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The Economic Times – ET In The Classroom – Archives – 5(Economics Concepts Explained)
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The Economic Times newspaper now and then publishes articles on current economic issues in a question and answer format under
the heading ‘ET In The Classroom’. They are simple to understand and remember.
Many tough concepts are beautifully explained by the ET team in these articles. All these articles are freely av ailable on the net.
They are the property of theEconomic Times. I hav e just consolidated all of them here for the benefit of the readers.
Complete credit is for The Economic Times newspaper for these wonderful articles.
For an IAS aspirant preparing for the UPSC civ il serv ice examination, ET in the Classroom is a one-stop solution for getting
acquainted with many economic jargon and concepts.
ET in the classroom: New concepts & ideas in Budget 2013
The budget for 201 3-1 4 introduced some new concepts and ideas. ET explains some of these items.
SERVICE TAX VOLUNTARY COMPLIANCE ENCOURAGEMENT SCHEME
A one-time amnesty for those who hav e collected serv ice tax but not deposited the same with the gov ernment. Those serv ice tax
prov iders that hav e not filed serv ice tax return since October 2007 can disclose true liability and get an interest or penalty waiv e
off.
COMMODITIES TRANSACTION TAX (CTT):
This is on the lines of securities transaction tax lev ied on sale and purchase of shares on stock exchanges. The tax will be lev ied on
nonagricultural commodities futures at 0.01 per cent of the trade v alue, the same rate as that on equity futures.
INVESTMENT ALLOWANCE
A tax break giv en to companies for high v alue inv estment in plant and machineries, ov er and abov e depreciation benefits enjoy ed
by them. A company inv esting Rs 1 00 crore or more in plant and machinery during the April 201 3 to March 201 5 will be entitled
to deduct an inv estment allowance of 1 5 per cent of the inv estment. This is expected to see enormous spill-ov er benefits to small and
medium enterprises.
INFLATION-INDEXED BONDS
The gov ernment hopes this will help increase financial sav ings instead of buy ing gold. In the recent y ears the rate of return on
debt inv estmentshas often been below inflation, which effectiv ely means that inflation was eroding sav ings. Inflation indexed bonds
prov ide will prov ide returns that are alway s in excess of inflation, ensuring that price rise does not erode the v alue of sav ings.
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ET in the classroom: Goodwill Impairment (2013)
What is goodwill impairment?
Goodwill is a set of unidentifiable intangible assets through which an enterprise is suppose to deriv e future economic benefits,
explains Arijit Barman
What constitutes goodwill?
It is generally recognised or booked in a transaction where a business is being purchased by one entity from another. It is the excess
of the total consideration paid for the business ov er the v alue of all its other assets and liabilities (referred to as net assets). Under the
Indian accounting framework, goodwill can originate in a merger or acquisition through a high court-prescribed scheme or it may
be recorded on account of consolidation of acquired entity by the holding company or when a group of assets are purchased for a
lump-sum consideration. Indian GAAP prohibits capitalisation of internally generated goodwill.
When is goodwill written off, or impaired?
Just like an asset on a balance sheet, a company is continuously required to assess the v alue of the goodwill. It is generally tested for
impairment on an annual basis unless there is a significant change in the business env ironment. Goodwill is written off when the
carry ing v alue of the group of assets is higher than v alue in use or net realizable v alue less costs to sell. Value in use is generally
determined through a discounted cash flow method whereas realizable v alue is determined through market-based inputs.
What can cause goodwill impairment?
Adv erse effect of changes in technology , markets and economic or legal env ironment
Adv erse interest rate mov ements
Ev idence of obsolescence or phy sical damage to the company ’s assets
Significant changes in the enterprise; say , plans to discontinue or restructure ops, plans to dispose of an asset before expected date
Actual net cash flows or operating profit or loss flowing from the asset/ company are significant ly lower than those budgeted
Negativ e publicity about a firm can create goodwill impairment, as can the reduction of brandname recognition.
What is the difference between amortisation and goodwill impairment?
Amortisation is the sy stematic reduction of the carry ing amount ov er its useful life. It is similar to depreciation. If goodwill arises on
account of an M&A then it is generally required to be amortized within fiv e y ears unless a higher period can be justified.
Impairment is generally carried out in respect of goodwill arising on account of consolidation of legal entities or a slump sale. This is
required at an annual frequency unless we hav e triggers to do it on a quarterly or half-y early basis.
Where do goodwill writeoffs get reflected?
They are reduced from the carry ing amount of goodwill in the balance sheet with a corresponding entry in the profitand-loss
account.
Are indian companies mandated to conduct goodwill tests?
Indian companies are generally required to assess at each balance sheet date whether there is any indication the goodwill is
impaired or not. If one or more indications exist, then the company is required to carry out impairment testing on a more frequent
basis, quarterly or half-y early .
ET in the classroom: Why banks need to follow KYC rules?
Money laundering by banks and insurance companies is more widespread than earlier thought, another expose by an online news
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website has rev ealed. This dev elopment is bound to force banks to undertake a fresh round of v erification of the identity of almost all
account holders, an exercise called ‘Know y our Customer’. ET explains what a KYCentails:
WHAT IS KYC?
Banks undertake this exercise to v erify the identity of their customers. The KYC exercise aims to prev ent banks from being used,
intentionally or unintentionally by criminal elements, for money laundering.
DOES KYC APPLY TO ALL CUSTOMERS?
Yes. KYC is applicable to ev ery indiv idual who wants to hav e any business relationship with the bank. This means, any indiv idual
wanting to open an account (sav ings or current account and recurring or fixed deposit), get a bank draft, open a locker, receiv e any
benefits on account of financial transactions, remittance or wire transfer, and apply for a loan.
DOES IT HAVE ANY LEGAL BACKING?
Yes. The KYC norm has been v alidated under Section 35A of the Banking Regulation Act, 1 949, and Rule 7 of the Prev ention of
Money -Laundering Rules, 2005. Any v iolation of these norms could attract sev ere penalty under the BR Act.
WHAT IS NEEDED FOR A KYC CHECK?
KYC has two components: identity and address. While PAN and v oter card, driv ing licence and any other identity document that
satisfies the banks requirements serv e as proof of identity , a copy of passport, electricity or phone bill or bank account statement are
accepted as proof of address.
DO BANKS OPEN ACCOUNTS FOR THOSE WITHOUT AN ADDRESS PROOF?
Yes. But such indiv iduals hav e to submit an identity document along with a utility bill of the relativ e with whom the prospectiv e
customer is liv ing and a declaration from the relativ e that the said person is a relativ e.
CAN KYC NORMS BE RELAXED?
To ensure financial inclusion, a low-income group customer without identity and address proofs can open a bank account with an
introduction from another account holder who has fulfilled the bank’s KYC procedure. Howev er, the balance in all his accounts
taken together is not expected to exceed 50,000 and the total credit in all the accounts taken together is not expected to exceed 1
lakh. The introducer’s account with the bank should be at least six months old and should show satisfactory transactions.
IS KYC COMPLIANCE A ONE-TIME EXERCISE?
No. Banks can ask customers to re-submit fresh identification and address proof to update their records. They can also ask for
additional documents if they hav e doubts about some transaction in order to prev ent the account from being used for
laundering, terrorist or criminal activ ities.
HAVE BANKS BEEN PENALISED FOR KYC NORM VIOLATIONS?
Yes. The RBI has penalised HDFC Bank, ICICI Bank, Citibank andStandard Chartered Bank.
ET in the Classroom: How Chit funds and crooks raise so much money
Before it became a political slogan, ‘Ma Mati Manush’ was an open-air folk play that enthralled rural Bengal. What’s now unfolding
in Bengal is a sad v audev ille that threatens to destroy liv es and liv elihoods. Here we bring y ou upto speed on the goings on.
How does a bunch of crooks raise so much money ?
Lay inv estors compare returns with post office sav ing schemes. Any thing that looks dramatically better is irresistible to them. Ads,
adv ertorials, word-of-mouth campaigns, collection outlets in ev ery nook and corner, and hefty margins to collection agents work
wonders.
But aren’t there restrictions?
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There’s a way out. These are neither deposits, nor loans, nor bonds, nor stocks. The person who inv ests may be giv en a title to a tiny
slice of land the company buy s or promises to buy . It’s as bizarre as collecting money against teak or sandalwood saplings that would
be worth crores ten y ears later.
Is that how chit funds operate?
No way . Chit funds’ business model is different. Say , each member in a group of 20 puts in Rs1 lakh to create a corpus of Rs2 core.
The fund conducts an auction and members bid to borrow. The winner – say the one quoting a 40% discount — would borrow Rs1 .2
crore, but has to pay back Rs2 crore after 20 months. The pieces of paper on which the discounts are scribbled in the auction are
called chits.
How did the bubble burst?
Saradha indulged in sharp practices of pay ing huge agent commission – as high as 30% — and inv esting illiquid assets like land. It
could not generate abnormal returns that were promised after pay ing agents and another 1 0-1 5% to staff and in ads. Money raised
in 2008 was coming up for repay ment and no fresh funds could be raised to repay as the word was out that Saradha was in trouble.
One hears of v arious 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 pay ing
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 way s to sidestep regulations?
An influential Andhra businessman tried it a few y ears ago by using an HUF (or Hindu undiv ided 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 gov ernment opposed it.
What about the Sahara model?
Sahara raised money by issuing optionally fully conv ertible debentures to crores of inv estors. But others can’t take this route any
more with the Supreme Court backing Sebi that such securities hav e to be listed and regulatory approv al is a must if number of
inv estors 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,
it’s almost impossible to stop ‘cheat funds’.
ET in the classroom: Qualified foreign Investors get direct entry
On January 1 , the gov ernment decided to allow Qualified Foreign Inv estors, or QFIs, to inv est directly in the Indian equities
market, a mov e which it hopes will help boost capital inflows.
Who are qualified foreign investors?
Qualified foreign inv estors, or QFIs, can be indiv iduals, groups or associations based abroad who are allowed by the gov ernment to
inv est directly in mutual funds and stocks of Indian companies.
Last y ear, the gov ernment opened a new window for this class of inv estors 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 inv estors
or NRIs.
Are QFIS a separate class of foreign investors compared to FIIs?
Qualified Foreign Inv estors will be distinct from foreign portfolio inv estors and non-resident Indians. A QFI can, for instance, be a
foreign indiv idual inv estor in Singapore or Russia, who can buy into stocks of a Tata groupcompany or Coal India or any other listed
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stock after fulfilling the Know Your Customer norms through an Indian depository participant and obtaining the approv al of the
RBI.
QFIs can buy up to 5% of the paid-up capital of a company , with the ov erall limit capped at 1 0% in a company . And these
inv estment limits are separate or ov er and abov e 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 div erse set of inv estors in the local markets will help ensure more capital inflows, reduce market
v olatility and deepen the markets. It would also mean facilitating the entry of a set of relativ ely wealthy inv estors who could not
access the Indian markets as there were regulatory restrictions on their entry .
For a long time, the gov ernment and regulators kept foreign indiv idual inv estors at bay owing to concerns relating to
laundering and due diligence. With restrictions in place, foreign indiv idual inv estors had to either buy into Indian stocks
through Participatory Notes, or PNs, or inv est in India-focused offshore funds.
By allowing a new set of inv estors, the gov ernment and regulators are hoping that it will lead to more inflows at a time when
capital inflows hav e v irtually 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 gov ernment’s expenditure ov er its tax and non-tax
rev enues 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 gov ernment cornering the bulk of the sav ings, leav ing 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 y ear, the gov ernment has budgeted a
fiscal deficit of 4.6% of GDP.
REVENUE DEFICIT
Rev enue deficit is an important control indicator. All expenditure on rev enue account should ideally be met from receipts on
rev enue account. Ideally , rev enue deficit should be zero, else the gov ernment debt will keep rising. Rev enue deficit means the
gov ernment is essentially borrowing to consume, a recipe for financial disaster. Ideally , gov ernment borrowing should fund asset
creation, which will y ield returns in the future.
PRIMARY DEFICIT
The primary deficit is fiscal deficit minus interest pay ments the gov ernment makes on its earlier borrowings. It is another indicator
to judge the quality of the gov ernment deficit.
FINANCING OF FISCAL DEFICIT
Market borrowings are the biggest source of funds for meeting the fiscal deficit. The gov ernment also takes a portion of the funds
raised through small sav ings by issuing securities to the fund that manages small sav ings. A part of deficit is also met through
external sources of funds. Prov ident fund accumulations of state gov ernment employ ees is also av ailable for meeting the fiscal
deficit.
FRBM ACT
Enacted in 2003, the Fiscal Responsibility and Budget Management Act had proposed to eliminate rev enue 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
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forced the gov ernment to abandon the path of fiscal consolidation. A new fiscal consolidation framework is expected in the budget for
201 2-1 3 .
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 v erification of address and identity , prov iding financial status, occupation and
such other demographic information to CDSL Ventures Limited (CVL), a wholly owned subsidiary of Central Depository Serv ices
India Limited. Inv estments equal to and more than Rs 50,000 in a mutual fund portfolio necessarily hav e 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 inv estors. You hav e to approach CVL
through any of the point of serv ice (POS). The KYC application form is av ailable on the CVL website in the downloads section. One
can take a printout of the applicable form. The same is also av ailable on mutual fund websites.
Inv estors 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. Alternativ ely , the inv estors 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. Inv estors need not v isit
POS in person. The application can be routed through mutual fund distributors or a representativ e of inv estors. The original
documents are v erified at the counter and giv en back to the applicant or representativ es of the applicant.
Non-resident Indians also need to undertake the same process. They additionally hav e to prov ide certified true copy of their ov erseas
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 ov erseas branches of scheduled commercial banks registered in India.
POS upon v erification 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 representativ es of POS. In the case of joint holdings in a portfolio, all joint holders
hav e to get themselv es KYC-compliant. Applications where the inv estments are in joint names, photocopies of KYC
acknowledgement letters of all applicants must be attached with the application form. In the case of inv estments 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 y ou hav e completed in respect of any of the mutual fund
houses. It is y our responsibility to do so. You can attach a photocopy of KYC acknowledgement letter, along with the application
letter, at the time of fresh inv estments. You can simply write to the fund houses where y ou hav e an inv estment and request them
to update y our 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 y our request for additional inv estments in y our mutual fund portfolio.
A point to note that upon submission of y our KYC acknowledgement letter, the mutual fund house will update y our status in their
books. The address mentioned in y our KYC letter will prev ail ov er the address y ou hav e mentioned in y our 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
WHAT IS A NON-DELIVERABLE FORWARD, OR NDF?
Non-deliv erable forwards are ov er-the-counter transactions settled not by deliv ery but by exchange of the difference between the
contracted rate and some reference rate such as the one fixed by the Reserv e Bank of India.
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The need for an NDF market arose because there were countries where forwards trading in currencies is not allowed or is allowed
with a lot of restrictions that increases the cost of hedging for corporates. Also, such a market was felt necessary for economies with
partially conv ertible currencies.
WHERE DO THESE TRADES HAPPEN? WHICH ARE THE PROMINENT CURRENCIES?
NDF trading happens in cities such as Singapore, London, New York and Hong Kong. Brazilian Real, Chinese Renminbi, Taiwanese
dollar, South Korean won and Indian rupee are among the prominent currencies.
WHO TRADES IN NDFS?
Hedge funds and foreign institutional inv estors, which are allowed to hedge only their actual exposure and not potential exposure;
global corporations that do their inv oicing in Indian rupee but are not allowed to hedge their exposures; and speculators betting on
the direction of the rupee without any exposure.
HOW DOES AN NDF TRANSACTION OCCUR?
An Indian corporate that is registered in, say , Singapore under a different name and has nothing to do with its Indian counterpart
legally , may buy dollars from the spot market in India (Mumbai) at, say , 53 .60 per dollar (the reference rate) and sell it in the NDF
market in Singapore at 54 per dollar (the contract rate), making an arbitrage of 40 paise. The transaction is carried out by a
foreign bank that has branches in both Mumbai and Singapore.
WILL NDF MARKET MOVEMENTS AFFECT SPOT RATES?
Yes, they do to some extent and mainly through international banks and companies that take offsetting positions in the domestic
and ov erseas books. WILL RBI CURBS ON OVERNIGHT POSITIONS AFFECT NDFS? Yes, it will squeeze international banks that were
profiting from the wild currency mov ements through their positions in the NDF market while pressuring the spot market due to
temporary factors. RBI studies had shown weak linkage between the domestic and NDF markets when the currency mov ements are
in a narrow range.
WHAT ARE FIXING AND SETTLEMENT DATES?
The fixing date is the date on which the difference between the prev ailing market exchange rate and the agreed upon exchange rate
or the reference rate is calculated.
Budget 2012: All you wanted to know about DTC and other taxes
ET’s helps readers navigate through the maze of tax jargon:
Direct Taxes: It’s the tax indiv iduals & companies pay directly to the gov t.
Corporation Tax: It’s the tax companies pay (30% at present) on their profits.
Taxes On Income Other Than Corp Tax: It’s income-tax paid by indiv iduals or ‘non-corporate assessees’. This ranges from 1 0%
to 30%, depending on income.
Securities Transaction Tax ( STT): Applicable if y ou’re dealing in shares or mutual fund units. It was introduced in the 2004-05
budget, replacing the tax on profits earned from the sale of shares held for more than a y ear (known as long-term capital gains tax).
Minimum Alternate Tax (MAT): Indian companies pay 30% tax on profits as per the I-T Act. But tax holiday s could lower the
outgo. If a company ’s tax liability is less than 1 0% of its profits, it has to pay a MATof 1 5% of book profits. This prov ision is expected
to change once the direct taxes code (explained below) proposals are accepted. Under DTC, MAT will be lev ied on gross assets.
INDIRECT TAXES: It’s essentially a tax on expenditure. Considered regressiv e, this tax does not distinguish between the rich and
the poor and hence most gov ernments prefer to raise their rev enues through direct taxes.
Customs: Any thing y ou bring from abroad comes at a price. By lev y ing a tax on imports, the gov ernment achiev es twin
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objectiv es: it raises rev enues and protects local industries.
Union Excise Duty : Imposed on goods manufactured in the country .
Service Tax: You pay the gov t when y ou eat out or v isit y our hairdresser — it is a tax on serv ices rendered. Lev ied on 1 1 9
activ ities.
Value-Added Tax: State gov ernments lev y this on goods at the point of sale, based on the difference between the v alue of the
output and the v alue of inputs used to produce it. The aim here is to tax a firm only for the v alue it adds to the inputs, and not the
entire input cost. Thus, VAT helps av oid 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 lev ied on goods, including central and state-lev el taxes. Billed as an improv ement on the VAT sy stem, 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 activ ities that
hav e come since then, the gov ernment formulated the DTC. It proposes to simplify tax laws and include a new way to calculate
taxes on income.
Budget Process
The gov ernment’s annual budget is no different from that of a household, only it has a lot more jargon. In a fiv e part series, ET will
help readers make sense of the key items of the budget, from rev enue 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 minister’s 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 1 3-1 5 other documents. Div ided 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 gov t’s finances. All rev enues, money borrowed and receipts from loans it has giv en flow into this account. All
gov ernment 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 prov ident fund. The gov ernment 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 pay ments that do not entail sale or creation of assets fall
under the rev enue 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 receiv e interest).
REVENUE VS CAPITAL
The budget has to distinguish all receipts/expenditure on rev enue account from other expenditure. So all receipts in, say , the
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consolidated fund, are split into Rev enue Budget (rev enue account) and Capital Budget(capital account), which include non-
rev enue receipts and expenditure.
REVENUE/CAPITAL BUDGET
The gov t has to prepare a Rev enue Budget (detailing rev enue receipts and rev enue expenditure) and a Capital Budget (capital
receipts & capital expenditure).
ET in the classroom: All you want to know about Economic Survey
The first Economic Surv ey was reportedly presented for the financial y ear 1 951 -52 and since has been presented ev ery y ear as a
rev iew of the economy by the gov ernment. Ov er the y ears, the Economic Surv ey has transformed from a mere representation of
facts to a more suggestiv e document giv ing out adv ice.
What Is The Economic Survey?
The Economic Surv ey is a y early report card of the economy put out by the Chief Economic Adv isor. It is a comprehensiv e
document that analy ses important economic, financial and social dev elopments ov er the y ear. Ov er the y ears, it has expanded to
accommodate more sectors and include more of analy tical content. From 362 pages in 2004-05, the surv ey has grown to a 459
page document in 201 0-1 1 that included separate chapters on prices, financial intermediation, and serv ice, reflecting their
importance in the economic debate.
What Is The Significance Of The Survey?
In terms of information, the Surv ey has little usefulness as most of the data presented is already out in the public domain. Its real
significance is that it lay s down the economic reforms agenda for the country and contains suggestions to the policy makers 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 Surv ey will find their way into the budget.
Has The Survey Lived Up To Its Role?
Though the Surv ey is tabled in Parliament by the finance minister, it largely reflects the v iews of the chief economic adv isor. The
reforms agenda laid out in the Surv ey 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 Surv ey documents y ear after y ear does not
usually reflect in the budget presented the next day . But it does lay down the ground for informed debate on v arious economic
issues.
ET in the classroom: Non-inflationary rate of growth
Economist, Nomura
In a recent interv iew to the Wall Street Journal, D Subbarao, gov ernor of the Reserv e Bank of India, said India’s
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 achiev e 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 & serv ices. 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.
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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 lev el of growth
higher than 7 % could translate into another bout of high inflation unless there is inv estment in capacity creation and easing supply
bottlenecks to increase resource flow. According to theRBI annual bulletin for the y ear 201 0-1 1 , the threshold for inflation was in
the range of 4-6%.
“Lower trend growth is the result of sharp falls in the inv estment and sav ings rates, a higher fiscal deficit
reforms. Therefore, concerted efforts to address supply -side bottlenecks are imperativ e to rev erse the decline.” say s Sonal Varma
ET in the classroom - BEGGAR THY NEIGHBOUR POLICY
What is beggar thy neighbour policy
The beggar thy neighbour policy refers to a policy that aims at addressing ones own domestic problems at the expense of others
trading partners in particular.
What are the instances of such a policy
The most popular forms of a beggar thy neighbour policy are in the areas of foreign trade and currency
management.Conv entionally ,countries often impose tariff barriers and restrict imports to protect their domestic
industries.Howev er,with globalisation,such practices are not popular.But to achiev e its domestic policy objectiv e,for
instance,encouraging exports,central banks dev alue or encourage the depreciation of their own currencies compared to its trading
partners to retain their respectiv e competitiv e edge.Sometimes economies compete in encouraging appreciation of their currencies
to tame inflation at the expense of hurting income in the exporting countries.
Is China adopting a beggar thy neighbour policy
Many economists,especially in the US,say China has deliberately kept the v alue of its currency low to forge ahead in exports.But in
this case,more than the competitors,the importing country ,US,is complaining because more than any thing else,cheap Chinese
imports are hurting its domestic economy .
How do current economies policies compare
Currently ,the raging concern among most emerging market economies in Aisa is spiralling inflation on account of rising global
commodity prices.Central banks in most economies,including Indias,are (though not necessarily planned) encouraging
appreciation of their respectiv e currencies.This is helping them curtail inflation arising out of imported goods as imposing tariff
barriers is perceiv ed to be against the principles of free trade.Such a practice hurts export earnings of the countries from where such
imports are sourced.But the impact also depends on how crucial such exports are for each economy .
What are the limitations of such a practice
In certain cases,such a policy may prov e counter productiv e.If,for instance,ev en the competing country counters one policy
mov e,of say ,depreciation (to protect exports ) then such a practice may not hav e desirable results,especially the country s imports
are not price elastic (the imports are essential and not dependent on prices) and instead could end up hurting the trade balance
through higher import price and resulting in inflation in such economies.
ET in the classroom: Interest Rate Swap
What is an interest rate swap?
An interest rate swap is an ov er-the-counter (OTC) deriv ativ e instrument av ailable in the currency market where counter parties
can exchange a floating pay ment for a fixed pay ment and v ice-v ersa related to an interest rate.
Financial institutions going for foreign borrowings usually buy interest rate swaps to hedge their interest rate exposure due to
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fluctuating interest rates.
These were originally created to allow multinational companies to ev ade exchange controls. Today , they are used to hedge against
or speculate on changes in interest rates.
Interest rate swaps are also used speculativ ely by hedge funds or other inv estors who expect a change in interest rates or the
relationships between them. Traditionally , fixed income inv estors who expected rates to fall would purchase cash bonds, whose
v alue increased as rates fell.
Today , inv estors with a similar v iew could enter a floating-for-fixed interest rate swap; as rates fall, inv estors 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 pay s a fixed rate (the swap rate) to counter party B while
receiv ing a floating rate (usually pegged to a reference rate such as LIBOR — London Inter Bank Offered Rate).
A pay s fixed rate to B (A receiv es floating rate)
B pay s floating rate to A (B receiv es fixed rate).
Consider the following swap in which Party A agrees to pay Party B periodic fixed interest rate pay ments of 3 .7 84%, in exchange for
periodic floating interest rate pay ments of LIBOR + 7 0 bps (0.7 0%). There is no exchange of the principal amount and that the
interest rates are on a notional principal amount.
The interest pay ments are settled in net. The fixed rate (3 .7 84% in this example) is referred to as the swap rate.
What are the different ty pes of swaps?
Being OTC instruments, interest rate swaps can come in a huge number of v arieties 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 abov e 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 pay ment, as does
floating-for-floating swap.
ET in the classroom: Deposit Insurance
What is deposit insurance?
It is a limited lev el of protection prov ided by the gov ernment to depositors against bank failures. Ev ery bank is mandatorily cov ered
under the lev el of Deposit Guarantee and the Insurance Corporation of India. It is particularly relev ant in countries like India where
financial literacy is v ery low. At a macro-lev el, its objectiv e is to contribute to the stability of the financial sy stem.
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
cov ered under the deposit insurance scheme. Ev en co-operativ e banks are cov ered. The scheme, howev er, does not cov er deposits
with NBFCs and company fixed deposits.
What is the amount covered and how is the premium charged?
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Under the prov isions of the DICGC Act, the insurance cov er deposits up to Rs 1 00,000 under the deposit insurance. The premia to be
paid by insured banks are computed on the size of their deposits. Insured banks pay adv ance insurance premia to the Corporation
semi-annually , within two months from the beginning of each financial half y ear, based on its deposits at the end of prev ious half
y ear. The premium is currently pegged at Re 1 for ev ery Rs 1 ,000 of the deposits.
What types of deposits are covered under the scheme?
The Corporation insures all bank deposits, such as sav ings, fixed, current, recurring, etc., except deposits of foreign gov ernments;
deposits of central/state gov ernments, deposits of state land dev elopment banks with the state co-operativ e banks, inter-bank
deposits, deposits receiv ed outside India.
How are the claims settled?
In the ev ent of winding up or liquidation of an insured bank, ev ery depositor is entitled to pay ment 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 . Howev er, the pay ment to each depositor
is subject to the limit of the insurance cov erage fixed from time to time.
ET in a classroom: Cheque Truncation System
What is cheque truncation?
It is one of the major innov ations in cheque clearing after the Magnetic Ink Character Recognition (MICR) cheques introduced in the
80s. Cheque truncation is a sy stem between clearing and settlement of cheques based on electronic images. This form of clearing
does not inv olv e any phy sical exchange of instrument.
Bank customers would get their cheques realised faster as local cheques are cleared almost the same day as the cheque is presented
to the clearing house, while intercity clearing happens the next day . Besides speedy clearing of cheques, banks also hav e additional
adv antage of reduced reconciliation and clearing frauds. It is also possible for banks to offer innov ativ e products and serv ices based
on CTS.
Why is it needed?
Though MICR technology helped improv e efficiency in cheque handling, clearing is not v ery speedy as cheques hav e to be
phy sically transported all the way from the collecting branch of a bank to the drawee bank branch.
The CTS is more adv anced and more secure. Many countries hav e sought to address this issue with cheque truncation, in which the
mov ement of the phy sical instruments is curtailed at a point in the clearing cy cle, bey ond which the process is completed, purely
based only on the electronic data and images of the cheques.
What has been the international experience in this regard?
Denmark and Belgium are pioneers in CTS. They adopted complete cheque truncation sy stem more than two decades ago. Sweden is
the ty pical example for hav ing achiev ed complete truncation where all the cheques can be presented and encashed at any branch;
irrespectiv e of the bank on which they are drawn. CTS also takes care of the needs of future electronic transactions.
What has RBI and banks done?
RBI has already enabled CTS to be fully functional in New Delhi. Soon ev en cheque clearing in Chennai will be settled through CTS.
Banks hav e also taken steps to introduce appropriate technology to facilitate this sy stem.
What are the salient features of CTS?
The phy sical cheque is truncated within the presenting bank itself. Settlement is generated on the basis of current MICR code line
data. These images will be archiv ed electronically and be preserv ed for eight y ears. A centralised agency per clearing location will
act as an image warehouse for the banks.
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ET in the Classroom: Capital Controls
What are capital controls?
Foreign capital inflows in the form of loans and equity that are allowed in a restricted form are said to be controlled. Many countries
which had closed economies had imposed sev ere restrictions on foreign capital. Howev er, as these economies started opening up in
the 80s, capital controls were eased, facilitating free flow of capital and ensuring integration with global financial markets.
What are capital inflows?
From the perspectiv e of balance of pay ments — a country ’s external sector balance sheet — foreign currency inflows are broadly
div ided into current account and capital account flows. While current account flows arise out of transactions in goods and serv ices
and are permanent in nature, capital account flows are essential in v arious kinds of loans and equity inv estments, which can be
rev ersed. That is why policy makers hav e to keep a close ey e on capital flows.
What are the kind of capital inflows in India?
These would include inflows through foreign borrowings by Indian corporates and businesses, NRI deposits and portfolio flows from
institutional inv estors into the stock markets Loans to gov ernment and short-term trade credit are also included.
What has been the extent of dismantling of capital controls in India?
India had controls on both capital account transactions as well as on the current account with the local currency fixed by the
central bank. Howev er, since 1 991 , when structural changes to the Indian economy were carried out, the rupee was first made
conv ertible on the current account. Subsequently , capital controls were eased. In 1 994, a big shift took place with the gov ernment
allowing foreign portfolio inv estments. Ov er a period of time, foreign direct inv estment norms and ov erseas borrowing norms were
eased.
Why are policy makers thinking of reimposing controls?
Though allowing foreign capital allows firms in a capital scarce economy to access cheaper resources to finance their growth plans,
the flip side is that it presents risks to v alue of the country ’s currency as well as managing local liquidity arising out of such inflows
(as the central bank buy s the foreign currency and pumps in local currency ).
Dependence on foreign capital could leav e a country v ulnerable to risks, arising out of a abrupt rev ersal of flows. With many
emerging economies remaining relativ ely unscathed after the global financial crisis, there has been a surge in such inflows, leading
to an appreciation in their currencies, including in India. But inflows bey ond the absorptiv e capacity of an economy pose other
challenges such as high demand side inflation.
ET in the Classroom: Understanding Aviation Industry Jargon
Av iation business is riddled with gobbledy gook such as code-sharing and business av iation 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. Howev er, in itself, a high PSF does not mean that
the airline is making money . The flights could be hav ing high occupancy because of the low fares offered.
What is code-sharing ? Why do airlines enter into such arrangements?
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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 hav e 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 India’s website then he or she would find a flight ev en if the
national carrier does not operate to the German capital. The passenger would locate a Lufthansa flight on Air India’s website as the
two hav e a code-share agreement. Without the arrangement, airlines would lose traffic to bigger riv als. Such an arrangement is
extremely beneficial for smaller airlines.
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pranav eJuly 26, 201 3 at 1 0:46 am
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sir what is the income limit for obc non creamy lay er
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INSIGHTSJuly 26, 201 3 at 1 0:51 am
It is Rs 6 Lakhs.
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SabyaAugust 20, 201 3 at 7 :09 pm
Thank y ou ! Bless y ou !
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