Indian Economy, 5th edition (131 page)

Unlike a general borrowing or lending transactions in the money market, repos are safer as the lender holds government securities (or other special bonds with the repo status) in its own name. Thus, a repo is a
zero-risk
transaction. A repo helps banks to meet their mandatory requirements for investing in government securities (i.e., the SLR). Under the law, banks are required to invest a certain portion of their deposits in government securities. If their holdings are not up to the prescribed level, they face punitive action. So, if a bank needs securities for a short period, it provides the opportunity.

There are two benchmark rates through which RBI influences interest rates in the system. The first is the
bank rate
–the rate at which it lends to banks. The second is the
reverse repo rate
–the rate at which it borrows funds from the banking sector–and repo rate–the rate at which it makes funds available to banks which need it. However, over the years, reverse repo and repo have emerged as the more dynamic indicators of the interest rates. Remember, the reverse repo rate acts as a floor for lending rates in the money market since banks have the option of lending to the Reserve Bank at the reverse repo rate if short-term money market rates fall below that level.

Residual risk

What is left after one takes out all the other shared risk exposures to an asset, also known as
alpha
(a).

w
hen one buys an asset one is exposed to a number of risks, many of them not unique to the asset but reflect broader possibilities (such as the future behaviour of stock market, interest rate, inflation or even government policies, etc.). Exposure to this risk can be reduced by diversification.

Retail banking

A way of doing banking business where the banks emphasise the individual-based lending rather than corporate lending–also known as
high street banking.
Such banking focusses on consumer loans, personal loans, hire-purchase, etc., considered more cumbersome and risky.

RETROCESSION

The term has got
three
different meanings in which it is used –

(i)
The purchase of ‘reinsurance’ by a ‘reinsurance company’ (as in the case of India, the GIC going for ‘reinsurance’ on the ‘reinsurance’ it has provided to other ‘insurance companies’ operating in India). This limits the risk that a reinsurance company may face, since it has purchased insurance against an ‘event’ that might affect a company that it had underwritten (reinsured). If a reinsurance company
continues
to purchase insurance it might ‘unknowingly’ buy back its own risk, which is known as ‘spiraling’.

(ii)
The ‘voluntary’ act of returning ceded property by one to another which may be a result of ‘request’ to have property returned. But, by definition, it is not the result of a ‘forced’ transaction. Returning of Hong Kong to China by the UK in 1997 is the best such example of the recent times.

(iii)
The act of ‘differentiating’ and ‘diversifying’ assets by consolidating and then dividing them amongst a number of stakeholders – by doing so the risk involved is ‘retroceded’ (i.e., cut down or minimised). This is, usually, done by the ‘hedge funds’ in their day-to-day portfolio management.

Reverse takeover

The term is used to mean two different kinds of takeovers:

(i)
Takeover of a public company by a private one, and

(ii)
t
akeover of a bigger company by a smaller one.

Residual unemployment

Unemployment of those who remained unemployed even in the times of full employment (as for example employing a severely handicapped person may far outweigh the productivity obtained from him).

Reverse mortgage

A scheme for senior citizens in India announced in the Union Budget 2007–08. Under this scheme, the senior citizens go to mortgage their house owned by them in reverse to a bank and the bank pays them the agreed money either in installments or lumpsum. Guidelines for reverse mortgage announced by the National Housing Bank (NHB) in May 2007 has a provision of maximum period of 15 years for such mortgage. Once the period of mortgage is complete either the house should be vacated or the bank will sell the house at the market price and the loan of the bank will be settled. If the value of the house is more than the loan, the difference is paid to the senior citizens or their heirs. If the heir wants to possess the house, he/she needs to pay the loan.

Reverse yield gap

An excess of returns on gilt-edged (government) securities above those on equities. This occurs during periods of high inflation because equities provide capital gains to compensate inflation while the gilt-edged securities do not.

Revealed preference

The notion that what one wants is revealed by what one does, not by what one says–actions speak louder than words.

Ricardian equivalence

An idea which (generated too much controversies) originally suggested by David Ricardo (1772–1823) and more recently by Barro, that government deficits do not affect the overall level of demand in an economy.

This is because tax-payers know that any deficit has to be paid later, and so they increase their savings in anticipation of a higher tax bill in future; thus government attempts to stimulate an economy by increasing public spending or cutting taxes, will be rendered impotent by private sector reaction.

The equivalence can be seen as part of a thread of economic thinking which holds that only decisions about real variables (e.g., consumption and production) matter, and that decisions about financing will, in a perfectly functioning market, never have an effect.

Risk seeking

An act whereby investors prefer an investment with an uncertain outcome to one with the same expected returns and certainty that it will deliver them – the act which cannot get enough risk.

Rule of thumb

A rough-and-ready decision-making aid that provides an acceptably accurate approximate solution to a problem. Where refined decision-making processes are expensive (in terms of information gathering and processing them), such a method looks justified.

Rounding error

The error which comes up due to rounding off the figures in decimals, for example, considering 3.6 as 4 and 3.4 as 3. Such rounding off the data is never going to be mathematically correct.

Salary

The payment made to employees of an organisation, firm, etc., for the use of labour as a factor of production. It differs from
wage
in the following two ways:

(i)
It is not paid on hourly basis (or for the actual number of hours worked by the employee) as wages are paid, and

(ii)
It is usually paid on monthly basis whereas wages are paid on daily or weekly basis.

Satisficing theory

A theory which suggests that firms do not want only ‘satisfactory’ profits but maximum profits as well as other objectives such as sales increase, size increase, etc. might be having equal or greater importance than profits.

Say’s law

Named after the French economist Jean Baptise
s
ay (1767–1832), the law proposes that aggregate supply creates its own aggregate demand.

The logic of the law goes like this–the very act of production generates an income (in the form of wages, salaries, profits, etc.) exactly equal to the output which if spent is just sufficient to purchase the whole output produced. Ultimately, it gives an important clue, i.e., in order to reach full-employment level all that is needed is to increase the aggregate supply.

The key assumption behind the law is that the economic system is ‘supply-led’ and that all income is spent. But in practice, some income ‘leaks’ into saving, taxation, etc., and there is no auto-guarantee that all income is ‘injected’ back as spending. This is why others suggest for a ‘demand-led’ idea of the economic system under which demand creation is attended vigorously.

Second-best theory

The idea was put forward by Richard Lipsey and
k
elvin Lancaster (1924–99) in 1956 which suggests a way out of the situation when all the assumptions of an economic model are not met. As per the theory, the second-best situation is meeting as many of the assumptions as possible (but it might not give the optimum or the desired results).

SECURITIES TRANSACTION TAX

[See Chapter 17
Tax Structure in India
]

Seignorage

A method of generating resource by a government through printing of fresh notes/currency notes. Money printing at higher rate to pay the government expenditures leads to inflation that enables the government to secure extra resources though that is called ‘inflation tax’ also.

Sequestration

The process under which a third party (
the sequestrator
) holds a part of the disputed assets till the dispute is settled.

Sharpe ratio

The idea of William Forsyth Sharpe (Nobel Economist) which checks whether the rewards from an investment justify the risk. For this Sharpe uses past data of rewards and calculates it using standard deviation. This is why the ratio says nothing about the future performance of the investment.

Short selling

Selling shares without possessing them. After the prices fell to a certain extent the short-seller covers his position by cheaper shares booking the difference in price as profits. It is also known as
bear operation.
Short-sellers, however, could get caught on the wrong foot if the market reverses the downtrend.

Shutdown price

That lower level of the prices for the product of a firm at which the firm decides to close (
shut
) down – as it has become impossible to recover even the short-run variable cost at the price. Many such instances we get in the Euro-American economies during the period of the Great Depression (1929).

Sixth Pay Commission

Almost after every 10 years, the central government appoints a pay commission to revise the salary structure of about 5.5 million central government employees. The pay commission is not a constitutional body unlike the Finance Commission, and therefore, the government can have a lot of leeway about which part of the report to adopt and in what time frame.

The
f
irst
p
ay
c
ommission was constituted in May 1946 and it submitted its report in a year. The abysmal level of salary of the average government employee prompted the establishment of the commission. This may seem surprising, but the appointment of the pay commission was seen as a humane measure–a far cry from today. The average salary of the employees, even after making allowance for the lower living standards of the day, ranged around Rs. 30. The
s
econd
p
ay
p
anel was set up in August 1957, based on the recommendation of the first commission to set up one after 10 years. It was also necessitated by the Partition and the need to restructure the bureaucracy accordingly. It gave its report exactly after two years. The financial impact of the report was about Rs. 39.6 crore.

The
t
hird
p
ay
c
ommission, set up in April 1970, gave its report in March 1973. The implementation of its proposals did cost the government Rs. 144 crore. The
f
ourth
c
ommission was constituted in June 1983, and gave its report in three phases within four years. The financial hit on the government was Rs. 1,282 crore. It was the
f
ifth
p
ay
c
ommission which really set back the government finances severely. Formed in April 1994, the panel report was acted upon by the government from January 1997. The financial impact of the the fifth pay panel was a whopping Rs. 17,000 crore. If one adds the Rs. 25,000 crore that state governments paid up as salary and pension to their staff, the impact on the country becomes clear. According to a World Bank report the impact of the award of the pay commision on the states was simlar to the Balance of Payments crisis that the Centre faced in 1991. The states had to re-write their fiscal acts considerably.

First, the fifth commission did not suggest the steep hike that the United Front government finally acceded to. It had broadly recommended a 20 per cent rise in salary scale. But the staff unions managed to push it up to 40 per cent from the existing levels.

Recognising the possible fiscal impact of another pay commission, the fifth commission recommended some far-reaching changes in finances. One of the first was a sustained drive to reduce the number of government staff pruning the size of the bureaucracy by at least 30 per cent. It had also asked for introducing a productivity-linked salary structure and other reforms. None of these had been implemented.

However, the carrots have all been implemented. The panel had suggested that for every 100 points rise in DA, the government should merge 50 per cent of the DA with the salaries to revise the pay scales. This was meant to delay the need for another commission but that has not happened.

The best bet against any profligacy by the new commission is the memory of the impact of the last pay commission. The states and Centre have become wiser. So it is on the cards, that there will be no shock like the last time. But just as the last commision led to the enactment of the Fiscal Responsibility and Budget Management Act, the present could result in scuttling of the act, or at least delaying the goals of achieving a 3 per cent fiscal deficit at the Centre and zero revenue deficit by 2009, by another few years. The proposed commision is, however, in a good position to look at the still rising numbers in the government staff rolls and suggest clear cut policy to check it.