Current Affairs: Economy - Minor Issues 25 Aug to 25 Sept 2010

CAG Weekly
(Current Affairs & GK)
By Om Prakash (Goldy sir)

Economy (Minor Issues)

SEBI boss slams steep IPO pricing

  • Market regulator CB Bhave (SEBI Chairman) charged investment bankers with fleecing investors by pricing initial public offers (IPOs) at astronomical valuations, leading to investor anguish when the market tide turns.
  • Steep pricing could enrich bankers and companies, but persistence of the practice could demoralise investors, damaging capital markets, he said in what may be the first regulator comment on share-sale pricing since the abolition of the Controller of Capital Issues in 1992.
  • The underperformance of the BSE IPO index—it gained 14.5% in the last 12 months, when the benchmark Sensex rose 19.45%—reflects the Sebi chairman’s charges. Furthermore, a price performance study by CARE Research, a unit of rating company CARE, showed that 62% of the 116 IPOs between August 2007 and August 2010 are trading lower than their sale price while 35% are ruling higher.

Government turns cautious in gauranteeing loans of PSUs

  • The government came out with a policy shift in respect of its gaurantees to the loans advanced by bankers to the PSUs.  This is reportedly done with a view to ensure two things -- one to discourage laxity in loan appraisals by the bankers and two to ensure that the lenders do bear some risk in advancing loans to PSUs.
  • This is a marked shift from the earlier policy where the entire loan was guaranteed. The new policy on government guarantees says the state will back only 70-90% of the loan amount in some cases, leaving the lender to bear the balance risk.
  • In the case of default on such a partially-guaranteed loan, the borrower will also have to first negotiate with the lender for the unguaranteed part. It could then approach the government to settle the balance amount.
  • The immediate fallout of the new rules will be that despite the credit enhancement provided through government guarantees, such loans will be priced higher because of the partial risk that will stay with the lender.
  • The government had committed to keeping such guarantees in check by putting a limit of 0.5% of GDP in any financial year in the fiscal discipline act, or the Fiscal Responsibility and Budget Management Rules, 2004.
  • At the end of fiscal 2007-08 the total outstanding central government guarantee was Rs. 1,04,872 crore, 2.2% of GDP. The bulk of these relate to those given to international financial institutions for funding local lenders.
  • The tighter rules will help free up guarantees where they may be needed more.
  • It went on to suggest that instead of a 0.5% annual ceiling, the government should put a cap of 5% of GDP on the guarantee outstanding at the end of every year.
  • The reduced level of government guarantee will have the desired effect of forcing public sectors to use the public-private partnership mode more for financing projects.

Govt names WDRA chief; FMC may lose turf war

  • Putting to rest a simmering dispute between the commodity futures market regulator and the food department, the government has appointed Dinesh Rai, a retired IAS officer, as chairman of Warehousing Development & Regulatory Authority (WDRA). The regulator is being set up to develop a negotiable warehouse receipt (NWR) system for agri commodities.
  • Soon after Parliament passed the WDRA Act in 2007, Forward Markets Commission held that since its jurisdiction extended from the execution of a trade on exchanges to the settlement of a futures contract, it should be notified as the WDRA authority.
  • However, the food department was in favour of having a separate regulator for monitoring warehousing and had been scouting for a whole-time chairman and two members to sit on the board of WDRA. In the absence of an independent regulator for warehousing, FMC has been regulating over 1.5 million tonne of warehousing capacity.

Remember the 'impossible trinity'

  • It refers to the belief that it is not possible for the central bank to achieve the following three objectives simultaneously: manage exchange rate, have free capital flows and also manage interest rates. Once the doors of capital flows are opened, market forces will determine the exchange rate and the interest rate. If the central bank attempts to fix the exchange rate, the flow of capital will slow down. It is possible to continue to attract more capital even after fixing the exchange rate if the central bank give up its flexibility to manage interest rates. But if RBI wants to have a say in both — the exchange rate as well as the interest rate — it will have no choice but to place restrictions on the flow of capital across the country’s borders.

CAG fires a salvo against the Telecom Minsiter Mr. A. Raja

  • We have read recently in ET that the telecom ministry is considering bailing out the telecom companies with licenses from 2008 by allowing them to sell out or merge, paving the way for a possible consolidation in the 14-player domestic telecom market.  The circumstances under which these companies emerged in 2008 have resulted in allegations that the exchequer has been deprived of thousands of crores of revenues.
  • These companies, which include Videocon, Uninor, Sistema Shyam, Loop, S Tel, Etisalat DB and Allianz Infratech, have struggled with their rollout plans. For those that have launched services, the growth in the number of subscribers has slowed down to a trickle.
  • In a rare pre-emptive intervention by a constitutional body, the public accounts watchdog has now warned the telecom ministry against bailouts to mobile phone firms in violation of rules.
  • Recently, telecom minister A Raja, who is under fire for selling mobile licences and wireless spectrum to a clutch of new operators in 2008 too cheap, held out hopes of a ‘bailout’ for these firms, risking a fresh storm of corruption allegations against him and the government. Many of the new entrants are battling for survival as tariff wars in India’s ultra-competitive mobile market have significantly lowered average revenues per customer, making their businesses unviable.
  • The Comptroller and Auditor General of India (CAG) told the department of telecom (DoT) that allowing the new entrants to merge with incumbent cellphone companies will result in the combined entity holding more airwaves than permitted under current rules.
  • Allowing companies to exit without fulfilling their rollout obligations would violate existing regulations, said the CAG's letter.  Such a step, the letter said, would amount to letting off ‘companies that hoarded a valuable national resource (airwaves) without paying any revenue share to the exchequer’.
  • CAG is already investigating alleged wrongdoing in the allocation of 2G spectrum and licences to new companies in 2008. DoT has insisted that the watchdog has no business questioning policy decisions, and this position has been backed by the law ministry. This endorsement may provide crucial ammunition to Mr Raja in the latest standoff with CAG.

One more exchange makes a beginning

  • The country's newest exchange is the USE -- United Stock Exchange.  It has among its promoters the BSE and Jaypee Capital, a significant volume provider in the derivatives market. Jaypee Capital currently owns 5% in the exchange. BSE owns 15% in the new exchange while other shareholders include 21 public sector and five private sector banks, which hold over 50% of the exchange’s paid-up capital.
  • On the first day, USE clocked volumes of 45,485 crore in four currency pairs, including rupee versus dollar, euro, yen and GBP, respectively, taking total volumes on the exchange-traded currency futures market to a record Rs. 87,389 crore. Against this, the combined volume of stock and index futures was a little over Rs. 46,000 crore.

REC gets infrastructure finance company status

  • The RBI has granted the Rural Electrification Corp (REC) the infrastructure finance company status.  This would allow the firm to lend more to power projects.
  • REC is into financing power generation, transmission and distribution projects in the country. With IFC status, REC can now take an additional lending exposure of up to 5% of its owned funds in case of a single borrower and up to 10% of its owned funds in case of a group of borrowers. The total permissible exposure would thus be 40% of owned funds in case of a group of borrowers.
  • REC also becomes eligible for issuance of infrastructure bonds and for raising funds up to $500 million ( 2,500 crore approximately) through external commercial borrowing (ECB) in a year.
  • REC is the second company after Power Finance Corp (PFC) to be accorded the status of IFC by the Reserve Bank.

Pricing freedom: IOC first off the block, raises petrol price by 27p

  • IOC is the first state-run oil company to exercise the pricing freedom announced by the government on June 26.  It has raised the price of petrol in its outlets by 27 paise.
  • In 2002, the government dismantled administrative price mechanism to attract private investments in refining and marketing sectors. That saw Shell, Reliance and Essar entering into fuel retail business. Since then private oil companies were free to charge market rates for petrol and diesel.
  • While India’s refining capacity increased 155% to 184 million tonne, private oil companies had to shelve their retail plans.
  • On June 26 this year, the government announced freeing of petrol and diesel prices, but allowed state-owned oil companies to fix petrol prices only.

Basel III and some worthy comments about it

  • Against 2% tier I capital that banks are presently mandated to hold, they will have to hold 4.5%, the additional amount being phased in by 2015. In addition, they will have to set aside another 2.5% as contingency capital, taking the overall capital ratio to 7%.
  • This higher capital-to-risk-weighted assets ratio is to be supplemented with a leverage or debt-equity ratio (likely to be pegged at 3% of tier I capital, i.e., the balance sheet size cannot exceed 33 times tier I capital) to ensure banks do not overreach themselves. In addition, a liquidity buffer, akin to our statutory liquidity ratio, is to be made mandatory by January 2018.

How are the UID and NPCI going to make a difference for extending financial inclusion in India?

  • With the UID project establishing recognition on the basis of biometric details — fingerprints, photograph and iris scan — banks will be able to identify customers, thus taking care of KYC issues and use the UID-based authentication service to process transactions. Innovative solutions leveraging UID authentication ability can bring about the true last-mile connectivity.
  • In conjunction with the work being done by the UIDAI, the National Payments Council of India (NPCI) has also been mandated with creating the financial infrastructure on several major projects: other than managing the National Financial Switch (NFS) for domestic ATMs, the NPCI is working on creating a National Automated Clearing House (ACH) system, a switch for mobile-to-mobile payments — called India Pay Mobile Switch — and creating an infrastructure to enable UID-to-UID micropayments.
  • The vision is to link the UID to a bank account and a mobile number in a central database. Once this mapping is done, a payment can be initiated through any bank or mobile phone-enabled business correspondent, and routed to the beneficiary’s UID or mobile number, and this will be automatically credited to the bank account linked to that UID.

FMC bill gets cabinet clearance

  • After a chequered history, a bill which promises to electrify the seven-year old commodity futures market and put the commodity regulator on a par with its capital market counterpart, Sebi, will be tabled in Parliament during the winter session.
  • The Cabinet approved amendments to the Forward Contracts (Regulation) Act 1952, paving the way for the introduction of the Forward Contracts (Regulation) Amendment Bill, 2010 in Parliament. If passed by the both the Houses, it will pave the way for local and foreign institutional investors in commodity futures and bring in new products. Significantly, such a law can also transform the Forward Markets Commission (FMC) from a department, overseen by the Ministry of Consumer Affairs, into an independent body with regulatory and financial autonomy.
  • Futures trading in commodities was restarted in 2002-03, after almost four decades, with the establishment of three national level exchanges, including MCX, NCDEX and NMCE.
  • At present, the parent ministry frames policy for the commodity futures market, consisting of four national and 17 regional commexes, while FMC implements it. Under the amended Act, FMC will be able to raise fees from transactions undertaken on the commodity exchanges, recognise and derecognise exchanges, increases its manpower on lines similar to that of Sebi, facilitate the entry of foreign and domestic institutional investors such as banks, mutual funds and FIIs into the commodities market and introduce user-friendly products such as options and indices in a market which currently offers only plain vanilla futures contracts to participants. While FMC has suspension powers of up to three years under the present act, its penal powers are muted. This will also change under the amended act.
  • The FCRA Amendment bill was first tabled in the Rajya Sabha in 2003-04 but could not be passed due to the dissolution of the Lok Sabha. Subsequently, an ordinance passed in January 2008 lapsed since it could not be taken up by Parliament. An ordinance lapses if it is not introduced within six weeks from the time Parliament convenes.

Mining companies may have to share revenues with displaced

  • The government is likely to make it mandatory for mining companies to hand over a part of their revenues and make annual payments to land losers, bringing compensation rules in this sector in line with a policy followed by the Haryana government which has won the backing of Congress president Sonia Gandhi.
  • The revenue sharing model combined with annual payments is likely to find its way into a proposed legislation setting the rules for investment in minerals. The legislation, known as the Mines and Mineral (Development and Regulation) Bill is being written under the supervision of a group of senior ministers.
  • What is the liberalised debt regime that the Government is reportedly considering for alleviating the airline industry's debt burden?
  • The Government is reportedly considering permitting the airlines to use external debt to repay domestic loans.  There is a proposal to exempt airlines from a regulation that bars Indian companies from using foreign debt (ECBs) to repay loans from local banks.
  • Usually ECBs are cheaper than local debt.  
  • A final decision will be taken by a committee headed by the finance secretary. If the committee decides in favour of the airlines, it may have to face the same demand from other sectors.
  • Jet has debt of 13,750 crore while Kingfisher Airline owes 7,000 crore. Air India has total debt of over 22,000 crore.

On the importance of the recent Supreme Court ruling on CCI's powers

  • the SC ruled that Competition Commission of India's investigations cannot be thwarted on flimsy grounds.  The import of this judgement for the India Inc:
  • One, it firmly establishes the legitimacy of the Commission’s investigation into practices that distort fair play in the market.
  • Two, it has cleared doubts, if at all any existed, about the nature of appeals that the Competition Appellate Tribunal can entertain — the tribunal cannot thwart investigations initiated by the Commission.
  • Three, the Commission will need to complete preliminary investigations within 60 days.
  • Four, a possible flood of complaints from the private sector against exclusive arrangements between public sector enterprises and government departments in future could potentially lead to overhaul of purchase preference that state-owned companies enjoy.

On GAAR

  • GAAR stands for General Anti Avoidance Rule.  This is proposed in the draft DTC -- Direct Taxes Code.
  • GAAR gives sweeping powers to income tax commissioners to treat an arrangement as impermissible if ‘the intention of the taxpayer is to derive tax benefit and the transaction lacks commercial substance or is not for a bona fide purpose.’ Benefits available under tax treaties can also be denied if GAAR provisions are invoked. At a time when treaty abuse is rampant and MNCs not above cutting a sharp deal, GAAR is just the right armour for a beleaguered IT department.

On SPVs

  • Special Purpose Vehicle, or SPV, is a specially created business entity for a specific financial transaction. An SPV can be a corporation, trust, partnership, or limited liability company. Most often, the SPV is set up as a trust. These entities are very common in securitisation transactions. Here the originator or the entity which converts loans into bonds and sells it to the third party, does most of the transactions through an SPV, specially created for the purpose. These SPVs are responsible for servicing of the securities sold to third parties issued by originators. The originator on his part, transfers the interest amount to the SPV on which it has a legal right. The SPV, in turn, ensures that the securities sold to the investors are serviced by the originator.

Difference between FII and FDI

  • There is a clear distinction between portfolio investment or FII and FDI. FIIs are generally not interested in management control. Thus, Suzuki’s investment in Maruti is undoubtedly FDI while investment by, say, Morgan Stanley or Nomura, is portfolio investment. It is also accepted that FDI is more rooted and has a number of positive spinoffs in terms of employment generation, transfer of technology and management practices while portfolio inflows, while quite useful, are relatively more footloose.

Some facts/figures about agriculture investing in the country

  • The number of venture investments in agribusiness firms and start-ups rose to 11 in 2010 from nine in 2009, according to data from research firm Venture Intelligence. The amount of money flowing into the sector almost doubled to $167 million this year from $89 million in 2009.
  • Data collated by ICICI Bank said that the Indian agricultural and food business is expected to double to $280 billion in next decade. There is an opportunity of private investments up to $50 billion by that time.

PM lays foundation for NBPPL

  • The Pime Minister has laid the foundation stone for the Rs. 6,000 crore power equipment manufacturing plant of NBPPL near Tirupati.
  • NBPPL -- NTPC BHEL Power Projects Pvt Ltd will go on stream in 2014-15 and produce equipment to support 5,000 MW of power generation capacity.
  • This will be India's first integrated plant that will manufacture turbines, generators and boilers.
  • NBPPL is a 50:50 joint venture between state-owner power generator NTPC Ltd and equipment manufacturer Bharat Heavy Electricals Ltd (BHEL).
  • NBPPL Chairman and Managing Director: C P Singh.

Why the nutrient is based subsidy policy in fertilizers, a failure?

  • Simply stated: old habits die hard.  Consumption of urea has increased in the first few months of the NBS policy, contrary to expectations that it would lead to a balanced use of fertilisers.  The sale of urea in kharif 2010 season up to July 31 rose to 73.59 lakh tonne from 68.05 lakh tonne in the same period last year.   Overall urea use last kharif stood at 136.65 lakh tonne compared with 120.03 lakh tonne in the previous year.
  • Consequently, the central government’s subsidy spend on the fertiliser will remain high, defying projections of a lower bill in 2010-11.
  • Industry analysts believe that deregulation of urea imports will result in lower subsidy bills. Urea accounts for more than half of the country’s fertiliser consumption. Currently, only government agencies are allowed to import the fertiliser.
  • In 2009-10, the fertiliser subsidy spend of the Centre on indigenous urea totalled 17580.25 crore and another 6999.63 crore was spent on imported urea. In volume terms, imported urea went up to 52.10 lakh tonne in 2009-10 compared to only 20.57 lakh tonne in 2005-06, burgeoning the urea subsidy bill each year. The government’s fertiliser subsidy spend for 2009-10 stands at 64,932 crore but it has signalled its desire to reduce this to 1.5% of the GDP by 2011-12.

Mines: 26 p.c. of profit for affected people

  • The Group of Ministers, headed by Finance Minister Pranab Mukherjee, on Friday cleared the draft mining bill, which makes it mandatory for miners to share 26 per cent of their profits with the people affected by their projects.
  • “It is largely approved. One more sitting of the GoM remains, and after which it will go to the Cabinet. Whatever we have suggested has by and large been approved,” Union Minister for Mines B.K. Handique told journalists after the meeting.

Cabinet approves Bill to make FMC autonomous

  • The Union Cabinet approved for introduction in Parliament the Forward Contracts (Regulation) Amendment Bill, 2010, that amends the Forward Contract (Regulation) Act and the Multi-State Cooperative Societies (Amendment) Bill, 2010, that seeks to improve the accountability of cooperatives. Both Bills will be tabled in the next session of Parliament.
  • The FC(R) Act, 1952, provides for the regulation of commodity futures markets and the establishment of the Forward Markets Commission (FMC).
  • The proposed amendments will enable the FMC, as a regulator, to become an autonomous body with powers to regulate the market on the lines of the Securities and Exchange Board of India. At present it functions under the Department of Consumer Affairs.
  • The FC (R) Bill permits exchanges to trade in options in goods or options in commodity derivatives that enables stakeholders to effectively manage risk from price fluctuations.
  • The amendments proposed include corporatisation and demutualisation of the existing commodities exchanges and setting up of a separate Clearing Corporation, registration of Intermediaries and enhancement of penal provisions in the FC(R) Act.
  • The Bill calls for designating the Securities Appellate Tribunal (SAT) as the Appellate Tribunal. The other Bill okayed by the Cabinet that amends the Multi-State Cooperative Societies Act, 2002, intends to enhance the public faith in cooperatives and to ensure better accountability of the management towards its members and the law of the land, said an official press release.
  • It also allows for co-opting experts from various sectors such as banking, finance and the specialised field of the cooperative.

Relaxation in FDI rules for joint ventures proposed

  • In a bid to pep up the declining flow of foreign direct investment (FDI), the Industry Ministry has proposed allowing foreign investors to bring in fresh money and technology irrespective of the impact on local partners in any existing joint ventures.
  • Seeking to amend the 12-year old rule, the Department of Industrial Policy and Promotion (DIPP) has floated a discussion paper in this regard suggesting abolition of the present rule. Under the present dispensation, a foreign player who entered India before January 12, 2005, has to take government approval and demonstrate that fresh investment in the same field would not affect interest of his domestic joint venture partners.
  • The FDI rules proposed to be relaxed were not applicable to joint ventures entered after January 12, 2005.

Key messages from RBI Annual Report

  • The Reserve Bank of India's Annual Report, a statutory publication issued by the bank's board, for 2009-10, was released recently.
  • Analysing the broad economic and financial trends in the post-crisis period, the RBI notes that the domestic macroeconomic environment changed significantly over four distinct half-yearly phases, beginning the second half of 2008-09. The economy decelerated in the second half of 2008-09. The weakness continued in the first half of 2009-10.
  • The RBI had promptly introduced conventional and non-conventional measures to limit the impact of the global crisis.

Connect 2010 to unfold critical issues

  • The CII-Connect 2010 conference theme and discussions, scheduled for September 8 and 9 in Chennai, will unfold around the critical issues. In the last nine years, Connect has brought stakeholder attention to relevant topical themes, followed by action in various streams.
  • Thinking through this time, the conference has brought focus to the IT collaboration in four main areas: automotive, healthcare, entertainment and security. We'll hear the Connect echoing these and other questions:

For more effective cash transfers

  • For over a decade now, conditional cash transfers (CCT) have become an important part of the toolkit of economic policymakers to reduce poverty in the developing world.
  • The core principle of this strategy, linking cash to verifiable behavioural attributes, has two advantages: short-term monetary benefits and long-term investments in human capital. That this policy intervention has started paying dividends is evident from Latin American experiences.
  • In those countries, important socioeconomic indicators such as education, health, and nutrition showed improvements after the introduction of CCT schemes. Five years on, an evaluation of the JSY — one of the world's largest conditional cash transfer programmes in terms of the number of beneficiaries — has pointed to the beneficial effect as well as the lags in India's latest effort to provide for safer motherhood. A paper published in The
  • Lancet in June reported a substantial increase in the number of beneficiaries between 2005-06 and 2008-09 (up from 0.74 million to 8.43 million) and other positive outcomes such as reduction in perinatal and antenatal deaths.
  • Although these point to the advantage of linking cash to welfare, there are inter-State disparities to be corrected. In addition, better staffing and infrastructure for public sector health facilities is an imperative for cash transfer schemes to be truly beneficial. Another constraint identified by the paper which needs to be remedied urgently is improper targeting. T
  • he finding that “the poorest and the least educated women do not consistently have the highest odds” of becoming the beneficiaries is a critical pointer to the manner in which cash transfer schemes are implemented in India. The solution to such lags lies in proactive governance that reaches out to the needy, including through greater publicity and greater transparency, and filling the gaps in the provision of public health facilities.