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GS Paper: Indian Economy

  • Risks involved in investment in cryptocurrencies

    Context

    We are witnessing the change where the cult of savers has changed into investors. They are looking for a good return and willing to take the risk.

    Changing the behaviour of the savers

    • There is a new wave of savings and investments in the country that is evolving quite fast.
    • Crypto exchanges assure you that they are safe.
    • But it is the exchange that is safe, not the value of the coin, which will be driven by the market.
    • The equity boom is on, and all the unicorns have delivered excellent results.
    • That’s why bank deposits are no longer on our plates.
    • Banks discouraging deposits: Interestingly, banks today are discouraging deposits with low rates as this is the only way they can manage their balance sheets.
    • Low-interest rate: There are few deployment avenues and paying 5 per cent interest to savers and investing the deposits at 3.35 per cent in the reverse repo auction is a sub-optimal game.

    How safe is investment in cryptocurrencies?

    • From equities, there has been a swift shift to cryptos, which is still a grey area.
    • The regulators/government are wondering what to do. The issue will be discussed in the winter session of Parliament.
    • But investments have been made and there is no stopping this global wave.
    • Currency with no underlying asset: Making money on a currency that has no underlying asset like a metal or other currency and is traded on faith is unique; especially Bitcoin, whose originator is not known by face but by just a name.

    Gaming as a skill

    • There is another door to a new kind of gaming where you make money by making teams and following the matches.
    • The law was first silent, and then confused.
    • But it finally accepted gaming as a skill.
    • Logically, soon we should be able to bet on matches too, if all this is in order.

    Conclusion

    We are witnessing a change in the pattern of holding onto money, where savings get transformed to investment and risk appetite changes from conservative to aggressive. Will this change? Probably not, in the near future, as long as conventional deposits continue to give inferior returns.

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  • UNCITRAL Model for Cross Border Insolvency

    The Ministry of Corporate Affairs (MCA) has published a draft framework for cross-border insolvency proceedings based on the UNCITRAL (United Nations Commission on International Trade Law) model under the Insolvency and Bankruptcy Code.

    About Insolvency and Bankruptcy Code (IBC)

    • The IBC, 2016 is the bankruptcy law of India that seeks to consolidate the existing framework by creating a single law for insolvency and bankruptcy.
    • It is a one-stop solution for resolving insolvencies which previously was a long process that did not offer an economically viable arrangement.
    • The code aims to protect the interests of small investors and make the process of doing business less cumbersome.

    Cross border insolvency proceedings

    • Cross-border insolvency proceedings are relevant for the resolution of distressed companies with assets and liabilities across multiple jurisdictions.
    • A framework for cross-border insolvency proceedings allows for the location of such a company’s foreign assets, the identification of creditors and their claims.
    • This helps establishing payment towards claims as well as a process for coordination between courts in different countries.

    Current status of foreign stakeholders and courts in other jurisdictions under IBC

    • While foreign creditors can make claims against a domestic company, the IBC currently does not allow for automatic recognition of any insolvency proceedings in other countries.
    • Current provisions under the IBC do not allow Indian courts to address the issue of foreign assets of a company being subjected to parallel insolvency proceedings in other jurisdictions.

    The UNCITRAL model

    • The UNCITRAL model is the most widely accepted legal framework to deal with cross-border insolvency issues.
    • It has been adopted by 49 countries, including the UK, the US, South Africa, South Korea and Singapore.
    • The law allows automatic recognition of foreign proceedings and rulings given by courts in cases where the foreign jurisdiction is adjudged.
    • Recognition of foreign proceedings and reliefs is left to the discretion of domestic courts when foreign proceedings are non-main proceedings.
    • The model law deals with four major principles of cross-border insolvency:
        • Direct access to foreign insolvency professionals and foreign creditors to participate in or commence domestic insolvency proceedings against a defaulting debtor.
        • Recognition of foreign proceedings & provision of remedies.
        • Cooperation between domestic and foreign courts & domestic and foreign insolvency practitioners.
        • Coordination between two or more concurrent insolvency proceedings in different countries. The main proceeding is determined by the concept of Centre of Main Interest (COMI).
          • The COMI for a company is determined based on where the company conducts its business on a regular basis and the location of its registered office.
      • It is designed to assist States in reforming and modernizing their laws on arbitral procedure so as to take into account the particular features and needs of international commercial arbitration.

    Issues with Indian framework

    • The framework for cross-border insolvency adopted in India may require reciprocity from any country which seeks to have its insolvency proceedings recognized by Indian courts.
    • This would allow Indian proceedings for foreign corporate debtors to be recognized in foreign jurisdictions.

    Back2Basics: UNCITRAL

    • It is an affiliate organization to the UN made up of business and legal professionals.
    • This group develops model standards and procedures for dealing with issues affecting international business.
    • Perhaps most notably, UNCITRAL promulgated the Convention on International Sale of Goods (CISG).
    • The CISG is a model law commonly used as the governing provisions in contracts between parties from different nations.

     

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  • Is crypto mania more a symptom than a cause?

    Context

    The draft legislation on crypto currency being introduced in Parliament and the stance of the RBI suggest that consideration is being given to banning crypto currencies in India.

    What fascination with crypto reveals about our society?

    • It is about faith in that value is largely a matter of belief.
    • It is about politics because money is always about the allocation of power.
    • The money itself may not be material, but it is still embedded in a materiality.
    • The fact that money is subject to politics is actually the advantage of money.
    • It allows a modicum of collective control over our future, and allows distributive questions to be posed.
    • It is mania because the alchemy of creating something out of nothing is always deeply alluring.
    • Cheap money: The global economy is awash with cheap money.
    • Seeking return: In an Indian context small savers are desperate for return.
    • In this context it is easy for the powerful to misallocate money and the small saver to express desperation by speculation.

    Background

    • Faced with the inflation of the 1970s, thinkers like Friedrich Hayek theorised about reasserting the dominance of private currencies, protected from the state.
    • Crypto currencies are a fascinating technological innovation.
    • Part of their initial attraction was that they promised a new governance order. 
    • It is at the confluence of faith, politics, and psychological mania.
    • Solving the problem of trust: This project crucially depended on solving the problem of “trust” on which every currency depends.
    • Crypto seemed to solve that problem, with its decentralised architecture and community and self-verification protocols.

    How cryptocurrency poses challenges to the state?

    • No state was going to let go of its power to assert control over the monetary system.
    • Significance of fiat money: The sustenance of state-sponsored fiat money is one of the great achievements of modern state formation and the foundation of its power and legitimacy.
    • Cryptocurrency requires material infrastructure: There was a delusion, as if crypto is conjured out of thin air: It actually requires substantial material infrastructure, which a state could always control.
    • States can shut down mining as China has done.

    Way forward

    • We allow people to invest in all kinds of things. Why ban this, especially now that so many investors are in it?
    • Analyse the risk to the financial system: The answer to this question depends on how much risk the existence of crypto assets pose to the stability of the rest of the financial system.
    • Insulate financial system: One answer is if you can insulate the financial system from the gyrations of crypto markets there are few systemic risks.
    • This is why it was a good idea of the RBI to prohibit the entanglement of financial institutions with this market.
    • Instead of just focussing on issues of fraud, money laundering, and private risks, the RBI’s case would be strengthened if it spelled out the systemic risks that crypto might pose to the stability of the real economy.
    • Avoid ban with exception scenario: For political economy reasons, the RBI should avoid a scenario where it bans but then carves out exceptions.
    • Ensuring that trade does not go offshore: The second thing is that if it somehow allows Indians to invest then it has to ensure that trade does not go offshore. 
    • Not fully banning and allowing it offshore will be the worst of both worlds.

    Challenges in insulating the crypto market

    • In practice the insulation of crypto markets will be difficult to achieve.
    • Political economy: The first reason is political economy. Once you have a large number of investors, and some influential ones, they will be a vested interest in their own right, potentially demanding the socialisation or mitigation of losses.
    • Impact of volume: The second reason is that it is difficult to pretend that a major new class of assets, especially if volumes grow, does not have systemic effects on the rest of the economy.

    Consider the question “What are the risks and advantages provided by the cryptocurrencies? Suggest the approach India should adopt in dealing with cryptocurrencies.”

    Conclusion

    As the RBI makes the case for banning crypto, we also need to ask, why it is alluring in the first place. What does this mania reveal about our politics and economics?

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  • Finance Ministry backs three-rate GST structure

    The Government can rationalize the GST rate structure without losing revenues by rejigging the four major rates of 5%, 12%, 18% and 28% with a three-rate framework of 8%, 15% and 30%, as per a National Institute of Public Finance and Policy (NIPFP) study.

    GST Slabs

    • In India, almost 500+ services and over 1300 products fall under the 4 major GST slabs.
    • These comprise rates of 5%, 12%, 18%, and 28%. The GST Council periodically revises the items under each slab rate to adjust them according to industry demands and market trends.
    • The updated structure ensures that the essential items fall under lower tax brackets, while luxury products and services entail higher GST rates.
    • The 28% rate is levied on demerit goods such as tobacco products, automobiles, and aerated drinks, along with an additional GST compensation cess.

    Why harmonize GST slabs?

    • Multiple rate changes since the introduction of the GST regime in July 2017 have brought the effective GST rate to 11.6% from the original revenue-neutral rate of 15.5%.
    • Merging the 12% and 18% GST rates into any tax rate lower than 18% may result in revenue loss.
    • The nature of rate changes has also meant that over 40% of taxable turnover value now falls in the 18% tax slab, thus any move to dovetail that slab with a lower rate will trigger losses.

    What next?

    • Restructuring GST rates is a timely idea to improve revenues.
    • It is important to sequence the transition to the new rate structure so as to minimize the costs associated with tax compliance, administration, and economic distortions.

     

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  • The growth and inclusion potential of India’s telecom sector

    Context

    Shortly after the Cabinet announced nine structural and procedural reforms in September to address the deep financial woes of telcos, Vodafone Idea and Bharti Airtel hiked their tariff.

    About the package for telecom sector

    • The telecom relief package announced by the government in September supports proposals that have been repeatedly presented to the government by the regulator, industry associations and think tanks.
    • Risk of duopoly: With the risk of a duopoly looming large, the government was pushed to take up these long-pending decisions that included nine key changes.
    • Provisions in the package: Besides providing immediate relief on payment of licence fee and penalties due to the government, the package increased FDI limits, extended licence tenure to 30 years from 20, removed charges on spectrum-sharing and proposed timelines for spectrum auctions.
    • The package will undoubtedly have a positive short-term impact and perhaps safeguard competition in the future.

    Reforms and  challenge of addressing the inequality

    • From socialist to market-oriented economy: In July this year, we celebrated three decades of India’s 1991 reforms, one that catapulted India from being a socialist economy with a heart but no trickle-down, to a market-oriented economy with a mind but also very little trickle-down.
    • Inequality has been a feature of both models.
    • The 2018 Oxfam report showed that 10 per cent of the richest Indians took home 77.4 per cent of wealth (compared to 73 per cent the year before).
    • Moreover, 58 per cent of India’s wealth was in the hands of 1 per cent of the country’s population.
    • Changes in the modes of distribution: In the pre-1991 period, the principal modes of redistribution were taxation and public sector operations.
    • In the post-1991 period, it has been a combination of taxation, technology, smartphones and the associated direct benefit transfers.

    Role of telecom sector in addressing the challenge of achieving growth and inclusion

    • High growth dividend of telecom sector: Every 10 per cent increase in investment in telecom, for example, leads to a 3.2 per cent increase in GDP growth for India.
    • Not only is the growth dividend positive, it is large.
    • Mobile as a mean of financial integration: At the same time, the mobile phone has become a means for sophisticated financial integration, as shown by the expanding usage of pre-paid payment instruments and mobile banking.
    • The Jan-Dhan Yojana (JDY) attempts to include the marginalised and unbanked through technology.
    • As of October 2021, a total of 440 million bank accounts have been opened and more than 310 million RuPay cards have been issued under the latter, indicating the large unmet demand for banking services.
    • Making transfers predictable and targeted: The Jan-Dhan-Aadhaar-Mobile (JAM) trinity ties the Aadhaar number to an active bank account, making income transfers predictable and targeted.
    • There is already evidence that payments through Aadhaar-linked bank accounts have increased efficiency and reduced leakages.

    Way forward

    • Predictable and less erratic telecom policy: The benefits of digitalisation could have been much larger and more widespread had telecom policy been more predictable and less erratic.
    • That Indian reforms more often than not happen on the back of a crisis is true for the telecom sector.
    • The principal motive of the New Telecom Policy of 1999 was to rescue the deeply indebted sector of its own reckless bidding by replacing the fixed licence fee system with a revenue-sharing regime.
    • In hindsight, it was the right thing to do since it threatened business continuity.
    • The move to auction spectrum “for all times to come” in 2008 was necessitated by the administrative bungling in spectrum assignment.
    • Quick adaptation: A question we pose is why did it take a crisis — a grave one at that — to push the needle on policy change?
    • It is a a reasonable expectation of policy to adapt quickly and not wait for a crisis to emerge.

    Consider the question “Telecom sector could play an important role in achieving the growth with inclusion. In context of this, examine the challenges facing the sector and suggest the measures to deal with these challenges.”

    Conclusion

    The seemingly naïve question about the adaptation in policies may not be as credulous for the intensely dynamic digital markets. For there is no point shutting the stable door after the horse has bolted.

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  • Risks involved in over-valued unicorns

    Context

    The biggest-ever initial public offering (IPO) in India fell flat on its face on the first day of its listing in the stock exchange, with shares being traded at prices less than 27% of the IPO price.

    Rise of unicorns in India and factors driving it

    • Unicorns in diverse sectors: There has been a unicorn gale in India in recent years, covering diverse sectors from fintech to cloud kitchen.
    • Growth in digital payment is reflected in the fintech sector that has contributed the most to the unicorn list.
    • Factors driving growth: An ecosystem which combines thriving digital payments, a growing smartphone user base and digital-first business models adopted by many start-ups has driven expectations of investors, resulting in large-scale fund flows into new business ventures.
    • Growing smartphone user: Expectations are high as the country has around 640 million Internet users, of which 550 million are smartphone users.
    • Growing digital payments: Digital payment has seen a growth of 30.19% as of March 31, 2021 and by the end of September 30, the unified payments interface (UPI) registered 3.5 billion transactions amounting to ₹6.54 trillion.

    FinTech and EdTech leading unicorns

    • American investment firms Tiger Global and Sequoia Capital have been the major investors, providing very quick follow-up rounds of funds across all stages and sectors.
    • Fundamental financial performance of the business is not factored in these decisions which could lead to biased valuations.
    • Idea of disruptive technologies: The idea of disruptive technologies has become a buzzword for characterising start-ups.
    • The idea was that start-ups with limited resources can aim at technology disruption by inventing an entirely new way of getting something done.
    • The story is similar in educational technologies (EdTech) as well.
    • The novel coronavirus pandemic has been a blessing in disguise for EdTech firms, as it is this external environment that is pushing the industry, giving it an acceleration by four to five years.
    • Too many acquisitions with big ambitions to grow inorganically puts pressure on the balance sheet in the years to come as some of the new acquisitions are likely to fail.
    • Even, EdTech firms with reasonably good business models are highly overvalued due to abundant liquidity.
    • Cost of achieving behaviour change: Almost every second advertisement on primetime television is either of a digital payment firm or EdTech platform.
    • New firms in services will have to indulge in this process for a longer period than firms in other industries such as transportation as these firms have to bring about a particular kind of change that customers are significantly comfortable using the service.
    • Firms burn cash to give massive discounts to customers in the hope that people will get so habituated to these platforms that they will remain active even when the prices are hiked.
    • To some extent this worked in the context of mobile telephone services as Indians have got hooked to mobile phones and reoriented spending to buy more sophisticated smartphones and data.
    • But in other services this does not seem to work so easily.
    • The projection flaw: Data by the Centre for Monitoring Indian Economy (CMIE) points to this flaw of over-optimistic demand projections as there are just about 23 million households which earn more than ₹5 lakh per year i.e., less than ₹42,000 a month, which is about 7% of all Indian families.
    • It is only this class which can be coaxed to behavioural changes — i.e. people who can afford various kinds of goods and services.
    • If firms want to go beyond this 7% of households they have to offer bigger discounts, burning more cash, with the possibility that once the discounts are reduced, customers drop off.

    Consider the question “India is witnessing the unicorn boom in the starts-ups. However, valuation of these unicorns has raised concerns. In light of this, examine the factors driving the rise of unicorns in India and why their valuation raises concerns?”

    Conclusion

    We are witnessing new unicorns emerging every month, which are products of inflated valuations to tap more funds to burn more cash. These valuations are solely on the basis of future earnings, with virtually no profits to show in the present.

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  • Tackling the problem of bad loans

    Context

    The newly-created National Asset Reconstruction Company (NARCL) in the public sector offers hopes for the faster clean up of lenders’ balance sheets.

    Features of National Asset Reconstruction Company (NARCL)

    • The newly-minted ARC, NARCL is not a bank, but a specialised financial institution to help resolve the distressed assets of banks.
    • Faster aggregation: Its greatest virtue lies in the faster aggregation of distressed assets that lie scattered across several lenders.
    •  Soverign assurance: Its securitised receipts (SRs) carry sovereign assurance.
    • This is of particular comfort to PSU banks as price discovery would not be subject to later investigations.
    • Focus on large accounts: It would initially focus on large accounts with debts over Rs 500 crore.
    • IDRCL: All eyes will be focused on IDRCL (Indian Debt Resolution Company), the operating arm, which would be in the private sector.

    Past policy measures to resolve the bad debts

    • Institutional measures include BIFR (Board for Industrial and Financial Reconstruction, 1987), Lokadalat, DRT (Debt Recovery Tribunal, 1993), CDR (Corporate Debt Restructure, 2001), SARFAESI (Securitisation and Reconstruction of Financial Assets and Enforcement, 2002), ARC (Asset Recovery Company, 2002).
    • The RBI has also launched a slew of measures during 2013-14 to resolve, reconstruct and restructure stressed assets.

    Why the measures to resolve the bad debt failed?

    • Of the 28 ARCs (private sector) in operation, many are bit players.
    • Dominance of few ARC: The top five ARCs account for over 70 per cent of the asset under management (AUM) and nearly 65 per cent of the capital.
    • Restructuring as an exception: Financial and business restructuring appears to be more an exception than the norm.
    • Nearly one-third of debts are rescheduled.
    • This is not much value addition to what lenders would have otherwise done at no additional cost.
    • Success and shortcomings of IBC: The IBC, introduced in 2016, was landmark legislation and marked a welcome departure from the earlier measures, with a legally time-bound resolution.
    • The focus is on resolution rather than recovery.
    •  It nearly put an end to evergreening.
    • Even though there are delays under this newfound promise, they are counted in terms of days and not years and decades.
    • The NCLT (National Company Law Tribunal)  is the backbone of the IBC, but lamentably is starved of infrastructure and over 50 per cent (34 out of 63) of NCLT benches were bereft of regular judges.
    •  Even the parliamentary committee has expressed indignation on a large number of positions left vacant.
    • This lack of adequate infrastructure, coupled with the poor quality of its decisions, has proved to be the IBC’s Achilles’ heel.
    • We need judicial reforms for early and final resolutions.
    • Issue of delayed recognition and resolution: Forty-seven per cent of the cases referred to the IBC, representing over 1,349 cases, have been ordered for liquidation.
    • Against the aggregate claims of the creditors of about Rs 6.9 lakh crore, the liquidation value was estimated at a paltry Rs 0.49 lakh crore.

    Suggestions to make IBC more effective

    • Delayed recognition and resolution: Lenders and regulators need to address the issue of delayed recognition and resolution.
    • Business stress and/or financial stress needs to be recognised even prior to regulatory norms on NPA classification.
    • Dealing with anchoring bias: The tendency to make decisions on the basis of first available information is called “anchoring bias”.
    •  The first available information in bidding for distressed assets is the cost of acquisition to ARCs.
    • Potential bidders would quote prices nearer to this anchor.
    • Nobel Laureate Daniel Kahneman has suggests a three-step process to mitigate anchor bias: One, acknowledge the bias; two, seek more and new sources of information, and three, drop your anchor on the basis of new information.

    Way forward for NARC

    • Forbid wilful defaulters from taking back distressed asset: The IBC has made considerable progress in bringing about behavioural change in errant and wilful defaulters by forbidding them to take back distressed assets.
    • Otherwise, the credit culture suffers.
    • The NARC should uphold this principle, not dilute it
    • Introduce Sunset clause: It should have a sunset clause of three to five years.
    • This will avoid the perpetuation of moral hazard and also encourage expeditious resolution.
    • Deal with anchor bias: Anchor bias needs to be mitigated by better extrinsic value discovery.
    • Avoid selling to other ARCs: It should avoid selling to other ARCs.

    Conclusion

    The RBI has recently released (November 2) a report on the working of ARCs and makes 42 recommendations to improve the performance of ARCs. This article incidentally makes an effort to identify some constraints and offer solutions to improve the performance of ARCs.

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  • Why India’s pro-rich, anti-poor taxation policies must change

    Context

    To develop their renewable energy capacities poor countries may well have to help themselves to make the transition that society urgently needs. One source of funding could well be the well-off citizens of India, who are getting richer and richer.

    Growing inequality in India

    • A 2018 Oxfam report revealed that 10 per cent of the richest Indians garnered 77.4 per cent of the nation’s wealth.
    •  In fact, according to the report, 58 per cent of India’s wealth was in the hands of one per cent of the country’s population.
    • The combined income of this handful of people in 2017 was almost as much as India’s budget that year.
    • In 2017, the fortune of India’s 100 richest tycoons leaped by 26 per cent.
    •  According to Crédit Suisse, the number of dollar millionaires in India has jumped from 34,000 in 2000 to 7,59,000 in 2019 — in other words, the country has one of “the world’s fastest-growing population of millionaires”.
    • The average wealth of these millionaires has increased by 74 per cent over this period.

    Issues with taxation policies

    • The taxation policy of the government, instead of making the exchequer benefit from this trend, has actively strengthened the trend of growing millionaires.
    • Replacing wealth tax by increasing income tax: The government replaced the wealth tax by an income tax increase of two per cent for households that earned more than 10 million rupees annually.
    • Corporate tax was reduced: The corporate tax was lowered, for existing companies from 30 per cent to 22 per cent, and for manufacturing firms incorporated after October 1, 2019 that started operations before March 31, 2023, from 25 to 15 per cent — the biggest reduction in 28 years.
    • Increase in income tax exemptions: In the 2019-20 budget, the income tax exemption limit jumped from Rs 2,00,000 to 2,50,000 and the tax rate for incomes up to Rs 5 lakh was reduced from 10 to 5 per cent.

    Impact of pro-rich taxation policy

    • Deprives the state of resources: This taxation policy deprived the state of important resources.
    • Increase in indirect taxes: To (partly) compensate for the decline of direct taxes, the government has increased indirect taxes, unfairly so, because they affect all Indians irrespective of their income.
    • The share of indirect taxes in the state’s fiscal resources has increased to reach 50 per cent of total taxes in 2018.
    • Taxes on petroleum products are a case in point.

    High taxes on petroleum products

    • About two-thirds of the cost of a litre of petrol now goes towards taxes.
    • The tax collected on petrol and diesel has increased by 459 per cent in the past seven years — from Rs 52,537 crore in 2013 to Rs 2.13 lakh crore in 2019-2020.
    • Given that petrol is a less elastic good, people are bound to consume it even at higher prices.
    • This also explains why the government sees fuel sale in India as a safe “revenue collection” medium.
    • In 2018-19, excise duty on petroleum products alone accounted for roughly 24 per cent of the indirect tax revenue.

    Consider the question “India’s taxation policies are criticised for being pro-rich. In the context of this, discuss the issues with the taxation system and suggest the measure to deal with these issues.”

    Conclusion

    The government’s taxation policy will probably continue to prevail depriving the exchequer of some of the resources it needs for dealing with issues as important as climate change.

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  • Cryptocurrencies

    With cryptocurrencies such as Bitcoin gaining popularity among citizens, the Centre has been compelled to take a stance on the legal status of cryptocurrencies.

    Background

    • The Union Government is said to be considering a proposal to tax cryptocurrency transactions in the country.
    • The move would bring cryptocurrency trading, which has till date happened outside the ambit of the law, into the formal economy.

    Defying RBI ban

    • RBI has been vehemently opposed to the idea of legalizing cryptocurrencies.
    • It had banned financial institutions such as banks from facilitating transactions involving cryptocurrencies back in 2018.
    • The RBI’s order was overturned by the Supreme Court in 2020, and this led to a tremendous surge in cryptocurrency transactions through exchanges.

    Why did RBI propose a ban?

    • Financial stability: The RBI has characterized private cryptocurrencies as a threat to financial stability.
    • Threat to the sovereignty of Rupee: It perceives cryptocurrencies rise as a threat to the sovereignty of the rupee.
    • Beyond regulatory scope: The widespread acceptance of cryptocurrencies could interfere with the ability of the RBI to conduct monetary policy effectively.
    • Digital currency in the pipeline: It should be noted that RBI and other central banks are also looking to come up with digital versions of their own currencies.
    • Competition of currencies: The rupee or central bank digital currencies may not be able to outcompete cryptocurrencies just because they are digital.

    Legislative opinion on Cryptocurrencies

    • Not in favour of ban: This week, a Parliamentary Standing Committee recommended that cryptocurrencies be regulated rather than banned.
    • Making a legal framework: The Government is also expected to table a bill that clarifies its position on cryptocurrencies in Parliament next year.
    • Taxing cryptocurrencies: There is a proposal to classify cryptocurrency exchanges as e-commerce platforms and tax them under the GST framework comes.

    Why has the Government chosen to regulate rather than ban cryptocurrencies?

    • Popularity amongst Public: The growing popularity of cryptocurrencies among citizens may have played a role in the Government opting for regulation over an outright ban.
    • Lack of evident threat: There is no clear evidence of the misuse of cryptocurrencies and their risks.
    • Boosting with policy: The Union govt may also not want to kill the nascent cryptocurrency industry which many believe can be a hub for financial innovation.
    • Revenue generation: Fiscal revenues can be adversely impacted by the increased tax evasion opportunities that crypto-currencies can facilitate.
    • Capitalizing the market: The govt wants to capitalise on the recent surge in the usage of cryptocurrencies to tax them and shore up its revenues.
    • Financial innovation: Blockchain technology has multiple uses beyond just facilitating cryptocurrency transactions.

    Issues with the ban

    • Brain-Drain: Ban of cryptocurrencies is most likely to result in an exodus of both talent and business from India, similar to what happened after the RBI’s 2018 ban.
    • Capital inflows will be restricted: If cryptos begin to get mined onshore, they will induce capital inflows.
    • Killing financial innovation: A ban will deprive India, its entrepreneurs and citizens of a transformative technology that is being rapidly adopted across the world.

    Other generic concerns:

    • Safety (cyber-attacks and fraud)
    • Financial integrity (money laundering and evasion of capital controls)
    • Energy usage (outsized energy needs to mine cryptos)

    Way forward

    • Thus it can be inferred that cryptocurrency is better classified as an asset rather than as a currency, in order to gain acceptance and avoid a ban.

    Conclusion

    • There is no doubt that the acceptance of cryptocurrencies by the Government is likely to be limited.
    • While cryptocurrencies may be accepted as speculative assets, it is highly unlikely that they will be accepted as full-fledged currencies competing against the rupee.

     

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  • RBI panel brings law to regulate Digital Lending

    A Reserve Bank of India (RBI) Working Group (WG) on digital lending has recommended separate legislation to oversee such lending as well as a nodal agency to vet the Digital Lending Apps.

    Digital Lending

    • Digital lending is the process of availing credit online.
    • Its increased popularity amongst new-age lenders can be attributed to expanding smartphone penetration, credit range flexibility, and speedy online transactions.

    Significance of Digital Lending

    India has a huge growth potential when it comes to the Digital Lending landscape:

    • Alternate source of finance: Digital lending is mostly preferred by those who are generally not able to avail any credit through the formal sources of finance, like banks.
    • Lender of the last resort: Digital lending is mostly preferred by those who are generally not able to avail any credit through the formal sources of finance, like banks.
    • Financial inclusion: Digital lending is a powerful tool that can be used for financial inclusion.
    • Cost-efficient lending: With new innovations underway, digital lending offers much better products to the masses at a much faster rate which is even more cost-efficient.
    • Exception for red-tapism: Online lending has played a pivotal role in evading cumbersome red-tapism usually involved while availing loans offline in a traditional setting.
    • Preference by MSMEs: The online lending platforms have gained massive popularity among MSMEs post-Covid as they were unable to secure finance through traditional lending.
    • Easy onboarding: The quick turnaround time and onboarding, easy KYC, as well as disbursement within minutes have attracted the cash-crunched MSMEs towards these digital routes to secure credit.

    Issues with Digital Lending

    • No business model: There are many gaps that are existent in this model of digital lending like any new business operation.
    • High interest: Unauthorised lenders provided credit to customers without any collateral and at exorbitant rates coupled with unachievable deadlines to pay off these humongous debts.
    • Coercing and harassment for recovery: Resultantly, borrowers were coerced by the lenders to recollect when they were unable to pay off these debts. We see many cases of suicides due to such harassment.

    Key recommendations by RBI

    • Self-Regulation: RBI has mooted a Self-Regulatory Organisation for participants in the digital lending ecosystem.
    • Developing a Baseline Technology: Development of certain baseline technology standards and compliance with those standards as a pre-condition for offering digital lending solutions.
    • Direct loan disbursement: Disbursement of loans directly into the bank accounts of borrowers; disbursement and servicing of loans only through bank accounts of the digital lenders.
    • Data collection: With the prior and explicit consent of borrowers with verifiable audit trails.
    • Standardized code of conduct: for recovery to be framed by the proposed SRO in consultation with RBI.

    Way forward

    • There is a growing need for regulation in this space or unauthorized players like pointed out above will keep popping up.
    • Stringent provisions must be formulated which can be enforceable legally.
    • Regulation must be enforced in this industry soon to ensure consumer trust remains unfettered.

     

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