WEATHER DERIVATIVES – CONCEPT, CHALLENGES, AND FEASIBILITY

By  Ishan Kekre & Girish C

Introduction

A weather derivative is a tool for managing weather risk. It is a financial contract that allows a firm to hedge itself against unexpected and adverse weather. A weather derivative contract or WD derives its value from future weather conditions. Contrary to stereotypical weather insurance, the payout of this kind of derivative is based on a parametric weather index. For instance, the index could be centimeters or millimeters of rainfall. The index could also be a cumulative frequency distribution of temperatures across many locations. The underlying of WD could also be related to snowfall or hurricanes.

Origin of Weather Derivatives

The weather derivative market as compared to other financial instruments is relatively young. The first transaction in the WD market dates back to 1997. The sector developed due to the severe repercussions of El Niño. These events were forecasted correctly by the meteorological community. Firms that had their revenues linked to weather realized the importance of protecting themselves against seasonal weather risks. Many companies who were in the business of dealing with financial futures and options saw WDs as attractive tools to hedge weather risks.

The insurance sector achieved substantial financial consolidation. As a result, there was significant capital to hedge weather risks. Insurance firms started writing options with payoffs linked to weather events. This, in turn, elevated the liquidity for the development of a WD market. Thus, the WD market evolved over the years into a strong over-the-counter market.

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EFFECTS OF DEMONETIZATION ON THE FINANCIAL SECTORs OF INDIA

By The Editorial Board of TJEF

(Anil Shankar, Gandhali Inamdar and Isha Varma)

Introduction

Demonetization has been the buzz word since November 8th 2016 when our Prime Minister made the historic announcement about the decision to discontinue the 500 and 1000 rupee notes. This historic decision has affected almost all the sectors. Some have benefited while others have suffered. This paper intends to analyze the effects of demonetization on the major financial institutions and the Indian economy in general.

Effects of Demonetization on Banking sector

Since the advent of asset quality review (AQR), there has been a rise in the number of NPAs. To get an idea, the GNPA of banks is 6 lakh crore as of June, 2016 which is 8.2% of the total loans1. These are only the NPAs as there are an equal number of restructured loans which might transform to NPAs in future.

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Figure 1: Total NPAs as of March 2016, Source: Finance Ministry

A recent data provided by the Finance ministry, which has been depicted in Figure 1, shows that 5.3 lakh crore of the 6 lakh crore NPAs are under the public sector banks. It’s clearly visible that there has been a rise in the NPAs from October 2015. This can be attributed to the ever greening of loans which led to the creation of a distorted picture of the banks. Though the asset quality review led to the identification of such NPAs which were previously classified as standard, the problem of NPAs existed since the 2008 financial crisis but remained hidden due to the above mentioned reason.

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Budget Impact Analysis – FMCG and Consumer Durables Industry

By Nishant D’Souza

Year on year FMCG companies has posted robust results in their 3rd quarter reason being many major festivals happen during this period. However, the same was not emulated this year, companies posted flat or below par results as demonetization sent the FMCG sector into paralysis and the only budget could be the probable savior.

Measures and their impact:

  • Income tax has been lowered from 10% to 5% for individuals in tax slab 2.5 lakh- 5 lakh – This will greatly benefit the youth considering the fact that many falls in this tax bracket. Even individuals earning up to 8 lakhs will surely make an effort to bring their taxable income within the 5 lakhs tax slab. We shall see a launch of many entry-level products in the white goods sector.
  • Increase in MNREGA allocation from 38,500 crores to 48,000 crores year on year – MNREGA scheme provides a minimum of 100 days of guaranteed wage payment to every individual who has opted to do unskilled manual labor. MNREGA has already been a success in providing employment for rural folks during off-season farming. Considering the fact we had good monsoon in most parts of the country and with this increase in MNREGA allocation FMCG companies having exposure in rural areas will greatly benefit. FMCG companies will amend their existing products into smaller packs to attract rural attention.
  • Reduction in presumptive tax from 8% to 6% under section 44AD for gross payments received through electronic mode – This will benefit professionals and we can expect a rise in white goods sales with summer soon approaching. I don’t see mom and pop stores declaring taxable income even after this tax discount.
  • Reduction in corporate tax from 30% to 25% for companies with an annual turnover below 50 crores – Many raw material supplying companies fall within this tax bracket, we can expect a reduction in the cost of raw materials.

A lot of initiatives have been undertaken to revive agricultural growth and increase the focus of investments in rural areas:

  1. A target of 10 lakh fixed per person as agricultural credit and overall target of 10 crores for the financial year 2017-2018.
  2. Extension of tenure of loans under Credit Linked Subsidy Scheme of the Pradhan Mantri Awas Yojana to 20 years.
  3. Allocation for agriculture sector has increased by 24% to Rs 1,87,223 crores.
  4. 8,000 crores set aside for dairy processing infrastructure fund.

Additional surcharge of 10% on annual income over 50 lakhs will surely come as a dent on the revenues of the high-end service industry.

Apart from the change in excise duty on cigarettes no other change in service tax or excise duty was witnessed. Abolition of Foreign Investment Promotion Board should witness the much needed FDI in the consumer durable industry. Overall this budget has greatly helped in meeting the expectations of the corporates who have been vying for an increase in the personal disposable income.

 

Rise of Bitcoin in India

By Sachit Modi

Bitcoin – World’s Best Performing Currency

Bitcoin, one of the most famous cryptocurrency, has become the world’s best performing currency for 2016, with rates hovering at around $970 per bitcoin (as of 28/12/2016), which is almost a rise of 120% as compared to the start of the year. In India, since the last 2 months, it has been trading at a premium of 10% as compared to the international markets.

Several factors have been attributed to the steep rise of this investment vehicle in the international markets, one of them being the need for currency stability in the highly volatile geo-political scenario of China and U.S. Also, Bitcoins have a relatively lower correlation with international assets classes, thus giving them the status of being an entirely different class.

The Indian Context – Demonetization and Black Money

In India, the monumental move of removing almost 86% of country’s currency out of circulation, taken by the GOI on 8th Nov’ 16 lead to the rise of this lesser known currency.  Demonetization may not have had a direct impact, but it has triggered an interest in the citizens towards everything which is cashless and digital, including bitcoins. Also, since bitcoins act as an attractive and viable option of sending remittances from abroad, it has seen a huge spike in demand. Due to these factors, bitcoins are facing demand-supply mismatch, which is being reflected in its trading prices.

There has been a widespread belief that Bitcoins are being used as an alternate option to park cash, post the ban on Rs. 500 and Rs. 1000 currency notes. However, chances of this happening are remote as all bitcoin transactions are completely cashless and are only possible through linked bank accounts and KYC procedure.

Future Prospects

In India, there are 4 major Bitcoin exchanges – Zebpay, Unocoin, Coinsecure and BTCXIndia. All of these have seen an increase in queries in the last couple of months and have now been adding 50000 users per month on an average, owing to which they have levied a premium on the prices of bitcoins. However, bitcoins enjoy the benefit of having lower transaction costs (almost 90% less than a typical credit card transaction), which has worked heavily in its favor.

This year has been one of the most successful in the eight-year history of the crypto-currency, and this trend is expected to continue. There has been a widespread increase in the knowledge of bitcoin among the general public, and in India, demonetization has already set the stage for its popularity. It is just a matter of time before Bitcoin emerges as the mainstream payment and investment alternative.

E-WALLETS – NOT JINGLING ALL THE WAY

Nandita ShyamSundar

As the holiday season is around the corner, shopping for gifts for our mothers, bosses and Chris Children among others, is in full swing. The e-commerce revolution has brought a wide range of products to our fingertips (literally!). And demonetization has increased the workload of our fingertips by making us click to pay. Cash-back offers and reward points are added incentives to use plastic money and e-wallets. Yet, quite a few of us still struggle with giving/receiving the right amount of change in day-to-day situations. This article is an attempt to explore some of the elements that cause friction on the path of progression for e-wallets, and possible solutions to address these issues.

Illiteracy

Many people do not know how to use PayTM, MobiKwik, and other e-wallets, and hence do not use them. Conducting workshops and setting up telephonic assistance for set-up/installation and routine use can increase their usage. Increasing the number of languages in which the services are available can also make consumers feel more comfortable.

Security

Even those who do know to use e-wallets are apprehensive since security breaches aren’t a rarity. Fraudsters are always prowling and people see avoiding the situation altogether as a way to mitigate the risk. A well-known media company recently reported that “Paytm has made headlines for showing its weakest side of security compliance”. Are we willing to take a chance with our hard earned money?

Culture

A taboo on the unknown is not a recent phenomenon. People are apprehensive about trying something new, especially when it involves putting their money in a virtual location.

Regulation

Inadequate regulation can make the buyer beware even more. Integrating technical aspects and creating/amending laws to protect the interests of different types of customers can make the industry more reliable.

Redressal

If customers are to understand and accept that technical glitches are always a possibility, a mechanism to ensure that their genuine concerns are addressed quickly and satisfactorily must also be in place. Unresponsive staff and irresponsible answers are bound to ward off users.

In essence, the e-wallet industry is still half-baked. Promotions and advertisements alone will not encourage usage. The shortcomings have to be addressed by the government as well as companies, if they wish to see a truly cashless economy.

Should NBFCs be regulated in the same way as Banks in India?

By Nayan Saraf

Indian banking sector has played a crucial role in developing the Indian economy, but if there is one segment, which would significantly make a big difference in coming years, it would be the Non-banking financial services sector. The total asset base for NBFC’s stood at more than Rs. 14.5 Lac Crore and the profit of Rs. 30,000 Cr. in the year 2015 with a CAGR of about 13% over last 3 years. This enormous growth of NBFC segment has resulted in more regulations from RBI which in effect have opened the debate whether NBFCs should be regulated in the same way as banks or not.

Over the years, RBI has changed its stance on NBFC from no regulations to over regulations. This over regulation has come into the picture in recent years after the global financial crisis where the fall of systematically important FI, Lehman Brother, resulted in systematic risk across the financial world. But many economists have argued that these over regulations are nothing but overly cautious measures by the RBI which are hampering the growth of the NBFC segment.

One reasonable argument that goes in the favour of lesser regulations for NBFCs is that unlike banks they don’t have any unsophisticated depositors. The bank’s depositors are unsophisticated as they can withdraw money from the bank at any time and the bank is liable for that. Even for fixed deposits, the principal is protected in the case of premature withdrawal. Hence, banks run the risk of having ‘Run on the bank’. On the other hand, NBFC’s do not have unsophisticated depositors as they raise money by issuing bonds and promoter’s contribution. Hence, NBFCs do not run the risk of having ‘Run on the bank’.

Second argument that goes in favour of lesser regulations for NBFCs is the low risk of asset liability mismatch. Since, NBFCs lend money which was raised through bonds and promoter’s contribution rather than depositors’ money (as they cannot accept deposits); there’s a very little chance of having asset liability mismatch. In their balance sheet, the liability would be due only on maturity. Hence they can easily manage the asset liability mismatch. On the other hand, banks that lend depositors’ money, run a higher risk of asset liability mismatch as in their balance sheet the liability can be due at any time.

These two arguments question the importance of stringent regulations on NBFCs by RBI. When NBFCs are different from banks, then why should they have the same stringent regulations? NBFCs should be more risk seeking in nature for the growth of Indian economy.