Subhash Davda BD 2011-13

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Applied Economics Lecture 2

Closed Economy o We had less integration with less of the world. o Stringency for building domestic capabilities o No FDI, FII, high import duties and tariffs then o Indias more integrated with the world now and so global recession might affect us more. o Impact now will be higher. o Open Economy

We need to understand the economy as a flow. Real sector/Deficit sector Household sector/Surplus sector Flow of products goes from Real to Household (this sector saves money) and has to necessarily buy products that the real sector produces (private and govt industry). It constantly needs funds, govt has fiscal deficits and companies have debt. It produces goods and services and gives our wages and that becomes inputs to the household sector, this can be either saved or spend the money as sales revenue. If they want to save the money then you have the financial markets that become conduits or intermediaries between the 2 sectors. Its a circular flow, and if there is any disturbance at any time and this affects the flow and has a negative impact on the economy. For example households do not spend at all (Japan) or do not save at all (USA). So households pass the problem to the economy. If the real sector says for example cant repay loans, so affects financial markets and that is passed onto households. What the flow looks like? Financial markets o Money market (Regulated by RBI, has to maintain CRR of 6 INR) Commercial banks (biggest players) T. Bills Certificates of deposit (Inter bank instrument) Commercial papers (Inter corporate) Both lending instruments. There isnt much of a market for them, and the secondary market hasnt picked up either.

Call money market (money/credit on tap) Rates can go as high as 80%, instant overnight cash Used when theres a severe liquidity crunch.

Capital market Long term securities Shares Guild edge bonds or govt bonds o Primary (IPOs) o Secondary (Share market)Its a very small component of the whole capital market.

If banks dont have enough reserves for CRR then they are imposed a penalty and publishes advertisement for non compliance of statutory laws. So call money markets run for such desperate situations for banks. Net time and deposit liability FDs (time) Deposits (savings, etc) Supposing the economy is isolated like Bhutan, N.Korea. These economies can be corrected more easily as it is insulated. Open economies are tougher to correct. How does Forex come in? Exports FIIs FDIs Remittances World Bank loans Tourism Patents and IPR Private commercial borrowings.

What is happening in the FOREX marketing? Stables FDIs World Bank Exports (J-Curve talks about the impact of devaluation of a currency on its exports or trade balance. When a currency is devalued, initially our exports will remain stable but imports will become expensive. When a country is used to buying a certain amount of goods from your country it will continue. So you cant switch trading partners just because of currency devaluation. Youre devaluing generally because you want to increase the exports. Then your trade balance dips but if you

impress

other countries but then gradually increases becoming a J Curve) o Unstables NRI Remittances (Goes into speculative markets such as real estate, etc) o Unstable because it goes into banks, we dont have capital account convertibility but we have current account convertibility. Please refer Tarapore Committee report. o He has to convert those dollars to a rupee cheque and cannot buy straight from dollars. Even when he has to take money out, he has to re-convert to dollars and bring it out. o Current account convertibility means using international debit cards in India, but cannot issue cheques. o So all FOREX gets routed through banks, take HK for example, ATMs allow you to choose your currency. But dont have it India yet. And this causes damage because of currency fluctuations. o Unlike FIIs and NRI-R, which when FII starts selling, the market plunges, and when it plunges the very portfolio of the FII comes down. So they wouldnt leave in a hurry unless bad liquidity issue or has been devalued. o NRI-Rs on the contrary NRIs remove their money on a whiff of a problem. The value is retained. FIIs Exports Tourisms FDIs External commercial borrowings

The dollars are then lying in banks. Since interest has to be paid, RBI sucks out these dollars and gives rupees in returnprocess called sterilization. Then it issues MSS (Market stabilization schemes) they are bonds. So then theres hot money of rupees, it sucks away the rupees by MSS-bonds. These bonds earn money because of which the banks are able to service their forex activities and thats how the how market works. How Interest Rates were reduced by the Fed. Reserve Alan Greenspan reduced interest rates and money began flowing into India because rates were higher, so while money can come in and it can create excess liquidity in our system. There is a danger that rupee is becoming weaker and dollar is stronger. Other Information =============== (CPs) -Bajaj for example, other income surpasses sales revenue. It tells you that the company isnt doing its core business and it may be doing well. It was flush with cash at one point of time because it was a monopoly and this deposit money was lending to other companies and making money. Piramal invested in Vodafone and also investing in realty, other income will start increasing vis--vis its core pharmaceutical business. And in the future may not be very profitable unless diversifies properly.

Subhash Davda BD 2011-13

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Applied Economics Lecture 3 *Extra Information* IMF Only lends to govt. Solves BOP problems Balances currency rates across countries Doesnt play a role a as important as the WTO

World Bank Can lend for development projects, not only countries. RBI Allows rupee to fluctuate between 44-50 INR to dollar, steps in case goes outside this range.

Argentina Crisis 2002 Converted their currency into dollars and drove them out of the country FOREX reserve gap

Subprime Explained Fed reduces interest rates to counter NASDAQ, dotcom bust. Housing became very cheap; however the first batches of these loans were genuine. But secondary mortgages on loans drove hedonistic misuse of them Ninjas were given loans with teaser interest rates (First 2 years no interest). They took some of these loans (good loans/ninjas/other subprimes) and clubbed them togetherhence collateralized debt obligations (CDOs). After that they would get AAA ratings from credit rating agencies. They gave ratings to institutions and not to the instruments. They never asked for paperwork, creditworthiness proof, etc. These instruments then got insured by AIG, creating huge secondary markets for securitized CDOs. As these float about, the most important link was mark-to-marked (your security has to be marked to market rates ;). Lehman Brothers suddenly found that there were no takers for their CDOs, as Goldman Sachs and others pulled out. There was no market for their securities as mark-to-marked prices showed their CDOs as zero. Hence rendering them bankrupt.

*Decoding the Jargon* Arbitrage Buying an asset in one market and simultaneously selling an identical asset in another market at a higher price. Different prices depend on different players and different demand and supply situations. Its a very healthy practice and it allows for price discover and different players to find other stuff. Some kinds of arbitrage are completely risk-freethis is pure arbitrage. Today a lot of arbitrage is done by hedge funds, involves assets that have some similarities but are not identical. This not pure arbitrage and can be far from risk free. VCs Green field project funding High risk capital Specialize in giving funds for a certain period of time, assuming 10 years and expect returns of over 10%. Looks at a variety of investments.

Angel Investor The word comes from Broadway. When they would talk to rich patrons who funded them, they were coined into angels. These are people who are very passionate about the industry, and they are semi-retired and now want to put money back into that very same industry. Most of the times they wont carry v-cards. Hedge and Mutual Funds Hedging (Not hedge funds) against currency risks. Where you are taking a position of the future valuation of todays current, speculating. Using that mechanism. Hedging is a process of covering your risk based on your future expectations of what the price would be of certain assets and currencies. Hedge Funds may hedge or may do other things. It is primarily a fund of private equity players with high capital, unlike mutual funds which are common household investors whod like to spread their risk. Hedge funds are not regulated at all, mutual funds are heavily regulated. E.G.Madoff. Hedge funds buy index stocks, invest in emerging markets, new technologies. Mutual funds may bail it out if it fails. Adverse Selection/Asymmetric Info When there is adverse selection, people know they have a higher risk of claiming than the average of the group will buy the insurance, whereas those have a below-average risk may decide its too expensive to be worth buying. Moral Hazard It is when I dont monitor the functioning of an organization, considering their owner and their reputation. Because there is this

kind of a trust, the organization takes extra risk. And there is a bailout possibility, they continue taking such risks. The entire subprime problem occurred because of moral hazard.

Balance of Payments The total of all the money coming in and going out of the country during the same period. It always balances. Trade deficit, current account deficit are relevant concepts here. Like in the case of money coming into India, RBI sucks the dollars, MSS comes into play, and then rupees coming out buying MSS bonds. At the end of this is T-1 from the bank with T+2, hence the banking system would have the same liquidity as it did before. Equalized. o Exports can be of two types, goods and services. Goods sold come into the TRADE A/C, showing goods exported and imported. Services (IT majorly) gets added, and together theyre called invisibles. When both goods and services are added they form something known as the CURRENT A/C. o There exists the capital account alongside, which has all FDIs, NRI remittances, etc coming in (all inflows apart from exports). Both these assets and liabilities have to match, this occurs because of the matching of the capital and current account. Take for example; I have a current account deficit, so I pay for the debts through the capital account. Thus one side always has to show an equal positive side to a negative opposite. If there is a deficit that I cant equalize I press the panic button called IMF to balance it out. This gets added to liabilities. Thus Balance of Payments always balances. Capital Adequacy Banks are highly leveraged and also they run on trust, a bank is always liquid but never solvent. The reason for this is every time I withdraw money, more people deposit the money. The day it ceases to be trusted it ceases to exist. You buy a car, costing you 6 lacs and you take it out of the showroom, it depreciated by 10%-20%. Now suppose that youve take a loan of 5 lacs, and within a years time, the bank has a problem and starts recalling all the loans back. The only way for you to repay the loan is by selling the assets. But it wont get the fair value of its assets. For any point of time, their loan assets are always depreciating, this because of the collateral against them is depreciating all the time. At the point of liquidation the value of your assets must exceed that of liabilities. That is solvency. Banks because of this have are allowed to have secret reserves. In 84 when Japs were entering into the US, they were using the help of Japanese banks reached the apex. They were all using a small capital base, they had a non-fund business. Fund is when you give loans and earn interest, but by lending their name they can earn interest and commission.

Thats when BASEL 1 came in through the BIS and said you shouldnt have your capital to your liabilities but rather to assets. They were known as CRAR (Capital risk asset ratio). So capital has been maintained on the risk assets. We now had to measure the risk, and this whole norm came upwhere for the first time even non-fund business was also taken into purview. So they had to prepare a CRAR framework, where they wrote assets, risk weight, risk assets and capital assets. So RBI has prescribed a risk capital rate of 9.5% on risk assets. Thus explaining capital adequacy. o In India a lot of foreign banks have a non-fund business.

Big MAC Index Pam Woodall of the Economist devised it in 1986. Based on the oldest concepts in the international economics, PPP (Purchasing power parity) The notion says that a dollar, say, should buy the same amount in all the countries. It shows the difference between the price of currencies and the price of a BIG MAC shows the overvaluation or undervaluation of the respective currencies. Exchange Rate The price at which one currency can be converted to the other. o Only applies in trade, otherwise its only the PPP that really matters. Free float (USA) or managed float (India) is the current system of currency conversion. Free float says it never intervenes and allows market forces to decide, whereas managed float is where Fed or central bank intervenes. Fiscal Policy It comprises PUBLIC SPENDING and TAXATION, and any other GOVERNMENT income or assistance to the private sector (such as tax breaks) It can be used to influence the level of demand in the economy, usually with the twin goals of getting UNEMPLOYMENT as low as possible without triggering excessive INFLATION. Full Employment Where everyone who wants a job gets a job and all resources are fully utilized. Its utopian and doesnt exist. GDP Is a measure of the total outflow of goods and services by the economy over a specified time period, normally a year. It is obtained by valued outputs of goods and services at market prices and then aggregating. Note that all intermediate products are excluded, and only goods used in the final consumption or investment are included. This is because the values of the intermediate goods are already implicitly included in the price of the final goods. The word gross means that no deduction/depreciation is made for the value of expenditure on capital goods for replacement purposes. Because the income arising from the investments and possessions owned abroad is

not included. Only the value of goods and services of goods and services produced are included and estimated, hence the word DOMESTIC to differentiate it from GROSS NATIONAL PRODUCT. Its a measure of the economic activity in a country. It is calculated by adding the total value of a countrys annual OUTPUT of goods and services. Thus GDP=Private consumption + INVESTMENT+ PUBLIC SPENDING + the change in inventories + (EXPORTS-IMPORTS).

*Lec Stuff* Asian Crisis Short term debt If we look at the genesis of the crisis, the South East Asian countries were on a high growth trajectory and plus they allowed capital without inflows and outflows and there was a fixed rate of dollar rate. Firstly you have dollars coming in and coming out and you can only convert the local currencies to the dollar. Thats why it creates a risk and since everyone comes and asks for it could cause FOREX reserve drain. BEHEST lending, they were forced to give loans to people who were connected politically; its also called crony capitalism. You must also observe asset bubbles, when a lot of hot money flows in and it overvalues the asset and creates a bubble. They were export driven economies and where China succeeded here they devalued the yuan and caused their exports to be cheaper. There was also a time lag because of the J-Curve. By this time US interest rates went up and crony capitalism occurred, simultaneous the US banks removed their money which they had invested in short-term borrowings to the Asian banks. Thus causing the collapse of the south East Asian banks. IMF stepped in to save them and created a conditionality, creating revaluation of your currency, fiscal binding, tighten up your economy. Youll have to open up your market. This unofficially means allowing American companies in. They didnt allow US banks in, to protect their domestic banks. But post the crises and due to IMF restrictions they were forced to let them in. Malaysia decided not to go to IMF, and they began spending more and went contrary to them. They created capital controls and closed the economy. These measures helped them recover quicker than the other countries.

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Applied Economics Lecture 4

*Extra Information* Trickle Down Effect You create a huge investment in something and it trickles down to various industries, so two ways to look at is it that it reaches the bottom of the pyramid and secondly as an economic concept shows that how a big initial investment creates a snowballing effect into several allied industries and creates economic growth. E.GMax trickle down growth in automobiles and residential real estate Q.I start an auto plant, so note the other allied industries will come if I come there, and likewise I invest in real estate what will develop around it. Spare parts Petroleum Lubricants Servicing Tyres Roads Infrastructure After sales services Tourism Logistics Warehousing Food and agricultural Retail Exports Healthcare Waste treatment 91The HDFC brought out real estate loans and made real estate more accessible to Mumbai Kars. It was a trigger that gave real estate a big boost. So when Indian govt. wanted to create a trickle down effect for housing, they supported the housing loans. Crowding When the available resources in the economy go to funding the fiscal deficits so the private sector doesnt get much of them. US Downgrading by S&P The trigger was they wanted more money to be pumped in but wasnt as much as what the market wanted. Sovereign ratings: Traditionally a govt. would not default, sovereign ratings are so important despite the fact that S&P, Moodys and Fitch lost their credibilityas soon as they were downgraded, the market was going downwards into a spiral.

Sovereign ratings become important after OPEC was formed and price hikes happened, since the OPEC started minting petrodollars. So they had begun beautified their countries they still had plenty of money left, so they began putting these dollars in London banks. US banks to be precise, because there were rules such as regulation cues which put restrictions on where the banks could on-lend. They couldnt onlend freely so they had major London branches. London is full of foreign banks as is the traditional financial capital. This was the beginning of the Euro-Dollar market as they had petrodollar reserves on Euro-soil. They lent this money to sovereigns (govt.) as they are safest bets. Mainly the Latin American countries save Venezuela. They began borrowing and investing in infrastructure. They should have gone to a development bank such as the World Bank which would give longer term loans, but commercial banks would have shorter loan times. They were being run by dictators and didnt want World Bank and IMF monitoring their activities. Another mistake they made was that they took these loans on floating rates pegged to LIBOR. So when LIBOR started rising, with oil price increases, the market became very difficult and in 1979-81, we saw the maximum number of defaults globally. The Latin American recession would have been snowballed into a global recession, the Brady Plan was important here when he came up with a plan to come out of this crisiswhich said let us securitize these assets. This is the first time now countries had to be sovereign rated, some countries are rated by their choice and some without.

*Lec Stuff* GDP at a Glance GDP in 2002-2003 5.8% o Agricultural and allied activities 27.1% o By 08 Agricultural dropped down to 17.8% o Growth rates have also been dropping o Share in the GDP reduces by workers dependent on it has increased and now lies at 65% of total workforce. o As any economy develops into a developed economy there something called value addition, for example an apple juiced becomes food processing and when served in a crystal glass contributes to the services market. So in an emerging economy it still remains an apple, and has lower value addition. o The GDP states how an economy will withstand any crises, so if you know youre export led and you find that thats more than domestic demandyour capacity to handle capacity reduces drastically. Phases of Indian Economy Nehru Years (47-64) Garibi Hatao Years (66-77) The Spending Boom and rising fiscal deficits (77-91) Reforms and recovery (1991-)

Globalization (99 onwards) [Her take on it because Tata took over Tetley, where we really took on the globalization paradigm to a proper level)

We started out in 1950S High growth rates of National income, 50-51, and was impressive 3.5% compared to the near zero growth in thr period of 18901940. Openness to trade and investment A mixed economy based on the The Bombay Plan (Rahul Bajaj wanted protection against liberalization and created another Bombay Plan that was quite against the existing Bombay Plan) Social Expenditure awareness (Nehrus focus was always that we couldnt ever be a purely capitalistic economy). o Nehru brought some of the best brains the worldwide and have them work in his core committee. Confidence that poverty would be surely and seriously dented by growth. Macro stability Optimisn and hence Admiration of the world. Walt Rostow, the famous US economist who has just written his classic treatise on the stage of economic growth in 1960, had viewed India as an economy that was created the preconditions for a take off. But why we ended by the 1980s Low growth rates less than Hindu growth rate but based on excessive internal spending Closure to trade and investment A license-obsessed, restrictive state. Inability to sustain social expenditure. Loss of confidence in the efficacy of The scene was dismal, 50-51, the country stood at 361 million The literacy rate was a poor 18% Per capita income was at RS.1127 1962: The China War 1956-66: Dramatic fall in Indias agricultute due to failure of the monsoon. 65War with Pakistan Political Crisis: Death of Nehru. Basic Characteristics of Indian economy as an under developed economy Low per capita income Occupational pattern Heavy population pressure Prevalence of chronic unemployment, underemployment Low rate of capital formation Ma-distribution of wealth/assets Poor quality of human capital Low level of living

The Crisis of 1991Fall Out: Dramatic Liberalization The early 1990 and again in April May the FOREX reserves fell of to about 1 billion USD. Equal to 2 weeks imports The sharp downgrading of Indias credit rating and a cut off of foreign private lendingthere was no private funding available. An LC opened by SBI for an importer, and it wasnt honored by the corresponding bank, until a foreign bank co-honors. This means all our LCs (Letters of credit) would be null and void, and it asked Citibank who didnt stand by us. (Study Sovereign Rating) It was brought to the boil by Iraqi Invasion of Kuwait in August 1990 resulting in the rise of the price of oil. So when 91 happened, India never defaulted on its loan. People thought wed go the Mexico or Argentina way. We had to move to a situation where we had to liberalize at gunpoint. Normally what happens in such situations is that LPG (Lib-PrivGlobalize, in that order). We had to comply to IMF, brought out fairly inflation rates, 16.7% in Aug 1991. Large fiscal deficits: 8.4% if GDP financed by money creation. Very limited domestic securities market. The roots of the crisis can be traced back to Indias reaction to the earlier crisis of 79-81 when oil prices doubles. This exogenous shock changed Indias current account position from near balance. From 82-85 the persistence of current account deficits was the re4sult of almost complete stagnation of exports which was in turn the result of inappropriate exports rate policy. The real exchange rate was allowed to appreciate by 15% from 79 to 81 and remained at the level for the next 4 years. From 1986 the exchange rate policy became more flexible and the real exchange rate depreciated substantially. Exports revived strongly in response and grew in real terms at 10% per annum between 86-90. But was insufficient to outweigh to rapid import. Growth is lso an added to the problem. The GDP grew rapidly in 5.5% but added to fiscal deficits. FLASHPOINT: o India was faced with the prospect of defaulting on its international commitments. The access to the external commercial credit markets was completely denied and we could only borrow against the security of our gold reserves by physical transporting the gold abroad. o The govt. was forced to borrow from the IMF $2.2 billion as a standby loan.

Liberalization, Stabilization and Structural Adjustment Program Liberalization: Less govt. control, on private business activities. Reduce role of government: In manufacturing and servicing sectors by curtailing size and scope through divestments.

Liberalization Process

Began in 1980s partly as a result of the IMF loan of US dollars 5.2$ billion taken in 1982. But the process got accelerated from 84-85 under Rajiv Gandhi govt. However in 91, this process was introduced by making ad hoc and piecemeal modifications in the existing policies.

Four Ds of SAP The conditionalities attached to these loans necessitated introduction of the SAP prescribed by IMF. Deregulation Deflation Devaluation Denationalization Attitude on 91 LPG (SUPER IMPORTANT) Attitude: Feel of loss of economic sovereignty Aim: Develop a strong industrial base to alleviate poverty. Approach: Planned economic development for growth, modernization, selfrealize and justice. Strategy: Emphasis on heavy industry, protection, public ownership and import substitution (indigenize fast and plan to be submitted) Instruments: 5-year plans, FERA, MRTP, the budget, RBIs monetary policies, industrial licensing, administered price mechanism. Post 1991 Paradigm shifts Govt as protector > Govt as competitor Supply side concerns > Cost push concerns Labour militancy and unrest > Cost Of capital (A KRA for execs) Sickness of units (Prosperity for group) > Sick of unit (Road block for group) Navel-gazing syndrome > Outside-In Approach Small is beautiful > Big is better Mass Production > MPPPs (Mass produced personalized products) Innovation Managerial Toolkit > InnovationThe Sole Competitive Edge Unfulfilled Task Challenges *Decoding the Jargon* Nothing yay!

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Applied Economics Lecture 6

*Extra Information* When the Penny Drops (Non-economic) Important book to read. When the Rupee falls Companies because interest rates are lower, theyve been borrowing from outside. Here they are high, because we want to lower inflation. And now rupee is weakerthe borrowers have more expensive loans (their lower interest rates are neutralized by this). The borrowing cost thus goes up because of currency cost. Companies will report lower growth rates, drop in Sensex and mild recessionary activity occurs. Credit Cards Credit card companies not the happiestwe are one of the lowest defaulters. Its a great source of money. The Economist has articles regarding economic trends. HBR has an article marrying neuroscience and economics, they decoded all the signals, they inferredupon entering malls, seeing colours their pupils dilate, like zombies and buy a lot, there is a feeling of gain. But upon coming close to the cash counter, they start blinking, showing anxiety. Cash signals have stronger responses than those of credit card users. There is a feeling of loss. There come sin a conflict of what youve gained and what youve lost. So when using cash, you rethink your purchases, but when using credit cardsthat rethink response is much lower. --M3 should be double of GDP, RBI should have tried reducing SLR and CRR, the money in the system would have gone upthus stimulating spending, and because interest rates are up, people are constrained. Nick LeesonBearings Bank There is a movie called the Rogue Trader, and it documents of what happened to Bearings Bank (UK), Leeson was a Singapore trader who brought it down and had to be bought for GBR 1. Functions of Central Banks May be a question in exam. Norwegian Sovereign Fund One of the most profitable sovereign funds in the world. Ethical investing. RBI: The Prudent Regulator (Hare and the Tortoise) The approach was captured in the Annual Monetary and Credit Policy 200708 thus: As part of the gradual process of financial sector liberalization in India, it is considered appropriate to introduce credit derivates in a calibrated manner at this juncture. Indian Banks Exposure to the subprime market ICICI: $1.5 Billion

SBI: $900 Million BoI: $440 million Axis $150 Million These cover credit default swaps (CDS) and reit-linked notes by Indian companies. The RBI Act of 1934 was also amended to empower the RBI as the nodal agency to regulate over the counter (OTC) derivatives. The RBI in turn, has put the place a framework for the oversight of financial conglomerates along with the SEBI and IRDA. This situation does not gold good in any other country. Not even the US. While introducing derivative modes, the RBI took care to ensure that all transactions are held in the book or balance sheets with due accounting values. It did not the permit what are called off-balance-sheet (OBS) transactions, endemic along foreign banks. These OBS ghosts have ravaged those banking flaunting OBS accounts. Further under these derivatesregimes, synthetic products are not permitted. It limits the range of CDS to instruments where the reference entity is a single entity. GAPHedge funds operated indirectly through participatory notes (PNs) and 80% of them operate at their behest. When FIIs invest money in our country, they are registered and thus show the source of money. A lot of people dont want to, so these FIIs buy PNswhich is not revealed to regulators here. If you look at household indebtedness by 55%, the retail lending boom and softer interest rates caused this in the first half of 2006-07. They were the main driver for increased borrowings by banks. ARCEL Asset Reconstruction Corporation of India Ltd. ICICI bank is one of the main sponsors of ARCEL, and there was a controversy along with it as they were passing their NPAs to ARCEL.

*Lec Stuff* What is money? Anything that can be used for transactions could be a shell, coin or notes. 3 important functions Must be accepted as Medium of exchange. (Dollar is accepted worldwide as a medium of exchange across the world). It should be a unit of account, how do you measure the value of money and that happens when you translate it onto something monetaryin this case money. (Can be gold as well). Store of valueWe need money for the future, and the value of the money must remain constant over a period of time to avoid hyperinflation. Our main need for money is liquidity, savings are secondary. Evolution of Payment System. Commodity Exchange Fiat Money (Issued by govt. our cash, only Re.1 notes are issued by Govt. of India, everything else is RBI-issued.) Checks E-MoneyAdvanced form of e-money is the stored-value card. The more sophisticated version is known as the smart card. It contains a chip that allows to be loaded with digital cash from the owners bank account whenever needed. E-Cash Why are Scandinavians ahead of Americans in e-payments? 1. The existence of giro payments without checks even before the advent of PCs 2. Europeans, particularly Scandinavians have much greater use of mobile phones. Money aggregates at a glance --Its an important concept because money is in a continuum from most liquid to least liquid. --CashSavings AccountFixed Deposit (Highly illiquid for us, but for bank the basis for their on-lending) --M1M2M3 M1=Current + Demand Deposits + Other deposits i. Narrow money ii. Notes + Coins iii. Deposit component 1. Demand deposits held by the general public with all banks (DD) 2. Demand deposits iv. M1=C +DD + OD

M2= M1+time liability portion of savings deposits with banks +CDs issued by banks + term deposits maturing within one year. M3= M2 + term deposits over one year maturity + call/term borrowings of banks. (Best for credit creation). i. Broad money

Liquidity Aggregates --Monthly Compilation L1= M3+ all deposits with the post office savings bank (excluding National Savings Certificates) L2= L1+ FDs with developments financial institutions+ certificates of deposit issued by development financial institutions +term borrowings of FIs --Quarterly Compilation L3=L2+ Public deposits of non-banking financial

Reserve Money Reserve money may be called govt. money and is issued by the RBI. It is cash held by the public and the banks. It comprises of: a. Currency in circulation with the public that is the cash and coins held by general public. As (C)this is the total amount of notes and coins issued by and circulated by RBI less the amount held by banks as cash on hand. b. Deposits of other people in RBIother deposits c. Cash reserves of banks (CR) which are actually composed of two parts viz. i. CRs kept by banks with themselves and ii. Bankers deposits with RBI RM=C+OD+CR RM is partly held by the public (C and D) and partly by banks (CR) RM=C+OD+CR M1=C +DD + OD How CRR affects growth. The cash reserves of banks (CR) are the actual base for the total demand deposit structure (DD) of the banking system. So we say that the CRR by impounding the money, money is lesserso those banks will give less loans and because of that current accounts also go low. Credit Creation This power of commercial banks to expand deposits through this. Money Multiplier When reserve money changes, money supply also changes. M=mRM M=M/RM M=Money Supply M=Money multiplier

RM=Reserve Money In other words money multiplier is the money supply divided by the reserve money. m=M1/RM m=M3/RM Money multiplies more with M3, the capacity of it to multiply is way more. Uses for greater credit creation. Are we banks free to decide RM? Techniques of reserve requirements, varying discount rate and open market operations. Change is liquidity Lead to more or less spending on real assets or financial assets by either GDP is directly affected or indirectly by change in interest. How des RBI know how much if the increase in money supply will translate into public spending thereby affect GNP? This remains a gray area for RBI. Its a missing link that RBI does not have its thumb. The relationship between the increase in the GNP over a period and the change in the money supply that brought it about is called the velocity of money. Wealth effect Term coined in 2000, during NASDAQ crash, wherein if you have a house worth a crore and that was bought for 10 lacs, you feel richerbut may not be able to spend as a crorepati. So during NASDAQ, because their portfolios value increased, they loaned more and ended up with big debts when their shares were devalued.

Money Illusion Some govt. employees saw their earnings more than double in the 6th Pay Commission, but there is a lot of inflation. It is when your nominal income goes up but your real income remains similar. This mirage causes more spending. This is called creeping inflation. Happens slowly and creeps in our lives. That is what policymakers wantthey double your income, allow inflation so spending increases.