SIMSREE Arthneeti Dec 2012

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A SIMSREE FINANCE FORUM INITIATIVE ARTHNEETI DECEMBER 2012 ISSUE

EDITORIAL

SPECIAL FEATURE

An Interview with Mr. Harish Hulyalkar, Director, M&A, Citigroup India

Financing the Indian SME’s: Challenges and The way Forward……. By- Saurabh Aggarwal

Subsidy Cuts and FDI Inflow: Two Catalysts for Indian Economy Revival By Vivek Srivastava & Tushar Sharma, PGDM-IFMR, Chennai

Fiscal Cliff in Totality By SIMSREE FINANCE FORUM

The government of India has a major problem to tackle this

financial year- Fiscal Deficit. It has tried all possible means

to reduce the deficit to the acceptable level. Subsidy bill are

a major part of government spending in India. So GOI is now

determined to reduce the subsidies on diesel. It has now

agreed to deregulate the prices of diesel in a gradual

manner. So is the case with LPG cylinders. These steps

suggest the desperate need of the government to bring its

spending below the threshold. Another important step that

has been taken is disinvestment of PSUs.

Another important issue in India is the financing of SMEs.

Small and medium enterprises are growing in India.

However they have not yet found a proper and a simpler

way to finance themselves except for a few. In fact it can be

said that there is a lack of adequate access to finance for

the SMEs which is a bottleneck in itself. The problem here is

not just with the banking sector but also with the ignorance

among the SMEs with the options available. India can

become a sustainably growing economy if all these

bottlenecks are addressed.

Finally we had the huge global issue of Fiscal Cliff. The US

government have just taken a decision to defer the tax

discount cuts. So the situation is still not absolutely clear.

The danger has been deferred and not avoided.

In this issue we have taken the interview of Mr. Harish

Hulyalkar, Director, Investment Banking (M&A) at Citigroup.

He shares with us some important details about the M&A

industry. As part of our forum activity we have an article on

“Subsidy cuts and FDI inflows:Two catalysts for the Indian

Economy” written by Tushar Sharma and Vivek Srivastava

from IFMR. We also have an article from our alumnus Mr.

Saurabh Aggarwal on “Financing the Indian SMEs:

Challenges and the way forward.” Finally we have an article

from our team on fiscal cliff.

Happy Reading!

TEAM ARTHNEETI

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Q.1 What according to you are the

problems facing the M&A market in India

and around the world?

Ans: The M&A volumes are strongly

correlated with the global economy and

growth sentiment around the world. The

GDP growth of major economies in

Europe and North America has been slow

which has been reflected in the M&A

volumes as well. However these

economies are now recovering slowly and

hence the M&A market is also seeing a

revival. As such there are no hurdles in the

way of this market and it is a function of

the economy and global sentiment. This is

the case in India as well as around the

world. Cross-border M&A volumes will

continue to contribute a greater

percentage of total volumes, as

companies look to invest capital in growth

opportunities outside their home country.

Q.2 Are there any regulation problems

with respect to the M&A taking place in

India? If yes what are those?

Ans: India is a relatively highly regulated

market from an M&A perspective. Every

transaction in India has to closely

evaluated from a tax, legal and regulatory

perspective. A key regulation which

impacts M&A is the ability to delist the

target company from stock exchanges. In

many countries, if an acquirer acquires a

majority stake in a target company and

reaches a certain ownership threshold,

the acquirer has the ability to delist the

target company and squeeze out the

minority ownership to achieve 100%

control. However in India this is not

allowed. This tends to be an inhibitor

specially for international companies

looking to acquire listed Indian

companies.

Q.3 What is the role of CCI in M&A deals

in India?

Ans: The role of CCI is to ensure that

mergers, acquisitions and similar

arrangements do not stifle competition

and provide undue bargaining power. The

CCI role has been very clear and most of

the M&A deals have been cleared by the

CCI in line with the prescribed rules and

within the prescribed time frame.

Q.4 Tetley was acquired by TATA tea

which is a smaller company when the

market share is considered for the

beverages market. Why would such a

large company let a small company

acquire itself? Or what are the factors

considered by a larger company before

such a deal happens?

Ans: One reason can be the attractiveness

of the offer. If a target company gets an

attractive offer, then its Board of Directors

have a fiduciary obligation towards their

Interview: Mr. Harish Hulyalkar,

Director, Investment Banking (Mergers & Acquisitions),

Citigroup India

Topic: M&A trends in India


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shareholders to evaluate whether

accepting the offer creates more

shareholder value than steady state

operations.

Another reason could be that the target

company is doing well, but its controlling

shareholder is in financial distress and

hence may consider divesting its stake in

the target company based on the most

attractive offer (potentially from a smaller

bidder).

Q.5 Does the purview of M&A consulting

include consultations during splits? Like

the one that happened recently with

Hero and Honda.

Ans: Sometimes joint venture terms need

to be restructured. In such situations, the

M&A advisor can help in structuring the

revised commercial terms of the joint

venture. In some cases, the joint venture

partners may decide to part ways, by one

party selling its stake to the other party,

or by finding a new third party buyer. An

advisor can help find a new buyer, or

advise on funding alternatives to facilitate

the buyout.

Q.6 Since 2005 there have been a lot of

India companies acquiring firms outside

India. Do you see this as a new trend in

India or is it just a co-incidence?

Ans: We saw the first wave of outbound

M&A deals from India in the 2006-2008

timeframe, pre financial crisis. As you will

appreciate, the world was a very different

place then; there was ample liquidity in

the global financial markets and

economies around the world were

confident about the growth prospects.

So during this timeframe, we saw some

large acquisitions done by Indian

corporates.

However since the financial crisis of 2008-

09, Indian corporates have been more

cautious about international acquisitions,

given the less attractive growth prospects

and higher uncertainty in these end

markets. The outbound acquisitions in

the last 2-3 years have been largely

focused in sectors like energy and metals

& mining, where Indian acquirors have

pursued acquisitions to get access to

natural resources like oil and coal.

Q.8 Since you have been in this industry

more than a decade now, what was the

most attractive deal according to you or

rather a historic deal for a particular

region or sector?

Ans: That is an interesting question. A

few global deals come to mind, which

transformed the landscape of their

respective sectors. For example, Ciba-

Geigy and Sandoz came together to form

Novartis, which is a global leader in the

pharma industry today. P&G’s acquisition

of Gillette and the Exxon-Mobil merger

are other examples of transformational

deals which created hugely successful

global companies.


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As far as India is concerned, we have not

seen many such transformational

transactions, but one that comes to mind

is the merger of ICICI Bank and ICICI,

which created a highly successful

universal bank, and redefined the banking

sector in India

Q.9 Can you forecast the M&A market in

India for the coming year in India? Or

some deals that you feel are on the verge

of consummation.

Ans: I think there will be interest in

inbound M&A into India across sectors,

and this trend will continue this year. As

far as outbound M&A activity is

concerned, it likely to be focused across a

few industries only.

One other theme which could play out is

M&A activity driven by exits by private

equity firms. Several PE firms who

invested during the 2006-2008 period

could look at M&A opportunities to sell

their stake, as generally the investment

cycle for these investors is around 5 years.

Q.10 Can you talk about the M&A activity

in the emerging markets like Africa, Latin

America and others?

Ans: These are fast growing markets, and

since the home countries of many global

companies are showing low-single digit

growth rates, it is obvious that new

emerging markets will look very

attractive. With the slowdown in China

growth, M&A buyers could also look at

faster growing Asian economies like

Indonesia and Malaysia.


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-By Saurabh Aggarwal

Small and medium-sized enterprises (SMEs) are widely seen as engines of economic growth. In developed countries, they are credited with creating jobs, delivering innovation and raising productivity. But SMEs in third world countries are not currently meeting that promise. While there is no lack of interest in promoting entrepreneurship in developing countries like India, we do lack evidence about what helps, or even what represent the biggest barriers to growth.

India is home to about 26 million small enterprises (with investments less than 50 million) that account for about 20 per cent of the country's GDP. Growing at over 10% in the last few years, the small and medium enterprises (SME) sector is considered a vital part of the Indian economy. However, one of the major bottlenecks to the growth of the SME sector is its lack of adequate access to finance. Despite the efforts of Ministry of Small and Medium Enterprises, SIDBI and support from the RBI by inclusion under priority sector, there continues to be a huge demand-supply mismatch in small enterprise financing.

Small enterprises, such as brick-kilns, grocery stores and small restaurants, need finance to purchase raw materials, procure stock, pay wages, meet other working capital requirements and support expansion plans.

Limited Access to Finance…

It will not be an exaggeration to say, Indian SMEs are in dire need for funding. The situation is extremely grim. Look at the contribution of SMEs in the GDP of countries like USA and UK. They contribute 40%-60% of the GDP and provide employment to 50%+ of the workforce. Even in developing countries like China and Vietnam, the ratios are very similar. However, in case of India, the contribution to GDP is just 20%. This shows huge untapped potential for SMEs. The major cause is lack of financing for SMEs.

One of the main reasons for banks/financial institutions (FIs) being unable to bridge this gap is the perceived credit risk involved in financing small enterprises. This is primarily on account of non-availability of valid bills, proper accounting systems and lack of known buyers.

Accurate information about the borrower is a critical input for decision-making by banks in the lending process which is not easily forthcoming in the case of SMEs, as the sheer ticket size of SME lending makes it non-viable for banks to invest in developing information systems about SME borrowers.

To mitigate such credit risk, banks typically look for enhanced collateral or

Financing the Indian SME’s: Challenges and The way

Forward…….


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traditional equity, both of which cannot be brought in by most entrepreneurs. . The credit managers are hesitant to fund new-age business ideas, and definitely not

without the guarantee of an asset that is 100% of the value of the asset. This is so owing to the higher degree of involvement required by the banker to understand the underlying cash flows of the business. Further, due to their small size and local presence, the transaction costs involved in financing them are very high.

In the face of lenders’ reluctance to finance, these enterprises are compelled to resort to high cost, non-continuous financing from money lenders and other informal sources, or continue to operate at sub-scale.

Ignorance among SMEs

The lack of financing is not only because of lack of interest of banking institutions but also because of ignorance among SMEs on the financing available. Most of them are promoted by 2nd or 3rd generation Entrepreneurs who understand only the traditional financial products. They can’t afford to hire modern day finance managers to deal with banks and adapt to modern financial products.

However, there are many consulting companies that have come up in recent years specifically focused on SMEs. They provide consulting services to them by advising the cheapest way to raise funds, liaising with Government to avail the schemes, and consult on overall operational and technical issues to improve efficiency, reduce bottlenecks, and optimize costs.

It is good idea to speak with such consulting companies for advice. Though SMEs may not need help in many cases if

they have right people to interact with financial institutions. However, in case of any uncertainty, the right way is to avail the services of these consulting firms.

Today, banks and financial institutions are also actively engaged in imparting knowledge of complex products to SMEs. Regular Events and seminars are being organized to spread information related to modern trade and treasury products.

Conclusion

The SMEs need to do their management planning and make the processes more formal, so as to have the documentations ready for financing opportunities. Accounting policies and consistency in book information will lead to better reliability from the bankers. The balance sheet clean – up would improve the credit worthiness of the average SME, qualifying the company for more bank loans as well.

Institutionally, provisions need to be included in the rules governing the SME sector so that periodically the enterprises are evaluated on a five-year basis and re-certified so that they can graduate from SME to mid-size companies.

Given the importance of the sector, the government, industry chambers, think-tanks and policy-makers need to come together to create an environment conducive for SMEs to flourish. This would in turn make SMEs banking-friendly. Adequate RBI and SEBI support and institutional reforms are also necessary to take the sector to the next level of global competitiveness.

To ensure the competitiveness of SMEs, it is essential that the availability of infrastructure, technology and skilled manpower are in tune with the global trends. Currently, the state of infrastructure, including power, water,


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roads, etc. in most areas where SMEs are set up is poor and unreliable.

It is worth noting that the current banking infrastructure, utilised for credit cards and ATMs, can be extended to SME financing. The system of SME financing is fundamentally similar to that of credit cards—hence the use of the processes and distribution networks is possible. Similar extension of existing infrastructure will be necessary in order to reduce the transaction costs involved.

Thus, a two-sided approach involving innovative lending from the financial sector, and better corporate governance systems in the SME sector can lead to a growing flow of financing.

In conclusion, at a time when the process of transformation of the economy has thrown up major challenges, it is important that the financial sector gears up for catering to this new segment and, in turn, fuel its growth in the coming decades.

FIN-QUIZ

1. Who is father of accounting

2. NYSE is called also as..change

3. The value of a forward contract at its initiation is

4. This term is derived from the Greek word 'Oikanomia' means "House Management". What is it?

5. What is known as "Greenshoe Option" or "Overallotment"?

6. Name the first Indian woman CEO of a Foreign Bank?

September 2012 Issue Answers:

1. Luca Pacioli

2. Arbitrage

3. Nostro Account

4. Letter of Credit

5. UCPDC – Uniform Customs and Practices for Documentary Credits


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By Vivek Srivastava and

Tushar Sharma

PGDM - IFMR Chennai

(Winners of Arthneeti Article writing

competition- December 2012)

“No Power on Earth Can Stop an Idea

Whose Time Has Come”

- Manmohan Singh (1991)

Introduction:

The growth exhibited by Indian economy

over the past decade has been truly

inspiring. But the story was not a happy

one in 1990. Once derided for its 2%

“Hindu Rate of Growth”, the economic

might of India was unleashed in 1991.

Pre 1991, Indian economy faced a severe

BoP crisis. With dwindling exports and

rising debt, the situation appeared bleak.

Forex Reserves stood at `11,416 Croresi,

barely enough to last 3 weeks. The

situation was exacerbated by the

increasing oil prices due to Gulf War.

Inflation had reached its highest level of

13%. Subsequently, India’s credit rating

fellii. Simply put, the Indian economy was

on the verge of default with respect to its

external payments liability.

It was India’s decision to open its door to

FDI which led to tiding over the crisis.

Sectors such as mining, banking,

telecommunications and highway

construction were opened to investors’ iiipost 1991. FDI inflow rose from `2,705

Crores in 1990 to `18,486 Crores in March

2000 and `123,378 Crores in 2010iv. With a

growth rate of close to 7.7% over the past

decade, India today truly occupies pride of

place in the new economic order. India’s

journey has been an interesting one.

Positive investor sentiment in Indian

economy brought about by opening of the

doors to foreign investors led to infusion

of liquidity in funding starved Indian

economy and filled the coffers of the

Government. The push in upgrading

Indian infrastructure was possible only

because Government realized revenues

brought about by FDI. The social benefits

of this decision can be seen in the wide

variety available to the Indian consumers,

increased cosmopolitan fabric of our

society and increased competitive nature

of the nation’s firms.

The Story Today

Today, India is slowly slipping from the

path of high growth. IIP has plummeted

from 9.69% in 2010 to a measly 2.4% in

2012v. There is a wave of pessimism and a

loss of investor confidence that the India

Growth Story is coming to an end. Fiscal

Deficit is showing no signs of contracting,

and India’s External Debt has skyrocketed

to $ 289.7 Bn from a stable $ 237 Bn just a

yearvi ago (a 22% rise in just 1 year).

Spiraling budget deficit has led to

inflation. Infrastructure projects are all

coming to a standstill as major private

sector companies are overleveraged and


Subsidy Cuts and FDI Inflow:

Two Catalysts for Indian Economy Revival

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experiencing funding problems. Banks are

constrained in their funding projects

because of mounting NPAs on their

balance sheets. There are fears of

downgrades from credit rating agencies.

The Case against Subsidies

The biggest burden on Indian economy is

its burgeoning subsidies bill. There has

been a 200% rise in subsidiesvii since 2007-

08. In 2010-11, the country's subsidy

burden was `164,153 Crores -- or 2.08% of

the GDP -- and increased to `223,000

crore in the current financial year, which

is 2.5% of the GDP.

As late as October 2012, the Kelkar

Committee recommended that

Government cut subsidies in three

significant F's - Food, Fuel & Fertilizer - in

order to meet its budgeted fiscal deficit

target. The Committee further said that

the current deficit level of 5.1% could

balloon up to 6.1% if no corrective

measures were taken. The Committee

warned that India was on the edge of a

'fiscal precipice' and headed for a “fiscal

storm worse than 1991”viii.

The problems with the current subsidy

system are many. The ineffectiveness of

subsidies is an open fact. Still, policy

makers refuse to infuse a new line of

thinking to solve the problems. Low

property taxes have made Municipal

Corporations unviable. Municipal

Corporations and State Electricity Boards

are reeling under heavy losses. Low

electricity and water tariffs have reduced

the incentive to optimize usage and have

led to wastage of precious resources. The

PDS system for distribution of food grains

and kerosene has spawned practices like

black marketing and hoarding. Subsidized

urban housing is sold off and beneficiaries

revert to squatting. Low-priced public

transport tickets have pushed State

Transport Corporations towards

bankruptcy. Wage guarantees have

distorted labor incentives and prevented

efficient labor allocation.

The problem with fuel subsidies is that

they impose a heavy burden on

Government budgets, add to global

warming, pollution and cause wasteful

consumption in general. This, in turn,

diverts much-needed resources from

more pressing needs, such as health and

education. As National Income rises, so

does the consumption of fuel. Indian

policy makers have been oblivious to this

trap of rising fuel subsidy bill. The

lingering uncertainty over the outlook for

fuel prices may also affect investor and

consumer confidence at a time when the

global economic environment is more

challenging.

Similar is the case with subsidies in the

form of free power, fertilizers etc. The

biggest challenge for the government is

selecting an appropriate channel for

subsidy transfers. The current channels of

providing subsidies to the farmers are

deeply flawed. The most effective

approach to minimizing such distortions is

eliminating price subsidies and replacing

them with direct equivalent cash

transfers. In this context, the proposed

Direct Cash Transfer system via Aadhar is

revolutionary.


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The Government, constrained by coalition

compulsions, has paid some cosmetic

heed to the Panel's suggestions but with

the caveat that certain subsidies were

unavoidable. The recent hikes in diesel

prices and cap on subsidized LPG cylinders

are steps in the right direction. For a

country with a burgeoning middleclass,

such a cut in deficits is not a severe

problem. The middle class can afford it.

Indian citizens should be ready to pay the

price for development.

IS FDI Really the Engine for Growth?

The rationale for economic liberalization

during 1991 was to foster greater

competition in private sector which would

ensure efficient allocation of resources,

greater efficiency and achieve a spread of

income and prosperity. FDI in itself is not

the be all and end all solution. FDI and

growth form a complex cycle – where one

is the cause of another. Only when there

are conditions conducive for growth will

multi-national firms invest in India. And

their investing will provide a push to the

economy. FDI inflows are a signal that the

investment climate is fair and investors

have a sense of comfort and security.

Though it is a vital step for the

improvement of economy – it is only an

addition that bridges the gap in capital

formation required to sustain a targeted

growth. Our economic strategy cannot be

entirely based on FDI-led growth alone. In

India, it is estimated that FDI contributed

just 0.7% - 2.1% to GDP growth during the

period from 2003-10. Thus, to root out

prevailing pessimism, steps should be

taken to ensure that FDI inflows increase.

This can be achieved by:

Adopting a transparent policy

framework

Conducting an overhaul of the

regulatory framework

Evolving transparent procedures for

allotment of land, power,

environmental clearances, etc.

Time-bound single-window approvals

of various clearances

Developing physical infrastructure

comparable to international

standards

Developing a social infrastructure to

attract both highly-skilled and semi-

skilled human resources

For achieving high growth, India requires

more knowledge cities, SEZs, Industrial

clusters, IT Parks, Highways and R&D Hubs

etc. A 9% GDP growth would need $1

Trillion worth of investment in core

infrastructure alone. Funding for such

ambitious prospects mean that we pave

way for FDI.

FDI provides immense job opportunities

to local people and also assists in

improving the economic situation.

Sentiment plays a major role in the

growth of an economy. Government

recently allowed 51% foreign investment

in multi—brand retail but left it to the

states to permit global retailers to open

stores.

The sectors where we are seeing

stupendous growth today are the sectors

in which FDI has played crucial roles. The

drugs and pharmaceutical sector has seen


http://economictimes.indiatimes.com/topic/private%20sector

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a 15-fold jump in FDI in FY12. India has

gained from FDI in automobile, IT/ITES

and telecom sectors in terms of lower

prices and myriad choices, flourishing

infrastructure and continuous

accumulation of knowledge capital.

Parting Shot

Faltering FDI flows have affected India's

economic growth process and

undermined its position. For India,

considering its demographic challenge,

achieving high growth is not an option but

a necessity. The two catalysts - subsidy

cuts and FDI inflows - are crucial Indian for

unleashing the “Animal Spirits”. Only time

will tell if the revival in FDI is here to stay.

Transitory or not, revival in FDI flows is

certainly good news for the economy. And

sooner our baggage of subsidies is

trimmed, the better off we will be.

i Bulletin RBI (Table 45); Economic Survey 2011-12 iiIndia’s Credit Rating - Rajwade (Business Standard

May 1,2006) iii Study of FDI And Indian Economy – Sapna Hooda

(NIT-K) ivImpact of FDI on Indian economy - Mahanta

Devajit (RJMS Sept, 2012) v www.indexmundi.com

vi Finmin.nic.in – India’s External Debt (End Sept,

2011) vii

10 Problems Ailing The Indian Economy & Solutions To Revive It (ET June 2, 2012) viii

Kelkar Committee Report (RBI) pp4


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BY SIMSREE FINANCE FORUM

The Fiscal Cliff overview

“Fiscal cliff” is the popular shorthand term used to describe the situation that the U.S. government was speculated to face at the end of 2012. This was the period when the terms of the Budget Control Act of 2011 were scheduled to go into effect.

The deadline of December 31, 2012 was set to make some changes such as:

End of last year’s temporary payroll tax cuts which would result in 2% tax increase for workers

End of some tax breaks for businesses

Shifts in the alternative minimum tax that would take a larger bite

A rollback of the "Bush tax cuts" from 2001-2003

Beginning of taxes related to President Obama’s health care law

Also, the spending cuts those were agreed upon as part of debt ceiling deal of 2011 - a total of $1.2 trillion over ten years - were scheduled to go into effect. This spending cut had a projected size of a total of $1.2 trillion over ten years.

The Fiscal Cliff policy

Some important features of the fiscal cliff policy are as follows:

An increase in the payroll tax by two percentage points to 6.2% for income up to $113,700

A reversal of the Bush tax cuts for individuals making more than $400,000 and couples making over $450,000 which entails the top rate reverting from 35% to 39.5%

An increase in the tax on investment income from 15% to 23.8% for filers in the top income bracket

3.8% surtax on investment income for individuals earning more than $200,000 and couples making more than $250,000

A 2 per cent payroll tax cut was enacted during the economic slowdown. This would be allowed to expire as of the deadline of December 31, 2012

An estimate of budgetary impact of the various provisions suggested is as follows:

Raising taxes on individuals making more than $400,000 and couples earning more than $450,000 would help in raising $617 billion in revenue.

Extending unemployment insurance will release $30 billion in spending.

Postponing sequester cuts could cause $24 billion in spending to get stuck.

Delay in scheduled Medicare payment cuts to doctors relates to $30 billion in spending.

Extending various tax credits holding a share of $76 billion.

Extending tax credits from the economic stimulus legislation constitute for $78 billion.

The Fiscal Cliff in

Totality


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How actually the deficit became a real problem for US The huge deficit in the fiscal budget of United States has many reasons to count for. The major five reasons are as follows:

In 2011, almost 63% of the spending was made on past promises made for social security, Medicare, Medicaid, subsidies, debt interest.

One out of four dollars goes to health care. In 1960, spending on health care was about 10% before Medicare and Medicaid was part of spending. In contrast to this, healthcare spending has increased to 25% in 2012 and is projected to touch 33% in future.

Federal government employs an enormous number of four million people. This also constitute to a significant portion of US spending.

US government spends approximately 700 billion dollars on defence.

Tax paid by US citizens is falling significantly.

The Fiscal Cliff Debate The US lawmakers had three options to act upon the fiscal cliff. The first option was to let the policies come into effect as they were scheduled. The policy featured a number of tax rate increases and fiscal spending cuts. This would have cut the fiscal deficit significantly. But at the same time, the policies were speculated to affect the growth of economy and possibly push it back into recession. Another option was to cancel all or some of the scheduled tax increases and spending cuts. This measure would have

further increased the deficits and would have added to the hardships US already is facing. Another angle to this option was that US debt would have continued to grow which is not favourable at all. The other option could have been to take a middle path which would address the budget issues to a limited extent, but that would have a more modest impact on growth. This is ultimately the course lawmakers choice in the agreement reached on December 31, 2012.

How the fiscal cliff deal was handled actually The important date that comes into picture when fiscal cliff is mentioned is 31st December, 2012. The fiscal cliff agreement that came into picture can be considered as good news to some extent. But this cannot be ignored that the US lawmakers had 507 days to come to a solution to this problem. (These 507 days are calculated from the August, 2011 debt ceiling agreement to 31st December, 2012.) But, in spite of this, US lawmakers came down to the final hours before they were able to reach a solution. This caused unnecessary burden on financial markets and the economy. Now, after this much turmoil, the agreement only addresses the revenue side i.e. the taxes paid by US citizens. But, the discussion of spending cuts which called as “sequester” is postponed until March 1. So, we can see that it is still a wait and watch game.

So, we can say that the problem is temporarily solved as the deadline of 31st December is passed. But still the portion of the deal needs to be addressed. On a longer term basis, the cliff deal still needs to address the US debt load which is as high as $16.4 trillion.


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Features of the bill passed by the Senate: Past its own New Year's deadline, the Senate agreed to a deal to avert the fiscal cliff. Democratic-led Senate passed the measure that seeks to maintain tax cuts for most of the Americans but increase rates on the wealthy.

According to different estimates, this legislation would raise roughly $600 billion in new revenues over 10 years.

Republicans stood for higher tax rates for the wealthiest Americans, while democrats suggested a higher threshold for the people who are wealthy enough to face higher taxes. According to President Barack Obama, the law would be signed that would raise taxes on the wealthiest two per cent of Americans while preventing tax hikes that could have sent the economy back into recession.

The Worst Case Scenario If there would have been no change in the current policy chalked out to deal with the fiscal cliff, there wold have been a two way effect on economy. The step of spending cuts and raise in taxes would reduce the deficit by $560 billion approximately. But on the other hand, according to Congressional Budget Office, the policy would have slowed down the gross domestic product by four percentage points in 2013 which would have sent the economy into recession. Also, it was predicted that unemployment would rise by a per cent point which could have caused almost two million people to lose their job.

A May 16, 2012 Wall St. Journal article estimated the impact in dollar terms as: “In all, according to an analysis by J.P. Morgan economist Michael Feroli, $280 billion would be pulled out of the economy by the sun setting of the Bush

tax cuts; $125 billion from the expiration of the Obama payroll-tax holiday; $40 billion from the expiration of emergency unemployment benefits; and $98 billion from Budget Control Act spending cuts. In all, the tax increases and spending cuts make up about 3.5% of GDP, with the Bush tax cuts making up about half of that.”

Brighter Side to This If we think on the issue of fiscal cliff, we can see some brighter side to it. If at all the fiscal cliff happens, it might not be that much bad as it is imagined.

The other school of thoughts argues that the cliff would bring some long-term positive changes on the cost of some short term hardships. The argument says that U.S. has to tackle its deficits at some point, and this sort of "bitter medicine" would be a harsh, but definitive, step in that direction. Now, this short term effect could be severe and might cause recession in 2013. But, at the same time it can fetch long term benefits like lower deficits, better growth prospects, lower debt, etc.

According to the projections of the Congressional Budget Office, by 2022, the budget deficit would fall to $200 billion from its current level of $1.1 trillion. To achieve this, nation might have to face some tough situations as mentioned earlier.


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SIMSREE Arthneeti Dec 2012