Relevance of Debt-to-GDP Ratio in Discerning an Economy’s Health

By Deepika S

Sovereign debt is the debt owed by the central government. It is issued in foreign currency in order to fund the country’s development needs. This debt can be further categorized as internal and external debt. Recession, ad-hoc spending and a quest for higher economic growth have resulted in higher levels of sovereign debt across the globe. Between the years 2002-2015, the global debt rose from 200% to almost 226% of the GDP.

Significance of debt-to-GDP Ratio

The continuous rise in debts has resulted in a new metric: debt-to-GDP ratio. It determines if the country’s sovereign debt is too high given its gross domestic product. For instance, if sovereign debt levels are too high, it might create panic among foreign investors resulting in a withdrawal of FDI or it might leave the government with the option of increasing tax rates resulting in low/stagnant economic growth. Further, it may lead creditors to seek higher interest rates when lending. These discussions have paved way for the argument that high debt-to-GDP ratios cause macroeconomic instability which is not healthy for the growth.

Reliability of debt-to-GDP Ratio

In actuality, there are many exceptions which can’t be explained using this ratio. For instance, Japan’s debt-to-GDP ratio in 2011 is over 220%, but its economy received very little analyst attention. Meanwhile, Greece’s was only 160% and many rating agencies were predicting its collapse. In addition to this, a close scrutiny of the ratios of different countries shows that the relationship between debt-to-GDP ratio and macroeconomic instability is weak.

123

dvzfz

abc

Analyzing the above graphs, we can infer that the countries with higher debt levels are highly developed and comparatively economically stable. But again, this inference doesn’t apply to all countries and has exceptions.

Reasons for Disparity

A higher debt-to-GDP ratio is acceptable when the creditors are domestic investors, when an economy is rapidly growing, and when an economy issues securities (debt denominated) in its own currency.

The ratio is mute about the interest rates associated with the debt. Let’s consider 2 countries, A& B, with similar debt-to-GDP ratios. A’s debt is due in 30 years at 5% interest rate, whereas B’s debt is due in 2 years at 20% interest rate. It is evident that B is worse off in comparison to A. They are liable to pay the same amount for a shorter duration at a higher interest rate. However, the ratio downplays the severity and shows both countries as equally well-off.

Conclusion

Overall, though debt-to-GDP is one of the important metrics to be looked at to discern the economic health of the country, there are many other metrics that must be factored in as well.

#Fincabulary 11 – Champagne Stock

Meaning:  A slang term used to describe a stock that has appreciated dramatically.

A champagne stock is typically one that has at least doubled or tripled in value in a relatively short period, creating a huge profit for the company’s shareholders. The term is used because individuals who hold such stocks will often order an expensive bottle of champagne to celebrate their good fortune.

WEATHER DERIVATIVES – CONCEPT, CHALLENGES, AND FEASIBILITY

By  Ishan Kekre & Girish C

Introduction

A weather derivative is a tool for managing weather risk. It is a financial contract that allows a firm to hedge itself against unexpected and adverse weather. A weather derivative contract or WD derives its value from future weather conditions. Contrary to stereotypical weather insurance, the payout of this kind of derivative is based on a parametric weather index. For instance, the index could be centimeters or millimeters of rainfall. The index could also be a cumulative frequency distribution of temperatures across many locations. The underlying of WD could also be related to snowfall or hurricanes.

Origin of Weather Derivatives

The weather derivative market as compared to other financial instruments is relatively young. The first transaction in the WD market dates back to 1997. The sector developed due to the severe repercussions of El Niño. These events were forecasted correctly by the meteorological community. Firms that had their revenues linked to weather realized the importance of protecting themselves against seasonal weather risks. Many companies who were in the business of dealing with financial futures and options saw WDs as attractive tools to hedge weather risks.

The insurance sector achieved substantial financial consolidation. As a result, there was significant capital to hedge weather risks. Insurance firms started writing options with payoffs linked to weather events. This, in turn, elevated the liquidity for the development of a WD market. Thus, the WD market evolved over the years into a strong over-the-counter market.

Continue reading

RISING NPAS IN INDIAN BANKING SECTOR: CAUSES, EFFECTS, IMPLICATIONS AND REMEDIES

By Charudutt Sehgal

Introduction

The economic progress of a nation and development of its banking sector is invariably interrelated. The banking sector is an indispensable financial service sector supporting development plans through channelizing funds for productive purpose, intermediating flow of funds from surplus to deficit units and supporting financial and economic policies of the government. Banks serve social objectives through priority sector lending, mass branch networks and employment generation. Maintaining asset quality and profitability are critical for banks survival and growth. In the process of achieving such objectives, a major roadblock to banking sector is prevalence of Non-Performing Assets (NPA). In India, the problem of bad debts was not taken seriously until it was mandated by the Narasimham and Verma committee. The committee mandated the curbing of the particular issue because NPA direct towards credit risk that bank faces and its efficiency in allocating resources.

The aim of this research paper is to study the current trend of NPAs in Indian scheduled banks (up to 2013-14 only). The paper further examines the critical reasons behind the rise of this issue, its impact on Indian banking sector and Indian economy. In order to understand the criticality of the problem an effort has been made to study what impact NPAs have on ease of doing business rankings. Furthermore, the paper concludes with some of the important measures which if implemented then can improve the current scenario of NPAs in SCBs.

Continue reading

EFFECTS OF DEMONETIZATION ON INDIAN AGRARIAN ECONOMY

By Pushkar Moni and Purvee Khandelwal

Introduction

The currency (notes) is the most liquid legal tender issued by the RBI which can be used to extinguish a public or private debt. The Indian economy, until 8th November 2016 had an estimated ₹14.18 trillion worth of currency notes in circulation, making India predominantly a cash-based economy. The Indian agrarian economy which is also primarily cash based, and is highly unorganized, has emerged as a source to route black money, back into the system both in terms of tax exemptions and channelling funds to create legitimate funds [1]. According to the Central Board of Direct Taxes, only 3.81% of the total Indian population pay income taxes and it is suspected that enormous sums of money are tied up in illegal transactions that are unaccounted for. These illegal transactions not only form a parallel economy in the country but also distort the actual Indian economy. As a countermeasure, the Government of India hitherto referred to as GoI, enacted to demonetize (strip a currency of its legal status) its currency notes of 500 and 1000 denomination. These denominations accounted for 86% [2] of the total currency in circulation. This paper intends to highlight the effects of demonetization on the Indian agrarian economy.

Impact of Cash Crunch on Agriculture

Agriculture is primarily a cash based sector with large capital input. This sector contributes about 15% to the Indian GDP and employs about 49% of the total workforce. The real growth rate of the sector is reported to be 1.3% [3]. This low growth rate is usually attributed to the droughts experienced in the past two years.

Continue reading

EFFECTS OF DEMONETIZATION ON THE FINANCIAL SECTORs OF INDIA

By The Editorial Board of TJEF

(Anil Shankar, Gandhali Inamdar and Isha Varma)

Introduction

Demonetization has been the buzz word since November 8th 2016 when our Prime Minister made the historic announcement about the decision to discontinue the 500 and 1000 rupee notes. This historic decision has affected almost all the sectors. Some have benefited while others have suffered. This paper intends to analyze the effects of demonetization on the major financial institutions and the Indian economy in general.

Effects of Demonetization on Banking sector

Since the advent of asset quality review (AQR), there has been a rise in the number of NPAs. To get an idea, the GNPA of banks is 6 lakh crore as of June, 2016 which is 8.2% of the total loans1. These are only the NPAs as there are an equal number of restructured loans which might transform to NPAs in future.

 p1g1

Figure 1: Total NPAs as of March 2016, Source: Finance Ministry

A recent data provided by the Finance ministry, which has been depicted in Figure 1, shows that 5.3 lakh crore of the 6 lakh crore NPAs are under the public sector banks. It’s clearly visible that there has been a rise in the NPAs from October 2015. This can be attributed to the ever greening of loans which led to the creation of a distorted picture of the banks. Though the asset quality review led to the identification of such NPAs which were previously classified as standard, the problem of NPAs existed since the 2008 financial crisis but remained hidden due to the above mentioned reason.

Continue reading