Indian Economy Dossier

We understand that a lot of students, especially from science background face a great difficulty in understanding news/issues of economy. The most common complaint we have come across is that terms used in the news/articles are difficult to understand and so is the implication of a certain event.

So we have decided to come up with a new feature where we will answer questions on economy posted by students on this blog in the simple, layman terms and helps students appreciate a news/issue better and gain better understanding of the same.

So let your questions flow in.

Hello Students,

After an encouraging response from the students, the second issue of the “Oracle” for the week of January 20-26 is out. Its being uploaded here for your viewing.

Please note that free copies will be available only for the next two issues so students wishing to subscribe may contact us.

Cheers,

Team IAS Mentors

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p-2.pdf

p-3.pdf

Export Oriented Unit means a unit, which exports more than 50% of its production.

Background:

• The Government amended in November 1983 a concession scheme to facilitate the setting up of export-oriented units (EOUs) in order to enable them to meet requirements of foreign demand in terms of pricing, quality, precision etc.

• EOUs can be set up anywhere in the country and may be engaged in the manufacture and production of software, floriculture, horticulture, agriculture, aquaculture, animal husbandry, pisciculture, poultry and sericulture or other similar activities.

• A 100 per cent export-oriented unit is an industrial unit offering for export its entire production, excluding the permitted levels of domestic tariff area sales. EOUs may be set up with a foreign equity participation of up to 100 per cent.

Benefits offered to 100% EOUs

The main advantages in setting up a unit as an 100% export oriented unit are

• Full duty exemption on all imports;
• Tax holiday for any 5 consecutive years within 8 years from the commencement of production;
• Full exemption from sales tax and excise duty on all local purchases;
• Permission to convert all foreign exchange earnings at market determined rate; and
• Permission to have upto 100% foreign equity;
• EOUs/EPZ units can raise foreign currency loans, subject to certain conditions;
• Industrial plots and standard design factories are available to EOUs/EPZ units at concessional rates

Textile manufacturing sector that has borne the brunt of the appreciating rupee over the past year is likely to get a bailout package in Budget 2008 in the form of reduction in excise duty rates and moratorium in term loan repayments

Proposals like reduction of basic excise duty (BED) on textile machinery and equipment to 8% from 16%, a moratorium on repayment of principal amount of term loans and extending the exemptions enjoyed exclusively by export-oriented units (EOU) to other manufacturers can be considered

Certain textile machinery and equipment are exempt from the BED. However, most of the machinery attracts 16% duty. The finance ministry may reduce the duties on those machinery. Also, there are options like bringing down import duty on textile machinery to a uniform level of 5% to boost manufacturing activity in the sector.

There is a strong possibility that the government would restore the total (excise) duty exemption on crucial textile machinery that was withdrawn in Budget 2007.

The government may also relax norms for the debundling of EOU(Export Oriented Units). At present, such units need to pay all the required duties on their machinery if they want to shift. (see the Important Terms section for definition of EOUs)

Expectations are also on for reducing both the excise and Customs duties on furnace oil for captive consumption of the textile and clothing industry. While Customs duty is likely to be scrapped on the product, used as an alternative to power, excise duty may be brought down to 8-9%. There is a likelihood the government would reduce import duty on long staple cotton to 5% from 10%.

Imports are less than 2% of domestic production and mostly of extra long staple cotton that does not compete with domestic production. With increase in production and improvement in the quality of domestic cotton, import of cotton will now be only in the segments where domestic production is insufficient and, therefore, imports will not offer competition to domestic cotton. Therefore, the present level of 10% basic Customs duty and 4% ACD only results in eroding the price competitiveness of the cotton textile value chain

Also expected is the proposed export-import control over dual use chemicals to be less rigorous. The government might bring down the number of chemicals in the list that it drew up a couple of months ago for strict export-import control. The idea is that legitimate trade of these commercially important chemicals should not suffer where we do not have an international obligation to restrict them.

The ministry of external affairs and the ministry of chemicals had in November agreed to subject international trade in 24 products known as the Australian group of chemicals and many other items in the same class to greater scrutiny.

The Australian group, an association of countries, has a larger list of 63 items as chemical weapons precursors that need stricter licensing. The initial move was aimed at preventing the proliferation of dual use materials from India.

These chemicals should not be subjected to rigorous licensing norms, if at all, then only a few There is no legally binding international obligation on the part of the government to regulate all the chemicals

While India is not a member of this association of nations called the Australia group, America is.

The move has implications for the export of chemicals and allied products, biotechnology materials and products of the aerospace industry

Refers to the process of conceiving, planning, approving, executing, monitoring, analyzing
and auditing budgets in a gender-sensitive way

• On 29 May, 1953 at the age of 33, he and Sherpa mountaineer Tenzing Norgay became the first climbers known to have reached the summit of Mount Everest.

• They were part of the ninth British expedition to Everest, led by John Hunt.

• In 1939 he completed his first major climb, reaching the summit of Mount Oliver in the Southern Alps.

• Hillary was part of a British reconnaissance expedition to Everest in 1951 led by Eric Shipton before joining the successful British attempt of 1953.

• The crucial move of the last part of the ascent was the 40-foot (12 m) rock face later named the “Hillary Step”.

• Hillary climbed ten other peaks in the Himalayas on further visits in 1956, 1960–61 and 1963–65. He also reached the South Pole as part of the Commonwealth Trans-Antarctic Expedition, for which he led the New Zealand section, on 4 January 1958. His party was the first to reach the Pole since Amundsen in 1911 and Scott in 1912, and the very first that motor vehicles had ever reached the Pole.

• Hillary took part in the 1975 general election, as a member of the “Citizens for Rowling” campaign

• However, in 1985 he was appointed New Zealand High Commissioner (ambassador) to India, Nepal and Bangladesh, and spent four and a half years based in New Delhi.

• In 1985 he accompanied Neil Armstrong in a small twin-engined ski plane over the Arctic Ocean and landed at the North Pole. He thus became the first man to stand at both poles and on the summit of Everest.

• Hillary was created a Knight Commander of the Order of the British Empire (KBE) on 6 June 1953; a member of the Order of New Zealand (ONZ) in 1987; and a Knight of the Order of the Garter (KG) on 22 April 1995. He was also awarded the Polar Medal for his part in the Commonwealth Trans-Antarctic Expedition.

• In 1992 Hillary appeared on the updated New Zealand $5 note; Hillary was the only New Zealander to appear on a banknote during their own lifetime

• To mark the occasion of the 50th anniversary of the first successful ascent of Everest the Nepalese Government conferred honorary citizenship upon Hillary at a special Golden Jubilee celebration in Kathmandu.

• He was the Honorary President of the American Himalayan Foundation, a United States non-profit body that helps improve the ecology and living conditions in the Himalayas.

·         In 1972, he became the first, and so far only, American to win the official World Chess Championship, defeating defending champion Boris Spassky

·         In 1975, Fischer refused to defend his title when FIDE, the international chess federation, would not accept all his conditions. He was stripped of his title as a result, after which he became more reclusive

·          Played no more competitive chess until 1992, when he had a rematch with Spassky. The competition was held in Yugoslavia, which was then under a strict United Nations embargo. This led to a conflict with the US government and he never returned to his native country

·          In his later years, Fischer lived in Hungary, Germany, the Philippines and Japan.

·          In 2004–2005, after his US passport was revoked, he was detained by Japanese authorities for nine months under threat of extradition. He was then granted Icelandic citizenship and released to Iceland by the Japanese authorities. He lived in Iceland from 2005 until his death in 2008.

·          At age 14, became the youngest US champion ever (unbroken record yet). He earned the title of International Master with this victory, becoming the youngest player ever to achieve this level (a record since broken)

·          On January 17, 2008, he died at home in his apartment from kidney failure at the age of 64 in Reykjavík.

· Was formed in October 2007, when a consortium led by Vijay Mallya and Michiel Mol bought the Spyker F1 team for € 88 million.

· The team’s roots can be traced back to 1991, when it was founded as Jordan Grand Prix.

· The Silverstone-based squad and facilities were bought by the Midland group in 2005 and re-named Midland F1 in 2006, before being sold to Spyker Cars towards the end of the 2006 season

Colin Kolles will remain as team principal into 2008. Michiel Mol is director of F1 racing, and Mike Gascoyne is the Chief Technology Officer.

· Will be using Ferrari engines in 2008, with the team’s existing deal with Ferrari running to 2010.

· The team will also be using the Indian flag in its team logo from 2008

· Former Spyker sponsor Etihad Airways have a contract with the team until 2009, and have yet to announce any changes to this arrangement

· In November 2007 the team invited Vitantonio Liuzzi, Christian Klien, Giancarlo Fisichella, Ralf Schumacher, Franck Montagny and former Spyker test drivers Giedo van der Garde and Roldan Rodriguez to take part in winter tests along with Adrian Sutil

· Force India chose Giancarlo Fisichella as first driver and Vitantonio Liuzzi as a test driver. Adrian Sutil took the Second Driver Role

· Former Spyker test drivers Roldan Rodriguez and Giedo van der Garde were chosen the as test drivers for Force India

· In June, 2007 The Indian Olympic Association reached an agreement with Formula One boss Bernie Ecclestone to stage a Grand Prix in New Delhi from 2009

· Valencia and Singapore will hold races for the first time in 2008, while Abu Dhabi will enter the fray in 2009 followed by South Korea a year later.

The agreement not to hinder or interfere with India’s nuclear programme for military purposes. * US will help India negotiate with the IAEA for an India-specific fuel supply agreement.

* Washington will support New Delhi develop strategic reserves of nuclear fuel to guard against future disruption of supply.

* In case of disruption, US and India will jointly convene a group of friendly supplier countries to include nations like Russia, France and the UK to pursue such measures to restore fuel supply.

* Both the countries agree to facilitate nuclear trade between themselves in the interest of respective industries and consumers.

* India and the US agree to transfer nuclear material, non-nuclear material, equipment and components.

* Any special fissionable material transferred under the agreement shall be low enriched uranium.

* Low enriched uranium can be transfered for use as fuel in reactor experiments and in reactors for conversion or fabrication.

* The ambit of the deal include research, development, design, construction, operation, maintenance and use of nuclear reactors, reactor experiments and decommissioning.

* The US will have the right to seek return of nuclear fuel and technology but it will compensate for the costs incurred as a consequence of such removal.

* India can develop strategic reserve of nuclear fuel to guard against any disruption of supply over the lifetime of its reactors.

* Agreement provides for consultations on the circumstances, including changed security environment, before termination of the nuclear cooperation.

* Provision for one-year notice period before termination of the agreement.

* The US to engage Nuclear Suppliers Group to help India obtain full access to the international fuel market, including reliable, uninteruppted and continual access to fuel supplies from firms in several nations.

* The US will have the right to seek return of nuclear fuel and technology.

* In case of return, Washington will compensate New Delhi promptly for the “fair market value thereof” and the costs incurred as a consequence of such removal.

* Both the countries to set up a Joint Committee for implementation of the civil nuclear agreement and development of further cooperation in this field.

* The agreement grants prior consent to reprocess spent fuel.

* Sensitive nuclear technology, nuclear facilities and major critical components can be transferred after amendment to the agreement.

* India will establish a new national facility dedicated to reprocessing safeguarded nuclear material under IAEA safeguards.

* Nuclear material and equipment transferred to India by the US  would be subject to safeguards in perpetuity.

• The Indian currency has risen more than 10 percent this year and nearly 2 percent since the U.S. Federal Reserve announced a larger-than-expected cut in its key lending rate and triggered a worldwide stock market rally
• As of Jan 21,2008 one U.S. dollar was worth 39.27 Indian rupees, more than 10 percent less than its worth (45.79 rupees) a year ago

• To put the currency situation in historical context, the dollar hasn’t dipped this much against the rupee since 1996

REASONS
1. Weakening Dollar Worldwide
• The rupee’s rise is part of a larger trend of dollar weakness against all major currenciesaround the globe
• As opposed to the dollar weakness between 2002 to 2004 on account of inadequate capital inflows to finance the huge current account deficit, the present dollar weakness. is beingdriven by more structural factors, particularly,the momentum of growth shifting away from the US towards Europe, Japan and the emerging markets
• Till 2005, the USD 13 trillion US economy provided nearly 50% of the incrementalgrowth in the world economy; by 2006, it had fallen below 40% and in 2007 it is expected to fallfurther
• Another factor giving impetus to dollar weakness is start of a significant diversification intoEuro-denominated assets of portfolios worldwide. There is a noticeable trend of oil invoicing inEuros and of several emerging market central banks diversifying their reserves holdings out ofDollar
• Dollar’s weakness can also be explained by US Federal Reserve’s easing of interest rates. As interest rates of any economy decrease, the value of its currency against other currencies also decreases which decreases its demand as the returns decrease. Hence investors move out of that particular country to greener pastures

2. Capital Inflow into India
• Currently, India as an emerging market is on the radar screen of investors and fund managers worldwide
• The impressive growth story, booming real estate and infrastructure makes India an attractive investment destination for ample liquidity floating around in the world markets at the moment
• In September 2007, investments during 2007 by foreign funds crossed the $11-billion mark, surpassing the previous high of $10.8 billion recorded during the whole of 2005. Foreign direct investment nearly tripled in the past financial year to US$16 billion from US$5.5 billion a year earlier
• Apart from this, Tons of dollars are being repatriated home by Indians or those of Indian origin living abroad. Total Remmitances from Resident Abroad have increased from $78,624 million (1990-99) to $113,402 million(2000-2005)

IMPACT
1. The rise in rupee will have an adverse impact on the fortunes of sectors dependent on earnings in dollars like IT, textile , auto component manufacturers, BPOs and KPOs etc
- As the amount of Rupees per Dollar EARNED will decrease, the pressure on margins of companies in these sectors will be immense. Already, these guys have started feeling the pinch and are demanding a rescue act from the government
- According to the CII’s 19th Business Outlook Survey of Exporters, 71 % respondents expect a negative impact on their bottomlines, while 29 % of respondents expect status quo
2. The news is good for importers whose buying costs will greatly decrease as the number of rupees per dollar GIVEN goes down
- Already we have seen a significant surge in the export numbers. Data released from RBI shows that India’s import of automobiles went up by whopping 77.3 per cent and alcoholic beverages by 32.8 percent in the current financial year
- Overall imports have shown a rising trend, largely due to high imports of non-oil items. Non-oil imports have grown by 42.85 per cent higher so far this year, compared with last year
- Data on imports of sensitive items showed automobile import increased to Rs 350.52 crore from Rs 197.75 crore, while that of alcoholic beverages rose to Rs 41.78 crore from Rs 31.45 crore
- Imports of sensitive items from Indonesia, US, Brazil, Germany, Japan, Thailand, Australia, among others have risen, while those from Argentina, China, Ivory Coast, Malaysia and Sri Lanka have shown a decrease in rupee terms during April-July 2007-08
3. From a macro perspective, rupee appreciation is good news as costs of sensitive items like oil cool down and give a ripple effect on those of other essential commodities
- India imports 70-75 percent of its oil requirement. Even if the cost of oil per barrel has hit a record high of $84 in recent times, the appreciating rupee definitely helps to soothen the harshness of oil price increase
- As India pays in dollars for its oil imports, the cost lowers significantly even as the rupee gains in strength. If at $84 to a barrel India would pay Rs 3, 444 (assuming a dollar rupee rate of Rs 41 for simplicity) for every barrel, at Rs 39.91 India will have to pay only Rs 3,352 for every barrel, a gain of Rs 91
4. Other notable beneficiaries will be students and travelers going abroad (especially to the US) who will have to spend lesser rupees for every dollar that they purchase for their vacation or stay abroad. The rates of international tickets will come down as the cost of aviation turbine fuel drops and students going to US universities pay less as tuition fees
5. A stronger rupee, will also force Indian companies to become even more efficient, which will make them more competitive in the global market, especially as China’s currency slowly appreciates over the next couple of years

STEPS TAKEN BY RBI

The rupee exchange rate is neither completely free-floating nor fixed, but is “managed” by the Reserve Bank of India through buying and selling other currencies. Up until April, the Reserve Bank was buying lots of U.S. dollars, as much as $24 billion to keep the rupee at around 44 to the dollar. But with investor sentiment so hot on India and money pouring in from abroad , the Reserve Bank found itself having to spend more and more on foreign currencies just to keep the rupee stable. When inflation shot up to over 6% in April, Bank officials appeared to decide to stop buying dollars
Instead of going in for direct intervention, the RBI has taken the following indirect measures to check the rupee rise:
- Overseas investment limit of corporates enhanced to 300 per cent of net worth from 200 per cent
- Mutual funds allowed to invest up to $4 billion abroad ($3 billion now)
- Ceiling on prepayments of foreign borrowing increased to $ 400 million from $ 300 million
- `No questions asked remittances/investments’ of individuals raised to $100,000 from $50,000
- Interest rates on FCNR deposits have been reduced below LIBOR and those on NRI rupee deposits equated to LIBOR – effectively near-zero rates given forward premiums

The central bank seems to be more intent on letting the currency appreciation tackle inflation(a big headache for sometime now for the fellas on the parliament street). But it is not overly necessary that rupee rise will check inflation. A lot will depend on source of price-pressures there.

WHAT TO DO?

There is an obvious beating the margins of companies with dollar earnings are taking. In such an environment, the industry needs to be proactive and apart from waiting for the government to come and rescue them, steps need to be taken, some of which are suggested below:

- Systematic hedging of receivables – by heading their earnings at a pre-determined price, the companies can minimize the risk of a further free-fall in dollar
- Diversify Currency Exposure – The other hedging option available to exporters is to invoice their business in different currencies rather than only in the dollar
- Deal Denomination – get into rupee contracts with overseas clients rather than accepting dollar denominated ones
- Operating within a Currency Band – the deal should be structured in such a way that both the parties should enter into contract and decide the band of fluctuation that is acceptable to both
- Use of Derivatives – Various options such as strip, vanilla, natural and structured options should be regularly and after specific period should be used to hedge currency risk. Currency swaps also should be used regularly when the currency deprecates more than expected
- Time for a relook? – Looking at the rupee appreciation may be the time has come for the RBI to switch to a basket of currencies to value the rupee. The other alternative is to increase the business being invoiced in Euro terms.

So, overall the call of the times is to install and maintain proper risk management systems and departments capable of handling volatility in forex exposures keeping in mind when to hedge and how much to hedge, as it’s never possible to hedge 100%.
From a macro perspective, the rupee rise does reflect the underlying strength of the economy as much as it depicts the dwindling dollar. Encouraging overseas investment is a step in the right direction and should help balancing the inflow-outflow tilt. Nevertheless, the impact of such measures remain to be seen and RBI will have its eager eyes on the Inflation mark. Also, the oil being at its all-time high at the moment, it will certainly help if and when it will resume reasonable levels of $65-70 per barrel, which should further help curb inflation. Exporters and other sectors hit by the rupee rise should be given more incentives (no subsidies/protection please!). All in all, we should remember that the present situation has come out of something fundamentally right in our economy as much as it has stemmed from something fundamentally wrong in the dollar. It is beautifully balanced at the moment and one is enjoying the show.