Indian Economy, 5th edition (124 page)

EFFECTIVE REVENUE DEFICIT

[See Chapter 18,
Public Finance in India
]

Engel’s Law

The law which says that people generally spend a smaller part of their budget on food as their income rises. The idea was suggested by Ernst Engel,
a Russian statistician in 1857.

Environmental accounting

The method of accounting which includes the ecological and environmental damages done by the economic activities in monetary terms. Integrated environment and economic (green) accounting attempts at accounting for both socioeconomic performance and its environmental effects and integrates environmental concerns into mainstream economic planning and policies. The
green GDP
of an economy is measured by the same method–experimented in Costa Rica, Mexico, Netherlands, Norway, and Papua New Guinea, among others. Indicative estimates suggest that conventionally measured GDP may exceed GDP adjusted for natural resources depletion and environmental degradation by a range between 1.5 per cent and 10 per cent.

Environmental audit

Assessment of the environmental impact of a firm/public body through its activities. This is done with an objective to reduce or eliminate the pollution aspect.

Environmental taxes

As against the Command and Control approach to managing environment, the Economic or Market Based Instruments (MBIs) approach sends economic signals to the polluters to modify their behaviour. The MBIs used for environmental taxes include pollution charges (emission/affluent & tax/pollution tax), marketable permits, deposit refund system, input taxes/product charges, differential tax rates, user administrative changes and subsidies for pollution abatement, which may be based on both price and quality. India has been already collecting taxes on
water
and
air
via the
w
ater Act and the
a
ir Act.
d
ue to its experience India is among the chief participant in devising the MBIs in the world.

Equity Linked Saving Scheme

Equity linked savings schemes (ELSS) are open-ended, diversified equity schemes offered by mutual funds. They offer tax benefits under the new section 80C introduced in the Finance Bill 2005
–
06. Till the fiscal year 2004
–
05, maximum investment of Rs. 10,000 was eligible for tax benefits under the erstwhile Section 88 of the I-Tax Act. Effective April 1, 2005, the investment is included in the overall ‘1,00,000 limit set by the new Budget.

Besides offering the tax benefits, the scheme invests in shares of frontline companies and offers long-term capital appreciation. This means unlike a guaranteed return by assured return schemes like Public Provident Fund or National Savings Certificate, the investor gets the benefit of the upside (if any) in the equity markets.

Unlike other mutual fund schemes, there is a three-year lock in period for investments made in these schemes. Investors planning to build wealth over the long-term and save on tax can use these schemes.

Returns in these schemes are linked to the fortunes of the stock market. It falls in the high risk and high return category. Over the past one year, these schemes have clocked a return of over 30 per cent. The BSE 200 index rose 7 per cent over the past one year. This indicates that these funds outperformed the broader market. However, past performance is not a guarantee for future growth. Investors should assess their respective risk appetites before investing.

Equity share

A security issued by a company to those who contributed capital in its formation shows ownership in the company. The other terms for it are ‘stock’ or ‘common stock’.

Such shares might be issued via public issue, bonus shares, convertible debentures, etc. and may be traded on the stock exchanges.

Such shareholders have a claim on the earnings and assets of the company after all the claims have been paid for. This is why such shareholders are also known as the
residual owners.

ESCROW ACCOUNT

In simple terms, an ‘escrow account’ is a
third party account
. It is a separate bank account to hold money which belongs to others and where the money parked will be released only under fulfilment of certain conditions of a contract. The term
escrow
is derived from the French term ‘escroue’ meaning a scrap of paper or roll of parchment, an indicator of the deed that was held by a third party till a transaction is completed.

An escrow account is an
arrangement for safeguarding
the ‘seller’ against its ‘buyer’ from the payment risk for the goods or services sold by the former to the latter. This is done by removing the control over cash flows from the hands of the buyer to an independent agent. The independent agent, i.e, the holder of the escrow account would ensure that the appropriation of cash flows is as per the agreed terms and conditions between the transacting parties.

Escrow account has become the standard in various transactions and business deals. In India escrow account is widely used in public private partnership projects in infrastructure. RBI has also permitted Banks (Authorised Dealer Category I) to open escrow accounts on behalf of Non-Resident corporates for acquisition / transfer of shares / convertible shares of an Indian company.

ESOPs

Employee Stock Option Plans (ESOPs) is a provision under which a foreign company (i.e., MNC) offers shares to its employees overseas. Till February 2005 in the case of local firms, an MNC needed a permission from the RBI before allotting ESOPs, but since then, it does not need any permission provided the company has a minimum of 15 per cent holding in the Indian arm.

Exploding arms

A term associated with the mortgage business which became popular after the subprime crisis hit the US financial system in mid-2007. Exploding arms are mortgages with initial low, fixed interest rates which escalate to a high floating rate after a period of two to three years.

Externalities

Factors that are not included in the gross income of the economy but have an effect on human welfare. They may be
positive
or
negative
–training personnel is an example of the former while pollution falls in the latter.

FCCB

Foreign Currency Convertible Bond, (FCCB) is an unsecured instrument to raise long-term loan in foreign currency by an Indian company which converts into shares of the company on a predetermined rate. It is counted as the part of external debt. It is a safer route to raise foreign currency requirements of a company.

FEDERAL FUND Rate

The federal fund rate (also popular as
Fed Fund Rate
or
Fed Rate
) is the rate of interest banks charge each other on overnight loans in the USA. The rate is fixed by the US central bank Federal Reserve. This is equivalent to the
Repo rate
of India which is fixed by the RBI.

The Federal Reserve cut the Fed Rate by 0.75 per cent on January 22, 2008 (now the rate stands at 3.5 per cent) to ward off the increased fear of a recession in the US economy which has also generated worldwide free fall of share indices since mid-January 2008. In wake of the sub-prime real estate crisis wrecking havoc on the US economy, the Fed Rate has been cut time and again to counter the possible future recession.

Fiduciary issue

Issuance of currency by the government not matched by gold securities, also known as
fiat money.

FINANCIAL CLOSURE

Financial closure is defined as a stage when all the conditions of a financing agreement are fulfilled prior to the initial availability of funds. It is attained when all the tie ups with banks or financial institutions for funds are made and all the conditions precedent to initial drawing of debt is satisfied.

In a Public Private Partnership (PPP) project, financial closure indicates the commencement of the
Concession Period
– the date on which financial closure is achieved is the appointed date which is deemed to be the date of commencement of concession period. In order to give a uniform interpretation to the term, the RBI has provided a definition – for ‘Greenfield’ projects, financial closure is
“a legally binding commitment of equity holders and debt financiers to provide or mobilise funding for the project. Such funding must account for a significant part of the project cost which should not be less than 90 per cent of the total project cost securing the construction of the facility”
.

FINANCIAL STABILITY BOARD (FSB)

The Financial Stability Forum (FSF) was established by the G7 finance ministers and central bank governors in 1999 to promote international financial stability through enhanced information exchange and international cooperation in financial market supervision and surveillance. It decided at its plenary meeting in London on March 2009 to broaden its membership by inviting the new members from the G20 countries, namely, Argentina, Brazil, China, India, Indonesia, Korea, Mexico, Russia, Saudi Arabia, South Africa, and Turkey. the FSF was relaunched as the Financial Stability Board (FSB) on April 2, 2009, in order to mark a change and convey that the FSF in future would play a more prominent role in this direction.

Fiscal drag

The restraining effect of the progressive taxation economies feel on their expansion–fall in the total demand in the economy due to people moving from lower to higher tax brackets and the government tax receipts go on increasing. To neutralise this negative impact, governments usually increase personal tax allowances.

Fiscal neutrality

A stance in policy making by governments when the net effect of taxation and public spending is neutral–neither encouraging nor discouraging the demand. As for example, a
balanced budget
is the same attempt of fiscal policy when the total tax revenue equals the total public expenditure.

Fisher effect

A concept developed by
Irving
f
isher
(1867–1947) which shows relationship between inflation and the interest rate, expressed by an equation popular as the
fisher equation
i.e., the nominal interest rate on a loan is the sum of the real interest rate and the rate of inflation expected over the duration of the loan:

R = r + F;

where R = nominal interest rate, r = real interest rate and F = rate of annual inflation.

The concept suggests a direct relationship between inflation and nominal interest rates – changes in inflation rates leads to matching changes in nominal interest rates.

The Fisher effect can be seen each time one goes to the bank; the interest rate an investor has on a savings account is really the nominal interest rate. For example, if the nominal interest rate on a savings account is 4 per cent and the expected rate of inflation is 3 per cent, then money in the savings account is really growing at 1 per cent. The smaller the real interest rate the longer it will take for savings deposits to grow substantially when observed from a purchasing power perspective.

Flag of convenience

Shipping rights in oceans and seas are governed by international treaties. Flag of convenience is a grant of a shipping ‘flag’ by a member of these treaties to a non-member nation establishing the legality of shipping to the latter (
usually used for illegal activities
).

Forced saving

The enforced reduction of consumption in an economy. It may take place directly when the government increases taxes or indirectly as a consequence of higher inflation–a tool usually utilised by the developing countries to generate extra funds for investment. Also known as
involuntary saving.

F
o
B

This is the abbreviation of ‘free-on-board’–when in the balance of payment accounting, only the basic prices of exports and imports of goods (including loading costs) are counted. It does not count the ‘cost-insurance-freigth’ (CiF) charges incurred in transporting the goods from one to another country.

Form of a life insurance firm

a
life insurance company can be a joint-stock or mutual entity. If joint-stock, it has to have some capital, to begin with. A mutual fund company need not have any. Prudential, the second largest life insurance company in the UK was a mutual fund company till a few years ago and had no capital. Standard Life, another big company, was a mutual company till a few months ago. If such big companies could function without any capital till recently, there is no reason why LIC cannot.

The policyholders are the owners of a mutual company and the entire profit goes to them. A significant proportion of the profit goes to shareholders in the case of joint-stock companies. The LIC, owned fully by the Government, is effectively a mutual fund company and it is not surprising, therefore, that pressure is being mounted to privatise it, so that a chosen few could not corner its huge profits.

Forward contract

A transaction contract of commodity on an agreed price which binds the seller and buyer both to pay and deliver the commodity on a future date. The price agreed upon is known as
forward
rate.

One must not confuse this with the term ‘future contract’ as in it, the term of the contract cannot be decided by the mutual needs of the parties involved (which is possible in a ‘forward contract’).

Forward trading

A trading system in certain shares (as allowed by the SEBI in India) in which buyers and sellers are allowed to postpone/defer payment and delivery respectively after paying some charges. If the buyer wants deferment, it is known as
badla
(an Indian term for
contango
) and if the seller goes for deferment of delivery of shares, it is known as
undha badla
(in India, elsewhere it is known as
backwardation
).