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GS Paper: Indian Economy

  • Advantage of Market Based Economic Dispatch

    Market Based Economic DispatchContext

    • The game changing scheme is being proposed by the central government in power sector governance. The scheme under consideration is the market-based economic dispatch (MBED). When it comes to any drastic change in the power sector, a clash between the Centre and the states is inevitable.

    What is Market Based Economic Dispatch (MBED)?

    • Market Based Economic Dispatch (MBED) is new approach towards power distribution to help distribution companies save costs and transition to a new form of power market.
    • It is a shift to a centralised framework, marks a radical departure from the current decentralised, voluntary pool-based electricity market.

    Market Based Economic DispatchWhat is the framework under MBED?

    • The cheapest power from across the country will be dispatched to meet the system wide demand. The architecture would also lead to a “Market clearing price”.
    • Sellers and buyers will place their bids for the day market, and an outcome of this will be the discovery of the market clearing price.
    • This process is expected to generate significant savings for consumers.

    What is the Present system of power Distribution?

    • Under the present regime, each distribution company (Discom) is bound by the power purchase agreements (PPAs) that it holds.
    • It can schedule power only from its own PPAs, starting from the cheapest PPA and then moving up; it cannot schedule power from the PPA of some other distribution company.

    Market Based Economic DispatchWhat are the drawbacks of present system?

    • Financial Burdon:
    • The Indian government responded to COVID-19’s economic shock with a stimulus package of Rs.20-lakh crore, out of which Rs.90,000 crore was earmarked for discoms (later upgraded to Rs.1,25,000 crore). While it was called a stimulus, it is really a loan, meant to be used by discoms to pay off generators.
    • Discoms owe one lakh crore rupees to generators, and without such an infusion the chain will collapse.
    • States are defaulters:
    • State governments are the biggest defaulters, responsible for an estimated a third of trade receivables, besides not paying subsidies in full or on time.
    • On an annual cash flow basis, the shortfall in subsidy payments appears very low, only about 1% but cumulative unpaid subsidies, with modest carrying costs, make discoms poorer by over Rs.70,000 crore just over the last 10 years.

    Market Based Economic DispatchWhat will be the Advantages of MBED?

    • Centralized approach: The centralised dispatch will be done with the assistance of electricity exchanges. Each discom and each generator will place a bid in the day-ahead market of the electricity exchanges, which will indicate how much power is being demanded/ supplied at what price.
    • Pan India market: These bids will enable the load dispatcher to construct a pan India demand and supply curve, the intersection of which will determine the market clearing price (MCP). All generators whose variable cost of generation is below the MCP will be asked to dispatch and all of them will receive the same MCP irrespective of what they had bid. Generators whose variable cost is higher than the MCP will sit idle.
    • No loss to discom: The MBED is so devised that its operation will not affect the current finances of either the discoms or the generators for the following reasons.
    • First, the fixed cost of the generators will still be paid by the discoms outside the market as determined by the regulator.
    • Second, if the MCP comes out to be Rs 3 per unit, and if in the case of any PPA, the variable cost is Rs 2.75 per unit, then the generator will compensate the discom to the extent of Rs 0.25 per unit. Similarly, if the MCP so determined is Rs 2.50 per unit, then the discom will compensate the generator to the extent of Rs 0.25 per unit.
    • Increasing efficiency: The logic is that by adopting MBED, only the relatively efficient plants will generate, without affecting the revenues of either the discoms or generators. Hence, the total cost of generation under the MBED system would be less.
    • Less pollution: There would be less coal consumption and less carbon dioxide injected into the atmosphere.
    • Easy integration with renewable: It would also mean less movement of coal leading to decongestion of railway tracks. Further, there would be enhanced renewable integration since the balancing area would shift from state to national level.
    • Single market clearing price (MCP): Incidentally, since there are three electricity exchanges in operation today, there would be three different MCPs determined. What we need is a single MCP for which there will be an institution called the “market coupler”. It will be the job of the coupler to determine a national MCP based on what has arrived at the three different exchanges.

    Why states are opposing?

    • High generation cost: The reason is the state-owned generators are relatively inefficient and may have to sit idle as their variable cost of generation is likely to be more than the MCP.
    • Political backlash: Today, the states are operating their own generators to the hilt, even though they are inefficient, and drawing only the balance from the more efficient interstate generating stations. Keeping state generators idle has its own political implications and no state would be enamoured of this idea.

    Conclusion

    • Power distribution companies (discom) are sinkhole of government finances. Every year budgetary support is needed to this loss-making companies , With due consultation, all states and union territories need to adopt and implement the MBED and save the resources for other development activities.

    Mains Question

    Q. India has became the power surplus nation, however power distribution and financial unsustainability is still a nightmare for union and states. Elaborate.

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  • Foreign Trade Policy

    The government has extended the launch of new Foreign Trade Policy (FTP) (2022-27) by six more months and would continue with the existing one.

    Why such delay in Foreign Trade Policy?

    • Geopolitical uncertainty: The geo-political situation is not suitable for long-term foreign trade policy, said Union Commerce Minister.
    • Global recession: Currently, fears of a recession in major economies like the US and Europe have escalated a panic among investors.
    • Decline in USD inflows: Foreign investors have begun to pull back their money from equities.
    • Rupee depreciation: The US Dollar is at a 22-year high, while the Rupee hit a new all-time low of $81.6.
    • Huge trade deficit: The trade deficit widened by more than 2-folds to $125.22 billion (April – August 2022) compared to $53.78 billion in the same period last year.

    What is a Foreign Trade Policy?

    • India’s Foreign Trade Policy (FTP) is a set of guidelines for goods and services imported and exported.
    • These are developed by the Directorate General of Foreign Trade (DGFT), the Ministry of Commerce and Industry’s regulating body for the promotion and facilitation of exports and imports.
    • FTPs are enforceable under the Foreign Trade Development and Regulation Act 1992.

    What is India’s Foreign Trade Policy?

    • In line with the ‘Make in India,’ ‘Digital India,’ ‘Skill India,’ ‘Startup India,’ and ‘Ease of Doing Business initiatives, the Foreign Trade Policy (2015-20) was launched on April 1, 2015.
    • It provides a framework for increasing exports of goods and services, creating jobs, and increasing value addition in the country.
    • The FTP statement outlines the market and product strategy as well as the steps needed to promote trade, expand infrastructure, and improve the entire trade ecosystem.
    • It aims to help India respond to external problems while staying on top of fast-changing international trading infrastructure and to make trade a major contributor to the country’s economic growth and development.

    Issues with FTP (2015-2020)

    • Acting on Washington’s protest, a WTO dispute settlement panel ruled in 2019 that India’s export subsidy measures are in violation of WTO norms and must be repealed.
    • Tax incentives under the popular Merchandise Exports from India Scheme (MEIS) (now renamed as RODTEP Scheme)and Service Exports from India Scheme (SEIS) programmes were among them.
    • The panel found that because India’s per capita gross national product exceeds $1,000 per year, it may no longer grant subsidies based on export performance.

    Way forward

    • WTO-compliance: With incentives under MEIS and SEIS in the cloud, WTO-compliant tax benefits are a must.
    • Access to credit: Credit availability has long been a need of exporters, particularly MSMEs.
    • Infrastructure upgrade: China’s network of ports, motorways, and high-speed trains, which are among the greatest in the world, is one of the reasons it is a manufacturing and export powerhouse.
    • Digitization and e-commerce boost: India requires innovative trading procedures as a result of Covid-19 breaking old supply channels.

     

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  • RBI’s attempt to manage currency could prove to be a costly mistake

    currencyContext

    • A currency defence will also impose costs on the economy.

    Why in news?

    • Legally, the Reserve Bank of India is mandated to target an inflation rate. But with the global economic environment taking a turn for the worse, the central bank has also been targeting the exchange rate. This could prove to be a costly mistake.

    What is a simple definition for inflation?

    • Inflation is the rate of increase in prices over a given period of time. Inflation is typically a broad measure, such as the overall increase in prices or the increase in the cost of living in a country.

    What is exchange rate?

    • An exchange rate is a rate at which one currency will be exchanged for another currency. Most exchange rates are defined as floating and will rise or fall based on the supply and demand in the market. Some exchange rates are pegged or fixed to the value of a specific country’s currency.

    What is monetary policy?

    • Monetary policy is the control of the quantity of money available in an economy and the channels by which new money is supplied. Economic statistics such as gross domestic product (GDP), the rate of inflation, and industry and sector-specific growth rates influence monetary policy strategy.

    What is fixed exchange rate in simple words?

    • A fixed exchange rate is a regime applied by a government or central bank that ties the country’s official currency exchange rate to another country’s currency or the price of gold. The purpose of a fixed exchange rate system is to keep a currency’s value within a narrow band.

    currencyWhat is a simple definition of capital?

    • Capital is a broad term that can describe anything that confers value or benefit to its owners, such as a factory and its machinery, intellectual property like patents, or the financial assets of a business or an individual.

    What is meant by the impossible trinity?

    • Many economists think of possible policy responses to capital flows in terms of the so-called “impossible trinity,” or “policy trilemma”, according to which, with an open capital account, a central bank cannot simultaneously exercise monetary control and target the exchange rate.

    A currency defence will impose costs on the economy?

    • Little economic gain: Some may believe that a stronger currency gives the impression of economic stability and generates confidence in the economy. But there is an inherent contradiction between artificially propping up the rupee and the country’s growth prospects. Very little economic gain will accrue from turning the currency’s value into a political issue.
    • Inflation should be tackled through monetary policy: Understandably, a depreciating currency leads to concerns over higher imported inflation. But inflation should be tackled through monetary policy, while exchange rate management should be linked to growth. Not the other way around.

    Significance of currency defence for foreign exchange reserves

    • Decline by 10 per cent: A large part of the current relative strength of the rupee vis-à-vis other currencies is due to the sale of dollars by the RBI  it has lost more than 10 per cent of its foreign reserves in the space of about nine months.
    • Why country needs foreign exchange: A developing economy needs foreign exchange to finance its international transactions for both the current account (goods and services) and capital account (assets) transactions.
    • Cost involved: The benefits of this stock are obvious, but there are also costs associated with the holding of these.

     

    https://www.civilsdaily.com/burning-issue-global-trade-in-rupees/We should follow Tenfold Path to manage Exchange Rate Volatility rather monetary policy path

     

    (1) Selling dollars

    • The first course of action has been selling dollars in the spot forex market.
    • This is fairly straightforward, but has limits as all crises are associated with declining reserves.
    • While this money is meant for a rainy day, they may just be less than adequate.
    • The idea of RBI selling dollars works well in the currency market, which is kept guessing how much the central bank is willing to sell at any point of time.

    (2) NRI deposits

    • The second tool used is aimed at garnering non-resident Indian (NRI) deposits.
    • It was done in 1998 and 2000 through Resurgent India bonds and India Millennium Deposits, when banks reached out asking NRIs to put in money with attractive interest rates.
    • The forex risk was borne by Indian banks.
    • This is always a useful way for the country to mobilize a good sum of forex, though the challenge is when the debt has to be redeemed.
    • At the time of deposits, the rates tend to be attractive, but once the crisis ends, the same rate cannot be offered on deposit renewals.
    • Therefore, the idea has limitations.

    (3) Let oil importers buy dollars themselves

    • The third option exercised often involves getting oil importing companies to buy dollars directly through a facility extended by a public sector bank.
    • Its advantage is that these deals are not in the open and so the market does not witness a large demand for dollars on this account.
    • It is more of a sentiment cooling exercise.

    (4) Let exporters trade in dollars

    • Another tool involves a directive issued for all exporters to mandatorily bring in their dollars on receipt that are needed for future imports.
    • This acts against an artificial dollar supply reduction due to exporter hold-backs for profit.

    (5) Liberalized Exchange Rate

    • The other weapon, once used earlier, is to curb the amount of dollars one can take under the Liberalized Exchange Rate Management System.
    • This can be for current account purposes like travel, education, healthcare, etc.
    • The amounts are not large, but it sends out a strong signal.

    (6) Forward-trade marketing

    • Another route used by RBI is to deal in the forward-trade market.
    • Its advantage is that a strong signal is sent while controlling volatility, as RBI conducts transactions where only the net amount gets transacted finally.
    • It has the same power as spot transactions, but without any significant withdrawal of forex from the system.

    (7) Currency swaps

    • The other tool in India’s armoury is the concept of swaps.
    • This became popular post 2013, when banks collected foreign currency non-resident deposits with a simultaneous swap with RBI, which in effect took on the foreign exchange risk.
    • Hence, it was different from earlier bond and deposit schemes.
    • Most preferred options by the RBI
    • Above discussed instruments have been largely direct in nature, with the underlying factors behind demand-supply being managed by the central bank.
    • Of late, RBI has gone in for more policy-oriented approaches and the last three measures announced are in this realm.

    (8) Allowing banks to work in the NDF market

    • First was allowing banks to work in the non-deliverable forwards (NDF) market.
    • This is a largely overseas speculative market that has a high potential to influence domestic sentiment on our currency.
    • Here, forward transactions take place without real inflows or outflows, with only price differences settled in dollars.
    • This was a major pain point in the past, as banks did not have access to this segment.
    • By permitting Indian banks to operate here, the rates in this market and in domestic markets have gotten equalized.

    (9) Capital account for NRI deposits

    • More recently, RBI opened up the capital account on NRI deposits (interest rates than can be offered), external commercial borrowings (amounts that can be raised) and foreign portfolio investments (allowed in lower tenure securities), which has the potential to draw in forex over time.
    • Interest in these expanded contours may be limited, but the idea is compelling.

    (10) Settlement in Rupees

    • RBI’s permission for foreign trade deals to be settled in rupees is quite novel; as India is a net importer, gains can be made if we pay in rupees for imports.
    • The conditions placed on the use of surpluses could be a dampener for potential transactions.
    • But the idea is innovative and could also be a step towards taking the rupee international in such a delicate situation.
    • Clearly, RBI has constantly been exploring ways to address our forex troubles and even newer measures shouldn’t surprise us.

    Way ahead

    • The RBI (which is in charge of monetary policy) should focus on containing inflation, as it is legally mandated to do.
    • The government (which is in charge of the fiscal policy) should contain its borrowings.
    • Higher borrowings (fiscal deficit) by the government eat up domestic savings and force the rest of the economic agents to borrow from abroad.
    • Policymakers (both in the government and the RBI) have to choose what their priority is containing inflation or being hung up on exchange rate and forex levels.
    • If they choose to contain inflation (that is, by raising interest rates) then it will require sacrificing economic growth. So be prepared for that.

    Mains question

    Q.What do you understand by the term impossible trinity? How should RBI respond to manage currency exchange rate? Discuss.

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  • New Account Settlement System for Stock Trading

    Beginning October 1, the new account settlement system for the stock broking industry will kick in under the new guidelines issued by the Securities and Exchange Board of India (SEBI).

    What is Settlement of Accounts?

    • The SEBI mandates stockbrokers to settle i.e., transfer the available credit balance from trading account to bank account, at least once in a quarter (90 days) or 30 days.
    • The process of transferring the unutilised funds back into the bank account is called ‘Running Account Settlement’ or ‘Quarterly Settlement of Funds’.
    • The funds are transferred back to the primary bank account of the customer that is linked to the trading account.
    • As per the latest guidelines, the settlement will now be done on the first Friday of the quarter or the month depending upon the option selected by the customer.

    What are SEBI’s new settlement guidelines?

    • On July 27, SEBI issued new guidelines on running accounts of client funds and securities lying with the broker.
    • As per the new guidelines, with effect from October 1, 2022, the settlement of running account of clients’ funds will be done by the trading members after considering the end of the day (EOD) obligation of funds.
    • In cases where the client has opted for a monthly settlement process, then the running account shall be settled on the first Friday of every month.

    How will it impact investors and traders?

    • Changes in settlement brought in by SEBI over the last few years have had the aim of protecting the investor and preventing the misuse as money lying in trading accounts of investors for long periods.
    • SEBI’s move will give certainty to investors and trading members.
    • It will help brokers develop a system just like banks, which credit interest in the accounts of their customers at the end of the quarter.
    • Another advantage would be that if a customer has more than one demat account with different brokers, having one settlement date for the entire industry will make it easier for her to keep track of her funds.

    Back2Basics: Securities and Exchange Board of India (SEBI)

    • The SEBI is the regulatory body for securities and commodity market in India under the jurisdiction of Ministry of Finance Government of India.
    • It was established on 12 April 1988 and given Statutory Powers on 30 January 1992 through the SEBI Act, 1992.

    Jurisdiction of SEBI

    • SEBI has to be responsive to the needs of three groups, which constitute the market:
    1. Issuers of securities
    2. Investors
    3. Market intermediaries

    SEBI has three powers rolled into one body: quasi-legislative, quasi-judicial and quasi-executive.

    • It drafts regulations in its legislative capacity, it conducts investigation and enforcement action in its executive function and it passes rulings and orders in its judicial capacity.
    • Though this makes it very powerful, there is an appeal process to create accountability.
    • There is a Securities Appellate Tribunal which is a three-member tribunal and is currently headed by Justice Tarun Agarwala, former Chief Justice of the Meghalaya High Court.
    • A second appeal lies directly to the Supreme Court.

     

    Also read:

    SEBI introduces T+1 Settlement System

     

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  • Pre-Pack IBC resolution

    pre-pack

    India introduced the pre-packaged insolvency resolution process (PPIRP) in April 2021, as an alternative resolution process for micro, small and medium enterprises (MSMEs). However, it has only two cases admitted under it so far.

    What is the Insolvency and Bankruptcy Code (IBC)?

    • The IBC was enacted in 2016 to simplify insolvency and bankruptcy proceedings, safeguard interests of all stakeholders (the firm, employees, debtors and especially creditors), and resolve non-performing assets.
    • From a ‘debtor in possession’ regime, it was a shift to a ‘creditor in control’ one.
    • IBC provides for a time-bound process for resolving insolvencies.
    • The Insolvency and Bankruptcy Board of India (IBBI) is the regulator implementing the code and overseeing the functioning of stakeholders.
    • The IBBI last week allowed payment of performance-linked incentives to resolution professionals.

    What are Pre-packs?

    • A pre-pack is the resolution of the debt of a distressed company through an agreement between secured creditors and investors instead of a public bidding process.
    • This system of insolvency proceedings has become an increasingly popular mechanism for insolvency resolution in the UK and Europe over the past decade.
    • Under the pre-pack system, financial creditors will agree to terms with a potential investor and seek approval of the resolution plan from the National Company Law Tribunal (NCLT).
    • The approval of a minimum of 66 percent of financial creditors that are unrelated to the corporate debtor would be required before a resolution plan is submitted to the NCLT.
    • Further NCLTs are also required to either accept or reject any application for a pre-pack insolvency proceeding before considering a petition for a corporate insolvency resolution process (CIRP).

    How does it work?

    • Unlike the CIRP, an informal understanding is reached with creditors before the application is filed.
    • PPIRP begins only after 66% of financial creditors approve the proposal and the name of resolution professional.
    • Debt resolution agreement between financial creditor and a potential investor is arrived at in consultation with the corporate debtor for which subsequent approval of the resolution plan is sought from the NCLT.

    What were the objectives behind introducing PPIRP?

    • MSMEs greatly contribute to the economy, and employ a wide section of the population.
    • The pandemic severely impacted their operations.
    • This alternative insolvency resolution process was designed to ensure quicker, cost-effective and value-maximizing outcomes for all.

    What is the progress in PPIRP so far?

    • Only two insolvency cases have been initiated under PPIRP since it was introduced.
    • The poor response has been attributed to the hesitancy on the part of financial institutions.
    • In the case of CIRP, the haircut involved is a last resort, against a voluntary one in case of PPIRP.
    • Data shows that between December 2016 and June 2022, a total of 5,636 CIRPs commenced, of which 3,637 have been closed.

    Does PPIRP defeat the purpose of IBC?

    • The IBC’s objective is to facilitate exit from failed units so that capital can be reallocated to better ones.
    • However, banks are not comfortable initiating PPIRP due to voluntary haircuts.
    • There is a fear that such a decision might be scrutinized later.
    • This means capital will remain locked up in failed units, defeating the purpose of IBC.
    • Voluntary haircuts mean fewer resources from the winding-up process and greater scope for corrupt practices.

     

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  • High Inflation in India

    inflation Context

    • It seems that inflation may hover around 7 per cent despite RBI’s tightening of monetary policy in the months to come.

    What is a simple definition for inflation?

    • Inflation is an increase in the level of prices of the goods and services that households buy. It is measured as the rate of change of those prices. Typically, prices rise over time, but prices can also fall (a situation called deflation).

    Inflation Rate

    • Inflation Rate is the percentage change in the price level from the previous period. If a normal basket of goods was priced at Rupee 100 last year and the same basket of goods now cost Rupee 120, then the rate of inflation this year is 20%.
    • Inflation Rate= {(Price in year 2 – Price in year 1)/ Price in year 1} *100

    inflationTypes of Inflation

    Creeping Inflation

    • Creeping or mild inflation is when prices rise 3% a year or less. This kind of mild inflation makes consumers expect that prices will keep going up. That boosts demand. Consumers buy now to beat higher future prices. That’s how mild inflation drives economic expansion.

    Walking Inflation

    • This type of strong, or pernicious, inflation is between 3-10% a year. It is harmful to the economy because it heats up economic growth too fast. People start to buy more than they need, just to avoid tomorrow’s much higher prices. This drives demand even further so that suppliers can’t keep up. More important, neither can wages. As a result, common goods and services are priced out of the reach of most people.

    Galloping Inflation

    • When inflation rises to 10% or more, it wreaks absolute havoc on the economy. Money loses value so fast that business and employee income can’t keep up with costs and prices. Foreign investors avoid the country, depriving it of needed capital. The economy becomes unstable, and government leaders lose credibility. Galloping inflation must be prevented at all costs.

    Hyperinflation

    • Hyperinflation is when prices skyrocket more than 50% a month. It is very rare. In fact, most examples of hyperinflation have occurred only when governments printed money to pay for wars. Examples of hyperinflation include Germanyin the 1920s, Zimbabwe in the 2000s, and Venezuela in the 2010s. The last time America experienced hyperinflation was during its civil war.

    Core Inflation

    • The core inflation rate measures rising prices in everything except food and energy. That’s because gas prices tend to escalate now and then. Higher gas costs increase the price of food and anything else that has large transportation costs.

     

    Consumer Price Index

    • CPI is used to monitor changes in the cost of living over time. When the CPI rises, the average Indian family has to spend more on goods and services to maintain the same standard of living. The economic term used to define such a rising prices of goods and services is Inflation.

    Whole sale Price Index

    • WPI is used to monitor the cost of goods and services bought by producer and firms rather than final consumers. The WPI inflation captures price changes at the factory/wholesale level.

    GDP Deflator

    • Another important measure of calculating standard of living of people is GDP Deflator. GDP Deflator is the ratio of nominal GDP to real GDP. The nominal GDP is measured at the current prices whereas the real GDP is measured at the base year prices. Therefore, GDP Deflator reflects the current level of prices relative to prices in a base year. Example, In India the base year of calculating deflator is 2011-12.

    inflationFactors fuelling inflation in India

    • Falling rupee: Inflation is here to stay because it has much to do with the decline in value of the rupee that has fallen to its lowest, which makes imports of oil and gas more expensive.
    • Ukraine crisis: The war in Ukraine has the same effect and pushes the price of some food items upward.
    • Poor inflation management: With inflation, as measured by the consumer price index, in August going back to 7 per cent, and the wholesale price index coming in at 12.4 per cent, one thing is clear India is not out of the woods on inflation management.

    Rising inflation have these implications

    • Impact on the poor: This upsurge of inflation is affecting the poor more because some of the commodities whose prices are increasing the most represent a larger fraction of the budget of the most vulnerable sections of society.
    • Rising inequality: As a result, inequalities which were already on the rise are increasing further. Recently, the State of Inequality in India report showed that an Indian making Rs 3 lakh a year belonged to the top 10 per cent of the country’s wage earners. 
    • Inequality in healthcare: India’s spending on healthcare is among the lowest in the world. Decent level of healthcare is available only to the ones who can afford it because of increasing out-of-pocket expenditure the payment made directly by individuals for the health service, not covered under any financial protection scheme. Overall, these out-of-pocket expenses on healthcare are 60 per cent of the total expenditure on public health in India, which is one of the highest in the world.

     

    inflationNeed for bold steps on three fronts to tackle inflation

    • Unless bold and innovative steps are taken at least on three fronts, GDP growth and inflation both are likely to be in the range of 6.5 to 7.5 per cent in 2022-23.

    1] Tightening of loose monetary policy: The Reserve Bank of India (RBI) is mandated to keep inflation at 4 per cent, plus-minus 2 per cent.

    • The RBI has already started the process of tightening monetary policy by raising the repo rate, albeit a bit late.
    • It is expected that by the end of 2022-3, the repo rate will be at least 5.5 per cent, if not more.
    • It will still stay below the likely inflation rate and therefore depositors will still lose the real value of their money in banks with negative real interest rates.
    • That only reflects an inbuilt bias in the system — in favour of entrepreneurs in the name of growth and against depositors, which ultimately results in increasing inequality in the system.

    2] Prudent fiscal policy: Fiscal policy has been running loose in the wake of Covid-19 that saw the fiscal deficit of the Union government soar to more than 9 per cent in 2020-21 and 6.7 per cent in 2021-22, but now needs to be tightened.

    • Government needs to reduce its fiscal deficit to less than 5 per cent, never mind the FRMB Act’s advice to bring it to 3 per cent of GDP.
    • However, it is difficult to achieve when enhanced food and fertiliser subsidies, and cuts in duties of petrol and diesel will cost the government at least Rs 3 trillion more than what was provisioned in the budget.

    3] Rational trade policy: Export restrictions/bans go beyond agri-commodities, even to iron ore and steel, etc. in the name of taming inflation.

    • But abrupt export bans are poor trade policy and reflect only the panic-stricken face of the government.
    • A more mature approach to filter exports would be through a gradual process of minimum export prices and transparent export duties for short periods of time, rather than abrupt bans, if at all these are desperately needed to favour consumers.

    Conclusion

    • Though the government is opting for market-based economics, currently, India needs a mixed solution that comprises price stability via government channels and subsidies.

    Mains question

    Q.What are the fuelling factors for inflation? Discuss what steps should be taken to tackle inflation.

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  • Europe heading for Recession

    The Eurozone is almost certainly entering a recession, with surveys showing a deepening cost-of-living crisis and a gloomy outlook that is keeping consumers wary of spending.

    What is Recession?

    • A recession is a significant decline in economic activity that lasts for months or even years.
    • Experts declare a recession when a nation’s economy experiences negative GDP, rising levels of unemployment, falling retail sales, and contracting measures of income and manufacturing for an extended period of time.
    • Recessions are considered an unavoidable part of the business cycle—or the regular cadence of expansion and contraction that occurs in a nation’s economy.

    What causes Recessions?

    These phenomena are some of the main drivers of a recession:

    • A sudden economic shock: An economic shock is a surprise problem that creates serious financial damage. The coronavirus outbreak, which shut down economies worldwide, is a more recent example of a sudden economic shock.
    • Excessive debt: When individuals or businesses take on too much debt, the cost of servicing the debt can grow to the point where they can’t pay their bills. Growing debt defaults and bankruptcies then capsize the economy.
    • Asset bubbles: When investing decisions are driven by emotion, bad economic outcomes aren’t far behind. Investors can become too optimistic during a strong economy.
    • Too much inflation: Inflation is the steady, upward trend in prices over time. Inflation isn’t a bad thing per se, but excessive inflation is a dangerous phenomenon. Central banks control inflation by raising interest rates, and higher interest rates depress economic activity.
    • Too much deflation: While runaway inflation can create a recession, deflation can be even worse. Deflation is when prices decline over time, which causes wages to contract, which further depresses prices. When a deflationary feedback loop gets out of hand, people and business stop spending, which undermines the economy.
    • Technological change: New inventions increase productivity and help the economy over the long term, but there can be short-term periods of adjustment to technological breakthroughs. In the 19th century, there were waves of labour-saving technological improvements.

    What’s the difference between Recession and Depression?

    • Recessions and depressions have similar causes, but the overall impact of a depression is much, much worse.
    • There are greater job losses, higher unemployment and steeper declines in GDP.
    • Most of all, a depression lasts longer—years, not months—and it takes more time for the economy to recover.
    • Economists do not have a set definition or fixed measurements to show what counts as a depression. Suffice to say, all the impacts of a depression are deeper and last longer.
    • In the past century, the US has faced just one depression: The Great Depression.

    The Great Depression

    • The Great Depression started in 1929 and lasted through 1933, although the economy didn’t really recover until World War II, nearly a decade later.
    • During the Great Depression, unemployment rose to 25% and the GDP fell by 30%.
    • It was the most unprecedented economic collapse in modern US history.
    • By way of comparison, the Great Recession was the worst recession since the Great Depression.
    • During the Great Recession, unemployment peaked around 10% and the recession officially lasted from December 2007 to June 2009, about a year and a half.
    • Some economists fear that the coronavirus recession could morph into a depression, depending how long it lasts.

    How long do recessions last?

    • Gulf War Recession (July 1990 to March 1991): At the start of the 1990s, the U.S. went through a short, eight-month recession, partly caused by spiking oil prices during the First Gulf War.
    • The Great Recession (2008-2009): As mentioned, the Great Recession was caused in part by a bubble in the real estate market.
    • Covid-19 Recession: The most recent recession began in February 2020 and lasted only two months, making it the shortest US recession in history.

    Can we predict a recession?

    Given that economic forecasting is uncertain, predicting future recessions is far from easy. However, the following warning signs can give you more time to figure out how to prepare for a recession before it happens:

    • An inverted yield curve: The yield curve is a graph that plots the market value—or the yield—of a range. When long-term yields are lower than short-term yields, it shows that investors are worried about a recession. This phenomenon is known as a yield curve inversion, and it has predicted past recessions.
    • Declines in consumer confidence: Consumer spending is the main driver of the US economy. If surveys show a sustained drop in consumer confidence, it could be a sign of impending trouble for the economy.
    • Drop in the Leading Economic Index (LEI): Published monthly by the Conference Board, the LEI strives to predict future economic trends. It looks at factors like applications for unemployment insurance, new orders for manufacturing and stock market performance.
    • Sudden stock market declines: A large, sudden decline in stock markets could be a sign of a recession coming on, since investors sell off parts and sometimes all of their holdings in anticipation of an economic slowdown.
    • Rising unemployment: It goes without saying that if people are losing their jobs, it’s a bad sign for the economy.

    How does a recession affect individuals?

    • We may lose your job during a recession, as unemployment levels rise. It becomes much harder to find a job replacement since more people are out of work.
    • People who keep their jobs may see cuts to pay and benefits, and struggle to negotiate future pay raises.
    • Investments in stocks, bonds, real estate and other assets can lose money in a recession, reducing your savings and upsetting your plans for retirement.
    • Business owners make fewer sales during a recession, and may even be forced into bankruptcy.
    • With more people unable to pay their bills during a recession, lenders tighten standards for mortgages, car loans, and other types of financing.

     

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  • Alcohol Laws in India

    The most ambitious Delhi’s Alcohol Policy 2021-22 which brought in big discounts for consumers was scrapped on July 31 amid allegations of corruption and irregularities in the drafting and implementation of the policy.

    After scrapping the new policy, the Delhi government decided to bring back the ‘old excise regime’ that was in force before.

    Definitely! We shall not nit-pick the old vs. new policy. Let us generally understand how alcohol is regulated in India.

    Alcohol laws of India: A backgrounder

    • The legal drinking age in India and the laws which regulate the sale and consumption of alcohol vary significantly from state to state.
    • In India, consumption of alcohol is prohibited in the states of Bihar, Gujarat, Nagaland and Mizoram.
    • There is partial ban on alcohol in some districts of Manipur.
    • All other Indian states permit alcohol consumption but fix a legal drinking age, which ranges at different ages per region.
    • In some states the legal drinking age can be different for different types of alcoholic beverage.

    Regulation

    • Alcohol is a subject in the State List under the Seventh Schedule of the Constitution of India.
    • Therefore, the laws governing alcohol vary from state to state.
    • Liquor in India is generally sold at liquor stores, restaurants, hotels, bars, pubs, clubs and discos but not online.
    • Some states, like Kerala and Tamil Nadu, prohibit private parties from owning liquor stores making the state government the sole retailer of alcohol in those states.
    • In some states, liquor may be sold at groceries, departmental stores, banquet halls and/or farm houses.
    • Some tourist areas have special laws allowing the sale of alcohol on beaches and houseboats.

    Drunk driving law

    • The blood alcohol content (BAC) legal limit is 0.03% or 0.03 mg alcohol in 100 ml blood.
    • On 1 March 2012, the Union Cabinet approved proposed changes to the Motor Vehicle Act.
    • Higher penalties were introduced, including fines from ₹2,000 to ₹10,000 and imprisonment from 6 months to 4 years.
    • Different penalties are assessed depending on the blood alcohol content at the time of the offence.

    Dry days

    • Dry days are specific days when the sale of alcohol is not permitted.
    • Most of the Indian states observe these days on major national festivals/occasions such as Republic Day (26 January), Independence Day (15 August) and Gandhi Jayanti (2 October).
    • Dry days are also observed during elections in India.

    Taxation on Alcohol

    • Most states levy either Value added Tax (VAT) or Excise duty or both.
    • Excise duty is a tax levied to discourage the consumption of a product.
    • It is calculated on a per-unit basis. Meaning, if you buy 1 litre of liquor, you pay a fixed excise duty of Rs 15.
    • Value-added Tax is charged in the proportion of the product. If a bottle costs Rs 100, and the state levies 10 percent VAT, the price rises to Rs 110.

    Tax rates in States

    • The 29 states/UTs in India approach liquor taxation differently.
    • For instance, Gujarat has banned its citizens from consuming liquor since 1961.
    • But outsiders with special licenses can still buy.
    • Puducherry, on the other hand, earns most of its revenue from alcohol trading.
    • Bihar has prohibited alcohol consumption entirely, meaning the state’s revenue from liquor consumption is nil.
    • Its neighbour, Uttar Pradesh, earns the most excise duty on liquor.
    • The state does not levy VAT but a special duty on liquor, collecting funds for particular purposes.

    Do you know?

    Andhra Pradesh, Telangana, Kerala, Karnataka, and Tamil Nadu consume as much as 45 percent of the liquor sold in the country.

    Nationally, Maharashtra charges the highest rate but draws only a portion of its revenue from its sales.

    Why alcohol isn’t banned everywhere?

    • Taxes from alcohol sales roughly form a quarter of state revenues.
    • If this stream suddenly stops, states have to compulsorily cut some important spending.
    • Also, moderate alcohol consumption may provide some health benefits.

     

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  • What is a Windfall Tax?

    windfall

    Finance Minister has defended the windfall tax imposed by the Centre on domestic crude oil producers, saying that it was not an ad hoc move but was done after full consultation with the industry.

    What is a Windfall Tax?

    • Windfall taxes are designed to tax the profits a company derives from an external, sometimes unprecedented event — for instance, the energy price-rise as a result of the Russia-Ukraine conflict.
    • These are profits that cannot be attributed to something the firm actively did, like an investment strategy or an expansion of business.
    • The US Congressional Research Service (CRS) defines a windfall as an “unearned, unanticipated gain in income through no additional effort or expense”.
    • One area where such taxes have routinely been discussed is oil markets, where price fluctuation leads to volatile or erratic profits for the industry.

    When did India introduce this?

    • In July this year, India announced a windfall tax on domestic crude oil producers who it believed were reaping the benefits of the high oil prices.
    • It also imposed an additional excise levy on diesel, petrol and air turbine fuel (ATF) exports.
    • Also, India’s case was different from other countries, as it was still importing discounted Russian oil.

    How is it levied?

    • Governments typically levy this as a one-off tax retrospectively over and above the normal rates of tax.
    • The Central government has introduced a windfall profit tax of ₹23,250 per tonne on domestic crude oil production, which was subsequently revised fortnightly four times so far.
    • The latest revision was on August 31, when it was hiked to ₹13,300 per tonne from ₹13,000.

    Why govt. introduced windfall tax?

    • There have been varying rationales for governments worldwide to introduce windfall taxes like:
    1. Redistribution of unexpected gains when high prices benefit producers at the expense of consumers,
    2. Funding social welfare schemes, and
    3. Supplementary revenue stream for the government

    Why are countries levying windfall taxes now?

    • Prices of oil, gas, and coal have seen sharp increases since last year and in the first two quarters of the current year, although they have reduced recently.
    • Pandemic recovery and supply issues resulting from the Russia-Ukraine conflict shored up energy demands, which in turn have driven up global prices.
    • The rising prices meant huge and record profits for energy companies while resulting in hefty gas and electricity bills for households in major and smaller economies.
    • Since the gains stemmed partly from external change, multiple analysts have called them windfall profits.

    Issues with imposing such taxes

    • Companies are confident in investing in a sector if there is certainty and stability in a tax regime.
    • Since windfall taxes are imposed retrospectively and are often influenced by unexpected events, they can brew uncertainty in the market about future taxes.
    • IMF says that taxes in response to price surges may suffer from design problems—given their expedient and political nature.
    • It added that introducing a temporary windfall profit tax reduces future investment because prospective investors will internalise the likelihood of potential taxes when making investment decisions.
    • There is another argument about what exactly constitutes true windfall profits; how can it be determined and what level of profit is normal or excessive.
    • Another issue is who should be taxed — only the big companies responsible for the bulk of high-priced sales or smaller companies as well— raising the question of whether producers with revenues or profits below a certain threshold should be exempt.

     

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  • GST Council

    The Union Finance Minister has heaped praises on Goods and Services Tax (GST) Council.

    Why in news?

    • FM was reacting to a case made by Fifteenth Finance Commission chief N.K. Singh to set up a Fiscal Council with the Centre and States.
    • This is another such recommended body to act as a bridge between the GST Council and the Finance Commission.

    What is the GST Council?

    • The GST regime came into force after the 101st Constitutional Amendment was passed by both Houses of Parliament in 2016.
    • The GST Council – a joint forum of the Centre and the states — was set up by the President as per Article 279A (1) of the amended Constitution.
    • The members of the Council include the Union Finance Minister (chairperson), the Union Minister of State (Finance) from the Centre.
    • Each state can nominate a minister in-charge of finance or taxation or any other minister as a member.

    Why was the Council set up?

    • The Council, according to Article 279, is meant to “make recommendations to the Union and the states on important issues related to GST, like the goods and services that may be subjected or exempted from GST, model GST Laws”.
    • It also decides on various rate slabs of GST.
    • For instance, an interim report by a panel of ministers has suggested imposing 28 per cent GST on casinos, online gaming and horse racing.
    • A decision on this will be taken at the Council meeting.

    Recent reforms

    • The ongoing meeting is the first since a decision of the Supreme Court in May this year, which stated recommendations of the GST Council are not binding.
    • The court said Article 246A of the Constitution gives both Parliament and state legislatures “simultaneous” power to legislate on GST .
    • Recommendations of the Council are the product of a collaborative dialogue involving the Union and States.
    • This was hailed by some states, such as Kerala and Tamil Nadu, who believe states can be more flexible in accepting the recommendations as suited to them.

     

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