Are You a Victim of Fiscal Deficit…..???

Fiscal deficit- what and why?


Just imagine you are expecting your salary at the beginning of the month. Out of the total amount received you need to pay your home rent, get your vehicle repaired, keep some money for yourself, give some for your loving spouse and parents, need to pay all the bills, need to pay for fuel and food, pay medical insurance premiums and do many more things and in case run out of cash in mid month or at the end of the month what do you do? Borrow from your friends or relatives and what in case you have already borrowed a lot from them which you have not repaid? This is pretty much the same situation that occurs in Indian economy.
There has been a lot of fuss about fiscal deficit especially during the announcement of budget this year and post budget announcement. Every now and then you must have gone through the statements given by finance minister Pranab Mukherji or Mr. P.Chidambaram or even our Prime Minister Mr. Manamohan Singh. But what is this fiscal deficit anyway and why is it being given such an attention?
 
Fiscal deficit is defined as the deficit in the earnings by a government. Deficit in the sense the government spends a lot of money to see that the whole nation is stable and each individual is taken care of. The spending starts right from food to the protection. Whatever is the amount spent by the government it also gets the revenue from that. If the revenue generated by government is less than the investment or money that has been spent by the government it is called as fiscal deficit.

To define in terms of an economist “Fiscal deficit is an economic phenomenon, where the Government's total expenditure surpasses the revenue generated”.
Government’s revenue
The government gets revenues from many sources and one of the main sources of revenue for it is the taxes and duties. You will be surprised to know that more than 50% of the revenues of government come from the taxes and duties. Let’s find out the revenues of the government as per the budget 2009-10.

• Income tax (9%)
• Borrowings and other liabilities (34%)
• Non-tax revenue (12%)
• Service tax and other taxes (5%)
• Union Excise Duties (9%)
• Customs (8%)
• Non-debt capital receipts (1%)
• Corporate tax (22%)

Impact of fiscal deficit on You :-
Fiscal deficit can affect your day to day life in all the ways. It will have a huge impact on your standard of living. If the govt. doesn’t have sufficient money to spend, developmental activities will be stopped, generation of new employment opportunities will not happened. So it is very important that we all must be aware of the impact of fiscal deficit on the economy.

• Poor infrastructure Development
• Lack of money supply in the economy
• Low standard of living
• Unemployment Poverty
• Instability in the economy

Fiscal deficit will kill the growth of a country. If the country is not growing, citizens of that country also will face difficulty.
Reasons for deficit:-
There are many reasons which contribute to the shortage in the revenues collected by government and some of them are;

• Capital investments done by government. Capital investments are those it’s worth or value is not realized in one year. For example the bridges, large utility buildings, purchase of machinery etc. these are some of the things in which you don’t get the entire amount that you have invested in the same year. Government also invests huge amount (in terms of hundreds of crores) and the returns are not obtained in one year, what it indicates is that spending or outflow is more compared to cash inflow.

• Last two years we have experienced one of the worst cases of recession and some of the experts have even opined that it was more severe than the great depression of 1930’s. to overcome the effect of recession on economy government had taken many steps like reduction of interest rates, bail outs, easing of certain rules and regulations, tax exemptions to some extent, several economic stimulus packages. The fiscal stimulus package provided by government in order to maintain stability in economy was whopping 1,86,000 crore rupees.
• Some of the investments done by the government which do not yield any returns for it. Some of such investments are rural development programs, food for school children, NREGS programs etc.
• Last year the central government had to implement the recommendations of sixth pay commission and as a result of that it had to incur huge non-planned expenditures .
• The government increased the income tax slabs and as a result of that the number of individuals who were liable to pay tax received a tax shield.
• There was a huge increase in the government’s non-planning expenditure.

Is it a matter to be worried?
The fiscal deficit for year 2009-10 was 6.8 and was the highest one in the last 17 years. Experts have said that when you include the state’s fiscal deficit of 3-4% the real fiscal deficit turns out to be 14% of GDP and the problem is that the domestic debt also is increasing. You will be surprised to know that the debt-GDP ratio of Greece is 90% and it is also said that the chances of Greece defaulting is “five minutes to midnight”. Happy news is that India’s debt-GDP ratio is 77%, but the matter to worry is that the French debt crisis and Italian debt crisis which happened in 1950 and 1970 were mainly due to the domestic debt. You may say that the government can print the money and pay off all the debts at once and at one look this may look as the best option, but the government will never ever opt for this option the reason is the whole financial system is balanced on two most important economic words “demand and supply”, what happens is that when there is a lot of money entering into the system the supply will rapidly increase and the value of money will fall and there will be a huge increase in the inflation.
Remedial measures :-
Whenever the debt increases the government borrows money it may be borrowing from foreign countries, institutions like IMF or domestic borrowing from the citizens or from Reserve Bank of India which is the authorized banker for central government. The government needs to take some remedial measures in order to decrease this financial debt. Some of them would be;

• The government is taking up some of the things like divestment of PSU’s which will increase the capital inflow for itself which will further decrease its borrowings, but the important thing to be noted here is that although with the divestment process government will get lump sum amount but at the same time it will also increase its debt obligation mainly the domestic debt.
• Subsidies for items like food, oil, fertilizer etc should be done with great care because it’s seen that these subsidies are counter-productive for the government.
• The new tax code also will play an important role because according to the government sources it will be implemented by 2011 and there are many changes on the block.
• The estimates according to some of the new reports released by the government indicate that the government borrowings will be cut down from Rs 5,38,000 crores in 2009-10 to Rs 3,65,000 crores in 2010-11.

Latest updates :-


The fiscal deficit for the period April to October has been Rs 2.45 trillion. The tax receipts collected was Rs 2.14 trillion and the expenditure for the first seven months according to the government reports was at Rs 5.37 trillion. The high fiscal deficit of 6.4% percent this year has been accounted for the stimulus given to the businesses and duty sops provided in order to reduce the affect of ongoing financial depression. The finance minister has given his side of opinion that India will not be able to sustain high financial deficit. Government has aimed at reducing the fiscal deficit to 4% next year and to 1.5% by the end of 2012.
Source: http://indianmoney.com/article-display.php?cat_id=1&sub_id=113&aid=894&ahead=Are%20You%20a%20Victim%20of%20Fiscal%20Deficit%85..???#bottom



 

Income Tax Exemptions.....!!!

In our previous article “How to calculate Income Tax…..???” We have depicted the calculation of Income Tax. We have received 1000s of comments on the article with appreciation. We are glad to know that you are benefitted from the article. In this article we are elaborating the topic by including the calculation of Gross total income (GTI), Net income, Tax Deductions, etc.

Income tax calculation is one of the easiest as well as toughest job a person needs to do. Easy in the sense all you need to do here is calculate your taxable income and find out the tax liability according to tax slabs and tough in a way that there are every chances that a person will commit mistakes while calculating his tax liability though he knows what is his income, investments and tax slab under which he falls. Then how to calculate the tax effectively and be error free and what are the things that an assessee needs to consider while calculating tax liability?
 
The income tax that a person needs to pay is calculated from the Net income or Taxable income. You can get this taxable income once you deduct all the deductions which come under section 80 from gross total income. Hence the first step in calculating the income tax would be to calculate gross total income.
Gross total income (GTI) :-

Gross total income is calculated by taking into consideration five heads of income they are

• Income from Salary
• Income from house property
• Income from business / Profession
• Income from Capital Gains
• Income from Other sources .

Add up incomes from each head to get gross total income. For most of assessees they will be having income from all the heads of income except third one or income from business or profession.

Once you get the gross total income all you need to do is deduct all the exemptions so as to get the taxable income.
Source:- http://indianmoney.com/article-display.php?cat_id=1&sub_id=110&aid=895&acat=&page_id=3&ahead=Income%20Tax%20Exemptions.....!!!

Is your Friend or relative an Insurance Agent…..???

Is your Friend or relative an Insurance Agent…..??? Have you ever forced by them to take an insurance policy…..??? Nowadays we can see that most of the youngsters are getting attracted towards this industry. Huge salary, commissions and incentives make them to choose this industry. But have you ever thought how companies are providing them this much…..??? or how these companies are paying huge commission to their employees……???

Everything is out of your Investment…..!!!

ULIPs are new trend in the industry; nowadays 90% of the insurance agents are trying to sell ULIPs because in ULIPs charges are high compared to traditional plans and this will help them to get more commission. Generally there are two kinds of ULIPs such as Customer beneficial (with fewer charges) and Agent beneficial (with higher charges). Always prefer customer beneficial plans so that the burden of charges will be less on your investment. More the charges less the benefit you will get and vice versa.

There are so many things you need to consider while choosing an insurance product. A little negligence will make you to lose your hard earned money. Below given are some of the major charges levied on ULIPs.

Charges You Need to Consider

As we have already discussed that most of the insurance products carry (ULIPs) a number of charges, out of this majority will be hidden charges. If you are well aware of the charges, you can have a look into different charges levied on the product before buying it so that you can escape from the fraudulent sales tactics of insurance agents. The charge structure varies from product to product. Some of the common fees and charges are given below-

• Premium Allocation Charges
• Administrative charges
• Fund Management Fees
• Mortality Charges
• Fund Switching Charges
• Surrender Charges
• Premium Allocation Charges

The money appropriated from the premium paid by you toward charges before allocating the units under the policy is called Premium Allocation Charges. It normally includes initial, renewal expenses, and commission expenses. This cost worst effects your returns and in initial years you have to more Premium Allocation charges then later years.

Administrative charges:-

You have to pay some charges out of your premium toward payment to the sale people/insurance agents/banks from whom you bought policy. It also includes the fees for administration of your plan this fee can be fixed or variable.
Fund Management Fees:-

This is one the most important charge which you have to pay for ULIPs. It is deducted as a percentage from the fund value. The fees levies for management of fund(s) and it is deducted before arriving the Net Present Value of the fund.

Mortality Charges:-

This is the cost that you bear for your insurance cover. It would vary depending on policyholder's age, sum assured and policy term. For ULIPs which pay higher of sum assured or fund value on death, Mortality Charge falls with time while ULIP which pays both the sum assured and fund value, it remains constant.

Fund Switching Charges:-

ULIPs give you the option to switch your fund to different equity or debt options which are applicable in your policy. There is a limited number of fund switches are allowed without charge but if you exceed that limits then you will be levied a charge.

Surrender Charges:-

ULIPs provide you to encash your units before the maturity date. When you go for premature partial or full encashment of units you have to pay Surrender Charges. Things to be considered while buying a Policy

• Qualification of the Agent
• Agent’s Knowledge about the product
• Word of mouth
• Never go by what you see
• Past accolades
• Avoid Miss-selling
• Consider different policies
• Conditions apply

Benefits of Life Insurance :-

• Life insurance serves the following needs
• Financial Security
• Helps to Avail Tax Exemptions
• To Save/Invest
• Helps To Diverts States Resources for Other Purpose
• Facilitates Economic Movements

Financial Security:-

Life Insurance provides financial security for a human. When the breadwinner of a family dies the life insurance policy comes into picture to help the family. It helps the dependence of the insured person to meet their Individual and family’s needs. Therefore they will naturally be forced to give sufficient funds for this purpose. This practice encourages thrift and also helps people to plan for some productive schemes.

Helps to Avail Tax Exemptions :-

Insurance policy holders are allowed to claim income tax exemptions for the payment of premiums. The amount and the level to which they are allowed depends on different factors like the persons income, investment, etc. This provision is the most tempting point which makes people to invest in insurance and attain a mutual benefit of tax exemption. Since universal life insurance is a long term investment it is not advised to borrow money either by loans or through surrender values as they reduce your policy amount.

To Save/Invest :-

This is the third important reason to buy insurance. Generally savings is the amount remaining with a person after he/she meets all their basic expenses and other cash needs. If one has to build wealth, savings need to be channelized into an investment with precise time horizon and goal. But purchasing an insurance policy is neither savings nor investment; it is simply an effort going waste.

Life insurance is the only investment option that offers specific products tailor-made for different life stages. It thus ensures that the benefits offered to the customer reflect the needs of the customer at that particular life stage, and hence guarantees that the financial goals of that life stage are met.
Source::- http://indianmoney.com/money-gyan-articles.php?cat_id=1&sub_id=13&aid=943&acat=&page_id=3&ahead=Is%20your%20Friend%20or%20relative%20an%20Insurance%20Agent…..???%20&subcat=2

Tax Deductions under Section 80C.....!!!

Section 80C, even a layman who doesn’t have thorough knowledge about Income Tax knows about this. Under Section 80C of the Income Tax Act, government gives tax benefits to certain financial products in order to encourage savings. The investments made in these products are eligible for Tax Exemption up to a limit of Rs 1 lakh. If your annual income is more than 500000 and you invest Rs. 1 lakh in this investments you save Rs 33,000 in taxes.
The concern is how many of you know about the investments that come under Section 80C. People are aware only about ULIPs; this scenario is because insurance companies are promoting their products massively to increase the sales. But understand ULIP is not the only product that offers Tax benefit under section 80C. In this article we are introducing all the investments which come under section 80C.
Generally people think about investments only in the month of February or March because they are concerned only about Tax saving, they never bother to understand the productivity of the investments. In this scenario there is a possibility of losing money that you have saved without paying tax.




For Example: Mr. X’s annual income is Rs.300000. His total tax liability is Rs. 14000. By investing Rs. 100000 in any investments that come under Sec-80C he can save Rs. 10000. But by making an investment in a wrong product he may lose more than 20000. This is where you need to concentrate.



While choosing a place to park your investment you need to be very careful because the effectiveness of investments depends on many factors such as investment objective, age, risk aversion, economic conditions etc.



Investments Comes Under Section 80C

Below given is the list of investments that falls under section 80C. This will help you to chose the best one that better suites your needs.
1.Life Insurance Premium
2.Unit Linked Insurance Plans (ULIP)
3.Equity Linked Savings Schemes (ELSS)
4.Public Provident Fund (PPF)
5.Provident Fund (Contribution by the Employee)
6.NSC - National Savings Certificate
7.Fixed Deposit for 5 years
8.Home Loan Repayment (Principal)
9.Stamp Duty and Registration Charges
10.Tuition Fee Payment
11.Post Office Time Deposit Account
12.Infrastructure Bonds
13.Senior Citizen's Savings Scheme
Life Insurance premium : -


Life insurance is an important aspect of life; it helps you to cover the uncertainty of life. Every earning person having dependents should have adequate life insurance coverage. Any contributions made as a premium of Life Insurance policies are eligible for income tax deduction under Section 80C. Apart from premium of your own policy, premium paid on behalf of your spouse or your children is also eligible for exemption under Section 80C. If you and your spouse (husband/wife) both have Life Insurance policies, and your spouse's taxable income doesn’t come under the tax bracket, you can show both of your Insurance premium and get more benefit of deduction under Section 80C. Premium in excess of 20% of sum assured is not eligible for deduction in other words; to get the full tax exemption on the premium paid your sum assured should be atleast 5 times of the premium paid.
ULIPs : -

Unit Linked Insurance Plans (ULIPS) are a combination of Life Insurance as well as mutual fund investment. Money invested in ULIPs is eligible for deduction under Section 80C. ULIPs give you life cover as well as exposure to stock market.
ELSS:-

Equity Linked Savings Schemes (ELSS) are specially designed Mutual Funds for offering you tax savings. All the investments made in ELSS are eligible for deduction under Sec 80C. Remember that not all mutual fund investments qualify for 80C deduction. All ELSS have a lock-in period of 3 years. ELSS are also knows as tax saving Mutual Funds.

Provident Fund (PF):-


Provident Fund is the fund which is made out of the contributions made the employee along with an equal contribution by employer during the time he has worked his employers. PF calculated as a percentage of his salary, say 12% and is returned to him on his retirement with interest. Current annual interest is set at 8.5%. Any contribution made to Provident Fund can be deducted from your taxable income according to Section 80C.

Public Provident Fund (PPF) :-

You can open a Public Provident Fund (PPF) account and any amount invested in your PPF account qualifies for deduction under section 80C while the maximum investment allowed is Rs. 70000. By investing in a Public Provident Fund the increased contribution also qualifies for deduction. PPF accounts can be opened in most of the well known banks and the minimum with a minimum investment of Rs. 500.

National Saving Certificate (NSC):-

Amount that you are investing in National Saving Certificate (NSC) is eligible for tax deduction under Section 80C. For all the investments made in National Saving Certificate there is a lock in period of 6 years. Under this scheme the initial investment plus the total interest accrued is also eligible for deduction.
Fixed deposits


Any amount invested in Fixed Deposits with a term greater than or equal to 5 years is eligible for tax exemption under section 80C. This is a recent amendment and is one of the best risk free saving options where you can save money as well as get benefit of Section 80C.

Home Loan Repayment (Principal) : -

Repayment of Home Loan Principal is also eligible for deduction under section 80C. If you have bought a new house and have a housing loan for that, you can get benefited from Section 80C deduction. Here the point to note is that Equated Monthly Installment (EMI) of housing loan has two components – ‘Principal’ and ‘Interest’. Only the principal part is exempted under Section 80C. Even the interest part is eligible for tax deduction but not under Section 80C, it is under Section 24.

Stamp Duty and Registration Charges:-

Stamp duty charges and registration charges paid while purchasing new house is eligible for tax deduction under Section 80C.
Tution Fees :-

Amount paid as tution fees for education of one or two of your children are exempt from Income Tax and you can claim the deduction under Section 80C.
Post Office Time Deposit Account :-


A Post-Office Time Deposit Account is a banking service offered by Department of post it is similar to a Bank Fixed Deposit. One can open this account in any post office in the country. Interest on Post Office Time Deposit Account is free from tax.

Infrastructure Bonds :-

Infrastructure Bonds are popularly called as Infra Bonds. These are issued by infrastructure companies, and not the government. The amount that you invest in these bonds is also exempt from tax under Sec 80C.

Senior Citizen's Savings Scheme :-

Senior Citizens Savings Scheme (SCSS) is a Government of India Product. It is one of the safest investment options. An Individual who attained the age of 60 can open this account. Under this scheme there is lock in period of 5 years, on the option of depositor it can be extended for another 3 years. This scheme offers 9% interest to the depositors. Interest earned from the investments is not exempt from tax.
Source: http://indianmoney.com/article-display.php?cat_id=1&sub_id=110&aid=897&acat=&page_id=3&ahead=Tax%20Deductions%20under%20Section%2080C

Save Tax by Investing in Medical Insurance.....!!!

Deductions under 80D….


Every individual needs to pay tax without any doubt. If we try to evade it then we will be punished as it is against the law, but what we can do is reduce tax liability. How can an assessee reduce his tax liability? Answer to this question is deductions. Government of India has provided certain investment avenues through which we can reduce tax liability and 80D is one of them.

What’s 80D?

80D is one of the sections which come in the income tax act of 1961. This refers to deduction which an assessee can claim to reduce his tax liability. Like 80D there are other deductions such as 80C, 80DD, 80E, 80G,80GGB etc. some of these are in connection with individual assessees (80C, 80D), some with Hindu Undivided Family (80C,80D), some applicable only to companies (80GGB) and some to all irrespective of whether assessee is an individual or HUF or company (80G).

Claiming deduction to reduce tax liability is neither very easy nor is difficult. All you need to do is go according to the rules and regulations prescribed. For example you can claim 100 % or 50% deductions on donation made provided the trust or the fund or institution is recognized by government of India, if the fund is not in the list or in unrecognized then all the donations that an assessee has made cannot be taken as deduction. Hence it is very important for an assessee to ensure that he follows every rules and regulations. Most of the deductions have certain Do’s and Don’ts.




80D is Applicable to whom?

Assessees’ who are paying the tax as individuals and those who are paying under the head Hindu Undivided Family (HUF) can claim this deduction. Companies be it domestic, Indian or foreign cannot avail this deduction.



What’s the amount?

Amount deductible under this section is 15,000 in case of assessees below age of 65 (to keep in effect the insurance of assessee or his spouse or children) and 20,000 in case of senior citizens. Previously insurance amount paid on behalf of parents was not given as deduction, but since financial year 2008- 2009 even if the parents are independent premium paid can be claimed as deduction. Hence the total amount of deduction an assessee can claim under this category is 30,000.

In case of HUF (Hindu Undivided Family) if an assessee can claim insurance premium paid by him on behalf of family members.




This insurance premium paid cannot be claimed if an assessee has paid it by cash. It has been clearly stated in the income tax act that assessee needs to pay the insurance premium through any other means except by cash. Hence payment through cheque is of the most popular methods followed by assessees’.



After reading the above paragraphs don’t jump to a conclusion that you will be able to deduct 15,000 or 30,000 from your taxable income because all that’s said above is just the half part. The other half part is that the actual amount as insurance premium paid or 15,000 whichever is lower is deductible. For example an assessee who has paid 3,000 rupees as his insurance premium, 2500 rupees to keep in effect his wife’s insurance and 2000 each in case of his two children out of his annual income of 2,25,000 rupees the deduction given to him will be



Total amount of insurance paid= 3000+2500+2000+2000

= Rs 9500



Taxable salary = 2,25,000 – 9500

= Rs 2,15,500



And not Rs. 2,10,000 (2,25,000-15,000)



It also holds good when its reverse, which is insurance premium, is more than 15,000 then the deduction will be taken as 15,000 and not the total amount of insurance premium paid. For example an assessee Mr. Z has annual income of 2,00,000 rupees and has paid 6000 rupees as his insurance premium, 5000 as his wife’s premium and 4,000 for his elder son’s premium and 3000 for his younger daughter’s insurance premium.



Total premium paid by him is = 6000+ 5000+ 4000+ 3000

= Rs 17,000



In this his taxable income will be Rs 1,85,000 (2,00,000-15,000) and not Rs 1,83,000 (2,00,000-17,000)



For whom…..?

This is useful for assessees who are not insured by their employers. Some companies insure their employees and some do not believe in that so depending on that an assessee can make judgment. If your employer has already taken care of your insurance then make sure that you have insured your wife and children.



Being an assessee from HUF can I claim this deduction?

My answer to all the assessees’ who have this question is absolutely yes. Not only the premium paid to keep in effect your or your spouse’s or children’s health insurance, but also the premium paid on your relatives in your undivided family. Provided it is within the upper limit (15,000 for individuals below 65 years and 20,000 in case of senior citizens).



Points to be taken care of

Make sure that premium is paid by cheque or any other means except by cash

If you have paid insurance premium for your parent’s insurance make sure that you claim that too.

If you are from HUF then keep in mind the entire insurance premium that you have paid on behalf of family members.

In case of insurance premium paid by children, the premium exempted will be a maximum of 30,000 rupees. This is again broken down into two units’ one representing family of an assessee (assessee himself, spouse, and children) and the other part is parents. Maximum limit for each unit is 15,000. It means that if any unit has premium more than 15,000 rupees then the amount liable for exemption is 15,000 rupees only. For example an assessee has paid premium of 17,000 for his family and 13,000 rupees for his parents’ insurance premium. Then amount liable for deduction will be 28,000 (15,000+13,000) and not 30,000 (17,000+13,000).
Source: http://www.indianmoney.com/article-display.php?cat_id=1&sub_id=14&aid=903&acat=&page_id=3&ahead=Save%20Tax%20by%20Investing%20in%20Medical%20Insurance.....!!!

A Comparative Study OF ELSS and Traditional Investments…..!!!

ELSS refers to Equity Linked Savings Scheme. ELSS as the name clearly suggests is a savings scheme linked to equity markets. It is a type of mutual fund, which additionally offers tax benefits to the investors.




Equity linked saving schemes is a kind of mutual funds like diversified equity funds with Tax benefits. It is just like other tax saving instruments like National Savings Certificate and Public Provident Fund. Main advantage with ELSS is lock-in period is only 3 years while for NSC it is 6 years and for PPF it is 15 years. At the same time risk factor is high in ELSS.
As per Income Tax act 80c investment up to Rs 1, 20, 000 is eligible for deduction from the gross total income hence reducing the total taxable income. For example if your total annual income is Rs 6,00,000 and you invest Rs 1,20,000 in ELSS then your taxable income will become Rs 4,80,000, so that you can reduce the tax liability from 20% to 10%. Instead of paying 54000 you just have to pay 32000, here you are saving Rs.22000.




Previously there was an upper limit for investing in tax saving instruments like ELSS of 5,00,000. Only individuals with less than 5, 00,000 annual incomes are allowed to invest in tax saving instruments. But last now any individual can invest in ELSS irrespective of their income level.



Key Features of ELSS

ELSS is a fund with a lock-in period of 3 years.

It offers tax benefit to the investors under section 80c of the income tax Act up to a maximum limit of 1.2 Lac per annum.

Investment has to be for long term, any expectation of short term gains is not appropriate.

Involves a little bit of risk because of equity allocation.

ELSS helps an investor to get addicted to investments and savings by offering systematic investment option.

ELSS is very beneficial to salaried people.
Source : http://indianmoney.com/money-gyan-articles.php?cat_id=1&sub_id=11&aid=910&acat=&page_id=3&ahead=A%20Comparative%20Study%20OF%20ELSS%20and%20Traditional%20Investments%85..!!!&subcat=2

How Much You are going to Save as per the New Tax Rates (FY 2010-11).....???

What is Income Tax……??? In Simple terms, Income Tax is the Tax levied on the income of individuals and business. Everybody those who are earning an income of more than 160000 are suppose to pay income tax to Government of India. In every budget our finance minister will announce new Tax slabs/rates. In budget 2010-2011, finance minister Pranab Mukherjee announced the new Tax Rates. According to the new tax rates many people have got relief in Tax.

People know what is income Tax but most of the times they are confused, how is the calculation is done…..??? IndianMoney.com is taking an initiative to make people aware of the calculation of Income Tax by taking the new tax rates into consideration.
Source: http://indianmoney.com/money-gyan-articles.php?cat_id=1&sub_id=110&aid=916&acat=&page_id=3&ahead=How%20Much%20You%20are%20going%20to%20Save%20as%20per%20the%20New%20Tax%20Rates%20(FY%202010-11).....???&subcat=2

How Shares are Issued in the Primary Market…..???

A company needs capital if it wants to expand its business or diversify its business or in order to modernize its whole structure no matter if it is a public company or public sector undertaking. To get the capital that is required by the company it usually goes for the issue of shares and the process of issuing of shares is done in the primary market.

Public issue

A public limited company can raise the amount of capital by selling its shares to the public. Therefore, it is called public issue of shares or debentures. For this purpose the company has to prepare a 'Prospectus'. A prospectus is a document that contains information relating to the company such as;

Name
Address
Registered Office
Names And Addresses of;
Company Promoters
Managers
Managing Director
Directors
Company Secretary
Legal Advisors
Auditors
Bankers.

It also includes the details about project, plant location, technology, collaboration, products, export obligations etc. The company has to appoint brokers and underwriters to sell the minimum number of shares and it has to fix the date of opening and closing of subscription list. The new issue of shares or debentures of a company are offered for exclusive subscription of general public. But the prospectus should be approved by SEBI. A minimum of 49 per cent of the amount of the issue at a time is to be offered to public.
The company makes a direct offer to the general public to subscribe the securities of a stated price. The securities may be issued at par, at discount or at a premium. An existing company may sell the shares at a premium. There is no practice of selling shares at a discount in India. Public issue is a popular method of raising capital. It provides wide distribution of ownership securities. It also promotes confidence of investors through transparency and non-discriminatory basis of allotment. It satisfies compliance with the legal requirements. However, the issue of securities through prospects is time consuming because there are various formalities to be completed by the company. The cost of raising capital is also very high due to underwriting, commission, brokerage, publicity, legal, and other administrative costs.


Ways of Issuing stocks in Primary Market

Initial public offer
Private placement
Offer for sale
Bought out deals
Right issue
Bonus issue
Book-building
Initial Public Offer (IPO)

When a company makes public issue of shares for the first time, it is called Initial Public Offer. The securities are sold through the issue of prospectus to successful applicants on the basis of their demand. The company has to appoint underwriters in order to guarantee the minimum subscription.

An underwriter is generally an investment banking company. They agree to pay the company a certain price and buy a minimum number of shares, if they are not subscribed by the public. The underwriter charges some commission for this work. He can sell these shares in the market afterwards and make profit. There may be two or more underwriters in case of large issue.

Process of IPO

Company has to issue a prospectus giving full information about the company and the issue.

It has to issue share application forms through the brokers and underwriters.

The brokers collect orders from their clients and place orders with the company.

The company then makes the allotment of shares with the help of stock exchange.

The share certificates are delivered to the investors or credited to their Demat accounts through the depository.

This method saves time and avoids complicated procedure of issue of shares. With more and more companies coming out with tempting IPO or additional offers, there is greater need to exert caution and pick the best IPO investments.

Factors should be studied in an IPO offer document


Following four critical factors should be studied in an IPO offer document, before making an IPO investment:

Promoter
Performance
Prospects
Price.
Private placement

In Private placements the securities are offered for sale privately to individuals and institutions privately. They do not follow the procedure of issuing the prospectus. This method is usually adopted to save time of issuing and the cost involved in the same. Most of the new and small companies are involved in such offerings. This method has become very popular in the recent days. Since the shares are concentrated in few hands, there lies an artificial scarcity which intern increases the prices temporarily and is sold to the common and small investors. Thus this method proves beneficial for the company but is a loss for the investors.



Offer for sale

Offer for sale is almost similar to private placement where the securities are sold to issue houses and stockbrokers. Some negotiations take place between the company and stockbrokers on the price and other terms and conditions. The intermediaries after the negotiations come to a common agreement and buy the shares from the company. These securities are then sold to the common investors at a higher price in order to earn some profit. This method is adopted to save time, cost and the procedure involved in the share issue. The middlemen get the maximum benefit out of this method.

Bought out deals


In case of Bought out Deals any company who wants to bring shares to the market makes the sale of all the equity shares to a single sponsor or the lead sponsor. This is an agreement between the company and the sponsors for a particular quantity of equity shares. The sale price is finalized through negotiations as similar to that of offer for sale.



Factors Influence the Negotiation

Various factors that influence the negotiation are;
Project evaluation
Reputation of the promoter
Market sentiments etc.

Bought out deals are in the nature of fund-based activity where the funds of the merchant bankers are locked in at least for a minimum period. These shares are sold at over the Counter Exchange of India or at a recognized stock exchange. When the company earns profit and performs well they get listed.

Right issue

Rights issue is made by an existing company to its existing shareholder in the proportion to the number of shares that they possess. The guidelines for the issue of right share have been clearly given by SEBI. Certain rules regarding the right issue of share are;



Only listed company can make right issue

Right issue can be made only in respect of fully paid up shares.

Company will have to make announcement before such issue and this cannot be withdrawn

The rights issue should be open for minimum period of 30 days, and maximum up to 60 days.

Company will have to make an agreement with the depository to issue the share in demat form.

A no complaints certificate is to be filed by the Lead Merchant Banker with the SEBI after 21 days from the date of issue of offer document.

A minimum subscription of 90 per cent of the issue should be received.

Bonus issue


Bonus shares are usually issued when a company earns extra profit or have extra reserves and they want to convert the same into share capital. These shares are issued in proportion to the number of shares held by the shareholders. Rules regarding issue of bonus shares are given in the SEBI. Issue of bonus shares reduces the market price of the company's shares and keeps it within the reach of ordinary investors. Issue of bonus shares is generally indicates future growth.



Book-building

In the actual public offer process, investors are not involved in determining the offer price, whereas in book building pricing is determined on the basis of investor feedback which assures investor demand. Since the issue price after the issue marketing there is flexibility in the issue size and the price of the shares. The option of book building is available to all body corporate, which are otherwise eligible to make issue of capital to the public. The initial minimum size of issue through book-building process was fixed at Rs. 100 crores/-. However, issue of any size was allowed since 1996. Book-Building facility is available as an alternative to firm allotment. A Company can opt for book-building process for the sale of securities to the extent of the percentage of the issue that can be reserved for firm allotment.



Stages are involved in the book-building

The following stages are involved in the book-building process:
Appointment of book-runners.
Drafting of prospectus and getting approval from SEBI.
Circulating draft prospectus.
Maintaining offer details.
Intimation of aggregate orders to the book-runner.
Bid analysis.
Mandatory underwriting.
Filing copy of prospectus with registrar of companies.
Opening bank accounts for collection of application money.
Collection of applications.
Allotment of shares.
Payment schedule and listing of shares
Source: http://www.moneyschool.indianmoney.com/money-gyan-articles.php?cat_id=1&sub_id=12&aid=921&acat=&page_id=3&ahead=How%20Shares%20are%20Issued%20in%20the%20Primary%20Market%85..???%20&subcat=2

10 Things to do Before March 31.....!!!

1. Submit your investments proofs
To get tax relief for your investments, you have to submit the proof of investments to your employer. There are a variety of investments that offers tax relief under section 80Csuch as;
Receipt of insurance premium

Deposits made in your public provident fund (PPF) account

Investment made in equity-linked savings schemes (ELSS)

Purchase of National savings certificates (NSC)

Children’s tuition fees paid, etc.

Your employer would need the details and the documentary proof of your investments to provide the deduction under Section 80C of Income Tax Act. This will help you to save tax upto Rs. 100000
2. Submit proof for HRA (House Rent Allowance) & travel receipts


You can claim income tax deduction under HRA & travel receipts, if you intent to claim deduction for house rent allowance or travel receipts, please make sure that your rent and travel receipts have been submitted to your employer. Following are the necessary proofs for this deduction;



Rent receipt

Travel receipts

Lease deed, etc,

3. Collect TDS certificates

To ensure the right amount of Tax deduction, you need to collect all your TDS (Tax Deducted at Source) certificates from banks (Account statements) and your previous employer.

TDS certificates and Bank statements will help you to figure out the interest income on bank deposits and pay balance taxes, if any.



If you have changed the job during the course of the financial year, then you need to collect your TDS certificate (Form 16) from your former employer, and this should be submitted to your new employer so that you can ensure that the right amount of tax deductions are being accounted for in your salary. Following are the sources from where you have to collect TDS certificate;



TDS certificate from Banks

TDS certificate from former employer
Source: http://indianmoney.com/money-gyan-articles.php?cat_id=1&sub_id=110&aid=922&acat=&page_id=3&ahead=10%20Things%20to%20do%20Before%20March%2031.....!!!&subcat=2

All You Must Know About Home Insurance…..!!!

With the increasing number of houses in the country, the importance of home insurance is also increasing. Boom in the real estate industry really increases the significance of home insurance. How many of you really understand the significance of home insurance…..??? most of the people are not aware of its benefits. Home is a cover against the possible damages to your house. If any damage occurs to your home, company will pay for that. Suppose if your home is destroyed by fire, earthquake or any other natural or un-natural calamities then what will you do…..??? So it very important to cover your house with a home insurance to save your home from damages.
Benefits of home insurance are many so it is necessary for home owners to about the details of home insurance.
In standard home insurance package you may find different kinds of coverage but most of the package covers repairing and rebuilding the house. But now due to concentrated competition in this sector companies are providing other benefits also.
Source: http://www.moneyschool.indianmoney.com/money-gyan-articles.php?cat_id=1&sub_id=14&aid=923&acat=&page_id=3&ahead=All%20You%20Must%20Know%20About%20Home%20Insurance%85..!!!&subcat=2

Wealth Tax – Do you need to pay?

Paying income tax has become very common to all of us and we do it regularly. Though we have little confusion on the various procedures involved in filing the returns, we are pretty clear with Income Tax. Are you aware that apart from your income tax returns, you may also be required to file wealth tax returns?




Yes, every individual, who has wealth exceeding Rs 15 lakh, is required to pay wealth tax as well as file a return of wealth tax with the revenue authorities by July 31 every year, immediately following the end of the previous year (the previous year runs from April 1 to March 31). Currently, the wealth tax rate is 1%.



Wealth refers to (as per Tax laws terminologies), is the value of prescribed assets of an individual as reduced by debts owed in respect of assets. Therefore, if the asset is valued at Rs 30 lakh and the outstanding loan against the asset is Rs 14 lakh, the amount that would be considered as wealth would be Rs 16 lakh.



An important point to note is that the value for the purpose of wealth-tax would be the value of the assets as on the last day of the respective previous year (i.e., March 31). There are prescribed guidelines that need to be followed for valuation of the assets. So let us consider an example for a better understanding. Avinash owns the following assets as on March 31, 2008: One residential house valued at Rs 30 lakh; one motor car valued at Rs 5 lakh; a bank balance of Rs 1.5 lakh; shares valued at Rs 28.5 lakh and gold jewellery valued at Rs 10 lakh.



Would this mean that Avinash has wealth of Rs 75 lakh and he has to pay a wealth-tax of Rs 75000? (I.e. 1% of 75 lakh as mentioned above, it should be noted that only wealth exceeding Rs 15 lakh is taxable).



Thankfully the answer is No! While the definition of assets covered under wealth tax is extremely wide, fortunately a description has been provided for assets that fall within the purview of wealth-tax (both covered as well as exemptions thereto have been defined). Broadly, the following assets are considered as part of the taxable wealth of an individual: House, motor car, jewellery, cash in hand in excess of Rs 50,000, urban land (that is land situated, within the jurisdiction of municipality and having a population of 10,000 and more or in any area within such distance from the local limits of any municipality) and yachts, boats and aircraft.



Therefore, in the above example, shares and the bank balance are not covered as taxable assets. In addition to this, even the covered assets enjoy certain exemptions. Typically, the wealth tax is only applicable on non-productive assets. Thus, where the aforesaid assets are used for commercial purposes (like boats and aircraft) or held as stock for trading purposes (like jewellery and motor car), they are not liable to wealth tax. One must be careful in examining the exemptions that are available in respect of each asset. Let us for instance, look closely at the definition of house. Your own house, in which you reside, is not an asset subject to wealth tax, nor is a plot of land owned by you provided that it does not exceed 500 sq meters. A house held as stock in trade or used for own business or profession is also exempt, as are commercial complexes. If a residential property has been let out for 300 days or more in the previous year, the same is also exempt from wealth-tax.



Therefore, in Avinash’s case, even the residential house is exempt from wealth tax (and only the car and jewellery are finally liable to wealth tax). After all this, Avinash would only be liable to pay wealth tax on the value of Rs 15 lakh, the wealth tax amounting to a mere Rs 15,000.



You must also note that dispersing ownership of the asset amongst family members may not exempt you from being taxed. Similar, to the income tax provisions, there are provisions for clubbing where assets transferred by an individual to his spouse, sons wife or to a person for the benefit of spouse or sons wife without adequate consideration form part of his/her wealth and not the transferees. While resident Indians are liable to wealth tax on their global wealth, foreign citizens please note that your assets situated in India are also liable to wealth tax in India.
Source: http://www.indianmoney.com/article-display.php?cat_id=1&sub_id=110&aid=110&acat=&ahead=Wealth%2520Tax%2520%e2%80%93%2520Do%2520you%2520need%2520to%2520pay%3f

A Guide to Investments

A lot of people have asked me how to invest in stocks, mutual funds or other securities. I thought of putting across a brief guide on how to invest in any security.




How to invest in stocks?

To invest in stocks, one need to have a Demat account with a registered bank such as ICICI, Citi, HDFC and SBI or a brokerage firm such as IndiaBulls, ShareKhan and IndiaInfoline. There is another way of investing stocks as well – asks your broker to do invest in stocks on your behalf. However, trading through demat account is more safe, less costly, transparent and convenient.



Once you have your Demat account, you can buy, sell, transfer and transact shares online without any hassle. However, it is always advisable to so some basic research on stocks before investing in them.



How to invest in mutual funds?

Again, there are two ways of investing in mutual funds. First, you can invest online using your Demat account or through online banking account of your banks such as HDFC Online, ICICI and SBI. You will require an online account, either Demat or Savings, and a PIN (Personal Identification Number). Second way of investing is through brokers. These brokers may be banks such as ICICI and HDFC or financial planning companies such as Bajaj Capital.



Using online services, you can purchase, redeem, switch, view your account details, view your portfolio valuation and download account statements without any effort. These services are just a click away. However, in case of brokers when you redeem your investments you get your money as cash or get deposited in your account.



How to invest in Gold?

Investment in gold can be done directly through ownership, or indirectly through certificates, accounts, spread betting, derivatives or shares.

1. Gold Bars or Coins: Physical investment in gold should be either in gold coins or bars. However, it should always be bought from banks which certify the quality of gold. Moreover, only buy government-certified gold coins or bars and preferably the purity level should be 99.9 as they are easy to sell. All leading banks such as ICICI and HDFC provides such an investments.

2. Gold Certificates: A certificate which represents ownership of gold bullion held by a financial institution for convenient and safe storage. There is a fee for storage and insurance. Again leading banks provide such a service.

3. Gold Futures: Gold contracts are the hottest commodities traded in the Indian market. It is traded on MCX (Multi Commodity Exchange) Gold has become the largest traded commodity in India’s domestic futures market as a large number of traders are taking delivery of the yellow metals through the futures route. This can be done by opening an account with brokerage firms such as Bonanza Online.

4. Gold ETFs: You may not be able to touch and feel your Yellow metal through ETFs, but they are perhaps the safest method of buying and owning gold. ETF stands for Exchange Traded Funds. These are generally open-ended funds i.e. they are traded on the exchange just like stocks. There are quite a few ETFs in the market namely- Reliance, Kotak, UTI Gold ETF to name a few. For investment in ETFs, please read “How to invest in mutual funds” above.



How to invest in commodity?

Commodity trading is nothing but trading in commodity spot and derivatives (futures). Commodity derivatives are traded on the National Commodity and Derivative Exchange (NCDEX) and the Multi-Commodity Exchange (MCX). Gold, silver, agri-commodities including grains, pulses, spices, oils and oilseeds, mentha oil, metals and crude are some of the commodities that these exchanges deal in.



You can invest in commodity through derivative markets only. At present in India ETFs in commodity is not allowed except Gold. Thus, you have to go through commodity traders or brokers such as Bonanza Online who invests in commodity traders.



How to buy insurance?

You can buy insurance either through underwriters (i.e. those who design and manage plans) such as HDFC, ICICI and Kotak or through brokers and third parties such as Agents, Howden India and IndiaInfoline. You need to fill up an application form with the concerned party and make an annual payment called as “policy payment”. It is extremely simple – you just have to call any of these banks and somebody will touch base with you. You may even monitor your insurance plan online. HDFC Standard Life provides you such a facility.



How to invest in government bonds or securities?

Individuals can invest in government bonds in two ways: directly and indirectly. People can directly buy government securities through Kisan Vikas Patra or National Savings Certificate.



If you want to invest in bigger government issues such as infrastructure bonds or oil bonds you have to use the direct route i.e. mutual funds. There are a number of mutual funds which invest only in fixed income securities or a mix of securities and equities. For more information on this, please read “How to invest in mutual funds” above.



How to invest in corporate bonds?

Corporate bonds are “bonds” issued by companies either private limited or public companies. If you want to invest in corporate bonds you have to do it through mutual funds. There are a number of funds which invest in high investment grade bonds (BBB- or above) or junk bonds.
Source: http://www.indianmoney.com/article-display.php?cat_id=1&sub_id=115&aid=250&ahead=A%2520Guide%2520to%2520Investments

Fundamental Analysis

Today I got a query from one of my reader that he wants to know about fundamental analysis, and then I thought of posting the same answer on my site, so that others will also get benefited.




Fundamental analysis is the key and very prominent factor while buying and selling of stocks and securities. This provides a complete analysis of the company, industry and economy related news to the investors. Fundamental analysis can be best compared with our cloths, because while purchasing our cloths we always look at the quality, price and outlook of the cloth; brand value, goodwill and popularity of the company and finally, we start thinking whether it suits to the current season or not.



Fundamental analysis of shares and stocks is a conservative and non-speculative approach based on the “fundamentals”. A fundamental analyst always looks at a three dimensional analysis instead of analyzing what is happening in the Dalal street. The three important dimensional factors are:

The Economy

The Industry

The Company



The Economy Analysis

The Economy analysis is a major factor stands behind the success of any investor. Economic analysis includes the study and understanding of various economic indicators and their possible impact on the stock market. Following are the economic indicators which has impact on the stock market movements:

GNP

Price Conditions

Economy

Housing Construction

Employment

Accumulation of Inventories

Personal Disposable Income

Personal Savings

Interest Rates

Balance of trade

Strength of the Rupee in Forex market

Corporate Taxation (Direct & Indirect)



The Industry Analysis

Every industry has to go through a life cycle with four distinct phases

i) Pioneering Stage

ii) Expansion (growth) Stage

iii) Stagnation (mature) Stage

iv) Decline StageThese phases are dynamic for each industry.

You as an investor is advised to invest in an industry that is either in a pioneering stage or in its expansion (growth) stage. Its advisable to quickly get out of industries which are in the stagnation stage prior to its lapse into the decline stage. The particular phase or stage of an industry can be determined in terms of sales, profitability and their growth rates amongst other factors.



The Company Analysis

There may be situations where the industry is very attractive but a few companies within it might not be doing all that well; similarly there may be one or two companies which may be doing exceedingly well while the rest of the companies in the industry might be in doldrums. You as an investor will have to consider both the financial and non-financial aspects so as to form a qualitative impression about a company. Some of the factors are



History of the company and line of business

Product portfolio's strength

Market Share

Top Management

Intrinsic Values like Patents and trademarks held

Foreign Collaboration, its need and availability for future

Quality of competition in the market, present and future

Future business plans and projects Tags - Like Blue Chips, Market Cap - low, medium and big caps

Level of trading of the company's listed scripts

EPS, its growth and rating vis-à-vis other companies in the industry.

P/E ratio

Growth in sales, dividend and bottom line.
Source: http://www.indianmoney.com/article-display.php?cat_id=1&sub_id=12&aid=24&acat=&ahead=Fundamental%2520Analysis

Equity Linked Savings Scheme

Definition:


ELSS refers to Equity Linked Savings Scheme. ELSS as the name clearly suggests is a savings scheme linked to equity markets. It is a type of mutual fund, which additionally offers tax benefits to the investors.



Key Features and benefits of ELSS are:



ELSS is a fund with a lock-in period of 3 years.

It offers tax benefit to the investors under section 80c of the income tax Act up to a maximum limit of 1 Lac per annum.

Investment has to be for long term, any expectation of short term gains is not appropriate.

Involves a little bit of risk because of equity allocation.

ELSS helps an investor to get addicted to investments and savings by offering systematic investment option.

ELSS is very beneficial to salaried people.

Up to March 31,2005 an investor could claim only rebate under Section 88 if invested in ELSS and the maximum amount that could be invested in ELSS was only Rs.10,000/-. But from March 31, 2006 the investment limit in ELSS has been increased to Rs.1, 00, 000/- and this entire investment is eligible for deduction under sec 80C of Income tax Act, 1961.

Comparison between ELSS and ULIPs:



ULIPs and ELSS works almost in the similar way as both offers tax benefit. Money will be mostly invested in the equity markets in both the cases. I would like to put before few points which differentiates ULIPs and ELSS.

ELSS plans are offered by Asset Management Companies, where as ULIPs are mostly offered by Life Insurance Companies.

ELSS plans does not offer switching facility, but ULIPs offers switching facility to the investors, which helps an investor to safe guard his money in the time of market fluctuations by allowing the switch over of funds from equity to debt instruments.

The fund management charges in ELSS would always be higher than ULIPs.

SIP in ELSS is not convenient to investors, as money invested on monthly basis has to be locked for three years from the date of investment of the respective monthly investment. Where as in case of ULIPs investment amount and its return can be taken back after completion of 3 years from the date of first monthly investment made.

The Investment strategy of ELSS is not that strong when compare to the ULIPs as the investment strategy of ULIPs are governed by law.

Advantages of ELSS over NSC and PPF



Main advantage of ELSS is its short lock-in period. Maturity period of NSC is 6 years and PPF is 15 years.

Since it is an equity linked scheme earning potential is very high.

Investor can opt for dividend option and get some gains during the lock-in period.

Investor can opt for Systematic Investment Plan.

Some ELSS schemes also offer personal accident death cover insurance.

Provides 30 to 40% returns compared to 8% in NSC and PPF.
Source: http://www.indianmoney.com/article-display.php?cat_id=1&sub_id=11&aid=98&ahead=Equity%2520Linked%2520Savings%2520Scheme

Inflation - its causes and effects on the economy

Inflation is a rise in the general level of prices of goods and services in an economy over a period of time. Inflation can also be described as a decline in the real value of money—a loss of purchasing power in the medium of exchange which is also the monetary unit of account and the monetary store of wealth. When the general price level rises, each unit of currency buys fewer goods and services. A chief measure of price inflation is the inflation rate, which is the percentage change in a price index over time.




When I was a kid my grandparents used to tell me – “Son, in our time we use to take money (paisa) in pockets and carry goods to home in bags. But in your age you will carry money (rupees) in bags and carry goods to home in your pocket”. He was so right! This is inflation –which reduces the purchasing power of common man.



Measuring Inflation

In major economies, inflation is measured by CPI, which is Consumer Price Index. CPI is a measure of the average price of consumer goods and services purchased by households. The percent change in the CPI is a measure of inflation. Two basic types of data are needed to construct the CPI: price data and weighting data. The price data are collected for a sample of goods and services from a sample of sales outlets in a sample of locations for a sample of times. The weighting data are estimates of the shares of the different types of expenditure as fractions of the total expenditure covered by the index. These weights are usually based upon expenditure data obtained for sampled periods from a sample of households.



In other words, Inflation is calculated as percentage change in CPI in two periods. Hence,

Inflation (%) = (CPI2- CPI1)*100/CPI1

Where, CPI1 = CPI in the previous period and CPI2 = CPI in the current period



India uses a different price index called the Wholesale Price Index (WPI) to calculate the rate of inflation in our economy. It is quite similar to Consumer Price Index, but uses whole sale prices instead of retail consumer prices. WPI is the index used to measure changes in the average price levels in the wholesale market. Data on 435 commodities is tracked through WPI, in India, which is an indicator of movement in prices. I share the common view of other economists who believe WPI, as a measure of inflation, is flawed. India should switch to CPI, which has been adopted by most developed countries.



There are several other ways of measuring inflation as well. They are GDP price deflator, Producer Price Indices and Commodity Price Indices. However, they are not commonly used.



Flaws of WPI

Former RBI governor once explained why India does not use CPI as a measure of inflation. The CPI data is not released as frequently as WPI data. WPI data is released almost weekly and sometimes at most biweekly, where as CPI data is released once in a month. There is also a lot of lag in collating all the CPI data. There is another problem with the CPI data in India. We don’t have a single CPI data, but four different CPI figures relating to agriculture goods, urban manual labor and non-urban labor etc. There is no discipline in when these different figures are released and with what frequency. So government of India has a genuine reason in not going for CPI based inflation.



WPI based calculation is full of flaws. WPI is supposed to measure impact of prices on business. But we use it to measure the impact on consumers. The WPI that was constituted in 1993-94 has virtually remained unchanged since then, and it has lost quite a bit of its relevance while calculating inflation. Some of the WPI commodities include coarse grains that go into making of livestock feed but they continue to be considered while measuring inflation. The sole reason why many unimportant commodities continue to remain included is possibly because data on their prices was available!



Causes of Inflation

Let’s get back to our discussion on the fundamentals of inflation. Economists believe that inflation is a monetary phenomenon. However, in the short and medium term inflation may be affected by supply and demand pressures in the economy, and influenced by the relative elasticity of wages, prices and interest rates.

1. Over-expansion of money supply i.e. excess liquidity in the economy leads to inflation because “too many money would be chasing too few goods”.

2. Expansion of Bank Credit Rapid expansion of bank credit is also responsible for the inflationary trend in a country.

3. Deficit Financing: The high doses of deficit financing which may cause reckless spending, may also contribute to the growth of the inflationary spiral in a country.

4. A high population growth leads to increase in demand and money income and cause a high price rise.

5. Excessive increase in the price of fuel or food products due to political, economic or natural reasons will lead to inflation for short- as well as long-term.



For example – We all remember that price of crude went up from $50 to $140 within two years. Almost every industry including agriculture, transportation and manufacturing depends on crude for its operation. Any excessive increase in the price of crude leads to increase in cost of good and services i.e. inflation.

Another example – China and India consist of almost 34% of the world’s population. As the economy in these two countries are growing at a rate of over 9%, people are consuming more and more goods due to increased income and better life. Demand for those goods and services has led to a high inflationary environment in these countries.



States of Inflation

There are different states of inflation which is characterized based on its value as well as variation from the previous value.

1. Hyperinflation – It is a very high rate of inflation, usually a rate in excess of 50%. History has some excellent examples of hyperinflation. In Germany, inflation exceeded 1 million % in 1923. It was said that a horse cart full of money would not buy even a newspaper. Right now, Zimbabwe is having an inflation of 1 million %. They have to issue currency of $500 Million dollar (I am not kidding!!) which could only buy a lunch at McDonalds.

2. Deflation – It is the decrease in the general price level of goods and services only when annual inflation is below 0% resulting in the real value of money. Hence, it is sometimes called “negative inflation”. Japan suffered from deflation for almost a decade in 1990s. To control recession and Central Bank of Japan was forced to have a negative interest rate on deposit for over a decade.

3. Disinflation – It refers to a time when the rate of change of prices is falling while the inflation rate is positive. For example – if the inflation rate comes down from 3% to 2%, we would say it is disinflation. In India, we have a disinflation because inflation has come down from a high of 13% to 6% and it is still dropping.

4. Stagflation – It is an economic situation in which inflation and economic stagnation occur simultaneously and remain unchecked for a period of time. Stagflation can result when an economy is slowed by an unfavorable supply shock, such as an increase in the price of oil in an oil importing country, which tends to raise prices at the same time that it slows the economy by making production less profitable.



Effects of Inflation on economy

As we know Inflation is the increase in the price of general goods and service. Thus, food, commodities and other services become expensive for consumption. Inflation can cause both short-term and long-term damages to the economy; most importantly it causes slow down in the economy.



1. People start consuming or buying less of these goods and services as their income is limited. This leads to slowdown not only in consumption but also production. This is because manufactures will produce fewer goods due to high costs and anticipated lower demand.

2. Banks will increase interest rates as inflation increases otherwise real interest rate will be negative. (Real interest ~ Nominal interest rate – inflation). This makes borrowing costly for both consumers and corporate. Thus people will buy fewer automobiles, houses and other goods. Industries will not borrow money from banks to invest in capacity expansion because borrowing rates are high.

3. Higher interest rates lead to slowdown in the economy. This leads to increase in unemployment because companies start focusing on cost cutting and reduces hiring. Remember Jet Airways lay off over 1000 employees to save cost.

4. Rising inflation can prompt trade unions to demand higher wages, to keep up with consumer prices. Rising wages in turn can help fuel inflation.

5. Inflation affects the productivity of companies. They add inefficiencies in the market, and make it difficult for companies to budget or plan long-term. Inflation can act as a drag on productivity as companies are forced to shift resources away from products and services in order to focus on profit and losses from currency inflation.



Inflation Targeting

There are various ways of controlling inflation in an economy. I will discuss two main ways of doing so:



Monetary Policy



The most important and commonly used method is monetary policy. Most central banks use high interest rates and slow growth of the money supply as the traditional ways to fight or prevent inflation. RBI raised CRR, Repo rate and Reverse repo rate to reduce money supply in the economy to fight inflation which was hovering in double digit. High interest rates make borrowing expensive and hence, people as well as corporate borrow less money from banks. This reduced the demand for goods and services such as real estate, automobiles and others.

Fixed Interest Rate

As we know high inflation reduced the value of money. A number of smaller countries who do not have sophisticated banking system rely on tying their currency with that of a developed country. Under a fixed exchange rate currency regime, a country's currency is tied in value to another single currency or to a basket of other currencies (or sometimes to another measure of value, such as gold). A fixed exchange rate is usually used to stabilize the value of a currency, vis-à-vis the currency it is pegged to.



Government Measures

Apart from these two broad methods, government takes some protectionist measures as well to fight inflation. Government may ban export of essential items such as pulses, cereals and oils to support the domestic consumption and hence reduced their prices. Also, government may lower duties on the import of similar items which are having less supply in the economy.



Positive side of inflation

You may be wondering how come inflation is good for economy. A little bit of inflation is not a bad thing. It implies the possibility of higher prices and profits in the future. To the worker, a little bit of inflation may imply rising wages in the future. What I am trying to say is that they are based more on “psychology” than “economics”.



In the next article, I will analyze the inflation situation in India last year, its causes and method adopted by RBI to control it.
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Resident Foreign Currency Accounts

Residents with foreign currency can open these accounts. These include people like export earners, non residents on their becoming residents, those returning to the country with foreign exchange after a business trip or holiday and foreigners.




Different Types of Resident Foreign Currency Accounts:

Different types of accounts that can be opened in foreign currency are given below:

1. Resident Foreign Currency Accounts (RFC)

2. Exchange Earners Foreign Currency Account (EEFC)

3. Resident Foreign Currency (Domestic) Account

4. Resident Foreign Currency (External) Account

5. Resident Foreign National’s account

6. Diamond Dollar Account.



1. Resident Foreign Currency Accounts (RFC)

These accounts can be opened by a person of Indian nationality or Indian origin, who has returned to India for permanent settlement or persons inheriting assets abroad from persons who acquired such assets while being a non- resident.

The account can be opened in any foreign currency excluding the currency of Nepal or Bhutan.

Persons who have been residing outside India for a continuous period of more than one year (exclusive of short visits for personal reasons) who return to India for permanent settlement should change the status of their NRO/NRE Account from non-resident to resident and inform the bank of the change in status. Such persons should close NRE and FCNR (B) deposit accounts on maturity. The proceeds can be transferred either partly or completely to an RFC account.





Features of Resident Foreign Currency Accounts

· RFC account can be current, savings or fixed deposit account.



· The term of fixed deposits are ranging from 30 days to 6 months.



· Cheque facility is not available for RFC current accounts.

· Balance held in a RFC account is repatriable for a bona fide purpose, without the prior permission of RBI.



· A RFC account is free from all restrictions concerning utilization including any restrictions on investments outside India.



· Interest earned on the balance in this account is free of tax for 2 years from the date of return to India.



· The account can be operated jointly or individually.



· Nomination facility is available in RFC account. If the account holder dies and the nominee is abroad, the balance in the account can be repatriated to him/ her.



· Loans can be granted against the balances lying in the account subject to commercial judgment.

Deposits that can be credited to the RFC account are:

· Remittances from abroad representing funds in bank accounts outside India, income such as dividend, interest, profit, rent, etc. earned on eligible assets held abroad and from the sale proceeds of eligible assets.



· Pension and other monetary benefits received from abroad arising out of employment taken up outside India prior to return to India.



· Interest earned on RFC Accounts.



· Foreign currency notes/ traveler’s cheques brought by returning non-residents.



· Balances in non-resident external accounts and foreign currency non-resident accounts.



· Earnings of insurance claims/ maturity value or surrender value of insurance policies taken by the holder when he was a non-resident and settled in foreign currency. It can include policies issued by insurance companies in India. But they should be registered with IRDA to conduct insurance business.

Funds in an RFC account are free from all restrictions regarding utilization. The funds can even be used for making investments outside India.

2. Exchange Earners Foreign Currency Account (EEFC)

A person resident in India can open, hold and maintain EEFC accounts; the account will be maintained only in the form of non-interest bearing current account. Credit facilities such as fund-based or non-fund based, are not permitted against the security of balances held in the account.





The limits of credit facilities to the accounts are given below:

· 100% for Status Holder Exporter (as defined in EXIM Policy)

· 100% for Export Oriented Units, Units in Export Processing Zones (EPZs), Electronic Hardware Technology Park (EHTPs) and Software Technology Park (STP)

· 50% for persons resident in India

Individual professionals are allowed to keep up to 100 per cent of their foreign exchange earnings from consultancy and other services provided to persons or bodies outside India, in their Exchange earners’ foreign currency (EEFC) account. This is for the benefit and convenience of individual professionals, doctors, artists, architects, engineers, consultants, lawyers, chartered accountants, directors on boards of overseas companies, etc. Payments received in foreign exchange by a unit in domestic tariff area (DTA) for supply of goods to a unit in special economic zones (SEZ) out of its foreign exchange currency account may be credited to an EEFC account.

Exporters can avail trade related loans / advances to overseas importers out of their EEFC balances without any upper limit. They can also repay packing credit advances whether availed in rupee or in foreign currency from balances in their EEFC account or rupee resources to the extent exports have actually taken place. Purchase of foreign exchange from the market for refunding advance payments credited to accounts would be allowed only after utilizing the entire balance in the exporter’s EEFC accounts maintained at different banks.





With regard to units in Special Economic Zones (SEZ):

· All foreign exchange funds received by the unit in the SEZ must be credited to this account. This also includes foreign exchange purchased by units in Domestic Tariff Area (DTA) for making payment towards goods supplied by Units in SEZ.

· Foreign exchange purchased in India against rupees will not be credited to the account without the permission of the Reserve Bank

· The funds should represent bona fide transactions of the unit in the SEZ.

· Balances in EEFC accounts sold forward by the account holders shall remain assigned for delivery and such contracts shall not be cancelled.

Investments in overseas joint ventures can be funded out of balances in EEFC accounts. Cheque facilities are available in EEFC account. Exporters are allowed to grant trade related loans/ advances from their EEFC account to overseas exporter or importer clients without any ceiling. Where the amount of loan exceeds US$ 1,00,000, a guarantee of a bank of international status located outside India will be required to be provided by the overseas borrower in favor of the lender. These funds are not to be lent or made available to any person or entity in India. The balances will be credited to NRE/FCNR (B) Account, at the request of the account holders. – Claims settled in rupees by ECGC (Export Credit and Guarantee Corporation of India Ltd) should not be interpreted as export realization in foreign exchange and claim amount must not be credited to the EEFC account. Prior approval of the Reserve Bank (RBI) is not required for remittances made from EEFC accounts for consultancy services received.

3. Resident Foreign Currency (Domestic) Accounts (RFCD)

A person resident in India can open RFCD accounts out of foreign exchange acquired in the form of currency notes, bank notes and traveler’s cheques acquired in the following ways:





· While on a visit to any place outside India by way of payment for services not arising from any business or anything done in India.



· From any person not resident in India and who is on a visit to India, as gift or for services rendered or in settlement of any lawful obligation.



· By way of gift or honorarium while on a visit to any place outside India.

· The unspent amount of foreign exchange obtained from an authorized person for travel abroad.



· The proceeds of life insurance policy claims/maturity/surrender values settled in foreign currency from an insurance company in India permitted to undertake life insurance business.



· Being gifts received from close relatives.



These types of accounts are current accounts and will earn no interest. There are no maximum to the balance that may be held in these accounts. Balances in the RFCD accounts may be credited to NRE/FCNR (B) Account, at the request of the account holders consequent upon change in their residential status from resident to non-resident.

4. Resident Foreign Currency (External) Account (RFCE)

A firm or company incorporated in India can open, hold and maintain a foreign currency account outside India by making remittances from India for the purpose of regular business operations of a branch office or a representative there. Indian companies or individuals carrying out turnkey projects or civil construction contract may also be able to open foreign currency accounts abroad. A national of another country living in India and working for a foreign company on delegation in India or a citizen of India employed by a foreign company outside India on deputation in India may open, hold and maintain a foreign currency account (RFCE) with a bank outside India and receive the salary payable to him for services rendered in India, by credit to such account provided that:





· The amount to be credited to such account should not exceed 75 percent of the salary accrued to or received by such person from the foreign company

· The outstanding salary is paid in rupees in India

· Income tax paid on the entire salary in India.

The surplus funds held in this account must not be invested abroad without prior permission of the RBI and any funds rendered surplus should be send back to India.





Information / statements to be submitted:

· Account number, name of bank, place and country where the account is opened within 15 days from the date of opening the account



· Statement of operation on the account on half yearly basis



· Bank certificates confirming the amount repatriated periodically



Closure of foreign currency (RFCE) account with bank certificates evidencing transfer of balance to India immediately on completion of the relevant contract. A liberalized remittance scheme of US$ 25000 for resident individuals per calendar year for any purpose has been introduced. Resident individuals are permitted to open, maintain and hold foreign currency accounts with a bank outside India without the prior approval of the RBI for the purpose of making remittances under the scheme.

5. Resident Foreign Nationals account

Branches of foreign firms in India and foreign nationals resident in India (not permanently resident in India) are permitted to open such bank accounts. But care should be taken that the foreign currency is not given to residents. No rupee loans can be given under this account except personal loans, this may be up to Rs.5 lakhs.

Diplomatic personnel, Diplomatic missions and non-diplomatic staff of foreign embassies, who are nationals of the concerned foreign countries and holding official passport, can maintain foreign currency deposit accounts.



6. Diamond Dollar Account (DDA)

Diamond dollar accounts (DDA) can be opened by firms and companies dealing in purchase/sale of rough, cut or polished diamonds / diamond studded jewelry. They must have a track record of at least three years in import or export of diamonds and an average annual turnover of Rs. 5,00,00,000 or above during preceding three licensing years (from April to March)

Nevertheless not more than five Diamond Dollar Accounts can be opened with banks. Under the Diamond Dollar Account (DDA) Scheme, it would be in order for banks to liquidate PCFC granted to a DDA holder by dollar proceeds from sale of rough, cut and/ or polished diamonds by him to another DDA holder.
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Are we going to face problems of deflation?

Nowadays we keep on reading that global economies such as US and Europe will face severe problems of deflation due to recession. Fed fund rate in the US is between 0.00-0.25% or 25 bp (100 basis point = 1%). Inflation in these countries is close to 0. With the falling interest rates in India will we too face similar situation?




Deflation is a “sustained” fall in the general price level of goods and service below zero percent inflation. It results in an increase in the real value of money — a negative inflation rate. It is just opposite of inflation, which is the general increase in the price level of goods and services. When the inflation rate slows down (decreases, but remains positive), this is known as disinflation. Disinflation is a substantial drop in the rate of increase of the price level. Deflation should not be confused with temporarily falling prices; instead, it is a sustained fall in general prices.



Inflation destroys real value in money whereas Deflation creates real value in money.

Real Price ~ Nominal Price –Inflation

With the passage of time, the “real price” of any good or service is characterized by above equation. Hence, if it is positive inflation or normal inflation, real price decreases over a period of time. However, if inflation is negative i.e. deflation, real price increases with time. Alternatively, the term deflation was used by the classical economists to refer to a decrease in the money supply and credit.



Causes of deflation

1. Deflation is caused by the fall in aggregate level of demand i.e. there is a fall in how much the whole economy is willing to buy, and the going price for goods. Because the price of goods is falling, consumers have an incentive to delay purchases and consumption until prices fall further, which in turn reduces overall economic activity - contributing to the deflationary spiral. (As we can currently see that buyers believe real estate prices will fall further, thus delaying their purchase decisions. This in turn has reduced the demand for the real estate properties which in turn has reduced the construction activities. Thus, general economic activities such as cement production etc are down.)



As demand and economic activity falls, investments fall as well because corporate do not want to invest in increasing capacity as there is no demand. This leads to further reduction in aggregate demand. This is the deflationary spiral i.e. a situation where decreases in price lead to lower production, which in turn leads to lower wages and demand, which leads to further decreases in price. An answer to falling aggregate demand is stimulus, either from the central bank, by expanding the money supply, or by the fiscal authority to increase demand such as reducing interest rates or giving money to corporate or people at significantly lower rates.



2. In monetarist theory, deflation is related to a sustained reduction in the velocity of money (It is the average frequency with which a unit of money is spent in a specific period of time. Velocity affects the amount of economic activity associated with a given money supply) or number of transactions. This is attributed to a dramatic contraction of the money supply, perhaps in response to a falling exchange rate, or to adhere to a gold standard or other external monetary base requirement. In the present scenario it appears to be one of the prime reasons for growing fears of deflation.



3. Deflation also occurs when improvements in production efficiency lower the overall price of goods. Improvements in production efficiency generally happen because economic producers of goods and services are motivated by a promise of increased profit margins, resulting from the production improvements that they make. Competition in the marketplace often prompts those producers to apply at least some portion of these cost savings into reducing the asking price for their goods. When this happens, consumers pay less for those goods; and consequently deflation has occurred, since purchasing power has increased.



4. Deflation may be caused by a combination of the supply and demand for goods and the supply and demand for money, specifically the supply of money going down and the supply of goods going up. Historic episodes of deflation have often been associated with the supply of goods going up (due to increased productivity) without an increase in the supply of money, or (as with the Great Depression and possibly Japan in the early 1990s) the demand for goods going down combined with a decrease in the money supply.



Indian scenario – Last few years we saw massive boom in all the sectors. There were huge demands for real estate properties, IT services, Cements, Food products etc. Our economy was growing in excess of 9% and mood was upbeat. Everybody thought this growth will continue forever. Hence, corporate invested heavily in building capacity, developers invested billions of dollars in launching new projects etc. Suddenly the boom busted due to financial crisis. People lost jobs, interest rates went up through the roof and demand plunged. There was a huge mismatch between supply (more) and demand(less). This led to price correction - real estate saw over 40% drop in prices, commodities went down by over 70% and so on. Moreover, due to global financial crisis, there is acute shortage of liquidity in the market and hence less flow of money in the economy. People are holding back to their investments as well as consumption; thus, reducing velocity of money. Does it sound like symptoms of deflation?



Effects of deflation

1. Deflation leads to decrease in prices of good and services, increasing value of money. While an increase in the purchasing power of one's money sounds beneficial, it can actually cause hardship when the majority of one's net worth is held in illiquid assets such as homes, land, and other forms of private property.



2. Deflation raises real wages, which are both difficult and costly for management to lower. Moreover, falling prices and demand discourages corporations from investing. This frequently leads to layoffs and makes employers reluctant to hire new workers, increasing unemployment.



3. Deflation often follows a period of nearly zero interest rates. When the central bank has lowered nominal interest rates all the way to zero, it can no longer further stimulate demand by lowering interest rates. This is the famous liquidity trap. When deflation takes hold, it requires "special arrangements" to "lend" money at a zero nominal rate of interest (which could still be a very high real rate of interest, due to the negative inflation rate) in order to (artificially) increase the money supply.



Why deflation is bad?

While shoppers see falling prices as a good sign, economists see it as a threat to the economy or nation. Deflation hurts the economy much more than inflation. In fact a small positive inflation is good for the economy because it suggests growing demand as well as healthy economy. However, in deflationary conditions consumers postpone expenditure, because they think prices will decrease further. This decreases demand in the economy which badly affects firms, who then scale back production and investment plans, leading to job losses, further affecting purchasing power and demand, which leads to a downward spiral in the economy.



We will now take a look at the most infamous deflation in the history of modern world.



Deflation in Japan

Deflation in Japan started in the early 1990s. The Bank of Japan and the government tried to eliminate it by reducing interest rates, but this was unsuccessful for over a decade. In July 2006, the zero-rate policy was ended. There were several reasons for deflation in Japan which are explained below:



1. Bust of Asset price bubble: There was a rather large price bubble in both equities and real estate in Japan in the 1980s (peaking in late 1989). When assets decrease in value, the money supply shrinks, which is deflationary.



2. Insolvent companies: During the boom time (1980s) Japanese banks lent aggressively to companies and individuals that invested in real estate. However, when real estate values dropped, people were not able to pay back these loans to banks. The banks tried to collect the collateral (land or properties), but this wouldn't pay off the loan because their prices had fallen significantly. Banks delayed their decision to foreclose these loans hoping asset prices would improve. These delays were also allowed by national banking regulators. This continuing process is known as maintaining an "unrealized loss", and until the assets are completely revalued and/or sold off (and the loss realized), it will continue to be a deflationary force in the economy. Improving bankruptcy law, land transfer law, and tax law were suggested by leading economists as methods to speed this process and thus end the deflation.



3. Insolvent banks: Japanese banks had a larger percentage of their loans as "non-performing" i.e. they were not receiving any interest payments on them, but have not yet written them off. With high non-performing loans or assets, they were unable to lend more money; thus, their earnings declined significantly and risk of insolvency increased many a fold.



4. Imported deflation: Japan imports Chinese and other countries' inexpensive consumable goods, raw materials (due to lower wages and fast growth in those countries). Thus, prices of imported products were decreasing with the rise of economy of scale in China. Domestic producers had to lower their prices in order to remain competitive. This decreasing in prices of domestic products over a period of time led to deflation.



5. Fear of insolvent banks: Japanese people were afraid that banks might collapse so they preferred to buy gold or (United States or Japanese) Treasury bonds instead of saving their money in local bank accounts. Thus less money was available for lending and therefore economic growth. This meant that the savings rate depresses consumption, but did not appear in the economy in an efficient form to spur new investment.



Deflation alarms in the US?

With the fed fund rate at a historic low (0.00-0.25%), there is a growing fear of deflation in the US. Many economists believe that USA could face short term period of deflation. With the bust of housing bubble, acute shortage of credit and falling consumption, USA has more or less similar conditions that were prevalent in Japan in early 1990s. However, I believe there are some basic yet crucial differences.



Firstly, Japanese companies were far more dependent on commercial banks for financing than are today's U.S. multinationals, which have stockpiles of internal capital as well as broader access to capital markets. Moreover, US Treasuries are still considered as the safest investments in the world. This keeps the flow of money into the US economy.



Secondly, Bank of Japan’s exceptionally poor monetary policymaking was a big reason for the country's protracted problem. The central bank's failure to lower interest rates in the early 1990s ultimately drove the economy into a deflationary death spiral. They were just too slow and conservative to react to the situation. However, US Fed has been quite aggressive and proactive in taking sound monetary decisions and ensuring that they do not repeat those mistakes. In 1992, for example, amid negligible inflation and a comatose economy, the Bank of Japan's key interest rate was still nearly 4%. In contrast, after the tech bubble burst in the USA, the Fed quickly slashed its benchmark rate to 1 %. Also, the current fed rate is between 0.00-0.25%.



Thirdly, though both USA and Japan faced housing trouble and mortgage crisis, Japan's central bank was too slow to act. The country's banks hid their bad loans beneath opaque corporate structures rather than absorb the losses. But rather than write off the loans, Japanese banks extended additional credit to borrowers, allowing them to at least make minimal interest payments. Those made banks look healthier than they were, at the cost of impairing the flow of credit to new businesses. However, American banks have been forthcoming in absorbing the losses on their books and writing off loans. This has given fed a clear picture of true losses and subprime crisis in the economy.



Having said that I believe the US economy may bleed for some time and enter a period of deflation. However, that period would be short lived and not as prolonged as that of Japanese economy in 1990s. As per an estimate, avoiding a long period of deflation and recession might cost the US a staggering $3 Trillion.



Will India face deflation?

Let’s examine Indian economy vis-à-vis Japanese economy of 1990s. In the last five years BSE exchange went up from 5,000 to 21,000, an increase of 400% while real estate prices in Indian witnessed an increase of over 300%. This is phenomenal increase in prices and asset prices looked highly inflated. After the global financial crisis, Indian stock exchange plunged by over 60% and real estate values dropped by almost 30-40% in less than six months. Some welcomed this fall while majority believed Indian global dream is finally over. The mayhem still continues with stock prices and real estate prices further going down.



Compare this with that of Japan - In the five years before its 1989 peak, the Nikkei (Japanese stock exchange) stock average rose 275%. Property prices became so inflated that the tiny spit of land surrounding the Imperial Palace in central Tokyo was briefly worth more than the entire state of California. At the time, Japan's seemingly unstoppable rise inflamed fears among Americans that the United States had slipped into permanent economic inferiority. When the bubble finally busted in late 1989, stock and property prices nose-dived in tandem. In less than three years, the Nikkei stock average fell 63% from its peak of 38,916. It didn't hit bottom until April 2003 and a total decline of 80%. Do these two stories sound similar? Yeah they do!



Inflation figures for the last week was 3.92% which is far less than the peak rate of 12% less than six months back. Are we going into a period of negative inflation or deflation? We are currently in a state of disinflation which is a decreasing value of inflation as the inflation rate is still positive. However, this may lead to a situation where downward price movement continues and we enter a period of deflation. I believe this is highly unlikely because we are a growing economy with very young population. Moreover, we are not an export oriented economy and hence do not depend too much on external demand. Our economy is mostly driven by domestic demand and consumption, which is somewhat insulated from other countries and global events. We still have lot of room to maneuver our policies to regenerate demand and spending. Yet, with the growing globalization we too run a risk of deflation if our monetary and fiscal policies are not handled well.



How deflation can be avoided?

To counter deflation we have to revitalize our growth story, reignite demand and create confidence among people. Compare to the inflation rate, 3.92%, lending rates in India are still close to 10%, which is quite high. Unless lending rates do not come down people won’t buy properties, automobiles or other consumer goods. Moreover, corporate won’t be able to borrow money to launch new innovative projects, spend on infrastructure or build capacity. Thus, to create demand and investments, government as well as RBI has to bring down this lending rate by implementing ways to reduce cost of borrowing funds.



Hence, only monetary policy won’t be sufficient to tackle this menace; fiscal policy too has to play a significant role here. Government has to be more aggressive in implementing reforms and speeding up infrastructure spending. Let us hope better sense will prevail among our political class.
Source: http://www.indianmoney.com/article-display.php?cat_id=1&sub_id=113&aid=248&acat=&ahead=Are%2520we%2520going%2520to%2520face%2520problems%2520of%2520deflation%3f