Foreign Trade Development & Regulation Amendment Bill, 2009

Standing Committee on Commerce invites Suggestions on Foreign Trade (Development and Regulation) Amendment Bill, 2009

The Foreign Trade (Development and Regulation) Amendment Bill, 2009, introduced in the Rajya Sabha on the 25th November, 2009, has been referred to the Department Related Parliamentary Standing Committee on Commerce, with Shri Shanta Kumar, Member, Rajya Sabha, as its Chairman, for examination and report.

The Bill seeks to amend the Foreign Trade (Development and Regulation) Act, 1992 with a view, interalia, to:-

i) Provide a statutory provision for safeguard measures enabling imposition of Quantitative Restrictions (QRs);
ii) Bring in tighter export or trade control in the case of dual-use goods and related technologies and to provide enabling provisions for establishing controls as in the Weapons of Mass Destruction and their Delivery Systems (Prohibition of Unlawful Activities) Act, 2005;
iii) Bring “technology” and “services”, including financial services, within the ambit of the Act for the purpose of administering incentive schemes and other provision of the Foreign Trade Policy;
iv) Dispense with the requirement of obtaining any licence or permit for import or export except as may be provided under the Act;
v) Enable swift and exemplary action in trade dispute matters;
vi) Further rationalise as well as improve the system of levying and realising fiscal penalties;
vii) Empower Customs and Central Excise Settlement Commission for settlement of customs and excise duty and interest dues;
viii) Broaden the scope of word “licence” defined in the Act;
ix) Provide a provision for review of all decisions of subordinate officers by Director General of Foreign Trade.

Foreign Trade Policy

In India, the main legislation concerning foreign trade is the Foreign Trade (Development and Regulation) Act, 1992. The Act provides for the development and regulation of foreign trade by facilitating imports into, and augmenting exports from, India and for matters connected therewith or incidental thereto. As per the provisions of the Act, the Government :- (i) may make provisions for facilitating and controlling foreign trade; (ii) may prohibit, restrict and regulate exports and imports, in all or specified cases as well as subject them to exemptions; (iii) is authorised to formulate and announce an export and import policy and also amend the same from time to time, by notification in the Official Gazette; (iv) is also authorised to appoint a 'Director General of Foreign Trade' for the purpose of the Act, including formulation and implementation of the export-import policy.
Accordingly, the Ministry of Commerce and Industry has been set up as the most important organ concerned with the promotion and regulation of foreign trade in India. In exercise of the powers conferred by the Act, the Ministry notifies a trade policy on a regular basis with certain underlined objectives. The earlier trade policies were based on the objectives of self-reliance and self-sufficiency. While, the later policies were driven by factors like export led growth, improving efficiency and competitiveness of the Indian industries, etc.
With economic reforms, globalisation of the Indian economy has been the guiding factor in formulating the trade policies. The reform measures introduced in the subsequent policies have focused on liberalization, openness and transparency. They have provided an export friendly environment by simplifying the procedures for trade facilitation. The announcement of a new Foreign Trade Policy for a five year period of 2004-09, replacing the hitherto nomenclature of EXIM Policy by Foreign Trade Policy (FTP) is another step in this direction. It takes an integrated view of the overall development of India’s foreign trade and provides a roadmap for the development of this sector. A vigorous export-led growth strategy of doubling India’s share in global merchandise trade (in the next five years), with a focus on the sectors having prospects for export expansion and potential for employment generation, constitute the main plank of the policy. All such measures are expected to enhance India's international competitiveness and aid in further increasing the acceptability of Indian exports. The policy sets out the core objectives, identifies key strategies, spells out focus initiatives, outlines export incentives, and also addresses issues concerning institutional support including simplification of procedures relating to export activities.The key strategies for achieving its objectives include:-
Unshackling of controls and creating an atmosphere of trust and transparency;
Simplifying procedures and bringing down transaction costs;
Neutralizing incidence of all levies on inputs used in export products;
Facilitating development of India as a global hub for manufacturing, trading and services;
Identifying and nurturing special focus areas to generate additional employment opportunities, particularly in semi-urban and rural areas;
Facilitating technological and infrastructural upgradation of the Indian economy, especially through import of capital goods and equipment;
Avoiding inverted duty structure and ensuring that domestic sectors are not disadvantaged in trade agreements;
Upgrading the infrastructure network related to the entire foreign trade chain to international standards;
Revitalizing the Board of Trade by redefining its role and inducting into it experts on trade policy; and
Activating Indian Embassies as key players in the export strategy.
The FTP has identified certain thrust sectors having prospects for export expansion and potential for employment generation. These thrust sectors include: (i) Agriculture; (ii) Handlooms & Handicrafts; (iii) Gems & Jewellery; and (iv) Leather & Footwear. Accordingly, specific policy initiative for these sectors have been announced.

In order to review the progress and policy measures, each year, "Annual Supplements" to the five year Foreign Trade Policy (FTP) have been announced by the Ministry :-
The Annual Supplement announced in April, 2005 incorporated additional policy initiatives and further simplified the procedures. It provided for an active involvement of the State Governments in creating an enabling environment for boosting international trade, by setting up an Inter-State Trade Council. Also, different categories of advance licences were merged into a single category for procedural facilitation and easy monitoring. The supplement provided renewed thrust to agricultural exports by extension of 'Vishesh Krish Upaj Yojna' to poultry and dairy products and removal of cess on exports of all agricultural and plantation commodities.
The Annual Supplement put forward in April 2006, announced the twin schemes of 'Focus Product' and 'Focus Market'. To further meet the objective of employment generation in rural and semi urban areas, export of village and cottage industry products were included in the 'Vishesh Krishi Upaj Yojana', which was renamed as "Vishesh Krishi and Gram Udyog Yojana". Also, a number of measures were introduced in order to achieve the objective of making India a gems and jewellery hub of the world. These include:- (i) allowing import of precious metal scrap and used jewellery for melting, refining and re-export; (ii) permission for export of jewellery on consignment basis; (iii) permission to export polished precious and semi precious stones for treatment abroad and re-import in order to enhance the quality and afford higher value in the international market.
Likewise, the third Annual Supplement to the Foreign Trade Policy was announced on 19 April,2007 (effective from 1 st April, 2007). Some of the important measures introduced by it are:- (i) exemption from service tax on services (related to exports) rendered abroad; (ii) service tax on services rendered in India and utilized by exporters would be exempted/remitted; (iii) categorization of exporters as 'One to Five Star Export Houses' has been changed to 'Export Houses & Trading Houses', with rationalization and change in export performance parameters; (iv) expansion of ceiling, scope and coverage under the 'Focus Market Scheme (FMS)' and 'Focus Product Scheme (FPS)'.
The final annual supplement to the Foreign Trade Policy for 2004-2009 was announced in April 2008 in which several innovative steps were proposed. They included the following:
Import duty under the EPCG scheme is being reduced from 5% to 3%, in order to promote modernization of manufacturing and services exports.
Income tax benefit to 100% EOUs available under Section 10B of Income Tax Act is being extended for one more year, beyond 2009.
To promote export of sports and toys and also to compensate disadvantages suffered by them, an additional duty credit of 5% over and above the credit under 'Focus Product Scheme' is being provided.
Our export of fresh fruits and vegetables and floriculture suffers from high incidence of freight cost. To neutralize this disadvantage, an additional credit of 2.5% over and above the credit available under Visesh Krishi and Gram Udyog Yojana (VKGUY) is proposed.
Interest relief already granted for sectors affected adversely by the appreciation of the rupee is being extended for one more year.
DEPB scheme is being continued till May 2009.

In accordance with the provisions of the Act, a "Directorate General of Foreign Trade (DGFT)" has been set up as an attached office of the Ministry of Commerce and Industry. It is headed by the 'Director General of Foreign Trade' and is responsible for formulating and executing the Foreign Trade Policy/Exim Policy with the main objective of promoting Indian exports. The DGFT also issues licences to exporters and monitors their corresponding obligations through a net work of 32 regional offices located at the following places:- Ahmedabad; Amritsar; Bangalore; Baroda (Vadodara); Bhopal; Kolkata; Chandigarh; Chennai; Coimbatore; Cuttack; Ernakulam; Guwahati; Hyderabad; Jaipur; Kanpur; Ludhiana; Madurai; Moradabad; Mumbai; New Delhi; Panaji; Panipat; Patna; Pondicherry; Pune; Rajkot; Shillong; Srinagar(Functioning at Jammu); Surat; Thiruvananthapuram; Varanasi; and Vishakhapatnam.

Foreign trade policy to be aligned with GST after April 1, 2010

The new foreign trade policy, which is being prepared by the commerce ministry, will be aligned with the Goods and Services Tax (GST) only after implementation of this indirect tax mechanism.
The new policy is likely to be announced by the next government at the Centre by mid-2009, while the GST is likely to be implemented from April 1, 2010.
The current foreign trade policy of 2004-09 was unveiled by the United Progressive Alliance government on September 1, 2004 and was to expire on March 31, 2009. However, the Directorate General of Foreign Trade (DGFT) under the commerce ministry had extended its tenure till a new policy was ready.
The foreign trade policy has several export promotion measures that reimburse indirect levies charged on exports. These levies will now be subsumed under the proposed GST and will have only two slabs — one for the Centre and the other for the states. Therefore, the new export policy will have to specify how the current benefits given to exporters are matched with the proposed GST rates.
“We expect the new policy to be released by mid-2009. Till the GST mechanism is in place, provisions of the policy will not be changed. This is to ensure there is no confusion. Once GST is rolled out, the foreign trade policy will be modified to take into account the new taxation mechanism,” said a government official requesting anonymity.
Officials are still not clear if the state-level GST levied on exporters will be reimbursed. At the moment, many state-level duties are not reimbursed to exporters.
The DGFT has already started consultations with various export-related organisations and industry lobby groups on the new Foreign Trade Policy.
Officials maintained that the new government would take a call whether the present structure of the foreign trade policy should be continued.
“The process of consultations will go on till April 20, after which the suggestions will be compiled. Thereafter inter-ministerial consultations will begin. The commerce ministry wants to be ready with the recommendations when the new government is in place,” the official added.
Before the current policy was released, foreign trade procedures were spelt out through an “export-import policy”. This mechanism was prevalent from 1992 to 2004. The UPA government replaced this with the current five-year trade policy to bring stability and incorporate sector-specific export promotion measures.
Exporters have been demanding a host of benefits in the new policy, including continuation of the Duty Entitlement Passbook Scheme, which was extended till further notice by the commerce ministry. This scheme, which is not compliant with world trade rules, reimburses indirect tax levied on inputs used by exporters.
Representatives of the Federation of Indian Chambers of Commerce and Industry (Ficci), who met DGFT officials today, demanded customised schemes to help exporters tide over the liquidity crisis, reduce transaction time and other costs related to foreign trade.
Pointing out that reimbursement of Value Added Tax levied on exporters took about 12 to 15 months, Ficci demanded refund of the Fringe Benefit Tax and Service tax.

More stimulus not needed: Subbarao

Reserve Bank of India Governor D Subbarao said on Friday that another stimulus package could help the economy in the short-term but a sustainable recovery required the government to return to fiscal consolidation.
The governor's statement at a financial management conference came hours before the new government was sworn in. So far, the government and the central bank have announced two packages to boost economic activity in addition to tax cuts following the Interim Budget.
"Given the still soft economy, the pressure to provide more stimulus will persist," the governor added.
The packages had resulted in a sharp increase in government borrowing. "Large borrowings by the government run against the low interest rate environment that the Reserve Bank is trying to maintain to spur investment demand in keeping with the stance of monetary policy," Subbarao said.
Large borrowings translate into money, available with banks, flowing into government securities instead of being deployed for lending. "However, with every percentage point increase in the fiscal deficit, maintaining adequate liquidity in the system becomes that much more difficult. Managing this trade-off between our short-term compulsions and longer-term sustainability will be one of the big challenges going forward," the governor said.
During 2008-09, the Centre's gross borrowings went up from Rs 1,76,453 crore budgeted at the start of the year to Rs 3,42,769 crore, a 94 per cent rise. To ensure that the borrowings did not affect the markets, RBI and the government also unwound the bonds issued under the Market Stabilisation Scheme besides mopping up liquidity through open market operations. During 2008-09, the Centre's fiscal deficit was budgeted at 2.5 per cent of gross domestic product at the start of the year and was revised sharply to 6 per cent in the Interim Budget.
The fiscal deficit has grown mainly on account of a large loan waiver package for farmers, higher salaries to government employees and a nation-wide employment guarantee scheme.
Subbarao said RBI will continue to use a combination of monetary and debt management tools to manage the government borrowing programme.
While pointing out that sectors such as cement, steel and automobiles were showing signs of revival, Subbarao said India could see an economic turnaround later this year as the stimulus packages work through, provided the global economic environment improved. At the same time he said that the global financial outlook remained uncertain.
"These signs are not unambiguous--there is as yet no clear sign of export decline reversing the trend, and credit growth continues to be subdued," Subbarao said.
He added that RBI was in the process of setting up an inter-disciplinary Financial Stability Unit to monitor and address systemic vulnerabilities in the financial sector.
In his speech, the government also prodded banks to lower lending rates. "Although deposit rates are declining and effective lending rates are falling, there is clearly more space to cut rates given declining inflation. Making liquidity available in sufficient quantity, as RBI has done, should also help by giving confidence to banks of the availability of funds," he said.
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Inflation data based on monthly WPI series from new year

The Centre plans to release inflation figures based on a revised wholesale price index (WPI) series, with 2004-05 as the base year, from the start of the new calendar year.
“The test run of the new series is now under way, based on price data received from about 3,500 manufacturing units.
“The idea is to extend this universe to 5,000-plus firms, from where the entire backlog of weekly price information since April 2004 is to be sourced and which can, then, be used to generate the relevant product and group-wise indices,” a senior official involved with the exercise told Business Line.
He said the target is to construct the new WPI series and take it up with the National Statistical Commission by end-October. “After that, we need about two months to stabilise the flow of the new data, which can be received online by the Office of the Economic Advisor (OEA) and automatically processed through software developed by the National Informatics Centre. So, by end-December or early-January, the inflation numbers derived from the new series could be ready for launch,” the official added.
The existing WPI series, having 1993-94 as the base year, covers 435 commodities, which include 98 ‘primary articles’, 318 ‘manufactured products’ and 19 ‘fuel, power, light & lubricant’ items. The proposed 2004-05 base series will have 1,224 commodities. While the ‘primary articles’ and ‘fuel’ groups will have more or less the same number of items — 105 and 19, respectively — there would be as many as 1,100 ‘manufactured products’. Price quotations
Also, in each of these individual commodities, it is planned to obtain at least five price quotations. This is against the present WPI series, where of the total 435 items, there are 214 (with a combined weight of over 36 per cent) represented by three or less quotations and as many as 86 with single quotations.
“Covering 1,200-plus commodities and having a minimum of five quotations for each of them is ambitious. But, with 5,000-odd reporting firms who are required to submit data online to the OEA only once a month, it is not difficult,” the official pointed out.
Currently, the OEA releases weekly WPI inflation every Thursday. The Working Group for Revision of WPI Numbers, headed by the Planning Commission Member, Prof Abhijit Sen, has recommended changeover to a monthly index in line with standard practice in other countries. The idea has, however, not found complete favour with the Finance Ministry and the Reserve Bank of India.
“It is a trade-off you have to make between more frequent, less reliable data (as is now the case) and less frequent, more reliable data. Maybe once a proper system of flow and processing of data at the planned levels gets established, it is possible to release weekly indices as well,” the official added.

Asset liability management

Asset-Liability Management (ALM) can be termed as a risk management technique designed to earn an adequate return while maintaining a comfortable surplus of assets beyond liabilities. It takes into consideration interest rates, earning power, and degree of willingness to take on debt and hence is also known as Surplus Management. But in the last decade the meaning of ALM has evolved. It is now used in many different ways under different contexts. ALM, which was actually pioneered by financial institutions and banks, are now widely being used in industries too. The Society of Actuaries Task Force on ALM Principles, Canada, offers the following definition for ALM: "Asset Liability Management is the on-going process of formulating, implementing, monitoring, and revising strategies related to assets and liabilities in an attempt to achieve financial objectives for a given set of risk tolerances and constraints."

Basis of Asset-Liability Management Traditionally, banks and insurance companies used accrual system of accounting for all their assets and liabilities. They would take on liabilities - such as deposits, life insurance policies or annuities. They would then invest the proceeds from these liabilities in assets such as loans, bonds or real estate. All these assets and liabilities were held at book value. Doing so disguised possible risks arising from how the assets and liabilities were structured. Consider a bank that borrows 1 Crore (100 Lakhs) at 6 % for a year and lends the same money at 7 % to a highly rated borrower for 5 years. The net transaction appears profitable-the bank is earning a 100 basis point spread - but it entails considerable risk. At the end of a year, the bank will have to find new financing for the loan, which will have 4 more years before it matures. If interest rates have risen, the bank may have to pay a higher rate of interest on the new financing than the fixed 7 % it is earning on its loan. Suppose, at the end of a year, an applicable 4-year interest rate is 8 %. The bank is in serious trouble. It is going to earn 7 % on its loan but would have to pay 8 % on its financing. Accrual accounting does not recognize this problem. Based upon accrual accounting, the bank would earn Rs 100,000 in the first year although in the preceding years it is going to incur a loss. The problem in this example was caused by a mismatch between assets and liabilities. Prior to the 1970s, such mismatches tended not to be a significant problem. Interest rates in developed countries experienced only modest fluctuations, so losses due to asset-liability mismatches were small or trivial. Many firms intentionally mismatched their balance sheets and as yield curves were generally upward sloping, banks could earn a spread by borrowing short and lending long. Things started to change in the 1970s, which ushered in a period of volatile interest rates that continued till the early 1980s. US regulations which had capped the interest rates so that banks could pay depositors, was abandoned which led to a migration of dollar deposit overseas. Managers of many firms, who were accustomed to thinking in terms of accrual accounting, were slow to recognize this emerging risk. Some firms suffered staggering losses. Because the firms used accrual accounting, it resulted in more of crippled balance sheets than bankruptcies. Firms had no options but to accrue the losses over a subsequent period of 5 to 10 years. One example, which drew attention, was that of US mutual life insurance company "The Equitable." During the early 1980s, as the USD yield curve was inverted with short-term interest rates sky rocketing, the company sold a number of long-term Guaranteed Interest Contracts (GICs) guaranteeing rates of around 16% for periods up to 10 years. Equitable then invested the assets short-term to earn the high interest rates guaranteed on the contracts. But short-term interest rates soon came down. When the Equitable had to reinvest, it couldn't get even close to the interest rates it was paying on the GICs. The firm was crippled. Eventually, it had to demutualize and was acquired by the Axa Group. Increasingly banks and asset management companies started to focus on Asset-Liability Risk. The problem was not that the value of assets might fall or that the value of liabilities might rise. It was that capital might be depleted by narrowing of the difference between assets and liabilities and that the values of assets and liabilities might fail to move in tandem. Asset-liability risk is predominantly a leveraged form of risk. The capital of most financial institutions is small relative to the firm's assets or liabilities, and so small percentage changes in assets or liabilities can translate into large percentage changes in capital. Accrual accounting could disguise the problem by deferring losses into the future, but it could not solve the problem. Firms responded by forming asset-liability management (ALM) departments to assess these asset-liability risk.

Techniques for assessing Asset-Liability Risk Techniques for assessing asset-liability risk came to include Gap Analysis and Duration Analysis. These facilitated techniques of managing gaps and matching duration of assets and liabilities. Both approaches worked well if assets and liabilities comprised fixed cash flows. But cases of callable debts, home loans and mortgages which included options of prepayment and floating rates, posed problems that gap analysis could not address. Duration analysis could address these in theory, but implementing sufficiently sophisticated duration measures was problematic. Accordingly, banks and insurance companies started using Scenario Analysis. Under this technique assumptions were made on various conditions, for example: - • Several interest rate scenarios were specified for the next 5 or 10 years. These specified conditions like declining rates, rising rates, a gradual decrease in rates followed by a sudden rise, etc. Ten or twenty scenarios could be specified in all. • Assumptions were made about the performance of assets and liabilities under each scenario. They included prepayment rates on mortgages or surrender rates on insurance products. • Assumptions were also made about the firm's performance-the rates at which new business would be acquired for various products, demand for the product etc. • Market conditions and economic factors like inflation rates and industrial cycles were also included. The capital of most financial institutions is small relative to the firm's assets or liabilities, and so small percentage changes in assets or liabilities can translate into large percentage changes in capital. Accrual accounting could disguise the problem by deferring losses into the future, but it could not solve the problem. Firms responded by forming asset-liability management (ALM) departments to assess these asset-liability risk. Based upon these assumptions, the performance of the firm's balance sheet could be projected under each scenario. If projected performance was poor under specific scenarios, the ALM committee would adjust assets or liabilities to address the indicated exposure. Let us consider the procedure for sanctioning a commercial loan. The borrower, who approaches the bank, has to appraise the banks credit department on various parameters like industry prospects, operational efficiency, financial efficiency, management qualities and other things, which would influence the working of the company. On the basis of this appraisal, the banks would then prepare a credit-grading sheet after covering all the aspects of the company and the business in which the company is in. Then the borrower would then be charged a certain rate of interest, which would cover the risk of lending. But the main shortcoming of scenario analysis was that, it was highly dependent on the choice of scenarios. It also required that many assumptions were to be made about how specific assets or liabilities will perform under specific scenarios. Gradually the firms recognized a potential for different type of risks, which was overlooked in ALM analyses. Also the deregulation of the interest rates in US in mid 70 s compelled the banks to undertake active planning for the structure of the balance sheet. The uncertainty of interest rate movements gave rise to Interest Rate Risk thereby causing banks to look for processes to manage this risk. In the wake of interest rate risk came Liquidity Risk and Credit Risk, which became inherent components of risk for banks. The recognition of these risks brought Asset Liability Management to the centre-stage of financial intermediation. Today even Equity Risk, which until a few years ago was given only honorary mention in all but a few company ALM reports, is now an indispensable part of ALM for most companies. Some companies have gone even further to include Counterparty Credit Risk, Sovereign Risk, as well as Product Design and Pricing Risk as part of their overall ALM. Now a day's a company has different reasons for doing ALM. While some companies view ALM as a compliance and risk mitigation exercise, others have started using ALM as strategic framework to achieve the company's financial objectives. Some of the business reasons companies now state for implementing an effective ALM framework include gaining competitive advantage and increasing the value of the organization.

Asset-Liability Management Approach ALM in its most apparent sense is based on funds management. Funds management represents the core of sound bank planning and financial management. Although funding practices, techniques, and norms have been revised substantially in recent years, it is not a new concept. Funds management is the process of managing the spread between interest earned and interest paid while ensuring adequate liquidity. Therefore, funds management has following three components, which have been discussed briefly.

A. Liquidity Management Liquidity represents the ability to accommodate decreases in liabilities and to fund increases in assets. An organization has adequate liquidity when it can obtain sufficient funds, either by increasing liabilities or by converting assets, promptly and at a reasonable cost. Liquidity is essential in all organizations to compensate for expected and unexpected balance sheet fluctuations and to provide funds for growth. The price of liquidity is a function of market conditions and market perception of the risks, both interest rate and credit risks, reflected in the balance sheet and off-balance sheet activities in the case of a bank. If liquidity needs are not met through liquid asset holdings, a bank may be forced to restructure or acquire additional liabilities under adverse market conditions. Liquidity exposure can stem from both internally (institution-specific) and externally generated factors. Sound liquidity risk management should address both types of exposure. External liquidity risks can be geographic, systemic or instrument-specific. Internal liquidity risk relates largely to the perception of an institution in its various markets: local, regional, national or international. Determination of the adequacy of a bank's liquidity position depends upon an analysis of its: - • Historical funding requirements • Current liquidity position • Anticipated future funding needs • Sources of funds • Present and anticipated asset quality • Present and future earnings capacity • Present and planned capital position As all banks are affected by changes in the economic climate, the monitoring of economic and money market trends is key to liquidity planning. Sound financial management can minimize the negative effects of these trends while accentuating the positive ones. Management must also have an effective contingency plan that identifies minimum and maximum liquidity needs and weighs alternative courses of action designed to meet those needs. The cost of maintaining liquidity is another important prerogative. An institution that maintains a strong liquidity position may do so at the opportunity cost of generating higher earnings. The amount of liquid assets a bank should hold depends on the stability of its deposit structure and the potential for rapid expansion of its loan portfolio. If deposit accounts are composed primarily of small stable accounts, a relatively low allowance for liquidity is necessary. Additionally, management must consider the current ratings by regulatory and rating agencies when planning liquidity needs. Once liquidity needs have been determined, management must decide how to meet them through asset management, liability management, or a combination of both.

B. Asset Management Many banks (primarily the smaller ones) tend to have little influence over the size of their total assets. Liquid assets enable a bank to provide funds to satisfy increased demand for loans. But banks, which rely solely on asset management, concentrate on adjusting the price and availability of credit and the level of liquid assets. However, assets that are often assumed to be liquid are sometimes difficult to liquidate. For example, investment securities may be pledged against public deposits or repurchase agreements, or may be heavily depreciated because of interest rate changes. Furthermore, the holding of liquid assets for liquidity purposes is less attractive because of thin profit spreads.

When a sub-prime earthquake hits

Ever since the sub-prime crisis hit the US economy and began to impact its financial sector firms, the debate in the Indian software sector was whether the slowdown staring it in the face would be as bad as in 2001-02, when the technology and telecommunications bubbles burst and terrorist attacks hit New York.

Now, with the US financial sector going through an earthquake, the debate over whether things are 'as bad' has taken on a new, even fearsome, meaning. As much as 60 per cent of the revenue of India's software firms comes from the global financial sector, so the plight of the Indian IT sector can well be imagined.

Currently, the key vendors to the two casualties, Lehman Brothers and Merrill Lynch, are all claiming that they will not be seriously affected. But how serious is 'serious?'

Leading Indian IT firms, which had lately been acquiring consulting skills, will find their financial clients' appetite for contemplating 'transformational' change in their business models virtually gone. Indian firms have of course been trying over the last few years to de-risk their businesses by seeking growth in verticals like telecommunications, manufacturing and logistics, but it takes years to change a business mix and the present crisis has come too soon in the day.

The immediate challenge facing Indian firms will be the consolidation that will take place in the Western financial services industry as leading firms go belly up and are quickly taken over by the handful of firms which have not lost either their capital or the ability to raise fresh funds. The consolidation in the industry will affect not just its own staffing but also the vendors. With severe cuts in budgets all round, outsourcing spend is likely to be affected.

The saving grace is that nameplates can be replaced but legacy systems cannot, and the most important part of Indian IT's revenue still comes from the maintenance of such systems. Such jobs will continue to be outsourced, but vendors will have to face cuts in rates that will eat into not just top line but also margins.

Understandably, there is gloom all round, but innovative IT firms like Tejas Networks and Ittiam are either selling their own boxes or developing entire reference designs of gadgets like MP3 players and video phones, many of them made and sold under East Asian labels. Large Indian companies are needed who can take such products global under their own brand names.