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  • Dilution of efficiency based principles and its implications for finacial markets

    The article discusses the themes of the recently published books by Viral Acharya and Urjit Patel. Both the books deal with the issues with the financial markets in India

    Context

    • Two recently published books by Viral Acharya and Urjit Patel throws light on the issues with India’s finance market and role of RBI and the government.

    Importance of financial markets

    • Banks along with bond and equity markets oversee the matching of savers with borrowers.
    • Without financial markets, businesses would be restricted to investing out of retained earnings alone.
    • The financial markets have to satisfy the return appetites of savers while minimising their risk exposure.

    Undue preference to fiscal interest of the government

    • A major theme of Acharya’s book is the rampant subjugation of the financial and monetary infrastructure to the fiscal interests of the government.
    • Consider, for example, the conduct of monetary policy.
    • Since bank assets are marked to market, cuts in interest rates induce treasury gains for banks that effectively recapitalises them.
    • Consequently, rate cuts are preferred by governments needing to inject capital into public sector banks (PSBs).
    • For the same reasons, liquidity injections, which raise bond prices, are preferred to liquidity absorptions.
    • Fiscal compulsions of government can induce liquidity policies that have the opposite effect on the rate-setting by the MPC.
    • This contradiction is further complicated by the fact that the RBI is also the debt management agency for the government.
    • As a debt management agency, RBI’s key tasks is to sell government bonds at the highest possible price.
    • Pressures for regulatory forbearance in recognising NPAs often arise from the government wanting to avoid having to recapitalise PSBs.
    • The sameexplains the fact that stock exchanges in India having a 30-day disclosure norm for registered borrowers who default on their bank loans.
    • The standard in developed capital markets is immediate disclosure.
    • But that would induce an overnight rating downgrade of the concerned borrower thereby triggering additional capital provisioning needs for the lending bank.

    Conflict in government owning the PSBs

    • Patel’s book deals with conflicts inherent in the state owning the banks that control about three-fourth of total banking assets in India.
    • The primary problem with PSBs is that governments have used them as tools for macroeconomic management.
    • PSBs are regularly used for resource mobilisation to finance fiscal deficits.
    • The government often announces credit policies rather than having the banks allocate credit based on risk-return management criteria.
    • PSBs are the favoured instrument for meeting employment targets, supporting farmers through loan write-offs, etc.

    What are the implications of government owning PSBs

    • This kind of state interface naturally induces extreme levels of moral hazard in the behaviour of both debtors and creditors.
    • PSBs are not incentivised to exercise due diligence since they expect regulatory forbearance and recapitalisation in the event of rising NPAs.
    • The dilution of efficiency-based principles for banking has implications for all borrowers.
    • Creditworthy borrowers pay the risk premia to cover the riskiness due to unhealthy borrowers.
    • The worsening risk pool of borrowers is partly to blame for the fact that long term borrowing rates have remained stubbornly high despite repeated rate cuts by the MPC over the past 18 months.

    3 Problems and 3 Reforms

    Problems

    • There are three obvious problems with the existing architecture.
    • The first is the state ownership of banks.
    • The second is the chronically high fiscal deficit run by the consolidated public sector.
    • The third is the widespread perception that market regulators work under close government direction. 

    Reforms

    • Dealing with this will require, at a minimum, three reforms.
    • First, there has to be a wholehearted attempt at privatisation of PSBs.
    • Second, the RBI needs to be relieved of its public debt management role.
    • Third, the RBI has to be empowered to act independently of the government.

    Conclusion

    The growth of firms, which is a key driver of productivity and growth, requires well-functioning financial markets. India has a lot of work to do.

    Back2Basics: How cuts in interest rates induce treasury gains for banks?

    • Falling rates across the debt markets increase the demand for instruments that pay higher interest.
    • At this stage, prices of bonds which banks had bought when interest rates were high rise.
    • Hence, the value of government securities that banks have bought for the SLR requirement rises.
    • This increases profits as banks record the market value of these securities in their books.
    • Under this process, called marking to market, organisations record profits/losses in their books on a daily basis without actually booking any profit or loss.
    • So, more SLR bonds the bank holds, the higher its mark-to-market profit.
    • The other reasons bank profits rise when interest rates fall are pick-up in growth as companies borrow at lower rates as well as improvement in liquidity.

    Source:-

    https://www.businesstoday.in/moneytoday/banking/banks-to-make-huge-treasury-gains-on-bonds-on-rbi-rate-cut/story/193552.html

  • Explained: Auction theory

    This year, the Nobel Prize for Economics was awarded to Paul R Milgrom and Robert B Wilson for “improvements to auction theory and inventions of new auction formats”.

    Do you remember the 2G spectrum scam, Coalgate scam etc. that rocked the nation? Can you relate this auction theory for bidding public assets to private entities?

    What is Auction?

    • Essentially, it is about how auctions lead to the discovery of the price of a commodity.
    • Auction theory studies how auctions are designed, what rules govern them, how bidders behave and what outcomes are achieved.
    • When one thinks of auctions, one typically imagines the auction of a bankrupt person’s property to pay off his creditors.
    • Indeed, this is the oldest form of auction. This simple design of such an auction — the highest open bidder getting the property (or the commodity in question) — is intuitively appealing as well.

    Evolving definitions of auction

    • Over time, and especially over the last three decades, more and more goods and services have been brought under auction.
    • The nature of these commodities differs sharply. For instance, a bankrupt person’s property is starkly different from the spectrum for radio or telecom use.
    • Similarly, carbon dioxide emission credits are quite different from the spot market for buying electricity, which, in turn, is quite different from choosing which company should get the right to collect the local garbage.
    • In other words, no one auction design fits all types of commodities or seller.

    The Auction Theory

    Three key variables need to be understood before we move to actual propositions.

    (1) Rules of the auction

    • Imagine participating in an auction. Your bidding behaviour is likely to differ if the rules stipulate open bids as against closed/sealed bids.
    • The same applies to single bids versus multiple bids, or whether bids are made one after another or everyone bids at the same time.

    (2) Commodity or service

    • The second variable is the commodity or service being put up for auction. In essence, the question is how each bidder values an item.
    • This is not always easy to ascertain. In terms of telecom spectrum, it might be easier to peg the right value for each bidder because most bidders are likely to put the spectrum to the same use.
    • This is called the “common” value of an object.

    (3) Uncertainty

    • The third variable is uncertainty.
    • For instance, which bidder has what information about the object, or even the value another bidder associates with the object.

    The theory

    • Wilson developed the theory for auctions of objects with a common value — a value which is uncertain beforehand but, in the end, is the same for everyone”.
    • Wilson showed what the “winner’s curse” is in an auction and how it affects bidding.
    • As shown in the illustration, it is possible to overbid — $50 when the real value is closer to $25. In doing so, one wins the auction but loses out in reality.
    • Milgrom “formulated a more general theory of auctions that not only allows common values but also private values that vary from bidder to bidder”.
    • He analysed the bidding strategies in a number of well-known auction formats, demonstrating that a format will give the seller higher expected revenue when bidders learn more about each other’s estimated values.

    Significance of Auction theory

    • Throughout history, countries have tried to allocate resources in various ways.
    • Some have tried to do it through political markets, but this has often led to biased outcomes. For Ex: The rationing of essential goods worked in State-controlled economies. People who were close to the bureaucracy and the political class came out ahead of others.
    • Lotteries are another way to allocate resources, but they do not ensure that scarce resources are allocated to people who value it the most.
    • Auctions, for a good reason, have been the most common tool for thousands of years used by societies to allocate scarce resources.
    • When potential buyers compete to purchase goods in an auction, it helps sellers discover those buyers who value the goods the most.
    • Further, selling goods to the highest bidder also helps the seller maximise his or her revenues. So, both buyers and sellers benefit from auctions.
    • Whether it is the auction of spectrum waves or the sale of fruits and vegetables, auctions are at the core of allocation of scarce resources in a market economy.

    What are the criticisms levelled against auctions and what are the economists contribution?

    1.Issue of Winner’s Curse

    • The most common one is that auctions can lead buyers to overpay for resources whose value is uncertain to them.
    • This criticism, popularly known as the ‘winner’s curse’, is based on a study that showed how buyers who overpaid for U.S. oil leases in the 1970s earned low returns. Dr. Wilson was the first to study this matter.
    • The rational bidders may decide to underpay for resources in order to avoid the ‘winner’s curse’, and Dr. Wilson argued that sellers can get better bids for their goods if they share more information about it with potential buyers

    2.Auction formats

    • Economists traditionally working on auction theory believed that all auctions are the same when it comes to the revenues that they managed to bring in for sellers. The auction format, in other words, did not matter.
    • This is known as the ‘revenue equivalence theorem’.
    • But Dr. Milgrom showed that the auction format can actually have a huge impact on the revenues earned by sellers.
    • The most famous case of an auction gone wrong for the seller was the spectrum auction in New Zealand in 1990.
    • In what is called a ‘Vickrey auction’, where the winner of the auction is mandated to pay only the second-best bid, a company that bid NZ$1,00,000 eventually paid just NZ$6 and another that bid NZ$70,00,000 only paid NZ$5,000.
    • In particular, Dr. Milgrom showed how Dutch auctions, in which the auctioneer lowers the price of the product until a buyer bids for it, can help sellers earn more revenues than English auctions.
    • In the case of English auctions, the price rises based on higher bids submitted by competing buyers. But as soon as some of the bidders drop out of the auction as the price rises, the remaining bidders become more cautious about bidding higher prices.

    Conclusion

    • The contributions of Dr. Milgrom and Dr. Wilson have helped governments and private companies design their auctions better.
    • This has, in turn, helped in the better allocation of scarce resources and offered more incentives for sellers to produce complex goods.

  • Mars ‘Opposition’ Event

    Due to an event referred to as “opposition”, which takes place every two years and two months, Mars will shine the brightest.

    Try this question from CSP 2017:

    Q.Which region of Mars has a densely packed river deposit indicating this planet had water 3.5 billion years ago?

    (a) Aeolis Dorsa (b) Tharsis (c) Olympus Mons (d) Hellas

    What is the Opposition Event?

    • ‘Opposition’ is the event when the sun, Earth and an outer planet (Mars in this case) are lined up, with the Earth in the middle.
    • The time of opposition is the point when the outer planet is typically also at its closest distance to the Earth for a given year, and because it is close, the planet appears brighter in the sky.
    • An opposition can occur anywhere along Mars’ orbit, but when it happens when the planet is also closest to the sun, it is also particularly close to the Earth.
    • It will outshine Jupiter, becoming the third brightest object (moon and Venus are first and second, respectively) in the night sky during the month of October.

    When does opposition happen?

    • Earth and Mars orbit the sun at different distances (Mars is farther apart from the sun than Earth and therefore takes longer to complete one lap around the sun).
    • In fact, the opposition can happen only for planets that are farther away from the sun than the Earth.
    • In the case of Mars, roughly every two years, the Earth passes between sun and Mars, this is when the three are arranged in a straight line.
    • Further, as the Earth and Mars orbit the sun, there comes a point when they are on the opposite sides of it, and hence very far apart. At its farthest, Mars is about 400 million km from the Earth.
    • In case of opposition, however, Mars and Sun are on directly opposite sides of the Earth. In other words, the Earth, sun and Mars all lie in a straight line, with the Earth in the middle.

    Logic behind the name

    • As per NASA, from an individual’s perspective on the Earth, Mars rises in the east and after staying up all night, it sets in the west just as the sun rises in the east and sets in the west.
    • Because from the perspective on Earth, the sun and Mars appear to be on the opposite sides of the sky, Mars is said to be in “opposition”.
    • Essentially, the opposition is a reference to “opposing the sun” in the sky.

  • National Supercomputing Mission (NSM)

    The Centre for Development of Advanced Computing (C-DAC) has launched the second phase of the ambitious National Supercomputing Mission (NSM).

    Tap to read more about National Supercomputing Mission (NSM):

    [pib] National Supercomputing Mission (NSM)

    National Supercomputing Mission (NSM)

    • NSM is a proposed plan by GoI to create a cluster of seventy supercomputers connecting various academic and research institutions across India.
    • In April 2015 the government approved the NSM with a total outlay of Rs.4500 crore for a period of 7 years.
    • The mission was set up to provide the country with supercomputing infrastructure to meet the increased computational demands of academia, researchers, MSMEs, and startups by creating the capability design, manufacturing, of supercomputers indigenously in India.
    • Currently, there are four supercomputers from India in the Top 500 list of supercomputers in the world.

    Aims and objectives

    • The target of the mission was set to establish a network of supercomputers ranging from a few Tera Flops (TF) to Hundreds of Tera Flops (TF) and three systems with greater than or equal to 3 Peta Flops (PF) in academic and research institutions of National importance across the country by 2022.
    • This network of Supercomputers envisaging a total of 15-20 PF was approved in 2015 and was later revised to a total of 45 PF (45000 TFs), a jump of 6 times more compute power within the same cost and capable of solving large and complex computational problems.

    What is a Supercomputer?

    • A supercomputer is a computer with a high level of performance as compared to a general-purpose computer.
    • The performance of a supercomputer is commonly measured in floating-point operations per second (FLOPS) instead of million instructions per second (MIPS).
    • Since 2017, there are supercomputers which can perform over a hundred quadrillion FLOPS (petaFLOPS).
    • Since November 2017, all of the world’s fastest 500 supercomputers run Linux-based operating systems.

    Why do we need supercomputers?

    • Tackle problems: Developed and almost-developed countries have begun ensuring high investments in supercomputers to boost their economies and tackle new social problems.
    • These high-performance computers can simulate the real world, by processing massive amounts of data, making cars and planes safer, and more fuel-efficient and environment-friendly.
    • They also aid in the extraction of new sources of oil and gas, development of alternative energy sources, and advancement in medical sciences.
    • Disaster Management: Supercomputers have also helped weather forecasters to accurately predict severe storms, enable better mitigation planning and warning systems.
    • They are also used by financial services, manufacturing and internet companies and infrastructure systems like water-supply networks, energy grids, and transportation.
    • Future applications of artificial intelligence (AI) also depend on supercomputing.
    • Due to the potential of this technology, countries like the US, China, France, Germany, Japan, and Russia have created national-level supercomputing strategies and are investing substantially in these programmes.

    When did India initiate its efforts to build supercomputers?

    • India’s supercomputer programme initiated in the late 1980s, when the United States ceased the export of a Cray Supercomputer due to technology embargos.
    • This resulted in India setting up C-DAC in 1988, which in 1991, unveiled the prototype of PARAM 800, benchmarked at 5 Gflops. This supercomputer was the second-fastest in the world at that time.
    • Since June 2018, the USA’s Summit is the fastest supercomputer in the world, taking away this position from China.
    • As of January 2018, Pratyush and Mihir are the fastest supercomputers in India with a maximum speed of Peta Flops.

  • Need for guidelines for gene-editing research in India

    The Nobel Prize in Chemistry for 2020 has been awarded for the discovery of CRISPR Cas9. The two scientists have pioneered the use of CRISPR  – Cas9 (CRISPR-associated protein 9) system as a gene-editing tool.

    Background of discovery of CRISPR

    • In 1987a group of Japanese researchers observed an unusual homologous DNA sequence bearing direct repeats with spacing in a eubacterial gene.
    • In subsequent years CRISPR was discovered and showed to be a bacterial adaptive immune system and to act on DNA targets.
    • A notable discovery on the use of CRISPR as a gene-editing tool was by a Lithuanian biochemist, Virginijus Šikšnys, in 2012.
    • Šikšnys showed that Cas9 could cut purified DNA in a test tube, the same discovery for which both Charpentier and Doudna were given the credit.
    • Thus, the exclusion of Siksnys from this year’s Nobel is going to raise discussions.

    Issue of gene-edited babies

    • The world was alarmed by such a mission in 2018 when Chinese scientist edited genes in human embryos using the CRISPR-Cas9 system which resulted in the birth of twin girls.
    • The incident became known as the case of the first gene-edited babies of the world.
    • Following the incident, the World Health Organization formed a panel of gene-editing experts.
    • The expert panel suggested a central registry of all human genome editing research in order to create an open and transparent database of ongoing work.

    Guidelines and regulations in India

    • In India, several rules, guidelines, and policies are notified under the Environment Protection Act, 1986 to regulate genetically modified organisms.
    • The above Act and the National Ethical Guidelines for Biomedical and Health Research involving human participants, 2017, by the Indian Council of Medical Research (ICMR), and the Biomedical and Health Research Regulation Bill implies regulation of the gene-editing process.
    • This is especially so in the usage of its language “modification, deletion or removal of parts of heritable material”.
    • However, there is no explicit mention of the term gene editing.

    Consider the question “What is CRISPR-Cas9? How it helps in the gene-editing? What are the concerns with use of it for gene-editing?”

    Conclusion

    It is time that India came up with a specific law to ban germline editing and put out guidelines for conducting gene-editing research giving rise to modified organisms.

    Back2Basics: What is CRISPR?

    • CRISPRs: “CRISPR” stands for “clusters of regularly interspaced short palindromic repeats.”
    • It is a specialized region of DNA with two distinct characteristics: the presence of nucleotide repeats and spacers.
    • Repeated sequences of nucleotides — the building blocks of DNA — are distributed throughout a CRISPR region.
    • Spacers are bits of DNA that are interspersed among these repeated sequences.
    • In the case of bacteria, the spacers are taken from viruses that previously attacked the organism.
    • They serve as a bank of memories, which enables bacteria to recognize the viruses and fight off future attacks.

  • Towards cleaner air in Delhi

    The article suggests the three-pronged strategy to deal with the emission from transportation and highlights the importance of coordination at various level to deal with the issue of pollution.

    Anti-pollution campaign in Delhi

    • With air pollution returning to pre-COVID levels, the Delhi administration has launched a major anti-pollution campaign this month.
    • The campaign is focused on cutting the deadly smoke from thermal plants and brick kilns in the National Capital Region as well as on chemical treatment of stubble burning from nearby States.

    Abating emission from transportation

    • Delhi’s long-term solution will depend importantly also on abating emissions from transportation.
    • Delhi needs a 65% reduction to meet the national standards for PM2.5.
    • Vehicles, including trucks and two-wheelers, contribute 20%-40% of the PM2.5 concentrations.
    • Tackling vehicle emissions would be one part of the agenda, as in comparable situations in Bangkok, Beijing, and Mexico City.

    Three-part action to combat emissions from transportation

    • A three-part action comprises emissions standards, public transport, and electric vehicles.

    1) Stricter enforcement of emission controls

    • Two-wheelers and three-wheelers were as important as cars and lorries in Beijing’s experience.
    • Bangkok ramped up inspection and maintenance to cut emissions.
    • The first order of business is to implement the national standards.

    2) Strengthening public transport

    • Bus Rapid Transit (BRT)  around the world show how the sizeable investment cost is more than offset by the benefits, and that financing pays off.
    • Delhi has lessons from its BRT experience in designating better BRT lanes, improving the ticketing system and synchronising with the Metro.
    • The Supreme Court’s ruling to increase Delhi’s bus fleet and align it with the Metro network must be carried out.
    • The ‘odd-even’ number plate policy can help, but the system should reduce exemptions, allow a longer implementation period, and complement it with other measures.

    3) Adoption of electric vehicle: A long term solution

    •  Subsidies and investment will be needed to ensure that EVs are used to a meaningful scale.
    • The Delhi government’s three-year policy aims to make EVs account for a quarter of the new vehicles registered in the capital by 2024.
    • EVs will gain from purchase incentives, scrappage benefits on older vehicles, loans at favourable interest and a waiver of road taxes.

    Need for coordination at various level

    • Transport solutions need to be one part of pollution abatement that includes industry and agriculture.
    • Delhi’s own actions will not work if the pollution from neighbouring States is not addressed head on.
    • Technical solutions need to be underpinned by coordination and transparency across Central, State, and local governments.
    • Public opinion matters.
    • Citizen participation and the media are vital for sharing the message on pollution and health, using data such as those from the Central Pollution Control Board.

    Conclusion

    • It is a matter of prioritising people’s health and a brighter future. Once the pandemic is over, Delhi must not stumble into yet another public health emergency. The time to act is now.

  • Indian Sat: Another satellite made by students

    An experimental satellite developed by three students of Karur (TN) has been selected for launch in sub-orbital space by NASA.

    Try this PYQ:

    Q.The term ‘IndARC’, sometimes seen in the news, is the name of:

    (a) An indigenously developed radar system inducted into Indian Defence

    (b) India’s satellite to provide services to the countries of Indian Ocean Rim

    (c) A scientific establishment set up by India in Antarctic region

    (d) India’s underwater observatory to scientifically study the Arctic region

    Indian Sat

    • The Indian Sat is made of reinforced graphene polymer. It is 3 cm in size and weighs 64 gm.
    • It has its own radio frequency communication to transmit and receive a signal from earth to outer space. The solar cells attached to the satellite generate power for it.
    • The photographic film will absorb and measure the cosmic radiation inside the rocket.
    • It would study the effect of reinforced graphene polymers in microgravity. It would be in sub-orbital space flight for a few minutes before landing in the ocean.

    What is micro-gravity?

    • The term micro-g environment is more or less synonymous with the terms weightlessness and zero-g, but with an emphasis on the fact that g-forces are never exactly zero—it is just very small.
    • On the ISS, for example, the small g-forces come from tidal effects, gravity from objects other than the Earth, such as astronauts, the spacecraft, and the Sun, and, occasionally, air resistance.

    Back2Basics: Femto-satellites

    • Femto-satellites are satellites with a mass lower than 100 grams.
    • These new categories of satellites are, by concept, low cost devices if they are based on Commercial-of-the-Shelf (COTS) components.
    • Some examples of applications are related to low-cost missions with a short time of development.

     Kalamsat

    • Kalamsat was a communication satellite with a life span of two months launched in 2017.
    • The nanosatellite is a 10cm cube weighing 1.2 kg.
    • It will be the first to use the rocket’s fourth stage as an orbital platform.
    • The fourth stage will be moved to higher circular orbit so as to establish an orbital platform for carrying out experiments.
    • It is named after former Indian president Dr APJ Abdul Kalam and was built by an Indian high school student team, led by Rifath Sharook, an 18-year-old from the Tamil Nadu town of Pallapatti.
    • It is the world’s lightest and first-ever 3D-printed satellite.

  • [pib] Rashtriya Kamdhenu Aayog

    Rashtriya Kamdhenu Aayog (RKA) has started a nationwide campaign to celebrate “Kamdhenu Deepawali Abhiyan” this year on the occasion of Deepawali festival.

    Try this PYQ:

    Q.Consider the following statements:

    1. Agricultural soils release nitrogen oxides into the environment.
    2. Cattle release ammonia into the environment.
    3. Poultry industry releases reactive nitrogen compounds into the environment.

    Which of the statements given above is/are correct?

    (a) 1 and 3 only

    (b) 2 and 3 only

    (c) 2 only

    (d) 1, 2 and 3

    Rashtriya Kamdhenu Aayog (RKA)

    • RKA has been constituted by PM for the conservation, protection and development of cows and their progeny and for giving direction to the cattle development programmes.
    • It is a high powered permanent body to formulate policy and to provide direction to the implementation of schemes related to cattle so as to give more emphasis on livelihood generation.

    Why need RKA?

    • Livestock economy sustains nearly 73 million households in rural areas.
    • Even though, the country is the largest producer of milk, the average milk yield in India is only 50% of the world average.
    • The low productivity is largely due to deterioration in genetic stock, poor nutrition and unscientific management.

  • Economic recovery and its discontents

    The article highlights the measures taken by the RBI in the recent MPC meeting to assure the buyers of the Government bonds and ensuring the policy rate transmission.

    Dealing with the rate transmission issue and why it matters

    • The gap between the repo rate and the average lending rate of banks is at a record high.
    • So, the RBI and the MPC focused on improving rate transmission.
    • This gap can be broken up into two parts:
    • The first is the gap between the RBI-set repo rate and the rate at which the government of India borrows (the GSec yield).
    • It is also called the “term premium” can be influenced by the RBI’s actions.
    • The second is the gap between the GSec yield and the rate at which individuals or private firms borrow.
    • This gap reflects risk aversion in the financial system and a lack of capacity.
    • The RBI has avoided directly influencing the term premium, perhaps to maintain its credibility and independence, staying clear of accusations that it is financing the government’s fiscal deficit.
    • However, unless the rate at which the government borrows comes down borrowing costs for the whole economy will stay elevated.

    Challenge of Balance-of-Payment surplus (i.e. excess dollars)

    • Over the past few months, the country’s foreign currency reserves have been growing at an unprecedented rapid pace.
    • This means that India is getting far more dollars than it needs. Three factors are responsible for this.
    • 1) Some short-term factors responsible are weak imports and a faster normalisation of exports.
    • 2) There have also been structural shifts in India’s economic policy which point to a persistent BoP surplus.
    • In addition to low energy prices, policies supporting Atmanirbhar Bharat mean lower imports and the push towards making India a participant in global value chains mean higher exports.
    • 3) At the same time, India’s capital account is being opened up: The special-category government of India bonds, for example.

    Why BoP surplus is opportunity

    • When the excess dollar inflows turn into a deluge, as they have over the past six months, the supply of rupees in the domestic economy also becomes excessive.
    • If the RBI can direct this surplus into government bonds, it can maintain its independence and credibility, and at the same time achieve its target of rate transmission.

    Measures by the RBI to assure the bond market

    • The buyers of government bonds need to feel reassured of not getting hurt by the volatility in bond prices.
    • When bond prices rise, the yields fall, and vice versa.
    • Banks parking trillions of rupees with the RBI at 3.35 per cent overnight would earn nearly 6 per cent if they bought government bonds.
    • That they did not was because they were afraid of the bond prices falling, which would offset the gains from higher rates.
    • The increase in the Hold-To-Maturity limits by the RBI  by one year to March 2022, has assured the banks that they need not fear booking interim losses if bond prices are volatile.
    • The announcement that the RBI would purchase state and central government bonds on the market (even if in small sizes) would provide further comfort.
    • The change in assessment of inflation should help buyers of government bonds take the risk.
    • Banks or other bond investors that refrained from purchasing government bonds because they felt the RBI would increase interest rates at some point to comply with its legal mandate, would be reassured by this clear communication.
    • The targeted refinancing operations (TLTRO) should help bring down borrowing rates in the targeted industries.

    Conclusion

    Economic challenges may persist for the foreseeable future. The economic scars of the last six months are likely to take time to heal. The RBI and the MPC, which have been proactive, creative and accommodative so far, may have to stay so for a while longer.

  • Issues with the MSP in the age of surplus production

    The author analyses the inefficiencies in the MSP regime while comparing it with the sugar sector and the milk sector. The recent agri-reform in the opinion of the author could help to make the Indian agriculture more efficient.

    MSP system Vs. Market-driven system

    • MSP regime was the creation of the era of scarcity in the mid-1960s.
    • Indian agriculture has, since then, turned the corner from scarcity to surplus.
    • In a surplus economy, unless we make agriculture demand-driven, the MSP route can spell financial disaster.
    • This transition is about changing the pricing mix — how much of it should be state-supported and how much market-driven.
    • The new laws are trying to increase the relative role of markets without dismantling the MSP system.
    • Currently, no system is perfect, be it the one based on MSP or that led by the markets, but the MSP system is much more costly and inefficient.
    • The market-led system will be more sustainable provided we can “get the markets right”.

    Issues with the MSP

    • A perusal of the MSP dominated system of rice and wheat shows that the stocks with the government are way above the buffer stock norms.
    • The economic cost (to FCI) of procured rice comes to about Rs 37/kg and that of wheat is around Rs 27/kg.
    • No wonder, market prices of rice and wheat are much lower than the economic cost incurred by the FCI.
    • So, grain stocks with the FCI cannot be exported without a subsidy[i.e. export below the cost], which invites WTO’s objections.
    • The FCI’s burden is touching Rs 3 lakh crore which is not reflected in the Central budget as the FCI is asked to borrow more and more.
    • The FCI can reduce costs if it uses policy instruments like “put options”.

    2 Lessons: from sugarcane and milk pricing

    1) Populism resulted in making sugar industry globally non-competitive

    • In the case of sugarcane, the government announces a “fair and remunerative price” (FRP) [not MSP]to be paid by sugar factories [not paid by the Government].
    • While some states like Uttar Pradesh announces its own “state advised price” (SAP).
    • The sheer populism of SAP has resulted in cane arrears amounting to more than Rs 8,000 crore, with large surpluses of sugar that can’t be exported.
    • This sector has, consequently, become globally non-competitive.
    • Unless sugarcane pricing follows the C Rangarajan Committee’s recommendations the problems of the sugar sector will not go away.

    2) Success story of milk sector

    • In the case of milk co-operatives, pricing is done by the company in consultation with milk federations.
    • It is more in the nature of a contract price.
    • It competes with private companies, be it Nestle, Hatsun or Schreiber Dynamix dairies.
    • The milk sector has been growing at a rate two to three times higher than rice, wheat and sugarcane.
    • Today, India is the largest producer of milk — 187 million tonnes annually.

    So, how the recent reforms will help the farmers

    •  As a result of changes in farm laws in the next three to five years companies will be encouraged to build efficient supply lines somewhat on the lines of milk.
    • These supply lines — be it with farmers producer organisations (FPOs) or through aggregators — will, of course, be created in states where these companies find the right investment climate.
    • These companies will help raise productivity, similar to what has happened in the poultry sector.
    • Milk and poultry don’t have MSP and farmers do not have to go through the mandi system paying high commissions, market fees and cess.

    Conclusion

    The pricing system has its limits in raising farmers’ incomes. More sustainable solutions lie in augmenting productivity, diversifying to high-value crops, and shifting people out of agriculture to high productivity jobs elsewhere, the recent reforms are the steps in this direction.

    Back2Basic: What is MSP

    • Minimum Support Price (MSP) is a form of market intervention by the Government of India to insure agricultural producers against any sharp fall in farm prices.
    • The minimum support prices are announced by the Government of India at the beginning of the sowing season for certain crops on the basis of the recommendations of the Commission for Agricultural Costs and Prices (CACP).
    • The minimum support prices are a guarantee price for their produce from the Government.
    • The major objectives are to support the farmers from distress sales and to procure food grains for public distribution.
    • In case the market price for the commodity falls below the announced minimum price due to bumper production and glut in the market, government agencies purchase the entire quantity offered by the farmers at the announced minimum price.

    What are ‘put options’

    • Put options give holders of the option the right, but not the obligation, to sell a specified amount of an underlying security at a specified price within a specified time frame.
    • Put options are available on a wide range of assets, including stocks, indexes, commodities, and currencies.
    • Put option prices are impacted by changes in the price of the underlying asset, the option strike price, time decay, interest rates, and volatility.
    • Put options increase in value as the underlying asset falls in price, as volatility of the underlying asset price increases, and as interest rates decline.
    • They lose value as the underlying asset increases in price, as volatility of the underlying asset price decreases, as interest rates rise, and as the time to expiration nears.