Why gold allures

It is said that gold may after all not be such a good investment because it has no underlying assets like in the case of shares, units, etc., and instead its value is always the scarcity value. What is your take?
Abhishek Mahendru, New Delhi
It is true that gold unlike shares does not have any underlying assets but this by itself does not make investments in gold unwise. After all, its scarcity value reflects the power of the market forces. Gold indeed is becoming scarcer by the day with new mines hard to come by, just as discovery of new oil wells is not keeping pace with the increase in demand for oil.
So long as a commodity is in short supply, its prices would surge. There is also a criticism that while oil has got a wide range of use in day to day life, thus making it indispensable, the same is not the case with gold which has a small industrial use.
It is acquired more for its ornamental value and for its capital appreciation.
Implicit in this argument is the fear that should the yellow metal cease to fascinate people, its value may nosedive. But this seems to be unlikely as things stand, with some economists wistfully hoping for the return of gold standard if only to rein in fiscal profligacy and unbridled printing of currency notes.
S. MURLIDHARAN

Effect of MNCs

What are MNCs? What exactly are their objectives?
Panchapakesan, Madurai
A company that has operations in at least six other locations in other countries qualifies for this honorific. Multinational corporations play a vital role in the global trade and investments. Some of them have turnovers that are much larger than the GDP of some small countries.
MNCs fan out to other countries in keeping with the theory of product cycle — when the demand for a new product reaches a saturation point in the country of origin. Even otherwise profit maximisation is every company’s objective which can be realised only if it has global footprints.
They have done good to developing economies by bringing precious capital and technology that produces multiplier effect on these economies, such as increased employment opportunities, better infrastructure, greater tax collections, etc. Wherever possible, MNCs first exhaust the export possibilities for obvious reasons before putting up plants in developing nations.
S. MURLIDHARAN

Floating the yuan

Why is China not floating its currency?

Purushotham Kaushik, Bhopal
Because a floating currency presupposes complete freedom for entry and exit of foreign capital.
This does not sit well with the Chinese political system of dirigisme. China is a tightly controlled political economy. Its main aim is not to be macho in the marketplace but to be realistic and give employment to its masses.
That is why it has been pursuing a strategy of export-led growth. And for exports to grow, the domestic currency needs to be devalued so as to make it profitable for the exporters. A floating currency may upset this delicately poised applecart of China. If the Chinese currency rules high in the currency markets, it would adversely impact its exports.
S. MURLIDHARAN

Tax on FII inflows

Brazil has imposed a 2 per cent tax on FII inflows. Is it a right move?
Chaman Bagga, Hoshiarpur
Brazil found that FII money was threatening to create an asset bubble, which has all along been the Indian experience and apprehension too. After all, the Indian bourses have been driven by the FII money.
Brazil has made bold to discourage foreign exchange inflow through this small impost which our government has not been able to do. The truth however is that the FII money is indeed hot, capable of wrecking havoc both in the bourses as well as in the foreign currency market. Often many of us in India have missed the wood for trees when the Sensex shot up to dizzy levels. Liquidity driven boom in the bourses was mistaken for growth in the real economy as well
S. MURLIDHARAN

Cash for clunkers scheme

Why cannot the Indian government emulate the cash for clunkers scheme of the US government?
Meghna Tripathi, Gandhi Nagar
Well, the scheme has won a lot of rave reviews especially from the starry-eyed developing nations. But without having the slightest intention of sounding cynical, it must be pointed out that it wasn’t marked by altruism or seriousness.
Fuel-guzzling cars were sought to be replaced by more eco-friendly ones, and to stimulate demand for these cars, the government gave a cash subsidy to the purchasers. That the scheme remained open only for a short period — from July 1 to August 24 — clearly shows that the main purpose was to stimulate demand for cars rather than to cleanse the air.
The scheme was evidently a product of the powerful auto industry’s lobbying efforts. Be that as it may, we in India cannot do something similar because already our subsidy bill is bursting at its seams and there would be a justified criticism of squandering away of our resources on non-merit subsidy given the fact that enabling people to buy cars, even if eco-friendly ones, cannot be accorded a high priority.
S. MURLIDHARAN

One-person company

Why has the government proposed to allow one-person-companies (OPCs)?

Dhanraj, Mayiladudurai
Maybe for two reasons. First, because many other countries do allow OPCs. And, second, it might have thought when two person companies can be allowed — private companies can be followed with just two persons — why not go a step further and allow a single person to form a company and thus acquire two faces. Perhaps, the idea is to put those dealing with individuals on guard — verify the creditworthiness and adequacy of their capital that they have committed to their business before dealing with them.
S. MURLIDHARAN

Junk bonds

What are junk bonds?

Padmapriya Ramprasad, Chennai
They are non-investment grade and, hence, highly risky. Hedge funds and others with ravenous appetite for high risks and returns fall for them. Risk-averse investors shun them. In the sub-prime crisis that unfolded in the US last year, one saw the bonds emanating out of mortgage loans through the securitisation process turning into junk bonds. When companies with poor credit ratings issue bonds, they have necessarily got to offer higher rates of interest to attract investor interest. These are called junk bonds. Sometimes bonds are investment grade to start with but in course of time, the company’s financials turn sour and the market morphs them into junk category by sending its prices crashing down so as to give a higher yield warranted by the risk perception.
S. MURLIDHARAN

Tax benefit on PPF

I contribute Rs 70,000, the maximum permissible, every year to my PPF account. I am told there will not be any tax benefit for such contributions from next year. Should I stop contributing?

Brahmananda Raju, Cuddapah
The Direct Taxes Code Bill, 2009 has proposed discontinuance of tax benefit to one’s contribution to PPF among other things, perhaps to make the Government’s New Pension Plan take off. One has the feeling that the Government might not implement the DTC in its present form because it is riddled with several irrationalities and half-baked proposals even though at first flush it looks impressive with its steep reduction in tax rates.
Even if the PPF scheme is rendered unattractive when the tax benefits are wrenched away, you may have to carry on with minimum contributions of Rs 500 per year till its maturity, unless of course the PPF rules are concomitantly amended to allow premature exit.
S. MURLIDHARAN

Bond prices vs interest rates

I am unable to understand the inverse relationship that exists between bond prices and interest rates. Please help me.

Pranab Bhardhan, Burdwan
Suppose a company has issued a bond with a face value of Rs 1,000 carrying an interest of 10 per cent per annum. If a few months after the issue, the interest rate on similar bonds fetch 12 per cent per annum, the bond issued by the company would have to fall to such an extent — approximately to Rs 833.33 — that the investment therein gives a yield of 12 per cent per annum. And should the interest rate come down to 8 per cent, the bond price would rise to such an extent — approximately to Rs 1,250 — that the yield therefrom approximates to 8 per cent.
There is another way of looking at this phenomenon. When the interest rate rises vis-À-vis the one offered on the bond, the bond becomes that much more unattractive to the investors and when the interest rate falls down vis-À-vis the one offered on the bond, the bond becomes that much more attractive.
S. MURLIDHARAN

Company shares

Safety net mechanism

Shares of five companies out of the nine that hit the market during the last three months are languishing below their IPO prices. Can anything be done about it?
Shilpa Suri, New Delhi
There is one thing that can be done. And that is called safety net mechanism which at present is optional. Under it, company promoters can bind themselves to buying a maximum of 1000 shares per retail investor should the market price of the shares offered on IPO to them dip below the offer price during the first six months of listing. The optional regime should be converted into a mandatory one.

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Direct Taxes Code Bill

Will DTC become law?

Do you think the Direct Taxes Code Bill, 2009 in its present form will become the law?
Muktha Srivasthava, Lucknow
I don’t think so. There is a feeling amongst the commentariat that it has given too much away to those who can afford to pay. A presumptive income of 8 per cent of gross receipts for professionals is something that is bound to warm professional cockles but the one that could rankle those who have to pay tax through their noses.
Similarly, wresting away tax concessions from Public Provident Fund only to popularise and bolster the floundering New Pension Scheme has not done too well with the masses. MAT of 2 per cent on the corporates on the gross value of their assets is a sore point with them. I think a lot needs to be done to render it fit to be signed into law.

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Cost audit

Cost audit

It seems cost audit is getting the pride of place in Companies Bill, 2009. Is it a good development?
Manoj Tiwari, Patna
I think it is a good development because we should be more cost conscious if we were to take on the world on the price front. Our products are out-competed on the price front by the Chinese, for example, in the export markets. It is not as if cost audit will suddenly make our products competitive. The point is it is time we paid attention to cost cutting and optimum utilisation of resources. Hype and hoopla through ads alone will not deliver the goods.

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Currency swap

Can you please explain to me in simple terms what a currency swap is?

Monika Manchanda, New Delhi
Suppose an Indian company having a Japanese collaboration is able to get a yen denominated loan from a Japanese bank on attractive terms requiring repayment of loan instalments as well as periodic interest in Japanese yen whereas the company’s export earnings are in US dollars, it would naturally like to go for a swap under which it would be able to pay dollars with the counterparty agreeing to pay in Japanese yen.
In other words, a currency swap enables one to secure the benefit of natural edge that consists in foreign exchange earnings and foreign exchange obligations being denominated in the same currency so that there is no need to worry about exchange rate fluctuations which in turn obviates the need for taking cover against such fluctuations. A currency swap ideally should be done between a party and counterparty but if this is not possible, then one has to use the services of a bank maintaining a swap book.
S. MURLIDHARAN

One-person company

The Companies Bill, 2009 allows incorporation of One-Person Company (OPC). As a lay person, I wonder how it would conduct a general meeting for example.

Lakshmi Shekar, Chennai.
The Bill spares an OPC from conducting annual general meetings. But I am getting the drift of your question. An OPC to my mind is a contradiction. I think the developed nations allowed themselves to be carried away by bestowing a duality on humankind hitherto talked about only by religions and psychology.
The Hindu religion, for example, sets store by a man and his soul. Psychologists have for long recognised split personalities and called them schizophrenics. Now the law says individuals have two personalities, Janus-like, one natural and one for the commercial world.
While the idea of OPC is to confer the benefit of limited liability to individuals till recently available only to companies, it appears that creditors won’t be naïve as to not to see through the gimmick. They would be even more chary now that there is every chance of an individual flashing his OPC card when pressed to pay up.
S. MURLIDHARAN

Escrow explained

What is an escrow account?
Shailaja Tarapore, Pune
It is an account with a bank which cannot be used by the accountholder for any purpose other than the one agreed in terms of the tripartite agreement entered into by the accountholder, a creditor and the bank. Suppose, a financial institution has given a large loan to a power project, it may insist on all the customers of the power company paying into the specified bank account.
The idea is the amounts deposited therein would be released by the bank only in the manner envisaged.
It can be in the ratio of 1:1 between the accountholder and the financial institution or in any other ratio. This is an excellent way of securing the loan. In my view, it is even better than physical securities.
S. MURLIDHARAN

Tax outgo after pay hike

I am a government employee. After the pay hike given on the basis of the Sixth Pay Commission recommendations, I find my tax outgo unbearable so much so that I wish albeit irrationally that I had not got this increase. I believe this would be aggravated when I get the remainder 60 per cent of the arrears soon. What can I do?
K. Achiah, Bangalore
I am able to get your point and empathise with you. The Government should not give with one hand what it is going to take away with another. There is a crying need for hiking the limit under Section 80C to Rs 3 lakh, which the government is planning to do from next year. There is no reason why this cannot be advanced by a year by bringing an ordinance urgently. This would be in the Government’s interest also because the money mopped up thus would help fight inflation given the fact that greater amount of cash in circulation without corresponding increase in supply of essential commodities would only fuel inflation.
People do not mind locking their money in tax saving avenues, as much as they mind paying taxes, even if the rate of interest offered is low. Therefore, on the extra Rs 2 lakh, the Government may even offer less by way of interest.
S. MURLIDHARAN

Banana republic

What is a banana republic?
Ragini Nandakumar, Chennai
The term is a pejorative used to derisively call any small country which is dominated by foreign companies and depends on survival on export of one product. The term has its origin in Central America where small nations often politically unstable and dependant on foreign companies with just bananas to show, have been a butt of joke by political commentators in more stable economies.
S. MURLIDHARAN

Food alone costly, for now

Why it is that food prices alone are rising even as the price situation is otherwise under control?
Mamata Ganguly, Burdwan
Failure of monsoon is the major reason. Sugarcane output has been down for the second year in succession and we haven’t taken any vanguard action by arranging for imports sufficiently in advance. In fact, the government is guilty of not doing much to ease the supply side constraints. Governments, both at the Center and States, have by and large been guilty of neglecting agriculture and irrigation.
Very few States – Punjab, Haryana and Gujarat, to be precise – have well developed and integrated irrigation network. The Centre’s Minimum Support Prices announced on the eve of each sowing season for wheat and rice have been so attractive that there has been a noticeable shift away from pulses and other crops making them even scarcer and hence more expensive. Right now, one is feeling the heat only on the food front, but sooner than later this could degenerate into inflation on a larger front.
S. MURLIDHARAN

China-dollar connection

Why is China reluctant to float its currency and position it as an alternative to the US dollar?
Pundarikash Basu, Kolkatta
This suggestion has been made time and again especially in the context of the most enduring paradox of the last year or two – how come the US dollar is ruling the world despite the US economy being in a shambles. To be sure, the Chinese currency, the renminbi, is highly undervalued, to boost Chinese exports. The ploy has paid rich dividends. But now China finds itself in an unenviable situation – it has more than $2 trillion invested in the American bonds market. If it makes any precipitous move, much of its investments would vaporise. China and the US thus have a symbiotic relationship – China needs US’s market and the US needs Chinese products. Moreover, the US dollar has entrenched itself during the last six decades. It is the undisputed world currency. True, China now has a domineering presence in every facet of international relationships transcending economics, but it remains as inscrutable as ever. In the event, its currency may not receive the kind of universal acceptability that the US dollar has.
S. MURLIDHARAN