Niveshak Jan 2013

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THE INVESTOR VOLUME 6 ISSUE 1 January 2013

New Banking Licenses: Should

RBI bite the bait?, PG. 25

United States Fiscal

CliFF Deal, PG. 18


2/30Disclaimer: The views presented are the opinion/work of the individual author and The Finance Club of IIM Shillong bearsno responsibility whatsoever.

F R O M E D I T O R S D E S K

NiveshakVolume VI

ISSUE I

January 2013

Faculty Mentor

Prof. P. Saravanan

Editorial Team

Akanksha Behl

Akhil Tandon

Anchal Khaneja

Anushri Bansal

Chandan Gupta

Gourav Sachdeva

Harshali Damle

Himanshu Arora

Ishaan MohanKailash V. Madan

Kaushal Kumar Ghai

Nilkesh Patra

Nirmit Mohan

Rakesh Agarwal

Creative Team

Anuroop Bhanu

Kritika Nema

Neha Misra

Venkata Abhiram M.

All images, design and artwork

are copyright of

IIM Shillong Finance Club

Finance Club

Indian Institute of Management

Shillong

www.iims-niveshak.com

THE TEAM

Dear Niveshaks,

The year 2012 witessed many big events. The top in the list included passing ofverdict on the long lasting debate over 2G scam, Facebook Inc. marking the third

largest IPO in the histor of US with an oer price of $38, LIBOR Scam hiing

the global economy, suspension of the ying license of Kingsher Airlines by

the Aviation Sector reglator DGCA, leadership tansition in China and last but

not the least, the retirement of Mr. Ratan Tata. This issue brings to you The Year

That Was which takes you through the big happenings of 2012.

2013 marked its beginning with a gowth forecast of around 2.4% by the World

Bank for the world economy. According to a repor, emerging economies will

lead gowth in 2013 as the global economic outlook remains challenged by the

Eurozones debt crisis and high unemployent in the United States. Growthrates in and around Europe are exected to look weak over the nex 12 months

with an exected exansion of 0.2 percent in the Eurozone and 1.1 percent in the

United Kingdom.

The GDP gowth rate for Indian economy has been predicted to be around 5-6%

by Indias Finance Minister P. Chidambaram. Due to the hike in impor taxes

on gold to 6% om 4%, the last week of Januar saw a reduction in impors.

The goverment passed the decision of parially dereglating the diesel price

allowing a hike of 40-50 paise a lite per month for retail customers and nearly

Rs.11 for bulk consumers. This decision is exected to cut the subsidy bill by

Rs.12900 crore on account of hike in price of fel sold to bulk consumers likeRailways and state tanspor underakings.

With forard looking policy refors like opening up of FDI in many sectors,

forulation of Cabinet Commiee on Investents and more such in the

pipeline like GAAR and new banking licenses, the markets have entered the New

Year with renewed zeal and optimism. In this issues Cover Stor, we technically

analyze the jourey of Sensex so far and come up with buy and sell stateg for

this year. A critical analysis and top picks for Banking and Auto sector have also

been touched upon.

Furher, the issue brings to you some more interesting and insightfl issues.

The Aricle of the month deals with the demerger decision taken by Wipro

and Pantaloon and whether these decisions are a route to unlock value for the

shareholders as well as the company. Other aricles in this issue deal with Fiscal

Cli Deal being ageed upon by the US lawmakers and new banking licenses

being issued by the Resere Bank of India. The Finistor section takes you back

to time of late 1920s and ties to exlain the causes and impact of the stock

market crash of 1929. Lastly, the Classroom this month exlains the concept of

Ponzi schemes.

We would also like to thank our readers for their constant suppor through

wonderfl aricles and appreciation. It is your endless encouragement and

enthusiasm that keeps us going. Kindly send in your suggestions and feedback

to [email protected] and as always,

Stay Invested!

Team Niveshak


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C O N T E N T S

Niveshak Times

04The Year That Was

Article of the month

08 Demergers: The Route toUnlock Value

Cover Story

11 Sensex 2013: The RoadUnpaved

FinGyaan18 United States Fiscal Clif

Deal

Finistory21 Stock Market Crash 1929:Causes And The Impact On TheEconomy

Finsight

25 New Banking Licenses:Should RBI bite the bait?

CLASSROOM

27 Ponzi Schemes


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2G Scam verdict

In the long lasting debateover the 2G license scam, the

Supreme Court of India finally ordered the 122telecom licenses held by eight operators to berevoked. Though the ruling potentially affected only5% of the users, it built confidence in the role of thejudiciary and efforts to crack down on corruption. Thisverdict was also seen as a setback for Prime MinisterManmohan Singhs Congress led UPA government.

According to the Comptroller and Auditor General,the scandal over the alleged allocation of telecomlicenses at a price below the market prices couldhave cost the treasury an estimated amount of INR1.76 lakh crore.

The licenses cancelled by the Supreme Courtincluded 22 of Uninor, 21 of Videocon, 9 of Idea,21 of Loop, 6 of S-Tel, 21 of Sistema, 3 of TataTeleservices, 13 of Swan and 2 of Allianz. TRAI wasordered to make fresh issue of the licenses that werecancelled. Indian stock markets were seen to react

better than expected to the ruling and the largerand established players benefitted. Allegations werealso imposed upon Mr. P. Chidambaram, Indias thenHome Minister, for his due indulgence in the scamduring his tenure as the Finance Minister which waslater overruled by the court. Banking sector wasalso affected by this verdict as the loans to telecomsector account for 3% of the portfolio of the bankingindustry. Those loans given in respect of 2G licenseswere seen as a threat of becoming NPAs. It was alsodebated that this verdict would be a big blow to

Indias reputation as a preferred foreign investmentdestination.

Facebook went public

After 8 long years of itsexistence, Facebook finally

came up with the IPO in May12 but the much awaitedoffer did not go as anticipated. The huge valuationby the social networking company combined with a30 minute delay in the opening of trade and tradingglitches due to high volume of orders resulted inthe stock price staying sticky to its offering price of

$38 at the close of the market. The Facebook shareopened 11% higher than the offering price but afterthe highest point of $45, it fell rapidly to close at$38.23.

The IPO of Facebook Inc. was the third largest in

the history of US after Visa and General Motors andresulted in $104 billion valuation of the eight yearold company. This unexpected scenario led to asetback for the lead underwriter on the deal, MorganStanley. It had to buy shares on the open marketto secure the $38 price level. The company was,however, valued at $32 a share by Morningstar butKrapfel expected Facebook shares to trade over $50.FBs Chief Executive Mark Zuckerberg, who foundedthe company from his Harvard dorm room in 2004,

had a net worth of $19.25 billion at the time of IPO.Libor Scam revealed

In June 2012, the Britishmultinational bank Barclays

revealed the significant manipulation of interestrates by the various banks which led to the LiborScam. This scam was touted as the mother of allscams due to its wide impact on global economy.LIBOR (London Interbank Offered Rates) is usedas the benchmark rate in the markets such as USDerivatives market. As per the committee reports,

the participating banks reported the manipulatedinterest rates from 2005 to 2010 or may be longer.All this led to a loss to the tunes of thousands ofdollars.

By lowering the reported rate, the banks were madeto appear healthier than they were and committed afraud on the market as a whole. The scandal whenunfolded rocked the global financial markets. UBSand Barclays Bank are some of the biggest banksthat have been found guilty for their insider role inthe scam. Recently, RBS became the third victim of

the American watchdogs which levied a penalty ofaround $800 million on the bank for its alleged rolein Libor scam with nearly all the money going to theUnited States.

Foreign Direct Investment Policy

As per the notificationissued by the government

on September 2012, the foreign direct investmentpolicy now allows up to 51% FDI in multi-brandretailing with prior permission from the governmentand subject to certain conditions imposed. Earlier inJanuary 2012, the Indian Government had permitted100% FDI in single brand retailing. Similarly, the FDIpolicy in other sectors was also changed. To mentiona few, civil aviation sector will be allowed a FDI ofup to 49% , broadcasting segment up to 74% and

The Niveshak Times


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power exchanges up to 49% ( FDI investment of 26%

and FII investment of 23%). Reactions to this policychange were mixed. Bombay Stock Exchange showedimmediate optimism and Sensex jumper to a 14month high by gaining 443 points on the day theannouncements were made. Shares of companieslike Kingfisher (airlines) and Pentaloon (retail) wentup to nearly 20%. Rupee also went up by 1.13%against the dollar. FDI as a strategic componentof investment is desired for a sustained economicgrowth and development through creation of jobs,expansion of existing manufacturing industries,short and long term project in the field of healthcare,education, research and development (R & D) etc.

Kingsher license suspended

The Aviation Sector regulatorDGCA suspended the flying

license of Kingfisher Airlines in Oct12. The airlineshad failed miserably to come up with the viable planfor its revival which led DGCA to pass the suspensionorders. This resulted in cancellation of any futurebookings on Kingfisher Airlines w.e.f. 20th Decemberand the situation has worsened since then. The

airlines has seen regular strikes from its employeeson failing to pay them salaries. The result could alsobe seen in the stock market where the shares ofKingfisher fell by around 5% in a single day.

The airlines has also not been able to bear otheroperational expenses in the recent past. As a result,the airlines has been saddled with a loss of Rs. 8000crores and a debt burden of another Rs. 7524 crores,a large part of which it has not serviced since Jan12.The liquor- baron Vijay Mallya is trying hard to garnerthe support of foreign airlines but chances are very

bleak seeing the heavy debt-laden balance sheetof the airlines. Recently, the Kingfisher CEO SanjayAggarwal had informed DGCA that the airlines wouldrequire Rs. 652 crores in the coming 12 months andthe amount would be paid by the parent company UBgroup. Out of this, Rs. 120 crores would be requiredto meet the salaries of its employees.

Leadership transition in China

China, worlds second largesteconomy, witnessed the

nomination of Mr. Xi Jinping who will take over

the reign from the current leader Mr. Hu Jintao, inMarch 2013. Xi Jinping has been responsible forthe successful organization of Olympics and hisfamiliarity and openness towards western economiessignal that a much needed change in the functioning

of the economy that is driving the world economy

might be a possibility. Mr. Xi Jinping faces a lot ofchallenges in this coming year which include sloweconomic growth, a public clamor to end corruptionand demands for change in the political system thatthreatens the hold on power. In his first addressto the nation, Xi promised to provide better socialservices along with making sure that China standstall in the world economy. Xi will need to rethinkabout the international relations, as Chinas externalenvironment has been weakening significantly andits relations with the major powers of the worldand its neighbors are at the worst since the days ofTiananmen Square crackdown in 1989. China goesinto transition at a time when reforms and policiescan breathe a new life into the sentiments of thepeople of China and put the global economy on arising trajectory.

The legacy of Ratan Tata

Ratan Tata, on 28th Decemberretired as the chairman of

Tata Group. He steered the group for 21 years afterhe succeeded the iconic figure of Mr. JRD Tata. This

paved the way for Cyrus Mistry to head one of themost reputed organizations of the world. During hisstay as the chairman of Tata Group, Ratan Tata playedan instrumental role in taking the organization tonew heights. Ratan Tata has been credited with thetitle of a man who could take bold decisions whichis evident from the fact that the group has crossedthe $100 billion (around Rs. 475,721 crore) mark in2011-12 from a mere turnover of Rs. 10,000 crore in1991.

Mr. Tata led the group into some notable acquisitions,

starting from Tetley by Tata Tea for $450 million in2000, steelmaker Corus by Tata Steel in 2007 for GBP6.2 billion to the landmark Jaguar LandRover in 2008for $2.3 billion by Tata Motors. Currently, over half ofthe groups revenues come from outside the country.Not limiting himself to big-ticket acquisitions, Mr.Tata also displayed sensitivity to the needs of theburgeoning middle class with the launch of the Rs.one lakh Nano battling the odds in West Bengal.

The Niveshak Times

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TheYearThatWas

FINANCE CLUB, INDIAN INSTITUTE OF MANAGEMENT SHILLONG

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MARKET CAP (IN RS. CR)BSE Mkt. Cap 6,864,893

Index Full Mkt. Cap 3,166,830

Index Free Float Mkt. Cap 1,652,684

CURRENCY RATESINR / 1 USD 53.85

INR / 1 Euro 71.72

INR / 100 Jap. YEN 60.30

INR / 1 Pound Sterling 85.26

POLICY RATESBank Rate 8.75%

Repo rate 7.75%

Reverse Repo rate 6.75%

Market Snapshot


RESERVE RATIOSCRR 4.00%

SLR 23%

LENDING / DEPOSIT RATESBase rate 9.75%-10.50%

Deposit rate 8.50% - 9.00%

Source: www.bseindia.comwww.nseindia.com

Source: www.bseindia.com

Source: www.bseindia.com21st Decemebr to 24th January 2013

Data as on 29th January 2013

MarketSnapshot

CURRENCY MOVEMENTS


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MarketSnapshot

BSEIndex Open Close % changeSensex 19453.92 19923.78 2.42%

MIDCAP 7101.79 6848.68 -3.56%

Smallcap 7434.86 7069.84 -4.91%

AUTO 11406.99 10834.39 -5.02%

BANKEX 14343.78 14396.88 0.37%

CD 7723.79 7423.32 -3.89%

CG 10916.42 10617.55 -2.74%

FMCG 5949.40 5780.34 -2.84%

Healthcare 8198.73 7873.41 -3.97%

IT 5637.90 6355.87 12.73%

METAL 11241.04 10435.61 -7.17%

OIL&GAS 8469.24 9499.14 12.16%

POWER 1981.27 1959.89 -1.08%

PSU 7276.75 7583.87 4.22%

REALTY 2123.08 2091.28 -1.50%

TECK 3405.37 3803.68 11.70%


Market Snapshot

% CHANGE


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Demerger, by definition, is a business strategy inwhich a business is segregated into one or morecomponents, either to operate on their own, tobe sold or to be dissolved. A demerger allowsa large company to split its various brands to

invite or prevent an acquisition, to raise capitalby selling off components that are no longerpart of the businesss core product line, or tocreate separate legal entities to handle differentoperations.One of the prime reasons why large corporatehouses go in for demerger is to increase the roleof specialisation in the particular segment. Incase of large conglomerates, demerging entitiesare often the departments/businesses whichare growing at an impressive rate and have

substantial potential. Therefore, in a sense ademerger is the reverse of a merger.Therefore, demerger is a form of restructure inwhich shareholders or unit holders in the parentcompany gain direct ownership of the demergedentity or the subsidiary entity. The company orentity that ceases to own the entity is calledthe demerging entity. If the parent entity holdsa majority stake in the demerged entity, theresulting company is referred to as the subsidiary.India Inc. has recently witnessed a spurt ofdemergers like Provogue, Zee Telefilms, Cinemax,

Wipro, Reliance Industries etc. In this write-up on demergers, we shall have a look at thedemergers of Wipro and Pantaloon because theyare the most recent ones. We shall also have alook at questions like Is demerger a route tounlock value? What is there for shareholders andthe company in the demerger?Wipros Demerger: A Win-Win Deal

On November 1st, 2012, Wipro had announced ademerger plan to hive off its non-IT businesses intoa separate company. As per the announced plan,

Wipro wished to hive off its three units - WiproConsumer Care & Lighting, Wipro InfrastructureEngineering and Wipro GE Healthcare PrivateLimited - into a separate unlisted company called

Wipro Enterprises. Together, the three unitscontributed 14 per cent to Wipros revenue. TheIT business, which contributes 86 per cent of therevenue, will remain a publicly listed company.In FY12, IT business contributed 96 per cent to

the operating profit and on December 29th, 2012,Wipro got shareholders nod for demerger.The demerger step looks obvious at this stagebecause Wipros non-IT businesses have achieveda critical mass. A delay would have made itdifficult for Wipro to separate its IT & non-ITbusinesses. Another reason which could haveprompted Wipros board to take the demergerroute is that when it comes to acquisitions, ITcompanies come cheaper than FMCG companiesin terms of price/sale. Normally, an IT company is

valued at 1 to 1.5 times its annual sales turnover,while an FMCG company costs 2-3 times, at timeseven 7-8 times. This is because the brand valueweighs more when it comes to FMCG business.Since, Wipros shareholders come with an IT mind-set; they are unlikely to take kindly to the highvaluations for acquisition of FMCG companies.It is pertinent to mention here that WiprosConsumer Care business has made numerousacquisitions. It has bought brands like Glucovita,Chandrika, Yardley and North West Switches &Unza Holdings. WCCL acquired LD Waxson Group,a Singapore-based FMCG company, as recent asin December 2012. Therefore, there is a littledoubt in the fact that a demerger would makeboth the IT & the non-IT businesses leaner andmeaner.Another rationale that supports Wipros demergeris that all the three non-IT business units generateenough cash in their balance sheets every year.This is the reason why once the separation iscomplete, Wipro Enterprises would be a debt-free company with healthy cash flows. This will

give Wipro Enterprises necessary impetus to goall out with acquisition opportunities coming itsway in the future.Apparently, low profitability of Wipros non-IT

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business was also a big reason for the demerger.Wipros non-IT business accounts for 14 per centof the companys turnover but only 6 per cent ofits operating profit. Thus, it was widely presumedthat Wipros non-IT business was pulling backWipros bottom line. The reason behind this isthat Return on Capital Employed (ROCE), for theIT and non-IT business is quite different. Forexample, ROCE in case of Wipro Consumer Care& Lightings is about 19 per cent, much lower ascompared to its IT business.Coming to the terms of the deal proposed by

Wipro, the terms of the demerger are complexenough to keep the shareholders thinking.Wipro has offered its shareholders the followingoptions 1. Receive one equity share with face value ofRs.10 in Wipro Enterprises for every five equityshares with face value of Rs.2 each in WiproLimited that they hold.2. Receive one 7% Redeemable Preference Sharein Wipro Enterprises, with face value of Rs.50,for every five equity shares of Wipro Limited that

they hold. Each Redeemable Preference Shareshall have a maturity of 12 months and shall beredeemed at a value of Rs.235.20.3. Exchange the equity shares of WiproEnterprises and receive as consideration equityshares of Wipro Limited held by the Promoter.The exchange ratio will be 1 equity share inWipro Limited for every 1.65 equity shares inWipro Enterprises Limited.Digging deep into this complex deal, Wiproinvestors, if they choose preference shares,

will get roughly Rs 47.7 after one year for eachshare of Wipro. At todays prices, this is roughlyRs 43.4 per share. Investors thus get 12.1 percent compensation for letting go of the non-ITbusiness. And if they opt for equity in Wipro

Enterprise and swap it with the promoters, theywould again make a gain of about 12.1 per centon the transaction.Rough calculations carried out for the deal showsthat Wipro is valuing its non-IT businesses atabout Rs 10,900 crores, which means a price-earnings multiple of about 29-30 times the netprofit for the business. Now, this is a generousvaluation taken up by Wipro and this valuationis aimed at providing investors a good price fortheir exit.Needless to say, the demerger as proposed by

Wipro is a win-win deal for promoters. If theinvestors opt for the preference shares, Wiprowill get access to preference capital at the costof 7 per cent a year, which is more or less atpar with the market rates for preference capital.But more investors opting for preference shareswill also mean a smaller equity base, boostingEarnings Per Share (EPS) for Wipro Enterprises.And if the investors opt for equity shares insteadof preference shares, promoters of Wipro willget a chance to reduce their own holdings in

the listed IT Company. This will make sure thatthey meet the governments minimum publicshareholding norms of 25 per cent, withoutselling in the market.In conclusion, we can say that the demergerdeal is happening at the right time for Wipro.And because Wipros non-IT business is a partof an IT giant, these businesses didnt get asmuch visibility as the other companies in theirsectors have enjoyed. Also, the shareholders arenot taken for a ride with the demerger. They are

well compensated for letting go off the non-ITbusiness. The valuation of the non-IT businessalso is quite generous. On the other side, thedemerger deal is a win-win deal for Wipro. Thereis no doubt in the fact that the deal has been

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Fig 1: Contibution of Wipros various segments to Revenue and Operating Income


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well crafted to suit each and every stakeholder.Pantaloons Demerger: SynergisingOperations

Another demerger to have happened recently isthat of Pantaloon. Future Group demerged thefashion business of its two entities, namelyFuture Ventures India Ltd. (FVIL) and PantaloonRetail India Ltd. (PRIL), into a new entity namedFuture Fashion. This will help the companiesto focus on their respective businesses moreeffectively. The appointed date for the deal isJanuary 1, 2013 and it will take around 6-8 monthsto complete the deal. After the demerger, PRILwill focus on its core business brands like BigBazaar and Food Bazaar while FVIL will focus onthe food and FMCG sector which includes brandslike Fresh & Pure, Premium Harvest etc. Also, thenew entity Future Fashion will focus on operating

retail chainswith domesticand globalbrands. FVILwill transferf a s h i o nbrands likeS c u l l e r s ,U r b a n a ,Urban Yogaetc. to Future

Fashion. Keyf i n a n c i a laspects ofthis demergerare as follows: The new entity Future Fashion Ltd. will be listed. The share exchange ratio will be 1 equity shareof Future Fashion Ltd. for every 3 equity sharesheld in PRIL and 1 equity share of Future FashionLtd. for every 31 equity shares of FVIL. Post demerger, 49.8 % in the new entity will beheld by PRIL, 30.5 % by shareholders of FVIL and19.7 % will be held by PRIL as a corporate entity. Post demerger, face value of the shares ofFuture Ventures India Ltd. will change from Rs.10 per share to Rs. 6 per share.The major reason for this demerger is that PRILsmanagement wants to deleverage the company.Currently PRIL has a debt of Rs. 3700 crore onits book. It will transfer debt of Rs. 1226 crore tothe new entity Future Fashion. Fashion businessalready has debt of Rs. 200 crore. So the totaldebt on the books of Future Fashion will be of Rs.

1426 Crore and PRILs debt will come down to Rs.2474 Crore. Another reason for demerger is theinterest that Aditya Birla Nuvo Ltd. has shown inowning a majority stake in PRIL. ABNL would investRs. 1600 crore in Pantaloons retail business. This

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deal got the approval of Competition Commissionof India (CCI) on December 27, 2012. Anotherrationale for demerger is the new challenges andopportunities that the company awaits after theapproval of 51 % FDI in multi-brand retail.For the shareholders of PRIL and FVIL, it is abeneficial move as they will get shares of this

new entity in addition to their existing shares inPRIL and FVIL. After the clearance of the demergerby CCI the share price of Pantaloon Retail IndiaLtd. (PRIL), has reached to Rs. 255 per share onDecember 30th from 235 per share as on 27thDecember which shows investors are bullish inthis stock. It is also beneficial for the existingstockholders of PRIL as now the company isless leveraged; so on one hand their dividendearnings will increase because now there will beless interest expense and on the other hand it will

decrease therisk involvedin theinvestmentas nowdebt equityratio of thecompany willalso reduceAlso, PRILsold itsinvestmentof worthR s . 2 9 5Crore in the

quarter ended 30th September, 2012. This showsthat the company is in desperate need of cashto reduce its debt. Now after transfer of somedebt to the new entity and after Rs. 1600 Croreinvestment by ABNL, PRIL doesnt need to sell itsexisting investments. Therefore PRIL will be ina better position to provide more returns to itsshareholders.

The only concern for the Future group as a wholeis that it is transferring a debt of Rs. 1426 croreto a new entity. If this entity fails to operate asintended or if it fails to generate profit due toeconomic slowdown, Future Group as the parentcompany would be in trouble. The other concernfor the shareholders of FVIL is that company isreducing face value of its shares from Rs. 10 toRs. 6 and as a result shareholders may opposethe demerger. If these circumstances arise,entire value created for shareholders and for the

company itself by demerger will be at risk. Butas of now this demerger looks to be a good dealfor both the Future Group and its Shareholders.


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Chidambarams return to the finance ministry duringthe same period, the markets revived growth by the

Governments reform drive. From being the worstglobal performer in 2011, SENSEX turned the cornerregistering a 26% YoY growth, poised for its biggestannual growth since 2009 as foreign investorspoured in a net US$23 billion this year.

Taking a deeper look into the sectorial indices inFigure 1 and Figure 2, we see that the major growthcame from the Banking, Realty, FMCG and Consumerdurables whereas the IT sector was still found in the

TEaM nIvEshak

Introduction

2012 was an action-packed year, from big events

like the U.S. presidential race, New Chinese LeaderNomination, the London Summer Olympics, toregional conflicts in the Africa and Middle East and,to issues closer to home like Coal Gate Scam, 2GScam etc. Despite very little going Indias way, theperiodic bursts of FII flows, and reform measuresannounced by the government kept Investorsentiments up and going. Till August, the rally wasmainly on account of benign liquidity but post Mr.

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Fig 1: World Indices CY12 performance( in %) Fig 2: Major indices CY12 performance

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A correction of over 55% from peak value followsafter every eight year top

Each eight year major peak is not preceded bymulti fold gains whereas every 16 year peak is ledby multi fold and broad based rallies. For instance,the 1992 and 2008 tops were anteceded by 11-fold and 7- fold rallies respectively and broad basedgains, while the 2000 peak was led alone by amajor uptrend in the IT and media stocks.

The Sensex continues to witness its usual cyclicalbear and bull rallies within every large eight yearcycle.

Also, the Sensex has a tendency to top out in thefirst quarter of every year. In the adjoining monthlychart (refer exhibit 6 make a table) of the Sensexsince 2000, we have observed that out of 13 times

entangles of Eurozone crisis registering a negativegrowth of 1.1%. The basic sectors like Power, Metaland Oil Gas registered a steady growth of 10-20%YoY.

With forward looking policy reforms like openingup of FDI in many sectors, formulation of CabinetCommittee on Investments and more such in thepipeline like GAAR and new banking licenses, themarkets have entered the New Year with renewedzeal and optimism. In this story, we aim totechnically analyze the journey of Sensex so far andcome up with buy and sell strategy for this year. Acritical analysis and top picks for Banking and Autosector have also been touched upon.

The 8 year Sensex Cycle

Our analysis is guided by a long term structuredstudy of the index in order to determine how we arecurrently positioned. Interestingly, the Sensex hasfollowed certain patterns of time, cycle and price

behaviour since its inception. One such pattern hasbeen the eight year operating cycle since 1984. Inthe Figure 3, we observe that the year 1984 startedwith a bull run which lasted for eight years till thepeak of 1992. A similar trend was observed in eightyear rise and fall cycles from 1992 to 2000 and from2000 to 2008. While the first two turning points(1992 and 2000) coincided with the Harshad Mehtascam and Ketan Parekh scam respectively, the thirdone (2008) was encountered in the backdrop of theUS Sub-prime Crisis, the 26/11 terrorist attack and

Satyam scam .Based on our observations from Figure 3, weidentify the following trends for the eight year cyclephenomenon:

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Fig 3: Sensex Quaterly Chart showing Eight-year cycle phenomenon

Fig 4: Sensex peak pattern in the rst quarter of every year



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the index has made a significant top on 11 occasionsin the first quarter of every year. Currently, we arepositioned on the upward leg of the first quarter of

2013.

Attempts of RetestBull markets are born on pessimism, grow onskepticism, mature on optimism and die oneuphoria- Sir John Templeton

The rally before a major eight year cycle top is fraughtwith extreme market euphoria. Subsequently,this market uptrend is brought to an unexpectedstandstill and the consequent sharp collapse has amajor impact on investors sentiments. It is for thisvery reason that the succeeding pullback effortsto replicate the major eight year cycle tops aresubject to reactions. As a matter of interest, theindex behaviour so far post the 2008 top has exactlyemulated the trend post the 1992 peak and wecan safely assume that what transpired post 1992top has a bearing on what comes post the 2008uptrend. Since we are still in a consolidation phasepost the 2008 top, it becomes extremely importantto understand the index behavior within this phase

in the 1992 cycle.

First attempt to re-test in 1994/2010

There was an attempt to retest the high of 1992(4546) in 1994 as the index marginally bettered

the 1992 high by 2% and jumped to 4643 in 1994before going into a consolidation phase for almostfour years. After this retest attempt, the indexplummeted and lost 39% towards early 1996. Acomparable movement was detected post the 2008peak wherein the index almost duplicated the 2008high (21206) in November 2010 (21108) and took aplunge thereafter to register a correction of 28%(15135) by December 2011.

Second attempt to retest in 1997/2013

After a 39% correction towards early 1996, theindex once again endeavored to touch the 1994highs (4643) during August 1997 (4605). However,this attempt failed to take off and the index onceagain started its journey downhill. By looking atthe trends, one might also think that in 2013 therewould be a higher peak. But, the first attempt inthis case has already been made in 2010. So, in2013 we dont expect the index to outdo the 2008

Fig 5: Performance post 2008 top

Fig 6: Fibonacci retracement

Fibonacci Retracement

A term used in technical analysis that refers to areas of support

(price stops going lower) or resistance (price stops going

higher). The Fibonacci retracement is the potential retracement

of a financial assets original move in price. Fibonacci

retracements use horizontal lines to indicate areas of support

or resistance at the key Fibonacci levels before it continues in

the original direction (refer Figure 6). These levels are created

by drawing a trend line between two extreme points and then

dividing the vertical distance by the key Fibonacci ratios of

23.6%, 38.2%, 50%, 61.8% and 100%.

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high.

Time period of alternate peaks and troughs

If one analyzes the historical movement, the

velocity of Sensex is swift in the direction of the

primary trend. Whereas

the secondary swings

(the swing inside the

8 year operating cycle)

tend to gulp up more

time. Post the 2008

peak, we observe that

each major down-leg/

up-leg for the Sensex

has lasted around 13-19

months (refer Figure 5).

The first downfall from

January 2008 to March

2009 lasted 15 months

while the matchingrally from March 2009

to November 2010 spent 19 months. The next fall

from November 2010 to December 2011 took 13

months, while the current rally from the December

2011 low is already 13 months old while we are still

approximately 5% away from completely retracing

the previous segment.

Verdict for Sensex

Before concluding the long term prognosis of

SENSEX movement, it may be noted that our

study is primarily governed

by History repeats itself

principle. Currently, the index is

fluctuating at a well-established

medium term uptrend touching

a 24-month high. The recent

sentimental boost provided

by Indian Government through

the much anticipated reforms,

coupled with the successful

dodging of Fiscal Cliff by the US,

is likely to sustain the journey

uphill into 2013. However, the

SENSEX approaching the 2010

highs or even surpassing thesame by a small margin (2%) in

the near future cannot be assumed as the start of

the new Bull Run. It can be perceived that, SENSEX

is in the midst of a larger consolidation phase post

2008 (peak) and thus it should re-test the previous

highs. However, the sustainability of such highs is

APPLICATION OF FIBONACCI

RETRACEMENT

Taking the 2012 lows (16358) and as-suming 2013 high as 21200, the golden

Fibonacci ratio of 61.8% of the entire

rally from 2012 lows to 2013 highs is

placed around 17592 points.

Fig 7: BSE Bankex: Monthly Candlestick Chart



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uncertain.

Burning question: Whether long term retail investorsshould get tempted to put their money in themarket in anticipation of a new bull run?

Based on the above-mentioned technical analysis,we expect the current upward movement in SENSEXto attempt a re-test of the 2010 high or even exceed

the same by a 2% margin (as has been the casein post 1992 scenario) in the early part of 2013leading to a rally towards 21000/21500 levels. Afterattaining the previous top in the first quarter of 2013(second attempt of retest), we expect triggering ofa downward trend, which can last for around 12-15months leading up to the middle of 2014. On theother hand, we also believe the price wise correctiontowards 17500- 16800 concurring with time wisecorrection up to middle of 2014 would be the mostopportune moment for long term investors to take

out the shopping cart and start cherry picking tobuild a portfolio to ride the next wave up which isexpected to last up to 2016, the next potential eightyear cycle top.

Banking Sector

After the 2008 peak the banking index went downhitting a low of 3600 around March 2009. Post that,

the banking index has performed decently in the

last four years. The index showed a sustained

upwards movement in 2009-2010 and also crossed

the 2008 peak making a new all-time high of 15108in November 2010. But the correction during 2011

caused a retracement of 50% of the previous

upwards rally making the index to fall down to

9263 (around 50% of low-3600 and high-15108 of

previous rally). After the pause in 2011 the indexhas continued to move up throughout 2012 and is

now trading at its all-time high. The figure above

shows the peaks of 2008, 2011 and 2012, which is

the current all-time high. It also shows the lows of

March 2009 and early 2012.

The index currently is moving up and is expected to

perform well at least in the near future. After this

upward move if the index falls, the support for theindex should be placed in the range of 11500-12000

based on the following arguments: While the index was moving up in 2012, trend

line resistance breached during September 2012 ataround 11400 level. This line is expected to reverse

its role as support line in case the index falls.

The 50% and 61% Fibonacci retracement of theup leg since January 2012 lows (9058) to all-time

Fig 8: PNB: Monthly Candlestick Chart

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Based on the technical analysis,

we expect the current upwardmovement in SENSEX to attempt

a re-test of the 2010 high or even

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high of 15108 is placed at 12100 and 11400 levels

respectively.

Hot Picks

The Figure 8 shows how the share price of Punjab

National Bank has behaved in the last four years.

After retracing from its 2008 high of 670 to March

2009 low of 266, it showed a steady increase inprice for the next 20 months reaching its all-time

high price of INR 1323. This sustained growth in

price was followed by a corrective phase that lasted

till August 2012 when the share price fell up to INR

659. The following phenomenon can be seen in the

behavior of the stock price of Punjab National Bank:

The August 2012 low of 660 is the Golden Fibonacci

retracement (61.8%) of the 20 month long 2009-2010

rally that started from low of 266 to high of 1323.

The retracement also coincides with the 2008

peak, which has reversed its role from causing

resistance to providing support.

Seeing the past behavior it is expected that the

share price of PNB will continue its upwards

movement, which has already started in August

2012, till the price reach around INR 990 to INR 1050,

which are 61.8% and 50% retracement respectively

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of the previous decline from 1323 to 659. So Punjab

National Bank shares are the hot pick currently in

the banking sector. It should be a correct move to

buy its shares now and keep it till it reaches the

target of INR 990.

Auto Sector

Very much like the Banking Sector, the automotivesector has also seen a strong upward trend in the

last four years, during which the index has jumped

almost 5 times from the low of 2128 in December

2008 to a strong 10500 in November 2010. For almost

2 years post this achievement, the index had been

in a consolidation phase where it drifted in the

range of 10800-7900. More recently, the index has

broken out of this range embarking on a positive

ride achieving an all-time high of 11868 in the past

one year and more importantly the trend looks

promising. On the week ended January 18, 2013,

BSE Auto Index (Figure 8) stood at an encouraging

level of 11298.

The long term analysis of this strongly growing

sector indicates that the index is expected to

reach a minimum of 12600 (61.8% of the depth of

consolidation range of 2900 (10800-7900)) before

Fig 8: BSE Auto: Monthly Candlestick Chart

Very much like the Banking Sector,

the automotive sector has also seen

a strong upward trend in the last

four years, during which the index

has jumped almost 5 times from the

low of 2128 in December 2008 to a

strong 10500 in November 2010



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it encounters any significant resistance. Also, themonthly long term Moving Average ConvergenceDivergence (MACD) which has been above the triggerline for almost 3.5 years now thereby indicating apositive momentum, signals the buy strategy forthe sector. MACD is calculated as the difference ofthe value of the 12 day and the 26 day Exponential

Moving Averages.So, now that the technical analysis suggests a goodinvestment strategy in the automotive sector forthe coming year, the obvious question that comesnext is which stocks are the best bets in the sector.Again, we use the technical analysis to arrive atthe answer. The analysis which follows gives thefollowing verdict:

1. Ashok Leyland

2. JK Tyre & Industries

Ashok Leyland that trades at around Rs.26.5 pershare today was not so long ago (read January 2009)trading at only Rs.6 per share. In the subsequent 2years, it saw almost a 7 fold rally, hitting an all-time high of Rs.39 in November 2011. The next 10months saw a corrective phase during which thestock hit a double bottom at around Rs.20, whichstands at a very important support level of 61.8%of the difference of the multi fold rally (61.8% of33). The past experiences have suggested positivesignals for the shares that start the bullish pattern

at the Fibonacci retracement levels. The volumes ofshares changing hands in the last 4 months or soare also a very healthy sign for our first pick in thesector. Team Niveshak suggests the target price forAshok Leyland at around Rs.35.

JK Tyre and Industries which is our second pick inthe auto sector, has also witnessed a seven foldrally from March 2009 to April 2010, where it hastraded at rock bottom price of Rs.30 to an all-timehigh of Rs.204. Post this period, JK Tyre entered acorrective phase, retracing almost 80% of the gainsit had made in the financial year 2010 by the end

of 2011. Since the start of 2012 however, the stockhas only known one direction. The volumes of thestock being traded are also significantly highersince the start of 2012. By joining the higher lowssince January 2012, the value of the rising trendline is placed around the level of 106. This roundingbottom breakout level is expected to act as a strongsupport and should be used as a price level toinclude JK Tyre and Industries in ones portfolio.Team Niveshak suggests the target price for theshare at Rs. 152.

Fig 9: Ashok Leyland: Monthly Candlestick Chart

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period, people began to feel them permanentrather than temporary.

The Bush Tax Cuts were fairly extensive andcovered a wide range of tax provisions. Ingeneral, below are the changes that werescheduled to occur after January 2, 2013 -

1. The standard deduction for married coupleswill be lower - no longer double the single filerdeduction.

2. The ceiling of the 15% tax bracket will be lower- also no longer double that of single filers.

3. The tax rate on qualified

dividends earned by middleand upper-income earnerswill balloon from 15% to thetaxpayers ordinary incometax rate; as high as 39.6% forthe highest tax bracket.

4. The 10% tax bracket forlower income earners willrevert back to the 15% taxbracket.

5. The child tax credit willdrop from $1,000 to $500.

6. The Earned Income Credit will be eliminatedfor lower income taxpayers.

7. The tax rate on long term capital gains earnedby middle and upper income taxpayers will risefrom 15% to 20%.

8. Ordinary income tax rates will increase.

9. The Alternate Minimum Tax (AMT) will revertto the higher 2001 levels, which have not beenadjusted for inflation, meaning that many

middle class earners will fall into AMT territory.10. The Personal Exemption Phase-Out (PEP)and Pease itemized deduction phase-outwill be restored, removing the value of some

Some people believe that the term Fiscal Cliffwas first used by Goldman Sachs economist,Alec Phillips. Others credit Federal ReserveChairman Ben Bernanke for taking the phrasemainstream in his remarks in front of Congress.Still others regard Safir Ahmed, a reporter forthe St. Louis Post-Dispatch, who in 1989 wrotea story detailing the states education fundingand used the term Fiscal Cliff, as the one whocoined the term.

Fiscal Cliff is used to describe the measures ofdeficit reductions in accordance

with the Budget Control Act of2011 beginning on January 2,2013. The measures aimed atsharp decline in the budgetdeficit due to increasedtaxes and across-the-boardspending cuts (known assequestrations). Accordingto the Congressional BudgetOffice (CBO), by 2022, thebudget deficit would fall to

$200 billion from its currentlevel of $1.1 trillion with thesemeasures.

The current crisis came to fore with theexpiration of Tax Relief Act of 2010 and deficitreduction steps under the Budget Control Actof 2011. The former extended the Bush tax cutsfor two years, while the latter was enacted toresolve the public debt ceiling crisis.

Bush Tax Cuts

They are referred to a series of temporary incometax relief measures, the Economic Growth andTax Relief Reconciliation Act of 2001, enacted byPresident George W. Bush in 2001 and 2003. Butas the tax cuts were in place for such a long

IIT Madras

Niket Kumar Dixit

UNITEDSTATES

FISCAL CLIFF

DEAL


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would have gone up respectively to 15%, 28%,31%, 36% and 39.6% (shown in the figure 1).

In addition, the Congressional Budget Office(CBO) estimated that 3.4 million or morepeople would lose their jobs. The October2012 unemployment rate of 7.9% representssignificant improvement over the October 2009rate of 10%. The Congressional Budget Office(CBO) believes that up to 3.4 million jobswould be lost, post fiscal cliff, due to a slowingeconomy with layoffs stemming from cuts inthe defence budget and other things. This couldresult in an increasing unemployment rate up to9.1% or more.

The Fiscal Cliff deal

The American Taxpayer Relief Act of 2012, alsoknown as Fiscal Cliff deal, was signed into law

by the President Obama on January 2, 2013 andeliminated much of the tax side of the fiscalcliff, with the Congressional Budget Office (CBO)projecting an 8.13% increase in revenue and1.15% increase in spending for FY 2013. The Actresulted in a projected $157 billion decline inthe 2013 deficit relative to 2012, rather than thesharp $487 billion decrease projected under thefiscal cliff.

The main features of the fiscal bill that theCongress passed aimed at averting wide tax

increases and budget cuts scheduled to takeeffect with the beginning of this year. Themeasure would raise taxes by about $600 billionover 10 years compared with tax policies thatwere due to expire on December 31, 2012. Itwould also delay for two months across-the-board cuts to the budgets of the Pentagonand numerous domestic agencies. Some of themeasures are -

1. Income tax rates: Extends decade-old taxcuts on incomes up to $400,000 for individuals,

$450,000 for couples. Earnings above thoseamounts would be taxed at a rate of 39.6%, upfrom the current 35%. It extends Clinton-eracaps on itemized deductions and the phase-out of the personal exemption for individualsmaking more than $250,000 and couples earningmore than $300,000.

2. Estate tax: Estates would be taxed at a toprate of 40%, with the first $5 million in valueexempted for individual estates and $10 millionfor family estates. In 2012, such estates weresubject to a top rate of 35%.

3. Capital gains, dividends: Taxes on capitalgains and dividend income exceeding $400,000for individuals and $450,000 for families would

exemptions and deductions (like charitablecontributions) from high income earners.

11. The Lifetime Estate Tax Exemption andLifetime Generation Skipping Tax (GST) will revertfrom $5.12M to $1 million exclusion.

Arguments in favour of Fiscal Cliff

The cliff itself would prove to be a positive stepin long-term. Macroeconomists argue that theUnited States has to fight its budget deficits atsome point. The Fiscal Cliff would be harsh,but right step in that direction. The short-termimpact could be severe, but the long termgains like lower budget deficits, lower debts,better investor sentiment and better growthprospects would be worth the short-term gains(? Or losses).

As already mentioned, it is expected that thebudget deficit would fall to $200 billion in 2022from its current level of $1.1 trillion. That wouldall be welcome news, but in order to get there,the nation would face almost certain financialturmoil.

Arguments against Fiscal Cliff

The Tax Policy Centre reported that middle-incomefamilies would pay an average of $2,000 more intaxes in 2013. Many itemized deductions wouldbe subject to phase-out, and popular tax creditslike the earned income credit, child tax credit,and American opportunity credits reduced. The401(k) and other retirement accounts would besubject to higher taxes.

The marginal tax rate is the tax you pay on

each additional dollar of income you earn. Asyour income rises, the marginal tax rate (betterknown as your tax bracket) rises. For 2012, thetax brackets were 10%, 25%, 28%, 33% and 35%.If the deal did not get through, those rates

Fig 1: Tax rates with the Bush Tax Cuts and without them


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increase from 15% to 20%.

4. Alternative minimum tax: Permanentlyaddresses the alternative minimum tax andindexes it for inflation to prevent nearly 30million middle- and upper-middle incometaxpayers from being hit with higher tax billsaveraging almost $3,000. The tax was originallydesigned to ensure that the wealthy did notavoid owing taxes by using loopholes.

5. Other tax changes: Extends for five yearsObama-sought expansions of the child taxcredit, the earned income tax credit, and anup-to-$2,500 tax credit for college tuition. Alsoextends for one year accelerated bonusdepreciation of business investments in newproperty and equipment, a tax credit forresearch and development costs and a tax creditfor renewable energy such as wind-generated

electricity.6. Unemployment benefits: Extends joblessbenefits for the long-term unemployed for oneyear.

7. Cuts in Medicare reimbursements to doctors:Blocks a 27% cut in Medicare payments todoctors for one year. The cut is the product ofan obsolete 1997 budget formula.

8. Social Security payroll tax cut: Allows a2-percentage-point cut in the payroll tax first

enacted two years ago to lapse, which restoresthe payroll tax to 6.2%.

9. Across-the-board cuts: Delays for twomonths $109 billion worth of across-the-boardspending cuts set to start striking the Pentagonand domestic agencies this week. Cost of $24billion is divided between spending cuts andnew revenues from rule changes on convertingtraditional individual retirement accounts intoRoth IRAs.

Will Fiscal Cliff deal end the economic

woes?Though fiscal cliff deal is a welcome step, butit should not be forgotten that the deal is onlyaddressed with the revenue side (taxes) andhas postponed any discussion of spending cutsfor another two months. And on a longer-termbasis, the cliff deal did little to address thecountrys debt load - which currently stands atapproximately $16.4 trillion.

Also, the Fiscal Cliff is not the only issuenagging the United States and world economy.

In February-March, United States will again hitthe debt ceiling and Congress will need tonegotiate it. The Congress will also renegotiatethe sending/appropriations bill for the remainderfinancial year 2013.

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1929

Finistor

y

The Stock Market Crash of 1929, which startedin the month of October that year, has been themost catastrophic stock market crash ever in thehistory of the United States. Although the crash

lasted just for four days, it had a tremendousimpact globally. The crash signalled the startingof the Great Depression that affected all theWestern industrialized economies.

Just to explain in brief about the magnitudeof crash, theDow JonesI n d u s t r i a lAverage felldown toalmost 10%

of its recordhigh value of381.2, whichit attained onSeptember 3,1929. It wastrading ataround 41.22on July 8,1932 whichwas almost at

the bottom ofits valuationcycle. Thatwas the worstslump inmarket in terms ofpercentage loss inthe modern U.S. history. It took almost 25 yearsfor the same index i.e. Dow jones to actually reachits September 3 high. The details of the crashare as follows. The market started to crash from

October 24, 1929; the day that later came to beknown as the Black Thursday. The stock marketopened to trade at 305.85, falling approximatelyby 10% during day trading, barely, a stock

market correction. It regained momentum byaround 8%, to close just 2% down for the day.Even then there was some abnormality whichmade the bankers worried because the volume

traded on that day was quite abnormal; almosttriple the normal volume was traded during theentire trading session. Even though there was ahuge buying to prop up the market, it fell againon Black Monday 28th October 1929. The stock

m a r k e tcrash endedwith a panicselling onthe stockm a r k e ton BlackT u e s d a y ,29th October1929. Over16 millionshares weresold juston that dayalone. Overthe fourdays duringw h i c hthe stockm a r k e tcrashed, theDow fell by

around 25%,losing almost

$30 billion of market capitalization. The peoplewere terrified. This was almost equivalent to thetotal cost of World War I.

Situation before the crash: Roaring1920s

The economic condition that existed before thecrash was in complete contrast to the one that

IIM shIllong

Deepak P.

STOCK MARKET CRASH 1929:

CAUSES AND THE IMPACT ON

THE ECONOMY

Fig 1: Fluctuation of the Dow Jones Industrial Index


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The Roraring Twenties

saw the Dow Jones IndustrialIndes almost quadruple with

the stock market growing by

almost 20% every year

Finistory

was after the crash. This could be inferred fromthe fact that the period before the crash wasalso called the Roaring Twenties. The conditionwas such that during the 1920s discoveriesand inventions took place in almost every fieldthat later became the foundation of thrivingbusinesses. New business and productionmethods that were followed resulted in hugeprofits which they invested back into newbusinesses resulting in a tremendous increasein the buying power. The share markets showeda tremendous upward trend and reached peaksduring the period. Stock market grew by almost20% every year. The Dow jones Industrial indexalmost quadrupled during this period. Most ofthe investment was bought on Margin, i.e. only10%-20% was required to be put in the marketand the rest was borrowed from the brokers. Thesituation was such that out of every 5 dollarsa bank lent, 2 dollars were invested in stockmarket. The low unemployment rates of around4%-5% were another evidence of the economicprosperity that existed during the decade. TheGNP also skyrocketed from $4700 per householdto $5500 per household. The rising GNP also

meant that the workers had enough money tospend, resulting in mass consumption leadingto creation of even more jobs and more demandfor products.

Some of the factors which contributed to theEconomic boom of the early 1920s include the

advancements in science and technology thatresulted in the invention of a new materialcalled Bakelite which was used for themanufacturing of radios and telephones. Fordsassembly line means of production resulted inproduction of approximately 6 cars per minute,also huge advancements were made in thefield of medicine and healthcare. The rulesand regulations that imposed high tariffs onimported goods made the imported goods moreexpensive and hence most of the people bought

US made goods which resulted in creation ofmore jobs in the factories. Confidence was skyhigh among the people, credit system was moreprevalent which also increased the amount ofgoods purchased; out of every 10 cars bought6 were bought on credit. It seemed that thiseconomic prosperity would go on forever.

Fig 2: Volume of shares traded during the crash



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The Stock Market crash of

1929 led to a major economiccrisis known as the Great

Depression

Finistor

y

Causes of the Crash

There were many reasons that led to the stockmarket crash in 1929.The significant contributorto the crash was the overvaluation of stocks. Thestocks were overvalued to a great extent and theP/E ratios were very high. The overconfidence

among the citizens riding from the economicboom of the 1920s influenced them to searchfor an easy source of money and they investedhugely in the stock market. Another importantreason was that of marginal buying. When shareprices eventually slumped, investors had to selltheir shares to meet margin calls resulting infurther decrease in share prices, worsening theproblem and leading to the share market crash.The government also was partly responsible forthe crash. Mr Adolph Miller, the then president

of the Federal Reserve board, introduced verystrict monetary policies. The interest rates on theloans were increased to a great extent making itextremely difficult for the investors. Some otherreasons include the proliferation of investmenttrusts, large number of bank loans which couldnot be liquidated, and an economic downturnthat had begun earlier in this phase. Analystsalso opine that frequent comments by the publicofficials that the stock prices were too high couldalso be a reason for the crash. For example,

the then President of the US, Herbert Hoover,stated publicly that stocks were overvalued andthat speculation could have hurt the economy.Hoovers statement was indicative of the drasticsteps he was willing to take to control themarket. These types of statements by an officialof such repute made the investors believe thatthe market would correct itself soon and attainthe true value, which could be attributed as oneof the reasons for the crash. All the above factorsmore or less contributed to the most disastrous

stock market crash ever that happened in thehistory of the US economy.

Consequences of the Stock Market crash1929:

The stock market crash of 1929 had a significantimpact on the economy. It led to a major economiccrisis known as the Great Depression.

The stock market crash marked the beginningof a decade of unemployment, poverty, lack ofeconomic and personal growth, and decreasein other market opportunities. The US economyfell into a complete downturn or ratherrecession that lasted for almost a decade. Atthe height of this great depression, GNP wasdown by almost 40% from its original levelsand unemployment rate was above 25% whileunderemployment was much higher at a rate of50%. During this economic downturn, millions

of American workers lost their jobs. Industrialand construction workers faced great difficultiesduring this period. In Ohio, by 1933, more than40% of factory workers and 67% of constructionworkers were unemployed. Farmers did not getfair value for their products resulting in farmforeclosures across the United States. Industrialgrowth was hampered and fell by almost 45%.Some of the industries that were most severelyhit include the construction, shipping, miningand logging industry. The economic condition


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Finisitory

continued to slide and eventually reachedits lowest in the winter of 1932-33. Anothersignificant impact of this was that during therecession, approximately 9000 banks had tobe closed which resulted in millions of peoplelosing their savings. The economic slump sawthe average income of an average American

family being reduced by about 40%. Around3 lakh people were left homeless. Corporateprofits slumped by around 10 times during thisperiod. Amount spent on education was veryless, causing many schools to operate with veryless staff or shut down due to lack of funds. Thewages of the workers was significantly reduced.Due to the bad economic conditions, worldtrade decreased sharply as each country tried tosafeguard their own industries and products byraising tariffs on imports. The depression also

resulted in major political changes. In countriessuch as Germany and Japan, reaction to thiscurrent economic downturn brought aboutthe rise of power of militarist governmentswho followed aggressive foreign policies thateventually resulted in the Second World War.

Many Reforms were introduced after the crash.After a loss of approximately $14 billion, reformshad to be introduced to stabilize the economy.One of them included setting up of the Securitiesand Exchange Commission or SEC. The role ofthis body was to lay down the market rules andpunish the offenders in case of any violation.Another act called the Glass-Stegall Act wasalso passed. This act was passed to cut theconnection that commercial and investmentbank had before passing the law. The otherreform that was introduced was the setting upof the Federal Deposit Insurance Corporationor FDIC. This was introduced to make sure thateach and every individual bank account wasinsured up to $100000.

But the questions that we face today are: Havewe learnt from the past? Have we got in place asystem that shields us from the drastic effectsthat such a crisis can bring about?

I dont think so. There is still a long way togo before we can say that with certainty. Thefinancial crisis of 2008 was a harsh reminder

January 2012

of the same. But we can confidently say thatwe have taken several measures that helpedreduce the impact. Measures like BASEL III canreally go a long way in solving the problem.

Approximately 9000 banks

had to be closed which resultedin millions of people loosing

their savings



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Finsig

ht

Should Reserve Bank of India (RBI) bite the bait? Inorder to answer this question, lets understand bait

in RBIs context. Reserve Bank of India, the centralbank of the country, regulates and supervises thefinancial system, manages exchange rates, issuescurrency, and is the banker to all banks. The baitbeing offered in this case is the assurance that thechange in Banking Act 1949 will be passed by theHouse in upcoming budget sessions.

Pranab Mukherjee, the then Finance Minister,promised the issue of new banking licenses in his2010 Budget Speech. RBI was then asked to draftthe guidelines and the conditions to be fulfilled inorder to apply for this license. RBI agreed to dothe same but put forward a condition, it wanted theBanking Act 1949 to be changed a bit. It proposedthe following clauses:

1. A new section 12B should be inserted in the Actwhich states that any acquisition of 5% or more ofthe share capital of a bank will require RBIs approval.

2. The updated Act should empower RBI to supersedethe board of directors of a banking company andappoint an administrator during the period of super

session.3. The updated Act should also empower RBI tocall for information or inspection of any associateenterprise of a banking company.

For the below mentioned reasons, the Governmentof India (GoI) is trying to convince the RBI toissue the licenses based on the current Act. Thecontention of Government of India is that the Act

does state that no acquisition of 5% or more cantake place unless there is a prior acknowledgement

(and not approval) from the RBI. On the issue ofsuper session, the Act says that the promoter or thepromoter groups will be permitted to set up a newbank only through a wholly owned non-cooperativeholding company which will hold the bank as wellas other financial services companies regulated bythe RBI and other financial regulators. Governmentof India also says that Section 36AA and 36AB of theAct already empowers the RBI to replace members ofthe board or any officer of a banking company andto appoint additional directors.

One cannot deny that the new banks will be good forthe economy. Opening of new banks will extend thegeographic coverage of banks and improve accessto banking services. Though the Indian financialsystem has made impressive strides in resourcemobilization, geographical and functional reach,financial viability, profitability and competitiveness,vast segments of the population, especially theunderprivileged sections of the society, have still noaccess to formal banking services. This will also leadto greater competition, innovation, reduction in cost

and improvement in quality of service.One need not be an economist/analyst to figurethat Target 2014 is the Governments objective. In arecently held meeting between P. Chidambaram andthe heads of the state controlled banks, the financeminister said that he wanted the process of issuingnew bank licenses to start without waiting for anamendment of banking rules. Is the Government

srCC dElhI

Abhinav Sonal & Gautam Bansal

Pranab Mukherjee, the then

Finance Minister, promisedthe issue of new banking

licenses in his 2010 Budget

Speech.


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rushing into issuing new bank licenses? If it is true,why is that so? To put things into perspective, it isvery evident that the current government is findingit tough to get a foothold as the party of choice formost of the countrymen. It can be debated that theGovernment of India is approaching the opening of

new banks as another effort to redeem its failuresand scams. RBI probably appreciates and supportsthe actions being taken by the Ruling Governmentand all it demands is the safeguard on the functioningof new and existing banks. In short, RBI wants toensure that the Banks do not start to overlook thepublic interests to simply be more profitable.

Stable India is RBIs objective. Section 22 of BankingRegulation Act 1949 entrusts Reserve Bank of Indiawith the power to issue the licenses to new banks.But the Act also lists down certain conditions whichneeds to be satisfied in order to issue the license.Some of the conditions are that the affairs of thecompany are not being, or are not likely to be,conducted in a manner detrimental to the interestsof its present or future depositors; that the generalcharacter of the proposed management of thecompany will not be prejudicial to the public interestor the interest of its depositors; etc.

In order to ensure law and order in the bankingindustry it makes sense for the RBI to first get thechanges made in the Act and ensure that they areallowed to supersede the Board of Directors.

RBIs conservative approach in the past has paiddividends. During the booming period of the early21st century, the whole world was optimistic.Everyone was talking about the Great India Story.India was growing at a very rapid pace. But RBI waskeeping a close tab on the future. While everyonewas hoping for more liquidity in the market, RBItook an unexpected channel. It increased the CRRand reduced the liquidity. It abolished Land Loansand prohibited Off-Balance Sheet financing. All thishad an adverse impact on the investments andthe profitability of the companies. And while theworld financial sector collapsed, India averted amajor disaster. In retrospect, we all appreciate thestrong stand taken by the RBI. India did come out ofrecession better than a number of other nations andthe future of India still looks bright.

Looking forward, one senses caution. Indiasgrowth has been on an 8-year low. Inflation (CPI)has averaged 8% for the same period. Governmenthas been in regular talks with the heads of statecontrolled banks to infuse more capital into thebanks. Well-to-do Public sector banks such as Indian

Overseas Bank, Central Bank of India and Bank ofMaharashtra are stacking up NPAs in their balancesheets and need major revisions in their budgetedprovisions.

Can our economy really afford non-regulated newbanks, when half a century old banks are repeatedlyfailing on their budgets and provisions year-after-year?

All we want is the Banking System, which is complexand very sensitive in nature, to not get corrupted bythe misdoings of the new banks. We have a live case

on how Spanish banks have failed their economymiserably because (of unregulated banking system/loopholes in their banking policies) they could notanticipate the sub-prime/Eurozone failure. Also,we do not want a 2G scam, a Coalgate scam, aReliance 1992 ADR issue problem, etc. to happenwith the Banking industry, the consequences ofwhich can have fatal effects on the economy andthe common man. Therefore, RBI ought to takecalculative precautionary measures and ensure thatits reasonable demands are fulfilled before theyissue licenses to new banks.

Section 22 of Banking Reg-

ulation Act 1949 entrusts

Reserve Bank of Indiawith the power to issue the

licenses to new banks



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Sir, often there are articles innewspapers on actions being taken againstcompanies following Ponzi Schemes. What

is a Ponzi scheme?

In a Ponzi scheme, a single personwoo the investors by offering a higherprofit than what is offered in the market byshowing some made up investments. But

the truth is that the initial set of investors are paidby their own money or by the money paid by thesubsequent investors. This is different from a Pyramidscheme where one person starts it in much the same

way as a Ponzi scheme and then tiers of investorscontinue the trend in place of the single person.

How exactly is a Ponzi scheme carriedout?

Ponzi Schemes are quite basic butcan be very powerful. They are carried outin the following way:

1.Convince a few investors to invest in

your scheme2. Make the promised payment along with the

specified rate of return to the investors

3. Banking on the success of the investment,

attract more investors, mostly the initial investors

4.Repeat the first 3 steps. Most of the times, thecycle breaks due to lack of new investors.

How is this different from what aBank does? Even a Bank run has the sameeffect as a Ponzi scheme. Then why is aPonzi master mind adjudged as a criminalwhile a banker is not?

See, banks and other legitimatefinancial institutions are supposed toinvest the money which they receive fromdepositors and increase it, thus being ableto repay the investors later on. The problem

is that most of the funds with the bank are tied intoinvestments. When a bank run occurs, the bank runsout of cash to give to those who want to withdrawtheir funds. But, that doesnt mean that the bankhas run out of money! That money is there but it is

tied into investments that are not liquid. It is just aninstance of inefficient cash management. On the otherhand, the Ponzi scam master mind supplies the victimwith false documentation making it appear as if theirinvestment is still intact and earning a very high rateof return.

Even after so many Ponzi scams beingexposed, why are people still becoming avictim to such schemes?

A very good question, the first schemethat was exposed was that of Ponzi in 1920,after whom the scheme is named. Lack ofproper research before investing is makingpeople invest in such schemes.Most of the

times the people getting ripped off are not ignorant toscams. Informed investors often fall apart in the faceof offers to make money fast. A successful Ponzischeme requires an investor who thinks he is smarterthan he really is and a fraudster who makes him think

hes being given an opportunity which no one else isgetting.Another reason is that a Ponzi resurfaces everytime in different forms. For every exposed Ponzi scam,there are others who read about the mistakes madeand create a different version of that fraud. Therewere some schemes like the one followed by CharlesPonzi that were too good to be true, offering closeto 40% profit and at the same time there were otherschemes like the one offered by Bernard Madoff thatprovided a consistent return of 8% every year to makethe scheme look lucrative.

Thank you very much sir for theexplanation.

CLASSROOM

FinFundaof theMonth

Ponzi Schemes

NIVESHAK 27

Classro

omIIM Shillong

V RAMPRASAD


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F I N - Q1. He received his doctorate of economics from Harvard University and taught at the

Yale School of Management. He is best known for the development of the X in 1970s

as well as for his role in developing the model Y which uses a discrete-time modelof the varying price over time of the underlying financial instrument. Identify theperson and X and Y.

2. X is an investment firm founded in New York in 1947 as Franklin Distributors, Inc. It islisted on the NYSE under the ticker BEN. In 1973 the companys headquarters movedfrom New York to San Mateo, California. In October 1992, X acquired Y for a reportedcost of $913 million, leading to the common name XY. The owner of Y, a mutual fundpioneer, together with his son and Z together owned 70% of the firm. X, Y, Z?

3. Company X acquired Indian operations of Y to broaden its product offerings in MutualFund Business this year. Identify X and Y.

4. Identify the third company?

5. Incorporated in 2007, the company has been in existence since 1967. The companyrecently issued its IPO with the issue price of Rs. 48-50 per equity share. Thecompany has its only manufacturing plant located in Hardwar, Uttarakhand. Namethe company.

6. Self-employed people and the business houses which are unincorporated can avail

a plan for retirement purposes. This plan provides that the contributions are taxdeductible up to 25% of annual income with certain limits. Identify the plan.

7. X was involved in a financial scam which shook the country considering the amountof money he made. X was sentenced to rigorous imprisonment for 13 years. Cureout who is X ?

All entries should be mailed at [email protected] by 10th February, 2013 23:59 hrs

One lucky winner will receive cash prize of Rs. 500/-


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Team Niveshak invites articles from B-Schools all across India. We are looking fororiginal articles related to finance & economics. Students can also contribute puzzlesand jokes related to finance & economics. References should be cited wherever nec-essary. The best article will be featured as the Article of the Month and would be

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Instructions Please send your articles before 10th February, 2013 to [email protected] The subject line of the mail must be Article for Niveshak_ Do mention your name, institute name and batch with your article Please ensure that the entire document has a wordcount between 1200 - 1500 Format: Microsoft WORD File, Font: - Times New Roman, Size: - 12, Line spacing: 1.5 Please do NOT send PDF files and kindly stick to the format

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