IIM Shillong Niveshak March 2013

THE INVESTOR VOLUME 6 ISSUE 3 March 2013

Niveshak

JP MorgAn’s TrAding DebAcle,

pG. 16

TaXing the superrich:

A costly move, PG. 22

RESPONSIBLY REALISTIC

Women’s PSU Bank

THE TRIPLE I’’s- Investment,

Infrastructure and Industry

Gold limit hiked

Disclaimer: The views presented are the opinion/work of the individual author and The Finance Club of IIM Shillong bears no responsibility whatsoever.

F R O M E D I T O R ’ S D E S K

NiveshakVolume VI

ISSUE IIIMarch 2013

Faculty MentorProf. P. Saravanan

Editorial Team

Anchal Khaneja

Anushri Bansal

Gourav Sachdeva

Himanshu Arora

Ishaan Mohan

Kaushal Kumar Ghai

Kritika Nema

Neha Misra

Nirmit Mohan

All images, design and artwork are copyright of

IIM Shillong Finance Club

©Finance ClubIndian Institute of Management

Shillong

www.iims-niveshak.com

THE TEAM

Dear Niveshaks,

As we enter the month of February, the most talked about topic is the Union Budget, a very important event which is eyed by the markets, investors and rating agencies. This year’s budget became more important considering the global and Indian economic slowdown. Persistent inflation, sagging investor confidence, growing fiscal deficit and decade low growth rate were some of the major problems faced by India. Growing Fiscal Deficit was accentuated by a sharply higher Current Account Deficit, thanks to exces-sive dependence on energy imports of oil and coal and the Indian psyche of hoarding gold as a safe haven investment in uncertain times. There was also the threat of Global Credit Rating agencies downgrading India, which could worsen India’s fiscal situation even further as foreign inflows of debt and equity would now factor in additional risks of lower rating, leading to lower inflows at higher costs.

Looking at the challenges facing the Indian Economy the expectations from the Fi-nance Minister and Union Budget further increased. This month’s cover story critically analyzes some of the major reforms of Union budget 2013, whether these reforms would be able to have a positive impact or are just promises considering the general elections due in April-May next year.

This issue brings to you some more interesting and insightful reads. The article of the month talks about decoupling, from an economical perspective. The article discusses on whether the developing nations have decoupled from the developed nations or not. Secondly it also throws some light on the need to decouple the use of natural resources and their impact on the environment in the pursuit of economic growth. With the budget around the corner, taxing the superrich seemed to be the talk of the town. The FinSight section analyzes the government’s moves of taxing the super-rich. In the past, India has had a disastrous experience by levying exorbitant taxes on the rich. The article talks about the impact this policy would have on the honest tax payers and also on the dishonest rich. Banks are respectable institutions, and the simple reason for this respect is the kind of work it does and the sense of responsibility with which it operates. Should the banks follow Sir Volcker’s path, aiming to minimize conflicts of interest between banks and their clients, or take steps that are risky but entail huge profits? FinGyaan section discusses this issue with J P Morgan’s hedging disaster. The Finistory section brings to you one of the most significant events in the history, The Great De-pression of 1929. Lastly, the Classroom this month will help its readers to understand in and out of Passbook Loans.

Also, Team Niveshak is pleased to extend its gratitude to senior team, who have taken Niveshak to new heights during their association for two years. They are: Akanksha, Akhil, Anuroop, Chandan, Harshali, Kailash, Nilkesh, Rakesh and Venkat. Please join us in wishing them all the very best in their future endeavors. We hope to continue this association with you in times to come through your support and guidance. We would also like to thank our readers for their constant support through wonder¬ful articles and appreciation. It is your endless encouragement and enthusiasm that keeps us going. Kindly send in your suggestions and feedback to [email protected] and as always,Stay invested. Team Niveshak

C O N T E N T S

Niveshak Times04 The Month That Was

Article of the month 08 Decoupling Demystified-An Economical Perspective

Cover Story

12 Budget 2013-Responsibly Realistic

FinGyaan 16 JP Morgan Chase’s Trading Debacle

Finistory 19 The Recession within Depression

Finsight22 Taxing the Superrich- A costly move!

CLASSROOM27 Passbook Loan

MARCH 2013

Bharti Told To Stop 3G Services In 7 Circles

Bharti Airtel, the country’s largest mobile phone company, was ordered by the government to stop providing third-generation (3G) services in seven circles, namely - Kolkata, Maharashtra, Gujarat and four other regions. The government plans to crack the whip on companies offering these services in areas where they do not have permits. A penalty of 350-crore has been imposed by the Telecom Department (DoT) on the company for offering high-end data services in seven regions where it does not have 3G frequencies. It was confirmed by a government department official that similar bans and penalties would be imposed on other operators including Vodafone and Idea Cellular. If Bharti is not able to secure relief from the court, it will have to shut services in the seven circles. As a result, the customers of Bharti will have to migrate to other operators. The 3G customer base of the company as of December 2012 was about 7 million. But it is not known how many of them belong to the seven regions, which also include Haryana, Uttar Pradesh, Kerala and Madhya Pradesh, where it does not have own 3G airwaves. It was said that this even if the courts decline to issue a stay, the impact on Bharti’s balance sheet will be minimal as 3G revenues account for less than 2% of its total sales currently. The concern is on the long-term impact due to such steps from the government.

Banks Stop Offering Long-Term Bonds Over Basel Iii Uncertainty

Indian banks have stopped offering long-term debentures as the markets aren’t yet mature enough to handle such instruments as these come with an element of uncertainty under Basel III norms. Until now, Indian banks have been issuing bonds, known as Tier-II bonds, to boost their capital base. The pricing of these bonds has been similar to other debt but with the introduction of Basel III norms from April, they take on some of the characteristics of equity. Traditionally, debt has been considered low-risk and low-return in relation to stock. However, under the clause of the “loss absorption mechanism” in Basel III norms, a bank’s debenture

holders must also bear part of the risk. These bonds get converted into equity in case a bank has to be rescued by tax payers. As a result, the debenture investors are asking for a risk premium, which in turn pushes up their cost for the banks. The existing bonds, issued to boost Tier-II capital in the past, are losing their value fast. As per Basel III, bonds without the loss-absorption mechanism should be devalued by 10% every year, which means erosion of the capital base every year at a time when the government is struggling to recapitalize its banks. According to a report by Crisil, the government needs to create the market by investing in such bonds through its subsidiaries. Indian banks will need a minimum Rs.1.4 trillion as non-equity Tier-I capital, which would be difficult to raise as these instruments will carry higher risks because of their equity-like features. It will also reduce their attractiveness for banks, as these instruments will be costlier than those under Basel II.

Ford India To Locally Make Engine For Ecosport Suv

The Indian unit of Ford Motor Co. is likely to manufacture a 1.0-liter gasoline engine locally for its soon-to-be-launched EcoSport SUV. This move will help the company reduce tax on the vehicle and keep its price competitive. The Vice President for ma r ke t i n g at Ford’s India unit said that they will initially import the engines from Europe, but will manufacture them locally in future. The co. plans to manufacture the same in the southern Indian port city of Chennai. There is a tax of 30% on locally manufactured vehicles fitted with imported engine. Manufacturing engines locally will make the SUV cheaper for India’s price-sensitive customers. Ford has to keep the price of the SUV’s gasoline variants low as demand for vehicles powered by gasoline has fallen in India as gasoline is far costlier than diesel. The sales of the co. fell 30% to 7,253 vehicles in February. The co. expects the compact SUV will

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help the company turnaround its falling sales in India. Sales of compact SUVs, especially with diesel engines, are still strong. Ford is likely to introduce the EcoSport in India in June with 1.5-liter gasoline and diesel engines as well as the 1.0-liter engine. It already manufactures 1.5-liter diesel and gasoline engines in India. The vehicle is currently sold in Brazil and will shortly start selling it in China.

Money laundering case: ICICI Bank suspends 18 employees

Eighteen employees have been suspended by ICICI Bank, after the lender and two of its peers were accused of indulging in money laundering activities. Country’s three largest private banks, HDFC Bank Ltd, Axis Bank Ltd and ICICI Bank, were accused of indulging in money laundering both within and outside, with an online portal Cobrapost claiming that a sting operation conducted by it has revealed a scam. The portal Cobrapost revealed the contents of the purported video taken in ‘Operation Red Spider’, which showed a number of senior executives of the three banks verbally agreeing to take huge amounts

of cash from the undercover reporter and putting them into a variety of long-term investment plans so that the black money ultimately is converted into white. However, no account was opened nor any cash deposited in these banks. After the sting operation was played out, ICICI Bank have constituted a high-level inquiry and a report in this regard will be submitted in two weeks.

Aditya Birla, Tata Motors, Lic Top Reputation Index: Nielsen

Aditya Birla group, Tata Motors and LIC have emerged as top three companies, out of 40 leading firms, as per a study by information and insights provider Nielsen. “Aditya Birla Group (ABG) has emerged “Best in Class” across all the six pillars of Corporate Image,” Nielsen said in a statement. “The six pillars of Corporate Image comprise product and service quality; vision and leadership; workplace management; financial performance; operating style and social responsibility,” it added. ABG replaced

Tata Motors, which had ranked first in the 2011-12 fiscal, at the top spot for this year.

Conglomerate ITC ranked fourth while IT majors Infosys and Wipro are tied at the fifth spot in the survey. According to the survey, 25 per cent of respondents indicated that Tata Motors is the “Most admired Corporate” in India, followed by Aditya Birla Group (17 per cent), Wipro (17 per cent), Infosys (16 per cent) and ITC (16 per cent)

Cyprus secures bailout, avoids bankruptcy

An eleventh hour deal has been struck by Euro zone finance ministers to keep Cyprus in the Euro zone and save its banking system from near total collapse. The powers that be have agreed a bailout plan worth 10bn euro which will see those with less than 100,000 euros deposited in Cypriot banks breath a collective sigh of relief, as this amount will be fully guaranteed. As part of the plan the country’s second largest bank (Laiki Bank) will be wound down and it is likely that those with savings in Laiki Bank will be hit hard. Christine Lagarde said the bailout deal agreed was “a comprehensive and credible plan” to help restore trust in the banking system. The deal now has to be passed by Cypriot politicians. So far the markets have responded favourably to the news.

Two Ambani Groups Lose Rs 20,000 Cr Market Value In A Week

Amid an intense selling pressure in the stock market, the two Reliance groups headed by Mukesh and Anil Ambani have seen their respective market values skid by about Rs 10,000 crore each in a week’s time (17th to 23rd march, 2013). The six listed companies from the Reliance Group are Reliance Communications, Reliance Power, Reliance Infrastructure, Reliance Capital, Reliance MediaWorks and Reliance Broadcast Network Ltd. Among these, Reliance Power saw the steepest decline of Rs 3,395 crore in its market capitalisation, as the shares of the company tanked by about 16 per cent and touched their lowest level of Rs 61.05 on Friday. The market value of RCom also plunged by Rs 2,590 crore to Rs 11,156 crore, with its share tumbling 18.84 per cent. Reliance Infrastructure’s m-cap tanked by Rs 2,113 crore, while Reliance Capital lost Rs 1,440 crore of market worth.

The Niveshak Times

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MARKET CAP (IN RS. CR)BSE Mkt. Cap 6,330,944Index Full Mkt. Cap 3,069,774Index Free Float Mkt. Cap 1,598,677

CURRENCY RATESINR / 1 USD 54.34INR / 1 Euro 70.10INR / 100 Jap. YEN 57.37INR / 1 Pound Sterling 82.56

POLICY RATESBank Rate 8.50%Repo rate 7.50%Reverse Repo rate 6.50%

Market Snapshotwww.iims-niveshak.com

RESERVE RATIOSCRR 4.00%SLR 23%

LENDING / DEPOSIT RATESBase rate 9.70%-10.25%Deposit rate 7.50% - 9.00%

Source: www.bseindia.com www.nseindia.com

Source: www.bseindia.com

Source: www.bseindia.com15th February to 22nd March 2013

Data as on 22nd March 2013

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arket Snapshot

BSEIndex Open Close % changeSensex 19468.15 18735.6 -3.76%

MIDCAP 6626.86 6079.79 -8.26%Smallcap 6540.92 5772.93 -11.74%AUTO 10836.08 10115.33 -6.65%BANKEX 14146.30 12866.93 -9.04%CD 7241.71 6825.22 -5.75%CG 9763.24 9123.58 -6.55%FMCG 5808.34 5853.3 0.77%Healthcare 7899.28 7952.69 0.68%IT 6477.68 6787.91 4.79%METAL 9904.10 8625.34 -12.91%OIL&GAS 8928.35 8422.26 -5.67%

POWER 1817.21 1637.7 -9.88%PSU 7287.15 6377.08 -12.49%REALTY 2036.63 1781.36 -12.53%TECK 3778.69 3847.2 1.81%


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Recently, there have been multiple reports and debates on “decoupling”. However, this single word has more than one meanings attached to it, each as important as the other in the current scenario of the world economy. The two popular debates related to decoupling are – whether the developing nations have decoupled from the developed nations or not; and secondly the need to decouple the use of natural resources and their impact on the environment in the pursuit of economic growth. The objective of this article is to understand both these theories and their ramifications.Decoupling Of Developing And Developed NationsOne of the most well-document and researched theories is the North-South relationship between developed and developing economies. According to this, because of their technological and economic advancement, the developed nations (referred to as the North) have a unidirectional impact on the growth and business cycles of the developing countries (referred to as the South). However, recently there has been a lot of debate relating to the issue of economic decoupling.Economic decoupling refers to increasing independence of the business cycle movement of developing nations from the business cycle movement of the developed nations. It refers to the growing non-applicability of the traditional North-South relationship. This term gained prominence when the economic performance of some developing economies picked up

tremendously in the globalization era. These economies, which were also referred to as the Emerging Market Economies (EMEs), were growing at unprecedented high growth rates while the growth in developing countries lagged behind. These economies were able to industrialize and reduce their dependence on agriculture. Further, along with this sectoral transformation, there was also an increase in intraregional trade and growth in domestic demand, which helped in reducing the dependence of EMEs on developed economies.However, the global financial crisis of 2008 sowed the seeds of the debate whether there has been economic decoupling or not. The crisis which originated in the United States, affected not only the developed nations but also the developing economies . The business cycle co-movement was clearly seen. EMEs were not spared of this global crisis.And this became the point of contention – Have the developing economies actually decoupled from developed ones? Even if they had decoupled in the past, are they re-coupling now i.e. is there a return of the traditional North-South relationship? With the developed economies still burdened with a variety of problems, will developing economies also be pulled into the mess? Or will they be able to continue on their growth path, and even help the developed nations to recover?The economists and experts who support the view that the world is experiencing economic decoupling are of the view that with globalization,

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the financial and trade linkages between all nations have increased considerably. This affects the developing countries more because they are dependent on the developed nations for exports in the trade aspect and for capital flows in the financial aspect. The main reason why the developing economies were affected in the global financial crisis was because of the decline in exports and increase in capital outflows (as the foreign investors pulled out with the developments on the global economic landscape).However, while this view seems pretty sound theoretically, the other side has empirical evidence to support their argument. One study by the International Monetary Fund classifies the developing a.k.a. the countries in the south as Emerging South and the low-income Developing South. While the business cycle co-movement still happens for the North countries and Developing South, the same cannot be said for the North and Emerging South. In case of the latter, regional developments play the major role in determining business cycle movement instead of global factors and shocks. The EMEs have grown in importance in the past few decades. Their share in world’s gross domestic product (GDP) has increased from 25 to 34 percent while that of the North has declined from 70 to 62 percent. The growth in the world’s GDP is also being driven by the Emerging South. The contribution of the EMEs has increased from 22 percent to a whopping 52percent. They have surpassed the developed countries which contribute just 45 percent to world’s growth.Further, greater share of EMEs exports are now being directed to other developing economies instead of the developed nations. As shown in Table 1 for example, the dependence of the BRIC nations on United States for its exports is minimal.

Another important trend in the EMEs is the substantial increase in domestic consumption and investment. Hence, there is a shift of reliance from external demand to domestic demand which is providing a thrust to the growth in the EMEs.

Further there has been a substantial decline in

the share of debt in the assets and liabilities of the developing nations. Instead, there has been a sharp increase in the share of FDI and portfolio equity. According to a study by the World Bank, while cyclical coupling still exists between the developed and the developing nations, there has been a trend decoupling i.e. developing countries are expected to grow at a much higher rate than the developed nations. Not only have the EMEs become less dependent on the developed nations, but at the same time the dependence of the latter on the former is increasing. Greater proportion of the total exports from the developed nations is being directed to the developing economies. Emerging economies are importing 25 percent of the total world exports up from a mere 15 percent. Based on such trends, some economists expect that there can be a switchover. This means that instead of the North having a uni-directional impact on the South, now there would be a bi-directional influence. Hence, the developing nations may also play an important role in pulling up the growth trends in the developed nations.However, it is still too early to pass a judgement whether the world will experience a decoupling, re-coupling or switchover. While the case for decoupling is slightly stronger at the moment, the trends and developments in future will help in determining the answer to the question which is disturbing everyone – Economic decoupling is a myth or reality?Decoupling of Economic Growth and The Impact on the EnvironmentA widespread and common belief is that if any economically productive activity has to be undertaken, then it would require the use (or more appropriately, sacrifice) of natural resources and some impact on the environment as well. Thus, economic growth necessarily needs to be accompanied by an increasing pressure on the environment. However, recently, this view is being

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Country Export To USA(as a % of GDP)

Brazil 3%Russia 1%India 4%China 8%

Table 1: Exports to USA

Fig 1: Trend vs. Cyclical Decoupling

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challenged. More importantly, it is necessary to realize that this view needs to be challenged in light of the present condition of the earth and its natural resources. Hence, there is a need for a decoupling between economic growth and environmental pressures which means achieving growth without having a harmful impact on the environment.According to a report by UNEP, there are multiple

types of decoupling which can be observed in an economy, namely relative decoupling and absolute decoupling; impact decoupling and resource decoupling. Absolute decoupling means for the same level of resource use and impact on the environment, the economy is growing at a higher rate. Relative decoupling refers to a situation in which both resource use

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and economic growth are increasing, but the latter is increasing at a greater rate than the former. Impact decoupling refers to a situation in which the environmental impact is reduced for the same level of economic growth. And finally, resource decoupling refers to reducing the rate of environmental impact per unit of economic growth/activity/output. Decoupling is an important step in the pursuit

of sustainable development. Across the world, natural resources are being depleted and are being used indiscriminately leading to widespread negative consequences for the environment like land degradation, pollution, loss of wildlife and biodiversity, climatic change etc. A disturbing trend is the sharp increase in consumption patterns across the world. The rate of extraction of raw materials has increased substantially reaching unsustainable levels. The developed countries always had a high per capita usage of resources, many-times the per capita resource usage in developing countries. Now as the developing nations have also embarked on the path of high growth, the use of resources by them is also rising sharply. The rising population contributes to the quantum of resources used. Further, there has been a consistent shift from use of renewable resources

Fig 2: Resource and Impact Decoupling

Fig 3: Natural Resource Extraction over 1900-2005


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to non-renewable resources. The overall impact of these trends is the extreme pressure on the natural resources.A certain level of decoupling has been observed in the world economy automatically. This can be explained by the increasing resource productivity leading to a greater output for the same resource input. But this is much lower than the level required for sustainable development. Further, this is only true for a few resources which have been documented. Many resources like biodiversity have been completely ignored, and the impact on them could actually be even more. Thus a two-fold approach to decoupling

is required. One deals with increasing the efficiency in the use of resources. Research and development is required to improve the technologies, techniques and processes so as to improve the utilization of resources, hence reducing the adverse environmental impact without sacrificing economic growth. The other deals with shifting to renewable resources and those non-renewable resources, that have a lower negative environmental impact.Many countries like China, South Africa, Germany and Japan have realized the need for sustainable development and have embarked on a pursuit to decouple their growth from the environmental issues.

However, there are many challenges which they may have to face. The biggest problem with environment issues is that they are widespread leading to many difficulties in regulating and coordinating their activities. Thus, not only the concerted efforts on the part of the national governments are required, but also the consumption by individuals and the mindset of the firms needs to be changed drastically. Also, as these issues transcend borders, extensive coordination between the governments is also essential. The second major issue is that it is extremely difficult to identify the activities harmful to the environment and to quantify them. Another issue would be providing the right and effective incentives for the development of technologies which support and quicken the process of decoupling. The disparities between usage of resources by different countries create political issues as well. Ideally, the usage of resources by all the countries should converge to similar levels. However, increasing developing countries’ use to the developed countries level is environmentally infeasible but reducing developed countries’ use is politically problematic.The issue of decoupling is relatively new and have not been researched adequately. The nations, citizens, corporate, NGOs, supranational organizations and environmental groups, all need to notch up their efforts for the betterment of the environment and to sustain growth for the future.ConclusionThis article dealt with two important issues with which the world is grappling – one deals with the prospects for world economic growth and the role of developing nations, and the other revolves around the impact of this growth on the environment. And both have not been researched adequately. Thus, it is important to understand these aspects, their ramifications in the short run and in the long run, the roadblocks and the ways to deal with it, in order to make a road map for sustaining growth and development in future without harming the environment.

Fig 4: Relative Decoupling

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imaginative initiatives. Moody’s Investor’s Service has lauded the fiscal consolidation plan outlined in the Union Budget, terming it as “realistic” and “credit positive”. In fact many experts termed it as an ambitious and do-able budget as we were successful in bringing down the fiscal deficit to 5.2%, in line with our expectations.

The Economy And Its Challenges

The FM highlighted the fact that growth is a necessary condition and we must unhesitatingly embrace it as our highest goal. Decelerating economic growth in FY13 has been partially driven by high inflation of more than 9 percent in FY11 and FY12 that led to a tight monetary policy (interest rates were increased 13 times during March 2010-March 2012) by the RBI. Though the central bank has been successful in bringing it down to about 7.3, inflation still remains above its comfort zone of 5.0-5.5 percent. The government initially had a fiscal deficit target of 5.1 of GDP for FY13 as announced in the Union

The Indian economy that stood amidst huge problems such as low growth forecast of 5% and widening current account deficit owing to huge gold and oil imports, uncertain investment conditions, low tax revenues and unsustainable fiscal deficit had a lot of hopes banked upon the Union budget 2013-14 for its revival. The Union budget 2013-14 unveiled on February 28th, was crucial for two reasons: Firstly, what should be the prime focus of the budget when we actually had so much to deal with, and second, how will the budget pave roadway for both short and long term economic growth. The budget had the above and a lot more.

One of the most anticipated Indian budgets of recent years adopted “fiscal consolidation” as its weapon to fight against all its problems. Finance Minister P.Chidambaram has deftly crafted Budget 2013 to generate both faith and optimism in the future and to lift the growth trajectory by a judicious blend of well-conceived incentives and

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measures to streamline and simplify norms in order to make it easier for foreign and domestic portfolio investors. The KYC norms will be made uniform to facilitate the registration of the foreign investors through designated brokers. The Foreign Institutional Investors henceforth will be allowed to use their investments in government securities and corporate bonds to meet the margin requirements and FII’s will also be allowed to take part in exchange traded currency derivatives segments. This move to invite foreign investors is expected to reverse the trend in FII’s which have been on a downtrend for the last few months, dipping by around 19% in December 2012.

Another matter of deep concern is the unprecedented fall in the domestic savings rate from 36.8 per cent in 2007-08 to 30 percent in 2012-13. A high interest rate scenario, wherein, people can get almost 10 per cent returns on low-risk products like fixed deposits is coming in way of a diverse equity culture getting developed in the country. The Rajiv Gandhi equity savings scheme (RGESS), which was started last year in order to improve domestic capital markets and encourage investments in equity, was further liberalized. The annual salary limit for investors wanting to invest in RGESS has been raised to Rs. 12 lakh from Rs. 10 lakh earlier and this investment can be done not in one year alone, but in three successive years. The securities that form a part of the list that are eligible for investment under RGESS have also been increased in number. This was a good move by the Finance Minister considering that it would have multiple benefits such as improving the domestic capital markets, curbing investment in gold, which would further help in tightening the control over Current account deficit.

The Finance Minister accepted that of all sectors, it’s the infrastructure sector that needs the most investment. New and innovative measures such as

Budget 2012. However, weak economic growth, low receipts from disinvestment and the 2G auction and a higher subsidy bill, took a toll on government’s fiscal health. Red lines were drawn for fiscal deficit at 5.3% this year and 4.8% next year, as can be seen in Figure 2. As a result of these measures, the fiscal deficit in FY13 has been contained at 5.2 percent of GDP. The CAD position had already deteriorated at the beginning of FY13 (Figure 3), as the country recorded its eight year high CAD of 4.2 percent in FY12. Even this year, CAD is expected to remain about 4.2 percent owing to high trade deficit and slow growth in services exports reflecting the weak economic growth in advanced economies. Thus, any improvement in global conditions is expected to play a crucial role in easing CAD and improving the rupee value.

Agriculture

With the agricultural growth rate set at 4% in 12th five year plan, FM allocated 27,049 crore to mobilise green revolution in eastern states and boost agricultural credit. He was also emphatic on food security which is as much a basic human right as any other fundamental rights. Promoting farmer producer organisations (FPO) and Farmer producer companies are other targets lined up for the near future.

The Triple I’s- Investment, Infrastructure And Industry

The hullabaloo that has been prevailing from a long time regarding increasing infrastructural investment, investment rates and removal of apprehensions from minds of domestic and foreign investors was definitely a concern for the finance minister. The Budget unveils a series of approaches to this daunting challenge.

In the wake of slowing growth and dipping FDI and FII, Chidambaram announced that The Securities and Exchange Board of India (SEBI) would take

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Fig 2: Fiscal deficit as a percent of GDP Fig 3: Current Account deficit as a percent of GDP

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Infrastructure Debt Funds and credit enhancement to infrastructure companies were announced in the budget to mobilize funds for investment in the infrastructure sector. Infrastructure tax-free bonds up to Rs.50000 crore were also proposed. Though Infrastructure debt funds and credit enhancement looks a good move by Mr Chidambaram, infrastructure bonds might not be exciting news for institutions such as National Highway Authority of India (NHAI) and India Infrastructure Finance Company (IIFC). These institutions are already sitting on a huge bag of cash which was raised through earlier bond sales, and are yet to spend, owing to the failure in take-off of a number of infrastructure projects across various sectors in FY 2012-13. The government has also set strict conditions of ‘need and capacity to raise money’ as recently NHAI was reprimanded by the Finance Minister for parking funds raised through bonds in bank deposits. So unless the government comes out with a way to speed up stuck infra projects, these institutions would not be raising money through the bond market, making the proposal inefficient.

In order to help grow the Micro, Small & Medium Enterprises, the budget proposed to extend the non-tax benefits to these sectors for 3 years even after they grow out of these sectors. Many micro, small and medium firms were reluctant to graduate to higher sectors because of no benefits in the higher category. In addition to the extension of the benefits, Chidambaram also enhanced the capacity of Re-financing of SIDBI (Small Industries Development Bank of India) from the current level of INR 5000 crore to INR 10,000 crore. This will address the issue of credit crunch for all the small and medium enterprises. SIDBI extends financial assistance to NGO’s, Micro Finance Institutions for further lending to the micro, medium and small enterprises.

Tax Proposals

In India where the tax base has poorly grown

from 312 million to 320 million from 1994 to 2004, increasing the tax revenues remains a daunting challenge. However, this budget primarily aimed at taxing the rich more, giving a sigh of relief to common man. The increase in excise duty on SUVs and mobile phones and increase in import duties on luxury goods such as high-end motor vehicles, motorcycles, yachts and similar vessels indicates the government’s idea of taxing the rich.

Basic tax slabs that were introduced last year were untouched. Additionally, a surcharge of 10% on people with income of over Rs one crore was also imposed (Table 1), backed by the argument that the country can look at only the people who are relatively well placed in the society at the times when there is resource shortage. To a surprise, when the number of luxury cars in India this year were 27,000 there were only 42, 800 people across the nation who reported their income to be more than 1 crore per year. Simultaneously, the surcharge for companies whose income is more than Rs 5 crore a year was increased from 5% to 10%, as can be seen in Table 2. Also a tax credit of Rs. 2,000 for income up to Rs 5 lakh is proposed. 1.8 Crore taxpayers are expected to benefit from the proposed scheme, entailing a revenue sacrifice of Rs 3,600 crore. However this move is not sustainable in a long run as government should focus on widening the tax net rather than burdening a particular section of society which will provoke a vicious cycle of tax avoidance.

In the absence of any significance tax reliefs, Finance Minister’s proposal of additional tax deduction for first time home buyers has brought some cheer. There was already a tax benefit of Rs. 1.5 lakh on housing loan interest. The additional deduction of Rs. 1 lakh can be claimed for the loan amount less than Rs. 25 Lakh and only for those loans which will be obtained between 1st April, 2013 and 31st March 2014. In order to be eligible for this deduction the value of the property purchased should not exceed Rs 40 lakh, given a loan of 70% of the property cost.

Net Income range (INR)

Income Tax Rates Education Cess Surcharge

Upto 2,00,000 NIL NIL NIL2,50,000 - 5,00,000 10% 3% NIL5,00,000 - 10,00,000 20% 3% NIL

10,00,000 - 1,00,00,000 30% 3% NILGreater than 1,00,00,000 30% 3% 10% of Income tax

Table 1: Income Tax slabs for individuals

NIVESHAK 15


So the additional benefit might not sound very pleasant news for people planning to buy a house in metros and Tier 1 cities, as prices of houses in these cities are generally more than Rs. 40 lakhs.

Financial Sector

This sector being the heart of the economy needs special attention and hence a standing council of experts was constituted to examine the competitiveness of Indian financial sector. The budget also brought some innovative and evocative strokes such as India’s first and exclusive public sector bank of the women, by the women and for the women with a whopping capital of Rs 1,000 crore; pilot schemes for composite and novel nutri-farms; social security package for the unorganised sector; launching of waste-to-energy projects in the public-private-partnership mode. A number of proposals relating to capital markets have been finalized in consultation with SEBI. These include simplification of procedure and uniform norms for foreign portfolio investors, clarity related to FDI investment etc.

Other Proposals

A promise was made to give unrelenting focus on improving the lot of, and expanding the opportunities for, women, youth and the poor.

To women of India: Inspired from the very unfortunate incident that shook the nation on December 16, 2013, the Finance Minister has proposed a sum of Rs.1000 crore “Nirbhaya Fund” for the empowerment of the women in the country.

To youth of India: Youth across the nation were encouraged to join skill development programmes and launching several of them so that skill trained youth will give enormous boost to employability and productivity in the country.

To poor of India: Promise was made to unfold cash transfer scheme in its full capacity very soon.

From ‘encouraging’ to ‘could have been better’ to ‘nothing for us’, the Union Budget evoked varying responses from home buyers, investors, realtors and builders all across the nation. While announcing a tax rebate of up to Rs 2,000 for those with incomes of not more than Rs 5 lakh, increasing the deduction from Rs.1.50 lakh to Rs.2.50 lakh, women’s bank etc. are definitely a welcome move, there is still a flip side of the coin. The two questions that need to be answered are: does the Budget have anything that will attract much needed foreign direct investment? Has the Budget done anything that will encourage Indian entrepreneurs to set up large industries that alone will generate employment? Well, the truth will transpire only in future and let us hope that the budget which claimed to leave no room for gloom and pessimism actually helps the nation to achieve what it is aiming for because if it fails to provide the right investment climate and continues the path of fiscal profligacy, India will soon have neither the strength nor the succour to make any kind of future.

Table 2: Modified Corporate tax rates

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The respect which a bank commands in the mind of the common folk is much more than that of other institutions, be it a big corporate or a trust. The simple reason for this respect is the kind of work it does and the sense of responsibility with which it operates. A bank is a financial intermediary which channelizes funds from the suppliers to the seekers, thus helping the economy to grow. Banks have evolved over the years. Today they are more than institutions which accept public deposits and lend to the required parties. There exists a gamut of services which a bank can provide. Now days you can see banks giving Priority Banking Services, Institutional (Corporate) Banking Services, Investment Banking Services etc. Experts created new breeds of financial products like Futures, Forwards, Options, Swaps, Credit Default Swaps and dozens of others which made the system all the more complex. All these combined are called the Derivatives. These

products help bankers, speculators and hedgers make billions of dollars, if used properly.

But sometimes over speculation driven by greed can cause big problems. When one tries to squeeze

profits from a very sensitive market which is gradually making a comeback from a slump/crisis ex: American Stock markets, then he/she might go awfully wrong. The same happened with the biggest bank of USA – JP Morgan Chase. It is an American multinational banking corporation providing financial, retail, securities & investment services. It also provides asset management, wealth management & treasury services. It is the biggest bank by assets and one of the most valuable companies in the world.

Basically, JP Morgan Chase is regarded as one of the safest banks, because of its risk aversion nature. It generally does not put hands in the riskier ventures. One can say that it follows

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the Volcker Rule. The rule poses restrictions on trading transactions such as proprietary trading, investment banking and investing in/as a private equity. But of late, there is a feeling in the investors’ mind that it might not be the case, because of the hedging disaster that had cost the bank $2 billion. Additional costs shot the loss bill up to $6 billion.

The problem started in the CIO office of the bank. CIO or Chief Investment Office is an arm of JP Morgan which is in charge of managing excess cash and some of its investments. CEO Jamie Dimon for the past 5 years transformed the operations by way of investing in much riskier bets. The CEO followed an anti-Volker path. His main motive was to generate profits rather t h a n accomplishing the office’s m i s s i on to protect JP Morgan from r isks inherent in the system like

currency fluctuations & interest rate risk. A trader called Bruno Iskil from London seemed

to follow religiously what his CEO thought. He started

buying Credit Default Swaps. JP Morgan was of the opinion

that credit condition in Euro Zone would worsen. It was 2011 and they

made a lot of money by betting on this. When ECB provided the euro zone bank

with long term loans by way of bonds, the stance of JP Morgan started shaking. Earlier

this year traders of JP Morgan betted on the

performance of 121 companies’ credit default swaps listed in the Markit CDX. They thought that the price would flatten down as market will do better and in turn went short on insurance on the index with a maturity of 2017.

Bruno & other traders went long on insurance on the same index to mitigate the short term losses, again using the contracts. But what they didn’t take into account was the size of contracts bought and sold. This trading became so big that some experts believe it could have directed the price to move in the $10 trillion market of Credit Derivatives. This hedging almost reduced the cost of insurance by 20%. Looking at this, some other external hedge funds came in and went long on 2017 contracts being short on insurance credits expecting the price to come back to normal. It became ‘too’ big and eventually price further fell down and resulted tremendous losses to the parties involved. This debacle earned Bruno the name of “London Whale”.

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JP Morgan lost almost $2 billion. Some say it has been revised and the loss is to the tune of $ 9 billion. The other collateral damages were:

a) Fall in the stock price to the tune of 13% knocking $20 billion off the company’s market value as of May 16.

b) Dent in the reputation of the bank which once could buy other investment banks like Bear Stearns back in 2008.

This is not the end, some experts are of the opinion that derivatives market is worth trillions of dollars. A loss of $2 billion is nothing. According to the U.S. Government report, the derivatives exposures of “too big to fail” banks can be represented by Table 1.

Banks Exposure in Derivatives Market

JP Morgan Chase $70.1 Trillion

Citibank $52.1 Trillion

Bank of America $50.1 Trillion

Goldman Sachs $44.2 Trillion

Nine largest banks of U.S. combined have a total exposure of $200 trillion which is 3 times the global economy of U.S. let alone the total derivatives market which is around $791 trillion i.e. almost 11 times the size of world economy. Imagine what will happen, when say 50% of this market defaults? In the words of ‘Warren Buffet’ derivative is a weapon of mass destruction. It is turning out to be true.

Wall Street didn’t learn the lesson from the 2008 crisis. When bankers earn from riskier investments, they earn big time, but when they lose, they almost die. They must remember this money belongs to the shareholders. Moreover, they expect government to bail them out, again with the tax payer’s money. Why?? Why is it that the Wall Street bankers take the risk when the risk/reward ratio in the market is not clear? A simple management theory-you cannot manage what you cannot measure. Is it too difficult to learn?

I conclude with a question to the common masses, do you agree that the bank should do what it was meant to do and follow Sir Volcker’s path or take steps that are risky but entail huge profits?

FinG

yaan

Table 1: Derivatives Exposure of Big Banks

FIN-Q SolutionsFEBRUARY 2013

1. Harshad Mehta

2. Godrej

3. Odd Lot Theory

4. A is Arturo Di Modica and B is “Charging Bull Statue”

5. Mundra Port and SEZ IPO, 115 times over-subscribed

6. X- ETF Y-Spider

7. Economic moat

8. BNP Paribas

9. Union Bank of India; Promotion of Joint Account


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1937-38Finistory

The Great Depression of 1929 is one of the most significant events in the history that is etched in the minds of people as a storm that took the world by surprise. Though the stock market crash occurred in the year 1929, its after effects lasted for more than a decade and it took a long time till the economy was able to recover from the shock. One such aftershock was felt in the year 1937-38 when the economy once again plummeted into depression even before it could recover from the great depression. Such behavior of the economy is known as the double-dip or W-shaped recession; when the economy recovers from a recession, has a period of growth, but then falls back into recession, well short of a full economic recovery.

In the year 1933, Franklin D. Roosevelt was elected to the Presidential office of the United States and one of his major tasks was to revive the economy of the country from the great depression. He brought about a number of reforms in order to improve the economy and one such reform was the New Deal.

The New Deal

During the first term of his Presidency since 1933, Franklin D. Roosevelt initiated a number of reforms in response to the Great Depression. These laws mainly focused on the “3 Rs” - Relief for the unemployed and poor; Recovery of the economy to normal levels; and Reform of the financial system to prevent a repeat depression.

The “First New Deal” is generally associated with the first two years of Roosevelt’s presidency. The economic reforms that were part of the first new deal mainly focused on the immediate relief of the depression such as unemployment, lack of confidence in banks and low agricultural prices. In order to balance the federal budget, the Economy

Act was passed which proposed a cut in the salaries of the government employees and pensions to veterans. Another hindrance was the lack of confidence among the masses in banks due to the losses in investment banking which eventually lead to bank runs. This resulted in 40% of all the banks going bankrupt between 1929 and 1933. In order to stabilize the banking system, the Emergency Banking Act was passed that supported reopening of banks under the Treasury supervision that made available federal loans as and when needed.

One of the reasons for the Wall Street crash of 1929 was the lack of adequate regulations on the securities market. The Securities Act of 1933 made it mandatory to disclose the balance sheet, profit and loss statement, the names and compensations of corporate officers, of the firms whose securities were traded. These had to be verified by the auditors.

These were some of the new reforms that resulted from the implementation of the New Deal. However, even with these positive reforms the US economy still went into recession yet again in the year 1937-38.

The Recession Of 1937-38

Even though the economy was still reeling under the effects of the great depression, the economy had begun to improve since 1933. The GDP had begun to increase gradually. By 1936, the GDP of the US had reached the pre-1929 levels but the unemployment rate was still high at 11%.

Post the onset of the great depression in 1929, the unemployment levels rose from 3% to 25% in 1933 as seen from figure 1. However there was a slight improvement in the unemployment rate post 1933. But, though there was an increase in

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the GDP post 1933, the unemployment rate did not decrease significantly. This is because even though the GDP of the US was growing, the labor force was also gradually increasing. Also, for the same level of GDP the increase in productivity resulted in fewer jobs for the population. In order that the unemployment rate improves, the growth rate of GDP should be greater than the sum of the growth rate of the labor force and productivity, as was not the case.

Gold Sterilization

In April 1933, the Roosevelt’s administration decided to take the US dollar off the gold standard in order to revive the economy. This ended the deflation, reduced nominal and real interest rates, depreciated the foreign exchange value of the dollar, which in turn stimulated the economy.

However, after a period of monetary instability, the US passed the Gold Reserve Act in 1934. Through this Act, US reverted to the gold standard and the price of gold was pegged to $35 per troy ounce from $20.67 earlier. Out of the total monetary reserves, Gold constituted 85% and changes in the gold reserves accounted for the major change in the monetary reserves. During the mid-1930s, the gold inflows to US were substantial. All this resulted in an increase in the money circulation in the economy thereby aiding the process of

economic recovery.

But the increase in the money inflow may lead

to a higher inflation was what became a cause of worry

f o r the Roosevelt administration. To counteract the possible

inflation, starting December 1936, the Treasury Department decided to sterilize all gold.

Normally, the treasury department purchased all gold inflows from its balance at the Federal reserves in exchange for a gold certificate of an equivalent amount. The certificate would be a part of the monetary base which increased the bank reserves. However, with gold sterilization in place, the withdrawn amount was not replaced by the gold certificates. Instead they were kept separately in an “inactive” account and did not form part of the monetary base thereby freezing the monetary base at the existing level.

The implication of gold sterilization on the monetary reserves is shown in Figure 3. Both the monetary base and the gold stock increased steadily from 1934 to 1936. In 1937, even though the gold stock continued to increase, the increase was sterilized which in turned flat lined the monetary base. The amount of gold in monetary form is depicted by the non-sterilized gold stock.

By October 1937, U.S. was already reeling under recession, and the market sentiments grew apprehensive that the Roosevelt administration may devalue the US dollar in order to combat the recession. Due to this, the gold inflow to the US was suddenly stalled. In February 1938, the Treasury ended its gold sterilization policy. From April 1938, the Treasury began desterilizing its gold holdings and the economy started recovering by June 1938.

Reserve Requirements

During 1936-37, the Federal Reserve was of the opinion that increasing the reserves would in the future lead to excessive credit growth and hence doubled the reserve requirements in three steps in August 1936, March 1937, and May 1937. However, it did not consider that the unusual buildup of excess reserves was as a result of banks insuring themselves against a situation that they faced during the great depression. When the Federal

Fig 1: US Unemployment Rate Fig 2: US Money Supply


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Reserve increased the reserve ratio, the banks responded by cutting down on loans in order that the level of excess reserves is maintained. The effect was seen by a drop in the money multiplier and growth in the money supply was stalled. This is shown in the Figure 4.

The goal of the Federal Reserve was not to tighten the monetary conditions, but to put itself in a position such that it could either tighten or ease policy later using open-market operations and changes in the discount rate.

However, what happened was the exact contrast of what was expected.

Fiscal Policy

The Roosevelt administration did not want to run a long-term deficit and believed that decrease in the federal deficit would help to revive the US economy. There was a spike generated in the government spending in 1936 due to the payment of Veteran bonuses. However, in 1937, Roosevelt and Congress cut government spending by 18%. As a result, the federal deficit decreased to $2.5 billion (2.8% of GDP) in the year 1937, from the previous year’s $5.5 billion (5.5% of GDP). Further in 1938 the expenses dropped another 10% from the previous year.

There were a number of tax reforms that were i m p l e m e n t e d in 1937. With the imp lementa t ion of the Revenue Act passed in June 1936, it established an “ u nd i s t r i b u t e d profits tax” on corporations in the US. The top marginal rate was increased from 59% to 75%. Secondly, surtax was levied on the undistributed

earnings of the corporations which

President Roosevelt argued were shielding income

from taxation by refusing to increase dividends. In January 1937, the Social Security taxes were introduced which further increased the tax revenue for the government.

All these led to the tightening of the fiscal conditions by the government which eventually was one of the major contributing factors towards the recession.

Recovery

By mid-1938, the US economy had recovered owing to some of the policies like the gold sterilization being withdrawn. However, the unemployment levels were still comparatively high and did not regain the 1937 level till late 1941 when the US entered into the World War II. The agricultural population fell by 5% but there was an increase in the output by 19% in 1939.

The Recession of 1937-38 is often cited as illustrating the dangers of withdrawing fiscal and monetary stimulus too early in a weak recovery.

Fig 3: Gold Stock, Non-Sterilized Gold

Fig 4: Effects of Reserve ratio hike on Money Stock and Money Multipler

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underground black markets. This counteractive sway of high tax rates became the raison d’ etre for steady decline in tax rates to their current levels. Fast forward to 2013 January, the government was faced with quite the opposite situation. The economy has an untamable tiger, the rising fiscal deficit. High disposable incomes and low Tax/GDP ratio as compared to other developing countries forced the government to rethink the prevailing marginal tax rates. Table 1 details the marginal tax rates and the Tax/GDP ratio of some of the developing and developed countries of the world. A quick scan tells us that India has the lowest Tax/GDP ratio among countries having similar/greater marginal tax rates.

Country Marginal Tax Rate

Tax/GDP ratio (%)

UK 50% 39Brazil 28% 34.4

Australia 50% 30.8Japan 50% 28.3

US 40% 26China 45% 17India 30% 10.3

(Data as of 2012, Marginal Tax rate of India is revised following the budget)

Until a few days back, with the budget around the corner, taxing the superrich seemed to be the gossip of the town. With an ominously increasing fiscal deficit, this move would aim at improving direct tax revenues, simultaneously giving an upward boost to our Tax/GDP ratio. Populists and generalists supported this view; however the economists came out against it vehemently. While the former were of the opinion that marginal tax rates should be increased as incomes have risen leading to greater tax collections, the latter argued that this move would have a detrimental effect on the economy due to increased incidences of tax evasions. Both arguments had their merits in place, what mattered was the cost at which the benefits would be accrued. Pre-liberalization, India had an unfriendly tax regime, unfavorable on all terms for the common man. In 1970-71, the personal income tax had 11 tax brackets with the tax rates progressively rising from 10 per cent to 85 per cent. In the decades that followed, marginal taxes were progressively reduced from the astronomical levels of 85% to less than 40%. Post liberalization, in 1997-98, income tax brackets were defined at 10%, 20% and 30% and haven’t changed since. Post-independence though, the government had noble intentions of increasing the country’s revenues, sky-rocketing tax rates led to large scale tax evasion, increased incidences of smuggling and emergence of

Infosys

Nitin Bhat

Taxing the

Superrich

A costly move!

Table 1: Tax Rates and Tax/GDP Ratio for some De-veloped and Developing countries

For a country with one of the lowest marginal tax rates, this is indicative of the low levels of fiscal jurisprudence among the masses. Other factors which can be attributed to this anomaly are:1. High poverty levels and low disposable incomes2. Inability of the govt. to capture the earnings of SME’s/proprietary firms across the country3. High tax exemptions to certain sectors like agricultureThe finance minister was treading on thin ice when he presented this year’s budget. Among others, fiscal consolidation, reeling inflation, containing fiscal deficit and tax reforms were some of the key expectations of the common man. The finance minister did manage to live up to the expectations of the common man by proposing appropriate measures to bring the economy back on track. The bone of contention was on the issue of taxing the superrich. The finance minister offered his two cents by maintaining the marginal tax rates as it is while imposing an additional 10% surcharge on individual and corporate incomes more than 1 crore rupees. Given the large number of concessions and exemptions available, the number of tax-paying entities falling in this range is small. The Minister himself provides a figure of a paltry 42,800 individuals who qualify. With due considerations to economic implications, the finance minister expects this move to add about 180 billion rupees to the revenue base. This move makes the most economic sense for the following reason. The surcharge of 10% on the highest tax bracket of 30% translates to an effective tax rate of 33.99% (with education cess included). Such individuals were so far taxed at 30.90 % for incomes exceeding 10, 00,000 rupees. Under the new tax regime, such individuals will have to pay the new tax of just 33.99% on income exceeding 10 times their sum.For individuals with such high incomes, this increase in tax is too small an incentive to launder the excess money in the hope of tax evasion. They might as well as end up paying it rather than being questioned about a suspicious tax evading deal. The costs associated with t a x avoiding money laundering activities are far higher than the benefits of being tax complaint. This will ensure a greater ratio of tax

compliance, thus boosting the tax collections of the government.

Other than the one reason mentioned in the above paragraph, there are quite a few economic implications entailing higher taxes for the superrich. They also serve as reasons why the superrich should not be taxed extra. Any tax regime needs to give due considerations to these points, failing which the myopic vision of increasing revenue will cloud the greater evil of tax evasion. The Classical Laffer Curve ExplanationThe Laffer curve is a representation of the relationship between possible rates of taxation and the resulting levels of government revenue. It illustrates the concept of taxable income elasticity—i.e., taxable income will change in response to changes in the rate of taxation. It postulates that no tax revenue will be raised at the extreme tax rates of 0% and 100% and that there must be at least one rate where tax revenue would be a non-zero maximum. This “economic effect” assumes that the tax rate will have an impact on the tax base itself. At the extreme of a 100% tax rate, the government theoretically collects zero revenue because taxpayers change their behavior in response to the tax rate: either they have no incentive to work or they find a way to avoid paying taxes. Thus, the “economic effect” of a 100% tax rate is to decrease the tax base to zero. This theory also subtly hints that as the tax rate crosses the optimal tax rate where the tax revenue is maximum; imposing any additional taxes will act as a negative incentive for citizens to pay taxes. Thus, citizens of such economies resort to money laundering measures to

avoid paying taxes to the government. Increasing taxes act as

a disincentive for tax compliance and causes tax avoidance. (The tax rate t* is

an indicative value varying across economies.)Historical failure

In the past, India has had a disastrous experience by levying

exorbitant taxes on the rich. At its zenith, taxes were more than 90% which

achieved unintended objectives of massive tax evasion and erosion of national character. As per Laffer, there was no incentive whatsoever for any individual to part with so much of earnings with the government. This led to large scale unaccounted cash transactions, thus fuelling

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evasions are prevalent. Such incidences have eroded the faith of the tax system in the eyes of the so-called-rich, who continue to look for greener pastures outside the Indian economy. The Dishonest Rich According to the Ministry of Finance, India has nearly 35 million taxpayers, but only 1.7 million have a declared income of more than Rs 10 lakh. Nearly 89 per cent say their income is under Rs 5 lakh. A paltry 400,000 people declare an income of more than Rs 20 lakh. From the data provided, it is evident that the tax base of the superrich is a sliver of the total taxable population. Nearly 60 per cent of the economy is out of the tax net and tax collections from services, which account for more than half of the economy, are less than one per cent of GDP. Instead of increasing the marginal tax rate, the finance ministry needs to shift focus on increasing the taxable base. An attempt to tax the super-rich will drive a greater proportion of income underground, thereby fuelling the incentive to buy goods and services without

accounting for it. Heavily taxing this base of population will result in a distinct class of dishonest rich, leading to large scale migration of bright minds from India to

other countries in search of regimes which are more favorable to stash their kitties. If the below picture is any

indication of the magnitude of the tax evasion at current tax rates, it would not be a

“taxing” exercise to determine the sky-rocketing levels to which these figures will soar to if the marginal tax rates are increased.

a massive black market economy. Historically, there is not a single instance where taxing the superrich has worked as a solution to increase tax revenues. Similar problems, albeit on a much compounded scale can be expected in case similar tax regimes are adopted. Burdening the Honest Tax payer In the past, the honest tax payer has always been haunted by the image of the vicious tax official waiting to wring every last penny out of people’s pockets. More often than not, the IT department knocks down the doors of individuals and corporates who religiously pay their taxes. Be it a regular salaried job individual or a reputed MNC entering India through an acquisition, they are harassed and interrogated about their supposedly suspicious transactions, while the IT dept. turns a nelson’s eye towards sectors like liquor, real-estate, education where massive tax

Fig 3:Ministry of Finance data for 2011/12

Fig 2: Laffer’s Curve

[t* represents the rate of taxation at which maximal revenue is generated.]

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Sir, today while going through the terms and conditions for availing a loan, of a renowned Bank, I came across a term called ‘Passbook Loan’. As I was hurriedly reading

through the T & C’s, I didn’t look the explanation for that term. Can you please brief me about it?

Can you give me the context i.e. the section precisely, where you read this term?

Sir, I don’t remember exactly, but I think I read this term while I was reading about the collateral to be provided to the bank while availing a loan.

Yes exactly. Ok, now let me ask you what was the first thing that came to your mind when you read the term ‘Passbook Loan’?

Sir, actually it is a very confusing term. A passbook is generally used to record our transactions with bank. What else can be the term ‘Passbook Loan’ mean, except to record

the transactions related to the loan we have availed but actually it doesn’t make much sense.

Ok, think of it in another way. The Passbook not only contains the transaction details but it also indicates the balance you have in your account. So the term ‘Passbook

Loan’ implies that, the balance you have in your savings account can be used as collateral for the loan, maximum up to that amount. So based on the balance you have in your account, the custodial bank can extend a personal loan to you (a savings account holder).

Oh, I have never thought of that. But why is such a technique used by banks instead of taking property etc. as collateral?

It is very logical. See, these types of loans are considered of very low risk as the amount lent by the bank is already there in the lender’s account. And also it saves time for bank with respect to the paper work they

have to do, checking the validity of lender’s claim on the property etc. So it is of a great help to the bank as well as to the lender.

Very well, Sir. But still, the account holder can withdraw the amount he has in his account any time he wishes for. Then how

does it serve the purpose of ‘collateral’?

The bank generally puts a hold on the funds in the savings account up to the amount of the loan. The rest of the funds can be used by the holder according to his wish. Or the

borrower may have to hand over the passbook until the loan is repaid and he won’t be able to withdraw further from his account. Any of the two alternatives can be implemented by the bank according to the policy and terms of the bank.

Sir, Assuming that I am the passbook holder; I don’t understand why should I borrow the same amount from the bank with the passbook as the collateral? If I use the

amount in the passbook directly, I don’t need to pay the interest associated with the loan. May I know what the purpose of this loan is?

Look, many a times we don’t want to put our property as collateral and it may also be possible that we don’t have anything to mortgage as collateral and we still want to

avail a loan, at that time we can use our balance as our collateral. It may also be possible that we want to keep a certain amount intact with us as for several reasons like safety, last minute need etc. then it is better to go for a loan then to use the cash in the account.

Indeed sir. I must say it is a very useful concept and it will not only save time and money but also brings down the risk level for banks.Thank you very much, Sir.

CLASSROOMFinFunda

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lassroomIIM ShillongPUNIT BHANSALI

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For me, Finance Club has been a great learning experience that I will always cherish. Niveshak means ‘an investor’ & it surely has helped us invest our time in one of the most profitable investments- ‘knowledge’. We have tried to live up to the expectations of the readers and wish to apologize for the mistakes made, if any. We hope you guys keep make Finance Club and Niveshak an even bigger & better brand. Hope you learn and enjoy as much as we have being a part of Finance Club. Stay Invested – Always!

Finance Club for me is something I had wanted to be a part of since the first month of coming to Shillong. I still remember the day the results came and I got a call from a friend saying I was through. It was indeed one of the most joyous moments for me at IIM Shillong. Being a member of this club and working for Niveshak, which is a brand in itself not only within the institute but also across the country, fills me with a great sense of pride and honor. The highly talented and motivated team has added a lot to my learning at Finance Club and made this experience truly enriching. The team meetings, discussing the articles to be selected for each month’s issue, brainstorming on new initiatives as a part of the club for taking it to a higher level, writing articles and so on have been both fun and productive. A lot goes behind maintaining a brand name and I’m proud to have been a part of the team which could carry forward the legacy started by our seniors. I wish the junior team good luck and hope that the magazine becomes bigger and better in times to come.

Ever since Finance Club for 2011-13 was inducted, the journey for me has been full of some wonderful experiences. Finance Club has given me the opportunity of working with the best minds on campus and being part of such a talented team which is a matter of pride and honor for me. The responsibility of publishing a magazine every month and sticking to deadlines with no compromise on quality is a challenge and I am happy that we, as a team, have been able to deliver the promise made to our seniors making the magazine better at each phase possible. I would like to wish Finance Club 2012-14 all the best in all their future endeavors and hope to see Niveshak reaching new heights in near future.

Finance club has given me an opportunity to work with some of the brightest fin minds of our batch and the experience was one to cherish for a lifetime. The discussions that we had and the ideas that we bounced of each other were just amazing. The continuous increase in the reader base of Niveshak was a direct result of the commitment, passion and hard work of the team. After more than a year in finance club I can proudly say that Niveshak has taken my creativity skills to the next level. I wish all the best to the new team and hope that they will take Niveshak to the next level.

Venkata Abhiram M.

Akanksha Behl

Chandan Gupta

Harshali Damle

Time to bid farewell to our Senior Team

MARCH 2013

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Finance Club provided me with the coveted opportunity to work with the best finance brains of our campus and the experience is worth treasuring for a life time. Most of our efforts were devoted to Niveshak, our monthly magazine, which is very close to my heart. It has been a memorable two year journey where we spent numerous hours each month pondering over every minute detail of the magazine in an effort to come up with an issue which our readers would enjoy.Looking forward to see the club scale greater heights in the future. All the best junior team. And for our readers- Stay Invested!!

I still remember my first few days in college when Niveshak was one of the magazines I used to read with utmost sincerity and acute detail. The crispness and factual accuracy of each and every article used to amaze me; something which eventually brought about a burning desire in me to join this elite club. As things had it, I was selected and the 14 odd months spent with the best financial minds of IIM Shillong have been an enriching and an insightful experience. Being part of the Finance Club has definitely helped me keep abreast of the latest happenings in the financial world and has most importantly helped me develop opinions about topics I used to shy away from previously. I must say discussions and brainstorming are indeed fruitful and I would be eternally indebted to this club for teaching me the basics and then the intricacies in the world field of finance.

I had a great experience working for the Finance Club and Niveshak. Apart from the theoretical finance knowledge, the day to day affairs in the financial world as well as the economy helped me understand the real application of Finance. I like everything about the club starting from writing cover stories, reading & editing articles, arguing for different issues, brainstorming for conducting events and finally the operation of the club (No single chief editor), team members and the bonding within the club. I think this platform has added a lot of value to its readers and has done the same for me. I hope that the club reaches greater heights in times to come.

Anuroop Bhanu

Kailash V.Madan

Nilkesh Patra

Akhil Tandon

Well, as the saying goes, – time flies when you are having fun. It was definitely fun and a whole lot more being part the meetings for deciding the content of next month’s Niveshak issue and the discussions on new club initiatives. Releasing our monthly magazine Niveshak on time became top priority for the better part of my association with the club. Being part of a team with such diverse group of people, each having a unique thought process, added a lot to my learning experience. I am grateful for getting the opportunity to work with such talented people that helped in taking the brand to greater heights. I wish the best to the new team and hope that they will exceed all expectations. Till our paths cross again, Stay Invested.

As I always had a strong inclination towards the world of finance, it was a dream come true when I was inducted into the Finance Club. Over the years, the Finance Club has strengthened its value through Niveshak and various events. The opportunities that I have come across during my stint in the finance club have been great. The stint has not only helped me keep myself updated in the world of finance, but it has also helped me learn about various issues though the writings of management students from the top B-schools of the country. Continuously increasing readership and contributions from the best B-schools are a testimony to the fact that Niveshak has been reaching new heights. I wish the club members the best in their endeavor.

Rakesh Agarwal


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F I N - Q1. What is the day that marked the beginning of the Great Depression

known as in the history of finance?

2. What was created by an eminent M&A lawyer in 1982, which is

used to deter takeover bids?

3. Two technology companies, A and B witness a rise in their stock

prices due to reporting of strong financial statements. Another

technology company, C, also sees stock price rise. Say if the

actual reason for the increase turns out to be because of potential

acquisitions of A and B, what is rise in stock price of C along with

A and B called?

4. Connect the Following: Indore, Jaipur, Hyderabad, Saurashtra,

Mysore, Patiala, Travancore, India.

5. This bank is one of the Big four banks of USA. It is among the top

30 oldest bank in the World history and now is the largest U.S bank

by assets. Identify the bank.

6. According to the disgruntled former Goldman guy Greg Smith, what

TV characters did Goldman Sachs Group Inc.’s managing directors

cynically compare to their clients?

7. If we talk about descendant of an oil tycoon who became first

American bank executive to enter china since the 1949 revolution,

whom would we be talking of? Can you also name the bank which

the person worked for?

8. TA momentum based advanced trading strategy which focuses

only on short term outlook of the market. Which trading strategy

are we talking about?

9. Rearrange ITC to get a term associated to real estate and property.

All entries should be mailed at [email protected] by 10th April, 2013 23:59 hrs. One lucky winner will receive cash prize of Rs. 500/-

Article of the MonthPrize - INR 1000/-

Soumyajit Sengupta and Aneesha ChandraMDI Gurgaon

W I N N E R S

A N N O U N C E M E N T SALL ARE INVITED

Team Niveshak invites articles from B-Schools all across India. We are looking for original articles related to finance & economics. Students can also contribute puzzles and jokes related to finance & economics. References should be cited wherever nec-essary. The best article will be featured as the “Article of the Month” and would be awarded cash prize of Rs.1000/- along with a certificate.

Instructions » Please send your articles before 10th April, 2013 to [email protected] » The subject line of the mail must be “Article for Niveshak_<Article Title>” » Do mention your name, institute name and batch with your article » Please ensure that the entire document has a wordcount between 1200 - 1500 » Format: Microsoft WORD File, Font: - Times New Roman, Size: - 12, Line spacing: 1.5 » Please do NOT send PDF files and kindly stick to the format » Number of authors is limited to 2 at maximum » Mention your e-mail id/ blog if you want the readers to contact you for further

discussion

SUBSCRIBE!!Get your OWN COPY delivered to inbox

Drop a mail at [email protected]

ThanksTeam Niveshakwww.iims-niveshak.com

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FIN - QPrize - INR 500/-

Anadi MitraIIM Ahmedabad

COMMENTS/FEEDBACK MAIL TO [email protected]://iims-niveshak.comALL RIGHTS RESERVED

Finance ClubIndian Institute of Management, Shillong

Mayurbhanj Complex,NongthymmaiShillong- 793014

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IIM Shillong Niveshak March 2013

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