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GS Paper: Indian Economy

  • How policy can bridge the gap

    Context

    India must use the windfall from oil to provide assistance to the most vulnerable to mitigate the impact due to COIVD-19 outbreak.

    Estimates of impact

    • Impact on major economies: Minus 40 per cent, -30 per cent, -22 per cent, and -14 per cent. These are the estimated impacts (at an annualised rate) on the quarterly growth rates of China, the UK, Eurozone, and the US because of the Covid-19 virus.
    • Even excluding China and those that are closely tied to its supply chain — Korea and Taiwan — emerging markets (EM) are expected to go into recession in the first half of 2020, with the second quarter taking the biggest hit at over an 8 per cent quarterly decline.
    • Impact on India: India will not be spared this growth shock. In fact, the economic impact could be deeper and longer in emerging markets where the capacity of public health systems is limited at the best of times.

    Prospects of recovery

    • Sudden stop to economic activity: We also know from the experiences of the countries already infected that the way to control the spread of the virus is through aggressive containment and social distancing that inevitably brings economic activity to a sudden stop.
    • There doesn’t seem to be a middle path. We also know that unlike natural catastrophes like earthquakes, capital stock is not destroyed by the virus.
    • Sharp recovery and conditions: Once the containment period is over and social interaction normalises, there is every reason to believe that activity can recover very sharply.
    • Unless the containment period is long because of capacity constraints in the healthcare system which could turn supply chain disruptions into a long-term problem, or the credit stress created by the lack of earning by households and firms during the sudden stop stymies the recovery.

    India needs to brace itself

    • Unfortunately, India, where the virus still appears to be in the early stage, needs to brace for such a sudden stop.
    • The lockdown could be for an extended period given the already stretched public health system.
    • Impact on urban economy: The swathe of the economy that depends on social interaction — retail sales, entertainment, restaurants, and importantly construction and manufacturing — is very large.
    • Even if one believes that rural areas with relatively low population densities will not be affected much, the impact on urban economic activity could be very large.

    Role of economic policy

    • What is the role of economic policy in such circumstances? It needs to “bridge the gap” between the brutal downturn and the eventual recovery.
    • While public health policies force a sudden stop in the economy to save lives, economic policies need to ensure that the impact from the shutdown is cushioned, incomes of households and firms supported, credit stress is contained, and the recovery is not hamstrung by policy headwinds.
    • This requires policy support to be operated on various fronts.
    • Role of the Central bank: Central banks not only need to cut rates but also need to provide adequate liquidity and extend regulatory forbearance to prevent credit stress and non-performing loans from clogging up the already strained financial system when the economy starts to recover.
    • Role of fiscal policy: The role of fiscal policy is even larger, from direct and indirect tax cuts or postponement to targeted credit support for sectors that are likely to be most affected such as airlines and retail trade.
    • Support to the vulnerable: The key is income support to the most vulnerable: From daily wage earners to SMEs (small and medium enterprises).
    • Using JAM trinity for cash transfer: It is here that the government’s efforts over the last five years make India one of the best-placed economies to deliver such cash transfers.
    • Since 2015, substantial time, effort, and resources have been expended to establish Jan Dhan (bank accounts), Aadhaar and mobile banking (JAM), and Mudra, the programme that dispenses loans to SMEs.
    • The objective of JAM and Mudra is to use Aadhaar as a way of accurately identifying beneficiaries and use mobile banking to digitally and seamlessly transfer cash/subsidies directly to households’ bank accounts and provide loans to SMEs without any leakages.
    • According to government reports, the total number of Jan Dhan accounts stand at around 380 million and 59 million MUDRA loans were sanctioned last year.
    • For a country with a population of 1.3 billion and about 63 million SMEs, even if there are duplicate accounts, JAM and Mudra should be able to cover almost all households and SMEs.
    • With Aadhaar accurately targeting beneficiaries, leakages should be minimised. If there ever was a time that India needed JAM and Mudra it is now.

    Issue of fiscal space and solution

    • Some will argue that India doesn’t have the fiscal space. But it does.
    • Use oil windfall: In the last month or so, the crude oil price has dropped from around $60/bbl to around $30 and is likely to stay at this level given the breakdown in agreement among oil-producing countries and the massive collapse in global demand.
    • If the government simply taxed the oil windfall by raising excise duties, as it did during the 2014-15 oil price collapse, it could potentially raise almost 1 per cent of GDP or a staggering Rs 2.25 trillion.
    • If 50 million households have to be provided assistance because of the shutdown, it comes to about Rs 14,000 per month for three months or about Rs 24,000 a month to half of the 63 million SMEs.
    • And this without even having to increase this year’s budgeted deficit.

    Conclusion

    The government might have other uses for the oil windfall. But if India is forced into lockdown, the economic costs will be very large and the recovery will crucially depend on whether the pilot-light of the economy is kept lit through this period. This critically requires income transfers to vulnerable households and SMEs. India cannot complain that it does not have the fiscal space or the infrastructure to provide it.

  •  The double whammy that India’s economy now faces

    Context

    India is currently in the grip of dual shocks: Covid-19 and a financial one.

    The supply and demand shock

    • Containing outbreak at economic cost: Even as infection rates have tapered in China, they are rising elsewhere. Countries that have succeeded in containing it have done so at an economic cost, by quarantining people, implementing lockdowns and social distancing.
      • This has resulted in a plateauing of new infection cases in China and South Korea, but they are still rising exponentially across Europe and the US.
    • Supply shock: This is both a supply as well as demand shock. On the former, the impact is via disruptions in China-centred supply chains.
    • Demand shock: But there is also a hit to final demand as infections spread across the rest of the world, hurting travel, tourism, hotels and local retail activity.
    • Tightened financial condition: The correction in equity markets and wider credit spreads have tightened financial conditions, and both consumer and business confidence has faltered.
    • Rising infections in Europe a big concern: Rising infections in Europe and the US are a big concern as both are large services-driven economies. Any pullback in their consumption demand will likely result in a demand shock for the rest of the world.

    Global spillover of Covid-19

    • Hitting economies in waves: One uncertainty pertains to how long this shock will last. There are no definite answers as of now. Covid-19 shocks are hitting economies in waves and countries are imposing lockdowns, one by one.
      • Hence, instead of a synchronized global slump over one or two months, the economic impact is getting spread out.
      • For example, supply chain disruptions and lockdowns in China are gradually easing, and we estimate that factories should be operating at full capacity by mid-April.
    • Hit to travel and tourism to last till June: The hit to travel and tourism will last at least until June because even if the number of new infection cases eases, travellers will remain cautious initially.
    • Demand in the US and Europe to remain low until April: Curtailment in discretionary demand due to social distancing in the US and Europe only started in March and will likely continue until April, if not longer.
    • Global spillover to continue till May: The global spillovers of Covid-19 will likely be spread out over February and May, implying a weak first half of 2020.
      • Whether the shocks last longer will depend on whether countries successfully contain infections.
      • It also depends on the ability of countries to prevent spillover effects onto corporate balance sheets (more defaults) and the labour market (job losses).
    • Global GDP to remain low in the first half: Global gross domestic product (GDP) growth in the first half of 2020 is likely to be weaker than during the global financial crisis of 2008-09, due to a sharp first-quarter decline in China, and weaker  final demand in developed economies in the second.

    What will be the impact on India?

    • The economic hit to India will be felt through multiple channels.
    • First, India is not a part of China-centric global value chains, but China accounts for a significant share of India’s imports (14%) and its production halt will hit India’s imports of
      • primary and intermediate goods,
      • disrupting domestic production,
      • particularly in industries such as pharmaceuticals, auto, electronics, solar power and agriculture.
    • Second, there will be a slowdown in international and domestic travel and tourism. India earns over 1% of GDP as foreign exchange earnings from tourism annually.
    • Third, social distancing measures, along with the public fear factor will hit domestic retail activity as people avoid public places.
    • Fourth, India will face the indirect effects of weaker global demand, tighter financial conditions and low confidence.
      • Oil windfall offset: Even though lower oil prices are a boon, in the current environment any benefit from lower oil prices will be offset by other negatives.
    • Domestic financial sector risk: Another big challenge for India relates to domestic financial sector risks.
      • The spillover effect of Yes bank: Weak growth and financial stability concerns have been brewing for over a year now and the spillover effects of Yes Bank’s takeover are still reverberating through the system.
      • The fallout of the shadow banking slowdown via potential stress for real estate developers and small and medium-sized enterprises is a risk.
      • If the asset quality of both shadow banks and the banking sector deteriorate in the next few quarters, as is likely, then domestic credit conditions may stay tight, as the perceived risk premium could rise further.
    • GDP growth rate: In this backdrop, the real activity could suffer. The GDP growth is expected to average around 4% year-on-year in the first half of 2020, with risks skewed to the downside.
      • GDP growth in 2020-21 is unlikely to be more than 2019-20’s 5%.

    Way forward

    • An optimal policy response to Covid-19: The optimal policy response to is globally-coordinated public health safety and virus containment. India has taken some worthy decisions on this.
      • Since Covid-19 will adversely impact service sectors like retail, hospitality, travel and civil aviation, the government’s fiscal policy response should be aimed well through measures such as tax relief and interest-free loans, particularly for small and medium enterprises.
    • Liquidity easing and policy accommodation: On monetary policy, a combination of liquidity easing and policy accommodation would be needed beyond the moves already made.
      • Macro-prudential steps such as lowering the counter-cyclical capital buffer for banks could be announced.
      • Fixing the financial sector, though, would need a broader response, including a recognition of the full scale of the problem and then adequately recapitalising banks and shadow banks.
      • Else, credit risk premia may stay elevated and credit growth may not pick up.

    Conclusion

    In all, the economic impact on India due to shocks emanating from Covid-19 could get compounded due to weak domestic balance sheets. The coming quarters call for close vigilance of credit risks and the prioritizing of financial stability.

  • What are Open Market Operations (OMOs) ?

    The Reserve Bank of India (RBI) has decided to infuse ₹10,000 crore liquidity in the banking system by buying government securities through open market operations (OMO).

    What are Open Market Operations (OMOs)?

    • OMOs are conducted by the RBI by way of sale and purchase of G-Secs to and from the market with an objective to adjust the rupee liquidity conditions in the market on a durable basis.
    • When the RBI feels that there is excess liquidity in the market, it resorts to sale of securities thereby sucking out the rupee liquidity.
    • Similarly, when the liquidity conditions are tight, RBI may buy securities from the market, thereby releasing liquidity into the market.

    How and in what form can government securities be held?

    • The public debt office (PDO) of RBI, acts as the registry and central depository for G-Secs.
    • They may be held by investors either as physical stock or in dematerialized (demat/electronic) form.
    • It is mandatory for all the RBI regulated entities to hold and transact in G-Secs only in dematerialized subsidiary general ledger or SGL form.

    Types:

    i) Physical form

    • G-Secs may be held in the form of stock certificates. A stock certificate is registered in the books of PDO.
    • Ownership in stock certificates cannot be transferred by way of endorsement and delivery.
    • They are transferred by executing a transfer form as the ownership and transfer details are recorded in the books of PDO.
    • The transfer of a stock certificate is final and valid only when the same is registered in the books of PDO.

    ii) Demat form:

    • Holding G-Secs in the electronic or scripless form is the safest and the most convenient alternative as it eliminates the problems relating to their custody, viz., loss of security.
    • Besides, transfers and servicing of securities in electronic form is hassle free.

    How are the G-Secs issued?

    • G-Secs are issued through auctions conducted by the RBI.
    • Auctions are conducted on the electronic platform called the E-Kuber, the Core Banking Solution (CBS) platform of RBI.
    • The RBI, in consultation with the Government of India, issues an indicative half-yearly auction calendar which contains information about the amount of borrowing, the range of the tenor of securities and the period during which auctions will be held.
    • The RBI conducts auctions usually every Wednesday to issue T-bills (Treasury Bills) of 91-day, 182-day and 364-day tenors.
    • Settlement for the T-bills auctioned is made on T+1 day i.e. on a working day following the trading day. Like T-bills, CMBs are also issued at a discount and redeemed at face value on maturity.
    • The tenor, notified amount and date of issue of the CMBs depend upon the temporary cash requirement of the Government. The tenors of CMBs are generally less than 91 days.

    What is meant by repurchase (buyback) of G-Secs?

    • Repurchase (buyback) of G-Secs is a process whereby the central government and state governments buy back their existing securities, by redeeming them prematurely, from the holders.
    • The objectives of buyback can be the reduction of cost (by buying back high coupon securities), reduction in the number of outstanding securities and improving liquidity in the G-Secs market (by buying back illiquid securities) and infusion of liquidity in the system.
    • The repurchase is also undertaken for effective cash management by utilising the surplus cash balances.
    • The state governments can also buy back their high coupon (high-cost debt) bearing securities to reduce their interest outflows in the times when interest rates show a falling trend.
    • States can also retire their high-cost debt pre-maturely in order to fulfil some of the conditions put by international lenders like Asian Development Bank, World Bank etc. to grant them low-cost loans.

  • Let clear principles prevail in the bailout of Yes Bank

    Context

    Resolving bank failure is tough but following a set of principles could achieve a fair and efficient outcome.

    Key issues involved in the resolution

    • Challenge in courts: Resolving Yes Bank’s failure is no easy task. Some bondholders are already challenging the restructuring plan of the Reserve Bank of India in court, and seem ready for a long-drawn battle.
    • How much dilution is fair for existing shareholders to take?
    • AT-1 Bonds issue: Should the value of the Additional Tier 1 (AT-1) bonds be written off entirely?
      • As such issues become matters of policy discussion and address, we must not lose sight of some fundamental principles of resolving bank failures.
    • Three of them should be on the top of the list: honour contracts, address market failure and protect systemic stability.

    How honouring contracts matter for economy?

    • For efficient outcomes: Honouring contracts is vital for achieving efficient outcomes between contracting parties such as lenders and borrowers, managers and shareholders, and insiders and outsiders.
    • Shying away from entering a contract: If there is uncertainty over this fundamental principle, contracting parties will shy away from entering contracts in the first place.
      • Lenders will be less willing to lend.
      • Prospective minority shareholders will be less keen to buy shares in a company.
    • Impact on allocative efficiency: This will ultimately compromise the economy’s allocative efficiency, or the market’s ability to deploy capital to its best use.

    AT-1 bond issue

    • Honouring contract in Yes banks resolution: There are several issues in the application of this principle in Yes Bank’s resolution.
      • The most visible one concerns the decision of writing off its perpetual contingent, or AT-1, bonds.
    • Write off: According to the original agreement, these additional tier-1 (AT-1) bonds are indeed supposed to be written off at a time like this.
      • And this write-off need not happen before the common equity value goes down to zero.
      • The entire idea behind these perpetual contingent bonds is to improve a bank’s capitalization if its common equity value falls below a certain threshold, but does not hit zero.
    • Counter argument: These bondholders and some commentators are arguing that writing off those bonds will be a big blow to India’s bond market.
      • Moral hazard problem: This is just the opposite of the truth. Not writing them off in accordance with the original contract will create a severe moral hazard problem.
      • What incentive would any bondholder have to correctly price and monitor these banks in the future?
      • Market discipline would die a quick death, and the bond market will suffer in the long run.
    • What the resolution process should do? Therefore, the resolution process should honour the contract and write off the entire value of Yes Bank’s AT-1 bonds.

    Dealing with critical market failures

    • Second core principle: The second core principle in this resolution should be to tackle some critical market failures that led here.
      • Several observers have pointed out the failure of board oversight, promoter negligence and reckless lending at the bank.
    • Vital market failure in the purchase of AT-1 bonds by retail investors: Indeed, these issues must be addressed. But there seems to be another vital market failure hidden in this crisis: the purchase of AT-1 bonds by retail investors.
    • Why AT-1 bonds are complex? AT-1 bonds are “information-sensitive” instruments, which means that the value of these instruments is extremely sensitive to information on the firm’s fundamentals.
      • Complex financial security: They are very complex financial securities. Understanding the risk and reward associated with these securities and valuing them properly is not an easy task even for the best of market professionals.
      • Retail investors are certainly not suited to buy this product. Still, several of them ended up holding Yes Bank AT-1 bonds in their asset portfolios.
    • Demand deposits and market failure: Banking theory relies on the idea that demand deposits are information-insensitive instruments.
      • Hence, a retail investor can place deposits in a bank without worrying about understanding the real risks borne by it. Government-backed deposit insurance makes deposits even more liquid and riskless.
      • Hence, retail investors should hold regular deposits in a bank, and not complex securities like AT-1 bonds.
      • Where is the market failure involved? If such bonds are sold to them without proper disclosure of the associated risks, then it amounts to a serious market failure.
    • Way forward: This market failure must be corrected.
      • Holding investment advisors to higher standards of fiduciary responsibility is one way of doing so.
      • Prohibiting retail investors from investing in such securities is another critical step to prevent such a market failure.

    Way forward to carry out the resolution process

    • Restitution of value to retail investors: Meanwhile, the resolution process could consider partial or full restitution of value to retail investors in Yes Bank’s AT-1 bonds, if these products were indeed mis-sold to them.
    • Large professional investors should be treated differently: But such a rescue must not extend to large professional investors who willingly bought these bonds for higher returns.
      • One mechanism to do this could be to create a separate fund for retail investors with investments capped at a certain point.
      • Or, their AT-1 investments up to a specific limit could be converted into a simple deposit contract. The legal hurdles may be insurmountable.
      • However, in principle, those who mis-sold these products to retail investors should be required to compensate them.
    • Conflict in two principles: Sometimes, these principles can come into direct conflict with each other.
      • If the resolution allows retail investors in those AT-1 bonds to recover their investments, it would go against the “honour the contract” principle, but it would address the “market failure” issue.
    • Ensuring systemic stability: How should we reconcile this conflict? That’s where the third principle comes in: ensuring systemic stability.
      • After all, the regulator’s main objective is to restore the market’s faith in the country’s financial system.
      • While this is not an easy task, protecting the capital and confidence of small investors can go a long way in restoring their faith in the banking system.

    Conclusion

    Resolving bank distress is never an easy job. But honouring contracts, addressing market failure and ensuring systemic stability can together go a long way in achieving a fair and efficient outcome.

     

     

     

     

     

  • Triggering a Global Financial Crisis

    Context

    Although we could not have predicted it, Covid-19 was not the reason, but just the trigger for the ongoing financial crash as all we needed was the proverbial straw to break the finance sector’s back

    Economic sudden stop

    • Not just any trigger: Covid-19 was not just any trigger as it gave birth to the concept of the economic “sudden stop.” When the global equity markets dropped on 31 January 2020 following the WHO declaration of the Public Health Emergency of International Concern, El-Erian (2020) warned the investors on 2 February 2020 that they should snap out of the “buy the dip” mentality.
      • Pointing out two vulnerabilities, namely structurally weak global growth and less effective central banks, he introduced the concept of “sudden stop” economic dynamics.
    • What is sudden stop? It can be considered as an abrupt onset of a deep recession.
      • Supply and demand shock: In the case of Covid-19, it is a sudden stop of economic activity resulting in supply and demand shocks to the global economy as major cities in infected countries, more than 100 and counting, are put on lockdown.
      • And, add to that the deepening oil price war between Russia and Saudi Arabia.
    • On 8 March 2020 in New York, the futures markets opened and oil futures (both Brent and WTI) are trading about 21% down, gold is above $1,700 per ounce, and all United States (US) equity index futures are trading about 4% down.
    • Long terms treasury yield at historical lows: What is worse is that with the long-term US Treasury yields at their historical lows (10-year yield below 0.5% and 30-year yield below 1%), the capital markets are frozen (not to mention many oil projects that will go bust at these prices).

    Disorderly non-financial private sector debt leading to dire consequences

    • A disorderly global non-financial private sector debt deleveraging, which is likely to lead to deep global debt deflation, followed by a recession (and possibly a depression).
      • Which could result in creating financial and economic instabilities, and further tensions in international relations with dire consequences for emerging and developing countries, not to mention developed countries.
    • Difference in developed and developing countries debts: While in developed and high-income developing countries, the non-financial private sector is more over-indebted, in middle-income and low-income developing countries, the public sector is more over-indebted.
    • Impact on developed economies: Given that the global non-financial private sector debt deleveraging has already started, the public sector debts of the developed and high-income developing countries will also go up and the governments’ ability to rescue their economies will also decline in these countries.
    • Impact on funding for climate change: Furthermore, this will severely constrain the governments’ ability to spend on climate change-related projects to address the potentially catastrophic effects for many years to come, diminishing our hopes to make the necessary investments and innovations to address the now existential climate crisis on time will diminish.
    • The corona factor: The measures we have to take to control the spread of Covid-19 before a cure is found will further challenge the financial system, as people stop earning an income and businesses go bankrupt.

    Way forward

    • Three authorities solution: In the suggested framework, there would be three authorities to maintain a deposit account at the central bank in each country
      • 1. A deleveraging authority for leverage reduction.
      • 2. Lastenausgleich (based on German Currency Reforms) authority for capital levies.
      • 3. Climate authority for financing needs in developing national climate plans.
      • These national authorities should be globally coordinated through the appropriate United Nations agencies.
    • Control the three authorities: The Lastenausgleich authority would be under the finance ministry, whereas the deleveraging and climate authorities would be not-for-profit corporations promoted by the government.
    • Capitalisation issue: The government would capitalise the deleveraging and climate authorities by the Treasury-issued zero-coupon perpetual bonds.
    • The deleveraging authority would then sell its equalisation claims to the central bank in exchange for an increased balance in its deposit account at the bank, while the climate authority would wait until the deleveraging concludes.
      • Further, the climate authority would not be allowed to open deposit accounts to its borrowers to ensure that it would be a pure financial intermediary, not a bank.
    • Framework: Assuming that a globally agreed-upon debt reduction percentage that would bring the global non-financial sector leverage well under 100% is determined and that all countries agree to act simultaneously, the framework is as follows
      • (i) the financial institutions comprising the banks and non-bank financial institutions (NBFIs) write down all the loans and debt securities on both sides of their balance sheets by the required percentage;
      • (ii) the deleveraging authority compensates the banks and NBFIs for the loss if any; and
      • (iii) the deleveraging authority pays each qualified resident their allocated amount less than the debt relief if any.
      • If an NBFI gain after the above debt reduction, it should owe equalisation liabilities to the deleveraging authority of its jurisdiction.
      • Note that as all debts mean all debts, public sector debts will also be written down by the same percentage except the official debts of the sovereigns that fall out of the scope of our proposed framework and should be handled by other means.
    • After deleveraging: After deleveraging the balance of the deleveraging authority account at the central bank goes down whereas the total balance of the bank accounts (reserves) at the central bank goes up by the total payment made by the deleveraging authority.
      • Hence, the base money goes up by the total payment of the deleveraging authority.
      • Since NBFIs and residents cannot maintain deposit accounts at the central bank, they have to be paid through a bank which creates deposits for the NBFIs and residents against reserves.
      • Hence, the broad money goes up by the amount of the payment to the NBFIs and residents.
    • Issue of multi-currency balance sheet: One issue is that in many countries, the bank and NBFI balance sheets are multi-currency balance sheets.
      • However, the deleveraging authority payments are in domestic currency, which may create currency risk for some banks and NBFIs.
      • Backed by the central banks, the globally coordinated national deleveraging authorities should stand ready to intervene to avoid potential crises.
    • Condition to spend on climate bonds: The authorities would require their domestic banks and other financial institutions to spend an internationally agreed-upon percentage of their newly found money, if any, after the deleveraging on the interest-bearing, finite-maturity bonds the national climate authorities would issue.
      • Since the promoter of the climate authority is the government, the bonds of the climate authority would have the same credit with the government bonds, and the central bank would accept the climate authority bonds in its open market operations.
    • Climate authority bonds as reserves: Therefore, the climate authority bonds would be the main tool to manage the reserves and deposits created through the equalisation claims.
      • In addition, the climate authority bonds could be used for the greening of the financial system through the investment of foreign exchange reserves of the central banks proposed by the Bank of International Settlements (BIS 2019).
    • Progressive wealth tax collection: Lastly, equipped with a “globally coordinated wealth registry” (Stiglitz et al 2019), the Lastenausgleich authorities would collect progressive wealth taxes from the owners of real and non-debt financial assets for the equalisation of burdens.
      • While a part of these taxes could be used to retire some of the equalisation claims and the corresponding reserves and deposits created in the deleveraging process, another part could be transferred to the climate authorities, and the rest could be spent in the interests of the society.

  • Essential Commodities

    The Price Monitoring Division (PMD) in the Department of Consumer Affairs is monitoring the retail and wholesale prices of 22 essential food commodities due to increased panic buying by customers.

    Essential Commodities Act

    • The ECA is an act which was established to ensure the delivery of certain commodities or products, the supply of which if obstructed owing to hoarding or black-marketing would affect the normal life of the people.
    • The ECA was enacted in 1955. This includes foodstuff, drugs, fuel (petroleum products) etc.
    • It has since been used by the Government to regulate the production, supply and distribution of a whole host of commodities it declares ‘essential’ in order to make them available to consumers at fair prices.
    • Additionally, the government can also fix the maximum retail price (MRP) of any packaged product that it declares an “essential commodity”.
    • The list of items under the Act includes drugs, fertilizers, pulses and edible oils, and petroleum and petroleum products.
    • The Centre can include new commodities as and when the need arises, and takes them off the list once the situation improves.

    How ECA works?

    • If the Centre finds that a certain commodity is in short supply and its price is spiking, it can notify stock-holding limits on it for a specified period.
    • The States act on this notification to specify limits and take steps to ensure that these are adhered to.
    • Anybody trading or dealing in the commodity, be it wholesalers, retailers or even importers are prevented from stockpiling it beyond a certain quantity.
    • A State can, however, choose not to impose any restrictions. But once it does, traders have to immediately sell into the market any stocks held beyond the mandated quantity.
    • This improves supplies and brings down prices. As not all shopkeepers and traders comply, State agencies conduct raids to get everyone to toe the line and the errant are punished.
    • The excess stocks are auctioned or sold through fair price shops.

    Ex: The Union Government has brought masks and hand-sanitisers under the ECA to make sure that these products, key for preventing the spread of Covid-19 infection, are available to people at the right price and in the right quality.

    What about Food Items?

    • The items covered include rice, wheat, atta, gram dal, arhar dal, moong dal, urad dal, masoor, dal, tea, sugar, salt, Vanaspati, groundnut oil, mustard oil, milk, soya oil, palm oil, sunflower oil, gur, potato, onion and tomato.
    • Based on the deliberations, Government takes various measures from time to time to stabilize prices of essential food items which, inter-alia, include appropriately utilizing trade and fiscal policy instruments like import duty.
    • The govt. can impose stock limits and advise State for effective action against hoarders & black marketers etc. to regulate domestic availability and moderate prices.
    • The government utilizes the buffer of agri-horticultural commodities like pulses, onion, etc. built under Price Stabilization Fund (PSF) to help moderate the volatility in prices.

    Back2Basics

    Price Stabilization Fund (PSF)

    • The PSF was set up in 2014-15 under the Department of Agriculture, Cooperation & Famers Welfare (DAC&FW) to help regulate the price volatility of important agri-horticultural commodities like onion, potatoes and pulses were also added subsequently.
    • Procurement of these commodities will be undertaken directly from farmers or farmers’ organizations at farm gate/mandi and made available at a more reasonable price to the consumers.
    • Losses incurred, if any, in the operations will be shared between the Centre and the States.
    • PSF provides for advancing interest-free loans to State Governments/ UTs and Central agencies to support their working capital and other expenses they might incur on procurement and distribution interventions for such commodities.
    • The scheme provides for maintaining a strategic buffer of the commodities for subsequent calibrated release to moderate price volatility and discourages hoarding and unscrupulous speculation.
    • The PSF is managed centrally by a Price Stabilization Fund Management Committee (PSFMC) which will approve all proposals from State Governments and Central Agencies.
    • The PSF is maintained as a Central Corpus Fund by Small Farmers Agribusiness Consortium (SFAC), a society promoted by the Ministry of Agriculture for linking agriculture to private businesses and investments and technology.

    With inputs from: http://www.arthapedia.in/index.php?title=Price_Stabilisation_Fund_(PSF)

  • India can use Yes Bank debacle to chase China in Crypto

    Context

    There’s an opportunity to stabilize the financial system and prevent a rival power from widening its lead.

    The backdrop of YES bank failure time for cryptocurrency

    • Perfect time for cryptocurrency: Confidence in the Indian financial system has been breaking down for some time. Instead of trying to restore trust, it may be time to require less of it — with the help of an official rupee cryptocurrency.
    • The last straw: The collapse of corporate lender Yes Bank Ltd. was the last straw, which failed in slow motion in full view of authorities.
      • Depositors have been assured that their $20 billion-plus in stuck funds will be released after a rescue by the government-controlled State Bank of India.
      • What could be the impact on the sentiment of the people? While that may help prevent widespread panic, even temporarily stopping people from accessing their funds would mean that from now on, not all savings and current accounts will be treated by individuals and businesses as a perfect substitute for cash.

    Why it would be costly and difficult to revive the public faith?

    • It will be both difficult and costly to revive the public’s dwindling faith.
    • Nationalisation not an option: A nuclear option is to nationalize the banks and non-bank finance firms that provide $1.75 trillion in annual funding. Doing so would be a doomed throwback to the late 1960s when India lurched toward stultifying socialist-style state controls.
    • Corruption in banking won’t go away: Similarly, it would be unrealistic to assume that the Yes Bank embarrassment would trigger an improvement in the status quo.
      • Deep crony-capital relationship: The crony-capital relationships between financiers and borrowers in India are steeped in its colonial history.
      • Basel III won’t solve the problem: Putting on the gloss of Basel III capital requirements, which are supposed to make lenders less prone to failure, doesn’t make corruption in banking go away.

    Can cryptocurrency be an answer?

    • It offers hope: Blockchain technology, which the Indian establishment is trying to snuff out in finance, offers hope. Government should consider official crypto to obviate the need for trusted intermediaries, which are in short supply, anyway.
    • China expected to launch digital currency: Before the coronavirus outbreak, China was widely expected to start its own central bank digital currency this year.
      • But India’s need is greater, and its motivation very different from Beijing’s desire to shake the hegemony of the dollar.
    • After the Yes Bank debacle and botched rescue, deposits in India will probably gravitate toward four or five large lenders, whose managers may be emboldened to make risky bets with other people’s money. The remaining banks will struggle for liquidity. A perennially unstable credit delivery network will always be one misstep away from the next blowup. While every country has its share of manias, panics and crashes, to be gripped by absolute financial mistrust every few years is not an environment where growth can flourish.
    • Opportunity to think afresh: Earlier this month, India’s highest court set aside the Reserve Bank of India’s directive that asked banks to not offer services to cryptocurrency traders and exchanges.
      • A legal defeat has provided the opportunity to think afresh.
      • But in parallel, the government is considering a blanket ban on private virtual tokens. The crypto activity could get slammed again.
    • Possibility of misuse: To be sure, one popular use of technology is money laundering.
      • But to kill the industry and send practitioners packing would be to lose out on a valuable innovation at a time when India needs to build on the globally recognized successes of its digital payments industry, which has gained users’ trust just as banks and shadow banks have lost it.

    Implications for deposit in the aftermath of Yes bank debacle

    • Deposits may gravitate towards big banks: After the Yes Bank debacle and botched rescue, deposits in India will probably gravitate toward four or five large lenders, whose managers may be emboldened to make risky bets with other people’s money.
      • The remaining banks will struggle for liquidity.
    • Next blowup: A perennially unstable credit delivery network will always be one misstep away from the next blowup.
    • Impact on growth: While every country has its share of manias, panics and crashes, to be gripped by absolute financial mistrust every few years is not an environment where growth can flourish.

    Possible pathways for central banks digital currency

    • Pathways suggested by BIS: After surveying 17 projects around the world — from Norway and Sweden to China, Cambodia and South Africa — the Bank for International Settlements (BIS) has identified four possible pathways for a central bank digital currency.
    • Starting point- Rupee token: Of the pathways suggested by the BIS, a rupee token that doesn’t require the holder to have an account with anyone but has value guaranteed by the Reserve Bank of India could be a starting point.
    • Who should enable the fund transfer? Cryptography (“I know a secret, therefore I own the funds”) rather than an account relationship (“I am who I say I am, therefore I own the funds”) would be used to enable transfers.
      • Later, the RBI can open up the validation of transactions to authorized parties on distributed ledgers.
    • What is the current system and issues with it? Currently, a deposit holder has to rely on everyone from the bank’s management and board to the auditors, the rating firms and the regulator to do their jobs.
      • When they all fail, as in the case of Yes, the bank’s chequebook, ATM card, and online banking password cease to generate liquidity.
      • Deposits stop being the same as cash, even if the state guarantees their safety.
      • It would be far less painful if deposit owners only had to trust the RBI, not as a banking regulator but as a money-printing authority that could never run out of resources to settle its IOUs.

    Conclusion

    • China’s ambition challenge dollars position as a reserve currency: China wants the yuan to take over from the dollar as the world’s reserve currency. A tech-enabled global alternative to the greenback — of the kind that Facebook Inc.’s proposed Libra had threatened to be — would have been an obstacle. Hence, Beijing accelerated its tokenized currency initiative.
    • India should jump the bandwagon: India needs to jump on the bandwagon for self-preservation. If the RBI doesn’t make easy-to-transact digital rupees available and leaves ordinary folks at the mercy of poorly run and supervised banks like Yes, people would rather store their wealth in Silicon Valley-sponsored tokenized money — or Beijing’s digital yuan — whenever they arrive.

  • Excise Duty on Petrol and Diesel

    The Central levies on petrol and diesel were hiked amid sliding global crude oil prices. But the price of petrol and diesel registered a decline after oil companies further cut auto fuel prices in light of the substantial fall in global crude oil prices.

    What is Excise Duty?

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

    Purview of excise duty

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

    Types of excise duty in India

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

    Basic Excise Duty

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

    Additional Excise Duty

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

    Special Excise Duty

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

  • The real reform

    Context

    The IBC has started emerging stronger as it delivered on its promise, passed the constitutional muster, earned global recognition and became the preferred option for stakeholders in case of default.

    Demystifying the myths surrounding IBC

    Myths about recovery:

    Most of the myths surround recovery. Consider the following example for quick appreciation.

    • M/s. Synergies Dooray was the first company to be resolved under the IBC. It was with the Board of Industrial and Financial Reconstruction (BIFR) for over a decade.
    • The realisable value of its assets was Rs 9 crore when it entered the IBC process. It, however, owed Rs 900 crore to the creditors.
    • How much did IBC recover? The resolution plan yielded Rs 54 crore for them.
    • Some condemned IBC because the resolution plan yielded a meagre 6 per cent of the claims of the creditors, disregarding the fact that they recovered 600 per cent of the realisable value of the company, which had been in the sick bed for over a decade.
    • If the company was liquidated, assuming no transaction costs, the creditors would have got at best Rs 9 crore — 1 per cent of their claims.

    The myth that recovery under IBC is dismal

    • Let’s examine the myth that the recovery through resolution plans is dismal.
      • Two hundred companies had been rescued till December 2019 through resolution plans.
      • They owed Rs 4 lakh crore to creditors. However, the realisable value of the assets available with them, when they entered the IBC process, was only Rs 0.8 lakh crore.
      • The IBC maximises the value of the existing assets, not of the assets which do not exist. Under the IBC, the creditors recovered Rs 1.6 lakh crore, about 200 per cent of the realisable value of these companies.
      • Why creditors had to take a haircut? Despite the recovery of 200 per cent of the realisable value, the financial creditors had to take a haircut of 57 per cent as compared to their claims. This only reflects the extent of value erosion that had taken place when the companies entered the IBC process.
      • What is the conclusion? As compared to other options, banks are recovering much better through IBC, as per RBI data.

    The myth that IBC is sending companies for liquidation:

      • What is the primary objective of IBC: Recovery is incidental under the IBC. Its primary objective is rescuing companies in distress.
      • More number of companies sent for liquidation: There is a myth that although the IBC process has rescued 200 companies, it has sent 800 companies for liquidation. The number of companies getting into liquidation is thus four times that of the companies being rescued.
      • The context for the numbers: Numbers, however, to be seen in context. The companies rescued had assets valued at Rs 0.8 lakh crore, while the companies referred for liquidation had assets valued at Rs 0.2 lakh crore when they entered the IBC process.
      • Looking from the value term angle: In value terms, assets that have been rescued are four times those sent for liquidation. It is important to note that of the companies rescued, one-third were either defunct or under BIFR, and of the companies sent for liquidation, three-fourths were either defunct or under BIFR.

    The myth that IBC is resulting in huge job losses

    • The next myth is that the IBC is resulting in huge job losses through liquidation. It is misconstrued that 600 companies — for which data are available and which have proceeded for liquidation — have assets (and consequently employment) at least equal to the aggregate claim of the creditors — Rs 4.6 lakh crore.
    • Unfortunately, they have assets on the ground valued only at Rs 0.2 lakh crore.
      • Take the examples of Minerals Limited and Orchid Healthcare Private Limited, which have been completely liquidated. They owed Rs 8,163 crore, while they had absolutely no assets and employment.
      • What matters in this context is the assets a company has or the employment it provides — not how much it owes to creditors.
    • The IBC process would release the idle or under-utilised assets valued at Rs 0.2 lakh crore, which would have dissipated with time, for business and employment.
    • One also needs to consider the jobs saved through the rescue of 80 per cent of the distressed assets, and the job being created by these companies, post-rescue.

    What changes IBC has brought?

    • Changed the behaviour of debtors: A distressed asset has a life cycle. Its value declines with time if the distress is not addressed.
      • The credible threat of the IBC process, that a company may change hands, has changed the behaviour of debtors.
    • Debtors are settling debt at an early stage: Thousands of debtors are settling defaults at the early stages of the life cycle of a distressed asset.
      • They are settling when the default is imminent, on receipt of a notice for repayment but before filing an application, after filing the application but before its admission, and even after admission of the application.
      • These stages are akin to preventive care, primary care, secondary care, and tertiary care with respect to sickness. Only a few companies, who fail to address the distress in any of these stages, reach the liquidation stage.
    • Value erosion at the liquidation stage: The value of the company is substantially eroded, and hence some of them would be rescued, while others are liquidated.
      • The recovery may be low at this stage, but in the early stages of distress, it is much higher — primarily because of the IBC.
      • The percentage of companies or distressed assets getting into liquidation is insignificant.
      • Stakeholders should increasingly address the distress in the early stages and the best use of the IBC would be not using it all.

    Conclusion

    Stakeholders who understand business and have the backing of sophisticated professionals are using IBC with open eyes after evaluating all options. There is no reason to doubt their commercial wisdom. The 25,000 applications filed so far under IBC indicate the value and trust that stakeholders place on the law — the ultimate test of its efficacy.

     

  • The circuit breaker in the stock market

    The stock markets in India are witnessing historic single-day falls with an increase in the number of COVID-19 cases.  Since the indexes plunged more than 10 per cent each day earlier, a circuit breaker was triggered for the first time since 2009 halting trading.

    What are circuit breakers?

    • In June 2001, the SEBI implemented index-based market-wide circuit breakers.
    • Circuit breakers are triggered to prevent markets from crashing, which happens when market participants start to panic induced by fears that their stocks are overvalued and decide to sell their stocks.
    • This index-based market-wide circuit breaker system applies at three stages of the index movement, at 10, 15 and 20 per cent.
    • When triggered, these circuit breakers bring about a coordinated trading halt in all equity and equity derivative markets nationwide.