eco session _2009

8/3/2019 ECO Session _2009

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Economic and Business Affairs

8/3/2019 ECO Session _2009


Agenda:

•Indian Financial System

•The state of Indian Economy

•Global Economic Meltdown – its effects on India

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Indian Financial System:

1.Monetary system

2.Banking system

3.Tax system

4.Share Market Fundamentals

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Monetary System o Reserve Bank of India (RBI) – Central Bank of India

o RBI functions include –

Control and regulation of money and credit

Control of foreign exchange operations

Banker to the government

Banker‟s bank

Lender of the last resort

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Monetary System o CRR (Cash Reserve Ratio) – 3 to 15%

o SLR (Statutory Liquidity Ratio) – 25%

o Bank Rate – Rate at which banks borrow from RBI

(currently at 6%)

o Open market operations – Involves sale and purchase of

government securities by the

RBI (vis-à-vis banking system)

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Monetary System o REPO and Reverse REPO – REPO transactions imply liquidity

adjustment facility of the RBI whereby it injects and

absorbs liquidity vis-à-vis the banking system to even out

short term fluctuations in the money market.

o Absorption of liquidity by the RBI is termed as „reverse

repo‟ and injection as „repo‟.

o Reverse repo rate at present is 6% and the repo rate is

7.75%

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Monetary System - FAQs o When is monetary policy announced?

Twice a year

A slack season policy (April-

September)

A busy season policy (October – March)

o Impact of CRR cut on interest rates?

When CRR is reduced, more cash

is available with the banks As more money chases the same

number of borrowers, interest

rates come down

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Monetary System - FAQs o Difference between monetary policy and fiscal policy.

RBI is responsible for formulating and implementing

monetary policy

Fiscal policy is a broader tool with the government

Monetary policy brings about a change in the economyby changing money supply and interest rate.

Fiscal policy can be used to overcome recession and

control inflation

Fiscal policy decides the change in government revenueand expenditure to influence the level of national output

and prices

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Banking System o Participants of the Indian financial

systems

Commercial Banks

Co-operative Banks

Financial Institutions (FI)

Investment Institutions

Specialised financial institutions

State-level development banks

Non-banking financial companies(NBFC)

Market intermediaries – stock

brokers and moneylenders

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Commercial Banks o Main functions

Acceptance of deposits

Giving loans

Overdrafts

Discounting bills of exchange

Investment of funds

o RBI categorisation of commercial banks Public sector banks

Private sector banks

Foreign banks

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Money market o Market for borrowing and lending of short-term fundso Call money market – inter-bank transactions on day-to-day

o Call money rate –

High call money rate indicates scarcity of funds and

tight money market Low call rate means easy availability of funds

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Tax system o Different heads of income for tax structure in India

Salary

House property

Profit in business or

profession Capital gains

Other sources

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Tax system – important facts o Laws on central government income tax collection and recovery

are governed by the Dept of Tax and Revenue under Min of Finance, India

o System of taxation is completely based on the personal

assessment of income

o Penalties and interest are charged on the non-payment of taxes

and failure to file returns

o Filing date is not extended and any late filing is charged with

interest

o All large sized and medium sized taxpayers are subjected to

investigative assessmento Designated due dates are ascertained for the purpose of filing of

returns

o The tax is deducted at source by the employers on behalf of the

employees and from all kinds of defrayments to non residents

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Tax incentives – personal o Exemption on income spent on higher educational

purpose

o Exemption on income spent for the treatment of a

diseased person who is dependent

o Exemption on income spent as contribution to provident

fund, insurance policies, etco Exemption on the income spent on buying NSC and

investments in other government based savings

schemes

o Exemption on the income of a disabled persono Exemption on the income spent on the payment of

interest on home loan

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Tax incentives - corporate o Govt of India provides incentives for :

Corporate profit

Accelerated depreciation allowance

Deductibility of certain expenses subject to some

conditions

o Tax incentives are available for new investments :

Infrastructure

Power distribution

Certain telecom services

Rural hospitals

Food processing

Handling of food grains

Companies carrying on R&D, etc

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GST o Goods and Services Tax (GST)

o GST will include CENVAT, VAT, Service tax, Turnover tax,

Octroi.

o Aim is to bring uniformity in the indirect tax structure

o Kelkar Task Force has recommended a standard rate of

20%

o Out of 20%, 12% will go to the Central government and

8% will go to the state government.

o Recommendation also included higher rate on non-merit

goods and lower rate on merit goods

o Proposed schedule for the implementation of GST is April 1,

2010

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Share Market - Terms o Stock Exchange

o Equity / Share

o Debt instrument

Bond – Issued by central and state governments and

public sector organizations

Debenture – Issued by private corporate sector

o Derivative – Product whose value is derived from the value

of one or more basic variables, called underlying, which can

be equity, index, foreign exchange, commodity or any other

asset.

o Index – Shows how a specified portfolio of share prices is

moving in order to give an indication of market trends,

Snesex, Dow-Jones

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Share Market – More Terms o Depository – Like a bank wherein the

deposits are securities (shares, etc)

in electronic form

o Dematerialization – Process of

conversion of physical share

certificates to electronic form and

crediting to the investor‟s account

with his Depository Participant (DP)

o Securities Market Regulator – Dept of

Economic Affairs, Dept of Company

Affairs, RBI and SEBI (Securities and

Exchange Board of India)

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Securities - Terms o Face Value – Nominal or stated amount assigned to a

security by the issuer

o For shares, it is the original cost of the stock

o For bonds, it is the amount paid to the holder at maturity

o Also known as par value

o When a security is sold above its face value, it is said to be

issued at a premium

o When it is sold at less than its face value, then it is said to

be issued at a discount.

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Issue of Shares o Initial Public Offering (IPO) – when an unlisted company makes

either a fresh issue of securities or an offer for sale of its existing

securities or both for the first time to the public.

o Rights Issue – When a listed company proposes to issue fresh

securities to its existing shareholders.

o Market Capitalisation – Market value of a quoted company;calculated by the product of the current share price and the

number of shares in issue

o ADR (American Depository Receipt) – physical certificate of

ownership of ADS (American Depository Share). ADS is a US

dollar denominated form of equity ownership in a non-US

company.

o GDR (Global Depository Receipts) – A global finance vehicle that

allows an issuer to raise capital simultaneously in two or more

markets through a global offering

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Analysing a company o Industry Analysis – Effects of govt policy, future demand of

products, etc

o Corporate Analysis – Information on current operations,

managerial capabilities, growth plans, its past performance

vis-à-vis its competitors, etc

o Financial Analysis- Used to check if at the current price the

share is a good buy.

Annual Report – Best source of information about a

company‟s financial health

Balance Sheet/ P&L account – Balance sheet shows the

financial position of the company at a particular point of

time. P&L account shows the financial performance over

a period of time.

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Mutual Fund o A corporate body registered with SEBI that pools money

from individuals/corporate investors and invests the samein a variety of financial instruments or securities.

o Benefits of investing in Mutual Funds:

Small investments – wide spectrum with small

investments Professional Fund

Management

Spreading risk

Transparency

Choice

Regulations (SEBI protects

the interests of the investors)

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Mutual Fund - Terms o NAV – Net Asset Value of the fund is the cumulative market

value of the assets of the fund net of its liabilities.

o NAV of an open end scheme should be disclosed daily and

that of a close end scheme should be disclosed at least on a

weekly basis

o Entry/Exit load – Charges levied to cover the up-front cost

incurred by the mutual fund for selling the fund. Also covers

one time processing fee

o Entry load – 1 to 2%

o Exit load – 0.25 to 2%

o Risks involved –

Market risk

Non-market risk

Interest rate risk

Credit risk

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State of Indian Economy o Despite signs of recovery from the global financial crisis, the GDP

growth rate for the Indian economy is likely to be between 5.8 to

6.1 per cent in 2009-10, below the 6.7 per cent recorded in fiscal

2008-09.

o While there has been an improvement in Indian industry,

particularly the manufacturing sector, the adverse impact of thefall in kharif production due to a rainfall deficiency will act as a

drag on the overall growth of the economy.

o In the current financial year, the major policy challenges for the

government will come from the rather sharp rise in inflation and

deteriorating public finances.

o The balance of payments situation may also require policy

attention despite a narrowing of the current account deficit and a

considerable capital account surplus because of the appreciation

of the rupee.

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Monetary measures o In mid-September 2008, the central

bank started to ease liquidity but no cuts

were made yet in policy rates.

o Inflation measured in terms of the

wholesale price index (WPI) peaked at

12.9 per cent in early August 2008 andremained high for some time.

o From mid-September till end-October

2008, the economy was in the grip of a

serious liquidity crisis and credit crunch.

o The Reserve Bank of India (RBI) acted

aggressively from mid-October to ease

the situation by a series of rate cutting

and liquidity injecting measures that

went on till April 2009.

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Fiscal stimulus o The central government announced three successive fiscal

stimulus packages: one in early December 2008, the second one

in early 2009 and the last one in early March 2009.

o These included an across-the-board central excise duty reduction

by 4 percentage points; additional plan spending of Rs.200 billion;

additional borrowing by state governments of Rs.300 billion forplan expenditure; assistance to certain export industries in the

form of interest subsidy on export finance, refund of excise

duties/central sales tax, and other export incentives; and a 2

percentage-point reduction in central excise duties and service

tax.

o The total fiscal burden for these packages amounted to 1.8 per

cent of GDP.

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Impact on Economy o The growth in GDP dropped to 5.8 per cent (year-on-year)

during the second half of 2008-09 from 7.8 per cent in the

first half.

o Growth improved slightly to 6.1 per cent in the first quarter

of 2009-10.

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Indian Economy-GDP

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Indian Economy - GDP

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Impact on Economy - Sectors o Industry, and particularly the manufacturing sector, was the most

severely affected by the crisis.

o Industrial growth plunged to 1.9 per cent in the second half of

2008-09 from 6.1 per cent in the first half and manufacturing

growth collapsed to -0.3 per cent in the second half from 5.3 per

cent in the first half.o Industrial growth picked up to 5.0 per cent in the first quarter of

2009-10 and manufacturing to 3.4 per cent.

o The services sector as a whole had been resilient up to the third

quarter of 2008-09 but later showed signs of weakness with its

growth declining to 8.6 per cent in the last quarter of 2008-09

(average 10 per cent growth in the previous three quarters) and

further to 7.8 per cent in the first quarter of 2009-10.

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Impact on Economy - Sectors

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Fiscal Stability o Public finances had improved considerably

o The fiscal deficit (centre and states combined) came down

to 4.2 per cent of GDP in 2007-08 (well below the

permitted 6 per cent), the primary deficit (fiscal deficit net

of interest payments) turned into a surplus of 1.3 per cent

of GDP and total public debt as a proportion of GDP also

came down from the peak of 81.4 per cent in 2003-04 to

75.1 per cent in 2007-08.

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Fiscal Stability o The situation changed drastically in 2008-09

o The fiscal deficit shot up to 8.9 per cent of GDP (10.7 per

cent including off-budget bonds against 5 per cent in 2007-

08) and the primary surplus turned into a deficit of 3.5 per

cent of GDP.

o The public debt, however, declined marginally to 74.7 per

cent of GDP. Budget estimates for 2009-10 indicate a

further worsening in the current year with the fiscal deficit

rising to 10.2 per cent of GDP, primary deficit to 4.5 per

cent and debt ratio deteriorating to 76.6 per cent.

o This has raised afresh the issue of India‟s fiscal stability and

debt sustainability.

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Fiscal Stability o The policy implication is that

we should strive to reduce

primary deficit or achieve a

primary surplus, raise the

growth rate and reduce the

interest rate.

o The growth is in nominal terms

and there is surely an option of

inflating our way out of debt.

o However, this is not feasible

given the political sensitivity

regarding inflation.

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Inflation o In India, the year-on-year change in the wholesale price

index (WPI) is used as the measure of inflation.

o The wholesale price index has long been discarded by

countries for measuring inflation.

o 157 out of 181 countries in the IMF statistics use consumer

price index (CPI) for tracking inflation.

o While WPI inflation is very low or negative from March

2009, CPI inflation was high and rising from April 2009. It

touched about 12 per cent in July 2009.

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Inflation o Although year-on-year WPI inflation was negative till

August 2009, food items under both primary articles and

manufactured products have shown rising and high inflation

at double digit levels in recent months.

o The negative inflation continues in the case of fuel and

metal groups.

o It appears that inflation is concentrated in food items and

what we have is “food inflation” and not a general inflation.

o For products like „personal care and effects‟ and other

miscellaneous items, the rates of inflation have touched 12

per cent and 20 per cent respectively in June 2009.

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Balance of payments - Terms o Current Account Deficit – Occurs when a country's total

imports of goods, services and transfers is greater than the

country's total export of goods, services and transfers. This

situation makes a country a net debtor to the rest of the

world.

o Capital Account - The capital account is calculated bynetting the public and private investments within the

country with those the government and domestic

companies are making outside the country.

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Balance of payments o India‟s balance of payments underwent major shifts in 2008-09

that resulted from the transmission of the direct impact of the

global crisis to India.

o The current account deficit shot up to 2.6 per cent of GDP in

2008-09 from 1.5 per cent of GDP in 2007-08.

o This is the highest level of current account deficit for India since1990-91

o The impact on the capital account was more pronounced as the

capital account surplus dropped from a record high of 9.2 per cent

of GDP in 2007-08 to a meagre 0.8 per cent of GDP in 2008-09.

o This is the lowest level of capital account surplus for India since

1981-82.

o The year ended with a decline in reserves of US$ 20.1 billion

(inclusive of valuation changes) against a record rise in reserves

of US$ 92.2 billion for 2007-08.

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A major concern o A sharp dip in the growth rate of private consumption.

o Four factors seem to have contributed to this slowdown.o It could be due to the wealth effect, resulting from a decline

in the equity/property prices.

o The uncertainty in the labour market and some decline in

employment in India‟s tradable sectors may havemoderated the growth in consumption expenditure.

o Cutbacks in consumer credit by private banks NBFCs and

other lenders, because of their limited deposit base and

difficulties in secondary market financing because of theknock on effect of global financial market freezing.

o During slowdown a dominance of precautionary motive may

induce consumers to either defer their spending decisions

or shift to unbranded lower quality alternatives.

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The way ahead o The industrial sector which underwent a severe downturn in

2008-09 is beginning to recover from early 2009-10, but it

is not yet clear that the pick-up is underpinned by a strong

revival in real demand.

o The monsoon failure has created uncertainty as to whether

demand growth will be sustained.

o The fiscal stimulus has helped in substituting for lost private

demand to some extent and prevented a steeper fall in GDP

growth.

o While the growth in the non-agricultural sector in the

current year would be somewhat higher than last year, a

marked decline in agricultural output is expected to bring

down this year‟s growth in GDP below last year‟s level.

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The way ahead o In this context, high inflation, which has emanated from the

agricultural shock and may be spreading to non-food

products, will pose a big policy challenge.

o At a time when last year‟s aggressive monetary loosening

measures seem to have just started boosting growth, the

central bank may have to start tightening sooner than later.

o Too early a tightening, however, can harm the fragile,

incipient industrial recovery.

o Policy can take comfort from some likely moderation of

inflation in August and September.

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The way ahead o The return of confidence to the financial market has pushed up

stock prices and companies have been able to raise resourcesagain from the capital market.

o However, the flow of bank finance to the economy has not

improved.

o The return flow of capital from abroad is taking place strongly,

particularly from foreign institutional investors.

o This, in turn, has put upward pressure on the rupee, which is

appreciating rapidly.

o Some appreciation may not be problematic as the real effective

exchange rate had depreciated steeply during 2008-09.o But as we go forward, the central bank will be hard-pressed to

balance the objectives of inflation control, exchange rate stability

and growth.

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Global Economic Meltdown o The first hint of the trouble

came from the collapse of two

Bear Stearns hedge funds early

2007.

o Subsequently a number of other banks and financial

institutions also began to show

signs of distress.

o Matters really came to the forewith the bankruptcy of Lehman

Brothers, a big investment

bank, in September 2008.

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Reasons o Boom in the Housing Market

o Speculation

o High-risk Mortgage Loans and Lending Practices

o Securitisation Practices

o Poor Regulation

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Impact on India o Information Technology

o Exchange Rate

o Foreign Exchange Outflow

o Investment

o Real Estate

o Stock Market

o Exports

o Banks

o Increase in Unemployment

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How India faces it? o Compared to other emerging economies, India has several

strengths that can help an early mitigation of the adverse effects

of the global financial crisis and the recession in major OECD

economies.

o India has a relatively high share of services in GDP than many

other emerging economies and developing countries. Historically,

across countries, services tend to be less affected by cyclical

downturns than manufacturing.

o Six years of average 4.4 per cent agriculture growth together with

scaling up of rural development programmes, including the

National Rural Employment Guarantee Scheme (NREGS), during

the past year has kept the rural income and consumption strong.

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How India faces it? o Like other high-growth Asian economies, India‟s domestic saving

rate remains high and has risen sharply with higher growth during

the last five years. In fact the increase in the gross domestic

saving over the last five years was greater than the increase in

gross domestic capital formation over the same period.

o The ambitious programme of infrastructure investment designed

for the Eleventh Five Year Plan period, which has now been front-

loaded as a part of the policy response to the growth slowdown,

provides the basis for offsetting some decline in corporate

investment in manufacturing by increased investment in

infrastructure by government and by the private sector through

the public-private partnership model.

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How India faces it? o India continues to retain its position as a preferred destination for

investments. In a recent UNCTAD study on assessing the impact

of the current financial and economic crisis on global flows, it was

found that India achieved a growth of 85.1 percent in foreign

direct investment flows in 2008, the highest increase across all

countries.

o The steep decline in commodity prices in the second half of 2008-

09 along with the likely slack in global demand or at least the next

12 months would not only help in cutting down the import bill, but

also have a favourable impact in effecting a reduction in below the

line deficit to less than the level in 2008-09.

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Prospects – Indian Economy o Indian economy has slowed and has not shrunk unlike most OECD

and many emerging economies.

o A large domestic market, resilient banking system and a policy of

gradual liberalization of capital account have been a key factor.

o A number of forecasts and projections have been made on the

prospects of the Indian economy in 2009-10.

o These range from a low of 4.8 per cent (ICRIER, March 2009) to a

high of 6.5 to 7.5 per cent (ICRA, April 2009). The RBI‟s April

2009 projection stands at 6 per cent and that of PM‟s Economic

Advisory Council at 7-7.5 per cent.

o Among the international agencies, the March 2009 ADB forecast

for 2009-10 is 6.5 per cent, IMF is 5.6 per cent and World Bank‟s

forecast for the calendar year 2009 is 4 per cent.

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eco session _2009

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