Indian Economy Dossier

“All in all, its just a brick in the wall..” – Pink Floyd

What is it about you that is different? What makes you special? Actually, what makes “YOU”? Have you ever taken a moment and thought about this?

All day we set about our daily lives, working to achieve our goals, to reach somewhere, to realize a dream. But do we stop and ponder over what we are right now and what do we want to be?

And what are those goals anyway? Let’s say you want to become a bureaucrat.  What is in you that makes you eligible to become one? Are you intelligent? Are you well-balanced? Are you knowledgeable? What is it about you?

It is very important to think about these questions because this will give a better understanding of yourself. And life in general and any great task in particular is nothing but a journey of self-realization. You discover yourself when you set about doing something. You discover yourself when success kisses your feet or failure looks in your eye. Someone said in a great movie “you never truly get to know yourself unless you’ve been in a fight”.

Now why do you need to waste time in thinking about yourself. You might say that you’d rather work/study in that time. Very true. But life is like a game of chess. To reach your goal (victory), you would have to know about your various moves to choose the right ones for the right moments. If you don’t know what your queen is and what she does, you are in for a big trouble.

Running this race is fine, its fun. But an athlete who wins is an athlete who knows himself. So many people run races, but there’s only one winner. So many batsmen play cricket, but there is only one Sachin, So many play tennis, but there is only one Roger Federer.

 So many aspire, only one achieves.

Why?

Because he is the one who knows himself. And who always wants to get better. He is the one who is constantly measuring himself. He is the one who is NEVER SATISFIED. He is the one who gets up in the morning when every body else is sleeping. He is the one who never says “enough for today!”. He is the one who does not give up. He sees OPPORTUNITY in roadblocks. He is the one who stays humble and focused in success. He is the one who LEARNS.

He is the one who wins.

How do you define success?

Medals? Trophies? Ranks? Titles? Press interviews? BMWs? Blondes? Page3 parties?

NAH!

Ask any of these achievers how would they describe their success and they will always tell you that its what they’ve become in achieving all these things that is the real success.

Its not an idealistic view, but a very practical one.

You set a goal. You measure yourself. There are so many others that match you or surpass you. You work hard. You get ahead of some. You work hard. You get ahead of some more. You work harder still. And finally you will get ahead of all. THAT is the key.

But unless you stop and measure yourself, you will never get to know where you are, where you want to be, and how to get there. For reaching B from A, you need to know both B and A. many people know their Bs, but since they don’t stop and get to know their As, they don’t get to their Bs.

What do you do then, once you do measure yourself. You look at two things – where others are, and where CAN you be.

And what is more important?

The latter.

Why?

Who is your greatest enemy/competitor/foe?

You might have rattled off many names, but I will give you an advice.

Get up and reach the closest mirror available.

Let me introduce you to your greatest rival.

YOURSELF.

If you are not the best around, fight yourself. Because it is you yourself that is stopping you to be one. That’s very true. If we are not what we can be, we have no one else to blame but ourselves.

Your greatest enemy manifests itself in various forms – indiscipline, laziness, anger, jealousy, distraction, procrastination.

This is the army you fight. And you have a battle on your hands.

So ask yourself. What sets you apart.

A student called Sankalp asked us this question and as apprehended by him, this is not that stupid a question. Simply, why does the RBI not choose to simply print more money instead of thte country taking more loans from the IMF and world bank.

Well, its a good idea in a perfect world but unfortunately, the world and especially the economy does not work that way.

If the RBI simply prints more money, that will mean that the people, with extra money will demand more goods and service,s which in turn, will increase the prices of those goods and services which will increase the amount of inflation in the country.

As requested by John, we are explaining the impact of Capital inflows on Exchange Rate, Inflation and Stock Market Index.

When more capital flows into the country, the currency appreciates in value and the inflation increases.

This is because as the the supply of more dollars in the economy increases, it is bound to decrease its price. So if one dollar used to cost 40 rupees, then if the supply of dollars will increase, the price of dollar will go down to say 39 rupees.

Also with more dollar flowing into the market, there will be too much money chasing too few goods and services, i.e. excess demand of goods and services, which will increase inflation.

Also, when more money flows into the country in the form if FII, that increases the investment into the securities of companies listed on the stock exchanges. This leads to appreciation of the value of the securities as a result of increase in their demand. And as the value of individual or important securities increase, the stock market index as a whole will also rise accordingly.

As requested by Payal, we are explaining the different rates in monetary policy used by RBI

Repo (Repurchase) Rate

Repo rate is the rate at which banks borrow funds from the RBI to meet the gap between the demand they are facing for money (loans) and how much they have on hand to lend.

If the RBI wants to make it more expensive for the banks to borrow money, it increases the repo rate; similarly, if it wants to make it cheaper for banks to borrow money, it reduces the repo rate.

Reverse Repo Rate

This is the exact opposite of repo rate.

The rate at which RBI borrows money from the banks (or banks lend money to the RBI) is termed the reverse repo rate. The RBI uses this tool when it feels there is too much money floating in the banking system

If the reverse repo rate is increased, it means the RBI will borrow money from the bank and offer them a lucrative rate of interest. As a result, banks would prefer to keep their money with the RBI (which is absolutely risk free) instead of lending it out (this option comes with a certain amount of risk)

Consequently, banks would have lesser funds to lend to their customers. This helps stem the flow of excess money into the economy

Reverse repo rate signifies the rate at which the central bank absorbs liquidity from the banks, while repo signifies the rate at which liquidity is injected.

Bank Rate

This is the rate at which RBI lends money to other banks (or financial institutions .

The bank rate signals the central bank’s long-term outlook on interest rates. If the bank rate moves up, long-term interest rates also tend to move up, and vice-versa.

Banks make a profit by borrowing at a lower rate and lending the same funds at a higher rate of interest. If the RBI hikes the bank rate (this is currently 6 per cent), the interest that a bank pays for borrowing money (banks borrow money either from each other or from the RBI) increases. It, in turn, hikes its own lending rates to ensure it continues to make a profit.

Call Rate

Call rate is the interest rate paid by the banks for lending and borrowing for daily fund requirement. Si nce banks need funds on a daily basis, they lend to and borrow from other banks according to their daily or short-term requirements on a regular basis.

CRR

Also called the cash reserve ratio, refers to a portion of deposits (as cash) which banks have to keep/maintain with the RBI. This serves two purposes. It ensures that a portion of bank deposits is totally risk-free and secondly it enables that RBI control liquidity in the system, and thereby, inflation by tying their hands in lending money

SLR

Besides the CRR, banks are required to invest a portion of their deposits in government securities as a part of their statutory liquidity ratio (SLR) requirements. What SLR does is again restrict the bank’s leverage in pumping more money into the economy.

We had received a query from a student, Neha in which she could not understand the meaning of an Economic Times article.

http://economictimes.indiatimes.com/Market_News/VAT_rate_Exporters_upset_with_Centre/articleshow/2757378.cms

The meaning is explained as follows:

Refund of any tax is the refund of overpaid taxes from the government to the taxpayer. Refunds are due when the taxpayer has been over-withholding or has overestimated income or underestimated deductions, exemptions, and credits.

About VAT

VAT works on the principle that when raw material passes through various manufacturing stages and manufactured product passes through various distribution stages, tax should be levied on the ‘Value Added’ at each stage and not on the gross sales price. This ensures that same commodity does not get taxed again and again and there is no cascading effect. In simple terms, ‘value added’ means difference between selling price and purchase price. VAT avoids cascading effect of a tax.

Sales Tax is a State subject. Over the period, many distortions had come in taxation due to unhealthy competition among States by giving sales tax incentives and ‘tax rate war’ started to attract more revenue to State.

Introduction of VAT is difficult in India as sales tax is a State Subject and sales tax on sale within the State can be levied only by respective State Government. Even in respect of Central Sales Tax (CST), though the tax is levied under Central Act, the CST is collected in the State from which goods are sold, i.e. originating State and CST so collected is retained by that State only. The CST amount never goes to Union Government.

After lot of persuasion by Central Government, all States ultimately agreed to introduce State Level sales tax VAT at the conference of Chief Ministers all States at Delhi in November, 1999. A high power committee consisting of senior representatives of all 29 States was constituted under Chairmanship of Dr. Asim Dasgupta, Finance Minister, West Bengal. It was decided to introduce Sales tax VAT w.e.f. 1-4-2002. It was delayed on several occasions and finally, all State Governments (except UP, Tamil Nadu and few other States) introduced State Sales Tax VAT w.e.f. 1-4-2005.

States ruled by BJP like Gujarat, Chhattisgarh, Jharkhand, Madhya Pradesh and Rajasthan had not introduced VAT. They have introduced Vat w.e.f. 1-4-2006. Tamilnadu has introduced Vat on 1-1-2007.

Uttar Pradesh and Uttaranchal also have not introduced VAT

In this article, it is written that the exporters are not happy about the Central government’s idea to increase the rate of VAT, especially because they have not even received their due refunds from the respective state governments. It highlights that apart from Andhra Pradesh, Gujarat, Tamil Nadu, Punjab and Maharashtra, non-payment of VAT refunds to exporters remains an worry in majority of states, especially in West Bengal and Orissa.

As shown in our article on the rise of the rupee, exporters are already under the hammer because of currency appreciation. Now, if the VAT rate itself is increased, given that due refunds haven’t seen the light of the day, it will prove to be very harsh on the exporter community. As suggested in the article, an increase in the tax rate should also be accompanied by a corresponding mandatory refund requirement. And in this the Centre should take the initiative by punishing the defaulter states by withholding plan allocations.

Hello students,

The third edition of Oracle is now out. You can download it here:

oracle-3.pdf

In this section we are putting up vital facts students need to cover especial for the prelims exam.

Here we are uploading a list of National Institutes, about which questions are frequently asked.

national-institute-of-importance2.pdf

We received a query regarding the Fed cut and its possible impact on the Indian Economy. So we are posting a response to this question. Any doubts regarding this topic, you may ask us immediately.

Interest Rates and their Role

A Basis Point is 1/100th of of one percent. A Basis Point is generally used in reference to interest rates and additions or subtractions done to interest rates. To put it simply if a central bank changes interests rates by 75 basis points, it means that the change is of 0.75%.

Now, let us see what are interest rates. Suppose you have a certain amount of money. Now you want to lend it to someone. To do that, u have to let go of some things you could have done with that money. Eg – with Rs 10,000 you might have wanted to add some accessory to your PC, but now since you will lend that money, you will have to forget it for some time. So you will demand some price of it, won’t you? This price is the interest rate which the lender gets from the borrower. If you charge an interest rate of 10% on Rs. 10,000 annually, you will get an additional interest payment of Rs. 1,00o(10% of Rs. 10,000).

Now think of a lender and borrower in an economy. Where does the money come from? In India, it is the Reserve Bank of India that prints money. It gives that money to banks who further lend it to end-consumers like you and me. That is how money simply flows in an economy. Now RBI gives the money to banks at a certain?? – yes, interest rate. The banks in turn lend it to consumer at a higher interest rate to earn profit.

Now a central bank has to keep in balance a lot of things. It has to keep prices in an economy under control – i.e. inflation, It has to maintain a favourable Exchange Rate, and finally it has to to maintain all the conditions of growth intact.

It does it through many instruments, one of which is controlling interest rates. Now, what reductions or increases of interest rates do to an economy. Lets have a look.

If you INCREASE the interest rates, that means the money in the economy will be available at a HIGHER cost. This means that the demand of money will be LESSER, because, as a borrower, one will have to shell out extra money as interest. Simple rule of demand. When price of anything increases, its demand decreases. So people will demand lesser money, (simply put, people will have lesser money in their hands) which will in turn, reduce the demand of general goods and services in the economy. And as an effect, the prices of these goods and services decrease because of the lower demand.

So the cycle goes like this:

Increase Interest Rate – Money becomes costlier-Lower demand of money-Lower demand of goods and services- Lower prices of goods and services- Lower inflation

Also, higher interest rates will attract investment in the form of capital flows into a country which will have its effects. We will come to that later

Now, a central bank would INCREASE interest rate when a country is facing high inflation. Pretty simple isn’t it?

On the other hand – if you DECREASE interest rates, money in an economy would become CHEAPER. So people will demand MORE money and thus MORE goods and services, which will increase prices of goods and services i.e. increase inflation.

This cycle goes:

Decrease Interest Rate – Higher demand of money-Higher demand of goods and services- Higher prices of goods and services- Higher inflation

Again lower interest rates would make the investment go out of the economy in the form of capital outflows. And again, a central bank would reduce interest rates when the economy is in the state of deflation or lower activity in the economy. I hope it clears the concepts. Any doubts, shoot a question.

Fed Cut and its impact

Now that we have understood what interest rates are and why do central banks reduce or increase them, we come to your specific question of Fed cuts and its implication on us.

Well, Fed is the central bank of United States (short form of Federal Reserve). A fed cut would mean that the Federal Reserve has cut the interest rate.

Now why has fed done so? This is because the US economy is in a state of slowdown. Prices are falling, so is dollar and the consumption demand in the economy is falling. To mend this situation, the Federal Reserve has taken this step to reduce the interest rate. This is expected to increase the demand for money and increase the demand for consumption of goods and services and help the economy fight recession/slowdown.

As far as impact on us in concerned, I would bring in the discussion of capital flows that we touched upon earlier.

Now in the global economy, there are investors who have money with them and they are looking at investment options all around the world. So they invest where they see higher returns. Now picture this:

In the US, interest rates are lower. In India, interest rates are higher. As an investor, if you have two options- in the U.S you investment fetches you 4% and in India, you get 9%. Where would you invest? Yes, of course –India

So what is happening is that a lot of dollar is flowing into India – which is doing two things – Raising the value of the rupee in dollar terms and of course our stock market indexes are rising.

So that, in a nutshell, is the impact on us. But in the long term, the impact on India will depend upon RBI’s response. The RBI has to keep its own things in mind- like Inflation. If it keeps the rate intact, capital inflows will increase because the rates in the US are falling.

And of course, capital inflows have their own impact on exchange rate and inflation etc.

We hope this makes it a bit clearer.

We have received some feedback on how the latest issue of Oracle (posted on 30th Jan 08) is not downloading properly. This problem has now been addressed. Any inconvenience caused is of course, deeply regretted.

PS: If left clicking on the links doesn’t seem to do anything, try right clicking on them and choose the “save link as” option to store it on any location on your drive.