Economics Basics - Insights
Economics Basics - Insights
Economics Basics - Insights
Saumya
SourceInsightsBased on Economic Times-TopicGS 3 (Mains: UPSC)
1. What is Islamic finance?
Islamic finance refers to a financial system that is consistent with the principles of Sharia,
the sacred law of Islam. It is different from regular banking in that it prohibits earning of
interest (or Riba) through the business of lending. It also prohibits direct or indirect
association with businesses involving alcohol, pork products, firearms and tobacco. It also
does not allow speculation, betting and gambling.
How does it work?
Islamic finance takes the form of Islamic banking and Islamic insurance, also known as
Takaful.
Islamic banking is done in five ways:
1. Mudarabah, a profit-sharing agreement
2. Wadiah, a safe keeping arrangement
3. Musharakah, or a joint venture for a specific business
4. Murabahah, cost plus arrangement where goods are sold with a pre-determined margin
of profit
5. Ijirah, a leasing arrangement
Takaful is a form of mutual insurance based on partnership and collective sharing of risk by a
group of individuals.
How has Islamic banking progressed in recent years?
Islamic banking is most prevalent in Malaysia. It is spreading rapidly in West Asia, where the
population is predominantly Muslim. New global financial centres such as Singapore, Hong
Kong, Geneva, Zurich and London have made changes in regulations to accommodate the
Islamic finance industry, which is nearly a trillon dollar in size now.
Indian regulations do not allow Islamic banking but the government is considering allowing
it.
What restricts the growth of Islamic finance?
Most banks conducting Islamic operations have a panel of Muslim scholars called Sharia
committee or Sharia board, which determines whether a product or practice complies with
Islamic provisions. Also, the accounting is done differently for which there is an official
standard-setting body known as the accounting and auditing organization for Islamic
financial institutions. The strict code makes Islamic banking a very niche product.
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2. Infrastructure debt fund
What is the Infrastructure debt fund or IDF?
Infrastructure debt fund is a debt instrument being set up by the finance ministry in order to
channelise long-term funds into infrastructure projects which require long-term stable capital
investment. According to the structure laid out by the finance ministry, after consultations
with stakeholders, infrastructure NBFCs, market regulators and banks, an IDF could either be
set up as a trust or as a company.
What happens in either of the scenario?
If the IDF is set up as a trust, it would be a mutual fund, regulated by Sebi or the Securities
and Exchange Board of India. The mutual fund would issue rupee-denominated units of five
years maturity to raise funds for the PPP, or public private partnership projects . In case the
IDF is set up as funds, the credit risk would be borne by investors and not the IDF.
As a company, it could be set up by one or more sponsors, including NBFCs, IFCs or banks. It
would be allowed lower risk-weightage of 50%, net-owned funds (minimum tier-I equity of
150 crore). It would raise resources through issue of either rupee or dollar-denominated
bonds of minimum five-year maturity. It would invest in debt securities of only PPP projects,
which have a buy out guarantee and have completed at least one year of commercial
operation.
Refinance by IDF would be up to 85% of the total debt covered by the concession
agreement. Senior lenders would retain the remaining 15% for which they could charge a
premium from the infrastructure company. The credit risks associated with the underlying
projects will be borne by IDF. As an NBFC, the fund would be regulated by the Reserve Bank
of India.
Who would be the major investors?
Domestic and offshore investors, mainly pension funds and insurance companies, who have
long-term resources, would be allowed to invest in these funds, while banks and financial
institutions would act as sponsors.
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3. Marginal standing facility
What is the marginal standing facility?
The Reserve Bank of India in its monetary policy for 2011-12, introduced the marginal
standing facility (MSF), under which banks could borrow funds from RBI at 8.25%, which is
1% above the liquidity adjustment facility-repo rate against pledging government securities.
The MSF rate is pegged 100 basis points or a percentage point above the repo rate. Banks
can borrow funds through MSF when there is a considerable shortfall of liquidity. This
measure has been introduced by RBI to regulate short-term asset liability mismatches more
effectively.
In the annual policy statement, RBI says: The stance of monetary policy is, among other
things, to manage liquidity to ensure that it remains broadly in balance, with neither a large
surplus diluting monetary transmission nor a large deficit choking off fund flows.
What is the difference between liquidity adjustment facility-repo rate and
marginal standing facility rate?
Banks can borrow from the Reserve Bank of India under LAF-repo rate, which stands at
7.25%, by pledging government securities over and above the statutory liquidity
requirement of 24%. Though in case of borrowing from the marginal standing facility, banks
can borrow funds up to one percentage of their net demand and time liabilities, at 8.25%.
However, it can be within the statutory liquidity ratio of 24%.
4. Priority-sector lending
What is priority-sector lending?
Banks were assigned a special role in the economic development of the country, besides
ensuring the growth of the financial sector. The banking regulator, the Reserve Bank of India,
has hence prescribed that a portion of bank lending should be for developmental activities,
which it calls the priority sector.
Are there minimum limits?
The limits are prescribed according to the ownership pattern of banks. While for local banks,
both the public and private sectors have to lend 40 % of their net bank credit, or NBC, to the
priority sector as defined by RBI, foreign banks have to lend 32% of their NBC to the priority
sector.
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5. What the Greek crisis means to the world
Why Does the World Want to Save Greece?
No one can quantify the damage to the world if Greece is allowed to sink. But few are willing
to risk it either. Such a fear owes its origin to the 2008 crisis.
----Many economists, policymakers and some within central banks believe that the financial
meltdown of 2008 could have been ringfenced, or at least cushioned, if Lehman was bailed
out. But since Lehman was an investment bank, and not a commercial bank holding savings
of millions, Fed and the US government had thought that the collateral damage from its
bankruptcy would be contained within a few blocks of Wall Street, and no one really would
lose jobs and take pay cuts. Within months we all found out how wrong they were. Today, no
one wants to take a chance with Greece. Leaders across Europe fear that a Greece collapse
can start a fire that will engulf continents.
How does fear spread when markets are in such a state?
Banks impacted by a default may find themselves cut out from the dollar market the
engine of global liquidity. As a result, these banks will find it very difficult to roll over their
dollar assets as the other banks which are more solvent would be unwilling to lend them.
Thats when the world outside financial markets would feel the pinch. Suppose, a French
bank that had given a dollar line to the European subsidiary of an Asian company, or to bank
in Asia which, in turn, had extended a dollar credit to a local company, would not roll over
the credit line
Will a default cause a dollar scarcity?
Banks and companies are already holding on to the dollar. A default will only deepen it.
Consider the Asian company whose dollar line has been pulled bank. It will somehow try to
organise the money by paying a premium. Having sensed a dollar scarcity and fearing that
things may turn worse, it will raise more than it needs. When all companies start doing it,
there is artificial scarcity. Not just banks, corporates in Greece would also default
How will panic boil over to other Euro nations
Speculators will target Portugal, and then Italy. The logic is simple: if Germany & ECB do not
help Greece, they will also let Portugal and Italy sink. Soon these will be perceived as basket
cases and their bonds, stocks and currencies will face a brutal attack from short-sellers. That
would be a problem as Italys debt is more than the combined debt of Portugal, Spain and
Ireland
So, times running out for Greece?
Close to $8 billion worth Greek bonds will mature in December. It needs the money before
that, failing which a default is inevitable. IMF is willing to lend a little over $8 billion, but only
if Greece takes a string of austerity measures. IMF is not spelling out exactly when it will
sanction the loan. Some economists fear the IMF pressure can make things difficult for
Greece: how will lower consumption help a country which is already doldrums
Isnt Germany in a bit of a Catch-22 situation
It is. German politicians know that if there was no euro, its currency would have gained so
much that their exporters would have been wiped out. It needs the euro. But convincing
Germans isnt easy. They dont want to bail out all Europeans, particularly those who dont
work hard. Some think Greece should be exiled from EU for a few years to should put their
house in order
securities transaction tax (STT). The initial margins are also lower, which could attract
volumes for the product. Interest rate futures can be used by investors to take a directional
call on the interest rates or for hedging their existing position.
8. Self-help group
What is a self-help group (SHG)?
SHG primarily comprises members with homogenous social and economic backgrounds. It is
a voluntarily formed group consisting of women, rural labourers, small farmers and microenterprises . The concept is akin to the concept of democracy.
SHGs are formed by the members, for the members and of the members. The number of
members could be as less as five and could even go up to 20. They save and contribute to a
common fund which is used to lend to the members. Since they know each other, members
do not seek collateral from each other.
What are the goals of an SHG?
observations are implemented, it gets final approval & the document then becomes RHP
(Red Herring Prospectus).
How is DRHP useful to investors?
DRHP provides all the necessary information an investor ought to know about the company
in order to make an informed decision. It contains details about the company, its promoters,
the project, financial details, objects of raising the money, terms of the issue, risks involved
with investing, use of proceeds from the offering, among others. However, the document
does not provide information about the price or size of the offering.
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10. Reserve Bank oversight functioning
What is the oversight function of RBI?
The Bank for International Settlements defines oversight as central bank function ,
whereby the objectives of safety and efficiency are promoted by monitoring existing and
planned systems, assessing them against these objectives and, where necessary, inducing
change .
The three key ways in which oversight activity is carried out are through (i) monitoring
existing and planned systems; (ii) assessment and (iii) inducing change. In India, the
Payment and Settlement Systems Act, 2007, and the Payment and Settlement Systems
Regulations, 2008, provide the necessary statutory backing to the Reserve Bank of India for
undertaking the oversight function. The central bank manages the various settlements
system, including cash, through currency chest and clears cheques, besides various
electronic clearing services.
What is Electronic Clearing Service?
It was among the early steps initiated towards moving to a paperless settlement system by
the Reserve Bank of India. The Bank introduced the ECS (Credit) scheme during the 1990s to
handle payment requirements like salary, interest, dividend payments of corporates and
other institutions .
The ECS (Debit) Scheme was introduced by RBI to provide a faster method of effecting
periodic and repetitive collections of utility companies. ECS (Debit) facilitates
consumers/subscribers of utility companies to make routine and repetitive payments by
mandating bank branches to debit their accounts and pass on the money to the
companies.
What are the various settlement systems & agencies?
National Electronic Funds Transfer (NEFT) System: In November 2005, a more secure system
was introduced for facilitating one-to-one funds transfer requirements of
individuals/corporates . Available across a longer time window, the NEFT system provides for
batch settlements at hourly intervals, thus enabling a near real-time transfer of funds.
Real-Time Gross Settlement (RTGS): It is a funds transfer system where transfer of money
takes place from one bank to another on a real time and on a gross basis . Settlement in
real time means payment transaction is not subjected to any waiting period.
Gross settlement means the transaction is settled on one-to-one basis without bunching or
netting with any other transaction. Once processed, payments are final and irrevocable. This
was introduced in 2004 and settles all inter-bank payments and customer transactions
above Rs 2 lakh.
Clearing Corporation of India (CCIL): The Corporation, set up in April 2001, plays the Central
Counter Party (CCP) in government securities, the US dollar and the rupee forex exchange
(both spot and forward segments) and Collaterised Borrowing and Lending Obligation (CBLO)
markets.
CCIL plays the role of a central counterparty whereby, the contract between a buyer and a
seller gets replaced by two new contracts between CCIL and each of the two parties. This
process is known as Novation . ----- -----Through novation, the counterparty credit risk
between the buyer and seller is eliminated with CCIL subsuming all counterparty and credit
risks.
What does the National Payments Corporation of India do?
The Reserve Bank set up the National Payments Corporation of India (NPCI), which became
functional in 2009, to act as an umbrella organisation for operating various Retail Payment
Systems (RPS) in India. NPCI has taken over National Financial Switch (NFS) from the
Institute for Development and Research in Banking Technology (IDRBT). The National
Financial Switch (NFS) is an inter-bank network managed by Euronet India.
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11. What is an EEFC Account?
Exchange Earners Foreign Currency (EEFC) account is foreign currency-denominated
account maintained with banks dealing with foreign exchanges. The Reserve Bank of India
introduced this scheme in 1992 to enable exporters and professionals to retain their foreign
exchange receipts in banks without converting it into the local currency. Any person residing
in India who receives inward remittances in foreign currency or a company with foreign
currency earnings can open EEFC account but they dont earn any interest from the deposits
and it is a non-interest bearing scheme.
What is the minimum balance for EEFC?
This is typically a zero-balance account like normal current accounts. In other words, this
means no account holder needs to maintain an average or minimum balance in the EEFC
account.
How does EEFC help exporters or individuals earn foreign currency
receipts?
As the account is maintained in foreign currency, no depositors are protected from exchange
rate fluctuations.
Is there any prescribed limit of deposits in EEFC?
There is no such limit. One can credit his or her entire foreign exchange earnings into this
account, subject to some permissible credits.
Can one take a foreign currency loan and put it in EEFC?
Remittances received on account of foreign currency loan or investment received from
abroad cant be deposited in EEFC.
What are the permissible credits in this account?
a) Inward remittances received by an individual
b) payments received by a 100% export-oriented unit, export processing zone, software
technology park and electronic hardware technology park
c) Payments received in foreign exchange by a unit in domestic tariff area for supply of
goods to a unit in SEZ
d) Payment received by an exporter for an account maintained with an authorised dealer for
the purpose of counter trade, which is an adjustment of value of goods imported against
value of goods exported
e) Advance remittance received by an exporter towards export of goods or services
Can one withdraw in rupees from EEFC account?
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13. Take-out financing
What is take-out financing?
Take-out financing is a method of providing finance for longer duration projects of about 15
years by banks sanctioning medium-term loans for 5-7 years. It is given that the loan will be
taken out of books of the financing bank within pre-fixed period by another institution, thus
preventing any possible asset-liability mismatch. After taking out the loan from banks, the
institution could offload them to another bank or keep it.
Though internationally this kind of lending has been in existence for many years, it came to
India only in the late 90s. These long-tenure loans were primarily introduced to incentivise
banks to lend to the infrastructure sector as banks back then had very little exposure to
long-term loans, and also because they did not have adequate resources of similar tenure to
create such long-term assets.
What does the Reserve Bank rule say?
Banks/FIs are free to finance technically feasible, financially-viable and bankable projects
undertaken by both public sector and private sector undertakings, provided the amount
sanctioned is within the overall ceiling of the prudential exposure norms prescribed by RBI
for infrastructure financing. They should also have the requisite expertise for appraising
technical feasibility, financial viability and bankability of projects.
Which institutions, besides banks, are engaged in this practice?
The government promoted Infrastructure Development Finance Corporation, by setting aside
a corpus from the union budget, with a primary mandate to promote infrastructure funding.
Later, India Infrastructure Finance Company also came up essentially to refinance
infrastructure loans of commercial banks.
What are the problems with take-out financing?
Though take-out financing is a permissible practice in India, the concept has not taken off in
a big way. Though the concept in a way addresses the asset-liability issue, regulators still
want banks to set aside higher capital for their exposure. Besides, banks are also wary of
taking risks such as construction risks, which may delay the project as well as increase its
cost.
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14. LIQUID COAL
Did you know coal can be liquid fuel too?
Coal liquification is seen one of the options to cope up with high crude oil prices. While
availability of coal in plenty goes in favour of this process in the energy-scarce scenario,
environmental concerns and high cost has so far limited the use of coal-to-liquid (CTL) fuel
to an insignificant position except in the case of South Africa.
Use of coal for power generation is considered a better option in India as there is no
consensus among policy-makers. Lets look at the basic issues related to conversion of coal
into liquid fuel.
Can coal be converted into liquid fuel?
Yes. Coal can be converted into a synthetic liquid fuel and the process is known as coal-toliquid (CTL) worldwide. Broadly, there are two different methods to convert coal into liquid
fuelsdirect and indirect liquefaction. Under the direct method, hydrogen is added to
crushed coal and liquid is created with the presence of catalysts.
However, further refining of this liquid is needed to achieve liquid fuel with high-grade fuel
characteristics. The indirect liquefaction process first gasifies coal using oxygen, steam
heating them to very high temperatures. The resultant gas is purified and mixed with water.
The liquid fuel that is created can be refined to produce diesel, naphtha, jet fuel, cooking gas
and lubricants. Creating this fuel is a very intensive process that requires large amounts of
coal, water and energy.
Is CTL commercially viable?
Skyrocketing price of oil and concern over depleting crude reserves are triggers generating
interest in CTL. Ambitious CTL projects are in operation in South Africarun by Sasol, the
company that pioneered CTL.
Liquid fuel generated from coal caters to 30% of the needs of South Africa. Sasol has
patented Fischer Tropsch technology of indirect liquefaction, which converts synthetic gas,
extracted from coal, into oil.
More than 30 CTL projects across the world are being studied for feasibility, depending on
the quality of coal, availability of water and other local conditions. The initial investment in
CTL projects is quite high.
Is India game for CTL?
The government has studied CTL. The Tata Group, in collaboration with Sasol, made a
presentation on a $8-billion indirect liquefaction project using Sasols technology to convert
high-ash Indian coal into liquid fuel with a capacity of 80,000 barrels per day of liquid fuel.
An inter-ministerial group (IMG) examined the proposal. The Planning Commission rejected
the idea, saying that coal be better used for electricity generation rather than making liquid
fuels. The IMD discussion also led to a view that those wishing to set up CTL projects should
bid for coal blocks, competing with other users.
Finally, the government offered three blocks of coal in Orissa with cumulative reserves of
about six billion tonnes for the project to private players. There were 22 applicants including
Reliance Group and the Tatas. The eligibility criteria says the applicant company should have
a minimum net worth of $1 billion, besides having a tie-up with the proven technology
providers.
The IMG has to decide which companies would be allowed to implement CTL projects. What
is CTLs impact on the environment?
Green lobbies are fighting against CTL tooth and nail, alleging that Sasol has a questionable
environmental and social record in South Africa. They advocate higher investment in
renewable resources like wind energy and solar energy, rather than opting for CTL.
Liquefying large coal reserves will release huge amounts of carbon dioxide, a greenhouse
gas. Proponents of this technology say the gas can be captured and stored underground.
The cost of carbon capture and storage will impact the economics of CTL. Coal liquification
requires vast amounts of water too and this has led to concerns in water-deficient areas.
Federal Reserve chairman Ben Bernanke will push for a fresh infusion of about a trillion
dollars into the markets this week, by way of buying bonds, which will push up bond prices
and bring down the yields, and the bond markets in India would react accordingly.
Since economies like China and Singapore have closed doors, or are at best cautious in their
regulation of capital flows, India is likely to see a gush of capital flows, which is likely to push
up the stock prices, and might eventually call for capital control from regulatory authorities.
What are economists saying?
The expert opinion is mixed on this. Nobel Laureate Paul Krugman, who has been a
vehement critic of US policies, seems to be favouring QE II. Higher commodity prices will
hurt the recovery only if they rise in real terms, he said. And theyll only rise in nominal
terms if QE succeeds in raising real demand. And this will happen only if QE II is successful in
helping economic recovery, he said in a recent media interview.
Another Nobel prize winner, Joseph Stiglitz, who was formerly the chief economist with World
Bank, feels that the Fed and its advocates are falling into the same trap that led us into the
crisis in the first place. Their view is that the major lever for the economic policy is the
interest rate, and if one just gets it right, one can steer this. That didnt work.
It forgot about the financial fragility and how the banking system operates. Theyre thinking
the interest rate is a dial you can set, and by setting that dial, you can regulate the
economy. In fact, it operates primarily through the banking system, and the banking system
is not functioning well. All the literature about how the monetary policy operates in normal
times is pretty irrelevant to this situation.
Nouriel Roubini, who gained fame after his prediction of the global economic crisis of 2008,
thinks further quantitative easing will have little effect on the US growth in 2011. He regards
QE II as the wrong way to go. An excessive, permanent increase in money, in his view, is an
indirect manipulation of the exchange rate.
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17. Systematic Transfer Plan
What is STP?
Mutual funds not only manage our money but also offer us various easy to use tools that are
aimed at improving our investment experience.
Most of us know systematic investment plan, where we invest at regular intervals. But few
are aware of systematic transfer plan (STP).
Under STP, at regular intervals, an amount you opt for is transferred from one mutual fund
scheme to another of your choice. Typically, a minimum of six such transfers are to be
agreed on by investors.
You can get into a weekly, monthly or a quarterly transfer plan, as per your needs.
You may choose to transfer a fixed sum from one scheme to another. The mutual fund will
reduce the number of units equal to the amount you have specified from the scheme you
intend to transfer money. At the same time, the amount such transferred will be utilised to
buy the units of the scheme you intend to transfer money into, at the applicable NAV. Some
fund houses allow you to transfer only the capital appreciation to be transferred at regular
intervals.
How is it useful?
STP is a useful tool to take a step by step exposure into equities or to reduce exposure over
a period of time. Say you have Rs 10 lakh to invest in equity over a period of time. You could
put this amount in the liquid fund of a mutual fund or a short-term bond fund. This gives an
opportunity to earn a better than saving bank account rate of return. You than start an STP
where every month a pre-determined amount will be invested into an equity fund. This helps
in deploying funds at regular intervals in equities with minimum timing risk.
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ET guides you through the key policy rates of the Reserve Bank of India
What are the key policy rates used by RBI to influence interest rates?
The key policy or signalling rates include the bank rate, the repo rate, the reverse repo
rate, the cash reserve ratio (CRR) and the statutory liquidity ratio (SLR). RBI increases its key
policy rates when there is greater volume of money in the economy. In other words, when
too much money is chasing the same or lesser quantity of goods and services. Conversely,
when there is a liquidity crunch or recession, RBI would lower its key policy rates to inject
more money into the economic system.
What is repo rate?
Repo rate, or repurchase rate, is the rate at which RBI lends to banks for short periods. This
is done by RBI buying government bonds from banks with an agreement to sell them back at
a fixed rate. If the RBI wants to make it more expensive for banks to borrow money, it
increases the repo rate. Similarly, if it wants to make it cheaper for banks to borrow money,
it reduces the repo rate. The current repo rate is 5.50%.
What is reverse repo rate?
Reverse repo rate is the rate of interest at which the RBI borrows funds from other banks in
the short term. Like the repo, this is done by RBI selling government bonds to banks with the
commitment to buy them back at a future date. The banks use the reverse repo facility to
deposit their short-term excess funds with the RBI and earn interest on it. RBI can reduce
liquidity in the banking system by increasing the rate at which it borrows from banks. Hiking
the repo and reverse repo rate ends up reducing the liquidity and pushes up interest rates.
What is Cash Reserve ratio?
Cash reserve Ratio (CRR) is the amount of funds that banks have to park with RBI. If RBI
decides to increase the cash reserve ratio, the available amount with banks would reduce.
The bank increases CRR to impound surplus liquidity. CRR serves two purposes: One, it
ensures that a portion of bank deposits are always available to meet withdrawal demand,
and secondly, it enables that RBI control liquidity in the system, and thereby, inflation by
tying their hands in lending money. The current CRR is 6%.
What is SLR? (Statutory Liquidity Ratio)
Apart from keeping a portion of deposits with RBI as cash, banks are also required to
maintain a minimum percentage of deposits with them at the end of every business day, in
the form of gold, cash, government bonds or other approved securities. This minimum
percentage is called Statutory Liquidity Ratio. The current SLR is 25%. In times of high
growth, an increase in SLR requirement reduces lendable resources of banks and pushes up
interest rates.
What is the bank rate?
Unlike other policy rates, the bank rate is purely a signalling rate and most interest rates are
delinked from the bank rate. Also, the bank rate is the indicative rate at which RBI lends
money to other banks (or financial institutions) The bank rate signals the central banks
long-term outlook on interest rates. If the bank rate moves up, long-term interest rates also
tend to move up, and vice-versa.
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As China and the US tussle over the value of the Yuan, ET helps you deconstruct
the issue.
What is a currency peg?
There are various ways in which the price of one currency against another is arrived at. In a
pegged exchange rate, the value of the currency is fixed with respect to another currency,
usually the US dollar. In other words, it is the rate the country or the central bank of the
country maintains as the official exchange rate. Chinese currency, for example, is pegged at
6.83 yuan to the dollar.
How is the currency peg maintained?
Currency pegs work only when the central bank has the muscle to intervene in the market to
check the currency from going beyond a permissible band. It should be able to supply the
market with enough dollars in the event of a huge demand at the pegged rate and in the
event of too much supply be ready to buy dollars from the market. It implies that the central
bank must have large foreign exchange reserves. China has foreign currency reserves of
nearly $2.5 trillion.
How does a currency peg help ?
Countries go for a pegged exchange rate to have stability in the foreign exchange market.
China had also effectively gone to a dollar peg in July 2008 keeping its currency steady at
6.83 yuan to a dollar as it fought the global economic crisis.
The stable currency creates a conducive environment for investments as investors do not
fear losses on account of currency fluctuations. Exports benefit as appreciation is kept in
check. However, there are numerous instances of currency pegs causing financial crises.
Pegged values are difficult to maintain if the central bank is not in position to intervene and
defend the peg.
Why is the US so bothered about the currency peg?
The US believes that China accumulates its huge current account surplus (to the tune of 8%
of GDP) and the US, its current account deficit (to the tune of 2.9% of GDP) because its
currency is undervalued, making its exports to the US cheap and its imports from the US
expensive. The US blames the pegged yuan for the resultant global imbalance, and want the
yuan to appreciate.
A bit of history
From 1997 to mid-July 2005, Chinese currency was pegged to the US dollar. On 21 July 2005,
China ended the peg to the US dollar and switched to a crawling peg linked to a basket of
currencies. The renminbi gradually appreciated over 20% over the next three years. In July
2008, China went back to the dollar peg, bringing the Yuan appreciation to an end. Yuan is
now valued a 6.83 to a dollar with a plus/minus 0.5% fluctuation.
The US seems ready for another round of quantitative easing to boost growth, employment
generation and consumer spending. There is consensus among economists and
policymakers in the worlds largest economy that the Federal Reserve should target a higher
level of inflation to spur growth. ET takes a look at the concept of quantitative easing.
What is quantitative easing?
Central banks usually stimulate a slowing economy by cutting interest rates, which
encourage people to spend by borrowing more or discouraging them to save. But with
interest rates in the developed world already close to zero, that option is no longer available.
In such situations , the central banks resort to pumping money directly into the economy, a
process known as quantitative easing. It is done by buying bonds usually government
paper but can also be private bonds from banks and financial institutions. The developed
countries used quantitative easing to spur growth in the aftermath of the financial meltdown
of 2008.
What is the idea behind quantitative easing?
At any given point of time there is a fixed amount currency /money chasing products and
services available in the economy. The idea essentially is to get more money into the system
chasing the same amount of produce to drive up their prices. In the case of quantitative
easing, the bondsellers will receive money that has not been in circulation, which will
increase the money supply in the system. As the money in the economy increases the
demand for different products rises.
How does it help?
The flood of cheap money causes asset prices to rise i.e. the price of shares, real estate etc.
The notional high wealth, together with cheap and easy credit, encourages people to spend.
Quantitative easing also helps devalue the currency, thereby encouraging exports further
and increasing the level of activity in the economy. The final consequence is increased
demand resulting in ramping up of production, which, in turn, creates more jobs in the
economy.
Why is it important in the current scenario?
Quantitative easing could potentially ward off deflationary expectations and kickstart an
uncertain economy. But in todays globalised world, cheap money from developed
economies may flow into emerging economies and fuel asset bubbles and inflation there.
Brazil has been struggling to deal with the rising tide of inflows . India, too, is keeping an eye
on increasing forex inflows.
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Chinas growing affluence and influence over the world economy has created huge demand
for assets denominated in yuan, the basic unit of the renminbi. China is also keen to
globalise its currency to offset any losses to its record foreign exchange reserves due to
weakness of the dollar. This has led to the creation of the Dim Sum bond market in Hong
Kong. ET explains the concept.
What Is A Dim Sum Bond?
A bond denominated in yuan and issued in Hong Kong. Derived from a traditional Chinese
cuisine that offers a variety of small eats, Dim Sum bonds are issued by Chinese government
and companies as well as foreign entities.
What Makes Dim Sum Bonds Attractive For Investors?
Investors across the world are looking for opportunities to make money out of Chinas
phenomenal growth, but the countrys stiff capital controls prohibit them from investing in
Chinese debt. Dim Sum bonds offer an avenue to such investors. Investors are rushing to the
Dim Sum market on expectations that Beijing will continue to let the yuan appreciate.
Exposure to yuan-denominated assets also provides an alternative to bonds issued by
western governments and companies and fits well with the Principle of Diversification, that a
portfolio containing different assets and kinds of assets carries lower risk.
Lower interest cost is also encouraging companies to raise money through the Dim Sum
market. Last month, IDBI Bank became the first issuer of Dim Sum bonds from India. It sold
650 million yuan ($102 million) of three-year bonds priced at a fixed coupon of 4.5% per
annum. The bank said it cut a percentage point off its dollar funding costs by going to the
Dim Sum market. Reports say infrastructure lender IL&FS is also planning to raise $100
million through Yuan-denominated bonds.
Is There A Limit On Such Issuances By Indian Entities?
Recently, the yuan was added to the list of currencies in which Indian companies can raise
funds overseas, in addition to dollar, euro, pound and yen. Indian firms can raise an
equivalent of $1 billion in yuan.
How Big Is the Dim Sum Bond Market?
The Dim Sum market has risen from 10 billion yuan in 2007 to more than 100 billion yuan.
Analysts forecast the market to grow beyond 300 billion yuan in 2012.
Where can Indian Issuers deploy The Proceeds?
Indian issuers can deploy the money for capital expenditure within China and use the
proceeds for settling trade accounts. They can also enter into swap contracts to get other
currencies. However, if the money is to be brought back to India, companies will have to
comply with the External Commercial Borrowing guidelines set by the Reserve Bank of India.
What is LTE?
LTE, or Long Term Evolution , is the latest wireless mobile broadband technology that will
power future 4G, or fourth generation, networks designed primarily for data transmission at
unprecedented speeds. It uses spectrum to carry data traffic, just as we need roads to carry
vehicular traffic. Spectrum may be likened to a highway of airwaves on which mobile signals
travel.
Since LTE uses wider chunks of spectrum, data speeds on LTEbased 4G networks are nearly
four times faster than on 3G. An iPad user, for instance, will be able to watch videos at LTE
speeds of 300 Mbps while a laptop user will be able to download a chunky 25MB file in
seconds if adequate spectrum is available. LTE is also a scalable bandwidth technology that
works alongside 2G and 3G. So a 3G operator can easily upgrade his network to LTE.
WHEN WAS IT DEVELOPED?
LTEs genesis goes back to November 2004, when a workshop was held by the 3GPP (3rd
Generation Partnership Project) in Toronto to define Long Term Evolution . The 3GPP was a
global alliance of top telecom associations who tried to identify the next wave of mobile tech
after UMTS, the 3G technology based on GSM.
IS LTE BETTER THAN WiMAX?
Wireless communication happens over paired or unpaired spectrum. Paired spectrum is two
equal chunks of airwaves for sending and receiving information while unpaired spectrum is a
single strip of airwaves meant to either receive or send information.
Voice signals travel over paired spectrum while data communications works better on
unpaired spectrum as people download more than upload. WiMAX had an edge as long as it
was the sole wireless technology working commercially over unpaired spectrum. But the
WiMAXparty crashed when an LTE variant, TDD-LTE which also worked over unpaired
spectrum arrived.
Whats more, leading vendors unveiled compatible gear commercially in 2010. This LTE
variant was heralded by the worlds top telcos as the coolest technology for high-speed data
communications on the go. WiMAX suffered a body blow when big telcos across China, India
and the US also embraced TDD-LTE
. Commercialization of TDD-LTE devices hit fast-track after Qualcomm pitched for wireless
broadband spectrum in the 2010 auction and won 20MHz of BWA airwaves in four circles.
Even WiMAX backers like Clearwire in the US and Yota in Russia warmed up to LTE. Ditto with
WiMAXgear vendors like Nokia and Cisco.
IS TDD-LTE CATCHING ON IN INDIA?
Not as yet. But that said, the first seeds of an LTE ecosystem were sown when Bharti Airtel
joined some of the worlds top LTE backers at Mobile World Congress 2011 in Barcelona to
launch the Global TD-LTE Initiative (GTI). Global deployment of this technology was in fact at
the heart of last years auction of BWA airwaves in India.
But the big challenge to fast-track deployment of TD-LTE in India is the paucity of compatible
devices andsmartphones. Only Qualcomm has launched TDD-LTE multi-mode devices. NSN is
slated to unveil 4G devices by the time LTE network rollouts start happening in India by
December 11 to early-2012.
Offshore banking unit (OBU) is the branch of an Indian bank located in a special economic
zone (SEZ), with a special set of rules aimed at facilitating exports from the region. As laws
define it, its a deemed foreign branch of the parent bank situated within India, and it
undertakes international banking business involving foreign currency denominated assets
and liabilities.
The concept comes from the practice prevalent in several global financial centres. Here an
OBU can accept foreign currency for business but not domestic deposits from local residents.
This was conceived to prevent competition between local and offshore banking sectors.
What was the need for OBUs?
In addition to providing power, tax and other incentives to SEZs, policymakers felt a need to
provide SEZ developers access to global money markets at international rates. So in 2002,
RBI instituted OBUs, which would be virtually foreign branches of Indian banks. These would
be exempt from CRR, SLR and few other regulatory requirements.
RBI regulations make it mandatory for OBUs to deal in foreign exchange, source their foreign
currency funds externally, follow all prudential norms applicable to overseas branches and
are entitled for IT exemptions. Thus in many respects, they are free from the monetary
controls of the country.
What price, freedom from regulations?
In the eight years that they have been operational, concerns have been raised that, funding
by OBUs to SEZs would lead to increase in external debt of India. Also, some have suggested
that OBUs as vehicles for extending dollar loans have no use as long as they are restricted to
doing business only in the zones in which are they located.
This would create an unnecessary regulatory arbitrage like booking business because there
is some arbitrage advantage on offer. Anyways, ground realities could not be more different.
Hardly a handful of banks have set up their OBUs, so the argument looks very far fetched.
SEZ, itself as a concept has been struggling, given the issues that SEZ developers have
faced over acquiring land from farmers.
What is the future of OBUs?
Most international financial centres still house OBUs, so saying they are not required may be
incorrect. However, some analysts have said OBUs are losing relevance at a time of
increasing globalisation.
They say OBUs will be of no use after the economy opens up fully and the rupee is fully
convertible. These experts argue for one or two OBUs, instead of having several of them
spread across the country.
separately from the central bank and has nothing to do with the formulation of the monetary
policy or setting interest rates.
What are the conflicts of interests if the body that formulates the monetary policy
also acts as the Centres investment banker?
There are certain inherent conflicts of interest when the agency, which raises funds for the
government, also manages its monetary policy and regulates interest rates. The basic
conflict of interest is between setting the short-term interest rates and selling government
securities.
The Reserve Bank of India, like a good merchant banker to the government, sells bonds at
high prices. At lower interest rates or yields, it runs the risk of adding to inflationary
concerns.
Another area of concern is that RBI is also the regulator of all banks, which means the
central bank could arm-twist the banks to buy bonds at higher prices or for longer tenors.
For a very long time now, economists have been arguing in favour of an independent debt
management office, which in the Indian discourse is called National treasury management
agency or debt management agency, so that RBI can be relieved of the burden of being the
Centres investment banker.
What is the practice in advanced economies?
Developed economies such as the UK, the US and New Zealand, already have independent
public debt offices in place. Former RBI governors have time and again complained about
the difficulties in managing government debt while trying to keep interest rates high to rein
in inflation.
Does India have a debt management office?
The finance ministry had proposed setting up of the debt management agency in its 200708 Budget. A series of expert committees have recommended the establishment of the debt
management agency. These include groups headed by the former finance secretary Vijay
Kelkar, former World Banker Percy Mistry and ex-IMF chief economist Raghuram Rajan.
A draft legislation had also been created by the Jahangir Aziz Working Group. While
presenting the Budget for 2011-12, finance minister Pranab Mukherjee had announced the
governments intention to introduce the bill for an autonomous debt management office in
the next financial year.
How is it expected to be structured?
The agency is likely to be an autonomous body under the administrative control of the
finance ministry. The central bank will be on the management committee of the agency. A
middle office or MoF is already working in the finance ministry that prepares the borrowing
calendar of the Centre.
A mid-office would constitute a single comprehensive database about all liabilities and
guarantees of the government of India. For now, the 21 public debt offices of RBI continue to
function. The structure and functions of the debt management office have been discussed
and reworked on for three years now but little sense of urgency has been seen.
.
The Government of India conducts periodic auctions of government securities and of the
total amount notified for auctions, a certain portion is kept aside for the non-competitive
bidder, or the small and medium investors.
Non-competitive bidding means a person would be able to participate in the auctions of
dated government securities without having to quote the yield or price in the bid. That saves
him the worry, about whether the bid will be on or off-the-mark.
How is the process useful?
It helps deepen the government bonds market by encouraging wider participation and retail
holding of government securities. It enables the participation of individuals, firms and other
mid-segment investors who neither have the expertise nor the financials to participate in
auctions. RBI gives such investors a fair chance of assured allotments of government
securities.
Who can be referred to as the non-competitive bidder?
RBI allows individuals or firms, provident funds, corporate bodies or trusts who do not have
current account (CA) or subsidiary general ledger (SGL) account with the Reserve Bank of
India. Regional Rural Banks (RRBs) and Urban Co-operative Banks (UCBs) can also apply
under the non-competitive bidding scheme.
Eligible investors have to place their bid through a bank or Primary Dealer (PD) for auction.
Each bank or PD, on the basis of firm orders, submits a single bid for the total sum of noncompetitive bids on the day of the auction.
The bank or PD will furnish details of individual customers, viz., name, amount, etc., along
with the application. The non-competitive bidding facility is available only in dated central
government securities and not in treasury bills.
What happens if the total amount offered for bidding via non-competitive
bidding basis exceeds the amount allotted?
In case the amount bid by PDs on behalf of the investors is more than the reserved amount
through non-competitive bidding, allotment would be made on a pro-rata basis. For example,
the amount reserved for allotment in an auction in noncompetitive basis is Rs 15 crore.
The total amount of bids for noncompetitive segment is Rs 20 crore. The partial allotment
percentage is =15/20=75%. That is, each bank or PD, who has submitted non-competitive
bids received from eligible investors will get 75% of the total amount submitted.
The countrys policymakers seem to be fighting a losing battle with Inflation. Some
economists link the persistently high prices to the pace of economic growth. They say Indian
economy is expanding at a rate beyond its potential growth rate. ET examines the concept
and its relationship with prices:
What is the potential rate of growth of an economy?
Potential output is broadly the maximum output growth that an economy can sustain over
the medium to long term without stoking inflation. In a recent report on India, the
International Monetary Fund (IMF) estimates Indias potential growth rate at 7-8%.
Widespread poverty is the biggest challenge for Indias policymakers. The government has
drawn criticism for its inability to tackle the menace despite high economic growth. Some
estimates place the number of poor at 40% of the population. ET looks at how poverty
numbers are generated:
How is the poverty line defined?
The concept of poverty is associated with socially perceived deprivation with respect to
basic human needs. Historically, India has followed a poverty line, which is based on a
minimum number of calories that an individual should consume and a rupee amount was
calculated on this basis. The existing rural and urban official poverty lines were originally
defined in terms of per capita total consumer expenditure (PCTE) at 1973-74 market prices
and are adjusted over time and across states for changes in prices.
The method still retains the original 1973-74 all-India reference poverty line baskets (PLB) of
goods and services. These PLBs were derived separately for rural and urban areas, anchored
in per capita calorie norms of 2400 (rural) and 2100 (urban) per day. People whose PCTE is
below the required minimum are considered to be below the poverty line.
What is the international poverty line?
The common international poverty line is based on an income of around $1 a day. In 2008,
the World Bank revised the figure to $1.25 at the 2005 purchasing power parity.
800 band is moderately concentrated. A measure of 1,800 and more indicates a highly
concentrated market. As a general rule, mergers that increase HHI by more than 100 points
in concentrated markets raise antitrust concerns and invite further scrutiny by authorities.
Interest income above 10,000 a year attracts TDS of 10% in case of term deposits. However,
there is no major benefit for current account deposits, which is mainly maintained by
corporates and traders.
What are the disadvantages of high Casa?
These deposits can move out of banks books anytime, leading to asset-liability mismatches.
While in case of term deposits, banks are almost certain that the depositor may not
withdraw money before the maturity of the deposit and may also renew the deposit on
maturity. Further, to finance long-term projects, banks need to have long-term liabilities on
their books to avoid mismatches. Banks cannot rely on Casa deposits to fund long-term
loans.
The Prime Minister will soon hold a meeting of chief ministers to discuss the alarming food
price situation and review the implementation of Essential Commodities Act (ECA). ET looks
at the ECA and how it can help combat the rising prices of food articles.
What are essential commodities?
The government has powers under the Essential Commodities Act, 1955 (EC Act) to declare
a commodity as an essential commodity to ensure its availability to people at fair price. The
EC Act, 1955 allows the government to control the production, supply, and distribution of
these commodities for maintaining or increasing supplies and securing their equitable
distribution. Essentially, the act aims to ensure easy availability of important commodities to
consumers and check exploitation by traders.
How many commodities are covered by the Essential Commodities Act?
There are seven broad categories of essential commodities covered by the Act. These are (1)
Drugs; (2) Fertilizer, inorganic, organic or mixed; (3) Foodstuffs, including edible oilseeds and
oils; (4) Hank yarn made wholly from cotton; (5) Petroleum and petroleum products; (6) Raw
jute and jute textile; (7) (i) seeds of food-crops and seeds of fruits and vegetables; (ii) seeds
of cattle fodder; and (iii) jute seeds. Recently cotton seed was also included in the list.
How does the Act help check price rise?
The Act is implemented by the state governments and union territories, leaving the central
government to merely monitor the action taken by states in implementing the provisions of
the Act. State and UT administrations use the powers of the Act to impose stock or turnover
limits for various commodities and penalise those who hold them in excess of the limit.
Stock limits have been imposed in several states for pulses, edible oil, edible oilseeds, rice,
paddy and sugar.
How effective is the Act?
Over the three years 2006-2008 , state and union territory governments prosecuted 14,541
persons under the provisions of EC Act, 1955 and secured conviction in 2,310 cases. In 2009
as on 31 August 2533 persons had been prosecuted and 37 convicted. But, doubts have
been raised about effectiveness of the Act time and again. Recently, Parliaments estimates
committee asked the government to come out expeditiously with a new legislation for
controlling the retail prices of essential commodities such as rice, wheat, pulses, edible oils,
sugar, milk and vegetables.
It is the gap between the local price of fuel and what would have been the price if the fuel
were imported.
Is under-recovery the same as loss?
It is a notional loss in revenue to the extent the international price of the fuel is higher. It
may or may not be a loss-making proposition to produce the fuel when there is an underrecovery.
In case of kerosene, oil companies suffer an under-recovery as well as a loss because the
local retail price is much lower than the cost of crude oil. But sale of a product like petrol can
still be very profitable at times, even if oil companies are reporting under-recovery of a few
rupees a litre.
Does a rise in under recovery make an oil cos operation less profitable?
It may not. At times, international crude oil prices remain flat but petrol and diesel prices
rise. In such a situation, an Indian refinerys profitability will not change because crude oil
costs have not gone up. But under-recovery would have risen because the cost of importing
the fuel would have risen.
Has the concept of underrecovery exaggerated the problems of oil firms?
This year it did. Prices of oil products in Asia rose earlier this year, when a fire shut down a
large refinery in Taiwan. This reduced the supply of refined oil products and the change in
the demandsupply situation made petrol and diesel more costly.
The Tsunami in Japan and a recent fire at a refinery in Singapore had the same impact. The
refining margin for diesel, called crack spread has been $20 a barrel most of this year. In
April, diesel margins jumped to a three-year high of $24 per barrel. Last year, it was $10-15.
So, under-recovery on diesel looks higher this year. In other words, oil companies want a
higher price for diesel partly because some refineries in other countries were shut down.
Apart from this, oil companies also charge a customs duty and a marketing margin, in
addition to marketing cost, to calculate underrecovery. These are profits, not costs.
Can oil companies be at a disadvantage by linking prices to underrecovery?
Yes. This may happen next year. In 2010, very little new refining capacity was added in Asia,
while demand was strong. Next year, China and the Middle East will add about 1 million
barrels per day of refining capacity. This is expected to increase supply of products and
deflate refining margins. As a result under-recovery is expected to fall.
No. The exemption can be claimed only twice in a block of four calendar years. The current
block has started from January 1, 2010, and will last until December 31, 2013. The previous
one ended on December 31, 2009. If you do not avail of the concession in any particular
block or undertake just one journey, you become entitled to carry forward one journey to the
next block. However, this has to be utilised in the first year of the new block.
For instance, if you availed of the concession just once instead of twice between January 1,
2006 and December 31, 2009, then you are allowed to carry forward the unused one into
the subsequent block (2010-2013), provided you undertake the journey in 2010 itself. A
point to be noted here is that even if you dont avail of the concession at all during a
particular block, you can carry forward only one entitlement to the next block.
Can the entire amount be claimed as an exemption?
The exemption will depend on certain criteria specified. Firstly, it is the lower of the actual
expenses incurred and the allowance granted by your employer. Lets assume your LTA is Rs
10,000, but you end up spending Rs 15,000 on travelling. In such a case, the exemption will
be allowed to the extent of Rs 10,000. Conversely, if your LTA stands at Rs 15,000 and your
actual expenses amount to Rs 10,000, you will still be entitled to a deduction of only Rs
10,000.
Other parameters that decide the extent of exemption?
If you have opted to fly to the destination, an amount not exceeding the economy class
airfare of the national carrier by the shortest route to that city would be admissible as
deduction. In case you are travelling by road or rail, the cost of first class air-conditioned
ticket to the destination by the shortest route would constitute the benchmark. Besides, if
your travel plan entails visiting multiple places during the trip, the destination farthest from
your place of residence would be taken into account for determining the exemption amount.
What if the travel bills are not submitted before the deadline?
If you fail to submit your travel bills pertaining to LTA claim with your employer within the
time prescribed, your employer would consider the amount of LTA paid as taxable and
deduct income tax at the rate applicable to you. However, you can claim LTA exemption at
the time of filing your income tax return.
Non-tax Revenues
Any loan given to state governments, public institutions and PSUs earn interests and this
forms the most important item under this head. The government also receives dividends and
profits received from PSUs. It also earns income for the various services it provides. Of this,
the railways is a separate ministry, though all its receipts and expenditure are routed
through the consolidated fund.
Capital Receipts
Receipts in the capital account of the consolidated fund are divided into three broad heads
public debt, recoveries of loans and advances, and miscellaneous receipts.
Public Debt
Since everything the government does is on behalf of the people, its borrowings eventually
are the burden of the people. In budget parlance, the difference between borrowings (public
debt receipts) and repayments (public debt disbursals) during the year is the net accretion
to the public debt. Public debt can be split into two heads, internal debt (money borrowed
within the country) and external debt. The internal debt comprises Treasury Bills, market
stabilisation scheme, ways and means advances, and securities against small savings.
Treasury Bills (T-Bills)
These are bonds (debt securities) with maturity of less than a year. These are issued to meet
short-term
mismatches in receipts and expenditure. Bonds of longer maturities are called dated
securities.
Market Stabilisation Scheme (MSS)
The scheme was launched in April 2004 to strengthen RBIs ability to conduct exchange rate
and monetary management. These securities issued under MSS are not to meet the
governments expenditure but to provide the RBI with a stock of securities with which it can
intervene in the market to manage liquidity.
Ways & Means Advances (WMA)
RBI is the banker for both the central and state governments. Therefore, it provides funds to
manage mismatches in the governments receipts and payments in the form of WMAs. Now,
RBI wants the government to issue short-term securities to meet temporary needs.
Securities Against Small Savings
The government meets a small part of its loan needs by appropriating small savings
collection by issuing securities to the funds that manage such schemes.
In the monetary policy on Wednesday, the RBI raised the repo rate by 25 basis points to
5.75% and the reverse repo rate by 50 basis points to 4.5%. This has narrowed the rate
corridor from 150 basis points to 125 basis points. ET demystifies the concept of rate
corridor.
What are repo and reverse repo rates?
Repo rate is the rate of interest charged by the central bank when banks borrow money from
it. It is the tool through which the RBI in-fuses funds into the system by lending to banks
against pledging of securities.
The reverse repo is the rate the RBI offers to banks when they deposit funds with it. The RBI
drains out liquidity from the financial system through reverse repo by releasing bonds to the
banks. This is a daily operation by the central bank to manage liquidity Over a longer time,
the RBI can also manage liquidity through open market operations.
What is an interest rate corridor?
Interest rate corridor refers to the window between the repo rate and the reverse repo rate
wherein the reverse repo rate acts as a floor and the repo as the ceiling. Ideally, rates in the
overnight interbank call money market, where lending and borrowing is unsecured, should
move within this corridor. However, when banks are short of funds and the overnight call
money rates are high and above the repo rate, banks approach the RBI to borrow under the
repo window.
Therefore, the repo rate becomes an effective policy tool as it would help bring down the
rates in the overnight market . The reverse hap-pens when money market rates fall below
the reverse repo rate. Banks then park surplus funds with the RBI through a reverse repo
trans-action. As a result, when there is excess liquidity in the system, the reverse repo is
more effective. When liquidity is tight and banks need short-term funds from the RBI to
manage mismatches, then the repo rate emerges as the effective policy rate. But if liquidity
returns to the system the reverse repo would become the operative policy rate as the RBI
would be draining out funds from the system.
Why is a narrow rate corridor desirable?
A narrow rate corridor means that short-term interest rates in the call money market will
move within that band. This band was earlier 150 basis points, which has now been lowered
to 125 basis points. Effectively, the narrower rate corridor will mean there will be less
volatility in short term rates.
Do other central banks also have rate corridors?
Many developing countries have the rate corridors but central banks in developed and
deeper financial markets have a single rate. In the US, for instance, the Fed Fund rate is the
key interest rate. Short term funds are available at this rate to the eligible borrowers.
Why are Indian airlines in the red despite rising passenger traffic?
Because of high taxes on fuel and rising operational costs. Moreover, cutthroat competition
in the sector prevents airlines from raising ticket prices. Taxes constitute 40% of an airlines
total expenditure, far above the global average of 32%. Besides, revenues barely cover
operational costs. For instance, operating margin for Kingfisher stands at 0.12 while it is
negative for Jet Airways (-8.25%) and Spice Jet (-6.7%).
Why cant airlines raise fares to cover these costs?
Fierce competition in the Indian skies prevents them from doing so. In the case of Jet, cost
per available seat km (ASKM) rose to Rs 3.31 in the second quarter of this fiscal compared
with Rs 2.74 in the previous quarter. In contrast, revenue passenger km (RPKM) has crawled
up to Rs 3.63 from Rs 3.5.
So if an airline goes bust, should the government bail it out?
The tempting answer is that those responsible for corporate recklessness must bear the
consequence, but in real world things are not so simple. Many experts argue that
had Lehman Brothers not been allowed to go bust, the financial crisis could have been less
damaging. But, a corporate bailout sends the wrong signal or creates a moral hazard of
encouraging more recklessness, the cost of which is borne by the taxpayer.
What is moral hazard?
In economic theory, the concept of moral hazard comes from the insurance industry where
an individual or a company behaves differently when he is protected from a risk than when
he is exposed to the risk. The guarantee of insurance can make the insured less risk averse,
as he knows he is protected from the financial consequences of his actions.
How does the concept apply to bailouts?
If a company believes its existence is crucial for the economy or for public good, it may be
tempted into taking reckless risks believing that the government will step in to bail it out if it
were to land in trouble. Therefore, any rescue of troubled private sector firms makes others
believe that they could also be similarly helped out if things went wrong.
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The Export Promotion Capital Goods (EPCG) scheme was one of the several exportpromotion initiatives launched by the government in the early 90s.
The basic purpose of the scheme was to allow exporters to import machinery and equipment
at affordable prices so that they can produce quality products for the export market.
The import duty on capital goods like all other items was high during that period, inflating
the cost of capital goods nearly 50%, so the government allowed exporters to import capital
goods at only 25% import duty.
For waiver of the remaining portion of import duty, exporters were supposed to undertake an
export obligation (a promise to export) which was worked out on the basis of the duty
concession obtained.
Exporters were given eight years to carry out their commitment to export. Once the export
obligation was fulfilled, the owner of the capital goods concerned could sell them or transfer
them to another facility.
Till the promised export materialised, the owners of the machinery or equipment
were barred from even moving the goods concerned out of their manufacturing unit.
Did liberalisation of imports have an impact on EPCG?
Gradual reduction in import duties, particularly in the case of capital goods, has been
rendering EPCG scheme less attractive. However, till last year, EPCG was preferred by many
since the exemption also included 4% special additional duty of customs (SAD) which has
been abolished now.
Textile machinery, for example, attracted an import duty of only 5% but the 4% SAD resulted
in the duty burden going up to nearly 10%. This led many textile units to prefer the EPCG,
but the scenario may change now in view of the governments decision to abolish SAD.
The government has been modifying the EPCG scheme over the years in line with the
demands of the domestic industry. The first change was the introduction of two windows
the first one attracting 15% duty while the second one attracted 25%. Those who preferred
to pay higher duty under the second window had a lower export obligation. In 95, the
government offered duty-free imports under the first window while the duty under the
second was 15%. This was the first time duty-free imports were made available under EPCG.
Since the purpose of the scheme was to allow exporters compete internationally, it was
decided to allow them to buy machinery at internationally-competitive rates. The pent-up
demand for imported machinery had peaked at this point and the domestic industrys initial
trouble with competing imports had come to an end. Thereafter, the government even
reduced the import duty on capital goods under the second window to 10% while the first
remained duty-free. Subsequently, the policy was changed in 00 to merge the two windows
into one import capital goods by paying 5% and undertake uniform export commitment.
Who were the major beneficiaries of the EPCG?
The manufacturing industries, especially those who had to import their capital goods, were
the main beneficiaries over the years. The service sector was nowhere in the picture till last
year. Now service industries like hotels can also avail of EPCG imports and fulfil the export
obligation through the foreign exchange earned by them.
This is a major concession for service providers who were ignored over the years. Since
services now account for nearly 50% of the countrys GDP, it is fair to allow service providers
to imports goods at internationally-competitive rates.
The attraction of EPCG has, anyway, diminished over the years and it will be a question of
time before the scheme becomes redundant. Import duties will come down over the years,
especially in the case of capital goods.
It will be curtains for the EPCG scheme once the duty on capital goods comes down to 5%.
Going by the pace at which India is signing free trade agreements, this possibility seems
nearer. Like other outdated instruments like the cash compensatory scheme (CCS) for
exporters and the quantitative restrictions (QRs) on imports, the once-popular EPCG will also
exist only on records once the duty reduction materializes over a period of time.
Those in financial services can explore small and medium enterprises and retail. Those from
telecoms can look at anything that can connect B2C social network, e-commerce,
technology companies. Approach the principals and entities who would see close synergy
with these profiles and start informal discussions with potential employers or interested
parties.
Continuous skilling and learning is recommended. There is a need to be entrepreneurial so
that in every change one finds newer opportunities and value propositions.
A top-up premium is something that a policyholder can invest into his ULIP over and above
his existing premium payment. If you want to take advantage of a well-performing ULIP, you
can increase its investment component by paying an extra premium.
Will the sum assured increase in tandem with top-ups?
There is no compulsion to increase the insurance component of the ULIP.
But some ULIPs increase the sum assured in accordance with the top-up premium. For
example, in ICICI Pru Life Time Maxima, a recently-launched ULIP, the sum assured would be
increased by either 125% or 500% of the top-up premium as chosen by the customer.
Hence, prepare your policy document carefully.
How can you top up a ULIP?
You can top up a ULIP anytime during the life of the policy until the total of top-up premiums
does not exceed 25% of the total premium paid. Every company clearly defines the
minimum top-up amount in the policy document itself. It is usually more than Rs 2,000. But
this option is available only for disciplined customers who pay their premiums on time.
If your regular premium is due and you pay a top-up premium, the insurance company will
direct the additional funds towards the regular premium amount. If the total of top-up
premiums exceeds 25% of the total premiums paid, the sum assured of the policy can go up
by as much as 125 times of the top-up, depending upon the underwriting requirements of
the life insurance company.
What are the charges?
The premium allocation charge of a top-up plan is anywhere between 1% and 3% and varies
from policy to policy.
How will I benefit from a top-up premium?
You can save on the premium allocation charge by opting for a top-up premium. For
instance, you can opt for a low-value ULIP to test the waters. You can then step up your
investment component in a staggered manner after monitoring its performance. Secondly,
you can benefit from lower premium allocation charges by adopting this approach. For
example, the lowest allocation charge of any regular premium of a ULIP available in the
market today is 5%, which is still higher than the premium allocation charge of top-up
premiums.
Ideally, you should avail yourself of the low base effect benefit in the initial years of the
policy and top up the policy subsequently. But a word of caution: if your top-ups exceed a
limit, the final sum may be subject to tax proceeds at maturity. This clause again varies from
policy to policy.
Can you opt for partial withdrawal from top-up premiums?
Usually the lock-in-period for each top up premium is three years from the date of payment
of that top-up premium for the purpose of partial withdrawals. In fact, some ULIPs do not
permit partial withdrawals if top-up premiums are paid in the last three years before
maturity date.
Most companies use a table of charges prepared by the Life Insurance Corporation (LIC)
since this is the only company which has five decades of experience and consequently has
historical data on life expectancy. Since private insurers have been around for a decade,
some have made alterations to the rates based on their own experience. Work is on progress
on a new mortality table with data from all companies and prices are expected to fall as life
expectancy has gone up.
Will the policyholder benefit from buying a policy at a young age?
Yes. For instance, the life expectancy of a 25-year-old will be higher than that of a 55-yearold, and hence, the former will stand to benefit in terms of lower charges while buying
insurance.
How will the updated mortality table impact pension policies?
Since the life expectancy of the average Indian has gone up, it is likely that you will have to
incur a higher cost when it comes to buying whole-life annuities. Those who invest in
pension plans will have to use at least two-thirds of the accumulated sum to buy annuities
a product where the investor gets regular income for a specified period in return for a
lumpsum payment. The savings under a pension plan have to be invested in annuities to
avoid them being taxed. One-third of the pension fund value at maturity is made available to
the insured for tax free. The balance has to be used for purchase of annuities from any
insurer.
we have an overall measure of WPI/CPI, which is used appropriately. This is why year-end
estimates of GDP are more reliable than quarterly estimates.
underlying equity shares are secured with a custodian. An Indian investor pays in Indian
rupees for the IDR whereas a shareholder in the issuers home country pays in home
currency.
What is the security of the underlying shares? Where will the receipts be
deposited?
The underlying shares for IDRs will be deposited with an overseas custodian who will hold
the shares on behalf of a domestic depository. The domestic depository will accordingly issue
receipts to investors in India. Investors will get an entry in their demat accounts reflecting
their IDR holding.
How will IDRs be issued? Who can participate?
IDRs will be issued to Indian residents in the same way as domestic shares are issued. The
issuer company will make a public offer in India, and residents can bid the same way as they
do for Indian shares. Investors eligible to participate in an IDR issue are institutional
investors, including FIIs but excluding insurance companies and venture capital funds
retail investors and non-Institutional Investors. NRIs can also participate in the Issue.
Commercial banks may participate subject to approval from the RBI.
What are the benefits that Indian investors can look forward to?
Indian individual investors have restrictions on holding shares in foreign companies, but IDR
gives Indian residents a chance to invest in a listed foreign entity. No resident individual can
hold more than $200,000 worth of foreign securities, including shares, as per foreign
exchange regulations. However, this will not be applicable for IDR. Besides, these additional
key requisites such as demat account outside India to hold foreign securities, KYC with
foreign broker, foreign bank account to hold funds are too cumbersome for most investors.
These troubles are completely avoided in holding IDRs.
Will Indian investors get equal rights as shareholders?
Indian investors have equivalent rights as shareholders. They can vote on EGM resolutions
through the overseas custodian. Whatever benefits accrue to the shares, by way of dividend,
rights, splits or bonuses will be passed on to the DR holders also, to the extent permissible
under Indian law.
Can IDRs be converted?
IDR holders will have to wait for an year after issue before they can demand that their IDRs
be converted into the underlying shares. However this conversion is subject to certain
conditions:
a) IDR Holders can convert IDRs into underlying equity shares only with the prior approval of
the RBI.
b) Upon such exchange, individual persons resident in India are allowed to hold the
underlying shares only for the purpose of sale within a period of 30 days from the date of
conversion of the IDRs into underlying shares
c) Current regulations do not provide for exchange of equity shares into IDRs after the initial
issuance i.e.reverse fungibility is not allowed
The rupee has appreciated sharply against the dollar in the last few months, raising some
concerns, especially among exporters. The real issue, economists say, is not the exchange
rate as we know, or the nominal exchange rate, but the effective exchange rate. ET takes a
look at the concept of real and nominal exchange rates.
What do real numbers mean?
ET takes a look into and explains about forward premium in the foreign exchange market.
What is a forward premium in the foreign exchange market?
Its the price paid for hedging by buying dollars in the forward market. Forward transactions
take place at a premium or discount to the spot rate. The outright forward transactions are
over-the-counter transactions undertaken by dealers. In India, it is generally the banks that
transact in forward markets.
The maturity date agreed upon by the parties generally varies from months to a year or two.
But maturities beyond that tend to have wider bid-ask spreads, in other words, tend to be
more expensive, so are rare. The forward rate could be in premium or discount, based on the
interest rate differential in case of currencies which are fully convertible and in case of
partially-convertible currencies, they are determined purely on the basis of demand and
supply.
For example, in India, the USD/INR forward rate for six months could be in premium or at a
discount over the spot rate, based on how liquid the dollar is.
What determines forward premium?
Countries that have fully-convertible currencies, the forward premium is deduced from their
interest rate differentials, respectively. The premium/discount is measured in points, which
represent the interest rate differential of the countries to which the currencies belong, for
the period of maturity.
These points are the quantum of foreign exchange that would neutralise the interest rate
differential. Points are subtracted from the spot rate, when the interest rate of the base
currency is higher, since the base currency should trade at a forward discount and points are
added to the spot rate, when the interest rate of the base currency is lower, since the base
currency is expected to trade at a forward premium.
This is, however, only applicable to non-rupee currencies, that are fully convertible.
What are currency futures?
Exchange-traded currency forward transactions are known as currency futures. Before April
2007, only banks were allowed to trade in currency forwards market through over-thecounter deals.
But it was not a structured market, in the sense that it was not traded on an RBI-recognised
exchange platform. But in 2007, RBI and Sebi allowed trading of currency futures on the
National Stock Exchange.
The objective of opening up trading in currency futures on the exchanges was to deepen the
futures market by allowing the small retail investors to take a view and hedge their foreign
exchange risks. The regulatory authorities in India are on their way to allow trading in
currency options on exchanges as well, though it is already available as a product.
India has refused market economy status to China. ET looks at what it means for china?
What is a market economy status?
When a country accords market economy status to another country, it recognises that free
market forces of demand and supply are operating there. It accepts that economic variables
such as prices and exchange rates are not determined by the state. When a country
recognises another as a market economy, it will have to accept information on prices
supplied by that country while contesting anti-dumping cases.
Why is India refusing to give the status?
India believes that Chinas corporate governance and accounting systems are not
transparent and the country is not following global best practices in its financial & banking
systems and stock markets.
It had recently sent a questionnaire to China seeking information on key issues such as land
laws, accounting practices, minimum wages and electricity rates, which was the first step
towards granting the status. China, however, dismissed the move labelling the entire issue
as a political one.
Is the issue economic or political?
The issue is both economic and political. China has the maximum cases of dumping
exporting goods at prices lower than those prevailing in its domestic market against it.
India does not want to give the market economy status to China as it would then have to
accept all information on local prices supplied by China while framing its dumping cases.
At present, India fights anti-dumping cases against China on the basis of prices prevailing in
third countries exporting the same product to India. Refusing to recognise China as a market
economy also suits India politically at the moment because of the renewed tension on the
border.
A few years back when political relations with China were better, the ministry of external
affairs was trying to convince the commerce department to grant the status to the country.
Is India breaking multilateral trade rules?
Not at all. As per Chinas accession contract with the World Trade Organisation (WTO),
members are not obligated to recognise China as a market economy till 2016. Only about 60
countries have given China the status. These countries include members of the 10-member
Asean, which has a free trade agreement with China.
The direct taxes code bill, recently tabled in the Lok Sabha, proposes to bring down the
effective tax rates for individuals and corporates. The government hopes this will increase
tax collections. In the developed world, it is being debated if tax rates should be increased
to cut high deficits. The UK has already raised rates. The economic principle that drives the
debate is Laffer Curve. ET takes a look at the concept.
What is Laffer curve?
The Laffer curve is the graphical representation of the relationship between tax rates and
absolute revenue these rates generate for the government. The principle thought behind the
Laffer curve is that a zero tax rate would produce zero revenue and a 100% tax rate would
also generate zero revenue, as there would be no incentive to work. This means there must
be an optimal tax rate that will yield maximum revenue for the government.
Economist Arthur Laffer discovered this relationship that came be known as the Laffer curve.
It is based on the idea that at a particular tax rate evasion will make no sense as the cost, in
terms of the money and time going into it, would be higher than benefits.
The nominee appointed has to be an individual only. Only one person can be appointed as a
nominee. It is not compulsory to appoint a nominee for each investment of yours.
However, it is your interest that you appoint a nominee for your investment so that in the
event of your death, there is little difficulty in transferring your assets. So when you make an
investment in a fixed deposit, there is a column where you can mention the name of the
nominee.
Similarly in the case of a mutual fund investment, there is a column where you can appoint a
nominee. You can appoint only one person as a nominee. In case you do not appoint a
nominee while making an investment, you can also do the same at a later date, by filling the
relevant application form and giving it to the bank.
Can a minor be made a nominee?
Yes, a minor can be a nominee. In such case, the guardian will sign on behalf of the nominee
and in addition to the name and photograph of the nominee, the name, address and the
photograph of the guardian must be submitted.
Are joint holders of accounts allowed to nominate?
Nomination for joint holders is permitted, however, in the event of death of any of the
holders the benefits will be transmitted to the surviving holders name.
In the case of death of all holders, the benefits will be transmitted to the nominee account.
So a bank has to book losses on investment. In Indian context, banks have made huge
strides in increasing the share of non-fund based revenue, which includes revenue from
distribution of insurance and mutual funds, revenue from investment bank related activities
like debt syndication and etc.
Such non-fund based revenue comes under other income, which contributes an important
share to a banks bottom line today.
What are the key items that determine the efficiency of a bank?
Be it a bank or any other company, its efficiency is measured by how well it utilises its
assets. So in a banks case return on assets (RoA) is very important measure to separate the
wheat from the chaff.
The return from assets should not come at the cost of comprising the asset quality. And
therefore, what percentage of loan-book are non-performing assets (NPA) is another most
important criterion. NPA is often expressed as a percentage of advances.
Another important criterion to measure a banks efficiency is net interest margin (NIM),
which is a measure of spread between the interest rate at which a banks lend and borrows.
In Indian context, a 3% NIM is considered as a benchmark level. Among large banks, only a
handful includingHDFC Bank, Punjab National Bank & Axis Bank has been able to maintain
that level of NIM. Banks improve their NIM by controlling their cost of funds, which in turn is
done by improving the share of low cost current account and saving account (CASA) deposits
in total deposits.
What are the other factors that display strengths or weaknesses of a bank?
A low NPA indicates high asset quality and vice versa. Apart from it, capital adequacy ratio
(CAR) shows whether the bank has sufficient capital to grow in short to medium term. Since
banking is a capital-intensive business, the regulator requires banks to maintain a minimum
percentage of their assets as capital. As per Reserve Bank of India (RBI) regulation, Indian
banks have to maintain a minimum CAR of 9%. Most of the Indian banks meet this
regulatory requirement.
A capital adequacy ratio of higher than 9% indicates that the bank has sufficient capital to
grow for sometime without bothering to raise more funds. So a high CAR provides a kind of
cushion to the bankers.
Not at all. Companies that are issued compulsory licenses to produce a patented product
have to pay adequate remuneration based on the economic value to the patent holder,
but there is no elaboration on what the value is.
Why has India not been issuing compulsory licenses? Why has it suddenly woken
up to the need?
While the Indian Patents Act provides for issuing of compulsory licenses, the procedural
guidelines and the policy framework for the same are not in place. India had been taking it
easy so far, as it had a flexible patent regime till 2005, which granted protection only to
processes and not the final product. This allowed other producers to manufacture generic
versions using a different method.
However, ever since there was a switch-over to the more stringent product patent regime in
2005 (under which a patented product cannot be produced through any other process) to
meet the countrys commitments under Trips, the country has been facing a shortage of lifesaving drugs such as anti-cancer medicines and prices of patented versions have been going
up. This prompted the DIPP to float a note on compulsory licensing inviting comments on
how the country should go about implementing it.
Can compulsory licenses be issued for exporting to other countries?
Compulsory licenses are generally issued for producing for the domestic market. However,
during the Doha ministerial meet in 2001 the WTO recognised that there are countries which
do not have manufacturing capacities and allowed such countries to import generic versions
from other countries by issuing compulsory licenses.
In the monetary policy on Wednesday, the RBI raised the repo rate by 25 basis points to
5.75% and the reverse repo rate by 50 basis points to 4.5%. This has narrowed the rate
corridor from 150 basis points to 125 basis points. ET demystifies the concept of rate
corridor.
What are repo and reverse repo rates?
Repo rate is the rate of interest charged by the central bank when banks borrow money from
it. It is the tool through which the RBI in-fuses funds into the system by lending to banks
against pledging of securities.
The reverse repo is the rate the RBI offers to banks when they deposit funds with it. The RBI
drains out liquidity from the financial system through reverse repo by releasing bonds to the
banks. This is a daily operation by the central bank to manage liquidity Over a longer time,
the RBI can also manage liquidity through open market operations.
What is an interest rate corridor?
Interest rate corridor refers to the window between the repo rate and the reverse repo rate
wherein the reverse repo rate acts as a floor and the repo as the ceiling. Ideally, rates in the
overnight interbank call money market, where lending and borrowing is unsecured, should
move within this corridor. However, when banks are short of funds and the overnight call
money rates are high and above the repo rate, banks approach the RBI to borrow under the
repo window.
Therefore, the repo rate becomes an effective policy tool as it would help bring down the
rates in the overnight market . The reverse hap-pens when money market rates fall below
the reverse repo rate. Banks then park surplus funds with the RBI through a reverse repo
trans-action. As a result, when there is excess liquidity in the system, the reverse repo is
more effective. When liquidity is tight and banks need short-term funds from the RBI to
manage mismatches, then the repo rate emerges as the effective policy rate. But if liquidity
returns to the system the reverse repo would become the operative policy rate as the RBI
would be draining out funds from the system.
Why is a narrow rate corridor desirable?
A narrow rate corridor means that short-term interest rates in the call money market will
move within that band. This band was earlier 150 basis points, which has now been lowered
to 125 basis points. Effectively, the narrower rate corridor will mean there will be less
volatility in short term rates.
Do other central banks also have rate corridors?
Many developing countries have the rate corridors but central banks in developed and
deeper financial markets have a single rate. In the US, for instance, the Fed Fund rate is the
key interest rate. Short term funds are available at this rate to the eligible borrowers.
promised after paying agents and another 10-15% to staff and in ads. Money raised in 2008
was coming up for repayment and no fresh funds could be raised to repay as the word was
out that Saradha was in trouble.
One hears of various entities that raise money
There are Nidhis or benefit companies in the South, but they are much smaller in size. Here,
one has to become member by paying a token fee. Members can deposit money as well as
borrow. Like chit funds, there is no cap on money that can be raised.
Are there ways to sidestep regulations?
An influential Andhra businessman tried it a few years ago by using an HUF (or Hindu
undivided family) entity to raise collections. It was a unique structure where beneficiaries of
the HUF were family members, but depositors were general public. There was no explicit ban
on this. But the then state government opposed it.
What about the Sahara model?
Sahara raised money by issuing optionally fully convertible debentures to crores of
investors. But others cant take this route any more with the Supreme Court
backing Sebi that such securities have to be listed and regulatory approval is a must if
number of investors is more than 50.
Is it end of road for shoddy operators?
It will be tougher for them. But public memory is short. And, scamsters stay ahead of rule
makers. In a country as large as India, its almost impossible to stop cheat funds.
ET in the classroom: Qualified foreign Investors get direct entry
On January 1, the government decided to allow Qualified Foreign Investors, or QFIs, to invest
directly in the Indian equities market, a move which it hopes will help boost capital inflows.
Who are qualified foreign investors?
Qualified foreign investors, or QFIs, can be individuals, groups or associations based abroad
who are allowed by the government to invest directly in mutual funds and stocks of Indian
companies.
Last year, the government opened a new window for this class of investors to buy into Indian
mutual funds directly. It has now gone one step further and allowed them to buy into stocks,
too, just like registered foreign institutional investors or nonresident Indians, or NRIs.
Are QFIS a separate class of foreign investors compared to FIIs?
Qualified Foreign Investors will be distinct from foreign portfolio investors and non-resident
Indians. A QFI can, for instance, be a foreign individual investor in Singapore or Russia, who
can buy into stocks of a Tata groupcompany or Coal India or any other listed stock after
fulfilling the Know Your Customer norms through an Indian depository participant and
obtaining the approval of the RBI.
QFIs can buy up to 5% of the paid-up capital of a company, with the overall limit capped at
10% in a company. And these investment limits are separate or over and above that for FIIs
and NRIs.
How does it help by opening up the markets to one more category of investors?
Indian policy makers reckon that a diverse set of investors in the local markets will help
ensure more capital inflows, reduce market volatility and deepen the markets. It would also
mean facilitating the entry of a set of relatively wealthy investors who could not access the
Indian markets as there were regulatory restrictions on their entry.
For a long time, the government and regulators kept foreign individual investors at bay
owing to concerns relating to money laundering and due diligence. With restrictions in place,
foreign individual investors had to either buy into Indian stocks through Participatory Notes,
or PNs, or invest in India-focused offshore funds.
By allowing a new set of investors, the government and regulators are hoping that it will
lead to more inflows at a time when capital inflows have virtually dried up.
ET in the classroom: Revenue and spend
In the fourth part of the series, we look at how government meets the gap between
revenues and expenditure and how it impacts the economy.
FISCAL DEFICIT
The rising fiscal deficit has dominated all discussions on the budget. The excess of
governments expenditure over its tax and non-tax revenues has to be met with borrowings
from the public. This borrowing is called fiscal deficit, which is usually expressed as a
percentage of GDP. A high fiscal deficit runs the risk of government cornering the bulk of the
savings, leaving little for corporate and other borrowers, or what is called crowding out.
Prolonged periods of high fiscal deficit run the risk of raising interest rates and inflation and
depressing growth. A deficit of 3% of GDP is seen as sustainable. In the current year, the
government has budgeted a fiscal deficit of 4.6% of GDP.
REVENUE DEFICIT
Revenue deficit is an important control indicator. All expenditure on revenue account should
ideally be met from receipts on revenue account. Ideally, revenue deficit should be zero, else
the government debt will keep rising. Revenue deficit means the government is essentially
borrowing to consume, a recipe for financial disaster. Ideally, government borrowing should
fund asset creation, which will yield returns in the future.
PRIMARY DEFICIT
The primary deficit is fiscal deficit minus interest payments the government makes on its
earlier borrowings. It is another indicator to judge the quality of the government deficit.
FINANCING OF FISCAL DEFICIT
Market borrowings are the biggest source of funds for meeting the fiscal deficit. The
government also takes a portion of the funds raised through small savings by issuing
securities to the fund that manages small savings. A part of deficit is also met through
external sources of funds. Provident fund accumulations of state government employees is
also available for meeting the fiscal deficit.
FRBM ACT
Enacted in 2003, the Fiscal Responsibility and Budget Management Act had proposed to
eliminate revenue deficit by 2008-09. The Act also mandates a 3% limit on fiscal deficit after
2008-09. The 2008 financial crisis and the economic slowdown that followed forced the
government to abandon the path of fiscal consolidation. A new fiscal consolidation
framework is expected in the budget for 2012-13.
ET in the classroom: KYC norms for MF investments
What is KYC?
Client identification process is known as Know Your Customer or Client aka- KYC. Sebi has
made it mandatory for all mutual funds to know their clients. This would be in the form of
verification of address and identity, providing financial status, occupation and such other
demographic information to CDSL Ventures Limited (CVL), a wholly owned subsidiary of
Central Depository Services India Limited. Investments equal to and more than Rs 50,000 in
a mutual fund portfolio necessarily have to be accompanied by a KYC acknowledgement
letter.
How to get KYC compliant?
CVL is the designated body to carry out the KYC compliance procedure for mutual fund
investors. You have to approach CVL through any of the point of service (POS). The KYC
application form is available on the CVL website in the downloads section. One can take a
printout of the applicable form. The same is also available on mutual fund websites.
Investors need to attach self-attested photocopy of the pan card as identity proof, along with
the application form. There is a need of self-attested photocopy of an address proof enlisted
by CVL. Alternatively, the investors can also attach true copies attested by a notary or a
gazetted officer or a manager of a scheduled commercial bank of a multinational foreign
bank. Investors need not visit POS in person. The application can be routed through mutual
fund distributors or a representative of investors. The original documents are verified at the
counter and given back to the applicant or representatives of the applicant.
Non-resident Indians also need to undertake the same process. They additionally have to
provide certified true copy of their overseas address. If the same is in foreign language other
than English, the same has to be translated in English for submission. The documents can be
attested by the consulate office or overseas branches of scheduled commercial banks
registered in India.
POS upon verification of the documents and receipt of duly filled-in application form issues
an acknowledgement letter free of cost. The letter needs to be duly stamped and signed by
representatives of POS. In the case of joint holdings in a portfolio, all joint holders have to
get themselves KYC-compliant. Applications where the investments are in joint names,
photocopies of KYC acknowledgement letters of all applicants must be attached with the
application form. In the case of investments in the name of minors, the KYC
acknowledgement letter of the guardian is a must.
What should you do with KYC acknowledgement letter?
Please note that neither POS nor CVL will inform about the KYC exercise you have completed
in respect of any of the mutual fund houses. It is your responsibility to do so. You can attach
a photocopy of KYC acknowledgement letter, along with the application letter, at the time of
fresh investments. You can simply write to the fund houses where you have an investment
and request them to update your KYC status. Such requests must be accompanied by the
photocopies of the KYC acknowledgement letter. You can also attach the photocopy of KYC
acknowledgement letter with your request for additional investments in your mutual fund
portfolio.
A point to note that upon submission of your KYC acknowledgement letter, the mutual fund
house will update your status in their books. The address mentioned in your KYC letter will
prevail over the address you have mentioned in your original application. All future
correspondence by the fund house will be maintained at the address mentioned in the KYC
letter.
ET in the classroom: Forwards contract, over the counter
Value-Added Tax: State governments levy this on goods at the point of sale, based on the
difference between the value of the output and the value of inputs used to produce it. The
aim here is to tax a firm only for the value it adds to the inputs, and not the entire input
cost. Thus, VAT helps avoid a cascading of taxes.
TAX REFORMS GOODS AND SERVICES TAX: The proposed GST is expected to streamline
the indirect tax regime. It contains all indirect taxes levied on goods, including central and
state-level taxes. Billed as an improvement on the VAT system, a uniform GST is expected to
create a seamless national market. It could also mean lower taxes.
DIRECT TAXES CODE: The I-T Act came into effect nearly half a century ago. To account for
the new business and activities that have come since then, the government formulated the
DTC. It proposes to simplify tax laws and include a new way to calculate taxes on income.
Budget Process
The governments annual budget is no different from that of a household, only it has a lot
more jargon. In a five part series, ET will help readers make sense of the key items of the
budget, from revenue account to the much in debate fiscal. In the first part, we explain the
basic architecture of the budget:
ANNUAL FINANCIAL STATEMENT
The ordinary man confuses the finance ministers budget speech for the annual budget. But
as laid down in the constitution, the budget actually refers to the annual financial statement
tabled in Parliament along with the 13-15 other documents. Divided into three parts
Consolidated Fund, Contingency Fundand Public Account it has a statement of receipts and
expenditure of each.
CONSOLIDATED FUND
This is the core of the govts finances. All revenues, money borrowed and receipts from loans
it has given flow into this account. All government expenditure is made from this fund. Any
expenditure from this fund requires the nod of Parliament.
CONTINGENCY FUND
All urgent or unforeseen expenditure is met from this ` 500-crore fund, which is at the
disposal of the President. Any amount withdrawn from this fund is made good from the
Consolidated Fund.
PUBLIC ACCOUNT
All money in this fund belongs to others, such as public provident fund. The government is
merely working as a banker in respect of this fund.
REVENUE RECEIPT/EXPENDITURE
All receipts like taxes and expenditure like salaries, subsidies and interest payments that do
not entail sale or creation of assets fall under the revenue account.
CAPITAL RECEIPT/EXPENDITURE
Capital account shows all receipts from liquidating (eg. selling shares in a public sector
company) of assets and spending to create assets (lending to receive interest).
REVENUE VS CAPITAL
The budget has to distinguish all receipts/expenditure on revenue account from other
expenditure. So all receipts in, say, the consolidated fund, are split into Revenue Budget
(revenue account) and Capital Budget(capital account), which include non-revenue receipts
and expenditure.
REVENUE/CAPITAL BUDGET
The govt has to prepare a Revenue Budget (detailing revenue receipts and revenue
expenditure) and a Capital Budget (capital receipts & capital expenditure).
ET in the classroom: All you want to know about Economic Survey
The first Economic Survey was reportedly presented for the financial year 1951-52 and since
has been presented every year as a review of the economy by the government. Over the
years, the Economic Survey has transformed from a mere representation of facts to a more
suggestive document giving out advice.
What Is The Economic Survey?
The Economic Survey is a yearly report card of the economy put out by the Chief Economic
Advisor. It is a comprehensive document that analyses important economic, financial and
social developments over the year. Over the years, it has expanded to accommodate more
sectors and include more of analytical content. From 362 pages in 2004-05, the survey has
grown to a 459 page document in 2010-11 that included separate chapters on prices,
financial intermediation, and service, reflecting their importance in the economic debate.
What Is The Significance Of The Survey?
In terms of information, the Survey has little usefulness as most of the data presented is
already out in the public domain. Its real significance is that it lays down the economic
reforms agenda for the country and contains suggestions to the policymakers on the issues
that dominate economic discourse. Tabled usually a day before the Union budget for the
next fiscal is presented, it is expected that some of the suggestions in the Survey will find
their way into the budget.
Has The Survey Lived Up To Its Role?
Though the Survey is tabled in Parliament by the finance minister, it largely reflects the
views of the chief economic advisor. The reforms agenda laid out in the Survey is statement
of what ought to do be done without actually going into their political considerations. This is
largely the reason the ambitious reforms agenda included in the Survey documents year
after year does not usually reflect in the budget presented the next day. But it does lay down
the ground for informed debate on various economic issues.
Economist, Nomura
In a recent interview to the Wall Street Journal, D Subbarao, governor of the Reserve Bank of
India, said Indias Non-inflationary rate of growth had come down since the global financial
crisis and now probably stands at around 7%. ET looks at the concept:
What is non-inflationary rate of growth (NIRG)?
Non inflationary rate of growth is the maximum rate of growth that the Indian economy can
achieve without fanning inflationary pressures. It is similar to the concept of potential rate of
growth and is crucial input in the monetary decisions.
How does this concept work?
If an economy is growing faster than its potential rate of growth, capacities tend to get
stretched and resources scarcity emerges. Both producers & workers are then able to raise
prices and wages because of the high demand for their products & services. These rising
prices across the board lead to generalized inflationary pressures. This implies that there
exists a rate of growth for an economy at which inflation will be within a particular comfort
zone.
What is the risk at the moment?
India grew by 6.9% in the second quarter that is almost equal to its potential rate of growth
estimated by the RBI. A level of growth higher than 7% could translate into another bout of
high inflation unless there is investment in capacity creation and easing supply bottlenecks
to increase resource flow. According to theRBI annual bulletin for the year 2010-11, the
threshold for inflation was in the range of 4-6%.
Lower trend growth is the result of sharp falls in the investment and savings rates, a
higher fiscal deficit and a lack of policy reforms. Therefore, concerted efforts to address
supply-side bottlenecks are imperative to reverse the decline. says Sonal Varma
Interest rate swaps are also used speculatively by hedge funds or other investors who
expect a change in interest rates or the relationships between them. Traditionally, fixed
income investors who expected rates to fall would purchase cash bonds, whose value
increased as rates fell.
Today, investors with a similar view could enter a floating-for-fixed interest rate swap; as
rates fall, investors would pay a lower floating rate in exchange for the same fixed rate.
How does it work?
In an interest rate swap, each counter party agrees to pay either a fixed or floating rate
denominated in a particular currency to the other counter party. The fixed or floating rate is
multiplied by a notional principal amount (say, $1 million).
This notional amount is generally not exchanged between counter parties, but is used only
for calculating the size of cash flows to be exchanged.
The most common interest rate swap is one where one counter party A pays a fixed rate
(the swap rate) to counter party B while receiving a floating rate (usually pegged to a
reference rate such as LIBOR London Inter Bank Offered Rate).
A pays fixed rate to B (A receives floating rate)
B pays floating rate to A (B receives fixed rate).
Consider the following swap in which Party A agrees to pay Party B periodic fixed interest
rate payments of 3.784%, in exchange for periodic floating interest rate payments of LIBOR
+ 70 bps (0.70%). There is no exchange of the principal amount and that the interest rates
are on a notional principal amount.
The interest payments are settled in net. The fixed rate (3.784% in this example) is referred
to as the swap rate.
What are the different types of swaps?
Being OTC instruments, interest rate swaps can come in a huge number of varieties and can
be structured to meet the specific needs of the counter parties. By far the most common are
fixed-for-floating, fixed-for-fixed or floating-for-floating.
The legs of the swap can be in the same currency or in different currencies. The above
example is a specimen of fixed-for-floating swap. Fixed-for-fixed works the same way except
that there is no change in the rate used during the date of payment, as does floating-forfloating swap.
ET in the classroom: Deposit Insurance
What is deposit insurance?
It is a limited level of protection provided by the government to depositors against bank
failures. Every bank is mandatorily covered under the level of Deposit Guarantee and the
Insurance Corporation of India. It is particularly relevant in countries like India where
financial literacy is very low. At a macro-level, its objective is to contribute to the stability of
the financial system.
Which entities are covered under deposit insurance in India?
All commercial banks, including the branches of foreign banks functioning in India, local area
banks and regional rural banks are covered under the deposit insurance scheme. Even cooperative banks are covered. The scheme, however, does not cover deposits with NBFCs and
company fixed deposits.
What is the amount covered and how is the premium charged?
Under the provisions of the DICGC Act, the insurance cover deposits up to Rs 100,000 under
the deposit insurance. The premia to be paid by insured banks are computed on the size of
their deposits. Insured banks pay advance insurance premia to the Corporation semiannually, within two months from the beginning of each financial half year, based on its
deposits at the end of previous half year. The premium is currently pegged at Re 1 for every
Rs 1,000 of the deposits.
What types of deposits are covered under the scheme?
The Corporation insures all bank deposits, such as savings, fixed, current, recurring, etc.,
except deposits of foreign governments; deposits of central/state governments, deposits of
state land development banks with the state co-operative banks, inter-bank deposits,
deposits received outside India.
How are the claims settled?
In the event of winding up or liquidation of an insured bank, every depositor is entitled to
payment of an amount equal to the deposits held by him at all the branches of that bank as
on the date of cancellation of registration (i.e., the date of cancellation of licence or order for
winding up or liquidation), subject to set-off his dues to the bank, if any. However, the
payment to each depositor is subject to the limit of the insurance coverage fixed from time
to time.
Aviation business is riddled with gobbledygook such as code-sharing and business aviation
to name a few. ET simplifies and explains the industry lexicon.
What is passenger seat factor (PSF)? Does a high PSF suggest better
performance?
The passenger seat factor is a percentage measure of seat occupancy on a flight. However,
in itself, a high PSF does not mean that the airline is making money. The flights could be
having high occupancy because of the low fares offered.
What is code-sharing ? Why do airlines enter into such arrangements?
Each airline is identified by a code assigned to it. Code-sharing is a marketing alliance
between two carriers. Under such an arrangement, an airline can sell seats in its own name
on sectors it does not have operations by booking tickets on the flight operated by the
airline with which it has a code-sharing pact.
For example, if a person intending to fly to Berlin has gone to Air Indias website then he or
she would find a flight even if the national carrier does not operate to the German capital.
The passenger would locate a Lufthansa flight on Air Indias website as the two have a codeshare agreement. Without the arrangement, airlines would lose traffic to bigger rivals. Such
an arrangement is extremely beneficial for smaller airlines.
We have seen landmark shift in Indian Economy since the adoption of new economic policy
in 1991. This had far reaching impacts on all spheres of life in India. There can be no
concrete conclusions about their impact on Indian people. This turns out to be more of an
ideological debate like capitalism vs Socialism. But there is no doubt in the fact that those
reforms were unavoidable and very compelling. There was in fact, similar wave all across the
globe after disintegration of USSR and end of the Cold War. Many Post-colonial democratic
regimes, which were earlier sheltered by USSR, lost their umbrella. They had no option, but
to fall in line to new unipolar world order dictated by USA. Even China in late 1980s adopted
Open Door Policy through which it liberalized its economy by shedding communist
mentality completely. South East Asian economies also reformed their economy and started
engaging more with global economy. These along with China, pursued export led growth
whereas Indian economy still relies almost wholly on domestic consumption.
Governments all across the world has lost their capacity to regulate and ward of against
malicious, false, sensitive information and content. Rise of Islamic State demonstrates that,
IT revolution has helped development of global Terrorist links more than anything. Moreover,
explicit content is freely available on web, to which unmatured children have unrestricted
access
GDP growth rate Indias annual average growth rate from 1990 2010 has been 6.6 %
which is
almost double than pre reforms era. GDP growth rate surpassed 5% mark in early 1980s.
This made impact of 1990s reforms on growth unclear. Some believe that 1980s reforms
were precursor to LPG reforms. Other things apart, it is clear that 1980 reforms led to crash
of economy in 1991, which was remedied by LPG reforms which were quite more
comprehensive. It was IMF loan which gave government to adjust its economy. It was largest
ever loan given by IMF. Initially there were global doubts on Indias credibility for loan, but
India has been so far a disciplined borrower.
Industrial Growth Rate Barring few years industrial growth rate has been not much
impressive. Share of Industry still remains stagnantly low at 25%. Worst is that India has
transitioned to be a service led economy, directly from an agrarian one. One expiation of this
is end of policy of imports substitution which derived industrial growth upto 1990. Foreign
companies got free access to Indian markets and made domestic products uncompetitive.
They obviously had better access to technology and larger economies of scale.
Indias position also lagged on account of Research and innovation. Import substitution
required certain degree of investment and efforts in domestic production. It was carried out
even when imports were cheaper. This resulted in good and better capacity building upto
that time. This was coupled with constant technology denial by west, which further pushed
government to spend on R&D. Technology Denial ended with liberalization and globalization.
Till that time Indian Industry was better and modern than that of China. But in two decades
China has surpassed India by huge margin in case of both Industry and innovation.
Impact on Small Scale in India
This impact shall be studied right from the beginning of colonization in 18th century.
Colonization can be considered as 1st wave of globalization. In pre colonization era, Indias
textiles and handicraft was renowned worldwide and was backbone of Indian economy. With
coming of industrial revolution along with foreign rule in India, Indian economy suffered a
major setback and much of its indigenous small scale cottage Industry was destroyed.
After independence, government attempted to revive small scale sector by reserving items
exclusively for it to manufacture. With liberalization list of reserved items was substantially
curtailed and many new sectors were thrown open to big players.
Small scale industry however exists and still remains backbone of Indian Economy. It
contributes to major portion of exports and private sector employment. Results are mixed,
many erstwhile Small scale industries got bigger and better. But overall value addition,
product innovation and technology adoption remains dismal and they exist only on back of
government support. Their products are contested by cheaper imports from China. Policies
of government toward SSI were covered in previous article access here and here
Impact on Agriculture
As already said, share of agriculture in domestic economy has declined to about 15%.
However, people dependent upon agriculture are still around 55%. Cropping patterns has
undergone a huge change, but impact of liberalization cant be properly assessed. We saw
under series relating to agriculture that there are still all pervasive government controls and
interventions starting from production to distribution (here SPS and here WTO).
Global agricultural economy is highly distorted. This is mainly because imbalance in
economic and political power in hands of farmers of developed and developing countries. In
developed countries, commercial and capitalistic agriculture is in place which is owned by
influential Agri corporations. They easily influence policies of WTO and extract a better deal
for themselves at cost of farmers of developing world.
Farming in developing world is subsistence and supports large number of poor people. With
globalization there has been high fluctuation in commodity prices which put them in massive
risk. This is particularly true for cash crops like Cotton and Sugarcane. Recent crises in both
crops indicate towards this conclusively.
Also there is global Food vs. Fuel confusion going on. Sugar and corn are used to
manufacture ethanol which is used as fuel. In USA Corn is produced mainly for this purpose,
as sugar cane is in Brazil. Now there are apprehensions that what if converting food into fuel
is more remunerative for producers? More than 1 billion people still live in hunger, much
more are just hand to mouth. It is futile to expect that free market will take care of these
people, who dont have any purchasing power. Clearly, Agriculture is biggest market failure,
but is rarely discussed for being so in WTO.
Another global debate born out of globalization is one of GM crops. Here too powerful MNCs
like Monsanto hold the key. USA allows unhindered use of GM crops, but EU bans it. In India
field trails are going on. (It was discusses here)
On the positive note, Indias largely self-sufficient and high value distinguished products like
Basmati Rice are in high demand all over. Generally speaking, India is better placed to take
up challenge of globalization in this case. If done in sustainable and inclusive manner, it will
have a huge multiplier impact on whole economy. Worldwide implicit compulsion to develop
Food processing Industry is another landmark effect of globalization.
Apart from these, Farm Mechanization i.e. use of electronic/solar pumps, Tractors, combines
etc. all are fruits of globalization. Now moving a step further, Information technology is being
incorporated into agriculture to facilitate farming.
Impact on Services Sector
In this case globalization has been boon for developing countries and bane for developed
ones. Due to historic economic disparity between two groups, human resources have been
much cheaper in developing economies. This was further facilitated by IT revolution and this
all culminated in exodus of numerous jobs from developed countries to developing countries.
Here US have to jealously guard its jobs as we guard our agriculture.
IT industry
Software, BPO, KPO, LPO industry boom in India has helped India to absorb a big chunk of
demographic dividend, which otherwise could have wasted. Best part is that export of
services result in export of high value. There is almost no material exported which consume
some natural resource. Only thing exported is labor of Professionals, which doesnt deplete,
instead grows with time. Now India is better placed to become a truly Knowledge Economy.
Exports of these services constitute big part of Indias foreign Exchange earnings. In fact, the
only three years India had Current Account surplus, I.e. 2000-2002, was on back of this
export only.
Banking
Further, in banking too India has been a gainer. Since reforms, there have been three rounds
of License Grants for private banks. Private Banks such as ICICI, HDFC, Yes Bank and also
foreign banks, raised standards of Indian Banking Industry. Now there is cut through
competition in the banking industry, and public sector banks are more responsive to
customers.
Here too IT is on path of bringing banking revolution. New government schemes like Pradhan
Mantri Jan dhan Yojana aims to achieve their targets by using Adhaar Card. Having said this,
Public Sector Banks still remain major lender in the country.
Similarly Insurance Industry now offers variety of products such as Unit Linked Insurance
plans, Travel Insurance etc. But, in India life Insurance business is still decisively in hands of
Life Insurance Corporation of India.
Stock Markets
Another major development is one of Stock Markets. Stock Markets are platforms on which
Corporate Securities can be traded real time. It provides mechanisms for constant price
discovery, options for investors to exit from or enter into investment any time. These are
back bone of free markets these days and there is robust trade going all over the world on
stock exchanges. Their Importance can be estimated from the fact that, behavior of stock
markets of a country is strongest indicator of health and future prospects of an economy.
These markets has thrown open wide array of associated services such as Investment
Banking, Asset Management, Underwriting services, Hedging advice etc. These collectively
employ lakhs of people all over India.
Similarly there are commodities market which provides avenues for investment and sale of
various eligible commodities.
Telecom Sector
Conventionally, Telecom sector was a government owned monopoly and consequently
service was quite substandard. After reforms, private telecom sector reached pinnacle of
success. And Indian telecom companies went global. However, corruption and rent seeking
marred growth and outlook of this sector.
Entry of modern Direct to Home services saw improvements in quality of Television services
on one hand and loss of livelihood for numerous local cable operators.
Education and Health Sector
It should be noted that food (Agriculture), Health and education (and to lesser extent
banking) are among basic necessities, which every human being deserves and cant do
without. Unfortunately, in developing countries there is market failure in all these sectors
and majority of people cant afford beyond a certain limit (or cant afford at all). Concept of
free markets, globalization, liberalization etc. fails here miserably. Free markets provide
goods and services to people who can afford paying for them, not to those who deserve and
need these.
Now if we consider these sectors from angle of our inclination towards free markets,
certainly there has been lot of progress. There has been world class education available in
India and Deregulation has resulted in Mushrooming of private engineering and Medical
Colleges. But in reality, this had far reaching devastating effect on society.
These new colleges accommodate only a miniscule proportion of aspirants at very high
costs. Recently, an Independent organization Transparency International came out with
report claiming that Indias medical system is most corrupt in the world. This was no
surprise, we all know from where it starts. High fees of education forces many aspirants to
take educational loans from banks. After qualifying job market is unable to absorb majority
of them. Practice turns out to be option of last resort. Now to make a decent living and to
pay back the loans person is lured by corruption. Consequently, when many similar cases
are put together, we get a corrupt system, economy and society.
Reality is that after deregulation and liberalization, government along with other sectors,
pulled its hand from social sectors too. Now there is Mediocre to high quality options are
available in private sector which can be availed as per ones budget. In public Sector Less
than Mediocre to Mediocre options are available. This leaves huge proportion of aspiring
students and expecting patients.
On Social front Indias performance is deplored all over the world and it is probably behind
all important developing economies. This lacuna has been recognized and government has
taken the charge. In case of education almost universal enrollments has been achieved upto
primary level and now impetus should be on improving quality, so that student of public
schools comes at par with atleast average private ones.