What global crisis means for India While India must eventually liberalise its financial sector, we must

err on the side of caution. Main Street reforms promise much better prospects of multiplying well-paid jobs for India's poor, says Arvind Panagariya.

THE current economic crisis, which originated in the financial sector of the United States, is being transmitted to the countries around the world through three principal channels. First, it has directly impacted the balance sheets of financial institutions that invested in the mortgage-backed securities and their derivatives, which turned toxic following large-scale defaults in the US housing market. In Asia, Korean banks suffered the most, requiring a $130 billion bailout package. Second, the crisis has created a liquidity crunch. The US firms seeking liquid resources massively withdrew their investments in stocks and bonds in other countries. The resulting decline in the prices of bonds and stocks also led local investors to pull back from the market. Both factors contributed to the tightening of credit. Reinforcing these factors was the return of the local firms, which had previously borrowed in foreign markets, to the domestic market. These firms saw the foreign markets suddenly dry up. The final source of transmission of the crisis has been the real sector now frequently referred to as the 'Main Street' in the United States. The financial crisis coincided with the creeping recession in the United States and made it worse. That has meant a cut in the US demand for imports from other countries. Thanks to the former RBI governor, Dr Y V Reddy, India almost entirely escaped the devastation of the financial sector wrought by the crisis in countries such as Korea. The finance ministry, while paralysed on numerous urgent Main Street reforms, has been actively pushing for deregulation in the financial sector. In this effort, it has found an unlikely ally in the Planning Commission. Unable to focus on and deliver in its core areas, infrastructure and social services, the commission has increasingly and proactively ventured in areas outside its jurisdiction. Thus, last year, it appointed a high level committee on the financial sector, which predictably called for progressive opening up of the sector. Luckily, governor Reddy withstood these pressures, carefully regulating investment activities of Indian commercial banks. To fully appreciate the importance of prudent regulation of the financial sector, briefly consider the origins of the current crisis. Under a largely unregulated environment, mortgage lending to subprime borrowers had rapidly expanded in the United States in the 2000s. By definition, subprime borrowers either have prior default history or lack incomes to qualify for the loan they seek in the prime market. Therefore, they carry high risk of default. Interest rates in the subprime market exceed those in the prime market by 2 to 3 percentage points. Because lenders could sell the mortgages they issued to other financial

institutions such as Goldman Sachs or Lehman Brothers, they were emboldened to lend to ever-riskier borrowers. These institutions in turn packaged a large number of the mortgages into a mortgage-backed security (MBS) and issued bonds of varying risks and returns backed by it. Bonds with highest return would also carry the highest risk: if default occurred on some of the mortgages in the MBS, holders of these bonds would be the first to experience a cut in payments. At the other extreme, bonds with the lowest return would carry the lowest risk — payments on them would be the last to stop. Financial institutions further packages MBS backed bonds of different ratings into collateralised debt obligations (CDOs) and sliced them yet again into secondary CDOs of varying risk and returns (along the lines of MBS backed bonds). FINANCIALinstitutions and even individuals around the world invested in these instruments. As long as the US housing market boomed, mortgage-default rates remained low and various mortgage-backed instruments remained attractive investments. But once the housing market tanked, the instruments turned toxic and their holders saw their balance sheets go into red. Under the watchful eye of governor Reddy, only $1 billion worth of Indian investments could slip into these assets. The lesson of this experience is that while India must eventually liberalise its financial sector, we must err on the side of caution. Modern-day 'wizards' in the financial sector have the talent to 'innovate' products that even the most sophisticated analysts are unable to evaluate. Thousands of individual investors in Singapore, Hong Kong and Taiwan recently took to the streets to protest against the implosion of US-based securities that The Economistdescribed as being characterised by "fiendish complexity." Mindless deregulation in this sector has greater chance of creating egregiously high emoluments for a few (and a crisis) than significant gains for the masses. Main Street reforms, on the other hand, promise much better prospects of multiplying well-paid jobs for India's poor. While India has largely avoided being impacted by the first channel of transmission of crisis, it has not escaped the remaining two channels: It faces a temporary liquidity crunch as also a decline in the export demand induced by the global slowdown. To combat liquidity crunch, the RBI must continue working towards restoring confidence in lending and injecting liquidity. It must dispel the fear of lending that currently engulfs the banks. The impact of the recession in the United States and Europe, which has also slowed down China, now an important trading partner of India, is likely to remain with us longer. I have maintained for some months now that absent Main Street reforms and accelerated build up of infrastructure, especially power, India will take a cut of two percentage points in the growth rate this year and the next bringing the growth rate to 7%. This is not a catastrophe but it does setback our efforts to rapidly eliminate poverty. On the positive side, we can take some comfort in the thought that the current crisis is not about to turn into the Great Depression of the 1930s. At the height of the Great Depression, the unemployment rate in the United States had exceeded

25%. Currently, it stands at 6.5% and is predicted to peak around 8% in mid 2009. Dear Friends, This is a nice data collection and could be of use to understand much talked about global financial crisis and crashing of stock market etc. This is related to USA and unfortunately, such data's are not shared with public in India to avoid panic and lesser public education, so that we group in the dark. May be, my understanding is poor, due to my limited knowledge in these matters. Being graphical, one can just see and understand than reading numerical data.

RISING COMMODITY PRICES

GLOBAL BANK LOSSES

Banks and other financial institutions could lose $1 trillion from the credit crisis as mortgage-backed assets have lost most of their value.

Banks have already written off nearly $500bn worth of assets but the IMF points out that they have only been able to raise new capital to cover about two-thirds of those losses, so the likelihood is that they will have to restrict their lending further than they already have done in the last year (See Frozen Credit Markets chart below). FROZEN CREDIT MARKETS

COLLAPSING HOUSING MARKETS Underlying the financial market wobbles is a real decline in US house prices nationwide for the first time since the 1930s.

JITTERY STOCK MARKETS Stock markets around the world - from Shanghai to London - have plunged, while in the US the Dow Jones industrial average has made big losses this year.

THE TIGHTENING SQUEEZE

Figures show change in prices June 2007 to June 2008 for petrol and food, July 2007 to July 2008 for housing

THE FUEL SQUEEZE

THE FOOD SQUEEZE

THE PROPERTY SQUEEZE

INFLATION AND JOBLESS ON THE UP

Government inflation target up to Dec 2003 was RPIX 2.5%, since then CPI 2%

SPENDING MONEY SLOWDOWN

The US sub-prime mortgage crisis has led to plunging property prices, a slowdown in the US economy, and billions in losses by banks. It stems from a fundamental change in the way mortgages are funded. THE NEW MODEL OF MORTGAGE LENDING [ ] How it went wrong

Traditionally, banks have financed their mortgage lending through the deposits they receive from their customers. This has limited the amount of mortgage lending they could do. In recent years, banks have moved to a new model where they sell on the mortgages to the bond markets. This has made it much easier to fund additional borrowing, But it has also led to abuses as banks no longer have the incentive to check carefully the mortgages they issue. THE RISE OF THE MORTGAGE BOND MARKET

In the past five years, the private sector has dramatically expanded its role in the mortgage bond market, which had previously been dominated by government-sponsored agencies like Freddie Mac. They specialised in new types of mortgages, such as sub-prime lending to borrowers with poor credit histories and weak documentation of income, who were shunned by the "prime" lenders like Freddie Mac. They also included "jumbo" mortgages for properties over Freddie Mac's $417,000 (?202,000) mortgage limit. The business proved extremely profitable for the banks, which earned a fee for each mortgage they sold on. They urged mortgage brokers to sell more and more of these mortgages. Now the mortgage bond market is worth $6 trillion, and is the largest single part of the whole $27 trillion US bond market, bigger even than Treasury bonds. HOW SUB-PRIME LENDING AFFECTED ONE CITY
THE SUB-PRIME CRISIS IN CLEVELAND

(X)
Sub-prime lending

()
Black areas

()

Foreclosures (repossessions)

( Deutsche Bank properties )

For many years, Cleveland was the sub-prime capital of America. It was a poor, working class city, hit hard by the decline of manufacturing and sharply divided along racial lines. Mortgage brokers focused their efforts by selling sub-prime mortgages in working class black areas where many people had achieved home ownership. They told them that they could get cash by refinancing their homes, but often neglected to properly explain that the new sub-prime mortgages would "reset" after 2 years at double the interest rate. The result was a wave of repossessions that blighted neighbourhoods across the city and the inner suburbs. By late 2007, one in ten homes in Cleveland had been repossessed and Deutsche Bank Trust, acting on behalf of bondholders, was the largest property owner in the city. THE CRISIS GOES NATIONWIDE

Sub-prime lending had spread from inner-city areas right across America by 2005. By then, one in five mortgages were sub-prime, and they were particularly popular among recent immigrants trying to buy a home for the first time in the "hot" housing markets of Southern California, Arizona, Nevada, and the suburbs of Washington, DC and New York City. House prices were high, and it was difficult to become an owner-occupier without moving to the very edge of the metropolitan area.

But these mortgages had a much higher rate of repossession than conventional mortgages because they were adjustable rate mortgages (ARMs). The payments were fixed for two years, and then became both higher and dependent on the level of Fed intereset rates, which also rose substantially.

Consequently, a wave of repossessions is sweeping America as many of these mortgages reset to higher rates in the next two years. And it is likely that as many as two million families will be evicted from their homes as their cases make their way through the courts. The Bush administration is pushing the industry to renegotiate rather than repossess where possible, but mortgage companies are being overwhelmed by a tidal wave of cases. THE HOUSING PRICE CRASH

The wave of repossessions is having a dramatic effect on house prices, reversing the housing boom of the last few years and causing the first national decline in house prices since the 1930s. There is a glut of four million unsold homes that is depressing prices, as builders have also been forced to lower prices to get rid of unsold properties. And house prices, which are currently declining at an annual rate of 4.5%, are expected to fall by at least 10% by next year - and more in areas like California and Florida which had the biggest boom. HOUSING AND THE ECONOMY

The property crash is also affecting the broader economy, with the building industry expected to cut its output by half, with the loss of between one and two million jobs. Many smaller builders will go out of business, and the larger firms are all suffering huge losses. The building industry makes up 15% of the US economy, but a slowdown in the property market also hits many other industries, for instance makers of durable goods, such as washing machines, and DIY stores, such as Home Depot.

Economists expect the US economy to slow in the last three months of 2007 to an annual rate of 1% to 1.5%, compared with growth of 3.9% now. But no one is sure how long the slowdown will last. Many US consumers have spent beyond their current income by borrowing on credit, and the fall in the value of their homes may make them reluctant to continue this pattern in the future. CREDIT CRUNCH

One reason the economic slowdown could get worse is that banks and other lenders are cutting back on how much credit they will make available. They are rejecting more people who apply for credit cards, insisting on bigger deposits for house purchase, and looking more closely at applications for personal loans. The mortgage market has been particularly badly affected, with individuals finding it very difficult to get non-traditional mortgages, both sub-prime and "jumbo" (over the limit guaranteed by government-sponsored agencies). The banks have been forced to do this by the drying up of the wholesale bond markets and by the effect of the crisis on their own balance sheets.

BANK LOSSES

The banking industry is facing huge losses as a result of the sub-prime crisis. Already banks have announced $60bn worth of losses as many of the mortgage bonds backed by sub-prime mortgages have fallen in value. The losses could be much greater, as many banks have concealed their holdings of sub-prime mortgages in exotic, off-balance sheet instruments

such as "structured investment vehicles" or SIVs. Although the banks say they do not own these SIVs, and therefore are not liable for their losses, they may be forced to cover any bad debts that they accrue. BOND MARKET COLLAPSE Also suffering huge losses are the bondholders, such as pension funds, who bought sub-prime mortgage bonds. These have fallen sharply in value in the last few months, and are now worth between 20% and 40% of their original value for most asset classes, even those considered safe by the ratings agencies.

If the banks are forced to reveal their losses based on current prices, they will be even bigger. It is estimated that ultimately losses suffered by financial institutions could be between $220bn and $450bn, as the $1 trillion in sub-prime mortgage bonds is revalued

.

The impact of slowdown on India
Our response to the emerging global turmoil has been essentially monetary. More focused action, including fiscal, is needed to stem the worsening of the real economy, says Ajay Dua.

AFTER asserting that the global financial meltdown will not affect us, it is now being acknowledged that India is impacted and the effects will intensify. A flurry of activity to size up the happenings and counter the financial virus fast spreading across the globe is now being witnessed. As early as April 2008, the early alarms had been sounded but our preoccupation with inflation-management made us virtually sidestep it — all in the belief that we were not vulnerable. This was somewhat naïve looking at the magnitude of the predicament. The subprime crisis was translating into huge losses, and resulting in billions of dollars of capital raisings, including public offerings and asset-disposals. Market caps were plunging sharply, and not just in the US, but also of European banks. Central banks across the globe had begun to revive financial institutions, hit by what former Federal Reserve governor Alan Greenspan has described as 'the crisis of the century'. India may be one of the least open economies in Asia but its external trade already constitutes over 40% of its GDP. Net investments by FIIs in Indian stock exchanges by January 2008 were $65 billion. In the last four years India has received $50 billion as FDI. On October 23, by which time FIIs had pulled out

over $10 billion, the rupee plunged to 49.79 against the dollar, in comparison to under Rs 39 a year ago. GDP growth had started slowing and it had become obvious that the projected growth at 9% was untenable. By mid-October, India was well in the midst of a global slowdown. Estimates of annual GDP growth had been lowered from 9% to 7.5%. During Q1 2008-09 growth was 7.9% compared to 9.2% in Q1 2007-08. Deceleration has been widespread. Industrial growth is much slower. April-August 2008 saw 4.9% growth compared to 8.5% in April-August 2007 and 10% during entire 2007-08. Expansion in manufacturing, the emerging star of Indian economy, fell from 10.6% to 5.2%. Electricity generation nose-dived from 8.3% to 2.3%. Agriculture declined in Q1 2008-09 from 4.4% to 3% and services from 10.6% to 10.2%. Foreign trade during H1 2008-09 registered a deficit of $60 billion as against $30 billion in H1 2007-08. Hitherto, export growth was being bolstered by rising commodity prices and the yet strong demand from emerging markets and oil producers. All such contributory factors are no longer there. There has been a reversal of portfolio equity flows, largely because of foreign institutions' need to enhance their liquidity positions and the overall reduction in the risk appetite of global investors. Equity market is down 30% since April 2008 and had dipped below the 10,000 level. A sharp decline in FII inflows exacerbated the downward pressure with the rupee depreciating by almost 25% and touching a five-year low of 50.18 on November20. Since mid-September, the tight liquidity conditions in the economy have led to extreme volatility in the money market. Inter bank call rates have been posting significant jumps, well above the official repo and reverse-repo corridor. By October 20, the call rates had become 20% and averaged 12% between midSeptember and mid-October. By mid-October the economy had clearly deviated from its long run growth path. The positive cycle had turned negative and the actual growth had lagged behind the potential output growth. The manufacturing inflation gap has become positive, with the actual inflation being higher than warranted for many months. OUR response to the emerging global turmoil has been essentially monetary. The RBI, which for 18 months had been increasing interest rates and the cash reserve ratio to cool down the overheating economy, has since October changed tracks. Repo rate has been cut by 150 bps, CRR by 350 points and SLR reduced from 25% to 24%. Such facilities aim at infusing greater liquidity and making credit cheaper. However, the additional liquidity of Rs 2 lakh crore has primarily gone to offset the sizeable money withdrawals which occurred upon issue of bonds to oil and fertiliser companies for not effecting price increases. Commercial banks have so far not significantly reduced their lending rates or started lending as before. Till the fragile financial systems start functioning normally again, the various macro measures might not be fully effective particularly in the transmission of increased liquidity to investors and consumers. Many non-linear effects are anticipated as weaknesses in our trading partners spill over to us. There would also be reduction in investment financed through FDI, remittances, international debt and aid.

India, like many other Asian countries, is expected to suffer severely from the lagged effects of the commodities' price shock. Also China, with whom Indian foreign trade has been steadily growing, is highly exposed to the downturn in the US and Europe. Already Indian iron ore mine owners have cut down their output by 40%. The number of investor accounts at stock exchanges has surged. A crash in equity prices is affecting more people than ever before. Property markets have deepened substantially and the losing values of real estate have a potential multiplier effect. The global credit crunch has caused more restrictive lending by commercial banks, upon which Indian corporates and households heavily depend for finance. The monetary measures recently initiated are not adequate to spur banks to lend more as they are concerned, and perhaps rightly, about shortterm prospects of the economy. Most Indian IT firms are vulnerable to the emerging global recession — 70% of India's $40 billion software exports are to the US and 40% of it for financial services which are shrinking rapidly. Our manufacturing and construction trade face prospects of further slackening investment. Financial services are up against tight liquidity and falling markets. Plummeting travel and tourism are slowing down transportation and hospitality sectors. More focused action, including fiscal, is needed to stem the worsening of the real economy.

Obama victory and Indo-US relations
The current trajectory of the Indo-US relationship is well-poised and the muted anxiety about the victory of Barack Obama in the US presidential election is premature and misplaced, says C Uday Bhaskar

AUDACITY of Hope — the title of Barack Obama's biography published in 2006 captured the collective mood on Tuesday, November 4, when the US elected its first black President. The much-awaited 'change' that the American voter was seeking became real. The anxiety and unease that persisted till the very end that the US was not yet ready to put its shameful racial and colour prejudices behind it, has finally been put to rest. The world's oldest democracy has now regained the moral high ground as far as the treatment of its minorities is concerned and this has an embedded message for the largest democracy — though hopefully this breakthrough in India will not take as many decades to be realised. The sub-text of the Obama biography is 'Thoughts on reclaiming the American dream' and the current mood in the US is one of hope, born out of weariness and despondency after eight years of the Bush presidency and the many excesses associated with the current White House. When he assumes office, Mr Obama,

the Democrat President-elect will have his hands full with urgent domestic issues and none more stark than a bankrupt economy with a trillion dollar deficit and the steady erosion of the prevailing global financial turmoil. Capitals the world over are making their individual assessments about what an Obama victory will mean for their bilateral relations with the US and on balance, it would be fair to aver that there is no indication of any major or radical changes in US external policies. The perceived US national interest will be the lodestar for any incumbent in the White House and it will be no different for Mr Obama who will inherit many crosses from his predecessors. As regards the Indo-US bilateral, there has been some anxiety expressed about the implications of the Obama victory. Reference has been made to his campaign statements regarding the India-Pakistan relationship and the desirability of both countries working "towards resolving their dispute over Kashmir." In like fashion, the Obama amendment during the US Congressional debate over the Hyde Act that was once described as 'killer' has also come up on the radar screen to add to the disquiet. However linear extrapolations that are over-interpreted may not be valid at this stage in the Indo-US bilateral relationship. The Obama victory needs to be contextualised against the larger backdrop of the 60-year-old tumultuous New Delhi-Washington DC relationship to better comprehend the texture of the potential implications. Yes, it is true that India and the US had a very estranged relationship for almost 40 years and much of this was derived from the ontological divergences over the nuclear nettle. To his everlasting credit, President Bush in his second tenure was able to innovatively recast the template of the bilateral and after the NSG waiver of September this year and the signing of the 123 agreement, IndoUS relations have been qualitatively transformed. They have moved from long estrangement to preliminary engagement. This basic orientation will not be altered by the Obama victory. Thus the Black and White reduction, that Democrat Presidents have been less favourable to India, would be a simplistic conclusion. The global architecture, US strategic interests, and India's own profile have changed irrevocably. HOWEVER,there are identifiable areas wherein the Obama policy preference will be of special relevance to India. Two may be deemed global — namely climate change and trade/economic policies. Will the US under Obama become more 'protectionist' about its own interests and thereby jeopardise the interests of the developing world? On current assessment, the Obama vision appears to be more inclined towards meaningful multilateralism but much will depend on the domestic US political compulsions that will prevail after January 20, 2009. During his campaign, Mr Obama adopted a strong antiout-sourcing position and there was predictable gloom in the Indian IT sector but it merits repetition that the larger global trade dynamic and the choices made by the Democrat-controlled US Congress will define the final Obama position. Some of the other issues with a distinctive southern Asian flavour that may come into sharp focus on the Obama watch will be nuclear non-proliferation, religious extremism and related terrorism. While the US war in Iraq was a major campaign issue, it would be premature to expect any dramatic reversal of current

US policies. The only exception may be Iran — where the much-needed US dialogue with Tehran offers some hope. But from all accounts, Mr Obama as the next US commander-in-chief would be loath to be seen as hesitant or ineffective when it comes to US security interests, and hence the attention being paid to the Pakistan-Afghanistan combine — the new hyphenation in US foreign policy. Paradoxically, the Obama agenda during the campaign trail which generally veered towards multilateralism and persuasive diplomacy had become unilateral and almost muscular when it came to Pakistan and the war against terrorism. The kind of policy shift that could take place on these issues and their impact on India will depend to a great extent on the choice of the key officials in the core Obama team. Having arrived at a modus vivendi on the nuclear issue, the second major area of divergence in the Indo- US bilateral is that of terrorism and the state support extended to this scourge. In the Indian perception, the Pakistani military establishment, tacitly encouraged by the US, had adopted a long-term anti-India strategy whose principal element was nurturing covert terror. There are faint signs that the Zardari-led civilian government in Pakistan will finally bite the bullet but this will not be accomplished easily. Terrorism and its linkages with Pakistan's opaque nuclear narrative will challenge the sagacity of the Obama White House and this will be of direct relevance to India. The Senator from Illinois has generated an enormous amount of hope — a fervour last seen in the Kennedy victory — but this euphoric expectation must be tempered with caution. The current trajectory of the Indo-US relationship is well-poised and the muted anxiety about the Obama victory is premature and misplaced. MF Industry records Rs 14,014.82 bn funds mobilization in Q1FY09
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The first quarter of fiscal 2008-09 witnessed a deceleration in the growth of Assets Under Management (AUM) of mutual funds (MF). According to Association of Mutual Funds in India (AMFI), while the industry has been growing 50-60% per annum in the last couple of years, the first quarter growth in assets has declined to little over 30% over the year. This clearly reflects the impact of market meltdown. Due to a steep fall in the equity prices, investors kept away from investing in equity oriented mutual funds (MF). According to AMFI, for the first time in several years, collections under the New Fund Offerings (NFO) of equity schemes declined sharply during the first quarter ended June 2008. However, there was no pressure on redemptions. In the present scenario, Systematic Investment Plans (SIP) is witnessing an encouraging trend with substantial accounts being added every month. In the background of a fall in equity prices, the asset preference shifted towards Income schemes and fixed maturity plans (FMP) became very popular among the investors. During the first quarter of fiscal 2008-09, 146 new schemes were launched and a sum of Rs 297.99 billion was mobilized with Rs 276.13 billion under income schemes, Rs 16.51 billion under equity schemes, Rs 1.79 billion under equity linked saving schemes, Rs 500 million under other exchange traded funds and Rs 3.06 billion under fund of funds investing overseas. For the corresponding period in the last year 162 new schemes were launched and a sum of Rs 386.53 billion was mobilized.

Total funds mobilized for the quarter stood at Rs 14,014.82 billion as against Rs 7,898.54 billion for the corresponding quarter last year, representing an increase of 77%. Redemptions at Rs 13,630.44 billion were 85% higher than the redemptions of Rs 7,384.04 billion in the corresponding quarter, last year. On a net basis, there was an inflow of Rs 384.38 billion during the quarter as against an inflow of Rs 514.5 billion in the corresponding quarter, last year.

Crisil on mutual fund industry
Anita Gandhi Tuesday, March 25, 2008 (Andamans)

Fixed income markets to benefit

Measures

Revenue deficit target reduced to 1% in FY09 from 1.4% in FY08; fiscal deficit target reduced to 2.5% in FY09 from 3.1% in FY08. Gross borrowings lower at Rs.1.45 trillion in FY09 from Rs.1.56 trillion in FY08; net borrowing also lower at Rs.1.01 trillion from Rs.1.11 trillion in FY08. Measures announced to develop bond, currency and derivatives markets that will include launching exchange-traded currency and interest rate futures and developing a transparent credit derivatives market with appropriate safeguards. Measures announced to enhance tradability of domestic convertible bonds by putting in place a mechanism that will enable investors to separate embedded equity options from convertible bonds and trade them separately. Measures announced to encourage development of a market-based system for classifying financial instruments based on their complexity and implicit risks. Proposal announced to exempt from TDS, corporate debt instruments issued in demat form and listed on recognized stock exchanges. Impact

Decision of expanding the corporate debt market will help in increased focus towards bond funds and in a scenario where interest rates are not expected to be adverse in the medium term, this would further assist in increasing the popularity of bond funds which have not been doing well in the last few years.

Development of the derivatives markets can in turn enhance the development of the structured products market. Better than targeted fiscal position of the government can impart some bullishness to G-Secs and hence to Gilt funds.

Service Taxes Realigned for ULIPs Measures

Asset management services provided under Unit Linked Insurance Plans (ULIPs) would be brought on par with asset management services provided under mutual funds as regards chargeability to service tax. Services provided by stock/commodity exchanges and clearinghouses would also be brought under the service tax net. Impact

The competitiveness of mutual funds vis-à-vis ULIPs in the investment basket of investors is expected to increase somewhat. Transactional expense levels of mutual funds are expected to go up marginally on account of their exposure to stock and commodity exchanges which are expected to pass on the service tax. But clarity on what would define services here and on what amount the service tax would be levied is awaited. Easing in Income Tax Slabs Measures Threshold limit of Income Tax exemption for individuals raised as follows:

Up to Rs.150,000 - NIL

Rs.150,001 to Rs.300,000 - 10%

Rs.300,001 to Rs.500,000 - 20%

Rs.500,001 and above - 30% Impact

This is expected to increase the disposable income in the hands of the individuals to some extent which could translate into increased retail investments in mutual funds Increase in Short Term Capital Gains Tax Measures

Short Term Capital Gains Tax raised from 10% to 15%. Impact

Since long term capital gains tax has been left unchanged, this hike in short-term capital gains tax could encourage long-term investments which augur well to the development of the concept of "long termism" in the Indian Mutual Fund industry, which is conspicuous by its absence but which is coveted by the fund industry given the greater flexibility that this provides in fund management. At the same time since the short term capital gains tax is still lower than the income tax slabs of typical capital market investors, it is not expected to cause too many investors to turn away from mutual funds. The fact that the dividend distribution tax structure has not changed would mean that dividend reinvestment plans in liquid schemes will continue to be popular and also the liquid plus category will continue to attract inflows as the tax rates there would continue to be lower than the liquid category. Thrust on Infrastructure Sector Measures

Call for more reforms in coal and electricity sectors. Coal sector regulator to be appointed. Fourth Ultra Mega Power Project (UMPP) at Tilaiya to be awarded shortly; five more UMPPs in Chhattisgarh, Karnataka, Maharashtra, Orissa and Tamil Nadu likely. Allocation for National Highway Development Programme (NHDP) raised from Rs.109 billion in FY08 to Rs.130 billion in FY09. Rural Infrastructure Development Fund (RIDF) corpus in FY09 raised to Rs.140 billion Oil and Gas - New Exploration Licensing Policy (NELP) to attract investment of the order of $3.5 - $8 bn for exploration and discovery. Government of India is expected to list more PSUs to unlock their values. Impact

With so much focus on the infrastructure sector, it is expected that infrastructure funds which have been the key out-performers in the industry of late both in terms of returns performance as well as attracting fund flows, will continue to occupy a prominent place

Mutual funds: What lies in store in 2008
Personalfn.com
January 02, 2008 10:55 IST

W

ith the Indian stock markets growing at a frantic pace in 2007 (much like 2006), investors who were willing to take on risk have been rewarded rather handsomely for their efforts. While the smart investor has been grounded, many an ecstatic investor has lost his bearings taking on even higher dosage of risk for that additional return. Nonetheless, 2007 had a lot of innovation in store for the mutual fund investor, not all of which were positive. And there are indications that 2008 could prove to be just as innovative. The year gone by Given that the domestic mutual fund industry has far from matured, it is only natural to expect a lot of new products and innovation along the way. 2007 witnessed some of these innovations. 1) Gold ETFs make a debut While there was considerable talk (which built up even more anticipation) about Gold ETFs (exchange traded funds) for quite some time, they never really took off. That changed in 2007. As regulations crystallised and there was greater clarity on this front, fund houses stepped in to launch Gold ETFs, actually they rushed in. And like with all other innovations, every fund house now looks eager to launch a Gold ETF, even those who don't even have the basic mutual fund offerings in place. 2) Global funds take off Another long-standing innovation � global funds, debuted in the industry. This is another investment option that never really took off as expected because a) there was lack of clarity regarding the regulations and b) fund houses were averse to launching global funds in the avatar of debt funds (since global equities are classified as debt from a taxation perspective). Nonetheless, global funds did take off although fund houses adopted varying routes; while some invested directly in global equities, others opted for the Fund of Funds (FoF) route by investing in global funds. 3) Infrastructure funds storm the rankings Like we mentioned, not all innovations were positive; infrastructure funds count among the innovations that the industry could have done without. We believed that after the disaster with the technology/media/telecom (TMT) funds in 2000, fund houses would have become wiser regarding sector/thematic funds. But no, themes like infrastructure were as popular as ever and many fund houses launched infrastructure-centric funds. Those that already had one open-ended infrastructure fund did not hesitate in launching more infrastructure funds (although of the close-ended variety). Of course, there is nothing to detract from the blistering performance of infrastructure funds. However, this has come at higher risk to the investor and unfortunately investors haven't been told this in as many words. At Personalfn, our view on sector/thematic funds is that they are best avoided; instead investors should opt for well-managed, well-diversified equity funds which in any case do invest in infrastructure (and also have the flexibility to exit the theme when valuations have peaked). Leading equity funds in 2007
Equity Funds NAV 6-Mth 1-Yr 3-Yr Since Incep.

(Rs) (%) Reliance [Get Quote] Power (G) JM Basic (G) Stanchart Premier (G) Tauras Discovery Stock JM Emerg. Leaders (G) Reliance Reg. Sav-Equity (G) Canara Robeco Infrastructure (G) 81 82.5

(%)

(%) (%)

126.0 85.9 77.6 108.8 50.5 37.7 107.8 56.2

38.8 57.4 27.3 54.2 30.8 66.8 20.3 70.0 29.7 70.7 26.5 62.7

100.4 49.6 9.2 93.2 90.9 90.9 90.8 90.1 89.4 45.9 34.0 53.2 60.2 92.7 69.5

JM Financial [Get Quote] Services Sector (G) 18.8 48.3 ICICI [Get Quote] Pru. Infrastructure (G) Kotak Opportunities (G) BSE Sensex (Source: Credence Analytics. NAV data as on December 28, 2007.) 35 64.8

53.6 65.6 37.8

61.7 66.4 45.5

It is apparent from the table why infrastructure funds were so popular with fund houses and investors alike in 2007. There were at least three funds among the top ten equity funds that were focussed on the infrastructure theme. Another point worth noting is that with most funds a major portion of the growth has been registered in the last 6 months, a performance trait which is common with sector/thematic funds. This is because thematic funds tend to perform in shorter spurts as opposed to diversified equity funds which are known to clock growth steadily. What lies in store in 2008 1) Guidelines on real estate funds We expect the launch of real estate funds to be among the high points of 2008. A draft of the guidelines has already been released by SEBI (Securities and Exchange Board of India). Once the guidelines are finalised, you can expect fund houses to go all out with their real estate offerings. The launch of REITs (real estate investments trusts) will be the logical conclusion to the launch of real estate funds. 2) Entry load waiver Despite the steps taken by SEBI to empower investors, it can be safely stated that fund houses and distributors continue to call the shots in the mutual fund industry. To further the cause of investor empowerment, SEBI has waived entry loads on open-ended funds. Investors can now invest directly with the fund house without the intervention of a mutual fund distributor. The advantage of this move is that a) there will not be an entry load and investors can have their entire investment corpus invested in the markets and b) they will no longer be at the mercy of unethical mutual fund distributors for their mutual fund investments. Finally, distributors will be forced to truly 'earn' their income and this bodes well for investors. What should investors do in 2008? For starters, investors would do well to appreciate the importance of sticking to the basics of investing. This is probably their best defense in light of the complex investment environment that they will have to contend with. Investors must have predetermined investment objectives and plans before they start investing; also, they must invest in line with the same at all times. Finally, not losing sight of their risk profile is pertinent as well. 'Block all the noise and stick to the basics' - that could well be the mantra for a rewarding 2008.

New to Mutual Funds? Tips for a beginner

First time investors in Mutual Funds act in the face of imperfect information and often get overwhelmed by uncertainties characterizing the investment situation. But there’s more to Mutual Fund investing than market timing. First things first.. The first thing an aspiring unit holder must do is to establish what type of portfolio he wants to build. In other words, to decide the right asset allocation. Asset allocation is a method that determines how you invest your money in different investments with the proper mix of various asset classes. Remember, the type or class of security you own i.e. equity, debt or money market, is much more important than the particular security itself. The popular thumb rule for asset allocation says that whatever the investor’s age, he should keep that percentage of his portfolio in debt instruments. For example, if an investor is 25, he should have 25% of his investments in debt instruments and the rest in equity. However, in reality, different circumstances and financial position for each individual may require different allocation. Portfolio variable is another factor that one needs to understand to practice asset allocation. These are age, occupation, number of dependants in the family. Usually the younger you are, the more riskier the investments you can hold for getting superior returns. How to pick the right fund/s? Next, focus on selecting the right fund/s. The key is to select the fund/s based on their investment philosophy and consistency in terms of returns. To ensure you are selecting the right type of funds that are appropriate for your needs, consider following:

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Determine what your financial goals are. Are you investing for retirement? A child’s education? Or for current income? Consider your time frame. Do you need money in three months time or three years? The longer your time horizon, the more risk you may be able to take.

7 good reasons to invest in SIPs
Fact No. 1: Over a long term horizon, equity investments have given returns which far exceed those from the debt based instruments. They are probably the only investment option, which can build large wealth. Fact No. 2: In short term, equities exhibit very sharp volatilities, which many of us find difficult to stomach. Fact No. 3: Equities carry lot of risk even to the extent of loosing ones entire corpus. Fact No. 4: Investment in equities require one to be in constant touch with the market. Fact No. 5: Equity investment requires a lot of research. Fact No. 6: Buying good scrips require one to invest fairly large amounts. Systematic Investing in a Mutual Fund is the answer to preventing the pitfalls of equity investment and still enjoying the high returns. And it makes all the more sense today when the stock markets are booming. (Also Read - 5 corners of a sound Investing Strategy) 1. It’s an expert’s field – Let’s leave it to them Management of the fund by the professionals or experts is one of the key advantages of investing through a mutual fund. They regularly carry out extensive research - on the company, the industry and the economy – thus ensuring informed investment. Secondly, they regularly track the market. Thus for many of us who do not have the desired expertise and are too busy with our vocation to devote sufficient time and effort to investing in equity, mutual funds offer an attractive alternative. (Read more - The Investors biggest Dilemma)

2. Putting eggs in different baskets Another advantage of investing through mutual funds is that even with small amounts we are able to enjoy the benefits of diversification. Huge amounts would be required for an individual to achieve the desired diversification, which would not be possible for many of us. Diversification reduces the overall impact on the returns from a portfolio, on account of a loss in a particular company/sector. 3. It’s all transparent & well regulated The Mutual Fund industry is well regulated both by SEBI and AMFI. They have, over the years, introduced regulations, which ensure smooth and transparent functioning of the mutual funds industry. This makes it safer and convenient for investors to invest through the mutual funds. (Check out - Foolproof strategies to maximize your profits) 4. Market timing becomes irrelevant One of the biggest difficulties in equity investing is WHEN to invest, apart from the other big question WHERE to invest. While, investing in a mutual fund solves the issue of ‘where’ to invest, SIP helps us to overcome the problem of ‘when’. SIP is a disciplined investing irrespective of the state of the market. It thus makes the market timing totally irrelevant. And today when the markets are high, it may not be prudent to commit large sums at one go. With the next 2-3 years looking good from Indian Economy point of view, one can expect handsome returns thru’ regular investing. 5. Does not strain our day-to-day finances Mutual Funds allow us to invest very small amounts (Rs 500 – Rs 1000) in SIP, as against larger one-time investment required, if we were to buy directly from the market. This makes investing easier as it does not strain our monthly finances. It, therefore, becomes an ideal investment option for a small-time investor, who would otherwise not be able to enjoy the benefits of investing in the equity market. 6. Reduces the average cost In SIP we are investing a fixed amount regularly. Therefore, we end up buying more number of units when the markets are down and NAV is low and less number of units when the markets are up and the NAV is high. This is called rupee-cost averaging. Generally, we would stay away from buying when the markets are down. We generally tend to invest when the markets are rising. SIP works as a good discipline as it forces us to buy even when the markets are low, which actually is the best time to buy. (Read more - Invest wisely and get rich with equity MFs) 7. Helps to fulfill our dreams The investments we make are ultimately for some objectives such as to buy a house, children’s education, marriage etc. And many of them require a huge one-time investment. As it would usually not be possible raise such large amounts at short notice, we need to build the corpus over a longer period of time, through small but regular investments. This is what SIP is all about. Small investments, over a period of time, result in large wealth and help fulfill our dreams & aspirations.
Benefits of Investing Through Mutual Funds Professional Money Management Fund managers are responsible for implementing a consistent investment strategy that reflects the goals of the fund. Fund managers monitor market and economic trends and analyze securities in order to make informed investment decisions. Diversification Diversification is one of the best ways to reduce risk (to understand why, read The need to Diversify). Mutual funds offer investors an opportunity to diversify across assets depending on their investment needs. Liquidity Investors can sell their mutual fund units on any business day and receive the current market value on their investments within a short time period (normally three- to five-days).

Affordability The minimum initial investment for a mutual fund is fairly low for most funds (as low as Rs500 for some schemes). Convenience Most private sector funds provide you the convenience of periodic purchase plans, automatic withdrawal plans and the automatic reinvestment of interest and dividends. Mutual funds also provide you with detailed reports and statements that make record-keeping simple. You can easily monitor the performance of your mutual funds simply by reviewing the business pages of most newspapers or by using our Mutual Funds section in Investor’s Mall. Flexibility and variety You can pick from conservative, blue-chip stock funds, sectoral funds, funds that aim to provide income with modest growth or those that take big risks in the search for returns. You can even buy balanced funds, or those that combine stocks and bonds in the samefund. Tax benefits on Investment in Mutual Funds 1) 100% Income Tax exemption on all Mutual Fund dividends 2) Capital Gains Tax to be lower of 10% on the capital gains without factoring indexation benefit and 20% on the capital gains after factoring indexation benefit. 3) Open-end funds with equity exposure of more than 65% (Revised from 50% to 65% in Budget 2006) are exempt from the payment of dividend tax for a period of 3 years from 1999-2000.