Monday, December 31, 2012

RBI keeps us guessing

This article was originally published in Postnoon on December 28, 2012. Co-author: Purvee Hetamsaria

Prof. Nicky was strolling in the park when she heard a familiar voice calling out her name. She turned around to face a gasping Mr. Mukherjee. The face had a question mark.

Prof: Hello Mr. Mukherjee. What's troubling you?

Mukherjee (trying to regain his breath): You got me! I was wondering if the Reserve Bank of India (RBI) will lower the interest rates in their upcoming policy review. The general view is that there is a strong possibility of a 75 basis points cut next year. With 50 bps being cut during the last quarter of the current fiscal year.

Prof. Nicky: Well. I cannot predict what RBI is going to do. But yes, it might be welcome by many sections of the industries and the common man.

Mukherjee: That is what I am not able to understand. How does it help the common man? Why should he worry about the matters of monetary policy? I am personally indifferent to it.

Nicky: So you feel! But it's not true. Remember the time when you took a loan to buy that car of yours and you were complaining to me about the high interest rates?

Mukherjee: Yes. But what does that have to do with RBI and rate cuts?

Nicky: How do banks determine at what rate to lend? How are auto loan, home loan, personal loan, etc, their interest rates determined? It depends on the interest rates set by the RBI. The rate at which banks can borrow funds from the RBI is known as the Repo rate. When the repo rate goes down, banks get funds at a lower rate, which they can pass on to their customers in the form of cheaper loans.

Mukherjee: Hmmm...but since I have already taken the loan, it's not going to help me.

Nicky: Its not going to help you if your loan has a fixed interest rate. If the loan has a floating interest rate, that is, it changes with the changes in the Prime Lending Rate (PLR), then your Equated Monthly Instalments (EMIs) will come down.

Mukherjee: PLR?

Nicky: It's the rate at which banks lend to their most credit worthy customers. So for most of us, after taking our credit worthiness into account, the banks decide on an x percent to be added to the PLR, to determine the interest rate. For those who have floating rate loans, the banks generally quote the interest rate as PLR plus x percent. So when PLR comes down, EMI also comes down.

Mukherjee: Got it. But what about my deposits? Will the banks continue to pay me the same interest rates on them?

Nicky: For your existing Fixed Deposits, the answer is yes. For new fixed deposits, the banks may reduce the rates.

Mukherjee: Understood. Thank you.

Friday, December 21, 2012

KYC Norms eased

This article was originally published in Postnoon on December 21, 2012. Co-author: Purvee Hetamsaria

“The KYC (Know Your Customer) Guidelines were formulated to protect the financial system against threat of money laundering/terror financing and frauds”, said Prof. Nicky, when she was asked about their purpose by one of the new first year student.

Prof. Nicky: But why do you ask?

Student: I have been trying to open a savings bank account in a bank which has a branch just outside my home. The executive wanted a host of documents which I provided to him. But he is asking for separate identification and address proofs. I gave him my passport which also has my address. But he says that he needs an electricity bill or a bank statement as an address proof. Now where do I get that from? There is no separate electricity bill for me. It's on my father's name. Also, I want a bank account because I don't have one.

Prof. Nicky: Oh! In that case you need not worry any more. Just a couple of days back, the Reserve Bank of India, the regulator for all banks in India, revised the guidelines for KYC. To ease the burden in complying with the KYC requirements for opening new accounts, RBI has now notified that if the address on the document submitted for identity proof is same as that declared in the account opening form, the document may be accepted as a valid proof of both identity and address.

Student: Ah...that solves at least part of my problems.

Prof. Nicky: You must keep in mind though, that this happens only if you give the same address in the form as mentioned in the proof that you have provided.

Student: Ok. That is what I have done. Though I have another problem.

Prof. Nicky: And that is?

Student: The executive has also asked me for an introduction from an existing customer. My parents have accounts in a different bank. I do not know of anyone who has an account with this bank. What am I to do?

Prof. Nicky: You are in luck lady! Seems like RBI has been taking note of your prayers! RBI has notified that the introduction is not necessary any more under the KYC guidelines. So the bank should not insist on introduction for opening an account. So call back the executive and ask him to update himself with the newest changes and then open your account.

Student: I must thank RBI for these changes. This problem was being faced by a few of my other friends too. I must go and inform them too about these developments. Thank you, as usual!

Saturday, December 15, 2012

Deeper PF cut will help in long term

This article was originally published in Postnoon on December 14, 2012. Co-author: Purvee Hetamsaria

There was urgency in Abhi's voice when he called to ask me if he could see me. I immediately agreed. He was in my office before I could get myself a cup of coffee from the Cafe. What is it Abhi?, I asked. "You look disturbed".

Abhi: Yes. I am disturbed. And who wouldn't be? My salary just went down because of the Government's action.

Nicky: Really? What did the Government do now?

Abhi: The Employees Provident Fund Organisation (EPFO) of India has come out with a notification which says that now we will have to contribute towards the provident fund on the basis of allowances as well. This will reduce my take home salary.

Nicky: Ah that! You should be happy. Don't think short term. Think long term. You are forced to save more.

Abhi: What do you mean?

Nicky: See, earlier, you and your employer, both contributed 12% each, on your Basic plus Dearness Allowance (DA) only, towards the EPF. Now, suppose your Basic plus DA is ₹4,000. The contribution will amount to ₹480 from you and ₹480 from your employer. There is no contribution on the allowances that you receive. If your allowances total up to ₹2,000, your take home salary will be ₹4,000 minus ₹480 plus ₹2,000. That is ₹5,520. And your total contribution to EPFO is ₹960.

Abhi: Yes, this is exactly what happens in my case right now.

Nicky: But with the new circular, contribution will need to be made on Basic plus DA plus Allowances. This means, your contribution will be on ₹6,000. Hence, the total contribution to the EPFO by your employer (₹720) and you (₹720) will be ₹1440. This way, you take home only ₹5,280 but you save ₹480 more and your total income goes up by ₹240, the extra contribution made by the employer! So you should be happy.

Abhi: are right, but I am still not happy about the lower take home salary. You know that I recently got married and have bought a flat too, which comes with a fat EMI.

Nicky (laughing): True Abhi. But saving for your old age is important too. And many employees structure their salary to increase allowances and decrease PF contributions. This means that they are not saving enough. Also, because of higher contributions to the PF account, you will be able to claim a higher amount as section 80c deductions in income tax.

Abhi: But the limit for section 80c is ₹1 lakh right?

Nicky: Yes. So it will be beneficial to you only if you are not able to meet the ₹1 lakh through your life insurance and existing PF contributions.

Abhi: So overall, you are saying, the government may not have done such a bad thing! Well, I am not happy, but I do understand the government's point of view now. I'll have to think of rationing certain expenditures though!

Saturday, December 8, 2012

For investors or govt?

This article was originally published in Postnoon on December 7, 2012

"So Life Insurance Corporation (LIC) of India is launching a new Unit Linked Insurance Plan (ULIP)?" asked Srikanth.
"Yes. So the newspapers and news channels have reported", I replied.

Srikanth: I remember, ULIPs were really popular a couple of years back. Everyone was talking about it, investing in it. Then suddenly, they disappeared from the investments arena. Why? What happened?
Me: Well, as the regulations stood way back in 2010, the costs to the investors were huge in the case of ULIPs. The distributors and agents got large selling commissions, as high as 40% of the first year premium, and hence many of them pushed the product, mis-informed and mis-sold it to the investors.

Srikanth: Wow...isn't that wrong?

Me: It is. Hence the investors protested, once they realized that they had a product which was a sure way to lose money. Following the protests and a legal battle with the capital markets' regulator, SEBI, the Insurance Regulatory and Development Authority (IRDA), brought in new regulations regarding the costs and losses in the event an investor fails to pay subsequent premium installments. After this, ULIPs did not remain as lucrative for the agents as they were earlier. Hence they stopped pushing it to the investors. And the sheen faded.
Srikanth: Legal battle with SEBI?

Me: Yeah, SEBI claimed that ULIPs were Mutual Funds being sold as Insurance and hence they should have jurisdiction over ULIPs. Anyways, the result was a set of new regulations, which brought down the charges for the investors and increased the minimum lock-in period of ULIPS from three years to five years.
Earlier, most of the insurers charged higher during the initial years of the plan. But now, the charges have to be distributed evenly over all the years of the lock-in period. IRDA also mandated a minimum mortality cover and a minimum guaranteed return. The charges are capped between 2.25% to 4%.

Srikanth: That's good for the investors. But not for the insurers and the distributors.

Me: That's the reason the share of ULIPs has only gone downhill since 2010. LIC is now coming out with a ULIP product after almost two years. And even that may not be with the investors' in mind. As Vivek Kaul points out in his article on, it could just be a ploy to help the government raise money through divestment. Since the investor's may not be willing to pick up stocks in PSUs, LIC will bail out the government by picking up stake in those companies.
Srikanth: But why launch a ULIP product for it?

Me: That's because the premiums collected through traditional plans cannot be invested in the Equity markets completely. There is a cap of 15% on equity exposure for the traditional plans, according to the Insurance Act. However, in the case of ULIPs, the entire premium can be invested in equities.
Srikanth: Ah, so basically LIC may be hoodwinking the investors, in order to help the government.

Me: Hmmm...I did not think in that direction earlier. But after reading Vive Kaul's article, I feel that may be the real story! Ultimately, the investors must do their homework before making any investment decision!

Friday, November 30, 2012

Debit Cards, Credit Convenience

This article was originally published in Postnoon on November 30, 2012

Laxmiamma was a happy soul. Instead of keeping her savings under the mattress, she had opened up a bank account and had started a recurring deposit on my insistence. The obligation of putting aside the money for the deposit every month, made her save more. Also, she had no choice when tempted to buy unnecessary food or household articles as there was no money lying around at home to do so. Now she had accumulated enough money to buy back her jewellery from the jeweller, which she had sold way back in 2002, when her husband died and she needed some money to tide over the bad times.
She invited me home to celebrate the liberation of her jewellery, over a cup of Irani chai and biscuits. While chit chatting with her about the weather, she told me that she needs to go to the bank to withdraw some cash the next day. I was surprised. In this day and age, who goes to the bank to withdraw cash, unless the amount is very large?

On being asked, she said, "then how else does one withdraw cash?"
Nicky: Haven't you seen ATMs around?

Laxmiamma: I have heard about them, but I thought that those are not for people like us. I thought those are for the rich.
Nicky: Nonsense. It's for everyone who has an account with the bank.

Laxmiamma: How? And what is an ATM? I have seen the large box like things around, but don't know how that shells out cash!
Nicky: An ATM or an Automated Teller Machine is a machine which counts and gives out the amount of cash that you want, after ensuring that your bank account has the desired amount. Did you get a small card when you opened an account?

Laxmiamma: Yes I did. But I just kept it away safely.
Nicky: That is a Debit Card. The card carries a unique number, which is linked to your savings account. You can use this card to withdraw and deposit cash, transfer money to other accounts, pay your bills, look at your account balance and statement for the last few transactions, all through the ATM. You can even use this card at shops to pay. The money will be directly debited to your account, provided you have enough money in the account. So, you do not need to carry cash with you when you go shopping. But of course, you can't use it when you shop at smaller establishments like kirana shops or vegetable carts.

Laxmiamma: Ah see, its of no use to me then! I don't go to the malls like you.
Nicky: You miss the point. Apart from shopping, there are so many other uses of debit cards and ATM. You conveniently ignored that!

Laxmiamma (sheepishly): Uh...hmmm...I heard. I'll use this card to withdraw cash from now on. But what about safety? Can anyone with my card withdraw money from my account?
Nicky: No. There will be a 4 digit password given to you from the bank. You need to key in that password for authenticating the transaction. Also, you can change this password if you want. Don't share the password with anyone.

Laxmiamma: Ah...I forgot to tell you about this new recipe for karela might want to try it out!

Tuesday, November 27, 2012

Tax implications of buying versus renting

This article was originally published in Postnoon on November 23, 2012
Nicky: Oh hello Abhi! When did you come?
Abhi complained: I have been waiting for you since the past half an hour.
Nicky: You should have called before coming. I would have told you that I would be in a meeting. Anyways, tell me how is your new house? I am sorry, I could not come for the house warming ceremony.

Abhi: The house is good, comfortable. Actually I am here to discuss the tax implications of buying the house.
Nicky: What about it?
Abhi: Till last year, I was claiming Housing Rent Allowance (HRA) deduction under section 10(13A) of the income tax act. Am I still eligible to claim those?

Nicky: How can you? Since you are living in your own house, you are not paying any rent. So you cannot claim HRA as a deduction. It is treated as an income for you. But you can claim deductions for your Equated Monthly Installments (EMIs) on your home loan.
Abhi: How?

Nicky: The EMI is divided into the principal component and the interest component. The bank must have sent a statement to you with this break up. Or they will send it to you, if they haven't done it yet. The principal component of up to Rs1 Lakh can be claimed under section 80c and the interest component of up to Rs1.5 Lakhs can be claimed under section 24b of the income tax act.

Abhi: But isn't section 80c the same section where we claim our life insurance premium and provident fund (EPF) contributions?

Nicky: Yes, you are right. Hence the benefit of claiming the principal under section 80c is limited. In the initial years of the EMI payment, the principal component is very small. In the later years, when the principal component is larger, assuming that your salary goes up with time, the entire 80c limit may be reached with EPF contributions and insurance premiums alone.

The interest deductions do help in saving significant amounts of tax though. If you fall under the 30% tax bracket and pay more than Rs1.5 lakhs as interest, you end up saving Rs45,000 in taxes.
Abhi: So even if I am not able to claim the HRA, a home loan still helps me reduce my tax burden.

Nicky: Absolutely. Infact you did a very good job of buying a house in Hyderabad. A recent research done by has shown that Hyderabad is one of the most affordable places to buy a house for a professional.
Abhi: Oh really? I am glad I made the right decision.

Monday, November 26, 2012

Will Social Media give birth to the next Warren Buffett?

This article was first Published in Hindu BusinessLine on 25th November, 2012. Co-author: Khemchand H. Sakaldeepi

While taking a hard look at the evolution of human civilisation one cannot help but notice how the financial markets indicate our evolution more than anything else.
To quote Prof. Niall Ferguson of Harvard University, in his book “The Ascent of Money”, “financial history is the essential back-story behind all history”.

It is a well know fact that every bull - bear run is largely correlated with something major happening in the world.
The invention of electricity, use of small motors that power home and kitchen appliances, the advent of television and computers, etc. have all impacted how financial markets behave. These events have changed how the world is connected and does business, for good. Today the biggest driver in the way we connect and do business is social media.

Any student or practitioner of finance would have come across the term “Efficient Market Hypothesis (EMH)”. It essentially says that the stock market is “informationally efficient”, that is, the current prices reflect all the available information. Flow of information is one of the most important ingredients in making the markets efficient.
While EMH is one of the most profound theories in the history of finance, of late, it is also the most disproved.

The recent global financial crisis has further raised questions about the rationality of the EMH. Warren Buffet argues that the preponderance of value investors among the world’s best money managers rebuts the claim of EMH proponents.
Similarly, former Federal Reserve Chairman, Paul Volcker said that it’s “clear that among the causes of the recent financial crisis was an unjustified faith in rational expectations [and] market efficiencies”.

In fact there are many investors who scout for opportunities (read: inefficiencies) with the changing business environment and capitalise on information advantage.
Traders at Wall Street are known to use Flash Trading - which allows certain market participants to see incoming orders to buy or sell securities very slightly earlier than the general market participants, typically 30 milliseconds, in exchange for a fee.

Lately, some of the major financial institutions are latching onto the fact there might be something to the information that is available in social networks such as Facebook, Twitter, Blogging sites, etc.
For instance, a research done by Bollen et. al. (2011), published in the Journal of Computational Science, looked at around ten million Tweets posted between March and December of 2008 to see if the micro blogs could be used to predict the market.

The authors sorted the Tweets into different indices – calm, alert, sure, vital, kind and happy – and compared them to the market. The researchers found that the calmness index can predict with 87 per cent accuracy whether the Dow Jones Industrial Average goes up or down for a time horizon between two and six days.
Certain proprietary terminals have, over the past few years, kept various traders informed with live new feeds. They, however, have not come close to creating a way to instantaneously monitor the pulse of the world and observe the stream of human consciousness. The news regarding the death of Osama Bin Laden first entered the public sphere through a tweet and a tool called DataMinr was able to spot this with just 19 tweets on the subject.

The company then issued a signal to their clients, alerting them to this important piece of information. It would have been over 20 minutes before that story appeared on traditional news sites.
Access to a data stream that can beat traditional media sources by over 20 minutes requires no explanation as to its value for traders and investors. Speed matters.

It will just be an understatement to say that there will be an increasing relation between social media and finance. Traders and fund managers are relying on social signs and sentiment analysis to base their decisions on.
There is no doubt that technologies are improving and challenging the finance and banking industry. In the language of Analytics, the more data you have the better your decisions are and better is your competitive advantage. And social media can do just that.

So the point to note here is that in this era of Social Networks, it has become essential for any budding investor to be able to analyse the social data if she/he wants to “get the pulse of the market”.

Monday, November 19, 2012

Plan your retirement

This article was originally published in Postnoon on November 16, 2012

Why should we plan for our retirement?, asked an indignant Mr. Mukherjee. "Professor, you don't understand our Indian culture and values. My son will take care of me when my wife and I grow old. We are giving him the best possible education, so that when he starts earning, I can retire in peace. He is a good son. And, I too save some money every month. My wife runs the household very efficiently".

Prof. Nicky: I agree Mr. Mukherjee. I am not denying that your son is a good son and your wife is very efficient. All I am saying is that, why do you want to depend on your son in your old age? What if he gets a job in another city or another country? Are you willing to move with him? Do you want to leave all your friends and family behind, so that your son can take care of you?

Mukherjee: Not at all. I will not leave Hyderabad. I have lived here all my life. But my son will not take a job anywhere else. He will take up a job in Hyderabad only.

Prof. Nicky: How can you be so sure? He may get transferred, he may get a better opportunity somewhere else. Would you want him to sacrifice all the opportunities for you?

Mukherjee: No I would not like that. But even if he lives somewhere else, he can still send money for us.

Prof. Nicky: Yes he can. But what if he finds it difficult? He will have his own family to fend for. Everything is so expensive now a days. Maintaining two different households may be difficult for him. Since you are already saving some money every month, all that I am asking you to do is invest it in a way which will help you lead a better life during your retirement.

Mukherjee: But even the money that I am putting aside every month, in a recurring deposit, will be available to me when I retire. What is the difference between saving and retirement planning?

Prof. Nicky: Finally you have asked a relevant question. Saving is good. It gives you returns close to the prevailing interest rates, whether you put your money in fixed deposits or recurring deposit. You save what you have left after all your monthly expenses.

On the other hand, retirement planning determines how much you must invest every month, so that you don't have to change your lifestyle much after your retire. The planning includes planning your investments in different asset classes like mutual funds, insurance, equities, real estate etc., so that you achieve your financial goals.

Mukherjee: But who will do it for me? Will you do it?

Prof. Nicky: No, I will not do it. There are certified financial planners, who will do the planning for you for a fee. You only need to ensure that you find a good financial planner who is qualified and experienced.

Mukherjee: There seems to be merit in what you are saying. Let me think about it!

Nicky: Whatever...

Monday, November 12, 2012

Gold on my mind

This article was originally published in Postnoon on November 9, 2012

Diwali is round the corner and the retailers are trying everything from discounts to promotions to free gifts, to lure the customers into buying. Gold has a special place in the hearts of the Indian customers. Buying gold on 'Dhanteras' is considered auspicious and is a part of our culture. But, apart from heart, the mind also has a role to play in buying gold. Historically, gold is seen as a hedge against inflation and less risky than the other asset classes.

In recent times, gold is also being seen as The Performer! In the past 10 years, gold has given a return of approximately 18% per annum, and close to 25% per annum over the last five year period, on a compounded basis. That is much higher than the returns on the other popular classes of investments, be it equities, debt or mutual funds. So buying gold not just gratifies the heart, but also the mind.

To tap on this opportunity, Gold Exchange Traded Funds (ETFs) was introduced on the Indian stock exchanges in 2007. Since then, it has become a very popular product with the current Assets Under Management (AUM) in Gold ETFs being more than Rs10,000 crores.

Buying gold for investment purposes, in its physical forms, comes with associated costs like making charges (jewellery), storage and insurance costs (jewellery, coins, bars) or risks of theft. These are reduced to zero in the case of gold ETFs, while giving returns that are very close to the returns of the physical asset, as each unit of the ETF is equivalent to 1 gram of 99.5% pure Gold. There are transaction costs but they are very small.

The attractiveness of the fund is also due to the fact that they are tax efficient. They are not subject to sales tax, value added tax, securities transactions tax or the wealth tax, which the physical gold is subject to. The ETFs can also be exchanged for 99.5% pure Gold when needed, in multiples of 1 kg. The prices at which the transactions take place are transparent and real time, just like stocks on the stock exchange.

Both NSE and BSE have announced that they will hold special trading sessions for gold ETFs alone on Sunday, Dhanteras, November 11th, from 11.00am to 3.30pm. BSE has also announced to waive off any transaction costs as well on that day. So this Diwali, make a new beginning, by investing in Gold ETFs. Even if it is only for 1gm of Gold. It's just a better way of investing in gold.

Here's wishing all the readers a very happy and prosperous Diwali!

Disclaimer: The author is not associated with any fund house or the exchanges offering Gold ETFs. The author has not yet invested in Gold through ETFs but plans to do it this Diwali.

Monday, November 5, 2012

Sebi to the Rescue

This article was originally published in Postnoon on November 2, 2012

Srikanth was clearly in a bad mood, when I met him outside my office. He was pacing up and down the corridor with a scowl and fists clenched. On seeing me, he smiled faintly. I led him into my office and asked, "what happened? Did you lose a lot of money in the stock market?", for Srikanth was an active investor!

Srikanth: Yes I did. But I would not feel so bad if I had made a wrong call and invested in the wrong stock. I am feeling bad and I am upset because I lost money due to my broker's mistake.

Nicky: Really? How? What happened?

Srikanth: I had placed a sell order for my holdings in a company, through my broker. But the shares were not sold on the same day. In fact they were sold two days later. In those two days, the stock price went down by about 6% and I ended up losing close to Rs20,000/-.

Nicky: Did you ask the broker for a clarification?

Srikanth (annoyed at the question): Of course I did. They said that there were some technical issues.

Nicky: Do you have a record or any documentation relating to when you placed the order?

Srikanth: You are not really helping me by asking these obvious questions. But, to answer you, of course I do. The records will be available in the 'order history' of my account.

Nicky: I am asking you these questions because I have a solution for you. Why don't you complain to the Securities Exchange Board of India (SEBI)? SEBI has a cell dedicated for Investor Assistance and Education (OIAE), which also handles investor grievances. But before you go to them, you must file a complaint with the stock exchange against the broker. If the exchange's response is not satisfactory to you, then you can go to SEBI.

Srikanth: Why should I unnecessarily get into litigation? My money is not going to come back.

Nicky: Well, it might! The stock exchange might pay you from their investor protection fund, or they might instruct the broker to pay you the amount of loss incurred by you. In case the exchange is not able to settle the case and you lodge a complaint with SEBI, then SEBI might get the exchange or the broker to pay to you.

Srikanth (finally getting what I was talking about): But how do I lodge my complain?

Nicky: Now you are asking obvious questions...Complain by writing to them through post, mail, hand deliver your written complaint or talk to them on their toll free number. All these details are available on the SEBI website.

Srikanth: Thank you professor. Yet again, your inputs were very helpful.

Saturday, October 27, 2012

Will FDI in retail be good for consumers?

This article was first published in Moneylife Magazine and on October 25th, 2012

Wal-mart or Tesco may fail in India but consumers must get a choice
At 6am on a Tuesday, the wholesale market for vegetables—Bowenpally Monda (Hyderabad)—is already humming with activity. When talking to a commission agent about their cornering a share of the farmers’ profits, the agent asks, “While statistics are available and the media quotes the number of farmers who have committed suicide or number of farmers who have become impoverished or their condition has worsened, does any government institution or any institution have statistics on how many intermediaries have gone bankrupt? How many people have entered the trading business and lost money and, hence, quit? How much bad debt is there in intermediation? If this statistic is compiled, one would realise that intermediation is not an easy job.” In this, and possibly other markets, the intermediaries or commission agents perform a very important function—that of taking financial risk.

Others from his trade join in to ask: “Why should a farmer worry about what the others are getting? If a farmer gets Rs2 and he has invested only Re1, it’s good business. He makes 100%-200% return on his investment. Any project should be measured on the basis of return on capital. Intermediaries do not make money on each transaction. They make money once in a while. That’s part of the game. Sometimes, they make a killing; on other days, they barely break even or make losses. Volumes bring them money. Their average margins are wafer-thin.

Across the country, debate is raging over foreign direct investment (FDI) in retail and the entry of larger players like Wal-Mart and Tesco. The traders do not seem to be concerned about this. One of the agents asks me, “How is a Reliance or an ITC less smart than Wal-Mart?”

Reliance has the deepest pockets in the country and did hire the best talent in the world for its retail operations. But Reliance Retail has been a fiasco. While one can argue that Reliance has always operated in the industrial arena and does not have a mindset for retail, what about ITC? ITC is a thoroughly farm-consumer market company with deep pockets and deep understanding of the entire value chain. They have worked with farmers at the grassroots level for over 100 years in India. Yet, their fresh retailing business has not been successful.

What is the problem? And can Wal-Mart and others handle it? The CEO of a company, who does not want to be named, which is into large-scale commercial farming, says, “Either the market is more efficient than is believed or the market has not evolved to a point where models of large retail chains can be absorbed in the system.”

It is often said that in India 30%-40% of the fresh produce gets wasted. I once heard Damodar Mall, director of strategy-food at the Future group, which pioneered organised retail business in India, say that in a country like India where people make serious living out of rag-picking, nothing is thrown away. Nothing is wasted. “Yes, the value of the produce can be better preserved. But the cost of retaining that value through refrigeration or pre-cooling, etc, versus the value saved is not financially viable.”

The natural chain is far more efficient. Apples are a classic example where cold chain can be applied. They are produced only in one part of the country and consumed across the country. Concentrated production and distributed consumption. Companies like Adani and Concor, have invested heavily in the cold chain. Yet, cold chain has not become entirely successful.

The marketing and distribution channels have designed themselves in such a way that it is very close to ‘Just-in-Time’. In the US, food habits are more or less uniform throughout the country. In India, every 300km, eating habits are completely different, determined by production in the local catchment which, in turn, depends on the soil, agro-climatic conditions, etc. So the production and consumption is more localised. While there are products like paddy and wheat which are produced in one part of the country and consumed across the country, fruits and vegetables, especially vegetables, are localised. Except for onions and potatoes, few products move further than 300-400km in the country.

When asked about the impact of FDI on the mom-and-pop kirana stores, the CEO, who prefers to be called a farmer, says “Mom-and-pop stores will flourish. They will not go anywhere. In fact, in places where the retail chains set up shop, the mom-and-pop stores will become even more efficient. The Indian trader is very smart. There are several instances where when organised retailers like Reliance run a promotion on tomatoes, for, say, Rs5 per kg, the corner shop vendor comes and buys 10kg and stocks it in his shop. These promotions result in losses for organised retailers and gains for the small shops.”

The guidelines for FDI in retail impose limitations too. Outlets can be opened only in cities with a population of one million and above; 50% of the investment should be for backward linkages. These are tough conditions to meet.

Also, the regulatory and procedural hurdles are not going to be easy for foreign investors to manoeuvre around. Even a simple food-processing unit needs anywhere between 15-20 licences/permissions from agencies/authorities such as electricity, pollution control, labour, fire safety, panchayat, taluka, weights and measures, etc. They are needed and should be there. But the way they are monitored and the way the system operates, it is very difficult to start and operate a project.

The retail pie is obviously very big and everyone can benefit from it. But it’s only fair to give the consumers a choice. If a Wal-Mart or a Tesco is more efficient and offers cheaper products, then why should the customer suffer? Whether they will be able to do so is a big question; but it is worth giving them a chance for the sake of the consumer.

Make best of deft NEFT

This article was originally published in Postnoon on October 26th, 2012, Co-Author: Anuj Hetamsaria

A few days back, I had counseled Mr. Mukherjee about mobile banking, in the context of transferring funds from one account to the other. Today he came to me with further questions with regards to funds transfer.

Mukherjee: Professor, the relationship manager at the bank told me that funds could be transferred via NEFT. What is this NEFT?

Nicky: NEFT stands for National Electronic Funds Transfer and it facilitates the transfer of funds across different branches of the same bank or different banks. It is easy, cheap, safe and fast.

Mukherjee: I am sure it comes with its own set of requirements!

Nicky (smiling at the cynicism): Oh yeah! You will need to provide to your bank, the Account Number and name of the beneficiary, the name, address and IFSC (Indian Financial System Code) of the beneficiary's branch.

Mukherjee: Where do I get all these details from?

Nicky: The person to whom you want to transfer the money to, that is, the beneficiary, should be able to help you with this. All these details will be found on the cheque book of the beneficiary. IFSC code can also be found out on RBI website and from the bank branch. Care must be taken to ensure that these details are provided to your bank correctly, to avoid transaction errors.

Mukherjee: What is this IFSC? I have never heard of it before?

Nicky: According to, IFSC is an alphanumeric code that uniquely identifies a bank branch for participating in NEFT system. It is an 11-character code with the first 4 alphabetic characters representing the bank and the last 6 characters (usually numeric, but can be alphabetic) representing the branch. The 5th character is 0 (zero). IFSC is used by the NEFT system to route the messages to the destination banks / branches.

Mukherjee: So I can transfer funds using NEFT at any time of the day or night and any day of the week?

Nicky: Not really. You cannot transfer funds on bank holidays, like public holidays and Sundays. From Monday to Friday, the facility is available between 9 AM and 7 PM and on Saturdays, between 9 AM and 1 PM. There are eleven hourly settlements between 9 AM and 7 PM on all weekdays and five hourly settlements between 9 AM and 1 PM on Saturdays.

The money will be credited to the beneficiary’s account on the same day or at the most next day in case the message is sent during the last batch of settlement. If the amount is not credited within the specified time then the same must be reported to the banking authorities and proper follow up of the same to be done.

Mukherjee: You did tell me that it is cheap. But can you offer some specifics on charges?

Nicky: Well...My bank changes Rs5/- per transaction if the amount is less that Rs 1 lakh and Rs 25/- if the transaction amount is more than Rs. 1 lakh.

Mukherjee: Hmmm, that's really not much. Thank you Prof.

Monday, October 22, 2012

A Simple Solution for Tail Risk

FFTW’s Thomas Philips on an enhancement to mean-variance optimization

The interview was first published by the Global Association for Risk Professionals on October 16th 2012

In scenarios that are simply not accounted for in classical theories of finance, how will most investment portfolios perform? "Poorly!" asserts Thomas Philips of asset manager Fischer Francis Trees and Watts. "Classical risk budgeting solutions are based on Harry Markowitz's mean-variance optimization paradigm," he says, "and are ill-suited to assets and strategies with significant amounts of tail risk."

Philips is not alone in having to face this conundrum, but he has been original and innovative in doing so in his role as global head of investment risk and performance at FFTW, a New York-based, fixed-income-focused firm that manages $56 billion on behalf of clients around the world.

"While algorithms to optimize tail risk are known," he notes, "they tend to be complex and are not easily implemented. In addition, they tend to rely on historical data for their inputs, as they are not readily adapted to include forecasts of risks."

In the interview that follows with Nupur Pavan Bang (, senior researcher at the Centre for Investment at the Indian School of Business in Hyderabad, Philips discusses a simple enhancement to the mean-variance paradigm that allows for the inclusion of tail risk.

According to Philips, this approach is easily implemented and has proven itself in the management of a wide range of fixed-income portfolios. It can be solved in closed form and typically results in a 15% to 20% reduction in tail risk relative to a classical mean-variance solution, with no change in volatility.

Philips, who has a PhD in electronic and computer engineering from the University of Massachusetts, is also BNP Paribas Investment Partners' regional head of investment risk and performance for North America. (Fischer Francis Trees and Watts has been an affiliate of BNP Paribas since 1999 and wholly owned by the Paris-based bank since 2006.) Philips has also worked at the IBM Thomas J. Watson Research Center, the IBM Retirement Fund, Rogers Casey and Associates, Paradigm Asset Management and OTA Asset Management. He has published more than 30 research papers and is credited with two patents. He won the first Bernstein/Fabozzi/Jacobs-Levy prize for his paper "Why do Valuation Ratios Forecast Long Run Equity Returns?" and the Graham and Dodd award for "Saving Social Security: A Better Approach."

Philips elaborated on his methods, their academic grounding and practical implementation during an August visit to the Indian School of Business.

NUPUR BANG: Markowitz's mean-variance optimization model is one of the most widely used models in the investment industry. How does your model differ from his?

THOMAS PHILIPS: To understand that, you have to understand what mean-variance optimization addresses and what it does not. Mean-variance optimization allows us to build portfolios which appeal to us in two dimensions. In particular, it gives us a simple and computationally tractable way to relate the expected return and the risk of a portfolio to the risk and returns of its underlying assets, and a reasonable way in which to think about a trade-off between the two.

The last step involves utility theory, but even without the use of utility theory, mean-variance optimization is very useful. Before Harry Markowitz developed it, there wasn't such a clear-cut focus on risk and return. A great deal of work, particularly on risk, had been done by gamblers and insurers, but their work was disjointed from the investment literature. The notion of a common person trading off risk and return came to the forefront because of Markowitz. And he made it accessible to a wide range of people because he used simple, computable measures of return and risk.

If you look at assets whose returns are largely a function of their mean and their variance, such as stocks, mean-variance optimization is a pretty good way to think about the problem of portfolio construction. But for assets such as bonds and options, it is a poorer approximation. Our model addresses the issue of how one ought to trade off risk and return when the distribution of asset returns is more complex.

Can you explain this further? Why is it a poor approximation for bonds and options?

Largely because their returns tend to be very skewed.

Let's think about how corporate bonds are created. Risky corporate cash flows are split between two classes of investors: bondholders and stockholders. Bondholders are offered a relatively low, but correspondingly safe, rate of return. Equity holders are residual claimants to corporate cash flows -- they get paid a higher (but risky) return. In particular, they get paid only if there is money left over after bondholders have been paid.

As a consequence, stockholders pick up almost all the variability in the company's earnings, while bondholders experience little variability in their cash flows. But if a company gets deeply distressed (think of Enron) and then is unable to pay its bondholders, they take a huge hit. So, most of the time, bonds have a steady return, but once in a while they suffer huge losses. In other words, the distribution of bond returns cannot be normal.

It is worth pointing out that bonds typically come with protective covenants which give bondholders possession of the machines in the factory or the desks in the office in the event that the corporation cannot pay them what they were promised. In principle, at least, the bondholder can take those machines and desks and sell them at an auction to recover some, but likely not all, of their investment. It is commonly assumed that the recovery rate is about 40%.

How do you deal with this in practice?

One approach is to simulate the behavior of bonds and options, or to sample their historical returns and then build a complex optimization around these samples. Unfortunately, if the simulation model is not good, or if the historical returns don't cover bad times as well as good times, one can get silly results. Another approach is to model the distribution of returns more accurately using a mixture of stable distributions.

Regardless of which approach one chooses, the level of mathematical sophistication rapidly escalates, and one has to be careful not to get trapped in a mathematical quagmire. Typically, when thinking about investments, simple math works best.

We address this problem by modeling risk in a simple, sensible way that is intuitive for fixed-income investors. We are happy to settle for a model that isn't exact but points us in the right direction and is analytically tractable. In the special case when all returns are Gaussian, our model returns the same results as a classic mean-variance optimization. In other words, it is a good approximation in difficult cases, and exact in easy cases.;;

How is it different from some of the other efforts by, say, Black and Litterman?

There actually is a point of connection between our model and the Black-Litterman model. The key insight that underlies Black-Litterman is that one can use results from general equilibrium to get a basic solution in closed form, and can then modify this basic solution in accordance with some further insights on the relative expected returns of a few assets.

Our model is similar in spirit. We start by solving a simple mean-variance optimization problem in closed form, and then gently modify this solution in accordance with some insights that we have about the tail risk of each asset or strategy. Basically, if an asset or a strategy has a lot of tail risk, we decrease its allocation, and if an asset has very little tail risk, we increase its allocation. But after all the adjustments we make, the variance of the portfolio remains the same. So both solutions start with a simple solution and then modify it a bit in accordance with some auxiliary insights.

You discuss coherent measures of risk. Can you shed some light on this?

The theory of coherent risk measures was developed by Artzner, Delbaen, Eber and Heath in the mid to late 1990s. It turns out that many popular measures of risk, such as VaR, have some undesirable properties. In particular, they don't satisfy something called the diversification axiom. If you combine two risky portfolios, you expect that the overall risk of the combined portfolio will not exceed the sum of the risks of its constituents. But Artzner et al. showed that under some widely used risk measures, you could have two portfolios with zero risk in isolation, but positive risk when combined. In essence, diversification was creating risk!

Any reasonable risk measure should not have this flaw. They went on to define a set of axioms that any reasonable measure of risk should satisfy, and call a risk measure that satisfies these axioms a coherent measure of risk. Markowitz used variance as his preferred measure of risk because it was both intuitive and tractable. Unfortunately, it is not coherent. We use expected shortfall as our risk measure because it is coherent and easily computed.

You are an example of how academic research blends with practice. How do you actually use your model?

FFTW is a fixed-income house, and we manage portfolios against a variety of benchmarks. We start by replicating the benchmark, and then layer on a set of active alpha strategies to build a complete portfolio. The alpha strategies come from several alpha teams. There is a structured securities team that analyzes mortgages, a rates team that analyzes the shape and level of yield curves, a money market team that focuses on the short end of the yield curve, a sector rotation team that rotates allocations between sectors, an FX team that focuses on currencies, a quant team that builds quantitative strategies, and an EM team that focuses on emerging markets. We compute the risk profile of each team's model portfolio and use our model to allocate risk among the various alpha teams.

Have you found this to be much better than the traditional portfolio?

Yes, but in a very specific way. It reduces tail risk by 10% to 20% while leaving portfolio variance unchanged.

Could your model be extended to stocks, real estate and options?

It is easily applied to any asset class. However, as a general rule, I'd suggest using the simplest model that captures the key aspects of the problem you working on. Most optimization models work well when returns are approximately normal. If there is non-normality involved, tail risks get amplified, and you ought to use something like our model.

It is widely believed that asset allocation is 70% to 80% of the job and accounts for 70% to 80% of the returns that any investor gets. Stock selection, or selection of bonds/options or any other assets, accounts for just about 20%. Your model is a big step in deciding what an asset allocation should be in a portfolio. What are your general views on asset allocation?

This is an interesting question, and it is often misunderstood. There is a very nice paper by Roger Ibbotson and Paul Kaplan that appeared in the Financial Analysts Journal a few years ago and answers the most common variants of this question. If you are asking what fraction of the variability of your portfolio over time is explained by its asset allocation, the answer is about 90%. If, on the other hand, you ask what fraction of the cross sectional variation in return across funds is explained by asset allocation, the answer is about 40%. If you ask what fraction of your total return is explained by asset allocation, the answer is 100%.

I don't think asset allocation has to be hugely subjective. But I do think that a few simple rules of thumb are very useful. You absolutely ought to diversify globally. And you ought to hold a wide range of assets. You won't go too far wrong by having half your money in stocks and the other half in bonds, half domestically and half internationally. Is this perfect? No. Is it a reasonable starting point? Yes. It is even better if the bonds are indexed for inflation.

If you know your utility function, or if you can build good estimators of expected return, you could do better. But most investors don't know what their utility function is. The only utility function that makes intuitive sense to me is the log utility function, because it corresponds to maximizing target wealth. Jarrod Wilcox had a paper in the Journal of Portfolio Management some years ago on an approach to maximizing return while preserving capital. In essence, he invested his discretionary wealth log-optimally and kept the remainder in cash equivalents. It's a very clever idea.

What is your view on risks pertaining to countries? In the past two to three years, we have seen economies default which we never thought could go down. What are your thoughts generally on deleveraging and defaults by such economies.

Any country can get into trouble. A number of things went wrong in Europe and the U.S. in 2008, but they could well have happened anywhere. The deleveraging process is not easy, and it takes time. But I believe Europe will recover from the mess it is in. Policy makers are finally getting their act together, and pro-growth policies will soon start to take root.

What about India? Last year, the rupee depreciated by almost 25%, and "India shining" seems to have become a thing of the past, with uncertainties in policies and politics coming in the way of performance. What is your take?

I think you are being overly pessimistic. India is not a complete disaster that is falling apart, and it never was a perfect country that was headed straight up. It has always been something in between. There are (and were) pockets of innovation and pockets of stagnation. No one expected the IT industry to spring up in India. And I can see that happening again with pharmaceuticals. So, both good and bad things are happening, but I believe that India's problems (like most problems) are fixable.

What is your view on the state of research in the field of finance and how disconnected it may be from the real world.

I always tell young people who are starting out on a career in research that the world offers them incredibly interesting problems to solve. Take a look at the world -- don't just read journals. The other thing that I stress is the need to be interdisciplinary. I am always shocked by the number of solutions to problems I face that come from other fields. For example, at FFTW we monitor portfolios using ideas from statistical process control, and we estimate volatilities using ideas from digital signal processing. It is also a good idea to study history. As the old saying goes, all that's new under the sun is what you didn't learn in your history class.

Friday, October 19, 2012

Mobile Banking

This article was originally published in Postnoon on October 19th, 2012, Co-Author: Anuj Hetamsaria

Mukherjee was pacing furiously at the lounge of our building when I arrived after a long day. He generally waited for me there when he wanted to ask me something. He was an impatient man and I knew from experience that I did not have a choice. I will have to answer his questions before I was allowed to proceed to the elevator. Reluctantly, I asked him the reason for his anger.

Mukherjee: I had to transfer money to my daughter studying in Delhi for her college fees. It was urgent. I went to the bank so that I could take out cash from my account and deposit it in her account.

There was a long queue at the teller’s counter. At 1pm the teller got up and went for his lunch. I waited for half an hour for him to return. After he came back and when my turn came, he refused to let me withdraw cash with my PAN card as the amount was more than Rs50,000. I was not carrying my PAN card. By the time I came back home, took my PAN card and reached the bank again, the bank had closed. My daughter is furious with me. I am furious at the teller. Overall, I am very upset.

Nicky: Why do you need to go to the bank to transfer the money? Aren’t you registered for mobile banking?

Well you must get registered for it then. This time, you don’t have a choice. You will have to go to the bank again tomorrow morning and deposit the amount in your daughter’s account. But you must immediately apply for the username and password for mobile banking. In future, you can transfer the money to her through your mobile.

Mukherjee: Really? Is it simple? What are the things that I can do using mobile banking?

Nicky: Ofcourse. Mobile banking is becoming popular by the day. You need not wait in the queue. You need not confront any rude tellers. You can transact sitting anywhere and at anytime. You can check your account balance, see transaction history, transfer money, pay bills, etc.

Nicky: Mobile banking is very safe, if not 100 per cent. But then, nothing is 100 per cent safe! Once you register, you will get a Mobile Money Identifier (MMID). It is a unique user ID which the bank gives you. You also have a Mobile PIN, that is, a password. This MPIN needs to be changed at regular intervals for safety purposes. There are always issues like viruses attacking your mobile. But they are rare occurrences.

Mukherjee: Will this work on my mobile?

Nicky: I don’t know that. You must have a phone that is compatible with the software/application that your bank uses. The customer care of the bank will help you download the necessary software and will also be able to guide you on compatibility issues. Your phone number will be linked to your bank account number.

Mukherjee: Is it free? Or is mobile banking free?

Nicky: Well… mostly its free. Only a few may charge a small fee. But even if there is a small fee, its worth it because it saves time and effort or physically going to the bank.

Friday, October 12, 2012

Discipline and Dispute in Credit Cards

This article was originally published in Postnoon on October 5th, 2012, Co-Author: Anuj Hetamsaria

Two days after our conversation on credit cards, once again there was a message from Sethu, blinking on my desktop. I put my coffee down with one hand and clicked on the Gtalk tab with the other. Even though taking a credit card is mostly harmless if one is disciplined in its use, Sethu is so suspicious about anything even remotely modern, that he is difficult to convince. He has more doubts before he applies for a credit card.

Sethu: I have heard that some of the shopkeepers charge an additional percent if the payment for purchases is made by credit card. Is it true?

Nicky: While most shop keepers or service providers do not charge anything extra, a few do charge about 2.5% extra if you pay by credit card. Also, some of them may not accept payment through credit card if the bill amount is very small, typically below Rs250 or Rs200. So, the ideal thing is to pay by cash if the shop keeper or the service provider charges an extra fee for payment through credit card.

Sethu: Hmmm...what about payments to online stores? Do they charge anything extra? Are they secure?

Nicky: Most of them don't charge anything extra. Site like, or have very secure payment gateways and credit cards are immensely helpful in making online payments. However, you have to be very careful with your credit card details like card number, cvv code, expiry date etc. Because, anyone who has these details, can make a payment online. It is a good practice to take benefit of services like mobile alerts. This will help you identify any payment that you did not make, immediately. You can then report misuse of the card to the bank and block your card to prevent further misuse.

Sethu: All this is fine. But don't you think that credit card encourages people to buy things they don't need?

Nicky: No. I don't think so. You cannot blame credit cards for lack of planning and discipline.

Sethu: You are right. But what if there is a dispute regarding either the credit card bill or charges or benefits?

Nicky: All banks have a well established grievance redress mechanism. Small issues can be settled at the customer care officers level. For the others, you may approach the bank branches, or write to the appellate or banking ombudsman. However, you too have to be careful about not signing any blank application forms or documents, provide correct details to the bank officials, take everything from the bankers in writing about the charges and the benefits, keep copies of all documents that you submit to the card issuer for your future reference, don't share your card pin or password.

Sethu: Thank you Nicky. I feel more comfortable now regarding applying for a credit card.

Thursday, October 11, 2012

Smart users stand to gain

This article was originally published in Postnoon on October 5th, 2012, Co-Author: Anuj Hetamsaria

I have known Sethu since at least a decade. A manager at a Multi National Company, Sethu always had strong opinions against the growth of internet, internet banking, credit cards etc. He is the kind of person who feels that these developments compromise on security and lack personal touch. I was surprised when he recently pinged me on Google talk to discuss credit cards! He was contemplating taking up a credit card finally.

Sethu: Nicky, I know you are going to say that I have finally converted. Well you can say so. Credit cards have become so popular now a days that I am forced to rethink my beliefs. And honestly, I have also started to feel that it is safer to carry a credit card than cash. Since you carry many credit cards, I thought you would be the best person to tell me a bit more about them.

Nicky: You are right. Credit cards are not only safer, but they also provide credit facility for as much as 50 days if you time your purchases well. A number of banks also offer cash back, discount, bonus and reward benefits on the purchases using their card.

Sethu: The banks offer either VISA or MATER CARD mostly. Isn't there an Indian gateway?

Nicky: Ah...the swadesi! You are in luck. The National Payments Corporation of India launched the indigenous RuPay in March 2012. You can take up a RuPay card through banks like SBI, BoB, BOI, Axis Bank, etc. RuPay is all set to give tough competition to VISA and MASTERCARD in India and abroad.

Sethu: Oh that's nice. But how do I decide the bank?

Nicky: Compare factors like joining costs (if any), annual maintenance cost, interest rate on rollover, cash withdrawal limits and charges, reward points, special benefits etc. Credit limit being offered by the bank may also be a deciding factor. Different banks adopt different policies in calculating limits extended to the customers. Steady income, income range, good credit history, etc. are some the factors the banks look at.

Depending on these, they will offer to you an appropriate card. It could be gold, platinum, titanium, classic, world, etc

Sethu: I have heard that the rollover facility come with very steep interest rates?

Nicky: That's right. But you should not use your credit card as a means for longer term loans. You must have the discipline to pay on time. Also, you should not use your credit card for cash withdrawals. As the free credit period is not available on cash withdrawals and interest is charged on them from the day of withdrawal, till it is paid back in full. These facilities are available, but they should be used only in the event of an emergency requirement, not regularly.

Sethu: Thanks Nicky. I think I am now ready to apply for a credit card, albeit, after some research!

Friday, September 28, 2012

Magical or Menace

This article was originally published in Postnoon on September 28, 2012

Dr. Raghuram G. Rajan, former chief economist of the International Monetary Fund (IMF), and currently the Chief Economic Advisor (CEA) in the Ministry of Finance, Government of India, a proponent of Foreign Direct Investment (FDI), supported the recently announced 51% FDI in retail by the Indian ruling government, calling it (FDI) the 'safest form of financing' because it is 'long-term' and brings in 'competition'. He is also hopeful that the FDI would result in improvements in the logistical infrastructure.

The ruling United Progressive Alliance government has also claimed that the FDI in retail will change the supply chain and infrastructure at the farm level and will reduce wastages. On the other hand, the opposition claims that the FDI in retail will wipe out the so-called mom-and-pop store.

The infrastructure is needed. But, the so called proposition that the infrastructure landscape will change due to FDI, it's a misnomer. Why is it that the large retail chains like Reliance and the Aditya Birla group have not been able to do it? They have deep pockets and the best talent in the world. The answer lies in the bottlenecks and the systemic problems that are there in the sector. Such infrastructural projects are not financially viable.

The cost of funds are typically around 16-17% for such projects. At this cost, a simple agricultural warehouse, without land, costs between Rs 400-500/- per sqft to construct. And the going rentals are Rs5-7 per sqft. The return is less than the cost of funds. How will investment come into this sector? And this is without land. If you don't have land, if you include the cost of land, the costs will go up to Rs1200-1300sqft. Even if you take the best of rentals (10-15 sft) at the most prime locations, it is still a negative NPV project.

It is often said that food is being wasted due to lack of infrastructure. Yes, the food does rot in the Food Corporation of India's (FCI) warehouses. Have you seen any trader's stock rotting? No. That's because FCI has a populist mandate. FCI is supposed to be a trading organization. It is supposed to buy the grains depending on the capability to sell, based on the demand from the Public Distribution System. It should have storage space, only then buy. They don't do it and hence the grains get damaged.

The mom-and-pop stores too will survive. They offer a different kind of paradigm and value proposition in comparison to the large stores. Another allegation is that the foreign retail companies have very deep pockets and can afford to make losses for 3-5 years. By then they will wipe out the mom and pop stores and then they will monopolize the market. It seems baseless. While the theoretical possibility is there, the cultural and systemic nature of India makes it a very remote possibility.

Well, the reality is that FDI is neither a magical wand, nor a menace. It is about giving choice to the people of this country.

Thursday, September 27, 2012

CRR and Repo explained

This article was originally published in Postnoon on September 21, 2012

The Reserve Bank of India (RBI), announced on Monday, that they with keep the policy repo rate unchanged at 8% and cut the Cash Reserve Ratio (CRR) by 0.25%, to 4.5%. What does this mean for you (the readers)?

The repo rate is the rate at which RBI lends money to the commercial banks. Using this rate as the benchmark, the banks decide their Prime Lending Rate (PLR). PLR is the rate at which a bank lends to its most credit worthy customers. They add basis points (one basis point is 0.01%) to PLR, if a customer's credit worthiness is lower.

The credit worthiness of a customer is determined by the repayment capacity of the customer, repayment of both interest and principal. It is also determined by the past record of the customer with respect to payments. For example, does the customer pay his credit card bills on time, does he pay his loan installments on time etc. There is an agency called Credit Information Bureau (India) Limited (CIBIL), which assigns a credit score to each individual depending on the past payments records. Banks use this score when determining the creditworthiness of an individual.

Now back to repo rate. So when repo rate goes up, our loans get more expensive as the banks will raise the PLR and if the repo rate goes down, our loans will get cheaper. RBI has kept this rate unchanged at 8% this time.

CRR is the percentage of money that the banks are supposed to keep with the RBI to meet the withdrawal demands for fixed deposits or any other time liabilities. The CRR is a percent of the Net Demand and Time Liabilities (NDTL) of the bank. When CRR is high, banks have lesser money with them to lend out. On the other hand, when CRR is reduced, the banks have more money with them to lend. This brings in more money supply in the market. Since RBI has reduced the CRR, the money supply should go up in the market.

What is meant by money supply going up? It means that the banks will have more money to lend, and hence more people may be able to get loans. This means that more money will be circulating in the economy. A few banks may decide to decrease the interest rates for auto or home loans. Though it is unlikely as the repo rate is same.

Why did the RBI not reduce the repo rate as well? That's because they are being cautious. They are worried about inflation. If the repo rate is reduced, people will be able to borrow money at a cheaper rate. This will encourage them to borrow and spend. If they borrow and spend, the demand for goods and services will go up. If demand goes up, prices will further go up.

Hence, the RBI has kept the repo rate unchanged.

Friday, September 21, 2012

Is Inflation Good for Growth?

Published in the business section of on 21 September, 2012

In a G-24 Policy brief (2012), Anis Chowdhury (UN-DESA) and Iyanatul Islam (ILO) sum up the Inflation Targeted as well as non-targeted)-Growth debate. From their brief, it can be said that monetary policies targeting inflation may not result in better growth than countries that do not have a policy of targeting Inflation.

They quote Friedman (1973): “Historically, all possible combinations have occurred: inflation with and without [economic] development, no inflation with and without [economic] development”.

A little bit of Inflation is good. But too much is bad. Empirical Analysis of inflation and growth over the past 50-60 years, in multiple nations, have concluded every possible combination of the two variables is possible, which ratifies Friedman's statement.

The monetary policy announced on Monday, left the interest rates unchanged at 8%. However, in a surprise move, the cash reserve ratio (CRR) of scheduled banks were reduced by 25 basis points from 4.75 per cent to 4.50 per cent of their net demand and time liabilities (NDTL) which according to RBI is expected to infuse approximately Rs170 billion of primary liquidity into the banking system. While the move will give greater freedom to the banks to lend, the unchanged policy repo rate, may not bring in many takers for the loans.

The Reserve Bank of India has maintained that Inflation is too high for their comfort. The point to note here is that the correlation between interest rate and inflation, in India, in the past 10 years, taking September to September rates, is a very small 0.16 only. On the other hand, they are highly correlated with GDP (-0.31) and stock market performance (-0.60).

In a research done by Muneesh Kapur and Harendra Behera (2012), who were both with the RBI at the time of doing the research, they concluded, " the evidence for both India and other countries suggest that the impact of monetary policy actions on inflation is modest and subject to lags... Despite the monetary tightening by Reserve Bank of India during 2010 and 2011, inflation remained high and this could be attributed to the structural component of food inflation as well as the surge in international commodity prices beginning the second half of 2010 and continuing into the first half of 2011".

Inflation can be controlled by controlling budget deficits and by easing bottlenecks to improve supply, as well. But burgeoning subsidies expenditure by the government and inefficiencies have resulted in an expected fiscal deficit of more than 7%; and if the government fails to raise money by divesting the proposed public sector undertakings in the coming year, it will be a reality.

Because of this, the entire onus of controlling the inflation has fallen on the RBI. Which is having an impact on the growth rate.

The stock market rejoiced on Friday, with the benchmark index (SENSEX) moving up by 443 points as the government, led by Dr. Manmohan Singh, announced a subsidy cut on Diesel and easing the FDI norms for the retail and aviation sectors. Monday was not to be the icing on the cake.

Thursday, September 20, 2012

Corruption and Money Laundering

This article was first published in Moneylife on September 20th, 2012, co-authored with Khemchand H Sakaldeepi

First the Gandhian, Anna Hazare and then the yoga guru, turned social activist, Baba Ramdev; India has witnessed two major voices against corruption in the last year. While Anna and his team's movement primarily focused on bringing a strong Lokpal Bill, Baba Ramdev has been crusading to bring back the black money stashed away in Swiss banks, to India.

Corruption has assumed unprecedented proportions with the Coalgate allocation scam running into billions of dollars and everyone from the erstwhile Bhartiya Janta Party government (now the main opposition party), led by Atal Bihari Vajpayee to the current United Progressive Alliance (UPA) government, led by Dr. Manmohan Singh, being under the scanner. The Indian parliament hardly worked in the monsoon session, with the ruling party and the opposition at loggerheads with each other.

A ray of hope, in the midst of the political circus, seems to be the Indian banking system, that has been resilient in the past, conservative and cautious. The recent cases of laxity in vigilance and violation of regulations at the HSBC and the Standard Chartered banks, have resulted in trillions of illicit money gaining access to the US markets. This raises questions about the steps taken towards the prevention of money laundering by countries across the globe.

India became a full-fledged member of the Financial Action Task Force (FATF), an inter-governmental body which works towards combating money laundering and terrorist financing in the year 2010. Since then, India has been co-operating with the other member nations in sharing information regarding suspicious, money laundering and terrorist financing activities.

According to FATF, "corruption has the potential to bring catastrophic harm to economic development, the fight against organized crime, and respect for the law and effective governance". Early this month, both NSE and BSE, the leading stock exchanges of the nation, urged the investors to exercise caution in dealing with entities linked to Iran, following warnings from FATF.

The question is, being a member of FATF and at the same time struggling with corruption at home, is India doing enough to combat money laundering? A survey on Anti Money Laundering by KPMG in India (2012) revealed that about 11 percent of the respondents find that more than 25 percent of their SWIFT messages have incomplete originator information. The survey also finds that more that majority of respondents found the client screening, handling of filter hits and maintenance of sanction lists was either moderately challenging or challenging. And less than 50 percent use either internal or external sophisticated IT systems to identify potential money laundering cases.

In the US there exists a list of Specially Designated Nationals and a list of Countries identified which should be screened for identifying potential risky transactions, better known as OFAC (Office of the Foreign Asset Control) List. US people and companies are banned from dealing with entities in this list.

In India too, Financial Intelligence Unit - India (FIU-India) along with the RBI, has been working towards making the screening system more rigorous. If the processes are implemented in letter as well as spirit, financial companies like Banks, NBFCs and Insurance companies, who collectively control the flow of money in the economy can directly hinder the plans of rogue elements by making their financial life miserable.

Also, there exists Know Your Customers (KYC) and Customer Due Diligence (CDD) guidelines in India, which can be easily flouted due to the multiple ways in which one can fulfill these requirements. India still does not have a single identity for its citizens, on the lines of the US Social Security Number. Same person can have multiple address and identity proofs in the form of state issued passport, driving license, ration card, or the most recent being the Aadhar card.

Going by the KPMG report, while India is taking baby steps in the right direction, there are major milestones to be covered in terms of training, reporting and technology to be able to use some of the most sophisticated algorithms involving abnormality detection, predictive models and social network analysis. In fact, it is said that if Facebook was a country then it would be the 3rd biggest in the world. The combination of data from social network and technology can help us create sophisticated bad behavior detection tools.

The recent technological advances have helped many institutions to harness the power of large datasets. The companies can process and collect data at close to real-time and with the help of certain algorithms, classify and detect malicious behavior instantly. This is like any other antivirus system found on computers, but different in terms of target units i.e. money laundering and terrorist financing.

The existing systems in India have clearly not prevented black money and the proceeds of corruption from leaving the country. Hopefully the next generation revolutionaries can actually use technology to bring about the change we want to see instead of relying on the old fashioned political rhetoric. Next time when someone says “Hum bahar ka paisa vapas layenge” (Read: Baba Ramdev claiming to bring back the black money stashed in Swiss banks) then we must ask “What’s your analytics quotient?”