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A SIMSREE FINANCE FORUM INITIATIVE ARTHNEETI DECEMBER 2012 ISSUE
EDITORIAL
SPECIAL FEATURE
An Interview with Mr. Harish Hulyalkar, Director, M&A, Citigroup India
Financing the Indian SME’s: Challenges and The way Forward……. By- Saurabh Aggarwal
Subsidy Cuts and FDI Inflow: Two Catalysts for Indian Economy Revival By Vivek Srivastava & Tushar Sharma, PGDM-IFMR, Chennai
Fiscal Cliff in Totality By SIMSREE FINANCE FORUM
The government of India has a major problem to tackle this
financial year- Fiscal Deficit. It has tried all possible means
to reduce the deficit to the acceptable level. Subsidy bill are
a major part of government spending in India. So GOI is now
determined to reduce the subsidies on diesel. It has now
agreed to deregulate the prices of diesel in a gradual
manner. So is the case with LPG cylinders. These steps
suggest the desperate need of the government to bring its
spending below the threshold. Another important step that
has been taken is disinvestment of PSUs.
Another important issue in India is the financing of SMEs.
Small and medium enterprises are growing in India.
However they have not yet found a proper and a simpler
way to finance themselves except for a few. In fact it can be
said that there is a lack of adequate access to finance for
the SMEs which is a bottleneck in itself. The problem here is
not just with the banking sector but also with the ignorance
among the SMEs with the options available. India can
become a sustainably growing economy if all these
bottlenecks are addressed.
Finally we had the huge global issue of Fiscal Cliff. The US
government have just taken a decision to defer the tax
discount cuts. So the situation is still not absolutely clear.
The danger has been deferred and not avoided.
In this issue we have taken the interview of Mr. Harish
Hulyalkar, Director, Investment Banking (M&A) at Citigroup.
He shares with us some important details about the M&A
industry. As part of our forum activity we have an article on
“Subsidy cuts and FDI inflows:Two catalysts for the Indian
Economy” written by Tushar Sharma and Vivek Srivastava
from IFMR. We also have an article from our alumnus Mr.
Saurabh Aggarwal on “Financing the Indian SMEs:
Challenges and the way forward.” Finally we have an article
from our team on fiscal cliff.
Happy Reading!
TEAM ARTHNEETI
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Q.1 What according to you are the
problems facing the M&A market in India
and around the world?
Ans: The M&A volumes are strongly
correlated with the global economy and
growth sentiment around the world. The
GDP growth of major economies in
Europe and North America has been slow
which has been reflected in the M&A
volumes as well. However these
economies are now recovering slowly and
hence the M&A market is also seeing a
revival. As such there are no hurdles in the
way of this market and it is a function of
the economy and global sentiment. This is
the case in India as well as around the
world. Cross-border M&A volumes will
continue to contribute a greater
percentage of total volumes, as
companies look to invest capital in growth
opportunities outside their home country.
Q.2 Are there any regulation problems
with respect to the M&A taking place in
India? If yes what are those?
Ans: India is a relatively highly regulated
market from an M&A perspective. Every
transaction in India has to closely
evaluated from a tax, legal and regulatory
perspective. A key regulation which
impacts M&A is the ability to delist the
target company from stock exchanges. In
many countries, if an acquirer acquires a
majority stake in a target company and
reaches a certain ownership threshold,
the acquirer has the ability to delist the
target company and squeeze out the
minority ownership to achieve 100%
control. However in India this is not
allowed. This tends to be an inhibitor
specially for international companies
looking to acquire listed Indian
companies.
Q.3 What is the role of CCI in M&A deals
in India?
Ans: The role of CCI is to ensure that
mergers, acquisitions and similar
arrangements do not stifle competition
and provide undue bargaining power. The
CCI role has been very clear and most of
the M&A deals have been cleared by the
CCI in line with the prescribed rules and
within the prescribed time frame.
Q.4 Tetley was acquired by TATA tea
which is a smaller company when the
market share is considered for the
beverages market. Why would such a
large company let a small company
acquire itself? Or what are the factors
considered by a larger company before
such a deal happens?
Ans: One reason can be the attractiveness
of the offer. If a target company gets an
attractive offer, then its Board of Directors
have a fiduciary obligation towards their
Interview: Mr. Harish Hulyalkar,
Director, Investment Banking (Mergers & Acquisitions),
Citigroup India
Topic: M&A trends in India
A SIMSREE FINANCE FORUM INITIATIVE ARTHNEETI DECEMBER 2012 ISSUE
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shareholders to evaluate whether
accepting the offer creates more
shareholder value than steady state
operations.
Another reason could be that the target
company is doing well, but its controlling
shareholder is in financial distress and
hence may consider divesting its stake in
the target company based on the most
attractive offer (potentially from a smaller
bidder).
Q.5 Does the purview of M&A consulting
include consultations during splits? Like
the one that happened recently with
Hero and Honda.
Ans: Sometimes joint venture terms need
to be restructured. In such situations, the
M&A advisor can help in structuring the
revised commercial terms of the joint
venture. In some cases, the joint venture
partners may decide to part ways, by one
party selling its stake to the other party,
or by finding a new third party buyer. An
advisor can help find a new buyer, or
advise on funding alternatives to facilitate
the buyout.
Q.6 Since 2005 there have been a lot of
India companies acquiring firms outside
India. Do you see this as a new trend in
India or is it just a co-incidence?
Ans: We saw the first wave of outbound
M&A deals from India in the 2006-2008
timeframe, pre financial crisis. As you will
appreciate, the world was a very different
place then; there was ample liquidity in
the global financial markets and
economies around the world were
confident about the growth prospects.
So during this timeframe, we saw some
large acquisitions done by Indian
corporates.
However since the financial crisis of 2008-
09, Indian corporates have been more
cautious about international acquisitions,
given the less attractive growth prospects
and higher uncertainty in these end
markets. The outbound acquisitions in
the last 2-3 years have been largely
focused in sectors like energy and metals
& mining, where Indian acquirors have
pursued acquisitions to get access to
natural resources like oil and coal.
Q.8 Since you have been in this industry
more than a decade now, what was the
most attractive deal according to you or
rather a historic deal for a particular
region or sector?
Ans: That is an interesting question. A
few global deals come to mind, which
transformed the landscape of their
respective sectors. For example, Ciba-
Geigy and Sandoz came together to form
Novartis, which is a global leader in the
pharma industry today. P&G’s acquisition
of Gillette and the Exxon-Mobil merger
are other examples of transformational
deals which created hugely successful
global companies.
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As far as India is concerned, we have not
seen many such transformational
transactions, but one that comes to mind
is the merger of ICICI Bank and ICICI,
which created a highly successful
universal bank, and redefined the banking
sector in India
Q.9 Can you forecast the M&A market in
India for the coming year in India? Or
some deals that you feel are on the verge
of consummation.
Ans: I think there will be interest in
inbound M&A into India across sectors,
and this trend will continue this year. As
far as outbound M&A activity is
concerned, it likely to be focused across a
few industries only.
One other theme which could play out is
M&A activity driven by exits by private
equity firms. Several PE firms who
invested during the 2006-2008 period
could look at M&A opportunities to sell
their stake, as generally the investment
cycle for these investors is around 5 years.
Q.10 Can you talk about the M&A activity
in the emerging markets like Africa, Latin
America and others?
Ans: These are fast growing markets, and
since the home countries of many global
companies are showing low-single digit
growth rates, it is obvious that new
emerging markets will look very
attractive. With the slowdown in China
growth, M&A buyers could also look at
faster growing Asian economies like
Indonesia and Malaysia.
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-By Saurabh Aggarwal
Small and medium-sized enterprises (SMEs) are widely seen as engines of economic growth. In developed countries, they are credited with creating jobs, delivering innovation and raising productivity. But SMEs in third world countries are not currently meeting that promise. While there is no lack of interest in promoting entrepreneurship in developing countries like India, we do lack evidence about what helps, or even what represent the biggest barriers to growth.
India is home to about 26 million small enterprises (with investments less than 50 million) that account for about 20 per cent of the country's GDP. Growing at over 10% in the last few years, the small and medium enterprises (SME) sector is considered a vital part of the Indian economy. However, one of the major bottlenecks to the growth of the SME sector is its lack of adequate access to finance. Despite the efforts of Ministry of Small and Medium Enterprises, SIDBI and support from the RBI by inclusion under priority sector, there continues to be a huge demand-supply mismatch in small enterprise financing.
Small enterprises, such as brick-kilns, grocery stores and small restaurants, need finance to purchase raw materials, procure stock, pay wages, meet other working capital requirements and support expansion plans.
Limited Access to Finance…
It will not be an exaggeration to say, Indian SMEs are in dire need for funding. The situation is extremely grim. Look at the contribution of SMEs in the GDP of countries like USA and UK. They contribute 40%-60% of the GDP and provide employment to 50%+ of the workforce. Even in developing countries like China and Vietnam, the ratios are very similar. However, in case of India, the contribution to GDP is just 20%. This shows huge untapped potential for SMEs. The major cause is lack of financing for SMEs.
One of the main reasons for banks/financial institutions (FIs) being unable to bridge this gap is the perceived credit risk involved in financing small enterprises. This is primarily on account of non-availability of valid bills, proper accounting systems and lack of known buyers.
Accurate information about the borrower is a critical input for decision-making by banks in the lending process which is not easily forthcoming in the case of SMEs, as the sheer ticket size of SME lending makes it non-viable for banks to invest in developing information systems about SME borrowers.
To mitigate such credit risk, banks typically look for enhanced collateral or
Financing the Indian SME’s: Challenges and The way
Forward…….
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traditional equity, both of which cannot be brought in by most entrepreneurs. . The credit managers are hesitant to fund new-age business ideas, and definitely not
without the guarantee of an asset that is 100% of the value of the asset. This is so owing to the higher degree of involvement required by the banker to understand the underlying cash flows of the business. Further, due to their small size and local presence, the transaction costs involved in financing them are very high.
In the face of lenders’ reluctance to finance, these enterprises are compelled to resort to high cost, non-continuous financing from money lenders and other informal sources, or continue to operate at sub-scale.
Ignorance among SMEs
The lack of financing is not only because of lack of interest of banking institutions but also because of ignorance among SMEs on the financing available. Most of them are promoted by 2nd or 3rd generation Entrepreneurs who understand only the traditional financial products. They can’t afford to hire modern day finance managers to deal with banks and adapt to modern financial products.
However, there are many consulting companies that have come up in recent years specifically focused on SMEs. They provide consulting services to them by advising the cheapest way to raise funds, liaising with Government to avail the schemes, and consult on overall operational and technical issues to improve efficiency, reduce bottlenecks, and optimize costs.
It is good idea to speak with such consulting companies for advice. Though SMEs may not need help in many cases if
they have right people to interact with financial institutions. However, in case of any uncertainty, the right way is to avail the services of these consulting firms.
Today, banks and financial institutions are also actively engaged in imparting knowledge of complex products to SMEs. Regular Events and seminars are being organized to spread information related to modern trade and treasury products.
Conclusion
The SMEs need to do their management planning and make the processes more formal, so as to have the documentations ready for financing opportunities. Accounting policies and consistency in book information will lead to better reliability from the bankers. The balance sheet clean – up would improve the credit worthiness of the average SME, qualifying the company for more bank loans as well.
Institutionally, provisions need to be included in the rules governing the SME sector so that periodically the enterprises are evaluated on a five-year basis and re-certified so that they can graduate from SME to mid-size companies.
Given the importance of the sector, the government, industry chambers, think-tanks and policy-makers need to come together to create an environment conducive for SMEs to flourish. This would in turn make SMEs banking-friendly. Adequate RBI and SEBI support and institutional reforms are also necessary to take the sector to the next level of global competitiveness.
To ensure the competitiveness of SMEs, it is essential that the availability of infrastructure, technology and skilled manpower are in tune with the global trends. Currently, the state of infrastructure, including power, water,
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roads, etc. in most areas where SMEs are set up is poor and unreliable.
It is worth noting that the current banking infrastructure, utilised for credit cards and ATMs, can be extended to SME financing. The system of SME financing is fundamentally similar to that of credit cards—hence the use of the processes and distribution networks is possible. Similar extension of existing infrastructure will be necessary in order to reduce the transaction costs involved.
Thus, a two-sided approach involving innovative lending from the financial sector, and better corporate governance systems in the SME sector can lead to a growing flow of financing.
In conclusion, at a time when the process of transformation of the economy has thrown up major challenges, it is important that the financial sector gears up for catering to this new segment and, in turn, fuel its growth in the coming decades.
FIN-QUIZ
1. Who is father of accounting
2. NYSE is called also as..change
3. The value of a forward contract at its initiation is
4. This term is derived from the Greek word 'Oikanomia' means "House Management". What is it?
5. What is known as "Greenshoe Option" or "Overallotment"?
6. Name the first Indian woman CEO of a Foreign Bank?
September 2012 Issue Answers:
1. Luca Pacioli
2. Arbitrage
3. Nostro Account
4. Letter of Credit
5. UCPDC – Uniform Customs and Practices for Documentary Credits
A SIMSREE FINANCE FORUM INITIATIVE ARTHNEETI DECEMBER 2012 ISSUE
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By Vivek Srivastava and
Tushar Sharma
PGDM - IFMR Chennai
(Winners of Arthneeti Article writing
competition- December 2012)
“No Power on Earth Can Stop an Idea
Whose Time Has Come”
- Manmohan Singh (1991)
Introduction:
The growth exhibited by Indian economy
over the past decade has been truly
inspiring. But the story was not a happy
one in 1990. Once derided for its 2%
“Hindu Rate of Growth”, the economic
might of India was unleashed in 1991.
Pre 1991, Indian economy faced a severe
BoP crisis. With dwindling exports and
rising debt, the situation appeared bleak.
Forex Reserves stood at `11,416 Croresi,
barely enough to last 3 weeks. The
situation was exacerbated by the
increasing oil prices due to Gulf War.
Inflation had reached its highest level of
13%. Subsequently, India’s credit rating
fellii. Simply put, the Indian economy was
on the verge of default with respect to its
external payments liability.
It was India’s decision to open its door to
FDI which led to tiding over the crisis.
Sectors such as mining, banking,
telecommunications and highway
construction were opened to investors’ iiipost 1991. FDI inflow rose from `2,705
Crores in 1990 to `18,486 Crores in March
2000 and `123,378 Crores in 2010iv. With a
growth rate of close to 7.7% over the past
decade, India today truly occupies pride of
place in the new economic order. India’s
journey has been an interesting one.
Positive investor sentiment in Indian
economy brought about by opening of the
doors to foreign investors led to infusion
of liquidity in funding starved Indian
economy and filled the coffers of the
Government. The push in upgrading
Indian infrastructure was possible only
because Government realized revenues
brought about by FDI. The social benefits
of this decision can be seen in the wide
variety available to the Indian consumers,
increased cosmopolitan fabric of our
society and increased competitive nature
of the nation’s firms.
The Story Today
Today, India is slowly slipping from the
path of high growth. IIP has plummeted
from 9.69% in 2010 to a measly 2.4% in
2012v. There is a wave of pessimism and a
loss of investor confidence that the India
Growth Story is coming to an end. Fiscal
Deficit is showing no signs of contracting,
and India’s External Debt has skyrocketed
to $ 289.7 Bn from a stable $ 237 Bn just a
yearvi ago (a 22% rise in just 1 year).
Spiraling budget deficit has led to
inflation. Infrastructure projects are all
coming to a standstill as major private
sector companies are overleveraged and
A SIMSREE FINANCE FORUM INITIATIVE ARTHNEETI DECEMBER 2012 ISSUE
Subsidy Cuts and FDI Inflow:
Two Catalysts for Indian Economy Revival
10
experiencing funding problems. Banks are
constrained in their funding projects
because of mounting NPAs on their
balance sheets. There are fears of
downgrades from credit rating agencies.
The Case against Subsidies
The biggest burden on Indian economy is
its burgeoning subsidies bill. There has
been a 200% rise in subsidiesvii since 2007-
08. In 2010-11, the country's subsidy
burden was `164,153 Crores -- or 2.08% of
the GDP -- and increased to `223,000
crore in the current financial year, which
is 2.5% of the GDP.
As late as October 2012, the Kelkar
Committee recommended that
Government cut subsidies in three
significant F's - Food, Fuel & Fertilizer - in
order to meet its budgeted fiscal deficit
target. The Committee further said that
the current deficit level of 5.1% could
balloon up to 6.1% if no corrective
measures were taken. The Committee
warned that India was on the edge of a
'fiscal precipice' and headed for a “fiscal
storm worse than 1991”viii.
The problems with the current subsidy
system are many. The ineffectiveness of
subsidies is an open fact. Still, policy
makers refuse to infuse a new line of
thinking to solve the problems. Low
property taxes have made Municipal
Corporations unviable. Municipal
Corporations and State Electricity Boards
are reeling under heavy losses. Low
electricity and water tariffs have reduced
the incentive to optimize usage and have
led to wastage of precious resources. The
PDS system for distribution of food grains
and kerosene has spawned practices like
black marketing and hoarding. Subsidized
urban housing is sold off and beneficiaries
revert to squatting. Low-priced public
transport tickets have pushed State
Transport Corporations towards
bankruptcy. Wage guarantees have
distorted labor incentives and prevented
efficient labor allocation.
The problem with fuel subsidies is that
they impose a heavy burden on
Government budgets, add to global
warming, pollution and cause wasteful
consumption in general. This, in turn,
diverts much-needed resources from
more pressing needs, such as health and
education. As National Income rises, so
does the consumption of fuel. Indian
policy makers have been oblivious to this
trap of rising fuel subsidy bill. The
lingering uncertainty over the outlook for
fuel prices may also affect investor and
consumer confidence at a time when the
global economic environment is more
challenging.
Similar is the case with subsidies in the
form of free power, fertilizers etc. The
biggest challenge for the government is
selecting an appropriate channel for
subsidy transfers. The current channels of
providing subsidies to the farmers are
deeply flawed. The most effective
approach to minimizing such distortions is
eliminating price subsidies and replacing
them with direct equivalent cash
transfers. In this context, the proposed
Direct Cash Transfer system via Aadhar is
revolutionary.
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The Government, constrained by coalition
compulsions, has paid some cosmetic
heed to the Panel's suggestions but with
the caveat that certain subsidies were
unavoidable. The recent hikes in diesel
prices and cap on subsidized LPG cylinders
are steps in the right direction. For a
country with a burgeoning middleclass,
such a cut in deficits is not a severe
problem. The middle class can afford it.
Indian citizens should be ready to pay the
price for development.
IS FDI Really the Engine for Growth?
The rationale for economic liberalization
during 1991 was to foster greater
competition in private sector which would
ensure efficient allocation of resources,
greater efficiency and achieve a spread of
income and prosperity. FDI in itself is not
the be all and end all solution. FDI and
growth form a complex cycle – where one
is the cause of another. Only when there
are conditions conducive for growth will
multi-national firms invest in India. And
their investing will provide a push to the
economy. FDI inflows are a signal that the
investment climate is fair and investors
have a sense of comfort and security.
Though it is a vital step for the
improvement of economy – it is only an
addition that bridges the gap in capital
formation required to sustain a targeted
growth. Our economic strategy cannot be
entirely based on FDI-led growth alone. In
India, it is estimated that FDI contributed
just 0.7% - 2.1% to GDP growth during the
period from 2003-10. Thus, to root out
prevailing pessimism, steps should be
taken to ensure that FDI inflows increase.
This can be achieved by:
Adopting a transparent policy
framework
Conducting an overhaul of the
regulatory framework
Evolving transparent procedures for
allotment of land, power,
environmental clearances, etc.
Time-bound single-window approvals
of various clearances
Developing physical infrastructure
comparable to international
standards
Developing a social infrastructure to
attract both highly-skilled and semi-
skilled human resources
For achieving high growth, India requires
more knowledge cities, SEZs, Industrial
clusters, IT Parks, Highways and R&D Hubs
etc. A 9% GDP growth would need $1
Trillion worth of investment in core
infrastructure alone. Funding for such
ambitious prospects mean that we pave
way for FDI.
FDI provides immense job opportunities
to local people and also assists in
improving the economic situation.
Sentiment plays a major role in the
growth of an economy. Government
recently allowed 51% foreign investment
in multi—brand retail but left it to the
states to permit global retailers to open
stores.
The sectors where we are seeing
stupendous growth today are the sectors
in which FDI has played crucial roles. The
drugs and pharmaceutical sector has seen
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12
a 15-fold jump in FDI in FY12. India has
gained from FDI in automobile, IT/ITES
and telecom sectors in terms of lower
prices and myriad choices, flourishing
infrastructure and continuous
accumulation of knowledge capital.
Parting Shot
Faltering FDI flows have affected India's
economic growth process and
undermined its position. For India,
considering its demographic challenge,
achieving high growth is not an option but
a necessity. The two catalysts - subsidy
cuts and FDI inflows - are crucial Indian for
unleashing the “Animal Spirits”. Only time
will tell if the revival in FDI is here to stay.
Transitory or not, revival in FDI flows is
certainly good news for the economy. And
sooner our baggage of subsidies is
trimmed, the better off we will be.
i Bulletin RBI (Table 45); Economic Survey 2011-12 iiIndia’s Credit Rating - Rajwade (Business Standard
May 1,2006) iii Study of FDI And Indian Economy – Sapna Hooda
(NIT-K) ivImpact of FDI on Indian economy - Mahanta
Devajit (RJMS Sept, 2012) v www.indexmundi.com
vi Finmin.nic.in – India’s External Debt (End Sept,
2011) vii
10 Problems Ailing The Indian Economy & Solutions To Revive It (ET June 2, 2012) viii
Kelkar Committee Report (RBI) pp4
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BY SIMSREE FINANCE FORUM
The Fiscal Cliff overview
“Fiscal cliff” is the popular shorthand term used to describe the situation that the U.S. government was speculated to face at the end of 2012. This was the period when the terms of the Budget Control Act of 2011 were scheduled to go into effect.
The deadline of December 31, 2012 was set to make some changes such as:
End of last year’s temporary payroll tax cuts which would result in 2% tax increase for workers
End of some tax breaks for businesses
Shifts in the alternative minimum tax that would take a larger bite
A rollback of the "Bush tax cuts" from 2001-2003
Beginning of taxes related to President Obama’s health care law
Also, the spending cuts those were agreed upon as part of debt ceiling deal of 2011 - a total of $1.2 trillion over ten years - were scheduled to go into effect. This spending cut had a projected size of a total of $1.2 trillion over ten years.
The Fiscal Cliff policy
Some important features of the fiscal cliff policy are as follows:
An increase in the payroll tax by two percentage points to 6.2% for income up to $113,700
A reversal of the Bush tax cuts for individuals making more than $400,000 and couples making over $450,000 which entails the top rate reverting from 35% to 39.5%
An increase in the tax on investment income from 15% to 23.8% for filers in the top income bracket
3.8% surtax on investment income for individuals earning more than $200,000 and couples making more than $250,000
A 2 per cent payroll tax cut was enacted during the economic slowdown. This would be allowed to expire as of the deadline of December 31, 2012
An estimate of budgetary impact of the various provisions suggested is as follows:
Raising taxes on individuals making more than $400,000 and couples earning more than $450,000 would help in raising $617 billion in revenue.
Extending unemployment insurance will release $30 billion in spending.
Postponing sequester cuts could cause $24 billion in spending to get stuck.
Delay in scheduled Medicare payment cuts to doctors relates to $30 billion in spending.
Extending various tax credits holding a share of $76 billion.
Extending tax credits from the economic stimulus legislation constitute for $78 billion.
The Fiscal Cliff in
Totality
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How actually the deficit became a real problem for US The huge deficit in the fiscal budget of United States has many reasons to count for. The major five reasons are as follows:
In 2011, almost 63% of the spending was made on past promises made for social security, Medicare, Medicaid, subsidies, debt interest.
One out of four dollars goes to health care. In 1960, spending on health care was about 10% before Medicare and Medicaid was part of spending. In contrast to this, healthcare spending has increased to 25% in 2012 and is projected to touch 33% in future.
Federal government employs an enormous number of four million people. This also constitute to a significant portion of US spending.
US government spends approximately 700 billion dollars on defence.
Tax paid by US citizens is falling significantly.
The Fiscal Cliff Debate The US lawmakers had three options to act upon the fiscal cliff. The first option was to let the policies come into effect as they were scheduled. The policy featured a number of tax rate increases and fiscal spending cuts. This would have cut the fiscal deficit significantly. But at the same time, the policies were speculated to affect the growth of economy and possibly push it back into recession. Another option was to cancel all or some of the scheduled tax increases and spending cuts. This measure would have
further increased the deficits and would have added to the hardships US already is facing. Another angle to this option was that US debt would have continued to grow which is not favourable at all. The other option could have been to take a middle path which would address the budget issues to a limited extent, but that would have a more modest impact on growth. This is ultimately the course lawmakers choice in the agreement reached on December 31, 2012.
How the fiscal cliff deal was handled actually The important date that comes into picture when fiscal cliff is mentioned is 31st December, 2012. The fiscal cliff agreement that came into picture can be considered as good news to some extent. But this cannot be ignored that the US lawmakers had 507 days to come to a solution to this problem. (These 507 days are calculated from the August, 2011 debt ceiling agreement to 31st December, 2012.) But, in spite of this, US lawmakers came down to the final hours before they were able to reach a solution. This caused unnecessary burden on financial markets and the economy. Now, after this much turmoil, the agreement only addresses the revenue side i.e. the taxes paid by US citizens. But, the discussion of spending cuts which called as “sequester” is postponed until March 1. So, we can see that it is still a wait and watch game.
So, we can say that the problem is temporarily solved as the deadline of 31st December is passed. But still the portion of the deal needs to be addressed. On a longer term basis, the cliff deal still needs to address the US debt load which is as high as $16.4 trillion.
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Features of the bill passed by the Senate: Past its own New Year's deadline, the Senate agreed to a deal to avert the fiscal cliff. Democratic-led Senate passed the measure that seeks to maintain tax cuts for most of the Americans but increase rates on the wealthy.
According to different estimates, this legislation would raise roughly $600 billion in new revenues over 10 years.
Republicans stood for higher tax rates for the wealthiest Americans, while democrats suggested a higher threshold for the people who are wealthy enough to face higher taxes. According to President Barack Obama, the law would be signed that would raise taxes on the wealthiest two per cent of Americans while preventing tax hikes that could have sent the economy back into recession.
The Worst Case Scenario If there would have been no change in the current policy chalked out to deal with the fiscal cliff, there wold have been a two way effect on economy. The step of spending cuts and raise in taxes would reduce the deficit by $560 billion approximately. But on the other hand, according to Congressional Budget Office, the policy would have slowed down the gross domestic product by four percentage points in 2013 which would have sent the economy into recession. Also, it was predicted that unemployment would rise by a per cent point which could have caused almost two million people to lose their job.
A May 16, 2012 Wall St. Journal article estimated the impact in dollar terms as: “In all, according to an analysis by J.P. Morgan economist Michael Feroli, $280 billion would be pulled out of the economy by the sun setting of the Bush
tax cuts; $125 billion from the expiration of the Obama payroll-tax holiday; $40 billion from the expiration of emergency unemployment benefits; and $98 billion from Budget Control Act spending cuts. In all, the tax increases and spending cuts make up about 3.5% of GDP, with the Bush tax cuts making up about half of that.”
Brighter Side to This If we think on the issue of fiscal cliff, we can see some brighter side to it. If at all the fiscal cliff happens, it might not be that much bad as it is imagined.
The other school of thoughts argues that the cliff would bring some long-term positive changes on the cost of some short term hardships. The argument says that U.S. has to tackle its deficits at some point, and this sort of "bitter medicine" would be a harsh, but definitive, step in that direction. Now, this short term effect could be severe and might cause recession in 2013. But, at the same time it can fetch long term benefits like lower deficits, better growth prospects, lower debt, etc.
According to the projections of the Congressional Budget Office, by 2022, the budget deficit would fall to $200 billion from its current level of $1.1 trillion. To achieve this, nation might have to face some tough situations as mentioned earlier.
A SIMSREE FINANCE FORUM INITIATIVE ARTHNEETI DECEMBER 2012 ISSUE
16
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