AGRICULTURE SHOULD BE THE ONE DRIVING INDIA NOW

While presenting the country’s mid-year report card to the parliament, Finance Minister Pranab Mukherjee slashed the country’s growth forecast in the second week of December, stating, “The sharply deteriorating global economic environment has had a dampening effect on India. Compounded with some domestic factors, the global situation has led to a clear slowdown in the growth rate of the Indian economy...” It was almost like accepting the bitter truth in hindsight, because by then, almost everyone who kept a track of the country’s economy had realised this very fact. For that matter, the FM’s new growth forecast of 7.5% sounded a lot more optimistic; some have even started forecasting that the GDP growth will be limited to 6.5-7%. But can we blame it all on the global economic environment, or is it the effect of the ongoing domestic troubles including inflation, trade deficit and current account crises? Well, certainly not!

As I see it, the current imbroglio is the negative impact of years of imbalanced growth in the economy in which we are living now. Over the past decade and a half, the country’s rapid economic growth has been driven by the services sector, and increasingly by high value added manufacturing. But what about the agriculture sector? It has been left out as an underdeveloped child despite the fact that 58.2% of the country’s population still works in this sector. Horrendously, while the country has been growing at a healthy rate, the sector has recorded growth rates like –0.1% in 2008-09 and 0.4% in 2009-10. Though the advance estimates given in Economic Survey 2010-11 suggest 4.7% growth for the sector, we know that no miracle has happened during the year to suggest the same. In reality, that’s the period when India’s food inflation started to shoot up to record highs. So, it’s just a matter of time as the revised figures to be presented in February 2012 will again confirm a growth of just around 1%.

As a matter of fact, post the green revolution in the 1960s, the country and the policy makers have just taken this sector for granted. And the sector, which employs the lion’s share of the population, barely manages to contribute about 14% of the country’s GDP. As a result, India, which had not imported wheat for decades, was forced to go for it as domestic production had not increased over the past many years. But that is like a crime, because this is one sector where the country was self-sufficient since time immemorial. And at a time when high imports (and thus the trade deficit) are emerging as far more daunting problems, an import bill from a sector that can still be self-sufficient is truly not understandable. But the reason for the same is simple enough. While all other sectors are receiving huge investments, lack of investment in agriculture is frighteningly low. Additionally, lack of appropriate support is seeing farmers leaving their lands for development of real estate, hence reducing India’s total cultivable land. And this will end up dampening the sector’s growth forecasts very soon.

India has always been a land of agriculture and the country’s economy still has it as its base. For that reason, to manage a smooth growth in the economy, the government needs to push this sector and give it its due credit. And if it cannot do so, then it should better be prepared to shift 58.2% of India’s population to an alternative job opportunity, so that they can contribute in a better manner rather than being disguised unemployment for the country.

RE-ENGINEERING THE AUDITOR

We live in frighteningly uncertain times and more than anything else, globalisation is to be blamed for the situation. What started as a process to make this world a more manageable ecosystem gave rise to an unending need for growth. As a result, we have in place a system (not by default, but by design), which renders almost every checkpoint defunct. Billions of dollars are spent every year in organising conferences and round table meeting where thought leaders supposedly have a dialogue on how to fix this recurring mess. But as is evident, nothing happens. In fact, more scams and accounting frauds are unearthed everyday. I think – to start with – it is time that we actually sit up and reengineer the role of auditing firms.

The Madoff Scam would be a good case in point to understand what I’m trying to put forth. In December 2008, Bernard Madoff, the former Chairman of Nasdaq, was charged with fraud. His investment firm was running a Ponzi scheme and the size of the fraud is estimated to be around $64.8 billion. Madoff’s accounting firm – Friehling & Horowitz – had offices in a strip mall and was run by three employees. Given the size of this firm, it is quite obvious why there was no whistle blowing. After all, they had to be in business! But what is not so obvious is the fact that KPMG, PricewaterhouseCoopers, BDO Seidman and McGladrey & Pullen (the auditing firms for institutions that invested in Madoff’s company) also gave a clean chit to the funds that were invested with Madoff.

Not so surprisingly, the scenario in India is not different either. The Indian arm of PwC was fined with $7.5 million by the United States Securities and Exchange Commission on failing to reveal that Satyam Computer Services’ balance sheets were cooked up. If such instances are not enough to reconsider the role of auditing firms, then sample this. In a landmark report released by The Committee of Sponsoring Organizations (COSO) [an independent US body, which provides guidance on governance], it was revealed thus, “79% of companies found to be engaged in frauds were being audited by the Big Four (Ernst & Young, PwC, KPMG and Deloitte) between 1998 and 2007.”

Around 90% of companies in India are privately held. Big and small auditing firms alike are paid by them. The fact is, till the time this transactional relationship exists between corporates and auditing firms, such scams will continue to flourish. Further, auditors are regulated by ICAI guidelines. Most of the auditors survive on a handful of clients. Further, the remuneration they receive is not based on their ability to add to the business but to fill certain documents and add their signature. Therefore, such auditing firms are left with no choice but to help promoters circumvent the law. I feel that auditors must undertake assignments, which they can manage with resources at hand. Moreover, ICAI will have to take a stronger stand on this issue so that the system becomes more rewarding. In fact, in the prevailing system, I see these auditing firms as nothing more than image managers. Most Indian companies bring the likes of PwC and E&Y on board because they hope that such an association would enhance their image before investors. There are two choices from here on. Either turn a blind eye – let the auditors rake in billion of dollars for perpetrating frauds and allow the companies to fool investors – or bring in a regulatory body or make amendments in the Companies Bill to clamp down on these auditing firms. If not, then auditors will continue to act as voluntary puppets instead of the watchdogs they are supposed to be.

EVEN THE AMERICANS MISS THE RIGHT TO INFORMATION!

It was just a thought. But it had a powerful appeal, powerful enough to spread from Seattle to Gothenburg and Genoa, to lead to demonstrations & bloody protests, and to become a new movement that apparently labels itself as anti-capitalist.

The anger this time is against Wall Street and the quite obvious reason is the overstretched and persistent US economic crisis. As they see the situation, it’s all an offshoot of corporate greed. Corporations have, in a sense, infiltrated their way into the government and the way it makes policy. They were given undue advantages, including the legal means that were provided to the companies and their shareholders, but not to the consumers. But the question is – why has the whole of US suddenly risen to the anti-capitalism movement?

Well, consider this. The 400 richest families in the US now hold as much wealth as the bottom 50% combined & 1% of the people control 40% of the wealth. Since 2009, 88% of the income growth went to corporate profits and 1% went to wages. During this period, the US government bailed out banks and big corporate houses with huge amounts of ‘public money’ to boost growth and create jobs, but unemployment constantly remained at historic highs. For that matter, till September, it was still at 9.1% with little hopes of easing in the near future.

This is where the thoughts of the two German Economists Hayek and Mises comes into mind. In 1944, they wrote, “In the eyes of the public, not anti-capitalistic policies, but capitalism is the root cause of economic depression, unemployment, inflation and rising prices, of monopoly and of waste, of social unrest and of war.” Those who learned from this, did well. What can be a better example than Germany itself (one of the few countries in the world that has learned the lesson this century and has restrained spending), which is not only among the strongest remaining economies at present, but also, in a way, has become the growth (& hope) engine of the crisis-struck EU zone.

Moreover, policies that create a non-transparent wall between capitalists and the public add to the woes. For example, a promoter employee of a company gets both dividends and remuneration from a company. While the salary saves him in the bad days, he gets a double benefit in the good days. But what about a normal shareholder in the days of loss, when the stock prices don’t even offer positive returns under market pressure? Small disillusionments like this finally add up to bigger movements like the anti-capitalism movement we see today. And their incidence is all the more likely in a prolonged period of recession, joblessness, bankruptcy and high prices such as the one that is currently on in US.

A logical way out would be to become transparent. For example, all discussions and debates that take place before enactment of a law must come to the public domain and people should be given sufficient time to react to it & to express their concerns. This is even more important when it is about serious policy measures like bailing out the private sector on public money and then seeing them distributing hefty bonus packages in the board room, while continuing job cuts on the ground. It’s not only about the US. Nations across the globe must understand the very fact that if a movement that started in Egypt can go on to rock half a dozen nations, and bring about the end of a powerful dictator like Muamar Gaddafi, the furore over the anti-capitalism ideology has the potential to spread really wider and a lot faster.

BANKS AND ‘COLLATERAL’ DAMAGES TO ENTRE-PRENEURSHIP IN INDIA

Ask any entrepreneur what was the biggest hurdle that they had to face in the process of making their dream venture a reality – and more often than not, you will hear: getting the project financed. This is more so, when the entrepreneur has no assets to offer as collateral to obtain funding. The practice of collateral based funding, widely used by Indian banks, has been a great deterrent for entrepreneurs in this country. Owing to family-owned business structures and underdeveloped capital markets (lack of any primary market platform to support MSMEs like AIM, the London Stock Exchange’s international market for smaller growing companies), banking finance has been a preferred choice for Indian entrepreneurs not only as seed capital, but also as growth capital. But stringent collateral requirements including personal guarantees and short lending periods, have always restricted entrepreneurs either from obtaining the desired amount of capital or, at times, from getting any capital whatsoever.

No doubt, some wise men in the country’s banking system attempted to experiment in the late 1960s to move away from the “security based lending” practices to “purpose based lending”. The purpose underneath, as described by K. C. Chakraborty, Deputy Governor, RBI recently, was that credit and finance were instruments of empowerment. By unfettering credit from security, those who were able and willing, creative and talented would not be constrained by lack of funds. The security for the funds lent would not be physical assets but the discounted value of cash flows that the enterprise would generate. This marked a decisive shift in methods of lending – it reoriented lending from a static to a dynamic concept. But the real problem came thereafter. The experiment was a success, but it was never pursued the way it should have been. There is also the biggest fear that the massive corruption and rampant criminality existing within the financial industry’s rank and file would ensure that loans are blindly handed out to ‘purposes’ that are either fraudulent or impractical at the best. Still, till a way is found, entrepreneurs with great ideas but with no money or collateral, will keep suffering.

But this is not to say that there is no way. Some sparkling exceptions are already taking place. Take for example the case of SMEs. This is one segment which accounts for close to 40% of the country’s manufacturing output and over 33% of the exports. And most importantly, this is where most entrepreneurs first step into. The segment suffered for long in the hands of the banks to obtain funds, and finally the RBI came to their rescue in 2008 when it passed guidelines that asked banks not to insist on collateral security from SMEs for advances up to Rs.500,000, but only take into account the viability of their projects. However, as Usha Thorat, Deputy Governor, RBI in 2008, pointed out in a seminar, that despite banks not being supposed to ask for collateral security in SME requests, a few banks are still insisting on the same. Moreover, banks which did not ask for immovable collateral securities, required even tougher guarantee norms to be fulfilled, charged higher rates of interest and even the loan period was shortened. All this defeats the very purpose of equitable growth, where it has been proven way and beyond that a nation can spread economic gains equitably only when it promotes the SME sector – which results in massive increase in employment rates. 65% of Europe’s GDP comes from SMEs; 45% of US GDP too comes from SMEs.

Entry of an increased number of private equity players, both domestic and foreign, over the past decade has helped entrepreneurs to obtain finance on the basis of the merit of their projects. But a lack of a platform to facilitate the same and insufficient awareness is still playing spoilsport. And bank financing still remains to be the major source of funding.

To achieve and continue with a dream double-digit growth, India today needs a lot more entrepreneurs who can add to the GDP by creating employment. But for that, their basic necessity of finance must be taken care of in a good manner. And considering that India will still take some time before entrepreneurs look forward to PE players and not banks for getting their projects financed, it’s high time that RBI comes forward to facilitate the process, not just by bringing out some radical guidelines, but also by ensuring that the banks follow them religiously.

THE MYTH ABOUT THE BIG FOUR AUDIT FIRMS IN INDIA

While the existing Indian Companies Act needs an overhauling on many accounts, one big area of concern is its provisions related to auditors of the companies. While auditors should be used more efficiently and diligently to put a check on the companies, due to the lack of adequate legal barriers, especially on the penalty and punishment front, over the past few years auditors have constantly failed to act as the real whistle blowers.

Going by market share, the Big Four global audit firms – Ernst & Young (E&Y), PricewaterhouseCoopers, KPMG and Deloitte – have grown tremendously in India in recent times. Reason, India Inc. feels that their association with one of the Big Four will provide them a clear image in front of the investors. So much so that many a time I have noticed companies changing their auditor and getting one of the Big Four on the board right before public issues. But the question remains, does hiring these ‘foreign branded’ firms actually help in image building? More importantly, do they really bring out all facts better than the Indian audit firms, or is this a utopian urban legend? Well, going by their track record globally, raised eyebrows are obvious; more so after their startling admissions in front of the House of Lords economic affairs committee in November last year. The irresponsibility was spot on when one of the Big Four clarified that they assumed it to be perfectly alright to portray a better picture in front of investors about their banking clients’ solvency after the government entered into discussions on possibility of a bailout. If that was not enough, a report by COSO (the US body that revolutionised the understanding of corporate reporting) points out that 79% of companies found to be engaged in frauds were being audited by the Big Four between 1998-2007. The same COSO report also indicates that 26% of the companies engaged in fraud had changed auditors during the period, as compared to just 12% of those who were not into fraud.

Cut to the Indian scenario, they have not fared anything extraordinary to keep their image better. While PwC was nearly banned for its lapses in the case of Satyam (had the PwC ban happened, it would have been the third for PwC after being banned in Russia and Japan; it’s the third mess up for the firm after DSQ Software and Global Trust Bank), very few had actually noticed that the biggest of Big Four in India, E&Y, was the auditor of Ramalinga Raju’s family firms, Maytas Properties and Maytas Infrastructure. Not that mere association with a questionable company should throw an audit firm in poor light. But if the questionable company’s financial skullduggery could have been caught much earlier by the audit firm – and it visibly chose not to – that is what is pulling the image of these firms down. For that matter, there have been instances in both global and domestic arenas, which vouch for the fact that hiring the Big Four firms does not necessarily work in favour of the regulatory bodies. In fact, in the post SOX era, while CFOs are forcing audit firms to do more for less fees, audit firms – and not just the Big Four – are focussing more on their consulting businesses rather than concentrating on diligent audit work.

However, the most surprising fact about their operations in India is that two of the Big Four (E&Y and KPMG) are not even registered with the Institute of Chartered Accountants of India. This simply means, technically they are not eligible to conduct audit of Indian companies. But still, they are here and operate through tie-ups with Indian firms. While E&Y has a tie up with S. R. Batliboi & Associates for audit works, KPMG has tied up with Bharat S. Routh & Associates to manage the show. For that matter, how many have enquired about the connection between PricewaterhouseCoopers and Coopers & Lybrand Pvt Ltd? I ask, is one company marketing its services but the cheques being cut in the other company’s name to avoid scrutiny? The fault does not lie primarily with these firms, but with the government or even, I should say, with ICAI. If the ICAI or the government plans to ensure that Andersen-like Enron cases are not encouraged, then the first step would be to ensure that audit firms do not indulge into consulting and other paid research based activities, whether directly or indirectly. And that there is no overlap of marketing functions and project functions – where a foreign name is peddled to get the audit contract and the cheque is cut in the name of the local partner by the client. For whatever it’s worth, at least a consulting firm like McKinsey & Co. sticks to what it claims and does not concurrently take up auditing activities.

Thus, before the Big Four take things for granted in India, apart from stricter norms for auditors in the newCompanies Bill, regulators must also see to the fact that the audit firms must be registered in India (and not operate by tie ups with Indian audit firms) at the very first instance, abided by Indian rules and not take up additional work. Till that time, they must be forced to disclose their various business arrangements through public notices. If the Big Four are here, they should act like watchdogs, not just voluntary puppets in the hands of the companies.

NON- SETTLE-MENT BETWEEN FARMERS AND GNIDA: WHAT DOES IT MEAN FOR ALL

It has been over a few months now that the farmers, builders, home buyers and even the Greater Noida Industrial Development Authority are in a flux without any clue as to what’s there in future. While the court has given a deadline of August 12 to find out a solution, the talks between GNIDA and farmers have failed again on August 1. The reason was simple: farmers want higher compensation; and in his discussion with the farmers Rama Raman, CEO, GNIDA, failed to give any assurance in this regard. This actually made me think, what if they fail to arrive to what the court says an amicable solution? In that case, the court will be left with no other option than to give a verdict that has two key points - return the land to the farmers and refund money to the home buyers. But the question remains on whose will this decision go? Who will gain the most?

Well, in order to find out the biggest gainer, we first need to find out the future impact on the three parties who are at stake; namely the farmers, builders and home buyers.

Farmers: Considering the verdict assumed above, the farmers get their land back. But the only problem is that construction work had already started on most part of this land, and thus the fertility of the land is a big question.

Builders: As per this verdict, they will be at a double loss. First they will lose their investment on the land and the construction activities they have carried on so far. Second, they have to pay back to the home buyers, and most probably with interest. This will not only trouble them in funding them their other ongoing projects, but will also obstruct in getting funded by banks or other sources. Home buyer: Well, they may look like the safest lot as they will get back their money with interest. But the problem is that by the time they get back their money (assuming that the process of refund will take three to six months to complete), their affordable home will not remain affordable anymore. The prices of affordable housing around the same region (where these home buyers are likely to move) have already gone up by Rs.1,500 to Rs.2,000 per sq. mtr. Considering such escalation in price and adding up the very fact that builders will soon raise this price to make for their losses at Greater Noida, when the home buyers will book a new affordable house around the area, they will have to shell out at least Rs.10,000 to Rs.15,000 more per sq. mtr. And that will be really costly.

Moreover, with this price hike, the concept of affordable housing in NCR will be over soon. The purpose behind creating NCR was that the necessity to reduce the congestion in Delhi. But with the recent developments, the middle-class population in Delhi, mostly living in rented properties, will not shift out of the main capital region as they see no benefit in terms of cost savings. At the same time, with the NCR outburst and high real estate prices in Delhi, the common man now cannot even dream to own a house in his entire life.

As the scenario suggests, it’s a loss-loss situation for all parties. In fact, it’s a loss for the Indian real estate sector too for the simple fact that all we get to see here is an artificial escalation of home prices, which will definitely add a lot more to the already burgeoning real estate bubble.

Certainly, the farmers deserve a fair price for their land. But, at the same time builders need to carry on for the betterment of thousands of middle-class home buyers and for the industry as a whole. So a more logical way to solve the issue is that in stead of dealing with GNIDA (which actually created the whole mess by its illegal acquisition of the land and then by selling it to the builders) as the neutral party, farmers and builders should talk directly and negotiate to bring an end to this issue once and for all. Else, the issue will keep getting delayed escalating losses for all parties.

NBFC NCDS MAY AGAIN MAKE US SEE A DISASTER SIMILAR TO FD DEFAULTS OF 90S

It was in 1997 when I saw C. R. Bhansali and group taking many lives without violence. They just defaulted on fixed deposits (FDs) that they had raised from public when the instruments matured. The question that troubled me then was, why NBFCs for FDs? Well, the answer was simple. After Harshad Mehta was arrested, the stock market was in a mess and investors were looking for a place to park their money. On the other hand, with RBI cautioning banks against lending to NBFCs (1995), they were hunting for sources to fund their operations. And as it happened, NBFCs started attracting investors with their high interest rate bearing FD schemes (some even promised a return as high as 26%). As the money started flowing in, to serve these high-cost deposits, NBFCs started venturing into all possible sectors, in most cases, without substantial experiences. Result; they not only suffered on asset quality, but ultimately failed to pay back the investors.

Cut to the present scenario, if you observe a little more carefully, retail investors are again slipping into a similar situation and the only difference is that FDs are now replaced by NCDs (Non-convertible debentures). Over the past few months, while few NBFCs like L&T Finance and Shriram Transport Finance have already raised sums in excess of Rs.5 billion, a number of others have lined up retail NCD issues at attractive rates. As per estimations, the next six months will see retail NCD issuance of around Rs.50 billion at an interest offering between 9% and 12%. And considering that the market is already heading south, this is one bait that most investors will get trapped by.

However, NCDs are not the problem, it’s the usage of the money raised. NBFCs are again gung ho on expansion and realty estate is their prime target. While they funded Rs.30 billion to 20 developers last year, it is set to grow high this year (more for the banks’ disinterest in lending to commercial real estate sector, which already owes Rs.1.10 trillion to them). But this funding means a disaster for the NBFCs. As Liases Foras Real Estate Rating & Research Pvt suggests that over the next two years, prices (in Mumbai) will go down by as much as 35%. In that scenario, it will be tough for NBFCs to generate the return desired to redeem the NCDs at the offered interest rates. But the question remains, if there is a bubble in making, why are investors still lurching to jump off the cliff? Well, perhaps the market regulators can answer this better. According to the existing policy framework, there are number of gray areas (allowing the scope for different interpretations), which allow NBFCs to operate at their will without any transparency. For example, there are no guidelines for private placement of NCD. This allows players to issue securities to public at large under the cover of private placement. Also, Listed NBFCs are under no compulsion to disclose their secured and unsecured loans in the quarterly results under clause 41 of SEBI listing agreement. At the same time, NBFCs just need one certificate from a single bank to prove the quality of their assets. If these are not the killer, read this; there are no remedies available to an investor in the Companies Act in the event of default by a company to redeem the debenture on maturity. That means, when the bubble bursts, investors go bankrupt and the bosses of the NBFCs go scot free only to return to action later to suck the life out of a few more investors.

In view of the above facts, this is actually the time when regulators need to act... and act fast. If not anything else, then at least they must come up with a notification that treats all NCD issues for more than a limited amount, say Rs.1 billion, as public issue and forces NBFCs to comply to all disclosure and other norms accordingly. This is the time when regulators must prove that they also learn from past mistakes, else we will soon hear some investor dying of heart attack and CBI chasing the big boss of some NBFC.

TRUST IS THE KEY FOR SUCCESS OF RM MODEL IN INDIA

In a good faith, to help senior citizens, the RBI issued guidelines for Reverse Mortgage (RM) in 2007 and then revised the same in 2008. The then Finance Minister P. Chidambaram also promoted the concept to great an extent in Union Budgets of 2007-08 and 2008-09. The apex body in housing finance, National Housing Board (NHB) came up with a definitive scheme for RM and today as many as 20 banks offer different RM products to Senior Citizens. But till January 2011 (since 2007 when RMs started in India) only 7,000 RMs were sold in the country clearly indicating how big a failure it is.

RMs, as the name suggests, can be considered as reverse EMIs wherein a Senior Citizen (over 60 years of age) can pledge his/her biggest asset, the house, to receive a series of cash flows from the bank for a fixed tenure with the rights to live in the house till the house owner or spouse is alive. For a country like India where insurance is still to go deep into the masses, pension schemes have started drawing attention just recently and pension by Central and State Governments are not enough to sustain the lives of those who are already retired with not much of cash in their pockets, RMs are a boon. But still the senior citizens have not woken up to it. The mute question remains, why?

Well, the answer remains in the basics. In stead of being friendly to the senior citizens, RMs actually aim at minting money for the issuer. For example, one of the main turn offs in these schemes is the loan tenure. While life expectancy is on rise, RMs offer cashflows for 15 years with the clause that the money cannot be used for reinvestment or business purpose. This jeopardizes the person’s future for the fact that if he buys a RM at 60, after 75 he receives nothing from the bank, owing to the terms of RM he could not invest anywhere so no income from other sources, and worse he cannot even rent or sell the property to get funds as it’s already mortgaged with the bank (RM clauses specify so). For that matter, the cash flows that the house owner receives from the mortgage lender is only equivalent to 60% of the value of the property (for example, Rs.3 million for a house valued at Rs.5 million). With such preposterous clauses that almost send senior citizens’ a full-circle from problems at a particular age to even bigger problems and helpless conditions after 15 years, it is certainly not very difficult to understand why the seniors are trying to keep their hands off such schemes.

Nevertheless, there came a ray of hope last year when a new product came out of a bank-insurance tie up and offered annuity with RM allowing the seniors to receive a payment till life. But it is just the beginning, if the RM model needs to be successful; the mortgage lenders need to make the seniors feel that they are their well wishers and not Shylocks from Shakespear’s Merchant of Venice. More so in the Indian context, where the lenders have to go past the biggest hurdle in form of pre-dominant cultural believes whereby most elderly see residential properties as entitlements of bequeaths for their next generation. RM lenders have to prove a point to the seniors before the model can take off in India, and they have to do so by their works, not just words.

The minimum that they must do in this context is to provide a better value for the mortgage (like around 90% of value of the property) and the make cash flows available to the seniors till at least one, mortgagee or spouse, is alive. This becomes all the more crucial in case of the urban middle-class nuclear families, who are the ideal target group for RMs. The government should also show some responsibility towards the senior citizens and play a vital role by subsidising the interest rates associated with these schemes. It’s our moral duty to help the seniors in our society. Thus, instead of creating schemes to mint money, if the financial institutions can act as trustworthy friends to the senior citizens, the RM model can deliver a lot for them in the long-run.

DOES SENSEX REFLECT A TRUE PICTURE OF THE STOCK MARKET?

For most common Indian, the BSE Sensex is equivalent to the Indian stock market, and for experts it is the nerve of Dalal Street. But, since the day I started understanding stock market and its functions, the biggest question that kept haunting me was, when we have a huge pool of listed (public limited) companies in the country (as many as 81,926 as on December 31, 2010), how correct are we by following a benchmark indicator that consists of just 30 companies selected on the basis of a single parameter - market capitalisation?

As a finance professional, I often get to see many presentations which compare BSE Sensex with NYSE Composite to prove a point. But I just want to ask a simple question to those sophisticated presenters; the comparison that they showcase, is it between two equals? Certainly not! While the Sensex presents an ultra-narrow view point by indicating stock movement of 30 companies of an exchange that houses the world’s largest number of listed companies, NYSE Composite, on the other hand, presents a broad and global view by showing market movements of 1867 stock (1530 US companies and 337 non-US companies).

Moreover, while the top global indices, be it NYSE Composite or Nasdaq Composite, provide comprehensive sector coverage by including stocks from all the 10 industries defined by the Industry Classification Benchmark, the Sensex does not even pay a heed to the same. On the contrary, the Indian benchmark index is heavily skewed towards just 3 sectors - Oil & Gas, Financial Services and Information Technology - as combined together they control over 50% of the total weight in the index at any point of time – whereas some other key sectors like aviation and gems and jewellery are either completely ignored or get a paltry weight of 1%-2% like the healthcare sector (Cipla is the only healthcare company in the Sensex with a weight of 1.1% as on April 21, 2011).

But possibly, what makes Sensex the worst possible indicator from India’s point of view is the fact that the index does not even represent 30 stocks in true sense. Thanks to sole selection criteria of market capitalisation, it’s just a representative of the top 10 stocks which have a combined weight of 67.25% (as on April 21, 2011) in the index, whereas, the top 10 in NYSE Composite holds a total weight of less than 15% at any point of time. What’s laughable in the Indian context is the fact that any strong movement in the top 2 index constituents, Reliance Industries (11.78% weight) and Infosys (9.43% weight), alone is good enough to rig the Sensex much more than what the bottom 5 (combined weight of just 3.69%) can do together.

For an average common man, who does not understand what the Sensex at 20,000 actually means, the index is also an indicator of the country’s economic growth. But as the past records suggest (in 2008, the economy grew at 9% when the Sensex dropped over 52%; on the other hand, Sensex gained 81% in 2009 when the economy only managed a 7.4% GDP growth) the Sensex is on a completely different tangent as compared to the economy. And the reason, for sure, is the narrow base that it represents. So it’s high time that we actually should either abandon looking at the Sensex as a benchmark of any sort and move one to some other index like BSE 500 or perhaps BSE 1500, or change the existing selection criteria of Sensex to present a comprehensive and wider indicator that also shows the real picture of the economy. BSE has already lost the stock market war to NSE in 2009. It might also lose the index war in 2011...

THE BRILLIANT CONSPIRATORS OF THE INDIAN CORPORATE BOND MARKET

It’s unfortunate, but true! The strangest thing about the Indian capital market is its retail investing community. While they have already mastered the art of losing money in the equities market almost on a daily basis, they have no clue about a safe heaven called the corporate bond market. They are ready to bet their net worth for a 12-15% return on the tips given by the so called market pundits, but they are not ready to learn about how to earn 8-9% ‘risk-free’ returns by investing in corporate bonds. And the result? While the key nations across the world have a well balanced capital market with the bond segment complimenting the equities segment, India on the other hand has a capital market wildly tilted towards the equities – conspiratorially so, because of the lobbying power of the equity powerhouse FIIs. Between 1996 and 2008, the ratio of equity market capitalization to GDP has more than trebled to 108%, while that of the bond market has less than doubled to just 40%. The worst issue is that only 3.3% of this is contributed by the corporate bonds. Why should it be like this, I ask? Why is the Indian corporate bond market at such a dismal state despite having such a large number of listed companies?

Well, the major reasons are, one, a lack of interest on the part of India Inc., and two, as I mentioned before, a well managed calumnious tactic to never motivate retail investors in the bond market. So far, India Inc. has walked out of this responsibility by conveniently blaming the lack of demand for corporate bonds in India. But the truth underneath depicts an ugly picture of vested interests. While the corporate sector pays around 9-11% for raising long-term funds in form of bank loans or issue of bonds, in the latter case, the companies need to maintain a level of transparency for the whole world – they can do away with the same in case of loans from banks. Moreover, while raising funds through bonds, companies need to face the acid test of investors due to the due diligence process. At the same time, in a country like India, which ranks 87 in the world (Transparency International’s Corruption Perception Index 2010), paying a little bribe to get a loan clearance is not a big hassle and Indian companies know it quite well since the license raj days. While there is a lot that can be discussed, the LIC Housing Finance bribery scam, where the CEO got arrested, is the pristine example with which I shall rest my case.

But then, why blame the corporate sector alone? Has the government shown any determination to develop the market? None whatsoever. There is no doubt that the intent was there always (remember the 2005 R. H. Patil committee report, which is now biting dust somewhere on bureaucratic shelves), but the interest was always missing. While governments the world over have encouraged their bond markets with various tax incentive models, India is yet to formulate anything in this direction. At the same time, equity investors are enjoying a fair deal of tax free provisions. If that is not enough proof of some deliberate connivance between the government and the equity players, then what is? Despite the Prime Minister requesting his finance ministry for developing a ‘vibrant’ corporate bond market in India, the chapter was again missing in the latest Union Budget. Not that we were too surprised by such a ramshackle act of ignoring.

Keeping in mind that the country now needs a massive $1 trillion investment in the infrastructure sector to keep up with a near double-digit growth rate, the best way at the moment is to rev-up the corporate bond market. And when do I personally expect this to happen? 2015; no sooner...

THIS ONE IS DEDICATED TO YOU, ME AND MILLIONS OF INVESTORS LIKE US

As someone who knows something about the way our financial services industry operates-though not the way so many experts and pundits project themselves on TV screens – I have often wondered why is it that people like you and me never get to know about things before it is too late. I mean, retail investors often wonder-like their counterparts in Hindi movies – about how much more tension and torture they have to undergo before they are saved. Like in Hindi movies, retail investors like you and me get comfort only after the robbery has been done and some one heroic has bested the villains. And then the police arrive-like the Securities Exchange Board of India (SEBI) arrives-after the deed has been done, people have been harmed and faith in institutions has been shaken. As a professional who has been trying to understand-forget master-this industry, I know how difficult it is for me even to point out these things. And yet, we have all realised that it is time to fill up a significant gap. The gap, in my mind, is very clear: most media outlets tend to glorify the people who are movers and shakers in the financial services industry. Today, you will have a story about how this ‘bullish’ stockbroker is going to transform the market. Tomorrow, you just might read or hear about a ‘bear’ who has equally compelling reasons. And then the other day, you will hear about how the FIIs have saved Dalal Street from ruin by buying at a strategic time!. If you believe all that, then this modest and yet ambitious offering called BFM is not for you.

As far as I am concerned, BFM is about investors like you and me who expect some level of honesty and transparency from players in the financial services industry. I know, we will often fail to get that kind of honesty. Then, we would bring to you stories like the cover feature this on Insider Trading which analyses how retail investors might be getting perennially fooled by pundits, brokers and corporate leaders. I am sure we will also do stories of the other kind when corporate houses, companies, investment banks and consultancies reveal proof of transparency and clean practices. In fact, I am still waiting for the day when I can go through the balance sheet of an Indian company and claim with pride that it can defy that detergent ad tag line that says: Kyoonki Daag Acche Hote Hain...

This being the first issue of BFM, we are also not going to shock you-the retail investor-with more horror stories of what happens in Dalal Street and beyond. Like good news, even disturbing news should come in small doses! But we do promise you this much, our research and editorial team will always be striving to keep you the retail investor in mind when they are pursuing leads and stories. In the process, we are willing to sacrifice advertisers and antagonise regulatory bodies like the SEBI-and even their real masters sitting in North Block. Mind you, we will often praise them too.

It would be wonderful to get your feedback on this issue-acclaim and calumny are both welcome. It will help us become a more efficient interface between you and the Indian version of the Masters of the Universe!