1. What is financial inclusion? 2. Why Business Correspondents system? 3. Who/What is Business correspondent? 4.

Who can become Business correspondent for Banks? 5. Functions of Banking Business Correspondents? 6. Swabhimaan 7. Reforms in BC model 1. Common BC 2. NREGA payment 3. Kiosk Banking 8. BCA for Direct Cash Transfer? 9. Mock questions What is financial inclusion?

Give every poor man a bank account. And help him get a loan from banks. Financial inclusion involves 1. Give formal banking services to poor people in urban & rural areas. 2. Promote habit of money-savings, insurance, pension-investment among poor-people. 3. Help them get loans at reasonable rates from normal banks. So they dont

become victims in the hands of local moneylender cum thugs. Three important initiatives taken by RBI for financial inclusion:

1969

Lead banking scheme (LBS). RBI assigns a district to a particular bank. That Bank will be responsible for promoting banking services and financial literacy, in that district.(=financial inclusion).

2005

No frills account. Poor people can open bank accounts with very low balance e.g. Rs.5 only. Weve already discussed that in earlier articles: Click me and click ME

2006

Business Correspondents (BC) system. Discussed in this article.

Why Business Correspondents system?

If Financial inclusion means open bank accounts for poor people. Then whats the big deal, just open a damn account!

Not so easy. India has around 6 lakh villages. Most of them dont have bank branches. Ok so Why cant banks open branches in every village?

No profit Because Administrative costs will be high= Building rent, telephone, electricity, staff salary, security guards. On the other hand volume of business is very low in village areas=amount of money deposited, loans taken. Means there is No profit. Actually itll lead to heavy losses.

Reluctant staff

In many villages, there is no electricity, no good schools/drinking water, naxalite problem= Bank staff doesnt want to serve there. Therefore banks dont like to open branches below district HQ or Tehsil level. Now comes the problem Hardships faced by poors

A poor man lives in remote village.

This man has deposited some Rs.2000 in a bank @his tehsil. Now, He wants to take out some money from his bank account. So Hell have to make a trip for 10 -20 kms =travel =time and cost. He is illiterate so he doesnt know how to fillup bank slips, other paperwork. He needs to ask for help here and there in the bank office. And most banks/post-offices dont treat poor people with respect or priority like they do with regular customers. So, he may have to wait for many hours, move from this table to that table, before he gets his money. = he cannot return to his village and do his daily job/work. = his one days income is lost. Same process repeats, when this man wants loan to buy a new cow, pumpset, seeds or fertilizers. One the other hand, local money lenders in his village, give money quickly, without asking many questions or requiring him to fillup two dozen application forms. (but then they extract 36% compound interest

from this poor man, thus making his life a living hell.) Ultimately 1. Bank We cant open branches @every village, because its not s profitable. 2. poor We cant make trip to nearest people town to access banking facilities, because it is inconvenient.

So, whats the solution? How about a middleman / agent between banks and the poor people? Who/What is Business correspondent? Business correspondents are bank representatives. They help villagers to open bank accounts. They help villagers in banking transactions. (deposit money, take money out of savings account, loans etc.) The Business Correspondent carries a mobile device. The villager gives his thumb impression or electronic signature, and get the money.

Business Correspondents get commission from bank for every new account opened, every transection made via them, every loan-application processed etc.

Who can become Business correspondent for Banks? farmers clubs 9. Community based organisations 10. Cooperatives societies 11. Village Knowledge Centres, 12. Agri Clinics/ Agri Business Centers, 13. Krishi Vigyan Kendras 14. Khadi and Village Industries units 15. corporate entities with IT 8.

1. NonGovernmental Organisations(NGOs ) 2. Self Help Groups (SHGs), 3. Micro Finance Institutions (MFIs) 4. Post Offices 5. Insurance agents 6. Panchayats 7. Civil Society Organisations (CSOs)

outlets in rural parts. Functions of Banking Business Correspondents? Create awareness about savings. 2. Give advice to villagers, about how to save/invest money and how to arrange/manage loans. 3. Help the villagers to open bank accounts. 4. Collect loan applications, forward them to bank. 5. Preliminary processing of loan applications for example: verification of persons identity, home-address etc. 6. Help the Self Help Groups (SHG), to get loans. 7. Help the bank to collect EMIs and recover loan money. Swabhimaan

1.

Initiative by the Finance Ministry + Indian Banks Association launched in 2011

To bridge economic gap between rural and urban India. Objectives

Make banking facilities available to every habitat with a population >2000 (by March 2012.) Banks will provide basic services like deposits, withdrawal, Kisan Credit Card (KCCs) etc via Business Correspondents (BCs) also known as Bank Saathi. Banks will also working together with the Unique Identification Authority of India (UIDAI) for opening new bank accounts. Government will send subsidies and social security benefits (pension etc.) directly to beneficiarys account. Beneficiary can withdraw the money from the Business Correspondents (BCs) in their village itself. Government has provided 500 million rupees to banks for taking these ^initiatives.(e.g. paying Commissions to Bank Saathi, their training cost, doing paperwork with UID.)

Reforms in BC model

Common BC Last year Finance ministry came up with this proposal: India be divided into 20 clusters. A common BC be appointed for all public sector banks operating in that geography. Such a move would improve the economics of the BC model. (otherwise so many BCs, fragmentation=nobody earning decent Commission=nobody improving the service delivery.) Reserve Bank of India (RBI) has permitted all business correspondents (BCs) working for one particular bank, to conduct business for other banks as well. FINO, Indias largest Business Correspondents company FINO=Financial Inclusion Network and Operations (FINO). It is promoted by various Public and Private sector banks and insurance companies like LIC. Last year, FINO become the common Business Correspondents company for all public sector banks operating in Jharkhand.

NREGA payment Old system 1. 1. A villager earns some cash under MNREGA. 2. Government gives cash to bank. 3. Bank gives it to B.C. 4. B.C. deposits it into MNREGA workers account. New system All accounts will be maintained by core banking system. 2. So, cash directly goes from Government > Bank >MNREGA workers bank account. 3. Villagers will have the freedom to make their withdrawals from any BC they choose.

Kiosk Banking The D.I.Y. (Do it yourself) banking services e.g. ATM, internet kiosks = still expensive. There is also lack of education + awareness in rural areas about such things.

So even if Government /bank installs such automatic ATM, internet kiosks=> most of the time they just gather dust. Therefore, technology-based self-service model (e.g ATM, internet kiosks) is not useful at this stage. And hence we need Personnel (these Business Correspondents=middlemen). Because often villagers are illiterate, so they cant even fill up the forms for opening bank accounts or loan-application or filling the deposit slips etc. Business Correspondents are essential at this stage. But again problem: The cost per transaction remains high. (Because Bank has to pay commission to B.C.agent.) Therefore, Chindu has suggested following solution for long term: Migrate from banking correspondent model to Kiosk banking = mobile vans fitted with ATM machines+ biometric devices. Theyll provide banking services in remote areas. BCA for Direct Cash Transfer?

In November 2012, Mohan announced Direct Cash transfer scheme. (will be covered in detail, later) Anyways, under Direct Cash transfer scheme, Government will directly deposit payments, subsidies, scholarships, pensions etc into the beneficiarys bank account. Sounds well and good? Well, here is the big problem There are about six lakh villages in India.

And despite all these financial inclusion initiatives (of FINMIN+RBI), still only ~75,000 villages have a bank branch or business correspondent agents (BCA). So for the poor people in remaining ~525000 villages still face the problems we saw` in MNREGA payment withdrawl. So Direct Cash Transfer will be #EPICFAIL unless each and every village is covered under banking services. Therefore, recently Chindu asked the banks to have at least one bank branch or business correspondent agents (BCA) for every village or group of villages with 1,000 to 1,500 households.

In the villages without BCA, Department of Electronics and Information Technology will install Common Service Centre (CSC). This CSCs will serve as the BCA. Right now, CSC will used only for opening new accounts of beneficiaries under the scheme for direct cash transfer. Only after banks install the software and complete other technical requirements for cash transactions, the CSC will allow villagers to withdraw cash from their accounts. Side note on CSC

Common Services Centers scheme= started in 2006. Aim= set up of 100,000+ (one lakh) internet enabled centers in rural areas under the National e-Governance plan (NeGP) Mock questions MCQs Q1. Financial inclusion involves

1.

Covering rural poors in banking net.

Covering urban poors in banking net. 3. Providing jobs to poor people. 4. Providing vocational training to poor people. 5. Spreading banking awareness among poor people. Ans.choices a. b. Only 1, 3 and 5 Only 1,2 and 5 c. Only 3 and 4. d. All of them

2.

Q2. Find incorrect statements about Swabhimaan scheme It was launched by the Ministry of Social justice in 2009. 2. It aims to provide insurance coverage to laborers in unorganized sector. 3. It aims to provide financial inclusion to people residing in remote areas of India. Ans Only 3 b. Only 1 and 2 c. Only 2 and 3 d. Only 1 and 3 a. 1.

Q3. Who among the following, is/are eligible to become Business correspondents for banks? 1. Post office 2. Panchayats 3. NGO and Insurance Agents 4. Self Help Groups (SHG) Ans a. Only 1 and 2 b. Only 2 and 4 c. Only 2 and 3 d. All of them. 1. How does Government control Sugar industry? 2. Stage #1: Crops and Farmer 3. Stage #2: Sugar Mills: 4. What is FRP and SAP? 5. Rangarajan Committee:Recommendations 6. Conclusion to all the UPSC aspirants How does Government control Sugar industry?

There is a lot of control by the government both state and centre over the sugar industry. To look at this one must look into the production lineup of sugar. Let us understand the sugar producing process first. This simple diagram will explain the process

Now the government control on the major aspects can be visualized easily. So the control by government at every stage is: Stage #1: Crops and Farmer The farmers must sell their produce to the nearest mill. And just the converse of this, the sugar mills have to purchase sugarcane from reserved areas.

Stage #2: Sugar Mills: 1. Distance Mills must have a distance of 15kms between them. The mill owners must compensate the farmers Pricing of according to 2 different Sugar norms for giving them the sugarcane FRP and SAP.(explained below). The other products such as Molasses, Bagasse, Press Pricing of Mud are very useful side Other products of sugar industry. products Their remuneration to the farmer is not fixed and varies with the time. The mill owners must give 10% of their production to the central government Levy of which they use to supply to Sugar the state governments for their state Public Distribution Systems (PDSs). The sugar must be Packagin packaged in jute bags. (this g is done to promote labour

2.

3.

4.

5.

6.

intensive jute industry.) The market is also heavily government controlled. The Market export and import of sugar is decided by the government depending upon the domestic demand.

Before going into the recommendations of the committee let us look at the difference between FRP and SAP. What is FRP and SAP?

The FRP and SAP are prices set by the different governments at which the mill owners will reimburse the farmers. This is the minimum price that they pay to the farmers for the sugarcane. FRP SAP

Fair Remunerative State Administered Price Package Central Government issues State government issues price.(Has no price(Has most voice). voice) Generally lower. Generally higher.(To fulfill

the votebank issues as sugarcane farmers form a large votebank). When the state government issues its SAP then the mills in the state are bound to pay by that amount only. This was held valid in a Supreme Court judgment in 2009. Rangarajan Committee:Recommendations Remembering the earlier diagram of the sugar process and the government control, the Rangarajan committee report recommendations can be easily mapped. Governm ent Control Sugar crop area Recommendation Remarks Empoweri ng the farmer to do better business. To enable competitio n.

Do away with reserved area. Give farmer option to trade with any mill.

Do away with minimum Mill distance distance between mills.

Pricing 1. Give the farmers FRP Double of Sugar price at the 1st stage and stage

Packagi ng

Levy of Sugar

Market

do away with SAP.2. strategy to Share 70% of the sold have value of better sugar+molasses+bagass cash flow e+press mud at the 2nd to stage. mills.Putti ng proper system for remunerat ion. Can save Do away with the jute about packaging 1000 crores. Can ease Do away with the 10% central sale to the central subsidy government. Instead, tension. pass on the subsidy to The levy state government, which savings is can buy the sugar from about the market and give it 2000 subsidized. crores. The move Ease the market control is to help of government on export India(17% and import. of world

production ) to enable its exports(on ly 4% of world export), but leaving it all to the market is risky. Conclusion to all the UPSC aspirants:

This is similar to many other committees formed by the government to recommend the sugar industry decontrol. Committees under Mahajan (1998), Tuteja (2004), Thorat (2009) and Nandakumar (2010) had similar recommendations. So most probably these recommendations will also bite the dust like others. 1. What is Debenture? 2. Difference between Bonds and Debentures? 3. Types of Debentures

4. What is Optionally fully-convertible debentures (OFCD)? 5. 2008-09: The game begins 6. 2011: SEBI Order 7. 2012: Supreme Court hearing 8. Order of Supreme Court 9. Governments response What is Debenture? From the earlier Debt + Equity article, you know there are two (legit) ways to arrange money for starting or expanding a company Type meaning Borrow money from someone. Offer him interest Debt rate and guarantee to repay the principal after xyz date. Take money from someone and offer Equity him part ownership of the company. Example 1. Bank loans 2. Borrowing from friends, relatives, moneylenders 3. Bonds 4. Debentures IPO-> Share. 2. Venture Capitalist 3. Angel 1.

Investor

Suppose a Telefilm company is producing a new bogus saas-bahu series. The company needs additional finance of 100 Crore rupees just for the make-up, jewelry and expensive sarees of those actresses. Company can approach the bank for a loan, but problems: 1) terms and conditions are heavy 2) the SARFAESI act (with its new amendments) So, its better just to borrow from public. Whoever gives you Rs.100, you give him a piece of paper titled blah blah blah..these are the terms and conditions, repayment dates, interest rates etc. This piece of paper is called Debenture. In this case, you need 100 crores, meaning print 1 crore papers (debentures) each worth Rs.100. Whoever holds such paper units is called Debenture holder. The cash thus collected is a loan for the company. (=debt)

Difference between Bonds and Debentures? Overall, the principle behind Bonds and Debentures is same: They offer fixed interest rate + principal repaid at the specified date. Ok then whats the difference? 1.Bond Issued by 1. Union Government 2. State Government 3. PSUs

2.Debenture

Issued by companies.

Second difference: the different rates of Stamp Duty applied on each of them. Third difference: The interest rate offered by Debenture is (usually) higher than Government Bonds. Because Government more likely to repay = no need to seduce customers with higher interest rate. Types of Debentures

Based on convertibility the Debentures are of two types 1.Convertible debentures 2.NonConvertible Debentures

They can be converted into shares of the company on the expiry of xyz date. They cannot be converted into shares.

When debenture is converted into shares, it means debt holder becomes an equity holder. Both debt vs equity have their own advantages and disadvantages. Weve discussed it in the earlier article (click ME) But by and large, from the investors point of view, Debt is safer than Equity. What is Optionally fully-convertible debentures (OFCD)?

These debentures can be converted into shares, when debt holder (investor) wishes (after expiry of xyz pre-decided date).

But the rate, will be decided by the company e.g. 20 debentures =>1 share.

From investors view, this option to convert Debenture into Shares is good ONLY IF Company is likely to make huge profit (so you, the shareholder can earn more dividend.) OR 2. Companys share-price is likely to rise in the share market (then you can sell shares to third-party and make profit). BUT if the Company is going bankrupt, then it is better to avoid converting the Debenture into shares. Because when a company is liquidated (i.e. its assets sold off), the Debenture holders get the money before the shareholders. It means OFCD is a bit tricky game. Investors should have some knowledge and understanding of share prices, company performance etc. else they could lose money. (or end up not getting maximum profit out of their investment). Now lets move to the SEBI-SAHARA case. 2008-09: The game begins Two firms of Sahara Conglomerate: 1.

1. 2.

Sahara Housing Investment Corporation Sahara India Real Estate Corporation. (aka Sahara Commodities)

These ^two companies Issued OFCD to collect money from investors. ~23 million people, mostly from villages and small towns subscribed to this scheme. They invested ~24,000 crores rupees in these OFCDs of SAHARA. 2011: SEBI Order You (SAHARA) have violated rules. If OFCDs are issued then whole process should be completed within SEBI 10 working days, but here you continue collecting money from people for more than two years! This fund-raising was in the form of a private placement. I.e. we offered SAHARA the schemes only to our select clients, this wasnt meant a Public Offer! So whats your problem? Dude if this is private placement, SEBI then maximum only 50 people can invest money in it.

Here ~23 million people have parked their hard earned cash! Hell the number of investors in this case, is even more than the total number of people investing in the conventional stockexchanges of India! Indias biggest IPO till date was of Coal India worth Rs.15000+ crores, and youve made 24,000 crores out of these OFCDs! It is my responsibility to protect the investors in Capital market. Hence, By the powers given to me under SEBI Act, I hereby order you to stop collecting money and refund all the money to those investors with 15% interest rate.

SAHARA

This is not right! Well, if youre unhappy with my SEBI order you can go to the Securities Appellate Tribunal (SAT) SAHARA Pleads before SAT. SEBI is right. You refund money to SAT those people.

SAHARA SC

Now, Ill go to Supreme Court. What are your arguments? Those two companies are unlisted. Meaning, their shares are not listed on any Stock Exchange of India. Therefore, their conduct is outside the jurisdiction of SEBI. Because SEBI is regulator for listed firms only. Our matter falls under Union Corporate Affairs Ministry and not under SEBI.

2012: Supreme Court hearing

SAHARA

SEBI

Nope, this matter comes under my jurisdiction, because OFCD is a security under the Securities Act= it comes under the Sebi Act= Ive the jurisdiction= Hence I can pass a special order to regulate unlisted companies!

Order of Supreme Court

Saare sabuto aur gawaaho ko madde nazar rakhte hue (in the light of all evidence and witnesses) To SAHARA We are unconvinced with your logic that OFCD schemes dont come under the scope of SEBI. Mostly rural people have Invested money in your schemes and theyre not aware of OFCD. At the end of day, they would come and say that they were cheated. You know Harshad Mehtas case, same modus operandi was there. Investors were not aware of the

To SEBI If those two companies of SAHARA donot refund money, youre free to attach their properties and freeze their bank accounts. Also conduct a probe against those two Sahara companies to find out their actual subscriber base. (to make sure some funny game or money laundering isnot going on.) Check the genuineness of

scheme. It seems you have no intention of returning the investors money. Your intentions are shady. We order you to refund the money.

the investors and if the investors are not traceable, the amount will go to the government.

Governments response As youve seen in ^this case, SAHARAs main argument is SEBI doesnt have jurisdiction over our OFCD investment scheme, because this money was

meant for our unlisted companies. Government has decided to fix this ambiguity in the new Companies Act. According to Companies Bill 2012 (passed in Lok Sabha): SEBI will have undisputed jurisdiction over any investment scheme involving more than 50 investors-It doesnt matter whether youre a listed company or an

unlisted company. MCQ Find incorrect Match: 1. SEBI: SAT 2. CCI: COMPAT a. b. Only 1 Only 2 c. Both d. None

1. What is CSR? 2. Examples of CSR? 3. Why CSR? 4. Methods of CSR? 5. Companies Bill 2012 6. Who is covered? 7. Provision? 8. Punishment? 9. CSR: Pro-Arguments 10. CSR: Anti-Arguments What is CSR?

Corporate social responsibility. Activities done by a company to give social-economic-environmental benefits to the society.

Examples of CSR? 1. IndianOil gives special allotment of petrol/diesel station dealerships and LPG distributorships to beneficiaries from among SC/ST/PH/Ex-servicemen, war widows, etc. 2. Installation of hand pumps/bore well/tube wells/submersible pumps 3. Rainwater harvesting projects, 4. Aquaguard water purifiers/water coolers to schools/community center etc. 5. Organising Medical/Health Camps on Family Planning, 6. Immunization, AIDS awareness Big companies like Tata, Wipro, Birla, Essar have done many such projects. Why CSR?

The term Corporate social responsibility was coined in late 50s, but it remained just an academic concept for many years.

The issue was raised in Rio Earth Summit (1992). But MNC-giants were noncommittal and lobbied heavily against such moves. (recall how American corporate giants did not allow UN to get control over DNS registry in the recent WCIT Dubai conference. Click me) In the 90s, big NGOs such as Greenpeace started exposing the environmental and human rights abuse done by American oil and mining companies abroad. (particularly Shale company in Africa.) This led to huge negative publicity for those companies particularly among the consumers in first world. Hence the MNC giants started taking up CSR initiatives in third world (Asia, Africa) as a PR-image improvement exercise. Apart from that, CSR is done for 1. Pure philanthropic reasons. 2. Earning Good will among customers and local community members. 3. Long term interest: e.g. a company spends money in child-education of XYZ, in long term those kids grow up= can

provide skilled labour, or atleast earn more money than their parents= more purchasing powers =good for all companies. 4. Getting tax-benefits from Government. Methods of CSR? Via Company will just donate money to Charity Red Cross, UNICEF etc. Company will hire an NGO/another Via special agency to carry out a project Contract and pay them money. Company will create separate Administrative machinary and staff By itself of its own, to do the social welfare work. (E.g.in big companies like Microsoft, IBM, Dabur etc.) Companies Bill 2012 Itll replace the Companies Act 1956 Lok Sabha Rajya Sabha

Passed it in Winter session (Dec 12) Likely to pass it during Budget Session (Feb 13)

Companies bill is likely to come in effect from April 1, 2013.

This Companies bill contains provisions regarding CSR. Companies that have a turnover of over Rs 1,000 crore 2. or have a net worth of Rs 500 crore 3. or that have recorded a net profit of Rs 5 crore 1.

Who is covered?

^These companies are expected to spend 2 per cent Provision? of their profit in preceding three financial years towards CSR. The bill says, theyre expected tomeaning it is not compulsory to spend money. BUT, the same bill provides that Punishment? 1. Board of directors will be responsible for seeing that company spends money for CSR. 2. It is compulsory to send report on the CSRspending to the Corporate

Affairs Minister. 3. If company is not spending money for CSR, itll have to explain why they are not doing so. 4. Companies that do not report will face a penalty ranging from Rs 50,000 to Rs 25 lakh or even imprisonment of up to three years

In Budget 2013, Chindu is likely to allow some tax-deduction /benefits to companies who spend money for CSR, thus making it attractive for the companies to spend money for CSR. An estimated 2,500 companies fall into this mandatory CSR-reporting category. CSR activities in the first year would be between Rs 9,000 crore and Rs 10,000 crore spent in social welfare. This could significantly benefit the society at large. CSR: Pro-Arguments 1. Big Companies in India are already making a killing, particularly in mining,

real-estate and IT sector, so spending a few crores on CSR shouldnt be an issue. Besides, CSR spending has been kept very low: only 2%. 2. Government could increase the taxrates to collect additional 2% and then spend the money on its own for various social welfare schemes. But instead Government has given flexibility to the companies to do take up projects on their own= there would be corruption and leakages. So, If the companies themselves spend the money on CSR, more likely to show some result. 3. Media is unnecessarily creating panicCSR spending is not compulsory, CSRreporting is compulsory. 4. This provision will lead to about 30% increase in CSR-linked jobs. (those special project officers, MSW degree etc). For example, Dabur is reviewing its existing CSR programmes in the wake of the latest developments. It will hire more professionals if it feels the need to extend the existing CSR-programmes. CSR: Anti-Arguments

Companies already paying so much in taxes + global economic crisis= decline in profit. It is the job of Government to do all the social welfare stuff. Companies are only responsible to their shareholders and not to society as a whole. If company has to spend 2% of profit in CSR= means less profit will be shared among the shareholders. Might lead to creative accounting (only showing work on paper) or doing work that actually benefits the company rather than society. Corporate Affairs ministry doesnt have the manpower to manually inspect the CSR-projects done. Thus making the whole exercise useless to society. NGOs often feed journalists stories of supposed corporate malpracticies, tribal exploitation etc, which the reporters are happy to print without much background check. Hence companies just throw off donation money to such NGOs in the name of CSR and to media houses in the name of advertizemenst, just to keep them both

in good humor. So in many cases, CSR is done because of yellow-journalism and yellow-NGOism. Thus, CSR doesnt cleanse the sins of a company. often it merely allow companies to continue bad behavior in the shadows. (child labour, environmental degradation etc.) 1. What is NPA? 2. Debt Recovery tribunals (DRT)? 3. What is the Sarfaesi Act? 1. Appeal structure 2. Bank: Power to Auction 4. What is ARC? 1. What are Security Receipts (SR)? 2. What is Qualified Institutional Buyer (QIB)? 3. Foreign investment in ARC? 4. ARC New Power: convert Debt into equity 5. Anti-arguments: Debt to Equity conversion 6. What is Central Registry? 7. Misc.Amendments 8. Summary 9. Mock Questions CSAT 10. Boring details 11. Committees

What is NPA? Bank gives loan to a person. Person fails to make regular payments. Bank gives him notice to correct his behavior. But he doesnt. Bank declares that loan as NonPerforming Asset (NPA) (=Bad Loan) Currently Indian banks have NPAs worth more than Rs. 1 lakh crores.

Debt Recovery tribunals? Prior to 90s, banks had very hard time recovering bad loans. Because often, borrowers (loan takers) would file frivolous cases in civil courts, then taarikh pe taarikh, taarikh pe taarikh.. proceeding would go on for years. So 1993, Government established Debt Recovery Tribunals to deal with NPA matters. Now borrower cannot approach civil court, theyve to goto special Debt Recovery Tribunal (DRT). This led to some relief, but then DRTs clogged down by truckload of cases.

(Even now, more than 60,000 cases pending with DRTs) In 2002, Government came up with new Act, named SARFAESI Act. What is the Sarfaesi Act? Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002,

Suppose, Mr.Paraajay has opened factory with Rs.100 crores. He financed this, via mixture of Debt + equity in following way. (make sure you understand debt vs Equity, if not click me) Holder Equity (IPO>Shares) Debt (loans, Bonds) Total Paraajay and his family Juntaa (public) Business loan from SBI Bonds Rupees in Cr. 20 30 40 10 100

Initially the company runs well and good. But then Mr.Paraajay doesnt revise his MBA books often, so he forgets the business concepts. His company starts making losses. He fails to pay loan EMIs for many months. SBI gives him notice to correct his behavior. Still, he doesnt start paying money. SBI declares this Rs.40 crores loan NPA (Non-Performing Asset). Once a loan is declared as nonperforming asset, SBI can take actions under SARFAESI act, to recover the loan money. Bank have following powers under SARFAESI Act 1. Take possession of Mr.Paraajays assets without requiring court order. (Commericial or residential, fixed or moving assets.) 2. Auction / Sale them. 3. Change the administration/ Management of those assets.

4. If Mr.Paraajay had sold away the mortgaged asset to third party Mr.X, bank can order Mr.X to surrender that Asset. 5. If Mr.X owes money to Mr.Paraajay, he can be ordered to pay money.

*ARCs explained after a few paragraphs. SARFAESI applies only to loans above Rs.10 lakhs.

By the way SARFAESI applies only to those assets mortgaged/secured to get the loan. E.g. if Mr.Paraajay had taken businessloan, SBI would have asked him to sign away his factory/machinary/vehicles/land etc. specific items as mortgage. Hence SBI can attach only ^those assets. But SBI cannot take away Paraajays personal home-furniture, expensive wristwatch or his sons bicycle in the name of SARFAESI. Similarly, Agricultural land is exempted from SARFAESI attachment. Appeal structure The borrower (loan taker) has following options:

Get a stay order from Debt Recoverty tribunal (DRT) against the auction/sale of his properties. (He cannot file case in Civil courts.) Fight the case in DRT. If unhappy with DRT verdict, he can appeal to Debt Recovery Appellate Tribunal (DRAT). But before filing appeal with DRAT, hell have to deposit 50% of his pending loan money.

Bank: Power to Auction First SBI contacts the experts, gets valuation of Mr.Paraajays assets. Expert says those assets are worth Rs.50 crores according to present market value of land/ building/ machinary whatever. Then SBI will give advertisement in newspapers we are auctioning xyz land/machinary/building. Minimum bidding amount is Rs.50 crores. Whoever wishes to bid, send us application along with Rs.50,000 as deposit, and their class 10, 12 mark-sheets and school leaving certificates, duly attested by a Gazetted officer.

Problem: sometimes, bidders donot take interest in buying such properties, factories etc. To fix this problem, Amendment bill of 2011, makes a new provision: if noone else comes to bid in the auction, Bank itself can buy that property. Here comes the new problem:

Suppose SBI attached a warehouse of Mr.Paraajay. If the land was in good urban area, SBI could open a new branch office there (or housing for its employees). But if plot/factory/house is in some remote area= useless for SBIs personal business. Under the Banking regulation Act, a bank cannot keep such immovable property beyond 7 years, (max 12 years with RBIs permission). So ultimately SBI will have to auction it to someone. What if they dont get better price? Critiques of the bill say, this is not clarified in the bill.

What is ARC? Asset reconstruction company (ARC). They buy NPA (Bad loans) from Banks and try to extract maximum money out of it=profit. Theyve to register with Reserve Bank of India.

Examples: 1. ARCIL (Indias first and largest asset reconstruction company (ARC))

2.

Reliance Asset Reconstruction Company Limited by Anil Ambani

In our example, SBI has NPA worth Rs.40 crores. ARC will buy the NPA file from SBI at a lower rate say 35 crores. (well, SBI is making loss, yes, but something is better than nothing.) Besides, banks have hundreads of bad loan cases, they donot have time or manpower to pursue individual case, sometimes no bidders are interested in auction. All the filework and donkey labour, In such cases, its better for bank to transfer NPA to ARC. But that doesnt mean ARC will give 35 crores to the SBI from its own pocket! Then how will the Asset reconstruction company (ARC) arrange for the money?= via Security Reciepts. What are Security Reciepts (SR)? In above example, ARC needs Rs.35 crores to buy a Non performing asset from SBI.

So ARC will issue security reciepts (SR) worth Rs.35 crores. Only Qualified Institutional buyers (QIB) can buy these security reciepts (SR). SR are not bonds, they donot carry fixed interest rate. ARC will promise to pay money on SR, when it gets money the bad loan. Although, ARC usually promise 9% profit on security reciepts (SR). So, three possible situations:

A.

Qualified institutional buyers (QIB) buy those security reciepts (SR). So Rs.35 cr cash goes from QIB -> ARC -> SBI. B. SBI itself recieves SR worth Rs.35 crores for free. (that means ARC will gradually pay the money to SBI). C. combination of both: QIBs buy SR worth 30 crores + SBI recieves free SR worth 5 crores.

What is Qualified Institutional Buyer (QIB)? These people have the expertise and the financial muscle to evaluate and invest in the capital markets.

Examples: (click on each to read previous articles on them) 1. 2. Scheduled Commericial Banks Foreign Institutional Investor 3. Mutual Funds 4. Venture Capital Investors 5. Insurance Companies 6. Pension/ Providend Funds Foreign investment in ARC ARC =buy bad loans from banks. ARC =arrange money from QIBs to buy bad loans from banks. Problem= Indian QIBs do not invest much in ARCs. Therefore ARCs capacity to buy NPA= very low. And bank themselves dont have enough expertize or manpower to dispose those NPAs quickly. Previously Foreign investors could invest only upto 49% in ARC=minority shareholder=cannot influence company decisions. Now, Government also increased foreign investment limit in ARCs. This would

attract more investment in ARCs and help in quicker purchase and disposal of NPAs. Foreign investment in ARC % Earlier 49% Now (December-24-2012) 74% Anyways, back to the topic, lets recap: 1. SBI had NPA. First solution: auction the property. Did not work out. 2. Second solution: sell it to ARC.

So, ARC purchased the NPA worth Rs.40 crores (at Rs.35 crores). ARCs aim= extract maximum money out of this investment. But how? 1. Auction the assets fully or partially. (sell the machinary now, rent the building and wait for land prices to go up for two years and then sell it.) 2. Sell the property in combination with other NPA properties of other defaulters. (similar to buy one large pizza and get 20% discount on any medium sized pizzas).

3.

Restructure the EMIs of Mr.Paraajay. E.g. instead of 1 lakh per month, give us 75,000 per month. 4. Change the Management of that asset, appoint its own directors/officers. 5. Order Mr.Paraajay to outsource or lease his business to a another company.

^SARFAESI act empowers ARC to do such things. The amendment Bill adds a new power to the ARC. ARC New Power: convert Debt into equity Before reading further, Make sure you know the pros and cons of Debt Vs. Equity (already discussed in an old article click me) The new Amendment in SARFAESI, empowers ARC to convert debt into equity.(fully or partially). Share holding Before: Shares Rupees Cr. % Paraajay and his family 20 40% Juntaa 30 60% Total shares worth 50 100% Share holding After Shares Rupees Cr. Approx.

Paraajay and his family Juntaa ARC Total shares worth

20 30 40* 90

% 22% 33% 44% 100%

*that is the paper value of original debt (NPA loan of SBI to Mr.Parajaay), Otherwise ARC purchased it @Rs.35 crores. Anyways, This leads to two situations: If company starts making more profit in future, ARC will receive more share from that profit. (because more profit=more dividend to shareholders.) 2. If price of companys shares go up in the sharemarket, ARC can sell those shares to third party and make decent profit. Anti-arguments: Debt to Equity conversion Critiques says this debt to equityprovision will be abused. This provision is made to help bad corporates. How so? Well consider following: Banks loss 1.

SBI gave Rs.40 crores loan to Mr.Parajaay He refuses to pay loan=bad loan/NPA. Then SBI sells this bad loan file to an ARC company @Rs.35 crores. Hence, SBIs loss is 40-35=5 crores. (actually more than 5 crores, if we count the possible interest rate that he would have paid, if he had not defaulted. And loss figure will be different if he had paid a few installments earlier. Anyways, lets keep the loss at 5 crore for the moment.)

ARCs profit Now ARC owns the NPA assets. (their investment Rs 35 crores) Paraajay offers Rs.37 crores and ask ARC to sell the assets to his relative, friend or proxy. Hence, ARCs profit is 37-35=Rs.2 crores. And yet Mr.Parajaay successfully saved Rs.3 crores (because originally he had to pay Rs.40 crores to SBI, but he walked away by paying just Rs.37 crores!) Few years back, CVC had held a meeting with Bank chairmans and CBI officers.

They alleged ^this type of mischief going on, in many loan default cases. Now under the new provision: if ARC converts its debt into equity (shares), then what will happen? 1. It is very unlikely that Parajaays company will start making huge profits (otherwise it wouldnt be in bad loan problem in the first place!) 2. It is very unlikely that share-price of Parajaays company will go up in sharemarket. (because it has negative publicity due to NPA). Hence it is very unlikely that ARC will make huge profit out of this Equity. Then Mr.Parajaay can simply offer them a way out : sell those shares to me, in my friend,relative,driver or peons name @Rs.37 crores. And ARC would agree, because 37-35=Rs.2 crores profit! Side question How would Mr.Parajaay arrange those Rs.37 crores?

Ans. If Mr.Parajaay is totally awesome then he wouldnt give 37 crores from his own pocket. Hed just open another company, get new loan from second bank, issue IPOs to get money from juntaa. Then Iski topi uske sar pe. ^This is (one of the many) reasons why Mr.Ratan Tata said following thing: Overseas people go bankrupt or companies go bankrupt. Here they never dothey continue to be sick and still operate. Then they are operating to kill you with destructive competition (using predatory pricing etc.) (Airline business) is proliferated by many operators, some of them in financial trouble. I would hesitate to go into the (airline) sector today in the sense that the chances are that you would have a great deal of competition which would be unhealthy competition.

Bank Employee unions are also against the Debt to Equity clause of SARFAESI amendment. (When they had gone on strike

to oppose Banking Amendment bill, they also cited this Debt-equity reason as well.) Central Registry Previously, borrowers used to forged property documents and get loans from multiple banks by giving them duplicate property documents as security. So when borrower refuses to pay up loan, many banks would make claim for the same property! To fix this problem, Reserve Bank of India (RBI) setup Central Registry in 2011, under SARFAESI. This central registry has details of all properties against which loans have been taken. Any person or bank can inspect records of this registry to make sure the mortgaged property is genuine. Official name: Central Registry of Securitisation Asset Reconstruction and Security Interest of India (CERSAI)

Misc.Amendments 1. In public interest, Union Government can issue notification that xyz provision of

SARFAESI act may not apply or may apply with modifications to a class or classes of banks or financial institutions. Suppose many textile exporters have taken loans from banks but due to global recession they are not receiving payments and hence unable to repay loans. In that case, Government can order notification that SARFAESI will apply to all loans except those given for textile-export business. 2. Earlier a borrower could approach Debt Recovery tribunal (DRT) to get stay order against bank/ARC. New amendment says DRT cannot grant any stay order unless both parties (Borrower vs. lender bank) are heard. This will ensure the process of law is not misused by unscrupulous borrowers to get stay orders just to delay money-recovery. 3. Bill proposes to enable banks and financial institutions to enter into settlement or compromise with the borrower. It also seeks to empower the Debts Recovery Tribunal to pass an order acknowledging any such settlement or compromise.

Summary

SARFAESI empowers banks and other financial institutions to attach secured assets of a loan defaulter and sale, auction or manage them without requiring court intervention. Parliament passed the amendment to SARFAESI Act and the debt recovery tribunal, in Winter session 2012. Salient features of new amendment

1.

Bank

can buy for the NPA property if there are no other bidders. multi-state cooperative banks can also take actions under SARFAESI.

2.

Borrower

cant get stay orders from DRT easily. Can make settlement / compromise with

Bank/ARC. 3. Asset can convert their debt reconstruction into equity (fully or companies (ARC) partially) 4. Government can prohibit or modify SARFAESIs applicability in public interest.

Apart from this amendment, Government has also increased foreign investment limit in ARCs from 49 to 74%. Mock Questions Q1. Which of the following are Qualified Institutional buyers (QIB)? 1. ICICI 2. LIC 3. EPFO FII registered with SEBI A. B. C. D. Only 2 and 3 Only 1 and 4 Only 2 and 4 All of them.

4.

Q2. Which of the following is not correct about SARFAESI act? 1. It mandates the Rural regional banks to lend atleast 15% of their total loans to rural cottage industries. 2. It empowers banks to reduce their NPAs. 3. It empowers RBI to impose penalties on Bank responsible for NPAs. A. B. Only 1 and 2 Only 2 and 3 C. Only 2 D. Only 1 and 3 Q3 Find Correct Statement 1. Foreign investment is prohibited in asset restructing companies. 2. To enjoy the priviledges under SARFAESI act, the Asset Reconstruction Companies have to get themselves registered with SEBI. A. Only 1 B. Only 2 C. Both D. None

Boring details 1. Recovery of Debts Established Debt Due to Banks and Recoverty Financial Institutions tribunal (DRT) Act of 1993 (RDBF) and

2.

Securitisation and Reconstruction of Helps banks Financial Assets and Enforcement of Security recover money from bad loans. Interest Act of 2002 (SARFAESI) Passed in Lok 3. Enforcement of Sabha in Dec Security Interest and 2012, to amend Recovery of Debts Laws (Amendment) Bill, above two laws (RDBF + 2011 SARFAESI) Committees

SARFAESI was based on recommendation of these two Committees 1. Committee on Banking Sector Reforms (Narasimham Committee II), 1998 2. Restructuring of weak Public Sector Banks -Verma Committee

The latest amendment (Debt to Equity), is based on recommendations of Alok Nigam Panel on ARCs, made by Finance Ministry. 1. What is Banking Regulation Act? 2. RBI Power #1: Can remove entire Board of a Bank 3. RBI Power #2: Connected Lending Prevention 4. RBI Power #3: Unclaimed Accounts 5. Public Banks Issue#1: Need consolidation 6. Public Banks Issue#2: Need more investment 7. Banks issue #3: More voting rights for investors 8. Foreign Banks Issue #1: Stampduty 9. Foreign Banks Issue #2: Want to invest in Commodity 10. Standing Committee problem 11. Set: parliament 1. Parliament fight #1: Commodity speculation 2. Parliament Fight #2: Competition Monitoring: RBI vs CCI 12. Anti-Bill arguments

Boring technical details intentionally skipped. I dont do Ph.D on current affairs, neither should you. What is Banking Regulation Act?

It is governs all public sector banks (SBI, PNB etc.) and private sector banks.(ICICI, HDFC etc.) in India. Set : Finance Ministers Office Finance minister and RBI governor are holding a meeting.

Yaar many new players want to open banks in India. But they cant, Chindu because youre not giving new licenses, So what is your problem? Well, Im given powers to regulate public and private sector banks, under Banking Regulation Act 1949.But those powers are not RBI enough. governor So, Im not going to give new banklicenses to anybody, unless and until you get me more powers, by updating that Banking Regulation Act. Chindu Ok, Ill move a Banking laws

(Amendment) bill, to amend the necessary things.But first tell me what new powers do you need? RBI Power #1: Can remove entire Board of a Bank At present, if a Bank doesnt play by my rules, I can remove its CEO or one or two directors. But that is not enough. What if the whole board of directors is involved in some mischief. So, I want powers to remove the entire RBI board of directors. I also want you to increase the rates of existing monetary penalties that I can impose on a bank if it disobeys my rules, directives or gives me false information. Ok agreed.Ill get you the powers to supersede boards of the banks if any Chindu irregularities.And Ill increase the penalty rates as well.Anything else? RBI Second problem. Connected lending. Chindu What is that? RBI Power #2: Connected Lending Prevention

Suppose Mr.Paraajay gets license to open a new bank. He opens Pawn-Fisher bank, people deposit their hard earned cash in it. Ideally, bank should lend this money to the home, car, education and businessloan seekers, who then pay interest and thus bank makes profit. Bank must make good profit, so It can pay 1) good interest rate to its bank account holders. 2) good dividends to its share holders. But Mr.Paraajay also owns another company, Pawn-Fisher airlines. And this airlines company is making losses. Mr.Paraajay gives loans from Pawn-Fisher bank to Pawn-Fisher airlines @very low interest rate, to fix the mess. And or, this Pawn-Fisher airlines gets the bank loan @market rates from the PawnFisher Bank but it doesnt pay EMIs regularly, yet the bank doesnt take any action. Similarly, Mr.Paraajay also opens PawnFisher Mutual funds, but it also makes losses, and money is transferred from

bank deposits to mutual funds, to cover up those losses. These type of activities = Not good, because in long term, bank will collapse and depositors money will be stuck. So, I must be given powers to check the records and account-books of RBI those mutual funds, insurance and other companies associated with a bank. Agreed. youll get the power to inspect those Chindu other business arms of a bank. Anything else? Yes, money from unclaimed bank RBI accounts. RBI Power #3: Unclaimed Accounts

If Mr.X has not used his bank account for more than 10 years, it is called unclaimed bank account. There are crores of rupees in such unclaimed bank accounts, it increases the Administrative burden on bank employees (=need to maintain files etc)

Plus there is also an opportunity to commit a fraud. for example some bank employee knows that Mr.Xs bank account is never checked, then hell forge checkbooks signature or some other trick to withdraw money from Mr.Xs account.

so we must take some measure to tackle this issue.

RBI

If a bank account is not operated for more than 10 years, bank will have to transfer its money in the Depositor Education and Awareness Fund And Ill appoint a Committee to use money from this fund to create awareness. Although if Mr.X returns, he can claim his money and that bank will have to pay him interest also.

Chindu

Agreed. Anything else Yes one tea, two samosas and four more powers 1. If any person wants to buy more than 5% shares of any bank, hell have to take permission from

RBI

me. And before giving him approval, I can put conditions on him, For example give me deposit worth Rs.xyz, so if you play some mischief, Ill take away your deposit. 2. If primary cooperative societies want to continue their banking business, theyll have to get a license from me. 3. I can conduct special audits of cooperative banks because theyre more liable to collapse and frauds. 4. If a bank fails to maintain the prescribed minimum amount of Cash Reserve Ratio (CRR) on any day, I can demand penalty interest from that bank. Chindu RBI All agreed. Anything else. Thats enough for now. Ok then please leave my cabin and Chindu send the SBI chairman in. He too had an appointment with me. Public Banks Issue#1: Need consolidation SBI chief Good morning Mr. Finance Minister. As youre aware, SBI is the largest

public sector bank in India, weve more than 11,000 branches. Yet if you make a list of top 5 biggest banks of the world, our name doesnt figure. Chindu Why is it so? This is because too many small public banks exist in India. So, the incomingmoney (from people to bank SBI accounts) gets fragmented in so many bank branches. Finally, we dont have enough cash, to expand in a big way. Chindu Ok so what do you want from me? There is need for consolidation in the banking sector so India can have two to three large public banks that can compete globally. For this, I need you to simplify Banking Companies Acquisition SBI and Transfer of Undertakings Act. And to exclude bank mergers from the scrutiny of Competition Commission of India (CCI). Bank mergers should need only approval of RBI. Chindu Agreed.

PSU Banks Issue#2: Need more investment Right now the Public Sector banks cannot issue shares worth more than SBI Rs.3000 crores. I want you to relax this, because We need lot of investment. Ok agreed. You can issue more shares, including bonus shares and rights issue etc. (already explained Chindu click me)But youll have to take permission from Central Government + RBI if you want to do it. SBI Agreed. Banks issue #3: More voting rights for investors Before moving on, I must thank you for allowing us to issue bonus shares etc. SBI But that alone will not bring investment in public or private sector banks. Chindu Why? Because in shareholders meetings, voting is done on many SBI issues (for example election of board of directors, changing name of company etc.).

A shareholder should have voting rights proportional to the number of shares held by him. But in case of public banks, the shareholders have only 1% voting right irrespective of number of shares held. So they cannot heavily influence any Decision. I need you relax these voting rights. Only then foreign investors will be attracted to invest in Indian banks.

Chindu Agreed. Well revise the voting rights. Revised voting rights Voting rights (%) Bank Example Before After Private sector HDFC, ICICI 10 26 Public sector SBI , PNB 1 10 Chindu Anything else. SBI No this is all for now. Then you may leave. But please send the chairman of Citibank in, he too had Chindu taken appointment and is waiting outside. Foreign Banks Issue #1: Stampduty

Ok what can I do for you? When I transfer my branches from the main company to the subsidiary Citibank company, I dont want to pay stamp duty. This should help me expand my business in India. Chindu Agreed. Anything else. Citibank Yes there is one more matter Foreign Banks Issue #2: Want to invest in Commodity

Chindu

Citibank

Right now, the Banks can trade in shares, bonds and currencies speculation but the Banking Regulation Act forbids them from trading in commodities. But we (foreign banks) see huge profit making opportunity in that sector. So we need you to amend Banking regulation Act, to allow the banks to invest in Commodities market. Agreed.

Chindu

Standing Committee problem

After a bill is introduced in parliament, it goes to the Standing Committee of Parliament for particular subject. for example Banking Regulation bill to Standing Committee on finance. They inspect the bill clause by clause, put forward their recommendations. And then voting is done. In case of Banking regulation bill, after the parliamentary Standing Committee on Finance put its report, Chindu added some new provisions in it. so opposition parties got angry this wasnt part of the original bill, if you want to add new provisions, then this bill must be sent back to the Standing Committee for re-consideration.

Set: parliament In the parliament, Opposition members are shouting slogans. (as usual) Meera Kumar says beth jayiye, beth jayiye, kripyaa shaant ho jayiye.(as usual) Parliament fight #1: Commodity speculation Chindu What is the problem?

The share-market and mutual funds = regulated by SEBI.Similarly Oppn. Commodity market= regulated by Forward Market Commission (FMC) Chindu So? So, if banks invest in commodity futures, it would lead to high-risk speculative trading, especially with those Foreign banks. What if some investors loose money because of this? The Forward Markets Commission (FMC) doesnt have enough powers to safeguard them. because 1) FMC doesnt have legal powers Oppn. for compulsory registration of traders. 2) FMC doesnt have power to impose huge financial penalty. Parliament is yet to pass Forward Contract Regulation Act (FCRA) Amendment Bill, which aims to empower FMC. And more importantly, you added the this Commodity provision in banking bill, after it was reviewed

by Standing Committee. So this bill must be sent back to standing Committee for review. No, no, no. if bill goes back to standing Committee, itll take lot of time.Ok I Chindu back off, I remove this provision, so there is no need to send this bill back to standing Committee. Parliament Fight #2: Competition Monitoring: RBI vs CCI Friends, I also propose that only RBIs permission should be necessary for Bank mergers and Chindu acquisitions. Competition Commission of India should not play any role in it. Not acceptable. Again this is new provision added after Standing Opposition Committee gave its report. So, send the bill back to Standing Committee. No, no, no. if bill goes back to standing Committee, then itll delay Chindu the implementation.Ok I back off, I remove this provision.CCI will have the power to investigate and clear

mergers and acquisitions in the banking sector. Lok sabha passed the bill. Rajya Sabha also passed the bill. Now this bill file will goto President. Once he signs it, this bill will become a Law.

Anti-Bill arguments In December, employees of public banks went on strike. (although SBI employees did not join the strike.)

The Bank unions give following Anti-Bill arguments: Government claims more banks = more branches = more poor people get banking facilities = financial inclusion. But it is mere lip service. Because new corporate banks/foreign banks wont have any interest in serving poor people. If mergers are allowed then rural branches will close down and/or rural banking operations will be outsourced via contractual business route. This type of privatization will negatively affect our job security and interests of those poor people. Statistics indicate that only 50 percent of people in India have bank accounts. The Centre should focus on educating rural people and cultivating banking habit among them instead of taking steps to merge banks or diluting voting rights. Merger of banks will de-stablise public sector banks, then corporate firms will start their own banks and gobble up public savings. And that money will be misused for the benefit of few corporate honchos and not for the general public.

Although Chindu counters them saying these banking reforms= new banks will be opened= more employment. (he expects 6,000 new bank branches and recruitment of 84,000 people next year.) Critiques also argue that It seems the whole exercise is not a comprehensive banking reform but just firefighting because 1) Foreign banks and domestic players put pressure on FM to help them get bank licenses. 2) RBI blackmails FM to get more powers. 3) FM comes with banking regulation bill. Prime objective of this bill seems to help private players get new banking licenses. Government should further relax the voting rights otherwise, Government will keep abusing its majority shareholding to further its own political goals and election agendas. e.g. in 2008, public sector banks were asked to forgo farmers loans (Debt Waiver scheme). Although Government promised to refund the loan-money to banks on behalf of farmers but it is not a good business practice.

Summary The Banking regulation bill, 2011 was passed in the Winter session of parliament in Dec.2012. The salient features of the Banking regulation bill are (list not exhaustive) RBI can inspect books of associate business arms of a bank. 2. RBI can supercede entire board of directors of a bank. 3. RBI can conduct special audits of cooperative banks. 4. Cooperative societies cannot carryout banking activities without license from RBI. 5. A Depositor Education and Awareness Fund to receive money from deposit accounts not operated for more than 10 years. 6. Increased the penalties and fines for violating Banking Regulation Act. 7. Public Banks can obtain more capital via bonus shares and rights issue. 8. Increases the voting rights of shareholders in Public and Private sector banks. 1.

9. Prior approval of RBI necessary if a person wants to purchase more than 5% shares of a bank. 10. Banking Mergers and acquisition will fall under purview of CCI. 11. Bank will have to pay penalty interest rate, if it doesnt maintain CRR on daily basis. 12. Foreign banks exempted from stampduty payment for certain cases. 1. What is Capital Goods? 2. Examples of Capital goods? 3. Why is Capital Goods important? 4. What is capital gains? Question from a reader: What is the difference between Capital Goods and Capital Gains? What is Capital Goods? Capital goods are the tools and machinaries used for producing consumer products. Theyre (usually) expensive, and theyre purchased for long-term use.

Raw materials are also needed for producing consumer goods (Biscuits, bread etc) but they are not capital goods. Capital goods are also known as producer goods.

Examples of Capital goods?

Heavy equipment (such as excavators, forklifts, generators, metal-forming or metal-working machines, vehicles).

boilers, storage tanks, Chemical factory evaporators Mixer, grinders, Ice-cream factory refidgerators Dumpsters, bulldozers Construction, mining etc big vehicles industry.

In short, factory equipment are capital goods because theyre used to produce customer goods. But the equipment used in an office= not capital goods for example stapler, paper shredder, pen-holder, water-cooler table, chair etc. Similarly, specialized air-conditioners installed in drug/ ice-cream factories to

maintain uniform temperature during production= capital goods. But air-conditioners installed in that factory owners cabin=not capitals goods. Why is Capital Goods important? If Capital goods are expensive, then companies cannot buy them=low production= low GDP. If they buy expensive capital goods, theyll keep final products MRP high to keep the profit margin same. Hence, Government gives tax reliefs on purchase/import of Capital goods by businessmen. When you want to import Capital goods from a foreign country (e.g. USA ), youll need pay them in their own currency (dollars)? So where to arrange for the dollars? Recall the FCNR account article Click ME

What is capital gains?

Capital gains= profit made by selling your capital assets. When you make profit by selling your capital assets, youve to pay tax to the

Government on that profit. That is known as Capital Gains Tax. (CGT) Examples of Capital Assets are 1. Land (but not the agricultural land) 2. Building Factory Plant and machinery. (except raw-material, or finished products) So when you sell capital goods discussed above, and make profit, then youll have to pay capital gains tax (CGT). 3. Shares, debentures, mutual funds etc. 4. jewelry, paintings, sculptures and other Archaeological collections. (from 2008 onward)

Capital gains tax are of two types: short term and long term. (depending on how long you kept the asset before selling it.) Capital gains tax is a direct tax. (because direct tax=charged on your income and property). For more on Capital Gains tax, check Vodafone Case article click me). Mock Qs Q1. Which of the following is correct

1.

Capital Gains tax, Custom duty are examples of Direct tax

2.

Agricultural land is exempted from Capital Gains tax. a. b. Only 1 Only 2 c. Both d. none

Q2. Which of the following are not Capital goods? 1. Wheat stored in a granary 2. Boiler in a chemical factory 3. Air-conditioner in a corporate executives office Only 2 b. Only 1 and 2 c. Only 1 and 3 d. Only 2 and 3 1. What is GMR? 2. Delhi Airport Management 3. What is Airports Authority of India (AAI)? 4. What is GAGAN? 5. Male International Airport, 2009 6. What is International Financial Corporation (IFC)? 7. Coup, Feb 2012 a.

8. Singapore Court, Dec.2012 9. Indian Governments response 10. Should India stop giving ca$h to Maldives? 11. Should India be Assertive? 12. Conspiracy Parts 13. The Chinese angle 14. The Crony Capitalism Angle 15. The Rajnikanth angle 16. The Funny Parts 17. Mock Questions What is GMR? An Indian company dealing with infrastructure related business: airport Management, coal mining, highways etc. It operates the airports in Delhi, Hyderabad and Turkey. Grandhi Mallikarjuna Rao founded this company, hence the name GMR.

Delhi Airport Management Delhi airport is managed by Delhi International Airport Ltd or DIAL. But that company created by partnership between GMR + Airports Authority of India (AAI) etc.

What is Airports Authority of India (AAI)? Public Sector Undertaking (PSU) It operates more than 100 airports in India AAI also works as traffic police of Indian airspace. (Air Traffic Management). AAI has undertaken GAGAN project with Indian Space and Research Organization (ISRO). So aircrafts are fitted with GPS, and AAIs command centre will monitor them via satellites for efficient traffic Management.

What is GAGAN?

GPS Aided Geo Augmented Navigation (Gagan).

GAGAN GPS devices help pilot to fly in difficult weather, fog, tough terrains. They also help in efficient Air traffic Management= less fuel burned by aircrafts= less pollution.

Anyways enough sidetalk, back to the issue. First question: Why the hell would GMR want to run airport in Maldives? Well, for the same reason Ekta Kapoor makes Saas-Bahu serials= to make truckload of ca$h. When you own an airport, you can make money via 1. Car Parking fees. 2. Renting rooms to Jet-Airways, Kingfisher to run their ticket booths. 3. Open or rent food-stalls, duty-free liquor stores etc. 4. Charing money on airlines to use the air-strip, fuel refilling,. Male International Airport, 2009 Second Question: why would Government of Maldives want to give away the airport Management to a private company?

Male=capital of Maldives.

Maldives is a tourism economy. Their annual GDP=$2 billion annual GDP. th About 1/5 (=20%), of that GDP comes from this Male Airport. So far this Male Airport was managed by Maldives Airports Company Limited (MACL). Maldives Airports Company Limited (MACL)= 100% Government owned company. In 2009, Government decided to to handover Management and control this airport to a private company.

But Why? Well, for the same reason why experts recommend that Air India should be privatized. Because Government owned companies are mired with inefficiency and loss-making. Besides Maldives Government itself did not have enough money to develop or modernize the airport, they were looking for some foreign private investment. Therefore Government of Maldives (under President Nasheed) decided to invite Biddings/tenders for privatization of Male

Airport: Whichever foreign company agreed to share maximum profit with the Government, will get the contract to run the airport. But the bureaucrats of Maldives= had no prior experience of how to evaluate the financial, legal and technical worthiness of foreign bidders. So, Government asked International Financial Corporation (IFC) to oversee the bidding process. What is International Financial Corporation (IFC)? For that, weve to go back to Bretton Woods (CLICK ME). Bretton Woods conference led to creation of three organizations:

1. IMF 2. GATT->WTO 3. World Bank World Bank is made up of five organizations: Arm of world bank 1. International Bank for Role Give loans @market rates to middle class

Reconstruction and Development (IBRD)

and poor countries.

Give loans @ZERO 2. International interest rate to poor Development countries. +knowledge Association (IDA) sharing, health education etc. 3. Multilateral Loans and insurance to Investment private companies, Guarantee when they invest in Agency (MIGA) Developing countries. 4. International Centre for Settlement of Investment Disputes (ICSID) To settle investment disputes between foreign investors and their host developing countries. When foreign investor, wants to start business in developing country, IFC provides financing and technical advice and assistance,

5.

International Finance Corporation (IFC)

works as a catalyst. So, Aim of IFC= boost private investment in developing countries.

Anyways IFC was tasked to manage the bidding process for privatization of the Male airport to ensure fairness. Big players such as GMR, Reliance and other companies from Switzerland etc. were in the competition. The whole bidding process, checking applications etc. went on for 10 months (which is roughly the same time itd take UPSC to declare official answer key for any exam under R.T.I.)

Finally GMR of India, won the contract in 2010 (when Nasheed was the President of Maldives). They got the right to run Male Airport for 25 years. And the contract had provision: If there is any dispute in future, either party (Government or

GMR) can approach the High Courts of London or Singapore for settlement. Coup, Feb 2012 Fast forward to Feb-2012, There was a coup in Maldives, Nasheed had to resign and Waheed became the new President. (We already discussed this in previous article, click me) During all this time, there was political debate over privatization of Male Airport. Some politicians and experts projected that Government itself can run the airport (via that company MACL) and make 4 billion dollars till 2035. But now weve handed over the operation to private company GMR, theyll barely give 1.5 billion dollars to Government, during this period. Second, after getting the contract to run Male Airport, GMR decided to charge each passenger: $25 as Airport Development Charge (ADC) + $2 as insurance = total from each But the local court of Maldives ruled that it is one sort of tax and tax cannot be levied on passengers without approval of

parliament. Therefore, GMR cannot collect such charges from Passengers. However, GMR says This was all written in our contract agreement with previous Government.

President Waheed took the opportunity and started saying GMR contract is not in best interest of our country. They had got the contract by bribing previous President Nasheed. So well take over the airport Management. Our Government company MACL will run this airport. He also ordered criminal investigation against the company. Singapore Court, Dec.2012 GMR took the issue to Singapores Arbitration Court. In December Supreme Court of Singapore ruled in favor of Waheed, that Government of Maldives has full right to terminate contract. Now GMR has hired best lawyers and theyre studying the judgement. They plan to sue Government of Maldives for $800 million dollars for the losses caused.

Indian Governments response

Initially Government made aggressive statements like this will affect foreign investment in Maldives, we are committed to protect the interst of Indians abroad etc.etc.etc. But after Singapore judgement did not come in favour of GMR, Salman Khurshid says this is all legal matter, we respect the judgement.

Should India stop giving ca$h to Maldives?

From earlier article, you also know that India gives truckload of financial and technical aid to Maldives (and also to other poor countries of the region such as Bhutan, Bangladesh, Myanmaar).

Rich nation gives aid to poor nation, for three main reasons 1. Whenever there is voting in UN general assembly or other forum, the poor nation will vote in favor of rich nation. (e.g. Kashmir or Arunanchal pradesh border dispute, or WTO, Climate-change agreements).

2.

Poor nation will allow the rich nation to construct military, naval bases, radars, missile defense system etc. in its territory. 3. Poor nation will allow rich nations companies to get mines, mineral and other contracts.

Indian Government was planning to cancel financial aids to Maldivian Government, to force them into settling issue in favor of GMR. Experts are against this move because 1. If India stops giving money to Maldivian Government, then China (or US) will step in, start playing big-brother and giving cash to Maldives. 2. Loss of good will among Maldivian citizens. 3. Apart from GMR, Indian companies like Tata, Taj etc. invested in Maldives. So if Indian Government stops financial aid, then Waheed could start harassing them also. Should India be Assertive? Some other experts say India has not been Assertive in its diplomacy, and that led to GMR fiasco.

Now what is this assertiveness? Dictionary meaning: Aggressive selfassurance. Practical meaning: Mohan should call up Waheed and threaten him that 1. Ill stop or reduce financial and technical aids given to your country. 2. Ill also start bullying and harassing your companies working in India via Income Tax dept./CBI. 3. Ill start giving money, weapons and shelter to opposition parties, rebels of your country. 4. Ill increase taxes on goods imported from your country. 5. Ill hatch some conspiracy to get you out of office. (sting operation, buying coalition partners of Government.) 6. Ill order my state media, psuedo-civil society organization etc to bad mouth you in India and abroad about Human rights violation, corruption etc. Traditionally US and Chinese Governments are very assertive almost aggressive when it comes to protecting their national and commercial interests.

But it doesnt mean theyve always succeeded. For example, In 2011, Myanmar Government suspended $4 billion Chinese project to build a large dam on the Irrawaddy River. This happened despite Chinas strong support to Myanmar during its long years of international isolation and Western sanctions. Chinas relationship with Myanmar is much stronger than that between Delhi and Male. Yet China had to display patience and hold its tongue. Therefore, it is not the assertiveness but preparedness that is necessary to tackle such issues. (We saw earlier, how India was caught unguarded during the coup). >40 per cent of Indias GDP is linked to imports and exports. Indian corporate is investing tens of billions of dollars abroad every year. The real lesson is that India should be more prepared to protect the interests of its companies operating abroad. Problem with Maldives Economy= heavy dependence of tourism. Hence their GDP

is low, purchasing power is low and theyre suseptibe to instability. (both economic and political). India should see to it that they diversify (marine food processing etc.) and have strong import-export relationships with India. Once established, economic tries are harder to breakoff than diplomatic ties. Other necessary things for stable Maldives: Independent media, judiciary, penetration of internet, cable-TV, powerful civil society. Conspiracy Theories: The Chinese angle Behind the curtains, China had played role in it. First getting Nasheed replaced and then Getting Waheed to cancel the GMR deal. And (perhaps) later, itll get the contract to manage the airport. Maldives is of strategic interest for both China and India, because of its location in the Indian Ocean alongside major oil and shipping lanes. More than 80% of international trade to and from Asia passes through Maldivian territory.

Even USA has plans of building a military base in one of the islands of Maldives. China doesnt want this. China has recently opened an embassy in Male= proves theyre interested in the Maldives. China has been consistently expanding its own influence in island nations on Indias periphery the Maldives, Sri Lanka, Seychelles and Mauritius by giving several millions of dollars in aid and infrastructure projects. The Crony Capitalism Angle GMR is a shoddy company. It was unknown before 2000s. Suddenly it started making billions after getting DelhiHyderbad airport contracts and other plump highway, building and coal projects. There is nexus between Indian ministers and this company. GMR is charging Airport development fees in Indian airports also. (according to CAG report, this wasnt part of original contract.) Now even IT department has started raiding its offices.

Nasheed was already in debt of India Government (recall we purchased 100 million worth treasury bonds.) So behind the curtains he was diplomatically coerced into giving final approval to this company. This was either done because Indian Government wants to increase presence in Male or simply because GMR paid gave them a few suitcases for lobbying. The Rajnikanth angle

In his exam-oriented blockbuster movie Shivaji, The Boss, the Rajnikanth plays role of an NRI businessman. He wants to open free Medical college in Tamilnadu. But he has to pay crores of rupees as bribe to bureaucrats and politicians for land allotment. But then elections are held. New minister again demands bribes from the Rajnikanth. Similarly, after Waheed took charge, hed have asked GMR to pay another suitcase full of money, but GMR refused (or decided to delay bribe because, elections

are just upcoming in 2013 who knows if Nasheed again became President!) So, Waheed cancelled the contract to teach a lesson to GMR (and other Indian companies in Maldives) ki suitcase delivery mein delay nahi hona chaahiye. The Funny Parts Indian banks money stuck (AGAIN) So far GMR had invested about 500 million dollars in Male Airport. But all of that money didnot come from its own pocket. GMR had taken loans from Axis Bank and Indian Overseas Bank (IOB) worth approx 160 million dollars. Some experts believe that GMR will now refuse to pay interest rate on loan until matter is settled! (SBI must be feeling happy for not being the only bank loosing money on airline related loans.)

ADC charge in India In India, Government had allowed the airport operators to charge airport development fee from passenger. So, the airport operators charge anything

between 100 to 1300 rupees per passanger. CAG says, when DIAL (GMR and AAI owned company) got contract to run Delhi airport, this ADC charge was not mentioned in the agreement. Yet theyre collecting money from passengers. So far theyve made undue benefit of over Rs. 3,400 crore in the name of Airport development fee! (meaning they gave suitcase full of bribe to previous minister to order the airport development fee approval.) Now the new Aviation Minister ordered ban on ADC on Delhi and Mumbai airport from January 2013. But GMR is non-committal about it (They are planning to go to Airports Economic Regulatory Authority (AERA) and court against this move, in India also!) So, neither Indian nor Maldivian Government likes the private company making money through Airport Development fee, yet Indian Government is against Maldivian Governments move to scrap GMR contract the whole crisis has stemmed from ADC.

Tit for Tat/ Karma-Cycle Indian Government (and media) say, GMR crisis will affect Foreign investment in Maldives. Curiously, the same thing was said by Norway and Russia after their 2G licenses were cancelled.

Mock Questions Q1 which of the following, is not a function of Airports Authority of India (AAI)? 1. Air traffic management over Indian air space. 2. Arbitration of Labour disputes involving airline staffers. a. b. Only 1 Only 2 c. Both d. None

Q2. Which of the following, is a function of GAGAN? 2. 1. Weather forecasting Aiding pilots to navigate and land in difficult weather and terrain.

3.

Aiding Air-traffic Management. a. Only 1 and 2 b. Only 2 and 3 c. Only 1 and 3 d. All of them

Q3. Which of the following is correctly matched? Give loans 1. International Bank for Reconstruction and @ZERO interest rate to poor Development (IBRD) countries. Give loans 2. International @market rates to Development middle class and Association (IDA) poor countries. a. b. Only 1 Only 2 c. Both d. None

General Studies Mains Explain following terms (5 marks, 50 words each) 1. International Bank for Reconstruction and Development (IBRD)

2.

International Development Association (IDA) 3. Multilateral Investment Guarantee Agency (MIGA) 4. International Centre for Settlement of Investment Disputes (ICSID) 5. International Finance Corporation (IFC) 6. Applications of GAGAN Interview 1. How do you rate Indias handling of GMR crisis? 2. Apart from GMR, are you aware of any recent disputes involving Indian Businessmen vs Foreign Governments? 3. Are you in favor of Privatization of Airports? Yes/No and why? 4. What do you understand by Crony Capitalism? 5. Can you think of any solutions to tackle Crony Capitalism?

1. What is Infrastructure? 2. Why is Infrastructure important? 3. What is the problem with Infrastructure? 4. What is problem with Banks?

5. Mechanism of Infrastructure Debt Fund 6. Attracting investors 7. What is withholding Tax? 8. First IDF 9. Why EPFO interested in Infra-Debt Funds? What is Infrastructure? Things that are essential for functioning of economy: roads, sea-ports, airports, railways, metro rail, electricity-generation etc. Why is Infrastructure important? GDP=Money value of all goods and services produced in a country within a year. If there is shortage of electricity, factory owners cannot produce lot of mobilesets, TVs, refrigerators. = Production of goods decreases. If there is shortage of electricity, hospitals cannot carryout X-ray, CAT-scan etc. = Production of services decreases. Therefore, good quality Infrastructure is essential for achieving high GDP growth (9%).

What is the problem with Infrastructure?

Government estimates that one trillion dollars will be required in next 5 years to finance all the important infrastructure projects. But Government cannot finance all those projects by itself. Because theyre already spending lot of money on Food-Fertilizer subsidies, MNREGA, Air-India etc. Government cannot merely print more suitcases full of money to finance these infrastructure projects, else itll create inflation. click me to know why If Government borrows money from public, to finance these infrastructure projects, itll severe the problem of fiscal deficit. So, Government wants 50% of that required money to come from private sector (banks, domestic and foreign investors.)

What is problem with Banks?

Such infrastructure projects require longterm funding for 20-25 years, but banks are already exposed to too much risk (loans given to 2G players, Vijay Mallya etc.) In the present situation, banks are

unable to finance infrastructure projects for more than 5-7 years time-frame. Hence, there is need to channel money from the hands of investors into infrastructure projects. (+ also need to reduce investment in Gold, because it increases current-account-deficit.) To achieve this, Government has come up with new idea = Infrastructure Debt Funds.

Mechanism of Infrastructure Debt Fund You already know about Debt Vs Equity, Shares vs Bonds, if not click ME In technically-not-so-correct term, Infrastructure Debt Fund (IDF) essentially means that 1. You invest money in an IDF company. 2. IDF company lends your money in some Infrastructure project company (as Debt). 3. That infrastructure project company pays interest rate to IDF Company. 4. IDF company gives that interest money to you. (after cutting its commission). Thus you make profit on your investment.

Tax Policy to Attracting investors By merely allowing creation Infra Debt Funds, Government cannot bring in the investment in infrastructure projects. Government also needed to give some benefit (carrots) to lure the investors. Finance Minister has given two carrots 1. Withholding Tax reduced from 20% to 5% (for foreign investors) 2. Money earned from IDF is exempt from income tax. (for desi investors) What is withholding Tax?

Suppose a non-resident (foreigner), lends money to an Indian company and earns Rs.100 interest per year. Earlier he was supposed to pay Rs.20 to the Government, but from now onwards only Rs.5 It is called withholding tax, because he (foreigner) doesnt need to pay the tax himself, but the company who borrowed money, is required to withhold it and give money to Government. Example you (foreigner) loaned me (Indian company) some money. On 1st

December, Im supposed to pay you Rs.100 as interest, but Ill give you only Rs.95, and put aside Rs.5 and send it to Government as withholding tax. Since Government reduced withholding tax from 20% to 5%, that mean you (foreign investor) can earn more money, so this way Government has tried to seduce the foreign investors, into investing in Infra-Debt Fund in India. First Infra-Debt Fund of India

The first IDF-fund of India, was setup by a consortium (gang) of ICICI, BoB, Citi bank and LIC. This entity will work as a Non-Banking Finance Company (IDF-NBFC), and hence theyll come under the jurisdiction of RBI. They could have set it up as a mutual fund company, but then theyd have come under the jurisdiction of SEBI. Anyways, shareholding pattern is Member % ICICI 31 Bank of Baroda 30

Citi Bank LIC Total

29 10 100%

^there is no need to mugup, this is just for information. We can speculate that near future, SBI will also come up with something like this, to counter ICICI. Why EPFO interested in Infra-Debt Funds? Problem with EPFO Employees Provident Fund Organization (EPFO) takes money from people, invests it shares and bonds, earns money and pays it to the EPFO subscribers. (After cutting its commission). Central Board of Trustees= the decision making body of EPFO. It is headed by Labour minister. Theyve made rule : EPFO must invest in Government-securities (G-sec) and companies AAA credit rating only. Problem: Most companies dont have AAA-rating, so EPFO is forced to park majority of its money in Governmentsecurities (G-sec).

Recall the concept of Gilt-edged securities (click me). Government/ treasury bonds are more reliable, hence, they pay less interest. (because they dont need to seduce investors by offering higher interest rate, unlike some junk bond company with C or D credit rating.) So, ultimately problem for EPFO managers= G-sec doesnt pay much interest. (Around 8% only). While New Pension Scheme (NPS) managers, invests in many other places, including risky bonds, and make around 12% profit. If things go on as usual, then in long term, people might switch from EPFO to NPS and other various pension-providentretirement policies offered by private firms like Max Life insurance, Bajaj Alliance, Kotak Mahindra etc. to get better deals. Solution

Therefore, EPFO wants to invest money in Infrastructure Debt Funds (IDF) to earn more profit to give better return-oninvestment to its subscriber. It is looking

forward to invest about 5 lakh crores in IDF funds. But newly formed Infrastructure Debt Funds (IDF) companies will not get AAA credit rating immediately. So EPFO needs approval from Central Board of trustees to modify the investment rules. And since Central Board of Trustees, is headed by labour minister so essentially EPFO needs approval of Labour Ministry. Mock Questions Q1. Regarding Infrastructure Debt Funds (IDF) in India 1. 2. The first IDF fund was setup by State Bank of India (SBI) IDF is exempted from Withholding tax. Which of above is/are correct? a. b. Only 1 Only 2 c. Both d. None

Q2. Find Incorrect Statement

1. The apex decision making authority for EPFO rests with the Finance Minister of India. 2. Withholding tax is an example of Indirect Tax a. b. Only 1 Only 2 c. Both d. None

Q3. Which of the following fund receives the proceeds from disinvestment? 1. 2. 3. Infrastructure Debt Fund Consolidated fund of India National Investment Fund Only 1 b. Only 2 and 3 c. Only 1 and 2 d. Only 3 1. What was Subprime crisis? 2. What was US-Governments response to Sub-prime crisis? 3. What is Fiscal cliff? 4. Why is Fiscal cliff bad for US Economy? a.

5. What will be the Effect of Fiscal Cliff on India? Fiscal Cliff= new kid in the town. Before getting his introduction, lets meet his mom and dad. Youve already met his dad, Fiscal Deficit. If not click me. Now meet his mom, Subprime Crisis. What was Subprime crisis? Subprime crisis is also mother of all problems: LIBOR, Eurozone etc. (atleast partially). 1. Youre running a bank/Non-Banking Financial company that gives loans, and Im basically a loser who doesnt have the aukaat (capacity) to repay any loans. 2. Yet, You (American Bank) give me loan of $20,000, And I give you paper saying if I dont pay back, you can take away my house. This is mortgage. 3. Wait a minute, if I dont have the capacity to repay the loan, then why the hell are you giving me a loan in the first place? Well, Two reasons

i. Banks decide Loan interest rate based on a persons creditworthiness. So in my case you can demand higher interest rate=good for you. ii. Youre also speculating that in future the real-estate prices will increase, so even if I cant repay the loan, you can attach my house and sell it off to recover your loan. Thus, its a win-win situation for you whether I pay back the loan or not, youre going to make good profit.

Now, Back to the topic

4.

Like this, you gave $20,000 loans each to 5 unworthy people= your investment is 1 lakh dollars.

5.

Now repack those mortgage papers (security) in a new file and make a new security paper anyone who gives me $1,50,000, Ill give him mortgage papers of 5 houses = this is derivative product. (Because it derives its value from some other thing)

5.

See? You are making profit of $50,000 and you dont even have to bother about EMI payments, interest rates anymore. 6. Suppose 3rd guy bought such derivative papers and after few months, he repacks them- makes another derivative product and sell it to 4th guy. 7. Such papers are one sort of asset (because you can get money by selling it to someone.)

8. but as you can see, in above cases, people are not creating any new asset, they just keep repacking and reselling same stuff over and over to different

people. So youre blowing an assetbubble. 9. After few months, I, the bottom guy in food chain, refuse to pay loan-installments (EMIs), and I tell the 4th guy to take away my house (mortgage). 10. Fourth guy takes away my home, but since banks gave loan to so many unworthy people, there is over-saturation or over-availability of houses for sale in the real estate sector. So no one is ready to pay you even $5000 for that house. = This is toxic asset your asset bubble is burst. 11. The banks, pension and insurance fund managers of Europe had also invested in this game. They also lost. So in that way, Subprime crisis played a role in future Eurozone crisis. Click ME 12. A bank of London named Barclay also lost money in this game, that led to LIBOR crisis. Click ME ^This is just a crude explanation of what happened in sub-prime crisis. Otherwise the

actual crisis was result of many layers of refined and sophisticated loan and investment products interlinked with each other. Anyways, the Sub Prime crisis had negative effect on every sector. Stock market crashed, Companies started dismissing local staff (especially those banks and mortgage companies). If parents were working in some private company, lost jobs or their salary was reduced= theyd not hire maids or babysitters anymore, theyll buy less clothes and toys for their kids, theyll not goto some holiday resort during vacations. So indirectly many sectors get affected. More unemployment= less product demanded by those unemployed families=even more factories close down=even more unemployment. Cycle goes on.

But why is it called Sub-prime crisis? If a person has full capacity to repay loan, we call him prime. Therefore Im subprime because I did not have full capacity to repay the loan, my credit rating was bad. Yet you

gave me loan and ran into trouble= sub-prime crisis. What was US-Governments response to Sub-prime crisis? 1. US Government has things like Social Security, unemployment allowance, food stamps etc. to take care of those jobless families. 2. President Obama started some federal construction projects (roads, bridges etc.) to create employment. 3. Government also bought those toxic assets to rescue the banks. 4. The Feds (RBI of USA), decreased its lending rates so other banks could borrow at almost 0% interest rate from the Central Bank and then give cheap loans to needy people and businessmen. 5. Gave income tax cuts to workers. So they can save at least $1000 from their salary or profit. 6. Same way tax-benefits to private companies, If they invest money in research-development etc.

^President Obama took these steps to increase money in the hands of American

people, so they can go out for shopping = demand of more products and services= more employment could be created. But of course, money doesnt fall from sky. 1. Giving tax-cuts to workers and companies= incoming money reduced for the Government. 2. Giving unemployment allowance to jobless people= outgoing money increased. 3. +daily huge expenses for keeping army in Iraq and Afghanistan= outgoing money already high.

You already know when outgoing money is higher than incoming money = fiscal deficit.

Fiscal deficit is a big pothole in the road to countrys prosperity. This pothole can be filled with cash only. If this pothole keeps increasing in size then itll lead to very bad effects on economy. So, President Obama had planned some things in advance to increase incoming money and decrease outgoing money for the Government. These plans are:

Most of the tax-cuts, tax-benefits given to people will be removed from 1st January 2013. For example, earlier the people were given tax-cuts if they adopted a child, invested money in childrens college education plans, or businesshouses invested in research and Development etc. All that will expire from 1st January 2013, thus theyll have to pay higher taxes. Many of Government sponsored programs in space research, military research, lengthy unemployment allowances etc. will be either paused, reduced or shut down from 2013. (More than 900 billion dollars saved at the end of 2013)

If things go in ^this way, US Government will earn 4 trillion dollars in next 10 years. Thatll cover up most of its huge fiscal deficits and past mistakes. (i.e. buying toxic assets, money wasted on Iraq-Afghanistan and most importantly Pakistan). Ok sounds well and good, but What is fiscal Cliff? American economy was going through bad phase due to sub-prime crisis. So President Obama had to give stimulus to boost this economy (tax-cuts to companies, buying toxic assets from banks= examples of fiscal-stimulus.) Fiscal-Stimulus are similar to Steroids. If an athlete takes steroids, it will temporary improve his performance and take him towards the peak performance. But once you stop giving him steroids, his performance will suddenly decline. It will feel like falling off a cliff. Observe this graph:

Technically speaking What is Fiscal Deficit? 1. Fiscal cliff term refers to more than $500 billion in tax increases and acrossthe-board spending cuts scheduled to take effect after 1st January 2013. 2. Many economists say these new taxes and spending cuts would be too much deficit reduction, too suddenly, for a weak economy. Itll lead to an economic recession. Why is Fiscal cliff bad for US Economy?

When people have to pay more taxes= less money in their hands = less money to spend on cinema and Christmas

vacations= less demand of products= not good for economy. When Government reduces research in space, military programs = many people affected directly or indirectly. E.g. less funds for space research = less demand for electronic instruments, metals, penpencil-rubber required in those programs. Again, If parents were working in some Government-research program/ private company, lost jobs or their salary was reduced, theyd not hire maids or babysitters anymore, theyll buy less clothes and toys for their kids, theyll not goto some holiday resort during vacations. So indirectly many sectors get affected. If President Obamas plan is carried out, then 1. Middle class families of USA, will have to pay average $2000 more in taxes every year. And $2000 is a big amount given that many people in USA dont earn more than $40,000 a year. So imagine the reduction in their purchasing power. 2. Overall, American public will have to pay $500 billion more in taxes.

3.

More than 10 lakh people will become jobless.

^These numbers vary from site to site, if its a pro-Republican party newspaper or experttheyd say 20 lakh American will become jobless, but some other Pro-democratic party newspaper or analyst would say only 7 lakh will be jobless. Anyways, The point is, American Households and businessmen are accustomed (used) to a certain way of spending and saving habits in past four years and Obama plan will break that status quo = not good for economy, at least for the short term. Itll lead to a decline in GDP. Observe this graph

What will be the Effect of Fiscal Cliff on India? If American consumers have less money = they buy less= not good for Indian exporters (especially polished diamonds). 2. Many American companies outsource their research and development work to India, particularly pharmaceuticals (clinical trials of drugs), software, engineering. If Obama removes the tax-benefits given to them (+consumer demand already down)= theyll either delay payments, cancel or renegotiate the contracts given to the Indian companies. 1.

If American Corporate have to pay huge taxes @home, and consumer demand is already low, theyll try to concentrate more on India and other emerging economies to get new customers (Retail, Aviation, Pensioninsurance) = More FDI may come to India. 4. Americans already burned their hands in share-market and real-estate, if this fiscal cliff leads to recession, theyll park their money in GOLD = demand of gold increased= gold becomes even more expensive = bigger Current Account deficit for India (because we too love gold) = Rupee weakens against dollar, because when we import gold, weve to pay in dollars= weve to pay more rupees to buy same amount of crude oil = petrol price increase = inflation. 1. What is Spectrum? 2. Method #1: First come First Serve basis 3. Method#2: Auctioning method 4. What happened in 2G scam? 5. Swan Telecom(Shahid Balwa) 6. Unitech (Sanjay Chandra) 7. A.Raja (Telecom Ministry) 8. Kanimozhi

3.

9. Neera Radia 10. CAG: 1.7 lakh crore loss 11. Supreme Court verdict 12. Presidential reference on SC verdict 13. Supreme court on Presidential Reference 14. Impact of License Cancellation by Supreme Court 15. Sistema Russia issue 16. Spectrum Refarming Continuing the series of technically not-socorrect articles on economy. What is Spectrum? Whenever you watch TV, receive phone call, send SMS, surf internet.data is being transferred from one place to another, say Ahmedabad to Mumbai. So, If data was a truck, how would you transport it from Abad to Mumbai (or vice versa)? Obviously via highway. Spectrum is that highway.

Based on the width of the highways, we classify them into following Cable TV 145-860MHz

2G 800-1900MHz 3G 2100MHz 4G, broadband internet 2300MHz (^numbers for illustration only. Different websites will give different numbers.)

So, We first send the truck from Abad to a Satellite hovering in the sky, and from there, send the truck to Mumbai. Problem: satellite=expensive. Private Player(Businessman) cannot afford it. Solution: Government launches the satellite using ISRO. Thus the highway (spectrum), is created. Then Government will charge money to whoever(cellphone company) uses this highway (spectrum). Youre a businessman, you want to launch your own mobile service (like Vodafone, Airtel etc). Therefore youre interested in

using this 2G highway, to transport your trucks (data). You can also use 3G or 4G, which provide faster data transfer, but theyre more expensive. New Problem: to access this 2G highway, you need two things Problem (businessmans Solution side) 1. Drivers License Apply to Department (to operate the truck) of Telecom. 2. Pay rent/toll for Get loan from using this highway (spectrum). Just like SBI.Pay the money to Government. Or you pay for using even better, bribe Bandra-Worli seaminister so they give link or Yamuna free spectrum. Expressway.

Highways have fixed capacity. So Government cannot give license to 500000 truck-drivers else, itll create traffic jam. So, From Governments side what should be the ideal solution? 1. Check the application of driver: does he have previous experience of running

telecom business? and more importantly his class 10,12 and college marksheets and school leaving certificate. 2. After verifying his record, Sell the access to this highway (Spectrum). Another problem: how should Government sell access to this Highway (Spectrum)? Ans. Two methods, 1) first come first serve 2) Auction. Both have their advantages and problems. Method #1: First come First Serve basis You already know how cinema tickets are sold. The person who is first in the line, gets the ticket. If You come late, you dont get the ticket. This also leads to ticket blackmarketeering, for example, I come early, buy all the tickets. You come late, all the tickets are sold, I offer my tickets to you @higher price and make huge profit. This is not good for economy because Im making money without producing any new goods/services=inflation. But according to a theory propounded by Mr.Sibbal, this is zero loss. Because

Cinema hall did receive money for ticket sale. So its not like Cinema-hall making losses! anyways, for common men: 1. Buying ticket=not crime. 2. Buying ticket but not watching movie AND selling that ticket to third person @higher price=crime. Method#2: Auctioning method

As the name suggest, Auction the tickets. If person A offers Rs.200 for a seat and Person B offers Rs. 500 for the same seat, then sell the ticket to Person B. From theatre owner (Govt)s point of view: this method may look good, because now we can earn more money per ticket sold and use that money to finance whatever Development scheme weve in our mind. Here is the problem: if Person B was a doctor, and he had to shell out Rs.500 for one movie ticket. Then he may charge more fees from patients @his clinic to keep the profit margin same. So overall effect on economy= may not be good.

What happened in 2G scam? Recall that you needed two things to run telecom business 2. 1. Drivers license Access to Spectrum (via paying the money to Government) Government decided that 1. We will give license by First come first serve basis. 2. To get this license, youll have to apply before 1st October 2007 and pay money (Entry Fees) for license. 3. And whoever gets the license, he will automatically get spectrum for free. So no need to pay separate money for accessing highway(spectrum). This is known as Spectrum linked with License. 4. If we give you the licence (+spectrum), then youll have to cover 10 per cent district headquarters within the first year of the allotment (i.e. you start serving customers in that area). This is known as Roll out Obligation.

And then, what happened next, is a classic case of cinema ticket black-marketeering.

Swan Telecom(Shahid Balwa)

A new company, it had no experience of running telecom business. Yet it applied for license and got it. (officially) SWAN telecom paid about Rs.1,500 crores to Government, as 2G Spectrum License fees. But this company did not open a single outlet/mobile tower. So it didnot meet the Roll out Obligation. It simply sold 45% stakes to UAEs Etisalat for around 6000 crore rupees. Calculate the profit%. Shahid Balwa was arrested in 2011, released on bail, thus proving that he is totally awesome. His argument in the court, Since Mr Sibal and the PM have both said that there was no loss to the government from the allcoation of licenses in 2008, so Im being wrongly accused of corruption and conspiracy. Unitech (Sanjay Chandra)

This company didnot have any prior experiance of telecom business.

Yet, Applied for license, paid $365 million as licence fee to Government. Did not open any outlet/mobile tower. Then sold 60% stakes to Norways Talenor for $1.36 billion= huge profit without doing anything. Thus name of company changes: Unitech+Talenor=Uninor. Recall: bought the ticket, did not watch the movie and sold the ticket to third party @higher price. A.Raja (Telecom Ministry)

Behold my awesomeness. Ignored the advice of PM, Finance Ministry, Law ministry, TRAI etc. TRAI had advice Raja to sell the spectrum via auctioning.

But Raja used first come first serve basis. Licenses were sold in 2008 but the price (entry fees) were kept very low @2001s market rates. Initially the last date to apply for licenses = 1st October 2007. But then Raja changed policy well give license to only those companies who applied before 25th Sept. This way later-comers could not get license (and had to buy it from black market). He allowed ineligible companies to apply and get license (e.g. Unitech) The companies who got license but did not start business (UNITECH and SWAN)Raja did not take action against them. He should have cancelled their licenses or imposed heavy fines on them. Companies paid him the bribes, he transferred money to bank accounts under his wifes name in Mauritius and Seychelles. Arrested in 2011, got bail in 2012, came back in parliament, thus proving that he is totally (and that means totally) awesome.

Kanimozhi

Kanimozhi

DMK MP, Daughter of Karunanidhi. Shahid Balwa (SWAN) got benefit because of Raja. So he had to pay the bribe. He transferred Rs.200 crores to Kalaignar TV channel, which is owned by Kanimozhi and her step mom Dayalu Amma and other family members.

Arrested in 2011, got bail in 2012, came back in parliament, thus proving that she too, is totally awesome. Neera Radia

Her Shawl is worth Rs.1 Lakh

There are some phone-tapes, in which this lady is talking with Barkha Dutt (NDTV fame). To put this bluntly, Radia allegedly paid money to Congress party, to get Raja appointed as telecom minister. Then Raja could use the office to benefit particular companies in 2G auction (who had financed his posting). This phone scandal is known as Radia Gate. Only questioned, not arrested, and it is said that she wore a Kashmiri shawl worth Rs.1 lakh during questioning by Enforcement Directorate, so she too

is totally awesome. Now that shawl has become so recognisable that Kashmiri shawl sellers have started referring to it as the Radia shawl and sales of it have shot up= good for economy, GDP increased. There are some other players too- RK Chandolia, Siddharth Behura et al, but you get the idea- they too are totally awesome. CAG: 1.7 lakh crore loss

CAG Vinod Rai

The 122 2G licenses were given by Raja for over Rs 9,000 crore.

While 3G auctions for a smaller number of licenses had fetched the government a sum of Rs 69,000 crore. Therefore Government has lost money (Besides, whatever money made by ticket black-marketeers, is loss to the cinema hall owner) The question remains, how much money was lost? CAG says Government lost Rs.1.76 lakh crores, it has come to this figure, using extrapolations from 1.

licenses were sold in 2008, @the MRP of 2001 2. The money received from 3G auction vs the money recieved from 2G license. 3. 2G Spectrum was allotted for free. (recall Government only asked for entryfees for licenses. Spectrum was linked with License). 2G-Spectrum should have been auctioned. 4. Profit made by Swan and Unitech etc. through black-marketeering. Parliament -JPC

In Feb-2011, Parliament Constituted a Joint parliamentary Committee to probe the 2G scam. No real progress so far. Supreme Court verdict

Swami

Subramanian Swami, filled a petition in Supreme court, regarding the irregularities in 2G Auction. The case went on, finally in Feb 2012, The Supreme Court cancelled 122 licenses issued in 2008, by A Raja when he was Telecom Minister. Supreme Court said, these licenses were granted in an arbitrary and unconstitutional manner. SC asked the Telecom Regulatory Authority of India (TRAI) to recommend a new process of allocation of licenses,

along with guidelines for an auction of spectrum. Supreme Court has also ordered Government to finish the auctioning before Jan-2013. Presidential reference on SC verdict After above verdict of Supreme court, Government decided to get clarification, on whether should every natural resources (coal, gas, petroleum, water etc) be allotted through auction only. (although technically Spectrum is not a natural resource, it is generated because of man made satellites.) But, Mohan cannot just call any SC judge and seek clarification. A procedure has to be followed. Through Article 143 of the Indian constitution, the president can refer matters of public interest to the Supreme Court and seek their opinion. This is known as Presidential Reference. Here, first the Cabinet headed by Mohan approves a resolution that WE need to send presidential reference in this xyz matter.

Letter goes to President of India, then he/she sends a new letter to Supreme court asking what should be done in this XYZ matter?

Supreme court on Presidential Reference

Supreme court said auction cannot be the only method of allocating natural resources, it should be considered on a case-by-case basis. Earning maximum revenue is secondary to serving the public good in allocating natural resources. But if allocation of a particular resource is going to get sudden huge profit to a company, then such resource should be allotted through auction only. (for example 2G spectrum). In anycase, all decisions and actions of the government are open to being questioned by the court.

Apart from that, a committee on allocation of natural resources, headed by Ashok Chawla, also recommended the adoption of a transparent and competitive process for the allocation of natural resources.

Impact of License Cancellation by Supreme Court Customers

Since the license are scrapped, and new auction will be held = input cost of mobile companies will increase. So, Theyll increase the call-rates to keep the profit margin same. Therefore final consumer (common men) become the innocent victim in this game. Foreign Investors Norways Talenor and UAEs Etisalat Company had paid heavy price to invest in the telecom sector of India. But since the licenses are cancelled, in future, the foreign investors will be extremely cautious before investing in India, particularly in the sectors related with allocation of spectrum, coal mines etc.

Government

The reputation of Government =already down. So in terms of reputation theyve got nothing to lose.

They make excuse that 1) 2G =Zero loss. 2) Since licenses were not auctioned = companies got them cheap = call rates were cheaper = public benefited from this. Congi Government also maintains that we merely followed the policy of NDA (BJP), i.e. spectrum was linked with license and first-come-first serve basis. So, if our seniors did brutal ragging on us in the hostel, then we too will continue the glorious tradition by brutally ragging our juniors. Anyway nobody is a saint when it comes to allotment of land, coal reserves, spectrum etc be it congress, BJP, state Government, union Government. because everybody needs truckload of cash to finance election campaigns. Now Government will auction some 2G spectrum in Nov 2012 and expects to earn around Rs.40,000 crores. And this money could be used to solve the fiscal deficit problem (click me) or to finance any new Government schemes for poor people.

Banks

SBI, PNB and other banks had landed to some of those telecom companies and now licenses are cancelled, so loanmoney is stuck. Anyways, nothing new for SBI- their loanmoney is stuck with Vijay Mallya (Kingfisher) also. Theyve to prepare one more stupid topic for exams/group discussion /interview. Anyways, nothing new for them either, theyre used to this irony of life. Sistema Russia issue Just like Telenor (Norway) and Etilsat (UAE), Sistema (Russia) is also a foreign telecom company. Sistema had bought stakes in an India company (Shyam Telecom), but then Supreme court cancelled their license. Now Sistema has appealed the Supreme court to restore its license, current matter is pending in court. In the light of this event, Russian Government has warned India that

Innocent aspirants of competitive exams

If the issue of cancellation of 2G license to Sistema is not resolved in Indian courts, we will go for international arbitration. (because Russian Government too holds about 17% in this Sistema-Shyam telecom company.) 2. Row over Sistema will have great repercussion not only on Indo-Russian bilateral cooperation but also for foreign investments in India. 3. We will not let Sistemas USD 3.1 billion investment in its Indian telecom venture go waste due to internal problems here. 1. Spectrum Refarming This is a separate issue, not directly associated with 2G Scam of A.Raja. In 2001, some companies got License + free spectrum (900 Mhz). (recall that Spectrum was linked with the license.) Theyve to renew their license in 2014. But now Government has changed policy. According to new policy, Spectrum is delinked from License. So youve to apply for license separately and you have to

purchase spectrum separately (through auction). Telecom Regulatory Authority of India (Trai) has suggested that existing mobile operators will have to surrender the spectrum in the 900 Mhz band at the time of license renewal in 2014. And then, this 900 Mhz spectrum will be auctioned again. Under this so called Spectrum-refarming process, if the companies manage to win in the auctions, they will be able to retain the spectrum or, in lieu, they would be given the 1,800 MHz spectrum via another auction. Telecom companies are against this decision. Their argument, weve already invested more than one lakh crore rupees in machinery, mobile tower, other infrastructure for 900Mhz spectrum. If you take this away and give us new type of spectrum, well have to buy new machines=well increase call rate price to cover the losses. The matter will now be decided by Empowered group of ministers (EGoM).

1. Infrastructure Bottlenecks? 2. What is National Investment Board (NIB)? 3. Functions of National Investment Board (NIB)? 4. Anti-argument/Objections against NIB? Infrastructure Bottlenecks? Infrastructure= railways, roads, ports, thermal plants etc. that are essential for other economic activities. Infrastructure projects worth over Rs 7 lakh crore are pending because environment ministry is not clearing the files. Every time a coal miner wants to increase production, he has to get fresh clearance from environment ministry. It is timeconsuming. This has led to low coaloutput= thermal power plants cannot produce much electricity =grid failure, as we discussed in earlier article CLICK ME Another example: If you want to open a thermal power plant, you need to get a file cleared from the Coal Ministry. But to get that file cleared, you need to get environment and forest clearance from Environment Ministry. Even if environment

clearance is given, forest clearance may take longer or even ultimately be denied. Thus, some power projects are not executed for several years, even after winning an auction.

To extract bribes, the corrupt bureaucrats intentionally delay the files. But sometimes even honest officials delay the files because of mediasensationalization, NGO-lobbies, CAGactivism, judicial activism, R.T.I activismthey fear if some scam comes out and if their signature is on the approval file, then theyll get victimized or made scapegoats. So they too avoid taking decisions.

Because of ^these issues, 1. There is huge infrastructure deficit (=not enough rails, roads, power stations, electricity output required to get 9% GDP growth). 2. Delay in project= input cost increases= indirectly this leads to inflation (price rise) 3. Because files are not cleared= production/construction doesnt start= Less employment opportunities, directly (in the coal mine itself) and indirectly (in some xyz factory that will use that electricity). 4. Government is unable to achieve the Five year plan targets. Check this table: Source: Department of Economic Affairs.

What is National Investment Board (NIB)? Chindu has proposed to setup this National Investment Board.

At present, the final decision/decisions are to be taken by one or more ministries. This is the reason why a truly final decision does not emerge for many years, proposal files keep making merry go

round from one ministry to another ministry. Therefore, the power to take the final decision should be vested in separate board. This would be called National Investment Board Basically its a cabinet sub-Committee, chaired by the Prime Minister + FM, Law Minister as its members. For granting/refusing FDI- approvals, there is already a Foreign Investment Promotion Board (FIPB). And it has lead to fast clearing of files and boosted investment. NIB will provide the same benefits, especially in the infrastructure sector. Prime minister has talked about a new phase of reforms unleashing animal spirits. Hunting is a prime example of the latter and its high time we created a body that went out and energetically sought investment for India amidst an exciting global jungle.

Functions of National Investment Board? At first, NIB will focus on clearing investments project of Rs. 1,000 crore/more in roads, mining (especially coal), power, petroleum and natural gas, ports and railway projects. 2. A dedicated secretariat (staff) will support NIB to identify and monitor key projects and sectors. 3. In the long run, NIB will serve as an arbitrator i.e. If a company feels that its applications for infrastructure projects has been delayed or even rejected by some Ministry or Department without sound reasons, then it can approach NIB for clearance. 4. NIB will be to take over the process of granting licences, permissions and 1.

approvals whenever the respective ministries fail to act in time. 5. Once the final decision is taken by the National Investment Board (NIB), no other Ministry or Department or Authority will be able to interfere with that decision or delay its implementation. Anti-argument/Objections

The main objective of NIB seems to shortcircuit or overtake Environment Ministry for granting project approvals. But NIB might end up approving projects that are not good from long-term environmental view. 2. Creation of such an entity might lead to lax environmental standards and social safeguards (i.e. problems of displaced families because of a project). 3. Government should worry about not just growth but green growth.

1.

4.

NIB has no constitutional authority and its creation will decimate (wipeout) the role of the Environment ministry 5. NIB will turn individual ministries and departments into rubber-stamps. 6. Setting up NIB suggests that existing institutions are not functioning properly. But Creating more institutions to fix existing institutions, is like firefighting. The real long-term solution = re-write the office-manuals/ standard-operatingprocedures for each ministry to prevent file-delays and the tendency to evade responsibilities. 7. Many projects in the railways, coal, telecom, petroleum and power sectors are delayed due to law and order problem (=naxalites). NIB is no panacea for this. 8. Speedy project clearances and implementation would require solutions at the district administration and state Government levels, where the NIB would not be of help as it will comprise representatives only from central ministries. MCQ

Which of the following statements are correct, regarding the Proposed National Investment Board? 1. 2. Itll be headed by the Finance Minister. Itll deal with granting/refusing the FDI in retail, aviation and power-sector. Answer choices: a. Only 1 b. Only 2 c. Both 1 and 2 d. None 1. Prerequisite 2. How to measure inflation? o WPI o CPI o WPI vs CPI difference? o GDP deflator 3. Steps taken by Government to curb inflation o Via import o Via bans / coercive measures o Via schemes o Via Policy/Act 4. Why Govt could not control inflation?

Export bans = uncertainty o Export bans = CAD o Black money and gold purchase o FDI and infra= No quick results o Environmental clearances 5. Steps taken by RBI to curb inflation o CRR rates o SLR rates o Why RBI couldnt control inflation? 6. Way ahead 7. RESIDEX 8. Mock questions
o

Prerequisite To understand this article better, first go through earlier articles on following topics (click on the topic name) 1. WPI calculation 2. GDP deflator CRR, SLR, Repo, reverse repo, LAF and MSF How to measure inflation? There are three ways 1. 2. WPI CPI

3.

3.

GDP deflator WPI

Wholesale price index Compiled by Office of Economic Adviser >Ministry of Commerce and Industry. Base year 2004 Doesnt cover services. its calculated using Laspeyres formula. Items are classified into three categories

1. Primary articles 2. Fuel, power, light, lubricants 3. Manufactured products. Earlier Government used to give weekly primary and food inflation data based on the Wholesale Price Index. But this practice has been discontinued since 2012. CPI

Consumer price index In 2012, the CPI system was reformed

Before 2012 After There were four Now only three Subtypes subtypes of CPI subtypes of CPI 1. Agricultural 1. Entire

Labourer (AL) 2. Rural Labourer (RL) 3. Industrial Workers (IW) 4. Urban NonManual Employees (UNME)

urban population 2. Entire rural population 3. Urban + Rural (consolidate from above two)

Prepared by

First three subtypes of CPI were prepared by All prepared by Labour Bureau Central -> Ministry of Statistical Labour and Organisation Employment (CSO) -> Last subtype Ministry of was prepared Statistics and by Central Programme Statistical Implementation Organisation (CSO) -> Ministry of Statistics and

Programme Implementation . Different years for different subtypes. 1. Agri labour=1986 Common base 2. rural year ( 2010) for labour=1986 all three 3. Industrial subtypes. workers=2001 4. Urban nonmanual=1984 WPI vs CPI difference? CPI WPI (reformed in 2012) Compiled by Economic advisor CSO Statistics Ministry Commerce ministry ministry Includes No Yes services? Baseyear 2004 2010 Items 676 200

Baseyear

included Known as Headline inflation?

Yes

no

When RBI and Government make Importance policies, they mainly Not much pay attention to this number. GDP deflator

How and why GDP deflator is calculated? Already explained in earlier article, click me So not going into details in the current article. GDP deflator is calculated by Central Statistical Organisation (CSO)-> Ministry of Statistics and program implementation. GDP deflator =GDP @current price divided by GDP @constant price GDP deflator is the most comprehensive number to measure inflation, but RBI /Government doesnt use it much for policy making because GDP deflator data comes quarterly (and not weekly/monthly basis).

Measures to contain inflation By Government RBI How? Taxation, Expenditure, export bans etc. Repo, SLR, CRR

Steps taken by Government to curb inflation Via import 1. Govt reduced import duties for wheat, onions, pulses, and crude palmolein were reduced to zero 2. Govt. allowed duty-free import of white/raw sugar. 3. Govt. imported pulses and edible oils and distributed them at subsidized rate. Via bans / coercive measures 4. Govt. put ban on onion export for short periods of time whenever required 5. Govt. suspended futures trading in rice, urad, tur, guar gum and guar seed. 6. Govt. banned exports of edible oils (except coconut oil and forest-based oil) and edible oils.

7.

Govt. imposed stock limits on certain essential commodities such as pulses, edible oil, and edible oilseeds and rice. 8. Increased excise duty on gold. Via schemes

9.

Govt. has been giving rice and wheat to poor families at very cheap rate under the Antodyaya Anna Yojana. 10. Govt. allocated huge amount of foodgrain under the targeted PDS (TPDS).

11. government has allocated rice and wheat under the Open Market Sales Scheme (OMSS) 12. direct cash transfer. 13. Introduced Rajiv Gandhi Equity Saving scheme (with tax benefits) to make people invest money in it, rather than in gold. Via Policy/Act 14. Recently the government permitted FDI in multi-brand retail trading. This will improve logistical facilities connecting

farmers with the final consumers and cut down the middlemen. 15. The States of Madhya Pradesh and West Bengal have recently waived the market fee on fruits and vegetables. Such waivers are expected to promote investment private sector in the infrastructure necessary for transports and processing of fruits and vegetables. 16. Budgetary provisions for improving storage and warehousing facilities, creating infrastructure for aquaculture etc. Why Govt could not control inflation?

From above points, it seems Government did lot of things to reduce inflation. Then why are we not seeing any good results? Export bans = uncertainty Because, to fight food inflation, govt. started imposing ban on exporting some food commodities, increased and decreased the duties on import/export as necessary.

While this may look a good solution for the short term but in long term, this creates uncertainty for businessmen, farmers. It reduces their incentive to produce more, because theyre not certain whether govt. will allow them to export or not? (for example Sugarcane->sugar, onion etc.) So indirectly, this affects employment and income of people => leads to more inflation. Export bans = CAD

When Government puts ban on export of xyz item, that means India receives that much less foreign exchange (dollars). So this increases the Current Account deficit (CAD). When CAD increases = rupee weakens against dollar = crude oil become expensive for us = inflation in everything.

Therefore, export bans are like firefighting / short term quickfix solutions. They donot solve the fundamental problems of Indian economy, infact they worsen it in long run. Black money and gold purchase

All Government schemes = leakage, corruption. And corruption =black money. And black money is mostly invested in gold and real estate. So demand of gold forever high= high current account deficit = rupee weakens against dollar= crude oil price increases = petrol/diesel price increases = even more inflation. Government did try to hike excise duty, make PAN cards mandatory for high value gold purchase and even thought of putting bans on gold import. But these moves have been heavily opposed by the jeweler lobby, hence Government has shied away from doing anything radical to stop the gold consumption. Besides a small hike of 2-3% in gold excise duty doesnt prevent those bad guys with black money from buying gold! And Government hasnt done much to stop the Black money / corruption either.

FDI and infra= No quick results You have read and heard this ten thousand times that FDI in multibrand retail = no middlemen = less inflation in

food. And similarly cold storage, and food processing infrastructure= less wastage. But, suppose Government allows wallmart on Monday, that doesnt mean from Tuesday Wallmart will start running and from Wednesday inflation will be gone. All these things take months and years to get file permission, construction, hiring and training employees, setting up supply lines etc. Environmental clearances

Many coal and mining projects are not cleared due to environmental issues. This has affected the electricity and raw material supply = input cost increased in manufacturing sector=inflation. Fiscal consolidation

Government is on the path of fiscal consolidation so it increased the prices of petrol, diesel and reduced the number of subsidized LPG cylinders. These moves have increased the inflation. Steps taken by RBI to curb inflation

Lets do a recap: from SBI manangers point of view Ive to keep this much cash aside. I CRR cannot loan it to people. I donot earn any interest on this. Ive to invest this much cash in SLR govt. securities, gold and reliable corporate bonds. Ive to pay this much interest rate, Repo IF I take short term loans from RBI. I earn this much interest rate, IF I Reverse deposit my money in RBI for short Repo term. So what will be the impact on liquidity when RBI changes these rates? Rate CRR SLR Repo Rate

When rate is increased Liquidity decreases Liquidity decreases Liquidity decreases

When rate is decreased Liquidity increases Liquidity increases Liquidity increases

Note: RBI doesnt need to change reverse repo rate, because they automatically

keep it 1% less than repo rate. (1%= 100 basis points). In winter, the supply of green vegetables is high so their price goes down. But in summer, their supply is low, so price goes high. Same is the link between liquidity and interest rates. When liquidity increases = loan interest rate decreases. When liquidity decreases = loan interest rate increases = harder to get loans for home, car, bike, business. RBI focused its monetary policy on two objectives 1. 2.

Control inflation. Facilitate growth.

But It has been very difficult to do both these things at the same time. Because if RBI wants to control inflation, then it needed to reduce the liquidity= RBI had to increase repo rate, CRR. But this type of tight monetary policy badly affects both producers (businessmen) and consumers. Why?

But when repo rate is increased= liquidity decreased= difficult to get loans for home, car, bike etc.= demand down + difficult for businessmen to get loans = this hurts the businessman and whatever hurts the businessmen also hurt the GDP and employment.

To put this in refined words: the tight monetary policy of RBI decreased the flow of credit (loan) to productive sectors of Economy and hence negatively affected the growth.

But due to inflationary pressures, RBI followed tight monetary policy during 2010-11. During this period, RBI raised policy rate (repo rate) by 3.75%= repo rate was increased from 4.75 per cent to 8.5 per cent. Check the following chart.

But this move has backfired: global economy was progressing slow (due to problems in EU, and USA not yet fully recovered) => so, this tight monetary policy actually contributed to a sharper slowdown of Indian economy than anticipated. GDP growth rate fell down from good 9+% to around 5-6%.

CRR rates Check the chart

As you can see, between 2010-11, here too, RBI kept increasing CRR rates to curb inflation. But from 2012 onwards, RBI has started decreasing the CRR. SLR rates

As you can see, RBI hasnt changed SLR much in last three years.

Why RBI couldnt control inflation? Were facing inflation because there is mismatch between supply and demand. Supply (of food, gold, houses, everything) is low While demand of those items (particularly food) is high (because population is high, the income levels of public has increased). Now think about this: What can RBI do? It can only increase the interest rates. While increased interest rates may decrease the demand of houses, cars, bikes but it cannot directly decrease the demand of food, milk and other essential commodities. In other words, Interest rates cannot change the dietary habits of people, not at least in the short term. Besides, high interest rates make it difficult for businessmen to borrow = less new projects = less new employment, less GDP. Therefore primary solution to fight Indias inflation =Increase the supply of food items.

But this will requie thorough revision of the way govt. treats agriculture, allied activities, food processing and infrastructure. Small farms, disguised unemployment, heavy reliance on monsoon : all these issues must be addressed in comprehensive manner. Way ahead For RBI

World Banks report (January 2013) says prices of most of the global commodity prices are expected decrease in 2013 and 14 (except for metals.) However, as per the assessment of RBI, global economic and financial conditions are still fragile. So theyre not providing any growth stimulus to the economy. (for example, if situation in Europe and America was good, theyd have been importing a lot more goods and services from India= Indias GDP could increase.) So in that context, even if RBI drastically reduces repo or CRR, that wont do much good to economy. For Government

tackling the supply side bottlenecks take months and years. So in the mean time poor people must be protected from the inflation. Thats why govt. needs to continue giving welfare schemes and subsidies. But such support must be targeted to the right beneficiaries: thats where UID/Aadhar, Direct cash transfer comes into picture. Other than that, Government needs to continue pushing for fiscal consolidation, deregulation of sugar pricing (as per Rangarajans recommendations), and other policy initiatives. On a side note: RESIDEX

Rural to urban migration is an inevitable part of economic growth. But when people migrate from rural areas to urban areas, it creates pressure on civic amenities and housing (slums).

% of Indian population living in Urban areas 1951 17 Year

2011 2040

30 50 (expected)

Until recently, we did not have an index to capture the prices of residential buildings in urban areas. Hence Residex index was launched in 2007. This index records the changes in the prices of residential buildings. According to the RESIDEX, the housing prices have declined in Hyderabad, Banglore and Jaipur (from 2007 to 2012) but they have increased by more than 100% in Pune, Bhopal and Chennai. Mock questions 1. Correct statements about WPI? a. It is released by finance ministry b. It classifies items into three categories 1) primary 2) fuel and fodder 3) Manufactured products and services. c. It is calculated using Laspeyres formula. d. None of above 2. Incorrect statements about CPI

4.

a. The base year is 2004-05 b. It is calculated by Labour Bureau with the help of NSSO c. Both A and B d. Neither A or B. 3. Correct statements a. CPI measures price change in both goods and services. b. WPI measures price change in only in goods but not in services. c. Both A and B d. Neither A or B. What is the formula for GDP deflator? a. GDP at constant price divided by current price b. GDP at current price divided by annual WPI c. WPI divided by CPI d. GDP at current price divided by constant price 5. What is RESIDEX? a. It is a drug to combat swine flu. b. It is a new vaccine for rabies. c. It is an index to capture the prices of residential buildings in urban areas.

d.

6.

7.

It is an index to capture the prices of residential buildings in both rural and urban areas. Between March 2011 to March 2013, what was the highest Repo rate? a. 9.00 b. 7.25 c. 8.50 d. None of Above Which of the following can be used to measure inflation directly? a. Current Account deficit b. GDP deflator c. Fiscal deficit d. Purchasing power parity

1. Overview 2. What Is Fiscal Marksmanship? 3. Why Poor Fiscal Marksmanship? 4. Steps taken in Budget 2012-13 5. #3: GAAR (but delayed) 6. #4: SERVICE TAX: negative approach 7. Issues: Tax Buoyancy 8. Issue: COLLECTION RATES 9. Issue: Non-Tax Revenue 10. Issue: SUBSIDIES 11. Public debt 12. 14th finance commission

13. 14.

Background: why finance Commission? Finance Commission: structure 15. Terms of reference 16. Way ahead? 17. Mock questions Overview

We know that when Government spends more money than it earns= leads to fiscal deficit and high level of fiscal deficit = bad for economy. For more details, read the earlier Vijay Kelkar article click me Chapter 3 of economic survey, deals with these issues of public finances and deficits. What Is Fiscal Marksmanship? This is a new term introduced by Economic survey. Marksman= an expert shooter. Suppose Government decided that for the given year,

1.

our direct tax collection target is xyz cr.,

2.

our indirect tax collection target is xyz cr., 3. our subsidy bill will be xyz cr., 4. our fiscal deficit will be xyz cr.these are all targets set by Government.

For the moment, lets concentrate on the fiscal deficit target. From the earlier articles, you know that high level of fiscal deficit is bad for economy. So in 2003, Government had

enacted an act called fiscal responsibility and budget Management (FRBM) Act This FRBM act stipulated that Government will reduce its fiscal deficit. The original target was that fiscal deficit should be only 3% of the GDP for the year 2008-09. And similarly Revenue deficit should be 0% of the GDP for the year 2008-09. But actually for 2008-09 the fiscal deficit around 6% of the GDP! (instead of the target of 3%) That means, Governments gunman (finance minister) fired a bullet but instead of hitting 3%, it hit 6%. That means Governments fiscal marksmanship was poor (because they cant hit the target precisely). Now the question comes in mind. Why Poor Fiscal Marksmanship? How can Government overshoot the (fiscal deficit) target? Well, fiscal deficit will happen when Governments outgoing money is more than its incoming money. Recall that in 2007, subprime crisis happened in USA and its shocks were felt

on every country, including India: export declined, business activity declined.So, Government had to take some initiative to protect Indian economy from further damage. Therefore Government decreased excise duty, decreased the service tax + offered many tax incentives to businessmen, to boost demand of Indian products and services within India and abroad. (=incoming money of Government reduced). Thus, Government missed the Reven ue collection target (first proof of poor fiscal marksmanship.) On the other hand outgoing money was high because 1. MNREGA and other welfare schemes. (+ the lot of that money didnot go to actual poor people. so such schemes didnot show the desired positive result on the economy.) 2. Subsidies on petrol, diesel, LPG, Urea etc. 3. Since 2009s general election was coming, so Government wanted to woo the farmers. So it gave debt waiver to

farmers = again outgoing money increased. Government increased minimum support prices (MSP) to farmers for sugar, wheat etc. In other words, Government overshot (missed) the expenditure target (second proof of poor fiscal marksmanship.) And since Government already missed the first two targets (Revenue collection and Expenditure) so obviously third target (fiscal deficit) was going to be missed. Thus in 2008-09 Government could not show its sharp / precise / accurate fiscal marksmanship. To put this concept in refined words= Government overshot the deficit targets in 2008-09 to obviate the adverse impact of the global financial crisis and to give largesse on the eve of the 2009 general elections. Anyways ^that was the story of 2008-09, but even in 2011-12, Government was showing signs of poor fiscal marksmanship because

1.

Policy paralysis in last two years. Combine this with slowdown in

Europe=our (export) sector is not performing good, GDP is going down, low IIP=> low tax collection. 2. Disinvestment targets could not be met because markets response was lukewarm. (Meaning Government wanted to sell its shares of some PSU but private players were not interested in buying them @high price). 3. Inflation continued to be above 7 per cent=again higher subsidy payments, lower tax collection. 4. high inflation = people opting for goldpurchase as safe-investment + high crude oil price= CAD increased = rupee weakened against dollar= even more inflation= profit of businessmen declined = less tax collection. 5. In earlier years, Government could make truckload of money through proper auctioning of spectrum and coal mine licenses, but both were ridden with scams and corruption. So when Government tried to auction 2G again in the late 2012 (after supreme courts order), private players werent much interested.

6. Controversies surrounding Vodafone case and GAAR implementation = foreign players felt less confident investing in India. Lately Government has woken up and started firefighting: the increasing of petrol-diesel prices, decreasing number of subsidized LPG cylinders, increasing FDI limits in multibrand retail, insurance, aviation, increasing the railway ticket prices, direct cash transferthese are all measures to decrease the fiscal deficit (=achieving fiscal consolidation). anyways back to the story: Steps taken in Budget 2012-13 1. In Budget 2012-13, FM announced that Government will restrict expenditure on central subsidies to under 2 per cent of GDP. (meaning if Indias GDP was 100 billion rupees, then Government will only spend 2 billion or less on various central subsidies on petrol, diesel, urea, PDS). 2. FM introduced the concept of effective Revenue deficit. = Revenue deficit MINUS grants given to states for creation of capital assets. (this means

technically, on paper, Governments Revenue deficit will look smaller!) #3: GAAR (but delayed) GAAR was already discussed in earlier article, click me This was #EPICFAIL, because led to huge protests from business lobby. Government setup Shome Panel to look into GAAR. Shome says, delay GAAR implementation till 2016. Chindu agrees.

#4: SERVICE TAX: negative approach

Usual approach is: Government would say the service tax on xyz item is xyz%. But in 2012-13: Government introduced a new approach negative list. Here, Government would say xyz items are exempted from service tax payment(e.g. doctor, lawyer)= It means service tax applies on all the remaining services that are mentioned in the Negative list. Service tax=12%* on all services that are not included in the negative list. (rate is same for both 2012 and 2013s budget)

Government also implemented service tax on railways (first class or an air conditioned coach) from 1st October 2012.

*By the way service tax is 12% but some books/material/websites might say service tax is 12.36%. WHY? Because they include cess on the service tax. Service tax 12.00% 2% educational cess. Meaning tax +0.24 on tax = 2% of 12% 1% Senior & Higher Education +0.12 Cess= 1% of 12% Effective service tax =12.36% #5: IT in IT To increase the tax collection, Government is making extensive use of information technology is continuing, viz. along with e-filing of income tax returns, various forms, audit reports, and statements of tax deduction at source have been made compatible with electronic filing and computerized centralized processing. This helps checking tax evasion and black money.

Issues: Tax Buoyancy

A tax is buoyant when revenues increase by more than 1 per cent for a 1 per cent increase in GDP. After the FRBM act, both direct and indirect taxes remained buoyant except in the crisis years (2008-9 and 2009-10). But in 2011-12, the tax buoyancy declined sharply in corporate tax sector. Because high level of inflation decreased the actual profits of corporate sector. Issue: COLLECTION RATES

It is the ratio of revenue collected from imported items vs the value of imports in a year. Collection rates have decreased last year because petroleum, oil, and lubricants (POL) are expensive in terms of value but Government is levying lower levels of duties on them. 2. Tax exemptions are given on various imported items. Issue: Non-Tax Revenue 1.

Last year, Government couldnt get sufficient incoming money from non-tax Revenue sources because Market gave lukewarm response to disinvestment. Government was expecting to auctions of telecom spectrum and phase III FM Radio for around 15,000 cr. But it did not work out. As the 2G telecom spectrum auction elicited lukewarm response on account of the high reserve price.

Issue: SUBSIDIES The Budget for 2011-12 had estimated total expenditure to be contained at 14.0 per cent of GDP but Government also overshot this target due to high global oil prices and subsequent increase of subsidy bill (for oil and fertilizers) = another example of poor fiscal marksmanship. Government should give priority to food subsidy due to extent of malnutrition in the country. The government aims to do this via National Food Security Act.

But there is also need to reduce leakages involved in subsidy delivery= Government aims to do this via Direct benefit transfer (DBT) / direct cash transfer. Public debt It is further classified into internal (domestic) and external debt Internal debt makes up around 91 per cent of public debt. State governments are not allowed to directly borrow externally hence their entire debt is domestic.

14th finance commission Background: why finance Commission? India is a quasi-federal country. Weve union Government, weve state Government. Both have their De Jure heads (President vs Governor), Both have their De Facto (Real) heads (PM vs CM) Both have their separate administrative machinery (central service employees vs state service employees)

Both have their taxation powers and so on Point is: Taxation power of state Governments is limited. Majority of taxes paid by the public goes to the Union Government via income tax, corporate tax, service tax, excise duty. So if the Union did not give even single paisa from its pocket to the states, then state Governments cannot survive. (because state Government also need to pay salary to staff, public amnesties and interest on previous borrowings.) Therefore, Constitution of India mandates that Union has to share some of its taxes with the states. But who will decide how much tax money must be shared between union and the states? Ans. Finance Commission. (for more, read financial relations on pg 13.8 to 13.13 in Laxmikanth).

Under art. 280, President sets up this Commission every 5 year. Chairman Vijay Kelkar Year 2010-

Finance Commission 13th

14th

Y.V.Reddy, Former RBI Governor

15 201520

Finance Commission: structure

1 chairman + 4 members. 1 Chairman = experience of public affairs 4 members need to have following qualifications

1. Serving or retired judges of High Court, or someone who is qualified to become one 2. knowledge of Government finances or accounts, or 3. experience in administration and finance. 4. Special knowledge of economics. Terms of reference The 14th finance Commission will look into following matters 1. Distribution of certain taxes between union and state. 2. What principles should Union follow while paying grants-in-aid to states? (from the consolidated fund of India)

What measures should be taken to augment the Consolidated Fund of a states so they can help the panchayats and municipalities. 4. Review the state of finances, deficit, and debt levels of the union and states 5. Give suggestion to maintain a good fiscal environment and equitable growth. 6. Give suggestions to amend the FRBM Act. 7. How much money should be spent for the maintenance of capital assets 8. How to monitoring ^such expenditure? 9. Should Government insulate the pricing of public utility services like drinking water, irrigation, power ,and public transport via through laws? 10. How to make public-sector enterprises competitive and market oriented; 11. Matters related to Disinvestment 12. Should Government giveup nonpriority enterprises? 13. Climate change, sustainable economic development 14. What will be the impact of the proposed goods and services tax (GST) on Centre and State?

3.

15. Will GST implementation lead to Revenue loss to States? If yes, then how to compensate that loss? 16. How to arrange money for disaster Management related activities? Way ahead? Prolonged fiscal deficit leads to 1. higher real and nominal interest rates, 2. slower growth in capital formation 3. potentially lower the rate of output growth.

Therefore Government must stick to the fiscal targets. Although, Government cannot rapidly reduce its outgoing money (expenditure) because 1. 2. Government has to pay interest on earlier borrowings Continued payments on defense, civil service pay and pensions, etc.

Thus the annual budget has to maintain a delicate balance between 1. Non-developmental Expenditure that is necessary.

2.

development expenditure for inclusive growth. Mock questions

Q1. What is the correct equation of effective revenue deficit? Revenue deficit MINUS grants for creation of capital assets. b. Revenue deficit PLUS grants for creation of capital assets. c. Primary deficit plus fiscal deficit. d. Fiscal deficit MINUS Revenue deficit. Q2. Find Incorrect statement(s) about service tax? a. The service tax rate was 12% for 2012-13 and increased to 12.36% for 2013-14. b. Railways is exempted from service tax. c. Service tax is levied on the items listed in the negative list. d. All of above. Q3. Find Incorrect statement(s) about Finance Commission a.

The time frame for 14th finance Commission is from 2010-15 b. It has 1 chairman and 3 members. c. One of the member must be a serving or retired judge of Supreme Court. d. All of above. a. Q4. Find Correct statements 1. 2. Major portion of Indias public debt is financed from external sources. The debt of all state Governments is internal. Choice a. b. Only 1 Only 2 c. Both d. None

1. Liquidity? 2. What is Cash reserve ratio (CRR)? 3. WHY CRR: Cash reserve ratio? 4. WHY SLR: Statutory liquidity ratio? 5. Bank Runs: SLR+CRR 6. WHY Priority Sector lending? 7. What is NDTL? 8. Reverse repo rate?

9. What is repo rate? 10. Repo rate vs Bank rate? 11. What is LAF? 12. LAF timeline 13. What is RGTS? 14. What is Marginal Standing facility (MSF)? 15. Difference between LAF and MSF 16. Food for thought 17. Open market operations? 18. Mock Questions Liquidity?

Liquidity is a relative term. For assets: Rs.1 crore worth gold is more liquid than Rs.1 crore worth farmhouse. Because you can quickly sell the gold in a few days, but for selling farmhouse youll have to deal with so many prospective customers, real-estate agents, paper work, stamp duty etc., this would take more than 15 days= not so liquid. For banking: if yesterday SBI had Rs.100 to give as loan today SBI has Rs.200 to give as loan, then we say liquidity has increased. (And vice versa).

In winter, supply of green vegetables increases (compared to summer) so selling price of green vegetables decreases in winter (compared to summer). Similarly when liquidity (money supply) increases, the cost of borrowing (=interest rates) goes down. Very high liquidity can create demand pull inflation=bad. for more, click me Very less liquidity=cost of borrowing is extremely high for businessman = bad because he cannot easily start or expand his business=less people get employment. So one of the job of RBI= control this liquidity in banking system. RBI mainly uses following tools to control this liquidity / money supply in the banking system.

Cash reserve Ratio (CRR) 2. Statutory Liquidity Ratio (SLR) 3. Liquidity Adjustment Facilities (LAF) (Repo and reverse repo) 4. Open market operations (OMO) What is Cash reserve ratio (CRR)?

1.

For the sake of simplicity, lets assume there are only four people in India: 1) common men and 2) businessmen 3) Commercial banks (like SBI) 4) Central Bank (RBI.) Now the Question: How do commercial banks make money? Common men save their money in bank. Bank gives them say 7% interest rate on savings. Then Bank gives that money as loan to businessmen and charges 12% interest rate. So 12-7=5% is the profit of Bank. Although thats technically incorrect, because weve not counted banks input cost=staff salary, telephone-internetelectricity bill, office rent, xerox machine etc. So actual profit will be less than 5%. But anyways, first lets construct a technically incorrect model.

1.

SBI has only one branch in a small town. It was opened on Monday. 2. On the very same day, Total 100 common men deposited 1 lakh each in their savings accounts here (=total deposit is 1 crore)

3.

and SBI offered them 7% interest rate per year on their savings WHY CRR: Cash reserve ratio?

On Tuesday, SBI Branch manager gives away entire 1 crore to a businessman as loan for 12% interest rate for 5 years. From SBIs point of view, sounds very good right? 12-7=5% profit! But weve not considered the fact that on Wednesday, some of those common men (account holders) will need to take out some money from their banks savings account- to pay for gas, electricity, mobile bills, college fees, writing cheques and demand drafts etc. But SBIs office doesnt have a single paisa left! = problem, protest, rioting, suicides. So condition #1: Banks must not give away all of the deposit money to businessmen for loans. Banks must keep some money with aside. Ok but wholl decide how much minimum cash should a bank keep aside? Ans. RBI via CRR.(Cash reserve ratio).

But banks donot like high CRR. We already saw that in the CRR controversy article: click me

WHY SLR: Statutory liquidity ratio?

Continuing the same example. SBI got 1 crore on Monday. But suppose, RBI gave him order, you must keep Rs.10 lakhs aside. (CRR) Thus, SBI is left with only 1 crore 10 lakhs = 90 lakh rupees. So SBI manager decides to get maximum profit out of remaining money. Suppose ongoing rate for business loans is 12%. But there is one businessman Mr.Parajay. No bank is offering him loan, because his past track record is not good: his earlier business adventures were epic fail. This Mr.Parajay comes to SBI

I desperately need loan for my business. but no other bank is Mr.Parajay, giving me loan. Tell you what, the give me all of those 90 lakh businessman rupees as loans, Im ready to pay 36% interest rate on it! And trust me, Im going to

make lot of money in my new business project. And Im ready to mortgage all of my factories, cars, farmhouses. So if I cant repay loan, you can auction them and recover your money. Good! Ill give you all of my 90 SBI manager lakhs as loan! After six months, Mr. Parajays new business project = also #EPICFAIL. He cannot pay back the EMIs. Although SBI can attach his assets and auction them to recover the money. But itll take lot of time. In the mean time, common-men also read this story in local newspapers and they panic that SBI will collapse and bank manager will shut down the office and run away. So all the common men line up in front of bank and demand back their money. Recall that SBI still has 10 lakh left in CRR. But people want total 1 crore back!

Again money of account holders (common men) is stuck =problem, protest, rioting, suicides. So, Condition #2: Bank must not give away all its loans to risky loan takers. Banks must invest part of its money in safe and liquid investment. So during emergency, bank can sell those liquid investments and take out the money. For example, Government securities, gold, corporate bonds of reputed companies like Infosys, reliance, TCS. These are safe investments. These are also liquid, because you can sell them quickly whenever you want. (recall that SBI could also auction Mr.Parajays properties, but itll take lot of time in paperwork, legal issues etc.) Ok so, bank should invest part of common-mens money in safe investments like Government securities, gold and corporate bonds of highly reputed companies. BUT who will decide how much money should be invested in this sector? Ans. RBI via SLR (Statutory liquidity ratio). In

earlier article, weve already seen SLR in detail. click me Lets assume RBI ordered SBI to keep Rs.25 lakhs under SLR. Thus, out of original Rs.1 crore that SBI had, 10 lakhs (CRR) + 25 lakhs (SLR) are gone. Bank Runs: SLR+CRR

Suppose a rival bank of SBI, hires some people to spread rumors against SBI. The rumor is something like this= SBI invested lot of money in sharemarket but sharemarket is crashed so now SBI doesnt have any money left. Theyre going to shut down the office and run away. ^this is totally ridiculous rumor because according to RBI rules, banks cannot invest depositors money in the sharemarket in the first place! Anyways, out of the 100 SBI account holders (common men), 30 common men believe in this rumor and run to the SBI office.

They demand SBI to return their entire savings deposit. Such panic movement of bank customers is known as bank run. Thankfully, SBI has total 10 lakh (CRR), so they can directly give it back. SBI also has set aside Rs.25 lakhs under (SLR), so SBI can sell away those Government securities, gold worth 25 lakhs and give that money back to account holders. Thus, SLR+CRR protects a bank against Bank runs. However in case of a totally awesome bankrun, nothing can protect a bank. (i.e. when all of the account holders simultaneously demand all of their money on the same day!) anyways back to the topic:

WHY Priority Sector lending? So far, You know what is CRR and SLR. Now SBI manager start making calculation, how much money is left with him? Money received from common men Money set aside in CRR Money invested in SLR 1 crore=100 lakh MINUS 10 lakh MINUS 25 lakh

Money left

100-10-25=Rs.65 lakh.

Out of that 65 lakhs, lets assume SBI manager has to keep aside 15 lakh for Administrative costs, salaries of employees, electricity bill, internet bill, Xerox machine etc. So he has only 50 lakh left for providing loan to needy people. Now loan-takers line up in front of SBI office

Give us loans of 1 lakhs each for buying seeds and fertilizers. However, given the vagaries of 50 farmers monsoon and low profit margin in agriculture, we cannot pay more than 5% interest rate. Give us loans of 2 lakhs each to setup small retail shops / car mechanic / hair saloon etc. We 25 Small offer 11% interest rate. we businessman cannot offer a penny more because our profit margin isnot good. Sir please give us loan of 2 Students Rs.25 lakhs each, for paying

self-financed medical college. We can pay atmost 9% interest rate. Give me those 50 lakhs. In a few months, Diwali is coming 1 Big and I want to setup a new businessman firecracker factory. I offer you 15% interest rate. if SBI is run from purely profit point of view, then farmers, small businessmen, students and weaker sections of the society will never get any loan. Because SBI manager would want to give loan to a person that offers him highest interest rate. Then who is going to protect those weak people? Who is going to help them get loans at reasonable rates? Ans. RBI. Suppose RBI tells the SBI manager, 40% of the money you lend, must go to priorities sectors viz. agriculture, small scale business, housing and education. (=40% of 50 lakh=20lakh). ^This is the basic funda of priority sector lending. More details are given on page 15.12 of Ramesh Singh.

What is NDTL?

So far, We know that Banks have to comply with the CRR, SLR and priority sector lending rules of RBI. CRR, SLR is counted on amount of money a bank receives. But bank receives lot of money,

1. from depositors, 2. from loan takers whore re-paying EMI, 3. (fraudulent) hidden charges imposed on credit cards 4. Commission charged on giving demand draft 5. Commission charged on online money transfer 6. Commission charged on foreign currency conversion etc.etc.etc.

So how does bank exactly count CRR, SLR requirements? = Net Demand and Time Liabilities (NDTL)

Main example (list not exhaustive) 1. Money deposited in Fixed Time deposits (FD) liabilities 2. Cash certificates

3. gold deposits. 4. Staff security deposit. E.g. in some banks when you join as Probationary officer, youve to sign bond worth RS.1-2 lakh rupees. 1. Demand liabilities Money deposited in savings account 2. Money deposited in current account 3. Demand drafts 4. unclaimed deposits;

Im not going into minute nitty-gritty involved in computing NDTL because thats irrelevant from exam point of view. So long story cut short, CRR and SLR are calculated on this NDTL number with some caveats. And banks have to send reports to RBI on fortnight basis that our NDTL is xyz and we are maintaining xyz SLR and CRR on it as per your direction. Now here comes the problem: In our example, SBI followed SLR, CRR and 50 lakh rupees left for loaning.

However in the given period, priority sector loan takers (farmers, students etc.) and regular loan taker (businessmen, car/bike loans).all of them together take total loans worth only Rs.30 lakhs. so SBI is left with 50-30=surplus of 20 lakh rupees. These 20 lakhs are just gathering dust in the office. Nobody is coming to take new loans! What should SBI do? because SBI has to give 7% interest even on these 20 lakh rupees, so SBI cannot afford to let this money gather dust! Now comes the Liquidity adjustment facilities, Repo Rate and reverse repo rate. Lets start with reverse repo rate.

Reverse repo rate?

The book definition of Reverse repo rate = it is interest rate paid by RBI to its clients for short term loans. Ok but who are the clients of RBI? 1. 2. Central Government State Government

3. 4.

Banks (commercial, regional rural banks, cooperative banks) Non-banking financial institutions etc.etc.etc.

anyways, Reverse repo rate in crude words= when SBI parks its surplus money in RBI for short term, SBI makes ^this much profit. But actually reverse repo rate works in a bit complicated manner= via selling and repurchase of Government securities. Youre aware of Government securities: when Government wants to borrow money from market, Government security / Government bond is issued. Basically its a piece of paper. It has agreement something like: whoever gives me Rs.100 will get 8% interest rate for 10 years and then principle will be repaid. For the purpose of understanding Reverse repo, lets construct a simplified technically incorrect model: 1. RBI has Government securities worth Rs.100 lakhs. 2. SBI has surplus Rs.100 lakhs and nobody is taking them as loans. But SBI is

sure more people will come to take loans before Diwali. So SBI just wants to park this surplus 100 lakhs somewhere for the short-term. 3. SBI enters into Reverse Repo agreement with RBI. 4. The agreement reads I (SBI) will give buy Government securities worth Rs.100 lakhs from the RBI, and RBI promises to buy back those securities from me after 6 months @Rs.106 lakhs. Read it carefully: Time: after 6 months, SBIs investment: Rs.100 lakhs After 6 months, SBI gets: Rs.106 lakhs. So profit of SBI (or interest earned by SBI or interest paid by RBI)=(106-100)/100 = 6%. This is reverse repo rate.

Tied to repo rate In 2011, under RBI made following rule: 1. reverse repo rate would not be announced separately but will be linked to repo rate. 2. The reverse repo rate will be 100 basis points below repo rate.(=minus 1%)

So if RBI declares Repo rate=8% then reverse repo-rate is automatically 8-1=7%.But now comes the question: What is repo rate? Common sense says, it has to be reverse of reverse repo rate right? Yes that is right. Textbook definition says

Repo rate is the rate RBI charges on its clients for short term loans. To put this crudely, when SBI wants to borrow money from RBI for short term, SBI will have to pay ^this much interest rate. (again) For the purpose of understanding repo rate, lets construct a simplified technically incorrect model:

1. RBI has cash of Rs.100 lakhs. 2. SBI has Government securities worth Rs.100 lakhs. 3. SBI enters into Repo agreement with RBI. 4. The agreement reads I (SBI) am selling my Government securities worth Rs.100 lakh to RBI and I (SBI) promise to

buy back(repurchase) those securities from RBI after 6 months @Rs.107 lakhs. Read it carefully: 1. Time: after 6 months. 2. RBIs investment: Rs.100 lakhs 3. After 6 months, RBI gets: Rs.107 lakhs from SBI. 4. So profit of RBI (or interest earned by RBI or interest paid by SBI)=(107100)/100 = 7%. This is Repo rate. Question: Why all this gadhaa majoori (donkey labour), involving Government security? Why cant RBI and SBI give money to eachother without involving Government securities just like the normal people borrow and lend to each other? Answer= Because Government security acts as collateral. So if first party doesnt honor the agreement (of repurchase), then second party can sell away the Government security to a third party and recover its money. Just like pawning your jewelry in Muthoot finance or Mannapuram gold loans.

Repo rate vs Bank rate? Repo rate RBI lends money to banks for short term loans @this interest rate.

Bank RBI lends money to its clients for long term loans @this interest rate. rate What is LAF? liquidity adjustment facilities (LAF). Recall that one of the main task of RBI is to control money supply in the economy. RBI controls money supply via monetary policy. For this RBI uses various tools e.g. SLR and CRR. Liquidity adjustment facilities (LAF) is also a tool used by RBI to control short-term money supply.

LAF timeline 1998 1999 2000

Narsminam Committee on banking rector reforms, recommends LAF RBI introduces interim LAF RBI introduces full-fledged LAF.

In the old Bollywood movies, international smugglers often come to main villains hideout with suitcases loaded with cash.

Then main villain will auction some ancient Indian statues to them. Something similar happens under LAF. LAF helps banks to quickly borrow money incase of any emergency or for adjusting in their SLR/CRR requirements. Under LAF, RBI auctions Government securities, starting at the repo and reverse repo rate. Minimum bidding amount is Rs.5 crore. So LAF is a tool used by RBI to control short-term liquidity / money supply in the market. In LAF, money transaction is done via RTGS. (RTGS is an online money transfer method). So in this auction, players dont need to bring suitcases loaded with cash. What is RGTS?

RTGS, NEFT=These are online facilities for transferring money within the country.

National Electronic Fund Transfer (NEFT) Fast (immediate money Slow (done on hourly transfer) basis) Real Time Gross Settlement (RTGS)

Can be used only if Can be used for any money transfer amount amount. There is no is minimum 2 lakh minimum or rupees or more. maximum limit. What is Marginal Standing facility (MSF)? RBI started this thing in 2011. Under MSF, Scheduled Commercial Banks can borrow money from RBI @1% higher than the ongoing Repo rate under liquidity adjustment facility (LAF.) Although, the system of lending remains same just like under repo. = SBI sells Government security to RBI, and promises to buy it back after sometime, at a higher rate. Difference in selling and purchase = interest rate earned by RBI. we can memorize it like

1.

Repo rate = reverse repo + 1% 2. MSF rate= repo rate + 1%

Difference between LAF and MSF LAF Liquidity adjustment facility Minimum bidding MSF Marginal standing facility 1 cr.

amount is 5 cr. Only scheduled commercial banks can bid. Bank cannot sell bank can sell the Government security to Government security RBI that is part of from its SLR quota to banks SLR quota. RBI. Bank can borrow any Bank can maximum amount of money as borrow upto 2% of its long as it has the NDTL. securities to sell. Suppose repo rate is MSF lending rate is r% always (r+1)% All clients of RBI are eligible to bid. Food for thought

Lets take some approx. numbers based on past few months. Repo rate has been around 8%. That means reverse repo is around 7% and MSF is 9%. SBI offers around 7% interest rate on savings account and 0% interest rate on current account. SBI charges around 10% on home loans, 12% on car loans and 18% on bike loans.

That means SBIs profit margin is anything between 3% to 11%. (assuming that it doesnt borrow any money from RBI). Now consider what If SBI parks its money in RBI (via reverse repo rate). Well RBIs reverse repo is also around 7%! may be a few 0.25-0.75% higher than SBIs savings interest rate. Point being, SBI is better off finding more loan takers than parking money in Reverse repo rate because it can earn more profit that way. Reverse repo rate is there usually for worst case scenario, when bank is not finding any loan takers.(or there is recession so nobody is coming to take loans from SBI). Open market operations? Open market operation= when RBI buys/sells securities in open market. How is it different from LAF or MSF? Well in LAF or MSF, one party buys Government security from second party. But second party has agreed to buy back (repurchase) the same security from first party after some time. So Government security is not permanently sold, it is only used as a collateral= thats like

pawning your jewelry in Muthoot finance company. But in case of OMO, first party permanently sells the Government security to second party. Second party is free to do whatever it wants with that security. When RBI purchases Government securities =liquidity increased (because RBI is paying that party some money to buy that security, right? so RBI is pouring additional money into the system.) On reverse, when RBI sells Government securities= liquidity is decreased. (because those players are giving their cash to RBI to purchase the securities= money is sucked out of the system by RBI). Summary From SBI managers point of view I must keep this much money aside. I cannot give it as loan to anyone. I will not earn any interest rate on it. Ive to invest this much money in gold, Government securities (G-

CRR

SLR

sec) and RBI approved corporate bonds. If I borrow money from RBI for Repo rate short term, Ill have to pay them this much interest rate. Reverse If I park my money in RBI, theyll repo rate pay me this much interest rate. If I borrow money from RBI for long Bank rate term, Ill have to pay this much interest rate. Mock Questions Q1. If RBI purchases Government securities via open market operations, then liquidity _______. a. increases b. decreases c. Stays the same. d. None of above. Q2. Correct statement? Repo rate is always 100 basis points higher than MSF lending rate. b. Reverse repo rate is always 100 lower than MSF lending rate. c. Repo rate is always 100 basis point higher than reverse repo rate. a.

d.

None of above.

Q3. Incorrect statement? 1. RTGS and NEFT are two online money transfer methods within India. 2. NEFT is faster than RTGS. 3. NEFT can be used only for transections above Rs.2 lakh. Choice Only 1 b. Only 1 and 2 c. Only 2 and 3 d. All of them Q4. In which of the following, Bank will not be making any money? 1. Meeting CRR requirement. 2. Meeting SLR requirement. Parking money in RBI under Reverse repo. Choice a. b. Only 1 and 3 Only 2 and 3 c. Only 1 d. All of them a.

3.

Q5. If RBI wants to inject more liquidity in the system, it should a. Increase the CRR rate b. Increase the SLR rate c. Decrease the Reverse repo rate. d. Decrease the repo rate. Q6. If RBI wants to reduce liquidity from the system, it should a. decrease the reverse repo rate b. decrease the repo rate c. increase the CRR rate d. decrease the SLR rate

Q7. Time liabilities of a bank includes a. demand drafts b. cheques c. fixed deposits d. credit cards

Q8. Demand liabilities of a bank includes a. fixed deposits b. cash certificates c. current account d. Staff security deposits. 1. Demographic Dividend?

2. Why jobs are not created? 3. Problem#1: MSME o Problem: Bureaucratic procedures o Problem: Infra bottlenecks o Problem: Getting finance o Problems in Debt (borrow) method o Problem in Equity (partnership, IPO, shares) finance 4. Labour laws 5. Case#1: downsizing 6. Case #2: Shifting business 7. Rigid Labour laws: Implications? 8. Pro-Worker or Pro-employer? 9. Apprentices 10. Apprentice: Indian scenario 11. Education 12. School Governance 13. Education: recommendations 14. CONSEQUENCES AND CONCLUSION o Approach #1: Business as usual o Approach #2: Pro-active, Reformist o Approach #3: Populist, Anti-risk 15. Mock questions Demographic Dividend?

In next 35 years, around 70 percent of Indias population will be between the working age of 15 and 59. By 2050 Employable people (crores) India 100 Europe 45 USA 27

It means, India will have more number of people in the productive age groups= more incomes=more demand of products= more growth=high GDP. Seems plausible in theory. But hard to do in practice. A larger workforce translates into more GDP only if there are productive jobs for it. If people are given work of digging up wells and ponds (MNREGA), theyre employed but that doesnt lead to significant rise in GDP (compared to if same number of people were given some skill training and job in manufacturing or service sector).

So If you really want to tap the demographic dividend, then labour force must go through following transitions:

1.

3. 4.

From agriculture to non-agriculture (manufacturing / service sector). 2. from rural to urban from the unorganized sector to the organized. from subsistence self-employment to wage employment.

Why jobs are not created? Problem#1: MSME MSME= micro, small, and medium enterprises. MSME is defined as per investment in plant and machinery. Sector-> Goods Services Micro Upto 25 lakh 10 lakh Small 25 lakh to 5 crore. 10lakh-2cr Medimum 5-10 crore. 2cr-5cr

MSME sector employ 80+ million people in 30+ million units across the country. But in the MSME group, most of the firms are small, there are hardly any medium enterprises. Why?

Because The regulatory environment plays an important role in the lifecycle birth, growth, and death of MSMEs Small scale firms more receive tax benefits from various Government schemes. For example If your firm has less than annual 10 lakh Revenue= you dont need to pay service tax. Similarly, less than 1.5 crore annual turnover= you dont have to pay Central excise duty. While medium scale firms have to pay more taxes, have to obey more regulations on pollution, social security of employees etc. For more, check this Table:

That means, if your firm grows from small to medium size = Government benefits reduced but Government regulation increased. So most of the small scale firms dont buy expensive machinery for production.

In the short run: owner makes decent profit because there is less investment (in machines) + contract laborers are cheap. In the long run: their productivity remains very low (compared to Chinese or American firms of same size.) Low productivity gives them little incentive to grow, completing the vicious circle.

Problem: Bureaucratic procedures

According to the World Banks Doing Business 2013 data, India ranks 132 out of 185 countries in ease of doing business.

Entrepreneurs have to obtain a number of clearances when applying for building/occupancy permits and utility connections (gas, electricity, water, pollution control). Theyve to separately visits to various Government offices and applications are not approved without bribes. Problem: Infra bottlenecks Lack of quality infrastructure (roads, railways, telecom-internet-electricity connectivity etc.) Big firms are less impacted by such bottlenecks, because they have the cash to create alternatives. For example, if electricity is gone, a big company can install huge diesel generator/ its own thermal plant. So, absence of quality infrastructure increases transaction costs disproportionately for small and medium sized firm. Ok so solution = Government should create quality infrastructure. But there is a problem there too:= land acquisition.

However it doesnt mean, Government is not doing anything to improve infrastructure. One of the prominent project is Delhi-Mumbai Industrial Corridor (DMIC). DMIC project worth 90 billion dollars, covering about 17 percent population and 14 percent land in India It extends over seven states and two union territories, viz. Delhi, Uttar Pradesh, Haryana, Rajasthan, Madhya Pradesh, Gujarat, Maharashtra, Daman and Diu, and Dadra and Nagar Haveli The project goals are to double employment potential in 7 years, triple industrial output in 9 years, quadruple exports from the region in 8-9 years skill-building strategy in DMIC is based on a hub-and-spoke model. There will be one Skill Development Centre in every state with subsidiary institutions linked to it. Curricula will be based on the types of industries located in the region and identified regional strengths. Other infrastructure plans include logistic hubs, feeder roads, power generation facilities, up-gradation of existing ports

and airports, developing greenfield ports, environment protection mechanisms, and social infrastructure. Problem: Getting finance Suppose you finished cooking/catering course and you wish to start a restaurant/cafeteria. For that, you need initial investment of lets say 30 lakh rupees. But you dont have a single penny in your pocket. So you decide, Ill not borrow even a single rupee from anyone. first Ill work in some other persons hotel/restaurant. Save money and once Ive 30 lakh, Ill open my own restaurant. Problem?= well, depending on your salary (+family expenses), Itll 5-6-15 years to save that much money and by then inflation would have increased (property rents, electricity, milk, vegetables, tea, coffee etc.) so at that time, 30 lakh wont be sufficient to start a restaurant, youll need 50 or 70 lakhs! Thus, most of the time you cant start business by ^above approach. Youve arrange finance from someone else. And

we already know there are two ways arrange cash/finance to start a business: first is debt and second is equity. Click me For small scale firms, arranging finance by either way (debt or equity) = headache. Because Problems in Debt (borrow) method 1. Many small firms have defaulted on loans in the past. Therefore bank officers are often reluctant to approve their loan applications. 2. To prevent ^risk of loan-default, bank might ask for collateral (e.g. property/valuables that bank can attach if you dont pay EMIs) but most small scale entrepreneurs dont have such collateral.

Loan application procedures are bureaucratic in nature: theyd ask you lot of documentary proofs (like income tax returns, account books, property papers and so on). But most small scale firms run business informally without maintain lot of paper records. Problem in Equity (partnership, IPO, shares)

1.

Launching IPO = requires lot of paper work, team of CAs, finance experts, lawyers etc. = small scale firms dont have it. 2. In India, Angel investors, venture funds are at a nascent stage and small compared to America. (Their meaning / functions already explained in Debt-Equity article.) 3. The Indian angle investors and Venture funds prefer to invest in technology and e-commerce related business. So small scale firms (mostly concentrated in manufacturing sector) dont get finance from them either. Solutions?

A vibrant corporate bond market could help. Even though the MSMEs will typically not be able to issue bonds But large firms and infrastructure projects will be able to access (typically cheaper) bond financing for their long-term projects. So banks will get that much less loan takers from upper end of the pyramid= banks will have more spare cash lying

around. Then theyll be tempted to loan that money to small and medium sized firm to earn some profit (interest). Labour laws Indias labour regulations have been criticized on many grounds including sheer size and scope. There are 45 different national- and statelevel labour legislation in India. Labor laws in India = very rigid. As the size of a factory grows, it increasingly becomes subject to more and more outdated laws. This has hindered the growth of largescale manufacturing industry. Lets understand this with an example:

Suppose youre running a firm with 500 employees, exporting diamond jewelry to USA. But due to recession in USA, the demand of your diamond jewelry has decreased. Case#1: downsizing

Demand of your companys products is decreased, and there is no way you can increase demand because Americans

dont have money, so no matter how much you spend on advertisement, they wont buy more diamond jewelry. On the other hand, Indian consumers prefer gold jewelry instead of diamond. So you cannot increase the demand, then you have to reduce your input costs, else youll start making losses. One way to reduce input cost is downsizing=lay off a few workers, so youve to spent less money on wages. But according to Industrial Disputes Act (IDA), if a firm with more than 100 workers, wants lay off workers, it must get permission of state governments (via Labour Commissioner). While the Industrial dispute act does not prohibit laying off workers but State Governments are often unwilling to grant permission because opposition parties will make an issue out of it saying This Government is anti-worker, anti-poor. Case #2: Shifting business

Since you cannot lay off workers easily (case#1), you decide to shift the business and use those workers.

Instead of diamond jewelry, you decide to make gold jewelry, stop the export oriented business, and concentrate on domestic Indian consumers. But according to the same Industrial disputes Act, if the employer (boss) wants to change the terms and conditions /salary/ job description of workers or if he wants to move workers from one plant to another, then he must get (written) consent of workers. This again increases rigidity. The trade union type leaders will blackmail the employer, Give xyz amount of money else we will not sign the consent papers.

Rigid Labour laws: Implications? Because of the rigid labor laws, It is very difficult for the sick industry to either shut down, downsize or shift business arena. So Indian businessmen try to bypass such laws by

buying some expensive machinery to do to the production. =Industries turn capital intensive rather than labour intensive= less jobs created.

hiring contractual labour without doing paper work (so industrial disputes act doesnt apply in the first place!) and if there is any raid, theyll simply bribe the officials. + outsourcing non-core activities to even smaller firm and those smaller firms also hire contractual labour without doing paper work. Ultimately these things lead to Roughly 85 per cent of the workforce is engaged in the informal sector. = They dont receive social security benefits, pension, insurance, provident fund disability /maternity benefits, paid leave etc. informal workers are also more vulnerable to violations of basic human rights such as reasonable working conditions and safety at work. With little job security and limited access to safety nets, most of the informally employed remain extremely vulnerable to shocks such as illnesses and loss of income. Workers in informal sector are usually poor and hence they have neither the

time, money or knowledge to approach courts to seek justice. Thus informality and poverty are directly linked with each other. Pro-Worker or Pro-employer? From above examples, it is clear the Government needs to make labour laws flexible. But when Government tries to reform labour laws, opposition parties and trade unions create lot of hue and cry. Besides, there is always some state Government election after every few months so the ruling party in union Government doesnt want to lose any vote bank. Thats why labour reforms are always put on backburner. Anyways, if and when Government decides to reform labour laws, what should be its form? should it be proworker or should it be pro-employer? In most countries, there is a middle path in labour laws= not too pro-worker and not too pro-employer either. Such laws provide for

Employer can terminate a worker in case of business distress or for poor worker performance. 2. At the same workers are provided a redressal mechanisms if theyre fired without cause 3. Compensation for severance and unemployment benefits. Apprentices

1.

Apprentice = Someone who works for an expert in order to learn a trade. For example hawala operator, cricket bookie, running your own liquor and gambling dens etc. Such trades cannot be learned by reading theory from books. Youve to work under a master for many months and years to learn the actual skills. That is called Apprenticeship. The syllabus taught in Indian schools, colleges and polytechnics =outdated. The present Indian education system doesnt produce Work-ready labour force. That gap is filled by the system of Apprenticeship.

Apprenticeships are an effective way of ensuring that entry-level workers have the skills required to join the formal workforce by learning on the job and even earning while learning. Several countries have benefited greatly from focused programmes Apprenticeship. For example Japan, US, UK, and Germany. Germany, in particular, has a well-known dual education system that combines classroom/online courses at a vocational school with workplace experience at a company. More than 75 per cent of Germans below the age of 22 have attended an apprenticeship programme.

Apprentice: Indian scenario Years ago, Government had enacted Apprenticeship Act. But it is outdated and rigid from both employers and workers point of view. Problem#1: Apprentice ratio

The statutory limit on (regular) worker : apprentice ratio is very strict.

Implication: suppose the rules say for a drug company, worker : apprentice ratio cannot be more than 20:1. You recently finished final year exam and now you need an apprenticeship certificate otherwise university wont give you degree for B.Pharm. But the factory nearest to your home already got another apprentice and factory owner cannot take you because his quota is over according to that ratio. Ratios are strict because Government feared that businessmen will show their regular workers as apprentice on paper, in order to pay them very low salary. Even for small violations of Apprentice rules, the penalty provisions for companies, are very severe. So no matter how much you beg or request, the factory owner wont take you as apprentice once his quota is over. Thus the whole purpose of apprenticeship system is defeated because of that outdated law. Problem#2: coverage

Apprentices are only allowed in specified trades: for example Pharmacist, Engineers etc. But majority of graduates are not currently covered under formal Apprenticeships. Some recommendations

Simpler regulation: A single window mechanism is needed to clear company applications for pan-India apprenticeship programmes. Wider reach: Add more graduation fields in Apprentice Act. company-led apprenticeship programmes, that place employers at the heart of education, can play a powerful role in imparting job-relevant skills and also repairing, preparing, and upgrading the labour force. For example, the duration of apprenticeship training can be allowed to vary across trades and companies. Short-duration programmes (less than 12 months) can be freed from much of the oversight provided they pay minimum wages.

Relaxing the rigid requirements on the ratio of apprentices to workers could also accelerate capacity creation Dual system of training: Partnerships between companies and educational institutions should be encouraged Active exchanges: There should be active exchanges and portals, matching prospective apprentices to employers.

Education Government measures its success in education sector mainly by two numbers: 2. 1. School enrollment. Money spent in mid-day meal scheme

If we just look at those two numbers, then everything looks hunky-dory. But does it mean all Indian children are getting quality education? But does it mean all Indian children are getting quality education? According to ASER Survey-2012 (by NGO Pratham) 1. Among all children enrolled in Std. 8, only 47% could read English sentences. And Of those who could read English

words or sentences, barely 60% could convey its meaning in their own language. 2. In class 5, more than 50% students cannot read a class 2 level textbook. 3. In class 5, almost 50% students cannot solve two-digit substraction (e.g. 49-23) 4. In class 5, almost 75% students cannot do division. In rural India as a whole, 75% of kids cannot do simple division. (e.g. 25/5) Interestingly, Mohan has declared the year 2012 as the National Year Of Mathematics to mark the birth anniversary of Indian mathematical genius Srinivasa Ramanujan.

Anyways, point is Indian children are bad at maths, English and comprehension (especially in Government school). But There are no bad students, only bad teachers. (says Jackie Chan in Karate Kid) There is no positive relationship between teachers possessing formal teacher training credentials (B.Ed, M.Ed) vs. their teaching caliber.

Besides, State Governments treat teachers as contract laborers, paying extremely low salaries to those teaching assistants / vidhya sahayak. Hence there is no incentive for teachers to pour their hearts and minds into childeducation. On the other hand, since money is low, it doesnt attract brilliant minds into teaching profession in Government schools.

Pedagogy

The default Indian pedagogy (method of teaching) = complete the syllabus of textbook. But it does not reflect the learning levels of children in the classroom, who are considerably further behind where the textbook expects them to be. School Governance

In Government run schools, there is high rate of teacher absence . The fiscal cost of teacher absence was estimated at around Rs 7,500 crore per year.

There is evidence that even modest improvements in governance can yield significant returns. Education: recommendations

1. If Government improves the monitoring and supervision of its schools, then teacher absence will reduce significantly. 2. Government should make learning outcomes an explicit goal of primary education policy (rather than finishing textbook syllabus). 3. Government should invest in regular and independent high-quality measurement of learning outcomes. 4. Government should motivate teachers by rewarding good performance. 5. Government should Launch a national campaign of supplemental instruction targeted to the current level of learning of children (as opposed to teaching to the textbook) delivered by locally hired teacher assistants, with a goal of reaching minimum absolute standards of learning for all children: There is urgent need for a mission-like focus on delivering universal

functional literacy and numeracy that allow children to read to learn. 6. Government should pay urgent attention to issues of teacher attendance, teacher performance measurement, better monitoring and supervision. CONSEQUENCES AND CONCLUSION

Recent economic history is replete with examples of economies that were supposed to have great potential but ultimately did not achieve rapid economic growth and improvements in standards of living. India could become the next example of it. In India reforms are typically implemented only after there is really big crisis (for example 26/11, or Delhi rape). And that too after long debate and after some sort of political consensus is reached on them.

Lets check the possible scenarios:

Approach #1: Business as usual If Government continues on the current path then effects on Indian society and economy will be as following

1. Some improvement in infrastructure but only slow improvement in education, and no change in institutional structure such as business regulation and labour laws. 2. Some movement from agriculture to low skill services such as construction and household work, but very few quality jobs. 3. GDP growth settles into a comfortable 6-7 per cent, the new normal. Achieving 9-10% will be impossible. Approach #2: Pro-active, Reformist If Government seriously implements the necessary reforms then effects on Indian society and economy will be as following 1. The manufacturing sector becomes a training ground for workers, absorbing more students with a middle or high school education. 2. India moves into niches vacated by China such as semi-skilled manufacturing, even while enhancing its advantage in skilled manufacturing and services 3. India experiences faster and more equitable growth.

4.

Social frictions are minimized as both agriculture and manufacturing create better livelihoods. Approach #3: Populist, Anti-risk

In order to win election, if Government spends all money on populist schemes. It doesnt implement reforms for the fear of opposition (like FDI, labour laws, land acquisition etc.) then effects on Indian society and economy will be as following 1. There will be no improvement in infrastructure, education, or institutions 2. Very few jobs are created outside of agriculture. 3. ^because of that, more people stay in agriculture= Pressure on land will increase + Per capita income will decrease. 4. Small agricultural plots do not provide enough income, nor can they be leased out. 5. When things go really worse (a point is reached where monsoon is bad, farmplots are become extremely small, heavy inflation)villagers will start largescale migration to overburdened cities.

(=problems of slums=unhygienic living conditions=outbreak of some contagious disease, increase in crime etc.) 6. Then Government will come up with some scheme to prevent this large scale migration e.g. Rajiv Gandhi Village mein raho yojana under this scheme, whoever goes back to live in village, will be given monthly Rs.500 and 5 kilos of wheat. Thus strain on government finances increases. (=fiscal deficit=even more problems.) 7. The Income inequality between good service jobs in cities and marginal agricultural jobs in rural areas increases tremendously= rich and poor divide grows even further=social unrest, breeding ground for Naxal elements. Mock questions Q1. Which of the following are correct about ASER Survey-2012? 1. 2. It is related to status of University education in India. It is an official survey conducted by Ministry of Human resources and Development.

a. b.

Only 1 Only 2 c. Both d. None

Q2. Governments classification for Micro, Small or medium enterprise (MSME) is based on: a. Number of workers employed in a firm. b. Annual profit earned by a firm. c. Annual taxes paid to Government. d. Investment in plant and machinery. Mains Discuss the contribution of workers and GS1 trade unions in freedom struggle. 1. Write a note on National Child Labour Policy. GS2 2. Write a note on National Policy on Skill Development Examine the need for labour reforms in India. Essay Tapping the demographic dividend GS3 Interview

1. ASER survey has highlighted the pathetic status of Indian primary school education. As a district collector, what will you do to improve the situation? 2. Suppose youre the PM of a country whose demographic dividend phase has passed (number of people in working age are very low compared to aged). So what new policies, laws will you launch to keep your economy booming? 3. What do you understand by the term Industrial unrest. Can you cite any recent examples of Industrial unrest? 4. Last year a Maruti General manager died following a labour unrest at the factory. Some company decided to leave operations due to labour unrest in Kolkata Port Trust. should trade unions be banned to prevent recurrence of such episodes?