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GS Paper: Indian Economy

  • The idea of Central Bank Digital Currency in India

    The article discusses the idea of digital currency supported by the RBI and its advantages.

    Purpose of NUE

    • RBI recently released the framework for the establishment of a new umbrella entity (NUE) for retail payments.
    • NUE would help reduce payments concentration risk with Unified Payments Interface (UPI) facilitating over 1.5 bn transactions a month.
    • Given the sticky adoption and only a few payments apps dominating the UPI market, RBI intends to create a parallel retail system.

    5 requirements payment systems should fulfil

    • 1) The payments system should reduce the cost and time for government support to reach unbanked and underbanked people.
    • 2) It should ensure ease of access to credit for small and medium businesses.
    • 3) Improve the effectiveness of the implementation of monetary policy.
    • 4) The new payment system should effectively counter risk from unregulated new digital currencies like Bitcoin.
    • 5) It should discourage money laundering and tax evasion.

    CBDC: Solution to the above 5 requirements

    • CBDC is the digital form of fiat money, a digital equivalent of banknotes and coins.
    • A Central Bank Digital Currency (CBDC) could potentially solve the above problems.
    • Retail CBDCs can be issued directly by the central bank to people without going through traditional banks.
    • Individuals would have CBDC accounts directly on the central bank core ledger.
    • CBDC can reduce the cost and time for government support to reach people during desperate times (like pandemic).
    • CBDC can also enable many financial entities to settle directly with RBI.
    • In the current set up only a few large banks can settle directly with RBI.
    • With a digital currency, the settlement can be instantaneous and, as a result, more payments services providers like NBFCs could connect with RBI, thereby, reducing credit and liquidity risk.
    • CBDC lending would build MSMEs history and make further lending easier.
    • For India to be a $5 tn economy, businesses need credit, and that can happen when we have more banks.
    • India had 97 banks in 1947; today we are still at 95!
    • Interest bearing CBDCs can also improve monetary policy effectiveness by enabling real-time pass-through of the policy rate to the lending markets.
    • CBDCs can also allow for direct deposits into accounts of low-income households, senior citizens dependent on pensions and help cushion their purchasing power from the low-level interest rates during the times of economic downturn.
    • CBDC can thwart some competition against privately issued foreign currency-denominated digital currencies.

    Roles and responsibility of RBI with respect to CBDC

    • In terms of managing roles and responsibilities, RBI would only hold the accounts and implement monetary policies as it does now.
    • Fintech companies can become the channel for retail CBDC transmission and manage client relationships.
    • Fintechs can complement the commercial banks and can draw small businesses/poor households into the formal economy.
    • These companies could leverage their data to estimate customers’ creditworthiness and share their findings to banks for more efficient allocation of credit.

    Consider the question “A digital currency backed by the central bank could transform the retail payment landscape in India. Discuss.”

    Conclusion

    India has been at the forefront of the fintech revolution, and other developed countries have been following its path. While the world watches the melee between the Greenback and the Renminbi, it is time India also lays the foundation for a strong currency. CBDC may just be one of the ways to do it.

  • Boosting manufacturing

    The article analyses the issues of increasing manufacturing in India while dealing with the constraints faced by it. It also suggests the important role States can play.

    Why companies are expected to exit China

    • In the aftermath of the pandemic manufacturing companies are expected to exit China due to three primary reasons.
    • 1) Realisation that relying heavily on China for building capacities and sourcing manufacturing goods is not an ideal business strategy due to supply chain disruptions in the country caused by COVID-19.
    • 2) Fear of Chinese dominance over the supply of essential industrial goods.
    • 3) The growing risk and uncertainty involved in operating from or dealing with China in the light of geopolitical and trade conflicts between China and other countries, particularly the U.S.

    Where India stands in comparison with China

    • China ranks first in contribution to world manufacturing output, while India ranks sixth.
    • Against India’s target of share of manufacturing in Gross Domestic Product (GDP) to 25% by 2022, its share stood at 15% in 2018, only half of China’s figure.
    • Industry value added grew at an average annual rate of 10.68% since China opened up its economy in 1978, India’s grew at 7% after India opened up its economy.
    • Next to the European Union, China was the largest exporter of manufactured goods in 2018, with an 18% world share.
    • India is not part of the top 10 exporters who accounted for 83% of world manufacturing exports in 2018.

    Constraints faced by manufacturing sector in India

    India faces numerous constraints in promoting the manufacturing sector.

    • They chiefly include infrastructure constraints, a disadvantageous tax policy environment, restrictive trade policies, a non-conducive regulatory environment, rigid labour laws.
    • Constraints also include high cost of industrial credit, poor quality of the workforce, Low R&D expenditure, delays and constraints in land acquisition, and the inability to attract large-scale foreign direct investment into the manufacturing sector.

    What role States can play?

    • They  can  contribute land: Federal government system in India demands the participation of States for the lasting solution to the constraints on the sector.
    • An important requirement for the development of the manufacturing sector is the availability of land area.
    • This could be one of the reasons why manufacturing activity is mainly concentrated in Maharashtra, Gujarat, Tamil Nadu, Karnataka and Uttar Pradesh.
    • However, what is of concern is that some States that also have large land area contribute disproportionately little in manufacturing GSDP.
    • These states include Andhra Pradesh, Bihar, Chhattisgarh, Madhya Pradesh, Odisha, Rajasthan, Telangana, and West Bengal.

    Way forward

    • Identify reasons: The reasons for less manufacturing activity in these States have to be carefully examined.
    • State-specific industrialisation strategies: Based on such reasons, State-specific industrialisation strategies need to be devised and implemented in a mission mode with active hand-holding by the Central government.
    • State specific reforms: Policy actions on the part of individual States would improve India’s overall investment climate, thereby boosting investments, jobs, and economic growth.
    • Policy actions of the Centre and the States should  be well coordinated: Strategy Group consisting of representatives from the Central and State governments along with top industry executives to instil teamwork and leverage ideas through sharing the best practices of the Centre and States could be formed.

    Consider the question “What are the constraints faced by the manufacturing sector in India? Suggest the ways to deal with these constraints highlighting the important role States can play in boosting manufacturing.”

    Conclusion

    Both the States and the Central government needs to work in tandem to boost the manufacturing in India and transform the economic landscape of India.

  • How GST created single market

    The article analyses the instrumental role played by the GST in transforming nation into a single market dismantling the barriers across the states.

    Reduced tax burden on consumers

    • In the pre-GST era, the total of VAT, excise, CST and their cascading effect led to 31 per cent as tax payable, on an average, for a consumer.
    • In its first two years, as the collections improved, the GST Council kept reducing the tax burden on consumers.
    • Most items have been brought in the 18 per cent, 12 per cent or even 5 per cent category.
    •  Most items of daily common use are in the zero to 5 per cent slab.
    • An analysis by the Reserve Bank of India (RBI) observes that since the roll out of GST, the rate changes have brought down the GST incidence from 14 per cent to 11.6 per cent.
    • This explains the revenue loss stated above. The consumer pays less tax now under the GST.

    Flexibility and increased compliance

    • Taxation threshold for goods was increased to Rs 40 lakh.
    • The composition limit was increased from Rs 75 lakh to Rs 1.5 crore.
    • For manufacturers, composition tax rate was lowered from 2 per cent to 1 per cent.
    • The composition scheme was extended to services as well.
    • Special lower rates without Input Tax Credit (ITC) were prescribed for construction and restaurants.
    • As per an RBI calculation, the weighted GST rate at present is 11.6 per cent.
    • The revenue-neutral rate determined at the time of GST introduction by its own committee was 15.3 per cent.

    Widened tax base

    • Today, there are 1.2 crore GST assessees compared to 65 lakh at the time of introduction of the tax regime.
    • The average revenue collected per month for the nine months (July-March) in 2017-18 was Rs 89,700 crore in  2018-19 it rose by 10 per cent to Rs 97,100 crore.
    • In FY 2019-20, the revenue per month was Rs 1,02,000 crore.
    • This steady increase was despite the various concessions and rate reductions mentioned above.

     Simplification

    • GST is an IT-enabled platform.
    • Accounting and billing software is provided free to the small taxpayers.
    • Those with nil return to file can do so with an SMS.
    • Since the registration is completely online, the refund process is also fully automated.
    • The Centre is the only refund disbursal authority and no physical interface is required.

    Agriculture sector under GST

    • Concessions are extended to the agriculture sector under GST, agricultural inputs such as fertilisers, machinery have seen a considerable reduction in rates.
    • Other inputs such as cattle/poultry/aquatic feeds are kept at the nil rate.
    • Agricultural produce such as vegetables, fruits, flowers and foodgrains are exempt from GST.
    • Dairy products — milk, curd, lassi, buttermilk and minor forest produce such as lac, shellac and sisal leaves are also exempt.
    • Silk cocoon, raw silk, wool, jute fibre are nil rated.
    • In the pre-GST era, many of these were in the 5 per cent slab.
    • Service inputs to agriculture are similarly treated.
    • Before the introduction of GST, many such items were taxed at a standard rate of 15 per cent.

    MSME  under GST

    • Micro, small and medium enterprises (MSMEs) have consistently received sensitive treatment under the GST regime.
    • Items that have large employment creating activities, rough diamond/precious stone sorting and polishing for example, have seen a GST reduction from 3 per cent to 0.25 per cent.
    • Services rendered by MSMEs have also received such sensitive treatment.

    Concerns

    • Tax reduction in some cases has led to an inversion of duty structure.
    • Manufactured goods in lower slabs have suffered due to inversion in the duty structure.
    • With lockdowns and consequential deferrals in tax payments, compensation payments to the states is a concern that the Council has taken cognisance of.

    Consider the question “Elaborate on how the GST has been benefiting the various stakeholders and helped in transforming India into a single market?” 

    Conclusion

    The states have shown maturity and understanding. The spirit of collective responsibility and statesman-like thinking have kept mutual trust and confidence high. The much talked about cooperative federalism is actually in action in the GST Council.

  • Three areas to work on to put India on the path to growth

    The article suggests the three areas on which country should work on to make it resilient in the future. These three areas include the labour laws for informal employment, conditions of our cities and the strength of our rural economy.

    Background

    • The Prime Minister, while addressing the Confederation of Indian Industry (CII) annual meeting urged to think big and partner with the government in putting India on the path to growth.
    • There is much that we can be achieved if government and industry work towards the same objective, and in a spirit of mutual trust.

    Let’s look into some areas

    1) Employment

    • Over 85 per cent of employment in India is in the informal sector.
    • The Centre for Monitoring the Indian Economy (CMIE) estimates that between mid-March and mid-April, 120 million people lost their jobs.
    • With this unemployment rise to an all-time high of 27 per cent.
    • There was reverse migration on an unprecedented scale — some 10 million people abandoned cities to return to their native villages.
    • As economic activity has restarted in cities, CMIE reports that unemployment is now down to around 9 per cent.

    3 Problems we must address

    1) Need for labour regulation

    • We have stringent labour laws to protect workers, but this covers only the 15 per cent formal sector employment.
    • The 85 per cent of our workforce who are informally employed have almost no protection, and employers have almost complete flexibility.
    • We need to address both the formal and informal labour spectrum to get the balance right between flexibility and protection for all labour.

    Way forward

    • Everyone must have a minimum level of protection, and every employer a minimum level of flexibility.
    • This calls for a new social contract to define a well-calibrated social security system.
    • This huge project demands good faith and strong leadership by industry, labour and government.

    2) Living conditions of our cities

    • We need a massive private home-building programme.
    • It probably needs much more liberal land-use regulations — our cities have among the least generous floor-space indices (FSI) in the world.
    • New York, Hong Kong, and Tokyo have an FSI five times Mumbai’s.
    • Again, this is a multi-year project, and it involves state and city governments partnering with private developers.
    • India is unique in having 70 per cent of our population still residing in rural areas.
    • We must encourage the migration of people to higher productivity occupations in our cities.
    • And we must ensure that clean, affordable and accessible housing is available for all in our cities.

    3) Strength of our rural economy

    • Reverse migration is also an opportunity to collaborate in spreading the geography of development.
    • We need a three-pronged approach:
    • 1) As Ashok Gulati has often argued, the easiest way to grow farmer incomes is by having them grow more value-added crops.
    • Exports of fruits and vegetables must be consistently encouraged.
    • The cultivation of palm plantations with potential for huge import substitution, we need corporate farming as the gestation period of seven years for the first crop is too much for the average farmer to handle.
    • The Atmanirbhar agricultural reforms, which permit contract farming, and open up agricultural markets, are major medium-term reforms. Implemented right, they can transform agricultural markets.
    • 2) We need to encourage agro-processing near the source.
    • Fostering entrepreneurship in rural and semi-urban areas would combine nicely with local processing.
    • 3) We need to invest even more massively in rural connectivity.
    • Today, we would add digital connectivity to road connectivity to level the playing field for all regardless of where they live.

    Consider the question “What are the vulnerabilities in our economic structure that were highlighted by the covid pandemic? Also suggest the measures to make our rural economy strong and resilient to such shocks.”

    Conclusion

    The task is huge, and only collaboration between all levels of government (Union, state, and city) and our dynamic private sector can hope to make substantial progress.

  • A dicey dollar could yet revive Keynes’s Bancor currency plan

    The direct question in the exam from this article is not expected. Nevertheless, it is important to get a general understanding of the important role dollar plays in the world economy and the reasons for any viable alternative to it.

    Context

    • The dollar fell in July to a two-year low against the euro.
    • When the covid-19 pandemic went global in March, the dollar strengthened on the back of safe-haven flows into US Treasury bonds.

    What the depreciation of dollar indicate?

    • The dollar’s subsequent depreciation reflects the changing prospects of the US and European economies.
    • Some observers point instead to the agreement by European leaders to issue €750 billion ($884 billion) of European Union (EU) bonds.
    • With the spread of covid-19 investors expect the Fed to keep interest rates low for longer.
    • In the eurozone, the virus is under better control, and data from purchasing managers’ surveys are surprising on the upside.
    • This improving outlook doesn’t mean that the European Central Bank (ECB) will start raising its policy rate in the near future.
    • Interest rates determine the exchange rates as per the “interest parity” theory.

    Factors responsible for holding currency

    • 1) Normally, investors hold a currency when the issuer’s policies are sound and stable.
    • 2) Banks and firms hold a currency when it is useful for invoicing and settling trade with the issuing country.
    • But President Donald Trump’s administration has done more than any in living memory to disrupt US trade.
    • 3) Governments, for their part, hold and use the currencies of their alliance partners.

    Resilience of dollar

    • The most striking takeaway from recent experience is the dollar’s resilience.
    •  US policy has been risky and erratic.
    •  But President Donald Trump’s administration has done more than any in living memory to disrupt US trade.
    • Under Trump, the US today is no longer the reliable alliance partner it once was.
    • Despite all this, countries continue to hold the dollar.
    • The currency’s international role has not diminished significantly.
    • It has declined only along select dimensions—its share in central banks’ foreign-exchange reserves, for example—and even there, only marginally.

    No alternative

    • The euro is not an alternative to the dollar.
    • The stock of safe euro assets remains segmented along national lines.
    • Nor is the renminbi a viable alternative.
    • Given heightened tensions with China, no Western government will encourage its residents to depend on the People’s Bank of China for liquidity.

    Conclusion

    The only solution to this conundrum is more resources for the International Monetary Fund, so that it can supply countries in a crisis with the dollars that a future Fed fails to provide. This, of course, is the solution that John Maynard Keynes offered in 1944, albeit by another name-Bancor.

  • Dilemma the RBI faces

    Limitations and contradictions in the functioning of RBI

    • The Reserve Bank of India, along with the monetary policy committee, has undertaken measures to address the fallout of the COVID-19 pandemic.
    • Their actions are guided by multiple considerations — inflation and growth management, debt management and currency management.
    • These multiple considerations have inadvertently exposed the limitations of and the inherent contradictions in the central banking framework in India.

    Monetary policy functions

    • The MPC is guided by the goal of maintaining inflation at 4 plus/minus 2 per cent.
    • In its August policy, despite dire growth prospects, MPC chose to maintain the status quo.
    • This decision was driven by elevated inflation i.e. above 4 plus/minus 2 per cent. 
    • This raises the question: At the current juncture, should the MPC be driven by growth considerations or should short-term inflation concerns dominate?

    Understanding the nature of current inflation

    • The current rise in inflation is driven by supply-chain dislocations owing to the lockdowns.
    • This is evident from the growing disconnect between the wholesale and consumer price index.
    • Since April, while WPI has been in negative territory, CPI has been elevated.
    • The MPC’s mandate is to deliver stable inflation over long periods of time, not just a few months.
    • Yet, it would appear as if it is more concerned about elevated inflation in the short run.
    • Equally puzzling is the refusal of MPC to provide any firm projection of future inflation.

    Manager of government debt

    •  As manager of the government debt, the RBI is tasked with ensuring that the government’s borrowing programme sails through smoothly.
    • To this end, it has carried out several rounds of interventions popularly known as operation twist.
    • in operation twist government RBI intended pushing down long-term Gsec yields, and exerting upward pressure on short-term yields as a consequence.
    • In doing so, the RBI ended up doing exactly the opposite of what the MPC was trying to achieve by cutting short term rates, well before it reached the lower limit of its conventional policy response.

    3) RBI’s intervention in currency markets

    • The RBI’s interventions in the currency market have constrained its ability to carry out open market operations as these would have led to further liquidity injections into the system.
    • Put differently, its debt management functions have run up against its currency management functions.
    • Underlining the complexity of all this is the talk of sterilisation — the opposite of injecting liquidity in the system.

    Consider the question “RBI’s functions at the current juncture suffers from contradicting functions. Examine such contradictions in its role and suggest the ways to avoid such contradictions.”

    Conclusion

    The central bank must develop a clear strategy on what to do. At this juncture, there is a strong argument to look past the current spurt in inflation, and test the limits of both conventional and unconventional monetary policy. At the other end, while it may want to intervene to prevent the rupee’s appreciation, in doing so, it is constricting its debt management functions which will have its own set of consequences. There are no easy answers.

  • Re-imagining and reinventing the Indian economy

    The COVID-19 pandemic has disrupted the global economy and India is no different.  Besides the stimulus package totalling ₹20 lakh crore, a lot more needs to be done, however, to resuscitate the country’s growth engine.

    Try this question:

    Q.Economic reconstruction needs a multi-pronged strategy apart from economic stimulus. Discuss.

    Need for a two-pronged strategy

    • At this critical juncture, India needs a two-pronged strategy to successfully navigate the current crisis and recover strongly thereafter.
    • First, minimise the damage caused by the COVID and clear a path to recovery and second, rebooting and re-imaging India by promptly exploiting new opportunities unleashed by evolving business scenarios.

    Identifying the four major economic drivers:

    1. Big Business Houses which are a major contributor to GDP and large employment generators
    2. MSMEs which are the lifeline of the country, generating wealth for the middle class
    3. Startups which bring innovation and transformation to our country’s economy
    4. Approaching Indian Diasporas for driving foreign investments

    Following suggestions by the author gives a way forward strategy to recover the economy:

    1. Tax incentivization

    • Big business houses should be supported by the government to reopen their operations by way of tax incentives or ease of procurement of raw materials or other goods and services on credit.
    • This will energize consumer demand and boost the functioning of the vendor or ancillary industry in the MSME sector (which has huge potential for job creation).

    1. Ensuring seamless credit flows considering NPAs

    • The RBI should consider Single One Time Window for restructuring business loans, as required, by all banks.
    • There is a high probability that non-performing assets are likely to rise once the prevailing moratorium is lifted by RBI.
    • The government and RBI also urgently need to assure banks, that their business decisions will not be questioned, to encourage credit flows.

    1. Calibrating Make in India

    • The ongoing distrust on Chinese manufacturing amid US-China spat can be very well garnered by India.
    • Making India a global trading hub – devise an incentive regime for companies setting up global trading operations from India.
    • The govt. should think of establishing self-contained “industrial cities” that earmark space for manufacturing, commercial, educational, residential and social infrastructure.
    • The Centre can prepare a five-year plan on getting at least 60 per cent of those companies, desiring to move manufacturing out of China to India.

    1. Encouraging sunrise sectors

    • It should also encourage sunrise sectors as part of re-imagining Indian economy such as battery manufacturing (storage systems)/ solar panel manufacturing.
    • The government can also consider giving impetus to “Deep Tech”-leveraged businesses — blockchain, robotics, AI, machine learning, augmented reality, big data analytics, cybersecurity, etc.

    1. Creating an ecosystem to boost startups

    • India is amongst the top start-up ecosystems globally. Several of them are in pre-Angel or Angel-Funding stages and are under significant pressure to stay afloat in view of a lack of adequate liquidity.
    • Start-ups not only help drive innovation but also create jobs, which will be very important going forward.
    • The government needs to provide significant support to the start-up ecosystem.

    1. Auto-sector reforms

    • The auto industry which contributes significantly to GDP (nearly 9%) deserves special treatment.
    • In addition to reducing GST rate, old vehicle scrap policy with tax incentives for creating a demand for new vehicles may be formulated.
    • There is a need to recognise the Auto Sales Industry channel partners as MSMEs.

    1. Plug-and-Play model for foreign investment

    • Maharashtra has created a turnkey ‘plug-and-play’ model for foreign investors.
    • Similarly, other States must get their act together, be it on land acquisition, labour laws and providing a social, environment and other infrastructure.
    • Land should be made available for projects with all necessary pre-clearances — at Centre’s level (including Environmental), State’s and Municipal dispensations.

    1. Labour law reforms

    • Reforms in labour laws do not only mean permission to hire and fire.
    • Leeway should be given to strictly enforce discipline within the factory premises and demand higher productivity.
    • The moves by U.P., M.P. and Gujarat are welcome signals.
    • The government should provide health insurance for migrant labourers as experimented by certain States.

    1. Encouraging Diaspora

    • Investments of NRIs and OCIs in India should be treated on par with those of Resident Indians as regards interest and dividend repatriation and management control of Indian companies.
    • It may be mentioned that the Chinese government had called on rich overseas Chinese to invest in China with minimum government control, and massive investments followed.
    • This has contributed to China’s prosperity and economic rise.
    • A similar investment boom can take place in India through NRIs and OCIs who have the resources and expertise in manufacturing and technology.

    1. Creating off-Shore investment centres

    • Off-Shore investment centres like Singapore can be opened in Mumbai where Indian domestic laws and taxation will not be applicable.
    • MNCs may route their investments into India through the Off-Shore Centre in Mumbai.
    • Foreign legal firms and banks along with domestic institutions can be invited to have a presence in the Off-Shore Centre.

  • [pib] Partial Credit Guarantee Scheme (PCGS) 2.0

    As part of Aatmanirbhar Bharat Abhiyan, announced by the Government, the Partial Credit Guarantee Scheme (PCGS) 2.0   was launched to provide Portfolio Guarantee for purchase of Bonds or Commercial Papers (CPs) with a rating of AA and below issued by NBFCs/HFCs/ MFIs by Public Sector Banks (PSBs).

    Try this PYQ:

    When the Reserve Bank of India reduces the Statutory Liquidity Ratio by 50 basis points, which of the following is likely to happen? (CSP 2015)

    (a) India’s GDP growth rate increases drastically

    (b) Foreign Institutional Investors may bring more capital into our country

    (c) Scheduled Commercial Banks may cut their lending rates

    (d) It may drastically reduce the liquidity to the banking system

    About Partial Credit Guarantee Scheme (PCGS)

    • Under the scheme, any PSB can purchase securities (minimum rating of ‘AA’) of financially-sound non-banking finance companies.
    • The objective is to address temporary asset-liability mismatches of otherwise solvent NBFCs/Housing finance companies (HFCs) without having to resort to distress sale of their assets to meet their commitments.
    • The government will provide a one-time, six months’ partial credit guarantee to public sector banks for first loss of up to 10%.
    • Also, these NBFCs/HFCs are mandated that the CRAR (capital to risk-weighted assets ratio) shall not go below the regulatory minimum while exercising of the option to buy back the assets.

    What is CRAR?

    • CRAR also known as Capital Adequacy Ratio (CAR) is the ratio of a bank’s capital to its risk.
    • CRAR is decided by central banks and bank regulators to prevent commercial banks from taking excess leverage and becoming insolvent in the process.
    • The Basel III norms stipulated a capital to risk-weighted assets of 8%.
    • In India, scheduled commercial banks are required to maintain a CAR of 9% while Indian public sector banks are emphasized to maintain a CAR of 12% as per RBI norms.
    • It is arrived at by dividing the capital of the bank with aggregated risk-weighted assets for credit risk, market risk, and operational risk.
    • RBI tracks CRAR of a bank to ensure that the bank can absorb a reasonable amount of loss and complies with statutory Capital requirements.
    • The higher the CRAR of a bank the better capitalized it is.

  • Economic crisis without culprit

    Contradictions in the present crisis

    • India registered negative economic growth in 1972-73, 1965-66 and 1957-58.
    • All these were drought years.
    • 1957-58 also registered a significant balance of payments (BOP) deterioration and 1979-80 witnessing the second global oil shock following the Iranian Revolution.
    • Farmers harvested a bumper rabi crop last year and public cereal stocks at 94.42 million tonnes as on July 1 were also 2.3 times the required level.
    • There’s no shortage today of food, forex or even savings.
    • Foreign exchange reserves were at an all-time high of $538.19 billion.
    • So, the real GDP decline of 5-10 per cent for 2020-21 would be the country’s first-ever not triggered by an agricultural or a BOP crisis.

    “Western style” demand slowdown in India

    • What India has been going through is a full-fledged recession bereft of consumption and investment demand.
    • Households have cut spending.
    • The same goes with businesses. Many have shut or are operating at a fraction of their capacity and pre-lockdown staff strength.
    • This demand-side uncertainty and the resulting economic contraction is something new to India.
    • Banks are also facing a problem of plenty.
    • While their deposits are up 11.1 per cent, the corresponding credit growth has been just 5.5 per cent.
    • At some point when all this reduced spending and investments leads to a further contraction of incomes, it is bound to reduce savings as well.

    Why the government is not spending?

    • Solution in such a situation is the spending by the government.
    • There are three probable reasons why government isn’t doing that.

    1.Optimism

    • Hope that once the worst of the pandemic is behind us, people will start spending and businesses, too, will spring back to life.
    • However, this assumes the economy wasn’t doing all that badly previously and that the lockdown hasn’t caused too much of permanent damage.
    • The truth is that growth had already slid to 3.9 per cent in 2019-20.

    2.State of Government finances

    • In 2007-08 global financial crisis, the Centre’s fiscal deficit was only 2.5 per cent of GDP, whereas it stood at 4.6 per cent in 2019-20.
    •  The space for a fiscal stimulus, in other words, is very limited compared to that time.

    3.Sustainability of debt

    •  Between 2007-08 and 2019-20, the Centre’s outstanding debt-GDP ratio has come down from 56.9 to 49.25 per cent.
    • So has general government debt, which includes the liabilities of states, from 74.6 to 69.8 per cent.
    • Economists such as Olivier Blanchard have shown that public debts are sustainable provided governments can borrow at rates below nominal GDP growth (i.e. GDP unadjusted for inflation).
    • The nominal GDP averaged 11.1 per cent during  2014-15 to 2018-19.
    • As against this, the weighted average interest rate on Central government securities ruled between 6.97 per cent in 2016-17 and 8.51 per cent in 2014-15.
    • Only with nominal GDP growth falling to 7.2 per cent in 2019-20, and most likely zero this fiscal, has the Blanchard debt sustainability formula come under threat.

    Way forward

    • Government can take lessons from the Vajpayee period when the weighted average cost of Central borrowings more than halved from 12.01 per cent in 1997-98 to 5.71 per cent in 2003-04.
    • In the last four months, yields on 10-year Indian government bonds have softened from 6.5 to 5.9 per cent and even more for states — from 7.9 to 6.4 per cent.
    •  Interest rates will fall further as banks have nobody to lend to.

    Consider the question “Examine how covid induced economic recession is different from the past recessions? What are the options with the government to deal with the situation?” 

    Conclusion

    Governments should borrow and spend. They need worry only about GDP growth, real and nominal.

    Sources: https://indianexpress.com/article/opinion/columns/a-crisis-without-villains-6557602/

  • RBI revises guidelines for opening Current Accounts

    The article explains the salience of the RBI’s recent restriction on the opening of current accounts by the companies.

    Context

    • RBI has put restrictions on who can open a current account with which bank.

    What are the restrictions and why it matters

    • A company that has borrowed from a bank cannot open a current account with another bank.
    • It can open a current account with its lending banks under some circumstances.
    • Otherwise such company is encouraged to use the cash credit and overdraft facilities under which it has borrowed.

    Let’s understand why it matters

    • Firms borrow from PSU banks, but open current accounts with private or foreign banks.
    • When transactions move to current account of banks other than the lending bank, it loses visibility on end use of the funds.
    • Basically the PSU bank has no idea where the money has gone.
    • For example, when a firm gets money from its customers, instead of parking it with the lending bank it puts it in the current account with another bank.
    • The lending bank has no way of knowing if the loan is going bad wilfully or otherwise.

    Why private banks may oppose the move

    • Easy revenue source has got blocked.
    • They can, of course, start lending to firms to retain this business but that would mean taking risk.
    • It would be far safer to be with retail customers who have neither power nor lawyers to defend them against sharp banking practices.

    Why it matters to bank customers

    • Vanishing money raises the cost of funds to the bank and results in higher lending rates and lower deposit rates for us.
    • For taxpayers, it means regular use of our funds to recapitalize the banking system that periodically goes bankrupt due to loans gone bad.
    • So, an overall tightening of the system is great news.

    Conclusion

    For too long have the citizens been punished with greater scrutiny, tighter rules, higher costs and fewer benefits as compared to the suits. We should let the banks hand-wring, but celebrate the closure of each loophole as it happens.

    Back2Basics: What is the current account?

    • A current account is like a savings bank account, but with many facilities for swift and multiple transactions, overdraft facilities and it carries no interest.
    • Banks like to sell these accounts as they enjoy huge floats, or money that just sits with the bank waiting to be used by the depositing firms.