What Global Crisis Means for India

8/14/2019 What Global Crisis Means for India

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What global crisis means for India

While India must eventually liberalise its financial sector, we must err onthe side of caution. Main Street reforms promise much betterprospects of multiplying well-paid jobs for India's poor, says Arvind

Panagariya.

THE current economic crisis, which originated in the financial sector of theUnited States, is being transmitted to the countries around the world throughthree principal channels. First, it has directly impacted the balance sheets offinancial institutions that invested in the mortgage-backed securities and theirderivatives, which turned toxic following large-scale defaults in the US housingmarket. In Asia, Korean banks suffered the most, requiring a $130 billion bailoutpackage.

Second, the crisis has created a liquidity crunch. The US firms seeking liquidresources massively withdrew their investments in stocks and bonds in othercountries. The resulting decline in the prices of bonds and stocks also led localinvestors to pull back from the market. Both factors contributed to the tighteningof credit. Reinforcing these factors was the return of the local firms, which hadpreviously borrowed in foreign markets, to the domestic market. These firms sawthe foreign markets suddenly dry up.

The final source of transmission of the crisis has been the real sector nowfrequently referred to as the 'Main Street' in the United States. The financial crisiscoincided with the creeping recession in the United States and made it worse.That has meant a cut in the US demand for imports from other countries.

Thanks to the former RBI governor, Dr Y V Reddy, India almost entirelyescaped the devastation of the financial sector wrought by the crisis in countriessuch as Korea. The finance ministry, while paralysed on numerous urgent MainStreet reforms, has been actively pushing for deregulation in the financial sector.In this effort, it has found an unlikely ally in the Planning Commission. Unable tofocus on and deliver in its core areas, infrastructure and social services, thecommission has increasingly and proactively ventured in areas outside its

jurisdiction. Thus, last year, it appointed a high level committee on the financialsector, which predictably called for progressive opening up of the sector. Luckily,governor Reddy withstood these pressures, carefully regulating investmentactivities of Indian commercial banks.

To fully appreciate the importance of prudent regulation of the financial sector,briefly consider the origins of the current crisis. Under a largely unregulatedenvironment, mortgage lending to subprime borrowers had rapidly expanded inthe United States in the 2000s. By definition, subprime borrowers either haveprior default history or lack incomes to qualify for the loan they seek in the primemarket. Therefore, they carry high risk of default. Interest rates in the subprimemarket exceed those in the prime market by 2 to 3 percentage points.

Because lenders could sell the mortgages they issued to other financial


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institutions such as Goldman Sachs or Lehman Brothers, they were emboldenedto lend to ever-riskier borrowers. These institutions in turn packaged a largenumber of the mortgages into a mortgage-backed security (MBS) and issuedbonds of varying risks and returns backed by it. Bonds with highest return wouldalso carry the highest risk: if default occurred on some of the mortgages in the

MBS, holders of these bonds would be the first to experience a cut in payments.At the other extreme, bonds with the lowest return would carry the lowest risk payments on them would be the last to stop. Financial institutions furtherpackages MBS backed bonds of different ratings into collateralised debtobligations (CDOs) and sliced them yet again into secondary CDOs of varyingrisk and returns (along the lines of MBS backed bonds).

FINANCIALinstitutions and even individuals around the world invested in theseinstruments. As long as the US housing market boomed, mortgage-default ratesremained low and various mortgage-backed instruments remained attractiveinvestments. But once the housing market tanked, the instruments turned toxicand their holders saw their balance sheets go into red. Under the watchful eye of

governor Reddy, only $1 billion worth of Indian investments could slip into theseassets.The lesson of this experience is that while India must eventually liberalise its

financial sector, we must err on the side of caution. Modern-day 'wizards' in thefinancial sector have the talent to 'innovate' products that even the mostsophisticated analysts are unable to evaluate. Thousands of individual investorsin Singapore, Hong Kong and Taiwan recently took to the streets to protestagainst the implosion of US-based securities that The Economistdescribed asbeing characterised by "fiendish complexity." Mindless deregulation in this sectorhas greater chance of creating egregiously high emoluments for a few (and acrisis) than significant gains for the masses. Main Street reforms, on the otherhand, promise much better prospects of multiplying well-paid jobs for India'spoor.

While India has largely avoided being impacted by the first channel oftransmission of crisis, it has not escaped the remaining two channels: It faces atemporary liquidity crunch as also a decline in the export demand induced by theglobal slowdown. To combat liquidity crunch, the RBI must continue workingtowards restoring confidence in lending and injecting liquidity. It must dispel thefear of lending that currently engulfs the banks.

The impact of the recession in the United States and Europe, which has alsoslowed down China, now an important trading partner of India, is likely to remainwith us longer. I have maintained for some months now that absent Main Streetreforms and accelerated build up of infrastructure, especially power, India willtake a cut of two percentage points in the growth rate this year and the nextbringing the growth rate to 7%. This is not a catastrophe but it does setback ourefforts to rapidly eliminate poverty.

On the positive side, we can take some comfort in the thought that the currentcrisis is not about to turn into the Great Depression of the 1930s. At the height ofthe Great Depression, the unemployment rate in the United States had exceeded


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25%. Currently, it stands at 6.5% and is predicted to peak around 8% in mid2009.

Dear Friends,

This is a nice data collection and could be of use to understand muchtalked about global financial crisis and crashing of stock market etc.

This is related to USA and unfortunately, such data's are not shared withpublic in India to avoid panic and lesser public education, so that we groupin the dark. May be, my understanding is poor, due to my limitedknowledge in these matters.

Being graphical, one can just see and understand than reading numericaldata.

RISING COMMODITY PRICES

GLOBAL BANK LOSSES


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Banks and other financial institutions could lose $1 trillion from the creditcrisis as mortgage-backed assets have lost most of their value.

Banks have already written off nearly $500bn worth of assets but the IMFpoints out that they have only been able to raise new capital to cover abouttwo-thirds of those losses, so the likelihood is that they will have to restricttheir lending further than they already have done in the last year (SeeFrozen Credit Markets chart below).

FROZEN CREDIT MARKETS


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COLLAPSING HOUSING MARKETS

Underlying the financial market wobbles is a real decline in US house pricesnationwide for the first time since the 1930s.

JITTERY STOCK MARKETS

Stock markets around the world - from Shanghai to London - have plunged,while in the US the Dow Jones industrial average has made big losses thisyear.

THE TIGHTENING SQUEEZE


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Figures show change in prices June 2007 to June 2008 for petrol and food, July 2007 to July 2008 forhousing

THE FUEL SQUEEZE

THE FOOD SQUEEZE


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THE PROPERTY SQUEEZE


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INFLATION AND JOBLESS ON THE UP

Government inflation target up to Dec 2003 was RPIX 2.5%, since then CPI 2%


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SPENDING MONEY SLOWDOWN


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The US sub-prime mortgage crisis has led to plunging property prices, aslowdown in the US economy, and billions in losses by banks. It stems from

a fundamental change in the way mortgages are funded.

THE NEW MODEL OF MORTGAGE LENDING

[ ] How it went wrong


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Traditionally, banks have financed their mortgage lending through thedeposits they receive from their customers. This has limited the amount ofmortgage lending they could do.

In recent years, banks have moved to a new model where they sell on the

mortgages to the bond markets. This has made it much easier to fundadditional borrowing,

But it has also led to abuses as banks no longer have the incentive to checkcarefully the mortgages they issue.

THE RISE OF THE MORTGAGE BOND MARKET


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In the past five years, the private sector has dramatically expanded its rolein the mortgage bond market, which had previously been dominated bygovernment-sponsored agencies like Freddie Mac.

They specialised in new types of mortgages, such as sub-prime lending toborrowers with poor credit histories and weak documentation of income,

who were shunned by the "prime" lenders like Freddie Mac.

They also included "jumbo" mortgages for properties over Freddie Mac's$417,000 (?202,000) mortgage limit.

The business proved extremely profitable for the banks, which earned a feefor each mortgage they sold on. They urged mortgage brokers to sell moreand more of these mortgages.

Now the mortgage bond market is worth $6 trillion, and is the largestsingle part of the whole $27 trillion US bond market, bigger even thanTreasury bonds.

HOW SUB-PRIME LENDING AFFECTED ONE CITYTHE SUB-PRIME CRISIS IN CLEVELAND

(X)Sub-prime lending

( )Black areas

( ) Foreclosures (repossessions) ()

Deutsche Bank properties


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For many years, Cleveland was the sub-prime capital of America.

It was a poor, working class city, hit hard by the decline of manufacturingand sharply divided along racial lines.

Mortgage brokers focused their efforts by selling sub-prime mortgages inworking class black areas where many people had achieved home

ownership.

They told them that they could get cash by refinancing their homes, butoften neglected to properly explain that the new sub-prime mortgageswould "reset" after 2 years at double the interest rate.

The result was a wave of repossessions that blighted neighbourhoodsacross the city and the inner suburbs.

By late 2007, one in ten homes in Cleveland had been repossessed andDeutsche Bank Trust, acting on behalf of bondholders, was the largestproperty owner in the city.

THE CRISIS GOES NATIONWIDE


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Sub-prime lending had spread from inner-city areas right across America by2005.

By then, one in five mortgages were sub-prime, and they were particularlypopular among recent immigrants trying to buy a home for the first time inthe "hot" housing markets of Southern California, Arizona, Nevada, and thesuburbs of Washington, DC and New York City.

House prices were high, and it was difficult to become an owner-occupierwithout moving to the very edge of the metropolitan area.

But these mortgages had a much higher rate of repossession thanconventional mortgages because they were adjustable rate mortgages(ARMs).

The payments were fixed for two years, and then became both higher anddependent on the level of Fed intereset rates, which also rosesubstantially.


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Consequently, a wave of repossessions is sweeping America as many ofthese mortgages reset to higher rates in the next two years.

And it is likely that as many as two million families will be evicted from

their homes as their cases make their way through the courts.

The Bush administration is pushing the industry to renegotiate rather thanrepossess where possible, but mortgage companies are being overwhelmedby a tidal wave of cases.

THE HOUSING PRICE CRASH

The wave of repossessions is having a dramatic effect on house prices,reversing the housing boom of the last few years and causing the firstnational decline in house prices since the 1930s.

There is a glut of four million unsold homes that is depressing prices, asbuilders have also been forced to lower prices to get rid of unsoldproperties.

And house prices, which are currently declining at an annual rate of 4.5%,are expected to fall by at least 10% by next year - and more in areas like

California and Florida which had the biggest boom.

HOUSING AND THE ECONOMY


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The property crash is also affecting the broader economy, with the buildingindustry expected to cut its output by half, with the loss of between oneand two million jobs.

Many smaller builders will go out of business, and the larger firms are allsuffering huge losses.

The building industry makes up 15% of the US economy, but a slowdownin the property market also hits many other industries, for instance makersof durable goods, such as washing machines, and DIY stores, such as HomeDepot.

Economists expect the US economy to slow in the last three months of 2007to an annual rate of 1% to 1.5%, compared with growth of 3.9% now.

But no one is sure how long the slowdown will last. Many US consumers

have spent beyond their current income by borrowing on credit, and the fallin the value of their homes may make them reluctant to continue thispattern in the future.

CREDIT CRUNCH


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One reason the economic slowdown could get worse is that banks and otherlenders are cutting back on how much credit they will make available.

They are rejecting more people who apply for credit cards, insisting onbigger deposits for house purchase, and looking more closely atapplications for personal loans.

The mortgage market has been particularly badly affected, with individualsfinding it very difficult to get non-traditional mortgages, both sub-primeand "jumbo" (over the limit guaranteed by government-sponsoredagencies).

The banks have been forced to do this by the drying up of the wholesalebond markets and by the effect of the crisis on their own balance sheets.

BANK LOSSES


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The banking industry is facing huge losses as a result of the sub-primecrisis.

Already banks have announced $60bn worth of losses as many of themortgage bonds backed by sub-prime mortgages have fallen in value.

The losses could be much greater, as many banks have concealed theirholdings of sub-prime mortgages in exotic, off-balance sheet instruments

such as "structured investment vehicles" or SIVs.

Although the banks say they do not own these SIVs, and therefore are notliable for their losses, they may be forced to cover any bad debts that theyaccrue.

BOND MARKET COLLAPSE

Also suffering huge losses are the bondholders, such as pension funds, whobought sub-prime mortgage bonds.

These have fallen sharply in value in the last few months, and are nowworth between 20% and 40% of their original value for most asset classes,even those considered safe by the ratings agencies.


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If the banks are forced to reveal their losses based on current prices,they will be even bigger.

It is estimated that ultimately losses suffered by financial institutions couldbe between $220bn and $450bn, as the $1 trillion in sub-prime mortgagebonds is revalued


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.

The impact of slowdown on India

Our response to the emerging global turmoil has been essentiallymonetary. More focused action, including fiscal, is needed tostem the worsening of the real economy, says Ajay Dua.

AFTER asserting that the global financial meltdown will not affect us, it is nowbeing acknowledged that India is impacted and the effects will intensify. A flurryof activity to size up the happenings and counter the financial virus fast spreadingacross the globe is now being witnessed.

As early as April 2008, the early alarms had been sounded but ourpreoccupation with inflation-management made us virtually sidestep it all inthe belief that we were not vulnerable. This was somewhat nave looking at themagnitude of the predicament. The subprime crisis was translating into hugelosses, and resulting in billions of dollars of capital raisings, including public

offerings and asset-disposals. Market caps were plunging sharply, and not just inthe US, but also of European banks. Central banks across the globe had begunto revive financial institutions, hit by what former Federal Reserve governor AlanGreenspan has described as 'the crisis of the century'.

India may be one of the least open economies in Asia but its external tradealready constitutes over 40% of its GDP. Net investments by FIIs in Indian stockexchanges by January 2008 were $65 billion. In the last four years India hasreceived $50 billion as FDI. On October 23, by which time FIIs had pulled out


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over $10 billion, the rupee plunged to 49.79 against the dollar, in comparison tounder Rs 39 a year ago. GDP growth had started slowing and it had becomeobvious that the projected growth at 9% was untenable.

By mid-October, India was well in the midst of a global slowdown. Estimates ofannual GDP growth had been lowered from 9% to 7.5%. During Q1 2008-09

growth was 7.9% compared to 9.2% in Q1 2007-08. Deceleration has beenwidespread. Industrial growth is much slower. April-August 2008 saw 4.9%growth compared to 8.5% in April-August 2007 and 10% during entire 2007-08.Expansion in manufacturing, the emerging star of Indian economy, fell from10.6% to 5.2%. Electricity generation nose-dived from 8.3% to 2.3%.

Agriculture declined in Q1 2008-09 from 4.4% to 3% and services from 10.6%to 10.2%. Foreign trade during H1 2008-09 registered a deficit of $60 billion asagainst $30 billion in H1 2007-08. Hitherto, export growth was being bolstered byrising commodity prices and the yet strong demand from emerging markets andoil producers. All such contributory factors are no longer there.

There has been a reversal of portfolio equity flows, largely because of foreign

institutions' need to enhance their liquidity positions and the overall reduction inthe risk appetite of global investors. Equity market is down 30% since April 2008and had dipped below the 10,000 level. A sharp decline in FII inflowsexacerbated the downward pressure with the rupee depreciating by almost 25%and touching a five-year low of 50.18 on November20.

Since mid-September, the tight liquidity conditions in the economy have led toextreme volatility in the money market. Inter bank call rates have been postingsignificant jumps, well above the official repo and reverse-repo corridor. ByOctober 20, the call rates had become 20% and averaged 12% between mid-September and mid-October. By mid-October the economy had clearly deviatedfrom its long run growth path. The positive cycle had turned negative and theactual growth had lagged behind the potential output growth. The manufacturinginflation gap has become positive, with the actual inflation being higher thanwarranted for many months.

OUR response to the emerging global turmoil has been essentially monetary.The RBI, which for 18 months had been increasing interest rates and the cashreserve ratio to cool down the overheating economy, has since October changedtracks. Repo rate has been cut by 150 bps, CRR by 350 points and SLR reducedfrom 25% to 24%. Such facilities aim at infusing greater liquidity and makingcredit cheaper. However, the additional liquidity of Rs 2 lakh crore has primarilygone to offset the sizeable money withdrawals which occurred upon issue ofbonds to oil and fertiliser companies for not effecting price increases.Commercial banks have so far not significantly reduced their lending rates orstarted lending as before.

Till the fragile financial systems start functioning normally again, the variousmacro measures might not be fully effective particularly in the transmission ofincreased liquidity to investors and consumers. Many non-linear effects areanticipated as weaknesses in our trading partners spill over to us. There wouldalso be reduction in investment financed through FDI, remittances, internationaldebt and aid.


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India, like many other Asian countries, is expected to suffer severely from thelagged effects of the commodities' price shock. Also China, with whom Indianforeign trade has been steadily growing, is highly exposed to the downturn in theUS and Europe. Already Indian iron ore mine owners have cut down their outputby 40%.

The number of investor accounts at stock exchanges has surged. A crash inequity prices is affecting more people than ever before. Property markets havedeepened substantially and the losing values of real estate have a potentialmultiplier effect. The global credit crunch has caused more restrictive lending bycommercial banks, upon which Indian corporates and households heavilydepend for finance. The monetary measures recently initiated are not adequateto spur banks to lend more as they are concerned, and perhaps rightly, aboutshortterm prospects of the economy.

Most Indian IT firms are vulnerable to the emerging global recession 70% ofIndia's $40 billion software exports are to the US and 40% of it for financialservices which are shrinking rapidly. Our manufacturing and construction trade

face prospects of further slackening investment. Financial services are upagainst tight liquidity and falling markets. Plummeting travel and tourism areslowing down transportation and hospitality sectors. More focused action,including fiscal, is needed to stem the worsening of the real economy.

Obama victory and Indo-US relations

The current trajectory of the Indo-US relationship is well-poised and themuted anxiety about the victory of Barack Obama in the US

presidential election is premature and misplaced, says C UdayBhaskar

AUDACITY of Hope the title of Barack Obama's biography published in2006 captured the collective mood on Tuesday, November 4, when the USelected its first black President. The much-awaited 'change' that the Americanvoter was seeking became real. The anxiety and unease that persisted till thevery end that the US was not yet ready to put its shameful racial and colourprejudices behind it, has finally been put to rest. The world's oldest democracyhas now regained the moral high ground as far as the treatment of its minoritiesis concerned and this has an embedded message for the largest democracy though hopefully this breakthrough in India will not take as many decades to berealised.

The sub-text of the Obama biography is 'Thoughts on reclaiming the Americandream' and the current mood in the US is one of hope, born out of weariness anddespondency after eight years of the Bush presidency and the many excessesassociated with the current White House. When he assumes office, Mr Obama,


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the Democrat President-elect will have his hands full with urgent domestic issuesand none more stark than a bankrupt economy with a trillion dollar deficit and thesteady erosion of the prevailing global financial turmoil. Capitals the world overare making their individual assessments about what an Obama victory will meanfor their bilateral relations with the US and on balance, it would be fair to aver

that there is no indication of any major or radical changes in US external policies.The perceived US national interest will be the lodestar for any incumbent in theWhite House and it will be no different for Mr Obama who will inherit manycrosses from his predecessors.

As regards the Indo-US bilateral, there has been some anxiety expressedabout the implications of the Obama victory. Reference has been made to hiscampaign statements regarding the India-Pakistan relationship and thedesirability of both countries working "towards resolving their dispute overKashmir." In like fashion, the Obama amendment during the US Congressionaldebate over the Hyde Act that was once described as 'killer' has also come up onthe radar screen to add to the disquiet. However linear extrapolations that are

over-interpreted may not be valid at this stage in the Indo-US bilateralrelationship. The Obama victory needs to be contextualised against the largerbackdrop of the 60-year-old tumultuous New Delhi-Washington DC relationshipto better comprehend the texture of the potential implications.

Yes, it is true that India and the US had a very estranged relationship foralmost 40 years and much of this was derived from the ontological divergencesover the nuclear nettle. To his everlasting credit, President Bush in his secondtenure was able to innovatively recast the template of the bilateral and after theNSG waiver of September this year and the signing of the 123 agreement, Indo-US relations have been qualitatively transformed. They have moved from longestrangement to preliminary engagement. This basic orientation will not bealtered by the Obama victory. Thus the Black and White reduction, that DemocratPresidents have been less favourable to India, would be a simplistic conclusion.The global architecture, US strategic interests, and India's own profile havechanged irrevocably.

HOWEVER,there are identifiable areas wherein the Obama policy preferencewill be of special relevance to India. Two may be deemed global namelyclimate change and trade/economic policies. Will the US under Obama becomemore 'protectionist' about its own interests and thereby jeopardise the interests ofthe developing world? On current assessment, the Obama vision appears to bemore inclined towards meaningful multilateralism but much will depend on thedomestic US political compulsions that will prevail after January 20, 2009. Duringhis campaign, Mr Obama adopted a strong antiout-sourcing position and therewas predictable gloom in the Indian IT sector but it merits repetition that thelarger global trade dynamic and the choices made by the Democrat-controlledUS Congress will define the final Obama position.

Some of the other issues with a distinctive southern Asian flavour that maycome into sharp focus on the Obama watch will be nuclear non-proliferation,religious extremism and related terrorism. While the US war in Iraq was a majorcampaign issue, it would be premature to expect any dramatic reversal of current


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US policies. The only exception may be Iran where the much-needed USdialogue with Tehran offers some hope. But from all accounts, Mr Obama as thenext US commander-in-chief would be loath to be seen as hesitant or ineffectivewhen it comes to US security interests, and hence the attention being paid to thePakistan-Afghanistan combine the new hyphenation in US foreign policy.

Paradoxically, the Obama agenda during the campaign trail which generallyveered towards multilateralism and persuasive diplomacy had become unilateraland almost muscular when it came to Pakistan and the war against terrorism.The kind of policy shift that could take place on these issues and their impact onIndia will depend to a great extent on the choice of the key officials in the coreObama team. Having arrived at a modus vivendi on the nuclear issue, thesecond major area of divergence in the Indo- US bilateral is that of terrorism andthe state support extended to this scourge. In the Indian perception, the Pakistanimilitary establishment, tacitly encouraged by the US, had adopted a long-termanti-India strategy whose principal element was nurturing covert terror. There arefaint signs that the Zardari-led civilian government in Pakistan will finally bite the

bullet but this will not be accomplished easily.Terrorism and its linkages with Pakistan's opaque nuclear narrative willchallenge the sagacity of the Obama White House and this will be of directrelevance to India. The Senator from Illinois has generated an enormous amountof hope a fervour last seen in the Kennedy victory but this euphoricexpectation must be tempered with caution. The current trajectory of the Indo-USrelationship is well-poised and the muted anxiety about the Obama victory ispremature and misplaced.

MF Industry records Rs 14,014.82 bn funds mobilization in Q1FY09

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The first quarter of fiscal 2008-09 witnessed a deceleration in the growth of Assets UnderManagement (AUM) of mutual funds (MF). According to Association of Mutual Funds in India(AMFI), while the industry has been growing 50-60% per annum in the last couple of years, thefirst quarter growth in assets has declined to little over 30% over the year. This clearly reflects theimpact of market meltdown. Due to a steep fall in the equity prices, investors kept away frominvesting in equity oriented mutual funds (MF).

According to AMFI, for the first time in several years, collections under the New Fund Offerings(NFO) of equity schemes declined sharply during the first quarter ended June 2008. However,there was no pressure on redemptions. In the present scenario, Systematic Investment Plans(SIP) is witnessing an encouraging trend with substantial accounts being added every month. Inthe background of a fall in equity prices, the asset preference shifted towards Income schemes

and fixed maturity plans (FMP) became very popular among the investors.

During the first quarter of fiscal 2008-09, 146 new schemes were launched and a sum of Rs297.99 billion was mobilized with Rs 276.13 billion under income schemes, Rs 16.51 billion underequity schemes, Rs 1.79 billion under equity linked saving schemes, Rs 500 million under otherexchange traded funds and Rs 3.06 billion under fund of funds investing overseas. For thecorresponding period in the last year 162 new schemes were launched and a sum of Rs 386.53billion was mobilized.
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Total funds mobilized for the quarter stood at Rs 14,014.82 billion as against Rs 7,898.54 billionfor the corresponding quarter last year, representing an increase of 77%.

Redemptions at Rs 13,630.44 billion were 85% higher than the redemptions of Rs 7,384.04 billionin the corresponding quarter, last year.

On a net basis, there was an inflow of Rs 384.38 billion during the quarter as against an inflow ofRs 514.5 billion in the corresponding quarter, last year.

Crisil on mutual fund industryAnita GandhiTuesday, March 25, 2008 (Andamans)

Fixed income markets to benefit

Measures

Revenue deficit target reduced to 1% in FY09 from 1.4% in FY08; fiscal deficit target reduced to 2.5% in

FY09 from 3.1% in FY08.

Gross borrowings lower at Rs.1.45 trillion in FY09 from Rs.1.56 trillion in FY08; net borrowing also lower at

Rs.1.01 trillion from Rs.1.11 trillion in FY08.

Measures announced to develop bond, currency and derivatives markets that will include launching

exchange-traded currency and interest rate futures and developing a transparent credit derivatives market

with appropriate safeguards.

Measures announced to enhance tradability of domestic convertible bonds by putting in place a mechanism

that will enable investors to separate embedded equity options from convertible bonds and trade them

separately.

Measures announced to encourage development of a market-based system for classifying financial

instruments based on their complexity and implicit risks.

Proposal announced to exempt from TDS, corporate debt instruments issued in demat form and listed on

recognized stock exchanges.

Impact

Decision of expanding the corporate debt market will help in increased focus towards bond funds and in a

scenario where interest rates are not expected to be adverse in the medium term, this would further assist in

increasing the popularity of bond funds which have not been doing well in the last few years.


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Development of the derivatives markets can in turn enhance the development of the structured products

market.

Better than targeted fiscal position of the government can impart some bullishness to G-Secs and hence to

Gilt funds.

Service Taxes Realigned for ULIPs

Measures

Asset management services provided under Unit Linked Insurance Plans (ULIPs) would be brought on par

with asset management services provided under mutual funds as regards chargeability to service tax.

Services provided by stock/commodity exchanges and clearinghouses would also be brought under the

service tax net.

Impact

The competitiveness of mutual funds vis--vis ULIPs in the investment basket of investors is expected to

increase somewhat.

Transactional expense levels of mutual funds are expected to go up marginally on account of their exposure

to stock and commodity exchanges which are expected to pass on the service tax. But clarity on what would

define services here and on what amount the service tax would be levied is awaited.

Easing in Income Tax Slabs

Measures

Threshold limit of Income Tax exemption for individuals raised as follows:

Up to Rs.150,000 - NIL

Rs.150,001 to Rs.300,000 - 10%


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Rs.300,001 to Rs.500,000 - 20%

Rs.500,001 and above - 30%

Impact

This is expected to increase the disposable income in the hands of the individuals to some extent which

could translate into increased retail investments in mutual funds

Increase in Short Term Capital Gains Tax

Measures

Short Term Capital Gains Tax raised from 10% to 15%.

Impact

Since long term capital gains tax has been left unchanged, this hike in short-term capital gains tax could

encourage long-term investments which augur well to the development of the concept of "long termism" in

the Indian Mutual Fund industry, which is conspicuous by its absence but which is coveted by the fund

industry given the greater flexibility that this provides in fund management.

At the same time since the short term capital gains tax is still lower than the income tax slabs of typical

capital market investors, it is not expected to cause too many investors to turn away from mutual funds.

The fact that the dividend distribution tax structure has not changed would mean that dividend reinvestment

plans in liquid schemes will continue to be popular and also the liquid plus category will continue to attract

inflows as the tax rates there would continue to be lower than the liquid category.

Thrust on Infrastructure Sector

Measures


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Call for more reforms in coal and electricity sectors.

Coal sector regulator to be appointed.

Fourth Ultra Mega Power Project (UMPP) at Tilaiya to be awarded shortly; five more UMPPs inChhattisgarh, Karnataka, Maharashtra, Orissa and Tamil Nadu likely.

Allocation for National Highway Development Programme (NHDP) raised from Rs.109 billion in FY08 to

Rs.130 billion in FY09.

Rural Infrastructure Development Fund (RIDF) corpus in FY09 raised to Rs.140 billion

Oil and Gas - New Exploration Licensing Policy (NELP) to attract investment of the order of $3.5 - $8 bn for

exploration and discovery.

Government of India is expected to list more PSUs to unlock their values.

Impact

With so much focus on the infrastructure sector, it is expected that infrastructure funds which have been the

key out-performers in the industry of late both in terms of returns performance as well as attracting fund

flows, will continue to occupy a prominent place


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Mutual funds: What lies in store in 2008ersonalfn.com

January 02, 2008 10:55 IST

With the Indian stock markets growing at a frantic pace in 2007 (much like 2006), investors who were willing to take on risk have beenrewarded rather handsomely for their efforts. While the smart investor has been grounded, many an ecstatic investor has lost his bearingstaking on even higher dosage of risk for that additional return.

Nonetheless, 2007 had a lot of innovation in store for the mutual fund investor, not all of which were positive. And there are indications that2008 could prove to be just as innovative.

The year gone by

Given that the domestic mutual fund industry has far from matured, it is only natural to expect a lot of new products and innovation along theway. 2007 witnessed some of these innovations.

1) Gold ETFs make a debutWhile there was considerable talk (which built up even more anticipation) about Gold ETFs (exchange traded funds) for quite some time, thnever really took off. That changed in 2007. As regulations crystallised and there was greater clarity on this front, fund houses stepped in toaunch Gold ETFs, actually they rushed in.

And like with all other innovations, every fund house now looks eager to launch a Gold ETF, even those who don't even have the basic mutfund offerings in place.

2) Global funds take offAnother long-standing innovation global funds, debuted in the industry. This is another investment option that never really took off as expected because a) there was lack of clarity regarding the regulations and b) fund houses were averse to launching global funds in the ava

of debt funds (since global equities are classified as debt from a taxation perspective).

Nonetheless, global funds did take off although fund houses adopted varying routes; while some invested directly in global equities, othersopted for the Fund of Funds (FoF) route by investing in global funds.

3) Infrastructure funds storm the rankingsLike we mentioned, not all innovations were positive; infrastructure funds count among the innovations that the industry could have donewithout.

We believed that after the disaster with the technology/media/telecom (TMT) funds in 2000, fund houses would have become wiser regardinsector/thematic funds. But no, themes like infrastructure were as popular as ever and many fund houses launched infrastructure-centric funThose that already had one open-ended infrastructure fund did not hesitate in launching more infrastructure funds (although of the close-envariety).

Of course, there is nothing to detract from the blistering performance of infrastructure funds. However, this has come at higher risk to thenvestor and unfortunately investors haven't been told this in as many words.

At Personalfn, our view on sector/thematic funds is that they are best avoided; instead investors should opt for well-managed, well-diversifieequity funds which in any case do invest in infrastructure (and also have the flexibility to exit the theme when valuations have peaked).

Leading equity funds in 2007

Equity Funds NAV 6-Mth 1-Yr 3-Yr Since Incep.


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(Rs) (%) (%) (%) (%)

Reliance [Get Quote] Power (G) 81 82.5 126.0 85.9 77.6

JM Basic (G) 38.8 57.4 108.8 50.5 37.7

Stanchart Premier (G) 27.3 54.2 107.8 - 56.2

Tauras Discovery Stock 30.8 66.8 100.4 49.6 9.2

JM Emerg. Leaders (G) 20.3 70.0 93.2 - 34.0

Reliance Reg. Sav-Equity (G) 29.7 70.7 90.9 - 53.2

Canara Robeco Infrastructure (G) 26.5 62.7 90.9 - 60.2

JM Financial [Get Quote] Services Sector (G) 18.8 48.3 90.8 - 92.7

ICICI [Get Quote] Pru. Infrastructure (G) 35 64.8 90.1 - 69.5

Kotak Opportunities (G) 53.6 65.6 89.4 61.7 66.4

BSE Sensex 37.8 45.9 45.5

Source: Credence Analytics. NAV data as on December 28, 2007.)

t is apparent from the table why infrastructure funds were so popular with fund houses and investors alike in 2007. There were at least threfunds among the top ten equity funds that were focussed on the infrastructure theme.

Another point worth noting is that with most funds a major portion of the growth has been registered in the last 6 months, a performance traiwhich is common with sector/thematic funds. This is because thematic funds tend to perform in shorter spurts as opposed to diversified equfunds which are known to clock growth steadily.

What lies in store in 2008

1) Guidelines on real estate fundsWe expect the launch of real estate funds to be among the high points of 2008. A draft of the guidelines has already been released by SEB(Securities and Exchange Board of India). Once the guidelines are finalised, you can expect fund houses to go all out with their real estateofferings. The launch of REITs (real estate investments trusts) will be the logical conclusion to the launch of real estate funds.

2) Entry load waiver

Despite the steps taken by SEBI to empower investors, it can be safely stated that fund houses and distributors continue to call the shots in mutual fund industry. To further the cause of investor empowerment, SEBI has waived entry loads on open-ended funds.

nvestors can now invest directly with the fund house without the intervention of a mutual fund distributor. The advantage of this move is thathere will not be an entry load and investors can have their entire investment corpus invested in the markets and b) they will no longer be atmercy of unethical mutual fund distributors for their mutual fund investments.

Finally, distributors will be forced to truly 'earn' their income and this bodes well for investors.

What should investors do in 2008?For starters, investors would do well to appreciate the importance of sticking to the basics of investing. This is probably their best defense inight of the complex investment environment that they will have to contend with.

nvestors must have predetermined investment objectives and plans before they start investing; also, they must invest in line with the same

all times. Finally, not losing sight of their risk profile is pertinent as well. 'Block all the noise and stick to the basics' - that could well be themantra for a rewarding 2008.

New to Mutual Funds? Tips for a beginner
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First time investors inMutual Funds act in the face of imperfect information and often get overwhelmed by

uncertainties characterizing the investmentsituation. But theres more to Mutual Fund investing thanmarket timing.

First things first..

The first thing an aspiring unit holder must do is to establish what type of portfolio he wants to build. In otherwords, to decide the right asset allocation. Asset allocation is a method that determines how you invest yourmoney in different investments with the proper mix of various asset classes. Remember, the type or class ofsecurity you own i.e. equity, debt or money market, is much more important than the particular security itself.

The popular thumb rule forasset allocation says that whatever the investors age, he should keep thatpercentage of his portfolio in debt instruments. For example, if an investor is 25, he should have 25% of hisinvestments in debt instruments and the rest in equity. However, in reality, different circumstances andfinancial position for each individual may require different allocation. Portfolio variable is another factor thatone needs to understand to practice asset allocation. These are age, occupation, number of dependants inthe family. Usually the younger you are, the more riskier the investments you can hold for getting superiorreturns.

How to pick the right fund/s?

Next, focus on selecting the right fund/s. The key is to select the fund/s based on their investmentphilosophy and consistency in terms of returns. To ensure you are selecting the right type of funds that areappropriate for your needs, consider following:

Determine what your financial goals are.

Are you investing for retirement? A childs education? Or for current income?

Consider your time frame. Do you need money in three months time or three years? The longeryour time horizon, the more risk you may be able to take.

7 good reasons to invest in SIPs

Fact No. 1: Over a long term horizon, equity investments have given returns which far exceedthose from the debt based instruments. They are probably the only investment option, which canbuild large wealth. Fact No. 2: In short term, equities exhibit very sharp volatilities, which many ofus find difficult to stomach. Fact No. 3: Equities carry lot of risk even to the extent of loosing onesentire corpus. Fact No. 4: Investment in equities require one to be in constant touch with themarket. Fact No. 5: Equity investment requires a lot of research. Fact No. 6: Buying good scripsrequire one to invest fairly large amounts.

Systematic Investing in aMutual Fund

is the answer to preventing the pitfalls of equity investment and still enjoying the high returns. Andit makes all the more sense today when the stock markets are booming. (Also Read -5 corners ofa sound Investing Strategy)

1. Its an experts field Lets leave it to themManagement of the fund by the professionals or experts is one of the key advantages of investingthrough a mutual fund. They regularly carry out extensive research - on the company, theindustry and the economy thus ensuring informed investment. Secondly, they regularly track themarket. Thus for many of us who do not have the desired expertise and are too busy with ourvocation to devote sufficient time and effort to investing in equity, mutual funds offer an attractivealternative. (Read more -The Investors biggest Dilemma)
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2. Putting eggs in different basketsAnother advantage of investing through mutual funds is that even with small amounts we are ableto enjoy the benefits of diversification. Huge amounts would be required for an individual toachieve the desired diversification, which would not be possible for many of us. Diversificationreduces the overall impact on the returns from a portfolio, on account of a loss in a particularcompany/sector.

3. Its all transparent & well regulatedThe Mutual Fund industry is well regulated both by SEBI and AMFI. They have, over the years,introduced regulations, which ensure smooth and transparent functioning of the mutual fundsindustry. This makes it safer and convenient for investors to invest through the mutual funds.(Check out -Foolproof strategies to maximize your profits)

4. Market timing becomes irrelevantOne of the biggest difficulties in equity investing is WHEN to invest, apart from the other bigquestion WHERE to invest. While, investing in a mutual fund solves the issue of where to invest,SIP helps us to overcome the problem of when. SIP is a disciplined investing irrespective of thestate of the market. It thus makes the market timing totally irrelevant. And today when themarkets are high, it may not be prudent to commit large sums at one go. With the next 2-3 years

looking good from Indian Economy point of view, one can expect handsome returns thru regularinvesting.

5. Does not strain our day-to-day financesMutual Funds allow us to invest very small amounts (Rs 500 Rs 1000) in SIP, as against largerone-time investment required, if we were to buy directly from the market. This makes investingeasier as it does not strain our monthly finances. It, therefore, becomes an ideal investmentoption for a small-time investor, who would otherwise not be able to enjoy the benefits ofinvesting in the equity market.

6. Reduces the average costIn SIP we are investing a fixed amount regularly. Therefore, we end up buying more number ofunits when the markets are down and NAV is low and less number of units when the markets are

up and the NAV is high. This is called rupee-cost averaging. Generally, we would stay awayfrom buying when the markets are down. We generally tend to invest when the markets arerising. SIP works as a good discipline as it forces us to buy even when the markets are low, whichactually is the best time to buy. (Read more -Invest wisely and get rich with equity MFs)

7. Helps to fulfill our dreamsThe investments we make are ultimately for some objectives such as to buy a house, childrenseducation, marriage etc. And many of them require a huge one-time investment. As it wouldusually not be possible raise such large amounts at short notice, we need to build the corpus overa longer period of time, through small but regular investments. This is what SIP is all about. Smallinvestments, over a period of time, result in large wealth and help fulfill our dreams & aspirations.

Benefits of Investing Through Mutual Funds

Professional Money ManagementFund managers are responsible for implementing a consistent investmentstrategy that reflects the goals of thefund. Fund managers monitor market and economic trends and analyze securities in order to make informedinvestment decisions.

DiversificationDiversification is one of the best ways to reduce risk (to understand why, read The need to Diversify). Mutualfunds offer investors an opportunity to diversify across assets depending on their investment needs.

LiquidityInvestors can sell their mutual fund units on any business day and receive the current market value on theirinvestments within a short time period (normally three- to five-days).
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AffordabilityThe minimum initial investment for a mutual fund is fairly low for most funds (as low as Rs500 for someschemes).

ConvenienceMost private sector funds provide you the convenience of periodic purchase plans, automatic withdrawal plansand the automatic reinvestment of interest and dividends.

Mutual funds also provide you with detailed reports and statements that make record-keeping simple. You caneasily monitor the performance of your mutual funds simply by reviewing the business pages of mostnewspapers or by using ourMutual Funds section in Investors Mall.

Flexibility and varietyYou can pick from conservative, blue-chip stock funds, sectoral funds, funds that aim to provide income withmodest growth or those that take big risks in the search for returns. You can even buy balanced funds, or thosethat combine stocks and bonds in the samefund.

Tax benefits on Investment in Mutual Funds1) 100% Income Tax exemption on all Mutual Fund dividends

2) Capital Gains Tax to be lower of -10% on the capital gains without factoring indexation benefit and20% on the capital gains after factoring indexation benefit.

3) Open-end funds with equity exposure of more than 65% (Revised from 50% to 65% in Budget 2006) are

exempt from the payment of dividend tax for a period of 3 years from 1999-2000.
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