April 24, 2007
There is good news for all those people who are planning to go abroad. Be it for higher studies, on a vacation or for any other reason. The cost of their travel is likely to come down as the Indian rupee gathers strength against the US dollar.
Not only that. As the rupee becomes stronger compared to the US dollar, the cost of all the imported goods and services fall down.
Even those who are staying put back home, an appreciating rupee has its benefits. Like the cost of all imports will come down.
Remember that India imports three-fourths of its oil. As the value of dollar goes down importing oil becomes cheaper. Since oil prices are directly related to rise in prices of other goods and commodities in India, their prices will also fall down.
But how can the rupee strengthening in value against the dollar bring about these changes and what exactly does it mean?
Well, in recent years, the Indian economy has become increasingly global. This means economic events that occur far away from our borders have an increasing impact on our markets and economy.
One important way in which the global economy affects India is exchange rates. Exchange rate refers to the value of the Indian rupee vis-a-vis currencies of other nations like say, USA or England or Pakistan.
This article looks at some of the basic forces that determine exchange rates and how they impact financial markets and the economy at large.
There are two main ways in which countries determine their exchange rates: fixed and floating.
A fixed exchange rate, which is what India had before liberalisation (pre-1991), simply means that the government chooses the official exchange rate: say 1 dollar equals 25 rupees. All official exchange of currency has to take place at this fixed rate.
A fixed exchange rate is often associated with strict controls on the use of foreign exchange. It also sees the rise of black markets as individuals try to avoid the official exchange rate. Individuals do it because they think the government-fixed exchange rate gives them less value for their dollars. The black market, hypothetically, can give more than Rs 25 to a dollar.
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A floating exchange rate, by contrast, means that the exchange rate is determined in the foreign exchange markets by the forces of demand and supply. The exchange rate changes from day to day as market forces shift.
In practice, many countries including India now have a hybrid system called 'dirty float'. This is basically a floating rate where the government intervenes from time to time, trying to nudge the exchange rate in one direction or the other.
So what are the forces that affect exchange rate movements? What, in particular, has been causing the rupee to rise in value in recent months?
Buyers of dollars now have to shell out fewer rupees to buy one unit of a dollar. If they had to pay Rs 43 to buy one dollar earlier, they can now get the same dollar for Rs 42 ie they are getting it for a rupee less. This is what is meant by 'rise in the value' of the rupee in recent months.
Let's now look at the factors affecting the foreign exchange rate of currencies of two independent countries.
The most important factor, probably, is how attractive a country's economy is to foreign investors. Every time a foreign bank or company wants to invest in India -- whether it is by buying shares or opening a factory -- it will need to buy rupees. This will increase the demand for rupees in the foreign exchange markets, which will mean the rupee will rise in value.
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This is exactly what has been happening in India recently as it has become one of the fastest growing economies in the world. Multinational corporations are eager to get a slice of the action. In the financial year 2006-2007, India received $16 billion dollars in foreign direct investment; this is about three times the previous year's figure.
Another important factor is the interest rate in different countries. If Indian interest rates rise relative to other countries, Indian interest-bearing products become more attractive; this will once again increase demand for the rupee.
For instance, if the rate of interest in the US is only 4 per cent on bank deposits and a fixed deposit in India fetches, say, 10 per cent, the 6 per cent difference between the interest rates of these two countries will attract foreign investors to India.
In India, the Reserve Bank of India has been raising interest rates in recent months as a way of fighting inflation; this has played a role in the rising value of the rupee.
So what is the impact of a rising rupee on different sectors of the economy? In a nutshell, exporters are hurt and importers celebrate.
The logic is simple: suppose an exporter earns $1 million in foreign exchange. At an exchange rate of 47 rupees to the dollar, this is worth Rs. 4.7 crores while at a rate of 43 rupees it's only worth Rs. 4.3 crores.
This is why stocks of export-intensive technology firms like Infosys have performed relatively poorly in recent weeks. Firms in the textile sector have also been hurt. Both the information technology and the textile sector are export-driven and are hurt whenever the rupee's value increases.
The reason is they get less rupees for the dollars they earn through exports.
The opposite is true for companies with large imports. A stronger rupee means their import bill will fall in rupee terms. In India, the single biggest import is crude oil, and the rising rupee has seen stock market gains for oil marketing companies like IOC and HPCL in recent weeks.
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A barrel of oil that had cost them, say Rs 1720 ($1 = Rs 43; cost of one barrel of oil = $40), will now cost them Rs 1,680 ($1 = Rs 42; cost of one barrel of oil = $40), saving Rs 40 per barrel. This saving directly goes into the net profit kitty of oil marketing companies.
The rising rupee also has a direct impact on consumers who will face lower prices in rupees for imported goods or travelling abroad. For instance a typical weeklong trip abroad costing, say, $1000 (or Rs 42,000; $1 = Rs 42) will be cheaper because of the rise of the rupee in the last six months.
The same trip would have earlier cost Rs 44,000 (assuming $1 = Rs 44).
So what's likely to happen to the rupee in the future?
No one can say for sure as exchange rates are notoriously unpredictable. If the rupee rises significantly, you could see the RBI intervening in the markets and selling rupees in order to lower its value. As of now, it is not doing this, allowing the rupee to increase in value.
However, if India remains an attractive investment destination, the rupee is unlikely to drop significantly from its current level as foreign investments will come pouring in.
But if it does 'rise in value' further then you and I will be able to buy that imported watch, the latest laptop and of course, oil at much cheaper rates than we are doing now.
Monday, April 30, 2007
How SIPs help you invest wisely
The SIP is the best form of investing say analysts on television, or your newspaper, or your financial advisor or even articles such as this one. Ever wondered why? Read on to find out...
Basics revisited
SIP stands for Systematic Investment Plan. It means that instead of investing sporadically or in a lump sum, it is better to regularly invest a fixed amount. This will help you benefit from the averaging effect.
This averaging effect happens because you buy more units whenever the price falls and less units whenever the price rises.
For instance, assume you are investing Rs 10,000 every month. When the price of a unit falls to Rs 10, you get 1,000 units; when it rises to Rs 20 you get only 500 units.
However, if you calculate the average price of each unit, it comes to about Rs 13.3 (Rs 20,000/ 1,500) instead of Rs 10 or Rs 20.
A SIP is not necessarily restricted to mutual funds. It is a concept that can be applied to any investment.
The question now is: how do you quantify the benefits of investing in a SIP?
The 'averaging' benefit
Take a look at the charts given below. The first two charts are for an equity liked saving scheme.
The first chart shows how the rate (cost at which the investor bought units = NAV + charges) has changed in 2006. It also shows the average price an investor would have paid every month had he adopted the SIP route. The blue line is the rate at which the investor got the units, while the pink line is the average cost per unit for each month. The chart makes it clear that, even though the rate has swung wildly, the average cost per unit is fairly stable.
The chart below shows how the investor would have accumulated units over the last one year. You will notice that, as the rate goes down, he is getting more number of units and vice versa.
Statistical evidence
While the charts are self-explanatory, statistical analysis shows that the Standard Deviation (measure of volatility) for the ELSS rate over the year has been 1.47, while that for the ELSS SIP has been 0.38.
ELSS Rate Standard Deviation | 1.4723 |
ELSS SIP Standard Deviation | 0.3792 |
Power Rate Standard Deviation | 4.1790 |
Power SIP Standard Deviation | 1.3662 |
And standard deviation is...
If you are given a few numbers, and told to find their average, you can very easily do that. Now, if these numbers are more or less near to the average value, you can say that the data range is very near to the average value. To that extent, the data is stable. In case of NAV1 in the example below, the data range is 10.24 -- 15.02 (the lowest and highest value), which is relatively nearer to the mean or average value of 12.72.
For instance, if you have to calculate the average (mean) age of five children aged 32, 34, 36, 38 and 40 years, you add the ages and divide it by 5. In this example, the mean will come out to 36 (32+34+36+38+40 / 5).
However, if the data range were large on either side of the average value, it would mean that the data is fluctuating a lot. In NAV2, for example, the data range is from 22.96 to 36.43 and the mean is 29.11, which indicates high fluctuation.
2006 | NAV1 | NAV2 |
January | 11.6 | 23.88 |
February | 12.14 | 26.47 |
March | 13.21 | 30.80 |
April | 14.02 | 31.87 |
May | 15.02 | 31.88 |
June | 10.24 | 22.96 |
July | 10.89 | 25.24 |
August | 11.71 | 26.95 |
September | 12.22 | 27.81 |
October | 13.37 | 31.00 |
November | 13.88 | 33.94 |
December | 14.30 | 36.43 |
Average | 12.72 | 29.11 |
SD | 1.472 | 4.179 |
% change | 23% | 53% |
When it comes to your investments, you would like to have an instrument whose value steadily increases over time. However, since this is not practically possible in the case of stock markets (and, as a direct result, with equity mutual funds), you would like to have a scheme, where NAV has an upward trend but is not subject to wild fluctuations.
SD measures how far from the average the values sway. So, in case of huge swings, the SD will be higher. In case of low fluctuations, the SD will be lower. As can be seen above, the SD for NAV1 is 1.47, while that for NAV2 is 4.18.
Let us try to see this by the following example. We have taken the data mentioned under the columns NAV1 and NAV2. The only difference is, we have equated the first value of both the series to 100.
Now, if you observe, not only does the thick light blue line (representing the trend of NAV1) have a gentler slope than the thick light pink line (representing the trend of NAV2), the swing of the data (NAV1 � dark blue data line) on either side of the light blue line is lesser than that for the other set of data (NAV1 -- dark pink data line).
This means the scheme represented by NAV1 (ELSS) is less volatile than the scheme represented by NAV2 (of a power sector fund).
Take a look at the SD of these two data sets (base value = 100). You will notice the annual returns for NAV1 has been 23 per cent while that for NAV2 is 53 per cent.
How averaging works
Take a look at Chart 2. You will see the number of units increasing as the price falls. This is obvious, since you are investing a fixed amount every month.
When the same amount is used to buy units at various prices, then you will get more units when the price is less and less units when the price is more. This can be seen in Chart 2 where, as the NAV rises till May, the number of units bought falls. In May, as the NAV crashes, the number of units zoom up, only to steadily fall as the NAV rises till December.
So, at any point, if you wish to calculate the average price you are paying per unit, you will have to divide the total amount you have invested with the number of units you have been allotted.
Simplifying statistics
In a nutshell, this is what it means:
~ Investing in SIP reduces risk (volatility).
~ The cost per unit reduces due to averaging.
~ Extending SIP over longer periods of time in schemes that are doing well will increase the difference between the then prevailing NAV and average cost of buying.
Tax-planning tips for 2007-08
Wondering how to plan your taxes in the new financial year? Do you want your tax-planning to generate returns as well? Want to know about short-term investments that also offer you rebate on income tax? While tax can be saved on investments like insurance, mutual fund, fixed deposit and various other debt schemes, are you confused about the ideal mix? Are unit linked insurance plans bad investment options? Are their returns not as good as other insurance products? Get Ahead tax expert Mahesh Padmanabhan answered tax and investment-related queries in a chat with Get Ahead readers on April 25. For those of you who missed the chat, here is the transcript. Paul asked, I want to know if LTA is allowed to teachers also. How much value is it? Mahesh Padmanabhan answers, LTA or leave travel assistance is merely a component of your salary structure and is general in nature. There is nothing restrictive in its use in a segment manner for a certain class of employees. Yes, the basic condition, however, is that there should be an employer-employee relationship. phanichaganti asked, Hi my age is 27. Right now division of my tax savings is (Rs 100,000= Rs 25,000 (FD 5yrs) + Rs 28,000 (EPF) + Rs 30,000 (NSC) + remaining (MF). Is my way of investing good/bad/moderate? Mahesh Padmanabhan answers, From your investment mix, you seem to be a very risk averse person as the debt component is very high as compared to the equity component. Investment in debt securities is not a bad option but you need to consider the tax implication of the interest, liquidity of such investment, pre and post tax yield (returns), etc before deciding whether this investment mix is suitable for the growth of your wealth. Historically, equities have always scored higher in the long run. Krishna asked, Hi Mahesh, I am working in one of the company in a European country through business VISA through their branch in delhi, and my gross salary is Rs 10 lakhs. Please suggest how much I could invest for tax saving? Already I have been paying Rs 25,000 per annum through LIC. Also take into consideration that from April �08 I may go permanently to Europe through work permit visa. Please give your suggestions on the same. Thank you very much. Mahesh Padmanabhan answers, I guess you are looking at a short-term fix for your current tax problem. In this case you can invest in ELSS (equity linked saving scheme), which has a lock-in period of about three years. You can also put your money in a five year FD. In case of life insurance, you are seriously advised to consult a financial/ insurance advisor to determine your insurance needs and accordingly go about putting your money in such insurance without taking a look at the tax perspective. RAGHAVENDRA asked, HI RAGHU HERE, AM EARNING RS 35K PER MONTH IN HAND, AND REQUEST YOU TO SUGGEST ME A GOOD INVESTMENT PLAN. Mahesh Padmanabhan answers, Raghu, there is no single best plan available on a common platform; it all boils down to individual financial perspectives. However, if you are averse to taking risks, then go for debt tax savings instruments such as NSC, PPF, eligible FD etc or else go for ELSS mutual funds, ULIP schemes, etc. Additionally, you would also need to consider your long-term planning for various other aspects such as home acquisition, etc. sandhya asked, Hi ,My take home salary is Rs 15 k per month. Please let me know the best investment opportunities. I have already invested in FDs, RDs (recurring deposit) and NSC. Mahesh Padmanabhan answers, In case your salary structure is absolutely unfriendly and the entire Rs 1.8 lakhs salary is taxable, then you need to put aside at least Rs 35,000 in certain tax saving investments to bring your tax liability to zero. Generally, RDs are not tax saving instruments and you will need to ensure that the FD that you have created is stamped by the bank for being eligible for tax savings purpose. NSC is a tax saving instrument. dip asked, Sir, I have invested around Rs 54,000 in 2 ULIP funds , ICICI prudential (Rs 24,000) and AVIVA life bond 5 (Rs 30,000). I know that investing a huge chunk of money in ULIPs was not a good idea but do you think I should persist with these investments. Mahesh Padmanabhan answers, If someone has told you that investing in ULIP is bad, then the person is absolutely wrong. Yes, if you have done so without proper consultation with an advisor, then probably you might get involved with the wrong insurance company or the wrong plan. Generally all insurance companies generate reasonable returns on ULIPs but the cost varies between companies, making the returns relatively up or down in comparison to peer companies. What you need to ensure is that you learn about the scheme you have invested in and see if you can leverage by moving from debt oriented fund to equity oriented fund or vice versa as per your risk profile. Also, if you are unhappy with the scheme available as such then look at the escape route to get out of the insurance plan with as minimum damage as possible. Ravindra asked, Hi mahesh, I want to know about the investments that are short in time and also provide income tax rebate? Mahesh Padmanabhan answers, The lowest time frame that you can probably look at is three years of lock-in. ELSS schemes, infrastructure bonds, etc, carry such time frame. But my sincere advice is do not be shortsighted in investing; the deductions that are provided are to promote retirement funding or to provide long term financial security/ means to individuals. Do not liquidate these investments unless the funds are required badly. Also, invest your money with a proper strategy in mind after consulting a financial planner. ARPAN asked, What is an ELSS scheme? Mahesh Padmanabhan answers, ELSS schemes are mutual fund schemes specifically aimed at tax investing with a lock in time frame of 3 years. These are essentially same as the regular mutual fund investments but are more focused and generally yield consistent returns. However, these are also subject to the vagaries of the stock market |
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