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GS Paper: GS3

  • What is Wood Wide Web?

    Plants appear to be simple enough in their organization. Whether small shrubs or tall trees, all they seem to be made up of is leaves, flowers, fruits, stems, and roots. But simple they are not. Being rooted in one spot has required very special personality traits.

    Wood Wide Web

    • Trees in the forest share resources by using an underground network.
    • A scientist from the University of British Columbia, Dr. Suzanne Simard, revealed this network and called it the wood wide web.
    • In the wood wide web, mycorrhizal fungi colonize the plant roots, and their tiny fungal filaments, or mycelia, connect hairy root tips of different trees together.
    • Mycorrhizal fungi refer to the role they play in the plant’s root system—as symbionts.
    • These root-associated fungi are harmless to plants. Instead, they form harmonious symbiotic relationships with plants.

    An ancient association

    • The association between plants and fungi is ancient.
    • Fossils of plants from about 400 million years ago show the first evidence of roots, and these roots are fungus associations – rhizoids – suggesting that roots co-evolved with fungi.
    • One good example is species of Penicillium, the fungus from which Alexander Fleming isolated the antibiotic penicillin.
    • Fungus–root associations, called mycorrhizae, appear at first glance to be simple mutualisms that are beneficial to both.
    • The root-invading fungus gains nutrients made by the plant, and the plants get difficult-to-find minerals like phosphorus from the microbe. But the association is deeper.

    How does it work?

    • The wood wide web works by offering a win-win situation for all parties: mycorrhizal fungi and trees.
    • The fungal filaments transport nitrogen, phosphorous, water, and other hard-to-capture nutrients from the soil to the trees, in exchange for carbon-rich sugars made by the plants.
    • The fungi also help deliver substances from one tree to its neighboring trees.
    • By using the network, mature trees feed their seedlings with nutrients to boost their survival.
    • When a plant is sick or dying, it can allocate its nutrients to the other plants nearby through the wood wide web.

    Benefits offered

    • Bacteria that associate with roots are called rhizobacteria, and a very wide range of these species are plant growth promoters.
    • Like the fungi, mutualism operates in these relationships too. In exchange for sugars, these bacteria offer plants a wide range of benefits.
    • They may help plants ward off pathogens that cause diseases of the root. They may even trigger systemic resistance to a pathogen throughout the plant.

    Back2Basics: Symbiotic Relationship

    Parasitism

    • It is a type of interaction between two species that results in damage and harm to one member and benefit to another member.
    • Ex. As in the case of the tick-host relationship, the tick gains benefit by sucking blood while the host is harmed as it loses blood.

    Commensalism

    • In this type of relationship one species benefits without affecting the other.
    • Barnacles growing on the back of the whale, orchids growing as an epiphyte on some mango branch, cattle egret and grazing cattle in close association, Sea anemone, and the Clown Fish are some of the classic examples of Commensalism.

    Amensalism

    • In this relationship, one species is harmed while the other is neither harmed nor benefitted and remains unaffected.
    • When an organism excretes the chemicals as a part of the normal metabolism of its own, but which may severely impact other nearby species, this kind of relationship is seen.

    Mutualism

    • In this type of relationship both the partners benefit from one another. When similar interaction occurs within a species, it is known as cooperation.
    • Lichens a mutual relationship between algae and fungus. In this mutual cooperation, fungus gives protection and raw material for the preparation of the food while Green Algae synthesizes the food for both.

    Saprophytism

    • In this kind of biotic interaction, certain organisms live on dead and decaying organic matter.
    • Dung Beetles, Vultures, Fungi, Bacteria, Protozoa are the example of Saprophytism.

    Predation

    • In this type of biological interaction, a predator feeds upon its prey and in this type of relationship, one species is benefitted while the other is harmed.

    Competition

    • In this type of interaction both the species compete with each other for the resources like food, shelter, mating, and both the species get harmed out of the process of competition.

  • Why India’s Steady Exports Are At A Record High?

    Context

    First-quarter growth in India’s gross domestic product (GDP) stands at 20.1 %. This however still means that GDP in the first quarter was 9.2 % below its level two years ago.

    Export: Challenges

    • The key driver of growth in the coming quarters will be exports riding on the rapidity of recovery in major markets.
    • There are two serious worries here.
    • 1) Bullwhip element: This could cause an immediate ramp-up in demand for steel and other such upstream elements in global supply chains, with a corresponding damp down in the months to come.
    • In this connection, although the rates under the scheme for remission of duties and taxes on exported products (RODTEP) were finally notified in mid-August.
    • Steel, pharma and chemicals get no rebate at all, although many products using these inputs do.
    • The scheme looks like a subsidy to selected sectors disguised as duty rollback, which can get India into trouble at the World Trade Organization (WTO).
    • These excluded products need the rebate if they are to survive in a fiercely price-competitive global market in the months to come.
    • 2) Container shortage: A crippling shortage of sea-borne containers has afflicted key large-volume products in the Indian export basket (tea, basmati rice, furniture, garments).
    • Sea-freight subsidy: At a time when container rates have shot up, there is surely a case for a sea-freight subsidy (for a limited period).
    • Even more urgently, the estimated 25,000-30,000 containers locked up at different ports owing to customs disputes need to be unloaded into warehouses and these containers freed.

    Can National Monetisation Pipeline (NMP) spur growth?

    • Even if the expected ₹88,000 crore of revenue under NMP is realized during the current year, it is intended to feed only a small part of the infrastructure expenditure budgeted for the year.
    • It is the latter that will have to drive growth. Monetization is merely a funding source.
    • The scheme offers a participation incentive to states with a 33% matching transfer from the Centre for revenues that states realize under the scheme.
    • This matching transfer could well have the perverse consequence of states under-achieving the potential value realizable. 
    • Volume II of the NMP document refers to the Scheme for Special Assistance to States for Capital Expenditure announced in October 2020.
    • It offered states an interest-free loan with bullet repayment after 50 years to complete stalled capital projects, or settle the outstanding bills of contractors.
    • The NMP demands clear and well-thought-through processes, with sufficient transparency and safeguards in the form of regulatory structures.

    Conclusion

    For now, the need of the hour is export facilitation.

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  • Common Prosperity Drive in China

    Chinese President Xi Jinping has called for China to achieve “common prosperity”, seeking to narrow a yawning wealth gap that threatens the country’s economic ascent and the legitimacy of Communist Party rule.

    What is ‘Common Prosperity’?

    • “Common prosperity” was first mentioned in the 1950s by Mao Zedong, founding leader of what was then an impoverished country.
    • The idea was repeated in the 1980s by Deng Xiaoping, who modernized an economy devastated by the Cultural Revolution.
    • Deng said that allowing some people and regions to get rich first would speed up economic growth and help achieve the ultimate goal of common prosperity.
    • Common prosperity is not egalitarianism. It does not mean “killing the rich to help the poor”.

    Components of the drive

    • The push for common prosperity has encompassed a wide range of policies, that includes curbing tax evasion and limits on the hours that tech sector employees can work to bans on for-profit tutoring in core school subjects, and strict limits on the time minors can spend playing video games.

    Why in news now?

    • China became an economic powerhouse under a hybrid policy of “socialism with Chinese characteristics”, but it also deepened inequality, especially between urban and rural areas, a divide that threatens social stability.
    • This year, Xi has signaled a heightened commitment to delivering common prosperity, emphasizing it is not just an economic objective but core to the party’s governing foundation.
    • A pilot program in Zhejiang province, one of China’s wealthiest, is designed to narrow the income gap there by 2025.

    How will it be achieved?

    • Chinese leaders have pledged to use taxation and other income redistribution levers to expand the proportion of middle-income citizens, boost incomes of the poor, “rationally adjust excessive incomes”, and ban illegal incomes.
    • Beijing has explicitly encouraged high-income firms and individuals to contribute more to society via the so-called “third distribution”, which refers to charity and donations.
    • Several tech industry heavyweights have announced major charitable donations and support for disaster relief efforts.
    • Other measures would include improving public services and the social safety net.

    What will be the economic impact?

    • Chinese leaders are likely to tread cautiously so as not to derail a private sector that has been a vital engine of growth and jobs.
    • This goal may speed China’s economic rebalancing towards consumption-driven growth to reduce reliance on exports and investment, but policies could prove damaging to growth driven by the private sector.
    • Increasing incomes and improved public services, especially in rural areas, would be positive for consumption, and a better social safety net would lower precautionary savings.
    • The effort supports Xi’s “dual circulation” strategy for economic development, under which China aims to spur domestic demand, innovation, and self-reliance, propelled by tensions with the United States.

    Try answering this PYQ from CSP 2020:

    Q.One common agreement between Gandhism and Marxism is :

    (a) The final goal of a stateless society

    (b) Class struggle

    (c) Abolition of private property

    (d) Economic determinism

     

    [wpdiscuz-feedback id=”6hsoxr3t9f” question=”Please leave a feedback on this” opened=”1″]Post your answers here.[/wpdiscuz-feedback]

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  • The April-June quarter GDP numbers indicated at 20.1 per cent growth

    Context

    The April-June quarter GDP numbers indicated at 20.1 per cent growth.

    Making sense of the numbers

    • The higher GDP growth was driven by high indirect tax collections, largely GST.
    • The more representative measure of economic activity, gross value added (GVA), grew by 18.8 per cent.
    • GDP is derived by adding indirect tax collections, net of subsidy payouts, to GVA.
    • These numbers are over a base quarter that had contracted sharply due to the lockdowns during the first Covid wave last year.
    • The revival of manufacturing GVA was the most robust, with mining and electricity growth somewhat moderate.
    • The overall and sector-specific activity levels need to be evaluated vis-à-vis the corresponding thresholds of (the pre-pandemic) first quarter of 2019-20.
    • Agriculture grew at 4.5 per cent, with cereals, pulses and oilseeds output at all-time highs.
    • As could be expected, the services sector remained vulnerable, with activity even softer than expected.
    • Steel and cement output growth — proxies for construction activity — were also quite robust in the quarter.
    • Demand and expenditure: Private consumption was up 19.3 per cent while investment was at 55.3 per cent.
    • Government consumption was lower by 4.8 per cent.
    • Export: Net exports are typically in deficit, but the gap was much lower in the first quarter.

    How to sustain recovery: way forward

    • Looking beyond the first quarter, the set of high-frequency economic signals suggest a strong recovery in July and August.
    •  But, how can this recovery over the rest of the year and beyond be sustained, and even accelerated?
    • Sustaining 3 growth drivers: The three distinct potential growth drivers — consumption, investment and exports — will need to be effectively sustained by policy initiatives over the next couple of years.
    • Government spending: Centre’s revenues and expenditures during April-July this year suggest that it has significant room to increase spending.
    • National Monetisation Plan will open up further fiscal space to increase spending, in particular, on capex.
    • Credit support to stressed segment: mid-and small-sized enterprises will take some time to restore their pre-pandemic operational levels.
    • An increase in the flow of credit, from banks, NBFCs and markets, particularly to these stressed segments, is a priority, as a supplement to state spending.
    • Opportunity for exports: Global inventories are low and depending on the progression of the pandemic relaxations across geographies, are likely to provide opportunities for Indian exports to fill some of these gaps.
    • Reforms: Multiple reform initiatives, tax and other incentives are in the process of implementation.
    • These need to be accelerated in coordination with states to enable an environment of steady, high growth in the medium term.

    Challenges

    • Global central banks’ are signalling the imminent normalisation of ultra-loose monetary policy.
    • The resulting increase in financial sector volatility will have spillover effects on emerging markets, including India.
    • To keep the process smooth, it is crucial to raise India’s potential growth so that the economic recovery does not rapidly close the output gap, thereby preventing a surge in inflationary pressures.

    Conclusion

    There is a limited window of opportunity for India to leverage the current ongoing realignment of global supply chains and progressively onboard both manufacturing and services entities.

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  • Hydel projects in Ganga-Himalayan basin

    Context

    The affidavit filed recently by the Ministry of Environment, Forest and Climate Change (MoEFCC) in an ongoing matter in the Supreme Court of India has recommended the construction of seven partially constructed hydroelectric projects in the Uttarakhand Himalaya.

    Background

    • After the Kedarnath tragedy of 2013, an expert body (EB-I) was constituted to investigate whether the hydro-power projects in the State of Uttarakhand was linked to the disaster.
    •  In its findings, EB-I said there was a “direct and indirect impact” of these dams in aggravating the disaster.
    • The Ministry formed another expert body (EB-II; B.P. Das committee) whose mandate has been to pave the way for all projects through some design change modifications
    • This affidavit, dated August 17, reveals that the government is inclined towards construction of 26 other projects, as in the recommendation of the expert body (EB-II; B.P. Das committee). 
    • Ministry’s own observations and admissions given in its earlier affidavit dated May 5, 2014 admitted that hydroelectric projects did aggravate the 2013 flood.

    Concerns

    • Sustainability: The sustainability of the dams in the long term is highly questionable as hydropower solely relies on the excess availability of water.
    • Temperatures across the region are projected to rise by about 1°C to 2°C on average by 2050.
    • Retreating glaciers and the alternating phases of floods and drought will impact the seasonal flows of rivers.
    • Sediment hotspots: The most crucial aspect is the existence of sediment hotspot paraglacial zones, which at the time of a cloud burst, contribute huge amounts of debris and silt in the river.
    • The flash floods in these Himalayan valleys do not carry water alone; they also carry a massive quantity of debris.
    • This was pointed out by EB-II alongside its recommendation not build any projects beyond 2,000 metres or north of the MCT, or the Main Central Thrust (it is a major geological fault).
    • Externalities:  Though hydropower is renewable source, there are contentious externalities associated with the construction of dams such as social displacement, ecological impacts, environmental and technological risks.
    • Climate change: these projects exacerbate ecological vulnerability, in a region that is already in a precarious state.
    • The intense anthropogenic activities associated with the proliferation of hydroelectric projects in these precarious regions accelerate the intensity of flash floods, avalanches, and landslides.
    • Failure of mountain slopes: The construction and maintenance of an extensive network of underground tunnels carrying water to the powerhouses contribute to the failure of mountain slopes.
    • Aggravating the disaster: The Rishi Ganga tragedy and the disasters of 2012 (flashfloods), 2013 are examples of how hydroelectric projects which come in the way of high-velocity flows aggravate a disaster and should be treated as a warning against such projects.

    Conclusion

    Considering the environmental and cultural significance of these areas, it is imperative that the Government refrains from the construction of hydroelectric projects and declares the upper reaches of all the headstreams of the Ganga as eco-sensitive zones. It must allow the river to flow unfettered and free.

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    Back2Basics: Main Central Thrust (MCT)

    • The Main Central Thrust is a major geological fault where the Indian Plate has pushed under the Eurasian Plate along the Himalaya.
    • The fault slopes down to the north and is exposed on the surface in a NW-SE direction (strike).
    • It is a thrust fault that continues along 2200 km of the Himalaya mountain belt

  • How to unleash the entrepreneurial power of 1.3 billion Indians

    Context

    Last Independence Day, the PM announced that 15,000 of our current 69,000+ employer compliances and 6000+ filings have been identified for removal.

    Why India is a development economics outlier?

    • Software industry despite being low-income country: Few models predict a $2,500 per-capita income country with five million people writing software and internet data costs per GB at 3 percent of US levels.
    • Digital identity: In India there are1.2 billion people empowered with paperless digital identity verification.
    • Digital economy: India also witnesses 3.5 billion real-time monthly digital payments.
    • Attraction for Investment: $10 billion in private equity raised in July, and a $3 trillion public market capitalization.
    • Harvard’s Ricardo Hausman believes, the only sustained predictor of sustained economic success is economic complexity and suggests that India’s prosperity is less than our economic complexity would predict.

    India’s software industry

    • Our software industry is an oasis of high productivity — 0.8 per cent of India’s workers generate 8 percent of GDP.
    • The mandatory global digital literacy program and digital investment super-cycle sparked by Covid will double our software employment in five years.
    • Our software industry’s talent, alumni, and global engagement — 50,000 tech startups that have raised over $90 billion since 2014 from 500+ institutional investors.
    • India’s software services industry and tech startups are each estimated to be worth about $400 billion today which is expected to grow to $1 trillion by 2025.

    Why did India’s manufacturing sector fail to perform while its software industry flourished?

    • One of the reasons is the different regulatory thought worlds of the Software Technology Parks India rules of 1991 (STPI) and the Special Economic Zones Act of 2005 (SEZ).
    • STPI’s genius was simplicity. It allowed rebadging existing assets, embraced trust over suspicion, and adopted self-reporting that was largely paperless, presence less, and cashless.
    • SEZs largely replicated the regulatory cholesterol and distrust that has made India unfavorable for employment-intensive industries.

    Way forward

    • Productivity: Raising per-capita needs high productivity manufacturing and domestic services firms that disrupt our low-level equilibrium of labor handicapped without capital and capital handicapped without labor.
    • Opportunities for India: Until recently, China’s tech industry seemed unstoppable — half of their 160 unicorns operate in AI, big data, and robotics. But this is changing.
    • Over 50 recent regulatory actions against China’s tech industry have already cost investors over $1 trillion.
    • This offers an opportunity for India due to its attractiveness to factories, multinationals, startups, venture capital, and pension funds.
    • Replicate regulatory trust and simplicity offered to the technology industry to other sectors: India’s global soft power by reaching revenue and valuation possibilities that felt unimaginable — have come before physical infrastructure, farm employment reduction, and higher women’s labor force participation.
    • Massifying our prosperity needs massive formal, non-farm job creation.
    • Creating the productive firms that will offer these jobs to our young needs replicating the regulatory trust and simplicity that our technology industry enjoys in the rest of our economy.

    Conclusion

    Imagine India@100 if we cut regulatory cholesterol today and spent the next 25 years unleashing the entrepreneurial energies of 1.3 billion Indians — 65 percent of whom are below 35 years old.

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  • Taxing interest on Provident Fund

    Following its Budget announcement in February, the Finance Ministry has now notified the rules for taxing interest income on contributions made to the Employees’ Provident Fund (EPF) beyond Rs 2.5 lakh (for private-sector employees) and Rs 5 lakh (for government sector employees).

    What is Provident Fund?

    • Provident Fund is a government-managed retirement savings scheme for employees, who can contribute a part of their savings towards their pension fund, every month.
    • These monthly savings get accumulated every month and can be accessed as a lump sum amount at the time of retirement, or end of employment.
    • Since the provident fund money consists of a large chunk of savings, it can be used to grow your retirement corpus easily.

    Types of provident funds

    There are mainly three different types of PFs, which are as follows:

    1. General provident fund: It is a type of PF which is maintained by governmental bodies, including local authorities, the Railways, and other such bodies. Thus, these types of PFs are mainly defined by government bodies.
    2. Recognized provident fund: It is the one that applies to all privately-owned organizations that contain more than 20 employees. Moreover, holding a rightful claim to the PF associated with your organization, you will be given a UAN or Universal Account Number. This enables you to transfer your PF funds from one employer to another whenever you move from one occupation to another.
    3. Public provident fund: It is defined by the voluntary nature of investment on the part of the employee. The PPF is also associated with a minimum deposit of Rs. 50 and a maximum amount of Rs. 1.5 lakhs. The PPF has a lock-in period of 15 years.

    What is the tax on EPF contributions?

    • In February, the Budget proposed that tax exemption will not be available on interest income on PF contributions exceeding Rs 2.5 lakh in a year.
    • Although this has been a concern for salaried individuals contributing to EPF, it will impact only those who contribute more than Rs 2.5 lakh in a year.
    • It will not affect their existing corpus or the aggregate annual interest on that.
    • In March, the government proposed to double the cap on contribution from Rs 2.5 lakh to Rs 5 lakh for tax-exempt interest income where there is no contribution by the employer.
    • With this, the government provided relief for contributions made to the General Provident Fund that is available only to government employees and there is no contribution by the employer.

    Why tax the PF?

    • There have been instances where some employees are contributing huge amounts to these funds and are getting the benefit of tax exemption at all stages — contribution, interest accumulation, and withdrawal.
    • With an aim to exclude high net-worth individuals (HNIs) from the benefit of high tax-free interest income on their large contributions, the government has proposed to impose a threshold limit for tax exemption.
    • This will be applicable for all contributions beginning April 1, 2021.

    How will it get taxed?

    • For an individual in the higher tax bracket of 30%, the interest income on contribution above Rs 2.5 lakh would get taxed at the same marginal tax rate.
    • What this means is that if an individual contributes Rs 3 lakh every year to the provident fund (including the voluntary PF contribution) then the interest on his contribution above Rs 2.5 lakh —that is, Rs 50,000 — will be taxed.
    • So, the interest income of Rs 4,250 (8.5% on Rs 50,000) will be taxed at the marginal rate. If the individual falls in the 30% tax bracket, he/ she will have to pay a tax of Rs 1,325.
    • For an individual contributing Rs 12 lakh in a year, the tax will be applicable on interest income on Rs 9.5 lakh (Rs 12 lakh minus Rs 2.5 lakh). In this case, the tax liability would amount to Rs 25,200.

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  • [pib] Formation of Blue Straggler

    Carrying out the first-ever comprehensive analysis of blue stragglers, Indian researchers found that half of the blue stragglers in their sample are formed through mass transfer from a close binary companion star.

    What are Blue Stragglers?

    • A blue straggler is a main-sequence star in an open or globular cluster that is more luminous and bluer than stars at the main sequence turnoff point for the cluster.
    • The most likely explanation is that blue stragglers are the result of stars that come too close to another star or similar mass object and collide.
    • The newly-formed star has thus a higher mass and occupies a position on the HR diagram which would be populated by genuinely young stars.
    • One-third of them are likely formed through collisions of 2 stars, and the remaining are formed through interactions of more than 2 stars.

    How are they formed?

    • A bunch of stars born at the same time from the same cloud form a star cluster.
    • As time passes, each star evolves differently depending on its mass.
    • The most massive and bright stars evolve and move off the main sequence creating a bend in their track, known as the turnoff.
    • Stars above this bend or brighter and hotter stars are not expected in a cluster, as they leave the main sequence to become red giants.
    • But in 1953, Allan Sandage found that some stars seem to be hotter than the turnoff of the parent cluster.

    Behind the nomenclature

    • Initially, these blue stars still straggling above the turnoff were not part of these clusters.
    • However, later studies confirmed that these stars are indeed cluster members, and they were termed “Blue Stragglers”.
    • The only probable way these stars can still be present in these clusters is if they have somehow acquired extra mass along the way while on the main sequence.
    • Confirming the mechanisms of the mass gain required a study using a large sample of blue-straggler stars and estimates of the mass they have gained.

    What have Indian researchers found?

    • Research showed that these stars are primarily present in the older and massive star clusters. And due to their large mass, they are segregated towards the centre of the clusters.
    • The researchers compared the mass of the blue stragglers to the mass of the turnoff stars (which are the most massive ‘normal’ stars in the cluster) and predicted the formation mechanisms.
    • The study will help improve understanding of these stellar systems to uncover exciting results in studies of large stellar populations, including galaxies.
    • Following these findings, the researchers are conducting detailed analyses of individual blue stragglers in the catalog to obtain their stellar properties.

  • Behler Turtle Conservation Award

    Indian biologist Shailendra Singh has been awarded the Behler Turtle Conservation Award for bringing three critically endangered turtle conservation species back from the brink of extinction.

    Behler Turtle Conservation Award

    • The Award is a major annual international award honoring excellence in the field of tortoise and freshwater turtle conservation and biology, and leadership in the chelonian conservation and biology community.
    • It is co-presented by the Turtle Survival Alliance (TSA), the IUCN/SSC Tortoise and Freshwater Turtle Specialist Group (TFTSG) among others.
    • It is widely considered the “Nobel Prize” of turtle conservation and biology.

    Citation for the 2021 Award

    • For some species, such as the Red-crowned Roofed Turtle (Batagur kachuga), Northern River Terrapin (Batagur Baska), and Black Softshell Turtle (Nilssonia nigricans) Dr. Singh and his team’s efforts are the last hope for their wild survival in the country.
    • In just 15 years, there are few individuals that have made such monumental contributions to turtle conservation.

    Turtles in India

    • The Northern River Terrapin (Batagur Baska) is being conserved at the Sunderbans; the Red-crowned Roofed Turtle (Batagur kachuga) at Chambal; and the Black Softshell Turtle (Nilssonia nigricans) at different temples in Assam.
    • These critically endangered turtles are being conserved as a part of TSA India’s research, conservation breeding and education programme in different parts of the country.
    • There are 29 species of freshwater turtles and tortoises in the country.

    About Turtle Survival Alliance (TSA)

    • The TSA was formed in 2001 as an International Union for Conservation of Nature (IUCN) partnership for sustainable captive management of freshwater turtles and tortoises.
    • This alliance arose in response to the rampant and unsustainable harvest of Asian turtle populations to supply Chinese markets, a situation known as the Asian Turtle Crisis.

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  • Our banks are mispricing capital

    Context

    We have a situation in India today where the policy repo rate has been kept low. Banks are just about managing their non-performing assets (NPAs) and there is uncertainty in the air.

    Mispricing of capital by banks

    • There are different components of the cost of funds for banks, which are captured by the MCLR or marginal cost of funds-based lending rate.
    • For every ₹100 deposits that enter the banking system, there are different accompanying costs for the system.
    • These are deposit costs, provisioning for NPAs, return on assets (ROA or minimum profit), and the regulatory cost of cash reserve and statutory liquidity ratio balances (CRR and SLR) that perforce have to be held.
    • Adding these components, the basic cost works out to be 8.9%, which should be the rate at which incremental lending should take place.
    • By offering loans at a much lower rate of 7.23%, the system is actually mispricing capital.
    • It may be noted that deposit rates have been compressed to a very large degree and so this cost of 4% is very low.
    • Banks do have the advantage of getting free demand deposits and the right to offer differential rates on saving accounts.
    • Clearly, deposit-holders are subsidizing borrowers quite significantly.

    Issue of NPA provisioning in India

    • In the past couple of years, provisions as a proportion of NPAs have averaged 30-40%.
    • As NPAs increase, ideally, banks should load this cost onto their borrowers.
    • But that rarely happens in India. Instead, it is taken on banks’ books and gets reflected in their balance sheets.
    • If NPAs were kept in the region of, say, 4-5% of assets, it would have been possible to bring the cost down to 1.5% (from 3%), which would then have justified the present MCLR.

    Low return on assets (ROA)

    • The ideal return norm is 1%, which should be derived from all assets.
    • This does not happen for banks’ investment portfolios, and the value imputed here is only for loans.
    • The ROA for banks is abysmally low, as this aspect does not go into the pricing of products on the asset side.
    • Deposit costs have been driven down as savers don’t have a choice.
    • But a commensurate return does not materialize in the loan books of banks.

    Cost of regulations

    • The CRR component gets no compensation, while the SLR part earns around 6%, which is the average cost of fresh borrowing for the Union government.
    • While these numbers vary across banks, the minimum rate of 8.9% would hold for the system, which will vary by the level of NPAs.
    • The concept of linking benchmarks to certain loans further misprices fresh lending, as those loans are not ideal anchors to use, for they are being manually driven downwards by a deluge of liquidity in the system after the pandemic.
    • Excess liquidity of ₹4-7 trillion a day since April 2020 has meant banks have been placing funds costing them 8.9% with the central bank which gives them just 3.35%.
    • This is eventually borne by bank shareholders.

    Implications

    • With rather rigid policies on corporate lending to avert possible NPAs, banks have preferred lending to the retail segment, which is less risky, and small businesses, backed by the Centre’s credit guarantee.
    • The central bank’s government-bond buying programme to provide liquidity has been successful.
    • But in the absence of fructification of lending and a continuous rollover of funds at the reverse-repo window, Indian banks are bearing a negative carry trade, with a 6% return traded for just 3.35%.

    Conclusion

    Banks must price capital appropriately and not get overly influenced by arguments in favor of cheap credit or the fact that loans are cheaper in the West. We need to get practical on this issue.

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    Back2Basics: CRR and SLR

    • Cash Reserve Ratio, or popularly known as CRR is a compulsory reserve that must be maintained with the Reserve Bank of India.
    • Every bank is required to maintain a specific percentage of their net demand and time liabilities as cash balance with the RBI.
    •  The banks are not allowed to use that money, kept with RBI, for economic and commercial purposes.
    • It is a tool used by the apex bank to regulate the liquidity in the economy and control the flow of money in the country.
    • Statutory Liquidity Ratio, shortly called as SLR also an obligatory reserve to be kept by the banks, as prescribed securities, based on a certain percentage of net demand and time liabilities.
    •  It is used to maintain the stability of banks by limiting the credit facility offered to its customers.
    • CRR is maintained in the form of cash while the SLR is to be maintained in the form of gold, cash, and government-approved securities.