Prelims Spotlight is a part of “Nikaalo Prelims 2020” module. This open crash course for Prelims 2020 has a private telegram group where PDFs and DDS (Daily Doubt Sessions) are being held. Please click here to register.
Various FInancial Sector And External Sector Keywords in News
7 April 2020
- A bond, also known as a fixed-income security, is a debt instrument created for the purpose of raising capital.
- They are essentially loan agreements between the bond issuer and an investor, in which the bond issuer is obligated to pay a specified amount of money at specified future dates.
- A government bond or sovereign bond is a form of debt that the government undertakes wherein it issues bonds with the promise to pay periodic interest payments and also repay the entire face value of the bond on the maturity date.
Onshore and Offshore Trading
- Onshore markets in currency trading are quite straight forward. If you trade currency futures on the NSE or BSE or if you buy a forward cover from a bank in India to cover risk, it is basically an onshore market.
- When the currency is traded vis-à-vis other foreign currencies within the shores it is called onshore currency markets.
- Normally, it is the onshore markets that are closely regulated by the nodal regulators like the RBI and SEBI.
- Offshore markets are slightly more complicated. They are traded in a neutral country.
- For example, the USDINR contract is traded in over the counter (OTC) market in some principally large markets like London, Singapore and Dubai. This is popularly called the Non-Deliverable Forward (NDF) market.
- Non-Deliverable Forwards (NDF) are foreign exchange forward contracts traded in the OTC market at offshore destinations, generally major international financial centres.
- An NDF contract is similar to a regular forward foreign exchange contract but does not need physical delivery of currencies at the time of maturity. In fact, an NDF contract is typically cash-settled in international currency on a specified future date. Since the NDF market operates in overseas financial centres, it remains outside the regulatory purview of the local authorities.
- These are outside the purview of the RBI and SEBI, which is one of the reasons the regulators are wary of such offshore markets.
- These offshore markets also cannibalize a chunk of the onshore volumes. That is because; large traders and investors prefer to hedge their risk in the offshore markets considering that they are less regulated and the costs are much lower
Exchange-Traded Funds (ETFs)
- ETFs are mutual funds listed and traded on stock exchanges like shares.
- The ETF simply copies an index and endeavours to accurately reflect its performance.
- In an ETF, one can buy and sell units at a prevailing market price on a real-time basis during market hours.
- There are four types of ETFs already available — Equity ETFs, Debt ETFs, Commodity ETFs and Overseas Equity ETFs.
- The Bharat 22 ETF to be offered now allows the Government to park its holdings in selected PSUs in an ETF and raise disinvestment money from investors at one go.
- Bharat 22 is an ETF that will track the performance of 22 stocks, which the government plans disinvest.
- The ETF unit represents a slice of the fund, issued units are listed on exchanges for anyone to buy or sell at the quoted price.
- The B22 will span six sectors, such as basic materials, energy, finance, FMCG, industrials and utilities.
- Besides public sector banks, miners, construction companies, and energy majors, the ETF will also include some of the government’s holdings in SUUTI (Specified Undertaking of Unit Trust of India).
- The B22 ETF will be managed by ICICI Prudential AMC while Asia Index will be the index provider.
- They are rupee-denominated bonds i.e the funds would be raised from the overseas market in Indian rupees.
- According to RBI, any corporate, body corporate and Indian bank is eligible to issue Rupee denominated bonds overseas.
- While companies can raise funds through these bonds, there are limitations for the use of such proceeds.
- RBI mandates that the money raised through such bonds cannot be used for real estate activities other than for the development of integrated township or affordable housing projects.
- It also can’t be used for investing in capital markets, purchase of land and on-lending to other entities for such activities as stated above.
- Elephant Bonds are the 25-year sovereign bonds in which people declaring undisclosed income will be bound to invest 50 per cent.
- The fund, made from these bonds, will be utilized only for infrastructure projects.
- It is like an Amnesty scheme to help State treasury raising tax revenues, adding beneficiaries in tax base who have not declared their assets previously.
Capital Account Liberalization
- Foreign exchange transactions are broadly classified into two types: Current account transactions and Capital account transactions.
- The Current Account represents a country’s current transactions including exports, imports, interest payments, private remittances and transfers.
- The Capital Account records the net change of assets and liabilities which include external lending and borrowing, foreign currency deposits of banks, external bonds issued by the Government of India, Foreign Direct Investment (FDI),
- Municipal bonds are bonds issued by urban local bodies municipal bodies and municipal corporations (entities owned by municipal bodies) to raise money for financing specific projects specifically infrastructure projects.
- These Bonds have tax-free status if they conform to certain rules and their interest rates are market-linked.
- Bangalore Municipal Corporation was the first ULB to issue Municipal Bond in India in 1997.
- In 2015, SEBI made fresh guidelines for the issue of municipal bonds for enabling the ULBs to mobilize money.
- These bonds are known as revenue bonds when raised for one project.
- ‘Muni bond’ could help corporations directly raise funds without looking to State grants or agencies such as the World Bank and help in financing projects such as Smart Cities.
Credit Rating Agencies (CRAs)
- Credit Rating Agencies (CRAs) are companies that evaluate the financial condition of issuers of debt instruments.
- CRAs assign a rating that reflects its assessment of the issuer’s ability to make the debt payments.
- Rating is denoted by a simple alphanumeric symbol. E.g. AA+, A-, etc.
- In India, CRAs are regulated by SEBI (Credit Rating Agencies) Regulations, 1999 of the Securities and Exchange Board of India Act, 1992.
- The entities that are rated by credit rating agencies comprise companies, state governments, non-profit organisations, countries, securities, special purpose entities, and local governmental bodies.
Some of the key CRAs in India include –
- Credit Rating Information Services of India Limited(CRISIL)
- ICRA Limite
- Credit Analysis and Research Limited (CARE)
Corporate Bond Market
- Corporate bonds are debt securities issued by private and public corporations.
- Companies issue corporate bonds to raise money for a variety of purposes.
- A buyer buys a corporate bond and lends money to the “issuer,” the company that issued the bond.
- In exchange, the company promises to return the money (“principal”) on specified maturity date, and meanwhile, pays the stated rate of interest.
- Notably, a corporate bond does not involve an ownership interest in the company, unlike when one purchases the company’s equity stock.
Bond and Bond Yield:
- A bond is a debt instrument issued by a country’s government or by a company to raise funds and having a maturity period of more than one year.
- Every bond has a price fixed by the issuer known as face value and an annual interest known as coupon payment.
- Later when the bond is traded in the secondary market, its price fluctuates in response to changes in interest rates in the economy, demand for the instrument, time to maturity, and credit quality of that particular bond.
- The effective rate of return or the profit that the bond earns is called Bond Yield and is calculated by dividing the bond’s coupon rate by its face value. Bond Yield has an inverse relationship with the bond price.
- Government bonds (referred to as G-secs in India, Treasury in the US, and Gilts in the UK) come with the sovereign’s guarantee and are considered one of the safest investments compared to other investment options like shares, corporate bonds etc.
- Thus, when an economy slows, investors prefer to invest in government bonds, leading to rise in their demand and prices and thus fall in their yields.
- On the other hand, when an economy grows, there will be a rise in inflation leading to an increase in repo rate. This may increase the rate of interest in other investment options thus decreasing the demand for government bonds and their prices leading to a rise in their yield.
- Bond yields can, therefore, be a useful parameter in assessing economic health.
Bond Yield Inversion
- Yield inversion happens when the yield on a longer tenure bond becomes less than the yield for a shorter tenure bond.
- A yield inversion typically signals a recession.
- An inverted yield curve shows that investors expect the future growth to fall sharply; in other words, the demand for money would be much lower than what it is today and hence the yields are also lower
Social Stock Exchange (SSE)
- It is an electronic fundraising platform that allows investors to buy shares in a social enterprise that has been vetted by the exchange.
- Social enterprises, volunteer groups and welfare organisations will be listed on this platform so that they can raise capital.
- The social enterprise is a revenue-generating business whose primary objective is to achieve a social objective, for example, providing healthcare or clean energy.
- It will act as crowd-sourcing platforms for fund-raising by non-profit entities aimed at impact investment and transparency
- Non-tariff measures (NTMs) are policy measures other than ordinary customs tariffs that can potentially have an economic effect on international trade in goods, changing quantities traded, or prices or both.
- NTMs are broadly distinguished into technical measures (SPS measures, TBTs etc.) and non-technical measures.
- These are further distinguished in hard measures (e.g price & quantity control measures), threat measures (e.g. anti-dumping duties) and other measures such as trade-related finance and investment measures.
Types of NTMs
- Sanitary and Phyto-sanitary Measures: Measures that are applied to protect human or animal life from risks arising from contaminants or disease-causing organisms in food.
- Technical Barriers to Trade: Measures referring to technical regulations and procedures, related to environmental and sustainable standards E.g. Labeling requirements as incase of refrigerators need to carry a label indicating their size, weight & electricity consumption level •Licensing, quotas, prohibitions & quantity-control: Measures to restrain the number of goods that can be imported.
- Price Control Measures: Measures intending to control or affect the prices of imported goods. E.g. Minimum import prices imposed on precious metals like gold to cut down non-essential imports.
- Export Related Measures: Measures applied by the government of the exporting country on exported goods E.g. Exports of cultural heritage objects are prohibited.
- Geographical restrictions on eligibility: Restrictions on imports of dairy products from countries
- Contingent Trade Protective Measures: Measures implemented to counteract the particularly adverse effects of imports in the market. E.g. Anti-Dumping Duty, Countervailing Duty etc.
Non-Tariff Measures (NTMs) and Non-Tariff Barriers (NTBs)
- NTMs are often incorrectly referred to as non-tariff barriers (NTBs).
- The difference is that NTMs comprise a wider set of measures than NTBs, which are now generally intended only as discriminatory non-tariff measures imposed by Governments to favour domestic over foreign suppliers.
- The cause of this confusion is because in the past most NTMs were largely in the form of quotas or voluntary export restraints. These measures are restrictive by design which explains why the word “barrier” was used.
- In present times, policy interventions take many more forms and therefore it is preferable to refer to them as “measures” instead of “barriers” to underline that the measure may not be necessarily welfare or trade reducing.
Foreign Portfolio Investment (FPI):
- Foreign portfolio investment (FPI) consists of securities and other financial assets held by investors in another country.
- It does not provide the investor with direct ownership of a company’s assets and is relatively liquid depending on the volatility of the market.
- Along with foreign direct investment (FDI), FPI is one of the common ways to invest in an overseas economy.
- In a developing economy, foreign portfolio investors (FPIs) are perceived to be more uncertain than domestic institutional investors.
- Thus, foreign investment flows tend to be less stable as these are influenced by global liquidity drivers.
Fiscal Performance Index (FPI)
- The composite FPI developed by CII is an innovative tool using multiple indicators to examine the quality of Budgets at the Central and State levels.
- The index has been constructed using UNDP’s Human Development Index methodology which comprises six components for holistic assessment of the quality of government budgets.
Base erosion and profit shifting (BEPS)
- Firms make profits in one jurisdiction, and shift them across borders by exploiting gaps and mismatches in tax rules, to take advantage of lower tax rates and, thus, not paying taxes to in the country where the profit is made.
- BEPS refers to this corporate tax planning strategies to “shift” profits from higher–tax jurisdiction to lower–tax jurisdiction.
- The OECD has considered ways to revise tax treaties, tighten rules, and to share more government tax information under the BEPS project.
Double Taxation Avoidance Agreements
- Double Taxation Avoidance Agreements is a treaty signed between two countries, which, through the elimination of international double taxation, promote the exchange of goods, services and investment of capital between the two countries.
- Double taxation is an issue related to the taxation of income that crosses boundaries.
- DTAA can either cover all types of income or can target a specific type of income depending upon the types of businesses/holdings of citizens of one country in another.
- The following categories are covered under the Double Taxation Avoidance Agreements (DTAA):
- capital gains
- savings/fixed deposit accounts
What is tax buoyancy?
- Tax buoyancy is one of the key indicators to assess the efficiency of a government’s tax system.
- Generally, as the economy achieves faster growth, the tax revenue of the government also goes up.
- Tax buoyancy explains this relationship between the changes in the government’s tax revenue growth and the changes in GDP.
- In other words, it measures the responsiveness of tax mobilization to economic growth.