Recently with release of RBI circular on Base rate implementation, there has been a lot of debate going on regarding BPLR (benchmark prime lending rate). Here is our beginner’s guide to understand the two rates.

What is BPLR?

BPLR is the reference rate for banks for pricing their loan products. It is calculated taking into account the cost of funds, operational expenses, and the minimum margin to cover regulatory requirements of provisioning and capital and profit margin. Banks are supposed to lend to their prime customers at BPLR and increase the rate with risk premium in case of sub-prime customers and tenor premium wherever applicable.

Problems with BPLR

1. Main problem with BPLR is that banks have resorted to sub-BPLR lending. On an average, 67% of the total loans and Advances of banks was sub-BPLR. For Private banks, the figure was even higher at 83%. Housing, agriculture, and corporate segments were the major beneficiaries of sub-BPLR lending. Nearly 31% of the housing loans in FY08 were disbursed at an interest rate of less than 10%, while 49% of the housing loans were disbursed at 10-12%. In the case of loans to the industry, around 32% were disbursed at an interest rate of 10-12%.

A study of BPLR and actual lending rates of the banks show that as on Sep’2009, against a BPLR in the range of 11-13.5% for public sector banks, actual lending rates where in the range of 4.2-18%. For private banks, actual lending rates were 3-29.5% against BPLR of 12.5-16.7%.

2. Secondly, BPLR failed to respond to the changes in the monetary policy. Changes in monetary policy rates by RBI were not truly reflected in the BPLR. This was true during both the tightening phase as well as easing phase. This defeated the purpose of changes in these rates to some extent. Table below illustrates the point where changes in policy rates have not resulted in a proportionate change in the BPLR of the banks.

What is base rate?

Base rate would be the new benchmark of pricing of loan products by the banks. It is proposed to be calculated by including the cost of deposits, cost of maintaining the statutory liquidity ratio and cash reserve ratio, cost of running the bank, and profit margin. This will be the minimum lending rate for banks. Hence, the actual rate will depend upon the base rate plus borrower specific charges, which will include product specific operating costs, credit-risk premium, and tenure premium. As per the calculation of RBI, using the date of financial year 2008-09, the base rate for Indian banks works out to be about 8.55%. Banks would not be allowed to lend below the base rate except for Loans against fixed deposits, loans given by a bank to its own employees, as well as restructured loans, where borrowers get more time and pay lower rates to avert defaults.

Expected impact of Base rate

It is expected that base rate system will increase transparency in credit pricing and address the shortcomings of the BPLR system. Benchmark rate of most of the banks will decline to single digit. Again with the base rate, including negative carry on Cash Reserve Ratio (CRR) and Statutory Liquidity ratio (SLR) it is anticipated that base rate will be directly impacted by the monetary measures initiated by the RBI. Taking the calculation of RBI, Ceteris paribus, with an increase of 75 bps in the CRR, the base rate increases by 8 bps to 8.63% and an increase of 100 bps in the SLR from 24% to 25% could push up the minimum lending rate by 12 bps to 8.67%.

Small borrowers such as farmers who are close to BPLR rates would get credit at reasonable rates after the introduction of base rate. At the same time, large corporations that earlier utilised their negotiating power and bargained with banks in order to obtain loans at sub-BPLR rates, could find it difficult due to the minimum rate fixed by banks.

What this means for banks?

Large banks that have higher percentage of low cost deposits and better operating efficiency will have a lower base rate and thus they will be able to price their loan products competitively. Small banks on the other hand will face problems in extending credit to large corporate. This would render a number of banks uncompetitive and enable big banks to increase their business.

Author: Praveen Bajaj, B.Com(H), MBA (SCMHRD)

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Effective Interest Rate (EIR) is a new concept to the existing Indian GAAP.

TheEffective Interest Rate (EIR) method is a method of calculating the amortized cost of a financial asset or a financial liability and of allocating the interest income or interest expense over the relevant period.

TheEffective Interest Rate (EIR)use in the allocation process is the rate that exactly discounts estimated future cash flows (receipts or payments) to the net carrying amount of the financial instrument through the expected life of this instrument.

EIR calculation is not the same as for Yield to Maturity (YTM). YTM is nothing but the Internal Rate of Return (IRR) of the bond. But Effective Interest Rate (EIR) may also include some non-interest components such as loan origination charges, processing fees as part of the effective rate.

Under IFRS income from Loans and receivables has to be recognized through application of effective interest rate.

An illustration given below gives better clarity for calculation of Effective Interest Rate (EIR).

Given Data:

Calculation of INTERNAL RATE OF RETURN based on above data:

Thus IRR will work out to 3.83%

Thus companies has to maintain Coupon rate as well as EIR which will practically for each transaction will be a major task and will add significantly  load on IT systems.

Author: CA Shalini Tibe, IFRS Consultant

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Years back when the South African Government opened their country for outsiders to come and do mining for diamonds, entrepreneurs form all over the world rushed to South Africa in the hope of finding diamonds and changing their fortunes. Of them only very few were able to do so and become rich. But there was one African business man who instead of joining this rat race to discover diamond started the business of selling/renting hammers and other mining material whoever was coming to discover diamond. He eventually became a millionaire and one of the most successful entrepreneurs of this Diamond run.

I hope some of you must have realized the point I am trying to put here. In India currently most of the companies are running to set up the power plant to generate power and other half are running to build the great power generating turbines or boilers. But very few are there in the business of building the Balance of Plants (BOP) which accounts for more than 35% of the total money spent in building up a power plant.

Thus, I strongly believe that there is a huge potential in this sector and BGR energy being the undisputed leader with a strong order book and execution track record offers great long term investment opportunity.

I would recommend one to start a SIP form of investment in this stock for a minimum of 2.5-3 years period, since at the current levels investing lump sum might be a little dangerous given the market conditions.

Happy Investing…!!
Author: Rahul Sonthalia, Analyst, Kredent Group

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Market Developments
Global Outlook

• The US Dollar fell against all majors except the Japanese Yen, breaking out of its tight range against the Euro and testing its recent lows. A limited week of economic event risk initially left the heavily-traded currency relatively motionless, but the latter half of the week saw the Greenback considerably lower through Friday’s trade. The declines were perhaps surprising given a significantly stronger-than-expected US Retail sales report on Friday morning; robust spending gave modest hope that the US consumer may prove more resilient than previously predicted. CFTC data is mixed with Dollar’s net long positions fell from $5.58 billion to $3.99 billion, however Euro shorts rose to another record of 74551 contracts suggesting that 1.3800 would be hard to break. After the break of 80 levels in the dollar index we feel that 78.56 would a decisive level to watch. A busy week of economic event risk likewise promises considerable volatility in the days ahead.
• EUR/USD was encouraged by better equity market and stronger than expected EU Industrial Production to hunt for stops through 1.3750, despite initially hampered by Russian selling. Prices made a run close to 1.3800, but lost momentum. Equity markets were majorly buoyant for the major part of last week with S&P 500 breaking January’s high of 1150. Nikkei managed to rise 382 pts to close at 10751. Markets are cautiously looking at the upside after the consolidation which has lasted for almost two months. However only a weekly close above the 1.3800 levels should show more upside. Market is still short ahead of FOMC next week and that’s going to limit dips within a range of 1.3600-1.3800.
• The British Pound rose to 1.5200 levels and may continue to rise if the Bank of England is able to convince the markets about its current stance The British Pound may benefit if the BOE succeeds in branding themselves as standing truly at the center of the policy spectrum. Rating agency Fitch said the UK’s AAA credit rating may be jeopardized if it doesn’t do more about its fiscal shortfall reminding us that political risk could be a major factor in the United Kingdom.
• Commodity currencies continue to be bullish on the backdrop of strong economic data from Canada, Australia and New Zealand. Australia is the first country to raise rates to 4%. RBNZ left rates unchanged at 2.5% and reiterated the already stated stance of removing stimulus in the middle of 2010. The key risk for commodity currency comes from the tightening policies to cool down China.
• Key Data for the coming week are Euro-Zone Employment and US industrial production on Monday. Tuesday would be crucial with Euro-Zone CPI, ZEW survey, US Housing data and the most important FOMC rate decision (rate may not be hiked but the wordings need to be watched). On Wednesday we would see the UK Jobless and other unemployment figures for the UK with Thursday bringing focus back to the weekly jobless claims. Friday would see housing, retail sales coming out of various regions.

Domestic Outlook

• USD/INR saw downside for most of last week, though dips below the 45.40 saw importer buying interest amid intervention fears as well. As a result of such buying interest some the pair staged some sharp rally towards the upside all of which faltered at the 45.63 level. SENSEX gains aided with the INR upside though stock market gains were trimmed on fears of rate tightening on strong Jan Industrial Production for a second month in a row.
• Inflation data next week is to be the focal point and is likely to be higher on the backdrop of high weekly food prices. However we expect food inflation has peaked out and the same effect would be reflected on the WPI in the coming month which could settle in the range of 7-8%. The borrowing programme still being largely front loaded with almost 70% of the government borrowing being done in the first half is likely to keep yields in the 7.8 % levels for some time. On the whole we expect that the USD/INR to gradually tilt lower, but dips would not be very rapid till exporters start panicking. Broader range of 45.28-45.75 is seen being traded for now as the USD/INR consolidates with eyes on policy at home as well as external risks. Intraday range of 45.38-45.63 should hold as state bids and underlying strength of the INR unlikely to let the pair go either way. One more factor that might be a food for thought is that markets have started looking at the Real Effective Exchange Rate (REER) which is hovering at 112 against a historic high of 116. It remains to be seen how far the central bank stays on the side lines.

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1. Currency Outlook – Fortnightly Currency Review November
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3. Rating upgrade, rate hike – Growth on track

First time adoption of IFRS for PPE
An entity can use fair value as deemed cost on First time adoption of IFRS

OR

It has to apply Retrospective application which means recalculate carrying amount of each PPE item according to IFRS since its purchase date including transaction cost, useful life and residual value.

Suggestion
However fair value as deemed cost is more appropriate since there would be practical difficulties for companies to do retrospective application from the date when the asset has been purchased.

Fair value for PPE
Fair value for Land and Buildings is usually determined from market based evidence by appraisal normally undertaken by professionally qualified valuation officers and for other items of PPE their market value is determined by appraisal.

If there is no market-based evidence of fair value because of special nature of asset then it has to be determined on basis of either Income Approach or Depreciated replacement cost approach.

Methods for Subsequent Measurement of PPE
There are 2 methods available for Subsequent measurement of PPE i.e. Revaluation Model and Cost Model.

However most of the LSE listed companies have adopted Cost Model. Generally companies who are in business of Investment property prefer revaluation model.

Suggestion
Cost model is preferable over revaluation model mainly because of the following reasons:

• Once revaluation model is adopted one has to do frequent revaluation as prescribed by IAS 16 which requires expertise of professional valuer which may not be cost effective for companies.

• Also if the property prices changes drastically one has to book the difference in Income Statement resulting in huge volatility which may not be accepted to management of company.

Reclassification
Movement from Cost Model to revaluation model is permitted however vice versa is not permitted which means if Revaluation model once followed cannot move to Cost Model.

Suggestion
Companies should carefully examine the impact before making policy and procedures in respect of the same.

Author: CA Shalini Tibe, IFRS Consultant

Related posts:

1. Fixed Assets / Property, Plant & Equipment : Differences between Indian GAAP and IFRS
2. Accounting and Business are Interrelated in IFRS
3. Fair Value Accounting in IFRS

Equity

After correcting for most part of January and early February, Sensex touched a monthly low of 15725 on Feb 5 and thereafter gained strength from positive news on the budget front. It touched a monthly high of 16669 on the day of budget and closed the month at 16429, about 2 % above the last month’s close and 4.5% above the monthly low.

Rupee

Taking over from the appreciating trend in the last month, rupee weakened in the first week to touch a monthly low of 46.94, loosing 110 bps in 3 trading days. But post that, appreciation again set in and buoyed by the bullishness in equity markets, rupee closed the month at 46.08, marginally up from last month’s close of 46.12.

G Sec yields

After moving in the range of 7.57 to 7.72 for the month of January, the yields on 10 year benchmark 6.35% 2020 bond surged during February. Yields touched a high of 7.96 during mid feb and thereafter corrected to rise again during the budget following announcement of market borrowing of Government for the year 2010-11 which were in line with expectation. Yields closed the month at 7.86 against a close of 7.58 for January.

Gold

Gold futures on COMEX for March delivery which fell in the later half of January were in red in the beginning of February as well under the influence of better than expected economic numbers of USA. But since second week of February, after touching a monthly low of $1,044.50/ Oz, gold prices started moving up and touched a high of $1,131.50/Oz before closing the month at $1,118.90, 3.3% above last month.

Crude Oil

Crude oil for March delivery on NYMEX continued its downward journey carried over from the month of January and touched a low of $69.50/ barrel. But with optimistic numbers from US, economic recovery seemed to gain strength and prices started rising touching a monthly high of $80.78 before closing at $78.84, 9.2% above the January levels.

Author: Abhijit Ahir, Economic Analyst, MBA Finance (SIIB)

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3. Indian Economy – Annual Review and Analysis

BSE                    :              INFOSYS

NSE                   :              INFOSYSTCH

Bloomberg     :              INFO IS Equity

CMP                  :              Rs. 2,587.45

Sector              :              IT Services

View                 :          Neutral with positive bias

RESULT HIGHLIGHTS:

• The consolidated net sales for the quarter ended December 09 contracted by 1% to Rs. 5,741 cr, this was mainly on account of recovery by the North American Financial Services Sector
• Its other income grew by a whopping 505% to Rs. 230 cr this was on account of a Rs 20 cr gain from forex transactions as compared to a Rs 218 cr loss in Q3 2008
• Company’s net profit contracted by around 4% to a level of Rs. 1,582 cr, this is mainly on account of a strengthening of rupee on a YoY basis
• Company’s operating margin remained fairly stable around 35.5% on account of increased utilizations
• Company’s diluted EPS fell by around 3%, to Rs. 27.72/ share
• The company plans to be aggressive on the hiring front. It plans to add 6,000 employees to its rolls in Q4. It is comfortable with utilisation between 76-80%
• Its Q4 guidance is muted but has improved compared to the last quarter’s guidance and the company has also increased its full year EPS and revenue guidance both in rupee and dollar terms
• The management says clients are still cautious about the business environment and budgets from the clients side has not been finalised yet

• Dollar Guidance:
  • FY10 consolidated revenue seen at USD 4.75-4.76 billion, YoY growth of 1.8%-2.0%.
  • FY10 EPS seen at USD 2.26 a share, YoY growth of 0.4%

• Rupee Guidance:
  • FY10 revenues seen at Rs 22,473 cr-Rs. 22,519 cr, growth of 3.6% to 3.8%
  • FY10 EPS seen at Rs 106.85-107.06, YoY growth of 2.2% to 2.4%

Author: Rahul Sonthalia, Analyst, Kredent Group

Related posts:

1. Infosys Q4 results update
2. Indian Economy – Review and Analysis, September 2009
3. Indian Economy – Review and Analysis, January 2010

Author: Rahul Sonthalia, Analyst, Kredent Group

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Significant percentage of the balance sheet would be at Fair Value compared to current practice of carrying at historical cost under IFRS.

Use of Fair value:

At present Fair Value is limited to impairment of assets, measurement of retirement benefits and mark to market accounting of derivatives where as under IFRS it extend to Held for Trading  portfolio, Available for Sale, assets/liabilities designated as fair value through profit and loss and for initial recognition of all financial assets/liabilities will be at fair value.

Current definition:

Currently the definition of fair value stands as “Amount for which an asset could be exchanged, or a liability settled, between knowledgeable, willing parties in an arm’s length transaction”

–    If quoted in an active market then objective would be the price at which transaction would occur at the balance sheet date in most advantageous market and methods applied would be published price quotations when available, use market quoted rate in valuation techniques or bid price for asset held

–    If not quoted in an active market then objective would be transaction price in arm’s length transaction motivated by normal business considerations and method applied would be valuation techniques (recent market transactions, similar instruments, DCF analysis etc.), use commonly used and reliable valuation technique or use market based information

There is lot of doors open for judgement in terms of what will constitute “arm’s length transaction”.

Impact of Fair value:

Fair value accounting brings significant volatility in the income statement.

For instance: All derivative financial instruments have to be recorded at fair value on measurement date, and any change in fair value has to be recorded in income statement thereby bringing volatility in Profit an Loss Account.

Since markets are not liquid for all assets, corporate will have to obtain expert opinion to determine fair value.  For e.g. unquoted equity shares have to be recorded at fair value which are now recorded at cost

Different valuation models will be used by various companies which reduce consistency and comparability of financial information to a certain extent.

All these will involve substantial cost for hiring of expertise.

Proposed Definition:

Therefore for bringing all of them under one roof International Accounting Standard Board (IASB) has come out with Exposure draft on “Fair Value Measurement” where fair value has been defined as “the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (current exit price)”.

So does exit price reflect real fair value? Will exit price will be available for all assets and liabilities to be fair valued on measurement date.

Exit price can be used only when it is supposed that the asset or liability will be sold in a near future; if it is supposed that the asset or liability will remain for long in the company, exit value can’t reflect the right perspective.

In fact, if we want to obtain the value in use of the elements we can’t consider the benefits obtained by selling it, because it won’t be sold.

IASB is expected to come out IFRS on Fair value measurement by third quarter of year 2010.

Author: CA Shalini Tibe, IFRS Consultant

Related posts:

1. Accounting and Business are Interrelated in IFRS
2. Comparison of IFRS and Indian Accounting Standards
3. Treatment Of Tangible Assets Under IFRS

IFRS is a principle based model as compared to rule based I GAAP. IFRS requires extensive use of fair valuations for measurement of assets and liabilities. The objective of IFRS is to set the Balance Sheet right, and hence a significant volatility may come in Profit & Loss statement.

There are three principles laid down in IFRS i.e. Substance over form in reality, use of Fair Value and recognizing time value of money.

Changes in IFRS are pervasive and not limited to accounts department. Profit planning and budgeting need to be tuned to incorporate the expected increase in income volatility, arising out of fair valuation system. Staff would need training not only in IFRS accounting but also the changes in the products and processes entailed by the conversion

Key differences in IFRS Vis a Vis INDIAN GAAP

• Concept of group – Companies Act treats Indian companies as separate legal entity whereas IFRS promote a group concept

• Fair Valuation – IFRS based on Fair value concept and not historical cost

• Form and Substance of financial statements

• Correction of past errors – Under IFRS these are incorporated in the accounts of the years it pertains to, even if audited and adopted by shareholders whereas under Indian GAAP these are treated as adjustment in the current year

• Depreciation on revalued assets needs to be routed through income statement under IFRS – Companies Act disallows such a treatment

• Companies Act defines assets by classes which can be depreciated at given rates, whereas as IFRS promotes the concept of components of fixed assets based on their usefulness

• Preference shares are classified as debt instrument and not equity effecting profitability and Capital adequacy ratio

• No concept of proposed dividend – Declaration of dividend only when approved by shareholders

India being an important emerging economy in the world is yet to adopt the IFRSs. Internationally, in so far as cross-border investments are concerned, a non-IFRS compliant country is perceived as an additional risk factor. Within India also, in recent times, the issue of convergence with IFRSs has been raised time and again at various forums.

One of the risks I feel that IFRS entails is allowing companies to capture unrealized gain in P/L resulting in extra onus on the management to exercise better financial discipline. Because of this companies may end up declaring dividend out of unrealized profits.

Author: CA Shalini Tibe, IFRS Consultant

Related posts:

1. Fair Value Accounting in IFRS
2. Comparison of IFRS and Indian Accounting Standards
3. IFRS: an improvement in accounting quality as well as corporate governance