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GS Paper: Indian Economy

  • Ways and Means Advances (WMA)

     

    The RBI has raised the Ways and Means Advances, or WMA, limit by 30% for all States and UTs to enable them to tide over the crisis caused by COVID-19 outbreak.

    What are Ways and Means Advances?

    • The RBI gives temporary loan facilities to the centre and state governments as a banker to the government.  This temporary loan facility is called WMA.
    • It is a mechanism to provide to States to help them tide over temporary mismatches in the cash flow of their receipts and payments.
    • It was introduced on April 1, 1997, after putting an end to the four-decade-old system of adhoc (temporary) Treasury Bills to finance the Central Government deficit.
    • Under Section 17(5) of RBI Act, 1934, the RBI provides Ways and Means Advances (WMA) to the central and State/UT governments.

    How is WMA availed?

    • This facility can be availed by the government if it needs immediate cash from the RBI.
    • The WMA is to be vacated after 90 days.
    • The interest rate for WMA is currently charged at the repo rate.
    • The limits for WMA are mutually decided by the RBI and the Government of India.

    Types of WMA

    There are two types of WMA — (1) Normal and  (2) Special :

    • Special WMA or Special Drawing Facility is provided against the collateral of the government securities held by the state.
    • After the state has exhausted the limit of SDF, it gets normal WMA. The interest rate for SDF is one percentage point less than the repo rate.
    • The number of loans under normal WMA is based on a three-year average of actual revenue and capital expenditure of the state.

    Back2Basics

    How the govt. meets temporary cash needs?

    The fund deficit or cash-flow mismatches of the Government are largely managed through:

    1. Issuance of Treasury Bills
    2. Getting temporary loans from the RBI called Ways and Means Advances (WMA) and
    3. Issuance of Cash Management Bills (CMBs)
    • Treasury Bills are short term (up to one year) borrowing instruments of the Government of India which enable investors to park their short term surplus funds while reducing their market risk.
    • CMBs are short term bills issued by the central government to meet its immediate cash needs. The bills are issued by the RBI on behalf of the government having a maturity of less than 90 days.

  • PM-CARES Fund

    Context

    In the midst of all of this, our Prime Minister announced the creation of the Prime Minister’s Citizen Assistance and Relief in Emergency Situations Fund (PM-CARES), which—if the intention is to allow funds to move fast and circumvent bureaucratic hurdles—is a great initiative.

    About PM CARES Fund

    • The Prime Minister’s Citizen Assistance and Relief in Emergency Situations Fund (PM CARES Fund) was created on 28 March 2020 following the COVID-19 pandemic in India. 
    • The fund will be used for combating, containment and relief efforts against the coronavirus outbreak and similar pandemic like situations in the future. 
    • The Prime Minister is the chairman of the trust. Members will include the defence, home and finance ministers.
    • The fund will also enable micro-donations. The minimum donation accepted for the PM CARES Fund is ₹10 (14¢ US).
    • The donations will be tax exempt and fall under corporate social responsibility.
    • The Prime Minister had said that the PMO had received many requests to help in the war against COVID-19.
    • Accordingly, the fund was set up and will be used for disaster management and research

    The backdrop against which the fund was created

    • The battle is a struggle for so many people. The Prime Minister called for physical distancing and the shutdown.
    • But physical distancing is a luxury. Many people cannot do so, because they live in tiny homes, in close proximity to each other.
    • And then there are the migrant workers who are squeezed next to each other as they struggle to head home.
    • The announcement of the PM-CARES Fund will convince more people to give to the cause.
    • However, certain aspects make one to look at the PM-CARES fund with mixed emotions. Here is why:

    1. The government has faced challenges on the execution side

    • The PM did a great job rallying the country together, but the pictures of migrants walking hundreds of miles to get to the safety of their homes are heart-wrenching.
    • Criticism in hindsight: Of course, such decisions had to be made quickly, and it is easy to criticise the government in hindsight.
    • Inaction could be more damaging: And sometimes there are limited alternatives when one is doing work on a war footing. Mistakes are bound to be made, and in many cases, inaction could be more damaging.
    • The PM also acknowledged and apologised for these hardships in his latest Mann Ki Baat address.

    2. Non-profits working on relief and rehabilitation are already struggling

    • In this environment, nonprofits are already struggling on the funding side.
    • Many will shut down or go into hibernation over the next three months and their employees will join the daily wage earners as workers who suddenly do not have any income.

    3. Based on media reports, PM-CARES has been set up as a trust

    • Legislation to ban CSR funding to trusts: Despite the fact that the government is currently pushing legislation that aims to ban Corporate Social Responsibility (CSR) funding to nonprofits set up as trusts or societies.
    • Poor governance of the trusts: One of the reasons given for doing so is the alleged poor governance structure of trusts and societies when compared to Section 8 companies.
    • Why then has the government set up PM-CARES as a trust aimed at targeting corporate CSR funds?

    4. PM-CARES has made no announcements on governance, accountability, etc.

    • No questions asked: While many donors have stepped up to fund non-profits working on covid-19 relief measures, their amounts pale in comparison to how much PM-CARES raised in its first two days.
    • Moreover, donors have grilled nonprofits on how we will ensure proper delivery.
    • But no such questions are being asked of the PM-CARES Fund.
    • How will success be measured? What audited accounts will be given? This information has not been shared.
    • So far, the success with respect to funds raised for PM-CARES is a reflection of the confidence people have in our Prime Minister.
    • Problems are surfacing: However, problems are already surfacing, like reports of fake online accounts being set up to steal funds meant for PM-CARES.
    • Presumably, issues will be addressed over the next few days, because everything is moving so fast and decisions are being taken on a war footing.

    5. Centralised funding could hurt localised solutions

    • Solution comes from decentralisation: The internet has taught us that ideas and solutions come from decentralised, empowered teams driven by big, hairy, audacious goals.
    • Involving people in finding solutions: There are so many smart people across our country—in governments, research institutions and academia, the private sector, nonprofits, and civil society.
    • Today, more than ever, we need to get them all involved in finding solutions. And doing so requires money.
    • If a lot of funding for covid-19 gets centralised, funds to other players could get curtailed and localised solutions will die.
    • Funding to innovative solutions: Here again, it is hoped that the funds collected will also be given to other groups who are coming up with innovative solutions.

    6. The government needs to trust and work closely with the nonprofit sector

    • The central, as well as many state governments, are talking to individuals, nonprofits, and the private sector for help to handle this pandemic.
    • And they are relying on the generosity (and duty) of the citizens to come up with solutions because, as with all disasters, the state cannot handle this problem on its own.
    • At the same time, the stimulus packages offered to the private sector have been very little.
    • Nonprofits, most of whom are funded either by philanthropists or CSR, will, therefore, be squeezed for funding, as their donors pull back discretionary money.
    • And many nonprofit professionals are worried that they may not have a job soon.
    • So, on one hand, various governments rush to the private players for help, while at the same time some people in the government treat the nonprofit sector with suspicion.

    Conclusion

    It is hoped that PM-CARES will help various teams in the public and private sector work together, bridging our trust deficits, to fight the virus and reduce the pain inflicted on so many vulnerable people on various fronts—physical, mental, and financial.

  • The sudden return of quantity planning in the wake of covid-19

    Context

    We could take a leaf out of a booklet by Keynes in our effort to tackle some of the challenges posed by the covid-19 pandemic.

    The Crisis-Keynesian Mode response mode to pandemic

    • What is the war economy? One of the defining features of a war economy is that economic thinking is focused on quantities rather than prices.
    • Much of the ongoing global response to the covid-19 pandemic is still in crisis-Keynesian mode.
    • What is a crisis-Keynesian response: The nation-state has become the income supporter, financier and consumer of last resort.
    • However, there are also clear signs of war economics as well.
    • Signs of war economics: The decision by US President Donald Trump to use America’s Defense Production Act to force General Motors to make ventilators is one resonant example.
    • Just consider some of the key questions that are being asked right now.
    • How many ventilators are available? Are there ample food stocks? Can more hospital beds be made available? How many masks be produced in the next few weeks? Can the production of testing kits be ramped up? It’s all about quantities, quantities, quantities.

    Historical background and impact of a shift in economic strategies

    • Impact persists in subsequent decades: Such big shifts in economic strategies are usually not reversed overnight. Decisions taken in response to a particular emergency tend to remain with us in subsequent decades.
    • World War II example: What happened in India during World War II is instructive. Many of the controls that were introduced during that global conflagration formed the basis of the later interventionist state that sought to control who produces how much. Here are a few examples.

    1. Quantitative import controls

    • One of the first moves by the colonial state was to impose quantitative import controls in May 1940.
    • There were two reasons why this was done—to conserve foreign exchange as well as ensure that shipping capacity was used to bring in only what was essential to the war economy.

    2. Food rationing

    • Food rationing was also introduced during the war years.
    • Over 700 towns were covered by some rationing scheme or the other by the end of the War.
    • The government also brought in measures to buy surplus grain from farmers at administered prices.
    • Various forms of rent control were also instituted. Most of these controls continued after India gained independence.

    3. Balance of payment crisis in 1957

    • India was hit by a balance of payments crisis in 1957.
    • The massive investment thrust in the Second Five Year Plan had severely strained the country’s foreign exchange reserves.
    • The Indian government, once again as a temporary measure, imposed stringent controls on imports.
    • Many of these were quantitative in nature. They survived well into the 1980s.
    • In fact, the entire trade policy approach since the 1957 crisis was to minimize imports in a bid to preserve foreign exchange.

    Will the government opt for automatic monetisation of the deficit?

    • Money creation by the RBI to fund deficit: There is now a growing consensus that the Indian government will have to fund part of its growing fiscal burden through money creation by the Reserve Bank of India.
    • What about inflationary consequences? The inflationary consequences will be muted—for now—because the velocity of narrow money is most likely set to fall on account of weak demand conditions under a lockdown.
    • Precedence: The automatic monetization of Indian government deficits was part of the policy playbook after the 1950s till it was thankfully discontinued in 1997.
    • The main instrument for that was ad hoc treasury bills.
    • These were introduced in 1954 as a temporary measure to replenish the cash balances the government maintains with the central bank.
    • What was ad hoc treasury bills? Ad hoc treasury bills were not introduced through any formal law but as an arrangement between mid-level bureaucrats in New Delhi and Mumbai (i.e. RBI).
    • What began as a temporary measure to smoothen government cash holdings had become a near-permanent feature of Indian macroeconomic policy by the 1970s.

    The uncertain future

    • Longer the war more profound will be the changes: The longer the global battle against the pandemic lasts, the more profound will be the changes across the economic landscape.
    • In an insightful article in Bloomberg, Andy Mukherjee uses the lessons of history to look into the uncertain future.
    • Among the possibilities he mentions are the contrasting ones of an economy run by robots and algorithms but with little labour, or an economy in which labour has clawed back the power it lost in the second age of globalization.

    Managing the resources in the time of war

    • Managing the resources: In 1940, John Maynard Keynes wrote a little booklet How To Pay For The War, Keynes essentially argued that the main challenge was not how to finance the war effort, but how to manage real resources to produce the arms that the UK needed to defend herself.
    • Suppression of consumption: He then argued that war production would necessarily involve suppression of consumption, either through higher taxes or some scheme of deferment.

    Conclusion

    The war against the covid-19 pandemic is very different from the military war that Keynes was thinking about. Yet, his booklet offers useful lessons on how to think about some of our current challenges—and also about what we can expect once the situation returns to normal.

  • Moratorium Option for payment of installments

    The RBI has permitted banks to allow moratorium of three months on payment of instalments in respect of all loans including home, car and personal loan among others.

    What exactly this moratorium means?

    • Both the loan principal and interest are covered under the moratorium. This applies to all loans outstanding on March 1.
    • We must note that this is a postponement, not a waiver.
    • RBI’s wordings clearly say that the tenor for term loans across the board may be shifted by three months. This essentially means the loan will end 3 months later than was originally slated.
    • Essentially, it means that payees won’t be treated as a defaulter even if you don’t pay your EMI till May 2020, and your CIBIL score won’t be affected.
    • This moratorium period will not come free, and since the interest will continue to accrue on the outstanding portion of the loan during the moratorium period, it may increase the customers’ burden significantly.

    The installments include:

    1. principal and/or interest components;
    2. bullet repayments;
    3. Equated Monthly installments;
    4. credit card dues

  • Will RBI’s big-bang monetary easing work?

    Context

    On Tuesday, the Reserve Bank of India’s (RBI) Monetary Policy Committee (MPC) convened for an emergency meeting, ahead of schedule, to discuss its response to the economic challenges posed by the Covid-19 outbreak.

    Bond market reaction to the RBI announcement

    • The MPC deliberated for three full days, but its decision would most probably have been sealed right at the onset.
    • For that day, the Indian bond market saw no trades in the first twenty minutes.
    • Fear and uncertainty in the market: The gap between the asking price and bids was so wide that the first trade for the day took place at 9:33 am. Gripped by uncertainty and fear about the future following the outbreak, the market had frozen.

    Measures by the RBI

    • Injecting the liquidity of Rs. 3.74 trillion: Responding to the market signal, the RBI rolled out a slew of measures from its armoury that will release liquidity of up to ₹3.74 trillion, or nearly 2% of gross domestic product, in the financial system.
    • This will facilitate the market’s orderly functioning.
    • Condition on LTRO-created-liquidity: In particular, the condition that the liquidity created through the Long Term Repo Operations (LTRO) tool must only be deployed in corporate debt securities was a direct response to the disruption in the markets seeing heavy sell-offs in the midst of thin trading volumes.
    • Comparison with measures by the Fed.: The US Federal Reserve, which has launched an unconventional asset sales programme for $4 trillion, has announced it will also directly buy corporate bonds to ease the tight market.
    • RBI has refrained from following suit, instead of passing the buck to banks via the conditional LTRO liquidity.
    • Banks are unlikely to step in to ease the tight corporate securities market.
    • Repo rate below the level seen in 2008: To combat the economic consequences of the Covid-19 pandemic, the MPC has dropped its policy interest rate by 75 basis points, taking it down to 4.4%, a multi-year low.
    • The rate is now lower than it was in April 2009, when the central bank had taken it down to 75%, responding to the global financial crisis.
    • In 2008, just four days ahead of a scheduled policy review, RBI had cut the policy repo rate by 1 percentage point, sending an extraordinarily strong signal.

    How the challenge this time is different from the 2008 crisis?

    • The nature of the current economic challenge is a lot different.
    • Economy at standstill: The shock back then had depressed demand, but the economy had not been brought to a standstill as it has now, with resources, including labour and capacities idling.

    Why the measures would not kickstart the economy

    • Effect of rate cut: When all economic activity has halted, and uncertainty about the future is soaring, there’s no way a rate cut—no matter how steep—can kickstart the economy.
    • Businesses cannot plan for the future and will not borrow.
    • Banks will hold on too, fearful of the risk of loans going bad.
    • As it is, even before Covid-19 struck, credit disbursement was sluggish.
    • Now, with a host of companies facing the threat of credit rating downgrades, the probability of lenders turning a little less risk-averse is even lower.
    • Who would be the beneficiary of the rate cut? The biggest beneficiary of RBI’s rate cut—which was bigger than market expectations—would be the government.
    • Reduced borrowing cost for the government: In one stroke, the MPC has altered the fiscal deficit calculation by reducing the government’s borrowing cost.
    • There will be savings on its outgo on interest payments for new and rollover borrowings.

    Three-month moratorium and issue with it

    • RBI also permitted banks and non-bank financial institutions to grant a three-month moratorium on loan repayments and reclassification of stressed loans as non-performing assets (NPAs).
    • This will provide relief by cushioning cash flow pressures for firms and individuals when incomes and revenues have dropped sharply due to the lockdown.
    • The forbearance on downgrading these loans will prevent a sharp spike in NPA levels for banks and NBFCs.
    • There could be a sharp rise in the bad loans: The risk now is that a few quarters after the end of the moratorium there could be a sharp rise in bad loans.
    • It could give rise to the NPA problem: In that sense, it amounts to kicking the problem of a potential spike in NPAs down the road.
    • The problem of evergreening: On balance, it is the right call given the extraordinary challenge of the lockdown—provided a new cycle of evergreening of loans by banks is not allowed in a repeat of what happened in the aftermath of the global financial crisis.

    Way forward

    • What more could RBI have done? Special credit windows for the worst-hit sectors like aviation, hotels and tourism may soon be required.

    Conclusion

    While prioritising financial stability is fine, the MPC’s inflation projection is puzzling. While refraining from providing estimates on growth and inflation, given that the spread, intensity and duration of Covid-19 remain uncertain, RBI said it expects food price pressures to soften going ahead on account of a blow to demand during the lockdown. The projection seems unreasonable when there are unprecedented supply-side bottlenecks.

  • What the RBI has done to provide relief for the ongoing Coronavirus outbreak in India

    Context

    The RBI’s Governor’s ‘bazooka’ announcement earlier today has seen the usually conservative institution and its head pull out the big guns in word and action.

    Four steps taken by the RBI

    • One, increase the liquidity in the system.
    • Two, make sure the lower policy rate is transmitted. Steps one and two are linked.
    • Three, give a three-month window for a payback on all term loans.
    • Four, take steps to reduce volatility and provide stability.
    • Big cut in repo rate: He announced a big cut in the repo rate by 75 basis points (100 basis points make a per cent, so three-quarters of a percentage point) to 4.4%.
    • What is the repo rate? Repo rate is the rate at which the banks borrow from the RBI. Banks give ‘eligible securities’ they hold for cash that RBI gives as an overnight loan.
    • Banks pay the repo rate as interest for this borrowing.

    First two steps of the RBI: Increasing liquidity and ensuring policy rate transmission

    • Why lower repo rate matters? When the repo rate is high, banks find it costly to borrow and in turn raise the price of loans to their borrowers.
    • Reducing interest for the system: A low repo rate has the overall effect of reducing interest rates for the system. Lower rates make it easier for entrepreneurs to take loans for working capital and for households for homes, vehicles and so on.
    • Issue of policy rate transmission: Previous rate cuts have not been ‘transmitted’ by the banks who have not reduced lending rates and have preferred to keep money with the RBI at the ‘reverse repo rate’.
    • What is reverse repo rate? This is the rate at which banks lend to the RBI.

    How RBI is ensuring transmission now?

    • The RBI has now reduced the reverse repo rate by 90 basis points to 4%.
    • This cut in reverse rape sharper than the one on the repo rate to encourage banks to borrow from the RBI rather than lend to it.
    • How reverse repo rate matters? Banks have preferred to deposit money with the RBI rather than lend it out with an average daily amount of ₹3 trillion being kept with the RBI.
    • A reduction of the reverse repo to 4% makes it unattractive to banks to park it with the RBI and banks will be nudged to lend.
    • Why bank lending matters for business? Bank lending provides the needed oxygen to businesses for their working capital and longer-term loans.
    • Read this as a measure to help banks take the decision to lend rather than play it safe by keeping money with the RBI.

    How lock-down slows down the economy?

    • Rush to safety for money: If people are in a lock-down, the wheels of the economy begin to grind down and there is a rush to safety for money in the system.
    • Freezing of the markets market: Investors begin to redeem their shares, bonds and mutual funds. These redemptions cause a fire sale of assets. Finally, when there are no buyers, markets begin to freeze.

    What are the measures taken by RBI to stabilise the market?

    • To keep the wheels of the markets well-oiled with cash, the RBI has made ₹3.74 trillion available. This it has done using four weapons.
    • The first measure: It has used targeted long-term repo operations.
    • RBI will lend money to banks (a total of ₹1 trillion) that can be invested in bonds and other forms of lending instruments.
    • What is a hold-to-maturity way? Under the hold-to-maturity way, the portfolio is valued not on the market price but on what the price should be given the rate of interest of the bond, the holding period and the rating of the bond.
    • Basically, it allows trades to happen at a price that is not confused with the current pandemic in the market.
    • The second measure: The RBI reduced the cash reserve ratio (CRR) by a full percentage point down to 3% for a year.
    • The CRR is the percentage of demand and time deposits banks have to keep with the RBI.
    • Why CRR and not SLR was reduced? There is another 18.25% of deposits that is also not used for lending under the Statutory Liquidity Ratio (SLR), further reducing the money banks have to lend.
    • RBI has reduced the CRR to 3%, freeing up ₹1.37 trillion for banks to lend. CRR has been chosen rather than SLR because this increases ‘primary liquidity’ with the banks a bit better.
    • Not only is there CRR rate down, banks now need to maintain 80% of the limit on a daily basis instead of 90% till June 26, 2020.
    • The third measure: ₹1.37 trillion will be made available under the emergency lending window called the marginal standing facility (MSF).
    • Banks will now be able to borrow 3% of their deposits under this window, up from the current 2%. Basically, RBI is willing to lend more than before.
    • How much more? ₹1.37 trillion under this window.

    The third step of the RBI: Regulatory forbearance

    • What is the regulatory forbearance?

      What this means is that as economic activity grinds to a slowdown, people will not be able to pay back the loans they have taken for no fault of theirs.

    • This could be businesses with loans, households with EMIs on home loans and others with what are called ‘term loans’.
    • RBI will allow a moratorium of three months for loan repayment.
    • This is a relief especially for small entrepreneurs who have been forced to shut shop and for employees whose incomes have stopped since their place of work is shut.
    • It is good that the RBI has looked at the retail part of the market along with the corporate sector for once.
    • Working capital loans don’t come under the ‘term loan’ category, and these borrowers can defer paying interest for three months till June 2020.

    The fourth step of the RBI: Measures to reduce volatility in the exchange rate

    • Fourth is a measure to reduce the volatility of the price of the rupee in international markets by allowing banks to deal in off-shore non-deliverable rupee derivative markets.
    • It looks like reform using the crisis to bring about this long-awaited change.

    Conclusion

    We don’t know if measures taken by the RBI and the government are enough. But what is comforting is that the government and the RBI are working in tandem to deal with this giant killer of a virus.

  • Impacts of the Oil Price War

    Context

    A “pass-through effect” of low crude prices is improbable given the constrained fiscal space.

    The backdrop to the oil price war

    • Against the backdrop of the covid-19 pandemic and the economic slowdown, Saudi Arabia-led oil cartel OPEC (Organization of the Petroleum Exporting Countries) wanted to curtail oil production by 1.5 million barrels per day.
    • However, as Russia has not agreed to this proposal, Saudi Arabia has declared a price war by reducing the Brent crude oil price from $65 per barrel in end-December 2019 to $33 now.
    • The race to the bottom to this extent by Brent is the first time ever since the 1991 Gulf crisis.

    Would it impact India by providing a fiscal dividend?

    • A $20 reduction in Brent oil prices can reduce India’s current account deficit.
    • However, the instability in oil prices is a short-run phenomenon, and India cannot anticipate a prolonged fiscal dividend.
    • Quite contrary to the expectations about a “pass-through effect” of low crude oil prices on consumers, the Government of India (GoI) raised the excise duty on petrol and diesel by `3 per litre.
    • The special excise duty on petrol was hiked by 2 to 8 per litre in the case of petrol and to 4 in the case of diesel.

    Fuel price determination in India

    • There has been no “pass-through effect” primarily because the price determination of petrol and diesel in India is not linked to crude oil prices in the international market.
    • Price determination is done through dynamic pricing, termed as “trade parity pricing,” based on the international prices of petrol and diesel (finished products) prevailing in the international markets, and not on crude oil per se.
    • An obvious question here is whether the crude oil prices and the petrol-diesel prices move in tandem in the international market. Not always.
    • Globally, the market mechanism of ad hoc configurations of demand and supply of crude oil is different from the demand-supply dynamics of petrol and diesel, and, in turn, their pricing behaviour will also be distinctly different.
    • The goi fixes the price of petrol and diesel based on dynamic pricing and trade parity pricing by converting the price from dollars to Indian rupees.

    Factors affecting fuel prices in India

    • The rupee-dollar exchange rate mechanism also affects the pricing of petrol and diesel.
    • This can offset the benefits India can reap from comparatively lower prices of crude oil in the international market, quoted in dollars.
    • The other components of this pricing formula are: 1.The cost of inland freight marketing costs. 2. Taxes levied by the centre and the state governments. 3. The margins (charged by the oil companies) and (the dealer) commissions.
    • It is, therefore, obvious that low international prices per se do not translate into lower prices for petrol and diesel in India as long as the centre and states levy exorbitant taxes on these products.
    • The interstate variation in the prices of petrol and diesel is also significantly explained by the differentials in taxes imposed.
    • Yet another factor to be borne in our minds is that the effect of international prices on the in-house pricing of petrol and diesel in India is not instantaneous or spontaneous.
    • There is a time lag involved in the pricing process.
    • Even though the goi uses the daily pricing mechanism in the dynamic pricing formula of petrol and diesel, the international prices component enters into the pricing equation as an international “benchmark price” of petrol and diesel.
    • Today’s price in India reflects the average international prices of petrol and diesel of the previous fortnight.
    • However, the fuel prices will not come down in a fortnight’s time.
    • This is because, in the price equation, the international price component is just one among many components, whereas the tax component constitutes a dominant part in the equation.

    The Covid-19 factor

    • The covid-19 outbreak has started striking the financial markets and the real sector, and especially investment in the energy sector.
    • So, the lowering of the oil price by Brent cannot help the global economy from recession.
    • Overall, the oil price war can negatively affect the investment decisions in the energy sector and can be a drag on global growth.
    • Due to the covid-19 outbreak, there could be reduced oil-drilling activities in the energy sector, and there will be some cutbacks in demand and, in turn, in the capex energy infrastructure.
    • Analysts have revealed that every $10 fall in oil prices transfers around 0.3% of the global gross domestic product from oil-producing nations to oil-consuming nations.
    • The interest rate strategists are also concerned as the Russian 10-year bond yields reached a record low of 2.56%, and Saudi Arabian government bonds maturing in April 2030 are currently at 2.38%.

    Microeconomic policy to tackle oil price war?

    • The US Federal Reserve has lowered the federal funds’ interest rate by 50 basis points (one-half of a percentage point) to 1.25%.
    • The Bank of Canada also reduced the bank rate by 50 basis points to the US level. The stock market indexes fell to the levels of  2008.
    • The 1.25% federal funds rate now is below the 2.5% US inflation rate. However, monetary policy has failed to trigger the economy.
    • As mentioned by the European Central Bank, “targeting” rather than generalised public policy needs to be done.

    Conclusion

    • The Reserve Bank of India policy tools may be ineffective now to tackle the slowdown, especially against the backdrop of the worsening of the economy from the effects of covid-19. The re-dominance of fiscal policy by the North Block is what is keenly awaited, for an economic turnaround.

  • Mind your own economic health

    Context

    The fragility of the global economy has been exposed twice within the last two decades. In 2008, the collapse of a financial services firm in the US triggered a global financial meltdown. In 2020, the emergence of a novel virus in a food market in Wuhan has done it again.

    The global economy and system theory

    • Systems theory: It that systems take various forms. Broadly speaking, there are three types of systems-1. Chaotic systems. 2. Engineered Systems, and 3. Complex self-adaptive systems.
    • As the weather in a storm, chaotic systems are unpredictable and uncontrollable.
    • The global economy is behaving like a chaotic system.
    • Engineered systems, on the other hand, can be controlled quite tightly, like machines.
    • However, they are dull. A nuclear power plant is a well-engineered system. We would want it to do just what it is supposed to and not produce any surprises.
    • In contrast to these systems is the design of nature. It is a complex self-adaptive system. It produces myriad innovations. It evolves. Yet, its fundamental stability is very reassuring.
    • The realisation that mankind’s technologies and engineering marvels are disrupting nature’s stability, has raised alarms about the architecture of global economic governance.
    • More about self-adaptive systems: The architecture of complex self-adaptive systems is formed by essential design principles. One is “permeable boundaries”.
    • The many parts of a complex self-adaptive system have permeable boundaries between themselves. Each part has its integrity. The parts exchange information and energy across their boundaries as required.
    • When there are no boundaries within, or they are too weak, an accident at one end will soon sink the whole ship.

    Consequences of boundarylessness within the global financial system

    • The drive for boundarylessness within the global financial system since the 1990s caused the sloshing around of contagion during the global financial crisis in 2008.
    • Whereas global economic growth has undoubtedly been enabled by global supply chains, the vulnerability of economies everywhere to their disruption has become painfully evident with the COVID-19 pandemic.
    • Complex adaptive systems exhibit “fractal-like” shapes. Their parts are complex, combining the same diverse energies that permeate across the whole.
    • Social forces, economic forces, and environmental forces combine within all countries, and in parts within countries too, albeit in different ways.
    • Though the parts are similar to each other, they are not the same. Therefore, the same solutions will not fit all.
    • An insight from systems theory is that global systemic problems such as climate change, persistent economic inequality, among others, will require local systems solutions.

    Six reforms for reshaping Indian economy

    • Stress test: Crises create stress tests for the health of systems. The financial crisis of 2008 exposed the fragility of an inter-connected and under-regulated financial system.
    • The COVID-19 pandemic has exposed the architectural weaknesses in the global economy.
    • Instead of worrying too much about the reversal of globalisation, national leaders should now focus on the well-being of their citizens and the health of their own economies.
    • Six reforms are essential for reshaping the Indian economy.
    • First, focus on the provision of universal social security, rather than on the misdirected demand for even more “flexibility” in labour laws
    • Second, respect the “informal” sector which provides the majority of Indians with opportunities to earn incomes, and give it more strength. It is also a great source for practical innovations and widespread entrepreneurship.
    • Third, change the economic paradigm from “trickle-down” to “build up”. Build the internal engine of growth of India’s economy by increasing incomes of India’s citizens.
    • Fourth, strengthen public health services. Medical tourism may put India’s private hospitals on the global map. However, they are not the solution to India’s huge health problems.
    • Fifth, reform and strengthen the public education system. It will contribute greatly to creating a level playing field for all children.
    • Sixth, strengthen local governance in India’s towns and districts to develop and implement local systems solutions. The well-being of Indian citizens will be improved, and India’s economy will be more resilient too.

    Conclusion

    • All governments are asking their citizens to increase “social distancing” between themselves to prevent the spread of a health contagion. It would be wise for countries to maintain sufficient “economic distancing” amongst themselves too. They should mind the health of their own economies. Thereby, they will improve the health of the global economy too.

  • Dressing a wounded economy

    Context

    There are going to be the economic impact of the actions designed to combat the virus. The two major tools that the government has available before it are monetary policy and fiscal actions.

    Impact of virus and additional slowdown

    • The impact of the coronavirus pandemic is now felt by almost every country.
    • First, there are the health effects of the virus.
    • Second is the economic impact of the various actions that have to be taken to combat the virus.
    • The world is experiencing an additional slowdown on top of the contracting tendencies already present and India is no exception.
    • The economic impact on India can be traced through four channels: external demand; domestic demand; supply disruptions, and financial market disturbances.

    Impact on export

    • As the economies of the developed countries slow down (some people are even talking of recession), their demand for imports of goods will go down.
    • This lower demand will affect our exports which are even now not doing well.
    • In fact, after six months of negative growth, it was only in January that Indian exports showed positive growth.
    • The extent of decline will depend on how severely the other economies are affected. Not only merchandise exports but also service exports will suffer.
    • Besides these, the IT industry, travel, transport and hotel industries will be affected.

    Oil price factor

    • The only redeeming feature in the external sector is the fall in oil prices.
    • India’s oil import bill will come down substantially.
    • But this will affect adversely the oil-exporting countries which absorb Indian labour. Remittances may slow down.

    Supply disruption

    • To ward off the spread of the coronavirus, the government has declared a lockdown of the country.
    • As passengers travel less, the transportation industry, road, rail and air, is cutting down schedules, sometimes drastically.
    • This will affect in turn several other sectors closely related to them. The laying off of non-permanent employees has already started.
    • As people, in general, buy less, shops stock less, which in turn affects production.
    • Perhaps retail units will be first to be affected and they will, in turn, transmit this to the production units.
    • One is unable to make an estimate of the reduction in economic activity at this point.
    • If the situation is not reversed soon, there can be a serious decline in the growth rate during 2020-21.
    • Supply disruptions can occur because of the inability to import or procure inputs.
    • The break in supply chains can be severe. It is estimated that nearly 60% of our imports are in the category of ‘intermediate goods’.
    • Imports from countries which are affected by the virus can be a source of concern.
    • The domestic supply chain can also be affected as the inter-State movement of goods has also slowed down.

    Financial market issue

    • Financial markets are the ones which respond quickly and irrationally to a pandemic such as the coronavirus pandemic. The entire reaction is based on fear.
    • The stock market in India has collapsed. The indices are at a three-year low.
    • Foreign Portfolio Investors have shown great nervousness and the safe haven doctrine operates.
    • In this process, the value of the rupee in terms of the dollar has also fallen.
    • The stock market decline has a wealth effect and will have an impact on the behaviour of particularly high wealth holders.
    • How does the government deal with this sudden decline in economic activity which has come at a time when the economy is not doing well? The two major tools that are available are monetary policy and fiscal actions.

    Two major tools with government- Monetary Policy and Fiscal Action

    • Monetary policy: In a situation like this can only act to stimulate demand by a greater push of liquidity and credit.
    • The policy rate has already been brought down by 135 basis points over the last several months. There is obviously scope for further reduction.
    • But our own history, as well as the experience of other countries, clearly show that beyond a point, a reduction in interest rates does not work.
    • It is the environment of the overall economy that counts. Credit may be available. But there may not be takers.
    • Any substantial reduction of policy rate can also affect savers. Interest is a double-edged sword.
    • What the RBI needs to do? IT needs to go beyond cutting the policy rate.
    • A certain amount of regulatory forbearance is required to make the banks lend.
    • Even commercial banks on their own will have to think in terms of modifying norms they use for inventory holding by production units.
    • Repayments to banks can be delayed and the authorities must be willing to relax the rules.
    • Any relaxation of rules regarding the recognition of non-performing assets has to be across the entire business sector.
    • The authorities must be ready to tighten the rules as soon as the situation improves. This is a temporary relaxation and must be seen as such by banks and borrowers.
    • Fiscal Policy: Fiscal actions have a major role to play. Once again, the ability to play a big role is constrained by the fact that the fiscal position of the government of India is already difficult.
    • Even without the pandemic, the fiscal deficit of the Central government will turn out to be higher than that indicated in the budgets for 2019-20 and 2020-21.
    • Revenues are likely to go down further because of the virus-related slowdown in economic activity.
    • In this context, the ability to undertake big-ticket expenditures is
    • But there are some ‘musts’. The virus has to be fought and brought down. All expenditures to test and to take care of patients must be incurred.
    • Now that private hospitals are allowed to test, the cost of the people going to private hospitals must also be met by the government.
    • The involvement of private hospitals has become necessary. It is mentioned that a test costs ₹4,500. The total cost can be substantial if the numbers to be tested run in the thousands and more.
    • This may sound exaggerated. But we must be prepared so that we avoid the tragedy of Italy.
    • Therefore, the first priority is to mobilise adequate resources to meet all health-related expenditures which includes the supply of accessories such as masks, sanitisers and materials for tests.
    • The challenge is not only fiscal but also organisational.

    Mitigating the impact on the job sector

    • Serious concerns have been expressed about people who have been thrown out of employment. These are mostly daily-wage earners and non-permanent/temporary employees.
    • In fact, some of the migrant labour have gone back to home States. We must appeal to the business units to keep even non-permanent workers on their rolls and provide them with a minimal income.
    • Some relief can be thought of by the government for such business units even though this can be misused.
    • However, in general, in the case of sectors such as hospitality and travel, the government can extend relief through deferment of payments of dues to the government.
    • Issues in making cash transfer universal: There is talk of providing cash transfer to individuals. There is already a programme for rural farmers with all the limitations.
    • For a system of cash transfer to be workable, it has to be universal.
    • At this moment when all the energies of the government are required to combat the virus, to institute a system of universal cash transfer will be a diversion of efforts.
    • The burden on the government will depend upon the quantum of per capita cash transfer and the length of the period.
    • The government should advise all business units not to retrench workers and provide some relief to them to maintain the workers.
    • A supplemental income scheme for all the poor can be thought of once the immediate problem is resolved.
    • Provision of food and other essentials must be made available to the affected as is done at the time of floods or drought. States must take the initiative.

    Conclusion

    The fiscal deficit is bound to go up substantially. The higher borrowing programme will need the support of the RBI if the interest rate is to be kept low. The monetisation of the deficit is inevitable. The strong injection of liquidity will store up problems for the next year. Inflation can flare-up. The government needs to be mindful of this. All the same, the government must not stint and go out in a massive way to combat the virus. This is the government’s first priority.

  • [pib] Capital to Risk Weighted Assets Ratio (CRAR)

    The Cabinet Committee on Economic Affairs has given its approval for continuation of the process of recapitalization of Regional Rural Banks (RRBs) by providing minimum regulatory capital to RRBs which are unable to maintain minimum Capital to Risk weighted Assets Ratio (CRAR) of 9%, as per the regulatory norms prescribed by the RBI.

    What is CRAR?

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

    Why recapitalize RRBs?

    • RRBs are primarily catering to the credit and banking requirements of agriculture sector and rural areas with focus on small and marginal farmers, micro & small enterprises, rural artisans and weaker sections of the society.
    • A financially stronger and robust RRB with improved CRAR will enable them to meet the credit requirement in the rural areas.
    • As per RBI guidelines, the RRBs have to provide 75% of their total credit under PSL (Priority Sector Lending).
    • In addition, RRBs also provide lending to micro/small enterprises and small entrepreneurs in rural areas.
    • With the recapitalization support to augment CRAR, RRBs would be able to continue their lending to these categories of borrowers under their PSL target, and thus, continue to support rural livelihoods.

    Back2Basics

    Regional Rural Banks (RRBs)

    • RRBs are Scheduled Commercial Banks operating at regional level in different States of India. They are recognized under the Regional Rural Banks Act, 1976 Act.
    • They have been created with a view of serving primarily the rural areas of India with basic banking and financial services.
    • However, RRBs may have branches set up for urban operations and their area of operation may include urban areas too.
    • The area of operation of RRBs is limited to the area covering one or more districts in the State.

    Their functions

    RRBs also perform a variety of different functions. RRBs perform various functions in following heads:

    • Providing banking facilities to rural and semi-urban areas
    • Carrying out government operations like disbursement of wages of MGNREGA workers, distribution of pensions etc.
    • Providing Para-Banking facilities like locker facilities, debit and credit cards, mobile banking, internet banking, UPI etc.
    • Small financial banks etc.