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GS Paper: Indian Economy

  • What is Positive Pay System?

    With the New Year, a new concept of Positive Pay System for Cheque Truncation System (CTS) will be introduced by the Banking regulator Reserve Bank of India (RBI) seeking to further augment customer safety in cheque payments.

    Try this PYQ:

    Q.Which of the following is the most likely consequence of implementing the ‘Unified Payments Interface (UPI)’?

    (a) Mobile wallets will not be necessary for online payments.

    (b) Digital currency will totally replace the physical currency in about two decades.

    (c) FDI inflows will drastically increase.

    (d) Direct transfer of subsidies to poor people will become very effective.

    Positive Pay System

    • The concept of Positive Pay involves a process of reconfirming key details of large-value cheques.
    • Put simply, cheques will be processed for payment by the drawee bank based on information passed on by its customer at the time of issuance of the cheque.
    • When the beneficiary submits the cheque for encashment, the cheque details are compared with the details provided to the drawee bank through Positive Pay.
    • If the details match, the cheque is honoured. In case of mismatch in cheque details, the discrepancy is flagged by CTS to the drawee bank and the presenting bank, which would take redress measures.

    For cheques above 50k

    • The banks are advised to enable it for all account-holders issuing cheques for amounts of ₹50,000 and above.
    • While availing of this facility is at the discretion of the account-holder, banks may consider making it mandatory in case of cheques for amounts of ₹5 lakh and above, the RBI had said.

    Benefits of the system

    • Under the Positive Pay system, the drawee bank is already aware of the issuer the details of the high-value cheque (above ₹50,000) he has issued.
    • Without this intimation, if a cheque gets presented, then the drawee bank can reject payment and examine the case. Positive Pay is going to benefit both the issuer and the beneficiary.
    • For the issuer, the benefit from this concept is that there cannot be fraudulent cheques encashed out of issuer’s account.
    • For the beneficiary, the benefit is that the cheques handed out to him will mostly get honoured.

    Is Positive Pay the same as ‘certified cheque’?

    • The concept of ‘certified cheque’ was there long back — about 30 years back, long before technology swept across the Indian banking landscape.
    • Whenever anybody issued a cheque, banks used to certify that money is there in their customer’s bank account and, therefore, the cheque will get honoured.
    • This provided comfort to a beneficiary that cheque payment will get honoured and therefore did not insist on a pay order or demand draft.
    • Drawee banks used to earmark the amount in the account of the issuer and then certify the cheque.
    • This was adopted in an era when the cheque instrument used to travel physically for clearing.

    Why need such a system?

    • The RBI says the Positive Pay system is to augment customer safety in cheque payments and reduce instances of fraud occurring on account of tampering of cheque leaves.
    • Banks had recently witnessed a rise in frauds involving high-value cheques.

  • Spectrum auction

    The article analyses the factors influencing the outcome of the spectrum auction and suggests the measures to ensure the success and avoid the repeat of 2016 auction.

    Details of the auction

    • Based on the recommendation of the Telecom Regulatory Authority of India (TRAI), the government is planning to auction spectrum in the sub GHz bands of 700, 800, and 900 MHz along with mid-band frequencies in bands of 1800, 2100, 2300, and 2500 MHz across the 22 Licensed Service Areas (LSAs) of the country.
    • The cumulative reserve price — and hence the potential revenue accrual to the government at reserve prices — is about $50 billion.
    • The total reserve price of spectrum put on auction in 2016 was about $90 billion while the realized value was just about one-tenth of that.
    • Hence, while the 2016 auction could be considered as a failure from the auctioneer’s point of view.

    Factors determining the success of  the spectrum auction

    1) Right reserve price

    • Research on a cross-country spectrum database shows that the reserve price significantly and positively correlated to the winning bid price.
    • However, a higher reserve price also inhibits bidders from bidding for more spectrum blocks.
    • If the quantity effect is more than the price effect, then it results in reduced revenues for the government exchequer, as happened in 2016.

    2) Role of Over The Top (OTT) provider

    • Over The Top (OTT) providers who are providing substitute goods such as Voice Over Internet Protocol (VoIP); and capturing a greater mind share of customers while remaining relatively invisible to government regulators.
    • The rise of VoIP subscribers could have a positive effect on winning bid prices.
    • However, the erosion of the position of telcos in the overall digital value network of devices, connectivity, and apps, could result in a lower willingness to pay.

    3) Allocation of unlicensed spectrum for WiFi

    • By off-loading mobile data, Wi-Fi supplements the carrier network and reduces the demand for mobile network capacity.
    • A number of countries including the United States have unlicensed the V-band spectrum in 60 GHz — pencil beam band.
    • Referred to as “wireless fiber”, the 60 GHz spectrum provides huge capacities in a limited area.
    • Wi-Fi 6 (a.k.a. IEEE 802.11 ax) that operates in the 2.4/5 GHz unlicensed band requires additional unlicensed spectrum allocation to provide Gigabit speeds.
    • The more the unlicensed spectrum allocation, the lower will be the demand for licensed spectrum.

    4) Clarity on the availability of spectrum for auction

    • While there is an indication by the government that the spectrum for the 5G auction, namely 3.4-3.6 GHz, will be held in late 2021, the amount of spectrum that will be made available is not clear.
    • There is still uncertainty about the release of 26 GHz by the Department of Space for mobile services.
    • With this limited visibility, the bidders will be in a quandary whether to acquire the spectrum now or wait for subsequent auctions.
    • Further, some part of the current spectrum holding of all the operators is coming up for renewal in mid-2021, and hence there is additional pressure on them to retain them in the forthcoming auction.

    Steps need to be taken

    • A re-visit of reserve prices and lower it further, especially that of 700 MHz which is the “golden band” for covering the hinterlands of the country.
    • Releasing more unlicensed spectrum in 2.4/5/60 GHz for proliferating Wi-Fi as a suitable complement to [the] carrier network.
    • This will also augment the deployments of the Public Wi-Fi project which the cabinet approved recently.
    • Provide visibility of future auctions, especially the quantum of the spectrum that can be put on the block in 3.3/3.6/26/28 GHz.
    • The government should release guidelines on how OTT platforms will be regulated and what will be regulated so that the telcos and OTTs can join hands to provide superior services for the benefit of the consumers.

    Conclusion

    The government should follow the steps mentioned here to make the auction of the spectrum a success.

  • Laying the foundation for faster growth

    To ease the damage inflicted by the pandemic on the economy, India needs to act on multiple fronts. The article suggests the trajectory India should follow to compensate for the economic loss due to pandemic.

    Economy picking up

    • As the restrictions were slowly withdrawn, the economy has also started picking up.
    • There are many indicators such as collection of Goods and Services Tax (GST), the improved output of coal, steel, and cement, and positive growth in manufacturing in October 2020 which point to better performance of the private sector.
    • In Q1, the economy declined by 23.9%; it declined by 7.5% in Q2, when the relaxations were eased.
    • Reductions in the first half of GDP in 2020-21 as compared to the first half of 2019-20 is 7.66% of the 2019-20 GDP.
    • If the Indian economy at least maintains the second half GDP in 2020-21 at the level of the previous year, the full-year contraction can be limited to about 7.7%.

    Steps need to be taken

    • If the Indian economy grows at 8% in 2021-22 will we be compensating for the decline in 2020-21.
    • Thus, it is imperative that the Indian economy grows at a minimum of 8% in 2021-22.
    • This should be possible if by that time restrictions imposed because of COVID-19 are withdrawn and the nation goes back to a normal state.
    • Some sectors can act as lead sectors or engines of growth with increased government capital expenditures in them.
    • The private sector seems to be revising its future prospects.
    • Many new issues in the capital market have met with good response.
    • The attitude to trade must also change.
    • Closing borders may appear to be a good short-term policy to promote growth.
    • A strong surge in our exports will greatly facilitate growth, i.e. 2021-22.
    • However, much of Indian’s growth must rest on domestic factors.
    • Growth must not only be consumption-driven but also investment-driven.
    • It is the investment-driven growth in a developing economy that can sustain growth over a long period.

    The important role of monetary policy

    • The stance of monetary policy in 2020-21 has been extremely accommodating.
    • Three major elements in the policy are:
    • 1) A reduction in interest rate.
    • 2) Providing liquidity through various measures.
    • 3) Regulatory changes such as moratorium.
    • There has been a substantial injection of liquidity into the system.
    • With a large injection of liquidity, one should expect inflation to remain high.
    • In the final analysis, inflation is determined by the overall liquidity or money supply in the system in conjunction with the availability of goods and services.
    • While there may be sufficient justification for an accommodative monetary policy in a difficult year such as 2020, there will be a need to exercise more caution as we move into the next year.

    Role of government expenditure

    • Government expenditures play a key role in a situation such as the one we are facing.
    • The stimulus policies involving higher government expenditures were expected to arrest the contractionary momentum.
    • The government expenditures should be speeded up from now on so that the contraction in the current fiscal year as a whole can be reduced.
    • In 2021-22, government revenues should pick up with the rise in GDP.
    • The process of bringing down the fiscal deficit must also start.
    • What is required is a sharp increase in government capital expenditures which can act as a stimulus for growth.
    • A detailed investment plan of the government and public sector enterprises must be drawn up and presented as part of the coming Budget.

    Increasing investment

    • Over the past decade, the investment rate has been falling.
    • In 2018-19, the rate fell to 32.2% of GDP from 38.9% in 2011-12.
    • Some of the recent measures including corporate tax rate changes may help in augmenting investment.
    • A strong effort must be made to improve the investment climate. The National Infrastructure Pipeline is a good initiative.
    • But the government must come forward to invest more on its own.

    Reforms with consensus

    • Reforms are important in the context of rapid development.
    • However, timing, sequencing, and consensus-building are equally important while introducing them.
    • Labor reforms, for example, are best introduced when the economy is on the upswing.

    Consider the question ” Growth must not only be consumption-driven but also investment-driven. It is the latter which in a developing economy can sustain growth over a long period. In light of this, suggest the policy imperatives that India should follow to make good of the decline in 2020-202.”

    Conclusion

    To achieve the level of $5 trillion, we need to grow continuously at 9% for six years from now. That is the challenge before the economy. Jobs and employment will come from growth. They are not independent of growth. For that policymakers should eschew other considerations and focus only on growth.

  • A four-point agenda for Indian banking in the post-covid world

    The article suggest 4 imperatives to the banks in India to emerge successful from pain inflicted by the pandemic.

    Impact of pandemic on banking industry

    • Unlike other shocks, covid is not a banking crisis; it is, instead, a crisis of the real economy.
    • Globally, the average return on equity (RoE) for banks could go below 1.5% in 2021 before recovering to the 2019 pre-crisis levels of 9% by 2024
    • This is effectively a loss of five years for the banking industry.
    • This will likely play out in two stages:
    • 1) Loan loss provisions over a period of 12-18 months.
    • 2) Followed by a period where banking revenue growth lags gross domestic product growth, or GDP.

    Important role played by banks in pandemic

    • India has entered this crisis well-capitalized.
    • Their provision coverage ratios improved to 65% in 2019-20, compared to 41% in 2016-17, and RoE (return on equity) has turned positive to 2.5% after two years of negative readings.
    • The banking system is playing a critical role in the economic recovery by supporting businesses and individuals.
    • New challenges, however, continue to emerge. These, if left unmitigated, will lead to severe losses in efficiencies gained.

    4 Imperative to tackle the emerging challenges to banking

    1) Need to increase productivity

    • Indian banks start at a materially higher cost-to-assets ratio of 2.2% versus 1.4% globally.
    • Regaining pre-covid RoE levels and negating higher risk costs and margin compression will, however, require that Indian banks improve productivity by over 30%.
    • The Indian banking sector lagged in efficiency improvements; other industrial peers have leveraged a combination of digital adoption and analytics, and strong governance.

    Suggestions for productivity transformation

    • The productivity transformation will comprise multiple agendas.
    • To start with, there will be a branch format and network re-configuration for custormers who has shifted to online mode.
    • To drive a permanent digital shift, banks will need to accelerate digital engagement via contact centre transformations.
    • In conjunction, there will be the equally important need to create minimum viable support functions (zero-based operations, demand management across human resources, finance, marketing).
    • And, finally, there will be the need to re-skill the workforce for digital operations.

    2) Pre-emptive risk management

    • The second imperative is pre-emptive risk management.
    • Banks must rapidly rewire their policies and analytical models such that they reflect fast- moving indicators of risk.
    • This means investing in self-serve channels, digital nudges and frictionless journeys across payments, settlements and recoveries.
    • The overall collections strategy will have to be underpinned by micro-segmentation, and also leverage analytical models to drive efficiency.

    3) Technology imperative

    • The third is the technology imperative that must scale with demand and analytical complexity.
    • Banks are required to handle high digital traffic and process enormous data sets, and regulators getting increasingly sensitive on downtimes.
    • This will requires modernizing core banking platforms, creating the data architecture that supports the analytics life-cycle, instituting modern engineering practices and moving towards automated infrastructure.

    4) Capital management

    • Banks with exposure to hard-hit sectors will face more of a challenge.
    • And existing risk models are unlikely to be tuned to the differentiated impact the pandemic has had on various sectors.
    • Risk teams will need to review critical models and add overlays to account for different credit risk in each sector.
    • Scenario planning, stress testing and balance sheet optimization will need to become core to planning and management decisions.

    Conclusion

    In its own way, the pandemic has given banks a glimpse into the art of the possible. Banks should take this opportunity to embed their newfound speed and agility, reinvent their business model, and collaborate with the communities they serve to recast their contract with society.

  • [pib] Better Than Cash Alliance (BTCA)

    The Union Ministry of Finance and UN-Based Better Than Cash Alliance (BTCA) organized a joint Peer learning exchange on fintech solutions for responsible digital payments at the last mile.

    Make a note here that it is a BTCA is a global partnership with diverse funding, a UN office as its secretariat and Indian being its member.

    Better Than Cash Alliance

    • The BTCA is a global partnership of 75 governments, companies, and international organizations that accelerates the transition from cash to digital payments in order to reduce poverty and drive inclusive growth.
    • The United Nations Capital Development Fund serves as the secretariat. It was created in September 2012.
    • The Alliance is funded by the Bill and Melinda Gates Foundation, Citi, MasterCard, Omidyar Network, USAID, and Visa Inc.
    • By the time it launched, the program was already being rolled out in Peru, Kenya, Colombia, and the Philippines.

    India and the BTCA

    • India became a member of the alliance in 2015 to digitize payments to achieve financial inclusion and to share success stories from Pradhan Mantri Jan Dhan Yojana, the world’s largest financial inclusion program.
    • The alliance is working with several state governments towards the goal of building knowledge and programs where people, governments, and businesses can make and receive digital payments.

  • Need for avoiding misplaced optimism over economic recovery

    Overoptimism stemming from the signs of recovery shown by the figures for the second quarter could result in reduced spending and the rollback of the stimulus. However, other features indicate that fiscal conservatism at this moment is not a good idea.

    Hype over recovery

    •  India’s economy contracted by 7.5% in the second quarter of financial year 2020-21.
    • There are two ways to look at that figure:-
    • 1) That figure is far lower than the 23.9% contraction registered in the first quarter of this financial year.
    • 2) A 7.5% second quarter contraction is high both in itself and when compared with most similarly placed countries.
    • The government, however, has chosen to focus on the unsurprising evidence that GDP rose sharply, by 23%, between the first quarter and the second when restrictions were substantially lifted.
    • Based on that evidence, the Finance Ministry’s Monthly Economic Report, for November, speaks of a V-shaped recovery reflective of “the resilience and robustness of the Indian economy”.
    • The danger is that such optimism would provide the justification to avoid adoption of the measures crucially needed to pull the economy out of recession.

    India economy is still demand constrained: 3 signs

    • 1) The decline in private final consumption expenditure at constant prices, which accounts for 56% of GDP, has come down from minus 27% in the first quarter to minus 11% in the second, it still remains high.
    • Though there are signs of a short-run recovery in private consumption demand with the lifting of lockdowns, net incomes and consumer confidence are not at levels that can even restore last year’s levels.
    • 2) As is to be expected, with production restraints relaxed, depleted stocks are being replenished with a fall of 21% in the first quarter turning into an increase in stocking of 6.3% in the second quarter.
    • 3) The decline in fixed capital formation has fallen from a high minus 47% in the first quarter to minus 7% in the second, investment is still falling year-on-year.
    • These are all signs of an economy that is severely demand constrained, requiring a significant step up in government expenditure.

    Impact on spending by the Centre and the States

    • Figures from the Office of the Controller General of Accounts for the first seven months of 2020-21 (April to October) indicate that the total expenditure of the central government stood at only 55% of what was provided for in the Budget for 2020-21.
    • In fact, in a non-COVID-19 year, 2019-20, the ratio of actual spending by the central government over April-October relative to that budgeted figure was a higher 59%.
    •  Meanwhile, with Goods and Services Tax (GST) revenues having fallen from their lower-than-expected levels during the COVID-19 months, the States have been cash-strapped.
    • Yet, the government has decided not to compensate them for the shortfall, as promised under the GST regime.
    • States have been left to fend for themselves by going to market and borrowing at high interest rates, which they would find difficult to cover.
    • Needless to say, as a consequence, State spending has also been curtailed.

    Why government should avoid fiscal conservatism

    • The loss of jobs and livelihoods that happened during lockdown is sure to affect demand now.
    • This leads to increased indebtedness and the bankruptcies well after restrictions are relaxed.
    • So, the tasks of providing safety nets, reviving employment and spurring demand become crucial.
    • Since the market cannot deliver on those fronts, state action facilitated by substantially enhanced expenditure is crucial.
    • And since government revenues shrink during a recession, that expenditure has to be funded by borrowing.
    • This is no time for fiscal conservatism, as governments across the world have come to accept.
    • Trend suggests that allocations for welfare expenditures — ranging from subsidised food to minimal guaranteed employment — needed to support those whose livelihoods have been devastated by the pandemic, would be reduced over time.
    • As collateral damage, this frugality in a time of crisis is likely to prolong the recession.

    Conclusion

    The optimism that a V-shaped recovery is imminent, and that optimism, in turn, would justify the view that fiscal conservatism pays. It does not, as time would tell.

    Back2Basics: What is V-shaped recovery?

    • A V-shaped recovery is characterized by a quick and sustained recovery in measures of economic performance after a sharp economic decline.
    • Because of the speed of economic adjustment and recovery in macroeconomic performance, a V-shaped recovery is a best case scenario given the recession.
    • The recoveries that followed the recessions of 1920-21 and 1953 in the U.S. are examples of V-shaped recoveries.
    V-shaped recovery of the U.S. economy

  • Why Surge in FPI in India?

    While emerging economies have been facing the crunch of foreign capital due to the pandemic, India is witnessing the surge of FPI: a sign of investors confidence in the economy. 

    Surge in FDI: Sign of trust India has built

    • In the September quarter, FDI doubled year-on-year to $28.1 billion dollars.
    • While foreign portfolio investor (FPI) inflows across emerging economies witnessed a decline due to the pandemic, India recorded a surge to $13.5 billion – a testimony to investor confidence in India’s growth story.
    • This surge in foreign funds amid the pandemic has been possible because of the continuous effort of the government, businesses, and agencies to make India a sought-after destination.

    Strategies used by the government

    Various steps described below signalled the government’s intention to open up the economy to investments.

    Such steps include the following:-

    • Allowing NRI’s to acquire up to 100% stake in Air India.
    • 26% FDI in the digital sector.
    • Permitting 100% FDI through automatic route in the coal mining sector.
    • 100% FDI for insurance intermediaries.
    • The National Infrastructure Pipeline, a ₹13 trillion project to open up avenues for infrastructure investment for global investors.
    • Apart from these steps, the more recent Production Linked Incentive (PLI) scheme worth an estimated ₹1.5 lakh crore is also a testimony to the government’s intention to encourage entrepreneurship and investment in the country.
    • Steps to skill-train 3 lakh migrant workers the country to realign the rural youth towards industry-relevant jobs is also a step in the right direction.

    Reducing dependency

    • The urgency the Indian government has shown to reduce dependency on China as a hub of the global supply chain.
    • Also, providing an enabling alternative environment has struck the right chord with the world as we see global biggies contemplating a move to India.

    Consider the question “India witnessed a steady flow of foreign capital while the world was battling pandemic. What are the factors responsible for this? What are the risks associated with such capital in the economy?”

    Conclusion

    While persisting with its efforts to attract the capital, the government also needs to focus on improving the productivity and export competitiveness of the economy.

    Back2basics: Difference between FDI and FII

    • FDI is an investment that a parent company makes in a foreign country.
    • On the contrary, FII is an investment made by an investor in the markets of a foreign nation.
    • While FIIs are short-term investments, the FDI’s are long term investment.
    • FII can enter the stock market easily and also withdraw from it easily. But FDI cannot enter and exit that easily.

  • RBI keeps repo rate unchanged

    The MPC decided on Friday to leave the Repo rate unchanged at 4%. However, the RBI faces a dilemma over the excess liquidity in the economy while tackling inflation.

    Limits of monetary  policy

    • Even though our economy slumped into a recession in the first half of 2020-21, there seems little further RBI can do with monetary policy to spur growth.
    • Its monetary decision to leave its main policy rate unchanged at 4%, the rate at which it lends money to banks, thus seems appropriate.
    • This is because retail inflation has hovered above its 6% upper tolerance limit for much of this year.
    • It is the first time its 2016-adopted price-stability framework looks poised for failure.
    • Meanwhile, it has announced wider coverage of an earlier scheme by which banks buy bonds issued by firms in specific stressed sectors–a way to ease credit.

    Poor credit demand

    • Supply-side measures have their limits of efficacy, with aggregate demand observed to be in a bad way and investments restrained by uncertainty.
    • Therefore, RBI’s focus had to shift to the inflationary effects of excess liquidity detected in the economy.
    • Oddly, this doesn’t seem to have happened.
    • With over ₹6 trillion still being parked daily by banks with RBI at its reverse repo window, a reflection of poor credit demand.

    Dilemma RBI faces in maintaining low interest rate

    • Plus, India has seen a large sum of dollars coming into India.
    • To keep the rupee’s global value stable and Indian exports competitive, RBI has been buying those dollars, thus raising our foreign exchange reserves and pumping more liquidity into the domestic arena.
    • Sterilizing the inflationary effect of this usually requires bonds to be sold, which increases their market supply and pressures yields up-a dilution of its stance on easy money.
    • This poses a dilemma that RBI may soon have to grapple with.
    • RBI’s core task as a central bank, of watching both the external and internal stability of the currency under its charge, may get more complex than ever if capital inflows stay high, global investors see an opportunity in ‘carry trade’ profits, and price trends don’t go by its expectations.

    Conclusion

    If India’s broad policy frame is being pushed by our covid crisis towards a major reset, with the Centre’s fisc granted a freer run and its debt burden to be partially inflated away over the years, then that would call for another debate.

  • Perils of profits based economic recovery

    The economies across the world are showing recovery driven by profits. However, one cannot neglect the implication of such recovery for the long term growth given the pressure such recovery has been exerting on the labour markets. The article deals with this issue.

    3 Ways to look at GDP

    • The first is what they tell us about the past.
    • Here, the news has generally been better-than-expected.
    • The US and India saw a much stronger recovery last quarter than previously envisioned.
    • The second is sectoral, production side-agriculture, manufacturing, services- and the functional, expenditure side consumption, investment, net exports.
    • But there’s a third way — the income side.
    • Value addition must ultimately accrue to the different factors of production.
    • On the income side, therefore, GDP is simply the sum of profits, wages and indirect taxes.

    Profit-driven growth and impact on employment

    • The economic recovery in many parts of the world is driven disproportionately by capital than labour.
    • In India, the net profits of listed companies grew 25 per cent (in real terms) last quarter. This despite revenues shrinking.
    • Revenue shrank because firms aggressively cut costs, including employee compensation.
    • This implies that if listed company profits are growing 25 per cent, and yet GDP contracted 7.5 per cent, it reveals (by construction) significant pressure on profits of unlisted SMEs, wages and employment.
    • Labour market pressures are evident in India too.
    • Household demand for MGNREGA remains very elevated, suggesting significant labour market slack.
    • The employment rate in some labour market surveys still reveal about 14 million fewer employed compared to February, and nominal wage growth across a universe of 4,000 listed firms has slowed from about 10 per cent to 3 per cent over the last six quarters.

    Why this matters

    • It may be rational for any one firm to boost profits by cutting employee compensation.
    • But if every firm pursued that strategy, that simply reduces future aggregate demand and profitability for all firms.
    • This is quintessential fallacy of composition that Keynes enumerated.
    • Weak demand, in turn, disincentivises re-hiring, reinforcing the risks of settling into a sub-optimal equilibrium.

    Need to remain vigilant about labour market

    • Remaining vigilant about labour markets is particularly important for India.
    • Private consumption was increasingly financed by households running down savings and taking on debt pre-COVID-19.
    • Consequently, if job-market pressures induce households into perceiving this shock as a quasi-permanent hit on incomes, households will be incentivised to save, not spend in the future.

    Way forward for fiscal consolidation

    • While economic momentum is expected to slow as pent-up demand wears off, the level of output will progressively reach pre-COVID levels as the economy normalises.
    • The question is what will drive growth after that?
    • India’s fiscal response has been restrained thus far, with the Centre’s total spending similar to last year and state capex under pressure.
    • It’s therefore important for the Centre to step up spending in the remaining months.
    • More importantly, public investment, and a large infrastructure push, must be the leitmotif of the next budget.
    • This will be crucial to boost demand, create jobs, crowd-in private investment and improve the economy’s external competitiveness.
    • If higher infrastructure spending is financed by higher asset sales, the headline fiscal deficit (which matters for bond markets and interest rates) can be slowly reduced, even as the underlying fiscal impulse (which matters for growth and jobs) remains positive.
    • This is the only way to undertake fiscal consolidation without incurring a fiscal drag.
    • Monetary policy has led the charge in 2020. But with inflation continuing to remain sticky and elevated, the RBI has fewer degrees of freedom going forward.

    Conclusion

    The stronger-than-expected GDP print is very encouraging. But this is the start of a long journey back. Much, therefore, remains to be done. The excitement around the vaccine shouldn’t obscure this fundamental premise.

  • Trade-offs for growth revival: Why India’s policymakers need a new roadmap

    The article weighs in the policy options with the Indian policymakers to revive the India economy. This leads to the trilemma of managing the exchange rate, controlling the inflation and maintaining the capital account open all at the same time.

    A brief overview of 1991 economic reforms

    • The crisis in 1991 was centred on the balance-of-payments.
    • Allowing the Indian rupee to fall from an artificially high level  was a key part of the solution.
    • Since the reforms, the Indian rupee has steadily depreciated, roughly according to a market-determined equilibrium.
    • Extraordinarily high tariff barriers were reduced, allowing for welfare gains from greater international trade.
    • Reforms of the domestic economy that increased market orientation was, in some sense, opportunistically combined with these externally-oriented measures.

    What should be India’s foreign economic policy

    • In terms of connections to the rest of the world, however, it is less clear what the right policy mix should be.
    • We can think of three types of international flows: labour, goods and services, and capital.

    1) Internation flow of Indian labour

    • India has benefited from being able to send workers with a variety of skills to different types of economies: construction workers and nurses in the Persian Gulf, software engineers in the US, and so on.
    • Direct benefits came from large remittances back to India.
    • The pandemic and US immigration policy, have had some major impacts on this international connectivity, but new vaccines and a change in the US president are likely to reverse these shocks.
    • In any case, there is not much that Indian policymakers can do or need to do on this front.

    2) Trade in Goods and Service

    • India has been able to grow its exports, both in a variety of agricultural and manufactured commodities and in services, from software services to tourism.
    • It has been reasonably competitive in a range of goods and services.
    • It was only in the last few years, even before the pandemic, have Indian exports struggled to register growth.
    • Whereas the export powerhouses of East Asia consistently ran surpluses on the current account of the balance of payments, India has mostly run deficits, albeit manageable ones.

    3) Capital Flow: Area where policymakers have option

    • Current account deficits have to be covered somehow, though various forms of foreign capital.
    • Whereas economic theory and economic policymakers mostly agree on the benefits of international trade in goods and services there is less of a consensus on the benefits of international capital flows.
    • Capital flows can raise fears of instability if they are reversed, or make exports less competitive if they push up the value of the rupee. 
    • The country is a relatively attractive destination for foreign capital, both FDI and portfolio investment.
    • But, these flows can make Indian exports less competitive if the rupee appreciates too much, requiring domestic demand to do more of the work of absorbing increased output.

    Lesson from Japan

    • Right now, India is trying to build its manufacturing capacity by raising tariffs, in an old-style push for import substitution.
    • It is also providing direct incentives, such as the new scheme rewarding increases in production.
    • Arguably, this did work in Japan in the 1960s, but it is not clear if India is well-off enough to sustain that domestic strategy.
    • In addition, the lack of competitive discipline exporting can hinder the achievement of acceptable quality levels.

    Way forward

    • Capital controls to some extent can help mitigate the risk in this situation.
    • The Reserve Bank of India do more to keep the rupee at competitive levels, by accumulating foreign exchange reserves.

    Consider the question “In terms of links with the rest of the global economy, it is less clear what the right policy mix should be. Do you agree with the view that focus on simultaneously managing the exchange rate and domestic inflation while maintaining an open capital account would help in the revival of India’s economic growth

    Conclusion

    Lurking under the surface of these issues is the trilemma of being unable to simultaneously manage the exchange rate and domestic inflation while maintaining an open capital account, although foreign exchange reserves provide a way of softening the trade-offs. These are not new challenges, but they will need to be a focus for India’s policymakers as they seek renewed economic growth.

    Source:-

    https://www.financialexpress.com/opinion/trade-offs-for-growth-revival-why-indias-policymakers-need-a-new-roadmap/2142900/