Thursday, July 31, 2008

Reform of the defence offset policy

I am one of those die hard fans of companies like PWC (Price Waterhouse Coopers). Though I do criticise them at times; by and large I am a great fan of many an international consultant. They really bring lot of value add to the discussions on the table.

Look at today’s article by Dhiraj Mathur on India’s defence offset policy – a subject which we are interested in and have covered earlier also in our blogs.

He discusses with cogent reasons as to why the FDI cap in defence production (currently at 26%) makes no sense. While I recommend reading the full article at least once (do so here), let us look at some excerpts:

The government is scheduled to announce a new (and delayed) defence procurement policy (DPP 2008) in the next couple of days. From Indian industry’s perspective, the defence offset policy is a key element of the DPP. The existing version (DPP 2006) stipulates that 30% (or more) of the value of a defence purchase from a foreign vendor for a contract exceeding Rs 300 crore has to be ploughed back into the country via a defence offset obligation. Broadly, this obligation can be fulfilled by one of several methods — purchase from or exports on behalf of Indian defence industries of good or services produced or supplied by them, foreign direct investment (FDI) into Indian defence industries, investments in defence R&D etc.

The Indian government has launched a $100 billion capital investment plan over the 2007-12 period. The annual budget for the year 2008-09 is set at $26.4 billion.

The existing FDI policy restricts foreign equity in the manufacture of defence equipment to 26%. If one were to assume that approximately $10 billion of the offset obligation would be discharged through investment in manufacturing, the existing policy would require a domestic equity contribution of almost about $30 billion (Rs 1,20,000 crore). Since the offset policy requires that the obligation be discharged during the tenure of the defence equipment supply agreement, this quantum of domestic equity would need to be raised over a 2-5 year period in the defence sector alone, a target that seems quite impossible to achieve. Second and equally important, original equipment manufacturers (OEMs) aggressively guard their intellectual property and would be loathe providing cutting edge technology to a joint venture in which they own only 26% equity.

There is no economic or strategic rationale for this cap on foreign equity. For those who say that defence is a strategic sector in which we cannot have 100% foreign equity, I have only this to say — for the last 50 years, we have been buying equipment from companies that have no assets or even operations in India and over which we have no control. What great security threat would a company pose that would be incorporated in India, be subject to Indian laws and regulations with physical assets in India? The cap of 26% on the FDI thus works against fully exploiting the potential benefits of the offset policy.

Saturday, July 19, 2008

Concerns about WTO draft agreement on services

The release of the draft text had taken many countries by surprise as the delegations were reportedly not informed nor were all members consulted, and some even accuse the Chair of lack of transparency. Some member countries such as Bolivia, Cuba and Venezuela, which have been opposing a services text on the ground that it is inappropriate and unnecessary since the 2005 Hong Kong ministerial had already concluded the modalities, have expressed surprise. But the new draft had been agreed on July 15 to by ambassadors of the Enchilada Group (India, China, Pakistan, Philippines, Japan, the EU, the US, Canada, Brazil, South Africa, Indonesia, Malaysia, Thailand, and some others).

Paragraph 4 of the draft text has become the most contentious. Developed countries demand a comparable level of ambition in services as in agriculture and Nama. This means that developing countries should agree to bind their current actual level of liberalisation as well as offer more market access and national treatment commitments.

It may be worthwhile for you at this juncture to have a glimpse of what are the various ‘modes’ in services. The WTO’s site explains it very well. Take a look here. Look at the offending paragraph in the same page for reference.

India is pushing for a services text and therefore is unlikely to oppose the said paragraph.”

Friday, July 18, 2008

Press Note 1 (PN 1) on the way out?

THE government is planning to scrap Press Note 1, allowing foreign companies to invest in sectors where they already have a joint venture without obtaining a no objection certificate (NOC) from their current partner. The government appears to have veered round to the view that PN 1 is making MNCs bypass India to invest in China.

PN1 shields local firms by mandating that foreign allies must get their nod before investing in the same sector. It thus enables local companies to get the technology and financial resources to expand operations.

Scrapping PN-1 would allow foreign firms to invest without getting NOC from their JV partners. Getting NOC is a dampener for MNCs; their plans are often jettisoned on frivolous grounds.

Press Note 1 was formulated in 2005 to dilute an earlier government provision called Press Note 18, which stipulated that the foreign company had to furnish a NOC from an Indian partner if it planned to set up a wholly-owned subsidiary in an allied field. Press Note 1 has restricted the need for an NOC to the same activity only. In addition, joint ventures formed after January 2005 are not subject to Press Note 1.

Thursday, July 17, 2008

Fannie Mae and Freddie Mac

Why should the world be concerned about these US housing mortgage companies’ health?

It was on 13th July that we noted first about them. Look at it here. Their full names are Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac). One can’t help but feel a sense of déjà vu when reading about them again and again. The figures being reported about their liabilities keep going up.

The two institutions are now reported to have bought or guaranteed almost half the $12 trillion housing mortgages. As government-sponsored entities, their debt had been regarded as almost as good as gilts and hence is held by many central banks worldwide. Amazingly, it now transpires that their direct and guaranteed liabilities were almost 65 times their regulatory capital at the end of the first quarter.

The US government is trying to rescue the mortgage giants whose shares came under acute selling pressure last week on fears that they are not adequately capitalised. Under the plan, the US treasury will be authorised to increase its existing $2.25 billion lines of credit to Fannie and Freddie. No wonder the treasury plan, which is set to add some or all of their $5,000 billion in liabilities to the government’s balance sheet, more than half the US national debt of about $9,000 billion, has shaken already fragile world confidence in the US economy.

In the light of this, can the dollar remain strong? If the world’s central banks start withdrawing or redeploying their funds from them, that is enough to send the dollar down.

Tuesday, July 15, 2008

Why is the RBI concerned about the frenetic activity in the OIS market now?

OIS stands for Overnight Index Swap. To get a grip over the concept read this noting we made sometime back.

India's OIS market is unregulated. These deals, which do not cause any flow of funds into or outside the country, are not reported, unlike foreign institutional trading activity in stock or bond markets.

Offshore hedge funds operating through multinational banks in India have stepped up action in India’s OIS market in recent months. These players are convinced that rates will rise, even as the economy is showing signs of slowing down.

Concerned that this surge in hedge fund activity in OIS is boosting volatility in interest rates, the RBI is making inquiries with multinational banks about exposures of such funds in this market.

Monday, July 14, 2008

The country’s education market potential

With double digit economic growth demanding a sustained supply of knowledge workers, India has emerged as one of the world’s largest consumer of education services with a target population of more than 445 million (between age group of 5-24 years), which is expected to increase to approximately 486 million by 2025, far exceeding the combined target population in China (354 million) and the US (91 million) in the same year. With public and private spending on education services in India aggregating approximately $100 billion per annum, and private spending on education having grown at a CAGR of 10.38% since 1994 at constant prices (double the 5.11% CAGR for total private consumption spending during the same period at constant prices), the Indian education sector is on its way to become the next “flavour” of the season for private equity (PE) investors.

While government spending on education remains comparable to other developing nations (approximately 4% of GDP), structural inefficiencies and lack of focus on primary education have resulted in a low adult literacy rate of approximately 67% and a low retention rate in schools of approximately 73%. While India is rated amongst the highest in terms of GDP per capita spending per pupil on tertiary education (beating developed economies like United Kingdom, United States and Japan), it is ranked in the lower spectrum for GDP per capita spending per pupil on primary education, as per UNESCO statistics for 2006.

ECB vs. FII limits

Which is better? Raising the ECB limits for Indian corporates? Or raising the limits for FIIs to invest in Indian bonds?

The finance ministry and RBI jointly fix an annual limit for debt raising by Indian corporates abroad. Progressively, the cap has been raised and during the last fiscal, local firms are reckoned to have raised over $20 billion.

Over a month ago, the combined ceiling for investment by foreign portfolio investors in local corporate bonds and government securities was enhanced to $8 billion from $2.5 billion. Of this, the allocation for investment in corporate bonds stands at $3 billion.

The finance ministry has made out a case for a major revision in the policy on foreign borrowings to allow an investment of over $15 billion by foreign portfolio investors (FIIs) in rupee-denominated bonds issued by Indian corporates. The ministry’s argument is that allowing higher investment by foreign portfolio investors in local corporate bonds would make better economic sense rather than consistently raising the limit for Indian firms to borrow from the overseas loan and capital markets (ECBs).

Increasing the allocation for investment in local corporate bonds and cutting down on the entitlements for Indian firms to borrow abroad would mean shifting the currency risk on to foreign investors. Besides, the ministry believes that the move to allocate a large share for corporate bonds could add to the liquidity of firms here.

However, the RBI reportedly has not exactly warmed up to the idea. It appears to be concerned about monitoring the end use of funds raised by issuing corporate bonds.

Latest jargon on the global stock markets

Heard of things like 'dark pools' 'smart routers' and 'algorithmic trading'?

Dark pools, to put it simply, are essentially trading platforms and exchanges that match block institutional orders, bypassing the main exchanges completely in off-market deals, and don’t publish stock quotes. The geeky jargon in the circuit is primarily because it’s been made possible by increasingly sophisticated technology like algorithmic trading tools. They guarantee absolute anonymity and secrecy to buy-side traders worried about revealing their strategies, accesses available liquidity outside the exchanges, and is only reported to the light side post-trade. It is, of course, all intensely regulated and painstakingly legal — dark pools have taken off in Europe only after the introduction of MiFID, which discourages internalisation of trades, and regulation NMS in the US. A consortium of major banks, including Citigroup, Goldman Sachs, Deutsche Bank, Merrill Lynch, UBS, Morgan Stanley and Credit Suisse, are due to launch Turqoise, a pan-European dark pool trading platform come September.

In electronic financial markets, algorithmic trading, also known as algo, automated, black-box, or robo trading, is the use of computer programs for entering trading orders with the computer algorithm deciding on certain aspects of the order such as the timing, price, or even the final quantity of the order. It is widely used by hedge funds, pension funds, mutual funds, and other institutional traders to divide up a large trade into several smaller trades in order to manage market impact, opportunity cost, and risk. It is also used by hedge funds and similar traders to make the decision to initiate orders based on information that is received electronically, before human traders are even aware of the information. Algorithmic trading, says one study, will account for more than 50% of all shares that change hands in the US by 2010.

Smart order routers, which most traders now use as a given, do exactly what the name suggests, scan multiple options and sources of liquidity and routes your order through to the best price.

Dark algorithms allow disguised orders to be matched electronically without going through the Big Board, or letting any-one else know what you’re up to.

Sunday, July 13, 2008

Gist of the developments related to the Indo-US nuclear deal


Nuclear Deal: A nuclear deal, announced in July, 2005 and finalised in March, 2006, would allow the United States to sell nuclear material to India and it may end India’s nuclear isolation. India is self-sufficient in thorium but possesses a meagre 1% of the global uranium reserves. The deal will help India obtaining a steady supply of uranium required for running the present nuclear programme.

123 agreement: Section 123 of the United States Atomic Energy Act of 1954, titled “Cooperation With Other Nations”, establishes an agreement for cooperation as a prerequisite for nuclear deals between the US and any other nation. Such an agreement is called a 123 Agreement.

Hyde Act: Henry J Hyde United States-India Peaceful Atomic Energy Cooperation Act of 2006 is the legal framework for a bilateral pact between the United States and India under which the US will provide access to civil nuclear technology and access to nuclear fuel in exchange for International Atomic Energy Agency-safeguards on civilian Indian reactors.

NPT Signatories: Signatories to the Nuclear Non-Proliferation Treaty (NPT) are granted access to civilian nuclear technology from each other as well as nuclear fuel via the Nuclear Suppliers Groups in exchange for International Atomic Energy Agency-verified compliance of the NPT tenets. India, Israel, and Pakistan, however, have not signed the NPT.


  • It will help India meet its rising energy demands by reversing US sanctions, imposed after nuclear tests were carried out by India in 1974 and 1998.
  • India will get access to US civilian nuclear technology.
  • The deal guarantees India fuel supplies for its civilian programme, and allows it to reprocess spent fuel.
  • It could spur India’s economic growth as India’s objective is to increase the production of nuclear power generation from its present capacity of 4,000 MW to 20,000 MW in the next decade.
  • It could usher in a new era of nuclear power in India, freeing the country from heavy dependence on fossil fuels.


The deal ties India’s future foreign and energy policy closely to the US. India will now classify 14 of its 22 nuclear facilities as being for civilian use, and thus open to inspection.


July 2005

Prime Minister Singh and US President George W Bush agree to a civilian nuclear co-operation deal.

March 2006

Two countries agree on India’s plan to separate its civilian and military nuclear reactors.

Dec 2006

US Congress approves the deal. Approvals from Nuclear Suppliers Group, International Atomic Energy Agency and a second time by the Congress are still needed.

Dec 2006

Bush signs the law approved by Congress, which makes changes to the US Atomic Energy Act.

July 2007

The two countries announce finalisation of the deal.

Aug 2007

Text of the bilateral pact, called the 123 agreement, is unveiled.

Aug 2007

Left parties slam the pact and ask the government to suspend it saying it compromises India’s sovereignty and imposes US influence.

July 4, 2008

Samajwadi Party with 39 MPs agree to support the UPA on the deal.

July 8, 2008

Left withdraws support to the UPA; Govt approaches IAEA.