Harish Sati, Indian Banking Sector 2010

12:10 AM

Indian Banking Sector 2010 : Opportunities and Challenges

The current economic situation provides a lot of opportunities as well as challenges to the existing banks. It is up to the banks to leverage the opportunities to meet the challenges to the best of their abilities.

The past year witnessed a lot of turmoil in the Indian banking industry owing to the global financial crisis. The Reserve Bank of India (RBI), Ministry of Finance and other regulatory authorities have made several notable efforts to improve regulation in the sector. Many big banks operating in the market have made use of the changed regulations (viz., change in CRR and interest rate) to provide better options to potential and new customers. Adoption of new practices to cater to the demanding economy situation has enabled the banks to meet the changing customer requirements. Compared to other regional banks, over the last few years, Indian banks have performed favorably on growth, asset quality and profitability. The banking index has grown at a compounded annual rate of over 51% from April 2001 compared to the market index for the same period, which registered a growth rate of 27%.
The crisis that hit the financial services industry initially in the US and almost immediately in the entire world has moved our focus towards critical systemic issues—not only in the US banking business but also in India. Globally, these systemic issues are being tackled at the legislative and regulatory levels; in India, the solution to the systemic issues will require significant inputs and regulatory, industry and infrastructural interventions. To ensure survival, banks tried to quickly assess their liquidity reserves and capital position to check if they had any exposure to the failing global entities. Additionally, this check also meant a clear pulling down of new/additional credit outflow, unless and until their positions were clear. Over a short span of time, the situation resulted in banks totally stopping the outflow of new credit.
According to Indian Banks Association Data, retail credit growth dropped drastically from 30% in 2007 to 10% in 2008, owing to increased pressure on existing loan portfolios and the fear of anticipated mass job losses which would result in high NPAs. Analysts and credit rating agencies in their reports showed marginal to moderate increases in NPLs in assets such as two-wheelers, commercial vehicles and unsecured loans. Growth in mortgages, which forms 50% of banks' retail portfolio, was also hit due to upward movement in interest rates, restriction on collection practices and soaring real estate prices.
Indian banks had to clean up their systems and practices to ensure stability in a recovering economy. Four challenges must be addressed before success can be achieved.
• The market is witnessing haphazard growth, driven by new products and services, which include credit cards, consumer finance and wealth management on the retail side, and fee-based income and investment banking on the wholesale banking side. Continuous growth in these new products and services requires new skills in sales and marketing, credit, operations and, above all, a potential customer base to provide these offerings.
• There will be no windfall treasury gains, which banks used to enjoy as a result of the decade-long secular decline in interest rates provided. This will expose the weaker banks and put them in trouble to a large extent.
• Growing interest in India will encourage foreign banks to set shop in India, thereby intensifying the competition for domestic and other existing players.
• As India is experiencing demographic shifts resulting from changes in age profile and household income, now consumers will demand improved institutional capabilities and enhanced service levels from banks.
As has been mentioned earlier, in India, regulators need to play a major role in revolutionalizing and bringing about changes in the economy. Of late, it has been realized that there is a need to create a market-driven banking sector, with ample stress on social development. This requires dedicated efforts by the regulators in six important areas, which are as follows:
• Focus strongly on `social development' by shifting from universal directed norms to an explicit incentive-driven system by introducing credit guarantees and market subsidies to encourage leading public sector, private and foreign players to leverage technology to innovate and profitably provide banking services to lower income and rural markets, thereby improving financial inclusion in the economy.
• Like the biggest financial markets of the world, create a super regulator rather than having separate regulators for each and every participant in the financial services industry.
• Focus on corporate governance and ensure that the same is improved by primarily focusing on board independence and accountability.
• Speed up the process of creation of world-class supporting infrastructure (e.g., payments, Asset Reconstruction Companies (ARCs), credit bureaus, and back-office utilities) to enable the banking sector focus on core activities.
• Undertake labor reforms, focusing on enhancing human capital, to help the public sector and old private banks compete with the newly established and much more efficient private banks and foreign banks entering the country.
Not only the regulators need to gear up, but even the banks need to pull up their socks and bring about some changes to support the reforms which the regulators aim to bring in:
• Public sector banks need to improve certain areas of their work performance, viz., sales and marketing, service operations, risk management and the overall organizational performance ethic. Last but not the least is to enhance the human capital, which will be the single biggest challenge and definitely the most time-consuming one also.
• What is true for public sector banks is also true for old private sector banks, as they have to also strengthen their basic skills. Additionally, they have to ensure their proactive participation in the Indian banking sector. This is of utmost importance to them, because the same will keep them up-to-date in this fiercely competitive market.
• New private banks can achieve an altogether new height in their growth in the Indian banking sector by continuing to engineer new and differentiated business models to profitably, efficiently and effectively service segments like the rural/low income and affluent/HNI segments, and by keeping an eye open for the acquisition of small banks to grow and reach the next level of performance in their service platforms. Attracting, developing and retaining management capacity would be another critical factor for achieving this and would be the biggest challenge that these banks will have to face.
• Foreign banks entering India will have to be innovative in their approaches to win the largest customer base and share of wallet and above all, to build a value-creating customer franchise in advance of regulations potentially opening up post 2009. At the same time, they need to be an active player in the game for potential acquisition opportunities, as and when they emerge, to ensure growth and establishment in India. They need to sustain and maintain a long-term value-creation mindset, which will not be an easy task by any means.
Thus, banking in India involves the cooperation and participation of many stakeholders for the desired changes to be made in the existing system. Last year, during the economic slowdown, when the banking system globally went for a toss, the Indian banking industry emerged as a strong performer owing to the coordinated efforts of policy makers and the banks in bringing these policies to action for the best of the economy.
The Indian banking industry gathered the strength to sustain during such times through its huge deposit base, which is consistently on a growth path, central bank's proactive measures to steadily improve banks' balance sheet strength, and a demand in the economy for physical asset creation. These factors enabled the Indian banking sector to become stronger on the capitalization front and also ensure lower level NPAs and better spreads in the past one-and-a-half decade.
The strength provided through timely measures has helped the industry and the economy in many ways. Last year, the economy witnessed perhaps the biggest and positive impact of higher credit growth in infrastructure- related companies—power, telecom and others. However, it was partially compensated by the reduction in other funding sources such as private equity and foreign institutional investors.
The alarm will start ringing if the regulator decides to continue with the stimulus package for long. With dried-up liquidity and no borrowers (given the low credit growth), the banking system will continue to invest excessively in government securities, leading to fiscal deficit eventually.
However, an increase in domestic liquidity has had a cascading effect on the asset price inflation. According to a report by Tata Securities, the YTD growth in deposits is 9%, while the credit growth is only 5.4%, resulting in the banks' looking for other investment opportunities. The high liquidity with banks forced them to invest in the liquid funds of mutual funds, which in turn invested in commercial papers of corporates at a lower coupon— corporates would have otherwise borrowed at a higher cost from the banks for their working capital requirements.
The second half of the year, which is typically the time for maximum activity in the economy, usually witnesses a higher demand for bank credit, compared to the first six months of the financial year. The three broad segments of bank credit are: Capex and Infrastructure Credit; Working Capital Loans; and Consumer Loans.
It is expected that growth would be highest in the case of infrastructure credit and consumer loans. Additionally, it is also expected that the demand for working capital loans is likely to be low, as commodity prices (crude oil and metals) continue to be low, and thus companies will have to work with low working capital requirements on a yearly basis.
Infrastructure is expected to catalyze credit growth in the Indian economy. According to the allocations made by the authorities concerned, the planned outlay on infrastructure under the 11th Five Year Plan under the projected investment in infrastructure should be around Rs 4,500 bn per annum for the next three years. According to a report from Tata Securities, infrastructure as a percentage of total bank credit exists at 10.2% currently, and it is projected to grow at more than 40% y-o-y in the next three years.
Consumer demand has been very resilient. There has also been a rise in the purchasing power in smaller cities and rural areas, along with job stability in large cities and Pay Commission benefits. Research by Tata Securities suggests that secured retail loans in the mortgage and vehicle financing segments are seeing good demand and will drive the overall bank credit growth. The research also states that in the absence of a pickup in corporate working capital loans, banks are eager to grow the secured consumer loans portfolio. It is expected that a price correction in the real estate market and gentle interest rates are factors which will promote growth in loan portfolios.
The downturn which the economy witnessed has discouraged the banks from having any exposure to unsecured consumer credit, and a revival in this segment is not expected to happen soon. According to a research report from Tata Securities, retail loans showed a CAGR of 22% during FY05-FY09. Within the retail segment, housing loans grew by 20% CAGR during the same period and consisted ~10% of the total bank credit. Thus, the banks, which had a big challenge on the unsecured loan front, had at the same time a bigger opportunity in the mortgage-backed security portfolio.
Abundant liquidity in the banking system during FY10 has been ensured through secular growth in deposits, low credit demand and prudent borrowing schedule issued by the government to maintain a balanced growth. According to a research report, despite the huge borrowings of Rs 4,510 bn by the government in FY10, the money held in reverse repo by banks remained considerably high. This will provide an opportunity to the banks to utilize the money in the most efficient and effective way to the benefit of both the customers and the economy as a whole, comprising various stakeholders.
Having talked about comfortable liquidity and the much-wanted stability in the banking system, one can expect that bond yields will remain in a higher range and would not fall significantly. Other reasons which are likely to support this fact includes:
• Lower than expected government borrowings
• Reduced global risk premium
• Higher credit growth
This brings another opportunity for the
banks to earn higher income.
Besides the favorable condition for liquidity and high bond yield, it is expected that the Net Interest Margin (NIM) will not expand much. The banks need to have higher incremental CD ratio, improvement in spreads and stable yield on investments to improve NIMs. Banks are expected to have a low cost of deposits owing to a stable interest rate scenario and ample liquidity in the system.
Another important area which requires critical attention is fee income. In the past few years, fee income has been the major contributor of revenue for private sector banks. Private sector banks have leveraged those areas to achieve the above, which public sector banks have not been able to, viz., transaction- related services and third party products sales, among others, to increase this non-fund based income.
Thus, we can very well say that the current situation has provided a lot of opportunities and challenges to the existing banks. Now, it is up to the banks as to how well they leverage the opportunities to meet the challenges to the best of their capacities.
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VW-Suzuki Deal

12:09 AM
VW-Suzuki Deal : Small is Beautiful

The deal between Germany's VW and Japan's Suzuki Motors only reaffirms the fact that small cars hold the key to the survival of the global automakers.

On December 9, 2008, European auto giant Volkswagen AG—which makes such marque brands as Beetle, Golf and Passat, besides boasting of several others like Audi, Skoda and Bentley in its kitty through its holdings in various other group firms across the globe—announced its intention to pick up a 20% stake in Suzuki Motors, Japan's leading automaker, which controls more than half of the passenger car market in India through its Indian subsidiary Maruti Suzuki; the Japanese automaker will in turn own 2.5% stake in VW through cross shareholding valued at around $1.13 bn. The part acquisition boosts VW's India entry, as it aims to topple Toyota to emerge as the world's largest automaker. The acquisition fits perfectly into the scheme of things at VW, which is aiming to bootstrap its presence in the small car market in India, selling 1.6 million small cars in 2009 alone. According to industry estimates, small cars account for over three-fourths of all cars sold in India. With the demand for cars in the developed economies receding to an all-time low, automakers are shifting their focus to emerging economies, particularly China and India. Above all, one could say, one single event that has attracted the attention of global auto biggies is the resounding success of Tata Nano, which was launched last year.
However, cracking the market for small cars would not be easy. Also, the rush for small cars is not a new one. In fact, in the 1990s, the country witnessed a similar frenzy among global auto giants such as South Korea's Daewoo and Hyundai and Italy's Fiat, among others, to tap the growing demand for small cars in India. But of all, only Hyundai could succeed, as Fiat, after initial failure (Uno failed to click with the Indian buyers), has now partnered with Tata Motors in its second attempt, while Daewoo, which filed for bankruptcy a few years back, sold its successful small car Matiz to GM, which rebranded and relaunched it in the Indian market a couple of years back as Chevrolet Spark, the best-selling small car from the GM stable in the Indian market. According to analysts, creating small and compact cars demands access to new technologies and cost management skills, which is only feasible with the alliance between Indian and foreign counterparts to jointly develop in India.
Given that, a section of analysts believe VW's $2.5 bn deal with Suzuki to be a game changer for the global car majors, which are struggling to cope with technology issues, on the one hand, and stringent environmental regulations, on the other, to deliver fuel-efficient vehicles.

When coopetition, not competition, matters

The VW-Suzuki deal aims to solidify the alliance between two culturally different entities. Going ahead, both the players look to leverage on areas like production, distribution and development of more environment- friendly vehicles through cross-technology partnerships, while focusing on next generation electric and hybrid vehicles that are more fuel-efficient and low on emissions. According to the two firms, in terms of global presence and product diversity, the partnership marks an important step towards their future, while in terms of product portfolio, global distribution and manufacturing capacities, Volkswagen and Suzuki ideally complement each other. The companies plan a joint approach to the growing worldwide demand for more environment- friendly vehicles. Suzuki's Indian subsidiary, Maruti does over 30% of the global sales by its parent company, and the Japanese parent expects its Indian arm to play a pivotal role in promoting its "World Strategic Models" to drive long-term growth.
VW, the world's third largest automaker, will bank on Suzuki's prowess in making its micro and subcompact car, a category in which it has been struggling to find success for a long time. On its part, having VW as a dominant stakeholder would give the Japanese counterpart access to the much-needed array of VW technologies, such as its diesel power trains and electronic capabilities, besides giving it a strong hold in Europe and China. VW has a little presence in the US, with 2% market share. Besides, the deal will also enable Maruti Suzuki to directly import diesel power trains for its popular models like Maruti Swift and Dzire. According to analysts, the Indian subsidiary of Suzuki currently sources diesel engines from Fiat through a three-way partnership with GM and Fiat, which, however, is set to expire as soon as the deal materializes with VW. The US auto giant General Motors Corp, which remained world's top automaker from 1931 to 2007, lost its supremacy to Toyota Motor Corp in 2008 as the world's top automaker. VW is now aiming to unseat Toyota as the top automaker by 2018 by aligning with Suzuki Motor Co, which also gives it an entry into India's booming car market. "Eight to ten years from now, we want to become No. 1 in the world and I believe that we'll be able to accelerate that into happening with cooperation with Suzuki," said Martin Winterkorn, CEO, VW. Auto analysts believe that the two players would aggressively exploit each other's expertise in clean technologies like electric and hybrid versions to launch more futuristic models under respective brand names.
Further, as both the partners have shown interest in developing cars through common platforms, it will enable VW to use Suzuki's existing platforms in India and Japan to export to Europe. To begin with, VW has invested around $850 mn in Suzuki's Indian subsidiary Maruti-Suzuki' s plant in Pune and has started to roll out its Polo models in India. The start of Polo's production in India "marks a milestone in our journey together into a successful future for the Volkswagen Group in India," said Jochem Heizmann, a member of the company's management board. With car sales zooming past 61% y-o-y in November 2009, it holds `enormous potential' for Volkswagen, he added. Currently, the Pune plant has the capacity to produce 110,000 cars annually. The two partners are also expected to jointly develop a small compact in the near future. Volkswagen AG, which runs 10 different brands from Audi, Seat, Skoda and Porsche AG, in which it recently acquired a 49.9% stake for 3.9 bn euro ($5.8 bn), has presence in US, Europe and China. However, it has struggled to indigenously develop small cars and grab market share in emerging economies like India and Southeast Asia, which is less than 2%. "Volkswagen is like a department store carrying everything from luxury brands to truck makers," said Koji Endo, Managing Director of Advanced Research Japan in Tokyo. "What they're missing is any presence in India and Southeast Asia. The point of partnering with Suzuki is to grab India."
While Global auto giants Toyota and Honda are struggling with declining demand and rising inventory costs, which is further eroding their profits, the inorganic route might be an advantage for VW, as it intends to lower entry costs through associating with domestic vendors in India. Currently, VW imports around 85% of the parts for its cars and acquires only 15% from the local vendors. With this deal materializing, VW intends to improve localization, giving it an advantage over Toyota and Honda in the long run. "VW has a poor vendor base in India and Maruti-Suzuki has the biggest number of equipment suppliers," said Ashok Taneja, MD of Sriram Pistons. "With this alliance, VW gets ready-made platform and vendors get additional volume," added he.

Alliances, the way to go

As demands continue to wane in the developed markets, more and more auto biggies are now chasing the emerging market growth story. For instance, many foreign players are partnering with auto companies in India to exploit the low-cost factor from procurement of raw material to production and distribution of the compact cars to Europe and other parts of the globe. Analysts believe that in the coming years, India would transform itself into an auto manufacturing hub with foreign auto giants either establishing their shops in India or partnering with the Indian peers to develop micro and subcompact cars inexpensively and profitably, benefitting each other in the long run through joint R&D efforts. A case in point is the latest tie-up between General Motors and Chinese SAIC. The two firms have formed a 50:50 joint venture to produce small cars in the Indian subcontinent. While GM will contribute through its existing factories and distribution network in India, China's biggest carmaker SAIC will invest up to $350 mn in cash and other assets to jointly develop minivans and pick-ups along with another Chinese partner, Wuling, apart from developing ultra-cheap cars. Experts say that partnerships such as this are expected to be the game changer for the auto industry, with more players expected to follow the inorganic route. "The automobile industry is going through a fundamental shift," said Winterkorn of VW. He added, "Alliances are at the top of the agenda and they are indispensable for competition. The global crisis has speeded up this reorganization. " Italian automaker, Fiat, has a successful partnership with Tata Motors. The tie-up has worked well so far for the former, as the Italian automaker registered a 50% sales growth, thanks to the wide network presence of India's most trusted brand. And the trend is set to continue, with heavy vehicle manufacturers like Ashok Leyland partnering with Nissan to jointly develop trucks and France's Renault partnering with Mahindra to manufacture mini-trucks and heavy vehicles.
With more and more foreign players focusing on tie-ups with Indian auto companies, this is expected to boost the business opportunities for existing auto ancillary manufacturers and suppliers like Rane Steering and Amtel Auto, stated analysts. According to the Society of Indian Automobile Manufacturers (SIAM), passenger vehicles sales in the country zoomed past the 15-lakh mark in FY2008-09, while in the first nine months of FY'10, it sold off 1.6 million cars, though it pales in comparison with neighboring China where passenger car sales crossed over 12.2 million in 2009. Nevertheless, India remains a hot spot for the global auto biggies, given its growth prospects. According to the global consultancy firm, KPMG, "By 2014, the Indian car market will double itself. And a big chunk of sales will come from smaller towns and cities where the small car will be the main driver of growth." No doubt, the auto majors are in a hurry. In a latest example, French automaker PSA Peugeot Citroen is desperately attempting to acquire around 30-50% stake of Mitsubishi Motors Corp. The alliance will focus more on developing environment- friendly cars like Electric Vehicles and Hybrid range to enter into emerging markets. "The small car segment in this country has been growing at 14-15% y-o-y and it will maintain its double-digit momentum for a long time to come," Michael Boneham, Ford India's Managing Director, was quoted as saying by The Economic Times.
The shift towards small cars is also in part driven by the worldwide economic slowdown and its aftereffects, forcing consumers to shift from luxury cars and large vehicles to low-priced, fuel-efficient small cars. Besides, the emphasis by many developed nations to impose tougher emission norms and on fuel-efficiency has also forced automakers to invest millions of dollars into clean technologies for developing hybrids and electric vehicles in future. This move is set to change the dynamics of the auto industry, as it further integrates the auto and electric industries on the common platform. According to auto analysts, the three main drivers that are set to realign the future auto industry are focusing on emerging economies, emphasis on clean energy and lowering their costs through cross-technology partnerships and alliances.

Stumbling blocks ahead

As global automakers enter the consolidation phase by partnering with other players to jointly develop more futuristic models, emerging markets will tremendously benefit from their investments with initiatives like greenfield projects. However, analysts caution that the aggressive approach by automakers to conquer new markets by associating with Indian players might not spell success, as Nissan Renault's alliance with Mahindra, offering Logan, is fast losing its market share, and believe only those with strong fundamentals and technical know-how can dare to lead the race. Christoph Stuermer advised VW not to take the aggressive approach and warned that "several European groups that were too aggressive had problems in Japanese markets." A Commerzbank analyst worried that purchases like sports car maker unit Porsche AG might cause VW "to lose sight of its priorities" and advised to increase its capacity, which remains below that of world's top automaker Toyota Corp.
While several automakers in the past have made alliances to develop low-cost cars, not many have succeeded in achieving the synergies in the long run. Several complexities like cultural differences among the Asian and Western car makers, followed by the reluctance to share technology with the other partner, were the major constraints which played spoilsport. Recently, Bajaj and Renault were at odds as to who should represent the ultra low-cost car jointly developed by both the companies to be pitted against Tata Nano in India. Moreover, the Indian auto market is a very challenging one for foreign players, as three big automakers like Tata Motors, Maruti Suzuki and Korean automaker Hyundai rule the Indian roads. Tata Motors with its first car, Indica, stormed the passenger car market at the end of the 1990s and continues to gain market share with new brands like Indigo, Indica Vista and Manza while Maruti Suzuki, which sells every second car in the subcontinent, has become a household name in India. The Korean automaker Hyundai too has steadily made its presence felt in the Indian market with new, technologically- competent models. The world's fourth largest automaker, which had initially forayed into small car segment with its Santro, Accent, Sonata and Embera, now has two of the top-selling models in India in Hyundai i10 and i20. All these three automakers are competing fiercely to stay ahead in the race with aggressive price cuts, discounts and providing largest number of service stations across India. Given that, it will not be easy for the challengers to compete head on with the incumbents. Further, automakers are focusing on fuel-efficient vehicles while reducing the emission levels to grab the prospective buyers in the country. In this scenario, new entrants have to make a balance between the pricing and technology well; in other words, they would have to understand the trade-offs well.
Against this backdrop, the Suzuki-VW deal, if succeeds, may offer some useful lessons. According to Phillipe Houchois, Auto Analyst at UBS, "By comparison, Suzuki deal is more game changing, than the VW's acquisition of Porsche AG," giving the Japanese auto giant an advantage to access VW's technological expertise in developing diesel power trains for its small and compact cars. However, some analysts believe that despite the strategic rationale behind the VW-Suzuki deal, its success would depend on how well the two carmakers iron out the differences and complexities. For example, VW intends to market, distribute and promote under respective brands, which will give Suzuki a tough competitor in the form of Volkswagen's Polo, which clashes with its brands like Swift and Dzire, and thus may eat into the latter's market share. Last but not the least, though GM had a large stake in Suzuki, it never managed to achieve the level of cooperation it intended to. As Houchois said, "That may largely be because of GM, but it's probably not just GM's fault, pointing to Suzuki's strong family-run corporate culture," something which the German auto giant may have to guard itself against.
"VW would need low-cost sourcing as well as economies of scale in manufacturing. Maruti Suzuki can provide both."

What are the factors behind the VW-Suzuki deal?

VW and Suzuki have announced a partnership, with VW buying a 19.9% stake ($2.5 bn) in Suzuki, and Suzuki in turn using half of this to buy a cross shareholding in VW.
The key factors involved:
• Strategic step to be No. 1 globally: The combined entity will immediately match Toyota in terms of overall volume.
• Complementary gains in terms of geographical footprints: Suzuki is strong in Japan and India, whereas Volkswagen has little or no presence there. This will give opportunity to both to extend their reach in the market where they are weak.
• Complementary gains in terms of segmental footprints: Suzuki is strong in small cars, particularly in the A-segment, while Volkswagen is more focused on the B-segment and C-segment. This can help both to design and develop using the expertise of each other in strong areas.
• Emission norms: Present Suzuki vehicles are having Japan 09 norms. These Japan 09 norms are close to Future Euro 6 norms, so this will help Volkswagen spend less on achieving the future Euro norms, which will be applicable in the years to come in Europe.
• Design capability sharing: Suzuki's small car body designs capability, coupled with Suzuki platforms, can help both of them to bring out a small car which can sell across the globe.
• Sourcing of parts from India: Volkswagen and Suzuki can further leverage the India advantage better in terms of developing and sourcing the parts from India for their global cars.

What are the major synergies the two partners can derive from the alliance?

Benefits for Volkswagen

• Small-car technology and accelerated growth in Asia beyond China, focused on India. VW wants to use India as a base for manufacturing small cars like the Up! In order to make this cost-competitive, VW would need low-cost sourcing as well as economies of scale in manufacturing. Maruti Suzuki can provide both. European majors want to acquire low-cost development and production capabilities and are tying up with Indian companies in order to achieve this. Fiat already has a tie-up with Tata, and Renault/Nissan has a tie-up with Bajaj, so VW also needs to have this capability to match its rivals. Maruti Suzuki will be a key contributor in this strategic move. At this stage, we do not think Suzuki will share a distribution network with VW in India, as it is their big strategic advantage in the Indian market. However, if in the future VW takes a majority stake in Suzuki, this could be shared.
• Access to Suzuki platforms like the YN platform, which supports a wide range of compact/subcompact programs supporting vehicles like the Swift, SX4 and Dzire. These platforms could be used across the emerging markets in South America and ASEAN and help VW expand its small-car portfolio.

Benefits for Suzuki

• Access to advanced diesel technology. This is very relevant for the Indian market; due to the government incentives for diesel, we expect penetration to increase significantly in passenger vehicles. Currently, Suzuki sources Fiat diesel engines; access to VW engines would likely see this end. As the Japanese market warms up to the concept of `clean diesel', access to VW's expertise in this area could also provide a major benefit to the Japanese domestic market.
•Access to large-car platform technology for vehicles like the Kizashi. Suzuki is predominantly a small-car manufacturer, but as income levels increase in the emerging markets, customers will demand bigger, better-equipped vehicles, an area in which Suzuki has been traditionally weak.
•Access to 3- and 4-cylinder down-sized, boosted gasoline engines, plus dual-clutch transmissions, VW's other major areas of expertise. This would help close the technology gap with Suzuki's major domestic competitors.

What are the challenges faced by the two players?

• Differences in cultures: Volkswagen is a German brand and Suzuki is a Japanese brand. There are huge cultural differences between their habits. So, it may take some time for both to actually bring some real action onto the field.
• Differences in marketing strategy: Volkswagen believes in pitching their products as premium products; however, Suzuki globally has competed as a manufacturer who prices its product relatively low in comparison to other OEMS.
• Differences in engineering/ quality standards.
• Differences in choosing suppliers: Volkswagen may believe more in European parts, whereas Suzuki may believe more in Japanese suppliers.
• Differences in process/rules/ employee benefits, etc.

How do you see the automobile industry evolving in the near future (with alliances and tie-ups)?

Alliances are a win-win proposition for OEMs (car manufacturers, suppliers, dealers, and other parties involved in the process). In future, alliances and consolidations will happen not only at the car manufacturers end, but also at the suppliers end at tier 1, tier 2 and tier 3 levels. These alliances will eliminate the energy required to produce a product/process which is already available with any of the partners. Example, like Maruti Suzuki in India makes A Star, hatchback car, and the same vehicle with few changes is sold as Nissan Pixo globally. This helps in saving tremendous amount of money, which otherwise would have been wasted to design, develop and produce the two cars separately. Other examples would be, using the same platform to develop more than one car in terms of body style. Swift Hatchback and Swift Dzire, Tata Indica and Tata Indigo are two different cars but developed on the same platform. This approach helps OEMs in using money efficiently, which finally helps customers to get a better value proposition. Moreover, with complexities increasing in terms of safety and emission norms, the collaborative approach will not be an option but a need, for the OEMs. In other words, we can say, whosoever believes in the collaborative approach will survive in the years to come.

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Indian IPO Market

12:08 AM

Indian IPO Market : Poised for a Big Leap!

If 2009 was the year of capital erosion, 2010 could well be the year of capital raising! Thanks to the recovering capex cycle and surging domestic expansion activities, the year is all set to witness a frenzy of capital raising activities via IPO, right issues and overseas issues.

The collapse of Lehman Brothers has led to the rechristening of the financial events as `Before Lehman Brothers' and `After Lehman Brothers'. The spiralling events in the last two years have uprooted the conventional wisdom and, in many cases, forced the entities to go back to the basics. Banks have gone back to deposit and lending business, investors have gone back to long-term investments, (re)understanding the risk-reward relationship (high yield = high risk), and in most cases, nations have become `police states'. As developed economies started getting into recessionary trends, overseas investment in emerging markets flew back to its original source. For example, Indian equity market witnessed net sales of $12 bn in 2008. As the demand for investment ideas started drying up, the primary market—IPO market—in India became much quieter. To stretch Schumpeter's idea of `innovator' to `break the cycle'—the government's stimulus package did just that. Globally billions of dollars were pumped into the economies to encourage spending and the investing attitude of public. A cursory look at the Indian IPO market over the last two years shows that economic fundamentals continue to dominate the financial markets. Domestic demand, consumption, savings, and investment are the main currents flowing under the glamorous facade of financial markets.
During 2008 (see Table 1), India Inc. raised Rs 185,526.3 mn ($~4bn) through IPOs. This amount is negligible, compared to almost $30 bn mopped up through IPOs in the US during the same period. Even during the turbulent times, Visa Inc. managed to launch a massive IPO of $17.9 bn. In 2008, a majority of the Indian IPOs were concentrated in the energy sector. The crude oil prices were hitting a new high everyday, so also the commodity prices. Reliance Power managed to make a debut just before global meltdown in January 2008. As the year 2008 progressed, the US continued to record negative GDP growth. The UK government forecast a worst recession in decades, and capital flight from emerging economies gained momentum. Domestically, in the backdrop of falling exports and employment, growth in industrial production (IIP) reached its nadir (see Chart).
During 2008, 35 IPOs were canceled and/or postponed (see Table 2). A majority of these IPOs belonged to engineering, financial and IT-related sectors. The first axe of global recession fell on these sectors, as companies decided to go slow on new capex and expenditure. A sharp fall in domestic manufacturing was also evident from the fact that as global demand—especially from developed markets—slowed down, domestic companies put a cap on capex.
Despite the stimulus packages announced globally, including by India, year 2008 remains one of the worst years for financial markets. The volatility continued for the Indian market because of the general elections in May 2009. The possibility of a hung Parliament kept investors at bay and away from the Indian capital market. The domestic consumption took a hit, as fears of unemployment widened. During 2009, 42 IPOs were canceled and/or postponed. A majority of those belonged to the real estate sector. The demand for new and existing housing in tier 2-3 cities had started waning and companies were trying to tap the primary market to fund the existing and new projects. Low domestic consumption also badly hit the FMCG sector, where some IPOs were canceled and/or postponed. Interestingly, many companies involved in gems and jewelry business tried to tap the capital market, but in vain.

Signs of revival

A historic win by the UPA government ensured the possibility of a stable government for the next five years. Meanwhile, the government stimulus package started working like a panacea. Globally and domestically, demand started picking up gradually, especially in the second half of 2009. A major push in the IPO market was witnessed during this period. The theory of decoupling became more evident, as the Indian and Chinese economies continued to show a stronger growth rate, though lower than the previous year. During 2009, 17 IPOs worth Rs 151,568 mn were launched. Though engineering and energy sectors continued to dominate the IPO market (in terms of value), new economy sectors such as media, hotels and IT also showed their presence. Companies involved in shipping and oil and gas exploration also tapped the primary market to mop up funds for expansion. The growth in India's exports was the sharpest in late 2008; over a long period of more than 12 months, exports growth turned positive in November 2009. The growth recovery in industrial production was well-rounded, as mining and electricity also contributed positively towards the overall growth.
Global liquidity is very comfortable; in fact, it is a debatable whether to call it liquidity or savings glut. Indian equity market has witnessed a net inflow of ~$11 bn of overseas funds. The prospects of the emerging economies, including India, remain brighter. In fact, investing in the BRIC economies has become the `call of the decade'. Year 2010 is likely to witness a flush of IPOs in the Indian market. However, it is important to remember and practice the lessons from the last two years. Going back to the basics, due diligence remains the main priority for the investors.
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Reviving Indian Agriculture

12:07 AM

Reviving Indian Agriculture : Back to Basics

The strategies for reviving Indian agriculture include innovation in using technology and resources, future policies that are quantity and business-oriented, and creating a competitive market for allowing public-private partnership to invest in agriculture infrastructure, extension, and technology transfer.

It is a norm to observe the relative decline of agriculture' s share in the GDP of a developing economy. Nearly half of India's GDP came from agriculture sector in 1960, and even more in her early unrecorded primeval history. However, agriculture made up only one-fifth of India's GDP, with stark differences in the growth rate compared to that of industrial and services sectors in recent years. This phenomenon only managed to attract slightly more attention when food security was threatened after feeling the heat from food crisis and perhaps riots in the first half of 2008. Pessimists call it the dire agricultural crisis. Optimists watch the sparkling opportunities, beyond the gloom, in times of crisis.
Some quarters, particularly those who do not understand what is included in the accounting system of agriculture sector in GDP, are generally against the painful disproportionate growth of agriculture sector in GDP during the development process of an open economy. They have every right to protest because post-farm and value-adding activities are in the boundary of industrial or services sector, leaving the least primary level of agricultural production value for the account of agriculture sector in GDP. Bear in mind that agricultural production value is a result of multiplication between quantity and price.
Food security to the nation has been the thrust of the policy for the agriculture sector in India. The need for food security is translated into a number of multi-pronged policy objectives: to attain a reasonable level of self-sufficiency and buffer stocks and affordable prices for consumers. The major objectives of attaining self-sufficiency and adequate buffer stocks were achieved predominantly in the Green Revolution by the end of the 1970s.
With ample agricultural production as well as government interventions, prices of agriculture commodities have been relatively low over the years. The ultimate aim is to ensure food accessibility for food security among rural poor. However, low agricultural commodities prices mean less farmers' income. Agriculture is then less profitable compared to other economic activities. Farmers are trapped between increasing input costs and marginal returns. With the rise of other more profitable sectors, the opportunity cost of basic resources—namely, land, water, and labor—becomes obviously high. Some farmers therefore switched these resources for other sectors. The remaining farmers, on the other hand, though are aging and uneducated, still understand the importance of raising agricultural productivity to increase farm income.
This `formula' of reducing poverty by raising agriculture productivity was realized and articulated in various government policies. The subsequent results were pleasing, particularly after the reforms introduced in the early 1990s. India recorded significant productivity growth and continued enjoying more than self-sufficiency in major crops. The surpluses were traded. Agricultural commodities exports at primary level increased steadily to about $3 bn in 2005, while imports recorded constantly just below $0.75 bn during 1992-2005. India, being a net exporter of commodities, started to shine at international level. However, it is the post-farm and value-adding activities that represent greater value.
The post-farm and value-adding activities are made possible by its ability to transfer commodities surpluses to the more important industrial and service sectors. Regardless, it is an intermediate or final agricultural product; they are processed and value-added. Further, marketing efforts even see obvious differentiation in their values. The combined value of intermediate and final agricultural products easily outshines the trade value of commodities. The export value of processed agricultural products was a triple of commodities export value during 1992-2005. What would it be if they were captured under the account of agriculture sector in GDP? Regardless of the accounting system of GDP, they are close-knit siblings in a family.
Economists highlighted the potential of agriculture to stimulate industrialization, and some argued that industry's demand that promotes modernization would boost agricultural production. This sounds encouraging, but the interconnection may soon find out there is supply scare to support post-farm and value-adding activities on top of competitions for direct human consumption and animal feed. This is because productivity growth has been stagnant in recent years. The food crisis in 2008 was a whammy as well as timely to pull the trigger of red alert for India's agriculture sector to make huge strides in increasing productivity, although early success was tasted in the 1990s.
The room for productivity growth is blindingly obvious. Yields of major crops in India are lower than in many other countries. For example, the average rice yield in India (3.21 ton/ha) was lower than world average (4.15 ton/ha), China (6.35 ton/ha), and Bangladesh (3.88 ton/ha) in 2007. The low yield was mainly attributed to below average performance in Assam, Bihar, Chhattisgarh, Gujarat, Jharkand, Madhya Pradesh, Maharashtra, Orissa, Uttar Pradesh, Uttaranchal, and other states. Comparatively, the richer states (Andhra Pradesh, Punjab, Haryana and Tamil Nadu) have attained a yield of 5-6 ton/ha in recent years. The gap in yield performance is not only just a challenge but also an opportunity for growth.
The challenge and opportunity for growth, yet, are overshadowed by climate change. Drought that keeps monsoon away may see major crops—rice, wheat, soybean, cotton and sugarcane—take a severe hit. It may not be so severe if a farm has modern irrigation system and energization of wells. However, it is the uncertainty in climate change which is less predictable, less stable, and wilder. Sudden monsoon may lead to thunder flood and wipe out farm production in an unprecedented way. Unexpected long-term drought may send agricultural production down adversely. Climate change is not something that technology can do away with, but certainly there is technology that can help farmers cope with it.
However, worrisome climate change may not be as guilty as man-made market failure. Ever since the 1980s, agricultural investment as a share of total investment has been on a downward trend. Public investment in agriculture was just 1.9% of agriculture GDP in the early 2000s. Agricultural subsidies, on the other hand, were below Rs 50 bn in 1980, but spurred tremendously to about Rs 450 bn in 2005. Bulk of the subsidies was made up by power subsidy, fertilizer subsidy and irrigation subsidy. These measures produced promising result in productivity and area expansion during 1980s-1990s when other sectors were `newly promoted' as more profitable. However, with the rise of industrial and services sectors, the agricultural output growth rate started stagnating and more so in recent years.
The well-intentioned subsidy programs, in simple terms, have resulted in adverse impact and caused disorder and distortion, albeit unintentionally. The destruction it wrought has also made the agriculture sector fail to respond to market signals. The subsidies were misallocated and failed to render its service where it was most needed. This episode implicitly addresses the need for subsidies to be revisited. Without freedom for market adjustment and efficiency in resource allocation, the subsidies have crowded out productivity- enhancing investments for irrigation development, agricultural research and extension, rural roads and electrification.

Investments: Need of the hour

More investments are needed in agricultural science, technology, capacity building, research and development. The reasons for this seem evident when one considers the growth of rice yield in West Bengal that increased about 43% to 3.85 ton/ha during 1990-2007. The success story of rice cultivation in West Bengal can be traced back to the early days of its transformation from low flood valleys to viable farmland. The recent innovation in using technology and resources efficiently has further seen West Bengal market its surplus to other states.
Similar technology and resources are also available to other states. However, the inadequacy in the spread of extension services and information has limited farmers' knowledge and adoption for technologies and modern agricultural practices, including cultivation of High Yielding Varieties. Small farm holders, especially in the rural area, are further marginalized and find it difficult to access new technology and adopt more efficient forms of farm production. All these inherent institutional challenges have unfavorably affected agricultural growth in the country.

Useful suggestions

Some success stories may sound good but may not be relevant to the current scenario. A close look would reveal that the underlying determinants of agriculture share are its production quantities, prices, and subsequently values. Future policies that are quantity (both productivity and area expansion) and business (price) oriented must be introduced to replace the existing `outdated' subsidy programs and policies. The future policies may slowly transform the mechanism of agriculture sector to be business and market-oriented. The motivations for this orientation are efficiency, profitability and sustainability.
There is also a need to revive some old yet relevant and useful suggestions. To name a few: a competitive market is needed for allowing public-private partnership to invest in agriculture infrastructure, extension, and technology transfer. Small farms must be given incentives for consolidation into a powerful generator for resource efficiency, farm productivity, business sustainability, and most importantly, farmers' welfare.

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Indian Mutual Fund Industry

12:06 AM

Indian Mutual Fund Industry : Winds of Change

By announcing the setting up of trading platform for mutual fund units in the exchanges, Sebi has automatically opened the mutual fund window to millions of potential investors from the rural and semi-urban areas. This is an indication that the investors are all set to rule in the fast-growing mutual fund industry.

A very recent circular issued by the Sebi created big news in the mutual fund circles. In another paradigm shift, Sebi announced a dedicated trading platform for the mutual fund products on the major stock exchanges. The din that was created in the distributor and advisor circles after the announcement of the ban on entry load (a charge levied while selling mutual fund products) a few months back had not settled down completely, when the above new announcement hit the mutual fund industry. The writing is on the wall for the intermediaries in the mutual fund industry. Shape up or ship out. Even the fund houses got a clear message. Reorient policies for investor benefit. It is evident that investors are set to rule.

The beginning

Before examining the two big recent events, along with many other investor-friendly initiatives of the regulator, that have shaken many in the mutual fund industry, let us peruse the issue from scratch. In the last 18 months, Sebi made news on several occasions when they released as many as 22 circulars with a strike rate of more than one a month (may be a record), touching almost every issue of the mutual fund business and possibly hitting every participant of the industry barring one, `the investor'. The given Table highlights the major circulars issued by Sebi to the mutual fund industry.
The pace and intent are clearly visible. The number of circulars, the wide coverage of various facets of mutual fund business and micro management of certain issues clearly spell the depth of importance given by Sebi. As it is seen, it involves everyone who is associated with this industry. The genesis of the current new `investor-friendly avatar' dates back to a period prior to October 2008, when things were moving fast in the mutual fund industry. The pace was visible and felt. The Assets Under Management (AUM) growth was phenomenal then. The number of new entrants evincing interest in this industry was encouraging. The new fund offers were pushed at great speed towards investors. Several varieties of existing products were offered. Above all, one community was smiling all the way with roaring business. That was the `distributor or advisor' fraternity, a vital intermediary in the mutual fund setup. Things were smooth when the first jolt was felt around the October 2008 liquidity crisis. In order to overcome the crisis, when redemptions were pressed by some large entities on or ahead of schedule, leaving small investors' interest highly risky, Sebi must have got the first wake up call for a major overhauling. Since then Sebi has not looked back. While many other micro events might have equally convinced Sebi towards the new thrust to protect investors, October's was possibly the trigger. The pace shifted to the regulator side, and since then there was no looking back. Who is the loser? Will investors truly benefit? Are we going to see the same growth in the industry? How is the landscape likely to change in the future? These are some of the questions we must answer. We discuss the two major salvos of Sebi first, before trying to answer the questions and predict the future scenario.

Entry load

The first major salvo of Sebi was to scrap the entry load with effect from August 1, 2009. Entry loads are upfront payments from investor's pocket along with his investment in a specific mutual fund scheme. The entry load paid is passed as commission to the distributor/ agent, either wholly or partly or by supplementing further amount, by the Asset Management Company (AMC) for the service rendered by him in collecting the payment. By scrapping this, Sebi empowered the investors in deciding the commission paid to distributors. Before this, the distributors earned a fixed sum on mutual funds irrespective of performance. Those were times, when investor investments were more through inducement than knowledge. This led to constant churning across schemes and hampered long-term asset creation, which might have forced Sebi to issue this diktat. While some other reasons might have equally prevailed, this one appears to be the most important one.
The effect is that it has already altered the dynamics of the mutual fund industry. The impact has already started showing in the AUM of the mutual funds. The AMCs have begun to reorient their strategies. More time is spent in marketing existing funds than the new ones. Some have diverted the resources to other avenues like PMS etc. to keep the net revenue intact. The distributors, who by far have made the maximum noise, have come to terms with the new environment and have initiated steps to augment infrastructure, knowledge, systems, etc. to earn rightfully. In the new scheme of things, the distributors now prefer to push alternative products, especially the high incentive insurance products. For survival, many distributors have now offered to provide several services across various financial products.
Voluntary service from distributors and advisors to sell mutual funds has virtually stopped. The investors who got used to the `perceived' free service are shying away from paying, even if they are offered genuine service. The `rich' AMCs have devised new methods to pay the distributors, albeit lower than before, by dipping into their coffers, and aim to continue to collect funds the inducement way. The new process may not last long. This increased expense, lack of organized distribution channels, and decline in profitability may force reconsideration and may also force some smaller fund houses to quit the business and could result in industry consolidation. However, ultimately it is the good fund performance that would rule the market.
Automatic inflows would be seen only when the investor becomes knowledgeable, and he understands that quality service needs to be paid and it is the good performance that is going to augment his wealth. We know that money chases better returns. Obviously, this fact would force investors sooner or later to shift money to better performing funds. Investor education is important here. It is a challenge for everyone, including the regulator. Investor education is the joint responsibility of all fund houses, Association of Mutual Funds of India (AMFI) and the regulator, and in fact of the government and every entity who believes that mutual fund industry growth is an important requirement for the overall healthy investment setup.

MF products on stock exchanges

In what we can as a second salvo, the regulator Sebi, in its most recent and landmark announcement, pronounced the creation of separate mutual fund trading platform on the stock exchanges. It has opened a new transaction point for the investor. This one being the easiest way of buying and selling mutual fund units, which can be done over phone. Units purchased or sold will be credited or debited to the investor's dematerialized account, just like the way the shares are traded today; with similar convenience, even redemptions can be pressed. Obviously, the required formalities are to be completed. This means an investor can have just one consolidated demat account showing all his mutual fund holdings and equities as well. At present, liquid funds and systematic investment plans are not available on stock exchanges. The broker needs to be certified by the AMFI and has to apply for the trading platform.
The numbers of Indian cities where one can buy and sell MFs would go up straightaway to about 1,500, up from about 300. Possibly, Sebi did not want to wait for mutual funds to take the initiative of setting up offices in the Indian hinterlands. Alternately, it can be viewed as Sebi wanting to signal financial inclusion.
For the mutual fund, this is an opportunity to tap a new source of inflow. It is the mutual fund house that would be the biggest beneficiary if it clicks the way Sebi thinks. An MF would save on the cost of printing and dispatch of account statements if the transaction is done on a stock exchange. The same goes for printing application forms. Now, under a new setup, since one can place an order to buy or redeem units over the phone, there is no need to fill any forms. The savings would amount to crores of rupees, with the amount significantly large for the biggies. This amount can be spent productively towards investor education or for other productive avenues.
The decision might be another blow for the mutual fund distributors and Individual Financial Advisor (IFA) who are already struggling with the no entry load norms, especially the ones who do not have enough infrastructure or those who have nil infrastructure. The weak ones are set to perish and only the fittest and the efficient will survive. Interestingly, the stock broking fraternity might see mutual fund distribution as a new line of business. It could also give brokers a different profile of potential customers for their business.
A big advantage for a stockbroker would be the advantage of directly being able to debit the client's accounts, much like the banks, which a normal MF distributor was not having. Going forward, this would lure distributor- broker tieups owing to the presence of tremendous synergies for both.
It is feared that what Sebi has taken away from the distributors, it has returned to the brokers. In the earlier era, most distributors were pushing products for commissions and promoted churning. Now it is felt that the brokers would do no different job because brokers are not expected to give an expert advisory call. Therefore, the tendency of investors to trade without knowledge would still remain in the new era. In fact, now it would be a convenient world for investors with a wider reach.
Another issue that might be open for discussion is the brokerage that would be charged by the broker when an investor transacts a buy/sell/both in the exchange trading platform. Unless brokers charge a lower rate for MF schemes as compared with direct equity, an investor would not be much interested in transacting through the exchange. Also, any grievance at the brokers' end is a new problem for the investor. Add to this, the cost of advice that the broker would charge. The overall cost would be higher, as the opportunity cost of time for a broker is much higher as he is already very much engaged in his business and requires him to take the mutual fund business seriously enough to invest time and effort.
Another fear is that MF units would be treated like stocks by investors. If stock-like activity is seen, then AUM volatility is likely to be high. And fluctuating AUM is not good for fund management and frequent buying and selling increases transaction costs and affects returns.

Other issues

In the changed setup, post-entry load ban, many investors were put to great discomfort whenever they wanted to switch investments from an AMC to the other. Investors were required to get an NOC (No Objection Certificate) from the old distributor, in case he decided to change the distributor or were to apply directly at AMC. This created lot of hardships to investors. The old distributors avoided issue of NOC because they would be losing the trail commission once the investor switches to another distributor. Post-entry load ban, giving away even the trail is simply going broke for many. This required the intermediation of the regulator. Sebi in its most recent circular has sent a terse warning to entities concerned to desist from insisting on NOCs.
Among other measures, Sebi has directed asset management companies to have a systems audit conducted by an independent CISA/CISM auditor at least once in two years. The asset management activity is mostly technology-driven and hence the requirement of the audit. This systems audit report and compliance status should be placed before trustees of the mutual fund and that the report/findings along with trustees' comments should be communicated to Sebi. Audit of the entire system ranging from front office, back office, fund accounting, financial accounting and its integration would be done.
Sebi has also announced exit load rules, which bars mutual funds from having different exit load structures for various classes of investors. This measure is definitely aimed at helping small investors. Certain AMCs deliberately kept lower exit load for big investors. This was affecting returns of small investors. Sebi also introduced norms on valuation of debt securities, simplification of offer documents and Key Information Memorandum (KIM), etc. which all are investor-friendly.

Future prospects

So many changes so fast might be the first remarks of anyone who is associated with the industry. But if one understands the underlying notion, it would be evident that the changes have happened with a clear thought process. For instance, with the announcement of the setting up of trading platform for mutual fund units in the exchanges, Sebi has automatically opened the mutual fund window to millions of potential investors from the rural and semi-urban areas. With the entry load ban, Sebi has helped investors save cost and enhance returns.
When Sebi imposed entry load ban, distributors chased higher commission and suddenly switched to marketing insurance products. It automatically implies that all these days distributors sold mutual fund products with sole financial objective. In India, investors listen to the distributors and inducement way of selling prevails. Investor education is the only cure.
Going forward, investor education initiatives would therefore increase, and investors in future are likely to make more informed investment decisions. Investor expectation would change from chasing highest returns to sensible investment planning. Only knowledgeable financial planners would survive in future. Investors would start gauging the performance based on risk. Therefore in future, risk adjusted returns would be the benchmark of performance in investors' eyes.
Understanding of products would automatically improve with investor education. Investor meetings would be more frequent for a fund marketing personnel. Brand building in the MF industry would gain prominence. And it is brands that would forge stronger relationships with investors. Mobile, Internet and possibly television would become dominant platforms for information and trading.
The new environment would see more consolidation in the mutual fund industry. The one who would invest in their brands, people and technology would survive. Cost reduction along with investor education would be assigned top priority. Services will be top notch and for that to happen best technology would be invested upon. Sooner or later, an investor would be able to buy and sell mutual fund units using his mobile phone. As such, the initiative has already begun with the listing of mutual funds on stock exchanges.
The future of mutual funds in India is very bright, though it has paused owing to the structural change that is underway. If one believes that the goal of `financial inclusion' would be met realistically, tremendous expansion of the industry can be visualized.
Some may complain about the pace of change during the last one year, but the new environment is here to stay, foremost to protect investor interest than any other one thing. The regulator would play its part, ensure effective MF governance. Every initiative of Sebi is towards empowering the investor. Investors are henceforth set to rule in the fast-growing mutual fund industry.
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Export & Import Trends in Indian Gems & Jewelry Industry

12:05 AM

Export and Import Trends in Indian Gems and Jewelry Industry

Although gems and jewelry have been a part of the Indian civilization since its recorded history, the significance of the gems and jewelry industry in the Indian economy was realized only in the last three or four decades. This article attempts to provide an insight into the problems and prospects of this industry. It examines the export trends of various components of this industry, i.e., gold, diamond, synthetic stones and gemstones. Demand, recent developments in this industry, measures being taken by the government to give a `push' to the industry and the future prospects of this industry have also been discussed.

The Gems and Jewelry (G&J) sector, basically, deals with sourcing, processing, manufacturing and selling of precious metals and gemstones, such as platinum, gold, silver, diamond, ruby, and sapphire. This sector deals with:
• Polished Diamonds: India is one of the best markets in the world in the polished diamonds sector and is known for its world-class quality of diamonds, as well as for its exquisite diamond cutting skills. Surat and Jaipur are famous world class polishing and designing centers.
• Gemstones: This category refers to precious stones other than diamonds. These stones come under two basic categories: precious stones and semiprecious stones.
• Gold and Jewelry: This category includes gold and jewelry, which are used in the manufacture of various ornaments.
• Synthetic Stones: Synthetic diamond is a diamond produced in the lab by chemical or physical processes. Like naturally occurring diamonds, synthetic diamonds are also composed of three-dimensional carbon crystals. Synthetic diamonds are also called cultured diamonds.
India is one of the fastest growing jewelry markets in the world and is the largest consumer of gold (around 20% of the global consumption) and also the largest diamond processor (around 90% by pieces and 55% by value of the global market). The industry is highly unorganized and fragmented—with around 96% of the players being family-owned businesses. It is estimated that the country has around 450,000 goldsmiths, 100,000 gold jewelers, 6,000 diamond processing players and 8,000 diamond jewelers. The major players in this sector are: Rajesh Exports, Classic Diamond (India) Ltd., Shrenuj & Company Ltd., Goldiam International Ltd., Gitanjali Gems, Suhashish Diamonds, Su-Raj Diamonds & Jewellery Ltd., Vaibhav Diamonds and Tanishq. The major export markets include: the US, Hong Kong, UAE, Belgium, Israel, Japan, Thailand and the UK.

Export Trends

According to the Investment Commission of India, this industry is expected to have a 65% share of the global market by the end of 2010. According to a McKinsey report, in terms of domestic sales, branded jewelry is likely to become the fastest growing segment and is expected to witness a growth of 40% per annum to $2.2 bn by the end of 2010. The export of gold jewelry was valued at Rs. 3,642.5 mn in 1990-91. This increased to Rs. 11,486.9 mn in 1993-94. The export statistics of gold is shown in Tables 1 and 2 and Exhibit.
• As per the latest release from the Gems and Jewelry Export Promotion Council (GJEPC), the industry registered exports worth $15 bn in April-December 2008 (provisional) , compared to $14.9 bn in the corresponding period of 2007, representing a growth of 0.59%.
• Further, the total exports of gems and jewelry from India stood at $20.8 bn in the financial year 2007-08, against $17.1 bn in the previous year, indicating a growth of 22.27%. The sector accounted for 13.41% of India's total merchandise exports in 2007-08.
• Out of the total $20.88 bn exports from the Indian gems and jewelry sector, the US and Hong Kong markets accounted for the largest imports with a share of 26% each, followed by UAE at 21%.
• Gold jewelry exports increased from $5.2 bn in 2006-07 to $5.6 bn in 2007-08.
• Export of cut and polished diamonds grew from $10.9 bn in 2006-07 to $14.2 bn in 2007-08, indicating a growth of nearly 68%.
• Export of colored gemstones increased from $246.4 mn in 2006-07 to $276.42 mn in 2007-08.
• The export industry mainly comprises of small-to-large units based in various Special Economic Zones (SEZs), Export Processing Zones (EPZs) in Chennai and Noida and Santacruz Electronics Exports Processing Zone (SEEPZ) in Mumbai, primarily supplying diamond-studded jewelry. The government is proposing to establish more SEZs.

Demand: Gold and Jewelry

In India, rural areas are major consumers of gold. In 2006, 60% of the demand for gold came from rural India as they have fewer investment options compared to the urbanites. In the first half of 2007, gold consumption rose 70% over the corresponding period in 2006. The first six months saw gold consumption of 528 tons, compared with 307 tons in the corresponding period of 2006. The southern region alone accounted for 40-45% of the country's gold demand. India's import of gold fell by almost 50% to 101 tons during the first quarter of 2008. India imports about 90% of gold from South Africa and the rest from Australia and Russia. To summarize:
• India accounts for 20% of the world's gold consumption, the largest in the world. The country consumes nearly 800 tons of gold yearly, of which nearly 600 tons goes into making jewelry. Further, India is also emerging as the world's largest trading center for gold targeting $16 bn by the end of 2010.
• The Indian diamond jewelry industry is the third largest consumer of polished diamonds after US and Japan. Diamond jewelry consumption is likely to jump to nearly 80% by the end of 2010 and over 95% between 2010 and 2015.

Problems and Expectations

This sector has passed through one of the most difficult years in 2008 with more than 100,000 skilled and unskilled laborers being laid off due to poor demand from the US market—which is reeling under the current global economic downturn. In fact, India's jewelry sales to the US declined over 20% even during the holiday season, i.e., Christmas and New Year. Furthermore, the domestic jewelry demand also decreased by over 20% during the last half of 2008 and the first half of 2009. To counter the situation, the industry demanded for a separate bailout package from the government in the third stimulus package. On July 11, 2009, Vasant Mehta, Chairman, GJEPC, held discussions with the Finance Minister, Pranab Mukherjee, on initiatives needed to revive the industry. Government intervention was sought in the following areas:
• Increasing the flow of dollar liquidity to the industry. Such additional dollar finance may be made available from the foreign exchange reserves of the country.
• Domestic funding at internationally competitive rates (LIBOR based) as opposed to the high interest rates being charged by the banks at present. This can be facilitated with an interest subvention of 2%.
• Citing the peculiar nature of the industry which is impacted by daily price fluctuations, leading to taxation disputes, the GJEPC has proposed the levy of a flat 1% turnover tax in place of all forms of current direct taxes, thereby doing away with arbitrariness, confusion and delays in finalization of tax returns. Owing to recessionary pressures, income on export earnings should be made tax-free for the coming two years.
• Export credit limits sanctioned by the banks as on April 1, 2008 to exporters of the Gem and Jewelry Industry should be continued till March 31, 2011.
• The lack of availability of duty-free gold in many parts of the country severely constrains small exporters who find it difficult to procure their primary raw material and are unable to compete in the international markets. As a relief to them, a Duty Drawback Scheme for gold jewelry exports be introduced.
Certain other measures were also demanded by the GJEPC to provide a relief to the industry. These include: Reduction in import duty on machinery from 10% to 5%; reduction in import duty on plain sold jewelry from 10% to 5%; removal of import duty on rhodium and rough coral; and reduction in import duty on precious metal scrap from Rs. 257.50 per 10 gm to Rs. 100 per 10 gm.

Government Initiatives

In order to revive the Indian economy from the current global economic downturn, the government announced a stimulus package on December 7, 2008. Some of the measures announced in the package that would benefit the gems and jewelry sector include:
• Increasing the post-shipment rupee export credit period from 90 days to 180 days with effect from November 28, 2008.
• Increasing the pre-shipment rupee export credit period from 180 days to 270 days with effect from November 15, 2008.
• Providing an interest subvention of 2% up to March 31, 2009, subject to minimum rate of interest of 7% per annum, to make pre- and post-shipment export credit for labor intensive exports, such as gems and jewelry, more attractive.
• Allowing exporters to avail refund of service tax on foreign agent commissions of up to 10% of FOB value of exports. They will also be allowed refund of service tax on output services while availing of benefits under Duty Drawback Scheme.

Recent Developments

DVN Traders, a Mumbai-based jewelry exporter and manufacturer leveraged the use of IT for its business. The company found online B2B market places such as Alibaba.com and Tradekey.com for selling its products to the customers spread across the world.

Foreign Trade Policy (2009-2014)

In the new Foreign Trade Policy (2009-2014), certain measures were announced for the Gem and Jewelry sector. These include:
• In order to neutralize the duty incidence on gold jewelry exports, it has now been decided to allow duty drawback on such exports.
• Import of diamonds on consignment basis for certification/ grading and re-export by authorized offices/agencies of Gemological Institute of America (GIA) in India or other approved agencies will be permitted.
• To promote export of gems and jewelry products, the value limit of personal carriage has been increased from $2 mn to $5 mn in case of participation in overseas exhibitions. The limit in case of personal carriage, as samples, for export promotion tours, has also been increased from $0.1 mn to $1 mn.
• The number of days for reimport of unsold items in case of participation in an exhibition in US has been increased to 90 days.
• In an endeavor to make India an International Diamond Trading Hub, the Government has planned to establish "Diamond Bourses".
• With an objective to meet the dollar credit needs of exporters, a Committee has been constituted with the Finance Secretary, Commerce Secretary and Chairman IBA as its members.

India-Mercosur Preferential Trade Agreement

Mercosur is a trading bloc in Latin America comprising Brazil, Argentina, Uruguay and Paraguay. Mercusor was formed in 1991 with the objective of facilitating the free movement of goods, services, capital and people among the four member countries.
As a follow up to the framework agreement, a Preferential Trade Agreement (PTA) was signed in New Delhi on January 25, 2004. The aim of this PTA was to expand and strengthen the existing relations between Mercusor and India and promote the expansion of trade by granting reciprocal fixed tariff preferences with the ultimate objective of creating a free trade area between the parties. This agreement came into effect from June 1, 2009.

Anant Diamond Jewelry Promotion

The GJEPC initiated a national campaign to promote the domestic gem and jewellery sector and strengthen India's share in the international market on September 19, 2009. The campaign was based on the concept of single line of diamond jewelry and was named the "Anant" Diamond Jewelry Promotion campaign with Bollywood actress Sonam Kapoor as its brand ambassador. This initiative was in tandem with Gold Souk India, Rio Tinto, International Gemological Institute (IGI), and the All India Gem & Jewellery Trade Federation (GJF). The campaign will run through till February 14, 2010. Local retailers and diamond jewellery manufacturers will gain an opportunity to unite and work progressively

Prospects: Investment Scenario

Favorable Government policies such as 100% Foreign Direct Investment (FDI) in Gems and Jewelry through the automatic route have further provided an impetus to the booming gems and jewelry industry. Some of the other major developments in this sector include:
• Reliance Retail is planning an aggressive entry into the jewelry retail market. According to reports, the company will soon open about 400 to 500 jewelry retail outlets across the country.
• The Gitanjali Group has bought `Nakshatra', the premium brand of jewelry promoted by Diamond Trading Company (DTC). Gitanjali Gems, a diamond and jewelry manufacturer has entered into an agreement with the Mineral and Metal Trading Corporation of India (MMTC), a leading bullion trader, and would invest $12.69 mn in the first phase of the joint venture.
• Thai company, Pranda Jewelry, is foraying into retailing in India and will be investing $21.15 mn towards retail expansion in the country.
• Geneva-based luxury watch and jewelry brand, de Grisogono, is firming up its plans to foray into the Indian market. It has set up its first flagship boutique for $5.29 mn. The company will be adding six mono-brand outlets by 2011.

Conclusion

Gold is a time tested asset. Even when the price rises, people continue to buy it. The real value of gold for investors lies, not in its price performance, but in its reliable diversification return. Jewelry designers will have to work on innovative design concepts that will add some utility value to the luxury jewelry products and help them to stay afloat. The KPMG report titled, "The Global Gems and Jewellery: Vision 2015: Transforming for Growth", has projected that global jewelry sales will grow at 4.6% on year to year basis to touch $185 bn in 2010 and $230 bn in 2015. Hence, the outlook for gold looks extremely bullish.
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Growth of Corporate Sector in India

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Growth of Corporate Sector in India

The Indian corporate sector comprises of two main components—the Government-owned and privately held companies. Government companies are mainly in the basic, heavy and capital intensive industries, whereas the private sector is predominantly in industries which cater to the consumer markets directly. The origin of the corporate sector in India dates back to the mid-19th century when the Joint Stock Companies Act, 1850, gave birth to the legal institution of Joint Stock Companies.

Corporate sector, today, occupies a pivotal place not only in developed economies but also in developing economies like India. The origin of the corporate sector in India dates back to the mid- 19th century when the Joint Stock Companies Act, 1850, gave birth to the legal institution of Joint Stock Companies. After the World War II, on October 25, 1950, the Government of India appointed a committee comprising 12 members under the Chairmanship of H C Bhabha for the revision of the Indian Companies Act. Based largely on the recommendations of the Company Law Committee, a bill–the Companies Act, 1956–was introduced in Parliament. This Act brought about many changes in the Indian corporate sector. The corporate sector has witnessed an unprecedented growth with the introduction of the Companies Act, 1956. Not only there was spurt in the formation of new companies, but also there was an all-around expansion in the capital base of the existing companies. It is noticed that coinciding with the relaxation of control and liberalization of the economy since the beginning of the 1980s, Indian companies have grown by leaps and bounds in term of numbers and paid-up capital.
Another important event in 1956 was the initiation of the Second Five Year Plan, which specially targeted at the rapid development of industries in the country. In the same year, the new Industrial Policy was announced by the Government of India.

Objective and Scope of the Study

This article studies the growth of the corporate sector in India after the enforcement of the Companies Act, 1956. It covers a period of 49 years period, i.e., from April 1956 to March 2005. It covers all types of companies that can be registered under the Companies Act, 1956, namely: (i) companies with liability limited by shares; (ii) companies with unlimited liability; (iii) companies with liability limited by guarantee; (iv) association not for profit; and (v) branches of foreign companies.
Data related to number of companies at work over time and their paid-up capital has been taken from the various issues of the Annual Reports on the Working and Administration of the Companies Act, 1956, issued by the Ministry of Corporate Affairs in pursuance of the provisions of Section 638 of the Companies Act, 1956.

Companies Limited by Shares

A company limited by shares is one where the liability of the members of the company is limited to the amount unpaid on the shares. In such companies, each share has a fixed nominal or face value which the shareholder is required to pay either at a time or in installments. Whatever may be the liabilities of a company, shareholders are not bound to pay anything more than the face value of the shares held by them. Thus, the liability of each of the shareholders of such a company is always limited to the extent to the amount unpaid on his shares. Companies limited by shares are the most common. This type of a company may be a public company or a privately held one.
Table 1 represents the companies limited by shares at work in India during the last five decades of operation of the Companies Act, 1956 i.e., the year 1956-57 to 2004-05.
During 1956-57, the total number of companies operating in India was 29,357 and the paid-up capital was Rs. 1,078 cr. From 1956-57 to 1960-61, the total number fell by 10.92%, and the same came down to 26,149, whereas their paid-up capital rose by 68.74% and touched Rs. 1,819 cr. An increase of nearly 15.96% was witnessed in the total number of companies functioning in India from 1960-61 to 1970-71. During 1970-71, the number was 30,322 and the paid-up capital was Rs. 4,504 cr - an increase of 147.60% from 1960-61. During 1980-81, the total number of companies at work was 62,714 and their paid-up capital was Rs. 16,357 cr - an increase of approximately 106.82% and 263.17% respectively. In next decade, there was a tremendous growth both in the number of companies at work and their paid-up capital. The total number of companies increased by 257.90% and their paid-up capital by 357.28% over the 1980-81, and touched 224,452 and Rs. 74,798 cr respectively.
During 2000-01, there was an increase in number of companies and paid-up capital but in terms of the growth rate of number of companies, it was slow, when compared to the previous decade. The total number of companies rose by 153.55% during the decade and their paid-up capital increased by 377.62%. In 2000-01, the total number of companies at work was 569,100 and their paid-up capital was Rs. 357,247 cr.
From 2000-01 to 2004-05, the total number of companies increased by 19.43% and their paid-up capital grew by 83.07%. This led to an increase in the total number of companies and their paid-up capital and the figure touched 679,649 and Rs. 654,022 cr respectively.
At the time of commencement of the Companies Act, 1956, the total number of companies at work was 29,357 and their paid-up capital was of the order of Rs. 1078 cr. As on March 31, 2005, i.e., within a span of 49 years, the number of companies increased to 679,649 (45.21% growth annually) and their paid-up capital aggregated Rs. 654,022 cr (1,236.12% annual growth rate).
Figure 1 shows the trends of the number of companies at work in India and their paid-up capital. From the figure, it becomes clear that after, 1990-91, there was tremendous increase both in the number of companies at work and their paid-up capital.
It can be observed that the companies limited by shares have recorded a phenomenal growth during this period. The number of such companies increased over 23.15 times from 1956-57 to 2004-05. Their paid-up capital also increased over 606.7 times during the same period. The average paid-up capital of the companies went up from Rs. 3.67 lakhs to Rs. 96.23 lakhs during this period.

Government and Non-Government Companies

The joint stock companies have acquired a prominent place in the corporate sector as a result of their rapid growth and increasing scale of operations and investments. The rapid growth of Joint Stock Companies over time and the increasing scale of their operations and investments make them the most dominant form of economic life that far transcends the immediate interests of their shareholders, creditors, and employees. Moreover, it is not only in the private sector that joint stock companies have acquired a position of eminence, but they have also become the most favored form of public enterprises in India, particularly after 1956. This is because the Companies Act, 1956, for the first time, created a category called `Government Companies'.
Section 617 of the Companies Act defines a government company as any company in which not less than 51% of the paid-up share capital is held by–
• The Central Government; or
• Any State Government/Governme nts; or
• Partly by the Central Government and partly by one or more than one State Government.
A subsidiary of a Government company has also been treated as a Government company.
A company which is controlled and operated by a private capital is called Non-Government Company.
The Companies Act, 1956, came into force on the April 1, 1956. The corporate sector, at the time of the commencement of the Companies Act, 1956, comprised of 29,357 companies limited by shares with a paid-up capital of Rs. 1,077.6 cr (this included 74 government companies with a paid-up capital of Rs. 72.6 cr and 29,283 non-Government companies with a paid-up capital of Rs. 1,005 cr). The total number of companies limited by shares, i.e., 679,649 with a paid-up capital of Rs. 654,021.6 cr in 2004-05, included 1,328 Government companies with a paid-up capital of Rs. 155,814.5 cr and 678,321 non-government companies with a paid-up capital of Rs. 498,207.5 cr. The growth of corporate sector shows that the number of government companies over a period of 49 years has increased more than 17.94 times and paid-up capital has increased by 2,146.19 times. The number of non-government companies has increased 23.16 fold while their paid-up capital has increased 495.72 times during the said period. Share of paid-up capital of government companies in their total paid-up capital of the corporate sector has increased from 6.74% as on March 31, 1957 to 23.82% as on March 31, 2005. Table 2 gives the number and paid-up capital of government companies limited by shares during the years 1956-57 to 2004-05 and also the position of non-government companies limited by shares over the same period.

Companies with Unlimited Liability

Section 12(2)(c) of the Companies Act provides for the formation of the companies not having any limit of the liability of its members, i.e., companies with unlimited liability. An unlimited company may or may not have a share capital. If it has a share capital, it may be a public company or a private company. An unlimited company must have Articles of Association, stating the number of members with which the company is to be registered, and if the company has a share capital, the amount of share capital with which the company is to be registered.
An unlimited company can get itself registered as a limited liability company under the Section 32 of the Companies Act. These type of companies, however, were incorporated under the Companies Act for the first time in 1973-74 when one such company was registered in the Union Territory of Delhi. Table 3 shows the number of companies at work in India with unlimited liability. Their number as on March 31, 2005 was 196. All these are non-government private companies.

Companies Limited by Guarantee and Association not for Profit

As per the provision of the Section 12(2)(b) of the Companies Act, 1956, "a company having the liability of its members limited by memorandum to such an amount as the members may respectively undertake by the memorandum to contribute to the assets of the company in the event of its being wound up" is called a company limited by guarantee. These type of companies may or may not have a share capital. A company limited by guarantee and having a share capital may be a public company or a private company (Refer Figure 2).
According to the Sachar Committee, "although guarantee companies,… constitute a very negligible fraction of less than 3% of total companies at work in India, they still do have a useful role to play as companies for furthering the objects of commerce, art, science, religion, charity or some other useful objects and usually such a company does not apply its profits or rather income except for these desirable objectives. It is, however, inherent in the very nature of these objectives that such companies be formed as public limited companies, limited by guarantee only and for the purpose enumerated in the present Section 25 of the Act". The companies limited by guarantee are generally associations formed for promoting arts, science, religion, charity or for any other useful object and intend to apply their members. These associations, in general, are `not for profit' (Section 25(1) of the Companies Act). Majority of these companies do not have share capital, but have only membership fee. The position about the companies limited by guarantee over the period 1956-57 to 2004-05 has, therefore, been shown in terms of their numbers only (Refer Table 4). It is seen that there has not been much variation in the number of these companies over these periods. The number of such companies was 3,432 by 2005.

Foreign Companies

Foreign companies have been defined under the Section 591(1) of the Companies Act as companies incorporated outside India that have established a place of business within India. According to Section 591(2) of the Companies Act , any foreign company may be prescribed as an Indian company, when a minimum of 50% of the paid-up share capital of a foreign company is held by one or more citizens of India or/and by one or more bodies corporate incorporated in India, whether singly or jointly. At the time of introduction of the Companies Act, 1956, the number of foreign companies operating in India was 551 and this figure remained almost constant until 1973-74. It started declining after the Foreign Exchange Regulation Act, 1973 came into force on January 1, 1974. The number of foreign companies during 1973-74 was 540 and by 2004-05, it touched 1840. Table 5 shows the number of foreign companies from 1956-57 to 2004-05.

Conclusion

In the wake of new economic policies, the corporate sector has been assigned the role of the main leader of the growth process. Joint stock companies occupy an important position in organized economic activity. The corporate sector has witnessed an unprecedented growth after the enforcement of Companies Act, 1956. Not only there was spurt in new company formation, but there was an all-around expansion in the capital base of the existing companies. It has been noticed that coinciding with the relaxation of control and liberalization of the economy since the beginning of the 1980s, the Indian corporate sector has grown by leaps and bounds in term of numbers and paid-up capital.

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