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Subject: Economics

  • India- UAE Local Currency Settlement System (LCSS)

    uae dirham rupee india lcss local currency

    Central Idea

    • India and the United Arab Emirates (UAE) signed a pact during PM Modi’s visit to Abu Dhabi.
    • It established a framework for promoting the use of the Indian rupee (INR) and UAE Dirham (AED) in cross-border transactions.

    Local Currency Settlement System (LCSS)

    • LCSS Establishment: The framework aims to establish a Local Currency Settlement System (LCSS) between India and the UAE.
    • Domestic Currency Transactions: LCSS enables exporters and importers to invoice and pay in their respective domestic currencies.
    • Foreign Exchange Market Development: LCSS facilitates the development of an INR-AED foreign exchange market.
    • Transaction Optimization: The use of local currencies optimizes transaction costs and settlement time.
    • Remittance Benefits: LCSS benefits remittances from Indians residing in the UAE.

    Interlinking of Payment Systems: UPI-IPP Linkage

    • Payment System Linkage: The Memorandum of Understanding (MoU) includes the linking of India’s Unified Payments Interface (UPI) with the UAE’s Instant Payment Platform (IPP).
    • Card Switches and Messaging Systems: It explores linking the card switches (RuPay switch and UAESWITCH) and messaging systems of both countries.
    • Efficient Cross-Border Fund Transfers: UPI-IPP linkage facilitates fast, convenient, safe, and cost-effective cross-border fund transfers.
    • Mutual Acceptance of Domestic Cards: The agreement enables the mutual acceptance of domestic cards and processing of card transactions.

    Impact of the Move

    • Trade boost: Bilateral trade between India and the UAE reached around $85 billion in FY23.
    • Exchange Rate Risk Management: The agreement helps Indian exporters’ hedge exchange rate risks in rupee-based trade.
    • Internationalization of the Rupee: It supports India’s efforts to internationalize the rupee and reduce dependence on the US dollar.
    • Interest from Other Countries: Countries in Africa, the Gulf region, Sri Lanka, and Bangladesh have shown interest in trading in rupee terms.

    Significance for Exporters

    • Denominating in Local Currencies: Denominating export contracts and invoices in local currencies minimizes exchange-rate risks and aids in competitive pricing.
    • Enhanced Cooperation: Enhanced cooperation between the banking systems of India and the UAE supports trade and economic activity.
    • Major Export Categories: Major Indian exports to the UAE include mineral fuels, pearls, precious stones, electrical machinery, and equipment.
    • Trade Growth and Destination: The UAE is India’s second-largest export destination, and India-UAE trade reached $85 billion in 2022.

    Benefits for Remittances

    • Reduced Transaction Costs: The agreement reduces high transaction costs and exchange rate margins associated with remittances.
    • Affordable and Efficient Remittances: It makes remittances more affordable and efficient, particularly for low-wage earners.
    • Increased Remittance Inflows: In 2022, India experienced a 24.4% increase in remittances to $111 billion, accounting for 3.3% of GDP.
    • Contribution of GCC Countries: Remittance inflows from Gulf Cooperation Council (GCC) countries contribute significantly to India’s total remittance inflows.

    Larger Impact

    • Reducing Dollar Dependence: The agreement promotes the use of local currencies, reducing dependence on the US dollar in international transactions.
    • Strengthening Economic Ties: Strengthened economic ties between India and the UAE encourage investments, remittances, and trade growth.
    • Rupee Internationalization: The agreement aligns with India’s goal of internationalizing the rupee and expanding its global acceptance.
    • Similar Cross-Border Efforts: Similar efforts, such as collaboration with Singapore’s PayNow, have been undertaken to facilitate cross-border transactions.

    Conclusion

    • The agreement positively impacts bilateral trade, facilitates remittances, and supports India’s goal of internationalizing the rupee.
    • By reducing transaction costs and enhancing financial connectivity, the agreement strengthens economic relations between India and the UAE, fostering trade growth and cooperation.

  • India to launch Global Biofuel Alliance (GBA)

    biofuel

    Central Idea

    • The upcoming 14th Clean Energy Ministerial and Eighth Mission Innovation (CEM14/MI-8) conference, taking place in Goa from July 19-22, 2023, aims to establish the Global Biofuel Alliance (GBA).

    What are Biofuels?

     

    • Biofuels are a type of renewable energy derived from organic materials, such as plants, crops, and agricultural waste.
    • They are considered an alternative to traditional fossil fuels, such as coal, oil, and natural gas, because they areproduced from renewable biomass sources.

    There are several types of biofuels, including:

    1. Ethanol: It is a biofuel produced by fermenting and distilling sugars or starches found in crops like corn, sugarcane, and wheat. It is commonly used as a blending component in gasoline and can be used as a fuel for vehicles in its pure form, known as E85 (85% ethanol and 15% gasoline).
    2. Biodiesel: It is a renewable fuel made from vegetable oils, animal fats, or recycled cooking oils. It is typically used as a substitute for diesel fuel and can be blended with petroleum diesel or used in its pureform. Biodiesel has lower emissions of pollutants compared to petroleum diesel and can be used in conventional diesel engines without any modifications.
    3. Biogas: It is produced through the anaerobic digestion of organic waste materials such as agricultural residues, food waste, and animal manure. It primarily consists of methane and carbon dioxide. Biogas can be used for heating, electricity generation, or as a vehicle fuel after purification.

    What is Global Biofuel Alliance (GBA)?

    • G20 Priority: The GBA is a crucial priority under India’s G20 Presidency.
    • Learning from ISA: The GBA draws inspiration from the International Solar Alliance (ISA), jointly initiated by India and France in 2015 to combat climate change through solar energy adoption.
    • Objective: This alliance will focus on promoting international collaboration and cooperation to encourage the acceptance and utilization of biofuels.
    • Core Members: The GBA, comprising Brazil, the US, and India, aims to impact the global energy architecture and achieve net-zero emissions.
    • Membership and Endorsement: Other nations can join the GBA by endorsing the foundation document, and membership is open to non-G20 countries.

    Focus Areas of GBA

    • Focus areas of the GBA include:
    1. The GBA will focus on strengthening markets and facilitating global biofuel trade.
    2. Concrete policy lessons will be shared, and technical support will be provided for national biofuel programs worldwide.
    3. The alliance will highlight successful cases and best practices in the biofuel industry.

    Significance of GBA

    • Addressing OPEC+: The initiative signals India’s focus on reducing dependence on conventional hydrocarbons and calls for increased production by the OPEC+
    • Transformative Opportunities: GBA offer transformative opportunities for economic growth, rural development, energy self-sufficiency, reduced air pollution, and clean energy transition.
    • Adoption of Sustainable Biofuels: The alliance aims to accelerate the adoption of sustainable biofuels.

    India’s Biofuel Achievements

    • Milestone Achieved: In the fiscal year 2020-21, India produced 4.08 billion litres of ethanol, achieving a blending rate of 10.02% and resulting in a reduction of 2.7 million tonnes of CO2 emissions.
    • Goals and Targets: India aims to achieve a blending rate of 12% by 2022-23 and a goal of 20% blending by 2025, requiring an expanded production capacity of ethanol to 17 billion litres.
    • Focus on Compressed Bio-Gas (CBG): India actively promotes compressed bio-gas (CBG) derived from waste through the Sustainable Alternative towards Affordable Transportation (SATAT) program.
    • Target Deadline: India aims to install 5,000 CBG plants across the country by 2024.

    Biofuel Advancements in Aviation

    • First Commercial Passenger Flight: India conducted its first commercial passenger flight using sustainable aviation fuel (SAF) blend produced domestically.
    • Program Committee Established: The Bio-Aviation Turbine Fuel Programme Committee has been established to advance the use of SAF in the aviation sector.
    • Blending Targets: India aims to achieve a 1% SAF blend in jet fuel by 2025, requiring 140 million liters of SAF per year, and a more ambitious target of a 5% blend would need approximately 700 million liters per year.

    Global response

    • Brazil’s Support: Brazil expressed support for the GBA and its goals to expand and strengthen sustainable biofuels markets.
    • Saudi Arabia’s Focus: Saudi, a major oil producer, has a focus on conventional hydrocarbons and has not favored the GBA.
    • Russia’s Opec+ Involvement: Russia, as part of the Opec+ group, has been implementing production cuts despite fragile global economic recovery.
    • China’s Opposition: China, a major biofuel producer, opposed the India-led initiative and boycotted a G20 meeting on tourism held in Srinagar.

    Conclusion

    • The establishment of GBA represents a significant step towards promoting international collaboration and the adoption of sustainable biofuels.
    • India’s achievements in biofuel production and advancements in aviation fuel provide a strong foundation for the alliance’s objectives.

  • A roadmap to eliminate poverty in India

    What’s the news?

    • With the receding impact of Covid-19 and hopeful prospects for an amicable resolution to the Russia-Ukraine War, India must now focus on charting its future growth strategy

    Central idea

    • India’s current per capita income estimated at $2,379 in 2022-23, which needs to be raised by nearly six times over the next 25 years. This ambitious goal will pave the way for a higher standard of living and the eradication of poverty. However, achieving this vision requires a comprehensive understanding of the challenges ahead and the necessary actions to overcome them.

    What is per capita income?

    • Per capita income refers to the average income earned by individuals in a specific geographic area. It is calculated by dividing the total income of a population by the total number of individuals in that population.
    • Per capita income provides an indicator of the average standard of living and economic well-being within a given population.

    What is Gross Fixed Capital Formation (GFCF)?

    • GFCF refers to the total value of investment in fixed assets within an economy, such as machinery, equipment, buildings, and infrastructure, during a specific period.
    • It represents the net increase in the stock of fixed capital goods.
    • GFCF is an essential component of aggregate demand and is considered a driver of economic growth.
    • Higher levels of investment in fixed assets contribute to increased production capacity, improved productivity, and long-term economic development.
    • The GFCF ratio is often expressed as a percentage of GDP, indicating the proportion of total investment in fixed assets relative to the size of the economy.

    What is incremental capital-output ratio (ICOR)?

    • The ICOR is an economic indicator that measures- amount of investment required to generate an additional unit of output.
    • It represents the ratio between the change in capital investment and the corresponding change in output or GDP.
    • It provides insights into the efficiency of capital utilization and the productivity of investment in an economy.
    • A lower ICOR indicates that a smaller amount of investment is required to generate a given increase in output, indicating higher efficiency and productivity of capital.
    • A higher ICOR suggests that a larger amount of investment is needed to achieve the same level of output growth, indicating lower efficiency of capital utilization.

    Growth Target and Investment Requirements

    • To sustain continuous growth of 7 percent over the next 25 years, India must maintain a GFCF rate of 28 percent.
    • According to the latest release of NSO, the GFCF rate in current prices for 2022-23 is 29.2 per cent of GDP.
    • While the commonly assumed incremental capital-output ratio (ICOR) of 4 suggests improved capital efficiency, recent trends indicate an average ICOR of 4.65 from 2016-17 to 2022-23.
    • Acknowledge the evolving ICOR and work towards an estimated investment rate of 30-32 percent of GDP.
    • Both public and private investments, especially from the corporate and non-corporate sectors, need to increase.
    • Direct investments into sectors that promote growth and generate employment opportunities
    • Welcoming Foreign direct investment in emerging technological sectors

    What global factors at present poses challenges?

    • The overall climate for peace– necessary for growth– deteriorated- Ukraine-Russia conflict.
    • Prolonged tension and conflicts- negative impact on global stability and economic growth.
    • Shifting attitude of some countries towards global trade.
    • Developed countries, which previously advocated for free trade, are now imposing restrictions on imports– challenges for developing countries like India, particularly as they strive to compete in the world market.
    • Supply disruptions of critical imports, such as oil, can cause setbacks for developing and developed countries alike.
    • The absorption of new technologies, such as Artificial Intelligence (AI)- impact on the industrial structure and employment landscape– challenge for populous countries like India
    • Balancing economic growth with environmental sustainability may require compromises and adjustments in the growth rate.

    What strategy India must follow to sustain its growth?

    • India’s economic transformation in 1991 marked a departure from the past, embracing a more market-oriented approach.
    • India needs to adopt a multi-dimensional approach that encompasses agriculture, manufacturing, and exports.
    • Given India’s strength in the services sector, it is essential to preserve and enhance this advantage.
    • Prepare to absorb new technologies, including Artificial Intelligence (AI),
    • Reorienting the educational system to equip students with required skills and
    • Identifying labour-intensive economic activities to address potential job losses due to adoption of technology

    Conclusion

    • India has made significant strides in building a strong and diversified economy over the past 75 years. However, India’s per capita income remains low compared to many countries, emphasizing the need for sustained growth. By addressing domestic challenges, seizing opportunities, and prioritizing inclusive development, India can realize its vision of a prosperous and equitable future.

    Also read:

    Why Indian manufacturing’s productivity growth is plummeting and what can be done?

  • Private Digital Currencies

    Digital

    What is the news?

    • The emergence of Private digital currencies presents a challenge to central banks’ control and can disrupt the established order by introducing new dynamics and possibilities.

    Central idea

    • The control over money supply, circulation, and value holds significant influence over economic systems and national trajectories. Governments and central banks play a crucial role in managing currency, shaping economic policies, and ensuring macroeconomic stability. However, the rise of private digital currencies introduces new dynamics and challenges to this control, potentially disrupting the established order.

    What are Private digital currencies?

    • Private digital currencies, also known as cryptocurrencies, are digital or virtual currencies that utilize cryptographic technology to secure transactions and control the creation of new units.
    • They operate independently of traditional financial institutions and are typically decentralized, meaning they are not controlled or regulated by a central authority like a government or central bank.
    • Some of the most well-known private digital currencies include Bitcoin (BTC), Ethereum (ETH), Ripple (XRP), and Litecoin (LTC)

    What are stable coins?

    • Stablecoins are a type of cryptocurrency that are designed to maintain a stable value relative to a specific asset or a basket of assets.
    • Unlike many other cryptocurrencies that experience significant price volatility, stablecoins aim to provide stability and minimize price fluctuations.
    • They achieve this stability by pegging their value to an underlying asset, such as a fiat currency (like the U.S. dollar), commodities (like gold), or a combination of assets.

    What is mean by monetary sovereignty?

    • Monetary sovereignty is the country’s ability to exercise control over its own currency and monetary policy without external interference.
    • It is the authority of a nation’s government and central bank to determine and manage the value, supply, and circulation of its currency, as well as to shape and implement monetary policies that promote economic stability and growth.

    Challenges posed by Private digital currencies to monetary sovereignty

    • Private digital currencies- utilizes blockchain technology– bypasses the need for central intermediaries like banks and central banks
    • Alternative systems of value transfer- peer-to-peer transactions – diminish the relevance of banks and other financial institutions.
    • Operate outside the regulatory frameworks– challenges in terms of enforcing financial regulations- Anti Money Laundering and KYC requirements, which are designed to prevent illicit activities.
    • The volatility and speculative nature– risks to financial stability.
    • Sharp price fluctuations and market instability- adverse effects on investors, consumers, and the broader economy- particularly developing economies– less robust financial systems.
    • Facilitate illicit activities- money laundering, tax evasion, and terrorist financing

    Case study 1: Myanmar’s digital dynamics of power

    • In Myanmar, the National Union Government (NUG) has utilized- cryptocurrency to – circumvent the military controlled economy- raise funds for the resistance.
    • The NUG issued- Digital Myanmar Kyat (DMMK) -evade military oversight-independent determination of exchange rates.
    • The DMMK- cross-border payments – easier to collect donations from diaspora communities.
    • Serves as- means of fundraising- challenges the legitimacy of the military-issued kyat.
    • The split financial system in Myanmar highlights the risks and consequences of digital currencies on sovereign legitimacy.

    Case study 2: China’s Cautious Monetary Security Approach

    • Contrasting views on cryptocurrencies and central bank digital currencies (CBDCs)
    • Cryptocurrencies- strict restrictions- not recognized as legal tender
    • Actively promotes its digital yuan- internationalize the currency- reduce reliance on US-controlled financial networks.
    • Acknowledges the potential of digital money to reshape the financial ecosystem and sees it as a catalyst for global monetary decentralization.
    • China’s comprehensive ban- cryptocurrencies- commitment to safeguard monetary sovereignty.

    Case study 3: India’s apprehensions

    • The Reserve Bank of India (RBI) has underscored the need for decisive actions to address the escalating risks associated with the crypto-assets ecosystem.
    • The primary concern- risks associated with stablecoins– susceptible to potential risks of redemptions and investor panics- necessitating careful mitigation measures.
    • The RBI has further cautioned- private currencies, emphasising their historical propensity to generate instability– undermine sovereign control over money supply, interest rates, and macroeconomic stability- especially in developing economies.
    • India’s own CBDC- Digital Rupee- perceived as a strategic response- counter the challenges- crypto-assets ecosystem.

    Way forward

    • Clear and comprehensive regulatory frameworks for private digital currencies- address consumer protection, investor safeguards, financial integrity, and risk management.
    • International coordination and collaboration- engage in dialogue- information sharing- standardization efforts
    • Continue exploring the potential of CBDCs as regulated digital currency alternatives
    • Public education and awareness-building trust- benefits and risks- foster responsible usag
    • Invest in research and development- development of solutions- enhance financial systems- increase efficiency.

    Conclusion

    • Private digital currencies present both opportunities and challenges to monetary sovereignty. The examples of Myanmar, China, and India demonstrate the complex interplay between currency control, legitimacy, and trust. As the world navigates the development of digital currencies, the balance between innovation and maintaining sovereign control will continue to shape the future of monetary systems

    Also read:

    India’s Central bank digital currency (CBDC) in detail

  • Cash Transfers vs Foodgrain Distribution

    Central idea

    • Three years ago, financial constraints prevented the Centre and states from providing cash transfers to vulnerable households during pandemic lockdowns. However, there was an abundance of wheat and rice in FCI’s warehouses, allowing distribution to 813.5 million people. However, the current scenario has reversed, with governments having funds but limited grain stocks, raising concerns for future provisions.

    Grain Distribution and Export Scenario

    Grain Distribution:

    • During the pandemic-enforced lockdowns the government distributed 10 kg of grain per month practically free to 813.5 million people from April 2020 to December 2022.
    • This distribution was made possible through the public distribution system (PDS) and aimed to support poor and vulnerable households suffering from job and income losses.

    Offtake of Grains:

    • 2020-21 (April-March): The offtake of wheat and rice totalled 92.9 million tonnes, surpassing the annual average of 62.5 million tonnes during the first seven years after the National Food Security Act (NFSA) implementation.
    • 2021-22: The offtake further increased to 105.6 million tonnes.
    • 2022-23: The offtake remained high at 92.7 million tonnes.

    Grain Exports:

    • Rice: In 2021-22, India exported 21.2 million tonnes of rice, valued at $9.66 billion. In 2022-23, rice exports reached 22.3 million tonnes, valued at $11.14 billion.
    • Wheat: Wheat exports accounted for 7.2 million tonnes ($2.12 billion) in 2021-22 and 4.7 million tonnes ($1.52 billion) in 2022-23

    Karnataka Case: Shift from Grain to Cash Transfers

    • Change in Financial Situation: As economic activities resumed, the financial situation improved for both the Centre and the states. Gross GST revenues grew, indicating increased financial resources available to the governments.
    • Reduction in Grain Quota: From January 2023, the monthly grain quota under the National Food Security Act (NFSA) was reduced from 10 kg to 5 kg per person.
    • Additional grain demand: The government in Karnataka sought additional grain from the FCI to fulfill its election promise of providing 10 kg of free rice per month to all members of below-poverty-line (BPL) households.
    • Centre’s Refusal: The Centre did not allow the state government to distribute the extra rice beyond the 5 kg provided under the National Food Security Act (NFSA)
    • Resort to Cash Transfers: As a result the Karnataka government started giving cash transfers instead. They started transferring Rs 170 to the bank accounts of the BPL family heads in lieu of the extra 5 kg of rice

    Implications of cash transfers 

    • Inflationary Pressures:
    • When households receive cash instead of free grain, they have the flexibility to use the money for various purposes, including purchasing rice or other goods.
    • Increased demand for rice in the market can lead to higher prices, potentially contributing to inflationary pressures.
    • Deflationary Impact of Free Grain Distribution:
    • When surplus grains are distributed without a monetary transaction, it can help stabilize or reduce the prices of grains in the market.
    • This can mitigate inflationary pressures and ensure affordable access to essential food items for vulnerable populations.
    • Budgetary Considerations:
    • This allocation needs to be carefully managed to ensure that it aligns with overall fiscal goals and priorities.
    • The availability of adequate financial resources for cash transfers can be a determining factor in choosing between cash transfers and free grain distribution.
    • Flexibility for Beneficiaries:
    • Instead of receiving a predetermined amount of grain, households can decide how to allocate the cash according to their priorities.
    • This flexibility allows households to address their unique requirements beyond food, such as healthcare, education, or other essential expenses.
    • Market Dynamics:
    • Cash transfers can stimulate economic activity by injecting money into local markets. This can have positive multiplier effects, benefiting various sectors and local businesses.
    • On the other hand, free grain distribution may limit the market demand for grains, potentially affecting the livelihoods of farmers and traders.

    Depleted grain stocks and uncertain monsoon

    • Depleted Grain Stocks:
    • The total stocks of wheat and rice in the Central pool today stands at a five-year-low.
    • While these stocks are still above the normative minimum required, there are concerns about the monsoon and its impact on this year’s rice crop, which may affect procurement and future stocks.
    • Monsoon Impact on Production:
    • The poorly distributed rain has resulted in lower-than-usual rice cultivation, with farmers having planted only 123.18 lakh hectares out of the normal total of 399.45 lakh hectares under rice during the monsoon season. Additionally, the cumulative area sown is 6.1% lower than the previous year.
    • Insufficient rainfall in the monsoon’s second half can impact not only the kharif rice but also the upcoming rabi wheat crop.

    The Export conundrum

    • Record Export Quantities: Despite the imposition of restrictions on grain exports, India witnessed record-breaking exports of rice, wheat, and other cereals. Specifically, total exports amounted to 32.3 million tonnes in 2021-22 and 30.7 million tonnes in 2022-23, valued at $12.87 billion and $13.86 billion, respectively.
    • Inflationary Pressures:  The rising demand for rice, coupled with reduced domestic availability due to exports, can lead to higher prices for consumers within the country.
    • Limited Import Capability for Rice: As India is the world’s largest rice exporter, importing rice in case of domestic production shortfalls becomes challenging. Unlike wheat, which can be imported due to ample global supplies, rice imports are restricted.
    • Price Volatility and Potential Export Restrictions: The rising rice prices globally, indicating potential price volatility. Given concerns over depleted grain stocks and uncertainties related to the monsoon, the government is considering additional export restrictions.

    Way forward: A balanced approach

    • Targeted Cash Transfers: Implement focused cash transfer programs to support the most vulnerable households affected by economic hardships.
    • Optimal Grain Procurement: Strengthen grain procurement mechanisms to ensure an adequate supply of grains for the Public Distribution System (PDS) and strategic reserves.
    • Strategic Stock Management: Develop effective strategies to balance grain distribution for immediate consumption while maintaining sufficient reserves for emergencies.
    • Diversify Food Sources: Explore diverse food options, such as millets, pulses, and vegetables, to reduce reliance on a single crop and enhance food and nutritional diversity.
    • Enhance Food System Resilience: Improve supply chain efficiency, reduce food waste, and enhance coordination among stakeholders for a resilient food system.
    • Continuous Monitoring and Evaluation: Establish robust monitoring and evaluation systems to track the effectiveness of cash transfer programs, grain procurement strategies, and food security initiatives.

    Conclusion

    • The current state of depleted grain stocks, coupled with the uncertainties surrounding monsoon performance and global market dynamics, presents a significant challenge for the government. Balancing the need for cash transfers to alleviate the plight of vulnerable households while ensuring adequate grain reserves to sustain the country’s food security is a delicate task.

  • What are AT-1 Bonds?

    Central Idea

    • Subscription Disappointment: State Bank of India (SBI)’s additional tier-1 (AT-1) bond issue saw a very low response from investors, raising ₹3,101 crore against an issue size of ₹10,000 crore.
    • Market Sentiment Impact: The lackluster response is expected to dampen market sentiment and make fundraising more challenging for other PSU banks, potentially leading to delays in their fundraising plans.

    What are AT1 Bonds?

    • Definition: AT-1 bonds, or Additional Tier-1 bonds, are unsecured, perpetual bonds issued by banks to strengthen their core capital base in compliance with Basel-III norms.
    • Complex Hybrid Instruments: AT-1 bonds are complex instruments suited for institutions and knowledgeable investors who can analyze their terms and determine if the higher rates compensate for the higher risks involved.
    • Face Value: Each AT-1 bond typically carries a face value of ₹10 lakh.
    • Acquisition Routes: Retail investors can acquire these bonds through initial private placement offers by banks or by purchasing already-traded AT-1 bonds in the secondary market based on broker recommendations.

    Key Features and Importance of AT1 Bonds

    • Perpetual Nature: AT-1 bonds do not have a maturity date. Instead, they include call options that allow banks to redeem them after a specific period, usually five or ten years. Banks can choose to pay only interest indefinitely without redeeming the bonds.
    • Flexibility in Interest Payments: Banks issuing AT-1 bonds can skip interest payouts or even reduce the bonds’ face value if their capital ratios fall below certain thresholds specified in the offer terms.
    • Regulatory Intervention: If a bank faces financial distress, the RBI has the authority to ask the bank to cancel its outstanding AT-1 bonds without consulting the investors.

    Back2Basics: Basel Norms

    • Basel is a city in Switzerland and the headquarters of the Bureau of International Settlement (BIS).
    • The BIS fosters cooperation among central banks to achieve financial stability and common standards of banking regulations.
    • Basel guidelines are broad supervisory standards formulated by the Basel Committee on Banking Supervision (BCBS).
    • The Basel accord is a set of agreements by the BCBS that primarily focuses on risks to banks and the financial system.
    • The purpose of the Basel accord is to ensure that financial institutions maintain sufficient capital to meet obligations and absorb unexpected losses.
    • India has accepted the Basel accords for its banking system.

     

    Basel I Basel II Basel III
    Year Introduced 1988 2004 2010
    Focus Credit Risk Credit, Market, Operational Risks Capital, Leverage, Funding, Liquidity
    Capital Requirement Fixed at 8% of Risk-Weighted Assets (RWA) Minimum Capital Adequacy Requirement of 8% of Risk Assets Strengthening capital requirements
    Pillars – 1. Capital Adequacy Requirements 2. Supervisory Review 3. Market Discipline –
    Objective Define capital and risk weights for banks Encourage better risk management and disclosure Promote a more resilient banking system
    Implementation in India Adopted in 1999 Yet to be fully implemented March 2019 (postponed to March 2020 due to COVID-19)
    Key Parameters – – Capital: 12.9% capital adequacy ratio, Tier 1 and Tier 2 capital ratios, capital conservation buffer, and counter-cyclical buffer; Leverage: minimum 3% leverage rate; Funding and Liquidity: LCR and NSFR ratios

     

  • Why normative recommendations of finance commissions remain on paper

    finance

    What is the news?

    • This article critically examines the historical outcomes of the 13th FC and underscores the need for realistic expectations regarding the forthcoming 16th FC

    Central idea

    • The Finance Commissions (FC) in India play a crucial role in determining the fiscal framework for resource allocation between the Union and state governments. Established under Article 280 of the Constitution, the FCs provide recommendations on vertical devolution, horizontal distribution, and grants-in-aid. However, the effectiveness of these recommendations in achieving their intended objectives remains a matter of contention

    Purpose and Scope of Finance Commissions

    • Finance Commissions are constituted under Article 280 of the Constitution and their recommendations encompass three key areas: vertical devolution, horizontal distribution, and grant-in-aid.
    • Vertical devolution focuses on Union to state transfers
    • Horizontal distribution involves the allocation of resources between states based on a specific formula.
    • Grant-in-aid, covered under Article 275, provides financial assistance to states deemed in need.
    • It is important to note the distinction between grants and grant-in-aid, as the latter operates at arm’s length and offers more flexibility in terms of control.

    Recommendations of the previous Finance Commission

    13th Finance Commission Recommendations:

    • Increase the number of court working hours using existing infrastructure.
    • Enhance support to Lok Adalats.
    • Provide additional funding to State Legal Services Authorities to enhance legal aid for the marginalized.
    • Promote the use of Alternative Dispute Resolution (ADR) mechanisms.
    • Enhance the capacity of judicial officers and public prosecutors through training programs.
    • Support the creation of a judicial academy in every state for training purposes.
    • Allocate funds for the setting up of specialized courts.

    15th Finance Commission Recommendations:

    • Gather quantifiable data on the level of various services available in different states.
    • Collect corresponding unit cost data to estimate cost disabilities among states.
    • Fill gaps in statistical data through the efforts of the Ministry of Statistics.

    Challenges encountered in the implementation of Finance Commission recommendations

    • Lack of Implementation of Homilies: The recommendations made by Finance Commissions, both at the Union and state levels, are often ignored as mere pious intentions. This indicates a lack of commitment and follow-through in translating the recommendations into concrete actions.
    • Conditionalities and Expenditure Restrictions: The objections raised by some states in the article indicate challenges related to conditionalities attached to grants. Conditionalities may restrict the expenditure options of states, creating obstacles in implementing the recommended reforms.
    • Inadequate Resource Allocation: The allocated funds for specific reforms may not be sufficient, leading to inadequate implementation. Financial constraints and competing budgetary priorities can limit the availability of resources needed to effectively execute the recommended measures.
    • Lack of Coordination: The implementation of Finance Commission recommendations requires cooperation between the Union and state governments. Any lack of coordination or disagreements between these entities can hinder the execution of reforms

    Way forward: Need for realistic expectations regarding the forthcoming 16th FC

    • Acknowledging Implementation Challenges: Recognize the challenges and complexities involved in implementing Finance Commission recommendations, such as coordination issues, administrative capacity, and resistance to change. This understanding will help shape realistic expectations and strategies for addressing these challenges.
    • Strengthening Implementation Mechanisms: Focus on improving the implementation mechanisms and processes. This includes enhancing coordination and cooperation between the Union and state governments, strengthening administrative capacity at all levels, and streamlining the implementation of conditionalities to facilitate smoother execution.
    • Robust Monitoring and Evaluation: Establish effective monitoring and evaluation mechanisms to track the progress and outcomes of implemented reforms. Regular assessment will help identify implementation gaps and provide opportunities for course correction and improvement.
    • Building Stakeholder Consensus: Foster stakeholder engagement and consensus-building to ensure the buy-in and ownership of recommended reforms. Engage relevant stakeholders, including government departments, civil society organizations, and local communities, to create a shared vision and collective commitment towards implementation.
    • Learning from Past Experiences: Analyze past experiences and identify the reasons behind the limited implementation of previous recommendations. This will help inform future strategies, learning from the challenges faced and replicating successful implementation models.
    • Advocacy and Public Awareness: Create awareness among the public about the importance of Finance Commission recommendations and their impact on governance and development. Foster advocacy efforts to generate public support and hold governments accountable for implementing the recommended reforms.

    Conclusion

    • Finance Commissions in India fulfill a critical role in determining fiscal transfers between the Union and state governments. However, the implementation of their recommendations often falls short of expectations due to various challenges and limitations. By critically analyzing the past experiences of Finance Commissions, it becomes evident that a more pragmatic approach is necessary to align expectations with the actual outcomes.

    Also read:

    Finance Commission and the Challenges of Fiscal Federalism

  • Supreme Court seeks SEBI’s explanation FPI Amendments

    sebi

    Central Idea

    • The Supreme Court has asked the Securities and Exchange Board of India (SEBI) to clarify why amendments were made in 2018 to the Foreign Portfolio Investors (FPI) Regulations.
    • These amendments had eliminated crucial clauses aimed at preventing opacity in FPI ownership structures.

    Why discuss this?

    • A judicial inquiry report has stated that SEBI’s investigation into allegations against the Adani Group by Hindenburg Research had been hindered by FPI ownership amendments.
    • The report highlighted the challenges faced by SEBI in determining the “ownership” of 13 overseas entities, including the FPIs mentioned in the Hindenburg report, due to the lack of clarity in their ownership chain.

    What are FPIs?

    • Foreign Portfolio Investments (FPI) refer to investments made by foreign individuals, institutional investors, pension funds, sovereign wealth funds, and other entities in financial instruments of a foreign country.
    • These investments typically involve the purchase of securities such as stocks, bonds, mutual funds, exchange-traded funds (ETFs), and other tradable financial assets.

    Key characteristics of foreign portfolio investments include:

    • Indirect Ownership: FPIs involve indirect ownership of financial instruments rather than direct ownership of physical assets or businesses. Investors hold portfolios of securities issued by companies, governments, or other entities in the target country.
    • Diversification: FPIs allow investors to diversify their investment portfolios internationally. By investing in different countries and asset classes, investors can reduce risks associated with a concentration in a single market or asset type.
    • Liquidity: FPIs offer high liquidity as they involve trading in financial instruments that can be easily bought or sold in the secondary market. Investors have the flexibility to enter or exit their positions quickly based on market conditions or investment objectives.
    • Market Access: FPIs provide foreign investors with access to the securities markets of other countries. This enables them to participate in the economic growth and potential returns of different markets and take advantage of investment opportunities that may not be available domestically.
    • Regulatory Framework: FPIs are subject to regulations and guidelines set by the regulatory authorities of the target country. These regulations may include registration requirements, investment limits, disclosure obligations, and compliance norms to ensure market integrity and investor protection.
    • Market Impact: Large FPI flows can have a significant impact on the target country’s financial markets. They can influence stock prices, bond yields, exchange rates, and overall market sentiment. As a result, FPIs are closely monitored by regulatory bodies and policymakers.

    Key Issue: FPI Regulations Amendment

    The Foreign Portfolio Investors (FPI) Regulations were first introduced in 2014 by the Securities and Exchange Board of India (SEBI).

    • Removal of “opaque structure” provision: The 2018 amendments eliminated provisions in the FPI Regulations that addressed opaque structures and required FPIs to disclose every ultimate natural person in the ownership chain.
    • Justice Sapre panel’s observations: The expert committee report stated that the removal of these provisions had put SEBI in a “chicken-and-egg situation” in its investigation of the 13 overseas entities suspected of having opaque structures.
    • Need for information on ultimate economic ownership: The report emphasized that SEBI’s investigation required information about the ultimate economic ownership, rather than just beneficial owners, of the entities under scrutiny.

    Supreme Court’s Query and SEBI’s Response

    • Court’s inquiry on the amendments: The Chief Justice asked SEBI to explain the circumstances and reasons behind the changes made to the provisions dealing with opaque structures.
    • SEBI’s assertion on ongoing investigation: The Solicitor General, representing SEBI, stated that the investigation was progressing at full speed and that the agency was working diligently to meet the extended deadline set by the court.
    • Petitioners’ arguments on fatal impact: The petitioners argued that the amendments made in 2018 had rendered SEBI’s current investigation ineffective, as the definition of opaque structure was removed. They claimed that these amendments were intended to prevent fraud exposure.

    Court’s Concerns and Request for Explanation

    • Court’s curiosity about the amendments: The Chief Justice expressed the court’s interest in understanding the reasons behind the changes made by SEBI in 2018.
    • Potential impact on the investigation: The court acknowledged the argument that the amendments might restrict SEBI from delving into the layers of transactions, potentially hindering the investigation.

    Conclusion

    • The court seeks clarification on the circumstances surrounding these changes and their impact on SEBI’s investigation into the Adani Group.
    • The court’s concern lies in understanding the potential limitations these amendments may have imposed on SEBI’s ability to explore the ownership chain and layers of transactions.

  • In news: GST Council Decisions

    Central Idea

    • The Goods and Services Tax (GST) Council convened its 50th meeting on July 11, announcing significant revisions and clarifications to tax rates.
    • Additionally, the council discussed the establishment of GST Appellate Tribunals.
    • It sought to address the concerns surrounding inclusion of the GST Network under the Prevention of Money Laundering Act (PMLA).

    What is GST Council?

    • The Goods and Services Tax (GST) Council is a crucial body established under the 101st Constitutional Amendment in 2016 to oversee the implementation of the GST regime in India.
    • Comprised of representatives from the central government and the states, the Council plays a pivotal role in making recommendations and decisions related to GST.

    Composition of the GST Council

    • Joint forum: The GST Council is a joint forum consisting of members from the Centre (Union Finance Minister and Union Minister of State for Finance) and representatives from the states.
    • State representation: Each state nominates a minister in charge of finance, taxation, or any other relevant minister to be a member of the Council.

    Objectives of the GST Council

    • Recommendation-making authority: The Council is responsible for making recommendations to the Union and the states on important GST-related issues. This includes suggestions on the goods and services that should be subjected to or exempted from GST, as well as the formulation of model GST laws.
    • Decision-making on tax rates: The Council determines the various rate slabs under the GST regime. It has the authority to decide the applicable tax rates for different goods and services.

    Recent Tax Rate Changes proposals

    • Uncooked and unfried snack pellets and fish soluble paste: The tax rate on these items was reduced from 18% to 5%.
    • Imitation zari threads or yarn: The GST rate on these items was reduced from 12% to 5%.
    • Food and beverages consumed inside cinema halls: The GST rate for these items was reduced to 5% without any input tax credits, compared to the previous 18% levied on cinema services.
    • Special utility vehicles (SUVs): The tax treatment for SUVs was clarified, ensuring that the higher GST compensation cess does not affect sedans. The conditions for classifying a vehicle as an SUV were revised to exclude the requirement of being popularly seen as an SUV. The ground clearance of 170 mm should now be for an unladen vehicle.
    • Exemption for satellite launch services: The Council offered an exemption on GST for satellite launch services provided by private organizations.

    Other recommendations: GST Appellate Tribunals

    • Proposal for setting up GST Appellate Tribunals: States’ proposals to establish 50 Benches of GST Appellate Tribunals were examined. These tribunals will play a crucial role in resolving GST disputes.
    • Operational timeline: The government aims to make the tribunals operational within four to six months, starting with the establishment of Benches in State capitals and places where High Courts have Benches.
    • Appointment and service conditions: The Council cleared the appointment and service conditions for tribunal members and the president, which will come into effect from August 1.

    Inclusion of GST Network under PMLA

    • Concerns raised by non-BJP ruled states: Representatives from states not governed by the BJP criticized the decision to bring the GST Network under the purview of the Prevention of Money Laundering Act (PMLA) administered by the Enforcement Directorate (ED).
    • Tamil Nadu’s opposition: Tamil Nadu expressed opposition to the move, stating that it is against the interests of taxpayers and goes against the objective of decriminalizing offenses under the GST law.
    • Explanation and clarification: Revenue Secretary presented an explanation of the provision, stating that it is a requirement of the Financial Action Task Force (FATF) and not directly related to the GST law.
    • Information sharing: The GSTN will not share information about private businesses with other law enforcement agencies. The ED will neither receive nor provide information, but the director of the Financial Intelligence Unit may provide information to the GSTN to empower tax authorities in combating tax evasion and money laundering.

     

  • Why Indian manufacturing’s productivity growth is plummeting and what can be done?

    What is the news?

    • According to a recent study Productivity growth in Indian manufacturing has been slowing since the 1990s, with a more pronounced decline in the years leading up to the Covid-19 pandemic. Exploring the causes behind this decline is crucial to develop effective strategies for revitalizing the sector.

    Central idea

    • India’s manufacturing sector has long been a matter of concern for policymakers and the subject of extensive academic research. The government has consistently aimed to increase the share of manufacturing in the country’s GDP. However, despite efforts to promote manufacturing, the sector’s contribution and overall employment has remained stagnant.

    Key Facts about Manufacturing Productivity in India

    • Slowing Growth: Productivity growth in India’s manufacturing sector has been declining since the 1990s, with a significant acceleration in the mid-2010s and leading up to the Covid-19 pandemic.
    • Gap with the United States: India’s manufacturing productivity per worker is considerably lower compared to the United States. In 2020, it was only around a fifth of the productivity level in the US.
    • Regional Disparities: There are wide variations in manufacturing productivity across Indian states. Western and Central Indian states tend to have higher average productivity, while Southern and Eastern states have lower productivity levels. This contrasts with the GDP per capita rankings, where Southern states generally have higher incomes than their Western and Central counterparts.

    Potential reasons behind the decline in manufacturing productivity

    • Slow Manufacturing Sector Growth: The overall growth rate of India’s manufacturing sector has been decreasing, particularly since around 2015. This sluggish growth can limit the opportunities for productivity improvement and hinder overall sector performance.
    • Insufficient Investments: Inadequate investments in technology, infrastructure, and research and development (R&D) can hamper productivity growth. Limited capital expenditure by firms may result in outdated machinery, inefficient processes, and lower productivity levels.
    • Skill Mismatch: The manufacturing sector requires a specific skill set, and a mismatch between the skills possessed by the labor force and the skills demanded by the industry can impede productivity. The lack of trained and skilled workers in areas such as advanced manufacturing techniques, automation, and specialized operations may contribute to lower productivity levels.
    • Informality and Informal Labor Market: The prevalence of informal employment in the manufacturing sector can hinder productivity growth. Informal workers often lack access to training, social security benefits, and stable employment conditions, which can lead to lower productivity levels compared to formal employment arrangements.
    • Regulatory Challenges: Cumbersome regulatory processes, including complex labor laws, bureaucratic red tape, and regulatory compliance burdens, can hamper productivity growth. These challenges may discourage investment and hinder the adoption of efficient production practices.
    • Infrastructure Deficiencies: Inadequate infrastructure, such as poor transportation networks, unreliable power supply, and limited access to technology and connectivity, can negatively impact manufacturing productivity. Insufficient infrastructure can increase costs, disrupt supply chains, and hinder efficiency in production processes.
    • Inefficient Supply Chains: Weak linkages and coordination within supply chains can contribute to lower productivity in manufacturing. Challenges such as fragmented value chains, inefficient logistics, and inadequate coordination between suppliers, manufacturers, and distributors can result in delays, increased costs, and reduced overall productivity.
    • Lack of Innovation and Technology Adoption: Limited emphasis on innovation, research, and development, as well as a slower adoption of advanced technologies, can constrain productivity growth in the manufacturing sector. Insufficient investment in technological upgrades and a reluctance to adopt new manufacturing techniques can lead to lower productivity compared to global standards.

    Implications of Declining manufacturing productivity 

    • Economic Growth: Declining manufacturing productivity can hinder overall economic growth.
    • Reduced Competitiveness: Declining productivity in manufacturing can erode a country’s competitiveness in the global market. This can lead to a decline in exports and an increase in imports, negatively impacting the trade balance and potentially affecting the overall economic stability of a nation.
    • Employment and Labor Market Challenges: Lower productivity can result in reduced job creation within the manufacturing sector, leading to unemployment or underemployment.
    • Technological Progression: When productivity declines, the incentives for firms to invest in research and development or adopt new technologies may diminish, leading to a slower pace of technological advancement within the manufacturing sector.
    • Industrial Development and Diversification: A decline in productivity can hinder the growth and diversification of the manufacturing sector, limiting its ability to contribute to overall industrial development.
    • Investment and Innovation: Declining productivity in manufacturing can discourage investment and innovation within the sector.
    • Sectoral Shifts: Declining manufacturing productivity may result in a shift towards other sectors of the economy. If manufacturing becomes less competitive and less productive, resources and investments may be redirected to other sectors such as services.

    What can be done? 

    • Boost Investments: Encouraging both domestic and foreign investments in the manufacturing sector can help upgrade infrastructure, improve technology adoption, and enhance productivity. This can be achieved through attractive investment policies, tax incentives, and easing of regulatory procedures.
    • Skill Development and Training: Focusing on skill development programs tailored to the manufacturing sector can address the skill mismatch and enhance the capabilities of the workforce. Collaborating with educational institutions and industry associations to design training programs and apprenticeships can ensure a skilled labor force.
    • Infrastructure Development: Prioritizing infrastructure development, including transportation networks, power supply, logistics, and digital connectivity, is essential for improving productivity. Investment in infrastructure projects can create an enabling environment for manufacturing activities and reduce operational inefficiencies.
    • Regulatory Reforms: Streamlining regulatory processes, reducing bureaucratic complexities, and simplifying labor laws can create a business-friendly environment. Establishing a favorable regulatory framework can attract investments, foster innovation, and enhance productivity in the manufacturing sector.
    • Research and Development (R&D): Encouraging R&D activities and innovation in the manufacturing sector can lead to technological advancements and productivity gains. Collaborations between industry, research institutions, and academia can facilitate knowledge transfer and promote innovation-driven manufacturing.
    • Entrepreneurship and Start-up Ecosystem: Supporting entrepreneurship and nurturing a vibrant start-up ecosystem in manufacturing can bring fresh ideas, innovation, and competitiveness. Providing access to finance, mentorship programs, and incubation support can encourage entrepreneurial growth and drive productivity.
    • International Collaborations: Strengthening international collaborations and partnerships can facilitate knowledge exchange, technology transfer, and best practice sharing. Engaging with global manufacturing networks can help Indian manufacturers learn from successful models and adapt to global standards.

    Conclusion

    • The findings of this study underscore the urgent need for policy interventions to address the challenges faced by India’s manufacturing sector. Encouraging investments in workers, improving labor market conditions, and promoting a conducive business environment are crucial steps that can help revitalize India’s manufacturing sector, enhance productivity, and lift millions out of poverty.

    Also read:

    Revisiting India’s Manufacturing Dilemma: A Call for Comprehensive Ecosystem Development