The Economic Times - ET in The Classroom - Archives - 2 (Economics Concepts Explained) - INSIGHTS PDF

10/3/13
The Economic Times -ET In The Classroom Archives 2 (Economics Concepts Explained) | INSIGHTS
INSIGHTS
JULY 1 8 , 2 0 1 3 9 :3 7 A M
The Economic Times -ET In The Classroom Archiv (Economics Concepts Explained)
Archiv es -1 Archiv es -2 archiv es 3 Archiv es 4 Archiv es 5
The Econom ic Tim es newspaper now and then publishes articles on current econom ic issues in a question and an the heading ET In The Classroom . They are sim ple to understand and rem em ber.
Many tough concepts are beautifully explained by the ET team in these articles. All these articles are freely av ai
They are the property of theEconom ic Tim es. I hav e just consolidated all of them here for the benefit of the reade
For an IAS aspirant preparing for the UPSC civ il serv ice exam ination, ET in t he Classroom is a one-stop solutio acquainted with m any econom ic jargon and concepts. This is part -2 of the archiv es. Read and spread the knowledge. Click here for Archiv es-1
ET in the classroom: Quantitative Easing II

What is quant it at ive easing II? The term becam e fashionable post the global econom ic crisis in 2 008, following which m ost gov ernm ents across
pum p in huge am ount of liquidity in the m arkets to tide ov er the crisis. Quantitativ e easing is the process of infu
the sy stem by creating new m oney and ev entually buy ing financial assets like bonds and corporate debt from fi essentially is to m ake adequate m oney in the sy stem to spur consum ption dem and in any econom y .
institutions in the country . This is done by central banks through what is popularly known as open m arket opera
Quantitativ e easing II is the popular phrase used in the context of Am erican econom y these day s as the US Federa touted to go for another round of quantitativ e easing to consolidate the recov ery of the Am erican econom y , whic
because of fundam ental reasons such as lower consum ption and job losses and escape of capital to other econom ies What does it mean for India?
Quantitativ e easing II could flood em erging econom ies with the dollars, thus m aking the dollars cheaper and, hen
com petitiv e while forcing other related currencies to appreciate on account of increase in capital inflows. There i
Federal Reserv e chairm an Ben Bernanke will push for a fresh infusion of about a trillion dollars into the m arkets
of buy ing bonds, which will push up bond prices and bring down the y ields, and the bond m arkets in India would Since econom ies like China and Singapore hav e closed doors, or are at best cautious in their regulation of capital regulatory authorities.
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to see a gush of capital flows, which is likely to push up the stock prices, and m ight ev entually call for capital con
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What are economist s say ing?
The expert opinion is m ixed on this. Nobel Laureate Paul Krugm an, who has been a v ehem ent critic of US policies
fav ouring QE II. Higher com m odity prices will hurt the recov ery only if they rise in real term s, he said. And the he said in a recent m edia interv iew.
nom inal term s if QE succeeds in raising real dem and. And this will happen only if QE II is successful in helping ec
Another Nobel prize winner, Joseph Stiglitz, who was form erly the chief econom ist with World Bank, feels that th econom ic policy is the interest rate, and if one just gets it right, one can steer this. That didnt work. It forgot about the financial fragility and how the banking sy stem operates. They re thinking the interest rate is
adv ocates are falling into the sam e trap that led us into the crisis in the first place. Their v iew is that the m ajor l
and by setting that dial, y ou can regulate the econom y . In fact, it operates prim arily through the banking sy stem this situation.
sy stem is not functioning well. All the literature about how the m onetary policy operates in norm al tim es is pret
Nouriel Roubini, who gained fam e after his prediction of the global econom ic crisis of 2 008, thinks further quant his v iew, is an indirect m anipulation of the exchange rate.
hav e little effect on the US growth in 2 01 1 . He regards QE II as the wrong way to go. An excessiv e, perm anent in
ET in a Classroom: Beggar Thy Neighbour Policy

What is beggar t hy neighbour policy ?
The beggar thy neighbour policy refers to a policy that aim s at addressing ones own dom estic problem s at the ex trading partners in particular. What are t he inst ances of such a policy ?
The m ost popular form s of a beggar thy neighbour policy are in the areas of foreign trade and currency m anagem globalisation, such practices are not popular. But to achiev e its dom estic policy objectiv e, for instance, encouraging exports, central banks dev alue or encoura
Conv entionally , countries often im pose tariff barriers and restrict im ports to protect their dom estic industries. H
of their own currencies com pared to its trading partners to retain their respectiv e com petitiv e edge. Som etim es e
in encouraging appreciation of their currencies to tam e inflation at the expense of hurting incom e in the exportin Is China adopt ing a beggar t hy neighbour policy ?
Many econom ists, especially in the US, say China has deliberately kept the v alue of its currency low to forge ahe im ports are hurting its dom estic econom y . How do current economies policies compare?
in this case, m ore than the com petitors, the im porting country , US, is com plaining because m ore than any thing
Currently , the raging concern am ong m ost em erging m arket econom ies in Aisa is spiralling inflation on account com m odity prices. Central banks in m ost econom ies, including Indias, are (though not necessarily planned) enc appreciation of their respectiv e currencies.
This is helping them curtail inflation arising out of im ported goods as im posing tariff barriers is perceiv ed to be a also depends on how crucial such exports are for each econom y .
principles of free trade. Such a practice hurts export earnings of the countries from where such im ports are sourc
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What are t he limit at ions of such a pract ice?
In certain cases, such a policy m ay prov e counter productiv e. If, for instance, ev en the com peting country count
m ov e, of say , depreciation (to protect exports) then such a practice m ay not hav e desirable results, especially the through higher im port price and resulting in inflation in such econom ies.
are not price elastic (the im ports are essential and not dependent on prices) and instead could end up hurting the
ET in the classroom: Systematic Transfer Plan

What is STP?
Mutual funds not only m anage our m oney but also offer us v arious easy to use tools that are aim ed at im prov ing experience.
Most of us know sy stem atic inv estm ent plan, where we inv est at regular interv als. But few are aware of sy stem a (STP).
Under STP, at regular interv als, an am ount y ou opt for is transferred from one m utual fund schem e to another o Ty pically , a m inim um of six such transfers are to be agreed on by inv estors. You can get into a weekly , m onthly or a quarterly transfer plan, as per y our needs. You m ay choose to transfer a fixed sum from one schem e to another. The m utual fund will reduce the num ber of
am ount y ou hav e specified from the schem e y ou intend to transfer m oney . At the sam e tim e, the am ount such tr transfer only the capital appreciation to be transferred at regular interv als. How is it useful?
utilised to buy the units of the schem e y ou intend to transfer m oney into, at the applicable NAV. Som e fund hous
STP is a useful tool to take a step by step exposure into equities or to reduce exposure ov er a period of tim e. Say y o
to inv est in equity ov er a period of tim e. You could put this am ount in the liquid fund of a m utual fund or a short pre-determ ined am ount will be inv ested into an equity fund. This helps in deploy ing funds at regular interv als i m inim um tim ing risk.
This giv es an opportunity to earn a better than sav ing bank account rate of return. You than start an STP where
ET in the classroom: RBIs key policy rates

ET guides you through the key policy rates of the Reserve Bank of I ndia What are t he key policy rat es used by RBI t o influence int erest rat es?
The key policy or signalling rates include the bank rate, the repo rate, the rev erse repo rate, the cash reserv e ra
statutory liquidity ratio (SLR). RBI increases its key policy rates when there is greater v olum e of m oney in the ec crunch or recession, RBI would lower its key policy rates to inject m ore m oney into the econom ic sy stem . What is repo rat e?
words, when too m uch m oney is chasing the sam e or lesser quantity of goods and serv ices. Conv ersely , when the
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Repo rate, or repurchase rate, is the rate at which RBI lends to banks for short periods. This is done by RBI buy ing
from banks with an agreem ent to sell them back at a fixed rate. If the RBI wants to m ake it m ore expensiv e for ba current repo rate is 5.50%. What is reverse repo rat e?
m oney , it increases the repo rate. Sim ilarly , if it wants to m ake it cheaper for banks to borrow m oney , it reduces
Rev erse repo rate is the rate of interest at which the RBI borrows funds from other banks in the short term . Like t facility to deposit their short-term excess funds with the RBI and earn interest on it. RBI can reduce liquidity in t pushes up interest rates. What is Cash Reserve rat io? Cash reserv e Ratio (CRR) is the am ount of funds that banks hav e to park with RBI. If RBI decides to increase the c
by RBI selling gov ernm ent bonds to banks with the com m itm ent to buy them back at a future date. The banks us
by increasing the rate at which it borrows from banks. Hiking the repo and rev erse repo rate ends up reducing th
the av ailable am ount with banks would reduce. The bank increases CRR to im pound surplus liquidity . CRR serv e
One, it ensures that a portion of bank deposits are alway s av ailable to m eet withdrawal dem and, and secondly , it
control liquidity in the sy stem , and thereby , inflation by ty ing their hands in lending m oney . The current CRR i What is SLR? (St at ut ory Liquidit y Rat io)
Apart from keeping a portion of deposits with RBI as cash, banks are also required to m aintain a m inim um percen m inim um percentage is called Statutory Liquidity Ratio. The current SLR is 2 5%. In tim es of high growth, an in requirem ent reduces lendable resources of banks and pushes up interest rates. What is t he bank rat e?
with them at the end of ev ery business day , in the form of gold, cash, gov ernm ent bonds or other approv ed secur
Unlike other policy rates, the bank rate is purely a signalling rate and m ost interest rates are delinked from the b
bank rate is the indicativ e rate at which RBI lends m oney to other banks (or financial institutions) The bank rate
banks long-term outlook on interest rates. If the bank rate m ov es up, long-term interest rates also tend to m ov e u
ET in a Classroom: Currency Peg

As China and the US tussle over the value of the Yuan, ET helps you deconstruct the issue. What is a currency peg?
There are v arious way s in which the price of one currency against another is arriv ed at. In a pegged exchange ra
currency is fixed with respect to another currency , usually the US dollar. In other words, it is the rate the countr
bank of the country m aintains as the official exchange rate. Chinese currency , for exam ple, is pegged at 6 .83 y u How is t he currency peg maint ained?
Currency pegs work only when the central bank has the m uscle to interv ene in the m arket to check the currency
bey ond a perm issible band. It should be able to supply the m arket with enough dollars in the ev ent of a huge dem foreign exchange reserv es. China has foreign currency reserv es of nearly $2 .5 trillion. How does a currency peg help ?
rate and in the ev ent of too m uch supply be ready to buy dollars from the m arket. It im plies that the central ban
Countries go for a pegged exchange rate to hav e stability in the foreign exchange m arket. China had also effectiv peg in July 2 008 keeping its currency steady at 6 .83 y uan to a dollar as it fought the global econom ic crisis.
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The stable currency creates a conduciv e env ironm ent for inv estm ents as inv estors do not fear losses on account o
fluctuations. Exports benefit as appreciation is kept in check. Howev er, there are num erous instances of currency
financial crises. Pegged v alues are difficult to m aintain if the central bank is not in position to interv ene and defe Why is t he US so bot hered about t he currency peg? The US believ es that China accum ulates its huge current account surplus (to the tune of 8% of GDP) and the US,
deficit (to the tune of 2 .9 % of GDP) because its currency is underv alued, m aking its exports to the US cheap and i
US expensiv e. The US blam es the pegged y uan for the resultant global im balance, and want the y uan to apprecia A bit of hist ory From 1 9 9 7 to m id-July 2 005, Chinese currency was pegged to the US dollar. On 2 1 July 2 005, China ended the
and switched to a crawling peg linked to a basket of currencies. The renm inbi gradually appreciated ov er 2 0% ov dollar with a plus/m inus 0.5% fluctuation.
y ears. In July 2 008, China went back to the dollar peg, bringing the Yuan appreciation to an end. Yuan is now v
ET in the classroom: Quantitative easing
The US seem s ready for another round of quantitativ e easing to boost growth, em ploy m ent generation and consu There is consensus am ong econom ists and policy m akers in the worlds largest econom y that the Federal Reserv e higher lev el of inflation to spur growth. ET takes a look at the concept of quantitativ e easing. What is quant it at ive easing?
Central banks usually stim ulate a slowing econom y by cutting interest rates, which encourage people to spend b
or discouraging them to sav e. But with interest rates in the dev eloped world already close to zero, that option is n
In such situations , the central banks resort to pum ping m oney directly into the econom y , a process known as qu dev eloped countries used quantitativ e easing to spur growth in the afterm ath of the financial m eltdown of 2 008 What is t he idea behind quant it at ive easing?
It is done by buy ing bonds usually gov ernm ent paper but can also be priv ate bonds from banks and financia
At any giv en point of tim e there is a fixed am ount currency /m oney chasing products and serv ices av ailable in t quantitativ e easing, the bondsellers will receiv e m oney that has not been in circulation, which will increase the the sy stem . As the m oney in the econom y increases the dem and for different products rises. How does it help?
idea essentially is to get m ore m oney into the sy stem chasing the sam e am ount of produce to driv e up their price
The flood of cheap m oney causes asset prices to rise i.e. the price of shares, real estate etc. The notional high wealt cheap and easy credit, encourages people to spend. Quantitativ e easing also helps dev alue the currency , thereby ram ping up of production, which, in turn, creates m ore jobs in the econom y . Why is it import ant in t he current scenario?
exports further and increasing the lev el of activ ity in the econom y . The final consequence is increased dem and r
Quantitativ e easing could potentially ward off deflationary expectations and kickstart an uncertain econom y . Bu
globalised world, cheap m oney from dev eloped econom ies m ay flow into em erging econom ies and fuel asset bubb
there. Brazil has been struggling to deal with the rising tide of inflows . India, too, is keeping an ey e on increasing
ET in a Classroom: Stock Valuation

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What are t he various analy t ical approaches for valuat ion of st ocks?
For inv esting, an inv estor can use an approach based on either fundam ental analy sis, technical analy sis or quan What is Fundament al Analy sis?
It is the process of looking at a com pany s business from an inv estm ent point of v iew. The process inv olv es analy s m anagem ent capabilities, its com petitiv e adv antages, its com petitors and the m arkets it functions in.
As part of the analy sis, y ou would look at exam ining key financial ratios like the net profit m argins, operating m per share and so on.
After exam ining the key ratios of a business, one can com e at a conclusion about the financial health of a stock an
v alue of the stock. It further focuses prim arily on the v aluation of a com pany and its relationship with the curre
Com bining all this, the analy st arriv es at a v aluation for a stock. Fundam ental analy sts believ e that it is possible true v alue of a com pany using these financial v aluation m ethodologies. If the share price is trading below the v alue arriv ed at by a fundam ental analy st, inv estors should buy the stock inv estors should sell. What is Technical Analy sis?
the share price rising to the true v alue in the future. Conv ersely , if the share price is higher than the estim ated t
This technique focuses on the past to predict the v alue of the future, using share prices and v olum es traded in a s share price.
look at fundam entals or financial results at all. Technical analy sts believ e that all inform ation about a com pany
According to them , share price behav iour is repetitiv e in nature and hence can be used to predict future share pr
Based on historical share price data of a com pany , technical analy sts identify share price lev els that act as suppo
They try to identify support, resistance and breakout lev els for stocks. Technical analy sts also use v arious techni chart patterns to help them determ ine probable future share price m ov em ents. What is quant it at ive analy sis?
With the adv ent of com puters, a third ty pe, nam ely quantitativ e analy sis, has com e up. Quantitativ e analy sis s behav iour by using com plex m athem atical and statistical m odelling, m easurem ent and research. It is a process v alue of a security by exam ining its num erical, m easurable characteristics like sales, earnings and profit m argi
Pure quantitativ e analy sts look only at num bers with alm ost no regard for the underly ing business. Although ev
analy sis look at num bers from a balance sheet, their prim ary focus is alway s the underly ing business, the env iro sell decisions. Which is t he best ?
the com pany is operating and so on. Quantitativ e analy sts create m athem atical algorithm s, which help them ar
The different analy tical tools hav e different uses. For instance, fundam ental analy sis could be used to identify co possibility of strong earnings growth in the future. Technical analy sis could be used to decide when to buy this stock. When y ou com bine technical and fundam enta
called techno-fundam ental research. Depending upon y our sty le and tim e fram e of inv estm ent y ou could choose
ET in the classroom: Care for a Dim Sum?

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Chinas growing affluence and influence ov er the world econom y has created huge dem and for assets denom inate
basic unit of the renm inbi. China is also keen to globalise its currency to offset any losses to its record foreign exch
to weakness of the dollar. This has led to the creation of the Dim Sum bond m arket in Hong Kong. ET explains the What Is A Dim Sum Bond? A bond denom inated in y uan and issued in Hong Kong. Deriv ed from a traditional Chinese cuisine that offers a v Dim Sum bonds are issued by Chinese gov ernm ent and com panies as well as foreign entities. What Makes Dim Sum Bonds At t ract ive For Invest ors?
Inv estors across the world are looking for opportunities to m ake m oney out of Chinas phenom enal growth, but th
capital controls prohibit them from inv esting in Chinese debt. Dim Sum bonds offer an av enue to such inv estors. denom inated assets also prov ides an alternativ e to bonds issued by western gov ernm ents and com panies and fits Principle of Div ersification, that a portfolio containing different assets and kinds of assets carries lower risk. Lower interest cost is also encouraging com panies to raise m oney through the Dim Sum m arket. Last m onth, first issuer of Dim Sum bonds from India. It sold 6 50 m illion y uan ($1 02 m illion) of three-y ear bonds priced at a 4 .5% per annum . The bank said it cut a percentage point off its dollar funding costs by going to the Dim Sum m a infrastructure lender IL&FS is also planning to raise $1 00 m illion through y uandenom inated bonds. Is There A Limit On Such Issuances By Indian Ent it ies?
rushing to the Dim Sum m arket on expectations that Beijing will continue to let the y uan appreciate. Exposure t
Recently , the y uan was added to the list of currencies in which Indian com panies can raise funds ov erseas, in add euro, pound and y en. Indian firm s can raise an equiv alent of $1 billion in y uan. How Big Is t he Dim Sum Bond Market ?
The Dim Sum m arket has risen from 1 0 billion y uan in 2 007 to m ore than 1 00 billion y uan. Analy sts forecast th bey ond 3 00 billion y uan in 2 01 2 . Where can Indian Issuers deploy The Proceeds? Indian issuers can deploy the m oney for capital expenditure within China and use the proceeds for settling trade also enter into swap contracts to get other currencies. Howev er, if the m oney is to be brought back to India com ply with the External Com m ercial Borrowing guidelines set by the Reserv e Bank of India.
ET in the classroom: The A-Z of 4G technology

What is LTE?
LTE, or Long Term Ev olution , is the latest wireless m obile broadband technology that will power future 4 G, or f
networks designed prim arily for data transm ission at unprecedented speeds. It uses spectrum to carry data traffi
roads to carry v ehicular traffic. Spectrum m ay be likened to a highway of airwav es on which m obile signals trav
Since LTE uses wider chunks of spectrum , data speeds on LTEbased 4 G networks are nearly four tim es faster than
user, for instance, will be able to watch v ideos at LTE speeds of 3 00 Mbps while a laptop user will be able to downl So a 3 G operator can easily upgrade his network to LTE. WHEN WAS IT DEVELOPED?
2 5MB file in seconds if adequate spectrum is av ailable. LTE is also a scalable bandwidth technology that works al
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LTEs genesis goes back to Nov em ber 2 004 , when a workshop was held by the 3 GPP (3 rd Generation Partnership m obile tech after UMTS, the 3 G technology based on GSM. IS LTE BETTER THAN WiMAX?
to define Long Term Ev olution . The 3 GPP was a global alliance of top telecom associations who tried to identify t
Wireless com m unication happens ov er paired or unpaired spectrum . Paired spectrum is two equal chunks of airw
and receiv ing inform ation while unpaired spectrum is a single strip of airwav es m eant to either receiv e or send i
Voice signals trav el ov er paired spectrum while data com m unications works better on unpaired spectrum as peo the WiMAXparty crashed when an LTE v ariant, TDD-LTE which also worked ov er unpaired spectrum arriv
than upload. WiMAXhad an edge as long as it was the sole wireless technology working com m ercially ov er unpai
Whats m ore, leading v endors unv eiled com patible gear com m ercially in 2 01 0. This LTE v ariant was heralded b telcos as the coolest technology for highspeed data com m unications on the go. WiMAXsuffered a body blow when China, India and the US also em braced TDD-LTE . Com m ercialisation of TDD-LTE dev ices hit fast-track after Qualcom m pitched for wireless broadband spectrum auction and won 2 0MHz of BWA airwav es in four circles. Ev en WiMAXbackers like Clearwire in the US and Yota up to LTE. Ditto with WiMAXgear v endors like Nokia and Cisco. IS TDD-LTE CATCHING ON IN INDIA?
Not as y et. But that said, the first seeds of an LTE ecosy stem were sown when Bharti Airtel joined som e of the wor technology was in fact at the heart of last y ears auction of BWA airwav es in India. But the big challenge to fast-track deploy m ent of TD-LTE in India is the paucity of com patible dev ices and Qualcom m has launched TDD-LTE m ulti-m ode dev ices. NSN is slated to unv eil 4 G dev ices by the tim e LTE netw happening in India by Decem ber 1 1 to early -2 01 2 .
backers at Mobile World Congress 2 01 1 in Barcelona to launch the Global TD-LTE Initiativ e (GTI). Global deploy m
ET in the classroom: Offshore Banking Unit

What is offshore banking unit ?
Offshore banking unit (OBU) is the branch of an Indian bank located in a special econom ic zone (SEZ), with a spec
aim ed at facilitating exports from the region. As laws define it, its a deem ed foreign branch of the parent bank
India, and it undertakes international banking business inv olv ing foreign currency denom inated assets and liab
The concept com es from the practice prev alent in sev eral global financial centres. Here an OBU can accept foreig business but not dom estic deposits from local residents. This was conceiv ed to prev ent com petition between local banking sectors. What was t he need for OBUs?
In addition to prov iding power, tax and other incentiv es to SEZs, policy m akers felt a need to prov ide SEZ dev elop These would be exem pt from CRR, SLR and few other regulatory requirem ents.
m oney m arkets at international rates. So in 2 002 , RBI instituted OBUs, which would be v irtually foreign branch
RBI regulations m ake it m andatory for OBUs to deal in foreign exchange, source their foreign currency funds ext m onetary controls of the country . What price, freedom from regulat ions?
prudential norm s applicable to ov erseas branches and are entitled for IT exem ptions. Thus in m any respects, the
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In the eight y ears that they hav e been operational, concerns hav e been raised that, funding by OBUs to SEZs wou in external debt of India. Also, som e hav e suggested that OBUs as v ehicles for extending dollar loans hav e no use 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 som e arbitrage adv Any way s, ground realities could not be m ore different. Hardly a handful of banks hav e set up their OBUs, so the v ery far fetched. SEZ, itself as a concept has been struggling, giv en the issues that SEZ dev elopers hav e faced ov er acquiring land What is t he fut ure of OBUs?
Most international financial centres still house OBUs, so say ing they are not required m ay be incorrect. Howev er hav e said OBUs are losing relev ance at a tim e of increasing globalisation. They say OBUs will be of no use after the econom y opens up fully and the rupee is fully conv ertible. These expert two OBUs, instead of hav ing sev eral of them spread across the country .
ET In The Classroom: Public Debt Office

What is a public debt office?
A public debt office or a debt m anagem ent office is an autonom ous gov ernm ent agency which acts as the inv estm gov ernm ent and raises capital from the m arkets for the gov ernm ent.
It form ulates the borrowing calendar for the gov ernm ent and decides upon the m aturities of the securities to be i m onetary policy or setting interest rates.
the gov ernm ent. A public debt office works separately from the central bank and has nothing to do with the form
What are t he conflict s of int erest s if t he body t hat formulat es t he monet ary policy also act s as t he C invest ment banker?
There are certain inherent conflicts of interest when the agency , which raises funds for the gov ernm ent, also m a gov ernm ent securities.
policy and regulates interest rates. The basic conflict of interest is between setting the short-term interest rates a
The Reserv e Bank of India, like a good m erchant banker to the gov ernm ent, sells bonds at high prices. At lower in y ields, it runs the risk of adding to inflationary concerns.
Another area of concern is that RBI is also the regulator of all banks, which m eans the central bank could arm -tw buy bonds at higher prices or for longer tenors.
For a v ery long tim e now, econom ists hav e been arguing in fav our of an independent debt m anagem ent office, w of being the Centres inv estm ent banker.
discourse is called National treasury m anagem ent agency or debt m anagem ent agency , so that RBI can be rel
What is t he pract ice in advanced economies?
Dev eloped econom ies such as the UK, the US and New Zealand, already hav e independent public debt offices in pl gov ernors hav e tim e and again com plained about the difficulties in m anaging gov ernm ent debt while try ing to high to rein in inflation. Does India have a debt management office?
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The finance m inistry had proposed setting up of the debt m anagem ent agency in its 2 007 -08 Budget. A series of secretary Vijay Kelkar, form er World Banker Percy Mistry and ex-IMF chief econom ist Raghuram Rajan. A draft legislation had also been created by the Jahangir Aziz Working Group. While presenting the Budget for 2 office in the next financial y ear. How is it expect ed t o be st ruct ured?
hav e recom m ended the establishm ent of the debt m anagem ent agency . These include groups headed by the form
m inister Pranab Mukherjee had announced the gov ernm ents intention to introduce the bill for an autonom ous d
The agency is likely to be an autonom ous body under the adm inistrativ e control of the finance m inistry . The cen on the m anagem ent com m ittee of the agency . A m iddle office or MoF is already working in the finance m inistry borrowing calendar of the Centre.
A m id-office would constitute a single com prehensiv e database about all liabilities and guarantees of the gov ernm discussed and reworked on for three y ears now but little sense of urgency has been seen. .
now, the 2 1 public debt offices of RBI continue to function. The structure and functions of the debt m anagem ent o
ET in the Classroom: Non-competitive bidder

What is non-compet it ive bidding in dat ed government securit ies?
The Gov ernm ent of India conducts periodic auctions of gov ernm ent securities and of the total am ount notified for portion is kept aside for the non-com petitiv e bidder, or the sm all and m edium inv estors.
Non-com petitiv e bidding m eans a person would be able to participate in the auctions of dated gov ernm ent securi
to quote the y ield or price in the bid. That sav es him the worry , about whether the bid will be on or off-the-m ark. How is t he process useful?
It helps deepen the gov ernm ent bonds m arket by encouraging wider participation and retail holding of gov ernm participate in auctions. RBI giv es such inv estors a fair chance of assured allotm ents of gov ernm ent securities. Who can be referred t o as t he non-compet it ive bidder? RBI allows indiv iduals or firm s, prov ident funds, corporate bodies or trusts who do not hav e current account (CA general ledger (SGL) account with the Reserv e Bank of India. Regional Rural Banks (RRBs) and Urban Co-operati can also apply under the non-com petitiv e bidding schem e.
enables the participation of indiv iduals, firm s and other m id-segm ent inv estors who neither hav e the expertise n
Eligible inv estors hav e to place their bid through a bank or Prim ary Dealer (PD) for auction. Each bank or PD, on orders, subm its a single bid for the total sum of non-com petitiv e bids on the day of the auction. The bank or PD will furnish details of indiv idual custom ers, v iz., nam e, am ount, etc., along with the application com petitiv e bidding facility is av ailable only in dated central gov ernm ent securities and not in treasury bills.
What happens if t he t ot al amount offered for bidding via non-compet it ive bidding basis exceeds t he allot t ed?
In case the am ount bid by PDs on behalf of the inv estors is m ore than the reserv ed am ount through non-com petit is Rs 1 5 crore.
allotm ent would be m ade on a pro-rata basis. For exam ple, the am ount reserv ed for allotm ent in an auction in no
The total am ount of bids for noncom petitiv e segm ent is Rs 2 0 crore. The partial allotm ent percentage is = 1 5/2 0= bank or PD, who has subm itted non-com petitiv e bids receiv ed from eligible inv estors will get 7 5% of the total am
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ET in the classroom: Potential growth rate
The countrys policymakers seem to be fighting a losing battle with I nflation. Some economists link the persistently hig of economic growth. They say I ndian economy is expanding at a rate beyond its potential growth rate. ET examines relationship with prices: What is t he pot ent ial rat e of growt h of an economy ?
Potential output is broadly the m axim um output growth that an econom y can sustain ov er the m edium to long t 7 -8%. What fact ors decide t he pot ent ial growt h rat e?
stoking inflation. In a recent report on India, the International Monetary Fund (IMF) estim ates Indias potential g
There are two m ajor determ inants of the potential rate at which an econom y can grow in the long run. One is th in determ ining the potential growth rate.
key inputs such as labour and capital, while the other is the rise in productiv ity . Within the two key inputs, labo
The increase in labour supply through an increase in num ber of workers or the num bers of hours put by a giv e
workers and an increase in labour productiv ity will result in an increase in the long-term potential growth rat Any thing that aids productiv ity increases can help boost potential growth rate. Infrastructure inv estm ents and can raise Indias potential growth rate because the country has am ple labour supply . How does growing fast er t han t he pot ent ial rat e cause inflat ion? The ov erall dem and in the econom y picks up due to fast growth and m ore resources are used to m eet higher dem the econom y m ay not find enough inputs to m eet the dem and, leading to an increase in prices.
If there is surplus capacity in the econom y then it can grow abov e the potential rate for a while. But for an econo working at full capacity , excessiv e dem and results in increase in the price lev el.
The IMF say s India was growing at a rate faster than its potential rate in 2 007 -08, but because of the financial cr high inflation if the Indian econom y grows too fast.
substantial slack em erged in econom y . It say s the quick rebound from the crisis has exhausted that slack and now
ET in a classroom: How are poverty numbers calculated
Widespread poverty is the biggest challenge for I ndias policymakers. The government has drawn criticism for its inab numbers are generated: How is t he povert y line defined?
menace despite high economic growth. Some estimates place the number of poor at 40% of the population. ET looks a
The concept of pov erty is associated with socially perceiv ed depriv ation with respect to basic hum an needs. Histo was calculated on this basis. The existing rural and urban official pov erty lines were originally defined in term s
followed a pov erty line, which is based on a m inim um num ber of calories that an indiv idual should consum e and
consum er expenditure (PCTE) at 1 9 7 3 -7 4 m arket prices and is adjusted ov er tim e and across states for changes i
The m ethod still retains the original 1 9 7 3 -7 4 all-India reference pov erty line baskets (PLB) of goods and serv ices People whose PCTE is below the required m inim um are considered to be below the pov erty line.
deriv ed separately for rural and urban areas, anchored in per capita calorie norm s of 2 4 00 (rural) and 2 1 00 (ur
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What is t he int ernat ional povert y line?
The com m on international pov erty line is based on an incom e of around $1 a day . In 2 008, the World Bank rev is $1 .2 5 at the 2 005 purchasing power parity . What is t he new way t o define t he poor? As the earlier estim ates of pov erty hav e been largely perceiv ed as inadequate, a com m ittee led by Suresh Tendu
a new way to define the poor. Tendulkar m ov ed away from calorie anchor while testing the adequacy of actual fo
The m ethod uses sam e consum ption basket for rural and urban poor, but applies different price lev els of rural an and education. Does India need t o redefine poor?
arriv e at the pov erty estim ate. The m ajor departure from the original m ethod is the prov ision for including expe
With India hitting a high growth trajectory , the liv ing standards and consum ption patterns in both urban and r
changed, while existing data continues to use consum ption baskets that reflect trends prev alent in 1 9 7 3 -7 4 . Ear
m echanism s also assum ed that basic social serv ices like health and education would be supplied by the state, the then. ..
were cov ered in base y ear 1 9 7 3 -7 4 , no account was taken for the change in the proportion of expenditure in thes
ET in the Classroom: Competition

Why is compet it ion import ant ? What is it s economic rat ionale?
Com petition, according to econom ic theory , forces firm s to dev elop new products, serv ices and technologies which causes product prices to drop below the lev el that would be if there were no com petition; that is, if there was just (m onopoly ) or a few firm s (oligopoly ). How is compet it ion measured?
consum ers greater choice and better products. If m ore and m ore firm s deal in a sim ilar product, consum er choice
Com petition is generally m easured by calculating concentration ratios . Concentration ratios indicate whether a the N-firm concentration ratio. Herfindahl Hirschman Index:
of a few large firm s or m any sm all firm s. Two of the m ost com m only used m etrics are the Herfindahl Hirschm an
Under the HHI, the m arket share of each firm in a relev ant sector is squared and added to arriv e at a statistical m
concentration. The v alue of the index v aries from close to 0, indicating nearly perfect com petition, to 1 0,000, in from close to zero to 1 00). N-firm concent rat ion rat io:
presence of just one firm , a m onopoly . HHI = s1 2 + s2 2 + 3 2 + + sn 2 (Where sn is the m arket share of the nth
This m ethod m easures the dom inance of the biggest firm s in a particular sector. N in this case is the num ber of fi m arket. Fewer firm s hav ing a large m arket share would indicate less com petition. How are t hese measures used? In the US, m ergers are scrutinized by analy sing concentration ratios. Generally , a m arket with a HHI of less tha considered com petitiv e . A m arket with a HHI in the 1 ,000-1 ,800 band is m oderately concentrated. A m easure m arkets raise antitrust concerns and inv ite further scrutiny by authorities.
considered. A four-firm concentration ratio, for instance, would just sum up the m arket shares of the four biggest
indicates a highly concentrated m arket. As a general rule, m ergers that increase HHI by m ore than 1 00 points i
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10/3/13
ET in the Classroom: Asset classes

What is asset classificat ion?
In any banking sy stem , loans or assets created by lenders are div ided into sev eral qualitativ e categories. In sim p categories reflect how good or bad an asset is in term s of the possibility of default in repay m ent of loan from a bor practice is known as classification of assets. How is asset classificat ion import ant t o bankers?
This practice helps banks know the strength of its credit portfolio. If there is a risk of non-pay m ent of loans or defa start focusing on their credit m onitoring act and take correctiv e m easures. According to classifications, banks m take care of the fallout of a default. What are t he broad classificat ions prescribed by t he regulat or, t he Reserve Bank of India?
The RBI has classified assets into four broad categories. These are prescribed by the Bank for International Settlem gov ernm ental body of central banks. Howev er, each central bank is allowed to tweak the definition as per their l St andard asset Asset where borrowers pay their interests on the loan as per the schedule is a standard asset. Sub-st andard asset
A sub-standard asset is one which has rem ained an NPA for a period less than or equal to 1 2 m onths. An NPA or a asset is one where a borrower fails to pay the interest on the loan for three consecutiv e m onths. Doubt ful asset
An asset would be classified as doubtful if it has rem ained in the sub-standard category for a period of 1 2 m onths. Loss asset
When banks see little possibility of recov ering the loan, it becom es a loss asset for the bank. Banks or auditors con for the bank. What are t he provisioning requirement s for t hese asset s?
For loss assets, if kept in the book of banks, 1 00% of the outstanding has to be prov ided for. For doubtful assets, if t y ears, it calls for a prov isional cov erage of 3 0%.
rem ained in the doubtful category for 1 y ear, then the prov isional requirem ent is 2 0%. If it has stay ed there for
ET in the Classroom: How is infrastructure defined in India?

Policy anomalies and lack of consensus on what constitutes infrastructure have undermined efforts to spur creation o look at the current status and the need to define infrastructure. How is infrast ruct ure defined in India?
There is no clear definition as of now. A broad m eaning of the term is based on a series of reports and observ ations
gov ernm ent agencies and com m ittees. A com m ission chaired by C Rangarajan in 2 001 attem pted to define infra
according to six characteristics: natural m onopoly , high sunk costs, non-tradability of the output, non-riv alry in
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(which im plies benefit of public good can be extended to additional consum ers without any huge additional cost), exclusion and bestowing externalities on society . Howev er, these characteristics were not considered absolute.
For taxation purposes, the incom e-tax departm ent considers com panies dealing with electricity , water supply , se
roads & bridges, ports, airports, railway s, irrigation, storage (at ports) and industrial parks or SEZs as infrastruc
special tax benefits are also giv en to sectors like fertilizers, hospitals and educational institutions, adding to the co The Reserv e Bank of India and the Insurance Regulatory and Dev elopm ent Authority hav e also tried to define in identify sectors. Why is a precise definit ion of infrast ruct ure needed?
A clear understanding of what is cov ered under the rubric of infrastructure is necessary for policy form ulation, s and m onitoring projects to ensure consistency and com parability in the data collected and reported by v arious a the em phasis on infrastructure has led to the gov ernm ent extending m any incentiv es and tax benefits to infrast Without a proper definition these benefits can be m isused. What is t he int ernat ional norm? Globally , too, defining infrastructure has been an arduous task. The US and m ost European countries hav e defin
sectors for tax purposes. There is no consistency across the dev eloped world on what constitutes infrastructure. M
also identified sub-sectors like core infrastructure, social infrastructure, retail infrastructure, and urban and rur How is India approaching t he issue? The finance m inistry will identify the sectors prim arily based on the characteristics set out by the Rangarajan c sectors will be eligible for tax incentiv es, v iability gap funding and will be cov ered by regulatory fram ework for which will include lev y of user charges. ..
som e additional requirem ents. Based on the criteria, the finance m inistry is likely to notify 2 5 sectors as infrastr
ET in the Classroom: corporate repo bonds

What is corporat e repo bond?
Banks, corporate and prim ary dealers pledge corporate bonds with each other to raise short-term m oney . It is sim corporate bonds does not receiv e the entire v alue of the bond. When did RBI allow repo in corporat e bonds?
pledging gov ernm ent securities (gsec) with RBI to raise short-term m oney . Unlike pledging of g-secs, here the bor
RBI guidelines on repo in corporate debt securities cam e into effect on March 1 , 2 01 0.These guidelines were am en
2 01 0 as the m arket participants dem anded a reduction in hair-cut m argins. It was reduced from a flat rate of 2 5 two day s of the deal. How does t he repo in corporat e bonds work?
1 5%, depending on the rating of the corporate bond. According to the am ended guidelines, the settlem ents had to
Inv estor A, who needs finance for an interim period, can issue these bonds while entering into an agreem ent with a giv en point of tim e he would buy back the bond from inv estor B, though the bond issuer would hav e to suffer a 1 0-1 5%, which will v ary according to the credit rating of the bond. How act ive is t he repo in corporat e bonds in India? Only fiv e deals hav e been reported so far. Com panies that hav e issued corporate bonds in India are REC, PFC,
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Why has repo in corporat e debt not t aken off?
Lack of m arket participation could be because of lenders or issuers m aintaining a cautious approach as well as du trade guarantee m echanism . Also, the hair-cut m argin of 1 0-1 5%, (which is the m argin enjoy ed by the inv estor
agreem ent is rev ersed), is still v ery high from the inv estors point of v iew considering the v olatility in corporate prices. There is no centralised clearing agency like the Clearing Corporation of India (CCIL ) for central gov ernm .
not dem and such a high hair cut. Interest rate is determ ined ov er-the-counter, but there is no m echanism for eff
ET in the classroom: What is stagflation?

Stagflation is an economic situation where the growth rate slows down, unemployment levels remain steadily high & high. What is st agflat ion?
Stagflation, a concept which did not gain acceptance till the 1 9 6 0s, is described as a situation in the econom y wh the first instance, high inflation and unem ploy m ent or slower growth seem like opposites and m utually exclusiv It cam e to be seen in the 1 9 7 0s as a situation when the econom y has low productiv ity and y et the goods are high
slows down, the lev el of unem ploy m ent rem ains steadily high and y et the inflation or price lev el rem ains high a
low unem ploy m ent. The term stagflation cam e to be used for the first tim e in the British Parliam ent by Lain Ma (cutting interest rates or increasing gov ernm ent spending) also increases inflation.
Once stagflation occurs it is difficult to deal with. The m easure a gov ernm ent usually takes to rev iv e an econom y
Under norm al recessionary conditions, inflationary policies are acceptable, but here, giv en the already high infl inflation still higher could m ean prices spiralling out of control, thus further hitting productiv ity and growth. What causes st agflat ion?
The m ajor reasons for stagflation, whenev er it has occurred in history , hav e been-supply shocks or shortages due
reasons which push up prices of essential com m odities, causing an inflationary situation and at the sam e tim e pu
production costs, as it happened in 1 9 7 0s in the US. The other reason is failure of the m onetary authority to cont
growth of m oney supply in the econom y and excessiv e regulation of goods and labour m arkets by the gov ernm en
the 1 9 7 0s, a sim ilar situation occurred during the global stagflation, where it began with a huge rise in oil price spiral. Is India on t he brink of st agflat ion?
continued as central banks used stim ulativ e m onetary policy to counteract the resulting recession, causing a run
Though the central bank and the Centre hav e had to rev ise their growth targets, which hav e taken a hit due to p
double-digit inflation, econom ists are far from assum ing a stagflation like situation in India just as y et. The Reser m oderate growth but will keep it steady , which according to RBIs estim ates, should be between 5% and 6 %.
deputy gov ernor Subir Gokarn has said headline inflation num bers are m uch higher than the appropriate rate o
ET Classroom: Casa
What is Casa Rat io? Casa is basically the current and sav ings sccount deposits. Casa ratio is the share of current and sav ings account Reserv e Bank of India. Why are banks keen on garnering a higher share of Casa?
deposits of the bank. In India, interest rates paid on current and sav ings account deposits is adm inistered by bank
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Interest rate paid on Casa is m uch lower com pared to other deposits like term deposits or recurring deposits. Whil
any interest on current account, interest paid on sav ings account deposit is 4 %. Banks therefore m ake m axim um 52 %, followed by the State Bank of India at 4 8% and ICICI Bank at 4 5%. What does Casa mean for cust omers?
the share of Casa on their books to reduce their ov erall cost of deposits. HDFC Bank has the highest share of Casa t
Recently , RBI increased interest paid on sav ings account deposits from 3 .5% to 4 %. Further a y ear ago, RBI told b
interest on sav ings deposits on a daily basis rather than pay ing on the m inim um balance m aintained by them in
result, sav ings account custom ers earn better returns com pared to what they earned a y ear ago. Further, intere case of term deposits. Howev er, there is no m ajor benefit for current account deposits, which is m ainly m aintain and traders. What are t he disadvant ages of high Casa?
sav ings account deposits does not attract TDS (tax deduction at source). Interest incom e abov e 1 0,000 a y ear att
These deposits can m ov e out of banks books any tim e, leading to asset-liability m ism atches. While in case of term
alm ost certain that the depositor m ay not withdraw m oney before the m aturity of the deposit and m ay also rene Banks cannot rely on Casa deposits to fund long-term loans.
m aturity . Further, to finance long-term projects, banks need to hav e long-term liabilities on their books to av oid
ET in the Classroom: Sovereign debt crisis

What is sovereign debt crisis?
Sov ereign debt crisis m eans the sov ereign gov ernm ents borrowing from dom estic and external m arkets is in exc repay , resulting in loan defaults requiring rescheduling of loans or bailout packages from other countries or m ul institutions such as IMF. How did t he Greek crisis originat e ?
The crisis in Greece surfaced in 2 007 -08 , when it cam e to be known that Greece was not in a situation to m eet it
obligations to its external creditors. The budget deficit of Greece was in the range of 1 3 .6 % of its gross dom estic pr
debt was equiv alent to 1 1 5% of the gross dom estic product. The debt problem was further com pounded by the fac
fourths of the gov ernm ent debt was held by foreign institutions, particularly foreign banks. Not only was the hig
problem , it was also cam ouflaged by deriv ativ e hedging. Reportedly , inv estm ent banks m isled inv estors into inv allegedly failed to assess the correct fiscal position. Who bailed out Greece?
gov ernm ent bonds of Greece by being secretiv e about the actual state of affairs. The rating agencies play ed accom
Greece reached an agreem ent with IMF, the European Com m ission and the European Central Bank on a rigorous
stabilise its econom y with the support of a $1 4 5-billion financing package against which the Greek gov ernm ent w
im plem ent fiscal m easures, structural policies and financial sector reform s. Som e of the points of the reform pack had to be curtailed and social security benefits cut.
reducing the fiscal deficit to 3 % by 2 01 4 , pensions and wages to be reduced for three y ears, gov ernm ent entitlem
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10/3/13

ET in the classroom: Quantitative Easing II

What are economist s say ing?

ET in a Classroom: Beggar Thy Neighbour Policy

What are t he limit at ions of such a pract ice?

ET in the classroom: Systematic Transfer Plan

ET in the classroom: RBIs key policy rates

ET in a Classroom: Currency Peg

ET in the classroom: Quantitative easing

ET in a Classroom: Stock Valuation

ET in the classroom: Care for a Dim Sum?

ET in the classroom: The A-Z of 4G technology

ET in the classroom: Offshore Banking Unit

ET In The Classroom: Public Debt Office

What is t he pract ice in advanced economies?

ET in the Classroom: Non-competitive bidder

ET in the classroom: Potential growth rate

ET in a classroom: How are poverty numbers calculated

What is t he int ernat ional povert y line?

ET in the Classroom: Competition

ET in the Classroom: Asset classes

ET in the Classroom: How is infrastructure defined in India?

ET in the Classroom: corporate repo bonds

Why has repo in corporat e debt not t aken off?

ET in the classroom: What is stagflation?

ET in the Classroom: Sovereign debt crisis

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