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the next generation is that while that success will increasingly be taken for granted and indeedwill become an increasing source of frustration in these pinched times, its success cannot bematched outside the markets natural domain. It is not so much the most capitalist parts of thecontemporary economy but the leastthose concerned with health, education and socialprotectionthat are in most need of reinvention.

US dollar to remain dominant global currency despite its economic

travailsThe relative economic decline of the US has led many economists and policymakers to question the US

dollar's position as the world's anchor currency. Suggested alternatives range from a global reserve

system to even a return to gold. While recent efforts to internationalise the Chinese yuan have only

added to the expectation of a shift in the international monetary system, we believe the US dollarwill

remain thedominant global currencyfor a long time to come.

History shows that the global economic system has often been based on an asymmetricrelationship of an anchor economy - currently the US - that runs persistent current accountdeficits even as it providesliquidityto the rest of the world. This leads to a symbioticrelationship where the anchor country gets cheap financing and the rest of the world gets themonetary liquidity needed to lubricate economic activity.

Unfortunately, history shows this system eventually breaks down because the anchor countryneeds to run continuous current account deficits in order to provide more and more liquidityneeded by an expanding world economy, making it increasingly indebted over time. In turn, this

undermines the very credibility on which the monetary system is based. This scenario was firstdescribed in the 1950s in relation to the Bretton Woods system by Robert Triffin and has sincebecome known as Triffin's Dilemma.

During the Roman times, the world economic system was underpinned by booming tradebetween the Roman empire and India. The problem with Indo-Roman trade, however, was thatIndia ran a large trade surplus with the empire. This deficit meant that there was a continuousdrain in gold and silver coins that, in turn, created shortages of these metals in Rome (in modernterms, this was a monetary squeeze).

The Romans unsuccessfully tried to impose restrictions on imports but eventually resorted to

reducing the gold/silver content of imperial coins (the ancient equivalent of printing money).Yet, frequent findings of Roman coins in India suggest that Roman coinage continued to beaccepted for a long time after it was obvious that the gold/silver content had fallen.

Spain was the world's dominant power in the 16th century but expensive wars caused it to runcontinuous deficits and eventually default. Yet, Spanish silver coins continued to be the keycurrency used in world trade right up to the American Revolution. In fact, they remained legaltender in the US till 1857 - long after Spain itself had ceased to be a major power.

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In fact, the only clear historical solution to Triffin's dilemma can be seen with the 'triangulartrade' system between Britain, India and China in the 19th century. Under this arrangement, theBritish sold manufactured goods to the Indians and purchased opium. The opium was then soldto the Chinese in exchange for goods that were then sold back in Europe.

Britain did not bleed gold in order to keep the system flowing. This system was stable in thesense that it did not suffer from Triffin's Dilemma but functioned because the East IndiaCompany was militarily able to impose its will. Chinese attempts to close down the opium traderesulted in the Opium Wars of 1839-42 and 1856-60. In other words, Triffin's dilemma wascircumvented through war, colonisation and drug-running.

By the 1870s, the world had shifted to a gold standard underpinned by the Bank of England'swillingness to convert sterling into gold on demand. However, Britain's economy was surpassedby the US in 1890 and the Gold Standard was abandoned due to the shocks of WW1 and theGreat Depression. The pound sterling however, continued to be a world currency till after WW2.Even in 1950, 55% of foreign exchange reserves were held in sterling and many countries

continued to peg their currencies to it.

Under the Bretton Woods system after WW2, the USdollarbecame the anchor currency with anexplicit gold peg. Yet again, the need to run deficits to supply the Europe with liquidityundermined the gold peg and the Bretton Woods system collapsed in 1971. Or did it? Over thenext few decades, Asian currencies pegged themselves to the dollar and pursued exported-oriented growth strategies.

The system allowed the peripheral economy (say, China) to grow rapidly even as the anchoreconomy (US) enjoyed cheap financing. Note how the relative rise of China did not diminish therole of the US dollar and may even have enhanced it. Indeed, like the Japanese during their

period of high growth, the Chinese resisted the internationalisation of the Chinese yuan tillrecently and even now are proceeding very cautiously.

So, should we expect the demise of the US dollar? The best sign of the resilience of the dollar-based system is that its trade-weighted index has been stable since the crisis began - hardly a signthat it is being abandoned. Far from it, the world appears to be willing to finance the US at verylow interest rates.

History shows that once an anchor currency has established itself, it can be very resilient andoften outlasts the economic and geo-political dominance of the country of origin. It is possible(albeit not certain) that China will replace the US as the world's largest economy within adecade, but we feel that US dollar will remain the dominant global currency for a long timeafterwards.

What are the three major sectors of an economy?The major sectors of an economy are: agriculture, industry, and services.

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Agriculture includes allied activities too, like horticulture and animalhusbandry. Industry relates to manufacturing while Services sectors comprisesinvisibles like banking, insurance and education.

What is GDP?Gross Domestic Product (GDP) relates to the total money value of all goods andservices produced in one country's domestic territory in one fiscal (financial) year.

Here, India's domestic territory includes land within the country's political boundary,territorial waters (which extend up to 200 nautical miles into the sea), commercialships and aircraft that ply between India and nations abroad, oil rigs and fishingvessels (generating sea-based economic activity), military bases abroad (India has onlyone - Aini in Tajikistan), and our embassies around the world.

So, to calculate GDP, we take the money value of all goods (like books andmotorcycles) and services (like banking and legal).

What is Fiscal Year?Any 12-month period taken for accounting purposes is called fiscal year, which is alsocalled financial year.

A lot of countries, like China, follow the calendar year as the fiscal year.

India and Canada start the fiscal year on April 1 while ending it on March 31 of thefollowing year.

The United States' fiscal year starts on October 1 and ends on September 30 of thefollowing year.

How is GDP growth represented?GDP growth is represented in terms of percentage change over the previous period (itcould be a quarter or a half-year or a year).

For example, India's GDP in 2010-11 is expected to be Rs7877947 crore. This isprojected to increase to Rs8980860 crore in 2011-12 (as per Budget 2011-12document). In this case, India's GDP will increase by 14% in one year. Please note thatthese are not final GDP figures; the final figures for the last financial year will not be

out till the end of this fiscal year.

In 2010-11, India's GDP grew by 8.5%, which means that the country added that muchpercentage of the absolute money value of total goods and services produced in 2010-11.

Name the world's ten largest economies by GDP.

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The United States is the world's largest economy by GDP. Find below the2010 GDP figures for the planet's ten largest economies. The data have beentaken from the IMF.

Rank Country 2010 GDP in Trillion U.S.$1 U.S. 14.522 China 5.873 Japan 5.454 Germany 3.285 France 2.566 UK 2.257 Brazil 2.098 Italy 2.059 India 1.63

10 Canada 1.57

Which sector contributes most to India's GDP?Services sector contributes most to India's GDP. It employs nearly 35% of India's totallabour force but contributes about 56% of India's GDP.

Manufacturing contributes about 27% of the country's GDP while employing about 14%of the labour force.

Agriculture, often called the bedrock of the Indian economy, contributes a meager

17% to the nation's GDP while sustaining the more than half of the labour force.

The next installment will focus on GDP at Factor Cost, GDP at Market Price, and GDPin Purchasing Power Parity terms.

Inflation has been around for several years now. In fact, the last few years have seendouble digit inflation rate that has severely impacted both producers (through rise incost of raw materials) and consumers (because of increase in retail price). In the caseof producers, rising prices have eroded competitiveness of their products whileconsumers are seeing a fall in the general quality of life, including in their standard oflife.

(ReadThe Explainer: InflationandInfographic on Inflation)

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Today'sEconomic Timeshas an interesting infographic on inflation in India and how ithas impacted the economic growth. It also carries views of experts on what they wantto steer the Indian economy on the path to consistent growth.

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The Explainer: The eurozone Debt Crisis

The European Union has 27 members. Of these, 17 member states have adopted the euro as

their common currency. This common currency union is called the eurozone (written in lower

case).

As you know, the monetary policy of a country is made by its central bank. For example, the

Reserve Bank of India, India's central bank, formulates the monetary policy. Similarly, the

eurozone too has a central bank: the European Central Bank, based in Frankfurt, Germany.

Check out the below terrificReuters infographicfor a lowdown on the debt, GDP, and

budget deficit status of some of the most vulnerable eurozone economies.

Decoding graphic jargon:

Gross Domestic Product (GDP) relates to the total money value of all goods and services

produced in one country's domestic territory in one fiscal (financial) year.

The combined GDP of these 17 eurozone members is a little over 9 trillion euros (2010).

Budget Deficit refers to the (negative) difference between income and expenditure. In more

simple terms, budget deficit arises when a country's government runs up expenditure which is

greater than its revenues.

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To fund this deficit, the country has to borrow, either from internal sources or from external

bodies (like foreign banks). This borrowing is called debt.

As the graphic depicts, Greeces total debt is a whopping 162% of its GDP, and is further likely

to touch 200%!

The above graphic relates the same picture about Ireland, Italy, and Portugal. These nations,

along with Spain, are facing mounting debts, but they do not have enough funds to pay their

debts.

These nations borrowed heavily, raised public sector salaries, built public infrastructure, and

upped social welfare spending. In a sense, they made merry with borrowed money.

However, they forgot to fix the tax system. The tax collection systems in these nations are

riddled with loopholes, which helped encourage massive tax evasion. Tax revenues are the

biggest source of a governments revenues. From these collections, the government pays the

interest and sometimes (part of) the principal.

However, an inefficient tax system leads to poor tax collections, which rendered these

countries incapable of honouring their debt payments. When you do not pay your debt on

time, you are declared a defaulter.

Once a country defaults, it becomes untrustworthy in the eyes of the lenders (like foreign

banks and multilateral institutions like IMF). So the lenders begin to charge a higher rate of

interest, which in turn, raises the mountain of the countrys debt.

This is precisely the anatomy of the problems faced by some of the eurozone nations likeGreece, Portugal, Spain, Ireland, and Italy.

In my next post on this issue, I will dwell on the likely effects of the eurozone Debt Crisis.

The Explainer: InflationFriends, this Friday's Explainer focuses on 'Inflation'.

I have kept jargon out of this article; in fact, I have used a conversational mode of writing to

explain this important issue.

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What is inflation?Inflation relates to the sustained rise, over a period of time, in the general price level when

there is a rise in demand (for goods) without an equal rise in supply.

In todays interconnected world, a lack of stability in the prices of goods and services

characterises all types of economies, be it in an emerging economy like India or in anadvanced economy like the United States or underdeveloped economy like that of Senegal.

But as we all know, any kind of uncertainty is not good for business; so is the case with priceinstability.

What causes inflation?

Generally, there is never a single cause behind the sustained rise in prices of a basket ofgoods and services, like wheat, rice, and cooking oil. However, some general reasons include:

(a) increase in money supply;(b) rise in government spending;(c) rise in purchasing power (a direct result of rising incomes);(d) low supply across a range of goods, and

(e) infrastructure issues.

In India, inflation is seen as a result of a combination of all these factors. Let us elaborate ona few of them.

Explanation of causesSince independence, the Government of Indias (GoI) expenditure has been shooting up

steadily. Currently, the GoIs spends lakhs of crores of rupees every year on welfare functions

(like subsidies and insurance for the poor), development works (like building roads) andadministrative expenses (like salary payments).

For your information, the current expenditure of the Government of India is more thanRs12,00,000 crore yes, a staggering Rs12 lakh crore! To put this in perspective, the

expenditure in 1980 was just a little over Rs23,000 crore.

When the government spends, it puts money into the hands of the common man, whichincreases her purchasing power. In short, higher spending would mean higher income, leading

to higher purchasing capacity of the individual.

Higher purchasing power often raises the demand for goods and services; however, in theshort run, the supply of such goods and services may not rise in equal proportion to meet thedemand. This would lead to a rise in prices, a situation dubbed inflation.

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Also, black-marketing, hoarding, speculation, and exploding population have all contributed

to a rise in demand for goods and services.

It is also true that inflation might arise because of cost-push factors, like changes inproduction (as in the case of foodgrains), rise in prices of controlled-supply goods (like LPG

and kerosene), and external factors like oil prices and global inflation. Yes, you could add

increase in indirect tax too.

Cascading effect

By itself a rise in price of diesel wont raise the overall inflation rate. It is just one

commodity among a wide range of commodities consumed by us. However, when you look atthe cascading impact of the rise in price of diesel, you will know that it straight way impacts

you too!

It is like this: a rise in price of diesel will force the transporters to increase freight cost. Nowvegetable / grain vendors use trucks to transport large quantities of their stocks to the

market; this would mean that rising freight cost would add to the price they charge from theretailer / consumer. This means that we will have to pay more to buy the same old stuff!

Take another example, this time on indirect tax (a favourite tool of the government to

increase its tax revenues). You must have heard of Service Tax (ST) and Value Added Tax

(VAT), which the government imposes on a range of services, including on restaurants.

Let us say, you go down to your favourite restaurant to gorge on the delicious buffet spread.Now the bill arrives, and you notice that the final bill includes items like ST and VAT! (No, no,you didnt order for these items but the government did!) All these taxes will add up to asubstantial part of your food bill and thats how indirect tax lead to inflationary situation.

How does inflation affect the common man?

Rapidly rising inflation leads to a fall in the purchasing power of money. In other words, the

purchasing value of money comes down during an inflationary situation.

For example, lets say you have Rs100 and a kilogram of mangoes cost Rs100. One month

later, you visit the market, again, with Rs100. This time the mangoes are priced at 150 per

kg. How much will you be able to buy with Rs100? About 2/3 kg or 670 grams. In short, thepurchasing value of your money has fallen by 1/3.

What are WPI & CPI?

Dear Reader, to be honest, any note on these indexes will have to include jargon, which is,

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for most people, difficult to understand. So, I will reserve that stuff for some other day.

Anyway, I will stick to some basic aspects of these indexes.

WPI stands for Wholesale Price Index while CPI stands for Consumer Price Index. The WPI isprepared by the Central Statistical Organisation (CSO). It includes all the important and price-

sensitive goods, which are traded in wholesale markets across the country. The articles in theWPI consist of major foodstuffs, raw materials, semi-manufactured goods and manufactures.Hey, thats too much technical stuff already!

What does it mean if todays newspaper says that thecurrent inflation rate is 10%?If a newspaper story title screams that the inflation rate is 10%, then it means that the prices,on an average of a basket of commodities (like those in the WPI oil, rice, wheat), have goneup by 10% over the prices that prevailed exactly on that date last year. (Its actuallycalculated on a fortnight basis; however for simplicitys sake, we took this approach.)

Confused? Lets simplify. Let us say, on July 22 last year, you spent Rs100 to buy a basket of

commodities. If the inflation rate today is 10%, it means that the price of that basket ofcommodities would have gone by 10%, to Rs110, today, i.e. on July 22 this year. It also means

that the purchasing value of your Rs100 has gone down by 10%.

Forget the Indian middle class; rising inflation has pushed more than one crore households,which would mean a minimum of 6 crore people, into poverty. It has the debilitating impact

of depriving people of nourishment. Such deprivation affects the poor and the marginalisedthe most. It is no secret that more than 65% of all Indian children and 52% of all Indian women

are malnourished; rising prices have only added to their woes.

Kindly forgive me for any spelling / grammatical error; I write in one go! Thank you!

(Please select your reaction to this post in the footer; see below.)

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The Explainer: The War on Terror - Part IIn the last two weeks, I have not published The Explainer. Most of my posts in The Explainer

Series are full-length and in Q&A style. From today, most of my posts in this series will be

short and will come in installments; I have seen it works best when we read important ideas

relating to one crucial central idea in one short go and then refresh it with another one a few

days later. So here's my first endeavor in this direction: a short Explainerof the U.S.-led Waron Terror.

How did the 9/11 attacks unfold?I think rather than write any description of how the attacks unfolded on that unfortunate day,

here's an infographic that's sourced fromReuters.

What is the War on Terror?The September 11 2001 attacks on American soil remain one of the most definingmoments of our age. The attacks, in a way, shattered the myth that geographicisolation of the United States, flanked as it is by two massive oceans, would protect it

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Name a few major terror attacks after 9/11.Year - 2002; Place - Bali; Who carried out - Jemmah Islamiya, a local cell of Al-Qaeda;What happened - bombs detonated at two popular nightclubs, frequented by foreign

tourists; How many died - 202.

Year - 2003; Place - Baghdad; Who carried out - Al-Qaeda in Iraq; What happened -Truck laden with explosives rammed into UN headquarters; How many died - 19,

including the UN Special Representative for Iraq, Sergio Vieira de Mello.

Year - 2004; Place - Madrid; Who carried out - Not established, but Al-Qaedasuspected; What happened - 10 serial blasts on 4 trains; How many died - 191.

Year - 2005; Place - London; Who carried out - British citizens, with links to Pak-based terror groups though group identity not established; What happened - 4 serial

blasts on buses; How many died - 52.

Year - 2007; Place - Algiers; Who carried out - Al-Qaeda in the Islamic Maghreb; Whathappened - suicide bombers run into UN building; How many died - 34.

Year - 2008; Place - Mumbai; Who carried out - 10 Lashkar-e-Toiba terrorists, withlinks to Pakistan's ISI; What happened - Multiple attacks on high-value targets, like the

Taj Mahal hotel and Trident hotel; How many died - 166.

Year - 2010; Place - Kampala (Uganda); Who carried out - Al-Shabab, Somalia-basedterror group, with links to Al-Qaeda; What happened - 2 blasts at one hotel and a

club; How many died - 74.

Repeated terror attacks have a numbing feeling; unfortunately they numb our mindand hence whenever any terror attack happens, all we do is to 'click our tongue - tch

tch' and move on to an entertainment channel on the Idiot Box.

The Explainer: Foreign Direct InvestmentStarting today, every Friday, I will blog on 'explaining' crucial issues, including issues ofeconomic and political nature. This feature will be titled 'The Explainer'. Most of these

Explainers will be in the form of Question & Answer (Q&A), with minimal jargon.

I will start this series with 'Foreign Direct Investment', or FDI, as it is more popularly known.

The language and interpretation are mine; the data have been taken fromhere.

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What is FDI?FDI refers to the capital invested by a foreign company in an existing or new domestic

company. This way, by directly acquiring a 'stake' (by contributing to capital) in the domestic

business, the foreign company becomes a shareholder.

(Please note that FDI does not relate to the funds invested by a foreign company in the share

market; such investment is called Foreign Institutional Investment (FII).)

For example, if Prudential, a British company, invests in ICICI Prudential Life Insurance, by

way of capital, such investment is termed FDI.

In what way can a company bring in FDI?FDI can be brought in through direct injection of funds into the capital of the company,

subject to government rules.

What are the advantages of FDI?A foreign partner (the one who brings in FDI) may come with better technology, technology

transfer, expertise in executing large and complex projects (like airports), global reputation,

financial leverage, access to markets elsewhere, etc.

How much FDI did India receive between April 2000

and March 2011?Between April 2000 and March 2011, India received a cumulative FDI of U.S.$194.81 billion.

How much FDI did India receive in the last financial

year (2010-11)?

In 2010-11, India received U.S.$19.42 billion in FDI. This figure is 25 per cent less than the FDI

inflow of U.S.$25.83 billion received in 2009-10.

Which sectors attracted the highest FDI in 2010-11?

The top three sectors (in order of highest) are: Services (21% of all FDI), Computer Hardware

& Software (8%), and Telecom (8%).

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Which were the top investing countries in India in

2010-11?

Mauritius (42% of all FDI came via this island country), Singapore (9%), and the U.S. (7%).

How is it that the tiny island nation of Mauritius is the

biggest foreign investor in India?

India has a Double Taxation Avoidance Agreement (DTAA) with Mauritius. Without getting into

complex tax jargon, if a company based in Mauritius is paying tax there, it will not be asked

to pay tax in India. Since the tax rates are either nil or extremely low in Mauritius, companies

prefer to route their investments into India through Mauritius.

Let me bring to you a snapshot of FDI limits in some major sectors as laid down by the

Government of India.

Sector % of FDI Cap / Equity

Agriculture & related fields like Aquaculture 100

Mining 100

Defence 26

Airports (Greenfield & Existing) 100

BankingPrivate Sector 49 through automatic route

74 via Govt. approval

BankingPublic Sector 20 (both FDI & FII)

In Broadcasting

- Terrestrial FM

- Cable Network

- Direct-to-Home

20

49 (incl FDI, FII, & NRI)

49 (incl FDI, FII, & NRI)

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Commodity Exchange 49 (includes 23% for FII)

Insurance 26

Petroleum & Gas Sector (exploring &

refining)

- by private sector companies

- by public sector companies

100

49

In Print Media

- Current Affairs & News

- Scientific & Technical journals

- Facsimile edition of foreign newspapers

26

100

100

Telecom 49 through automatic route

74 via Govt. approval

Internet Service Providers 49 through automatic route

74 via Govt. approval

Trading

- Wholesale Cash & Carry

- Single Brand Retail

100

51

An example: In telecom, the FDI limit is 74%. What it means is that in a telecom company

like Uninor (a joint venture between Unitech, an Indian company, and Telenor, a company

based in Norway), the maximum that Telenor can contribute to the capital base of thecompany is 74%. The rest of the capital (also called equity) should be held by an Indian

company or a clutch of Indian investors.

Jargon decoded:

Greenfield: Any project that is not constrained by prior or existing project. In short, abrand new project. For example, the building of the Hyderabad International Airport is

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a greenfield project. The developers were not constrained by existing infrastructure.Now contrast this with the Indira Gandhi International Airport in New Delhi. It wasbuilt in and around the existing old airport, and the developers were constrained bythe existing infrastructure in developing it.

Automatic Route: Any FDI under the automatic route does not require prior approvaleither by the Government of India or the Reserve Bank of India (RBI).

Government Approval: Any FDI that is NOT under the automatic route requires priorapproval by the Government of India.

I have tried to keep it simple. This is meant for a reader who is not comfortable with

economic jargon. I have deliberately skipped putting in some real tough terms, like capital

gains tax, while explaining DTAA with Mauritius.

Do you like this new feature - The Explainer? Please select your reaction to this new feature

and to this post by selecting the relevant check boxes below.

The Explainer: Stock Market - Part ILast week, I started 'The Explainer' - a feature on explaining important political and economic

issues. Initially I was skeptical of your response; however, your response to the first article on

FDI was overwhelming and extremely positive. Thank you!

The Explainerthis Friday will focus on 'Stock Markets'. In the space below, I have explained a

lot of stock market terms, like dividend and demat accounts. I will try to explain these

complicated terms in a layman's language.

What is the basic difference between a Private

Company and Public Company?

In a private limited company, the minimum number of people required to start the business istwo (2); in other words, you require a minimum of two people to contribute to the capital. In

a public limited company, seven (7) people are required to start the business.

As for the maximum members who can contribute to the capital of a private company, it is

50. In the case of a public limited company, it is unlimited; in other words, a public company

can have lakhs of people contributing to the capital base. For example, Reliance Industries, a

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public limited company, has more than two million shareholders.

In a very simple way, the people who start the company are called promoters.

What is a 'Share'?

The total capital of a company is divided into a large number of units. Each unit is given an

equal value; such value is called par value (also called face value). Each such unit (with an

equal value) is called a share. In short, a share is a unit of capital.

Example:

Let us say that you and six of your friends wish to start a public limited company, with

Rs10,00,00,000 (Rs Ten Crore). Now you do not wish to invest a lot of your own money in thecompany because there is an inherent risk associated with it (like you may lose your entire

investment if the company goes bankrupt!). So follow a simple principle of investment: use

OPM Other Peoples Money!

To make it easy for people to invest in small parts, you divide the total capital of Rs10 crore

into 1 crore units, each with an equal value of Rs10. In this example, Rs10 crore is the total

capital of the company, the total number of shares is 1 crore, and Rs10 is the par value (also

called face value) of each share of the company.

The company now comes out with a prospectus, asking people to subscribe to the capital of

the company. Let us say, I have bought 2000 shares of your company, at Rs10 each, for a totalinvestment of Rs20,000. So now I have become a shareholder of your company; in other

words, a co-owner of your company.

What is Dividend?

There are different names for the returns gained on various kinds of investments. For

example, when you invest money in a Fixed Deposit, the return is called interest. Similarly

when you invest in shares, the return on such investment is called dividend.

Let me open this up. A dividend is that part of the profit that is distributed amongshareholders. Each share-holder will receive her share of the dividend in proportion to her

share holding (as a part of the total shares issued). In other words, dividend can be termed

as distributed profit.

Recall that I had purchased 2000 shares. Now if the company declares a dividend of 20% on

the face value of the share, then the dividend would be Rs2 per share. So, the total dividend I

would receive would be Rs4000 (2000 shares x 2 per share).

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What is a Stock Exchange?

A stock exchange is a marketplace where the shares of public limited companies are bought

and sold. In India, the two main stock exchanges are the National Stock Exchange (NSE; India'slargest) and the Bombay Stock Exchange (BSE; Asia's oldest, established 1875).

What comprises a Stock Market?There are two major components in a stock market: primary market and secondary market.

What is a Primary Market?The primary market can also be called capital market. It is a market in which newly issuedshares are sold and purchased, via application. Hence, the primary market is also known as

new issues market.

You must have seen ads of companies coming out with new issue of shares: in other words,

these companies are raising fresh capital and are asking members of the public to buy shares

(by subscribing to the capital) at the quoted par value and thus become shareholders.

What is a Secondary Market?

In this kind of a market, you deal in shares which already exist. In other words, it is a market

in which previously issued shares are traded. Trading in such shares is done through a stock

exchange.

Can you buy / sell shares on a stock exchange directly?

No. One needs membership of a stock exchange to be able to buy / sell shares on a stock

exchange. The membership of a stock exchange comes with a very high price tag; hence it is

difficult for common people like you and me to directly trade shares on a stock exchange.

So, how do you buy / sell shares?

We can buy / sell shares by approaching a stock broker, who is already a registered member

of a stock exchange. There are a large number of stock brokers in the market (like Motilal

Oswal and Anand Rathi) who can help us buy / sell shares.

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Recall again that I had bought 2000 shares. Now if I wish to sell these shares, I need to have

two things: (1) approach a stock broker to find a buyer and (2) own a demat account.

The easy part is that a stock broker can help me find a buyer on the stock market and help

me dispose of my shares.

What is a demat account?Demat stands for dematerialisation. In the past, when you purchased shares, you received

hard / physical copies of certificates as proof of ownership of shares (just like a fee receipt or

a fixed deposit receipt).

However, in order to avoid legal hassles like stealing of share certificates (and tax

transparency) and administrative problems like crumpled share certificates, demat accounts

were introduced.

A demat account can be opened with a bank or a stock broking house, for which the bankcharges a fee. It works like a normal bank account or like your email account. In the most

basic way, when you purchase shares, an electronic entry is entered in your demat account

that mentions such a purchase. Similarly when you sell shares, another entry is made which

reflects such a sale. In other words, a hard copy of your demat account will look like the

passbook of your savings account.

What is Speculation?In the world of stock markets, Speculation relates to any activity that involves risk-taking. For example, a speculator may try to buy at a low price to sell later at ahigher price, thus making a neat profit in the bargain. Now, you may wonder where isthe risk here?

Any activity which is future-based involves risk. Look at it this way: the speculatorbuys at what he believes is a low price; he does this to sell at a higher price -something that may happen in the future. But there is no guarantee that the pricewill rise in the future. Thus he is taking a chance; in stock market jargon, this 'takinga chance' is called speculation.

In a simple way, let's say, even before the third test between India and Englandstarts, you place a bet on its outcome - that India will win the match. Now what youare doing here is that you are speculating, with considerable risk involved - India mayor may not win the match!

Who is a Broker?A broker is a middleman who brings a buyer and a seller together. He helps strike adeal; he charges brokerage or commission for his services. He does not buy or sell forhimself; he does this to earn commission. In the stock market, there are bothindividual brokers as well as corporate brokers (like Motilal Oswal).

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Types of Stock BrokersThere are two important types of brokers: Bear and Bull. Though brokers, they arecalled by these peculiar names after the kind of speculation they indulge in.

Who is a Bear?A bear is a broker and a speculator. He is a pessimist; he expects the price of sharesto fall. So what he tries to do is to sell at today's price, which he fears will fall in thefuture. He believes that by selling the shares at today's higher price, he can avoidmaking a loss in the future. If there is large-scale selling by a large number of bears,such a market sentiment is called bearish.

Who is a Bull?A bull is a broker and a speculator. He is an optimist; he expects the price of shares

to rise. So what he tries to do is to buy at today's price, which he hopes will rise inthe future. He believes that by buying the shares at today's lower price, he can makea big profit in the future after selling the shares at a higher price. If there is large-scale buying by a large number of bulls, such a market sentiment is called bullish.

After this simple take on stock brokers like bulls and bears, now let us look at twoimportant types of investors: Chicken, Pig, and Stag.

Types of InvestorsThere are three important types of investors: Stag, Chicken, and Pig. I will not focus on the longterm investor.

Who is a Stag?A Stag is an investor who buys shares through a famous company's Share Issue, i.e. onapplication when the company comes out with a share issue. He does this with asimple view: Buy at the face value (i.e. par value) and sell either before the companygets listed on the stock exchange (i.e. before trading starts on the stock exchange),or on the first day of the listing or in the first few days after the company gets listedon the stock exchange.

The idea behind this is simple: buy at a low price (on application) and sell at a profit

when the price goes up in the first few days of the company's listing. There is prettylittle risk involved in this kind of trading.

Who is a Chicken?Ever heard the term - 'chicken-hearted'? If you called someone 'chicken-hearted', youmeant to call that person a coward, i.e. someone lacking courage.

In the same way, a Chicken is an investor who does not have the courage to take risk.

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He is risk-averse, i.e. he avoids taking risk. He does not wish to lose money (andsleep!). So he does not speculate; he also avoid buying / selling anything for the shortterm. Typically he invests money in fixed deposits (mostly with nationalised banks;the guy would not trust private sector banks) and government bonds, like those issuedby the RBI. On a rare occasion, he might invest in some blue chip stocks for the long

term.

For your information, blue chipstocks relate to those companies that are financiallysecure, have a long track record of consistent growth, and sometimes, high dividendpayout history.

Who is a Pig?As an investor, a Pig is the antithesis of a Chicken; a Pig loves to take risk, to makethat LARGE profit. Being impulsive and greedy by nature, he buys on the spur of themoment, without doing any background check on how the company is performing orwhether the share price will rise.

A Pig is the darling of a stock broker (bear / bull). Since he is a huge risk-taker, thestock brokers love him. The Pig may or may not make money but the stock brokerdoes (by earning his commission).

I wanted to keep this article short; I hope this helps.About an hour ago, the courier guy delivered a parcel containing a copy of Monsoonby Robert Kaplan. Geopolitics and geostrategy have always fascinated me; in fact,along with history, philosophy, and literature, I just love these two ideas.

I will keep this post short, that is because I am eager to start reading the panoramic

sweep of ideas that this book promises. In this week's The Explainer, I will focus onfactors that influence share price.

What factors influence share price?The major factors are:(a) company performance & dividend income;(b) speculation;(c) industry prospects, and(d) government policy.

(a) Company Performance & Dividend:Investors often keep an eye on a companys performance, especially with regard to itsearnings. Often, you must have observed that your investor-parent / uncle / sibling orsimply any player in the stock market pays great attention to the declaration of thecompanys earnings (quarterly or half-yearly or annual).

If a company is running profitably, investors would definitely show interest in owning

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shares of such a company. As the business churns out profit, it may reward itsshareholders with rising share prices.

Also, some investors buy shares with an eye on dividend (distributed profit; return oninvestment in shares). When the company declares dividend, it distributes the profit

among the shareholders. A company that declares dividends on a consistent basis willattract investors.

However, there is demand from investors even if the company does not declaredividend. Thus is because if the company does not declare dividend, it would convertthe profit into cash reserves, which can be used to buy other companies, invest inbetter technology, and to ride over rough market times.

For example, Apple Inc. has not declared a dividend since 1995! It is sitting on a cashpile of U.S.$75 billion. Its share price has gone by more than four times in the lastfour years. I think you have got the point.

(b) SpeculationIn India, most people invest to reap a profit in the short term, and not to maximizethe value of their capital appreciation in the long run. Given the nature of Indiasstock market, speculation is the norm, not the exception!

Speculation can lead to volatile movement in share price, even in a short time. A fewyears back, in a mail to a student I explained speculation in the following manner:

You buy the shares of Company A because you believe somebody else will pay morefor it in the future. Now the reasons for the expected price rise do not really matter.

All that matters is the beliefthat the share price will rise. Such speculators (short-term traders) dont base their buying behaviour on factors like company performance.Most bubbles in the stock market are the result of large-scale speculative trading. It isin the nature of a bubble to burst, and when it bursts, it takes with it a large numberof speculators down the drain.

In the same way, a companys poor performance, poor earnings outlook, misseddividend payment, or even speculation can drive its share price down.

(c) Industry Prospects

Another major factor that plays a major role in determining the share price is theindustry outlook. Investors (am not talking of speculators) like certainty; stability isgood for business. The nature of business environment often determines the growth ofan entire industry.

For example, the current outlook of the U.S. and Eurozone economies is pessimisticand negative; these are the major markets for the IT and ITeS (IT-enables Services,like BPO) sectors. Now if the clients in these markets scale down their deals with

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Indian companies in these two sectors, the latter's performance will also suffer. Thiswill, in turn, impact the revenues, profits, and overall business. It is these negativefactors (i.e. downturn and fears of recession in the U.S. & Eurozone economies) thathave brought down the share prices of IT companies in the last few weeks.

(d) Government PolicyGovernment policy can also play a vital role in influencing share prices. Thegovernment's has a positive attitude toward a particular sector / industry can helpsend positive signals to the investor community. Government incentives may includetax holiday and supply of land and power at concessional rates.

For example, if the government gives tax holiday (no tax payment for a specificnumber of years) to companies in a specific sector, then the company need not paytax, thus saving precious money and build reserves or pay dividend.

There is another major factor: the company's performance against its peers. But I will

stop here. Monsoon is waiting for me! Thank you!________________________________________________________________________

In 'The Explainer' this week, I will focus on a not-so-well understood economic term:Cash Reserve Ratio (CRR). The Cash Reserve Ratio (CRR) is used by the RBI to controlthe supply of money in the economy. The amount of money determines the rates ofinterest and the prices of different commodities.

What is Cash Reserve Ratio?In terms of Section 42(1) of the RBI Act 1934, Scheduled Commercial Banks are

required to maintain with RBI an average cash balance, the amount of which shall notbe less than three per cent of the total of the Net Demand and Time Liabilities (NDTL)in India, on a fortnightly basis and RBI is empowered to increase the said rate of CRRto such higher rate not exceeding 20% of the Net Demand and Time Liabilities (NDTL)under the RBI Act, 1934.

In simple terms, all scheduled commercial banks must keep a 'certain percentage oftheir total time and demand liabilities with the RBI'.

This is all Greek to me. Please explain the definition.

A liability is also called a loan. Here, a liability is simply a deposit account with abank, i.e. what we call a deposit is called a liability by the bank as it would have torepay us (the money in that account). In other words, a deposit is our LOAN to thebank (and hence the interest paid by the bank).

There are two kinds of liabilities (hereon, we will use the term, 'deposit'):(1)time deposit, and (2) demand deposit.

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Explain Time and Demand Deposits.A Time Deposit is a type of account from which you can withdraw your money ONLYafter a specified period of time. An example is a fixed deposit account. Hence, it is

also called Term Deposit.A Demand Deposit is one from which you can withdraw your money on demand. Forexample, from your Savings or Current account, you can withdraw money at anytime.(Also, you must have observed that an ATM is card is typically issued on these kinds ofaccounts, though they are also issued on some special types of fixed deposits).

Now, having understood the backgrounder on deposits,let's go further on CRR.

Under the CRR, every scheduled commercial bank has to keep a certain percentage ofsuch deposits with the RBI. The percentage lower limit is 3% while the upper limit is20%. The current CRR is 6%. (You can access these data pointshere.)

How does this affect people like us and the economy ingeneral?As mentioned earlier, the CRR is used by the RBI to control the supply of money in themarket. The amount of money determines the rate of interest and the prices ofdifferent commodities.

How does this work?

0.25% roughly equals about Rs8000 crore (Rupees Eight Thousand Crore only).

Let us say the RBI increases the CRR by 0.25%. This would mean that banks wouldhave to keep more money with the RBI (Rs8000 crore will go into the RBI). This wouldreduce the money available with them. So this brings down the overall money supplyin the market.A lower money supply would raise the interest rates (as demand formoney is always high).

Now look at the reverse scenario. A reduction in CRR by 0.25% would release Rs 8000crore into the market.As the money supply rises, the interest rates decrease.

What do we do when the interest rates are high?Common sense dictates that when interest rates are high we SAVE money and notSpend it. On the other hand, lower interest rates would make us SPEND more and notSave.

Lower interest rates would boost demand for goods and services. In the short run, thisresults in inflation as supply may not be able to match consumer demand.

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However, in the last three years, the RBI has raised the CRR from 3% to 6%. A higherCRR would mean that there is less money in the market. So there will be less moneywith people, which would mean that their demand for goods and services would below. So the prices would be low. Hence inflation will be low.

Just think about an increase in CRR of 3% in about three years; over Rs2 lakh crore hasbeen sucked out of the system into the RBI! Though such a large amount has gone outof the system, it still has not brought down the rate of inflation.

As we can see today, inflation is very high and is impacting the common man in a verynegative way. The RBI has tried various measures, like raising the CRR, to bring downinflation but to no avail.

Sometime in the next four weeks, I will write on why the inflation rate is so high andhow higher interest rates may impact economic growth in a negative way.

The Explainer: Credit RatingIn the wake of the twin crises of Eurozone economy and U.S. debt ceiling, the concept of

credit rating has come into sharp focus. This week's The Explainerfeatures a Q&A on credit

rating.

What is Credit Rating?

Any form of debt (i.e. money borrowed) has to be repaid. So before you lend money, you

would like to perform a background check on the borrowers repayment capacity, i.e. ability

and willingness to repay the debt. In other words, this background check is used to test the

creditworthiness of the borrower.

Based on the result of the background check, a credit rating is used to assess the

creditworthiness of a borrower or issuer of debt. This kind of credit rating is assigned by a

credit rating agency.

Name some famous Credit Rating Agencies.

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Globally, there are three famous credit rating agencies: Standard & Poors (S&P), Moodys,

and Fitch. ICRA, CRISIL, and CARE are some of the credit rating agencies in India.

On what basis is Credit Rating assigned?These agencies assign ratings to issuers of debt, such as companies and governments. To

arrive at a credit rating, the agencies evaluate not only current and historical information but

also assess the potential impact of foreseeable future events on the borrowers capacity to

repay the debt.

While assigning a credit rating to a country (like India), the focus is on political stability,

monetary stability, impact of global events on the countrys economic and political stability,

and overall debt burden.

When it comes to rating a company for its creditworthiness, the factors taken into

consideration are: companys past and current performance, industry profile, companys

position in the industry and how does it compare with its competitors in the industry, revenue

model and cash flow, projected earnings, current debt load, corporate governance, and

accounting practices.

If a country or company has AAA rating, what does it mean?

The AAA (triple A) rating is the highest possible rating that can be given to a country or

company. S&P says that it gives AAA when there is an extremely strong capacity to meet

financial commitments and is the least likely to default on its debt payments.

The major benefit of AAA rating is that it helps a country or company borrow at low rates of

interest. This is because lenders know that lending to such a borrower comes with low risk as

it would almost not default.

Important to remember:

Credit ratings reflect relative opinions about the creditworthiness of a borrower, from the

strongest (AAA) to weakest (D).

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For example, a company or country that is rated 'A' is only less likelyto default on a debt

payment than a country or company with a 'BBB-' rating. It is not that it will not default, but

only that the possibility of a default is less likely than those rated below it.

Also, note that different credit rating agencies may assign different credit rating depending

on its analysis of the company or country's situation.

In the space below, you will find three different

graphics:

(a) Types of Credit Ratings and what they mean:

(b) Current Global Credit Ratings

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(c) Current Credit Ratings assigned to Eurozone countries:

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The Greece MessAs you can deduce from the last graphic, Greece is on the verge of a default whilePortugal runs a substantial risk of default.

For want of space, I will share only a short backgrounder behind the credit ratingassigned to Greece.

Just look at Greece's financial condition: its external debt is at U.S.$380 billion, whichis 142% of its GDP! Its economy is not doing well; in fact, its GDP contracted by 10.2%last year (i.e. its GDP fell below previous year's amount). Some of its debt was due forpayment; however, it does not enough money to pay back the huge debt it hasaccumulated over the years. Hence it had needed bailouts (emergency funds) to

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overcome the debt payment crisis. In fact, you could apply, more or less, the samereasons for both Ireland and Portugal.

I know this was a difficult topic to deal with; but I am sure that since I have usedpretty little jargon, you will understand most of this complex stuff.

Self-induced sluggishness

This year will probably be a pretty bad one for the world economy; it

doesnt have to be

POLITICIANS like to promise better times ahead. But these days many are peddling gloom. Inher new years address, Angela Merkel, Germanys chancellor, predicted that 2012 would bemore difficult for the euro zone than 2011. Nicolas Sarkozy, Frances president, spoke of theyear of all risks. Half a world away, Manmohan Singh, Indias prime minister, warned Indiansnot to take fast growth for granted.

In one way this pessimism looks a little overdone. The worst outcomesa collapse of Europessingle currency or a hard landing in Chinaare avoidable. The latest crop of statistics,particularly better-than-expected figures on global manufacturing prospects, argue against a

sudden slump. America may do a bit better than forecast. The overall effect should be sluggish,not dire: global output may grow by 3%, the slowest since 2009 and well below the average ofthe past decade.

But in another way, the sombre warnings are apt, and profoundly depressing. One reason whythe outlook is so

lacklustre is that politiciansespecially in the Westwill do little to help (and may harm) theireconomies. It could be better.

Begin with Europe, the weakest cog in the global engine. The euro zone has almost certainly

already slipped into recession, which most forecasters expect to be short and shallow: a group ofseers polled regularly by The Economistestimates that output will fall by 0.5% in 2012. The casefor a mild downturn assumes that Europes policymakers, however haltingly, are on course tosolve their debt crisis; that the European Central Bank (ECB) has reduced the risk of a debtcalamity with its recent provision of three-year liquidity to banks; and that the impact of fiscalausterity on growth will be brief and modest.

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Those hopes may be misplaced. Uncertainty about the euro zones future is st ill acute, not leastbecause its politicians are more focused on preventing future profligacy than supportingembattled economies today. Despite the ECBs liquidity injection, banks seem reluctant to buymany government bonds. And since Italy and Spain alone need to roll over 150 billion ($195billion) of debt in the first three months of this year, the odds are that worries about sovereign

debt will intensify. A pernicious circle of weak growth, bigger deficits and more austerity issetting in. Look at Spain, where the new government revealed that the 2011 budget deficit wouldbe worse than expected (8% of GDP rather than 6%) and immediately announced new spendingcuts and tax increases to compensate (seearticle). If these contractionary forces feed onthemselves, Europes downturn could be ghastly.

Some emerging concerns

The euro zone is thus the darkest shadow hanging over the world economy; but it is not the onlyone. Emerging markets may stumble. Chinas economy is clearly cooling. And even if, as seemslikely, Beijing loosens macroeconomic policy deftly enough to prevent a sharp slowdown,

growth this year is likely to be no more than 8%. Slower growth in China is dampeningcommodity prices, hitting exporters in Latin America. Add in some home-grown problems(India, for example, faces a big budget deficit, declining confidence and high inflationseearticle) and the ripple effects of the euro crisis (which will hit growth in eastern Europe andTurkey hard) and it is plausible that emerging economies will grow by only about 5%. Thatwould be their weakest performance in a decade, aside from the global slump of 2009.

If there is a positive surprise, it is likely to come from the United States. That is not becausegrowth there will soar, but because expectations for the worlds biggest economy are so low. Theconsensus among professional forecasters is that Americas GDP will grow by 2% in 2012,below its underlying speed limit, and far too slow to bring the jobless rate down.

That could prove a bit too gloomy. Unlike Europe, America has moderated the pace of its fiscaltightening, thanks to the temporary extension of the payroll-tax cut. Household-debt burdenshave fallen, the housing market shows signs of stability and the labour market is showing flickersof life. But Americas outlook, like Europes, is darkened by political uncertainty. The payroll-tax cut has only been extended for two months, ensuring that the rest of the year will bepunctuated with fiscal skirmishes, even as nothing is done to deal with Americas medium-termfiscal mess, or to smooth the huge tax hikes and spending cuts that loom at the end of 2012 undercurrent law. It is a recipe for crushing confidence and scaring off investors.

History teaches that financial crises are followed by years of weakness. But some of the currentpain is unnecessary. There is no excuse for the lack of clarity around the euro zones future, norfor Americas fiscal paralysis. Europeans do not need to compound the peripheral economiesproblems with even deeper austerity. A more calibrated approach with more financing and morestructural reforms makes far more sense. Inept politicians have placed a big burden on centralbanks, which will have to take more unconventional measures, such as quantitative easing (seearticle). That will ease the agony, but it wont make up for politicians mistakes. It looks like2012 will be the year of self-induced sluggishness.

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