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