Final My Report on financial system

7/27/2019 Final My Report on financial system

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ACKNOWLEDGEMENTACKNOWLEDGEMENT

The most pleasant part of any project is to express gratitude andThe most pleasant part of any project is to express gratitude and

bestow honour towards all those who directly or indirectly contributed tobestow honour towards all those who directly or indirectly contributed to

the smooth flow of the project work and this being the good opportunity; Ithe smooth flow of the project work and this being the good opportunity; I

dont want to miss it.dont want to miss it.

Sincere acknowledgement are due foremost to the institutionSincere acknowledgement are due foremost to the institution

Hindustan Institute Of Management And Computer Studies, Farah,Hindustan Institute Of Management And Computer Studies, Farah,

Mathura which endowed me with the valuable opportunity to explore soMathura which endowed me with the valuable opportunity to explore so

interesting and a critical topic as is the subject of the present report.interesting and a critical topic as is the subject of the present report.

I thank my project guide Ms. Jyoti, for her valuable inputs in theI thank my project guide Ms. Jyoti, for her valuable inputs in the

research and spending so much of valuable time and effort in helpingresearch and spending so much of valuable time and effort in helpingwith my topic.with my topic.

I also wish to express sincere gratitude to all the respondents of theI also wish to express sincere gratitude to all the respondents of the

project without the kind of co-operation of whom this work would notproject without the kind of co-operation of whom this work would not

have been possible.have been possible.

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OBJECTIVES OF THE

RESEARCH REPORT

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OBJECTIVE OF THE RESEARCH REPORT

The objective of the study include following points

To understand the macro-economic environment and

developments.

To analyze the prospects of the industry to which the firm

belongs.

To assess the projected performance of the company and the

intrinsic value of its shares.

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________________________

RESEARCH

METHODOLOGY

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RESEARCH METHODOLOGY

Redman and Mory has defined research as

A systematized effort to gain new knowledge.

Research Methodology is a way to systematically solve the research problem. In it we

study the various steps that are generally adopted in studying the research problem --

identification & evaluation along with the logic behind it.

It is necessary for the researcher to know not only the research methods/ techniques but

also the methodology. Research not only need to know how to apply particular research

techniques, but also need to know which of these methods or techniques are relevant and

which are not and which are necessary for the researcher to design to objective.

When we talk of research methodology we not only talk of the research methods but also

considers the logic behind the methods we use in the context of our research study and

explain why we are using a particular method or technique so that research results are

capable of being evaluated.

The steps involved in the making of the research report are:

Reviewing literature (reviewing concepts and theories & reviewing previous

research findings)

Design research (including sample design)

Collect data (Execution)

Analyze data (Test hypothesis if any)

Interpret and report

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TYPES OF RESEARCH

DESCRIPTIVE REASEARCH

ANALYTICAL RESEARCH

APPLIED RESEARCH

FUNDAMENTAL RESEARCH

QUANTITATIVE RESEARCH

QUALITATIVE RESEARCH

CONCEPTUAL RESEARCH

EMPIRICAL RESEARCH

The kind of research used in this research report is DESCRIPTIVE RESEARCH.

Descriptive research, also known as statistical research, describes data and

characteristics about thepopulation or phenomenon being studied. Descriptive researchanswers the questions who, what, where, when and how.

Although the data description is factual, accurate and systematic, the research cannot

describe what caused a situation. Thus, descriptive research cannot be used to create a

causal relationship, where one variable affects another. In other words, descriptive

research can be said to have a low requirement forinternal validity.

Descriptive research is also called Statistical Research. The main goal of this type of

research is to describe the data and characteristics about what is being studied. The idea

behind this type of research is to study frequencies, averages, and other statistical

calculations. Although this research is highly accurate, it does not gather the causes

behind a situation.

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http://en.wikipedia.org/wiki/Statisticshttp://en.wikipedia.org/wiki/Statistical_populationhttp://en.wikipedia.org/wiki/Statistical_populationhttp://en.wikipedia.org/wiki/Causalityhttp://en.wikipedia.org/wiki/Internal_validityhttp://en.wikipedia.org/wiki/Statisticshttp://en.wikipedia.org/wiki/Statistical_populationhttp://en.wikipedia.org/wiki/Causalityhttp://en.wikipedia.org/wiki/Internal_validity


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METHODS OF DATA COLLECTION

The research can call for primary data, secondary data or both. The data have mainly

been collected via primary sources. However a good amount of secondary data was also

used to have a general understanding of the subject.

Primary Source:

The primary data are gathered for specific purpose and are collected by the researcher

himself. It includes direct communication with the customer. For the purpose of

collecting information from customers a structured questionnaire was formulated and is

contacted directly.

Secondary Sources:

The secondary sources are data which are collected for another purpose and already

exists somewhere. The secondary source of information here includes books, articles in

various newspapers and magazine, product catalogs and online articles.

The method used in this report fro data collection is SECONDARY METHOD.

Probably the quickest and most economical way for researcher to find possible

hypothesis is to make advantage of the work of others and utilize their research

programs over a number of years. Data or desired information has been collected

through books, newspapers, trade journals and white papers, industry portals, &

monitoring of industrial news and developments.

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INTRODUCTION TO THEFINANCIAL SYSTEM

FINANCIAL SYSTEM

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Overview:

Financial System of any country consists of financial markets, financial intermediation

and financial instruments or financial products. A financial system may be defined as a

set of institutions, instruments and markets which foster savings and channels them to

their most efficient use. The system consists of individuals (savers), intermediaries,

markets and users of savings. Economic activity and growth are greatly facilitated by the

existence of a financial system developed in terms of the efficiency of the market in

mobilizing savings and allocating them among competing users.

The word "system", in the term "financial system", implies a set of complex and closely

connected or interlined institutions, agents, practices, markets, transactions, claims, and

liabilities in the economy. The financial system is concerned about money, credit and

finance-the three terms are intimately related yet are somewhat different from each

other. Indian financial system consists of financial market, financial instruments and

financial intermediation.

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CONSTITUENTS OF A FINANCIAL SYSTEM

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CAPITAL MARKETS

Indian capital markets have been one of the best performing markets in the world in the

last few years. Fuelled by strong economic growth and a large inflow of Foreign

Institutional Investors (FIIs) as well as the development of the domestic mutual funds

industry, the Indian stock market indices have delivered truly explosive growth during

the last 5 years rising over 3 times during the period. However, it would be a mistake to

think that growth has happened only in valuation. During this period Indian capital

markets have exhibited explosive growth in almost every respect.

While the two major Indian exchanges, the Bombay Stock Exchange (BSE) and the

National Stock Exchange (NSE) ranked 16th and 17th respectively among exchanges

around the world in terms of market capitalization. The former has close to 5,000 stocks

listed, of which about half actually trade. In terms of concentration (i.e. the share of top

5% of stocks in total trading) they are not out of line with other major exchanges, though

in terms of turnover velocity, BSE is the lowest among the top 20 exchanges.

The relatively newly formed NSE has overtaken the more traditional BSE (which is

older than the Tokyo Stock Exchange) and now has over 30% higher turnover in terms

of value and almost 2.5 times BSEs turnover in terms of number of trades (see table

3.1). Table 3.2 depicts the evolution of liquidity in Indian capital markets in recent years.

The regional stock exchanges in India, numbering 20, have recently been relatively

speaking devoid of action. In March 2006, the BSE market capitalization accounted for

about 86% of Indian GDP while that of the NSE accounted for about 80%. In terms of

risk and return, while the Indian markets have been more volatile than those in

industrialized nations, the returns have been largely commensurate (see table 3.3).

Table 3.4 shows the growth in the number of players in the different segments of the

Indian capital markets since 1993. In the new century, a huge derivative market has been

created from scratch, foreign institutional investors have almost doubled in number,

venture capital funds have made their appearance and exhibited sound growth, and the

number of portfolio managers has risen over three-fold. The entire industry has therefore

gone through a major transformation during the period.

During 2005-06, Indian corporations mobilized over Rs. 1237 trillion ($ 30.93 trillion)

from the markets (which accounted for close to 4% of the GDP at factor cost in current

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prices) of which close to 78% was debt, all of which was privately placed. Of equity

issues amounting to over Rs. 273 trillion ($ 6.825 trillion), about 40% were IPOs and the

remainder seasoned offerings. Close to 25% of these latter were rights offerings.

Qualitatively, these proportions have remained more or less stable over the years.

The liberalization and subsequent growth of the Mutual Funds industry, for decadesmonopolized by the state-owned Unit Trust of India (UTI), since the turn of the century

has been one of major stories of Indian capital markets. From the turn of the century,

assets under management have more than tripled, in pace with and fuelling the rise of the

markets.

The biggest development in the Indian capital markets in recent years is undoubtedly the

introduction of derivatives futures and options both on indexes as well as individual

stocks with turnovers growing 50 to 70 times in the past 5 years and the derivatives

segments quickly becoming a crucial part of the Indian capital markets.

The rapid growth in Indian capital markets, and the spread of equity culture has

doubtlessly strained its infrastructure and regulatory resources. Nevertheless the

securities market watchdog, the Securities and Exchanges Board of India (SEBI) has

maintained a rate of around 95% in redressing investor grievances reported to it, though

investigations undertaken and convictions obtained have, on a proportional basis, trailed

those of the Securities Exchange Commission (SEC) of the USA.

Capital markets play a vital role in providing liquidity and investment instruments. A

liquid corporate bond market can play a critical role in supporting economic

development as it supplements the banking system to meet the requirements of the

corporate sector for long-term capital investment and asset creation. The domestic

capital market can help financial stability by reducing currency mismatches and

lengthening the duration of debt11. The private corporate debt market, which is an

important segment of the capital market, plays a crucial role in promoting financial

stability by providing an alternative means of long-term resources. Such markets also

improve economic efficiency by generating market-determined interest rates that reflect

the opportunity costs of funds at different maturities. In economies lacking well-

developed capital debt markets, long-term interest rates may not be competitively

determined and thus may not reflect the true cost of funds. This, in turn, will make it

difficult for banks to price long-term lending, and borrowers will lack a market reference

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Mutual funds have played an important role in the development of the capital market.

Growing investor interest in the equity market over the years could also be gauged from

the resource mobilization by mutual funds. Net funds mobilized by mutual funds (net of

redemptions) increased sharply to Rs.93,985 crore during 2006-07 as compared with

Rs.52,780 crore during 2005-06 mainly due to resources mobilized under debt oriented

schemes which almost quadrupled during the year. Such schemes are preferred for

parking surplus funds for short periods with minimum risks. The net mobilization of

resources by mutual funds under equity oriented schemes during 2006-07 declined,

reflecting the risk aversion tendency among investors particularly in view of the stock

market touching record peaks.

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FUNDAMENTAL ANALYSISFundamental analysis of a business involves analyzing its income statement, financial

statements and health, its management and competitive advantages, and its competitors

and markets.

The analysis is performed on historical and present data, but with the goal to make

financial projections. There are several possible objectives:

to conduct a company stock valuation and predict its probable price evolution,

to make projection on its business performance,

to evaluate its management and make internal business decisions,

to calculate its credit risk.

The intrinsic value of an equity share depends on a multitude of factors. The earnings ofthe company, the growth rate and therisk exposure of the company have direst bearing

on the price of the share. Theses factors in turn rely on the host of other factors like

economic environment in which they function, the industry they belong to, and finally

companies own performance. The fundamental school of thought appraised the intrinsic

value of the shares through:

Economic Analysis

Industry Analysis

Company Analysis

Fundamental analysis serves to answer questions, such as:

Is the companys revenue growing?

Is it actually making aprofit?

Is it in a strong-enough position to beat out its competitors in the future?

Is it able to repay its debts?

Is management trying to "cook the books"?

Of course, these are very involved questions, and there are literally hundreds of others

you might have about a company. It all really boils down to one question: Is the

companys stock a good investment? Think of fundamental analysis as a toolbox to help

you answer this question.

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http://en.wikipedia.org/wiki/Income_statementhttp://en.wikipedia.org/wiki/Financial_statementshttp://en.wikipedia.org/wiki/Financial_statementshttp://en.wikipedia.org/wiki/Competitorshttp://en.wikipedia.org/wiki/Marketshttp://en.wikipedia.org/wiki/Stock_valuationhttp://en.wikipedia.org/wiki/Credit_riskhttp://www.investopedia.com/terms/p/profit.asphttp://www.investopedia.com/terms/d/debt.asphttp://www.investopedia.com/terms/c/cookthebooks.asphttp://en.wikipedia.org/wiki/Income_statementhttp://en.wikipedia.org/wiki/Financial_statementshttp://en.wikipedia.org/wiki/Financial_statementshttp://en.wikipedia.org/wiki/Competitorshttp://en.wikipedia.org/wiki/Marketshttp://en.wikipedia.org/wiki/Stock_valuationhttp://en.wikipedia.org/wiki/Credit_riskhttp://www.investopedia.com/terms/p/profit.asphttp://www.investopedia.com/terms/d/debt.asphttp://www.investopedia.com/terms/c/cookthebooks.asp


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Researchers have found that stock price changes can be attributed to the following

factors:

Economy-wide factors: 30-35 percent

Industry factors: 15-20 percent

Company factors: 30-35 percent

Others factors: 15-25 percent

Based on the above evidence, a commonly advocated procedure of fundamental analysis

involves a three-step examination which calls for:

Understanding of the macro-economic environment and developments

Analyzing the prospects of the industry to which the firm belongs

Assessing the projected performance of the company and the intrinsic value

of its shares

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_______________________

_

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MACRO-ECONOMICANALYSIS

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MACRO-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 grow rapidly and

viceversa. When the level of the 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.

MACRO-ECONOMIC FACTORS

There are various factors that need to be analysed.

Some of the parameters taken under consideration are:

Gross Domestic Product

Savings and Investments

Inflation

Interest rates

Budget

Balance of Payment

Monsoon and Agriculture

Industrial Growth Rate

Foreign Investments

Sentiments

Infrastructure Facilities

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Gross Domestic Product:

The Indian BPO sector, skyrocketed the India GDP growth rate to around 6%, during the

period from 1988 to 2003. The period after 2004 marks the meteoritic rise of gross

domestic product of India and this rise was affected by service and manufacturing

industry. The India GDP growth rate registered an impressive growth of 8.5% during

this period. The present target of India GDP growth rate is pegged at 9.5% to 10 %.

The higher the growth rate of GDP, other things being equal, the more favorable is

for the stock market.

GDP factor for the first quarter of 2007-08 was at Rs 7, 23,132 crore, registering a

growth rate of 9.3% over the corresponding quarter of previous year.

The Table below gives the overall rates of GDP growth for the past several Quarters.

Fiscal year Quarter OverallGDP

2002 / 03 Q-1Q-2Q-3Q-4

5.2%5.8%1.6%3.8%

2003 / 04 Q-1Q-2Q-3

Q-4

5.5%8.8%11.0%

8.5%2004 / 05 Q-1

Q-2Q-3Q-4

8.1%6.9%5.5%8.9%

2005 / 06 Q-1Q-2Q-3Q-4

8.4%8.0%9.3%10.0%

2006 / 07 Q-1Q-2

Q-3Q-4

9.6%10.2%

8.7%9.1%

2007/08 Q1Q2

9.3%8.9%

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Industrial Growth Rate

The GDP growth rate represents the average of the growth rates of the three principal

sectors of the economy, viz. the services sector, the industrial sector, and the agricultural

sector.

The higher the growth rate of the industrial sector, other things being equal, the

more favorable it is for the stock market

During the period AprilOct. 2007/08, the cumulative expansion of Industrial output was

9.7%, lower than the 10.2% registered in the comparable period of the previous year.

Manufacturing output expanded by 10.4% during AprilOct. 2007/08, which was also

lower than the 11.2% recorded in the Comparable period last year. The lower rate of

manufacturing output growth in 2007/08 has become pronounced since June 2007. The

main contributory factor is the drop in the rate of expansion in consumer durable output,

unsupported by a matching offset from expansion in other product categories.

Infrastructure

Infrastructural facilities and arrangements significantly influence industrial

performance. More specifically, the following are important:

o Adequate and regularsupply of electric power at reasonable tariff.

o A well developed transportation and communication system (railway

transportation, road network, inland waterways, port facilities, air links, and

telecommunications system).

o An assured supply of basic industrial raw materials like steel, coal, petroleum

products, and cement.

o Responsive financial support for fixed assets and working capital .

The infrastructural bottlenecks have traditionally been the bane of the Indian industry.

While the situation has improved in some ways over the years, the industrial sector often

has to contend with inadequate and irregular availability of infrastructural inputs.

During April-November 2007, the infrastructure sector recorded a lower growth of 6.0

per cent than a year ago (8.9 per cent) reflecting slow down in all the sectors. High base,

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decline in refinery output in some public sector refineries and lower capacity utilization

led to the moderation in growth of petroleum refinery products. A sharp deceleration in

crude oil production was attributable to decline in production in some of the Oil and

Natural Gas Corporation (ONGC) and Oil India Limited wells. Lower growth in the coal

sector was mainly on account of decline in production in some of the subsidiaries of

Coal India Limited. Capacity constraints faced by major steel producers combined with

high base slowed down the growth of the steel sector. High base coupled with capacity

constraints have led to moderation in cement sector.

GRAPH SHOWING THE GROWTH IN

INFRASTRUCTURE INDUSTRIES

Investment requirements by 2012 estimated by the Committee on

Infrastructure, headed by the Prime Minister, in some of the key

sectors are: Rs.2, 20,000 crore for modernization and upgradation of

highways; Rs.40, 000 crore for civil aviation; Rs.50, 000 crore for ports;

and Rs.3, 00,000 crore (of which 40 per cent is expected to come from

the private sector through PPP) for the railways.

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Aggregate Demand

Growth of the Indian economy continued to be driven by domestic demand, particularly

gross fixed capital formation (GFCF). While private final consumption demand

contributed 36.3 per cent to the incremental growth in real GDP during July-September

2007 (34.9 per cent during July-September 2006), the contribution of real GFCF was

49.4 per cent (34.6 per cent a year ago). The growth rate of private final consumption

expenditure (PFCE) was estimated at 5.6 per cent in the second quarter of 2007-08 as

compared with 6.3 per cent in the corresponding quarter of 2006-07. The growth rate of

real GFCF accelerated to 15.2 per cent from 13.3 per cent in the corresponding period of

2006-07. The expenditure composition of real GDP indicates a decline in the share of

real PFCE to 55.2 per cent in the second quarter of 2007-08 from 56.9 per cent in the

corresponding period of 2006-07. On the other hand, share of real GFCF, as per cent toGDP, increased to 30.3 per cent from 28.6 per cent.

Money Supply

There are several definitions of money. The two more commonly used ones are:

M1 = Currency with public + demand deposits with bank + other deposits with RBI

M3 = M1 + time deposits with banks

M1 is narrow measures of money supply and M3 is a broad measure. When we talk of

money supply, we usually refer to M3. The growth rate of M3 in India has been around

15 percent per year. This growth can be explained by three factors in the main: growth in

the real economy, monetisation of a portion of deficit financing (this means that the

Reserve Bank of India buys the securities issued by the government), and financial

deepening of the economy. At the end of March 2004, M3 was Rs. 2,000,349 crore.

Annual average growth of Money (M3) reached a trough of 13 per cent in 2003-04 and

has been on an accelerating trend since then, reaching 19.5 per cent in 2006-07. The

cumulative (FY to date) increase in the stock of M3 in 2007-08 has also remained above

the cumulative growth in 2006-07 and was 13.3 per cent on January 4, 2008, compared

to 12.2 per cent on January 5, 2006. The ratio of average M3 to GDP has increased from

44 per cent in 1990-91 to 71 percent in 2006-07. This could be attributed to the spread of

banking services and the saving habit, resulting in a rise of time deposits. The

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monetization of the economy as measured by the ratio of average M1 to GDP has

increased from 15 per cent in 1990-91 to 21 per cent in 2006-07.

Table: Monetary sector indicators upto October

Variation in M3 (Rs crore)

2006-07 2007-08Variation in M3 (%)

2006-07 2007-2008

April 42834 24852 1.6 1.8

May 49734 2832 8 1.0 8 0.9

June 55411 78638 2.0 2.4

July 106964 140792 4.0 4.3

August 166054 165806 6.1 5.0

September 223812 264149 8.2 8.0

October 216784 297906 7.9 9.0

November 222433 8.1

December 222433 10.6

January 380403 13.9

February 458241 16.8

March 566096 20.7.

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Agriculture and Monsoons

Agriculture accounts for about a quarter of the Indian economy and has important

linkages, direct and indirect, with industry. Hence, the increase or decrease of

agricultural production has a significant bearing on industrial production and corporate

performance. Companies using agricultural raw materials as inputs or supplying inputs

to agriculture are directly affected by the changes in agricultural production. Other

companies also tend to be affected due to indirect linkages.

A spell of good monsoons imparts dynamism to the industrial sector and buoyancy to the

stock market. Likewise, a streak of bad monsoons casts its shadow over the industrial

sector and the stock market.

There has been a loss of dynamism in the agriculture and allied sectors in recent years. A

gradual degradation of natural resources through overuse and inappropriate use of

chemical fertilizers has affected the soil quality resulting in stagnation in the yield levels.

Public investment in agriculture has declined and this sector has not been able to attract

private investment because of lower/unattractive returns. New initiatives for extending

irrigation potential have had a limited success during the Tenth Five Year Plan and only

a little over 8 million ha could be brought under irrigation and only three-fourths of that

could be utilized.

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Savings and Investment

The demand for corporate securities has an important bearing on stock price movements.

So investment analysts should know what is the level of investment in the economy and

what proportion of that investment is directed toward the capital market.

The level of investment in the economy is equal to: Domestic savings + Inflow of

foreign capital Investment made abroad.

A notable feature of the recent GDP growth has been a sharply rising trend in gross

domestic investment and saving, with the former rising by 13.1 per cent of GDP and the

latter by 11.3 per cent of GDP over five years till 2006-07. The average investment ratio

for the Tenth Five Year Plan at 31.4 per cent was higher than that for the Ninth Five

Year Plan, while the average saving rate was also 31.4 per cent of GDP higher than theaverage ratio of 23.6 per cent during the Ninth Five Year Plan.

Both private and public savings have contributed to higher overall savings. Private

savings have risen by 6.1 per cent points of GDP over the Tenth Five Year Plan period

while public sector savings increased by 5.2 per cent of GDP. Both have increased

steadily over this period, though private savings appear to have reached a plateau in

2005-06.

In contrast to the increase in savings the increase in investment has been driven by

private investment, which went up by 10.3 per cent of GDP over the five years of the

Tenth Five Year Plan. This improvement was in turn driven by private corporate

investment, which increased by 9.1 per cent of GDP over these five years. Private

corporate sector investment improved from 5.4 percent of GDP in 2001-02 to 14.5 per

cent in 2006-07. The upsurge in private corporate investment has been visible even to

the public as a Capex boom, and that is still continuing.

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Government Budget and Deficit

Governments play an important role in most economies, including the Indian economy.

The central budget (as well as the state budgets) prepared annually provides information

on revenues, expenditures, and deficit (or surplus, in rare cases).

In India, governmental revenues come more from indirect taxes such as excise duty

and customs duty and less from direct taxes such as income tax. The bulk of the

governmental expenditures go toward administration, interest payment, defense, and

subsidies, leaving very little for public investment. The excess of governmental

expenditures over governmental revenues represents the deficit. While there are

several measures of deficit, the most popular measure is the fiscal deficit.

The fiscal deficit has to be financed with government borrowings which are done in

three ways.

First, the government can borrow from the Reserve Bank of India. This leads to

increase in money supply which has an inflationary impact on the economy.

Second, the government can resort to borrowing in domestic capital market. This

tends to push up domestic interest rates and crowd out private sector investment.

Third, the government may borrow from abroad.

Borrowing per se is not bad but if the borrowed money is not put to productive purpose,

servicing the debt becomes very onerous leading to fiscal crisis.

Investment analysts examine the government budget to assess how it is likely to impact

on the stock market. They generally classify favorable and unfavorable influences as

follows:

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Favorable Unfavorable

A reasonably balanced

budget.

A level of debt (both

internal and external)

which can be serviced

comfortably.

A tax structure which

provides incentives for

stock market investment

A budget with a high

surplus or deficit.

A level of debt (both

internal and external)

which is difficult to

service.

A tax structure which

provides disincentive for

stock market investment.

Balance of Payments

India's balance of payments position continued to remain comfortable during the first

half of 2007-08 (April-September), notwithstanding some deceleration in exports and

higher growth in non-oil imports. Merchandise exports maintained the growth

momentum during April-November 2007, although there was some moderation as

compared with the growth rate during April-November 2006. Imports during April-

November 2007 posted a high growth rate; oil imports, however, witnessed a sharp

deceleration from the strong growth recorded during the corresponding period of the

previous year. Net invisibles surplus remained buoyant during the first half of 2007-08,

led by higher growth in private transfers and offset a large part of the trade deficit. The

current account deficit during April-September 2007 was marginally higher than that

during April-September 2006. Net capital inflows were substantially higher than those in

the corresponding period of 2006-07, resulting in a sharp increase in foreign exchange

reserves of US $ 85.7 billion during 2007-08 (up to January 18, 2008).

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TABLE SHOWING INDIAS BALANCE OF

PAYMENTS

Table : Indias Balance of Payments

(US $ million)

Item 2006-07 PR 2006-07 PR 2007-2008

April-March April- July- April- April- July- April-

June Sept. Sept. June PRSept. P Sept. P

1 2 3 4 5 6 7 8

Exports 128,083 29,614 31,836 61,450 35,790 37,875 73,665

Imports 191,254 46,631 48,593 95,224 56,480 59,586116,066

Trade Balance -63,171-17,017-16,757-33,774 -20,690-21,711 -42,401

(-6.9)

Invisible Receipts 115,074 24,946 24,953 49,899 29,379 32,213 61,592

Invisible Payments 61,669 11,994 14,471 26,465 13,886 16,018 29,904

Invisibles, net 53,405 12,952 10,482 23,434 15,493 16,195 31,688

(5.8)

Current Account -9,766 -4,065 -6,275-10,340 -5,197 -5,516 -10,713

(-1.1)

Capital Account (net)* 46,372 10,444 8,545 18,989 16,397 34,752 51,149

of which:

Foreign Direct Investment 8,479 1,579 2,912 4,491 1,738 2,142 3,880

Portfolio Investment 7,062 -506 2,150 1,644 7,458 10,876 18,334

External CommercialBorrowings +

16,155 3,974 1,761 5,735 6,963 3,594 10,557

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Short-term Trade Credit 6,612 1,182 2,683 3,865 2,153 3,558 5,711

External Assistance 1,767 49 337 386 276 453 729

NRI Deposits 4,321 1,302 908 2,210 -447@ 369 -78

Change in Reserves # -36,606 -6,379 -2,270 -8649 -11,200-29,236 -40,436

Memo:

Current Account net of -37,707-10,959-11,646-22,605 -13,537-15,596 29,133

Private Transfers (-4.1)

Foreign Exchange ReservesIndia's foreign exchange reserves were US $ 284.9 billion as on January 18, 2008,

showing an increase of US $ 85.7 billion over end-March 2007. The increase in reserves

was mainly due to an increase in foreign currency assets from US $ 191.9 billion during

end-March 2007 to US $ 276.1 billion as on January 18, 2008

India holds the third largest stock of reserves among the emerging market economies

after China and Russia. The overall approach to the management of India's foreign

exchange reserves in recent years reflects the changing composition of the balance of

payments and the 'liquidity risks' associated with different types of flows and other

requirements. Taking these factors into account, India's foreign exchange reserves

continued to be at a comfortable level and consistent with the rate of growth, the share of

external sector in the economy and the size of risk-adjusted capital flows.

TABLE SHOWING FOREIGN EXCHANGE RESERVES

Table : Foreign Exchange Reserves

(US $ million)

Month Gold SDR Foreign

Currency Assets

Reserve Position

in the IMF

Total

(2+3+4+5)

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1 2 3 4 5 6

March 1995 4,370 7 20,809 331 25,517

March 2000 2,974 4 35,058 658 38,694

March 2005 4,500 5 135,571 1,438 141,514

March 2006 5,755 3 145,108 756 151,622

March 2007 6,784 2 191,924 469 199,179

April 2007 7,036 11 196,899 463 204,409

May 2007 6,911 1 200,697 459 208,068

June 2007 6,787 1 206,114 460 213,362

July 2007 6,887 12 219,753 455 227,107

August 2007 6,881 2 221,509 455 228,847

September 2007 7,367 2 239,955 438 247,762

October 2007 7,811 13 256,427 441 264,692

November 2007 8,357 3 264,725 435 273,520

December 2007 8,328 3 266,553 432 275,316

January 2008* 8,328 3 276,134 433 284,898

* : As on January 18, 2008.

Exchange rates movements

As has been the case in recent years, there has been considerable movement in theexchange rates between the major currencies of the world. In 2007, one prominent

characteristic has been the appreciation of some emerging market currencies. In the

calendar year 2007 the Indian rupee was amongst the three emerging market currencies

that appreciated the most, after the Brazilian realand Thai baht, recording appreciation

in double digits. India was one of the very few emerging and NIC (newly industrialized

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country) economies in this list whose currency appreciated strongly despite having a

current account deficit. The reason is the widespread practice of managing exchange rate

movements through central bank intervention even where the current account surplus

as a proportion of GDP is 10% or more.

Inflation

The effect of inflation on the corporate sector tends to be uneven. While certain

industries may benefit, others tend to suffer. Industries that enjoy a strong market for

their products and which do not come under the purview of price control may benefit.

On the other hand, industries that have a weak market and which come under the

purview pf price control tend to lose.

On the whole, it appears that a mild level of inflation s good for the stock market.

Indian economy is bearing the high inflation. To some extent it is good for economy but

it should be controlled because if it will convert into hyper inflation then it will be of

great harm for the economy. The prices of goods have been increased and the

government and the RBI have taken several measures to suck the liquidity from the

market. inflation firmed up in major economies during the third quarter of 2007-08

reflecting the combined impact of higher food and fuel prices as well as strong demand

conditions, especially in emerging markets. The monetary policy response during thequarter, however, was mixed in view of heightened concerns about the implications of

credit crunch arising out of the US sub-prime crisis on financial stability. Since end-

September 2007, several central banks (such as the US Federal Reserve System, Bank of

England, Bank of Canada, Bank Indonesia, Central Bank of Philippines and Central

Bank of the Republic of Turkey) cut their policy rates aimed at promoting financial

stability and supporting growth notwithstanding persistence of inflationary pressures.

In India, inflation based on the wholesale price index (WPI) has remained below 4 percent since mid-August 2007 (3.8 per cent as on January 5, 2008), partly reflecting

moderation in the prices of primary food articles and some manufactured products items

as well as base effects. Pre-emptive monetary measures since mid-2004 accompanied by

fiscal and supply-side measures have also helped in containing inflation. Consumer price

inflation also eased during the third quarter of 2007-08 but continued to remain above

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the WPI inflation, mainly reflecting the impact of food prices and their higher weights in

the CPI vis--vis WPI. Various measures of consumer price inflation were placed in the

range of 5.1-5.9 per cent during November/December 2007 as compared with 5.7-7.9

per cent in September 2007 and 6.7-9.5 per cent in March 2007. It may, however, be

noted that since pass-through of higher international oil prices to domestic prices

remains incomplete, inflation has remained suppressed. Elevated international food

prices also pose potential inflationary pressures in the period ahead. Inflation galloped to

7 per cent on March 21, 2008.

The group fuel and power has, however, witnessed an increase in inflation in recent

months.

An increase in the prices of coal and domestic pass through of international price

increase in crude oil to petroleum products, other than petrol and diesel, contributed to

this firming up of inflation.

INFLATION IN INDIA: HOW TO TACKLE IT

Inflation climbed high from 6.68 to 7 percent

The inflation rate climbed to a three year high of 7% for the week ended March 22, well

above the Reserve Bank of India's (RBI's) "comfort zone" ceiling of 5%. This

development created a tremendous fear psychosis in the corridors of power because it is

a well acknowledged fact that inflation hits the lower strata much more than the better-

off section of the society.

Just when the government was contemplating on lowering the benchmark interest rates

in order to spur consumption in the country, this hike in the Wholesale Price Index

(WPI) perhaps put a spanner in their works.

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In the recent past, there has been a global spurt in the prices of food grains and crude oil.

Crude oil prices have crossed the 110 dollars a barrel mark and is likely to head northwards in

the days to come. There has also been a global shortage of output of food grains specially wheat

on account of natural calamities in Australia and China, one of the largest producers of the

commodity. India's output of wheat has also come down mainly because of low productivity.

In the light of this, food grains as well as crude oil prices have contributed in so small measure

to the spiraling prices of other commodities in the market.

The real worrisome factor in the investors' minds is what the government is likely to do

in order to tackle rising prices. While fiscal measures have already been taken, there is

fear that monetary steps, in the form of hiking the CRR hike could be taken as soon as

possible.

Government officials have said that it will take some time before its policies to tackle

inflation begin to take effect. They revealed that more fiscal measures could be taken in

this regard. Planning Commission Deputy Chairman Montek Singh Ahluwalia echoed a

similar view and said that the measures taken by the government, like duty cuts essential

commodities and ban on export of rice, would impact the rising inflation.

The Commerce Minister, Mr. Kamal Nath also pointed out that the government would

take all measures available at its disposal to crack down on people indulging in hoarding

adding that India was currently facing supply-side challenges.

However, leading Indian industrialists and businessmen cautioned the governmentagainst any further hike in interest rates that would harm the economy.

Cutting across political affiliations, parties are demanding a check on speculative

trading, hoarding and black marketing of essential commodities.

The government took steps such as banning export of non-basmati rice and pulses,

scrapping import duties on non-refined edible oil and cutting import duties on refined

oil, butter, ghee and maize to check rising prices. These measures are likely to ease

supply side constraints to a major extent.

Analysts now expect the central bank to take some immediate steps to suck up the excess

supply of money in the financial system thereby easing inflationary pressures to a

considerable extent.

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Financial Markets

The domestic stock markets recorded further gains during the third quarter of 2007-08

amidst intermittent corrections. Liquidity support from both foreign institutional

investors (FIIs) and domestic mutual funds on the back of strong GDP growth, healthy

corporate profitability and decline in the domestic inflation rate aided the market

sentiment. The upward trend in EMEs equity markets, increase in ADR prices in the US

markets and rise in global metal prices were the other factors that enthused the domestic

stock markets. The uptrend in the domestic stock markets, however, was interspersed by

corrections in mid-August and mid-December 2007 mainly on account of downward

trend in advanced economies equity markets on account of worries over sub-primelosses and credit crunch in the US and Europe, concerns over the slowdown in the US

economy, depreciation of the US dollar against major currencies and increase in global

crude oil prices to record high levels.

Between end-March 2007 and January 23, 2008, the BSE Sensex moved in a range of

12455.37-20873.33. The BSE Sensex closed at a record high of 20873.33 on January 8,

2008, an increase of 59.7 per cent over end-March 2007. The S&P CNX Nifty also

reached a record high of 6287.85 on January 8, 2008.

Since mid-January 2008 the domestic stock markets, however, witnessed sharp

corrections mainly on account of downward trend in the major international equity

markets amidst fears of recession in the US economy and depreciation of the US dollar

against major currencies. Liquidity squeeze from the secondary market in the wake of

the biggest IPO by Reliance Power, heavy net sales by FIIs in the Indian equity market,

decline in ADR prices and fall in metal prices on the London Metal Exchange also

dampened the market sentiment. The BSE Sensex closed at 17594.07 on January 23,

2008, witnessing a gain of 34.6 per cent over end-March 2007.

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Graph showing the trends in Indian stock market

The major gainers in the domestic stock markets during the current financial year so far

(up to January 18, 2008) were metal, capital goods, oil and gas, banking, consumer

durables, public sector undertakings, fast moving consumer goods and auto sector

stocks.

Graph showing Institutional investments and Indian

stock market

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TABLE SHOWING BSE SECTORAL STOCK INDEX

Table: BSE Sectoral Stock Indices

(Base: 1978-79=100)

Sector Variation (per cent)

End-March

2006@

End-March

2007@

January 18,

2008 #

1 2 3 4

Fast Moving Consumer Goods 109.9 -21.4 32.4

Public Sector Undertakings 44.0 -3.2 63.1

Information Technology 49.2 21.6 -22.6

Auto 101.2 -8.5 5.7

Oil and Gas 61.1 30.5 96.2

Metal 40.3 -4.3 103.3

Health Care 51.2 -5.4 10.3

Bankex 36.8 24.2 73.8

Capital Goods 156.0 11.1 102.0

Consumer Durables 115.4 11.1 63.7

BSE 500 65.2 9.7 60.9

BSE Sensex 73.7 15.9 45.5

@: Year-on-year variation. #: Variation over end-March 2007.

Source: Bombay Stock Exchange Limited.

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Foreign Investments

Foreign investment in India comes in two forms, foreign direct investment and

foreign portfolio investment. The former represents investment for setting up new

projects and hence is long-term in nature; the latter is in the form of purchase of

outstanding securities in the capital market and hence can be reserved easily.

Although foreign direct investment is more desirable that foreign portfolio investment,

India has received more of the latter to date. In recent years foreign institutional

investors who make portfolio investment have emerged as a powerful force on the India

Capital Market. In the calendar year 2004 alone, the net foreign portfolio investment has

exceeded $8.3 billion.

Foreign Direct InvestmentDuring April-November 2007, ForeignDirect Investment (FDI) equity inflows stood at

Rs. 45,098 crore (US$ 11.14 billion) against Rs.33,030 crore (US$ 7.23 billion) during

April-September 2006, signifying a growth of 36 percent in terms of rupee and 54 per

cent in termsof US dollar 8.73.

FDI: Cumulative equity flow

Period Rs. crore US$million

August 1991 to

March 2007

23041 54628

April 2007 to

November 2007

45098 11141

August 1991 to

November 2007

277139 65769

April 2000 to

November 2007

216534 49070

In the sectoral distribution of FDI inflows, financial and non-financial services During

August 1991 to November 2007, India received 7,898 approvals for foreign technology

transfer, of which 81 were obtained during 2006-07 and 52 during April-November

2007.

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Sentiments

The sentiments of consumers and businessman can have an important bearing on

economic performance. Higher consumer confidence leads to higher expenditure on

big ticket items. Higher business confidence gets translated into greater business

investment that has a stimulating effect on the economy. Thus, sentiments influence

consumption and investment decisions and have a bearing on the aggregate demand for

goods and services.

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MACROECONOMIC FRAMEWORK STATEMENT

(ECONOMIC PERFORMANCE AT A GLANCE)

Sl Item Absolute value Percentage change

No.

April - December April - December

2006-07 2007-08 2006-07 2007-08Real Sector

1 GDP at factorcost(Rs.thousandcrore)*a) at currentpricesb) at 1999-2000prices

3790.1 Q

2864.3 Q

4283.0 A

3114.4 A

15.7 Q

9.6 Q

13.0 A

8.7 A

2 Index ofindustrial

production (1)

239.8 261.4 11.2 9.0

3 Wholesaleprice index(Base 1993-94=100)(2)

208.7 216.0 5.9 3.5

4 Consumerprice index(2001=100)(3)

127.0 134.0 6.9 5.5

5 Money Supply(M3)(Rs.

thousand crore)

$ 3016.3 3702.8 19.3 22.8

6 Imports atcurrent prices**a) In Rs. croreb) In US $million

611522

134080

682088

168803

31.2

27.3

11.5

25.9

7 Exports atcurrent prices**a) In Rs. croreb) In US $million

41617691249

448377

110965

28.7

24.8

7.7

21.6

8 TradeDeficit(in US$million)** -

42831 -57838 32.9 35.0

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_______________________

_

ANALYSIS

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ANALYSIS

India's economy is on the fulcrum of an ever increasing growth curve. With positive

indicators such as a stable 8-9 per cent annual growth, rising foreign exchange reserves

of close to US$ 180 billion, a booming capital market with the popular "Sensex" index,

the Government estimating FDI flow of US$ 12 billion in this fiscal, and a more than 35

per cent surge in exports, it is easy to understand why India is a leading destination for

foreign investment.

It is clear from the above figures that Indian economy is progressing with a good speed.

Now, due to the governments liberalized policy the Indian market is open for foreign

players which is contributing to the growth of the country. Now, India has good foreign

reserve and moving ahead for achieving the targeted growth rates.

Overall Economy :

Indias GDP at constant prices for the first half of 2007-08 shows GDP growth

maintained the 9 percent plus level.

During April-September 2007-08, growth in agriculture, forestry and fisheries picked up

by 3.7 percent compared to that of 2.8 percent during the same period of previous year.

However the share of agriculture and allied services in Growth in manufacturing sector

slowed in the first half of the current fiscal while the percentage share to GDP was

maintained.

Share of mining, electricity, manufacturing and construction in GDP inched up against

the share in the corresponding period of previous year. Services sector maintained a

double-digit growth rate with widening share in GDP compared to that of last year.

Industrial Production:

During the first seventh-month period of the current fiscal Indias industrial production

went up by 9.7 percent compared to 10.1 percent increase registered during the same

period of the previous year.

Strong overall industrial growth numbers arrived in October 2007 after months of

slowdown. This strong growth was mainly led by the manufacturing sector.

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The capital and intermediate goods recorded an increase in the growth compared to that

of the growth posted in the last fiscal. The slowdown was however witnessed in the

basic goods.

Inflation :

The average inflation numbers up to November 2007 remains within the targeted

inflation for the current fiscal.

Overall inflation stood at 4.33 percent averaged during April- November period of 2007-

08. Some of the primary articles and the fuel prices have mainly contributed in checking

inflation.

But now the rate of inflation crossed the mark of 7%, which was recorded as a the

highest in 3 years.

Monetary Indicators:

In October 2007 money supply has increased (April-October) by 9 percent compared to

the 8 percent increase in the same period of the previous year. Borrowings have dropped

both in the government and in commercial sector.

Aggregate deposits increased mainly due to the increase in the benefit linked time

deposits. Credit off take was witnessed only in the non-food category, decline was

witnessed only in the food.

CRR has been increased by 50-point basis to 7.5 percent and this step will check the

excess liquidity due to foreign capital inflows.

Stock Market Trends:

Negative signals in some of the major markets have forced the foreign institutional

investors to divert their funds in safe havens. Recently the Indian stock market has been

primarily pulled by the FI investments, partially fueled by domestic investments.

Capital Flows :

Data on total foreign direct investments shows India received USD 26.6 billion up to

September 2007. Of the total FDI USD 18.4 billion came from the portfolio sources and

the rest USD 8.2 billion arrived as foreign direct investments.

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Foreign Exchange Reserves :

By the end of October 2007 our foreign exchange reserves touched USD 262.4 billion,

surging from USD 200 billion in March 2007. The current level of forex reserves is

adequate to meet 15 months of Indias imports.

Trends in Exchange Rate:

Indian Rupee against the USD further sunk to an average Rs 39.4 in November 2007

from Rs 40.3 in September 2007. November 2007 saw Indian Rupee weaken gradually

from a strong Rs 39.32 to Rs 39.67 traded in the concluding sessions of the month. The

RBI intervention was observed, maintaining the exchange rate at Rs 39-40 level despite

huge foreign exchange inflows.

FUTURE PROSPECTS

The rapid growth of the Indian economy in recent years has brought into sharp focus the

urgent need to develop the physical and social infrastructure. There are clear signals that

a rapid increase in the scale and quality of investment in physical infrastructure such as

power, railways, roads, airports, ports, and communications is underway. The

framework for encouraging public-private partnerships for developing physical

infrastructure is also in place and is expected to yield positive results. The Eleventh Plan

has also outlined a comprehensive programme for the development of the infrastructure

sector.

The well-known demographic dividend will manifest itself as a rise in the working age

population aged 15 to 64 years, from 62.9 per cent in 2006 to 68.4 per cent in 2026. To

tap this dividend, the Eleventh Plan focuses on ensuring better delivery of health care,

generation of more employment opportunities and skill development improving

employability of persons.

The circumstances today are favorable for sustained, rapid and a more inclusive growth

of the economy. The responsiveness of the Indian private sector to economic

liberalization and increased international integration has been generally satisfactory and

has imparted tremendous resilience to the economy. The changing composition of

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demand in recent times is indicative of addition to productive capacity, which is likely to

support the further growth of the economy.

________________________

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INDUSTRY ANALYSIS

INDUSTRY ANALYSIS

Each industry has differences in terms of its customer base, market share among firms,

industry-wide growth, competition, regulation and business cycles. Learning about how the industry works

will give an investor a deeper understanding of a company's financial health.

Since each industry is unique, a systematic study of its specific features and

characteristics must be an integral part of the investment decision process.

INDIAN BANKING SECTOR

One of the major areas of the economy that has received renewed focus in recent times

has been the financial sector. And within the broad ambit of the financial sector, it is the

banking sector that has been the cynosure of academia and policymakers alike. With

concerns about financial stability emerging to the forefront of policy challenges facing

central banks worldwide, it is being increasingly realized that promoting healthy

financial institutions, especially banks, is a crucial prerequisite towards this end. Not

surprisingly therefore, the banking sector in most emerging economies is passing

through challenging yet exciting times and India is no exception to this rule.

With deposits of over half a trillion US dollars, the Indian banking sector accounts

for close to three-quarters of the countrys financial assets. Over the decades, this sector

has grown steadily in size, measured in terms of total deposits, at a fairly uniform

average annual growth rate of about 18%. In the years since liberalization, several

significant changes have occurred in the structure and character of the banking sector

the most visible being perhaps the emergence of new private sector banks as well as the

entry of several new foreign banks. The spirit of competition and the emphasis on

profitability are also driving the public sector banks towards greater profit-orientation in

a departure from

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the socialistic approach followed for decades. In general it seems that the emergence of

the new private banks and the increased participation of foreign banks have increased

professionalism in the banking sector. Competition has clearly increased with the

Herfindahl index (a measure of concentration) for advances and assets dropping by over

28% and about 20% respectively between 1991-1992 and 2000-20019. Over the period,

SBI, the largest Indian bank, witnessed a decline in asset market share from 28% to 24%

while its loan market share dropped from 27% to 22%. The deposit share, on the other

hand, stayed pretty much the same at 23%. The asset, loan and deposit shares of the top

10 banks all fell from close to 70% to below 60%. Nevertheless, the public sector banks

still enjoy a pre-eminent position in Indian banking today, accounting for over 80% of

deposits and credit there is, however, a noticeable trend of private banks gradually

eroding the market share of the public sector.

Performance and efficiency of commercial banks are key elements of the efficiency and

efficacy of a countrys financial sector. It is not surprising then, that

considerable attention has been focused on the performance of commercial banks in

India in recent years. According to the general perception as well as on several metrics,

the new private sector banks and the foreign banks have led the way in terms of

efficiency.

Public sector banks, still not entirely free from the old bureaucratic mode of functioning

and constrained by certain developmental lending objectives, are often thought to be

lagging behind in the race to efficiency. Bank privatization and further liberalization of 9

Koeva (2003). The Herfindahl index is a measure of industry concentration and is

computed as the sum of the squared market shares of the firms in an industry. Ranging

between 0 and 10,000, a lower Herfindahl index represents less concentration and

greater competition.

With the Indian economy moving on to a high growth trajectory, consumption levels

soaring and investment riding high, the Indian banking sector is at a watershed. Further,

as Indian companies globalize and people of Indian origin increase their investment in

India, several Indian banks are pursuing global strategies,

The industry has been growing faster than the real economy, resulting in the ratio of

assets of commercial banks to GDP increasing to 92.5 per cent at end-March 2007. The

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Indian banks have also been doing exceptionally well in the financial sector with the

price-to-book value being second only to china, according to a report by Boston

Consultancy Group.

Consequently, the degree of leverage enjoyed by the banking system, as reflected in the

equity multiplier (measured as total assets divided by total equity), has increased from

15.2 per cent at end March 2006 to 15.8 per cent at the end of March 2007.

GROWTH OF THE INDIAN BANKING SECTOR

A burgeoning economy, financial sector reforms, rising foreign investment, favorable

regulatory climate and demographic profile has led to India becoming one of the fastest

growing banking markets in the world. The overall banking industry's business grew at a

CAGR of about 20 per cent from US$ 469.4 billion as of March 2002, to US$ 1171.29

billion by March 2007.

Aggregate bank deposits of banks increased by US$ 129.26 billion (22.1 per cent) at the

end of March 2007 over the corresponding in 2006. In the current fiscal, aggregate bank

deposits increased by 23.8 per cent, year-on-year, as of January 4, 2008 as against 21.5

per cent a year ago. While aggregate demand deposits increased by 15.6 per cent,

aggregate time deposits increased by 25.3 per cent in the same period, indicating

migration from small savings schemes of the Government.

Similarly, aggregate deposits of the scheduled commercial banks (SCB), after growing

by 17.8 per cent and 24.6 per cent in 2005-06 and 2006-07, rose by 25.2 per cent, year-

on-year, as on January 4, 2008. In fact, the absolute increase of US$ 96.34 billion (14.6

per cent) in the current fiscal year up to January 4 2008 was higher than the US$ 70.59

billion (13.2 per cent) increase in the same period last year.

Simultaneously, loans and advances of SCBs rose by over 30 per cent (i.e. 33.2 per cent

in 2004-05, 31.8 per cent in 2005-06 and 30.6 per cent in 2006-07) in the last three

financial years, underpinned by the robust macroeconomic performance. The growth has

continued in the current fiscal with non-food credit by SCBs increasing by 22.2 per cent,

year-on-year, as on January 4, 2008.

Significantly, the asset quality of the banks has also improved over this period. The

gross non-performing assets (NPA) as a per cent of total assets have declined from 4 per

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cent as of March 2002 to 1.46 per cent as of March 2006. Simultaneously, the capital

adequacy ratio of all SCBs has improved from 11.1 per cent as of March 2002 to 12.3

per cent by March 2007.

Ever since the banking operations had been opened to the private sector in 1990s, the

new private banks have been increasing its role in the Indian banking industry. Againstthe industry average growth of about 20 per cent in the past five years, the new private

sectorbanks registered a growth of about 35 per cent per annum, growing from US$

41.63 billion as of March 2002 to US$ 186.71 billion by March 2007.

Consequently, new private banks market share has increased from about 9 per cent in

2001-02 to 16 per cent as of March 2006-07. Foreign banks, which totaled 29 in June

2007, have also been expanding at a rapid pace. For example, India was the fastest

growing market for Global banking major HSBC in 2006-07, with a growth rate of 64

per cent.

The balance sheet of private banks and foreign banks in India expanded by 38.7 per cent

and 39.5 per cent during 2006-07, taking their combined share (along with private

banks) in total assets of the banking sector to grow from 22.3 per cent at the end of

March 2006 to 24.9 per cent by March 2007.

The flurry of mergers and acquisition deals by Indian corporates has boosted the

investment banking revenues to a record high. According to Dealogic, an internationalfirm that tracks global M &A transactions, investment baking revenues from India

crossed the US$ 1 billion mark for the first time in 2007 to US$ US$ 1.069 billion.

This is significantly higher than the US$ 400 million investment banking revenues

recorded in 2006. Also, this surge in revenues has propelled India to become the third

largest market for investment banking in Asia-Pacific in 2007.

While this growth has been very impressive, the potential banking market waiting to be

tapped in India is still fairly huge. Out of the 203 million Indian households, three-

fourths, or 147 million, are in rural areas and 89 million are farmer households. In this

segment, 51.4 per cent have no access to formal or informal sources of credit, while 73

per cent have no access to formal sources of credit.

In fact, according to a report by Boston Consultancy Group, India has the second largest

financially excluded households of about 135 million, which is next only to china. Also,

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about 60 million new households are expected to be added to India's bankable pool

between 2005 and 2009. With such a large untapped market, the Indian banking industry

is estimated to grow rapidly, faster than even china in the long run.

Indian banks are one of the most technologically advanced with vast networks of

branches empowered by strong banking systems, and their product and channeldistribution capabilities are on par with those of the leading banks in the world, says a

survey by McKinsey. It also reveals that IT effectiveness at the top Indian banks is world

class.

With the economy in overdrive and buoyancy in consumption and investment demand,

nine Indian banks, led by HDFC Bank and ICICI bank, have made it to the top 50 Asian

Banks list in Asian Bankers 300 report. Simultaneously, State Bank of India has become

the top loan arranger in the Asia-Pacific region in 2007, according to UK based Project

Finance International (PFI). Also, India emerged as the top provider of educational loans

worth US$ 3.67 billion till September in 2007.

Banks aspiring to become global must have a presence in India and other merging

markets, says a report of consultancy major Ernst & Young, as they are set to become a

major source of financial sector revenue and profit growth.

As the Indian banking industry continues its rapid growth along with rise in financial

services penetration in the Indian economy, the industry's profit is likely tosimultaneously surge ahead. According to a report by Boston Consultancy Group, the

profit pool of the Indian banking industry is estimated to increase from US$ 4.8 billion

in 2005 to US$ 20 billion in 2010 and further to US$ 40 billion by 2015.

Simultaneously, driven by the expansion of the middle class population, increase in

private banks and the burgeoning national economy, the domestic credit market of India

is estimated to grow from US$ 0.4 trillion in 2004 to US$ 23 trillion by 2050. With such

a favorable scenario, India is likely to emerge as the third largest banking hub in theworld by 2040, says a price water house Coopers report.

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SCHEDULED COMMERCIAL BANKS

The banking sector witnessed accelerated growth during 2006-07. The faster growth

of the banking sector in relation to the real economy pushed up the ratio of assets of

scheduled commercial banks to GDP to 92.5 per cent at end-March 2007.

Table: Select Financial Sector Indicators: 2006-07

Category Indicator 2005-06 2006-07

1 2 3 4

1.ScheduledCommercialBanks

a)Growth in Major Aggregates (percent)

Aggregate Deposits 17.8 24.6

Loans and Advances 31.8 30.6

Investment in Government Securities -1.2 9.3

b)Financial Indicators (as percentage oftotal assets)

Operating Profits 2.0 1.9

Net Profits 0.9 0.9

Spread 2.8 2.7

c)Non-Performing Assets (aspercentage of advances)

Gross NPAs 3.1 2.4

Net NPAs 1.2 1.0

2.Urban Co-operativeBanks a)Growth in Major Aggregates (percent)

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Deposits 6.3 6.1

Credit 4.0 9.8

b)Financial Indicators (as percentage oftotal assets)@


Net Profits 0.8 0.6

Spread 2.2 2.3

c)Non-Performing Assets (aspercentage of advances)

Gross NPAs 18.9 17.0

Net NPAs 8.8 7.7

3.Rural Co-operative Banks a)Number 1,07,497

b)Growth in Major Aggregates (percent)

Deposits 4.9

Credit 6.2

c)Financial Indicators

Societies in Profit (Number) 44,968

Societies in Loss (Number) 53,344

Overall Profit/Loss (Rs. crore) -271

d)Non-Performing Assets (aspercentage of advances)*

23.8

4.All-India Financial

Institutions

a)Growth in Major Aggregates (percent)1

Sanctions 41.0 12.9

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Disbursements 47.1 82.8

b)Financial Indicators (as percentage oftotal assets)2


Net Profits 1.0 1.5

Spread 1.8 1.6

5.Non-banking Financial

Companies

a)Growth in Major Aggregates (percent)

Public Deposits -32.1 -16.5


Net Profits 1.5 1.2

c)Non-Performing Assets (aspercentage of advances)3

Net NPAs 0.5 0.4

6.Residuary Non-

banking

Companiesa)Growth in Major Aggregates (percent)

Deposits 21.5 12.1


Net Profits 0.7 0.9

Financial performance of SCBs during 2006-07 was underpinned by hardening of

interest rates, both on the liability and the asset sides. Both net interest income and

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non-interest income of banks increased sharply in absolute terms, but declined in

relation to total assets. Banks, however, were able to maintain their profitability by

containing operating expenses.

29 Banks capital raising efforts kept pace with the asset growth and risk profile of

new assets. Hence, the capital to risk-weighted asset ratio of SCBs, a measure of the

capacity of the banking system to absorb losses, was at 12.3 per cent at end-March

2007-same as at end-March 2006.

CO-OPERATIVE BANKS

Operations of urban co-operative banks (UCBs) witnessed a moderate growth during

2006-07. The growth in loans and advances was higher than the deposits growth.

Balance sheets of all segments of the rural co-operative banking sector, exceptPACS, expanded during 2005-06. However, their financial performance worsened

during the year. Wide variations were also observed in the financial performance of

different segments of the rural cooperative banking sector.

FINANCIAL INSTITUTIONS

Financial assistance disbursed by All-India Financial Institutions (AIFIs) witnessed a

sharp rise during 2006-07 despite slowdown in financial assistance sanctioned by

them. Financial assistance sanctioned and disbursed by FIs increased by 12.9 per

cent and 82.8 per cent, respectively, during 2006-07 as compared with a rise of 41.0

per cent and 38.0 per cent, respectively, witnessed during the previous year. The

sharp rise in disbursements was accounted for mainly by a rise in disbursements by

investment institutions and specialised financial institutions, while the slowdown in

sanctions was mainly due to lower sanctions by all-India term-lending institutions.

Deposit rates of SCBs declined from July 2007 to August 2007, particularly at the

upper end of the range for various maturities. Interest rates of PSBs on deposits of

maturity of one year to three years were placed in the range of 7.25-9.00 per cent in

August 2007 as compared with 7.25-9.75 per cent in June 2007 (7.25-9.50 per cent in

March 2007), while those on deposits of maturity of above three years were placed in

the range of 7.75-9.50 per cent in August 2007 as compared with 7.75-9.75 per cent

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in June 2007 (7.50-9.50 per cent in March 2007). While BPLRs of PSBs and foreign

banks remained unchanged during the second quarter of 2007-08, those of private

sector banks softened to the range of 13.00-16.50 per cent in August 2007 as

compared with 13.00-17.25 per cent in June 2007.

CHALLENGES FACING BANKING INDUSTRY IN

INDIA

The banking industry in India is undergoing a major transformation due to changes in

economic conditions and continuous deregulation. These multiple changes happening

one after other has a ripple effect on a bank trying to graduate from completely regulated

sellers market to completed deregulated customers market.

DEREGULATION:

This continuous deregulation has made the Banking market extremely competitive with

greater autonomy, operational flexibility, and decontrolled interest rate and liberalized

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norms for foreign exchange. The deregulation of the industry coupled with decontrol in

interest rates has led to entry of a number of players in the banking industry. At the same

time reduced corporate credit off take thanks to sluggish economy has resulted in large

number of competitors battling for the same pie.

NEW RULES:

As a result, the market place has been redefined with new rules of the game. Banks are

transforming to universal banking, adding new channels with lucrative pricing and

freebees to offer. Natural fall out of this has led to a series of innovative product

offerings catering to various customer segments, specifically retail credit.

EFFICIENCY:

This in turn has made it necessary to look for efficiencies in the business. Banks need to

access low cost funds and simultaneously improve the efficiency. The banks are facing

pricing pressure, squeeze on spread and have to give thrust on retail assets

DIFFUSED CUSTOMER LOYALTY:

This will definitely impact Customer preferences, as they are bound to react to the value

added offerings. Customers have become demanding and the loyalties are diffused.

There are multiple choices, the wallet share is reduced per bank with demand on

flexibility and

customization. Given the relatively low switching costs; customer retention

calls for customized service and hassle free, flawless service delivery.

MISALIGNED MINDSET:

These changes are creating challenges, as employees are made to adapt to changing

conditions. There is resistance to change from employees and the Seller market mindset

is yet to be changed coupled with Fear of uncertainty and Control orientation.

Acceptance of technology is slowly creeping in but the utilization is not maximised.

COMPETENCY GAP:

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Placing the right skill at the right place will determine success. The competency gap

needs to be addressed simultaneously otherwise there will be missed opportunities. The

focus of people will be on doing work but not providing solutions, on escalating

problems rather than solving them and on disposing customers instead of using the

opportunity to cross sell.

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STRATEGIC OPTIONS WITH BANKS TO COPE

WITH THE CHALLENGES

Leading players in the industry have embarked on a series of strategic and tacticalinitiatives to sustain leadership. The major initiatives include:

Investing in state of the art technology as the back bone of to ensure reliable

service delivery

Leveraging the branch network and sales structure to mobilize low cost current

and savings deposits

Making aggressive forays in the retail advances segment of home and personal

loans Implementing organization wide initiatives involving people, process and

technology to reduce the fixed costs and the cost per transaction

Focusing on fee based income to compensate for squeezed spread, (e.g.CMS,

trade services)

Innovating Products to capture customer mind share to begin with and later the

wallet share

Improving the asset quality as per Basel II norms

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TRANSFORMATION INITIATIVES NEEDED FOR BANKS

In order to meet these challenges, the Reserve Bank initiated several measures during

2006-07.

MACRO LEVEL MEASURES

The stipulation of reserve requirement has traditionally been the key instrument of

monetary policy. A greater flexibility in use of these instruments provides greater

manoeuvrability to the central bank in ensuring monetary stability. With the amendment

to the Reserve Bank of India Act, 1934, effective April 1, 2007, the floor and ceiling on

the cash reserve ratio (CRR) have been removed and the Reserve Bank has been

empowered to prescribe the CRR depending upon the prevailing monetary conditions.

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PRUDENTIAL MEASURES

Following the revised capital adequacy framework of the Basel Committee on

Banking and Supervision (BCBS), the final guidelines for implementing the revised

framework in India were issued to banks in April 2007.

With a view to providing a wider choice of instruments to Indian banks for raisingTier I and Upper Tier II capital, guidelines for issuing preference shares as part of

regulatory capital were issued on October 29, 2007. It has been decided to allow the

banks to issue the following types of preference shares in Indian rupees: i) perpetual

non-cumulative preference shares (PNCPS) under Tier I capital; and ii) perpetual

cumulative preference shares (PCPS), redeemable non-cumulative preference shares

(RNCPS) and redeemable cumulative preference shares (RCPS) under Upper Tier II

capital

Recognising the implications of investment pattern of banks on financial stability

and with a view to discouraging banks to undertake risky exposures, it was advised

to banks in September, 2006 that the exposure of banks to entities for setting up

special economic zones (SEZs) or for acquisition of units in SEZs, which included

real estate, would be treated as exposure to the commercial real estate sector and

banks would have to make provisions as also assign appropriate risk weights for such

exposures as per the guidelines laid down for this purpose.

Considering the high risks inherent in Banks exposure to venture capital funds, the

prudential framework governing banks exposure to VCFs was revised on August

23, 2006. Accordingly, all exposures to VCFs (both registered and unregistered) are

deemed on par with equity and hence are reckoned for compliance with the capital

market exposure ceilings and the limits prescribed for such exposure also apply to

investments in VCFs. The quoted equity shares/ bonds/units of VCFs in the banks

portfolio should be held under available for sale (AFS) category and marked-to-

market preferably on a daily basis, but at least on a weekly basis in line withvaluation norms for other equity shares as per the laid down instructions.

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STRENGTHENING OF RISK MANAGEMENT

PRACTICES

Banks are now facing increased risk on account of greater fluctuation in prices, exchange

rates and interest rates, which underscore the need for developing regular systems for

stress testing. Internationally, stress testing has become an integral part of banks risk

management systems and is used to evaluate the potential vulnerability to some

unforeseen events or movements in financial variables.

There are broadly two categories of stress tests used in banks, viz., sensitivity tests and

scenario tests. Sensitivity tests are normally used to assess the impact of change in one

variable (for example, a high magnitude parallel shift in the yield curve, a significant

movement in the foreign exchange rates and a large movement in the equity index) on

the banks financial position.

Scenario tests include simultaneous moves in a number of variables, for instance, equity

prices, oil prices, foreign exchange rates, interest rates, and liquidity based on a single

event experienced in the past. The need for banks in India to adopt stress tests as a risk

management tool was emphasised in the Annual Policy Statement for 2006-07.

Accordingly, guidelines on stress testing were issued by the Reserve Bank on June 26,

2007. Banks are required to put in place appropriate stress test policies and the relevant

stress test framework for various risk factors by September 30, 2007 and make formal

stress testing operational from March 31, 2008.

SUPERVISORY MEASURES:

From the financial stability point of view, crisis prevention is the major

objective of financial regulators and supervisors. This involves continuous

monitoring of potential risks and vulnerabilities that may threaten the health of

the financial system. The success in preventing the occurrence of crisis depends on the process of

information gathering, technical analysis, monitoring and assessment. The

analytical process involves gathering information about macroeconomic

performance and various aspects of the financial system through supervisory,

regulatory and surveillance mechanism.

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The supervisory process based on information on individual institutions could be

gainfully aided by the information on economys position in the business and

credit cycles because macroeconomic and market performance provide the

background against which the operational performance of individual institutions

should be assessed. Thus, the supervisory framework plays a critical role in

maintaining suitable conditions for financial stability and putting in place

adequate safeguards so that the impact of shocks on the financial system is

minimised.

The Reserve Bank has also put in place a robust supervisory framework

comprising on-site and off-site supervision. The focus of supervisory measures

during 2006-07 was on strengthening the monitoring mechanism of financial

conglomerates (FCs).

BENCHMARKING OF THE INDIAN BANKING SECTOR

The financial soundness of the banking and financial institutions is a pre-requisite for

financial stability. The increasing degree of financial globalisation puts domestic

banking and financial institutions on international platform of competition, thereby

compelling them to meet international standards in respect of financial soundness. The

competition in the Indian banking system has intensified with the

Documents

Final My Report on financial system