Markets – On the Roller Coaster

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The excessive market euphoria that was apparent in the beginning of the month has faded and has given way to apprehensions for investors worldwide.

Even as the markets seemed to recover from the concerns over Cyprus bank run, tagging it a one off event, the news of political turmoil in Italy shook the European stock markets. Greece’s ATHEX Composite was off 4.8%. US indexes opened in red today. This certainly signals nervousness and dampened sentiments of investors. The Asian markets will also be impacted negatively.

Bank deposits that were so far considered as safe investment options, no longer seem to be safe after the Cyprus government decided to levy taxes on deposits, in a bid to secure bailout package from the European Union. The banks have remained closed for about a week and are likely to reopen with the imposition of capital controls by Cypriot authorities.

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Global Markets – Riding high on sentiments

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Worldwide markets are echoing bullish sentiments.

The US Dow Jones Industrial Average index has surpassed its 2007 high and continues to make new all-time highs. The Standard & Poor’s 500 Index too is trading at post-2007 highs. Asian & European markets are rallying too based on cues from the US market. Indian markets are recovering from February lows.

All this barely a week after the US sequestration set in on March 1, 2013!!

The bullish markets have revived positive sentiments and created excitement, but it also warrants cautiousness.

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Market Reaction to new CEO announcement

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On 21st Nov, Indian generic drug maker Cipla Ltd. announced its plans to acquire South African firm  Cipla Medpro. Subsequent to the announcement that is likely to boost its prospects in Africa, and is expected to be accretive to earning, Cipla Ltd. shares rose by more than 3 % after the announcement and were trading at Rs 390 on NSE.

On 22nd Nov, Cipla Ltd announced the appointment of Mr. Subhanu Saxena as Chief Executive Officer. Mr. Saxena has rich work experience of over 25 years, in industries as varied as FMCG, consulting, banking and pharmaceuticals. Following the announcement of the appointment of new CEO, Cipla share fell down during the day while the NIFTY index showed a upward movement. Cipla share price clearly did not follow the pattern in sync with the movement of NIFTY.

 

This weak movement of the share price on 22nd Nov could have something to do with the announcement of new CEO appointment. Generally some market reaction is expected around the announcement day of a CEO appointment. In considering CEO candidates, boards of directors and selection committees are almost always concerned about the market reaction on the company’s share price.

 

At times markets tend to react unfavourably to the announcement of a new CEO, as investors may anticipate some amount of uncertainty involved with the change in CEO. There are other instances when there have been positive abnormal returns around the announcement of an outside CEO appointment. In such cases, results suggest that new outsider CEO appointments can be considered as beneficial to investors because they bring in knowledge from other organizations and can objectively evaluate and challenge the current strategy of the company and incorporate new and fresh ideas.

Though the initial market reaction is in anticipation of  the CEO’s likelihood of success, however a  latest research by HBR shows that there is no positive correlation between how a company’s stock fares upon the announcement of a new CEO and the share price over that CEO’s tenure so the initial market reaction should not be considered an indicator of the CEO’s likely performance.

Irrespective of the initial market reaction, it will only be evident over a period of time how the new CEO steers the Cipla towards higher levels of growth and creates value for the shareholders.

 

Impact of policy environment on funding start-ups in India

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Funding has always been the biggest challenge that every venture has to face. Particularly the technology and knowledge based start-up enterprises that are based on intangible assets such as human capital and an entrepreneurial idea. In absence of physical assets, such start-ups find it difficult to secure bank financing and they need to approach equity financiers such as angel investors or VCs. Mostly start-ups do not even have access to working capital loans; though some finance companies offer collateral-free working capital loans to small enterprises with at least three years of operations.

Like any other investment, the investment in start-ups is influenced by the policy environment prevailing in the country. The current policy environment in India is reasonably conducive for start ups, but still leaves a lot more to be desired. Domestic money to VC/PE funds are either restricted or prohibited in current regulatory framework. For example SEBI regulations for Domestic Venture Capital Funds do not permit registration of a fund which would have corpus of less than Rs.5 crore ($ 1 million). This makes it difficult for angel groups and seed funds to get registered and raise funds. Pension funds, which are the biggest source of money worldwide, are not allowed to invest in VC/PE funds. Insurance companies are allowed to invest in infrastructure funds only; even banks’ exposure to VC/PE funds is severally controlled.

The National Innovation Act that proposes tax incentives for angel investors is likely to be passed by the government. The Department of Industrial Policy and Promotion (DIPP) in India also plans to incentivise venture capitalists (VC) who invest in small and medium-size enterprises (SMEs). It is anticipated that with implementation and stabilization of Goods and Services Tax (GST), the environment will be more favourable for promoting entrepreneurship and business.At present, for a business, planning to set up manufacturing units in India, the existing complex and high taxation structure consumes a large portion of the available cost arbitrage. Though the manufacturing cost of most products in India is nearly half than in the west, but due to tax levied at various stages, the cost advantage is reduced by almost 50%. The existing multi tax structures often compel manufacturers to base their inventory and distribution decisions on tax avoidance rather than on operational efficiency. The implementation of Goods and Services Tax (GST) is expected to reduce the hassles associated with the existing tax structure and facilitate investment decisions to be made purely on economic concerns, independent of tax considerations.

The policy environment in India is gradually evolving and regulations are expected to evolve in a manner that encourages more investment bringing it at par with that in the mature markets. However the timelines by which these proposed policy changes will be implemented and the overall impact on the VC community is yet to be seen.

Fall of the Rupee – Part II

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Continuing from the last post, let’s see how the price of rupee is determined vis a vis dollar.

The market determines the price of a currency vis-à-vis another based on its demand and supply.  Some countries that permit exchange rate to be determined by the market do not impose any restriction on the amount of local currency to be exchanged for foreign currency. On the other hand, countries with a nonconvertible currency policy, fix the exchange rate by diktat. The Indian rupee is fully convertible on current account but there are restrictions on convertibility on capital account. This means that though foreign exchange for trade in goods and services is determined on the basis of market demand and supply, but the government has put in some restrictions on flow of different forms of capital in & out of the country.

Some of the probable causes of the rupee’s depreciation against dollar are –

Deficits in the trade of goods and services – India reported a trade deficit equivalent to $196 billion in October 2011 as compared with $104.4 billion in March 2011. The widening trade deficit poses downside risks to the weak Indian currency. Surpluses and deficits in trade of goods and services reflect the competitiveness of a nation’s economy and impact the value of currency. The decrease in growth of exports coupled with the increase in imports has contributed to a widening deficit in trade of goods and services.

Fiscal deficits – India has been running large fiscal deficits due to dwindling growth in tax revenues, rising subsidy bill and the government’s failure to raise funds through stake sale in state-run firms. The market usually reacts negatively to widening government budget deficits the impact is reflected in the fall in the value of rupee.

Capital flight – The government has attributed the depreciation in rupee to the withdrawal of funds from India by the Foreign Institutional Investors. A number of scandals, governance deficit, policy delays and slowdown of growth in India, have seen FII’s pull funds from India.

RBI has taken short term steps to stabilize rupee by reducing banks’ forex trading limits and curbing speculative activity resulting from exporters cancelling their earlier contracts and rebooking exports to take advantage of sliding rupee, thereby fuelling depreciation. To increase the supply of dollars, RBI may announce a scheme for overseas Indians to bring in their funds, or offer higher returns to NRI’s. RBI may also sell dollars to oil management companies to prevent spikes in demand for $ due to large imports. But there are limitations in selling dollars from capital reserves as India’s foreign exchange reserves are mainly created by purchase of dollars bought in by FIIs and may be needed if FIIs choose to exit.

While RBI might not introduce capital controls to prevent outflow of dollars from the country, as it is against India’s policy of moving towards full capital convertibility, but RBI may ease rates in future to bring in liquidity. This will boost the equity market & money will flow into the country as growth picks up.

 

Fall of the Rupee

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The Indian rupee continues with its free fall against dollar having fallen up to 18% in Dec 2011 from its year’s high in July 2011. Rupee has been Asia’s worst performing currency this year.

The depreciation of rupee against dollar means that now it takes more rupees to buy a dollar; thus indicative of an increase in the demand of dollar. In absence of sufficient dollars to cater to the increased demand, there is supply-demand mismatch which causes the price of a dollar to rise against the Indian Rupee.

The impact of a depreciating currency varies across businesses. Export oriented industries such as IT services which earn revenues in $ and incur costs majorly in rupee gain from the fall in rupee. In contrast, the import oriented industries such as Oil Management Companies which import crude are negatively impacted due to fall in rupee as they end up paying much higher for the imports. Furthermore the Indian companies that have raised debts in foreign currency will have increased burden to service interest payments.

One way of reducing such losses is to hedge against currency movements. But since it is very difficult to forecast exchange rate, the risk due to sharp changes in currency rates are not completely mitigated . How much a company hedges and at what rates, is therefore based more on the risk appetite of a company rather than on the accuracy of forecasts.  Among the top 3 Indian IT firms, Infosys, is the biggest beneficiary of the current depreciation given that its hedging for $ receivables is lower than that of TCS & Wipro.

 

None the less, the sudden movement in exchange rates is discomforting for business as well as government. It becomes difficult for the government to meet its targets of fiscal deficit.

Left on the markets and the economy, exchange rate adjusts on its own and again settles to a value such that there is no arbitrage. Till the rate settles, changes in exchange rate will have large implications on the domestic prices, company’s profitability and government finances. But sometimes, these movements can be very steep and a sharp incessant fall can destabilise the economy and put government under pressure to intervene. Which is when, the Reserve Bank of India, central bank to the Government of India takes rescue measures by selling or buying dollars or other open market operations to improve dollar supplies and ease the fall of rupee.

Role of Independent board directors in Indian companies

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The probe into Satyam scam is finally over.  SEBI has barred Satyam Computer’s founder B Ramalinga Raju and four others from markets for 14 years and asked them to return Rs 1,849 crore worth of unlawful gains with interest.

Following the takeover of scam-hit firm Satyam by Tech Mahindra in 2010, Mahindras were contemplating to sue the company’s erstwhile independent directors to recover Rs 11 million paid as commission to non-executive directors during the financial year 2008-09. Each of Satyam’s former independent directors were paid a commission of Rs 12 lakh over and above sitting fees for the financial year 2008-09.

The Independent Directors of Satyam included renowned people like management guru Krishna G Palepu, Pentium chip innovator Vinod Dham, former Indian School of Business dean Prof Mendu Rammohan Rao, former cabinet secretary TR Prasad, former IIT Delhi director V S Raju and US-based academician Mangalam Srinivasan. It is ironical to note that in the presence of such eminent independent directors, the company’s founder Ramalinga Raju could manage to fudge the company’s accounts for several years.

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