The document provides a summary of the 95th issue of the financialdharma newsletter. It discusses the following key topics: - The significance of the Urjit Patel Committee report on adopting inflation targeting in India's monetary policy framework. - Rising income inequality globally and in India based on Gini coefficient measurements. - Moody's warning about India's ability to absorb rising government debt if economic growth remains low and inflation high. - Using debt funds to strengthen investment strategies by considering bond duration and interest rate outlook.

1. financialdharma
Dear Readers:
This 95th issue of financialdharma explains the
significance of RBI’s Urjit Patel Report, rising income
inequality, currency outlook during tapering, Moody’s
warning on government debt and use of debt funds in
strengthening investment strategy.
India’s economy is mired in its sharpest downturn for a
decade with economic growth rate hitting a new decade’s
low of 4.5% in the fiscal year 2012-13. This reflects a
much slower pace than the 5% estimated earlier due
mainly to a sharper-than-projected slowdown in
construction and mining, as well as an upward revision of
growth data for the previous fiscal year. Some of this drop
in growth numbers can be attributed to high borrowing
costs, stalled investments and high inflation. In reading
this situation one needs to keep in the possibility of 201213 numbers being revised upwards when ASI data is
released. That has been the trend for last few years.
Sincerely,
SSK
E: ssrikrishna@shubasri.com
SSK is an accomplished CA with extensive experience in
financial management with reputed organizations such
as Indal, Tatas, Wipro/GE Healthcare, Motorola and
Reliance. He has led several initiatives to transform the
financial and business results in these organizations. He
currently focuses his efforts in disseminating financial
literacy, mentoring and consulting services.
1 Copyrights reserved
A Fortnightly Financial Bulletin Friday January 31, 2014
 Financial Gyaan- Key
takeaways in RBI’ s
Urjit Patel Report
 Income inequality rises
 Crystal gazing –The
currency outlook
during tapering
 Moody’s warning
 Jargon Buster: Gini
coefficient
 Use debt funds to
strengthen strategy
in
A large majority of financial
crises that occurred between
1982 and 2008 have been
preceded by persistently high
levels of income inequality.
Income inequality is measured
by the Gini coefficient (which is
0 when everybody has the
same income and 1 when one
person has all the income). The
gap between rich and poor in
OECD countries had widened
continuously over the three
decades to 2008, reaching an
all-time high. India has the
highest income inequality at
0.54, which 50% higher than
other OECD countries and
Japan the lowest at 0.25. New
OECD data show that the global
economic crisis has squeezed
incomes from work and capital
in most countries. The pain of
the crisis was not shared
evenly. There is no co-relation
between economic growth and
changes in inequalities. But
there is a suggestion of positive
relationship
between
GDP
growth and rises in inequality.
The key takeaway in the Urjit Patel committee’s report is
about adopting inflation-targeting as a policy in the RBI’s
monetary policy framework. Inflation targeting is an economic
policy in which a central bank estimates and makes public a
projected, or "target", inflation rate and then attempts to steer
actual inflation towards the target through the use of interest
rate changes and other monetary tools. The committee
argues that as high inflation makes real interest rates
negative, households invest more in gold and less in financial
assets; the high gold imports cause a CAD problem and with
the rupee going for a toss, this also results in a balance sheet
problem for India Inc and the banks that have lent to it. The
other important takeaway from the report is its
recommendation for setting up a five-member monetary policy
committee which will meet once every two months to decide
on the monetary policy. If this committee is not able to achieve
the inflation target for three successive quarters, it will be
assumed that it has failed. In this case, it will have to issue a
statement explaining why it has failed besides proposing
actions to achieve the target and laying out a road map over
how many quarters it expects the inflation drops to the desired
level. According to the Urjit Patel report, the conduct of
monetary policy should be consistent with a sustainable
growth trajectory and financial stability only after establishing
and achieving the nominal anchor i.e., the targeted inflation.
This means RBI’s top priority will be containing inflation and
economic growth will feature on its radar only after this aim is
met. The acceptance of this report is key to fighting inflation.

2. financialdharma
an
Use
debt
funds
strengthen strategy
to
The mutual fund data from 2013 clearly
shows that investors were making their
debt fund allocations around market
sentiment. In reaction to the fall in
inflation index, the yield on the 10-year
8.83% 2023 government securities has
fallen from around 8.65% to 8.57%.
Market experts opine that the 10-year GSec yield could fall to 8% by the end of
the calendar year. Rate cuts are not likely
in the near future as confirmed by the
recent RBI’s monetary policy. The core
consumer price index (CPI) is still high;
once we see that coming lower, we may
see the rate cycle turn. Many believe that
we may be at the peak of the interest rate
cycle and, hence there are gains to be
made in the future. But it could take at
least 6 months to a year or more for this
view to materialize. As bond prices are
inversely linked to interest rates, when
rates in the economy fall, the price of an
existing bond rises. Risk is always there;
the way to consider your debt fund
allocation is to first segregate funds
according to their characteristics. Debt
funds do not necessarily mean all fixed
income funds. Duration is a measure of
how sensitive the price of a bond is to
change in interest rate, and is expressed
in years. Longer the maturity of a bond,
the higher is its duration. And higher the
duration, the more sensitive is the bond’s
price to the fall in interest rates. If one
wants to make a more opportunistic
investment, investors should look at long
2 Copyrights reserved
duration income funds and gilt funds after
considering both risk and returns.
A Fortnightly Financial Bulletin Friday January 31, 2014
Gini coefficient is commonly
used as a measure of inequality
of income or wealth It is a
measure of statistical dispersion
intended to represent the
income distribution of a nation's
residents.
This
coefficient
measures the inequality among
values
of
a
frequency
distribution. A Gini coefficient of
zero expresses perfect equality,
where all values are the same
(for example, where everyone
has the same income). A Gini
coefficient of one (or 100%)
expresses maximal inequality
among values (for example
where only one person has all
the income). Some persons
may have negative income or
wealth, in which the value may
be greater than one. The index
is named after its developer,
Corrado
Gini,
an
Italian
statistician of the early 20th
century. It is typically expressed
as a percentage, so a 20
coefficient would be shown as
"
20%.
in
The Indian financial system’s
ability
to
absorb
rising
government debt could diminish
significantly if the combination of
low economic growth and high
inflation persists. Between 200203
and
2012-13,
India’s
government
debt
as
a
proportion of GDP fell to 66%
from 83%, despite a fiscal deficit
that averaged 7% over that
period. The drop in the
government debt-to-GDP ratio
was due to government debt
and interest payments growing
at a slower pace than nominal
GDP growth. Moody warned in a
report that if growth slows
significantly and inflation and
interest rates remain high,
government debt will revert to
the high levels seen in 2000,
unless the fiscal deficit is
reduced significantly from the
average of the last decade.
Thus, growth, inflation, interest
rate, and fiscal policy trends
over the next 12-18 months will
determine the sovereign credit
profile for the next 3-5 years.
QE tapering is detrimental to the economy particularly when a lot of easy
money is flowing out from emerging markets. This easy money turbulence is
a possibility that one must be wary about. The $10 billion per month
reduction in December was met with relative equanimity by the markets. But
a further $10 billion a month has evoked a completely different reaction.
Strikingly, while the Indian rupee was amongst the hardest-hit currencies
when the idea of a taper first emerged last May, it has been amongst the
most stable this time around. This should provide enormous comfort to both
policymakers and investors, who had to deal with the extreme pressure on
the currency then. In May, the economy's CAD deficit stood at 4.8% of GDP
during 2012-13. Thus, the daily demand for dollars far outstripped the
decreasing and more volatile inflows that the taper announcement
engendered. Persistently high demand and a falling and uncertain supply is
the recipe for rapid currency depreciation. While many measures were taken
by the RBI and the government to stem situation, three factors seem to have
contributed to the sharp decline in the CAD- restrictions on gold imports;
pickup in exports; and the sluggish growth and investment situation has
resulted in a sharp drop-off in imports. Overall, the vulnerability to the
currency caused by the narrowing of the CAD has declined significantly and
this is being reflected in the rupee's comparative stability. These
developments however do not guarantee permanent protection to the rupee.
The extent that tapering reflects a stronger US economy. Thus the prospects
of US recovery will keep export prospects bright, but high inflation and the
depreciation in currencies of competing exporters will quickly erode the
rupee's competitive advantage. Continuing sluggishness in growth could lead
to fiscal deterioration which would exert intense pressure on the rupee.