VOLUME 8 ISSUE 1

FEBRUARY 2016

IN-FIN-NITIE

ALSO FEATURES
India: A Cashless Economy
Dragon enters SDR Market
NPA in Banking Sector

www.nitie.ac.in

StreetAtNITIE

IN-FIN-NITIE Vol 8 Issue 1

IN-FIN-NITIE Vol 8 Issue 1

MESSAGE FROM THE CONVENOR

Jeffrey Fuller, Principal Advisor of Human Capital.

Heartiest congratulations to all of you. With the release of yet

another edition of the magazine, we are getting bigger and better and
it gives me immense pleasure and satisfaction to be the convenor of
Street. In-FIN-NITIE has given me the opportunity to work with
the students and advance forth with the common goal of learning
and practising finance.
As always, In-FIN-NITIE brings you something new this time
around too. After a series of issues with identified theme and articles
related to that theme, the current issue just gave the students to write
about finance. Themes and matching articles aside, this issue has a
plethora of written words by students about whatever caught their
eye in the field of finance.
I applaud the effort of Street for their unstinting efforts. I hope they
strive to take the magazine to greater heights, and also hope that issue
will entertain you and keep you engaged about the recent happening
is the world of finance. We look forward for your comments and
wish to bring out more interesting issues in the future.

There exists a huge gap between the skills that are required by the industry and what the Indian academic
system produces. The objective of IIQF is to impart training to students in those skill-sets that are in demand
in the industry and make them industry ready, or as we call them The Street-Ready.

Dr. M Venkateswarlu
Senior Professor of Finance
NITIE

Want to become an Investment Banker

or a Financial Research Analyst
Stop dreamingAdd the skill sets required to become one

IIQF is the pioneer of high-end finance education in India. It is an education initiative of top industry practitioners
who have pioneered the most sophisticated financial technologies in India like Portfolio Risk Management Models and
Systems and Algorithmic Trading Systems using High Performance Parallel Computing.

A mere 25% of graduates that India produces every year is actually employable. Even though India is poised
to become the third largest economy in the world by 2050, out of all the graduates that pass out in an academic year, only 25% are suitable for getting inducted into the industry.

Certificate Program in
Financial Modelling in Excel

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required for making a career in Investment Banking,
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etc. This is a program where practicing Investment Bankers and Treasury Professionals teach the latest techniques
and modeling skills that are used in the industry. This
is a hands-on course, with extensive use of computers
and spreadsheets, the training will be imparted through
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Lot of financial professionals who do all kinds of financial

modelling feel handicapped to quite a large extent in implementing certain models that requires them to do considerable amount of programming in VBA. Merely knowing how
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on Financial Applications.

Leaning Outcome:
Create MS Excel based financial models.
Use the advanced tools of Excel.
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Carry out financial analysis, forecasting, etc.
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Basic knowledge of MS Excel
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Knowledge of MS Excel
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For more information log on to: www.iiqf.org or email to: info@iiqf.org

Contact Person: Nitish Mukherjee (+91-9769860151/ +91-22-28797660)

Patron
Prof. Ms. Karuna Jain
Director, NITIE

Convenor
Prof. (Dr.) M Venkateswarlu

Editorial Board
Ankur Gupta
Jitendra Agarwal
Raj Shah
Shashank Kale
Sundeep Tariyal

Design Team
Anish Kumar
Siddhartha Paul

EDITORS NOTE
The oil industry, with its history of booms and busts, is in its deepest
downturn since the 1990s. Encompassing the magnitude and the horizon
of its effects, this edition brings to you an exclusive article highlighting
the causes and the impacts of the slump in oil prices. Complementing
the analysis of Yuan devaluation presented in the earlier edition of INFIN-NITIE is a look into the possible effects of the entry of the Chinese
currency into the SDR basket.
As the air surrounding the speculation of Fed rate hike cleared, global
economies looked inwards for ripples it could cause. An abridged analysis
of its impact on major economies has been presented in this edition. With
the reverberation of GST in elongated session of Parliament sometimes
eulogising and sometimes putting it under the shadow of clouds, Is the
GST Bill Panacea for Indian Economy is an attempt to untangle the
complexities of the bill for the readers.
With the coming of digital India, this edition makes a case for a cashless
economy. Also, in our quest to bring to our readers a varied content, we
look into the issue of NPAs and the benefits that the banks can reap through
the use of analytics.
We were inundated with some brilliant articles that really made us toil
hard to find the best. We extend our sincere gratitude to all the authors
who burned the midnights oil to write such wonderful articles. In our
endeavour towards continuous improvement we invite feedback and
criticism at street.nitie@gmail.com

IN-FIN-NITIE Vol 8 Issue 1

IN-FIN-NITIE Vol 8 Issue 1

IN-FIN-NITIE

VOLUME 8 ISSUE 1

Decreasing Crude Oil Prices and its Impact on Global Economy

Leveraging Analytics for achieving Banking without a Bank

Is the GST Bill Panacea for Indian Economy

10

Street Wall- Masala Bonds

12

Fed Rate Hike: Impact

14

India: A Cashless Economy

17

Dragon Enters the SDR Market

22

Deconstructing Indian Bankings Achilles Heel- The Curse of Default

26

DECREASING CRUDE OIL PRICES AND ITS IMPACT ON

GLOBAL ECONOMY
- Manisha Manaswini, XIMB

Since 1990s there have been periods of booms and

the top oil producer that was out of market due to the
embargo is all set to become active exporter again,
the global economy will bump to spring out some
new mode of economic vibration.

bursts in oil industry and has impacted the world

economically and politically. The declining oil price
during 1985-1986 is considered to have contributed to the fall of the Soviet Union. The oil importing
countries like Japan, China or India would benefit
but the oil producing countries would lose. It may
enhance consumer oriented stocks but may hurt oil
based stocks. There may be
a GDP increase between
0.5% to 1.0% for India and
China but decline of greater than 3.5% for Saudi Arabia and Iran. Consistent
drop in oil price will result
changes in global economy. But now with the
added scenario of shale oil
supply and the largest importer of oil -USA cease to
be so anymore, the largest
consumer, China in slowdown period, Iran, one of

The three key variables of oil is

1) Production
2) Consumption
3)
Price per barrel

IN-FIN-NITIE Vol 8 Issue 1

IN-FIN-NITIE Vol 8 Issue 1

lated taxes and subsidies. The fall in the price of oil will
have a greater direct effect on inflation in countries in
which oil-related products form a large part of the
CPI basket. The size of the indirect effects, which is
to say how much other prices and wages are affected
by a fall in the price of oil, also varies from country to
country. The level of oil-related taxes also affects how
great the impact will be on consumer prices. Falling
oil prices give some relief to consumers with higher discretionary income, but given deflation
and low consumer confidence, they are unlikely to spend it but prefer to save. Falling oil
prices rather than helping increase spending
is pushing down the headline inflation rate
and making actual deflation a real possibility.

to lower cost of living and a lower inflation rate. Big

energy companies will be forced to cut down their
capital spending and reduce exploration budgets.
Profit margins will be squeezed. Lower oil prices will
drive down production. The small and medium sized
companies will face a great risk because of lower oil
prices.

Effects on inflation

Impact on Indian economy

From the figure, we can decipher the causes of changes in oil prices due to various events especially during
wars, crisis, global financial collapses the oil prices
have increased. So, during these times the supply
becomes low which in turn raises the prices of the
barrels.

Macro economic impact of falling oil prices

a)
Lower inflation
b)
Higher output

GDP effects
As the fall in oil prices due to an increased supply
of oil, it is assumed to have positive effects on global
economy .However, the effects will vary greatly from
country to country, depending on net importers or
net exporters of oil. In oil-importing countries, the
effect of falling oil prices on GDP growth is overwhelmingly positive. Households scope for consumption increases and companies production and
transportation costs decrease, which leads to higher
profits, investments and new recruitments like in India, Indonesia and China have more energy intensive
economies than developed economies and therefore
grow greater benefits from lower oil prices. In contrast, among the net exporters such as Saudi Arabia,
Russia and Iraq, GDP growth is dampening as export
revenues are falling. The tendency among certain
oil-producing countries to compensate for the decreased prices by producing and exporting more so
as not to lose too much export revenue has probably
contributed towards further price decreases in recent
months. Countries exporting oil are generally more
dependent on the price of oil than countries importing oil.

Impact on oil consumers world wide

More than 200,000 oil workers have lost their jobs and
manufacturing of drilling and production has fallen
sharply. Decline in oil prices has definitely benefitted
consumers but not to that extent as experts expected. The extent of retail prices varies from countries to
countries and from regions to regions of the world.
For instance in many countries retail prices are fixed,
thereby prices remain constant though world prices
change. There appear two cases for consumers:
a) If consumer thinks it is temporary then spending
pattern of consumers remains more or less the same.
b) If consumer thinks it is permanent then spending
on other things becomes high or pay down the debts.
Due to fall in prices, real wages become stagnant, this
in turn results fall in the cost of living is important for
giving Western consumers more income to spend. A
fall in oil prices is like a free tax-cut. The fall in oil
prices could lead to higher spending on other goods
and services and add to real GDP.

Lower oil prices help to reduce the cost of living.

Oil related transport costs will directly fall, leading

Impact on Macroeconomic entities

India to sustain a growth rate of 8-10% has

to work on measures to eradicate poverty,
meet its developmental goals and meet its
energy needs in the form of renewable and
sustainable form at competitive prices. India
is heavily dependent on coal to meet its half
of its energy requirements. The other half is
dominated by oil and gas. Oil meets 24% of
Indias commercial energy requirements .
India is the fourth largest oil consumer after
US, China and Japan. Indias reserves and oil
AD-AS Model of Falling Oil Prices As a Positive Supply Shock: Lower
production has little significance over the
Prices, Higher Output
years. So, it largely depends on imported
crude oil to meet its energy requirements. 70% of InLower oil prices lead to lower global inflation. In dias crude oil is imported from Middle East mainly
the assessment of the World Bank (2015), global in- from Saudi Arabia and Iran.
flation would fall by 0.40.9 percentage points over
2015 as a result of a
fall in oil prices of
30 per cent. However, the effects vary
from country to
country depending
on factors such as
the weight oil products have in the CPI
basket, the effects
of the oil price on
wages and other
prices,
exchange
rate developments,
how much freedom
of action monetary
policy has and the
structure of oil-re-

IN-FIN-NITIE Vol 8 Issue 1

IN-FIN-NITIE Vol 8 Issue 1

ucts. Lower growth prospects and a slowdown in real

estate and increased household savings is a matter
of concern. One of the reasons for lower oil prices is
the lower demand from China The falling oil price
may help stimulate growth in China especially in the
industrial investment field it may translate into huge
foreign exchange savings for China will bring down
business expenditures for downstream industries, logistic companies and airline industries, agricultural
products .This will in turn benefit the consumer sectors as lower inflation raises consumption through
higher disposable incomes.

The Saudi economy is dependent on oil revenues almost 90% of it. The fall in prices will result in a higher
government deficit and lower government spending.
It will have significant impact on job creation within
the country. But even after the drastic fall in oil prices, the Saudis havent cut their oil production in order
to push oil prices upward. The reasons for not doing
so are claimed to be entirely political in nature, as the
lower prices are likely to hurt shale oil production in
the US, which would be a long term positive for the
Saudis. Prices of OPECs benchmark crude oil have
fallen about 50% since the organization declined to
cut production at a 2014 meeting in Vienna.

Germany

When prices were increasing

a) The price increase was passed on to consumer
b) Rationalizing taxes and other levies on petroleum
products.
c) Making the National oil companies bear the burden.

Russia
Russia is one of the worlds largest oil producers. Russia loses about $2bn in revenues for every dollar fall
in the oil price, and the World Bank has warned that
Russias economy would shrink by at least 0.7% in
2015 if oil prices do not recover.

High domestic demand for petroleum products projected high investments into refining sector. India has
18 refineries and the government of India has made
a lot of efforts to place India amongst net petroleum
product exporter countries.

The war in Syria and Iraq has also seen Isis capturing
oil wells. They are making about $3m a day through
black market sales and undercutting market prices
by selling at a significant discount around $30-60 a
barrel.

The German economy depends largely on manufacturing. So, decrease in oil prices is a crucial determinant for its economy. It will accelerate car purchases
worldwide. A higher oil price favours fuel-efficient
cars and German car industry is at the forefront of
innovation. But in long run vehicles will be fuelled
by cheap solar or wind energy thus eliminating the
changes in oil price.

Other economic impacts of lower oil prices

1) Reduced profitability for alternative energy sources.
2) Delay in investment into alternative greener
forms of energy, such as electric cars.
3) Decline in car use leading to decrease in traffic
congestion and environmental costs of petrol use.

OPEC

Despite this, Russia has confirmed it will not cut production to shore up oil prices.

Although lower oil prices are always welcomed by

consumers, the global impact of the fall in oil prices is much more difficult to interpret, since many
countries depend on oil as a major revenue source
and lower prices hurt their economy. Lower oil prices could also signify a weak global economy, which
could more than outweigh the benefits of lower oil
prices.

The Russians need oil prices to be above US $105 a

barrel to balance Russias budget; market conditions
in which the prices fall below this will either cause
the Russian government to run deficits or force it to
cut down on its other development programs.

Impact on US Economy
The forecasted impact on GDP due to lower oil prices
is accounted for 0.2-0.4 percentage point. This sector
has added 5000 jobs in the past 5 years. So, it will
have minimal impact of job cuts over the economy in
the broader sense. Lower oil prices benefits major oil
consumers like Goodyear, UPS, American Airlines,
General Motors and Carnival. The Fed may keep interest rates lower and thereby keeping a check in inflation. But Lower oil prices will also negatively affect
the profitability of US energy companies such as Exxon, Chevron etc. It has been this growth in US energy
production, where gas and oil is extracted from shale
using hydraulic fracturing.

Iran
Though in the short term the impact on Irans economy will be cushioned by the governments use of a
fund to counter lower oil prices, in the long run it is
estimated that Iran needs oil prices to be above US
$130 to balance its budget. The nuclear deal with Iran
will be positive for Irans economy, but it would also
signal that Irans oil would be added to the present
supply of oil on the market, which may put further
downward pressure on oil prices.

Shale has essentially severed the linkage between

geopolitical turmoil in the Middle East, and oil price
and equities.

China
Though China is going to become largest importer
of oil still the benefits of falling prices are not as expected due to government raising taxes on oil prod-

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IN-FIN-NITIE Vol 8 Issue 1

Decrease
in no. of
visits
No Decrease
Moderate
Decrease
Substantial
No Resp.

PNB

ICICI
Bank

% Change

% Change

22%

26%

24%

54%

52%

53%

12%

18%

15%

12%

4%

8%

Total

Table 1: A comparative study of VAS and customer

retention by faculty of MDU, Rohtak
There has been a significant increase in takers for value added services like ATM banking, internet banking, tele-banking. Post availability of VAS, we can
see that customers have decreased their bank visits
considerably but still they prefer visiting the physical
branch when it comes to decisions regarding investments, processing of loans.

LEVERAGING ANALYTICS FOR ACHIEVING BANKING WITHOUT A BANK

The banking industry is going through major dis-

ruptions with several new players entering the market and seizing significant market share across the
banking value chain.
Weaker customer experience levels have opened the
doors for many non-bank competitors. Technology
companies (like PayUMoney, m-rupee), retail firms
(like Paytm) and social/crowd source fund aggregators (like KickStarter, GoFundMe) are few such entities which have gained significant customers in a
short period of time.

-Richa Agarwal and Dheeraj Lamkhade, Welingkar Institute of Management

Retail Bank: It is a visible face of the bank to the public, which deals which with the retail customers directly.

is core of the business. Due to Hyper-competition in

the market the industry is facing challenges to maintain this relationship.

Retail banking is not a new phenomenon in India.

It has become synonymous with mainstream banking for many banks in last few years. It is typically
mass market banking where individual customers
use local branches of larger commercial banks. Services offered include savings and checking accounts,
mortgages, personal loans, debit cards, credit cards
and so.

Lost personal touch

For Banks, growing cost advantage made the service
industry move from a physical model to a digital one.
As per BCG analysis an average bank transaction
through a branch costs 40-50 INR where as a mobile
transaction costs 0.20 INR.

The retail loans constitute less than seven per cent of

GDP in India Vis-a- Vis about 35 per cent for other
Asian economies: South Korea (55 per cent), Taiwan
(52 per cent), Malaysia (33 per cent) and Thailand
(18 per cent). (Source: International Journal of Recent Scientific Research)

Let us first understand the main types of bank and its

core functions:
Commercial Bank: It is also known as business banking, which deals with corporates customers.
Investment Bank: It is that division of bank, which is
used to assist the ways to create capital to individuals,
corporates and the government.

Thus a Digital model (Physical + Digital) can give

banks a small but significant window to build relationship with the customer.

Industry Challenges

Customer Churn Analysis

When a customer leaves a bank, not only the future life time value of the customer is lost but also
the total marketing spend in acquiring the customer
is accounted. With lucrative products in the market
and lower switching cost for customer, there is a big
challenge for banks to retain the customers. Small
changes in customer churn can easily bankrupt the
business or can turn a slow moving business into a
power house.

For customers, advancements in technology and

multichannel service availability, has resulted in customers using PCs and smartphones for interacting
with banks. This resulted in reduced stickiness and
lower switching costs, which in turn affected the
banks profitability.

For Example: Past data showed, a customer is more

likely to buy a home loan after 3-4 years of regular
income. He/ She goes around searching for lowest
rates and offers associated with his employer and
the builders. If this customer switches to a new bank
there is a high possibility that he/she will move their
salary account too. So, banks need to provide right
information at right time for making the cross-sell
happen.

A recent report shows a relative study of customer

visits to bank with respect to new value added services offered, considering ICICI and PNB data.

In retail banking industry the customer relationship

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IN-FIN-NITIE Vol 8 Issue 1

Risk Assessment
The total credit off-take has seen the growth side
due to the positive economic conditions. Risk based
funding still continuous to be a major consideration
factor for decision making.

Over the period banks have implemented various

reporting and descriptive analytic systems like the
CRM, accounting systems, data mining systems
which have resulted into multiple disparate systems.
But now the need of the hour is to integrate data from
all these systems for providing predictive and prescriptive analytics onto a single dashboard.

It is believed that with years of data in the pocket,

we can start developing BI models which can act as a
supporting agent for risk assessment.

Below are few of the banking segments with significant use of analytics:

1. Customer behavior and marketing:

Banks are already analyzing your
spending patterns. One of my recent
interaction with a telebanking executive revealed that they are tracking my frequent flying patterns and
have suggested credit card insurance
in case the card is lost in-travel. The
concept is backed with a great creative idea of providing travel ticket
and hotel booking assistance in case
of credit card theft at nominal premium of 1000 INR per year. But there is
an issue with the data science behind
selecting a customer like me who is a student without
any regular income, who always pre-books a ticket
and havent booked a hotel yet.

Figure 1: Reserve bank of India, TechSci research

Analytics the way forward

With growing competition it is imperative for banks
to offer an interactive and consistent online banking
experience coupled with high-quality branch banking service. In order to achieve faster time to market,
banks need to anticipate the customer needs well in
advance. Analytics thus play an important role in developing a base for future banking products.

Time-to-market reduced by 25%

Operating cost for a new product reduced by 15%
Conversation rate in trigger based selling was 45%
higher than usual.
Target customer campaigns helped in increasing
the assets by 15% over normal YoY growth

assessment.

Business Analytics can thus help in creating refined

customer risk profiles for a better understanding of
assets.

3. Product and portfolio optimization:

2. Risk, fraud and KYC:

Multiple product lines spread across the globe, it is

very important for the company to find out the key
performance indicators to determine the asset pool
quality. This can also help in analyzing the effect of
pre-payments on the cash-flows and effects of payment defaults.

Recently I had attended this Analytics roundtable

conference held at Welingkar Institute of Management, Mumbai. The key speaker for the event was
from SaaS global who talked about how SaaS helped
the Income Tax department in order to detect below
2 types of risks:
Know Unknown Tax evasion happens and it
is one of the know issues for the IT office, SaaS helped
them identify the unknown side The evaders.
Unknown Unknown The same team was
able to discover another VAT refund scam which was
totally unknown to the IT department.

If the mortgage portfolio is used for trading/investing, analytics can be used to calculate risk of these
portfolios.

Even though the data is important, the right data is

essential. The clear business goals gives the understanding of whats important to the business and
helps analyst to find what data counts or should be
counted.

Reducing NPAs has been one of the top challenges

for most of the banks. Post 2008 crisis there has been
lot of compliance requirements in the banking industry. The introduction of Basil III norms and new
regulations in the industry (like credit card accountability, responsibility and disclosure act), has significantly increased the operating cost due to additional
activities like record keeping, auditing, portfolio risk

Banking without a bank is the new

trend.

It will be interesting to watch how the veterans in

banking industry will compete with this new trend.

So it is important to have a balance between creativity and discipline, between art and science.
Some of the predictive and prescriptive analytics
techniques for significantly improving the marketing
outcomes without proportionately increasing marketing budget are:
Social media listening and measurement of customer sentiments
Customer segmentation Identifying profitable
customers, profitable cross and up selling products,
possible avenues for migrating customers from less
profitable relationships to more profitable ones.
Omni Channel Engagement and Campaign management
Trigger based cross selling Customers are irritated with the telebanking calls for old vanilla products
like credit card, insurance. Identifying the triggers in
the customer behavior and then selling the product
will give higher probabilities of a sell.

Figure 2: Key focus areas for Analytics

Some examples for impact analysis are:

IN-FIN-NITIE Vol 8 Issue 1

IS THE GST BILL PANACEA FOR INDIAN ECONOMY?

-Ajay Singla, IIM Raipur

In India, currently we have a number of indirect

taxes including excise duty, countervailing duty and

service tax levied by central government and value
added tax, octroi tax, entry tax and luxury tax by the
state government. All of these add a lot of complexity
in the whole taxation system. The panacea is nothing
but Goods and services tax (GST). It has been proposed that GST would be implemented from April 1,
2016 by the Government of India.

ample, currently supply chains have been decided in

such a manner so as to minimize the Central Sales
Tax.
GST would bring down the inventory costs. The
people at each stage of value addition would get tax
credit on the inputs used by them. GST would result
in repricing of the products after variations in the
margins over the cost. Also the timing of payment of
tax will also get changed which will force the man-

IN-FIN-NITIE Vol 8 Issue 1

manufacturer sells the output at 1500 lakhs, he has
already paid a tax of 100 lakhs on the inputs used
for production. Now he would pay only 50 lakhs additionally because he would get a tax benefit of 100
lakhs while calculating tax of 150 lakhs on sales. Thus
GST decreases the burden on the manufacturers.
This is true with the people at all stages of value addition. The outcome is the reduction in the overall tax
which would reduce the cost of the production and
thus boost the output in the long run.
GST would reduce the overall tax burden of the consumers which is currently around 25%-30%. GST
brings a pool of benefits for all. It is a very transparent tax system and would simplify the tax complianc-

Goods and Services Tax would work as a comprehensive tax on manufacture, sale and consumption of
goods and services except petroleum products, alcohol for human consumption and tobacco throughout
India replacing taxes levied by the Central and State
governments.
Over 130 countries have already implemented GST
system to ensure an efficient and transparent taxation
system. In the proposed GST system, the customers
will have the burden of only the GST charged at the
last stage after getting benefits of tax charged in earlier stages. According to the recommendations, the
Centre will collect tax on inter-state business activities. The tax amount would be distributed between
the Centre and the states according to the set provisions. The council for GST consists of Union finance
minister, union minister of state of finance and the finance ministers of all the states. To mitigate the losses of the state governments due to incoming of GST,
the Centre is planning to levy an additional tax not
exceeding one percent on inter-state trade in goods
and services. The power to make rules related to inter-state business transaction will be available to the
Centre while the state would have the power related
to intra-state business activities.
GST will help in elimination of multiplicity of taxes.
This system would rationalize the overall tax structure and simplify the compliance procedures. There
would be less errors and duplication would be mitigated. A major distinguishing feature is of the proposed GST is the destination principle. Under this
principle, exports would be zero-rated while the taxes would be imposed on imports. Similarly, the taxes would apply in the destination state instead of the
point of origin. GST would change the ways how
the companies operate their businesses. For ex-

ufacturers to plan their cash flows accordingly. The

software which is currently in use for recording the
transactions will also become redundant and will
need to be replaced. The employees would have to be
educated to ensure smooth implementation of GST
system.
Let us understand with an example how the GST regime works. Assume there is a sugar manufacturer
that purchases raw materials at 1000 lakhs per batch.
The manufacturer obtains an operating profit of 300
lakhs and incurs a processing cost of 100 lakhs. The
total tax amount to be paid by the manufacturer to
the government would be 250 lakhs. It includes 100
lakhs on procurement and 150 lakhs on the sales. But
if we have GST in place, the total tax required to be
paid is just 150 lakhs instead of 250 lakhs. When the

10

es. Customers would come to know the exact amount

of tax paid by them on the items of purchases. The
tax burden would be distributed equally between
the manufacturing activities and services. After the
incoming of GST, there would be no hidden tax
and thus doing business would become easier. GST
would prove beneficial for the country as a whole. It
would promote exports and provide more employment which would boost the economy.
Currently there are separate taxes for goods and
services which have created a lot of confusion. It requires division of the transaction values separately
between goods and services for taxation purposes
which makes the whole process very complicated.
This problem would not exist in GST system. There

would be no economic distortion as GST would be

levied only at the final stage and not at various points.
GST would make the tax administration corruption
free.
But there is a lot of opposition against GST in the upper house of parliament where the bill could not be
passed. GST excludes petroleum and alcohol products. Introduction of GST would bring heavy loss
to the exchequer. The proposed GST rate of 16% is
higher compared to current 12.5 % VAT. Introduction of GST would create huge revenue losses for
some states. So they are reluctant to support GST.
There is some disagreement between states and the
Centre regarding tax sharing provisions. Some of the
critics say that the real estate industry would heavily suffer because of GST. It is estimated that GST
would increase the cost of new houses by about eight
percent and thus the demand will decrease by about
twelve percent. Some of the economists are of the
view that GST is nothing but the old wine in the new
bottle. They dont find GST to be very different from
the present indirect taxes. GST is projected as a single taxation system but actually it is dual in nature
where both Centre and the state play important roles.
Currently some categories of persons and goods are
exempted from central excise which is not available
in the proposed GST system. So, it would affect their
businesses negatively. Some people think that macroeconomic factors like production, exports, government support etc. are the factors which promote
growth. A country has never revolutionized because
of the taxation system in that country.
There is a lot of support for GST from the corporates.
But the implementation of GST is not an easy task.
GST can not be launched in India effectively without adequate IT infrastructure. GST requires proper
IT infrastructure not just at administration level but
also at the tax payer level. A lot of changes are needed
in the present IT infrastructure to enable GST implementation. But this task is very challenging and costly for IT department. Bringing substantial changes in
such a short span of time adds to the problem. As of
now, the GST bill has been passed by the lower house
but yet to be tabled and passed in the upper house
of the Parliament. The opposition parties would not
let the bill pass easily. So it is very much necessary
to convince those parties. For successful implementation of GST bill, the state governments should also
to be taken into confidence. The government should
adopt a flexible stance and appreciate the suggestions
to make it happen.

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Government borrowing cost as well as mortgage

rates will increase.
All this and much more is there for USA with this
hike. But this hike brings about both, good as well as
bad effects.
This hike will have a crippling effect on global markets as it ripples through commodity prices, and
weakens currencies in comparison to US Dollar due
to significant capital outflows. Even for the U.S economy, the exports will become less competitive in the
global market and inflation will be reduced (as we all
know a little inflation is good for the market).

FED RATE HIKE: IMPACT

-Shivangi Sharma, Institute for Financial Management and Research

On December 16, 2015, Fed Open Market Com-

mittee (FOMC) declared an increase in the Fed fund

rate by 25 basis points. This was the most long awaited decision and many countries were eying towards
this hike. This rise in rates came after 7 years. So let us
first start with what this Fed hike is all about.

Fed Hike: All you need to know

Just like any other countrys Central
Bank, The USAs central bank (Federal
Reserve) announced a hike in its interest
rates by 25 basis point. This announcement comes after almost a decade- from
zero rate of interest to 0.25%. This hike
ends the ultra-loose monetary policy
which was initiated to fight 2008 financial crises. Typically, in any economy, the
interest rates are increased to fight off
inflation. During inflation, the money
flow is in abundance and is also cheap.

So in order to control this flow, the central bank increases interest rate (i.e., cost of borrowing money
becomes expensive). So what could be the possible
reasons for this hike?
As per Federal Reserve, Job Growth is the main reason for such increase. Unemployment is falling in
USA since the recession, which is a good sign. So a
rise in interest rate will curb inflation thereby helping
to boost employment.

Also, savers will also see higher rates which means

that different saving vehicles will start offering higher
returns on safe investments. More returns will bring
in more investments.

As far as benefits are considered,

For savers, low interest rates have brought about the
financial equivalent of a long drought.
A positive inflation scenario after a rate hike might
include lower prices of imported consumer goods,
due to a likely higher exchange value of the dollar if
the domestic rate increases are not matched by policy
tightening in other major economies.
After the crisis, lending came to a halt. Now lending has resumed but credit remains tight in some sectors. When interest rates rise, financial institutions,
including banks, may part with their money more
freely.
As a rate hike brings better returns to savings vehicles, the nations senior citizens should enjoy better
paydays.
Stock prices may start to make more sense.
So after understanding what rate hike is and how itll
impact USA, let us now shift our focus to India.
Any change that takes place far away
from our country, definitely have an
impact on our economy. The economists always wait for such instances
where even a small change in some
other economy, can bring about a
meager effect on ours. Be it 2008 Financial crisis in USA or Chinas step
to devalue its currency, all such happenings may have an impact on our
economy.
So looking at this rate hike, how
could this possibly affect India?

Federal Reserve; Bureau of Economic Analysis; Bureau of Labor Statistics

14

Looking at the past trends, we can

take lessons from how markets behaved when similar

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IN-FIN-NITIE Vol 8 Issue 1

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hikes have taken place. Since 1983, the Fed has raised
rates six times, the last one being in 2004. For Indian markets, however, the last three in 1994, 1999
and 2004 are more relevant since foreign money
data has been maintained by SEBI only from 1993
onwards.
The immediate impact of the hike on India seems to
have been pretty mellow owing to the markets seeming to have effectively priced in the move.

Indian Currency and Inflation: Because of an

increase in interest rates, there is a high chance that

rupee will depreciate. This will make India more
competitive in exports, but because of slowdown, India has not been able to take advantage of the situation. Being an importer of crude oil a depreciating
rupee will add pressure on inflation.
If Fed will increase its interest rate then a strong
message will go around the world that the economic
condition of the USA is improving. Due to this investor from around the world will pull out their money
from other countries whose economic policies are
not so good like India. Investors pull out their money from Indian market that will put upward pressure
on rupee and rupee will become cheap compared to
dollar (for e.g. $1= Rs 68). And when this will happen, import will become more costly and export will
decrease, hurting CAD and eventually BOP crisis.

Stock markets: This rate hike has been widely an-

ticipated. The FIIs have already been pulling money

(around $2.5 billion) from equity market. Hence, the
correction in the market started long before because
of the speculation. This was one of the prevailing reasons for the continuous fall of stock markets.

A series of hikes in interest rates in the US over a

period of time will raise the borrowing cost for carry trade (borrow from US and invest in India), and
thereby reduce their risk-adjusted return in India.
On the other hand, the Reserve Bank of India has
embarked on cutting interest rates, and has cut repo
rates twice by 25 bps each. A cut in India and a hike
in US further reduces their risk-adjusted return. Experts also say that this may make US bonds more attractive. The US is in any case considered a safe haven, and investors looking for stable returns will be
more attracted towards US bonds.

Investments: A rate hike will increase the strength

of the US Dollar and make it more difficult for Indian investors to invest in American equity. A normal
middle class Indian citizen, will not feel much of an
impact. It will most likely make American manufactured exports more expensive. This means that the
prices of imported diamonds, aircraft and electric
machinery, and medical instruments could rise because they are Indias largest imports from the United States. But again, as a normal middle class Indian,
this wont affect you much.
So, overall, India is better placed than most of its
peers. Its external balances have improved significantly (about $65bn to $353bn as of November 2015).
Plus, only a small part of Indias sovereign debt is held
by foreigners or is denominated in foreign currency.
All this can have a positive impact on our countrys
economy despite the rate hike. Also, institutions such
as RBI are established to protect our economy from
any sort of externalities.

References:
http://www.nytimes.com/interactive/2015/09/12/business/economy/fed-rates-explainer.html?_r=1
https://anequivocalomen.quora.
com/Rising-Interest-Rates-in-theUnited-States-and-its-Impact-onthe-Indian-Economy
http://www.financialexpress.
com/article/markets/indian-markets/how-indian-markets-willreact-if-us-fed-hikes-interestrates/136766/
http://www.thehindu.com/news/
cities/mumbai/business/what-fedrate-hike-means-for-india/article8028102.ece

Downward trend in Indian Equities

16

INDIA: A CASHLESS ECONOMY

- Akshay Ratan and Aishwary Kumar Gupta, XLRI

In the words of famous French poet, Victor Hugo,

no one can stop an idea whose time has come, and

with FY2016 Budget and recent push of envisioning
a Digital India by PM Narendra Modi, the idea of India as a cashless society has become of paramount
importance. The annual report of the RBI for 201314 estimates the cash currency in circulation to be
around Rs. 12.83 trillion with a CAGR of 10% over
the past two years. The banks only have a nominal 5%
of the amount with them, ultimately costing us about
0.25% of our GDP in maintaining and managing the
cash-based economy of India which has become one
of most cash-intensive economies in the world having a Cash-to-GDP ratio of 12%.

Cashless economy is defined as a scenario of an economy in which all monetary transactions have to be via
electronics channels such as debit and credit cards,
electronic clearing payment systems such as IMPS,
NEFT, and RTGS in India. The journey of the nation
from a cash-based to a less-cash and eventually a cashless economy might be a long one, but it will have a
deep impact by providing with a methodological and
transparent structure to improve the delivery of services for the citizens. Transparency and accountability under a cashless system is very well recognized by
the society. Apart from the fact that cherishing for a
sharp economic growth of India is not possible with
such over-dependence on cash in circulation, but also
analyzing the value-chain of social developmental
projects, the government has realized the presence of

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substantial cash leakage resulting in tax evasions and
black money. Cashless transactions would by and
large ensure that these loopholes in public systems
are plugged and benefits are delivered to the intended
beneficiaries. As a nation, the reforms such as JAM
trinity (Jan Dhan Yojna, Aadhar, & Mobile Banking)
to implement direct transfer of benefits to the citizen,
is a big step in reducing the fallacies of cash transactions and thus fueling the economy to success. A
Moodys recent research concluded thatthe impact of
electronic transactions to 0.8% increase in GDP for
emerging economies and 0.3% increase in developed
ones. The benefits of a cashless society is not limited
to effective government administration but more to
individuals. Cashless transactions with secure digital system ( implementing biometrics) addresses the
inconvenience of long queues outside ATMs, bearing transaction costs of using ATMs of other banks,
risk of carrying currency in wallets and even makes
it easier to loan or borrow money. There would be
a considerable reduction in volumes of cheque and
demand drafts with very few people actually carrying
cash with them. From the business perspective, the
result of this digital wave will help the E-Commerce
sector grow more rapidly, and will lead to reduced
logistic costs and increased security with a drop in attempts to steal cash. Further, improvement in credit
access would eventually contribute in the growth of
Small and Medium Enterprises in the long run. Specialized payment entities such as Giro, aggregating
the billers and unifying the framework of payments
induced by payer to payee, intends to bring a more
effective and efficient system of payer-induced payments throughout the payment life cycle. Advanced
Nordic economies (such as Denmark, Norway &
Sweden), for instance, have ensured the successful
cashless transactions of smallest of services, and it
has consistently proved it to be a cheaper, hassle-free,
and secured mechanism.
Historian Ramachandra Guha while commenting on
the diverse nature of our nation wrote in his book,
India after Gandhi, how it is so difficult to even encompass the nation like India in our minds. The path
to a cashless economy has to be much strategized but
not before identifying the potential roadblocks and
stakeholders to the issues which plague this vision.
The stakeholders discussed here are crucial in understanding the strategy to be proposed to envision
an India with an entirely cashless economy. One of
the primary stakeholder is the informal, unorganized
business sector comprising of retailers, suppliers and
service providers. The lack of access and adoption to

digital technology, this unorganized sector neither

has the infrastructure to offer services for cashless
transactions, nor any inclination to incentivize their
customers. Further, cash-based transactions leave a
room of opportunity to avoid payment of taxes, and
thus there lies a negative connotation for government
to encourage them to shift their transaction practice. Some of the incentives which the government
can strategize is to set up revenue models for facilitating payments towards Government run utility
payments, simplifying the approval process & giving
income tax rebates for those retailers who are reporting more than 50% of their customer-transactions
through electronic means. For instance, a percentage
reduction in the VAT could be considered on all card
transactions made by merchants.
This in turn would ensure than the retailers would
advertise their business accordingly resulting in promotion of cashless transactions. On the similar lines,
rural economy is also not a walkover while strategizing for a cashless economy. India accounts for almost
21% of the worlds unbanked population, and thus envisioning an India with digital financial services first
requires enabling our masses with linked banking
facilities. Through Direct Benefit Transfer Scheme &
Pradhanmantri Jan Dhan Yojna, the government has
managed to make huge improvements in financial
inclusion and financial awareness. The latter scheme
launched in 2014 has already facilitated the opening
of more than 180 million bank accounts. This leads to
analyzing the second stakeholder - Consumers. The
perception of the ease of transaction through cash,
the habit of having a bargaining power and perceived
no-advantage from the use of cards and electronic
transfers remains as an important hurdle in the task.
India has always been an economy which focuses on
savings. The financial discipline that a middle-class
family man in India has grown up in, the branding of
the credit cards and online banking which talks more
of an affluent lifestyle and impulse buying rather than
enlisting the utilitarian financial aspects of cards has
done little to entice them for using credit cards. Unless these challenges of helping the consumers shift
their habitual transaction patterns, the idea of a cashless society will elude us. The most important thing
to be done here is to largely incentivize the electronic
payments. Card users should be granted discounts,
banks should promote cards and e-transfers by removing the transaction charges and confidence must
be given to the consumers that cashless system is
an end to end framework. For this, the government
needs to create a solid ecosystem to create a value
chain right from manufacturers to distributors to

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IN-FIN-NITIE Vol 8 Issue 1

make the services to the end user fully compatible
and as extensive as possible. Removing additional
transaction costs such as Merchant Fee, convenience
fee, interoperability of wallets, tax incentives, and delivery of a secure system along with constant interventions to make the consumer aware are some of the
key steps which can be taken to ensure that the consumers feel comfortable in making this tectonic shift.

tion in the economy. The perspective to see the entire

situation need not be to oppose the use of cash, but
to gradually assist the use of cash, and ultimately to
substitute the use of cash. Cashless transactions can
thus become a reality to be successfully implemented
in India.

Smartphones could be a big game changer in helping

the society to seamlessly transition itself to a cashless mode. With gradually every Indian household
possessing a smartphone, branchless banking in remote rural areas can be enabled, thus making the
smartphones a Point-of-Sale (POS) credit card terminal. According to a data analytics report, in just
three years the number of transactions using mobile
banking has increased 4 times to 95 million while the
amount transacted has increased three times to 60
billion Rupees. The new paradigm shift of a cashless
era would come from this smartphone wave increasingly penetrating the inaccessible areas of the country. The telecom industry has to spearhead this digital change and lead India for a transformation.

References

The status quo is that we have a mix of cash and cashless transactions taking place, and many policies by
the Government and the Reserve Bank of India are
pushing towards a less-cash economy by giving various kind of incentives to the stakeholders discussed.
With a cashless society, the nation can aspire to put
its economy on a fast track, with improved credit access, financial inclusion, reduced tax avoidance and
more importantly lean balancing the cash circula-

Anand R. (2015, June 15). Ready for a cashless economy?

Live Mint. Retrieved from http://www.livemint.com/
FE Bureau (2015, June 18). Tax sops, other incentives proposed to boost e-transactions. The Financial Express. Retrieved from http://www.financialexpress.com/
Zandi, M., Singh, V., & Irving, J. (2010). The impact of electronic payments on economic growth. ECONOMIC ANALYSIS.
RBI Notifications (2014, November, 28). Implementation of
Bharat Bill Payment System (BPPS) Guidelines
Andersen, T. M., Holmstrm, B., Honkapohja, S., Korkman,
S., Tson, S. H., & Vartiainen, J. (2007). The Nordic Model. Embracing globalization and sharing risks. ETLA B.
Harrison V, (2015, June 2). This could be the first country to
go cashless. CNNMoney. Retrieved from http://money.cnn.
com/
Chaia, A., Dalal, A., Goland, T., Gonzalez, M. J., Morduch, J.,
& Schiff, R. (2013). 2 Half the World Is Unbanked. Banking the
world: empirical foundations of financial inclusion, 19.
FE Bureau, (2015, June 27). Data Drive: Less currency for
a cashless economy. The Financial Express. Retrieved from
http://www.financialexpress.com/
Petrone N, (2015, October 20). Why and How should we
move towards a #Cashless Society? New initiatives afoot in
Ireland and India. Lets Talk Payments (LTP). Retrieved from
http://letstalkpayments.com/

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Current SDR Basket

9.40%
11.30%

US Dollar

41.90%

Euro
British Pound
Japanese Yen

37.40%

SDR Basket by October 2016

10.92%
US Dollar

8.33%
8.09%

41.73%

Euro
British Pound
Japanese Yen
Chinese Yuan

DRAGON ENTERS THE SDR MARKET

Definition:

30.93%

-Milan Modi and Preyas Jain, SIMSR

dollar, Euro, British Pound and Yen (Japan)

Statutory Drawing Rights is a kind of reserve of foreign exchange assets comprising of leading currencies globally and formed by the International Monetary Fund in 1969.

AND

Description:
Before 1969, all the trade internationally took place
in US Dollars. So if Brazil wanted to import Ford car
from USA, the latter would accept the payment only
in dollars. In order to settle accounts, the world used
US dollars and Gold. The countries could use gold
holdings and commonly accepted currencies to buy
their local currencies abroad in order to maintain
their exchange rates. But the world trade increased
at a rapid speed and thus the supply of gold and the
dollar was insufficient in the new developments of
financial markets. In order to address the issue, IMF
created an asset that could be exchanged for freely
usable currencies - Special Drawing Rights (SDR).
SDR consists of 4 major currencies of the world - US

22

and is also known as a basket of national currencies.

After a period of 5years, the composition of this basket of currencies is reviewed and the weightage of
currencies may be altered. This adjustment of weights
is done by taking into account the contribution by
its member counter to world trade and national foreign exchange reserves. As of Sept 2015, SDRs worth
$204.1 billion had been created and allocated to
members of IMF.
During the Global Financial Crisis of 2008-09, the
SDR allocations totaling 182.6 billion played an important role in providing liquidity to the global economic system and augmenting member countries
official reserves amid economic turmoil.
The below was the percentage share of four national
currencies in the SDR as on 2011 to 2015. The image
also shows the new share by with Chinese Yuan eating up a small share of the pie.

The Entry of the Dragon

IMF decided to include Yuan into its SDR basket as a
5th currency, along with the British Pound, the Euro,
US Dollar and the Japanese Yen with effect from 1st
October 2016.
Central banks across the world use their reserves of
foreign currencies to buy their own currency or pay
international debts. Now the inclusion of the yuan
would mean these banks who tend to hold their
foreign exchange reserves in either dollars or euros
could have an option. For many emerging economies
of the world, trade linkages with this Asian giant are
already strong and now their reserves could reflect
this understanding.

What does the move by IMF suggests?

This addition of Yuans in the basket indicates that
the IMF believes about the global standing of the

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Chinese currency, similar in strength to other four
currencies currently in the basket.
The decision to include the yuan is landmark milestone in the assimilation of the Chinese economy
into the international financial system.
Although China is marred by other problems, this
assimilation shows the progress that the Chinese authorities have made in the recent past in reforming
Chinas economic and monetary systems.

How will this recognition affect the yuan?

In the short run:
The Chinese economy was growing strong for the
past ten years. However in it the growth numbers
started ailing since 2014. The country also devalued
its currency to increase its exports in the world. In
order to have a firm hold in the global trade of currencies, China was pursuing since many years to enter this basket. As this integration is sustained and
further deepened, it will bring about a strong international financial system, which shall help in achieving a stable Chinese economy. This in turn will keep
the world economy also stable as far as impacts from
a manufacturing giant like China is concerned.
The currency should be freely usable this is one
of the pre-requisites for a currency to be included
in SDR basket. The Peoples Bank of China (PBoC)
has also clarified that it would allow the currency to
be increasingly determined by market forces. In the
near future, this may lead to more volatility.
In the long Long-run:
The inclusion of the yuan is likely to result in the
currency becoming more international. Many Central banks around the world will be encouraged to
increase their holdings of the yuan. Asian countries
like South Korea, and Indonesia are planning to increase their Yuan reserves.
Other central banks may also take steps to increase
the percentage holdings of yuan to diversify their
foreign exchange reserves. Moreover, the portfolios
of international entities like the World Bank are inter-linked to the SDR basket.
The currency may appreciate in the long-term as
there may be an increased demand from the investors for the yuan.
If the currency does appreciate, it is likely to back

the governments determination in rebalancing the

economy. The Chinese governments plan to decrease
the economys reliance on exports and investment
and to increase the contribution of consumption to
economic growth reinforces its intention.

nas over-capacity as well as its devalued currency.

The latter will now pose a lesser threat as the ability
of China to influence its exchange rate will become
more restricted which will consequently make its exports less competitive.

A stronger yuan will act as an incentive for the consumers to purchase foreign goods and restrict the
burgeoning current account surplus of China. Over
the last few years, China has run large surpluses that
have been blamed for causing global imbalances.

As the PBOC (Peoples Bank of China) allows markets to be more open and accessible to outside investors, this would give Indian investors a chance to invest in Chinese companies which are not listed in the
Hong Kong and NY stock exchanges. Good thing for
Indian investors: This generally would include small
cap and mid cap opportunities for Indian investors.
This is very significant as China is fast shifting from
an industrial economy to retail economy, so percentage of growth of these retail companies is supposed
to be higher.

Furthermore, with the official recognition of yuan

as a global reserve currency, China may attract more
FPI inflows, especially from sovereign wealth funds
because of accommodative monetary policies in Europe and Japan. Currency appreciation usually follows higher foreign inflows.

The counter view

Yuan making its way into the SDR basket is
no big deal
After a lot of equivocation the Chinese Renminbi has
at last made its way into the SDR basket. However,
according to many economists the move is largely
symbolic as it isnt going to have an impact on the
ground reality as regards its increased circulation in
the international market is concerned. The reason
being that SDR is not a floating currency and cannot
be sold and purchased in the international currency markets. It is used by the Government of the IMF
members to settle their inter se accounts through
books.
Moreover, it played an insignificant role in the 2008
world financial crisis with its epicenter in the USA.
Therefore, Yuans elevation is, to a large extent, a nonevent except that it has fueled larger expectations
as to whether this is an antecedent to the currency
eventually becoming yet another reserve currency.
Whether or not, it will become another floating and
freely available currency in the international market
is a big question one might ask. This doubt rears its
head because despite yuan being a freely usable currency, is not a freely convertible currency yet.

Impact on India
The move to include Yuan will indirectly benefit
India. Till now, India had to bear the brunt of Chi-

24

Since China is a major trading partner for India,

so the trade can now be handled in yuan rather than
dollars so it makes the trading process more convenient.
BRICS Bank do not have to buy and sell loans in
U.S. Dollar. BRICS Bank will issue loan in Yuan. The
countries (other than BRICS) will have to pay Yuan
to BRICS Bank to buy the loan. At maturity, BRICS
Bank will payback in Yuan. The value of loan will
depend on the exchange market value of Yuan. The
stable Yuan will encourage investors to buy the yuan-denominated bond.
Like BRICS Bank, India will benefit in a similar way.
We all are well aware of the fact that how much RBIs
monetary policy depends on U.S. Central Banks decision to cut interest rate. Even stock market go high
or low on hearing a rumor about U.S. interest rate
hike or cut. Such high exposure to U.S. Dollar is a
sign of concern. U.S. can use this dependence in its
favor in areas like climate change and WTO negotiation. So, Yuans inclusion in reserve currency basket
will allow India to diversify its portfolio. Although,
India will still continue to depend on Dollar, Yuan
will give India a little breathing space.

The bottom-line:
The projected higher inflows may materialize only
gradually. Global central banks need not increase
their reserves just because the change in SDR basket.
Moreover, Chinas A-shares are still excluded from

key global indices, which to some extent, stands in

the way of foreign inflows.
Some reforms must be implemented before China
can increase its ties with global markets. Along with
the PBOCs indication of gradually relinquishing its
control of the yuan, China should also emphasize on
liberalizing its capital markets.
The inclusion of the yuan in the SDR will hopefully
be an incentive to policymakers to persist in its financial and monetary reforms to enable the yuan to take
on a more global role and also fall in line with The
IMFs expectation for the same.
The transparency and reliability of Chinese financial data is often under the scanner with its notorious
shadow banking hiding a lot of bad debts.
The Central bank restricts the fluctuation of yuan
within a tightly defined range which is a bad sign to
any floating currency which by definition must not
be hamstrung by any restrictions.
Due to favorable circumstances and the first mover advantage gained by the US Dollar in 1944, it remains the only true global reserve currency with US
dollars sloshing around outside the US estimated to
be as much as within the US.
A large number of Chinese capital goods manufacturers give or arrange tied loan so that both the currency and such goods are sold. However, the oil exporting nations are happy accepting dollar payments
rather than in any other currency.
Although China is the worlds largest exporter and
the largest economy after the US, the Economist rather pertinently points out that the Yuan is not going to
become a global reserve currency in the foreseeable
future and will inspire confidence only among those
who have strong economic ties with China.

References:
www.imf.org
www.chinadaily.com
www.pboc.com
www.economict.com
www.cnbc.com
www.ibtimes.co.uk
www.bloomberg.com

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The Regulators Role

The Reserve Bank of India came up with the Securitization and Reconstruction of Financial Assets
and Enforcement of Securities Act (SARFAESI Act)
in 2002 to enable banks deal with the problem of
non-performing assets by vesting more power with
the banks on the legal front to facilitate recovery of
such loans.
Along with the SARFAESI Act, other bodies and
mechanisms were set up to ensure smoother resolution of non-performing cases and enable both the
lender and the borrower reach an optimal solution.
These institutions were the Board for Industrial and
Financial Restructuring (BIFR), Debt Recovery Tribunals (DRTs) in each state, Corporate Debt Restructuring Mechanism (CDR) and now the Strategic
Debt Restructuring (SDR). However, none of these
have really helped barring a few cases in recovery or
resolution but have only contributed to deferring the
problem by a few years if not more.
Along with the SARFAESI Act, in line with establishments in European and South Asian economies
like Korea and Singapore the RBI started giving licenses for setting up companies which would deal in
the secondary market for these bad loans and help
in recovery, resolution and in many cases reviving
these fledgling business by infusing fresh capital into
them. These companies are called Asset Reconstruction Companies (ARCs).

DECONSTRUCTING INDIAN BANKINGS ACHILLES HEEL

-THE CURSE OF DEFAULT

-Rachit Jain, XLRI

Govt seeks extra $4 billion capital boost for
PSBs to beat NPA blues TOI article on
31.08.2015

he headline published in the Times of India pretty

much sums up the situation in the Indian Banking
sector at the moment. The banking sector has been
grappling with the problem of non-performing assets for over half a decade now. When borrowers are
not able to pay back the amount they borrowed from
banks and other lenders as per agreed terms they are
classified as non-performing assets by the lender.
Under ordinary circumstances when financial institutions (FIs) perform at a moderate efficiency level
the ratio of non-performing assets to total lending of
the bank should be not more than 2%. To put things

into perspective, the Indian financial system is currently witnessing NPA levels close to 6% totaling to
more than 4,00,000 crores, with an additional 10% of
stressed and restructured assets

Public Sector Vs Private Sector Banks

As you may already have anticipated, the private
sector banks have clearly outperformed their public
sector peers in this space as well, i.e. they have been
much more efficient and have had lower number of
stressed assets thanks to better due-diligence and
credit appraisal mechanisms. Also, a very important
factor in getting things back on track for banks with
NPAs is their recovery. Private Banks with their better management expertise, skill set and non-bureaucratic behavior have managed to recover their bad

26

loans at a much faster rate than public sector banks

like the State Bank.
NPA Figure for As on March As of June
Indian Banks 2015
2016
Public Sector
Figures in Rs. Crores
Banks
-State Bank &
73,508
73,557
Associates
-Other Public
269,483
285,748
Sector Banks
342,991
359,305
Total (PSBs)
Private Sector
Banks

Grand Total

31,857

34,710

374,848

394,015

In India, as on date there are 15 such ARCs dealing

in the business of non-performing assets. The primary business model of an ARC is to acquire bad loans
from banks at a discounted value and try to maximize recovery to generate a return on investment
which is generally higher than the usual ROI because
of the higher risk involved in the transaction. One
could compare it to the business of junk bonds in
mature financial markets

Why the CDR, BIFR, and now SDR are not

the right solution.
As exclaimed earlier, these methods have failed miserable and continue to do so, heres why. Most of these
mechanisms are developed for the restructuring and
resolution of big ticket transactions involving a consortium of lenders. More often than not,

27

IN-FIN-NITIE Vol 8 Issue 1

IN-FIN-NITIE Vol 8 Issue 1

it would take almost 20-24 months only for the
lenders to reach a consensus with a restructuring or
stimulus package to support the business entity and
create a win-win situation for all parties involved.
In situations where banks having to compromise on
their recovery value, smaller banks may sometimes
jeopardize the entire package by not playing ball. RBI
rules mandate for at least 60% of lenders (in terms of
loan exposure) and 75% of no. of lenders to agree for
any proposal to get through the respective mechanism, i.e. CDR/BIFR or SDR.

A recent report published by Religare Institutional

Research on 4th January, 2016 mentions that SDR
would only delay the problem associated with NPAs.
Banks might end up financing 30-40 big ticket accounts under SDR, and then convert debt into equity
to end up with no real buyers. This in effect will only
postpone the classification as NPA. According to the
report, banks have already invoked their option of
SDR in 15 companies, worth a whopping Rs 81,300
crore and found no resolution in these cases to date.

Increasing number of failed cases under the Corporate Debt Restructuring Scheme. Here are some
numbers to validate why the CDR is not the most
effective of tools to encourage restructuring of bad
loans.

Challenges faced by Public Sector Banks

86 cases
Rs. 14000 crs

2013-14

12 cases
Rs. 4300 crs

Rs. 3000 crs

Coming to how this entire problem is directly related

to the common man on the street who pays his taxes
to the government. If you had a good look at the first
quote of the article you might have guessed it. Heres
how I have deconstructed the cycle of flow of funds.
Capital boost is the need of the hour for most public
sector banks at the moment. Thanks to high provisioning for bad loans as well as Basel III norms making it mandatory for banks to have adequate level of
capital for which they would have to raise money
from the markets. Raising fresh capital from the market is going to be an immense challenge for bankers.

Having spoken about the inefficiency of Indian

banks and PSBs in particular to control and keep the
amount of slippages towards stressed assets in their
books, there are certain issues in built in the system
which do not allow much room for managers at the
head office and branch level in avoiding the current
problem.

Basel III norms are to be implemented by banks

which would require banks to have a higher capital
base. The total regulatory requirement under Basel
III guidelines will be in the form of a 2 Tier structure - Tier I Capital (going concern capital) will mandate banks to have 5.5% of total risk-weighted assets
(RWAs) in the form of common equity, in addition to
this there will be a requirement of capital conservation buffer (CCB) to the tune of 2.5% of RWAs. Tier
II Capital (gone concern capital) would comprise of
general provision and loss reserves which will be another 2% of RWAs.

If you thought that corrupt practices of business

honchos getting loans sanctioned for big proposals
(in excess of 100 crores) via the finance ministry in
Delhi were a thing of the past then you are sadly mistaken. Things like due diligence and checking for viability of a project go over the window once there is a
call from the ministry babu to get a proposal sanctioned at any public sector bank. The manager at the
branch, the general manager at the head office and
the directors, all are left with no choice when such a
directive arrives.

2012-13

9 cases

Capital Boost & How the Tax Payer eventually suffers

2011-12

The Reserve Bank of India on 8th June, 2015 came up

with something called the Strategic Debt Conversion
option for banks. Under SDR (Strategic Debt Restructuring), banks could take a guarantee from promoters to allow banks convert their debt into equity
if promoters fail to honor the terms laid out in the
restructuring proposal. Banks will then hold a minimum of 51% in equity capital of the company and
can then sell the unit or assets; or effect a change in
management. The issue with SDR is that banks have
only 18 months post conversion of debt to equity to
sell the unit.

Therefore, we can understand the situation which is

pressurizing Indian banks to maintain cleaner books
of accounts to be able to raise fresh capital from the
public and institutional investors come 2017. A proposal floated by Mr. Jaitley in mid-2015 to get approval for an injection of $4 Billion in the current
fiscal of which 50% was earmarked to inject liquidity
into state-run banks.

Another plaguing issue lies in the legal system. The

challenges faced by banks to enforce their rights as
lender for recovery of bad loans are as bad as those
faced by the aam aadmi in getting his pension from
the government coffers. Debt recovery Tribunals
(DRTs) are not only marred with bureaucracy but
also have inefficient management in terms of number of Presiding Officers (judges in the DRTs are
called POs) available to hear the pleas of banks and
not to forget the level of corruption involved in delaying tactics by promoters and their lawyers.

28

Banks Extend
Loans

Borrower
Defaults

Design for Systemic Change

Having seen the various issues and reasons for the

Banks take
haircuts and
book losses

Govt Infuses
Fresh Capital

Fresh Capital
= Tax Payers
Money

same, let us take a look at what could possibly be

done by various stakeholders to curb the issue of existing NPAs and reduce further slippages in the long
term.
The first step which needs to be taken is in line with
making the Central Vigilance Commission (CVC)
more proactive. The CVC has all the tools in place to
punish those who have resorted to unlawful means
to avail sanctions from banks either by bribes or by
their rich contacts in the ministry. Second and equally important is careful due diligence. Banks do not
have the necessary wherewithal to undertake effective due diligence for credit appraisal. Three aspects
need to be taken care of while sanctioning any limit
Financial, Legal and Real Estate due diligence.
On the resolution front, Fast track DRTs could be setup for cases with outstanding debt of more than 100
crores to make sure unnecessary delays are avoided
and disputes if any between the borrower and lender
are also settled at a much faster pace. As far as ARCs
are concerned, they have been accused of being overly conservative while bidding for acquisition of bad
loans. The RBI needs to put some thought into how
to bridge this gap between expectations of bank and
ability of ARCs to offer a decent bid such that it creates a win-win situation for both institutions.
Another proposition would be to set up a bad bank to
digest all the bad loans and allow public sector banks
focus more on their core competencies. An attempt
like this was made though on a very small scale by
the RBI by setting up IDBI SASF (Stressed Asset Stabilization Fund), however with no concrete resolution strategy in place for various types of accounts it
has now become a burden more than an efficient tool
to take care of the pool of stressed assets.
The problem of businesses not doing well due to micro or macroeconomic factors will always be there.
What would differentiate the scenario now from
maybe 10 years from now in similar situations is the
ability of financial institutions to tap problems at
their roots and identify early warning signs. To be
able to extend credit only to the most suitable applicant and be patient with examining proposals. There
is still a lot to be done in this space and finding the
right synergy between borrowers, banks, and the
regulator is key to address this huge issue engulfing
the banking sector at the moment.

29

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