The New Direct Taxes Code and the Companies Bill 2009, are both, a step towards effective administration & regulation of Taxes and Company Law, respectively.

The Government surely deserves kudos for introducing these two path-breaking initiatives.

I feel, individuals and the corporates will both be in a ‘win-win situation’ due to the friendly provisions in the New Direct Taxes Code. The corporate tax rate being reduced and individual taxation base expanded are growth oriented provisions.

Reduction in and consolidation of provisions in the New Income Tax and Companies Act, were much needed and will prove to investor friendly.

The EET regime of taxation was sure to come and is in line with global practice.

I feel, the people of the nation will be left with more disposable income and this will increase spending in the economy. This will encourage people for better saving, better investments and better tax management.

Anand Wadadekar
Pune

Dis-investment is a good option? I feel, YES!

With globalization and privatisation being the song of the globe in the 21st century, I feel, there is no need for the Government to get itself involved in carrying on business and lock its money by holding major stake in the companies capital.

It is has been seen that the Government companies/public sector companies are not professionally managed and their functioning is a question in itself. Also, government holding a major stake in the companies gives scope for politics and to satisfy the vested interests of the politicians.

I surely feel, that the Government should divest its stake and unlock the capital invested and re-deploy the same capital in the economy through ‘government spending’. The Government may well keep their ‘Director Nominees’ on the board of public companies which may be economically sensitive like ONGC, BHEL, SAIL, etc. but holding a major stake is not required since there a good number of regulations in place which can help it keep a control on the functioning of the companies in general.

However, there is no need to divest fully, but to keep a minimum stake so as to have a healthy ‘public-private partnership’ regime, which the Government is looking at from the recent past.

Basically, I feel, the Government’s primary job is to govern the business and not to do business in real sense. Government, through different regulators have been assigned the task to govern and regulate the business and so there is no need to get itself involve too much in doing business. However, if at all it feels that the companies are not functioning in the best interest of its stakeholders and public, it can very well get its hold through Constitutional and Company Law provisions.

Let the economy be function openly and the Government should maintain the doctrine of laissez faire.

- Anand Wadadekar
Pune

This article makes an attempt of co-relating or linking Economics and Law – an out of the world unestablished & rare combination/concept as you may term it.

Sanjay and Deepak co-incidentally met in a restaurant some months after they completed their graduation in Commerce. And a conversation started...

Sanjay: Hey, Deepak! How’s you buddy? How’s life?

Deepak: Hey, Sanjay! What a pleasant surprise to see you here! I am fine, thank you! Life is cool… How about you?

Sanjay: I am doing well! Just got myself admitted to ICSI’s Company Secretary course and also simultaneously registered for Masters in Economics (M.A) from our University.

Deepak: What? CS course and Economics together, how can Economics and Law be studied together? There is no co-relation between the two. These two are completely different fields. To me, this sounds weird, Sanjay! Don’t you feel so? I feel you should pursue either hardcore Economics or hardcore Law.

Well, I am doing 3 years LL.B from our University itself. I have got highly interested in law.

Sanjay: I knew you would react this way and would feel this weird. Actually anybody would have reacted the same way as you did. I understand!

Deepak: I am sorry, Sanjay! Still can you please explain me your thought behind taking such decision of pursuing Economics and CS together? What do you have in mind exactly?

Sanjay: Yes sure! Hey but don’t get bored ok while I am explaining 

Deepak: Hey not at all!

Sanjay: See, as we all know and studied, Economics is the study of human behaviour in relation to the unlimited wants and scarce means to satisfy them. But then, any Law emerges taking into consideration the same human behaviour. Economics tries to make a balance between the unlimited wants and scarce means and Law tries to avoid and penalize the human act which results from the same desire of satisfying unlimited wants but scarce means i.e. Frauds and Scams.

Co-existence of Economics, Commerce and Law makes for a complete economic atmosphere. I feel Economics & Law need to go hand-in-hand in order to make the whole system work smoothly and efficiently and to get the desired results from the economic activity.

We need to understand that any economic activity to derive desired results should be backed and complimented by favourable legal environment.
Deepak: Sorry to interrupt you! Can you give me an example?

Sanjay: A classic example can be given of The Industrial Policy of 1991. Liberalization of the legal compliances and deregulation proved to be a boon for industries and that resulted in increased economic activities, growth and progress, the fruits of which we are witnessing now. New legislations were enacted by the Government and amendments to the existing ones were done to accommodate the changes proposed in the Industrial Policy. Likewise, the Companies Amendment Act, 2000 which brought some forward looking provisions like Postal Ballot Voting, Buyback of shares, Directors Responsibility Statement, etc. and ten-fold increase in penalties for non-compliance, has proved to be a boon for the shareholders. Shareholders are now assured of transparency, corporate governance which will lead to increase in confidence in companies, their goods and services and thereby results in increased demand and ultimately increase in economic activity.
Do you agree, Deepak?

Deepak: Oh yes, I agree!

Sanjay: Economic phenomenon – National and International – also initiates changes in the legal structure of a country. If the laws are extremely or unnecessarily stringent, then the transition to the particular economic change may become difficult and ultimately the country suffers.
A classic example can be given of Globalisation, GATS & WTO. Globalisation being an economic phenomenon, to reap the benefits, favourable legal enactments was necessary. So legislations like Limited Liability Partnership Act (LLP), New Company Law, New Foreign Direct Investment (FDI) norms were required. In other words, introduction of a global economic phenomenon brings about changes as well as the need of new amendments in the legal structure.

See, Under the GATS, the countries signatory to the Agreement are advised to reform their policies so as to allow foreign education institutions, foreign service providers, etc to establish a place of business in their country. In order to allow them, the country needs to amend its concerned laws and give the foreign entities the required legal status to work. The US wants India to amend the Intellectual Property Laws and so as to place them at par to the global practices. This will benefit the country immensely.

Deepak: Ok! I got! These examples were on macro level. I am not able to understand how we as individuals or future professionals benefit from this co-relation.

Sanjay: You are right! The above examples were on macro level. If we now think on a micro level, the relation between Economics and Law still exists.

In the industry, management strategies & policies are definitely based & taken on the basis of Economics, irrespective of what type of the organization or sector it is. The implementation of these policies and strategies has to be in the given framework of the law at that particular time. Legal professionals who have studied Economic Laws like MRTP, Competition Act, IPR, Environmental Laws, etc. can well contribute in the strategy and policy making process, provided they have a firm base of knowledge in Economics. Legal professionals can have an edge over others in the management cadre. Knowledge of Economics will enable them to innovate new ideas, strategies and since they are already masters in Laws*, they can put those ideas and strategies to use. They can think whether any legal provision is a deterrent to the implementation of the said policy or strategy and provide solution to that, on the basis of their legal knowledge.

See Deepak, changes in the economic situations bring about changes in legal policies of a country. Knowledge of both – Economics & Law – can bring about a change in how an organization works.

So Deepak, tell me was I able to throw some light on your doubts?

Deepak: Well, buddy! With such an excellent explanation, you have almost convinced me of the relation between Economics & Law. Such combinations are rare, indeed!

Sanjay: Thanks Deepak! Just to give you a live example. We have a person before us, who is a master in law* and also has expertise in Economics. He is none other than our country’s former Finance Minister, Mr. P Chidambaram. He was a hardcore Lawyer first and was a person who shaped our economy through fiscal policies.

So can we still say, “There can’t be a co-relation between Economics and Law?”

• The phrase ‘Masters in Law’ does not necessarily mean any education masters’ degree. Here it is taken as a qualitative concept.

© Authors

This article makes an attempt of co-relating or linking Economics and Law – an out of the world unestablished & rare combination/concept as you may term it.

Sanjay and Deepak co-incidentally met in a restaurant some months after they completed their graduation in Commerce. And a conversation started...

Sanjay: Hey, Deepak! How’s you buddy? How’s life?

Deepak: Hey, Sanjay! What a pleasant surprise to see you here! I am fine, thank you! Life is cool… How about you?

Sanjay: I am doing well! Just got myself admitted to ICSI’s Company Secretary course and also simultaneously registered for Masters in Economics (M.A) from our University.

Deepak: What? CS course and Economics together, how can Economics and Law be studied together? There is no co-relation between the two. These two are completely different fields. To me, this sounds weird, Sanjay! Don’t you feel so? I feel you should pursue either hardcore Economics or hardcore Law.

Well, I am doing 3 years LL.B from our University itself. I have got highly interested in law.

Sanjay: I knew you would react this way and would feel this weird. Actually anybody would have reacted the same way as you did. I understand!

Deepak: I am sorry, Sanjay! Still can you please explain me your thought behind taking such decision of pursuing Economics and CS together? What do you have in mind exactly?

Sanjay: Yes sure! Hey but don’t get bored ok while I am explaining :)

Deepak: Hey not at all!

Sanjay: See, as we all know and studied, Economics is the study of human behaviour in relation to the unlimited wants and scarce means to satisfy them. But then, any Law emerges taking into consideration the same human behaviour. Economics tries to make a balance between the unlimited wants and scarce means and Law tries to avoid and penalize the human act which results from the same desire of satisfying unlimited wants but scarce means i.e. Frauds and Scams.

Co-existence of Economics, Commerce and Law makes for a complete economic atmosphere. I feel Economics & Law need to go hand-in-hand in order to make the whole system work smoothly and efficiently and to get the desired results from the economic activity.

We need to understand that any economic activity to derive desired results should be backed and complimented by favourable legal environment.

Deepak: Sorry to interrupt you! Can you give me an example?

Sanjay: A classic example can be given of The Industrial Policy of 1991. Liberalization of the legal compliances and deregulation proved to be a boon for industries and that resulted in increased economic activities, growth and progress, the fruits of which we are witnessing now. New legislations were enacted by the Government and amendments to the existing ones were done to accommodate the changes proposed in the Industrial Policy. Likewise, the Companies Amendment Act, 2000 which brought some forward looking provisions like Postal Ballot Voting, Buyback of shares, Directors Responsibility Statement, etc. and ten-fold increase in penalties for non-compliance, has proved to be a boon for the shareholders. Shareholders are now assured of transparency, corporate governance which will lead to increase in confidence in companies, their goods and services and thereby results in increased demand and ultimately increase in economic activity.
Do you agree, Deepak?

Deepak: Oh yes, I agree!

Sanjay: Economic phenomenon – National and International – also initiates changes in the legal structure of a country. If the laws are extremely or unnecessarily stringent, then the transition to the particular economic change may become difficult and ultimately the country suffers.
A classic example can be given of Globalisation, GATS & WTO. Globalisation being an economic phenomenon, to reap the benefits, favourable legal enactments was necessary. So legislations like Limited Liability Partnership Act (LLP), New Company Law, New Foreign Direct Investment (FDI) norms were required. In other words, introduction of a global economic phenomenon brings about changes as well as the need of new amendments in the legal structure.

See, Under the GATS, the countries signatory to the Agreement are advised to reform their policies so as to allow foreign education institutions, foreign service providers, etc to establish a place of business in their country. In order to allow them, the country needs to amend its concerned laws and give the foreign entities the required legal status to work. The US wants India to amend the Intellectual Property Laws and so as to place them at par to the global practices. This will benefit the country immensely.

Deepak: Ok! I got! These examples were on macro level. I am not able to understand how we as individuals or future professionals benefit from this co-relation.

Sanjay: You are right! The above examples were on macro level. If we now think on a micro level, the relation between Economics and Law still exists.

In the industry, management strategies & policies are definitely based & taken on the basis of Economics, irrespective of what type of the organization or sector it is. The implementation of these policies and strategies has to be in the given framework of the law at that particular time. Legal professionals who have studied Economic Laws like MRTP, Competition Act, IPR, Environmental Laws, etc. can well contribute in the strategy and policy making process, provided they have a firm base of knowledge in Economics. Legal professionals can have an edge over others in the management cadre. Knowledge of Economics will enable them to innovate new ideas, strategies and since they are already masters in Laws*, they can put those ideas and strategies to use. They can think whether any legal provision is a deterrent to the implementation of the said policy or strategy and provide solution to that, on the basis of their legal knowledge.

See Deepak, changes in the economic situations bring about changes in legal policies of a country. Knowledge of both – Economics & Law – can bring about a change in how an organization works.

So Deepak, tell me was I able to throw some light on your doubts?

Deepak: Well, buddy! With such an excellent explanation, you have almost convinced me of the relation between Economics & Law. Such combinations are rare, indeed!

Sanjay: Thanks Deepak! Just to give you a live example. We have a person before us, who is a master in law* and also has expertise in Economics. He is none other than our country’s former Finance Minister, Mr. P Chidambaram. He was a hardcore Lawyer first and was a person who shaped our economy through fiscal policies.

So can we still say, “There can’t be a co-relation between Economics and Law?”

* The phrase ‘Masters in Law’ does not necessarily mean any education masters’ degree. Here it is taken as a qualitative concept.

© Anand Wadadekar
CS. Monika Bhardwaj
anandwadadekar@gmail.com
monikabdj@gmail.com

In common parlance the terms ‘Agreement’ and ‘Contract’ are used as synonyms. But in legal jargon, these two terms are not the same. Agreement is a vital element for a contract to become valid, but it’s not a contract in itself. The enforceability of an agreement makes it a Contract. It is said that, every Contract is an agreement, but every Agreement is not a contract.

In India, the entire law covering the concept of ‘Agreement’ is embodied in the Indian Contract Act, 1972. Commencing from our day-to-day life to the important decisions of the business world everybody is exposed to either one (express) or the other (implied) form of an Agreement; whether it’s an account opening form or a joint venture / technical collaboration; agreements touch life of every person.

However, in industry, drafting an Agreement is crucial task and extreme caution is required so as to protect the interest of the concerned entity. Increasing business activities makes it imperative to carefully draft or vet an agreement since this is the stage where potential disputes can be avoided and course of actions can be framed or freezed.

The art of drafting in India has developed without the aid of formalized structure of legislation; instead, it is totally based on legal traditions. Of late, India has immensely benefited by exchanging the drafting techniques with the rest of the world. Each type of agreement has some peculiar clauses, which need extra caution and care.

The purpose of this Article is to highlight the importance of drafting an agreement vis-à-vis few important clauses in an agreement. This article shall focus on drafting the general commercial agreements. Here in this article the term ‘Agreement’ is used as a synonym of the term ‘Contract’.

Indemnity

Almost all commercial agreements have an indemnity clause, wherein one party agrees to indemnify the other from the losses / damages caused by its own acts. Such clauses are inevitable and need to be capped. Further, amount of risk involved in the indemnification needs to be compared with the benefits to be derived out of the business relationship. Indemnification for exemplary, consequential, indirect and incidental damages should be avoided. In view of the risk involved, these clauses need careful drafting. Root cause analysis is required for the existence of such clauses. If not required in a particular situation, such clauses should be avoided.

Jurisdiction

‘Jurisdiction’ determines which Court should properly adjudicate a case / dispute i.e. Competent Court. Jurisdiction means the authority to govern or legislate and such authority is derived out of the subject, type or cause of action. The clause excluding one out of two competent courts should not be against the public policy. The contract ousting the jurisdiction of the Indian courts, however, the Indian courts was not without jurisdiction.
It was held that the agreement ousting the jurisdiction was void as it was opposed to the public policy [Rajendra Sethia vs. Punjab National Bank (AIR 1991 Delhi 285)]. That means, if a court in India has jurisdiction to entertain the suit and in agreement it is specifically agreed that any dispute between the parties will be submitted to a Foreign Court. Being opposed to public policy, such clause would be void. The plea that party agreed to submit to the Foreign Court will not up held. This can be considered for stay of a suit but cannot be a ground for rejection of a plaint.
(However, Supreme Court has now overruled this judgement)

Arbitration

Of late, the number of disputes in the industry has increased tremendously. Initially, the principal burden was on Courts that have traditionally captured the majority of such disputes. In an attempt to control litigation costs and expediting the process of dispute resolution, many companies are looking to employ alternate dispute resolution mechanisms commonly referred to as ADR — to avoid the lengthy court procedures. Two of the most commonly used ADR mechanisms are ‘mediation and arbitration’. Mediation is a voluntary process through which the parties meet and try to negotiate a resolution to their dispute by referring to a third-party facilitator. Arbitration is a process that results in a binding decision that the parties can seek to enforce through the courts. Arbitration through a single arbitrator, mutually appointed by the parties, is a cost effective and speedy way for dispute resolution. Generally companies seek mediation and if they fail, they prefer to refer the dispute to Arbitration. Therefore Arbitration clause is very must.

Intellectual Property Rights

Intellectual Property Rights (IPR) has gained significant importance amidst globalization and liberalization. The agreement should provide for the protection of IPR of the parties. Mere acquisition of Intellectual Property (IP) rights is of little importance if it cannot be enforced effectively. Well-framed IP clauses are the best means to limit the instances of IP violations. Declaration of ownership on all Intellectual Property Rights on the subject matter is imperative. The party must seek protection of the intellectual property rights on its own products / services. At the same time, indemnification should be taken for Intellectual Property Rights infringement of any third party.

Force Majeure

Sometime in spite of all the efforts, a party finds it difficult to fulfill its obligations under the Agreement for some reasons beyond its control. The situation becomes pathetic if the damage clause is severe. Here comes the ‘Force Majeure’ clause to rescue. Such clauses enables a party to escape from the liability arising out of non-performance of its duties under the agreement for some reasons beyond its control / unpredictable circumstances viz. delivery failure due to transport strike, non payment of dues due to banker strike, act of god, lock-outs, war, riot, sabotage etc. Such clause needs care, the party suffering from any factor considering Force Majeure must inform the other party about the existence of such factor responsible for nonperformance and must take due care for resumption of its obligations under the agreement at its earliest possible otherwise it may lead to termination of the agreement itself. The period of delay / non-performance should be excluded from the total term of the agreement.

Termination Clause

Every agreement must contain an ‘exit clause’. At times, it becomes difficult to carry the relationship throughout the term of the Agreement; then in such circumstances this clause comes handy. This depends upon the position and requirement of the contracting parties. Sometimes, the parties intentionally agree not to provide exit clause to one of the contracting party or to provide some lock-in period or to provide exit under some particular situations viz. in case of material breach of the terms of the agreement / insolvency etc..

Other cautions

Exclusive agreements should be avoided. Generally these agreements attract anti-trust laws. Any agreement, which is a restraint on the civil rights of a party, is generally void. Agreements wherein one party is to reveal some confidential information to the other for the execution of the agreement, must provide non-disclosure clause for maintaining the confidentiality of the information till the time it comes into public domain; without breaching the terms of the agreement. In employment agreement, clause containing any restraint on the civil rights of the employee should be avoided.

In almost all agreements, the potential disputes should be kept in mind and accordingly the safeguards should be provided viz. in case of leases; refund of security deposit should be protected, in case of delay in refund the possession of premises should be retained, in case of non-vacation liquidated damages should be provided and so on. The clause pertaining to the governing law should be carefully considered since it provides the enforcement mechanism for the agreement. Scope of work, consideration, relationship between the contracting parties and the procedural part should be clearly stated. In conglomerates, the specific policies of the entity needs to be adhered whether it’s anti-corruption, anti-boycott or any other to save it from the consequences of international laws. The main purpose of an agreement is to bring transparency in a transaction, minimize chances of disputes by bringing as much clarity as is possible and also to avoid any misinterpretation.

To conclude, we can say that, ‘Clauses’ play a crucial role in agreements and contracts and help in creating a legal relationship which is transparent and forward looking.

© CS. Monika Bhardwaj,
Gurgaon, India
monikabdj@gmail.com

A Sister...

A Wife...

A Daughter...

A Friend...

Woooowwww . . . .

All these roles only A ‘Woman’ can play . . .

J. Rudyar Kipling said,
“A woman’s guess is much more accurate than a man’s certainty. . . . ”

This is so true . . . . . . . . .

I SALUTE on the ocassion of ‘International Women’s Day’ to . . .
‘A Woman’ who made a difference in the world . . . .

Warmest Regards,
- Anand Wadadekar

Mohandas Pai, Director HR, Infosys Technologies said that “We have asked our recruitment staff not to poach anybody from Satyam. The company is in the middle of a crises and people will jump ship”.A person familiar with the matter, who asked not to be named, said that “Infosys would refrain from even hiring domain experts or project managers from Satyam. Infosys has even advised its staff against entertaining calls from the Satyam employees.”

It is really a sad statement by Mohandas Pai, Director HR, Infosys Technologies.I feel, this is extremely unfair and unjust on the part of the Satyam employees who are seeking employment else where, since the Satyam fraud was not caused by the deeds of these employees, but by the misdeeds of management board themselves and of which these employees were in no knowledge of. Whatever income/revenue Satyam has had was majorly because of the work done by these employees only.

On one hand, where we consider that the company is a distinct personality from its stakeholders, employees, etc., on the other hand we make such unjust statements and blame the employees for no fault of theirs per se.

On one hand, companies say that they are not able to find talented people for jobs and on the other, they ignore the talent of the such employees.

Does all this mean real HRM?

- Anand Wadadekar
Pune, Maharashtra

Quote by Anand Wadadekar

The exchange rate of the currency of a country in relation to the currency of another country depends on the comparative trade advantages and economic strengths of the countries.
If one US dollar is equal to 45 rupees, it simply means that in the US, if a dollar fetches 45 oranges while in India, a rupee would fetch only one orange of equivalent size and quality.

Just like any other commodity, the currency of any economy is based on dynamics of supply and demand, and its value depends on trading in currency exchanges all over the world. Higher the demand for a currency on an exchange, the stronger it becomes and vice versa. However, for currencies like INR which are not traded on exchanges, the value depends on capital inflows in the country.

Appreciation & Depreciation of currency:

A currency appreciates means its value has increased in relation to another currency.
A currency depreciates means its value has decreased in relation to another currency.
Eg. If 1 $ costs Rs 45 and if it now costs Rs 44, this means rupee has appreciated in its value (i.e. instead of Rs 45 you will get 1 $ in Rs 44, this also means the dollar has weakened). Similarly, if 1 $ costs Rs 45 and if it now costs Rs 46, this means rupee has depreciated in its value (i.e. instead of Rs 45 you will get 1 $ in Rs 46, this also means the dollar has strengthened).

Why do currency values fluctuate?

There are many participants in any foreign exchange market. These entities — like banks, corporations, brokers, even individuals — buy and sell currencies everyday.
Here too the universal economic law of demand and supply is applicable: when there are more buyers for a currency than sellers, its exchange rate rises. Similarly, when there are more sellers of a particular currency than buyers, its exchange rate will fall. This does not mean people no longer want money; it only means that people prefer to keep their wealth in some other form or another currency.

Scenario before occurrence of the current financial crises:

We were witnessing a surge of dollar-inflows into India due reasons like strong economic fundamentals and favourable business atmosphere, etc. These dollar inflows can be in the form of Foreign Direct Investment, portfolio inflows (foreign investment in equity), External Commercial Borrowings by Indian companies abroad, remittances to India by Non-Resident Indians. Since the Indian economy and the Indian stock markets have been on a roll, the capital inflows to India has been pretty strong which has primarily led to the appreciation in value of rupee. This huge influx caused a significant demand – supply gap between the dollar and the rupee. Going by the laws of demand & supply, the rate of the rupee vis-à-vis the dollar, rises.

Due to this exporters were placed at a disadvantage with a rising rupee, since the dollar became weaker. Thus a dollar which fetched Rs. 48 about two years ago today fetched only Rs. 44 eating into the profit margins of exporters (since they earned less on their exports).
At the same time, importers benefit (since they need to pay less for their imports), but our economy was at a stage where we first needed to build our dollar reserves to meet our import payments and so the exporters’ woes were needed to be tackled first.

The Reserve Bank of India (RBI), as the central bank of India, which oversees the foreign exchange (forex) management of this country quite often intervened to ensure that the rupee was adequately propped at a particular rate. This was done to ensure that there are no sudden currency shocks, to protect exporters and importers and above all, to ensure the feeling of ‘national pride,’ which is attached to a stable and healthy currency.

When the RBI intervened to keep the rupee at some weak value, it had to buy the dollar inflows from exporters, from NRIs, from foreign direct investors, from companies that borrow abroad. In any case the sellers of dollars need rupees to conduct their businesses here. The RBI buys or sells dollars via state-run banks to prevent excessive volatility in the forex market and avoid any sharp appreciation or depreciation in the currency. When the RBI purchases foreign currency inflows, the domestic monetary base or money supply or both rises since for every dollar the RBI buys from the market, an equivalent amount of rupees gets injected into the system, adding to excess money in the system or the liquidity overhang. When the RBI buys dollars, it pays for them using freshly printed rupee notes. This leads to greater money supply, higher credit growth and inflation.

And precisely, here comes the catche. As RBI sells more rupees, the money supply increases which means too much money chasing same (or less) number of goods, thereby leading to inflation. So in effect one act of RBI creates another problem. In other words, when the RBI buys dollars from the Indian market, it simultaneously pumps rupees into the currency markets, creating the risk of inflationary pressures. The RBI typically controls the appreciation by manipulating demand-supply dynamics of currency market. It purchases dollars (to create more demand for dollar) and sells rupees (to increase supply of INR, thereby decreasing its value).

To contain inflationary pressures, the RBI adopts a measure termed as ’sterile intervention.’ Under this measure, the RBI sells Government of India bonds in the market. With the sale of these bonds, the rupee, which had flowed into the market for buying dollars, is once again sucked out of the market. When the RBI buys dollar-denominated assets, (to create demand for dollars and reduce supply of rupee) it sells rupee-denominated securities to suck the rupees back. But when the RBI has to suck out a whole lot of rupees back, it has to raise rupee interest rates, the Repo rate (the interest rate at which commercial banks borrow for short term from RBI) and the Cash Reserve Ratio (CRR).

This is how the RBI protects the dollar-rupee exchange rates and yet, manages to contain inflation.

Scenario after occurrence of the financial crises:

The sub-prime crises, bankruptcy, sale, restructuring and merger of some of the world’s largest financial institutions caused cataclysmic disruptions in the international stocks and money markets. Imprudent financial decisions, fed by greed and bad luck, have seen global financial markets collapse.

The current financial crises that shook the global financial markets has seen unprecedented bailouts and infusion of dollars into the US economy at a cost of many an emerging market, from where funds have been pulled out to flow back into America.
India, which was till recently having huge capital dollar inflows, now is experiencing flow of dollars outside the country due to selling of more Indian shares than bought (to the tune of over $9 billion), thereby making dollars scarce in India and reduced demand for rupees, simultaneously, as there is increased demand for dollars due to spurt in crude oil prices and the dipped capital inflows.

The dollar prices fell by some considerable amount with respect to most of the currencies. Here in India the rupee rose to around 40-41 a dollar from around the 45 rupees a dollar. There is a lot of panic among the exporters because a weak dollar adversely affects the exporters, especially in the services sector who have all their expenditure in rupees and earnings in dollar.

The growing Indian trade deficit and the large fiscal deficit are also contributing to the fall of the rupee. The higher price of imported goods, especially oil (India is a heavy importer of oil), has also led to an increase in domestic inflation and a fall in the value of the Indian currency. High inflation and a strong growth in the Indian economy have already forced the RBI to raise interest rates.

Example: Consider a firm; say ‘K software’ that has a profit margin of 5 %. Now ‘K software’ bags a contract of 100,000 USD from a big US based firm when the dollar Rupee exchange rate is 45 Rs a dollar. So the profit of ‘K software’ would be 5 % of 100,000 i.e. USD 5k (= 225k Rs at the exchange rate of 45Re= 1USD) and expenditure which is in Rupees as USD 95k i.e. 4275k Rupees. Therefore, ‘K software’ goes ahead with its project and when the project is completed the dollar gets weak and trades at 40 Rupees a dollar. Now ‘K software’ has already spent 4275k and now despite getting the promised 100,000 USD they get only 4000K rupees and end up, in effect, paying 275k for developing the software. So weakening of dollar is detrimental for the exporters.

To explain it with another example; Say that exchange rate is US 1 $ = 50 INR. If an exporter X earns US $ 1000 by exporting his goods/services to US, his earnings in Rupee terms is Rs. 50,000. If the Rupee appreciates to US 1 $ = 40 INR, then in rupee terms the earnings of exporter will be Rs. 40,000. A fall in earnings despite the exports being constant. But the exporter who is based in India has to spend in INR in India; he has less money at his disposal constraining his further growth by way of limiting his investment capacity.

Importers on the other hand have to pay less to import the same thing suppose you buy a 100$ iPod now you will have to shell out just around 4k instead of the earlier 4.5k. This is one of the reasons why all those Oil economies which are primarily the importers maintain very high exchange rates by regulating their currencies.

Reverse of what was happening before the crises:

Therefore, where the RBI was sucking out the excess liquidity from the system caused due to huge capital dollar inflows, it is now compelled to reverse its stance and infuse liquidity back into the system. Where previously the CRR was hiked, RBI now reduced the CRR, repo rate and adopted to increase the reverse repo rate(the interest rate at which RBI borrows for short term from the commercial banks), since there is shortage of money supply in the system and therefore reduced credit in the market.

FROM:
Anand Wadadekar
M.Com, M.A Economics, MBA Finance, AMFI, DIT
PUNE