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GS Paper: Indian Economy

  • Recent amendments to FDI policy – a boon or a bane?

    This article deals with the recent changes made by the government in the FDI policy. The major change was that the government approval route was made mandatory for investment coming from certain countries. There are certain ambiguities and issues with the latest changes.These are discussed here.

    What changes were made in the FDI policy?

    • Government approval route for investment: Investment is permitted through government route only in the following cases-
    • 1) An entity situated in a country which shares a land border with India.
    • 2) Where the owner of investment into India is situated in or is a citizen of any such country.
    • Further, any transfer of ownership of any existing or future foreign direct investment (FDI) in an entity in India (indirectly or indirectly) resulting in the beneficial ownership falling within the purview of the above restrictions, would require the government’s approval.

    Ambiguities arising due to press note

    • There appear to be certain ambiguities arising from the press note and the amendments to the Rules.
    • The usage of the term “FDI” in the press note and the relevant amendments to Rule 6(a) of the Rules, seem to suggest that the restrictions are on investments that are structured as FDI.
    • FDI is defined under the Rules to mean investment through equity instruments by a person resident outside India in an unlisted Indian company, or in 10% or more of the post issue paid-up equity capital on a fully diluted basis of a listed Indian company
    • The restriction doesn’t seem to be on investments by an FPI registered with SEBI.
    • FPI is permitted to invest in listed or to be listed Indian companies’ securities, in the manner set out in Schedule II of the Rules.
    • Also not on investments under the FVCI route.
    • Investment through FVCI is an investment in the securities of Indian companies operating in certain specific sectors, in the manner set out in Schedule VII of the Rules.
    • It is also unclear if “foreign investments” in LLPs, not being FDI, would also be subject to these restrictions.
    • This ambiguity is further amplified by the subject line of the press note, which reads “curbing opportunistic takeovers/acquisitions of Indian companies”, without making any reference to LLPs.
    • And the amendments to Rule 6(a) of the Rules, which only pertain to investments in equity instruments of an Indian company under Schedule I of the Rules.

    The points mentioned here add to our understanding of FDI and issues with it. A question based on the issue can be asked, for ex-“What are the reasons for a steady decline in FDI in India? To what extent FDI poilcy is responsible for this?”

    Difficulties in seeking government approval

    • The requirement of seeking government approval may also pose operational difficulties for many entities.
    • For instance, the approval requirement seems to be applicable in all cases of further investments irrespective of the threshold.
    • It applies whether or not such investments are in the form of rights issue (where all or almost all existing shareholders also participate) or preferential allotments.
    • Which results in causing some amount of hardship for entities to raise further capital, especially where entities already have existing investments from investors situated in countries like China.
    • The amendments to the Rules also do not attempt to clarify the applicability of the approval requirements where there is no change in the shareholding percentage of the investor pursuant to a follow-on investment.
    • Another aspect which is important, is the usage of the terms “directly or indirectly” in the context of transfer/ divestment of beneficial ownership of existing FDI, to entities in/ citizens of a country which shares a land border with India.
    • This may require global acquisitions of entities in other jurisdictions which have subsidiaries/ investee companies in India, by a person in one of India’s neighbouring countries, to be subject to the approval requirements, thereby impacting timelines for closing.

    No restrictions on external commercial borrowings (ECB)

    • There are presently no such commensurate restrictions under the ECB regulations.
    • Therefore, an eligible borrower could avail ECB from a recognised lender.
    • That includes a foreign equity holder in one of India’s neighbouring countries which are FATF compliant for any immediate funding requirements.
    • Any conversion of the ECB or any part thereof, into shares of the Indian company, would be subject to the restrictions and approval requirements under the FDI policy and the Rules.

    Conclusion

    The government/RBI should provide necessary clarifications on these issues and ambiguities at the earliest. With there being no sunset clause presently contemplated on the applicability of these restrictions, only time will tell if the amendments to the Rules are a boon to the economy and a step in the right direction, or otherwise.

    Back2Basics: What is ‘Rights issue’

    • Cash-strapped companies can turn to rights issues to raise money when they really need it.
    • In these rights offerings, companies grant shareholders the right, but not the obligation, to buy new shares at a discount to the current trading price.
    • A rights issue is an invitation to existing shareholders to purchase additional new shares in the company.
    • This type of issue gives existing shareholders securities called rights.
    • With the rights, the shareholder can purchase new shares at a discount to the market price on a stated future date.
    • The company is giving shareholders a chance to increase their exposure to the stock at a discount price.
    • Until the date at which the new shares can be purchased, shareholders may trade the rights on the market the same way that they would trade ordinary shares.
    • The rights issued to a shareholder have value, thus compensating current shareholders for the future dilution of their existing shares’ value.
    • Dilution occurs because a rights offering spreads a company’s net profit over a larger number of shares.
    • Thus, the company’s earnings per share, or EPS, decreases as the allocated earnings result in share dilution.

    What is the Limited Liability Partnership (LLP)?

    • LLPs are a flexible legal and tax entity that allows partners to benefit from economies of scale by working together while also reducing their liability for the actions of other partners.
    • In a general partnership, all partners share liability for any issue that may arise.
    • The LLP is a formal structure that requires a written partnership agreement and usually comes with annual reporting requirements depending on your legal jurisdiction.

    What is the FVCI route of investment?

    • Foreign Venture Capital Investor’ (FVCI) means an investor incorporated and established outside India and registered with Securities and Exchange Board of India under Securities and Exchange Board of India (Foreign Venture Capital Investors) Regulations, 2000.
    • The amount of consideration for all investment by an FVCI has to be received/made through inward remittance from abroad through banking channels or out of funds held in a foreign currency account and/ or a Special Non-Resident Rupee (SNRR) account maintained by the FVCI with an AD bank in India.
    • The foreign currency account and SNRR account shall be used only and exclusively for transactions under the relevant Schedule.

  • Restarting the coronavirus-hit economy

    The theme of the article is the restarting of the Indian economy. Striking the right balance between livelihood and the spread of the virus is important for India. While India has been doing well on the curbing of the spread of the virus, its economy remains in the complete shutdown. So, we must restart our economy and this article offers some suggestions to do so and some trends that our economy is showing are discussed here.

    Striking the balance between the economy and the spread of the virus

    • One critical problem is striking the right balance between curbing the spread of the virus and keeping the economy functioning.
    • We cannot have the poor, the labourers and the migrants bear the brunt of the effort to contain the spread of the virus.
    • And nor do we want to weaken the foundations of the economy so much that we emerge from the pandemic onto an economic wasteland.
    • The choice between lives and economy is also a choice between lives and lives.

    Appreciation of India’s effort to curb the virus

    • India’s effort to curb the spread of the virus has received appreciation — not just the state of Kerala, which has got accolades from around the world, but the country as a whole.
    • The incidence of COVID-19 remains low in India.
    • Of every 10 million people, there are as yet 5 lives lost in India.
    • Comparison with the world: This is vastly lower, not just compared to Belgium, which tops the list with 5,180 fatalities for every 10 million people, but many other nations, such as the United States with 1,370 fatalities, Spain with 4,550, Italy with 4,080 and the UK with 2,550 fatalities.

    One of the many puzzles associated with the Covid-19 is variation shown by it in fatality rate across the globe. Following are some figures about it.

    Worldwide variation in the fatality rate

    • To be fair, the low fatality, per 10 million population, is not specific to just India.
    • We have comparably low figures currently in almost all African and South Asian nations.
    • Thus, it is seven for Bangladesh, three for Sri Lanka, nine for Pakistan, two for Tanzania, one for Nigeria, and 0.3 for Ethiopia.
    • No one fully understands these huge differences between Europe and North America, on the one hand, and Africa and South Asia, on the other.
    • Isolation of nation, not a factor: This cannot be because these nations are more isolated.
    • Bangladeshis are among the most globally scattered people and Ethiopia has huge interactions with China, but the fatality rates are low in both countries.
    • Why is this so? The short answer is we do not know.

    Defeating the virus by keeping reproduction number below one

    • It is important to realise that the risk cannot be cut to zero — nothing in life is a zero-risk activity.
    • To defeat the virus, the aim has to be to keep the “reproduction number”, or R-0, down to less than one.
    • R-0 refers to the number of people, on average, who get infected by each infected person.
    • When R-0 reaches less than one in any given region, such as is the case in Kerala, we know that the incidence of the disease is winding down in that region.

    Following points are important from the UPSC perspective. A question can be framed on the economic damage of the Covid-19, opportunities provided by it, its implications for the vulnerable section of the society, unemployment, international trade, changes in the economic policies of the government etc.

    Coming out of lockdown: Economic policy challenge

    • The economic policy challenge is about how to come out of the lockdown.
    • This has to be done carefully, but quickly.
    • The stringency of India’s lockdown at top: A study by researchers at the University of Oxford, of the stringency of lockdowns in 73 countries, places India right on top.
    • For a short while, this is worth it, and also impressive for a populous nation like India.
    • Not desirable position: The top rank on the stringency index is not something any country will want to occupy for long.
    • That will have a devastating effect on the poor and damage the nation’s long-run economic prospects.

    Trends in the Indian economy

    • Unemployment rate at an all-time high: There are studies showing that India’s unemployment rate is now at 24 per cent, an all-time high.
    • Biggest ever capital outflow in a month: March also saw the biggest outflow of capital from the nation ever recorded in one month — roughly $15 billion left the nation.
    • This also happens to be the largest capital outflow from any emerging economy in March.
    • Clearly, global players are reacting to the fact that the economy is not functioning.
    • Rupee at an all-time low: These sentiments have weakened the Indian rupee, which is now at an all-time low.
    • Some of these problems are inevitable in this dystopian world; we can deal with these problems for a short while.
    • Global trade: If these trends persist, India would end up ceding space to other nations in global trade, exports and business, and the suffering will be huge on the working classes.

    Way forward in opening the economy

    • Once this phase of the lockdown ends on May 3, we will have to start opening businesses, allowing the private sector, especially the informal enterprises and small firms, to operate.
    • Rule of behaviour: There will have to be rules of behaviour in place, such as social distancing, masks, hand-washing, but we have to begin to facilitate poor labourers to reach their place of work, and our farms and factories to function.
    • Focus on participation, not permission: We have to encourage the rules of behaviour to continue by “participation” and not by bureaucratic “permission”.
    • India has a long history of the “permit raj”, where all businesses were beholden to the bureaucracy for what they did.
    • This had a tendency to strangle all but a few big firms and had held up the nation’s economic growth for long.

    Conclusion

    India stands at an important juncture. A misstep at such moment could turn the course of history for the nation. So, the right steps at various fronts from containing the spread to the reopening of the economy are required from the government.

  • Fiscal empowerment of States

    The article elaborates on the central role played by the States in the fight against Covid-19. The article emphasises the role that States can play in the implementation of the various measures to tackle the epidemic and economic revival of the country. It also highlights the lack of resources at the States’ disposal and reasons for the lack such as revenue loss in the lockdown and lower devolution by the Central Government. In the end, there is a suggestion to increase the borrowing limit of the States’.

    Time to relax fiscal constraints on the States

    • The speed of economic revival will depend on how long it will take to revive economic activities and the volume of stimulus through public spending the government is able to provide.
    • It now appears that the lockdown will be lifted in stages and the recovery process will be prolonged.
    • The country is literally placed in financing a war-like situation.
    • The government will have to postpone the fiscal consolidation process for the present, loosen its purse strings and finance its deficits substantially through monetisation.
    • This is also the time for the government to announce relaxation in the States’ fiscal deficit limit to make them effective participants in the struggle.

    The following points highlight the importance of States in dealing with the crisis. The federal structure of India comes to the fore here. The UPSC can aks question on this theme, for example, “Discuss the important role played by the States in dealing with the Covid-19 and how it underscores the federal character of the Indian polity?”

    The important role played by the States

    • Prioritise health spending: It is also important for the States to realise the importance of health and prioritise spending on health-care services.
    • Being closer to the people, the States have a much larger responsibility in fighting this war.
    • Public health, as well as public order, are State subjects in the Constitution.
    • Acts invoked for lockdown: Some States were proactive in dealing with the COVID-19 outbreak by involving the Epidemic Diseases Act, 1897, even before the Government of India declared a universal lockdown invoking the Disaster Management Act, 2005.
    • Of course, the Centre under Entry 29 of the Concurrent List has the powers to set the rules of implementation which states, “Prevention of the extension from one State to another of infectious or contagious diseases or pests affecting men, animals or plants”.
    • Implementation at the ground level: While Central intervention was done to enable, “consistency in the application and implementation of various measures across the country”, the actual implementation on the ground level will have to be done at the State level.
    • Furthermore, States are better informed to decide the areas and activities where relaxations should be done as the coronavirus curve is flattened.
    • Coordination: Hopefully, there will be better coordination between the Union and State governments instead of claiming credit and apportioning blame.

    Covid-19 has made clear the neglect and poor state of health in India. The UPSC can frame the question based on the health infrastructure and expenditure on it. The question can be framed on the following lines “Covid-19 has highlighted India’s lack of preparedness and the poor health infrastructure in the country. What are the reasons for it? Give suggestions to improve it.”

    Neglect of the health-care sector in the country

    • The pandemic has underlined the historical neglect of the health-care sector in the country.
    • Expenditure on health as a percentage of GDP: The total public expenditures of Centre and States works out to a mere 3% of GDP.
    • In 2017-18, in per capita terms, the public expenditure on medical and public health varied from an abysmal ₹690 in Bihar and ₹814 in Uttar Pradesh to the highest of ₹2,092 in Kerala.
    • The centrally sponsored scheme, the National Health Mission, is inadequately funded, micromanaged with grants given under more than 2,000 heads and poorly targeted.
    • The focus of “Ayushman Bharat” has been to advocate insurance rather than building wellness centres.

    Economic revival by the States

    • Besides protecting lives and livelihoods, States will have to initiate and facilitate economic revival, and that too would require substantial additional spending.
    • Hand holding small and medium enterprises which have completely ceased production, providing relief to farmers who have lost their perishable crops and preparing them for sowing in the kharif season are other tasks that require spending.
    • In fact, States have been proactive. Kerala came out with a comprehensive package allocating ₹20,000 crores to fight the pandemic.
    • Almost all States have taken measures to provide food to the needy besides ramping up health-care requirements.

    Lack of resources and revenue loss suffered by the States

    • While the requirement of States for immediate expenditures is large, they are severely crippled in their resources.
    • In the lockdown period, there has virtually been no economic activity and they have not been able to generate any revenue from State excise duty, stamp duties and registration fees, motor vehicles tax or sales tax on high-speed diesel and motor spirit.
    • The revenue from Goods and Services Tax is stagnant and compensation on time for the loss of revenue has not been forthcoming.
    • As the recovery process will be staggered, it is doubtful whether tax revenues will register any positive growth in 2020-21.
    • Not surprisingly, the State has decided to monetise land through auctions to get money besides regularising unauthorised constructions by paying high fees.

    Lower tax devolution from the Centre

    • The position regarding tax devolution from the Centre is even more precarious.
    • To begin with, the tax devolution in the Union Budget estimate is lower than the Commission’s estimate by ₹70,995 crores.
    • In fact, the Budget estimate for 2020-21 itself is a huge overestimate when seen against the 11-month actual collections in 2019-20.
    • The required growth to achieve the Budget estimate is 33.3% over the annualised actual collection.
    • The projections are that the growth of nominal GDP in 2020-21 will be just about 4%.
    • And if the tax revenue increases by the same rate, devolution to the States would be lower by ₹2.2-lakh crore than the Finance Commission’s estimate.
    • This results in a loss of ₹9,173 crores for Tamil Nadu, ₹9,000 crores for Andhra Pradesh, ₹8,000 crores for Karnataka, ₹4,671 crores for Telangana, and ₹4,255 crores for Kerala.
    • Supplementary report by the Finance Commission: There is a strong case for the States to go back to the Finance Commission with a request to make and give a supplementary report.

    Of late, the poor fiscal health of the States has been in the news. Following are some of the factors that are responsible for it. A question can be asked with relation to this problem like “The States are facing fiscal constraints owing to the lack of revenue. What are the reasons for it? What are the options available to help the States to deal with such a situation?”

    Problems faced by the States in raising resources

    • There is only a limited scope for expenditure switching and reprioritisation now.
    • Limited space for borrowing: Their borrowing space too is limited by the fiscal responsibility and budget management limit of 3% of Gross State Domestic Product (GSDP).
    • High yield no the State bonds: Faced with an acute fund crunch, Kerala floated 15-year bonds but was faced with a huge upsurge in the yield to 8.96%.
    • Increase in the WMA limit: The announcement by the Reserve Bank of India on the increase in the limit of ways and means advances by 60% of the levels prescribed in March 31 could help States to plan their borrowing better.
    • But that is too little to provide much relief.

    Conclusion

    It is important for the Central government to provide additional borrowing space by 2% of GSDP from the prevailing 3% of GSDP. This is the time to fiscally empower States to wage the COVID-19 war and trust them to spend on protecting lives, livelihoods and initiate an economic recovery.

  • Super-power rivalries exacerbated by coronavirus pandemic offer India an opportunity

    The article discusses three fronts on which actions are required viz- health, economy and geopolitics. How much the global economy is going to be affected? how the US-China rivalry would affect the recovery? what the lack of global coordination means? all such questioned are discussed here.  It also suggests actions that India should take to deal with the crisis.

    Many unknowns than knowns about Covid-19

    • The virus currently has many more unknowns than knowns.
    • We don’t know for sure how it spreads, whether people can get re-infected, whether it is mutating, whether the hot weather kills it, and what the real fatality rate is.
    • We don’t know for sure how far we are from an anti-viral.
    • We know that we are at least 18 months away from having a vaccine that works and is available at scale.
    • Till an anti-viral is found, economic activity will be constrained, and this will affect people, industries and countries in disparate ways.

    The extent of damage to the global economy

    • Loss of ten trillion dollars: The global economy is set to lose close to ten trillion dollars because of the “self-induced coma” it has been put into — to use Paul Krugman’s evocative phrase.
    • Loss of effectiveness of monetary policy: The preceding global financial crisis (GFC) has exhausted the efficacy of monetary tools.
    • In addition, corporates globally are leveraged to the tune of $12 trillion.
    • The slump in demand: The accompanying oil price collapse, beginning due to a spat between producers Saudi Arabia and Russia have been compounded by a precipitous slump in demand.
    • The Chinese economy can’t help as it did during the GFC, as it is hemmed in itself.
    • Even if it could, there is too much global suspicion of China to allow it to do so. So, countries will largely be on their own.

    Tensions between the US and China

    • The tensions between the US and China have escalated into a full-scale superpower crisis after the virus spread.
    • Since 2010, there has been great concern in the US about China’s rise.
    • China’s muscular foreign policy together with its aggressive stance on multiple issues, most importantly on technology and technology standards, has created conflict.
    • The coronavirus is spreading in the US in an election year and smashing its economy.
    • The virus infected over three-quarter of a million people in the country and killed more than 40,000.
    • After this, China could be seen as enemy number one in the US.

    No global coordination

    • No wonder then that at a time when the world yearns for global coordination, there is almost none — in healthcare responses and economic coordination.
    • Multilateral agencies, especially the WHO and UN, suffer a complete loss of credibility.
    • India needs to chart its own course in these turbulent times.
    • If India takes the requisite actions it may come out well.

    Following suggestions are important from the UPSC perspective. The suggestions deals with three fronts-health, economic and geopolitics.

    How India could come out of the crisis?

    • India needs to act at three levels — health, economic and geopolitical.

    1. Actions at the health level

    • The Union Ministry of Health and Family Welfare has done well to stem the spread of the infection.
    • It has sensitised the public, introduced the concept of social distancing and isolation in the most challenging situations.
    • Now it must test at scale and isolate.

    2. Actions at the economic level

    • Indians cannot afford to stay locked much longer.
    • We are too poor and too many of us live on a day-to-day basis — not even on a paycheck to paycheck basis.
    • Economic activity will be subdued in the near-term, but it must be “unlocked”.
    • The current IMF projections suggest that India will have the highest growth rate in the world this year.
    • Oil prices have collapsed, really helping our balance of payments.
    • Our food stocks are plentiful, the rabi crop has been good, and the prognosis for the monsoon is positive.
    • Low inflationary pressure: This, together with the fact that aggregate demand is down, will dampen inflationary impulses.
    • The “new RBI” has acted boldly and strongly.
    • It has taken prompt actions to reduce rates, increase liquidity, adjust prudential norms, allow moratoriums, and protect financial entities.
    • Indian is better placed: The weakened rupee will help our exports and with a debt to GDP ratio of about 73 per cent, along with better growth prospects, India is relatively better placed than several other countries.
    • We should, therefore, not unduly worry about our credit rating. This both allows and actually requires the government to act on the fiscal front.
    • The government needs to implement the following four steps to spur the economy.
    • (1) It should do so by “printing money” given the moderated inflation
    • (2) It needs to provide additional direct benefit transfers of Rs 2,000 every month for three months to Jan Dhan accounts, together with foodgrains release from the FCI, to the tune of around Rs 65,000 crore, to alleviate people’s miseries.
    • (3) It needs to protect MSMEs directly by providing them working capital (with an RBI backstop) and, like in the UK, provide 80 per cent of the salary to employees of the “GST-paying MSMEs” for six months.
    • (4) It needs to launch a massive public works programme outside the Budget as suggested by the chairman of CII’s National Committee of Infrastructure and PPP, Vinayak Chatterjee.
    • This fund should be earmarked for infrastructure and a quarter of its budget should be set aside for strengthening and upgrading primary health centres.
    • The allocation should not be less than Rs 200,000 crore.
    • Push through pending reforms: The government should take advantage of the crisis to push through much needed pending reforms in agriculture-especially those pertaining to APMC), power-pricing and discoms, banks-government ownership at 30 per cent and bad banks.
    • Revenue from private gold: Given the paucity of tax revenues, the government could also consider having the PM making an appeal for private gold from people and temples.
    • It could target 1,000 tonnes of gold worth $30 billion and offer a five per cent tax-free return repayable ($1.5 billion a year) after 10 years, in rupees or gold.

    3. Actions at the geopolitical level

    • India can come out ahead if we act now.
    • Super-power rivalries will create opportunities to replace China as a major supplier to the US and Japan.

    Conclusion

    The battle to deal with the corona disaster has to be fought on many fronts. India must form a strategy and act on various front i.e. health, economic and geopolitical- to be victorious at the end.

  • Monetary Policy Committee (MPC) to meet 5x this Fiscal

    The rate-setting Monetary Policy Committee (MPC) will be meeting five times in FY21, against seven in FY20.

    Monetary Policy tools are all-time favourites of UPSC. Kindly go through the link given in the Back2Basics section.

    Monetary Policy Committee (MPC)

    • The Monetary Policy Committee (MPC) is a committee of the RBI, which is entrusted with the task of fixing the benchmark policy interest rate (repo rate) to contain inflation within the specified target level.
    • The RBI Act, 1934 was amended by Finance Act (India), 2016 to constitute MPC to bring more transparency and accountability in fixing India’s Monetary Policy.
    • The policy is published after every meeting with each member explaining his opinions.
    • The committee is answerable to the Government of India if the inflation exceeds the range prescribed for three consecutive months.
    • Suggestions for setting up a Monetary policy committee is not new and goes back to 2002 when YV Reddy committee proposed to establish an MPC, then Tarapore committee in 2006, Percy Mistry committee in 2007, Raghuram Rajan committee in 2009 and then Urjit Patel Committee in 2013.

    Composition and Working

    • The committee comprises six members – three officials of the RBI and three external members nominated by the Government of India.
    • The meetings of the Monetary Policy Committee are held at least 4 times a year and it publishes its decisions after each such meeting.
    • The Governor of RBI is the chairperson ex officio of the committee.
    • Decisions are taken by a majority with the Governor having the casting vote in case of a tie.
    • They need to observe a “silent period” seven days before and after the rate decision for “utmost confidentiality”.

    Back2Basics

    Monetary Policy tools and Money Supply in India

     

    Also read:

    How reverse repo rate became benchmark interest rate in the Indian economy?

  • What is Helicopter Money?

    With the coronavirus-hit economy falling deeper and deeper into a chasm with each passing day, Telangana chief minister KC Rao earlier this month has said helicopter money can help states come out of this crisis.

    Various monetary policy tools are being considered to boost consumer demand in the economy which is stricken by the coronavirus pandemic. Helicopter Money is one such tool.

    What is Helicopter Money?

    • This is an unconventional monetary policy tool aimed at bringing a flagging economy back on track.
    • It involves printing large sums of money and distributing it to the public. American economist Milton Friedman coined this term.
    • It basically denotes a helicopter dropping money from the sky.
    • Friedman used the term to signify “unexpectedly dumping money onto a struggling economy with the intention to shock it out of a deep slump.”
    • Under such a policy, a central bank “directly increases the money supply and, via the government, distributes the new cash to the population with the aim of boosting demand and inflation.”

    Is helicopter money the same as quantitative easing (QE)?

    • Quantitative easing involves the use of printed money by central banks to buy government bonds.
    • But not everyone views the money used in QE as helicopter money.
    • It sure means printing money to monetize government deficits, but the govt has to pay back for the assets that the central bank buys.
    • It’s not the same as bond-buying by central banks “in which bank-owned assets are swapped for new central bank reserves.
    • Helicopter money is also different from a central bank directly financing the debt of a government.

    Pros and cons of helicopter money

    Pros

    • Helicopter money does not rely on increased borrowing to fuel the economy, which means that it doesn’t create more debt and interest rates can remain unchanged.
    • Generally, helicopter money boosts spending and economic growth more effectively than quantitative easing because it increases aggregate demand – the demand for goods and services – immediately.
    • While government money drops that come from debt might not boost consumer spending, due to the debt needing to be repaid, it is often thought that ‘money finance’ will stimulate the economy.

    Cons

    • Unlike quantitative easing, using helicopter money as a tactic is not reversible, and many argue that it’s not a feasible solution to revive the economy.
    • A country’s central bank sets its interest rates to reach economic growth targets.
    • However, a helicopter drop means that a central bank cannot use interest rates to recover any costs, because the money is not linked to a borrowed asset (loan).
    • Instead, the money is given directly to the public. This may lead to over-inflation and cause damage to the central bank’s financials.
    • One of the main risks associated with helicopter money is that it could lead to a significant devaluation of the currency on the foreign exchange market.
    • As more money is printed and supply increases, the value of the domestic currency could significantly decrease.
    • It could also discourage speculators from buying the currency as it is less likely to perform well.

  • Economy in lockdown: On India’s worst-case scenario

    This op-ed discusses the latest projections by the IMF. The latest projection and suggestions by IMF are the bleak reminder of economic disruption we have been experiencing.

    IMF discards its previous projections

    • Less than two months ago, IMF had asserted that “global growth appears to be bottoming out” (i.e. announcing the worst is over).
    • But the pandemic induced ‘Great Lockdown’ has forced the IMF to junk all its previous projections for economic output in 2020.
    • Faced with the stark reality of sweeping shutdowns of almost entire economies worldwide, the fund last week acknowledged that the current “crisis is like no other”.
    • The IMF slashed its projection by 6.3 percentage points from its January forecast for 3.3% growth to a 3% decline.
    • This is the sharpest contraction in world output since the Great Depression of the 1930s.
    • Comparison with 2009 slowdown: In contrast, the recession of 2009 saw world output contract by a mere 0.1%.
    • The IMF was blindsided by the comments from Chinese authorities and WHO.
    • Which is clear from the fact that as recently as February 22, the fund’s chief, Kristalina Georgieva, told G20 Finance Ministers that “global growth would be about 0.1 percentage points lower” than forecast in January.
    • China’s GDP, she projected, would expand by 5.6% this year, 0.4 percentage points slower than assumed in January.

    Latest projections for China by the IMF

    • Last week, the IMF slashed China’s forecast to a growth of 1.2%, citing data on industrial production, retail sales, and fixed asset investment that, it said, suggested a contraction of about 8% in the first quarter.
    • China reported a 6.8% first-quarter contraction.
    • Still, in projecting an annual expansion in Asia’s largest economy, the fund is rather optimistically foreseeing a sharp rebound in activity over the rest of the year.

    The following data of the revised projections gives us an idea about the extent to which the crisis has been damaging the economy. There are also suggestions about the strategy to deal with the crisis and that includes a stimulus package.

    Projections and suggestions for India

    • On India, the IMF has cut its projection for growth in the fiscal year that started on April 1, from January’s 5.8%, to 1.9%.
    • This projection is base on two assumptions given below.
    • 1. This again appears predicated on the fund’s baseline scenario that assumes that the pandemic would ‘fade in the second half of 2020’, allowing containment efforts to be unwound and economic activity to normalise.
    • 2. Another key assumption by the IMF’s economists is the availability of policy support to nurture the revival once activity restarts.
    • Suggestion for India: Jettisoning its storied fiscal conservatism, the IMF’s chief economist, Gita Gopinath, has advocated ramping up a broad-based and coordinated stimulus once the disease has been contained.
    • Such measures would help avoid the errors of the Great Depression years when premature efforts to prune budget deficits prolonged the downturn.
    • Inadequate fiscal measures in India: In this context, India’s fiscal measures pale in terms of scale when compared with what several other nations have undertaken.

    Conclusion

    Given the size of the informal sector in India as well as the anticipated prolonged disruption in labour supply even in more formal parts of the economy, the Centre needs to proactively commit to a substantial stimulus package in order to ensure that once the economy reopens, it has the legs to run.

  •  Indian’s decision on FDI to stop predatory Chinese hunt for Indian companies

    This editorial discusses the implications of growing Chinese investment in India. After People’s Bank of China bought 1 per cent stake in HDFC bank, Indian government made prior government approval mandatory for investment from countries sharing border with India. Various aspects of the move are discussed here.

    No separating commerce and security in dealing with China

    • India’s move to prevent a predatory Chinese hunt for Indian companies comes at a time when the stock market has been badly bruised by the coronavirus.
    • It underlines the emerging perception in India that there is no separating commerce and security in dealing with China.
    • India’s concerns are similar to those being expressed elsewhere in the world.
    • A number of European countries have already moved in that direction.
    • In recent years, apprehensions have grown, in both the developing and developed world, that China is targeting their infrastructural, industrial and technological assets for control.
    • But many governments were willing to give the benefit of doubt to Beijing.
    • That willingness has rapidly eroded in the wake of the corona crisis that has devastated the Western world.

    Taking economic advantage of other nation’s misery

    • Although few world leaders want to join the US President in publicly attacking China.
    • Many of them know that Beijing bears some responsibility for letting a health emergency in one of its cities become a global pandemic.
    • That Chinese companies, with access to easy money and strong political support in Beijing, are now taking economic advantage of other nations’ misery has added insult to injury.
    • While most leaders are preoccupied with the corona crisis, they are not likely to let Beijing have its way.
    • Even in Britain, where the Boris Johnson government is now taking a second look.
    • Last week, the British Foreign Secretary, said there will be no going back to “business as usual” with China.

    China’s growing influence has been posing challenges for India on various fronts. Its growing footprint on India’s economy is one of such challenges. The UPSC frames question in relation to China from various angles. So, the penetration of China in India economy is also an important aspect from the Mains perspective.

    Rethinking the commercial engagement with China

    • Beyond the question of accountability for the spread of the coronavirus, many countries are rethinking the very nature of their commercial engagement with China.
    • Gaming the system by China: On a host of issues ranging from trade and investment to intellectual property protection, there is an inescapable sense that China has gamed the global system for unilateral gains.
    • India late in learning: India certainly has had a longer learning curve than the West in recognising the relationship between commerce and national security.
    • Since the early 1990s, Delhi bet that expanding economic cooperation with China will help mitigate political disputes.
    • But the differences have only become intractable even as China became stronger economically.
    • India gave China an easy pass into the WTO.
    • India’s trade deficit: It let cheap imports from China undermine India’s manufacturing sector and run up a massive trade surplus.
    • India allowed massive Chinese penetration of its telecom, digital and other advanced sectors only to discover the multiple negative consequences.
    • India’s new approach: The last few years have seen a new approach that has seen India oppose China’s Belt and Road Initiative and walk out of the RCEP negotiations citing the trade imbalance with China.

    Conclusion

    The decision on Chinese FDI can be seen as one of the piece of the puzzle India has to face on the various front. But the puzzle of dealing with a rising China’s strategic economic onslaught will test India for a long time.

  • How reverse repo rate became benchmark interest rate in the Indian economy?

    Context

    • The Indian economy’s slowdown during 2018 and 2019 is becoming much worse in 2020 with the spread of COVID-19 and the stalling of almost all economic activity.
    • Like most other central banks in the world, the RBI, too, has tried to cut interest rates to boost the economy.
    • However, unlike in the past, when the RBI used its repo rate as the main instrument to tweak the interest rates, today, it is the reverse repo rate that is effectively setting the benchmark.

    We can expect a straight forward question based on this newscard.  For example:  “Critically examine the efficacy of reverse repo rate as benchmark interest rate in the Indian economy. “

    What are repo and reverse repo rates?

    • The repo rate is the rate at which the RBI lends money to the banking system (or banks) for short durations.
    • The reverse repo rate is the rate at which banks can park their money with the RBI.
    • With both kinds of the repo, which is short for repurchase agreement, transactions happen via bonds — one party sells bonds to the other with the promise to buy them back (or repurchase them) at a later specified date.
    • In a growing economy, commercial banks need funds to lend to businesses.
    • One source of funds for such lending is the money they receive from common people who maintain savings deposits with the banks. Repo is another option.

    Repo as benchmark

    • Under normal circumstances, that is when the economy is growing; the repo rate is the benchmark interest rate in the economy.
    • This is because it is the lowest rate of interest at which funds can be borrowed and, as such, it forms the floor rate for all other interest rates in the economy.
    • For instance, the interest rate consumers would have to pay on a car loan or the interest rate they will earn from a fixed deposit etc.

    What has changed now?

    • Over the last couple of years, India’s economic growth has decelerated sharply.
    • This has happened for a variety of reasons and has essentially manifested in lower consumer demand.
    • In response, businesses held back from making fresh investments and, as such, do not ask for as many new loans.
    • Add to this, the pre-existing incidence of high non-performing assets (NPAs) within the banking system.
    • Thus, the banks’ demand for fresh funds from the RBI has also diminished. This whole cycle has acutely intensified with the ongoing lockdown.

    Consequences: Rise in Liquidity

    • As such, the banking system is now flush with liquidity for two broad reasons.
    • On the one hand, the RBI is cutting repo rates and other policy variables like the Cash Reserve Ratio to release additional and cheaper funds into the banking system so that banks could lend.
    • On the other, banks are not lending to businesses, partly because banks are too risk-averse to lend and partly because the overall demand from the businesses has also come down.

    So, how has reverse repo become the benchmark rate?

    • The excess liquidity in the banking system has meant that banks have been using only the reverse repo (to park funds with the RBI) instead of the repo (to borrow funds).
    • As of April 15, RBI had close to Rs 7 lakh crore of banks’ money parked with it.
    • In other words, the reverse repo rate has become the most influential rate in the economy.

    What has the RBI done?

    • Recognising this, the RBI has cut the reverse repo rate more than the repo (see graph) twice in the spate of the last three weeks.
    • The idea is to make it less attractive for banks to do nothing with their funds because their doing so hurts the economy and starves the businesses that genuinely need funds.

    Will the move to cut reverse repo, work?

    • It all depends on the revival of consumer demand in India.
    • If the disruptions induced by the outbreak of novel coronavirus continue for a long time, consumer demand, which was already quite weak, is likely to stay muted.
    • Businesses, in turn, would feel no need to borrow heavily to make fresh investments.
    • If consumer demand revives quickly, the demand for credit will build up as well.

    Concerns of lower reverse repo

    • From the banks’ perspective, it is also important for them to be confident about new loans not turning into NPAs, and adding to their already high levels of bad loans.
    • Until banks feel confident about the prospects of an economic turnaround, cuts in reverse repo rates may have little impact.

    Back2Basics: Long Term Repo Operations (LTRO)

    • The LTRO is a tool under which the RBI provides 1-3 year money to banks at the prevailing repo rate, accepting government securities with matching or higher tenure as the collateral.
    • Funds through LTRO are provided at the repo rate.
    • But usually, loans with higher maturity period (here like 1 year and 3 years) will have a higher interest rate compared to short term (repo) loans.
    • According to the RBI, the LTRO scheme will be in addition to the existing Liquidity Adjustment Facility (LAF) and the Marginal Standing Facility (MSF) operations.
    • The LAF and MSF are the two sets of liquidity operations by the RBI with the LAF having a number of tools like repo, reverse repo, term repo etc.

  • SDR general allocation by IMF

    • Finance Minister has said that India could not support a general allocation of new Special Drawing Rights (SDR) by the IMF because it might not be effective in easing coronavirus-driven financial pressures.
    • FM Nirmala Sitharaman has stated that such a global liquidity boost by the IMF could produce potentially costly side-effects if countries used the funds for “extraneous” purposes.

    Details of SDR mechanism:

    What is SDR?

    • The SDR is an interest-bearing international reserve asset created by the IMF in 1969 to supplement other reserve assets of member countries.
    • To participate in this system, a country was required to have official reserves.
    • This consisted of a central bank or government reserves of gold and globally accepted foreign currencies that could be used to buy the local currency.
    • It is based on a basket of international currencies comprising the U.S. dollar, Japanese yen, euro, pound sterling and Chinese Renminbi.
    • It is not a currency, nor a claim on the IMF, but is potentially a claim on freely usable currencies of IMF members.
    • The value of the SDR is not directly determined by supply and demand in the market but is set daily by the IMF on the basis of market exchange rates between the currencies included in the SDR basket.

    Who can hold SDRs?

    • SDRs can be held and used by member countries, the IMF, and certain designated official entities called “prescribed holders”.
    • It cannot be held, for example, by private entities or individuals.
    • Its status as a reserve asset derives from the commitments of members to hold, accept, and honour obligations denominated in SDR.
    • The SDR also serves as the unit of account of the IMF and some other international organizations.

    General allocation of SDRs

    • An SDR allocation is a low-cost way of adding to members’ international reserves, allowing members to reduce their reliance on more expensive domestic or external debt for building reserves.
    • The IMF has the authority under its Articles of Agreement to create unconditional liquidity through “general allocations” of SDRs to participants in its SDR Department (currently, all members of the IMF) in proportion to their quotas in the IMF.

    The SDR Interest Rate

    • The interest rate on SDRs, or the SDRi, provides the basis for calculating the interest rate that is charged to member countries when they borrow from the IMF and paid to members for their remunerated creditor positions in the IMF.
    • It is also the interest paid to member countries on their own SDR holdings and charged on their SDR allocation.
    • The SDRi is determined weekly based on a weighted average of representative interest rates on short-term government debt instruments in the money markets of the SDR basket currencies, with a floor of five basis points.

    How many SDRs have been allocated so far?

    The general SDR allocation of August 28, 2009 is by far the biggest allocation to date:

    • SDR 9.3 billion was allocated in yearly installments in 1970–72.
    • SDR 12.1 billion was allocated in yearly installments in 1979–81.
    • SDR 161.2 billion was allocated on August 28, 2009.

    What happens to the SDRs once they are allocated?

    • The IMF’s SDR Department keeps records of members’ SDR allocations and holdings; the SDR Department is also the channel through which all transactions and operations involving SDRs are conducted.
    • Once allocated, members can hold their SDRs as part of their international reserves or sell part or all of their SDR allocations.
    • Members can exchange SDRs for freely usable currencies among themselves and with prescribed holders; such exchange can take place under a voluntary arrangement or under designation by the Fund.
    • IMF members can also use SDRs in operations and transactions involving the IMF, such as the payment of interest on and repayment of loans, or payment for future quota increases.

    Issues with new allocations

    • New reserves are allocated according to members’ quotas — or shares in the IMF.
    • A great deal of the benefit in 2009 went to advanced economies that didn’t need help in accessing markets or financing fiscal deficits.
    • If the same system is being used now, only 40 per cent of the total would be given to the emerging economies. That is not good enough.

    Other reasons

    • The possible extraneous purposes FM could be referring to maybe misuse of resources for terror funding or some such purpose by neighbours.
    • This may seem far-fetched to some, but is par for the course for the government.
    • The other possibility is that India is merely trying to prove its loyalty to the Trump administration.
    • India has already requested to access the US Fed’s currency swaps.