GS Paper: Indian Economy

Why in the News?

It is essential to incorporate the significance of insolvency laws into global trade discussions through both multilateral and bilateral channels.

What are the key challenges in managing cross-border insolvency cases?

• Jurisdictional Conflicts: Difficulty in determining which country’s courts have jurisdiction over insolvency proceedings, especially when a company has assets and creditors in multiple countries.
• Recognition of Foreign Proceedings: Some countries may not recognize foreign insolvency proceedings, leading to inconsistent outcomes.
• Coordination Issues: Lack of cooperation between courts and administrators in different countries can complicate the resolution of cross-border insolvency cases.
• Legal and Cultural Differences: Variations in legal systems, insolvency laws, and business practices across countries make harmonization challenging.
• Enforcement of Judgments: Difficulty in enforcing insolvency-related judgments or agreements across different jurisdictions.

How does the Insolvency and Bankruptcy Code (IBC) address cross-border insolvency in India?

• Limited Provisions: The IBC, 2016, has provisions for handling cross-border insolvency on a case-by-case basis through bilateral agreements, but it lacks a comprehensive framework.
• Bilateral Arrangements: India’s approach currently relies on ad hoc bilateral agreements to manage cross-border insolvency cases, making the process fragmented and less efficient.
• No Adoption of the UNCITRAL Model Law: Despite several recommendations by committees, India has yet to adopt the UNCITRAL Model Law on Cross-Border Insolvency, which would provide a more standardized and efficient resolution mechanism.

What international frameworks exist to facilitate cross-border insolvency resolutions?

• UNCITRAL Model Law on Cross-Border Insolvency (1997): A widely recognized framework designed to facilitate cooperation between courts and administrators in different countries.
  • It operates on four pillars: access, recognition, cooperation, and coordination. It has been adopted by over 60 countries.
• EU Insolvency Regulation: Provides a framework for handling insolvency within EU member states, facilitating the recognition of insolvency proceedings across borders within the EU.
• NAFTA/US-Mexico-Canada Agreement (USMCA): Includes provisions for resolving insolvencies with cross-border implications between member countries.
• Bilateral and Multilateral Trade Agreements: Some international agreements include limited provisions on cross-border insolvency, though most focus on general trade and dispute resolution, leaving a gap in addressing insolvency directly.

Way forward: 

• Adopt the UNCITRAL Model Law: India should expedite the adoption of the UNCITRAL Model Law on Cross-Border Insolvency to establish a standardized framework, improving cooperation, recognition, and legal certainty in international insolvency cases.
• Integrate Cross-Border Insolvency in Trade Agreements: India should incorporate cross-border insolvency provisions in Free Trade Agreements (FTAs) and Comprehensive Economic Partnership Agreements (CEPAs) to ensure seamless insolvency resolution in international trade.

Why in the News?

During the transition to the Scale-Based Regulation (SBR) framework, the NBFC sector experienced double-digit credit growth, maintained adequate capital levels, and saw a reduction in delinquency ratios.

What are the key points presented by RBI on the resilience of the NBFC sector?

• Improvement in Asset Quality: Since the introduction of the Scale-Based Regulation (SBR) framework in October 2022, the asset quality of NBFCs has improved, with lower gross non-performing asset (GNPA) ratios.
  • By December 2023, GNPA ratios had decreased to 2.4% for government-owned NBFCs and 6.3% for non-government NBFCs, reflecting enhanced risk management.
• Double-Digit Credit Growth: The NBFC sector maintained strong credit growth throughout 2023, driven by a diversified funding base, including retail credit (gold loans, vehicle loans, and housing loans) and expanding into industrial and service sectors.
• Improved Profitability: The sector witnessed a rise in profitability, as evidenced by better returns on assets (RoA) and equity (RoE).
• Net NPA (NNPA) Performance: Upper layer NBFCs had lower GNPA ratios than middle layer NBFCs, but the latter maintained sufficient provisions for riskier portfolios, ensuring that their NNPA ratios were also controlled.
• Compliance with SBR: Major NBFCs in the “Upper Layer” identified by the RBI under the SBR framework, such as LIC Housing Finance, Bajaj Finance, and L&T Finance, have complied or initiated steps to comply with listing requirements.

Regulatory measures  taken up by the NBFC sector 

• Scale-Based Regulation (SBR) Framework: Introduced in October 2022, the SBR framework categorizes NBFCs into different layers based on their size, systemic importance, and risk profile. For instance, strengthen asset quality, capital requirements, and risk management.
• Prompt Corrective Action (PCA) Norms: Effective from October 2024, PCA norms will apply to government-owned NBFCs. These measures aim to enhance financial discipline, focusing on capital adequacy and asset quality.
• Diversification of Funding Sources: Due to rising risk weights on bank lending, NBFCs have diversified their funding base by reducing dependence on bank borrowings and expanding into secured retail credit.
• Listing Compliance: Many NBFCs in the upper layer have complied or are in the process of complying with listing requirements as part of regulatory mandates.

What are the emerging risks that NBFCs need to cater? (Way forward) 

• Cybersecurity Risks: With the increasing use of digital platforms, NBFCs need to enhance cybersecurity measures to safeguard against evolving cyber threats.
• Climate Risk: The financial impact of climate change poses a new risk. NBFCs must integrate climate-related risks into their risk management frameworks to mitigate potential disruptions.
• Financial Assurance Functions: The RBI emphasizes that assurance functions like risk management, compliance, and internal audit are critical in maintaining resilience in the face of rapid changes in the financial landscape.
• Evolving Regulatory Environment: As the financial sector continues to evolve, NBFCs must stay ahead of regulatory changes and ensure that their risk management practices are aligned with emerging threats and new regulations.

Why in the News?

The United States Federal Reserve, responsible for the country’s monetary policy, announced on Wednesday that it will lower its key interest rate, called the Federal Funds Rate, by 0.5%, or 50 basis points.

Why did the Fed cut interest rates?

• The Federal Reserve cut the benchmark interest rate by 50 basis points to address rising unemployment concerns while inflation was stabilizing.
• After a series of aggressive rate hikes to counter inflation that surged due to post-COVID recovery and the Russia-Ukraine war, inflation began to moderate, nearing the Fed’s target of 2%.
• Rising unemployment data signaled that the restrictive monetary policy might harm the labor market, prompting the Fed to act.

Will the US economy achieve a soft landing?

• Optimistic Projections: Despite earlier predictions that high inflation would lead to a recession, the Fed’s strategy may succeed in achieving a soft landing, reducing inflation without crashing the economy.
• GDP Growth: The Summary of Economic Projections (SEP) estimates GDP growth to remain around 2% for the next few years, indicating a stable economy.
• Unemployment: While the unemployment rate has risen slightly to 4.4%, it remains manageable, with expectations of improvement.
• Risks: Potential policy shifts, especially related to the upcoming presidential election, could disrupt the economic outlook, particularly if trade tariffs are imposed.

How will India be affected?

• Increased Foreign Investments: Lower US interest rates could encourage foreign investors to borrow in the US and invest in India through stocks, bonds, or foreign direct investment (FDI), benefiting capital inflow.
• Rupee Strengthening: With falling US interest rates, the US dollar may weaken against the Indian rupee, potentially strengthening the rupee. This would negatively affect Indian exporters but benefit importers.
• RBI’s Interest Rate Decisions: While the Fed’s rate cuts influence global markets, India’s central bank, the RBI, may not directly follow suit due to differing inflation targets and mandates. The RBI prioritizes inflation control and GDP growth over unemployment figures.

Way forward: 

• Encourage Capital Inflows: India should take advantage of lower US interest rates by attracting foreign investments through improved ease of doing business, fostering growth in key sectors like infrastructure, technology, and manufacturing.
• Maintain Monetary Stability: The RBI should carefully assess global trends but prioritize domestic conditions when adjusting interest rates, focusing on inflation control, financial stability, and sustained GDP growth.

Mains PYQ:

Q Do you agree with the view that steady GDP growth and low inflation have left the Indian economy in good shape? Give reasons in support of your arguments. (UPSC IAS/2016)