GS Paper: Indian Economy

The article highlights the challenges posed by the second wave of covid and how aggressive vaccination could help dealing with the issue.

Severe second covid wave in India

• India’s daily new cases have surged past 1,50,000, much above the first peak.
• In India’s first wave, the increase from 50,000 to about 1,00,000 cases took about 50 days; in the second wave, it’s taken just 13.
• To start with, the second wave was more concentrated, with Maharashtra accounting for 60 per cent of cases.
• While the top five states still account for about 65 per cent of cases, the reproduction (R) factor in almost 10 states is estimated to be two or higher, creating risks for a wider and more rapid spread, if unaddressed.

Lessons from the first wave

• Policymakers, businesses and households have all learnt from the first wave and with the private sector better adapted to “live with the virus”.
• Therefore, the economic costs should hopefully not be comparable to the first wave. Yet, they may not be trivial either.
• The five states that account for 65 per cent of new cases also account for almost 36 per cent of GDP.
• As virus cases have grown and restrictions have been imposed, retail and recreational mobility across these five states, is down 10 per cent since mid-March.
• Labour market surveys have also begun to show discernable impacts on both participation and unemployment rates.

Implications of unequal recovery for developing countries

• The IMF projects India’s FY22 growth at 12.5 per cent, this would still leave India about 8-9 per cent below the level of output that was projected pre-pandemic for the end of 2021-22.
• The challenge for emerging markets is that, given the quantum of fiscal and monetary space expended in combating the first wave, space to respond to subsequent waves will be constrained.
•  Owing to the fiscal support and pace of vaccinations the US will be the only large economy, apart from China, to surpass its pre-pandemic path.
• This, resulted in increased US yields, tightened global financial conditions, induced dollar strength and triggered
• All this makes it harder for emerging economies to respond expansively to domestic shocks.
• In effect, the heterogeneity of the recovery across developed and emerging markets is imposing policy constraints on the latter which, ironically, will simply compound the economic divergence.

Challenges for India

• India’s fiscal space to respond to a second wave appears constrained due to the following two factors:
• 1) In India’s case, consolidated public debt will approach 90 per cent of GDP.
• 2) The consolidated public sector borrowing requirements are budgeted above 11 per cent of GDP in FY22.
• The dependence on budgeted asset sales has only increased, both as a hedge to tax revenues that could be impacted from a second wave, and as a means of protecting expenditures.
• It will be equally crucial to leaving enough space for higher MGNREGA demand and other safety nets on account of a second wave, even while protecting capital expenditures — which generate large multiplier effects on the economy.
• Similarly, monetary policy is already very accommodative, and with core inflation sticky and elevated, global deflationary pressures entrenched, there are natural limits to the degree of more monetary accommodation.

Aggressive vaccination is the key

• Israel, the UK and the US have all demonstrated how aggressive vaccinations can bend the COVID-curve.
• Therefore, the Indian government’s decision to approve a third vaccine and fast-track emergency approval for foreign-produced vaccines is unambiguously positive.
• On the demand side, of an estimated 100-110 million population of seniors (60-plus) in India, only about 40 million have taken the vaccine over the last six weeks, suggesting a reluctance to get vaccinated.
• But, in fact, it’s crucial to ensure the vulnerable — those whose probability of hospitalisation is the highest — are fully vaccinated to reduce pressure on the health infrastructure.

Consider the question “What are the challenges posed to the developing countries by heterogeneity of recovery across the developed and developing countries?

Conclusion

Vaccinations should be construed as simultaneously delivering both a positive demand and supply shock (for the economy), and a negative demand shock (for health infrastructure), thereby providing the best chance to decisively break the trade-offs between lives and livelihoods that bedevilled emerging markets all of last year.

The article highlights the failure of FRBM Act to contain India’s rising debt and suggests an alternative framework.

Issues with the FRBM Act

• Economic disruption caused by the COVID has prompted calls for a relook atthe Fiscal Responsibility and Budget Management Act (FRBM).
• The introduction of the FRBM in 2003 reflected the belief that setting strict limits on fiscal deficits, both for the centre and the states, was the solution.
• But this framework didn’t work.
• Apart from the initial period, when growth was booming, the deficit targets were largely honoured in the breach, leaving the primary balance [Revenue-Non-intrest expenditure] essentially unchanged (Figure 2, phase 2).

Debt has increased to record levels

• India’s general government debt has soared.
• It is now close to 90 per cent of GDP — the highest independent India has ever seen.
• The debt ratio will come down naturally as GDP normalises.
• Even so, on current policies, it is likely to exceed 80 per cent for the foreseeable future.

Would such a high level of debt be sustainable?

• Briefly, sustainability depends on two key factors:
• 1) The primary balance (PB), revenue less non-interest expenditures.
• 2) The difference between the cost of borrowing and the nominal growth rate (r-g).[interest-growth differential]
• Debt does not explode when the primary balance is greater than the interest-growth differential.
• In India’s case, PB has been negative as the government has run primary deficits.
• But this has been counterbalanced over the past decade by favourable differentials, as interest rates have been lower than growth.
• Hence, the broadly stable debt ratio.
• This equilibrium has now been upset by the sudden increase in debt.
• If the interest-growth differential consequently turns unfavourable, as occurred during the previous period of high debt in the early 2000s (Figure 2, phase 1), then debt sustainability could only be preserved by shifting the primary balance into surplus.
• And this would not be easy.

Why shifting primary balance intro surplus is not easy

• Primary deficit of the Centre and states combined is typically about 3 per cent of GDP. [say PB is -3% of GDP]
• So, shifting the primary balance into a modest surplus [i.e. turning PB from -ve to +ve] would require an adjustment of 4 percentage points of GDP.
• But non-interest expenditure is only roughly 20 per cent of GDP.
• If tax increases were ruled out, then a sudden adjustment would require non-interest spending to be cut by no less than 20 per cent (4 divided by 20 times 100).[20% of 20 is 4]
• Clearly, this would be politically impossible.
• But this would render India susceptible to panic and possibly even crises.
• The government needs to eliminate the tension, undertaking a pre-emptive consolidation to prevent the need for a sudden adjustment.

Strategy based on 4 principles

• The government should start by defining a clear objective, based not on arbitrary targets but on sound first principles: It should aim to ensure debt sustainability.
• To this end, the government could adopt a strategy based on four principles.

1) Abandon multiple fiscal criteria

• The current FRBM sets targets for the overall deficit, the revenue deficit and debt.
• Such multiple criteria impede the objective of ensuring sustainability since the targets can conflict with each other,
• This creates confusion about which one to follow and thereby obfuscating accountability.

2) Don’t get fixated on specific number

• Around the world, countries are realising that deficit targets of 3 per cent of GDP and debt targets of 60 per cent of GDP lack proper economic grounding.
• In India’s case, they take no account of the country’s own fiscal arithmetic or its strong political will to repay its debt.
• Any specific target, no matter how well-grounded, encouraging governments to transfer spending off-budget such as with the “oil bonds” in the mid-2000s and subsidies more recently.

3) Focus on one measure for guiding fiscal policy

• In this regard, Arvind Subramanian and Josh Felmanwe propose targeting the primary balance.
• This concept is new to India and will take time for the public to absorb and accept.
• But it is inherently simple and has the eminent virtue that it is closely linked to meeting the overall objective of ensuring debt sustainability.

4) Don’t set yearly target for the primary balance

• The Centre should not set out yearly targets for the primary balance.
• Instead, it should announce a plan to improve the primary balance gradually, by say half a percentage point of GDP per year on average.
• Doing so will make it clear that it will accelerate consolidation when times are good, moderate it when times are less buoyant, and end it when a small surplus has been achieved.
• This strategy is simple and easy to communicate; it is gradual and hence feasible.

Consider the question “Despite the FRBM framework India’s debt level have touched a historic high. In light of this, examine the reasons for the failure of FRBM in controlling the debt level and suggest the way forward to make India’s debt level sustainable.”

Conclusion

COVID has upended India’s public finances. It is time to learn from past experience and adapt. Adopting a simple new fiscal framework based on the primary balance could be the way forward.

What explains the Indian government borrowing at a higher interest rate than the interest rates for a home loan? The answer lies in the structural shortage in demand for government bonds. 

How the government’s cost of borrowing matter

• Interest on government debt is a transfer from taxpayers to savers who own government bonds.
• As the government bondholders are primarily domestic, interest paid by the government is just a transfer from one hand to the other within the economy.
• However, the government’s cost of borrowing does matter.
• The large increase in interest costs limits the government’s ability to spend elsewhere.
• But more importantly, this rate also affects the cost of borrowing for large parts of the economy.

Understanding the term premium and credit spread

• The RBI sets the repo rate, which is the short-term risk-free rate.
• That is, the loan must be repaid in a few days and there is almost no risk of default.
• The rate at which the government borrows is the long-term risk-free rate.
• But the lender wants higher returns given the longer duration of the loan.
• The difference between the repo rate and government’s borrowing cost, say on a 10-year loan, is called the term premium.
• When a private firm takes a 10-year loan, it would have some credit risk too, which means a credit spread is added to the 10-year risk-free rate.

Challenge posed by term premium

• From an average rate of 73 basis points since 2011 (one basis point is one-hundredth of a per cent), and 120 basis points in 2018 and 2019, the 10-year term premium is currently 215 basis points.
• In other words, the interest rate for a 10-year period borrowing is 2.15 per cent higher than the current repo rate.

How this is related to dysfunction in bond market in India

• Financial markets are forward-looking, and as the collective expression of the views of thousands of participants, efficient ones can occasionally “predict” what comes next.
• But the Indian bond market is not one such: The view some hold, that the rise in term premium reflects future rate hikes by the monetary policy committee (MPC), is mistaken.
• The Indian bond market is still too illiquid and not diverse enough to predict future trends.
• Even though some pandemic-driven measures are being withdrawn, the MPC continues to be accommodative, and for several months at least, headline inflation is unlikely to force an abrupt change.
• In any case, the spurt in yields after the budget points to the causality being fiscal instead of inflation-related.
• But even the fiscal rationale seems weak.
• The Centre’s tax collection for FY2020-21 has been substantially ahead of target, and state governments have also borrowed Rs 60,000 crore less than expected.
•  Also, the14 states, accounting for three-fourths of all state deficits, have budgeted FY2021-22 deficits at 3.3 per cent, far lower than the 4 per cent average expected earlier.
• Just these factors suggest that total bonds issued by the central and state governments should be lower than what the market had feared before the union budget was presented.
• And yet, government borrowing costs have not returned to pre-budget levels.
• This reflects dysfunction in the market.
• Why else would a government be borrowing at a higher cost than a mortgage on a house?

What is the reason for dysfunction in bond market

• Dysfunction can be traced to residential mortgages being among the most competitive of loan categories.
• On the other hand, there is a structural shortage in demand for government bonds.
• In such a market where there is a structural shortage in demand the marginal buyer holds all the cards, and as any buyer would, demands higher returns.
• Over 15 years,  the share of banks in the ownership of outstanding central government bonds has fallen from 53 per cent to 40 per cent now.
• But no alternative buyer of size has emerged to fill the space vacated.
• The RBI sometimes buys bonds to inject money into the economy, but of late this space has been used to buy dollars to save the rupee from appreciation.

Solutions

• The solution to the problem of bond market may lie in getting new types of buyers.
• The RBI opening up direct purchases by retail investors is a step in this direction, though it may not become meaningful for a few years.
• That leaves us with tapping foreign savings.
• The limit on share of government bonds that foreign portfolio investors (FPIs) can buy has been raised steadily.
• But without Indian bonds being included in global bond indices, these flows may not be meaningful, and would be volatile, as they have been over the past year.
• To enable inclusion in bond indices, the RBI and the government have earmarked special-category bonds which are fully accessible (FAR) by foreign investors.
• The FTSE putting India on a watch-list for “potential future inclusion” in the Emerging Markets Government Bonds Index is a step forward, and, one hopes, triggers similar actions by other index providers.

Consider the question “How the lack of retailness in the bond market affects the cost of borrowing of the government as well as the private borrowers? Suggest the measures to deal with the issues.”

Conclusion

The issues with bond markets in India highlights the urgency to find new buyers for government bond as it has implications not just for the government’s own fiscal space, but also for the cost of borrowing in the economy.

The article highlights the untapped potential of the e-commerce sector in the transformation of the Indian economy and suggests factors to take into account in the new e-commerce policy.

How pandemic contributed to the growth of e-commerce

• A celebrated McKinsey study has revealed that we have covered a ‘decade in days’ in the adoption of digital during the pandemic.
• Behavioural changes have been witnessed in most areas like work, learning, health, travel, entertainment, etc.
• But the biggest surge has been in e-commerce, both in goods and services.

Significance of the sector for India

• E-commerce is one of India’s fastest-growing sectors, for attracting FDI and creating jobs, and providing a pan-India market for lakhs of SMEs, and facilitating exports.
• India has a vibrant retail sector, bubbling with energy and a bright future.
• E-commerce can rope in lakhs of MSMEs in cross-border trade and multiply turnover and revenues enormously.
• Its role in facilitation of exports with linkages and access to overseas markets can also help inject competitiveness in our products and creating a lot of jobs and market opportunities, adding to inclusive growth.

Issues faced by the sector

• The digital interface during e-commerce processes with multiple agencies has resulted in a plethora of compliances.
• These compliances include Income Tax Act 1961, Information Technology Act 2000, Consumer Protection Act 2019, FEMA Act 2000, Competition Act 2002, Companies Act 2013, Anti-Piracy Law, GSTN, DGFT, etc.
• In addition, handling, generation and protection of humongous data is a major issue under data protection laws.
• At times, there are requirements of compliances with various local and state laws, and during exports, adherence to foreign laws, many of which could be quite complex and rigorous.

E-commerce policy to aid Inclusive growth

• Inclusive growth being an important objective of the proposed e-commerce/FDI policy, it should recognise and support new business models in both product and service segments.
• The policy should be aimed at improving consumer experience and providing gainful employment to regular and gig workers with improved earnings.
• India, in fact, is the first country to extend protections to workers including the new-age gig and platform workers, which is being viewed with interest globally.
• With the passage of the Code on Social Security 2020, policymakers have focused on financial and social security associated with employment to contemporary socio-economic realities.
• The role of platform workers amidst the pandemic has presented a strong case to attribute a more robust responsibility to platform aggregator companies and the State.
• This has cemented their role as public infrastructures who also sustain demand-driven aggregators and e-commerce platforms.
• This role of the platform workers may help in higher productivity and more sustainable employment, when many of them could potentially become mini-entrepreneurs.
• This, however, would need to be facilitated by concerned public and private institutions as also the multiple regulators in the e-commerce ecosystem.
• In an online services market place and to provide full support to regular and gig professionals rendering services on the platform, it must be imperative on the service platform to build their capacity through training, technology and access to high-quality consumables and tools.

Consider the question “Examine the role e-commerce can play in India’s pursuit of inclusive growth? What are the issues faced by the sector in India?” 

Conclusion

We are in for exciting times, as we enter this decade, rightly called the ‘Techade’; 2020 has accelerated technology infusion in all segments of life and activity. The world is looking at India with expectations and we owe it to our nation.

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Source: https://www.financialexpress.com/opinion/e-commerce-policy-needed-for-speedy-inclusive-growth/2226729/

The article deals with the issues of demand for the inclusion of fuel oils in the GST regime and its implications for the revenue of the states and the Centre.

How much tax we pay on petrol and diesel

• The Union and state levies put together account for roughly 55 per cent and 52 per cent of the retail price of petrol and diesel respectively.
• These work out to around 135 per cent and 116 per cent of the base prices of the two products respectively.
• The central levy on petrol and diesel works out to around 36 per cent of the retail price while the state component is around 20 per cent (diesel) to 28 per cent (petrol).
• Of the total central levies on petrol and diesel, Rs 1.40 per litre and Rs 1.80 per litre is the basic excise duty for the two fuels, and Rs 11 per litre and Rs 18 per litre is the special additional excise duty.
• Both these components form part of the divisible pool of taxes i.e. 42 per cent of which (approximately Rs 52,000 crore) goes to the states.
• The remaining portion of Rs 18 per litre in both cases is the Road and Infrastructure Cess and Rs 2.50 per litre and Rs 4 per litre is the Agriculture Infrastructure and Development Cess which are retained by the Centre.

How other countries tax fuel oils

• Being demerit goods, fuel oils and liquor are almost universally subject to a dual levy by countries that implement any kind of VAT or GST.
• The levy is a mix of GST at a fixed percentage of the price which qualifies for credit in the value chain and a fixed amount or percentage of the price which is not creditable and is thus outside GST.
• Punitive taxes of this order are levied primarily to discourage consumption of environmentally degrading fossil fuels and to garner revenues to fund infrastructure, while the creditable component enables offsetting of taxes on basically capital inputs.
• These products are subjected to a plethora of levies like VAT, excise duty, storage levies, security levies and environmental taxes in the EU and the total incidence of such taxes ranges from around 45 per cent to 60 per cent.
• The US is an exception in these matters since it imposes taxes at rates as low as around 15 per cent.

Including fuel oils in the GST regime

• the 122nd Constitution Amendment Bill in 2014 for GST adopted the delayed choice approach.
• Under the delayed-choice approach, petroleum products would be subjected to GST with effect from such date as the council may recommend.
• Accordingly, sections 9(2) and 5(2) of the CGST/SGST Act and the IGST Act respectively, explicitly provide for levy of GST on these products with effect from such date as the Council may recommend.
• Thus, bringing the aforesaid petro-products under GST is not within the reach of the central government alone.

How much will be the loss of revenue

• A 28 per cent levy of GST on the base price would fetch around Rs 5.40 per litre on petrol and around Rs 5.45 on diesel to the central and each of the state governments.
• Contrast the above with the current yield of Rs 32.90 per litre on petrol and Rs 31.80 per litre on diesel to the Centre alone and an average of around Rs 20 per litre and Rs 15 per litre on petrol and diesel, respectively, to each of the states.
• This, however, would bring down the prices of petrol and diesel to around Rs 55 per litre.
• This would translate into a revenue loss of around Rs 3 lakh crore on account of petrol and around Rs 1.1 lakh crore on account of diesel to the Centre and the states, at current volumes.

Consider the question “What are the various levies contributing to the prices of petrol and diesel in India? Examine the rationale for the heavy taxing of these products in India.”

Conclusion

Clearly, bringing petro-products under GST would not lower fuel oil prices by itself, unless the Union and the state governments are willing to take deep cuts in their revenues.