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GS Paper: Indian Economy

  • What is Vertical Fiscal Imbalance? 

    Why in the News?

    The financial relationship between the Union and State governments in India is imbalanced, similar to other nations with a federal constitutional structure.

    What is Vertical Fiscal Imbalance (VFI)?

    Vertical fiscal imbalance (VFI) refers to the mismatch between the revenue-raising powers and expenditure responsibilities of different levels of government (between the Center and state) within a country.

    Why should Vertical Fiscal Imbalance (VFI) be reduced?

    • Decentralization of Expenditure: States are responsible for 61% of the revenue expenditure, focusing on crucial sectors like health, education, and infrastructure, but they generate only 38% of the revenue.
      • This imbalance creates a dependency on central transfers, limiting the States’ fiscal autonomy.
    • Need Efficiency in Spending: Reducing VFI would provide states with more resources, allowing them to respond better to local needs and improve governance efficiency.
    • Need to strengthen Fiscal Federalism: A reduction in VFI promotes a healthier system of cooperative federalism, ensuring that states have adequate resources to carry out their constitutional responsibilities and meet the demands of their populations.
    • Need Preparedness for crises: VFI becomes more pronounced during crises (e.g., COVID-19), leading to fiscal stress for States. A more balanced fiscal arrangement ensures better crisis management at the sub-national level.

    Present Scenario of VFI and Tax Devolution in India

    • VFI Extent: The 15th Finance Commission noted that despite States‘ heavy spending responsibilities, their revenue-raising powers are limited.
    • Tax Devolution Rates: The 14th and 15th FC recommended devolving 42% and 41%, however, estimates suggest that an average share of 48.94% was necessary between 2015-2023 to eliminate the VFI.
    • Exclusion of Cesses and Surcharges: The exclusion of cesses and surcharges from the divisible pool of taxes shortens the net proceeds. States argue this limits the resources available to them to meet their expenditure responsibilities.
    • Fiscal Responsibility: Despite the constraints, states have largely adhered to borrowing limits under fiscal responsibility legislation. However, states still struggle to meet their expenditure responsibilities, highlighting the need for greater financial support from the Centre.
    Note: The Sixteenth Finance Commission was constituted on December 31 2023 with Dr. Arvind Panagariya as the Chairman. The 16th FC has been requested to make its report available by the 31st day of October 2025 covering 5 years commencing on the 1st day of April, 2026.

     

    What should be the role objective of the 16th FC?

    • Increase Tax Devolution: Many States demand that tax devolution from the Union’s net proceeds should be raised to 50%. The 16th Finance Commission must consider raising the devolution rate to around 49% to address the VFI and ensure sufficient untied funds for States.
    • Address Cesses and Surcharges: The 16th Finance Commission should evaluate the exclusion of cesses and surcharges from the divisible pool.
    • Empower States with Fiscal Autonomy: The Commission’s objective should be to empower States with greater fiscal autonomy by ensuring adequate resources for them to perform their constitutional duties without undue dependence on the Centre.
    • Support Local Priorities: The Commission should aim to provide States with untied resources, enabling them to cater to jurisdictional needs and set priorities that align with their specific developmental challenges, ensuring a more responsive governance system.

  • Did Corporate Tax cuts increase Wages?

    Why in the News?

    Before the pandemic, the U.S. and India reduced corporate taxes to boost growth but we now we can evaluate their effects.

    Case Study on the Effects of Tax Cuts in the U.S.

    The Tax Cuts and Jobs Act (TCJA), enacted in December 2017, significantly reduced the corporate tax rate from 35% to 21%. A recent analysis by economists Gabriel Chodorow-Reich, Owen Zidar, and Eric Zwick highlights several key findings:

    • Investment Increase: The TCJA led to an estimated increase in investment of approximately 8% to 14%.
    • GDP Growth: The long-term increase in GDP is projected to be modest, around 0.9%, which is substantially lower than initial expectations.
    • Wage Impact: The increase in annual wages due to the tax cuts was less than $1,000 per worker, contrasting sharply with earlier claims of increases between $4,000 and $9,000.
    • Tax Revenue Decline: The TCJA is expected to result in a long-term reduction in tax revenue of nearly 41%, raising concerns about the fiscal health of the U.S. economy.

    Tax Cuts in India

    In September 2019, India also implemented corporate tax cuts, reducing the rate for existing companies from 30% to 22% and for new companies from 25% to 15%.  The primary reason for this move was to stimulate economic growth and attract investment, particularly in the manufacturing sector.

    Impact of the Tax cuts:

    • Revenue Loss: The tax cuts resulted in a revenue loss of approximately ₹1 lakh crore in 2020-21.
    • Gig workers (insecure forms of work): Although unemployment has decreased since the pandemic, much of the new employment is in insecure forms of work.
    • Decline in Regular Employment: According to the Periodic Labour Force Survey (PLFS) in India, the share of regular wage employment fell from 22.8% in 2017-18 to 20.9% in 2022-23.
    • Tax Burden Shift: There has been a notable shift in the tax burden from corporate taxes to individual income taxes. The share of corporate taxes in gross tax revenues fell from about 32% in 2017-18 to 26.5% in 2024-25.

    What must be the next step? ( Way forward)

    • Focus on Future Investment: Policymakers should consider implementing high taxes on existing profits while providing incentives for future investments to stimulate economic activity.
    • Addressing Income Inequality: Tax policies should be designed to ensure that the benefits of tax cuts do not disproportionately favour wealthier individuals or corporations at the expense of wage earners.
    • Evaluating Economic Conditions: Need to evaluate the tax cuts to ensure they are not merely providing short-term benefits without addressing long-term growth and fiscal stability.

    Mains PYQ:

    Q  Enumerate the indirect taxes which have been subsumed in the Goods and Services Tax (GST) in India. Also, comment on the revenue implications of the GST introduced in India since July 2017. (UPSC IAS/2019)

  •  An either-or approach won’t help quell food inflation 

    Why in the News?

    The recently released Consumer Price Index-Combined (CPI-C) data reveals that food inflation, particularly from pulses, vegetables, and cereals, is rising faster than the overall CPI inflation.

    • The Consumer Price Index-Combined (CPI-C) is the index used to calculate headline inflation in India. It is calculated and published monthly by the Bureau of Labor Statistics.

    Key Highlights of the CPI-C Data:

    • On Current Inflation Rates: The general CPI inflation stands at 3.54%, while food inflation is notably higher at 5.06%, driven by increases in prices of pulses, vegetables, and cereals.
    • On Inflation Dynamics in the Past: Over the past decade, food inflation has contributed to the overall volatility of prices. In 52 of the 124 months analyzed, food inflation exceeded the general CPI rate, indicating a significant and fluctuating impact on overall inflation.
    • Expectations by the report: The RBI has highlighted that food inflation significantly influences inflationary expectations, which remain unanchored, often exceeding actual inflation rates.

    (*Note: These data don’t include income taxes or investment items like stocks, bonds, and life insurance.)

    Recently impact of good Monsoon on Food Production and Inflation: 

    • Increased Sowing Due to Robust Monsoon: India has reported a significant increase in the sowing of paddy and pulses, with paddy sowing up by 16% to 39 million hectares and pulses by 7% to 12 million hectares as of August 23, 2024, driven by a strong monsoon.
    • Potential Impact on Food Inflation: Despite concerns over rising food inflation, the expanded cultivation area for staple crops like rice and pulses could positively impact the agriculture sector and support government efforts to enhance farm productivity.

    Present Situation of Inflation in the Agri-Food Sector

    • Volatility in Food Prices: Food inflation has been volatile, with instances of both high and low inflation. For example, food inflation was above 6% in 52 out of 124 months, while it was below 2% in 20 months, including periods of negative inflation.
    • Supply-Side Factors: The disparities between food and retail inflation can be attributed to supply-side issues such as monsoon variability, crop failures, and government policies like minimum support prices (MSPs). Excess demand for specific food categories, such as oils and fats, has also contributed to higher inflation.
    • Regional Disparities: Rural CPI inflation is higher (5.43%) compared to urban CPI (4.11%), reflecting the impact of agricultural conditions and market dynamics on rural households.

    How Can the Gap Between Farmer and Consumer Be Reduced?

    • Market-Driven Pricing: The government should reconsider its intervention in agricultural markets through MSPs, allowing market forces to determine food prices. This could help reduce production distortions and improve price signals for farmers.
    • Enhancing Agricultural Productivity: Government expenditure should focus on increasing agricultural productivity through better technology and irrigation practices, which can lead to more stable food supplies and prices.
    • Reducing Middlemen: Implementing measures to eliminate middlemen in the supply chain can help narrow the gap between what farmers receive and what consumers pay.
    • Infrastructure Development: Improving infrastructure for storage and transportation can help reduce food wastage and ensure that food products reach consumers efficiently, further stabilizing prices.

    Conclusion: Need to encourage the adoption of advanced agricultural technologies and sustainable farming practices to boost productivity and reduce the impact of supply-side disruptions, ensuring more consistent food supplies and stable prices.

    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/2017)

  • MUDRA 2.0 Loans

    Why in the News?

    The Union Budget 2024 has sought to increase the loan limit under the MUDRA scheme signifying the potential launch of MUDRA 2.0.

    What is MUDRA 1.0?

    Details
    Launch
    • Pradhan Mantri Mudra Yojana (PMMY)
    • Launched in 2015.
    Purpose To extend affordable credit to micro and small enterprises, bringing them into the formal financial system and funding the unfunded.
    Loan Providers Public Sector Banks (PSU Banks), Regional Rural Banks, Cooperative Banks, Private Sector Banks, Foreign Banks, Micro Finance Institutions (MFI), and Non-Banking Finance Companies (NBFC).
    Eligibility Indian citizens with a business plan for non-farm sector income-generating activities in manufacturing, processing, trading, or services, requiring less than ₹10 lakh.
    Types of Loans • Shishu: Loans up to ₹50,000.
    • Kishor: Loans above ₹50,000 and up to ₹5 lakh.
    • Tarun: Loans above ₹5 lakh and up to ₹10 lakh.
    Subsidy
    • No direct subsidy;
    • Loans linked to Government schemes providing capital subsidies are eligible under PMMY.

    Achievements of MUDRA 1.0

    • Financial Inclusion: Disbursed over Rs 27.75 lakh crore to 47 crore small entrepreneurs, improving access to formal credit.
    • Support for Marginalized Groups: 69% of loans went to women, and 51% to SC/ST and OBC entrepreneurs, enhancing social equity and gender equality.
    • Job Creation: Helped create jobs and encouraged self-employment, especially in rural and semi-urban areas.
    • Reduction in NPAs: Reduced non-performing assets (NPAs) from 3.61% in FY21 to 2.1% in FY24, showing better loan management.

    Challenges Faced by MUDRA 1.0

    • Unequal Loan Distribution: In 2021-22, the top 10 districts received Rs 26,000 crore, about the same as the bottom 318 districts, showing uneven credit distribution.
    • High NPAs in Early Categories: The Shishu (loans up to Rs 50,000) and Kishore (loans between Rs 50,001 and Rs 5 lakh) categories had NPAs above 4% from FY20 to FY22 due to a lack of business skills among early-stage entrepreneurs.
    • Low Financial Literacy: Only 27% of the population is financially literate, leading to poor loan management and higher defaults.
    • Monitoring and Credit Appraisal Issues: Increased lending led to challenges in maintaining quality credit appraisal processes and monitoring, resulting in some misuse of funds.

    What is MUDRA 2.0?

    • MUDRA 2.0 is the proposed next phase of the scheme, aiming to expand and enhance support for micro-entrepreneurs, especially in underserved regions.
    • Features of MUDRA 2.0:
      • Expanded Outreach: Establish new centers in rural and semi-urban areas to provide financial literacy, mentorship, and business support.
      • Enhanced Financial Literacy: Launch nationwide programs covering budgeting, savings, credit management, and digital literacy to help entrepreneurs manage their finances better.
      • Improved Credit Support: Introduce the Enhanced Credit Guarantee Scheme (ECGS) to reduce risks for banks and encourage more lending to small enterprises.
      • Stronger Monitoring: Implement a robust monitoring framework using data analytics to track loan disbursements, usage, and repayments in real-time, ensuring transparency and reducing misuse.

    PYQ:

    [2016] Pradhan Mantri MUDRA Yojana is aimed at:

    (a) Bringing the small entrepreneurs into formal financial system.

    (b) Providing loans to poor farmers for cultivating particular crops.

    (c) Providing pension to old and destitute persons.

    (d) Funding the voluntary organizations involved in the promotion of skill development and employment generation.

  •  Time to reset the GST system   

    Why in the News?

    Most states appear to be opposed to altering the current five primary GST rate slabs: 0%, 5%, 12%, 18%, and 28%.

    About Goods and Service Tax (GST):

    • The Goods and Services Tax (GST) in India was introduced by the Constitutional (One Hundred and First Amendment) Act of 2017. It is a unified tax system that replaced multiple indirect taxes levied by both the Central and State Governments.
    • Under GST, the Central (CGST) and state government (SGST) share the authority to levy and collect taxes on goods and services. In the case of Inter-state transactions, Integrated GST (IGST) is applicable.

    Essential Features of GST

    • Multiple Tax Levels: India’s GST system has multiple tax rates, with four primary tax rates (5%, 12%, 18%, and 28%). Additionally, there is a “zero rate” for certain essential goods and services (e.g. exports).
    • One Nation, One Tax: GST is based on the principles of value-added tax and applies to the supply of goods and services across the nation. It brings uniformity in the tax structure across India, eliminating the cascading effect of taxes.
    • Destination-Based Tax: This means that the revenue generated from GST is collected by the state where the goods or services are consumed, rather than where they are produced.
    • Eliminating Cascading Effect: Under the Indian GST system, businesses can claim input tax credit for the GST they paid on their purchases. This ensures that taxes are levied only on the value added at each stage of the supply chain.
    • Sector-specific Exemptions: Certain sectors, such as healthcare, education, and basic necessities like food grains, are either exempted from GST or have reduced tax rates to ensure affordability and accessibility.
    • Threshold Exemption: Small businesses with a turnover below a specified threshold (currently, it is 20 lakhs: supplier of both goods & services and 40 lakhs: for supplier of goods (Intra–State) in India) are exempt from GST.

    Present Challenges in GST Rates

    • Complexity and Confusion: The existence of multiple GST slabs creates confusion for businesses and consumers alike. Different rates for similar items lead to complications in compliance and classification, resulting in litigation and disputes.
      • For instance, the GST on cement is 28%, while essential items like milk are exempt, yet products derived from milk, such as skimmed milk powder, are taxed at 5%.
    • Anomalies in Taxation: There are notable inconsistencies in the application of GST rates. For example, the taxation of medical and life insurance premiums at 18% is seen as burdensome for individuals seeking financial protection against uncertainties.

    Need to simplify the current GST Slabs

    • Rationalization Proposal: There is a growing consensus among industry experts and some government officials that the GST structure should be simplified to a maximum of three slabs. 
      • This would not only streamline compliance but also reduce the administrative burden on businesses and the government alike.
    • Economic Stimulus: Simplifying GST rates could potentially stimulate economic activity by lowering indirect tax burdens, encouraging consumption, and ultimately leading to higher tax revenues.

    Why are states resisting?

    • Fear of Revenue Loss: Many states are apprehensive about the implications of changing the GST structure, fearing that it might lead to a decrease in their revenue streams.
    • Political Considerations: The political landscape also plays a role in the resistance to change. With upcoming elections and the need to maintain fiscal health, state governments may prioritize short-term revenue stability over long-term structural reforms.

    Way forward: 

    • Phased Implementation: Start by introducing pilot programs in select states or sectors to test the impact of GST simplification. This approach can help address specific concerns and refine the model before a nationwide rollout.
    • Revenue Protection Schemes: Develop robust mechanisms to compensate states for any potential revenue losses during the transition. This could involve a formula-based compensation fund or a temporary revenue guarantee.

    Mains PYQ: 

    Q Explain the rationale behind the Goods and Services Tax (Compensation to States) Act of 2017. How has COVID-19 impacted the GST compensation fund and created new federal tensions? (2020)

  • Global Finance Central Banker Report Cards, 2024

    Why in the News?

    The Reserve Bank of India (RBI) Governor has been awarded an “A+” rating for the second consecutive year in the Global Finance Central Banker Report Cards 2024.

    About the Global Finance Central Banker Report Cards

    • The Central Banker Report Cards are published annually by Global Finance, a magazine that has been grading central bank governors since 1994.
    • The report grades the central bank governors of nearly 100 countries, territories, and districts, including major institutions like the European Union, the Eastern Caribbean Central Bank, the Bank of Central African States, and the Central Bank of West African States.
    • Grading Scale:
      • The ratings range from “A+” for excellent performance to “F” for outright failure.
      • The grades assess success in key areas such as inflation control, economic growth, currency stability, and interest rate management.

    Significance 

    • This recognition highlights his exceptional performance in managing India’s monetary policy, particularly in areas such as inflation control, economic growth, currency stability, and interest rate management.

    PYQ:

    [2016] ‘Global Financial Stability Report’ is released by which organisation?

    (a) European Central Bank

    (b) International Monetary Fund

    (c) International Bank for Reconstruction and Development

    (d) Organisation for Economic Co-operation and Development

  • A ground plan for sustainable mass employment 

    Why in the News?

    The ambitious ₹2 lakh crore employment package aims to create 4.1 crore jobs, but evidence shows low wages and short-term skill programs hinder long-term sustainability.

    Low wages and short-term skill programs hinder long-term sustainability:

    • Low Wages Lead to Economic Insecurity: Low wages create economic insecurity for workers, making it difficult for them to meet basic needs. For instance, in the garment industry, there is a 48.5% gap between minimum wages and living wages in major garment-producing countries.
    • Short-Term Skill Programs Fail to Enhance Employability: Many short-term skill programs do not provide the depth of training needed for long-term employability. In India, for example, 75% of technical graduates and 90% of other graduates are considered unemployable, primarily due to a lack of practical skills and experience that employers seek.
    • Stagnation of Workforce Productivity: When workers are paid low wages, there is little incentive for them to enhance their skills or productivity. This stagnation is detrimental to both individual career growth and overall economic development.
    • Lack of Investment in Long-Term Skill Development: Low wages often correlate with limited investment in employee training and development.This is evident in the fact that only 15% of those trained under the Pradhan Mantri Kaushal Vikas Yojana (PMKVY) found jobs, indicating that short-term training initiatives are not effectively translating into sustainable employment outcomes.
    • Perpetuation of Poverty and Inequality: The combination of low wages and inadequate skill development contributes to the perpetuation of poverty and inequality. With 42% of the global workforce in vulnerable employment.

    12-point policy initiatives for sustainable mass employment:

    • Identify the skill need: Begin from below through decentralized community action to identify skilling needs. Create a register of those wanting employment/self-employment and a plan for every youth in partnership with professionals at the cluster level.
    • Initiative at the local level: Converge initiatives for education, health, skills, nutrition, livelihoods, and employment at the local government level with women’s collectives to ensure community accountability and effective outcomes.
    • Vocational programmes: Introduce need-based vocational courses/certificate programmes alongside undergraduate programmes in every college to improve employability.
    • Healthcare at international benchmark: Standardize nursing and allied health-care professional courses according to international benchmarks to meet the demand for skilled professionals.
    • Women security: Create community cadres of caregivers to run crèches universally so that women can work without fear.
    • Invest in skill development: Invest in ITIs, and polytechnics as hubs in skill development for feeder schools with a focus on States/districts with the least institutional structure for vocational education.
    • Startup skills in high school: Introduce enterprise and start-up skills through professionals in high schools to impart finishing skills to students.
    • Apprenticeship program in Industry: Have a co-sharing model of apprenticeships (combine practical training in a job with study) with the industry on scale to ensure the industry has a stake in the apprenticeship program.
    • Absorption of youth at the workplace: Apprenticeships on the scale can facilitate the absorption of youth in the workplace, with the government’s condition for employer subsidies being wages of dignity on successful completion of the apprenticeship.
    • Capital oan for women: Streamline working capital loans for women-led enterprises/first-generation enterprises to enable them to go to scale.
    • Skill accreditation programme: Start a universal skill accreditation programme for skill-providing institutions, with candidates co-sponsored by the state and employers.
    • Majority of fund in water scares block: Use 70% funds under MGNREGA in 2,500 water-scarce blocks and blocks with high deprivation, with a thrust on the poorest 20 families and a focus on skills for higher productivity.

    Way forward: 

    • Strengthen Industry-Academia Linkages: Enhance collaboration between educational institutions, industry, and vocational training centers to align curricula with industry needs, ensuring employability through internships, apprenticeships, and job placements.
    • Focus on Inclusive Skill Development: Prioritize investment in underdeveloped regions and marginalized groups by expanding access to quality education, vocational training, and entrepreneurship opportunities, especially for women and youth, to bridge the skill gap and promote economic inclusion.

  • The path to Viksit Bharat runs through fields  

    Why in the News?

    India’s 78th Independence Day is a time to reflect on our significant successes and setbacks. We should learn from both to make quicker progress towards the Prime Minister’s vision of a Viksit Bharat@2047 by 2047.

    Key Aspects of Viksit Bharat@2047

    • Economic Growth: The vision aims to elevate India to the status of the world’s third-largest economy and strive for a $30 trillion economy by 2047.
    • Environmental Sustainability: Viksit Bharat aims to preserve biodiversity and mitigate climate change impacts through restoration and conservation efforts.
    • Social Progress: The initiative seeks to build an inclusive society that respects cultural diversity and ensures the dignity and well-being of all citizens.
    • Good Governance: Effective governance is a cornerstone of the Viksit Bharat vision, focusing on accountability, transparency, and sound policies that are responsive to the needs of the people.
    • Youth Engagement: Recognizing the potential of India’s youth, the government has launched initiatives like the “Voice of Youth” portal to encourage young people to contribute ideas for achieving the goals of Viksit Bharat.

    Economic Challenges

    • Weak Domestic Demand: Stagnant or declining demand for goods and services due to low-income growth, high inflation, unemployment, and the impact of the Covid-19 pandemic.
    • High Unemployment: Despite rapid growth, unemployment remains a serious issue, worsened by the pandemic. The unemployment rate in India rose to 8.1 per cent in April 2024 from 7.4 per cent in March 2024, according to CMIE’s Consumer Pyramids Household Survey. 
    • Poor Infrastructure: India lacks adequate infrastructure like roads, railways, ports, power, water and sanitation, hampering economic development. The infrastructure gap is estimated at around $1.5 trillion.
    • Balance of Payments Deterioration: India runs a persistent current account deficit, with imports exceeding exports. Exports and imports decreased by 6.59% and 3.63% respectively in 2022.
    • High Private Debt Levels: India has witnessed a significant rise in debt levels in recent years.
      • According to the Reserve Bank of India (RBI), the total non-financial sector debt reached 167% of GDP in March 2020, up from 151% in March 2016. 
      • Household debt in India rose to 40.10% of GDP in the fourth quarter of 2023, up from 39% in the previous quarter. 

    Military Challenges

    • Securing Borders: Despite conflicts with Pakistan and China, India has reasonably managed border security. However, the rapid rise of China poses economic and military challenges.
    • China’s Growing Influence: Almost all of India’s neighbours are moving closer to China, necessitating better policy and diplomacy to secure India’s interests and ensure regional stability.
    • Military Modernization and Resource Allocation: India’s dependence on foreign arms imports, despite efforts to promote self-reliance through initiatives like “Make in India,” highlights the need for a robust domestic defense industry.
      • The country has been the largest arms importer from 2018 to 2022, indicating ongoing challenges in achieving military self-sufficiency

    Suggestive measures: (Way forward)

    • Agricultural Reforms: Investment in agricultural research and development, irrigation, and land-lease markets is vital. Building value chains for perishables can enhance food security and adapt to climate challenges.
    • Nutritional Security: Transitioning from mere food security to nutritional security is crucial, addressing issues like child malnutrition, which affects 35% of children under five.
    • Support for Farmers: Implementing subsidies for pulses and other sustainable crops can encourage healthier diets and environmental benefits. The government should provide financial incentives to farmers to shift from water-intensive crops to pulses.
    • Infrastructure Development: Continued investment in infrastructure, including transportation and digital connectivity, is essential for economic growth and improving citizens’ quality of life.
    • Education and Skill Development: Reforms in education to prioritize skill development and innovation are necessary to prepare the workforce for emerging industries and ensure inclusive growth.
    • Healthcare Initiatives: Expanding access to affordable healthcare services nationwide is critical for enhancing public health and productivity.

    Mains PYQ:

    Q Foreign Direct Investment (FDI) in the defence sector is now set to be liberalized: What influence this is expected to have on Indian defence and economy in the short and long run? (UPSC IAS/2016)

  • [17th August 2024] The Hindu Op-ed: The essence of India’s inflation problem

    PYQ Relevance:

    Q.1) 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/2019)

    Q.2) Besides the welfare schemes, India needs deft management of inflation and unemployment to serve the poor and the underprivileged sections of society. Discuss. (UPSC IAS/2022)

    Mentor comment: Food inflation in India significantly impacts the economy, particularly affecting low-income households that spend over 50% of their income on food. High food prices can lead to increased overall inflation, influencing wage demands and inflation expectations. This creates second-round effects, where rising food costs contribute to broader inflationary pressures. The persistence of food inflation complicates monetary policy, as the Reserve Bank of India struggles to control inflation without directly addressing food prices, which are influenced by supply-side factors beyond its control. Thus, food inflation remains a critical challenge for economic stability.

    Let’s learn!

    __

    Why in the news? 

    The Economic Survey suggests removing food prices from the RBI’s inflation target, shifting focus from headline to core inflation, and impacting inflation control strategies.

    Challenges related to Food Inflation: 

    1. Persistent High Food Inflation: Food price inflation in India has been elevated since 2019, with a year-on-year increase of close to 10% reported in June 2024. This trend indicates that high food inflation is not solely a consequence of external factors like the COVID-19 pandemic or the Ukraine war, but also reflects underlying domestic issues.
    2. Impact on Overall Inflation: Food prices constitute a significant portion of the consumer price index (CPI), accounting for nearly 50% of household expenditure in India. This high share means that fluctuations in food prices directly influence overall inflation rates, which have been higher than usual due to persistent food price increases.
    3. Food Prices as a Determinant of Core Inflation: Research indicates that food price inflation significantly affects core inflation in India. Rising food costs can lead to increased wages, which are a major component of production costs for firms. Thus, ignoring food prices in inflation targeting undermines the effectiveness of monetary policy.
    4. Long-Term Food Inflation Issues: Food price inflation has not been negative in any of the past 13 years, highlighting a persistent issue in the Indian economy. food inflation is a structural problem that needs to be addressed through comprehensive economic policies.

    The reason behind removing food prices from the RBI’s inflation target:

    1. High Sensitivity of Food Prices: Food prices in India are highly susceptible to supply shocks, such as erratic monsoon rains and agricultural disruptions. This volatility can lead to significant fluctuations in headline inflation, making it difficult for the RBI to maintain a stable inflation target when food prices are included in the calculation.
    2. Overshadow the impact of Monetary policy: Food constitutes about 46% of the Consumer Price Index (CPI) basket in India. This high weight can dilute the effectiveness of monetary policy aimed at controlling inflation, as changes in food prices can overshadow the impact of policy rate adjustments on core inflation measures.
    3. Core Inflation as a More Stable Measure: By focusing on core inflation, which excludes food and energy prices, the RBI could potentially achieve a more stable and manageable inflation target. This shift is based on the premise that core inflation is less influenced by volatile food prices and can provide a clearer picture of underlying inflation trends

    Way forward: 

    • Strengthening Agricultural Infrastructure and Supply Chain Management: To tackle the persistent issue of high food inflation, it is crucial to invest in and strengthen agricultural infrastructure, including irrigation systems, storage facilities, and transportation networks.  
    • Integrated Monetary and Fiscal Policy Approach: A more holistic approach is needed, where monetary policy is complemented by targeted fiscal interventions to manage food inflation.
      • The RBI should coordinate with the government to develop policies that address food price volatility, such as creating strategic food reserves, implementing effective buffer stock management, and providing targeted subsidies to protect vulnerable populations.  
  • [7th August 2024] The Hindu Op-ed: Powering up to get to the $30-trillion economy point

    [7th August 2024] The Hindu Op-ed: Powering up to get to the $30-trillion economy point

    PYQ Relevance:

    Mains:

    Q1 Define potential GDP and explain its determinants. What are the factorsthat have been inhibiting India from realizing its potential GDP?  (UPSC IAS/2020) 
    Q2 Explain the difference between the computing methodology of India’s Gross Domestic Product (GDP) before the year 2015 and after the year 2015. (UPSC IAS/2021) 

    Note4Students: 

    Mains:  Challenges related to Indian economy ;

    Mentor comments: India aims to achieve a $30 trillion GDP by 2045-2050, driven by robust consumption and exports. Current projections estimate GDP growth at around 6.3% annually, with nominal growth potentially reaching 10-12%. To realize this ambitious target, India must enhance private sector involvement, improve infrastructure, and foster industrial clusters. Urbanization and technological advancements in agriculture will also play crucial roles in boosting productivity and employment. Maintaining a steady growth trajectory is essential for transforming India into a global economic powerhouse while addressing income inequality challenges.

    Let’s learn!

    __

    Why in the News? 

    India should pursue rapid economic growth through liberal policies that harness the potential of the private sector, remaining undeterred by criticisms regarding income inequality.

    Demographic Dividend

    • India’s demographic dividend is poised to peak around 2041 when the share of the working-age population (20-59 years) is expected to hit 59%. This window of opportunity provides a chance for India to achieve higher economic growth by engaging more people in the workforce.
    • By 2020, India had one of the youngest populations in an ageing world, with a median age of just 28, compared to 37 in China and the US, 45 in Western Europe, and 49 in Japan. This youthful population can drive innovation and productivity.

    Gender Disparities

    • Female Labor Force Participation Rate (FLFPR): India’s FLFPR stands at 37%, significantly lower than that of countries like China and Japan, which range between 60%-70%. This disparity represents a vast untapped resource, as increasing women’s participation in the workforce could lead to substantial economic benefits and poverty reduction.
    • Post-COVID Recovery: The FLFPR was reported at 26% in 2019, but post-COVID-19, many women have returned to work, primarily in agriculture. This trend underscores the importance of creating more diverse employment opportunities for women in various sectors.

    Economic Growth and Poverty Reduction

    • Historical Context: From 1991 to 2011, India’s economic liberalization led to a significant reduction in poverty, with the poverty rate dropping from approximately 50% to around 20%. This period saw 35 crore people lifted out of abject poverty, illustrating the direct correlation between economic growth and poverty alleviation.
    • Growth Elasticity of Poverty Reduction: The growth elasticity of poverty reduction in India is relatively low, at just over 0.12 between 1995 and 2012.
      • In contrast, countries like China exhibit a higher elasticity (0.28), suggesting that while growth has reduced poverty in India, it has not done so as effectively as in other nations, indicating room for improvement in how growth translates into poverty alleviation
    The growth elasticity of poverty reduction measures how much poverty decreases in response to economic growth, typically expressed as the percentage reduction in poverty per percentage increase in income.

    Structural Challenges

    • Labour Utilization: India has struggled to leverage its surplus labour effectively in low-end manufacturing sectors. The inability to transition workers from low-productivity sectors like agriculture to manufacturing hampers economic diversification and growth potential.
    • Dependency on High-Tech Sectors: The IT sector has provided an alternative growth pathway, but it has limitations in terms of employment generation. 

    Economic Growth Requirements

    • Sustained Growth Rate: To avoid falling into the middle-income trap, India needs to maintain a nominal growth rate of around 8% until 2047. This is crucial for increasing its GDP and per capita income significantly, especially given that it grew at approximately 9% over the last 25 years.
    • 3I Strategy: The World Bank recommends a “3I strategy”—Investment, Infusion, and Innovation. While investment and infusion (adopting foreign technologies) have been effective in the past, India must now focus on fostering innovation to escape the middle-income trap.
      • Countries like South Korea successfully implemented this strategy, which included substantial investments in education and public universities to develop necessary skills for growth.

    Way Forward: 

    • Focus on Manufacturing and Exports: To maximize the potential of its workforce, India should prioritize low-skilled, employment-intensive manufacturing with a strong focus on exports.
      • Historical examples from South Korea, Taiwan, and Vietnam demonstrate that such strategies can lead to sustained economic growth and job creation.
    • Investment in Human Capital: Enhancing education and skill development is essential for preparing the workforce to meet the demands of a rapidly evolving economy. This investment will help improve productivity and earnings, thereby reducing poverty.
    • Avoiding Protectionism: As India seeks to attract global manufacturers, it is crucial to maintain an open trade policy to facilitate growth. High tariffs could hinder the import of necessary goods and technologies, which are vital for boosting domestic industries and exports.