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GS Paper: Indian Economy

  • New approach to the revival of economy

    As our attention now shifts to the revival of the economy, we have to take stock of the damage to the economy. As recently as 2008 we have faced a financial crisis, but this crisis is bigger in the scale and our fiscal health is weaker than it was at the time of the 2008 crisis. So, to deal with the situation we have to adopt a novel approach. What should be the approach? Read further to know.

    From 2014 to Covid-19 in finance and banking

    • TBS challenge: As far back as December 2014, the banking sector and infrastructure firms had come under financial stress, a problem that was termed the Twin Balance Sheet (TBS) challenge.
    • By December 2019, the problem had spread to the NBFC and real estate sectors, raising the number of stressed balance sheets to four.
    • Following the Covid-19 shock, the problem of stressed balance sheets will spread across the economy.

    How bad is the damage likely to be?

    • Reports suggest that around one-third of industrial and service firms have applied for moratoria on their bank loans.
    • If only a quarter of these deferred loans eventually go bad, then the stock of non-performing assets (NPAs) would increase by Rs 5 lakh crore.
    • Senior bank officials have been quoted as estimating that the stock of NPAs could increase by as much as Rs 9 lakh crore.
    • In this case, we would be looking at NPAs of Rs 18 lakh crore, equivalent to around 18 per cent of current loans outstanding.

    So, how is the situation different from 2008 financial crisis?

    • At one level, the answer is simple: The shareholders of the financial institutions, which in most cases means the government.
    • But this is where the ubiquity of the balance sheet problem comes in.
    • When the TBS challenge first materialised, after the Global Financial Crisis of 2008-09, the government had a relatively strong balance sheet.
    • Deficits were low, and the consolidated debt-GDP ratio, having fallen by 17 percentage points over the previous 7 years, stood at just over 60 per cent of GDP.
    • So, fiscal room was available, allowing the government to recapitalise the PSU banks.
    • This time, the government’s financial position will be quite different.
    • Central and state government deficits and debts will increase dramatically this year.
    • Revenues, already slowing, have been decimated by the Covid crisis, while expenditures have increased.
    • Add in a slowly recovering economy, and it becomes clear that the fiscal position will remain weak for some considerable time.
    • What are the options with the government? The government will want to pass the burden onto the corporate and household sectors, in the form of higher taxes, more arrears, and possibly higher inflation.
    • But these sectors will resist, for they have financial problems of their own.

    2 ways to minimise the size of the loss

    • It will be tempting to delay recognising the problem, pushing it into the future, by allowing banks not to classify bad loans as NPAs, and barring them from taking defaulters to the IBC system.
    • But this would be the wrong approach and there are two ways to minimise the loss.
    • 1. Prevent bankruptcies from occurring.
    • To do this, banks will need to identify the firms that are viable, and lend them the funds they need to tide them over the immediate crisis.
    • But banks are reluctant to bear the risk of making such loans.
    • So, the government might need to create a guarantee fund to support lending.
    • 2. When firms default, resolve as quickly as possible
    • Speed is necessary because the financial position of stressed firms tends to worsen over time.
    • By definition, stressed firms have poor cash flows and can’t obtain much in the way of loans from banks.
    • So, they don’t have enough money to fund their operations properly.
    • Which means that over time their underlying business deteriorates, destroying the firms’ market value.
    • While public attention focuses on the size of the NPAs, a much more important number is the recovery rate — the degree to which the banks can recover on these loans.
    • And the only way to maximise the recovery rate is to sort out the bad loans speedily.
    • The economy will reap an additional benefit since the resolved firms will be able to contribute to the recovery.

    Consider the question “As the economy stares at the destruction caused by the pandemic certain novel measures to salvage the economy are necessary. In light of this statement suggest the measures that the government should take to avoid the NPA problem from mounting.”

    Conclusion

    A new approach is consequently needed. The immediate problems created by the crisis must be addressed, decisively and quickly. Then the attention will have to turn to address the pre-COVID legacy balance sheet problems.

    Back2Basics: What is NPA?

    • A non-performing asset (NPA) is a loan or advance for which the principal or interest payment remained overdue for a period of 90 days.
    • Banks are required to classify NPAs further into Substandard, Doubtful and Loss assets.
    • Substandard assets: Assets which has remained NPA for a period less than or equal to 12 months.
    • Doubtful assets: An asset would be classified as doubtful if it has remained in the substandard category for a period of 12 months.
    • Loss assets: As per RBI, “Loss asset is considered uncollectible and of such little value that its continuance as a bankable asset is not warranted, although there may be some salvage or recovery value.”

  • Economy and the challenges ahead

    Various projections of growth paint a grim picture of the Indian economy as well as the global economy. This article analyses the sector-wise impact and comes with the GVA projections for 2020-21. The government has to deal with serious challenges like financing huge fiscal deficits. So, what will be the growth rate for 2020-21 and what will be the size of GVA? Read to know!

    Projections of growth and uncertainty

    • Various institutions have assessed India’s growth prospects for 2020-21 ranging from 0.8% (Fitch)to 4.0% (Asian Development Bank).
    • This wide range indicates the extent of uncertainty and tentative nature of these forecasts.
    • The International Monetary Fund (IMF) has projected India’s growth at 1.9%, China’s at 1.2%, and the global growth at (-) 3.0%.
    • The actual growth outcome for India would depend on: 1) the speed at which the economy is opened up 2) the time it takes to contain the spread of virus, and, 3) the government’s policy support.

    Health of India economy before the crisis

    • India slid into the novel coronavirus crisis on the back of a persistent economic downslide.
    • There was a sustained fall in the saving and investment rates with unutilised capacity in the industrial sector.
    • In 2019-20, there was a contraction in the Centre’s gross tax revenues in the first 11 months during April 2019 to February 2020, at (-) 0.8%.
    • These trends continue to beset the Indian economy in this crisis.

    Growth prospects for 20-21 from the output side

    • In 2019-20, which would serve as the base year, India may show GVA growth of about 4.4%,
    • This is well below the Central Statistics Office’s second advance estimate of 9%.
    • The IMF’s GDP growth estimate for 2019-20 is at 2%.
    • GVA is divided into eight broad sectors. Although all sectors have been disrupted, some may be affected less than the others. We divide the output sectors in four groups.
    • Group A- This group is likely to suffer minimum disruption.
    • Agriculture and allied sectors, and public administration, defence.
    • Despite some labour shortage issues, agriculture sector may show near-normal performance.
    • The public and defence services have been nearly fully active, with the health services at the forefront of the the COVID-19 fight.
    • For the group A sectors, it may be possible to achieve 90% of the 2019-20 growth performance.
    • Group D- This group is likely to suffer maximum disruption.
    • This includes, trade, hotels, restaurants, travel and tourism under the broad group of “Trade, Hotels, Transport, Storage and Communications”.
    • This sector may be able to show 30% of 2019-20 growth performance.
    • Group B
    • This comprises sectors which may suffer average disruption showing 50% of 2019-20 growth performance.
    • These sectors are mining and quarrying, electricity, gas, water supply and other utility services, construction, and financial, real estate and professional services.
    • Group C
    • In this group come manufacturing which has suffered significant growth erosion in 2019-20.
    • It is feasible to stimulate this sector by supporting demand.
    • In this case a 40% performance factor on the average growth of the preceding three years is applied.

    So, what are the estimates for 2020-21 GVA?

    • Considering these four groups together, a GVA growth of 2.9% is estimated for 2020-21.
    • Realising this requires strong policy support, particularly for the manufacturing sector which has a weight of 17.4%.
    • It is also based on the assumption that the Indian economy may move on to positive growth after the first quarter.
    • In the first quarter, GVA growth will be negative.

    Policy support for the growth

    • Monetary policy initiatives undertaken so far include a reduction in the repo rate to 4.4%, the reverse repo rate to 3.75%, and cash reserve ratio to 3%.
    • The Reserve Bank of India has also opened several special financing facilities.
    • These measures need to be supplemented by an appropriate fiscal stimulus.
    • Cash-constrained central and State governments have taken expenditure reducing measures by announcing freezing of enhancements of dearness allowance and dearness relief.
    • This may result in savings of ₹37,000 crore for the Centre and about ₹82,000 crore for the States, together amounting to 6% of GDP.
    • There is also talk of substantially reducing non-salary defence expenditure.
    • With lower petroleum prices, fertilizer and petroleum subsidies may be reduced.
    • These expenditure cuts are contemplated to keep the fiscal deficit under some control.

    Fiscal stimulus and fiscal deficit

    • Fiscal stimulus can be of three types:
    • 1) Relief expenditure for protecting the poor and the marginalised.
    • 2) Demand-supporting expenditure for increasing personal disposable incomes or government’s purchases of goods and services, including expanded health-care expenditure imposed by the novel coronavirus, and,
    • 3) Bailouts for industry and financial institutions.
    • The Centre had earlier announced a relief package of ₹1.7-lakh crore.
    • The Centre’s budgeted fiscal deficit of 3.5% of GDP may have to be enhanced substantially to 1) make up for the shortfall in budgeted revenues; 2) account for a lower than projected nominal GDP for 2020-21, 3) provide for a stimulus.
    • Thus, the Centre’s fiscal deficit may increase to 6.0% of GDP.
    • Expenditure on the construction of hospitals, roads and other infrastructure and purchase of health-related equipment and medicines require prioritisation.
    • These expenditures will have high multiplier effects.
    • Similar initiatives may be undertaken by the State governments which may also enhance their combined fiscal deficit to about 0% of GDP to account for 3.0% of GDP under their respective Fiscal Responsibility Legislation/Law and to provide for the shortfall in their revenues and some stimulus.

    Challenges

    • Financing of the fiscal deficit poses a major challenge this year.
    • On the demand side, the Central (6.0%) and State governments (4.0%) and Central and State public sector undertakings (3.5%).
    • These together present a total public sector borrowing requirement (PSBR) of 13.5% of GDP.
    • Against this, the total available resources may at best be 9.5% of GDP.
    • The gap of 4.0% points of GDP may result in increased cost of borrowing for the Central and State governments.

    Consider the question, “Examine the sector-wise damage caused to the economy due to Covid-19 pandemic. What were the fiscal and monetary measures taken to mitigate the damage and challenges faced by the government in meeting the required revenue demands.”

    Conclusion

    The gap in requirement of resources and availability may be bridged by enhancing net capital inflows including borrowing from abroad and by monetising some part of the Centre’s deficit. The monetisation of debt can at best be a one-time effort. This cannot become a general practice. 

    Back2Basics: What is GVA?

    • GVA it is a measure of total output and income in the economy.
    • It provides the rupee value for the amount of goods and services produced in an economy after deducting the cost of inputs and raw materials that have gone into the production of those goods and services.
    • It also gives sector-specific picture like what is the growth in an area, industry or sector of an economy.
    • While GVA gives a picture of the state of economic activity from the producers’ side or supply side, the GDP gives the picture from the consumers’ side or demand perspective.
    • Both measures need not match because of the difference in treatment of net taxes.
    • GDP = GVA + taxes on products – subsidies on products

  • Is the perpetual bond a suitable option to raise money?

    The government is exploring ways to raise money to deal with the destruction caused by COVID pandemic. One of the suggestion is the monetisation of fiscal deficit. But this article looks into an alternative approach of issuing bonds based on the idea of Consol bond issued by the British government during WW 2. So, how much amount needs to be raised? and why a perpetual bond like Consol bond is a suitable option for India? Read to know!

    A gathering financial storm

    • India projected a deficit of ₹7.96-lakh crore in the Budget before the pandemic.
    • Adding to the above concern: 1) Off-balance sheet borrowings of 1% of GDP. 2) The overly excessive target of ₹2.1 lakh crore through disinvestments.
    • Thus, financial deficit number is set to grow by a wide margin owing to corona crisis.
    • There will be revenue shrinkage from the coming depression that will most certainly be accompanied by a lack of appetite for disinvestment.

    Need for stimulus package and measures taken by the RBI

    • In addition to the expenditure that was planned, the government has to spend anywhere between ₹5-lakh crore and ₹6-lakh crore as a stimulus package.
    • The stimulus provided by the government so far and recent announcements by the Reserve Bank of India (RBI) achieved little.
    • All the RBI’s schemes are contingent on the availability of risk capital, the market for which has completely collapsed.
    • The government and the RBI have tried several times to increase lending to below investment grade micro, small and medium enterprises, but have come up short each time.
    • Furthermore, while the 60% increase in ways and means limits for States is a welcome move, many States have already asked for doubling the limits due to the shortages in indirect taxation collections from Goods and Services Tax, fuel and liquor.
    • The government and the central bank need to understand that half measures will do more harm than good.

    What is the Consol Bond?

    • Consol bond is a form of British government bond that has no maturity and that pays a fixed coupon.
    • Consols are basically rare examples of actual perpetual bonds.
    • The bonds were issued in 1917 as the government sought to raise more money to finance the ongoing cost of the First World War.

    So, why bond like Consol Bonds is a good option for India?

    • There is no denying the fact that the traditional option of monetising the deficit by having the central bank buy government bonds is one worth pursuing.
    • Citizens’ active participation is ensured in Consol Bond type alternative.
    • Furthermore, with the fall of real estate and given the lack of safe havens outside of gold, the bond would offer a dual benefit as a risk-free investment for retail investors.
    • When instrumented, it would be issued by the central government on a perpetual basis with a right to call it back when it seems fit.
    • An attractive coupon rate for the bond or tax rebates could also be an incentive for investors.
    • The government can consider a phased redemption of these bonds after the economy is put back on a path of high growth.

    The solution of bond offered here could be a valuable addition in points to the answer to the question which asks about the ways to raise money. Consider the question, “Economic devastation caused by the COVID pandemic has forced the government to explore the various ways to raise the money. Discuss the options available with the government and issues associated with the options.”

    Conclusion

    Politicians and epidemiologists across the world have used the word “war” to describe the situation the world is currently in. So, to raise the money to fight this war against Covid-19, we can take the cue from past and issue bond based on the Consol bond.

    Back2Basics: What is fiscal deficit?

    • A fiscal deficit is a shortfall in a government’s income compared with its spending.
    • The government that has a fiscal deficit is spending beyond its means.
    • A fiscal deficit is calculated as a percentage of gross domestic product (GDP).
    • There can be different types of deficit in a budget depending upon the types of receipts and expenditure we take into consideration. Accordingly, there are three concepts of the deficit, namely-
    • Revenue deficit = Total revenue expenditure – Total revenue receipts.
    • Fiscal deficit = Total expenditure – Total receipts excluding borrowings.
    • Primary deficit = Fiscal deficit-Interest payments.
    • Primary deficit shows how much government borrowing is going to meet expenses other than interest payments.
    • Thus, zero primary deficits mean that the government has to resort to borrowing only to make interest payments.
    • To know the amount of borrowing on account of current expenditure over revenue, we need to calculate the primary deficit.
    • Thus, the primary deficit is equal to fiscal deficit less interest payments.

    Perpetual Bonds

    • A perpetual bond, also known as a “consol bond” or “prep,” is fixed income security with no maturity date.
    • This type of bond is often considered a type of equity, rather than debt. One major drawback to these types of bonds is that they are not redeemable.
    • However, the major benefit of them is that they pay a steady stream of interest payments forever.
    • Perpetual bonds exist within a small niche of the bond market.
    • This is mainly due to the fact that there are very few entities that are safe enough for investors to invest in a bond where the principal will never be repaid.
    • AT-1 bonds which were recently in news due to YES bank failure is an example of a perpetual bond.

     

  • Stimulus package conundrum

    There are many suggestions and expectations around the stimulus package deal to revive the economy crippled post corona pandemic. While everyone agrees over the need of stimulus but there are several opinions and suggestion around the various aspects of the package like size, time, source of revenue etc. But we must be mindful of the pitfalls and constraints while thinking about the stimulus package. So, what are the suggestion and expectation and what are the limitations? Read to know!

    1. Supply-side constraints on stimulus

    • It is argued that a fiscal stimulus package has to follow the timeline.
    • But you cannot ‘stimulate’ an economy during a supply-side lockdown.
    • And that there are ‘announcement effects’ — both good and bad — that go with the stimulus.
    • So, any ‘good stimulus’ can only come into effect post lockdown and extensive consultations are on with everyone for that.

    2. What should be the size of the stimulus package?

    • While thinking about the stimulus, we cannot forget that government revenues too will be seriously hit.
    • The government revenue will be hit by 2-3% of GDP, given that disinvestment target itself is 1% of GDP and the realisation is likely to be close to zero in the current financial year.
    • So, the effective fiscal deficit is going to be somewhere around 7.5 % if you take into account all the off-balance sheet borrowings.
    • The U.S. government has set aside $2 trillion for bailouts or 9% of its GDP.
    • India’s starting point is going to be at around 7.5% of GDP fiscal deficit, then how much more can we afford on top of that?
    • On top of this is all the ‘merit expenditure’ on health and direct income support to the poor cannot be reduced.
    • Can we still formulate a stimulus package comprising 10% of GDP, to be footed by the Central government alone?

      Monetising the deficit and debt-to-GDP ratio

    • From 1947 to 1997, the Central government always routinely monetised its deficit, without leading to high rates of inflation, much less hyperinflation.
    • The Fiscal Responsibility and Budget Management (FRBM) limits are hardly a success and routinely all governments have broken the barrier.
    • Other countries with huge debt-to-GDP ratios like Japan (>200%) and U.S. (125%) get away with barely a rap on the knuckles.
    • But India is pulled up for minor slippages on a 70% debt-GDP ratio.

    3. Should we pay attention to needs and forget about affordability?

    • Some have argued that bailouts should be based on need and not affordability.
    • Can printing money be a solution out of this situation?
    • Possible dangers of printing money: The currency could plunge, inflation soar high and rating agencies could downgrade us to junk.
    • So, shouldn’t there be a more nuanced approach to what constitutes a ‘good’ stimulus?

    4. The problem of low credit flow despite high liquidity

    • There is a lot of liquidity in the economy, but limited credit is flowing due to anaemic lending.
    • Thus, another mantra being espoused is that bank managers should be incentivised to lend and the government should indemnify loans given during this period.
    • This could well lead to bogus companies springing up overnight to grab the stimulus in collusion with banks.
    • The government owes about ₹1 lakh crore on tax refunds and also had promised to make up for any difference to the States, if the GST did not grow by 14% per annum.
    • This is the time for it to transfer this to the States as a grant, for one year, to offset the revenue loss to States.

    5. Should we go to the IMF?

    • There is talk of going to the International Monetary Fund (IMF).
    • Do we really need the IMF’s bailout which comes with conditions when there is no foreign exchange crisis for financing rupee expenditure?
    • Moreover, there is a perceived global stigma attached to doing so.
    • Won’t the conditionality-led cure be worse than the disease?

    Consider the following question based on the issue “Economic crises accentuate the role of governments. Covid-19 has not been different. In light of the above statement, discuss the various issues that the government faced while coming up with a stimulus package to revive the economy. What are the sources of revenue to be tapped by the government?”

    Conclusion

    Fate is what happens to us. Destiny is what we make in spite of our fate. India’s destiny appears relatively safe, if we cast the mind’s eye around the globe. Lifting the lockdown will be the first step towards a good stimulus and one does need to un-handcuff a billion people to save their lives too.

  • Co-operative banks can use SARFAESI Act to recover dues: Supreme Court

    A five-judge Constitution Bench of the Supreme Court (SC) has ruled that all co-operative banks in the country could make use of the SARFAESI Act to make recovery against defaulting persons.

    Possible mains question:

    What is the SARFAESI Act, 2002? Discuss its various provisions and efficacy to curb Non-Performing Assets (NPAs)?

    What is Sarfaesi Act, 2002?

    • Sarfaesi is an acronym for Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest.
    • It allows banks and other financial institution to auction residential or commercial properties (of Defaulter) to recover loans.
    • The first asset reconstruction company (ARC) of India, ARCIL, was set up under this act.
    • Under this act secured creditors (banks or financial institutions) have rights for enforcement of security interest under section 13 of SARFAESI Act, 2002.

    Provisions of the Act

    • If the borrower of financial assistance makes any default in repayment of a loan or any instalment and his account is classified as NPA by secured creditor, then secured creditor may require before the expiry of a period of limitation by written notice.
    • The act does not apply to unsecured loans, loans below ₹100,000 or where remaining debt is below 20% of the original principal.
    • This law allowed the creation of asset reconstruction companies (ARC) and allowed banks to sell their non-performing assets to ARC’s (which are regulated by the RBI).
    • Banks are allowed to take possession of the collateral property and sell it without the permission of a court.

    To summarize, the SARFAESI Act empowers financial institutions to ‘seize and desist’. They should give a notice to the defaulting borrower asking to repay the amount within 60 days.

    If the debtor doesn’t comply, the bank can resort to one of the three following measures:

    1) Take possession of loan security

    2) Sell or lease or assign the right over the security

    3) Manage the asset or appoint someone to manage the same

    Ambit of the Act

    • The recent judgment said that the SARFAESI Act qualifies the test of legislative competence, as well as the definition, cannot be said to be beyond the competence of the Parliament.
    • In 2013, the Gujarat High Court had, while hearing a challenge to the amendment of Banking Regulation Act of 1949, to include cooperative societies as financial institutions, ruled it null and void.
    • The high court had then agreed with the submissions of the petitioners who had argued that Sarfaesi would not be applicable to cooperative banks formed under the state law.
    • The Delhi High Court had, on the other hand, ruled that the cooperative banks and societies were for all purposes banks and financial institutions and thus were allowed to use Sarfaesi to make recoveries against defaulters.
    • In its judgment, the apex court held that all such cooperative banks involved in the activities related to banking are covered within the meaning of ‘banking company’.

  • Pathways to design a resilient economy

    The pandemic of COVID is a watershed moment in the way we look at the world. Truly, the future vocabularies will consist of ‘Pre COVID world’ and ‘Post COVID world’. Undoubtedly, the economic system shall be deeply affected by the COVID wave. The focus of this article is to redesign our economy through new 7 golden rules in the aftermath of Covid-19. As we read these ideas we also come across the faults that lie at the bottom of the present system. This is our opportunity to design a resilient and just system. So, what is the way forward to achieve this? Read to know!

    • When complex systems come to catastrophes, they re-emerge in distinctly new forms.
    • The COVID-19 global pandemic is a catastrophe, both for human lives and our complex
    • Economists cannot predict in what form the economy will emerge from it. But we can develop principles for what lies ahead.

    7 Radical ideas to build back economy

    The COVID-19 catastrophe has challenged the tenets of economics that have dominated public policy for the past 50 years.

    Here are seven radical ideas emerging as pathways to build a more resilient economy and a more just society.

    1. Time to rethink GDP as a measure of growth

    • The obsession with GDP as the measure of progress has been challenged often, but its challengers were dismissed.
    • Now, Nobel laureates in economics-Joseph Stiglitz, Amartya Sen, Abhijit Banerjee, Esther Duflo and others-are calling upon to rethink the fundamentals of economics, especially the purpose of GDP.
    • A five-point ‘de-growth’ manifesto by 170 Dutch academics has gone viral amidst the heightened Internet buzz during the lockdown.
    • Goals for human progress must be reset.

    2. Opening boundaries is not always good

    • Boundary-lessness is a mantra for hyper-globalisers. Boundaries, they say, impede flows of trade, finance, and people.
    • However, since countries are at different stages of economic development, and have different compositions of resources, they must follow different paths to progress.
    • According to systems’ theory, sub-systems within complex systems must have boundaries around them, be permeable ones, so that the sub-systems can maintain their own integrity and evolve.
    • This is the explanation from systems science for the breakdown of the World Trade Organization (WTO).
    • In WTO system, all countries were expected to open their borders.
    • Opening borders caused harm to countries at different stages of development.
    • Now COVID-19 has given another reason to maintain sufficient boundaries.

    3. Role of the government is indispensable

    • Ronald Reagan’s dictum, “Government is not the solution… Government is the problem”, has been upended by COVID-19.
    • Even capitalist corporations who wanted governments out of the way to make it easy for them to do business are lining up for government bailouts.

    4. Problems caused by marketization

    • The “market” is not the best solution.
    • Money is a convenient currency for managing markets and for conducting transactions.
    • Whenever goods and services are left to markets, those who do not have money to obtain what they need are at loss.
    • Moreover, by a process of “cumulative causation”, those who have money and power can acquire even more in markets.
    • The “marketization” of economies has contributed to the increasing inequalities in wealth over the last 50 years, which Thomas Piketty and others have documented.

    5. Focus on citizen welfare, not consumer welfare

    • In economies, human beings are consumers and producers. In societies, they are citizens.
    • Citizens have a broader set of needs than consumers.
    • Citizens’ needs cannot be fulfilled merely by enabling them to consume more goods and services.
    • They value justice, dignity, and societal harmony too.
    • Economists’ evaluations of the benefits of free trade, and competition policy too, which are based on consumer welfare alone.
    • Such evaluations fail to account for negative impacts on what citizens value.

    6. Competition Vs. Collaboration

    • Competition must be restrained: Collaboration is essential for progress.
    • Faith in “Darwinian competition”, with the survival of only the fittest, underlies many problems of modern societies and economies.
    • Blind faith in competition misses the reality that human capabilities have advanced more than other species’ have, by evolving institutions for collective action.
    • Further progress, to achieve the Sustainable Development Goals will require collaboration among scientists in different disciplines and among diverse stakeholders, and collaboration among sovereign countries.
    • Improvement in abilities to share and govern common resources have become essential for human survival in the 21st century.

    7. Public ownership of technologies

    • We are living in an era of knowledge.
    • Just as those who owned more land used to have more power before, now those who own knowledge have more power and wealth than the rest.
    • Intellectual property monopolies are producing enormous wealth for their owners, though many were developed on the back of huge public investments.
    • Moreover, powerful technologies can be used for benign or malign purposes.
    • It is imperative to evolve new institutions for public ownership of technologies and for the regulation of their use.

    How to walk the talk?

    • COVID-19 has revealed structural weaknesses in the global economy. Putting more liquidity in the system as was done in case of 2008 crisis will not be sufficient.
    • The system is in the need of paradigm change.
    • 1. Coordination among experts
    • Experts need to work together with keeping in mind the larger picture.
    • The economic system cannot be redesigned by domain experts devising solutions within their silos.
    • 2. Focus on innovation
    • Innovations are required at many levels to create a more resilient and just world.
    • Innovations will be required in business models too, not just for business survival but also to move businesses out of the 20th-century paradigm that “the business of business must be only business”. 

    The UPSC can ask a question based on the issues discussed here. Consider this question- “COVID has upended the global economy in such a way that it would need an overhaul. The basic tenets of the global economic order would undergo a revaluation. In light of the above statements examine the factors that contributed to the vulnerability of the Indian economy. Suggest the ways to make it more resilient and just.”

    Conclusion

    The redesign of economies, of businesses, and our lives, must begin with questions about purpose. What is the purpose of economic growth? What is the purpose of businesses and other institutions? What is the purpose of our lives? What needs, and whose needs, do institutions, and each of us, fulfil by our existence?

  • Why liquor sale matters to states?

    Following the ease of restrictions in the third phase of the nationwide lockdown, some of the most striking images showed long queues outside liquor stores around the country. The Delhi government announced a 70% hike in the price of liquor across categories in the capital.

    Aspirants must note:

    1. Purview of Excise duty (i.e. Petroleum and Liquor)

    2. Excise duty before and after GST regime

    3. Sources of state revenue etc.

    4. Argument relating to inclusion of Liquor in GST

    Why liquor matters?

    • Delhi’s “special corona fee” on alcohol underlines the importance of liquor to the economy of the states.
    • Manufacture and sale of liquor is one of the major sources of their revenue, and the reopening comes at a time when the states have been struggling to fill their coffers amid the disruption on account of the lockdown.

    How do states earn from liquor?

    • Liquor contributes a considerable amount to the exchequers of all states and UTs except Gujarat and Bihar, both of which have enforced prohibition.
    • Generally, states levy excise duty on manufacture and sale of liquor.
    • Some states, for example, Tamil Nadu, also impose VAT (value-added tax).
    • States also charge special fees on imported foreign liquor; transport fee; and label & brand registration charges.
    • A few states, such as UP, have imposed a “special duty on liquor” to collect funds for special purposes, such as maintenance of stray cattle.

    Share in revenue

    • A report published by the RBI last year shows that state excise duty on alcohol accounts for around 10-15 per cent of Own Tax Revenue of a majority of states.
    • In fact, the state excise duty on liquor is the second or third largest contributor to the category State’s Own Tax revenue; sales tax (now GST) is the largest.
    • This is the reason states have always wanted liquor kept out of the purview of GST.

    What exactly is State Excise?

    • Excise duty on alcohol, alcoholic preparations, and narcotic substances is collected by the State Government and is called “State Excise” duty.
    • For most of the states, excise duty is the second largest tax revenue after sales taxes (state VAT).
    • Besides, a substantial amount comes from licences, fines and confiscation of alcohol products.

    What has changed with the State Excise after the GST regime?

    • At the central level, excise duty earlier used to be levied as Central Excise Duty, Additional Excise Duty, etc.
    • However, the Goods and Services Tax (GST), introduction in July 2017, subsumed many types of excise duty. Today, excise duty applies only on petroleum and liquor.
    • Excise duty was levied on manufactured goods and levied at the time of removal of goods, while GST is levied on the supply of goods and services.
    • Alcohol does not come under the purview of GST as exclusion mandated by constitutional provision.
    • States levy taxes on alcohol according to the same practice as was prevalent before the rollout of GST.
    • After GST was introduced, central excise duty was replaced by Central GST because excise was levied by the central government. The revenue generated from CGST goes to the central government.

    What are the other sources of revenue for the states?

    • The states’ revenues comprise broadly two categories — Tax Revenue and Non-Tax Revenue.
    • Tax revenue is divided into two further categories: State’s Own Tax Revenue, and Share in Central Taxes.
    • Again, Own Tax Revenue comprises three principal sources:

    1) Taxes on Income (agricultural income tax and taxes on professions, trades, callings and employment);

    2) Taxes on Property and Capital Transactions (land revenue, stamps and registration fees, urban immovable property tax); and

    3) Taxes on Commodities and Services (sales tax, state sales tax/VAT, central sales tax, a surcharge on sales tax, receipts of turnover tax, other receipts, state excise, taxes on vehicles, taxes on goods and passengers, taxes and duties on electricity, entertainment tax, state GST, and “other taxes and duties”).

    Back2Basics: What is Excise Duty?

    • Excise duty is a form of tax imposed on goods for their production, licensing and sale.
    • It is the opposite of Customs duty in sense that it applies to goods manufactured domestically in the country, while Customs is levied on those coming from outside of the country.
    • At the central level, excise duty earlier used to be levied as Central Excise Duty, Additional Excise Duty, etc.
    • Excise duty was levied on manufactured goods and levied at the time of removal of goods, while GST is levied on the supply of goods and services.

    Purview of excise duty

    • The GST introduction in July 2017 subsumed many types of excise duty.
    • Today, excise duty applies only on petroleum and liquor.
    • Alcohol does not come under the purview of GST as exclusion mandated by constitutional provision.
    • States levy taxes on alcohol according to the same practice as was prevalent before the rollout of GST.
    • After GST was introduced, excise duty was replaced by central GST because excise was levied by the central government. The revenue generated from CGST goes to the central government.

    Types of excise duty in India

    Before GST kicked in, there were three kinds of excise duties in India.

    1) Basic Excise Duty

    • Basic excise duty is also known as the Central Value Added Tax (CENVAT). This category of excise duty was levied on goods that were classified under the first schedule of the Central Excise Tariff Act, 1985.
    • This duty was levied under Section 3 (1) (a) of the Central Excise Act, 1944. This duty applied on all goods except salt.

    2) Additional Excise Duty

    • Additional excise duty was levied on goods of high importance, under the Additional Excise under Additional Duties of Excise (Goods of Special Importance) Act, 1957.
    • This duty was levied on some special category of goods.

    3) Special Excise Duty

    • This type of excise duty was levied on special goods classified under the Second Schedule to the Central Excise Tariff Act, 1985.
    • Presently the central excise duty comprises of a Basic Excise Duty, Special Additional Excise Duty and Additional Excise Duty (Road and Infrastructure Cess) on auto fuels.

  • RBI’s job involves trade-offs, not conflicts

    The article discusses three things for the RBI to follow in fulfilling its role, these are- 1) Prudence 2) Flexibility 3) Acting within the mandate. Besides that, problems the RBI has been facing are also discussed. These things are discussed against the backdrop of Covid-19.

    Role of the RBI

    • A central bank like the RBI must replace intellectual certainty with the continuous debate over their actions.
    • RBI’s job involves complex trade-offs — next quarter vs quarter century, growth vs stability, and mandates vs expectations.
    • A global anthropological shock-like COVID makes these trade-offs — they are not conflicts — even harder.
    • The RBI must remember three things — acting prudently to balance the next quarter and quarter century, acting flexibly to blunt this economic cataclysm, and acting within their mandate to ensure institutional legitimacy and immunity.

    These three things are discussed below-

    1. Acting prudently

    • If everybody believed that in the long run we are all dead, we would never sit under trees planted by people who had no chance of sitting under them.
    • The coronavirus is a human tragedy but a central bank must not act like a commercial bank because that would compromise the balance between today and tomorrow.
    • A narcissism — bordering on solipsism — already reflects in global debt levels that steal from our grandchildren.
    • More importantly, India doesn’t have the economic strength to copy the US Federal Reserve’s $2.3 trillion offer to lend to businesses of all sizes and sorts.
    • And run anything close to this year’s expected US fiscal deficit of 15 per cent of GDP, or sustain Japan’s public debt levels at 240 per cent of GDP.
    • We are all in the same storm but we are all not in the same boat.

    2. Acting flexibly within the mandate

    • Renaissance physician Paracelsus had important advice for central banks; the dose makes the poison.
    • Anything powerful enough to help has the power to hurt; handling the inevitable tensions between the RBI’s dual mandate of growth and stability requires continuous work.
    • Our inflation targeting regime is a macroeconomic gift to India.
    • But recognising that is hardly inconsistent with acknowledging that inflation’s secular decline has many parents, some economic models are useful but all are incomplete, and the fog of war involves making second-best choices as long as they are reversible, proportional, and accountable.
    • Central banks often undertake liquidity management while leaving policy rates unchanged; current actions are not a conspiracy to undermine the MPC or its interest rate corridor (between reverse repo rate and MSF rate with repo rate midpoint targeting and call rate operating target).
    • They are a pragmatic encouragement for banks to lend to clients rather than lend Rs 7 lakh crore to the RBI.
    • Other virus flexibility includes repayment moratoriums (with 10 per cent provisions), bad loan accounting forbearance (despite past experience of breaking the thermometer doing little for the fever) and bank windows for NBFC/Mutual Fund liquidity.
    • Listening is hardly compromise.
    • Especially if accompanied by a will to unwind liquidity, asymmetry and forbearance when the planet’s gap year ends.

    3. Follow the mandate

    • Central bank governance is a fine balance; they function best when they don’t declare separation from the government and they aren’t considered a part of the finance ministry.
    • The difficulty of balance isn’t uniquely Indian.
    • The RBI must build on its track record of wisely balancing the trade-offs between depositors vs borrowers, companies vs banks, and stability vs growth.
    • And it must continue to stay out of the government’s domain.
    • The central bank crisis role debate is skewed by the great book, Lords of Finance, by Liaquat Ahamed that shows how central bankers of the 1920s failed to fight the Great Depression.
    • History matters but nobody knows if this is the beginning or ending of the virus.
    • Yet the global central bank COVID toolbox has been substantial; buying corporate bonds, making corporate loans, cutting interest rates, conducting open market operations, and reducing reserve ratios.
    • Additionally, banks have been permitted to grant loan moratoriums, hold less capital, restructure loans, pay lower deposit insurance premiums and delay bad loan recognition.
    • The emergency authority under Section 13 of the US Federal Reserve Act being used — prematurely — also exists in Section 18 of the RBI Act.
    • But emergency powers are the last resort. We are not there yet.
    • The recovery being V-shaped, U-shaped, or Bathtub-shaped is only modellable after the lockdown.

    Pre-existing problems facing the RBI

    • The RBI’s COVID balm is constrained by pre-existing conditions in Indian banking, which are given below-
    • Bad loans which peaked at Rs 14 lakh crore but still large.
    • Inadequate competition- scheduled commercial bank numbers have hovered between 90 and 100 since 1947.
    • Private bank governance- CEO so powerful that boards and shareholders are weak.
    • Public sector bank governance- shareholder so powerful that boards and CEOs are weak.
    • And the RBI’s own game (process, technology and human capital in regulation and supervision).
    • All these must be tackled with urgency when normalcy returns.

    A question based on the role of the central bank can be asked by the UPSC. Consider the following question “Crises have always tested the utility of central banks, be it the Great Depression, 2008 financial crisis or Covid-19. In light of this statement, explains the trade-offs involved in the RBI’s decisions and how shocks like Covid-19 makes these trade-offs even harder.”

    Way forward

    • Supplementing India’s fiscal and monetary policy interventions by announcing two bold reform plans — 90-day flick-of-pen and one-year structural — that tackle overdue reforms in labour, education, cities, finance, compliance, and civil services, will catalyse hope among employers, employees, banks, and overseas investors.

    Conclusion

    Creating a prosperous India needs many things. One of them is an independent, accountable, and boundaried central bank that listens.

     

  • Pandemic calls for deep-set forces and scientific concepts of development for building a modern economy

    The article discusses the recovery strategies for India. There are three examples from the past from which we can draw the lessons. 1) Recovery of the US and Europe after the World Wars 2) Recovery of Japan after World War 3) China’s stimulus package after the 2008 financial crisis. In the case of the first two, climate change was not the factor. But in case of the 2008 financial package, China emphasised green technologies and was benefited from it. Drawing on China’s example, the article suggests three pronged strategy for India’s recovery taking into account the climate change factor.

    Decisions on recovery and lessons from the past recovery frameworks

    • The decisions and directions taken by states from hereon will be judged ruthlessly by historical lenses.
    • Though India has managed the pandemic with relative precision, we cannot deny an impending emergence of a new socio-economic order, where the recovery is going to be hard-earned.
    • This is not the first time the world has faced an economic crisis and won’t be the last.
    • Can a country like India, which might be one of the few countries to come out of the crisis without a recession, take lessons from past recovery frameworks?
    • Recovery frameworks: Even though the very nature of the current health crisis is much different from the past crises like World Wars and their repercussions in Europe, the US and Japan.
    • But the evidence shows that ambitious recovery plans made these nation-states more prosperous than the pre-crisis period.

    Recovery lessons form the western world after the World Wars

    • Hurt by the two World Wars and a Great Depression in between, the western world demonstrated unprecedented recovery to attain post-war full employment and stabilized income levels.
    • Almost thirty years between World War II and 1973 recession (“Glorious Thirties“), the countries like the US, Canada, Germany, and France experienced a golden period of growth.
    • In the US, the labour productivity grew at 2.82% per year which meant that productivity doubled every 25 years thanks to better machines driven by electricity and internal combustion engines, better education and massive capital investment.
    • The world wars accelerated technological innovations in energy, manufacturing and vastly improved the labour pool.

    Recovery of Japan after World War

    • Severely hit by the war, Japan’s miraculous growth from 1950 to 1990 is another example of a state using great adversity to propel itself towards prosperity.
    • Post-war liberalization was augmented by multilateral trade agreements and export promotion schemes.
    • That propelled the Japanese economy to dizzying heights making it the second-largest economy at the time.
    • Apart from fiscal stimuli, immense efforts went into strengthening human capital by promoting R&D and skilling activities.
    • Suddenly, Japan becomes one of the most ingenious economies churning out one innovative product after another in fields like electronics.
    • In addition, pioneering quality systems made Japan the first Asian economy to become a developed state.

    Recoveries based on values and technological innovations

    • All the above recoveries are rooted in modern values like create, explore and meet challenges.
    • While large investments garner a lot of attention, role played by massive skilling and resultant technological innovation should not be forgotten.
    • Skilling and innovation enabled creating goods and services of the future.

    Climate change and recovery

    • These successful recovery plans did not have the responsibility to plan for an impending climate change hanging over our head by a thread.
    • The times were different; the needs were different: more importantly, the evidences were not as irrefutable as now.
    • A 2018 study titled ‘Earth’s future’, estimated that India will lose 10% of its GDP annually in a 3°C scenario and lose 14% of its GDP annually in a 4°C scenario in the long term.
    • And the time to act is ‘now’, as consequences of inaction are existential.

    China’s stimulus after the 2008 crisis with a focus on green technologies

    • Fast-forwarding to the 21st century, the 2008–09 Chinese economic stimulus plan pumped in $586 billion to manage the crisis.
    • With serious money of $586 billion going into upgrading selected industrial sectors to firm up its presence in the global value chains (GVC).
    • Interestingly, a sizeable portion went into green technologies.
    • China understood that if the world is provided with affordable green technologies at scale, the states will incentivize the increasingly eco-aware consumers to buy these products.
    • Catalyzed by plans like “Ten Cities, Thousand Vehicles and “Thousand Talents Program (TTP)” and generous state incentives, China became a global leader in e-vehicles.
    • Chinese-made buses started roaming famous cities across the world, the roads traditionally dominated by European makers.
    • Powered by generous capital infusion, China also attained leadership in solar panels, batteries and associated supply chains in a short period setting up a sustainable growth module.
    • A lesson in fiscal prudence: The 2008–09 Chinese economic stimulus plan is also criticized for raising the Chinese debt levels, hence giving us lessons in fiscal prudence.

    Should India opt for a green recovery module?

    • Can a developing India afford to allocate a significant portion of its precious resources towards a green recovery module?
    • Unbridled economic growth and sustainable development are not mutually exclusive.
    • In fact, we might not have a choice, given the movement of global supply chain towards green technologies and tightening screws around strict sustainability standards.
    • European Commission, for instance, has announced that every euro into the recovery plan will be linked to green recovery.

    A three-pronged approach is suggested for recovery

    1. Investment and incentives for green economic activities in the selected sectors

    • First, ambitious investment and incentives in catalyzing futuristic green economic activities in selected sectors.
    • Developing, manufacturing and deploying low carbon products could help India create more jobs: the kind of jobs that will survive into the future.
    • With Giga scale battery and solar manufacturing plans already underway, there is a huge demand globally for sustainable supply chain of even traditional sectors such as textiles.
    • India could choose 5 sectors where it can fill the sustainability vacuum helping the sub-continent emerge as a new global leader in those sectors.
    • India has the potential to scale-up currently ready technologies like e-VTOLs (intra-city electric aerial mobility), which will upend the global mobility modules, increasing the profitability of growing Indian e-mobility supply chain.
    • Companies like Hyundai who have already announced manufacturing of e-VTOLs should be attracted to India.
    • Crisis situations often provide policy windows, where all the stakeholders are empowered, and historically time-consuming decisions are fast-forwarded.
    • If India manages to efficiently remove regulatory bottlenecks and creates standards for e-VTOLs before anyone else, it will take a huge chunk of the global future mobility pie.
    • Similar initiatives for other strategic sectors could be carried out.

    2. Resolve regulatory and on-ground legacy issues

    • Aggressively resolving on-ground legacy issues and challenges.
    • Shackles around entrepreneurship from labour laws to clearances regimes should be broken one by one.
    • It could be done by leveraging the cooperative and competitive federalism evidenced through the crisis under the able leadership of the Hon’ble Prime Minister.
    • And the current policy window might be an ideal opportunity for Indian democracy to deliver.

    3. Focus on skilling people

    • Third, a big-ticket omni-channel skilling architecture should be instituted.
    • Universities should be empowered and enabled to come up with new-age educational programmes to serve futuristic industries.
    • A special focus should be given to develop enough trainers to train the millions of Indian youth getting ready for the labour market every year, in new-age skills.
    • Adequate online-offline training courses must be designed in a way that it does not affect daily wages drastically.
    • The big-ticket vocational programmes, specially directed at the informal sector which constitute more than 90% of the total workforce, has the potential to employ displaced and poor labourers.
    • A strategic skill committee may be empowered to dynamically identify key skills and tweak the training modules.
    • This can be integrated with the Ministry of Environment’s Green Skill Development Program to train 10 million youth by 2030.

    The issues discussed here are important for achieving sustainable and inclusive growth. A question based on this theme was asked by UPSC in 2019.

    Consider the question “It is argued that the strategy of inclusive growth is intended to meet the objectives of inclusiveness and sustainability together. Comment on this statement.”

    Conclusion

    The current pandemic calls for deep-set forces and scientific concepts of development for building a dynamic and modern economy. Green growth is one such concept that will add a new dimension to the economic dynamism of the sub-continent helping it serve the aspirations of its citizens.

  • It is time to design clear rules for departure from accepted norms of fiscal prudence

    This editorial spells out the size of the stimulus package that would be required to restart the economy. It also discusses the possible sources that the government could tap to raise the revenue. Such huge expenditure is likely to result in the huge fiscal deficit which would necessitate that the stimulus is time-bound and transparent.

    Prospects of substantially negative growth

    • Arvind Subramanian has likened the current economic situation to a “pralay (deluge)”.
    • A deluge in which the government should spend more than even what it ought to in a rainy day.
    • India, the former chief economic adviser said that India must plan for a “substantially negative” growth this year that might require an additional fiscal expenditure of Rs 10 lakh crore.
    • Corporate indebtedness was already high before the lockdown.
    • Insolvency cases will mount further.
    • Even companies facing no significant cash flow issues wouldn’t invest in uncertain public health as well as the demand-constrained environment.
    • Banks, too, aren’t going to lend, no matter how much liquidity the Reserve Bank of India (RBI) may infuse.
    • The burden of non-performing assets, which is set to get heavier in the coming months, makes it impossible for them to finance an economic recovery.
    • Last, but not the least, are faced with layoffs and pay cuts, they would rather save and will be afraid to spend.

    Importance of government spending in the current situation

    • Under the circumstances, the onus for ensuring that the wheels of the economy start moving lies on the government.
    • There’s no guarantee of it happening even with all lockdown restrictions being lifted.
    • Without somebody to spend, the economy is in real danger of contraction, which will, in turn, worsen the problem of businesses going bust, joblessness and loan defaults that can spread to the entire financial services industry.

    No “3F” constraints and risk of deflationary shocks

    • The one consolation today is that India is not saddled with its traditional “3F” constraints — food, fuel and foreign exchange — which were triggers for inflation and balance of payments crises.
    • On the contrary, public foodgrain stocks are at an all-time high, global oil prices have crashed and there is no run on the rupee, unlike during the “taper tantrum” period of May-August 2013.
    • Risk of deflationary shock: The risks, if at all, are tilted more towards demand-side “deflationary shocks” than supply-side inflation concerns.

    How will the government manage the resources?

    • The finances of both the Centre and states are in a mess, with receipts from tax and non-tax sources hardly covering even existing expenditures.
    • But governments enjoy sovereign borrowing powers that allow fund-raising at rates below that of triple A-rated instruments issued by private corporates, more so in the present risk-averse scenario.
    • Also, there is the option of deficit financing (“printing money”) through the RBI subscribing to primary auctions of government securities.
    • There are, of course, costs in such powers being exercised.
    • Past precedents — whether the issuance of ad hoc Treasury Bills to the RBI prior to April 1997 or the stimulus package post the 2008 global financial crisis — do not inspire confidence.

    A question based on the stimulus package and its consequences can be framed, for ex- “Do you agree with the view that a stimulus package by the government to restart the economy is necessary? What are the options with the government to raise the money for such a package? What could the consequences of such a package on the economy in the future?”

    Conclusion

    This is the time to design clear rules for departure from accepted norms of fiscal prudence. Any stimulus has to be transparent and time-bound.