Fall of the Rupee – Part II

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

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

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

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

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

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

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

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

Related articles

• CHART OF THE DAY: The Indian Rupee Is Getting Absolutely Brutalized (businessinsider.com)
• Fall Of Rupee
• Currency crisis in the Emerging Markets 

Fall of the Rupee

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

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

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

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

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

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

Related articles

• CHART OF THE DAY: The Indian Rupee Is Getting Absolutely Brutalized (businessinsider.com)
• Fall Of Rupee - Part II
• Currency crisis in the Emerging Markets 

Material Girl and Mother Monster

Besides the obvious similarity in their profession and the huge popularity enjoyed by the two music artists, the other common point between Madonna and Lady GaGa is that they both have been chosen the subject of case study at B Schools. 

I remember having an interesting start to the strategy class at London Business School with a slide on Madonna. Came to know that she started her career in 1982 and by 2008 she had amassed personal fortune of $300 million with a record sale of 220 million albums. Michael Jackson wondered what it was about her that made her so popular. Not a great dancer or a singer and yet she is always at your face. The answer lies in her positioning, efficiently leveraging and exploiting resources, employees, relationships (Prince, Warren Beatty, Sean Penn & Guy Ritchie) and other organizing skills such as building and using and even breaking alliances, creating controversy, manipulating press but above all ambition, discipline and self development. With an uncanny ability to spot trends, Madonna became known for her music and sex appeal in the period 1988 – 1995, turned to brazen sexuality and controversy in 1996 – 2002 and again reinvented herself into spirituality and politics between 2004 – 2008. She has a very strong sense of what it takes to survive in the business.

Now Lady Gaga has been chosen the subject of a case study at European School of Management and Technology, in Germany. Gaga’s case is different than that of Madonna as she is recognized by music industry insiders as having real talent. She is known to never lip-sync during performances and also writes many of her own songs. Nicknamed as ‘Mother Monster’ and recognized by most for her provocative outfits and wild shows, she is “the most successful contemporary entertainer”. High demand for a special 99-cent download of her album ’Born This Way’ caused the servers of online retailer Amazon to crash.

Says Professor Krupp, Gaga seems to have found the balance between business and art. At a time when the music industry is struggling to compete with free Internet download, Lady Gaga has adapted social media and used her social media strategy to her fullest advantage. She has developed an army of fans through virtual interaction by using Facebook and micro-blogging site Twitter.

The two cases highlight that an individual or an organization can shake up an established industry and bring about strategic innovation by framing and answering the three fundamental strategic questions “Who, What , How” ; “Who is the customer”. “What do we offer this customer,” and “How do we create value for the customer – and ultimately for ourselves”.

Bail me out - Kingfisher Airlines

Corporate India is abuzz with the news of KingFisher’s need for a bailout. Though the airlines company has  not yet defaulted, but with a debt exceeding Rs 7000 cr and losses mounting to thousands of crores, there is little doubt that the company is at the brink of default.

Again, this is not the first time when the company has sought rescue. The airlines underwent a debt restructuring exercise in April 2011, when a consortium of 13 banks converted their debt into equity, paying a significant premium of 62% over the ruling market price of shares.

In the event of a bankruptcy, the assets are liquidated and proceeds are paid to the creditors in the order of their seniority. The equity holders receive only the portion of the proceeds that is left over after paying off the creditors (which, for a company under distress can reduce to nothing). By agreeing to convert a part of their debt into equity, the banks helped the company to lower its interest payments and thus infused liquidity in the company. In the process, the banks increased their ownership stakes in the company while consenting to forego their interest income. After the conversion, the banks equity stakes in KF increased to 23.37% whereas the promoter shareholding including Vijay Malaya’s and other United Breweries group companies fell to 58%.

The question now is, after a restructuring attempt this year itself, what could be a means to salvage the crisis ridden airline. At this stage, when the company is reeling under debt and is at the point of default, any new investment will benefit the debt providers as the cash flows generated from the business will go towards serving the debt interest. Therefore no one will want to put in new equity, not even the promoters. Neither will the creditors be interested to lend more as the company will/may not be in a position to pay the interest. 

In wake of such a situation, both creditors and equity providers would now need to agree upon a restructuring plan wherein creditors could either accept a haircut on debt (by reducing interest/increasing the debt tenure/ granting moratorium) or consent to convert a portion of debt to equity. The company could also go in for supra priority financing where the providers of new money get priority on cash flows over the other existing debt holders.

Restructuring at this stage may require both the promoters and creditors to put in new equity. There has been some news about government having requested Life Insurance Corporation (LIC) to purchase a portion of new equity. In the final shareholding promoters’ stakes is bound to get further diluted from the present 58%. If the promoters holdings are reduced to a level of around 35%, it will open up the possibility for banks, LIC & other shareholders to get together and vote out the current management. It is not uncommon in many parts of the world to vote out a failed management in favour of a competent and professional management.

Such an exercise will send a strong message to founders that restructuring may reduce their stakes to a point where they could lose the ownership and control of the company, if such need arises. This will make them prudent in managing the company and prevent them from taking rash or highly adventurous decisions, as a poor management could cost them the ownership of their company. This will augur well for the India Inc, which is still dominated by family businesses where promoters are generally closed to bringing in outside management. Finally, it will also send a clear signal that incompetent owners cannot flourish at the cost of their employees, while keeping their high salaries and indulging in lavishness.

That, in a free market economy, will be a perfect disincentive to promoters managing their companies poorly.


Related links

Stuck in the middle - Kingfisher Airlines

Stuck in the middle - Kingfisher Airlines

Kingfisher is losing ground. Vijay Mallya is seeking investment, investors are not exactly willing to oblige.  Brand Kingfisher is a strong brand known for its excellent product & service offering. So what went wrong with the airlines?

Captain Gopinath, the founder of Air Deccan believes that Mallya’s big mistake was to change Air Deccan to Kingfisher Red. Kingfisher Airlines catered to the top of the pyramid while Air Deccan was meant for the base of the pyramid and came with its huge customer base and massive network.

After Kingfisher acquired Air Deccan, the rebranding of Air Deccan as Kingfisher Red left little difference between the two brands. They looked the same and offered similar services. This created inconsistency between the value proposition and the market segment to which the brands catered; Kingfisher Red remained neither low cost nor full services. With add on frills, it came out costlier than the other low cost airlines such as Indigo & SpiceJet.

Markets punished the inconsistency. Passengers started to migrate from Kingfisher Airlines Economy to KF Red, which was cheaper and almost on par. And the low cost fliers ditched KF Red for the really low cost airlines. This led to cannibalization of the mother brand while simultaneously hitting the acquired brand.

According to management theory, competitive advantage for a business is derived by either selling a product similar to the contemporary products at a lower cost or creating a unique product and charging a price premium for it. The source of competitive advantage for a business is either a Cost Advantage or a Differentiation Advantage.

Looking at the Kingfisher case, in light of the two generic strategies i.e. Cost Leadership & Differentiation, it is proven yet again that loss of focus on the generic strategies or any attempt to blur the boundaries between the two, leads a business to be ‘Stuck in the middle’. 

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Bail me out - Kingfisher Airlines

Endowments and spending in B schools

While the program fees for MBA and other executive education programs in B schools is widely known,  funding of the B schools remains a key area of interest for any B school’s management team. 

In B schools, funding comes in mainly through 3 sources: MBA Tutions, Development Activities and Executive program fees. Development activities generally include annual giving, capital giving and corporate giving.  During a discussion at roundtable conference in Mexico in 2010, it was found that in top tier US B schools, percentage of revenue distribution is in the range of 40% from MBA Tutions,  30% from Development Activities and 20% from Executive program fees. On the other hand, In European B schools distribution is in the range of 70% from MBA Tutions, 7% from Development Activities and 23% from Executive program fees. In Mexican B schools the distribution between MBA Tutions & Exec Education is 80% & 20%.

Alumni givings vary as per the culture to give back & Corporate givings vary as per tax treatment. Tuck has an excellent Development office as the culture of giving back is part of the structure of their society.  In Europe, very few have been able to create an endowment larger than ten million Euros.  For example, INSEAD still has a rather small endowment despite 20 years of intense work & close alumni relations. Oxford and Cambridge recently have been more successful in the UK but probably because they have a larger base of alumni and very strong brand names.  The rest of the schools in Europe are not very successful in annual giving or endowments. In Mexico individual alumni giving is not very well developed since it is not part of the tradition.  

The financial models drive B schools to build up their strategy and business models. European B schools have a full service business model with a large portfolio of programs & large faculty pool whereas B schools in Mexico (EGADE), Columbia, Argentina and Venezuela have a tuition driven model. In IMD 80% of the revenue comes from executive education. Most schools in the U.S. get most of their revenues from tuition. The top of the pyramid B schools in US have significant annual donations and endowment earnings.

An endowment is the permanent capital of a university, which provides funding for the academic mission of the institution. According to the 2010 report of the National Association of College and University Business Officers (NACUBO), the University of Virginia, has an endowment of roughly $3.9 billion, Duke has an endowment of about $4.8 billion, Notre Dame has an endowment around $5.2 billion, the University of Pennsylvania has an endowment of about $5.7 billion. Princeton’s endowment exceeds $11 billion and Yales exceeds $15 billion. Stanford and Harvard have roughly $13.9 billion and $27.6 billion, respectively.

The rate of spending is between 4% - 5% in the US B schools including Harvard, Yale and Princeton.  Some critics feel that a 5% annual withdrawal from the endowment is far too conservative. Based on analysis of giving patterns and investment returns at a variety of schools, 6% would be more reasonable. On the other hand at 4%, schools are signalling they won't use new gifts for decades to come. Increasingly many donors may realize that their modest contribution is going to mean very little to the school. 

How consumers can help you create new products | How consumers can help you create new products - London Business School BSR

How consumers can help you create new products | How consumers can help you create new products - London Business School BSR

Role of Independent board directors in Indian companies

A recent article in Economic times reveals that following the takeover of scam-hit firm Satyam by Tech Mahindra in 2010, Mahindras are now contemplating to sue the company's erstwhile independent directors to recover Rs 11 million paid as commission to non-executive directors during the financial year 2008-09. Each of Satyam's former independent directors were paid a commission of Rs 12 lakh over and above sitting fees for the financial year 2008-09.

The independent directors of Satyam included renowned people like management guru Krishna G Palepu, Pentium chip innovator Vinod Dham, former Indian School of Business dean Prof Mendu Rammohan Rao, former cabinet secretary TR Prasad, former IIT Delhi director V S Raju and US-based academician Mangalam Srinivasan. It is ironical to note that in the presence of such eminent independent directors, the company’s founder Ramalinga Raju could manage to fudge the company's accounts for several years. This brings into question the role of the board, independence of the so called independent directors and the equation that they share with the company’s management and other stakeholders.

The corporate governance systems in different countries vary depending upon the legal set up, social and cultural values, and the structure of capital markets. The shareholder centric model of corporate governance in US and UK was created based on common law, which associates an equal or even higher weight to past precedential court decisions on similar cases, as to the statutes passed by legislative bodies. In the Anglo Saxon model followed, a unitary board of executive and non executive directors serves as the controlling mechanism to ensure that management act in the interest of shareholders of publicly traded corporations and pass on the profits to them. The corporate environment in India is very similar to that in the UK, having been built from the legal foundations and legacies of the UK. India is pre-eminently a common law country with a well developed system of law and justice. Similar to the UK and the US, the Indian regulations focus on the role of the board as the bridge between owners and management.

Taking into account the existence of concentrated and controlling shareholders in India, the amended Clause 49 of SEBI guidelines seeks to moderate this particular influence by the presence of majority of independent directors. Clause 49 requires that at least half of the board directors should be independent in companies where chairman is an executive and one third of the board directors should be independent in companies where chairman is a non- executive. Why is it that in spite of majority of independent directors, the Satyam boards of directors acted as silent spectators and were largely ineffective in monitoring the actions of management? To some extent to this behaviour can be attributed to the process through which the directors come on the board. The directors are generally brought in by the promoters and management; therefore they could look upon themselves as having responsibility to the promoters rather than to the outside shareholders. As a result, the boards of directors may remain passive or largely function as mouth- speak of the management.

In India, family run companies continue to dominate the corporate landscape. In most family controlled businesses, the managerial control of the business is often in the hands of the members of the family, who either own the majority stake, or maintain control through the aid of other block holders like financial institutions. The interests of the promoters, who are the majority shareholders, need not coincide with those of the other minority shareholders. This can lead to expropriation of minority shareholder value through actions like “tunneling” of corporate gains or funds to other corporate entities within the group. Under such circumstances, the directors who are friends and allies of the promoters may opt to confess incompetence and ignorance rather than to disturb the family based governance structures of Indian companies. When Dr Rao, the dean of the prestigious BSchool resigned from Satyam board, he was reported to have acknowledged of having no prior knowledge of the scam and was said to be stunned by the revelations of Ramalinga Raju.

Such instances of failure in corporate governance highlight the need for more changes to the existing systems. While the corporate governance framework established in India is robust and in principle as effective as those of the UK and US, the effectiveness of enforcement of the framework still remains an interesting empirical question.

Related articles

• Companies Bill 2012– Giving Voice to Minority Investors in India
• Is shareholder engagement good for companies 

Risks and return considerations for companies investing in foreign markets

Since the past few months, the telecom service provider Uninor has been under scanner on eligibility criteria for allocation of 2G spectrum, by the former telecom minister of India. India’s Department of Telecom (DoT) has imposed a penalty of Rs 6.35 crore for not complying with the roll-out obligations, of which Uninor has been directed to pay Rs 3.8 crore by the telecom tribunal TDSAT, following the company’s petition challenging the penalty imposed by the DoT. The cancellation of licences or even the imposition of penalties could severely hurt cash flows of Uninor and of some other telcos which were issued similar notices.

Uninor is a joint venture between reality firm Unitech and telecom firm Telenor of Norway, of which the Norwegian government is a major shareholder. Telenor’s acquisition of 67.25% stake in Unitech Wireless of India was funded with a Rights issue in October 2008. Telenor’s share price had dropped by 25% on the announcement day and by 45% over the month. The negative market reaction could have stemmed from the fact that India was an unknown market for Norwegian investors and they had doubts regarding the future returns from investments in India. Now, with India’s Supreme court monitoring the 2G scam investigations, their future is increasingly looking uncertain. Till date Uninor is reported to have invested around Rs 9,000-10,000 crore and set up 30,000 towers.

This brings us to the question why do companies invest overseas and what are the risks and the expected returns for investing in the foreign markets.

Some of the key reasons for which companies choose to invest overseas are to gain access to new markets, to obtain superior or less costly access to the inputs of production (land, labor, capital, and natural resources) than at home or to build strategic assets, such as distribution networks or new technology. Diversification into uncorrelated markets may result in reduction of risks.

A point to be noted is that the cost of capital for investors of a company that invests in a foreign land is different from the cost of capital for investors of a company investing in its own stock market.  This is due to the fact that the investors investing in a foreign country are exposed to risks such as exchange rate risk, political, sovereign and expropriations risks. The dividends can be paid to these investors only after the generated cash is repatriated to the home country. During war or unrest there could be possibility of expropriation in a foreign land. As such, the parent company may not be able to repatriate interests, dividends, or royalties it earned abroad, send home the funds held in a foreign bank account opened by a branch office. Sovereign risk or transfer risk refers to the possibility of the cash generated in the foreign country being blocked when the reserves of hard currency in the host country are low. Such risks can typically be insured by private or government insurance companies.

In case of Telenor, the cost of capital for evaluating an investment in India is likely to be different from the cost of capital for an Indian firm, let’s say Idea cellular evaluating a similar investment in India. The returns from the investment of an Indian firm in India are likely to be strongly correlated with the Indian market index since there are common factors that affect all Indian firms in similar ways. On one hand exchange rate risk, political, sovereign and expropriations risks increase the riskiness of the Norwegian investment. On the other hand, the same project may yield benefits of diversification of risk for Telenor, if the returns from the Indian project are essentially uncorrelated with the returns on the Norwegian market portfolio.

The return on equity for an Indian firm making an investment in India can be calculated by using a beta (the non-diversifiable risk of a company) obtained by regressing returns from a portfolio of stocks in the same industry on the Indian stock market index. Beta is the product of the relative volatility of a security's returns and the correlation of the security's returns to the market's returns.

For the Norwegian firm, the company would first forecast the cash flows from operations in India. It would then take into account the effect of intra-firm transactions, which will be affected by international taxation, transfer risks and remittance Policy. At the same time, the discount rate by which the cash flows will be discounted will be different for domestic company & a foreign company. For the foreign company the discount rate will take care of the exchange rate risk, country risk, political, sovereign and expropriations risks. At the same time the beta used for calculation of the discount rates will also be different, to account for correlation with the market.

Due to the inherent riskiness of overseas investment, investors may have a home bias and would expect higher returns on the cost of capital if the target acquisition is funded with investors’ money.

An Year off from Job - Mid Career B School Program

'The pen is mightier than the sword' said the English author Edward Lytton. Taking a cue from this famous adage, it would not be out of place to say that in today’s world 'The net is mightier than the jet'. Having completed a reputed program for senior executives from the top Business School in UK and now exploring career options in India, I feel that blog would be a great medium of expression for reaching out to people and sharing my thoughts with those who might be interested in reading this. 
Since the last one year many people have approached me to find out what the Sloan experience has been like, with the obvious question at the back of the mind 'Is it worth investing a huge  sum of money for a one year management program at a mid career stage in life?'. Honestly it is difficult to have a cookie cutter answer to the question because a whole lot of it depends on what a person aims to achieve in that one year and how he or she is able to leverage on the learning while building on the past professional experience. I will attempt to pen down the aspects that a person may want to consider before taking the decision to go in for a mid life academic retooling.

The reason that people opt for mid career management programs is primarily because they want to explore different career options such as the option of changing industry or job function or else reaching a higher level within their existing careers, exploring entrepreneurial options or expanding their existing business. These could be people who have harboured the ambition of going to the best B schools earlier on in life but could not do so, due to some reason or the other. Some who feel monotony setting in their current jobs are desirous of acquiring the skills that will help them to enhance their career growth prospects and make a transition to a different function or a different industry or to the next higher level. For such folks, a one year management program is generally the most favoured option, considering the opportunity cost i.e. forgone salary and repayment of loan, particularly when the candidate is not on a company sponsored sabbatical. 

While considering the choice of the program, aspirants may want to look at the ones that offer insights into the best and current business practice and research, helps in building a global network, offer a diverse peer group and a good brand name. After attending the Sloan program, I can easily vouch for the fact that such programs help to widen one’s knowledge horizon, challenge one’s thought process, encourage lateral thinking and may ignite the passion for entrepreneurship. It is a riveting experience to hear from and interact with the top business leaders in the world, to understand and appreciate their views on policy and business matters. We learn to work in diverse groups consisting of people with different backgrounds, from different countries with different work cultures. The program is so engrossing that at times the means looks more important than the end. It involves a lot of hard work and before one realizes, the year gets over and one returns with the hope to get the opportunity to put into use the knowledge acquired during the year.

The other side of the coin to be considered is the placement options available after completion of the program. Here I must say that a lot of patience, determination & clarity is needed for chalking out the future career path. Prospective candidates are expected to have a mature mindset as the program prepares people for long term success. Such program cannot be looked upon as a short cut route to make quick bucks.

Unlike the MBA campus recruitments, the campus recruitments for mid career program are limited and very few in number. So it is advisable that the location in which a person wants to work is taken into account while selecting a B school program. Residing in the same geography in which a person wants to work gives visibility to the market and the recruitment scenario.

One has to be aware of the fact that recruitment consultants work on company mandates and they are likely to position a candidate only they see a great fitment of your profile with the requirement in hand. So consultants may not be the best route to take if one is looking for a change in industry or function.

In B schools a substantial emphasis is placed on networking. In order to effectively network it is crucial to understand the sector in which the person wishes to work & network accordingly. While for some it may yield quick results, for others it could be a long time before one gets good leads, contacts or references. It would be good to know the number of self sponsored alumni who could make a successful transition. Contacting alumni could be a good way to know how to go on about making the desired change.

Finally a candidate should not discount or rule out the possibility of joining back the same company as the one in which the person worked prior to joining the program. This is due to the fact that if one is looking for a change in function, it is easier done in a company where the person has worked before. After all it is easier to convince people with whom one has worked before than convincing a different set of people in a new environment.

With all these considerations, I believe, a person can make an informed decision to take up a mid career academic program.