Should NBFCs be regulated in the same way as Banks in India?

By Nayan Saraf

Indian banking sector has played a crucial role in developing the Indian economy, but if there is one segment, which would significantly make a big difference in coming years, it would be the Non-banking financial services sector. The total asset base for NBFC’s stood at more than Rs. 14.5 Lac Crore and the profit of Rs. 30,000 Cr. in the year 2015 with a CAGR of about 13% over last 3 years. This enormous growth of NBFC segment has resulted in more regulations from RBI which in effect have opened the debate whether NBFCs should be regulated in the same way as banks or not.

Over the years, RBI has changed its stance on NBFC from no regulations to over regulations. This over regulation has come into the picture in recent years after the global financial crisis where the fall of systematically important FI, Lehman Brother, resulted in systematic risk across the financial world. But many economists have argued that these over regulations are nothing but overly cautious measures by the RBI which are hampering the growth of the NBFC segment.

One reasonable argument that goes in the favour of lesser regulations for NBFCs is that unlike banks they don’t have any unsophisticated depositors. The bank’s depositors are unsophisticated as they can withdraw money from the bank at any time and the bank is liable for that. Even for fixed deposits, the principal is protected in the case of premature withdrawal. Hence, banks run the risk of having ‘Run on the bank’. On the other hand, NBFC’s do not have unsophisticated depositors as they raise money by issuing bonds and promoter’s contribution. Hence, NBFCs do not run the risk of having ‘Run on the bank’.

Second argument that goes in favour of lesser regulations for NBFCs is the low risk of asset liability mismatch. Since, NBFCs lend money which was raised through bonds and promoter’s contribution rather than depositors’ money (as they cannot accept deposits); there’s a very little chance of having asset liability mismatch. In their balance sheet, the liability would be due only on maturity. Hence they can easily manage the asset liability mismatch. On the other hand, banks that lend depositors’ money, run a higher risk of asset liability mismatch as in their balance sheet the liability can be due at any time.

These two arguments question the importance of stringent regulations on NBFCs by RBI. When NBFCs are different from banks, then why should they have the same stringent regulations? NBFCs should be more risk seeking in nature for the growth of Indian economy.


Scope of Islamic Banking

By Durgesh Desai

Islamic banking is a type of a banking system which is in accordance with the Sharia law that prohibits paying any interest or fee for renting money. It also has rules about the type of businesses where money can be invested. These businesses have to function according to the principles of Islam. So investments cannot be made in companies or projects that deal with alcohol, drugs, war weapons etc.

Banking without interest

It is quite difficult to imagine any banking system functioning without paying or receiving interest on any transaction, but in Islamic banking, there is a concept of profit and loss sharing where banks invest the deposited money in Shariat compliant businesses and divide the profit and loss equally or as per the terms agreed with the depositor. Therefore Islamic banks act as a sort of equity funds. Islamic banks also provide many products like Musharaka (resources are equally shared), Mudarbah (finance provided by one party and expertise by the other) etc.

Islamic Banking in the World

The IMF in April 2015 endorsed the Islamic financial system saying that it could provide a safer alternative to conventional modes of finance. Islamic banking is common in Islamic countries and is starting to grow in other non – Islamic countries as well. The UK was the first non – Islamic country to issue license to the Islamic Bank of Britain which is in accordance with the Sharia law. The Dow Jones had started an Islamic Market Index in 1999 which had only Shariat compliant companies listed on it.

Islamic Banking in India

The RBI is mulling over the idea of introducing an Islamic window in conventional banks in India. This could help attract huge funds from Gulf countries and other investors who want to invest only in Shariat compliant businesses. It would also help in financial inclusion among the members of the Indian Muslim community who possibly shied away from investing in conventional banks due to its non – compliance with Sharia Law. State Bank of India had launched an Islamic equity fund in December 2014 with the mandate to only invest in Shariat compliant companies. To open an Islamic window in banks, the Banking Regulation Act needs to be amended. This will require Parliament’s approval which could be difficult in light of the political nature of this subject.  Islamic Banking offers an alternative investment option for investors. It would help broaden the Indian financial system.

Trump – Clinton face-off- Effect on Economies worldwide

By Isha Varma

While the result of the Trump-Clinton face-off is unknown as yet, the speculations regarding the same are at its peak.

From Clinton’s email controversy to Trump’s comment on nuclear weapons, there has been a lot to fathom about the US Presidential elections 2016.  One major feature of the Presidential election is the uncertainty and that is exactly what the financial markets don’t like. It creates an atmosphere of risk and fear of financial loss which is dangerous for businesses. Furthermore, the markets will have to adjust with the new ideology and personality of the new President.

According to a report by Merrill Lynch, on an average the first year of a new presidential term witnesses a rise in markets by 6% which is below the normal 7.5% average of all years since 1928. The markets seem to be quiet volatile at present. Political environment affects everyone’s investment behavior. There is conflict of interest between Democratic and Republican supporting investors. Some investors even hold on to the money or make limited investments so as to judge how the markets are reacting to the change and then invest accordingly. Some financial advisors and experienced investors are making strong statements which in turn might influence the investing decisions of the retail investors.

Donald Trump is expected to cut taxes by a large margin. Also, his strong remarks on countries like Mexico might affect the trade relations with these nations under his leadership. Hillary Clinton on the other hand has endorsed regulatory reforms which will prevent Wall Street from taking excessive risk. It has been experienced that the presence of Democrat Presidents has been good for stocks while Republicans are supposedly more business friendly. Also, a Republican President is likely to bring about more changes in policies and hence US financial markets could expect more fluctuations in case Donald Trump wins the elections.

With Trump leading in 168 states as against Clinton who is leading in 131 states, the markets around the globe have been tumbling. Japan’s Nikkei 225 Index dropped 2.4%, Hong Kong’s Hang Seng plunged 1.7%, South Korea’s Kospi Index fell 1.4%, Australia’s S&P ASX/200 lost 1.2%, Dow futures nosedived over 600 points, and the SENSEX crashes 1600 points. The US dollar sank against the Japanese Yen, a condition that will be unfavorable to Japanese exporters, and the Mexican peso plunged nearly 10% to record low versus USD.

However, the fact that stocks have gained under every President only except Nixon and Bush 43, should be a relief. Also it is known that investments in stock markets are usually good in the long run. Change in the economies in the coming months is inevitable. The consolation here is that the change might actually prove to be good.

MASALA BONDS: Elixir to the ailing PSB’s?


After playing host to Yankee, Bulldog, Samurai & Dim sum, foreign bonds market witnessed the entry of a new member, “Masala Bonds”. The first Masala bond (Rs.1000 Cr.) was issued by the World Bank backed International Finance Corporation (IFC) in November 2014. In July 2016, HDFC raised Rs.3000 Cr. from Masala bonds becoming the first Indian company to issue masala bonds. NTPC, Adani Transmission, Axis Bank and Indiabulls followed suit.

Masala bond is a term used to refer to a financial instrument through which Indian entities can raise money from overseas markets through bonds issued in Indian Rupee for a minimum period of 3 years. If the dollar value appreciates, investor gets lesser amount in hand at maturity. Thus, currency risk lies with the investor.

Furthermore, the limited offshore liquidity in Rupee, the cost and availability of hedging for investor, and investors’ view of exchange rate fluctuations will affect the pricing of these bonds.

In the Indian context, there is merit in the masala bond move, since India Inc. can do good with some foreign investment minus the currency risk for their capital requirements, infrastructure financing and affordable housing projects. Masala bonds can also be considered as a step towards internationalization of the Indian rupee and can also help strengthen the Indian Financial System.

As a initiative to support Masala Bonds, the Finance minister has cut the withholding tax on interest income from 20% to 5%, making it more attractive for investors. Also, the tax from capital gain due to Rupee appreciation will also be exempted.

For foreign investment bankers, the interest rates on Masala bonds (approx. 7%) are much more attractive than their domestic bond counterparts. Furthermore, the Ratings agency S&P has predicted that Masala bonds will reach $5 billion in next two-three years.

Masala bonds are expected to bring to the Indian economy the required energy to recover from its investment slumber and the malaise of NPAs. Indian banks, especially Public Sector Banks (PSBs), need rather a lot of capital going forward. There are three reasons for this. First, banks are looking towards positive cash inflow opportunities to tackle NPAs. Second, the Indian economy is growing and this requires an increase in credit in the future. Third, there’s a general tightening up of bank capital standards under Basel III norms and this means that all banks would need more capital.

PSBs international Credit Rating (CR) derives its strength from India’s sovereign rating. Private Bank’s CR dependence on India’s sovereign rating is primarily indirect. Thus, a masala bond issued by a PSB could be considered as a proxy to India’s sovereign credit rating. This aspect can have interesting after effects on economy.

Investors would need to keenly watch the credibility of the issuer. Higher the CR of a firm, the better would be the appetite for their bonds. Since the currency risk is on the investors, they will prefer Rupee to be stable.

Having a huge growth potential, only time will tell if Masala bonds can become the penicillin to India’s current cold.


Ashwath Narayana B Sanket

Tuhina Kumar


The aim of this research paper is to critically examine how important it is to have the appropriate rate of GST and how this rate will affect government revenue. This is done by analyzing the various factors that affect the appropriation of the GST rate. We will also examine the impact of GST on inflation and the effects of having a high or low RNR rate. We conclude by examining the long-term effects of implementing GST.

Need for GST

In developing countries like India, the government plays an important role in augmenting the growth and development, given the paucity of private capital and initiative. The government is also responsible for supporting the economically backward classes, maintaining law and order and security of the country (9). To carry out these responsibilities, the government needs sufficient revenue. Revenue collection is done through various means like taxes, fines, fees and charges, and foreign grants of which taxes form a major chunk.

Row Labels Sum of Revised 2014-15 Sum of Budget 2015-16
Direct 705628.0 797995.0
Corporation tax 426079.0 470628.0
Income tax 278599.0 327367.0
Wealth tax 950.0
Indirect 545763.2 651495.6
Customs 188713.0 208336.0
Service tax 168132.0 209774.0
Taxes of union territories 3437.8 3577.0
Union excise duties 185480.4 229808.5
Grand Total 1251391.2 1449490.6

Table 1: Revenue from taxes, Source: (8)

The government earns 14,49,490 crores from taxes, the breakup of which is given in Table 1. Indirect taxes contribute a significant 44.95% to the total tax revenue. Hence, it is important to streamline this tax base. Introduction of GST will remove the multiplicity of taxes and simplify the tax structure.

Revenue Neutral Rate (RNR)

Since GST is a value added tax that provides tax credits for the taxes charged on the preceding stage of production, it will eliminate the cascading effects of taxes. This, in turn, might reduce the total government revenue from indirect taxes. To avoid this loss in revenue, the government will have to raise its taxes. This increased tax rate that ensures the government earns consistent revenue is called the revenue neutral rate (RNR). The committee headed by the Chief Economic Advisor of India, Arvind Subramanian, submitted a report that suggested an RNR of 15-15.5%. The principle behind calculating this RNR is defined by the following basic equation:


where ‘t’ is the RNR, ‘R’ is equal to the revenue generated from the current sales tax (12.5%) and the exercise tax (14%). This revenue which will be replaced by the GST is estimated to be 3.28 lakh crore from the center and 3.69 lakh crore from the state, which sums up to 6.97 lakh crores (Excluding revenues from petroleum and tobacco for the Centre, and from petroleum and alcohol for the States) or 6.1 per cent of GDP. Now the total potential tax base ‘B’ should be determined to calculate the RNR(1).

The committee has used three methods to determine the total potential tax base; the macro approach, the indirect tax turnover (ITT) approach, and the direct tax turnover (DTT) approach. This paper will explain the macro approach. In this approach, the tax base is calculated using the data from national income accounts. As per the Arvind Subramanian report, the base ranges from 59 per cent to 67 per cent of the GDP. This calculated base excludes the basic food items, petroleum, and electricity(1).

As stated earlier, the total revenue to be replaced by the GST is 6.1 per cent of the GDP. By using the basic formula t=R/B, the GST RNR ranges from 9.1 (0.061/0.67) to 11.1 per cent (0.061/0.55). For OECD (Organization for Economic Co-operation and Development) countries, there is commonly a loss of 10 to 20 per cent in revenue (1). Taking this loss into account the RNR ranges from 9-11 per cent to 11-14 per cent(1).

The aforementioned approaches have their own merits and demerits because of the underlying assumptions and data used. The Subramanian committee evaluated these and made suitable adjustments to arrive at an RNR rate of 15-15.5%

Standard Rate of GST

The standard rate is calculated using the below mentioned formula (1):

R=αLG +βSG +γSS +μDG

Where ‘R’ is the RNR, ‘LG’ is the lower rate on goods, ‘SG’ is the standard rate on goods, ‘SS’ the standard rate on services, and ‘DG’ the demerit rate on goods; α, β, γ, and μ are the respective shares of these four rates in the underlying tax base, and together add up to 1(1). Hence the whole rate structure depends on policy choices about exemptions, what commodities to charge at a lower rate, and what to charge at a higher rate. Figure 1 shows the standard rate of GST in some emerging economies.

pic1Figure 1: Standard rate of GST in high income and emerging markets economies, Source: (1)

The average standard rate in emerging market economies (EME’s) is 14.1% and the highest standard rate is 19% while for high income countries, the average standard rate is 16.8%. As India is an emerging market economy, an RNR of more than 15-15.5% will lead to a standard rate of 19-21%(1).

It should be kept in mind that GST is a regressive tax, which means that an increase in price due to increase in tax rates will extract a higher proportion of income from a consumer belonging to a lower income group. Developed countries can effectively offset the impact of regressive taxation by increasing their government spending and introducing many social security schemes. But India, being an emerging economy, will be unable to do so in their already limited budget. Hence India needs to be cautious of very high interest rates.

Learnings from other countries

As observed in countries like Australia, New Zealand and Canada, the implementation of GST will lead to a one-time price increase in the short-run but this inflationary effect will be stabilized in the long-run.

Canada follows a dual-rate GST system like the proposed GST system in India. Its initial GST rate of 7% lasted for 15 years after which it was reduced twice by 1% in 2006 and 2008. Canada has been decreasing its dependence on the consumption tax, which is contrary to the world trend. Many studies have proved that consumption tax is the most efficient way of taxation(5). This means that a reduction in consumption tax leads to a very small change in the economic well-being of people as it causes a very small distortion effect on an individual’s decisions and does not change their investment decisions or the type of economic activity they practice. So the cut in the tax rate would only lead to a minimal increase in the consumption expenditure in the short run and might not lead to an increase in savings or investment to have any long term effect. Hence, Canadian government’s decision to reduce the GST rate may not be in the best interest of the economy at large.

Also, the GST system has become increasingly complex over time like the sales tax on manufacturing goods(5). This is mainly due to the complexity of Canadian tax legislation, the number of taxes companies are subject to, and the multi-jurisdictional tax system. Furthermore, as more people came under the purview of the taxation system (because GST is a broad based tax), more people had to deal with this complex tax structure increasing their adjustment costs. A useful learning from Canada’s example is that a country should keep the taxation structure fairly simple to comply with. Also, as consumption tax is the most effective way of taxation, India should increase its dependence on indirect taxes.

Another useful learning can be taken from the example of Malaysia that faced a lot of opposition from its businesses even after providing 1.5 years to prepare for the change in the tax regime(6). Since India plans to implement GST from 1st April 2017, it may be very challenging for the businesses to adjust to this change in less than nine months.

Using Malaysia’s strategy, India could also release a probable tax structure for each segment to aid this transition.

Inflationary impact

 It is essential to understand the inflationary impact of GST on different goods and services. Some necessary goods will be exempted from taxes as the poor may not be able to afford them at high prices. For example, if we consider the pharmaceutical sector, it expects to gain from the overall increase in efficiency due to costs saved on the supply chain. However, if the rate is more than 12%, it will have a negative effect as healthcare is a necessity and it should be charged at a low rate with input credit funds available so that the end cost does not increase considerably(2). It will be interesting to see how existing indirect tax exemptions and inverted tax structures are modified to ensure that the overall costs of pharmaceutical products do not increase on account of GST.


Figure 2: Weightage of different categories in CPI, Source: (1)

Moreover, a major part of the Consumer Price Index (CPI) basket (as shown in exhibit 3) which includes categories like food and beverages, clothing and rent, are either exempted or taxed at low rates as these are essentials for the lower income group. The effective tax rate on CPI is 10.4%. However, this includes goods outside the purview of GST like petrol, diesel, and alcohol. If we exclude these items, only 46% (approx.) of the CPI will be taxed. Out of this, 32% is taxed at a low rate and only 15% is taxed at a normal rate. This builds up to an effective tax rate of 7% on CPI because these excluded goods are charged at very high rates (1).

However, if a good is exempted from taxes, it does not necessarily mean that the net tax charged on that good is zero. This is primarily because the embedded taxes on inputs, like the taxes paid on fuel during the transportation of these goods, are carried forward to the final product. Also, if food, fuel, and light are exempted from taxes and the Public Distribution System (PDS) continues to subsidize, the net price impact on the consumption of these goods for the poor will be minimal.

The proposed GST structure is a dual-rate tax structure and its inflationary impact will depend on the RNR rate and the standard rate. An RNR of 15% with a lower rate of 12% and a standard rate of 17-18% will have no inflationary impact(3). This is so because the revenue received by the government remains the same. Moreover, while the prices of some goods will go up, the prices of some other goods will go down negating the inflationary pressure. A higher RNR of 17-18% with a lower rate of 12%, a standard rate of 22% will have an inflationary impact of 0.3% if only the headline tax rate is considered. Furthermore, when the change in price is adjusted to the cascading input taxes, the net inflationary impact will be around 0.7% (1).

Effect of different rates of RNR

Since we don’t know the RNR rate, we can only speculate the effects of a high and low RNR rate. If a low rate of RNR is set, it will lead to a fall in revenue. As the center has promised to compensate the states for any loss of revenue over a five-year period, it will have a huge negative impact on the center as it has to support the states while it faces fall in its own revenue. Also, if this compensation is delayed, then it will lead to a loss of trust between the center and the state. The loss in revenue can also lead to a reduction in the growth rate of the country and this will further reduce the revenue(4).

We need to keep in mind that India is a developing country with diverse needs. Economic and social disparities have to be addressed while we simultaneously invest in education, healthcare, transport, energy, infrastructure etc. to boost development. This requires huge capital investments. GST rate will be set in order to meet these investment demands and any loss of revenue due to a reduction in rate will defeat the purpose of this taxation system.


In the long-run, GST is expected to benefit the economy in many ways. It provides credits on input taxes paid at the previous stage of production, decreasing the burden of tax on the end consumer. It also fosters greater compliance due to its multi-point collection system and an invoice trail that minimizes tax evasion because one needs to issue and obtain invoices in order to set-off the taxes from the previous stage of production. It increases the efficiency of the supply chain by saving travel time due to a reduction in hindrances and better warehousing and distribution of goods, leading to more cost-efficient decision making. On the whole, it will induce growth in the economy by creating an integrated economy with a common market while increasing the ease of doing business by streamlining the tax structure.


  1. Report on the Revenue Neutral Rate and Structure of Rates for the Goods and Services Tax (GST). (2015, December 4). Retrieved August 14, 2016, from Ministry of Finance, Government of India:
  1. Mukherjee, R. (2016, August 4). Impact from GST to be negative on pharma if rate exceeds 12%: Industry. Retrieved August 14, 2016, from The Times of India:
  1. GST expected at 22%: Will it upset April 1 rollout plans? (2016, August 18). Retrieved August 18, 2016, from Money Control:
  1. Keep GSTbelow 20% for inflation to be in check: Arvind Subramanian to NDTV. (2016, August 4). Retrieved August 14, 2016, from NDTV:
  1. Lefebvre, E. S. Is Cutting the GST the Best Approach? Retrieved July 25, 2016, from Certified General Accounts Association of Canada:
  1. Pachisia, V. (2016, July 28). GST: Lessons from countries that have implemented the Goods and Services Tax. Retrieved Augsut 25, 2016, from Financial Express:
  1. CEA REPORT: RNR AT 15%-15.5%; 5 KEY RECOMMENDATIONS. (2015, December 4). Retrieved August 20, 2016, from GST INDIA UPDATES:
  1. Receipt Budget, 2015-2016. (2016). Retrieved August 10, 2016, from National Informatics Centre:
  1. Akrani, G. (2010, December 12). Role of Taxation in Developing Countries Like India. Retrieved September 24, 2016, from Kalyani City Life:

About the authors:


The author is currently a student of the PGDM batch of 2016-18. His areas of interests are micro and macroeconomics. He is also a Committee member of TAPMI Toastmasters Club. You can contact him at:


The author has done economics and is currently a student of finance in the PGDM batch of 2016-18. Her areas of interest are Economics and Finance. The author also has a keen interest in the financial news of around the world. You can contact her at:

Strategic Disinvestments of Public Sector Undertakings

By Vishnu Pillai

Disinvestment is the opposite of Investment. In investment, one acquires an earning asset with the help of money.  Contrarily, disinvestment means the sale of earning assets at one’s disposal in order to generate cash. India today has 264 operating central PSU’s.

Is it worth staying on a sinking boat when you have a life jacket? Probably No. Then why to hold on to a firm which eats on to the pie of another well-governed profit making firm?

If by strategic disinvestment the enterprise is privatized then the control shifts from the government to a private entity which may help in efficient functioning. Even if the government retains control of the unit, the induction of private ownership will increase the accountability of management.

The industrial policy adopted by the government in 1991 had reduced the role of PSU’s. The government was intended to run the PSU’s on sound commercial principles and the sick PSU’s were to be referred to BIFR for examining their viability. It was decided that government organization can typically disinvest an asset as a strategic move for the company, for raising capital to meet its needs, to encourage wider share of ownership and reduce the burden on the government. According to the proponents, this progressive & strategic expansion of PSU’s was initiated to attain the goal of moving towards the socialistic pattern of society.

But like a coin, disinvestments too have another side, a critical one. The deprecator term disinvestment as selling the family silver to meet daily expenditure. They believe disinvestments reduced current account deficit but lose robust funds like dividends. In 2015-16 the government received Rs.36,000 Crore from dividends which itself was 50% of the targeted amount of Rs. 69,500 Crore to raised from disinvestments. Even wider ownership claim by the government failed since large corporates and financial institutions benefitted with the disinvestment than the common man. Moreover, the most of the disinvestments funds received were used to fund fiscal deficit.

So before jumping the “Disinvestment” trigger, the government should restructure PSUs to enhance the value of shares and increase sale proceeds. They should focus on areas like corporate governance, financial restructuring, and business & technological restructuring. The process of disinvestment should take into account the conditions in the capital market and not result in “crowding out” resources available for the private sector. The government has lowered the target by 19% in the last budget. Let’s hope this is a beginning towards a better and rational approach towards disinvestments.