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GS Paper: GS3

  • Artificial intelligence technologies have a climate cost

    Context

    While there is an allure to national dreams of economic prosperity and global competitiveness, underwritten by AI, there is an environmental cost.

    Issues with AI

    • Unfair race for dominance in AI:  A few developed economies possess certain material advantages right from the start, they also set the rules.
    • They have an advantage in research and development, and possess a skilled workforce as well as wealth to invest in AI.
    • Inequality in terms of governance: We can also look at the state of inequity in AI in terms of governance: How “tech fluent” are policymakers in developing and underdeveloped countries?
    • What barriers do they face in crafting regulations and industrial policy?
    • At the same time, there is an emerging challenge at the nexus of AI and climate change that could deepen this inequity.

    Climate impact of AI

    • The climate impact of AI comes in a few forms: The energy use of training and operating large AI models is one.
    •  In 2020, digital technologies accounted for between 1.8 per cent and 6.3 per cent of global emissions.
    •  In November 2021, UNESCO adopted the  In November 2021, UNESCO adopted the Recommendation on the Ethics of Artificial Intelligence, calling on actors to “reduce the environmental impact of AI systems, including but not limited to its carbon footprint.” , calling on actors to “reduce the environmental impact of AI systems, including but not limited to its carbon footprint.”

    Inequitable access to resources

    • Both global AI governance and climate change policy (historically) are contentious, being rooted in inequitable access to resources.
    • Developing and underdeveloped countries face a challenge on two fronts:
    • 1] AI’s social and economic benefits are accruing to a few countries.
    • 2] Most of the current efforts and narratives on the relationship between AI and climate impact are being driven by the developed West.

    Way forward

    • Assess technology-led priorities: Governments of developing countries, India included, should also assess their technology-led growth priorities in the context of AI’s climate costs.
    •  It is argued that as developing nations are not plagued by legacy infrastructure it would be easier for them to “build up better”.

    Consider the question “How Artificial Intelligence technologies could transform the world as we know it? What are the concerns with it?

    Conclusion

    It may be worth thinking through what “solutions” would truly work for the unique social and economic contexts of the communities in our global village.

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  • What are Virtual Digital Assets?

    Recently, The Central Board of Direct Taxes (CBDT) issued detailed guidelines on the Tax Deducted at Source (TDS) rule for Virtual Digital Assets (VDAs) such as cryptocurrencies .

    What are Virtual Digital Assets?

    • To define the term “virtual digital asset”, a new clause (47A) is proposed to be inserted into section 2 of the Act.
    • A virtual digital asset is proposed to mean any information or code or number or token (not being Indian currency or any foreign currency):
    1. Generated through cryptographic means or otherwise
    2. Providing a digital representation of value that is exchanged with or without consideration with the promise or representation of having inherent value
    3. Functions as a store of value or a unit of account and includes its use in any financial transaction or investment, but not limited to, investment schemes
    4. Can be transferred, stored, or traded electronically.
    • Non-fungible token (NFT) and; any other token of similar nature are included in the definition.

    Why tax them?

    • Popularity: Virtual digital assets have gained tremendous popularity in recent times and the volumes of trading in such digital assets have increased substantially.
    • Growing market: Further, a market is emerging where payment for the transfer of a virtual digital asset can be made through another such asset.
    • Increased transactions: There has been a phenomenal rise in such transactions and the magnitude and frequency of these transactions have made it imperative to provide for a specific tax regime.
    • Prevalence of gifting: The gifting of virtual digital assets is also a popular mode of exchange.

    Key takeaways from the FM’s speech

    • The bill provides for the definition of virtual digital assets which is wide enough to cover emerging digital assets including NFT, assets in metaverse, cryptocurrencies, etc.
    • This recognition of digital assets under income tax is NOT akin to granting legal status.

     

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  • Places in news: Sultanpur National Park

    Homestays would soon be allowed in the villages around Sultanpur National Park in Gurugram to promote tourism and provide an opportunity for the visitors to catch a glimpse of rural life in Haryana.

    Sultanpur National Park

    • Sultanpur NP is located at Sultanpur village on Gurugram-Jhajjar highway, 15 km from Gurugram, Haryana and 50 km from Delhi.
    • It was a bird sanctuary, ideal for birding and bird lookers. Its area covers approximately 142.52 hectares.
    • Migratory birds start arriving in the park in September. Birds use the park as a resting place till the following March-April.
    • During summer and monsoon months the park is inhabited by many local bird species.
    • In April 1971, the Sultanpur Jheel inside the park (an area of 1.21 sq. km.) was accorded Sanctuary status under section 8 of the Punjab Wildlife Preservation Act of 1959.
    • The status of the park was upgraded to National Park under the Wildlife (Protection) Act, 1972 in July 1991.

    Why must we remember it?

    • It is one of the few NPs in the small state of Haryana.
    • Another NP in Haryana is Kalesar National Park.

    Important Fauna at the Park

    • Mammals: Blackbuck, Nilgai, Hog deer, Sambar, Leopard etc.
    • Birds: Siberian Cranes, Greater Flamingo, Demoiselle Crane etc.

     

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  • What is the Digital Rupee?

    The Union Finance Minister has announced the launch of the Digital Rupee — a central bank digital currency (CBDC) — 2022-23 onwards.

    Who will launch the CBDC?

    • The Reserve Bank of India will launch the CBDC in the upcoming financial year.
    • This follows the government’s plans to launch the CBDC that will be backed by blockchain technology.

    What is a CBDC?

    • CBDC is a legal tender issued by a central bank in a digital form.
    • It is similar to a fiat currency issued in paper and is interchangeable with any other fiat currency.
    • One chief difference will be that a Digital Rupee transaction will be instantaneous as opposed to the current digital payment experience.

    Features of CBDC

    • High-security instrument: CBDC is a high-security digital instrument; like paper banknotes, it is a means of payment, a unit of account, and a store of value.
    • Uniquely identifiable: And like paper currency, each unit is uniquely identifiable to prevent counterfeit.
    • Liability of central bank: It is a liability of the central bank just as physical currency is.
    • Transferability: It’s a digital bearer instrument that can be stored, transferred, and transmitted by all kinds of digital payment systems and services.

    What is the need for CBDC?

    • Online transactions: India is a leader in digital payments, but cash remains dominant for small-value transactions.
    • High currency in circulation: India has a fairly high currency-to-GDP ratio.
    • Cost of currency management: An official digital currency would reduce the cost of currency management while enabling real-time payments without any inter-bank settlement.
    • The growth of cryptocurrencies such as Bitcoin, Ethereum, etc has raised challenges to fiat currencies.

    Key benefits offered

    • Faster system: CBDC can definitely increase the transmission of money from central banks to commercial banks and end customers much faster than the present system.
    • Financial inclusion: Specific use cases, like financial inclusion, can also be covered by CBDC that can benefit millions of citizens who need money and are currently unbanked or banked with limited banking services
    • Monetary policy facilitation: The move to bring out a CBDC could significantly improve monetary policy development in India.
    • Making of a regional currency: In the cross-border payments domain, India can take a lead by leveraging digital Rupee especially in countries such as Bhutan, Saudia Arabia, and Singapore where NPCI has existing arrangements.

    Why is CBDC preferred over Cryptocurrency?

    • Sovereign guarantee: Cryptocurrencies pose risks to consumers.  They do not have any sovereign guarantee and hence are not legal tender.
    • Market volatility: Their speculative nature also makes them highly volatile.  For instance, the value of Bitcoin fell from USD 20,000 in December 2017 to USD 3,800 in November 2018.
    • Risk in security: A user loses access to their cryptocurrency if they lose their private key (unlike traditional digital banking accounts, this password cannot be reset).
    • Malware threats: In some cases, these private keys are stored by technical service providers (cryptocurrency exchanges or wallets), which are prone to malware or hacking.
    • Money laundering: Cryptocurrencies are more vulnerable to criminal activity and money laundering.  They provide greater anonymity than other payment methods since the public keys engaging in a transaction cannot be directly linked to an individual.
    • Regulatory bypass: A central bank cannot regulate the supply of cryptocurrencies in the economy.  This could pose a risk to the financial stability of the country if their use becomes widespread.
    • Power consumption: Since validating transactions is energy-intensive, it may have adverse consequences for the country’s energy security (the total electricity use of bitcoin mining, in 2018, was equivalent to that of mid-sized economies such as Switzerland).

    Way forward

    • The launch of CBDCs may not be a smooth affair and still requires more clarity in India. There are still a lot of misconceptions about the concept of digital currency in the country.
    • The effectiveness of CBDCs will depend on aspects such as privacy design and programmability.
    • There is a huge opportunity for India to take a lead globally via a large-scale rollout and adoption of digital currencies.

     

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  • Govt. proposes new SEZ Law

    The government has proposed to replace the existing law governing Special Economic Zones (SEZs) with new legislation to enable States to become partners in ‘Development of Enterprise and Service Hubs’.

    Why amend SEZ Act, 2005?

    • Units in SEZs 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.
    • SEZs now have started losing their sheen after the imposition of minimum alternate tax and the introduction of a sunset clause for the removal of tax incentives.
    • The new act will cover all large existing and new industrial enclaves to optimally utilize the available infrastructure and enhance the competitiveness of exports.
    • The government will also undertake reforms in customs administration of SEZs with a view to promote ease of doing business.

    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.
    • To encourage businesses to set up in the zone, financial policies are introduced.
    • These policies typically encompass investing, taxation, trading, quotas, customs, and labor regulations.
    • 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.

    Who can set up SEZs? Can foreign companies set up SEZs?

    • Any private/public/joint sector or state government or its agencies can set up an SEZ.
    • Yes, a foreign agency can set up SEZs in India.

    What is the role of state governments in establishing SEZs?

    • A representative of the state government, who is a member of the inter-ministerial committee on private SEZ, is consulted while considering the proposal.
    • Before recommending any proposals to the ministry of commerce and industry (department of commerce), the states must satisfy themselves that they are in a position to supply basic inputs like water, electricity, etc.

    Are SEZs controlled by the government?

    • In all SEZs, the statutory functions are controlled by the government.
    • The government also controls the operation and maintenance function in the central government-controlled SEZs. The rest of the operations and maintenance are privatized.

    Are SEZs exempt from labor laws?

    • Normal labor laws are applicable to SEZs, which are enforced by the respective state governments.
    • The state governments have been requested to simplify the procedures/returns and for the introduction of a single-window clearance mechanism by delegating appropriate powers to development commissioners of SEZs.

    Who monitors the functioning of the units in SEZ?

    • The performance of the SEZ units is monitored by a unit approval committee consisting of a development commissioner, custom, and representative of the state government on an annual basis.

    What are the special features for business units that come to the zone?

    • Business units that set up establishments in an SEZ would be entitled to a package of incentives and a simplified operating environment.
    • Besides, no license is required for imports, including second-hand machinery.

    How do SEZs help a country’s economy?

    • SEZs play a key role in the rapid economic development of a country.
    • In the early 1990s, it helped China and there were hopes that the establishment in India of similar export-processing zones could offer similar benefits – provided, however, that the zones offered attractive enough concessions.
    • Traditionally the biggest deterrents to foreign investment in India have been high tariffs and taxes, red-tapism, and strict labor laws.
    • To date, these restrictions have ensured that India has been unable to compete with China’s massively successful light-industrial export machine.

     

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  • PM’s Development Initiative for North East (PM-DevINE)

    Union Budget 2022-23 provided for a new scheme, Prime Minister’s Development Initiative for North East (PM-DevINE) will be implemented through the North-Eastern Council.

    PM-DevINE

    • It will fund infrastructure, in the spirit of PM GatiShakti, and social development projects based on felt needs of the northeast.
    • This will enable livelihood activities for youth and women, filling the gaps in various sectors.
    • While the Central Ministries may also pose their candidate projects, priority will be given to those posed by the States.

    Some of the projects to be implemented are:

    1. Dedicated Services for the Management of Paediatric and Adult Haemotolymphoid Cancers in North East India, Guwahati
    2. Construction of Aizawl bypass on western side, gap funding for passenger ropeway system for Pelling to Sanga-Choeling in West Sikkim
    3. Gap funding for eco-friendly Ropeway (Cable Car) from Dhapper to Bhaleydhunga in South Sikkim
    4. Pilot project for the construction of Bamboo Link Road at different locations in various districts in Mizoram

     

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  • What is UNCITRAL Model for Cross-Border Insolvency?

    The Economic Survey 2021-22 has called for a standardized framework for cross-border insolvency as the Insolvency and Bankruptcy Code (IBC) at present does not have an instrument to restructure firms involving cross-border jurisdictions.

    What is the Insolvency and Bankruptcy Code (IBC)?

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

    Cross-border insolvency proceedings

    • Cross-border insolvency proceedings are relevant for the resolution of distressed companies with assets and liabilities across multiple jurisdictions.
    • A framework for cross border insolvency proceedings allows for:
    1. Location of such a company’s foreign assets
    2. Identification of creditors and their claims
    3. Establishing payment towards claims and
    4. Process for coordination between courts in different countries

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

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

    What is the UNCITRAL Model?

    • The UNCITRAL model is the most widely accepted legal framework to deal with cross-border insolvency issues.
    • It has been adopted by 49 countries, including the UK, the US, South Africa, South Korea, and Singapore.
    • It is designed to assist States in reforming and modernizing their laws on the arbitral procedure so as to take into account the particular features and needs of international commercial arbitration.

    Key provisions

    This law works on four main principles: access, recognition, cooperation and coordination:

    1. Direct access to foreign insolvency professionals and foreign creditors to participate in or commence domestic insolvency proceedings against a defaulting debtor.
    2. Recognition of foreign proceedings & provision of remedies.
    3. Cooperation between domestic and foreign courts & domestic and foreign insolvency practitioners.
    4. Coordination between two or more concurrent insolvency proceedings in different countries: The main proceeding is determined by the concept of Centre of Main Interest (COMI).

    Implications for India

    • The framework for cross-border insolvency adopted in India may like in the case of some other countries require reciprocity from any country which seeks to have its insolvency proceedings recognised by Indian courts.
    • This would allow Indian proceedings for foreign corporate debtors to be recognised in foreign jurisdictions.

    How is IBC different from the model law?

    • Many countries that adopt the UNCITRAL model law do make certain changes to suit their domestic requirements.
    • The Indian cross-border insolvency framework excludes financial service providers from being subjected to cross-border insolvency proceedings.
    • This is because many countries exempt businesses providing critical financial services, such as banks and insurance companies, from the provisions of cross-border insolvency frameworks.

    Back2Basics: UNCITRAL

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

     

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  • What is Design Linked Incentive (DLI) Scheme?

    India has invited applications from 100 domestic companies, startups, and small and medium enterprises to become a part of the design-linked incentive (DLI) scheme.

    What is the DLI scheme?

    • Aims to provide financial and infrastructural support to companies setting up fabs or semiconductor making plants in India.
    • It aims to attract existing and global players as it will support their expenditures related to design software, IP rights, development, testing, and deployment.
    • Centre for Development of Advanced Computing (CDAC), a scientific society operating under MeitY, will serve as the nodal agency for the implementation of the DLI scheme.

    Components of the scheme

    It has three components which are

    1. Chip Design infrastructure support: C-DAC will set up the India Chip Centre to host the state-of-the-art design infrastructure (viz. EDA Tools, IP Cores, and support for MPW (Multi Project Wafer fabrication) & post-silicon validation) and facilitate its access to supported companies.
    2. Product Design Linked Incentive: Reimbursement of up to 50% of the eligible expenditure subject to a ceiling of Rs. 15 Crore per application will be provided as financial support to the approved applicants who are engaged in semiconductor design.
    3. Deployment Linked Incentive: An incentive of 6% to 4% of net sales turnover over 5 years subject to a ceiling of Rs. 30 Crore per application will be provided to approved applicants whose semiconductor design for Integrated Circuits (ICs), Chipsets, System on Chips (SoCs), Systems & IP Cores and semiconductor linked design are deployed in electronic products.

    Why need such a scheme?

    Ans. Growing semiconductor demand in India

    • The semiconductor industry is growing fast and can reach $1 trillion dollars in this decade. India can grow fast and reach $64 billion by 2026 from $27 billion today.
    • Mobiles, wearables, IT, and industrial components are the leading segments in the Indian semiconductor industry contributing around 80% of the revenues in 2021.
    • The mobile and wearables segment is valued at $13.8 billion and is expected to reach $31.5 billion in 2026.

    A boost to semiconductor manufacturing

    • The sudden surge in demand for chips and semiconductor components has underpinned the need to establish a robust semiconductor ecosystem in India.
    • Several sectors, including auto, telecom, and medical technology suffered due to the unexpected surge leading to the scarcity of chips manufactured by only a few countries.
    • The inception of new companies will help in meeting the demand and supply and encourage innovation in India.

    What are other countries doing to be dominant in the race of chip-making?

    • Currently, semiconductor manufacturing is dominated by companies in the U.S., Japan, South Korea, Taiwan, Israel, and the Netherlands.
    • They are also making efforts in solving the chip shortage problem.
    • The US wants to bring manufacturing back to America and reduce the country’s reliance on a small number of chipmakers based largely in Taiwan and South Korea.
    • These chipmakers produce up to 70% of the world’s semiconductors.

    Challenges in India

    • No incubation: In India, more than 90% of global companies already have their R&D and design centers for semiconductors but never established their fabrication units.
    • Strategic sector: Although India has semiconductor fabs in Mohali and Bangalore, they are purely strategic for defense and space applications only
    • Capital requirement: Setting up fabs is capital intensive and needs investment in the range of $5 billion to $10 billion.
    • Lack of supportive policies: Lack of investments and supportive government policies are some of the challenges to setting up fabs in India.
    • Geopolitical limitations: A combination of capital and the geopolitical situation comes into play to build new fabs.

    Way forward

    • Further incentivization: Schemes like the DLI are crucial to avoid high dependencies on a few countries or companies.
    • Raw material supply: Several gases and minerals which are a part of the global semiconductor supply chain are produced in India.
    • Large talent pool: Availability of highly-skilled engineers for semiconductor manufacturing.

    Conclusion

    • The 21st century will be an era of Digital revolution signifying an increased use of mobile phones and computer devices. This enhanced usage can be met only with a robust availability of semiconductor chips that sustains their functioning. Therefore India needs to focus on the indigenous development of semiconductors in order to realize its digital potential and emerge as a strong power in the present era.

     

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  • What is Pegasus Spyware Controversy?

    A New York Times report has claimed that the Indian government had bought the Pegasus Spyware in 2017.

    What is Pegasus?

    • Pegasus is a spyware developed by NSO Group, an Israeli surveillance firm that helps spies hack into phones.
    • In 2019, when WhatsApp sued the firm in a U.S. court, the matter came to light.
    • In July 2021, Amnesty International, along with 13 media outlets across the globe released a report on how the spyware was used to snoop hundreds of individuals, including Indians.
    • While the NSO claims its spyware is sold only to governments, none of the nations have come forward to accept the claims.

    Why is Pegasus so lethal?

    • What makes Pegasus really dangerous is that it spares no aspect of a person’s identity.
    • It makes older techniques of spying seem relatively harmless.
    • It can intercept every call and SMS, read every email and monitor each messaging app.
    • Pegasus can also control the phone’s camera and microphone and has access to the device’s location data.
    • The app advertises that it can carry out “file retrieval”, which means it could access any document that a target might have stored on their phone.

    Dysfunctions created by Pegasus

    • Privacy breach: The very existence of a surveillance system, whether under a provision of law or without it, impacts the right to privacy under Article 21 and the exercise of free speech under Article 19.
    • Curbing Dissent: It reflects a disturbing trend with regard to the use of hacking software against dissidents and adversaries. In 2019 also, Pegasus software was used to hack into HR & Dalit activists.
    • Individual safety: In the absence of privacy, the safety of journalists, especially those whose work criticizes the government, and the personal safety of their sources is jeopardised.
    • Self-Censorship: Consistent fear over espionage may grapple individuals. This may impact their ability to express, receive and discuss such ideas.
    • State-sponsored mass surveillance: The spyware coupled with AI can manipulate digital content in users’ smartphones. This in turn can polarize their opinion by the distant controllers.
    • National security: The potential misuse or proliferation has the same, if not more, ramifications as advanced nuclear technology falling into the wrong hands.

    Snooping in India:  A Legality check

    For Pegasus-like spyware to be used lawfully, the government would have to invoke both the IT Act and the Telegraph Act. Communication surveillance in India takes place primarily under two laws:

    1. Telegraph Act, 1885: It deals with interception of calls.
    2. Information Technology Act, 2000: It was enacted to deal with surveillance of all electronic communication, following the Supreme Court’s intervention in 1996.

    Cyber security safeguards in India

    • National Cyber Security Policy: The policy was developed in 2013 to build secure and resilient cyberspace for India’s citizens and businesses.
    • Indian Computer Emergency Response Team (CERT-In): The CERT-In is responsible for incident responses including analysis, forecasts, and alerts on cybersecurity issues and breaches.
    • Indian Cyber Crime Coordination Centre (I4C): The Central Government has rolled out a scheme for the establishment of the I4C to handle issues related to cybercrime in the country in a comprehensive and coordinated manner.
    • Budapest Convention: There also exists Budapest Convention on Cybercrime. However, India is not a signatory to this convention.

    Issues over government involvement

    • It is worth asking why the government would need to hack phones and install spyware when existing laws already offer impunity for surveillance.
    • In the absence of parliamentary or judicial oversight, electronic surveillance gives the executive the power to influence both the subject of surveillance and all classes of individuals, resulting in a chilling effect on free speech.

    Way forward

    • The security of a device becomes one of the fundamental bedrock of maintaining user trust as society becomes more and more digitized.
    • Constituting an independent high-level inquiry with credible members and experts that can restore confidence and conduct its proceedings transparently.
    • The need for judicial oversight over surveillance systems in general, and judicial investigation into the Pegasus hacking, in particular, is very essential.

    Conclusion

    • We must recognize that national security starts with securing the smartphones of every single Indian by embracing technologies such as encryption rather than deploying spyware.
    • This is a core part of our fundamental right to privacy.
    • This intrusion by spyware is not merely an infringement of the rights of the citizens of the country but also a worrying development for India’s national security apparatus.

     

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  • What is Reverse Repo Normalization?

    In a recent report, the State Bank of India, which is the largest public sector bank in the country, has stated that the stage is set for a reverse repo normalization.

    What is Monetary Policy Normalisation?

    The RBI keeps tweaking the total amount of money in the economy to ensure smooth functioning by two types of policies:

    (I) Loose Monetary Policy

    When the RBI wants to boost economic activity it adopts a so-called “loose monetary policy”.

    There are two parts to such a policy:

    1. RBI injects more money (liquidity) into the economy: It does so by buying government bonds from the market. As the RBI buys these bonds, it pays back money to the bondholders, thus injecting more money into the economy.
    2. RBI also lowers the interest rate: it charges banks when it lends money to them; this rate is called the repo rate. Lower interest rates and more liquidity, together, are expected to boost both consumption and production in the economy.

    (II) Tight Monetary Policy

    • It involves the RBI raising interest rates and sucking liquidity out of the economy by selling bonds (and taking money out of the system).
    • When any central bank finds that a loose monetary policy has started becoming counterproductive in reducing inflation, the central bank “normalizes the policy” by tightening the monetary policy stance.

    What is Reverse Repo?

    • An interest rate that the RBI pays to the commercial banks when they park their excess “liquidity” (money) with the RBI.
    • The reverse repo, thus, is the exact opposite of the repo rate.
    • Under normal a circumstance, that is when the economy is growing at a healthy pace, the repo rate becomes the benchmark interest rate in the economy.
    • That’s because it is the lowest rate of interest at which funds can be borrowed.
    • As such, the repo rate forms the floor interest rate for all other interest rates in the economy — be it the rate you pay for a car loan or a home loan or the interest you earn on your fixed deposit, etc.

    How does Reverse Repo fit into policy normalization?

    • Imagine a scenario where the RBI pumps more and more liquidity into the market but there are no takers of fresh loans.
    • This is because the banks are unwilling to lend or because there is no genuine demand for new loans in the economy.
    • In such a scenario, the action shifts from repo rate to reverse repo rate because banks are no longer interested in borrowing money from the RBI.
    • Rather they are more interested in parking their excess liquidity with the RBI. And that is how the reverse repo becomes the actual benchmark interest rate in the economy.

    What does reverse repo normalization mean?

    • Simply put, it means the reverse repo rates will go up.
    • Over the past few months, in the face of rising inflation, several central banks across the world have either increased interest rates or signaled that they would do so soon.
    • In India, too, it is expected that the RBI will raise the repo rate.
    • But before that, it is expected that the RBI will raise the reverse repo rate and reduce the gap between the two rates.
    • In the immediate aftermath of Covid, RBI had increased this gap.

    Implications of such policy

    • Incentivize commercial banks to park excess funds with RBI, thus sucking some liquidity out of the system.
    • The next step would be raising the repo rate.
    • This process of normalization, which is aimed at curbing inflation, will not only reduce excess liquidity but also result in higher interest rates across the board in the Indian economy.
    • This will help reduce the demand for money among consumers (since it would make more sense to just keep the money in the bank) and make it costlier for businesses to borrow fresh loans.

    Try this PYQ from CSP 2020:

    Q.If the RBI decides to adopt an expansionist monetary policy, which of the following it would NOT do?

    1. Cut and optimize the statutory liquidity ratio
    2. Increase the Marginal Standing Facility Rate
    3. Cut the Bank Rate and Repo Rate

    Select the correct answer using the code given below:

    (a) 1 and 2 only

    (b) 2 only

    (c) 1 and 3 only

    (d) 1, 2 and 3

     

    [wpdiscuz-feedback id=”sr109h9q0i” question=”Please leave a feedback on this” opened=”1″]Post your answers here:[/wpdiscuz-feedback]

     

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