by Viral Shah.
The Reserve Bank of India has stepped in to regulate the pricing for debit card transactions. The rationale behind this regulatory change seems to be that lower transaction processing fees paid by merchants will lead to an increase in the adoption of retail electronic payments overall. Issuing banks will have to give up interchange revenue in the short run, but increased transactions will make up for lower fees in the long run. An unintended consequence could be that transaction processing gets adversely affected, and the current growth rate of retail electronic payments slows down. The RBI circular was released on June 28, 2012, and the industry is expected to comply from July 1, 2012.
Card payments background
Electronic payments are an outcome of the delicate combination of technology and incentives. A card scheme (Mastercard, Visa, etc.) brings four stakeholders together. Issuing banks issue payment cards to their customers, who become cardholders, whereas acquiring banks sign up merchants to accept card payments. The card scheme provides the interconnect between issuing and acquiring banks, so that a merchant can accept a payment from any cardholder. The diagram below shows the relationships between all participants in a payments transaction.
The service fee that merchants pays to the acquiring bank for processing transactions is called the merchant discount rate (MDR). The acquiring bank collects the MDR from the merchant and pays an interchange (I) fee to the issuing bank and a network fee (N) to the card scheme. The interchange is usually enabled by the card scheme, which guarantees revenue for the issuing bank. This incentivises the issuing bank to keep issuing more cards, and to spend on marketing and loyalty programs so that cardholders activate the cards and use card payments frequently. The MDR necessarily has to be higher than the interchange and includes the acquirer’s processing fee (A), which is used to operate the card processing infrastructure. It is traditionally market determined, and is a contract between the acquiring bank and the merchant, based on the merchant’s volumes, risk, chargebacks, infrastructure needs, etc.
We thus have the equation:
MDR (Merchant Discount Rate) = I (Interchange) + N (Network fee) + A (Acquirer’s processing fee)
Debit card transaction volumes are growing much faster than credit card transactions, and if one extrapolates the trend from the RBI electronic payments data, it is expected that debit card transactions will have overtaken credit card transactions by volume.
Different methods of payments
||Value (Rs. Trillion)
||Extrapolated from NPCI 2012 data
||Merchant / Biller
||Merchant / Biller
||Rs.50 (average txn of Rs.3000)
||Merchant / Biller
||Rs.25 (average txn of Rs.1500)
||Merchant / Biller
We have a topsy-turvy world, where banks are willing to bear the cost of transactions for cheques and cash, but expect fees when transactions are processed electronically. Given that electronic payments often lead to customers keeping higher balances in their accounts, and savings on cheque processing and cash withdrawal, it would be rational for banks to incentivise electronic payments for customers and merchants alike.
Should credit card and debit card transactions have the same pricing?
Credit cards are really instruments for lending, whereas debit cards are instruments for making payments. The card transaction model evolved first in the case of credit cards, and was subsequently adopted for debit cards. In the case of credit cards, the interchange fee is used by the issuing bank to fund the cost of credit offered to the customer, and the risk of default, between the time of purchase and the time the customer pays the credit card bill. As a result, in case of a debit card transaction, one would expect (I) to be lower due to absence of credit, (A) to be similar since it is already market determined, and hence, (MDR) to be lower.
Large merchants are often able to negotiate a lower (MDR) with acquirers, even lower than (I), implying that (A) is negative. The acquiring bank offers this service to the merchant if the merchant maintains their current account with the acquirer. Clearly, this model is not scalable and does not work for the long tail of small merchants.
Should point-of-sale (POS) and e-commerce pricing be different?
Today, both credit and debit card transactions have the same MDR – roughly 1.6% for POS transactions, and 2% for e-commerce transactions. E-commerce transactions were once considered riskier with higher rates of fraud, and hence justified higher pricing. Now that two factor authentication is mandatory for internet and mobile transactions, there should be no difference in (I) and (A), and hence in (MDR) for POS vs. e-commerce transactions.
Why do regulators step in?
The card business is a two-sided platform, where the card issuing and merchant acquiring incentives are managed by card schemes. Consider the case of a new entrant in the card scheme business. The new entrant may want to lower prices to establish market share. However, if the entrant offers a lower (MDR) to merchants by lowering (I), issuers find the proposition unattractive. If the new entrant offers issuers a higher (I), merchants face a higher (MDR), and will be unwilling to accept the product. (A) is already market-decided and offers little opportunity for differentiated pricing. A new entrant can at best, charge a lower (N). These are the kinds of challenges faced by the Government backed National Payments Corporation of India (NPCI) in launching the domestic card scheme, RuPay. The issue of debit card transaction pricing was first highlighted in the public domain in the Report of the Task Force on Aadhaar-enabled unified payment infrastructure. Due to such high barriers to entry, card schemes are routinely examined by Governments, and regulators have stepped in to regulate debit interchange pricing. Regulators have typically capped (I), but in India, RBI has decided to cap (MDR). This is likely to have interesting consequences that are not easy to predict.
What will happen on July 1, 2012, when the new pricing kicks in?
On July 1, 2012, the MDR cannot exceed 0.75% for transactions up to Rs.2,000, and 1% for other tansactions. If existing contracts remain in place, then issuers are guaranteed to receive (I) (usually 1.1% or higher) and the card scheme is guaranteed to receve (N) (roughly 0.15%). In such a case, (A) becomes negative, and acquirers will lose money on every transaction they process. However, this announcement by RBI is likely to be considered a material adverse change, one expects contracts to be renegotiated. As per the data above, if debit card volumes are Rs.40,000 crore, MDR paid by merchants at 2% is roughly Rs.800 crore. The new regulation effectively means that the merchants are as a group better off by Rs.400 crore on a notional basis on July 1. The acquirers are likely to be inelastic on pricing, which means that it is issuers and card schemes that will have to largely absorb the notional loss – (I) and (N) will have to be reduced in the new regime. Much of this will be absorbed by five large issuers. Over time, as more transactions are processed electronically, banks will save on processing cheques and cash, and instead earn fees from processing electronic transactions.
Will the lower pricing due to regulation lead to higher acceptance of debit cards overall?
It is clear that merchants who were on the margin, are going to be more likely to accept card payments. It is even likely that merchants will now start demanding debit cards from customers instead of credit cards. At the same time, it is also worth noting that cards are largely accepted by merchants in metros and by e-commerce merchants. India has a network of only 600,000 POS devices and 100,000 ATMs, which is grossly inadequate for a country of our size. (A) is now likely to get fixed due to MDR being capped, and the acquiring business could start seeing stable revenues. This is also likely to lead to an interesting opportunity for the low cost merchant acquiring technologies similar to Square, a number of which are getting ready to launch in India. It could also create an opportunity for NPCI to differentiate itself from established competitors. Overall, the best case scenario is an increased demand for electronic payments with debit cards by merchants and consumers, savings for issuers due to reduced cash and cheque usage, greater acquiring revenues, and more banks entering the acquiring business (PSU Banks are notably absent in the acquiring business). At the very least, one hopes that the oil marketing companies will no longer charge a petrol surcharge fee of 2.5% when paying with a debit card.
What are the possible negative consequences of this regulation?
If (A) is set too low by the card schemes, the acquiring business will be affected. With no further bargaining power, acquirers may have to focus on cost cutting and holding back new investments. Issuing is unlikely to be affected much given the existing base of 300 Million debit cards, and that banks will continue to issue debit cards for ATM usage. One does expect cash-back schemes, loyalty programs, and various other cardholder incentives for debit products to effecively stop, and cardholder fees to increase. Even with ATM interoperability and pricing, RBI has continues to refine its policy (making interoperability mandatory at first, then free interoperable transactions, then restricting the number of free interoperable transactions to five, white labelled ATM policy, etc.). Similarly, this is likely to be the beginning and not the last word on the matter from the regulator. The policy should be stabilized quickly, since it is consumers who suffer during the experimentation phase.
Ken Booth has been involved in the mining industry for 30 years and sees the past two decades of quiet, stable growth that Cambodia has enjoyed out of the world’s economic spotlight as an opportunity for investors. The once ignored country has highly prospective geology, an emerging exploration services industry and a mining-friendly legal framework. In this exclusive interview with The Gold Report, Booth discusses why Cambodia should not be ignored by investors seeking first mover advantage and names companies who are poised to profit.
The Gold Report: Why should investors pay attention to Cambodia?
Ken Booth: Because of political forces, Cambodia was forgotten and ignored. The French explored during its colonial period in Vietnam and other parts of Southeast Asia. That information was lost. The Australians explored Southeast Asia, but focused more on Indonesia, closer to its backyard. The political strife that ended in the mid-1980s further stopped foreign investment in Cambodia and it became a forgotten place.
While things were quiet in Cambodia, the past 20 years have seen significant exploration and development in Vietnam, Laos and Thailand. As a result, Laos has a world-class copper mine and a producing gold mine. Those countries share many geological similarities to Cambodia. For now, there isn’t a big database of exploration results for Cambodia. But the country should be on people’s maps for mining exploration. And it is beginning to be.
TGR: What types of deposits are explorers searching for? Gold? Copper?
KB: From a commercially viable point of view, the targets are copper, copper/gold systems and epithermal precious metal systems. That is true of the east and central areas of the country. In the western regions on the border with Thailand, small-scale miners have been extracting precious and semi-precious stones for decades.
TGR: So what’s the situation with regard to exploration in Cambodia right now? Is it a greenfield?
KB: It would be considered greenfields, but some initial work has been done. Some geological maps are available. Initial exploration is not too difficult—it’s fairly easy to get around. We’re not talking about difficult physiography. First-stage exploration can be done rapidly through stream-sediment sampling and geophysics. Modern exploration would be considered greenfield.
Interestingly, on the eastern border with Vietnam, there has been significant small-scale and artisanal mining over the past 10 years. That activity does not appear to be historical and seems to be on the decline. Many of the miners cross the border illegally; it is a fairly porous border. The miners mine the alluvial material down to hard rock.
TGR: In those areas, do companies follow the small-scale miners to the most prospective areas?
KB: Yes. There are many forces at work in this situation. The border is tightening up. A lot of those small miners don’t use the best environmental mining practices and many use mercury. The Cambodian government is in the process of removing many of these people off the properties, pushing them back into Vietnam. The good news is the miners have exposed veins at surface, or they’ve excavated pits and you can get to hard rock or regolith. Clearly, they are extracting gold out of the alluvium and out of the veins, so the miners are also benefiting while doing the prep work for the modern explorers.
TGR: Does this put the mining companies and the government in the path of conflict with the local population?
KB: The Cambodian government is encouraging economic development on all fronts. It looks around the world and sees how mining has benefited a lot of countries. The government is making positive moves toward resource development. With mineral resources, the government is proactive in making sure that illegal miners—especially the ones who have crossed over the border—are moved off the land. That places the government in a good position to work with companies. If a company has a memorandum of understanding with the government on a particular piece of ground, the government will support the company in its endeavors. In those cases, the government will resolve the issues with illegal mining. Most of the small-scale mining is alluvial, which is very different from the mining exploration that public companies are engaged in.
TGR: In the past, you have discussed Angkor Gold Corp. (ANK:TSX.V). What is new there?
KB: Angkor Gold is one of the most active companies in Cambodia. The other significant company is Renaissance Minerals Ltd. (RNS:ASX) from Australia, which recently purchased a 750,000 ounce (750 Koz) gold deposit from OZ Minerals Ltd. (OZL:ASX) Those are the companies that are the most proactive explorers in Cambodia. I’ve heard that there are Chinese-backed private entities working within the country, but I don’t have any knowledge as to who they are or what they’re looking for. Angkor Gold’s main focus is exploration for gold, copper and copper-gold systems while Renaissance Minerals’ main focus is developing its 750 Koz gold resource.
TGR: Angkor Gold is an early-stage exploration company. With so many projects, how do you value the company?
KB: Angkor Gold has a lot of projects. The beauty about going into a country like Cambodia at this stage of the game is you get to be the first mover. The best company to bet on is the first mover that gets in and acquires the most prospective land. Angkor Gold has used its in-country managers, who have had experience in Cambodia over the last decade, to claim or apply for large tracts of land in order to ensure that it is the first mover. Over time, as exploration companies explore their land packages, less prospective areas will be dropped. While Angkor Gold looks as if it has a lot of land, and it does, it’s only from the point of view of saying, “I’ve got six or seven areas here I really think are prospective, I want to make sure I have those.” And as it works those properties, hopefully it will be successful on one or more. But, that land position will change dynamically over time.
TGR: What would be the timeline to get a resource estimate in this situation?
KB: Faster than you might think. Cambodia has four drilling companies and three assay labs. I believe two of those assay labs are accredited for reporting under the Australian reporting system as well as under Canadian NI 43-101 policies. Drillers and labs are busy, but they exist. The large labor force is not a problem; people are available and ready to work. Infrastructure is good and improving.
Getting to a resource is no worse than in a first-tier mining jurisdiction like the U.S., Canada, Mexico or Peru. In fact, you could be slightly ahead just by virtue of not having to compete for labor and potentially less bureaucratic red tape than in more developed countries. If a company is looking at a small vein-style deposit, it can probably develop the resource in fairly short time. If it is trying to drill off a resource in a large copper-porphyry system, that will take a lot longer, just by virtue of it being a much larger target.
TGR: Many sources state that Cambodia has a stable legal and regulatory framework. The mining law was written about 10 years ago, so it is still young. Can you comment?
KB: The legal system was developed with external advisers to ensure that it could be used by foreigners who wanted to invest within the country to protect property and individual rights. For a country that has a fairly new legal system, it appears to be good. The same applies to the mining law.
In creating legal systems, many developing countries rely on the expertise of people and legal systems from other jurisdictions. It seems to work well. It is an open system with clear rules spelled out in the memorandum of understanding. Companies can apply for small acreage or large acreage. But either way, exactly how to make the application and then what companies have to do to keep their tenure are well defined. It is an open and transparent legal system and mining law.
TGR: What are your thoughts on how an investor should participate in Cambodia?
KB: Investors should align themselves with managers that understand resource development in emerging jurisdictions. Investors need to realize that if they are in early, they have the potential for outsized rewards—if they pick the right managers. Early investment in a country like Cambodia needs to be managed by people who understand the initial foray into the country by companies like Angkor Gold, Oz Minerals and now Renaissance Minerals. Those initial prospects may generate gains when sold to developers.
In all these countries, people have their views on where they’ve come from and how bad the situation was. But the most important thing is to understand where they are today. Resource investors who get in early should do well. But they need an appetite for risk.
I consider Cambodia to be in its infancy, and it has not been explored to any great degree. There are similar stories of ignored countries in Africa including Somalia, Sierra Leone and the Democratic Republic of the Congo. We’ve got an example close by in Colombia. Fifteen years ago, exploring for gold in the Colombian jungle would have been considered crazy. Now Colombia is a major destination for exploration.
TGR: At this point, do you have an idea of what fraction of Cambodia has been explored?
KB: Oh, I would put it down to less than 5%.
TGR: There’s a lot of room for exploration still.
KB: A lot of room for exploration. Here is how I think it will play out. Somewhere, there will be a success or a discovery. You will see additional modern techniques applied on a large scale countrywide. How much has been explored? Well, a relatively small percentage, because it’s all being done using tried-and-true methods—feet on the ground, mapping and sampling. When larger surveys, such as airborne geophysics, start to highlight prospective areas, things could really open up.
TGR: What thoughts would you like to leave with the readers?
KB: If investors are looking for a company that’s early stage and prospective, they should look at Angkor Gold. If investors are looking for a country that is early stage and prospective, they should look at Cambodia. It is a mining-friendly jurisdiction. Investment is coming to the country and infrastructure is improving. As an investor or a company, the “first mover” gets the pick of the litter. And I think Angkor Gold has definitely done a good job on that. Investors should pay attention to both Cambodia and Angkor Gold.
TGR: Thanks for taking the time to talk to us.
Ken Booth has more than 30 years of experience in exploration, mining corporate finance and public company administration. In mining corporate finance, he has worked for two of Canada’s largest investment banks executing numerous equity financings for both junior and senior companies and was involved in a variety of significant mergers and acquisitions. While working for resource companies, Booth has held several positions including CEO and vice president of corporate development. He is currently providing financial advice to the junior mining sector and is a director of four exploration companies.
The market action of last week repeated a lesson that many a punter appeared to have forgotten. Never run a bearish book into a European summit and especially not one where expectations for a result are as lows as they were going into Friday’s meeting. Risk assets went up like a rocket with especially oil releasing heavily oversold momentum and you really could not do much wrong if you were running even moderately net long.
Above Expectations in Europe
Obviously, the market is buying the rumour and not the fact. In traditional summit fashion we got a lot of road maps and promises but very little concrete effort. Details were exceedingly sketchy and to talk about game changers is premature. We usually do not get game changers from the EU, but merely fudge cakes. Alpha.Sources would however like to remind investors that such fudge cakes may be enough to quell the market’s sugar addiction for several weeks.
Three points are worth making.
Firstly, the ESM appears to get the ability recapitalise banks directly and the door has also been opened up for the ESM/EFSF to buy peripheral debt without implied seniority. This is a big step in breaking the link between banks and the sovereign. Ireland and Spain in particular will be the beneficiaries of this. Alpha.Sources remain skeptical that the broadcasted notion of no conditionality will hold, but at least in principle there is a now a negotiated result which seems to allow countries to get help for their banks with little or no conditionality on the sovereign and no addition to sovereign debt to GDP. This is a significant step towards risk mutualisation through a banking union and ultimately a fiscal union. Alpha.Sources would note however that without applying haircuts to bondholders of both sovereign and private debt, One link is broken but another one is created between core Europe and the entire European banking system. While such a link may be stronger through the effective backing of the whole eurozone balance the key question is how far Germany and the EU will go. This question is particularly relevant (and binding) as it will inevitably become clear that whatever initial amount of euros ceded to the ESM/EFSF to sprinkle over Europe’s barren financial markets, it will almost surely be too low.
Secondly, the electorate and political establishment in Greece have every right to be perplexed. Greece has thus spent the past 3 months under an effective threat of being kicked out of the eurozone only to watch Spain and Italy get away with what is essentially preferential treatment. The fact that systemically important entities, sovereign as well as private, are given special treatment in this crisis is nothing new, but it remains a democratic problem in the EU. Like Portugal who remains the only country ever to get fined under the Stability and Growth Pact even as virtually every country violated the rules, Greece may rightfully feel a sense of injustice.
Alpha.Sources would then venture the claim that a Greek exit is now out of the question in the short run (i.e. in 2012). Even as Germany may still move to extract its pound of flesh from Italy and Spain, there is now little chance that Germany and the EU can play hard ball against Greece in the coming negotiations with the Troika. Greece could obviously still become the whipping boy, but the continuing argument that Greece is special is now so worn that even European politicians must be able to see that they can’t use it anymore. On this background, Alpha.Sources can’t see the ECB shutting off Greece from the ELA while the ESM/EFSF is loading up on Spanish bank equity as well as non-senior Italian and Spanish sovereign debt.
Thirdly, the modest but clear movement towards official creditors not being considered senior could potentially go a long way to break the doomsday loop by which once a country enters bailout proceedings it will never access the market again. Alpha.Sources emphasizes potentially here however and for now, Alpha.Sources will stick to the main rule that whatever we might constitute normal market access the eurozone periphery is far from it, but there is another silver lining to this. Consequently, in Greece it will alleviate the pressure on the ECB, EU and the IMF as it is clear that the country will need a second write down of its debt which will inevitably involve its official sector creditors.
As a general conclusion, the summit results implies a very large degree of risk mutualisation which it is unclear that Germany will ultimately go for, but multiple conclusions are not possible at the same time and so far the market and punditry seem to view this, rightly or wrongly, as victory for Hollande, Monti and Rajoy. This also means that the decoupling of Bunds from US treasuries and Gilts as well as the recent steady increase in German CDS is set to continue. This is also why Alpha.Sources believes that unlike the German national team who might have to wait two years and the World Cup to redeem itself, Merkel will get her shot much sooner.
One thing Germany will push for is the fiscal compact rules to be put in motion at a fast track pace and also, if the ESM is to take direct and equal ownership of European banks Alpha.Sources feels certain that this will come with extended EU supervision of the involved banks.
Unimpressed in Japan
Another seemingly important political result this week was the approval of the increase in Japan’s consumption tax, an increase which has been debated consistently for 5 years in Japan. If the final tax bill is passed, the tax rate will increase from the current 5% to 10% in two steps from to 8% in 2014 and 10% in 2015.
While the consumption tax has long been touted as the first step to put an end to the fiscal train wreck of Japan’s public finances Alpha.Sources believes that the measure will ultimately be counter productive. Japan’s fiscal problems consequently do not stem from a lack of revenue, but rather from too much spending. Trying to extract more revenues from a domestic economy where aggregate demand is already chronically weak due to an ageing population will only steal consumption from a future which is, in an almost literal sense, not there.
In this piece written on a similar VAT hike in Germany, yours truly presented a relatively simple economic framework for what it means to increase indirect taxes in the context of a rapidly ageing economy. In a nutshell, the argument is that while there will be a pure statistical effect on inflation readings as a result of the tax hike as well as positive effect on consumption as the purchase of durables is pushed forward, the end result is likely going to be deflationary.
The following quote, while requiring a little bit of basic microeconomic intuition, presents the argument,
(…) students of applied microeconomics learn to distinguish between the point of impact and point of incidence of a tax. The former constitues the party who actually levies the tax towards the government whereas the latter denotes the party who actually supports the tax. In the case of a value-added tax (an indirect tax) the point of impact would then be the consumer who (through an intermediary; e.g. a retailer) levies the tax towards the government. However, it is much more interesting in this case to discuss the point of incidence of the tax that is who actually supports the tax. In order for us to do so we need to introduce yet another economic concept, namely supply and demand elasticities of the tax hike. Consequently, the party with the highest relative elasticity (i.e. flexibility) towards the tax will also avoid supporting the lion’s share of the tax increase. What this means in the concrete case of the German tax is of course very difficult to asses. Yet, since for example consumers’ demand elasticity in this case can be operationalized as the relative fraction of disposable income which is consumed and saved (i.e. the MPC and MPS) we might actually be able to sketch a framework which suggests why the VAT hike in fact should not have been expected to rapidly push up inflation in the first place. The point would then be that the consumers’ demand elasticity towards consumption and thus flexibility towards avoiding the tax relative to businesses would be positively correlated with the marginal propensity to save.
In a rapidly ageing society, the attempt to extract tax revenue through consumption taxes fundamentally misunderstands the consumption and saving dynamics in the context of population ageing.
Still, we should expect higher consumption in Japan and also, ironically, that inflation may nudge its way up close to the 1% mark set as the target for the BOJ. It would be tragic if this prompted the central bank to lay down its guard because the end result would almost surely be more deflation and contraction.
With that dear reader it seems that just as Italy spearheaded by the enigma that is Balotelli managed to exceed expectations against Germany (only to come crashing down in the final!), so did we also get a number of political results which, at a first glance at least, were above expectations. In Europe, Alpha.Sources harbours a scant hope that the seeds layn may provide a little calm in the coming months however fleeting this might be while in Japan, the sentiment here at this blog is decidedly unimpressed.
The Monster Employment Index for June was released today, and the index moved up 6 points from last month to a value of 153, and is 5% higher than last June’s value.
At 8:30 AM EDT, the Employment Situation report for June will be announced, and the consensus for non-farm payrolls is an increase of 90,000 jobs compared to 69,000 in the previous month, the consensus for the unemployment rate is that it will remain at 8.2%, the consensus average hourly earnings rate is expected to increase 0.2%, and the consensus for the average workweek is 34.4 hours.
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