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GS Paper: Indian Economy

  • Fixing the rules of economy

    The article discusses the three fundamentals which need an examination to fix the issues faced by the economy. 

    Re-examining the fundamentals

    • India has an incomes crisis: incomes of people in the lower half of the pyramid are too low.
    • The solutions economists propose are: free up markets, improve productivity, and apply technology.
    • These fundamentals of economics must be re-examined when applied to human work.

    Three solutions and issues with them

    1) Freeing up the markets

    • It is suggested that markets should be freed up for agricultural products so that farmers can get higher prices; and freed up for labour to attract investments.
    • Without adequate incomes, people cannot be a good market for businesses.
    • In fact, it is the inadequate growth of incomes that has caused a slump in investments.
    • Ironically, the purpose of freeing up markets for labour is to reduce the burden of wage costs on investors just when wages and the size of markets must be increased.

    2) Increasing productivity

    • Productivity is a ratio of an input in the denominator and an output in the numerator.
    • The larger the output that is produced with a unit of input, the higher the productivity of the system.
    • Improvement of ‘productivity’ is key to economic progress.
    • Economists generally use labour productivity as a universal measure of the productivity of an economy.
    • Humans are the only ‘appreciating assets’ an enterprise has. They can improve their own abilities.
    • The values of machines and buildings depreciate over time, as any accountant knows.
    • Whereas human beings develop when they are treated with respect, and are provided with environments to learn.
    • For capital-scarce and human resource-abundant countries, such as many developing countries, the correct ratio of productivity is output per unit of capital.
    • This must be the driver of business as well as national strategies.
    • This was the strategy of ‘Japan Inc.’ to make Japan an industrial powerhouse.
    • This was E.F. Schumacher’s insight also.

    3) Use of technology

    • Schumacher, best known for his seminal idea ‘small is beautiful’ understood where capitalism powered with technology would be heading.
    • In his essay he wrote: “If we define the level of technology in terms of ‘equipment cost per work-place’, we can call the indigenous technology of a typical developing country (symbolically speaking) a £1-technology, while that of the modern West could be called a £1,000-technology.
    • The current attempt of the ‘developing ‘countries, supported by foreign aid, to infiltrate the £1,000-technology into their economies inevitably kills off the £1-technolgy at an alarming rate.
    • This results in destroying traditional workplaces at a much faster rate than modern workplaces can be created and producing the ‘dual economy’ with its attendant evils of mass unemployment and mass migration.
    • Schumacher had warned there was a malaise brewing beneath the drive to ‘Westernise’ and ‘technologise’ economies.

    Way forward: Social contract between society and workers

    • Workers provide the economy with the products and services it needs.
    • In return, society and the economy must create conditions whereby workers are treated with dignity and can earn adequate incomes.
    • Good jobs require good contracts between workers and their employers.
    • Therefore, the government should create a good society for all citizens, must regulate contracts between those who engage people to do work for their enterprises, even in the gig economy.
    • Goverment should push innovation in socially more beneficial directions to augment rather than replace less skilled workers.

    Conclusion

    The power balance must shift. Small enterprises and workers must combine into larger associations, in new forms, using technology, to tilt reforms towards their needs and their rights.

  • Weakening financial capacity of States

    The financial health of the States has been declining in the last several years. The article explains the reasons and its implications for the States.

    Role of States in development

    • State governments drive a majority of the country’s development programmes.
    • Greater numbers of people depend on these programmes for their livelihood, development, welfare and security.
    • States need resources to deliver these responsibilities and aspirations.

    Factors responsible for declining discal capacity of the States

    1) Declining devolution to State

    • Finance Commissions recommend the share of States in the taxes raised by the Union government and recommendations are normally adhered to.
    • The year 2014-15 commenced with a shock: actual devolution was 14% less than the Finance Commission’s projection.
    • Between 2014-15 and 2019-20, the States got ₹7,97,549 crore less than what was projected by the Finance Commission.

    2) Cess and surcharge

    • Various cesses and surcharges levied by the Union government are retained fully by it, they do not go into the divisible pool.
    • This allows the Centre to raise revenues, yet not share them with the States.
    • Hence, the Union government imposes or increases cesses and surcharges instead of taxes wherever possible and, in some cases, even replaces taxes with cesses and surcharges.
    • As a result, the States lose out on their share.
    • Between 2014-15 and 2019-20, cesses and surcharges soared from 9.3% to 15% of the gross tax revenue of the Union government.
    • This systematic rise ensures that the revenue that is fully retained by the Union government increases at the cost of the revenue that is shared with the States.
    • This government has exploited this route to reduce the size of the divisible pool.

    3) GST shortfall

    • Shortfalls have been persistent and growing from the inception of GST.
    • Compensations have been paid from the GST cess revenue.
    • GST cesses are levied on luxury or sin goods on top of the GST.
    • GST compensation will end with 2021-22. But cesses will continue.
    • With the abnormal exception of this year, the years ahead will generate similar or more cess revenue.
    • Hence, many States have been insisting outside and inside the GST Council that the Union government should borrow this year’s GST shortfall in full and release it to the States.
    • The Union government will not have to pay a rupee of this debt or interest.
    • The entire loan can be repaid out of the assured cess revenue that will continue to accrue beyond 2022.
    • Of the nearly ₹3 lakh crore GST shortfall to the States, the Centre will only compensate ₹1.8 lakh crore.
    • The States will not get the remaining ₹1.2 lakh crore this year.
    • In fact, it flies against the need of the hour to revive the economy.
    • Governments ought to spend money this year to stimulate demand.

    4) Declining grants from the Centre

    • Central grants are also likely to drop significantly this year.
    • For instance,₹31,570 crore was allocated as annual grants to Karnataka.
    • Actual grants may be down to ₹17,372 crore.

    Implications for the States

    • To overcome such extreme blows to their finances and discharge their welfare and development responsibilities, the States are now forced to resort to colossal borrowings.
    • Repayment burden will overwhelm State budgets for several years.
    • The fall in funds for development and welfare programmes will adversely impact the livelihoods of crores of Indians.
    • The economic growth potential cannot be fully realised.
    • Adverse consequences will be felt in per capita income, human resource development and poverty.
    • This is a negative sum game.

    5) Loss of financial autonomy due to GST

    Consider the question “What are the reasons for the declining financial health of the States in India? What are the implications for the States? Suggest the ways to deal with the issue.”

    Conclusion

    States are at the forefront of development and generation of opportunities and growth. Strong States lead to a stronger India. The systematic weakening of States serves neither federalism nor national interest.

  • Reinforcing the RBI’s accountability

    Inflation targeting and legal provisions

    • The inflation target, notified in August 2016, is 4%.
    • The upper tolerance level was set at 6% and the lower tolerance level at 2%.
    • Inflation was 6.7% in the January-March quarter, 6.6% in the April-June quarter and 6.9% in the July-September quarter.
    • Breaching limits for any three consecutive quarters constitutes a failure to achieve the inflation target.
    • In such an event, the Reserve Bank of India (RBI) is required to send a report to the Centre, stating the reasons for the failure to achieve the inflation target, the remedial actions it proposes to initiate, and an estimate of the time-period within which it expects to achieve the inflation target through the corrective steps proposed.
    • Through amendments passed by Parliament in 2016, these new provisions were written into the RBI Act.
    • They are aimed at ensuring enhanced transparency and accountability of the central bank.

    Reason given by the RBI for missing the target

    • The normal data collection exercise of the National Statistics Office was disrupted during the lockdown imposed due to the COVID-19 pandemic.
    • The minutes of the Monetary Policy Committee (MPC) meeting after its August policy review suggest that the RBI’s defence for the breach of the 4% inflation target and 6% upper tolerance limit was the handicap of data limitations.

    Issues with the reason given by the RBI

    • The range around the inflation target that the Ministry provided to the RBI is for accommodating constraints and challenges like data limitations.
    • The whole point of the range around the target, the statement emphasised, is that it “accommodates data limitations, projection errors, short-run supply gaps and fluctuations in the agriculture production”.

    Way forward

    • RBI should be made to explain what it plans to do to control inflation.
    • The central bank should be allowed to state expressly what support by way of government policy it needs to meet the inflation target.
    • This can only strengthen the RBI’s hand; it should not let go of the opportunity to reinforce the MPC framework.

    Conclusion

    Transparency can enable more informed decision-making within the government, greater public scrutiny of the RBI’s performance, and an improved inflation-targeting regime. To slack off on it would be to compromise with the credibility, transparency and predictability of monetary policy.

  • Index of Eight Core Sector Industries

    The Office of Economic Advisor within the Department for Promotion of Industry and Internal Trade (DPIIT) has released the Index of Eight Core Industries (ICI) for September 2020.

    Try this PYQ:

    Q.In the ‘Index of Eight Core Industries’, which one of the following is given the highest weight?

    (a) Coal production

    (b) Electricity generation

    (c) Fertilizer production

    (d) Steel production

    What is the Index of Core Industries?

    • As the title suggests, this is an index of the eight most fundamental industrial sectors of the Indian economy and it maps the volume of production in these industries.
    • It gives the details of these eight sectors — namely Coal, Natural Gas, Crude Oil, Refinery Products (such as Petrol and Diesel), Fertilizers, Steel, Cement and Electricity.
    • Since these eight industries are the essential “basic” and/or “intermediate” ingredient in the functioning of the broader economy, mapping their health provides a fundamental understanding of the state of the economy.
    • In other words, if these eight industries are not growing fast enough, the rest of the economy is unlikely to either.

    ICI this year

    • This data is to focus on the trend of ICI growth over the past 6 months — that is, since the start of the Covid-19 pandemic and associated lockdowns.
    • A crucial factor in this regard would be the next wave of Covid-19 infections.
    • If there is a surge in the winter months — as is being witnessed in most Europe and the US — then India’s recovery will be dented yet again.

  • Natural gas to come under GST

    Officials have indicated that the government is considering bringing natural gas under the ambit of the GST regime.

    Try this question from CSP 2018:

    Q.Consider the following items:

    1. Cereal grains hulled
    2. Chicken eggs cooked
    3. Fish processed and canned
    4. Newspapers containing advertising material

    Which of the above items is/are exempt under GST (Goods and Services Tax)?

    (a) 1 only

    (b) 2 and 3 only

    (c) 1, 2 and 4 only

    (d) 1, 2, 3 and 4

    Why such demands?

    • Global energy MNCs have called on the government to bring natural gas under the GST regime.
    • Currently petrol, diesel, aviation turbine fuel, natural gas and crude oil fall outside India’s Goods and Services Tax (GST) regime.

    Why is it important to bring natural gas under the GST regime?

    • Bringing natural gas under the GST would lead to a reduction in the cascading impact of taxes on industries such as power and steel, which used natural gas as an input.
    • This would do away with the central excise duty and different value-added taxes imposed by states.
    • This would lead to an increase in the adoption of natural gas in line with the government’s stated goal to increase the share of natural gas in the country’s energy basket from 6.3% to 15%.

    Back2Basics: GST

    • GST launched in India on 1 July 2017 is a comprehensive indirect tax for the entire country.
    • It is charged at the time of supply and depends on the destination of consumption.
    • For instance, if a good is manufactured in state A but consumed in state B, then the revenue generated through GST collection is credited to the state of consumption (state B) and not to the state of production (state A).

    Must read:

    Goods and Services Tax

  • Base Year of CPI- Industrial Workers revised to 2016

    The Labour and Employment Ministry has revised the base year of the Consumer Price Index (CPI) for Industrial Workers (CPI-IW) from 2001 to 2016.

    Why such a move?

    • This revision reflects the changing consumption pattern, giving more weightage to spending on health, education, recreation and other miscellaneous expenses while reducing the weight of food and beverages.

    What is the Consumer Price Index (CPI)?

    • The CPI is a measure that examines the weighted average of prices of a basket of consumer goods and services, such as transportation, food, and medical care.
    • It is calculated by taking price changes for each item in the predetermined basket of goods and averaging them. Changes in the CPI are used to assess price changes associated with the cost of living.
    • The CPI is one of the most frequently used statistics for identifying periods of inflation or deflation.
    • Essentially it attempts to quantify the aggregate price level in an economy and thus measure the purchasing power of a country’s unit of currency.

    Types of CPI in India

    • CPI in India comprises multiple series classified based on different economic groups.
    • There are four series, viz the CPI UNME (Urban Non-Manual Employee), CPI AL (Agricultural Labourer), CPI RL (Rural Labourer) and CPI IW (Industrial Worker).
    • While the CPI UNME series is published by the Central Statistical Organisation, the others are published by the Department of Labour.
    • From February 2011 the CPI (UNME) released by CSO is replaced as CPI (urban), CPI (rural) and CPI (combined).

    How it is different from WPI?

    • CPI is different from WPI, or Wholesale Price Index, which measures inflation at the wholesale level.
    • While WPI keeps track of the wholesale price of goods, the CPI measures the average price that households pay for a basket of different goods and services.
    • WPI measures and tracks the changes in the price of goods before they reach consumers; goods that are sold in bulk and traded between entities or businesses (rather than consumers).
    • Even as the WPI is used as a key measure of inflation in some economies, the RBI no longer uses it for policy purposes, including setting repo rates.
    • The central bank currently uses CPI or retail inflation as a key measure of inflation to set the monetary and credit policy.

    Major components of WPI

    • Primary articles are a major component of WPI, further subdivided into Food Articles and Non-Food Articles.
    • Food Articles include items such as Cereals, Paddy, Wheat, Pulses, Vegetables, Fruits, Milk, Eggs, Meat & Fish, etc.
    • Non-Food Articles include Oil Seeds, Minerals and Crude Petroleum
    • The next major basket in WPI is Fuel & Power, which tracks price movements in Petrol, Diesel and LPG
    • The biggest basket is Manufactured Goods. It spans across a variety of manufactured products such as Textiles, Apparels, Paper, Chemicals, Plastic, Cement, Metals, and more.
    • Manufactured Goods basket also includes manufactured food products such as Sugar, Tobacco Products, Vegetable and Animal Oils, and Fats.

    Note: WPI has a sub-index called WPI Food Index, which is a combination of the Food Articles from the Primary Articles basket, and the food products from the Manufactured Products basket.

    Now try this PYQ from 2014 CSP:

    Q.With reference to India, consider the following statements:

    1. The Wholesale Price Index (WPI) in India is available on a monthly basis only
    2. As compared to the Consumer Price Index for Industrial Workers (CPI (IW)), the WPI gives less weight to food articles.

    Which of the statements given above is/are correct?

    (a) 1 only

    (b) 2 only

    (c) Both 1 and 2

    (d) Neither 1 nor 2

    Back2Basics: Base Year

    • A base year is the first of a series of years in an economic or financial index. It is typically set to an arbitrary level of 100.
    • Any year can serve as a base year, but analysts typically choose recent years. They are periodically revised to keep data current in a particular index.
    • A base year is used for comparison in the measure of business activity or economic index.
    • For example, to find the rate of inflation between 2013 and 2018, 2013 is the base year or the first year in the time set.

  • SC asks govt to implement ‘interest waiver’ scheme at the earliest

    The article examines the implications of the Supreme Court order dealing with the loan waiver and ban on the recognition of the bad loan.

    Significance of common man as a depositor

    • India’s Rs 144 lakh crore in bank deposits make our Rs 110 lakh crore in bank loans possible.
    • The “common man” is more likely a depositor than a borrower; banks have 21 crore deposit accounts but only 2.7 crore loan accounts.

    Issues with the court order

    • The Supreme Court has weighed in on the waiver scheme and recognition of the bad loan.
    • Waiving interest dues or banning bad loan recognition is economically ignorant because more than 20 per cent of Indians are depositors while less than 2 per cent are borrowers.
    • It has nothing to with economic justice defined as the greatest good for the greatest number.
    • It sabotages economic justice because fiscally funding banking diverts money from education, health and skilling expenditure.
    •  It’s commercially ignorant because any “annualised effective rate” is adjusted for interest payment frequency.
    • Resources are finite with total central government expenditure at Rs 29 lakh crore, scarce as COVID creates a Rs 3 lakh crore GST shortfall and fragile our fiscal deficit may exceed 12 per cent.
    • Also, it is hardly what our Constitution imagined as the role of courts.
    • Our Constitution writers made a distinction between fundamental rights and directive principles was not a lack of ambition but a measured assessment of state capacity, resources and sequencing.
    • The Constitution also envisaged distinct roles for the judiciary, executive and legislature to balance samaj (society), bazaar (markets) and sarkar (government).
    • Courts have become less mindful of these two distinctions.

    Cost of credit and availability issue in India

    • One of the reasons for small size of Indian enterprises in the availability and cost of credit in India.
    • India’s credit-to-GDP ratio stands at dismal  50 per cent  — Bihar is 12 per cent and Arunachal is 1 per cent.
    • The MSME lending is stuck at Rs 20 lakh crore — needs to rise to 100 per cent.
    • Despite lower inflation and fiscal discipline, most borrowers don’t get globally competitive interest rates due to high bad loans and financial statement uncertainty.
    • The availability of credit will not rise and cost will not fall till our banking system has strong competition, consistent regulation, effective supervision and non-fiscal sustainability.

    Consider the question “How the crisis in the banking sector is different from the crisis in other sectors? Also, examine the issues with the Supreme Court order on the loan waiver and recongnition of bad loan ban?” 

    Conclusion

    Institutional immunity needs balancing of independence and accountability; rising citizen concern about mandates and appointments should trigger court introspection.

  • [pib] Framework for Regulatory Sandbox

    The International Financial Services Centres Authority (IFSCA) has introduced a framework for Regulatory Sandbox to tap into innovative Fin-tech solutions.

    Try answering this simple question:
    Q.What is Regulatory Sandbox? What are its salient features?

    Regulatory Sandbox

    • A regulatory sandbox usually refers to live testing of new products or services in a controlled/test regulatory environment for which regulators may permit certain regulatory relaxations for the limited purpose of the testing.
    • The objective of the sandbox is to foster responsible innovation in financial services, promote efficiency and bring benefit to consumers.
    • It provides a secure environment for fintech firms to experiment with products under supervision of a regulator.
    • It is an infrastructure that helps fintech players live test their products or solutions, before getting the necessary regulatory approvals for a mass launch, saving start-ups time and cost.

    Its inception

    • The concept of a regulatory sandbox or innovation hub for fintech firms was mooted by a committee headed by then RBI executive director Sudarshan Sen.
    • The panel submitted its report in Nov 2017 has called for a regulatory sandbox to help firms experiment with fintech solutions, where the consequences of failure can be contained and reasons for failure analysed.
    • If the product appears to have the potential to be successful, it might be authorised and brought to the broader market more quickly.

    What is the new framework?

    • IFSCA has introduced a framework for “Regulatory Sandbox”.
      Under this Sandbox framework, entities operating in the capital market, banking, insurance and financial services space shall be granted certain facilities and flexibilities.
    • It will experiment with innovative FinTech solutions in a live environment with a limited set of real customers for a limited time frame.
    • These features shall be fortified with necessary safeguards for investor protection and risk mitigation. The Regulatory Sandbox shall operate within the IFSC located at GIFT City (Gandhinagar).
    • IFSCA shall assess the applications and extend suitable regulatory relaxations to commence limited purpose testing in the Sandbox.

    Other propositions

    • As additional steps towards creating an innovation-centric ecosystem, the IFSCA has proposed the creation of an “Innovation Sandbox”.
    • It will be a testing environment where Fin-tech firms can test their solutions in isolation from the live market.
    • This would be based on market related data made available by the Market Infrastructure Institutions (MIIs) operating in the IFSC.
    • The Innovation Sandbox will be managed and facilitated by the MIIs operating within the IFSC.

    Back2Basics: GIFT City, Gandhinagar

    • GIFT city is India’s first operational smart city and international financial services centre (much like a modern IT park).
    • The idea for GIFT was conceived during the Vibrant Gujarat Global Investor Summit 2007 and the initial planning was done by East China Architectural Design & Research Institute (ECADI).
    • Currently approximately 225 units/companies are operational with more than 12000 professionals employed in the City.
    • The entire city is based on concept of FTTX (Fibre to the home / office).The fiber optic is laid in fault tolerant ring architecture so as to ensure maximum uptime of services.
    • Every building in GIFT City is an intelligent building. There is piped supply of cooking gas. India’s first city-level DCS (district cooling system) is also operational at GIFT City.

  • Next Generation Treasury Application (NGTA)

    In a bid to improve its functioning, the RBI has decided to move to the Next Generation Treasury Application (NGTA) for managing the country’s foreign exchange and gold reserves.

    Aspirants must make a note here:

    1.Authority managing FOREX in India

    2.Components of FOREX

    3.IMF’s SDRs

    4.Emergency use of FOREX

    What is NGTA?

    • The NGTA, according to the RBI, would be a web-based application providing scalability, manoeuvrability and flexibility to introduce new products and securities, besides supporting multi-currency transactions and settlements.
    • It would be supporting various transactions in asset classes like Fixed Income (FI), Forex (FX), Money Market (MM) and Gold.
    • It would be used for managing the foreign exchange reserves in a more efficient way, mitigate risk, achieve operational efficiencies, dealing in various asset classes and reporting.

    Objectives of NGTA

    The objectives of the proposed system include:

    • dealing in various asset classes (like Fixed Income Securities, Forex, Money Market, Gold);
    • portfolio management; workflow management; reserve management;
    • integration with various third-party and in-house systems; and dashboards, reports, widgets.

    Features of NGTA

    • The NGTA shall automatically fetch all the relevant details of a security/contract from a trading platform.
    • It shall support all internationally accepted conventions pertaining today count, interest computation, holiday logic, shut period-dividend, ex-dividend, cash flows, and odd coupon.
    • With respect to transactions in gold, the NGTA shall support purchase, sale, deposit (including rollover and premature withdrawal).
    • On maturity of a gold deposit, there can be exact, under or over delivery.

    Back2Basics: Forex Reserves

    • Reserve Bank of India Act and the Foreign Exchange Management Act, 1999 set the legal provisions for governing the foreign exchange reserves.
    • RBI accumulates foreign currency reserves by purchasing from authorized dealers in open market operations.
    • The Forex reserves of India consist of below four categories:
    1. Foreign Currency Assets
    2. Gold
    3. Special Drawing Rights (SDRs)
    4. Reserve Tranche Position
    • The IMF says official Forex reserves are held in support of a range of objectives like supporting and maintaining confidence in the policies for monetary and exchange rate management including the capacity to intervene in support of the national or union currency.
    • It will also limit external vulnerability by maintaining foreign currency liquidity to absorb shocks during times of crisis or when access to borrowing is curtailed.

  • What is Debt-to-GDP Ratio?

    India’s public debt ratio, which remarkably remained stable at about 70% of the GDP since 1991, is projected to jump by 17 percentage points to almost 90% a/c to IMF.

    Try this PYQ:

    Q.Consider the following statements:

    1. Most of India’s external debt is owed by governmental entities.
    2. All of India’s external debt is denominated in US dollars.

    Which of the statements given above is/are correct?

    (a) 1 only

    (b) 2 only

    (c) Both 1 and 2

    (d) Neither 1 nor 2

    Why such a spike?

    • The increase in public spending, in response to COVID-19, and the fall in tax revenue and economic activity, will make public debt jump by 17 percentage points to almost 90% of GDP.

    What is Debt-to-GDP Ratio?

    • The Debt-to-GDP ratio is the ratio between a country’s government debt and its gross domestic product (GDP).
    • It measures the financial leverage of an economy.
    • A country able to continue paying interest on its debt-without refinancing, and without hampering economic growth, is generally considered to be stable.
    • A country with a high debt-to-GDP ratio typically has trouble paying off external debts (also called “public debts”), which are any balances owed to outside lenders.
    • In such scenarios, creditors are apt to seek higher interest rates when lending. Extravagantly high debt-to-GDP ratios may deter creditors from lending money altogether.
    • A low debt-to-GDP ratio indicates an economy that produces and sells goods and services sufficient to pay back debts without incurring further debt.
    • Geopolitical and economic considerations – including interest rates, war, recessions, and other variables – influence the borrowing practices of a nation and the choice to incur further debt.