Impact of High Fiscal Deficit on Indian Financial Markets

Recent article by S&P rating agency, threatened India to degrade its rating to junk. One of the reasons behind this warring is India’s fiscal deficit and its consequences on Indian economy.

Fiscal deficit measured on two factors in any economy, first total expenditure and second total revenue. Fiscal deficit is difference between government spending and government revenue for particular year, excluding money from borrowing. It is also known as budget deficit. India’s fiscal deficit for FY 2011-12 was 5.9% of GDP and is estimated 5.1% of GDP for FY 2012-13. But poor structured fiscal policies and external factors like, Euro crisis, inflation, slow growth in economy etc. could bring fiscal deficit at 6% or more level of GDP.

In FY 2011-12, Indian government’s revenue was Rs. 8, 44,912 crore, and in Union Budget 2012-13 it was estimated Rs. 9, 77,335 crore for FY 2012-13. In which, major source would be from tax collection, around Rs. 9, 35,685 crore. In total revenue taxes are contributed around 78% of total, and in FY 2012-13 it is estimated to grow around 22.7%. This estimation was made on new tax reform, Direct Tax Code (DTC), but delay in DTC implementation may fall short on estimated figures.

Indian Government’s total expenditure is divided in plan and non plan expenditures through the year. In FY 2011-12, government’s non plan and plan expenditure was Rs. 8, 92,116 crore and Rs. 4, 26,604 crore respectively. For FY 2012-13 is estimated by Rs. 9, 69,900 crore and Rs. 5, 21,025 crore for non plan and plan expenditures. In FY 2011-12 total growths in government spending was 10.1 % against original budgeted 3.4% and non plan expenditure was up by 9% due to high subsidy payments.  It had direct effect on fiscal deficit levels. Total subsidy for FY 2011-12 was Rs. 1, 43,570 crore and for FY 2012-13 estimated Rs. 1, 90,015 crore, these changes are due to high crude oil price and its import which counts 33% of total and rupee depreciation in context of other external factors. Non plan expenditures for FY 2012-13 are Rs. 9, 69,900 crore in which interest payments are Rs. 3, 19,759 crore. This indicates increase in borrowing, which is around Rs. 4.79 lakh crore. This results in government securities and bond market volatility.

Suppose India’s fiscal deficit reach at 6% level of GDP then its consequences could be worst enough to shrink India’s GDP growth by less than 5%.  India could face high inflation, because of rupee depreciation and its impacts. And this could cause exchange rate fluctuation. In FY 2009-10 when fiscal deficit was at 6.9% of GDP, inflation was all time high at average 14%. This would further accelerate to balance of payments crisis.

Increase in fiscal deficit and government spending would necessarily increases interest rate of government securities. And this would induce the rise in net private sector savings to support government borrowing. And consequences would be ‘crowding out’ of private sector.

How crowing out takes shape due to high fiscal deficit? To finance fiscal deficit government will borrow from other countries, and this will result in higher central bank’s rate and will discourage private borrowings.

Bond market would see high volatility because of these events. Bond prices fall and yield increases as market expects a higher supply of government securities. Banks are largest buyers of government securities and bonds, would face losses in particular investments.

Estimations from the macro econometric models suggests that an increase in the budget deficit by 1% of GDP would raise long term interest rate by about 50 basis points after one year and about 100 basis points after ten years. 

In Union Budget 2012-13, Indian Finance Minister estimates to reduce fiscal deficit to 5.1 % of GDP, through reducing total subsidy expenses by 2% of GDP to 1.5% of GDP in next three years. But these steps are not enough. Government can reduce fiscal deficit by increasing revenue or decreasing spending. To increase revenue government can increase tax brackets (including direct and indirect taxes), but by this demand will fall and business investment activities will come down. Is last few years government cut subsidies in sectors like education, health and poverty alleviation and it created inverse effect in booming demand. For FY 2012-13 government target Rs. 30,000 crore incomes by disinvestment activities, but it cause negative impact in long term. The Public Sector Units (PSUs) that the government disinvesting are profit making firms like Oil and Natural Gas Corporation (ONGC), Gas Authority of Indi Limited (GAIL) and Life Insurance Corporation (LIC). From these firms government earns lump sum amount at the end of financial year, and by disinvestment government will lose profit on it.

As growth target remains high, cost of borrowing would be at higher level. To support spending government is limited on money creation because it will fuel inflation and external borrowing because it will increase debt burden.

Implementation of DTC in next year and allowance of FDI in retail and aviation would help India to bring down its fiscal deficit. 

Greece no longer a part of European Union

After June 17, 2012, Greece will have two choices. First, continue with Euro currency and be a part of Euro zone. Second, separate from Euro zone and introduce its own currency ‘drachma’.

Whether Greece stays in EU or leaves EU, Indian financial market will follow global sentiments. Based on this study one can say that Global and Indian financial markets will see little progress, until there are other external factors in India like, Inflation, GDP figures, fiscal deficit etc.

At this stage 70% suggest that Greece would remain in Euro Zone. Even The U.S.A. president and IMF chief want Greece in Euro Zone.

Why countries and global leaders want to save Greece through bailouts or liquidity injection, even after world is aware about Greece’s debt and possible default risk on it?

Greece’s economic crisis turned into fully political crisis. If Syriza party comes in power (which has high possibility in June re-election), would cancel bailout deal. And Europe and IMF will stop loans to Greece. By this Greece would be no longer able to pay wages, pensions, essential services etc and probably run out of cash in July. And Greece will default on debts.

If Greece leave Euro Zone then country will introduce new currency, drachma. And drachma would depreciate by 50% -70% with compare to Euro. And Greece government bonds will be worthless, which are highly exposed by German and French banks.

Greece exit from Euro Zone would not create direct impact on Indian financial markets but indirect effect would repeat 2008 crisis scenario. In case of direct impact, Indian has 0.14% of total export to Greece, which is negligible. But if Greece default and decides to exit Euro, then global crises is imminent.

India’s exports growths are linked with global growth. India has great exposure in Europe market. March 2011, total exports to The U.S.A. were 10% and to Europe were 18% of the total. This indirect effect would make India and Europe trade suffer. EU imports from India, Manufactured Goods: 9,572 million euro, Machinery and Transport equipments: 7,004 million euro, Textile and related articles: 7,326 million euro, Clothing: 5,131 million euro. These are the major imports of EU from India, and these sectors would have more impact.

Euro is known as second largest currency reserves in world after The U.S.A. dollar. Greece crisis is depreciating Euro as well. This will devalue commodities, like Gold, Silver, Crude oil etc on commodity exchanges around the world.

This Euro and Greece crisis will make The U.S.A. dollar the safest haven and investors will lure towards that. By this Indian rupee will depreciate more, and would result in inflation, fiscal deficit rise. In this macro concern and domestic factors, FIIs will lose confidence in Indian market, and would further make Indian secondary market more volatile. Even in last three years EU’s FDI with Indian has also shown negative results too, In 2009 and 2010 outflow was 3.3 billion euro and 4.7 billion euro respectively, where inflows in same years were 0.8 billion euro and 0.5 billion euro respectively.

This will also cost high to Indian banks and corporate to raise funds from foreign countries. And this will result in low growth and profit to Indian banks and corporate.

Along with this Indian IT sector has 20% - 30% earnings from European countries, this will drag down Indian IT business. 

A story of Three Musketeers: volatile currency and its risk on FIIs

Once upon a time there were three rich men in the United States of America. People nick named ‘Three Musketeers’. Three Musketeers were seeking opportunity to invest their capital in to emerging countries. One fine morning they heard about place called ‘India’. Three Musketeers decided to invest their USD    2, 00,000, a country called India. India’s currency is measured in rupee, widely known as Indian rupee or INR. Three Musketeers choose to invest in Indian secondary markets. To invest in Indian securities they need to convert USD to INR. Hypothetically, As per the 1^st May, 2001 1 USD=51 INR. Three Musketeers invest USD 2, 00,000 on 1^st May, 2001.

Three rich men done one mistake, they forget to calculate risk on currency fluctuation. They contact risk manager from such and such risk analysis firm. Hypothetically, Risk manager predicted two situations, to ensure whether Three Musketeer’s invested money is safe or not based on INR fluctuation.

Situation A:

First he assumed, on 2^nd May, 2001 INR appreciate up to 50 INR against 1 USD. Here we assumed that Three Musketeers investment has not done any profit or loss on their invested capital. Suppose if they want to pull out their invested money then they get USD 2, 04,000 (after converting it from INR to USD as per current currency rate). Without doing anything they earn USD 4,000 (ignoring all taxes).

Situation B:

Assumed, on 2^nd May, 2001 INR depreciate up to 52 IND against 1 USD. Here we assumed that Three Musketeers investment has not done any profit or loss on their invested capital. Suppose if they want to pull out their invested money then they get USD 1, 96,153 (after converting it from INR to USD as per current currency rate). Without doing anything they earn USD 3,847 (ignoring all taxes).

From both of these case situations we can conclude that how important is to understand forex market and currency fluctuation of domestic and international country.

In these hypothetically situations we neither took profit and loss in calculation nor levied taxes.

Just think and assume situation B, even if Three Musketeers make profit of INR 50,000, they occur loss of USD 2,885 (ignoring all taxes) if they pull out their money on 2^nd May, 2001.

Indian rupee depreciation and currency fluctuation are the biggest concern for Foreign Institutional Investors (FIIs).

For more on Indian rupee depreciation: Volatile currency, INR :

http://rutvij-bhutaiya.blogspot.in/2012/02/volatile-currency-inr.html

Analysis,Union Budget 2012-13

First union budget was presented by Mr. Chetty on 26^th November, 1947. From 1947 to 2012 union budget has sincerely followed its ‘parampara’ in Indian context.

Does Union budget 2012-13 satisfy, ‘I’ (taken from BRICS nations)?

From 2012 year India is entering into 12^th five year plan; focus is faster, sustainable and inclusive growth. What are those indications, which Mr. Mukherjee tried to reflect on 16^th March, 2012 for upcoming five year plan?

India share its prosperity with world through three main sectors, Agriculture (contributes 18%), Industry (26%) and Services (55%). In India inflation structure is largely driven by agriculture. To bring down inflation government introduce schemes for short term crop loans, cash inflow in rural banks and raised agriculture credit.

To maintain sustainability, India should sound strong in its financial sector. Funds inflow of 159bn, to capitalization of PSB, RRB and financial institutes. To improve investment; infra sector is open for foreign investment, QFI get green flag in Indian corporate bond market, STT cut from 20% to 0.1%, also by simplifying IPO process, to reach more retail investors.

Union budget 2012-13 gave some fresh oxygen to individual in direct tax, by basic exemption of I-T raised to 2 lakh from 1.8 lakh, additional deduction from saving bank account. These will results in high disposable income, which would impact on demand-driven growth.

To tap fiscal deficit government find direct way through raising indirect tax. Central excise duty and service tax increase by 200bps, this will increase inflationary pressure and delay in the interest rate cut. Custom duty remains unchanged, but to control domestic saving, custom duty on yellow metal has been doubled.

Major industrial impact,

On Automobile industry impact would be neutral, reasons are, excise duty increased by 2% but manufacturer would pass this burden to users, increase in import custom duty will force manufacturer to increase assembly activities in India, in-house R&D facilities gets benefits.

Power industry has positive impact, by exemption from custom duty on coal and LNG, will boost power production and reduction on withholding tax on interest by ECB from 10% to 5%, will increase funding.

Cement, Fertilizer and Metal & Mining industry would see positive impact, while other side Oil & Gas and Real Estate industry would see neutral impact. Parma will face negative impact by levy of Minimum Alternate Tax.

Union budget has its unique impact in each sector, this year for some it’s aesthetic and for some it’s dry.

India’s missile man, Dr. A.P.J. Abdul Kalam

14^th May, 2004, I met India’s missile man, Dr. Avul Pakir Jainulabdeen Abdul Kalam. Till that date I don’t know anything about this person. But since that Friday he became my favorite leader.  On that Friday afternoon Dr. Kalam shared his thoughts with us at Rashtrapati Bhavan, New Delhi.

Dr. A.P.J. Abdul Kalam was born on 15^th October, 1931 at Rameswaram, Tamil Nadu. He was the President of India from 25^th July, 2002 to 24^th July, 2007. Dr. Kalam is renowned aerospace engineer, professor of Aerospace engineering and first chancellor of Indian Institute of Space Science and Technology Tiruvananthapuram. He is the only person who gave India “Vision 2020”. He is a great and stalwart leader.

Leadership practices by former President of India.

What are the models that leaders built to succeed in its term? In Dr. Kalam’s way it is creativity. Creativity brings knowledge in society, creativity encourages Innovative thinking. It changes person’s ability to think and generate ideas, like Google, productivity of creative thinking.

Second, model he talks about Law of Development, which stand on three pillars; enable resource to develop nation, technology, productivity. In technology he gave weighted to communication and importance of communication. Basic technology and Science is vital for any growth targeted sectors. Technology has two sides; it can lead to economic prosperity and create capability for national security.

Third, he added society grid. Society grid divided in four parts; Knowledge grid, Health grid, Rural grid and Legal grid. This grid system will bring prosperity to nation. It also adds value to nation in formal or informal way.

Dr. Kalam’s name is permanently added in the list of India’s great visionaries. In his words, Leader must have a vision for Organization. He is leading ‘Vision 2020’ for India, as a developed country by the year 2020. In that vision he included Agricultural and food procession, Infrastructure, Water mission, Sustainable Rural Development through PURA, PURA (Providing Urban Amenities in Rural areas) mission, Education development. He wants to make India Energy independent country by 2030, with the help of solar energy, Nuclear energy and Bio fuel energy.

As a leader, one should challenge the processes. Dr, Kalam says, ‘A leader must know how to celebrate the successes and manage the failures.’ Here he gave message, to handle success and more importantly how to manage failures. Because as a leader he/she has to come across failures in any field, and how he/she manages and bypass that failure without any negative effect on his team’s performance and productivity. In the challenging process, leader must have courage to take decisions. And if decision went wrong he has been able to take responsibilities. 

Mr. Kalam is a kind of leader, who believes in creating opportunities and creates leadership.  As per his view a leader must be able to explore uncharted areas. A leader must think towards welfare of society, and must have creative ideas to explore new opportunity and paths for people.  A leader should have nobility in management, when one is leader he do not thinks only about his/her own, but he has to thinks for management and organization’s purpose with people in mind.

A leader should be enough capable to motivate other peoples and encourage hearts. Here Dr. Kalam tells about how he was inspired by this role model leaders, how he studied and lived with great scientists. As he was keen to learn about Space science and technology leadership qualities that underscore the significance of Space and Technology in the developed nation.

He motivates younger generation through the example of his idol Dr. Vikram Sarabhai. And from live examples, how Dr. Sarabhai and his team launched satellite and create satellite vehicle launce programmer in Indian soil. And how space applications has become a part of our daily life and how it is changing the map of India in Global view.

“Learning gives creativity,

Creativity leads thinking,

Thinking provides knowledge,

Knowledge makes you great.”

                                                                                  _ Dr. A.P.J. Abdul Kalam

Apple Inc.: Simplicity is the ultimate sophistication

Apple Inc. is the world top renowned company. Thinks different, company’s punch line itself suggests about its innovation.  And credit goes to co-founder and company’s former CEO Steve Jobs. In period of Jobs when he was CEO, Apple has shown consistence performance beyond fashion, not only in company’s top line and bottom line figures, but mainly because of its innovative products, like, ipad and iphone. The true growth engine behind these innovations is Steve Jobs. Unfortunately, Mr. Think different is not with us today, but we as a people around the globe will never forget his passion and creativity about unique products.

October, 1983 when company introduced its first Macintosh computer, Jobs said, ‘People will fall in love with it.’ When we talk about Apple, usually we talk about its products. Why Apple’s product is so different? One can say because of simplicity in design and use, company identifies people needs and their wants, it also finds how people interact with computers. After finalizing these ingredients company heads towards design and technical achievement. Apple had not done great innovations only in products but in every smallest detail, like packaging and inventory management. Company has done modified tasks like separation of external devices and developed plug and ports.

Ipod, ipad, iphone and Mac computers are the major innovative products which company gave to the world. What is so unique about these products? These products are based on simplicity in design and use. Simplicity is the ultimate sophistication, like iphone and ipod touch, which has one button approach to function device. Ipod, which is specially developed for music lovers, is made up of double shot polycarbonate and transparent plastic materials. Apple prefers quality in material selection too; this is where innovation takes place in its initial steps.

Apple Inc. is not pioneered only in ‘iproducts’, along with that company have world’s amazing operating system, Macintosh OS, Which have unique features like multiple type face and proportionate fonts.  Latest which company had launched is ‘Lion X OS’, in 2011.

Apple uses same platform for ipod touch, iphone and ipad, by this strategy company is able to reduce cost and increases reliability. Apple works with employees and costumers too, company has given benefits to their employees. Customers’ benefits, product requires less repair, maintains and service. Company is lot more in customer involvement, like interacting with customers to experience design and development process.

Steve Jobs, man behind innovation. When Jobs was fired from its own company, in an interview he shared emotional experience, he said, ‘Getting fired from Apple was the best think ever happen to me.’ During that period Jobs found a company name Next, the target was the education system. Jobs found Pixar too, a world’s first animated studio. Jobs never hit limit button on innovation, in strategy and decision making. When he returned back to the company in August 1994, he went through lots of changes. He took brave decisions and applies real time experiments with distribution of products. He preferred to move into retail not only with physical present ‘bricks’, but through internet ‘clicks’ too.

‘Do what you love, keep looking forward and never settle down’ – Steve Jobs (1955 - 2011)

Volatile currency, INR

What is Depreciation?

As per accounting term depreciation means decrease in asset value. In case of currency (rupee) or real estate deprecation means the same, for e.g. rupee depreciate against dollar. In case of rupee and dollar, rupee value is decreased against dollar value in currency market (forex market). In simple language a currency will tend to become less valuable when its demand is less than supply.

If we understood definition, next question would be the reasons behind INR (Indian rupee) depreciation.

First Reason - Dollar is in Demand

BRIC countries like India have emerging economy, so a huge percentage of investment in India is from outside the country, especially from US but due to recession in US, big institutions are collapsing and many of them are on the verge of breakdown. They are suffering huge losses in their country. They have to maintain their balance sheets and look strong on all statements, so to recover losses in their country, they are pulling out their investments from India. Due to this pulling out of investment by these big companies from India or in other terms disinvestment, demand of dollar is raising up and rupee is depreciating.

Global slowdown and global investors’ preference US$ for safe investments, poor returns from Indian stock market (BSE Sensex lost close to 25% in 2011).

Second reason - Collapse of International Trade 

Importers are trying to accumulate dollars, as they have to pay in terms of dollars and at the end demand is increasing against the rupee. Exporters have a very few orders from outside countries, so there is no matter of converting dollar into rupee thereby decreasing demand for rupee.

If there is any deficit in the current account, which means country is doing more trading outside the country then its actual earning inside the country. This situation is not good for a country because the country needs to buy more foreign currency to fulfill its need inside the country. A country needs to manage its deficit within control; otherwise it will lead to an economic problem.

Depreciation in rupee is only beneficial to exporters, like IT industry, handicrafts, gems, jewelry, textiles, ready-made garments, industrial machinery, leather products, chemicals and related products. Because if $1=50 INR and dollar appreciate with 10% then rupee becomes 55 INR against $1. So, in this case where exporters get 50 INR in case of $1, now they earn 55 INR from $1.

But it inversely impact importers, like petroleum products, capital goods, chemicals, dyes, plastics, pharmaceuticals, iron and steel, uncut precious stones, fertilizers, pulp paper etc. The most impact which India gets from depreciating INR is from oil imports. Oil imports consume the largest part of the forex reserves. Take for instance crude oil imports. Brent crude oil price was $118.46 per barrel on April 2011 when exchange rate for the rupee was Rs 44.4 to a dollar. Oil price had gone down to $109.03 per barrel and exchange rate was Rs 52.7 to a dollar. Thus, because of the rupee depreciation not much benefit can be derived out of the lower oil price.

This effect is directly affected on balance of payment. And it results in high debt.

A depreciating rupee is not only impacting the import bill it has also affected the cost of borrowings for the corporate sector. Total external debt has increased by Rs.2186.8 billion for the period June 2011 to November 2011.

Even, Students going abroad for further studies and Indians going to foreign travel will be pinched hard due to his movement in rupee.

What was the role of RBI, dose it met expectations?

• ·         The Reserve Bank of India reduced trading limits for banks in the foreign exchange market.
• ·      The RBI deregulated non-resident external (NRE) rupee deposits and ordinary non-resident (NRO) accounts.

The reasons behind these steps are to support dollar inflow in Indian economy. By reducing barriers on Indian banks, RBI wants more inflow of dollars in country. If dollar supply will increase rupee value would appreciate.

Now, take a look on global exchange rate, country wise. Let’s start with China. Chinese Yuan is constantly appreciated in last year against USD, which means it is not satisfying Chinese exports any more. In July, 2011 Chinese trade balance was near about 30 billion Yuan, and in January, 2012 it was around 16 billion Yuan. If you can use same appreciation logic, you can easily get the reasons behind decrease in trade balance.

Japanese Yen, especially Japanese economy suffers a lot on Yen depreciation against dollar in 2011-12. After tsunami and Fucushima disaster Japan faces structural imbalances in economy. Yen also depreciate against USD in 2011, and Japanese trade balances ends with negative figure in January, 2012 from positive in mid 2010. 

“Finance is the art of passing currency from hand to hand until it finally disappears” – Robert W. Samoff