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The Economic Times – ET In The Classroom – Archives – 3(Economics Concepts Explained)

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The Economic Times newspaper now and then publishes articles on current economic issues in a question and answer format under

the heading ‘ET In The Classroom’. They are simple to understand and remember.

Many tough concepts are beautifully explained by the ET team in these articles. All these articles are freely av ailable on the net.

They are the property of the Economic Times. I hav e just consolidated all of them here for the benefit of the readers.

For an IAS aspirant preparing for the UPSC civ il serv ice examination, ET in the Classroom is a one-stop solution for getting

acquainted with many economic jargon and concepts.

ET In the CLASSROOM: ESSENTIAL COMMODITIES ACT

The Prime Minister will soon hold a meeting of chief ministers to discuss the alarming food price situation and rev iew the

implementation of Essential Commodities Act (ECA). ET looks at the ECA and how it can help combat the rising prices of food

articles.

What are essential commodities?

The gov ernment has powers under the Essential Commodities Act, 1 955 (EC Act) to declare a commodity as an essential commodity

to ensure its av ailability to people at fair price. The EC Act, 1 955 allows the gov ernment to control the production, supply , and

distribution of these commodities for maintaining or increasing supplies and securing their equitable distribution. Essentially , the

act aims to ensure easy av ailability of important commodities to consumers and check exploitation by traders.

How many commodities are covered by the Essential Commodities Act?

There are sev en broad categories of essential commodities cov ered by the Act. These are (1 ) Drugs; (2) Fertilizer, inorganic, organic

or mixed; (3) Foodstuffs, including edible oilseeds and oils; (4) Hank y arn made wholly from cotton; (5) Petroleum and petroleum

products; (6) Raw jute and jute textile; (7 ) (i) seeds of food-crops and seeds of fruits and v egetables; (ii) seeds of cattle fodder; and (iii)

jute seeds. Recently cotton seed was also included in the list.

How does the Act help check price rise?

The Act is implemented by the state gov ernments and union territories, leav ing the central gov ernment to merely monitor the

action taken by states in implementing the prov isions of the Act. State and UT administrations use the powers of the Act to impose

stock or turnov er limits for v arious commodities and penalise those who hold them in excess of the limit. Stock limits hav e been

imposed in sev eral states for pulses, edible oil, edible oilseeds, rice, paddy and sugar.

How effective is the Act?

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http://economictimes.indiatimes.com/





Ov er the three y ears 2006-2008 , state and union territory gov ernments prosecuted 1 4,541 persons under the prov isions of EC Act,

1 955 and secured conv iction in 2,31 0 cases. In 2009 as on 31 August 2533 persons had been prosecuted and 37 conv icted. But,

doubts hav e been raised about effectiv eness of the Act time and again. Recently , Parliament’s estimates committee asked the

gov ernment to come out expeditiously with a new legislation for controlling the retail prices of essential commodities such as rice,

wheat, pulses, edible oils, sugar, milk and v egetables. – http://www.economictimes.indiatimes.com

ET in the classroom: What is underrecovery?

It is the gap between the local price of fuel and what would hav e been the price if the fuel were imported.

Is under-recovery the same as loss?

It is a notional loss in rev enue to the extent the international price of the fuel is higher. It may or may not be a loss-making

proposition to produce the fuel when there is an under-recov ery .

In case of kerosene, oil companies suffer an under-recov ery as well as a loss because the local retail price is much lower than the cost

of crude oil. But sale of a product like petrol can still be v ery profitable at times, ev en if oil companies are reporting under-recov ery

of a few rupees a litre.

Does a rise in underrecov ery make an oil co’s operation less profitable?

It may not. At times, international crude oil prices remain flat but petrol and diesel prices rise. In such a situation, an Indian

refinery ’s profitability will not change because crude oil costs hav e not gone up. But under-recov ery would hav e risen because the

cost of importing the fuel would hav e risen.

Has the concept of underrecovery exaggerated the problems of oil firms?

This y ear it did. Prices of oil products in Asia rose earlier this y ear, when a fire shut down a large refinery in Taiwan. This reduced

the supply of refined oil products and the change in the demandsupply situation made petrol and diesel more costly .

The Tsunami in Japan and a recent fire at a refinery in Singapore had the same impact. The refining margin for diesel, called

“crack spread” has been $20 a barrel most of this y ear. In April, diesel margins jumped to a three-y ear high of $24 per barrel. Last

y ear, it was $1 0-1 5.

So, under-recov ery on diesel looks higher this y ear. In other words, oil companies want a higher price for diesel partly because some

refineries in other countries were shut down. Apart from this, oil companies also charge a customs duty and a marketing margin, in

addition to marketing cost, to calculate underrecov ery . These are profits, not costs.

Can oil companies be at a disadvantage by linking prices to under-recovery?

Yes. This may happen next y ear. In 201 0, v ery little new refining capacity was added in Asia, while demand was strong. Next

y ear, China and the Middle East will add about 1 million barrels per day of refining capacity . This is expected to increase supply of

products and deflate refining margins. As a result under-recov ery is expected to fall.

ET in the Classroom: Leave Travel Allowance

What is Leave Travel Allowance?

Leav e Trav el Allowance (LTA) is the part of the remuneration granted to employ ees by the employ er to prov ide for personal trav el

expenses incurred during the y ear. Apart from the employ ee, it cov ers trav elling expenses of spouse, children as well as dependent

parents and siblings. Further, the exemption is restricted to two children born on or after October 1 , 1 998. There is no restriction on

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the number of children born before this date.

How does LTA save on tax outgo?

Under section 1 0 (5) of the Income-Tax Act, if an employ ee who is in receipt of LTA undertakes a journey within the country , s/he

can claim the v alue of the allowance exempt from income tax. For the purpose, the indiv idual should hav e been on leav e for the

period during which the journey was undertaken.

Can you claim it every year?

No. The exemption can be claimed only twice in a block of four calendar y ears. The current block has started from January 1 , 201 0,

and will last until December 31 , 201 3. The prev ious one ended on December 31 , 2009. If y ou do not av ail of the concession in any

particular block or undertake just one journey , y ou become entitled to carry forward one journey to the next block. Howev er, this

has to be utilised in the first y ear of the new block.

For instance, if y ou av ailed of the concession just once instead of twice between January 1 , 2006 and December 31 , 2009, then y ou

are allowed to carry forward the unused one into the subsequent block (201 0-201 3), prov ided y ou undertake the journey in 201 0

itself. A point to be noted here is that ev en if y ou don’t av ail of the concession at all during a particular block, y ou can carry forward

only one entitlement to the next block.

Can the entire amount be claimed as an exemption?

The exemption will depend on certain criteria specified. Firstly , it is the lower of the actual expenses incurred and the allowance

granted by y our employ er. Let’s assume y our LTA is Rs 1 0,000, but y ou end up spending Rs 1 5,000 on trav elling. In such a case,

the exemption will be allowed to the extent of Rs 1 0,000. Conv ersely , if y our LTA stands at Rs 1 5,000 and y our actual expenses

amount to Rs 1 0,000, y ou will still be entitled to a deduction of only Rs 1 0,000.

Other parameters that decide the extent of exemption?

If y ou hav e opted to fly to the destination, an amount not exceeding the economy class airfare of the national carrier by the shortest

route to that city would be admissible as deduction. In case y ou are trav elling by road or rail, the cost of first class air-conditioned

ticket to the destination by the shortest route would constitute the benchmark. Besides, if y our trav el plan entails v isiting multiple

places during the trip, the destination farthest from y our place of residence would be taken into account for determining the

exemption amount.

What if the travel bills are not submitted before the deadline?

If y ou fail to submit y our trav el bills pertaining to LTA claim with y our employ er within the time prescribed, y our employ er would

consider the amount of LTA paid as taxable and deduct income tax at the rate applicable to y ou. Howev er, y ou can claim LTA

exemption at the time of filing y our income tax return.

ET in the classroom: Non-tax sources of income for the government

Non-tax Revenues

Any loan giv en to state gov ernments, public institutions and PSUs earn interests and this forms the most important item under this

head. The gov ernment also receiv es div idends and profits receiv ed from PSUs. It also earns income for the v arious serv ices it

prov ides. Of this, the railway s is a separate ministry , though all its receipts and expenditure are routed through the consolidated

fund.

Capital Receipts

Receipts in the capital account of the consolidated fund are div ided into three broad heads — public debt, recov eries of loans and

adv ances, and miscellaneous receipts.



Public Debt

Since ev ery thing the gov ernment does is on behalf of the people, its borrowings ev entually are the burden of the people. In budget

parlance, the difference between borrowings (public debt receipts) and repay ments (public debt disbursals) during the y ear is the

net accretion to the public debt. Public debt can be split into two heads, internal debt (money borrowed within the country ) and

external debt. The internal debt comprises Treasury Bills, market stabilisation scheme, way s and means adv ances, and securities

against small sav ings.

Treasury Bills (T-Bills)

These are bonds (debt securities) with maturity of less than a y ear. These are issued to meet short-term mismatches in receipts and

expenditure. Bonds of longer maturities are called dated securities.

Market Stabilisation Scheme (MSS)

The scheme was launched in April 2004 to strengthen RBI’s ability to conduct exchange rate and monetary management. These

securities issued under MSS are not to meet the gov ernment’s expenditure but to prov ide the RBI with a stock of securities with

which it can interv ene in the market to manage liquidity .

Ways & Means Advances (WMA)

RBI is the banker for both the central and state gov ernments. Therefore, it prov ides funds to manage mismatches in the

gov ernments’ receipts and pay ments in the form of WMAs. Now, RBI wants the gov ernment to issue short-term securities to meet

temporary needs.

Securities Against Small Savings

The gov ernment meets a small part of its loan needs by appropriating small sav ings collection by issuing securities to the funds that

manage such schemes.

ET in the classroom: All about rate corridor

In the monetary policy on Wednesday, the RBI raised the repo rate by 25 basis points to 5.75% and the reverse repo rate by 50 basis

points to 4.5%. This has narrowed the rate corridor from 150 basis points to 125 basis points. ET demystifies the concept of rate corridor.

What are repo and reverse repo rates?

Repo rate is the rate of interest charged by the central bank when banks borrow money from it. It is the tool through which the RBI

in-fuses funds into the sy stem by lending to banks against pledging of securities.

The rev erse repo is the rate the RBI offers to banks when they deposit funds with it. The RBI drains out liquidity from the financial

sy stem through rev erse repo by releasing bonds to the banks. This is a daily operation by the central bank to manage liquidity Ov er

a longer time, the RBI can also manage liquidity through open market operations.

What is an interest rate corridor?

Interest rate corridor refers to the window between the repo rate and the rev erse repo rate wherein the rev erse repo rate acts as a

floor and the repo as the ceiling. Ideally , rates in the ov ernight interbank call money market, where lending and borrowing is

unsecured, should mov e within this corridor. Howev er, when banks are short of funds and the ov ernight call money rates are high

and abov e the repo rate, banks approach the RBI to borrow under the repo window.

Therefore, the repo rate becomes an effectiv e policy tool as it would help bring down the rates in the ov ernight market . The rev erse

hap-pens when money market rates fall below the rev erse repo rate. Banks then park surplus funds with the RBI through a rev erse



repo trans-action. As a result, when there is excess liquidity in the sy stem, the rev erse repo is more effectiv e. When liquidity is tight

and banks need short-term funds from the RBI to manage mismatches, then the repo rate emerges as the effectiv e policy rate. But if

liquidity returns to the sy stem the rev erse repo would become the operativ e policy rate as the RBI would be draining out funds from

the sy stem.

Why is a narrow rate corridor desirable?

A narrow rate corridor means that short-term interest rates in the call money market will mov e within that band. This band was

earlier 1 50 basis points, which has now been lowered to 1 25 basis points. Effectiv ely , the narrower rate corridor will mean there

will be less v olatility in short term rates.

Do other central banks also have rate corridors?

Many dev eloping countries hav e the rate corridors but central banks in dev eloped and deeper financial markets hav e a single rate.

In the US, for instance, the Fed Fund rate is the key interest rate. Short term funds are av ailable at this rate to the eligible

borrowers.

ET In the Classroom: Making a Case of Financial Inclusion

What is a ‘business correspondent’ model?

In 2006, the Reserv e Bank of India allowed banks to use non-bank intermediaries as business correspondents, or business

facilitators, to extend banking and other financial serv ices to areas where the banks did not hav e a brick and mortar branch

present. The objectiv e behind it was to aid the process of financial inclusion and consequently take banking to the remotest areas of

the country and make them bankable.

What do these correspondents do?

The business correspondent is nothing but a bank-in-person, who is authorised to collect deposits and extend credit on behalf of the

bank of small-ticket sizes. He also recov ers principal interest of small v alue deposits, sale of micro insurance, mutual fund products,

pension products, receipt and deliv ery of small v alue remittances/other pay ment instruments.

Who is eligible to be a banking correspondent?

RBI has allowed a host of entities to act as business correspondents (BCs) of banks. These include NGOs/MFIs set up under

Societies/Trust Acts; societies registered under Mutually -Aided Co-operativ e Societies Acts, or the Co-operativ e Societies Acts of

States; Section 25 companies, which are not-for-profit companies; companies in which NBFCs, banks, telecom companies and other

corporate entities or their holding companies do not hav e equity holdings in excess of 1 0%; post offices and retired bank employ ees,

ex-serv icemen and retired gov ernment employ ees.

How is a business facilitator different from a business correspondent?

Very often the term ‘business correspondents’ is used interchangeably with the term ‘business facilitators’ (BFs). But RBI makes a

clear distinction between the two. BFs are allowed to undertake only facilitation serv ices like identification of borrowers, collection

and preliminary processing of loan applications, including v erification of primary information, creating awareness about sav ings

and other products, processing and submission of applications to banks and promoting and nurturing SHGs and follow-up of

recov ery and debt counselling. Howev er, facilitation of these serv ices does not include conduct of banking business by BFs, which is

the exclusiv e function of business correspondents.



ET in the classroom: Saving private airlines

Why are Indian airlines in the red despite rising passenger traffic?

Because of high taxes on fuel and rising operational costs. Moreov er, cutthroat competition in the sector prev ents airlines from

raising ticket prices. Taxes constitute 40% of an airline’s total expenditure, far abov e the global av erage of 32%. Besides, rev enues

barely cov er operational costs. For instance, operating margin for Kingfisher stands at 0.1 2 while it is negativ e for

Airway s (-8.25%) and Spice Jet (-6.7 %).

Why can’t airlines raise fares to cover these costs?

Fierce competition in the Indian skies prev ents them from doing so. In the case of Jet, cost per av ailable seat km (ASKM) rose to Rs

3.31 in the second quarter of this fiscal compared with Rs 2.7 4 in the prev ious quarter. In contrast, rev enue passenger km (RPKM)

has crawled up to Rs 3 .63 from Rs 3 .5.

So if an airline goes bust, should the government bail it out?

The tempting answer is that those responsible for corporate recklessness must bear the consequence, but in real world things are not

so simple. Many experts argue that had Lehman Brothers not been allowed to go bust, the financial crisis could hav e been less

damaging. But, a corporate bailout sends the wrong signal or creates a ‘moral hazard’ of encouraging more recklessness, the cost of

which is borne by the taxpay er.

What is moral hazard?

In economic theory , the concept of moral hazard comes from the insurance industry where an indiv idual or a company behav es

differently when he is protected from a risk than when he is exposed to the risk. The guarantee of insurance can make the insured

less risk av erse, as he knows he is protected from the financial consequences of his actions.

How does the concept apply to bailouts?

If a company believ es its existence is crucial for the economy or for public good, it may be tempted into taking reckless risks

believ ing that the gov ernment will step in to bail it out if it were to land in trouble. Therefore, any rescue of troubled priv ate sector

firms makes others believ e that they could also be similarly helped out if things went wrong.

ET IN THE CLASSROOM What’s EPCG scheme?

The Export Promotion Capital Goods (EPCG) scheme was one of the sev eral export-promotion initiativ es launched by the

gov ernment in the early ’90s.

The basic purpose of the scheme was to allow exporters to import machinery and equipment at affordable prices so that they can

produce quality products for the export market.

The import duty on capital goods – like all other items – was high during that period, inflating the cost of capital goods nearly 50%,

so the gov ernment allowed exporters to import capital goods at only 25% import duty .

For waiv er of the remaining portion of import duty , exporters were supposed to undertake an ‘export obligation’ (a promise to

export) which was worked out on the basis of the duty concession obtained.

Exporters were giv en eight y ears to carry out their commitment to export. Once the ‘export obligation’ was fulfilled, the owner of

the capital goods concerned could sell them or transfer them to another facility .

Till the promised export materialised, the owners of the machinery or equipment were barred from ev en mov ing the goods

concerned out of their manufacturing unit.

Did liberalisation of imports have an impact on EPCG?

http://economictimes.indiatimes.com/topics.cms?search=Kingfisher

http://economictimes.indiatimes.com/jet-airways-india-ltd/stocks/companyid-4374.cms

http://economictimes.indiatimes.com/topics.cms?search=Lehman%20Brothers



Gradual reduction in import duties, particularly in the case of capital

goods, has been rendering EPCG scheme less attractiv e. Howev er, till last

y ear, EPCG was preferred by many since the exemption also included 4%

special additional duty of customs (SAD) which has been abolished now.

Textile machinery , for example, attracted an import duty of only 5% but the

4% SAD resulted in the duty burden going up to nearly 1 0%. This led many

textile units to prefer the EPCG, but the scenario may change now in v iew of

the gov ernment’s decision to abolish SAD.

The gov ernment has been modify ing the EPCG scheme ov er the y ears in line

with the demands of the domestic industry . The first change was the

introduction of two windows – the first one attracting 1 5% duty while the

second one attracted 25%. Those who preferred to pay higher duty under the

second window had a lower export obligation. In ’95, the gov ernment offered

duty -free imports under the first window while the duty under the second was

1 5%. This was the first time duty -free imports were made av ailable under

EPCG.

Since the purpose of the scheme was to allow exporters compete

internationally , it was decided to allow them to buy machinery at

internationally -competitiv e rates. The pent-up demand for imported machinery

had peaked at this point and the domestic industry ’s initial trouble with

competing imports had come to an end. Thereafter, the gov ernment ev en

reduced the import duty on capital goods under the second window to 1 0%

while the first remained duty -free. Subsequently , the policy was changed in

’00 to merge the two windows into one – import capital goods by pay ing 5%

and undertake uniform export commitment.

Who were the major beneficiaries of the EPCG?

The manufacturing industries, especially those who had to import their

capital goods, were the main beneficiaries ov er the y ears. The serv ice

sector was nowhere in the picture till last y ear. Now serv ice industries

like hotels can also av ail of EPCG imports and fulfil the export obligation

through the foreign exchange earned by them.



This is a major concession for serv ice prov iders who were ignored ov er the

y ears. Since serv ices now account for nearly 50% of the country ’s GDP, it is

fair to allow serv ice prov iders to imports goods at

internationally -competitiv e rates.

The attraction of EPCG has, any way , diminished ov er the y ears and it will be

a question of time before the scheme becomes redundant. Import duties will

come down ov er the y ears, especially in the case of capital goods.

It will be curtains for the EPCG scheme once the duty on capital goods comes

down to 5%. Going by the pace at which India is signing free trade

agreements, this possibility seems nearer. Like other outdated instruments

like the cash compensatory scheme (CCS) for exporters and the quantitativ e

restrictions (QRs) on imports, the once-popular EPCG will also exist only on

records once the duty reduction materialises ov er a period of time.

ET in the classroom: The anatomy of layoffs

What are layoffs?

When companies discharge employ ees either temporarily or permanently because they hav e no money to pay them or there is no

work for them. The term is also known v ariously as downsizing, redundancy , right-sizing, workforce optimisation and

redeploy ment.

Sev eral companies, banks and financial institutions across the world resorted to lay offs during the slowdown after the collapse

of Lehman Brothers in September 2008. In India, the term became more familiar during late 2008 and early 2009.

Are there any warning signs before jobs are shed?

Lay offs are a function of business sentiment. So job losses happen during slowdowns, which are usually preceded by phases of

inflation.

During a slowdown, job markets tighten up as entities go on austerity driv es to lower their administrativ e and other costs.

Generally , the next phase of critical action deals with rightsizing initiativ es. Lay offs are imminent at this stage.

Is there a way to pre-empt and, thus, avoid job loss?

Sometimes organisations resort to lay offs as a natural reaction to slowdown. But instead of such knee-jerk measures, there are many

other prev entiv e steps they can take.

Proper work-force planning, continuous focus on cost control, multiskilling and creating a positiv ely enabling work culture are

some of the way s in which organisations can plan ahead of time so that they do not hav e to downsize and lay off people during a

downturn.

How can one cope?

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Craft a nice resume, circulate it in y our professional network and approach headhunters which deal in y our specialisation or in

y our target sectors. Do not hide the ‘pink-slip’ fact from y our near family . Share it with them so that they can prov ide y ou

emotional support.

How does one prepare for a new career?

Employ ees should reflect on their skillset and be clear about their competencies. Telecom and financial serv ices sectors in India hav e

experienced lay offs and ‘workforce deploy ment’ in recent months. If certain sectors are not doing well, look for similar options.

Those in financial serv ices can explore small and medium enterprises and retail. Those from telecoms can look at any thing that can

connect B2C — social network, e-commerce, technology companies. Approach the principals and entities who would see close

sy nergy with these profiles and start informal discussions with potential employ ers or interested parties.

Continuous skilling and learning is recommended. There is a need to be entrepreneurial so that in ev ery change one finds newer

opportunities and v alue propositions.

ET in the classroom: No-claim Bonus (NCB)

What is a `No-claim’ bonus?

No-claim bonus (NCB) is a discount in premium offered by insurance companies if a v ehicle-owner has not made a single claim

during the term of the motor insurance policy . The discount, which is on ‘own damage’ cov er, ie, cov er against damage to the

v ehicle, can go as high as 50% for both 2-wheelers as well as 4-wheelers.

How much NCB can you enjoy?

This discount in the premium is usually 20% for the second y ear, 25% for the third y ear, 35% for the fourth y ear, 45% for the fifth

y ear and 50% for the sixth y ear. The v alue of the discount depends upon the insurance claims y ou hav e made in that particular

y ear. NCB can be carried forward and will be only allowed prov ided the policy is renewed within 90 day s of the expiry date of the

prev ious policy .

What if you sell your car?

The no-claim bonus is a reward to the v ehicle owner for prudent use of the v ehicle. If y ou sell a 1 0-y ear old hatchback and purchase

a C-segment car, the no-claim bonus will pass on to the new v ehicle and y ou can sav e considerably on y our insurance costs.

Can you get the NCB transferred to another insurance company?

Yes, subject to ev idence in the form of a renewal notice or letter, confirming the NCB entitlement from the prev ious insurer.

What should you do if you renew the policy online?

You hav e to scan and send the cov er note to the insurance company online and it will do the needful.

What if you hide your claim history and avail of a no-claim bonus from a new insurance company?

Initially , y ou might succeed in getting a no-claim bonus by hiding y our claims history . But insurers are sharing their claims

databases and any false declaration will surely be detected.



ET in the classroom: New rules treat GDRs/ADRs on par with shares

Do Global Depository Receipts (GDRs) and American Depositary Receipts (ADRs) currently have voting rights?

The GDRs and ADRs in themselv es do not hav e v oting rights, but the underly ing equity shares do. These shares are held by a

depository , which then issues the corresponding receipts (GDRs/ADRs) to inv estors looking to buy such instruments. So it is the

depository that has the v oting rights. Whether the holders of the GDRs/ADRs can v ote or not depends on the depository agreement

between the company issuing the GDRs/ADRs and the depository . During the initial y ears when GDRs and ADRs came into v ogue,

the agreement mandated depositories to v ote on behalf of the management. But later, the depository agreements were changed so as

to allow the GDR/ADR holders to instruct the depository to v ote on their behalf.

How do ADRs/GDRs work?

ADRs/GDRs are issued by companies looking to raise funds ov erseas. These instruments may represent one, multiple or a fraction of

the underly ing shares. For instance, if an Indian company wants to issue ADRs, it will deliv er the corresponding number of shares

to the US depository bank. The depository will then issue receipts to inv estors who hav e subscribed to the issue. Depository receipts

are transferable instruments, so they can be freely traded on the exchange on which they are listed. They are also fungible, which

means the holder of ADRs can instruct the depository to conv ert them into underly ing shares and offload them in the local market

(in this case India).

What did Sebi say about GDRs/ADRs on Tuesday?

Till now, purchases made through GDRs/ADRs did not trigger an open offer by the acquirer ev en if the 1 5% threshold was crossed so

long as the depository receipts had not been conv erted into underly ing shares. But on Tuesday , the regulator amended this rule.

Any one now holding ADRs/GDRs with v oting rights will hav e to make an open offer to minority shareholders if his holding touches

the 1 5% limit.

Why did the regulator have to make this amendment?

Securities lawy ers and merchant bankers say the Takeov er Regulations relating to ADRs/GDRs were drafted at a time when the

depositories alway s v oted on behalf of the management. Now that depository receipt holders hav e the right to v ote, it makes little

sense to keep ADR/GDR holdings outside the purv iew of the Takeov er Regulations.

How does this amendment affect the Bharti-MTN deal?

Bharti’s proposed takeov er of MTN inv olv ed issuing GDRs to the South African telecom firm and its shareholders, which would add

up to 27 % of Bharti’s equity base. In an informal guidance to Bharti in July , the regulator had said that purchases through the GDR

route would not trigger an open offer unless the GDRs were conv erted into shares. But under the new rule, MTN will hav e to make

an open offer for an additional 20% in Bharti. This would make the deal expensiv e for MTN and also for Bharti, if it wants to get

around the new rule.

Can Bharti still go ahead with its deal with MTN?

It can. For instance, the depository agreement can stipulate that the GDRs will not hav e any v oting rights. This is the most

inexpensiv e way of getting around the new rule. But the key question here is whether MTN shareholders will agree to such an

arrangement. The other option for Bharti is to cut down the issuance of GDRs to below 1 5% and pay more cash to MTN. But that

could increase the cost significantly for Bharti.

ET Classroom: Top-up premiums in ULIPs



A top-up premium is something that a policy holder can inv est into his ULIP ov er and abov e his existing premium pay ment. If y ou

want to take adv antage of a well-performing ULIP, y ou can increase its inv estment component by pay ing an extra premium.

Will the sum assured increase in tandem with top-ups?

There is no compulsion to increase the insurance component of the ULIP.

But some ULIPs increase the sum assured in accordance with the top-up premium. For example, in ICICI Pru Life Time Maxima, a

recently -launched ULIP, the sum assured would be increased by either 1 25% or 500% of the top-up premium as chosen by the

customer. Hence, prepare y our policy document carefully .

How can you top up a ULIP?

You can top up a ULIP any time during the life of the policy until the total of top-up premiums does not exceed 25% of the total

premium paid. Ev ery company clearly defines the minimum top-up amount in the policy document itself. It is usually more than

Rs 2,000. But this option is av ailable only for disciplined customers who pay their premiums on time.

If y our regular premium is due and y ou pay a top-up premium, the insurance company will direct the additional funds towards the

regular premium amount. If the total of top-up premiums exceeds 25% of the total premiums paid, the sum assured of the policy can

go up by as much as 1 25 times of the top-up, depending upon the underwriting requirements of the life insurance company .

What are the charges?

The premium allocation charge of a top-up plan is any where between 1 % and 3% and v aries from policy to policy .

How will I benefit from a top-up premium?

You can sav e on the premium allocation charge by opting for a top-up premium. For instance, y ou can opt for a low-v alue ULIP to

test the waters. You can then step up y our inv estment component in a staggered manner after monitoring its performance.

Secondly , y ou can benefit from lower premium allocation charges by adopting this approach. For example, the lowest allocation

charge of any regular premium of a ULIP av ailable in the market today is 5%, which is still higher than the premium allocation

charge of top-up premiums.

Ideally , y ou should av ail y ourself of the low base effect benefit in the initial y ears of the policy and top up the policy subsequently .

But a word of caution: if y our top-ups exceed a limit, the final sum may be subject to tax proceeds at maturity . This clause again

v aries from policy to policy .

Can y ou opt for partial withdrawal from top-up premiums?

Usually the lock-in-period for each top up premium is three y ears from the date of pay ment of that top-up premium for the purpose

of partial withdrawals. In fact, some ULIPs do not permit partial withdrawals if top-up premiums are paid in the last three y ears

before maturity date.

ET in the classroom: Mortality Charges

What are mortality charges?

Mortality charges are that part of life insurance premium that go towards prov iding a death benefit cov er. In other words, these are

the actual cost of insurance in a life policy . In most policies, the bulk of the premium goes towards inv esting in a sav ings fund which

is returned to the policy holder when the policy matures or the policy holder dies.

How are they calculated?



Most companies use a table of charges prepared by the Life Insurance Corporation (LIC) since this is the only company which has

fiv e decades of experience and consequently has historical data on life expectancy . Since priv ate insurers hav e been around for a

decade, some hav e made alterations to the rates based on their own experience. Work is on progress on a new mortality table with

data from all companies and prices are expected to fall as life expectancy has gone up.

Will the policyholder benefit from buying a policy at a young age?

Yes. For instance, the life expectancy of a 25-y ear-old will be higher than that of a 55-y ear-old, and hence, the former will stand to

benefit in terms of lower charges while buy ing insurance.

How will the updated mortality table impact pension policies?

Since the life expectancy of the av erage Indian has gone up, it is likely that y ou will hav e to incur a higher cost when it comes to

buy ing whole-life annuities. Those who inv est in pension plans will hav e to use at least two-thirds of the accumulated sum to buy

annuities — a product where the inv estor gets regular income for a specified period in return for a lumpsum pay ment. The sav ings

under a pension plan hav e to be inv ested in annuities to av oid them being taxed. One-third of the pension fund v alue at maturity is

made av ailable to the insured for tax free. The balance has to be used for purchase of annuities from any insurer.

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