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GS Paper: Indian Economy

  • Why policymakers prefer targeting of Retail Inflation over Wholesale Inflation?

    The wholesale inflation in India has grown by double digits. This is the highest year-on-year increase recorded in any month since the start of the 2011-12 data series.

    Context

    • It is surprising policymakers are not looking as concerned as the inflation figures show.
    • The Finance Ministry has largely focused on the trend in retail inflation — or the inflation rate at the level of retail consumers.
    • It is not just the policymakers within the government who prefer to focus on retail inflation but also the RBI.

    Wholesale and Retail (Consumer) Inflation

    • The wholesale and retail (consumer) inflation rates are based on the wholesale price index (WPI) and the consumer price index (CPI), respectively.
    • In other words, we make two separate indices — one each for wholesale prices and retail prices — and see how the index values have gone up in a particular month as against the same month last year.
    • The percentage change is the rate of inflation.
    • The CPI-based inflation data is compiled by the Ministry of Statistics and Programme Implementation (or MoSPI) and the WPI-based inflation data is put together by DPIIT.

    The tables alongside detail how the two indices — WPI and CPI — differ in their composition. There are two key differences.

    [A] Wholesale Price Index

    Component Weight (in %) Inflation rate (in %);

    Nov 2021
    All Commodities 100.00 14.23
    Primary Articles 22.62 10.34
    Fuel & Power 13.15 39.81
    Manufactured Products 64.23 11.92

    [B] Consumer Price Index

    Component Weight (in %) Inflation rate (in %); 

    Nov 2021
    General Index 100.00 4.91
    Food and beverages 45.86 2.60
    Pan, tobacco and intoxicants 2.38 4.05
    Clothing and footwear 6.53 7.94
    Housing 10.07 3.66
    Fuel and light 6.84 13.35
    Miscellaneous (services) 28.32 6.75

    A Comparison

    (1) Manufactured Goods Vs. Food Items

    • WPI is dominated by the prices of manufactured goods while CPI is dominated by the prices of food articles.
    • As such, if the year-on-year increase in the prices of food articles is subdued, as is the case at present, chances are that the overall (also called headline) retail inflation will be within reasonable bounds.
    • In WPI, if manufactured products are getting costlier at the wholesale level then that would likely spike wholesale inflation regardless of how food prices are doing at the wholesale level.

    (2) Accounting Service

    • Two, WPI does not take into account the change in prices of services. But CPI does.
    • If services such as transport, education, recreation and amusement, personal care etc. get significantly costlier, then retail inflation will rise but there will be no impact on wholesale price inflation.

    Why do policymakers prefer targeting retail inflation instead of wholesale inflation rate?

    • RBI’s limitations: RBI is the monetary authority that has little ability to control food and fuel prices. Ex: raising the repo rate (rate at which RBI lends money to banks) is unlikely to contain the price of vegetables if any disruptions have led to a sudden spike.
    • Non-commodity Inflation: Wholesale inflation does not capture price movements in non-commodity-producing sectors like services, which constitute close to two-thirds of economic activity in India.
    • Large revisions in WPI: Movements in WPI often reflect large external shocks and as such, the wholesale inflation rate is often subject to large revisions.

    Arguments in favour of CPI-based inflation targeting

    • Commodity basket: A crucial reason why CPI-based inflation could not be ignored is the fact that it has almost 57% dominance of food and fuel prices.
    • Affecting general public: Since most people use retail inflation as a way to arrive at their real earnings, and use it for wage negotiations etc., it makes more sense for policymakers,
    • Public faith: The choice of CPI establishes ‘trust’ viz., economic agents note that the monetary policy maker is targeting an index that is relevant for households and businesses.
    • Inflation affecting people: True inflation that consumers face is in the retail market. It is for this reason that almost all central banks in big economies use CPI as their primary price indicator.

    Impact of Wholesale inflation on Retail

    • The Urjit Patel committee analysed the relationship between WPI and CPI based on monthly data from January 2000 to December 2013 — a total of 14 years.
    • When they looked at the impact of an increase in WPI-food inflation on CPI food inflation, they found it to be “significant”.
    • It stated that higher food inflation in wholesale markets leads to an increase in retail food inflation “till two months”.
    • An increase in retail food inflation leads to a corresponding increase in WPI-food inflation.

     

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  • The challenge of achieving 9.5% growth rate

    Context

    The National Statistical Office (NSO) released the second quarter gross value added (GVA) and gross domestic product (GDP) numbers on November 30, 2021, indicating the pace of economic recovery in India after the two COVID-19 waves.

    Strong growth momentum required to exceed pre-COVID-19 levels

    • The real GVA for the first half of 2021-22 at ₹63.4 lakh crore has remained below the level in the first half of 2019-20 at ₹65.8 lakh crore by (-)3.7%.
    • This difference is even larger for GDP which at the end of first half of 2021-22 stood at ₹68.1 lakh crore, which is (-) 4.4% below the corresponding level of GDP at ₹71.3 lakh crore in 2019-20.
    • As the base effect weakens in the third and fourth quarters of 2021-22, a strong growth momentum would be needed to ensure that at the end of this fiscal year, in terms of magnitude, GVA and GDP in real terms exceed their corresponding pre-COVID-19 levels of 2019-20.
    • Domestic demand including private final consumption expenditure (PFCE) in the first half of 2021-22 remains below its corresponding level in 2019-20 by nearly ₹5.5 lakh crore.
    • This indicates that investment as well as consumption demand have to pick up strongly in the remaining two quarters to ensure that the economy emerges on the positive side at the end of 2021-22 as compared to its pre-COVID-19 level.

    Annual growth prospects

    • Required rate in second half of 2021-22: To realise the projected annual growth at 9.5% for 2021-22 given both by the Reserve Bank of India (RBI) and the International Monetary Fund (IMF), we require a growth of 6.2% in the second half of 2021-22.
    • This will have to be achieved even as the base effect weakens in the third and fourth quarters since GDP growth rate in these quarters of 2020-21 was at 0.5% and 1.6%, respectively.
    •  Thus, achieving the projected growth rate of 9.5% is going to be a big challenge.

    What should be the policy to achieve higher growth rate

    • Fiscal support: The policy instrument for achieving a higher growth may have to be a strong fiscal support in the form of government capital expenditure.
    • The Centre’s gross tax revenues have shown an unprecedented growth rate of 64.2% and a buoyancy of 2.7 in the first half of 2021-22.
    • The Centre’s incentivisation of state capital expenditure through additional borrowing limits would also help in this regard. According to available information, 11 States in the first quarter and seven States in the second quarter qualified for the release of the additional tranche under this window.
    • Even as Central and State capital expenditures gather momentum, high frequency indicators reflect an ongoing pick-up in private sector economic activities.

    Robust growth in Centre’s gross tax revenue

    • The growth in the Centre’s GTR in the first half of 2019-20 was at 1.5% and there was a contraction of (-)3.4% for the year as a whole.
    • In the face of such weak revenues, the Central government could not mount a meaningful fiscal stimulus in 2019-20 even as real GDP growth fell to 4.0%.
    • In contrast, the government is in a significantly stronger position in 2021-22 since the growth in GTR in the first half is 64.2% and the full-year growth is expected to be quite robust.

    Conclusion

    Thus, the key to attaining a 9.5% real GDP annual growth in 2021-22 lies in the government’s ongoing emphasis on infrastructure spending as reflected in the government’s capital expenditure.

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  • The NMP is hardly the panacea for growth in India

    Context

    As the government seeks to monetise core assets through National Monetisation Pipeline (NMP), it needs to investigate the key reasons and processes which led to once profit-making public sector assets becoming inefficient and sick businesses.

    Background of the MNP

    • The National Monetisation Pipeline (NMP) envisages an aggregate monetisation potential of ₹6-lakh crore through the leasing of core assets of the Central government.
    • These assets are in sectors such as roads, railways, power, oil and gas pipelines, telecom, civil aviation, shipping ports and waterways, mining, food and public distribution, coal, housing and urban affairs etc. over a four-year period (FY2022 to FY2025).
    • Strategic objective of NMP: According to NITI Aayog, the strategic objective of the asset monetisation programme is to unlock the value of investments in public sector assets by tapping private sector capital and efficiencies.
    • Unlocking idle capital: The NMP policy advocates unlocking idle capital from non-strategic/underperforming government owned assets
    • Contribution of core sectors: Eight core industrial sectors that support infrastructures such as coal, crude oil, natural gas, refinery products, fertilizers, steel, cement, and electricity have a total weight of nearly 40% in the Index of Industrial Production (IIP).

    Reasons for the decline of PSU and why the government should introspect the decline

    • Cost overruns, inter alia, is one of the major reasons.
    • Exceeding project completion time: In some cases, project completion time is exceeded, leading to elevated project cost so much so that either the project itself becomes unviable at the time of its launching or delays its break even point.
    • Lack of optimum input-output ratio: Optimum input-output ratio is seldom observed in a majority of government infrastructural projects leading to their overcapitalisation.
    • A reluctance to implement labour reforms, a lack of inter-ministerial/departmental coordination, poor decision-making, ineffective governance and excessive government control are other reasons for the failure of public infrastructural assets.
    • Need for introspection: It is quite likely that the nation may find itself in a vicious cycle of creating new assets and then monetising the same when they become liabilities for the Government at a later stage.

    Importance of public sector enterprises

    • Going by the annual report (2020-2021) of the Department of Public Enterprises there are 256 operationally-run central public sector undertakings (CPSUs), employing about one million people.
    • They posted a net profit of ₹93,294 crore (FY 2019-20).
    • Ratna Status: Out of these, 96 have been conferred the Ratna status (72, 14, and 10 are Miniratnas, Navaratnas, and Maharatna companies, respectively).
    • As India needs to invest about $1.5 trillion on infrastructure development in order to aspire to become $5 trillion economy by the year 2024-25, according to the Economic Survey 2019-20, public enterprises should be in focus.

    Steps to strengthen public sector businesses

    • Gati Shakti National Master Plan: Recently, the “Pradhan Mantri Gati Shakti National Master Plan” for multi-modal connectivity was launched.
    • It is essentially a digital platform for information sharing among different Ministries and departments at the Union and State levels.
    • Seamless planning and coordinated execution: The plan aims ‘to synchronise the operations of different departments of 16 Ministries including railways and roadways.
    •  Revamping corporate governance structure of PSUs: As enunciated in the Economic Survey 2020-21, an important step for the Government to take to strengthen public sector businesses would be to completely revamp their corporate governance structure in order to enhance operational autonomy augmented with strong governance practices including listing on stock exchange for greater transparency and accountability.
    • Initiative to boost domestic production of steel: The Economic Survey also highlights the Government’s initiatives as part of the Atmanirbhar Abhiyaan in order to boost domestic production in the steel sector.
    • Under it, four different types of steel are included for incentives under the production linked incentive (PLI) scheme; selling steel to Micro, Small and Medium Enterprises (MSMEs), affiliated to Engineering Export Promotion Council of India at export parity price under the duty drawback scheme of the Directorate General of Foreign Trade (DGFT);
    • It also include measures to provide preference to domestically produced iron and steel in government procurement, where aggregate estimate of iron and steel products exceeds ₹25 crore;
    • Protection of domestic industry from unfair trade practices: Protecting industry from unfair trade through appropriate remedial measures including imposition of anti-dumping duty and countervailing duty on the products on which unfair trade practices were adopted by the other countries.

    Conclusion

    More such out-of-the-box policy initiatives are needed to rule out public asset monetisation schemes such as the NMP in future.

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  • The stepping stones in the post-pandemic world

    Context

    The COVID-19 pandemic has profoundly impacted lives and livelihoods across the world. Governments, global institutions, industry, academia and non-profit organisations around the world have joined hands to tackle the global challenge and help countries rebuild their economies.

    Criticality of international cooperation and role for India

    • The novel coronavirus pandemic has once again highlighted the criticality of international cooperation in combating current and future challenges.
    • Areas of cooperation: Key among these include economic growth, building competitiveness of the investment climate, ensuring sustainable development paths and adapting to technology acceleration.
    • Strengthening global partnership: Building resilience to cope with the threats posed by pandemics and other man-made and natural disasters has necessitated strengthening global partnerships now more than ever.
    • Global partnerships help in building mutual trust and understanding by agreeing upon common rules and standards and sharing of best practices.

    Areas to focus on

    [1] Challenge of long term sustainability of growth process

    • While the world economy is rebounding strongly, the long-term sustainability of the growth process needs to be strengthened.
    • Exit from the massive stimulus packages itself may pose risks of economic and financial instability.

    [2] Challenges of supply chain management:

    • The pandemic severely disrupted global supply chains and set the global trade trajectory on a downward path.
    • Even as the world emerges from the pandemic, facilitating medical supplies and essentials will continue to remain a top priority and for this, supply chains will need to be kept flowing.
    • For this year, the United Nations Conference on Trade and Development (UNCTAD) indicates an increase of 22.4% in the value of global merchandise trade compared with 2020.
    • World trade is expected to stand about 15% higher than before the COVID-19.
    • FDI flows in developing economies also increased significantly, totalling $427 billion in the first half of 2021.
    •  Cooperation on trade facilitation for enhancing open and transparent markets, technical assistance and reduction of complex process and arrangements must be promoted.

    [3] Increasing competitiveness

    • Competitiveness will be key in facilitating growth and inclusive development.
    • New opportunities and avenues across potential high growth sectors such as manufacturing and start-ups must be leveraged.
    • An ecosystem of entrepreneurship and innovation with targeted policies and interventions will contribute to enhancing productivity and generating employment.

    [4] Structural changes with the emergence of digital economy

    • Certain structural changes are likely to become permanent in the future and this is especially true of the digital economy
    • Equitable adaptation: The rise of telemedicine, remote work and e-learning, delivery services, etc. necessitates equitable adaptation to advanced technologies and tools, building robust infrastructure, and occupational transitions.
    • Skill development and worker training, investments in education and vocational training, and capacity building would be some key areas of focus for filling technology gaps and nurturing new and existing talent.
    • Investment in innovation: At the same time, investments in innovation will be crucial, especially during a crisis.

    [5] Climate change

    • Matter of urgency: Climate change has now acquired urgency from policymakers around the world, as seen in the recent COP26 at Glasgow.
    • International alliances and cooperation on building sustainable solutions, green technology, resource efficiency, sustainable finance, etc., must be promoted to fast-track meeting the sustainable development goals and for ensuring all-round development.

    Opportunities for India

    • Attaining faster growth path: India’s recent reforms, role in combating the pandemic, and startup vibrancy, among other factors, have attracted global attention and can help it attain a faster growth path, provided its integration with the world economy and trade gains strategic intensity.
    • Reliable and trusted player: With multiple strategic shifts, India’s role as a reliable and trusted player in the comity of nations stands enhanced.

    Way forward

    • In the post-pandemic world, it will be critical for India to improve on its investment climate and systematically target its export capabilities across sectors and regions.
    • Ease of doing business and new free trade agreement with major markets will help it integrate closely with the world through trade and investment partnerships.

    Conclusion

    The time for India is here and it must leverage international partnerships for ensuring a robust and sustained economic growth path.

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  • Why crypto currency legislations needs careful consideration

    Context

    The government has decided to introduce a bill that seeks to prohibit all private cryptocurrencies in India.

    Background of the bill

    • In 2018, the three-judge bench of the Supreme Court set aside the RBI circular that prevented crypto exchanges from dealing with the formal financial system on grounds of proportionality.
    • Purpose of the bill: The current bill now attempts to define the rules of the game so that the RBI, tax authorities, SEBI and other agencies have much better legal guidance in deciding the course of action with respect to VCs in their respective domains.
    • The rules can, therefore, range from a ban to controlled interaction with the formal financial system.

    Issues involving cryptos

    • Issues involving cryptos can be seen at three levels, each of which is equally important.
    • The first is its impact on sovereignty.
    • The second is its interaction with financial markets.
    • Third is the value proposition that the entire concept of crypto brings to the economic debate.
    • Incorporation of price stability mechanism: Some of the variants of cryptos such as the stable coin clearly indicate that these are attempts to create systems of money that incorporate features of price stability that imply a parallel monetary system.
    • Diluting the sovereign function of money creation: Unrestricted co-opting of VC clearly dilutes the sovereign function of money creation, clearly impacting the revenues of RBI.
    • Concerns pertaining to money laundering, terrorist threats and narco-trading also come under this category given the high value and anonymity offered by cryptocurrencies.

    Challenges in cryptocurrencies interaction with the formal system

    • As of now cryptos have been recognised as assets or commodities and as a medium of exchange. Their role as units of account or legal tender is rather limited.
    • They may offer a store of value given their short supply. From a banking point of view, certain issues do arise.
    • Since VCs are not legal tenders, they cannot be used in the discharge of debt.
    • Thus, banks cannot accept VCs to close a loan account.
    • Second, can banks lend in fiat by accepting VCs as collateral assuming the VC is an asset?
    • Incompatible with the fractional system of banking: At a deeper level, the very idea of VCs and the way they are designed are incompatible with the fractional system of banking.
    • The fluctuations in interbank liquidity require that money supply adjusts to system requirements.
    • If money supply undergoes compositional change in favour of VCs, this ability will be curtailed thus accentuating the crisis.
    • In financial markets, crypto such as ICOs bring another set of issues.
    • The ICO is a creature that disrupts the very concept of limited liability in corporate finance.
    • ICOs are, at times, designed in such a way that the beneficial owner identity is concealed.
    • SEBI is yet to convey a position on various issues surrounding this idea.
    • Issues with making VCs medium of exchange: VCs have emerged as a medium of exchange and many countries have permitted VC ATMs.
    • But how does this proposition fare given that considerable advances have been made in the payment systems domain in India.
    • Is it worthwhile that additional competition is introduced in a market that is hyper-competitive?
    • It will have impact on existing investments in mobile payment and UPI technology.
    • Impact on poor states: It is well known that the Indian population exhibits significant behavioural divergences in their savings and credit behaviour across regions.
    • Such wide behavioural changes have profound implications on bank strategies and product designs.
    • In the past, there have been several instances of states having low per capita income being more prone to chit fund investments that have negatively impacted the savings of many poor households.
    • The issue of consumer protection needs to be addressed and the current laws may have to be reviewed considering this innovation.

    Conclusion

    The bill must meet many important objectives. While there are obvious concerns of money laundering and benami transactions, there are equal concerns with respect to company laws, payment systems and banking, securities and other commercial laws.

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    Back2Basics: About Stablecoin

    • Stablecoins bridge the worlds of cryptocurrency and everyday fiat currency because their prices are pegged to a reserve asset like the U.S. dollar or gold.
    • This dramatically reduces volatility compared to something like Bitcoin and results in a form of digital money that is better suited to everything from day-to-day commerce to making transfers between exchanges.

    What is ICO?

    • ICO stands for “initial coin offering,” and refers to a formerly popular method of fundraising capital for early-stage cryptocurrency projects.
    • In an ICO, a blockchain-based startup mints a certain quantity of its own native digital token and offers them to early investors, normally in exchange for other cryptocurrencies such as bitcoin or ether.

  • Goods and Services Tax as an unfinished agenda

    Context

    Seen purely from a revenue point of view and as a fiscal policy tool, India’s GST is still on a rocky road.

    Background

    • The GST was launched by India on the midnight of July 1, 2017.
    • Benefits of GST: Hailed as a landmark reform in India’s tax history, it was expected to improve tax-GDP ratio, end tax cascading, enhance efficiency, competitiveness, growth, and ensure lower prices.
    • Fiscal federalism: It was also projected as a watershed in India’s fiscal federalism.
    • the States have forgone a substantial part of their own tax revenue.
    • States were in turn guaranteed a GST compensation assuring 14% growth in their GST revenue during the initial five years.
    • India’s GST architecture: India’s GST architecture is built on the firm foundations of a GST Council and the GST Network (GSTN).
    • GST Council as due federal process: The first is the key decision-making body, chaired by the Union Finance Minister with a Minister of State in charge of Finance and the Finance Ministers of States as members.
    • This is envisaged as a due federal process to protect the interests of the States.

    Unresolved issues

    [1] Revenue neutrality not achieved

    • India’s GST paradigm stands on two key pillars: revenue neutrality and GST compensation for the States.
    • The assured revenue neutrality remains a mirage and many States have experienced a declining tax-GDP ratio.
    • Decline in tax to GDP ratio of state: In the case of major 18 States, the ratio of own tax revenue to GDP has declined.
    • While the share of the Centre in total GST increased by 6%, that of States put together lagged behind with only a 4.5% increase.
    • Stark differences between the Revenue Neutral Rates (RNR) for the producing States and consumption State have been observed. States producing exempted food grains also lost out.
    • Since the rates were lower under GST vis-à-vis the VAT regime, revenue neutrality was not adhered ab initio.
    • The problems were compounded with massive evasion following the dismantling of check posts, and later on fake invoices, that grew by leaps and bounds.
    • Experience of other countries: The South African experience illustrates how zero-rating and large exemptions have defeated revenue goals.
    • Canadian experience shows that GST could be improved by limiting zero rating, tax-exemptions and harmonising tax rates.
    • The resilience of the economy at the time of rolling out of GST is critical for its wider reception as the Australian experience shows.

    [2] Not conducive to co-operative federalism

    • While the States collectively forewent 51.8% of their total tax revenue, the Centre surrendered only 28.8%.
    • Yet, GST is shared equally between the Centre and States despite two expert committees recommended for a higher share for the States.
    • Given the revenue neutrality failure and the host of other issues, many of the States are left with no option except to depend on GST compensation.
    • This is not conducive to sustainable co-operative federalism.

    [3] Need for revenue sharing formula for IGST

    • Although IGST is a key source of revenue for many of the States, the clearing house mechanism and the process therein remains unknown territory.
    •  It was pointed out that GST is discriminatory to manufacturing States, indicating the need for a revenue sharing formula that duly incentivises exporting States by sharing IGST revenue among three parties instead of two.

    [4] Other issues

    • Swift functioning of Input tax credit: The Malaysian experience demonstrates the need for swift and transparent functioning of the input tax credit system through a flawless IT infrastructure.
    • We operate in an almost information vacuum especially with respect to IGST along with several glitches in the digital architecture.
    • GSTN is now in the doldrums.
    • Data monopoly: It neither makes effective use of the massive and invaluable data being generated nor shares them to enable others to make use of them.
    • Such practice in “data monopoly” was a fact of history in India’s statistical system and has to go sooner rather than later.
    • Australia, having several similarities with India, in terms of Centre and the subnational units, and destination-based, multi-stage tax with input credit provisions, has not been revenue-buoyant.
    • It is a matter for consideration whether widening exemptions and the replacing of income-tax by GST in the case of small and medium enterprises are advisable measures in the Indian context.

    Consider the question “What are the challenges facing the GST in India? What India can learn from the experience of other countries’ experience.”

    Conclusion

    Despite many years of efforts in evolving an Indianised GST system and over 50 months of adjustments with over a thousand notifications, with accompanying uncertainties in the first year and the novel coronavirus pandemic and the lockdown still in the saddle, GST continues to be an unfinished agenda. But how far and how long?

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  • RBI must tackle surplus liquidity on way to policy normalisation

    Context

    Monetary Policy Committee (MPC) voted to maintain status quo on policy rates, with one member continuing to dissent on the “accommodative” stance of policy.

    What is accommodative stance of policy?

    Accommodative monetary policy is when central banks expand the money supply to boost the economy. Monetary policies that are considered accommodative include lowering the Federal funds rate. These measures are meant to make money less expensive to borrow and encourage more spending.

    Overview of RBI policy measures during Covid-related lockdown

    • Cut in policy rates and injection of liquidity: The RBI had moved proactively to cut the repo and reverse repo rate and inject unprecedented amounts of funds into banks and other intermediaries.
    • The short-term interest rate at reverse repo level: a combination of the lower reverse repo rate and the large liquidity injection had resulted in a drop in various short-term rates down to (and occasionally below) the reverse repo rate, making it the effective operating rate of monetary policy.
    • Gap between repo and reverse repo increased to 65 bps: In addition, both the repo and reverse repo rates had been cut to 4.0 and 3.35 per cent, respectively, with the gap – the “corridor” – between the rates widening from the usual 25 basis points to 65 bps.

    Central bank’s role in modern monetary policy

    • Determining basic overnight interest rate: A central bank’s main role in modern monetary policy operating procedures is to determine the basic overnight interest rate, deemed to be consistent with prevailing macroeconomic conditions and their economic policy objectives, in balancing the ecosystem for sustained growth together with moderate inflation.
    • This is achieved through buying and selling very short-term (predominantly overnight) funds (mainly) from banks to keep a specified operating rate (the weighted average call rate in our case) very close to the policy rate.

    Liquidity management: Key pillar of monetary policy normalisation

    • Liquidity management: Liquidity management in the extended banking and financial system (which includes non-banking intermediaries like NBFCs, mutual funds and others) will now be the key pillar of normalisation.
    • This process is the domain of RBI and not MPC.
    • These operations will be conducted within RBI’s liquidity management framework.
    •  There are two sources of liquidity additions:
    • (i) Exogenous: which are largely due to inflows of foreign currency funds and outflows of currency in circulation (cash) from the banking sector.
    • (ii) Voluntary or endogenous: which is the result of the creation of base money by RBI through buying and selling of bonds, thereby injecting or extracting rupee funds.

    How RBI is managing liquidity surplus?

    • Stopped GSAP and OMOs: Post the October review, RBI had stopped buying bonds under the Govt Securities Asset Purchase (GSAP) and done negligible Open Market Operations (OMOs), thereby stopping addition of voluntary liquidity injection into the system, our own version of “tapering”.
    • Union government balances with RBI, arising from cash flow mismatches between receipts and expenditures, has hybrid characteristics and also impacts liquidity.
    • Use of reverse repo window: RBI has used the reverse repo window to absorb almost all this liquidity surplus from banks.
    • Allowed repaying TLRTOs: It has again allowed banks the option to prepay the outstanding borrowings from the Targeted Long Term Repo Operations (TLTROs), thereby potentially extracting another Rs 70,000 crores.

    How RBI is managing interest rate in the policy normalisation process

    • Increased rates and closed the gap between repo and reverse repo: RBI – post the October review – has gradually guided short-term rates up with a sure hand from near the reverse repo rate to close to the repo rate.
    • It has shifted its liquidity absorption operations from the predominant use of fixed rate reverse repos (FRRR) into (largely) 14-day variable rate reverse repo (VRRR) auctions to guide a rise in interest rates.
    • Since early October, these rates had steadily moved up in a smooth and orderly fashion up to 3.75-3.9 per cent.
    • The VRRR rates moving up have also resulted in various short-term funding interest rates like 90-day Treasury Bills, Commercial Papers (CP) and banks’ Certificates of Deposits (CD) moving up from the reverse repo rate or below in September to 3.5 per cent and higher since December.
    • The OMO and GSAP operations have also helped in managing medium- and longer-term interest rates in the yield curve.

    Way forward

    • There is a likelihood of further additions to exogenous system liquidity.
    • Other instruments to absorb surpluses: There might consequently be a need for other instruments to absorb these surpluses apart from VRRR auctions.
    • Liquidity surplus of non-banking intermediaries: Managing liquidity surpluses of the non-banking intermediaries, especially mutual funds, will be another challenge since they do not have direct access to VRRR operations.

    Consider the question “Since the onset of the Covid-related lockdowns, RBI had moved proactively to cut the repo and reverse repo rate and inject unprecedented amounts of funds into banks and other intermediaries. In this context, what are the challenges in monetary policy normalisation as RBI plans to absorb the excess liquidity and increase the interest rates ?”

    Conclusion

    The shift to the tightening phase, with hikes in the repo rate, is likely towards the late months of FY23, with shifts “if warranted by changes in the economic outlook”.

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    Back2Basics: Monetary Policy Corridor

    • The Corridor in monetary policy of the RBI refers to the area between the reverse repo rate and the MSF rate.
    • Reverse repo rate will be the lowest of the policy rates whereas Marginal Standing Facility is something like an upper ceiling with a higher rate than the repo rate.
    • The MSF rate and reverse repo rate determine the corridor for the daily movement in the weighted average call money rate.

  • The brush with crypto offers some lessons for regulation

    Context

    The fact that crypto exchanges successfully managed to signal legitimacy for their services and offer these tokens to a mostly-uninformed public for over a year provides lessons on how the government and sectoral regulators may need to act before the game gets out of hand.

    Regulating the technology innovation

    • Technology innovation typically remains a step ahead of regulatory frameworks, which are designed with current practices in mind.
    • Problems occur when these innovations push the envelope beyond accepted codes of social and ethical behaviour.
    • Digital lending apps: The joint parliamentary committee (JPC) on a proposed data privacy law that recently released its controversial report has pointed to dubious “digital” lending apps proliferating on the Android platform.
    • Blockchain technology, of which cryptos are a part, is an innovation that can facilitate transactions across assorted functions.

    Issues with unregulated cryptocurrencies in India

    • Some estimates show that over 15 million Indians have invested in cryptos, many of whom live in Tier-II or Tier-III towns.
    • But crypto exchanges in India have pushed the boundaries of this invention.
    • Important disclaimer not communicated properly: They have been advertising aggressively across media platforms often announcing important disclaimers at warp speed.
    • These provisos were supposed to communicate that cryptos are neither currencies nor strictly “assets”, and that these trading platforms are not truly “exchanges”, that crypto values are not determined by the usual dynamics governing other income-yielding assets, and that investing in cryptos was an exceedingly risky proposition.
    •  In the meantime, with advertising overload stimulating viewer interest, many scam crypto issuers and exchanges have sprung up in attempts to separate the gullible from their savings.

    Regulation challenges and how government is tackling it

    • The government has now stepped in, seized with the political perils of speculative investments turning sour.
    •  Unfortunately, sectoral regulators, such as the Reserve Bank of India (RBI) and Securities Exchange Board of India (Sebi), were unable to step in and act earlier because they are governed by specific Acts which do not mention cryptos as a category that needs regulation.
    • Need for enabling clauses: This episode provides a valuable lesson on how these Acts should perhaps include some enabling clauses that allow financial sector regulators to intervene whenever any intermediary tries to sell a financial service or any new innovative financial service poses the risk of disrupting financial stability.
    • Two important documents have recently been released which discuss entry norms into formal banking, both further strengthening RBI’s hands.
    • Think-tank Niti Aayog’s paper on licensing digital banks recommends an evolutionary path for digital banks that’s RBI-regulated at all stages: first a restricted licence, then a regulatory sandbox offering some relaxations, and finally a “full-stack” digital banking licence.
    • Simultaneously, RBI has accepted some of the suggestions of its internal working group and modified a few to make entry norms stricter, but has maintained silence on the entry of private sector corporate houses into banking.
    • The JPC’s concerns over unregulated digital lending have also focused attention on an RBI-appointed committee’s report on digital lending, given that multiple fintech-based online lenders have mushroomed during the pandemic.

    Conclusion

    This highlights the need for principle-based regulations, rather than rule-based regulations, to allow for flexibility and adaptability in a fast-changing technology environment.

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  • Challenges facing cooperative sector in India

    Context

    The article delved into the past of the cooperative movement and give some suggestions to resolve the issues facing cooperatives in India.

    Background of cooperatives

    • Friedrich Raiffeisen, who along with compatriot Schulze-Delitzsch in Germany, and Luzzatti of Italy, pioneered cooperatives in Europe.
    • Cooperatives in India: The Governor of the Madras Presidency, Lord Wenlock, was the first to seriously attempt replicating European cooperatives in India.
    • Principles: Raiffeisen based them on the principles of self-help, self-governance, and self-responsibility.
    • Nicholson wrote that the ‘future of rural credit lies with those who being of the people, live among the people, and yet by their intelligence, prescience and energy, are above the people’.
    •  Plunkett, in his foreword to Eleanor Hough’s The Cooperative Movement in India (1932), commented that what India had was not a movement, but a policy.
    • It was ‘created by ‘resolutions of the Central Government’ unlike Europe.
    • Increasing government control: John Matthai wrote in 1925 that the challenge was to loosen government grip on cooperation over the years.
    • But, government control has only increased, violating a core cooperative principle of political neutrality.
    • This reflects a collective failure of the political class.

    Challenges facing cooperatives

    • After Independence, cooperative institutions became an instrument of planning and state action.
    • Not surprisingly, successful Indian cooperatives such as the Gujarat Cooperative Milk Marketing Federation Ltd (GCMMF)/Amul, Indian Farmers Fertiliser Cooperative Limited (IFFCO) and Krishak Bharati Cooperative Limited (KRIBHCO), are outside government control.
    • Globally, seven of the top 10 cooperatives by asset size are from the financial sector.
    • The Indian financial sector is nowhere in the picture going by asset size.
    •  Cooperatives have also become avenues for regulatory arbitrage, circumventing lending and anti-money laundering regulations.
    •  The committees which examined cooperative banking suffered from the top-down quality that Plunkett and others frowned upon.
    • Recent initiatives such as an umbrella organisation for urban cooperatives and a new Ministry of Cooperation at the Centre threaten to further this approach in the absence of safeguards.

    Suggestions

    • First, the powers of the RCS need to be scaled back.
    •  In almost all States, the RCS has become an instrument of inspection and domination, one which imposes uniform by-laws, and amends them when individual societies do not fall in line.
    •  There is a need to transfer work from the RCS to cooperative federations — as in Singapore.
    • Second, the rural-urban dichotomy in the regulatory treatment of cooperatives is specious and outdated.
    • Such differences are immaterial when regulation is to be based on the cooperative nature of organisations.
    • Third, the regulation and the supervision of cooperative banks should move to a new body from the Reserve Bank of India (RBI) for urban banks and the National Bank for Agriculture and Rural Development (NABARD) for rural banks.
    • Fourth, lessons from the Netherlands, where cooperative banks owe their success to a segmented market, are pertinent.
    • In India, adopting a multi-agency approach, especially after bank nationalisation, has affected the efficiency of both commercial and cooperative banks.
    • Commercial bank-cooperative sector linkages at various levels could alternatively provide better synergies.

    Conclusion

    The cooperative sector in India faces challenges on various fronts. There is a need for implementing the changes suggested above to play an important role expected from it in the economy.

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  • India’s electric vehicle push will lead to brighter, greener future

    Context

    The transition to electric mobility is a promising global strategy for decarbonising the transport sector.

    Electricity mobility revolution

    • The global electric mobility revolution is today defined by the rapid growth in electric vehicle (EV) uptake.
    • This phenomenon is today defined by the rapid growth in EV uptake, with EV sales for the year 2020, reaching 2.1 million.
    • Falling battery costs and rising performance efficiencies are fueling the demand for EVs globally.

    Significance of India’s transition to electric mobility

    • India is the fifth largest car market in the world and has the potential to become one of the top three in the near future.
    • India is among a handful of countries that supports the global EV30@30 campaign, which aims for at least 30 per cent new vehicle sales to be electric by 2030.
    • Part of global climate agenda: The push for EVs is driven by the global climate agenda established under the Paris Agreement to reduce carbon emissions in order to limit global warming.
    • Ensuring energy security: It is also projected to contribute in improving the overall energy security situation as the country imports over 80 per cent of its overall crude oil requirements, amounting to approximately $100 billion.
    • Job creation: The push is also expected to play an important role in the local EV manufacturing industry for job creation.
    • Strengthen grid operation: Through several grid support services, EVs are expected to strengthen the grid and help accommodate higher renewable energy penetration while maintaining secure and stable grid operation.

    Battery storage: Opportunities and challenges

    • Promoting sustainable development: With recent technology disruptions, battery storage has great opportunity in promoting sustainable development in the country, considering government initiatives to promote e-mobility and renewable power (450 GW energy capacity target by 2030).
    • Economic opportunity: With rising levels of per capita income, there has been a tremendous demand for consumer electronics in the areas of mobile phones, UPS, laptops, power banks etc. that require advanced chemistry batteries.
    • This makes manufacturing of advanced batteries one of the largest economic opportunities of the 21st century.
    • Concern of absence of manufacturing base: It is estimated that by 2020-30 India’s cumulative demand for batteries would be approximately 900-1100 GWh, but there is concern over the absence of a manufacturing base for batteries in India, leading to sole reliance on imports to meet rising demand.

    Government schemes to promote EV ecosystem

    • To develop and promote the EV ecosystem in the country, government has remodeled Faster Adoption and Manufacturing of Electric Vehicles (FAME II) scheme (Rs 10,000 crore) for the consumer side.
    • It has also launched production-linked incentive (PLI) scheme for Advanced Chemistry Cell (ACC) ( Rs 18,100 crore) for the supplier side.
    • Finally the recently launched PLI scheme for Auto and Automotive Components (Rs 25,938 crore) for manufacturers of electric vehicles was launched.
    • All these forward and backward integration mechanisms in the economy are expected to achieve robust growth in the coming years and will enable India to leapfrog to the environmentally cleaner electric vehicles and hydrogen fuel cell vehicles.

    Benefits of EV ecosystem

    • This will not only help the nation conserve foreign exchange but also make India a global leader in manufacturing of EVs and better comply with the Paris Climate Change Agreement..
    • Battery demand creation: All three schemes cumulatively expect an investment of about Rs 1,00,000 crore which will boost domestic manufacturing and also facilitate EVs and battery demand creation along with the development of a complete domestic supply chain and foreign direct investment in the country.
    • Reduction of oil import bill: The programme envisages an oil import bill reduction of about Rs 2 lakh crore and import bill substitution of about Rs 1.5 lakh crore.

    Conclusion

    India’s push for EV ecosystem is in line with the country’s climate change commitments, will help boost manufacturing sector and also help ensure energy security.

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