The Outside view from Equitymaster

Why Income Funds are witnessing rise in AUM?

Fri, 24 May 2013 00:00:00 GMT

In the last fiscal year amid a slowdown in economic growth rate, the Reserve Bank of India (RBI) as many of you may have observed has taken a rather calibrated stance on reducing policy rates. This is because while handling the growth-inflation dynamic in the monetary policy, Wholesale Price Index (WPI) inflation was plateauing above the 7.0% plus mark for quite some time causing discomfort to the central bank. But now that WPI inflation has mellowed down and moderation seen, it has brought in some sigh of relief which has induced central bank to address to growth risks, although again in a very gradual manner.

AUM of income funds on a rise

Data as on April 30, 2013
(Source: AMFI, PersonalFN Research)

The Indian debt markets too amid this scenario have kept rational expectations and with gradual steps taken by RBI to reduce policy rates along with liquidity situation being addressed to (via cut in Cash Reserve Ratio (CRR) and / or Open Market Operations) at appropriate point in times; "income funds" have attracted debt mutual fund investors. As on April 30, 2013 the Assets Under Management (AUM) of income funds is at Rs 4,22,300 crore - it being a three-year high; and from last April too there's been an increase of 36%.

Tight liquidity situation at present along with expectation of further easing in monetary policy aided by further drop in WPI inflation for April 2013 to 4.89% - a 41-month low, has induced many to look at income funds. But it is noteworthy that most of the inflows has come in the ultra-short-term and short-term income fund category as fund managers expect the yields of shorter tenure bonds to firm up in the near future due to tight liquidity conditions and investors too are allocating their hard earned money to shorter maturity debt papers. Long-term income funds have also seen increase in inflows exuded by expectations of further rate cut from the RBI now that WPI inflation is placed below the comfort level of RBI.

At present yields of shorter maturity papers are hovering around 8.50% (upto 1 year maturity), while those of longer maturity papers near 7.50%. Fund managers are expecting the coupon rates of longer duration debt papers to remain low, as interest rates are expected to fall over the next one year if WPI inflation continues to remain below RBI's comfort level.

A strategy should debt investors...

At present while taking exposure to debt mutual fund schemes and fixed income instruments, it would not be very prudent to take exposure to longer duration instruments as most of the rally has already occurred ahead of expectation of a 25 basis points (bps) policy rate cut from RBI in the annual monetary policy 2013-14. With drop in WPI inflation for April 2013 while expectations of a 25 bps rate cut have been built yet again, PersonalFN is of the view that the central bank would also keep a watch on May 2013 WPI inflation data. Likewise, they would take into account the trade deficit and Current Account Deficit (CAD) too which is depicting a worrisome picture. At present, as many of you may be aware, India's trade deficit for April 2013 has widened upto U.S. $ 17.8 billion led by high gold imports. The Current Account Deficit (CAD) data too is expected to touch a record high of 5.0% of GDP in 2012-13 (as measures to curb gold imports have only had a marginal effect thus far); so all these facets would be evaluated carefully and then the central bank would take stance whether to cut rates in its 1st mid-quarter review of monetary policy 2013-14 (scheduled on June 17, 2013).

However if one wishes to take exposure to longer duration instruments or debt mutual fund schemes holding longer maturity papers (as permitted by their high risk appetite), PersonalFN recommends that you do so by investing in dynamic bond funds, since there would always be intermediate interest rate risk involved.

In the current scenario while investing in debt instrument, it would be ideal to invest in shorter duration instruments vide debt mutual fund schemes having shorter maturity profile. Investors with an extreme short-term time horizon (of less than 3 months) would be better-off investing in liquid funds for the next 1 month, or liquid plus funds for next 3 to 6 months horizon. If you as an investor have a short to medium term investment horizon (of 1 to 2 years), you may allocate a part of your investment to short-term income funds, provided that you are willing to take some interest rate risk. Avoid investing in G-sec funds, as they may see high volatility and may not be an ideal instrument to yield fruitful returns. Fixed Maturity Plans (FMPs) of 3 months to 1 year period can also be considered as an option to bank FDs only if you are willing to hold it till maturity. Alternatively you can also invest in 1 year Fixed Deposits (FDs), as banks are offering interest on 1 year FDs in the range of 7.50% - 9.00% p.a.

PersonalFN is a Mumbai based personal finance firm offering Financial Planning and Mutual Fund Research services.

Disclaimer:

The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.

Sanofi India: Merely chugging along

Tue, 21 May 2013 00:00:00 GMT

Posted by Equitymaster

The principal shareholders must explain why the company is not pumping in more moneys into capex and why they are content with the company merely drifting along.

The Mallya link

The board of directors of Sanofi India is still chaired by guess who-Dr Vijay Mallya! But by God’s grace he has no control over the functioning of the undertaking. (The other connection of Vijay is the shareholding in United Breweries Holdings Ltd and United Breweries Ltd by Sanofi. But we will delve more on this shareholding aspect of the company later on in the copy). At least this is my understanding of the ground reality, and based on the brief 10 year financials that the company has appended to the annual report. The gross sales have grown to Rs 15.3 bn in 2012 from Rs 7 bn in the base year 2003 -an increase of 117%, while the profit before tax adopted a very zig zag route to rest at Rs 2.6 bn from Rs 1.45 bn over the same time span.

Vijay’s association with Sanofi derives from the erstwhile Hoechst Pharmaceuticals, the German pharma giant whose Indian operations were 40% owned by the UB group care of the late pater familias Vittal Mallya. The UB group subsequently sold their holding in Hoechst to Hoechst if my memory serves me right. A lot also happened subsequently in the global world of pharmaceuticals. Hoechst subsequently merged with Phone Poulenc of France to form Aventis. (Hoechst GmbH Germany is still a legal entity though and is the principal shareholder of the Indian offspring). In the meantime a company called Sanofi was founded by the French oil company Elf Aquitaine in 1973 which engineered a series of mergers and acquisitions of its own. Sanofi finally acquired Aventis but retained its name. The Indian unit in turn changed its name to Sanofi in 2012. The promoters - read as Hoechst and Sanofi together -- hold a slice over 60% of the paid up capital of Rs 230.3 m consisting of equity shares of the face value of Rs 10 each.

The Indian pharma market

The company states that the total Indian pharmaceutical market was estimated at Rs 712 bn in the calendar year ended December 2012. The company achieved gross revenues from operations of Rs 16.1 bn. After deducting excise duty, it toted up net revenues of Rs 15.7 bn. (The operating revenues include other operating income of Rs 92 m against Rs 120 m previously). Means its stake in the Indian market amounted to 2.3% on a gross basis and 2.2% on a net basis. In other words the company’s operations amounted to a mere flea bite in the overall Indian context. In reality its take in the Indian market is even lower if one factors in the export sales. Export sales at Rs 2.53 bn amounted to 15% of net sales by the company’s admission. If one deducts this amount, then the domestic penetration gets reduced to 1.9% on a net sales basis. It is indeed as pygmy alright. In reality I have to add another caveat. The sale includes bought items for resale. The company purchased traded goods (formulations) worth Rs 1.85 bn against Rs 1.35 bn previously. I do not know the value of rupee sales that the traded products generated as a result, as this information has not been separately furnished. In effect therefore the fixed assets to revenue from operations stand even lower.

Intangible assets

It is also the first manufacturing company that I have come across where the bulk of the fixed assets constitute intangible assets. The total gross block at year end amounts to Rs 10.1 bn. The intangible assets in this total amounts to Rs 6.1 bn-or 60.4%. The vast bulk of this intangible asset block was apparently acquired in the preceding year when the merger took place. The intangible assets basically comprise of goodwill and brand. The constituents of the tangible assets also make for interesting reading. It almost completely comprises of buildings or plant and machinery. The two between them account for 88 % of the tangible gross block. Close to 52% of the tangible gross block was depreciated at year end.

The tangible assets generated revenues from operations 3.90 times its size. The gross block in totality generated revenues 1.6 times its size. That would not appear to make for much revenue generation on the face of it but that is the reality of the matter. Besides, the total addition to gross block during the year was a very paltry Rs 523 m against an even more miniscule Rs 259 m in the preceding year. Why the company is going slow in adding to its gross block is not known. This could also be a factor in its inability to rustle up a higher increase in revenues. It is not known what impediments the company is facing in its journey forward or whether it is deliberate.

Generous returns to the principal shareholders

Whatever, the foreign promoters must be more than happy at the returns that the company is providing to them. On net revenues including other income amounting to Rs 16.1 bn the company recorded a lower pre-tax of Rs 2.62 bn against figures of Rs 13.6 bn and Rs 2.84 bn previously. The decrease in pre-tax profit was caused by a seemingly extraneous factor. The depreciation provision rocketed to Rs 899 m from Rs 311 m previously-due to the large addition to its intangible asset portfolio. (Given the massive accretion in the intangible asset portfolio by Rs 5.7 bn it is a bit surprising to note that the revenue expenditure on advertisement and sales promotion has increased only marginally to Rs 929 m from Rs 800 m previously). Probably the acquired brands sell on their own. The post tax profit rested at Rs 1.76 bn against Rs 1.91 bn previously. There are no interest charges as the company is completely debt free. The company declared a dividend of 390% on its paid up capital base of Rs 230.3 m. There is no reason for the principal shareholders to feel unhappy. As a matter of fact they appear so happy that they have not levied any royalty fees on the sibling. But then there are plenty other inter-se transactions with group companies.

The many tentacles of the parent company

The company expended forex worth Rs 4.4 bn and generated forex of Rs 3.2 bn during the year. So it was forex negative by a mile. The company makes do with 30 fellow subsidiaries. This includes four companies based out of India---Genzyme India Pvt. Ltd, Sanofi Pasteur India Pvt. Ltd, Shantha Biotechnics and Sanofi Synthelabo (India) Ltd. Sanofi India does not hold any shares in these fellow offspring. But as stated earlier it holds shares in two Mallya group companies. It holds 99,636 shares in United Breweries Holdings Ltd and 332,120 shares in United Breweries Ltd. One wonders what value the company sees in holding on to these shares given the lack of synergy between what it does and what the investee companies do. But these shares were acquired for a pittance and hence there is no carrying cost to the company. Besides, the market value of the shares was estimated at Rs 321 m at year end. It will of course come to Dr Vijay’s advantage when the management holding is toted up and at no cost to Dr Vijay.

But to get back to the point that I was extolling on. In the details of inter-se group company transactions Sanofi India sold raw materials and finished goods to group companies valued at Rs 2.48 bn while it in turn has bought the same items from group companies valued at Rs 3.77 bn. It is not known whether all the finished goods that it has sourced are from group companies -but in all probability it was so. Then there is the sharing of ‘common expenses’ and ‘Income from Service’ rendered or for services paid which in turn run into the many hundreds of millions of rupees. Whether these transactions had a positive or negative effect or whether it was profit neutral on the company is not known, but presumably it was effected in the best interest of all concerned. This is a ‘burden’ that all MNC siblings have to contend with. One of the group companies, Shantha Biotechnics, was also a beneficiary of a corporate loan from the cash rich Sanofi India.

Financial management

Whatever may be the shortcomings in putting the company in the all systems go mode, the company spins like a top. The cash flow shows an excess of cash riches at the end of the financial year. Cash and bank balances of Rs 4.28 bn at year end. Not surprisingly it has zero debt. The best part of the deal from the company viewpoint is that it does not have to splurge more than a few dimes on gross block addition. This frees a lot of cash for which the company has not found any profitable hideaways. How the company manages to sail by with such a pittance of any capital investment beats me totally-but that is the reality of the matter. It must he flogging its plant and machinery to the very ends of the earth for sure. The trade payables at Rs 1.5 bn towers over that of trade receivables of Rs 986 m. That in itself shows its clout in the market. And, for all practical purposes the company sells cash down. Only the inventories at 17% of gross revenues appear to be to on the higher side-in a manner of speaking that is. And, excluding the cash balance at year end, the current assets and current liabilities are almost on par.

But it would appear from the quivering manner in which the margins are generated that its major pharma products require the nod of the National Pharmaceutical Pricing Authority (NPPA) to obtain price increases and in such an exercise there is some delay between the lodging of the request and the sanction. Just as the NPPA sanctions price increases it also effects a reduction in prices.

But this is definitely not a company that would fit into the investment bracket notwithstanding the fact the share price (Rs 10 face value) ranged from a high of Rs 2,430 to a low of Rs 2,002 during the financial year.

Disclosure: I do not hold any shares in this company, either directly, or under any non discretionary portfolio management scheme

This column Cool Hand Luke is written by Luke Verghese. Luke has been a business journalist, financial analyst and knowledge management head with a professional experience of more than 20 years. An avid watcher of the stock market, he has written extensively on stock market trends. His articles have featured in Business Standard, Financial Express and Fortune India amongst others. He has also been the Deputy Editor, Fortune India and the Financial Editor of The Business and Political Observer.

Disclaimer:
The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.

Monetary policy: Common man's perspective

Mon, 20 May 2013 00:00:00 GMT

Posted by Equitymaster

The governor of the Reserve Bank of India (RBI), Dr D Subbarao, announced the Annual Monetary Policy for 2013-14 on May 3, 2013. The annual policy is significant, as both monetary policy and developmental and regulatory policies are covered. While the policy has a large number of measures, this column is restricted to a few issues which directly impinge on the common person.

Implications of Lower Repo Rate

Against the backdrop of a large balance of payments, the Current Account Deficit (CAD) of 5 per cent of GDP in 2012-13, a Consumer Price Index (CPI) increase, on a year-on-year basis at the end of March 2013 of 10.4 per cent (since come down to 9.4 per cent for April 2013), the RBI reduced the repo rate, i.e. the rate at which it lends to banks, against holdings of government securities, from 7.5 per cent to 7.25 per cent. Of course, the reduction of the policy rate is defended as a response to the Wholesale Price Index (WPI), which showed an increase at the end of March 2013 of 6 per cent (later data for April 2013 shows an even lower inflation rate of 4.9 per cent).

While banks have not immediately reduced their deposit rates, there will be an inevitable downward movement of deposit rates. Individuals would be well-advised to lock into the two-year maturity for fixed deposits, as any significant increase in deposit rates can be ruled out for the next 12-18 months. The government diktat to public sector banks to reduce or eliminate the additional premium for senior citizens is indeed cruel.

As regards shorter term surplus funds, most individuals leave such balances in savings bank accounts, which, in most banks, earn a low rate of return of 4 per cent. As a matter of discipline, depositors must develop a practice of moving funds out of savings bank accounts and put them in short-term deposits of seven days with automatic roll-over instructions; such fixed deposits earn significantly more than savings bank accounts. Withdrawal after a seven-day block will not lead to any loss of interest. The All-India Bank Depositors' Association (AIBDA) would do well to publicise this option. If depositors move out of savings bank accounts, which offer only 4 per cent, banks will start opting out of the informal cartel arrangement. The AIBDA needs to articulate that cartelisation is against the interests of depositors and should be examined by the competition commission. The RBI needs to counsel banks that most banks fixing the rate at 4 per cent could conceivably be considered as cartelisation.

The triad

According to the policy statement, the triad of financial inclusion, financial literacy and consumer protection are intertwining threads in the pursuit of financial stability. Dealing with these issues in a connected and coordinated manner will greatly enhance the effectiveness of these measures. The attainment of financial inclusion is not going to be an easy task and would need years of work. Nonetheless, it would ultimately be rewarding.

Financial Inclusion

The implementation of the Financial Inclusion Plan (FIP) for 2010-13 has led to the establishment of banking outlets in more than two lakh villages. The policy statement stresses that it is necessary to take financial inclusion to the next stage. The target of universal coverage to facilitate direct benefit transfer for delivery of social welfare benefits by direct credit of the bank accounts of beneficiaries will require a stupendous effort of opening accounts for all eligible individuals. Accordingly, banks have been directed to draw up the next FIP for the period 2013-16. One would not underestimate this stupendous task, but there has to be an on-going assessment of both success stories, as well as failures, which would facilitate the attainment of the goals.

Under the Lead Bank Scheme, districts in metropolitan areas are excluded. It is recognised that financial exclusion is also widespread in metropolitan areas among the disadvantaged and low-income groups. This will require a very different approach, as compared with the rural areas, as in the urban areas, these segments are itinerant.

Financial Literacy and Awareness

In order to link financially excluded segments with the banking system, models for conduct of literacy camps by banks have been prepared to culminate in effective financial access. The RBI is now empowered to establish a Depositor Education and Awareness Fund (DEAF), which would be credited with balances in deposit accounts which are not operated for ten years. The fund would be used for promotion of depositors' interest. If a rightful beneficiary comes up with a valid claim, DEAF would provide a refund of the amount.

Consumer Protection

It is increasingly recognized that contracts between banks and customers are invariably stacked against the customer and while a lot has been done to provide customer protection, much remains to be done.

Informal and Formal Financial Sectors

It is well-known that many disadvantaged persons hold bank deposits and yet borrow from the informal market at rates as high as 60 per cent per annum (without security) or 24 per cent (with security). Rudimentary financial literacy would avoid such pathetic situations. These are not minor issues, but are widespread, hence there is a need to strengthen the law as well as the regulatory system. It is well-known that for the disadvantaged, what is vital is the availability of credit and not its cost. Excessive preoccupation with low interest rates is counter-productive, but somewhat higher interest rates in the organised financial sector, albeit much lower than in the informal sector could ultimately benefit the disadvantaged.

Way back in the late 1960s and the early 1970s, considerable work was undertaken on developing links between the indigenous banking system and the formal banking system. In this context, the Banking Commission had undertaken useful work. In the aftermath of the bank nationalisation in 1969, the view taken was that the formal banking system would eventually supplant the indigenous banking system and, as such, there should be no link between the two systems. Unfortunately, 44 years after the nationalisation of banks, the indigenous banking system still thrives.

The Rajamannar Working Group, set up by the Banking Commission) had drafted a legal code for indigenous banking and provided for the revival of the link between the formal and informal segments, with the rediscounting of the Hundi by banks. Incidentally, the first class Hundi had an immaculate track record, without failure of payment of the Hundi on due date. In the context of the current comprehensive review of the financial legislative structure, a detailed assessment needs to be made of restoring the link between the formal and informal markets through the Hundi. One cannot just wish away the indigenous banking system

Please Note: This article was first published in The Free Press Journal on May 20, 2013. Syndicated.

This column, Common Voice is authored by Savak Sohrab Tarapore. Mr. Tarapore, is an economist and he runs his own Multi-Language Syndicated Column. Mr. Tarapore's other column, which appears in The Hindu Business Line, is titled Maverick View.

Disclaimer:
The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.

Alfa Laval (India): Complicated set of affairs

Fri, 17 May 2013 00:00:00 GMT

Posted by Equitymaster

The 75 year old Indian sibling which has wisely chosen to ride out into the sunset from the perspective of listing in its platinum jubilee year

Delisting from the Indian bourses

This is my second take on Alfa Laval (India) Ltd having first covered its financial results for the 12 months ended December 2010. In the interim the company organised a buyback of shares from the Indian public offering a price of Rs 4,000 for each equity share tendered. The offer went down well with the desi shareholders and the parent Alfa Laval Corporate AB, Sweden, was able to hike its stake in the Indian sibling to 94.45%. Following the increase in the stake holding the company delisted its shares from the local bourses from April 2012. Thereafter an exit offer was made for the remaining minority shareholders and as on January 2013 the parent held 97.73% of the paid up equity capital of Rs 181.6 m. The company seems very intent on a full buyback of its public holding of shares. But there are still some diehard Indian shareholders still clinging on to their shareholding and this copy is for them. I may add here that the first visible causality of the delisting process is the forgoing of any dividend payment for the just concluded year. This may well be the beginning of the shape of things to come.

The product range

The company specialises in the manufacture and sale of capital equipment---separators, decanters, heat exchangers, fabrication equipment, fittings and other parts, and manufactured components in the main. The item classified as spares is bought out and resold. The other major revenue accrual is an item labelled as bought out/erection items. Then, at the relatively minor level there is income from ‘maintenance and other services’ of Rs 93 m against Rs 61 m previously, and income from scrap sales of Rs 54 m against Rs 64 m previously. The products on offer are used in a host of industries ranging from food and water supply, energy, environmental protection, and pharmaceutical industries. Together, all the items on offer including ancillary services brought in gross revenues of Rs 10.45 bn against Rs 11.47 bn previously. Separately, other income added its mite by contributing Rs 289 m to the top-line against Rs 409 m previously-a wide variation. The two big contributors here are ‘export benefits’ at Rs 63 m against Rs 85 m previously, and ‘customer settlement and excess liabilities’ written back at Rs 72 m against Rs 50 m previously. There is no set pattern in all this.

The company makes a variety of equipment all of which appear to be of significant importance to its ability to earn its bread, but it is not known however whether each of these items is also interdependent or independent of the other. For example, for each separator that it manufactures does it also have to make a decanter, and so on. In any event the company sold less by value in 2012 than in the preceding year. Why this should be so has not been suitably explained. Then there is an item called Contract Revenue which in 2012 amounted to a sizeable Rs 2.45 bn which again is difficult to track. This is followed by ‘Service income’ and ‘Scrap sales’ which also contribute to the top-line in some haphazard way. Simultaneously, the company also bought and sold manufactured items like heat exchangers and spares during the year, as is the practice. The company bought items worth Rs 441 m and sold items worth Rs 781 m. On a fairly good reckoning the company would have made a hefty gross margin of Rs 340 m on this exercise. The margin that it would have made in the preceding year is not known due to the lack of data. It becomes impossible to get a fix on how the revenues tote up at the end of the year given the manner in which all the incomes add up. The ‘other income’ which again can vary significantly accounted for 17% of pre-tax profit against 22% previously.

A complex generation of incomes and expenses

If the income side is difficult to comprehend, then the expenditure side is just as tricky. There is a significant item called ‘subcontractor charges’ which features under two heads of account. Probably there is a very valid reason for doing so. Then there are such imponderables as liquidated damages, and warranty charges which collectively run into over Rs 100 m, and IT charges of Rs 110 m --which appears to be entirely outsourced. Compounding the issue is the substantial inter-se transactions with group companies.

The sale of products and services to group companies amounted to Rs 3.6 bn while the purchase from group companies amounted to Rs 862 m. The value of such sales amounts to close to 38% of gross sales which gives an indication of how the group companies are interlinked. It is possible that all the traded goods bought for resale were entirely sourced from affiliates. What is interesting in this masala mix is that the trade receivables accounted for 21.5% of group company sales while the trade payables accounted for 32% of group company purchases. That is to say it gets more leverage to pay its dues than it gives credit for revenue receipts. Is this deliberate or accidental please?

There are numerous other group company debits and credits on revenue account which do not have to be gone into in detail-barring driving home the point that the Indian sibling cannot exist without group support. It is all planned down to the letter T. One may add here that the annual report has furnished the names of 71 group companies, including two operating out of India with whom transactions have taken place-presumably during the year. The companies are based out of 38 countries excluding our own Bharat. The two Indian companies are Alfa Laval Support Services Pvt. Ltd, and Tranter India Pvt. Ltd. Then there are another two companies ' the holding company, and the other being the ultimate holding company. It is a pyramid structure out there.

Myriad group company interactions

The effect of the group company interactions is vividly pictured in the following footnote in the latest annual report. The note states that for the assessment year 2008-09, the IT department has passed an assessment order demanding adjustment on account of transfer pricing and other matters under various sections of the IT Act. The tax amount involved is Rs 125 m excluding interest-Rs 135 m in the previous year. The company has filed an appeal with the Appellate authorities against the order. The company has also received a transfer pricing order for the Assessment year 2009-10 proposing an adjustment of Rs 22.3 m excluding interest. What about the subsequent years also please? Besides these contingent liabilities, the company is also faced with another demand of Rs 155 m from the Commercial Tax officer, Pune towards the demand of recovery of sales tax of Rs 155 m for the period FY04, FY06 and FY07. �

Financials in fine fettle

But one must also add here that in spite of the many complexities within which the company operates, the year end financials reveal a company in fine fettle. The company has no borrowings for starters. The reserves and surplus at Rs 5.86 bn towers over that of the piddling paid up capital. The cash flow statement reveals a company operating on a high. The cash flow from operations was more than sufficient to fund the capex of Rs 740 m (Rs 458 m previously) and the company also indulged in some large scale purchase and sale of securities. It bought debt securities of the value of Rs 2.5 bn and sold debt securities of the value of Rs 2.1 bn leaving a surplus of Rs 412 m in its kitty. It made some money in the bargain, and this capital accretal is accounted for in the other income schedule.

Its investment schedule is divided into current investments and non-current investments. From an analysis of the two profiles it is difficult to comprehend why the company resorted to such a bifurcation as the investments in both portfolios consist of similar debt securities. But anyways the company is able to profit on two counts here. It earns a profit on the purchase/sale of securities and earns a dividend on the portfolio. The total portfolio at book value at year end amounted to Rs 977 m against Rs 549 m previously. The net increase in book value in a sense represents the additional net investment from its free cash flow.

Being in the manufacture of capital equipment, erection services and sub-contracting-- the company has quite some working capital locked up in inventories and in trade receivables. But the good news here is that it is also simultaneously able to collect substantial advances from customers for orders -- which reduces the receivables burden by a fat amount on the one hand, and on the other the fact that the amount of trade payables is almost on par with that of the trade receivables. This is also one of the few companies which bifurcates some of its assets into current and non-current-meaning out-standings over one year from the date of the balance sheet and dues within one year. The assets so bifurcated include Loans and advances, trade receivables, other loans and advances and other assets. It is, as I implied earlier, all a trifle too complex.

Singing its swan song

As I mentioned earlier, the first visible sign of the company going off the radar of the bourses is the skipping of the dividend. This may well become a permanent feature in the years to come. There are other ways of getting succour. For example, the inter-se transactions between the group companies especially on revenue account may witness a sharp spurt. And, this is also a company that barring its brand equity is more than a fistful for any analyst to decipher competently. Its very nature of operations makes it so.

But at the end of the day it is sad that another branded MNC is singing its swan song from the Indian shareholder point of view.

Disclosure: I do not hold any shares in this company, either directly, or under any non discretionary portfolio management scheme

Disclaimer:
The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.

Monetary policy in a cauldron

Fri, 17 May 2013 00:00:00 GMT

Posted by Equitymaster

The 2013-14 Annual Monetary Policy announced by Reserve Bank of India (RBI) Governor D. Subbarao, was his last Annual Policy.

The worry lines for the RBI are becoming increasingly visible. Growth has slowed down to a level of 5 per cent in 2012-13.

Although annual inflation for the fiscal, as per the Wholesale Price Index (WPI), was 6 per cent at the end of March 2013, the same based on the combined Consumer Price Index (CPI) for urban and rural segments was still high at 10.4 per cent (the latter has come down to 9.4 per cent for April 2013).

While the Government and RBI continue to use the WPI as the reference for policy purposes, the world over, however, it is the CPI that is the standard reference indicator. Sooner or later, the Indian authorities will have to switch over to the CPI as a reference for policy purposes.

Policy rates and inflation

The Government has been more than explicit in stressing that revival of real growth is an overriding priority; hence, the sabre-rattling on lowering policy interest rates. The discomfort to the RBI is that India's CPI inflation is the highest among the emerging and major developing economies. More importantly, India stands out as an outlier with the policy interest rate being substantially lower than the inflation rate.

As the latest Policy statement rightly stresses, the current account deficit (CAD) in the balance of payments is the biggest risk to the Indian economy.

With a CAD estimated at 5 per cent of GDP in 2012-13, the external payments position is clearly alarming. The ratio of short-term external debt to total debt (on a residual maturity basis) is 44 per cent and as a ratio of the official foreign exchange, is as high as 56 per cent.

Although the CAD has so far been easily financed, without any significant loss of reserves, it is well known that a CAD which is easily financed in one year can become difficult to finance in a subsequent period. The need to reduce the CAD is clear, but the underlying analysis in official policymaking circles is a cause for real worry.

Basic Analysis of CAD

A major plank of macroeconomic policy, at the present time, is to step up the growth rate. The RBI's projection for GDP growth of 5.7 per cent in 2013-14 has been labelled by Government policy honchos as too pessimistic compared with the Government's own projection of 6.4 per cent. At this juncture, with the outcome of the monsoon being unclear, it is only apposite to be cautious in projecting the growth rate.

It is generally recognised that investment needs to be stepped up and this is the central reason for the Government pressing for interest rate reductions. Furthermore, efforts are being made to encourage foreign capital inflows to finance the large CAD.

An increase in investment by itself, however, increases the gap between investment and saving which, as per the basic macroeconomic identity, is the CAD (i.e. CAD=Investment minus Saving). The artificially low interest rates have been dampening savings, and within savings, there is a shift taking place from financial savings to physical savings.

The upshot of all this is that the CAD could go up and not down with a rise in investment and the country could be faced with a major external sector crisis.

It is felt that the easing of prices of oil and gold would reduce the CAD. In fact, reduction in prices will increase the import demand for gold. As explained above, the CAD is the gap between investments and savings and this would not be affected by changes in import prices.

The balance between investment and saving can be reduced only by either reducing investments or increasing savings. Since there is a need to step up investments, the only option is to increase savings. Reducing interest rates is not conducive to increasing saving.

Reversing monetary easing

In the emerging context, it would appear that the RBI's recent decision to reduce its repo or overnight lending rate from 7.50 per cent to 7.25 per cent was not the appropriate policy decision. The ground reality, however, is that the Government has an overbearing role in the formulation of monetary policy and its pronouncements have been more than explicit that the RBI should ease monetary policy.

Given that the policy interest rate transmission mechanism is rather weak, the reduction in repo rate by 0.25 per cent should be considered as a giveaway that has the least damage. A reduction in the cash reserve ratio requirements for banks would have been more damaging. Again, the RBI needs to be parsimonious in undertaking open market purchases of securities.

The next Mid-Quarter Monetary Policy Review on June 17 and the First Quarterly Review on July 30 should be strategically used by the RBI to resist pressures for easing monetary policy.

Ideally, the Second Quarterly Review in October 2013 could be the best time to reverse gears with a monetary tightening.

Any further easing of monetary policy now will only invite the next balance of payments crisis. The RBI, in fact, needs to reverse gears to prevent that.

Please Note: This article was first published in The Hindu Business Line on May 17, 2013.

This column, Maverick View is authored by Savak Sohrab Tarapore. Mr. Tarapore, is an economist and he runs his own Multi-Language Syndicated Column. Mr. Tarapore's other column, which appears in The Freepress Journal, is titled Common Voice.

Disclaimer:
The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.

Why is Contingency Fund so important?

Wed, 15 May 2013 00:00:00 GMT

Posted by Equitymaster

One of our financial Planning client Mr. X (Name changed to protect privacy) working with an IT firm as a consultant was informed about the slowdown in IT industry. The consequences of slowdown in IT industry can be so dramatic that he might end up losing his job in next couple of months. God forbid, but if he really does lose his job, the financial goals which he dreams off such as cosy retired life, giving the best to children - be it education or even getting them married-off well amongst others; may all go haywire, but more concerning would be funding his day-to-day expenses to run a home including the EMI for a home loan.

Mr. X might stop investing for his financial goals till the time he finds a new job but his regular expenses such as household Expense of Rs. 25,000 p.m., medical Expense of Rs. 5,000 p.m., child School Fees of Rs. 10,000 p.m. and EMI on home loan of Rs. 15,000 p.m. has to be met in any case. Cumulating these entire expenses he cannot avoid paying a sum of Rs. 55,000 p.m. and other regular expenses.

Therefore, you see a need arises to primarily have a contingency fund to confront such a situation and embarrassments. Typically a contingency fund consists of 6 to 24 months of regular expenses. This includes all necessary expenses, but can exclude luxuries.

Contingency Fund Requirement of Mr. X

Expenses	Amount p.m. (Rs)
Household Expense	25,000
Medical Expense	5,000
Child School Fees	10,000
EMI	15,000
Total Expenses	55,000
6 months Expenses	330,000
24 months Expenses	1,320,000

In the case of Mr. X, 6 months of expenses would be Rs. 3,30,000, and 24 months of expenses if Mr. X chooses to be conservative in his outlook, would be Rs. 13,20,000.

Many a times when people first hear that it is important to keep at least 6 months and up to 24 months of expenses aside as a contingency fund, they tend to think of it as a large sum. Often the reasoning is, this money is just lying idle, and that means it is losing out on what it could earn if deployed into an asset classes such as equity, debt and gold. In order to utilize your contingency fund effectively, you could also look at flexi deposits offered by banks these days.

But that's not what a contingency fund is for.

You see, the purpose of having a contingency fund is to take care of your family and your expenses in an emergency situation, such as loss of job, markets crashing, medical emergency or any unfortunate event that come with an economic loss for some time.

Often there are financial obligations that are absolutely must to meet no matter what your professional or personal situation is. Loan EMIs are a prime example. This is why you must have a contingency fund. So that if for some reason, your cash inflows reduce or halt or your expenses suddenly shoot up more than your income, you don't have to worry because you have anticipated this and have set the funds aside. In the case of Mr. X, he chose to build a 1 year contingency fund because his cash flow uncertainty was higher, being a consultant. This 1 year of contingency fund will help him to take care of his regular expenses in case he really loses his job and will also give him time to find a suitable job in next 1 year without worrying much about his regular expenses.

So what to do if you don't have a contingency fund?

Your first step should be to start saving for at least 6 months of your regular expenses before investing for any financial goals and keep it in a savings bank account or if you want a better return than putting money into a savings bank account, then opt for sweep in account, flexi deposit or liquid funds. Once 6 months of your contingency funds are available then your next aim should be to increase it to 12 or 24 months of regular expenses which can be done in phased manner over a period of time. If you have any EMIs you must remember to include them in your regular expenses when building up your contingency fund.

Remember, there are events such as job loss or illness that can get in the way of your regular cash flows, but this should not get in the way of letting you achieve your life goals with consistent investments into the right investment avenues.

PersonalFN is a Mumbai based personal finance firm offering Financial Planning and Mutual Fund Research services.

Il&Fs Engineering: Efforts to resurrect still to yield results

Fri, 10 May 2013 00:00:00 GMT

Posted by Equitymaster

The fully jiggered EPC (engineering/procurement/construction) company is being given a new lease of life by its present promoters

A tie up with the Saudi Bin Laden group

IL&FS Engineering and Construction Company is presently a joint venture with the Saudi Bin Laden group. The latter we are informed is one of the leading multinational infrastructure, development, construction, and project management Company. SBG Projects Investment Ltd, which is a part of Saudi Bin Laden, was co-opted as a co promoter of the company in June 2010 with a 20% equity stake in the equity capital. (This was definitely a very bold move on the part of the Indian promoters). The Indian company specialises in the EPC (engineering, procurement and construction) business. This company has seen some 24 summers pass by in its journey as a corporate entity.

The current chief promoter of the Indian venture is Infrastructure Leasing and Financial Services Ltd (IL&FS)-the mother hen of the group bearing its initials. IL&FS was inducted into the management of the company in 2009 on the express orders of the Company Law Board to turn around its operations. The erstwhile promoter of the company was Ramalinga Raju of Satyam infamy. IL&FS in turn was promoted by the Central Bank of India, Housing Development and Finance Company (HDFC), and the Unit Trust of India (UTI). Subsequently other institutional shareholders like The State Bank of India, the LIC, a Japanese company Orix, and the Dubai Investment Authority also came on board. IL&FS in turn has a very distinctive mandate-that of catalysing the development of infrastructure in the country. That is to say the development of infrastructure projects and the creation of value added financial services. IL&FS seems to have spawned some eight companies bearing its initials.

The major shareholders

According to the schedule which lists the shareholding pattern of IL&FS Engineering, the promoters hold 29.78% of the paid up equity capital. Bodies corporate control another 41.88% of the capital. (This list includes ICICI and the Saudi Bin Laden group among others-but more on this later). Collectively the holding of the corporates would amount to 71.66% of the capital base of Rs 898 m. The total capital base at year end including the preference capital base amounts to Rs 3.40 bn. The preference capital base in turn consists of cumulative redeemable preference shares, and optionally convertible cumulative redeemable preference shares. The preference share capital of Rs 2.5 bn is almost completely subscribed to by the PSU banks. It is not known whether this capital issue was forced down their throats or not -but it is entirely possible given the government hold on the banks. The latter capital structure also infers that the equity capital will go up on the conversion of the preference shares into equity, and the simultaneous extinguishment of the preference shares.

The schedule showing the list of shareholders holding more than 5% shares of the company shows a slightly different structure. Infrastructure Leasing and Financial Services Ltd (IL&FS) and IL&FS Financial Services Ltd (IFIN) together hold 29.78% of the voting capital. (Too many similar sounding names get one all muddled up). The Saudi Bin Laden group holds another 27.91% of the capital and is the second largest shareholder. The two principal shareholders between them hold 57.69% of the equity capital. Three other corporate shareholders including ICICI Bank together hold another 18.35% of the capital base. It is not known whether the two other corporate shareholders -- SNR Investments and Veeyas Investments --are also joint promoters but if they are - then the total promoter holding going by this schedule is 76%. The company is today also the not so proud owner of seven companies sporting the first name Maytas (Satyam spelt backwards) which are all in some sort of a bind due to the questionable cross border flow of moneys within the Satyam group of companies, and it has now fallen on its lot to try and set the account books right.

Still haemorrhaging

The company on its part is also haemorrhaging and that was the reason why the accounts were extended by six months to close for an 18 month period. The company refers to the extended closing as a part of the capital restructuring scheme. Thanks to the scheme the accumulated losses of the company amounting to Rs 6.1 bn were set off against the share premium reserves. Another bunch of seemingly incomprehensible entries were accorded in the ‘surplus lying in the in the P&L account’ which converted a debit balance of Rs 4.3 bn at the beginning of the year to a credit balance of Rs 723 m by the end of the year. This reverse engineering makes for a massive turnaround in its wellbeing. I have noticed that it always happens like this when the accounts have to be inverted to make for a more presentable set of figures, with the accountants resorting to ingenious gobbledygook tricks to make it happen.

From the directors’ report it appears that some of the group underlings, Maytas SNC, are even unable to furnish their accounts as on balance sheet date. Such is the rot in the group. The consolidated results of the group include the unaudited financial statements of all the joint ventures. There is also the unresolved issue of outstanding inter corporate deposits running into billions of rupees due from and due to group companies including Satyam Computer Services, which the present management is not quite able to come to grips with.

Bagging new projects

Notwithstanding the turmoil that the company has been enduring the report states that during the eighteen month period April to September 2012 the company bagged projects worth Rs 21.4 bn. During this period it completed projects worth Rs 8 bn and that the order book position as at year end was Rs 84.3 bn. The company recorded a gross income of Rs 21.4 bn and negative results after provision for interest but before provision of depreciation. The market on its part took both a high and low viewpoint on the company’s functioning. The Rs 10 face value scrip oscillating from a high of Rs 230 in April 2011 to a low of Rs 48.50 in January 2012 and closing at Rs 52 in September 2012.

To make a long story short the company generated revenues of Rs 20.4 bn and other income of Rs 1 bn during the 18 month period. The revenues in turn accrue under multiple heads of account-including revenues from equipment hiring, revenues from design consultancy, and Rs 281 m from reversal of provisions for estimated future loss on projects. (One does not know the efficability or otherwise to sustain such disparate revenue streams in succeeding years). On an annualised basis the revenues from operations rose substantially. But unfortunately so did the operational expenses, and, finance costs and depreciation provision too. The company on an average would have paid a coupon rate in excess of 14% on its year end debt. Consequently, the loss after depreciation but before exceptional items and prior period items amounted to Rs 1.36 bn against Rs 1.20 bn previously. Finance costs are a big bugbear having risen to Rs 2.13 bn from Rs 743 m previously-reflecting sharply high debt levels.

Rising debt levels

The company has ended the year with total debt of Rs 13.65 bn against Rs 8.46 bn previously. The increase in debt has been brought about by higher long term working capital needs. The cash flow statement avers that the company generated positive cash of Rs 808 m from operations against a negative cash flow of Rs 970 m in the preceding year. That in itself is a revelation. But where it was put paid was in the demands of other group companies which had to be provided with extra cash of Rs 3 bn, and other corporate advances of Rs 767 m. It also led to the purchase of Rs 366 m of securities of its siblings as new share capital. Hopefully, something positive will arise from these outflows of capital-but expect no direct returns immediately. The fixed assets fortunately do not sponge very much off the company-it is asset light here. It was also forced to purchase ‘pass through securities’-whatever that is -- valued at Rs 766 m which had to be pledged with its principal promoter as some sort of a security I would guess-but for what earthly purpose I knoweth not. The principal promoter is letting all concerned know who is the real badshah here. Such extraneous demands led to additional borrowings.

The investment portfolio

The book value of its investments portfolio at year end amounted to Rs 2.90 bn. This includes a portfolio investment of Rs 2.26 bn (against Rs 1.5 bn previously) in the form of ‘pass through certificates’ in Maytas Investment Trust and it is fully pledged to IL&FS Ltd under a very complicated formula. Another investment is in Maytas Infra Saudi Arabia Company valued at Rs 332 m against Rs NIL previously. This company is shown as a subsidiary. (The parent has seven siblings and investments in six of them-but the investments barring the stake in the Saudi venture, is a combined pittance). The third largest investment is in the preference shares of Bangalore Elevated Tollways valued at Rs 244 m against Rs NIL previously. As one can see the bulk of the investments were effected during the year. The total other income during the year amounted to a very respectable Rs 1 bn against Rs 500 m previously. It does not include any dividends accruing from its portfolio investments -but let that be. What it does include is the interest income of Rs 41 m from bank deposits, and interest income of Rs 734 m ( Rs 185 m previously) from inter corporate deposits. How it managed the latter feat is not readily known--but either way it obviously involved very dexterous management of resources given the demand for funds during the year. The company does show ICDs of the value of Rs 3.44 bn outstanding at year end, the same as in the preceding year. But this figure pertains to a disputed and claimed sum of money, and it is not known whether the company received any interest on this ICD. Or, do the investments in ‘pass through securities’ account for this interest perhaps? Anyways, it is a taxing effort to get a proper fix.

Under the schedule of ‘names of related parties’ the parent is shown as having eight siblings. The investment schedule shows seven siblings. The related party schedule gives the names of 10 joint ventures. But in the investment schedule it is shown as having only two joint ventures-and with zero investments! It has an investment in one associate and had inter-se dealings with it. The investment schedule also reveals a head of account going by the name of ‘Investment in association of persons’ numbering five such. Separately it also has 15 joint ventures which are in the nature of jointly controlled operations. Mark the wording here. A footnote states that the company’s share in the assets, liabilities, income and expenditure are duly accounted for in the accounts of the company. One wonders when it will drum up some other such concoction. It is also a very complex and muddling portfolio to say the very least.

The bulk of the large inter-se transactions between the parent and its associates -barring Maytas Properties -are of a capital nature. In the case of Maytas Properties the inter-se transactions are large both on capital and revenue account. The company’s interest in its joint ventures ranges from a low of 25% to a high of 70%. But the income and expenditure generated by these ventures by and large is of a relatively minor value.

The auditor’s take

The auditors in their report to the shareholders state that the consolidated financial statements include the unaudited financial statements of six joint ventures and seven subsidiaries with aggregate assets of Rs 3.37 bn as on Sep 30, 2012, and aggregate revenues of Rs 1.93 bn. The report goes on to add that the accompanying consolidated financial statements do not include the consequential impacts that may have been required had the audited financial statements of the joint ventures and subsidiaries been made available.

The revenue account figures of the subsidiaries given in the briefest for possible do not for a pretty sight make. Barring the Saudi venture the other six companies do not boast of any revenues or any cash flow at all. The siblings include such exotica as plantation companies or some such. Alteast this is what one can make of it from their name plates. The five joint ventures whose brief financials are also available are not on any better wicket-with some of them yet to open their account.

The situation is about as bizarre as it can get as at the close of the extended financial year end. But irrespective of the intrigues at hand the share price jiggered from a high of Rs 230 in April 2011 to a low of Rs 49 in Jan 2012 (face value Rs 10). The share continued to rule at the lower end of the price range for the rest of the extended financial year. The market has its own way of digesting the flow of information that it gets buffeted with --and therein hangs a tale.

Disclosure: I do not hold any shares in this company, either directly, or under any non discretionary portfolio management scheme

Disclaimer:
The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.

Mutual Fund Roundup: April 2013

Fri, 10 May 2013 00:00:00 GMT

Posted by Equitymaster

Market Overview

After depicting a descending move in the last couple of months i.e. February 2013 and March 2013, the Indian equity markets (i.e. the S&P BSE Sensex) exhibited a good impulse, gaining +3.5% (or 668.41 points) in April 2013.

The beginning of the month gone by until mid-April 2013, saw pessimism gripping Indian equities as focus of foreign investors shifted to U.S. economy, as signs of economy vigour seemed evident with a 2.5% GDP growth rate clocked by them in Q1 of 2013. Likewise amongst the BRIC economies with growth continuing to be below trend in China, Russia and India, while acceleration seen in Brazil and South Africa; had a negative impact on Indian equities as foreign investors seemed to have allocated assets in such economies. Also growing concerns over ballooning Current Account Deficit (CAD) also posed concern and the International Monetary Fund (IMF) too in its World Economic Outlook, projected India's CAD only a tad lower to 4.9% than 5.1% in the previous year. Similarly the industrial activity which has been depicting a 'see-saw' movement for quite some time with tepid growth also exhibited setback on Indian equities as it did not portray a healthy picture of the economy as growth languished.

However, when the Wholesale Price Index (WPI) inflation data for March 2013 was released (on April 15, 2013) it revived sentiments of the Indian equity markets; since the data instilled hopes of a rate cut from the Reserve Bank of India (RBI) in annual monetary policy 2013-14 (held on May 03, 2013) in order to reinvigorate economic growth. Likewise statements from the Finance Minister, Mr P. Chidambaram saying that CAD could be halved in 1 or 2 years, inflation would be contained and reform initiatives would be taken in next two-four months in order to boost economic growth; also help to infuse positive sentiments. As far as controlling CAD is concerned, it seems to have been acknowledged by the market in light of falling prices of gold, Brent crude oil and strengthening Indian rupee. Thus in the last 10 trading sessions of the month of April 2013, the Indian equity markets ascended by good +6.9%. However going forward, how gold and Brent crude oil move, along with political environment (which seems tainted and uncertain at present) would decide the course for the markets.

The precious yellow metal - gold in the month gone by, after descending gradually until mid-April 2013, fell rather violently and ended the month with a loss of -8.3%. Frantic sell-offs pushed the price below Rs 29,000 per 10 grams mark. On the global front, the yellow metal came under heavy selling pressure from exchange-traded funds, following upbeat jobless claims data in Europe and amid speculation that Cyprus might sell excess gold to tide over its financial crisis. However not ruling out that uncertainty yet persists in the global as well as domestic economy smart investors continued to take refuge under precious yellow metal and thus towards the tail of the month, we witnessed a truncated recovery after a corrective move.

Speaking about Brent crude oil, prices eased considerably (by -5.1%) as outlook for global oil demand growth dimmed with lower-than-expected demand from the United States and China. It is noteworthy that the global supply too rose with growth in oil production from the U.S. and Canada. But going forward with signs of steady economic recovery shown by the U.S., and political turmoil, prices may once again move up.

For the bond markets, they waited to see what policy stance the RBI will take in its annual monetary policy 2013-14, after IIP showed a lull in industrial activity and WPI inflation for March 2013 too mellowed down to 5.96%. The bond markets on hopes of at least a 25 basis points (bps) rate cut rallied as yields softened. It is noteworthy that yields of 1-month and 3-month CDs mellowed by 155 bps and 75 bps respectively, placing them at 7.95% and 8.20% respectively; while the 8.15% 2022 (10-Yr) G-Sec ended the month at 7.71% (down by 19 bps) as WPI inflation relaxed and corrective move in gold and Brent crude oil brought in hopes that CAD would indeed be contained. Going forward now that RBI has cut policy rates in accordance to market expectations, PersonalFN is of the view that it may not lead to much easing in short-term yields, while the longer tenure papers, would take cues from how the country manages the twin deficit problem and inflation data.

Monthly Market Roundup

	As on April 30, 2013	As on March 31, 2013	Change	% Change
S&P BSE Sensex	19,504.18	18,835.77	668.41	3.5%	▲
CNX Nifty	5,930.20	5,682.55	247.65	4.4%	▲
CNX Midcap	7,818.60	7,401.60	417.00	5.6%	▲
Gold (Rs /10 gram)	27,150.00	29,610.00	(2,460.00)	-8.3%	▼
Re/US $	53.81	54.28	0.47	0.9%	▲
Crude Oil ($/BBL)	103.72	109.27	(5.55)	-5.1%	▼
8.15% 2022 (10-Yr) G-Sec Yield (%)*	7.71	7.90	(0.19)	19bps	▼
1-Yr FDs	7.25% - 9.00%

*The 8.15% 2022 is the new 10-Yr benchmark which was introduced on June 9, 2012
(Monthly change as on April 30, 2013)
(Source: ACE MF, Personal FN Research)
As far as participation of Foreign Institutional Investors (FIIs) in the Indian equity market is concerned, while it was heartening to see them continue to buy into Indian equities, in the month gone by they tuned cautious and slowed paced by being net buyers to the tune of Rs 5,414 crore, as against net buying of Rs 9,124 crore in the month of March 2013. It is noteworthy that first two months of the calendar year 2013, FIIs had net bought aggressively, aggregating to the tune of Rs 47,314 crore.

S&P BSE Sensex vs. FII inflows

(Source: ACE MF, Personal FN Research)

The main reasons for them to turn cautious while buying into Indian equities seem to be:

Political uncertainty (which has put the country to risk on early election);
Policy logjam and interrupted session of the Parliament
Scam stories (viz. coal allocation and 2G spectrum allocation)
Structural bottlenecks in mining and infrastructure space
Slowdown in economic growth rate; and
RBI hinting in its 4th quarter mid-review of monetary policy 2012-13 that headroom for further monetary easing remained quite limited

Also with the U.S. economy showing signs of economic vigour and other Emerging Market Economies being on investment radar of FIIs for host fundamental reasons; they seemed to have allocated assets in such economies, which in turn led to reduction of India's share of foreign flows.

Mutual Fund Overview

Contrary to the cautious participation of Foreign Institutional Investors, domestic mutual funds (MFs) continued to be net sellers in the Indian equity markets yet again. With redemption pressures building in with every up-move of the Indian equity markets in an uncertain economic and political environment, they net sold to the tune of Rs 1,423 crore in the month of April 2013, as against net selling worth Rs 1,767 crore in March 2013. It is noteworthy that for the period January to April of the current calendar year, domestic mutual funds have been on a selling streak, with Rs 8,772 crore of Indian equities being net sold.

The fund managers too seemed to be worried about:

Reform measures not translating very well (although the economy has been opened up with increase in Foreign Direct Investment (FDI) limit);
Policy logjam
Intermediate inflationary pressures (emanating from food inflation);
Slowdown in economic growth rate;
Indications from RBI hinting that headroom for further monetary easing remains quite limited;
Political uncertainty; and
Global economic headwinds

S&P BSE Sensex vs. MF inflows

(Source: ACE MF, Personal FN Research)

As far as the performance of various categories of mutual funds is concerned, in the diversified equity funds category, those with a mandate to invest predominantly in large caps topped the list, followed by those investing in mid & small cap segments of the market. Likewise mutual fund schemes following a flexi and opportunities style of investment also did well, enabled by their mandate which allowed them to take exposure across market capitalisations and sectors. So broadly in the diversified equity funds gains were seen across market capitalisation bias and investment styles, aided by the upward streak of the markets.

Among the sector funds, those investing in banking & financial services and defensive sectors such as pharma and FMCG delivered stunning returns. Likewise since consumption story in India is yet strong and the Government giving emphasis to fund the infrastructure story, mutual fund schemes focusing on investing in these respective themes also did end the month gone by in green with luring returns, and of course well supported by the up-move in the Indian equity markets. However technology funds eroded gains as seen in March 2013, and ended the month gone by deep in red as the Indian rupee too appreciated vis-a-vis the U.S. dollar; which kept underlying stocks in their portfolio (especially the export oriented ones) under pressure.

As far as ELSS funds are concerned (which follow fluid investment style), all of them ended the month of April 2013 in green, thereby recovering from the dismal gains or in most cases a wealth erosion witnessed in the month of March 2013.

In the Fund of Fund (FoF) category, some of those focusing on investing the world markets (in real estate and emerging markets) reported gains and so did those focusing on investing in domestic equities, aided by ascending move the markets and performance of their underlying mutual fund schemes. Likewise asset allocation funds and financial planning funds which are structured as FoFs ended the month in green. However in the FoF category, the ones investing in world agribusinesses, mining (including gold mining) and gold saving funds ended the month in red with negative undercurrents for the respective businesses and / or asset class.

Speaking about the hybrid funds; the performance of balanced funds revived as they ended the month gone by in green after exhibiting negative returns in the month of February 2013 and March 2013. The debt portion of their Assets Under Management (AUM) did well with softening in yields on expectations that RBI would reduce policy rates in the annual monetary policy 2013-14. Thus Monthly Income Plans (MIPs), which invest a dominant portion of its assets in debt securities across maturities, also did well aided by rally in bond markets. A well-managed equity portfolio and the ascending movement of the Indian equity markets too seemed to have helped in delivering better returns than in the month of March 2013.

Monthly top gainers: Open-ended Equity Funds

Diversified Equity Funds	1-Mth	Sector Funds	1-Mth	ELSS	1-Mth
Reliance Vision Fund (G)	9.35%	UTI Banking Sector Fund (G)	9.69%	JM Tax Gain Fund (G)	8.76%
IDBI India Top 100 Equity Fund (G)	7.89%	JM Core 11 Fund (G)	9.66%	Reliance Tax Saver (ELSS) (G)	7.07%
JM Multi Strategy Fund (G)	7.68%	Baroda Pioneer Bank & Fin Serv Fund (G)	9.45%	SBI Tax advantage Fund-II (G)	6.31%

(1-Mth returns as on April 30, 2013)
(Source: ACE MF, Personal FN Research)
Monthly top gainers: Open-ended Fund of Funds

Fund of Funds	1-Mth
ING Global Real Estate Fund (G)	6.63%
Kotak Equity FOF (G)	4.36%
Quantum Equity FoF Fund (G)	4.12%

(1-Mth returns as on April 30, 2013)
(Source: ACE MF, Personal FN Research)
Monthly top gainers: Open-ended Hybrid Funds

Balanced Funds	1-Mth	Monthly Income Plans	1-Mth
JM Balanced Fund (G)	8.78%	Reliance MIP (G)	2.89%
Reliance Reg Sav Fund-Balance Plan (G)	4.40%	IDBI MIP (G)	2.71%
Birla SL '95 Fund (G)	4.25%	DSPBR MIP Fund-Reg (G)	2.57%

(1-Mth returns as on April 30, 2013)
(Source: ACE MF, Personal FN Research)
Monthly top gainers: Open-ended Debt Funds

Floating Rate Funds	1-Mth	Income Funds	1-Mth	Gilt funds	1-Mth
Short Term		Short Term		Short Term
Reliance FRF ST (G)	1.25%	Axis Income Saver Fund (G)	1.98%	HSBC Gilt-ST-Reg (G)	2.30%
L&T FRF (G)	1.18%	Religare Bank Debt (G)	1.71%	Templeton India G-Sec-Treas (G)	1.98%
Sundaram Flexible-STP (G)	1.10%	Reliance STF (G)	1.57%	HDFC Gilt-Short Term Plan (G)	1.91%
Long Term		Long Term		Long Term
ICICI Pru Corporate Bond Fund-Reg (G)	1.62%	ICICI Pru Income-Reg (G)	2.88%	ICICI Pru Gilt-Invest-Reg (G)	3.11%
Sundaram Flexible-FIP (G)	1.38%	Birla SL Income Plus (G)	2.70%	ICICI Pru Gilt-Invest-PF-Reg	2.99%
HDFC FRIF-Long Term Plan (G)	1.14%	Morgan Stanley Active Bond-Reg (G)	2.64%	Templeton India G-Sec-LTP (G)	2.90%

Liquid Funds	1-Mth	Liquid Plus funds	1-Mth
IDFC Ultra Short Term Fund-Reg (G)	0.98%	PineBridge India Total Return Bond-Ret (G)	1.38%
Birla SL Cash Mgr Fund (G)	0.96%	DWS Money Plus-Reg (G)	1.16%
HDFC Cash Mgmt-Savings (G)	0.86%	DWS Treasury-Invest Plan-Reg (G)	1.07%

(1-Mth returns as on April 30, 2013)
(Source: ACE MF, Personal FN Research)
As far as performance of debt mutual fund schemes are concerned, with short-term CD yields having mellowed noticeably (as cited above) debt mutual fund schemes with a mandate of holding shorter maturity papers did well. Luring returns were seen in short-term floating rate funds, short-term income funds and short-term G-sec funds - which performed better than in the month of February 2013 and March 2013. Since yields of longer maturity paper also softened with WPI inflation mellowing and after it exhibited signs of moderation along with reducing pressure on CAD (due to correction in price of gold and Brent crude oil); the long-term debt fund category also performed well (than in the month of February 2013 and March 2013), with appealing returns exhibited by long-term floating rate funds, long-term income funds and long-term gilt funds.

Similarly, liquid funds and liquid plus funds (also known as ultra-short-term funds) also did well with positive undercurrents in the Indian debt markets.

Going forward, now that RBI has cut policy rates in accordance to market expectations, PersonalFN is of the view that there may not lead to much easing in short-term yields, while the longer tenure papers, would take cues from how the country manages the twin deficit problem and inflation data. Also in the guidance from the monetary policy, RBI has enunciated that headroom for further monetary easing remains quite limited and monetary policy action alone cannot revive growth. It has put the onus on the Government by saying that growth needs to be supplemented by efforts towards easing the supply bottlenecks, improving governance and stepping up public investment, alongside continuing commitment to fiscal consolidation.

It is noteworthy that in the Indian debt market, both FIIs and domestic mutual funds continued to be net buyers; with FIIs having bought net to the tune of Rs 5,334 crore thereby slightly slowing pace from March 2013's net buying worth Rs 5,795 crore. But comparatively domestic mutual funds participated rather in a roaring manner having net bought to the tune of Rs 51,885 crore, as against Rs 75,005 crore net buying in the month of March 2013.

Performance across various categories of mutual funds

(1-Mth average returns of funds in various categories as on April 30, 2013)
(Source: ACE MF, Personal FN Research)

The graph above depicts how various categories of mutual funds performed in the previous month. Amongst the sector and thematic funds, banking & financial services sector funds took the lead followed by defensive sectors such as Pharma and FMCG funds which are generated luring returns. Likewise infrastructure funds also did well with positive undercurrents for the theme with Government giving emphasis for infrastructure development. However technology funds took the maximum beating with the appreciation of the Indian rupee vis-a-vis the U.S. dollar, which kept underlying stocks in their portfolio (especially the export oriented ones) under pressure. From market capitalisation perspective, large cap funds outperformed the mid cap ones, while from a fund management style perspective flexi and opportunities style funds outperformed the ones a value style of investing.

Tracing the descending move in the precious yellow metal - gold, Gold ETFs exhibited negative returns for investors (on average -8.4%).

In the debt mutual fund category, those with a mandate to invest in shorter maturity instruments displayed slightly better returns than in the month of February 2013 and March 2013, as yields of short-term debt papers mellowed down noticeably. Likewise with yields of longer maturity papers also easing, gains were seen in long maturity debt mutual funds.

Other News and NFOs:

In the Union Budget 2013, the finance minister clarified that the returns from Pass-Through Certificates (PTCs) are exempt from tax. The clarification came in as the mutual industry body - the Association of Mutual Funds in India (AMFI) approached the finance ministry last year after the Income-tax (I-T) department maintained that income from instruments such as PTCs is taxable.

But now again the I-T department has sent fresh notices to mutual fund houses, asking them to pay tax on income from PTCs (which is a securitised product), despite Bombay High Court in March 2012 having quashed the I-T department's demand for tax on income from mutual funds' investments in securitised instruments such as PTCs, in response to an appeal filed by UTI Mutual Fund.
As many of you may be aware that the financial year gone by has been the toughest for the Indian mutual fund industry to garner more Assets Under Management (AUM). The turbulence in the Indian capital markets, downbeat sentiments in both global and domestic economy along with political uncertainty have kept investors away from risky asset classes and investment avenues therein.

But it is evident that domestic mutual fund houses are leading the race of garnering more AUMs when compared to their foreign counterparts. In the last quarter of the financial year gone by, domestic mutual fund houses could manage to garner AUM to the tune of Rs 7.24 lakh crore - an increase of +23.6%, while foreign mutual fund by 17.6%. However persistent turbulence in the Indian capital markets has attributed to tepid growth in AUM on an annual basis. It is noteworthy that in the last financial year, the growth in AUM for domestic mutual fund houses and their foreign counterpart has been mere 8.4% and 10.0% respectively.
Many of you may be aware that in the Union Budget 2013, it was proposed to reduce the Securities Transaction Tax (STT) as under (and the revised rates be applicable from June 01, 2013):
- On Equity futures: from 0.017% to 0.01%
- On Mutual Fund/ETF redemptions at fund counters: from 0.25% to 0.001%
- On Mutual Fund/ETF purchase/sale on exchanges: from 0.1% to 0.001%, only on the seller
- Thus at present until May 31, 2013, if you transact in the aforesaid securities the old rate of <>STT applies - which is higher than the one proposed.
Ascertaining this fact, even mutual fund houses are awaiting the reduction in STT rate to merge their schemes in the current financial year. Thus far in the present financial year (i.e. FY14) two mutual fund houses are looking at merging schemes. LIC Nomura Mutual Fund has already announced the merger of four of its schemes - LIC Nomura MF Top 100 Fund, LIC Nomura MF Systematic Asset Allocation Fund, LIC Nomura MF Vision Fund and LIC Nomura MF Opportunities Fund (merging schemes) with LIC Nomura MF Equity Fund (merged scheme), an open ended growth scheme. Likewise IDFC Mutual Fund is looking at merging a couple of its equity schemes, but is waiting for STT to reduce with effect from June 01, 2013.

It is noteworthy that every time a scheme is merged, the mutual fund house bears the STT and is not passed onto to you investors in the process of sale of units by "merging scheme" and purchase of the same by the "merged scheme". At present some mutual fund houses are waiting to merge some of their schemes, since reduced STT (with effect from June 01, 2013) would help reduce their cost of merging the schemes considerably with the aforementioned proposal.
Motilal Oswal Mutual Fund launched its first actively managed mutual fund scheme named "Motilal Oswal MOst Focused 25 Fund (MF25)" mandated to invest in a concentrated portfolio of 25 stocks and limiting is sectoral exposure to higher of 25% or 1.5 times the weight of sector in the benchmark index. M25 follows CNX Nifty Index as its benchmark and is positioned as an aggressive fund focused on long term growth of capital. As per the offer document, the investment objective of M25 is, "to achieve long term capital appreciation by investing in upto 25 companies with long term sustainable competitive advantage and growth potential."
IDFC Mutual Fund launched an equity opportunities fund named "IDFC Equity Opportunities Fund (IEOF)" - a close-ended scheme, mandated to invest 60-80 stocks without being biased to any particular market capitalisation. IEOF follows S&P BSE 500 Index as its benchmark and as per its offer document, the investment objective is "to seek to provide long-term capital appreciation from a portfolio that is invested in equity and equity-related securities. The fund will invest in either growth stocks or value stocks or both without any capitalization bias. As and when the fund manager is of the view that the investment has met its desired objective, the same shall be liquidated and distributed by way of dividend. However, there can be no assurance that the investment objective of the scheme will be realized".

PersonalFN is a Mumbai based personal finance firm offering Financial Planning and Mutual Fund Research services.

FSLRC Revamp of Deposit Insurance and Consumer Protection

Mon, 6 May 2013 00:00:00 GMT

Posted by Equitymaster

The existing financial legislation/administration framework is not satisfactory and many fundamental changes are required to ensure effective consumer protection; in this context it is important to examine the recommendations of the Financial Sector Legislative Reforms Commission (FSLRC).

Setting Up of a Resolution Corporation

The FSLRC claims that, under the present framework, action is initiated far too late when banks/financial companies get into trouble, and hence it lays great store on setting up a 'Resolution Corporation', backed by legislative powers, to undertake timely intervention. As in every other sphere, in the area of deposit insurance and consumer protection, the FSLRC game plan is to first demolish the existing framework before setting up a new framework.

Scope of the Resolution Corporation

The Resolution Corporation would be a hybrid organisation covering both deposit insurance as well as safeguarding the interests of stakeholders. At the present time, insurance cover is provided by the Deposit Insurance and Credit Guarantee Corporation (DICGC), a wholly owned subsidiary of the Reserve Bank of India (RBI), only for bank deposits and that to for deposits up to Rs one lakh per depositor. The Deposit Insurance Agency is a mere passive pay-out agency and it has no role in early rectification of the problems of the banks/institutions.

In contrast, under the FSLRC recommendation, the Resolution Corporation is to have sweeping powers to intervene well before financial firms fail The proposal is based essentially on the US Resolution Trust but it is also envisaged that the kind of activities undertaken by the US Federal Deposit Insurance Corporation (FDIC) would be subsumed under the proposed Resolution Corporation.

Present Structure of Deposit Insurance in India

While the FSLRC gives extensive acknowledgement to many previous Reports, by Committees/Working Groups, it uses selective institutional memory. The FSLRC fails to take cognisance of the Jagdish Capoor RBI Working Group on Deposit Insurance (2000) which made many path-breaking recommendations. This Report advocated differential deposit premia for banks according to their risk profile and more importantly advocated the granting of regulatory and supervisory powers for the Deposit Insurance Agency akin to the US FDIC. The US FDIC has sweeping powers of regulation and supervision over banks in the area of deposits. The reference to Prompt Corrective Action, correctly emphasised by the FSLRC, is not new to India but in this area, as in other areas, there is considerable pussy-footing when it comes to effective action- this is essentially because the polity does not support strong, timely and effective corrective action. The FSLRC would have gained credibility if it were to acknowledge the lineage of its ideas to the Jagdish Capoor Working Group.

The onus of lack of progress in this area lies partly with the RBI, partly with the government and partly with the overall attitude of the Indian polity. The whole issue of providing teeth to the Deposit Insurance Agency is bogged down in inter-departmental dominance within the RBI. The reluctance to go in for differential premia is attributable to the unfounded fear of government that banks which have a high premia could face a run on their deposits. If this were to happen it would not necessarily be a bad thing as it would trigger faster Prompt Corrective Action. The core of the problem is the Indian philosophical leaning of the Indian psyche which encourages banks/institutions to lend, to lose and to live and death of banks/institutions is just not acceptable in our ethos.

Hazards of Subsuming Deposit Insurance Within the Resolution Corporation

One of the major hazards of subsuming deposit insurance (presently provided only for banks) under the Resolution Corporation, as proposed by the FSLRC, would be that there would be pressures, which cannot be resisted, to bring non-bank finance companies (NBFCs) within the ambit of the insurance agency. More than one Committee/Working Group has examined this issue and they have unanimously concluded that it would be hazardous to bring NBFCs within the ambit of the insurance agency. If such insurance was provided, there would be an exodus of funds from banks to non-banks. This is the primary reason why the Deposit Insurance Agency should not be subsumed within the Resolution Corporation. The obvious solution would be to leave Deposit Insurance where it is at present, but give the Deposit Insurance Agency effective powers of regulating and supervising banks' deposit activities. But this does not fit into the philosophy of the FSLRC: 'Give me a problem and I will give you a new institution'.

Need for Caution on Setting Up a Resolution Trust

The success of the US Resolution Trust is unlikely to be replicated in the Indian context. In the US, the Resolution Trust was set up in the context of the housing collapse and the Resolution Trust took over real assets which were subsequently sold off once the housing market improved. In India, it is likely that by the time the Resolution Corporation swings into action, the NBFCs would be empty shells and all that the Resolution Corporation would become is an agency to pick up losses. Hence, there should be great care in setting up a Resolution Corporation. Recognising that increasingly banking activity could be in the private sector the Resolution Corporation could, at best, be restricted to banks. The NBFC segment has historically been the most difficult segment to regulate and supervise and has also been litigation prone. Setting up a Resolution Corporation which would also cover NBFCs would ensure that profits will be private and losses will be public.

Consumer Protection and Redress Agency

The FSLRC does well to stress the need for better consumer protection as there is a proliferation of unequal contracts which calls for an effective Redress Agency. While the FSLRC needs to be commended for placing consumer protection at the heart of financial regulation its iconoclastic obsession leads it to first destroy existing institutions and then build them once again with an article of faith that the new architecture would be the ideal structure. During the past two decades considerable advances have been made in the area of consumer protection and the development of the Redress mechanism and it is not optimal to knock down the present system to satisfy the FSLRC's grand design.

While the consumer protection and Redress system needs to be strengthened, it does not make sense to clean swipe the present structure and build everything afresh; any strengthening should be via improving the existing infrastructure. If the Commission's recommendations are implemented in toto, it would merely result in a highly centralised control system which would go against the very thought of financial liberalisation. The Commission's Report pays scant attention to the ground realities. Our Parliamentary system requires minute scrutiny of legislative changes. While the Commission's recommendations may be pulsating, they are unlikely to see the light of day in the life time of the Commissioners.

Please Note: This article was first published in The Free Press Journal on May 06, 2013. Syndicated.

Disclaimer:
The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.

A plot to destroy RBI

Fri, 3 May 2013 00:00:00 GMT

Posted by Equitymaster

The Financial Sector legislative Reforms Commission (FSLRC) claims that it has set out a new legislative structure which would meet the requirements of the future.

It is not enough for the Commission to be convinced that the reform is for the general good; all major economic agents should be convinced that the revamp is in the best interests of the country.

Unfortunately, the Commission's Report reeks of an anti-Reserve Bank of India (RBI) bias. The FSLRC game-plan is to vivisect the 'RBI' and after dismembering it, talk about independence and accountability for objectives which would be set for it by the government!

Commission's agenda

Institutions which are not His Master's Voice should first be destroyed, which would enable the setting up of an obedient edifice. Given this backdrop, it is no surprise that the RBI is the central target for attack.

The clever ploy is to argue that the RBI has too much on its plate which creates a conflict of interest and hence the rationale for dismemberment: Public debt should be taken away from the RBI without any preconditions on fiscal consolidation. Non-banking finance companies should have no place in the RBI firmament.

The RBI should be stripped of its role in financial markets, and capital controls should be vested with the Ministry of Finance (the very strong notes of dissent by Malegam, Udeshi and Nayak need to be noted).

Grudgingly, the Commission leaves banking regulation and supervision, and the payments and settlements system with the RBI, but only for a temporary period.

Proposed Structure of RBI

The Commission envisages a 12-member RBI Board with not more than one half being executive members; this by itself is reasonable but one has to dwell a little further into the Commission's proposal. There is an insidious proposal, in that the post of 'Governor' should be abolished and the head of RBI should be named as 'Chairperson'.

The Commission's ready defence would be that, after all, the head of the US Fed is called 'Chairman'; the Commission would conveniently forget that members of the US Fed are called Governors and the head is known as Chairman of the Board of Governors.

Furthermore, the Deputy Governors are to be brought down a peg and called members and one of the members would be called an 'administrative law member'.

The whole ploy seems to be to downgrade the RBI to the level of any other financial regulators. The Commission needs to appreciate that central banks are unique.

Monetary Policy Function

The Commission emphasises the need for independence of the central bank with accountability. It is argued that the central bank must be given a quantifiable monitorable objective by the Government for its monetary policy function.

The Commission discusses the broad international consensus on price stability as the clear focus of the central bank but backs off from such a recommendation.

The setting of objectives would be by the Government in consultation with the RBI.

In fairness, the Commission refers to a predominant objective and secondary objectives, which would be prioritised and subject to the predominant objective being delivered. The Statement, which would be issued every two years, would also specify what would constitute a substantial failure.

Illustratively, the Government could prescribe a predominant objective of, say, a 10 per cent per annum real growth and secondary objectives of 20 million new jobs per annum and a 3 per cent per annum inflation rate.

The RBI could be given an impossible task and made the whipping boy for the Government's own failure.

Any credible setting of objectives should follow the assignment rule of a policy being required to attain the objective it is best suited to deliver and, by this token, the predominant objective should be price stability.

If the polity is unwilling to give price stability the predominant objective, a second best option would be for the RBI to be allowed to set out the objectives which would then be discussed with Government and, in case the Government uses an override, the RBI objectives and the override should both be placed in the public domain.

Devil in the detail

The Commission recommends the setting up of a statutory Monetary Policy Committee (MPC) to take executive decisions on monetary policy with each member having a vote and the Chairperson having a veto, which must be explained with a public statement. The devil is in the detail.

There would be only two RBI members and five external members appointed by the Government. The Ministry of Finance nominee would be a non-voting member on the MPC but would articulate the Government viewpoint.

With Big Brother watching over their shoulder, brave would be the external member who would deviate from the Government line. The RBI would be better off with the present arrangement.

The leitmotif of the FSLRC is to charge the gate of the temple of money with iconoclastic fervour. One prays that in this internecine battle, the RBI's Pretorian Guards fight off the charge of the Commissioners.

One must remember that countries that destroy their central banks destroy themselves.

The Financial Sector Legislative Reforms Commission wants to restructure, or effectively dismember, the RBI by arguing that it has too much on its plate.

Please Note: This article was first published in The Hindu Business Line on May 03, 2013.

Disclaimer:
The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.