The loneliness of a treasurer
Unfortunately, corporate risk management is often looked at as a 'regulatory' requirement.
To hedge or not to hedge — this is one of the important dilemmas a treasurer faces. There are many other choices to be made, and his/ her actions will be judged on all the parameters, well past the event. The treasurer, of course, has to plan whether to hedge for the short or long term and, if for the long term, for how long. He/ she must also work out the proportion of the total exposure to be hedged and the instruments for hedging.
And, after all this comes the difficult part — figuring out what the competition is up to. The 'swim together, sink together' syndrome is strong in the market, and if the industry leader is following a particular strategy then the other players are likely to follow suit. Many industries do not hedge their commodity exposures simply because no company is doing so!
The other major factor adding to the confusion in the decision-making process is the 'market view'. There is no dearth of 'expert' views on the expected currency movements, leaving the treasurer bewildered. He/ she ultimately ends up relying on instincts and hoping things work out. The reliability of market views has taken a beating in the past couple of years as the rupee lurched dangerously in both directions and touched all-time lows.
Uncertainty in the markets has led to volatility not only in the currency market, but also in the commodity and equity markets. With market uncertainty expected to continue, planning and budgeting may remain a daunting task. Different businesses have different hedging requirements based on business cycles and risk-taking capacity. A company should therefore have a well-defined approach to managing currency risk, and reduce its dependence on other 'variables' such as market views and peer strategies.
Unfortunately, corporate risk management is often looked at as a 'regulatory' requirement. The policy should be so drafted that it balances between staying conservative to ensure the company is not exposed to unwanted risk and being able to take advantage of favourable market movements. High volatility, of course, makes decision-making difficult as treasurers are unwilling to lock-in exposures at unfavourable rates in expectation of a future turnaround.
Another reason behind the hesitation to hedge future exposures is the practice of benchmarking the treasury's performance against the spot rate prevailing at the maturity of the exposure. While on one hand the treasury is expected to protect the internal budget rate and business profitability, it is also judged by the profit on the hedging decisions as compared to existing market rates. This inhibits the decision-making process, as treasurers try to juggle managing both benchmarks and staying ahead of market movements. This is highlighted in a recent survey by KPMG in India — "Managing currency and commodity risks".
It is, of course, not possible to beat the market consistently — so the tendency could be to keep a large part of the exposures un-hedged, and hedging closer to the final maturity. Most companies hesitate to hedge long-term borrowings, hoping the market will not depreciate as much as the hedging cost and they will end up with a very low cost of borrowing.
It is, therefore, the implementation of the policy that is the most important part of the risk management process — one that requires support from the top management. A greater appreciation of the risk process at the Board level, and a skilled risk specialist team would help in the implementation and regulation — thereby reducing the treasurer's dilemma.
The author is Director, KPMG in India
(This article was published on July 28, 2013)
Cyber criminals on the prowl
Cyber attackers aim at disrupting vital operations, leading to loss of not just financial resources but also customer confidence.
In today's business environment and with the global nature of supply chains, newer and creative fraud schemes are emerging each day. The perpetrators not only target organisations but also individuals. According to the KPMG India Fraud Survey Report 2012, cyber crime and intellectual property fraud, including counterfeiting and piracy, are the emerging fraud concerns.
In cyber crime, either the tool or the target is a computer or computer network. The report shows that cyber crime is fast becoming a popular means of defrauding individuals and entities. Perpetrators typically attempt to steal either money or, more seriously, sensitive data. Cyber attackers also aim at disrupting vital operations and functions, leading to loss of not just financial resources but also customer confidence and market reputation.
The report also suggests that intellectual property fraud, counterfeiting and piracy are rampant and increasing, because of the enormous profits in return for a small investment and little business risk.
Moreover, the low levels of penalty and prosecution for intellectual property fraud provide little or no deterrence against further infringements. While companies seem to be aware of piracy and counterfeiting, there is little understanding of how such practices can affect business.
Companies should therefore identify their sensitive data, classify them appropriately based on vulnerability, and put in place necessary protection measures to prevent frauds.
Fresh lease of life for lease accounting
A significant global development in accounting is a recent exposure draft from the International Financial Reporting Standards which will fundamentally change the way leases are reported. Proposing Type A and Type B leases, it does away with the concept of operating and finance leases. The classification would be based on the nature of the underlying asset and the extent to which it is consumed over the lease term. This is different from the risk and rewards approach currently followed. If the underlying asset is not property, it is a Type A lease, unless the lease term is an insignificant part of the total economic life of the asset or the current value of the lease payments is insignificant relative to the fair value of the asset. If the underlying asset is property, it is a Type B lease, unless the lease term extends over the major part of the remaining economic life of the asset or the current value of the lease payments accounts for substantially all the fair value of the underlying asset.
In a Type A lease, the lessee would recognise a lease liability, initially measured at the current value of future lease payments, as also a right of use (ROU) asset measured at cost. Subsequently, the lessee would measure the lease liability at amortised cost and the ROU asset at cost less accumulated amortisation — generally on a straight-line basis. The lessee would present amortisation of the ROU asset and interest on the lease liability as separate expenses. In a Type B lease, the lessee would follow the approach for Type A leases, except for calculating amortisation of the ROU asset as a balancing figure, such that the total lease cost would be recognised on a straight-line basis over the lease term and present the total lease cost (amortisation plus interest expense) as a single-line item.
The impact of the exposure draft would be felt across sectors. Companies that have significant assets on lease — such as airlines, retail companies and banks — would see a considerable increase in reported liabilities.
While the exposure draft seeks to increase visibility by bringing all leases on the balance sheet, it poses challenges that could force companies to rethink their leasing strategies.
(This article was published on July 28, 2013)
Taxpayers still not out of the woods
Taking cognisance of the difficulties faced by taxpayers owing to incorrect tax demands resulting from the computerisation and centralised processing of income-tax returns, the Delhi High Court in March 2013 directed the Central Board of Direct Taxes to resolve the matter.
The CBDT accordingly issued instructions aimed at speedy disposal of applications filed by taxpayers for rectifying incorrect demands (two months from receipt of application and rectifying TDS mismatches).
Though welcome, the directions need to be implemented effectively and in a time-bound manner. Especially because the onus is on the taxpayer to approach the Income-Tax Department to get his/ her records corrected, and income-tax officers still retain the authority for disposing of grievances.
Tacit warning against tax havens
Finance Act, 2011 introduced anti-avoidance measures for transactions with persons in jurisdictions not notified by the Central Government (those that do not effectively exchange information with India). The term 'person' is widely defined to include a permanent establishment of a person who otherwise is not a resident of the notified jurisdiction. The memorandum explaining Finance Bill 2011 had referred to this section as a 'toolbox of counter-measures'.
Under Section 94A of the Indian tax code, any transaction in which one of the parties is located in the notified jurisdictional area (NJA) shall be deemed international, subject to Indian transfer pricing regulations (including the onerous documentation under existing transfer pricing provisions, according to Rule 10D). Additionally, the section provides for an authorisation for payments made to financial institutions and prescribed documentation for payment to any other person.
The Central Board of Direct Taxes recently notified Rule 21AC in the Income-tax Rules, 1962, prescribing Form 10FC for furnishing the authorisation to claim deduction of payment made to a financial institution. For any other expenditure/ payment, in addition to the prescribed documentation under existing transfer pricing provisions, the following information should be maintained:
A description of the ownership structure of the specified person, and details of other entities, whether located in the notified jurisdictional area or outside, having directly or indirectly more than 10 per cent shareholding or ownership interests in the specified person;
a profile of the multinational group of which the specified person is a part, along with other details of each of the enterprises in the group with which the taxpayer has entered into a transaction, and the ownership linkage among them;
a broad description of the business of the specified person and the industry it operates in;
any other information which may be relevant for the transaction.
In a way, Section 94A authorises the Government to blacklist certain jurisdictions in order to curb transactions with them. Even though the section is effectively non-operational, as the Government has not yet notified any such jurisdiction, the CBDT has now prescribed forms and documentation. In a way, this is tacit warning from the Government to taxpayers to keep away from transacting with such jurisdictions (perceived tax havens); else they should be ready to be burdened with onerous requirements.
(This article was published on July 28, 2013)
Modi visa issue: MPs' letters to Obama 'original and authentic'
The Hindu United States has been refusing to grant visa to the Gujarat Chief Minister Narendra Modi for his alleged role in 2002 riots. File Photo.
Washington, July 28:
The controversy over Indian MPs' letters to President Barack Obama for denying visa to Narendra Modi has taken a new turn with a California-based Forensic Document Examiner certifying that the signatures of the lawmakers are "original and authentic" and not a cut and paste job as claimed.
"Using accepted principles and methods of forensic examination, it is my opinion that the Q1-Q3 (three pages of Rajya Sabha MPs' letter) document was created in a single event, and that the signatures found upon it are original/authentic wet ink signatures," said the report after a forensic examination of the letter.
A similar finding was made in respect of the letter by Lok Sabha members.
The forensic examination of the handwritings on the two letters to Obama by members of Rajya Sabha and Lok Sabha on November 26 and December 5 last year respectively, which were re-faxed to the White House on July 21, was done by Nanette M Barto, approved Forensic Document Examiner, in California.
The examination was prepared at the request of Coalition Against Genocide (CAG) campaigning against Modi after some parliamentarians, notably CPI(M) leader Sitaram Yechury, M P Achutan (CPI) and K P Ramalingam (DMK) denied having signed the letter to Obama.
CAG, a broad alliance of about 40 Indian American organisations, has been campaigning against US visa for Modi.
When contacted for reaction to the forensic examination report, Achutan maintained that he did not remember to have appended his signature to a memorandum like this.
All that he remembered was that he had signed a representation expressing anguish at the detention of Muslim youths in different parts of India, especially in northern states, by branding them as terrorists on flimsy grounds, he said.
Ramalingam said this was a privilege matter which has to be given to Chairman Hamid Ansari. "I have already said I have not signed the letter," he said.
Yechury, who had earlier said that he had not signed the letter and his purported signature on the document, was a "cut and paste job" is away in Pyongyang on a visit as part of a parliamentary delegation to North Korea. He could not be reached for his comments.
Raja Swamy of CAG claimed that the forensic examination proved that the documents "are authentic, without any cut and paste operation done on either the paper copy or the electronic version and that each of the signatures is distinct individual".
"Since the authenticity of these letters has been called into question by some members of parliament who either do not recollect or deny having signed the letters, CAG decided to engage a professional forensic examiner, to verify the authenticity of the two letters.
"The forensic examiner we engaged is Ms. Nanette Barto, a court qualified Forensic Document Examiner and Handwriting Analyst," Swamy, a CAG spokesperson, told PTI.
Notarised copies of the reports, which are admissible as evidence in a court of law, were provided to PTI by the CAG.
"To summarise, the forensic examination proves that the document is authentic, without any "cut and paste" operation done on either the paper copy or the electronic version, and that each of the signatures is from a distinct individual," Swamy said.
In her forensic report, one for each of the letters, Barto said that font, leading, and kerning are consistent between each page indicating that the document was created all at one time.
"Staples impressions are consistent with the three-page document having been stapled together at the same time. The jpeg scan was scanned in at 300 dpi and in color. Examination of the handwriting revealed that this document was the original wet ink document scanned in at a high resolution," the report said.
"Careful examination of the document blown up to 400 per cent revealed that each entry was crisp, smooth, and fluid handwriting in various color and types of inks. Natural pooling, breaking, and feathering of ink can be easily seen to support that this is a scan of an original document," it said.
"Examination for halo effects, pixel distortion, breaks in borders or baselines to determine it any alteration by way of cut and paste / computer alteration revealed no instances of these characteristics," the forensic report said.
(This article was published on July 28, 2013)
Bhagwatinomics vs Senology
Only growth and efficiency can generate the resources for tackling poverty.
The debate between professors Jagdish Bhagwati and Amartya Sen as to what exactly India's right development path is, has continued unabated.
Jagdish Bhagwati and his co-author Prof. Arvind Panagariya, in their new book, India's Tryst with Destiny, suggest that growth is critical for the generation of resources that can then be used for tackling poverty and engendering development. This is the essence of Bhagwatinomics!
Two decades ago, Bhagwati had written: "It is necessary to argue forcefully that efficiency and growth are important, indeed given our immense poverty, the most important, instruments for alleviating poverty."
Conversely, Sen, with his co-author Jean Dreze, in their new book Uncertain Glory: India and its Contradictions, strongly supports active participation by the State in the provision of healthcare, education, and the development of social and physical human capital so that there can be eradication of ill health, anomie and illiteracy. Thereby, development will occur. This is the essence of Senology!
This debate between Bhagwatinomists and Senologists is nothing new.
Bhagwati and Sen have, however, not fully dealt with all the core issues.
Caught up in articulating issues of the long past 1960s and the 1970s, a period when both Bhagwati and Sen gained fame, path-dependencies may have clouded their vision of an Indian future.
Thus, both the Bhagwatinomists and the Senologists have not addressed the most fundamental issue: Where does growth, and thereby development, actually come from?
Value of entrepreneurship
Growth and wealth creation in an economy can only be propelled by innovation and productivity. All of economic growth is endogenous.
A country's economic future lies in the hands of its entrepreneurs. Lloyd Reynolds, a generation ago, had highlighted the key role of entrepreneurial manufacturers adding value to raw materials.
Industrial manufacturing-driven resource accretions for the economy, based on value addition, have major connotations for wealth creation and poverty reduction. This is the process adopted by the industrial revolutionaries, in the 18th and 19th centuries, and in the 20th century by Japan, Taiwan, South Korea and China.
The economic historian, Thomas Ashton, in describing the industrial revolution in Britain in the 18th century had written that "the central problem of the age was how to feed and clothe and employ generations of children outnumbering by far those of any other time".
This problem was solved by wealth creation. Another economic historian, Phyllis Deane, echoed this sentiment, stating : "It is now almost an axiom of the theory of economic development that the route to affluence lies by way of an industrial revolution."
Wealth creation and poverty reduction are two sides of the same coin. Wealth creation implies a positive attitude, based on additive motivation.
Poverty reduction implies dealing with a negative condition, based on amelioration dispensation.
Industrialisation is a value-additive process preceding amelioration since it generates the resources to eventually improve the lot of people.
The late Chidambaram Subramanian had written that "there are no rewards for caution in economic development. On the contrary, the economic history of nations has nowhere recorded a penalty for boldness".
If a central concern in India is poverty reduction, then bold risk-taking by her entrepreneurs can foster development and reduce poverty.
What Can Foster Growth?
How does entrepreneur-led industrialisation based on innovation and productivity come about?
All prognostications point to three critical factors: an enabling environment, empowerment of the individual, and efficiency in the conduct of economic transactions. Let us take each. Why does an enabling environment matter? An entrepreneur investing in an activity is a person looking to mobilise resources for organising production so that there may be profitable outcomes.
Yet, in the absence of an enabling institutional environment that provides the appropriate incentives and safeguards, she will not invest. Institutions are constraints influencing social interactions and providing incentives for regular behaviour.
It is vital to get the institutions right, to create wealth. Why does empowerment of the individual matter?
All economic activity is oriented towards the one great goal of enhancing individual living standards. Even the most macro of all debates eventually deals with the issue of individuals' lives. It is the individual entrepreneur and the manufacturer who creates wealth.
To be able to do so, she must have competencies, skills, resources and motivation. She must be literate, amiable and capable.
Why does efficiency in transactions matter? Eventually, the incremental amounts needed for further and further re-deployments of assets, skills and capabilities have to be acquired from the stock of surplus economic activity. Efficiency in deals, transactions, and activities lead to the optimal utilisation of resources that then generate the amounts to be used for amelioration of poverty.
Ranking the two
It is useful to rate both Bhagwatinomics and Senology on how each approach has dealt with the three factors. I tabulate scores awarded to each approach on a scale of 1 to 5, quite arbitrarily. Then I sum up the scores and we can see which approach, Bhagwatinomics or Senology, wins. I am biased, but the reader is invited to use the framework to offer his or her rankings and insights. (See table)
As it stands, Bhagwatinomics scores 11 out of 15 and Senology scores 7 out of 15. Bhagwatinomics wins!
Paradoxically, for the political economist, a conservative programme and not a free-spending government-run approach generates the wealth that ameliorates poverty.
Bhagwatinomics is the way out if India is not to meet its destiny of remaining a Third World country in the foreseeable future.
The author is Professor, University of Texas, Dallas.
(This article was published on July 28, 2013)
Who wants to run a bank
Savers have discovered avenues other bank deposits; borrowers have learnt to game the system and regulators are turning the screws. Banking is not the business it used to be.
July 28, 2013:
Anyone watching India's large business houses jostling each other for a new banking licence would think that running a bank is a cakewalk. And it probably was, when the times were good.
You collected thousands of crores in deposits from the public, using 'safety' as your trump card. You paid the bare minimum as interest, because the depositor really had nowhere else to go. You then lent this money back to the public at stiff rates, in the form of housing, auto or personal loans, with hefty collateral.
What made this whole retail banking model quite lucrative is that you could collect deposits at fixed rates, but lend them at market rates.
You could (if you chose) lend to industrial houses too. But evaluating corporate borrowers may not always be easy. In that case, you could park your excess money in SLR (statutory liquidity ratio) securities and still earn a risk-free 8 per cent. But in the last couple of years, high inflation and the persisting economic slowdown have combined to expose the chinks in this wonderful business model.
Savers shun deposits
Retail investors, for one, have woken up to the fact that they are paying a stiff price for the apparent safety of bank deposits — the deposits don't offer interest rates that manage to beat inflation.
Savers, therefore, have been cold-shouldering deposits and turning away instead to any and every avenue that offers a better 'real' return (pun unintended) — gold coins, chit funds, even ponzi schemes.
In fact, trends in household savings in the last three years clearly show that retail savers have begun to actively switch their money between different investment avenues, based on interest rates, to earn the best returns.
Industrial borrowers, who earlier used to line up for bank loans, are no longer at the mercy of banks either.
Borrowers seek haircuts
The top-notch borrowers can easily raise foreign loans at lower costs. The more doubtful ones have the bankers jumping through hoops to recover their loans.
Companies that have binged on loans have seen a sharp erosion in their debt servicing ability in the last two years, thanks to steadily dwindling sales and sluggish profit growth. They have responded, not by cutting back on debt, but by taking on yet more debt to keep the business going.
Business Line's recent analysis of 500 leading companies with leverage showed that these companies increased their debt by 17 per cent, while their net worth grew only by 9 per cent in 2012-13. Half of these companies saw their leverage worsen, with a few sporting debt-equity ratios of over 8 times (2 is the accepted norm). Large industrial houses don't mind going overboard on borrowings, because once they manage to become a particularly large 'exposure' for the bank, they are on the velvet.
If you are unable to repay the loan, you simply apply to your lenders for 'restructuring'. Having made the application, you can move on with your life.
You can travel the country in great style, bid aggressively at IPL auctions, do deals with foreign partners and even sue the lenders for defaming your character, if they complain too much to the media about your overdue loans.
India's draconian debt recovery laws will make sure that it is the bank, and not the promoter of the failing business, which takes all the 'haircuts' and makes all the sacrifices necessary to salvage the most of this bad bargain.
Banks on their part have to make a devil-or-deep sea choice when approached by such borrowers. If they refuse and move to recover the dues at a court of law, the case may drag on for years and the asset may have lost all value by the time the bank gets its hands on it. If they decide to accommodate the borrower through easier terms, the envelope gets pushed a little more.
Thanks to this situation, Indian banks are today estimated to be sitting on Rs 2.5 lakh crore of restructured loans, on top of the Rs 1.6 lakh crore of non-performing assets that figure in their books. Distressed accounts now make up nearly 10 per cent of the combined loan book.
RBI's pound of the flesh
If collecting deposits and loaning it to the credit-worthy has become a tricky endeavour, the regulators have not been making bankers' lives easier either. In recent times, the Reserve Bank of India has co-opted the banking system as its unwilling partner in fixing everything that is wrong with the Indian economy.
Faced with the problem of a depreciating rupee, it jumped to the conclusion that it is bank money which is fuelling all that currency speculation. It promptly moved to squeeze every drop of excess liquidity from the banks. No matter if the sudden increase in overnight rates has sharply escalated the banks' costs or aggravated the bad loan problem.
Faced with a trade deficit, it is banks once again that the RBI has been relying on, to forcibly curb the Indian savers' appetite for gold.
It first asked banks to stop their gold retail business and make sure that gold was imported only to make jewellery. Then it required them to resort to cash-and-carry sales of gold consignments. Now, the RBI actually expects banks to police the jewellery industry and 'ensure' that the jeweller fulfills his export obligations!
All this has made banking stocks a no-no for stock market investors too. Over two-thirds of the listed banks today have their stock prices languishing below their book value. An equal number generate a return on equity of less than 15 per cent.
New kids, new rules
There is already an onerous set of conditions put in place by RBI for the grant of new banking licences. There are minimum net worth and capital limits, rules on accounting, provisioning and disclosures and mandatory SLR and CRR balances, of course. But, even as the older banks struggle to make a viable business of lending to the existing set of borrowers, the central bank now wants the new banks to meet the 40 per cent priority sector lending norms from day one. They also have to set up a fourth of their branches in un-banked areas.
So, the question is, what were India's leading business groups thinking of when they threw their hats into the ring for new banking licences. Compared to this, isn't operating an oil refinery or executing an EPC contract a far simpler proposition? Why would anyone want to run a bank?
(This article was published on July 28, 2013)
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