The square rooted path to recovery

It has been almost a year since the Lehman collapsed and the world economy is still in its path to recovery. Speculations have been there about the path the recovery is going to take which is giving bulls the sleepless nights and economists are wary of predicting the new path the recovery is going to take. The recovery path charted out seems to be a square root shaped curve with every measure and indicator being back somewhat halfway of the normal level and then what seems to stay at a constant level for sometime. The global market capitalization fell from $75 trillion to $35 trillion post Lehman and market has now recovered $20 trillion of its value. In India sensex closed to 16454.45 after a fall from 21000, an increase in the excise collection over 22% for this month over the previous month and recovery of about $11 billion from the $12 billion capital outflows are a strong indicator that the economy is on its way back despite some hiccups but it is still a long way to say that it will bounce back to the previous levels. Emerging markets particularly the BRICs have returned to their pre Lehman levels but developed ones are still far below. These indicators support the fact about a slow recovery which still does not have the substance and the strength to take it upwards and to bring it back to the same level. For now the best way could be a pervasive action instead of waiting and watching economy bounce back and forth.

Contributed by:-

Divyank Gupta

Money by Magic!!

In the wake of recession, Central Banks around the world are scrambling to increase money supply to boost spending and ease terms of credit. One way is through Borrowings: internal and external but they are weighed down by unwillingness and high terms of credit. Another instrument is Quantitative Easing which literally means reducing the monetary burden by creating more money.



Traditionally, Banks lower interest rates to stimulate economy but with interest rates inching to near zero levels, the method has limited application. Quantitative Easing is a policy where Central Banks purchase government and corporate bonds (issued by Banks), financial assets etc.

As the supply of bonds decrease it increases their price. Consequently, their utility as an attractive investment option shrinks or the yield on bonds diminishes. Hence, the Banks that sold the bonds are flush with excess money and they can lend the money to individuals or businesses as the yield on bonds is lower. This results in greater and easier access to credit and spurs economic activity.
Alternatively, for an economy unilaterally pursuing Quantitative Easing can be negative. For example, for US if too much money is created, it will lead to inflation or even hyperinflation. With rising inflation, investors will search for other financial instruments like gold or other currencies which could weaken dollar.
Quantitative Easing was first used by Central Bank of Japan to counter deflation. Lately, both US and UK have used it vigorously. The Bank of England has announced its intention to increase its exposure to £175 billion of which £125 billion has already been created. Central Banks across the world are taking proactive steps to negate recession, but will they it out to be a magic wand or a hex, can only be conjured.

Contributed By:

Ankit Agarwal

Playing the Weather Game

Today weather is not just an environmental issue – it is a major economic factor, more so if the economy is agriculture driven as is the case with India. It has an impact on corporate revenues and earnings of virtually every industry, including agriculture, energy, entertainment, construction, travel and many others. Until recently, there were very few financial instruments which could help companies in hedging against weather risks. However, since the inception of the weather derivative, things have changed.
In contrast to insurance, weather derivatives cover low risks and high probability events as per certain customised policies. Currently, energy companies and energy-related businesses use Weather Futures. However, there have been growing concerns and signs of potential growth in weather futures trading among agricultural firms and companies involved in tourism and travel as well. As such, India also has witnessed a welcome response to weather derivatives owing to the fluctuations in weather conditions. In India, Rainfall insurance has wide spread implications because despite the technological advancements, India has to depend on monsoon rains, with lack of irrigation. Still, it has been most often used in the U.S. and the U.K.
No doubt, this form of derivative trading is highly applicable in context with the present scenario but this carries along with it certain disadvantages as well for the daily models on the flip side of the coin. It may be as follows:
• Complexity of the model
• Risk of model error due to more complexity in the structure.
• Modelling daily temperature which is no less than a herculean task
Thus, in spite of the above mentioned flaws in the system, chances are high that weather derivatives shall help countries redeem themselves from the clutches of the mercurial rains and work towards strengthening of the economies, thereby, giving a fillip to droughts and floods.

Submitted By:
Ritika Yadav

Subsidies - The Double Edged Sword

Subsidies are a double-edged sword which every country professes to promote in the domestic economy but not without negative implications. Basically, subsidies are a form of financial assistance granted by the Government to a business or an economic sector (Source:Wikipedia). The most important effect of subsidies on the economy is the income redistributive effect. Subsidies are expected to provide some kind of monetary benefit to the underprivileged section of the society, thereby increasing their welfare. However, there could be other types of subsidies, which need not necessarily result in income redistribution: for example, export subsidies. These are typically given to encourage export oriented units, who would otherwise (i.e., without the benefit of subsidy) have to charge much higher prices because cost of production may be high due to smaller scale of production etc. If they charge higher prices, they will lose market and hence will die. So sometimes subsidies are provided to help some specific types of industries, because, they are supposed to lead to larger economic gains like increased foreign exchange earnings etc. Further, there could also be hidden subsidies like tax holidays for export oriented units or emerging sectors in the economy.

Notwithstanding whichever type of subsidy, they will all ultimately lead to resource redistribution in some or the other form. To illustrate it with an example, lets assume that an investor has 2 crore, which she intends to invest in some industry. Now, there are two options available to her : one, in an industry which doesnt receive any subsidy (eg: opening a motor car dealership) and two: an industry which involves some kind of subsidy ( eg. cold storage unit). It is most likely that the investor will choose to invest in the industry which enjoys a subsidy because her income will be more from the subsidized industry. Therefore, investments generally tend to flow to those areas, which have some kind of subsidy. But, considering the situation when the economy needs more motor car garages than cold storage, even though subsidies are available for cold storage, then investment is likely to flow to cold storage than motor car garages, though the other way would have been more desirable. So at times, the subsidies tend to alter the flow of resources to certain sectors from their competing sectors.

Usually, therefore, subsidies are given to those sectors, which the policymakers think need to have greater resource flow.

Since subsidies usually have income redistributing effects, they are widely favoured as a policy choice. If properly designed and implemented, subsidies can give a big boost to an industry or a sector (for instance, tax holiday to software exports led to the software boom in India).

However, subsidies are harmful, if they are poorly targeted or do not reach the intended beneficiaries. Two examples of this are the food subsidy and the fertilizer subsidy granted by the Government of India.

In case of food subsidy, the Government buys food grains at higher prices (called Minimum Support Prices). It enables the farmers to receive higher income, and then sell the same grains at lower prices (called Common Issue Prices) to poor people. Since it buys at higher price and sells at lower price, the difference will have to be borne by the Government as subsidy. This subsidy is called food subsidy. The annual food subsidy bill amounted to Rs 43627 crore in 2008-09 (Source:Public information bureau release). However, just 42% of the deserving people are benefited by it, according to a Planning Commission study released in 2008. A major portion of the allotted money is consumed in the system itself for example, the carrying costs of the Food Corporation of India.

Like-wise, in case of fertilizer subsidy also, it goes to support inefficient fertilizer companies (mostly public sector units). So, the two most important subsidies in India accounting for 4% and 3.5% of the GDP respectively are actually wastage of public money.

Moreover, if subsidies are financed by debt, the Government's debt liability increases. When the debt liability of the government increases, after a certain point, the Government's major part of revenues will go for interest payments, thereby leaving very little scope for developmental work. So subsidies have many drawbacks, if they are not implemented properly. This has led to lot of criticism against the subsidies in India and also across the world.

Submitted By:

Seeona Pani