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GS Paper: Indian Economy

  • India’s Path to Prosperity through Formal Employment

    prosperity

    Context

    • Mass prosperity for massive populations is hard. India’s large remittances from a small population overseas and IT sectors employability reinforce that our mass prosperity strategy should be human capital and formal jobs.

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    prosperity

    Why human capital formation is effective tool for mass prosperity?

    • Disproportionate contribution of IT employees: A strong case for human capital-driven productivity is our software employment — 0.8 per cent of workers generate 8 per cent of GDP.
    • Remittance by NRIs: This case is reinforced by remittances from our overseas population of less than 2 per cent of our resident population crossing $100 billion last year.
    • Shift towards formal employment: A World Bank report suggests that the qualitative shift during the previous five years from low-skilled, informal employment in Gulf countries (dropped from 54 per cent to 28 per cent) to high-skilled formal jobs in high-income countries (increased from 26 per cent to 36 per cent) is significant.
    • Remittances are higher than FDI: Our rich forex remittance harvest roughly 25 per cent higher than FDI and 25 per cent less than software exports is fruit from the tree of human capital and formal jobs.

    prosperity

    Limitations of Fiscal and monetary policy

    • Credit availability is bigger issue: Monetary policy is, at best, a placebo, painkiller, or steroid especially since credit availability is a bigger problem in India than credit cost.
    • Source of finance is important than expenditure: Global experience suggests where governments spend money (pensions, interest, salaries, education, healthcare, roads, etc) and how this spending is financed (taxes or debt) matters more than how much is spent (about Rs 80 lakh crore in India this year).
    • Fiscal policy tends to overshoot: Covid made enormous fiscal and monetary policy demands, but the bigger the binge, the bigger the hangover. Western central banks are struggling to shrink their balance sheets because they used what Harvard’s Paul Tucker calls “unelected power” to chase goals outside their mandate, administer medicine with poorly understood side effects, and speed down highways with no known return paths.
    • India avoided the fiscal and monetary trap: Rich-country borrowing rates have risen by 300 per cent plus and inflation hurts the poor the most. India avoided these fiscal and monetary policy excesses. This prudence now combines with previous structural reforms (GST, IBC, MPC, UPI, DBT, NEP, etc) and a reform “tone from the top” to create a fertile habitat for productive citizens and firms.

    prosperity

    What should be the strategy in next fiscal year for employment generation?

    • Targeting the job creation: The Finance Bill must target productivity and continuity by legislating human capital and formal job reforms previously proposed.
    • NEP should be implemented in 5 years: It should reduce the implementation glide path for the powerful National Education Policy 2020 from 15 years to five years.
    • Abolishing the licensing: It should abolish separate licensing requirements for online degrees and freely allow all our 1,000-plus accredited universities to launch online learning.
    • Accelerating apprentices: It should accelerate growing our 0.5 million apprentices to 10 million by allowing all universities to launch degree apprentice courses under tripartite contracts with employers under the Apprentices Act.

    What are the other steps that can be taken through next budget?

    • Notify labour code: It should notify the four labour codes for all central-list industries while appointing a tripartite committee to converge them into one labour code by the next budget.
    • Universal enterprise number: It should continue EODB reforms by designating every enterprise’s PAN number as its Universal Enterprise Number.
    • Remove the factory act: It should explore manufacturing employment by abolishing the Factories Act this painful Act accounts for 8,000 of the 26,000 plus criminal provisions in employer compliance and require all employers to comply under each state’s Shops and Establishment Act (like Infosys, TCS, and IBM India do).
    • Ensuring better compliances by employer: It should create a non-profit corporation (like NPCI in payments) that will operate an API-driven National Employer Compliance Grid and enable central ministries and state governments to rationalise, digitise and decriminalise their employer compliances.
    • Making EPFO contribution optional: Making employees’ provident fund contributions optional but raising employer PF contributions from the current 12 per cent to 13 per cent. It should notify a previous budget announcement to create employee choice in their contributions to health insurance (ESIC or insurance companies) and pensions (EPFO or NPS).
    • Subsidy to high wage employer: Most importantly, it should link all employer subsidies and tax incentives to high-wage employment creation (a difficult-to-fudge and easy-to-measure effectiveness metric for this public spending is employer provident fund payment).

    Conclusion

    • Experience and evidence now firmly suggest the odds of mass prosperity in the planet’s most populous nation rise from possible to probable by anchoring our strategy in human capital and formal jobs rather than fiscal or monetary policy.

    Mains Question

    What are the limitations of Fiscal and monetary policy in mass welfare of people? What are the possible strategies for creation of mass prosperity in India?

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  • Credit Ratings Agency and their Significance

    credit

    Fitch Ratings on December 20, 2022, retained its rating for India at ‘BBB’-with a stable outlook.

    What does BBB mean?

    • A ‘BBB’ rating indicates that expectations of default risk are currently low.
    • The capacity for payment of financial commitments is considered adequate, but adverse business or economic conditions are more likely to impair this capacity.

    What is a Rating Agency?

    • Rating agencies assess the creditworthiness or potential of an equity, debt or country.
    • Their reports are read by investors to make an informed decision on whether or not to invest in a particular country or companies in that geography.
    • They assess if a country, equity or debt is financially stable and whether it at a low/high default risk.
    • In simpler terms, these reports help investors gauge if they would get a return on their investment.

    What do they do?

    credit

    • The agencies periodically re-evaluate previously assigned ratings after new developments geopolitical events or a significant economic announcement by the concerned entity.
    • Their reports are sold and published in financial and daily newspapers.

    What grading pattern do they follow?

    • The three prominent ratings agencies, viz., Standard & Poor’s, Moody’s and Fitch subscribe to largely similar grading patterns.
    • Standard & Poor’s accord their highest grade, that is, AAA, to countries, equity or debt with the exceedingly high capacity to meet their financial commitments.
    • Its grading slab includes letters A, B and C with an addition a single or double letter denoting a higher grade.
    • Moody’s separates ratings into short and long-term definitions. Its longer-term grading ranges from Aaa to C, with Aaa being the highest.
    • Fitch, too, rates from AAA to D, with D being the lowest. It follows the same succession scheme as Moody’s and Fitch.

    Criticism of rating agencies

    • Popular ratings agencies publicly reveal their methodology, which is based on macroeconomic data publicly made available by a country, to lend credibility to their inferences.
    • However, credit rating agencies were subjected to severe criticism for allegedly spurring the financial crisis in the United States, which began in 2017.
    • The agencies underestimated the credit risk associated with structured credit products and failed to adjust their ratings quickly enough to deteriorating market conditions.
    • They were charged for methodological errors and conflict of interest on multiple counts.

    Do countries pay attention to ratings agencies?

    • Lowered rating of a country can potentially cause panic selling or offloading of investment by a foreign investor.
    • In 2013, the European Union opted for regulating the agencies.
    • Over reliance on credit ratings may reduce incentives for investor to develop their own capacity for credit risk assessment.
    • Ratings Agencies in the EU are now permitted to issue ratings for a country only thrice a year, and after close of trade in the entire Union.

     

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  • Economic inequality and the relationship between state, citizens and taxation

    inequality

    Context

    • Economic inequality in India impacts every aspect of our everyday lives, despite the country being a welfare state. As we celebrate 75 years of Independence, the poor citizens of India continue to face increased fiscal burden in the form of inflation and higher taxes, with fewer benefits.

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     “No taxation without representation”

    • This slogan played a crucial role in the freedom movements of India and the United States.
    • The statement indicates the relationship between the state, citizens and taxation.

    inequality

    Analysis: Relationship between the state, citizens and taxation

    • A concept of welfare state: The legitimacy of taxation is derived from the welfare done by the government.
    • Government’s role: The Constitution of India envisaged the state’s role as a welfare one. For that, the government is empowered to administer taxes and their transfer.
    • However, in the year of Azadi ka Amrit Mahotsav, ‘transfers’ are being painted as revadi (freebies) and the lives of poor citizens are being burdened by regressive “taxes”
    • Inflation as a hidden tax: Inflation acts as a hidden tax on poor and middle-class citizens. For instance, at the time of the introduction of the central scheme Pradhan Mantri Kisan Samman Nidhi or PM-KISAN, which gave Rs 6,000 cash benefit to farmers, diesel cost Rs 65 per litre. Thus, fuel inflation devours the cash benefit of this scheme
    • Highway taxation in contrast with the idea of a welfare state: The roadways are meant to be available free of cost, being public goods. However, Privatisation and PPP models, such services now demand a fee. In the financial year 2021-2022, the government mopped up Rs 35,000 crore as toll tax. The same is projected to reach Rs 1.34 lakh cr by 2025.
    • The diversion of funds meant for one to other sectors is an implicit fiscal burden: The road cess that was intended to fund the construction of roads is diverted to other projects, while citizens are charged heavy tolls for the roads, adding up to already toll burdened people.
    • The case of municipal tax and user charges: When citizens pay municipal tax, the municipality is supposed to ensure cleanliness and sanitation facilities. But the Ahmedabad Municipal Corporation (AMC) introduced a “User Charge” of Rs 365 per household to make the city clean, which is 15% of the municipal tax amount.
    • Discriminatory practices of the administration: Flawed administrative rules also impose fiscal costs on the poor and middle classes of society. Administration allows cars to be parked on the road with impunity, but if two-wheelers are parked on the road, they get towed.

    inequality

    Criticism: Discriminatory treatment to rich and poor in the name of welfare state

    • Monetisation of public spaces weakens state- citizen relationship: It is said when people take ownership and responsibility of public spaces, people become citizens. It ought to be remembered that monetisation of public spaces portends to weaken the state-citizen relationship.
    • The nomenclature of government language itself reflects discriminatory approach: When governments provide fiscal help to the poor, it is called revadi, but the same offered to the rich is lucratively termed “incentive”.
    • Subsidised food is advertised while incentives provided to corporates are not well known: Posters for subsidised food to the poor are ubiquitous across India, but no public posters are screaming about the Rs 1.97 lakh crore “incentive” given to the corporate sector under 13 production linked incentive schemes.
    • Flawed mechanism of personal details in the name of transparency: In the name of transparency, the government uploads the personal details of each Mahatma Gandhi National Rural Employment Guarantee Act (MGNREGA) worker on its website; but the same government does not disclose the names of willful bank defaulters to uphold those ideals of privacy.

    inequality

    Conclusion

    • 73% of the wealth generated in India in 2017 went to the richest 1%, while the poorest half of the population saw only a 1% increase in their wealth. When we celebrate the Azadi Ka Amrit Mahotsav, the need of the hour is to focus must be to make India economically equal and prosperous.

    Mains question

    Q. As we celebrate 75 years of Independence, the poor citizens of India continue to face increased fiscal burden in the form of inflation and higher taxes, with fewer benefits. Critically examine.

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  • India’s Current Account Deficit (CAD) Strategy amidst the Global Uncertainty

    Deficit

    Context

    • There seems to be considerable optimism about India’s near-term growth prospects now that the major global energy and commodity shocks have subsided. Even if these shocks have subsided, India still faces one big problem of its large current account deficit (CAD). How will this be managed? It turns out that the answer to both questions lies in one word exports.

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    Deficit

    What is Current Account Deficit (CAD)?

    • A current account is a key component of balance of payments, which is the account of transactions or exchanges made between entities in a country and the rest of the world.
    • This includes a nation’s net trade in products and services, its net earnings on cross border investments including interest and dividends, and its net transfer payments such as remittances and foreign aid.
    • A CAD arises when the value of goods and services imported exceeds the value of exports, while the trade balance refers to the net balance of export and import of goods or merchandise trade.
    • CAD = Trade Deficit + Net Income from Abroad + Net transfers

    What has been the recent trend?

    • Swelling CAD: Over the past year, the post-pandemic normalisation has caused the current account deficit to swell to exceptional proportions.
    • Decline in demand abroad: At home, normalisation has spurred a renewed demand for imported inputs. But abroad, it has had the opposite effect, leading to a decline in demand.
    • India’s import soared while exports fell: Foreign households are no longer demanding so many goods now that the lockdowns that kept them in their houses and the fiscal stimuli that gave them the money to spend have both ended. So, India’s imports have soared just at a time when its merchandise exports have started to fall.
    • Statistics for instance: The difference between the value of goods imported and exported fell to $54.48 million in Q4FY 2021-22 from $59.75 million in Q3 FY2021-22.
    • Service sector is saviour: However, based on robust performance by computer and business services, net service receipts rose both sequentially and, on a year, -on-year basis.

    Future projections

    • Looking ahead, the situation seems set to worsen: Foreign demand will slow further as advanced countries slip into what now seem like inevitable recessions.
    • In the backdrop of recession India’s CAD could widen further: In that case, India’s CAD could widen even further, possibly to four per cent of GDP in 2022-23, double the level that the Reserve Bank of India (RBI) traditionally regards as “safe”.

    Deficit

    Analysis: How should India respond?

    1. Attracting foreign capital inflow: Attract foreign capital inflows worth at least four per cent of GDP.
    • Is this realistic in time of global uncertainty: The world is currently facing unprecedented levels of uncertainty. Two years of the pandemic, now a land war in Europe, inflation and energy crisis in Europe, interest rate hikes in the history of the US Federal Reserve, slowdown in china, etc. In such an uncertain environment, foreign investors prefer to invest in safe assets such as US government bonds rather than emerging markets like India. As a result, India has witnessed large outflows of foreign capital in 2022-23
    1. Deploying RBI’s Forex to pay for imports: If India cannot attract the required amount of capital inflows, the RBI’s foreign exchange reserves could be deployed to pay for imports.
    • Is this strategy sustainable: The country’s reserves are meant to tide the country over short-term problems, such as commodity price spikes. India’s merchandise exports have been structurally weak, stagnating for the past decade, until the pandemic induced a short-lived boom.

    Deficit

    How depreciating rupee could be helpful?

    • Price needs to be adjusted by depreciating rupee: This means that something fundamental needs to change. Ultimately, India’s CAD reflects a mismatch between the demand and supply of foreign exchange. To restore balance, first and foremost, the price needs to adjust, that is, the rupee needs to depreciate.
    • Exporting becomes more profitable: When this happens, exporting becomes more profitable, inducing more and more firms to explore foreign markets. Meanwhile, foreign demand improves, because the rupee depreciation makes India’s products more price-competitive. As a result, exports increase and the CAD falls.
    • Exchange rate depreciation is helpful in sustained growth: The recovery of the Indian economy from the pandemic was largely fuelled by exports. But with exports now declining, this crucial source of growth has now become uncertain for India. Strengthening the export sector is, therefore, critical for sustaining growth.

    Way forward

    1. Allow the rupee to depreciate,
    2. Encourage foreign firms to produce in India by letting them access their supply chains,
    3. Encourage domestic firms to step up to the competition, and
    4. Create a level playing field for all players.

    Conclusion

    • The large CAD, however, is not a short-term problem: It is a long-term problem requiring a long-term solution. By adopting the discussed strategy, India could potentially solve its two most important macroeconomic problems that are reducing the large CAD and securing rapid, sustained growth.

    Mains question

    Q. What is Current account deficit (CAD)? In a time of global uncertainty How India can reduce its large CAD and secure sustained growth. Analyze

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  • Capital Expenditure and Fiscal Consolidation

    Fiscal

    Context

    • The 2023-24 Union budget will be announced on February 1, followed by the states’ respective budgets. These budgets will set the policy tone for the rest of the year and, as such, are followed closely.

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    Situation of Capex and fiscal consolidation after pandemic

    • Rise in fiscal deficit: The overall fiscal deficit of the government has soared and we believe the next few years will be all about getting it back on track.
    • Rising interest payments: This is important because interest payments on past debt make up a whopping 50 per cent of net tax revenues for the central government, leaving very little room for other spending.
    • less room for social spending: Given the needs of the economy on various fronts like health, education and capex, it is important to lower the interest burden over time. That can only be achieved by fiscal consolidation.

    Analysing the tax revenue and expenditure of central and state Government

    • Central government tax revenues have risen faster than state revenues: Both benefitted as small and informal firms struggled with the lockdowns and lost market share to large firms, which tend to pay more taxes.
    • Disparity in revenue collection: A large chunk of the tax revenues in the early part of the pandemic period came from the “special” duty and surcharge on oil, which went primarily to the central government. To be fair, the central government subsequently cut the duty on oil (in both 2021-22 and 2022-23) and the tax share that went to the states rose somewhat.
    • Capex of centre is more: The Centre has committed to more current expenditure than the states. While it increased across the board during the pandemic, current expenditure rose more for the central government.
    • Higher spending on social schemes: This was led by higher social welfare spending (for instance, on the free food distribution scheme) and, more recently, higher subsidies (for example, fertilisers) in the face of rising commodity prices.
    • States have a moderate capex: The common perception is that states have gone all out on unsustainable current expenditure. But the data shows that it’s just a few states which have spent heavily (for example, Telangana, Assam, West Bengal and Punjab).

    Fiscal

    Analyzing the capex and fiscal deficit of central and state government

    • The central government capex has risen but state capex has contracted: Making a commendable choice, the central government used both its tax bounty as well as its ability to borrow more at a time when banking sector liquidity was loose to raise capex spending, which rose by 1.2 per cent of GDP between 2019-20 and 2021-22.
    • Cut in state capex: On the other hand, the states cut back on capex, which has fallen as a percentage of GDP over the last few years, and continues to be on a weak footing in the current year. In fact, putting the central government’s capex alongside the state and public sector capex shows that the overall public sector thrust is not any stronger than it was back in 2018-19.
    • Centre has breached the fiscal deficit target: The central government’s fiscal deficit has overshot targets while the state deficit is relatively contained. At a budgeted 6.4 per cent of GDP in 2022-23, the central government’s fiscal deficit has risen above the pre-pandemic level of 3.4 per cent in 2018-19, and is well above the 3 per cent medium-term target.
    • Sharp fall in states fiscal deficit target: Even though the state fiscal deficit rose in the first year of the pandemic (from 2.5 per cent of GDP in 2018-19 to 3.8 per cent in 2020-21), it has fallen sharply since (to 2.7 per cent in 2021-22).
    • Low borrowing by states: In fact, state government borrowing is rather low in the current year so far. If this continues, the fiscal deficit could be even lower in 2022-23 (around 2.5 per cent of GDP), which is well under the 3 per cent medium-term target, and bang in line with pre-pandemic levels.

    Fiscal

    What are the challenges?

    • Less consolidation by states: The states have less fiscal consolidation to do than the central government.
    • High quality spending: Both have a common challenge to commit to more capex, which is considered high quality spending as it “crowds in” private investment if done responsibly. And we believe investment is the only sustainable way to increase the capacity of the economy to grow and create jobs.
    • Balancing the capex and fiscal consolidation: For the central government, the challenge is to hold on to its capex push at a time of fiscal consolidation. For the states, the challenge is to start doing more.

    Fiscal

    What should be the way forward?

    • Lowering the fiscal deficit: The central government’s aim is to lower the fiscal deficit by about 2 per cent of GDP over the next three years. About half of this consolidation can come from lowering current expenditure to pre-pandemic levels.
    • Raising the tax revenue through formalization: Continued formalisation of the economy that raises tax revenues (though “organic” formalisation will likely be more sustainable than “forced” formalisation).
    • Disinvestment of PSUs: A bigger push for disinvestment by selling stakes in public-owned companies, and further tax reforms (in terms of direct taxes and the GST).
    • Capex cut is the last option: If these don’t work, the default option will be to cut capex, which is a concern as it has implications for medium-term growth.

    Conclusion

    • Fiscal consolidation and capital expenditure should go hand in hand. More government spending means more infrastructure building and more chances of growth and employment. However, this spending should be done with sound fiscal base.

  • Urban-rural manufacturing shift: A mixed bag

    manufacturing

    Context

    • There is growing evidence to suggest that the most conspicuous trend in the manufacturing sector in India has been a shift of manufacturing activity and employment from bigger cities to smaller towns and rural areas. This ‘urban-rural manufacturing shift’ has often been interpreted as a mixed bag, as it has its share of advantages that could transform the rural economy, as well as a set of constraints, which could hamper higher growth.

    Recent data by Annual Survey of Industries for 2019-20

    • In terms of capital: The rural segment is a significant contributor to the manufacturing sector’s output. While 42% of factories are in rural areas, 62% of fixed capital is in the rural side.
    • In terms of value addition: In terms of output and value addition, rural factories contributed to exactly half of the total sector.
    • In terms of employment: In terms of employment, it accounted for 44%, but had only a 41% share in the total wages of the sector.

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    Why is this shift of manufacturing away from urban locations to rural?

    • A report on manufacturing shift brought out by World Bank: The movement of manufacturing away from urban locations was brought out by the Work Bank in a report a decade ago, “Is India’s Manufacturing Sector Moving Away from Cities? Policy Research Working Paper, World Bank).
    • Higher urban-rural cost caused this shift: This study investigated the urbanisation of the Indian manufacturing sector by “combining enterprise data from formal and informal sectors and found that manufacturing plants in the formal sector are moving away from urban areas and into rural locations, while the informal sector is moving from rural to urban locations”. Their results suggested that higher urban-rural cost ratios caused this shift.
    • Steady investment in rural areas: This is the result of a steady stream of investments in rural locations over the last two decades.
    • Input costs are relatively less in rural area: Rural areas have generally been more attractive to manufacturing firms because wages, property, and land costs are all lower than in most metropolitan areas.
    • Factory floorspace supply constraints: When locations get more urbanised and congested, the greater these space constraints are.
    • Increased capital intensity of production: The driving force behind such a shift is the continuing displacement of labour by machinery as a result of the continuous capital investments in new production technologies. In cities, factories just cannot be expanded as opposed to rural areas.

    How this trend is a welcome sign?

    • Fulfilling the need of balanced development: Given the size of the Indian economy and the need for balanced regional development, the dispersal of manufacturing activities is a welcome sign.
    • Created an opportunity for small scale industries to survive after liberalization: In the aftermath of trade liberalisation, import competition intensified for many Indian manufacturers, forcing them to look for cheaper methods and locations of production. One way to cut costs was to move some operations from cities to smaller towns, where labour costs are cheaper.
    • Source of livelihood diversification in rural area: The shift in manufacturing activities from urban to rural areas has helped maintain the importance of manufacturing as a source of livelihood diversification in rural India.
    • Make up for loss of employment: This trend helped to make up for the loss of employment in some traditional rural industries. The growth of rural manufacturing, by generating new jobs, thus provides an economic base for the transition out of agriculture

    What are the challenges ahead and a solution to it?

    • While the input cost is less but the cost of capital is high, offsetting the benefits: Though firms reap the benefits of lower costs via lower rents, the cost of capital seems to be higher for firms operating on the rural side. This is evident from the shares in rent and interest paid. The rural segment accounted for only 35% of the total rent paid, while it had 60% of the total interest payments. The benefits reaped from one source seem to be offset by the increased costs on the other front.
    • Skill shortages in rural area: There exists an issue of “skills shortage” in rural areas as manufacturing now needs higher skilled workers to compete in the highly technological global ‘new economy’. Manufacturers who need higher skilled labour find that rural areas cannot supply it in adequate quantities. Manufacturers who depend only on low-wage workers simply cannot sustain their competitive edge for longer periods as this cost advantage vanishes over time.
    • Solution to this issue lies in skill development: This suggests the need for clear solutions to the problems of rural manufacturing and the most important is the provision of more education and skilling for rural workers. A more educated and skilled rural workforce will establish rural areas’ comparative advantage of low wages, higher reliability and productivity and hasten the process of the movement out of agriculture to higher-earning livelihoods

    Conclusion

    • Given the size of the Indian economy and the need for balanced regional development, the dispersal of manufacturing activities is a welcome sign. However, the compulsions of global competition often extend beyond the considerations of low-wage production and depend on the virtues of ‘conducive ecosystems’ for firms to grow.

    Mains Question

    Q. There is growing evidence to suggest that the trend in the manufacturing sector in India has been a shift of manufacturing activity and employment from bigger cities to smaller towns and rural areas. Discuss the reasons for this trend and note down the challenges ahead.

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  • What is a Loan Write-Off?

    Banks have written off bad loans worth ₹10,09,511 crore during the last five financial years, finance minister informed the Parliament.

    What is a loan write-off?

    • Writing off a loan essentially means it will no longer be counted as an asset.
    • By writing off loans, a bank can reduce the level of non-performing assets (NPAs) on its books.
    • The bank moves the defaulted loan, or NPA, out of the assets side and reports the amount as a loss.
    • An additional benefit is that the amount so written off reduces the bank’s tax liability.
    • The loans written off by the banks are the depositors’ money.

    Why do banks resort to write-offs?

    • Recovery issues: The bank writes off a loan after the borrower has defaulted on the loan repayment and there is a very low chance of recovery. However, the chances of recovery from written-off loans are very low.
    • Provisioning: After the write-off, banks are supposed to continue their efforts to recover the loan using various options. They have to make provisioning as well.
    • Reduce tax liability: The tax liability will also come down as the written-off amount is reduced from the profit.

    Who is at the forefront of write-offs?

    • Public sector banks reported the lion’s share of write-offs at Rs 734,738 crore accounting for 72.78 per cent of the exercise.
    • Among individual public sector banks, reduction in NPAs due to write-offs in the case of State Bank of India Rs 204,486 crore in the last five years.
    • Among private banks, ICICI Bank’s reduction in NPAs due to write-offs was Rs 50,514 crore in the last five years.
    • Axis Bank wrote off Rs 49,715 crore and HDFC Bank Rs 34,782 crore during the period, according to the RBI.

    What about recovery of such loans?

    • Since the loan account is not closed in write-off, the right to recovery of the amount is not waived by the lender or the bank.
    • The bank or lender can try to recover the loan amount from the loan defaulter.

    Back2Basics: Non-Performing Assets (NPAs)

    • A NPA is a loan or advance for which the principal or interest payment remained overdue for a period of 90 days.
    • Banks are required to classify NPAs further into Substandard, Doubtful and Loss assets.
    1. Substandard assets: Assets which has remained NPA for a period less than or equal to 12 months.
    2. Doubtful assets: An asset would be classified as doubtful if it has remained in the substandard category for a period of 12 months.
    3. Loss assets: As per RBI, “Loss asset is considered uncollectible and of such little value that its continuance as a bankable asset is not warranted, although there may be some salvage or recovery value.”

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  • Discussing the Indian Economy’s pressing problems

    Economy

    Context

    • Several agencies, including the IMF and the World Bank have projected lower growth rates for the Indian economy in FY23, than the 7.2 per cent estimated by the RBI in April. The Central bank has now lowered its forecast to 6.8 per cent. Given the current situation, with the Q2 FY 2023.

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    Economy

    Current economic growth estimation

    • Economy is likely to grow at 6.5-7.0 per cent: Given the current situation, with the Q2 FY 2023 GDP growth clocking in at 6.3 per cent, the economy is likely to grow at 6.5-7.0 per cent in this fiscal year.
    • Considering economic uncertainties it is difficult to arrive at precise estimate: It is difficult to arrive at a precise estimate for growth this year with unprecedented economic uncertainty worldwide, including high global inflation, synchronized monetary tightening, and the impact of the Ukraine war.

    Positive signs in the Indian Economy

    • Positive medium-term growth prospects: Company and bank balance sheets are healthier, credit growth is rising, and capacity utilisation has increased, all of which augur well for investment activity.
    • Positive impact on tourism: The waning of Covid-19 should hopefully have a positive impact on travel, transport and tourism. Construction activity should pick up further with the reduction in housing inventory and almost stable prices over the last decade.
    • On inflation India is doing better: On the inflation front, India is doing better than many advanced economies and emerging markets.

    Economy

    What is Indian economy’s pressing problems specifically in terms of Labour-intensive growth?

    • Employment a biggest concern: Employment, an issue that has persisted over the last two decades. In brief, we have not generated enough good jobs to match the scale at which the economy has grown, especially in the organised sector. As a result, we have very high under-employment and poor-quality employment, which have hampered a much-needed move away from agriculture.
    • Lack of precise data on people living in poverty: We do not have a precise estimate of the current levels of poverty, as there has been no household consumption survey since 2011-12, and the 2017-18 survey was abandoned due to technical issues. But there is reasonable consensus that poverty could be around 10 per cent of the country’s population, A low number compared to the past, but as many as 140 million people could still be living in poverty.
    • Lack of non-agricultural jobs: The rising demand for the MGNREGA, and the importance of food distribution schemes and other welfare programmes for the poor are indicators of the lack of non-agriculture jobs being generated.
    • Lowest rate of women participation in labour force: An alarming aspect of the employment problem in India is the low participation rate of women in the labour force, which is among the lowest in the world. This loops back to the importance of labour-intensive manufacturing. For example, much of Bangladesh’s success, and that of Southeast Asian countries, in exports and manufacturing stems from the large number of women working in their factories.
    • Women literacy is rising but increasing number of educated women are not working: A positive trend in India has been the growing trend in girls attending schools and college in the last 20 years, but this also means that an increasing number of educated women are not working.
    • Despite of 1991 reforms still remains an untapped opportunity: With the LPG reforms, the expectation was that, as the economy opened up to global competition, India’s low wage levels would attract private investment into labour-intensive manufacturing, thus generating jobs. This was the path followed by the East Asian economies that experienced high growth and rapid development. But for India this remains an untapped opportunity.
    • Manufacturing is shifting to countries other than India: Even with rising wage levels in China, manufacturing is shifting to countries other than India. The PLI (production-linked incentives) scheme has been rolled out to encourage manufacturing. It may need some tweaking to be biased towards labour-intensive manufacturing as China vacates space in this area. This may seem at odds with the more popular view that it is small and medium enterprises which promote employment.
    • Country’s real exchange rate is not healthy: An overvalued rupee has discouraged the export of labour-intensive manufacturing goods, which are very price-sensitive in global markets. It has also had a dampening effect on domestic production as our currency has depreciated at a lower rate than other emerging economies like China and Indonesia.
    • Depreciated rupee impacting domestic producers by inflow of cheaper imports: Domestic producers of goods that compete with imports into our markets have been impacted by the inflow of cheaper imports. This has disincentivised them from expanding production and generating employment.
    • Micro, small and medium enterprises (MSMEs) are severally hit: Problems that have come to the fore post-pandemic include the health of micro, small and medium enterprises (MSMEs). Accurate information on this is somewhat scarce but anecdotal evidence suggests that they have been more severely hit than the formal sector.

    Economy

    Way ahead

    • The rupee has been overvalued for long and needs to be allowed to depreciate, though in a calibrated way, ensuring external and financial stability.
    • Job growth is crucial if we are to reduce the still high levels of poverty in the country
    • Incentivizing the domestic producers so that they can compete with the cheaper inflow of imports and expands their manufacturing thereby generating employment in the economy
    • The continued recovery of the formal sector, as indicated by various metrics, in terms of the improved health of corporates and banks should effectively pull up the MSMEs through supply chains linkages, among others.
    • We still have a negative real interest rate (that is, the difference between the RBI’s policy rate and inflation). Hence, the policy rate needs to rise further, providing a push to financial savings, which are needed to generate higher investment for growth.
    • Inflation need to be contained through supply-side measures as well, such as an improvement in the supply of food products.

    Conclusion

    • High under-employment and poor-quality employment have hampered a much-needed move away from agriculture. A focus on labour-intensive formal manufacturing is the need of the hour.

    Mains Question

    Q. India is showing positive signs of economic recovery however the economy still has a hangover from the past and some are exacerbated by Covid. Discuss.

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  • What is Goods Trade Barometer?

    barometer

    The World Trade Organization’s Goods Trade Barometer says the global economy, hit by strong headwinds and weakening import demand, may see trade growth slowdown in the closing months of 2022 and into 2023.

    What is Goods Trade Barometer?

    • The Goods Trade Barometer was developed by the WTO to complement conventional trade statistics and forecasts.
    • It is the world’s leading composite indicator that highlights the turning points in the global merchandise trade and provides forecasts of its likely trajectory in the near future.
    • It is released on a quarterly basis based on the availability of data.
    • It provides real-time data on the trajectory of merchandise trade relative to the current trends.
    • Values higher than 100 indicates above-trend growth and the values less than 100 indicates below-trend growth.

    Key trends

    • In its recent release, it said trade growth is likely to slow down in 2022 and into 2023.
    • Reflecting a cooling demand for traded goods based on actual trade developments through the second quarter of 2022, the current reading of 96.2 is below the baseline value index and the prior reading of 100.0.
    • The downturn in the goods barometer is in line with the earlier forecast which predicted a merchandise trade volume growth of 3.5% in 2022 and a revised lower estimate of 1% for 2023.

    Impact on India’s trade balance

    • With a likely fall in export earnings, and no decrease in imports of essential items like crude oil and capital goods, India’s trade deficit is set to widen.
    • The projection is that the country’s current account trade deficit is expected to be around 3% of GDP for FY23.
    • Foreign exchange reserves which have already depleted by over $100 billion over the last year are likely to shrink further.

    What does a slowdown mean for India?

    • India is not an export-led economy. In FY22, 21.5% of Indian GDP depended on exports.
    • However, in view of the poor performance of the country’s major market destinations such as the US and China, Indian exports are bound to suffer.
    • During the subprime crisis which engulfed the entire world, India’s export-oriented sectors had to pay the price though the economy was to a large extent insulated due to a vibrant rural sector.
    • But currently rural India is not in a strong position unlike in 2008-09.

     

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  • What is First Loss Default Guarantee (FLDG) System?

    Two months after the RBI issued guidelines on digital lending, banks, NBFCs and fintech players are still awaiting clarity on many aspects, including the First Loss Default Guarantee (FLDG) system.

    What is FLDG System?

    • FLDG is an arrangement between a fintech company and regulated entity (RE), including banks and non-banking finance companies, wherein the fintech compensates the RE to a certain extent if the borrower defaults.
    • Under this, the fintech originates a loan and promises to compensate the partners up to a pre-decided percentage in case customers fail to repay.
    • The bank/NBFC partners lend through the fintech but from their own books.
    • FLDG helps expand the customer base of traditional lenders but relies on the fintechs underwriting capabilities.
    • FLDG is also seen as a validation of the fintechs underwriting capabilities for loans disbursed.

    Issues with FLDGs

    • A report by an RBI-constituted working group on digital lending has laid down risks of FLDG agreements with unregulated entities.
    • The other concern is that FLDG costs are often passed on to customers.

     

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