Innovative Indian Banking

Globalization of Indian economy has resulted into modernization and innovations in banks in India..

Globalization has brought about structural changes in the world economy. This includes services, particularly banking and financial services. Although service sector contributes significantly to the national output, the impact of globalization on services is yet to capture the attention of researchers and policy makers in many countries.

Since the mid-1990s, there has been a steep increase in the number of branches and ATMs opened by foreign banks in the emerging economies. This is being led by banking crisis, deregulation and globalization of financial services. Most of the foreign entries have been through two routes: (i) Acquisition of domestic banks in the host country, (ii) Strategic alliances.

The banks do business in foreign countries also and this business has grown slowly over a period of time. The overseas business of banks include provision of trade-related banking services such as negotiation and collection of bills, opening of letters of credit, channelizing foreign inward remittances, and mobilizing savings abroad. They also provide import and export finance to local businessmen, arrange for foreign currency loans, promote project export, joint ventures and provide merchant banking services.

Cases

This section is designed to provide information based on the case studies of three banks in India with focus on innovative products of these banks—the ICICI Bank, the HSBC Bank and the SBI. These banks were selected for case analysis to analyze the effects of recent changes on commercial banks based on the representative character; i.e., the ICICI Bank represents the private sector, the HSBC Bank, which is a foreign bank and the SBI, a public sector bank. Retail banking products have been focused in the cases.

ICICI Bank

The ICICI Bank was established by the ICICI in the year 1994. The Bank's activities have gained momentum with the reverse merger of the parent company ICICI with the bank. ICICI Bank is India's largest private bank and the second largest Indian bank including all public enterprises with about US$21 bn in assets. The ICICI Group comprises ICICI Bank and various subsidiaries in the area of life insurance, general insurance, asset management, investment banking and venture capital. ICICI Bank is well-known as the first Indian company to be listed on the New York Stock Exchange (NYSE). ICICI Bank has created global benchmarks through its US GAAP audit processes, Securities and Exchange Commission (SEC) compliance practice and corporate governance standards. The bank has been rated above the sovereign rating by Moody's. Its business has been driven by the multi-channel distribution through over 600 branches, 1,600 ATMs, mobile, telephone and Internet banking facilities. The bank to its credit has pioneered Internet banking in India and more than 30% of its retail customers are on the Internet. ICICI Bank has set up representative offices and branches in countries such as United Kingdom and UAE.

ICICI Bank has introduced a wide spectrum of innovative domestic and international banking products to facilitate trade, investment, cross-border business and foreign exchange services. The different innovative services and products offered by ICICI Bank are: Savings Account, Fixed Deposit, Quantum Optima, Recurring Deposit, ICICI Select, Roaming Current Account, Kid-ebank, Bank@campus, Power Pay, and Locker Facility.

Innovations in savings bank account

The salient features of savings account are given below: i.e., an ICICI Bank, SB account holder is eligible for free Debitcum- ATM card, Internet Banking, Phone Banking, Anywhere Banking, Standing instructions and Nomination facility

• The ICICI Ncash debit card is a debitcum- ATM card providing its customers with the convenience of acceptance at merchant establishments and cash withdrawals at ATMs

• Internet Banking is offered free of cost.

• Anywhere Banking enables the customer to bank at any of their branches across India. This too is offered at no additional cost.

Cards offered by ICICI Bank

• Credit Card

• Debit cum ATM Card

Internet banking

• First bank in India to launch a website-– 1996

• First bank in India to launch Internet banking-– 1997 through www.icicibank.com

• First bank in India to launch online bill payment-– 1999

• Only bank in India with million online customers

• Monthly average transactions per online customer-7

ICICI Bank Demat Services boasts of an ever-growing customer base of over 4 lakh account holders. This bank offers various innovative products in their endeavor to offer best of the class services to their customers.

HSBC Bank

The HSBC Group is one of the world's largest multinational banking and financial services organizations, with major commercial and investment banking and insurance businesses in Europe, the Asia-Pacific region, the Americas, the Middle East and Africa. The group's name is derived from one of its founder members, the Hong Kong and Shanghai Banking Corporation Limited, which was established in Hong Kong and Shanghai in 1865. The HSBC group, headquartered in London, has more than 5,000 offices in 80 countries and territories.

Retail banking and innovations

HSBC Bank offers a wide range of financial products and services, from current and savings account to term deposits, automobile and home loans, mutual funds, loans against shares, gold and silver, Master and Visa credit/debit cards. HSBC provides latest self-service banking technology including Automated Teller Machines (ATM) in each branch and at off-branch locations and 24 hours telephone banking. They have more branches in the cities of Bangalore, Kolkata, Gurgaon, Hyderabad, Mumbai, New Delhi, Trivandrum, Cochin and Visakhapatnam. Innovative products like Smart Money Accounts have been introduced in India. (A product for 400 days with many add-on facilities).

Corporate banking

Being a multinational organization, HSBC Bank stands for fostering longterm relationships with corporate clients based on its global connections and extensive knowledge of Asian business. The bank provides services including working capital, term finance, syndications, import and export finance.

Treasury

HSBC has five dealing rooms in India linked to its Mumbai treasury. Through one of the most advanced systems, it provides a comprehensive range of services to clients, including foreign exchange, money markets and financial instruments. HSBC's treasury is open until midnight in both Europe and North America on a real-time basis.

Investment banking

HSBC investment banking is a trade name for merchant banking, stock broking and fund management activities of the HSBC group.

HSBC securities and capital markets limited, headquartered in Mumbai, are considered as specialists in research and distribution of Indian securities to both Indian and international institutions. It has a seat on the National Stock Exchange of India, as well as on the exchange in New Delhi and Mumbai.

State Bank of India (SBI)

The State Bank of India (SBI) was constituted on July 1, 1955. SBI in its drive for deployment of ATMs has put in place a record number of over 2,000 ATMs— the largest number of installed ATMs in the country. It is worth nothing that SBI did so much expansion work in last five years by opening ATMs everywhere in a record time.

SBI has also taken this 24-hour userfriendly banking channel all over the country—from metros to small towns to remote places. The big gainer in this drive is the customer in small places and remote corners—the latest technology is now made available to each and everyone.

Innovation through networked ATMs

SBI realized the need for more ATMs by the end of 1990s. In order to retain the Innovations in Banking 78
Chartered Financial Analyst
December 2005 customers, the bank started implementing its ATM Networking Project in 2001 and within a short period it deployed largest number of networked ATMs. The bank has procured state-of-the-art Compaq's Tandem Switch and ACI's Base24 software which enables them to scale up to meet the growing requirement.

Innovation-depository participant services and dematerialization

Depository is an organization, which holds customers' securities in the form of electronic book entries. This is being done at the request of shareholders through a Depository Participant (DP). An investor has to open an account with the DP, if he/ she wants to avail the services of depository. A depository can transfer securities as per the investor's instructions (without actually handling securities), through the electronic mode. The DP maintains the account balances of securities bought and sold by the investor from time to time. The DP also gives the investor a statement of holdings, which is similar to a passbook given to an SB account holder. SBI introduced this facility immediately after the launch of electronic trading in securities.

Dematerialization is the process by which an investor gets his physical certificates converted into electronic form into his account with the DP. The customer has to fill in a Dematerialization Request Form available with his DP and submit his share certificates along with the above form. If one wishes to convert his electronic shares back to physical shares at a later stage, he/she can still do so by applying for rematerial-ization through a request form available with his/her DP.

Innovation -Internet banking

The Internet banking service of the State Bank is being offered through the website www.onlinesbi.com. Through www.onlinesbi.com one can:

• Access information about transactions and balance status

• Request for transfer of funds • Ask for issue of cheque books

• Give instruction for stop payment of cheque

• Request for issue of drafts from the funds in account

• Request for issue and renewal of Term Deposits

• Issue standing instructions.

Portfolio management services

State Bank of India has set up Portfolio Management Services (PMS) section to handle investment-related concerns of institutional investors.

The PMS forms part of the Integrated Treasury Department of State Bank of India, and is based at Mumbai. The officers of the PMS section are highly experienced officers of State Bank, who have in-depth knowledge to handle large investment portfolios.

Innovation through STEPS

State Bank Electronic Payment System (STEPS) is a highly innovative and effective payment solution developed and implemented by the State Bank of India in selected Fully Computerized Branches (FCBs). STEPS provides an end-to-end Electronics Funds Transfer (EFT) with speed and efficiency. STEPS facilitates credit of funds to the beneficiary's account at the other branch on the next day.

Conclusion

Getting global through innovations

Globalization of Indian economy has resulted into modernization and innovations in banks in India. The importance of sophisticated or high technology for improving the customer service, productivity, and operational efficiency of banks is well-recognized. As a part of their action plans, banks in India have introduced many new techniques and also a considerable degree of mechanization and computerization in their operations. Banks have set up exclusive data communication network for themselves known as BANKNET. For this, the RBI and 36 other banks have become members of the Society for Worldwide Interbank Financial Telecommunications (SWIFT) and have installed the SWIFT Regional Processor at Bombay. Through this network, any bank will be able to establish connection with its own offices and with any other banks/offices/computers in the national and international network.

Another change taking place is the use of alternatives to cash by most of the constituents of banks. The large scale use of cards for settlement of financial transactions—whether credit cards or debit cards or even the new smart cards —proves beyond doubt that cash is slowly losing the prominence of the yesteryears. Banks are quickly adapting to provide non-cash-based services. Transactions through the automated teller machines or through electronic mode are gaining importance.

Asset Reconstruction Companies (ARCs) : Cure for NPAs

ARCs are still at a nascent stage of development and market dynamics is likely to change with the entry of new players.

It has been observed that high levels of Non-Performing Assets (NPAs) in the banking system can adversely affect economy in many ways such as, financial crisis, under-utilization of the productive resources, and deteriorating the investment climate in the country. Many nations have started Asset Reconstruction Companies (ARCs) to solve the problem of bad loans only after experiencing a financial crisis. However, the Government of India has proactively taken steps to clean up bad loans in the banking system even before NPAs have become a burden on the financial system.

The primary objective of ARCs is rapid disposal of bad assets owned by banks to cleanup their balance sheets. With quick resolution process of NPAs, banks can concentrate on core business activities and other business opportunities. In 2004, Gross NPAs pegged at 90,000 crores, representing about 9% of the total advances, and net NPAs at 5% of the total advances. A large chunk of bad assets are from the industrial sector. Resolution of these assets would largely be through operation of the industrial assets over an extended time frame. These assets requires in-depth skills for operational and financial restructuring for the speedy resolution process. However, India is better positioned in comparison with its Asian peers.

ARCs are a product of the Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI Act). The act provides full right to the lenders to acquire the assets without any judicial intervention. Banks are the major beneficiaries of the resolution of NPAs as multiple costs are associated with keeping NPAs for a longtime. Estimates show that the holding cost of NPAs is at 8.1% annually, and it can dent net profits of banks at 22% annually. Apart from the above quantitative factors there are also opportunity loss of interest-rate spread, impact on the credit rating resulting from the poor performance, diminishing ability to raise capital, and distract the core banking activities. The resolution of bad assets at early stages would enhance the recovery as value decreases with the passage of time. Also, it can protect the intangible assets such as brand, human resources, and distribution network to enhance the realization.

For the past few years, economy is growing at a healthy rate and NPA levels in the Indian banking are declining. Even they represent lower proportions of the bank assets, only 16% of the bad loans are transferred to ARC. Banks may have some reservations in moving the bad loans to ARCs due to the lower valuation than what they can show by keeping in their books. But the magnitude of NPAs is very large to deal with them, and they lose value of 20-30% every year. Ultimately, to deal with the bad loans, either they have to start separate departments within banks or outsource loan resolution process to ARCs. Ample opportunities are available for them in NPA portfolio of corporate loans, SME (Small and Medium Enterprises), and retail loans. Industry experts opine that, the ARCs will have a role to play and the actual effectiveness will depend on whether they have the right capabilities, skills, and resources as well as the capital.

Business model

Role of ARCs is the same everywhere, i.e., acquiring the bad loans to resolve them. Unlike other Asian countries, in India, it is a purely private-enterprise model funded by a consortium of banks. ARCs acquire the assets through trusts set up by them. Valuation of these assets depends on many factors such as, nature of the assets that lender has over the borrower's assets, value that can be realized from the security, and time taken to liquidate the assets. Trust raises the resources through the issue of Security Receipts (SRs) to eligible investors and money realized through the issue of Security Receipts is utilized towards the payment of purchase consideration to the bank or FI. SRs represent undivided rights, title, and interest of the investors on the financial assets held in the fund floated by the Trust. SRs can only be converted out of the realization from financial assets held under the Trust, and they carry no fixed returns. SRs may also be sold in the secondary market. The domestic investor, thus, has the twin-advantage of higher returns and diversified risk.

ARC led resolution approach, which is followed by the private-sector model, has a few merits in terms of engaging the borrower appropriately for resolution and establishing the accurate data. In the process, ARCs acquire/develop the resolution skills. Hence, these developments results in the enhancement of market liquidity and the availability of information. Resolution framework followed by the ARCs depends upon the management quality and the industry viability of the acquired asset. They follow the settlement, restructuring, sale of business or M&A, and strip-sale of assets routes depending on the prevailing conditions. Corporate Debt Restructuring (CDR) and ARCs are a double pronged strategy for the resolution of assets. CDR mechanism is effective in the early stages of the distress. In the later stages of resolution, ARCs can sell the businesses and assets of the borrower.

The role and present status of ARCs in India ARCs are organizational units created to manage and recover NPAs acquiredfrom the banking system. Thus, ARCs provide an intermediation in NPA resolution process. The role of ARCs in the NPA resolution process would be critical as the Indian banking landscape is characterized by the consortium/multiple lending, with different classes of security. This results in significant inter-creditor issues inhibiting prompt implementation of the appropriate resolution strategy, and causing loss of value. Debt aggregation from various lenders andfocused handling of the resolution process in order to quicken the realization,is the important value addition by the ARCs. We understand that three ARCs have obtained certificate of registration so far. However, Arcil is the only operational ARC till date. Arcil has completed two years of operations. It has so far acquired total dues of Rs. 16,500cr of 368 borrowers from 25 banks and financial institutions. Arcil has puton the resolution path about 40% of cases by value. NBFCs entry and their impact on ARC business model RBI Guidelines allowing the purchase/sale of NPAs amongst banks/FIs/NBFCsincreases the options available to the selling banks/ FIs. With more players onthe buyer side, it would lead to price discovery and benchmarking. However,it would not make any significant impact on the model of Arcil, which can offer both cash and SRs. In fact, one of the key advantages that the sellers would find in dealing with Arcil, would be the structuring of the purchase consideration to suit their needs, as they have an option to receive cash and obtaincle an exit or receive SRs to participate in the potential upside or a combination of both. We also believe that Arcil would be in a better position to acquire andresolve large NPAs accounts compared to the banks. This would naturally reflect in the pricing/valuations offered by ARCs. ARCs are sponsored or funded by the banks in India whereas in the other countries they are government sponsored companies. So, whatare those advantages/disadvantages that Indian companies can haveby following this mechanism? The Indian ARC model envisages market forces to consolidate and attractively package lender interests, arrange funding to provide a clean exit to the seller banks, and lend focused attention for NPA resolution. The key advantageof the Indian model is the development of a market for the NPAs, wherethe transactions can take place on a sound commercial platform, without any implicit tax on the system or on the exchequer. FDI/FII participation and impact In order to give a clean exit to banks/FIs from NPAs, attracting new investment is critical. ARCs may require over Rs. 20,000 cr for this.The domestic market has no appetite for such an investment considering the risk associated with it and the resultant capital requirements.FIIs specialized in distressed debt would be the primary source of such new funding. Government and the regulators are examining this issue. Fiscal incentives and taxing issues The government may consider 'tax-exempt' status to the trusts set up by the ARCs for acquisition, management, and resolution of NPAs similar to the Mutual Funds as the Trusts set up by the ARCs are 'pass through' in natureakin to mutual funds. Secondly, there is a need to reduce stamp duty and registration charges on the transfer of financial assets from banks/ FIs to ARCs to notional levels considering the nature of underlying transaction. While several large states such as Maharashtra, Gujarat, and Tamil Nadu have implemented the reduction, the other States need to take a cue from these states and implement the reduction. Major factors in the successful functioning of ARCs ARCs are adequately empowered to resolve the NPAs. As mentioned earlier, ensuring the participation of FIIs, which would bring in new money, and providing tax-exempt status to the Trust SPVs of ARCs, would reduce theintermediation costs further. The banks/FIs need to accelerate the sale ofNPAs to ARCs, thereby converting their illiquid, capital-consuming NPAs tocash. Lessons from the global experiences of selling bad loans ARCs need to provide an early exit to the banks from NPAs. They also have to focus on the acceleration and maximization of recoveries through the resolution of NPAs, thereby improving the efficiency of capital in both real and financialsectors. Future of ARCs As mentioned earlier, the Indian ARC model has been founded upon soundbusiness platform, where willing buyer and willing seller participate on anarms-length basis. Participation of several players is desirable as it provides price and performance benchmarking, bringing in market efficiencies critical for the development of a vibrant market for NPAs.

Critical success factors

As ARCs are a risky business to operate, the critical success factors in the wellfunctioning of ARCs are different from the other businesses. The foremost factor is quality of the team and the resources available with them. People with right experience and maturity, technical skills as well as other soft-skills such as, negotiating and dealing with the complex situations in a multi-lender situation, are much needed in the resolution. Having the ability to work with the legal system always proves to be a principle factor in achieving the success. The second part is the availability of capital, as the availability of capital in the system often makes crucial difference in many businesses.

NPA financing is a highly risky business and in India, it is further compounded by the absence of a market for the NPAs and benchmarks. The sustainability of ARCs depends upon their ability to attract the capital. Also, patience is needed, as resolution process takes a longer time in the case of really bad assets. Above all these, positioning is yet another differentiating factor as new markets are developing in NPA portfolio such as consumer loans.

ARCIL – Buying NPAs (in crores)
Bank/FI	Total Dues	Acquisition Price	Principal Debt	No. of Cases
ICICI Bank	9,028	2,395	4,529	136
State Bank of India	2,634	428	1,402	189
IDBI	1,334	349	497	20
IFCI	1,144	172	348	9
Punjab National Bank	842	54	371	40
Bank of India	431	78	199	7
Canara Bank	192	14	73	6
Exim Bank	155	105	138	4
Others	4,208	119	387	72
Total	16,492	3,714	7,944	483
Source: ARCIL

Issues hindering growth

Investments are needed to set up ARCs, and domestic players alone can't meet the capital requirements. Going by this, government is in the process of opening the sector for FDI. There are two levels of FDI; one at the share-capital level and the other at security receipts level. It will be more difficult for foreign players if investments in SRs are restricted to 49% than at the share capital level because investors need more liberal environment in case of troubled NPAs. Allowing FDI into ARCs can be a lesson for India to learn from the global experience. There is another route now, in which RBI is allowing banks and NBFCs to buy and sell loans. Besides NBFCs, foreign banks such as, Deutsche Bank, Bank of America, and Barclays Bank are also eyeing the NPAs in India. Alongside, the industry is seeking incentives from the government. ARCs are urging the government to tax them on par with the mutual funds because incomes generated by the trust are subject to taxation. They want exemption from the taxing on the trust which is working to resolve the particular barrower's bad loans. So far, ARCs are operating around the recover- able trusts, which are dissolved after the completion of specified task, to avoid double taxation. Also, there is a need for reducing the stamp duty in certain states to quicken the process of transferring the assets to ARCs. Bankers opine that being "such a risky business, it takes time to book profits and enhance the revenues. Tax exemptions, holidays, and avoidance of double tax—all these are quite relevant and most appropriate for the progression of industry".

Future outlook

As of now, RBI has issued licenses to three more companies, and some NBFCs are also readying to enter the business. Competition is likely to grow with the entry of new players into ARC business. These developments are expected to bring more transparency and better valuation of bad loans in future. Arcil, the only player in the asset reconstruction business in India, is not able to acquire 100% of the bad assets, as members of the consortia of lenders are not willing to sell the NPAs because of the low valuation at which the assets are being sold. So, benchmark for valuations should evolve. RBI has now allowed NBFCs to get into asset reconstruction business. NBFCs are willing to pay cash on bad loans instead of Security Receipts issued by the Arcil. According to industry sources, "it won't impact the existing business model of the ARCs in issuing the SRs, as Arcil can follow the same model of paying cash." With the Basel-II norms and the RBI regulations coming into force, it would be difficult for the weaker banks to keep bad loans. Hence, they would be forced to sell off bad assets to ARCs. With weak capital base and low provisioning coverage, they prefer to keep them in their books than with Arcil. ARCs have an edge over the commercial banks in selling NPAs because, according to the RBI norms, banks cannot sell them until they remained as an NPA for at least two years whereas ARCs can sell them at any time.

After the hesitant start of ARCs two years ago, market for the distressed loans is likely to pick-up in the coming years with the implementation of more stringent norms for the banks holding on to the NPAs, and more players entering into ARC business, which has the potential of $20-25 bn of bad loans. An industry expert opines that, "At this juncture, it is unfair to say that India is lacking in following the global best practices because the experiences are not enough and there have been not enough players in the market". Industry players are hoping that the entry of more focused players will bring better valuations and market development for NPAs. A lot of foreign funds are hoping that regulatory framework will permit them to participate soon. However, it is not an easy task to bring the adequate investments into ARCs, until government provide conducive environment.

FDI - India vs. China

With the rapidly changing world economy, every country around the globe is trying to integrate its economy with rest of the world. This process is known as globalization. Globalization, as a process of integration of economies around the globe, usually goes through various ways and one such visible way is the inflow of Foreign Direct Investment (FDI). In recent times, FDI has emerged as a buzzword in international business and has received substantial consideration in the policy analysis circles. It represents long-term movement of capital in and out of a country with the purpose of buying physical assets to start a business. It specifies the transfer of a package of resources across the countries, which not only includes capital, but also technology, management, and marketing expertise. Although the process of FDI is a universal phenomenon, the developing countries, however, have strived hard to attract more of it to fill the resource gaps for their economic development.

The global FDI inflows have been on an increasing trend and have increased from a low of US$ 209 bn in 1995 to US$ 612 bn in 2005. Though the major share of FDI inflows was always into developed countries, but an important feature was that all developing regions including Africa lately saw an increase in inflows. Among the individual countries, China has been particularly active and successful in attracting large FDI inflows since the beginning of its economic reforms in 1979. On the contrary, India has been successful in attracting large inflows of FDI, though at a slower rate in comparison to China, since the reforms that began in 1990. One of the most visible reasons for China having an upper hand in attracting FDI is that the country started its reform process much earlier than India. During the beginning of 1990s, India had only US$0.097 bn FDI inflows while China had US$3.5 bn and the ratio of FDI inflows between the two countries was about 36:1. Both the Asian neighbors were progressing at a faster rate during the 1990s for attracting more and more FDI inflows into the economy. In the turn of the century, China attracted an amount of US$40.7 bn FDI, while India attracted US$2.3 bn only but substantially high in comparison to its earlier period. The increase in the FDI inflows led to the decline of FDI ratio between the countries to about 17:4. At present, China's FDI inflows have increased to US$62 bn, while India's FDI inflows are in the region of US$6 bn and have, in the process, contributed to the decline of the ratio between the two countries to 10:3. It is predicted that if this declining ratio continues, India can level its FDI inflows with China within a couple of years. But the question is why is China very successful in attracting FDI inflows and how can India level its position with China?

There are large numbers of factors that affect the substantial inflows of FDI into Chinese economy and can be roughly grouped under three broad heads: Economic structure, open economic policies and cultural and legal environment. Under economic structure, China is very successful for its market potentiality. As we know, market size is considerably an important factor in attracting more FDI from Europe and USA. In fact, many MNCs of USA and Europe have been India can attract more FDI and can compete with China, if it can create a favorable environment similar to that of China. – Rudra Prakash Pradhan Faculty, Economics and Finance Group, Birla Institute of Technology and Science (BITS), Pilani, Rajasthan. Chartered Financial Analyst
December 2005
13 The FDI Inflows: China vs. India setting up their factories in China with the aim of producing goods for domestic market. Another factor that is favorable for China's FDI inflows is its cheap, skilled labor force. The low wage costs appear to have played a significant role in attracting export-oriented FDI to China and in the distribution of FDI flows across its provinces. This has contributed to China's rapid emergence as an important global competitor in laborintensive manufacturing. Empirical studies have already confirmed that a region with more developed infrastructure tends to receive more FDI. China is no exception to it and is successfully attracting more FDI inflows because of its excellent infrastructure. If we look into the Chinese economy, the FDI inflows are substantially high in eastern coastal-China because of this region's superior infrastructure and transport links to external markets. Taking the advantage of positive impact of infrastructure on FDI inflows, China classified its economy into certain special economic zones as per the availability of infrastructure and made the local governments to put an effort to upgrade the infrastructure in order to attract more FDI. China is substantially advanced in transport, electricity, gas, water, posts and telecommunication, which all have a positive impact on FDI inflows.

China has strong scale effects. It suggests that once a province has attracted a critical mass of FDI, it finds easier to attract more. This is because foreign investors perceive the presence of other foreign investors as a positive signal. Additionally, economies of scale make it more efficient for MNCs to locate in the same area, allowing them to share information and facilities (like education and health) for expatriate workers. The coastal provinces of China particularly the southern provinces of Guangdong and Fujian, which are close to Hong Kong SAR and Taiwan, have been the largest recipient of FDI and have acquired an important advantage over the inland provinces in attracting FDI over the past two decades.

The open door policies of China towards attracting FDI are very encouraging. Since the beginning of reform process, Chinese government fixed the goal of attracting FDI inflows into its economy, expecting that it would introduce new technologies and capital that would be helpful to develop its export sector. China's open door policy for attracting FDI follows relaxation in governmental controls and provides practical assistance along with political and legal assurances. It also follows with tax concessions and special privileges for foreign investors and the establishment of Open Economic Zones (OEZs). The tax incentives for Foreign- Found Enterprises (FFEs) are mostly in the form of reduced enterprise income tax rates and tax holidays. These are available to all FFEs as well as domestic firms in the OEZs and to export-oriented and advanced-technology FFEs outside the OEZs. The firms in the OEZs enjoy great autonomy in managing their operations. They face minimal controls on the movements of goods and are allowed to export and import almost freely. These firms also benefit from more flexible labor relations and more land use rights. For export- oriented and advanced-technology FFEs, there is tax exemption on profit remittances and additional tax benefits for reinvested profits and larger reductions in land use fees. OEZs have played a central role in the gradual opening of economy to foreign investors. The local authorities in the OEZs are solely responsible for infrastructural development and other investment as long as they could raise the funds from taxation, from profits of the enterprise they wholly or partly own, or from banks in the zones. The foreign enterprises are allowed to access foreign exchange and domestics market.

The inflow of FDI is also significantly affected by culture, corruption, and legal environment. It is often argued that the unique phenomenon of a large Chinese Diaspora has been the key to China's success in attracting FDI. The fact that Hong Kong SAR, Singapore and Taiwan Province of China together account for more than half of FDI inflows into China is usually used to support this argument. Simultaneously, it is also indicated that the large share of non-resident Chinese in FDI flows into China is a reflection of distortions rather than a unique advantage. Cultural barriers such as language that deter foreign investors from entering China could be a sign that the investment climate is difficult for outsiders, which implies a cost, not an advantage. Also, Chinese law is ambiguous and legal disputes are often settled through personal contracts rather than formal contracts enforceable in the courts. The ambiguity in the law has, in turn, contributed to corruption. China scores relatively poor on corruption and governance indicators in international comparisons, which is measured through Transparency International Corruption Perceptions Index.

In brief, the Chinese success in attracting FDI inflows has been primarily due to its large special economic zones as well as the availability of adequate infrastructure, highly streamlined administration, cheap yet skilled labor force, flexible labor laws, low corruption, strong legal environment, better bureaucratic delivery system, and favorable regulatory and tax treatment to foreign firms. In this range, the position of India is comparatively low and that leads to low FDI inflows into the Indian economy. India can attract more FDI and can compete with China, if it can create a favorable environment similar to that of China. Institutional reforms in a more accountable and transparent way, are imperative for the country. It calls for the creation of special economic zones, improvement in infrastructure, policy stability, introduction of labor reforms, establishment of a strong legal environment, streamlining of the bureaucracy, and the elimination of corruption. It should not be a daunting task, if there is adequate political will with respect to the economy.

Equity is everywhere: debt is nowhere

Below mentioned views are of the mine. Please comment if you feel like.

Equity is everywhere: debt is nowhere

I wonder why suddenly with the boom in stocks everybody is running towards stock market ? whats reason? everyone wants to make money... but then what about safety. Is there always a proper combination of Risk & Return for every investor, small or big. If not, then why everybody runs to stock market without even knowing whats the reason behind boom, why ABC Ltd. company's stock has doubled in last 10 days or why XYZ Ltd is suddenly at all time high.

Not every company is fundamentally strong then why most of them see the highs in prices & that too every other day?

Mr. A won't spend 100 Rs. without having a good value for money... he won't buy a pen worth 20 rs. in 25 rs. 'cuz Mr. A wants value for money but why Mr A. is still ready to buy a stock (a share in the company's ownership) in 100 rs. without knowing whats the underlying asset value or i should say just because someone told him that price will rise.

The boom has given many, alot to cheer about but the same boom has given many restless nights also. The reason why people run to equities in booming market is very simple.. they want to make money & they have heard the inflated success stories but they have ignored the failures of many. Famous Investor Warren Buffet suggests that buying a stock is just like buying an asset & one must compare the price with value of stock.. irrespective of what his future expectations are. If one invests this way... probably of failure is less. but still people go their own way..

why ?

I believe one of the very important reasons is lower interest rates & high inflation. If you see the kind of interest rates one gets in saving accounts now a days with the bank.. i think the interest rates would hardly cover the inflation factor over a period of 4-5 years. so the saving one makes seems to have stop growing or sometimes the value starts declining also.

Another reason could be timings of Investment & Cash Flows. some of the Government schemes offer greater returns than Saving Accounts but then again the problem is the long investment periods like 4-5 years or sometimes 8-10 years. One may not always be willing to invest for such a long time.. specially the middle income group which normally doesn't have much surplus funds to use when needed urgently. About the Companies debentures also.. well companies do not normally come out with debt issues in booming equity markets, simply because they know.. most of the investors will turn their backs to debt at that time. so companies prefer to come out with Public issues & normally shares are issued at a much higher price than the fair value. The pity is that investors who keep a check on company's future expectations when applying for debt issues normally invest in shares blindly when they see market going up daily.

All in one is that most of the investors, specially retail investors, do not invest by the fundamentals of the company. It was clearly proved when a share had seen a surge in prices just becuz the company's name would be changed from ABC LTD to ABC INFOTECH LTD or something similar, during IT boom

so in short a boom creates a Risk-Return imbalance in the market for small investors & sometimes for very big investors also. One must walk with care & not invest just because the broker called up to say, "sir !! xyz share is 10 rs. up since morning.. & its 75 rs. up frm last month."

Remember - Booming stock market is the time to sell & not the time to buy, if you can't decide upon the fundamentals.

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Sumit K. Gupta
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End Of The Road For Google?

End Of The Road For Google?

Since its IPO in August 2004 Google (GOOG) has long been a market darling, continually beating market estimates and providing investors with stellar returns. It was priced for perfection, trading at triple digit multiples, with the future being seen as nothing but bright. It was this perfection that set the company up for a large fall if it could not meet these lofty expectations. Well January 31, 2006 was the day that Google did not perform to perfection, at least in the eyes of investors, who sent the price of shares down nearly 12% in after-hours trading. Let's take a look at Google's fourth quarter results to get an idea of how bad the miss was.

Google reported earnings of $1.54 per share on a non-GAAP basis compared to market expectations of $1.76 per share. The company reported GAAP net income of $1.22 but eliminated charges that arouse from stock-based compensation, a charitable donation, and a charge from in-process research and development to arrive at the $1.54 reported EPS number. This was the first time that Google missed expectations since the company went public.

The company blamed an unexpected hike in their effective tax rate, which rose from 30% to 41.6%, as the main cause of the earnings miss. The rate increase stemmed from an unexpectedly large international expense which allocated more income to the U.S. side of the business, one which faces a higher tax rate. The company expects that the overall tax rate for 2006 to be 30%.

If you forget the tax rate increase the performance at Google remained relatively strong as revenues at the company grew 86% to $1.919B in the fourth quarter compared to $1.032B in the same quarter in 2004. GAAP net income for the quarter was $372M which was an increase of 82% compared to net income of $204M in the fourth quarter of 2004. However there are signs of a slow down in growth, proving that Google can't avoid the restrictions of the growth curve (sort of like avoiding the laws of gravity). Revenue grew 22% from Q3 to Q4 in 2005, lower than the 28% growth achieved between Q3 and Q4 in 2004.

So is the party over at Google? Is it time to sell? These are highly contested issues, where there exists two well defined camps, Google bears and Google bulls. However, I am going to set up shop on the sidelines for now. The reason for this is I like the future of Google's business and the internet ad space but I do not feel as strongly about the valuations the company currently sports and the return potential.

While the valuations of the company are relatively high and it is futile to predict short-term price movements, I will not be shorting shares in Google anytime soon however. The reason for this is that the company remains the best online search tool in the market making it attractive to advertisers who are increasingly embracing online advertising, seemingly recognizing that it is an inevitable evolutionary step. Revenue and income growth while expected to slow over time continues to grow at rapid rates, which will likely provide the company will healthy growth for the foreseeable future. The company continues to add features that both attract additional viewers and add new revenue streams. One such feature is the addition of searchable content which allows users to download TV broadcasts for a small fee. For example you can go to Google Video and download the entire LA Lakers game in which Kobe scored 81 points for $3.95.

There is no question that this was a disappointing quarter for investors but in my opinion it is not an end of the world quarter. The company remains strong and so does its growth potential for the future. The fact is however, much of this supersized future growth is already priced into the shares, leaving investors with little, if any, margin of safety. The lack of margin of safety will likely lead to a lot more volatility in GOOG shares.

This is not the end of the road for Google but it may be the start of a lot bumpier one.

Source: Misc. Online Contents

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Sumit K. Gupta
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Value Investing

The stock market has seen its fair share of fortunes built from keen value investors who make timely purchases of undervalued stocks. Entire companies, such as Warren Buffett's Berkshire Hathaway have been fueled by such successful value plays. Buffett's major investment in American Express, made at time in the 1960s when the Salad Oil Scandal was spiraling AXP shares down to extreme lows, catapulted his company and shareholders on to great successes.

It comes as no surprise then that scores of investors seek to replicate those successes by hunting for the next undervalued stock destined to turn around and beat the market in the long run. Probably more than a few of these "value investors" had their interest piqued when troubled auto manufacturer Ford Motor Corporation's (F ) CEO, William Clay Ford, Jr. detailed his outlook for the company's turnaround prospects in a recent interview with Business Week.

But what makes a stock a good value play? Obviously, one of the first things most investors look for is a low share price, P/E ratio or similar metric compared to the company's historical range. Taking a quick look at Ford's price performance over the last five years, we see it's settling down into a long-term low.

If one wants to follow Buffett's strategy of buying at low, undervalued prices, we can see that Ford is currently giving us a price not seen in five years. In fact, the company's stock is dangerously close to hitting a 20-year low. Looks like a good opportunity, right? The only trouble is, simply comparing a company's current price to historic valuations doesn't tell us the whole story.

In fact, for an investment in F shares to become an A+ for our portfolio, the company will need to overcome some serious challenges before it has a chance of winning back the market's affection. For starters, growth in auto sales would be nice to see. And I'm not talking about stratospheric growth on par with the likes of Google or Yahoo!, I'm only asking for positive growth. I say this because, as of their last 10-K filing, Ford was able to ring in a total of 17.3 million automobile sales in 2004, about 500,000 less than the 17.8 million sales they registered way back in 2000.

On top this, as a company Ford has been suffered a net operating loss from their automotive production unit for every single year since 2001. And yes, industry conditions are part of the problem, but competitors like Toyota Motor (TM ) have been able to steadily increase their operating profits during this time.

Meanwhile, Ford's financing division has been the only thing keeping it in the black the last few years, and trying to improve the company's automotive division seems like an almost impossible task. Recent attempts such as offering employee-only prices to all consumers, a strategy also employed by troubled automaker General Motors Corporation, have cleared out some surplus inventory but done little to improve bottom line profits.

Analysis of why this discrepancy of performance exists between Ford and its competitors could easily turn into a full-blown report, but at the end of the day the bottom line is rather simple. As an auto company, Ford can't compete well enough in its market to provide a good expected return for its stockholders.

It quickly becomes obvious to us as investors that the odds of a near-term Ford comeback are pretty slim, and we begin to the realize that the old "turn-arounds seldom turn" cliché popularized by guys like Warren Buffett is a cliché for a reason – it's true. Even though Ford's trading at very low historical levels, it might still be overpriced.

When it comes to making value stock picks, simply buying up stocks that are trading low prices, P/E ratios or similar metrics just isn't going to cut it. Successful value investors are able to pick out stocks that are not only cheap, but also belong to good companies that will generate reasonable growth over time. This isn't easy, but it can be done.

One of our Core Holdings, Iron Mountain, Inc, is a prime example – the company consistently produces strong, recurring revenues, enjoys a wide economic moat and significant pricing power in its market. Since our selection of IRM for our portfolio this past July, the stock has appreciated over 35%, and that return sure is much more of an A+ for our portfolio than an investment in F shares would have been.

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Sumit K. Gupta