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GS Paper: Indian Economy

  • Will capping the bank CEO tenure make difference

    The article examines the utility of the proposed limit on the banks CEO tenure.

    Context

    • Last month, the Reserve Bank of India released a discussion paper on governance in commercial banks in India.
    • It has a proposal to cap the tenure of bank CEOs.

    Details of the proposed limit and rationale

    • The paper proposes to cap the maximum tenure of a promoter/major shareholder of a bank as a CEO or a Whole Time Director (WTD) at 10 years.
    • This move aims to separate ownership from management.
    • The rationale offered is that 10 years is an adequate period for a promoter/major shareholder of a bank as CEO/WTD to stabilise its operations and to transition the managerial leadership to professional management.
    • The corresponding limit for a CEO who is not a promoter/major shareholder is 15 consecutive years. T
    • Thereafter, that individual is eligible for re-appointment as CEO or WTD only after the expiration of three years.

    Why banks are different from other companies: 3 Reasons

    • Ordinary corporate governance norms exhort managers to run a company in the interest of shareholders but it may not be suitable approach for all types of banks.
    • 1) Banks are highly leveraged, creating powerful incentives for shareholders to engage in risky strategies at great risk to creditors, including retail depositors.
    • 2) Bank failure could involve systemic risk, which could result in a government bail-out.
    • This moral hazard creates even more high-powered incentives for shareholders to engage in risky strategies.
    • 3) Financial assets held by a bank are hard to monitor and measure.
    • Consequently, external scrutiny of a bank by depositors and creditors is difficult.
    • These unique factors are likely to encourage bank managers to take excessive risks to maximise shareholder value.

    Purpose of Bank governance

    • Bank governance seeks to curb such excessive risk-taking discussed above.
    • It encourages prudent risk-taking such that shareholders’ interests are secondary to depositors’ interests.
    • This is the main logic as suggested in the Basel Committee on Banking Supervision guidelines and the Financial Stability Board principles respectively.

    Will capping the CEO tenure help

    • It is unclear whether imposing a maximum cap on CEO tenure would encourage prudent risk-taking by the management.
    • For Indian banks, the limited empirical evidence seems to suggest that bank performance improves with increasing CEO tenure.
    • A paper published in International Journal of Financial Studies finds that an increase in CEO tenure is associated with significant improvements in asset quality and performance of the bank.
    • The effect of CEO tenure increases rapidly with the year of CEO tenure.
    • Concerning public sector banks (PSBs), the P J Nayak Committee report had identified shorter tenure of chairmen and executive directors as a key reason for weaker empowerment of their boards.
    • These findings seem to be at odds with RBI’s suggestion to cap CEO tenure.

    Consider the question “Examine the factors that justify the application of stricter governance principle for the banks. What would be the impacts of the RBI’s proposed limit on the CEO term of the banks on governance?

    Conclusion

    It may be prudent for the RBI to publish an empirical study on the impact of CEO tenure on bank performance before translating this proposal into an enforceable regulation.

  • What are Pre-packs under the present insolvency regime?

    The Ministry of Corporate Affairs (MCA) has set up a committee to look into the possibility of including what is called “pre-packs” under the current insolvency regime to offer faster insolvency resolution.

    Practice question for mains:

    Q.What are the key features of the Insolvency and Bankruptcy Code? Discuss how operationalization of IBC is hindered by the slower resolutions of insolvency cases. Suggest measures for faster resolution.

    What is Pre-pack?

    • A pre-pack is an agreement for the resolution of the debt of a distressed company through an agreement between secured creditors and investors instead of a public bidding process.
    • This system of insolvency proceedings has become an increasingly popular mechanism for insolvency resolution in the UK and Europe over the past decade.

    Why need Pre-packs?

    • Slow progress in the resolution of distressed companies has been one of the key issues raised by creditors regarding the Corporate Insolvency Resolution Process (CIRP) under the IBC.
    • Under the IBC, stakeholders are required to complete the CIRP within 330 days of the initiation of insolvency proceedings.

    A case for India

    • In India’s case, such a system would likely require that financial creditors agree on terms with potential investors and seek approval of the resolution plan from the National Company Law Tribunal (NCLT).
    • This process would likely be completed much faster than the traditional CIRP which requires that the creditors of the distressed company allow for an open auction for qualified investors to bid for the distressed company.
    • The process needs to be completed within 90 days so that all stakeholders retain faith in the system and cases that take more than this time should be taken through the normal CIRP.

    What are the other key benefits of a pre-pack?

    • Pre-packs would mostly be used for businesses that are running; the investors would likely need to maintain good relations with operational creditors.
    • In the case of pre-packs, the incumbent management retains control of the company until a final agreement is reached.
    • The transfer of control from the incumbent management to an insolvency professional as is the case in the CIRP leads to disruptions in the business and loss of some high-quality human resources and asset value.

    Some limitations

    • The key drawback of a pre-packaged insolvency resolution is the reduced transparency compared to the CIRP.
    • Financial creditors would reach an agreement with a potential investor privately and not through an open bidding process.
    • This could lead to stakeholders such as operational creditors raising issues of fair treatment when financial creditors reach agreements to reduce the liabilities of the distressed company.

  • RBI signs $400 mn currency swap facility for Sri Lanka

    The RBI has agreed to a $400 million currency swap facility for Sri Lanka till November 2022.

    Practice question for mains:

    Q. What are Currency Swaps? Discuss the efficacy of Currency Swap Agreements for liberalizing bilateral trade.

    Why such move by RBI?

    • The RBI’s action follows a recent bilateral ‘technical discussion’ on rescheduling Colombo’s outstanding debt repayment to India.
    • Following the outbreak of COVID-19 in the region, India had proposed a virtual meeting to discuss the request. Sri Lanka owes $960 million to India.
    • In turn, Sri Lanka would facilitate, protect and promote a liberal ecosystem for Indian investors.

    What are Currency Swaps?

    • A currency swap, also known as a cross-currency swap, is an off-balance sheet transaction in which two parties exchange principal and interest in different currencies.
    • Currency swaps are used to obtain foreign currency loans at a better interest rate than could be got by borrowing directly in a foreign market.

    How does it work?

    • In a swap arrangement, RBI would provide dollars to a Lankan central bank, which, at the same time, provides the equivalent funds in its currency to the RBI, based on the market exchange rate at the time of the transaction.
    • The parties agree to swap back these quantities of their two currencies at a specified date in the future, which could be the next day or even three months later, using the same exchange rate as in the first transaction.
    • These swap operations carry no exchange rate or other market risks, as transaction terms are set in advance.

    Why does one need dollars?

    • FPIs investors look for safer investments but the current global uncertainty over COVID outbreak has led to a shortfall everywhere in the global markets.
    • This has pulled down foreign exchange reserves of many small and developing countries.
    • This means that the government and the RBI cannot lower their guard on the management of the economy and the external account.

    Benefits of currency swap

    • The absence of an exchange rate risk is the major benefit of such a facility.
    • This facility provides the flexibility to use these reserves at any time in order to maintain an appropriate level of balance of payments or short-term liquidity.
    • Swaps agreements between governments also have supplementary objectives like the promotion of bilateral trade, maintaining the value of foreign exchange reserves with the central bank and ensuring financial stability (protecting the health of the banking system).

  • Gold and forex reserves cannot finance stimulus

    The article analyses the issues with suggestions like printing of currency and using forex reserves to finance the stimulus. They also lead to an increase in government debts.

    Context

    • Prime Minister announced a stimulus package of ₹20 trillion to fight the economic fallout of the covid pandemic.
    • Since then, several unorthodox ideas have been floated to raise funds for it without straining government finances.
    • Among the suggestions are the printing of currency, and using foreign exchange reserves or household gold.

    Let’s look at entries in the RBI’s balance sheets

    • On the liabilities side of it is the currency in circulation, commercial bank reserves  and government reserves.
    • On the asset side of it is forex reserves, government securities and gold.
    • The balancing item represents the central bank’s equity and accumulated surplus.

    Let’s look at 3 options suggested above and issues with them-

    1) Printing currency

    • Doing this would increase the liabilities of the RBI under “currency in circulation”.
    • But it first needs to acquire assets to offset this increase in liability.
    • These assets could be government securities, forex reserves or gold.
    • Thus, one way for the government to finance its expenditure would be to issue government bonds and ask RBI to print currency with which to subscribe to such bonds.
    • This is known as deficit monetization.
    •  It is important to note that for the central bank to print money, the government would have to issue bonds to it.
    • It will increase government debt.

    2) Monetisation of gold held by household

    • This would first involve the government buying gold from households in exchange for its bonds.
    • Then, the accumulated gold would be bought by RBI from the government with newly printed currency.
    •  In this case, instead of creating new money to acquire government bonds, RBI would be doing the same to acquire gold.
    • This too involves the Centre taking on additional debt.
    •  Moreover, gold monetization schemes in the past have yielded only mild success.

    3) Using RBI’s forex reserves

    • Against every dollar of forex reserves shown by RBI on the asset side, an equivalent rupee amount has already been created on the liability side.
    • This is because whenever RBI acquires foreign currency, it pays for it using the Indian rupee.
    • Thus, no additional currency can be printed against such already-acquired reserves.
    • The only way our forex reserves can be used for generating additional resources is by pledging them to a third party.
    • The pledging of RBI’s assets to raise funds is done only under extreme circumstances, for instance, during the 1991 balance of payments crisis.
    • We are certainly not in a situation that warrants a repeat of an exercise where RBI’s assets, be it gold or forex reserves, have to be mortgaged.

    So, what is the way out?

    • There are only three ways to finance government expenditure: taxes, debt and asset sales.
    • Taxes and asset sales can pitch in a bit towards the stimulus bill.

    Consider the question “Examine the ways in which government can raise the funds to finance the stimulus package and also discuss the issues with each move.”

    Conclusion

    There is no escaping the fact that we are staring at a higher build-up of government debt in the future. When we stop harbouring the notion that we can pay the stimulus bill without any deterioration in government finances, we will be able to see the bitter truth: There is no such thing as a free lunch.

    Read more about the issue here:

    India’s rising Forex Reserves

  • Open Credit Enablement Network (OCEN)

    A new credit protocol infrastructure called the OCEN protocol is set to be launched very soon.

    Practice question for mains:

    Q. What is Open Credit Enablement Network (OCEN)? How it is expected to be a gamechanger in the micro-credit facilitation services in India?

    Open Credit Enablement Network (OCEN)

    • OCEN is a credit protocol infrastructure, which will mediate the interactions between loan service providers, usually fintech and mainstream lenders, including all large banks and NBFCs.
    • It is developed by a think tank, Indian Software Products Industry Round Table (iSPIRT).
    • With this, a credit will become more accessible for a large number of entrepreneurs and small businesses in the country.
    • Private equity and venture capital players, angel investors, high net worth individuals and others also could be part of this exercise as investors.

    How will it work?

    • iSpirit is partnering with key leaders such as SBI, HDFC Bank Ltd., ICICI Bank Ltd., IDFC First Bank Ltd., Axis Bank Ltd. etc. for this new credit rail.
    • Account Aggregators which will be using these APIs to embed credit offerings in their applications, and will be called ‘Loan Service Providers’, which will play a crucial role in democratizing access to credit, and lowering interest rates for customers.

    Why need OCEN?

    • The cost of lending being too high in India, small value loans becomes very unfeasible.
    • OCEN which seeks to connect lenders to marketplaces and thereby to borrowers is a technology system.
    • If implemented, the technology can democratize lending to micro-enterprises and street vendors in a big way.

  • Comparing fiscal responses to Covid on qualitative and quantitative basis

    For all the talks over the size of Atmanirbhar package, India’s response turns out to be inadequate when compared with the other countries with similar levels of per capita income. This article analyses the same.

    Context

    • India’s fiscal response is compared to countries which are similar in GDP per capita, state capacity, and structure of the labour force.
    • Before the Atmanirbhar Bharat package, India lagged significantly behind comparable developing countries.
    • As of early July, the gap seems to have narrowed.

    Comparison and challenges

    •  Due to the blurring of the distinction between fiscal and monetary components, ensuring comparable and accurate figures for fiscal responses is a challenge.
    • For example, the total Atmanirbhar package is billed at 10% of GDP by the government.
    • While the headline number for India’s fiscal response in international databases is around 4% of GDP.
    • But some estimated that the new fiscal outlay is around 1.7% of GDP.
    • Vietnam, Indonesia, Pakistan, and Egypt, all while averaging less stringent measures than those in India, have announced stimulus measures that are as large or more substantial, as a share of GDP.

    Demand-side interventions in the package

    • The one significant demand-side intervention in the Atmanirbhar Bharat package was ₹40,000 crore of additional outlay for the MGNREGA.
    • Most other demand-side measures involve the frontloading, consolidation, or rerouting of existing funds.

    How developing countries are financing responses

    • Developing countries are resorting to drastic means to finance COVID-19 responses.
    • Actions so far include the amendment of legal budget limits.
    • Some are also exploring enhanced issuance of bonds-including a ‘pandemic bond’ by Indonesia.
    • Central banks in many emerging economies are experimenting with purchases of public and private bonds in the secondary market (quantitative easing).
    • Or some are directly purchasing government bonds on the primary market (monetising the deficit).
    • In India, the debate continues over whether the Indian government should invoke the “escape cause” in the FRBM Act.
    • Escape clause will enable the central bank to directly finance the deficit.

    Cash transfer: Lessons for India

    • Demand-side interventions announced by other developing countries could provide lessons for additional measures in India.
    • Of the World Bank’s list of 621 measures across 173 countries, half were cash-based. 
    • While only 2% related to public works, a clear indication of the popularity of cash transfers over public works for income support,
    • Countries have also significantly expanded coverage of their cash transfer programmes from pre-COVID-19 levels.
    • Bangladesh and Indonesia have increased the number of beneficiaries by 163% and 111%, respectively.
    • Indonesia’s cash schemes now cover more than 158 million people or 60% of the population.
    • Additionally, the Indonesia central government has directed village authorities to focus their budgets on a cash-for-work programme.

    Suggestions for India

    • India could take these actions about cash transfers into account in decisions about expanding existing transfer programmes or even creating new ones.
    • India has been a leader in employment guarantee policies with its flagship MGNREGA programme.
    • This is the right time to expand entitlements MGNREGA.
    • There is a need to introduce an urban version of the MGNREGA.
    • In India, one reason for the subdued fiscal response and the resort to monetary measures is a concern with the debt-to-GDP ratio.
    • However, aggregate demand and confidence in the economy have slumped and may not recover for many months.
    • Additional fiscal outlay -would save lives and jobs today and might prevent a protracted slowdown.

    Consider the question “How India fares in comparison with other countries over its fiscal response to Covid? Also examine the utility of income support schemes related to public works against the cash transfer schemes adopted by the other countries.”

    Conclusion

    Not spending more now, therefore, might only worsen the debt-to-GDP ratio if growth remains depressed. The fiscal outlay in the form of cash and in-kind transfers and expanded public works schemes is the need of the hour.

    Original op-ed:

    https://www.thehindu.com/opinion/op-ed/the-covid-19-fiscal-response-and-indias-standing/article32154153.ece

  • Exporting agri-inputs

    Some changes could make India exporter of agri-inputs. The article examines bottlenecks that holds India back and suggests the policy changes in key agri-inputs-seeds, fertilisers and machinery.

    Context

    In the following 3 key agri-inputs India has the untapped potential. What is needed is policy changes.

    1) Seeds

    • India can emerge as an important seed producer and a large exporter of seeds to many developing countries in South and South-east Asia as well as Africa.
    • The country can produce very competitively-priced seeds for hybrid rice, hybrid corn, hybrid Bt HT cotton, and several vegetables including tomato, potato and okra.
    • For this to happen, we have to set our regulatory system right.
    • Let’s use the case of cotton.
    • India’s decision in March 2002 to allow Bt cotton made India the largest producer of cotton in the world and the second-largest exporter of cotton by 2013-14.
    • But due to policy changes since 2014-15 and issues such as trait fees companies stopped the introduction of new generation of seeds
    • Now there is an “illegal” spread of Bt HT cotton in Maharashtra.
    • This is partly because our regulatory system is complex.
    • And more so because the present government has ideological blinkers against modern science.
    • This is the biggest bottleneck holding India back from becoming the seed capital of the developing world.

    2) Fertilisers

    • India has been a net importer of fertiliser nutrients (NPK) for almost two decades.
    • In 2019-20, India imported fertilisers worth $6.7 billion, topping the list is urea $2.9 billion.
    • We are totally dependent on imports and likely to remain so in case of MOP and in the case of DAP.
    •  In the case of urea, India wants to be atmanirbhar by opening up five new urea plants in the public sector with a total capacity of 6.35 MMT.
    • Almost 70 per cent of the gas being used in urea plants is imported at a price much higher than the price of domestic gas.
    • The cost is going to be more than $400/tonne when the international price generally hovers between $250-300/tonne.
    • The government should allow existing private sector urea plants to expand and produce at a much lower cost.
    • The best way to achieve self-reliance in fertilisers is to change the system of fertiliser subsidies.

    Suggestion on changes in fertiliser subsidies

    • 1) Deposit equivalent cash directly into farmers’ accounts, calculated on a per hectare basis.
    • 2) Free up fertiliser prices.
    • 3) Allow the private sector plants to compete and expand urea production in a cost-competitive manner.

    3) Farm machinery

    • Before the Green Revolution, India produced only 880 tractor units.
    • It increased to about 9,00,000 units in 2018-19.
    • So, India is the largest tractor manufacturer in the world.
    • India also exported almost 92,000 tractors, largely to African and ASEAN countries.
    • Though Green Revolution gave tractor production a push, the real break-through came after de-licensing in 1991.
    • The new class of entrepreneurs and start-ups are coming up with special apps for “Uberisation of tractor services”.
    • In an economy of small landholders, owning a tractor is a high-cost proposition as it is not fully utilised.
    • This needs to be made more efficient by creating a market for tractor services.

    Consider the question “Despite having the potential to transform itself into the exporter of agri-inputs, India ends up being the importer of some of them. In light of this examine India’s potential to become the exporter of agri-input products and suggest the measures to achieve this.”

    Conclusion

    The private sector is our strength. The only thing the government has to do is to unshackle them from the chains of controls and webs of unnecessary regulations. They will make an Atmanirbhar Bharat.

  • A demand problem contributing to lower imports

    India registered a trade surplus after almost two decades. But this is not the result of a sudden rise in India’s export. It is due to subdued import indicating the low demand.

    What latest data indicate

    • Data released by the commerce ministry indicate a contraction in exports observed over the past few months easing slowly.
    • But the continuing contraction in import which indicates low demand is worrying.
    • This is trend is leading to the growing gap between import and export.

    India registered a trade surplus: what it indicates

    • This growing gap led to India registering a trade surplus of nearly $800 million in June.
    • This is the first time in almost two decades that the country has registered a trade surplus.
    • But does this mean that India’s exports have grown drastically?
    • No. It is a sign of collapse in domestic demand.

    Merchandise exports growing trends

    • India’s merchandise exports continue to witness an upward swing.
    • The pace of contraction fell to 12.4 per cent in June, from 36.2 per cent in May and 60 per cent in April.
    • Exports of items such as iron ore, drugs and pharmaceuticals, chemicals and various agricultural commodities saw an expansion in June.

    What growing exports and falling import indicate

    • An upswing in exports could be indicative of a faster recovery of India’s export partners.
    • Restrictions on economic activities in some of these countries had eased earlier.
    • Other reason could be the rush by Indian exporters to ship out orders to meet their seasonal deadlines.
    • Imports continue to remain deep in negative territory.
    • The contraction in non-oil exports has actually worsened with decline observed in both consumer and investment/industrial goods imports.
    • Some movement is visible in imports of electronic goods.
    •  But the import of machinery and transport equipment has not moved significantly.
    • Of the 30 main import items, only four registered mildly positive growth in June — this indicates the pace of the domestic slowdown.

    Conclusion

    Economic activities across the world will take time to return to normalcy, India’s exports will take time to reach pre-COVID levels. It seems that the chasm between exports and imports could persist, given the plateauing of the post-lockdown spurt in demand/production.

  • Do we need Fiscal Council

    Why there is a need for Fiscal Council?

    • With a complex polity and manifold development challenges, India need institutional mechanisms for prudent fiscal practices.
    • An independent fiscal council can bring about much needed transparency and accountability in fiscal processes across the federal polity.
    • International experience suggests that a fiscal council improves the quality of debate on public finance, and that, in turn, helps build public opinion favourable to fiscal discipline.
    • In a globalised world of enormous capital flows, market volatility across the world and especially in emerging markets, in response to monetary policy changes in major economies, and geopolitical tensions that ebb and flow, causing currencies and commodity prices to swing, countries like India need macroeconomic management as an active function round the year.
    • Also, it is supposed to report to the parliament regarding the practicability of government forecasts in the budget. This will make executive more responsible in budget preparation.
    • For the last eight years the projections of the government has fallen short by a consistent 10 percent, leading to fund cuts in the middle of the year. Thus, an independent Fiscal council would evaluate budget proposals and forecasts using objective criteria.
    • This would also boost confidence in global credit rating agencies about government’s fiscal commitment.

  • Digitising the state

    This article examines the issues with governments account problems and their implications. It also suggests the ways to deal with the problems with data management in India.It is is line with the suggestions made by the CAG in this regard.

    Problem with government account keeping

    • The Union budget grew from Rs 197 crore in 1947 to Rs 30 lakh crore last year.
    • Total government expenditure may be higher than Rs 70 lakh crore. (states+union)
    • But the form and manner of keeping accounts have more or less remained unchanged since Independence.
    • Manual transactions and manual payments often lead to manually entered data at different stages in different databases on different systems.
    • This makes data unreliable, violates the principle of “single source of truth”.
    • This also sabotages transparency and good governance.

    Issues with computerisation by government

    • Government “computerisation” has often mechanised manual processes rather than “re-engineered processes”.
    • This has created siloed IT systems.
    • It has created various separate databases that lack modern data sharing protocols for organic linking like APIs (Application Programming Interfaces).
    • It leaves fiscal data being incomparable as basic as salary expenditure across states.
    • It creates the problem of obscurity in which large expenditures are booked under omnibus head called other.
    • Non-traceable actual expenditure against temporary advances drawn or funds drawn on contingent bills.
    • It creates the problem of misclassification so that grants in aid is classified as capital expenditure and bookings under suspense heads.

    3 Steps to deal with the issues

    1)  100% end-to-end data capture

    • All receipts and expenditure transactions including demands, assessment, and invoices should be received, processed, and paid electronically.

    2)  Data governance for standards

    •  Data standards are rules for describing and recording data elements with precise meanings that enable integration, sharing, and interoperability.
    • Prescribing data elements for all transactions will ensure standardisation.
    • This standardisation will clarify ambiguity, minimise redundant data, and create protocols for integration across different databases across entities receiving government funds.
    • It will also integrate entities collecting revenues on behalf of the government, and those discharging core functions on behalf of the government.
    • Government-wide data standards coupled with real-time data captured end-to-end will enable the use of cognitive intelligence tools like analytics, artificial intelligence, machine learning.
    • These tools, will support the establishment of budget baselines, detecting anomalies, data-driven project/activity costing, performance comparisons across departments and agencies, and benchmarking.

    3) Technology architecture

    • The element of technology architecture must ensure that all IT government systems should conform to a prescribed open architecture framework.
    • This framework should ensure robust security and maintaining privacy.

    How will these 3 steps help

    • It will help in recognising off-budget transactions, the last Union budget took steps towards this fiscal transparency and consolidation.
    • These steps will ensure business continuity: electronic records cannot be lost or misplaced like files or paper records.
    • It will also provide an incontrovertible audit trail.
    • It will enable Parliament and legislatures to draw “assurance” that each rupee due to the government has been collected, and each rupee has been spent for the purpose it was allocated.

    Consider the question “Government expenditure has increased manifold since 1947 but the form and manner of keeping data have remained more or less the same. In light of this examine the issues with payments, accounting and transactions data system of the government. Suggest the measures to improve it.”

    Conclusion

    A citizen-centric view of a single source of truth encompassing every rupee of public money would make the 299 remarkable people who wrote India’s Constitution proud of this 21st-century citizen empowerment innovation.

    Original Op-ed

    https://indianexpress.com/article/opinion/columns/digitising-the-state-6496692/