Monday 30 July 2012

BASICS OF MARKET

What is economics? 

 Economics can be defined as a science which deals with distribution,production and consumption of goods and services. 

 What is GDP ? 

GDP stands for Gross Domestic Product which is an indicator shows the total value of all the goods and services in a country within a specific time period. 

 What is the significance of GDP ? 

It shows the economic stability of the country. GDP has an impact on everyone who is in the economy. Higher the GDP means, higher is the business, unemployment is low, everyone earns money and spending is also more. That results in good growth for Companies and as regards the stock market, the share price of the companies goes up. 

 How GDP is calculated ? 

Most basic understanding of GDP calculation is adding up all the values what everyone under the economy earned in a year. This is also known as income approach. Another way of calculating GDP is adding up all values what everyone spent in a year. (expenditure method). Expenditure method is the common approach calculated by adding total consumption, investments, Govt spending and net of exports. In India, Reserve Bank of India announce the GDP growth rates periodically. 

 What is inflation ? 

In a general term, Inflation is a sustained increase in the average price of all goods and services produced when compared between two given periods. Eg : If the price of 1 Kg wheat is Rs 30/- in December 2010 and if it is Rs 33/- per kg now in December 2011. That means that inflation on wheat is 10%. ( price has increased by Rs 3/- over Rs 30/-in one year). 

 What are the causes for inflation ? 

Inflation (Increase in price) can happen for various reasons. 

1) If there is an increase in the cost of production like raw material price, rise in the labor costs etc, then the price of the finished products will definitely going to rise which may lead to inflation 

 2) Inflation may occur if the government of a country prints money in excess than what is actually required, to deal with financial emergencies. As a result, there will be more money in circulation than the products or services available in the market and demand for products increases which will drive the price higher. Money supply plays a large role in inflationary pressure as well. It is important to control the money supply adequately, otherwise it may actually grow at a rate faster than that of the potential output of products in the economy, or real GDP. This will drive up prices and hence, inflation. Low interest rates correspond with a high levels of money supply and allow for more investment in big business and new ideas which eventually leads to unsustainable levels of inflation as cheap money is available. 

 3) Inflation may also occur when Govt. imposes taxes on consumer goods like fuels or cigarettes. When the taxes increase, price also increase. 

 4) Inflation may be due to the national debts and international lending. The countries has to pay interest on the money borrowed from international institutions and as result increases the overall prices of commodities, to keep up with their debt repayment programs. 

 5) A fall in the exchange rate can also be a cause for inflation. Since the Govt has to deal with the differences in the imports and exports of the country, to make up with the difference there may be a overall price rise or taxes on other commodities. 

 How The inflation is measure ? 

Consumer Price Index (CPI) Inflation is measured through the consumer price index (CPI) CPI is a weighted average of prices of a specified set of goods and services purchased by consumers. It is a price index that tracks the prices of a specified basket of consumer goods and services, providing a measure of inflation 

 Wholesale Price Index (WPI) 

WPI is the index that is used to measure the change in the average price level of goods traded in wholesale market. In India, a total of 435 commodities data on price level is tracked through WPI which is an indicator of movement in prices of commodities in all trade and transactions. It is also the price index which is available on a weekly basis with the shortest possible time lag only two weeks. The Indian government has taken WPI as an indicator of the rate of inflation in the economy In India, Reserve Bank of India, announce the Price Index on weekly, monthly basis. 

 How the inflation can be controlled ? 

 There are broadly two ways of controlling inflation in an economy – Monetary measures and fiscal measures 1) Monetary measures 
2) Fiscal measure 

Monetary measures are the common method used to control inflation. In this method Govt makes some monetary policy changes like interest rates, CRR etc to control the money flow in the economy. All these policies are to control the money flow in the economy and hence reduced the inflation 

Fiscal measures are that , in which Govt makes some policy changes like reducing its own expenditure, reduces the public borrowings. Govt can also make some policy changes like banning export of some of the essential items like pulses, cereals and oil etc. 

Controlling the money supply is very important to keep the inflation on check. How does money supply works ? 

To understand this, let us consider an example 
Consider an economy where there are only two people A & B doing business. Money supplied is Rs 100/-. 
A and B do business with each other. A produces some goods and sell to B and B makes some goods and sell it to A. This cycle goes on. Money in circulation is only Rs 100/- 

In a month, “A” produced some goods and sold it to “B” for Rs 100/-. Money comes to “A”. Same way “B” also produced some goods and sold to A for Rs 100/-. Now the money change hand and comes to “B”.  

As a result, both A & B together made a business of Rs 200/- thus contributed Rs 200/- to the GDP in that month. Which means with a money supply of Rs 100, the GDP of the country in that month is Rs 200/-

If this cycle continues for 12 months, then the GDP will be 12 x 200 = Rs 2400. That is with a money supply of Rs 100/-, made a GDP of Rs 2400/- in a year. Money in circulation is only Rs 100/- but money keep changing hands. 

 Now les us consider little bigger example : 

Assume that there is a village with 10 people doing 10 different businesses and the money supplied is Rs 10 lacs. Each one of them produce something and sell it to one another. Each one of them does a business of approx 1 lakh per month. 

So the GDP is Rs 10 lakhs per month ( |Rs 1 Lakh business each ) which amounts to a GDP of Rs 1,20,00,000 a year. 

That means that, Rs 10 lakhs money supplied in to the economy, generated a GDP of Rs 1,20,00,000 ( Rs. One crore twenty lakhs). 

In both the examples above, we assume that all the parties BUY and SELL same amount every month.. All are earning approximately same amount In this village there were 10 businesses and money supplied Rs 10 lakhs and each one of them does Rs 1 lakh business per month. So there is no winner or looser. Money was changing hands at a particular speed and economy was running smoothly so far. 

If some more people start doing business, then what happens ? 

Assume that 2 more people of that village start doing business and their product being good, they become famous immediately and started doing Rs 1 lakh business per month same as other 10 business men who were doing business originally. Money supplied is still the same Rs 10 lakhs and there are 12 businesses now in that village. 

Now, if the money changes hand little more quickly than before, then everyone can make Rs 1 lakh business per month and eventually the GDP should grow to Rs 1,44,00,000 in a year ( 12 business men doing 12 lakhs business each in a year). 

But, if the money doesn’t change hands at the required speed ( velocity of money doesn’t change), then each one of the business men will be buying and selling less quantity than before and as a result each one of them would be doing a business of Rs 80,000 instead of Rs 1 lakh per month which they were doing earlier.

 Assuming that each one would be doing a business of Rs 80,000, then the business per year will be Rs 80,000 x 12 = 9,60,000 ( approx 10 lakhs) a year which is 2 lakhs less compared to the business they were doing earlier. 

Since there are 12 businesses in that village now, total GDP would be 12 x 10,00,000 (approx) = 1,20,00,000. ( which should have been 1 Crore 44 lakhs if the money as changed hands quickly). Here, though the GDP is still the same as before but divided among 12 people instead of 10 earlier and hence everyone feels like that the business is down or recession has started. 

What we found just now is there is a mismatch in the “demand and supply” of money here. So the central bank (Reserve Bank) now should take some action ( increase the supply of money or some other action) and bring the money flow into normalcy. This is just a simple example of how the money flow works. 

 What are the various ways RESERVE BANK adopt to control the money flow ? 

Reserve bank controls the money flow in the economy through various meausures like, interest rates, repo rates, reverse repo rate, CRR, SLR etc. 

bps 

bps stands for basis point and used to indicate changes in rate of interest and other financial instruments. 1 basis point is equal to 0.01%. So when we say that repo rate has been increased by 25 bps, it means that the rate has been increased by 0.25%. 

 Repo Rate and Bank Rate 

Repo rate or repurchase rate is the rate at which banks borrow money from the central bank (read RBI for India) for short period by selling their securities (financial assets) to the central bank with an agreement to repurchase it at a future date at predetermined price. It is similar to borrowing money from a money-lender by selling him something, and later buying it back at a pre-fixed price. 

Bank rate is the rate at which banks borrow money from the central bank without any sale of securities. It is generally for a longer period of time. This is similar to borrowing money from someone and paying interest on that amount. Both these rates are determined by the central bank of the country to control the demand & supply of money in the economy. 

 Reverse Repo Rate 

Reverse repo rate is the rate of interest at which the central bank borrows funds from other banks for a short duration. The banks deposit their short term excess funds with the central bank and earn interest on it. 

Reverse Repo Rate is used by the central bank to absorb liquidity from the economy. When it feels that there is too much money floating in the market, it increases the reverse repo rate, meaning that the central bank will pay a higher rate of interest to the banks for depositing money with it. 

CRR (Cash Reserve Ratio) 

All the Banks are required to maintain a percentage of their deposits as cash. Eg: If you deposit Rs. 100/- in your bank, then bank can’t use the entire Rs. 100/- for lending or investment purpose. They have to maintain a portion of the deposit as cash and can use only the remaining amount for lending/investment. This minimum percentage which is determined by the central bank is known as Cash Reserve Ratio. 

If CRR is 6% then it means for every Rs. 100/- deposited in bank, it has to maintain a minimum of Rs. 6/- as cash. However banks do not keep this cash with them, but are required to deposit it with the central bank, so that it can help them with cash at the time of need. 

 SLR (Statutory Liquidity Ratio) 

Apart from keeping a portion of deposits with the RBI as cash, banks are also required to maintain a minimum percentage of deposits with them at the end of every business day, in the form of gold, cash, government bonds or other approved securities. This minimum percentage is called Statutory Liquidity Ratio. Example If you deposit Rs. 100/- in bank, CRR being 6% and SLR being 8%, then bank can use 100-6-8= Rs. 86/- for giving loan or for investment purpose. 

 What is a Mortgage? 

A mortgage is the transfer of an interest in property (or the equivalent in law – a charge) to a lender as a security for a debt – usually a loan of money. A mortgage represents a loan or lien on a property/house that has to be paid over a specified period of time. Think of it as your personal guarantee that you’ll repay the money you’ve borrowed to buy your home. Mortgages come in many different shapes and sizes, each with its own advantages and disadvantages. Make sure you select the mortgage that is right for you, your future plans, and your financial picture.While a mortgage in itself is not a debt, it is the lender’s security for a debt. It is a transfer of an interest in land (or the equivalent) from the owner to the mortgage lender, on the condition that this interest will be returned to the owner when the terms of the mortgage have been satisfied or performed. In other words, the mortgage is a security for the loan that the lender makes to the borrower. 

Mortgages come in two primary forms, fixed rate and adjustable rate, with some hybrid combinations and multiple derivatives of each. A basic understanding of interest rates and the economic influences that determine the future course of interest rates can help consumers make financially sound mortgage decisions, such as making the choice between a fixed-rate mortgage or adjustable-rate mortgage (ARM) or deciding whether to refinance out of an adjustable-rate mortgage. 

 The Mortgage Production Line 

The mortgage industry has three primary parts or businesses: the mortgage originator, the aggregator and the investor. The mortgage originator is the lender. Mortgage originators introduce and market loans to consumers. They sell loans. They compete with each other based on the interest rates, fees and service levels that they offer to consumers. The interest rates and fees they charge consumers determine their profit margins. The aggregator buys newly originated mortgages from other institutions. They are part of the secondary mortgage market. Most aggregators are also mortgage originators. Mortgage-backed securities are sold to investors. 

Fixed Interest Rate Mortgages 

The interest rate on a fixed-rate mortgage is fixed for the life of the mortgage. However, on average, 30-year fixed-rate mortgages have a lifespan of only about seven years. This is because homeowners frequently move or refinance their mortgages. The Federal Reserve plays a large role in inflation expectations. This is because the bond market’s perception of how well the Federal Reserve is controlling inflation through the administration of short-term interest rates determines longer-term interest rates, such as the yield of the U.S. 

Concluding Tips 

An understanding of what influences current and future fixed- and adjustable-rate mortgage rates can help you make financially sound mortgage decisions. This knowledge can help you make a decision about choosing an adjustable-rate mortgage over a fixed-rate mortgage and can help you decide when it makes sense to refinance out of an adjustable rate mortgage. 

 BLUE PRINT OF INDIA 

 The man at the midst of all the action insists that the inspiration behind the National Manufacturing Policy which aims to achieve enviable growth figures in the next few years is not inspired by our northern neighbour, China, which has sustained rapid growth as it successfully scaled up its manufacturing capabilities over the past years. Leaving the ‘inspiration’ debate aside, what’s important here is that as the man of the moment, Commerce and Industry Minister Mr Anand Sharma, gears to introduce the first ever National Manufacturing Policy to the nation, we caught up with him to bring you some exclusive insights as to what’s going on in the power corridors. 

The pace is hectic and feverish as he gets into last minute troubleshooting before the National Manufacturing Policy is unveiled. The journey from draft to blueprint is proving to be an uphill task with steep challenges. The draft manufacturing policy, which has been in the making for 18 months and aims to attract overseas investments besides increasing the share of manufacturing in the GDP, has been stuck due to inter-ministerial differences with opposition coming mainly from the labour and environment ministries. These ministries are seen to be blocking the policy, which proposes to simplify the procedure in designated areas. The draft policy had suggested that the procedures be simplified in several ministries, including Labour and Environment, where inspector raj and a plethora of approvals make life difficult for companies. 

Apparently, the Indian industry had objected to the Environment Ministry’s intervention in some of the big-ticket projects that had halted the government’s development agenda and also resulted in declining foreign direct investments. The government is also concerned about an impending slowdown in the manufacturing sector and industrial production. While the industry raised concerns on the high cost of credit, investment slowdown, skill shortage, high input cost, hurdles in getting various clearances, environmental issues and debottlenecking of logistics, the ‘tool of change’ that this new policy is slated to be, promises to act like a magic wand. 

To start with, the draft policy promises to create 100 million new jobs and take the share of manufacturing to 25 per cent in the country’s GDP by 2025. At present, manufacturing contributes 15-16 per cent to the economy. And there are actions already being taken towards achieving this national dream. States like Rajasthan, Maharashtra and Gujarat have already initiated the land acquisition process for the super manufacturing zones, known as national manufacturing and investment zones, proposed in the new manufacturing policy. 

While the prospects are plum post this policy, it remains to be seen how it is implemented and practiced…therein lies the key to our fortunes.