax structure, wherein the constitution empowers the union government tolevy income tax, tax on capital transactions (wealth tax, inheritance tax), sales tax, service tax,customs and excise duties and the state governments to levy sales tax on intrastate sale ofgoods, tax on entertainment and professions, excise duties on manufacture of alcohol, stampduties on transfer of property and collect land revenue (levy on land owned). The localgovernments are empowered by the state government to levy property tax, Octroi and chargeusers for public utilities like water supply, sewage etc. More than half of the revenues of theunion and state governments come from taxes, of which half come from Indirect taxes. Morethan a quarter of the union governments tax revenues is shared with the state governments. 27 Babasabpatilfreepptmba.com
  28. 28. Construction of Balanced Portfolio comprising of Equity and DebtThe tax reforms, initiated in 1991, have sought to rationalise the tax structure and increasecompliance by taking steps in the following directions:• Reducing the rates of individual and corporate income taxes, excises, customs and making it more progressive• Reducing exemptions and concessions• Simplification of laws and procedures• Introduction of Permanent account number to track monetary transactions• 21 of the 29 states introduced Value added tax (VAT) on April 1, 2005 to replace the complex and multiple sales tax system.The non-tax revenues of the central government come from fiscal services, interest receipts,public sector dividends, etc., while the non-tax revenues of the States are grants from the centralgovernment, interest receipts, dividends and income from general, economic and socialservices.General budgetThe Finance minister of India presents the annual union budget in the Parliament on the lastworking day of February. The budget has to be passed by the Lok Sabha before it can come intoeffect on April 1, the start of Indias fiscal year. The Union budget is preceded by an economicsurvey which outlines the broad direction of the budget and the economic performance of thecountry for the outgoing financial year. This economic survey involves all the various NGOs,women organizations, business people, old people associations etc.LabourThe large population puts further pressure on infrastructure and social services. A positivefactor has been the large working-age population, which forms 45.33% of the population and isexpected to increase substantially, because of the decreasing dependency ratio. The nationallabour market has been tightly regulated by successive governments ever since the WorkmensCompensation Act was passed in 1923. 28 Babasabpatilfreepptmba.com
  29. 29. Construction of Balanced Portfolio comprising of Equity and DebtNatural resourcesIndias total cultivable area is 1,269,219 km² (56.78% of total land area), which is decreasingdue to constant pressure from an ever growing population and increased urbanisation.India has a total water surface area of 314,400 km² and receives an average annual rainfall of1,100 mm. Irrigation accounts for 92% of the water utilisation, and comprised 380 km² in 1974,and is expected to rise to 1,050 km² by 2025, with the balance accounted for by industrial anddomestic consumers. Indias inland water resources comprising rivers, canals, ponds and lakesand marine resources comprising the east and west coasts of the Indian ocean and other gulfsand bays provide employment to nearly 6 million people in the fisheries sector. India is thesixth largest producer of fish in the world and second largest in inland fish production.Indias major mineral resources include Coal (fourth-largest reserves in the world), Iron ore,Manganese, Mica, Bauxite, Titanium ore, Chromite, Natural gas, Diamonds, Petroleum,Limestone and Thorium (worlds largest along Keralas shores). Indias oil reserves, found inBombay High off the coast of Maharashtra, Gujarat, and in eastern Assam meet 25% of thecountrys demand.Rising energy demand concomitant with economic growth has created a perpetual state ofenergy crunch in India. India is poor in oil resources and is currently heavily dependent on coaland foreign oil imports for its energy needs. Though India is rich in Thorium, but not inUranium, which it might get access to if a nuclear deal with US comes to fruition. India is richin certain energy resources which promise significant future potential - clean / renewableenergy resources like solar, wind, biofuels (jatropha, sugarcane).Physical infrastructureMumbai Airport 29 Babasabpatilfreepptmba.com
  30. 30. Construction of Balanced Portfolio comprising of Equity and DebtDevelopment of infrastructure was completely in the hands of the public sector and wasplagued by corruption, bureaucratic inefficiencies, urban-bias and an inability to scaleinvestment.Infosys Software Development Center in Pune.Indias low spending on power, construction, transportation, telecommunications and real estate,at $31 billion or 6% of GDP in 2002 had prevented India from sustaining higher growth rates.This had prompted the government to partially open up infrastructure to the private sectorallowing foreign investment which has helped in a sustained growth rate of close to 9% for thepast six quarters. India holds second position in the world in roadways construction, more thantwice that of China. As of 2005 the electricity production was at 661.6 billion kWh with oilproduction standing at 785,000 bbl/day. Indias prime import partners are : China 8.7%, US 6%,Germany 4.6%, Singapore 4.6%, Australia 4% as of 2006 CIA FactBook As of 15 January2007, there were 2.10 million broadband lines in India. Low tele-density is the major hurdle forslow pickup in broadband services. Over 76% of the broadband lines were via DSL and the restvia cable modems.Financial institutions 30 Babasabpatilfreepptmba.com
  31. 31. Construction of Balanced Portfolio comprising of Equity and DebtIndia has set up Special Economic Zones and software parks that offer tax benefits and betterinfrastructure to set up business. Pictured here is the Infosys headquarters in Bangalore, one ofthe largest software companies in India.India inherited several institutions, such as the civil services, Reserve Bank of India, railways,etc., from its British rulers. Mumbai serves as the nations commercial capital, with the ReserveBank of India (RBI), Bombay Stock Exchange (BSE) and the National Stock Exchange (NSE)located here. The headquarters of many financial institutions are also located in the city.Cyber Greens Office Complex. Containing offices like ABN Amro, Microsoft.The RBI, the countrys central bank was established on 1 April 1935. It serves as the nationsmonetary authority, regulator and supervisor of the financial system, manager of exchangecontrol and as an issuer of currency. The RBI is governed by a central board, headed by agovernor who is appointed by the Central government of India.Cuffe Parade is an important business district in Mumbai, home to the World Trade Center aswell as other important financial institutionsThe BSE Sensex or the BSE Sensitive Index is a value-weighted index composed of 30companies with April 1979 as the base year (100). These companies have the largest and mostactively traded stocks and are representative of various sectors, on the Exchange. They account 31 Babasabpatilfreepptmba.com
  32. 32. Construction of Balanced Portfolio comprising of Equity and Debtfor around one-fifth of the market capitalisation of the BSE. The Sensex is generally regardedas the most popular and precise barometer of the Indian stock markets. Incorporated in 1992,the National Stock Exchange is one of the largest and most advanced stock markets in India.The NSE is the worlds third largest stock exchange in terms of transactions. There are a total of23 stock exchanges in India, but the BSE and NSE comprise 83% of the volumes.The Securitiesand Exchange Board of India (SEBI), established in 1992, regulates the stock markets and othersecurities markets of the country.SECTORSAgricultureComposition of Indias total production (million tonnes) of foodgrains and commercial crops, in2003–04. India ranks second worldwide in farm output. Agriculture and allied sectors likeforestry, logging and fishing accounted for 18.6% of the GDP in 2005, employed 60% of thetotal workforce[4] and despite a steady decline of its share in the GDP, is still the largesteconomic sector and plays a significant role in the overall socio-economic development ofIndia. Yields per unit area of all crops have grown since 1950, due to the special emphasisplaced on agriculture in the five-year plans and steady improvements in irrigation, technology,application of modern agricultural practices and provision of agricultural credit and subsidiessince Green revolution in India. However, international comparisons reveal that the averageyield in India is generally 30% to 50% of the highest average yield in the world.The low productivity in India is a result of the following factors:• Illiteracy, general socio-economic backwardness, slow progress in implementing land reforms and inadequate or inefficient finance and marketing services for farm produce.• The average size of land holdings is very small (less than 20,000 m²) and is subject to fragmentation, due to land ceiling acts and in some cases, family disputes. Such small holdings are often over-manned, resulting in disguised unemployment and low productivity of labour.• Adoption of modern agricultural practices and use of technology is inadequate, hampered by ignorance of such practices, high costs and impracticality in the case of small land holdings. 32 Babasabpatilfreepptmba.com
  33. 33. Construction of Balanced Portfolio comprising of Equity and Debt• Irrigation facilities are inadequate, as revealed by the fact that only 53.6% of the land was irrigated in 2000–01, which result in farmers still being dependent on rainfall, specifically the Monsoon season. A good monsoon results in a robust growth for the economy as a whole, while a poor monsoon leads to a sluggish growth. Farm credit is regulated by NABARD, which is the statutory apex agent for rural development in the subcontinent.IndustryIndia is fourteenth in the world in factory output. They together account for 27.6% of the GDPand employ 17% of the total workforce.However, about one-third of the industrial labour forceis engaged in simple household manufacturing only.Economic reforms brought foreign competition, led to privatisation of certain public sectorindustries, opened up sectors hitherto reserved for the public sector and led to an expansion inthe production of fast-moving consumer goods.Post-liberalisation, the Indian private sector, which was usually run by oligopolies of old familyfirms and required political connections to prosper was faced with foreign competition,including the threat of cheaper Chinese imports. It has since handled the change by squeezingcosts, revamping management, focusing on designing new products and relying on low labourcosts and technology.34 Indian companies have been listed in the Forbes Global 2000 ranking for 2008. 33 Babasabpatilfreepptmba.com
  34. 34. Construction of Balanced Portfolio comprising of Equity and DebtThe 10 leading companies are: Market World Revenue Profits Assets ValueRank Company Logo Industry (billion (billion (billion (billion $) $) $) $) Reliance Oil & Gas 193 26.07 2.79 30.67 89.29 Industries Operations Oil and Natural Oil & Gas 198 18.90 4.11 33.79 54.11 Gas Corporation Operations State Bank of 219 Banking 15.77 1.47 188.56 33.29 India Indian Oil Oil & Gas 303 42.68 1.82 25.39 16.36 Corporation Operations 374 ICICI Bank Banking 9.84 0.64 91.07 29.85 411 NTPC Utilities 7.84 1.60 20.34 41.57 Steel Authority 647 Materials 7.88 1.45 8.05 26.37 of India Limited 738 Tata Steel Materials 5.83 0.97 11.48 14.63 Telecommunications 826 Bharti Airtel 4.26 0.94 6.61 39.16 Services Reliance Telecommunications 846 3.13 0.65 13.08 29.63 Communications ServicesServicesIndia is fifteenth in services output. It provides employment to 23% of work force, and it isgrowing fast, growth rate 7.5% in 1991–2000 up from 4.5% in 1951–80. It has the largest sharein the GDP, accounting for 53.8% in 2005 up from 15% in 1950. Business services(information technology, information technology enabled services, business processoutsourcing) are among the fastest growing sectors contributing to one third of the total outputof services in 2000. The growth in the IT sector is attributed to increased specialisation,availability of a large pool of low cost, but highly skilled, educated and fluent English-speakingworkers. On the supply side and on the demand side, increased demand from foreign consumersinterested in Indias service exports or those looking to outsource their operations. Indias IT 34 Babasabpatilfreepptmba.com
  35. 35. Construction of Balanced Portfolio comprising of Equity and Debtindustry, despite contributing significantly to its balance of payments, accounted for only about1% of the total GDP or 1/50th of the total services.Banking and financeThe Indian money market is classified into: the organised sector (comprising private, public andforeign owned commercial banks and cooperative banks, together known as scheduled banks);and the unorganised sector (comprising individual or family owned indigenous bankers ormoney lenders and non-banking financial companies (NBFCs)). The unorganised sector andmicrocredit are still preferred over traditional banks in rural and sub-urban areas, especially fornon-productive purposes, like ceremonies and short duration loans.Prime Minister Indira Gandhi nationalised 14 banks in 1969, followed by six others in 1980,and made it mandatory for banks to provide 40% of their net credit to priority sectors likeagriculture, small-scale industry, retail trade, small businesses, etc. to ensure that the banksfulfill their social and developmental goals. Since then, the number of bank branches hasincreased from 10,120 in 1969 to 98,910 in 2003 and the population covered by a branchdecreased from 63,800 to 15,000 during the same period. The total deposits increased 32.6times between 1971 to 1991 compared to 7 times between 1951 to 1971. Despite an increase ofrural branches, from 1,860 or 22% of the total number of branches in 1969 to 32,270 or 48%,only 32,270 out of 5 lakh (500,000) villages are covered by a scheduled bank.Since liberalisation, the government has approved significant banking reforms. While some ofthese relate to nationalised banks (like encouraging mergers, reducing government interferenceand increasing profitability and competitiveness), other reforms have opened up the bankingand insurance sectors to private and foreign players.Socio-economic characteristicsPoverty 35 Babasabpatilfreepptmba.com
  36. 36. Construction of Balanced Portfolio comprising of Equity and DebtLarge numbers of Indias people live in abject poverty. Wealth distribution in India isimproving since the liberalization and with the end of the socialist rule termed as the license raj.While poverty in India has reduced significantly, official figures estimate that 27.5% of Indiansstill lived below the national poverty line in 2004-2005. A 2007 report by the state-run NationalCommission for Enterprises in the Unorganised Sector (NCEUS) found that 70% of Indians, or800 million people, lived on less than 20 rupees per day with most working in "informal laboursector with no job or social security, living in abject poverty."Since the early 1950s, successive governments have implemented various schemes, underplanning, to alleviate poverty, that have met with partial success. All these programmes haverelied upon the strategies of the Food for work programme and National Rural EmploymentProgramme of the 1980s, which attempted to use the unemployed to generate productive assetsand build rural infrastructure. In August 2005, the Indian parliament passed the RuralEmployment Guarantee Bill, the largest programme of this type in terms of cost and coverage,which promises 100 days of minimum wage employment to every rural household in 200 ofIndias 600 districts. The question of whether economic reforms have reduced poverty or nothas fuelled debates without generating any clear cut answers and has also put political pressureon further economic reforms, especially those involving the downsizing of labour and cuttingagricultural subsidies.Occupations and unemploymentAgricultural and allied sectors accounted for about 57% of the total workforce in 1999–2000,down from 60% in 1993–94. While agriculture has faced stagnation in growth, services haveseen a steady growth. Of the total workforce, 8% is in the organised sector, two-thirds of whichare in the public sector. The NSSO survey estimated that in 1999–2000, 106 million, nearly10% of the population were unemployed and the overall unemployment rate was 7.32%, withrural areas doing marginally better (7.21%) than urban areas (7.65%).Unemployment in India is characterised by chronic underemployment or disguisedunemployment. Government schemes that target eradication of both poverty andunemployment, (Which in recent decades has sent millions of poor and unskilled people intourban areas in search of livelihoods.) attempt to solve the problem, by providing financialassistance for setting up businesses, skill honing, setting up public sector enterprises, 36 Babasabpatilfreepptmba.com
  37. 37. Construction of Balanced Portfolio comprising of Equity and Debtreservations in governments, etc. The decreased role of the public sector after liberalisation hasfurther underlined the need for focusing on better education and has also put political pressureon further reforms.Regional imbalanceOne of the critical problems facing Indias economy is the sharp and growing regionalvariations among Indias different states and territories in terms of per capita income, poverty,availability of infrastructure and socio-economic development.The five-year plans have attempted to reduce regional disparities by encouraging industrialdevelopment in the interior regions, but industries still tend to concentrate around urban areasand port cities. After liberalization, the more advanced states are better placed to benefit fromthem, with infrastructure like well developed ports, urbanisation and an educated and skilledworkforce which attract manufacturing and service sectors. The union and state governments ofbackward regions are trying to reduce the disparities by offering tax holidays, cheap land, etc.,and focusing more on sectors like tourism, which although being geographically andhistorically determined, can become a source of growth and is faster to develop than othersectors.External trade and investmentGlobal trade relationsUntil the liberalization of 1991, India was largely and intentionally isolated from the worldmarkets, to protect its fledging economy and to achieve self-reliance. Foreign trade was subjectto import tariffs, export taxes and quantitative restrictions, while foreign direct investment wasrestricted by upper-limit equity participation, restrictions on technology transfer, exportobligations and government approvals; these approvals were needed for nearly 60% of new FDIin the industrial sector. The restrictions ensured that FDI averaged only around $200M annuallybetween 1985 and 1991; a large percentage of the capital flows consisted of foreign aid,commercial borrowing and deposits of non-resident Indians. 37 Babasabpatilfreepptmba.com
  38. 38. Construction of Balanced Portfolio comprising of Equity and Debt Share of top five investing countries in FDI inflows. (2000–2007)[79] Inflows Rank Country Inflows (%) (Million USD) 1 Mauritius 85,178 44.24%[80] 2 United States 18,040 9.37% 3 United Kingdom 15,363 7.98% 4 Netherlands 11,177 5.81% 5 Singapore 9,742 5.06%Indian exports in 2006Indias exports were stagnant for the first 15 years after independence, due to the predominanceof tea, jute and cotton manufactures, demand for which was generally inelastic. Imports in thesame period consisted predominantly of machinery, equipment and raw materials, due tonascent industrialisation. Since liberalisation, the value of Indias international trade has becomemore broad-based and has risen to Rs. 63,080,109 crores in 2003–04 from Rs.1,250 crores in1950–51. Indias major trading partners are China, the US, the UAE, the UK, Japan and the EU.The exports during April 2007 were $12.31 billion up by 16% and import were $17.68 billionwith an increase of 18.06% over the previous year.India is a founding-member of General Agreement on Tariffs and Trade (GATT) since 1947and its successor, the World Trade Organization. While participating actively in its generalcouncil meetings, India has been crucial in voicing the concerns of the developing world. For 38 Babasabpatilfreepptmba.com
  39. 39. Construction of Balanced Portfolio comprising of Equity and Debtinstance, India has continued its opposition to the inclusion of such matters as labour andenvironment issues and other non-tariff barriers into the WTO policies.Balance of paymentsSince independence, Indias balance of payments on its current account has been negative.Since liberalisation in the 1990s (precipitated by a balance of payment crisis), Indias exportshave been consistently rising, covering 80.3% of its imports in 2002–03, up from 66.2% in1990–91. Although India is still a net importer, since 1996–97, its overall balance of payments(i.e., including the capital account balance), has been positive, largely on account of increasedforeign direct investment and deposits from non-resident Indians; until this time, the overallbalance was only occasionally positive on account of external assistance and commercialborrowings. As a result, Indias foreign currency reserves stood at $285 billion in 2008, whichcould be used in infrastructural development of the country if used effectively.India is a net importer: Per the CIA factbook in 2007, imports were $224bn and exports$140bn.Indias reliance on external assistance and commercial borrowings has decreased since 1991–92, and since 2002–03, it has gradually been repaying these debts. Declining interest rates andreduced borrowings decreased Indias debt service ratio to 4.5% in 2007. In India, ExternalCommercial Borrowings (ECBs) are being permitted by the Government for providing anadditional source of funds to Indian corporates. The Ministry of Finance monitors and regulatesthese borrowings (ECBs) through ECB policy guidelines. 39 Babasabpatilfreepptmba.com
  40. 40. Construction of Balanced Portfolio comprising of Equity and DebtForeign direct investment in IndiaAs the third-largest economy in the world in PPP terms, India is a preferred destination forforeign direct investments (FDI); India has strengths in information technology and othersignificant areas such as auto components, chemicals, apparels, pharmaceuticals, and jewellery.India has always held promise for global investors, but its rigid FDI policies were a significanthindrance in this regard. However, as a result of a series of ambitious and positive economicreforms aimed at deregulating the economy and stimulating foreign investment, India haspositioned itself as one of the front-runners of the rapidly growing Asia Pacific Region. Indiahas a large pool of skilled managerial and technical expertise. The size of the middle-classpopulation at 300 million exceeds the population of both the US and the EU, and represents apowerful consumer market.Indias recently liberalized FDI policy (2005) allows up to a 100% FDI stake in ventures.Industrial policy reforms have substantially reduced industrial licensing requirements, removedrestrictions on expansion and facilitated easy access to foreign technology and foreign directinvestment FDI. The upward moving growth curve of the real-estate sector owes some credit toa booming economy and liberalized FDI regime. In March 2005, the government amended therules to allow 100 per cent FDI in the construction business. This automatic route has beenpermitted in townships, housing, built-up infrastructure and construction development projectsincluding housing, commercial premises, hotels, resorts, hospitals, educational institutions,recreational facilities, and city- and regional-level infrastructure.A number of changes were approved on the FDI policy to remove the caps in most sectors.Restrictions will be relaxed in sectors as diverse as civil aviation, construction development,industrial parks, petroleum and natural gas, commodity exchanges, credit-information servicesand mining. But this still leaves an unfinished agenda of permitting greater foreign investmentin politically sensitive areas such as insurance and retailing.FDI inflows into India reached a record US$19.5bn in fiscal year 2006/07 (April-March),according to the governments Secretariat for Industrial Assistance. This was more than doublethe total of US$7.8bn in the previous fiscal year. Between April and September 2007, FDIinflows were US$8.2bn.INDUSTRY ANALYSIS 40 Babasabpatilfreepptmba.com
  41. 41. Construction of Balanced Portfolio comprising of Equity and DebtIndian Money MarketWhenever a bear market comes along, investors realize that the stock market is a risky place fortheir savings, a fact we tend to forget while enjoying the returns of a bull market! This,unfortunately, is part of the risk/return tradeoff. That is, to get higher returns, you have to takeon a higher level of risk. But for many investors, a volatile market is too much to stomach - analternative is the money market. The money market is better known as a place for largeinstitutions and government to manage their short-term cash needs. However, individualinvestors have access to the market through a variety of different securities.The money market is a subsection of the fixed income market. Many people think of the term"fixed income" as synonymous with bonds, but technically, a bond is just one type of fixedincome security. The difference between the money market and the bond market is that themoney market specializes in very short term debt securities (debt that matures in less than oneyear). Money market investments are also called cash investments because of their shortmaturities. Money market securities are essentially bonds issued by governments, financialinstitutions, and large corporations. These instruments are very liquid, and considered very safe.Because they are so conservative, money market securities offer a lower return than most othersecurities. One of the main differences between the money market and the stock market is thatmost money market securities trade in very high denominations and so individual investorshave limited access to them. Also, the money market is a dealer market, which means that firmsbuy and sell securities in their own accounts, at their own risk. Compare this to the stock marketwhere brokers usually act as agents, making money on commissions, while investors takes therisk of holding the stock. One other characteristic of a dealer market is there is no centraltrading floor or exchange. Deals are transacted over the phone or through electronic systems .The easiest way for us to gain access to the money market is with a money marketmutual funds, or sometimes a money market bank account. Although, some money marketinstruments like treasury bills may be purchased directly or through other large financialinstitutions with direct access to these markets. There are several different instruments in themoney market, offering different returns and different risks. Lets take a look at the major ones.Treasury BillsTreasury Bills (T-bills) are the most marketable money market security. Their popularity ismainly due to their simplicity. T-bills are basically a way for the government uses to raise 41 Babasabpatilfreepptmba.com
  42. 42. Construction of Balanced Portfolio comprising of Equity and Debtmoney from the public. T-bills are short-term securities that mature in one year or less fromtheir issue date. T-bills are issued with 3 month, 6 month, and 1 year maturities.Certificate of Deposit (CD)A certificate of deposit (CD) is a time deposit with a bank. Time deposits may not bewithdrawn on demand like a check account. CDs are generally issued by commercial banks butthey can be bought through brokerages. They bear a specific maturity date (from 3 months to 5years), a specified interest rate, and can be issued in any denomination, very similar to bonds.Commercial PaperFor many corporations, borrowing short-term money from banks is often a labored andannoying task. Their desire to avoid banks as much as possible has led to the Commercial paperis an unsecured, short-term loan issued by a corporation, typically for financing accountsreceivable and inventories.DebenturesThese are the normal types of bonds. It is unsecured debt, backed only by the name andgoodwill of the corporation. In the event of the liquidation of the corporation, holders ofdebentures are repaid before stockholders, but after holders of mortgage bonds. 42 Babasabpatilfreepptmba.com
  43. 43. Construction of Balanced Portfolio comprising of Equity and DebtINDIAN CEMENT INDUSTRYBackgroundThe Indian cement industry (120 million tons per annum) is the fourth largest in he world afterChina, Japan and USA. However, per capita consumption in the country is only around 80-90kg compared to the world average of approximately 250 kg.Historically, the Indian cement sector has been highly fragmented comprising 54 players thatoperate 124 plants. The majority of the plants are small-sized and well spread through out thecountry. The cement industry is cyclical and capital intensive. A new plant typically has agestation period of 3-4 years.Overview of The Indian cement industryThe Indian cement industry with a total capacity of 144 m tonnes (including mini plants) inFY07, has surpassed developed nations like USA and Japan and has emerged as the secondlargest market after China. Although consolidation has taken place in the Indian cement industrywith the top six players controlling almost 60% of the capacity, the remaining 40% of thecapacity remains pretty fragmented with around 40 players in the fray. • Despite the fact that Indian cement industry has clocked a production of more than 100 m tonnes for the second year in succession, the per capita consumption of 110 kgs compares poorly with the world average of 260 kgs. This, more than anything underlines the tremendous scope for growth in the Indian cement industry in the long term. • Cement, being a bulk commodity, is a freight intensive industry and transporting cement over long distances can prove to be uneconomical. This has resulted in cement being largely a regional play with the industry divided into five main regions viz. north, south, west, east and the central region. While the southern region is excess is capacity owing to the availability of limestone, the western and northern region are the most lucrative markets. Therefore, players like Grasim, L&T and Gujarat Ambuja enjoy high price realisations compared to the all India average. • Although the government has reduced the import duty on cement, imports do not pose a threat since prices of cement in India are lower than those prevailing in the international 43 Babasabpatilfreepptmba.com
  44. 44. Construction of Balanced Portfolio comprising of Equity and Debt markets. Moreover, the storage facilities on the Indian ports are inadequate for large- scale imports. Key points about the cement industry • Supply : There is an oversupply situation in the industry due to capacity additions by the major players in the industry. The situation is likely to improve, as there is no major Greenfield expansion in sight. • Demand : Housing sector acts as the principal growth driver for cement. However, in recent times, industrial and infrastructure sector have also emerged as demand drivers for cement. • Barriers to entry: High capital costs and long gestation periods. Access to limestone reserves (principal raw material for the manufacture of cement) also acts as a significant entry barrier. • Bargaining power of suppliers:Licensing of coal and limestone reserves, supply of power from the state grid and availability of railways for transport are all controlled by a single entity, which is the government. • Bargaining power of customers: Cement is a commodity business and sales volumes mostly depend upon the distribution reach of the company. However, things are changing and few brands such as Gujarat Ambuja and L&T have started commanding a premium on account of better quality perception. • Competition:Due to large number of players in the industry and very little brand differentiation to speak of, the competition is intense with players resorting to frequent price cuts in order to gain market share.Key Stages In Cement ProductionCement production is one of the world’s most energy intensive industries. Key productionstages can be summarized as:1.Raw materials 44 Babasabpatilfreepptmba.com
  45. 45. Construction of Balanced Portfolio comprising of Equity and DebtThese are generally combinations of limestone, shells or chalk, and shale, clay, sand or iron ore,usually mined from a quarry close to the plant where they undergo reduction using primary andsecondary crushers. When the reduced materials reach the cement plant they are proportioned tocreate a cement of specific chemical composition. Much work is being done on the use ofalternative raw materials – often the by-products of other industrial processes. These canminimize the effects of quarrying, reduce the impact of the cement plant on the localenvironment and enable the cement industry to become a major player in materials recycling.There are two basic methods used in Portland cement production – wet and dry. In the dryprocess dry materials are proportioned, ground to a powder, blended and fed into the kiln dry.The wet process involves adding water to the proportioned raw materials and completing thegrinding and blending operations in slurry form.2. Pre-heaterTo conserve energy, most modern cement plants pre-heat raw materials before they enter thekiln, using the hot exhaust gases from the kiln itself.3. KilnThe mixture of raw materials is fed into the upper end of a rotating, cylindrical kiln, whichachieves temperatures in excess of 1000°C. It passes through at a rate controlled by the slopeand rotational speed of the kiln. Chemical reaction inside the kiln leads to the fusion of the rawmaterials to produce clinker. Traditionally kiln fuels have been powdered coal or natural gas,but increasingly alternative fuels are being used. These include materials such as scrap tyres,processed sewage sludge and packaging waste.4. Cooling/finish grindingClinker is discharged from the lower end of the kiln and transferred to various types of coolers.Total productionThe cement industry comprises of 125 large cement plants with an installed capacity of 148.28million tonnes and more than 300 mini cement plants with an estimated capacity of 11.10million tonnes per annum. The Cement Corporation of India, which is a Central Public SectorUndertaking, has 10 units. There are 10 large cement plants owned by various State 45 Babasabpatilfreepptmba.com
  46. 46. Construction of Balanced Portfolio comprising of Equity and DebtGovernments. The total installed capacity in the country as a whole is 159.38 million tonnes.Actual cement production in 2006-07 was 116.35 million tonnes as against a production of106.90 million tonnes in 2004-05, registering a growth rate of 8.84%. Major players in cementproduction are Ambuja cement, Aditya Cement, J K Cement and L & T cement. Apart from meeting the entire domestic demand, the industry is also exporting cementand clinker. The export of cement during 2004-05 and 2006-07 was 5.14 million tonnes and6.92 million tonnes respectively. Export during April-May, 2007 was 1.35 million tonnes.Major exporters were Gujarat Ambuja Cements Ltd. and L&T Ltd. The Planning Commission for the formulation of X Five Year Plan constituted a WorkingGroup on Cement Industry for the development of cement industry. The Working Group hasidentified following thrust areas for improving demand for cement; i. Further push to housing development programmes; ii. Promotion of concrete Highways and roads; and iii. Use of ready-mix concrete in large infrastructure projects.Further, in order to improve global competitiveness of the Indian Cement Industry, theDepartment of Industrial Policy & Promotion commissioned a study on the globalcompetitiveness of the Indian Industry through an organization of international repute, viz.KPMG Consultancy Pvt. Ltd. The report submitted by the organization has made severalrecommendations for making the Indian Cement Industry more competitive in the internationalmarket. The recommendations are under consideration.Cement industry has been decontrolled from price and distribution on 1st March 1989 and de-licensed on 25th July 1991. However, the performance of the industry and prices of cement aremonitored regularly. Being a key infrastructure industry, the constraints faced by the industryare reviewed in the Infrastructure Coordination Committee meetings held in the CabinetSecretariat under the Chairmanship of Secretary (Coordination). The Committee onInfrastructure also reviews its performance.Technological changeContinuous technological upgrading and assimilation of latest technology has been going on inthe cement industry. Presently 93 per cent of the total capacity in the industry is based onmodern and environment-friendly dry process technology and only 7 per cent of the capacity is 46 Babasabpatilfreepptmba.com
  47. 47. Construction of Balanced Portfolio comprising of Equity and Debtbased on old wet and semi-dry process technology. There is tremendous scope for waste heatrecovery in cement plants and thereby reduction in emission level. One project for co-generation of power utilizing waste heat in an Indian cement plant is being implemented withJapanese assistance under Green Aid Plan. The induction of advanced technology has helpedthe industry immensely to conserve energy and fuel and to save materials substantially. India isalso producing different varieties of cement like Ordinary Portland Cement (OPC), PortlandPozzolana Cement (PPC), Portland Blast Furnace Slag Cement (PBFS), Oil Well Cement,Rapid Hardening Portland Cement, Sulphate Resisting Portland Cement, White Cement etc.Production of these varieties of cement conform to the BIS Specifications. Also, some cementplants have set up dedicated jetties for promoting bulk transportation and export.Future Prospects about the Cement industryThe industry is likely to maintain its growth momentum and continue growing at around 8% inthe medium to long term. Government initiatives in the infrastructure sector (such as thecommencement of second phase of NHDP, rural roads, 10,000 kms of additional highways asannounced in Finance Budget) and the housing sector are likely to be the main drivers ofgrowth for the industry. • The acquisition of L&Ts cement division by Grasim has changed the landscape of the entire cement industry and in one fell swoop has catapulted Grasim to the leadership position. This is a healthy sign for the industry, as this would result in consolidation and would give significant pricing power to the bigger players. With consolidation taking place at the lower end also, the unviable units will be forced to shut down thus benefiting the long-term interests of the industry. • With no major capacity expansion in the pipeline, the demand supply level is expected to achieve parity on a macro level by FY08 and this will help in the improvement of prices. However, since the level of demand supply mismatch is higher in the southern region, it will take longer to achieve demand supply parity. We expect cement price to increase by around 6% in FY08 owing to fundamental reasons. • The industry worked at estimated 84% capacity in FY08 and given the current growth rates and also assuming no major capacity expansion in the near future, the capacity 47 Babasabpatilfreepptmba.com
  48. 48. Construction of Balanced Portfolio comprising of Equity and Debt utilisation is likely to go up significantly in the future. This will help in improving the margins of all the major players and will lead to higher profitability.Despite these positives, the possibility of interest rates heading north and the consequent impacton housing demand remains to be seen. While infrastructure spending was a boon, there was astrong cushion from the steady growth of the construction sector. If this support wanes, it couldtake even longer for demand-supply balance to reach parity. Also, the hike in prices of coal andpetroleum products could impact cement companies margins (account for around 40% of sales).Though the pricing cushion exists, the margin rise will be mitigated to this extent.INDIAN STEEL INDUSTRYINTRODUCTIONSteel is a basic industrial metal because of its high specific strength and relatively low cost perunit. India is one of the major producers of steel in the world (10th largest) while Steel Authorityof India (a PSU) is the 11 th largest steel making company in the world. The per capitaconsumption of steel in India is 20 kgs compared to 20 kgs in Africa, 340 kgs in Europe, 420kgs in North America and 635 kgs in Japan.India has rich deposits of iron ore, ferrous ores, manganese ore, and chromate ore. India exportsiron ores to various countries. The major steel products are flat products such as HR-coils, CR-coils, Galvanised coils/sheets and Long products and steel alloys. The long products find use inthe construction business. HR coils form the raw material for the CR industry. They are usedfor LPG cylinders, tubes, pipes, drums, automobile components, boilers, etc. CR coil, which isa thin sheet, forms the raw material for the galvanised sheets/coils. Alloy steel is high valueadded steel for specific application.The Indian steel industry is plagued by over-capacity, high capital cost, inefficiency and labourproblems. After liberalisation, heavy investments were made in the steel sector. The steelmarket was expected to do well. But the fall of Russia, the Asian crisis, and overcapacity worldwide, led to a supply glut resulting in a fall in steel prices. Many developed countries startedprotecting the domestic companies by imposing heavy duties on the imported steel products. 48 Babasabpatilfreepptmba.com