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GS Paper: GS3

  • States, freebies and the costs of fiscal profligacy

    Context

    Many states are pursuing the freebie culture, which raises several questions.

    About freebies

    • Why do governments give freebies? The obvious motivation for States in expanding freebies is to use the exchequer to build vote banks.
    • Electoral calculations tempt them to place short-term gains ahead of long-term sustainability.
    • Case in which it is necessary? A certain amount of spending on transfer payments to provide safety nets to the most vulnerable segments of the population is not only desirable but even necessary.
    • What is the problem? The problem arises when such transfer payments become the main plank of discretionary expenditure, the spending is financed by debt, and the debt is concealed to circumvent the FRBM targets.
    • Opportunity cost: The more States spend on transfer payments, the less they have for spending on physical infrastructure such as, for example, power and roads, and on social infrastructure such as education and health, which can potentially improve growth and generate jobs.

    Questioning the logic of freebie culture

    • Sustainability: Is borrowing and spending on freebies sustainable?
    • Best use: Is this the best possible use of public money?
    • Opportunity cost: What is their opportunity cost — what is it that the public are collectively giving up so that the government can fund these payments?
    • Checks and balances: Should not there be some checks on how much can be spent on them?

    Where should government spend the borrowed money?

    • Ideally, governments should use borrowed money to invest in physical and social infrastructure that will generate higher growth, and thereby higher revenues in the future so that the debt pays for itself.
    • On the other hand, if governments spend the loan money on populist giveaways that generate no additional revenue, the growing debt burden will eventually implode.

    But what is the problem with freebies if states are confirming to the FRBM targets?

    • Any analysis of State Budgets by the Reserve Bank of India shows that State finances are in good health and that all of them are conforming to the Fiscal Responsibility and Budget Management (FRBM) targets.
    • This is a misleading picture.
    • Off budget borrowing: Much of the borrowing that funds these freebies happens off budget, beyond the pale of FRBM tracking.
    • The typical modus operandi for States has been to borrow on the books of their public enterprises, in some cases by pledging future revenues of the State as guarantee.
    • Effectively, the burden of debt is on the State exchequer, albeit well concealed.
    • The Comptroller and Auditor General of India (CAG) had in fact pointed out that in respect of some States.
    • Huget cost: The costs of fiscal profligacy at the State level can be huge.
    • The amount States borrow collectively every year is comparable in size to the Centre’s borrowing which implies that their fiscal stance has as much impact on our macroeconomic stability as does that of the Centre.
    • The need, therefore, for instituting more effective checks that can make wayward States fall in line is compelling.

    What are the institutional checks and balances? What are the reasons of their failure?

    • 1] Legislature and opposition: In theory, the first line of defence has to be the legislature, in particular the Opposition, whose responsibility it is to keep the Government in line.
    • But the Opposition does not dare speak up for fear of forfeiting vote banks that are at the end of these freebies.
    • 2] Lag in CAG reports: Another constitutional check is the CAG audit which should enforce transparency and accountability.
    • In practice, it has lost its teeth since audit reports necessarily come with a lag, by when political interest has typically shifted to other hot button issues.
    • 3] The market: The market is another potential check.
    • It can signal the health or otherwise of State finances by pricing the loans floated by different State governments differently, reflecting their debt sustainability.
    • But in practice this too fails since the market perceives all State borrowing as implicitly guaranteed by the Centre, never mind that there is no such guarantee in reality.

    Suggestions

    • 1] Amend FRBM Act for complete disclosure: First, the FRBM Acts of the Centre as well as States need to be amended to enforce a more complete disclosure of the liabilities on their exchequers.
    • Even under the current FRBM provisions, governments are mandated to disclose their contingent liabilities, but that disclosure is restricted to liabilities for which they have extended an explicit guarantee.
    • The provision should be expanded to cover all liabilities whose servicing obligation falls on the Budget, or could potentially fall on the Budget, regardless of any guarantee.
    • 2] Centre should impose conditionalities: Under the Constitution, States are required to take the Centre’s permission when they borrow.
    • The Centre should not hesitate to impose conditionalities on wayward States when it accords such permission.
    • 3] Use of financial emergency provision: There is a provision in the Constitution of India which allows the President to declare a financial emergency in any State if s/he is satisfied that financial stability is threatened.
    • This provision has never been invoked so far for fear that this will turn into a political weapon.
    • But the provision is there in the Constitution for a reason.
    • After all, the root cause of fiscal irresponsibility is the lure of electoral nirvana. It will stop only if the political leadership fears punishment.
    • 4] Course correction by the Centre: The Centre itself has not been a beacon of virtue when it comes to fiscal responsibility and transparency.
    • To its credit, it has embarked on course correction over the last few years.
    • It should complete that task in order to command the moral authority to enforce good fiscal behaviour on the part of States.

    Conclusion

    The state governments, as well as the Central government, need to avoid the freebies that harm financial health and cause long-term harm. For that, there is a need to implement the suggestions mentioned above.

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    Back2Basics: FRBM Act

    • The FRBM is an act of the parliament that set targets for the Government of India to establish financial discipline, improve the management of public funds, strengthen fiscal prudence and reduce its fiscal deficits.
    • It was first introduced in the parliament of India in the year 2000 by Vajpayee Government for providing legal backing to the fiscal discipline to be institutionalized in the country.
    • Subsequently, the FRBM Act was passed in the year 2003.

  • RBI sets up system to settle International Trade in Rupees

    RBI has decided to put in place an additional arrangement of international trade for invoicing, payment, and settlement of exports / imports in INR.

    • Banks acting as authorised dealers for such transactions would have to take prior approval from the regulator to facilitate this.
    • All exports and imports under the invoicing arrangement may be denominated and invoiced in Rupee.
    • Exchange rate between the currencies of the two trading partner countries may be market determined.
    • Exporters and importers can now use a Special Vostro Account linked to the correspondent bank of the partner country for receipts and payments denominated in rupees.
    • These accounts can be used for payments for projects and investments, import or export advance flow management, and investment in Treasury Bills subject to Foreign Exchange Management Act, 1999 (FEMA).
    • Also, the bank guarantee, setting-off export receivables, advance against exports, use of surplus balance, approval process, documentation, etc., related aspects would be covered under FEMA rules.

    Nostro and Vostro Accounts

    • Nostro and vostro are terms used to describe the same bank account; the terms are used when one bank has another bank’s money on deposit.
    • They are used to differentiate between the two sets of accounting records kept by each bank.
    • Nostro comes from the Latin word for “ours,” as in “our money that is on deposit at your bank.”
    • Vostro means “yours,” as in “your money that is on deposit at our bank.”

    Why such move?

    • The rupee is at a historic low against the dollar.
    • The mechanism is meant to facilitate trade with countries under sanction.
    • Payments had become a pain point for exporters immediately after the Russia-Ukraine war broke out, especially after Russia was cut off from the SWIFT payment gateway.
    • As a result of the trade facilitation mechanism, we see easing of payment issues with Russia.
    • The move would also reduce the risk of forex fluctuation specially looking at the Euro-rupee parity.
    • We see this as a first step towards 100% convertibility of rupee.
    • It will also help stabilize rupee.

    What does the change mean for exports?

    • Several countries including Sri Lanka and some in Africa and Latin America are facing forex shortage.
    • As such, the new mechanism will help India promote its exports.
    • It will also help buy discounted crude oil from Russia, which now accounts for 10% of all imported crude.

    Will the move help narrow trade deficit?

    • The gap between India’s exports and imports widened to record highs.
    • This puts pressure on the current account deficit, which some economists estimate would nearly double to more than 3% of GDP in FY23.
    • RBI’s decision may not benefit the external account immediately, but over the medium term, demand for dollars may come down.
    • This is partly because opening of new vostro accounts between banks may take some time.

    Back2Basics: Currency Convertibility

    • Convertibility is the ease with which a country’s currency can be converted into gold or another currency through global exchanges.
    • It indicates the extent to which the regulations allow inflow and outflow of capital to and from the country.
    • Currencies that aren’t fully convertible, on the other hand, are generally difficult to convert into other currencies.
    • Having a convertible currency allows a government to pay for goods and services in a currency that may not be the buyer’s own.

    Convertibility of Rupee

    • In order to face the serious current account deficit in the balance of payments, the Government of India introduced the partial convertibility of rupee from March 1, 1992.
    • This was an inevitable move for the expeditious integration of Indian economy with that of the world.
    • Under this system, 60 per cent of the exchange earnings were convertible in rupees at market-determined exchange rate and the remaining 40 per cent were at the officially determined exchange rate.
    • Current account convertibility relates to the removal of restrictions on payments relating to the international exchange of goals, services and factor incomes.
    • Capital account convertibility refers to a similar liberalization of a country’s capital transactions such as loans and investment, both short term and long term.

     

    A bit difficult, but pls take an effort to try this PYQ from CSP 2020:

    If another global financial crisis happens in the near future, which of the following actions/policies are most likely to give some immunity to India?

    1. Not depending on short-term foreign borrowings
    2. Opening up to more foreign banks
    3. Maintaining full capital account convertibility

    Select the correct answer using the code given below:

    (a) 1 only

    (b) 1 and 2 only

    (c) 2 only

    (d) 1, 2 and 3

     

    [wpdiscuz-feedback id=”3pp3us2fwp” question=”Please leave a feedback on this” opened=”1″]Post your answers here. Detailed explanation will be provided.[/wpdiscuz-feedback]

     

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  • The West has a chance to wean India off Russian weaponry

    Context

    Perturbed by India’s reluctance to condemn the Russian invasion of Ukraine and keen to bind the country closer in confronting China, Western governments have launched a fresh push to wean India, the world’s biggest importer of arms, off its long dependence on Russian weaponry.

    India’s concerns after Ukraine war

    • India has grown increasingly alarmed about China, following deadly border clashes in 2020.
    • Since the war in Ukraine began, it has also worried about Russia’s reliability as an arms supplier and about the quality of some of its weapons.
    • Diversification away from Russia: India, though insistent that it has every right to choose its own suppliers, is already diversifying away from Russia. 
    • The share of weapons it imports from Russia has fallen sharply, to around 50% between 2016 and 2021, down from 70% during the previous five-year period.
    • Western help for diversification: It has welcomed Western help in fulfilling its ambition to make more of its own weapons.

    Joint arms production plan

    • As the West cannot compete with Russia on price and remain reluctant to share their most cutting-edge technology, they are counting on joint arms production.
    • Western leaders have been vocal about their willingness to help India arm itself.
    • At a ministerial meeting in Washington in April, American officials discussed helping India to make advanced weapons, including reconnaissance aircraft and a system for combating aerial drones.
    • On visits to Delhi that month, Boris Johnson, Britain’s prime minister, and Ursula von der Leyen, the European Commission’s president, also proposed joint arms ventures.
    • Despite avowed interest from both sides, such a shift faces many challenges.

    Challenges

    • Dominance of PSUs: India’s arms industry, technically open to private investment since 2001, has long been hampered by the dominance of a small number of state-owned giants such as Hindustan Aeronautics Limited (HAL).
    • Inefficiencies: State-owned arms-makers remain notoriously inefficient.
    • They also retain long-running tie-ups with Russia, making Western governments wary of accepting India’s demands for the transfer of more advanced technology.
    • Low presence of private sector: The share of defence production in the hands of the private sector, which is a more natural partner for big Western defence manufacturers, is about a fifth—scarcely higher than it was five years ago.
    • Lack of industrial capacity and skill: Both the state and private sector still lack the industrial capacity and skilled workers to produce highly specialised defence technology at scale—especially military aircraft.
    • Trust issue: While Western companies worry about inadvertent technology transfers to Russia, India worries about the reliability of its Western partners.
    • Past record: Many see America, which in the past has imposed sanctions on India for its nuclear-weapons programme, as a fickle supplier.
    • More recently America refused to sell India its Patriot missile system, prompting India to fall back on a Russian alternative and thereby put itself at risk of American sanctions once more.

    Way forward

    • Liberalisation of defence sector: As a step to liberalise the industry as part of his push towards self-reliance, in 2020 India raised the limit on foreign ownership of defence firms from 49% to 74%.
    • Ordinance Factory Board was dissolved into small units to corporatize the entity.
    • Lockheed Martin, a big American defence manufacturer, last year approved the manufacture of wings for the f-16 fighter jet by its joint venture with Tata.
    • The company has also pledged to produce a more advanced fighter, the f-21, in India, provided it wins a multi-billion-dollar contract to supply 114 fighter jets.
    • Big deals like those would provide incentives for foreign governments to approve more technology transfer and for Western manufacturers to make the investments needed to spur India’s indigenisation drive.

    Conclusion

    Russia’s war and China’s muscle-flexing have opened a door for India and the West to walk through, but crossing the threshold will require some resolve on both sides.

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  • As GST compensation ends, state governments need to be provided certainty of revenues

    Context

    The five-year transition period after the adoption of the Goods and Services Tax (GST) on July 1, 2017, came to an end on June 30, 2022. With this, the era of GST compensation that the state governments were entitled to has ended.

    High estimated loan issuance

    • Many state governments have asked for the compensation period to be extended by a few years.
    • To tangibly assess the near-term outlook for state finances, we have to rely on the states’ own estimates for their market borrowing requirements for the second quarter of 2022-23.
    • The indicative calendar of market borrowings by 23 state governments and two Union territories for the second quarter has pegged their total state development loan issuance — the primary source of financing state government deficits — at Rs 2.1 trillion.
    •  This projected issuance is 29 per cent higher than the same period last year, and at an eight-quarter high.
    • This high level of issuance projected by states reflects concerns that some of them might rightfully have regarding the uncertainty of their cash flows in the post-GST compensation era.
    • High dependence on GST compensation: Of these 23 states, Tamil Nadu, Andhra Pradesh, Haryana, Punjab and Gujarat have indicated large increases in borrowings.
    • Most of these states have an above-average dependence on GST compensation.

    Implications of discontinuation of GST compensation

    • Alter the revenue compensation: The discontinuation of the GST compensation flows would alter the revenue composition of some states adversely, particularly those with a relatively larger share of such receipts in their overall revenue streams.
    • Increase in debt level: To offset a portion of the associated revenue loss, such states are likely to enhance their borrowings and/or to undertake some expenditure adjustments in the quarters ahead.

    Adjustment of borrowing limit of the States by the Centre

    • At the time of communicating to states their annual borrowing limits for the ongoing year, we understand that the Centre had informed state governments that their off-budget borrowings for the past two years (2020-21 and 2021-22) would be adjusted from their borrowing ceiling this year.
    • Data on off-budget borrowing: It appears that the calculation of the adjusted borrowing limit required the submission of detailed data by the state governments related to their off-budget borrowings for the last two fiscal years, followed by a thorough assessment of the same by the Centre.

    Need for early step up in tax-devolution

    • On the whole, though, states appear to have entered the year with a comfortable cash flow position.
    • This follows from the back-ended release of the tax devolution to states for 2021-22 — nearly half of the full-year amount was released in the fourth quarter.
    • Additionally, the total amount was also well above the revised estimate, providing an unexpected gain to states.
    • This may have allowed them to temporarily withstand the changes related to their borrowing permission.
    • Subsequently, the release of the GST compensation grant of Rs 869 billion for several months in May is likely to have further eased their cash flows.
    • If the government does decide to step-up tax devolution to the states in the near term, instead of back-ending it as was done in the last year, it may reduce the size of state borrowings in the second quarter.
    • But more significantly, such revenue certainty, despite the end of the GST compensation era, may embolden states to ringfence their capital spending, providing a positive impulse to the economy.

    Conclusion

    The discontinuation of the GST compensation flows would alter the revenue composition of some states adversely, tax devolution to the states in the near term could cushion the blow of the discontinuation.

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    Back2Basics: Compensation under GST regime

    • The adoption of the GST was made possible by the States ceding almost all their powers to impose local-level indirect taxes and agreeing to let the prevailing multiplicity of imposts be subsumed under the GST.
    • While the States would receive the SGST (State GST) component of the GST, and a share of the IGST (Integrated GST), it was agreed that revenue shortfalls arising from the transition to the new indirect taxes regime would be made good from a pooled GST Compensation Fund for a period of five years that is set to end in 2022.
    • This corpus in turn is funded through a compensation cess that is levied on so-called ‘demerit’ goods.
    • This GST Compensation Cess or GST Cess is levied on five products considered to be ‘sin’ or luxury as mentioned in the GST (Compensation to States) Act, 2017 and includes items such as- Pan Masala, Tobacco, and Automobiles etc.

  • Proposed Amendments to the Environment (Protection) Act, 1986

    The Ministry of Environment, Forest and Climate Change (MoEFCC), put out a note, proposing amendments in the Environment (Protection) Act, 1986.

    Environment Protection Act (EPA), 1986

    • EP Act was passed under Article 253 of the Constitution, which empowers the Centre to enact laws to give effect to international agreements signed by the country.
    • The purpose of the Act is to implement the decisions of the UN Conference on the Human Environment.
    • They relate to the protection and improvement of the human environment and the prevention of hazards to human beings, other living creatures, plants and property.
    • It was enacted in 1986 on the backdrop of Bhopal Gas Tragedy.
    • The Act was last amended in 1991.

    Why this Act?

    • The Act is an “umbrella” legislation that has provided a framework for the environmental regulation regime in India.
    • It covers all major industrial and infrastructure activities and prohibits and regulates specific activities in coastal areas and eco-sensitive areas.
    • The Act also provides for coordination of the activities of various central and state authorities established under other environment-related laws, such as the Water Act and the Air Act.

    What are the proposed amendments?

    • The Environment Ministry has proposed amendments in four key legislations:
    1. Environment (Protection) Act, 1986
    2. Water (Prevention and Control of Pollution) Act, 1974
    3. Air (Prevention and Control of Pollution) Act, 1981 and
    4. Public Liability Insurance (PLI) Act, 1991
    • These are the cornerstone environmental laws that led to the setting up of the Central Pollution Control Board (CPCB).
    • These laws empowered the CPCB to take criminal action against individuals and corporate bodies who pollute air, water and land.

    Powers given to CPCB by these Laws

    • The clutch of laws currently empowers the CPCB to either:
    1. Shut down a polluting industrial body or
    2. Imprison executives of an organization found to be environmental violators
    • The EPA currently says that violators face imprisonment up to five years or a fine up to ₹1 lakh or both.
    • There’s also a provision for the jail term to extend to seven years.

    Purpose of the Amendments

    • The Environment Ministry had received suggestions to decriminalise existing provisions of the EPA to weed out “fear of imprisonment for simple violations.”
    • These, however, don’t apply to violations that cause grave injury or loss of life.

    How will violators be punished?

    • The changes proposed include the appointment of an ‘adjudication officer’.
    • He/She will decide on the penalty in cases of environmental violations such as reports not being submitted or information not provided when demanded.
    • Funds collected as penalties would be accrued in an “Environmental Protection Fund.”
    • In case of contraventions of the Act, the penalties could extend to anywhere from 5 lakh to 5 crore, the proposal notes.

    Need for such amendments

    • Limited success of existing laws: The history of environmental action and its success in India shows that the current laws have had limited effectiveness.
    • Backlog of cases: An analysis by the Centre for Science and Environment found that Indian courts took between 9-33 years to clear a backlog of cases for environmental violations.
    • Capitalist power: Myriad challenges dogged the process of bringing violators to book.
    • Red tapism: Flag pollution from an industrial unit would mean filing a complaint with the court of the concerned DM, or furnishing evidence to the CPCB which would again have to approach the same institution.
    • Burden of proof: In most cases, it was practically impossible to hold a specific individual in an organization responsible for a specific crime given the burden of proof required.

     

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  • Places in news: Singalila National Park

    The Singalila National Park, the highest protected area in West Bengal, will soon wild Red Panda.

    Singalila National Park

    • Singalila National Park is located on the Singalila Ridge at an altitude of more than 7000 feet above sea level, in the Darjeeling district of West Bengal.
    • It is well known for the trekking route to Sandakphu that runs through it.
    • The Singalila area in Darjeeling was purchased by the British Government from Sikkim Durbar in 1882, and notified a Reserve Forest under the Indian Forest Act 1878.
    • It was notified as a National Park in 1992 and was also officially opened up for tourism.

    Why introduce Red Panda?

    • The number of red pandas has been declining in the wild, even in the Singalila and Neora Valley National Parks, the two protected areas where the mammal is found in the wild in West Bengal.
    • Recent studies estimate that there are 38 of them in Singalila and 32 in Neora.
    • The zoological park who is at the centre of the Red Panda Augmentation Programme.
    • Conservation breeding of red pandas is only one part of the programme.

    About Red Panda

    IUCN Red List: Endangered

    • The red panda (Ailurus fulgens), also known as the lesser panda, is a small mammal native to the eastern Himalayas and southwestern China.
    • It was first formally described in 1825.
    • The red panda inhabits coniferous forests as well as temperate broadleaf and mixed forests, favouring steep slopes with dense bamboo cover close to water sources.
    • It is solitary and largely arboreal.
    • It feeds mainly on bamboo shoots and leaves, but also on fruits and blossoms.

     

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  • Impact of GST on inflation

    Context

    The monumental indirect tax reform, the Goods and Services Tax (GST), has completed five years in existence. The article analyses the impact of GST on inflation.

    Background

    • Before the implementation, it was said that it would be a boon to the economy in terms of higher revenue buoyancy, lower inflation, higher revenue, higher growth etc.
    • During the 12 months preceding GST implementation, the Consumer Price Index (CPI) inflation was 3.66%, while it increased to 4.24% post-GST in the next 12 months.
    •  A similar pattern was observed in Australia, New Zealand, and Canada.
    • An Australian Competition and Consumer Commission study showed that GST initially increases inflation.

    How GST can affect prices

    • In theory, implementing GST should not lead to a change in overall inflation.
    • The revenue-neutral rate (RNR) is calculated so that it would not cause higher inflation.
    • But revenue neutrality does not mean that prices would not go up or down in the economy.
    • This is because the weight of goods in the consumption basket and their contributions to indirect tax collections are not the same.
    • Importantly, the effect of GST on the prices of certain goods and services depends on the structure and design of taxation.
    • The RBI, in a 2017 report, showed that about half of the groups of items that GST covers are not in the CPI basket.
    • So, the effect of GST on prices was expected to be small.
    • Finally, prior to the GST implementation, it was expected that prices would go down because GST harmonises indirect tax rates and eliminates the cascading effect.
    • Thus, whether GST has any effect depends on how different factors affect each other.

    So, how can we ascertain whether GST has had an inflationary impact in India?

    • Inflationary impact can be assessed by turning to statistical modeling?
    • Statistical results provide us with an interesting picture of the impact of GST on price levels.
    • First, we look into the overall price index (CPI).
    • Here, the actual CPI growth in the study period is 4.61%, whereas the counterfactual estimate of inflation is 3.24%.
    • This implies that without the GST implementation, the CPI inflation would have been 3.24%.
    • This indicates that with the implementation of GST, CPI increased by 1.37 percentage points (pp).
    • Second,  CPI core inflation (which strips off volatile components such as food and fuel from the headline inflation) increased by 1.04pp in the post-GST period (actual inflation was 4.57%, counterfactual inflation was 3.53%).
    • Third, GST is found to have a significant positive impact on inflation of commodity groups such as paan, tobacco and intoxicants, clothing.

    What explains rise in inflation post GST?

    • Rise in tax rate of some goods: The rise in inflation post-GST implementation could be due to the rise in the tax rate of some goods and services, the inclusion of business activities that were not taxed earlier, or the market structure.
    • The average weighted GST rate was designed to be neutral, so it might not have contributed much to the observed higher inflation.
    • Coverage of business activities under GST not taxed earlier would result in higher prices since the firms would pass on the cost to the consumers.
    • Market power: There is another possibility which would cause result inflation after the GST implementation.
    • As Joseph Stiglitz opined, rising market power is bad for the economy as it raises economic inefficiency and inequality and lowers the economy’s resiliency.
    • Further, taking advantage of market power, it is possible that most firms would have passed the taxes to end consumers.
    • With the existence of market power, firms’ price includes a significant mark-up over marginal costs.
    • Some results point out the possibility of profiteering in select segments after GST.
    • To pre-empt this possibility, the government set up National Anti-profiteering Authority (NAA).

    Way forward

    •  NAA should monitor the prices of critical or essential goods and services to see the price impact of GST.
    • Similarly, the Competition Commission of India should observe anti-competitive producer behaviour that hurts consumers via excessive price increases.
    • These measures may ensure that producers do not take advantage of the GST.

    Conclusion

    Statistical results suggest that GST implementation has resulted in a decrease in inflation of food items and raised inflation of non-food items.

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  • Why the criticisms of the RBI are misplaced

    Context

    All emerging markets (EMs), including India, are facing outflows of foreign portfolio investment as the US Fed tightens.

    Inflatioon and exchange rate

    • Exchange rate as response to capital flow: Canonical inflation targeting wants exchange rates to float as the correct response to capital flows.
    • Policy should respond to exchange rate fluctuations only after they affect inflation or output.
    • Any interest rate defence of the exchange rate would reduce the focus on inflation.
    • But most EMs intervene in foreign exchange (FX) markets in order to reduce volatility.
    • A research paper by Edward F Buffie and co-authors indicate that  FX intervention greatly enhances the efficacy of inflation targeting.
    • Two instruments for two targets work better than trying to do everything through the interest rate.
    • Excess depreciation of currency can raise inflation.
    • Other researches such as from the IMF, argues for the use of prudential capital flow management techniques and finds reserve accumulation and its use reduces risks and crises in EMs.

    Policies followed by RBI to reduce volatility

    • Not fully convertible: RBI’s sequenced approach to capital account convertibility, where, for example, debt inflows are only allowed as a percentage of domestic markets, saved it from the kind of interest rate volatility Indonesia experienced during the taper tantrum and is helping it now.
    • More liberalisation measures can be taken when needed.
    • India’s large foreign exchange reserves have allowed rupee depreciation to be lower than most other countries as the dollar strengthens.
    • The cost of holding foreign exchange: There are costs of holding large reserves and of too much intervention.
    • The central bank ends up supporting the US and not its own government borrowing and it sacrifices interest income.
    • But holding reserves and then not using them when required is the most costly.
    • Again use of multiple instruments can mitigate over-reliance on intervention.
    • Much research and recent experience suggest that all available instruments should be used to moderate volatility in nominal variables.

    Why increasing interest rates will be ineffective in reducing capital outflow

    •  A common suggestion is to raise policy rates to maintain a historical gap with US Fed rates.
    • But such an interest rate defence did not prevent outflows during the taper tantrum or in 2018 and only triggered a slowdown.
    • It forgets that interest-sensitive flows are only about 8 per cent of India’s foreign liabilities.
    • There have been no debt outflows in 2022 despite a narrowing interest differential.
    • Equity outflows also seem to be tapering.
    • Monetary tightening that dampens expectations of growth, induces more outflows as country risk-premiums rise.

    Issues with less intervention

    • Some want less intervention and more rupee depreciation in order to improve the current account deficit.
    •  But less intervention can lead to a chaotic fall and jittery markets as we saw in 2011.
    • It is best for policy to prevent over-depreciation due to global risks.
    • After about 4 per cent nominal depreciation, India’s real effective exchange rate against a basket of 40 countries is approaching 100.
    • That implies the real exchange rate is too depreciated since India has had relatively more structural reform and productivity growth.
    • Future corrections toward equilibrium will require a rise of the rupee.
    • High oil prices are a risk for India’s balance of payments, but multiple types of adjustments have the best chance of succeeding.

    Why sometimes policy changes are introduced as surprise?

    • Market participants want clear communication and no surprises for markets.
    • Forward guidance is an important part of inflation targeting. But when markets tend to overreact and are influenced more by the US than by Indian policy, the best way to introduce a policy change may be by surprise.
    • Thus markets had priced in excessive rate hikes after the US Fed began tightening.
    • The steep surprise hike in Indian repo rates prevented additional rate hikes from being priced in as domestic rate-rising began.

    Conclusion

    Inflation targeting is an art that requires skill, attention to context and an open mind.

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    Back2Basics: Real Effective Exchange Rate

    • The real effective exchange rate (REER) is the weighted average of a country’s currency in relation to an index or basket of other major currencies.
    • The weights are determined by comparing the relative trade balance of a country’s currency against that of each country in the index.
    • An increase in a nation’s REER is an indication that its exports are becoming more expensive and its imports are becoming cheaper.
    • It is losing its trade competitiveness.

  • Forest Rights Act 2006

    The Odisha government is chasing an ambitious target of completing the implementation of the Forest Rights Act (FRA) by granting all kinds of rights mandated under the historic Act by 2024.

    What is Forest Rights Act (FRA)?

    • The symbiotic relationship between forests and forest-dwelling communities found recognition in the National Forest Policy, 1988.
    • The policy called for the need to associate tribal people in the protection, regeneration and development of forests.
    • The Scheduled Tribes and Other Traditional Forest Dwellers (Recognition of Forest Rights) Act, 2006, was enacted in this regard.
    • It aimed to protect the marginalised socio-economic class of citizens and balance the right to environment with their right to life and livelihood.

    Provisions of the 2006 Act

    • The Act recognizes that tribal and other traditional forest-dwelling communities would be hard put to provide documentary evidence for their claims.
    • Rule 13 of the Act, therefore, stipulates that the Gram Sabhas should consider more than one evidence in determining forest rights.
    • The rule sanctions a wide range of evidence, including “statements by village elders”, “community rights” and “physical attributes such as houses, huts and permanent improvements made to land such as levelling, bunds and check dams”.

    Why in news now?

    • The forest rights claims of these tribes and forest-dwellers are mostly rejected by the States.
    • Being poor and illiterate, living in remote areas, they do not know the appropriate procedure for filing claims.
    • The gram sabhas, which initiate the verification of their claims, are low on awareness of how to deal with them.

    Why are forest rights important for tribals?

    • Aimed at undoing the “historic injustice” meted out to forest-dependent communities due to curtailment of their customary rights over forests, the FRA came into force in 2008.
    • It is important as it recognises the community’s right to use, manage and conserve forest resources, and to legally hold forest land that these communities have used for cultivation and residence.
    • It also underlines the integral role that forest dwellers play in the sustainability of forests and in the conservation of biodiversity.
    • It is of greater significance inside protected forests like national parks, sanctuaries and tiger reserves as traditional dwellers then become a part of management of the protected forests.

     

    Try answering this PYQ

    Q.Under the Scheduled Tribes and Other Traditional Forest Dwellers (Recognition of Forest Rights) Act, 2006, who shall be the authority to initiate the process for determining the nature and extent of individual or community forest rights or both?

    (a) State Forest Department

    (b) District Collector/Deputy Commissioner

    (c) Tahsildar/Block Development Officer/Mandal Revenue Officer

    (d) Gram Sabha

     

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  • Draft Development of Enterprise and Service Hubs (DESH) Bill

    The Centre plans to table the Development of Enterprise and Service Hubs (DESH) Bill in the monsoon session of the Parliament, which will overhaul the special economic zones (SEZ) legislation.

    What are SEZs?

    • A Special Economic Zone (SEZ) is an area in which the business and trade laws are different from the rest of the country.
    • SEZs are located within a country’s national borders, and their aims include increasing trade balance, employment, increased investment, job creation, and effective administration.
    • Additionally, companies may be offered tax holidays, where upon establishing themselves in a zone, they are granted a period of lower taxation.

    SEZs in India

    • The SEZ policy in India first came into inception on April 1, 2000.
    • The prime objective was to enhance foreign investment and provide an internationally competitive and hassle-free environment for exports.
    • The idea was to promote exports from the country and realize the need for a level playing field must be made available to the domestic enterprises and manufacturers to be competitive globally.
    • Subsequently, the SEZ Act 2005, was enacted to provide the umbrella legal framework, covering all important legal and regulatory aspects of SEZ development as well as for units operating in SEZs.
    • SEZ units used to enjoy 100% income tax exemption on export income for the first five years, 50% for the next five years, and 50% of the ploughed back export profit for another five years

    Why replace the existing SEZ Act?

    • The World Trade Organization’s dispute settlement panel has ruled that India’s export-related schemes, including the SEZ Scheme, were inconsistent with WTO rules.
    • India has been accused of giving tax benefits to exports through SEZs.
    • Countries aren’t allowed to directly subsidize exports as it can distort market prices.
    • SEZs also started losing their allure after the introduction of minimum alternate tax and a sunset clause to remove tax sops.

    How is the DESH legislation different?

    • The DESH legislation goes beyond promoting exports.
    • It has a much wider objective of boosting domestic manufacturing and job creation through ‘development hubs’.
    • These hubs will no longer be required to be net foreign exchange positive cumulatively in five years (i.e, export more than they import) as mandated in the SEZ regime.
    • They will be allowed to sell in the domestic area more easily. The hubs will, therefore, be WTO-compliant.
    • DESH legislation also provides for an online single-window portal for the grant of time-bound approvals for establishing and operating the hubs.

    Will there be any tax benefits at these hubs?

    • It’s not clear yet.
    • However, the draft Bill does state that states and the Centre will be allowed to give further incentives in the form of tax rebates, incentives, exemptions, and duty drawbacks.
    • Subsidy schemes may be offered for goods and services at these hubs.
    • States and the Centre may take fresh measures to speed up clearances and simplify compliance.

    Will it be easier to sell in the domestic market?

    • Companies can sell in the domestic market with duties only to be paid on the imported inputs and raw materials instead of the final product.
    • In the current SEZ regime, duty is paid on the final product when a product is sold in the domestic market.
    • Besides, there is no mandatory payment requirement in forex, unlike in the case of SEZs.
    • However, the government may impose an equalization levy on goods or services supplied to the domestic market to bring taxes at par with those provided by units outside

    What role will states play in DESH?

    • DESH is expected to play a larger role, definitely.
    • In the SEZ regime, most decisions were made by the commerce department at the Centre.
    • Now, states will be able to participate and even directly send recommendations for development hubs to a central board for approval.
    • Besides, state boards would be set up to oversee the functioning of the hubs.
    • They would have the powers to approve imports or procurement of goods, and monitor the utilization of goods or services, warehousing, and trading in the development hub.

    Way forward

    • If indeed India needs the special hubs, the govt must address the critical gaps in existing SEZ law through the DESH bill and it must be thought through before bringing it to the Parliament.
    • Effective implementation of the law could act as a lever to India’s growth.

     

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