Be smart with your money and you will see best results

This interview was first published by www.rediff.com on May 03, 2014
http://www.rediff.com/business/report/interview-be-smart-with-your-money-and-you-will-see-best-results/20140503.htm

To set up any business in India may be little time consuming, but it is not so difficult as it is conceived to be. Raamdeo Agrawal, joint managing director of Motilal Oswal Securities also not had it easy when he co-founded the firm in 1987. Agrawal follows some simple but very important fundamentals that have helped him steer his business through thick and thin.

Along with handling prime responsibilities at Motilal Oswal, Agrawal is an Associate of Institute of Chartered Accountants of India and also a member of the National Committee on Capital Markets of the Confederation of Indian Industry. He is the recipient of several accolades for his contribution to the capital markets.  

In a free wheeling conversation with Nupur Pavan Bang of the Insurance Information Bureau of India and Vikram Kuriyan of the Indian School of Business, Agrawal talks about his journey, investment process that he adopts and his faith in the Indian economy.  

You have built Motilal Oswal from the scratch. It is not easy to build a financial advisory firm in India as people do not want to pay for such services. Tell us about your journey, about the challenges.

In1987, Motilal Oswal and I started a sub-broking firm. The initial few years were a struggle. But we always insisted on research. The Harshad Mehta scam happened in 1992. The scam resulted in the Sensex touching 4,500 but it was a fantastic business opportunity. Volumes exploded and we made a lot of money and re-invested them into the market which further appreciated multiple times. Then the market crashed around 50 per cent. By 1993-94 we made a few crore.

We kept on building our research team and ventured into Institutional broking. Morgan Stanley became our first client. By 2002 we were the best Indian local brokerage house and since then we have maintained the number one or may be second position in research.

In 2003, Motilal Oswal had a topline of Rs 10 crore (Rs 100 million) and a bottomline of Rs 2 crore. The bull phase from 2003 to 2008 saw the firm growing 90 times to Rs 900 crore (Rs 90 billion) and pre-tax profit of Rs 300 crore (Rs 3 billion) respectively. We paid Rs 100 crore ( Rs one billion) in taxes in 2008.

When we got listed on NSE and BSE in 2007, our market capitalization on the day of listing was close to Rs 2000 crore (Rs 20 billion). In three months it crossed Rest 6000 crore (Rs 60 billion) indicating the confidence of the investors in the company. Complete client satisfaction and research are the basis of our business.

Focus on research must have been difficult way back in late eighties, as the World Wide Web and internet were not available then. How did you manage to research?

The absence of or limited access to resources had both advantages and demerits. I went to the US and walked into a Barnes and Noble book store and found many good books. But I could not buy them as I did not have the money. Up until 1994, there was a scarcity of resources. So what we did was that we physically went and collected almost 200 to 300 balance sheets each year. The biggest disadvantage then was that we did not have historic data.  

We examined ratios like the EBITDA margin, cost margin, etc. Very few other competitors had the kind of edge (competitive advantage) that we built in understanding corporate India. I had a good feel for numbers. I would remember everything for every company because my brain was empty. Today everyone’s mind is full of all irrelevant things due information flowing in from all corners. The biggest challenge is to focus your mind on getting what is important.

Where does one begin to look, in order to invest in the stock markets?

Before one starts investing, always look at the business of the company. Invest in a business you understand. 99 per cent of the job is in understanding the business. If someone tells me about VSNL, I leave. It’s a complex business and I don’t understand it. You cannot evaluate a company unless you understand it. For most people, a company is just a number. Most people don’t know what Reliance actually does.

Once you understand the business, see if the business is good or bad. Is the long term economics of the company favorable? Is management trustworthy and able? Figure out if the company actually makes money or not. Making an investment comes later.

You must also look at what the company does with the money that they make. Do they distribute [dividends], re-invest or destroy? Lots of companies do not allocate capital. Even Infosys is sitting with crore of cash. We saw a leading telecom company mis-allocating funds and buying businesses that did not add value. The stock has not done well for a few years.

When QGL : Quality, Growth and Longevity, all three come together, the company will make money. Invest in such companies and let compounding do its job.

How does one acquire the skills to evaluate the business? Stock markets are risky and people can lose money.

Start investing in the market with small amounts. When you lose, you will realise your mistakes. Value derived from small mistakes is huge. Those lessons will not be forgotten. So it is necessary to start investing in small amounts.

Invest time in reading. If you don’t have the reading habit then you are out. That habit cannot be cultivated. The urge to learn more should be there. It’s about understanding and not information. Investing skill is a global skill, same in any market, same across time series. You have to learn and acquire those frameworks. A beginning has to be made by actually entering the markets.

You are a proponent of equities. But in India, people prefer to invest in fixed deposits or gold. Retail investors mostly lose money inequities.

Warren Buffet defines Investing as foregoing current purchasing power now for a greater purchasing power in future. The first big anomaly is inflation. In the last 34 years, India has recorded consumer price inflation of about 8.4 per cent. You have to earn at least post tax 8-8.5 per cent to stay where you are and fixed income [deposits] delivers that. So basically you are running very fast to stay where you are standing.  

Till 2005, gold was as good or bad as fixed income. But in recent times it has done better. In India, it also has to do with the culture rather than the notion of investing.  

Equities are one asset class where you can beat inflation and by a large margin if you make the right decisions. There are two emotions in the market: greed and fear.

People come only out of greed. Greed is highest when market is at the peak of the bull phase. That is the time when 80-90 per cent of the investors enter the market, when actually no one should come close to it. They sell when fear is the dominating emotion, that’s when the market is at the bottom. So they buy at the top and sell at the bottom. It will keep happening. You have to master these emotions. Buy when everyone is selling and sell when everyone is buying. If you do that, you will not lose money.

How do you see the next 25 years unfolding for India?

When we became independent in 1947, our population was 330 million and our GDP was $10 billion. It took 60 years (2007) for the country to become a trillion dollar economy. When a country becomes a trillion dollar economy, it starts getting noticed. In 2013 or 2014, it will be a 2 trillion dollar economy, despite the rupee depreciation. The time taken to achieve the 3rd trillion mark will be even shorter.

Magic is in the $1000 per capita figure. $900 is non-discretionary. It is needed for food, shelter, etc. Anything beyond that is discretionary. As of now, we have only about $100 as discretionary. The journey has just started. In 1987 this journey was blank. The market capitalisation of Cipla was Rs 5 crore ( Rs 50 million). Today it is a Rs 30,000-40,00 crore (Rs 300-400 billion) company. Reliance would be a few 100 crores at that time. Scale has changed in the last 25 years and will be bigger in the next 25 years.

Doubling of GDP means exponential opportunity for various businesses. One must prepare for it and participate in it. Foreign Investors are already investing in India. We are looking at the present but they are seeing the future. Why does Walmart want to come? Because India will be one of the largest market in the next 25 to 40 years for brands or logistics.

Why Etihad? Why P&G? In the future, entry barriers will be much higher than it is now. Lots of businesses will become almost monopolistic and that’s where the opportunity for investing lies.

In 1991, we had a billion dollar reserve. The country did not have a credit rating. We are in different times now. We have $280 billion of foreign currency reserves. The next 25 years will be very exciting.

You mentioned about the $280 billion of foreign exchange reserves that we have. Since the Federal Reserve in the US is tapering off quantitative easing, we have a widening current account deficit, dwindling foreign portfolio investments and a currency that has depreciated more than 25 per cent in a year, would you say it would be prudent for the Reserve Bank of India (RBI) to fire fight and sell dollars in the open market to bring the exchange rate to 2011 levels?  

We now have Raghuram Rajan at the helm of affairs at RBI. He is a much acclaimed person and he will do his job. He understands what is required locally and also how to meet the global challenges.

The fear for the worse has resulted in the Rupee depreciating to Rs 65 against the dollar. Before opening up the capital accounts, he is using the challenge to get ample liquidity.

Lots of weapons are available. There is no crisis. There was bad currency pricing. For 10 years, we had inflation differential of 5-6 percent but the currency did not depreciate. So what happened is that existing companies kept on losing their competitiveness and it became difficult for manufacturing companies to conquer the Chinese threat. It is good that the currency has depreciated now and people have understood the implications.

Which other factors will have an impact on the Indian markets and its performance?

Governance is a key factor. A period of five years of good governance will change everything. Today, investment in India forms just less than 1percent of global equity portfolio. That figure can double if governance is good. The amount of money which the world can send to India is humongous. The question is, do we deserve it or not? We area capital scarce nation. So we must play the game and attract capital.  

Moves by the Chinese is something that we should be aware of. Till 1998china was like India, after which it emerged. From 1997-98 it is a trillion dollar economy. Since 2009 it is growing by trillion dollars every year with little appreciation of currency. The world economy including India, will be far more impacted by what China does in comparison to the US.

India is far behind in development than China. GDP has slowed down to sub 5percent levels. Why would capital flow to India? Is there any source for optimism?

Well, we can talk about the negatives in the economy. But let there be balance. It should not be that we overlook all good that has happened. There have been major improvements in road networks, telecom networks, infrastructure, in the last 10-15 years. Public-private partnerships have evolved. iPhones are launched in India at the same time as in the US. We may not be happy with the pace of it. But there has been development.

The strengths of this country are very different. I am not undermining the difficulties but let’s not be bogged down by them. I have seen the Mumbai riots, the balance of payments crisis, and the sanctions that followed the nuclear tests in Pokharan. This generation takes the internet as a given. I did not have electricity when I went to school.  

We are impatient. We want all our cities to be like Shanghai. What we should realise is that we don’t have capital. If we see it as a challenge, we will overcome the problem. The challenges have kept changing over time, but as a country, we have always emerged triumphant.

How deleveraging affects economy

This article was first published in the business section of www.rediff.com on April 23, 2014; Co-Author: Khemchand H. Sakaldeepi

http://www.rediff.com/business/report/special-all-about-deleveraging-and-fiscal-deficits/20140423.htm

In the first article in the series of understanding how the economic machinery works, we introduced transactions, credit, interest rates and inflation (the article can be read here). In the second article, we dealt with the importance of credit and introduced deleveraging (the article can be read here).  In this part (third), we will delve into the impact of deleveraging and introduce fiscal deficit and quantitative easing. The concluding part would weave all the different parts of the economic machinery together to help the readers take a view on the current economic scenario in India.

Impact of deleveraging

In the previous articles we saw that deleveraging happens when the rate of increase in debt outpaces the rate of growth of income. Incomes fall, people and organizations cut spending or austerity measures are taken up, such as projects halt, pay cuts for employees, bonuses come down and unemployment increases.

Asset prices drop, credit disappears, stock market falls, the banks try to reduce debt – restructuring of debt, writing off defaults, deposits into banks fall and default rate goes up.

Then the government tries to redistribute wealth by increasing its spending for generating employment. The spending of the government more often is larger than the income in such scenarios. This creates fiscal deficits.

During deleveraging the income falls more than reduction in debt due to the austerity measures. This is deflationary and painful. It may even lead to an extreme case of recession, also known as depression. This is a classic case that has repeated many times in history. For example, even Hitler came to power because of the social disharmony created by depression.

In such scenarios, many economies resort to printing more money. The central bank buys financial assets from the government, who in turn engages in spending to generate employment and lift demand. This is called quantitative easing.

Printing money has an impact on the exchange rate as the supply of currency being printed increases in the market.

The central bank must play very safe and must strike a balance such that the income growth is larger than the rate of growth of debt. Once deleveraging begins, going back to the boom periods usually takes 7-10 years. Hence, it is called “the lost decade”.

Source: http://planningcommission.nic.in/data/datatable/1612/table_23.pdf

The debt to GDP ratio of India stood at around 68 percent in 2013. While this ratio is much lower than in countries like US and many European nations, the interest payments and principal repayments make India very vulnerable. The fiscal deficit of India has been on the rise since 2008 and reached alarming levels in 2011-12.

This also had an impact on the exchange rate. The Indian rupee started to depreciate again the dollar as the fiscal deficit widened, the GDP growth rate started to come down, and inflation was at an all time high. The flight to a safer currency (US Dollar) meant that the Indian currency depreciated. This caused great deal of concern to importers as their imports, which are often priced in US Dollars, became more expensive in terms of Indian rupees.

In fact, The Indian economy has an underground economy, with an alleged 2006 report by the Swiss Bankers Association suggesting India topped the worldwide list for black money with almost $1,456 billion stashed in Swiss banks. We are not only a rich country, but we can actually take on more debt if we had that money in India and really wipe the tears off every citizen and more. 

The above is a pretty complex but easy to understand story of how the economic machine works. We as citizens often get lost because we look at things at the microcosmic level and hence react emotionally. But if we were to see the big picture then we can play really smart in more ways than one. 

In the next piece we shall delve deeper into the state of the Indian economy currently and the uphill task the next occupants of the North Block face.

What do a PhD scholar and an entrepreneur have in common?

This article was first published in www.yourstory.com on April 11, 2014

http://yourstory.com/2014/04/phd-scholar-entrepreneur/

I am a PhD in finance with a stable job and the assurance of a fixed expected salary every month. My husband is an entrepreneur, and worries daily about weather, inventory and changing prices. To use a cliché, we are as different as chalk and cheese.

Yet, there is something that binds us. Our journeys. His journey comprised of leaving a comfortable job and creating something of his own. Mine comprised of devoting about six years of my life to doing a PhD, after having already spent 19-20 years studying.

While doing a PhD is not often compared to being an entrepreneur, there are more comparisons than meets the eyes.

The investment in terms of time and the opportunity cost of not taking up (or leaving) a job is huge as the stipend paid to a PhD student is far below what he or she would earn by working in the industry, just as the first few years of an entrepreneur is spent thinking about every penny. On top of it, the horror tales of endless hours one has to put in, the ever shifting finishing line, and the failures dissuade many from taking up a PhD program, just as the same reasons prevent many from leaving their jobs.

There are many who take up a PhD program but abandon it midways. Excessive reading, long hours, low pay, when other batch mates from graduation and post graduation days go for long foreign holidays and eat at expensive places, wear expensive clothes, it keeps reminding you of the life that you could have had! Sure enough, I keep reminding my husband of all the foreign vacations that we could have had!

Then there are others who take it up and stick to it till they finish. Once they decide to stick to the program, it does not take long for them to realize that they have made an investment which would change the way they think forever. The key is of course to get into a good PhD program which gives you rigorous training. A startup’s story is pretty much the same. Once it survives a few years, the chances of its success are high.

The coursework in a PhD program intellectually stimulates, teaches one to learn beyond the superficial and to dig below the surface. An entrepreneur goes beyond the theory and thinks out of the box to reach its customers. He must always innovate and improvise.

Next comes the periods of independent study. Most of the PhD programs have long periods of independent study, where the candidate is given time to read, formulate the hypothesis, review the literature etc. It is easy to keep postponing all this as there may not be anyone watching or asking for progress at frequent intervals. Discipline and self-motivation is the key here. Without discipline, one may take eight to nine or may be more years to complete their thesis.

When I complain about the long hours that my husband spends in the office, his reply is usually, “if I don’t do it, who will?” Since an entrepreneur is his own boss, spending that extra hour in the office takes a lot of motivation.

An important milestone is getting the proposal ready. Curiosity to find something, to discover something new, or to fill an important gap in the existing body of literature results in a good defendable proposal. Some people are born curious but others acquire the curiosity when they repeatedly read about a single topic and related work. Similarly, for the entrepreneur, that first product or the first order is the most important milestone. It can be the defining moment for the venture.

The process of writing a thesis is actually a process of self discovery. The journey itself seems like the destination. The quest for accuracy, for measurement and deduction, the single minded pursuit of data collection, learning to write and run codes (which have become an integral part of doing a PhD now a days) which one earlier thought one was never capable of doing, are all activities which stretch the boundaries of learning.

An entrepreneur also discovers that while his core competency might be marketing or finance, he is an office boy to a CEO, an accountant to a strategist, all rolled into one.

Then comes the stage where the comments of the supervisors, advisors and friends start coming in. Incorporating changes and going through the drafts of the thesis numerous times needs patience. There is no choice. If one does not have this trait, they simply have to acquire it, just like an entrepreneur keeps revising his product and strategies as the business progresses.

When the thesis is submitted after all the years of hard work, the feeling is unbeatable. The defense of the thesis and the award of the degree is the stepping stone to a career in academics and lifelong learning. Similarly, when a venture succeeds, it brings immense joy and wealth to the entrepreneur.

So, if you are passionate about something, either do a PhD in it or become an entrepreneur with a venture revolving around your passion!

Why is credit so relevant to India's economy?

This article was first published in the business section of www.rediff.com on March 12, 2014; Co-author: Khemchand H. Sakaldeepi

http://www.rediff.com/business/report/special-why-is-credit-so-relevant-to-indias-economy/20140321.htm

In the first article in the series of understanding how the economic machinery works, we introduced transactions, credit, interest rates and inflation (the article can be read here). This part will deal with the importance of credit and introduces deleveraging. The third part will talk about the impact of deleveraging and introduces fiscal deficit. The concluding part, weaves all the different parts of the economic machinery together to help the readers take a view on the current economic scenario in India.

But why is credit important?

Credit allows the borrower to increase his spending today. Remember that the borrower is required to improve his productivity so that he can pay for his past expenses in the future. Credit is good because spending drives the economy. One persons spending is income for another.  It is the fuel to the engine.

When someone’s income rises he can borrow more and spend more as his creditworthiness increases. Creditworthiness is made up of two things – his ability to repay and his real assets that he bought from his rising income. This process continues until the spending at the origin stops. This whole process is cyclical. Hence the short term credit cycles are formed.

Credit is relevant in the short run but what actually matters is productivity in the long run. That is the amount of goods and services our country produces. This is measured by GDP. The credit created just acts as the motivational force to improve our productivity.  It helps businessmen to compete in the market and produce more efficiently.

In fact, credit is an outcome of human behavior. We want to spend more that our neighbors. Sometimes greed and envy take over the thinking process, making people irrational.

In a country like ours, the culture can actually help us be better economists. Our wisdom of ages teaches us not to be overly greedy and not overly materialistic, as is evident from the high savings rate of our households. If we all were to work rationally then our country will automatically become more productive in the long run.

The only problem with credit is that it forces us to consume or spend more when we acquire it and it forces us to spend less than we produce when we have to pay it back. Hence if we take credit, it is of utmost importance that we also produce more so that we can maintain our spending status when we have to repay.

This does not always happen. An example is the US housing bubble when people borrowed more than they could produce. This bought the lenders to their knees.

This does not mean that credit is bad. It is bad only if you borrow to consume but do not increase your productivity. Credit does create inflation due to more money coming into the market and creating more demand for goods and services.

Now let us talk about credit cycles that are long term in nature and the most dangerous. The short term typically lasts for 5-8 years but the long term cycle lasts for 75-100 years.  This happens because people are more willing to borrow and spend than to pay back and assume that productivity will naturally increase. They think that things will forever be great and that credit will always be available.

Now imagine a weighing machine. On one hand we have income (productivity) and on the other hand we have debt. When debt is increasing and incomes rise with the same rate then we have little to worry. In such an environment assets value soar and inflation is observed (Inflation is a proxy of growth here). But this environment does not last forever.

When the debt repayment increases more than the income we must believe that recession is at hand.

But there can be a worse scenario.  In the developed world in the years 1929 and 2008, the rate of increase in debt had outpaced the rate of growth of income. This led to the peak of debt cycle and recession. The consequences are as expected. Incomes fall, people cut spending, asset prices drop, credit disappears, stock market falls, social tensions rise, people feel poor. This scenario is called – Deleveraging

Deleveraging

A vicious cycle begins –This is different from recession because interest rates cannot be further reduced.

If the interest rates are already very low (even close to 0%), lenders stop lending, borrowers stop borrowing. The economy comes to a halt. This is something that has not happened in India since 1991, just before the financial reforms. We as a country have this opportunity to learn from others’ mistakes as well as our past and can actually be careful in creating CREDIT BUBBLES.

In 1991, the government of India was close to default. The central bank had refused to new credit with which the country runs and foreign exchange reserves had dried up. Remember this was a world where the government used to run all the businesses and there was little private participation. We had to airlift our gold reserves as a pledge with IMF.

Debunking the Indian economy machine

This article was first published in the business section of www.rediff.com on March 12, 2014; co-author: Khemchand H. Sakaldeepi, Swiss Re

http://www.rediff.com/business/slide-show/slide-show-1-special-debunking-the-indian-economy-machine/20140312.htm

The subject of economics has always been very fascinating and yet confusing. Many curious and critical minds find it difficult to actually understand the state of our economy. We all understand the meaning of GDP, IIP, inflation, interest rates and intervention of central bank, that is, the RBI, to control money flow, the volatility of Indian rupee etc. But it is very difficult to join all the dots.

The media and academia are ripe with reports, articles and peer reviewed papers. All of these are many times contradictory and have their own school of thought, and for a common man it is difficult to comprehend.

In this article we will attempt to put the conceptual pieces together. This article is divided into four parts. The first part introduces transactions, credit, interest rates and inflation. The second part will deal with the importance of credit and introduces de-leveraging. The third part will talk about the impact of deleveraging and introduces fiscal deficit. The concluding part, weaves all the different parts of the economic machinery together to help the readers take a view on the current economic scenario in India.

How the Economic Machine Works

Let us begin by summarising the framework created by Ray Dalio of Bridewater Associates. He presents a very robust framework to understand 'How the economic machine works'. If one understands this well, the rest will be just nuts and bolts to play with.

Let us begin by imagining that the economy works like a simple machine. This is something that many people do not understand, or if some do understand it, then they are at disagreement over how it actually works. This is the exact reason why policy-makers and economists just cannot come to a conclusion when taking critical decisions. Therefore Dalio presents a simple template that can help us in more ways than we can imagine.

The economy is made up of simple parts called ‘transactions’ that come together and is repeated over and over again. These transactions, above all, are driven by human nature. Some assume that they are rational and others say they are irrational. These transactions create three main forces that drive the economy:

·                     Productivity growth

·                     The short term debt cycle

·                     The long term debt cycle

The transaction here refers to quid pro quo where the Numéraire (unit) is usually the currency (due to historical reasons) issued by a statutory body of the government of various countries (There are other interesting forms of money but we shall not deal with them in this article).

In any transaction we have a buyer paying for goods and services using money (store of wealth) and/or credit (store of expected future wealth) to the seller.  This summation drives the economy. If we can understand transactions then we can also understand the economy.

The biggest participant in these transactions is the government. It consists of the central and state governments and the central bank, the RBI in our case. The government collects money in the form of taxes (direct and indirect) and the RBI controls the flow of money in the country.

The RBI has two basic tools to influence the flow of money and credit in the economy -- interest rates and printing new money. We must now pay attention to credit.

Credit

This is the most important and least understood concept. It is important because it is a really big and volatile part of the economy. Credit can be created out of thin air. All we need is a buyer (borrower) and a seller (lender).

The buyer in principle borrows to pay for his present needs and the lender just acts as a facilitator for the prospect of increasing the value of their excess money. Here come the interest rates.

When the interest rates are low then people are more likely to borrow than when the interest rates are high. The RBI controls the interest rates that it charges the banks for giving them money (repo rate).

The historical interest rates and inflation rate in India are shown in the chart below. One can note that the rate has gradually been increasing since 2010 to curb inflation in India.

When credit is created it becomes debt. This is an asset for the lender but a liability for the borrower. When the debt is settled then the asset and liability both disappear.

The Debt to GDP or the level of credit with respect to the assets and goods that produced is given below. Fortunately we are well off here as compared to other countries like Japan (214.3%), Singapore (114%) and USA (72.5%).

Yet, they are supposedly (based on some mathematical default models) more likely to pay off their debt in the long run than India. India at 67.57% lags behind China (31.7%), Brazil (54.9%) and Russia (12.2%).

India's largest and most profitable airline!!!!!! INDIGO

Indigo Flight 6E354 from Kolkata to Hyderabad, departure 8.30p.m., February 24th 2014

At 6.30p.m. I got a message which said that the flight had been rescheduled to 11.15p.m.

There was no explanation for the rescheduling at the airport. There was no indigo staff at the airport who was designated to alleviate the concerns of the guests.

At 9p.m., two indigo kids [staff] came and asked the guests to collect dinner. Dinner was a cheese sandwich, a muffin, a kachori and buttermilk. I wonder what percent of the Indigo staff eat such sumptuous dinner! I beg ignorance, but I did not know that the four assorted, dumped, cold, dry, something, thrown together in a box, items could classify as dinner.

In the meanwhile, we got another message from Indigo saying that the flight was now rescheduled to 10.40p.m. There was a change in gate number, which was not announced.

The two kids who were distributing the so called dinner disappeared. While everybody waited for someone to come and announce boarding for 10.40pm departure, 10.40p.m. came and went and there was no sign of any indigo staff. The kids came back at 11p.m. and sat down and chatted and laughed, while the tired guests watched. A few of us had woken up at 4a.m. or 5a.m., had full day meetings, had kids waiting at home, were concerned about our safety upon arriving at Hyderabad airport and taking the cab home, the kids laughed and chatted.

A few guests had had enough and demanded that a supervisor come and explain the situation. Another kid came at 11.15p.m. (supposedly senior to the other two), and to silence the crowd, announced boarding and then made the guests wait in the bus.

Finally we boarded the aircraft at around 12.00 midnight. Airhostesses [kids again] were laughing away with absolutely no sense of the grim situation or the discomfort of the guests. The aircraft had mosquitoes. Not one, not two, but the aircraft was full of mosquitoes. The way you find them hovering over a drain or in slums. When a guest asked one of the airhostesses to spray the repellant, she just ignored. When the request was repeated again, she gave the logic that if she sprays the repellant, we will all breathe it and it’s not good for our health. While technically I agree with her, shouldn’t the airhostesses, or who-so-ever is responsible for preparing the aircraft, take care of such details earlier? Do we pay thousands of rupees to travel in such conditions?

The flight finally took off at 12.30a.m. and reached Hyderabad at 2.30a.m. A few other women and I made our journeys home, in cabs, alone. Does Indigo care? No. Did the incidence even register with the management? No. 

How India prevents money laundering

This article was first published in the business section of www.rediff.com on February 19, 2014; Co-author: Harkishn Mourjani (Quadrisk Advisors Pvt Ltd)

http://www.rediff.com/money/slide-show/slide-show-1-column-how-india-prevents-money-laundering/20140219.htm

India has been classified as high risk zone in terms of money laundering. Out of 140 countries, India was ranked 70th in 2013 and 93rd in 2012, by the Anti Money Laundering (AML) Basel Index. 

This clearly shows that India, in the present-day scenario, is very vulnerable to money laundering activities. Many acts exist in India, which directly or indirectly curbs money laundering activities. 

A few of such acts are:

·         The Conservation of Foreign Exchange and Prevention of Smuggling Activities  Act, 1974 

·         The Income Tax Act, 1961 

·         The Benami Transactions (Prohibition) Act, 1988 

·         The Indian Penal Code and Code of Criminal Procedure, 1973 

·         The Narcotic Drugs and Psychotropic Substances Act, 1985 

They proved to be inadequate in the treatment of money laundering matters. To curb the instances of Money Laundering, the Prevention of Money Laundering Act (PMLA) was introduced in the Lok Sabha on 4th August 1998 and was ultimately passed on 17th January 2003.  

Apart from the PMLA, there are other steps taken by the government to ensure that the instances of money laundering are prevented. A few of them are discussed here:  

Financial intelligence Unit (FIU)

The Financial intelligence Unit (FIU) operates in the legal framework established by the PMLA. FIU performs the basic functions of receipt, analysis and dissemination of information in accordance with the international standards set up by the Financial Action Task Force (FATF) and Egmont Group of FIUs.

As prescribed under the PMLA, FIU receives reports on cash transactions, suspicious transactions, counterfeit currency transactions and funds received by non-profit organisations. 

These reports are filed by reporting entities i.e. banks, financial institutions and capital market intermediaries, casinos, private locker operators, registrar to an issue of shares and dealers in precious metals. 

FIU maintains a database and shares these reports with various agencies.

Know your Customer (KYC) Guidelines

The objective of KYC guidelines is to prevent banks from being used, intentionally or unintentionally, by criminal elements for money laundering or terrorist financing activities. 

In order to prevent identity theft, identity fraud, money laundering, terrorist financing, etc., the RBI had directed all banks and financial institutions to put in place a policy framework to know their customers before opening any account.

The KYC guidelines were introduced by RBI in 2002, and all banks were instructed to be compliant by 31st Dec 2005. 

This involves verifying customers' identity and address by asking them to submit documents that are accepted as relevant proof. Mandatory details required under KYC norms are proof of identity and proof of address.

There have been many instances of KYC norms being flouted and there is need for the RBI to make the system more robust. 

A few examples of such instances are:

An individual investor, Roopalben Panchal, opened as many as 6,315 demat accounts with the National Securities Depository Ltd (NSDL) in benami names. 

She received 150 shares each from 6,315 allottees through off-market transactions, 9,47,250 shares in aggregate, which were subsequently transferred to six accounts, five of which sold the shares on listing to make a handsome profit of Rs 1.37 crore.

Similar modus operandi was used by certain investors during the IPO of Infrastructure Development Finance Company (IDFC).

Recent Changes in Prevention of Money Laundering Act (PMLA)

Definition of “Activities of Terrorism” was not present in PMLA 2002, however the same was included in 2010 as “Transaction involving financing of the activities relating to terrorism includes transaction involving funds suspected to be linked or related to, or to be used for terrorism, terrorist acts or by a terrorist, terrorist organisation or those who finance or are attempting to finance terrorism.” 

Until 2010, the enactment allowed protecting identity of beneficial owners, who could be represented by lawyers and accountants. However, it has been abolished as a part of the recent amendments made to the act in 2013.

RBI and IRDA did not have any provision to address cases for filling Suspicious Transaction Report to Financial Monitoring Unit. Circulars have been issued by both institutions to address the deficiency.

The earlier provisions of the Act lacked the prowess for due legislative action. Hence, the scope was broadened in 2013 to include concealment, possession, acquisition or use of property, and projecting or claiming it as untainted property. Commodity future brokers have also been included within the scope of the Act now.

The recent changes in the PMLA are welcome as a report from Global Financial Integrity, published in December 2013, reported that the total black money outflow from India was nearly $343 billion during 2002-2011. 

BITS of Success: Inspiring stories of BITS Pilani alumni

The book review was first published by yourstory.com on February 19, 2014

http://yourstory.com/2014/02/book-review-bits-success-inspiring-stories-bits-pilani-alumni/

BITS of Success: edited by Harsh Bhargava, Kinnera Murthy, Anu Khendry

Universities Press (India) Private Limited

3-6-747/1/A & 3-6-754/1 Himayatnagar

Hyderabad 500 029

Rs 190 (paperback)

What does it take to be successful? Grit, guts and gumption, some would say. Dream, passion and perseverance, the others would vouch for. Educational Institution? That’s what the fifty alumni of BITS Pilani include as an important factor which helped then achieve success.

BITS of success is a book which compiles the stories of fifty successful alumni of BITS Pilani from various fields; as diverse as scientists and artists, politicians and teachers, technologists and skiers. A few names are very familiar household names like Sabeer Bhatia (founder of Hotmail), Prithviraj Chavan (Chief Minister of Maharashtra), Mani Shankar (Film maker) and Vivek Paul (Wipro Technologies). The others instill a desire to know more about them.

D Balasubramanian, Director-Research at L V Prasad Eye Institute, recipient of the Padma Shri, one of the oldest alumnus of BITS Pilani profiled in the book,  talks about the contribution of his teachers at BITS in inculcating the love for Chemistry and Music in him. The importance of good teachers cannot be demonstrated better than in his case. The early interest in the subject subsequently led to sustained learning and eventually path breaking innovations.

In an era where the public at large are in general disgusted by the politicians in India, Prithviraj Chavan is an outlier. The current Chief Minister of Maharashtra has a pleasing personality and is an efficient administrator. In the words of Babasaheb Neelkanth Kalyani, the Chairman and Managing Director of Bharat Forge, which might be true for most of the alumni of BITS Pilani, “I think the years that I spent at Pilani prepared me to face the challenges of life”.

Abraham Lincoln once said, “I’m a success today because I had a friend who believed in me and I didn’t have the heart to let him down.” The importance of friendship and the contribution of educational institutions in forging those ties also comes out in the book. B C Jain, Chairman of Ankur Scientific, and recipient of the Bio-Energy Man of the Year 2011–2012, apart from many other accolades, says, “This [BITS] gave me a large number of great friends and also led to development of excellent analytical and interpersonal skills”.

A common trait which is observable through the profiles of all the alumni is the desire to make the world a better place to live in. Whether it is the socially relevant movies made by Mani Shankar or the work being done by B C Jain in the bio-energy segment or the Janaagraha movement of Ramesh Ramanathan.

Innovation is another common thread which weaves the lives of these luminaries. Sabeer Bhatia founded the first free web-based email service in the world, hotmail. Sarathbabu Elumalai founded Foodking which serves good food at nominal prices and offers employment to illiterate and semi-illiterate people.

The selection of people profiled is commendable. While each of the story is fascinating, the book just touches upon the lives of a few of them and leaves the readers with the urge to read more about the person. This could very well be a strategy that the editors wanted to adopt.

The book must be read by the younger lot, who are disenchanted by the education system and the value that it adds. At times, the value is not tangible and not in marks received!

The Complications of Easy Money

The interview was first published by the Global Association for Risk Professionals on February 06th 2014

http://www.garp.org/risk-news-and-resources/2014/february/the-complications-of-easy-money.aspx

An Indian writer dives deep into the history of money and concludes that government interventions rarely end well

Although he is not by formal training an economist – and perhaps because he is not – Vivek Kaul has established a reputation as a provocative, clear-voiced economic commentator for Firstpost and other publications in India. One article about Kaul’s recently published history, “Easy Money: Evolution of Money from Robinson Crusoe to the First World War,” paid Kaul the compliment of being “readable.” In response, Kaul explained that he devotes considerable study to “break things down. If a child cannot understand what I am writing, it is pointless.”

Though perhaps understandable to the younger population, Kaul’s extensively researched, 300-page volume speaks to a very different, highly educated audience. He delves into the origins and evolution of monetary systems and finds in them pointed, cautionary lessons for the central bankers who manage the modern-day money supply and for policymakers concerned about the risks and stability of financial systems.

“One of the lessons from history is that money printing has never really ended well,” Kaul says in this recent interview conducted by Dr. Nupur Pavan Bang of the Insurance Information Bureau of India. “It has inevitably led to disaster. We don't seem to have learned that lesson at all.”

Why is “Easy Money” your title?

I use the term 'Easy Money' in the context of money being created out of thin air by kings, queens, rulers, dictators, general secretaries and politicians. The practice was regularly resorted to by kings of Rome and has been abused ever since. As the Roman Empire spread, it needed more and more money to keep its huge army all over the world going. But gold and silver could not be created out of thin air. Also, as Romans grew richer, luxury and showing off became an important part of their lives. This also increased the demand for precious metals. This meant more plunder of the territories Rome had captured in battle. But plunder could not generate gold and silver beyond a point. Hence, the Roman kings resorted to debasement.

How did debasement work?

A metal like copper was mixed with the gold or silver in coins, while keeping their face value the same. So let’s say a coin which had a face value of 100 cents had silver worth 100 cents in it. After it was debased, it only had 80 cents worth of silver in it. The remaining 20 cents was pocketed by the ruler debasing the currency. Once the Romans started this, the rulers who followed also debased various forms of money regularly. And that is a practice that has continued to this day. These days, governments print paper money and pump it into the financial system by buying government bonds. Actually, most of this money is created digitally and resides in bank accounts, but “printing paper money” is a simple way to explain this.

How and where has that history repeated?

Governments at various points in history have worked toward destroying money and the financial system. The Romans under Nero were the first to do it systematically by lowering the silver content in the Denarius coin. The Mongols, Chinese, Spaniards, French, Americans and Germans followed, at various points of time. When gold and silver were money, the governments destroyed money by debasing it, i.e., lowering the content of precious met­als in the coins they issued. When paper currency replaced precious metals as money, the governments destroyed it simply by printing more and more of it.

Today, in the U.K., for example, the government does not print money on its own. It sells securities to the central bank, which prints money to buy them. This started with the Bank of Eng­land being tricked into lending endless money to the government in the late 1790s by Prime Minister William Pitt. This al­lowed the government to borrow as much money from the Bank of England as it wanted to, without having to get clearance from the Parliament. Governments all over the world continue with this practice of borrowing unlimited amounts from their respective central banks. The practice has only increased over the last few years, since the advent of the financial crisis.

The first volume of your planned trilogy covers “from Robinson Crusoe to the First World War”. Do you think some earlier practices like barter were actually better?

Not at all. In fact, if barter was better, we would have probably stayed with it, and money and the financial system wouldn't have evolved. Barter had two fundamental problems. The first was the mutual coincidence of wants. I have some eggs and I want to exchange them for salt. So, I need to find someone who has salt and, at the same time, wants to exchange it for eggs. What if the person who has the salt does not want eggs, and wants sugar instead? To complete the transaction, I need to find someone who has sugar and is ready to exchange it for eggs. A simple, straightforward transaction could become fairly complicated.

In a barter system that has four goods to be exchanged, there are six ratios of exchange. But imagine a situation where there are 1,000 goods to be exchanged under a barter system. There will be 499,500 exchange rates.

And the second problem with barter?

Indivisibility. Let us say I have a potter’s wheel and want to exchange it for some basic necessities like eggs, salt and wheat. One way would be to find someone who has these three things and is ready to do an exchange. If I am unable to find such a person, then barter does not work for me.

That demonstrates the utility of money.

The evolution of the concept of money, where a standardized commodity could be used as a medium of exchange, did away with the problems of barter. Also, money allowed people to specialize in things they were good at. People can work in areas they feel they are most suited to without having to worry about how to go about getting the other things that they might require to live a decent life. This specialization, in turn, leads to discovery and invention. The concept of money is at the heart of human progress.

You write that gold, which historically backed the value of coins or currency, “is valuable, because it is useless". Can you explain this oxymoron?

That may sound oxymoronic, but it is not. Gold is highly malleable (it can be beaten into sheets), ductile (can be easily drawn into wires), and the best conductor of electricity. Despite these qualities, gold does not have many industrial uses like other metals have. This is primarily because there is very little of it around. Also, pure gold is as soft as putty, making it practically useless for all purposes that need metal.

Now, why am I making this point? It is important to understand that when commodities are used as money, they are taken away from their primary use. If rice or wheat is used as money for daily transactions and to preserve wealth, then there are lesser amounts of rice and wheat in the market for people to buy and eat. This, in turn, would mean higher prices of grains, which are staple food in large portions of the world. If a metal like iron is used as money, it is not available for its primary use.

Why is gold different?

Given the fact that it is extremely expensive, and that it does not have many industrial uses, the mere act of hoarding gold does not hurt anyone or infringe their rights. That “uselessness” also helps it to retain value.

Silver has lots of industrial uses. If one owns silver during a recession, chances are that the price of silver, and thus its purchasing power, would fall, because there would be less demand for silver for its industrial uses. The same would be true for metals like platinum and palladium which are also used for industrial purposes. Gold would not be impacted. As analyst Dylan Grice wrote in “A Minskian Roadmap to the Next Gold Mania“ (2009), “The price of gold will be unaffected by any decline in industrial de­mand because there is no industrial demand!” Hence, gold is useful because it is useless. This is paradoxical, but true.

What determines currency values now, and what causes them to crash, as was the case in the South East Asian crisis of 1997?

Paper currencies inherently do not have any value. What makes them money is the backing by the government that has issued them. Hence their designation as fiat currencies. One paper currency’s value vis-à-vis another to a very large extent depends on the economic strength of the issuing country. Before the South East Asian crisis, the Thai baht was pegged against the U.S. dollar: one dollar was worth 25 baht. Thailand’s central bank ensured that this rate did not vary. Hence, it sold dollars and bought baht when there was a surfeit of baht in the market and vice versa.

Once economic trouble broke out in Thailand’s and other regional currencies, investors exited them en masse. They exchanged baht for dollars to repatriate their money. In the normal scheme of things, with a surfeit of baht in the market, the value of the baht would have fallen. But the baht was pegged to the dollar. The Thai central bank kept intervening by selling dollars and buying baht. But it could not create dollars out of thin air. It ran out of dollars, and the peg snapped.

The baht was a piece of paper before the crisis. And it continued to be a piece of paper after the crisis. What changed was the economic perception people had of Thailand. As a result, the baht rapidly depreciated in value against the dollar.

What is the relevance today?

Central banks around the world have been on a money-printing spree since the late 2008. Between then and early February 2013, the U.S. Federal Reserve System expanded its balance sheet by 220%. The Bank of England did even better, at 350%. The European Central Bank came to the money-printing party a little late and expanded its balance sheet by around 98%. The Bank of Japan has been relatively subdued, increasing its balance sheet by 30% over the four-year period. But it is now printing a lot of money, planning to inject nearly $1.5 trillion into the Japanese money market by April 2015. This is huge, given that the size of the Japanese economy is $5 trillion.

One of the lessons from history is that money printing has never really ended well. It has inevitably led to disaster. But we don't seem to have learned that lesson at all.

In a past interview, Dr. Ishrat Husain, former governor of the Central Bank of Pakistan, pointed out that if shareholders' equity in a bank amounts to 8% of deposits, then 92% belongs to depositors, ang although excessive risks are taken with the depositors' money, the upside gains are captured by the shareholders and managers. But, if they lose money, taxpayers have to bail them out. This “asymmetric relationship in incurring risk and appropriation of reward makes the financial sector more vulnerable to exogenous shocks.”

I totally agree with Dr Husain. I talk about this in some detail in “Easy Money.” Walter Bagehot, the great editor of The Economist, wrote in Lombard Street, “The main source of profitableness of established banking is the smallness of requisite capital.” This book was published in 1873. So things haven't changed for more than a century. The low shareholders' equity of banks makes the entire financial system very risky.

What would it take to mitigate that riskiness?

Anant Admati and Martin Hellwig explain this point beautifully in “The Bankers' New Clothes” (2013). Let us say a bank has shareholders' equity of 2%, as some had between 2007 and 2009. If the value of the assets falls by 1%, half of its equity is wiped out. The bank cannot issue any new equity. So what does the bank need to do, if it wants to move its shareholders' equity back to 2%? If the bank has assets worth $100, its shareholders' equity earlier stood at $2. If the value of these assets fell by 1%, the bank's assets are now worth $99. Its equity is also down to $1. To increase shareholders' equity back to 2%, assets must fall to $50 – meaning $49 worth of assets must be sold.

In times of trouble, a lot of banks need to do this, leading to a rapid fall in the value of their assets. This tells us that if banks have a little more equity, then they will need to sell a smaller amount of assets, which will make for a more stable financial system during times of trouble.

Therefore, shareholders' equity in banks needs to go up. This is a no-brainer, the influence of Wall Street notwithstanding. 

The Coal Plight of India

This article was first published in www.garp.org on January 23, 2014; Co-author: Puran Singh

http://www.garp.org/risk-news-and-resources/2014/january/the-coal-plight-of-india.aspx/

India has the fifth largest coal reserves in the world (293.4 billion tons as of April 2012), is the third largest producer of coal (about 580 million tons in 2012-13), and still ranks third in the list of top coal importing countries, with imports of 192 million tons in 2012-13 (see Figure 1).

Coal as a resource assumes critical proportions in India as 74% of coal produced goes into the power sector and 68% of electricity generated comes from coal. However, the power and steel industries, top users of coal, often complain about short supplies. In many instances, power stations stay idle for want of coal, and annual production fails to meet demand. While part of the shortage is attributed to inefficient allocation of coal blocks and lack of the latest production technology, leakage of coal through illegal mining also contributes.

 Figure 1: Key Coal Statistics for India

Source: Ministry of Coal, Government of India

Illegal mining refers to the mining done in contravention of applicable rules: Groups of people burst explosives and use unscientific methods for extraction. Done in a haphazard manner on small patches of land, it deters subsequent legal mining due to security hazard. Coal mines abandoned by state corporations are also used by illegal miners.

According to a study conducted by Xavier Labor Research Institute (XLRI) of Jamshedpur, India in 2008, 447 illegal mines fall under operational areas of three subsidiaries of Coal India Limited, a public sector undertaking of the Government of India. Central Coalfields Limited and Bharat Coking Coal Limited in the state of Jharkhand accounted for 195 and 49 such mines, while Eastern Coalfields Limited in the state of West Bengal accounted for 203 mines. This amounted to illegal production of 63,600 tons of coal each year. According to the study, at least a billion rupees was lost to the companies in Jharkhand alone due to illegal mining.

According to the report of standing committee on Coal and Steel 2011-12, 616 First Information Reports (FIRs) against illegal mining were lodged until September 2009, and only one officer was noted to be suspended by these companies for inaction to curb illegal mining. The recovery of coal, mined illegally, also remains miniscule (see Figure 2).

Figure 2: Recovery of Illegal Coal Mining in India

Source: Report of Standing committee on Coal and Steel 2011-12

For decades, mafia groups have controlled the illegal mining, which has been passed on to subsequent generations. The report notes that gangs form cartels for coal contractors and scare the prospective bidders out of the tender process for mining jobs. They control the labor unions and create nuisances such as unnecessary strikes to disrupt daily activities, assaulting or murdering family members of mine officials, etc. In some cases, these mafia groups may be backed by Naxalite militants.

A former member of Parliament and Secretary of the Center of Indian Trade Union (CITU), Jibon Roy, stated in 2010 that around 10,000 coal cartels in India steal 5 to 6 million tons. Based on this estimate, a loss of around Rs 18 billion annually was estimated at the then-prevailing market prices.

Figure 3: Coal Pilferage Cases Reported in India

Source: Coal Mafia, A Menance for Coal Industry, Infraline Energy, 2009

Over the years, the number of pilferage cases reported has declined (Figure 3). However, the incidences actually taking place may have an altogether different story to tell.

Government has not been able to check the illegal mining of coal. The presence of Naxalite groups in the coal production areas has made the problem even worse. According to the standing committee on Coal and Steel 2011-12, organized crime forms a nexus with officials at some places. Elsewhere, local authorities are terrorized by mafia and are forced to cooperate.

The committee noted that except for XLRI in 2008, no other study had been conducted by other coal producing states to quantify economic impacts of criminal activities in the coal sector. Similarly, a special report by Thomson Reuters noted that a Coal ministry tender for a study had no bidders for fear of potential mafia reprisals. Therefore, only estimates of losses to coal companies and the state exchequer are available.