Impact of The Insolvency and Bankruptcy Code,2016

By Aditya Alamuri

With the Insolvency and Bankruptcy Code 2016, Indians can finally go legally broke. The new code will step into the shoes of existing bankruptcy laws and cover individuals, companies, LLP’s, and partnership firms. The code will repair laws including those mentioned in the Companies Act, to become an overall legislation to deal with corporate insolvency. The bill now has renewed teeth to recover loans at a quicker rate.

The Bankruptcy bill has come in at a time when banks are crippled with rising NPA’s. The new code will ensure the creation of a repository of unfaltering defaulters and will result in time bound settlement of solvency.

The bill proposes the following activities to improve the banking sector:

• Creation of a database of debtors to track serial defaulters

• Usage of existing infrastructure of debt recovery and NCL tribunals, to settle individual and corporate insolvency

• Create & train a new class of insolvency professionals who will specialize in assisting sick companies

• Setting up an Insolvency and Bankruptcy Board of India, to step in as a regulator of these information utilities and professionals.

Bankruptcy code also contains provisions to deal with cross-border bungles by way of bilateral agreements with other countries. It urges shorter & aggressive intervals for every step during insolvency process.

The code also ensures that the money due to employees and workers from the 3 funds i.e. (Pension, Gratuity & Provident) is not included in the domain of either the individual or the company. Furthermore, the salaries of employees will get 1st priority up to 24 months in case of liquidation of assets of company – earlier than secured creditors.

The Bill will lead to key transformations which will ensure ease of doing business in India. Currently, as per the World Bank records, it takes more than 4 years to solve a bankruptcy case. The new code seeks to cut it down to less than a year.

The Insolvency and Bankruptcy Code 2016, on the whole, proposes a comprehensive changeover in the current Indian banking system & the way corporates function today. However, it is easier said than done. The implementation of such a vast plan will take time and we will have to wait in order to see the upshot of the same.

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MASALA BONDS: Elixir to the ailing PSB’s?

By GANDHALI INAMDAR

After playing host to Yankee, Bulldog, Samurai & Dim sum, foreign bonds market witnessed the entry of a new member, “Masala Bonds”. The first Masala bond (Rs.1000 Cr.) was issued by the World Bank backed International Finance Corporation (IFC) in November 2014. In July 2016, HDFC raised Rs.3000 Cr. from Masala bonds becoming the first Indian company to issue masala bonds. NTPC, Adani Transmission, Axis Bank and Indiabulls followed suit.

Masala bond is a term used to refer to a financial instrument through which Indian entities can raise money from overseas markets through bonds issued in Indian Rupee for a minimum period of 3 years. If the dollar value appreciates, investor gets lesser amount in hand at maturity. Thus, currency risk lies with the investor.

Furthermore, the limited offshore liquidity in Rupee, the cost and availability of hedging for investor, and investors’ view of exchange rate fluctuations will affect the pricing of these bonds.

In the Indian context, there is merit in the masala bond move, since India Inc. can do good with some foreign investment minus the currency risk for their capital requirements, infrastructure financing and affordable housing projects. Masala bonds can also be considered as a step towards internationalization of the Indian rupee and can also help strengthen the Indian Financial System.

As a initiative to support Masala Bonds, the Finance minister has cut the withholding tax on interest income from 20% to 5%, making it more attractive for investors. Also, the tax from capital gain due to Rupee appreciation will also be exempted.

For foreign investment bankers, the interest rates on Masala bonds (approx. 7%) are much more attractive than their domestic bond counterparts. Furthermore, the Ratings agency S&P has predicted that Masala bonds will reach $5 billion in next two-three years.

Masala bonds are expected to bring to the Indian economy the required energy to recover from its investment slumber and the malaise of NPAs. Indian banks, especially Public Sector Banks (PSBs), need rather a lot of capital going forward. There are three reasons for this. First, banks are looking towards positive cash inflow opportunities to tackle NPAs. Second, the Indian economy is growing and this requires an increase in credit in the future. Third, there’s a general tightening up of bank capital standards under Basel III norms and this means that all banks would need more capital.

PSBs international Credit Rating (CR) derives its strength from India’s sovereign rating. Private Bank’s CR dependence on India’s sovereign rating is primarily indirect. Thus, a masala bond issued by a PSB could be considered as a proxy to India’s sovereign credit rating. This aspect can have interesting after effects on economy.

Investors would need to keenly watch the credibility of the issuer. Higher the CR of a firm, the better would be the appetite for their bonds. Since the currency risk is on the investors, they will prefer Rupee to be stable.

Having a huge growth potential, only time will tell if Masala bonds can become the penicillin to India’s current cold.

Finomenal 2016: Day 1

  1. Inauguration Ceremony ( http://tinyurl.com/hlsg6kf )
  1. “Potential of Asset Reconstruction Companies in India” – Mr. Sandeep Hasurkar, VP, IL&FS ( http://tinyurl.com/zv8e2qo
  1. “Investment in Stock Markets”– Mr. Sumit Kumar Jain, Senior VP, ASK Wealth Advisors Ltd. & Mr. Ashwani Agarwal, Equity Analyst, Baroda Pioneer Mutual Fund (http://tinyurl.com/hjgsbs4 )
  1. “Career in Financial Sector” – Mr. Gaurang Trivedi, Senior Investment & Management Consultant, Ministry of Corporate Affairs (GOI)( http://tinyurl.com/hk5c9sx )
  1. “Disruptions in Financial Industry” – Mr. Gajendra Kothari, MD & CEO, Etica Wealth Management Private Ltd. ( http://tinyurl.com/zyb3z7y )
  1. “CCAR Stress Testing” – Mr. Bharat Gupta, 2nd VP, Model Risk Management, Northern Trust Corporation ( http://tinyurl.com/guc9hcr )
  1. “Entrepreneurship Story of Bandhan Bank” – Mr. Tamal Bandyopadhyaya, Advisor, Bandhan Bank & Consulting Director, Mint ( http://tinyurl.com/jv9556g )
  1. “Fear of Automation in Financial Industry” – ECHO ( http://tinyurl.com/jm569o6 )
  1. Bloomberg Olympiad ( http://tinyurl.com/hr7nvuk )

ECONOMIC GROWTH V/S INFLATION FOR INDIA

By Jay Thakkar and Harshal Sharma

Introduction

There is great debate over the belief whether inflation promotes economic growth or not. The relationship between inflation and growth is a controversial one not only in theory but also in empirical findings. A group of economists supporting Keynes are of the opinion that inflation is a factor that contributes to economic growth. Keynesian theory states that inflation leads to redistribution of income and wealth. Keynes favors mild inflation on the grounds that it tends to increase business optimism due to rising prices, resulting in high profit expectation that stimulates further investments, output, employment and income. However, another group of economists are of the view that inflation does not contribute to economic development but on the contrary, works as an inhibitor. For instance Milton Friedman completely disagrees with the policy of development through inflation. We have tried to investigate the interactive effects between inflation and economic growth for India and the need for regulating inflation in its current developing phase.

The Relationship between Economic Growth and Inflation

The relationship between inflation and economic output is very delicate. Investors highly value GDP growth, as cash flows that are the key driver of valuation/performance of company’s stocks won’t increase if economic output of a country is falling or is in a steady state. On the other hand, if there is too much growth in GDP it leads to an increase in inflation, which undermines stock market gains as the money and future profits become less valuable than they are today. Today, most economists agree that a growth rate of 2.5 – 3.5% is safely attainable without any negative effects.

Over time, the growth in GDP would lead to inflation, and the rate will keep on rising as inflation engenders inflation. Once this progression starts, it doesn’t take much time for it to become a self-reinforcing feedback loop. The Rational Expectations Theory suggests that in the times of increasing inflation, households tend to spend more money as they are aware of the fact that the money will be less valuable in the future. Because of more expenditure by the people, there is an increase in GDP in the short run that leads to further increase in the prices of the goods and services. Also, a very peculiar feature of inflation is that the effects of inflation are nonlinear, i.e. 10% inflation is not just twice as harmful as 5% but much more than that. Most advanced economies have learned these lessons through experience. In 1980s when there was a prolonged period of high inflation in the US, the economy was restored only by going through a painful period of high unemployment and lost production, as prospective capacity remained idle.

So what is the ideal inflation level? While some economists insist that advanced economies should aim to have 0 percent inflation i.e. stable prices, the general consensus is that a little inflation is actually a good thing.

Relationship between GDP and CPI Growth Rate for India

The graph below plots the quarter on quarter GDP growth rate and CPI growth rate. It can be observed that economic growth rate is inversely related to CPI growth rate.

figure-1Untitled.png

It can be observed that there is a significant relationship between GD growth rate and inflation growth rate represented by a negative correlation coefficient. The value of adjusted R square is low due to other factors like exchange rate, technological development, natural resource availability, social and political conditions that influence the economic growth.

Major Reasons why Economic Growth and Inflation Control can’t go together

When inflation is high, interest rates are hiked. The reason being, a high interest rate will discourage additional borrowings. This shall reduce the amount of money people have in their hands to spend. Traditional economic theory suggests that as demand falls, prices also fall. Thus, RBI aims to control inflation by increasing interest rates. When economic activities falter, a cut in interest rates is required. This is because companies need to borrow in order to invest in new projects. A fall in interest rates reduces cost, thereby increasing profitability. This encourages borrowing, which in turn, helps fuel the economy.

A high interest rate is detrimental to growth. Companies discontinue expansion or growth plans due to high interest rates. They are forced to cut costs to maintain profits. This passes across the economy including the labor market. A low interest rate can cause a rise in inflation. This is a result of more money in the system. This leads to an overall price rise as demand increases. A high interest rate controls inflation but retards growth. In contrast, a low interest rate is beneficial for overall economic growth. Therefore, both economic growth and inflation cannot be targeted together.

RBI’s Stance

The goal of RBI’s monetary policy is primarily price stability, while keeping in mind the objective of growth.

The Dr. Urjit Patel Committee Report posited a few key recommendations; in 2014 a “glide path” for disinflation was announced. The aim was to maintain the CPI inflation at 8% by January 2015 and below 6% by January 2016. The Agreement on Monetary Policy Framework between the Reserve Bank of India and Government dated February 20, 2015 wants to maintain the consumer price index-combined (CPI-C) below 6% by January 2016 and 4% (+/-) 2% for the financial year 2016-17 and all subsequent years. Whilst formulating the monetary policy we focus on price stability and growth. However, the focus on each of these objectives varies across time depending on the evolving macroeconomic conditions. Various changes in the economic environment will dictate alteration of the objectives to facilitate the maintenance of price stability to ultimately achieve growth.

The Reserve Bank of India controls the amount of money in the system as well as the dominant interest rates. It reviews its policy regularly through the credit policy. This is dependent on multiple macro-economic factors like inflation, industrial production data and job growth. This often leads to a debate over growth and inflation control. India has never followed inflation targeting as a tool to control inflation. But, according to Narasimham and Rajan committee the central bank clearly lacks direction and needs one tool to focus on develop their monetary policy. They say that in a country like India where the central bank is independent of the government and the inflation rate is considerably low, a monetary policy targeted around keeping the inflation rate low and stable will accelerate output growth. Inflation targeting helps in reducing inflation volatility and inflationary impacts of shocks. It also leads to increased anchoring of inflation expectation.

There was a lot of backlash regarding this move as people felt that the central bank has various factors to monitor such as price stability, growth and financial stability and that India does not have the framework for the successful implementation of IT such as developed financial markets, confidence of global markets, and independence of RBI. Inflation targeting would also restrict the RBI’s ability to respond to financial crises or unforeseen events. It could also lead to potential instability in the event of large supply side shocks.

Conclusion

A macroeconomic policy ideally should aim at high economic growth accompanied with low levels of inflation. However, in reality, accomplishing both a low inflation rate and a rising economic growth is never possible. However, low inflation rate does not indicate slow economic growth. In situations of excess money, consumers begin the process of bidding which results in escalation of the cost of goods. In the case of Indian economy, a number of studies failed to establish any conclusive relationship between inflation and economic development. Low level of inflation is advantageous for development, but once inflation goes below a certain level it retards economic development. Therefore, it is mandatory to perform inflation control at an acceptable level to promote optimum economic growth.

Appendix

Year Quarter Total Gross CPI GDP growth rate CPI growth
2011-12   Q1 19717.87 106.489
Q2 19109.98 110.658 -3.08% 3.91%
Q3 20737.12 112.553 8.51% 1.71%
Q4 21501.59 113.311 3.69% 0.67%
2012-13   Q1 20779.26 117.29 -3.36% 3.51%
Q2 20468.18 121.458 -1.50% 3.55%
Q3 21743.09 123.922 6.23% 2.03%
Q4 22474.99 126.098 3.37% 1.76%
2013-14   Q1 22164.9 128.856 -1.38% 2.19%
Q2 21990.4 134.773 -0.79% 4.59%
Q3 23122.19 138.172 5.15% 2.52%
Q4 23566.2 136.493 1.92% -1.22%
2014-15   Q1 23805.34 138.971 1.01% 1.82%
Q2 23781.78 143.769 -0.10% 3.45%
Q3 24661.67 143.769 3.70% 0.00%
Q4 25026.12 143.689 1.48% -0.06%
2015-16   Q1 25514.35 146.048 1.95% 1.64%
Q2 25520.95 149.446 0.03% 2.33%
Q3 26353.58 151.445 3.26% 1.34%
Q4 26883.03 151.245 2.01% -0.13%

Table 3

Source: RBI website

Bibliography

  1. Inflation and economic growth. (2010, October 13). Retrieved July 28, 2016, from http://www.economywatch.com/inflation/economy/economic-growth.html
  2. Barnes, R. The importance of inflation and GDP. Retrieved July 28, 2016 from http://www.investopedia.com/articles/06/gdpinflation.asp
  3. Retrieved July 30, 2016, from http://www.economicshelp.org› Economics help blog › economics
  4. Gokal, V & Hanif S. (2004, December) Relationship between Inflation and Economic Growth. Retrieved July 29, 2016 from http://rbf.gov.fj/docs/2004_04_wp.pdf
  5. Mohaddes, K & Raissi, M. (2014, December) Does Inflation Slow Long-Run Growth in India? Retrieved July 28 ,2016, from https://www.imf.org/external/pubs/ft/wp/2014/wp14222.pdf
  6. Salian, P. & Gopakumar. Inflation and Economic Growth in India –An Empirical Analysis. Retrieved August 1, 2016, from http://www.igidr.ac.in/conf/money/mfc-13/Inflation%20and%20Economic%20Growth%20in%20India_Prasanna%20and%20Gopakumar_IGDIR.pdf
  7. Disclaimer. (1934). Reserve bank of India – function wise monetary. Retrieved July 29, 2016, from https://www.rbi.org.in/scripts/FS_Overview.aspx?fn=2752
  8. Help, & Terms, S. P. (2014, August 25). Inflation versus growth: Why RBI can only pick one. Retrieved August 2, 2016, from https://in.finance.yahoo.com/news/inflation-versus-growth–why-rbi-can-only-pick-one-102654757.html
  9. Tanwar, R (2014, September) Nexus Between Inflation and Economic Development in India. Retrieved August 3, 2016, from http://www.ijhssi.org/papers/v3%289%29/Version-1/J0391063067.pdf

harshal-sharmaAbout the author:

The author is currently a student of batch 2015-17. His area of interest is Banking, Economics and Corporate Finance. You can contact him at harshalsharma2015@gmail.com

img-20161015-wa0007About the author:

The author is currently a student of batch 2015-17. His area of interest is Economic Analysis, Corporate Finance and Investment Banking. You can contact him at  jaymmakhecha@yahoo.com

Strategic Disinvestments of Public Sector Undertakings

By Vishnu Pillai

Disinvestment is the opposite of Investment. In investment, one acquires an earning asset with the help of money.  Contrarily, disinvestment means the sale of earning assets at one’s disposal in order to generate cash. India today has 264 operating central PSU’s.

Is it worth staying on a sinking boat when you have a life jacket? Probably No. Then why to hold on to a firm which eats on to the pie of another well-governed profit making firm?

If by strategic disinvestment the enterprise is privatized then the control shifts from the government to a private entity which may help in efficient functioning. Even if the government retains control of the unit, the induction of private ownership will increase the accountability of management.

The industrial policy adopted by the government in 1991 had reduced the role of PSU’s. The government was intended to run the PSU’s on sound commercial principles and the sick PSU’s were to be referred to BIFR for examining their viability. It was decided that government organization can typically disinvest an asset as a strategic move for the company, for raising capital to meet its needs, to encourage wider share of ownership and reduce the burden on the government. According to the proponents, this progressive & strategic expansion of PSU’s was initiated to attain the goal of moving towards the socialistic pattern of society.

But like a coin, disinvestments too have another side, a critical one. The deprecator term disinvestment as selling the family silver to meet daily expenditure. They believe disinvestments reduced current account deficit but lose robust funds like dividends. In 2015-16 the government received Rs.36,000 Crore from dividends which itself was 50% of the targeted amount of Rs. 69,500 Crore to raised from disinvestments. Even wider ownership claim by the government failed since large corporates and financial institutions benefitted with the disinvestment than the common man. Moreover, the most of the disinvestments funds received were used to fund fiscal deficit.

So before jumping the “Disinvestment” trigger, the government should restructure PSUs to enhance the value of shares and increase sale proceeds. They should focus on areas like corporate governance, financial restructuring, and business & technological restructuring. The process of disinvestment should take into account the conditions in the capital market and not result in “crowding out” resources available for the private sector. The government has lowered the target by 19% in the last budget. Let’s hope this is a beginning towards a better and rational approach towards disinvestments.

Dr. Urijit Patel’s Contribution to Economic Development of India

AUTHOR- Nimisha Khattar

Popularly known as the Inflation Warrior, Dr. Urijit R Patel, has been associated with RBI since 2013. He has played a key role in formulating and shaping the monetary policy of India. With his appointment as the new RBI Governor, we can expect the government to continue with the existing macroeconomic policy.

An Economist from Yale University, Dr. Patel, believes that in order to make India a country characterized by stable growth, inflation needs to be in control. Dr. Patel has brought about many significant changes. Adopting Consumer Price Index as the base, instead of Wholesale Price Index, for measuring inflation in an ‘inflation targeting approach’ was one revolutionary reform.

Dr. Patel has been a great critic of the excessive government spending and subsidies. Time and again, he has emphasized the need for a discipline in fiscal expenditure. In order to control inflation, since the degree of correlation between monetary policy and fiscal policy is high, the greatest contribution by Dr. Patel has been to keep inflation in the targeted rate bracket of 4% ± 2% in the recent years.

Apart from his contribution in controlling the inflation by increasing the interest rates and reducing fiscal expenditure, one of the smart moves that Patel committee came up with was setting up a team of six members instead of one alone, for deciding the policy rates. This has led to minimization of risk and has helped in making the process a democratic one.

Considered as an owl (a symbol of wisdom) by the ex-RBI Governor, Dr. Raghuram Rajan, Dr. Patel had been advising central government on some major issues as well – like the development of debt market, growth of foreign exchange market and the banking sector.

Thus, it can be concluded that Dr. Urijit Patel’s contribution played a massive role in the economic development of India and going by the logic of keeping repo rate higher than the CPI, as remarked by him in the committee recommendation, let’s also keep our faith in the owl higher and stronger.