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GS Paper: Indian Economy

  • Bad bank is good move

    The article explains the important role bad bank can play in cleaning up the balance sheets of the banks.

    How India banks dealt successfully with pandemic

    • Indian banks were written off in the early days of the pandemic due to expectations of an exponential jump in non-performing assets.
    • Only after the banks consistently talked about the lower number of restructuring requests, and the higher provision coverage ratios that the markets began to get convinced.
    • What finally turned the corner were the budget announcements related to the financial sector
    • There are several reasons for this good performance by the banks.
    • First, banks in India and globally were much better capitalised prior to the pandemic.
    • Second, Indian banks had built up a sizeable buffer to provide for bad assets negating any surprise on balance sheets during and even after the pandemic.
    • Third, independent research shows that as the size of the middle class grows to about two-thirds of Asian households.
    • Banks in Asia, including in India, have begun to adjust for this steady growth in the size of pie by experimenting with new business models, rationalising costs and providing faster and superior customer digital experience, as was clear during pandemic.
    • Fourth, Indian banks and the RBI brought about financial discipline much before the pandemic.

    Creation of Bad Bank

    • The budget this year has the provision for reation of a bad bank.
    • The proposed structure envisages setting up of a National Asset Reconstruction Company (NARC) to acquire stressed assets in an aggregated manner from lenders, which will be resolved by the National Asset Management Company (NAMC). 
    • A skilled and professional set-up dedicated for Stressed Asset Resolution will be ably supported by attracting institutional funding in stressed assets through strategic investors, AIFs, special situation funds, stressed asset funds, etc for participation in the resolution process.
    • The net effect of this approach would be to build an open architecture and a vibrant market for stressed assets.

    How it will work

    • Banks may first transfer those assets to the proposed bad bank with a 100 per cent provision on its book and then based on the experience they will decide on transferring assets with less than 100 per cent provisioning at a later date.
    • It is also being speculated that of the total amounts recovered, a specified percentage will be in the form of security receipts.
    • These receipts will reside in the bank balance sheets, but will carry a zero-risk weight, with full government guarantees for a specified period of time.

    How it will benefit the banks

    • The benefits of this process includes the recovered value, and significant lending leverage because of three factors:
    • One, capital being freed up from less than fully provisioned bad assets.
    • Two, capital freed up from security receipts because of a sovereign guarantee.
    • Three, cash receipts that come back to the banks and can be leveraged for lending, also freeing up provisions from the balance sheet.
    • There are several international success stories of a bad bank accomplishing its mission and there is no reason to believe why India cannot accomplish its objective.
    • The current Indian approach will drive consolidation of stressed assets under the AMC for better and faster decision making.
    • This will free up management bandwidth of banks enabling them to focus on credit growth, leading to an enhancement in their valuations.
    • Governance of the AMC and its independence is central to its successful functioning, there are multiple suggestions to make.
    • These include keeping majority ownership in the private sector, putting together a strong and independent board, a professional team, and linking AMC compensation to returns delivered to investors.

    Consider the question “What is a bad bank? How its creation could help the banking sector?”

    Conclusion

    The creation of a bad bank will help the banking sector contribute more in the growth of the country

  • How did inflation targeting really impact India?

    The article analyses the success of the inflation targeting mechanism in India and its impact on the growth of the economy.

    Background of the inflation targeting policy in India

    • It has been three decades since inflation targeting was first adopted in New Zealand and subsequently by 33 other countries.
    • India adopted it in 2016.
    • The primary goal of inflation targeting was to contain inflation at around 4 per cent, within the allowable range of 2 to 6 per cent.
    • The RBI has announced a formal review of the policy instrument now.
    • At the first meeting of the RBI Monetary Policy Committee in October 2016, it was also formally announced that the MPC considered a real repo rate of 1.25 per cent as the neutral real policy rate for the Indian economy.
    • By a neutral real policy rate, the RBI meant a policy rate consistent with growth at potential (i.e. growth at full employment).

    Has inflation targeting worked in India

    • The evaluation of IT must provide answers to the following two questions:
    • Did inflation decline post the adoption of inflation targeting and what was the role of IT in the decline in inflation?
    • Was the adoption of inflation targeting associated with the policy of the highest real repo rates in India — ever — for almost three years 2017-2019?
    • The answer is yes to the latter, but it also needs to be acknowledged that high real repo rates were the primary cause of the GDP growth decline in India from 8 per cent to 5 per cent.

    Need to take into account the global context of inflation

    • An interesting feature of the Indian defence of inflation targeting is that very few take into account the global context of inflation in which the decline in inflation has occurred in India.
    • A research paper by Balasubramanian, Bhalla, Bhasin and Loungani at ORF evaluates inflation targeting in a global context and separately for Advanced Economies (AEs) and Emerging Economies (EES).
    • Some facts from the paper are the following.
    • First, the annual median inflation in AEs has been consistently low, so low that many central banks have official campaigns to raise the inflation rate.
    • One conclusion might be that IT succeeded beyond anyone’s dreams in these economies.
    • But attributing this decline in inflation to IT would be erroneous.
    • Inflation is global and price-taking by millions of producers in the world means that no one producer or one country can influence the price of any item.
    • Oil has ceased to be a factor in global inflation, at least post the mid-1980s.
    • The lowest inflation in Indian history occurred during 1999-2005, averaged only 3.9 per cent.
    • The average median rate among EM targetters during 2000-04 was 4 per cent, and among the non-targeting countries was 3.8 per cent.

    Did fiscal deficit play role in inflation targeting

    • In 2003, India passed the FRBM act to control fiscal deficits and inflation.
    • There is precious little evidence, either domestically or internationally, about fiscal deficits affecting inflation.
    • For three consecutive years preceding the FRBM announcement, the consolidated Centre plus state deficits registered 10.9 per cent(in 2001), 10.4 and 10.9 per cent.
    • For the seven-year 1999-2005 period, consolidated fiscal deficits averaged 9.4 per cent of GDP.
    • Yet, that these years represented the golden period of Indian inflation — without FRBM and without IT.

    Cost of inflation targeting in India

    • There are also costs to inflation targeting in India.
    • It led to higher real policy rates, in the mistaken belief that high policy rates affect the price of food, oil, or anything else.
    • But high real rates affect economic growth, by affecting the cost of domestic capital in this ultra-competitive world.
    • It is very likely not a coincidence that potential GDP growth, as acknowledged by RBI, was reached just before the MPC took over decision making in September 2016. 
    •  Since then there was a steady increase in real policy rates, and a steady decline in GDP growth.

    Consider the question “How far has the inflation targeting mechanism been successful in India? Give reasons in support of your argument.” 

    Conclusion

    So, in the inflation targeting mechanism has not been successful in containing the inflation though there had a cost associated with it which we paid in the form of growth.

  • An effective plan to monetise government assets

    The article discusses the government’s proposal to monetise assets and proposes the idea of an independent commission to carry out the task of monetisation.

    Roadmap for monetisation of asset: National Monetisation Pipeline

    • Finance Minister had introduced a roadmap for monetisation of asset in the Union Budget.
    • In the budget, the government proposed to launch a ‘National Monetisation Pipeline’ to assess the potential value of underutilised and unused government assets.
    • A number of countries including the United States, Australia, Canada, France and China have effectively utilised this policy.
    • In India too, the concept was suggested by a committee led by Vijay Kelkar on the roadmap for fiscal consolidation in 2012.
    •  The committee had suggested that the government start monetisation as a key instrument to raise resources for development.
    •  It asked the government to use these resources for financing infrastructure needs.

    Why monetisation

    • The global pandemic forced the government to increase spending.
    • Thus, total expenditure of the government has jumped to ₹34.50 trillion against the target of ₹30.42 trillion.
    • On the flip side, revenue of the government is shrinking.
    • As a result, total borrowing has increased by 2.3 times, from ₹7.96 trillion to ₹18.49 trillion.
    • An increase in borrowing also increases interest cost.
    • The ratio of interest payment to revenue receipts was 36.3% in 2019-20.
    • As per revised data, it has increased to 44.5% in the current fiscal year and is projected at an all-time high of 45.3% in 2021-22.
    • Almost half of the revenue is going towards servicing old debts. To revive the economy, capital expenditure is indispensable.

    National Infrastructure Pipeline

    • In this backdrop, the government has already launched the National Infrastructure Pipeline (NIP), with 6,835 projects in December 2019.
    • The project pipeline has been increased to 7,400.
    • The NIP has its own specific target and the government is committed to achieve it in the coming years.
    • It called for a major increase in funding.
    • For 2021-22, the government has proposed to spend ₹5.54 trillion, which is 34.5% higher than the budgeted amount of 2020-21.
    • Now, the government found that monetisation of government- and public sector-owned assets would be an important financing option for new infrastructure construction.

    Model for monetisation of asset: REITs

    • The government is looking at the Real Estate Investment Trusts (REITs) model for monetisation of assets.
    • Under REITs, the land assets are transferred to a trust providing investment opportunity for institutional investors.
    • The government has another option to lease or rent out the assets instead of going for monetisation.
    • The government expects monetisation will generate ₹2.5 trillion in non-debt capital revenue.
    • The objective of asset monetisation is to raise resources for future investment into the sector.
    • A pipeline monetisation plan for Indian Oil, GAIL, and Hindustan Petroleum has been drawn up by the government.
    • It is expected that the government will raise ₹0.17 trillion by selling stakes in these three companies.

    Consider the question “What is asset monetisation? What strategy should be followed by the government in the monetisation of assets?

    Conclusion

    To handle effectively the task of monetisation of assets, the government should constitute an independent commission clothed with requisite powers and staffed by professionals and researchers to formulate and implement its monetisation initiative.

  • Digital lending

    Digital lending has been on the rise in India. However, there are several concerns about the model. The article discusses these concerns and suggests the policy approach.

    3 digital lending models

    • Presently, there are three digital-lending models, seen through the regulatory-approach lens:
    • 1) Bank/NBFC-owned digital platforms operating under the direct regulatory purview of RBI.
    • 2) Fintech companies’ proprietary digital platforms, working in partnership with banks/NBFCs.
    • Being mere intermediaries, these platforms are not required to seek any registration with RBI, and are only indirectly regulated through RBI’s outsourcing guidelines applicable to Banks/NBFCs.
    • 3) Peer-to-peer (P2P) lending platforms, which usually involve the otherwise unregulated retail lenders.
    • RBI has mandated such platforms to seek registration as NBFC-P2P; thus, they are directly regulated by RBI.

    Issues with digital lending

    • The specific issues are unauthorised lenders, exorbitant rates of interest, use of coercive repayment methods, and non-consensual collection or use of user data.
    • These issues entail serious adverse implications for borrowers and have systemic implications, hampering the rise of legitimate fintech players.

    Steps taken

    • With a view to curb such practices, RBI, in 2020, issued a notification to Banks/NBFCs mandating additional disclosures/compliances, and an advisory to borrowers warning them against such platforms.
    • Following the notification, Google removed several such loan apps from its PlayStore.
    • The Digital Lenders’ Association of India (DLAI) also issued guidelines to help borrowers identify such unscrupulous platforms.
    • In the regulatory pipeline on this front is the report of the working group on digital lending, constituted by RBI in January 2021.

    Framing effective policy solutions

    • Given the significant contribution of legitimate fintech players, it is important to ensure that any policy solutions to address such issues do not impede the growth of such players.
    • The key to this lies in adoption of light-touch regulation, along with the effective implementation of the already proposed regulatory initiatives.
    • For instance, the primary cause of the rising supply of unauthorised lending platforms is the existing credit information asymmetry that genuine lenders face in respect of small borrowers.
    • Here, operationalising and on-scale implementation of RBI’s proposed ‘Public Credit Registry’ and the ‘Open Credit Enablement Network’ (an infrastructure protocol enabling digital low cost lending to small borrowers through access of consented data) would lead to increased participation of legitimate players and curb proliferation of unauthorised lenders.
    • Another foundation for framing effective policy solutions lies in leveraging the interdependence and impact of each individual constituent of the digital lending ecosystem, on other constituents.
    • Apart from lenders/platforms/borrowers, these constituents also include the digital lending industry associations, consent managers and technology developers.
    • Regulators and industry associations working together can provide the necessary foundations for addressing these issues.
    • Other solutions spear-headed by industry associations could be to establish ‘certification system’ based maintenance of a repository of lending platforms for easy identification of genuine players.
    • Similarly, on the data protection aspect, a structural solution through coordinated efforts of various digital lending constituents is required.

    Consider the question “Examine the factors aiding the growth of digital lending in India. What are the challenges the sector face? Suggest the measures to deal with these challenges.”

    Conclusion

    For the continued development of the Indian digital lending economy, it is important to implement policy solutions that adequately protect the borrowers from malpractices, while, at the same time, do not dampen innovation in this fast-evolving sector.

    Source:-

    https://www.financialexpress.com/opinion/soft-touch-regulation-for-digital-lending/2215702/

  • India should abandon its suspicion of digital currency

    The article discusses the advantages of central bank digital currency which could combine the advantages of both fiat money and cryptocurrency.

    India’s suspicion of the cryptocurrencies

    • In 2018, the Reserve Bank of India prohibited regulated entities from providing services to anyone who deals with or settles trades in any virtual currency.
    • This was effectively banning Bitcoin trading in the country.
    • The Supreme Court lifted this restriction in 2020.
    • There were rumours earlier this year that a new law was in the works that would make it a crime to possess, issue, mine, trade or transfer crypto assets in India.

    Thinking of digital currencies as asset not currency

    • There are concerns over the speculative nature of cryptocurrencies.
    • There are also law enforcement concerns around how digital currencies make it hard for the police to track down criminals.
    • One of the most important attributes of a currency is that it should be a stable store of value, and Bitcoin is anything but.
    • To deal with this difficulty, it will be helpful to think of digital currencies as just another asset—the digital equivalent of a scarce commodity that, like gold, certain collectors prize.

    Difference between working of banks and cryptocurrencies

    • Our financial system relies on banks to record transactions.
    • It is a ‘permissioned’ ledger system in that only trusted intermediaries-registered banks under the supervision of the central bank-can make changes to the ledgers to certify that a given transaction has been completed.
    • Cryptocurrencies, on the other hand, are ‘permissionless’ systems that need no intermediary.
    • Instead of a centralized ledger, transactions are recorded on a distributed database.
    • A purely permissionless system has no need of banks.

    Role of banks in maintaining financial health

    • Central banks are not just intermediaries managing the great big financial ledger of the country, they are responsible for its financial health.
    • To perform this function, they need to be able to take money out of the system when required or put money back into economic circulation.
    • None of this is possible in a purely permissionless system.

    Advantages of digitally native currencies

    • Digitally native currencies are programmable and capable of being incorporated into smart contracts, offering various opportunities for innovative digital solutions.
    • Since they can be directly allotted to citizens who don’t have a bank account, they are ideal for financial inclusion.
    • Being digitally auditable, transactions can be audited, reducing the scope for illicit activity.
    • The challenge is one of integrating the best that digital currencies have to offer into the traditional financial paradigm.

    Central bank digital currencies as an alternative

    • CBDCs are a completely re-engineered form of money that use a distributed ledger as their underlying technology layer, but are backed by suitable amounts of monetary reserves, just like normal fiat currency.
    • Many countries have been toying with the idea of a central bank digital currency (CBDC).
    • They are run by central banks along with select financial entities responsible for managing the distributed ledger.
    • The best CBDCs will converge the best of both worlds—the programability and security of cryptocurrencies and the reserve-backed stability of fiat currency.
    • Several countries are already testing this concept.

    How central bank digital currency differs from cryptocurrency? What are its advantages?”

    Conclusion

    Banning technology has never made it go away. Instead, let’s make an effort to better understand it, and having done so, do all we can to create the digital currency our country needs.

  • What is Index of Industrial Production (IIP)?

    Last week saw the release of the Index of Industrial Production (IIP), which recorded a contraction of 1.6% in January.

    Index of Industrial Production (IIP)

    • Index of Industrial Production data or IIP as it is commonly called is an index that tracks manufacturing activity in different sectors of an economy.
    • The IIP number measures the industrial production for the period under review, usually a month, as against the reference period.
    • IIP is a key economic indicator of the manufacturing sector of the economy.
    • There is a lag of six weeks in the publication of the IIP index data after the reference month ends.
    • IIP index is currently calculated using 2011-2012 as the base year.

    IIP Index Components:

    • Mining, manufacturing, and electricity are the three broad sectors in which IIP constituents fall.
    • The relative weights of these three sectors are 77.6% (manufacturing), 14.4% (mining) and 8% (electricity).
    • Electricity, crude oil, coal, cement, steel, refinery products, natural gas, and fertilizers are the eight core industries that comprise about 40 per cent of the weight of items included in the IIP.

    Basket of products

    There are 6 sub-categories:

    1. Primary Goods (consisting of mining, electricity, fuels and fertilisers)
    2. Capital Goods (e.g. machinery items)
    3. Intermediate Goods (e.g. yarns, chemicals, semi-finished steel items, etc)
    4. Infrastructure Goods (e.g. paints, cement, cables, bricks and tiles, rail materials, etc)
    5. Consumer Durables (e.g. garments, telephones, passenger vehicles, etc)
    6. Consumer Non-durables (e.g. food items, medicines, toiletries, etc)

    Who releases IIP data?

    • The IIP data is compiled and published by CSO every month.
    • CSO or Central Statistical Organisation operates under the Ministry of Statistics and Programme Implementation (MoSPI).
    • The IIP index data, once released, is also available on the PIB website.

    Try this PYQ:

    Q. In the ‘Index of Eight Core Industries’, which one of the following is given the highest weight?

    (a) Coal production

    (b) Electricity generation

    (c) Fertilizer production

    (d) Steel production

    Who uses IIP data?

    • The factory production data (IIP) is used by various government agencies such as the Ministry of Finance, the Reserve Bank of India (RBI), private firms and analysts, among others for analytical purposes.
    • The data is also used to compile the Gross Value Added (GVA) of the manufacturing sector in the Gross Domestic Product (GDP) on a quarterly basis.

    IIP base year change:

    • The base year was changed to 2011-12 from 2004-05 in the year 2017.
    • The earlier base years were 1937, 1946, 1951, 1956, 1960, 1970, 1980-81, 1993-94 and 2004-05.

    IIP vs ASI

    • While the IIP is a monthly indicator, the Annual Survey of Industries (ASI) is the prime source of long-term industrial statistics.
    • The ASI is used to track the health of industrial activity in the economy over a longer period. The index is compiled out of a much larger sample of industries compared to IIP.
    • The IIP essentially tracks the change in the volume of production in Indian industries.

  • Need for national security shield in FDI

     

    Relaxation on Chinese FDI

    • Last April, India had subjected all Chinese FDI to mandatory government screening.
    • The aim was to curb opportunistic takeovers of Indian companies, a concern fuelled by sharp corrections in equity markets in March 2020.
    • Several economies including the US, Australia, Canada and Germany faced similar concerns.
    • They blocked specific takeover attempts, using special laws for national security screening of inward FDI.
    •  In the absence of similar legislation, India did not differentiate between investments which raised genuine national security concerns and those that did not.
    • This is a crucial shortcoming.
    • With market indices now hovering at their peaks, reportedly India may allow Chinese FDI up to 25 per cent in equity under the automatic route.

    Regulation of FDI and issues with it

    • India regulates foreign investments primarily through FEMA.
    • FEMA clearly provides two specific macro-prudential objectives — facilitating external trade and payments; and promoting orderly development and maintenance of foreign exchange markets in India.
    • Accordingly, it empowers the central government and the RBI, acting in consultation with each other, to regulate capital account transactions.
    • These regulations determine who can invest through the FDI route, in which sector and how much.
    • In practice, however, FEMA regulations have often responded to concerns not strictly related to macro-prudential objectives.
    • One such concern has been national security.

    Need for the law to scrutinise FDI from national security angle

    • Shortcoming of FEMA underscores the need for India to emulates its western peers and enact a statute specifically designed for national security screening of strategic FDI.
    • Unlike FEMA, this new statute must explicitly lay down legal principles for determining when a foreign acquisition of an Indian company poses genuine national security threats.
    • In this regard, a policy paper published by the Peterson Institute for International Economics three types of legitimate threats from foreign acquisitions.

    3 Types of threat from foreign acquisitions

    1) Dependency on foreign supplier

    • The first threat arises if a foreign acquisition renders India dependent on a foreign-controlled supplier of goods or services crucial to the functioning of the Indian economy.
    • For this threat to be credible, it needs to be further established that the industry in which the acquisition is supposed to take place is tightly concentrated, the number of close substitutes limited, and the switching costs are high.

    2) Technology transfer

    • The second threat emanates from a proposed acquisition transferring a technology or an expertise to a foreign-controlled entity that might be deployed by that entity or a foreign government in a manner harmful to India’s national interests.
    • The credibility of this threat again depends on whether the market for such technology or expertise is tightly concentrated or if they are readily available elsewhere.

    3) Threat of infiltration, surveillance or sabotage

    • The third threat arises if a proposed acquisition allows insertion of some potential capability for infiltration, surveillance or sabotage via human or non-human agents into the provision of goods or services crucial to the functioning of Indian economy.
    • This threat is particularly credible when the target company supplies crucial goods or services to the Indian government, its military or even critical infrastructure units and the switching costs are high.

    Way forward

    • The above stated 3 types of threats could provide conceptual clarity in the new statute could make national security assessments objective, transparent and amenable to the rule of law.
    • On procedure, the statute must empower only the finance minister to reject certain strategic foreign acquisitions on national security grounds.
    • Both the power and accountability mechanisms should be hardcoded into the statute itself, as is the case in some mature parliamentary democracies.
    • For instance, the Australian Foreign Acquisitions and Takeovers Act, 1975 empowers the treasurer to block certain foreign acquisitions on national security grounds.
    • Similarly, the Investment Canada Act, 1985 empowers a minister to reject certain foreign acquisitions.

    Consider the question “India needs to recognise the national security threat emanating from strategic FDI. This requires identifying threats. In lights of this, examine the types of threats and suggest the ways to deal with it.” 

    Conclusion

    Overall, India’s tryst with Chinese FDI underscores the importance of identifying specific national security threats emanating from strategic FDI and addressing them objectively. This is too sensitive a matter to be left to capital controls under FEMA. A dedicated statute for national security screening of inward FDI would be best suited for handling such issues.

  • India as a factory for the Quad

    The article highlights how India could offer the solution to the tactical issue faced by the Quad: matching China’s manufacturing capacity.

    Strategic case for the Quad

    • The strategic case for the Quadrilateral Security Dialogue, better known as the Quad, has always been sound.
    • A rising China, with its authoritarian one-party system, is a challenge to the democratic order.
    • The strategic case for the Quad has, however, always faced a tactical hurdle.
    • China was the factory of the world.
    • It had become an almost indispensable cog in the global supply chain owing to its low-cost manufacturing prowess at a mass scale.
    • How could any grouping hope to challenge China’s power-play dynamics while at the same time being dependent on its factories to sustain its economies?

    Two recent development that changed the dynamic

    • Two recent developments have completely changed the dynamic.
    • First, Australia returned to the Malabar Naval exercises in 2020, after 13 years.
    • Second, on March 12, the first summit-level meet of the Quad — comprising the US, India, Japan and Australia — is scheduled to take place.

    Rise in India’s manufacturing ability

    • What has changed between 2007 and 2020 that Quad 2.0 has become viable is the globally visible rise in India’s manufacturing ability.
    • Consider the following examples.

    1) PPE Kit manufacturing

    • First, the success in PPE kits.
    • At the beginning of the COVID-19 pandemic, India was manufacturing zero PPE kits.
    • India not just created an overnight world-class manufacturing capacity to meet its own needs but also started exporting PPE kits.

    2) Vaccine Maitri

    • Second, the soft power of Vaccine Maitri.
    • The developed countries are scrambling to secure vaccines for their domestic population.
    • India is not only vaccinating its own people faster than any other country but is also exporting millions of vaccines to countries in need.
    • From Canada to Pakistan and from the Caribbean Islands to Brazil — Made in India vaccines have been a life vest across the globe.

    3) India’s private industry

    • Third, the enterprise of India’s private industry — a hallmark of the deepening manufacturing base.
    • As a recent New York Times report noted, when it came to syringes — without which the vaccines were useless — the global scramble again led to Indian manufactures.
    • Hindustan Syringes alone has ramped up its manufacturing capacity to almost 6,000 syringes a minute.

    4) Precision high-end manufacturing

    • The PLI scheme launched for electronics’ manufacturing evinced unprecedented global interest with 22 top companies, including the top manufactures for Apple and Samsung mobile phones.
    • Over the next five years, a manufacturing capacity of over $150 billion and exports of $100 billion have been tied up through this scheme.

    5) Figher plane manufacturing

    • Fifth, the success of India’s fourth-generation fighter jet programme and the orders placed by the Indian Air Force for 83 Tejas jets.
    • India’s success is one more milestone in its journey towards emerging as a global manufacturing destination.

    Policy changes to make India manufacturing destination

    • Concurrently, India has been reforming its economic policies to make it even more attractive as a manufacturing destination.
    • India has the lowest tax rate anywhere in the world — 15 per cent for new manufacturing units.
    • FDI norms have been relaxed across the board and automatic approval processes instituted for FDI even up to 100 per cent.
    • Privatisation of PSUs is now an established process.
    • Labour laws have been finally reformed and compliance burdens significantly eased.
    • Taxation is now faceless, thus ending the spectre of rent-seeking.
    • A well-functioning, world-class bankruptcy law is in place. Interest rates are low.
    • And India’s digital infrastructure rivals the best in the world and in many cases beats it.

    Consider the question “India’s growing prowess as the manufacturing hub could provide the Quad tactical basis by replacing China. Comment.“

    Conclusion

    The only arrow that was missing in the quiver of the Quad has now been attained. The strategic case for the Quad was never in doubt. The dependence on China’s factories is what kept the grouping of democracies from emerging. India has raised its hand to solve that problem.

  • Farmers produce organisations (FPOs)

    The article analyses the role farmers produce organisations (FPOs) can play in improving the bargaining power of the small farmers and also suggest ways to improve FPOs.

    Declining size of farm holdings

    • The average farm size in India declined from 2.3 hectares (ha) in 1970-71 to 1.08 ha in 2015-16.
    • The share of small and marginal farmers increased from 70 per cent in 1980-81 to 86 per cent in 2015-16.
    • At the state level, the average size of farm holdings in 2015-16 ranged from 3.62 ha in Punjab, 2.73 in Rajasthan and 2.22 in Haryana to 0.75 in Tamil Nadu, 0.73 in Uttar Pradesh, 0.39 in Bihar and 0.18 in Kerala.

    Encouraging FPOs to help small farmers

    • Small farmers face several challenges in getting access to inputs and marketing facilities.
    • In the last decade, the Centre has encouraged farmer producer organisations (FPOs) to help farmers.
    • Since 2011, it has intensively promoted FPOs under the Small Farmers’ Agri-Business Consortium (SFAC), NABARD, state governments and NGOs.
    • The membership of an FPO ranges from 100 to over 1,000 farmers.
    • The ongoing support for FPOs is mainly in the following two forms:
    • 1) A grant of matching equity (cash infusion of up to Rs 10 lakh) to registered FPOs.
    • 2) A credit guarantee cover to lending institutions (maximum guarantee cover 85 per cent of loans not exceeding Rs 100 lakh).
    • The budget for 2018-19 announced supporting measures for FPOs including a five-year tax exemption.
    • The budget for 2019-20 talked of setting up 10,000 more FPOs in the next five years.
    • Some studies show that we need more than one lakh FPOs for a large country like India while we currently have less than 10,000.

    Looking at the performance of FPOs in last decade

    • Experience shows a mixed performance of FPOs in the last decade.
    • Some estimates show that 30 per cent of these are operating viably while 20 per cent are struggling to survive.
    • The remaining 50 per cent are still in the initial phase of mobilisation and business planning.
    • NABARD has undertaken a field study on the benefits of FPOs in Punjab and Madhya Pradesh.
    • The study shows that in nascent FPOs, the proportion of farmer members contributing to FPOs activities is 20-30 per cent while for the emerging and mature FPOs it is higher at about 40-50 per cent.
    • A study by International Food Policy Research Institute (IFPRI) has undertaken a comparative study of FPOs in Maharashtra and Bihar.
    • In Maharashtra, some of the FPOs have organically evolved (OFPOs) when farmers have taken the lead to adopt market-oriented practices, develop cost-effective solutions in production and marketing.
    • In the case of Bihar, almost all FPOs have been promoted (PFPOs).

    Challenges

    • Studies of NABARD show that there are some important challenges for building sustainable FPOs.
    • Some of these are lack of technical skills, inadequate professional management, weak financials, inadequate access to credit, lack of risk mitigation mechanism and inadequate access to market and infrastructure.

    Focusing on 3 issues for the improvement of FPOs

    1) Getting credit

    • Issues such as working capital, marketing, infrastructure have to be addressed while scaling up FPOs.
    • Banks must have structured products for lending to FPOs.
    • These organisations lack professional management and, therefore, need capacity building.

    2) Linking with input companies

    • FPOs have to be linked with input companies, technical service providers, marketing/processing companies, retailers etc.
    • They need a lot of data on markets and prices and other information and competency in information technology.

    3) Augmenting the size of land

    • The FPOs can be used to augment the size of the land by focusing on grouping contiguous tracts of land as far as possible — they should not be a mere grouping of individuals.
    • Women farmers also can be encouraged to group cultivate for getting better returns.
    • FPOs can also encourage consolidation of holdings.

    Consider the question “How FPOs can play an important part in helping the small farmers by improving their bargaining power? What are the challenges faced by the FPOs?”

    Conclusion

    The FPOs have to be encouraged by policy makers and other stakeholders apart from scaling up throughout the country to benefit particularly the small holders.

  • Privatisation of Banks

    The article highlights the different aspects that need to be considered while contemplating the idea of privatisation of public banks.

    Opposite trends in India and the US

    • While the United States epitomises the private banking model, a nationwide public banking movement is coming into vogue.
    • In contrast, India seems to be quickly warming to the idea of bank privatisation.

    Public or the private?

    • The development view sees government presence in the banking sector as a means to overcome market failures in the early stages of economic development.
    • The government-owned banks can improve welfare by allocating scarce capital to socially productive uses.
    • The stellar success of Indian PSBs in implementing the PMJDY while missing the mark on creating high-quality credit highlights a critical divide between the asset and the liability side of a bank.
    • Banks provide two functions at a fundamental level: Payments and deposit-taking on the liability side and credit creation on the asset side.
    • The payment services function, a hallmark of financial inclusion, is similar to a utility business — banks can provide this service, a public good, at a low cost universally.
    • The lending side, in contrast, is all about the optimal allocation of resources through better credit evaluation and monitoring of borrowers.
    • Private banks are more likely to have the right set of incentives and expertise in doing so.
    • It comes as no surprise that the PSBs in India are better at providing the public good functions, whereas private banks seem better suited for credit allocation.
    • However, the political view argues that vested interests can influence the lending apparatus to achieve political goals.
    • This results in distortion of credit allocation and reduce allocative efficiency in government-owned banking systems.

    Reasons for privatisation of banks

    • Evidences shows that government ownership in the banking sector leads to lower levels of financial development and growth
    • This led to waves of banking sector privatisations that swept emerging markets in the 1990s.
    • Cross-country evidence suggests that bank privatisations improved both bank efficiency and profitability.

    How public banks performed in India

    • Public sector Banks (PSBs) dominate Indian banking, controlling over 60 per cent of banking assets.
    • The private-credit to GDP ratio, a key measure of credit flow, stands at 50 per cent, much lower than international benchmarks — in China it is150 and in South Korea it is 150 per cent.
    • India’s Gross NPA ratio was 8.2 per cent in March 2020, with striking differences across PSBs (10.3 per cent) and private banks (5.5 per cent).
    • The end result is much lower PSB profitability compared to private banks.
    • The rationale for privatisation stems from these considerations.

    Way forward

    • The optimal mix of the banking system across public and private boils down to what you need out of your banking system.
    • When the wedge between social and private benefits is large, as with financial inclusion, there is a strong case for public banks.
    •  At this stage, inefficiency in capital allocation seems to be a bigger issue for the Indian banking sector, whereas, in the US, the debate is centred around the public goods aspects of banking.

    Consider the question “What are the factors India needs to consider as it reverses the course of history by privatising the public banks?”

    Conclusion

    At this stage, inefficiency in capital allocation seems to be a bigger issue for the Indian banking sector, whereas, in the US, the debate is centred around the public goods aspects of banking.