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10/3/13 The Economic Times -ET In The Classroom Archives 2 (Economics Concepts Explained) | INSIGHTS

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INSIGHTS

JU LY 1 8 , 2 0 1 3 9 : 3 7 A M

The Economic Times -ET In The Classroom A

(Economics Concepts Explained)

Ar ch iv es -1

Ar ch iv es -2

archives 3

Ar ch iv es 4

Ar ch iv es 5

The Economic Times newspaper now and then publishes articles on current economic issues in a questio

the heading ET In The Classroom. They are simple to understand and r emember.

Many tough concepts are beautifully expla in ed by th e ET team in th ese articles. All th ese articles are f

They a re the property of theEconomic Times. I have just consolidated all of them here for the benefit of

For a n IAS aspiran t preparing for th e UPSC civil serv ice examina tion, ET in th e Classroom is a one-s

acquain ted with man y economic jarg on and concepts.

This is part -2 of the arch iv es. Read and spread the kn owledge. Click her e for Ar ch iv es-1

ET in the classroom: Quantitative Easing II

What is qu an tit at iv e easing II?

The term became fashionable post the global economic crisis in 2008, following wh ich m ost gover nm e

pump in hu ge amount of liquidity in the ma rkets to tide ov er the crisis. Quant itativ e easing is the proc

the system by creating new money and eventu ally buy ing finan cial assets like bonds and corporate d

institutions in the country . This is done by centr al banks through w hat is popularly known as open ma

essentially is to ma ke adequate m oney in the system to spur consumption dema nd in any economy .

Quantita tiv e easing II is the popular phrase used in the context of Am erican economy these day s as the

touted to go for another r ound of quant itativ e easing to consolidate the r ecov ery of the America n econo

beca use of funda menta l r easons such as lower consum ption a nd job losses and escape of ca pit al to oth er

What does it mea n for India ?

Quantita tiv e easing II could flood emerg ing economies with t he dollars, th us ma king the dollars cheap

competitiv e while forcing other related cur rencies to appreciate on account of increase in capital inflow

Federal Reserv e chairm an Ben Berna nke will push for a fr esh infu sion of about a trillion dollars into th

of buy ing bonds, wh ich w ill push up bond prices and brin g down the y ields, an d the bond markets in In

Since economies like China an d Singapore hav e closed doors, or a re at best cau tious in their regula tion

to see a gush of capital flows, wh ich is likely to push up the stock prices, and m ight ev entually call for c

regulatory authorities.
http://economictimes.indiatimes.com/http://insightsonindia.com/2013/07/18/the-economic-times-et-in-the-classroom-archives-2-economics-concepts-explained/http://insightsonindia.com/2013/07/17/the-economic-times-et-in-the-classroom-archives-1-economics-concepts-explained/http://economictimes.indiatimes.com/http://economictimes.indiatimes.com/http://economictimes.indiatimes.com/http://insightsonindia.com/2013/07/19/the-economic-times-et-in-the-classroom-archives-5-economics-concepts-explained/http://insightsonindia.com/2013/07/19/the-economic-times-et-in-the-classroom-archives-4-economics-concepts-explained/http://insightsonindia.com/2013/07/18/the-economic-times-et-in-the-classroom-archives-3-economics-concepts-explained/http://insightsonindia.com/2013/07/18/the-economic-times-et-in-the-classroom-archives-2-economics-concepts-explained/http://insightsonindia.com/2013/07/17/the-economic-times-et-in-the-classroom-archives-1-economics-concepts-explained/http://insightsonindia.com/2013/07/18/the-economic-times-et-in-the-classroom-archives-2-economics-concepts-explained/http://insightsonindia.com/


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insightsonindia.com/2013/07/18/the-economic-times-et-in-the-classroom-archives-2-economics-concepts-explained/ 2

What ar e economist s say ing?

The expert opinion is mixed on this. Nobel Laureate Paul Krug ma n, w ho has been a v ehement cr itic of

fav ouring QE II. Higher commodity prices will hu rt the r ecov ery only if they rise in real terms, he said

nominal terms if QE succeeds in raising r eal demand. A nd this will h appen only if QE II is successful in

he said in a recent media interv iew.

An other Nobel pr ize w in ner , J oseph Stigl itz, w ho w as for merly th e ch ief econom ist wit h World Bank, fe

adv ocates are falling int o the sam e trap tha t led us into the crisis in the first place. Their v iew is that th

economic policy is the interest rate, a nd if one just gets it right, one can steer t his. That didnt w ork.

It forgot about the financial frag ility and how the banking sy stem operates. They re thinking the inter

and by setting tha t dial, y ou can regulat e the economy . In fact, it operates prima rily through th e bank

system is not functioning well. All th e literatur e about how the m onetary policy operates in normal tim

this situation.

Nouriel Roubini, who gain ed fame after his prediction of the global economic crisis of 2008, thinks fur t

hav e little effect on the US growth in 201 1. He regards QE II as the wr ong w ay to go. An excessive, perm

his view, is an indirect man ipulation of the exchan ge rate.

ET in a Classroom: Beggar Thy Neighbour Policy

What is beggar thy nei ghbour policy ?

The beggar thy neighbour policy r efers to a policy that aim s at addressing ones own domestic problem

trading partners in particular.

What ar e the i nst an ces of such a policy?

The most popular form s of a beggar thy neighbour policy are in t he areas of foreign tr ade and curr ency

Conv entionally , countr ies often impose tar iff barriers an d restrict im ports to protect th eir domestic ind

globalisation, such practices are not popular.

But to achiev e its domestic policy objective, for instance, encourag ing exports, centra l banks devalu e o

of their own curr encies compar ed to its trading partners to retain their r espective competitive edge. So

in encouragin g appreciation of their cur rencies to tam e inflation at the expense of hur ting in come in th

Is China adopting a beggar thy neighbour policy?

Many economists, especially in the US, say China h as deliberately kept the va lue of its currency low to

in this case, more than t he competitors, the importing countr y , US, is complainin g because more than

imports are hur ting its domestic economy .

How do cur rent economies policies compare?

Curr ently , the rag ing concern am ong most emergin g m arket economies in Aisa is spiralling inflation o

comm odity prices. Centra l banks in m ost economies, including Indias, are (though not necessarily pla

appreciation of their respective curr encies.

This is helping t hem curt ail inflation ar ising out of imported goods as imposing tar iff barriers is perceiv

principles of free trade. Such a pract ice hur ts export earning s of the countries from wh ere such im port

also depends on how cru cial such exports are for each economy .


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What ar e the l im it at ions of such a pr act ice?

In certain cases, such a policy m ay prove counter productiv e. If, for in stance, even th e competing coun

mov e, of say , depreciation (to protect exports) then such a pra ctice may not hav e desirable results, esp

are not price elastic (the imports are essential and not dependent on prices) and instead could end up h

through higher import price and resulting in inflation in such economies.

ET in the classroom: Systematic Transfer Plan

What is STP?

Mutual fun ds not only ma nage our m oney but also offer u s var ious easy to use tools that are aim ed at i

experience.

Most of us know sy stematic inv estment plan , where w e invest at regu lar int erv als. But few are awar e

(STP).

Under STP, at regula r interv als, an am ount y ou opt for is transferred from one mut ual fun d scheme to

Ty pically , a m inim um of six such tr ansfers are to be agr eed on by inv estors.

You can get into a weekly , m onthly or a quar ter ly tr an sfer pla n, as per y our needs.

You may ch oose to tr an sfer a fix ed sum from one sch em e to an other. T he mutu al fund wi ll reduce t he n

am ount y ou hav e specified from the scheme y ou intend to tra nsfer m oney . At the same tim e, the amou

utilised to buy the un its of the scheme y ou intend to transfer m oney into, at the applicable NAV. Some

tran sfer only the capital appreciation to be transferr ed at regu lar int erv als.

How is it useful?

STP is a u seful tool to take a step by step exposure in to equities or t o reduce exposur e ov er a per iod of tim

to invest in equity over a period of time. You could put th is amount in the liquid fund of a m utu al fund

This gives an opportu nity to earn a better than sav ing bank account r ate of return. You than start an

pre-determ ined amount w ill be inv ested into an equity fund. This helps in deploy ing fun ds at r egular i

minimum timing risk.

ET in the classroom: RBIs key policy rates

ET guides you through the key policy rates of the Res erve Bank o f India

What ar e the key policy rates used by RBI to in flu ence int erest ra tes?

The key policy or signalling ra tes include the bank rat e, the repo rate, th e reverse repo rate, th e cash

statutory liquidity ratio (SLR). RBI increases its key policy r ates when there is greater v olume of mone

wor ds, w hen too much m oney is cha sing th e sam e or lesser qu an ti ty of goods an d serv ices. Con v ersely ,

crun ch or r ecession, RBI would lower its key policy rates to inject m ore money into the economic system

What is repo rate?


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Repo rate, or r epurc hase ra te, is the r ate at wh ich RBI lends to banks for short per iods. Thi s is done by R

from banks with an a greement to sell them back at a fixed rat e. If the RBI wants to make it m ore expen

money , it increases the repo rate. Sim ilarly , if it wants to make it cheaper for banks to borrow money,

curr ent repo rate is 5.50%.

What is reverse repo rate?

Rev erse repo ra te is the rat e of interest at w hich the RBI borrows funds from other ban ks in the short te

by RBI sellin g g ov ernm ent bonds t o ban ks w it h t he com m itm ent to bu y th em back at a futu re date. Th

facilit y to deposit their short-term excess funds with t he RBI and ear n int erest on it. RBI can r educe liquby in cr easing th e rat e at w hi ch it borrow s from bank s. Hikin g t he repo an d rev erse repo rat e ends up r

pushes up interest rates.

What is Ca sh Reser ve ra tio?

Cash reserv e Ratio (CRR) is the am ount of funds tha t ban ks hav e to park wi th RBI. If RBI decides to incr

the av ailable am ount with banks would reduce. The bank increases CRR to impound surplus liquidity.

One, it ensures that a portion of bank deposits are alw ay s ava ilable to meet withdraw al deman d, and s

control liquidity in the system, and thereby, inflation by ty ing their han ds in lending m oney. The cur

What is SLR? (St at ut ory Liqu idi ty Ratio)

Apa rt fr om keepi ng a port ion of deposits w it h RBI as cash, banks ar e a lso requ ir ed t o maint ain a m inim

wi th th em at th e end of ev ery bu siness day , i n t he form of gold, ca sh, gov ernm ent bonds or oth er appro

min imu m percentag e is called Statutory Liquidity Ratio. The curr ent SLR is 25%. In tim es of high g row

requirement reduces lendable resources of banks and pushes up interest rates.

What is t he ban k rat e?

Unlike other policy r ates, the bank ra te is pur ely a signalling rate an d most interest rates are delinked

bank rat e is t he indicat iv e rat e a t w hich RBI lends m oney to oth er banks (or fin an cia l inst itutions) T he

bank s long-t erm out look on i nt erest r at es. If t he bank rat e m ov es up, long -ter m in ter est r at es al so tend

ET in a Classroom: Currency Peg

As China and the US tussle over the v alue of the Yuan, ET helps you decons truct the issue.

What is a curren cy peg?

There are v arious way s in which the price of one curr ency a gainst another is arriv ed at. In a pegged ex

curr ency is fixed with respect to another cur rency , usually the US dollar. In other words, it is the rate

bank of th e cou nt ry mai nt ai ns a s th e offic ia l ex ch an ge rat e. Chinese cu rrenc y , for exam ple, is peg ged a

How is the currency peg maintained?

Curr ency pegs work only w hen the central bank ha s the mu scle to interv ene in the market to check th

bey ond a per missibl e ba nd. It shou ld be able to supply th e m ar ket wi th enoug h dolla rs in th e ev ent of a

rate an d in the event of too much supply be ready to buy dollars from th e mar ket. It implies that the ce

foreign exchan ge reserv es. China ha s foreign curr ency r eserv es of nearly $2.5 trillion.

How does a currency peg help ?

Countr ies go for a pegged exchange r ate to have stability in the foreign excha nge ma rket. China h ad a

peg in July 2008 keeping its curr ency steady a t 6.83 y uan t o a dollar as it fough t the global economic


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The stable currency creates a conducive env ironment for inv estm ents as investors do not fear losses on

fluctuat ions. Exports benefit as appreciation is kept in check. However, there ar e num erous instances o

financial cr ises. Pegged va lues are difficult to ma intain if the central ban k is not in position to interv en

Why is t he US so both ered a bout th e curren cy peg?

The US believes that Chin a accu mu lates its hug e curr ent account surplus (to the tune of 8% of GDP) an

deficit (to the tun e of 2.9% of GDP) because its currency is underv alued, m aking its exports to the US c

US expensiv e. The US blames the pegged yu an for the resultant global imbalan ce, and want the y uan t

A bit of history

From 1997 to mid-July 2005, Chinese currency was pegged to the US dollar. On 21 July 2005, China

and switched to a crawling peg linked to a basket of curr encies. The renm inbi gra dually appreciated ov

y ears. In Ju ly 2008 , Chi na went back to the dolla r peg, bri ng ing th e Yu an appreciat ion to an end. Y ua

dollar w ith a plus/minu s 0.5% fluctuat ion.

ET in the classroom: Quantitative easing

The US seems ready for another r ound of quantitativ e easing to boost growth, em ploy ment g eneration

There is consensus among economists and policym akers in t he worlds largest economy that the Federa

higher level of inflation to spur gr owth. ET takes a look at the concept of quantitat iv e easing.

What is qu an tit at iv e easing?

Central banks usually stimulat e a slowing economy by cuttin g interest rates, which encourag e people

or discouraging them to sav e. But w ith in terest r ates in the developed world already close to zero, that

In such situa tions , the centr al banks resort t o pum ping m oney directly into the economy , a process kn

It is done by buy ing bonds usually governm ent paper but can also be priva te bonds from banks an

developed countries used quantita tiv e easing to spur growth in the afterm ath of the financial m eltdow

What is t he i dea behind quan ti tat iv e easing?

At an y gi v en point of t im e th ere is a fix ed am oun t currency /m oney ch asing products a nd serv ices av a

idea essentially is to get more m oney into the sy stem chasing the sam e amount of produce to driv e up t

quantit ativ e easing, the bondsellers will receiv e money tha t has not been in circu lation, which will inc

the system. As the m oney in th e economy increases the dema nd for different products rises.

How does it help?

The flood of cheap m oney c au ses asset prices to rise i.e. th e price of sha res, rea l estate etc. Th e notional

cheap and easy credit, encourages people to spend. Quantitativ e easing also helps deva lue the cu rr ency

exports furth er and incr easing the level of activit y in the economy . The final consequence is increasedram ping up of production, w hich, in tur n, cr eates more jobs in the economy .

Why is i t i mport an t in the cu rrent scenar io?

Quantita tiv e easing could potentially war d off deflationar y expectations and kickstart a n un certain ec

globalised world, cheap money from developed economies may flow in to emerging economies and fuel a

there. Brazil ha s been strugg ling to deal with the rising t ide of inflows . India, too, is keeping a n ey e on

ET in a Classroom: Stock Valuation


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What ar e the v ar ious ana ly tical approaches for v al ua tion of stocks?

For inv esting, a n inv estor can use an approach based on either fundam ental ana ly sis, technical an aly

What is Funda men tal An al ysis?

It is the process of looking a t a compa ny s business from a n inv estment point of view . The process inv ol

ma nagem ent capabilities, its competitiv e adva ntag es, its competitors and the mar kets it functions in.

As pa rt of t he an aly sis, y ou w ould look a t ex am in ing key fin an cial rat ios like t he net profit m ar gi ns, op

per shar e and so on.

Aft er exam in ing th e key ra tios of a bu siness, one can com e at a conc lu sion a bout th e fina ncia l h ealth o

v al ue of th e stock . It furth er focuses pri m ar ily on t he v al uat ion of a c ompan y an d it s rela tionshi p wit h

Combinin g all this, the analy st arriv es at a v alua tion for a stock. Fundam ental analy sts believ e that it

tru e va lue of a company using these financia l v alua tion methodologies.

If the shar e price is trading below the valu e arriv ed at by a fundam ental ana ly st, investors should buy

the share price rising to the tru e va lue in the futu re. Conv ersely , if the shar e price is higher t han t he e

inv estors should sell.

What is Technical A naly sis?

This technique focuses on the past to predict the v alue of the futur e, using share prices and v olumes tra

look at fundamentals or financial results at all. Technical an aly sts believ e that all informa tion about a

share price.

Accordin g t o th em , sh ar e pr ice beh av iour is r epet it iv e in na tu re and hen ce can be u sed to pr edic t fut ur

Based on historical share price data of a compan y , technical a naly sts identify shar e price lev els that ac

They try to identify support, resistance a nd breakout lev els for stocks. Technical ana ly sts also use var i

char t patterns to help them determine probable futu re share price mov ements.

What is qu an tit at iv e an al ysis?

Wit h t he adv ent of computer s, a th ir d ty pe, na m ely quan tita tiv e ana ly sis, h as come up. Qua nt it at iv e

beh av iour by using com plex mat hem at ical an d sta tistic al m odelli ng , m easur em ent an d r esear ch . It is

v al ue of a secu rit y by exam inin g its nu m erical , m easur able c ha racter ist ics l ike sales, ea rning s an d pr

Pure quantitat iv e analy sts look only at num bers with alm ost no regard for the underly ing business. A

analy sis look at num bers from a bala nce sheet, their prim ary focus is alway s the underly ing business,

the compan y is operating and so on. Quantit ativ e analy sts create mat hemat ical algorithm s, which he

sell decisions.

Which is t he best?

The different a naly tical t ools hav e different u ses. For instance, fundam ental a naly sis could be used to i

possibility of strong ear nings gr owth in the futu re.

Technical an aly sis could be used to decide when to buy this stock. When y ou combine technica l and fun

called techno-fundam ental research. Depending upon y our style and tim e frame of inv estment y ou cou

ET in the classroom: Care for a Dim Sum?


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Chinas growing affluence and influence over the world economy has created hug e demand for assets d

basic u ni t of t he renm in bi. China is also keen to gl obalise its curr ency to offset an y losses to its record fo

to weakn ess of the dollar . Thi s has led to the cr eation of the Dim Sum bond ma rket in Hong Kong. ET ex

What Is A Dim Sum Bond?

A bond den omi na ted in y ua n an d issu ed in Hong Kong. Deriv ed fr om a t radi tional Ch inese cu isin e th at

Dim Sum bonds are issued by Chinese gov ernm ent an d companies as well as foreign entit ies.

What Makes Dim Sum Bonds At tractive For Inv estors?

Investors across the world ar e looking for opportu niti es to make m oney out of Chin as phenomenal g row

capital controls prohibit them from inv esting in Chinese debt. Dim Sum bonds offer a n av enue to such

rushing to the Dim Sum ma rket on expectations that Beijing will continue to let the y uan appreciate.

denomin ated assets also prov ides an alterna tiv e to bonds issued by western gover nm ents and compani

Principle of Div ersificati on, tha t a portfolio contain ing differen t assets and kin ds of assets car ries lower

Lower in terest cost is also encour aging companies to raise money through the Dim Sum ma rket. Last m

first issuer of Dim Sum bonds from India. It sold 650 million y uan ($102 million) of three-y ear bonds p

4.5% per ann um . The bank said it cut a percentage point off its dollar fun ding costs by g oing to the Dim

infrastru cture lender IL&FS is also planning to raise $100 million thr ough y uan denomin ated bonds.

Is There A Limit On Such Issuances By Indian Enti ties?

Recently , the y uan was added to the list of curr encies in w hich Indian companies can r aise funds overs

euro, pound and y en. Indian firm s can raise an equiva lent of $1 billion in y uan .

How Big Is the Dim Sum Bond Market ?

The Dim Sum mar ket has risen from 10 billion y uan in 2007 to more than 1 00 billion y uan. An aly sts

bey ond 3 00 bil lion y ua n in 201 2.

Where can Indian Issuer s deploy Th e Proceeds?

Indian issuers can deploy the m oney for capital expenditure w ithin China and u se the proceeds for sett

also enter into swap contracts to get other curr encies. However, if th e money is to be brought back to In

comply with the External Comm ercial Borrowing gu idelines set by the Reserv e Bank of India.

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

What is LTE?

LTE, or Long Ter m Evolution , is the latest wireless mobile broadband technology that will power futu

networks designed primar ily for data tr ansmission a t u nprecedented speeds. It u ses spectrum to carry

roads to carry v ehicular tr affic. Spectrum ma y be likened to a highw ay of airw av es on which mobile s

Since LTE uses wider chunks of spectrum, data speeds on LTEbased 4G networks are nearly four times f

user, for instan ce, will be abl e to wa tch v ideos at LTE speeds of 30 0 Mbps wh ile a laptop user will be abl

25MB file in seconds if adequate spectrum is av ailable. LTE is also a scalable bandwidth technology tha

So a 3G operator ca n easily upgra de his network t o LTE.

WHEN WAS IT DEVELOPED?
http://economictimes.indiatimes.com/topics.cms?search=Indiahttp://economictimes.indiatimes.com/topics.cms?search=Beijinghttp://economictimes.indiatimes.com/topics.cms?search=Hong%20Konghttp://economictimes.indiatimes.com/topics.cms?search=Dim%20Sumhttp://economictimes.indiatimes.com/topics.cms?search=China


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LTEs genesis goes back to November 2004, when a w orkshop was held by the 3 GPP (3r d Generation Pa

to define Long Term Ev olution . Th e 3GPP was a global a llian ce of top telecom a ssociations who tri ed t

mobile tech after UMTS, the 3G technology based on GSM.

IS LTE BETTER T HAN WiMAX?

Wir eless com munica tion h appens ov er pair ed or un pair ed spect rum. Pa ir ed spect rum is two equa l chu

and receivin g information while un paired spectrum is a single strip of airwa v es mean t to either r eceiv

Voic e sig na ls trav el ov er pai red spect ru m whi le dat a com munica tions w orks better on u npaired spect r

than upload. WiMAXhad an edge as long a s it was the sole wireless technology working comm ercially o

the WiMAXparty crashed when an LTE v aria nt, TDD-LTE which also worked ov er unpair ed spectrum

What s m ore, lea din g v endors u nv eiled com pat ibl e gear com mercia lly in 201 0. Th is LTE v ar iant wa s

telcos as the coolest technology for high speed data comm un icat ions on th e go. WiMAXsuffered a body b

China, India and the US also embraced TDD-LTE

. Comm ercia lisation of TDD-LTE devi ces hit fast-tra ck after Qualcomm pitched for wir eless broadban d

auction an d won 20MHz of BWA airw av es in four circles. Even WiMAXbackers like Clearw ire in t he US

up to LTE. Ditto with WiMAX gear v endors like Nokia an d Cisco.

IS TDD-LTE CA TCHING ON IN INDIA?

Not as yet. But th at said, th e first seeds of an LTE ecosystem wer e sown wh en Bhar ti Air tel joined some

backers at Mobile World Congress 201 1 in Bar celona t o launch t he Global TD-LTE Initiativ e (GTI). Glob

technology was in fact a t the hear t of last y ears auction of BWA airw av es in India.

But th e big chall enge to fast-tra ck deploy men t of TD-LTE in India is the pau city of compati ble dev ices a

Qualcomm has laun ched TDD-LTE mu lti-mode devices. NSN is slated to unv eil 4G devices by the tim e

happening in India by December 1 1 to early -201 2 .

ET in the classroom: Offshore Banking Unit

What is offshore banking un it ?

Offshore banking unit (OBU) is the branch of an Indian bank located in a special economic zone (SEZ), w

aim ed at facilitating exports from th e region. As laws define it, its a deemed foreign branch of the pa

India, and it un dertakes interna tional banking business inv olving foreign cur rency denomin ated asse

The concept comes from the practice prev alent in severa l global financial centres. Here an OBU can a c

business but n ot dom estic deposits fr om loca l r esiden ts. Th is w as conceiv ed to prev ent com peti tion betw

bank ing sectors.

What was t he n eed for OBUs?

In addition to providing power , tax a nd other incent iv es to SEZs, policy m aker s felt a need to prov ide SE

money ma rkets at internat ional rates. So in 2002 , RBI instituted OBUs, which would be v irtu ally fore

These would be exempt fr om CRR, SLR and few other r egulatory requirem ents.

RBI regula tions ma ke it ma ndatory for OBUs to deal in foreign exchange, source their foreign curr ency

prudential n orm s applicable to ov erseas branch es and are entitled for IT exemptions. Thu s in ma ny res

monetary controls of the countr y .

What pri ce, freedom from regul at ions?
http://economictimes.indiatimes.com/topic.cms?search=Mobile%20World%20Congresshttp://economictimes.indiatimes.com/topic.cms?search=Qualcommhttp://economictimes.indiatimes.com/topic.cms?search=3G%20technology


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In the eight y ears that th ey h av e been operational, concerns hav e been raised that, funding by OBUs t

in extern al debt of India. A lso, some h av e suggested that OBUs as vehicles for extending dollar loans ha

restricted to doing business only in th e zones in wh ich a re th ey located.

This would create an unn ecessary regula tory arbitr age like booking bu siness because there is some a rb

An y wa y s, g roun d real it ies could not be m ore di ffer ent. Har dly a ha ndful of ba nks ha v e set u p th eir OB

v ery far fetc hed.

SEZ, itself as a concept has been stru ggling , giv en the issues that SEZ developers hav e faced ov er acqui

What is t he fut ur e of OBUs?

Most international fina ncial centr es still house OBUs, so say ing t hey are n ot r equired may be incorrect

hav e said OBUs are losing r elevance a t a time of increasing globalisation.

They say OBUs will be of no use after the economy opens up fully and the r upee is fully convertible. Th

two OBUs, instead of hav ing severa l of them spread across the countr y .

ET In The Classroom: Public Debt Office

What is a publi c debt office?

A public debt office or a debt man ag em ent office is an au tonomou s gov ernm ent a gen cy which acts a s th

governm ent and raises capital from the mar kets for the govern ment.

It formula tes the borrowing calendar for the gov ernm ent and decides upon the ma tur ities of the securi

the govern ment. A public debt office works separately from the centra l bank an d has nothing to do wit

monetary policy or setting interest rates.

What ar e the confl icts of int erest s if t he body t ha t formul at es th e monetar y policy al so act

investment banker?

There are certain in herent conflicts of interest when the agency , which raises funds for the gov ernm en

policy and r egulates interest rat es. The basic conflict of interest is between setting th e short-term inter

governm ent securities.

The Reserv e Bank of India, like a good merch ant banker to the gov ernm ent, sells bonds at high prices. A

y ields, i t r uns t he risk of a ddin g to in fla tionary conc erns.

An other ar ea of conc ern is tha t RBI is a lso th e regul at or of a ll bank s, w hich m ean s th e cen tr al bank cou

buy bonds a t h ig her prices or for long er ten ors.

For a v ery long time now, economists hav e been argu ing in fav our of an independent debt mana gemen

discourse is called National treasury ma nagem ent agency or debt man agement a gency , so that RBI

of being the Centres investment ban ker.

What is t he practi ce in a dvan ced economi es?

Developed economi es such as the UK, the US and New Zealand, al ready ha v e independent public debt o

governors hav e time and again complained about the difficulties in mana ging gov ernm ent debt while

high to rein in inflation.

Does India h av e a debt ma nagement office?


10/17



The finance ministry had proposed setting up of the debt mana gement a gency in its 2007 -08 Budget.

hav e recomm ended the establishment of the debt ma nagem ent agency . These include groups headed b

secretar y Vijay Kelkar, form er World Banker Percy Mistry and ex-IMF chief economist Raghu ram Raja

A draft leg isla tion h ad al so been cr eated by th e Ja ha ng ir Aziz Workin g Group. While present in g t he Bu

min ister Prana b Mukherjee had announced the governm ents intention to introduce the bill for an aut

office in the next financial y ear.

How is it expected to be structur ed?

The agency is likely to be an aut onomous body u nder the administra tiv e control of the finance min istr

on the man agem ent committ ee of the agency . A m iddle office or MoF is already working in the finance

borr owing ca len dar of th e Cen tr e.

A m id-office would constitu te a sing le comprehensiv e data base about al l l iabil it ies a nd gu ar an tees of t h

now, the 21 public debt offices of RBI continu e to function. The struct ure and fun ctions of the debt m an

discussed and reworked on for thr ee year s now but lit tle sense of urg ency has been seen.

.

ET in the Classroom: Non-competitive bidder

What is non-compet it iv e biddin g in dat ed gover nm ent securi ties?

The Governm ent of India conducts periodic auctions of gov ernm ent securities and of the total am ount n

portion is kept aside for the non-competitiv e bidder, or the small and m edium inv estors.

Non-competitiv e bidding means a person would be able to participate in the au ctions of dated governm

to quote the y ield or price in t he bid. That sav es him the worry , about wh ether the bid will be on or off-

How is t he process useful?

It helps deepen the govern ment bonds market by encoura ging w ider participation and retail h olding oenables the participation of individua ls, firms and other m id-segm ent inv estors who neither hav e the e

participate in a uctions. RBI giv es such inv estors a fair cha nce of assured allotments of governm ent sec

Who can be referred t o as th e non-competit iv e bidder?

RBI allows indiv iduals or firms, prov ident funds, corporate bodies or tru sts who do not hav e curr ent ac

gener al ledger (SGL) account w ith th e Reserv e Bank of India. Regional Rur al Ban ks (RRBs) and Urban C

can a lso apply under th e non-competitiv e bidding scheme.

Eligible investors hav e to place their bid thr ough a ban k or Primar y Dealer (PD) for a uction. Each ban

orders, submits a single bid for the total sum of non-competitive bids on the day of the auction.

The bank or PD will furnish details of individua l customers, v iz., name, am ount, etc., along with t he a

competitiv e bidding facility is av ailable only in dated central gov ernm ent securit ies and not in treasu

What ha ppens if t he t otal amount offered for bi ddin g via non-competit iv e biddin g basis ex

allotted?

In case the am ount bid by PDs on behalf of the inv estors is more than the reserved am ount thr ough no

allotment would be made on a pro-rat a basis. For exam ple, the amount r eserv ed for allotm ent in an au

is Rs 15 c rore.

The total am ount of bids for n oncompetitive segment is Rs 20 crore. The par tial a llotm ent percentage i

bank or PD, wh o ha s submit ted non-competi tiv e bids recei v ed fr om eligible in v estors wi ll get 7 5% of t h


11/17



ET in the classroom: Potential growth rate

The countrys policymakers seem to be fighting a losing battle w ith I nflation. So me ec onomists link the pers

of economic growth. They s ay I ndian economy is expanding at a rate beyond its potential growth rate. ET

relationship with prices:

What is t he potential rat e of growth of an economy?

Potential output is broadly the m axim um output growth tha t an economy can sustain ov er the mediu

stoking i nflat ion. In a recen t report on India, t he Interna tional Monetary Fund (IMF) estim ates Indias

7-8%.

What factors decide the potenti al growth r at e?

There are two major determina nts of the potential ra te at which an economy can gr ow in the long r un

key in puts such as labour and capital, w hile the other is the rise in productiv ity . Within the tw o key in

in determ ining th e potential gr owth rate.

The increase in labour supply thr ough an increase in num ber of workers or th e num bers of hours pu

wor ker s and an in cr ease in labour productiv it y wi ll resul t i n a n incr ease in th e long-term poten tial g

An y th in g t ha t a ids pr oductiv ity incr eases can help boost pot ent ia l g rowt h r at e. Infrast ructure in v estm

can r aise Indias potential g rowth r ate because the countr y has am ple labour supply .

How does growing faster than the potential rate cause inflation?

The overall demand in the economy picks up due to fast growth a nd m ore resources are u sed to meet hi

the economy ma y not find enough input s to meet the deman d, leading to an increase in prices.

If there is sur plus capacity in the economy then it ca n gr ow abov e the potential r ate for a while. But fo

wor kin g at full capacit y , ex cessiv e dem an d r esul ts in incr ease i n th e pr ice lev el.

The IMF says India w as growing a t a r ate faster th an its potential r ate in 2 007 -08, but becau se of the f

substantia l slack emerged in economy . It says the qu ick rebound from the crisis has exhausted that sla

high inflation if the Indian economy grows too fast.

ET in a classroom: How are poverty numbers calculated

Widespread poverty is the biggest challenge for Indias policymakers. The government has drawn criticism

menace des pite high economic growth. Some es timates place the number of poo r at 40% of the population.

numbers are generated:

How is the povert y l ine defined?

The concept of poverty is associated with socially perceived depriv ation with respect to basic hum an n

followed a poverty line, which is based on a m inimu m n um ber of calories that an indiv idual should con

wa s ca lcul at ed on t hi s basis. T he exi stin g ru ral an d urban offici al pov erty lin es were ori gi na lly defin ed

consumer expenditur e (PCTE) at 19 7 3-74 ma rket prices and is adjusted ov er tim e and across states for

The m ethod still reta ins the original 19 7 3-74 all-India r eference poverty line baskets (PLB) of goods an

derived separately for ru ral an d urban ar eas, anchored in per capita calorie norm s of 24 00 (rur al) and

People whose PCTE is below th e requir ed mini mu m a re considered to be below th e pov erty line.


12/17



What is t he i nt ern at iona l povert y li ne?

The comm on international poverty line is based on an income of around $1 a day . In 2008, th e World B

$1.25 at the 2005 purchasing power parity .

What is t he n ew way to define the poor?

As t he earl ier estim at es of pov erty ha v e been largel y perceiv ed as inadequat e, a com mit tee led by Sur

a new w ay to define the poor. Tendulkar m oved away from calorie anchor while testing th e adequacy

The met hod uses sam e consum ption basket for ru ra l and ur ban poor, bu t applies different pric e levels o

arr iv e at the pov erty estima te. The major depart ure from the original m ethod is the provision for inclu

and education.

Does India need to redefine poor?

Wit h India hi tt in g a high gr owt h tr aj ect ory , t he liv in g st an dar ds an d consum ption pa tt erns in both ur

chang ed, while existing data continues to use consumption baskets that r eflect trends prevalent in 1 97

mechan isms also assum ed that basic social serv ices like health an d education would be supplied by the

were cov ered in base y ear 1 97 3-74, n o account was t aken for th e ch an ge in th e pr oporti on of ex pendit u

then.

..

ET in the Classroom: Competition

Why is compet it ion i mporta nt ? Wh at is its economi c rationa le?

Competition, acc ording to economic th eory , forces firm s to develop new products, serv ices and technolo

consumers gr eater choice and better products. If more and more firm s deal in a similar product, consum

causes product prices to drop below the level that would be if there were no competition; that is, if there

(m onopoly) or a few firms (oligopoly) .

How is competi tion m easured?

Competition is generally measured by calculat ing concentrat ion r atios . Concentr ation ratios indicate

of a few lar ge firms or ma ny small firm s. Two of the most comm only u sed metrics are th e Herfindahl H

the N-firm concentra tion ratio.

Herfindahl Hirschman Index:

Under th e HHI, the m arket shar e of each firm in a r elevant sector is squar ed and added to arriv e at a s

concentra tion. The v alue of the index v aries from close to 0, indicating near ly perfect competition, to 1

presence of just one firm, a m onopoly. HHI = s1 2 + s2 2 + 3 2 + + sn 2 (Where sn is the mar ket share

from cl ose to zero to 100 ).

N-firm concentration ratio:

This method measures the domin ance of the biggest firm s in a par ticular sector. N in this case is the nu

considered. A four-firm concentra tion rat io, for instance, w ould just sum up the ma rket shar es of the fo

ma rket. Fewer firms hav ing a la rge m arket share would indicate less competition.

How are t hese measures u sed?

In the US, mergers are scrutinized by an aly sing concentra tion ratios. Generally , a m arket wit h a HHI

considered competitiv e . A m arket w ith a HHI in the 1 ,000-1 ,800 band is moderately concentra ted. A

indicates a high ly concentra ted market. As a general ru le, mergers that incr ease HHI by m ore than 1 0

markets raise antitrust concerns and invite further scrutiny by authorities.


13/17



ET in the Classroom: Asset classes

What is asset cla ssificat ion?

In an y banking system, loans or assets created by lenders are div ided into severa l qualita tiv e categorie

categ ories reflect how good or bad an asset is in ter m s of the possibility of default in repay men t of loan f

prac tice is known a s classificat ion of assets.

How is asset classificat ion importan t t o bankers?

This prac tice helps banks know the stren gth of its credit portfolio. If ther e is a r isk of non-pay m ent of lo

start focusing on th eir credit m onitoring act an d take correctiv e measures. According to classifications

take care of the fallout of a default.

What ar e the broad classificati ons prescri bed by the r egulator, the Reserv e Ban k of India ?

The RBI has classified assets into four broad categ ories. These ar e prescribed by t he Bank for Intern ation

governm ental body of central ba nks. Howev er, each centr al bank is allowed to tweak the definition as

Standard asset

Asset wher e borrower s pay th eir inter ests on th e loan as per th e sch edule i s a st an dar d asset.

Sub-standard asset

A su b-standa rd asset is one which ha s remai ned an NPA for a per iod less than or equa l t o 1 2 m onths. An

asset is one where a borr ower fails to pay the inter est on the loan for three consecutiv e months.

Doubt ful asset

An asset wou ld be classified a s doubt ful i f it ha s rem ai ned in th e sub-standar d ca teg ory for a period of 1

Loss asset

When banks see litt le possibi lity of recov erin g t he loan , i t becom es a loss asset for t he bank . Ba nks or a u

for t he bank.

What ar e the provisionin g requ irement s for these a ssets?

For l oss assets, if kept in the book of bank s, 1 00% of the outstandin g h as to be provided for. For doubtfu l

rema ined in the doubtful category for 1 y ear, th en the prov isional r equirement is 20%. If it has stay e

y ears, it cal ls for a prov isional cov erag e of 3 0%.

ET in the Classroom: How is infrastructure defined in I

Policy anomalies and lack of consensus on what co nstitutes infrastructure have undermined efforts to spur

look at the current status and the need to define infrastructure.

How is infrastru cture defined in India?

Ther e is no clear definition as of now. A br oad mean ing of the term is based on a series of reports and ob

governm ent agencies and comm ittees. A comm ission chair ed by C Ranga raja n in 2 001 a ttempted to d

according to six cha racteristics: natur al m onopoly , hig h sunk costs, non-tradability of the output, non


14/17



(which implies benefit of public g ood can be extended to additional consum ers without any hug e additi

exclusion a nd bestowing externalities on society . However, these charact eristics were not considered ab

For taxa tion purposes, th e income-tax departm ent considers compan ies dealing w ith electricity , w ater

roads & bridges, ports, air ports, ra ilway s, irriga tion, storag e (at ports) and industrial par ks or SEZs as

special tax benefits are also given to sectors like fertilizers, hospitals and educational institutions, addin

The Reserv e Bank of India and th e Insuran ce Regulatory and Development A uthority hav e also tried to

identify sectors.

Why is a precise defini ti on of infrast ru ctu re n eeded?

A c lea r underst an din g of w ha t is cov ered u nder th e r ubric of infrast ructure is necessary for policy form

and m onitoring projects to ensure consistency and compara bility in the data collected and reported by

the emphasis on infrastructu re has led to the gov ernm ent extending ma ny incentiv es and tax benefits

Wit hou t a proper defin it ion th ese ben efit s can be m isu sed.

What is t he i nt ern at iona l norm?

Globally , too, defining infra structur e has been an ar duous task. The US and m ost European countr ies h

sectors for ta x pur poses. There is no consistency acr oss the developed world on wha t constitut es infr astr

also identified sub-sectors like core infrastructu re, social infra structur e, retail in frastructu re, an d urb

How is India a pproaching th e issue?

The finance ministry will identify t he sectors prima rily based on the char acteristics set out by th e Ran

some additional requirem ents. Based on the cr iteria, t he finance min istry is likely to notify 25 sectors

sectors will be eligible for tax incentiv es, v iability gap funding an d will be covered by regu latory fram

wh ich w ill in clu de lev y of user ch ar ges.

..

ET in the Classroom: corporate repo bonds

What is corporate repo bond?

Banks, corporate and prim ary dealers pledge corporate bonds with each other to raise short-term mone

pledging governm ent securities (gsec) with RBI to raise short-term money . Unlike pledging of g-secs, h

corpora te bonds does not receiv e the entir e va lue of the bond.

When di d RBI al low repo in corporat e bonds?

RBI guidelines on repo in corporate debt securities came into effect on March 1, 2010.These guidelines w

201 0 as the mar ket participants dema nded a reduction in ha ir-cut ma rgin s. It was reduced from a flat

1 5%, depending on the ra ting of the corporate bond. A ccording to the am ended guidelines, the settleme

two day s of the deal.

How does the r epo in corporate bonds work?

Inv estor A, w ho needs finance for a n int erim period, can issue these bonds while entering into an a gree

a giv en point of time he would buy back the bond from inv estor B, though the bond issuer would hav e t

1 0-1 5%, which will v ary according to the credit rating of the bond.

How activ e is th e repo in corporate bonds in India?

Only five deals hav e been reported so far. Companies tha t ha v e issued corporate bonds in India are REC


15/17



Why ha s repo in corporat e debt not taken off?

Lack of ma rket par ticipation could be because of lenders or issuers main tainin g a cautious approach as

trade guarantee mechanism. Also, the hair-cut margin of 10-15%, (which is the margin enjoyed by the

agr eement is reversed), is still v ery high from th e inv estors point of view considering the v olatility in

not dema nd such a hig h ha ir cu t. Interest ra te is determined over-the-counter, but t here is no mechan

prices. Ther e is no centralised clearin g a gency like the Clearing Corporation of India (CCIL ) for central

.

ET in the classroom: What is stagflation?

Stagflation is an econom ic situation where the growth rate slow s do wn, unemployment levels remain stead

high.

What is stagfla ti on?

Stagflation, a concept which did not ga in acceptance till the 1 960s, is described as a situation in th e ec

slows down, t he level of unem ploy ment r emains steadily high a nd y et the inflation or price level rem a

the first instance, high in flation an d unemploym ent or slower g rowth seem like opposites and mu tually

It cam e to be seen in the 1 97 0s as a situation wh en the economy has low productiv ity and y et the good

low u nemploym ent. The term stagflation cam e to be used for th e first time in the British Parliam ent b

Once stagflation occurs it is difficult to deal with . The measure a g ov ernm ent usually takes to rev iv e a

(cutting interest rates or in creasing gov ernm ent spending) a lso increases inflation.

Under norm al recessionar y conditions, inflationary policies are acceptable, but here, g iv en the alr eady

inflation still higher could mean prices spiralling out of control, thus furth er hitting productiv ity and

What causes stagflat ion?

The ma jor reasons for stagflation, w henever it ha s occurr ed in history , ha v e been-supply shocks or sho

reasons which push up prices of essential comm odities, cau sing an inflationary situation and at the sam

production costs, as it happened in 1 97 0s in the US. The other reason is failur e of the m onetary auth or

growth of money supply in the economy and excessive regu lation of goods and labour ma rkets by t he g

the 19 7 0s, a simila r situation occurr ed during t he global stagflation, where it began w ith a hu ge rise i

continu ed as central banks used stimulativ e monetary policy to count eract th e resulting recession, cau

spiral.

Is India on the brin k of stagflati on?

Though the central bank and the Centre have had to revise their growth targets, which have taken a h

double-digit inflation, economists are far from assuming a stagflation like situation in India just as y et

deputy governor Subir Gokarn has said headline inflation num bers are m uch hig her than t he appropr

moderat e growth but w ill keep it steady, which according to RBIs estima tes, should be between 5% a nd

ET Classroom: Casa

What is Ca sa Ra tio?

Casa is basically the cur rent an d sav ings sccount deposits. Casa ratio is the shar e of curr ent and sav ing

deposits of the bank. In India, interest rates paid on current and savings account deposits is administer

Reserv e Bank of India.

Why ar e banks keen on ga rneri ng a hi gher shar e of Casa?


16/17



Interest rate paid on Casa is much lower compared to other deposits like term deposits or recurring depo

any interest on cu rr ent account, interest paid on sav ings account deposit is 4%. Banks therefore m ake

the sha re of Casa on their books to reduce th eir ov eral l cost of deposits. HDFC Bankhas the highest shar

52%, followed by the Stat e Bank of India at 48% and ICICI Ban kat 45%.

What does Casa mea n for customers?

Recently , RBI increased interest paid on savin gs account deposits from 3. 5% to 4%. Further a y ear ag o

interest on savin gs deposits on a daily basis rather th an pay ing on the minim um balance ma intained b

result, saving s account cu stomers earn better retur ns compar ed to wha t they earned a y ear ago. Furthsaving s account deposits does not attra ct TDS (tax deduction at source). Interest income above 1 0,000

case of term deposits. Howev er, th ere is no major benefit for cur rent account deposits, w hich is main ly

and tra ders.

What ar e the disadvan tages of high Casa?

These deposits can m ove out of bank s books any tim e, leading to asset-liabilit y mi smat ches. While in ca

alm ost certain t hat th e depositor m ay not withdraw money before the matur ity of the deposit and may

ma tur ity . Furth er, to finance long-term projects, banks need to hav e long-term liabilities on th eir book

Banks can not rely on Casa deposits to fun d long-term loans.

ET in the Classroom: Sovereign debt crisisWhat is sover eign debt crisis?

Sov ereign debt crisis means the sov ereign gover nm ents borr owing from domestic and externa l ma rke

repay , r esulting in loan defaults requiring rescheduling of loans or bailout packag es from other countr

institu tions such a s IMF.

How did th e Greek crisis origina te ?

The crisis in Greece surfaced in 2 007 -08 , w hen it cam e to be known that Greece was not in a situation

obligations to its external creditors. The budget deficit of Greece was in the range of 13.6% of its gross do

debt w as equiv alent t o 11 5% of the gross domestic product. The debt problem w as furth er compounded

four ths of the gov ernm ent debt was held by foreign institutions, particu larly foreign ban ks. Not only w

problem, it w as also camouflaged by deriva tiv e hedging. Reportedly , inv estm ent banks misled inv esto

governm ent bonds of Greece by being secretive about the a ctual state of affairs. The ra ting a gencies pl

alleg edly failed to assess the corr ect fiscal position.

Who bailed out Greece?

Greece reached an ag reement w ith IMF, the European Comm ission and the Eur opean Centra l Bank on

stabilise its economy with the support of a $14 5-billion financing package aga inst which the Greek gov

implement fiscal measures, structural policies and financial sector reforms. Some of the points of the re

reducing th e fiscal deficit to 3% by 201 4, pensions and wag es to be reduced for th ree y ears, governm en

had to be curta iled and social security benefits cut.
http://economictimes.indiatimes.com/icici-bank-ltd/stocks/companyid-9194.cmshttp://economictimes.indiatimes.com/state-bank-of-india/stocks/companyid-11984.cmshttp://economictimes.indiatimes.com/hdfc-bank-ltd/stocks/companyid-9195.cms


17/17


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