BottomOfPyramid

Finance for Microenterprises

2012-02-02T20:28:00.001-08:00

Nature of MSME

TheMicro, Small and Medium Enterprises (MSME) are estimated to contribute 8% of India’sGDP, 45% of the manufactured output and 40% of its exports. India is estimatedto have more than 26 million MSMEs. While a few of the MSMEs operate asregistered entities (with at-least minimal registration required as per thetaxation laws) a large majority of them operate as very small unregisteredproprietary concerns owned by micro entrepreneurs.

Thefinancial needs of these enterprises have not been adequately addressed by formalfinancial institutions. An important reason that makes lenders reluctant is theinability of the entrepreneurs to provide collateral. While MFIs providecollateral free loans to the poor, these loans are inadequate to fulfill theneeds of micro enterprises. Moreover guarantee mechanisms such as jointliability groups seldom work effectively in the case of microenterprise loans.

Plain CollateralFree Debt May Not be the Solution

Therehave been pilots which have involved provision of collateral free credit toinformal-semiformal enterprises. In one such pilot in 2009, which involvedSatin Credit Care Network (an MFI operating in Delhi), SIDBI and GIZ (technicalassistance arm of the German Federal Government), loans in the range of Rs50,000 and Rs 500,000 were provided to 48 entrepreneurs in the Delhi clothcluster. A report prepared by M2i, “Financial Inclusion of Microenterprises inthe Informal Sector – Missing Middle” documents the experience of this pilot.One of the important findings of the pilot was that while over a period of timethe loans were being repaid, at any given point in time some of the loansappeared irregular. Irregular cash-flows of the borrowers made it difficult forsuch enterprises to make regular repayments of loans.

Solution MustLook For Risk Capital

Inorder to address this lack of finance for microenterprises it becomes importantto look beyond plain credit. An effective financial solution will be the onethat takes into account the irregular nature of cashflows of microenterprises.It is here that a mechanism which provides equity like capital to theseenterprises can fundamentally shift the way these enterprises are perceived bythe financial sector. Many microenterprises have highly profitable and scalablebusiness models. However, they are unable to scale-up their businesses in theabsence of equity capital. There are other constraints too, which provision ofequity can address:

1. Inabilityto obtain appropriate registrations under labour, environment, tax andcorporate laws

2. Lackof management capacity which leads to bad accounting and control

Equityinvestments in such enterprises can be a highly rewarding proposition withbenefits to all stake holders. The entrepreneur can potentially get rich andgenerate numerous jobs. The government stands to gain from the formalization ofthese enterprises. Cynics will argue that private equity investments are acostly affair and small value transactions in informal enterprises in a retailmodel is not feasible. Professor Mohammed Yunus helped disprove similar notionsregarding banking services to the poor two decades ago. Perhaps the time hascome to use innovative financing mechanisms to help the informal sector jointhe mainstream economy.

Short Story: Twitter Age

2011-12-30T21:38:00.001-08:00

Instinct: A small pup follows you in a dark cold night on a deserted road

Guilt: You know you cannot help the pup and probably it will not survive until next winter

This post: Easiest (lamest) way to rid guilt

Happy Birthday Dr Kurien

2011-11-25T21:14:00.001-08:00

Notes from Lagos

2011-10-01T12:20:00.000-07:00

Nigeria’s post colonial history has been turbulent. It has oscillated between military dictatorships and elected governments. While the former have been ruthless, the latter, typically corrupt, unpopular and eventually overthrown in military coups. The good news though, is that at present, Nigeria is witnessing a period of unprecedented growth under a democratically elected government led by a popular President, Goodluck Jonathan. Today, Nigeria celebrated its 51st independence day.

You don’t often come across a destitute in Lagos, which would suggest that occurrence of extreme poverty here is lower than in Indian cities such as Mumbai or Delhi. However, if you look at Nigeria’s macroeconomic data, you will realize that around 45% of the population lives below the poverty line, there is high income disparity (wikipedia reports a Gini of 43.7 for 2003), and the country gets a very low score on indicators such as the Human Development Index. Corruption is widespread and stark. A traveler to Lagos is likely to be demanded a bribe even before he lands. Lagos for visitors is an expensive city, especially when it comes to food and hospitality.

Most of the common people, one meets are friendly and warm. One feels a certain respect for them as one realizes the kind of challenges – conflicts, warlordism, corruption, poverty – they face as they go about building their society and economy.

Microenterprise Financing by MFIs

2011-06-10T23:19:00.000-07:00

Our analysis of the economic activities of microenterprises that can potentially be served by MFIs lead us to the following common contours of the products that MFIs can offer to microenterprises in enterprise clusters in general.

Nature of Facilities: The target microenterprises need finance for capital expenditures as well as for working capital. Accordingly, loan products for capital expenditures as well as working capital need to be provided.

Loan Limits: The targeted microenterprises have modest capital expenditure needs, as they do not desire to take excessive risks by borrowing excessive sums. Accordingly they can be served well by capital expenditure loans with the upper-limit at Rs 150,000. Similarly, these microenterprises will be served well by working-capital loans with limit at Rs 100,000. Sometimes entrepreneurs may be willing to finance a part of the asset through their own capital and hence may opt for lower sized loans.

Interest rates: The microenterprises have a high Internal Rate of Return (IRR) on their projects and are in a position to service loans which carry an interest between 24% and 26%. MFIs should offer loans to the microenterprises only if they can successfully provide products with these interest rates.

Repayment Periods: It emerges from our analysis that the microenterprises can comfortably service capital expenditure loans over a period of 12 to 24 months depending on their loan sizes. In some cases higher repayment periods not exceeding 36 months may also be considered. A repayment term of 12 months is also suggested for the working capital loan so that the microenterprise has adequate cushion. This is because even though the working capital cycles of the microenterprises may be less than a year, their payments are often delayed. A longer loan term would ensure that they are able pay the loan back without getting stressed.

Risk Management: In the case of capital expenditure loans which are utilized for creation of a productive asset, the MFIs may hypothesize the primary asset created. Also, MFIs may use the mechanism of joint liability or personal guarantees to manage the credit risk. However, the products they offer should not involve any other form of collateral.

Appraisal: Given the informal nature of these enterprises, they may not be able to provide statements of accounts. Under such circumstances, the appraisal of their business turnover would need to be made by independently verifying information from their buyers and suppliers. Also, experience in the enterprise, residence in the area, other existing liabilities as well as opinion of other microenterprises in the area should be included in the loan appraisal.

Documentation: Standard documentation pertaining to address (of the unit) and identity (of the owners) proofs need to be obtained from the potential clients. Additionally standard loan documents pertaining to the facility being provided need to be executed. In case the loan is for the creation of an asset, a hypothecation deed pertaining to the primary asset may also need to be executed.

Emerging Paradigms - IRDP to SGSY to NRLM

2011-06-02T22:18:00.000-07:00

The Integrated Rural Development Programme (IRDP) was launched by the Government of India in 1978. The focus in IRDP was provision of subsidized credit to the poor, to enable them to build productive assets and raise their income levels.

IRDP evolved into the Swarnjayanti Gram Swarojgar Yojana (SGSY) which was introduced in 1999. SGSY hoped to cover all aspects of self employment (training, technology, infrastructure and marketing) and utilize the power of Self Help Groups (SHGs) of poor to overcome the deficiencies of IRDP. It also provided a role for NGOs, who apart from formation of SHGs, were also supposed to have a monitoring role.

The National Rural Livelihood Mission has been initiated in 2010 to redesign SGSY. NRLM goes beyond self employment and includes wage employment as a means to reducing rural poverty. This follows from the realization that not everyone is able to utilize credit in a productive manner, and pushing credit can be counter-productive, particularly when assessment of repayment capacities have not been carried out.

On Corporate Failures

2011-05-25T23:18:00.000-07:00

Natwest WoodMac ‘s (now NatWest Markets) research concluded the following on corporate failures:

1. Aggressive expansion is a likely precursor to problems, particularly when this is accompanied by a rise in short term debt;

2. Dominant personalities often lead a company to doom;

3. Boardroom strife is also a leading indicator of trouble for companies;

4. Often fall comes after hype.

Interestingly this research was carried out in the early 90s. Subsequent events have only validated these conclusions.

Literacy@74%

2011-04-02T00:51:00.000-07:00

I grew up during a time when more than half of all Indians were illiterate. This was something that on the one hand caused you to feel inferior, on the other, also fired you on. It is in this light that the Census 2011 estimate of a literacy rate of 74% assumes significance. An interesting aspect is the trend that the literacy rate has followed, which is quite linear. In the decades since 1940s, India’s literacy rate has gone up by roughly 10% every decade. If this trend holds true in the future, we should be able to achieve total literacy in another two decades. This in my opinion marks an orbital shift. In all probability, many other social indicators such as health (think of immunization, nutrition, sanitation), awareness regarding rights and privileges, will show an improvement. Add to this, improvement in skills that can be used to exploit new livelihood opportunities, to get some idea of what we are on to!

Code of Conduct Assessment Reports in the Public Domain

2011-02-01T01:24:00.000-08:00

We at M2i had always maintained that for micro-finance to sustain sound client management practices, which strongly emphasize on ethical behavior and responsible lending, were necessary. The code of conduct assessment is a pioneering initiative - a global first in the micro-finance domain. M2i has developed the code of conduct assessment tool utilizing its ADDO framework. We have so far conducted four COC assessments which had been commissioned by the Small Industries Bank of India (SIDBI). SIDBI has made some of these reports public.

They are available on SIDBI's website.

The Onion Index

2011-01-14T23:17:00.000-08:00

I have been thinking of an Onion Index on the lines of the Big Mac Index.The Big Mac Index is published by The Economist as an informal way of measuring the purchasing power parity (PPP) between two currencies and provides a test of the extent to which market exchange rates result in goods costing the same in different countries. The Onion index, that would primarily be derived from Onion prices, can at once provide so many useful insights to the Indian Government:

1. an indicator of Government's popularity and approval rating

2. a lead indicator on whether the incumbent Government will be re-elected

3. an indicator of how much does the inflation pinch the common man

4. a lead monetary policy indicator on whether the benchmark interest rates will be raised

5. a lead fiscal policy indicator on whether government should come up with still more populist spending

Epilogue: My friend, Manu finds the idea of Onion Indices interesting. He says that two Onion Indices will be still more revealing - one with the farm gate onion prices and the other one with the retail (consumer) onion prices. The difference between the two (or the spread) will give us an insight into the state of our infrastructure. Brilliant idea Manu! This also ties up with our thoughts on the Infrastructure Requirement Index.

On Death

2010-12-23T04:55:00.001-08:00

Our whole outlook towards death changes when we start viewing it as something desirable. I think we all agree that death is desirable, but somehow, there is little acceptance of it. Or else why should euthanasia pose such a big moral dilemma. There is a general acceptance towards abortion in certain situations but euthanasia is considered a crime – I find this ironical.

Given the advances in medical sciences, it is quite possible that human longevity will increase manifolds. I wonder what would be the societal attitude towards death then. There is evidence to suggest that death for many people is an excellent experience despite the outward appearance of misery. Possibly, there will then develop a market for services that make death a pleasurable experience. I can imagine advertisements that allure people with the notion of death instead of sex. And I can imagine a Freud like psychologist who will interpret human attitude towards death.

Years of Advice on Social Performance Did Not Help Indian MFIs When the Need Arose

2010-12-10T03:36:00.000-08:00

I am really appalled at the pathetic thought leadership provided to organizations in the name of social performance advice! I feel sorry for investors who thought that this leadership will help them mitigate reputation related risks in socially sensitive sectors. I find it ironical how MFIs are now being blamed for indulging in bad practices, after having received years of tutoring on what constitutes social performance management. This is also an example of how bad thought leadership can put an entire industry at risk. Rather than ensuring that MFIs view sound client relationships as being central to this ecosystem, they were made to focus on select client groups on which social performance could be demonstrated. How foolish!

Macro economics textbooks in India

2010-12-07T21:37:00.000-08:00

Wonder why macroeconomics textbooks do not include the effect of leakages in government transfers, leakages in government revenues, and the overall black economy as such on national income, inflation, employment and interest rates. Has there been sound research in these areas and have these variables been explicitly modeled?

Assessing Ethical Microfinance: The ADDO Framework

2010-11-15T21:15:00.000-08:00

The table below presents M2i's ADDO framework for assessing ethical lending by Microfinance Organizations. The ADDO framework has been developed by drawing on our interactions with over 50,000 microfinance clients and over 100 MFIs through our various engagements over the past four years. It gives us great satisfaction that SIDBI (the pioneering financial institution that seeded microfinance and helped greatly in its evolution) as well as Sa-dhan (the premiere network organization in the microfinance sector) are utilizing this framework in their Code of Conduct Assessments.

Approval (A)	Documentation (D)	Dissemination (D)	Observance (O)
Has the board approved the policies covering these codes of conduct principles?	Have the guidelines that follow from these policies been documented in the appropriate manuals?	Have the guidelines been disseminated across the organization through training and making available guidelines and manuals at the branches?	Are the guidelines observed in practice as found through interactions with a sample of clients?





Client origination	Client origination	Client origination	Client origination
Loan pricing	Loan pricing	Loan pricing	Loan pricing
Loan appraisal	Loan appraisal	Loan appraisal	Loan appraisal
Client data security	Client data security	Client data security	Client data security
Staff conduct	Staff conduct	Staff conduct	Staff conduct
Client relationship and feedback	Client relationship and feedback	Client relationship and feedback	Client relationship and feedback

The Death Penalty

2010-11-01T05:01:00.000-07:00

Exploring the methods used for providing the capital punishment is an interesting exercise. If we go back a few hundred years in history we will find that women were burnt on stakes and men were hanged, drawn and quartered. The modern society debates the merits of capital punishment and at the very least explores humane way to end human life. Very interesting video link:

Humane way to kill!

Hits and Misses

2010-10-24T04:50:00.000-07:00

Our ability to act upon an opportunity (or an advice) is directly related to our awareness about the facts surrounding it. For example, I feel my neighbourhood shops can significantly improve their business if they did as simple a thing as to create a page over a social network and invite folks, who patronize the shop, to it. Think of it, if they can get testimonials regarding their businesses, wouldnt more people be drawn to these shops, particularly in areas such as my neighbourhood, where almost everyone has a social network account and an email id. I made this suggestion to the owner of the Gym I work out at, genuinely concerned as I was for his business, given that there have been occasions when I have been the lone soul working out. He has a decent Gym, in fact, he has better facilities as compared to some of the other more expensive places I have worked out at. I think his apprehension arises because 1. his awareness regarding the power of the internet is low, 2. he does not trust me enough (I dont trust my real estate agent) and 3. he hesitates in selling.

To generalize, I think for successful interventions either in the business or in the social development domain, it is important to address the three issues I have mentioned above - provide full information (and ensure that it is internalized), build credibility and help people overcome their potential-limiting inhibitions.

What makes Gandhi special?

2010-10-19T01:53:00.001-07:00

I think he possessed two very-very rare qualities.

He had an unwavering sense of purpose and he was not willing to compromise on it given the necessities of practicality - he'd rather be unreasonable than compromise. He'd rather pay the price of being impractical, than reap the rewards of being an opportunist. This made him extremely selfless;
He was supremely competent which made him extremely effective as a leader. He could capture the imagination of the masses, instilling self belief in them. And he did not need violent force to achieve it.

Any wonder then that Gandhi has been invoked in almost all popular movements related to human rights and freedom.

Bye-Bye, French Lie!

2010-10-07T20:40:00.000-07:00

SKS continues to intrigue. Its a publicly listed company now and in its board , it has some of the most competent people. Still, the decision making in SKS appears arbitrary (or rather tailor-made to favor the founder):

December 2008 - SKS appoints Sursh Gurumani as the CEO

May 2010 - Gurumani gets a 50% raise for his performance

July 2010 - SKS's IPO is oversubscribed

October 2010 - SKS board sacks the CEO, Suresh Gurumani

The day's central story in the Economic Times is better than a Hollywood drama. Read the Economic Times story on SKS, and figure out for yourself.

Happy Reflections (My Dear Peer Group)

2010-10-02T00:24:00.000-07:00

We are in a rather happy situation, isn’t it? After all we are the citizens of a powerful country growing at a rate of close to 10% annually – well there is a bit of a difference between 8% and 10% when it comes to GDP growth rates, but since these are happy reflections I have taken the liberty – with a very realistic chance that it will overcome economic backwardness and associated vulnerabilities. Those of us (everyone in my peer group), who are financially secure have the great opportunity to play a meaningful role in shaping our society and helping it overcome its gravest problems. But this particular post is not regarding the opportunity, it is regarding things from our past, things that we need to be thankful for.

Value System: We all started fairly poor – did not have an “economically” privileged childhood. What we had instead was a blessed childhood with our elders, teachers and parents emphasizing on the need to be hard-working, humble, polite and principled. Consequently, we all understand the importance of material possessions but these do not dictate the choices we make.

Glorious Traditions: We never had any doubts regarding our glorious traditions – be it religious tolerance, non violence, or overcoming unjust systems such as colonialism and “emergency”.

Learning Society: Proud that we are of our traditions, we embrace progressive systems. We chose to be constituted as a secular democracy in 1950, we started liberalizing in the early 90s, we have satellites facilitating mobile telephony (we still do not have public toilets in sufficient numbers). We have not turned a blind eye to the corrupting influences of economic incentives and are using technology to improve transparency in public as well as corporate governance.

Tenacity: We have all overcome odds to be what we are today. Be it the higher education system that tried to tell us we were just not good enough or the prospect of unemployment because there weren’t enough government jobs, we didn’t let these things deter us. In fact these have only made us stronger as we brush shoulders with the best the world has to offer.

Look at it from this perspective - Is there anything that can stop us?

NCEUS report - contribution of the unorganized sector to GDP

2010-07-02T01:47:00.000-07:00

Here is an interesting report by NCEUS task force on the estimation of contribution of micro enterprises to the GDP. NCEUS stands for National Commission for Enterprises in the Unorganized Sector. NCEUS has been set up to review the

1. status of unorganised/informal sector in India including the nature of enterprises, their size, spread, scope and magnitude of employment,

2. existing arrangements for estimating employment and unemployment in the informal

sector.

Pain at the Bottom of Pyramid

2010-07-02T00:25:00.000-07:00

Fortune lies at the bottom of pyramid. This is being told to us repeatedly by reports, books, media etc. Yet, why there is so much lackadaisical attitude by the authorities towards the bottom? There are reports which says that MSME sector was not that much affected during the crisis as is the common perception (see this)

The paper says:

Comparative performance measure index for micro and small scale (MSEs) items and non- small scale (Non-MSEs) items is constructed to evaluate the performance of the industry groups during the period 2001-09, with a particular focus on the slowdown period of 2007-09. Econometric analysis is then performed to explain the causal factors behind variations in the MSE production index. The paper finds evidence that the cyclical slowdown in the industry that set in during 2007-08Q1, retarded the pace of growth in MSEs as well as Non-MSEs. However, MSEs have recorded relatively better performance than Non-MSEs during the slowdown period at least in the ten items under review. Econometric analysis shows that both domestic and external demand bears a statistically significant influence on MSE output. However, the impact of domestic demand is comparatively stronger. Interestingly, credit to MSEs has been found to be very significant, although the sign of the coefficient (negative in this case) is contrary to theoretical expectations.

I have one reservation. How can you club Micro with Small and look at them at an aggregate level? The statistics may hide the pain at the real bottom or at the bottom of bottom. See today's Busines Line editorial. It says:

The Karnataka numbers point to what one might have suspected anyway — that the bulk of the credit has been cornered by medium-scale units.

I suspect this may be a pan India phenomena. We need to nurture the bottom. The data must be available at a very disaggregated level in regular frequency by RBI or by Ministry of MSME. Let's segregate the first M from the MSME. Fortune lies there and we must focus on Micro enterprises. That is the way to provide employment to vast rural youth.

A Brilliant Publication by RBI

2010-07-02T00:07:00.000-07:00

RBI has relased its report on Currency and Finance yesterday. Over the years, this particular title has covered a wide variety of issues and what amazes me is its coverage. The elegant writing style and depth of analysis makes it a good reference source for researchers.

The list is shown below:

1. 1998-99 The Structural Transformation of the Indian Economy
2. 1999-2000 Financial Sector and Market Integration
3. 2000-01 Revitalising Growth
4. 2001-02 Stock taking of the Reform Process and its Outcomes
5. 2002-03 Management of the External Sector in an Open Economy Framework
6. 2003-04 The Evolution of Monetary Policy
7. 2004-05 The Evolution of Central Banking in India
8. 2005-06 Development of Financial Markets and Role of the Central Bank
9. 2006-07 and 2007-08 The Banking Sector in India : Emerging Issues and Challenges
10. 2008-09 (Current) Global Financial Crisis and the Indian Economy

This year's publication has focused on the current global crisis and the lessons learned.The forward written by Dr. Subir Gokarn says this:

Every crisis provides us powerful lessons. What we carry forward from this crisis is the need for some new regulatory and supervisory institutions with emphasis on a system-wide approach,some new objectives for the central banks, importance of communication, transparency and coordination in central bank functioning, a new design of the international financial architecture and renewed faith in some of the safeguards adopted by the emerging market economies. This crisis has raised questions about the adequacy and efficacy of the current international financial architecture to prevent and manage global crises. In fact, the speed and intensity with which the US subprime crisis exploded into a global financial crisis and then into a global economic crisis has led to a whole new debate on dominant tenets of macroeconomics and has challenged established views on self correcting market mechanisms and the role of public policy. The depth and breadth of the crisis tested the limits of conventional and unconventional policy options available to policymakers around the world.

This particular volume is a must read for MBAs who have specialized in MBA (Mortgage Backed Assets).

Power of Context

2010-07-01T00:26:00.000-07:00

I have come across a speech by Dr. Subbarao, Governor, Reserve Bank of India. He is simply brilliant in his elocution. In my last posting, I have raised questions about the role of finance in an economy. Dr. Subbarao has delivered a speech linking ethics with finance. His broad views are - Ethics is contextual and varies from person to person. However, there is no such water tight compartmentalization as these set of people are extremely ethical and others are not. It shows great spatio-temporal and individual variations. He argues that People in the field of finance are not highly unethical as compared to people from other parts of life/society. There may be greater temptation due to involvement of pecuniary interest.

In the context of the current crisis, I find his observation quite fascinating. As per my understanding he argues what is legal need not be always ethical. Ethics is above the mundane law. To quote Dr. Subbarao:

At one level, it is possible to argue that nobody in the entire chain did anything legally wrong. But that is too simplistic an argument. We do not govern our behaviour simply by what is allowed by law or regulation. Our code of conduct should be held to a stricter test. Was the behaviour of actors across the chain of the financial sector fair, ethical and moral or was it swayed by the opportunity of making quick profit afforded by information asymmetries? Were sub-prime borrowers adequately warned that there is a good chance that asset prices would fall? Did investment advisers tell their clients of the risk they were taking in buying MBAs and CDOs? Did credit rating agencies not compromise their standards and cut corners? In sum, were professionals in the financial sector legally right, but only legally right and morally wrong?

I believe to answer these questions does not require great effort. It needs a little bit of soul searching, a little bit of courage, a little bit of honesty towards yourself.

It reminds me a great vedic story of India - the story of Lord Shiva and Bhasmasura. Being pleased at his severe penance Lord Shiva had granted him a boon that whatever he would touch with his right hand would be reduced to ashes. Bhasmasura wanted to test this boon and said "Lord, you have granted me the boon alright, but how will I know it is true? Once you disappear now, I will not be able to get you for the next few hundred years perhaps. I would like to test your boon. This is a mountainous, snowy area. For miles around there is no object that can be touched. Therefore, come forward. I will touch your head and see if what you say is true". Perhaps, Bhasmasura knew that he would become more powerful once Lord Shiva disappears for forever.

Well, I have cited this story for two reasons - A. (In case of Shiva) one may fall victim of his/her own actions if he/she is not adequately thoughtful of his/her actions. If you leverage yourself too much, you may see the value of your assets plummeting to zero one day. If you run excessive fiscal deficit, you may become bankrupt and people may brand you as Pigs (no disrespect towards the Pigs though!). If you mis-sell your product, you are only entering into a repo transactions which you have to buy back ultimately when the value is negative. B. (In case of Bhasmasura) Great responsibility must come with great power. If you try to misuse of your power, then you may be the next one to be ruined by the more powerful.

Please read the speech. Each of his lines is quite powerful.

Role of Finance

2010-06-29T23:40:00.000-07:00

What is the role of finance in an economy? Can 'finance' in itself be a goal of optimization in the economic planning? Can the growth of 'financial sector' in itself lead to national economic prosperity? These questions are pertinent to ask although it sounds naive and amateurish. 'Finance' is a means to achieve 'real' growth. You need finance to start your business, build your home or buy a motor vehicle. Finance is a mechanism to reallocate resources from those who are having excess to those who need it. It is the fuel to kick start the engine. What happens when Finance itself becomes the overriding goal of a society? You create 'Finance' then more 'Finance' on 'Finance' and then more.......till the edifice collapses. You start to believe that 'Finance' is real and real is a mirage. That is the crux of the current crisis. In the era of globalization, there can be specialization like some countries may focus merely on building the service sector enterprise and some may build factories and machines. But, as long as the level of opacity is less and there are mechanisms to inspect, scrutinize and certify the 'Finance' instruments, one feels safe and there is no imminent danger. However, when the complexity level increases and you fail to understand what you are buying, then a simple 'hoax' call may lead to a bank run or other financial chaos. It is more about 'trust' than anything else. This is a perfect time to re-look the entire development models of developing and advanced countries. Especially in India, we need more schools, more bridges, more factories and more health care facilities. We need Finance to develop all these. However, Finance should be a tool to achieve all these not a goal in itself. I think the policy makers when they are in doubt must refer to Gandhiji's talisman:

Whenever you are in doubt, or when the self becomes too much with you, apply the following test. Recall the face of the poorest and the weakest man [woman] whom you may have seen, and ask yourself, if the step you contemplate is going to be of any use to him [her]. Will he [she] gain anything by it? Will it restore him [her] to a control over his [her] own life and destiny? In other words, will it lead to swaraj [freedom] for the hungry and spiritually starving millions? Then you will find your doubts and your self melt away.

In the name of Reform

2010-06-29T03:25:00.000-07:00

Much water has flown under the bridge since my last post. There are signs of growth stabilization. Developing countries are recovering at a faster rate than the OECD countries. EU nations are again under a debt trap. Lot of stabilization measures have been initiated. We need to wait and watch the unfolding of this new debt ridden problems. There are lots of talks about REFORMS. It has become a buzz word. The latest being the cut of power of FSA (Financial Services Authority) of U.K. It has become a kind of subsidiary to the Bank of England. Seemingly impossible are now becoming possible. It reminds me of the view of the Austrian Economists - they view the economic calamities as Tuneup Cleaner - it cleans the unnecessary elements from your system. There is a lot of noise in India also to streamline the regulations (latest being the SEBI-IRDA spat and the Ordinance). Do we need to overhaul our system? I will continue to write on this subject.For the time being I would like you to go through a paper (I am not adding any adjective). The title of the paper is: Financial Sector Reform: Realities and Myths by R H Patil (Download the paper).

The Ig-Nobel and Market Predictions - Experts or Astrologers

2010-05-13T21:40:00.000-07:00

"The first Ig Nobels were awarded in 1991, at that time for discoveries "that cannot, or should not, be reproduced". The wikipedia post on these prizes makes an excellent read, something that should not be missed at all.See Wikipedia on Ig-Nobel. I sincerely hope some researcher coveting the Ig-nobel prize shall compare the accuracy of predictions made by "expert" traders with those made by astrologers regarding market movements. They can get all the required data on moneycontrol.com.

Transparency is the crying need as we embrace market based reforms

2010-04-17T04:07:00.000-07:00

Markets function when profitable private sector enterprises are transparent in revealing who really owns them and benefits from the profits. Be it the recent disclosure regarding how promoters of large MFIs in India have benefited from the high RoE churned by these institutions, that has created an adverse impression that affects the sector as a whole, or the muck surrounding the Indian Premier League. The positive is that the ownership patterns are out in the open. If the law allows for opaque functioning of any enterprise, it will invariably lead to corrupt practices with the complicity of corrupt lawmen. The scale will be enormous in case these happen to be for-profit enterprises operating at a significant scale. Conversely if enterprises function in a transparent manner and disclose their ownership structures, innovations will ensure that goods and services that earlier classified as public/merit/club goods will also be adequately provided for by the market.

(Only?) Markets can provide for sanitation services in India.

2010-04-17T03:51:00.000-07:00

A recent UN study has found that cell phones are more common in India than toilets. Private sector has ensured the availability of cell phones at prices that are attractive to the masses in India. Had it been for the public sector telephony would still have been the privilege of the elite. Sanitation (toilets) in India has been treated as a merit or a public good - something that the private sector cannot provide for.

It may be worthwhile to explore the business model of DMT mobile toilets (http://www.dmttoilet.com/aboutus.htm ). DMT is a for profit entity that has exploited technology to make available mobile toilets. Quite clearly these toilets are easy to maintain and require significantly lower investments as compared to the fixed structures that we have in India. While Sulabh was a pioneering concept, the technological model needs to be evolved. Also, a transparent for-profit model will ensure that these services are provided for adequately.

(I am sure CKP would have wanted to do a case study on DMT. I hope I am able to write one and post it on this blog as a remembrance post.)

CK Prahalad is no more.

2010-04-17T01:57:00.000-07:00

CK Prahalad is no more. He was a professor of Corporate Strategy at the Stephen M. Ross School of Business in the University of Michigan. He is best remebered for his "bottom of the pyramid" argument. I had met him in a workshop where I had the privilege of being a resource person alongside him. Many in my circle would criticize him for presenting poor as a business opportunity. I held him in high regard for the same reason. He was the inspiration behind this blog.

Thoughts from an excruciating train travel

2010-03-11T03:46:00.000-08:00

Things that lift the heart:

A fast moving goods train, at 90 kmph

Smooth roads in the rural hinterlands

Smiling women-micro entrepreneurs who have worked their way out of poverty

Cricket team India - the best test team in the world

Kind words that give hope

Mero gaam, Manthan (1976) (folk version)

2010-01-19T22:48:00.001-08:00

Kurien's management genius is hard to replicate. We are talking about a person who has helped align the livelihoods of over 1.7 million women with the creation of one of India's most valuable brands - Amul.
However, I think his failing lies in his rigid faith in cooperatives as the sole means to building something like Amul. In doing so, he rejects the very idea of capitalistic finance.
Agreed, that capitalistic organisations cannot by design retain the same social focus as cooperatives, still, their ability to attract private capital and scale up, without getting too political in the process enables them to have a much greater impact. Amul remains an exception as it was created under exceptional circumstances by exceptional people. Tata, Reliance, Airtel and SKS microfinance are more commonplace.
Cooperatives definitely have a place, but I have come to believe, that their institutional superiority is a function of easy availability of capital (a prosperous society) and good governance system (an evolved society). Cooperatives therefore, I am inclined to think are better suited to maintaining "social development" as against aiding "social development". Capitalistic organizations that follow the rule of the market (and hopefully with regulatory supervision to ensure that this is not the same as the rule of the jungle) are better at bringing social development.

My Favorite Management Gurus

2010-01-18T02:55:00.000-08:00

Name Specialization Rating

Michael Porter Strategy ***

Philip Kotler Marketing ***

Amartya Sen Development ***

Verghese Kurien All of the above *****

Brealy and Myers Finance ****

CK Prahalad Strategy ****

MK Gandhi Leadership *****

Views are personal :-)

A statement to reconcile the share holder v/s the stake holder debate

2009-12-18T03:11:00.000-08:00

Firms operate within the framework of rules created by the interaction of the industry and the government to maximise share holders wealth within the constraints imposed by the need to be socially responsible with respect to job security, product safety, environment, cultural sensitivities and economic impact on the poor.

Most SMEs are destined to stay small

2009-12-17T22:14:00.000-08:00

Given M2i’s positioning we get to work with a variety of small businesses – some fairly large small businesses attracting private equity and commercial funding, and some really small-small businesses backed by subsidies and donor funds. Among the latter, some are formally organized with appropriate registrations while many, in fact most, are informal enterprises with minimal registration – although a return is filed with the Income Tax Department. Business failure appears to be higher in those cases which have registrations and are required to comply with a number of regulations. Also, there is a reluctance among the entrepreneurs to grow a single enterprise, they’d rather divide their business and have several sole-proprietorships under various names, all engaged in the same business.

Public Sector Companies and Value Creation (Erosion)

2009-12-13T22:14:00.000-08:00

This is from the ICAI journal- The Chartered Accountant, (Dec -09 issue) "According to the latest report of C&AG of India for the year 2009-10, 103 government companies and corporations (including 11 listed companies) had accumulated losses of Rs. 96,992.49 crore. Equity capital of 72 government companies (out of 103) had been completely eroded. The accumulated losses in these 72 companies were Rs.94,428.27 crore against equity investment of Rs. 15,762.83 crore, making their combined net worth negative at Rs. 78,665.44 crore. At the state level, the position is even more alarming. Most of these had not prepared their financial statements for more than 10 years."

Available at - http://www.ejournal.icai.org/CA/CA/2009/12/01/index.shtml

Advice worth taking note of!

2009-11-20T22:37:00.000-08:00

This is the best advice you will ever receive.

Written By Regina Brett, 90 years old, of The Plain Dealer, Cleveland, Ohio

"To celebrate growing older, I once wrote the 45 lessons life taught me.
It is the most-requested column I've ever written. My odometer rolled over to 90 in August, so here is the column once more:

1. Life isn't fair, but it's still good.

2. When in doubt, just take the next small step.

3. Life is too short to waste time hating anyone...

4. Your job won't take care of you when you are sick.
Your friends and parents will. Stay in touch.

5. Pay off your credit cards every month.

6. You don't have to win every argument. Agree to disagree.

7. Cry with someone. It's more healing than crying alone.

8. It's OK to get angry with God.. He can take it.

9. Save for retirement starting with your first pay cheque.

10.When it comes to chocolate, resistance is futile.

11. Make peace with your past so it won't screw up the present.

12. It's OK to let your children see you cry.

13. Don't compare your life to others. You have no idea what their journey is all about.

14. If a relationship has to be a secret, you shouldn't be in it.

15. Everything can change in the blink of an eye. But don't worry; God never blinks.

16.Take a deep breath. It calms the mind.

17. Get rid of anything that isn't useful, beautiful or joyful.

18. Whatever doesn't kill you really does make you stronger.

19. It's never too late to have a happy childhood. But the second one is up to you and no one else.

20. When it comes to going after what you love in life, don't take no for an answer.

21. Burn the candles, use the nice sheets, wear the fancy lingerie. Don't save it for a special occasion, Today is special.

22. Over prepare, then go with the flow.

23. Be eccentric now. Don't wait for old age to wear purple.

24. No one is in charge of your happiness but you.

25. Frame every so-called disaster with these words 'In five years, will this matter?'

26. Always choose life.

27. Forgive everyone and everything.

28. What other people think of you is none of your business.

30. Time heals almost everything.. Give it time.

31. However good or bad a situation is, it will change.

32. Don't take yourself so seriously. No one else does.

33. Believe in miracles.

34. God loves you because of who God is, not because of anything you did or didn't do.

35. Don't audit life. Show up and make the most of it now.

36. Growing old beats the alternative -- dying young.

37. Your children get only one childhood.

38. All that truly matters in the end is that you loved.

39. Get outside every day. Miracles are waiting everywhere.

40. If we all threw our problems in a pile and saw everyone else's, we'd grab ours back.

41. Envy is a waste of time. You already have all you need.

42.The best is yet to come.

43. No matter how you feel, get up, dress up and show up.

44. Yield.

45. Life isn't tied with a bow, but it's still a gift."

Sustainable microfinance requires sound client relationship management

2009-11-16T23:21:00.000-08:00

While the microfinance sector has grown at a rapid pace, concerns have been raised about the qualitative aspects of this growth. There have been a few instances in Andhra Pradesh, Karnataka and Uttar Pradesh which have led to questions being asked on microfinance business models and their ability to sustain client relationships in the long run. The areas that have been particularly in focus are client over-indebtedness, coping strategies in case of crisis, transparency in loan pricing and overall client protection. There has been a lot of deliberation on how MFIs should deal with these issues, it is difficult to say whether MFIs have been effective in addressing them.

MFIs have to cope with the growth expectations that lenders and investors have of them and operate in an increasingly competitive environment. In addition, the nature of credit operations requires regular follow-up with clients in order to ensure prompt repayments. At times, this is construed to be coercive and leaves MFIs vulnerable to accusations of malpractices.

Practicing client protection principles requires MFIs to treat every client interaction as a relationship exercise. MFIs need to view this as an opportunity to build a sustainable and sound business.

There is a heaven after all, as there is a hell!

2009-11-04T21:48:00.000-08:00

Of all the strange thoughts one has one sometimes wonders how it would be like to experience death. The research on Near Death Experiences (NDEs) is an interesting one. This research gives us a window into the largely unknown realm of death. The most common NDEs are associated with feelings of calmness. NDEs include experiencing intense “pure bright light”, out of body experiences and communication with the divine, and a review of life. All these experiences are becalming and soothing. On the other hand, research suggests, some people (a minority) going through NDEs do not experience feelings of peace, nor do they visit Heaven or meet friendly spirits. Instead, they feel terrified and are accosted by demons or malicious imps. They may visit places that fit Biblical descriptions of Hell, including lakes of fire, tormented souls and a general feeling of oppressive heat.

A Gollop and Proctor research in 1982, which formed the basis of their book - Adventures in Immortality: A look beyond the threshold of death, found out that 15% of Americans who had been in near death situations had NDEs and only 1% had negative NDEs. However, there is little evidence that could suggest what could be the cause of a positive NDE or a negative one. What is clear though is that those who have a positive NDE very nearly experience something that is close to the common conceptualization of heaven, while those who have a negative NDE get close to hell.

Sustainable microenterprises

2009-10-01T05:10:00.000-07:00

We had a very interesting debate on microenterprises and the conditions that are necessary for their long term sustenance. There was a consensus that for microenterprises to sustain, they would have to follow one of the following paths:

1. Scale-up using commercial capital – small startups have opportunities in nascent industries. They also often bring innovations and may be able to attract capital that can allow them to scale-up and compete against larger players.

2. Have captive markets – microenterprises can also survive if they have access to captive or assured markets. Dairy cooperative societies are an example. While the societies are themselves small they cater to the demand of larger processing plants. Auto ancillary companies are another example, though they may not entirely classify as microenterprises. Autonomous R&D organizations performing research for larger clients are another example.

While it is possible to have an overlap for SMEs that operate on commercial motives, for community based social businesses that cannot reward (and therefore cannot attract) capital, the latter appears to be the only real possibility.

Microfinance: Good or Bad

2009-08-29T00:18:00.000-07:00

The problem with case studies is that they can powerfully portray certain things that are exceptions rather than being the general fact. That makes it important for any critic to study evidence that can be called “significant” in the statistical sense. Documentaries like the one on france24 (http://www.france24.com/en/20080404-bangladesh-burden-microcredit-caring-grameen-bank-mohammed-yunnus) may serve political constituencies, but are of little help as far as advancing facts is concerned.

The concept of lending involves taking money back which in itself may be construed as coercive. Let me explain - even if a lender charges no interest, she still has to collect the principal. She is likely to apply some pressure such as sending reminders that repayments have become due, making visits etc. If there was absolutely no pressure on borrowers to repay, I suspect a vast majority of them would be intelligent enough not to repay. A look at the performance of numerous development credit programs which did not have a system of adequate follow-up on disbursed loans will reveal that they could not be sustained and their outcomes were mixed at best.

Having said this, I believe information asymmetry and a lack of transparency in a capitalistic setting results in exploitation of poor clients. This happens even when the law of the land seeks to protect the poor.

Here is an example:

In the Indian context, there are strict restrictions on Non Banking Financial Companies (NBFC) taking savings from the public. Many NBFC-MFIs sought to get around this little problem by forming private trusts which were used to take members contributions. These contributions were then invested in the equity of the NBFC MFI. I wonder how many MFIs told their clients of the risks involved in such investments. I also wonder how many of them would share/have shared the upside that may translate on such investments?

In a lighter vein

2009-08-19T02:53:00.000-07:00

Its not often that one senses unambiguous accomplishment. I had this feeling today – I felt I had conquered the final frontier. I had successfully prepared my own breakfast.

Well, almost. The credit goes to my cook who incidentally is on leave. I hope the leave does him some good. He showers me with great respect and makes me feel like an unleashed alsatian with his reactions.

Cooking, though, is not rocket science. Its closer in complexity to conditional probabilities.

Archimedes discovered buoyancy in the bath tub. Have you ever wondered where Murphy figured out his law? I am quite convinced he did it in his kitchen.

Hans Rosling: No more boring data

2009-08-17T23:01:00.001-07:00

This one is for those who find statistics or development talk boring. AWESOME!!

Hans Rosling was born 1948 in Uppsala, Sweden. He is a Professor of International Health at Karolinska Institutet and Director of the Gapminder Foundation, which developed the Trendalyzer software system, used in the presentation above. Some components of the Trendalyzer software, particularly the Flash-based Motion Chart gadget, have become available for public use as part of the Google Visualizations. Try the spreadsheet application in Google docs. Its fun.

Rosling has studied statistics and medicine at Uppsala University, and public health at St John's Medical College, Bangalore.

Useful links:

http://www.gapminder.org/

http://www.roslingsblogger.blogspot.com/

http://en.wikipedia.org/wiki/Hans_Rosling

http://twitter.com/hansro

Accessing wlefare programs of the Government

2009-08-09T23:35:00.000-07:00

When I see a beggar in Delhi, what do I do? Am I aware of all the recourses this poor person has to be reasonably sure that begging in her/his case is a choice? In case it is a question of access to opportunities that may enable her/him to live a more dignified life, how can I help her/him? These are some of the questions that keep cropping up in my head and have got me to explore the headline welfare programs of the government. While I will post my observations gradually, I intend to follow the following framework:

1. Program details and origin

2. Agencies involved

3. Eligibility and conditions

4. Processes involved

a. Enrollment

b. Participation

c. Payment, remittance

5. Risks and mitigation

6. Recommendations

7. Present status

8. How can I help a poor person benefit from this program?

I welcome any suggestion on this framework.

Government Sponsored Rural Development Programmes in India

2009-08-07T23:31:00.000-07:00

The headline rural development programmes in India are:

National Rural Employment Guarantee Act (NREGA) – Wage employment
Swarnjayanti Gram Swarozgar Yojana (SGSY) – Rural self employment
National Social Assistance Programme (NSAP) – Social security for the poor
Bharat Nirmaan – Rural infrastructure such as drinking water, electricity, housing, irrigation and road
Council for Advancement of People’s Action and Rural Technology (CAPART) – Skill building
Prime Minister Gram Sadak Yojna (PMGSY) – Rural roads

Tracing the evolution these programmes is an interesting study of the emerging development paradigm in India.

Steve Jobs' 2005 Stanford Commencement Address

2009-08-04T04:19:00.001-07:00

Inspiring stuff! It helps to remember that we live the choices we make.

Just to complete Steve's story, Apple granted him ESOPs in 2001. These options apparently were granted at a strike price lower than what the price should have been. If this is true, Steve Jobs would have under-reported his income. An internal Apple investigation has cleared Jobs of the charges reporting that he had returned his options without exercising them in 2003. Apple's board remains under investigation for alleged securities fraud.

Source:

http://en.wikipedia.org/wiki/Steve_Jobs

“Who would ever think that so much went on in the soul of a young girl?” Anne Frank Quotes

2009-04-30T22:49:00.000-07:00

The quotes attributed to Anne Frank are intelligent and kind. They are also relevant to the world we live in – a world full of uncertainties. These quotes have an amazing healing effect. Their most remarkable property is that they are extremely positive, despite all that Anne had to go through in her brief life. An honest assessment will tell you that it’s a lot easier to be vengeful and unforgiving. Therefore these quotes are also sobering. Anne Frank will forever remain a “pole” star for those who feel lost in trying to figure out the right from the wrong.

The Quotes:

“I keep my ideals, because in spite of everything I still believe that people are really good at heart.”

“And finally I twist my heart round again, so that the bad is on the outside and the good is on the inside, and keep on trying to find a way of becoming what I would so like to be, and could be, if there weren't any other people living in the world.”

“Everyone has inside of him a piece of good news. The good news is that you don't know how great you can be! How much you can love! What you can accomplish! And what your potential is!”

“How wonderful it is that nobody need wait a single moment before starting to improve the world.”

“I live in a crazy time.”

“I must uphold my ideals, for perhaps the time will come when I shall be able to carry them out.”

“I soothe my conscience now with the thought that it is better for hard words to be on paper than that Mummy should carry them in her heart.”

“If I read a book that impresses me, I have to take myself firmly by the hand, before I mix with other people; otherwise they would think my mind rather queer.”

“It's really a wonder that I haven't dropped all my ideals, because they seem so absurd and impossible to carry out. Yet I keep them, because in spite of everything I still believe that people are really good at heart.”

“Laziness may appear attractive, but work gives satisfaction.”

“Boys will be boys. And even that wouldn't matter if only we could prevent girls from being girls.”

“No one has ever become poor by giving.”

“The best remedy for those who are afraid, lonely or unhappy is to go outside, somewhere where they can be quiet, alone with the heavens, nature and God. Because only then does one feel that all is as it should be.”

“The final forming of a person's character lies in their own hands.”

“Think of all the beauty still left around you and be happy.”

“We all live with the objective of being happy; our lives are all different and yet the same.”

“Whoever is happy will make others happy too.”

“I simply can't build my hopes on a foundation of confusion, misery and death... I think... peace and tranquillity will return again.”

The Value of a Promise

2009-03-28T03:08:00.001-07:00

A private equity investment in an enterprise that does not trade in the stock market poses multiple challenges. These challenges multiply if the enterprise operates in a nascent industry that is still in its early stages of development, because there is very limited data to compare the investment deal with.

Reaching a consensus on the value or price of equity is the first step in the equity investment process. Most often the valuation is based on the expected future returns to the equity investor. This usually involves forecasting future performance and an analysis of the business plan of the enterprise. When the buyer and the seller agree that the forecasted performance reflects mutually acceptable and realistic expectations regarding returns, there is usually an agreement on the price of the equity share of the enterprise also.

In most cases where the equity value being asked is at a significant premium to the book value because of the future reward potential, the investor may not be comfortable in making the investment at one go. In such a case, the investor may demand a milestone linked investment schedule, spanning between six months to over two years. Till such time, the investment may rest within the enterprise as a convertible debt.

In situations where an existing equity holder sells her equity stake to an investor in an equity deal, the investor may put even more stringent conditions such as requiring that a significant part of the money being paid for the equity stake be kept in an escrow account maintained by the investor till such time that the company achieves certain pre-decided milestones particularly relating to sales and profits.

Investors view these as mechanisms to ensure that the existing owners as well as the management of the enterprise do not make exaggerated profitability forecasts in order to create a false impression of value. As most enterprises look for equity to fuel growth, they invariably project very high growth in the first few forecasted years. Given the “mystery” surrounding any early stage enterprise, it adds to investor comfort if these projections are beaten.

It would be an interesting research to examine investment terms and conditions in private equity deals in emerging economy contexts.

Crystals

2009-03-08T21:57:00.000-07:00

Silent screams;

Deaf ears.

Escape;

Mortal fears.

Crystals of salt;

Dried tears.

Layoffs: Painful but not disgraceful

2008-10-22T19:38:00.000-07:00

Mass layoffs are very common in industrialized economies. As a matter of fact Bureau of labour statistics of the U.S government provides data on layoff actions every month. In case of U.K, national statistics department provides data on unemployment rate and claimant count on a regular basis. It does not deserve to be a national headline there and does not create much panic either. In particular layoffs are less significant events than unemployment. Why it is so? Because labour is an input in the production process and it becomes redundant, if not worthless, as demand slackens. Let’s look at recent layoff data of U.S. In the month of August, 2008 there were around 173,955 initial claimants in 1,772 mass layoff events! A claimant means a person who has applied for unemployment insurance but is actively seeking work. An event is registered when fifty or more initial claims for unemployment insurance benefits are filed against an employer during a 5-week period. In U.K the number of claimants is far higher – more than 900 thousand in month of August.

Figure 1: Mass layoff events in U.S - Sep, 2004-Aug, 2008

Source: Bureau of labor statistics, U.S

Figure 2: Growth rate of Mass Layoffs in U.S

Source: Bureau of labor statistics, U.S

Well, for us these numbers may be incredibly high but for a matured capitalist system, at best these could be systolic and diastolic readings of the economy which do not always require an aspirin dose. Only when mass layoffs result in higher unemployment, it could solicit some fiscal or monetary interventions. In August, U.S has 6.1 percent unemployment up from 4.7 percent a year earlier. That is what makes a headline. Only when unemployment crosses the natural rate of unemployment (4 – 5 %), it raises the eyebrow. Now we are back to the first question – why it is so in a capitalist system? Let’s understand the basics.

Capitalism thrives on profits and it must fulfill the first order condition of that which is the equalization of marginal revenue and resource cost, to survive in business. But, the decision to operate is a function of shut-down price – that is the price when the firm decides not to produce as the total variable cost of producing that output exceeds the total revenue derived from selling it. While this simplistic version of profit maximization condition may not be the final condition in all market forms, the essence holds – one must earn more than one spends in a business to survive. There could be cyclical, frictional and structural unemployment in this model. The cyclical unemployment is related to the business cycle phenomena – investment rate goes down due to gloomy business environment which results in labour unemployment. The frictional unemployment is very transitory in nature and could be described as a wait unemployment or seasonal unemployment. When a person moves from a company to another company, there may be an intervening period during which he remains unemployed. Similarly someone might have opted for a seasonal work which keeps him busy during certain months in a year and free from work in the remaining months. Structural unemployment arises due to skill or location mismatch. A new software language may lead to obsolescence of the old workers and till the time they are trained in a modern language, they may remain unemployed. Similarly, there may be a reserved army of IT at Bangalore but demand for them may be more at Thiruvantpuram. The changing dynamics of an economy creates such an unemployment scenario. Therefore, unemployment in one form or other always arises in a free market economy which is in a constant endeavour to adjust and readjust with changing dynamics.

Now let’s get back to the core issue that has become headline in the Indian media. Jet had laid off 800 plus employees while several others were in the queue. It has been done with a motive to rationalize costs and keep the airline afloat. As per the audited financial results of Jet, iit has incurred a loss of Rs. 253 crores post tax in FY08. It has incurred losses of Rs. 143 crores in the first quarter of FY09. Moreover the industry traffic growth rate has fallen from 11.1 percent in Q4FY08 to 4.2 percent in Q1FY09. The ATF which is around 50 percent of airline operating costs has increased by 52 percent between February, 2008 to July, 2008. Jet with the average headcount of 13,403 between April-June, 2008 with 85 fleet has to face the brunt of spiralling costs. Its workforce has increased by 24 percent between Q1FY08 to Q1FY09. Being bewildered by the international and domestic macroeconomic developments, it has taken an unprecedented step in recent times – that of retrenching 800 plus employees. As per the news it was in the process of manpower reduction by 15%. The basic economics of business infact won’t disagree with Jet’s move. We all do cost cutting or rationalize our personal expenses (politically correct word!) when faced with a tight financial situation.

Before dealing with the post-retrenchment development, I would like to spell few words to deal with such a situation from both macro and micro perspectives. Being laid off is an unfortunate event but certainly not a disgraceful one – especially when it is due to exogenous factors. One has to accept the reality that business cycle is an integral part of the capitalist development. India can no more take respite by ascribing dismal growth to ‘act of God’ which very often we do by regressing economic growth with respect to rainfall index. We are very much in the club of capitalist countries courtesy Manmohan Singh who has just made us a member of another club – that is called nuclear power, very recently. Coming to treatment, we need a trauma care centre – unemployment insurance. When you have asked people to join rafting, you have to ensure that everyone wears a lifesaving vest. It is there in U.S, in U.K and other western European nations. Least to speak in U.K, they give you additional allowance if you have a pet and become unemployed. India has to do this before it is too late. Even in the absence of any business cycle syndrome, otherwise also, enterprise restructuring would produce some temporary jobless people for whom some sort of insurance mechanism must be put in place. Whether it would be a complete transfer of income or from a contributory premium fund at a national level would need to be explored.

At the micro level also, people coming to the job market must be prepared for it. As the wise advice goes – do not put all of your eggs in one basket. One should possess multiple skills and in really bad times, one should not hesitate to jump to the periphery, may be, till the tide get back its level. For example, if you are a software programmer, you should learn a few other languages rather than being a specialist in one as you do not know when that lnguage would get obsolete. Sometime ago, Business Standard bore a headline that there is a scarcity of Ph.D s in Economics. Even if one discounts the academic virtues of being a Ph.D, it makes sense in terms of diversifying your risk. Similarly people in the aviation industry should learn the basics of hospitality services in other areas like hotels, clubs or hospitals. While I understand the predicament of most of the poor Indians in terms of bearing the massive expenses of a single professional course, it makes sense to aspire a little more than what one can manage. Maybe one should finish a Masters degree course even if one thinks of employment after a Bachelors.

Now let’s close the story. We all know that Jet has taken back the retrenched people. It has ended as a high octane melodrama where chairman of Jet Mr. Naresh Goyal could see his daughter among the sacked employees. Considering the high emotional quotient of Indians, there is no reason for me to disbelieve Mr. Goyal’s version. The conscience of the capitalist has surpassed (rather transcended!) balance sheet calculations. However, the basic principles of capitalist system must be respected in letter and spirit that is – marginal revenue should be equal the marginal cost atleast. There is no excuse to avoiding that. After all, in a capitalist system, companies exist to maximize share-holder value.

(Views are personal)

Effects of multiple borrowings on overall indebtedness of MFI clients

2008-08-05T22:59:00.000-07:00

The Indian microfinance sector has witnessed rapid growth during the past few years. Several new MFIs have come up, and older ones have expanded their operations geographically. There exist pockets in various states where there is a concentration of many MFIs. On the one hand competition has helped in bringing interest rates down, on the other hand there are concerns relating to overlap in clients resulting in clients borrowing from multiple MFIs and beyond their repayment capacity.

While expert opinion cautions against the adverse impacts of multiple borrowings by the clients, empirical evidence collected so far, does not establish that the recovery rates of MFIs deteriorate as a result of their clients borrowing from multiple sources. Intense competition among MFIs may lead to instances of multiple borrowings by MFI clients and clients may be tempted to enter into a situation of over indebtedness (Graham Wright). It may also lead to asymmetric information and borrowers may obtain multiple loans, which in the longer run would militate against provision of sustainable financial services (McIntosh and Wydick, 2005). However, an empirical study of the partnership clients of ICICI bank concludes that multiple borrowers have equal or better repayment records than their single borrowing peers in the same village (Krishnaswamy, 2007). The Bolivian experience in microfinance in the early years of this decade provides an example of the ill-effects of over indebtedness among microfinance clients (Rhyne). The microfinance experience was symptomatic of the problems in the macro- economy which resulted in reduced purchasing power overall.

The existing literature provides a divided view on the impact of multiple borrowings by MFI clients. A priori it does appear that while multiple borrowings may not be a problem on its own, if it leads to clients borrowing beyond their repayment capacities, problems arise. Also in case there are external shocks, client’s borrowing capacity may go down, and multiple borrowings increases the chance that the client is over-indebted.

Ravi J Mathai and Verghese Kurien

2008-07-14T22:09:00.000-07:00

Ravi Mathai was the first full time director of IIM Ahmedabad. The IRMA library carries his name. Verghese Kurien (founder of IRMA) and Ravi Mathai are cousins. Both are a study in contrast. Kurien is as much a showman, as much as he is a relentless, resilient maverick with a cause who is unambiguously credited for establishing AMUL, NDDB and IRMA and ushering in milk revolution in India. Mathai, on the other hand, was almost an ascetic, principled, equally passionate intellectual who established the foundations of IIMA and rapidly took it to great heights.

The Economic Times carried an article on Mathai in December 2007, which is worth a read. While the author rightly suggests that people such as Mathai, Sarabhai and Talwar were great institution builders, he forgets Verghese Kurien. To quote the author's blog (ttrammohan.blogspot.com) - "In relinquishing his job, Mathai lived up to the highest traditions of self-abnegation so greatly revered in this country. In many other ways, he set almost impossible standards of conduct. He instituted a rule (since waived) that the director should not be involved in consulting. He declined to seek reimbursement of his travel and medical bills. He never projected himself, it was always the Institute that got projected. I have heard that he was rather reclusive, locking himself in his house at the end of the day and mentally reviewing the events of the day.

The great thing about people like Mathai is that not only do they create the foundations for durable success, they also set standards for those who follow. It is impossible for anybody sitting in the director's chair to escape comparison with Mathai."

This is in sharp contrast to Verghese Kurien, who never wanted to relinquish his position at IRMA. The case that dragged to courts made a public spectacle as news channels carried live coverage of the then IIMA director Bakul Dholakia protesting outside IRMA gate because he was denied entry in the Institute's campus for an important board meeting. The full story is available in a Business Line article published on April 15, 2005. Part of the article is reproduced below:

"Minutes before the IRMA board met today to confirm the award of degrees on graduating students, the security staff at the gate prevented the entry of eminent personalities whose candidature as members of the IRMA board has become the subject of an intense court battle. Prof. Bakul Dholakia (Director of the Indian Institute of Management Ahmedabad), Mr Hasmukh Shah (Chairman of the National Institute of Design) and Mr Vijay Mahajan (Chief of Basix, a Hyderabad-based non-government organisation) were prevented from entering the IRMA campus on instructions from the acting Director of the Institute, Dr L.K. Vaswani. The IRMA Director, Prof. K. Prathap Reddy, who had been sacked by Dr Kurien earlier this week, was also prevented from attending the board meeting and was seen walking out of the campus.

Prof. Dholakia, Mr Shah and Mr Mahajan tried to force their way in but had to retreat as they ran into a bunch of private security guards who were determined not to let them in even as the National Dairy Development Board Chairperson (NDDB), Dr Amrita Patel, drove in.

After the board meeting and the convocation ceremony, Dr Kurien, who at 83 is still actively involved with IRMA and Amul, repeated his standard responses about a "conspiracy" to take control of the "beautiful institute" and said that he was not willing to be pushed out of IRMA. Asked why three board members were stopped at the gates, he said: "I must manage the function. If that requires stopping somebody at the gate, I will do it."

The Business Line had carried another article, published February,26 2004, when the IIMs had taken a stand against the government to safeguard their autonomy. This article carries an interesting dialogue Ravi Mathai and Verghese Kurien apparently had once:

Then, (Verghese) Kurien went on to build IRMA, the Institute of Rural Management Anand, with inputs from his cousin Ravi Mathai, who was the Director in IIM, Ahmedabad.

Avoid mistakes that happened in IIM, Mathai instructed: "So cousin, when you build IRMA, please build a bigger house for the director than for the professors so that they will know that there is a boss."

Next, don't give too much powers to professors; this is not Harvard. For this, Kurien recounts Mathai told him: "I told a professor whom I had appointed, `You are free to go ahead and fill all the lower posts in your department.' That person went to his village, brought all his relations and appointed them. That was a terrible mistake which I made."

And, there's one more: "The third point cousin, is that you should cut down on the number of people you employ. We have so many people, and therefore, labour union problems, courts, and so on. I am tired of it all. You are a dictator, so run it as a dictator. If anyone steps out of line, sack him. I can't do that; I am not made that way.'"

Now, this is Kurienspeak: "I said, `Ravi Mathai, neither you nor any of your professors have ever managed anything."

The positive aspect of Kurien's personality is that he never bowed to the bureaucracy. His last days at IRMA were not glorious, however, this does not belittle his achievements.

Policy measures of the welfare state!

2008-07-13T21:30:00.000-07:00

As the government interferes so much with markets, for example take the recent agri-debt waiver, imagine what else the government could do.
Sample a few thoughts:
The government can provide a minimum support level to stock market indices. Lets say there is a support for NSE Nifty at 5000, that ways, investors will not lose wealth.
The government can impose a ceiling to inflation levels at 5%, that ways prices wont rise.

Trading Social Credits

2008-06-18T05:58:00.000-07:00

The Economic Times in an article today informs that the government is planning to ask corporate houses to be more transparent about their social spending under the head corporate social responsibility (CSR). In a post in this blog some days ago, I had posted a question – Can we have a specialized exchange to trade "social credits" in order to develop capital markets for non-profits? Large corporations have corporate social responsibility (CSR) budgets that are spent on a variety of development projects. If NGOs (and even Government agencies that are responsible for implementing developmental programmes) could quantify the social returns they generate and bundle them through instruments which I call “social credits”, these could be sold to corporate houses, donors, socially motivated investors, government agencies which can utilize their CSR/developmental budgets for purchasing such social credits. Such trades can be facilitated through social credit exchanges, which would allow NGOs to raise resources for their developmental projects. NGOs that have high social credits would be able to generate more resources. Social credits themselves would be a function of the social impacts that are generated by these organizations. The quantification of such impacts is a challenge; however, the step that the government is planning is in line with the argument presented above.

Is a DCF Valuation Pre-money or Post-money?

2008-06-16T05:27:00.000-07:00

This question arises because of the different vocabularies of mainstream corporate finance literature and venture capital/private equity practicioners. I have seen many people believe that this is a point of negotiation between the investor and the investee. In my opinion, there is a very clear theoretical case, that the DCF approach to equity valuations yield a pre-money equity value as negative free cash flows are also discounted which reflect the impact of future dilutions in equity. Therefore no further adjustments are required.
Intuitively, though, consider what a negative free cash flow to equity implies. It indicates that the firm does not generate enough cash flows from current operations to meet its reinvestment needs. Since the free cash flow to equity is after net debt issues, the firm will have to issue new equity in years where the cash flow is negative. This expected dilution in future years will reduce the value of equity per share today. In the FCFE model, the negative free cash flows to equity in the earlier years will reduce the estimated value of equity today. Thus, the dilution effect is captured in the present value and no additional consideration is needed of new stock issues in future years and the effect on value per share today.
(Italics quoted from Aswath Damodaran - Professor of Finance at NYU-Stern, page 34-35 of the document - chapter 14, Investment Valuation, box on Negative FCFE, Equity Dilution and Value Per Share - available on www.damodaran.com).

Dispensability makes it sustainable

2008-06-10T23:53:00.000-07:00

Experience has convinced me about my own dispensability. I have a sense of pride in the fact that I have contributed to it significantly. It also means that I can take things lightly. If you are dispensable in the social setting, it allows you to sit back, enjoy the drama, take a few liberties and have fun, as you are free from the burden of having to live up to expectations.

In an institutional setting, it is organizational competence and not concentrated skill-sets that can ensure scale and sustainability. This is especially difficult to achieve in industries that are driven by people and not by machines such as the services industry. No matter how well defined and articulated processes are, it is almost impossible to achieve perfect standardization - the “production” and “distribution” of a "service" has a considerable human interface.

BPOs in India have successfully addressed this issue by designing well crafted trainings (for example in voice and accent, or in standard operating processes) that make it possible for them to deliver services that are uniform in quality. MFIs have much to learn from BPOs.

If a service involves intellectual processing of problems, the complexity increases manifolds. To take an extreme example, the service that a good CEO provides to her/his firm would virtually be impossible to standardize. No wonder, there is a lot of discussion on how CEOs’ actions, role, compensations etc. impact a host of organizational variables and ultimately firm-value. Successful companies are very effective in delegation of responsibilities. Also, functional boards with independent directors as well as a sound system of independent internal audits help build strong organizations. In effect these measures reduce the discretion a CEO has in taking arbitrary decisions and help reduce the risk that an “indispensable” CEO could expose her/his firm to. This is another imperative for MFIs in India.

It is essential to create dispensability in order to have sustainable outcomes that live beyond an individual. Isn’t it ironical that obituaries are written for an audience!

http://www.youtube.com/watch?v=jpf5MoxWuxQ&feature=related

Restless thoughts of a sleepless night

2008-06-08T22:22:00.000-07:00

Can we have a specialized exchange to trade "social credits" in order to develop capital markets for non-profits?
Can private sector monitoring (such as independent ratings, certified audits, transparent accounting) enhance market efficiency?
Can we think of a macroeconomic model that factors in the effects of the unaccounted economy (black economy) on national income, inflation and interest rates?

On M2i

2008-05-31T05:38:00.000-07:00

The economic times profiled M2i in Feb 08. Though we have grown since then, it is only appropriate that the article finds a place here.

Championing Financial Inclusion: M2i founders chase a dream

(The Economic Times, 15 February 2008)

Imagine building a business plan by combining a love for travel, desire to see development in villages, financial acumen and college friendships. That’s what three students at the Institute of Rural Management, Anand (IRMA) did in 2001. Deepak Alok, B Atul and Rajeev Kumar used to discuss how market forces could aid development. One compelling area to look at was the fledgling industry of microfinance, banking for the marginal sections of the society. It was not yet mature, but had all the ingredients of any mainstream industry, they believed.

A college project on rural finance and insurance convinced them that there was a need for professional intervention to take banking to the excluded masses. Next year, Mr Alok and Mr Kumar joined a microcredit ratings agency after graduation. One of their colleagues, Rahul Bist, another MBA from the Indian Institute of Forest Management (IIFM), shared their belief on the potential for microfinance. After years of preparation, the three friends and Mr Bist quit their jobs and joined hands to pursue their financial dream.

When lending and providing insurance to villagers and low-income groups was a marginal activity, the team went one step beyond and started a microfinance advisory firm. Initially, they worked out of home. “We started with our own savings and reinvested almost all our revenues. Our start-up capital was extremely small,” says Mr Alok. Microfinance Management and Investment (M2i) Consulting came into being in March 2006 and quickly landed a client in ESAF, Thrissur. The start-up advised ESAF on capital structure and conducted training. The success of the first assignment was noted and ICICI Bank soon signed up as a customer.

Travelling to villages and interacting with local people is a perk in the job, the four seem to believe. For instance, the ICICI Bank contract involves going to a remote district in Orissa to assess the bank’s local partner. This perspective of grassroots Indian economy may not be available from most business ventures. “We have to travel a lot and that makes the job more exciting,” says Mr Bist. “It is very important for us to understand their livelihood, their income stream and their mindset to develop products or to consult MFIs.”

The company got its first international assignment from Microfinance Investment and Support Facility for Afghanistan (MISFA). M2i assessed the financials of an MFI called Parwaz, which later became its client. More projects came from southeast Asian countries and the team had to travel to places like Indonesia, Philippines and Cambodia.

Today, M2i’s client list includes Rashtriya Grameen Vikas Nidhi (RGVN), Sadhan, Development Alternatives, ESAF, Cashpor, BISWA, Nirmaan Bharati and Appropriate Technology India (ATI). M2i trains and provides support and management consultancy to MFIs. It also helps these institutions in designing products for their clients — the villagers who borrow money from these MFIs.

Microfinance institutions often find raising capital a difficult proposition, given that the rural banking mechanism is unfamiliar to most investors, including private equity and venture capital firms. Making money in microfinance is itself a challenge and providing corporate advisory services could have been even more so, but M2i navigated through the early difficulty of winning clients by leveraging the prior contacts the partners had. “Initially, we were apprehensive, we weren’t sure how it will work. But, we had the confidence that it was all that we wanted to do,” Mr Bist says.

Entrepreneurship makes you an all-rounder, feels Mr Alok. Initially, he had to do everything from writing the books of accounts to ensuring numerous regulatory compliances and most of his time was spent on them. “But, it’s only when you go through this experience that you realise how very discouraging complex regulatory requirements can be for a start-up. Thankfully we now have fairly standardised and streamlined systems.”

The team has never regretted leaving their jobs to start on their own. “It feels great to be a decision-maker. Believe me, it’s quite exciting,” says Mr Bist.

Taxation in India: FAQs

2008-05-30T20:18:00.000-07:00

From a very interesting mail forward.

1) Qus. : What are you doing?
Ans.: Business.
Tax: PAY PROFESSIONAL TAX!

2) Qus. : What are you doing in Business?
Ans.: Selling the Goods.
Tax: PAY SALES TAX!!

3) Qus. : From where are you getting Goods?
Ans.: From other State/Abroad
Tax: PAY CENTRAL SALES TAX, CUSTOM DUTY & OCTROI!

4) Qus. : What are you getting in Selling Goods?
Ans.: Profit.
Tax: PAY INCOME TAX!

5) Qus. : Where you Manufacturing the Goods?
Ans.: Factory.
Tax: PAY EXCISE DUTY!

6) Qus. : Do you have Office / Warehouse/ Factory?
Ans.: Yes
Tax: PAY MUNICIPAL & FIRE TAX!

7) Qus. : Do you have Staff?
Ans.: Yes
Tax: PAY STAFF PROFESSIONAL TAX!

8) Qus. : Doing business in Millions?
Ans.: Yes
Tax: PAY TURNOVER TAX!

9) Qus. : Are you taking out over 25,000 Cash from Bank?
Ans.: Yes, for Salary.
Tax: PAY CASH HANDLING TAX!

10) Qus. : Where are you taking your client for Lunch & Dinner?
Ans.: Hotel
Tax: PAY FOOD & ENTERTAINMENT TAX!

11) Qus. : Are you going Out of Station for Business?
Ans.: Yes
Tax: PAY FRINGE BENEFIT TAX!

12) Qus. : Have you taken or given any Service/s?
Ans.: Yes
Tax : PAY SERVICE TAX!

13) Qus. : How come you got such a Big Amount?
Ans.: Gift on birthday.
Tax: PAY GIFT TAX!

14) Qus. : Do you have any Wealth?
Ans.: Yes
Tax: PAY WEALTH TAX!

15) Qus. : To reduce Tension, for entertainment, where are you going?
Ans.: Cinema or Resort.
Tax: PAY ENTERTAINMENT TAX!

16) Qus. : Have you purchased House?
Ans.: Yes
Tax : PAY STAMP DUTY & REGISTRATION FEE !

17) Qus. : How you Travel?
Ans.: Bus
Tax: PAY SURCHARGE!

18) Qus. : Any Additional Tax?
Ans.: Yes
Tax: PAY EDUCATIONAL, ADDITIONAL EDUCATIONAL & SURCHARGE ON ALL THE
CENTRAL GOVT.'s TAX !!!

19) Qus. : Delayed any time Paying Any Tax?
Ans.: Yes
Tax: PAY INTEREST & PENALTY!

And to add, taxes are collected in advance and you cannot offset one category of taxes against the other. Tax credits take a long time. The honesty and integrity of tax personnel - well I will leave that to the reader's imagination.

Food Price Inflation – Some Interesting Quotes

2008-05-28T22:06:00.000-07:00

At a lecture in Singapore, the Indian Finance Minister, P Chidambaram is reported to have said “It is a sign of the lopsided priorities of certain countries that they will resort to measures that will produce fuel at a cheaper cost in order to meet the transport requirements of a section of their population". Furthermore, he said the pursuit of such policies at a time when many in the world could barely afford to eat was "outrageous and... must be condemned"[1].

On May 3, 2008, the US President George Bush in an interactive session on the American economy at Missouri said that "Worldwide there is increasing demand. There turns out to be prosperity in developing world, which is good. It's going to be good for you because you'll be selling products in the countries, you know, big countries perhaps, and it's hard to sell products into countries that aren't prosperous.

In other words, the more prosperous the world is, the more opportunity there is. It also, however, increases demand. So, for example, just as an interesting thought for you, there are 350 million people in India who are classified as middle class. That's bigger than America. Their middle class is larger than our entire population.”

"And when you start getting wealth, you start demanding better nutrition and better food, and so demand is high, and that causes the price to go up". “No question that ethanol has had a part of it. But I simply do not subscribe to the notion that it is the main cost driver for your food going up”[2]. And as expressindia puts it, - ‘The comments come close on the heels of US Secretary of State Condoleezza Rice's controversial statement that ‘apparent improvement’ in the diets of people in India and China and consequent food export caps is among the causes of the current global food crisis’.

Noble Laureate Amartya Sen (rightly) feels its government policies (across the developing and the developed worlds) that are to blame, “Much discussion is rightly devoted to the division between haves and have-nots in the global economy, but the world’s poor are themselves divided between those who are experiencing high growth and those who are not. The rapid economic expansion in countries such as China, India and Vietnam tends to sharply increase the demand for food. This is, of course, an excellent thing in itself, and if these countries could manage to reduce their unequal internal sharing of growth, even those left behind there would eat much better.

But the same growth also puts pressure on global food markets —sometimes through increased imports, but also through restrictions or bans on exports to moderate the rise in food prices at home, as has happened recently in countries such as India, China, Vietnam and Argentina. Those hit particularly hard have been the poor, especially in Africa.

There is also a high-tech version of the tale of two peoples. Agricultural crops such as corn and soya bean can be used for making ethanol for motor fuel. So the stomachs of the hungry must also compete with fuel tanks. Misdirected government policy plays a part here, too. In 2005, the US Congress began to require widespread use of ethanol in motor fuels. This law combined with a subsidy for this use has created a flourishing corn market in the US, but has also diverted agricultural resources from food to fuel. This makes it even harder for the hungry stomachs to compete. Ethanol use does little to prevent global warming and environmental deterioration, and clear-headed policy reforms could be urgently carried out, if American politics would permit it. Ethanol use could be curtailed, rather than being subsidized and enforced.” [3]

[1] Reported on March 26, 2008 by the BBC (http://news.bbc.co.uk/2/hi/south_asia/7315308.stm)

[2] Reported on May 3, 2008 by the ExpressIndia (http://www.expressindia.com/latest-news/Rising-food-prices-After-Rice-Bush-blames-India/304902/)

[3] Amartya Sen quoted in the daily Mint on May29, 2008. (http://www.livemint.com/2008/05/29004356/Beyond-the-usual-explanations.html)

In search of a perfect peg...

2008-05-03T04:59:00.000-07:00

Prelude: Sa-dhan's Quick Report 2007 spells out a data of about 129 MFIs. DER of total industry assuming that there are only these 129 major MFIs, comes out to be around 12:1. Is this healthy from both lenders as well as owner's perspective? Write up below is just a penning down or playing-around with some ratios which concludes with a question, open for all bloggers of this BottomOfPyramid Blog to comment.

To calculate the return on equity using the DuPont model, multiply the three components (net profit margin, asset turnover, and equity multiplier.)

Return on Equity = (Net Profit Margin) (Asset Turnover) (Equity Multiplier).

[Equity multiplier is calculated as Assets/Equity; Equity is Networth]

Du Pont observes that Return on Equity is a product between Profitability, Asset Efficiency and Financial Leverage.

Using Equity Multiplier, one can clearly say how much of the return has actually come out of debt.

This is how it is...

Equity Multiplier = A/E; Where A = Assets and E = Equity

Say EM = 10

==> 10 = (D+E)/E
==> 10E = D+ E
==> 9E = D
==> 9 = D/E
==> Debt-Equity Ratio = 9
This shows that if EM is n, then DER is n-1

Now, at different levels of EM, the DER, Proportion of Equity and Proportion of Debt are as follows:

EM (n)	1	2	3	5	10	20	50	100
DER (n-1)	0	1	2	4	9	19	49	99
% of Equity (1/n)	100%	50%	33%	20%	10%	5%	2%	1%
% of Debt (1-(1/n))	0%	50%	67%	80%	90%	95%	98%	99%

The above table gives some valuable insights:

1. EM is a leverage ratio
2. As EM tends to infinity, proportion of equity tends to zero.

Further, its important to understand that the EM is a multiple of ROE (as referred above) and therefore highly significant increase in EM can alarm both the creditors as well as its owners. Creditors will be worried about their own funds more at stake than owner's equity and therefore there is a likelihood of the cost of borrowings going high. Similarly, if the owners also perceive risk, they also raise their expected return, and thereby increasing the cost of equity. Overall, an increased EM will increase Average Cost of Capital and thereby reduce profitability. Sometimes, a very low EM can also be costly as expected return on equity by shareholders will be high, and thereby increase the overall cost of capital.

So my question to the reader is: When do I say EM is optimal? or, When do I say EM of an average MFI is optimal? or more precisely, What levels of DER is more optimal?

Agents of change

2008-04-29T05:05:00.000-07:00

As I meander through the plains of North India meeting poor women who are changing their own lives as well as the lives of those around them, I find myself questioning the western notions of women’s liberation and empowerment. These women don’t feel deprived because they lack access to latest consumables. They are content with their scant material possessions and are extremely happy as they now feel more secure than they have ever felt in the past. They are the financial managers of their household enterprises and undertake complex transactions - they secure finance, they invest and they are also responsible for "internal control". Some of them are so good, they can humble their more fortunate peers who had access to formal education. These women are a barometer of the way India is changing economically as well as socially; they are also the force that’s driving this change.

My hypothesis of success for a consulting start-up

2008-04-15T03:53:00.000-07:00

After all, it seems one of my life ambitions of being able to pursue a Phd in finance will go unfulfilled. My colleague would like me to believe that my current vocation, ie, running a consultancy and building a business, is at least as good, if not better, an intellectual pursuit. In fact, if my colleague is to be believed, it involves hypothesis testing on a multiple basis. So, here is an attempt to articulate a hypothesis regarding the success of a consultancy business which (again to borrow my colleague’s idea) is capital un-intensive but highly intellect intensive. I have not attempted to define success here, but would simply allude to the intuitive meaning this word has.

The hierarchy of success prerequisites for a consulting start-up is:

Superior technical skill sets during the proof of concept phase. The critical challenges are marketing as well as service delivery.
Standardized offerings and the ability to train the larger team during the growth phase. The main challenge at this stage is to build a team that is capable enough to work on projects that are generated.
Establishing the brand equity simultaneously and to provide a platform in the form of a “brand” to the larger team so that it can also generate business on its own.
Building a strong research team that allows continuous and effective innovations.
Attracting capital to test new ideas to diversify business! Hiring people who are skilled in areas which may be unrelated.

Venture Funding in Bihar

2008-04-10T02:06:00.000-07:00

Venture Fund for Bihar

A substantial part of India has not benefited from it’s economic growth during the previous 18 years. For instance, Bihar’s economic growth that was very close to the national average in the 1980s, became far lower subsequently. A World bank report on Bihar states, that the state experienced zero growth in the first half of the 1990s, and since 1994, when data for divided Bihar became available, annual growth has averaged around 3.8% or about 1% per annum in per capita terms[1]. As a result income and consumption growth in Bihar have lagged seriously thereby increasing the gap between Bihar and the rest of India. Lagging social infrastructure and poor law and order situation have meant that the state has not been able to productively utilize its agricultural as well as human resource base. The total value of output of Agro-based industries in Bihar is less than 1% of the national output, despite the fact that Bihar produces about 10% of India’s total output of common fruits and vegetables. The availability of banking services in Bihar is much below the national average. The Credit to Deposit ratio of banks in Bihar is extremely low (measured at 31.4% in 2004-05), and banks are very reluctant when it comes to providing project financing in the state.

The investment climate in the state is gradually improving. While challenges remain in terms of high regulatory burden,[2]poor power situation and road networks, opportunities exist because of improving law and order perception as well as higher investments in infrastructure. The World Bank is reported to have sanctioned a US$ 225 million debt to the state to support implementation of structural reforms in governance, road infrastructure and agriculture among others. The state has been focusing on building a supportive industrial infrastructure. The table below presents some of the initiatives in the state.

Industrial Development Initiatives (Source: India Brand Equity Foundation, 2008)

The state has also sought to make investment friendly policies to encourage investments. The Industrial Policy of 2006 aims to ensure accelerated industrial development, with special focus on key industries, catalyze economic growth and ensure balanced regional growth[3]. Its objectives include promoting industries specifically identified as thrust areas - Pharmaceuticals, Drugs and Biotech Industries, Food Processing and Agro-based Industries, IT and IT-enabled services, Eco Tourism/Heritage Tourism/Adventure Tourism/Event Tourism/Medical Tourism and Entertainment Industry. It also puts in place Single Window Clearance systems for the benefit of potential investors.

In all probability, the state will now witness improved growth and entrepreneurial opportunities will emerge. However, given the state of financial services and capital market in the state, financing of entrepreneurial initiatives will present a key challenge. Readily available risk-capital financing is critical for enterprises (and industry) to flourish, more so in areas that are under developed. There has been a growing excitement in microfinance circles about the “microfinance market” in Bihar. Microfinance plays an important role by enabling the poor to build sustainable local scale livelihoods. This augurs well as a substantial proportion of enterprises in the state are unregistered and informal. Infact unregistered units dominate the overall industrial sector in the state, accounting for more than half of its total income. The number of large and medium industries is only 259. Its an imperative that investments be made in scalable businesses in the state for it to move on to a higher cycle of economic activity and income. The average size of a micro-loan is small, and insufficient for promoting a formal enterprise.

It is in this context that a Bihar focused venture fund can serve to promote enterprises and benefit from the potential returns that can be made. Assuming an average investment size of Rs 3 million (US$ 75,000), a Rs 60 million (US$ 1.5 million) fund can support twenty such investments and serve to demonstrate the latent economic potential the state possesses. Importantly, these investments will also help in generating comfort among banks and this will possibly facilitate the flow of loan funds. The key challenges for creating such a fund are:

Finding investors
Creating a Special Investment Vehicle (SIV) with the required regulatory clearances
Advocacy with the government in order to get a “buy-in” from the state
Simultaneously creating a management team that can seek investment proposals or business plans from interested entrepreneurs.

A fund of this kind will face several challenges in order to provide returns to its investors. Even after investments are made, local enterprises will need hand holding support as well as professional advice on an on-going basis, so that they can scale up. Finding an exit for the fund will remain another challenge. The Securities and Exchange Board of India has approved setting up of a SME stock exchange. Such a stock exchange may provide an exit for the fund, provided the enterprises are able to scale up to listing levels. Trade sales or buy-outs by larger funds are other alternatives that could provide an exit. There is no denying that equity investments made in enterprises in Bihar carry double the risk as compared to equity investments elsewhere. However, the potential returns that could be had not only in Financial ROEs but also in terms of the socio economic benefits these investments could generate is immense.

[1] Bihar – Towards a Development Strategy, 2005, The World Bank

[2] The World Bank defines regulatory burden as onerous regulations and intrusive and disruptive visits from Government officials.

[3] industries.bih.nic.in/Archive/IndPolicy2006en.pdf

Damning news article on Bihar

2008-04-04T05:00:00.000-07:00

How true is this? If it is exaggerated, it does the state a lot of disfavor.

Doing business the hard way in Bihar
(http://www.livemint.com/UserControls/2008/02/19011210/Doing-business-the-hard-way-in.html)
HAJIPUR, Bihar: The white envelope filled with 10 notes of Rs500 denomination was despatched to the electricity board official as a “goodwill gesture”.
Soon it came back, with a message from a subordinate. The official was not playing ball — at least not at that price.
“He refused to accept it, and now he is cooking up a problem,” the factory manager said as the envelope was handed back. “I will have to pay the bugger Rs20,000 in the evening.”
The manager had wanted a second power line for an extension for his small factory in the Hajipur industrial area in Bihar. A simple request, the official had threatened to tie it up in endless red tape, unless he was paid.
The routine way the bribe was offered, and the way the episode unfolded in front of a Reuters correspondent, offers a tiny insight into the problems of doing business in a state that has become a byword for poverty, lawlessness and corruption.
India’s boom has not reached Bihar, a state of 90 million people almost completely disconnected from the global economy.
It is the country’s poorest and one of its slowest growing states, with “exceptionally low” levels of private investment, according to the World Bank. There is no sign of any foreign investment at all.

Chief minister Nitish Kumar took over two years ago, promising to turn things around. Since then he has been wooing rich Indians at home and abroad, trying to attract the investment his state so desperately needs.
Last December, the World Bank said he was moving in the right direction. His government, it said, had initiated comprehensive reforms, improved the investment climate, stepped up public investment and improved the delivery of health and education services — albeit from an extremely low base.
The bank loaned Kumar’s government $225 million (Rs893 crore today), but private investors have not been so enthusiastic. India’s biggest industrialists have been visiting the state capital Patna, but so far they have kept their money firmly in their pockets.
The sad fact of Bihar is that it has little or no raw materials, intermittent power, terrible roads, a reputation for kidnapping businessmen and some of the least business-friendly bureaucrats in the capitalist world.
Law and order may be improving, but Kumar’s reforms are still only scratching the surface of the problem, said Shaibal Gupta of the Asian Development Research Institute in Patna. “Why would anyone invest in Bihar?” he asked. “In a place like Bihar you have to build everything from scratch. Where is the rate of return?”
A hopeless place
Hajipur is Bihar’s premier industrial park. Its factories get power when the rest of the state is in darkness, but only because they pay bribes. There is no drainage—factories just dump tens of thousands of litres of effluent every day in nearby ditches or ponds.
Squatters camp on the grass verges beside the factory walls, cows munch grass and wander across the potholed roads. Armed guards man security gates to ward off kidnappers.
“This so-called industrial area is really in a pathetic condition,” the manager said. “Bihar really is a hopeless place to do business.”
On the wall behind his head he displays nearly two dozen licences he needs to keep his business open, standards for health, safety, labour laws and pollution. Each costs a few hundred rupees a year to renew, plus a Rs10,000 bribe.
“Twenty-three departments have the power to shut down this unit,” he said. “They create problems, make money, go back. So much for a liberal economy.”
Rajesh Singh took a master’s in business administration at Bombay University before returning to Bihar to set up a tiny factory on his family’s farmland to manufacture jams, juices, sauces, pickles and canned fruits.
“I realized things in Bihar were not very good, so I decided to start an agri-venture,” he said. “It was a mix of good potential and good intentions.”
But Singh has found the odds stacked up heavily against A1 Farm Solutions. His friends and even his father tried to convince him out of the idea, before his bank manager took over.
“The banker was telling me I was a fool to leave my job and start a business here,” he said. “That is the attitude to coming back —t o dissuade you.”
It took Singh five years to get a bank loan, of just Rs5 lakh. To get it, he needed to offer Rs30 lakh as security and have Rs2.5 lakh parked in fixed-term deposits.
Today, his loan has been extended to Rs40 lakh — still, in his terms, “a meagre amount”, equivalent to just 10 days of raw material and labour costs.
“I had a lot of orders from the UK, from Sainsbury’s for lychees, but I couldn’t complete them because bankers are not ready to back us,” he said. “I am educated and I have assets. If I can’t get finance, how can ordinary Biharis get finance?”
If bankers were not hard enough to cope with, Singh has also found himself sucked into the divisive caste-based politics and society of Bihar.
His high-caste parents feared they would be made outcastes because he employs Dalits or “untouchables” in a food processing factory.
Then a lower-caste boy was killed on his farm when he fell under a tractor trailer. A local politician tried to exploit the issue to get Dalit votes, filing a police complaint in which he claimed the boy had been shot in the head. Although everyone knew this was untrue, the accident cost him a year, he said. “No one was willing to work for us, we couldn’t get financing,” Singh said, adding that all the time the police had been demanding money to drop the charges.
As we travelled down the potholed road to Singh’s factory, a 35km, three-hour trip on a “state highway”, he looked around at the congestion, the poverty, the crumbling infrastructure. “Look at this,” Singh said. “Someone has to come back...but at times you feel like asking ‘what am I doing with my life?’”
Is anywhere in the world more challenging to do business? “Maybe Somalia,” he said. “They are shooting at you there.”

Economic Book Value of MFIs as a basis of comparison

2008-03-10T06:21:00.000-07:00

The equity values of MFIs in the past have most often been compared against their book values. The book value of an MFI (or the net-worth) is the difference between the total assets and the total liabilities and represents the accumulated profits or losses within the MFI, over and above its initial capital during its operational history.

The book value is high for those MFIs that have strictly followed a profit maximization objective as against an MFI that, while focusing on charging sustainable interest rates, has chosen to keep its interest rates at low levels in order to pass on maximum benefits to its clients. The latter would have generated a lower book value and consequently its equity is likely to get a poorer valuation, if it is viewed only in terms of a multiple of the book value. In the absence of an objective method, whether or not this MFI gets a premium for the social value it has created would be left to the discretion of the investors.

There is a need to establish a measure of the “economic book value” of an MFI which would account for the benefits that an MFI could have passed on to its clients. The use of “opportunity cost shadow prices” for clients and the MFI can provide us with such a measure. This would involve an analysis of what is the cost the client would have to incur in order to avail of the facilities that the MFI provides, if the MFI did not exist. The difference between the opportunity cost and the real cost that the client incurs may give us an idea of the “economic book value” of the MFI-client eco-system.

Oh Dear! This Phnom Penh is a Wonderful Sight!!

2008-02-13T19:07:00.000-08:00

And it offers you paid pillion riding!!! The city also has the most amazing boulevards. And it has great Indian restaurants. If you feel let down and want to recharge those battered cells to take on the rough and tumble of the world, this got to be one of the best cities for you. It is one of those cities that give you the feel of monasteries while you are still in business. The city has survived some tough times, and is a living inspiration.

In the mid – 70s, when the CPK ruled Cambodia, if locals are to be believed, all college graduates were executed. Towns were evacuated and people were forced to go to rural areas and work in collective farms. In many areas of the country people were rounded up and executed for speaking a foreign language, wearing glasses, scavenging for food, and even crying for dead loved ones.

The serenity that one finds in the country now owes quite a bit to the international community which has helped in rebuilding the country. The Cambodian economy is small but vibrant with a lot of smiling faces driving it. And Phnom Penh indeed signifies resurrection.

PS: If you want to withdraw from the world for a while to reconnect with your spiritual self, I strongly recommend Cambodia.

Some questions

2008-01-16T04:51:00.000-08:00

Why don’t we have more projects like Tata’s Nano?

Why are we so afraid of imports?

Why are our civil society organizations so wary of scrutiny?

Why are NGOs a conduit for tax avoidance?

Why are most development interventions successful on paper (government or non government) but apparent and abject failures in terms of physical manifestations?

Why do we have to wait for a VVIP to inaugurate a flyover, before the ordinary mortals can start using it?

Why can’t we institute a prize that matches the Nobel in stature?

(A very happy b’day to my Naniji, the most intelligent grandmother in the world, who in spite of being very traditional, is my greatest ally and to warn you in advance, in case you are not in my good books, you better avoid her).

Happy New Year

2007-12-31T18:23:00.000-08:00

While the IIT alumni have always been benevolent in terms of donating substantial sums to their alma mater, these donations were primarily meant for creating or renovating infrastructure. There is a welcome departure this time as the January 1, 08 edition of the Times of India reports,"The batch of 1982 of the Indian Institute of Technology-Bombay had something to gift their alma mater for the new year. On Sunday, the alumni handed over a cheque of Rs 4 crore to the premier engineering institute. The money will be used to bring in more talent into the faculty. With the interest earned on the corpus, every year 25 incoming faculty members at IIT-B will be offered a bonus of Rs 1 lakh for three years."

Kudos to the IITB batch of 1982. However, there need to be more initiatives of this nature preferably with the involvement of the rich Indian corporates. For our institutions to be truly great, they need to attract the best from across the world. And this requires resources, which only private participation can ensure.

M2i Trainings (www.m2itrainings.com)

2007-12-21T22:38:00.000-08:00

In my experience with MFIs, I have noticed that very often the difference between those that perform well and those that dont is the quality and motivation of the line staff. While this is a function of the kind of internal control systems that an MFI possesses, it also has to do with recruitment policy as well as staff training. In the absence of control, agency problems invariably creep in and this leads to corrupt practices. If the institution has evolved good internal control systems, but has demotivated and untrained staff, there is again a problem as staff productivity suffers and staff turnover is high. I can say that the trainings that we offer allow MFI line staff to get a better perspective of their own roles in the wider scheme of things and their motivations improve quite a bit. In addition they also get exposed to best practices and gain in terms of professional skills.

We are introducing M2i trainings. I hope that it will evolve into a valuable resource for the microfinance sector. We will also strive to build in a world class team of researchers who will contribute in an original way not only to "the microfinance domain" but also to areas in applied economics, finance and public policy.

India 2020

2007-12-21T21:51:00.000-08:00

The Rockfellers made their millions from the industrial and economic transformation of towns like Bluefield and Pittsburg some hundred years ago. They "invested" millions to cultivate the sciences in the US. In addition (to quote Sylvia Nasar - A Beautiful Mind), they imported scientists from centers such as Berlin and Budapest, established European style professorships in US universities (including Princeton), with extravagant salaries. The fact that the USA today is a storehouse of intellectual giants owes at least as much to the private sector as it does to the US government. The universities on their part have ensured a supply of high quality human resource as well as the best technological innovations. In terms of economic ROI, the investments made by Rockfellers are unsurpassed.

Can our rich private sector attempt something similar? Can we think of an India where our institutions will support the best scientists of the world? Or shall they continue to take pride in how difficult they were to secure admissions into or how many of their students went to the US and got married and settled there?

IRMA Convocation of 2002

2007-12-07T08:21:00.000-08:00

Quote from APJ's convocation address to our batch - "When it comes to us actually making a positive contribution to the system we lock ourselves along with our families into a safe cocoon and look into the distance at countries far away and wait for a Mr. Clean to come along & work miracles for us with a majestic sweep of his hand. Or we leave the country and run away. Like lazy cowards hounded by our fears we run to America to bask in their glory and praise their system. When New York becomes insecure we run to England. When England experiences unemployment, we take the next flight out to the Gulf. When the Gulf is war struck, we demand to be rescued and brought home by the Indian government."

E T Bell on Ramanujan

2007-10-03T18:01:00.000-07:00

E T Bell in his book, Men of Mathematics (published by SIMON & SCHUSTER, 1937), has covered all great mathematicians till the nineteenth century. The great scientists of the twentieth century have just found an occasional mention. One finds “Einstein” scattered here and there. But in the chapter on Euler, this is what Bell says of Ramanujan, ‘It is fashionable today to despise the “mere algorist”; yet, when a truly great one like the Hindu Ramanujan arrives unexpectedly out of nowhere, even expert analysts hail him as a gift from Heaven: his all but supernatural insight into apparently unrelated formulas reveals hidden trails leading from one territory to another, and the analysts have new tasks provided to them in clearing the trails. An algorist is a “formalist” who loves beautiful formulas for their own sake.’

Only if we had more men in the mould of Ramanujan, I suspect, we would have been more advanced a nation. It is indeed a regret that the sciences continue to get neglected in this country of over a billion.

Lessons from my stint as a Statistical Consultant

2007-10-02T21:41:00.000-07:00

School teaches you to be methodical. There is indeed merit to method. But good work requires more than mere method. For instance, take empirical research. No amount of method will make you curious enough to formulate a worthwhile research hypothesis. Curiosity is a blessing, fuelled by will. When one is curious, nothing else matters. One only itches to get to the bottom of the matter. And herein is the foundation for great research. Methods are mere tools, which you need to possess and these are necessary but hardly sufficient. And formal qualifications are not even necessary.

Research begins with good design. It is important to ensure rigor. One needs to give a lot of thought to the design. It is very similar to conceiving a baby. There has to be considerable passion to the plan in order to ensure that the conception is good. You need to ensure that all ends are fastened and for this it is important that you get your design reviewed by the grand masters. Even at this stage it helps to think beyond the obvious. Because its possible that the tool that can answer your queries does not exist. And then you’d need to create it – you should be so in love with your research.

You need to love your variables and constructs. These are the building blocks of your research – the cells. They need to be properly explored and understood. This does not mean a mechanical exploration of their distributions, which while necessary, comes later. You need to think of what is it that will cause your variables to act in a certain manner, what could cause them to break your heart! You need to wonder whether your equations are good enough for your research.

You need to be very careful when you are collecting data. Its like nurturing the baby for the data that you collect is what nourishes it. Statistics warns against the many biases that creep in at this stage. Remember, biases distort reality and are really bad for your analysis and research – bad influences on the baby. The next part is exploring the data on your variables. It is here that distributions become important. If you have thought adequately over what your variables prefer, its very likely that you’d start getting a fair idea of patterns hidden within your dataset. If there are missing values (babies can get sick), how do you treat the variable in a manner that it does not distort your research is critical. What could be the possible undesirable effects of the treatment (side effects) – is one treatment suitable over the other, so evaluate all possibilities. Then, there are outlying observations, what could explain them, think about it.

The main analysis comes next. This is the moment you have waited for. The results generally give you a high that is hardly matched. But there are heart breaks and you need to be aware of the latter possibility. And if you are truly in love with your research you’d still feel the high or else you could end shattered. Research is not for the faint hearted!

Good Morning – India on an average is not poor any more!

2007-08-01T00:02:00.000-07:00

Getting up early in the morning can help one get over the worst of blues. So if you have recently been feeling that your world (of family and friends) does not really acknowledge your existence, give it a try. It also gives you enough time to catch up on news.

Primarily on the basis of published (and available for free on the internet) reports I had reasoned in one of my first posts on this blog in June 2004, (http://bottomofpyramid.blogspot.com/2004/06/macro-environment-of-india-favours.html), that the Indian economy looked poised for a virtuous growth cycle, and given some inherent structural strengths that the country possesses, consistent economic growth would enhance productive economic opportunities. Niranjan Rajadhyaksha, writing in the daily “mint”(Life Beyond Poverty, August 1, 2007, see http://www.livemint.com/2007/07/31200826/life-beyond-poverty.html?atype=tp) informs “in a report submitted on July 12, 2007, the Prime Minister’s economic advisory council estimated that per capita income in 2007-08 is likely to be $1,021. It was $561 in 2003-04.”

He also raises an interesting question, “ ..the Indian government will have to take a hard look at the various poverty alleviation strategies and programmes that were designed for an economy that was moving ahead at a tortoise trot. Perhaps the most interesting thing to watch out for is how well India and its government adjust to the strategic challenges of being a middle income nation.”

I am tempted to argue that India’s core structural strength would ensure appropriate governance. While we would continue to see populist practices for short term gains on the one hand, the odds on the future secular trend, on the other, appear much more favorable. Economic opportunities will continue to increase, administrative and tax reforms will ensure transparency and accountability. However, addressing basic concerns such as health and education for all will remain a challenge for the government.

I dare contend that it is beyond the government to address these needs. For the middle income India, its an imperative that its rich private sector makes substantial investments in these areas. It is indeed a “great need” for them to make these investments for deepening their own markets. But these investments would generate public goods (in the form of markets) which are equally available to every body. And expecting the private sector to invest heavily in public goods may be too much.

But a task of such magnitude can be undertaken by a Joint Venture of several companies or an industry association. So far, several companies and rich individuals have devoted a chunk of their wealth for noble causes. They have also evolved sustainable models. However, these have not scaled to any significance and appear largely isolated and ill-covered, given the populist focus on profit churning companies and record breaking stock indices. But if these companies come together and promote a widely held, for-profit organization that sells quality education and quality basic health services on a large scale, using innovative revenue models, there could be a more tangible impact.

The “no more” poor India offers unique opportunities. This is an important point in time, and how we fare in the long run would depend a lot on how courageous we were in seizing these opportunities.

Questions of a Friday Night

2007-07-28T06:53:00.000-07:00

I chose to work while two of my friends who are paying me a visit decided to “chill out” the Friday night with some vodka. And then after they were sufficiently drunk, I joined them to discuss grave issues related to social and economic development.

Aware of my sober state (and hence a self perceived notion of intellectual superiority at the time), I started, “You know, this is really a good time that we are living in. The economy is prospering and there are opportunities everywhere. I don’t think any of the previous generations enjoyed these..”, I could not even finish when one of my drunken friends cut me short, “ Opportunities are increasing? For whom? Go to any Indian village and look at the state of primary education, access to health services, access to basic infrastructure like roads, power drinking water.”

“But people have more to choose from”, I persisted. It was now my other friend who had to speak, “Most certainly village women can choose a Fair-ever over a Fair & lovely. But do you seriously they’d have a choice when it comes to getting good primary-education for their children.”

I sought defence in my favorite muse – microfinance, “Take financial services for example. With increasing market integration, even the poor have an opportunity to access credit and scale-up their businesses in case they are self employed and are involved in petty trade etc. Further, they can invest and park part of their savings in specialized mutual funds schemes that offer micro systematic investment plans and therefore, benefit from the wealth being created by the Indian corporate” I knew I was far from convincing. Market opportunities were limited for the poor. Moreover our regulators can still not ensure that the rights of the small investors in capital markets are protected against manipulations. In fact, in the nineties the Indian stock markets had been a zero sum game for the small investors. The evidence that this is no longer the case is still not over-whelming. Also, who would educate the poor about the risks involved in such investments?

But my friend had other arguments, “How do you ensure market access and development in education and health? Are the poor willing to pay a premium here too? How do you right size and right price these services to ensure that the poor can consume them?”

For once, I really had no answers. There are several examples of public-private initiatives in education and health in India but how many of these are really scalable? Given our government’s track record in public expenditures and the quality of work done, and the private sector's reluctance/inability to invest in such basic services and create a business model which makes quality education and health services accessible and affordable for the Indian poor, would we ever have a solution where quality health and quality basic education is available in every Indian village?

The vodka had started taking an effect on my friends as they dozed off…

Chuck's mail on the Compartamos listing and my reply to the mail

2007-04-26T00:41:00.001-07:00

Chuck Waterfield wrote on the microfinance practice Yahoo group on April 24, 2007:

Something very important for us to reflect on.Personally, I'm stunned by this. I've seen this in the works for years now,but still stunned that it has really happened.

Compartamos, working inMexico, has created a very large operation. They work currently with600,000 clients. They have kept their interest rates at over 100% for manyyears (effective interest rate is currently 105%, as stated on their ownwebsite). This is startlingly high to people inside of microfinance as wellas outside of microfinance.

They have gotten very profitable. For the last several years, they havegenerated an ROE of over 50%. "Invest $100,000 and make $50,000 in returnafter one year." You can see their financials at www.themix.org. As theyreached profitability, their interest rates did not come down. Theycontinued to keep them high and generate high profits. Last year they made$57 million in profits.

I've watched them over the years. I have worked in their offices, but thathas been some years ago.Friday they went "public". The board and key staff members have becomemulti-millionaires (valued in US dollars). They hold a considerable numberof shares. 30% of the total Compartamos shares were sold on the marketstarting Friday. Details are in the Reuters news article below.

This is a non-profit institution started with grants. They got the firstgrant ever awarded by CGAP. $1M in 1997. They have gotten support fromnumerous donors and networks.

They now are generating extremely highprofits that now, as a publicly held institution, go to their share-holdingboard and staff and to their shareholders.Is this the future of microfinance? Is this where some other MFIs havealready gone, and where other MFIs are hoping to go? Is this the "solutionto poverty"? Do the "benefits" of this market-based approach outweigh anypotential costs of such intentional and blatant moves that will inevitablydraw the attention of the public? Will these actions cause at least somepeople concern about how the "deeds" of microfinance more-and-more appear tocontradict the "words" we say? Will microfinance become the home of theprofit-maximizing investors instead of the area that donors and non-profitsuse to effect beneficial economic and social change?

Please read the following article from Reuters. Think carefully about thissubject. I strongly believe it is the most important current issue inmicrofinance. I believe it has been for years (as anyone who has attendedmy courses knows). I think it is time we stop avoiding this issue. I thinkwe need to openly discuss this. I don't believe it is necessary to "pickon Compartamos." I think we should be looking at the bigger "philosophical"picture, of where microfinance is going. I think this is an essentialissue for us to clarify. The world now knows about microfinance. The worldwill soon know about the "complexities" of microfinance. What will you saywhen people start to ask you about these issues?I look forward to your comments.Chuck WaterfieldBy Noel

RandewichREUTERS12:03 p.m. April 20, 2007MEXICO CITY - Shares of small Mexican bank Compartamos, which specializes inlending to mom-and-pop businesses, surged as much as 34 percent in their$407 million stock market debut Friday. Owners of Banco Compartamos, which means "let's share" in Spanish, soldabout 30 percent of the bank, spokeswoman Luisa del Castillo told Reuters. More than 80 percent of the offer was placed in New York, with the rest onMexico's stock exchange, according to a company release. Mexican shares of Compartamos jumped as high as 53.53 pesos after thecompany priced the offer at 40 pesos per share. In afternoon trading thestock eased back slightly to 52 pesos. Compartamos said it sold 111,572,532 shares, with an over allotmentprovision of 16,735,880 shares. It was unclear whether banks managing theoffer exercised the over allotment, worth about $61 million. Compartamos, with profits of around $57 million last year, has just over600,000 clients in rural and semi-urban regions of Mexico. "We have clients who work in food, clothing, shoes and crafts," Castillosaid. "They're people with anything from a super-small business up to acorner store." Despite lending to customers with little credit history or collateral,Compartamos has kept past-due loans below 1 percent of its portfolio. "The offer received a lot of demand from institutional and retailinvestors," said one banker associated with the offer. "This is aone-of-a-kind story in the market today, which is why there is so muchinterest." Last year, Bangladeshi economics professor Muhammad Yunus received the NobelPeace Prize for pioneering microlending as a way to create self-employmentand escape poverty. The World Bank's International Finance Corporation, which backs privatecompanies with an eye toward eliminating poverty in developing markets, isthe third-largest shareholder in Compartamos. Mexico's government gave Compartamos a banking license last year, prior towhich it had operated as a specialized lending firm. Mexico's mostly foreign big banks, led by Citigroup and BBVA, focus on asmall but growing middle class, although they are beginning to designconsumer products for lower-income clients. The big banks' branches are absent from many rural areas in Mexico, whereone in two people live on less than $5 a day.

I replied:

Hi Chuck,

You have raised several important points. I wonder which of these is really shocking:
1. The fact that Compartamos charges high interest rates.
2. The fact that somewhere in its institutional lifecycle it decided to transition to a for-profit structure.
3. The fact that it became fairly large and currently has 600,000 clients.
4. The fact that it is hugely profitable.
5. The fact that Compartamos went public.
6. The fact that it rewards its share-holders that includes its employees (I wonder how many people it employs).

I also wonder whether it is fair to criticize Compartamos at this juncture. I believe the decision to be a for-profit organization must have preceded the listing. The primary objective of for profit organizations is to maximize share-holder wealth.

Public listing allows small investors to participate and they would gain only if the listed company makes profit. Capital market regulators also strive to ensure (with varying degrees of success) that trade transactions are fair and equal. As a result listed companies are required to adhere to a variety of disclosure norms and guidelines. You atleast know what they are doing.

Compartamos charges a high interest rate but still has 600,000 clients. What is the value proposition it offers to its clients? I also wonder whether there is any competition. Compartamos being a bank is a regulated entity. I wonder what views the central bank has regarding such monopolies.

I guess one of the intriguing issues here also is that Compartamos has benefited from benevolent donors. I would like to relate it to the recent debate on whether IFI development investments crowd out commercial investments. Is it possible that such investments may actually lead to monopolies and their associated maladies?

Regards,

Atul

JBS Haldane

2007-04-05T01:06:00.000-07:00

Though as a student I never quite liked biology as a subject and did not subscribe to socialist ideals either I was immensely inspired by JBS Haldane. His quotes are memorable.

In his decompression chamber experiments, he and his volunteers suffered perforated eardrums, but, as Haldane stated in What is Life, "the drum generally heals up; and if a hole remains in it, although one is somewhat deaf, one can blow tobacco smoke out of the ear in question, which is a social accomplishment."

“My body has been used for both purposes during my lifetime and after my death, whether I continue to exist or not, I shall have no further use for it, and desire that it shall be used by others. Its refrigeration, if this is possible, should be a first charge on my estate”.

Shortly before his death in 1964, the irrespressible Haldane wrote an outrageous comic poem while in the hospital, mocking his own incurable disease:
“Cancer's a Funny Thing:
I wish I had the voice of Homer
To sing of rectal carcinoma,
Which kills a lot more chaps, in fact,
Than were bumped off when Troy was sacked…”

It was circulated among his friends, who savored the consistently witty irreverence with which Haldane had lived his courageous and productive life.

Sources:
1. Wikipedia
2. http://www.stephenjaygould.org/people/john_haldane.html

The Year That Was For Indian Microfinance

2007-03-27T05:43:00.000-07:00

The year 2006 has been unique for the microfinance sector.

Dr Muhammad Yunus and Grameen Bank were awarded the Nobel Peace Prize. Time magazine named Dr Vikram Akula, founder of SKS as one of “The People Who Shape Our World”. These awards/recognitions reflect, once again, the expectations that the world has from microfinance and the extent to which microfinance has fulfilled these expectations.

In the Indian context, 2006 was an intriguing year for microfinance. The years preceding 2006 had witnessed a rapid growth in the portfolios of Indian MFIs. This had been made possible by an increasing “market” view of microfinance – the idea that the “bottom of the pyramid” indeed constitutes a worthy clientele gained wider acceptance.

While these years had been characterized by exuberance and confidence, there was also a line of thought that advised caution – the institutional capacities of many MFIs may not have kept pace with the rapid scaling up of their portfolios. Also, the business of microfinance had drawn an occasional criticism for being exploitative.

Things appeared to be taking a turn for the worse towards the start of the Financial Year 2006. There were public complaints of misbehavior and malpractices against two of the largest microfinance institutions (MFIs) operating in Andhra Pradesh. It was reported that incriminating evidence of questionable practices such as blank papers bearing client signatures had been uncovered.

Andhra Pradesh has led the growth of microfinance in India by far. It was only natural that the sector as a whole in India was affected. There were suggestions that the MFI channel was too costly for the poor and that interest rates need to be regulated. The need to put a uniform regulatory mechanism in place was felt. However, these events in Andhra Pradesh complicated matters even more.

At this juncture, microfinance practitioners in India faced quite a few questions that had no easy answers.

Is there deterioration in the loan assets as an MFI grows?
Is it acceptable for an MFI to have a profit motive?
Does a profit motive necessarily degenerate into exploitative tendencies?
Is it possible that profit motive could give rise to a healthy competition among MFIs to provide better services to the poor?
What is the perception regarding the interest rates charged by microfinance institutions?
What would be reasonable interest rate?
Is there a need to regulate these interest rates?
What is the perception regarding MFIs being dependable lenders who provide friendly services with minimal transaction costs for the poor and hence need to charge a higher rate of interest?
Can entrepreneurs consider microfinance a market worthy pursuit?
Why do MFIs find it difficult to standardize their operations?
Is the cost of technological up-gradation justified given that it leads to gains in operating efficiencies?
How well prepared are MFIs to take to modern technology?
Are there infrastructural bottlenecks that they need to contend with?
Will MFIs find it difficult and costly to borrow form banks in the future?
Will MFIs be able to build the required processes and systems as they grow?

The uncertain environment meant that banks were more guarded in the manner they transacted with MFIs. While innovations such as the “Partnership Model” had earlier helped many MFIs to overcome capital constraints and scale up, these were now criticized for lacking adequate checks and balances to ensure that their practice was as per their design.

Challenging as it may have been, the year 2006 has given us many key-takeaways, some of which I have listed below.

Customer Satisfaction is a core value. The advantage that MFIs enjoy over traditional sources of financial services is their ability to service their clientele better. The overall experience that clients have with the MFI is NOT impersonal, and their satisfaction is also a function of the way they perceive they are valued by the MFI. This represents an opportunity for MFIs to measure and manage “client-delight”.
Managing Public Relations is critical for MFIs to succeed in the long run. Barring a few exceptions, MFIs have not been great communicators. As a result they have been vulnerable to adverse publicity. Given the many benefits that microfinance operations tend to provide to the society, there exists a great a potential to leverage this through creatively designed campaigns.
Pareto principle operates in microfinance. It is essential for MFIs to realize that the fundamental aspects of credit control and monitoring key operational indicators cannot be sacrificed for complicated products that are impossible to deliver.

Thankfully the microfinance sector in India seems to be rebounding with great energy. One hopes that the sector will live up to its potential and contribute its bit in realizing the fortune that lies at the “bottom of the pyramid” to quote Prof C K Prahalad.

Book Summary: The Fortune at the Bottom of the Pyramid (BOP)

2007-03-20T12:44:00.000-07:00

This book by C K Prahalad, Harvey C. Fruehauf Professor of Corporate Strategy and International Business at the University of Michigan Business School addresses a challenge that the author had thrown to himself in 1995 - "What are we doing about the poorest people in the world? … Why can't we mobilize the investment capacity of large firms with the knowledge and commitment of NGOs and the communities that need help? Why can't we co create new solutions?"

The ideas given in the book had earlier been propounded in a working paper, called "The Strategies for the Bottom of Pyramid", which the author had produced with his colleague, Professor Stu Hart but was considered too radical for publication by journals. However, a number of managers at Hwelett-Packard, DuPont, Monsanto and others read it on the internet and accepted its premise. Widespread discussions and acceptance came with publication of two articles, "The Fortune at the Bottom of the Pyramid" in Strategy+Business (January 2002) with Stu Hart, and "Serve the World's Poor Profitably" in the Harvard Business Review (September 2002) with Allen Hammond.

The book is divided into three parts. First part, 'The Fortune at the Bottom of the Pyramid' gives a framework for active engagement of the private sector at the Bottom of Pyramid (BOP) and is divided into six chapters. The starting proposition of the author is that 'if we stop thinking of the poor as victims or as a burden and start recognizing them as resilient and creative entrepreneurs and value-conscious consumers, a whole new world of opportunity will open up.'

The first Chapter is titled "The Market at the Bottom of the Pyramid" and discusses the unique character of the BOP market. The BOP as a segment consists of an estimated 4 billion people who live at below $2/day. They represent a latent market for goods and services. Active engagement of private enterprises at the BOP is a critical element in creating inclusive capitalism as private sector competition for this market will foster attention to the poor as consumers. The author states that each of the groups that is focusing on poverty alleviation - the World Bank, rich countries providing aid, charitable organizations, national governments and private sector - is conditioned by its own dominant logic. For example India had a deep suspicion about the private sector. Multinational companies (MNCs) suffer from deeply entrenched logic regarding cost structure, consumers and BOP sector. The donors consider private sector greedy. All these agencies have come to an implicit agreement that market based solutions cannot lead to poverty reduction and economic development.

If these agencies cross the barriers posed by their dominant logic, a whole set of opportunities emerge in terms of BOP market, representing a major engine of growth and global trade. This market has its own set of characteristics which are discussed in the book as under:

a. The dominant assumption is that there is no money at the BOP. The reality is that BOP offer huge opportunity due to their large numbers. BOP consumers also pay a high premium for the product and services they avail.

b. The dominant assumption is that distribution access to BOP markets is very difficult and therefore represents a major impediment for the participation of large firms and MNCs. The reality is that with urbanization and widespread migration of poor to the cities, distribution logistics have become easier. In rural areas, there may be "media dark" areas and dispersed communities. Solutions have emerged in different contexts - Project Shakti from Hindustan Lever Limited and "Avon ladies" in Brazil. These cases have been discussed in detail in part II of the book (discussed later in this review).

c. The third dominant assumption is that the poor are not brand-conscious. On the contrary, the poor are very brand-conscious. They are also extremely value conscious by necessity.

d. Contrary to the popular view, BOP consumers are getting connected and networked. They are readily exploiting the benefits of information networks.

e. Contrary to popular belief, the BOP consumers accept advanced technology readily.

The task therefore, is to convert the poor into consumers through market development. This would require giving the poor capacity to consume on a sustainable basis. Philanthropy might feel good but does not yield scalable and sustainable solutions. One illustration is innovative purchase schemes of Casas Bahia, a retail chain started by Samuel Klein in 1952 in Brazil and Cemex, started by Patrimonio Hoy in Mexico. Single serve packaging by consumer goods marketers is another example. The principles in creating the capacity to consume has been described as "Three As"

i. Affordability: Without compromising quality or efficacy

ii. Access: To be ensured through geographically intensive distribution

iii. Availability: To be ensured through distribution efficiency.

The ideal situation is to create capacity to earn more so that BOP consumers can afford to consume more. ITC's e-Choupal is a successful example in this regard. The critical requirement is the ability to invent ways that can take into account the variability in the cash flows of BOP consumers that makes it difficult for them to access the traditional market.
The involvement of the private sector at the BOP can provide opportunities for the development of new products and services, poor as consumers get more access to products and services and acquire the dignity of attention and choices from the private sector that were previously reserved for the middle-class and rich. The prerequisite is that both sides, the large firms and the BOP consumers develop trust, which has been missing traditionally.

Chapter 2, on "Products and Services for the BOP" calls for a new philosophy of product development and innovation in tune with the realities of the BOP market. The author has identified 12 principles of Innovations for BOP Markets:

1. Price performance: Quantum jumps in the price performance are required.

2. Hybrid Solutions: Advanced and emerging technologies that are creatively blended with existing and rapidly evolving infrastructure.

3. Scalable, transportable across countries, cultures and languages: Ease of adoption in similar BOP markets is a key consideration for gaining scale.

4. Focus on conserving resources: Eliminate, reduce and recycle resources.

5. Product development must start from a deep understanding of functionality not just form.

6. Process innovations are as important as product innovations.

7. Deskilling work is critical. Products and services must take into account skill levels, poor infrastructure, and difficulty of access for service in remote areas.

8. Education of customers on product usage is key.

9. Products must work in hostile environments.

10. Research on interfaces is critical given the nature of consumer population.

11. Innovations must reach the poor – designing methods for accessing the poor at low cost is critical.

12. Product developers must focus on the broad architecture of the system – the platform – so that new features can be easily incorporated.

Innovating at the BOP may seem daunting, but it is highly rewarding. It is also necessary for the MNCs who want to stay ahead of the curve. Such successful innovations are seen in Reliance Telecom’s “Monsoon Hungama”; Dr Venkataswamy’s Aravind Eye Care system in Madurai; Molecular encapsulation technology for iodizing salt by Hindustan Levers Limited; Amul’s Automatic Milk Collection System Units; Ram Chandra and Dr P K Sethi’s Jaipur Foot; Device agnostic system by Voxiva, Peru; ICICI banks multi channel delivery mode; ITC and EID Parry’s access to farmers through their networks.

Chapter 3 is titled “BOP: A Global Opportunity”. It justifies the efforts required for innovating for BOP by identifying four source of opportunity for a large firm that makes and effort to understand and cater to BOP:

a. Some BOP markets are large and attractive as stand-alone entities.

b. Many local innovations can be leveraged across other BOP markets, creating a global opportunity for local innovations. For example, Unilever has replicated products in India in other BOP markets – lessons from developing Wheel were used to launch a similar product, “Ala” in Brazil.

c. Some innovations from the BOP will find applications in developed markets. The Voxvia system found use in the U. S. Department of Defense in its inoculation programme.

d. Lessons from BOP markets can influence the management practices of global firms – Nirma and Wheel operate on lower gross margin but yield a higher return on capita employed.

The BOP market pose challenge emerging from rapid acceptance of innovation (a “I curve” as compared to traditional “S curve”. The rapid growth demands new approaches. Innovations such as SHGs and Shakti Amma cut costs drastically and reduce risks.

Chapter 4, “The Ecosystem for Wealth Creation”, shows how large firms can create a private sector ecosystem and act as a nodal firm. The author has included social organizations of different types – individual entrepreneurs, SMEs, Cooperatives and MNCs. A market based ecosystem for wealth creation consists of the following players:

• Extralegal NGO enterprises

• Micro enterprises

• Small and medium enterprises

• Cooperatives

• Large local firms

• MNCs

• NGOs

Every country has all these players, the relative importance of these firms differs across countries and the policymakers face a dilemma in this regard – If we can’t pick one sector for special attention, how do we mobilize the whole ecosystem? Alternatively, how do we move the composition of the ecosystem towards large firms? The author says that the debate must shift towards building market-based ecosystems for broad-based wealth creation. The HLL project Shakti and ITC’s e-chaupal are such examples. The benefit of private sector ecosystems result from the acceptance of sanctity of contracts by BOP and reduction in inequities of traditional money-lender, local slum lord based contract system. The private sector, in its desire to leverage resources and gain market coverage, will invest new systems depending on the nature of the market. This means not only gaining the benefits of globalization but also accepting the disciplines that it imposes. Also, opaque, local moneylender based contract enforcement and participating in a national or regional private-sector ecosystem are not compatible.

Chapter 5, “Reducing Corruption: Transaction Governance Capacity”, addresses the issue of corruption. Corruption is a market mechanism for privileged access. It adds to cost burden and business uncertainty. The author refers to the work of Hernando De Soto titled 'The Mystery of Capital' and establishes that substantial values lies locked within the underdeveloped societies due to corruption. This can be overcome by developing Transaction Governance Capacity (TGC) in the BOP.

TGC constitutes
a. Law to protect the property;
b. Micro regulation;
c. Social norms; and d. Institutions for enforcement.

BOP consumers live in a varying degrees of TGC – arbitrary, those where laws and market economy exist or where all the components are well developed. The specifications prescribed for building TGC are four fold:
a. A system of laws that allows for ownership and transfer of property
b. A process for changing the laws governing property rights that is clear and unambiguous.
c. A system of regulations that accommodates complex transactions.
d. Institutions that allow the laws to be implemented fairly, in a timely fashion and with transparency.

A successful attempt at building TGC is Government of Andhra Pradesh’s e-governance initiative. Here, however, it has been discovered that the level of corruption has initially increased during the transition period. However, once the transition to digital delivery of service and transfer of data in electronic mode is made and people become conversant with the new technology, the accompanying transparency would ensure an almost nil level of corruption.

Given the capacity to solve problems of poverty through profit, innovations are required in product design and in converting poor into market. The process generates TCG. These factors can trigger rapid economic and social development. The author discusses this aspect in Chapter 6, titled Development as Social Transformation.

Building markets help in breaking down barriers in communication. This is evident in e-choupal model. Farmers from villages could get information from Chicago Board of Trade. One of the farmers also wrote an e-mail to one of the researchers who was assisting the author in compiling the case studies. The BOP consumers are constantly upgrading in the process of participating in expanded market, gain access to knowledge and identity as individuals.

Another well understood but poorly articulated reality is the role of women in development. Their critical role is to be seen in the case of Avon Ladies, SHGs, Amul and in Cemex. Another feature is that a system of checks and balances are emerging, thanks to civil society organizations and free press. The last point the author makes is that the social transformation should lead the pyramid structure to morph a diamond. Pyramid depicts unequal distribution in the society. A diamond structure represents a minority at top and bottom and a majority of middle class. He quotes National Council of Applied Economic Research to discern such trend in states such Gujarat and Haryana. While states like Bihar and Orissa show a pyramid type of structure, Maharashtra and Punjab show an inverted pyramid. This pattern is likely to repeat itself in rural and urban India. The author concludes by emphasizing that the best allies in fighting poverty are the poor themselves and also conjectures that the bold initiatives would lead to elimination of poverty by 2020.

Part II of the book is a detailed discussion on the successful innovations under the heading Innovative Practices at the Bottom of the Pyramid. The cases are categorized into different sections –
1. The Market at the BOP, discusses Casas Bahia and CEMEX;
2. Known Problems and Known Solutions: What is the Missing Link, discusses Annapurna Salt Story and HLL’s initiative in soap market and public health;
3. Known Problems and Unique Solutions; Documents the Jaipur Foot and Aravind Eye Care System.
4. Known Problems and System Wide Reform; Documents ICICI Banks innovation in finance, ITC’s e-choupal storey and The EIC Parry Story (on CD);
5. Scaling Innovations: The Voxiva story and Innovations in Energy by E+Co’s Investment in Tecnosol (on CD);
6. Creating Enabling Conditions for the Development of Private Sector: E-Governance in Andhra Pradesh (on CD).

The cases are quite detailed with the objective of providing information about how to innovate at the BOP. The author also says that the cases go on to establish that there is no mystery to unlocking the potential of these markets. Finally, they demonstrate the size of the market.
___

M2i Consulting – Microfinance Management and Investment Advisory

2006-07-11T20:45:00.000-07:00

http://www.m2iconsulting.com/

M2i Consulting has been promoted by Deepak Alok and Atul. Both Deepak and Atul have rich microfinance experience and have known the microfinance sector closely.

We are based in Gurgaon, (near Delhi) India and provide our services in all part of the world.

M2i is a company set up with the objective of providing professional management skills to MFIs and other Medium and Small Enterprises. It has been our experience that many promising initiatives find it extremely difficult to manage growth challenges in the absence of adequate technical expertise in the areas of business forecasting and planning, budgeting-control and audit, information systems as well as communications and networking.M2i endeavors to provide these services at rates which are affordable by introducing them as standardized products.
M2i consultancy provides management consultancy services to the MFIs. Services provided by M2i for the microfinance sector are as below.

Business planning and business plan management
Product Development and organizational structuring
Development of Accounting system, MIS and Internal Audit
Financial and operational analysis
Equity valuations and capital structuring
Training on the technical aspects of microfinance
Assessment of microfinance programmes

MFIs can also outsource their key management services like accounting, Internal Audit and financial analysis to M2i.

Nonfinancial Data Can Predict Future Profitability

2006-02-25T10:13:00.000-08:00

After reading the below article, I believe that an interactive mathematical model which can predict future profitability using non-financial data can be a great value for Microfinance Institutions.

====================================
Nonfinancial Data Can Predict Future Profitability
====================================

November 2005
Research by
Madhav V. Rajan
Gregor G. Peterson Professor of Accounting
Stanford Graduate School of Business
Venky NagarAssociate Professor of Accounting
University of Michigan

STANFORD GRADUATE SCHOOL OF BUSINESS — Data on intangibles such as customer satisfaction can yield significant forecasts of earnings only when they are analyzed in conjunction with financial statistics, according to recent research. Accounting Professor Madhav Rajan used a collection of wide-ranging customer relationship data from 115 retail banks to develop the most powerful guidance yet for managers wanting to know how to use nonfinancial metrics effectively.

His key finding is that no single customer relationship metric can be used to predict future earnings. Rather, when considered in relationship to other measures, such metrics can lead to a financial profitability number 15 percent closer to the actual figure for the coming year than is otherwise possible. Such a percentage is gold for the soothsayers of finance.

In his study, Rajan, the Business School’s Gregor G. Peterson Professor of Accounting, examined the interactions of metrics such as customer satisfaction, employee turnover, the speed of loan processing, and the average number of products and services customers purchased against prices, costs, and other figures.

“Looking at a customer satisfaction number alone doesn’t do you much good unless you know the costs involved in achieving it,” says Rajan, who conducted his research with Venky Nagar, associate professor of accounting at the University of Michigan. “Customers might be satisfied because you’re giving them everything for free, but this doesn’t say much about what your future profitability will be.”

In other words, says Rajan, a bank must compare customer satisfaction to a cost such as the amount of interest it pays out. “We found that high customer satisfaction and low interest costs push profitability significantly,” he says. The bottom line: A bank can rely on the customer service metric as a predictor of profitability only when its interest or “deposit” costs are low.

Similarly, the number of additional goods and services cross-sold to customers becomes predictive depending on the bank’s business strategy. “The cross-sell figure is valuable only when banks are focused on innovation, that is, when their strategy is to emphasize new products and services,” Rajan says. “For banks with a different strategy, the number is a far less reliable future indicator.” Innovation-oriented banks, then, will want to keep an eye on their cross-sell metric, but other banks may be wasting their efforts trying to capture such a number.

Today intangibles such as customer relationships account for more than half of total assets of firms in the United States. The importance of nonfinancial measures has set off a search for ways to capture and use these metrics to predict future earnings. It’s critical information for both managers plotting a firm’s future and investors seeking to gauge just how rosy that future will be.

Knowing which measures are most important for its needs can save a bank a lot of time and money when it comes to applying the popular “Balanced Scorecard” tool that many businesses are now using to assess their performance across various categories. It also helps investors know which numbers they should be paying attention to if they want to gauge the ongoing health of a company. “If today’s earnings look good, but the bank’s deposit expense or customer volume measures look bad, then the future of that firm may not be as bright as one may think,” Rajan explains.

Rajan’s study also has applicability in industries beyond banking. “The drivers won’t be the same, but the analytical methods we use in this paper are universal,” he says. “Anyone can use them to figure out which measures best capture a firm’s relationship and spell future success.”

Insurance: Security for Poor Farmers?

2005-09-15T02:55:00.000-07:00

(Atul and Deepak Alok)

An assurance of a minimum guaranteed return should act as an incentive to the farmers to take to the new technologies, as the risk of such an adaptation would be covered. This should work out fine if the cost of insurance (i.e. money s well as effort) is small. However most of the dairy farmers in the country are quite poor and for them the premium turns out to be a significant portion of their savings. This makes it natural for them to expect some return on the premium paid.

There is also a limit to the level that the premium can be brought down to, as the risk to the Indian cattle is quite high. (Presently cattle kept under the best animal husbandry practices report a death rate of 2%). The shortcoming of the schemes presently in operation is that the premium payment is a one-time affair and the member gets nothing if he has not made any claim. For example to get a cover of Rs10000 on his cattle a member is required to pay a premium of Rs 400 at the beginning of the year.

In case the cattle survive through the year the member gets nothing back on the Rs 400 he has given initially. This is a disincentive for the member to provide necessary care to the cattle. In the absence of necessary care, the cattle productivity may come down; the insurance then becomes a means to cover deliberate and adverse risks, which the member then finds desirable. The whole purpose of productivity enhancement gets defeated.

Case Study in Mutual Insurance

2005-09-15T02:45:00.000-07:00

(Deepak Alok and Atul)

Govindpura village is situated about 50 kilometers from Mehsana, in the Bijapur taluka of the Mehsana district. The Dairy Cooperative society in the village is unique in the sense that it has evolved its own cattle insurance scheme for its members. This is in a situation when the cattle insurance schemes in all the places are facing a lot of problems including that of high premium rates, moral hazards etc.

The scheme started on 15 th August 1996. Need for such a scheme came out of a crisis that the society faced about that time. It had a contract for the group insurance of the cattle of the members of the cooperative society. That year there was an unusually high death rate of the cattle in the village and the insurance company raised the premium rates. The society decided to sever its links with the company. The villagers sat together and decided to have their own fund to insure the cattle of the village.

In the first year 200 members joined the scheme with a contribution of Rs. 400 each. That year 7 cattle died and their owners were compensated each Rs. 8000 for the same. This resulted in a saving of Rs 47000 including interest. The cumulative savings in the funds have now become about 1.92 lakhs. The progress of the scheme is shown in Table 10.

The scheme is running with very simple rules and regulations. All the members have to contribute an agreed premium at the beginning of the year. Against this premium all their cattle are insured for Rs. 8000. However the claim will be restricted to only one cattle per year. Thus if a member has 3 cattle he will get Rs. 8000 on the death of any one of the cattle. Entry and exit from the scheme are voluntary. (Even non-members of the dairy cooperative society can avail of the scheme provided they are pouring a given quantity of the milk in the society.) If any body wants to opt out of the scheme, he will get his share of the net worth. If anybody wants to join the group he will have to contribute an amount equal to a member’s net worth. (For example at the end of the insurance year 1996-97 the total net worth of the society is Rs. 47000, or Rs. 235 per member. If somebody opts out of the scheme he will get Rs. 235 as his share. If somebody wants to join the scheme he will have to contribute Rs. 235 as his share in the net worth of the society.)

At the beginning of every insurance year (an insurance year runs from 15th August one Year to 14th August next Year) a survey of the households in the village is carried to determine a list of the insurable cattle in the village. Only the healthy animals are insured. The cattle, which are uninsurable, are tagged. Upon any reported death, a team is sent from the society to investigate if it was the insured cattle that died. Upon establishment of this the claim is settled immediately. This hardly takes two days of time.

Let us now consider how this arrangement has solved various problems related to insurance. First this system has a very low (almost negligible) transaction cost. There is no medical certificate. No paperwork, no post-mortem. Only thing that is maintained is a small register where the names of the owners of the cattle that are held uninsured are written along with their identification marks. There is another register where the total transactions for the year are recorded.

The premium rates here are very low as compared to the other schemes. For a 2.5% premium in the current year, you get all your healthy cattle insured. It cannot be a coincidence that the death rate of healthy animals is quite low in the village (17 deaths in five years out of about 900 cattle). This only points out to the fact that in other arrangements there is an adverse risk selection that many high risk and therefore uninsurable animals are also insured. Then there is also the problem of moral hazards in case of other animals when claims are made for cattle that were not insured in the first place.

Written rules of Govindpura Insurance Society

Period of the Insurance is for 1 Year.
Premium is to be paid yearly.
Amount of claim is Rs. 8000.
At the most only one animal death claim will be entertained, that is one claim per year per family.
Animal will be insured only after calving.
Members are free to take insurance from other companies.
In case of loss to the group every member has to contribute equally to meet the loss.

This system also checks moral hazard to a great extent. First there is a social watch on everybody that they do not underfeed their cattle, deliberately starving it to death to get the insurance amount. This is more likely to work in this mechanism, as people understand that if someone is unduly benefiting it is at the cost of everyone else. This reasoning is difficult to understand in the case of third party insurance.

This System could not have evolved after the negotiations with the insurance agencies failed, had there been no sufficient need perception for cattle insurance. This supports the argument that there has to be a felt need for the security provided by insurance (utility) for it to work.

This system draws a lot from the social capital that a society possesses. In a particular society higher is the social capital; higher are the chances that such an arrangement will succeed. Govindpura is homogenous in the sense that this is a small village all of whose residents belong to a single community. The socio economic status is also rather homogenous. This is not to say that this arrangement will not succeed in other villages where there are multiple castes and socio economic groups. If there is an adequate quantum of social capital this can be replicated in other places as well.

REPLICATION OF GOVINDPURA

The evolution of Govindpura is a result of the villagers’ own initiative. The scheme was readily accepted and its provisions and requirements quickly disseminated because the villagers had themselves been responsible for these. An external initiation of a similar model may face resistance, as the cost of formation of a new group would have to be overcome. Hence a proper selection of the villages where a similar model is to be externally initiated becomes important. Equally important is the agency that would initiate the scheme.

The selected villages should fulfill the following criteria in order to achieve a successful implementation.
The villages should be homogenous with respect to socio economic variables like caste and annual income.
Dairying should be central to the lives of the people.
The levels of human and animal death should not be too high.
The village should not have a history of conflicts.
The members of the selected village DCS should have some experience with Group insurance schemes of the Dairy Union.

The agency that takes the responsibility to initiate this model must have some experience in similar exercises. The CS/CD group that helps in the formation of the women self help groups has the expertise to take this responsibility as the activities to be undertaken in this case are similar and involve group formation. Once the villages have been selected he scheme can be initiated in the following manner.

Visit 1:This visit entails the following objectives:
Identification of the potential participants.
Informing these potential participants about the success of Govindpura.
Detailed outline of the scheme in Govindpuraa, its rules and provisions to be provided to them.
Target setting for the next visit/meeting, which must include a targeted group size.

Visit 2:The objectives are:
Enabling the group to express to security needs.
Enabling the group to decide its insurance needs.
Enabling the group in to evolving its own rules.
Selecting a committee from the group to clearly lay down these rules.
Target setting for the next visit.

Visit 3:The objectives are:
Discussion of the rules and modifications if suggested.
The necessary assistance in paper work
Facilitation of collection off the member’s contributions.
Announcement declaring the scheme open.

Thereafter follow-up visits are suggested to see whether the schemes are functioning smoothly. Adding some incentives (like capital infusion after a certain number of years) is also suggested.

The Vicious Cycle in Cattle Insurance Schemes

2005-09-15T02:38:00.000-07:00

(By Atul and Deepak Alok)

Insurance paradox
For an insurance scheme to work the premium collected and the returns on it should be sufficient to settle claims that arise and to cover the expenses of operations. This would imply that the claim ratio should hover around one for sustainable insurance. The claim rates are high, particularly in the case of cattle insurance. There are also evidences to suggest that, paradoxically; the death rate is higher in the case of insured cattle. Our investigations also pointed out to the incidence of moral hazards (ie. not taking adequate care of the insured cattle) and adverse risk selection (ie. insuring unfit cattle). The insuring companies suspect cheating. The mechanism adopted by them to meet the cost of high claims is that of loading. In order to meet the cost of insurance (claim settlement and operational expenses) the insurance agencies increase the premium rates in proportion of the claim ratio.

Why take Insurance?
Most of the dairy farmers mention high premium rates as a reason for non-participation. Many of these farmers feel a definite need for insurance. The criterion for participating in insurance schemes at the society level is the surplus of the receipts due to claim settlements over the expenses due to premium payments (ie. the total premium paid by the members of the society). Such a criteria makes it difficult for the insurance companies to operate with a reasonable rate of premium. Higher claim ratio leads to loading and ever increasing premium rates. This results in a vicious cycle, which is described later.

Economic Rationality
From the point of economic rationality, a member would be ready to pay premium for an insurance instrument, without expecting any undue returns as long as his marginal utility for the safety provided by the instrument (ie the perceived benefits per incremental unit of premium paid) is greater than his marginal utility for money. The determinants for the former are primarily a) the member’s risk perception based on past experiences b) their own level of economic well being (affordability) and c) awareness about the presence of such an instrument. Once the marginal utility of the safety provided falls below the marginal utility for money spent on premium, the members start expecting returns and view insurance premium as a yield earning investment similar to securities. In fact we observed a high correlation between those who view insurance premium as investment along with safety and those who felt that the premium rate was high.

Role played by Dairy Cooperatives
There is a problem with the way insurance is seen at the society level. When the society is an intermediary between the members and the insurance company, it can clearly see the inflows and the outflows due to insurance. There is a possibility that the society will see this as another investment opportunity, the costs and benefits of which can be calculated on strictly monetary terms. Consider the case of a society, which has 1000 members who contribute Rs 100, each for the life of the members. This means an initial annual outflow of Rs100,000. If the premium rates had been calculated on strict actuarial principles, the amount received as claims will be around Rs100,000 during the year. There is also a possibility that the amount received will be less than Rs100, 000. The society may then feel that it would have been better off if it had kept the money with itself and compensated the members. This feeling may also tempt the societies to adopt fraudulent means to get a sufficient return on their “investment”.

The insurance agencies resort to loading when the claim ratio exceeds one. Thus the premium payable on a scheme increases. The question to be asked is that why did the claim ratio exceed one? Assuming that the initial premium rate was based on a good actuarial model that took into account all the inherent risks, it would seem that some irregularity was committed.

In the case of cattle insurance schemes running across the unions covered, only a few of the societies account for most of the deaths in the entire union. These societies are sporadically distributed in the region and did not record any epidemic. This points to some irregularity, some mechanism to get the maximum returns on the insurance premium paid. Obviously this requires a collusion of the members who participate, the doctors who certify and the authorities of the insurance agencies who monitor. The collusion between any two could result in the establishment of a fraud claim. This artificially inflates the claim ratio. As a result the premium rates increase. When this happens many of the members feel that the premium rates do not justify the real risks to their cattle. They then either pull out of the scheme or continue only if they are certain of returns (claims). Thus, there is an increase in adverse risk selection, and the upward spiral of the premium rates continue. Slowly most of the honest members drop out of the scheme and it degenerates. The scheme even when it is in operation fails to take care of the real insurance needs.

Interestingly, the perception at the society/union level is that while the members are their own, the insurance companies are the other party. Hence they usually condone some of the unscrupulous activities of the members. (In cattle insurance the union doctors limit their roles to identifying the correct animal and usually do not report if the death of the animal is due to negligence or bad Animal Husbandry practices). This precipitates the spiral - a vicious series of cycles, which lead to the failure of the schemes.

Rationale for Valuing Equity in MFIs

2005-09-10T01:03:00.000-07:00

The microfinance sector is evolving from being predominantly grant driven to a stage where it is looking forward to attracting commercial capital. MFIs have been successfully utilizing commercial debt funds and are increasingly looking forward to commercial sources of equity.

In the past an MFI that achieved a Financial Self Sufficiency of 100% was assumed to have reached the epitome of sustainability. However, Financial Self Sufficiency may not necessarily mean commercial sustainability. In the most widely accepted definition of FSS, the cost put to equity is just the inflation rate, which we know is not true. The cost of equity depends on the risky-ness of the business the equity is invested in and will always exceed the inflation rate by an amount equal to atleast the risk-free rate. In effect FSS puts no real cost to equity.

Thus, there is a need to value equity investments in microfinance which puts a market cost to it. In the absence of market information, (as the sector is still in a nascent stage and MFI’s stock don’t trade except for a few MFIs in Latin America), it is natural for most investors to value an MFI based on its Book Value – utilizing a valuation range constructed from multiples of book value . Book value – variously called shareholder equity and net worth – is broadly defined as total assets minus total liabilities. This difference is the excess value a business has generated in its life. Book value is then multiplied by pre-determined coefficients to create the valuation range. However, the Book Value method may not be appropriate for valuing MFIs because of the following reasons:1) Backwards Looking Nature: Book value is sum of the total excess value generated by a business. Hence, book value measures only what a business has done, and does not necessarily have bearing on what it will do. In mature companies and industries, past history is often a strong indicator of future performance; in such situations, book value is an effective tool for determining a company’s present value. Microfinance, however, is not a mature industry, nor are many MFIs truly mature companies. Prior operating history is therefore not a good predictor for future results.

Historically, the microfinance industry operated along purely social lines. MFIs sourced operating funds from donors and philanthropic organizations in the form of grants, soft loans, and subsidized loans. These investments did not require profit maximization; at most, some investments required a nominal interest rate and future return of capital. MFIs utilized these funds as budgets, not as commercial equity investments; the firms did not have an incentive to build a surplus. Excess funds were generally utilized to explore new niches or to lower borrowing costs. Additionally, microfinance activities were often only one of many initiatives under an NGO’s umbrella. Excess profit generated through microfinance quickly flowed back into other parts of the NGO.

MFIs looking for commercial financing have refined their outlook to marry their social missions with the profit seeking ends of capitalism. Managing their businesses for profit while offering financial services to the poor and very poor allows MFIs to dramatically scale their businesses. Commercially financed MFIs will necessarily operate very differently than they have in the past; investments can no longer be viewed as budgets, and an entire class of investors will demand profit maximization. Examining their history of value creation – the premise behind a book value valuation approach – is a misleading method of determining an MFI’s value creation potential.

2) Lack of Comparables: Without commercial history in the microfinance sector comparables to assess potential MFI profitability and an MFI’s risk profile do not exist. Selecting the appropriate coefficients for book value is impossible in such an environment. Multiple coefficients for the book value approach are based upon two factors: one, the return to an investor a unit of book value will yield, and two, the return an investor expects from a particular investment. In practice, the amount of profit delivered per unit of book value (or sales or assets, or otherwise) is generally not known to any degree of specificity. This value is generally determined by examining multiples ascribed to similar companies or by examining a “standard” long term business model of a company or industry. Owing to its unique evolution and young age, microfinance sector does not have a set of comparable companies from which to draw from. A long term “standard” business model for the microfinance sector is also difficult to ascertain; at this stage, no one knows if a 2% return on assets, a 20% return on sales, or a 15% return on net portfolio outstanding is appropriate. Without either tool, determining the appropriate multiples is impossible.

The situation is further complicated by the differences between microfinance firms. Due to the youth of the industry, a plethora of models continues to persist. Each model has different operating profiles, different profit potentials, and carries different risks. Some key differences include:
Full Grameen model vs. Self Help Group – Grameen hybrid
Livelihood consulting vs. pure MFI
Full intermediation vs. service company operations
Significant regional variations
A multiple used to value one microfinance firm rarely transfers to another. Hence, even after a handful of MFIs successfully source investments in the near to medium term, selecting book value multiples based on comparables will be difficult. An effective approach must both be forward looking and function in a nascent industry. A valuation approach that meets these requirements is the discounted cash flow (DCF) valuation.

Using DCF in MFIs
Free Cash Flows are defined as cash flows that remain after we subtract from expected revenues any expected operating costs and the capital expenditures necessary to sustain, and hopefully improve, the cash flows. The Free Cash Flows to Equity (FCFE) represent the free cash available to the equity holder of the company and are good measure of the company’s capacity to pay dividends and provide capital gains opportunity to its equity investors. Discounted FCFE, is therefore, is appropriate way to value equity of a company which is in its initial life cycle stage, does not trade in public and so far has not paid dividends like most MFIs.

Peculiarities involved in valuing MFI’s equity
Financial services firms including MFIs have certain peculiarities, and therefore FCFE calculation has to be more measured and careful.

1.RegulationBanks and financial services firms are heavily regulated. In general, these regulations take three forms. First, banks are required to maintain capital ratios to ensure that they do not expand beyond their means and put their claimholders or depositors at risk. Second, financial service firms are a minimum level of Net Owned Funds or Net Worth. Third, entry of new firms into the business is often restricted by the regulatory authorities. From a valuation perspective, assumptions about growth are linked to assumptions about reinvestment. With financial service firms, these assumptions have to be scrutinized to ensure that they pass regulatory constraints, particularly relating to capital adequacy levels.2.ReinvestmentIf we define reinvestment as necessary for future growth, there are other problems associated with measuring reinvestment with financial service firms. Primarily, – net capital expenditures and working capital, could be considered as reinvestments required for growth. However, measuring either of these items at a financial service firm can be debated.Unlike manufacturing firms that invest in plant, equipment and other fixed assets, financial service firms invest primarily in intangible assets such as brand name and human capital. Not surprisingly, the statement of cash flows to a bank show little or no capital expenditures and correspondingly low depreciation. Similarly, if we define working capital as the different between current assets and current liabilities, a large proportion of a bank’s balance sheet would fall into one or the other of these categories. Changes in this number can be both large and volatile and may have no relationship to reinvestment for future growth. For example a bank may accrue a large interest cost on its deposits while the actual payouts on account of withdrawals are much less. The bank’s cashflow would in this case, gets artificially inflated.

Parishkaar, Hyderabad www.parishkaarindia.com

2005-09-04T09:57:00.000-07:00

To view Creative Solutions for the Microfinance Sector, please visit Parishkaar Advisory Services Private Limited, Hyderabad at: http://www.parishkaarindia.com

2005-08-24T04:06:00.000-07:00

Old Mumbai

Council of Microfinance Equity Funds

2005-05-20T00:22:00.000-07:00

The Council of Microfinance Equity Funds (CMEF) (http://www.cmef.com/) is the first membership organization bringing together the leading private entities that make equity investments in microfinance institutions (MFIs) in the developing world. The Council’s members seek both social and financial returns from their investments in these institutions, all of which provide a range of financial services to poor households in developing countries.

ACCION International serves as Council Coordinator and provides the secretariat for the Council.

Contact:Deborah Drake, CMEF Coordinator

email: ddrake@accion.org

tel: +1 617-625-7080 x1045
Fax: +1 617-625-7020

Members
ACCION International Gateway Fund

ACCION Investments in Microfinance, SPC

Développement International Desjardins (DID)

Gray Ghost Microfinance Fund

Oikocredit

Open Society Institute

Opportunity International

ProFund International

Shorebank

ShoreCap International

Solidarité Internationale pour le Développement et l’Investissement (SIDI)

Triodos International Fund Management., B.V.

Unitus

Equity in Microfinance: Some Reference Text

2005-05-20T00:03:00.000-07:00

Financing Microfinance Institutions: The Context for Transitions to Private Capital, de Sousa-Shields, M., Miamidian, E., Steeren, J., King, B. & Frankiewicz, C., Dec 2004, USAID - U.S. Agency for International Development

This paper states that the microfinance sector is at crossroads between financing dominated by non-commercial sources and one that is increasingly and necessarily responding to private sector financing needs and interests. The authors observe that if the sector has to meet its goal of serving a large portion of the world’s poor with permanent financial services, it must continue to prove the viability of its core low income market and must develop significantly deeper access to domestic commercial capital.

Tapping the Financial Markets for Microfinance: Grameen Foundation USAs Promotion of this Emerging Trend, Meehan, J. Oct 2004, Grameen Foundation

This paper attempts to define the role of the financial markets in the microfinance sector. Stating that the global unmet demand for microfinance is pegged at around US $ 296 billion, the paper makes a case for long term role of the financial markets in biding the huge unmet demand. The author has made the following suggestions for greater integration of the microfinance sector with the financial markets:

· Hiring of an Experienced Chief Financial Officer;

· Hiring of an Advisor to communicate with potential investors;

· Preparation of a Business Plan;

· Training in Corporate Finance.

Raising Capital Through Equity Investments in MFIs: Lessons From ACLEDA, Cambodia, Kooi, P. Jun 2001, UNCDF

This paper presents issues in equity investment in microfinance institutions (MFIs).The paper also presents the fundamentals of the investment criteria that public and private investors would apply before investing:

· Development phase of the microfinance industry;

· Leadership status of the MFI;

· A clear vision and commitment to become a profitable MFI;

· A realistic business plan;

· Appropriate ownership and governance structures;

· Adequate management information systems;

· A sound exit strategy.

Raising Capital for Microfinance: Sources of Funding and Opportunities for Equity Financing, Fehr, D., Hishigsuren G, School of Community Economic Development, Southern New Hampshire University, Working Paper No. 2004-01

This paper reviews financing sources commonly used in microfinance, and suggests an outline financial analysis that MFIs might use in approaching potential equity investors. The authors state that these proposed financial procedures, while quite common corporate techniques in well-developed countries, have not been widely applied in microfinance. While this may partially be attributed to the lack of comprehensive financial and operating data in MFIs, most providers of donor and grant funding have been satisfied to concentrate on the social benefits of their investments. The authors argue that, if mainstream investors are to become investors in microfinance projects, they will likely require financial analyses similar to those used for their for-profit investing activities.

Limitations of Using Book Value Multiples to value MFI stock

2005-05-09T00:53:00.000-07:00

In the absence of market information, (as the sector is still in a nascent stage and MFI’s stock don’t trade except for a few MFIs in Latin America), it is natural for most investors to value an MFI based on its Book Value – utilizing a valuation range constructed from multiples of book value . Book value – variously called shareholder equity and net worth – is broadly defined as total assets minus total liabilities . This difference is the excess value a business has generated in its life. Book value is then multiplied by pre-determined coefficients to create the valuation range. However, the Book Value method may not be appropriate for valuing MFIs because of the following reasons:

1) Backwards Looking Nature: Book value is sum of the total excess value generated by a business. Hence, book value measures only what a business has done, and does not necessarily have bearing on what it will do. In mature companies and industries, past history is often a strong indicator of future performance; in such situations, book value is an effective tool for determining a company’s present value. Microfinance, however, is not a mature industry, nor are many MFIs truly mature companies. Prior operating history is therefore not a good predictor for future results.

Historically, the microfinance industry operated along purely social lines. MFIs sourced operating funds from donors and philanthropic organizations in the form of grants, soft loans, and subsidized loans. These investments did not require profit maximization; at most, some investments required a nominal interest rate and future return of capital. MFIs utilized these funds as budgets, not as commercial equity investments; the firms did not have an incentive to build a surplus. Excess funds were generally utilized to explore new niches or to lower borrowing costs. Additionally, microfinance activities were often only one of many initiatives under an NGO’s umbrella. Excess profit generated through microfinance quickly flowed back into other parts of the NGO.

MFIs looking for commercial financing have refined their outlook to marry their social missions with the profit seeking ends of capitalism . Managing their businesses for profit while offering financial services to the poor and very poor allows MFIs to dramatically scale their businesses. Commercially financed MFIs will necessarily operate very differently than they have in the past; investments can no longer be viewed as budgets, and an entire class of investors will demand profit maximization. Examining their history of value creation – the premise behind a book value valuation approach – is a misleading method of determining an MFI’s value creation potential.

2) Lack of Comparables: Without commercial history in the microfinance sector comparables to assess potential MFI profitability and an MFI’s risk profile do not exist. Selecting the appropriate coefficients for book value is impossible in such an environment. Multiple coefficients for the book value approach are based upon two factors: one, the return to an investor a unit of book value will yield, and two, the return an investor expects from a particular investment. In practice, the amount of profit delivered per unit of book value (or sales or assets, or otherwise) is generally not known to any degree of specificity. This value is generally determined by examining multiples ascribed to similar companies or by examining a “standard” long term business model of a company or industry. Owing to its unique evolution and young age, microfinance sector does not have a set of comparable companies from which to draw from. A long term “standard” business model for the microfinance sector is also difficult to ascertain; at this stage, no one knows if a 2% return on assets, a 20% return on sales, or a 15% return on net portfolio outstanding is appropriate. Without either tool, determining the appropriate multiples is impossible.

The situation is further complicated by the differences between microfinance firms. Due to the youth of the industry, a plethora of models continues to persist. Each model has different operating profiles, different profit potentials, and carries different risks. Some key differences include:
• Full Grameen model vs. Self Help Group – Grameen hybrid
• Livelihood consulting vs. pure MFI
• Full intermediation vs. service company operations
• Significant regional variations
A multiple used to value one microfinance firm rarely transfers to another. Hence, even after a handful of MFIs successfully source investments in the near to medium term, selecting book value multiples based on comparables will be difficult. An effective approach must both be forward looking and function in a nascent industry. A valuation approach that meets these requirements is the discounted cash flow (DCF) valuation.

Why is Financial Self Sufficiency not the best measure of commercial sustainability of institutions?

2005-05-09T00:45:00.000-07:00

An MFI that has achieved a Financial Self Sufficiency of 100% is often assumed to have reached the epitome of sustainability. However, Financial Self Sufficiency may not necessarily mean commercial sustainability. The reason, I say this is because while calculating FSS, the cost put to equity is just the inflation rate, which we know is not true. The cost of equity depends on the risky-ness of the business the equity is invested in and will always exceed the inflation rate by an amount equal to atleast the risk-free rate. In effect FSS puts no real cost to equity. In this light Subsidy Dependence Index which puts the cost of equity as market rate of debt would seem to be a better indicator. However there are two main limitations with SDI:

Cost of equity is not the same as cost of debt;
It’s a dependence index and hence it is not suitable for measurement of sustainability. To measure sustainability using SDI one would need to interpret negative values of SDI.

The sector needs a sustainability measure that puts a commercial cost to equity, which is adjusted for the risk profile of a Microfinance Institution. However, the rating methodologies in use today may not be appropriate to arrive at a risk-return relationship to arrive at a cost of equity.

Regulation and Supervision of Microfinance in India

2005-04-05T23:26:00.000-07:00

India has started moving towards a comprehensive regulatory structure for microfinance, with policy makers increasingly feeling the need to have such a framework in place. The Finance Minister in his budget speech for the year 2005 has indicated that a draft bill on microfinance will be introduced in the fiscal year 2005-06. However, presently, there is no distinct regulation governing microfinance specifically. The term “microfinance” was defined by a Task Force set by the National Bank for Agriculture and Rural Development (NABARD) in 1999 as “Provision of thrift, credit and other financial services and products of very small amounts to the poor in rural, semi urban or urban areas for enabling them to raise income levels and improve living standards.” The Reserve Bank of India (RBI) has drawn on this definition in its subsequent directives on microcredit and microfinance.

Microfinance Institutions (MFIs) in India have taken diverse legal forms, each constituted under different laws. The following table presents the different institutional forms along with the Acts regulating them.

Institutional Form	Act
Societies	Societies Registration Act,1860 Or State Legislations (Some states have their own societies registration acts such as Tamil Nadu and Karnatka)
Public Trusts	State legislations prescribing establishment and administration of public trusts.
Cooperatives	Cooperative Societies Act,1912 Or State Cooperative Societies Acts Or Mutually Aided Cooperative Societies Act (for states where this has been legislated, for example Andhra Pradesh) Or Multi State Cooperative Societies Act, 2002 (for cooperatives operating in more than one state)
Not for Profit (Section 25) Companies	Section 25 of the Companies Act, 1956
Non Banking Financial Companies (NBFC)	Companies Act, 1956 and Registration also required with the Reserve Bank of India (RBI)
Banks	Specific Acts such as State Bank of India Act, 1955 etc. Or Companies Act, 1956, with license form RBI under Banking Regulation Act Or Regional Rural Bank (RRB) Act (the central government may establish an RRB through a notification in the official gazette) Or Cooperative bank sunder state credit cooperatives/national credit cooperatives/ mutually aided cooperative societies acts

While RBI is the overall regulator of the financial sector in India, the control it exercises over the different set of microfinance institution varies. Thus on one hand, a commercial bank providing microfinance through Self Help Groups (SHGs) has to comply fully with the disclosure norms set by the RBI, on the other, societies and trusts are minimally supervised.

2005-03-18T09:57:00.003-08:00

There are many forms of treasuries hidden at the bottom of the pyramid. Follow this link to trace of such forms of hidden treasury:

http://www.geocities.com/knaveenchand/Parishkaar.html

Treasury at the Bottom of Pyramid

2005-03-18T09:57:00.002-08:00

There are various forms of treasuries hidden at the bottom of pyramid. Click here to view one of its forms.

Treasury at the bottom of pyramid

2005-03-18T09:57:00.001-08:00

There is treasury at the bottom of the pyramid in various forms. Have a glimpse of one of its forms. Click here to view the treasury

Treasury at the Bottom of Pyramid!

2005-03-18T09:57:00.000-08:00

Here you will find the best of the treasury hidden at the bottom of the pyramid ... These are handicrafts made by the SHG members in Chittoor District of Andhra Pradesh, India. Click here to find the treasury!

Peculiarities associated with valuing financial services firms

2005-02-26T23:13:00.000-08:00

Financial services firms have certain peculiarities, and there fore FCFE calculation has to be more measured and careful.

1. Regulation
Banks and financial services firms are heavily regulated. In general, these regulations take three forms. First, banks are required to maintain capital ratios to ensure that they do not expand beyond their means and put their claimholders or depositors at risk. Second, financial service firms are a minimum level of Net Owned Funds or Net Worth. Third, entry of new firms into the business is often restricted by the regulatory authorities.

From a valuation perspective, assumptions about growth are linked to assumptions about reinvestment. With financial service firms, these assumptions have to be scrutinized to ensure that they pass regulatory constraints, particularly relating to capital adequacy levels.

2. Reinvestment
If we define reinvestment as necessary for future growth, there are other problems associated with measuring reinvestment with financial service firms. Primarily, – net capital expenditures and working capital, could be considered as reinvestments required for growth. However, measuring either of these items at a financial service firm can be debated.

Unlike manufacturing firms that invest in plant, equipment and other fixed assets, financial service firms invest primarily in intangible assets such as brand name and human capital. Not surprisingly, the statement of cash flows to a bank show little or no capital expenditures and correspondingly low depreciation. Similarly, if we define working capital as the different between current assets and current liabilities, a large proportion of a bank’s balance sheet would fall into one or the other of these categories. Changes in this number can be both large and volatile and may have no relationship to reinvestment for future growth. For example a bank may accrue a large interest cost on its deposits while the actual payouts on account of withdrawals are much less. The bank’s cashflow would in this case, gets artificially inflated.

Valuing Equity in Start-ups1:Discounted Free Cash to Equity

2005-02-26T23:12:00.000-08:00

Free Cash Flows are defined as cash flows that remain after we subtract from expected revenues any expected operating costs and the capital expenditures necessary to sustain, and hopefully improve, the cash flows. The Free Cash Flows to Equity (FCFE) represent the free cash available to the equity holder of the company and are good measure of the company’s capacity to pay dividends and provide capital gains opportunity to its equity investors. Discounted FCFE, is therefore, the most appropriate way to value equity of a company which is in its initial life cycle stage, does not trade in public and so far has not paid dividends.

Valuing Equity in Start-ups 2: Using Monte Carlo Simulation

2005-02-26T23:00:00.000-08:00

Monte Carlo simulation in traditional capital budgeting use repeated random sampling from probability distributions of crucial primary variables underlying cash flows to arrive at output distributions or risk profiles of probable cash flows in the project for a given management strategy. Simulation attempts to imitate a real world decision setting by using a mathematical model (consisting of operating equations or identities) to capture the important functioning characteristics of the project as it evolves through time encountering random events, conditional on management's preset operating strategy.

A Monte Carlo simulation usually follows these steps :
Modeling the project through a set of mathematical equations and identities for all the important primary variables, including a description of interdependencies among different variables and across different time periods.

Specifying probability distributions for each of the crucial variables, either subjectively or from past empirical data.

A random sample is then drawn (using a computer random number generator) from the probability distribution of each of the important primary variables enabling (with the help of the modelling equations and identities) the calculation of net cash flows for each period.

The process is repeated many times, each time storing the resulting cash flow sample observations so that finally a probability distribution for the project's cash flows can be generated (along with its expected value, standard deviation and other statistics).

Thus simulation in capital budgeting is useful in assessing the probability distribution of cash flows, from which the expected value of cash flows and the appropriate risk adjusted discount rates can be determined and used to derive a single value expected valuation.

Valuing Equity in Start-Ups 3: Validating Your Valuation

2005-02-26T22:47:00.000-08:00

Simulating the Free Cash to Equity is an excellent way of validating the equity valuation in a start up. The FCE distributions returned by the simulation can be used to estimate the annual FCEs at a certain probablity value (p-values in statistical jargon). The FCEs at low p-values (such as 1%)can be viewed as Certainity Equivalents of the projected most likely FCEs. Certainty Equivalent (CE) of a cashflow (say C1) is the smallest certain pay-off for which an investor would exchange the risky cashflow (C1). The value calculated by discounting the CE at risk free/discount rate adjusted for moderate risk, and the value calculated by discounting the projected most likely FCEs at a certain discount rate reflective of investor's return expectations are close enough, then that particular investors return is arguably justified for the riskiness built into the most likely FCE projections.