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Why the decline of the West is best for us – and them

2011-11-06T18:41:00.001+05:30

Why the decline of the West is best for us – and them
By R Vaidyanathan, Professor of Finance, IIM Bangalore.

Ten years ago, America had Steve Jobs, Bob Hope and Johnny Cash. Now it has no Jobs, no Hope and no Cash. Or so the joke goes.

Only, it's no joke. The line is pretty close to reality in the US. The less said about Europe the better. Both the US and Europe are in decline. I was asked by a business channel in 2008 about recovery in the US. I mentioned 40 quarters and after that I was never invited for another discussion.

Recently, another media person asked me the same question and I answered 80 quarters. He was shocked since he was told some "sprouts" of recovery had been seen in the American economy.

It is important to recognise that the dominance of the West has been there only for last 200-and-odd years. According to Angus Maddison's pioneering OECD study, India and China had nearly 50 percent of global GDP as late as the 1820s. Hence India and China are not emerging or rising powers. They are retrieving their original position.

The dollar is having a rollercoaster ride at present. In 1990, the share of the G-7 in world GDP (on a purchasing power parity basis) was 51 percent and that of emerging markets 36 percent. But in 2011, it is the reverse. So the dominant west is a myth.

Similarly, the crisis. It is a US-Europe crisis and not a global one. The two wars – which were essentially European wars – were made out to be world wars with one English leader commenting that 'we will fight the Germans to the last Indian'.

In this economic scenario, countries like India are made to feel as if they are in a crisis. Since the West says there's a crisis, we swallow it hook, line and sinker.

But it isn't so. At no point of time in the last 20 years has foreign investment – direct and portfolio – exceeded 10 percent of our domestic investment. Our growth is due to our domestic savings which is again predominately household savings. Our housewives require awards for our growth not any western fund manager.

The crisis faced by the West is primarily because it has forgotten a six-letter word called 'saving' which, again, is the result of forgetting another six letter word called "family". The West has nationalised families over the last 60 years. Old age, ill health, single motherhood – everything is the responsibility of the state.

When family is a "burden" and children an "encumbrance," society goes for a toss. Household savings have been negative in the US for long. The total debt to GDP ratio is as high as 400 percent in many countries, including UK. Not only that, the West is facing a severe demographic crisis. The population of Europe during the First World War was nearly 25 percent and today it is around 11 percent and expected to become 3 percent in another 20 years. Europe will disappear from the world map unless migrants from Africa and Asia take it over.

The demographic crisis impacts the West in other ways. Social security goes for a toss since people are living longer and not many from below contribute to their pensions through taxes. So the nationalisation of families becomes a burden on the state.

European work culture has become worse with even our own Tata complaining about the work ethic of British managers. In France and Italy, the weekend starts on Friday morning itself. The population has become lazy and state-dependent.

In the UK, the situation is worse with drunkenness becoming a common problem. Parents do not have control over children and the Chief Rabbi of the United Hebrew Congregation in London said: "There are all signs of arteriosclerosis of a culture and a civilisation grown old. Me has taken precedence over We and pleasure today over viability tomorrow." (The Times: 8 September ).

Married couples make up less than half (45 percent) of all households in the US, say recent data from the Census Bureau. Also there is a huge growth in unmarried couples and single parent families (mostly poor, black women). Society has become dysfunctional or disorganised in the West. The government is trying to be organised.

In India, society is organised and government disorganised. Because of disorganised society in the West the state has to take care of families. The market crash is essentially due to the adoption of a model where there is consumption with borrowings and no savings. How long will Asian savings be able to sustain the western spending binge?

According to a recent report in The Wall Street Journal (10 October 2011), nearly half of US households receive government benefits like food stamps, subsidised housing, cash welfare or Medicare or Medicaid (the federal-state health care programmes for the poor) or social security.

The US is also a stock market economy where half the households are investors and they have been hit hard by bank and corporate failures. Even now less than 5 percent of our household financial savings goes to the stock market. Same in China and Japan.

Declining empires are dangerous. They will try to peddle their failed models to us and we will swallow it since colonial genes are very much present here. You will find more Indians heading global corporations since India is a very large market and one way to capture it is to make Indian sepoys work for it.

A declining West is best for the rest and also for the West, which needs to rethink its failed models and rework its priorities. For the rest—like us—the fact that the West has failed will be accepted by us only after some western scholars tell us the same. Till then we will try to imitate them and create more dysfunctional families.

We need to recognise that Big Government and Big Business are twin dangers for average citizens. India faces both and they are two asuras we need to guard against. The Leftists in the National Advisory Council want all families to be nationalised and governed by a Big State and reform marketers of the CII variety want Big Business to flourish under crony capitalism. Beware of the twin evils since both look upon India as a charity house or as a market and not as an ancient civilisation.
R.VAIDYANATHAN
Professor of Finance
IIM, Bangalore

Contributed by: swapnildavey @ gmail.com

Some Sane advice on trading

2011-11-06T18:34:00.000+05:30

As an investment advisor, I get lots of queries from investors across the country.

Here's a sample:

'I bought this scrip last week and it is down. Should I sell?'
'The markets are trading at a peak. Is it right to invest now?'
'I want to make maximum returns in minimum time. Suggest some stocks.'
'Which are the stocks worth buying with price less than Rs 50?'
'When will the market correct? I want to invest in some good shares.'

This kind of approach to investing in equity is a recipe for disaster.
There are some serious problems here. Let's pick up some important lessons.

Lesson #1

The moment the prices of scrips drop, say, by 5%-10%, we get worried.
In that anxiety, we want to sell and get out.

Let's say the Reliance share you bought last week is down 10%.

So what?

Will Reliance business close down?
Or will Mukesh Ambani run away with your money?

No.

The movement in stock prices has no impact on the business.
Reliance will continue to make profits and grow. Mukesh Ambani will
continue to build world-class projects. If that is the case, Reliance shares
will see new heights in future.

Why bother about these falls which likely will only be temporary?

The problem is, we buy stocks, not businesses. The Tatas and Birlas
have been around for over 100 years. Hundreds of successful companies
have run for decades and continue to grow irrespective of the stock market volatilities.

Yes, some businesses succeed, some fail. There are ups and downs.
That is the inherent nature of a business. But, in the long run, they will make
profits and grow. That is where management counts.
Good managements run profitable operations.

Second, that's why we diversify. Even if we lose money in a few stocks,
we will still make lots of money in others.

Moral: Buy businesses, not stocks.

Lesson #2

Recently, I read that if you had invested Rs 1 lakh in Infosys at the time of IPO, it would be worth about Rs 64 lakh now. But how many people made that kind of money?
None, I guess, except the employees and a lucky few who bought the shares
but forgot about it.

Answer honestly:
wouldn't you have sold the shares when it doubled or tripled or became a ten-bagger?
How many of us would have had the patience to hold on?

The problem is, we watch stock prices, not businesses. If people had kept track
of the business, they would have seen the company had the potential to grow at
30%-40% per annum. Then they would have never sold their shares.

I know many people who got out at 10,000 Sensex levels, thinking the markets
will correct and they will re-enter at lower levels. They are now ruing their decision.
The problem: they were so obsessed tracking the Sensex that they didn't see
strong economic and business growth.

Moral: Watch business growth, not rise in stock prices.

Lesson #3

The moment people buy a stock, they expect it to double soon. They see the stock
ticker 10 times a day. They call their broker a couple of times daily to find out what is
happening.

I have one question for such people.

Can you set up a steel plant in one day?
Can you build a power plant over the weekend?
Can you start a mobile company and expect to have 1 million customers on Day 1?

No.

Businesses take time to set up, acquire customers and generate profits.
Only when the companies increase their profits will the share price also increase.

Therefore, having bought a good business and good management, give it time
to prosper. If you don't have the patience, you might as well go to a casino or
call-up Shah Rukh Khan at KBC.

Moral:
The stock market is a serious long-term business,
not a make-money-overnigh t casino.

Lesson #4

Another interesting aspect is the stories we hear in local trains, buses, parties, offices, of how so-and-so doubled/ tripled his money.

We end up feeling like fools not to invest in the market. At the first opportunity, we buy a few stocks without proper research and understanding.

I am not saying they are lying. But I would like to ask them about their other investments too. More often than not, for every successful investment, they would have made five other poor investments and lost money. They won't tell you about those.

The point is, when our investment is motivated by others' half-truths, we never have the patience and discipline required for successful equity investing.

Moral: Don't be fooled by others' so-called success stories.

Lesson #5

As I mentioned earlier, people sold looking at the Sensex levels and lost out on the
huge potential profits. There are many waiting for the Sensex to fall to the 'right' levels
to enter the market.

There are two points here.

I highlighted one earlier: watch the economy not the Sensex.

Second, timing.

Given that humans can switch from irrational exuberance to extreme pessimism
and back in a matter of days, I believe even God will find it difficult to time the markets.

Moreover, I bet not even 1 per cent of you will enter the markets if they started crashing from tomorrow. The Dalal Street was totally deserted during the historic crash of May
2006, which was actually a great time to buy.

So I suggest let's get over this fixation with timing the markets.
Let us look at business potential and invest with a long-term perspective.

Moral: Time in the market is more important than timing the market.

Discipline and patience. That is the mantra to creating wealth on the stock markets.
Unfortunately, both are in short supply. If you have them, you make your riches.
If not, you could be in trouble.

I am not very sure how many would agree with the above lessons or even follow them.
Such is human nature: guided by greed and fear, than by reason and logic.

Author: Imad Ahmedi <imad_ahmedi @ yahoo.com>
Contributed by: bruntno1 @ yahoo.com

The Magnificient Rule of 72

2011-11-06T18:14:00.001+05:30

Today I found out about the Rule of 72, which is a very easy way to calculate in your head how long it will take to double your money or debt based on a given fixed interest rate, assuming the interest is annually compounded.

Use of the Rule of 72 is very simple.Â All you have to do is divide 72 by the interest rate.Â The resulting number is the number of years it will take for the amount to double, given that fixed interest rate.Â For example:Â if you invest $10,000 in a CD paying 4% compounded annually, it would take about 72/4 = 18 years to turn that into $20,000.Â On the flip side, if you have some amount of debt, say $30,000 in student loans, at a 5% interest rate which you donâ€™t make payments on, it will take 72/5 =Â 14.4 years for the amount owed to double to $60,000.

You can also run the calculation the other way, if you want to determine what interest rate youâ€™d need to double your money in a given amount of time.Â For instance: if you have $20,000 in savings and would like to double it in the next 10 years without adding anything to it, youâ€™d need an interest rate of around 72/10 = 7.2%.

You can, of course, also use the Rule of 72 to calculate the effect of inflation on your money that you donâ€™t invest.Â So, if the annual inflation rate is at 2%, for instance, then in 72/2 = 36 years, your money that you didnâ€™t invest will be worth half what it is today.

As you can see from the following table, the Rule of 72 is remarkably accurate:

Return % Rule of 72 Years Actual Years

3% 24 23.45

4% 18 17.673

5% 14.4 14.21

6% 12 11.896

7% 10.3 10.24

8% 9 9.006

9% 8 8.04

10% 7.2 7.273

For those curious, how the Rule of 72 works is as follows (warning: there be math ahead; skip to the Bonus Factoids if you got a headache just from reading the word â€œmathâ€) ;-) :Â we start with the general formula for annually compounded interest: P(1+r)Y where Y is the number of years, P is the principle and r is the interest rate.Â Now we want to see when it will double, so we modify it such that: 2P = P(1+r)Y

Now the exact principle doesnâ€™t really matter here, we just want to know when it will double, so next we simplify the problem and solve for Y, so that: Y = ln(2) / ln(1+r)

Now we simplify that to Y = K / r, whereÂ (K /r) = (ln(2)/ln(1+r)) and K will be some number that will result in a fairly accurate outcome given a certain range of values of r.

To begin with, weâ€™ll see what value of K would work for a 10% interest rate:

Step 1: ln(2) / ln(1 + r) = K / r

Step 2: ln(2) / ln(1 + .1) = K / 0.1

Step 3: K = [ln(2) / ln(1.1)] * 0.1

Solution: K = .727

So here we see that the number we get out to be divided by the interest rate in the Rule of 72 is, not surprisingly, really close to 72, namely: 72.7.Â Doing a similar calculation of 5% then results in .7103, so 71.03 when used to divide by the interest rate.

If you were to do the math for a wide range of commonly used interest rates, youâ€™ll see that K always hovers reasonably close to 72, which was possibly picked over 71 or 73 or the like due to the fact that 72 has many small divisors that are in the range of commonly used interest rates: 1, 2, 3, 4, 6, 8, 9, and 12, and within whose range the Rule of 72 is quite accurate.Â The Rule of 72 though does start to break down as you get to extremely high rates, such as 100%, where the Rule of 72 gives you .72 years, which is 28% off of the actual value of doubling in one year exactly.

Bonus Factoids:

There is also a â€œRule of 69â€³ that is derived and used in a similar fashion to Rule of 72, except that it is used to calculate doubling when the interest is compounded continually, rather than annually.Â In this case, 69 is chosen because, when you work the math, compounding daily for typical interest rates comes out to around 69-70 and compounding daily is a reasonable approximation for compounding continually.

The earliest reference to the Rule of 72 is from Summa de Arithmetica which was written around 1494 in Venice by Luca Pacioli.Â In this work, he uses the rule without deriving it, so it is assumed that the rule was already well known at that time: (rough translation of that part of the work): â€œIn wanting to know for any percentage, in how many years the capital will be doubled, you bring to mind the Rule of 72, which you always divide by the interest, and the result is in how many years it will be doubled. Example: When the interest is 6 percent per year, I say that one divides 72 by 6; obtaining 12, and in 12 years the capital will be doubled.â€

The Rule of 72 also gives rise to the rule of 144, which is used in exactly the same way as the Rule of 72, except 144 instead of 72.Â This will tell you when the value will quadruple.

The Rule of 72 doesnâ€™t just apply to money; it actually applies to anything that grows.Â For instance, if the average population growth rate for the planet Earth is 2%, then it will take just 72/2 = 36 years for the population of the Earth to double from the current 6.8 billion to 13.6 billion, then in another 36 years it will have doubled again to 27.2 billion!

The world population growth rate was at its highest in the last 50 years in the 1960s when it hovered just over 2%.Â Since then, it has been on a steady decline with the current annual population growth rate at just over 1%, so taking 72/1 = 72 years to double at that rate.

Given population growth models through human history, it is estimated that there have existed around 100-115 billion humans in Earthâ€™s history.Â The idea that the total number of people alive today is more than the total number that have been alive in the past was based on the faulty premise put forth in the 1970s that 75% of all people that have ever lived were alive in the 1970s.Â This has since been proven to be incorrect.

Currently, the two largest countries, in terms of population, are China and India at 1.346 billion people and 1.21 billion people respectively, comprising around 37% of the entire global population.Â Chinaâ€™s population growth rate is currently lower than the world-wide average; they are sitting at around .5%.Â Indiaâ€™s population growth rate is currently above the world-wide average at just below 1.5%.

Contributed by asharaj53 @ gmail.com

The mantras for financial freedom

2011-10-30T21:46:00.001+05:30

“A successful investor is not one who never loses, but who stays invested in the market.”

Contrary to popular belief, one does not have to earn a lot of money to become wealthy. Here are some simple Mantras to secure your financial freedom!

Dont procrastinate on wealth creation – Many people procratinate on saving money. They always wait for the next year, next increment, next bonus to start savings and then the cycle repeats again. You do not need to start investing large amounts, start small. Even a years delay makes a huge difference as wealth compounds with time.

Prepone Investments, Postpone expenses - Set targets on how much you want to invest and invest it as soon as you get the money. Do not spend first and save (whatever is left) later.

You do not need crores – It’s a myth that you need lots of money to start investing. Even small amounts over time become large due to the magic of compounding.

Go for the long term – Especially in Equity it is important to invest for the long term. They give the best returns in the long term. For short term look at debt.

Invest Regularly – This is very important. You can invest in SIP’s which average out your risk. For eg. investing 10,000 rupees a month would yield 1 crore in 15 years at a annual rate of 20%.

Don’t link your lifestyle to stock market - When the stock market is rising, our notional wealth increases. Soon we start believing that growth of our wealth is real and long term. This false state of suddenly feeling wealthy leads to change in lifestyle. One of the perils of increasing expenses on your lifestyle during stock market boom is that we get used to comforts and luxuries in life. When economic situation turns bad we will then struggle to curtail our expenses. In fact in reality while markets are rising, we should control our expenses and let our wealth grow. On the other hand when equity markets are down, our wealth is not growing in real terms. Things are also cheaper generally during such periods.

Ignore Rumours - If you are confident about the company you have invested in, leave it. Ignore rumours.

Research & Learn – Learn about budgeting, credit, and debt. Learn how credit cards work! If you get into debt early it can sabotage your progress. Whenever you buy a stock or fund, don’t do it on a tip or whim, but do solid research to back up your buy. Investing can be very interesting and rewarding!

Union Finance Minister Shri Pranab Mukherjee’s Address at the National Development Council Meeting

2011-10-26T21:03:00.001+05:30

Union Finance Minister Shri Pranab Mukherjee addressed the National Development Council Meeting in New Delhi today. Following is the text of his address:

"It is my privilege to address the meeting of the National Development Council, convened to consider the Approach Paper to the Twelfth Five Year Plan. I would like to congratulate the Deputy Chairman and the Members of the Planning Commission for the work undertaken in preparing this Paper.

2. The renewed uncertainty in the global economy, due to sluggish US growth and worsening of the Euro-zone sovereign debt crisis and weak business sentiments and persisting high inflation at home, poses considerable challenges to the task of making a five-year plan. The fact that this task has been done well and the Approach Paper is before us for consideration is commendable.

3. In the last decade, the Indian economy moved to a higher growth path. Between 2005 and 2008, the economy grew at around 9.5 per cent per annum. This made India one of the fastest growing nations in the world. The global financial crisis brought the growth down to 6.8 per cent in 2008-09, though even then India remained a growth leader in the world. This was followed by a strong recovery and the Indian economy grew by 8 and 8.5 per cent in the subsequent two years. Data for the first quarter of 2011-12 indicate a growth rate of 7.7 per cent. While there may be some moderation in growth in the current fiscal, the fundamentals of the economy are intact and the medium-term growth prospects remain buoyant.

4. Over the last two decades the Indian economy has become increasingly integrated with the global economy. It is indeed a matter of pride that the world views India today as a major driver of growth. But globalization also has a downside. It means that when the world sneezes, India runs the risk of catching a cold. Not surprisingly, the economic crisis in Europe and the slowdown in the US are impacting us adversely. As an important contributor to the global growth process, we are playing an increasing role in the international policy arena. In my intervention in the G 20 meet held recently in Paris, I highlighted the spill over effects of the policies of advanced economies. I pointed out that the strong injections of liquidity by Central Banks seem to have done little to stimulate lending and borrowing. Instead we are witnessing negative consequences, especially on asset and commodity prices that have strengthened inflation in emerging markets.

5. Let me at the outset say that I endorse the overall theme of the Approach Paper to the Plan, namely, "Faster, Sustainable and More Inclusive Growth". It captures well the aspirations of ordinary Indians. There are, however, several issues that we need to focus on, I intend to briefly touch upon some of these.

Growth target for the Plan

6. While making a plan, it is important to be realistic and not get carried away by flights of fancy. At the same time, when we make a plan in the midst of a difficult economic situation, it is easy to be over-pessimistic. We have to remind ourselves that a plan is not like a Budget. The horizon for a plan is much longer and we must look beyond the immediate concerns. The Approach Paper outlines two alternative growth scenarios – 9 per cent and 9.5 per cent. There are good reasons, as has been outlined in the document before us, to pitch for a 9 per cent average growth for the plan period. Yet we need to retain a certain flexibility in our planning to consider raising the growth target to above 9 per cent, should the global environment improve and we make good progress in strengthening our domestic growth drivers in the initial years of the Twelfth Plan. We have achieved 9 per cent plus growth prior to the global slowdown. Our ability to deepen and broad-base the inclusion of the marginalised and vulnerable segments of our society in the economic mainstream, hinges crucially on sustaining buoyancy in our resource mobilisation and sustaining high growth path.

7. It is also important that more of this growth takes place in the backward areas of our country. There is already evidence that some of the slow growing states in the past have improved their performance in the recent years. This trend should be further reinforced. The objective of making growth more inclusive cannot be realised unless we are able to narrow down the regional imbalances and disparities.

Fiscal consolidation

8. The budgetary support for the 11th Plan was targeted at Rs 16.08 lakh crore in nominal terms and has been fully financed by the Government. However, this was possible at high fiscal costs. After bringing down the fiscal deficit to 3.3 per cent of GDP in 2007-08 we had to breach fiscal targets and incur fiscal deficit of 7.8 per cent and 6.5 per cent of GDP in 2008-09 and 2009-10 respectively. The fiscal impact of these deviations will be felt in years to come in terms of high debt servicing requirements. We could afford this deviation to tide over the global economic crisis without any solvency concerns only because of the fiscal space we had created during the period 2004 to 2008. That fiscal space for manoeuvrability is no longer available.

9. Our recent experience has shown that sustained high growth and fiscal consolidation can be mutually reinforcing. The fiscal consolidation path as envisaged in the Medium Term Fiscal Policy Statement in the Budget 2011-12 has to be followed. As Finance Minister, I stand committed to this path of fiscal consolidation. However, I do recognize that to sustain growth along with fiscal consolidation, we will have to take our due diligence beyond monitoring the quantitative parameters. The quality of expenditure and its multiplier effect on growth must get our attention.

10. The States' finances have been improving steadily in recent years. The fiscal consolidation brought about through implementation of the Debt Consolidation and Relief Facility in the Twelfth Finance Commission award period, 2005-10, has been built upon through higher devolutions under the Thirteenth Finance Commission award. Plan assistance to the States through the Centrally Sponsored and Centrally administered schemes has also expanded over the years. The States' share in central taxes has been showing an upward trend: this share was 29.5 per cent during the Eleventh Finance Commission period (2001-2005); it was raised to 30.5 per cent during the Twelfth Finance Commission period (2005-2010) and currently stands at 32 per cent for the period 2010-15. The current Finance Commission award also aims to fulfil identified specific needs of States through grants of nearly Rs.28,000 crore over the next four years.

11. The flow of resources to the local bodies has been stepped up and made more buoyant during 2010-15, as the Thirteenth Finance Commission has linked grants to local bodies with the quantum of taxes collected by the Union Government. Reforms at the local body level have been incentivized through additional grants. The local body reforms have been uneven across States, but I am sure that the States are working at strengthening local bodies through improved devolution of funds and functions. The capacity of local bodies has to be enhanced by making higher devolutions through the State Finance Commissions.

12. These steps, and the States' own efforts, have led to improvement in the States' aggregate fiscal parameters. There has been a decline in the aggregate debt to GDP ratio for the States from 28.4 per cent in 2007-08 to an estimated 23.7 per cent in 2011-12. The estimated aggregate fiscal deficit of States in 2010-11 was 2.5 per cent of GDP, which was within the FC-XIII target of 2.6 per cent. The 2011-12 Budget Estimates of the States show an aggregate fiscal deficit of 2.2 per cent of GDP, which is well within the target of 2.5 per cent set by FC-XIII. The aggregate revenue surplus of States in 2011-12 is about 0.3 per cent, again ahead of FC-XIII projections. It is expected that the improved fiscal health of the States will result in their taking up more responsibilities for developmental activities at the State level, particularly in bridging the infrastructure gap during the Twelfth Plan period.

13. One area of concern which some States need to address relates to tax revenues of States'. The States' tax to GSDP ratios show wide variations. In the 2008-09 actuals, the tax to GSDP ratios of General Category States ranged from 4.1 per cent to 9 per cent, with the average being 6.7 per cent. The top two States had tax to GSDP ratios of 9 per cent and 8 per cent and the bottom two 4.1 per cent and 4.2 per cent. These ratios point towards the need for more work by many States to rationalize tax rates, improve compliance and widen the tax base.

Infrastructure Development

14. In the Eleventh Plan, the investment target in infrastructure was about Rs 20.5 lakh crore, with an attendant objective of increasing the share of private sector in the total investments, from around one-fourth to one-third. We have been successful in scaling-up infrastructure investments. According to Planning Commission estimates, in the first four years of the current Plan, the infrastructure investment will be around Rs.15.26 lakh crore. Gearing up to sustain the momentum during the next plan period commencing in 2012, would be a greater challenge. Issues like land acquisition, environment clearance and resettlement and rehabilitation will have to be addressed to de-risk both green-field and brown-field project development. We have to be focused on creating an enabling environment to facilitate investments.

15. A major challenge in this context would be to manage the funding requirement of the sector. We have to collectively plan for meeting the investment target of US $ 1 trillion during the Twelfth Plan, with half of the proposed investment coming from the private sector.

Power sector

16. In the context of Power generation, the recent concerns relate to supply constraints regarding fuel, coal and natural gas. Issues like land acquisition, deteriorating health of the state electricity boards and environmental clearances have also been adversely affecting this sector. On the distribution front, the efficiency as measured by the aggregate technical and commercial (AT & C) losses remains woefully low. On date the losses, on an average, exceed 40%. This is not acceptable. The operational efficiency of the distribution utilities has to be improved. The States will have to review and revise the tariffs regularly to ensure the financial health of these utilities. Urgent action is needed on both fronts to ensure that the cumulative losses of utilities do not ultimately devolve on State Governments.

17. I have recently reviewed the progress of the power projects requiring funding of Rs.5000 crore or more from Indian banks. A large number of cases are held up because of the delay in obtaining clearances from State Governments and some departments of the Government of India. While I am working with my colleagues at the Centre, I strongly urge Chief Ministers to set up a mechanism for according early clearance to such projects.

GST and DTC

18. We have initiated two major steps in the area of tax reforms. The first pertains to the DTC and the second to the Goods and Services Tax (GST). The DTC Bill was introduced in August, 2011 and has been referred to the Parliamentary Standing Committee. I am hopeful that the Committee will submit its report by the Winter Session of the Parliament, and thereafter we would seek to get the legislation passed during the Budget session. By amalgamating several taxes levied by the Centre and the States at different stages of the value chain, the GST would mitigate cascading and make Indian industry competitive in domestic as well as international markets. It would also improve compliance and make the level of taxation transparent to the end consumers.

The introduction of GST requires a Constitutional Amendment to enable the Centre to levy a tax on the distribution of goods beyond the manufacturing stage and to empower the States to levy a tax on supply of services. A Constitutional Amendment Bill to this effect has already been introduced and is currently with the Parliamentary Standing Committee. I seek full cooperation of the States in supporting this Constitutional Amendment Bill to pave the way for the early introduction of GST.

Food Security

19. Ensuring the food and nutritional security for all Indians is the collective responsibility of the Centre and the States. After initial consultations with States, Ministries, expert advisory bodies and other stake holders, the Department of Food and Public Distribution has prepared a draft National Food Security Bill.

20. The draft Bill has been sent to all States and Union Territories and the Central Ministries for their comments and suggestions. It has also been put on the website of the Ministry of Consumer Affairs, Food and Public Distribution. So far, only a few States and UTs have sent their comments. Since this is an important legislation, I request the States to send their views at the earliest to help us finalize the bill for introduction in the Winter Session of the Parliament.

21. The implementation of the Food Security Act will be the joint responsibility of the Centre and States. Both have to work together to procure the required quantity of food grains and ensure distribution of the food grains to the beneficiaries through an effective delivery system.

22. Revamping the PDS is a necessary pre-requisite for the effective implementation of the proposed National Food Security Act. The Supreme Court has also directed an end-to-end computerization of PDS. The Task Force under Shri Nilekani is working on direct transfer of subsidy that will eliminate leakages and will minimize the distortion of prices. As soon as this is available the States/UTs should draw up a time bound action plan for computerization of Supply Chain Management.

APMC reforms

23. It is important to reduce the gap between producer prices and retail consumer prices through an efficient supply chain management. The APMCs were established to protect the interest of farmers. However, in reality, the APMC system has led to monopolistic behaviour and reduced the choices available to small farmers. Reforms in APMC Act could play an important role in reducing the supply side constraints. I would urge upon this august gathering to consider these proposals on merits without any delay.

Plan Size and Centrally Sponsored Schemes

24. There is at present excessive focus on plan size and greater demands for resources. What is important is the plan outcomes; there is a need to correlate outlays with outcomes. The number of Centrally Sponsored Schemes needs to be rationalized. There has been some progress on this front over the years but there is scope for much more streamlining of these schemes.

25. Let me take this opportunity to make an appeal to all our leaders, cutting across party lines and regional identities. No matter which party each of us belongs to, our first commitment must be to India. As politicians we like to win elections. Let me confess that I too like to win elections. But our own election victory must never take precedence over India's victory. I say this because there are some important reforms, which need legislative action and cannot be brought in by an executive order. We all agree that reforms like this are important for India's development and can happen only if we all work together. We must remind ourselves that if India wins, we all win."

Identifying Systemic Risk in Global Markets – Lessons learned from the crisis

2011-10-26T20:51:00.001+05:30

Identifying Systemic Risk in Global Markets – Lessons learned from the crisis : Asian regulators' views on what have they done to contain the building up of systemic risk and to prevent the recurrence of future crisis

(Address by Mr. V.K. Sharma, Executive Director, Reserve Bank of India, at the 2nd Pan-Asian Regulatory Summit organized by Thomson Reuters at Singapore on September 28-29, 2011)

In my considered opinion, systemic risks in the global markets can be best identified and measured by looking at some select key parameters which, between them, indicate the extent of asset bubbles and the corresponding under-pricing of risks. In other words, it is not so much high volatility, which is the 'effect', that should be a cause for concern as persistent and excessively low volatility, which is the 'cause', and was the hallmark of the pre-crisis period. In particular, it is very instructive to look at the readings on parameters such as (i) TED Spread (3M LIBOR – 3M Treasury Bill), (ii) 3M LIBOR – 3M OIS, (iii) 3M LIBOR – Effective Fed Funds Rate, (iv) VIX Index and (v) CDX Crossover index. Pre-crisis these were about 48 bps, 12 bps, 27 bps, 24% and 154, respectively. This was the time when there was a veritable bubble across credit and equity markets and global policy makers were already warning about huge under-pricing of risks in the run up to the crisis. But unfortunately, nothing, in terms of pre-emptive, proactive and credible policy response, other than these warnings, was delivered. If one looks at the recent readings (from September 2010 to July 2011) on these five parameters, on parameter No. (i) at 13 bps, we were at almost quarter the level, on parameter No. (ii) at 9 bps, we were almost there, on parameter No. (iii) at 11 bps, we were less than half, on parameter No. (iv) at 14.62% we were roughly at half and on parameter No. (v) at 146, we were at slightly lower level. There is thus incontrovertible evidence that there is yet again a huge under-pricing of risks in the financial system and, therefore, it is not a question of if, but when, generic asset bubble caused by manifold increases in balance sheets of central banks will burst. Specifically, currently the global liquidity has become a bigger concern than it was in pre-2007 period what with ultra-low and near-zero policy rates and major central banks' balance sheets 1.50 to 3 times their pre-2007 levels, adding about USD 4 trillion in incremental central bank liquidity. Worse, US banks are reportedly keeping excess reserves of US $ 1.5 trillion with the Fed rather than lend to small businesses and households. Alongside, non-financial corporations in the US are reportedly sitting on cash and liquid assets worth USD 2 trillion which they do not know what to do with it ! In this background of huge deluge of global liquidity, there are unmistakable signs of asset bubble inflating again in almost a replay of the last global financial crisis. As the table I shows, as of 14 September 2011, the over-valuation of gold – what we can also call gold bubble-with reference to 7 competing asset classes varied from 84% against highly correlated metal prices proxied by LMEX, 90% against WTI crude, 123% against US Treasuries proxied by JP Morgan index, and roughly 250-300% against Credit Default Swap index, Dow Jones, the US dollar index DXY and the US home price Case-Shiller index. (To detect an asset bubble (gold in the present case), fair value/price of gold with reference to competing asset classes like US dollar, US stock market, crude oil, the US treasuries, credit risk, base metals, and US house prices, proxied, respectively, by the DXY (Euro, Pound Sterling, Japanese Yen, Swiss Franc, Canadian Dollar and Swedish Krona), the Dow Jones Industrial Average (DJIA), WTI spot, J.P. Morgan Bond Index, CDX IG, a CDS Index for Investment Grade US bonds, London Metal Exchange (LMEX) (nickel, tin, alluminium, copper, zinc and lead) and S&P CASE-SHILLER index, has been computed. The Table I is self-explicit. This intuitively appealing methodology of computing fair value is reasonably robust and rigorous based as it is on the assumption that any investor will have this maximum investment opportunity set to choose from to allocate her portfolio).

2. In fact, in my speech "Genesis, Diagnosis and Prognosis of the Current Global Financial Crisis", published in BIS Review 34/2009, I had mentioned that there was significant risk that the then monetary policy environment of very low interest rates and unprecedented deluge of liquidity may yet again engender another bubble in the not too distant future! Indeed, we almost had a commodity bubble which, to all intents and purposes, was caused by this very huge deluge of liquidity but burst due to the enveloping global economic downturn, in general, and countercyclical measure of NYMEX raising cash margins on crude oil futures and CFTC checking speculative positions, in particular. Perhaps, if this swamp of liquidity and monetary easing are not unwound appropriately, and in an orderly, and timely manner, the next crisis might well be a veritable "financial and economic nuclear winter"! Thus, you will see that we almost had a bubble which burst and now we are heading towards another one, shades of which, contextually, we experienced recently on August 4, 2011, and post FOMC meeting on September 20, 2011, when almost in prophetic confirmation of my prognostication, based on the aforesaid analysis, crude oil and global stock markets slumped by around 5% and gold slumped to $ 1530 per troy ounce on Chicago Mercantile Exchange raising cash margins on gold futures by 20% !

3. As regards mitigation of the building up of such systemic risks, the answer is addressing the 'cause' and which is again there in my same speech. At the risk of being repetitive, it must be noted that even if global imbalances and accommodative monetary policy provided an enabling environment for excessive leverage and risk taking, it was still the responsibility of regulators and supervisors to have taken appropriate macro-prudential measures, pre-emptively, decisively and proactively, rather than reactively. But unfortunately broad spectrum and generic regulatory and supervisory failure worldwide, especially in the West, precipitated the unprecedented global financial crisis. The most no-holds-barred acknowledgement of this, though it came much later only recently, was when Donald Kohn, former Vice Chairman of the US Federal Reserve apologized by saying, "The cops were not on the beat, resulting in the worst economic recession and loss of millions of jobs." This regulatory and supervisory inertia to unprecedented build up of risk globally, typical and characteristic, of the hunky-dory and gung-ho financial environment of the pre-crisis days, is most graphically epitomized by what Mark Twain said 100 years ago: "It ain't what you don't know that gets you into trouble; it is what you know for sure that just ain't so!"

4. As is invariably the case with any major crisis, the global financial crisis has unleashed a passionate debate over the design of a new global financial and regulatory architecture. However, the trouble has been not so much with the existing, inter-temporally evolved, global financial regulatory architecture as really with how it was actually worked in practice. Huge losses at global banks running to about USD 2 trillion were not because existing best practices, risk management and internal controls failed but because those responsible for implementing, and enforcing them, failed them ! From 1990s to 2011 and from Nick Leeson of Baring Brothers to Hamanaka of Sumitomo Corporation to Kerviel of Societe Generale to Adoboli of UBS AG, the underlying story has remained just the same ! After all, of all risks to regulators and regulatees alike, human resources risk is by far the most serious as it is the source of all risks as confirmed by the recent financial cataclysm. The crux of the matter is what we need is not more or less regulation and governance but good regulation and governance which simply means actually doing what must be done ! This has been the undoing of both regulators/supervisors and financial firms/banks alike. In the way of example, in the USA, the traditionally very healthy AAA rated AIG and mono-line bond insurers MBIA and Ambac changed their business model from insuring only their staple products and strayed into insuring CDOs and ABS and writing CDS. While this went unnoticed by insurance regulators, Pershing Square, a hedge fund, spotted trouble and started shorting both equity and credit risk of these two companies. But even after this, regulators failed to take notice and corrective action with the two companies being eventually downgraded several notches and AIG having to be bailed out by the Fed and US government. The same is true of financial firms and banks where independent directors on the boards, much less ask right questions, apparently didn't even understand the arcane world of modern finance and banking and according to a column in the Financial Times, after the crisis, one leading global bank ran an advertisement inviting applications for board positions from experienced professional bankers ! Besides, rather than take timely notice of, and act on, early warning signals coming from financial markets, like stock and CDSs markets, regulators chose instead to shut themselves to these early warning signals themselves by banning short selling which act effectively amounted to shooting the messenger for the unpalatable message it had to convey !

5. Another development that portends build-up of systemic risk is a rather rapid growth of ETFs with USD 1.5 trillion in assets under management (AUM) which has close parallels, in terms of complexity and opacity, with the CDO market, including its 'squared' and 'cubed' variants. Financial Stability Board and Financial Services Authority have already raised concerns what with emergence of synthetic ETFs, inverse, or short, ETFs and leveraged ETFs. In particular, there are concerns with synthetic ETFs which depend upon a swap with parent bank to track return of an index against collaterals which considerably deviate from the index being tracked. This gives rise to the possibility that banks may be using ETFs to finance their riskier and illiquid assets cheaply than they would be able to do in a standard repo market. The synthetic ETFs also introduce counter- party risk not present in plain vanilla ETFs. However, that leaves out the non-ETF financialized commodities as a significant component of the total global financial assets worth US $ 242 trillion (banking assets : $ 104 trillion, equity : US $ 47 trillion and bonds : US $ 91 trillion), of which there is no estimate in the Global Financial Stability Report of IMF; above-ground gold itself is worth about US $ 10 trillion at current prices !

6. Specifically, regulators/policy-makers need to deliver counter-cyclical prudential measures like selectively increasing capital charge for riskier categories of assets by increasing risk weights for asset classes where bubbles exist, or are in the process of building. In addition, they need to be complemented by fixing the maximum absolute leverage (not allowing for risk weights for assets) in addition to risk weighted asset-based capital prescription. These regulatory measures obviate the need of monetary policy tightening which is a blunt tool indiscriminately affecting all sectors of the financial markets and the real economy. Besides, significantly, the credit crisis has also thrown into sharp relief a "strong connect" between "liquidity risk" and "opaque off-balance sheet exposures" of whatever description. The appropriate supervisory and regulatory response to these risks would, therefore, be to insist on full disclosure and transparency of off-balance sheet commitments / exposures and supervisory insistence on an appropriate mix of "stored" and "purchased" liquidity and appropriate capital charge for liquidity risk; the higher the "purchased liquidity" component, the higher the capital charge and the higher the "stored liquidity" component, the lower the capital charge. Thus, banking supervisors and regulators need to be more hands-on and pro-active in focusing supervisory attention on this critical risk category than has been the case so far. (In fact, in India the Committee on Financial Sector Assessment almost presciently focused on this critical risk in the month of May itself, much before the liquidity and credit crunch of August 2007).

7. In refreshing contrast, in India, we have had remarkable financial stability, not fortuitously, but thanks to pre-emptively and pro-actively delivered prudential measures like increase in risk weights for exposures to commercial real estate, capital market, venture capital funds and systemically important non-deposit accepting Non Banking Finance Companies (NBFCs). These pre-crisis prudential regulatory measures of Reserve Bank of India represented what now are famously known as 'countercyclical prudential measures' and have been strongly commended for adoption by various recent Working Groups / Committees of international regulators. Indeed, in the aftermath of the global financial crisis and resulting economic recession, these counter cyclical prudential measures were rolled back to cushion the adverse impact of the crisis to considerable beneficial effect to the Indian economy. Significantly, recently again, to contain potential systemic liquidity risk, the Reserve Bank has capped banks' investments in Fixed Income Mutual Funds to 10% of their net worth.

TABLE I
Asset/Index	Avg. of daily gold to asset price ratio (Mar'2000- Feb'2010)	Current ratio as on Sep 14, 2011	Levels as on Sep 14, 2011	Implied price of gold as on Sep 14, 2011	over-valuation as on Sep 14, 2011	over-valuation as on Oct 27, 2010
Asset/Index	(1)	(2)	(3)	(1)x(3) =(4)	(5)	(7)
DXY	6.24	23.68	76.83	479.42	280%	174%
CASE- SHILLER US National Home price index	3.57	13.98	130.12	464.53	292%	169%
Dow Jones	0.05	0.16	11246.73	562.34	224%	138%
CDX IG*	5.50	19.32	128.88	518.10	251%	149%
JP Morgan US Treasury 7-10 yr bond index	1.27	2.84	641.65	814.90	123%	78%
WTI	10.76	20.47	88.91	956.67	90%	50%
LMEX	0.26	0.48	3795.30	986.78	84%	34%
(closing spot gold price as on Sep 14, 2011 was at US$1819.63) * The earliest CDX IG data are available from September 24, 2004. The average value of series 3 has been used as a proxy for CDS from March 1, 2000. The CDX spread-based index values have been converted into price-based based values so that the ratio of gold price and implied CDS price can be worked out on a "comparing apple- with–apple basis". ** CASE-SHILLER US National Home price index is published quarterly. The latest one is available up to quarter ended June 2011. The level of the index was compared with the quarterly average of daily gold price since April 2000.

TABLE II
	Pre-Sub-prime crisis (1st Apr'07- 1st week Aug'07)	Post-Lehman crisis (Oct-Dec'08)	Since last one year	As on Sep 14, 2011
CBOE VIX	23.67	80.86	14.62 (Apr 28, 2011)	34.60
TED Spread	0.48	4.64	0.13 (Sep 29, 2010)	0.35
3M LIBOR- 3M OIS	0.12	3.64	0.095 (Sep 10, 2010)	0.28
3M LIBOR- Effective Fed Fund Rate	0.27	4.03	0.07 (Nov 17, 2010)	0.26
CDX Cross over 5 yr	153.47	650.00	146.50 (July 7, 2011-Series 11)	252.80 (Series 11)
CDX Investment Grade 5 yr	34.08*	285.55	49.87 (May 2, 2011- series 12)	128.88 (Series 16)
iTraxx crossover 5yr	206.83*	1116.76	353.20 (May 2, 2011- Series 14)	740.60 (Series 14)
iTraxx Main Europe 5 yr	23.04*	206.55	88.00 (Apr 8, 2011 – Series 14)	186.00 (Series 14)
WTI	61.47	145.29 (on July 3, 08)	72.66 (Sep 22, 2010)	88.91
US Treasury 10 yr	5.29	2.05	3.74 (Feb 8, 2011)	1.98
Dow Jones	14000	7552	12811 (April 29, 2011)	11247
Implied value of Dow Jones	15038	27542	23116 ((Feb 8, 2011	47099
DXY	80.08	88.19	72.93 (Apr 29, 2011)	76.83
* Data pertains to May 1, 2007. The data for the entire period (April 1, 2007 to 1st week of Aug, 2007) is not available.

# Address by Mr. V.K. Sharma, Executive Director, Reserve Bank of India, at the 2nd Pan-Asian Regulatory Summit organized by Thomson Reuters at Singapore, on 28-29, September, 2011.

The views expressed are those of the author and not of the Reserve Bank of India

Source – RBI

Finance Minister’s Address at EEC – 2011

2011-10-26T20:48:00.001+05:30

Finance Minister Shri Pranab Mukherjee inaugurated the Annual Economic Editors' Conference here today. Following is the text of his address:

"Ladies and Gentlemen,

I consider it an honour to address this august gathering of Economic Editors from the length and breadth of this country. I am keenly aware of the vast knowledge and experience embedded in the audience and am looking forward to a productive exchange of ideas.

2. Feedback from the ground and from experienced analysts goes a long way in enhancing the efficacy of economic policies. It is important for you to realize that as editors you are not just people who report and comment on economic policy but you also, in an important sense, contribute to the formulation of policy. Through your writings you shape people's opinion and, in a democratic system like ours, the opinion that people hold has a large influence on the policies that get adopted. Hence, you have a large indirect impact on policymaking in India.

3. This conference has assumed an important role in the economic calendar of the nation. To have economics editors from different parts of the country assemble at one place and interact with policy makers and administrators in a free and frank atmosphere is a reflection of the strength of our vibrant democracy. I propose to present a bird's eye view of the economic situation in the country and then sit back and listen to your views and answer any questions that you may have.

Growth

4. In 2007-08 India's GDP grew by 9.3%. Due to the global financial crisis our growth rate in 2008-09 had slowed down to 6.8 per cent. However, India was among the earliest nations to recover from the crisis. Our growth rate rose to 8.0% in 2009-10 and to 8.5 per cent in 2010-11. Unfortunately, dark clouds have gathered in the global skies once again, and these are casting a shadow on us. The Indian economy grew by 7.7 per cent during April-June 2011. Agriculture, industry and services registered growth rates of 3.9, 5.1 and 10 per cent, respectively, in the first quarter.

5. Let me not hide the fact that I have been disappointed by our growth performance over the last few months. It is evident that India's growth rate in 2011-12 will be less than what we were expecting in February when I presented the Budget. In the last few months, a number of factors, both international and domestic, have impacted our economy. The international crude oil prices have continued to remain at or above US $105 per barrel. When we were working on the Budget earlier in the year, the price of crude was roughly between 90 and 95 dollars. This sharp subsequent rise has placed an unexpected burden on us. Other commodity prices have seen volatile changes, as also the capital flows. The monetary policy tightening and the increase in the interest rates along with the global uncertainty have not helped the industry to go in for fresh investments.

6. Most observers are expecting India's growth to go down to below 8%. This is disappointing but at the same time we must not lose perspective of the global situation. There is slowdown all over the world. In the second quarter of this calendar year (2011), the US economy grew by 1.6% and the European Union economy grew by 1.7%. If you look at the growth rate in the first and second quarters of this calendar year, among the G20 countries there is only one nation, Australia, which had faster growth rate in the second quarter, when it achieved a growth rate of 1.4%. Indonesia had the same growth rate in both quarters. All other nations had slower growth in the second quarter.

7. A number of policy measures are being taken and fortunately the long-run indicators look robust. Net FDI this year has been double that of last year for the corresponding period. In 2010-11 from April to August we received 6.5 billion dollars of FDI. This year over the corresponding period we have received 16.8 billion dollars. Credit off take is also showing a healthy trend. Last year from April to September Bank credit grew by 19.2%. This year the growth over the corresponding period was 19.5%. Revenue collections so far have kept pace with the expectations and there could be potential upside. Services have done well and agriculture is expected to grow at 3%. I am sure that these factors would help sustain growth. I will not make a formal forecast of the growth this year. For that you will have to wait for the Mid-Year Review which I will present to parliament in early December.

8. All I will say is that, in this climate, even if India's growth rate this year goes down to below our earlier expectation, we will still be among the 10 or so fastest growing nations in the world. Even ten years ago the news that India would grow by 8 per cent would be reason for celebration. The fact that we feel disappointed that India may grow by around 8 per cent this year shows more than anything else how our yardstick for evaluating India has changed. This to me is good news.

Inflation

9. Inflation as measured by Wholesale Price index (WPI) has remained sticky around 9 per cent during the first half of current financial year. The WPI inflation for the month of September 2011 is reported at 9.72 per cent as against 9.78 per cent last month. The inflationary pressure in recent times have emanated from multiple sources, the most important being the global rise in commodity prices and liquidity enhancing policies adopted by central banks in industrialized nations. There were also some seasonal factors that created upward pressure on prices.

10. Food inflation has significantly dropped from a peak of 20 per cent in February 2010 to about 8 per cent June-July 2011. However, the sources of inflation have now switched to non-food; much of it, as I just mentioned, was due to imported global commodity inflation. I expect overall WPI inflation to decline from December and I am hoping that we will end the fiscal year around 7 per cent.

Agricultural Production

11. As I have indicated earlier, during the southwest monsoon season, 2011, the cumulative rainfall over the country as a whole was above normal. As per the first advance estimates released by Ministry of Agriculture on 14.09.2011, production of kharif food grains during 2011-12 is estimated at 123.88 million tonnes compared to about 120 million tonnes in 2010-11. In the kharif season 2011-12, the country is likely to achieve production of 87.10 million tonnes of rice, 20.89 million tonnes oilseeds and 36.10 million bales (170 kg. each) of cotton. This augurs well for supply side response to arrest inflation in food items.

Industrial Growth

12. As per national accounts data, the industrial sector has not been doing well since the third quarter of 2010-11. This is mainly on account of the lower levels of growth in the manufacturing sector. The overall growth of the industrial sector as per the quick estimates of IIP released by the CSO for the month of August 2011 has been 4.1 per cent as compared to the growth rate of 4.5 percent recorded in August 2010. The cumulative growth during April-August 2011-12 has been 5.6 per cent as compared to 8.7 per cent during the corresponding months of 2010-11.

Monetary Developments

13. Monetary policy has been tightened by RBI to contain inflation and anchor inflationary expectations since March 2010 in a series of steps. The policy repo rate has been raised cumulatively by 325 basis points since then. The steady rise in policy rates was reflected in borrowing as well as lending rates with a lag. Though reserve money growth evinced a deceleration, broad money growth remained above the indicative trajectory in the current fiscal. Credit growth, which had accelerated in 2010-11, moderated in the first quarter of 2011-12 on a year-on-year basis. Non-food credit growth remained close to the indicative trajectory of RBI.

Financial Markets

14. Indian financial markets remained more or less orderly even in the face of corrections taking place in global financial markets and fragile financial conditions in some Euro Area countries. The benchmark 10-year G-Sec yield has trended up reflecting the tight conditions and the level of Government borrowings. Significant developments have taken place in the Capital Markets side. We raised FII limit on investments in corporate long-term infra bonds from US $ 5 Billion to US $ 25 Billion. US $ 5 billion was carved out of this for more liberal treatment. In the auction in the first week of October, 2011, the entire US $ 5 billion has been subscribed to by the FIIs. Qualified Foreign Investors (QFIs) have been allowed to invest a total of US $ 10 Billion in mutual fund equity schemes. QFIs have also been allowed to invest upto US $ 3 Billion in mutual fund debt schemes. Government has liberalized External Commercial Borrowings (ECBs). A separate treatment has been given for Infrastructure Debt Fund under ECB. Automatic approval route has been liberalized. For the first time, Renminbi (RMB) has been approved as an acceptable currency for raising ECB upto US $ 1 Billion. ECB for refinancing rupee loans on infrastructure has been opened up.

Balance of Payments

15. Capital flows to the tune of US$ 23.5 billion was received during the first five months of the current fiscal. Complete data on Balance of Payments is available only upto the first quarter. Net capital flows stood at US$ 20.9 billion during the first quarter of 2011-12 as against a level of US$ 16.8 billion in Q1 of 2010-11. Thus Current account deficit was placed at US$ 14.2 billion in the first quarter of 2011-12 as against US$ 12.1 billion in the previous years.

16. As you are aware, the growth in exports during the current year has been a matter of satisfaction. India's merchandise exports on customs basis have reached a level of US $ 160 billion during April-September 2011 reflecting an increase of 52 per cent over the corresponding period of previous year. Seen in the context of the uncertainty and slow down in the US and EU markets, our endeavour is to support our manufacturers and exporters in their efforts of diversification etc. for continued high exports. In this regard, while the DEPB Scheme was discontinued on 30th September, 2011, we were able to ensure a very smooth transition to the Duty Drawback Scheme, through addition of 1100 new items in the Drawback Schedule. Some minor issues of classification or omissions have also been rectified thereafter. During the same period, the imports were at US $ 233.5 billion; growth of 32.4 per cent. Consequently, trade deficit stood at US $ 73.5 billion, during the same period.

Fiscal Developments

17. Fiscal policy stance for 2011-12 remained broadly on the consolidation track complementing the monetary policy stance. We presume 4.6 per cent fiscal deficit this fiscal. We had originally planned for 5.5 per cent fiscal deficit for the year 2010-11. We hoped that this could be brought down to 5.1 per cent with huge inflows on 3G auctions in RE stage; but could end at 4.7 per cent last fiscal. One of the largest fiscal corrections was achieved in fiscal 2010-11 when fiscal deficit/GDP ratio declined to 4.7 per cent from a level of 6.4 per cent in 2009-10. The compression in fiscal deficit must be seen in the light of huge inflows last year on account of Telecom Spectrum auctions and which is not going to be repeated this year.

18. It may be recalled that the required growth for achieving gross tax collection as in 2011-12 BE was 17.3 per cent over 2010-11 actual collections. With the crude prices remaining where they are, it will be a great challenge to maintain the fiscal deficit numbers at 4.6 per cent this year; however, we will make strenuous attempts to keep the fiscal deficit at around these numbers. We would be closely monitoring the revenue and expenditure trends and take steps as deemed appropriate.

Global Scenario

19. In so far as the global economic environment is concerned, the lingering Euro Zone crisis is resulting in an uncertain external economic environment. The world economy suffers from the confluence of two adverse developments. First, a much slower recovery in advanced economies since the beginning of the year. Second, a large increase in fiscal and financial uncertainty, which has been particularly pronounced since August 2011. Each of these developments is worrisome and their combination and interactions more so. The peripheral eurozone is into a deep and structural sovereign debt crisis.

G-20 Issues

20. In the G-20 Ministers Meet last week in Paris, we impressed upon the Euro Zone Finance Ministers to fix the solvency problem of Euro Zone countries by the Cannes Summit. Additional resources for providing liquidity could be thought of when the solvency issue of the Euro Zone countries are assessed and addressed. Simultaneously, we pitched in for additional capitalization of the World Bank. We were able to develop predominant opinion on not rolling back of the NAB into the 2010 Quota Reforms.

Policy Decisions Taken

21. I would now briefly address the concerns of the so called 'popular' perception about policy paralysis. The only way I could demonstrate that is to list some of the key decisions taken and those on the anvil. We have recently announced a new Draft Telecom Policy; Infrastructure Debt Fund guidelines have been finalized by RBI and SEBI and its is expected that a couple of Funds would start soon; A new manufacturing policy is before a GoM; the Mining Bill is ready for introduction in the Parliament and Land Acquisition Bill has already been introduced in the last session of the Parliament; GoM on Coal is working earnestly to solve the issues related to coal. I have also met the captains of industry and am addressing their concerns. The Government has taken many measures including legislative measures recently to further develop banking sector in India. The State Bank of India (Amendment) Bill, 2010 and The State Bank of India (Subsidiary Banks Laws) Amendment Bill, 2011 have been recently passed in the Parliament. Many other legislations or amendments are at various stages in an active mode. RBI is actively engaged in the process of grant of new banking licences.

Black Money

22. The issue relating to the black money has also been attracting a lot of media attention.

23. Due to our sustained efforts in the last two years, both domestically as well as internationally, we have been successful in creating an environment where a regular flow of banking information has started.

24. The following achievements are noteworthy:

a) Huge network of amended DTAA (81) and TIEA with tax havens (4) has been created.

b) Specific requests in 333 cases (220 by Foreign Tax Division of CBDT and 113 by FIU) have been made by Indian authorities for obtaining information from foreign jurisdictions.

c) Over 9900 pieces of Information obtained (9743 information by Foreign Tax Division of CBDT and 177 information by FIU) regarding suspicious transactions by Indian citizens from several countries have been obtained which are now under different stages of processing and investigation.

d) Over 30,700 pieces of domestic information about suspicious transactions has been obtained by FIU which are under investigation by respective agencies.

e) Directorate of Transfer Pricing has detected mispricing of Rs. 34,145 crore in last two financial years thus preventing the outflow of this amount to foreign jurisdictions.

f) Investigation wing of CBDT has detected concealed income of Rs. 18,750 Crore in last two financial years. During the first five months of the current financial year, concealed income of Rs. 3,014 crores has been detected due to focused searches on the basis of information received from foreign jurisdictions.

g) Directorate of International Taxation has collected taxes of Rs. 33,784 crore from cross broader transactions in last two financial years.

h) Under the EOI Article of DTAA with France, India has received some information regarding Indians having bank accounts. In 69 cases, the taxpayers have admitted to the unaccounted income of Rs. 397.17 crores. Taxes of Rs. 30.07 crore have also been paid.

i) A Protocol to amend the Double Taxation Avoidance Agreement (DTAA) between India and Switzerland which was signed on 30th August 2010 after completion of all formalities.

The revised DTAA will allow India to obtain banking information (as well as information without domestic interest) from Switzerland in specific cases for a period starting from 1st April 2011. The revised DTAA is expected to improve the inflow of banking information to India substantially.

j) India is constructively engaged with Government of Mauritius to update the existing Double Taxation Avoidance Convention (DTAC) in line with the international practices.

k) OECD and Task Force on financial integrity & Economic Development have acknowledged outstanding work done by India in its crusade against Black Money.

25. Another critical area that often gets articulated in the media is that of governance; this is particularly relevant for many social welfare programmes involving a large number of beneficiaries. The challenge, inter alia, has been to improve the "last-mile" delivery of various social sector schemes. Ad-hoc measures cannot address this mammoth challenge. There needs to be in place a systemic approach to address the criticalities in governance and the challenges of last mile delivery. The Government is undertaking a number of steps for a strategic revamp of public delivery mechanisms. The implementation of the Aadhaar project which ensures a unique number to every resident in India in order to facilitate better access to services seeks to address the issue of improving delivery mechanisms in a systemic way. The Task Force on direct transfer of subsidies, as IT strategy for PDS and an Aadhaar enabled payment infrastructure would favour an electronic, transparent, auditable and systemic approach to delivery public benefits in a more efficient manner. The setting up of the Goods and Service Tax Network and Expenditure Information Network would enable improved governance.

An appeal

26. Let me take this opportunity to make an appeal, through you, to all Indians, cutting across party lines and other group identities. I am aware that journalists will want to win accolades for what they write, sportsmen will want to win prizes and, in a democratic system, politicians will try to win elections. But at the same time we must all remember that we all win if India wins. That will happen if the reform process gains momentum and economy surges ahead. I solicit your cooperation in this endeavour and look forward to your views.

Thank you.

Tax Benefits / Consequences to Mutual Fund Unit holders

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Tax Benefits / Consequences to Unit holders

i. Income-tax
All Unit holders

Income received, otherwise than on transfer (subject to the exemption of long-term capital gains provided for in section 10(38) of the Act, discussed elsewhere in this Statement), in respect of units of a mutual fund would be exempt from tax under Section 10(35) of the Act.

Tax Deduction at Source
All Unit holders
No income-tax is deductible at source, on any income distribution by the Mutual Fund under the provisions of Section 194K and 196A of the Act.
Capital Gains Tax
Foreign Institutional Investors
Long-term capital gains on sale of Units, held for a period of more than twelve months, would be taxed at the rate of 10% (plus applicable surcharge, education cess and secondary and higher education cess) under Section 115AD of the Act (subject to the exemption of long-term capital gains provided for in section 10(38) of the Act, discussed elsewhere in this Statement). Such gains would be calculated without indexation of cost of acquisition. Short-term capital gains would be taxed at 30% (plus applicable surcharge, education cess and secondary and higher education cess) (subject to the concessional rate of tax provided for in Section 111A of the Act, discussed elsewhere in this Statement).

As per Section 111A of the Act, short-term capital gains on sale of units of an equity-oriented fund, where such transaction of sale is chargeable to STT, shall be subject to tax at a rate of 15 per cent (plus applicable surcharge, education cess and secondary and higher education cess).

Exemption of capital gain from income tax

As per Section 10(38) of the Act, any long-term capital gains arising from the sale of units of an equity-oriented fund where such transaction of sale is chargeable to STT, shall be exempt from tax.

Income by way of long term capital gain of a company shall be taken into account in computing the Book profit and income-tax payable under Section 115JB (Minimum Alternate Tax)[MAT]. The matter is however not free from doubt in case of Corporate Foreign Institutional Investors.

Other Unit holders ( Other than equity oriented fund)

Long-term capital gains in respect of Units, held for a period of more than twelve months, will be chargeable under Section 112 of the Act, at concessional rate of tax, at 20% (plus applicable surcharge, education cess and secondary and higher education cess) (subject to the exemption of long-term capital gains provided for in Section 10(38) of the Act, discussed elsewhere in this Statement).
The following amounts would be deductible from the full value of consideration, to arrive at the amount of capital gains:

Cost of acquisition of Units (as adjusted by Cost Inflation Index notified by the Central Government in case of long term capital gain) and
Expenditure incurred wholly and exclusively in connection with such transfer (excluding any sum paid on account of STT)

However, where the tax payable on such long-term capital gains, exceeds 10% (plus applicable surcharge, education cess and secondary and higher education cess) of the amount of capital gains computed before indexation, such excess tax shall not be payable by the Unit holder, at his option.
In case of resident individuals and Hindu Undivided Families, where taxable income as reduced by long-term capital gains, is below the basic exemption limit, the long-term capital gains will be reduced to the extent of the shortfall and only the balance long-term capital gains will be subjected to the flat rate of income-tax (plus education cess and secondary and higher education cess).

As per Section 111A of the Act, short-term capital gains on sale of units of an equity oriented fund where such transaction of sale is chargeable to STT shall be subject to tax at a rate of 15 per cent (plus applicable surcharge, education cess and secondary and higher education cess). Further in case of resident individuals and HUFs where taxable income as reduced by short-term capital gains, is below the basic exemption limit, the short-term capital gains will be reduced to the extent of the shortfall and only the balance short-term capital gains will be subjected to the flat rate of income-tax (plus education cess and secondary and higher education cess).

Exemption of capital gain from income tax

As per Section 10(38) of the Act, any long-term capital gains arising from the sale of units of an equity-oriented fund where such transaction of sale is chargeable to STT, shall be exempt from tax.

Income by way of long term capital gain of a company shall be taken into account in computing the Book profit and income-tax payable under Section 115JB [MAT].

As per the provisions of section 54EC of the Act and subject to the conditions and investment limits specified therein, capital gains (subject to the exemption of long-term capital gains provided for in section 10(38) of the Act, discussed elsewhere in this Statement), arising on transfer of a long- term capital asset shall not be chargeable to tax to the extent such capital gains are invested in certain notified bonds within six months from the date of transfer.
As per the provisions of Section 54F of the Act and subject to the conditions specified therein, in the case of an individual or a HUF, capital gains (subject to the exemption of long-term capital gains provided for in section 10(38) of the Act, discussed elsewhere in this Statement) arising on transfer of a long term capital asset (not being a residential house) are not chargeable to tax if the entire net consideration received on such transfer is invested within the prescribed period in a residential house. If part of such net consideration is invested within the prescribed period in a residential house, then such gains would not be chargeable to tax on a proportionate basis. For this purpose, net consideration means full value of the consideration received or accruing as a result of the transfer of the capital asset as reduced by any expenditure incurred wholly and exclusively in connection with such transfer.

All Unit holders
Under the provisions of Section 94(7) of the Act, loss arising on sale of Units, which are bought within 3 months prior to the record date (i.e. the date fixed by the Mutual Fund for the purposes of entitlement of the Unit holders to receive income or additional units without any consideration, as the case may be) and sold within 9 months after the record date, shall be ignored for the purpose of computing income chargeable to tax to the extent of exempt income received or receivable on such Units.
Under the provisions of Section 94(8) of the Act, where any person purchases units (‘original units’) within a period of 3 months prior to the record date, who is allotted additional units without any payment and sells all or any of the original units within a period of 9 months after the record date, while continuing to hold all or any of the additional units, then any loss arising on sale of the original units shall be ignored for the purpose of computing income chargeable to tax. The amount of loss so ignored shall be deemed to be the cost of purchase of the additional units as are held on the date of such sale.

•Tax Deduction at Source
All Unit holders
No income-tax is deductible at source from income by way of capital gains under the present provisions of the Act in case of residents. However, the provisions of section 195 of the Act may apply to non-residents (other than Foreign Institutional Investors and long-term capital gains exempt under section 10(38) of the Act).

Accordingly income tax may have to be deducted at source in the case of a non- resident (other than foreign companies) at the rate of 15% (plus education cess and secondary and higher education cess) on short-term capital gains referred to in section 111A and at the rate of 30% (plus education cess and secondary and higher education cess) in case of short-term capital gains (other than under section 111A), unless a lower withholding tax certificate is obtained from the tax authorities, and at the rate of 20% (plus education cess and secondary and higher education cess) in case of long-term capital gains, unless a lower withholding tax certificate is obtained from the tax authorities.

In the case of foreign companies the rate of tax to be deducted at source on short-term capital gains referred to in section 111A would be 15% (plus applicable surcharge, education cess and secondary and higher education cess) and at the rate of 40% (plus applicable surcharge, education cess and secondary and higher education cess) in case of short-term capital gains (other than under section 111A), unless a lower withholding tax certificate is obtained from the tax authorities, and at the rate of 20% (plus applicable surcharge, education cess and secondary and higher education cess) in case of long term capital gains, unless a lower withholding tax certificate is obtained from the tax authorities.

With effect from 1 April 2010, where tax is deductible under the Act, and the deductee has not furnished a Permanent Account Number (PAN) to the deductor, tax should be deducted at source at the highest of the following rates:

At the rate specified in the Act
At the rates in force
At the rate of 20% (plus applicable surcharge and education cess and secondary and higher education cess )

•Gift of Units

With effect from 1.10.2009, as per the provisions of section 56(2)(vii) of the Act, certain specified property transferred, without consideration / adequate consideration, exceeding specified limits, are taxable in the hands of the recipient individual / HUF (subject to certain exceptions).

The term “property” includes shares and securities. Units of a mutual fund could fall within the purview of the term “securities”.

As per the Act, “property” would refer to capital assets only.

•Clubbing of income

Subject to the provisions of section 64(1A) of the Act, taxable income accruing or arising in the case of a minor child shall be included in the income of the parent whose total income is greater or where the marriage of the parents does not subsist, in the income of that parent who maintains the minor child. An exemption under section 10(32) of the Act, is granted to the parent in whose hand the income is included upto Rs. 1,500/- per minor child. When the child attains majority, the tax liability will be on the child.

•Deduction under section 80C

As per section 80C, and subject to the provisions, an individual / HUF is entitled to a deduction from Gross Total Income upto Rs. 1.00 lac (along with other prescribed investments) for amounts invested in any units of a mutual fund referred to in section 10(23D) of the Act, under any plan formulated in accordance with such scheme as the Central Government may notify.

•Securities Transaction Tax

All Unit holders

As per Chapter VII of the Finance (No. 2) Act, 2004 pertaining to STT, the STT shall be payable by the seller at the rate 0.25 per cent on the sale of a unit of an equity-oriented fund to the mutual fund.

OTHER BENEFITS
Investments in Units of the Mutual Fund will rank as an eligible form of investment under Section 11(5) of the Act read with Rule 17C of the Income-tax Rules, 1962, for Religious and Charitable Trusts.

TAX TREATY BENEFITS
A non- resident investor has an option to be governed by the provisions of the Act or the provisions of a Tax Treaty that India has entered into with another country of which the non- resident investor is a tax resident, whichever is more beneficial to the non- resident investor. The provisions of Section 195 and/or Section 197 of the Act would need to be complied and also documents will have to be furnished by the non- resident investor in this regard.

ii. Wealth-tax
Units of the Mutual Fund are not treated as assets as defined under Section 2(ea) of the Wealth-tax Act, 1957 and therefore would not be liable to wealth-tax.

iii. Gift-tax
The Gift-tax Act, 1958 has ceased to apply to gifts made on or after October 1, 1998. Gifts of Units of the Mutual Fund would therefore, be exempt from gift-tax.

The above Statement of Possible Direct Tax Benefits / Consequences sets out the provisions of law in a summary manner only and is not a complete analysis or listing of all potential tax consequences of the purchase, ownership and disposal of mutual fund units. The statements made above are based on the tax laws in force (including the amendments made by the Finance Act, 2011), Chapter VII of the Finance (No. 2) Act, 2004 pertaining to Securities Transaction Tax, and as interpreted by the relevant taxation authorities as of date. The proposals of the Draft Direct Taxes Code Bill, 2010 have not been considered therein. Investors/Unit Holders are advised to consult their tax advisors with respect to the tax consequences of the purchase, ownership and disposal of mutual fund units.

All you want to know about mutual Funds

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Introduction

Different investment avenues are available to investors. Mutual funds also offer good investment opportunities to the investors. Like all investments, they also carry certain risks. The investors should compare the risks and expected yields after adjustment of tax on various instruments while taking investment decisions. The investors may seek advice from experts and consultants including agents and distributors of mutual funds schemes while making investment decisions.

With an objective to make the investors aware of functioning of mutual funds, an attempt has been made to provide information in question-answer format which may help the investors in taking investment decisions.

What is a Mutual Fund?

Mutual fund is a mechanism for pooling the resources by issuing units to the investors and investing funds in securities in accordance with objectives as disclosed in offer document.

Investments in securities are spread across a wide cross-section of industries and sectors and thus the risk is reduced. Diversification reduces the risk because all stocks may not move in the same direction in the same proportion at the same time. Mutual fund issues units to the investors in accordance with quantum of money invested by them. Investors of mutual funds are known as unitholders.

The profits or losses are shared by the investors in proportion to their investments. The mutual funds normally come out with a number of schemes with different investment objectives which are launched from time to time. A mutual fund is required to be registered with Securities and Exchange Board of India (SEBI) which regulates securities markets before it can collect funds from the public.

What is the history of Mutual Funds in India and role of SEBI in mutual funds industry?

Unit Trust of India was the first mutual fund set up in India in the year 1963. In early 1990s, Government allowed public sector banks and institutions to set up mutual funds.

In the year 1992, Securities and exchange Board of India (SEBI) Act was passed. The objectives of SEBI are – to protect the interest of investors in securities and to promote the development of and to regulate the securities market.

As far as mutual funds are concerned, SEBI formulates policies and regulates the mutual funds to protect the interest of the investors. SEBI notified regulations for the mutual funds in 1993. Thereafter, mutual funds sponsored by private sector entities were allowed to enter the capital market. The regulations were fully revised in 1996 and have been amended thereafter from time to time. SEBI has also issued guidelines to the mutual funds from time to time to protect the interests of investors.

All mutual funds whether promoted by public sector or private sector entities including those promoted by foreign entities are governed by the same set of Regulations. There is no distinction in regulatory requirements for these mutual funds and all are subject to monitoring and inspections by SEBI. The risks associated with the schemes launched by the mutual funds sponsored by these entities are of similar type.

How is a mutual fund set up?

A mutual fund is set up in the form of a trust, which has sponsor, trustees, asset management company (AMC) and custodian. The trust is established by a sponsor or more than one sponsor who is like promoter of a company. The trustees of the mutual fund hold its property for the benefit of the unitholders. Asset Management Company (AMC) approved by SEBI manages the funds by making investments in various types of securities. Custodian, who is registered with SEBI, holds the securities of various schemes of the fund in its custody. The trustees are vested with the general power of superintendence and direction over AMC. They monitor the performance and compliance of SEBI Regulations by the mutual fund.

SEBI Regulations require that at least two thirds of the directors of trustee company or board of trustees must be independent i.e. they should not be associated with the sponsors. Also, 50% of the directors of AMC must be independent. All mutual funds are required to be registered with SEBI before they launch any scheme.

What is Net Asset Value (NAV) of a scheme?

The performance of a particular scheme of a mutual fund is denoted by Net Asset Value (NAV).

Mutual funds invest the money collected from the investors in securities markets. In simple words, Net Asset Value is the market value of the securities held by the scheme. Since market value of securities changes every day, NAV of a scheme also varies on day to day basis. The NAV per unit is the market value of securities of a scheme divided by the total number of units of the scheme on any particular date. For example, if the market value of securities of a mutual fund scheme is Rs 200 lakhs and the mutual fund has issued 10 lakhs units of Rs. 10 each to the investors, then the NAV per unit of the fund is Rs.20. NAV is required to be disclosed by the mutual funds on a regular basis – daily or weekly – depending on the type of scheme.

What are the different types of mutual fund schemes?

Schemes according to Maturity Period:

A mutual fund scheme can be classified into open-ended scheme or close-ended scheme depending on its maturity period.

Open-ended Fund/ Scheme

An open-ended fund or scheme is one that is available for subscription and repurchase on a continuous basis. These schemes do not have a fixed maturity period. Investors can conveniently buy and sell units at Net Asset Value (NAV) related prices which are declared on a daily basis. The key feature of open-end schemes is liquidity.

Close-ended Fund/ Scheme

A close-ended fund or scheme has a stipulated maturity period e.g. 5-7 years. The fund is open for subscription only during a specified period at the time of launch of the scheme. Investors can invest in the scheme at the time of the initial public issue and thereafter they can buy or sell the units of the scheme on the stock exchanges where the units are listed. In order to provide an exit route to the investors, some close-ended funds give an option of selling back the units to the mutual fund through periodic repurchase at NAV related prices. SEBI Regulations stipulate that at least one of the two exit routes is provided to the investor i.e. either repurchase facility or through listing on stock exchanges. These mutual funds schemes disclose NAV generally on weekly basis.

Schemes according to Investment Objective:

A scheme can also be classified as growth scheme, income scheme, or balanced scheme considering its investment objective. Such schemes may be open-ended or close-ended schemes as described earlier. Such schemes may be classified mainly as follows:

Growth / Equity Oriented Scheme

The aim of growth funds is to provide capital appreciation over the medium to long- term. Such schemes normally invest a major part of their corpus in equities. Such funds have comparatively high risks. These schemes provide different options to the investors like dividend option, capital appreciation, etc. and the investors may choose an option depending on their preferences. The investors must indicate the option in the application form. The mutual funds also allow the investors to change the options at a later date. Growth schemes are good for investors having a long-term outlook seeking appreciation over a period of time.

Income / Debt Oriented Scheme

The aim of income funds is to provide regular and steady income to investors. Such schemes generally invest in fixed income securities such as bonds, corporate debentures, Government securities and money market instruments. Such funds are less risky compared to equity schemes. These funds are not affected because of fluctuations in equity markets. However, opportunities of capital appreciation are also limited in such funds. The NAVs of such funds are affected because of change in interest rates in the country. If the interest rates fall, NAVs of such funds are likely to increase in the short run and vice versa. However, long term investors may not bother about these fluctuations.

Balanced Fund

The aim of balanced funds is to provide both growth and regular income as such schemes invest both in equities and fixed income securities in the proportion indicated in their offer documents. These are appropriate for investors looking for moderate growth. They generally invest 40-60% in equity and debt instruments. These funds are also affected because of fluctuations in share prices in the stock markets. However, NAVs of such funds are likely to be less volatile compared to pure equity funds.

Money Market or Liquid Fund

These funds are also income funds and their aim is to provide easy liquidity, preservation of capital and moderate income. These schemes invest exclusively in safer short-term instruments such as treasury bills, certificates of deposit, commercial paper and inter-bank call money, government securities, etc. Returns on these schemes fluctuate much less compared to other funds. These funds are appropriate for corporate and individual investors as a means to park their surplus funds for short periods.

Gilt Fund

These funds invest exclusively in government securities. Government securities have no default risk. NAVs of these schemes also fluctuate due to change in interest rates and other economic factors as is the case with income or debt oriented schemes.

Index Funds

Index Funds replicate the portfolio of a particular index such as the BSE Sensitive index, S&P NSE 50 index (Nifty), etc These schemes invest in the securities in the same weightage comprising of an index. NAVs of such schemes would rise or fall in accordance with the rise or fall in the index, though not exactly by the same percentage due to some factors known as “tracking error” in technical terms. Necessary disclosures in this regard are made in the offer document of the mutual fund scheme.

There are also exchange traded index funds launched by the mutual funds which are traded on the stock exchanges.

What are sector specific funds/schemes?

These are the funds/schemes which invest in the securities of only those sectors or industries as specified in the offer documents. e.g. Pharmaceuticals, Software, Fast Moving Consumer Goods (FMCG), Petroleum stocks, etc. The returns in these funds are dependent on the performance of the respective sectors/industries. While these funds may give higher returns, they are more risky compared to diversified funds. Investors need to keep a watch on the performance of those sectors/industries and must exit at an appropriate time. They may also seek advice of an expert.

What are Tax Saving Schemes?

These schemes offer tax rebates to the investors under specific provisions of the Income Tax Act, 1961 as the Government offers tax incentives for investment in specified avenues. e.g. Equity Linked Savings Schemes (ELSS). Pension schemes launched by the mutual funds also offer tax benefits. These schemes are growth oriented and invest pre-dominantly in equities. Their growth opportunities and risks associated are like any equity-oriented scheme.

What is a Fund of Funds (FoF) scheme?

A scheme that invests primarily in other schemes of the same mutual fund or other mutual funds is known as a FoF scheme. An FoF scheme enables the investors to achieve greater diversification through one scheme. It spreads risks across a greater universe.

What is a Load or no-load Fund?

A Load Fund is one that charges a percentage of NAV for entry or exit. That is, each time one buys or sells units in the fund, a charge will be payable. This charge is used by the mutual fund for marketing and distribution expenses. Suppose the NAV per unit is Rs.10. If the entry as well as exit load charged is 1%, then the investors who buy would be required to pay Rs.10.10 and those who offer their units for repurchase to the mutual fund will get only Rs.9.90 per unit. The investors should take the loads into consideration while making investment as these affect their yields/returns. However, the investors should also consider the performance track record and service standards of the mutual fund which are more important. Efficient funds may give higher returns in spite of loads.

A no-load fund is one that does not charge for entry or exit. It means the investors can enter the fund/scheme at NAV and no additional charges are payable on purchase or sale of units.

Can a mutual fund impose fresh load or increase the load beyond the level mentioned in the offer documents?

Mutual funds cannot increase the load beyond the level mentioned in the offer document. Any change in the load will be applicable only to prospective investments and not to the original investments. In case of imposition of fresh loads or increase in existing loads, the mutual funds are required to amend their offer documents so that the new investors are aware of loads at the time of investments.

What is a sales or repurchase/redemption price?

The price or NAV a unitholder is charged while investing in an open-ended scheme is called sales price. It may include sales load, if applicable.

Repurchase or redemption price is the price or NAV at which an open-ended scheme purchases or redeems its units from the unitholders. It may include exit load, if applicable.

What is an assured return scheme?

Assured return schemes are those schemes that assure a specific return to the unitholders irrespective of performance of the scheme.

A scheme cannot promise returns unless such returns are fully guaranteed by the sponsor or AMC and this is required to be disclosed in the offer document.

Investors should carefully read the offer document whether return is assured for the entire period of the scheme or only for a certain period. Some schemes assure returns one year at a time and they review and change it at the beginning of the next year.

Can a mutual fund change the asset allocation while deploying funds of investors?

Considering the market trends, any prudent fund managers can change the asset allocation i.e. he can invest higher or lower percentage of the fund in equity or debt instruments compared to what is disclosed in the offer document. It can be done on a short term basis on defensive considerations i.e. to protect the NAV. Hence the fund managers are allowed certain flexibility in altering the asset allocation considering the interest of the investors. In case the mutual fund wants to change the asset allocation on a permanent basis, they are required to inform the unitholders and giving them option to exit the scheme at prevailing NAV without any load.

How to invest in a scheme of a mutual fund?

Mutual funds normally come out with an advertisement in newspapers publishing the date of launch of the new schemes. Investors can also contact the agents and distributors of mutual funds who are spread all over the country for necessary information and application forms. Forms can be deposited with mutual funds through the agents and distributors who provide such services. Now a days, the post offices and banks also distribute the units of mutual funds. However, the investors may please note that the mutual funds schemes being marketed by banks and post offices should not be taken as their own schemes and no assurance of returns is given by them. The only role of banks and post offices is to help in distribution of mutual funds schemes to the investors.

Investors should not be carried away by commission/gifts given by agents/distributors for investing in a particular scheme. On the other hand they must consider the track record of the mutual fund and should take objective decisions.

Can non-resident Indians (NRIs) invest in mutual funds?

Yes, non-resident Indians can also invest in mutual funds. Necessary details in this respect are given in the offer documents of the schemes.

How much should one invest in debt or equity oriented schemes?

An investor should take into account his risk taking capacity, age factor, financial position, etc. As already mentioned, the schemes invest in different type of securities as disclosed in the offer documents and offer different returns and risks. Investors may also consult financial experts before taking decisions. Agents and distributors may also help in this regard.

How to fill up the application form of a mutual fund scheme?

An investor must mention clearly his name, address, number of units applied for and such other information as required in the application form. He must give his bank account number so as to avoid any fraudulent encashment of any cheque/draft issued by the mutual fund at a later date for the purpose of dividend or repurchase. Any changes in the address, bank account number, etc at a later date should be informed to the mutual fund immediately.

What should an investor look into an offer document?

An abridged offer document, which contains very useful information, is required to be given to the prospective investor by the mutual fund. The application form for subscription to a scheme is an integral part of the offer document. SEBI has prescribed minimum disclosures in the offer document. An investor, before investing in a scheme, should carefully read the offer document. Due care must be given to portions relating to main features of the scheme, risk factors, initial issue expenses and recurring expenses to be charged to the scheme, entry or exit loads, sponsor’s track record, educational qualification and work experience of key personnel including fund managers, performance of other schemes launched by the mutual fund in the past, pending litigations and penalties imposed, etc.

When will the investor get certificate or statement of account after investing in a mutual fund?

Mutual funds are required to despatch certificates or statements of accounts within six weeks from the date of closure of the initial subscription of the scheme. In case of close-ended schemes, the investors would get either a demat account statement or unit certificates as these are traded in the stock exchanges. In case of open-ended schemes, a statement of account is issued by the mutual fund within 30 days from the date of closure of initial public offer of the scheme. The procedure of repurchase is mentioned in the offer document.

How long will it take for transfer of units after purchase from stock markets in case of close-ended schemes?

According to SEBI Regulations, transfer of units is required to be done within thirty days from the date of lodgment of certificates with the mutual fund.

As a unitholder, how much time will it take to receive dividends/repurchase proceeds?

A mutual fund is required to despatch to the unitholders the dividend warrants within 30 days of the declaration of the dividend and the redemption or repurchase proceeds within 10 working days from the date of redemption or repurchase request made by the unitholder.

In case of failures to despatch the redemption/repurchase proceeds within the stipulated time period, Asset Management Company is liable to pay interest as specified by SEBI from time to time (15% at present).

Can a mutual fund change the nature of the scheme from the one specified in the offer document?

Yes. However, no change in the nature or terms of the scheme, known as fundamental attributes of the scheme e.g.structure, investment pattern, etc. can be carried out unless a written communication is sent to each unitholder and an advertisement is given in one English daily having nationwide circulation and in a newspaper published in the language of the region where the head office of the mutual fund is situated. The unitholders have the right to exit the scheme at the prevailing NAV without any exit load if they do not want to continue with the scheme. The mutual funds are also required to follow similar procedure while converting the scheme form close-ended to open-ended scheme and in case of change in sponsor.

How will an investor come to know about the changes, if any, which may occur in the mutual fund?

There may be changes from time to time in a mutual fund. The mutual funds are required to inform any material changes to their unitholders. Apart from it, many mutual funds send quarterly newsletters to their investors.

At present, offer documents are required to be revised and updated at least once in two years. In the meantime, new investors are informed about the material changes by way of addendum to the offer document till the time offer document is revised and reprinted.

How to know the performance of a mutual fund scheme?

The performance of a scheme is reflected in its net asset value (NAV) which is disclosed on daily basis in case of open-ended schemes and on weekly basis in case of close-ended schemes. The NAVs of mutual funds are required to be published in newspapers. The NAVs are also available on the web sites of mutual funds. All mutual funds are also required to put their NAVs on the web site of Association of Mutual Funds in India (AMFI) www.amfiindia.com and thus the investors can access NAVs of all mutual funds at one place

The mutual funds are also required to publish their performance in the form of half-yearly results which also include their returns/yields over a period of time i.e. last six months, 1 year, 3 years, 5 years and since inception of schemes. Investors can also look into other details like percentage of expenses of total assets as these have an affect on the yield and other useful information in the same half-yearly format.

The mutual funds are also required to send annual report or abridged annual report to the unitholders at the end of the year.

Various studies on mutual fund schemes including yields of different schemes are being published by the financial newspapers on a weekly basis. Apart from these, many research agencies also publish research reports on performance of mutual funds including the ranking of various schemes in terms of their performance. Investors should study these reports and keep themselves informed about the performance of various schemes of different mutual funds.

Investors can compare the performance of their schemes with those of other mutual funds under the same category. They can also compare the performance of equity oriented schemes with the benchmarks like BSE Sensitive Index, S&P CNX Nifty, etc.

On the basis of performance of the mutual funds, the investors should decide when to enter or exit from a mutual fund scheme.

How to know where the mutual fund scheme has invested money mobilised from the investors?

The mutual funds are required to disclose full portfolios of all of their schemes on half-yearly basis which are published in the newspapers. Some mutual funds send the portfolios to their unitholders.

The scheme portfolio shows investment made in each security i.e. equity, debentures, money market instruments, government securities, etc. and their quantity, market value and % to NAV. These portfolio statements also required to disclose illiquid securities in the portfolio, investment made in rated and unrated debt securities, non-performing assets (NPAs), etc.

Some of the mutual funds send newsletters to the unitholders on quarterly basis which also contain portfolios of the schemes.

Is there any difference between investing in a mutual fund and in an initial public offering (IPO) of a company?

Yes, there is a difference. IPOs of companies may open at lower or higher price than the issue price depending on market sentiment and perception of investors. However, in the case of mutual funds, the par value of the units may not rise or fall immediately after allotment. A mutual fund scheme takes some time to make investment in securities. NAV of the scheme depends on the value of securities in which the funds have been deployed.

If schemes in the same category of different mutual funds are available, should one choose a scheme with lower NAV?

Some of the investors have the tendency to prefer a scheme that is available at lower NAV compared to the one available at higher NAV. Sometimes, they prefer a new scheme which is issuing units at Rs. 10 whereas the existing schemes in the same category are available at much higher NAVs. Investors may please note that in case of mutual funds schemes, lower or higher NAVs of similar type schemes of different mutual funds have no relevance. On the other hand, investors should choose a scheme based on its merit considering performance track record of the mutual fund, service standards, professional management, etc. This is explained in an example given below.

Suppose scheme A is available at a NAV of Rs.15 and another scheme B at Rs.90. Both schemes are diversified equity oriented schemes. Investor has put Rs. 9,000 in each of the two schemes. He would get 600 units (9000/15) in scheme A and 100 units (9000/90) in scheme B. Assuming that the markets go up by 10 per cent and both the schemes perform equally good and it is reflected in their NAVs. NAV of scheme A would go up to Rs. 16.50 and that of scheme B to Rs. 99. Thus, the market value of investments would be Rs. 9,900 (600* 16.50) in scheme A and it would be the same amount of Rs. 9900 in scheme B (100*99). The investor would get the same return of 10% on his investment in each of the schemes. Thus, lower or higher NAV of the schemes and allotment of higher or lower number of units within the amount an investor is willing to invest, should not be the factors for making investment decision. Likewise, if a new equity oriented scheme is being offered at Rs.10 and an existing scheme is available for Rs. 90, should not be a factor for decision making by the investor. Similar is the case with income or debt-oriented schemes.

On the other hand, it is likely that the better managed scheme with higher NAV may give higher returns compared to a scheme which is available at lower NAV but is not managed efficiently. Similar is the case of fall in NAVs. Efficiently managed scheme at higher NAV may not fall as much as inefficiently managed scheme with lower NAV. Therefore, the investor should give more weightage to the professional management of a scheme instead of lower NAV of any scheme. He may get much higher number of units at lower NAV, but the scheme may not give higher returns if it is not managed efficiently.

How to choose a scheme for investment from a number of schemes available?

As already mentioned, the investors must read the offer document of the mutual fund scheme very carefully. They may also look into the past track record of performance of the scheme or other schemes of the same mutual fund. They may also compare the performance with other schemes having similar investment objectives. Though past performance of a scheme is not an indicator of its future performance and good performance in the past may or may not be sustained in the future, this is one of the important factors for making investment decision. In case of debt oriented schemes, apart from looking into past returns, the investors should also see the quality of debt instruments which is reflected in their rating. A scheme with lower rate of return but having investments in better rated instruments may be safer. Similarly, in equities schemes also, investors may look for quality of portfolio. They may also seek advice of experts.

Are the companies having names like mutual benefit the same as mutual funds schemes?

Investors should not assume some companies having the name “mutual benefit” as mutual funds. These companies do not come under the purview of SEBI. On the other hand, mutual funds can mobilise funds from the investors by launching schemes only after getting registered with SEBI as mutual funds.

Is the higher net worth of the sponsor a guarantee for better returns?

In the offer document of any mutual fund scheme, financial performance including the net worth of the sponsor for a period of three years is required to be given. The only purpose is that the investors should know the track record of the company which has sponsored the mutual fund. However, higher net worth of the sponsor does not mean that the scheme would give better returns or the sponsor would compensate in case the NAV falls.

Where can an investor look out for information on mutual funds?

Almost all the mutual funds have their own web sites. Investors can also access the NAVs, half-yearly results and portfolios of all mutual funds at the web site of Association of mutual funds in India (AMFI) www.amfiindia.com. AMFI has also published useful literature for the investors.

Investors can log on to the web site of SEBI www.sebi.gov.in and go to “Mutual Funds” section for information on SEBI regulations and guidelines, data on mutual funds, draft offer documents filed by mutual funds, addresses of mutual funds, etc. Also, in the annual reports of SEBI available on the web site, a lot of information on mutual funds is given.

There are a number of other web sites which give a lot of information of various schemes of mutual funds including yields over a period of time. Many newspapers also publish useful information on mutual funds on daily and weekly basis. Investors may approach their agents and distributors to guide them in this regard.

Can an investor appoint a nominee for his investment in units of a mutual fund?

Yes. The nomination can be made by individuals applying for / holding units on their own behalf singly or jointly. Non-individuals including society, trust, body corporate, partnership firm, Karta of Hindu Undivided Family, holder of Power of Attorney cannot nominate.

If mutual fund scheme is wound up, what happens to money invested?

In case of winding up of a scheme, the mutual funds pay a sum based on prevailing NAV after adjustment of expenses. Unitholders are entitled to receive a report on winding up from the mutual funds which gives all necessary details.

How can the investors redress their complaints?

Investors would find the name of contact person in the offer document of the mutual fund scheme whom they may approach in case of any query, complaints or grievances. Trustees of a mutual fund monitor the activities of the mutual fund. The names of the directors of asset management company and trustees are also given in the offer documents. Investors should approach the concerned Mutual Fund / Investor Service Centre of the Mutual Fund with their complaints,

If the complaints remain unresolved, the investors may approach SEBI for facilitating redressal of their complaints. On receipt of complaints, SEBI takes up the matter with the concerned mutual fund and follows up with it regularly. Investors may send their complaints to:

Securities and Exchange Board of India

Office of Investor Assistance and Education (OIAE)

Plot No.C4-A , “G” Block, 1^st Floor,

Bandra-Kurla Complex,

Bandra (E), Mumbai – 400 051.

Phone: 26449199-88-77

What is the procedure for registering a mutual fund with SEBI ?

An applicant proposing to sponsor a mutual fund in India must submit an application in Form A along with a fee of Rs.25,000. The application is examined and once the sponsor satisfies certain conditions such as being in the financial services business and possessing positive net worth for the last five years, having net profit in three out of the last five years and possessing the general reputation of fairness and integrity in all business transactions, it is required to complete the remaining formalities for setting up a mutual fund. These include inter alia, executing the trust deed and investment management agreement, setting up a trustee company/board of trustees comprising two- thirds independent trustees, incorporating the asset management company (AMC), contributing to at least 40% of the net worth of the AMC and appointing a custodian. Upon satisfying these conditions, the registration certificate is issued subject to the payment of registration fees of Rs.25.00 lacs For details, see the SEBI (Mutual Funds) Regulations, 1996.

Deduction U/s 80D for Mediclaim Premium available to Individual, HUF and Senior Citizens

2011-10-09T20:29:00.001+05:30

Deduction in respect of Medical Insurance Premium (Mediclaim) paid to keep in force insurance by individual either on his own health or on the health of spouse, dependent parents and children or HUF on the health of any members of the family. A Mediclaim policy is a must because should you fall sick or meet with an accident, your medical bills could wipe out your savings.

Features of Mediclaim policy

1. Premium based on Age: - As in term insurance, the premium rates will vary among the insurers and will also depend on your age. The older you are, the heftier the premium. For instance, Mediclaim policy from General Insurance Corporation has a fixed premium till 35 years and then it changes in 10-year slabs.

2. Who is it available to?

Individual (resident or non resident, Indian Citizen or foreign citizen):- In case an individual is taking the deduction, the medical insurance policy can be taken in the name of any of the following: the taxpayer or the spouse, parents or dependent children* of the taxpayer.
HUF(Hindu undivided Family may be resident or non resident) :- In case a HUF is taking the deduction, the medical insurance policy can be taken in the name of any member of the family.

Note

Dependent Children (i.e. legitimate or legally adopted children). Children above 18 years, if employed, can not be covered. Male children, if not employed, but a bonafide student can be covered upto age of 25 years. Female children, if not employed, can be covered until the time she is married.
parents need bot be dependent on the Assessee.
parents of Individual or Spouse both are covered.

3. Entry Age: This insurance is available to a person between the age of 18 to 59 years. However, the Policy can be renewed upto the age of 80 years.

a) Children above the age of 3 months can be covered provided parents are covered concurrently and suitable premium is paid. If the child above 18 years is employed or if the girl child is married, he or she shall cease to be covered under the policy. However male child can be covered upto the age of 25 years if he is a bonafide regular student and fully dependent on primary insured. Female child can be covered upto the time, she is unmarried.

b) If the insured has taken continuous Mediclaim insurance policy with us for at least 5 years prior to attaining the age of 80 years the policy can be renewed beyond the age of 80 upto the age of 90 years as a special case with the approval of Regional Incharge on case to case basis. The premium chargeable shall be 10% of the premium for 75-80 years age slabs for proposers above 85 and 20% of the premium for 75-80 age slabs for proposers above 90.

c) No inclusion of family member during currency of policy is permissible except for a new born child between the ages of 3 months to 6 months and newly married spouse within 60 days of marriage. Otherwise inclusion of family member shall be allowed only at the time of renewal. Prorata premium shall be charged for such inclusion during the currency of the policy for the unexpired period.

4. Sum Insured: Minimum sum insured shall be Rs 50,000/- and can be increased in multiples of Rs 25,000/-upto Rs 5 lacs. The sum insured must be identical for primary insured and the dependents. However, the children may be covered for 50% Sum Insured as per 4 above.

5. Payment of Mediclaim Premium out of taxable Income:- The amount must have been paid using the taxpayer’s income chargeable to tax.

6. In addition to deduction u/s, 80C, 80CC and 80CCD,:- This is an additional deduction available which do not include deduction u/s 80C, 80CCC and 80CCD for which overall limit is is Rs. 1,00,000.

7. Partly contribution: If part payment is done by you and part payment by the parent, both can claim deduction to the extent of their contribution subject to maximum allowed but amount should be paid directly to insurance company and paid through mode other than by cash.

8. Mode of payment: The premium may be paid by any mode of payment other than cash. Note prior to 1st April 2009, premium payment was required to be done only by cheque. Credit card or other online payment mechanism where not allowed. Now all payment modes except cash payment are accepted.

9. Which Mediclaim Premium is allowed? : - Mediclaim premium paid under Medical insurance scheme of General Insurance Corporation approved by the Central Government, or any other insurer approved by the Insurance Regulatory & Development Authority (IRDA).

10. What is the amount of the deduction?

For Individual

Basic deduction: Mediclaim premium paid for Self, Spouse or dependant children. Maximum deduction Rs 15,000. In case any of the persons specified above is a senior citizen (i.e. 65 years or more as of end of the year up to F.Y. 2010-11 and 60 years from F.Y. 2011-12) and Mediclaim Insurance premium is paid for such senior citizen, deduction amount is enhanced to Rs. 20,000.
Additional deduction: Mediclaim premium paid for parents. Maximum deduction Rs 15,000. In case any of the parents covered by the Mediclaim policy is a senior citizen, deduction amount is enhanced to Rs. 20,000.

For HUF

Mediclaim premium paid for any member of the HUF. Maximum deduction Rs 15,000. In case any member of the HUF covered by the Mediclaim policy is a senior citizen, deduction amount is enhanced to Rs. 20,000.

Senior citizen: means who is at least of 65 year of age or more at any time during the previous year.

EXAMPLE- 1
1. An individual assessee pays (through any mode other than cash) during the previous year medical insurance premia, out of his taxable income, as under:

(i) Rs 12,000/- to keep in force an insurance policy on his health and on the health of his wife and dependent children;

(ii) Rs 17,000/- to keep in force an insurance policy on the health of his parents.

Under the new provisions he will be allowed a deduction of Rs 27,000/- (Rs. 12,000/- + Rs. 15,000/-) if neither of his parents is a senior citizen. However, if any of his parents is a senior citizen, he will be allowed a deduction of Rs 29,000/- (Rs.12,000/- + Rs.17,000/). Whether the parents are dependent or not, is not a consideration for deciding the deduction under the new provisions.

Further, in the above example, if cost of insurance on the health of the parents is Rs 30,000/-, out of which Rs 17,000/- is paid (by any non-cash mode) by the son and Rs 13,000/- by the father ( who is a senior citizen), out of their respective taxable income, the son will get a deduction of Rs 17,000/- ( in addition to the deduction of Rs 12,000/- for the medical insurance on self and family) and the father will get adeduction of Rs 13,000/-.

EXAMPLE 2

An individual assessee pays through credit card during the previous year health insurance premium as under:

Rs. 12,000 to keep in force an insurance policy on his health and on the health of his wife and children
Rs. 17,000 to keep in force an insurance policy on the health of his parents.

Under the proposed new provisions, he will be allowed a deduction of Rs. 27,000 (Rs. 12,000 + Rs. 15,000) if neither of his parents is a senior citizen. However, if any of his parents is a senior citizen, he will be allowed a deduction of Rs. 29,000 (Rs. 12,000 + Rs. 17,000). Whether the parents are dependent or not, is not a consideration for deciding the deduction under Section 80D.

EXAMPLE- 3

Question:- In the last budget, the finance minister announced exemptions for Mediclaim charges paid for senior citizens. However, I am not sure if it has yet been notified and effective. I need to take medical insurance for both my parents, who are senior citizens. I would appreciate if you can let me know.

Answer:- Earlier Sec 80D deduction in respect of medical insurance premium was Rs 15,000 for an individual and Rs 20,000 for a senior citizen. However, from this year, if someone were to buy medical insurance for his parent/s, an additional deduction of Rs 15,000 (over and above Rs 15,000) will be available. If such parent/s were senior citizen, the additional deduction would be Rs 20,000. So a person insuring himself, his spouse, children and parents could potentially get a deduction of Rs 35,000. This provision is effective from 1.4.08.

EXAMPLE- 4

Can I pay mediclaim on behalf of my mother-in-law and claim deduction under Section 80D of the Income Tax Act?

An individual is allowed to claim deduction under Section 80D when the policy is taken on the health of the assessee, his spouse, parents (dependent or not) and dependent children. Accordingly, you cannot claim the deduction under Section 80D in respect of mediclaim paid for your mother-in-law.

Appendix: Section 80D of the Income Tax Act

Deduction in respect of medical insurance premium.

80D. (1) In computing the total income of an assessee, being an individual or a Hindu undivided family, there shall be deducted such sum, as specified in sub-section (2) or sub-section (3), payment of which is made by any mode, other than cash, in the previous year out of his income chargeable to tax.

(2) Where the assessee is an individual, the sum referred to in sub-section (1) shall be the aggregate of the following, namely:

(a) the whole of the amount paid to effect or to keep in force an insurance on the health of the assessee or his family as does not exceed in the aggregate fifteen thousand rupees; and

(b) the whole of the amount paid to effect or to keep in force an insurance on the health of the parent or parents of the assessee as does not exceed in the aggregate fifteen thousand rupees.

Explanation.For the purposes of clause (a), family means the spouse and dependant children of the assessee.

(3) Where the assessee is a Hindu undivided family, the sum referred to in sub-section (1) shall be the whole of the amount paid to effect or to keep in force an insurance on the health of any member of that Hindu undivided family as does not exceed in the aggregate fifteen thousand rupees.

(4) Where the sum specified in clause (a) or clause (b) of sub-section (2) or in sub-section (3) is paid to effect or keep in force an insurance on the health of any person specified therein, and who is a senior citizen, the provisions of this section shall have effect as if for the words fifteen thousand rupees, the words twenty thousand rupees had been substituted.

Explanation.For the purposes of this sub-section, senior citizen means an individual resident in India who is of the age of sixty-five years or more at any time during the relevant previous year.

(5) The insurance referred to in this section shall be in accordance with a scheme made in this behalf by

(a) the General Insurance Corporation of India formed under section 9 of the General Insurance Business (Nationalisation) Act, 1972 (57 of 1972) and approved by the Central Government in this behalf; or

(b) any other insurer and approved by the Insurance Regulatory and Development Authority established under sub-section (1) of section 3 of the Insurance Regulatory and Development Authority Act, 1999 (41 of 1999).]

Deloitte sued for $7.6 billion, accused of missing fraud

2011-10-01T21:14:00.001+05:30

(Reuters) Deloitte Touche Tohmatsu Ltd , the world's largest accounting
and consulting firm, was accused on Monday of failing to detect fraud
during its audits of one of the biggest private mortgage firms to
collapse during the U.S. housing crash.

A trust overseeing the bankruptcy of Taylor, Bean & Whitaker Mortgage
Corp, or TBW, and one of the company's subsidiaries filed complaints in
a Miami Circuit Court claiming a combined $7.6 billion in losses.

Deloitte "certified TBW as a solvent, viable company with accurate
financial statements every year from 2001 to 2008," one of the
complaints said.

"Despite Deloitte's credentials and expertise as one of the 'Big 4′
accounting firms, those statements — and the rosy picture they depicted
of TBW — were completely false," it said.

Deloitte spokesman Jonathan Gandal said the "claims are utterly without
merit."

It was the latest lawsuit to hit one of the major accounting firms over
their role in the credit crisis.

Pricewaterhouse Coopers, KPMG and Ernst & Young are also facing
accusations about their auditing standards by investors who collectively
seek to recoup billions of dollars lost in the financial meltdown.

Lee Farkas, the former chairman of Taylor, Bean and Whitaker, was
sentenced to 30 years in prison in April for masterminding what U.S.
officials described as one of the biggest bank frauds ever.

U.S. Justice Department officials said Farkas ran a $2.9 billion fraud
scheme that led to TBW's downfall and the collapse of one of the largest
U.S. regional banks, Colonial Bank.

The complaint filed by Neil F. Luria, a plan trustee of Taylor, Bean &
Whitaker Trust, claims losses of approximately $6 billion. A second
complaint by Ocala Funding, a wholly owned TBW subsidiary which served
as a lending facility, claims losses of $1.6 billion.

Farkas was accused of running a wide-ranging scheme to cover up large
losses at Taylor, Bean, which was based in Ocala, Florida, by moving
funds between accounts at Colonial Bank and also by selling mortgage
loans that either did not exist, were worthless or had already been sold.

"Deloitte missed this fraud because it simply accepted management's
conflicting, incomplete and often last-minute explanations of
highly-questionable transactions, even though those explanations made no
sense and were flatly contradicted by the documents in Deloitte's
possession," the complaint by Ocala Funding said.

"Ocala relied on Deloitte to detect material misstatements in the
financial statements due to error or fraud," the complaint said.

Gandal said the plaintiffs in the cases were "companies through which
convicted felon Lee Farkas and his co-conspirators committed their crimes."

"The bizarre notion that his engines of theft are entitled to complain
of injury from their own crimes and to sue the outside auditors they
lied to defies common sense, not to mention the law," he said in a
statement.

Several other Taylor, Bean and Colonial Bank employees who pleaded
guilty for their roles in the fraud were also sentenced earlier this year.

(Editing by Bernard Orr)

Must have components in your Salary, to minimise tax burden

2011-10-01T21:10:00.001+05:30

What does, however, ‘salary’ include? Salary includes basic salary, bonus, wages, pension, fees, commission, gratuity, encashment of leave salary, advances and arrears, profits in lieu of salary, allowances and perquisites. An ‘allowance’ is a fixed sum of money given regularly for meeting requirements of an employee while a ‘perquisite’ is a benefit attached to an office.

Salary income is taxable in the hands of an individual in the year of receipt or earning of salary income, whichever is earlier. Here are some of the safe components of your salary structure:

• If you live in a rented an accommodation and are entitled to a house rent allowance (HRA), the same is exempt to the extent of least of the following; 50 per cent of the basic salary, excess of rent paid over 10% of basic salary, actual HRA received. However, you cannot take benefit of HRA, if you live in a rent-free accommodation or live with your family or in your own house.

• Conveyance allowance for commuting between home and office is exempt up to Rs 800 per month.

• Children’s Education Allowance is exempt up to Rs 100 per month per child up to a maximum of two children.

• The value of any travel concession or assistance received by or due to you from your employer for yourself and your family in connection with proceeding on leave to any place in India subject to prescribed conditions.

• Leave encashment while in service is taxable, but is exempt at retirement, subject to prescribed limits and conditions.

• An allowance to the extent actually incurred to meet the cost of travel on tour or on transfer, expenses incurred on conveyance in the performance of official duties, expenditure on helper engaged in the performance of duties, daily charges on account of absence from normal place of duty on tour are exempt.

• Reimbursement of health insurance premium by your employer for you and your family is exempt.

• Actual expenditure incurred on your medical treatment or any of your dependents is exempt up to Rs 15,000 per annum as medical reimbursement subject to provision of bills. If you are paid a medical allowance instead of reimbursement, the same is fully taxable.

• In case you are entitled to a free or concessional company-provided accommodation, the same would be valued based on stipulated conditions.

• If the company provides you a car for personal and official purposes and reimburses the fuel, insurance, maintenance and driver’s salary, the taxable value shall be: in case the cubic capacity of the car is less than or equal to 1.6 litres – Rs 1,800 per month (plus Rs 900 for the driver) and in case the cubic capacity of the car is greater than 1.6 litres – Rs 2,400 per month (plus Rs 900 for the driver).

• In case you use your own car for official and personal purposes and the company reimburses the running and maintenance cost, the taxable value shall be: in case, the cubic capacity of the car is less than or equal to 1.6 litres – actual amount met or reimbursed by the employer less Rs 1,800 per month (plus Rs 900 for the driver) and in case the cubic capacity of the car is greater than 1.6 litres – actual amount met or reimbursed by the employer less Rs 2,400 per month (plus Rs 900 for the driver).

• The reimbursement of telephone expenses including a mobile phone actually incurred by you on behalf of your employer is not taxable in your hands.

• The reimbursement of health club, sports club membership fees and similar facilities provided uniformly to all employees would not be taxable in your hands.

• Free meals provided to you through paid vouchers, not transferable and usable only at eating joints to the extent of Rs 50 per meal are safe.

• Asset assistance given by your employer. For example, provision of a computer or laptop owned by the company and provided to you or any member of your household is not taxable in your hands.

Play effectively with these safe components of salary and save as much as you can!

Indian Economy – Progress and Prospects

2011-10-01T21:08:00.001+05:30

(Speech by Deepak Mohanty, Executive Director, Reserve Bank of India, delivered at the Harvard Business School, Boston on 27th September 2011)

It is an honour and privilege for me to be speaking at Harvard to such a distinguished audience. I thank Professor Benjamin Friedman and Professor Tarun Khanna for this opportunity. I will be speaking on the Indian Economy.

India is home to 1.21 billion people, which is about 17.4 per cent of the global population. However, it accounts for only 2.4 per cent of world GDP in US dollar terms and 5.5 per cent in purchasing power parity (ppp) terms. Hence, there exists a huge potential for catch up. The global welfare too is linked to progress in India as reflected in the keen global interest in India. But, India seems to inspire and disappoint at the same time. This is reflected in various comments on the Indian economy. Yasheng Huang and Tarun Khanna in their much debated article in July 2003 issue of Foreign Policy had observed: "Can India surpass China? This is no longer a silly question". The July 23rd 2011 issue of The Economist observed; "Twenty years ago they said the yardstick against which India should be measured was its potential. On that measure, there is much to do."

As a fledgling democracy, India's economic experiment of planned development was held out as an example to many aspiring low-income countries in the 1950s. While some countries raced ahead in the development process, India lagged behind. This is evident from the fact that it took 40 long years from 1950-51 for India's real per capita GDP to double by 1990-91. But, 1991-92 was a defining moment in India's modern economic history as a severe balance of payments (BoP) crisis prompted far reaching economic reforms, unlocking its growth potential. As a result, in only 15 years, India's per capita income doubled again by 2006-07. If the current pace of growth is maintained, India's per capita income could further double by 2017-18, in 10 years time. While acceleration in India's recent economic growth is noteworthy, maintaining the pace, no doubt, will be challenging.

Against this background, I propose to highlight the key policy reforms since 1991-92, review the economic progress made so far and then conclude with some reflections on policy challenges in the way forward.

Policy Reforms Post-1991

Macroeconomic crisis of 1991 marked a turning point in India's economic history for two reasons. First, fiscal deficit driven external payment crisis with a dip in foreign exchange reserves to below US$ 1 billion in July 1991 drew a crisis resolution strategy to restore macroeconomic stability. Sharp correction in fiscal deficit-GDP ratio and reduced monetisation of deficits contributed towards restoring macroeconomic balance by the mid-1990s. The reduced dependence of fisc on monetisation enabled the Reserve Bank of India to reduce its statutory pre-emption of funds from banks, thereby freeing resources for the private sector. Second, simultaneously efforts were made towards wide ranging structural reforms encompassing areas of trade, exchange rate management, industry, public finance and the financial sector.

An abiding objective in respect of industrial policy measures since then has been to create a competitive environment to improve productivity and efficiency. New industrial policy fostered competition by abolishing monopoly restrictions, terminating the phased manufacturing programmes, freeing foreign direct investment and import of foreign technology and de-reservation of sectors hitherto reserved for the public sector. These measures created a favourable environment for industry to upgrade its technology and build-up its capacity through imports in order to cater to growing domestic and external demand.

At present, only five industries are under licensing, mainly on account of environmental, health, safety and strategic considerations. Only two industries are reserved for the public sector, viz, atomic energy and railway transport. Reservation of industrial products for the small scale sector is still a lingering issue. However, the definition of small scale industry (SSI) has been changed to facilitate modernisation and now only 20 items are reserved for manufacturing in the small scale sector. Foreign Direct Investment (FDI) up to 100 per cent is allowed under the automatic route in most sectors, with a few exceptions.

The infrastructure sector has been thrown open to the private sector. Considering the large requirements of funds for infrastructure, 100 per cent FDI has been allowed in all infrastructure sectors. There are extended tax holidays to enterprises engaged in the business of development, operation, and maintenance of infrastructure facilities. The emphasis has been on public-private partnership (PPP) as one of the preferred modes for infrastructure project implementation.

Comprehensive fiscal reforms covered tax reforms, restructuring of public sector undertakings and improving fiscal-monetary coordination before eventually carrying these reforms forward under rule based fiscal consolidation path from 2004-05, which was interrupted by the global financial crisis in 2008-09. Reduction in customs duties over the years reflected India's commitment towards converging towards the ASEAN levels over the medium-term.

The monetary policy framework and the associated operating procedures of monetary policy in India have evolved over time with the changes in the underlying macroeconomic structure and development of financial markets. A landmark development was the abolition of the system of automatic monetisation of fiscal deficit from April 1997, which provided instrument independence to the Reserve Bank of India in the conduct of monetary policy. This, combined with the introduction of auctioning system in the government securities, enabled the Reserve Bank to switch from direct to indirect instruments of monetary control.

With the opening up of the economy and deregulation of the financial sector, the stability of money demand function became suspect. The Reserve Bank, therefore, switched from a monetary targeting framework, adopted in the mid-1980s, to a multiple indicator approach. Under this approach, various indicators such as rates of return in different markets, movements in currency, credit, fiscal position, trade, capital flows, inflation rate, exchange rate, refinancing and transactions in foreign exchange – available on a high frequency basis – are juxtaposed with output data for drawing policy perspectives. This approach continued to evolve and is presently in its augmented version, wherein forward looking indicators drawn from the Reserve Bank's industrial outlook survey, capacity utilisation survey, professional forecasters' survey and inflation expectations survey are used for macroeconomic assessment. The operating procedure of monetary policy also underwent a change with the overnight interest rate emerging as the operating target of monetary policy.

In the financial sector, the objective was to provide operational flexibility and functional autonomy to banks and other financial institutions so that they could allocate resources more efficiently. Some of the important initiatives in the financial sector were: reduction in statutory preemptions so as to release greater funds for commercial lending, interest rate deregulation to enable price discovery, allowing new private sector banks to create a more competitive environment, dilution of government holding in public sector banks and institution of prudential norms such as capital adequacy, income recognition, asset classification, provisioning and exposure norms to strengthen the health of the banking system besides improving transparency and disclosure standards.

The development of financial markets has been regarded as a critical prerequisite for improving the operational effectiveness of the transmission of monetary policy. During the first phase of financial sector reforms, various structural rigidities were eased, so as to increase participation in financial markets as well as develop and strengthen inter-linkages amongst market segments, and foster competition. The focus of various reform measures in financial market was on ensuring adequate liquidity in various segments of the market spectrum, and developing the regulatory, legal, institutional and technological infrastructure for orderly functioning of market activity. In the second phase of reforms, more sophisticated financial instruments were introduced. Further, issues relating to the stability of financial markets received priority in the policy agenda.

The key objective of the external reforms was to move to a more open trade regime by correcting for the implicit anti-export bias. Moreover, there was a greater recognition of the need to view trade policies, exchange rate policies and industrial policies in an integrated manner. In pursuance of this, the administered exchange rate regime gave way to a flexible market-determined system. The exchange rate has since been guided by underlying demand and supply conditions and the broad principles of careful monitoring and management of exchange rates with flexibility, without a fixed or preannounced target or band.

The trade policy reforms comprised withdrawal of the quantitative restrictions on exports and imports, phasing out of the system of import licensing and lowering the level and dispersion of nominal tariffs so as to bring them on par with the East Asian economies. The peak customs tariff rate was progressively brought down from 150 per cent in 1991-92 to 10 per cent by 2008-09. The liberalization of restrictions on various external transactions led to current account convertibility under Article VIII of the Articles of Agreement of the IMF in 1994.

With respect to capital account liberalization, India embarked on a gradual and well sequenced opening up of the capital account. The active capital account management framework was based on a preference for non-debt creating capital inflows like foreign direct investment and foreign portfolio investment. The capital account is virtually free for non-residents and resident corporates with some restrictions on financial institutions and higher restrictions on resident individuals.

Economic Progress Post-1991

The initiation of economic reforms in the 1990s saw India gradually breaking free of the low growth trap which was euphemistically called the "Hindu growth rate" of 3.5 per cent per annum. Real GDP growth averaged 5.7 per cent per annum in the 1990s, which accelerated further to 7.3 per cent per annum in 2000s. A feature of the growth acceleration during the period was that while the growth rate of industry and services increased that of agriculture fell. This was because there was no notable technological breakthrough after the "green revolution" of the mid-1960s which saw sharp increase in yields of cereal production particularly in northern part of India. By the 1990s, the momentum of "green revolution" had died down. Consequently, the yield increases in the 2000s were much lower than those experienced even in the 1990s.

Notably, the decade of the 2000s encompassed the inflexion point in the growth trajectory with an annual average GDP growth of about 9 per cent for the 5-year period 2004-08. Growth in all the sub-sectors of the economy, including agriculture, accelerated during this period. However, this growth process was interrupted by the global financial crisis. Subsequently, the average growth slowed down to 7.8 per cent during 2009-11 with a noticeable slow down in both agriculture and industry.

The growth dynamics altered the structure of the Indian economy with a decline in the share of agriculture from 28.4 per cent in the 1990s to about 15 per cent in 2009-11. There was corresponding gain in the share of services, including construction, from 52 per cent to 65 per cent during the same period. What is, however, of concern is that the share of industry has remained unchanged at around 20 per cent of GDP. This suggests that India's growth acceleration during the last two decades has been dominated by the services sector. The pace of average annual industrial growth had nevertheless picked up from 5.7 per cent during the 1990s to 9 per cent during 2004-08 before being interrupted by the global financial crisis (Table 1).

While the share of industry in GDP remained stagnant, there was noteworthy structural transformation in manufacturing over the period. As a process of restructuring, while the gross value added in organized manufacturing increased by 8 per cent per annum at current prices, employment fell by 1.5 per cent per annum during 1995-2003. Subsequently, during 2004-09 gross value added growth accelerated to 20 per cent per annum at current prices; but significantly, employment also increased by 7.5 per cent per annum.

With work participation rate of 39.2 per cent, India had a workforce of 400 million in 2009-10. Of this, 53 per cent was in agriculture and the rest 47 per cent in non-agricultural activity. While the bulk of the employment is in agriculture despite its shrinking share, the noteworthy feature of the employment structure has been that for the first time the absolute workforce in agriculture declined in the latter half of the 2000s (Table 2). The overall unemployment rate in the economy also declined from 8.3 per cent in 2004-05 to 6.6 per cent in 2009-10.

Table 2. Labour Force
(in million)
Usual Status	1993-94	1999-00	2004-05	2009-10
1	2	3	4	5
1. Agriculture	210.7	225.4	238.8	212.6
1.1 Self Employed	126.6	130.2	153.2	127.9
1.2 Regular Wage/Salaried Employee	2.9	3.2	2.6	1.9
1.3 Casual Labour	81.2	91.9	83.0	82.9
2. Non Agriculture	115.8	140.0	169.5	187.4
2.1 Self Employed	52.1	62.8	79.0	76.0
2.2 Regular Wage/Salaried Employee	40.2	47.9	55.6	60.5
2.3 Casual Labour	23.4	29.3	34.8	50.9
Total	326.5	365.4	408.2	400.0

Not surprisingly, the growth acceleration was accompanied by a sharp pick-up in the rate of growth of gross fixed capital formation which had more than doubled from an annual average of 7.2 per cent in the 1990s to 15.7 per cent in the high growth phase of 2004-08. It, however, has dropped significantly in the post-crisis period to 5.8 per cent (Table 1).

The structure of Indian economy also underwent a change during this period in terms of openness. The stereotypical view that India is a closed economy has not been borne out by the openness of Indian economy which was increasing rapidly. Exports and imports of goods and services have more than doubled from 23 per cent of GDP in the 1990s to 50 per cent in the recent period of 2009-11. If the trade flows are considered alongside capital flows, the rise in openness (measured as current receipts and payments plus capital receipts and payments) was more dramatic from 42 per cent of GDP in the 1990s to 107 per cent in the recent period (Table 3) Empirical evidence suggests that with increasing openness of the Indian economy, the trade and industrial cycles were getting more synchronised with the global business cycle.

The high growth phase of 2004-08 was accompanied by sharp increase in exports and imports as well as capital inflows. Net capital inflows as percentage of GDP more than doubled from 2.2 per cent in the 1990s to 4.6 per cent of GDP during 2004-08. Subsequently, growth rates in both trade and capital inflows moderated following the global financial crisis. The openness of the Indian economy has been accompanied by improvement in India's external position as the debt to GDP ratio fell from about 29 per cent in the 1990s to 19 per cent in the recent period. The debt service ratio has also declined from 25 per cent to under 5 per cent during the period (Table 4).

The openness in the capital account has resulted in two-way movement in capital with a sharp pick-up in India's outward FDI since the mid-2000s (Table 5). Uptrend in outward FDI mainly reflected the large overseas acquisition deals of Indian corporates to gain market share and reap economies of scale amidst progressive liberalisation of the external payments regime.

Table 5 : Foreign Direct Investment
(US $ billion)
Year	Inward	Outward	Net FDI to India	Outward/ inward (%)
1	2	3	4	5
2000-01	4.0	0.8	3.3	18.8
2001-02	6.1	1.4	4.7	22.7
2002-03	5.0	1.8	3.2	36.1
2003-04	4.3	1.9	2.4	44.7
2004-05	6.0	2.3	3.7	38.0
2005-06	8.9	5.9	3.0	65.9
2006-07	22.7	15.0	7.7	66.2
2007-08	34.7	18.8	15.9	54.2
2008-09	37.7	17.9	19.8	47.4
2009-10	33.1	14.4	18.8	43.3
2010-11	23.4	16.2	7.1	69.4
Source: Reserve Bank of India

Gradual improvements were also observed in the fiscal position with fiscal deficit moderating sharply during the high growth phase of 2004-08, which also coincided with a period of switch over to a rule based fiscal consolidation process. In fact, the high growth phase of 2004-08 saw a primary surplus for the Centre enhancing debt sustainability. The deficit indicators, however, have deteriorated in the recent period following crisis induced fiscal expansion (Table 6).

The average saving rate also showed a substantial increase from 23 per cent of GDP in the 1990s to about 31 per cent in the 2000s with a peak saving rate of over 33 per cent achieved during the high growth phase of 2004-08. Fiscal consolidation helped in lifting the overall saving rate as public sector saving rose significantly. The efficiency of capital utilisation also improved as the incremental capital output ratio (ICOR) declined to 3.7 during the high growth phase of 2004-08 from 5 in the 1990s. Subsequently, however, capital efficiency has declined in the post-crisis period (Table 7).

The high growth was achieved in an environment of price stability as headline wholesale price index (WPI) inflation dropped to an annual average of 5.5 per cent in the 2000s from 8.1 per cent in the 1990s. There was also similar drop in consumer price inflation. Subsequently, however, in the post-crisis period the inflation trend has reversed with the headline WPI inflation averaging over 7 per cent and the consumer price inflation crossing double digits during 2009-11. The uptick in food price inflation was particularly sharp during 2009-11 (Table 8).

Table 8: Inflation
Item	1991-2000	2001- 2010	2004-2008	2009-2011
1	2	3	4	5
(Annual Average Percentage change)
1. Wholesale Price Index	8.1	5.4	5.5	7.1
1.1 Food Articles	10.2	5.8	5.2	13.3
1.2 Fuel Group	10.6	8.9	7.3	7.2
1.3 Non-Food Manufactured Products	6.8	4.0	5.0	4.0
2. CPI- Industrial Workers	9.5	5.9	5.0	10.6
2.1 CPI- Industrial Workers Food	9.8	6.2	5.5	12.5

During this period, financial deepening of the Indian economy has also increased: broad money (M₃) to GDP ratio rose from an average of 50 per cent in the 1990s to 85 per cent in the recent period of 2009-11. Credit penetration, measured as credit to GDP ratio, also increased from 21 per cent of GDP to about 50 per cent during this period. The high growth phase of 2004-08 was accompanied by acceleration in growth of bank credit to the private sector to about 27 per cent per annum from about 15 per cent in the 1990s. However, during the high growth phase of 2004-08, the average increase in M₃ remained contained which aided price stability. This was made possible due to deceleration in banks' investment in government securities to about 13 per cent per annum during 2004-08 from 21 per cent in the 1990s. Fiscal consolidation opened up the space for private credit expansion without exerting much additional pressure on monetary expansion (Table 9).

Table 9: Money and Credit
Item	1991-2000	2001- 2010	2004-2008	2009-2011
1	2	3	4	5
(Percentage change)
1. Narrow Money (M₁)	15.6	16.0	19.6	12.3
2. Broad Money (M₃)	17.2	17.5	18.6	17.4
3. Non-food Bank Credit	15.4	22.4	26.7	18.7
4. Investment in Government Securities	20.9	17.7	13.3	16.2
(Per cent)
5. Credit-GDP Ratio	20.6	37.7	39.5	49.7
6. Broad Money-GDP Ratio	49.9	73.6	74.3	84.6

Policy Challenges

The draft approach paper for the Twelfth Five Year Plan (2012-17) released in August 2011 targets an annual GDP growth rate of 9 per cent. This is challenging but not unattainable. Why? Because India has already achieved an average growth rate of about 9 per cent during 2004-08 which was interrupted by the global financial crisis. Subsequently, average growth has dropped by about one percentage point to 7.8 per cent during 2009-11. In 2011-12, the terminal year of the Eleventh Plan, growth is expected to be about 8 per cent. Hence, growth will have to be raised by an additional percentage point per annum which is challenging because it will require a conducive global environment and policy reforms at home. While there are several tasks to be addressed, I will focus on six key issues.

First, India will have to raise agricultural productivity and diversify agriculture to feed its own population. The food entitlement has increased with the public employment guarantee programme (MGNREGA) which guarantees for 100 days of employment to one member of each family in the rural areas. This has also given better bargaining power to labour and consequently the overall wage rates have gone up raising the demand for food. While the country currently has sufficient foodgrains stocks, it is not yet self-sufficient in pulses and oilseeds. Further, demand for protein based products like meat, egg, milk and fish as well as fruits and vegetables has increased substantially with rise in income. The demand-supply mismatches in the case of these items have resulted in rise in their prices. There is, therefore, a need for another technological breakthrough to give fresh impetus to agriculture. At the same time, greater emphasis will have to be placed in the management of supply chain with investment in rural infrastructure. The annual growth in agriculture has to be raised to at least 4 per cent from the current trend growth rate of around 3 per cent.

Second, the fact that 53 per cent of overall work force is still engaged in the agricultural sector – whose share of GDP has shrunk considerably – is worrisome. A substantial part of this labour force will have to be ejected from agriculture not only to improve the productivity in agriculture but also in the overall economy. It is unconceivable that they can all be absorbed gainfully in the services sector. Hence, industrial employment will have to expand so also the relative contribution of industry. This needs a focused attention as we have seen that the share of industry in the overall GDP has stagnated over the last two decades. In this direction, the Government has taken up a major policy initiative to create National Manufacturing and Investment Zones (NMIZ) to increase the sectoral share of manufacturing in GDP to 25 per cent by 2022 and double the current employment level in the sector. Good physical infrastructure, a progressive exit policy, structures to support clean and green technologies, appropriate investment incentives, and business friendly approval mechanisms will be the cornerstones of this new initiative.

Third, to support industrialization and increased economic activity, there is a need to step up investment in infrastructure. The assessment of the Planning Commission suggests an investment of `45 trillion (US $ 1 trillion) over the Twelfth Plan (2012-17). Given the large requirement of long-term funds, financing infrastructure would be a big challenge. Besides budgetary support, the bulk of the funds has emanated from banks. However, channelling domestic and foreign financial savings of this scale into infrastructure will require developing the domestic private corporate debt market. Apart from the need for substantial financial outlays for infrastructure, there are several non-financing constraints: particularly land acquisition delays need to be addressed to avoid time and cost overruns.

Fourth, there is a need for the Government to revert to its rule-based pre-crisis fiscal consolidation path without compromising on the quality of fiscal correction. This is necessary to obviate the risk of twin deficits and to raise the overall saving rate. This will require further reform in the tax structure to ensure revenue buoyancy and greater focus on quality of expenditure with an emphasis on reduction of subsidy. In this regard, major reforms in the pipeline are the introduction of an integrated Goods and Services Tax (GST) by the Centre and the States to reduce cascading effect and improve tax compliance and operationalisation of a Direct Taxes Code (DTC), to improve allocative efficiency and equity of the direct taxes.

Fifth, credit markets have, historically, played a crucial role in sustaining growth through efficient intermediation of funds between savers and investors. Although India has a well-diversified financial system, and several measures for financial inclusion have been taken in the recent past, credit penetration continues to be relatively low in comparison with several other developed and emerging market economies. The extent of financial exclusion is staggering with around 61 per cent of population having a deposit account and only 10 per cent of population having a credit account. The Reserve Bank has embarked on a plan of making available basic banking services to all habitations of population of over 2000 by 2012 through a combination of brick and mortar branches and a system of business correspondents (BCs). Accelerated economic growth will depend on access to formal finance by the bulk of the population and greater credit penetration.

Sixth, empirical evidence suggests that the threshold level of inflation is in the range of 4-6 per cent. Hence, without bringing inflation down from the current level it will be difficult to sustain a high level of growth. This will require greater monetary-fiscal coordination and alleviation of supply constraints, particularly in agriculture.

Conclusion

Envisioning India's emergence as a major economic power in the world, Dr. Manmohan Singh in his Union Budget 1991-92 speech that launched wide ranging economic reforms had quoted Victor Hugo's saying, "no power on earth can stop an idea whose time has come". Ever since, there has been no looking back as India launched wide ranging structural reforms and has made significant economic progress over the past two decades. India's industrial environment has become more competitive and open, infrastructural gaps have been sought to be bridged through public-private initiatives with both domestic and foreign sources of funding, current account has become fully convertible while capital account is virtually free for non-residents. The policy environment has become more enabling with rule-based commitment on fiscal policy and considerable instrument independence for operation of monetary policy. As statutory preemptions were reduced and interest rates were deregulated, banks gained operational autonomy for commercial lending. As a result, India's per capita income, which had taken four decades to double by 1991, doubled thereafter in 15 years and is likely to double again in 10 years by 2017-18. If India could maintain the current pace of growth it will lift millions out of poverty and enrich the global economy. While India has come a long way, maintaining the current pace would itself be challenging and require continued reform efforts.

* Speech by Deepak Mohanty, Executive Director, Reserve Bank of India, delivered at the Harvard Business School, Boston on 27th September 2011. The assistance provided by Dhritidyuti Bose and Abhiman Das is acknowledged.

FM’s Address ‘India’s Continuing Growth Story’ at the India Investment Forum

2011-10-01T20:57:00.001+05:30

Finance Minister's Address "India's Continuing Growth Story" at the India Investment Forum, September 21, 2011

Following is the text of the Finance Minister's Address "India's Continuing Growth Story" at the India Investment Forum, September 21, 2011

"I am very happy to be here today and have this opportunity to speak on a theme, which as the Finance Minister of the country, is a matter of professional engagement and even a commitment for me. Growth is necessary for the opportunity that it creates for the teeming millions in India, who need to be lifted out of poverty and deprivation. Growth is equally important for the resources it generates for the Government to bridge the country's social and physical infrastructure deficit. Indeed, it is the means that gives us a realistic chance of putting the economy on a path of high, self supporting and sustainable long-term growth.

The Indian economy has traversed a long way during the course of which it has stepped up its growth trajectory over successive decades, especially since the 1980s. It grew at a rate of around 3.5 per cent between 1950 and 1980, about 5.5 in the 1980s, going up to over 6 per cent in the 1990s and in the early years of this century. Since about 2003-04 it has moved further to a higher trend growth path of 8.5 to 9 per cent per annum. Between 2005 and 2008, India's GDP grew at around 9.5 per cent per year making it one of, the fastest growing democracies in the world.

The economic slowdown in the wake of the global financial crisis also impacted India and its growth rate declined to 6.8 per cent in the crisis year of 2008-09. However the recovery was rapid and strong. The economy registered an average growth of over 8 per cent in the two years following the slowdown, demonstrating its resilience and the capacity to overcome adversities in its development path.

Though there has been some moderation in growth, with GDP increasing by 7.7 per cent in the first quarter of 2011-12, the fundamentals of the economy are still intact and the growth story of the Indian economy continues unabated. Continue it must in the next two decades so that we are able to deliver on the promise of meeting the developmental objectives that we have set for ourselves.

One of the defining features of the last two decades has been the shift in global economic power from the developed to the developing countries. G-20 and BRICS have emerged as groups that are guiding the world economy. The report on BRIC by Goldman Sachs made the world sit up and take notice of the potential economic clout of Brazil, Russia, India and China. Together these economies accounted for about 47 per cent of the contribution to global growth in 2011. We are glad that South Africa has now joined the BRIC cluster to give it a 'plural dimension' – BRICS. It is important for these partnerships to flourish if the global economy has to recovery quickly from the unprecedented downturn and to create a more stable and prosperous world in the coming years.

India has embraced a calibrated approach to globalization. The economy is gradually, but surely getting integrated with the global economy. There has been significant growth in India's trade, investment and capital flows with the rest of the world. Globalization has offered new opportunities, but it has also posed new challenges. Indeed, while it may not have been easy to raise the annual growth rate of the economy to over 8 per cent, it is certainly getting more difficult to sustain high growth over an extended period of time. The global events and their impact on our economy in the past few years, make this amply evident.

The challenge for us is to manage this process in a manner that our developmental goals are not compromised and that we attain them in a reasonable period of time. So far, we may have managed to be on track, despite uncertainties and recurrent economic turbulence, but we may have much more to do, in the coming years.

The sustained high growth of recent years reflects a maturing of the economic management in the country. Industry and services have emerged as the prime drivers of growth. The Indian manufacturing sector has come of age and is making its presence felt globally in sectors like the automobile and auto components, pharmaceuticals, textiles and steel. The changing composition of our exports in favour of engineering goods apparent in the recent export data for 2010-11 is an indication of that fact.

The services sector, contributing about 58 per cent of GDP, has become an important driver and a stabilizing factor for our economy in the face of growing exposure to global business cycles. The large service sector is also helping us absorb domestic shocks and uncertainties associated with a monsoon-dependent agrarian economy. The agriculture diversification has added to its resilience in the face of uneven and delayed monsoons in the recent past.

The medium term growth prospects of the economy remain buoyant. The savings and investment rates have reached levels that are reminiscent of the East-Asian high growth economies. As the demographic dividend begins to pay off in India, the savings rate is likely to rise further, provided we are able to create productive employment opportunities. Private enterprise, has flourished in the past decade and its growing competitiveness is opening new doors to Indian companies in the global market place. Indeed, I am confident that we are in a position to sustain high economic growth in the coming years and create a more inclusive outcome for our society.

More specifically, as we put ourselves to the task of preparing the Twelfth Five Year Plan we are aiming at a GDP growth of 9 per cent, possibly more, for the Plan period 2012-17. It would imply raising the average growth rate by about one percentage point from 8.2 per cent, likely to be realised in the Eleventh Plan. However, we have to work towards ensuring that the incremental improvement in the growth rate comes essentially from States that so far have been lagging behind the national average. Since there are quite a few major States that need to catch- up with the rest and are at a relatively lower base level, that is, in itself, a source for sustaining high growth in the coming decades.

Sustainability of the growth momentum in the medium term depends critically on the quality and pace of infrastructure development. Our intention has been to attract and leverage private investment in infrastructure to meet the growing requirement of the economy. One trillion dollars of investment is required in the infrastructure space during the Twelfth Plan period. The policy and regulatory kinks are being smoothed out. Our policy thrust in this regard is on creating efficient regulatory structures and enhancing investment. In particular, we are emphasizing on effective public-private partnerships, given the difficulties involved in direct government provision of many infrastructure services.

Deepening of reforms in the financial sector and strengthening of overall regulatory architecture is being pursued. A Financial Sector Legislative Reforms Commission (FSLRC) has been set up to re-write the financial sector laws and bring them in harmony with the new liberalized environment and global best practices. The RBI has embarked on the process of giving some additional banking licences to private sector players. The agenda on financial inclusion has been clearly carved out and is being implemented successfully by the different stakeholders.To make the FDI policy more user-friendly, all prior regulations and guidelines have been consolidated into one comprehensive document, which is reviewed every six months. This has been done with the specific intent of enhancing clarity and predictability of our FDI policy to foreign investors. A consensus on allowing FDI in multi-brand retail is being evolved and will be operationalised in the near future. The Competition Commission of India (CCI) is now functional and is gradually developing traction on the ground to guard against anti-competitive practices and oversee mergers and acquisitions.

Focus is also being put on issues of governance and institutional reforms and strengthening. The Government aims to empower the people; especially the poor with universal access to education and health and facilitate their participation in the development process through gainful employment. This has been reflected as the Central theme of faster, sustainable and more inclusive growth in the Approach Paper to the Twelfth Plan.

The direct cash transfers for subsidies announced in the Budget 2011-12 will help the targeted beneficiaries of the government programme. UIDAI will be issuing 1 million aadhaar numbers per day. It will give identity to the poor and open their access to many facilities and public programmes. This is one of the most far reaching initiatives of the present government.

In India, different coalition governments at the Centre have guided policy making over the last twenty years, yet all have broadly agreed on the basic thrust and direction of reforms. Contrary to popular perceptions, India's multi-party federal democracy has actually played a key role in implementation of reforms. Intensive deliberations on reforms has imparted to the economic policy-making a much-desired calibration that helps in safe guarding the interests of vulnerable sections of the society. Irrespective of political differences, the Central and State governments have worked together for furthering reforms. The biggest example of this is the gradually evolving consensus on the Goods and Services Tax. Besides, introduction of fiscal responsibility legislations in most Indian States and the Centre bears testimony to India's success in pursuing reforms through a broad political consensus. Reforms are slow but sure with a broad based democratic sanction.

Let me conclude by saying that despite the challenges before us, I am confident that we are in a position to sustain high economic growth in the coming decades and create a more inclusive outcome for our society. I have faith in the Indian entrepreneurial spirits and the other stakeholders, and we have the political will to do the needful to meet the aspirations of our people."

Anand Sharma Pushes for Making India HUB for Manufacturing Advanced Electronics Components

2011-10-01T20:56:00.000+05:30

Anand Sharma Pushes for Making India HUB for Manufacturing Advanced Electronics Components Cautions against Protectionism by The United States Presented Key of City of Dallas

The Commerce, Industry and Textile Minister of India, Sri Anand Sharma interacted with CEOs of top business firms and heads of Universities in Dallas, Texas on 21st September 2011. The business roundtable, hosted by the CEO of Texas Instruments, Mr Rich Templeton, included CEOs of companies engaged in Banking, Automation and Information Technologies, Oil and Gas Industry, Airports, Security Systems, Global Management Consulting Firms and Technology Solutions, Oil and Gas, apart from heads of institutions of higher learning engaged in Medicine, Public Research and a Community College.

In the roundtable, Mr Sharma spoke about India’s push to become a hub for manufacture of advanced electronics components and products through a slew of new initiatives. He emphasized the need for India and the US to collaborate in the field of education and appreciated the strengths of the United States in developing institutions of excellence in education and research. He pointed out that the two countries are ideally situated to collaborate in the manufacture of high-end products in view of their inherent capabilities. He underlined the importance of strengthening institutional linkages between India and the USA to promote innovation and research.

Earlier, on 20th September, the Commerce, Industry and Textiles Minister addressed a large gathering of the Indian diaspora and prominent citizens of the city of Dallas organised by the Greater Dallas Indo-American Chamber.He was presented the Key of the city of Dallas by the city administration. In his address, Minister Sharma highlighted the strategic partnership between India and the United States, which is based on shared values of democracy, plurality and the rule of law. He spoke about the new dynamics of the global economy with the shift in equilibrium from the developed nations towards the emerging and developing economies.

Mr Sharma also presented Awards to exceptional achievers of the Indian American Community in Dallas in the Annual Awards Ceremony of the Greater Dallas Indo-American Chamber. He lauded the contributions of the Indian American community to the American economy and stated that during these difficult times, the United States needs to look outwards as any attempt at protectionism would be counter-productive. The US should not erect barriers to trade or movement of professionals.

U.S.A 's financial mess explained simply through Heidi's Bar

2011-09-18T19:03:00.000+05:30

Heidi is the proprietor of a bar in Detroit. She realizes that virtually all of her customers are unemployed alcoholics and, as such, can no longer afford to patronize her bar. To solve this problem, she comes up with a new marketing plan that allows her customers to drink now, but pay later. Heidi keeps track of the drinks consumed on a ledger (thereby granting the customers' loans).

Word gets around about Heidi's "drink now, pay later" marketing strategy and, as a result, increasing numbers of customers flood into Heidi's bar. Soon she has the largest sales volume for any bar in Detroit. By providing her customers freedom from immediate payment demands, Heidi gets no resistance when, at regular intervals, she substantially increases her prices for wine and beer, the most consumed beverages. Consequently, Heidi's gross sales volume increases massively.

A young and dynamic vice-president at Heidi's local bank recognizes that these customer debts constitute valuable future assets and increases Heidi's borrowing limit. He sees no reason for any undue concern, since he has the debts of the unemployed alcoholics as collateral!!! At the bank's corporate headquarters, expert traders figure a way to make huge commissions, and transform these customer loans into DRINK BONDS. These "securities" then are bundled and traded on international securities markets.

Naive investors don't really understand that the securities being sold to them as "AAA Secured Bonds" really are debts of unemployed alcoholics. Nevertheless, the bond prices continuously climb!!!, and the securities soon become the hottest-selling items for some of the nation's leading brokerage houses.

One day, even though the bond prices still are climbing, a risk manager at the original local bank decides that the time has come to demand payment on the debts incurred by Heidi's bar. He so informs Heidi. Heidi then demands payment from her alcoholic patrons, but being unemployed alcoholics they cannot pay back their drinking debts.

Since Heidi cannot fulfill her loan obligations to the bank she is forced into bankruptcy. The bar closes and Heidi's 11 employees lose their jobs.

Overnight, DRINK BOND prices drop by 90%. **The collapsed bond asset value destroys the bank's liquidity and prevents it from issuing new loans, thus freezing credit and economic activity in the community.

The suppliers of Heidi's bar had granted her generous payment extensions and had invested their firms' pension funds in the BOND securities. They find they are now faced with having to write off her bad debt and with losing over 90% of the presumed value of the bonds. Her wine supplier also claims bankruptcy, closing the doors on a family business that had endured for three generations, her beer supplier is taken over by a competitor, who immediately closes the local plant and lays off 150 workers. In addition, the laid-off workers' pension funds and IRA'S all suffer substantial loss in value.

Fortunately though, the bank, the brokerage houses and their respective executives are saved and bailed out by a multibillion dollar no-strings attached cash infusion from the government.

The funds required for this bailout are obtained by new taxes levied on employed, middle-class, non-drinkers who have never been in or heard of Heidi's bar.

As simple as that!

Contributed by: muralikrishna_abbineni @ yahoo.co.uk
Original source: unknown

Monetary Policy Response to Recent Inflation in India

2011-09-17T13:46:00.000+05:30

Monetary Policy Response to Recent Inflation in India

(Speech by Deepak Mohanty, Executive Director, Reserve Bank of India, delivered at the Indian Institute of Technology (IIT), Guwahati on 3rd September 2011)

I thank the Indian Institute of Technology (IIT), Guwahati and Mr. Ankit Khemka, Convenor, Techniche 2011, for inviting me to address such a talented and bright group of youngsters . I propose to speak to you about inflation which is a matter of concern to all of us. It has been about two years since October 2009 that the Reserve Bank of India announced its exit from the crisis-driven accommodative monetary policy stance. However, inflation continues to remain elevated, despite sustained monetary policy action. Headline inflation, measured by year-on-year changes in the wholesale price index (WPI), averaged 9.6 per cent in 2010-11 and it has continued to be over 9 per cent in the current financial year so far. This spell of high inflation has been the longest since the mid-1990s. It has, therefore, posed a major challenge for policymakers, especially for the Reserve Bank as the key objective of monetary policy is price stability.

Why do we need to worry about inflation? How did the inflation dynamics evolve over the past two years? What was the monetary policy response? These are primarily the questions that I will address.

Why do we need to worry about inflation?

We need to be concerned about inflation as it has adverse impact on the real economy. First, high and persistent inflation imposes significant socio-economic costs. Given that the burden of inflation is disproportionately large on the poor, high inflation by itself can lead to distributional inequality. Therefore, for a welfare-oriented public policy, low inflation becomes a critical element for ensuring balanced progress. Second, high inflation distorts economic incentives by diverting resources away from productive investment to speculative activities. Third, inflation reduces households saving as they try to maintain the real value of their consumption. Consequent fall in overall investment in the economy reduces its potential growth. Fourth, as inflation rises and turns volatile, it raises the inflation risk premia in financial transactions. Hence, nominal interest rates tend to be higher than they would have been under low and stable inflation. Fifth, if domestic inflation remains persistently higher than those of the trading partners, it affects external competitiveness through appreciation of the real exchange rate. Sixth, as inflation rises beyond a threshold, it has an adverse impact on overall growth. The Reserve Bank’s current assessment suggests that the threshold level of inflation for India is in the range of 4-6 per cent¹. If inflation persists beyond this level, it could lower economic growth over the medium-term. These costs, therefore, necessitate monetary policy response to control inflation.

How did the inflation dynamics change?

It is important to appreciate the background in which the inflation surge has occurred. The current phase of high inflation followed the global financial crisis, which affected the India’s economy, though not with the same intensity as advanced countries. Managing inflation in an economy which is recovering from a downturn is much more complex because of associated uncertainties than managing inflation under normal conditions.

Prelude to current inflation surge

In the initial phase of the crisis, it appeared that emerging market economies (EMEs) were better positioned to weather the storm created by the global financial meltdown on the back of their substantial foreign exchange reserve cushion, improved policy frameworks and generally robust banking sector and corporate balance sheets. However, any hope about EMEs escaping unscathed could not be sustained after the failure of Lehman Brothers in September 2008 which triggered global deleveraging and heightened risk aversion. Eventually, EMEs were also adversely affected by the spillover effects: first through contraction in world trade and then from reversal in capital flows.

India, though initially somewhat insulated from the global developments, was eventually impacted significantly by the global shocks through all the channels – trade, finance and expectations channels. In response, the Reserve Bank swiftly introduced a comprehensive range of measures to limit the impact of the adverse global developments on the domestic financial system and the economy. The Reserve Bank, like most central banks, took a number of conventional and unconventional measures to augment domestic and foreign currency liquidity, and sharply reduced the policy rates. In a span of seven months between October 2008 and April 2009, there was unprecedented policy activism. For example: (i) the repo rate was reduced by 425 basis points to 4.75 per cent, (ii) the reverse repo rate was reduced by 275 basis points to 3.25 per cent, (iii) the cash reserve ratio (CRR) of banks was reduced by a cumulative 400 basis points of their net demand and time liabilities (NDTL) to 5.0 per cent, and (iv) the total amount of primary liquidity potentially made available to the financial system was over ` 5.6 trillion or over 10 per cent of GDP. The Government also come up with various fiscal stimulus measures.

In October 2009, it was not easy to exit from the excessively accommodative monetary policy stance for two main reasons. First, the year-on-year headline WPI inflation had just barely turned positive and was entirely driven by food inflation. Industrial production had started to pick up but exports were still declining. Hence, recovery was not assured. Second, globally, most central banks were in favour of continuing stimulus. On the other hand, domestically, consumer price inflation was high, households’ inflation expectations were rising and surplus liquidity was substantial as reflected in the Reserve Bank’s Liquidity Adjustment Facility (LAF) window. These developments had inflationary consequences.

In its Second Quarter Review of Monetary Policy for 2009-10, the Reserve Bank after wider consultations provided the arguments for and against beginning reversal of monetary easing. On balance of considerations, the Reserve Bank judged that the time was appropriate to sequence the exit in a calibrated way so that while the recovery process was not hampered, inflation expectations remained anchored. The exit process thus began with the closure of the special liquidity facilities instituted during the crisis. This amounted to withdrawal of potential liquidity to the tune of ` 1.7 trillion.

Phases of Inflation

The evolution of the inflation process since the beginning of the exit in October 2009 can be characterised into four different phases: Phase I – October 2009-March 2010; Phase II – April-July 2010; Phase III – August-November 2010; and Phase IV - December 2010 onwards. As the drivers of inflation changed over the phases, the response of monetary policy was calibrated on the basis of changing dynamics of inflation as also the growth-inflation balance and the evolving global economic conditions.

Phase I. October 2009- March 2010

The year-on-year headline WPI inflation accelerated from under 2 per cent in October 2009 to above 10 per cent by March 2010 (Chart 1).

A major part of this increase in inflation was attributed to the waning of base effect. In addition, the price pressures largely emanated from food. There was severe deficiency in rainfall during 2009-10, which adversely affected the food prices. Moreover, global commodity prices rebounded from the trough reached during the crisis. Fuel prices rose significantly during this period. Manufactured non-food products inflation also reverted to its medium-term trend (Chart 2).

The Reserve Bank, in its Second Quarter Review of monetary policy in October 2009, highlighted the need for exit from crisis-time monetary policy stimulus and withdrew the unconventional liquidity support measures and restored the statutory liquidity ratio (SLR) of banks to the pre-crisis level. At the same time, monetary policy had to recognise that the economic growth was recovering from the crisis time slowdown and any aggressive monetary tightening at that point would have affected the recovery. Subsequently, in January 2010, the CRR was raised by 75 basis points of banks’ net demand and time liabilities (NDTL), and policy rates were increased for the first time in March 2010 by 25 basis points. The transmission of rate-based monetary policy actions was weak during the periods of surplus liquidity in the financial system and, therefore, bringing down liquidity levels was the crucial challenge.

The Reserve Bank’s policy action during this period was effective in terms of bringing down the overall surplus liquidity available within the system to the levels consistent with monetary policy stance. At the same time, the recovery in economic growth was not dented as was seen from the trend in growth in industrial output, which picked up during this period (Chart 3).

Increase in headline inflation during this period, however, caught up with the households’ inflation expectations (Chart 4).

During the initial months of this phase, the major challenge for monetary policy was, on the one hand, to remain supportive of recovery while on the other hand to keep a vigil on the build-up of inflationary pressures which were getting amplified by the deficit in monsoon rainfall. Subsequently, increases in global commodity prices, especially fuel, emerged as a key risk. At the same time, consolidating recovery necessitated a shift in the monetary policy stance from ‘managing the crisis’ to ‘managing the recovery’.

Phase II. April –July 2010

During this phase, year-on-year WPI inflation remained stubborn around 10 per cent and the index advanced by 3.4 per cent (Chart 5).

It was expected that with a normal monsoon during 2010-11, food inflation would moderate. But, contrary to expectations, the major driver of inflation in this period was food. In fact, inflation in cereals, pulses and vegetables was significantly lower in July 2010 as compared with the March 2010 levels indicating that the good monsoon indeed had a moderating impact on these items. However, food inflation did not decline as price pressures were emanating from the protein-rich items such as milk, egg, meat and fish, whose output was less responsive to monsoon (Chart 6). The demand for these items has been growing with increasing per capita income and changing dietary patterns. In the absence of adequate supply response, price pressures were substantial. Another major contributor to increase in WPI during this period was the increase in administered prices of petroleum products and deregulation of petrol prices in June 2010. The major contribution to inflation thus emanated from food and fuel.

During this period, the key policy rates were increased gradually with a narrowing of the LAF interest rate corridor in order to reduce volatility in the overnight interest rate. While the level of inflation had increased, industrial production was showing a declining trend (Chart 3). On the global front, the weak US recovery and concerns over sovereign debt sustainability in euro area during this period raised fears of a double dip-recession and global commodity prices declined marginally. Moreover, the pressure on inflation during this period emerged largely from food and administered price revisions. Given the limitations of demand management policies to address supply shock induced inflation, monetary policy actions were geared towards normalisation of policy rates as well as anchoring inflation expectations. During this period, policy rates were raised thrice and the CRR was raised once (Table).

Table: Changes in Key Policy Rates
Period	Repo Rate (%)		Reverse Repo Rate(%)		CRR (% of NDTL)
Period	Magnitude	Frequency	Magnitude	Frequency	Magnitude	Frequency	Systemic Liquidity* ( ` billion)
I. Oct 09 to March 10	25	25 bps X 1	25	25 bps X 1	75	50 bps X 1 25 bps X 1	(+) 783
II. April to July 10	75	25 bps X 3	100	50 bps X 1 25 bps X 2	25	25 bps X 1	(-) 10
III. August to Nov 10	50	25 bps X 2	75	50 bps X 1 25 bps X 1	-	-	(-) 465
IV. Dec 10 to July 11	175	50 bps X 2 25 bps X 3	175	50 bps X 2 25 bps X 3	-	-	(-) 705
October 09 to July 11	325	50 bps X 2 25 bps X 9	375	50 bps X 4 25 bps X 7	100
* Systemic liquidity measured by daily average liquidity in LAF; positive indicates surplus (reverse repo) and negative indicates deficit (repo). NDTL: Net Demand and Time Liabilities of Banks.

By the end of this period, the liquidity in the system turned into deficit as was evident from banks borrowing from the LAF of the Reserve Bank. Therefore, effective policy rate showed an additional increase by the width of LAF interest rate corridor, i.e., 100 basis points, as the repo rate became the policy rate. The transition of liquidity situation from surplus to deficit mode also set the stage for improved monetary transmission.

Phase III. August-November 2010

This phase was marked by slowing down of price pressures as headline inflation declined to 8.2 per cent by November 2010 from above 10 per cent in the preceding phase (Chart 7). The increase in WPI during this phase by just 2.0 per cent was also moderate compared to the previous two phases. Of the increase in WPI, a major part emanated from the primary non-food articles, mostly raw cotton and minerals. The build-up in primary non-food articles prices, however, contained the risk in that they might pass-through to manufactured products inflation, depending on the prevailing demand conditions, the signs of which were first seen in November 2010.

Moderate softening of price pressures during this period also reflected that the calibrated approach of monetary policy was having an impact on demand in a non-disruptive manner. The available data then on industrial production from the old-base IIP series indicated that there was a slowdown in overall IIP growth. However, inflation expectations remained elevated. Global commodity price rebound in this period was largely driving the industrial raw material prices (Chart 8). But, monetary policy had to be cautious as mixed signs on growth sustainability were becoming evident coupled with gradual decline in inflation. At the same time, as inflation remained significantly above the comfort level, monetary policy had to act to anchor inflation expectations. Thus, the trend of moderating inflation and consolidating growth in the second and third quarters of 2010-11 justified the calibrated policy approach of the Reserve Bank.

Transmission of monetary policy improved significantly during this period as liquidity continued to remain in deficit with significant increase in banks borrowing from the repo window (Chart 9). Rates in all the segments of the financial market increased during this period with more prominent increase in the call money rate.

Phase IV. December 2010 Onwards

The moderately declining trend in inflation changed course significantly during this period: first, on account of a spurt in food inflation as unseasonal rains in some parts of the country caused significant damage to output of vegetables and subsequently on account of stronger than expected pass-through of increase in input costs to output prices (Chart 10).

The contribution of non-food manufactured products inflation to overall increase in WPI rose significantly during this period. The inflation in this group reached a high of 8.5 per cent in March 2011 and remained at or above 7 per cent thereafter indicating generalised price pressures. Consequently, the share of non-food manufactured product inflation rose sharply during this phase (Chart 11).

Given the high global commodity prices and their likelihood to remain firm, the threat to price stability from global inflation continues to persist. The faster than expected increase in core inflation suggested that high inflation was becoming increasingly persistent. There was also evidence of demand pressure from increase in real wages besides high fiscal deficit. Monetary policy also had to recognise that over the long-run, high inflation is inimical to sustained growth. It slows investment by creating uncertainty and thus poses significant risks to future growth. It was indicated by the Reserve Bank that bringing down inflation, given its generalised nature, even at the cost of some growth in the short-run, should take precedence.²

Taking into account these emerging factors, monetary policy was continuously tightened during this period both in terms of the number of increases as well as in terms of the stepped up magnitude of increase in the policy rate (Table). The increasing generalisation of inflation indicated that the supply shocks had morphed into a more generalised inflation process.

Conclusions

First, inflation in India has remained elevated and persistent over 18 months now. The inflation path was influenced by a number of domestic and international supply shocks. Monsoon failure in 2009-10 and sharp increase in international fuel and commodities prices accentuated domestic inflationary pressures.

Second, the evolution of inflation so far from its low level in October 2009 can be seen in four phases: first, driven by food prices and then by fuel and industrial raw material prices, and finally spilling over to a generalised inflation process. In fact, inflation was on a declining trajectory between August and November 2010 before reversing course in December and getting generalised.

Third, monetary policy response began early in October 2009 in anticipation of the likely path of the inflation trajectory as also on consideration of its source and composition. The background of calibrated monetary policy response is important as policy was reversed from its highly stimulative stance with policy interest rates at the historically lowest levels and liquidity was high. During this period, the global economy remained mired in uncertainties and domestic recovery was also not assured.

Fourth, the initial rounds of monetary policy response was in the nature of normalisation from an excessively stimulative stance in a non-disruptive manner. The policy response was calibrated to the domestic growth-inflation dynamics. As growth took hold and inflation became more generalised, monetary policy response was strengthened. Initially, monetary transmission was weak as systemic liquidity was in surplus. But once liquidity turned into deficit in July 2010, monetary transmission improved.

Fifth, since October 2009, the cash reserve ratio (CRR) has been raised by 100 basis points. The policy repo rate has been raised by a cumulative 325 basis points. As the liquidity in the system transited from surplus to deficit, the effective tightening has been of the order of 475 basis points. Thus, the cumulative monetary policy action would have the desired impact on inflation. It is expected that inflation would moderate towards the later part of 2011-12 and come down to around 7 per cent by the end of the year. The current monetary stance remains anti-inflationary.

Sixth, inflation imposes real costs which are borne disproportionately by the different segments of the economy. Prolonged high inflation, even if originating from the supply side, could give rise to increased inflation expectations and cause general prices to rise. As inflation is inimical to growth, it becomes necessary for monetary policy to respond to contain inflation and anchor inflationary expectations.

Seventh, the medium-term objective of the Reserve Bank is to bring down inflation to 3.0 per cent consistent with India’s broader integration into the global economy. In this direction, monetary policy aims to contain perceptions of inflation in the range of 4.0–4.5 per cent with a particular focus on the behaviour of the non-food manufacturing component. This objective is consistent with the estimated threshold level of inflation of 4–6 per cent suggesting the absence of a ‘new normal’ for inflation in India.

Finally, at the end of my talk what advice can I give to this gathering of bright minds? I believe, innovation and enterprise coupled with the spirit of youth will rapidly propel India to its rightful place in the global economy in the coming years. So unless you dare the frontiers, we will not know what lies beyond.

Thank you for your kind attention.

* Speech by Deepak Mohanty, Executive Director, Reserve Bank of India, delivered at the Indian Institute of Technology (IIT), Guwahati on 3rd September 2011. The assistance provided by G.V. Nadhanael is acknowledged.

¹ Reserve Bank of India Annual Report 2010-11.

² Monetary Policy Statement 2011-12, May 3, 2011, Reserve Bank of India.

Credit Rating Agencies – Frequently Asked Questions (FAQs)

2011-09-17T13:31:00.001+05:30

1. What is the full form of CRA?

The full form of CRA is Credit Rating Agency.

2. What is a credit rating agency?

A credit rating agency is an entity which assesses the ability and willingness of the issuer company for timely payment of interest and principal on a debt instrument.

3. How is a rating denoted?

Rating is denoted by a simple alphanumeric symbol, for e.g., AA+, A-, etc.

4. Whether the issuer company is rated or the instrument?

The rating is assigned to a security or an instrument.

5. What does credit rating convey?

Credit rating is an assessment of the probability of default on payment of interest and principal on a debt instrument. It is not a recommendation to buy, sell or hold a debt instrument. Rating only provides an additional input to the investor and the investor is required to make his own independent and objective analysis before arriving at an investment decision.

6. How is credit rating done?

Ratings are based on a comprehensive evaluation of the strengths and weaknesses of the company fundamentals including financials along with an in-depth study of the industry as well as macro-economic, regulatory and political environment.

7. What do the various rating symbols mean?

Each rating symbol is an alphanumeric representation of the probability of degree of repayment risk associated with debt instruments.

8. Are rating symbols the same across all types of debt instruments?

No. Rating symbols may vary depending on the type of debt instrument, as for example long-term or short-term.

9. What do the "+" and "-"sign indicate in a rating?

Plus and minus symbols are used to indicate finer distinctions within a rating category. The minus symbol associated with ratings has no negative connotations. In fact, ratings in a higher rating category such as 'AA' are stronger than ratings in a lower rating category such as 'A+'.

10. What are investment and speculative grade ratings?

An investment grade rating signifies the rating agency's belief that the rated instrument is likely to meet its payment obligations. In the Indian context, debt instruments rated 'BBB' and above are classified as investment grade ratings. Instruments that are rated 'BB' and below are classified as speculative grade category ratings in which case the ability to meet the payment obligations is considered to be "speculative". Instruments rated in the speculative grade are considered to carry materially higher risk and a higher probability of default compared to instruments rated in the investment grade.

11. Who pays for the credit rating?

In India, the issuer company pays for the credit rating.

12. Who regulates rating agencies?

Credit rating agencies are regulated by SEBI. The SEBI (Credit Rating Agencies) Regulations, 1999 govern the credit rating agencies and provide for eligibility criteria for registration of credit rating agencies, monitoring and review of ratings, requirements for a proper rating process, avoidance of conflict of interest and inspection of rating agencies by SEBI, amongst other things.

13. Does SEBI have a role in the rating exercise?

No. SEBI does not play any role in the assessment made by the rating agency. The rating is intended to be an independent, unbiased and professional opinion of the rating agency.

14. Is rating a one time exercise?

No. To protect the interest of investors, SEBI has mandated that every credit rating agency shall, during the lifetime of the securities rated by it, continuously monitor the rating of such securities and carry out periodic reviews of all published ratings.

15. Why do ratings change?

Rating is an opinion based on information available at a point in time with the rating agency and expectations made on the basis of such information by the agency. However, information can change significantly over time causing the rated instruments performance to deviate from the earlier expectations thereby affecting the future repayment abilities and thus, requiring the rating to be altered.

16. What does a rating downgrade indicate?

Rating is monitored throughout the life of the instrument. A downgrade in the rating indicates that the risk of default of the instrument is higher than what was earlier predicted.

17. What kind of responsibility or accountability will attach to a rating agency if an investor, who makes his investment decision on the basis of its rating, incurs a loss on the investment?

A credit rating is a professional opinion given after studying all available information at a particular point of time. Nevertheless, such opinions may prove wrong in the context of subsequent events. There is no contract between an investor and a rating agency and the investor is free to accept or reject the opinion of the agency.

18. Do agencies rating small and medium enterprises, mutual funds, banks, non-banking financial institutions, insurance providers, infrastructure entities, etc. also fall under the regulatory purview of SEBI?

No, SEBI regulates only the agencies which are engaged in the business of rating securities offered by way of public or rights issue.

19. From where can the credit ratings of instruments be obtained?

Credit ratings assigned by the credit rating agencies to various instruments are made available by the agencies through press releases and on their respective websites. The same are also available in the prospectus or the offer document of the issuer company and in media advertisements.

20. What are the common factors that are taken into account while awarding the credit rating?

Each credit rating agency may have its own set of criteria and different weight age for each component for assigning the ratings. Some of the common factors that may be taken into consideration for credit rating are Issuer Company's operational efficiency, level of technological development, financials, competence and effectiveness of management, past record of debt servicing, etc.

21. How can an investor know if a credit rating agency has changed its rating?

The credit rating agencies are required to continuously monitor the ratings assigned by them to a particular instrument. In case of any changes in the ratings so assigned, the agencies are required to disclose the same through press releases and on their respective websites.

22. What are the measures taken by SEBI in strengthening credit rating?

SEBI has, from time to time, taken several steps to strength the process of credit rating. SEBI directives require the credit rating agencies to be transparent and disclose to the public the information which may have a material bearing on the ratings, any sources of conflicts of interest while undertaking the rating exercise, rating methodology, rationale of the ratings, etc.

23. Why there are not common symbols for credit ratings of all agencies?

The credit rating agencies do not have common symbols because they use different rating methodologies and have different factors bearing different weightage.

24. Which are the Credit rating agencies registered with SEBI?

Name of the rating agency	Information
Credit Analysis & Research Ltd. (CARE)	4th Floor, Godrej Coliseum Somaiya Hospital Road Off Eastern Express Highway Sion (East) Mumbai-400 022 http://www.careratings.com
ICRA Ltd.	1105, Kailash Building, 11th Floor 26, Kasturba Gandhi Marg New Delhi-110 001 http://www.icra.in
CRISIL Ltd.	CRISIL House 121-122 Andheri Kurla Road Andheri (East) Mumbai–400 093 http://www.crisil.com
Fitch Ratings India (P.) Ltd.	Apeejay House, 6th Floor 3, Dinshaw Vachha Road Churchgate Mumbai-400 020 http://www.fitchindia.com
Brickwork Ratings India (P.) Ltd.	#39/2,Sagar Complex,2nd Floor Bannerghatta Road Near Diary Circle Bangalore-560 029 http://www.brickworkratings.com

Differences between Proposed Ind ASs and existing ASs - Part VI

2011-08-28T19:42:00.001+05:30

Ind AS 39, Financial Instruments: Recognition and Measurement and the existing AS 30, Financial Instruments: Recognition and Measurement

(i) The financial instruments to which Ind AS 39 does not apply include financial instruments issued by the entity that meet the definition of an equity instrument in Ind AS 32 (including options and warrants) or that are required to be classified as an equity instrument in accordance with paragraphs 16A and 16B or paragraphs 16C and 16D of Ind AS 32. The existing standard does not exclude the latter. (Paragraph 2(d) of Ind AS 39).

(ii) As per Paragraph 2(f) of AS 30, the contracts for contingent consideration in a business combination in case of acquirers are exempted from the scope of the Standard. However, Ind AS 39 does not include this exemption.

(iii) Paragraph 8.2(a)(ii) of AS 30 states that a financial asset or financial liability at fair value through profit or loss is classified as held for trading if ‘it is part of a portfolio of identified financial instruments that are managed together and for which there is evidence of a recent actual pattern of short-term profit-taking’. Ind AS 39 states that a financial asset or financial liability at fair value through profit or loss is classified as held for trading if ‘on initial recognition it is part of a portfolio of identified financial instruments………’. The existing standard does not use the words ‘on initial recognition’.

(iv) Ind AS 39 does not include the paragraph ‘this would normally be relevant in case of a venture capital organisation, mutual fund, unit trust or similar entity whose business is investing in financial assets with a view to profiting from their total return in the form of interest or dividends and changes in fair value corresponding to paragraph 8.2(b)(ii) of AS 30 when a group of financial assets, financial liabilities or both is managed and its performance is evaluated on a fair value basis, in accordance with a documented risk management or investment strategy.

(v) Ind AS 39 states that ‘an entity shall not reclassify any financial instrument out of the fair value through profit or loss category if upon initial recognition it was designated by the entity as at fair value through profit or loss; and may, if a financial asset is no longer held for the purpose of selling or repurchasing it in the near term (notwithstanding that the financial asset may have been acquired or incurred principally for the purpose of selling or repurchasing it in the near term), reclassify that financial asset out of the fair value through profit or loss category if the requirements in paragraph 50B or 50D are met.’ AS 30 prohibits any financial instruments into or out of the category of financial instruments designated at fair value through profit or loss. (Paragraph 50(b) of Ind AS 39)

(vi) AS 30 states that ‘an entity should not reclassify a financial instruments into or out of the fair value through profit or loss category while it is held or issued’ while Ind AS 39 states that ‘an entity shall not reclassify a derivative out of the fair value through profit or loss category while it is held or Issued.’ (Paragraph 50 of Ind AS 39).

(vii) Ind AS 39 (Application Guidance on effective interest rate) specifically states that ‘if a financial asset is reclassified in accordance with paragraphs 50B, 50D or 50E, and the entity subsequently increases its estimates of future cash receipts as a result of increased recoverability of those cash receipts, the effect of that increase shall be recognised as an adjustment to the effective interest rate from the date of the change in estimate rather than as an adjustment to the carrying amount of the asset at the date of the change in estimate.’ AS 30 does not specify so. (AG 8 of Ind AS 39).

(viii) The following paragraph has been added in Ind AS 39: ‘if an entity is unable to measure separately the embedded derivative that would have to be separated on reclassification of a hybrid (combined) contract out of the fair value through profit or loss category, that reclassification is prohibited. In such circumstances the hybrid (combined) contract remains classified as at fair value through profit or loss in its entirety.’ (Paragraph 12, of Ind AS 39)

(ix) Ind AS 39 modifies paragraph 2(g) of the existing standard as any forward contracts between an acquirer and a selling shareholder to buy or sell an acquiree that will result in a business combination at a future acquisition date. The term of the forward contract should not exceed a reasonable period normally necessary to obtain any required approvals and to complete the transaction.’ (Paragraph 2(g), of Ind AS 39)(Changes shown in bold)

(x) Paragraph 80 of AS 39 states that ‘for hedge accounting purposes, only assets, liabilities, firm commitments or highly probable forecast transactions that involve a party external to the entity can be designated as hedged items. It follows that hedge accounting can be applied to transactions between entities or segments in the same group only in the individual or separate financial statements of those entities or segments and not in the consolidated financial statements of the group.’ The words ‘or segments’ have been deleted in Ind AS 39. (Paragraph 80 of Ind AS 39, paragraph 89 of AS 30)

(xi) Paragraph 97 of Ind AS 39 modifies paragraph 108 of AS 30 to state ‘if a hedge of a forecast transaction subsequently results in the recognition of a financial asset or a financial liability, the associated gains or losses that were recognised in other comprehensive income in accordance with paragraph 95 shall be reclassified from equity to profit or loss as a reclassification adjustment (see Ind AS 1) in the same period or periods during which the hedged forecast cash flows affects profit or loss (such as in the periods that interest income or interest expense is recognised). However, if an entity expects that all or a portion of a loss recognised in other comprehensive income will not be recovered in one or more future periods, it shall reclassify into profit or loss as a reclassification adjustment the amount that is not expected to be recovered.’ (Paragraph 97 of Ind AS 39, AS 30, paragraph 108 of AS 30) (Changes shown in bold)

(xii) The financial instruments to which Ind AS 39 does not apply include financial instruments issued by the entity that meet the definition of an equity instrument in Ind AS 32 (including options and warrants) or that are required to be classified as an equity instrument in accordance with paragraphs 16A and 16B or paragraphs 16C and 16D of Ind AS 32. The existing standard does not refer to the latter. (Paragraph 2(d) of Ind AS 39)

(xiii) Ind AS 39 does not exempt contracts for contingent consideration in a business combination from its scope while the existing standard provides an exemption. In the existing standard, the exemption applies only to the acquirer. (Paragraph 2(f) of Ind AS 39).

(xiv) Ind AS 39 provides that in determining the fair value of the financial liabilities which upon initial recognition are designated at fair value through profit or loss, any change in fair value consequent to changes in the entity’s own credit risk shall be ignored. AS 30, however, requires all changes in fair values in case of such liabilities to be recognised in profit or loss.

(xv) Ind AS 39 gives guidance on- (i) Reassessment of Embedded Derivatives (ii) Hedges of a Net Investment in a Foreign Operation and Extinguishing Financial Liabilities with Equity Instruments. AS 30 does not give such guidance.

Ind AS 103, Business Combinations, and existing AS 14, Accounting for Amalgamations

(i) Ind AS 103 defines business combination which has a wider scope whereas the existing AS 14 deals only with amalgamation. (Appendix A of Ind AS 103 and Paragraph 1 of existing AS 14)

(ii) Under the existing AS 14 there are two methods of accounting for amalgamation. The pooling of interest method and the purchase method. Ind AS 103 prescribes only the acquisition method for each business combination. (Paragraph 7 of existing AS 14 and paragraph 4 of revised AS 14)

(iii) Under the existing AS 14, the acquired assets and liabilities are recognised at their existing book values or at fair values under the purchase method. Ind AS 103 requires the acquired identifiable assets liabilities and non-controlling interest to be recognised at fair value under acquisition method. (Paragraph 12 of existing AS 14 and paragraphs 18-19 of Ind AS 103)

(iv) Ind AS 103 requires that for each business combination, the acquirer shall measure any non-controlling interest in the acquiree either at fair value or at the non-controlling interest’s proportionate share of the acquiree’s identifiable net assets. On other hand, the existing AS 14 states that the minority interest is the amount of equity attributable to minorities at the date on which investment in a subsidiary is made and it is shown outside shareholders’ equity. (Paragraph 13 (e) of existing AS 21 and paragraph 19 of Ind AS 103)

(v) Under Ind AS 103, the goodwill is not amortised but tested for impairment on annual basis in accordance with Ind AS 36.The existing AS 14 requires that the goodwill arising on amalgamation in the nature of purchase is amortised over a period not exceeding five years. (Paragraph 19 of existing AS 14 and paragraphs B63 (a) of Appendix B of Ind AS 103)

(vi) Ind AS 103 deals with reverse acquisitions whereas the existing AS 14 does not deal with the same. (Paragraph B 19-B27 of Ind AS 103)

(vii) Under Ind AS 103, the consideration the acquirer transfers in exchange for the acquiree includes any asset or liability resulting from a contingent consideration arrangement. The existing AS 14 does not provide specific guidance on this aspect. (Paragraph 39 of Ind AS 103)

(viii) Ind AS 103 requires bargain purchase gain arising on business combination to be recognised in other comprehensive income and accumulated in equity as capital reserve, unless there is no clear evidence for the underlying reason for classification of the business combination as a bargain purchase, in which case, it shall be recognised directly in equity as capital reserve. Under existing AS 14 the excess amount is treated as capital reserve (paragraph 34 of Ind AS 103 and paragraph 17 of the existing AS 14).

(ix) Appendix C of Ind AS 103, deals with accounting for common control transactions, which prescribes a method of accounting different from Ind AS 103. Existing AS 14 does not prescribe accounting for such transactions different from other amalgamations.

Ind AS 105, Non-current Assets Held for Sale and Discontinued Operations, and the existing AS 24 (issued 2002), Discontinuing Operations

(i) Ind AS 105 specifies the accounting for non- current assets held for sale, and the presentation and disclosure of discontinued operations. The existing AS 24 establishes principles for reporting information about discontinuing operations. It does not deal with the non-current assets held for sale; fixed assets retired from active used and held for sale, are dealt in existing AS 10, Accounting for Fixed Assets. (Paragraph 1 of Ind AS 105 and ‘Objective’ of existing AS 24 )

(ii) In the existing AS 24, requirements related to cash flow statement are applicable when the enterprise presents a cash flow statement. Ind AS 105 does not mention so. (Paragraph 2 of existing AS 24 )

(iii) Under Ind AS 105, a discontinued operation is a component of an entity that either has been disposed of or is classified as held for sale. In the existing AS 24, there is no concept of discontinued operations but it deals with discontinuing operations.

(iv) As per Ind AS 105, the sale should be expected to qualify for recognition as a completed sale within one year from the date of classification with certain exceptions. The existing AS 24 does not specify any time period in this regard as it relates to discontinuing operations

(v) The existing AS 24 specifies about the initial disclosure event in respect to a discontinuing operation. Ind AS 105 does not mention so as it relates to discontinued operation. (Paragraph 15 of existing AS 24)

(vi) Under Ind AS 105, non-current assets (disposal groups) held for sale are measured at the lower of carrying amount and fair value less costs to sell, and are presented separately in the balance sheet. The existing AS 24 requires to apply the principles set out in other relevant Accounting Standards, e.g., the existing AS 10 requires that the fixed assets retired from active use and held for disposal should be stated at the lower of their net book value and net realisable value and shown separately in the financial statements. (Paragraphs 15 and 38 of Ind AS 105 and Paragraph 18 of existing AS 24 and Paragraph 14.2 of existing AS 10 )

(vii) Ind AS 105 specifically mentions that abandonment of assets should not be classified as held for sale. In the existing AS 24, abandonment of assets is classified as a discontinuing operation; however changing the scope of an operations or the manner in which it is conducted is not abandonment and hence not a discontinuing operation. (Paragraph 7 of existing AS 24 and paragraph 13 of Ind AS 105).

(viii) Ind AS 105 provides guidance regarding measurement of changes to a plan of sale. The existing AS 24 does not give any specific guidance regarding this aspect. (Paragraphs 26-29 of Ind AS 105).

(ix) As per Ind AS 105, a discontinued operation is a component of an entity that represents a separate major line of business or geographical area, or is a subsidiary acquired exclusively with a view to resale. Under the existing AS 24, a discontinuing operation is a component of an entity that represents the major line of business or geographical area of operations and that can be distinguished operationally and for financial reporting purposes. (Paragraph 3 of existing AS 24 and paragraph 32 of Ind AS 15).

Ind AS 107, Financial Instruments: Disclosures, and the existing AS 32 (Issued 2008) Financial Instruments: Disclosures

(i) The existing AS 32 does not apply to contracts for contingent consideration in a business combination in case of acquirers. Ind AS 107 does not exempt such contracts. (Paragraph 3 (c) of existing AS 32)

(ii) Ind AS 107 excludes from its scope puttable instruments dealt with by Ind AS 32. AS 32 does not exclude the same from its scope. (Paragraph 3 (f) of Ind AS 107 )

(iii) Ind AS 107 specifies disclosures in case of reclassification of a financial asset out of fair value through profit or loss category or out of available-for-sale category in accordance with Ind AS 39. Ind AS 32 does not provide for same. (Paragraph 12A of Ind AS 107 )

(iv) Ind AS 107 requires enhanced disclosures about fair value measurements and liquidity risk, as compared to existing AS 32. (Paragraphs 27, 27A-27B, 39, definition of liquidity risk, paragraphs B10A, B11, B11A-B11F of Appendix B and paragraphs IG13A-IG13B of Implementation Guidance of Ind AS 107. Paragraphs B12-B16 of Appendix B and IG 30-31 of Implementation Guidance of existing AS 32 has been deleted.)

Ind AS 108 Operating Segments, and the existing AS 17 (Issued 2000), Segment Reporting

(i) Identification of segments under Ind AS 108 is based on ‘management approach’ i.e. operating segments are identified based on the internal reports regularly reviewed by the entity’s chief operating decision maker. Existing AS 17 requires identification of two sets of segments—one based on related products and services, and the other on geographical areas based on the risks and returns approach. One set is regarded as primary segments and the other as secondary segments.

(ii) Ind AS 108 requires that the amounts reported for each operating segment shall be measured on the same basis as used by the chief operating decision maker for the purposes of allocating resources to the segment and assessing its performance. Existing AS 17 requires segment information to be prepared in conformity with the accounting policies adopted for preparing and presenting the financial statements. Accordingly, existing AS 17 also defines segment revenue, segment expense, segment result, segment assets and segment liabilities.

(iii) Ind AS 108 specifies aggregation criteria for aggregation of two or more segments. Existing AS 17 does not deal specifically with this aspect.

(iv) An explanation has been given in the existing AS 17 that in case there is neither more than one business segment nor more than one geographical segment, segment information as per this standard is not required to be disclosed. However, this fact shall be disclosed by way of footnote. Ind AS 108 requires certain disclosures even in case of entities having single reportable segment.

(v) An explanation has been given in the existing AS 17 that interest expense relating to overdrafts and other operating liabilities identified to a particular segment should not be included as a part of the segment expense. It also provides that in case interest is included as a part of the cost of inventories and those inventories are part of segment assets of a particular segment, such interest should be considered as a segment expense. These aspects are specifically dealt with keeping in view that the definition of ‘segment expense’ given in AS 17 excludes interest. Ind AS 108 requires the separate disclosures about interest revenue and interest expense of each reportable segment, therefore, these aspects have not been specifically dealt with.

(vi) Ind AS 108 requires disclosures of revenues from external customers for each product and service. With regard to geographical information, it requires the disclosure of revenues from customers in the country of domicile and in all foreign countries, non-current assets in the country of domicile and all foreign countries. It also requires disclosure of information about major customers. Disclosures in existing AS 17 are based on the classification of the segments as primary or secondary segments. Disclosure requirements for primary segments are more detailed as compared to secondary segments.

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