IIM Shillong Niveshak Feb 2013 by Zigu MBA

Niveshak THE INVESTOR

VOLUME 6 ISSUE 2

February 2013

Will it lead to an economic switch?

TAXING THE RIGHT TO INHErit, pG. 08

Taming indiaâ&#x20AC;&#x2122;s current account deficit: The need of the hour, PG. 15

FROM EDITOR’S DESK Dear Niveshaks, Niveshak Volume VI ISSUE II February 2013 Faculty Mentor Prof. P. Saravanan

THE TEAM Editorial Team Akanksha Behl Akhil Tandon Anchal Khaneja Anushri Bansal Chandan Gupta Gourav Sachdeva Harshali Damle Himanshu Arora Ishaan Mohan Kailash V. Madan Kaushal Kumar Ghai Nilkesh Patra Nirmit Mohan Rakesh Agarwal Creative Team Anuroop Bhanu Kritika Nema Neha Misra Venkata Abhiram M.

All images, design and artwork are copyright of IIM Shillong Finance Club ©Finance Club Indian Institute of Management Shillong

Japan, once dubbed as the next wave of the future of capitalism by everyone, is in a bad economic health for the past two decades. Failure of political leadership at the top of the pyramid coupled with the structural and cyclical problems has been a major concern for the country. With growing discontent among the people of Japan on account of rising unemployment, all eyes are set upon Shinzo Abe, who has been elected as the new Prime Minister of Japan last month. Bank of Japan has upgraded its economic outlook on February 14. While the growth rate has dropped for the quarter ended December, the small contraction confirmed that the economic slowdown was minimal. Weaker Yen and high stock prices have lifted the sentiments of the investors. Most of the governments around the globe are increasingly wary of Abenomics, the economic policy advocated by Prime Minister Shinzo Abe and see it as an attempt to weaken the value of the Yen. This month’s cover story is aimed at making our readers aware of the current situation of Japanese economy and what Mr. Shinzo Abe has to offer to the people of Japan and to the world economy by large. It would be interesting to see if Abenomics is just a buzz word or if it would actually provide a much needed support to the lagging Japanese economy. This issue brings to you some more stimulating and insightful reads. We seek the attention of our readers towards Inheritance tax which ceased to exist in 1985. The Article of the Month section explores the possibility of reintroduction of inheritance tax in India, drawing its support from the economies of U.S. and Italy along with the possible loopholes in Indian context. Other articles in this issue focus on the impact of GST in India and India’s current account deficit. The finistory section brings to you the America’s new deal reforms which helped America reviving its economy after the Great Depression of 1929. Lastly, the Classroom section this month will help the readers to understand Credit Ratings. We would also like to thank our readers for their constant support and appreciation. It is your endless encouragement and enthusiasm that keeps us going. Kindly send in your suggestions and feedback to niveshak.iims@ gmail.com and as always,

Stay invested!

Team Niveshak

www.iims-niveshak.com

Disclaimer: The views presented are the opinion/work of the individual author and The Finance Club of IIM Shillong bears no responsibility whatsoever.

CONTENTS Cover Story Niveshak Times

04 The Month That Was

Article of the month

08 Taxing the Right to Inherit

Shinzo’s Abenomics: Will it lead to an Economic Switch?

FinGyaan

15 Taming India’s Current

Account Deficit: The Need of the Hour

Finsight

Goods and Services Tax: Wheel of Change

Finistory 19 America’s New Deal

Reforms

CLASSROOM

27 Credit Ratings

NIVESHAK

The Month That Was

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The Niveshak Times Team NIVESHAK

IIM Shillong

IIP shrinks 0.6 percent in December Owing to persistent sluggishness in the economy, Industrial output contracted by 0.6 per cent in December, the second consecutive month of decline. The decline was mainly due to poor performance of manufacturing and mining sectors and decline in production of capital as well as consumer goods. The drop is also in sharp contrast to a growth of 2.7 per cent in the Index of Industrial Production registered during December, 2011. The manufacturing sector, which constitutes over 75 per cent of the index, registered a contraction of 0.7 per cent in December 2012, as against a growth of 2.8 per cent during the same month of 2011. For the nine-month period between April and December of current fiscal, the industrial production grew at a meagre 0.7 per cent, as against a 3.7 per cent growth in the previous year. In terms of industries, 12 out of 22 groups in the manufacturing sector have shown negative growth in December, 2012 as compared to the same month in 2011. Reacting to the IIP data, industry chamber Assocham said, “The continued fall in intermediate and capital goods production indicates that the revival is a distant dream”. India’s growth rate to slip to 5 percent in 2012-13: FM India’s GDP growth is expected to drop significantly to 5 percent for the fiscal year ending in March, according to advance estimates released by India’s Central Statistics Office, declining from the 6.2 percent growth rate seen in fiscal year 2012. The new figure is the lowest in a decade and substantially lower than the 5.7% projected earlier by the finance ministry. Slow growth may be attributed to the sluggish performance in the manufacturing (expected growth of 1.9 percent), agriculture (expected growth of 1.8 percent) and services sectors. The finance ministry, in a statement, said the growth projection is based on extrapolation of numbers till November and that the actual growth rate is yet to be known. Since November, leading indicators have turned up, suggesting some hope that we will end the year on a better note. Also, sectors such as trade and transport, which are

February 2013

related to industry, would also tend to get revised upwards, if growth outcomes are better. Dell’s buyout plan but investors say “NO” For the last few years, Dell, which has been public for about 25 years, has been dealing with the struggling PC market, which has been continually hammered by the sluggish economy and the fast emerging tablet market. In 2011, Dell was surpassed by Lenovo in its no. 2 position. Last week Dell announced the buyout offer in which Mr. Dell, Dell’s founder and CEO, and private-equity firm Silver Lake Partners said they would pay $13.65 a share – a premium of 25% over stock market price then – to make the computer maker private. Post announcement, a number of shareholders have come out against the technology giant’s $24 billion plan to go private. T. Rowe Price and Southeastern Asset Management, the two largest outside shareholders of Dell, behind founder Michael Dell, are against the $13.65-a-share deal being spearheaded by Dell and Silver Lake Partners. Though some analysts argue that the deal may go through despite shareholders’ objections, many seem to expect Michael Dell and Silver Lake to raise their bid. RBI issues guideline for New Banking License The Reserve Bank of India on 22nd February issued the much-awaited guidelines for new bank licenses culminating the 3 year long process. It allows corporates and public sector entities with sound credentials and a minimum track record of 10 years to enter the banking business. As advocated by the Finance Ministry, RBI has also not excluded any category like brokerages, real estate companies from entering into the banking space. The major prerequisites include minimum investment of 500 Crs, 49% cap on FDI, sound track record of 10 years and 25 % branches in unbanked rural centres.

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Following the grant of license, the promoter group will be required to set up a wholly-owned NonOperative Financial Holding Company (NOFHC). The NOFHC is aimed at protecting the banking operation from extraneous factors like other business of the Group i.e., commercial, industrial and financial activities not regulated by financial sector regulators. The final guidelines pave the way for corporate houses like Anil Dhirubhai Ambani Group, Larsen & Toubro, Tatas, Mahindra and Mahindra, Life Insurance Corporation and Aditya Birla Group to enter the banking business. Barclays finance director Lucas to retire The finance director of Barclays, Chris Lucas, will retire soon. Lucas has served Barclays for tough six years that spanned the global financial crisis. But the past nine months have been difficult for him. He is one of the four current and former employees

who are being investigated by UK authorities regarding a capital injection by Qatar in 2008. But it is being said that his departure is not linked to the investigations into Qatar. He is one of Barclays’ executive directors still in his post after the bank was fined $450 million in June for rigging the Libor global benchmark interest rate. Along with him, the Group General Counsel Mark Harding will also retire. Both will remain in their roles until their successors have been found and an appropriate handover completed. Sahara case: SEBI freezes bank accounts In Sahara case, SEBI ordered freezing of bank accounts and attachment of all properties of two group firms, Sahara Housing Investment Corporation Ltd (SHICL) and Sahara India Real Estate Corporation Ltd (SIRECL), and their top executives, including group chief Subrata Roy. The Supreme Court had asked Sahara group firms to refund the money to investors with 15 per cent interest in August last year and had asked SEBI to facilitate the refund. Later, the group was instructed to pay the amount in 3 installments – 1st in December, 2nd in January and 3rd in February. As per SEBI, neither of the first two instalments was paid. So necessary action was

needed to be taken. The properties being attached include the land owned by Sahara group firm Aamby Valley Ltd, development rights of land at prime locations in

Delhi, Gurgaon, Mumbai and various other places across the country, equity shares held in Aamby Valley Ltd, units of mutual funds, bank and demat accounts and investments in all the branches of all banks. SEBI has asked all the banks to transfer the amounts lying in those accounts to its SEBI-Sahara Refund Account. It ordered immediate freezing of all bank and demat accounts and attachment of all moveable and immoveable properties in the names of the four directors, namely Subrata Roy, Vandana Bhargava, Ravi Shanker Dubey and Ashok Roy Choudhary. Retirement savings under EET likely The new Direct Taxes Code proposes to bring all retirement savings under the EET (exempt-exempttaxation) system from the current system of EEE (Exempt-Exempt-Exempt). Under EET, a savings scheme would be exempted from taxation at the time of contribution, during accumulation of the corpus and would be taxed only on withdrawal. If the accumulated saving, on maturity, is ploughed back into fresh savings, the corpus would again be exempted from tax. Under the EEE regime, the investments made in tax saving instruments such as PF, were tax exempt at all the three stages but under EET, the taxation is deferred till the time of withdrawal. It is proposed under the Code that at the time of maturity of investments, the total amount of withdrawal shall be subject to taxation.

The Month That Was

The Niveshak Times

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NIVESHAK

Article Market of Snapshot the Month Cover Story

Market Snapshot

Source: www.bseindia.com www.nseindia.com

MARKET CAP (IN RS. CR) BSE Mkt. Cap Index Full Mkt. Cap Index Free Float Mkt. Cap

6,766,721 3,199,724 1,654,570

LENDING / DEPOSIT RATES Base rate Deposit rate

9.70%-10.50% 7.50% - 9.00%

Source: www.bseindia.com

CURRENCY RATES INR / 1 USD INR / 1 Euro INR / 100 Jap. YEN INR / 1 Pound Sterling

54.43 71.90 58.34 83.20

CURRENCY MOVEMENTS

RESERVE RATIOS CRR SLR

4.00% 23%

POLICY RATES Bank Rate Repo rate Reverse Repo rate

8.75% 7.75% 6.75%

Source: www.bseindia.com 24th January to 22nd February 2013 Data as on 22nd February 2013

FEBRUARY 2013

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NIVESHAK

BSE Index Sensex

Open 19923.78

Close 19317.01

% change -3.05%

MIDCAP Smallcap AUTO BANKEX CD CG FMCG Healthcare IT METAL OIL&GAS POWER PSU REALTY TECK

6848.68 7069.84 10834.39 14396.88 7423.32 10617.55 5780.34 7873.41 6355.87 10435.61 9499.14 1959.89 7583.87 2091.28 3803.68

6609.03 6564.76 10700.90 13855.12 7136.48 9677.21 5676.19 8019.85 6605.08 9561.05 9059.97 1828.17 7227.68 2113.12 3822.99

-3.50% -7.14% -1.23% -3.76% -3.86% -8.86% -1.80% 1.86% 3.92% -8.38% -4.62% -6.72% -4.70% 1.04% 0.51%

% CHANGE

Article Market of Snapshot the Month Cover Story

Market Snapshot

Article of the Month Cover Story

NIVESHAK

axing the

ight to Inherit

Raghuveer MSSA

IIM Shillong With the Union Budget 2013 on cards, it is the time for heated discussions, heavy negotiations and high criticisms regarding many issues in the budget. One of the most prominent is the issue of “Taxation”. The Indian tax system has seen many critics in the recent years for its vulnerable structure and inefficiency in its working. This month one new fruit was added in the basket of discussions, “Reintroduction of the Inheritance Tax”. The Indian Government has been under pressure for the last few months owing to the higher rates of inflation, lower growth rates, increasing fiscal deficit, decreasing GDP growth rate and many more. Of all these, the economists say, controlling the fiscal deficit is the most prominent and thus, bringing in fiscal consolidation by increasing the revenues and decreasing the expenditures is the need of the hour. Also, inequality has been one of the

FEBRUARY 2013

daunting issues for any nation in the world and India is no exception. Recently, the failure of the 2G spectrum auctions is an example of the increasing woes of the Government in increasing its revenues. The 2G spectrum auction has fetched merely one-third of the target. Two major ways of dealing with this issue are increased tax collection and better tax administration or improvised utilization of the existing public funds. Though both the methods can lead to fruitful results, if used efficiently they can be used as complements rather than substitutes. India is not the only country that has considered the introduction of inheritance tax. Obama in his tenure has always stuck to the collection of inheritance tax and the Italian Prime Minister Mario Monti also passed the law for the increase of inheritance tax rates in the times of crisis. Thus, it is no wonder that we are hearing the whispers of the reintroduction of the same now. But how relevant is this to the current context of the Indian economy is a question Mr. Chidambaram will be expected to answer.

NIVESHAK

Article of the Month Cover Story

Fig 1: Direct Expenditure as percentage of collections

Inheritance tax is a levy paid by a person who inherits money or property. It is different from the estate tax, one that’s imposed on the estate/ assets left behind by a deceased person. However this distinction is not generally perceived in the general tax laws. For example, in the United Kingdom, Inheritance tax is a tax on the assets of the deceased, and is hence strictly speaking, an estate tax. It is sometimes referred to as ‘death tax’. When a person dies, the Government assesses the worth of the estate of the person. If its value exceeds the threshold limit, a tax needs to be paid at a rate fixed by the Government. Inheritance tax was levied in the period between 1953 and 1985 in India. All the assets below the limit of Rs.1 lakh were exempted from the tax valuation. For a Hindu Unified Family (HUF), this limit was just Rs.50, 000. The tax rates varied from a minimum slab rate of 7.5% to a maximum of 40% for the estates worth more than Rs.20 lakhs. However, any property that’s passed to the heirs two years before death was not liable to taxation. Also only the legal heirs were supposed to pay the tax. If a property gets inherited by the owner’s spouse, no tax had to be paid. Though the objectives of this inheritance tax was reduction in the unequal distribution of wealth and wealth maximisation of the states, it was scrapped in 1985 by the

then Finance Minister VP Singh, saying that the benefits of the tax were not as high as the administrative costs thus failing to achieve its objectives. The tax added Rs.20 crore in 1984-85, constituting just 0.4% of the Rs.5329 crore direct taxes that year. The direct tax collection may reach the mark of Rs.6.5 lakh crore going by the 14 p.c. increase target set for this budget. If we consider 0.5 p.c. of this would be from inheritance tax that would amount to Rs.3250 crore, which definitely is a good share of increase for the Government revenues. But, these arguments aren’t very legitimate given the drastic changes the Indian economy has gone over the decades. The tax rates in India aren’t as high as they used to be in 1984-85, with the maximum now being 30 p.c. The GDP has grown by more than 35 times in the last 26 years. With the advent of technology, the argument of high administrative costs does not hold true anymore. The Utilitarian economic theory says that the market mechanism leads to an optimal social state only when the initial endowments are properly redistributed. It says, everyone must be on the same level playing field when they are born. If someone is inheriting property or wealth, then they are liable to be taxed. Thus, this can be used as a tool for bringing down inequality.

NIVESHAK

Article of the Month Cover Story

Fig 2: Total Tax Revenues(in crores)

The Indian tax system lacks progressivity. It relies more on the share of indirect taxes. Hence a new tax in the cover of direct taxes will be an advantage. While the introduction of inheritance tax is right morally and can bring in millions of money to the pool of Government revenues in the time of woes and may help getting the production indices back on the growth track, there are also many pitfalls included in this thought of reintroduction of Inheritance tax in India. The basic difficulty in the Indian context is the definition of the word ‘rich’. Consider a person who inherits a property: an estate from his ancestors which has a high present worth. Regardless of the present earning capability of the person, he will be covered under the tax net. To pay the taxes, he may even be forced to sell the property! And what about intangible assets, interests in partnership firms or palatial property holdings? Moreover, the Indian subcontinent people are emotionally connected to personal assets like jewellery or any art works. Even thinking of the option of selling them off to pay the taxes is prone to high criticism. One other point of argument is double taxation. Wealth tax is being imposed upon the net wealth comprising of farm houses, urban land, bullion, jewellery and others exceeding Rs.30 lakh. Thus bringing in inheritance tax would be double blow to the taxpayers. Thus the wealth creators may give out properties as gifts and donations to their heirs which may make the implementation

FEBRUARY2013 2013 FEBRUARY

of inheritance tax frustrating for the Government, which may also be forced to implement Gift tax to overcome this! The government is already fighting the problem of high inflation. This tax introduction may force the public to reduce their savings owing to the lack of motivation for doing so. This may give rise to higher spending, thus pushing the inflation curve higher. With the complexities involved in the taxing mechanisms, India is already facing problems in attracting the investments from other countries. Recent issues like the one of Vodafone have already started raising concerns regarding the Indian tax structure. If this new tax gets introduced, it may result in making things worse for the Indian economy. Higher tax rates may drive away the investors and the Indian super rich to tax haven countries like Singapore, Mauritius and others. All set aside, it’s also about the timing of introduction and the people introducing it. The ruling Congress party holds no right to counter the culture of inheritance for reasons well known. In 1985, the inheritance tax was dissolved by the Rajiv Gandhi Government and the dynastic Gandhi Government is trying to reintroduce it now. This is a double edged sword right on the neck of the Congress Government. The question remains, can this super-rich tax, if introduced, reduce the levels of inequality as it is expected to or drive away the savings and investments thereby hurting the economy. Only the upcoming budget can answer these questions.

NIVESHAK

Shinzo’s Abenomics

Anushri Bansal & Ishaan Mohan

Team Niveshak In periods of crisis, pundits and policymakers tend to scramble for historical analogies and most often, fail in their endeavors. This time, many have seized on Japan’s notorious “lost decade,” the decade of stagnation that followed a mammoth property bubble in the late 1980s. As many as five Prime Ministers have come to power in five years before the newly elected head of state, Shinzo Abe, but all of them have failed miserably. The onus to bring Japan back on the growth trajectory lies on Shinzo Abe. Two decades ago, Japan’s economic model was considered to be the next wave of the future for global capitalism by almost everyone. Today, it faces a mounting economic crisis, providing a stunning refutation of the claim that China or other so-called “emerging markets” can form the basis for stabilization of the world economy. The asset price bubble burst during the late 1980s has turned Japan, a miracle, into a disaster. The economy of Japan, third largest, after the U.S. and China, has contracted by 2.3 percent in the fourth quarter of 2012. The decline was much more

as compared to 1.3 percent which was forecasted by the authorities. It now faces the danger of entering into recession for the fifth time in the last fifteen years. With persistent deflation and continuously increasing public debt, Japan would be expecting some bold steps from Shinzo Abe. Japan recorded a trade deficit of JPY 641.50 Billion and inflation rate (refer Fig.1) of -0.1 percent in December of 2012. Economic and Structural problems The real interest rates are hovering at zero levels since 1998 but lack of demand has deteriorated the performance of the economy. This has posed the question on the solvency of banks in Japan. The contraction of Japanese economy is marked by several factors. Japan’s public debt is entirely owed to its domestic investors because of which the country’s political and financial market dynamics are closely related. Japan has witnessed nineteen Finance Ministers in the last twenty years with nine different Finance Ministers in the last five years itself. The government debt has increased at an average of 6.06 percent per year since 1990. Currently it stands at

Fig 1: Japan Inflation Rates

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Will it lead to an economic switch?

NIVESHAK

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Fig 2: Japan’s Fiscal Pain

211.7 percent of GDP and is expected to reach 237 percent by the end of this year as per the recent estimates by IMF. As it can be seen from fig. 2, this is majorly due to the decreasing tax revenues and persistent deficit spending on public welfare schemes and unproductive incentives. About thirty percent population is over sixty years of age as compared to meagre fifteen percent during the late 1980s. Low rate of return on investment in public traded companies is what makes investors risk-averse. The prices of property have also taken a hit after the real estate bubble in late 1980s and till now people have not been able to pay back the money. Japan’s stock market index, Nikkei 225, has plunged by 77.64% between 1989 and September 2011. The yield for government bond is very low which provides lack of avenues for the investors to invest. Most of the demand for government bonds comes from Japan’s

bank. While exports steered the growth engine of Japanese economy during 1960s and 1970s, domestic consumption took over after that for twenty years. The consumption pattern has not declined either, as can be seen from the rising import penetration in the last twenty years, dubbed as the lost decade(s). Now the question arises that why could Japan not replicate the tremendous growth which it had seen before 1990. This forms only one half of the story. The wage rates have risen marginally as compared to those in 1990 which led to the decrease in savings and hence deteriorated the investments. We can expect the savings to come down further in the coming future as the population age and the percentage of seniors-to-working age population increases. Before economic crisis in 2008, Yen depreciated by

Fig 3: Long Term Deterioration in Japan’s Trade Performance

FEBRUARY 2013

NIVESHAK

Program Size

Fixed Rate Fund-supplying Operation

End - December 2012 About 65 40 24 9.5 2.1 2.9 1.6 0.12 25

nearly thirty eight percent but Japan failed to capitalize on this opportunity also because of weaker demand and incompetent Japanese firms. High dependence of Japan’s economy on energy imports has led to widening of trade deficit (Refer Fig.3) and since 2008, it has been growing at horrendous rates. Lack of competency traces its roots to early post war period when the government policies were aimed at protecting the domestic companies by discouraging the imports. Not only this, the failure of Japanese government to attract foreign investors because of pro-domestic protectionist policies has resulted in high unemployment in the country. Only few years back, Japan has signed free trade agreements with the U.S. in agriculture products. As per the experts, this will increase the competency levels in Japan by fifty percent. The lack of policy innovation has caused the ever widening gap between imports and exports. Adoption of a new economic policy In order to deal with the financial crisis being faced by Japanese economy, the newly elected Prime Minister, Shinzo Abe, is being pressurized by the Bank of Japan to pursue an unlimited monetary easing so as to overcome deflation. In lieu of this pressure, the Bank of Japan has come out with its new monetary policy framework on 22nd January, 2013 which has two major elements. The first one being, a target price stability of 2% for the consumer price index (CPI) and the second one being, an “open-ended asset purchasing method” for its Asset Purchasing Program (APP). This easier monetary policy could help in lowering the value of Yen which in turn would help in lifting Japan from deflation. Price Stability Target: Since the time when Bank of Japan started with quantitative easing in March 2006, its decisions have undergone many changes. Till February 2012, the policy was related to “understanding of medium and long term price stability”. In the beginning, the

End - December 2013 About 101 76 44 24.5 2.2 3.2 2.1 0.13

End - December 2013 About +36 36 20 15 0.1 0.3 0.5 0.01

overall range was 0%-2% with a median of around 1%. The zero was removed in December 2009. This time when the targets were announced, Governor Shirakawa stated that the targets of 1% and 2% were both there as consistent with the price stability before and they are both there now, but the focal number has shifted from 1% to 2%. Open-ended Asset Purchasing Method: The new “open ended” purchasing method introduced by Bank of Japan for its APP will focus on its purchases of “traditional assets” including Japanese Government Bonds (JGBs) and Treasury Bills (T-Bills). Unlike other programs, there is no set target date for ending this program. Not marking any change in the program for 2013, the Bank of Japan has planned for a net increase of ¥36 trillion in its assets in the year ending December, which would raise its total assets in the program to about ¥101 trillion (refer Table 1). This increase would be brought through purchases of JGBs and T-bills which are considered to be the most conservative categories of assets. Implications of the new framework The basic question which arises in the minds of most of the people is “Will these ideas work?” Through the ambitious price stability policy aiming an inflation target of 2%, the Policy Board of Bank of Japan gave a median forecast that the CPI inflation will jump from 0.4% in FY2013 to 2.9% in FY2014 i.e. year ending April 2015. But this jump is mainly due to the scheduled increase of consumption tax from 5% to 8% which is due in April 2014, as the underlying inflation is estimated to be around 0.9%. Given that the central bank expects GDP growth of only 0.8% in FY2014, there is not much basis for expecting underlying inflation to increase much in the near term. Moreover, there is a basic disconnect between the target and the policy tools being used. The problem is that there is no deadline or penalty for not achieving the target, so the Bank has no incentive to deviate much from the policy path it

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Japanese Yen trillion Total size Asset Purchases Japanese Government Bonds Treasury Bills Commercial Paper Corporate Bonds Exchange Traded Funds Japan real Estate Investment Trusts

Change in Amount

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has pursued to date. It can wait in the hope that inflation will gradually pick up as a result of policies implemented by the government. The open-ended purchase program is quite conservative in nature. The new asset purchase program, although open ended, will probably add a less significant amount of liquidity. The interest rates on ten year JGB are very low as the yield varies from 0.7% to 0.8%. So the stimulative effect from such purchases would be small. It is being argued that more slackening of monetary policy will send an exactly opposite message: that additional demand for JGBs created by more quantitative easing might accommodate further government debt increase. The idea is that one of the major causes of deflation in Japan is the ballooning government debt. Financing government debt hampers spending from households directly and indirectly. Directly, the purchasing power gets subtracted through various social security schemes aimed at channeling private earnings towards the purchase of JGBs. On the other hand, indirectly, it imposes a low share of risky assets in private portfolios, putting a lid to significant increases in financial wealth leading to fall in purchasing power. If successful, these reforms will increase the contribution of Japan in supporting growth in the region and the global economy. If not, then the combination of mild deflation or near-zero inflation and weak growth will continue in Japan. Conclusion It can be said that the first moves that have been taken by the new Abe administration reflect a completely changed policy scenario. Fiscal consolidation has taken the back seat, a swift change from the previous administration palaver on the need to adjust public finances. It is believed that deflation in Japan does not have monetary roots; it reflects poor economic dynamics due to structural (productivity) and cyclical (consumption) factors. On the consumer side, a major cause of this situation is the inflating government debt which is subtracting resources for consumption. Certain future policies which were evoked during the campaign by Mr. Abe, like deregulating the economy which would allow an increase in potential growth, still have to see the light.

FEBRUARY 2013

FIN-Q Solutions JANAURY 2013 1. Stephen Ross, X=arbitrage pricing theory, Y=Binomial options pricing model 2. X=Franklin Templeton Investments, Y= Templeton, Galbraith & Hansberger Ltd., XY=Franklin Templeton, Z=John Galbraith 3. X=L&T Finance, Y=Fidelity 4. Facebook 5. Veto Switch Gears And Cables Ltd. 6. Keogh Plan 7. Abdul Karim Telgi

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FinGyaan

Taming India’s Rising Current Account Deficit : The Need of the Hour Ashish Khare & Deependra Kumar

MDI

A persistently negative current account deficit is a cause of concern for any economy. When a country runs a current account deficit, it builds up liabilities to the rest of the world that are financed by flows in the financial account. Large deficits and rising indebtedness could also leave countries more vulnerable to adverse external shocks. Because India has a long history of sizeable current account deficits, it makes for an interesting case study. A closer look at figure one clearly reveals India’s inability to maintain a positive current account balance. We can see that in only four years from the past two decades India has been able to claim a current account surplus. The present levels of current account deficit have clearly reached unsustainable levels, consistently rising for the past three years. Will India be able to reduce present high level of current account deficit that is such a big cause of concern? What implications such high levels of current account deficit have for the Indian economy in 2013. Can we learn something from other developing or developed economies? This

article explores answers to these questions with a focus on analyzing the implications of high current account deficit on the Indian economy in 2013 and possible measures to bring down such high levels of current account deficit. Current Account Deficit (CAD) Current Account Balance can be defined as the net of export and import and if the import is in excess to the export it is called a deficit. Although CAD constitute of other factors like factor income and transfer payment but major constituent of Current account balance is the trade balance (i.e. Export-Import). Major Implications of High Current Account Deficit High current account deficit is major concern because it cannot be sustained for long as the countries that ‘lend’ money (through the capital account surplus) will expect to get back their money with interest at some point. If the money is not seemed to be present in future, the lending country may demand higher returns

Fig 1: Current Account Deficit of India

Article FinGyaan of the Month Cover Story

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or may take back their money. With no one to lend, the country can’t import capital goods to make own good or even import consumer goods. Reasons for high current account deficit (CAD) - Indian Economy 2012-13 To put some numbers into perspective, current account deficit widened to 5.4 % of GDP in the Q2 2012. The current account deficit was $22.3 billion in the three months through September, or 5.4 percent of GDP, compared with $16.6 billion in the June quarter and $18.9 billion in the September quarter of 2011. The widening gap has been caused mainly by the increasing trade deficit. The trade deficit widened to 12.2% of GDP in Q3 from 9.7% in Q2. While oil prices have risen, most of this worsening is in the non-oil segment. Gold imports were the major cause of the widening current account deficit. India saw $60 billion worth of gold imports in fiscal 2011-12 which contributed to high CAD levels. Gold imports in the 2010-11 were $40 billion. The increase of $20 billion can be attributed to high level of inflation. While the imports were dominated by higher demand for gold, the exports contracted. In the April-November period, India’s total exports contracted by nearly 6 percent from a year earlier, leaving a trade deficit of nearly $130 billion. Another possible cause has been the higher demand or a supply shocks in the Indian Economy. In 2011-12 the growth in aggregate demand categories like consumption and fixed investment fell from about 8% to 5%. It has been observed that the Indian CAD is countercyclical, rising when output falls and not when demand is rising. This suggests the dominance of external supply shocks rather than the demand factor. Current account deficit is going to be as strained in Q3 2012-13 as it was in the second quarter because of the lower GDP growth. The depreciating INR also contributed to for the past one year and was the third worst performer in Asia in 2012. The rupee closed 2012 at 55.00 inflating the import bill and the current account deficit. Implications of the High Current Account Deficit for the Indian Economy The recent level of the Current account deficit at 5.4 % of the GDP is above the sustainable level. According to research report from RBI, India can sustain a current account deficit of 2.5

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% of GDP with a lower GDP growth. This clearly is an alarming situation for the Indian economy and has the capacity to impair India’s financial stability. This deficit will also cause the foreign exchange reserves to dry up if the inflows to make the deficit do not materialize. It will have direct bearing on the strength of INR. The depreciating INR has come under a lot of pressure with the increasing current account deficit. The Indian rupee has dropped more than 20% from its August 2011 peak against the dollar. This sharp depreciation is mainly due to India’s large current account deficit. Action Taken by Indian Government and RBI Government of India is considering steps to make gold imports costlier in order to reduce the huge foreign exchange outgo on the yellow metal, which has pushed the current account deficit to a record high. Government is also trying to create an investor friendly environment to increase investment from foreign investment in the form of FDI and FII, the income from these foreign investments positively contributes to current account. Current Account Deficit: Story of other Developing Nations While focusing on the current account deficit problem of Indian economy it becomes increasingly important to have a look at similar devloping nations to understand current account situation in these countires. Brazil Brazil is currently facing a big current account deficit which is 2.11% of GDP at the end of financial year 2011-12. Brazil has a current account deficit despite having a positive trade balance on account of large service deficit. The reason behind the positive trade balance is the export-oriented Brazil economy heavily dependent upon soybean, orange juice and iron. Russia Russia’s current account surplus is fuelled primarily by high oil exports. Oil prices have risen steadily over the past few years which have increased their export prices. From 2000 onwards, the country started to record positive trade surplus, taking advantage of the devalued currency. Russia’s current surplus decreased sharply in 2008-09 due to the global recession and decrease in demand for commodities. Increase in Russians income is set to fuel demand for imports; this would lead to narrowing of the

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FinGyaan Cover Story

Fig 2: Current Account Deficit of BRICS Nation

current surplus. China China has had a consistent Current Account Surplus which today is approximately $ 300 billion. The major reason for this surplus is the competitiveness of Chinese products which have gained a reputation in manufacturing sector and thus China has become the supplier of goods for the whole world. South Africa The current account of South Africaâ&#x20AC;&#x2122;s has been in the red lately. The weaker outlook for the global economy in response to the international financial crisis has already resulted in a largescale withdrawal of capital from South Africa. The Rand has depreciated by approximately 30% against the American dollar during this

period. Trade balance is only quarter of the current account deficit which makes it difficult to reduce the latter simply by reducing imports. Current Account Deficit of developed nations: a case study on USA 1991-2006: The phase of rising Current Account Deficit The U.S. current account deficit grew steadily after 1991, hitting levels of 4.4% in 2000 and steadily rose to a record high of 6.1% in 2005 and 2006. Much of the rise in the current account deficit over the period can be attributed to two factors: accelerating U.S. productivity and a surge in household wealth driven by the stock market. Due to the consumption boom, U.S. consumers satisfied part of the increased demand for

Fig 3: Current Account Deficit of United States

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Article FinGyaan of the Month Cover Story

Fig 4: Trade balance between US and China

goods and services with imports, purchasing more and more goods from foreign sources and thus increasing the CAD. 2007- Present: The decline of current account deficit (CAD) CAD began falling in 2007, and reached 3% of GDP in 2012. The decline may be attributed to cyclical causes. As a result of the recession and financial crisis, domestic savings became higher, domestic private investment became lower and so the need to borrow from abroad diminished. Conclusion The need to contain current account deficit as evident above is extremely urgent. Unfortunately there is no magic wand that can bring down Current Account (CAD) deficit in a go. It needs to be achieved through the synergy of a number of measures each aiming to strike at the very root of reigning current account deficit. The widening deficit is attributable to expensive oil, high gold imports and a sharp drop in exports. There is thus a need to reduce imports and boost merchandise exports to bring the CAD to sustainable levels. On the exports front a lot depends on the global economic situation. Our major markets are the US, Euro zone and China. If these markets recover and do well we can improve on the exports front, provided we maintain our competitiveness. With the worst of recession already behind us and United States averting the fiscal cliff, the prospects do look better. The more dominant cause of worry is the import bill. International commodity prices and rupee exchange rate should be the focus areas as the country imports many commodities it needs. An important step would be to make the gold imports expensive. The Indian government has

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taken right steps in this direction by imposing tax on gold jewellery and increasing the import duty for gold. However, it will not be easy for Indian economy to correct current account in 2013, precisely because of strong domestic demand and a weak external demand. Already environment sensitive policies, land acquisition issues and availability of quality infrastructure have contributed to moderation in FDI inflows which are extremely important to finance the current account deficit. While the subdued growth of receipts is cyclical in nature and can be expected to improve with the recovery in world economy, the rise in crude oil prices and reasons for moderation in FDI are more structural in nature. What is the ideal way out for Indian government then? Since Indiaâ&#x20AC;&#x2122;s linkage with the world economy, in terms of trade and finance, is likely to grow, it is important that resilience in its trade account is built up mainly by promoting productivity-based export competitiveness and improving the domestic fundamentals. The persistent global uncertainty and capital flow volatility demands increase in FDI to make the capital account more resilient. India should learn from other countries around the world. The competitiveness of products of China is something to look upon as India doesnâ&#x20AC;&#x2122;t have resources like Russia or Brazil. India should try to bring quality to its products similar to its services. One key thing to learn from USA is that India cannot sustain its current account deficit as can US because capital account in India is highly dependent upon the conditions of rest of the world. Adjusting government spending to favor domestic suppliers is another important step that needs consideration. Another important measure would be increasing the remittances through lucrative savings offer for Indian Diasporas all around the world by offering higher interest rates and lesser transaction charges. It is with the cumulative effects of the above outlined measures and a strong resolve to bring down the current account deficit that we can expect India to tame this monster and safeguard the countryâ&#x20AC;&#x2122;s financial health.

1929

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The Origin The Great Depression of 1929 is considered to be the most significant economic slowdown to have affected not just the United States economy but the entire global economy. The beginning of the Great Depression was marked by the stock market crash on October 29, 1929. The depression devastated the United States economy, with output levels shrinking to about two-thirds and the fall in prices by approximately 20%, making debt repayment a humongous task. Unemployment levels reached an all-time high to 25%, with no insurance on bank deposits and several banks bankrupt. There was no national safety net and no social security. Herbert Hoover was the President of the US during the crisis and felt that the government should not get excessively involved in helping the masses deal with the economic problems. However, this changed when Franklin D. Roosevelt accepted the 1932 nomination for President and promised “a new deal for the American people”. “Throughout the nation men and women, forgotten in the political philosophy of the Government, look to us here for guidance and for more equitable opportunity to share in the distribution of national wealth... I pledge myself to a new deal for the American people. This is more than a political campaign. It is a call to arms.”- Roosevelt. New Deal Franklin D. Roosevelt’s New Deal Reforms marked the first step of the US Government towards the cultural development of the country. The reforms were very similar to the current federal policy of the country; with democratic goals, support for activities not patronized by the private sector and an emphasis on culture. The Reforms were inspired

Finistory Article of the Month Cover Story

AMERICA'S NEW DEAL REFORMS

Anchal Khaneja

IIM Shillong

by the settlement and rural work extension practices followed in during the Russian Revolution. They were based on a concern for the labour; especially the professional artists and others involved in the cultural work. The New Deal was a set of economic reforms engrafted in the United States during 1933-36. The reform programs were focused on the “3 R’s”: Relief, Recovery and Reform. This meant relief for the unemployed, recovery of the nation to the normal level and reform of the financial system as a whole to prevent any such slowdowns in the future. The New Deal was implemented in two phases. The first phase (1933-34) was characterized by fiscal conservatism. It mainly focussed on relieving the economy from the Great Depression by means of programs relating to business and agricultural regulations, stabilization of prices, inflation and public works. The second phase, along with relief and recovery measures, also aimed at providing economic and social legislation for the benefit of the working population. The New Deal marked a significant shift in the domestic policy and the political ideology. It led to increased federal regulation of the economy and marked the onset of complex social programs and growing power of labour unions. First New Deal The American population was unhappy with the failing economy, high levels of unemployment and reduced wages. Roosevelt assumed the office at a time when the nation was demanding prompt action and he responded with a set of new programs in the “first hundred days” of his office. The Great Depression had caused a large number

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Article of the Month Cover Story Finistory

Fig 1: Snapshot of American Economy

of bank runs which destabilized the economy. Roosevelt implemented the Emergency banking Act which allowed for a framework of reopening of banks under the Treasury supervision. This resulted in three-fourths of the banks being reopened in the next three days of the enactment of the act. Money poured back into the economy and hence stabilizing the liquidity in the economy. Another major reform implemented in the first phase was the abolition of the gold standard system by the US. By the end of 1920s the Federal Reserve System faced a large outflow of gold which forced it to reduce the money supply in the economy. Roosevelt prohibited the export of gold, thus stopping the outflow of the gold from the economy, which marked the end of the era of the Gold standard. The US Dollar was allowed to float freely in the foreign exchange market, enabling the Federal Reserve System to elevate the money supply in the economy to the required levels. This phase also accompanied with the enactment of the Securities Act of 1933 which aimed at avoiding another Wall Street Crash. Further, to pump up the employment levels in the economy, Public Works Administration (PWA) was established. It organized funds for infrastructural activities such as building of roads, dams, hospitals and schools. Roosevelt liberalized the US trade policy and ushered the era of the liberalization that still persists. Second New Deal The second new deal was not only more liberal but also more controversial than the first new deal. It

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was mainly characterised by the implementation of the Social Security Act which established a system of retirement pensions, unemployment insurance and security benefits for the handicapped. The Wagner Act guaranteed labour the rights to collective bargaining. It led to the birth of the National Labour Relations Board that facilitated the wage agreements and promoted employee welfare. Roosevelt also formed the Works Progress Administration (WPA) in order to nationalize the unemployment relief programs. The WPA did not compete with the private sector and financed infrastructure projects that generated employment for many. He also instituted a tax program known as the Wealth Tax Act to redistribute wealth. And one of the last programs under the New Deal was the US Housing Authority which aimed at abolishing the slums from the country. Evaluation Of The New Deal Reforms Roosevelt reinstated hope in the economy at a time when it was on the verge of a major collapse. His reforms established the labour unions, improved the nation-wide infrastructure, rescued the banking system and hence upgraded the economy as a whole. However, the New Deal failed to rework the distribution of wealth and power within the American capitalism. The New Deal revised the role of the federal government, to that of helping the less privileged members of the society. It took up the responsibility of providing welfare programs and benefits. The government expenditure on welfare programs

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Finistory Article of the Month Cover Story

Fig 2: Number of persons unemployed

increased from virtually nothing in 1930 to almost $480 billion in 1940. The government also spent another $480 million on eradicating unemployment. Nevertheless, the expenditure was not adequate and just kept the people alive. Taking the year 1933 as the base year (the year when Roosevelt assumed office), we can observe that all the three parameters, namely GNP, amount of consumer goods bought and private investment, improved significantly. Since investor sentiments play a crucial role in determining the economic strength of a nation, these figures clearly point out that the American population had shown greater confidence in the system after the New Deal. The GNP witnessed an increase of 60% from 1933 to 1939, amount of consumer products bought increased by 40% and private investment increased by five times in a span of just six years. However, critics generally use unemployment figures for the 1930s to argue against the New Deal. Opponents of the New Deal argue that America never got rid of unemployment and Roosevelt’s policies only had a short term impact which virtually created

an impression that all the problems were coming to an end. Many believe that it was World War II that truly got the US out of the Depression. Nevertheless, Roosevelt was a leader whose skills were unparalleled. In desperate times he responded with a bold step and saved the American economy. No matter how sweeping his objectives were, they still helped in preserving the free-market economy of the United States. Industry was not nationalized and a social security net was created in the nation. Regardless of its weaknesses, Roosevelt and his New Deal Reforms helped the United States struggle through the dark times and conquer it successfully. Roosevelt’s Optimism became the nation’s most prized political currency. “Being bold entails failures, and Roosevelt had more than his share of these. But it is because he was bold, and persistent, that he is still honoured.”

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Article Finsight of the Month Cover Story

Rananjay Kumar

MDI Gurgaon Implementation of GST in India has been in the news for quite some time and does look a distinct possibility in the near future, especially considering the present pace of reforms that the Manmohan government has set. Before setting off into sunset, Manmohan Singh seems to at last reignite his economist soul. Every industry is looking ahead with anticipation and managers involved in logistics planning are delaying their decision making, hopeful of a new tax era. Logistics industry is bound to undergo great changes in its strategic planning and decision making processes. The present tax structure in India is a complication personified sutra wherein taxes are levied at both Central (Federal) level and the state level. Presently, only the central government is entitled to tax services as per Finance Act. Physical goods are taxed at central level as CENVAT and states levy their own independent taxes as per their whims and fancies. Though introduction of VAT did bring some uniformity but state governments, often out of political compulsions, have taken decisions resulting in critical differences in tax levels. Moreover some states are yet to implement VAT. The Story Goods and Services Tax (GST) is an attempt to do away with the multitude of taxes and introduce a comprehensive and allencompassing single tax to be levied on goods and services consumed in an economy. GST will be applicable and calculated for every stage in production-distribution stage but the incidence of tax will be on final consumption. The system is like a credit based tax system

FEBRUARY 2013

where credit-tax keeps on accumulating and at the time of final consumption, the seller of goods or services may claim input credit of tax which he has paid while purchasing the goods or procuring the service. To understand how GST will bring about uniformity across the nation, letâ&#x20AC;&#x2122;s take the example of a bicycle manufacturing company. First the central government charges an excise duty as the product leaves the company. At the point of sale, state introduces its own tax (VAT) which varies from state to state. This VAT is taxed on top of excise tax without giving credit to excise tax levied earlier. If implemented in its true spirit, GST will neutralize this tax on tax structure. Both central and state GST will be charged at manufacturing cost. It will be the single-biggest reform ever since industrial de-licensing in 1991 and could be worth $500 billion for India, according to Thirteenth Finance Commissionâ&#x20AC;&#x2122;s former chairman Vijay Kelkar. Owing to the continued opposition by states alleging encroachment of their financial and governing autonomy, the government is expected to introduce a dual GST model. As per this, a Central Goods and Services Tax (CGST) and a State Goods and Services Tax (SGST) will be levied on the taxable value of the transactions. Out of 140 countries, where GST has been implemented, Brazil and Canada are following dual GST model. This structure provides a higher involvement from the states, and soothes their apprehensions regarding federal encroachment of powers. The applicability of CGST or SGST will be determined by turnover value and thresholds in this regard are still under discussion. Besides there are concerns regarding loss of revenue for manufacturing based states as compared to service dominated states. The Centre has promised to come up with a compensation plan for first three years to address this issue.

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Finsight Article of the Month Cover Story

Impact of GST on industry Existence of complex and multistage taxation system has been eating up the profitability pie of the Indian manufacturing sector thus nullifying the cost arbitrage available because of low cost economy. The manufacturing cost of most products in India is almost half that of west, but the incidence of multistage taxing diminishes the advantage to the extent of 50%. GST intends to nullify this cascading impact on value chain of a product. Impact on Warehousing and Distribution On an average, an FMCG in India operates with 25 to 50 warehouses as compared to 5-8 in economies of similar geographical area. To account for complex state wise tax, companies have started maintaining warehouses in different states and apparently with little distributive advantages. Union Territories like Daman have attracted warehouses just because of the tax structure. Thus it is a matter of grave concern that tax avoidance and not operational efficiency has become a decision criterion for the firms. De facto, this results in operational inefficiency and higher cost or cost-quality trade-offs. GST will help reduce the warehouse space requirement by 20-50 per cent by nullifying the tax considerations. Also the number of warehouses will decrease and sizes will increase thereby providing the companies the advantage of economies of scale. Considerable reduction of overheads is expected by reduction in work duplication. Strategically located warehousing facilities will improve transportation efficiency and bring down the costs. The existing geographically distributed vast number of warehouses require ERP linkages throughout the network to ensure realtime visibility of inventory. This results in higher IT costs which will be considerably reduced. Material handling and compliance costs are also expected to come down. The state of the logistics industry The inefficiency of Indian logistics industry can be gauged from CRISIL report of September 2009, which states that the primary and secondary (from hubs to depots) transportation and infrastructure cost in India is 10.7 % of GDP as compared to around 5-7 % in

the developed countries. Present states of affairs are a result of failure of government or industry to optimally invest in building scale, automation, human capital and technology. The logistics industry is characterized by its unorganized structure, lack of legislative infrastructure and chronic underinvestment. On top of this, high competition and penalizing tax structure has resulted in poor quality and value delivered by the industry, thus eroding the profits. The advent of GST will provide companies to compete on the basis of their supply chain and logistics structure, thus proving a shot in the arm for Indian logistics industry. Advantages of advent of GST The multitude of benefits to be provided by GST has been listed by Dr Vijay Kelkar, chairman of the 13th Finance Commission. First and foremost, the burden of taxes will be equitably redistributed between manufacturing and services. Thus tax rate will come down by broadening the taxation base. This is necessary considering the present contribution of service sector in GDP. It will reduce distortions by completely switching to the destination principle. It will promote operational efficiency by ensuring decision making on purely economic concerns rather than tax considerations. The competitive advantage will help promote exports, employment and growth. • LOGISTICS: Introduction of GST will catalyze much needed consolidation in the industry. The state boundaries will become meaningless for industries and entire nation will emerge as a potential market. This will bring operational efficiencies and strategic planning in decision making processes of manufacturers and distributors. Also it will trigger large scale investment by logistics companies and 3PL service providers in scale, service focus and technology. • TAX CREDITS: The tax credit system, as envisaged by GST, would allow manufactures to offset the output

Finsight Article of the Month Cover Story

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tax liability on the sale of their finished products as against input tax credit for all inputs and capital goods purchased from any registered dealer in the country. Similarly, distributors would also be able to pass on the duty burden to their customers. Presently, no such credit can be claimed on services taxes. Thus, cost of doing business would come down. • INVENTORY COSTS: Currently, CENVAT is included in the inventory costs of companies, thereby affecting the balance sheet adversely. This impact is more profound for consumer durables companies and FMCGs. But the new GST structure would allow immediate recovery of GST paid in form of input tax credit, thus reducing the inventory financing charges. • CASH FLOW BENEFITS: Dealers and distributors would be collecting the GST at every sale but will be paying the same to the government at the end of the month. This extra cash in hand can be utilized for further improving the efficiency of their business model and short term investments. • CONSUMER BENEFITS: As manufactures receive the aforementioned benefits of GST, they might pass on the benefits to the consumers making it a win-win scenario. • REVENUES: GST would broaden the tax base and reduce exceptions. Even service sector will come under state purview. Reduced compliance costs have proved to be an incentive for industries in the past. Accordingly, the total revenue collections for the Centre as well as states are expected to go up (as proved by post-GST scenarios in other countries). Businesses need to gear up in tandem with government to avoid getting caught off-guard at its launch. Businesses need to look into supply chain infrastructure and bring in professional expertise into the field. 3PL and specialized players are required to consolidate the industry. Training and preparedness needs to be there to implement changes in ERP models available to discount the tax impact and adopt wheel-spoke model. Even pricing strategies need to be worked upon as per the new tax regime. GST elsewhere Approximately 140 countries have introduced GST in one form or another and hence there are multiple models available to choose from as per our specific requirements. For example, the United States has not yet introduced any GST or VAT structure on

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goods and therefore states are free to apply taxes at rates varying from zero to 8.5 per cent. Neighboring Canada has multiple structures available but in essence follows the dual GST model. Although EU prophesizes a European Common Market, it has varying VAT rates for different countries. China and Australia employ a single centrally-imposed VAT model and the revenue is shared between the Centre and the States according to a pre-agreed formula. Success of GST elsewhere has been apparent. For example, introduction of GST in New Zealand in 1987 yielded revenues 45 per cent higher than anticipated because of improved compliance and structural benefits resulting in improved economic productivity and efficiency. Canada had a similar taxation structure as India and replaced it with dual GST model as envisaged in India. It reaped the benefits in terms of increase in potential GDP by 1.4 per cent which constituted 0.9 percent increase due to higher factor productivity and 0.5 per cent increase from a larger capital stock (due to elimination of tax cascading). This can be taken as a suggestion of the potential benefits to the Indian economy. Kelkar committee estimates this value to be around US$ 15 billion annually. This value in itself can be a stimulant good enough for early actions. Current status The constitution needs to be amended to enable states to tax services. For the proposed constitution amendment, two third approval is required and also 15% of state assemblies would have to ratify it. Hence the role and attitudes of states is a matter of concern and needs to be taken care of. Hence, an Empowered Committee of State Finance Ministers has been constituted under the leadership of Shri Sushil Kumar Modi, the Finance Minister of Bihar, to ensure smoother transition and harmonization between federal government and states. This committee recently went to Canada to derive from their experiences in terms of the dual GST and held discussions with top Canadian politicians including Ontario Premier Dalton McGuinty, tax experts, legal luminaries and businesses to share their experiences. Mr. Modi shared his optimism regarding the implementation of GST in nearby future.

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Credit Ratings Siddharth Gupta IIM Shillong Sir, what does credit rating of BBB- signify?

Sir, there was an article in yesterday’s newspaper; “Fitch downgrades India’s credit rating outlook to negative”, but I couldn’t understand what does credit ratings mean? Could you please throw some light on it? It’s very easy to understand Credit Ratings. A credit rating/score determines the ability/worthiness of a person/institution to pay back the borrowed money. In general, a credit rating evaluates the credit worthiness of a debtor, especially a company or a government. A credit rating is generally represented in alphanumeric symbols.

Fitch assigns credit ratings from excellent to poor on the scale as: AAA(Prime), AA+, AA, AA- (High Grade), A+, A, A- (Upper Medium Grade), BBB+, BBB, BBB- (Lower Medium Grade), BB+, BB, BB- (Non-investment grade speculative), B+, B, B- (Highly Speculative), CCC (Extremely Speculative), DDD, DD, and D (In default). I think, now you can interpret what Fitch has to say about the Indian Economy. Does the “-“sign in a particular rating has any negative connotation in relation to the issuer’s performance or its debt-servicing capability? Not at all! “+” and “-” symbols are used just to indicate distinctions within a rating category.

Sir, is there any formula for calculating the Credit Score?

Sir, how do investors benefit from a credit rating?

There is no mathematical formula for calculating the credit score, instead, credit rating agencies use their judgment and experience in determining, what public and private information should be considered while giving credit ratings to a particular company or government. The main factors used to calculate an individual’s credit score are his or her credit payment history, current debts, time length of credit history, credit type mix and frequency of applications for new credit. The scoring systems are based on different criteria which are weighted differently, so for the same entity, different rating agencies can come up with different credit score and hence different ratings.

Credit ratings help investors facilitate comparative assessment of investment options. In this way, companies or individuals can decide the institutions in which they can invest their money.

Which are the different rating agencies apart from Fitch?

Some of the largest credit rating agencies are A. M. Best, Dun & Bradstreet, Standard & Poor’s (S&P), Moody’s. In India, CRISIL, ICRA are the major credit rating agencies.

Sir, but this is same as Equity Research, then why do we need Credit ratings? No, Credit Ratings are not the same as Equity research. Credit ratings are used to evaluate debt instruments, while equity research is used to evaluate equity shares. A credit rating is determines the worthiness of a debt issuer to pay back the borrowed money , the primary variable in debt instruments. Equity research is focused on growth possibilities, for that is what drives equity valuations. I hope that clarifies your doubt. Now I understood what Fitch meant. Thank you sir.

Article of the Month Classroom Cover Story

CLASSROOM FinFunda of the Month

FIN-Q 1. He was born in a Gujarati Jain family. He briefly worked for New India Assurance Company until he decided to trade in the stock market of BSE and NSE. He created one of the biggest scams in the Indian stock market history by carrying out there day forward transactions between the banks. Identify the person. 2. This company manufactured the first Indian typewriter as well as India‘s first refrigerator. It also had the order to manufacture 900,000 ballot boxes for independent India’s first general elections. Name the company. 3. This theory states that small individual investors can never be right. Hence whenever small individual investors are selling shares, its actually good time to buy them. Identify the third company? 4. Italian American artist “A” designed world famous “B” for $3.6 million, which put Wal-Mart into trouble. Identify A & B? 5. In 2012 2 IPOs MCX and CARE saw huge over-subscription. MCX being oversubscribed 53 times and CARE 41 times. Which is the most oversubscribed IPO in Indian market ever and by how many times? 6. X was a listed fund first launched by an American financial services firm in 1993 which tracked the S&P 500 share index. It soon got nicknamed as Y after the name of an insect because of its ticker code SPDR and widely known as Y fund. Identify X and Y. 7. A term coined by Warren Buffet and is used as a line of Defense around castles as well as against competitors to maintain long term profits and market share. 8. International Bank X-Y was formed from merger of Bank X and Bank Y. It was one of the very few banks which did not book any losses during the recession years of 2008 and 2009, primarily because of extraordinary gains from trading in its Investment Banking division. 9. The given image is taken from a print ad. Identify the company that gave this ad and the product they intended to advertise.

All entries should be mailed at niveshak.iims@gmail.com by 5th March, 2013 23:59 hrs. One lucky winner will receive cash prize of Rs. 500/-

WINNERS Article of the Month

Prize - INR 1000/-

Raghuveer MSSA IIM Shillong

FIN - Q

Prize - INR 500/-

Joanne Fernandes IIM Shillong

ANNOUNCEMENTS ALL ARE INVITED Team Niveshak invites articles from B-Schools all across India. We are looking for original articles related to finance & economics. Students can also contribute puzzles and jokes related to finance & economics. References should be cited wherever necessary. The best article will be featured as the “Article of the Month” and would be awarded cash prize of Rs.1000/- along with a certificate. Instructions »» Please send your articles before 5th March, 2013 to niveshak.iims@gmail.com »» The subject line of the mail must be “Article for Niveshak_<Article Title>” »» Do mention your name, institute name and batch with your article »» Please ensure that the entire document has a wordcount between 1200 - 1500 »» Format: Microsoft WORD File, Font: - Times New Roman, Size: - 12, Line spacing: 1.5 »» Please do NOT send PDF files and kindly stick to the format »» Number of authors is limited to 2 at maximum »» Mention your e-mail id/ blog if you want the readers to contact you for further discussion

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