Economy, Banking and Finance

Keywords: Budget, Banking, Economics, RBI

What is Budget?
The dictionary meaning of budget is a systematic plan for the expenditure of
a usually fixed resource during a given period.
Thus, Union Budget, which is a yearly affair, is a comprehensive display of
the Government’s finances. It is the most significant economic and financial
event in India. The Finance Minister puts down a report that contains
Government of India’s revenue and expenditure for one fiscal year. The fiscal
year runs from April 01 to March 31.
The Union budget is preceded by an Economic Survey which outlines the
broad direction of the budget and the economic performance of the country.
The Budget is the most extensive account of the Government`s finances, in
which revenues from all sources and expenses of all activities undertaken
are aggregated. It comprises the revenue budget and the capital budget. It
also contains estimates for the next fiscal year called budgeted estimates.
Barring a few exceptions -- like elections – Finance Minister presents the
annual Union Budget in the Parliament on the last working day of February.
The budget has to be passed by the Lok Sabha before it can come into effect
on April 01.

What is revenue budget?

The revenue budget consists of revenue receipts of the government
(revenues from tax and other sources) and the expenditure met from these
revenues.
Revenue receipts are divided into tax and non-tax revenue. Tax revenues are
made up of taxes such as income tax, corporate tax, excise, customs and
other duties which the government levies. Non-tax revenue consist of
interest and dividend on investments made by government, fees and other
receipts for services rendered by Government.
Revenue expenditure is the payment incurred for the normal day-to-day
running of government departments and various services that it offers to its
citizens. The government also has other expenditure like servicing interest
on its borrowings, subsidies, etc.
Usually, expenditure that does not result in the creation of assets, and grants
given to state governments and other parties are revenue expenditures.
However, all grants given to state governments and other parties are also
clubbed under revenue expenditure, although some of them may go into the
creation of assets.
The difference between revenue receipts and revenue expenditure is usually
negative. This means that the government spends more than it earns. This
difference is called the revenue deficit.
What is a capital budget?
It consists of capital receipts and payments. The main items of capital
receipts are loans raised by Government from public which are called Market
Loans, borrowings by Government from Reserve Bank and other parties
through sale of Treasury Bills, loans received from foreign Governments and
bodies and recoveries of loans granted by Central Government to State and
Union Territory Governments and other parties.
Capital payments consist of capital expenditure on acquisition of assets like
land, buildings, machinery, equipment, as also investments in shares, etc.,
and loans and advances granted by Central Government to State and Union
Territory Governments, Government companies, Corporations and other
parties.
Capital Budget also incorporates transactions in the Public Account.

What are direct taxes?

These are the taxes that are levied on the income of individuals or
organisations. Income tax, corporate tax, inheritance tax are some examples
of direct taxation.
Income tax is the tax levied on individual income from various sources like
salaries, investments, interest etc.
Corporate tax is the tax paid by companies or firms on the incomes they
earn.

What are indirect taxes?

These are the taxes paid by consumers when they buy goods and services.
These include excise and customs duties.
Customs duty is the charge levied when goods are imported into the country,
and is paid by the importer or exporter.
Excise duty is a levy paid by the manufacturer on items manufactured within
the country.
These charges are passed on to the consumer.
What is plan and non-plan expenditure?
There are two components of expenditure - plan and non-plan.
Of these, plan expenditures are estimated after discussions between each of
the ministries concerned and the Planning Commission. Plan expenditure
forms a sizeable proportion of the total expenditure of the Central
Government. The Demands for Grants of the various Ministries show the Plan
expenditure under each head separately from the Non-Plan expenditure.
Non-plan revenue expenditure is accounted for by interest payments,
subsidies (mainly on food and fertilisers), wage and salary payments to
government employees, grants to States and Union Territories governments,
pensions, police, economic services in various sectors, other general services
such as tax collection, social services, and grants to foreign governments.
Non-plan capital expenditure mainly includes defence, loans to public
enterprises, loans to States, Union Territories and foreign governments.

What is the Central Plan Outlay?

It is the division of monetary resources among the different sectors in the
economy and the ministries of the government.

What is fiscal policy? Fiscal policy is a change in government spending or

taxing designed to influence economic activity. These changes are designed
to control the level of aggregate demand in the economy. Governments
usually bring about changes in taxation, volume of spending, and size of the
budget deficit or surplus to affect public expenditure.

What is a fiscal deficit?

This is the gap between the government`s total spending and the sum of its
revenue receipts and non-debt capital receipts. It represents the total
amount of borrowed funds required by the government to completely meet
its expenditure.

What is the Finance Bill?

The proposals of the Government for levy of new taxes, modification of the
existing tax structure or continuance of the existing tax structure beyond the
period approved by Parliament are submitted to Parliament through the
Finance Bill.
The Budget documents presented in terms of the Constitution have to fulfil
certain legal and procedural requirements and hence may not by themselves
give a clear indication of the major features of the Budget.
Balance of Payment
What Does Balance Of Payments - BOP Mean?
A record of all transactions made between one particular country and all
other countries during a specified period of time. BOP compares the dollar
difference of the amount of exports and imports, including all financial
exports and imports. A negative balance of payments means that more
money is flowing out of the country than coming in, and vice versa.

Balance of payments may be used as an indicator of economic and

political stability. For example, if a country has a consistently positive BOP,
this could mean that there is significant foreign investment within that
country. It may also mean that the country does not export much of its
currency.

This is just another economic indicator of a country's relative value and,

along with all other indicators, should be used with caution. The BOP includes
the trade balance, foreign investments and investments by foreigners.
What Does Trade Deficit Mean?
An economic measure of a negative balance of trade in which a country's
imports exceeds its exports. A trade deficit represents an outflow of
domestic currency to foreign markets.
Economic theory dictates that a trade deficit is not necessarily a bad
situation because it often corrects itself over time. However, a deficit has
been reported and growing in the United States for the past few
decades, which has some economists worried. This means that large
amounts of the U.S. dollar are being held by foreign nations, which may
decide to sell at any time. A large increase in dollar sales can drive the value
of the currency down, making it more costly to purchase imports.
What Does Current Account Deficit Mean?
Occurs when a country's total imports of goods, services and transfers is
greater than the country's total export of goods, services and transfers. This
situation makes a country a net debtor to the rest of the world.
A substantial current account deficit is not necessarily a bad thing for certain
countries. Developing counties may run a current account deficit in the short
term to increase local productivity and exports in the future.
What Does Gross Domestic Product - GDP Mean?
The monetary value of all the finished goods and services produced within a
country's borders in a specific time period, though GDP is usually calculated
on an annual basis. It includes all of private and public consumption,
government outlays, investments and exports less imports that occur within
a defined territory.

GDP = C + G + I + NX
where:
"C" is equal to all private consumption, or consumer spending, in a nation's
economy
"G" is the sum of government spending
"I" is the sum of all the country's businesses spending on capital
"NX" is the nation's total net exports, calculated as total exports minus total
imports. (NX = Exports - Imports)

What Does Gross National Product - GNP Mean?

An economic statistic that includes GDP, plus any income earned by
residents from overseas investments, minus income earned within the
domestic economy by overseas residents.
GNP is a measure of a country's economic performance, or what its citizens
produced (i.e. goods and services) and whether they produced these items
within its borders.
Gross National Product. GNP is the total value of all final goods and services
produced within a nation in a particular year, plus income earned by its
citizens (including income of those located abroad), minus income of non-
residents located in that country. Basically, GNP measures the value of
goods and services that the country's citizens produced regardless of their
location. GNP is one measure of the economic condition of a country, under
the assumption that a higher GNP leads to a higher quality of living, all other
things being equal.

RBI Policy Rate

What is Bank rate?
This is the rate at which central bank (RBI) lends money to other banks or
financial institutions. If the bank rate goes up, long-term interest rates also
tend to move up, and vice-versa. Thus, it can said that in case bank rate is
hiked, in all likelihood banks will hikes their own lending rates to ensure and
they continue to make a profit.

What is CRR?
CRR means Cash Reserve Ratio. Banks in India are required to hold a certain
proportion of their deposits in the form of cash. However, actually Banks
don’t hold these as cash with themselves, but deposit such case with
Reserve Bank of India (RBI) / currency chests, which is considered as
equivalent to holding cash with themselves.. This minimum ratio (that is the
part of the total deposits to be held as cash) is stipulated by the RBI and is
known as the CRR or Cash Reserve Ratio. Thus, When a bank’s deposits
increase by Rs100, and if the cash reserve ratio is 9%, the banks will have to
hold additional Rs 9 with RBI and Bank will be able to use only Rs 91 for
investments and lending / credit purpose. Therefore, higher the ratio (i.e.
CRR), the lower is the amount that banks will be able to use for lending and
investment. This power of RBI to reduce the lendable amount by increasing
the CRR, makes it an instrument in the hands of a central bank through
which it can control the amount that banks lend. Thus, it is a tool used by
RBI to control liquidity in the banking system.

What is SLR?
SLR stands for Statutory Liquidity Ratio. This term is used by bankers and
indicates the minimum percentage of deposits that the bank has to maintain
in form of gold, cash or other approved securities. Thus, we can say that it is
ratio of cash and some other approved to liabilities (deposits) It regulates the
credit growth in India.

What are Repo rate and Reverse Repo rate?

Repo (Repurchase) rate is the rate at which the RBI lends shot-term
money to the banks. When the repo rate increases borrowing from RBI
becomes more expensive. Therefore, we can say that in case, RBI wants to
make it more expensive for the banks to borrow money, it increases the repo
rate; similarly, if it wants to make it cheaper for banks to borrow money, it
reduces the repo rate

Reverse Repo rate is the rate at which banks park their short-term excess
liquidity with the RBI. The RBI uses this tool when it feels there is too much
money floating in the banking system. An increase in the reverse repo rate
means that the RBI will borrow money from the banks at a higher rate of
interest. As a result, banks would prefer to keep their money with the RBI.

What is Headline Inflation?

A measurement of price inflation that takes into account all types of inflation
that an economy can experience. Unlike core inflation, headline inflation also
counts changes in the price of food and energy. Because food and energy
prices can rapidly increase while other types of inflation can remain low,
headline inflation may not give an accurate picture of how an economy is
behaving. Headline inflation is more useful for the typical household because
it reflects changes in the cost of living, while core inflation is used by central
banks because core inflation is less volatile and shows the effects of supply
and demand on GDP better.

What is Core Inflation?

A measure of consumer price increases after stripping out volatile
components such as energy and food. Core inflation is generally considered
more accurate than changes in the Consumer Price Index in representing the
economy's underlying inflationary pressures.

Banking

Tier I Capital: A term used to refer to one of the components of regulatory

capital. It consists mainly of share capital and disclosed reserves (minus
goodwill, if any). Tier I items are deemed to be of the highest quality because
they are fully available to cover losses Hence it is also termed as core
capital.

Tier II Capital: Refers to one of the components of regulatory capital. Also

known as supplementary capital, it consists of certain reserves and certain
types of subordinated debt. Tier II items qualify as regulatory capital to the
extent that they can be used to absorb losses arising from a bank's
activities. Tier II's capital loss absorption capacity is lower than that of Tier I
capital

Gross NPA: Gross NPA is the amount outstanding in the borrowal account,
in books of the bank other than the interest which has been recorded and
not debited to the borrowal account.
Net NPA: Gross NPA – (Balance in Interest Suspense account + DICGC/ECGC
claims received and held pending adjustment + Part payment received and
kept in suspense account + Total provisions held).

Substandard Asset: A substandard asset would be one, which has

remained NPA for a period less than or equal to 12 months. Such an asset
will have well defined credit weaknesses that jeopardize the liquidation of
the debt and are characterised by the distinct possibility that the banks will
sustain some loss, if deficiencies are not corrected.

Doubtful Asset: An asset would be classified as doubtful if it has remained

in the substandard category for a period of 12 months. A loan classified as
doubtful has all the weaknesses inherent in assets that were classified as
substandard, with the added characteristic that the weaknesses make
collection or liquidation in full, - on the basis of currently known facts,
conditions and values - highly questionable and improbable.

Run on a bank: When a large amount of bank customers try to withdrawal

their bank deposits simultaneously, and the bank's reserves are not
sufficient to cover the withdrawals.

Risk Weight Asset: A bank's assets weighted according to credit risk. Some
assets, such as debentures, are assigned a higher risk than others, such as
cash. This sort of asset calculation is used in determining the capital
requirement for a financial institution, and is regulated by the Federal
Reserve Board.

Leveraged Buyout: The acquisition of another company using a significant

amount of borrowed money (bonds or loans) to meet the cost of acquisition.
Often, the assets of the company being acquired are used as collateral for
the loans in addition to the assets of the acquiring company. The purpose
of leveraged buyouts is to allow companies to make large acquisitions
without having to commit a lot of capital.
In an LBO, there is usually a ratio of 90% debt to 10% equity. Because of this
high debt/equity ratio, the bonds usually are not investment grade and are
referred to as junk bonds. Leveraged buyouts have had a notorious history,
especially in the 1980s when several prominent buyouts led to the eventual
bankruptcy of the acquired companies. This was mainly due to the fact that
the leverage ratio was nearly 100% and the interest payments were so large
that the company's operating cash flows were unable to meet the obligation.
As of 2006, the largest LBO to date was the acquisition of HCA Inc. in 2006
by Kohlberg Kravis Roberts & Co. (KKR), Bain & Co., and Merrill
Lynch. According to the Washington Post, the three companies paid around
$33 billion for the acquisition.
It can be considered ironic that a company's success (in the form of assets
on the balance sheet) can be used against it as collateral by a hostile
company that acquires it. For this reason, some regard LBOs as an especially
ruthless, predatory tactic.

Economics Terms:

Big Mac Index: Burgernomics is based on the theory of purchasing-power

parity, the notion that a dollar should buy the same amount in all countries.
Thus in the long run, the exchange rate between two countries should move
towards the rate that equalises the prices of an identical basket of goods and
services in each country. Our "basket" is a McDonald's Big Mac, which is
produced in about 120 countries. The Big Mac PPP is the exchange rate that
would mean hamburgers cost the same in America as abroad. Comparing
actual exchange rates with PPPs indicates whether a currency is under- or
overvalued.

Sterilized Intervention: A method used by monetary authorities to

equalize the effects of foreign exchange transactions on the
domestic monetary base by offsetting the purchase or sale of
domestic assets within the domestic markets. The process limits the amount
of domestic currency available for foreign exchange.

Moral Suasion: A persuasion tactic used by an authority (i.e. Federal

Reserve Board) to influence and pressure, but not force, banks into adhering
to policy. Tactics used are closed-door meetings with bank directors,
increased severity of inspections, appeals to community spirit, or vague
threats. A good example of moral suasion is when the Fed Chairman speaks
on the markets - his opinion on the overall economy can send financial
markets falling or flying.

Structural Unemployment: Joblessness caused not by lack of demand, but

by changes in demand patterns or obsolescence of technology, and requiring
retraining of workers and large investment in new capital equipment.
Moral Hazard: The risk that a party to a transaction has not entered
into the contract in good faith, has provided misleading information about its
assets, liabilities or credit capacity, or has an incentive to take unusual risks
in a desperate attempt to earn a profit before the contract settles.
Moral hazard can be present any time two parties come into agreement with
one another. Each party in a contract may have the opportunity to gain from
acting contrary to the principles laid out by the agreement. For example,
when a salesperson is paid a flat salary with no commissions for his or her
sales, there is a danger that the salesperson may not try very hard to sell the
business owner's goods because the wage stays the same regardless of how
much or how little the owner benefits from the salesperson's work.
Moral hazard can be somewhat reduced by the placing of responsibilities on
both parties of a contract. In the example of the salesperson, the manager
may decide to pay a wage comprised of both salary and commissions. With
such a wage, the salesperson would have more incentive not only to produce
more profits but also to prevent losses for the company.

Adverse Selection: When you do business with people you would be better
off avoiding. This is one of two main sorts of MARKET FAILURE often
associated with insurance. The other is MORAL HAZARD. Adverse selection
can be a problem when there is ASYMMETRIC INFORMATION between the
seller of INSURANCE and the buyer; in particular, insurance will often not be
profitable when buyers have better information about their risk of claiming
than does the seller. Ideally, insurance premiums should be set according to
the risk of a randomly selected person in the insured slice of the population
(55-year-old male smokers, say). In practice, this means the AVERAGE RISK
of that group. When there is adverse selection, people who know they
have a higher risk of claiming than the average of the group will buy the
insurance, whereas those who have a below-average risk may decide it is too
expensive to be worth buying. In this case, premiums set according to the
average risk will not be sufficient to cover the claims that eventually arise,
because among the people who have bought the policy more will have
above-average risk than below-average risk. Putting up the premium will not
solve this problem, for as the premium rises the insurance policy will become
unattractive to more of the people who know they have a lower risk of
claiming. One way to reduce adverse selection is to make the purchase of
insurance compulsory, so that those for whom insurance priced for average
risk is unattractive are not able to opt out.
Asymmetry of Information: When somebody knows more than somebody
else. Such asymmetric information can make it difficult for the two people to
do business together, which is why economists, especially those practising
GAME THEORY, are interested in it. Transactions involving asymmetric (or
private) information are everywhere. A government selling broadcasting
licences does not know what buyers are prepared to pay for them; a lender
does not know how likely a borrower is to repay; a used-car seller knows
more about the quality of the car being sold than do potential buyers. This
kind of asymmetry can distort people's incentives and result in significant
inefficiencies.

Trickle Down theory: Proponents of this theory believe that when

government helps companies, they will produce more and thereby hire more
people and raise salaries. The people, in turn, will have more money to
spend in the economy.

Money Illusion: When people are misled by INFLATION into thinking that
they are getting richer, when in fact the value of MONEY is declining.
Whether, and how much, people are fooled by inflation is much debated by
economists. Money illusion, a phrase coined by KEYNES, is used by some
economists to argue that a small amount of inflation may not be a bad thing
and could even be beneficial, helping to “grease the wheels” of the
economy. Because of money illusion, workers like to see their nominal
WAGES rise, giving them the illusion that their circumstances are improving,
even though in real (inflation-adjusted) terms they may be no better off.
During periods of high inflation double-digit pay rises (as well as, say, big
increases in the value of their homes) can make people feel richer even if
they are not really better off. When inflation is low, GROWTH in real incomes
may hardly register.

Participatory Notes -- or P-Notes or PNs -- are instruments issued by

registered foreign institutional investors to overseas investors, who wish to
invest in the Indian stock markets without registering themselves with the
market regulator, the Securities and Exchange Board of India.
Financial instruments used by hedge funds that are not registered with
Sebi to invest in Indian securities. Indian-based brokerages to buy India-
based securities / stocks and then issue participatory notes to foreign
investors. Any dividends or capital gains collected from the underlying
securities go back to the investors.
Tobin Tax: The Tobin Tax is a tax on currency speculation, once per
transaction. The idea and name comes from James Tobin, a Nobel laureate
economist at Yale University. The currency market is now over one trillion
dollars daily, and the proposed tiny percentage tax (suggestions range from .
1% to .5%) would be on speculative transactions only. The purpose is to
discourage volatile short-term trading and its destabilizing effect on country
currencies, restoring national macroeconomic controls over currency
fluctuations. Billions in revenue would be generated, as much as $300 billion
to $1 trillion yearly. Part of the revenue would go to an international fund,
another part to national budgets.

NASDAQ: NASDAQ is the largest U.S. electronic stock market. With

approximately 3,200 companies, it lists more companies and, on average,
trades more shares per day than any other U.S. market. It is home to
companies that are leaders across all areas of business, including
technology, retail, communications, financial services, transportation, media
and biotechnology. NASDAQ is the primary market for trading NASDAQ-listed
stocks.

Systemic Risk: Risk that affects an entire financial market or system, and
not just specific participants. It is not possible to avoid systemic risk through
diversification.

Sovereign Wealth Fund: SWF. Foreign investment funds owned by

national governments and financed by the country's foreign currency
reserves (dollar, euro, yen), often through their central banks or via direct
investments. The term sovereign wealth fund was introduced in 2005, but
the first SEF was introduced in 1953 by the government of Kuwait (' Kuwait
Investment Authority,' a commodity SWF). These funds are now major
players in the world financial markets. The combined assets of the major
SWFs (owned by 20 governments) have reached over three trillion dollars,
and are expected to reach over 10 trillion dollars by 2012. Although the
current total amount makes up only some 3 percent of the world's traded
securities, the SWFs already have tremendous concentrated financial power.
Over half of the SWF assets are owned by oil and gas exporting nations, and
about one third by Australia, China, and Singapore. SWFs are aggressive
investors and have bought into firms as diverse as Morgan Stanley, General
Electric, and Sony.
Crowding Out: A situation in which the government is borrowing heavily
while businesses and individuals also want to borrow. The former can always
pay the market interest rate, but the latter cannot, and is crowded out.

Absolute Advantage: country has an absolute advantage over it trading

partners if it is able to produce more of a good or service with the same
amount of resources or the same amount of a good or service with fewer
resources. In the case of Zambia, the country has an absolute advantage
over many countries in the production of copper. This occurs because of the
existence of reserves of copper ore or bauxite. We can see that in terms of
the production of goods, there are obvious gains from specialisation and
trade, if Zambia produces copper and exports it to those countries that
specialise in the production of other goods or services.

Comparative Advantage: What did David Ricardo mean when he coined

the term comparative advantage? According to the principle of comparative
advantage, the gains from trade follow from allowing an economy to
specialise. If a country is relatively better at making wine than wool, it makes
sense to put more resources into wine, and to export some of the wine to
pay for imports of wool. This is even true if that country is the world's best
wool producer, since the country will have more of both wool and wine than
it would have without trade. A country does not have to be best at anything
to gain from trade. The gains follow from specializing in those activities
which, at world prices, the country is relatively better at, even though it may
not have an absolute advantage in them. Because it is relative advantage
that matters, it is meaningless to say a country has a comparative
advantage in nothing. The term is one of the most misunderdstood ideas in
economics, and is often wrongly assumed to mean an absolute advantage
compared with other countries.

Hedge Fund: A fund, usually used by wealthy individuals and institutions,

which is allowed to use aggressive strategies that are unavailable to mutual
funds, including selling short, leverage, program trading, swaps, arbitrage,
and derivatives. Hedge funds are exempt from many of the rules and
regulations governing other mutual funds, which allows them to accomplish
aggressive investing goals. They are restricted by law to no more than 100
investors per fund, and as a result most hedge funds set extremely high
minimum investment amounts, ranging anywhere from $250,000 to over $1
million. As with traditional mutual funds, investors in hedge funds pay a
management fee; however, hedge funds also collect a percentage of the
profits (usually 20%).

Hedge: An investment made in order to reduce the risk of adverse price

movements in a security, by taking an offsetting position in a related
security, such as an option or a short sale.