Monetary Policy
The responsibility for the control of money supply, bank credit, and interest rates lies with the central bank of the country, viz. the Reserve Bank of India.
The money in circulation with the public cossets of currency and coins issued by the central bank plus deposits with banks and some other depository institutions. Depending upon which deposits are being included we get different monetary aggregates which are termed M1, M2, M3 and so forth. M3 is the so called broad money and includes demand and fixed deposits along with currency and coin. Bank credit is also a measure of liquidity in the economy since banks’ ability to extend credit depends upon their ability to mobilize deposits and the cash reserves they have to maintain against these deposits. The stock of currency together with the reserves maintained in the banking system of the central bank constitutes the monetary base or high powered money. Changes in this are magnified and lead to changes in the total money stock or bank credit.
The central bank can use a variety of policy instruments to regulate the volume and cost of credit in the economy. It can lower or raise the cash reserve ratio (CRR) within specified limits to make it easier or more difficult for banks to extend credit. By engaging in open market purchases or sales of securities from its portfolio it can inject or suck out reserves enabling banks to expand or contract credit as also lowering or raising the cost of credit. It can use the discount rate – the rate it charges banks for refinancing facility and discretionary limits on refinancing facilities to influence the volume of bank credit. At times it can impose administrative controls to alter the volume and select oral composition of outstanding bank credit. Lately, the Reserve Bank of India has more or less dispensed with such administrative controls on credit and interest rates and has been relying more on open market operations and the market mechanism.
The RBI has adopted inflation control as the primary objective of monetary policy. From time to time it must also deploy the policy tools under its control to address other targets such as exchange rate and employment. Often, these objectives can conflict with each other. Thus massive capital inflows into the economy which is already awash with liquidity pose a dilemma for the central bank. If the central bank does nothing, the exchange rate would appreciate which may hurt exports; if it intervenes and buys foreign exchange to prevent this, it would have to inject additional liquidity into the system. At such times, it must trade off one target against another.
The degree of autonomy enjoyed by the central bank is an important determinant of its ability to conduct effective monetary policy and achieve credibility with financial markets. If it has to play second fiddle to the Finance ministry and accommodate government’s borrowing requirements irrespective of the resulting impact on money supply, interest rates and inflation, it loses its ability to conduct effective monetary policy. Similarly, excessive reliance on opaque administrative control mechanisms reduces its credibility with financial markets and makes it difficult to implement anti-inflationary policies or appropriate exchange rate policies. In recent years, there has been a gradual move towards granting more and more operational independence.
Some financial terms:
Macroeconomics focuses on aggregate variables such as Gross National Product, aggregate investment and saving, total employment wholesale and consumer price indices money supply and bank credit and key financial variables like interest rates and exchange rates.
Gross Domestic Product (GDP) and Gross National Product (GNP) are two widely used measures of the level of economic activity.
Per capita GDP is widely used as a measure of living standards. The World Bank classifies countries into: ‘Low Income, ‘Middle income’ and ‘High Income’. The low income countries are often referred to as the Third World.
Labels: Finance
Depreciation
Depreciation is an important item on the profit and loss account, its nature is often not properly understood by non-finance managers.
This article clarifies what deprecation is, explains the manner in which the depreciation schedule is prepared, presents information on the methods and rates of depreciation under the Companies Act and the Income Tax Act, and dispels some of the myths surrounding depreciation.
Nature of Depreciation
A fixed asset is used over a number accounting periods. So it is necessary to allocate its costs to various accounting periods that benefit from its use. Such an allocation is called depreciation. Accountants normally allocate the cost of an asset over its useful life using a well-defined procedure.
Depreciation Schedule:
Three steps are involved in calculating the depreciation schedule.
1. Determine the depreciable base.
2. Estimate the useful life of the asset
3. Choose the depreciation method
Depreciable Base: The depreciable base is the cost of the asset less its residual value.
The cost of the asset is equal to:
List price less discount
+
Taxes
+
Insurance, freight and handling
+
Installation charges
+
Interest during the construction period
The residual value (or salvage value) is the amount expected from the disposal of the asset after its useful life. Since it may not be much or difficult to estimate, it may be put at 5 per cent or so of the original cost or even completely ignored.
Useful Life: The useful life of an asset is the period over which it is expected to be used. Often it is less than the physical life of the asset because of factors such as technological obsolescence, fall in demand and legal restrictions. Estimating the useful life is largely a matter of managerial judgment.
Depreciation method: There are several methods of depreciation. The two most commonly used depreciation methods in India are the straight line method and the written down value method.
Under the straight line method the depreciable amount of the asset is allocated equally over the useful life of the asset. To illustrate, assume that a car costs Rs 500,000 and is expected to fetch a salvage of Rs 80,000 after a useful life of 7 years. The annual depreciation charge is:
Cost – Salvage value / Useful Life
= Rs 500,000 – Rs 80,000/6 = Rs 70,000
Under the written down value method, the depreciation charge for an accounting period is equal to a fixed percentage of the book value at the beginning of the period. To illustrate, assume that the cost of an asset is Rs 100,000 and the depreciation rate applicable to it under the written down method is 40 per cent. The depreciation schedule for the asset will be as follows.
Year Original Depreciation Accumulated Book value
Cost depreciation at year end
1 100,000 40,000 40,000 60,000
2 100,000 24,000 64,000 36,000
3 100,000 14,400 78,400 21,600
4 100,000 8,640 87,040 12,960
5 100,000 5,184 92,224 7,776
Depreciation for company Law and Income Tax Purposes
Unlike most other countries the methods and rates for depreciation are prescribed by law India.
Depreciation under the Companies Act; The Companies Act requires that a company that tends to pay dividend must provide depreciation in accordance with Schedule XIV of the Act. This schedule gives the rates under the straight line method and the written down value method for various classes of assets. For assets used in multiple shifts, extra depreciation has to be provided. The key rates presently are as follows:
Straight line method Writeen Down Value
Building (other than 1.63% 5.00%
factory Buildings)
Factory buildings 3.34% 10.00%
Temporary Structure 100.00% 100.00%
Furniture & Fittings 6.33% 18.10%
One shift Three shifts One shift Three shifts
Plant & Machinery 4.75% 10.34% 13.91% 27.82%
(Gen)
Note that the above rates are the legal minimum rates for determining divisible profit. The purpose of the Companies Act is to protect the creditors. It tries it ensure that companies do not overstate profits to pay large dividends to the detriment of creditors.
Depreciation for income Tax Purposes: For income tax purposes, tax payers have no choice but to follow the written down value method. The rates permitted for various assets presently are as follows:
Buildings: 5%
Plant and machinery: 25%
Vehicles on hire: 40%
Computers: 60%
Pollution control equipment: 100%
There is no concept of higher depreciation for multiple shifts under the Income Tax Act. Note that the rates prescribed under the Income Tax Act are the maximum rates that a company can claim whereas the rates prescribed under the Companies Act are the minimum rates that a company must charge.
Labels: Finance
Objectives of fringe benefits
The view point of employers is that fringe benefits form an important part of employee incentives to obtain their loyalty and retaining them. The important objectives of fringe benefits are:
1.To create and improve sound industrial relations
2.To boost up employee morale.
3.To motivate the employees by identifying and satisfying their unsatisfied needs.
4.To provide qualitative work environment and work life.
5.To provide security to the employees against social risks like old age benefits and maternity benefits.
6.To protect the health of the employees and to provide safety to the employees against accidents.
7.To promote employee’s welfare by providing welfare measures like recreation facilities.
8.To create a sense of belongingness among employees and to retain them. Hence, fringe benefits are called golden hand-cuffs.
9.To meet requirements of various legislations relating to fringe benefits.
Need for Extending Benefits to Employees
(i)Rising prices and cost of living has brought about incessant demand for provision of extra benefit to the employees.
(ii)Employers too have found that fringe benefits present attractive areas of negotiation when large wage and salary increases are not feasible.
(iii)As organizations have developed ore elaborate fringe benefits programs for their employees, greater pressure has been placed upon competing organizations to match these benefits in order to attract and keep employees.
(iv)Recognition that fringe benefits are non-taxable rewards has been major stimulus to their expansion.
(v)Rapid industrialization, increasingly heavy urbanization and the growth of a capitalistic economy have made it difficult for most employees to protect themselves against the adverse impact of these developments. Since it was workers who are responsible for production, it was held that employers should accept responsibility for meeting some of the needs of their employees. As a result, some benefits-and-services programs were adopted by employers
(vi)The growing volume of labor legislation, particularly social security legislation, made it imperative for employers to share equally with their employees the cost of old age, survivor and disability benefits.
(vii)The growth and strength of trade unions has substantially influenced the growth of company benefits and services.
(viii)Labor scarcity and competition for qualified personnel has led to the initiation, evolution and implementation of a number of compensation plans.
(ix)The management has increasingly realized its responsibility towards its employees and has come to the conclusion that the benefits of increase in productivity resulting from increasing industrialization should go, at least partly, to the employees who are responsible for it, so that they may be protected against the insecurity arising from unemployment, sickness, injury and old age. Company benefits-and-services programs are among some of the mechanisms which managers use to supply this security.
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Labels: Finance
Basics of capital market
The capital market consists of primary markets and secondary markets and there is a close link between them. The primary market creates long-term instruments through which corporate entities raise capital. This is also referred to as the new issue market. But secondary market is the one which provides liquidity and marketability t the instruments created in the primary market by providing an arena for the buying and selling (trading) of these securities.
Primary Market
Primary markets facilitate the formation of capital. This market generally referred to as the market for mobilization of resources by the companies and government. When a company wishes to raise capital by issuing securities, it goes to the primary market, where issuers exchange financial securities for long-term funds. No elements of trading in primary market operations and investors apply through applications and subscribe directly to equity / debt of a company.
Ways of raising capital in Primary Market.
*Public issue
*Rights issue
*Private placement.
*Bought-out deals.
Public issue involving the sale of securities to the public is the most important mode of raising long-term funds. Rights issue is the method of raising further capital fro the existing shareholders by offering additional securities to them on pre-emptive basis. For both public issue and rights issue SEBI has prescribed the prospectus contents and abridged prospectus requirements which should be accompanied by each applicationform.
Private placement is a way of selling securities by a company to one or few investors, and the terms of issue are negotiated between the company (issuing securities) and the investor. In private placement market, securities are sold, mainly to institutional investors like UTI, mutual funds, insurance companies (LIC and GIC) etc. SEBI has now prescribed a lock-in period for securities which are privately placed.
A bought-out deal is a process whereby an investor or a group of investors buy out a significant portion of the equity of an unlisted company with a view to taking it to the public in an agreed time frame.
Secondary Market
Secondary market is a market where securities created in primary market are traded. It provides liquidity to the securities issued in primary market. The secondary market operates through the medium of stock exchanges which regulates the trading activities in the market and ensures a measure of safety and fair dealing to the investor.
Ever since the decade of eighties there has been an unprecedented growth of the stock markets. The number of stock exchanges in the country increased from 8 in 1980 to 22. I addition, there are Over the Counter Exchange of India and National Stock Exchange (NSE). The twenty two stock exchanges are located at Mumbai, Calcutta, Delhi, Madras, Ahmedabad, Bangalore, Hyderabad, Indore, Pune, Kanpur, Cochin, Ludhiana, Mangalore, Patna, Guwahati, Bhubaneshwar, Jaipur, Saurashtra, Surat, Baroda, Coimbatore and Rajkot. These are referred to as Regional Stock Exchanges.
The stock exchanges in India are regulated under the Securities Contracts (Regulation) Act which was passed in 1956. Under this Act, Government has powers to supervise and control the stock exchanges and also keep a check on the governing body and supercede it if any irregularities are found committed.
The first Indian stock exchange established at Mumbai in 1875 is the oldest exchange in Asia. The Mumbai Stock Exchange represents two-thirds of the whole trading volume of the secondary market.
Securities and Exchange Board of India (SEBI), an autonomous body oversees the functioning of the securities market and the intermediaries like Brokers, Portfolio Managers, Investment Advisors and Transfers Agents etc.
Labels: Finance
Start early, however little you invest
That is the core advice for DNA Money reader Vikrant Ranade |
Balvir Chawla |
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Vikrant Ranade, 29, is working with Countrywide as a system administrator. He is married and has two sons, Aaryan and Eshaan, who are twins. He has been working with this organisation for the past two years and believes he has a good future with the company. He is expecting a decent rise this year-end when his salary is due for appraisal. At present, he is drawing a salary of Rs 20,000 p.m. and expects a rise of around 30% in the next financial year. Due to the responsibilities and the purchase of a house, Vikrant is left with low savings.
Financial goals
Vikrant is full of dreams and has the will to succeed. He believes that if he dreams big and plans for it, he will definitely achieve it. He plans to buy a car next year by selling off his existing car. He has his eyes set on making a second property, which he wants to be in the form of a penthouse. Also, being from a Brahmin family, he plans to hold his son’s thread ceremony with pomp and fanfare, three years from now. He also has to plan for his children’s education and his retirement.
Present situation
Vikrant is drawing a salary of Rs 20,000 p.m. and his wife is drawing a salary of Rs 2,000 p.m. The EMI for his house property at Panvel is Rs 9,272. This is at a fixed rate for a tenure of 20 years. He has an insurance policy for his kids for which he is paying a premium of Rs 2,717. The other financial details are as follows:
Investments
Mutual funds Rs 1,30,000
(Rs 1 lakh for kids’ education)
Provident fund Rs 20,000
FD & cash Rs 15,000
Assets
House Rs 25,00,000
(Bought at
Rs 15 lakh)
Valuables Rs 1,50,000
Liabilities
House loan Rs 9,50,000
His monthly expenses amount to Rs 10,700. The EMI on his housing loan is Rs 9,272.
Analysis of present situation
Expenses
Vikrant is paying nearly 50% of his salary as EMI. But, over a period of time, this EMI will remain constant and his salary will increase. His expenses on self, accessories and telephone are around Rs 3,500, which is on the higher side. He should try and reduce these expenses and start with a monthly saving plan for investment, however small the amount. Starting a systematic investment plan with a good diversified equity fund would be the ideal way to get started.
He should try and avoid using his wife’s salary and use this amount to save for a longer term.
Insurance
Vikrant is inadequately insured. His insurance requirement is a minimum of Rs 25 lakh for which he can take a term insurance cover, which won’t cost him more than Rs 7,500 p.a. If Vikrant is not covered for mediclaim from his company, he should cover his family under a mediclaim policy for a cover of around Rs 3 lakh for the complete family.
Achieving financial goals
Purchasing car
Purchasing a car can be avoided till some basic investments and cushions have been created. He can probably defer the decision by a year and accumulate the amount to minimise the loan for the new car. At any point, all his EMIs should not exceed 35% of his salary. His salary increments can be used to fund the purchase of his car. He should try and save around 75% of the increase, i.e. if his salary reached Rs 3.25 lakh, then he has an increment of Rs 85,000 and he should try and save around Rs 5,000 p.m. for the next two years to generate a corpus of Rs 1.50 lakh, assuming a return of 15% p.a.
Kids’ thread ceremony
Vikrant needs Rs 1 lakh in three years’ time for the thread ceremony of his children. To reach this figure, he will have to save Rs 2,200 per month, assuming a return of 15% p.a. on the investments. He can start saving his wife’s salary for this purpose and he will definitely reach a figure of Rs 1 lakh.
Penthouse
This goal of Vikrant is 5 years away and assuming his existing house will appreciate @ 10% p.a. for the next 5 years, the value of his existing house will become Rs 44 lakh and his loan amount outstanding will be around Rs 8,50,000. So the amount he can generate from selling his house will be around Rs 31.50 lakh, which can be used as down payment and the balance can be funded through a loan.
Conclusion
Small drops make an ocean. So, Vikrant should start small, remain disciplined and enjoy the fruits of his investments. A start has to be made and it is important for Vikrant to make the beginning as soon as possible. Once he gets into the habit of investing and controlling the expenses, he will have a more clear idea of investments and can also target his future goals and achieve them. Increments at any stage should be used to create assets besides any money coming in bonus or any other form.
Assumptions
The recommendations have been made based on the information provided.
(Source: DNA 11/19/2007)
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Labels: Finance
What is reverse mortgage?
and Reverse mortgage is one of several financial instruments that convert home equity into cash. There is already a fairly developed market for such products in the United States and other developed countries, but, so far, it has been introduced in India by only two entities – the country’s second largest home finance company, Dewan Housing Finance Corporation LimitedPunjab National Bank. A host of other banks are also planning to introduce similar products. In the US, these products are a big rage among the elderly and those nearing retirement. But then, what is reverse mortgage? This article provides an overview.
Home equity conversion products are useful to all those who are “house-rich but cash-poor” and they need not necessarily be only the elderly. There are many types of such products and where the market has attained some maturity, as in the United States, standard reverse mortgage products often incorporate one or more of these variations as options. Some of these options are:
- Reverse Mortgage: discussed in detail in later paragraphs
- Home Reversion / Sale and Lease Back: The homeowner sells his house outright now, but retains the right to live in it for life for a nominal/reduced rent. The sale proceeds may be paid in a lump sum or as an annuity. This could very well be an intra-family transaction.
- Interest-only Mortgage: This could be useful to those who are in need of an immediate lump sum, but still have only limited loan-servicing capacity. During the tenure of the loan, the borrower is required to make only interest payments. The principal is due only on maturity or death or a permanent move or sale.
- Mortgage Annuity/ Home Income: This is suitable for the very old for whom life annuity rates are more attractive. The loan amount is used to buy a life annuity. The mortgage interest is deducted from the annuity and the balance is paid as periodic income. The principal is repaid on death or sale of the house. The attraction is that the annuity will continue even if the borrower sells the house or moves out permanently
- Shared Appreciation Mortgage: This provides loans at a below market interest rate. The loan is repaid at death or moving or sale. In return, the lender gets a pre-agreed share in any appreciation in the property value over the accumulated value of the loan.
As must be obvious from the above, the basic idea of home equity conversion products is to enable those having a house property but not enough cash to get cash against the property without having to bear the burden of repayment of the cash received. The idea is that after the death of the home owner, the house property is owned by the lending institution which sells it off to recover the loan amount and the interest where the interest rate is similar to housing loan interest rates.
Reverse mortgage, specifically, works like this: in a conventional mortgage loan, the borrower starts with a large loan and low equity in his/her house and as he/she repays the loan through monthly instalments, the borrower reduces his/her outstanding loan amount and increases his/her house equity.
In reverse mortgage, on the other hand, the borrower starts with a very high equity in his house. The lender extends a non-recourse loan secured by the house property. The borrower may choose to receive the proceeds through:
- A lump sum at the beginning
- Monthly payments till a fixed term or a life-long annuity
- Establishing a credit-line with or without accrual of interest on credit balance
- A combination of the above
The borrower need not move out of the house or make any payment to the lender, as long he is alive and continues to live in the house or does not sell it. Therefore the loan and interest accumulates till maturity. There is no credit or income requirement to be satisfied. Even if the accumulated loan and interest goes above the realizable value of the house at disposal, the repayment is capped at that value only. Hence RM is a case of ‘raising debt, falling equity’.
Usually, the amount of loan is determined by:
- Age of the borrower and any co-applicant (life expectancy/ mortality risks)
- The current value of the property and expected property appreciation rate (real estate market risk)
- The current interest rate and interest rate volatility (interest rate risk)
- Closure and servicing costs
- Specific features chosen: fixed or floating interest; shared appreciation; interest earning credit-line; and mortgage insurance, if any
There is conceptually nothing in the reverse mortgage idea to restrict it only to the elderly. But the product is particularly suited for old people in fact, the older a person is, the more attractive reverse mortgage (RM) is. The reasons are:
- RM requires near total equity ownership of the house – more likely for ages above 50 (unless the property is inherited)
- It is attractive only to people with insufficient current income and little financial savings – by implication, retired persons
- For a given property value, the lower the life expectancy (older the person is), higher is the additional income through an RM.
- Public policy support including tax incentives is more likely if the borrowers are the elderly.
- The elderly are particularly likely to attach significant psychological/ emotional/ sentimental value to ‘ageing in place’ without moving out. In fact, the longer they have stayed in their current home, the more valuable this is likely to be, considering the benefits of a familiar neighbourhood.
With more and more instances of elderly people being thrown out of their homes by their children being reported in the newspapers, perhaps the time has come for introducing RM in India in a big way!
Labels: Finance
