Indian Economy, 5th edition (130 page)

The PFRDA will be a regulator on the lines of the watchdogs for insurance and capital market, to regulate and supervise pension funds in the country. It will regulate the new pension scheme which has been in vogue since January 1, 2004 for all fresh entrants to the central government, excusing the armed forces.
t
he PFRDA will also regulate the new pension schemes announced by state governments besides all gratuity and superannuating funds. However, other social security schemes which are in operation now like the one offered by Employees Provident Fund, Coal Miners Provident Fund, Seaman Provident Fund, Assam Tea Provident Fund, to name a few, will be out of the purview of PFRDA as they are governed by specific legislations.

Besides regulation of pension funds, the PFRDA will also have a promotional role to play like other regulators in the country. This will also mean an educational awareness role also. The pension fund regulator will evolve guidelines in consultation with the government on opening up of the pension sector. The PFRDA will also have to curb fraudulent and unfair practices in the sector by participants and protect the interests of subscribers. A pension fund subscriber education and protection fund will also be set up down the line in keeping with its mandate.

The PFRDA will decide on how many pension fund managers ought to be allowed initially, the kind of schemes, the norms for selection of the pension fund managers, capital requirements for these players and the investment norms for the pension funds.

It will also grant licences to pension fund managers. In short, all the operational guidelines for pension fund management will be laid down by the PFRDA. Besides, the regulator will also prescribe the level of investment by the pension fund managers in various types of instruments, whether debt or equity, both in the local and overseas markets.

Preference shares

The shares which bear a stated dividend and carry a priority over equity shares (in matters of dividend and assets) are also known as hybrid securities (since they have the qualities of equity shares as well as bond). Such shares in India cannot have a life over 10 years.

Price-earning ratio

A concept used in the share market to equate various stocks–is a ratio found/calculated by dividing market price of a share by the earning per share.

Primary and Secondary
Market

Primary market refers to buying of shares in an initial public offering. The shares are bought by applying through a share application form. Secondary market refers to transactions where one investor buys shares from another investor at the prevailing market price or at an agreed price. The shares are bought and sold in the secondary market on the stock exchanges. The investors may buy and sell securities on the stock exchanges through stock brokers.

Primary dealer

Primary dealer (PD) is an intermediary participating in the
primary
auctions of the government securities (i.e., G-See or the Gilt-edge securities or the Gilt) and the Treasury Bills (TBs); through a PD these instruments reach the secondary market.

Primary dealers are allowed participation in the call money market and notice money market. They get liquidity support from RBI via repos or refinance (against the G-Secs.).

Prisoner’s dilemma

A popular example in
game theory
which concludes why co-operation is difficult to achieve even if it is mutually beneficial, ultimately making things worse for the parties involved. It is shown giving an example of two prisoners arrested for the same offence held in different cells. Each prisoner has two options, i.e., confess, or say nothing. In this situation there are
three
possible outcomes:

(i)
One could confess and agree to testify against the other as a state witness, receiving a light sentence while his fellow prisoner receives a heavy sentence.

(ii)
They can both say nothing and may turn out to be lucky getting light sentences or even be let off due to lack of firm evidence.

(iii)
They may both confess and get lighter individual sentences than one would have received had he said nothing and the other had testified against him.

The second outcome looks the best for both the prisoners. However, the risk that the other might confess and turn state witness is likely to encourage both to confess, landing both with sentences that they might have avoided had they been able to co-operate by remaining silent.

In reality, firms behave like these prisoners, not setting prices as high as they could do if they only trusted the other firms not to undercut them. Ultimately, the firms are worse off i.e. all firms suffer.

Population trap

A situation of population growth rate greater than the achievable economic growth rate. This makes it difficult to alleviate poverty;–government is suggested to implement population control measures.

Poverty trap

A situation where an unemployed getting unemployment allowance is not encouraged to seek work/employment because his/her after-tax earnings as employed is less than the benefits as unemployed–also known as the
unemployment trap.

Predatory pricing

The pricing policy of a firm with the express purpose of harming rivals or exploiting the consumer. By price-cutting, firstly the rivals are ousted from the market and later the consumers are exploited as monopolistic suppliers by the firm.

ppp

Purchasing power parity (PPP) is a method of calculating the correct/real value of a currency which may be different from the market exchange rate of the currency. Using this method economies may be studied comparatively in a common currency. This is a very popular method handy for the IMF and WB in studying the living standards of people in different economies. The PPP gives a different exchange rate for a currency which may be made the basis for measuring the national income of the economies. It is on this basis that the value of gross national product (GNP) of India becomes the fourth largest in the world (after the US, Japan, and China) though on the basis of market exchange rate of rupee it stands at the
thirteenth rank.

The concept of the PPP was developed by the great European conservative economist,
Gustav Cassel (1866–1944), belonging to Sweden. This concept works on the assumption that markets work on the
law of one price,
i.e., identical goods and services (
in quantity
as well as
quality
) must have the same price in different markets when measured in a common currency. If this is not the case it means that the purchasing power of the two currencies is different.

Let us look at an example. Suppose that sugar is selling $1 in US and Rs. 20 in India a kilo then the PPP-based exchange rate of rupee will be $1 = Rs. 20. This is the way how
The Economist
of London has prepared its ‘Big Mac Index’ (comparing the Mc Donald’s Big Mac burger prices in different economies).

In theory, the value of currencies in terms of their market exchange rate should converge with their value in terms of the PPP in the long run. But that might not happen due to many factors like the fluctuations in inflation; level of money supply; follow-up to the exchange rate regimes (fixed, floating, etc.), and other.

For the calculation of the PPP, a comparable basket of goods and services is selected (a very difficult task) of the identical qualities and quantities. The other difficulty in computing PPP arises out of the flaw in the ‘one price theory’ i.e., due to transportation cost, local taxes, level of production, etc. The prices of goods and services cannot be the same in different markets (This is correct in theory only, not possible in practice.)

QIP

Qualified Institutional Placement (QIP) is a policy associated with the Indian stock market for raising capital by issuing equity shares. The companies listed on the BSE and the NSE are allowed (since May 2006) to raise capital by issuing equity shares, or any securities other than warrants, which are convertible into or exchangeable with equity shares. The attractive part of the new QIP is that the issuing company does not have to undergo elaborate procedural requirements to raise this capital. These securities have to be issued to Qualified Institutional Buyers on a discretionary basis, with just a 10 per cent reservation for mutual funds.

Q theory

As investment theory for firms proposed by the Nobel prize winning (1981) economist James Tobin (1918–2002). He theorised that firms would continue to invest as long as the value of their shares exceeded the replacement cost of their assets–the ratio of the market value of a firm to the net replacement cost of the firm’s assets is known as
‘Tobin Q’.
If Q is greater than 1, then it should expand the firm by investment as the profit it should expect to make from its assets (reflected by share price) exceeds the cost of the assets.

If Q is less than 1, the firm would be better off by selling its assets which are worth more than shareholders currently expect the firm to earn in profit by retaining them.

Random walk

When it is impossible to predict the next step. As per the Efficient Market Theory the prices of financial assets (such as shares) follow a random walk–there is no way of knowing the next change in the price. The reason this theory provides is that in an efficient market, all the information that would allow an investor to predict the next price move is already
reflected in the current price.
Such belief has led some economists to conclude that investors cannot outperform the market consistently.

As opposed to this, some economists argue that asset prices are predictable and that markets are not efficient–they follow a
non-random walk
perspective.

Redlining

The act of not lending to people in certain poor or troubled neighbourhoods shown on the map with a ‘red line’. Even if their credit-worthiness has been judged on the basis of other criteria, they are not considered as borrowers by the banks, simply because they live in that area.

Rent

It has two different meanings in economics:

(i)
The first is layman i.e. the income accruing from hiring land or other durable goods.

(ii)
The second (also known as
economic rent
) is a measure of
market power
i.e. the difference between what a factor of production is paid and how much it would need to be paid to remain in its current use.

For example, a cricket player may be paid Rs. 40,000 a week to play for his team when he would be willing to turn out for only Rs. 10,000, so his economic rent will be Rs. 30,000 a week.

Rent-seeking

Spending time and money not on the production of real goods and services, but rather on trying to get the government to change the rules so as to make one’s business more profitable.

It is like cutting a bigger slice of the cake rather than making the cake bigger trying to make more money without producing more for customers. The term was coined by the economist Gordon Tullock.

Rent-seeking behaviour

The behaviour which improves the welfare of someone at the expense of someone else. A protection racket is the most extreme example of it, in which one group (i.e., the protected one) betters itself without creating welfare-enhancing output at all.

Replacement cost

The cost of replacing an asset (such as machinery, etc.). Opposite to
historic cost
(i.e. the original cost of acquiring an asset), replacement cost adjusts the effects of inflation.

Repo, Reverse Repo, &
Bank Rate

It is a window which enables a bank or a financial institution to borrow money in the
short term.
In the transaction the entity in question sells government securities or bonds to be lender (another bank or institution), with an agreement to buy the securities back after a specified time and price. It is also called a
repurchase
agreement. (In the US, repo has different meaning; it is used to signify the repossession of hypothicated property by a financier).

A
repo
transaction is in the nature of secured borrowing; the difference between the sale and repurchase price is the borrowing cost. It is usually very short term in nature with the market practice being to conclude the sale and repurchase within a time frame of one day, to a fortnight.

When RBI conducts a repo what it does in effect is lend to banks by purchasing securities and selling them back at a predetermined price. When RBI does a
reverse repo,
it borrows from banks by selling them securities and buying them back at a future date. When RBI does reverse repo, it enables banks to park short-term surplus funds; on the other hand, it’s a tool for RBI to manage short-term liquidity. RBI pays an interest of 6 per cent to the banks on reverse repo today. The rate serves as a short term interest rate benchmark for banks and other intermediaries. Similarly, RBI makes funds available to banks through repo at 7.75 per cent today.

In India, only select institutions in the financial sector have RBI’s permission to enter into repo and reverse repo transactions.

Significantly, on April 28, 2007, RBI, for the first time allowed listed corporates to participate in the repo market as lenders. Thus, a corporate treasurer can choose between a liquid mutual fund and repo to park surplus money in the short term.

Banks have been banned to do repo with brokerage. The ban, still in force was imposed after the ’92 stock market scam masterminded by the late Harshad Mehta. Mehta used the repo/reverse repo operation with various banks as a subterfuge to divert funds to the stock market. After the scam, RBI came up with strict guidelines for repo transactions. It also limited the number of players in repo transactions to participants such as banks and primary dealers.