A project report on construction of balanced portfolio comprising of equity and debt at scm

Construction of Balanced Portfolio comprising of Equity and Debt

EXECUTIVE SUMMARY

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Babasabpatilfreepptmba.com


A stock market is a market for the trading of publicly held company stock and associated
financial instruments.

The stock market in India is very volatile and many investors are in a dilemma to invest in the
securities. Not surprisingly, recent market developments have once more focused attention on
the volatility that has come to characterise India’s stock markets. In volatile markets, domestic
speculators too attempt to manipulate markets in periods of unusually high prices.

Keeping in view the above observation about the Indian stock market, a project “Construction
of Balanced Portfolio of Equity and Debt”, with the problem statement being “To test the
significance of excess return to beta and find out whether one can construct a portfolio whose
beta is equal to market beta (beta =1), with returns greater than market returns.”.

Ten sectors were picked randomly consisting of 6 companies I Cement and 4 Companies in
each sector. Also the 10 corporate bonds along with 5 govt. securities are taken. With the help
of all, the statistical measures were calculated and a TRI was constructed. Then again another
portfolio was constructed using a particular sector stocks and this portfolio was compared with
the returns on the index to look at the performance at different combinations.

The Project was carried out at SMC Solutions, stock broking firm situated in Hubli.
Analysis of cement sector and steel sector give an immense insight to invest in these these
stocks. The Report describes the analysis being carried out in project and results obtained.

At the last, the portfolio was constructed with higher returns than
index returns with systematic risk of 1

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THEORETICAL BACKGROUND

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Fundamental Analysis

The earnings of the company, the growth rate, and risk exposure of the company have a direct
bearing on the price of the share. These factors in turn rely on the host of other factors like
economic environment in which they function, the industry which they belong to, and finally
the companies’ own performance. The fundamental analysis school of thought appraises the
intrinsic value of shares through:
 Economic Analysis
 Industry Analysis
 Company Analysis

Economic Analysis
The level of economic activity has an impact on investment in many ways. If the economy
grows rapidly, the industry can also be expected to show rapid growth and vice-versa. When the
level of economic activity is low, stock prices are low, and when the level of economic activity
is high, stock prices are high reflecting the prosperous outlook for sales and profits of the firms.
The analysis of macro economic environment is essential to understand the behaviour of the
stock prices. The commonly analyzed macro economic factors are as follows:
 Gross Domestic Product: GDP indicates the rate of growth of the economy. GDP
represents the aggregate value of the goods and services produced in the economy. GDP
consists of personal consumption expenditure, gross private domestic investment and
government expenditure on goods and services and net export of goods and services.
The growth rate of economy points out the prospects for the industrial sector and return
investors can expect from investment in shares. The higher growth rate is more
favourable to the stock market.
 Savings and investment: It is obvious that growth requires investment which in turn
requires substantial amount of domestic savings. Stock market is a channel through
which the savings of the investors are made available to corporate bodies. Savings are
distributed over various assets like equity shares, deposits,

mutual fund units, real estate and bullion. The saving and investment patterns of the public
affect the stock to a great extent.

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 Inflation: Along with the growth of GDP, if inflation also increases, then the real rate of
growth would be very little. The demand in the consumer product industry is
significantly affected. If there is a mid level of inflation, it is good to the stock market
but high rate of inflation is harmful to the stock market.
 Interest rates: The interest rate affects the cost of financing to the firms. A decrease in
interest rate implies lower cost of finance for firms and more profitability. More money
is available at a lower interest rate for the brokers who are doing business with
borrowed money. Availability of cheap fund, encourages speculation and rise in price of
shares.
 Budget: The budget draft provides an elaborate account of the government revenues
and expenditures. A deficit budget may lead to high rate of inflation and adversely
affect the cost of production. Surplus budget may result in deflation. Hence, balanced
budget is highly favorable to the stock market.
 The tax structure: Concessions and incentives given to a certain industry encourages
investment in that particular industry. Tax relief’s given to savings encourage savings.
The type of tax exemption has an impact on the profitability of the industries.
 The Balance of payment: The balance of payment is the record of a country’s money
receipts from and payments abroad. The difference between receipts and payments may
be surplus or deficit. BOP is the measure of the strength of rupee on external account. If
the deficit increases, the rupee may depreciate against other currencies, thereby,
affecting the cost of imports. The volatility of the foreign exchange rate affects the
investment of the foreign institutional investors in the Indian Stock Market. A favorable
balance of payment renders a positive effect on the stock market.
 Infrastructure facilities: Infrastructure facilities are essential for the growth of
industrial and agricultural sector. A wide network of communication system is a must
for the growth of the economy. Regular supply of power without any power cut would
boost the production. Banking and financial sectors should also be sound enough to
provide adequate support to industry and agriculture.
 Demographic factors: The demographic data provides details about the population by
age, occupation, literacy and geographic location. This is needed to forecast the demand
for the consumer goods. The population by age indicates the availability of able work
force. Population, by providing labour and demand for products, affects the industry and
stock market.

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Industry analysis

Industry analysis is a type of business research that focuses on the status of an industry or an
industrial sector (a broad industry classification, like "manufacturing"). A complete industrial
analysis usually includes a review of an industry's recent performance, its current status, and the
outlook for the future. Many analyses include a combination of text and statistical data.
Five Forces Affecting Competitive Strategy
Porter identifies five forces that drive competition within an industry:
 The threat of entry by new competitors.
 The intensity of rivalry among existing competitors.
 Pressure from substitute products.
 The bargaining power of buyers.
 The bargaining power of suppliers.

Industry Life Cycle Model
This model is a useful tool for analyzing the effects of an industry's evolution on competitive
forces. Using the industry life cycle model, we can identify five industry environments, each
linked to a distinct stage of an industry's evolution:
 An embryonic industry environment
 A growth industry environment
 A shakeout industry environment
 A mature industry environment
 A declining industry environment

Company Analysis

In the company analysis the investor assimilates the several bit of information related to the
company and evaluates the present and future value of stock. The risk and return associated
with the purchase of the stock is analyzed to take better investment decision.
The present and future are affected by a number of factors. They are:-

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Factors Share values
Competitive edge Historic price of stock
Earnings P/E ratio
Capital structure Economic condition
Management Stock market condition
Operating efficiency
Financial performance
Present price

Future price

The competitive edge of the company:- The competitive edge of the company can be studied
with the help of:-
 The market share
 The growth of annual sales
 The stability of annual sales
The market shares:- The market share of the annual sales helps to determine a company’s
relative competitive position within the industry. If the market share is high the company would
be able to meet the competition successfully.

Growth of sales:- The company would be the leading company, but if the growth of sales is
comparatively lower than another company, it indicates the possibility of the company losing

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the leadership. The rapid growth in sales would keep the shareholder in a better position than
one with a stagnant rapid growth.
Stability of sales: - If a firm has stable sales revenue, other things being remaining constant
will have more stable earnings. Wide variation in sales leads to variation incapacity
utilization, financial planning and dividend.
Earnings of the company:- Sales alone do not increase the sales the earnings but the costs and
expenses of the company also influence the earnings of the company. Further, earnings do
not always increase with the increase in sales. The company’s sales might have increased
but its per share may decline due to the rise in costs.
Capital structure: - The equity holders’ return can be increased manifold with the help of
financial leverage, i.e. using debt financing along with equity financing. The effect of financial
leverage is measured by computing leverage ratios. The debt ratio indicates the positions of
long term and short terms debts in the company finance. The debt may be in the form of
debentures and term loans from financial institutions.
Management: - Good and capable management generates profit to the investors. The
management of the firm should efficiently plan, organize, actuate and control the activities of
the company. The basic objective of management is to attain the stated objectives of the
company for the good of the equity share holders, the public and the employers. The good
management depends on the quality of the manager.
The following are special traits of an able manager:-
 Ability to get along with people
 Leadership
 Analytical competence
 Industry
 Judgment
 Ability to get things done

Operating efficiency: - The operating efficiency of a company directly affects the earnings of a
company. An expanding company that maintains high operating efficiency with a low break-
even point earns more than the company with high break-even points. If a firm has stable
operating ratio, the revenue will also be stable. Efficient use of fixed assets with a raw
materials, labour and management would lead to more income from sales. This leads to internal

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fund generation for the expansion of the firm. A growing company should have low operating
ratio to meet the growing demand for its product.
Financial analysis:- the best source of financial information about a company is its own
financial statements. This is a primary source of information for evaluating the investments
prospect in the particular company’s stock. Financial statement analysis is the study of a
company’s financial statement from various viewpoints. The statement gives the historical and
current information about the company’s operations. Historical financial statements help to
predict the future. The current information aids to analyse the present status of the company.
The two main statements used in analysis are:-
 Balance sheet
 Profit and loss account

Debt valuation techniques and concepts

In their simplest form bonds are pretty straightforward. After all, just about anybody can
comprehend the borrowing and lending of money. However, like many securities, bonds
involve some more complicated underlying concepts as they are traded and analyzed in the
market.
Bond Pricing
It is important for prospective bond buyers to know how to determine the price of a bond
because it will indicate the yield received should the bond be purchased. Bonds can be priced at
a premium, discount, or at par. If the bond’s price is higher than its par value, it would sell at a
premium because its interest rate is higher than current prevailing rates. If the bond’s price is
lower than its par value, the bond would sell at a discount because its interest rate is lower than
current prevailing.
Bondholder's Expected Rate of Return (Yield to Maturity)
The bondholder's expected rate of return is the rate the investor will earn if the bond is held to
maturity, provided, of course, that the company issuing the bond does not default on the
payments.

Computing Yield-to-Maturity on a Bond (YTM)

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 1   
1 − (1 + r ) n   
MP = C  +I  1 n 
 r  (1 + r ) 
   
  
 

Solving the equation for r gives the YTM.
1) If the investor's required return is greater than the YTM, the investor should not buy the bond
2) If the investor's required return is less than the YTM, the investor should buy the bond

Three Important Relationships
First relationship
A decrease in interest rates (required rates of return) will cause the value of a bond to increase;
an interest rate increase will cause a decrease in value. The change in value caused by changing
interest rates is called interest rate risk.
Second relationship
1. If the bondholder's required rate of return (current interest rate) equals the coupon interest
rate, the bond will sell at par, or maturity value.
2. If the current interest rate exceeds the bond's coupon rate, the bond will sell below par value
or at a "discount."
3. If the current interest rate is less than the bond's coupon rate, the bond will sell above par
value or at a "premium."
Third relationship
A bondholder owning a long-term bond is exposed to greater interest rate risk than when
owning a short-term bonds.
Relationships on the YTM
Since the bond's coupon rate, kc, is fixed for the life of bond, the following
YTM/bond price relationship is created:

 If YTM is > r, the bond sells at Discount.
 If YTM is < r, the bond sells at Premium

 If YTM is = r, the bond sells at par.

The Term Structure of Interest Rates

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The term structure of interest rates, also known as the yield curve, is a very common
bond valuation method. Constructed by graphing the yield to maturities and the
respective maturity dates of benchmark fixed-income securities, the yield curve is a
measure of the market's expectations of future interest rates given the current market
conditions. Treasuries, issued by the central government, are considered risk-free, and
as such, their yields are often used as the benchmarks for fixed-income securities with
the same maturities. The term structure of interest rates is graphed as though each
coupon payment of a non-callable fixed-income security were a zero-coupon bond that
“matures” on the coupon payment date. The exact shape of the curve can be different at
any point in time. So if the normal yield curve changes shape, it tells investors that they
may need to change their outlook on the economy.

Duration
The term “duration,” having a special meaning in the context of bonds, is a measurement of
how long in years it takes for the price of a bond to be repaid by its internal cash flows. It is an
important measure for investors to consider, as bonds with higher durations are more risky and
have higher price volatility than bonds with lower durations.

Factors affecting Duration
Besides the movement of time and the payment of coupons, there are other factors that affect a
bond's duration: the coupon rate and its yield. Bonds with high coupon rates and in turn high
yields will tend to have lower durations than bonds that pay low coupon rates, or offer a low
yield. This makes empirical sense, since when a bond pays a higher coupon rate, or has a high
yield, the holder of the security receives repayment for the security at a faster rate. The diagram
below summarizes how duration changes with coupon rate and yield.

Types of Duration

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There are four main types of duration calculations, each of which differ in the way they account
for factors such as interest rate changes and the bond's embedded options or redemption
features. The four types of durations are Macaulay duration, modified duration, effective
duration, and key-rate duration.

Macaulay Duration
Macaulay duration is calculated by adding the results of multiplying the present value of each
cash flow by the time it is received, and dividing by the total price of the security. The formula
for Macaulay duration is as follows:

n
t *c n*M
∑ (1 + i)
t −1
t
+
(1 + i ) n
Mac Dur =
P

n = number of cash flows
t = time to maturity
C = cash flow
i = required yield
M = maturity (par) value
P = bond price

 1   
1−   
MP =C 
(1 +r ) n  +I 
1  .
 r  (1 +r ) n 
   
  
 


So the following is an expanded version of Macaulay duration:

n
t *c
n*M
t−
∑(1 + i )(1 + i ) n
n
+
Mac Dur = 1

  1 
1 −  n 
C * (1 + i )   + M
 i  (1 + i ) n
 

 


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Modified Duration
Modified duration is a modified version of the Macaulay model that accounts for changing
interest rates. Because they affect yield, fluctuating interest rates will affect duration, so this
modified formula shows how much the duration changes for each percentage change in yield.
For bonds without any embedded features, bond price and interest rate move in opposite
directions, so there is an inverse relationship between modified duration and an approximate
one-percentage change in yield. Because the modified duration formula shows how a bond's
duration changes in relation to interest rate movements, the formula is appropriate for investors
wishing to measure the volatility of a particular bond. Modified duration is calculated as the
following:
 
 macaulaydurartion 
Modified Duraton =
 + YTM


.
1

 No of Cpn Periods 


Total Return Index
Nifty is a price index and hence reflects the returns one would earn if investment is made in the inde
portfolio. However, a price index does not consider the returns arising from dividend receipts. Onl
capital gains arising due to price movements of constituent stocks are indicated in a price index
Therefore, to get a true picture of returns, the dividends received from the constituent stocks also need t
be factored in the index values. Such an index, which includes the dividends received, is called the Tota
Returns Index.
Total Returns Index reflects the returns on the index arising from (a) constituent stock price movement
and (b) dividend receipts from constituent index stocks.

Methodology for Total Returns Index (TR) is as follows:
The following information is a prerequisite for calculation of TR Index:
1. Price Index close
2. Price Index returns
3. Dividend payouts in Rupees
4. Index Base capitalisation on ex-dividend date

Dividend payouts as they occur are indexed on ex-date.

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DividendPayout ( rs )
IndexedDividend = ×1000
BaseCapofindex( rs )

Indexed dividends are then reinvested in the index to give TR Index.

Total Return Index = [Prev. TR Index + (Prev. TR Index * Index returns)] +

[Indexed dividends + (Indexed dividends * Index returns)]

The base for both the Price index close and TR index close will be the same.

An investor in index stocks should benchmark his investments against the Total Returns index
instead of the price index to determine the actual returns vis-à-vis the index.

Operational Definitions

Bond: A debt instrument sold by a company or government to raise money. One who buys a
bond is a creditor of the company, but not an owner, as a stockholder would be.

Par: The value of a bond assigned by the issuer; also called face value.

Original issue discount: A bond with an offering price that is below par value.

Coupon: A bond's interest rate.

Premium: The amount by which a security sells above its par value.

Maturity: The length of time before the principal amount of a bond is due to the bondholders.
It is the time until a bond may be surrendered to its issuer, called as term-to-maturity.

Maturity date: The date on which a bond is to be redeemed and its principal and interest
returned to the owner.
Callability: The feature of some bonds whereby the issuer can redeem it before it matures.
Issuers often call their bonds when interest rates are falling and they want to replace high-

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yielding bonds with lower-yielding bonds. Call provisions must be made clear before a bond is
sold. A bond with this feature is a callable bond.

Debenture: A bond backed by the issuer's general credit and ability to repay and not by an
asset or collateral.

Investment-grade: A classification of the ability of a bond issuer to repay a bond.

Discount bond: A bond that sells at a discounted value of its face value. If a bond has a Rs
1000 par value but sells for Rs 900, it is "sold at a discount" of Rs100. Adverse market
conditions and reductions in interest rates can convince sellers to discount the bonds they sell.

Premium bond: A bond selling for more than its stated value. If a bond is Rs1000 par but sells
for Rs1100, it is "sold at a premium" of Rs100. Market conditions and increases in interest rates
can convince sellers to raise the prices of the bonds they sell.

Yield: The rate of return on an investment, described as a percentage of the amount of the
investment. For example, a bond purchased for Rs1,000 with a 7% yield would pay out 7% of
Rs1,000, or Rs70.

Yield to maturity: The fully compounded annual rate of return paid out over a bond's life,
from purchase date to maturity, including appreciation/depreciation and earnings. It is the most
comprehensive measure of yield.

Accrued interest: The interest that has been accumulating on a bond since the last time interest
was paid on it.

Current yield: The expected rate of return calculated by dividing the most recent annualized
distribution by the selling price. For example, a Rs.2,000 par bond that pays Rs140 but is
bought for Rs1600 has a current yield of 8 3/4 percent. The formula for deriving current yield is
annual income divided by current price.

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Coupon rate: The interest as a percent of par paid by a bond. It is called a coupon rate because
historically bonds included attached coupons that were clipped and surrendered for cash.
Today, most bonds come without the attached coupons.

Duration: The change in value of a bond (expressed in years) caused by a change in the
prevailing interest rates.
Floating-interest rate: A variable interest rate, one that changes periodically.

Floating-interest bond. A bond with an interest rate that changes each quarter to reflect
economic conditions.

Fixed-interest bond. A bond with an interest rate that stays the same over its life span is
corporate bond. A bond issued by a corporation and backed by the company's credit and/or its
assets.

Mortgage bond. A secured corporate bond that is backed by real estate. Because mortgage
bond collateral provides a clear claim on a company's assets, these bonds are considered secure
and high-grade.

Junk bond. Refers to the quality of bond that is a speculative, high yielding, and issued by a
company that typically finances its growth and operations with debt. Ratings companies usually
assign low grades to these bonds.

Revenue bond. A bond sold by a municipality to finance projects such as bridges, hospitals,
power plants and other local services. Also called limited obligation bonds, revenue bonds are
secured by the revenue generated by those projects.

Government bond. A bond sold by the. Government. Government bonds are rated the highest
of all bonds. They are used to finance federal projects.
Treasury bond (T-bond). A bond issued by the Treasury to meet the government's financial
needs. Treasury bonds are considered the safest bonds and are very popular with investors.
They have maturities lasting from ten to thirty years.

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Treasury note (T-note). An intermediate-term federal government debt, similar to a T-bond
but maturing in one to ten years.

Zero-coupon bond. A bond sold at discount and paying no interest, but instead paying the
holder the face value at maturity. A zero-coupon bond stated at 1000 but sold for 600 would
yield the holder a total of 1000 at maturity. The extra 400 the investor makes would be treated
as interest.

Fundamental Analysis: A method of evaluating a stock by attempting to measure its intrinsic
value. Fundamental analysts study everything from the overall economy and industry
conditions, to the financial condition and management of companies.

Intrinsic value: the economic value of a company or its common stock based on internally-
generated cash returns. Intrinsic value can be thought of as the discounted stream of net cash
flows attributable to an investment asset.

Terminal value: Terminal value refers to the value of the firm (or equity) at the end of the high
growth period. Terminal Value in year n= Cash Flow in year n+1/(r - g) .This approach requires
the assumption that growth is constant forever, and that the cost of capital will not change over
time.

Total Return Index: An index that calculates the performance of a group of stocks assuming
that all dividends and distributions are reinvested. This method is usually considered a more
accurate measure of actual performance than if dividends and distributions were ignored.

Beta: Statistically, beta is the measure of systematic risk in the CAPM and is the ratio of two co
variances: the individual security divided by a proxy for the market as a whole or the so-called
market portfolio. The beta factor is the expected change in the security's rate of return divided
by the accompanying change in the rate of return to the market portfolio.

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DESIGN OF THE STUDY

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Title :
“Construction of Balanced Portfolio comprising of Equity and Debt”

Statement of Problem:
To test the significance of excess return to beta and find out whether one can construct a
portfolio whose beta is equal to market beta (beta =1), with returns greater than market returns.

Objectives of the research:
• To analyze the performance of the shares of co’s in the steel and cement sector in
Indian stock market in light of the growth in infrastructure in India.
• To study the factors influencing the share price of the company.
• To analyze the companies based on Fundamental Analysis and TRI model
• To construct a Portfolio (Balanced Fund) of Equities and Debt. The construction
would be based on Fundamental Analysis Model.

Research Methodology
Type of research
The study is a descriptive research, describing the construction of portfolios.

Tools for data collection:
The study involves collection of data from secondary sources and collected from internet,
magazines, news paper, and research reports.
Sampling:
Type of sampling: Non-probabilistic judgment sampling.

Sample size: Four stocks from the steel sector and six stocks from the cement sector; 10
company’s Corporate debt; ten Government securities; and 364 day-T-bills

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Plan Of Analysis

After collecting financial data related to the entities, i.e. the sample selected from the selected
sectors, the various valuation ratios and other financial calculations which will help in the
company valuation will be calculated. A portfolio will be constructed on the basis of
fundamental analysis and on the basis of risk-return analysis with different combinations of
debt and equity to maximize the returns and minimize the risk (beta).

Limitations of the Study
• The study was confined only to the selected sectors.
• The study was more confined with secondary data.
• The study assumes no changes in the tax rates in the country.
• As the scope is defined by the researcher, it restricts the number of variables which
influence the industry.
• Sales growth were assumed on the basis of change in sales of yr 2007 and 2006

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EIC ANALYSIS

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ECONOMY ANALYSIS

Economic growth includes a raft of supply side policies that have helped to increase
competitiveness and productivity. For example financial markets have become more
deregulated, allowing more flexible loans. These have helped to increase investment
which has led to increased capacity and competitiveness. There has also been increased
focus put on training and education of at least part of the population. Despite the rapid
economic growth so far the Indian economy has managed to maintain relatively stable
prices, with inflationary pressures remaining subdued.

The success of the Indian economy shares several parallels with the Chinese economy. Like
China the Indian economy has a plentiful supply of cheap labour. This has enabled low labour
costs for firms which have made them particularly competitive in labour intensive industries.
This has often been at the expense of Western manufacturing sectors. For example recently
Dyson’s announced it would switch production of vacuum cleaners from the UK to Indian
where labour costs are cheaper.

The Indian economy has also benefited from the process of globalisation and improved
technology. A good example of this is in call centres, which benefit from the low labour costs.
Due to the internet and cheap telephone calls many Western companies have found it profitable
to switch their call centres to places in India where labour costs are significantly lower. India is
at a particular advantage for this growing market because compared to other developing
countries English is spoken to a reasonable standard by a high share of the population. The
Indian economy has also been able to diversify from its primarily agricultural roots. Mumbai
has emerged as one of the leading financial centres in Asia. India is also increasingly benefiting
from foreign investment into a variety of industries.

Strengths of Indian Economy.

After several decades of sluggish growth the Indian economy is now amongst the fastest
growing economy in the world. Economic growth is currently 8-9%, second only to China.

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Despite several problems facing the Indian economy many economists point to potential
strengths of the Indian economy which could enable it to continue to benefit from high levels of
economic growth in the future.

1. Demographics of India are favourable.
India still has a positive birth rate meaning that the size of the workforce will continue to
grow for the foreseeable future. (unlike India) A rising workforce helps to increase saving
and investment. It also enables increased productivity.
2. There is much scope for increases in efficiency.
The infrastructure of India is so bad in places that even moderate improvements could lead
to significant improvements in the productive capacity of the economy.
3. India is well placed to benefit from globalization and outsourcing.
A legacy of the British Empire is that India has one of the largest English speaking
populations in the world. For labour intensive industries like call centres India is an obvious
target for outsourcing. This is an economic development likely to continue in the future.
4. Positive Growth Forecasts
A recent study from Goldman Sachs, forecast that India could growth at a sustainable rate
of 8% growth until 2020.However it is worth noting that this assumed Indian would make
several supply side policies such as labour market deregulation and improvements in
education and training.

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Problems Facing Indian Economy

1. Inflation.

Fuelled by rising wages, property prices and food prices inflation in India is an increasing
problem. Inflation is currently between 6-7%. A record 98% of Indian firms report operating
close to full capacity .With economic growth of 9.2% per annum inflationary pressures are
likely to increase, especially with supply side constraints such as infrastructure. The wholesale-
price index (WPI), rose to an annualized 6.6% in Janu 2007

2. Poor educational standards.

Although India has benefited from a high % of English speakers. (important for call centre
industry) there is still high levels of illiteracy amongst the population. It is worse in rural areas
and amongst women. Over 50% of Indian women are illiterate

3. Poor Infrastructure.

Many Indians lack basic amenities lack access to running water. Indian public services are
creaking under the strain of bureaucracy and inefficiency. Over 40% of Indian fruit rots before
it reaches the market; this is one example of the supply constraints and inefficiency’s facing the
Indian economy.

4. Balance of Payments deterioration.

Although India has built up large amounts of foreign currency reserves the current account
deficit has deteriorate in recent months. This deterioration is a result of the overheating of the
economy. Aggregate Supply cannot meet Aggregate demand so consumers are sucking in
imports. Excluding workers remittances India’s current account deficit is approaching 5% of
GD

5. High levels of debt.

Buoyed by a property boom the amount of lending in India has grown by 30% in the past year.
However there are concerns about the risk of such loans. If they are dependent on rising
property prices it could be problematic. Furthermore if inflation increases further it may force

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the RBI to increase interest rates. If interest rates rise substantially it will leave those indebted
facing rising interest payments and potentially reducing consumer spending in the future

6. Inequality has risen rather than decreased.

It is hoped that economic growth would help drag the Indian poor above the poverty line.
However so far economic growth has been highly uneven benefiting the skilled and wealthy
disproportionately. Many of India’s rural poor are yet to receive any tangible benefit from the
India’s economic growth. More than 78 million homes do not have electricity. 33%
(268million) of the population live on less than $1 per day. Furthermore with the spread of
television in Indian villages the poor are increasingly aware of the disparity between rich and
poor.

7. Large Budget Deficit.

India has one of the largest budget deficits in the developing world. Excluding subsidies it
amounts to nearly 8% of GDP. Although it is fallen a little in the past year. It still allows little
scope for increasing investment in public services like health and education.

8. Rigid labour Laws.

As an example Firms employing more than 100 people cannot fire workers without government
permission. The effect of this is to discourage firms from expanding to over 100 people. It also
discourages foreign investment. Trades Unions have an important political power base and
governments often shy away from tackling potentially politically sensitive labour laws.

CURRENT STATE OF AN INDIAN ECONOMY

The economy of India, when measured in USD exchange-rate terms, is the tenth largest in the
world, with a GDP of US $1.50 trillion (2008). It is the third largest in terms of purchasing
power parity. India is the second fastest growing major economy in the world, with a GDP
growth rate of 9.4% for the fiscal year 2006–2007. However, India's huge population has a per
capita income of $4,542 at PPP and $1,089 in nominal terms (revised 2007 estimate). The
World Bank classifies India as a low-income economy.

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India's economy is diverse, encompassing agriculture, handicrafts, textile, manufacturing, and a
multitude of services. Although two-thirds of the Indian workforce still earn their livelihood
directly or indirectly through agriculture, services are a growing sector and play an increasingly
important role of India's economy. The advent of the digital age, and the large number of young
and educated populace fluent in English, is gradually transforming India as an important 'back
office' destination for global outsourcing of customer services and technical support. India is a
major exporter of highly-skilled workers in software and financial services, and software
engineering. Other sectors like manufacturing, pharmaceuticals, biotechnology,
nanotechnology, telecommunication, shipbuilding, aviation , tourism and retailing are showing
strong potentials with higher growth rates.

India followed a socialist-inspired approach for most of its independent history, with strict
government control over private sector participation, foreign trade, and foreign direct
investment. However, since the early 1990s, India has gradually opened up its markets through
economic reforms by reducing government controls on foreign trade and investment. The
privatisation of publicly owned industries and the opening up of certain sectors to private and
foreign interests has proceeded slowly amid political debate.

India faces a fast-growing population and the challenge of reducing economic and social
inequality. Poverty remains a serious problem, although it has declined significantly since
independence. Official surveys estimated that in the year 2004-2005, 27% of Indians were poor.

SOME IMPORTANT FACTS ABOUT INDIAN ECONOMY

Public expenditure

India's public expenditure is classified as development expenditure, comprising central plan
expenditure and central assistance and non-development expenditures; these categories can
each be divided into capital expenditure and revenue expenditure. Central plan expenditure is
allocated to development schemes outlined in the plans of the central government and public
sector undertakings; central assistance refers to financial assistance and developmental loans
given for plans of the state governments and union territories. Non-development capital
expenditure comprises capital defense expenditure, loans to public enterprises, states and union
territories and foreign governments, while non-development revenue expenditure comprises

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revenue defence expenditure, administrative expenditure, subsidies, debt relief to farmers,
postal deficit, pensions, social and economic services (education, health, agriculture, science
and technology), grants to states and union territories and foreign governments.

Headquarters of India's central bank, the Reserve Bank of India, in Mumbai (It's the tall
building in the background. The building in the foreground is the Asiatic Library)

India's non-development revenue expenditure has increased nearly fivefold in 2003–04 since
1990–91 and more than tenfold since 1985–1986. Interest payments are the single largest item
of expenditure and accounted for more than 40% of the total non development expenditure in
the 2003–04 budget. Defence expenditure increased fourfold during the same period and has
been increasing due to growing tensions in the region, the expensive dispute with Pakistan over
Jammu and Kashmir and an effort to modernise the military. Administrative expenses are
compounded by a large salary and pension bill, which rises periodically due to revisions in
wages, dearness allowance etc. subsidies on food, fertilizers, education and petroleum and other
merit and non-merit subsidies account are not only continuously rising, especially because of
rising crude oil and food prices, but are also harder to rein in, because of political compulsions.

Public receipts

India has a three-tier tax structure, wherein the constitution empowers the union government to
levy income tax, tax on capital transactions (wealth tax, inheritance tax), sales tax, service tax,
customs and excise duties and the state governments to levy sales tax on intrastate sale of
goods, tax on entertainment and professions, excise duties on manufacture of alcohol, stamp
duties on transfer of property and collect land revenue (levy on land owned). The local
governments are empowered by the state government to levy property tax, Octroi and charge
users for public utilities like water supply, sewage etc. More than half of the revenues of the
union and state governments come from taxes, of which half come from Indirect taxes. More
than a quarter of the union government's tax revenues is shared with the state governments.

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The tax reforms, initiated in 1991, have sought to rationalise the tax structure and increase
compliance by taking steps in the following directions:

• Reducing the rates of individual and corporate income taxes, excises, customs and making it
more progressive
• Reducing exemptions and concessions
• Simplification of laws and procedures
• Introduction of Permanent account number to track monetary transactions
• 21 of the 29 states introduced Value added tax (VAT) on April 1, 2005 to replace the
complex and multiple sales tax system.

The non-tax revenues of the central government come from fiscal services, interest receipts,
public sector dividends, etc., while the non-tax revenues of the States are grants from the central
government, interest receipts, dividends and income from general, economic and social
services.

General budget

The Finance minister of India presents the annual union budget in the Parliament on the last
working day of February. The budget has to be passed by the Lok Sabha before it can come into
effect on April 1, the start of India's fiscal year. The Union budget is preceded by an economic
survey which outlines the broad direction of the budget and the economic performance of the
country for the outgoing financial year. This economic survey involves all the various NGOs,
women organizations, business people, old people associations etc.

Labour

The large population puts further pressure on infrastructure and social services. A positive
factor has been the large working-age population, which forms 45.33% of the population and is
expected to increase substantially, because of the decreasing dependency ratio. The national
labour market has been tightly regulated by successive governments ever since the Workmen's
Compensation Act was passed in 1923.

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Natural resources

India's total cultivable area is 1,269,219 km² (56.78% of total land area), which is decreasing
due to constant pressure from an ever growing population and increased urbanisation.

India has a total water surface area of 314,400 km² and receives an average annual rainfall of
1,100 mm. Irrigation accounts for 92% of the water utilisation, and comprised 380 km² in 1974,
and is expected to rise to 1,050 km² by 2025, with the balance accounted for by industrial and
domestic consumers. India's inland water resources comprising rivers, canals, ponds and lakes
and marine resources comprising the east and west coasts of the Indian ocean and other gulfs
and bays provide employment to nearly 6 million people in the fisheries sector. India is the
sixth largest producer of fish in the world and second largest in inland fish production.

India's major mineral resources include Coal (fourth-largest reserves in the world), Iron ore,
Manganese, Mica, Bauxite, Titanium ore, Chromite, Natural gas, Diamonds, Petroleum,
Limestone and Thorium (world's largest along Kerala's shores). India's oil reserves, found in
Bombay High off the coast of Maharashtra, Gujarat, and in eastern Assam meet 25% of the
country's demand.

Rising energy demand concomitant with economic growth has created a perpetual state of
energy crunch in India. India is poor in oil resources and is currently heavily dependent on coal
and foreign oil imports for its energy needs. Though India is rich in Thorium, but not in
Uranium, which it might get access to if a nuclear deal with US comes to fruition. India is rich
in certain energy resources which promise significant future potential - clean / renewable
energy resources like solar, wind, biofuels (jatropha, sugarcane).

Physical infrastructure

Mumbai Airport

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Development of infrastructure was completely in the hands of the public sector and was
plagued by corruption, bureaucratic inefficiencies, urban-bias and an inability to scale
investment.

Infosys Software Development Center in Pune.

India's low spending on power, construction, transportation, telecommunications and real estate,
at $31 billion or 6% of GDP in 2002 had prevented India from sustaining higher growth rates.
This had prompted the government to partially open up infrastructure to the private sector
allowing foreign investment which has helped in a sustained growth rate of close to 9% for the
past six quarters. India holds second position in the world in roadways' construction, more than
twice that of China. As of 2005 the electricity production was at 661.6 billion kWh with oil
production standing at 785,000 bbl/day. India's prime import partners are : China 8.7%, US 6%,
Germany 4.6%, Singapore 4.6%, Australia 4% as of 2006 CIA FactBook As of 15 January
2007, there were 2.10 million broadband lines in India. Low tele-density is the major hurdle for
slow pickup in broadband services. Over 76% of the broadband lines were via DSL and the rest
via cable modems.

Financial institutions

30

India has set up Special Economic Zones and software parks that offer tax benefits and better
infrastructure to set up business. Pictured here is the Infosys headquarters in Bangalore, one of
the largest software companies in India.

India inherited several institutions, such as the civil services, Reserve Bank of India, railways,
etc., from its British rulers. Mumbai serves as the nation's commercial capital, with the Reserve
Bank of India (RBI), Bombay Stock Exchange (BSE) and the National Stock Exchange (NSE)
located here. The headquarters of many financial institutions are also located in the city.

Cyber Greens Office Complex. Containing offices like ABN Amro, Microsoft.

The RBI, the country's central bank was established on 1 April 1935. It serves as the nation's
monetary authority, regulator and supervisor of the financial system, manager of exchange
control and as an issuer of currency. The RBI is governed by a central board, headed by a
governor who is appointed by the Central government of India.

Cuffe Parade is an important business district in Mumbai, home to the World Trade Center as
well as other important financial institutions

The BSE Sensex or the BSE Sensitive Index is a value-weighted index composed of 30
companies with April 1979 as the base year (100). These companies have the largest and most
actively traded stocks and are representative of various sectors, on the Exchange. They account

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for around one-fifth of the market capitalisation of the BSE. The Sensex is generally regarded
as the most popular and precise barometer of the Indian stock markets. Incorporated in 1992,
the National Stock Exchange is one of the largest and most advanced stock markets in India.
The NSE is the world's third largest stock exchange in terms of transactions. There are a total of
23 stock exchanges in India, but the BSE and NSE comprise 83% of the volumes.The Securities
and Exchange Board of India (SEBI), established in 1992, regulates the stock markets and other
securities markets of the country.

SECTORS

Agriculture

Composition of India's total production (million tonnes) of foodgrains and commercial crops, in
2003–04. India ranks second worldwide in farm output. Agriculture and allied sectors like
forestry, logging and fishing accounted for 18.6% of the GDP in 2005, employed 60% of the
total workforce[4] and despite a steady decline of its share in the GDP, is still the largest
economic sector and plays a significant role in the overall socio-economic development of
India. Yields per unit area of all crops have grown since 1950, due to the special emphasis
placed on agriculture in the five-year plans and steady improvements in irrigation, technology,
application of modern agricultural practices and provision of agricultural credit and subsidies
since Green revolution in India. However, international comparisons reveal that the average
yield in India is generally 30% to 50% of the highest average yield in the world.

The low productivity in India is a result of the following factors:
• Illiteracy, general socio-economic backwardness, slow progress in implementing land
reforms and inadequate or inefficient finance and marketing services for farm produce.
• The average size of land holdings is very small (less than 20,000 m²) and is subject to
fragmentation, due to land ceiling acts and in some cases, family disputes. Such small
holdings are often over-manned, resulting in disguised unemployment and low productivity
of labour.
• Adoption of modern agricultural practices and use of technology is inadequate, hampered
by ignorance of such practices, high costs and impracticality in the case of small land
holdings.

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• Irrigation facilities are inadequate, as revealed by the fact that only 53.6% of the land was

irrigated in 2000–01, which result in farmers still being dependent on rainfall, specifically
the Monsoon season. A good monsoon results in a robust growth for the economy as a
whole, while a poor monsoon leads to a sluggish growth. Farm credit is regulated by
NABARD, which is the statutory apex agent for rural development in the subcontinent.

Industry
India is fourteenth in the world in factory output. They together account for 27.6% of the GDP
and employ 17% of the total workforce.However, about one-third of the industrial labour force
is engaged in simple household manufacturing only.

Economic reforms brought foreign competition, led to privatisation of certain public sector
industries, opened up sectors hitherto reserved for the public sector and led to an expansion in
the production of fast-moving consumer goods.

Post-liberalisation, the Indian private sector, which was usually run by oligopolies of old family
firms and required political connections to prosper was faced with foreign competition,
including the threat of cheaper Chinese imports. It has since handled the change by squeezing
costs, revamping management, focusing on designing new products and relying on low labour
costs and technology.

34 Indian companies have been listed in the Forbes Global 2000 ranking for 2008.

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The 10 leading companies are:

Market
World Revenue Profits Assets
Value
Rank Company Logo Industry (billion (billion (billion
(billion
$) $) $)
$)
Reliance Oil & Gas
193 26.07 2.79 30.67 89.29
Industries Operations
Oil and Natural Oil & Gas
198 18.90 4.11 33.79 54.11
Gas Corporation Operations
State Bank of
219 Banking 15.77 1.47 188.56 33.29
India
Indian Oil Oil & Gas
303 42.68 1.82 25.39 16.36
Corporation Operations
374 ICICI Bank Banking 9.84 0.64 91.07 29.85
411 NTPC Utilities 7.84 1.60 20.34 41.57
Steel Authority
647 Materials 7.88 1.45 8.05 26.37
of India Limited

738 Tata Steel Materials 5.83 0.97 11.48 14.63

Telecommunications
826 Bharti Airtel 4.26 0.94 6.61 39.16
Services
Reliance Telecommunications
846 3.13 0.65 13.08 29.63
Communications Services

Services

India is fifteenth in services output. It provides employment to 23% of work force, and it is
growing fast, growth rate 7.5% in 1991–2000 up from 4.5% in 1951–80. It has the largest share
in the GDP, accounting for 53.8% in 2005 up from 15% in 1950. Business services
(information technology, information technology enabled services, business process
outsourcing) are among the fastest growing sectors contributing to one third of the total output
of services in 2000. The growth in the IT sector is attributed to increased specialisation,
availability of a large pool of low cost, but highly skilled, educated and fluent English-speaking
workers. On the supply side and on the demand side, increased demand from foreign consumers
interested in India's service exports or those looking to outsource their operations. India's IT

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industry, despite contributing significantly to its balance of payments, accounted for only about
1% of the total GDP or 1/50th of the total services.

Banking and finance

The Indian money market is classified into: the organised sector (comprising private, public and
foreign owned commercial banks and cooperative banks, together known as scheduled banks);
and the unorganised sector (comprising individual or family owned indigenous bankers or
money lenders and non-banking financial companies (NBFCs)). The unorganised sector and
microcredit are still preferred over traditional banks in rural and sub-urban areas, especially for
non-productive purposes, like ceremonies and short duration loans.

Prime Minister Indira Gandhi nationalised 14 banks in 1969, followed by six others in 1980,
and made it mandatory for banks to provide 40% of their net credit to priority sectors like
agriculture, small-scale industry, retail trade, small businesses, etc. to ensure that the banks
fulfill their social and developmental goals. Since then, the number of bank branches has
increased from 10,120 in 1969 to 98,910 in 2003 and the population covered by a branch
decreased from 63,800 to 15,000 during the same period. The total deposits increased 32.6
times between 1971 to 1991 compared to 7 times between 1951 to 1971. Despite an increase of
rural branches, from 1,860 or 22% of the total number of branches in 1969 to 32,270 or 48%,
only 32,270 out of 5 lakh (500,000) villages are covered by a scheduled bank.

Since liberalisation, the government has approved significant banking reforms. While some of
these relate to nationalised banks (like encouraging mergers, reducing government interference
and increasing profitability and competitiveness), other reforms have opened up the banking
and insurance sectors to private and foreign players.

Socio-economic characteristics

Poverty

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Large numbers of India's people live in abject poverty. Wealth distribution in India is
improving since the liberalization and with the end of the socialist rule termed as the license raj.
While poverty in India has reduced significantly, official figures estimate that 27.5% of Indians
still lived below the national poverty line in 2004-2005. A 2007 report by the state-run National
Commission for Enterprises in the Unorganised Sector (NCEUS) found that 70% of Indians, or
800 million people, lived on less than 20 rupees per day with most working in "informal labour
sector with no job or social security, living in abject poverty."

Since the early 1950s, successive governments have implemented various schemes, under
planning, to alleviate poverty, that have met with partial success. All these programmes have
relied upon the strategies of the Food for work programme and National Rural Employment
Programme of the 1980s, which attempted to use the unemployed to generate productive assets
and build rural infrastructure. In August 2005, the Indian parliament passed the Rural
Employment Guarantee Bill, the largest programme of this type in terms of cost and coverage,
which promises 100 days of minimum wage employment to every rural household in 200 of
India's 600 districts. The question of whether economic reforms have reduced poverty or not
has fuelled debates without generating any clear cut answers and has also put political pressure
on further economic reforms, especially those involving the downsizing of labour and cutting
agricultural subsidies.

Occupations and unemployment

Agricultural and allied sectors accounted for about 57% of the total workforce in 1999–2000,
down from 60% in 1993–94. While agriculture has faced stagnation in growth, services have
seen a steady growth. Of the total workforce, 8% is in the organised sector, two-thirds of which
are in the public sector. The NSSO survey estimated that in 1999–2000, 106 million, nearly
10% of the population were unemployed and the overall unemployment rate was 7.32%, with
rural areas doing marginally better (7.21%) than urban areas (7.65%).

Unemployment in India is characterised by chronic underemployment or disguised
unemployment. Government schemes that target eradication of both poverty and
unemployment, (Which in recent decades has sent millions of poor and unskilled people into
urban areas in search of livelihoods.) attempt to solve the problem, by providing financial
assistance for setting up businesses, skill honing, setting up public sector enterprises,

36

reservations in governments, etc. The decreased role of the public sector after liberalisation has
further underlined the need for focusing on better education and has also put political pressure
on further reforms.

Regional imbalance

One of the critical problems facing India's economy is the sharp and growing regional
variations among India's different states and territories in terms of per capita income, poverty,
availability of infrastructure and socio-economic development.

The five-year plans have attempted to reduce regional disparities by encouraging industrial
development in the interior regions, but industries still tend to concentrate around urban areas
and port cities. After liberalization, the more advanced states are better placed to benefit from
them, with infrastructure like well developed ports, urbanisation and an educated and skilled
workforce which attract manufacturing and service sectors. The union and state governments of
backward regions are trying to reduce the disparities by offering tax holidays, cheap land, etc.,
and focusing more on sectors like tourism, which although being geographically and
historically determined, can become a source of growth and is faster to develop than other
sectors.

External trade and investment

Global trade relations

Until the liberalization of 1991, India was largely and intentionally isolated from the world
markets, to protect its fledging economy and to achieve self-reliance. Foreign trade was subject
to import tariffs, export taxes and quantitative restrictions, while foreign direct investment was
restricted by upper-limit equity participation, restrictions on technology transfer, export
obligations and government approvals; these approvals were needed for nearly 60% of new FDI
in the industrial sector. The restrictions ensured that FDI averaged only around $200M annually
between 1985 and 1991; a large percentage of the capital flows consisted of foreign aid,
commercial borrowing and deposits of non-resident Indians.

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Share of top five investing countries in FDI inflows. (2000–2007)[79]
Inflows
Rank Country Inflows (%)
(Million USD)
1 Mauritius 85,178 44.24%[80]
2 United States 18,040 9.37%
3 United Kingdom 15,363 7.98%
4 Netherlands 11,177 5.81%
5 Singapore 9,742 5.06%

Indian exports in 2006

India's exports were stagnant for the first 15 years after independence, due to the predominance
of tea, jute and cotton manufactures, demand for which was generally inelastic. Imports in the
same period consisted predominantly of machinery, equipment and raw materials, due to
nascent industrialisation. Since liberalisation, the value of India's international trade has become
more broad-based and has risen to Rs. 63,080,109 crores in 2003–04 from Rs.1,250 crores in
1950–51. India's major trading partners are China, the US, the UAE, the UK, Japan and the EU.
The exports during April 2007 were $12.31 billion up by 16% and import were $17.68 billion
with an increase of 18.06% over the previous year.

India is a founding-member of General Agreement on Tariffs and Trade (GATT) since 1947
and its successor, the World Trade Organization. While participating actively in its general
council meetings, India has been crucial in voicing the concerns of the developing world. For

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instance, India has continued its opposition to the inclusion of such matters as labour and
environment issues and other non-tariff barriers into the WTO policies.

Balance of payments

Since independence, India's balance of payments on its current account has been negative.
Since liberalisation in the 1990s (precipitated by a balance of payment crisis), India's exports
have been consistently rising, covering 80.3% of its imports in 2002–03, up from 66.2% in
1990–91. Although India is still a net importer, since 1996–97, its overall balance of payments
(i.e., including the capital account balance), has been positive, largely on account of increased
foreign direct investment and deposits from non-resident Indians; until this time, the overall
balance was only occasionally positive on account of external assistance and commercial
borrowings. As a result, India's foreign currency reserves stood at $285 billion in 2008, which
could be used in infrastructural development of the country if used effectively.

India is a net importer: Per the CIA factbook in 2007, imports were $224bn and exports
$140bn.

India's reliance on external assistance and commercial borrowings has decreased since 1991–
92, and since 2002–03, it has gradually been repaying these debts. Declining interest rates and
reduced borrowings decreased India's debt service ratio to 4.5% in 2007. In India, External
Commercial Borrowings (ECBs) are being permitted by the Government for providing an
additional source of funds to Indian corporates. The Ministry of Finance monitors and regulates
these borrowings (ECBs) through ECB policy guidelines.

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Foreign direct investment in India

As the third-largest economy in the world in PPP terms, India is a preferred destination for
foreign direct investments (FDI); India has strengths in information technology and other
significant areas such as auto components, chemicals, apparels, pharmaceuticals, and jewellery.
India has always held promise for global investors, but its rigid FDI policies were a significant
hindrance in this regard. However, as a result of a series of ambitious and positive economic
reforms aimed at deregulating the economy and stimulating foreign investment, India has
positioned itself as one of the front-runners of the rapidly growing Asia Pacific Region. India
has a large pool of skilled managerial and technical expertise. The size of the middle-class
population at 300 million exceeds the population of both the US and the EU, and represents a
powerful consumer market.

India's recently liberalized FDI policy (2005) allows up to a 100% FDI stake in ventures.
Industrial policy reforms have substantially reduced industrial licensing requirements, removed
restrictions on expansion and facilitated easy access to foreign technology and foreign direct
investment FDI. The upward moving growth curve of the real-estate sector owes some credit to
a booming economy and liberalized FDI regime. In March 2005, the government amended the
rules to allow 100 per cent FDI in the construction business. This automatic route has been
permitted in townships, housing, built-up infrastructure and construction development projects
including housing, commercial premises, hotels, resorts, hospitals, educational institutions,
recreational facilities, and city- and regional-level infrastructure.

A number of changes were approved on the FDI policy to remove the caps in most sectors.
Restrictions will be relaxed in sectors as diverse as civil aviation, construction development,
industrial parks, petroleum and natural gas, commodity exchanges, credit-information services
and mining. But this still leaves an unfinished agenda of permitting greater foreign investment
in politically sensitive areas such as insurance and retailing.

FDI inflows into India reached a record US$19.5bn in fiscal year 2006/07 (April-March),
according to the government's Secretariat for Industrial Assistance. This was more than double
the total of US$7.8bn in the previous fiscal year. Between April and September 2007, FDI
inflows were US$8.2bn.

INDUSTRY ANALYSIS

40

Indian Money Market
Whenever a bear market comes along, investors realize that the stock market is a risky place for
their savings, a fact we tend to forget while enjoying the returns of a bull market! This,
unfortunately, is part of the risk/return tradeoff. That is, to get higher returns, you have to take
on a higher level of risk. But for many investors, a volatile market is too much to stomach - an
alternative is the money market. The money market is better known as a place for large
institutions and government to manage their short-term cash needs. However, individual
investors have access to the market through a variety of different securities.

The money market is a subsection of the fixed income market. Many people think of the term
"fixed income" as synonymous with bonds, but technically, a bond is just one type of fixed
income security. The difference between the money market and the bond market is that the
money market specializes in very short term debt securities (debt that matures in less than one
year). Money market investments are also called cash investments because of their short
maturities. Money market securities are essentially bonds issued by governments, financial
institutions, and large corporations. These instruments are very liquid, and considered very safe.
Because they are so conservative, money market securities offer a lower return than most other
securities. One of the main differences between the money market and the stock market is that
most money market securities trade in very high denominations and so individual investors
have limited access to them. Also, the money market is a dealer market, which means that firms
buy and sell securities in their own accounts, at their own risk. Compare this to the stock market
where brokers usually act as agents, making money on commissions, while investors takes the
risk of holding the stock. One other characteristic of a dealer market is there is no central
trading floor or exchange. Deals are transacted over the phone or through electronic systems .
The easiest way for us to gain access to the money market is with a money market
mutual funds, or sometimes a money market bank account. Although, some money market
instruments like treasury bills may be purchased directly or through other large financial
institutions with direct access to these markets. There are several different instruments in the
money market, offering different returns and different risks. Let's take a look at the major ones.
Treasury Bills
Treasury Bills (T-bills) are the most marketable money market security. Their popularity is
mainly due to their simplicity. T-bills are basically a way for the government uses to raise

41

money from the public. T-bills are short-term securities that mature in one year or less from
their issue date. T-bills are issued with 3 month, 6 month, and 1 year maturities.
Certificate of Deposit (CD)
A certificate of deposit (CD) is a time deposit with a bank. Time deposits may not be
withdrawn on demand like a check account. CDs are generally issued by commercial banks but
they can be bought through brokerages. They bear a specific maturity date (from 3 months to 5
years), a specified interest rate, and can be issued in any denomination, very similar to bonds.
Commercial Paper
For many corporations, borrowing short-term money from banks is often a labored and
annoying task. Their desire to avoid banks as much as possible has led to the Commercial paper
is an unsecured, short-term loan issued by a corporation, typically for financing accounts
receivable and inventories.
Debentures
These are the normal types of bonds. It is unsecured debt, backed only by the name and
goodwill of the corporation. In the event of the liquidation of the corporation, holders of
debentures are repaid before stockholders, but after holders of mortgage bonds.

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INDIAN CEMENT INDUSTRY

Background

The Indian cement industry (120 million tons per annum) is the fourth largest in he world after
China, Japan and USA. However, per capita consumption in the country is only around 80-90
kg compared to the world average of approximately 250 kg.

Historically, the Indian cement sector has been highly fragmented comprising 54 players that
operate 124 plants. The majority of the plants are small-sized and well spread through out the
country. The cement industry is cyclical and capital intensive. A new plant typically has a
gestation period of 3-4 years.

Overview of The Indian cement industry
The Indian cement industry with a total capacity of 144 m tonnes (including mini plants) in
FY07, has surpassed developed nations like USA and Japan and has emerged as the second
largest market after China. Although consolidation has taken place in the Indian cement industry
with the top six players controlling almost 60% of the capacity, the remaining 40% of the
capacity remains pretty fragmented with around 40 players in the fray.

• Despite the fact that Indian cement industry has clocked a production of more than 100 m
tonnes for the second year in succession, the per capita consumption of 110 kgs
compares poorly with the world average of 260 kgs. This, more than anything underlines
the tremendous scope for growth in the Indian cement industry in the long term.

• Cement, being a bulk commodity, is a freight intensive industry and transporting cement
over long distances can prove to be uneconomical. This has resulted in cement being
largely a regional play with the industry divided into five main regions viz. north, south,
west, east and the central region. While the southern region is excess is capacity owing to
the availability of limestone, the western and northern region are the most lucrative
markets. Therefore, players like Grasim, L&T and Gujarat Ambuja enjoy high price
realisations compared to the all India average.

• Although the government has reduced the import duty on cement, imports do not pose a
threat since prices of cement in India are lower than those prevailing in the international

43

markets. Moreover, the storage facilities on the Indian ports are inadequate for large-
scale imports.

Key points about the cement industry
• Supply : There is an oversupply situation in the industry due to capacity additions by
the major players in the industry. The situation is likely to improve, as there is no major
Greenfield expansion in sight.
• Demand : Housing sector acts as the principal growth driver for cement. However, in
recent times, industrial and infrastructure sector have also emerged as demand drivers
for cement.
• Barriers to entry: High capital costs and long gestation periods. Access to limestone
reserves (principal raw material for the manufacture of cement) also acts as a significant
entry barrier.
• Bargaining power of suppliers:Licensing of coal and limestone reserves, supply of
power from the state grid and availability of railways for transport are all controlled by a
single entity, which is the government.
• Bargaining power of customers: Cement is a commodity business and sales volumes
mostly depend upon the distribution reach of the company. However, things are
changing and few brands such as Gujarat Ambuja and L&T have started commanding a
premium on account of better quality perception.
• Competition:Due to large number of players in the industry and very little brand
differentiation to speak of, the competition is intense with players resorting to frequent
price cuts in order to gain market share.

Key Stages In Cement Production

Cement production is one of the world’s most energy intensive industries. Key production
stages can be summarized as:

1.Raw materials

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These are generally combinations of limestone, shells or chalk, and shale, clay, sand or iron ore,
usually mined from a quarry close to the plant where they undergo reduction using primary and
secondary crushers. When the reduced materials reach the cement plant they are proportioned to
create a cement of specific chemical composition. Much work is being done on the use of
alternative raw materials – often the by-products of other industrial processes. These can
minimize the effects of quarrying, reduce the impact of the cement plant on the local
environment and enable the cement industry to become a major player in materials recycling.
There are two basic methods used in Portland cement production – wet and dry. In the dry
process dry materials are proportioned, ground to a powder, blended and fed into the kiln dry.
The wet process involves adding water to the proportioned raw materials and completing the
grinding and blending operations in slurry form.

2. Pre-heater

To conserve energy, most modern cement plants pre-heat raw materials before they enter the
kiln, using the hot exhaust gases from the kiln itself.
3. Kiln

The mixture of raw materials is fed into the upper end of a rotating, cylindrical kiln, which
achieves temperatures in excess of 1000°C. It passes through at a rate controlled by the slope
and rotational speed of the kiln. Chemical reaction inside the kiln leads to the fusion of the raw
materials to produce clinker. Traditionally kiln fuels have been powdered coal or natural gas,
but increasingly alternative fuels are being used. These include materials such as scrap tyres,
processed sewage sludge and packaging waste.

4. Cooling/finish grinding

Clinker is discharged from the lower end of the kiln and transferred to various types of coolers.

Total production

The cement industry comprises of 125 large cement plants with an installed capacity of 148.28
million tonnes and more than 300 mini cement plants with an estimated capacity of 11.10
million tonnes per annum. The Cement Corporation of India, which is a Central Public Sector
Undertaking, has 10 units. There are 10 large cement plants owned by various State

45

Governments. The total installed capacity in the country as a whole is 159.38 million tonnes.
Actual cement production in 2006-07 was 116.35 million tonnes as against a production of
106.90 million tonnes in 2004-05, registering a growth rate of 8.84%. Major players in cement
production are Ambuja cement, Aditya Cement, J K Cement and L & T cement.
Apart from meeting the entire domestic demand, the industry is also exporting cement
and clinker. The export of cement during 2004-05 and 2006-07 was 5.14 million tonnes and
6.92 million tonnes respectively. Export during April-May, 2007 was 1.35 million tonnes.
Major exporters were Gujarat Ambuja Cements Ltd. and L&T Ltd.
The Planning Commission for the formulation of X Five Year Plan constituted a 'Working
Group on Cement Industry' for the development of cement industry. The Working Group has
identified following thrust areas for improving demand for cement;

i. Further push to housing development programmes;
ii. Promotion of concrete Highways and roads; and
iii. Use of ready-mix concrete in large infrastructure projects.

Further, in order to improve global competitiveness of the Indian Cement Industry, the
Department of Industrial Policy & Promotion commissioned a study on the global
competitiveness of the Indian Industry through an organization of international repute, viz.
KPMG Consultancy Pvt. Ltd. The report submitted by the organization has made several
recommendations for making the Indian Cement Industry more competitive in the international
market. The recommendations are under consideration.
Cement industry has been decontrolled from price and distribution on 1st March 1989 and de-
licensed on 25th July 1991. However, the performance of the industry and prices of cement are
monitored regularly. Being a key infrastructure industry, the constraints faced by the industry
are reviewed in the Infrastructure Coordination Committee meetings held in the Cabinet
Secretariat under the Chairmanship of Secretary (Coordination). The Committee on
Infrastructure also reviews its performance.

Technological change

Continuous technological upgrading and assimilation of latest technology has been going on in
the cement industry. Presently 93 per cent of the total capacity in the industry is based on
modern and environment-friendly dry process technology and only 7 per cent of the capacity is

46

based on old wet and semi-dry process technology. There is tremendous scope for waste heat
recovery in cement plants and thereby reduction in emission level. One project for co-
generation of power utilizing waste heat in an Indian cement plant is being implemented with
Japanese assistance under Green Aid Plan. The induction of advanced technology has helped
the industry immensely to conserve energy and fuel and to save materials substantially. India is
also producing different varieties of cement like Ordinary Portland Cement (OPC), Portland
Pozzolana Cement (PPC), Portland Blast Furnace Slag Cement (PBFS), Oil Well Cement,
Rapid Hardening Portland Cement, Sulphate Resisting Portland Cement, White Cement etc.
Production of these varieties of cement conform to the BIS Specifications. Also, some cement
plants have set up dedicated jetties for promoting bulk transportation and export.

Future Prospects about the Cement industry
The industry is likely to maintain its growth momentum and continue growing at around 8% in
the medium to long term. Government initiatives in the infrastructure sector (such as the
commencement of second phase of NHDP, rural roads, 10,000 kms of additional highways as
announced in Finance Budget) and the housing sector are likely to be the main drivers of
growth for the industry.

• The acquisition of L&T's cement division by Grasim has changed the landscape of the
entire cement industry and in one fell swoop has catapulted Grasim to the leadership
position. This is a healthy sign for the industry, as this would result in consolidation and
would give significant pricing power to the bigger players. With consolidation taking
place at the lower end also, the unviable units will be forced to shut down thus
benefiting the long-term interests of the industry.

• With no major capacity expansion in the pipeline, the demand supply level is expected
to achieve parity on a macro level by FY08 and this will help in the improvement of
prices. However, since the level of demand supply mismatch is higher in the southern
region, it will take longer to achieve demand supply parity. We expect cement price to
increase by around 6% in FY08 owing to fundamental reasons.

• The industry worked at estimated 84% capacity in FY08 and given the current growth
rates and also assuming no major capacity expansion in the near future, the capacity

47

utilisation is likely to go up significantly in the future. This will help in improving the
margins of all the major players and will lead to higher profitability.

Despite these positives, the possibility of interest rates heading north and the consequent impact
on housing demand remains to be seen. While infrastructure spending was a boon, there was a
strong cushion from the steady growth of the construction sector. If this support wanes, it could
take even longer for demand-supply balance to reach parity. Also, the hike in prices of coal and
petroleum products could impact cement companies margins (account for around 40% of sales).
Though the pricing cushion exists, the margin rise will be mitigated to this extent.

INDIAN STEEL INDUSTRY

INTRODUCTION

Steel is a basic industrial metal because of its high specific strength and relatively low cost per
unit. India is one of the major producers of steel in the world (10th largest) while Steel Authority
of India (a PSU) is the 11 th largest steel making company in the world. The per capita
consumption of steel in India is 20 kgs compared to 20 kgs in Africa, 340 kgs in Europe, 420
kgs in North America and 635 kgs in Japan.

India has rich deposits of iron ore, ferrous ores, manganese ore, and chromate ore. India exports
iron ores to various countries. The major steel products are flat products such as HR-coils, CR-
coils, Galvanised coils/sheets and Long products and steel alloys. The long products find use in
the construction business. HR coils form the raw material for the CR industry. They are used
for LPG cylinders, tubes, pipes, drums, automobile components, boilers, etc. CR coil, which is
a thin sheet, forms the raw material for the galvanised sheets/coils. Alloy steel is high value
added steel for specific application.

The Indian steel industry is plagued by over-capacity, high capital cost, inefficiency and labour
problems. After liberalisation, heavy investments were made in the steel sector. The steel
market was expected to do well. But the fall of Russia, the Asian crisis, and overcapacity world
wide, led to a supply glut resulting in a fall in steel prices. Many developed countries started
protecting the domestic companies by imposing heavy duties on the imported steel products.

48

The Indian steel industry is showing some signs of revival. The steel consumption in India grew
at a good 11% in the first half of the current financial year while finished steel production was
up by 13%. The Indian industry is currently concentrating on the domestic market. Most of the
companies have recorded an increase in the sales in the first quarter of this year. The export
market is currently very dull. The prices of the HR coils and CR coils have dropped drastically.
The government had introduced floor prices to protect the Indian industry.

INDUSTRY STRUCTURE

The steel industry worldwide produces over 750 mn tonnes of crude steel each year. The largest
steel-producing countries are China, Japan and the United States. The integrated steel plants
(ISPs) - Steel Authority of India (SAIL), Tata Steel (TISCO) and Rashtriya Ispat Nigam
(RINL) dominate the Indian steel market. The major ISPs in India are SAIL, TISCO and RINL.
They account for almost 75% of the steel production. SAIL is the 11 th largest producer of steel
in the world while TISCO ranks 59th. TISCO is also one of the lowest cost producer of steel in
the world.

Steel plants can be classified into integrated steel plant (ISP), mini steel plants (MSP) and re-
rolling plants. There are nine integrated steel plants operating in India. There are more than
2,500 MSPs spread across the country. The re-rolling plants process the semi-finished and
intermediate products into finished products. With the liberalization of the steel sector new
private companies have started using of state of the art technology like COREX and CONARC
for production of liquid steel and value added steel respectively. Mini steel producers in India
employ either Electric Arc Furnace [EAF] or Induction Furnace [IF] for steel production.

The steel industry with an estimated turnover of Rs 75,819 crores in the year-end March 2004
comprises of two distinct producer groups.

Major producers: Also known as Integrated Steel Producers (ISPs), this group includes large
steel producers with high levels of backward integration. Steel Authority of India Limited
(SAIL), Tata Steel, Rashtriya Ispat Nigam Limited (RINL), Jindal Vijayanagar Steel Limited
(JVSL), Essar Steel and Ispat Industries form this group. SAIL, TISCO and RINL produce steel
using the blast furnace/basic oxygen furnace (BF/BOF) route that uses iron ore, coal/coke as the

49

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