Wednesday, May 30, 2012

Should you Exit your ULIPs Now?


The title is a Million Dollar question isn’t it? The economic uncertainty in the Euro Zone and USA has affected the Stock Markets worldwide. Markets like India which attract a significant portion of foreign investors are highly sensitive to cash inflows & outflows from the markets. The past 2-3 years have been very strenuous on the Indian Stock Markets. We have witnessed multiple corrections & dips along with a few bursts of growth as well. At this Juncture, many of you, who had bought ULIPs in the past few years, might be wondering what to do with these products. Are you one of them? If so, this article is just for you…

Should you Exit your ULIPs now?

Well, this questions can’t be answered in a simple Yes or No across the board. We are going to split our investor population into two groups and answer this question depending on the situation they are in.

Category 1 – ULIP is less than 5 years old

These are the relatively new investors who have been investing in ULIPs only in the past few years. ULIPs as you might be aware are long term investment options and they also include high fees & charges during the first 2 – 3 years of its life. So, even if the stock market performs very well, a well-managed ULIP will reach the break-even point only around the 5 year mark. For ex: If you were investing 1 lakh every year, in all probabilities your investment will be worth around 5-6 lakhs by the end of 5 years even if the ULIP is performing exceptionally well.

In the last couple of years, the market has witnessed severe corrections and hence the value of your investment right now will be at least 10 to 20% or more lesser than what you had invested.

Moreover, Insurance Cos charge penalties if we withdraw our investments within the first 5 years (3 or 7 in some cases). So, at this point when the market is very volatile, exiting the investment would mean incurring losses. It would be advisable to stay invested and continue for at least a few more years and then reconsider your decision when your investment is 7 years old.

A 1 lakh investment every year will be worth the following amounts if it were to grow at different rate: (Invested Amount = 7 lakhs)
1. Growth @ 5% p.a = 8.5 lakhs
2. Growth @ 6% p.a = 8.9 lakhs
3. Growth @ 8% p.a = 9.6 lakhs

As you can see, if your investment grows at an average of 6% p.a rate of interest for those 7 years it will be worth 8.9 lakhs.
If you are in need of the money and your investment has grown by at least 6% on an average, it would be a good idea to exit the investment. But, until then, staying invested would be the best way to go.


Category 2 – ULIPs are More than 5 years Old

These are the Seasoned Investors who have been investing regularly for more than 5 years and by now are sitting on a handsome corpus (Assuming that their ULIP scheme has performed well). They have most probably crossed the mandatory holding period and can exit the investment anytime they want.

In the current market scenario exiting would make sense if:
1. You have some plans for the money you will get – Either to spend it on some cause (like children’s education, buying a home etc.) or to invest in some other instrument (like Bank FDs, PPF etc.)
2. Your Investment has grown at at least 6-8% or more on an average
Let’s take the same example where we invest 1 lakh every year. If our investment were to grow at 8% per annum it will be worth the following amounts:
a. At the end of year 6 = 7.9 lakhs (Investment = 6 lakhs)
b. At the end of year 7 = 9.6 lakhs (Investment = 7 lakhs)
c. At the end of year 8 = 11.4 lakhs (Investment = 8 lakhs)
d. At the end of year 9 = 13.4 lakhs (Investment = 9 lakhs)
e. At the end of year 10 = 15.6 lakhs (Investment = 10 lakhs)
So, if your investment has grown to approximately the amounts mentioned above, it would be a good idea to exit the investment right now. If your investment has only grown to be less than this, then the judgement call is yours. You can decide to exit the fund based on the current returns it has offered or opt to stay invested.

What about cases where we have crossed 5 years but the Investment isn’t worth even the amount we invested?

Did you think about asking me this??

Well, if so, the answer is – Stay Invested but do not make any fresh investments. Let’s say you have invested 1 lakh each year for 7 years and your ULIPs value right now is 6.5 lakhs, then don’t exit right now. You are at a loss of 50k and there is no point in exiting at a loss. So, you can do the following:
1. Stop making fresh investment contributions. Let us now add more money on a fund that hasn’t performed so well in the past 7 years or so
2. Don’t exit the fund. Let the investment of 7 lakhs stay as it is.
3. Switch your units to a Balanced option that invests equally (around 50%) in both Equities & Debt instruments to cushion & minimize further losses
4. Keep track of the ULIPs performance on a regular basis – say every month. Wait for the time when your investment breaks-even.
5. Give the fund another 6 months to 1 year to generate returns for you and the moment your investment is grown by at least 7-8% on a year-on-year basis exit the investment

A General Suggestion to all ULIP Investors

Irrespective of which category you fall into, whether you want to exit your investment or stay invested, whether you are going to make fresh investment contributions or not, the following suggestion will have a big impact on your funds risk/return ratio.
Most ULIPs give you options to switch between various investment options. At the given market scenario, being heavily exposed to the stock market is not a good idea. At the same time, too little exposure would be bad too because the market is sure to rebound and if you are in defensive mode when the market gets back on its feet, you will not get the growth or returns you want.
Switch Over to a Balanced Fund Option that invests equally in both Equities & Debt Instruments.
So, go for a Balanced fund option that invests around 50% or so in Equities and Debt Instruments. This way, at least 50% of your corpus is set up to be safe and the remaining 50% can help you attain good returns once the market recovers.

Happy Investing!!!

Tuesday, May 29, 2012

Keeping Automobile Insurance Premiums in Check


Do you own a bike or a car? If so, you would’ve definitely purchased some sort of Motor Insurance on your vehicle. How did you purchase that Insurance? The dealer from whom you bought your bike/car had tie-ups with some XYZ Insurance Co and added the policy by default to the on-road price of your vehicle. Dint he? And from the subsequent year, you just paid the policy renewal premium amount that was sent to you by the Insurance Co without spending much time on this whole Vehicle Insurance fiasco…
If this is what happened to you, you must definitely read this post which will help you bring down your Automobile Insurance Premium.

What is Automobile Insurance?

Well, you all know what this is. In the event of any accident, the Insurance Company will pay for the damages & repair to your vehicle. Also, if you had third-party insurance, the Insurance Co will also pay the accident victim. For this facility, you pay an annual premium depending on the car you own. Owners of high-end luxury cars like a BMW or a Mercedes usually pay annual premiums that workout to approximately the price of a small hatchback :-). Nonetheless, the price of your car plays a big role in the annual insurance premium you pay. Irrespective of the car you own, the following ideas will help bring down your Insurance Cost…

Idea No. 1 – Buy only what is required by Law

As per the Indian motor vehicle regulations, there are certain minimum insurance requirements you need to purchase. There is a Mandatory Limited Liability requirement which every vehicle owner must purchase. Obviously you could buy a higher cover but this will also drive up your annual insurance premium. So, keeping all the liability requirements to the mandatory minimum will keep your premium amount to the minimum levels as well.

Idea No. 2 – Drive Safely

There is no better idea than this. Every year that passes by, where the customer does not make any claims on the insurance policy, he is eligible for a No-Claims Bonus or NCB. NCB will help reduce your annual premium by around 10 to 20% if you are a safe driver and haven’t made any claims in the previous year. For ex: If your annual insurance premium was Rs. 10,000/- last year and you did not make any claims, in all probabilities, the renewal premium amount this year will be around Rs. 8,000/- to Rs. 9,000/- because of the No-Claims Bonus.

An important point to note here is that, this NCB amount differs from one Insurance Company to another. As a general average, you can expect your premium to go down in the range of 10-20% every year if you don’t make any claims against your Insurance Policy.

Idea No. 3 – Opt for a Higher Deductible

The Deductible amount here is the amount you will pay towards the vehicle repair. For ex: let’s say you opt to pay 20% of the cost in case your vehicle meets with an accident, the Insurance company will have to pay only the remaining 80% which means lesser liability for them and hence lesser premiums for you. A point to note here is that depending on the Insurer, this deductible amount you can choose will vary. Always try to go for the higher deductible if you are confident of your driving skills. 5 years of accident free driving will save you more than enough money to fund the 20% cost of your vehicles repair if it happens. So, follow Idea 2 and drive safely and follow Idea 3 to bring down your insurance premium considerably

Idea No. 4 – Don’t buy unnecessary Add-On Covers

These Insurance Agents try to sell you almost anything and everything you just don’t need. When I was buying the Insurance Policy for my car, the Insurance agent was giving me add-on covers like hospital cash, emergency roadside assistance and so on.
Do you think he is going to give these things for free? Absolutely NOT. He is going to charge me additional premium for all these facilities. Here for ex: My Car Dealer offered free road-side emergency assistance for the first 5 years on the model of car I bought. So, taking this emergency roadside assistance add-on was overkill for me. I had medical insurance and they will take care of my cash requirements in the event of an unfortunate injury. So, the hospital cash add-on too was overkill for me. By avoiding these add-ons I avoided paying a few hundred bucks extra as premium.
So, think carefully before selecting these Add-on covers. Buy only what you need. Remember Idea No. 1?

Idea No. 5 – Install an Anti-Theft device approved by the ARAI (Automobile Research Association of India) in your vehicle

Most Insurers offer a small discount on the Insurance Premium if you have installed an anti-theft device approved by the ARAI. Not only is this device going to help you in the event of your vehicle being stolen, it will also help reduce your yearly premium as well. So, check if your Insurer offers this benefit and if so use it. Otherwise, go ahead and install the device and switch over to an Insurer who offers you this discount.

Idea No. 6 – Try to Buy your Policy Online

Online Policy Purchases are usually cheaper than in-person purchases because, the Insurer doesn’t have to pay any fee/commission to the Insurance Agent/Salesman. In turn, they pass on this saving to the customer by means of a lower premium.
But, an important point to note here is that, while buying online, make sure you read every single detail reg. the policy. Going behind lower premiums, we wouldn’t want any surprises in the unfortunate event of our vehicle meeting with an accident

Idea No. 7 – Don’t Rush to Make Claims

I know certain people prefer to make Claims against their Insurance policy even for minor damages on their vehicles. For ex: My colleague had parked his car just beside a Coconut Tree in a Restaurant in East Coast Road in Chennai during one of our Project Party outings. A coconut fell on his car bonnet and caused a dent. It was a simple accident and my friend had to shell out Rs. 1000/- to fix the dent on his car. He filed an Insurance Claim along with all necessary documentary proof and claimed Rs. 900/- after the 10% deductible and was boasting about it. His rationale was, “Why am I paying Rs. 25,000/- as premium every year on this car? Let the Insurer pay at least this 1000 rupees”

What did he do wrong here?

Do you remember Idea No. 2 about driving safely and the No Claims Bonus? Since my colleague made a claim of Rs. 1,000/- he will not be eligible for the No Claims Bonus this year. Assuming he hadn’t claimed this 1,000 rupees he would’ve been eligible for the NCB. Assuming a minimum 10% premium reduction (Actual might be even more) he would have saved Rs. 2,500/- in next year’s premium. By claiming this Rs. 1,000/- he missed out on saving Rs. 2,500/- in annual premium.
Which option would’ve been wiser? Claiming Rs. 1,000/- or Saving Rs. 2,500/- in insurance premium? I would go with option 2 and am sure so will you…

Idea No. 8 – Always Renew Your Policy on Time

Most Insurance Cos will let your policy lapse if you do not pay your policy renewal premium within a certain no. of days after the policy’s expiry date. If the policy lapses, you will be asked to go for a fresh policy which will cost you more than what it would if you renewed your policy.

A couple of years back, I forgot to renew my bike’s insurance policy. The previous year my premium was Rs. 850/- and I got a letter than this year’s premium was Rs. 700/- after the NCB. I thought of taking care of it later and totally forgot about it. The due date passed and the policy lapsed. The Insurer forced me to buy a new policy as my earlier policy lapsed and I had to pay him Rs. 800/- for the same policy. I had to pay Rs. 100/- extra because this was a new policy and not a policy renewal. Had I been more careful, I would’ve saved this extra 100 rupees. Though 100 rupees might sound like a small amount, imagine the loss if I owned a Car instead of a Bike and my premium was Rs. 8,500/- instead of Rs. 850/-

Hope you will use all these ideas to reduce your Automobile Insurance Premium…

Happy Insuring Your Vehicles!!!

Thursday, May 24, 2012

Should the Government of India Bailout Air India


This is probably the most discussed topics in social and economic forums in India including the Indian Parliament. Recently the Government of India has announced a bailout package worth 30,000 crores of rupees over the next 9 years which begins with an immediate bailout package of Rs. 6,750 crores. This article is going to be my take on “Should the Government of India bailout Air India” from its current financial mess…

About Air India

Air India is India’s National Carrier and this is something you know already. If you read my previous article on “What is wrong with Air India” you would also know that Air India is in dire financial situation. Poor Management Decisions, with careless staff performance and inferior customer service, India’s National Carrier is on the verge of a painful collapse. We also covered in great detail about some of the reasons which I feel have contributed to Air India’s current state of affairs.

What is a Bailout?

Do you know what a Bailout is? The first article in my blog was about this. A bailout in economic parlance is a financial aid that helps someone or some organization prevent declaring bankruptcy.

Government of India’s Bailout package for Air India in 2012

Last month, the Government of India has announced a bailout package worth 30,000 crores over the next 9 years. There will be an immediate cash influx of 6,750 crores which Air India is going to utilize for its day to day working capital cash requirements.
30,000 CRORES – A lottt of money – Isn’t it??

Is this the first Bailout Package received by Air India?

Do you want to make a blind guess and say “I don’t think so”???

If you did, you were 100% correct my friend. This is not the first and most probably not the last bailout package the ailing Indian National Carrier from the Government of India.

Actually speaking – this is the 4th bailout package that Air India is receiving from the Indian Government. The details are:
1. In 2009 the Government Injected Rs. 5500 Crores to keep the airline flying. This was the first bailout
2. In February 2010, the Government funded around 2000 crores
3. In August 2011 the Government gave another 1200 crores to help Air India meet its cash requirements
4. Now in 2012, it has approved an additional 30,000 crores of which 6750 crores will be given immediately

What is the Justification for this Bailout?

The Proposed Justifications on the part of both Air India & the Indian Government for this massive bailout package are:
1. To Meet its working capital requirements
2. To Improve Safety Features & Requirements in all its fleet aircrafts
3. To Increase the airlines on-time performance to 90% (It is 71% now which is one of the lowest in the world)
4. To purchase new aircrafts (Boeing Dreamliner’s)
They claim that, with all this capital infusion and radical management strategies, Air India will become a profit making entity by the year 2018.

Where does this Bailout Money come from?

Where else – From our Taxes. The Tax Money paid by the citizens of India is being spent to bailout Air India.

Do I think this Bailout is going to work?

From my Heart I want this Bailout to work. Air India performing in such a poor manner hurts the image of India across the globe.
From my Brain – I don’t think that this Bailout will work.

Reasons:
1. The Management is not going to mend its erroneous ways
2. The Staff is not going to mend its careless ways
3. The Government is going to continue to bailout Air India no matter how poorly they perform

Do I need to say more???

Should the Government Bailout Air India?

NOOOOOOOOOOOOOOOOOOOOOOOOOOOO!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!

Definitely NOT. Why must the government spend the tax payer’s money on a lost cause? Does this bailout package include any performance based clauses? Will the government pull the plug if Air India is going to continue to make losses? Of course not. So, as long as they are going to get paid their salaries & get bailouts every one or two years to cover for their losses, I don’t think the Air India Management will even take half-hearted steps to revive the airline.

What can the Government Do to Fix the Situation?

Well, this one is easy. The government can do either or all of the below:
1. Sell the Airline to a Private Player – This means a private company is going to own the airline and unless the management & staff of Air India are going to mend their erroneous ways, the new owner is going to kick their rear ends to get them to work. If I were to invest thousands of Crores to buy this airline, will I allow the staff to be as lethargic and careless towards customers as they are now?
2. Tighten the Noose around the Top Management of Air India – The Government must set performance targets and guidelines which must be like – Increase Operating Profit for 10% in the next 12 months, Increase Customer Satisfaction index to at least 6 out of 10 in the next 12 months and so on… If you cannot meet all these targets in the next 18 months (with a buffer of 6 months) we will sell the airline to a private player or shutdown the services. None of you will have your jobs if you fail to perform.

This sounds pretty harsh but unfortunately spending thousands of crores of public money on the airline which is continuing to perform poorly is a waste of time and this money could rather be spent on useful causes to help the common man who is paying this tax money

Hope things take a turn for the better in Air India!!!

What is wrong with Air India?


Air India – India’s National Carrier has been in the news for all the wrong reasons over the past few years. Are you one of those poor Indian Citizens who haplessly watch Air India go spiralling down towards its end? Are you one of those poor Indian Citizens who want to know what exactly is wrong with one of the world’s Large Airlines?

I assume the answer to both questions is a YES. In this article, we are going to analyse the reasons as to why Air India is doing so miserably in spite of the government pumping in thousands of Crores to keep the Airline running.

Reasons for Air India’s Poor Performance

There are numerous reasons for Air India’s dismal performance over the past few years. Some of the significant ones are:
1. Cost of Aviation Fuel
2. Poor Management
3. Poor Performance
4. Over-Staffed
5. Poor Customer Service
6. Corruption1
Point no.6 is something I am not going to waste both our times explaining it. So, let’s get right down to business and look at the other 5 major reasons.

Cost of Aviation Fuel

Aviation Fuel accounts to approximately 50% of the Operating Costs for any Airline. The actual % depends on the price of the Aviation Fuel in the respective country. In India the price of 1 kilo litre of Aviation Fuel works out to approximately 1250 USD which works out to around Rs. 68,000/- whereas it is comparatively cheaper in other countries. For ex: in Dubai & Singapore the price of 1 kilo litre of Aviation Fuel works out to around 810 USD which is approximately Rs. 45000/-

You can say that Dubai has oil wells and so it is cheaper there. What about Singapore? Do they have oil wells too? Unfortunately Not. Singapore too imports almost all of its Oil just like India. But, they are able to sell Aviation Fuel to their airlines at a much cheaper price than India.

If you wonder why, the reason is – TAXES. India has one of the highest taxation rates for fuel in the world and it is significantly affecting the operating expenses of all Airlines in India including Air India.

With the Indian Rupee depreciating so badly against the USD, even if the price of Aviation fuel in USD remains the same, the amount Airlines in India have to pay in Rupees is going up by the day. So, the only respite I can think of at this time is, the Government cutting a % of its Taxes. Unless that happens or the rupee returns back to the 45-48 rupees per USD Range, do you think Air India will make a profit??

Poor Management

A few years back, Air India and Indian Airlines merged into one creating the current Air India Ltd. Air India has tried to grow in a reckless fashion with very poor planning. They have also managed their finances badly. All this is evident from the fact that Government of India has bailed out Air India 4 times over the past 5 years. Around 15,000 Crores worth of Tax Payers Money has been infused into Air India by the Indian Government to keep the National Carrier flying.

The Management doesn’t look like it is learning its lessons. Since the Government will bail them out, no matter how poor their performance/management is going to be, they are continuing to make the same old mistakes and survive on the Tax Payers hard earned money. They don’t have to worry about their job. No matter what happens they are going to get paid and receive a fat pension after they retire because they are “Government Employees”. Nobody in the Government cares about whether Air India makes a profit or not.

So, until things continue this way, do you think Air India will make a profit???

Poor Performance

Airlines & Airports in India perform at a rate which is only around 50% of what the worldwide Industry Standard is.
Ex:
An Airport the Size of Delhi Airport can handle around 90 take-offs and landings in an hour. The actual number of take-offs and landings are only around 50 to 60.
An Airport the Size of Mumbai Airport can handle around 70 take-offs and landings in one hour. The actual number is only around 35.
If the Airlines & Airports continue to perform at such below-par standards, how can they make profits?

Over-Staffed

Air India Ltd has over 35000 Employees (Both Permanent & Contract) to handle its fleet of around 90+ Aircrafts. Since Air India is a government owned entity, all these staff members get good pay packages, retirement packages, bonuses plus a host of other benefits irrespective of whether Air India posts profits or losses.

A Simple Comparison:
Singapore Airlines, the National Carrier of Singapore has a fleet of around 100+ aircrafts but its employee strength is only around 21,500. They are able to handle a much larger fleet size at around 60% of staff strength that Air India employs.

With so many staff members, the company spends a huge chunk of its financial resources in paying for the salary & benefits. Do you think that with so much over-staffing Air India can post profits soon???

Poor Customer Service

In any Service Oriented Industry, customer service is of paramount importance. If you were a passenger and receive pathetic service on both occasions when you travelled with an airline, would you think about taking the same airline again?

Real Life Story:
When I went on my first trip to the United States, my company sent me via an Air India flight. The near 24+ hour journey was one of the most miserable trips in my life. The food was horrible, the staff were pretty unfriendly. If you ask them for a glass of water, they will look at you as if you asked them 1000 bucks out of their pocket. You will need to wait at least 10 mins before you actually get that glass of water. Similarly on my first trip to Singapore, my company chose Air India again. I hoped that my previous bad experience was one off but I was wrong. The service was equally poor. In fact, they did not even have enough blankets to give to the older passengers in the flight who were feeling cold. They dint even have 100 blankets in a flight whose capacity was over 250.
Can you guess if I ever took Air India again in my multiple trips to India & back?

Some things customers feel about the Staff of Air India (On-board the flight, in Airports, in their offices etc.) are:
1. They are Rude
2. Getting updates about lost baggage is next to impossible
3. Nobody cares if your flight is delayed or cancelled
4. Etc.

The Average customer satisfaction rating for all passengers who have ever flown in Air India according to a global survey is 4.1 out of 10.

Do you think that with this kind of customer service, Air India can post profits??

Final Verdict:

If you ask me, this poor performance is a direct result of the Government putting up with all sorts of nonsensical decisions taken by the Air India Management. Perform or Perish should be the words the Government must put to all staff of Air India. Unless the Government takes some tough stands the staff is not going to perform well and the airline is going to continue to languish in huge debts & losses.

The government will continue to bail them out using our hard earned tax money so that they can enjoy their so called “Government Job

Before we wrap up I want to write a few things about Singapore Airlines. They are a Government Owned Airline too, but they aren’t languishing like Air India.
1. I have almost always taken Singapore Airlines on my trips to India
2. The Customer Service they provide is exceptional
3. They posted an operating profit of 63.1 million SGD in the year ending March 2010 due to turbulent economy and rising fuel prices. Do you want to guess what their operating profit was in the year ending March 2011? It was 1271.3 million SGD.
All this is because – Neither Singapore Airlines, nor its staff enjoy the luxuries & benefits that Air India or its Staff enjoy. Perform or Perish is the whole idea and the results are for us to see…

Hope our Government does something to put Air India out of its misery!!!

Wednesday, May 23, 2012

A New Source of Income for Senior Citizens - Reverse Mortgage Loans


Before we begin, this article is dedicated to all those Senior Citizens who are facing financial hardships in their old age. Dear Grandpa's and Grandma's this article is for you...

This article is about a new source of income that is available for all Senior Citizens who own a house. It is called "Reverse Mortgage". This is a very popular scheme in the United States and has recently been introduced in India.

What is a Reverse Mortgage?

A Reverse Mortgage is similar to a Home Loan with a small difference. Instead of us repaying the bank monthly EMIs the Bank will pay us a Monthly Amount for as long as the Customer (Senior Citizen) is alive. After the demise of the Senior Citizen or end of loan tenure whichever is earlier, the bank will take possession of the house, sell it to collect the amount the customer owed them and pay the remaining to the survivor of the customer.

The great thing about this loan is the fact that, the customer can continue to stay/reside in the property during the loan tenure.

Sounds an Interesting Proposition, doesnt it?

Who can Use this Reverse Mortgage Loan?

Any Senior Citizen who is older than 60 years of age and owns a property in his/her name is eligible to apply for this Reverse Mortgage Loan. The amount we get every month depends on the value of the property we own.

How will this Reverse Mortgage be useful?


Funding their expenses post retirement when there is no regular monthly income is the single biggest concern in India. Especially since we do not have a well-established Social Security kind of System in India. So, citizens are left to fend for themselves. A majority of Senior Citizens in India do not have much savings and are entirely dependent on their children for their survival.

Lack of Financial Independence is something that no elderly individual in our country must go through. But, unfortunately the harsh reality is the fact that almost 80% of the Senior Citizen population in this country are Financial Dependent on their Children and hence all the trouble.

Can We Repay this Reverse Mortgage Loan?

Yes. If the Survivor of the customer or the customer himself wishes to close the loan, they can settle the whole amount due (including the Interest) to the bank and reclaim the property.

Some Terms & Conditions Reg. this Reverse Mortgage Loans

1. Any house owner over 60 years of age is eligible for a Reverse Mortgage
2. The Maximum Amount that can be borrowed is up to 60% of the property value. The Exact amount varies from bank to bank
3. The Maximum period of property mortgage is 15-20 years depending on the Bank
4. The borrower can opt for monthly/quarterly/half yearly/annual or lumpsum payments at any point as per their wish
5. The Bank will conduct a Revaluation of the property once every 5 years
6. The amount received from the bank is considered a Loan and not an Income. So, it is not taxable
7. Banks offer both Fixed & Floating Rate Interest options on the loan. The customer can choose the scheme that suits them best

Banks in India that Offer Reverse Mortgage

Almost all major banks in India offer this scheme. Bank of Baroda, Punjab National Bank, State Bank of India are some of the top names that offer this Scheme.

A Sample Example Calculation

Let us say Mr. Mahesh a senior citizen in my locality owns a Flat in Chennai that is worth 75 lakhs in todays market price. So, he is eligible for a Reverse Mortgage Loan of up to 45 lakhs.

What will be his monthly income if he chooses a Loan Tenure of 10, 15 or 20 years?

For 10 years - Rs. 21,375/- per month (At Rs. 475 per lakh for 45 lakhs)
For 15 years - Rs. 10,340/- per month (At Rs. 230 per lakh for 45 lakhs)
For 20 years - Rs. 5,625/- per month (At Rs. 120 per lakh for 45 lakhs)

Does this Scheme have any Negatives?

As pointed out by one of our blog readers Mr. MN, this scheme too has a drawback.

If the borrower outlives the loan duration, the bank will still take possession of the house and try to sell it to collect the money the borrower owes them. So, this is something every senior citizen must keep in mind before signing up for this loan.

Verdict:

Our beloved Senior Citizens have worked for more than 40 years of their lives to support their children. Post retirement, they must not have to face financial hardships just because they arent earning. Schemes like this Reverse Mortgage are a boon to these people to meet their monthly cash requirements. Even in todays cost of living 10,000 rupees is a significant amount of money that should be sufficient to meet the cash requirement of two people who have no Rental commitments to pay.

All in all, this is an excellent proposition for all Senior Citizens who are looking for a second source of Income.


A Humble Request: Not many people know about this Reverse Mortgage Scheme. It would be a good idea to share this information with all your friends so that they can pass on this valuable piece of information to help out the needy Senior Citizen population of our country. If even 100 Senior Citizens of our country benefit out of learning about Reverse Mortgage Scheme by reading this blog, I would consider it a fantastic success... Best Wishes!!!

Thursday, May 17, 2012

List of Foreign Banks in India


In one of our previous posts List of Banks in India we had taken a look at all the Banks that operate in India and are registered with RBI to provide Banking Services to the Citizens of India. As you might be aware, banks can be classified into 3 categories: Public Sector Banks, Private Sector Banks and Foreign Banks. The purpose of this article is to list down the Foreign Banks in India. Foreign Banks are those that are owned by people/company's that are based outside of India. Essentially these too will be considered as Private Sector Banks, but since they are based outside of India, it is best if we classify them as a seperate category...

1. ABN AMRO
2. Abu Dhabi Commercial Bank
3. Antwerp Diamond Bank
4. Bank International Indonesia
5. Bank of America
6. Bank of Bahrain and Kuwait
7. Bank of Ceylon
8. Bank of Nova Scotia
9. Barclays Bank
10. Citibank India
11. Credit Suisse
12. Deutsche Bank
13. HSBC
14. Royal Bank of Scotland
15. Standard Chartered
16. The Bank of Tokyo-Mitsubishi UFJ

A Very Important point to note here is that, some of these foreign owned banks offer regular banking services only to the Rich & Famous also known as the "High Net Worth" population.


List of Public Sector Banks in India
List of Private Sector Banks in India

List of Private Sector Banks in India


In one of our previous posts List of Banks in India we had taken a look at all the Banks that operate in India and are registered with RBI to provide Banking Services to the Citizens of India. As you might be aware, banks can be classified into 3 categories: Public Sector Banks, Private Sector Banks and Foreign Banks. The purpose of this article is to list down the Private Sector or Privately Owned Banks in India.

1. Axis Bank
2. Catholic Syrian Bank
3. City Union Bank
4. Development Credit Bank
5. Dhanalakshmi Bank
6. Federal Bank
7. HDFC Bank
8. ICICI Bank
9. IndusInd Bank
10. ING Vysya Bank
11. Jammu & Kashmir Bank
12. Karnataka Bank Limited
13. Karur Vysya Bank
14. Kotak Mahindra Bank
15. Lakshmi Vilas Bank
16. South Indian Bank
17. Tamilnad Mercantile Bank Limited
18. Yes Bank


List of Foreign Owned Banks in India

List of Public Sector Banks in India

List of Public Sector Banks in India

In one of our previous posts List of Banks in India we had taken a look at all the Banks that operate in India and are registered with RBI to provide Banking Services to the Citizens of India. As you might be aware, banks can be classified into 3 categories: Public Sector Banks, Private Sector Banks and Foreign Banks. The purpose of this article is to list down the Public Sector or Government Owned Banks in India.

1. Allahabad Bank
2. Andhra Bank
3. Bank of Baroda
4. Bank of India
5. Bank of Maharashtra
6. Canara Bank
7. Central Bank of India
8. Corporation Bank
9. Dena Bank
10. IDBI Bank
11. Indian Bank
12. Indian Overseas Bank
13. Oriental Bank of Commerce
14. Punjab & Sind Bank
15. Punjab National Bank
16. Syndicate Bank
17. UCO Bank
18. Union Bank of India
19. United Bank of India
20. Vijaya Bank
21. State Bank of India
22. State Bank of Bikaner & Jaipur
23. State Bank of Hyderabad
24. State Bank of Indore
25. State Bank of Mysore
26. State Bank of Patiala
27. State Bank of Travancore
28. State Bank of Saurashtra


List of Private Sector Banks in India

List of Foreign Owned Banks in India

Wednesday, May 16, 2012

Exiting A Mutual Fund Within 1 Year Without Paying Exit Load

We all know that, as investors we can exit a Mutual Fund anytime we want. However, if we are exiting an investment within a minimum investment period (Usually 1 year) an exit load (Usually 1%) is applicable and payable by the Investor. But, did you know that there are certain exceptional circumstances where an investor can exit a Mutual Fund without paying this Exit Load even if redeeming within the mandatory hold period? This article is about that...

When Can an Investor Exit a Fund without Exit Load?

Mutual fund investors have the option of exiting their investments if there are changes in the fundamental attributes of the scheme. Some of the changes that can trigger such an exit are:

1. A change in the controlling interest of the AMC or
2. An AMC buy-out by another AMC
3. Change in the investment objectives or asset allocation pattern of the scheme,
4. An alteration in the fees, expenses or
5. Anything that can affect the interest of unit holders.


Such changes require prior approval of SEBI. Most importantly, the fund house has to inform the investor in case of such alterations in writing.

In such a situation, the Investor can opt to exit the fund without paying an exit load if he/she is not satisfied with any of the changes outlined above.

Communication from the AMC:

The mutual fund AMC is required to send an individual communication to all investors in the scheme, giving details of the proposed change and the rationale for it. It must also mention the period within which the investors can exercise the exit option.

A Real Life Example:
Recently L & T Finance finalized a deal on buying out Fidelity Mutual Funds. This deal is subject to all regulatory approvals which are in progress, but once the approval is received, Fidelity MF will be owned by L&T Finance and they can choose to rename it as well. Here, the Fidelity AMC is being purchased by another company - L&T. So, in this case, all investors of MF Schemes run by Fidelity Mutual Funds will get a notification and be given an option to either continue their investments or exit.


How an Investor Proceeds with the Redemption Request?

Investors need to fill up a standard redemption form and submit it at the AMC office within the specified period. The units are redeemed at the NAV for the day on which the redemption request is made just like any regular redemption request.

An important point to note here is that, any Systematic Investment Plans that might be active will be automatically closed when you choose to exit.

What Happens if an Investor does not choose to Exit?

If an investor does not exercise the exit option within the stipulated time period as outlined in the communication, he/she is said to have consented to the change and automatically continues with his/her investment with the altered/modified scheme.

Any redemption request after that timeframe will be charged the exit load if applicable.

Is this applicable to all MF Schemes?

No. Equity Linked Savings Schemes (ELSS) also called Tax Saving Schemes are an exemption to this rule. If such a change happens during your mandatory 3 year lock-in period, you will not be able to exit the fund investment. If your investment has crossed the 3 year lock-in period, then you can exit.

Happy Investing in Mutual Funds!!!

Tuesday, May 15, 2012

Cheque Clearing & Collection by Banks


In one of the older posts titled Using a Bank Cheque we had taken a look at what a Cheque is, how to issue a cheque and the things to remember when we use one. There is one area that we did not touch "Cheque Collection & Clearing" in that article. One of our blog readers even has left a comment on the same in that post. So, the purpose of this article is to explain how the Cheque clearing & collection works along with a lot of other details.

Before we proceed with the Cheque collection & clearing part, let us take a look at the types of cheques we can use

Local Cheques - These are cheques whereby the cheque issuer and the receiver reside in the same city

Outstation Cheques - These are cheques whereby the cheque issuer and receiver reside in different cities

How Does Cheque Clearing & Collection Works?

Lets say I owe you Rs. 10,000/- and give you a cheque drawn on my bank account (ICICI). Let us see the sequence of events

1. I hand over the cheque worth Rs. 10,000/- drawn on ICICI Bank to you
2. You take it to your bank (lets say HDFC) and deposit it into your bank account
3. HDFC Processes the cheque and sends a request to ICICI for payment
4. If I have enough funds in my account, ICICI will process the payment and release the funds to HDFC Bank
5. HDFC Bank processes the payment and credits the funds into your bank account

The above is a simple illustration of how this whole Cheque Collection & Clearing mechanism works. If you had an ICICI Bank account too, this whole process would be much faster because, step 3 is not required at all. The bank will just check if you have enough funds in your account and if so, move the money into the payee's bank account.

Cheque Clearing & Collection Timelines

In the previous section, in Step 3 - HDFC Bank sends a request to ICICI Bank for payment and in Step 4 ICICI releases the funds to HDFC Bank. However, this step is the one that takes the most time. Banks have a predetermined service standards on how much time they can take to process cheques issued/deposited by customers. This depends on various scenarios like, whether both parties have a bank account with the same bank or whether it is a local or outstation cheque and so on...

The Guidelines as set by RBI are:

Local Cheques - All Local Cheques must be cleared on a T+1 basis. i.e., If I Deposit a local cheque into my bank account today (irrespective of which bank the cheque is drawn or deposited) the funds must reach my account by End-Of-Day Tomorrow. Of course, this is only if the deposit happened before the cut-off time for today.

For ex: Lets say ICICI Bank has a cut of time of 1:00 PM. So, all cheques deposited after 1:00 PM the previous day and those deposited before 1:00 PM today are processed in one batch and sent for payment. If you deposit your cheque after 1:00 PM, it will be processed only tomorrow and funds will be available one day after that.

Outstation Cheques - Processing of Outstation Cheques depends on what location the drawn bank is situation.

Banks in State Capitals - Max 7 days
Banks in Major Cities - Max 10 days
Banks in Other Locations - Max 14 days

Go back to the example a few paragraphs away where I gave you a cheque. Here, lets do a small change. Lets say you live in Delhi and I am giving you a cheque. If I lived in Chennai, you will get the money in a maximum of 7 days. Whereas, if I lived in a Major city of TamilNadu say Trichy or Madurai you will get the money in 10 days max and if I lived in an area like Thirumalaisamudram in Tanjore, it will take up to 14 days.

Did Thirumalaisamudram catch you off guard? That is the village in Tanjore, Tamil Nadu where I did my college. So, just used it for example :-)

Cheque Clearing & Collection Fees

Local Cheque collection charges are decided by the concerned bank from time to time and communicated to customer as part of the Code of Bank’s Commitment to Customers. However, these days most banks dont charge any fee on local cheque collection.

In case of Outstation Cheques, all banks charge a fee. Go back to the example where I lived in various parts of Tamil Nadu and gave you a cheque... In such cases, RBI has set up guidelines on the maximum fee banks can charge you depending on the cheque amount.

* Up to and including Rs.5000 – Rs.25 per instrument + service tax
* Above Rs.5000 and Up to and including Rs. 10,000 – not exceeding Rs. 50 per instrument+ service tax
* Above Rs. 10,000 and up to and including Rs. 1, 00,000 – not exceeding Rs. 100 per instrument + service tax
* Rs.1, 00,001 and above – left to the banks to decide. You need to check your banks oustation cheque collection policy & fees document to find out the fee. However, RBI has recently asked Banks in a recent circular to reconsider their charges & Reduce them. There is not much clarity on how much banks will reduce these fees but they will be reducing it soon.

No additional charges such as courier charges, out of pocket expenses, etc., should be levied.

So, if you used an outstation cheque and were charged a fee that is more than the amounts above, you have the right to question your bank.

Trivia:
Are you saying, Anand, where in the hell am I gonna find the cheque collection policy of my bank? - Relax my dear friend, All you gotta do is Click Here and you will go the Reserve Bank of India page that gives you a bank-wise list of policies. RBI Mandates that all banks maintain this policy on their website and this RBI Page links you to the policy of all the banks in India.

Happy Using Cheques!!!

Friday, May 11, 2012

Is This The Right Time To Invest In Debt Instruments?

Debt Instruments have been one of the staple investment options for Indians over the past decade. Though the number of people and the amount of investments going into the Stock Markets in India has gone up consistently over the past few years, exposure to Debt Instruments has always been steady. At the end of the day "Safety of the Invested Money" is one of the most important requirements for us Indians per say when we make any sort of investment.

In this post, we are going to take a look at two important reasons that make these Debt or Fixed Income Instruments very attractive.

Reason No. 1 - Carnage in the Indian Stock Markets


This is probably the most obvious reason for this suggestion. The Indian Markets have been very volatile over the past few months and the past few days have been especially worse. The Market has gone down by an average of around 100 points or more on a daily basis. This week alone it has gone down by around 400+ points. In this Volatility, Investing in the Stock Markets is a risky affiar and hence, going for Fixed Income Instruments like Fixed Deposits, Bonds etc would be a wise decision.

Reason No. 2 - Rising Interest Rates in India


The Interest Rate Market in India, for Fixed Income Instruments like Bonds & Deposits is one of the highest in the World. A Majority of the fixed income investment options available in India have hiked their rate of interest making these products all the more attractive for Investors. Look at the table below: This is the Rate of Interest Comparison of some of the Most Prominent Fixed Income Investment Options available in India over the past couple of years.

Investment Opption Rate of Interest in 2011 Rate of Interest now in 2012
5 year NSC 8.4% 8.6%
10 year NSC 8.7% 8.9%
PPF 8.6% 8.8%
5 year SCSS 9% 9.3%
5 year RD's 8.2% 8.5%
1 year FD's 8% 8.5%

Note: Rate of Interest for RD's & FD's is the Industry Average. Private Banks are offering an average of around 0.5% to 1% than their Public Sector counterparts.

In the above table:

NSC - National Savings Certificate
PPF - Public Provident Fund
SCSS - Senior Citizens Savings Scheme
RD - Recurring Deposit
FD - Fixed Deposit

As you can see, Debt or Fixed Income Instruments are giving us absolutely awesome returns and the best part is, these returns are guaranteed. So, at the current market scenario, I dont think we can get any investment that would be better than this...

Some Last Words:

If you think that this 8% or 9% Rate of Interest is less, just remember that India has one of the highest rate of Interests on Debt Instruments. Do you know what is the average rate of interest on Savings Accounts in Countries like USA or Singapore? It is less than 0.5% per annum. What about Fixed Deposits? It is in the 2% to 3% range. Now, go back and re-think if the Rate of Interest we earn on our deposits is less...

On the other side, Loans in India are one of the costliest. In Developed Nations, loans are atleast 50% cheaper than in India. Anyways, this isnt the topic of our discussion.

So, Happy Investing in Debt Instruments!!!

Wednesday, May 9, 2012

What to do in the Indian Stock Market - Amidst this Carnage


The Indian Stock Markets have bled heavily over the past few days. Economic Uncertainty in the Global Markets, Carnage in the markets in other countries and sudden/surprise taxation moves by the Indian Government all together have drowned the Investor Population in India in Deep Sorrow. The purpose of this article is to take some decisions on what to do as of now "As a Normal Investor"...

Before we begin, let us take a look at what happened in the Stock Markets yesterday - 8th May 2012.

Markets in India:

The Markets in India continued their Downward trend and fell by over 2%. All stocks - Large Caps, Mid Caps & Small Caps alike fell and some of them very heavily. The Exact Opening & Closing Values with how much they fell for the various Indices in India are as follows:





































Index Open Value Close Value Change % Change
Nifty (NSE) 5114.2 5000 -114.2 -2.2%
Sensex (BSE) 16912.7 16546.2 -366.5 -2.2%
BSE Midcap 6132.6 6053.9 -78.7 -1.3
BSE Smallcap 6608.35 6550.82 -57.53 -0.9


Note: Data Accurate as of End-Of-Day 8th May 2012.

Global Markets:

The Scenario in the Global Markets wasnt much different either. The Eurozone Crisis, uncertainty in USA etc have dragged the world indices down for months now and yesterday was no different. All the major global indices in USA, Japan, UK, Hong Kong & Singapore ended lower than their previous day close. The fall ranged from 0.4% to 1.8%. The Exact Opening & Closing Values with how much they fell for the various Indices are as follows:



















































Index Open Value Close Value Change % Change
Dow Jones (US) 13008.5 12932.1 -76.4 -0.6%
Nasdaq (US) 2957.8 2946.3 -11.5 -0.4%
FTSE (London) 5655.1 5554.6 -100.5 -1.8%
Hang Seng (Hong Kong) 20484.8 20313.3 -171.5 -0.8%
Nikkei (Japan) 9181.6 9063.9 -117.7 -1.3%
SGX Nifty (Singapore) 4985 4965.5 -19.5 -0.4%


Note: Data Accurate as of End-Of-Day 8th May 2012.

What to do Now?

This is a million dollar question and is not something that can be answered in a single word. What to do now depends entirely on who you are and what your risk appetite is. So, let us classify our Investory Population in India into various categories:

1. Super Aggressive Investor (Very High Risk)
2. Aggressive Investor (High Risk)
3. Moderate Investor (Medium Risk)
4. Conservative Investor (Low Risk)


Let us take a look at how these categories of Investors must approach the Stock Markets in India.

1. Super Aggressive Investor (Very High Risk)

Who They Are? - These are the Class of Investors who are young and energetic (Usually in their Late 20's or Early 30's) who earn a handsome salary and can afford to take a bump or two in the Stock Market. They invest only the surplus they can afford to lose and hence are willing to take very high risks.

What They Can Do? - The Market Valuations for some of the best cos in India like Reliance Industries, ICICI Bank, State Bank of India, TATA Consultancy Services etc are very attractive. Because of the carnage in the stock markets right now, these cos have fallen in price heavily. As these guys can afford to risk further downfalls, now would be a good time to start accumulating these blue-chip gems. This downfall in the market is not permanent and in the next few months, the markets will definitely recover and once they do, these guys can make a good profit.

An important point to note here is that, the investments must not be done in one shot. The shares must be bought in a staggered manner to average out short term volatility in prices. For ex: If you intend on buying 1000 shares of ICICI Bank, split up the purchase across weeks and buy lets say 200 shares every week for the next 5 weeks.

2. Aggressive Investor (High Risk)

Who They Are? - These are the Class of Investors who are young and energetic (Usually in their Late 20's or Early 30's) who earn a handsome salary and can afford to take a bump or two in the Stock Market. They invest only the surplus they can afford to lose and hence are willing to take very high risks. However, these guys are not willing to take as much risk as the super aggressive investors and hence would like to play it somewhat safer in comparison to the aforementioned category.

What They Can Do? - The advise is the same as for the Super Aggressive Investors. This is the right time to enter the Stock Markets. However, buying individual stocks is extremely risky. Instead, these investors can cherry-pick the best performing Mutual Funds in India and invest in them. This way they get the best of both words. By entrusting the job of selecting the best shares to buy & sell with an experienced fund manager, the risk part is considerably reduced. However, when the markets rise in future, these MF's will give handsome returns which is a win-win kind of scenario.

3. Moderate Investor (Medium Risk)

Who They Are? - These are the Class of Investors who are in their Early or late 40's. They are nearing Retirement and have children who are approaching the age where they have to be sent for higher education. At this stage, they do not wish to take huge risks. However, they want to have exposure to the Stock Market so that they can capitalize on the high-returns aspect of the Markets.

What They Can Do? - They can split up their investment into two. 60% must be dedicated to Fixed Income Instruments like Bank Deposits. The Remaining 40% must be split up and invested across 2-3 well performing Equity Mutual Funds preferably with atleast 1 Balanced Mutual Fund scheme. This way, around 60% or more (If we consider the debt portion of the Balanced MF Scheme) is going to be safe while the remaining amount can grow then the Markets rebound.

4. Conservative Investor (Low Risk)

Who They Are? - These are the Class of Investors who are in their 50's and are very close to Retirement. At such a scenario, they cannot afford to lose their nest egg to Market volatility. So, safety is their paramount concern.

What They Can Do? - They should essentially stay away from the Stock Markets as of now. If they do wish to have market exposure, they can invest a max of 10% of their portfolio in the Markets. This must be split into two and one must be in a Equity Diversified MF and the other in a Balanced MF. This way more than 90% of their portfolio is going to be safe and there will be a bonus if the markets rebound in the future.

Important:

The Risk Classification above is broadly based on age. You can be only 30 years and old and still do not wish to take as much risks as the Aggressive or the Super Aggressive Investor. The above is just a rough guideline. You can choose to model your investments based on what category of Investor you are.

Happy Investing!!!

Disclaimer: The author does not recommend buying any of the shares mentioned above. They are just for illustration purposes only.

Thursday, May 3, 2012

How to Handle Home Loan - Part Re-Payment


Part Re-Payment on Home Loans - Isn’t this something we all intend on doing right from day one when the Home Loan is even applied? We tell ourselves, if I get a bonus from my employer, I will use it to part repay my Home Loan. That is a Novel Idea. But, have you given a thought on how you want to proceed with it?

Let us say your Home Loan is worth Rs. 50 lakhs and you have a surplus of Rs. 5 lakhs with you right now and plan on using it to part repay your loan. The Bank will give you two options now

1. Reduce the Monthly EMI of your Loan & Retain the Tenure
2. Reduce the Tenure of the Loan & Retain the EMI

Which one would you choose???

The purpose of this article is to help you make that decision.


Reduce the Loan Tenure or Reduce the EMI

This is a very easy decision to Make. However, it won’t be good if I just told you which one is good. You need reasoning - don’t you?

Positives about option 1 - Reduce the Monthly EMI

1. The Burden on your Monthly Budget will be lower
2. You will have more surplus cash every month to utilize for other expenses

Positives about option 2 - Reduce the Loan Tenure

1. The Loan will be repaid well in advance
2. The Interest you Repay the Bank will be Much Lower

Which one would you Choose? I would choose "Option 2". In fact, even the bank will suggest the same. Are you Surprised???

Yes. By Default, banks will offer the option of Lowering the Loan Tenure by retaining the same EMI. This is because, any change in EMI requires a lot of Additional Paperwork.

From the Customer's Perspective - Below is how Reducing the Tenure will be useful. Let’s say you have taken a 20 year Tenure Home Loan for Rs. 50 Lakhs where your EMI works out to approx. Rs. 50,000 per month.

EMI Per Month = Rs. 50,000/-
Repayment Per Year = Rs. 6,00,000/- (6 Lakhs)
Repayment Over 20 years = Rs. 1,20,00,000/- (1.2 Crores)

Let’s say you Repay 2 or 3 lakhs now and retain your original EMI & Reduce your Loan Tenure by 1 year, you are saving 6 lakh rupees. Would you consider this a saving or saving Rs. 2000 or so every month in EMI???

Note: The Exact Amount Saved will depend on your EMI and Loan Tenure. Also, in case of Part Loan Repayments, the bank will offset the Principal portion of the loan and advise you on the Revised EMI or Loan Tenure. In either case the number is dependent purely on your Loan Amount and Rate of Interest. The Above example is just an illustration.

Important:
A Very important point about Choosing Option 2 is "Affordability". Can you afford to continue to pay the same EMI as before? If you are in a financial crunch and could use some extra cash through reduced EMI, then go for Option 1. Don't compromise on your peace of mind just to reduce your loan tenure by 1 or 2 years. That reduced tenure is going to come only 10 or 15 years from now. Think about what is happening to you right now and start worrying about 15 years from now later...

Happy Home Loan Repayment!!!

The 2 Trillion Dollar Hole in the Chinese Economy

Do you remember the Article titled "S & P Downgrades US Credit Rating"? I had mentioned in that article that China is the largest holder of US Debt. They hold over $ 1 Trillion worth of US Treasury Bills. With the World Economy moving at a sluggish pace and Major economies like US and European Union reeling under pressure, Growing Economies like India & China are significantly affected. This article is an Analysis of the Current Soup that China finds itself in!!!

Chinese Economy - A Quick Refresher

The People's Republic of China (PRC) is the world's second largest economy after the United States. It is the world's fastest-growing major economy, with growth rates averaging 10% over the past 30 years. China is also the largest exporter and second largest importer of goods in the world. They Exports Goods value at around US$ 1.9 Trillion every year to countries around the Globe. USA is the largest consumer of stuff exported by China. A little over 20% of all goods produced by China end up in USA.

Experts feel that, if China can grow at the current rate it could overtake USA as the Largest Economy in the World in the next 10 to 15 years.

China - The Single Largest Holder of US Treasury Debt

China is considered the Single Largest Lender/Creditor to the United States. Nearly 21% of US Treasury Debt is held by China. They hold around $1.1 Trillion worth of Treasury Bills issued by the United States of America. This effectively means that

"The United States of America owes the People’s Republic of China more than US$ 1 Trillion in Debt and has to pay both Interest & Principal on the Same"

What Does China Holding $1 Trillion in US Treasury Bills Got to do with this Article?

Did you think of this my friend? Well, to Answer your question "EVERYTHING"...

China holds close to US $ 3.3 Trillion worth of Forex Reserves. As suggested in the previous paragraph, roughly one-third of it is in US Treasury Bills. Apart from this China also holds hundreds of billions of dollars’ worth of foreign currency - Especially the US Dollar. So, around 60% of all their foreign exchange holdings is in United States Dollar (Roughly around 2 Trillion). So, with the United States Economy being as volatile as it is, the value of the Dollar has come to Question. So, at this Juncture, the price movement of the United States Dollar can make or break the Chinese Economy.

Now, go back to the paragraph heading and ask yourself the Question again "What Does China Holding $1 Trillion in US Treasury Bills Got to do with this Article?"

How Will the De-Valuation of the US Dollar Affect China?

As of the Writing of this article 1 USD (United States Dollar) = 6.3 CNY (Chinese Yuan Renminbi). So, USD 2 Trillion in Dollar denominated assets works out to CNY 12.6 Trillion in their local currency.

Let us say due to some problems in the US Economy, the value of the USD Falls and goes to 1 USD = 5 CNY, the value of this $ 2 Trillion Forex Reserves comes down to only CNY 10 Trillion in their local currency. Practically speaking, the Chinese Government stands to lose a hefty amount of their investment if the US Dollar depreciates...

Repayment Risk or Default Risk

On top of the Dollar getting Devalued there is one more, even bigger problem "Default Risk"

Default Risk is the risk that you face when you lend money to someone and the other party fails to repay the same. In this case, if the US Government fails to honor the Interest or Principal repayment on these Treasury Bills China stands to lose $1.1 Trillion.

Before we go any further, 1 Trillion = 1,000,000,000,000. and 1 Trillion USD = INR 53 Lakh Crores. This is a loooooooooottttttttttttttttttttttttttttt of Money. Isn’t it???

A Real Life Example:
If the above explanation wasn't too clear, think this way. Let us say, you bought a House in Chennai, India last year for INR 50 lakhs. Now, it is found that, due to dumping of poisonous chemicals in the ground by a neighboring factory, the ground water is heavily contaminated. As a result, people are avoiding that locality and the property prices have plunged in the past one year and the value of your house is roughly around INR 25 lakhs. Here, with no mistake of yours, the value of your investment (House) has come down and you will lose a lot of money if you sell the house now.

This is China's Situation. Because of Problems in the US Economy, if the value of the US Dollar goes down, the value of their investment will go down and they will lose a lot of money...

Has China done anything to reduce its Forex Exposure to US Dollar?

The answer is YES. But, sadly, China has tried practically every trick known to get into non-dollar assets. It has set up a $300 billion sovereign wealth fund to invest excess foreign reserves in foreign companies. It has encouraged state-owned companies to acquire assets abroad, such as natural resources and firms. It has launched an experimental scheme to settle foreign trade in the Renminbi, instead of the dollar. It has dabbled in purchasing distressed European sovereign debt. The list goes on.

Unfortunately, these efforts to diversify Forex holdings have yielded disappointing results. Chinese attempts to acquire natural resources have met with strong resistance in most parts of the world (except in Africa). China’s sovereign wealth fund’s investments overseas haven’t been successful either, mostly due to political opposition. Chinese state-owned firms seem to have done better. But the tens of billions of dollars they have spent on projects may not generate economic benefits. Expanding the use of the Renminbi to settle trade reduces currency risks, but does little to restrain the growth of China’s dollar holdings. In the two years since China began this experiment, Chinese Forex holdings grew more than 50 percent.

A Trillion Dollar Question!!!

US Treasury Bills are debt obligations that the United States promises to settle when redeemed. So, if today China surrendered its over 1 Trillion dollars’ worth of US T-Bills and asked the US to pay up, what will happen?

The answer is very simple.

"The United States of America will most probably declare Bankruptcy"


Anyways, the chances of that happening are very very remote. Because:

1. China has invested nearly 6 Trillion worth of their Currency in this US $ 1 Trillion worth of T-Bills. If they surrender their investments, the value of the US Dollar will crash and their investment may not be worth even 50% of what they invested (If you don't understand this, go back to the house buying example a few paragraphs away. Will you do anything to diminish the value of your house??)
2. If such an event happens, US will stop importing goods from China (They won’t have money to pay for it), and China can’t sell that much stuff to any other country. So, their economy will be crippled beyond repair.

So, considering the impact this will have on the Chinese Economy, I personally do not think that China can afford to take this drastic step. However, they can definitely use this 1 Trillion Dollar leverage as a bargaining chip during negotiations!!!

Contrary to the fears harbored by many Americans that China would use its mammoth Treasury holdings as a financial weapon of mass destruction against the United States, China is being taken to the equivalent of the financial cleaners in the US debt scenario.

The 2 Trillion Dollar Sized Hole in the Chinese Economy

For the moment, China finds itself in a $2 trillion hole it has dug for itself over the last decade. It watches the political situation in Washington and the resulting economic uncertainty in complete helplessness. All they can do is "Wait and Watch" and hope that the Financial Scenario in the United States Improves.


China's Economic Future

It’s easy to accuse the Americans, of behaving recklessly with their Finances. But for Beijing, the more meaningful thing to do is to figure out how to get out of its $2 trillion mess it is in right now. Allowing a more rapid pace of revaluation of the Renminbi is clearly one. Diversify the Forex Portfolio is another... The list is long and I am sure the Chinese policy makers are scratching their heads trying to find the right cure for their problem…

Since China has strong fundamentals in terms of Manufacturing & Production, the near-term impact will be minimal. However, how the Political & financial scenario in the United States pans out in the forthcoming months will have significant impact on the Chinese Economy in long-term.

So, just like the Chinese, all we can do is "Wait and Watch"...
© 2013 by www.anandvijayakumar.blogspot.com. All rights reserved. No part of this blog or its contents may be reproduced or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without prior written permission of the Author.

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