Category: Economy

The American government shutdown will probably cover the next few news cycles unless something very big happens, or it gets resolved very quickly, and in this post I’m going to give a quick primer on what this shutdown actually means.

What does the government shut down Mean?

The US federal government employs more than 2 million people, and out of these 2 million people, 800,000 are deemed to be non – essential, and they will be asked to take a temporary unpaid leave which is called a furlough. The other 1 million plus employees who continue to work will get paid late.

The federal government has departments and employees who take care of airport traffic control, national parks, food safety, border security, zoos, post office and several others like this, and each department has their own list of who is essential and who is non – essential and based on this classification, it is has been decided who takes a temporary leave and who shows up for work.

Why is the US government shutting down?

The United States Congress has two houses – House of Representatives and the Senate. The US government runs from a fiscal year of October 1st to September 30th. The Congress passes the budget that allows appropriation of funds for the government to function, and this budget should pass both the houses.

Currently, the House is controlled by the Republicans and the Senate is controlled by the Democrats, and while the spending bill passes one house, the other house rejects it and sends it back with their conditions.

Since the spending bill couldn’t pass, the government couldn’t authorize payments, and had to partially shut down.

What is causing the impasse?

In simple words, the Democrat led Senate passes the spending bill and sends it to the Republican led House. The House attaches some provisions related to what is commonly known as Obamacare, and sends it back to the Senate for their approval. These are unacceptable to the Senate who then remove these provisions, and send the bill back to the Senate who add back the provisions. This back and forth happened seven times before they ran out of time, and the NYT has a good graphic to explain this easily and quickly. 

Obamacare is the Patient Protection and Affordable Care Act  and has perhaps been the biggest fighting point between the Republicans and the Democrats. It was signed into law about three years ago but its legality was challenged, and the Supreme Court passed a ruling saying that it was constitutionally valid in June of last year. Its provisions are going to come into effect only now and that’s where the negotiations (or lack thereof) have been.

Is this the same as the debt ceiling?

Sadly, no. I say sadly because that drama is also coming upon us very soon. So first Congress needs to pass the budget so that it can appropriate funds, and then it needs to raise the government’s borrowing limit so it can borrow the money it needs to spend.

What are the effects of the government shut down?

This is not the first time the government is partially shutting down and there have been a total of 17 times that this has happened. But this is still significant enough to affect people’s lives and that’s why it is frustrating for all Americans that the two parties could not reach a compromise.

The big problem is of course the very huge number of people who will not get paid for what is petty politics. Two parties mandated with running a country should be able to work out a compromise when it affects the livelihood of close to a million people. Sadly, politics seems to the same every where.

For the larger economy, the problem that the government employees who are not getting paid will not spend, and then there is a possibility that some of them are forced to default on their mortgage payments, and either of these of course is not good for an economy.

In my opinion, this isn’t good news for the international economy either, and money will not flow into other markets of the world because of the antics of the US Congress. I say this because it is expected that a resolution on this is reached soon, and both parties reach a compromise quickly, and also because no other country presents a good investing alternative anyway, which is what we saw during the 2008 crisis.

Please leave a comment if you have any questions, and I’ll try to answer them to the best of my knowledge.

This post is written by Shiv Kukreja, who is a Certified Financial Planner and runs a financial planning firm, Ojas Capital in Delhi/NCR. He can be reached at [email protected]

What the Finance Minister P Chidambaram must have advised the RBI’s ex-Governor D Subbarao not to do and what he must have wanted US Federal Reserve Chairman Ben Bernanke not to do, the former Chief Economic Advisor, Raghuram Rajan has done exactly that in his first ever monetary policy as the new Governor of the Reserve Bank of India.

In the RBI’s September monetary policy today, Dr. Rajan has increased the Repo Rate, which Dr. Subbarao could have done a couple of months back, and spooked the Indian markets by his actions, which Mr. Bernanke could have done a couple of days back.

Actually, Dr. Subbarao resisted tinkering with the key policy rates in July, as he wanted the markets to initially believe that his policy actions were temporary in nature and he would reverse those measures quickly, as and when there is some stability in the currency markets. But, nobody could stop the market participants to panic at that point in time and the rupee to fall from 58-59 against the dollar to 68-69 in less than a month’s time.

Just before Dr. Rajan took charge at the Mint Street, markets were in a state of disarray. There were a number of pressure points, which were taking the global markets down and making the analysts predict NSE Nifty to touch 4,800. Those pressure points included a possible US attack on Syria over Syria’s use of chemical weapons, a high possibility of QE3 tapering by the US Federal Reserve, India’s trade deficit to remain high due to low exports & high imports, Indian rupee touching a psychological 70 mark and so on.

Call it a perfect luck or whatever, since then the global markets have seen all these fears receding very smoothly one by one. Tensions over Syria have come down considerably, India’s trade deficit has gone down to $10.9 billion in August, the rupee has recovered to below 62 levels and most importantly, US Fed has postponed its tapering programme till the time it sees the US economy growing the way they want it to grow.

Today was Dr. Rajan’s first serious test as the new Governor of the RBI. So, let us check what exactly Dr. Rajan has done in his first monetary policy and what exactly he wants to do with those measures.

0.25% hike in the Repo Rate to 7.50% – RBI has increased the Repo Rate by 25 basis points from 7.25% to 7.50%. This is the rate at which the commercial banks borrow money from the RBI for a short period of time. RBI has increased this rate to discourage banks to borrow and further lend money in the market, as the dangers of the inflation moving up have increased dramatically with a steep fall in the value of rupee since its last monetary policy.

So, what actually made him raise the Repo Rate? The answer is rising overall inflation, due to steep fall in rupee and upsurge in food inflation (including onions).

0.75% reduction in the MSF Rate to 9.50% – RBI has reduced the Marginal Standing Facility (MSF) Rate by 75 basis points from 10.25% to 9.50%. This is the rate which the RBI charges to the scheduled commercial banks for the money borrowed for their overnight liquidity requirements.

If you had made any investment in gilt funds or income funds during April-June period, then you must remember RBI’s first move in July to curb speculation in the currency market. RBI had hiked the MSF Rate very steeply by 200 basis points from 8.25% to 10.25%.

Now, the RBI has cut this rate to give some relief to the banking system for which the cost of borrowing money under this window had increased considerably. Also, RBI has been able to reduce this rate as the dangers of the currency volatility have reduced in the recent few days.

0.25% hike in the Reverse Repo Rate to 6.50% – RBI has increased the Reverse Repo Rate by 25 basis points from 6.25% to 6.50%. This is the rate at which the banks deposit their excess money with the RBI for a short period of time. This rate is linked to the Repo Rate and remains 1% below the Repo Rate. These are not the times of abundant liquidity in the banking system, so there is not much significance of hiking this rate.

Minimum daily cash reserve requirement reduced to 95% of deposits from 99% – This is the RBI’s second measure in favour of improving the sentiment in the banking system. In its second big move on July 23, RBI hiked the minimum cash reserve ratio (CRR) requirement of banks from 70% of their deposits to 99%. Today, Dr. Rajan reduced this requirement from 99% to 95%. This move is going to provide some elbow room to the banks as far as the liquidity is concerned.

No change in Cash Reserve Ratio (CRR) – RBI has left the CRR unchanged at 4%. Despite SBI Chairman, Mr. Pratip Chaudhuri, asking the RBI to cut the CRR many a times in the past, Dr. Rajan also did not bulge and decided to continue walking the same path as used by his predecessor.

Impact of the Monetary Policy

What happened today here in India was the exactly opposite of what happened in the US on Wednesday. Most of the people had expected the US Fed to announce some sort of QE3 tapering, be it of a smaller quantum, but Fed’s decision to leave it unchanged left the market participants pleasantly surprised.

Today, most of the people had expected the RBI Governor to start it from where the Fed had left it that day. Markets had expected Dr. Rajan to remain dovish and reverse most of the harsh steps the earlier Governor had taken. But, people were left extremely disappointed to have a hike in the Repo Rate and a token relief on the liquidity front.

Impact on Stock Markets: After yesterday’s big upmove and immediately after the RBI’s announcements, BSE Sensex and NSE Nifty nosedived to reverse all of their yesterday’s gains and thereafter recovered somewhat to close at 20,264 and 6,012 respectively.

Impact on Debt Markets: 10-year benchmark 7.16% G-Sec yield closed at 8.58%, 39 basis points higher than Thursday’s close of 8.19%.

Impact on Currency: Though a hike in the Repo Rate should have boosted the value of Indian rupee, but a fall in both the equity market as well as the debt market resulted in rupee closing at 62.24 vs. yesterday’s 61.77, a rise of 47 paise in the value of one dollar.

So, after RBI’s policy decisions and market closing, this is where we stand as of today:

It is such a pity that even after such a wonderful Rabi season early this year and some excellent monsoon rains in most parts of the country in the last few months, we are still struggling with a double digit food inflation. The government, which is not able to manage the supply of onions in some of the major cities of India, makes big claims to ensure food security in the remote parts of the country.

The steps Dr. Rajan has taken today, I think any sensible RBI Governor would have taken the same steps, including Dr. Subbarao. Till a few days back, Dr. Rajan’s press conferences used to reflect what the Finance Ministry’s priorities were. But, the erstwhile Chief Economic Advisor is now the Governor of the Reserve Bank of India and I think his responsibilities are his priorities now. That is what got reflected in the RBI’s monetary policy today.

I think Dr. Rajan has taken a balanced decision by increasing the Repo Rate to tame inflation and by reducing the MSF Rate to cut short-term funding costs in the banking system. After today’s 75 basis points reduction in the MSF Rate, the differential between the Repo Rate and the MSF Rate stands at 200 basis points now. I think Dr. Rajan would like to take it down to 100 basis points again, by the end of November 2013. How, what & when he does it, it will depend on the domestic as well as some of the global factors. Will he succeed in his efforts or not? As always, only time will tell. But, as an Indian, I hope he does!

Gunjan Talwani sent the following email day before yesterday:

Gunjan Talwani:

How can the citizens of India contribute and prevent value of rupee from falling?
Please suggest few steps.

I think this is a very noble sentiment and you don’t usually see these type of comments where people want to know what they can do to improve the situation, so I was impressed by it, and it got me thinking of what should an Indian do to prevent the value of Rupee from falling?

Buy less gold?

Gold imports were the first thing that came to my mind as the government has said several times that gold imports has burdened the CAD (Current Account Deficit) and they have raised duty on gold several times to slow down gold demand.

One way to slow down gold demand is if the people themselves started buying less gold, so that’s one way to help arrest the Rupee slide, but would this be patriotic?

I don’t think so because gold buying has increased a lot in recent years just for investment purposes and gold is being considered for this because there aren’t really that many alternatives available to Indian investors.

Most people aren’t comfortable with equities (justifiably so), real estate is ridiculously priced, and not everyone can afford that, fixed income options have all negative real rate of returns, and in this environment gold at least promises the hope of real return.

Long term readers know I don’t have any gold in my own portfolio and have never bought any throughout this rally, and my opinion on gold has certainly not changed. I’m merely saying  that most people want to choose this option, and it is not greedy or selfish for them to want to protect their money from the high inflation that has been caused by the government policies in the first place.

So, no, I don’t think it is patriotic to avoid gold.

Do not buy diesel cars?

After gold, oil is the second biggest thing on people’s mind when you talk about deficits because of its size, and also because of the various subsidies given in petrol and diesel.

If you are driving a diesel car then you’re benefiting from a government subsidy that punches a hole in the country’s finances, while you enjoy the high view from your SUV. There was a proposal to impose additional excise duty on diesel cars but I don’t think that has been implemented yet.

So, that might be a patriotic thing to do – drive a petrol car, and pay more. Would I do it myself? No, because if there is a policy anomaly then I want to take advantage of it, and the money saved from a diesel car can be used to buy onions.

Do not buy imported goods?

This is the third thing that came to mind – what if people just bought made in India with the hopes of keeping money within the country and lowering the import number so as to control CAD. I don’t think that is very practical if you look at all the things you use in your every day life, and even then it doesn’t solve the underlying problem of slow export growth. It also ignores the fact that we live in a globalized world where the whole world benefits from trade, and that’s not the problem.

Do you see the theme?

The point I’m trying to make here is that the common Indian citizen can take some steps to help the government bring down the CAD, and help the Rupee, but even if they do so they don’t solve the underlying problems like slow exports, policy inconsistencies or economic sluggishness.

I’m of the opinion that the people are the victim of these policies and this is not a situation similar to the 2008 US Housing Crisis where people who bought houses with the intention of selling them at a higher price one year down the line also had some share in the blame for the crisis. The Indian situation is different.

If you don’t attack the roots of the problems which can only be done by government policies then you can’t really find a long term solution to this problem.

Conclusion

I think the root cause of the Rupee decline and the economic slowdown in India is government policies and inaction, and I don’t feel that there is anything the common citizen can do to help this cause since finally policy making and implementation is beyond the public and that’s where the solution lies. This is disheartening and I hope someone can point out practical measures that I couldn’t think of but my assessment is that the government (this or the next) has to take action.

This post is written by Shiv Kukreja, who is a Certified Financial Planner and runs a financial planning firm, Ojas Capital in Delhi/NCR. He can be reached at [email protected]

India has seen an unprecedented fall in the value of its currency against the widely used global currency US dollar in the last couple of months. Analysts, experts, finance ministry, RBI, all are blaming high current account deficit (CAD) for the rupee fall.

To save the value of rupee somewhat by squeezing its supply and increasing the supply of dollar, the Reserve Bank of India (RBI) sometimes sell dollars in the open market. This action of RBI reduces our forex reserves and thus becomes one of the factors for such a reduction.

On September 3rd, Mr. Ramamurthy asked me how the RBI or the Government has raised these reserves over all these years, despite we having a higher import figures against the export numbers, thus always resulting in current account deficit (CAD) and never a current account surplus.

Here is his comment.

Ramamurthy September 3, 2013 at 12:07 pm

Shiv

RBI or Govt is supposed to be having a Dollar reserve.I dont know the exact amount.

But I would like to know how RBI have accumulated this amount? I thought India never had a favourable CAD respect of Dollars.Imports were always in excess of exports.

Let us understand it, we spend dollars on our imports and get dollars for our exports. Actually, current account deficit (or total imports > total exports) is just a part of our overall foreign exchange standing. There are many other sources which affect our forex reserves either positively or negatively.

India’s foreign exchange reserves as on September 11, 1998 were at $29.048 billion, which on August 30th, 2013 stand at $275.49 billion, a jump of $246.442 billion or approximately 848% in 15 years’ time. RBI releases this figure every Friday, for the reserves held on the preceding Friday. If any of you wants to have the week-wise data of India’s historical forex reserves, you can visit this page of RBI to check it.

On July 27, 2013, the RBI released India’s Balance of Payments (BoP) data for financial year 2012-13. Here is the RBI’s Press Release regarding that. It lists the “Sources of Variation in Foreign Exchange Reserves” and I will try to explain these sources in a simple language to the best of my abilities.

I. Current Account Balance (= -$88.2 billion) – Current Account Balance is nothing else, but it is the other name of our Current Account Deficit or Current Account Surplus, as the case may be. If it is positive, then we call it a surplus and if it is negative, then we call it a deficit. It is calculated by adding our balance of trade, factor income (interest and dividends from international loans and investments) and net transfer payments.

Balance of trade (or trade balance) is the most significant component of our Current Account. It is calculated by deducting India’s total imports of goods and services from its total exports of goods and services. For FY 2012-13, our current account deficit (CAD) stood at negative $88.2 billion or 4.8% of India’s GDP.

II. Capital Account (net) (= $92 billion) – To finance a country’s current account deficit, it is very important for the government to encourage international capital flows into the country. All the foreign money which flows into India or Indian money which flows to some other countries, in the form of capital investments, gets counted under capital account. What are the sources of India’s capital account? Here we have it:

a. Foreign Investment (= $46.7 billion)

(i) Foreign Direct Investment (FDI) (= $19.8 billion) – FDI refers to an investment made by a foreign entity into India that involves establishing operations or acquiring tangible assets, including stakes in other businesses. Here, the investor seeks to control, manage or have significant influence over its Indian operations, either by establishing its own subsidiary or entering into a joint venture with an Indian entity.

(ii) Portfolio Investment (= $26.9 billion) – This refers to a passive investment by a foreign investor in Indian securities such as stocks, bonds or other financial assets, none of which entails control, active management or significant influence of the issuer by the investor.

Foreign Institutional Investments (FIIs) – Overseas institutional investors investing in Indian securities, either debt, equities or other financial assets listed here in India, comes under foreign institutional investments.

ADRs/GDRs – Foreign investors can also invest in an Indian company through the purchase of American Depository Receipts (ADRs) or Global Depository Receipts (GDRs). ADRs or GDRs are essentially negotiable instruments, denominated in US dollar or any other currency, representing a publicly-traded issuer’s local currency equity shares.

b. External Commercial Borrowings (ECBs) (= $8.5 billion) – ECBs are money borrowed by Indian corporates from foreign sources in the form of commercial loans, credits, notes, bonds or preference shares. ECBs open another avenue of credit at lower international rates for Indian commercial borrowers.

c. Banking Capital including NRI Deposits (= $16.6 billion) – It includes foreign assets and liabilities of commercial banks, including NRI deposits, foreign currency holdings etc. and movement in balances of foreign central banks and international institutions like Asian Development Bank, International Bank for Reconstruction and Development, International Development Association etc.

d. Short-Term Trade Credit (= $21.7 billion) – It refers to either suppliers’ credit, extended by the overseas suppliers, or buyers’ credit, arranged by the importers themselves from a foreign bank or financial institution, for imports into India. Short-term credit has a maturity period of less than 3 years. If the maturity period is more than 3 years, then it comes under ECBs.

e. External Assistance (= $ 1 billion) – It refers to multilateral and bilateral loans given to India by foreign governments and loans given by India to foreign governments.

f. Other Items in Capital Account (= -$2.4 billion) – These are miscellaneous items of capital account, whose value is not of any major significance.

III. Valuation Change (= -$6.2 billion) – When the US dollar appreciates against other global currencies including Indian Rupee, it results in a “Valuation Loss” for India’s forex reserves and when the dollar depreciates, it results in a “Valuation Gain”.

As India has grown at a rapid pace in the past and is expected to maintain this growth chart in the coming couple of decades, foreign investors have been pouring money here to reap the benefits of this growth and that is how India has enjoyed a major uptick in its foreign exchange reserves. To maintain the value of rupee and thereby our forex reserves, India is required to become innovative, competitive and efficient. It is required to win foreign investors’ trust and thereby become a reliable partner in its future growth.

This post is written by Shiv Kukreja, who is a Certified Financial Planner and runs a financial planning firm, Ojas Capital in Delhi/NCR. He can be reached at [email protected]

We keep reading all these days RBI has done this to save rupee from falling further against the dollar or RBI has done that to contain inflation from rising further. Many of us must be wondering all the time what the heck these policy measures are and how do they actually affect our common day-to-day life.

What is RBI’s Monetary Policy? What exactly is the role of RBI in managing money supply in the country? What are RBI’s different tools through which it controls the money supply and other related factors. Through this post, I will try to throw some light on RBI’s monetary policy tools and impact of those tools on the factors which they are targeted on.

Open Market Operations (OMOs) involve sale and purchase of Government securities (G-Secs) by the RBI to adjust the liquidity conditions in the system. RBI conducts such selling operations to suck liquidity whenever it feels there is excess liquidity in the system. Similarly, when the liquidity conditions are tight, RBI goes for such buying operations in the open market, thereby releasing liquidity into the system.

Liquidity Adjustment Facility (LAF) is a policy tool which allows banks to borrow money from the RBI through repurchase agreements, popularly called repo transactions. As the name itself suggests, LAF has been provided to aid the banks in adjusting their day-to-day liquidity mismatches. LAF consists of repo and reverse repo operations. Repo transactions inject liquidity into the system, while reverse repo transactions result in absorption of excess liquidity.

Repo Rate is the rate at which commercial banks borrow money from the RBI for a short period of time. Banks sell their securities or financial assets to the RBI with an agreement to repurchase them at a predetermined price at some future date.

Expected Outcome: A high Repo Rate deters the banks to raise funds from the RBI, forces banks to keep their own lending and deposit rates high and thereby, keeps money supply in check. This is what RBI tried to do on July 16th, which caused panic among the market participants and banks/corporates scrambled to shore up their cash holdings.

Higher interest rates normally curtail investments, as a result of which the overall consumption and aggregate demand start falling. Lower demand results in lower resource utilization. When resource utilization is low, prices and wages usually rise at a more modest rate. On the other hand, RBI purposefully reduces Repo Rate as and when it wants to encourage banks to borrow money for further lending to spur investments.

Reverse Repo Rate is the rate at which banks deposit their excess money with the RBI for a short period of time. RBI lowers the Reverse Repo Rate whenever it wants banks not to deposit incremental cash with it, thereby raise liquidity in the banking system for further lending and to raise overall investment levels and hence the aggregate demand. It also makes banks to offer lower rate of interest on the deposits made by the general public. But, at the same time, it allows banks to lend at a lower rate. Reverse Repo Rate remains fixed these days at 100 basis points (or 1%) below the Repo Rate.

Cash Reserve Ratio (CRR) is the percentage of a bank’s total deposits, which the bank is required to maintain with the RBI. Banks are mandated to deposit this amount with the RBI on a fortnightly basis. CRR is a tool used by the RBI to control the liquidity in the system.

Expected Outcome: So, when there is excess money floating around in the system, RBI will raise the CRR to suck out the excess money. On the other hand, if there is a credit crunch, RBI cuts the CRR to release money into the system. Normally, CRR cut increases liquidity in the system to a marginal extent only.

Statutory Liquidity ratio (SLR) is the proportion of deposits that banks are required to maintain in cash or gold or government approved securities.

Expected Outcome: Similar to CRR, a reduction in SLR also increases some money supply in the financial system. After keeping the required amount for CRR & SLR, the banks are free to use the remaining deposits for their lending purposes.

Marginal Standing Facility (MSF) is a facility provided only to the scheduled commercial banks under which they can borrow funds from the RBI for their overnight liquidity requirements. Banks can do this borrowing only against their SLR holdings, up to 2% of their net demand and time liabilities (NDTL). MSF rate is the rate at which banks can do this borrowing.

Expected Outcome: A hike in the MSF rate can raise banks’ cost of borrowing for their overnight liquidity requirements under the MSF window. At the same time, a cut in the percentage of NDTL, up to which the banks can borrow funds from the RBI, can squeeze liquidity for these banks. So, these two simultaneous steps mean a double trouble for the banks.

Till July 16th, MSF rate was fixed at 1% above the Repo Rate i.e. at 8.25% (7.25%+1%). At present it has been hiked to 3% above the Repo Rate i.e. 10.25%. Also, the RBI has cut the borrowing limit under MSF on two occasions in July, once from 2% to 1% and then from 1% to 0.5%, in order to squeeze liquidity from the markets and curb speculative trades in the currency market.

Impact on Your Investments

Equity Investments like Stocks, Equity Mutual Funds – A cut in the interest rates by RBI is always cheered by the stock markets and equity investors as this step reduces interest expense burden of the companies listed on various stock exchanges and thereby increases their profitability.

Financial Sector including Banks, Housing Finance Companies (HFCs) & NBFCs: Again, a cut in the interest rates boosts the business growth, profitability and net interest margins (NIMs) of the financial sector companies. Banks, HFCs, auto loan companies etc. get benefitted as it increases loan demand from its borrowers and also increases their margins.

Auto Sector, Real Estate Sector & Consumer Durable Sector Companies: Companies, which are in the businesses of auto or auto ancillary, real estate and consumer durables, get benefitted with a fall in interest rates as it reduces the borrowers’ overall cost of taking a loan and thus increases the demand for these companies’ products used by their customers.

Market-linked Fixed Income investments like Gilt Funds, Income Funds, Tax-Free Bonds or NCDs – There is an inverse relationship between interest rates and bond prices. When interest rates go up, bond prices fall and when interest rates fall, bond prices rise. RBI’s policy measures influence movement of bond yields, both government as well as corporate. Your market-linked investments like debt mutual funds, NCDs and tax-free bonds also get affected due to these measures. The value (or market price) of these investments goes up with a cut in the policy rates and vice-versa. The higher the quantum of rate cut and the more unexpected it is, the more will be the jump in the value of your investments.

Investments in gilt funds, which in turn invest in government securities (G-Secs) primarily, and investments in income funds, which invest in corporate bonds primarily, could give higher returns to the investors as the interest rates decline and their prices go up. Your direct investments in tax-free bonds or corporate NCDs also appreciate in value due to a cut in the RBI’s policy rates and a subsequent fall in their yield to maturity (YTM). This results in a gain in your overall bond portfolio.

Fixed Income Investments like Bank FDs, Company FDs or Post Office Schemes – A reduction in RBI’s policy rates does not affect your existing investments in FDs or Post Office schemes at all because these investments are not market linked and the interest rates, you are eligible to get, do not change. But, at the same time, it signals a likely fall in the interest rates on these FDs in the times to come.

Indian Currency (Rupee) – All those measures, which the RBI takes to absorb liquidity in the system, result in reduced supply of rupee in the markets as compared to the other global currencies. This reduced supply of rupee should ideally result in higher value (or appreciation) of Indian currency against other global currencies.

So, if the present situation is tough, if it is making the interest rates go higher, share prices and NAVs of your investments in mutual funds go down, then it should be taken as part of a cycle which keeps on changing with moving times. With a change in the decision-making authority at the RBI, people are again expecting something dramatic to happen for their bleeding portfolio values. Lets see what Mr. Raghuram Rajan has in store for us during his tenure as the Governor of RBI.

I am sure a lot of you have come across this article that presents a number of charts presenting the USD-INR rate in a time period before the general elections and shows how the Rupee has depreciated every time there has been an impending election.

I came across this article on Saturday, and didn’t think much of it which shows how poor a blogger I am, not because of the substance of the article but because I completely missed its potential to go viral.

I have the following reservations about the claim:

1. How does Congress influence the exchange rate? How do they actually make the Rupee depreciate per their will? Why don’t they just reverse the trend once the election is over? Don’t they have to hoard money the next time there is an election, why don’t they reverse the trend during non election periods?

2. If Rupee was being brought into the country, the price of the Rupee would appreciate, not depreciate.

3. UPA has taken a series of very unpopular steps to try to rein in the Rupee fall, and in the current case, the fall of the Rupee has angered a lot of people who are already quite frustrated with the efforts of the government is every direction. How does the ruling party decide that the 20% extra cash is worth the pain it causes to the populace (in terms of lost votes) and the fodder it gives to the Opposition to exploit this depreciation?

4. Speaking of Opposition, how is it that only Congress is able to benefit from this depreciation, and not the BJP?

5. How much of an outlier is a 15% fall?

In one of the comments, the authors have explained point number 2 by saying that politicians deposit USD in Swiss accounts of businessmen and then those businessmen transfer money in INR in India itself so that takes care of the Rupee not appreciating. If this were happening then yes, I think this is certainly a way that they could overcome the problem of Rupee appreciating when it is send back to India, but I find it hard to believe this is actually happening.

The other points speak for themselves except for 5.

I dug up some exchange rate data since the year 2000, and with some simple Excel work – found out how many times has the Rupee depreciated more than 15% in a 12 month period since the beginning of 2000. Now if you were to just look at months, then there would be just many many months after 2008, but I tried to lump together the data so that when I started with September 2013, the month before that was at least 6 months earlier. Here are the results of that.

After 2008, these falls in a 12 month period have been much more frequent than before 2008. The data in the Havala post is different because at times their range is less than 15%, and at other times their period is more than 12 months. I increased the time frame on my datas-set to 18 months to see what would happen and even those numbers are similar. Prior to 2008, not many big moves, and after 2008, quite a few moves.

Here is a chart on how the Rupee has moved against USD from the beginning of 2000.

This chart also shows that the Rupee has been quite volatile post 2008 but prior to that moved in a narrow range. That’s the only conclusion I can draw from this movement, linking it to Congress bringing back black money during election times makes for a good conspiracy theory, but I simply don’t see how this can be actually carried out.

This is a post from the Suggest a Topic page.

This post is written by Shiv Kukreja, who is a Certified Financial Planner and runs a financial planning firm, Ojas Capital in Delhi/NCR. He can be reached at [email protected]

A 3%+ fall in the NAV of an equity mutual fund is somehow acceptable for an investor, as I think almost every investor knows equity markets remain volatile and such a movement in either direction is part and parcel of stock markets. But, how would a risk-averse investor react to such a steep fall in a debt fund scheme?

It would definitely be a rude shock for a conservative investor, who invested in such a scheme a few weeks back, expecting at least a couple of rate cuts from RBI in the rest of the financial year and thereby to earn somewhat better returns as compared to bank FDs.

On Tuesday, July 16th, some gilt funds suffered such a steep fall in their NAVs. Other debt fund categories, such as income funds and dynamic bond funds, also suffered huge losses. Even short-term funds, ultra short-term funds and liquid funds, which are considered as the safest options of mutual fund schemes, generated negative returns for their investors.

So, what caused such a big fall in the NAVs of all these debt funds?

Indian rupee has been falling and the fall is quite worrisome as it has happened quite fast. It is also making headlines in the newspapers and people are talking about it cursing the government, so it becomes more worrisome in an election year. In order to give some strength to the falling rupee, RBI in consultation with the finance ministry and SEBI took some short-term measures on Monday to squeeze excess liquidity from the system.

What are those measures and what do they mean?

* The Marginal Standing Facility (MSF) rate is recalibrated with immediate effect to be 300 basis points above the policy repo rate under the Liquidity Adjustment Facility (LAF). Consequently, the MSF rate will now be 10.25 per cent.

* Accordingly, the Bank Rate also stands adjusted to 10.25 per cent with immediate effect.

First, we need to understand what is Liquidity Adjustment Facility and what the Marginal Standing Facility rate is?

Liquidity Adjustment Facility is a policy tool which allows banks to borrow money from the RBI through repurchase agreements or popularly called repo transactions. As the name itself suggests, LAF has been provided to aid the banks in adjusting their day-to-day liquidity mismatches. LAF consists of repo and reverse repo operations. Marginal Standing Facility rate is the rate at which the scheduled banks can borrow funds from the RBI for their overnight liquidity requirements.

So, before Monday’s announcements, the MSF rate was 8.25%, 100 basis points (or 1%) above the repo rate of 7.25%. On Monday, RBI increased it to 10.25% to make it costlier for the banks to borrow and thereby tighten the liquidity.

Moreover, most of the market participants were surprised by such moves and they are considering these announcements as a prelude to policy rate changes.

* The overall allocation of funds under the LAF will be limited to 1.0 per cent of the Net Demand and Time Liabilities (NDTL) of the banking system, reckoned as Rs.75,000 crore for this purpose. The allocation to individual banks will be made in proportion to their bids, subject to the overall ceiling. This change in LAF will come into effect from July 17, 2013.

Earlier till Tuesday, July 16th, this percentage was 2% of the Net Demand and Time Liabilities of the banking system. So, by reducing it from 2% to 1%, RBI squeezed Rs. 75,000 crore from the system and capped it at Rs. 75,000 crore only from its earlier limit of around Rs. 1,50,000 crore.

This measure made the banks and the corporates to rush to the mutual fund houses on Tuesday to redeem their investments in debt funds, especially liquid funds, ultra short-term funds and short-term funds. Such a huge redemption by these entities caused a very high supply of these securities and therefore a fall in their values.

* The Reserve Bank will conduct Open Market Sales of Government of India Securities of Rs.12,000 crore on July 18, 2013.

RBI conducted this open market operation (OMO) today evening to squeeze an additional Rs. 12,000 crore from the system, but the results of the auction were shocking. Against its notified amount of Rs. 12,000 crore, RBI received bids worth Rs. 24,279.20 crore. But, the central bank accepted bids worth Rs. 2,532 crore only and rejected the remaining bids worth Rs. 21,747.20 crore. But, why the RBI did so?

I think RBI was not comfortable with the low quotes (or higher yields) at which the bids were placed. With this rejection, RBI wants to send a message to the market participants that the measures taken by it on Monday are temporary in nature and people should not use it as an opportunity to ask for higher yields on government securities.

But, at the same time, I think the market participants are also confused and probably right in their decision to quote higher yields as they are not able to adapt to the fast changing market dynamics and really do not know what the ideal yield should be for these long-term government securities in the current highly complicated interest rate environment.

Impact on Stock Markets: RBI measures spread the negative sentiment to stock markets also as the BSE Sensex lost 183.25 points, down 0.91% and the NSE’s Nifty declined 75.55 points or 1.25%.

Impact on Rupee: The booster dose of RBI helped rupee to jump to 59.31 per dollar, up 0.97% from its previous close of 59.895.

Impact on Borrowers: The banks which were planning to cut interest rates on home loans, car loans etc. must have changed their minds by now. So, the borrowers hoping for a rate cut should cut down their own expectations for a low interest rate regime.

Impact on Depositors: Some good news for the depositors. The fear of deposit rates falling has turned into a hope of them rising for a short term. Rajat Monga, CFO of Yes Bank, said that he expects deposit rates to harden 50-75 bps in the short-term.

Impact on the Government Borrowings & Fiscal Deficit: The interest rate tightening will increase the cost of government borrowings and thus worsen the condition of our fiscal deficit. High time for the government to take some bold decisions. Just a hike in FDI limits will not make foreign investors invest in India, they should be able to foresee returns getting generated on their investments.

These are turbulent and testing times, not just for our economy, but for our markets as well, be it stock markets, bond markets, forex markets or commodities markets. The question is, at a time when most of the professional fund managers or the so-called market experts are not able to take their investment decisions, what should a normal household investor do in such a times? It is a million dollar question and again, for most of the conservative investors, investing in bank FDs is the best solution.

The UPA government has said today that it is going to try and pass an Ordinance to implement the National Food Security Bill. They are going the Ordinance route without the full support of their allies and there are some news reports that talk about early elections due to this.

So far I’ve not seen a single group that supports the Food Security Bill and everyone has their own reasons for not supporting this. I’m going to talk about my impressions later on in this post, as I want to start by listing out features and highlights of this bill.

Features of the National Food Security Bill

The idea behind the National Food Security Bill is to provide really cheap food to people who may not able to afford it otherwise, and the Centre and State governments are both responsible to enable and implement this.

I think there are several things to understand here.

Why type of food does the National Food Security Bill provide?

This bill talks about providing rice, wheat or coarse-grains to people through PDS shops.  That’s also one criticism of the bill since people are now demanding protein rich food in India, and this bill doesn’t do anything to address that need.

Who does the National Food Security Bill aim to assist?  

The bill covers up to 75% of rural population, and 50% of urban population, and following categories are created in the bill.

Priority Households: People in the Priority Households are entitled to get 5 kgs of subsidized food grain per person per household.

Antodya or Eligible Households: An Eligible Household can get up to 35 kgs of subsidized food grain.

From reading the bill, it is my understanding that they haven’t yet defined these two type of households, just that these two categories together should cover 75% of the rural population, and 50% of the urban population.

In addition to the above two categories, the following will also be covered by the bill.

Children in the age group of 6 months to 6 years: The bill guarantees what is called an “age appropriate meal” for children falling under this age group.

Children in the age group of 6 years to 14 years:  Bill guarantees a free mid day meal in school for all children in this age group who go to schools run by the government or government bodies.

Pregnant or Lactating Mothers: These women will get a free meal during pregnancy and six months after child birth, and they will also get maternity benefit of not less than Rs. 6,000 in installments. The Bill doesn’t detail out how will these installments be paid.

What subsidy does the National Food Security Bill provide?

The bill states that rice will be sold at no more than Rs. 3 per kg, wheat for no more than Rs. 2 per kg and coarse grain for no more than Rs. 1 per kg.

What is the responsibility of the Central and the State Government?

The responsibility for procuring the food grain lies with the Central Government and the responsibility of distributing the food grain lies with the State governments. The bill also talks about women empowerment and to do that they are going to issue ration cards to women over 18 in every family as head of that family.

The States have the responsibility to build storage, ensure delivery and smooth functioning the scheme. They have the current Public Distribution System to work with, and clearly there is a lot of work to be done in that area.

How much does the Food Security Bill Cost?

The government has estimated Rs. 1.23 lakh crore as the subsidy cost for this bill. However, this is an incomplete estimate since it only includes the cost of food grain and doesn’t address the infrastructure or day to day running of the scheme.

Here is the government statement about this.

“As per the provision of the Bill, estimated annual requirement of food-grains at 2011 population is 60.74 million tonnes and the corresponding estimated food subsidy at 2013-14 costs is about Rs 1,23,084 crore,” Food Minister K V Thomas said in a written reply to Rajya Sabha.

They have already budgeted Rs. 90,000 crore as food subsidy this year, and based on how much they are able to implement this scheme

Thoughts on this bill

These were some of the main points of the bill, and now I will get to my impressions on this which are all rather negative. I can’t seem to find anything positive about this bill except perhaps the good intention behind it.

The government simply doesn’t have enough money to give away food like this. The government should be looking at cutting subsidies to get its spending control, not increasing it specially when everyone knows the leakages that exist in the system, and the black markets that are created due to such schemes.

The government doesn’t even have enough food grains. The grain stock is about 70 million tons and if the estimated requirement is 60.74 million tons then how will this be feasible three or four years down the line, the food stock isn’t getting replenished at the rate of 60 tons ever year, and one bad monsoon will leave the scheme totally infeasible.

There is no infrastructure to deliver the scheme – they haven’t defined who gets the benefit, there is no clarity on where the grain will be stored, or how it will be delivered.

The scheme distorts markets and it is not clear to me how this will affect prices for people who won’t buy food from this scheme. How will this affect farmers who will be dependent on state machinery to sell their food grains.

Such a costly bill is not good for the deficit, and while some brokerages have expressed that the deficit won’t be worsened because of the bill this year, that’s only because they don’t expect the bill to be really implemented this year, otherwise when the bill is fully implemented that will add to the food subsidy which in turn will worsen the deficit and ultimately fuel inflation.

I’m not optimistic that this bill will do anything to improve the state of the Indian economy or the state of the Indian people.