ET in Classroom Economics

ET in Classroom articles
Source:
http://articles.economictimes.indiatimes.com
http://csatstudymaterial.org
ET in the Classroom: Capital Controls
ET Bureau Feb 2, 2010, 03.58am IST

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 severe restrictions on foreign capital. However, 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 perspective of balance of payments a country's external sector
balance sheet foreign currency inflows are broadly divided into current
account and capital account flows. While current account flows arise out of
transactions in goods and services and are permanent in nature, capital
account flows are essential in various kinds of loans and equity investments,
which can be reversed. That is why policy makers have to keep a close eye
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 investors into the stock markets Loans to government and shortterm 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. However,
since 1991, when structural changes to the Indian economy were carried out,
the rupee was first made convertible on the current account. Subsequently,
capital controls were eased. In 1994, a big shift took place with the
government allowing foreign portfolio investments. Ov1er a period of time,
foreign direct investment norms and overseas 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 value of the country's currency as well as managing local
liquidity arising out of such inflows (as the central bank buys the foreign
currency and pumps in local currency).
Dependence on foreign capital could leave a country vulnerable to risks,
arising out of a abrupt reversal of flows. With many emerging economies
remaining relatively 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 beyond the absorptive capacity of an
economy pose other challenges such as high demand side inflation.
__________________________________________________________
ET in the classroom: Various types of Tax

Taxes come in various shapes and sizes, but primarily fit into two little slots.
DIRECT TAX
This is the tax that you, I (and India Inc) directly pay to the govern-ment for
our income and wealth. So income tax, wealth tax, and STT are all direct
taxes.
INDIRECT TAX
This one's a double whammy: It's essentially a tax on our expenditure, and
includes customs, excise and service tax. It's not just you who thinks this
isn't fair - governments too consider this tax 'regressive', as it doesn't check
whether you're rich or poor. You spend, you pay. That's precisely why most
governments aim to raise more through direct taxes.
MAKING YOU PAY
The various taxes that the government levies
CORPORATION (CORPORATE) TAX
It's the tax that India Inc pays on its profits.
TAXES ON INCOME OTHER THAN CORPORATION TAX
It's income-tax paid by 'non-corporate assessees' people like us.
FRINGE BENEFIT TAX (FBT)
No free lunches here. If you want the jam with the bread and butter, you'd
better pay for it. In the 2005-06 Budget, the government de-cided to tax all
perks what is calls the 'fringe benefit' given to employees. No longer
could companies get away with saying 'ordinary business expenses' and
escape tax when they actually gave out club memberships to their
employees. Employers have to now pay a tax (FBT) on a percentage of the
expense incurred on such perquisites.
SECURITIES TRANSACTION TAX (STT)
If you're dealing in shares or mutual funds , you have to loosen those purse
strings a wee bit too. STT is a small tax you need to pay on the total amount
you pay or receive in a share deal. In the 2004-05 Budget, the government
did away with the tax on profits earned on the sale of shares held for over a
year (known as long-term capital gains tax) and replaced it with STT.
CUSTOMS
Anything you bring home from across the seas comes with a price. By
levying a tax on imports, the government's firing on two fronts: it's filling its
coffers and protecting Indian industry.
UNION EXCISE DUTY
Made in India? Either way, there's no escape. In other words, this is a duty
imposed on goods manufactured in the country.
SERVICE TAX
If you text your friend a hundred times a day, or can't do with-out the
coiffeured look at the neighbourhood salon, your monthly bill will show up
a little charge for the services you use. It is a tax on services rendered.
__________________________________________________________
ET in the classroom: Non-tax sources of income for the government

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 RBI's ability to

conduct exchange rate and monetary management. These securities issued
under MSS are not to meet the government's 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.
__________________________________________________________
ET in the Classroom: Fiscal Consolidation

What is fiscal consolidation
A conscious policy effort is needed by the government to live within its
means and thereby bring down the fiscal deficit and public debt. It includes,
among other things, efforts to raise revenues and bring down wasteful
expenditure such as subsidies . As a larger mandate, it also involves the
participation by state governments in the process. But the whole initiative is
planned as a long-term exercise by the government through a road map for
fiscal reform rather than through a single Budget announcement. This is
particularly true for a country like India where the government's expenditure
is way beyond its revenues, forcing it to borrow.
Why do rating agencies often express their concern about it?
Just as a borrower's creditworthiness depends on her indebtedness, a
country's rating is often linked to its fiscal deficit. Fiscal consolidation
efforts are looked at positively by sovereign-rating agencies. This is because
it gives them an indication of a country's financial strength and hence, its
ability and capacity to service the debt it raises. Many a time, even though
an economy has grown well or its other indicators, such as external sector
strength, are buoyant, it does not get a good rating only on the ground of
poor efforts at fiscal consolidation.
How is India placed on fiscal consolidation ranking?
For many years, India ranked low on fiscal consolidation. However, from
2003 onwards , the government made conscious efforts to bring down its
fiscal deficit and public debt after it passed the Fiscal Responsibility and
Budget Management (FRBM) Act. This enabled the government to pursue
fiscal reforms aimed at committing to a pre-decided level of deficit.
Though its efforts went off well in the initial years, government finances
slipped in the last two years as it was forced to provide fiscal sops initially
to tackle high inflation and then to contain the impact of the global financial
crisis of 2008-09 that hit the real economy hard. As a result, through its
fiscal stimulus package, it had to announce several fiscal concessions and

also increase expenditure on account of some sops. This ended in a further
worsening of the country's finances.
What is India going to do about it?
Although the government does not borrow overseas, it cannot ignore the fisc
as it is now a part of the global economy. The cost of borrowing for private
corporates which raise money overseas, depends a lot on its home country's
sovereign ratings . It is expected that finance minister Pranab Mukherjee
will roll out a road map for fiscal consolidation during the Union Budget,
which includes unwinding of the fiscal stimulus.
__________________________________________________________
ET in the classroom: Interbank liabilities
ET Bureau Mar 9, 2010, 01.41am IST

How does a bank meet its day-to-day shortfalls of cash?
A bank treasury official's key task is to match the assets of a bank (loans
which mostly are long term) with its liabilities (that are mainly short term.)
Put simply, a bank's liabilities with other banks are its inter-bank liabilities
(IBL). These mainly consist of its borrowings in the overnight call money
market and money raised by selling certificate of deposits of other banks.
Even interbank CBLO and repurchase (repo) transactions where a bank
borrowing overnight funds from another bank is an IBL for the lending
bank. Well, deposits raised from retail investors are part of a bank's total
liabilities.
How is CBLO and repo different from call money?
A bank goes to the Collateralised Borrowing and Lending
Obligations(CBLO) market if he has government securities and wants to get
cash. The repo facility is used if a bank wants to increase his SLR, since a
bank can get government securities in lieu of the cash deposited. Both are
run by the Clearing Corporation of India and transactions take place on the
screen. However, call money market does not involve exchange of
securities. Here cash is borrowed and lent, through telephone calls between
banks.
CBLO is becoming popular with market participants in recent years because
its much more efficient and a secured market (government securities are
used as collateral.) In recent months, volumes in CBLO have been in the
range of Rs 50,000-75,000 crore daily, while that in market repo and call
money are around Rs 20,000 crore and Rs 10,000 crore everyday.
To what extent can a bank have such liabilities on their books?
In March 2007, RBI limited a bank's IBL to twice its net worth. A higher
IBL limit up to 300% of the net worth was allowed for banks whose CRAR
was at least 25% more than the minimum CRAR (9%) i.e., 11.25%.
10
Why is the regulator concerned?

According to RBI, the liability-side management has its own merits from the
point of view of financial stability. Controlling the concentration risk on the
liability side of banks is therefore as important as controlling the
concentration risk on the asset side. More particularly, uncontrolled IBL
may have systemic implications, even if, the individual counterparty banks
are within the allocated exposure. Further, uncontrolled liability of a larger
bank may also have a domino effect.
__________________________________________________________
11
ET in the classroom: Indian Depository Receipts

What is Indian Depository Receipt (IDR)?
An IDR is a receipt, declaring ownership of shares of a foreign company.
These receipts can be listed in India and traded in rupees. Just like overseas
investors in the US-listed American Depository Receipts (ADRs) of Infosys
and Wipro get receipts against ownership of shares held by an Indian
custodian, an IDR is proof of ownership of foreign company's shares. The
IDRs are denominated in Indian currency and are issued by a domestic
depository and the underlying equity shares are secured with a custodian.
An Indian investor pays in Indian rupees for the IDR whereas a shareholder
in the issuer's 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
12
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.
__________________________________________________________
13
ET in the classroom: Viability gap funding

What is viability gap funding?
There are many projects with high economic returns, but the financial
returns may not be adequate for a profit-seeking investor. For instance, a
rural road connecting several villages to the nearby town. This would yield
huge economic benefits by integrating these villages with the market
economy, but because of low incomes it may not be possible to charge user
fee. In such a situation, the project is unlikely to get private investment. In
such cases, the government can pitch in and meet a portion of the cost,
making the project viable. This method is known as viability gap funding.
How does the scheme work?
VGF is typically provided in competitively bid projects. Under VGF, the
central government meets up to 20% of capital cost of a project being
implemented in public private partnership (PPP) mode by a central ministry,
state government, statutory entity or a local body. The state government,
sponsoring ministry or the project authority can pitch in with another 20%
of the project cost to make the projects even more attractive for the
investors. Potential investors bid for these projects on the basis of VGF
needed. Those needing the least VGF sup-port will be awarded the project.
The scheme is administered by the ministry of finance.
Which are the eligible sectors?
Projects in a number of sectors such as roads, ports, airports, railways,
inland waterways, urban transport, power, water supply, other physi-cal
infrastructure in urban areas, infrastructure projects in special eco-nomic
zones, tourism infrastructure projects are generally eligible for viability gap
funding. The government now proposes to add social sectors such as
education and health to the list.
How does the government benefit?
14
The government has limited resources. It can use those funds to build
everything on its own, but such public funding will take years to cre-ate the
infrastructure that is needed to achieve higher growth. Through viability gap
funding, the same amount of funds can be used to execute many more
projects through private participation. VGF is in that sense a force
multiplier, enabling government to leverage its re-sources more effectively.
What has been the success rate?
The government has so far approved 199 VGF-supported projects in-volving
investment of Rs 170,651 crore by the end of December 2009.
__________________________________________________________
15
ET in the classroom: India refuses 'market economy' status to China
ET Bureau Apr 1, 2010, 03.26am IST

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 China's 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
16
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 China's 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.
__________________________________________________________
17
ET in the Classroom: Strips: get the right view

What is STRIPS?
It is an acronym for Separate Trading of Registered Interest and Principal of
Securities. Stripping is an act of detaching the interest payment coupons
from a bond and treating the coupons and the body as separate securities.
Each security so created, entitles its owner to a specified cash return on a
specific date. These are known as 'zero coupons' or 'zeros' because there are
no periodic interest payments on each instrument. After stripping, the zerocoupon bonds trade in the market at a discount and are redeemed at a predetermined face value.
For example, a 20-year bond with a face value of Rs 1,000 and a 10%
interest rate could be stripped into its principal and its 40-semi-annual
interest payments. The result would be 41 separate zero coupon instruments,
each with its own maturity date. The principal would be worth Rs 1,000
upon maturity, and each interest coupon of Rs 100, or one-half the annual
interest of 10% on Rs 1,000. Each of the 41 distinct securities so created
would be traded separately until its maturity date at prices determined by the
market.
How is it useful?
STRIPS are usually preferred by market players who have a certain cash
requirement at a fixed time. Buying the zero-coupon bonds can help them
fulfil that requirement without worrying about the fluctuation in prices.
Since there are no periodic interest payment, a bond holder does not have to
worry about the need for reinvestment of intermediate cash flows.
For the larger market too, Strips are beneficial since they will lead to the
development of a market-determined zero coupon yield curve (ZCYC). In
its recent release opertaionalising STRIPS from April 1, RBI said
instruments should also appeal to retail investors, given the simplicity of
such securities.
How will it be done?
18
Stripping is to be carried out at RBI through an automated process within

the Negotiated Dealing System (NDS) the debt-trading platform.
Requests for stripping is to be generated and approved by market
participants on the NDS, which will thereafter flow to a chosen Primary
Dealer (PD) for authorisation, RBI release said. Initially, STRIPS are to be
tradable only in the OTC market and reported on NDS.
What is the experience of STRIPS abroad?
It was in February 1985 that the US Treasury introduced STRIPS intended
primarily to reduce the cost of financing the public debt "by facilitating
competitive private market initiatives." Zeros have since become most
popular for investments on which taxes can be deferred, such as individual
retirement accounts and pension plans, or for non-taxable accounts.
__________________________________________________________
19
ET in the classroom: Government bond auctions

ET helps you know all about government bond auctions.
What was the need for bond auctions?
As the country started reforming its financial markets in the 90s, the need
was felt to put an end to "automatic monetisation" of fiscal deficit the
practice of printing more money when government expenses overshot
revenues. The abolition of monetisation led to significant increases in
market borrowings of the government. Putting in place a systematic process
for auction of government securities (G-sec) was the central bank's next
challenge.
What was the system that was put in place?
Today, everytime the government needs money, RBI announces the auction
of government securities through a press notification, and invites bids. The
sealed bids (bids received electronically as well as physically) are opened at
an appointed time, and the allotment is based on the cutoff price decided by
RBI. Successful bidders are those that bid at a higher price, exhausting the
accepted amount at the cutoff price. For the past one year, RBI has followed
a uniform price auction method where all successful bidders pay a uniform
price, which is usually the cut-off price (yield). (Earlier it followed the
discriminatory price auction, in which all successful bidders paid the actual
price (yield) they bid for.)
Are government bonds available in demat?
Government bonds are largely issued in the demat form. But unlike other
bonds, their records are not maintained in either NSDL or CDSL. Records
of G-secs are maintained in the subsidiary general ledger a demat
account maintained by RBI. Banks and primary dealers hold bonds in the
demat form in SGL while other entities need to open a constituent account
with banks through which they can hold the bonds. It is also possible to hold
the bonds in a physical form.
20
What is the role played by primary dealers in auctions?

Taking lessons from the US, RBI instituted a system of primary dealers in
the 90s STCI and DFHI were the first PDs in the country. These bond
houses underwrite bond auctions , which means they agree to buy securities
if not fully sold, in lieu of small commissions . One day prior to the auction,
bids are received from PDs, indicating the amount they are willing to
underwrite and the fee expected.
The auction committee of RBI then examines the bid on the basis of the
market condition and takes a decision on the amount to be underwritten and
the fee to be paid. Today G-secs , State Development Loans & TreasuryBills are regularly sold by RBI through periodic public auctions . PDs like
ICICI Securities, Nomura, Morgan Stanley, STCI underwrite auctions.
Can retail investors participate in G-sec auctions?
Individuals can participate in the auctions on 'non-competitive' basis,
indirectly through a scheduled bank or a primary dealer offering such
services. Here, allocation of the securities is at a price not higher than the
weighted average price arrived at on the basis of the competitive bids
accepted at the auction. FIIs are not allowed to buy G-secs in auctions
(primary market ), but can buy them later in the secondary market.
__________________________________________________________
21
ET in the Classroom: Asset-liability mismatch
ET Bureau May 6, 2010, 05.24am IST

What is asset-liability mismatch?
Banks' primary source of funds is deposits, which typically have short- to
medium-term maturities. They need to be paid back to the investor in 3-5
years. In contrast banks usually provide loans for a longer pe-riod to
borrowers. Home loans, for instance, can have a tenure of up to 20 years.
Providing such loans from much shorter maturity funds is called assetliability mismatch. It creates risks for banks that need to be managed.
What are the consequences of asset-liability mismatch?
The most serious consequences of asset-liability mismatch are interest rate
risk and liquidity risk. Because deposits are of shorter maturity they are
repriced faster than loans. Every time a deposit matures and is rebooked, if
the interest rates have moved up bank will have to pay a higher rate on
them. But the loans cannot be repriced that easily. Because of this faster
adjusting of deposits to interest rates asset-liability mismatch affects net
interest margin or the spread banks earn.
Liquidity issues also arise when loans and deposits have different maturities. Depositors have to be repaid when their funds mature, but banks
cannot recall their loans. They will have to find new deposits or roll over
those maturing or else they will not be able to service their depositors. In an
acute situation they may have to pay really high in-terests to raise funds.
How do banks manage asset-liability mismatches?
Most banks have elaborate institutional arrangement to manage assetliability mismatches. The interest rate risk is usually managed by pric-ing a
large percentage of loans at variable interest rates that move in tandem with
market rates. Fixed rate loans are, therefore, usually priced at a huge mark
up to variable rate loans to entice borrowers to opt for the latter.
This takes care of interest rate risks as loans are linked to a benchmark and
repriced when the benchmark rate moves up. Sophisticated derivatives are
22
also used to manage interest rate risk. Liquidity risk involves a more hands
on management. RBI requires banks to have dedicated asset-liability
management committees to manage liquidity risks. A careful matching of
cash inflows and out-flows and gap funding are employed to manage
liquidity risks.
__________________________________________________________
23
ET in the classroom: Offshore Banking Unit
ET Bureau Jun 1, 2010, 03.02am IST

What is offshore banking unit?
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, it's 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
24
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.
__________________________________________________________
25
ET in the classroom: Exchange Traded Funds

What are Exchange Traded Funds (ETFs)?
An ETF is a basket of stocks that reflects the composition of an index, like
S&P CNX Nifty, BSE Sensex or the banking index. An ETF's trading value
is based on the net asset value of the underlying stocks that it represents. It
is similar to a mutual fund that you can buy and sell in real-time at a price
that changes during the trading session. ETFs are essentially index funds
that are listed and traded on exchanges like stocks. They enable investors to
gain broad exposure to entire stock markets in different countries and
specific sectors with relative ease, on a real-time basis and at a lower cost
than many other forms of investing.
What are the type of ETFs?
The two popular ETFs in India are index ETFs and commodity ETFs. Most
ETFs in India are index funds that hold securities and attempt to replicate
the performance of a stock market index. Nifty Bees, Junior Bees, Gold
Bees, Bank Bees and Hang Sang Bees are some of the ETFs traded in India.
Among the commodity ETFs, gold ETFs are actively traded in India.
What are the advantages and disadvantages of using ETFs?
There are several benefits in investing in ETFs. They can be easily bought
and sold like stocks during trading hours using your demat account with no
additional paperwork. They have lower expense ratio and the minimum
investment is of one unit. However, unlike mutual funds that do not need a
demat account, for buying and selling ETFs you need a trading account.
Also since ETFs, like stocks, are bought through a broker, every time you
trade you also end up paying brokerage for your transaction. However, ETFs
allow investors to take the benefit of intra-day movements in the market,
which is not possible with open-ended funds.
Take the example of a gold ETF. Buying physical gold and storing it
involve tedious processes. You will have to pay a mark up to the jeweller
and then spend some more get a bank locker. On the other hand, buying,
26
selling and storing gold in electronic form is more convenient and priceeffective. As ETFs are listed on the exchanges, distribution and other
operational expenses are significantly lower.
How are ETFs used?
Asset allocation: For individuals it could be difficult to manage asset
allocation given the cost involved. ETFs provide investors with exposure to
broad segments of the equity markets. They enable investors to build
customised investment portfolios in line with their risk taking ability and
time horizon.
Ride the market rally: Many times, investors need time to make investment
decisions, like buying a particular stock, but do not want to miss out on the
opportunity in the stock markets. At such times they can park their funds in
ETFs. Because ETFs are liquid, investors can participate in the market rally
while deciding where to invest the funds for the longer-term, thus avoiding
potential opportunity costs.
Hedging Risks: ETF's can be used as hedging vehicle because they can be
borrowed and sold short. The smaller denominations in which ETFs trade
relative to most derivative contracts provide a more accurate risk exposure
match, particularly for small investment portfolios.
__________________________________________________________
27
ET in the classroom: China's yuan move

What is the issue with yuan?
China and the US have been trading charges over the exchange rate of the
yuan. The US has accused the country of keeping the yuan undervalued,
which, it argues, is the primary reason for the high trade deficit it runs with
the country. The undervalued yuan, many experts have said, is also the
reason for global imbalances deficits in the developed world and surplus
in China.
What exactly has China decided?
China's central bank, the People's Bank of China (PBC) said on Saturday,"
In view of the recent economic situation and financial market developments
at home and abroad, and the balance of payments (BOP) situation in China,
the Peoples Bank of China has decided to proceed further with reform of
the RMB exchange rate regime and to enhance the RMB exchange rate
flexibility." "It is desirable to proceed further with reform of the RMB
exchange rate regime and increase the RMB exchange rate flexibility," the
PBC added.
The PBC also indicated that the peg to the dollar could be abandoned and
instead the renminbi will be benchmarked to a basket of currencies.
What are the implications of China's move?
China's announcement is being seen as intent to allow a gradual appreciation
of the yuan, largely against the dollar. Though the PBC retained the existing
trading band for the currency at +/-0.5% per day, it is expected that the
renminbi, another name for China's currency, will appreciate against the
dollar over a period. Essentially, the tight trading band will ensure that there
is no volatile adjustment in the value of the renminbi to the perceived
market price of the currency.
How will the move impact the global economy?
28
Conceptually, a stronger yuan should erode competitiveness of China's

exports, making it easier for other countries to compete. This should help
address the global trade imbalances China's surplus against deficits of
others. However, to the extent the appreciation is expected to be very
gradual because of the tight trading bands, there is unlikely to be a sudden
change in comparative trade equation or capital flows.
In fact, the People's Bank of China effectively ruled out large scale
appreciation. It said, "With the BOP account moving closer to equilibrium,
the basis for large-scale appreciation of the renminbi exchange rate does
not exist."
However, the move will help reduce the tension between the US and China.
More importantly, it sends a strong signal about the state of the Chinese
economy and the sustainability of the global recovery.
__________________________________________________________
29
ET in the classroom: RBIs key policy rates
ET Bureau Jul 6, 2010, 02.41am IST

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 shortterm 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?
30
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 bank's long-term outlook on
interest rates. If the bank rate moves up, long-term interest rates also tend to
move up, and vice-versa.
__________________________________________________________
31
ET in the classroom: Lifestyle Inflation

Rising inflation raises the spectre of an increase in the cost of living. But for
most of the Indian middle class with high aspirations, the main reason why
their salaries are never enough is they acquire expensive tastes and desires
as their salaries rise. Welcome to lifestyle inflation.
What is lifestyle inflation?
Lifestyle inflation indicates the rise in your lifestyle expenses, which you
need to consider even if the headline inflation the data published every
Thursday is not soaring. There are two versions of lifestyle inflation. One
expensive tastes and desires, which is also the function of choices available,
coupled with higher purchasing power. For example, earlier you would have
been watching movies in a small theatre in your neighbourhood. But now,
you would have upgraded to multiplexes. That simply means a jump in your
ticket costs from Rs 100 to Rs 250. This jump in lifestyle costs is lifestyle
inflation. Another way to define your lifestyle inflation is the nature of your
consumption. For example, if your hobby is to travel and explore the earth,
then it is expensive today, considering the soaring oil prices.
Is it a new concept?
Earlier, the concept of lifestyle inflation was not prevalent. The reason
being, the growth in income of most individuals was usually 5% over and
above the inflation. Hence, people in earlier generations saw lesser or no
surplus income in the individual's hands. Now, the income grows a
minimum of 10% in excess of inflation. Second, the salary structures of
people working in the private sector realise higher disposable income as
most companies don't deduct retirement benefits. So, the affordability is
much higher which makes people succumb to aspirational and peer
pressures. Third, people have to actively save and invest to live off their
savings in future.
When does it affect you?
32
The lifestyle inflation bug hits individuals who are in the range of 30-45
years. This is the age where individuals stretch themselves to buy the latest
car or the LCD TV even if that siphons off their bank balance. They are
ready to take higher EMIs for their Honda City and subsequently replace it
with a Toyota Corolla even before completing the loan tenure. If an
individual is over 40 years, they show more maturity and just look at a car
more from the utility perspective than the status symbol. Also, an individual
doesn't expect as sharp an increase in his income at this age as in his thirties,
experts say.
How do I provide for it in my investments?
Whenever you invest in an instrument, compute the future value after
accounting for an inflation of 8-10% to get accurate results. Fixed deposits,
PPF or NSC assure safe returns, but are not capable of beating the inflation.
Real estate, gold, and equity are considered good hedges against inflation on
a long-term basis. It's crucial to provide a certain mark-up at the planning
phase itself. For retirement planning, every individual has to do a certain
loading on the numbers today based on their lifestyle to get the required
future value. Again, this loading has to vary from period to period so as to
reflect true value.
__________________________________________________________
33
ET in the classroom: Clash over ULIPs

The dust is yet to settle on a very public spat between market regulator SEBI
and insurance watchdog IRDA over regulation of unit-linked insurance
plans, or Ulips. The RBI is opposing a joint committee under the finance
minister, envisaged to settle jurisdiction disputes on hybrid products.
ET brings you the story so far.
Dispute over ULIPs
Ulips are hybrid instruments where a part of the amount paid by sub-scribers
is invested and a small portion goes towards insurance pre-mium. SEBI
passed an order in April this year saying that regulation of Ulips should be
its responsibility rather than IRDA's, as the funds were mostly invested in
stock markets. Sebi had justified it by saying that in some of the products
90% of the money was channelised into markets and not insurance.
On April 9, it had banned 14 insurance companies from selling ULIPs
without its approval, saying they needed to register with the market
regulator. This was opposed by IRDA, which asked insurance compa-nies to
ignore the directive. The finance ministry intervened and asked both sides to
seek legal recourse to the problem.
How was the dispute settled?
The President promulgated an ordinance last month clarifying that life
insurance business includes Ulips, which meant that IRDA would con-tinue
to regulate Ulips. Four Acts -- RBI Act 1934, Insurance Act 1938, Sebi Act
1992 and Securities Contract Regulations Act 1956-- had to be amended for
the purpose. The decision was taken just days before the Supreme Court was
scheduled to hear the matter on July 8.
What is the new controversy surrounding the joint committee envisaged by
the ULIP ordinance?
34
In a bid to ensure that similar disputes that may arise in the future are taken
care of, the ordinance provided for a joint mechanism headed by the finance
minister, two other government representatives and the four regulators, for
settling conflicts over hybrid products.
What are the RBI's concerns?
The RBI has said that it the central bank had certain reservations and
concerns relating to the ordinance. Reportedly, the central bank feels that the
dispute resolution mechanism worked out can undermine the autonomy of
the regulators. It is more inclined towards the current mechanism for dispute
resolution, --the non-statutory High Level Co-ordination Committee on
Financial Markets chaired by the RBI gover-nor. It is holding discussions
with the finance ministry on the issue.
What is the way ahead?
The government has to move a bill in Parliament in the monsoon ses-sion of
parliament to get the ordinance, a temporarily law, passed into a law. The
government can make changes when it moves the bill or allow the ordinance
to lapse by not moving the bill altogether.
What were fallouts of the dispute?
It prompted the IRDA to look within and reform ULIPs by issuing fresh
guidelines. Ulips launched after September 1, 2010 will have lower charges,
guaranteed returns, longer lock-in period and larger insurance cover.
__________________________________________________________
35
ET in the classroom: All about rate corridor

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
36
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.
__________________________________________________________
37
ET in the classroom: Compulsory licencing
ET Bureau Aug 26, 2010, 04.42am IST

ET explains Compulsory licensing, a provision that allows governments to
override Patent rights
What is compulsory licensing?
Compulsory licensing is a process through which a government allows the
local industry to produce drugs under patent protection without the
permission of the patent holder. While the global agreement on intellectual
property, the Trade Related Intellectual Property Rights (Trips) under the
WTO, says that a patent holder will have the sole right to give permission to
produce its patented products on payment of a licence fee, flexibilities have
been given to countries to address public health concerns by issuing
compulsory licenses.
When can a government issue compulsory licences?
These could be issued to address any public health concern as considered
appropriate by the issuing country. The Trips Agreement gives a country the
freedom to decide when it wants to issue such licenses and it does not
necessarily have to be an emergency. It is generally issued for producing
life-saving medicines to ensure their availability at low prices.
Does compulsory licensing strip a patent holder off the right to collect
license fees on patented products or process?
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
38
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 country's commitments under Trips,
the country has been facing a shortage of life-saving drugs such as anticancer 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.
__________________________________________________________
39
ET in the classroom: Overnight Indexed Swap
ET Bureau Sep 28, 2010, 05.12am IST

What is an overnight Indexed Swap?
An Overnight Index Swap (OIS) is a derivative instrument (a security where
the returns are linked to the performance of an underlying instrument) where
returns under a fixed rate asset are swapped against a pre-determined
published index of a daily overnight reference rate for an agreed period of
time.
How does an OIS work?
Overnight Index Swaps are instruments that allow financial institutions to
swap the interest rates they are paying without having to refinance or change
the terms of their existing loan. Typically, when two financial institutions
create an overnight index swap, one of the institutions is swapping an
overnight (floating) interest rate and the other institution is swapping a fixed
short-term interest rate.
For instance; assume there are two companies Company A, which has a
$10 million loan where interest is linked to overnight rates and company B
has a $10 million loan, on which it pays a fixed rate of interest. Now
suppose Company A expects overnight rates to remain soft and Company B
wants the assurance of a fixed rate. In this case, these two institutions could
create an overnight index swap with each other.
To get the swap rolling, both the firms would agree to continue servicing
their loans, but at the end of a specified time period whoever ends up
paying less interest will make up the difference to the other firm. For
example, if company A ends up paying an average interest rate of 1.5% on
its loan and company B ends up paying an interest rate of 2%, then company
A will pay company B the equivalent of 0.3% (2.0-1.5 = 0.5) because,
according to their agreement, they swapped interest rates. Of course, if
company A ends up paying an average interest rate of 2.4% on its loan and
company B ends up paying an interest rate of 2%, company B will pay
company A the equivalent of 0.2% (2.4- 2.0 = 0.4) because of the swap
contract.
40
What purpose does the OIS-Libor credit spread serve?

The OIS-Libor (London Inter-bank Offer Rate) credit spread is indicative of
the liquidity in the system. We have considered Libor as it is a global
benchmark interbank rate. If the OIS-Libor (or Mibor) credit spread is wide,
it signals tightening in the liquidity and a narrower spread signals presence
of liquidity in the system.
__________________________________________________________
ET in the Classroom: Current account deficit

41
India's current account deficit is expected to widen to 3% of GDP in the

current financial year. Funding such a large deficit is a concern, but strong
capital flows have so far provided comfort. ET takes a look at the concept of
current account deficit.
What is current account deficit?
A country's current account consists of merchandise trade (exports and
imports of goods) and the invisible trade income and expenditure from
export and import of services, profits earned on investments and remittances
by workers. A deficit would occur when total imports are greater than
exports. A deficit implies that the country is a net debtor to the world.
Where does India stand?
According to the Planning Commission, India's current account deficit is
likely to increase to 3% of the GDP from 2.9% last fiscal. This is largely
because of the rising and high trade deficit excess of merchandise exports
over imports. It stood at 23-month high of $13 billion in August. The full
year could see a trade deficit of around $135 billion, which is about 10% of
the country's GDP, the highest in recent years.
What are the reasons for high trade deficit?
The current account deficit is financed by a combination of portfolio
investment inflows, long-term capital inflows, remittances from nonresidents and overseas borrowings.
What are the risks posed by a widening current account deficit?
An increasing current account can pose serious problems for an economy.
Payments are dependent on long-term capital inflows, which, in turn,
depend on the growth prospects of an economy. A pause in these flows can
lead to payment problems and pressures on the local currency. It can then
encourage outflow of foreign capital.
__________________________________________________________
42
ET in the Classroom: Real and nominal exchange rates
ET Bureau Oct 7, 2010, 07.20am IST

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?
The word 'real' in economics -- as opposed to 'nominal' -- is used to describe
a metric, where the impact of prices has been taken into account. For
example, real GDP captures output of goods and services at constant prices,
removing the effect of inflation.
What is real exchange rate?
Real exchange rate can be defined as the rate that takes into account
inflation differential between the countries. Suppose the rupee was trading at
Rs 40 to a dollar at the beginning of 2009. Assuming a 10% inflation in the
Indian economy and 5% inflation in the US economy for the whole year,
then this model says the rupee should depreciate by 5% (10%-5%) to Rs 42
to a dollar, other things being equal.
Why is the real exchange rate important?
Competitiveness of a country's exports is decided not only by the nominal
exchange rate, but also relative price movements in domestic and foreign
markets. For instance, even if the nominal exchange of the rupee remains
unchanged with respect to, say, the dollar, India's exports to the US will
become less competitive if inflation in India is higher than in the US. This
means nominal exchange rate will have to be adjusted for effect of inflation.
How is nominal exchange rate adjusted for inflation?
Central banks use the concept of 'real effective exchange rate', or REER, to
adjust nominal effective exchange rate for inflation. Conceptually, the
43
REER is the weighted average of nominal exchange rates adjusted for the
price differential between the domestic and foreign countries. The price
differential, however, is based on the purchasing power concept. The
currencies used are of those countries with which trade is the highest.
How does the RBI calculate REER?
The RBI calculates REER for India. It calculates the value of the rupee with
respect to two indices, one comprising six countries and the other 36
countries with a 2004-05 base. The RBI, however, uses the wholesale price
index-based inflation whereas globally consumer price indices are used. One
conceptual flaw with this model is that it assumes that the base exchange
rate is the correct exchange rate or represents the purchasing power parities
accurately, which may not be the case.
__________________________________________________________
ET in the Classroom: Currency War

What is currency war ?
The term 'currency war' was used in recent times by Brazil's finance minister
Guido Mantega in the first week of October this year reacting to China's
attempt to protect the yuan from rising too quickly against the dollar. It
comprises competitive measures by governments to improve their trade by
maneuvering exchange rates. A cheap currency, vis-vis the dollar, adds to
the competitive advantage to the exporter. Countries such as China, Brazil,
South Korea and Japan have taken measures to devaluate their currencies
which would help them boost exports and create jobs. An attempt by the
government to prevent its currency from appreciating too steeply and too
fast against competing nation is what is seen as currency war between
different countries . The history of currency wars dates back to the Great
44
Depression era when major economies devalued their currencies as a part of

a measure to give preference to local goods over imported ones.
What is its impact on Indian economy?
When competitors devalue their respective currencies, domestic exporters
tend to lose out on the price advantage on their exportables as buyers prefer
to buy from a cheaper currency. This in turn hurts income as well as the jobs
in the export sector and the prospects for the economy. The central bank at
such times tries to intervene buy dollars and create an artificial demand
for the dollar, devaluing the value of the rupee in the process and retain
some price advantage for the exporter . But buying dollars involves a fiscal
cost as the central bank has to pump in equivalent amount of rupees and
again mop it up by selling bonds. These bonds need to be serviced by the
government. This would in turn worsen the fiscal position .
Howdoescurrencywarimpactglobal recovery?
Currency wars are a part of what is described as a 'beggar thy neighbour'
policy attempts by a country to solve its economic problems by causing
worse difficulties in other markets. When all countries engage in such
policies, it turns out to be a race to the bottom. As countries compete to
devalue their currencies to save the interest of their exporters, it collectively
reduces demand for foreign goods, something that world economies cannot
afford at a time when the process of global recovery from the after affects of
the crisis of 2008-09 is still underway. Also , competitive currency
devaluation is happening at a time, when some of the developed economies
have a soft money situation, wherein monetary regulators are on a
quantitative easing spree, lowering their interest rates, which is making
emerging economies trying to regulate their inflation an arduous task, as
direction of the capital flows has turned towards them. There is also the fear
of a bubble, which will burst once developed economies are back on track
and the flow of capital shrinks. This shrinking is expected to be first
reflected in the currency markets.
What is the current international thinking on the matter?
The United States is looking for global support at forums such as the G20 to
the IMF, so that there can be collective pressure on China to ease up on the
Yuan. IMF feels that it is the right place to make progress on the currency
question . Emerging nations are not very keen to range themselves in this
battle. Finance minister Pranab Mukherjee has said he urged countries to
work towards a consensus as the way forward.
45
__________________________________________________________
ET in the Classroom: Corporate hedging

What is corporate hedging?
Corporate hedging is a mechanism to protect a firm's exposure to foreign
exchange risk. The process is managed by corporate treasury officials and
they work toward maximising forex income and minimising costs. In the
process, they try to minimise losses from the volatility in the currency
markets, by covering the exposure. The extent of the foreign currency risk
for a firm depends on the value of the foreign exchange rates, among other
things.
Why do corporates hedge?
In India, with the Reserve Bank of India moving towards a more marketdetermined exchange rate since the early 90s, the rupee has become more
volatile against the dollar and other major currencies , forcing them to hedge
their foreign currency exposure. Another reason why companies attempt to
hedge is because they see foreign currency fluctuations as risks that are
directly linked to the central business in which they operate . Hedging
objectives vary widely from firm to firm, even though it appears to be a
fairly common issue faced by corporates . Another reason for hedging the
exposure of the firm to its financial price risk is to maintain the
competitiveness of the firm. Sometimes there is an opportunity loss in
hedging, which is why some corporates , as a matter of risk management
strategy, do not.
What are the risks to be hedged?
There risks arising out of transaction with clients and other business
associated which are called transactional risks. A foreign currency loan
46
would yield a different value on conversion, depending on the way currency

markets are moving. Similarly, an importer faces a currency risk as there
could be a significant movement in currency value from the date on which it
contracted the purchase and prevailing exchange rate on the delivery date.
The same logic holds for exporters. Corporates also hedge interest risks as in
the global markets, interest rates are also not steady.
What are the challenges in hedging?
What we have seen recently is the phenomenon of two-way hedging,
wherein both the importers as well as the exporters are hedging. This is due
to the unpredictability in the direction of the currency movement. In the
current year for instance , we have seen the rupee depreciating against the
dollar since mid-April and steeply appreciating against the dollar since midAugust . Hence, today, corporates have to take a critical call on when to
hedge and when not to, along with the extent to which it should be hedged
and what hedging instrument should be used to avert an opportunity loss.
__________________________________________________________
ET in the Classroom: GDP Figures
ET Bureau Nov 25, 2010, 05.37am IST

GDP estimates for the second fiscal quarter will be released next Tuesday
amid increasing concerns over the quality of data, especially after the
estimates for the first quarter were revised due to an error in calculation. ET
takes a look at the concept of GDP.
What is GDP?
GDP, or gross domestic product, is the value of all goods and services
produced in the economy over a period of time, normally a year. The
measure excludes intermediate goods, or the goods and services that go into
the production of other goods. This is to prevent double counting as value of
47
intermediate goods is already included in the final goods or service. It is a

gross measure in that value of capital goods that goes into replacement is not
netted out. It is a 'domestic' measure as it does not include income from
abroad.
What is the significance of GDP?
The absolute GDP and its growth are important indicators of the health of an
economy. While absolute GDP gives an idea of the size and the relative
importance of a country in the global system, its growth gives an indication
of its future progress. The measure, however , suffers from a number of
shortcomings. The creator of the GDP, Simon Kuznets, had pointed out the
flaws while presenting it to the US Congress. "The welfare of a nation can
scarcely be inferred from a measurement of national income," he had said.
What are the key shortcomings of the measure?
GDP measures only the overall income generation in the economy. It does
not tell us to whom the income accrues and where it is spent. A poor
distribution can mask islands of underdevelopment. For instance, agriculture
has an 18% share in India's GDP, but the sector supports more than 60% of
the people, implying that per person share of the national income is very low
for a vast majority. It also misses out on goods and services which are not
traded such as household work, natural resources and leisure. It is also a
quantitative measure that makes no distinction for the quality of national
income. For instance , environmentally harmful mining could boost national
income but at a huge cost to the society at large.
What other measures make it more meaningful?
A per capita measure of GDP, or the absolute level of GDP divided by the
population of a country, pitches the number in relation to the people. This
number gives us a sense of what everybody would be earning if the income
were distributed equally. Of course, in real situation the income will be
unequally distributed. India is among the biggest economies, but low per
capita GDP rightly pitches it among the poorer nations. Measures such as
Human Development Index give a qualitative dimension to GDP.
__________________________________________________________
48
ET in the classroom: PIGS economies

ET explains the concept of PIGS economies and helps you know about them
better.
Which are the PIGS countries?
After BRIC Brazil, Russia, India and China, financial market analysts
have now clubbed troubled European economies Portugal, Italy, Greece
and Spain together as PIGS. Each of these economies has been going
through sovereign debt crises and the European Union has had to bail them
out. However, unlike the BRIC nations, which have a positive connotation,
this has a negative feel, and hence, many European investment banks do not
prefer using this acronym, though it is popularly used in the media.
What were their individual problems?
Italy tried to pay high wages and had an under-competitive economy, hence,
a budget deficit crisis followed. Corruption in the state-run businesses sector
and the near-corporate failure of Alitalia also played a part in the balance of
payments crisis and the economy consequently crashed. Spain's wage bill
and economy went the Italy way. It had its bit of a housing bubble and bust.
Portugal was hit by the desire to have high wages and the inability to
manipulate national fiscal/currency policy to restart a failing economy. It
soon lost its favoured status among investors to Slovenia. Greece, on the
other hand, had most of the above-mentioned crisis since the Millennium
and took out excessive overseas loans in the hope of restarting its national
economy, especially after the slump in tourism.
How has a variation emerged?
With woes of Ireland, which could be similar in nature to that of the PIGS
economies, the acronym is now extended to PIIGs to include Ireland as well.
Besides the EU, even multilateral agencies like IMF have announced bailout
for them.
49
__________________________________________________________
ET in the classroom: What are sugar futures?
ET Bureau Dec 7, 2010, 06.29am IST

ET deciphers and tells about various aspects of sugar futures
What are sugar futures?
Like any futures contract, sugar futures allow the sale or purchase of sugar
at a predetermined price for delivery at a future date. Futures allow physical
market stakeholders, including producers, traders, processors, importers and
exporters, to hedge themselves against the price volatility and risk. Apart
from hedgers, speculators participate in a futures market by taking on the
risk that hedgers seek to cover themselves against.
A speculator is one who normally tracks the market and takes an informed
decision. In an ideal market, the proportion of hedgers and speculators
should be 50:50 but this does not always happen. It remains a fact though
that speculators help impart liquidity to a market and reduce the impact cost
by narrowing the bid (buy)-ask (sell) spread.
How does a sugar futures contract benefit the market?
A seller, who wants to insulate himself from prices falling a month, hence,
can sell a monthly contract forward at say Rs 100 for x quantity, while a
buyer, who wants cover against rising prices, could lock in at the same
price. If the price rises to say Rs 105 a month later, the seller can settle the
contract in cash at a loss of Rs 5, while the buyer makes a paper profit of Rs
5 by squaring off (selling what he has bought).
However, the seller can offset the paper loss by selling the same sugar at Rs
105 on the spot market since futures and spot price tend to converge upon
maturity. Similarly, the buyer can maintain his margin despite the price rise
50
(from Rs 100 to 105) on the spot market, thanks to the paper gain made on
the futures market. The beauty of an active futures market is that it ensures
price transparency and the exchange guarantees against counterparty default
risk, a possibility in the case of an over-the-counter (forward) market
contract entered into between counterparties.
What is the status of sugar futures in India?
Under intense attack against rising prices, the government suspended sugar
futures in May 2009 for six months, after which it extended the ban, which
it allowed to lapse by September 30, 2010 due to good crop prospects and
rationalisation of prices. The regulator of commodity futures trading,
Forward Markets Commission (FMC), is set to shortly relaunch sugar
contracts from January 2011. The decision will be taken after a meeting
between FMC and industry body Indian Sugar Mills Association (ISMA)
and commodity exchanges like NCDEX and MCX.
How will a relaunch help?
The sugar year is from October to September. The relaunch will give sugar
companies the option of delivering sugar for future months in case future
prices are trading at a premium to spot prices. It will also give buyers the
luxury of locking into futures prices instead of holding sugar in their
godowns for future needs, which adds to costs in terms of storage,
insurance, etc. In the absence of a local futures contract, genuine players are
left with no option but to hedge on overseas exchanges, which increase the
cost as they have to hedge against currency price fluctuation.
__________________________________________________________
ET in the Classroom: Take-out financing
ET Bureau Jan 4, 2011, 07.00am IST

What is take-out financing?
51
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 assetliability 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.
__________________________________________________________
52
ET in the Classroom: 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
53
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.
__________________________________________________________
ET in the classroom: Central plan and role of plan panel and finance ministry
54

The government's budget exercise usually begins with fixing the
contribution of the exchequer to the central plan. Though distributed over
many schemes, taken together this is the single biggest item of expenditure
in the annual budget. ET takes a look at the concept of Central Plan and the
budget support to the plan.
What is central plan in the context of the budget?
Central or annual plans are essentially the five year plans broken down into
five annual installments. Through these annual plans, the government
achieves the objectives of the Five-Year Plans. The details of the plan are
spelled out in the annual budget presented by the finance minister. But the
actual responsibility of allocation funds judiciously amongst ministries,
departments and state governments rests with the Planning Commission.
What is gross budgetary support, or GBS?
The funding of the central plan is split almost evenly between government
support (from the Budget) and internal and extra budgetary resources of
public enterprises. The government's support to the central plan is called the
Gross Budgetary Support, or the GBS. In the recent years the GBS has been
slightly more than 50% of the total central plan.
How is the GBS figure arrived at?
The administrative ministries responsible for various development schemes
present their demands before the planning commission. The planning
commission aggregates and vets these demand. It then puts forward a
consolidated demand before the finance ministry for the budgetary support it
needs from the cental excequer. The amount approved by the finance
ministry is usually less than that demanded by the planning commission
because of the multiple objectives the North Block has to keep in mind will
making allocations. The planning commission in turn adjusts the allocated
amount among various demands.
How do GBS, central plan and plan expenditure differ?
Central plan includes the GBS and the spending of the public enterprises
that do not figure in the budget. In that sense the government's spending on
the central plan is limited to GBS. But the centre also provides funds to
states and union territories for their respective plans. This contribution,
55
together with the GBS, makes up the total plan spending of the government
for a year. This is about 30% of the total government expenditure.
__________________________________________________________
ET in the Classroom: Asset classes

What is asset classification?
In any banking system, loans or assets created by lenders are divided into
several qualitative categories. In simple language, the categories reflect how
good or bad an asset is in terms of the possibility of default in repayment of
loan from a borrower. This practice is known as classification of assets.
How is asset classification important to bankers?
This practice helps banks know the strength of its credit portfolio. If there is
a risk of non-payment of loans or defaults, banks would start focusing on
their credit monitoring act and take corrective measures. According to
classifications, banks make provisions to take care of the fallout of a default.
What are the broad classifications prescribed by the regulator, the Reserve
Bank of India?
The RBI has classified assets into four broad categories. These are
prescribed by the Bank for International Settlements, an inter-governmental
body of central banks. However, each central bank is allowed to tweak the
definition as per their loan market.
Standard asset
Asset where borrowers pay their interests on the loan as per the schedule is a
standard asset.
56
Sub-standard asset
A sub-standard asset is one which has remained an NPA for a period less
than or equal to 12 months. An NPA or a nonperforming asset is one where
a borrower fails to pay the interest on the loan for three consecutive months.
Doubtful asset
An asset would be classified as doubtful if it has remained in the substandard category for a period of 12 months.
Loss asset
When banks see little possibility of recovering the loan, it becomes a loss
asset for the bank. Banks or auditors consider this as a loss for the bank.
What are the provisioning requirements for these assets?
For loss assets, if kept in the book of banks, 100% of the outstanding has to
be provided for. For doubtful assets, if the loan asset has remained in the
'doubtful' category for 1 year, then the provisional requirement is 20%. If it
has stayed there for a period of 1-3 years, it calls for a provisional coverage
of 30%.
__________________________________________________________
ET IN THE CLASSROOM: What is an EEFC Account?

What is an EEFC Account?
Exchange Earners' Foreign Currency (EEFC) account is foreign currencydenominated account maintained with banks dealing with foreign
exchanges. The Reserve Bank of India introduced this scheme in 1992 to
57
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 don't 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 can't 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?
58
There is no such restriction on withdrawal in rupees of funds held in an

EEFC account. However, the amount withdrawn in rupees can't be
converted into foreign currency again and re-credited to the account.
Can one make a payment directly from EEFC account?
One can make a direct payment from EEFC outside India as per the
provisions laid down in FEMA regulations. Fully export-oriented units can
also pay in foreign exchange for purchasing goods as per the country's
foreign trade policy. A person residing in India can use the account for
paying airfare or hotel expenditure.
__________________________________________________________
ET In the Classroom: Making a Case of Financial Inclusion

What is a 'business correspondent' model?
In 2006, the Reserve Bank of India allowed banks to use non-bank
intermediaries as business correspondents, or business facilitators, to extend
banking and other financial services to areas where the banks did not have a
brick and mortar branch present. The objective behind it was to aid the
process of financial inclusion and consequently take banking to the remotest
areas of the country and make them bankable.
What do these correspondents do?
The business correspondent is nothing but a bank-in-person, who is
authorised to collect deposits and extend credit on behalf of the bank of
small-ticket sizes. He also recovers principal interest of small value
deposits, sale of micro insurance, mutual fund products, pension products,
receipt and delivery of small value remittances/other payment instruments.
59
Who is eligible to be a banking correspondent?

RBI has allowed a host of entities to act as business correspondents (BCs) of
banks. These include NGOs/MFIs set up under Societies/Trust Acts;
societies registered under Mutually-Aided Co-operative Societies Acts, or
the Co-operative Societies Acts of States; Section 25 companies, which are
not-for-profit companies; companies in which NBFCs, banks, telecom
companies and other corporate entities or their holding companies do not
have equity holdings in excess of 10%; post offices and retired bank
employees, ex-servicemen and retired government employees.
How is a business facilitator different from a business correspondent?
Very often the term 'business correspondents' is used interchangeably with
the term 'business facilitators' (BFs). But RBI makes a clear distinction
between the two. BFs are allowed to undertake only facilitation services like
identification of borrowers, collection and preliminary processing of loan
applications, including verification of primary information, creating
awareness about savings and other products, processing and submission of
applications to banks and promoting and nurturing SHGs and follow-up of
recovery and debt counselling. However, facilitation of these services does
not include conduct of banking business by BFs, which is the exclusive
function of business correspondents.
__________________________________________________________
ET in the Classroom: Non-competitive bidder

What is non-competitive bidding in dated government securities?
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
60
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 noncompetitive 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.
__________________________________________________________
61
ET in the classroom: What is Islamic finance?

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 predetermined 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
62
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.
__________________________________________________________
ET in the Classroom: Public debt office

What is a public debt office?
A public debt office or a debt management office is an autonomous
government agency which acts as the investment banker to the government
and raises capital from the markets for the government. It formulates the
borrowing calendar for the government and decides upon the maturities of
the securities to be issued on behalf of the government. A public debt office
works 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 Centre's investment banker?
63
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 Centre's 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 2007-08 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 government's 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 midoffice 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.
64
__________________________________________________________
ET in the Classroom: Sovereign debt crisis
May 3, 2011, 06.32am IST

What is sovereign debt crisis?
Sovereign debt crisis means the sovereign government's borrowing from
domestic and external markets is in excess of its capacity to repay, resulting
in loan defaults requiring rescheduling of loans or bailout packages from
other countries or multilateral institutions such as IMF.
How did the Greek crisis originate ?
The crisis in Greece surfaced in 2007-08 , when it came to be known that
Greece was not in a situation to meet its repayment obligations to its
external creditors. The budget deficit of Greece was in the range of 13.6% of
its gross domestic product. The stock of debt was equivalent to 115% of the
gross domestic product. The debt problem was further compounded by the
fact that nearly three-fourths of the government debt was held by foreign
institutions, particularly foreign banks. Not only was the high fiscal deficit a
problem, it was also camouflaged by derivative hedging. Reportedly,
investment banks misled investors into investing in government bonds of
Greece by being secretive about the actual state of affairs. The rating
agencies played accomplice and allegedly 'failed' to assess the correct fiscal
position.
Who bailed out Greece?
Greece reached an agreement with IMF, the European Commission and the
European Central Bank on a rigorous programme to stabilise its economy
with the support of a $145-billion financing package against which the
Greek government was required to implement fiscal measures, structural
policies and financial sector reforms. Some of the points of the reform
65
package were reducing the fiscal deficit to 3% by 2014, pensions and

wages to be reduced for three years, government entitlement programmes
had to be curtailed and social security benefits cut.
__________________________________________________________
ET in the Classroom: How is infrastructure defined in India?
May 5, 2011, 12.55am IST

Policy anomalies and lack of consensus on what constitutes infrastructure
have undermined efforts to spur creation of physical assets. A look at the
current status and the need to define infrastructure.
How is infrastructure defined in India?
There is no clear definition as of now. A broad meaning of the term is based
on a series of reports and observations made by different government
agencies and committees. A commission chaired by C Rangarajan in 2001
attempted to define infrastructure according to six characteristics: natural
monopoly, high sunk costs, non-tradability of the output, non-rivalry in
consumption (which implies benefit of public good can be extended to
additional consumers without any huge additional cost), possibility of price
exclusion and bestowing externalities on society. However, these
characteristics were not considered absolute.
For taxation purposes, the income-tax department considers companies
dealing with electricity, water supply, sewerage, telecom, roads & bridges,
ports, airports, railways, irrigation, storage (at ports) and industrial parks or
SEZs as infrastructure. However, special tax benefits are also given to
sectors like fertilizers, hospitals and educational institutions, adding to the
confusion.
The Reserve Bank of India and the Insurance Regulatory and Development
Authority have also tried to define infrastructure and identify sectors.
66
Why is a precise definition of infrastructure needed?

A clear understanding of what is covered under the rubric of infrastructure is
necessary for policy formulation, setting of targets, and monitoring projects
to ensure consistency and comparability in the data collected and reported
by various agencies. Moreover, the emphasis on infrastructure has led to the
government extending many incentives and tax benefits to infrastructure
companies. Without a proper definition these benefits can be misused.
What is the international norm?
Globally, too, defining infrastructure has been an arduous task. The US and
most European countries have defined infrastructure sectors for tax
purposes. There is no consistency across the developed world on what
constitutes infrastructure. Many countries have also identified sub-sectors
like core infrastructure, social infrastructure, retail infrastructure, and urban
and rural infrastructure.
How is India approaching the issue?
The finance ministry will identify the sectors primarily based on the
characteristics set out by the Rangarajan committee with some additional
requirements. Based on the criteria, the finance ministry is likely to notify
25 sectors as infrastructure. These sectors will be eligible for tax incentives,
viability gap funding and will be covered by regulatory framework for
infrastructure which will include levy of user charges.
__________________________________________________________
ET in the classroom: Priority-sector lending
May 10, 2011, 06.07am IST

What is priority-sector lending?
67
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.
What is net bank credit?
The net bank credit should tally with the figure reported in the fortnightly
return submitted under Section 42 (2) of the Reserve Bank of India Act,
1934. However , outstanding deposits under the FCNR (B) and NRNR
schemes are excluded from net bank credit for computation of priority sector
lending target/subtargets.
Are there specific targets within the priority sector?
Domestic banks have to lend 18 % of NBC to agriculture and 10 % of the
NBC has to be to the weaker section. However, foreign banks have to lend
10 % of NBC to the small-scale industries and 12 % of their NBC as export
credit. However, for the balance, there are a vast number of sectors that
banks can lend as priority sector. The Reserve Bank has a detailed note of
what constitutes a priority sector, which also includes housing loans,
education loans and loans to MFIs, among others.
What has been the experience so far?
It has been observed that while banks often tend to meet the overall priority
sector targets, they sometimes tend to miss the sub-targets. This is
particularly true in case of domestic banks failing to meet their sub-targets
for agricultural advances. One of the reasons banks often site for not lending
to this sector is that recovery is often difficult.
Is there any penal action in case of non-achievement of priority sector
lending target by a bank?
Domestic banks having a shortfall in lending to priority sector/ agriculture
are allocated amounts for contribution to the Rural Infrastructure
Development Fund ( RIDF ) established in Nabard. In case of foreign banks
68
operating in India, which fail to achieve the priority sector lending target or
sub-targets, an amount equivalent to the shortfall is required to be deposited
with Sidbi for one year.
__________________________________________________________
ET in the classroom: What is stagflation?
May 17, 2011, 03.30am IST

Stagflation is an economic situation where the growth rate slows down,
unemployment levels remain steadily high & inflation also stays high.
What is stagflation?
Stagflation, a concept which did not gain acceptance till the 1960s, is
described as a situation in the economy where the growth rate slows down,
the level of unemployment remains steadily high and yet the inflation or
price level remains high at the same time. At the first instance, high inflation
and unemployment or slower growth seem like opposites and mutually
exclusive.
It came to be seen in the 1970s as a situation when the economy has low
productivity and yet the goods are highly priced in spite of low
unemployment. The term 'stagflation' came to be used for the first time in
the British Parliament by Lain Macleod in 1965. Once stagflation occurs it
is difficult to deal with. The measure a government usually takes to revive
an economy in recession (cutting interest rates or increasing government
spending) also increases inflation.
Under normal recessionary conditions, inflationary policies are acceptable,
but here, given the already high inflation, pushing inflation still higher could
mean prices spiralling out of control, thus further hitting productivity and
growth.
69
What causes stagflation?

The major reasons for stagflation, whenever it has occurred in history, have
been-supply shocks or shortages due to unforeseen reasons which push up
prices of essential commodities, causing an inflationary situation and at the
same time pushing up production costs, as it happened in 1970s in the US.
The other reason is failure of the monetary authority to control excessive
growth of money supply in the economy and excessive regulation of goods
and labour markets by the government. For example, in the 1970s, a similar
situation occurred during the global stagflation, where it began with a huge
rise in oil prices, but then continued as central banks used stimulative
monetary policy to counteract the resulting recession, causing a runaway
wage-price spiral.
Is India on the brink of stagflation?
Though the central bank and the Centre have had to revise their growth
targets, which have taken a hit due to persistently high double-digit
inflation, economists are far from assuming a stagflation like situation in
India just as yet. The Reserve Bank of India deputy governor Subir Gokarn
has said headline inflation numbers are much higher than the appropriate
rate of inflation that will moderate growth but will keep it steady, which
according to RBI's estimates, should be between 5% and 6%.
__________________________________________________________
ET in the Classroom: Marginal standing facility
May 24, 2011, 06.45am IST

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
70
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%.
__________________________________________________________
ET in the Classroom: corporate repo bonds

What is corporate repo bond?
Banks, corporate and primary dealers pledge corporate bonds with each
other to raise short-term money. It is similar to banks pledging government
securities (gsec) with RBI to raise short-term money. Unlike pledging of g-
71
secs, here the borrower who pledges corporate bonds does not receive the
entire value of the bond.
When did RBI allow repo in corporate bonds?
RBI guidelines on repo in corporate debt securities came into effect on
March 1, 2010.These guidelines were amended in December 2010 as the
market participants demanded a reduction in hair-cut margins. It was
reduced from a flat rate of 25% to a band of 10-15%, depending on the
rating of the corporate bond. According to the amended guidelines, the
settlements had to be made within two days of the deal.
How does the repo in corporate bonds work?
Investor A, who needs finance for an interim period, can issue these bonds
while entering into an agreement with investor B that at a given point of
time he would buy back the bond from investor B, though the bond issuer
would have to suffer a hair-cut margin of 10-15%, which will vary
according to the credit rating of the bond.
How active is the repo in corporate bonds in India?
Only five deals have been reported so far. Companies that have issued
corporate bonds in India are REC, PFC, HDFC and NHB.
Why has repo in corporate debt not taken off?
Lack of market participation could be because of lenders or issuers
maintaining a cautious approach as well as due to lack of proper trade
guarantee mechanism. Also, the hair-cut margin of 10-15%, (which is the
margin enjoyed by the investor on the day the agreement is reversed), is still
very high from the investors' point of view considering the volatility in
corporate debt market does not demand such a high hair cut. Interest rate is
determined over-the-counter, but there is no mechanism for efficient
discovery of prices. There is no centralised clearing agency like the Clearing
Corporation of India (CCIL ) for central government securities.
__________________________________________________________
72
ET in the Classroom: Draft Red Herring Prospectus

A company making a public issue of securities has to file a Draft Red
Herring Prospectus with Sebi through an eligible merchant banker prior to
filing a prospectus with the Registrar of Companies.
What is Draft Red Herring Prospectus?
A company making a public issue of securities has to file a Draft Red
Herring Prospectus (DRHP) with capital market regulator Securities and
Exchange Board of India, or Sebi, through an eligible merchant banker prior
to the filing of prospectus with the Registrar of Companies (RoCs).
The issuer company engages a Sebiregistered merchant banker to prepare
the offer document. Besides due diligence in preparing the offer document,
the merchant banker is also responsible for ensuring legal compliance. The
merchant banker facilitates the issue in reaching the prospective investors by
marketing the same.
Where is DRHP available?
The offer documents of public issues are available on the websites of
merchant bankers and stock exchanges. It is also available on the Sebi
website under 'Offer Documents' section along with its status of processing.
The company is also required to make a public announcement about the
filing in English, Hindi and in regional language newspapers. In case,
investors notice any inaccurate or incomplete information in the offer
document, they may send their complaint to the merchant banker and / or to
Sebi.
What does Sebi do with the DRHP?
The Indian regulatory framework is based on a disclosure regime. Sebi
reviews the draft offer document and may issue observations with a view to
ensure that adequate disclosures are made by the issuer company/merchant
bankers in the offer document to enable investors to make an informed
73
investment decision in the issue. It must be clearly understood that Sebi does
not 'vet' and 'approve' the offer document.
Also, Sebi does not recommend the shares or guarantee the accuracy or
adequacy of DRHP. Sebi's observations on the draft offer document are
forwarded to the merchant banker, who incorporates the necessary changes
and files the final offer document with Sebi, Registrar of Companies (ROC)
and stock exchanges. After reviewing the DRHP, the market regulator gives
its observations which need to be implemented by the company. Once the
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.
__________________________________________________________
ET in the classroom: 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.
74
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.
__________________________________________________________
ET in the Classroom: Interest rate futures

What is the interest rate futures on 91-day treasury bill?
75
Interest rate futures on 91-day treasury bill are interest rate-driven derivative
products that help banks, mutual funds and primary dealers to hedge their
interest rate exposure on treasury bills. Financial institutions can lock in the
interest rate or the yield on the 91-day treasury at a given date when counter
parties enter into the interest rate futures contract.
How are they settled?
The 91-day T-bill interest rate futures are cash settled. In case of the 91-day
treasury bill, the final settlement price of the futures contract is based on the
weighted average price/ yield obtained in the weekly auction of the 91-day
treasury bills on the date of expiry of the contract. But in case of interest rate
futures on the 10-year benchmark government security, the contract is
physically settled.
How is the product structured?
The minimum size of the contract is Rs 2 lakh and the tenor of the contract
cannot be more than 12 months, according to market regulator Sebi, which
has designed the product and will supervise its trading. The maximum
maturity of the contract can be for 12 months. The initial margin is
subjected to a minimum of 0.1% of the notional value of the contract on the
first day of trading and 0.05 % of the notional value of the contract
thereafter.
What kind of volumes has the product generated so far?
Last week, the average daily trading volume for the 91-day T-Bill IRF was
Rs 360 crore. So far, among the exchanges, only NSE has introduced the
product for trading. The interest rate futures (IRF) on 91-day TBills clocked
a volume of around Rs 730 crore on the National Stock Exchange (NSE) on
the first day of trading last Monday.
What are the advantages of the interest rate futures?
It is a good hedging tool for banks, primary dealers and mutual funds who
have huge exposure to these money market instruments such as 91-day
treasury bills. There is no 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.
__________________________________________________________
76
ET in the Classroom: 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. That's 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
77
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 Italy's debt is more than the combined debt of Portugal, Spain
and Ireland
So, time's 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
Isn't 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 isn't easy. They don't want to bail
out all Europeans, particularly those who don't work hard. Some think
Greece should be exiled from EU for a few years to should put their house
in order
__________________________________________________________
ET in the classroom: The A-Z of 4G technology
78

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?
LTE's 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.
WiMAXhad 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.
What's more, leading vendors unveiled compatible gear commercially in
2010. This LTE variant was heralded by the world's top telcos as the coolest
technology for highspeed data communications on the go. WiMAXsuffered
a body blow when big telcos across China, India and the US also embraced
79
TDD-LTE . Commercialisation 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
WiMAXbackers 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 world's 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
year's 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 and smartphones. 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 .
__________________________________________________________
ET in the classroom: What is underrecovery?

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 under-recovery.
80
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 underrecovery make an oil co's 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 refinery's 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 threeyear 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 under-recovery?
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.
__________________________________________________________
81
ET in the classroom: The anatomy of layoffs

What are layoffs?
When companies discharge employees either temporarily or permanently
because they have no money to pay them or there is no work for them. The
term is also known variously as downsizing, redundancy, right-sizing,
workforce optimisation and redeployment.
Several companies, banks and financial institutions across the world
resorted to layoffs during the slowdown after the collapse of Lehman
Brothers in September 2008. In India, the term became more familiar during
late 2008 and early 2009.
Are there any warning signs before jobs are shed?
Layoffs are a function of business sentiment. So job losses happen during
slowdowns, which are usually preceded by phases of high inflation.
During a slowdown, job markets tighten up as entities go on austerity drives
to lower their administrative and other costs. Generally, the next phase of
critical action deals with rightsizing initiatives. Layoffs are imminent at this
stage.
Is there a way to pre-empt and, thus, avoid job loss?
Sometimes organisations resort to layoffs as a natural reaction to slowdown.
But instead of such knee-jerk measures, there are many other preventive
steps they can take.
Proper work-force planning, continuous focus on cost control, multiskilling
and creating a positively enabling work culture are some of the ways in
which organisations can plan ahead of time so that they do not have to
downsize and lay off people during a downturn.
How can one cope?
82
Craft a nice resume, circulate it in your professional network and approach

headhunters which deal in your specialisation or in your target sectors. Do
not hide the 'pink-slip' fact from your near family. Share it with them so that
they can provide you emotional support.
How does one prepare for a new career?
Employees should reflect on their skillset and be clear about their
competencies. Telecom and financial services sectors in India have
experienced layoffs and 'workforce deployment' in recent months. If certain
sectors are not doing well, look for similar options.
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.
__________________________________________________________
ET in the classroom: What Are Pesky SMSes?

Unsolicited telemarketing text messages that mobile phone users listed with
telecom regulator Trai's National Do Not Call (NDNC) registry continue to
receive. Of the 860 million mobile phone connections in India, about 160
million are listed with the registry.
Why did this registry fail?
83
Telemarketers hire multiple individuals, use internet sites like way2sms.com

or indyarocks.com, or contract foreign carriers to send SMSes. They use
websites with servers in the US or other foreign countries, where Trai has no
authority. Calls from foreign numbers are equally difficult to stop.
Marketers also use message gateways like LM, TD and others which can
send nearly 2,000 SMSes per second, making it next to impossible for Trai
to monitor millions of text messages between 9 am and 9 pm.
So what else has trai done to curb this menace?
Last month, it hiked penalties up to Rs 2.5 lakh and introduced a provision
for blacklisting telemarketers for two years. It allowed customers to block
such messages, completely or selectively, choosing segments such as
financial products, real estate, consumer goods and automobiles etc. '
It also assigned a distinct series beginning with 140 to telemarketers to
allow customers to identify such calls. Besides, it imposed a termination
charge of 5 paise per message to increase the cost of sending commercial
SMSes. The regulator imposed a cap of 100 SMSes per day for every
mobile connection, but doubled it later.
It has issued notices to 1122 individuals, terminated mobile connections of
111 subscribers and imposed penalties in 17 cases for violation of
guidelines.
What should individuals do to stop pesky SMSes?
Dial 1909 or send SMS to 1909 to register for NDCN and block commercial
text messages completely or partially. If pesky SMSes do not stop coming
in, inform the service provider, with particulars of telemarketer, the
telephone number from which the unsolicited commercial communication
has originated, the date, time and brief description of such unsolicited
commercial communication. The service provider will revert with the action
taken on the complaint within a week.
Isn't it possible to block such messages on smartphones?
Most BlackBerry phones have a built in Firewall to block unwanted SMS
and calls. To activate, head to settings > security > firewall. Most users don't
use it, though, because it often blocks even essential messages.
For Apple's iPhone, iBlacklist from the Cydia app store will do the trick. But
for Android phone users, there is a free app available.
84
SMS Blocker from Optinno Mobitech is the best spam blocker out there.
Besides, Android phone users can opt for SMS Filter and Private SMS &
Call. This app is available for BlackBerry phones too, but at a cost of Rs
140.
__________________________________________________________
ET in the classroom: Technology that will replace credit cards
What is NFC?
NFC, or near-field communication, is a variant of RFID, or radio frequency
identification. It is an ultra shortrange wireless technology that allows
communication and data exchange between two devices held in tight
proximity about 4 cm apart.
How is it different from bluetooth?
Bluetooth is also a short-range high frequency wireless technology but one
that allows interaction between communication devices as much as 10
meters apart.
What makes NFC special?
NFC-enabled smartphones have the potential to replace credit cards. This is
because NFC phones pack a smart chip a complex 80-character code that
is really hard to crack. Such a device can safely store confidential credit card
details and be handy for purchases on the go.
Frost & Sullivan predicts the technology will revolutionise e-commerce and
drive over $150 billion worth of transactions by 2015, bulk of which is
expected to be powered by NFC phones.
What else can the technology do?
85
NFC can be deployed in ticketing services, rural banking, interactive and

targeted advertising, healthcare, hospitality, libraries and pharmacies. In
fact, an NFC phone could become the single-key to access to your car, home
and office.
How do NFC transactions work?
Any device, a cellphone, a camera or a watch, can be equipped with an NFC
'initiator' , which is simply an antenna that can store data. If the device is an
NFC smartphone, the 'initiator' and 'target' (an NFC reader) need to be up
close for data exchange to happen.
The 'reader' is attached to a point-of-sale (PoS) terminal or cash-register in a
retail store that accepts NFC payments. A simple wave of the phone can pay
for a purchase. Alternatively, two NFC phones can be tapped lightly to
exchange business cards.
Will NFC be a drain on battery life?
Geeks claim that in standby mode, a well-designed NFC solution does not
consume any power. And since transactions happen in seconds, the power
drain is not huge.
Are NFC-adoption levels growing?
Globally, NFC adoption is picking up via smartphones. RIM,
Nokia, Samsung and HTC have unveiled NFC smartphones. Apple iPhone5
is tipped to support NFC too. Google Wallet a mobile payments
technology that can be downloaded on some US mobile networks is
growing the NFC ecosystem. Payment trials have also begun in Australia,
Singapore and China.
Has NFC arrived in India?
The technology is still in its infancy here. As of now, the Reserve Bank does
not recognise NFC mobile payment transactions and PoS terminals
accepting NFC payments don't exist. But NFC-enabled phones like
BlackBerry's Touch Bold 9900 and Curve 9360, Samsung's Nexus S and
Galaxy S II and Nokia's C7, 700, 701 and 600 are available.
For NFC to take off, RBI has to frame norms and banks, carriers, creditcard
companies, apps developers and PoS terminal makers have to team up. But
awareness levels are growing and NFC is making some waves in
entertainment.
86
Shah Rukh Khanstarrer Ra.One was the first movie to be marketed by Nokia
using NFC technology. Armed with an NFC phone, you can download the
movie content by merely tapping the device on a NFC-tagged movie poster
at a Nokia priority outlet or a partner multiplex.
__________________________________________________________
ET in the classroom: Saving private airlines
Rishi Shah & Smriti Seth, ET Bureau Nov 14, 2011, 08.22am IST
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 airline's 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 can't 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
87
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.
__________________________________________________________
ET in the classroom: How pure is your platinum ring
Sutanuka Ghosal, ET Bureau Nov 22, 2011, 04.44am IST

How Is Purity Measured?
Platinum is a precious metal, rarer and more valuable than gold. It is
typically used in a very pure form, often as high as 95%. Platinum jewellery
falls into three categories of purity, each with its own marking: Platinum,
Plat/Pt, and Platinum Group Metal Mixtures.
What Do The Markings 'Platinum' And 'Plat' Signify?
88
Jewellery that contains at least 95% platinum (or 950 parts per thousand)
can be sold as platinum. A piece of this jewellery is marked 'Platinum'.
Jewellery that is 85% or 90% pure is marked as 'Plat' or 'Pt', with part per
thousand being 850 or 900. For example: '900Pt.' or '850Plat.'
What Are Platinum Group Metal Mixtures?
Another type of jewellery is made from a mixture of platinum and one or
more metals that are classified as the 'platinum group' metals. This group
includes platinum, iridium, palladium, ruthenium, rhodium and osmium.
A piece that contains at least 50% (500 parts per thousand) of platinum and
a total of 950 parts per thousand of any of the 'platinum group' metals can be
marked as platinum jewellery as long as the amount of each metal is
disclosed. For example, '700Plat. 200Pall. 50Irid'. But any jewellery with
platinum content less than 35% should not be considered as platinum
jewellery.
How is purity measured in gold?
In karats. Any gold sample will have a maximum purity of 24 karats. In
practice, however, this sample will have a purity of 999.99 per thousand.
There will still be 0.01 per thousand by weight of impurity left in the gold,
which is due to its refining process and cannot be removed.
A gold ornament with a 16-karat tag means that this piece has 16 parts of
gold and the remaining 8 parts of some base metal. So a 16-karat gold piece
or ornament is 66.67% pure (16/24). The remaining 33.33% (8/24) is the
impurity. Similarly, if you take a 20-karat gold sample, it means it has 20
parts of gold and the remaining 4 karats of impurity. In other words, it is
89
83.33% (20/24) pure and has an impurity of 16.67% (4/24). Jewellery below
9 karat does not qualify as gold even though it has a 37.5% gold content.
__________________________________________________________
ET in the classroom: Care for a Dim Sum?

China's 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 China's phenomenal growth, but the country's 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.
90
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 yuandenominated 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.
(Source: Web; Text: Rishi Shah)
__________________________________________________________
ET in the classroom - Employees security net: Falling returns
Vikas Dhoot, ET Bureau Dec 12, 2011, 04.48am IST
91
What is the Employees' Provident Fund?

survivors
How is it different from PPF, GPF and NPS?
the rest
How big is the EPF?
EPFO
Who manages EPFO corpus?
HSBC
How is the interest rate on EPF determined?
What is the Employees' Provident Fund?
survivors
__________________________________________________________
ET in the Classroom: Set up a personal Wi-Fi hotspot
Getting a separate data connection for your laptops, tablets, smartphones is

highly expensive. Learn how to set up a personal wireless hotspot - a single
data connection (whether via a fixed line broadband connection, or over
3G) - for all of them:
ON A PC
Wi-Fi hotspot
ON A MAC
92
__________________________________________________________
ET in the classroom: Forwards contract, over the counter
Ruchira Roy, ET Bureau Jan 3, 2012, 03.51AM IST

WHAT IS A NON-DELIVERABLE FORWARD, OR NDF?
Non-deliverable forwards are over-the-counter transactions settled not by
delivery but by exchange of the difference between the contracted rate and
some reference rate such as the one fixed by the Reserve Bank of India.
WHY IS AN NDF MARKET NEEDED?
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 convertible
currencies.
WHERE DO THESE TRADES
PROMINENT CURRENCIES?
HAPPEN?
WHICH
ARE
THE
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 investors, which are allowed to hedge
only their actual exposure and not potential exposure; global corporations
that do their invoicing in Indian rupee but are not allowed to hedge their
exposures; and speculators betting on the direction of the rupee without any
exposure.
93
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 overseas books.
WILL RBI CURBS ON OVERNIGHT POSITIONS AFFECT NDFS? Yes,
it will squeeze international banks that were profiting from the wild
currency movements 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
movements are in a narrow range.
WHAT ARE FIXING AND SETTLEMENT DATES?
The fixing date is the date on which the difference between the prevailing
market exchange rate and the agreed upon exchange rate or the reference
rate is calculated. The settlement date is the date by which the payment of
the difference is due
__________________________________________________________
ET in the classroom: Qualified foreign Investors get direct entry
ET Bureau Jan 10, 2012, 03.39AM IST
94
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.
95
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: How 'smart' is your smartphone?
Hitesh Raj Bhagat, ET Bureau Jan 25, 2012, 08.07AM IST

It's the operating system, or OS, that makes a phone 'smart'. Although there
are several choices (and many, like Symbian, still hold a fair share of
the smartphone market), you should scope out these four OS-Android,
BlackBerry, iOS and Phone 7-before buying a new device:
ANDROID
It is the fastest-growing operating systems, primarily due to multiple device
offerings by various manufacturers. It is open to extensive customisation
and many of the apps are common to both iOS and Android. You also have
the widest choice of hardware, but there are numerous OS versions doing
the rounds.
PROS: Widest choice of phone hardware, Open to change/customisation
with launchers and skins, You can easily make your own apps, Android
smartphones start at less than `5,000
CONS: OS updates depend on device makers, Hardware fragmentation
leads to occasional app issues, Manufacturer OS customisation can be tacky,
Limited screening leads to numerous poor quality apps
WINDOWS PHONE 7
Microsoft is trying hard to break free from the stigma created by previous
versions of Windows Mobile, and Windows Phone 7 is a step in the right
96
direction. It's intuitive and the live tiles give you information at a glance
without having to open an app.
PROS: Attractive and fresh interface, Fastest-growing app store, Consistent
performance across devices (standardisation), Efficient multitasking
CONS: Limited interface customisation, Devices mostly do not have
expandable memory, Limited apps-till the numbers catch up, Lukewarm
response thanks to Windows Mobile stigma
APPLE iOS
All of Apple's portable products (including the iPod Touch, iPad and
iPhone) run iOS-now in its 5th version. Since Apple makes both the
software and the device, everything is tightly integrated (but also controlled
by Apple). To make your device do things which Apple doesn't allow,
jailbreaking is required, which could be complicated and voids the warranty.
PROS: Most intuitive interface, Widest app library with high-quality apps,
Highest desirability factor, Tight hardware-software integration
CONS: Choice limited to versions of iPhone, Completely lockeddown OS,
Expensive hardware (compared to rivals), Latest iPhone 4S looks identical
to outgoing 4
BLACKBERRY
Once the stalwart of the business world, sales have been dwindling
particularly in developed markets-enough to threaten the company's
existence. Plus, free push email is offered by all three major competitors.
However, newer devices running the latest OS7 have a lot going for them.
PROS: Future of the company in doubt, No OS upgrades for older
customers, Severely limited apps (numbers & quality), Current OS will get
completely revamped soon
CONS: Future of the company in doubt, No OS upgrades for older
customers, Severely limited apps (numbers & quality), Current OS will get
completely revamped soon
__________________________________________________________
97
ET in the classroom: Non-inflationary rate of growth
Feb 24, 2012, 03.16AM IST

Sonal
Economist, Nomura
Varma,
In a recent interview to the Wall Street Journal, D Subbarao, governor of the

Reserve Bank of India, said India's 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 the RBI annual bulletin for the year 2010-11, the threshold for
inflation was in the range of 4-6%.
98
"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
__________________________________________________________
Budget 2012: ET in the Classroom explains the process
ET Bureau Mar 12, 2012, 03.10AM IST

The government's 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 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
13-15 other documents. Divided into three parts -- Consolidated
Fund, Contingency Fund and Public Account -- it has a statement of receipts
and expenditure of each.
CONSOLIDATED FUND
This is the core of the govt's 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.
99
Budget 2012 at ET: Budget

2012 | Budget News
2012 | Union
Budget | Rail
Budget
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).
__________________________________________________________
100
ET in the classroom: Revenue and spend
ET Bureau Mar 15, 2012, 06.35AM IST

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 government's 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
101
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: 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.
102
__________________________________________________________
ET in the classroom: Why GAAR caused panic
ET Bureau May 8, 2012, 02.48AM IST

Finance Minister Pranab Mukherjee's clarification on General AntiAvoidance Rules (GAAR) fired up the markets on Monday, when global
indices were deep in the red. A look at why GAAR has caused panic among
investors:
What are general anti-avoidance rules?
These rules, originally proposed in the Direct Taxes Code, are targeted at
arrangements or transactions made specifically to avoid taxes. The
government had decided to advance the introduction of GAAR and
implement it from the current financial year itself. More than 30 countries
have introduced GAAR provisions in their respective tax codes to check
evasion.
What are the implications?
GAAR allows tax authorities to call a business arrangement or a transaction
'impermissible avoidance arrangement' if they feel it has been primarily
entered into to avoid taxes.
Once an arrangement is ruled 'impermissible' then the tax authorities can
deny tax benefits. Most aggressive tax avoidance arrangements would be
under the risk of being termed impermissible. The rule can apply on
domestic as well as overseas transactions.
What were the key concerns?
GAAR is a very broadbased provision and can easily be applied to most taxsaving arrangements. Many experts feel that the provision would give
103
unbridled powers to tax officers, allowing them to question any taxsaving

deal.
Foreign institutional investors are worried that their investments routed
through Mauritius could be denied tax benefits enjoyed by them under the
Indo-Mauritius tax treaty. The proposal had spooked stock market as FII
inflows dropped on concerns, and the rupee hit a low of Rs 53.47 to the
dollar.
What has the govt done now?
It has postponed GAAR to the next financial year. This will give a breather
to tax payers and also allow the government time to frame clear rules after
consultations with stakeholders.
He has also clarified that the onus to prove that an arrangement is
'impermissible' will lie with the tax department. The GAAR panel, the final
body that will decide on the applicability of the law, will include an
independent member.
__________________________________________________________
ET in the classroom: Moving Averages- A Nifty Tool

A reliable technical indicator used by traders to track the trends of financial
assets by smoothing out day-to-day price fluctuations, or noise
What's a moving average?
A simple moving average indicates the average value of the price of an
asset- a stock, commodity or index - over, say, 15, 50, 100 or 200 straight
104
days. For example, a 15-day moving average is calculated by adding up the

closing prices in the past 15 days and then dividing the result by 15.
There are other moving averages too, such as the exponential moving
average. Of late, traders and analysts have been talking about the 200-day
moving average (200 DMA) of the Nifty index.
What is so special about Nifty's 200 DMA?
The Nifty broke below its 200 DMA of 5114 last week for the first time
since January, when it closed below 5086. Although the Nifty made an
attempt to recover on Friday, it has slipped way below this technical level in
the last two days.
How do analysts read the 200 DMA?

Roughly, around 200 trading days exist in a year after deducting weekends
and holidays.
When an index or a stock closes below the 200 DMA, it is said to be in a
longterm downtrend until it breaks out above the average.
This means a new buyer of the index or stock is willing to pay less than the
average price paid in the last 200 consecutive days.
When it trades above the 200 DMA it is in a long-term uptrend.
Technical analysts usually wait for three to five straight days of a stock's or
an index's closing below or above the 200 DMA to conclude a trend.
What does a fall below the 200 DMA mean?
105
The 200 DMA acts a major support in a bull

market and as a major resistance in a bear market.
Since it's a long-term average, it helps investors who hold a significant stock
portfolio and are in the market for the long haul.
When a market conclusively breaks below or out of its long-term average, it
provides a signal to the investor to either buy or sell.
__________________________________________________________
ET in the classroom: What is the difference between branch and subsidiary in

foreign banks?
Anita Bhoir, ET Bureau May 15, 2012, 02.11AM IST

After the global economic crisis, India has been encouraging foreign
banks to operate through subsidiaries, a move that promises to provide
regulatory comfort to the government.
WHAT IS SUBSIDIARISATION OF FOREIGN BANKS?
106
The conversion of a foreign bank with branch presence into a subsidiary is

called subsidiarisation. This arrangement protects Indian capital and
operations from external economic shocks as such outfits follow local
guidelines.
HOW IS IT DIFFERENT FROM THE CURRENT STRUCTURE?
At present, most foreign banks operate as branches or representative offices
of the parent. Unlike branches, locally incorporated subsidiaries are separate
legal entities. They have their own capital base and board of directors. In the
case of branches, parent banks are, in principle, responsible for
their liabilities.
HOW IS INDIA ENCOURAGING SUBSIDIARISATION?
Last week, Finance Minister Pranab Mukherjee proposed tax neutrality for
this route. Existing laws require overseas lenders to pay up to 30% of the
market value of their assets as capital gains and stamp duty while converting
branches into a new entity. Besides, the RBI had, in its discussion paper,
supported incentives for setting up subsidiaries, including liberal branch
expansion and allowing raising of rupee resources by issuing non-equity
capital instruments in form of hybrid instruments and subordinate debt.
Current regulations allow foreign banks to raise resources only from their
parent body or head office through Innovative Perpetual Debt Instruments.
BUT WHY ARE FOREIGN BANKS RELUCTANT?
Because they first want absolute clarity on the proposed tax neutrality,
branch licensing policy, priority lending norms and listing guidelines. At
present, it's not easy for foreign banks to acquire branch licences. On an
average, the RBI issues about 14 branch permits to all foreign banks every
year. Also, the priority sector limit for foreign banks is pegged at 32%
against 40% for domestic banks. But foreign banks want a more liberal
limit.
__________________________________________________________
107
ET in the classroom: Core Inflation, critical to policymaking

India's headline inflation has remained above the Reserve Bank's comfort
level for over two years. Yet, the bank cut its key interest rate by half-apercentage point last month, thanks largely to a moderation in core inflation.
Here's why policymakers across the world keep tabs on core inflation:
What is core inflation?
It refers to changes in the price of a select basket of commodities, which
excludes items with volatile prices such a food and fuel.
Why do central banks follow core inflation more closely than headline
inflation?
To manage the rate of price rise, central banks need to know the underlying
demand pressures in the economy, as heavy demand tends to push prices up.
Core inflation provides this measure. It gives an indication whether
manufacturers are able to pass on any rise in input costs without suffering a
drop in demand. Thus, core inflation helps central banks predict headline
inflation.
Does core inflation influence monetary policy?
High core inflation indicates demand pressures in the economy that can
trigger rapid price rise. A central bank can then lift interest rates to dampen
demand and lower inflation. On the other hand, if core inflation is low, the
central bank can cut rates to spur demand.
If a central bank focuses only on headline inflation, which could be rising
because of high food prices, then its monetary signals will fail to yield the
desired benefits because demand for food is not much influenced by interest
rates. In such a situation, monetary policy could hit elsewhere, for instance,
investments.
108
How is core inflation measured in India?

India got a nationwide measure of retail inflation only last year. Given the
lack of historical data, the wholesale price index is still the most widely
watched measure of prices.
It includes three broad categories of items - primary articles (which include
food), fuel and manufactured goods. While some economists consider
inflation in manufactured goods as a measure of core inflation, other slice it
further to consider only the non-food manufactured goods.
__________________________________________________________
ET in the classroom: Why rupee depreciation is not so bad
Sorry, Readability was unable to parse this page for content.

__________________________________________________________
ET in the classroom: What is Quantitative Easing?
ET Bureau Jun 6, 2012, 01.56AM IST
109
Central banks usually stimulate a slowing economy by cutting interest rates,

which encourages people to spend by borrowing more. But with rates in the
developed world already close to zero, that option is no longer available.
So central banks pump money directly into the economy, a process known
as quantitative easing.
How is this done?
Central banks expand their balance sheets by

buying government securities or other securities from the market and
financial institutions.
This process increases the money supply by flooding financial institutions
with capital, in an effort to promote increased lending and liquidity.
Has this been done earlier?
Developed countries used quantitative easing to spur growth following the
2008 financial meltdown.
Subsequently, the US Fed went ahead with another round of QE in late 2010
(called QE2).
Other central banks such as the Bank of England and Bank of Japan have
also increased money supply via QE in the past two years.
How does it work?
110
At any given point of time, there is a fixed amount

currency/money chasing products and services available in the economy.
The objective is to get more money into the system and promote
consumption.
The intention is also to spur lending by giving more cash in the hands of
financial institutions.
How does it help?
The flood of cheap money causes

asset (shares and real estate) prices to rise.
The notional high wealth, together with cheap and easy credit, encourages
people to spend.
Quantitative easing also helps devalue the currency, encouraging exports
further and increasing the level of economic activity.
The final consequence is increased demand resulting in ramping up of
production, which, in turn, creates more jobs.
What will be the impact of another QE?
111
In today's globalised world, cheap money from

developed economies may flow into emerging economies and fuel asset
bubbles and inflation by perking up commodity prices.
While India is in dire need of dollar inflows the positives are offset by rising
commodity prices.
__________________________________________________________
ET in the classroom: Pension Bill - What will it do?

On Thursday, the government was forced to defer a decision on the pension
bill following objections raised by some UPA allies. Here's a look at the
provisions of the bill:
What is the pension bill?
The Pension Fund Regulatory and Development Authority (PFRDA) Bill
2011 is usually referred to as the pension bill. It was introduced in the Lok
Sabha on March 24 last year and was subsequently referred to the standing
committee on finance for a detailed examination.
The government had introduced a similar bill in 2005 but it had lapsed as
the term of the 14th Lok Sabha expired before it could be passed.
What does the bill seek to do?
112
The government was finding it difficult to manage its rising pension liability
because of the defined-benefit system, under which the pension paid to
employee was based on their last salary drawn.
In 2004, it shifted to a defined contribution system, which required
employee to save for retirement from their earnings.
Towards this end, it set up a new pension system (NPS) for those joining
government service after January 2004 and subsequently set up the Interim
Pension Fund Regulatory and Development Authority to oversee the scheme
that already managed the retirement savings of lakhs of state and central
government employees.
The NPS was later extended to private individuals. The government now
hopes to establish the NPS as the premier retirement savings scheme.
The pension bill seeks to give statutory or legal powers to the PFRDA, and
set the framework for the regulation of pension fund schemes, including the
ones being currently offered.
What is the current status?
The standing committee had submitted its report on the bill in August last
year. The government has to now take a stand on the recommendations and
bring an updated bill. However, it has not been able to build a consensus on
the terms of the proposed law within the coalition.
What are the bill's key provisions?
Powers to PFRDA to regulate and develop the sector.
Provides for foreign investments in the sector but has not set a limit.
Detailed frame-work for the management of the NPS, which has two types
of accounts, Tier-1 and Tier-2. Withdrawal from Tier-1 accounts will be
allowed only on retirement. The NPS has three investment options of
varying exposure to equities, govt debt and corporate debt.
What are the committee's main suggestions?
Mention a FDI limit of 26%, same as that for the insurance sector.
Allow emergency withdrawal facility even from Tier-1 account and a 100%
government securities option for subscribers.
A minimum guaranteed return.
113
Why are UPA allies against the bill?

They are objecting to provisions enabling foreign direct investment in the
sector and allowing management of pension schemes by private players.
__________________________________________________________
ET in the classroom: What is crude oil benchmark and its relevance?

A look at the concept of crude benchmarks and their relevance for deciding
the price of fuels in India:
What is a crude oil benchmark?
Crude oil benchmarks are reference points for the various kinds of oil blends
that are available in the market. Known as oil markers, they were first
introduced in the 1980s and are used to establish trading standards for the
commodity.
While there are many crude oil benchmarks, the three primary ones
are WTI, Brent blend, and Dubai blend.
How are they different?
Crude oil extracted from different parts of the world differ in terms of
physical properties such as color, viscosity and relative weight and
composition.
Their classification is based primarily on the geographic location &
properties such as sulfur content and relative weight.
114
Some blends are considered superior to others. For example, crude oil
blends with lesser amount of sulfur are characterized as sweet while a blend
with higher sulfur content is known as sour.
Which benchmark is used for the Indian market?
India sources its crude oil requirements mostly from Far East, Gulf region,
Mediterranean, West Africa and Latin American sources. Because of the
diversity in India's sourcing, the regular crude benchmarks do not serve
India's purpose.
The country, therefore, has its own benchmark 'Indian basket' that is used
for pricing and subsidy calculation purposes.
The Indian basket uses Oman/Dubai for sour grade crude and Brent for the
sweet grade one in the ratio of 65.2 and 34.8.
What are under-recoveries and how are they calculated?
An under-recovery means recovering less than what could have been
realized had the product been sold at the notional market price.
Under-recoveries should not be confused with losses as for a loss to occur
the sale price has to be less than the cost of producing the fuel.
The calculation of under-recoveries is done by using formulas prescribed by
the government's Petroleum Planning and Analysis Cell.
__________________________________________________________
115
ET in the classroom: India's IMF contribution is not aid
The government has pledged $10 billion as its contribution towards a

planned International Monetary Fund's cash chest to tackle the European
crisis. So does that mean that Indians will pay for the rescue of the troubled
European countries? Or does this amount to giving away precious dollars at
a time when foreign inflows are slowing? No, the pledged amount will
remain part of India's reserves. Rishi Shah explains:
IS INDIAN CONTRIBUTION AN AID?
No, it is not a giveaway. India is simply buying bonds from the IMF. These
bonds are not free aid to the ailing European economies but financial
instruments that guarantee safe and reasonable returns. The notes would
provide a return of average interest rate of SDR's over the past three
months. SDR, or special drawing right, is a reserve currency created by
the IMF to supplement the existing reserves of member countries. After the
global financial crisis of 2008, the Group of Twenty industrialized and
emerging market economies agreed on April 2, 2009, to triple the
International Monetary Fund's lending capacity to $750 billion, enabling it
to inject extra liquidity into the world economy during times of crisis. India
had then agreed in principle to inject $10 billion to the IMF war chest.
__________________________________________________________
ET in the classroom: Interpreting rollovers
Nihar Gokhale, ET Bureau Jun 25, 2012, 03.05AM IST
116
Investors often roll over, or carry forward, their existing futures positions by
entering into similar contracts expiring at some other time. ET explains
what it means for the stock market:
WHAT IS A ROLLOVER?
Rollover is a process in which investors carry forward their positions in a
derivatives contract from one expiry date to another. Traders can either let a
position expire or carry forward their bets - that is, enter into a similar
contract expiring at a future date.
WHEN AND HOW TO ROLL OVER?
In India, equity derivatives expire on the last Thursday of each month.
So rollovers can happen till the close of trading hours on that day. Most
rollovers begin a week before expiry and end till the last minute. Usually,
contracts are rolled over to the next month.
For example, if a trader holds 10 long futures of State Bank of
India expiring in May, then a rollover means the trader squares off this
position and buys 10 SBI futures expiring in June. This way, the trader
extends the long position of 10 contracts in SBI till the June expiry. In other
words, the trader has rolled over bullish bets on SBI.
HOW TO INTERPRET ROLLOVERS?
Rollover numbers don't have a definite benchmark but are expressed as a
percentage of rolled positions to total positions. While some analysts may
note absolute changes in rollover quantities, the standard practice is to
compare a rollover percentage with its trailing three-month average. For
example, in the rollovers from April to May contracts, Nifty futures had a
rollover of 56.95%, up from the three-month average of 52.15%, indicating
slightly stronger sentiment. Rollover is a quick measure of investors'
willingness to bet in the market.
So lower-than-average rollovers are an indication of cautiousness while high
rollovers indicate a strong sentiment. Accordingly, any imbalance in long
positions or short positions indicates the direction the market is betting on.
Analysts also interpret rollovers on the basis of costs. For instance, a trader,
while rolling over a position, may enter into the next month's contract at a
premium or discount to the underlying value. In other words, the rollover
could happen at a high cost of carry, which would then indicate the degree
of bullishness.
HOW TO ACCESS ROLLOVER DATA?
117
Unlike trading data, rollovers are not distinctly captured by exchange

websites. Instead, analysts interpret rollovers by calculating and grouping
large amounts of trading data.
ARE THERE ROLLOVERS IN OPTIONS?
Rollovers are possible only in futures. This is because it is mandatory for
futures to be settled at expiry, whereas an option may or may not be
exercised. Options are not entirely out of the picture, though. Some traders
confirm their interpretation of a rollover by checking changes in the implied
volatility (IV) of options of a similar expiry. A high IV along with a strong
bullish rollover is said to strongly indicate positive sentiment.
__________________________________________________________
ET in the classroom: How monsoon affects Indian economy
ET Bureau Jul 2, 2012, 06.07AM IST

India faces the prospects of a second drought in 4 years, though it is too
early in the season to worry. ET takes a look at the role monsoon plays in
the Indian economy.
Is Farm Sector Crucial For Economy?
Statistically, its significance has declined as now farm sector has a much
lower share in GDP. However, with over 50% of population still finding its
livelihood in the sector, any stress in the sector has a disproportionately
large impact on people
118
How Important Is Monsoon For Agriculture?

Since India gets most of its water from the 3 months of rains, the importance
of monsoons cannot be understated. However, increase in irrigation facilities
has helped reduce risks
How Monsoon Affects Farm Output?

Only in extreme drought years does the output drop sharply. The rising
importance of winter crop and better irrigation has improved India's ability
to withstand monsoon shortfall
119
Is Monsoon Linked To Inflation?

A poor monsoon can create shortage. But in recent years, food inflation has
been high despite rains due to shift in demand patterns. A good buffer stock
has also weakened the linkage
__________________________________________________________
120
ET in the classroom: Lens on Libor

The Libor fixing scandal has put an unwelcome spotlight once again on the
world of banking and highly paid bankers. The resignation of Bob Diamond,
once dubbed as 'The Real-Life Gordon Gekko' by a British newspaper, may
just be the start of a long list of bankers who could fall on their swords over
the interest rate rigging scandal.
What is Libor?
The London Interbank Offered Rate or Libor is an average of how much it
would cost banks to borrow from one another. It is derived from a survey of
banks by the British Bankers' Association and not actual transactions. It is
done in dollars, euros, yen and Swiss francs.
Why is this rate important?
Trillions of dollars of bonds, derivatives and other financial transactions are
benchmarked to Libor. Manipulating it by even 0.01 percentage point could
lead to millions of dollars in profits (or losses).
What happens now?
Barclays is in turmoil. Other banks could soon be. Regulators are probing
UBS, HSBC, Royal Bank of Scotland, Deutsche Bank, JPMorgan,
Citigroup, as well as brokers ICAP and RP Martin Holdings.
And...
If more banks found guilty, regulators may expedite changing the way Libor
benchmark is being fixed.
__________________________________________________________
121
ET in the classroom: Why current account deficit will improve

India reported an all-time high current account deficit of 4.2% of GDP in
2011-12 and trade deficit of about 10% of GDP.
However, economists say these deficits will be under control as the J
curve effect comes into play. ET looks at the concept of the J curve.
What is 'J' curve?
The J curve is used to illustrate a movement in a variable's, which falls
initially but rises up to higher levels than before in the shape of the letter 'J'.
When applied to a country's external account, it says that whenever there is
depreciation in the currency's value, the trade deficit initially worsens as
imports become more costly and exports take more time to react.
Over time, depreciated currency makes exports competitive while imports
slowdown as cheaper domestic output replaces imports. This shift causes
trade balance to improve.
What's its significance?
The curve shows that depreciation of a currency due to deterioration in a
country's external balances is actually a part of the solution.
If the depreciation is managed properly through intervention to reduce
volatility, then it will help correct the imbalances.
Why is it relevant in the Indian context?
The rupee has depreciated from around `49 a dollar to `57 since the start of
the year, but has recently bounced back to around Rs 55. This has worsened
current account as a large portion of imports, including crude oil, is price
inelastic in the short run.
122
But economists expect imports to come down in future as costlier inputs

dampen demand, as evident in the case of gold.
Simultaneously, exports will pick up as they have become more
competitive/cheaper in the global market. This will lead to an improvement
in trade balance & consequently in Current account deficit.
What could hamper 'J' shaped recovery in external account?
While India's exports have become more competitive due to the massive
devaluation of the rupee, global growth has also stumbled which will limit
the demand for India's exports.
Also if the country does not pass on higher fuel costs to consumer, the
demand for imported crude will not come down.
__________________________________________________________
ET in the classroom: Details of India-Mauritius Tax Treaty

Mauritius has now agreed to include safety clauses in its tax treaty with
India, after the latter decided to put in place GAAR. ET explains the details
of India-Mauritius tax treaty.
Key elements of the treaty
The 1982 India-Mauritius tax treaty sought to eliminate double taxation of
income and capital gains to encourage mutual trade and investments.
The most discussed and controversial clause of the treaty is Article 13. It
says that any capital gain made by a Mauritian firm in India, including those
on sale of securities by a resident of that country, will be taxed in Mauritius
only.
123
Since Mauritius does not tax capital gains, any investment into India by a
Mauritian escapes capital gains tax on profits on investments made in India.
Why is it a concern for India?
India gets nearly 40% of FDI from Mauritius. A large portion of portfolio
investment also comes from there. Most of these investors have set
up special purpose vehicles or shell companies in Mauritius to take
advantage of tax treaty.
There is also an apprehension that a lot of investment may actually be Indian
money (round tripping) coming via Mauritius.
What has been done to prevent misuse of the treaty?
India has proposed a review of the DTAC to prevent treaty abuse. A Joint
Working Group (JWG) set up in 2006 didn't make much progress because of
the unwillingness of Mauritius to change the treaty.
India has now proposed GAAR, which can deny tax benefits to any
arrangement entered solely for the purpose of avoiding tax.
Tax authorities could club shell companies set up in Mauritius to invest in
India as such arrangements and deny them tax benefits.
What's 'limitation of benefits'?
As a safeguard measure, tax treaties have conditions that investors have to
meet to be eligible for benefits. Mauritius is now willing to include these
clauses in the India-Mauritius DTAC.
__________________________________________________________
ET in the classroom: When does government declare drought?
124
Rituraj Tiwari, ET Bureau Jul 12, 2012, 03.23AM IST

Even though the share of agriculture in the country's GDP is declining, a
year of poor rainfall means acute hardship for farmers which, in turn, has a
negative impact on the economy. ET explains when does a drought happen:
What is a drought year?
The Indian Meteorological Department defines a drought year as one in
which the overall rainfall deficiency is more than 10% of the longperiod
average and more than 20% of the agricultural area is affected.
Are there different categories of droughts?
Yes. There are three types depending on the impact.
Meteorological
This happens when the rainfall in an area is less than 25% of its long-term
average.
Hydrological
A marked depletion of surface water causing very low stream flow and
drying of lakes, rivers and reservoirs.
Agricultural
Inadequate soil moisture resulting in a fall in agricultural productivity.
When is a drought declared?
Traditionally, in India, district collectors recommend the declaration of a
drought after obtaining crop production estimates. Generally areas with less
than 50% normal sowing are considered to be affected by a drought. The
other markers of drought conditions include rain deficiency, normal
difference in vegetation index and moisture content in the soil.
What happens after the declaration of drought?
The government initiates planning and implementation of relief measures.
States roll out contingency plans, which include measures to provide
employment, food, drinking water, and fodder for the livestock.
How does a drought impact the economy?
125
A drought impacts virtually all spheres of economic activity. Farm produce

dips, water levels go down and the mortality rate of livestock and wildlife
goes up. The economy takes a hit as farm income falls, food prices
accelerate, consumption demand plummets and farm loan defaults rise. Its
social costs include unemployment and migration.
__________________________________________________________
ET in the classroom: Choose the best price gauge
Rishi Shah, ET Bureau Jul 19, 2012, 02.20AM IST

Reserve Bank governor D Subbarao has said India needs a new gauge of
inflation the producer price index. According to Subbarao, the most
widely watched measure of inflation in India, the wholesale price
index(WPI), does not include services, which forms a big part of economic
activity. Rishi Shah lists all current inflation measures and their
shortcomings and what the RBI wants:
WHOLESALE PRICE INDEX
The WPI is the most widely watched gauge of prices in India,
tracking commodity prices at the wholesale level. It has three major
components: primary goods, fuel and power index and manufactured goods.
Primary goods carry a weight of 20.12%, 'fuel and power' 14.91% and
manufactured products 64.97%.
SHORTCOMINGS
1. Not globally comparable as countries either have a producer price
index or a consumer price index, that is used by central banks
126
2. Only has goods, and excludes services, a huge part of the economy, which
directly affect prices of all other things.
3. Most of the prices are captured through mandis or places where wholesale
transactions take place. These rates do not reflect the prices consumers pay
for goods.
CONSUMER PRICE INDEX
India currently has four indices that measure changes in prices of goods and
services paid by the final consumer.
They are: CPI for rural labourers, agricultural labourers and industrial
workers, and (the latest) all-India consumer price index.
SHORTCOMINGS
1.The indices for rural labourers, agricultural labourers and industrial
workers are too narrowly targeted to be used for macro policy formulation.
2. The all-India CPI, which has been divided between urban and rural areas,
gives the most accurate picture of prices but has very limited history as it
was started in January last year.
PRODUCER PRICE INDEX
A producer price index tracks the price of goods recorded at the first
transaction. It measures changes in prices received by domestic producers of
goods and services over time.
This is different from the retail prices, which include shipping costs, taxes
and other levies. It gives an account of the economy's efficiency in
transferring goods and services from the producer to the consumer, who
could be the final consumer or another producer using it as an input.
PROGRESS
The government is in the process of creating a PPI besides revising the WPI.
The government plans to come out with both indices initially while moving
to the PPI in time to establish congruity with internationally established
standards.
127
__________________________________________________________
ET in the classroom: How to interpret implied volatility
Nihar Gokhale, ET Bureau Jul 24, 2012, 12.41AM IST

ET explains how an option's price is linked to volatility
What is implied volatility?
Implied volatility (IV) of an option contract represents a trader's perception
of near-term risk in the underlying index or stock. It is a one of the key
factors that decide an option's price, which usually rises in times of high
volatility. The implied volatility of an option at any point of time is derived
from its last traded price.
How is it tracked?
An option buyer pays a premium that is linked to the volatility expected in
the market. In transactions involving an illiquid option, counterparties
negotiate on implied volatility rather than just the price. Analysts also track
IVs as an indicator of broad market sentiment. Each contract has a unique
IV, which is displayed on terminals and exchange sites. Analysts generally
track IVs of at-the-money (ATM) Nifty options - those with strike prices
nearest to the spot.
What do its values imply?
When traders are pessimistic, they tend to buy put options as protection.
This increases the IV of puts, signaling bearishness. Similarly, when traders
are not aggressively protecting themselves from sharp market movements,
IVs drop. Most traders are comfortable with IVs between 20% and 25%.
Recently, IVs of ATM Nifty options have fallen to around 14%, because
traders are not expecting any events that can cause volatility.
128
Do high IVs always imply bearishness?

Theoretically, implied volatility readings do not signal market direction and
hence do not necessarily indicate bearishness. However, traders usually take
high IVs as a bearish signal. They argue that more often than not,
expectation of a downfall has a stronger impact on trading behaviour, than
hopes of an upside. So high IVs are usually a result of bearishness as
investors and fund managers rush to protect themselves from a sharp
downside.
How do traders profit from volatility?
When IVs are low, options are cheap and derivatives traders use so-called
'long vol' strategies to profit from a rise in volatility. A typical trade in such
a strategy is a 'long strangle', where traders buy Nifty call and put options
where the put option is of a lower strike price. The trade profits from a sharp
movement in Nifty - whether up or down. Thus, it captures the increased
volatility in the Nifty without betting on the direction.
Vol trading is very popular among institutional and proprietary traders.
However, these traders benefit from expectations of big moves in the market
ahead. In fact, some analysts believe that prolonged spells of low IVs mean
that these vol traders are not anticipating any big moves and are instead
expecting the options to expire worthless.
__________________________________________________________
ET in the classroom: What is Fiscal Cliff?

What is Fiscal Cliff?
129
The phrase "fiscal cliff" was first used by Fed chairman Ben Bernanke to
refer to the combination of tax increases and spending cuts that would come
into effect at the end of the year. Here's a look at the possible consequences:
What impact will the fiscal cliff have?
A number of tax cuts, including Bush-era tax cuts, and unemployment
benefits will expire almost together at the year-end. The result would be a
drop in government spending and lower disposable incomes.
These tax benefits and higher government spending had supported the
economic recovery at a time when private sector demand was low.
Expiry of tax benefits and lower government spending would help reduce
the federal budget deficit but could temporarily arrest economic recovery,
possibly even driving the US into a recession during the first half of the next
year.
What does it imply for the rest of the world?

The current fiscal policy in the US has raised concerns over the country's
long term fiscal stability and solvency. The increase in taxes and lower
government spending are part of the solution.
But if the tax increases and spending cuts are allowed, the resulting
recessionary climate would then cloud the prospects of even the fastestgrowing economies, China and India.
Why is it a big talking point now?
It has become a big issue because the US presidential elections are due in
November, which will leave little time for the new president to take
appropriate action. Also, due to political reasons neither party in the US is
backing down from its demands.
130
While the Dems want a combo of tax increases and some benefits, the
Republicans want tax cuts coupled with benefit reductions.
So what is the alternative?
The two parties could arrive at a compromise before the elections start,
which could calm financial markets. But so far they haven't shown any
inclination to talk; probably both are waiting to see who will have more
negotiating leverage after the November elections.
__________________________________________________________
ET in the classroom: Why does a power grid fail?
Sarita C Singh, ET Bureau Jul 31, 2012, 02.30AM IST

On Monday, the whole of north India suffered a blackout for several hours
after the sudden collapse of the northern grid. Sarita C Singh explains what
constitutes a grid and the possible reasons behind its failure:
What is an electricity grid?
It is a network of power lines that evacuates electricity from a generating
station. Its constituents are generating stations, transmission lines and
substations (transformers that step down voltage). India's electricity grid is
divided into five regional zones north, east, west, south and north-east
to optimally utilise the unevenly distributed power resources in the country.
How does it function?
States in each region communicate their electricity drawl schedule to their
respective load dispatch centers, which monitor grid frequency and voltage.
The grid operates in a narrow frequency band of 49.5Hz to 50.2Hz. The grid
frequency falls when there is excess drawl of electricity or the generation is
less and increases when there is excess supply or the drawal is less.
131
When does a grid collapse?

A grid collapses when the frequency falls below the lower limit of the (49.550.2Hz) band or increases beyond the upper limit. As a result, transmission
lines stop accepting power supply and other grid constituents, including the
generating stations, go offline.
How is power restored?
Restoration of power is an extensive process involving all the grid
constituents: the grid management authorities start restoring the
transmission lines and simultaneously make alternative arrangements for
power supply. Generating stations are restarted. Among all power projects,
coal-based plants take the longest to resume operations.
How is the fault determined?
This is a tough task as the authorities have to go through the details of persecond consumption and supply by each constituent of the grid at the time of
the collapse. As a routine exercise, the regional load dispatch center
authorities keep warning states and regulatory authorities at regular intervals
about possible failure due to excess or lower drawl of power.
__________________________________________________________
ET in the classroom: How independent is CAG?
Rishi Shah, ET Bureau Aug 21, 2012, 06.00AM IST

The Comptroller and Auditor-General of India (CAG), the chief auditor of
government accounts, has come under the spotlight for its reports on coal
block allocation, ultra mega power projects and the Delhi international
airport. ET explains the role of CAG and the possible action the government
can take on its reports.
132
WHAT IS CAG's ROLE?

Its main role is to audit and check accounts relating to all Union & state govt
departments and offices, including Railways, Posts and Telecoms. It also
scrutinises the accounts of companies owned or financed by the government.
There are about 1,500 public commercial enterprises and about 400 noncommercial autonomous bodies and authorities owned or controlled by the
Union or state governments. Besides, there are over 4,400 authorities and
bodies substantially financed from Union or State revenues that come under
CAG's purview.
HOW DOES THE CAG CONDUCT ITS BUSINESS?
The audit by CAG is classified into regularity audit and performance audit.
Under regularity audit, which is also called compliance audit, financial
statements are analyzed and it is ascertained whether all rules and
regulations were followed.
In performance audit, the CAG checks whether various government
programmes have achieved the desired objectives at lowest cost and yielded
the intended benefits.
IS IT INDEPENDENT?
The CAG is an authority established by the constitution of India and is
independent from govt's influence. It has been formed to keep a check on
govt's revenues and expenditures.
The CAG is appointed by the President and can only be removed from
office in like manner and on like grounds as a judge of the Supreme Court.
The salary & other conditions of service are determined by Parliament and
cannot be changed to his disadvantage post-appointment.
The administrative expenses of the office of CAG are charged upon
the Consolidated Fund of India.
WHAT HAPPENS AFTER CAG SUBMITS REPORTS?
The CAG submits its reports to various committees of Parliament and state
legislatures, such as the Public Accounts Committee and the Committee on
Public Undertakings.
These committees then scrutinize the reports and decide whether all policies
were followed and whether there was any wrongdoing on the part of any
133
government body. The matter is then debated in Parliament and corrective

action is taken.
__________________________________________________________
ET in the classroom: Why all eyes are on Jackson Hole?
ET Bureau Aug 31, 2012, 01.00AM IST

(The Federal Reserve Bank)
Prominent global central bankers, finance ministers and academicians will
meet at Jackson Hole, in the western US state of Wyoming, on Friday. This
gathering will be keenly watched for what Federal Reserve chairmanBen
Bernanke says on quantitative easing. Here's more on the annual meeting:
WHAT IS THE JACKSON HOLE SYMPOSIUM?
The Federal Reserve Bank of Kansas City hosts an annual economic policy
conference that is now popularly called the Jackson Hole Symposium. Held
every year since 1978, the conference usually debates topics that relate to
emerging issues and trends and may not necessarily focus on current
problems. Participation and media attendance is restricted in the interest of
encouraging meaningful dialogue. Every invitee has to pay a fee to attend
the conference and the proceeds are used to recover the expenses. All the
paper and transcripts of proceedings are available online or in print, free of
charge, from the Federal Reserve Bank of Kansas City.
WHAT IS ITS SIGNIFICANCE?
Investors and markets closely follow the statements made at Jackson Hole
for understanding the possible direction of policy. The restricted nature of
discussion encourages free thought, which can at times provides glimpse
into what policymakers are thinking. However, opinion is divided on
134
whether the statements made at the meeting are long-term ideas or

something that would lead to action sooner.
WHY HAS ITS IMPORTANCE INCREASED THIS TIME?
The symposium comes amid visible deterioration in the global economy,
with many of Europe's bigger economies contracting and the US slowing
down. The markets are now looking for some hints from Ben Bernanke
whether the US Fed will embark on a third round of quantitative easing.
The US economy expanded 1.7 per cent in the April-June quarter but some
encouraging data has dampened the case for further bond purchases by the
US central bank to pump more money into markets to push growth.
The European Central Bank is also working on a bond-buying plan to ease
the debt crisis in the region.
WHAT IS QUANTITATIVE EASING?
Central banks buy government securities or other bonds from the market and
financial institutions. This increases the money supply and also makes funds
available to lenders for giving out loans to consumers and investors. It is
hoped that this extra liquidity and lending will spur the real economy.
__________________________________________________________
ET in the classroom: Pygmalion Effect
Rica Bhattacharyya, ET Bureau Sep 11, 2012, 05.55AM IST

WHAT IS PYGMALION EFFECT?
Pygmalion Effect, also called selffulfilling prophecy, refers to the tendency
in which more the expectations placed upon people, be they children,
students or employees, the better they perform.
FROM WHERE HAS THE CONCEPT ORIGINATED?
135
The concept is taken from George Bernard Shaw's famous play 'Pygmalion'.
In the play, an uneducated flower girl is transformed into a beautiful, well
mannered and articulate princess by making her believe that she can become
a princess. Pygmalion Effect is a phenomenon of creating or instilling
confidence in a person to achieve what is desired of him/her to be achieved.
Pygmalion Effect necessarily has a person or mentor prophesying belief in
the capability of the subject to attain qualities that are desired. In the play
'Pygmalion', the eponymous character Professor Higgins does it admirably.
HOW IS THE CONCEPT USED BY MANAGERS?
Managers use the concept more often as a motivation tool to direct the
efforts of their subordinates. The application of this concept in most cases
leads to enhanced performance by employees. The reason is obvious as the
employee responds to the faith that the superior has reposed in her supposed
ability. This response is most often positive as the desired goal is
conditioned by the organisation and social expectations. The subject or
employees' own desire is often subordinate to the overarching expectations
from the superior. Pygmalion Effect has a greater impact as the employee
feels she is always under observation and there is a burden of expectations
from the superior or organisation on her shoulders. Pygmalion Effect is also
often used with regard to education and social class.
WHAT ARE SOME RELATED CONCEPTS?
Some of the concepts related to Pygmalion Effect are the Hawthorne
Effect and the Placebo Effect. Both these concepts have elements of
Pygmalion Effect in them, while all three are in turn based on the concept of
instilled self-belief.
__________________________________________________________
ET in the classroom: Inter-Bank Mobile Payment Service
Sep 14, 2012, 05.53AM IST

136
(IMPS offers an instant,)

Did you know you could use your mobile phone to make instant payments
for your rail tickets, credit card and DTH mobile recharges? Or transfer
funds to your friend? All of this can be done just through an SMS or an app.
This retail fund-transfer system, called the inter-bank mobile payments
service, works in real time and is available 24x7. Here's how:
WHAT IS IMPS?
IMPS offers an instant, 24X7, interbank electronic fund transfer service
through mobile phones. There are two types of IMPS services: A persontoperson (P2P) service and a person-to-merchant (P2M) service. While the
P2P service was launched some 18 months ago, P2M service was made
available only recently.
HOW TO START A P2P OR P2M SERVICE?
Register your mobile number with your bank. Get a seven-digit Mobile
Money Identifier, or MMID, number. This number is used to identify your
bank and is linked to your account number. The combination of mobile
number and MMID is unique for particular account, and the customer can
link the same mobile number with multiple accounts in the same bank, and
get separate MMID for each account.
After this, get a Mobile Banking PIN, or M-PIN, which is a password to be
used during transactions for authentication and security. Download mobile
banking application or use the SMS facility provided by the bank to make a
payment.
HOW TO SEND OR RECEIVE FUNDS FOR P2P TRANSACTIONS?
To send money, initiate an IMPS transaction using the mobile app or SMS.
You need to enter the beneficiary's mobile number and MMID, amount and
M-PIN for initiating a transaction. You will then receive a confirmation
SMS for the transaction. To receive money, share your mobile number and
MMID with the sender. The sender then initiates the above-mentioned steps.
And you get an SMS confirmation for the money received.
HOW DOES THE P2M SERVICE WORK?
There are two ways in which P2M transactions can be performed:
customerinitiated transactions (P2M PUSH) and merchantinitiated
transactions (P2M PULL). P2M push transactions can be used for
paying insurancepremium, mobile /DTH recharge, credit card fee, utility
137
bills, over-the-counter payments, and face-to-face payments such as pizza

delivery, couriers and cabs.
For P2M PUSH, a customer initiates transaction through the mobile banking
app or SMS facility provided by the bank. For P2M PULL, the transaction is
initiated through the website of the merchant. Plus you need to get a onetime password (OTP) from your bank.
IS THERE A CASH LIMIT?
Yes. Most banks cap the daily limit via IMPS app at Rs 50,000 per
day. SBI limits transfers to Rs 1,000 per day through the SMS mode.
Source: www.npci.org.in
__________________________________________________________
ET in the classroom: How a circuit filter prevents a burnout
Ram Sahgal, ET Bureau Oct 12, 2012, 06.00AM IST

NSE suspended trading for 15 minutes on October 5 after its benchmark
Nifty index fell 15% following punching errors worth Rs 650 crore by a
dealer at domestic brokerage Emkay Global. Trading halted after a
lower circuit breaker kicked in. Apart from the brokerage, which was the
worst hit, those who traded without stop losses were also affected. The
situation could have been worse but for the filter. ETexplains how does the
circuit-filter mechanism works:
What is a circuit filter?
It is a regulator prescribed price limit on stock indices. It sets a limit on the
extent to which an index such as Nifty or Sensex can fluctuate in a day. The
filter, followed by a cooling-off period, kicks in once an index rises or falls
by 10%, 15% and 20%. For instance, if a circuit limit of 10% is hit before
138
1'o clock in the noon, trading automatically stops and resumes after an hour.
In case of a 20% movement of the index, trading is halted for the remainder
of the day.
What's its purpose?
A filter or breaker aims to limit the spread of marketwide panic by giving
participants time to gather their wits. The moment a circuit filter is triggered
on the cash segment, trading comes to an automatic halt. In the case of index
futures, trading does not halt automatically but has to be stopped after
trading on the cash segment ceases.
How are filter percentages set?
The filter percentages are calculated on the closing index value of the
previous quarter. In the case of Nifty, for the October-December quarter, the
daily filter is set based on the index closing on the last trading day of the
September quarter (which was 5700 points on September 28). So to
calculate the 10% filter percentage for Thursday (October 11), add and
subtract 570 (10% of 5700) to Nifty's Wednesday's closing of 5620 (5652
+/- 570) to get 6,222 as the upper limit and 5082 as the lower limit.
Why did NSE resume trading in 15 minutes on October 5?
Friday's trades were not the result of panic but of human error. Once the
reason for the Nifty's fall was identified, the system did not accept any fresh
orders. Only the existing ones had to be matched to prevent trade integrity
issues from cropping up. Trading resumed normally with Nifty having
recovered shortly after the 15.5% fall.
Does a circuit filter apply to shares?
Circuit breakers are only for indices. The regulator has a 'price band' for
shares in the cash segment and an 'operating range' for the futuresandoptions segment. Individual stocks have a price band of 20%; that is, a stock
cannot fluctuate more than 20% from its previous day's closing. An
exchange is allowed to reduce this band to 10%. F&O stocks have operating
ranges, again at 20%; that is, an order cannot be placed by a trader above or
below the 20% limit. The absence of a price band caused certain frontline
Nifty stocks to drop below 20% on October 5 because of Emkay's erroneous
trades.
Was trading ever halted for the whole session?
139
Yes. On May 18, 2009, after both Nifty and Sensex hit the 20% upper
circuit following the UPA's victory in the general elections.
__________________________________________________________
ET in the classroom: GDP+: A better gauge of wellbeing
ET Bureau Oct 16, 2012, 05.09AM IST

All these years, gross domestic product, or GDP, has proved to be a trusted
measure of output and, hence, growth. But increasingly it is being felt that
this economic gauge doesn't measure things such as inequality or
environmental degradation or quality of life. Beginning Tuesday, India will
host the Fourth OECD World Forum in New Delhi that will deliberate a
superior measure of development. ET explains:
IS GDP A PERFECT GAUGE OF DEVELOPMENT?
GDP, as a measure of development, has increasingly come under fire for
using only economic capital to measure economic progress. For instance, it
doesn't measure household chores done by members cooking, washing
and taking care of children. Same for welfare services offered by the
government. Similarly, GDP per capita does not reveal how equitably a
country's income is distributed. Besides, it does not reveal the impact of
pollution or environmental degradation.
WHAT IS A 'GDP+' INDICATOR AND WHAT WILL IT INCLUDE?
Efforts are on to include social, human as well as natural capital along with
monetary steps to reach a more 'wholesome' development tracker. Some
economists have called this modified measure as GDP+. Apart from mere
income generation, the measure will try and capture other material
conditions such as jobs, earnings and housing. It will also try and capture
quality of life, education, gender equality, personal security and subjective
well-being, viewed as crucial parameters to gauge progress of a society.
140
WHY
SHOULD ENVIRONMENT DEGRADATION
CONSIDERED?
BE
For sustainable development for future generations, inclusion of natural

capital in accounting is increasingly being given more importance. Natural
disasters can severly set back a country from its economic path as was
witnessed in the aftermath of the tsunami in Japan. The UN's Statistical
Commission recently included Environmental-Economic Accounts as part
of GDP measure.
WHERE DOES THE WORLD STAND ON GDP+?
The Organisation for Economic Cooperation and Development has been
trying to work out a broader measurement for 10 years through continued
deliberations on conditions, varied country experiences and methodology.
The Delhi forum is the fourth meeting on this agenda after Italy, Turkey and
South Korea. However, developing countries such as India and China have
some reservations on an GDP+ indicator as they feel that concerns in
emerging nations differ from established economies and developed
countries can misuse the measurement to limit their economic growth.
__________________________________________________________
ET in the classroom: National Investment Board

WHAT IS NATIONAL INVESTMENT BOARD?
It is mechanism mooted by the finance ministry to speed up investment
decisions in the govt. It will be headed by the prime minister and have
ministers from key ministries such as finance, and law and justice as its
members.
DOES IT HAVE AN OVERRIDING ROLE?
141
It has been envisaged as an empowered standing committee of the Cabinet

under the chairmanship of the prime minister that will exercise the power of
the government.
__________________________________________________________
ET in the Classroom: A look at inflation targetting
142

Goldman Sachs in a recent report suggested that the Reserve Bank of
India should set a formal inflation 'target' for increasing transparency
in monetary policy and anchoring inflation expectations. ET takes a look at
the concept of inflation targeting.
WHAT IS INFLATION TARGETING?
A central bank announces a mediumto long-term inflation 'target' and its
subsequent monetary and interest rate policies are aimed at keeping inflation
around this target.
Since the 1990s, many central banks in advanced and emerging economies
have adopted explicit inflation targets as the most important goal of their
monetary policy.
The central banks that do not set explicit targets tend to signal a comfort
level of inflation. The US Federal Reserve followed this system until last
year, indicating a long-run preference of 1.5%-2%. In January, in a
significant shift, the Fed said it will target a long-run inflation of 2%.
HOW DOES AN EXPLICIT INFLATION TARGET HELP?
Economist say an explicit inflation target helps increase monetary policy
transparency and predictability, besides anchoring inflation expectations.
For example, if the central bank of a country has an inflation target of, say,
2% and the actual inflation is more than this, market participants will know
that the central bank will tighten monetary policy to rein in inflation.
In a reverse scenario, the bank will loosen monetary levers. This way the
monetary policy becomes more predictable. And because of the
predictability of action, inflation expectations are also tempered.
WHY HASN'T EVERY CENTRAL BANK ADOPTED EXPLICIT
INFLATION TARGET?
The Federal Reserve of the US adopted an explicit inflation target only this
year after extensive debate, suggesting that such an approach may not
necessarily suit every country.
The support for inflation targeting is based on the view that if a central bank
ensured price stability though an explicit inflation target, then there would
143
be financial stability because market participants would act in a particular

way.
However, the recent global financial crisis has dented this view somewhat.
The financial crisis happened even while there was price stability.
Moreover, in many developing countries, apart from price management, the
central banks also have to keep an eye on development issues, which means
they have to worry about growth, spread of organised finance and ensure
financial stability. An inflation centric approach could militate against these
equally important roles of the central bank.
WHAT PATH DOES THE RBI FOLLOW?
In a big country like India that is gradually opening its door, the RBI has to
worry about growth given the large-scale poverty, ensure a stable exchange
rate, adequate foreign exchange reserves and provide stable financial
markets.
Though these goals are not contradictory, at times the central banks need
flexibility on the inflation side to adjust one of these objectives.
For instance, although inflation is running well above its comfort rate of
around 5%, the RBI can still cut rates to stimulate growth as that is now
being seen as a more pressing concern than price stability.
If the RBI was committed to an explicit inflation target of 5%, it would be in
no position to relax the monetary policy.
__________________________________________________________
ET in the classroom: How bank loans turn bad
Sangita Mehta, ET Bureau Nov 16, 2012, 05.00AM IST
144
(When an asset ceases to generate)

WHAT IS A BAD LOAN?
An account is termed as a bad loan or NPA when a borrower fails to pay his
bank monthly-equated installment. According to banking rules, a loan is
classified as an NPA when the EMI, principal or interest component, is not
paid within 90 days from the due date. When an asset ceases to generate any
income, it's termed as a bad loan. There are classifications of loans
standard, sub-standard, doubtful and loss assets. In order to ensure that
banks are not affected due to defaults, regulator RBI has mandated them to
make provisions or set aside money when an account turns bad.
WHAT'S A STANDARD A/C?
If a borrower pays his dues regularly, it is classified as a standard account.
The RBI has asked banks to make provisions also for standard loans.
Provision on all types of standard loan is 0.40% of the loan amount.
WHAT IS A SUBSTANDARD ASSET?
An asset is sub-standard when it remains as a bad loan for a period less than
or equal to 12 months. In such loans, the net worth of the borrower or the
market value of the security charged is not enough to ensure entire recovery
of the dues. The provision to be set aside for sub-standard loan is 15% of the
overdue amount.
WHAT IS A DOUBTFUL ASSET CATEGORY?
When an asset remains in the sub-standard category for 12 months it is
classified as doubtful asset. Recovery of the full value of the overdue is
highly questionable and mostly improbable.
WHAT IS A LOSS ASSET?
A loss asset is when a bank acknowledges that there is little or no value in
retaining the account on its book and ideally, such loans should be written
off. The RBI has mandated banks to provide 100% for the outstanding dues.
IS IT POSSIBLE TO UPGRADE AN A/C FROM AN NPA TO
STANDARD CATEGORY?
When a borrower pays arrears of interest and principal, the account can be
upgraded from an NPA category to a standard loan category. Often banks
restructure a loan account by giving borrowers more time to repay dues and
at times interest rate is lowered.
145
__________________________________________________________
ET in the classroom: Making sense of direct plans
Shailesh Menon, ET Bureau Nov 30, 2012, 05.31AM IST

Market regulator Sebi has asked fund houses to roll out direct plans over
the next one month. Let's see what are direct plans, how will they help
investors and why are distributors not that happy to sell them.
WHAT IS A DIRECT PLAN IN MUTUAL FUNDS?
Direct plans allow customers to invest in funds directly - without incurring
any incidental cost and at lower expense ratios. They may be cheaper than
regular funds and bear separate NAVs. According to Sebi, every
fund/scheme should have a mandatory direct plan from January 1 onwards
for investors who do not want distributor support.
HOWWILL DIRECT PLANS HELP INVESTORS?
Direct plans will help widen the direct investment route and increase retail
participation. Direct plans will charge a lower expense ratio,
making investments cheaper by 50-100 basis points resulting in a higher net
asset value.
Put simply, investments in direct plans will yield higher returns than in a
regular plan. Industry insiders estimate that the yield will be 0.5% to 1%
higher per year for direct plans. According to Dhirendra Kumar, MD of
Value Research, direct plans will yield far better returns than regular plans
over a longer time frame.
WHY ARE DISTRIBUTORS OPPOSING DIRECT PLANS?
Distributors fear that many of their existing investors, including the rich
savvy type, may shift to direct plans, lured by lower expenses and higher
146
returns. Another big concern is that institutional investors will shift their
fund allocation to direct plans as they are mandated by their boards to invest
surpluses at a bare minimum cost.
IS THIS THE FIRST TIME THAT SEBI IS ALLOWING
INVESTORS TO INVEST DIRECTLY IN FUNDS?
No. Sebi, under chairman M Damodaran, had started a 'direct application
route' in January 2008, which allowed investors to invest in funds without
paying the 2.25% entry load, prevalent at that time. This lost its relevance
post the entry load ban. Industry watchers say direct plans will have more
impact than direct application route as the former offers higher NAVs.
__________________________________________________________
ET in the classroom: Understanding Portfolio Management Service
ET Bureau Nov 30, 2012, 05.36AM IST

Portfolio management service (PMS) is a method of investing used by
wealthy investors and companies who want exposure to a variety of
products such as equities, fixed income, gold and structured products. There
are several advantage and disadvantages of a PMS over mutual funds.
WHAT IS A PMS?
Portfolio management service providers advise clients on buying or selling
shares, derivatives or other type of securities. Depending on the type of
PMS, the manager can also buy or sell securities on behalf of the clients. An
entity needs to be registered with the Securities and Exchange Board of
India as a portfolio manager. An investor individually owns the securities in
a PMS portfolio, unlike a mutual fund where investors only own units of the
fund and not the actual securities.
WHAT ARE THE TYPES OF PMS?
147
In a discretionary PMS, the decision to select, buy or sell stocks is taken by

the portfolio manager. The trades are also executed by him. But in a nondiscretionary PMS, an investor can take the trading decisions advised by
the portfolio manager, which are then executed by the manager. In an
advisory PMS, a manager gives only investment ideas, and the trades can be
executed by the investor.
WHAT ARE THE FEES IN A PMS?
Portfolio management services either have a fixed, profit-sharing or hybrid
fee structure. In a fixed-fee structure, the manager charges a set fee every
quarter or on the corpus. It is levied irrespective of the returns generated by
a portfolio. Then, there is the profit-sharing model, where the fee paid by an
investor is a percentage of profits. This is usually a large chunk, around 2025% of profits. A hybrid model combines both, although charges are less.
WHAT ARE THE ADVANTAGES OF PMS?
PMS trade in a wide range of securities, including structured products,
which is not available to a mutual fund. PMS regulations are less strict than
MF regulations. A PMS is a more personalised investment solution; some
investors may ask their portfolio managers to allocate a large part of corpus
to non-equity products like fixed income, gold, etc.
WHAT ARE THE DISADVANTAGES OF PMS?
PMS do not disclose the portfolio as much as MFs. There have also been
cases where PMS managers have misused the money.
__________________________________________________________
ET in the classroom: What is a 'White-label ATM'?
Sangita Mehta, ET Bureau Dec 5, 2012, 04.27AM IST
148
The Reserve Bank recently allowed nonbanking companies to set up whitelabel ATMs in the country. ET explains how they differ from the usual
bank-run cash dispensers:
What is a white-label ATM?
Most automated teller machines (ATMs), or machines that dispense cash,
are owned by banks. But ones that are owned and operated by non-banking
companies are called while-label ATMs (WLAs). They function just the
same way as any other bank-run ATM.
Why did the RBI permit them now?
So far, banks have deployed almost 87,000 ATMs across India. Although
they are free to put up ATMs anywhere, there is still a huge scope for setting
up more ATMs in non-urban and nonmetro cities.
So, the RBI has allowed non-banking companies to deploy white-label
ATMs to expand their reach in rural India. However, non-banking
companies entering this market will have to maintain a certain ATM ratio
between rural and urban India. The RBI is yet to prescribe the ratio.
How does the customer benefit?
As the ATM network expands, more and more people will have easy access
to cash as any customer with an ATM card can access white-label ATMs.
However, the RBI norm allowing five free ATM transactions will not be
applicable at these ATMs.
While the non-banking company won't be allowed to charge a customer
directly for the transaction, the costs are expected to be displayed upfront on
the screen. It is likely that the bank may recover the transaction charge from
the customer separately.
What is the response so far?
As of now, many companies, such as Muthoot Finance and Prizm Payments,
have shown interest in setting up these ATMs. It is likely that ATM
manufacturers, such as NCR, Diebold and AGS, may also apply for setting
up these dispensers themselves. Worldwide, white-label ATMs are in use in
Canada and some African and European countries.
__________________________________________________________
149
ET In the Classroom: Making sense of mining
Rakhi Mazumdar, ET Bureau Dec 5, 2012, 04.00AM IST

WHAT IS THE MAIN PROBLEM PLAGUING THE STEEL
INDUSTRY IN INDIA?
Steel companies have been hit hard by mining issues which have severely
hit availability and supply of iron ore a key raw material used to make steel.
Due to iron ore scarcity, steel makers have begun pruning capacities and in
some cases have also been shutting down plants.
WHY HAS MINING BEEN AFFECTED?
The mining industry has been hit by charges of illegal mining. It concerns
companies which have mined in excess of the lease area. The Supreme
Court appointed a Central Empowered Committee (CEC) to probe the
alleged instances of illegal mining. Companies in three key iron ore mining
states Karnataka, Odisha and Goa have been been the most affected.
WHAT IS THE STATUS OF MINING IN THESE STATES?
In Karnataka's Bellary, SC suspended mining activity in July 2011, after the
CEC, its expert panel, reported "over exploitation" of the area leading to
large scale environmental degradation. The order came two days after
Karnataka Lokayukta Justice Santosh Hegde, brought out a detailed report
on rampant illegal mining in the districts of Bellary, Tumkur and
Chitradurga and its adverse impact on the environment and the people of
these areas. The ban on illegal mining in Karnataka affected some 40-45
million tonnes of iron ore supplies to steel companies. On September 3,
2012, SC allowed 18 Category A mines to resume operations at Bellary and
Chitradurga in Karnataka. The CEC found irregularities in Goa, too, a state
which produced over 50 million tonnes in 2010-11 and is a major exporter
of iron ore. Following this, the state government has imposed curbs on iron
ore mining. In Odisha, the Justice MB Shah Commission's first report on the
extent of illegal mining in the state is expected by December 2012.
150
WHAT ARE E-AUCTIONS ABOUT?

To provide respite to steel companies from sourcing ore, the Supreme Court
had allowed the e-auction of about 25 million tonnes of ore from the
stockpile. The SC had appointed the CEC on September 2, 2011 to oversee
the e-auction for iron ore from Karnataka every month. NMDC was asked to
produce 1 million tonnes every month to meet the needs of steel companies
in the state. However, ore supplies have fallen short of the monthly
requirement estimated at 2 million tonnes.
WHAT IS THE R&R POLICY & WHY IS IT IMPORTANT?
CEC has said that only those companies which adopt and implement a
proper R&R policy will be allowed to resume mining. The R&R policy was
brought into effect through an Official Gazette notification on Oct 31, 2007
to address involuntary displacement of people after quantification of cost
and benefit of adverse, economic, environmental, social and cultural impact
of such a displacement on the families.
WHAT ARE THE MAIN FEATURES OF THE R&R POLICY?
-Project affected person includes agricultural, non-agricultural, laborer,
landless persons, rural artisans, small trader, self-employed person affected
by land acquisition. -Preference to at least one person per nuclear family in
employment. -750 days minimum agricultural wages as cash compensation.
-Alternative land to the extent of actual land loss subject to a maximum of 1
hectare irrigated land and 2 hectare un-irrigated land. -Development of skills
for displaced persons. -Alternative house site for loss of house up to a
maximum of 25 square meters in rural area and 150 sq meters in urban area.
-25 days minimum agricultural wages per month for one year to each
family. -One time financial assistance of Rs 25,000 for construction of shed.
-Tribal families to get one time financial assistance of 500 days minimum
agricultural wages for loss of customary rights.
__________________________________________________________
ET in the classroom: Why amend Forward Contracts Regulation Act
151
ET Bureau Dec 5, 2012, 03.58AM IST

Optimism is high among commodity exchange officials and brokers that a
bill to amend the Forward Contracts Regulation Act, 1952 would be passed
in the current session of Parliament.
Once passed by both Houses of Parliament, the amended bill will put
the commodity
futures market
regulator, Forward
Markets
Commission (FMC), on a par with capital markets regulator Sebi, making it
an autonomous regulator from one overseen by a ministry Consumer
Affairs.
Why is passage of the bill important?
There are five national level commodity exchanges in the country now. The
combined turnover of the five national exchanges has grown to around Rs
50,000 crore daily, up from a few thousand crores in 2003.
The need for a strong regulator to effectively monitor the market and
facilitate institutional participation mutual funds, FIIs and banks
which are currently not permitted to trade makes passage of the FCRA
(Amendment) Bill, 2010 imperative.
What will change if the bill gets passed?
FMC will become an autonomous regulator like Sebi and will have
autonomy to raise funds from exchanges and recognise and derecognise
them.
FMC currently depends on funds from the Consolidated Fund of India but
will be able to raise funds from deals on exchanges and from brokers once
the Bill is passed.
This will enable it to offer competitive salaries to attract talent. It will also
be able to levy penalties, something which it cannot do now.
A stronger regulator will thus be able to lay the framework for the entry of
institutional players who can function as effective counterparties for large
corporates to trade on the homegrown exchanges.
What are the chances of the bill getting passed?
152
While optimism is high, the bill has a chequered history -- the bill was
tabled in the Rajya Sabha in 2003-04 but could not be passed due to the
dissolution of the Lok Sabha.
An ordinance passed in January 2008 lapsed since the bill could not be taken
up by Parliament. With a fortnight left for the winter session to end it will be
a close call since the bill is not on the priority list. However, like
theCompanies Bill, it is among the few non-controversial legislations.
Who trades on commexes and how do they function?
A few large sized agri companies, small and mid-sized enterprises, retail
traders, speculators and in some cases like rubber a few cooperatives.
The exchanges offer plain vanilla futures in products such as gold and silver,
which are the most liquid, copper, crude oil, chickpeas, pepper, rubber,
mentha, etc. A hedger can place an order on the futures market to protect
himself against price volatility.
__________________________________________________________
ET in the classroom: Will we finally see some law-making?

(Parliament will take up)
Parliament will take up two crucial financial legislations on Monday, after
more than half of the winter session has been lost to the extreme
polarisation over FDI in multi-brand retail. ET takes a look at the two laws
that will come up for consideration and passing.
THE BANKING LAWS (AMENDMENT) BILL, 2011
WHY
153
The bill will make changes in three laws to strengthen the regulatory powers
of the Reserve Bank of India. The three laws are Banking Regulation Act,
1949, the Banking Companies (Acquisition and Transfer of Undertakings)
Act, 1970 and the Banking Companies (Acquisition and Transfer of
Undertakings) Act, 1980
WHAT
It allows nationalised banks to issue bonus shares and rights to give them
flexibility to raise capital
Increase in voting ceiling for nationalized banks to 10% from 1%
Proposes to remove the 10% ceiling on voting in private banks Prior nod of
RBI needed for more than 5% stake buy in Indian banks
It will give the RBI powers to inspect the books of any associate enterprise
of a bank
The RBI will have powers to supersede the board of a bank, but not for not
more than 12 months
RBI will have powers to impose penalty if banks fail to maintain adequate
CRR
IMPACT
Reserve Bank of India will have more powers to ensure a tighter supervision
while banks will have more freedom in managing their capital
IMMEDIATE SIGNIFICANCE
RBI will be able to begin the process to issue new bank licences
THE ENFORCEMENT OF SECURITY INTEREST
RECOVERY OF DEBTS LAWS (AMENDMENT) BILL, '11
AND
WHY
It will make changes to the existing law to give more freedom to asset
reconstruction companies to acquire bad assets and resolve them. It will
amend the Securitisation and Reconstruction of Financial Assets and
Enforcement of Security Interest Act, 2002 and the Recovery of Debts Due
to Banks and Financial Institutions Act, 1993.
WHAT
154
It will allow asset reconstruction companies to convert of debt into equity

Multi-state co-operative banks will be included in the asset reconstruction
framework
Banks and financial institutions will be allowed to accept the immovable
property in full or partially to settle their claims if they cannot find a buyer
their security
Banks will have powers to file caveat to ensure their views are considered
by the Debt Recovery Tribunal
Give powers to the central government to exempt certain banks or financial
institutions from the provisions of this law in public interest
Banks and financial institutions will get powers to to enter into settlement or
compromise with bowower
IMAPCT
The strengthened law will help address mounting problem of bad assets, a
long term positive law Asset reconstruction companies will benefit
__________________________________________________________
ET in the classroom: Blame it on god, and why
Shilpy Sinha, ET Bureau Dec 12, 2012, 06.00AM IST

The term, Act of God, is widely used in insurance policies covering natural
disasters. In fact, a recent Bollywood release, Oh My God, popularised this
legal term by making it its central theme. In the film, the protagonist, who is
an atheist, seeks compensation from the intermediaries of God, namely,
priests, maulvis, pundits and spiritual gurus, for damages caused by an 'Act
of God' that were not covered under insurance. ET explains:
155
What is an Act of God?

An 'Act of God' is an event or events forced by nature, such as floods,
cyclone and volcanic eruptions, for which no one can be held responsible.
Which disasters are covered under an Act of God policy?
Such policies cover damage caused by natural disasters such as floods and
hurricanes. Only specific natural catastrophes defined in the policy are
covered. For example, if a policy covers flood as an Act of God but not
cyclone then the policy will not pay for damage caused by a cyclone. An
Act of God policy does not insure against earthquakes, which are covered
under a separate policy.
Do all standard policies cover Act of God?
Insurance contracts often exclude Act of God from the list of insurable
occurrences. This is an extension to the fire insurance policy and not a part
of the group coverage. It comes with additional premium. Earlier it was built
in under the standard fire policy and one had the option of opting out of it by
getting a discount of 0.25% per thousand of the sum assured. Car owners
have the coverage if they buy a comprehensive motor insurance policy.
Most home insurance packages cover Act of God.
Should one buy an Act of God cover?
The decision should be based on the risk and nature of the asset (home, car
or property) as it costs an extra 0.25% per thousand of the sum assured.
Why is earthquake kept outside Act of God?
Earthquake insurance is priced separately because the severity of damage
depends upon the country's respective seismic zones (I, II, III and IV). The
rates vary between 0.1% and 1% of the sum assured.
__________________________________________________________
156
ET in the classroom: Understanding trade settlement cycle

(India is one of the most advanced)
India is one of the most advanced markets when it comes to settlement of
trade. The domestic market follows a T+2 settlement cycle. Let's learn a bit
more about the trade cycle.
WHAT IS ROLLING SETTLEMENT?
In a rolling settlement , each trading day is considered as a trading period
and trades executed during the day are settled based on net obligations for
the day. In India, trades in rolling settlement are settled on a T+2 basis i.e.
on the 2nd working day after a trade.
WHICH DAYS ARE CALCULATED FOR THE PURPOSE OF
ROLLING SETTLEMENT?
For arriving at the settlement day, all intervening holidays, which include
bank holidays, exchange holidays,Saturdays and Sundays, are excluded.
Typically, trades taking place on Monday are settled on Wednesday,
Tuesday's trades are settled on Thursday and so on.
WHEN DOES THE OPEN POSITIONS RESULT IN PAYMENT/
DELIVERY UNDER ROLLING SETTLEMENT?
Under rolling settlement, all open positions at the end of the day
mandatorily result in payment/ delivery 'n' days later. Currently, trades in
rolling settlement are settled on T+2 basis where T is the trade day. For
example, a trade executed on Monday is mandatorily settled by Wednesday
(considering two working days from the trade day).
157
For intraday traders, rolling settlement changes nothing. For

institutional investors , who are forbidden to square off anyway, there would
be no change. It is for retail investors who take leveraged positions across
one night or more that rolling settlement has an impact. The funds and
securities pay-in and pay-out are carried out on T+2 days .
WHAT IS PAY-IN AND PAY-OUT ?
Pay-in day is the day when the securities sold are delivered to the exchange
by the sellers and funds for the securities purchased are made available to
the exchange by the buyers. Pay-out day is the day the securities purchased
are delivered to the buyers and the funds for the securities sold are given to
the sellers by the exchange. At present, the pay-in and pay-out happens on
the 2nd working day after the trade is executed on the exchange, that is
settlement cycle is on T+2 rolling settlement.
WHAT IS NO-DELIVERY PERIOD?
Whenever a company announces a book closure or record date, the
exchange sets up a no-delivery period for that security. During this period
only trading is permitted in the security. However , these trades are settled
only after the no-delivery period is over. This is done to ensure that
investor's entitlement for the corporate benefit is clearly determined.
158
WHAT IS AN AUCTION?
On account of non-delivery of securities by the trading member on the payin day, securities are put up for auction by the exchange. This ensures that
buying trading member receives the securities. The Exchange purchases the
requisite quantity in auction market and gives them to the buying trading
member.
__________________________________________________________
Keeping the ideas flowing with 'ET in the Classroom'
ETIG, TNN Aug 28, 2003, 01.09am IST

MUMBAI: The Economic Times has always gone that extra mile for its
readers. Over the years, it has added new features designed to give more to
its readers than any other information medium available in the country.
ET in the Classroom is one such feature we added to ET a few years back,
which has now become a hugely popular column among readers. It has
educated readers on diverse, yet need-to-know issues for most modern
managers the significance of the Doha ministerial and Seattle round, Bt
Cotton, double taxation avoidance agreements, Build, Own, Lease and
Transfer (BOLT) schemes, and many more with unfailing regularity
every Monday.
Time and again, readers of The Economic Times have asked for a collection
of these articles. So we are pleased to present to you The ET in the
Classroom CD Rom a handy and user-friendly volume that spans
industries across the spectrum. Terms, issues and trends dealing with
various industries are covered in the CD Rom.
Launching the ET in the Classroom CD on August 26, S Ramadorai, CEO
of TCS, said, "The ET in the Classroom CD is an excellent learning tool for
anyone eager to know more about today's business. The ease of navigation,
159
combined with high quality graphics make the experience pleasurable, not to
mention being easy on the eye. I wish The Economic Times the very best."
If you are a practising manager, this CD Rom gives you the opportunity to
increase your awareness, the primary pre-requisite to innovation. Moreover,
the industry specific articles will give business students a strong base to
shape their careers.
Entrepreneurs and budding managers are also bound to experience the flow
of ideas while browsing through the CD Rom.
__________________________________________________________
Grand finale to TN ET in the Classroom Quiz
TNN Dec 20, 2003, 02.08am IST

CHENNAI: Over 500 teams, 640 questions and one winner. These words by
quiz-master Giri Balasubramanian indicate the intensity with which the
grand finale of the Tamil Nadu edition of the ET in the Classroom Quiz,
presented by Cognizant Technology Solutions, was fought.
At the end of an hour of intense quizzing, the team from Bharathidasan
Institute of Management (BIM), Trichy, emerged the winners, followed by
Department of Management Studies (DoM), University of Madras.
The final round of the quiz saw BIM's Sabarish and Aditya sprint ahead of
DoM's Sandhya and Raghuraman, bagging 40 of the total 110 points they
scored to win the trophy. A round earlier, these two teams, both comprising
ET Club members, were neck-to-neck at 70 and 65.
A sample of questions: If you are trading in KO of New York Stock
Exchange, which share would you be trading in? In which company logo
will you find San Francisco Bridge? Which of these is the odd man out:
Salem Steel, Salem Mineral Water and Salem Cigarettes? The punch line
160
and product behind these jumbled words: Living quality life where infinity
reaches Kingsize. (Answers: Coke; Cisco; Salem Mineral Water; Living life
Kingsize - Four Square, Where quality reaches infinity - Wills Insignia).
The audience at MOP Vaishnav College for Women, the venue of the quiz,
had a lot more than the excitement of watching the teams compete. They
had their share of questions to volley and walk away with prizes from the
sponsors: Radio Mirchi, Turakhia Opticians, SAKS Casual Shop, Tanishq,
Trigger, BPL Mots, Sri Krishna Sweets and Sabols Packaged Mineral
Water.
__________________________________________________________
ET in the classroom: New rules treat GDRs/ADRs on par with shares

Do Global Depository Receipts (GDRs) and American Depositary Receipts
(ADRs) currently have voting rights?
The GDRs and ADRs in themselves do not have voting rights, but the
underlying equity shares do. These shares are held by a depository, which
then issues the corresponding receipts (GDRs/ADRs) to investors looking to
buy such instruments. So it is the depository that has the voting rights.
Whether the holders of the GDRs/ADRs can vote or not depends on the
depository agreement between the company issuing the GDRs/ADRs and
the depository. During the initial years when GDRs and ADRs came into
vogue, the agreement mandated depositories to vote on behalf of the
management. But later, the depository agreements were changed so as to
allow the GDR/ADR holders to instruct the depository to vote on their
behalf.
How do ADRs/GDRs work?
161
ADRs/GDRs are issued by companies looking to raise funds overseas.

These instruments may represent one, multiple or a fraction of the
underlying shares. For instance, if an Indian company wants to issue ADRs,
it will deliver the corresponding number of shares to the US depository
bank. The depository will then issue receipts to investors who have
subscribed to the issue. Depository receipts are transferable instruments, so
they can be freely traded on the exchange on which they are listed. They are
also fungible, which means the holder of ADRs can instruct the depository
to convert them into underlying shares and offload them in the local market
(in this case India).
What did Sebi say about GDRs/ADRs on Tuesday?
Till now, purchases made through GDRs/ADRs did not trigger an open offer
by the acquirer even if the 15% threshold was crossed so long as the
depository receipts had not been converted into underlying shares. But on
Tuesday, the regulator amended this rule. Anyone now holding
ADRs/GDRs with voting rights will have to make an open offer to minority
shareholders if his holding touches the 15% limit.
Why did the regulator have to make this amendment?
Securities lawyers and merchant bankers say the Takeover Regulations
relating to ADRs/GDRs were drafted at a time when the depositories always
voted on behalf of the management. Now that depository receipt holders
have the right to vote, it makes little sense to keep ADR/GDR holdings
outside the purview of the Takeover Regulations.
How does this amendment affect the Bharti-MTN deal?
Bharti's proposed takeover of MTN involved issuing GDRs to the South
African telecom firm and its shareholders, which would add up to 27% of
Bharti's equity base. In an informal guidance to Bharti in July, the regulator
had said that purchases through the GDR route would not trigger an open
offer unless the GDRs were converted into shares. But under the new rule,
MTN will have to make an open offer for an additional 20% in Bharti. This
would make the deal expensive for MTN and also for Bharti, if it wants to
get around the new rule.
Can Bharti still go ahead with its deal with MTN?
It can. For instance, the depository agreement can stipulate that the GDRs
will not have any voting rights. This is the most inexpensive way of getting
around the new rule. But the key question here is whether MTN
shareholders will agree to such an arrangement. The other option for Bharti
162
is to cut down the issuance of GDRs to below 15% and pay more cash to
MTN. But that could increase the cost significantly for Bharti.
__________________________________________________________
ET in the classroom: No-claim Bonus (NCB)

What is a `No-claim' bonus?
No-claim bonus (NCB) is a discount in premium offered by insurance
companies if a vehicle-owner has not made a single claim during the term of
the motor insurance policy. The discount, which is on 'own damage' cover,
ie, cover against damage to the vehicle, can go as high as 50% for both 2wheelers as well as 4-wheelers.
How much NCB can you enjoy?
This discount in the premium is usually 20% for the second year, 25% for
the third year, 35% for the fourth year, 45% for the fifth year and 50% for
the sixth year. The value of the discount depends upon the insurance claims
you have made in that particular year. NCB can be carried forward and will
be only allowed provided the policy is renewed within 90 days of the expiry
date of the previous policy.
What if you sell your car?
The no-claim bonus is a reward to the vehicle owner for prudent use of the
vehicle. If you sell a 10-year old hatchback and purchase a C-segment car,
the no-claim bonus will pass on to the new vehicle and you can save
considerably on your insurance costs.
Can you get the NCB transferred to another insurance company?
163
Yes, subject to evidence in the form of a renewal notice or letter, confirming

the NCB entitlement from the previous insurer.
What should you do if you renew the policy online?
You have to scan and send the cover note to the insurance company online
and it will do the needful.
What if you hide your claim history and avail of a no-claim bonus from a
new insurance company?
Initially, you might succeed in getting a no-claim bonus by hiding your
claims history. But insurers are sharing their claims databases and any false
declaration will surely be detected.
__________________________________________________________
ET in the classroom: Mortality Charges

What are mortality charges?
Mortality charges are that part of life insurance premium that go towards
providing a death benefit cover. In other words, these are the actual cost of
insurance in a life policy. In most policies, the bulk of the premium goes
towards investing in a savings fund which is returned to the policyholder
when the policy matures or the policyholder dies.
How are they calculated?
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
164
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-year-old, 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 twothirds 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.
__________________________________________________________
ET in the classroom: Taking banking rural doors

Here's a lowdown on financial inclusion and what it means
What is financial inclusion?
In a broader sense, financial inclusion is providing or ensuring banking
services at affordable costs to the weaker sections of society or the
unbanked segment which does not have access to the formal banking
165
system. In bigger cities, every household may have more than one bank
account but thousands of villages in India do not even have a bank branch.
The Indian central bank Reserve Bank of India, or RBI is keen on
achieving 100 per cent financial inclusion and has nudged banks to extend
the reach to as many citizens as possible.
What is the status of financial inclusion in India?
Despite the rapid advance in technology, after five decades since
independence, close to 60 per cent of the population in India do not have a
bank account. This ratio is especially higher in the North-Eastern part of the
country. Of the six lakh villages, only 30,000 have bank branches. A
government-sponsored report says only 10 per cent of Indians have a life
insurance cover, 13 per cent have debit cards and just two per cent own
credit cards.
Why is RBI keen on 100 per cent financial inclusion?
In a recent speech, RBI Governor D Subbarao said financial inclusion was
the key to sustaining equitable growth. Access to financial services will
provide the poor opportunities to build savings, make investments and avail
of credit. Also, such access helps them insure themselves against income
shocks and equips them to meet emergencies such as illness, death in the
family or loss of employment. Further, 'it protects the poor from the clutches
of the usurious money lenders,' he was quoted as saying.
__________________________________________________________
ET in the Classroom: Understanding Aviation Industry Jargon

Aviation business is riddled with gobbledygook such as code-sharing and
business aviation to name a few. ET simplifies and explains the industry
lexicon.
166
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 India's
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 India's website as the two have a code-share agreement.
Without the arrangement, airlines would lose traffic to bigger rivals. Such an
arrangement is extremely beneficial for smaller airlines.
__________________________________________________________
ET in the Classroom: Making sense of currency futures

What are currency futures and how are they different from other
derivatives?
Theoretically, a currency futures is a contract to exchange one currency for
another at a specified date in the future at a price that is fixed in advance.
The system was originally designed to protect against the risk of volatile
167
currencies, especially for businesses having receipts or outgo of foreign

currency as a part of their routine operations. However, today, currency
futures are most commonly used by traders to speculate on the rate of the
dollar and other currencies at a future date.
Who can profit from it?
Suppose an edible oil importer wants to import edible oil worth $100,000
and places his import order on January 15, 2010, with the delivery date
being four months ahead in April. At the time when the contract is placed,
one US dollar was worth, say, Rs 45.50 in the spot market. Now, suppose
the rupee depreciates to Rs 45.75 per US dollar when the payment is due in
April 2010, the value of the payment for the importer goes up
correspondingly. If the importer locks in a particular rate for April 2010 (by
buying a currency futures contract) he is not affected by this rise in rate.
The same is true for a jeweller who is exporting gold jewellery, and fears an
appreciating rupee. But we repeat, currently the product is mostly being
used by individual traders who make money every time their prediction on
the rate of the dollar is proved right.
Why has the product become so popular with Indian traders?
In the Indian version of the product, no hard currency actually changes
hands. The difference in the price a trader predicted and the market price can
be met through exchange of rupees. A forward contract, another derivative
instrument that can also help protect against volatility in rates, has to be
bought from a bank.
Besides that, one needs to have underlying business leading to receipts or
payments of a foreign currency. In futures, an individual can open an
account with a broker, like a share trading account, and get access to a
screen and are instantly ready for action. Futures were mainly conceived for
small corporates, while forwards are mainly used by large companies
dealing in mega-dollars.
What is the future of futures?
Futures contracts based on dollar-rupee pair were introduced in India in
August 2008. Given the recent surge in volumes, it's only a matter of time
before RBI and Sebi introduce futures based on other currency pairs. So
traders will soon get to speculate on the euro, yen and pound sterling.
Currency futures are currently listed on National Stock Exchange, Bombay
Stock Exchange and the MCX-SX.
168
__________________________________________________________
ET in the classroom: For banks, asset delivery is the key

How is a bank profit and loss statement different from a manufacturing
company's profit and loss account (P&L)?
As the name suggests, a manufacturing company manufactures a product.
The cost involved in the process of manufacturing is the cost of goods.
Other incidental costs like salaries, electricity and rent are clubbed under
selling, general and administrative expenses. Upon the sale of the goods, net
sales are recorded in the accounts. Unlike a manufacturing company, a bank
does not manufacture anything. It's an intermediary between a lender and a
borrower. Therefore, it accepts deposits and lends advances. Hence, the two
most important elements of a bank's P&L are interest expense on deposits
and interest earned on advances. In a manufacturing company's P&L, other
income is a trivial entry including one-off items like profit/loss on sale of
assets. However, in a bank's P&L, other income includes income from
distribution of financial products, income from investment banking related
activities, treasury gains and other fee incomes. While a manufacturing
company makes a provision for bad customers, a bank makes provision for
bad borrowers.
What are the factors that contribute to the bottom line of a bank?
As a bank's business depends upon interest rate at which borrows and then
lends it to borrowers, general level of interest in an economy plays a huge
part in a bank's performance. In a rising interest rate scenario, a bank often
has to borrow at higher rate and is unable to shift the entire incremental cost
of borrowing to its customers. So the percentage increase in interest expense
is more than that in interest earned. And the difference between them, which
is known as net interest income (NII) in banking parlance gets compressed.
On the other hand, in a falling interest rate scenario, a bank normally
169
improves its spread leading to high growth in NII. In a rising interest rate
scenario, the market value of bank's investments fall, as price of investment
is inversely proportional to interest rate. So a bank has to book losses on
investment. In Indian context, bank's 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 bank's
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 bank's 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 bank's efficiency is net
interest margin (NIM), which is a measure of spread between the interest
rate at which a bank's lend and borrows.
In Indian context, a 3% NIM is considered as a benchmark level. Among
large banks, only a handful including HDFC 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.
__________________________________________________________
170
ET in the classroom: What is the takeout financing scheme?

What is the takeout financing scheme?
The takeout financing scheme is aimed at encouraging commercial banks to
lend more to the infrastructure sector. Under the scheme, banks lend to
infrastructure projects but sell a part of that loan to a third party after a
certain period of time. This is called takeout financing.
Why is takeout financing important for infrastructure projects?
Core sector projects have long gestation periods and therefore require longterm funds, which banks are unable to provide because of the risks of assetliability mismatch . Deposits, the key source of funds for banks, are
generally of less than 5-year maturity. When banks lend for longer period
they are taking the risk of using short-term funds for providing long-term
loans. By selling a part of the loan to an institution that has long term funds
banks are able to reduce lending that involves some asset-liability mismatch.
This allows banks to lend more to infrastructure projects as their exposure is
limited .
How will takeout financing work in India?
India Infrastructure Finance Company (IIFCL), a stateowned company, will
soon start to provide take out finance scheme. Under the proposed scheme,
IIFCL will take over up to 75% of an individual bank's loan or 50% of the
residual project cost on to its own books. The loan can be repaid over a 15year time period. Projects that have a residual debt tenor of at least six years
or those which are yet to achieve financial closure will be eligible for the
scheme. The project developer, IIFCL and the lender will enter into a
tripartite agreement, which would include the rate of interest on the take out
amount. IIFCL can take over the loan after four year's from the
commencement of the project.
171
Will the scheme be able to successfully address core sector financing?

Internationally, the concept has a mixed response. But industry players say
that if banks have the comfort that their loan can be taken over by IIFCL at a
later date, they will provide funds more readily. Banks have, however, not
responded as enthusiastically. This is because under the scheme IIFCL will
charge an annual transaction fee of 50 basis points on the take out amount.
Banks have complained that loans will become more expensive and there
will be few takers. The actual litmus test will begin this year when a large
number of projects will be bid out.
__________________________________________________________
ET in the classroom: Credit info bureau

What is CIBIL?
CIBIL is the country's credit information bureau owned by banks and other
lending institutions. It collects commercial and consumer credit-related data
and collates such data to create and distribute credit reports to members.
Accessing to such data is crucial for lenders to assess the credit worthiness
of a borrower. CIBIL gets information from its members only and
supplements it with public domain information to create a comprehensive
snapshot of an entity's financial track record. The RTI Act, 2005 is not
applicable to CIBIL and it can't provide credit information report to credit
providers in other countries
What is a credit information report?
A credit information report (CIR) is a factual record of a borrower's credit
payment history compiled from information received from different lenders.
Reports can only be accessed by members who have provided all their data
to CIBIL only to take valid credit decisions. The CIR includes:
172
? Basic borrower information such as name, address, identification numbers,

passport ID, voters ID, date of birth etc? Records of loans availed by the
borrowers? Past payment history of the borrowers and the amount overdue?
Number of inquiries made on the borrower by different members? Suit filed
status
The CIR does not contain income / revenue details, amount(s) deposited
with the bank, details of borrowers' assets, value of asset(s) mortgaged,
details of borrower's assets etc
When is a credit facility classified as 'default'?
CIBIL does not classify any accounts as default accounts. It merely reflects
this information after the member has classified it as such. It does not
provide any opinion, indication or comment pertaining to whether credit
should be granted.
How do I ensure that a CIR drawn on me does not contain negative
information?
Exercise good money management practices and make repayments on time.
If I am a first-time borrower, will I be at a disadvantage as there will be no
information on me?
As a new borrower, there will be a new file created for you. It will be in
your interest to build up a favourable repayment track record for future
credit applications.
If my credit application has been rejected will this appear in my credit
record?
The members do not provide this information to CIBIL.
If a lender has denied me credit, could others reject my application?
Not necessarily. Different lenders may use a CIR differently. Although one
bank may deny you credit, another bank could accept your application, as
multiple factors influence the lending decision.
How can CIBIL benefit a borrower?
CIRs are aimed at helping lenders make fast and objective lending decisions
leading to a more competitive credit market. Responsible customers can
expect faster and more competitive services at better terms from lenders.
173
How do I rectify information in a credit report drawn on me?

Please contact the lender from whom you have availed the loan and request
the necessary changes. The lender will then report the change to CIBIL and
CIBIL will subsequently make the necessary updates.
(Source: www.cibil.com)
__________________________________________________________
ET in the Classroom: Leave Travel Allowance

What is Leave Travel Allowance?
Leave Travel Allowance (LTA) is the part of the remuneration granted to
employees by the employer to provide for personal travel expenses incurred
during the year. Apart from the employee, it covers travelling expenses of
spouse, children as well as dependent parents and siblings. Further, the
exemption is restricted to two children born on or after October 1, 1998.
There is no restriction on the number of children born before this date.
How does LTA save on tax outgo?
Under section 10 (5) of the Income-Tax Act, if an employee who is in
receipt of LTA undertakes a journey within the country, s/he can claim the
value of the allowance exempt from income tax. For the purpose, the
individual should have been on leave for the period during which the
journey was undertaken.
Can you claim it every year?
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
174
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 don't 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. Let's 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.
__________________________________________________________
175
ET in the classroom: Big words in the budget speech

The finance minister's budget speech may be ridden with jargon, but its core
is no different from that of a household budget. ET is publishing a 10-part
series to help readers make sense of all the big words in the budget speech
and the bulky documents that come with it. The glossary is arranged in a
particular order to ensure that no unexplained word jumps out suddenly.
ANNUAL FINANCIAL STATEMENT
This is the last word on the government's receipts and expenditure for the
financial year, presented to Parliament. This is actually the annual budget, as
stated in the Constitution. Divided into three parts Consolidated Fund,
Contingency Fund and Public Account it has a statement of receipts and
expenditure of each. Expenditure from the Consolidated Fund and
Contingency Fund requires the nod of Parliament.
CONSOLIDATED FUND
The government's lifeline. It contains all revenues, money borrowed and
receipts from loans it has given. All government expenditure is made from
this fund.
CONTINGENCY FUND
As the name suggests, any urgent or unforeseen expenditure is met from this
Rs 500 crore fund, which is at the disposal of the President. The amount
withdrawn is returned from the Consolidated Fund.
PUBLIC ACCOUNT
When it comes to this account, the government is nothing more than a
banker, as this is a collection of money belonging to others such as public
provident fund.
176
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 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/CAPITAL BUDGET
The government has to prepare a Revenue Budget (detailing revenue
receipts and revenue expenditure) and a Capital Budget (capital receipts and
capital expenditure).
__________________________________________________________
ET in the Classroom: Living beyond means

Going through govt borrowing and how it affects the economy in more ways
than one.
FISCAL DEFICIT
177
The government is taking a lot of flak these days for the 16-year high fiscal
deficit in the current fiscal year. Here's how it is: The government's 'nonborrowed receipts' revenue receipts plus loan repayments received by the
government plus miscellaneous capital receipts, primarily divestment
proceeds fall short of its expenditure. The excess of total expenditure
over total non-borrowed receipts is called 'fiscal deficit'. The government
then has to borrow money from the people to meet the shortfall.
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 will be in debt.
PRIMARY DEFICIT
This is a key indicator. When it shrinks, it indicates we are not doing too
badly on fiscal health. The primary deficit is fiscal deficit minus interest
payments the government makes on its earlier borrowings.
DEFICIT AND THE GDP
It's important to see where all this fit in the larger economic picture. The
Budget document mentions deficit as a percentage of GDP. In absolute
terms, the fiscal deficit may be large, but if it is small compared to the size
of the economy, then it's not such a bad thing. Prudent fiscal management
requires that the government does not borrow to consume in the normal
course.
FRBM ACT
Enacted in 2003, the Fiscal Responsibility and Budget Management Act
sought the elimination of revenue deficit by 2008-09. This means that from
2008-09, the government was to meet all its revenue expenditure from its
revenue receipts. Any borrowing was to be done to meet capital expenditure
that is, repayment of loans, lending and fresh investment. The Act also
mandates a 3% limit on fiscal deficit after 2008-09. The financial crisis and
the subsequent slowdown forced the government to abandon the path of
fiscal consolidation.
__________________________________________________________
178
ET in the classroom: 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.
179
__________________________________________________________
ET in the Classroom: Private Banking

What is private banking?
Private banking is a personalised financial and banking service offered to a
bank's high net worth individuals (HNIs). In India, it is offered by foreign
banks and few private sector banks. A dedicated relationship manager is
assigned to the customer who takes care of all his banking needs and
investments. So be it a simple thing like wanting cash delivered at your
doorstep, or planning for your retirement, drafting a will, investing surplus
money, or buying a complex structured product, it's just a call away for
these customers.
How does a bank define a private banking customer?
In India, the landscape of retail banking is divided into mass market
banking, priority banking which targets customers with an investible surplus
of Rs 1 lakh to 1.5 crore. Then comes private banking which targets the top
end of retail banking customers with investible surplus of Rs 1.5 crore to Rs
13 crore. The creamiest layer includes ultra high net worth individuals with
AUM of Rs 100 crore and above. The range of services improves as you
climb up the ladder. The rationale is that clients with such high levels of
wealth can participate in alternative investments such as private equity,
hedge funds and real estate. Secondly, this level of wealth prevents liquidity
problems.
What does the private banker do?
The private banker helps you in all your banking and wealth management
needs. The starting point of the relationship is understanding the customer.
So a private banker has initial meetings with the client to understand his risk
180
profile, his cash flows, his needs and wants. Based on that, he develops an
asset allocation model for the client. Using this model he allocates the client
wealth into various assets that he feels opportune such as equities, debt or
real estate. Within each category, he offers various products. Once a
portfolio is restructured and built, it is monitored on a monthly or a quarterly
basis. The private banker comes up with appropriate strategies to enhance
returns from the portfolio. A private banker's role is to anticipate and
understand client needs and to help achieve his immediate and long-term
wealth goals. So whether you run a business, or are employed or a
professional, a private banker should be able to help you.
Do you have to invest the entire money at one go?
Most customers tend to bank with 2-3 bankers. You can take time with your
bankers to find out your comfort and compatibility with your personal
bankers and invest money over a time period of 1-2 years. The bank
typically upgrades your relationship as you increase the bank balance.
How to select a private banker?
Customers will have to see wait for a market swing to judge the competency
of the private banker. For instance, just before the financial crisis in 2009,
many top notch banks in India didn't recommend their clients to exit the
market. Also, many of these banks sold structured products which affected
the financial health of customers. Hence, spread your wealth around to
minimise risks. Also, don't trust your banker blindly. Monitor your
investments regularly.
__________________________________________________________
ET in the classroom: Cashless mediclaim
181
Cashless mediclaim is not a new concept anymore. As the name suggests,

you can get hospitalised, undergo surgery or both without having to pay
cash at the time of bill settlement. The insurance company settles the bill
directly through its third-party administrator (TPA) whose contacts are
usually provided along with the policy. The hospital would require the
patients ID card to check the policy details so as to deliver the cashless
service. But this easy insurance works only under certain conditions.
Can you avail of cashless mediclaim in all hospitals?
Every insurer has a list of hospitals in which you can use the cashless
facility. You can get this information in the insurance company's website
and cross check with the TPA. The list, however, is subject to change as
hospitals frequently have disagreements with insurers and drop the cashless
arrangement. If the hospital of your choice is not on the list, you can still
avail of treatment there. However, you will have to pay for the treatment at
the first instance and later get a reimbursement from the insurer by
submitting your bills. The average time taken for reimbursing bills is 20
days.
Whom should you approach if there is a problem with your cashless
mediclaim?
Although the insurance policy would have been issued by some general
insurance company, third party administrators play an active role in cashless
mediclaim. The payment usually is made by the TPAs. Most of these TPAs
provide administrative support to the insurance companies for servicing
their insurance policies. As far as you are concerned, TPAs are the main
contact point for settling claims. If the insurance company fails to stick to its
contract, you can complain to the insurance ombudsman whose contacts are
available on the Irda website.
What happens if your cashless mediclaim gets partly reimbursed?
This doesn't mean that the claim has been rejected by the insurance
company. The claim has been rejected at the TPA's end. TPAs sanction the
claim amount based on a clause called "customary and reasonable charges".
They keep a database on average costs of various surgeries across cities.
Based on this database, the TPA sanctions the claim amount.
Usually, a surveyor visits the hospital to validate the claim. At times, the
TPA approves a part of the amount and the balance has to be borne by you.
In extreme cases, the TPAs reject the claim if the surveyor is suspicious of
the patient or hospital's credibility. In such cases, you have to settle the
hospital bill and take up the case with the TPAs/insurer later.
182
How can you avoid part-payment or rejection of the claim?

In case of planned surgeries, you should check the approximate bill amount
with the hospital. Then, you could check with the TPA on the size of the
claim amount and its likely settlement. Often, even hospitals should take an
in-principle approval from the TPA to avoid last-minute hassle in the case of
planned surgeries. In fact, some TPAs make it mandatory for
patients/hospitals to take prior in-principle approval except in case of
accident-related claims.
Can you use cashless facility abroad?
Yes, you can, provided you have an overseas students mediclaim or a travel
policy. Private insurers have tie-ups with hospitals abroad. Still, it is
advisable for travellers or students to take a prior in-principle approval as
mentioned above.
__________________________________________________________
ET in the classroom: Limited Liability Partnership

The government plans to encourage Limited Liability Partnerships - a
flexible way of organising businesses - by allowing 49% foreign direct
investment. LLPs do not carry restrictions on the number of partners or the
combination of services that an LLP can provide. Here's a ready-reckoner on
LLPs for the uninitiated.
What are the advantages enjoyed by LLPs?
Unlike an unlimited partnership firm, no partner in a LLP is liable for
independent or unauthorised acts of other partners. It gives individual
partners a shield against joint liability created by another partner's
negligence or misconduct. The basic difference between an LLP and a joint
183
stock company lies in its flexibility to formulate its internal governance

structure. The management-ownership divide inherent in a company is not
there in an LLP. The compliance norms are much easier compared with
companies.
Does it make sense to convert private companies into LLPs?
The LLP format gives private companies the flexibility of expanding its
members beyond 50 without converting itself into a public limited company.
Converting a private company into an LLP is much easy than to form a
public limited company. Such conversion provides the firm the benefits of
minimal government intervention and less compliance requirements. Even a
partnership can avail the benefits of expanding its business by converting
itself into a LLP. The conversion of a private company or unlisted public
company into an LLP will be exempt from tax, if the total sales or turnover
or gross receipts of the company does not exceed Rs 60 lakh in any of the
three preceding years, as proposed by the Union Budget 2010.
Will a partner be able to carry out commercial transactions with LLPs?
A partner may lend money to and transact other businesses with the LLP
and shall have the same rights and obligations with respect to the loan or
other transactions as a person who is not a partner.
Can LLPs carry out activities related to financing such as accepting
deposits?
Currently there is no regulation prohibiting LLP from carrying out activities
related to NBFCs, but as a matter of precaution before initiating any such
activity, it is advisable to contact Reserve Bank of India.
Can foreigners incorporate LLPs?
Yes, the LLP Act 2008 allows foreign nationals, including foreign
companies & LLPs, to incorporate an LLP in India provided at least one
designated partner is a resident of India. Such an LLP and its partners will
have to comply with all relevant foreign exchange laws and rules therein.
__________________________________________________________
184
ET in the classroom: IMF's note purchase agreement

Why is RBI investing in short-term debt from IMF?
Last April, the International Monetary Fund constituted a new war chest to
help nations affected by the global financial and economic crisis. This was
requested by G-20 leaders and the International Monetary and Financial
Committee. As per the multilateral agreement, the Fund (as IMF is
popularly called) will issue notes to member countries and their central
banks. By subscribing to the notes, nations are actually enhancing IMF's
lending capacity to lend to other nations who are facing financial
difficulties.
Since then, several members have already expressed their interest in buying
IMF paper, with India, Brazil and Russia promising to invest up to $10
billion each, while China is to give $50 billion. The EU and the US are the
largest donors to the fund with promised sums at around $178 billion and
$100 billion, respectively. The Fund is looking to raise $750 billion in all for
the cause.
Is this a loan given to IMF?
Yes it is, but it's more like a secure investment in IMF. The purchase of
notes is usually a temporary bilateral arrangement for an initial period of
one year, which may be extended by a period of up to two years. The
principal of the notes is to be denominated in SDR, the Fund's unit of
account, which is a currency basket composed of the US dollar, euro, yen,
and pound sterling. Interest payments are to be made quarterly, at the
official Special Drawing Rights (SDR) interest rate, which is a weighted
average of 3-month interest rates in these currencies.
Permanent increases in the resources of IMF are expected to take place
through an increase in quotas and standing borrowing arrangements, which
are currently under negotiation. This opens up room for central banks like
RBI to donate more to the cause in the coming months.
What happens after the notes are purchased?
185
Once purchased by member governments, or their central banks, the notes

would be tradable within the official sector, which includes all IMF
members, their central banks, and 15 multilateral institutions those which
are designated holders of SDR. So, if a member nation is in a financial crisis
and needs assistance, then it can approach IMF. For instance, Greek Prime
Minister George Papandreou recently said he might have to go to IMF to
meet debt obligations falling due in April if the European Union did not help
with funds.
__________________________________________________________
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 co-operative 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?
186
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 semi-annually, 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.
__________________________________________________________
ET in the classroom: All about Stock Market Index

What is a stock market index?
187
A stock market index is a number that measures the relative value of a group
of stocks. As the value of stocks in this group change when they are traded,
the value of the index changes as well. If an index goes up by 1%, then it
means the total value of the securities which constitute the index has
increased 1%. The most common indices such as the Sensex, Nifty or Dow
Jones Industrial Average, are stock indices, but there are also indices for
bonds, commodities, real estate, to name a few. Usually, the index value is
expressed in points. For example, if the Sensex fell by 200 points, it means
the Sensex was at 17,700 and closed at 17,500. In isolation the points don't
mean anything you have to compare it with a value such as the previous
day's number.
Why are indices important?
Indices provide a historical comparison of returns on money invested in the
stock market against other forms of investments such as gold or debt. Many
indices are used by financial services firms to benchmark the performance
of their portfolios. Indices also serve as a yardstick for measuring the
performance of fund managers and their respective funds. For gauging the
performance of individual sectors or sectoral mutual funds, sector-specific
indices can be used. If you invest in mutual funds or individual stocks, you
always want to measure the performance of your investments against a
relevant index. So, if your investments are always ahead of the index then
your strategy is right. However, if your investment consistently lags behind
the index then it might be time to come up with a new investment strategy.
What does the index mean?
A stock market index in reality reflects the mood of the market. A good
stock index captures the movement of well-diversified and highly-liquid
stocks. For a layman, it is the pulse rate of the economy. So, if the Nifty
moves up today, it implies that the stock markets expect higher future
returns from the stocks as compared to the expectations on the previous day
and vice-versa. Indices are derived from individual stocks and it is quite
possible that a few stocks account for a major portion of the index. Thus,
fluctuation in prices of a few stocks may affect the overall index too, which
will give an incomplete picture.
How is an index constructed?
One of the most popular methods of constructing a market index is the
value-weighted method. In this method, the initial market value of these
stocks is assigned a base index value. An index is calculated with reference
to a base period and a base index value. Say, we take the base year as 1993
and take 50 stocks which have a total market capitalisation of Rs 1,000
188
crore. Let us assume that the base value on the first day is 100. Suppose the
market capitalisation on the next day of these 50 stocks increases to Rs
1,100 crore. To calculate the index, you take that day's market capitalisation,
divide it by the base figure and multiply by 100 to get the new index. In this
case it will be, 1100/1000 multiplied by 100, and so the index on the next
day is 110 points. There are various indices constructed by BSE on sectors,
such as metals, banks and so on.
__________________________________________________________
ET in the Classroom: International Financial Reporting Standards

What is IFRS?
IFRS is a set of accounting standards developed by the International
Accounting Standards Board (IASB)--an independent group of 15 experts-that is steadily becoming the global standard for the preparation of financial
statements of public companies.
How many countries follow IFRS?
Approximately 120 nations require IFRS for domestic listed compa-nies. Of
these, about 90 countries have made it mandatory for their domestic
companies to follow IFRS, while in the rest it is optional for companies to
either follow IFRS or the domestic accounting norms. India, at the moment,
does no require companies to follow the IFRS. However, as per its
commitment in the G20 summit last year, India will converge its domestic
accounting standards with IFRS in a phased manner starting April 1, 2011.
While BSE and NSE listed entities, apart from companies with net-worth
over Rs 500 crore, are required to converge with IFRS from April 2011, for
banks and insurance companies the date of conver-gence has been extended
to April 1, 2013 and April 1, 2012 respectively.
189
How relevant is a shift to IFRS now?

By making a shift to IFRS, a business can present its financial state-ments
on the same lines as its foreign competitors, making comparisons easier.
This will lead to increased trust and reliance placed by investors, analysts
and other stakeholders in a company's financial statement. Companies also
need to convert to IFRS if they are a sub-sidiary of a foreign company that is
mandated to use IFRS, or if they have a foreign investor that is mandated to
use IFRS. Companies may also benefit by using IFRS if they wish to raise
capital abroad.
How difficult is it for Indian companies to converge their accounts as per
IFRS?
The costs would be determined largely by the size and nature of the
respective company. While the initial cost to identify and quantify the
differences between Indian accounting standard and IFRS, staff train-ing
and implementing IT support could be significant, the conversion could
result in an ultimate reduction of costs for capital and financial reporting.
Initial challenge lies in making changes to a company's in-ternal
infrastructure related to data storage and availability.
What are the regulatory impediments that come in way of IFRS convergence
in India?
For a smooth convergence to take place, India needs to amend key
provisions in the Companies Act, SEBI Act, Insurance Act as also RBI
regulations. While the changes to the Companies Act have been provided
for in the proposed new Companies Bill, sectoral regulators like Reserve
Bank of India and Insurance Regulatory and Development Authority of
India will have to bring in certain changes in their norms.
__________________________________________________________
ET in the classroom: Monetary policy transmission
190

What is monetary policy transmission?
It refers to various channels through which the monetary policy of a central
bank alters prices or output in the real economy.
What are the various transmission channels of monetary policy?
The central bank can achieve its objective through a host of measures. These
could include altering the money supply, credit availability, asset prices,
influencing exchange rates and finally by managing expectations. The more
popular channel of transmission these days is either by changing the bank
rate, which is a way of managing expectations. In the last quarter, the central
bank used the money supply channel by increasing the cash reserve ratio
and thereby reducing the availability of cheap credit. The central bank also
influences prices and output by increasing its lending and borrowing rates
(repo and reverse repo, respectively).
How efficient is monetary policy transmission in India?
The monetary policy transmission is reasonably efficient to the money and
bond markets, though, slower to the credit market because of structural
rigidities. In recent communications, RBI governor D Subbarao has
acknowledged that the transmission of monetary policy is weak on account
of which policy rates signals do not get effectively communicated to the
market participants. To an extent, the purpose of these signals get diluted. In
an attempt to address this, it has asked banks to rework their loan pricing
mechanism and adopt what is called the Base Rate system which it feels will
help improve monetary policy transmission.
How does the base rate system work?
Hitherto, banks were free to decide their prime lending rates which served as
the benchmarks for most of bank lending. In future, RBI will have much
lesser leeway in determining the benchmark rate. The proposed Base Rate,
which will replace the PLR, will be based on a formula linked to the cost of
deposits for every bank. From the middle of this fiscal, banks will have to
replace PLR with the base rate. RBI believes that the base rate will transmit
changes in the monetary policy more effectively as any drop in the cost of
borrowing for banks will result in lower lending rates
191
__________________________________________________________
ET in the classroom: What is put & call ratio

Nihar Gokhale, ET Bureau Aug 21, 2012, 02.26PM IST
192
ET in the classroom: Initial Public Offering

What is an Initial Public Offering (IPO)?
A maiden public issue of shares by a company is termed as an Initial Public
Offering (IPO). It is often treated as a milestone in a company's lifecycle
and usually marks the transition from a small closely-held company to a
listed entity. Most IPOs are done by smaller, younger companies which need
capital to expand their business. However, often they are also done by large
privately-owned companies looking to become publicly-traded. The new
investors who come in the company by way of owning shares, through the
IPO become members of the family of existing shareholders.
Why do companies go for an IPO? What are its benefits?
Companies float an IPO to raise capital. Listed companies get access to
cheaper capital. Since they are more compliant and transparent, and are
subjected to scrutiny by various authorities, they can get access to lower
interest rates when they issue debt. A listed company can issue more stock
and raise fresh capital faster than an unlisted company. They can also offer
their own stock to buy out a company. Hence, mergers and acquisitions are
easier for listed companies since they can issue stock as part of the deal. A
193
listed company can offer ESOPs to employees, which is an attractive

retention tool. There is also a considerable amount of prestige that follows a
successful listing.
How can an IPO be structured?
An IPO can be done either through a fresh issue of shares or through an
offer for sale of existing shares to investors. If fresh shares are issued, the
company's fresh capital is injected into the business and its equity base
increases. The stake of existing investors in the company decreases, to that
extent. When existing shareholders of the company sell equity shares that
they own, then it is called an offer for sale. In this case, there is no infusion
of money in the company. The existing shareholders sell their stake usually
for a profit.
How long does it take for a company to list post-IPO?
In a recent directive, Sebi has ordered companies to get their issue listed
within 12 days, from the date of closure of the IPO. Earlier, it took
companies 22 days to list the IPO.
How is an IPO priced?
IPOs are priced by companies in conjunction with merchant bankers.
Essentially, there are two ways of pricing an IPO the fixed-price route
and the book-building option. In a fixed-price mechanism, the price at which
the shares are issued to the public is disclosed, before the issue opens for
subscription. In the book-building process, the company announces a price
band within which investors have to bid for the shares. The lower end of the
price range is called the floor and the upper end is called the cap. After the
bidding process is complete, the cut-off price is arrived at based on the
demand of securities. Retail investors have the option of bidding at a cut-off
price.
__________________________________________________________
194
ET in the classroom: Sweat equity

What is sweat equity?
Sweat equity refers to shares given to a company's employees or directors
on favourable terms in recognition of their work. These shares are issued to
employees or directors at a discount or for a consideration other than cash
for providing know-how, making available rights in the nature of intellectual
property rights or value additions.
Why is sweat equity issued?
The idea behind issuing sweat equity is to retain your best employees. There
is no limit to the discount on share price that can be offered. Sweat equity
makes employees part owners of the company and gives them a share of
profits earned.
Is there any limit to the amount of sweat equity?
The sweat equity issued during a year should not exceed 15% of the total
paid-up capital of the company or a value of Rs 5 crore, whichever is higher.
The company needs to get prior approval of the central government to go
beyond this level. It is also restricted from issuing sweat equity before
completing one year of incorporation.
Who determines the value of sweat equity?
The price of sweat equity shall be determined by an independent valuer. If
shares are issued for a consideration other than cash, the valuation of
intellectual property or know-how shall be carried out by a valuer. Such
valuer shall consult experts considering the nature of the industry and the
value addition.
What steps do a company need to take?
The issue of sweat equity shares should be approved by shareholders by
means of a special resolution at a general meeting or an extra-ordinary
195
general meeting of a company. The explanatory statement accompanying

the notice of the general meeting should include reasons and justifications
for such the sweat equity issue, value of such shares, the valuation report
and other details.
__________________________________________________________
ET in the classroom: What do equity analysts' recommendations mean?

You often come across stock and industry reports made by analysts with
various terminologies such as buy, accumulate, overweight, underweight.
Let us try and understand what these various terminologies indicate.
Buy/ Accumulate or Sell/ Book Profits: These recommendations tell you
whether the analyst expects the stock price to rise, fall or trade in a range
from its current price or on the day the report is published. If an analyst
expects a company's performance in the near future to be good, he puts a
buy / accumulate recommendation. On the other hand, if he expects the
future financials to dive, he recommends you to sell the stock.
Many a time a sell recommendation could also indicate that he expects the
share price to drop sharply, and hence, is advising you to sell. Similarly, in
the case of a buy recommendation it could indicate he expects the share
price to move up sharply. A lot of time analysts suggest 'book profits' in the
place of a sell, if he has recommended buying at a lower price and the stock
has run up subsequently, leaving you with profits.
Hold: On the face, a hold recommendation calls for maintaining a status
quo. But this recommendation is far more useful when seen in conjunction
with the analyst's earlier recommendation. If the analyst earlier had a buy,
the subsequent hold means that he has downgraded the stock. However, if
the stock was a 'sell' earlier, the new recommendation would mean that the
company's prospects have improved.
196
Overweight / Outperformer: It is a rating system used by an analyst to

indicate the attractiveness of the stock being tracked. It conveys that the
analyst is positive about the company. So, if an overweight rating is
assigned to a stock, it indicates that an investor should hold proportionately
more than the benchmark weight of a certain asset.
So, if an analyst gives an overweight rating to say Infosys, it means in his
opinion the stock offers more value for money than others in the sector. If
the weight of Company X in Nifty is 8.55%, and the analyst is overweight it
means you should hold more than 8.55% of Company X in your portfolio.
However, as an investor, do not think that if a stock has been given an
overweight rating you cannot lose money as the rating in no way conveys
absolute return. If the Sensex slides by 20% over a month, a stock that is
down by only 15% would be an 'outperformer'... but you would not have
made any money on it.
Underweight / Underperformer: Underweight indicates that an investor
should hold proportionately lower than the benchmark weight of a certain
asset. So if your advisor tells you to be underweight on Company A, he
means your portfolio should hold less of 'A' than its weight in the index. If
your advisor is underweight on A and its value in the Nifty is 11%, you
should hold less than 11% of A in your portfolio.
Equal Weight / Neutral : This indicates that the analyst is not very optimistic
about a company's future, but neither does he have a negative view. He has
no firm view on the company and feels that the company may perform in
tune with the market and hence it is worthwhile holding it. Another way of
looking at a neutral rating is to check the previous rating on the stock. It is a
negative sign if the view on the stock has turned from a 'buy' to a neutral and
a positive one if the view has turned from 'sell' to 'neutral'.
__________________________________________________________
ET in the classroom: Progress of the Budget in Parliament and the concept of cut
motion
197

ET discusses the progress of the Budget in Parliament and the concept of cut
motion.
How is the budget debated in Parliament?
Budget discussion in the Lok Sabha is a two-stage process. In the first stage
there is a general discussion on the budget as a whole, lasting 4-5 days. Only
the broad contours of the budget and the principles and policies underlying
it are discussed at this stage. After the general discussion on both the
railway and general budgets, the House is adjourned for a period. In this
interval, demands for grants of various ministries and departments including
railways are considered by the concerned standing committees (Rule 331G).
These committees are required to submit their reports to the House within a
specified period without asking for more time. The reports of the standing
committees are of persuasive nature, they cannot suggest anything in the
nature of cut motions.
How are demands for grants dealt with by the Lok Sabha?
After the reports of the standing committees are available with the House, it
begins discussion and voting on demands for grants of each ministry. The
speaker, in consultation with the leader of the House, fixes for the time for
discussion and voting on demands for grants. On the last day, the speaker
puts all the outstanding demands to vote. This process is known as
'guillotine'. The Lok Sabha has the power to assent to or refuse to give
assent to any demand or even to reduce the amount of grant sought by the
government.
What are cut motions?
These are moved to discuss specific matters by the minister concerned or to
ventilate grievances or to suggest economies. Each motion has to focus on
one matter and one demand, which needs to be precisely stated. It must not
relate to expenditure charged to the consolidated fund of India and not
suggest any change of law. There are three types of cuts.
What are the different types of cut motions?
Policy cuts: There is a notional cut of Re 1 to express total disapproval of
the policy. Token cut: Grant is sought to be reduced by Rs 100 and the
purpose is to ventilate a grievance relating to the demand.
198
Economy cuts: There are cuts suggested by members to bring about

economy in expenditure, or to reduce the demand by such amounts that may
be considered necessary.
What are the implications of a cut motion getting passed?
The cut motions are put to vote after discussion. Depending on the result of
the vote the demands are either reduced or allowed to go through. Cut
motions invariably put the government on the defensive, but if the replies
are convincing and the ruling party has a good majority then it would not
mean much. If the cut motion goes through, the government will have to
resign.
__________________________________________________________
ET in the classroom: Basic travel quota

What is basic travel quota?
Foreign currencies that Indians are allowed to buy for leisure and/or
business travel overseas come under the basic travel quota which the
Reserve Bank of India prescribes. RBI fixes a cap on the amount that can be
bought for such purposes. This cap has been progressively relaxed.
Why did RBI increase forex limit recently?
The increase is a part of the central bank's move to liberalise foreign
exchange transactions. Travellers can now buy foreign exchange from banks
and full-fledged money changers up to $3,000 in cash. Any cash more than
this would require special RBI approvals. Earlier, this limit was $2,000. This
is a part of the government's ongoing efforts to ease restrictions around hard
currency movements. RBI has also specific limits for some countries. For
instance, for travel to certain countries like Iraq, Libya, Islamic Republic of
199
Iran, Russian Federation and other Republics of Commonwealth of

Independent States, the limit is even higher at $5,000.
Can travellers carry other alternate instruments?
A traveller can of course carry more money than this, but she or he will have
to do it with traveller's cheques, banker's drafts or prepaid cards issued by
banks. Banks and money changers can release foreign exchange up to
$25,000 for a business trip for most countries. For a casual tourist, this limit
is set at $10,000 for medical treatment and for studies abroad, it is $100,000.
Why does India have limits on hard cash for travellers going abroad?
The Indian rupee is fully convertible on current account, but only partially
convertible on capital account. This means that while exporters and
importers are allowed to buy and sell foreign currency as per their
requirements without RBI's permission, any currency movement outside
trade is strictly regulated. Typically, developing countries which have faced
foreign exchange problems in the past use such restrictions to avoid sudden
erosion of their foreign exchange reserves which are essential to maintain
financial stability and that of trade balances.
What is ultimate policy destination?
With India's forex reserves increasing steadily, it has slowly and steadily
removed restrictions on the movement of capital on many counts. An ideal
scenario is when the rupee is fully convertible on the capital account, so that
a person travelling abroad can take any amount of cash as he thinks fit, as is
the case with open markets like the US.
__________________________________________________________
ET in the Classroom: ACU
200
What is the Asian Clearing Union (ACU)?

ACU is a system for clearing payments among the member countries on a
multilateral basis. The central banks and monetary authorities of Iran, India,
Bangladesh, Bhutan, Nepal, Pakistan, Sri Lanka and Myanmar are the
members of the ACU. It was established in 1974, with its headquarters in
Tehran, Iran, at the initiative of the United Nations Economic and Social
Commission for Asia and Pacific (ESCAP), as a step towards securing
regional co-operation.
How are the ACU transactions to be handled?
All transactions to be cleared through the ACU are handled by authorised
dealers in foreign exchange, which are essentially commercial banks with a
foreign exchange treasury, in the same manner as other normal foreign
exchange transactions. All authorised dealers in India have been permitted
to handle ACU transactions. They may freely enter into correspondent
arrangements with banks in the other countries participating in the Clearing
Union. The Asian Monetary Unit is the common unit of account of ACU
and is equivalent in value to one US dollar. The Asian Monetary Unit may
also be denominated as ACU dollar.
What is the procedure for settlement of transactions?
Large part of transactions are settled directly through the accounts
maintained by authorised dealers with banks in the other participating
countries and vice-versa, only the spill-overs in either direction are required
to be settled by the central banks in the countries concerned through the
clearing union. Authorised dealers are permitted to settle commercial and
other eligible transactions in much the same manner as other normal foreign
exchange transactions. Authorised dealers can open ACU dollar accounts in
the names of all banks, in all member countries, including Pakistan, without
the prior approval of RBI.
What is the mechanism for settlement through ACU?
RBI undertakes to receive and pay US dollars from/to authorised dealer for
the purpose of funding or for repatriating the excess liquidity in the ACU
dollar accounts maintained by the authorised dealer with their
correspondents in the other participating countries. Similarly, the central
bank has also been receiving and delivering US dollar amounts for
absorbing liquidity or for funding the ACU dollar (vostro) accounts
maintained by the authorised dealers on behalf of their overseas
correspondents.
201
What are the transactions which are eligible to be settled through ACU?
Transactions that are eligible to be made through ACU are payments from a
resident in the territory of one participant to a resident in the territory of
another participant. Other eligible transactions among others include the
ones for current international transactions as defined by the Articles of
Agreement of the International Monetary Fund.
Source: RBI
__________________________________________________________
ET in the classroom: G20 in fire-fighting mode

G20 IN FIRE-FIGHTING MODE
The finance ministers and central bank chiefs of G20 countries will meet at
Busan, South Korea through Friday and Saturday amid growing fears of another round of economic crisis. The meeting will set the agenda for the G20
summit later this month in Canada.
BACKDROP
- Sovereign debt crisis in the Europe threatens another round of economic
slow-down.
- Stock markets across the world have crashed, Dow down almost 8% in
May.
- The euro has depreciated sharply, raising questions over the currency's
viability. The currency does not offer the individual country flexibility to
take cor-rective action.
202
- Overhanging issue of the over-valued Chinese currency yuan.

- Renewed tensions between North and South Koreas.
ON THE MENU
Reform of the global financial system to prevent another crisis.
Bank levy: Making banks pay for future bailouts; the US and the EU in
favour, but countries such as Canada and Australia oppose the plan.
Bank Capital: New capital standards for banks as the financial crisis has exposed the current ones.
Capital Flow: Regulations to cushion capital flows could be discussed.
European debt crisis: Many of the indebted countries face tough time and
pose risk for the global economy. A reaffirmation of support to troubled
countries to calm the markets.
THE G20
Founded in 1999, G-20 includes Argentina, Australia, Brazil, Canada,
China, France, Germany, India, Indonesia, Italy, Japan, Mexico, Russia,
Saudi Arabia, South Africa, Republic of Korea, Turkey, the UK and the US.
The grouping gained prominence after the shock of 2008, when it
spearheaded efforts to contain tackle the crisis. It largely replaced G-7 as the
key actor in the world economy.
__________________________________________________________
ET in the classroom: Banking Ombudsman
203
What is the Banking Ombudsman Scheme?

The Banking Ombudsman Scheme provides an expeditious and inexpensive
forum to bank customers for resolution of complaints relating to certain
services rendered by banks. The Banking Ombudsman Scheme was
introduced under Section 35 A of the Banking Regulation Act, 1949, by RBI
in 1995. The Banking Ombudsman is a senior official appointed by RBI to
redress customer complaints against deficiency in certain banking services.
Where can one lodge his/her complaint?
One may lodge his/her complaint at the office of the Banking Ombudsman,
under whose jurisdiction, the bank branch complained against is situated.
For complaints relating to credit cards and other types of services with
centralised operations, complaints may be filed before the Banking
Ombudsman within whose territorial jurisdiction, the billing address of the
customer is located.
Can compensation be claimed for mental agony and harassment?
The Banking Ombudsman may award compensation not exceeding Rs 1
lakh to the complainant only in case of complaints relating to credit card
operations for mental agony and harassment. The Banking Ombudsman will
take into account the loss of the complainant's time, expenses incurred by
the complainant, harassment and mental anguish suffered by the
complainant while passing such award.
What happens after a complaint is received by the Banking Ombudsman?
The Banking Ombudsman attempts to ensure a settlement of the complaint
by an agreement between the complaint and the bank named in the
complaint. If the terms of settlement (offered by the bank) are acceptable to
one in full and final settlement of one's complaint, the Banking Ombudsman
will pass an order as per the terms of settlement which becomes binding on
the bank and the complainant.
Is there any further recourse available if one rejects the Banking
Ombudsman's decision?
If one is not satisfied with the decision passed by the Banking Ombudsman,
one can approach the appellate authority against the Banking Ombudsmen's
decision. Appellate Authority is vested with a Deputy Governor of RBI.
204
One can also explore any other recourse and/or remedies available to
him/her as per the law. The bank also has the option to file an appeal before
the appellate authority under the scheme.
__________________________________________________________
ET in the classroom: Liquidity

What is Liquidity?
Liquidity simply means the amount of money floating in the system that is
available to all participants in the financial markets, which includes
individuals, corporate entities and the government.
What affects liquidity?
Liquidity is influenced by demand and supply of money in the system. The
central bank, the Reserve Bank of India, can increase or decrease the
liquidity in the financial markets. There are three ways the liquidity gets
affected. First, the borrowings of the government the biggest borrower in
India to fund the deficit that arises when its income falls short of
expenses.
Second will be the increased borrowings by the corporate sector to fund
capital expenditures and short-term credit needs. A third reason could be a
reduction of availability of the rupee by the central bank by buying rupee
and selling a foreign currency such as the US dollar. This is primarily done
to maintain the value of rupee. The central bank prefers to withdraw excess
liquidity from the financial market when asset prices near a bubble situation.
What are the variables affected by liquidity?
205
Commodities that are not available easily tend to become costly. Money is
no exception to this. If the central bank prefers to reduce liquidity from the
financial system, the same is reflected by a hardening of interest rates. It is
especially visible at the short end of the yield curve. Put simply, the loans
become costlier. At the other end, borrowers will have to pay more to raise
money.
If there is ample liquidity in the financial system, investors and speculators
find it easy to leverage. This ensures that the asset prices rise. Hence periods
of low interest rates, with ample liquidity in the financial system, create a
good environment for price rise across asset classes, such as equities,
commodities and real estate.
But if the liquidity is reduced, the speculators find it difficult to hold on to
their positions due to higher interest burden or non availability of money.
This results in a fall in asset prices.
What should investors do?
As the central bank makes their stand clear on policy issues such as interest
rates, investors should be prepared to take advantage of the same.
When the interest rates enjoy upward bias and liquidity is seen tight, it
makes sense to go for short-term bond funds to enjoy good risk adjusted
returns. As liquidity tightens, the short end of the yield curve finds the
maximum movement and short-term bond fund managers, if they can catch
the movement, reward investors well.
There are events where large-scale borrowings from the corporate sector
draws money out of the system, pushing interest rates up. This is the time
one can lock in returns by investing in fixed maturity plans. Traditionally,
such opportunities were seen ahead of advanced tax payments by the
corporate sector, when the liquidity in the system goes down.
Investors can also find solace by investing in floating rate instruments, to
catch interest rate movements arising out of a modification in liquidity in the
financial system. Investors with high risk appetite can consider resorting to
leverage to build big positions in assets of their choice.
__________________________________________________________
206
ET in the classroom: Family floater policies

It's a well-known fact that healthcare costs are on the rise and one has to
provide for it. Mediclaim covers offered by general insurers are popular
among customers to meet their healthcare expenses. But is it a perfect
hedge? Is the size of the policy good enough to manage your entire family's
healthcare expenses? It's more prudent to go for a family floater instead of
opting for multiple policies for your family, especially in the case of
younger families.
What is a family floater?
Family floater covers the family as a whole for a fixed sum assured. So if
you take a policy of Rs 4 lakh, each member of your family (who is covered
under the policy) can utilise the entire amount. It doesn't mean the amount is
split among the family members. Such policies are generally targeted at a
family of two adults and two children. Although couples with no children or
a single child can opt for a floater.
Can I cover my old parents under this scheme?
Most policies have 60 years as the upper limit. Hence it's advisable to cover
your spouse and children under this option.
What's the advantage?
Saving on multiple premium cost is the biggest advantage. For example, if
we take a family, with husband (38 years), wife (34 years) and two children
(aged 8 & 6), the premium for a four-lakh policy works out to Rs 12,000. If
this amount is split among four people, by opting for individual policies, the
premium works out to around Rs 12,650. But the sum assured for each
individual is much lower in that case.
What are the facts you should keep in mind?
A single claim by any one of the family members can exhaust the cover
limit. As a result, other family members will have less or no coverage for
207
the rest of the year. Secondly, the policy cannot be renewed if the senior
most member crosses the maximum eligible age as mentioned in the policy.
At this point of time, the rest of the family will have to go for a fresh policy.
As a result, the premiums would be much higher for family members who
have crossed 40 years of age. This logic also applies to children who cross
the maximum age, which is 25 years in most policies. At this stage, a child
has to opt for a separate policy. Like a regular policy, the renewal premium
shall be calculated as per the age of the senior most insured member as
covered under the policy. A loading may be charged on the premium in case
there is a claim in the expiring policy. For instance, ICICI Lombard charges
a loading of 10% for claims in the range of Rs 25,000 to Rs 50,000 and it
increases to 20% for claims in the range of Rs 50,000 to Rs 1,00,000, 50%
for claims in the range of Rs 1,00,001 to Rs 2,00,000 and 75% for claims
above Rs 2 lakh.
Hence family floater is an economical option that is more beneficial for a
family with younger members, with the oldest member being 45 years of
age, helping them in the long run.
__________________________________________________________
ET in the classroom: Mining area rules

ET takes a look at mining area rules that have sent the coal & power sectors
in a tizzy
What are 'go' and 'no go' areas?
The environment ministry has categorised mining regions into 'A' or 'no go'
areas where coal mining is prohibited and 'B' or 'go' areas where ministry
could permit mining subject to other statutory clearances.
How has the environment ministry categorised these areas?
208
The categorisation of mining regions into 'go' and `no go' areas has been
done on the basis of a study conducted by the environment ministry in nine
major coal fields of the country. The areas were demarcated by
superimposing coal-bearing areas and forest areas as per the records of coal
and environment ministries. So the forest areas (as per records of the
environment ministry) covering coal bearing regions identified by the coal
ministry were categorised as 'no go' areas.
What is the implication of this categorisation?
The study has labelled almost 48% mining areas identified by the coal
ministry in the nine coal fields as 'no go'. This has put 203 coal blocks in
these coalfields in the barred list. Over 600 million tonnes per annum of coal
production capacity (about 400 mtpa from Coal India Ltd's areas and over
200 mtpa from captive blocks) will get affected.
Will it also impact power projects?
Yes, as 70-80% of country's coal production is currently consumed by
power stations. The coal ministry has estimated that under the new
categorisation, domestic coal production would not reach 1,000 mtpa in the
next decade. It would remain at 400 mtpa level (loss of 600 mtpa) against a
projected demand of 1500 mtpa by then, thereby severely impacting several
existing and upcoming power projects. The 600 mtpa of coal could support
about 1,50,000 MW of power capacity which is equal to country's current
generation capacity.
Is there a change in stance of the environment ministry with respect to this
categorisation?
The Prime Minister's Office is looking into the matter to balance
environmental concerns and development goals. The environment and coal
ministries now seem to have agreed to permit coal mining in such `no go'
areas where there is no contiguous forest or the forest density is thin and
where some mining activities are already taking place. This could release 77
out of 203 coal blocks barred for mining but still keep a substantial portion
out of bounds for mining. Mining in these areas will be permitted by putting
additional burden on companies to pre-vent environment degradation.
__________________________________________________________
209
ET in the Classroom: Non-Deliverable Forwards

What are NDFs?
Non Deliverable Forwards, or NDFs as they are popularly known, are shortterm forward contracts on foreign exchange. International investors use this
market to bet on currencies like the rupee in the overseas markets. NDF
contracts are largely on thinly-traded or non-convertible currencies and they
are settled at an international financial centre, generally in US dollars. They
are quoted for periods between a month and a year. These deals are offbalance sheet and are always settled in cash. In other words, if an overseas
investor feels that the rupee will rise, he will place an order for rupees in the
forward market. If the currency does indeed rise, he will receive the
difference between the exchange rates in dollars. There is no physical
settlement of two currencies at maturity.
The purpose of an NDF
Emerging markets are the fastest growing and most international investors
are keen on participating in their growth. Some players are also keen in the
emerging market currencies. However, emerging markets always face a
convertibility risk as there is a possibility that their partially convertible
currency might turn inconvertible (Mexico, 1982). Also, investors find the
documentation process in these partially convertible markets very elaborate.
This makes hedging emerging market currency exposure difficult and
expensive. NDFs allow foreign investors to hedge their exposures against
emerging market currencies risk outside the country. But NDFs are carried
out in an offshore market, and the central banks have little say in these
operations, as they are being carried out in foreign shores outside their
jurisdiction.
How does an NDF transaction occur?
When an international company invests in India with the object of taking out
its money in six months, the company enters into an NDF contract with its
bank. If on the fixing date, the rupee has weakened, the investor will collect
210
the difference. If it's stronger, the investor will pay the bank the difference
again, in dollars.
What is the Fixing date and Settlement date?
The fixing date is the date at which the difference between the prevailing
market exchange rate and the agreed upon exchange rate or the
reference rate is calculated. The settlement date is the date by which
the payment of the difference is due to the party receiving payment.
__________________________________________________________
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.
211
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.
212
__________________________________________________________
ET in the classroom: Electronic Clearing Service

ET makes it easier for you to understand ECS.
What is ECS?
Electronic Clearing Service (ECS) is a mechanism of electronic funds
transfer for transactions that entail an outgo of specified amounts at regular
intervals. It is used by corporates to make various payments to their
employees or investors; banks for accepting EMIs (equated monthly
instalments) and utilities to collect payments for various bills.
Out of the two variants of the facility, that is, ECS Credit and ECS Debit, it
is the latter that primarily concerns an individual user termed beneficiary
in this context. Individuals intending to make payments to these utilities or
discharge their EMIs have to sign up with these entities to participate. From
the individual's point of view, ECS mandate is in the nature of issuing
standing instructions to his/her bank for making payments on a pre-decided
date. You can also use the facility to make your insurance premium and
EMI payments as well as mutual fund investments through systematic
investment plan (SIP) route.
How does an individual avail of this service?
To avail of this service, you have to give the organisation for instance,
the telephone utility you pay bills to every month or the fund house in
whose scheme you invest SIP a mandate that represents your consent to
avail of the facility and authorisation to your bank to honour the payment
when due. It contains details such as your name, bank account number,
branch, etc, along with the date on which your account is to be debited. The
213
mandate forms can be obtained either from the entities' websites or their
designated centres.
What are the charges to be paid to avail of this service?
Typically, banks which carry out your ECS debit instructions do not charge
any fee to provide the service.
What are the advantages of opting for an ECS debit facility?
It obviates the need to keep track of payments to be made and visiting your
bank branch to effect the same. Apart from helping you save on time and
efforts, it could also entitle you to discounts that certain utilities offer to
their customers who undertake to make payments through the ECS mode.
For instance, MTNL offers a discount of 1% capped at Rs 250 per bill
if you opt for the ECS mode. Similarly, Reliance Energy offers a discount of
0.5% restricted to Rs 250 per bill.
The discounts are usually reflected in the subsequent month's bill. You can
also assign an upper limit for the maximum debit as well as the validity
period for the ECS mandate furnished by you. Remember, ECS-based
payments are treated on par with cheques, and therefore, like in the case of
latter, dishonour of ECS instructions is a punishable offence.
Can one withdraw the ECS mandate whenever he/she chooses?
You can choose to withdraw the mandate by notifying the service provider
say, the utility or the lending bank in advance, in the format
prescribed. Likewise, you would do well to inform your bank to spell out
your intention to stop using the facility. This will help you present a strong
case in the event of an erroneous debit.
__________________________________________________________
ET in the classroom: Interest Rate Swap
214

What is an interest rate swap?
An interest rate swap is an over-the-counter (OTC) derivative instrument
available in the currency market where counter parties can exchange a
floating payment for a fixed payment and vice-versa related to an interest
rate.
Financial institutions going for foreign borrowings usually buy interest rate
swaps to hedge their interest rate exposure due to fluctuating interest rates.
These were originally created to allow multinational companies to evade
exchange controls. Today, they are used to hedge against or speculate on
changes in interest rates.
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
215
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-forfixed works the same way except that there is no change in the rate used
during the date of payment, as does floating-for-floating swap.
__________________________________________________________
ET in the classroom: Demat Account

What is a demat account? What securities can I hold in my demat account?
Today, to buy and sell securities, brokers insist on having a demat account.
Just as you open a bank account to hold money and make payments,
similarly you need to open a demat account now to buy and sell securities in
the financial markets. Today, all trades are settled in dematerialised form i.e.
in the form of electronic records rather than certificates. Physical securities
carry the risk of being stolen, forged or faked, and hence, it is necessary for
investors to trade in demat form. A demat account can be used not only to
216
hold shares, but also mutual funds, debentures and exchange-traded funds
(ETFs). Hence, it is essential to have a
demat account.
How does one convert physical shares into demat form?
If you are holding shares in physical form, it is advisable to convert them
into dematerialised form. To get your shares dematerialised, you have to
open a demat account and get into an agreement with a depository
participant (DP). You need to surrender your physical share certificates to
the company which issued them, informing them and giving details of your
agreement with your depository participant. On the basis of this, the
company would cancel your certificates and register your shareholdings in
the name of your depository participant as the registered owner of those
shares and intimate this registration through a notice to your depository
participant. On receipt of the aforesaid notice from the company, the
depository participant would register you as the beneficial owner of those
shares. As a registered owner, your depository participant has no rights of
benefits from those shares. All rights would lie with you as the beneficial
owner.
With whom can you open a demat account?
You can open a demat account with any depository participant which could
be a bank or even a stock broker having the licence to do so depending on
your convenience. A broker is separate from a DP. A broker is a member of
the stock exchange who buys and sells shares on his behalf and on behalf of
his clients, though he could also hold a licence to provide depository
services. A DP will just give you an account to hold those shares. It is not
necessary for you to open a DP account with your broker. Your account can
be different from that of the broker. Many brokers also offer you three-inone trading accounts which link your broking, demat and bank accounts
online, thus making it easier for you to trade. To view a complete list of
registered depository participants, you can visit the websites of NSDL and
CDSL.
What are the charges incurred in a demat account?
Various entities could levy various charges while operating a demat account.
Broadly, there are three kinds of charges which a depository participant can
levy. The first is an account opening charge, which also covers the cost of
the agreement with the depository participant. The second is the annual
maintenance charge to maintain your account and send you statements on a
regular basis. The third charge is the transaction charge which is charged
217
every time you sell a security, and request the DP to move it from your
account to the broker's account.
__________________________________________________________
ET in the classroom; Regulatory autonomy

What is regulatory autonomy?
Financial market regulators like the Reserve Bank of India, the Securities
Exchange Board of India ( Sebi) and the Insurance Regulatory Development
Authority ( IRDA) have their jurisdiction over different segments of the
market. Their activities are overseen by the government, though they are
supposed to be autonomous - meaning the government will not interfere in
their daily functioning or in the rules and guidelines they formulate for
market participants. But there is a regular interface between the government
and the regulators over several issues.
How does this interface work?
In case of RBI, its most essential function is that of public debt management
on behalf of the government. RBI performs an important function of
regulating the volume and the value of money in circulation in the system,
both locally as well as globally. So whether and how should the money
created by RBI be used for government expenditure becomes an issue of
conjecture.
In which areas do regulators interact with the govt?
There are three areas where autonomy of the regulator interacts with the
powers of the legislature - matters of appointment, matters of monetary
policy making and matters of finance of public debt, as a whole,
maintenance of financial stability of the economy. In matters of
218
appointments, we refer to the extent of the government's involvement in

appointment, dismissal and terms of procedures of central bank top officials
and the governing body. Autonomy in financial matters, refers to RBI's
power to manage the limit of its credit to be used for servicing government's
expenditure. Finally autonomy in terms of policy making refers to the
autonomy of RBI to formulate and regulate the monetary policy.
Have there been instances of clashes between RBI and the govt in the past?
The differences were summarised by former governor YV Reddy in his
speech earlier this year. RBI came to be nationalised in 1948. Back then
there were minimal areas of conflict as price inflation was modest. But
differences have always been there. For example, during the five-year plans
in the 1950s, RBI did not approve of financial planning being substituted
with "Physical planning", but it had little autonomy to oppose it. The
differences between the RBI and the government led to resignation by
Governor Rama Rau. In the '60s Governor Iyenger identified four areas of
conflict between the RBI and the Government - interest rate policy, deficit
financing, co-operative credit policy and management of sub-standard
banks. But in the post-liberalisation period, the relationship between the two
took a new turn. In 1994, RBI and the legislature mutually disabled the adhoc treasury bills, the move moderated the magnetisation of government
deficits.
__________________________________________________________
ET in the Classroom: Estate planning

Everyone talks about the importance of succession planning. What comes to
your mind when you have to assign beneficiaries for your hard earned
savings? It's a Will. But what if the Will is challenged once it comes into
being. It will be difficult to clarify the soundness of the Will as the testator
(one who makes the Will) would have passed away. Is there a better
219
alternative to ensure a hassle-free process to bequeath wealth? The answer is

Estate Planning.
What is Estate Planning?
Estate Planning is a process of accumulating and disposing of your wealth,
be it cash, shares or property in a systematic and pre-determined manner to a
certain beneficiary/beneficiaries of your choice. This process is carried out
through the Trust route. The testator sets up a Trust, which is manned by
trustees appointed by him/her. The idea is to appoint third party trustees, so
that the asset transfer process is carried out in a neutral manner. This also
helps in maintaining the confidentiality of the Will.
How estate planning scores over a will?
The first step to estate planning is making a will. You have the option of
transferring your assets to your legal heirs either through will or estate
planning. Estate planning will gain ground in India because even today a
large percentage of Wills get challenged. When Wills are challenged, it
leaves individual beneficiaries and families in disarray.
If an individual carries out succession planning through Trusts, in one's life
time, then the possibility of loopholes is minimal. Moreover, an individual is
perishable not the entire trust. There are evidences of deceit by individual
lawyers at the time of the execution of Will. So setting up of a Trust will
help especially those individuals who have a high net worth
Who offer these services?
There are some independent firms that specialise in such services. Recently,
banks have started offering Estate Planning services for their HNI and ultraHNI clients. They mainly include individuals, who have bank balances of a
few crores of rupees. Banks and firms help I in a range services. Apart from
helping the customers write a Will, they help you register and safe keep the
Will.
Banks preserve the Will in physical form as well as in e-form. Banks also
help in setting up of the Trust, its registration, documentation management
and execution. Over and above, such banks take care of legal and regulatory
requirements. Further, they also help in filing tax returns and settling
liabilities of the Trust. Usually, these banks work in conjunction with
lawyers to ensure a smooth process of Estate Planning.
How much does it cost?
220
You can walk into your bank to seek its help in appointing the trustees or the
bank can just handhold you till you set up a Trust. If you have to just make a
Will, it might cost you anything between Rs 6,000 and Rs 10,000. Making
of a Will, registration, other processes like safe-keeping and execution will
work out to about Rs 25,000.
If you are taking your bank's help in setting up of a Trust, its management
and execution, the bank will charge you 0.5-3% of total assets under
management (AUM) as the estate planning fee. If you seek an independent
professional the charges vary depending upon the service. The setting up of
a trust, will work to a one time cost of Rs 2-3 lakh.
__________________________________________________________
ET in the classroom: Forward Premium

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?
It's 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-
221
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-the-counter 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.
__________________________________________________________
222
ET in the classroom: Rider benefits in life insurance policies

ET looks at the concept of riders in insurance policies and explains the
various aspects related to it.
What are riders?
Riders refer to covers that are offered by insurance companies in addition to
the basic life cover. In other words, they cover risks that are beyond the
scope of the main life policy, resulting in more comprehensive protection.
What are the types of riders offered by insurers?
Rider benefits offered could vary as per the insurance company and the
policy purchased by the insured. Typically, riders extended include critical
illness (or dreaded diseases) cover, personal accident (or accidental death
and dismemberment) and waiver of premium benefit.
How do riders help the insured?
They help customise the life cover as per the policyholder's needs. Let's say
a policyholder, the sole breadwinner in the family, meets with an accident
resulting in temporary disability. If it forces her to stay away from work
during the period of recovery, the life cover will not make good the loss of
income. This is where a personal accident rider covering temporary
disability could come to the family's rescue. In such cases, the insurance
company undertakes to provide monetary compensation to the insured,
subject to the terms and conditions mentioned in the insurance contract.
Similarly, for a policyholder diagnosed with a critical or terminal illness, the
life insurance cover can provide little relief as it is not capable of preventing
the drain on finances during the treatment. A critical illness rider could
come in handy in such times. The illnesses generally covered under the
include cancer, kidney failure, paralysis, bypass surgery, major organ
223
transplant and so on. The sum assured under the rider is paid upfront as a
lump-sum to the policyholder.
Therefore, even if you have a health insurance policy in place, this amount
can help meet other expenses or act as succour if the insured is unable to
resume work during the period.
How does one choose the rider best suited for her?
The decision could depend on a variety of factors like your age, regular
mode of commuting and history of illnesses in your family, if any. For
someone who has just started her career and relies on public transport or
two-wheeler for daily commuting, a personal accident policy is a must.
Critical illness cover, on the other hand, would be of use to policyholders
across age-groups.
Does one have to incur an extra cost for availing these covers?
Yes. The insurer arrives at the additional premium chargeable to the
policyholders based on factors like their age, sum assured, premium paying
term and the company's underwriting norms.
What are the tax benefits available to those who opt for these riders?
The tax breaks depend on the rider chosen. For instance, while tax benefits
pertaining to premium paid towards the accidental death rider can be
claimed under section 80C, critical illness premium falls under section 80D.
__________________________________________________________
ET in the Classroom: Benchmark Bond
224
ET explains benchmark bond, most actively-traded paper in the government

securities market.
What is a benchmark bond in the government securities market?
The benchmark bond is the most actively-traded paper in the government
securities market. In case of India, the 10 year Government bond maturing
on March 5, 2020, with the fixed coupon rate of 7.8%, currently trading at
an yield of 7.97% is the benchmark government bond.
Why is the maturity of a benchmark bond always 10 years?
Theoretically, there is a benchmark for a bond of every tenure, which would
be the most liquid in the particular category, but in practice, the 10-year
bond is the most prevalent and the most liquid among the g-sec bonds. Also,
the government is most comfortable with such a tenure, to finance its longterm social infrastructure development projects. Therefore, in the Indian
bond market, the 10-year security severs as the bellwether security.
What determines whether a bond will be a benchmark security?
The most important factor is the liquidity of the bond. Generally, the most
liquid, in other words, most traded bond is the benchmark bond. Also, the
residual tenure of the bond has to be of 10 years. The benchmark has a low
bid-offer spread.
How long does a security remain a benchmark?
A security remains a benchmark for six months to a year or till its
outstanding amount crosses `50,000 crore, whichever occurs earlier. Beyond
a year, its tenure changes.
Why does the market need a benchmark?
A benchmark bond brings efficient price discovery as prices are determined
by market forces of demand and supply based on its yield, unlike the illiquid
bonds. The benchmark is a reference point for the pricing of other bonds
along the yield curve. For example, it aids the pricing of non-SLR bonds
along the yield curve. The benchmark helps peg floating rate assets and
liabilities.
__________________________________________________________
225
ET in the classroom: Merchant discount rate

What is the merchant discount rate?
It is the invisible charge that consumers pay to banks in establishments that
accept payment cards. It is invisible because the payment is made by a
merchant to his bank in the first instance. But like all input costs, the cost of
transactions too has to be recovered by the merchant from goods and
services. In extremely low margin businesses like petrol pumps, the charge
is passed on to the consumer directly.
Which are the banks that make money in card transactions?
The revenues earned from a credit card transaction are shared among four
players . First is the credit card issuing bank, which gets the lion's share of
the revenue. Second, part of the money also goes to the bank that has
installed the point of sales terminal the electronic swipe machine through
which the customer's account is debited and the merchant's account is
credited. The bank which has installed the POS terminal is also called the
acquiring bank. A portion of the revenue also goes to the payment company
such as Visa, MasterCard or American Express.
How much is the charge and how is it distributed?
Currently, for any merchant, the cost of processing a payment received by a
card ranges from 1.5-1 .75%. Around 80% of what he pays goes to the bank
that issues the credit card. Another 15% goes to the bank that has set up the
POS terminal and roughly 5% goes to the payment service provider.
What are the costs for the bank?
For a bank, the cost depends on whether it is a credit card or a debit card. In
the case of a credit card, a bank has to recover the money that it expends by
way of free credit period for the cardholder, the cost of printing and mailing
statements and the reward programme that cardholders are entitled to. In
226
case of debit cards, the costs are a fraction of what they are for the issuing
bank. For the acquiring bank, the costs are largely the same for nearly all
transactions.
__________________________________________________________
ET in the classroom: Quantitative easing

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 world's 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
227
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 today's 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.
__________________________________________________________
ET in the classroom: Quantitative Easing II

What is quantitative easing II?
The term became fashionable post the global economic crisis in 2008,
following which most governments across the globe had to pump in huge
amount of liquidity in the markets to tide over the crisis. Quantitative easing
is the process of infusing money into the system by creating 'new money'
and eventually buying financial assets like bonds and corporate debt from
228
financial institutions in the country. This is done by central banks through

what is popularly known as open market operations. The idea essentially is
to make adequate money in the system to spur consumption demand in any
economy.
Quantitative easing II is the popular phrase used in the context of American
economy these days as the US Federal Reserve Board is touted to go for
another round of quantitative easing to consolidate the recovery of the
American economy, which has slowed down because of fundamental
reasons such as lower consumption and job losses and escape of capital to
other economies.
What does it mean for India?
Quantitative easing II could flood emerging economies with the dollars, thus
making the dollars cheaper and, hence, the US exports competitive while
forcing other related currencies to appreciate on account of increase in
capital inflows. There is speculation that 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 they'll 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 didn't work. It forgot about the
financial fragility and how the banking system operates. They're 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
229
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.
__________________________________________________________
ET in the classroom: Why EPFO doesnt invest in equities?

The provident fund manger for the organised sector, Employees' Provident
Fund Organisation (EPFO), has been under pressure to invest in equities to
earn higher returns for subscribers. But the fund, which manages around Rs
3,00,000 crore retirement corpus of nearly five lakh employees, has
stonewalled every proposal. ET takes a look at the reasons why the fund
invests only in high-quality bonds.
Obligation to declare returns every year
Unlike traditional funds, the EPFO has to declare annual returns, which is
added to the accumulated corpus of the subscriber. Any drop in returns
invites flak. EPFO , therefore, chooses to play safe and stay with toptier debt
that has allowed it to give steady returns of 8.5% since 2005-06 and 9.5% in
the current year. EPFO says the decision to invest in equities would have
been easier if there was no obligation to earn a minimum return. In fact, this
is the reason why the labour ministry has asked the finance ministry for a
guarantee on capital and some minimum returns if it were to invest in
equities.
230
Expert take
A valid argument, but EPFO could think of a reserve for the equities portion
to smoothen out earnings from equities. A very small exposure will not
cause too much volatility.
Very large number of low-income subscribers
A large number of subscribers of the EPFO are from the low-income group.
Not only is the accumulated corpus very small, very often it is a substantial
portion of their savings for retirement. It is not fair to risk this savings in
equities, the EPFO says. The investors have the option of routing their
personal investments in equities, ensuring that they have a good mix of fixed
investments in through provident fund and potentially high discretionary
savings in equities.
Expert take
Equities are risky in the short-term, not if investment horizon is over five
years. Besides, EPFO could think of providing an element of choice, as is
the case with the new pension scheme, to those investors who want a part of
their provident fund contributions invested in equities.
Large redemptions
Unlike NPS, which keeps the deposits till retirement, subscribers are
allowed to withdraw from the EPF for various purposes like education,
buying of property or marriage. Every year the EPFO faces redemptions to
the tune of about Rs 20,000 crore. So, returns have to be firm, or else if
equities are down at the time of premature withdrawal, subscriber will get a
raw deal.
Expert take
Withdrawal rules need to be tightened.
__________________________________________________________
231
ET in the classroom: Potential growth rate

The country's 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 India's
potential growth rate at 7-8%.
What factors decide the potential growth rate?
There are two major determinants of the potential rate at which an economy
can grow in the long run. One is the rate of increase in key inputs such as
labour and capital, while the other is the rise in productivity. Within the two
key inputs, labour has a bigger say in determining the potential growth rate.
The increase in labour supply through an increase in number of workers or
the numbers of hours put by a given number of workers and an increase in
labour productivity will result in an increase in the long-term potential
growth rate. Anything that aids productivity increases can help boost
potential growth rate. Infrastructure investments and skilling of labour can
raise India's potential growth rate because the country has ample labour
supply.
How does growing faster than the potential rate cause inflation?
The overall demand in the economy picks up due to fast growth and more
resources are used to meet higher demand. After a point, the economy may
not find enough inputs to meet the demand, leading to an increase in prices.
If there is surplus capacity in the economy then it can grow above the
potential rate for a while. But for an economy already working at full
capacity, excessive demand results in increase in the price level. The IMF
232
says India was growing at a rate faster than its potential rate in 2007-08, but
because of the financial crisis in early 2009 substantial slack emerged in
economy. It says the quick rebound from the crisis has exhausted that slack
and now there is a risk of high inflation if the Indian economy grows too
fast.
__________________________________________________________
ET in the Classroom: 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 micro-enterprises . 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?
An SHG is seen as an instrument for achieving a variety of goals, including
empowering women. Data from Nabard, which pioneered the concept,
shows that 90% of members in the SHG are women and most of them do not
have any assets. It also helps in developing leadership abilities among the
poor, increasing school enrolments, improving nutrition and in birth control.
An SHG is generally started by non-profit organisations, such as an NGO
with broad anti-poverty agendas. It is also a popular channel of microlending by commercial banks, particularly government-run banks.
What are the advantages of financing through an SHG?
233
A poor individual benefits enormously being part of an SHG . Raising

finance through SHGs reduces transaction costs for both lenders and
borrowers. Lenders have to handle only a single SHG account instead of a
large number of small-sized individual accounts, borrowers as part of an
SHG cut down expenses on travel to the branch to get the loan sanctioned.
What are the different ways in which banks fund SHGs?
Banks deal directly with individual SHGs . They provide financial
assistance to each SHG for lending to individual members. Alternatively,
banks provide loans to SHGs with recommendation from NGOs. Here the
SHGs are formed by NGOs or government agencies, which raise funds from
banks. In this, NGOs would organise the poor into SHGs , undertake
training, help in arranging inputs and marketing and assist in maintenance of
accounts.
__________________________________________________________
ET in the Classroom: Competition
Apr 28, 2011, 04.57am IST

Why is competition important? What is its economic rationale?
Competition, according to economic theory, forces firms to develop new
products, services and technologies which would give consumers greater
choice and better products. If more and more firms deal in a similar product,
consumer choice widens. This causes product prices to drop below the level
that would be if there were no competition; that is, if there was just one firm
(monopoly) or a few firms (oligopoly).
How is competition measured?
Competition is generally measured by calculating concentration ratios .
Concentration ratios indicate whether an industry consists of a few large
234
firms or many small firms. Two of the most commonly used metrics are the
Herfindahl Hirschman Index (HHI) and the N-firm concentration ratio.
Herfindahl Hirschman Index:
Under the HHI, the market share of each firm in a relevant sector is squared
and added to arrive at a statistical measure of concentration. The value of
the index varies from close to 0, indicating nearly perfect competition, to
10,000, indicating the presence of just one firm, a monopoly. HHI = s1 2 +
s2 2 +3 2 + ... + sn 2 (Where sn is the market share of the nth firm, and s
varies from close to zero to 100).
N-firm concentration ratio:
This method measures the dominance of the biggest firms in a particular
sector. N in this case is the number of firms being considered. A four-firm
concentration ratio, for instance, would just sum up the market shares of the
four biggest firms in the market. Fewer firms having a large market share
would indicate less competition.
How are these measures used?
In the US, mergers are scrutinized by analysing concentration ratios.
Generally, a market with a HHI of less than 1,000 is considered competitive
. A market with a HHI in the 1,000-1 ,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.
__________________________________________________________
235

ET in Classroom Economics

Enviado por

Dados do documento

Direitos autorais

Formatos disponíveis

Compartilhar este documento

Compartilhar ou incorporar documento

Opções de compartilhamento

Você considera este documento útil?

Este conteúdo é inapropriado?

Direitos autorais:

Formatos disponíveis

ET in Classroom Economics

Enviado por

Direitos autorais:

Formatos disponíveis

ET in Classroom articles

ET in the Classroom: Capital Controls

ET Bureau Feb 2, 2010, 03.58am IST

ET in the classroom: Various types of Tax

ET Bureau Feb 9, 2010, 01.46am IST

ET in the classroom: Non-tax sources of income for the government

ET Bureau Feb 11, 2010, 05.37am IST

The scheme was launched in April 2004 to strengthen RBI's ability to

ET in the Classroom: Fiscal Consolidation

ET Bureau Feb 23, 2010, 06.46am IST

fiscal stimulus package, it had to announce several fiscal concessions and

ET in the classroom: Interbank liabilities

ET Bureau Mar 9, 2010, 01.41am IST

Why is the regulator concerned?

ET in the classroom: Indian Depository Receipts

ET Bureau Mar 24, 2010, 02.38am IST

ET in the classroom: Viability gap funding

ET Bureau Mar 25, 2010, 05.28am IST

ET in the classroom: India refuses 'market economy' status to China

ET Bureau Apr 1, 2010, 03.26am IST

ET in the Classroom: Strips: get the right view

ET Bureau Apr 7, 2010, 03.01am IST

Stripping is to be carried out at RBI through an automated process within

ET in the classroom: Government bond auctions

ET Bureau Apr 27, 2010, 05.23am IST

What is the role played by primary dealers in auctions?

ET in the Classroom: Asset-liability mismatch

ET Bureau May 6, 2010, 05.24am IST

ET in the classroom: Offshore Banking Unit

ET Bureau Jun 1, 2010, 03.02am IST

ET in the classroom: Exchange Traded Funds

ET Bureau Jun 2, 2010, 03.34am IST

ET in the classroom: China's yuan move

ET Bureau Jun 23, 2010, 03.08am IST

Conceptually, a stronger yuan should erode competitiveness of China's

ET in the classroom: RBIs key policy rates

ET Bureau Jul 6, 2010, 02.41am IST

ET in the classroom: Lifestyle Inflation

ET Bureau Jul 7, 2010, 01.18am IST

ET in the classroom: Clash over ULIPs

ET Bureau Jul 15, 2010, 05.15am IST

ET in the classroom: All about rate corridor

ET Bureau Jul 29, 2010, 02.54am IST

ET in the classroom: Compulsory licencing

ET Bureau Aug 26, 2010, 04.42am IST

ET in the classroom: Overnight Indexed Swap

ET Bureau Sep 28, 2010, 05.12am IST

What purpose does the OIS-Libor credit spread serve?

ET in the Classroom: Current account deficit

ET Bureau Sep 30, 2010, 03.34am IST

India's current account deficit is expected to widen to 3% of GDP in the

ET in the Classroom: Real and nominal exchange rates

ET Bureau Oct 7, 2010, 07.20am IST

ET in the Classroom: Currency War

ET Bureau Oct 12, 2010, 05.26am IST

Depression era when major economies devalued their currencies as a part of

ET in the Classroom: Corporate hedging

ET Bureau Oct 26, 2010, 06.50am IST

would yield a different value on conversion, depending on the way currency

ET in the Classroom: GDP Figures

ET Bureau Nov 25, 2010, 05.37am IST

intermediate goods is already included in the final goods or service. It is a

ET in the classroom: PIGS economies

ET Bureau Nov 30, 2010, 05.53am IST