Issue 45

22 Feb, 2013
Weekly
nd

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BFS Roundup @ FLIP

The week that was.

Capping diesel, LPG doles could cut govt

burden 40%
Phased decontrol of diesel prices and capping
of subsidised LPG (or cooking gas) cylinders
are likely to reduce the petroleum subsidy by a
little over 40 per cent in 2013-14.
Though politically risky, the cut of
approximately Rs 60,000 crore will be handy
for a government burdened by a high fiscal
deficit. The` govt. paid Rs 68,481 crore as
subsidy to its three oil marketing companies
(OMCs), in FY 2011-12.
Government companies (which also bear part
of the subsidy burden) want a share in the
benefit from reduction in subsidy
FLIPs View: If executed to its entirety in an
election year, will be a huge boost to the
country's financial position. Given the trade
union backlash, one needs to see if the
government can stick to its stand.
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Indian bonds hit 30-month peak; no

supply until March end
India's benchmark bond rose to its highest
level in two-and-a-half years after the
government cancelled the last scheduled debt
sale for the current fiscal year.
The finance minister has said he aims to
contain the fiscal deficit for the current fiscal
year ending March 31 at 5.3% of the GDP and
cut it to 4.8% in the next. The cancellation of
the 120 billion rupee debt auction scheduled
for this week comes after the government
already announced several spending cuts and
accelerated its stake sales to meet the deficit
target, building up its cash position.
Bond markets have rallied since late December
s government would maintain fiscal
on hopes the
discipline and on expectations of interest rate
cuts from the Reserve Bank of India.

Types of Banks
Banks act as a backbone to a countrys
financial system. You must have seen and
heard about various banks operating in India
like State Bank of India, Citibank, ICICI Bank,
Saraswat Co-operative Bank etc.
Ever wondered, are they all the same? Lets
understand how they are different from one
another.
Public Sector Banks: These are the banks
where the government holds more than 50%
stake. Hence, they are driven more by a larger
social objective, than just profitability.
They have a very large network of branches,
and you will find some of them in very remote
areas as well. Some examples here would be
State Bank of India, Punjab National Bank,
Canara Bank etc.
Currently there are 21 public sector banks
operating in India. All these banks are
governed by RBI regulations, like any other
bank. They have a huge deposit base, given
their number of branches.
Private Sector Banks: These are banks
where the majority stake lies with private
shareholders. . They tend to be more
aggressive; some have a large branch
network, and are more driven by profitability.
Some examples here would be ICICI Bank,
HDFC Bank, Axis Bank etc. Currently there are
22 private sector banks operating in India. All
these banks are also governed by the same
RBI regulations.

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FLIPs View: Here again, THE FM has mde
these statements repeatedly. However, we feel
that if the deficit is being cotrolled by reducing
planned expenditure that can be detrimental to
growth. If some social welfare schemes are
being scrapped, that dents the aam aadmi
image of the govt. So, one has to see the
coming budget, to check the sustainability of
the fiscal consolidation. That would decide if
the bond market continues to rally.

BFS Roundup @ FLIP

Interesting to Know?

Term of the Week

Repo Rate and Reverse Repo Rate

RBI cuts repo rate, loans may get

cheaper
India's central bank reduced its policy interest rate by
a widely expected 25 basis points on Tuesday,
taking comfort from cooling inflation as it made the first cut in nine months to support an economy
headed for its slowest growth in a decade. Subsequently, the reverse repo rate fell to 6.75 percent.

We regularly read in the news that the RBI controls money supply in the economy by
changing the policy rates - repo rate, reverse repo rate etc. Let us understand these terms
and how they work.

Repo Rate What is it?

When banks face shortage of funds, they can borrow from RBI to meet the gap. The rate at
which RBI lends to the bank is called the repo rate. This is a short-term lending rate the
funds are lent/borrowed for one day.
How does it work?
The bank sells a certain amount of government securities to RBI, with an agreement to
repurchase (hence the term repo) them the next day at a price, that reflects the amount of
interest for one day.
Example: HDFC bank sells INR 100 million of govt. securities to RBI at market value (say the
security is trading at INR 105). Considering the current repo rate (i.e. 7.75%), HDFC Bank will
repurchase the securities from RBI at 105.22. This will include the interest amount of
(105*(1+0.0775* 1/365= INR 0.22 million)

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BFS Roundup @ FLIP

Term of the week (contd.)

Reverse Repo Rate What is it?

It is just the opposite of repo. Its the interest rate at which banks lend money to RBI.
Considering the previous example, HDFC Bank will buy INR 100 million of government
securities from RBI at INR 105 and sell it to RBI at INR 105.02 (105*(1+0.0675*1/365)).
Currently, Reverse Repo Rate is 6.75%.

How do they help in controlling money supply?

Banks decide the lending rate basis its cost of funds and margin. When RBI increases the repo
rate and reverse repo rate, banks cost of funds increases (as now banks will have to pay more
to RBI for borrowing). Banks transfer this cost to its customers by increasing the lending rate.
This discourages borrowing/credit growth, and thereby money supply.
Further, an increase in repo rate, would also result in increase in deposit rates. This acts as an
incentive for customers to park their funds with banks, further reducing the money supply.

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