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Subject: Economics

  • Weighing in on India’s investment-led revival

    Context

    The Finance Minister, Nirmala Sitharaman, said recently that India’s long-term growth prospects are embedded in public capital expenditure programmes. She added that an increase in public investment would crowd in (or pull in) private investment, thus reviving the economy.

    Significance of public investment-led economic growth

    • Public investment-led economic growth forms a credible strand of explanation for India’s post-Independence economic growth. 
    • Revival after Asian financial crisis: When it was faced with a slow-down after the Asian financial crisis of 1997, the  government initiated public road building projects.
    • In the form of the Golden Quadrilateral and the Pradhan Mantri Gram Sadak Yojana, these initiatives sowed the seeds of economic revival, culminating in an investment and export-led boom in the 2000s; GDP grew at 8%-9% annually.
    • In comparison, the investment record during the 2010s has been dismal.
    • However, a recent uptick is evident in the real gross fixed capital formation (GFCF) rate — the fixed investment to GDP ratio (net of inflation).
    • The ratio recovered to 32.5% in 2019-20 from a low of 30.7% in 2015-16.

    Analysing the Investment distribution

    • As in the June edition of the Ministry of Finance’s Monthly Economic Review, the fixed investment to GDP ratio was 32% in 2021-22.
    • However, there is need for caution in reading the most recent data, as they are subject to revision.
    • Moreover, the budgetary definition of investment refers to financial investments (which include purchase of existing financial assets, or loans offered to States) and not just capital formation representing an expansion of the productive potential.
    • The National Accounts Statistics provides disaggregation of gross capital formation (GCF) by sectors, type of assets and modes of financing; over 90% of GCF consists of fixed investments.
    • No change in investment distribution: The investment distribution has hardly changed over the last decade, with the public sector’s share remaining 20%.
    • Fall in share of agriculture and industry: Between 2014-15 and 2019-20, the shares of agriculture and industry in fixed capital formation/GDP fell from 7.7% and 33.7% to 6.4% and 32.5%, respectively.
    • Services’ share rose to 52.3% in 2019-20 compared to 49% in 2014-15.
    • The rise in the services sector is almost entirely on transport and communications.
    • The share of transport has doubled from 6.1% to 12.9% during the same period.
    • Within transportation, it is mostly roads.
    • Decline in the share of investment: Its share in the investment ratio (column 2.1) fell from 19.2% in 2011-12 to 16.5% in 2019-20.
    • This indicates that ‘Make in India’ failed to take off, import dependence went up, and India became deindustrialised.
    • Import dependence on China is alarming for critical materials such as fertilizers, bulk drugs (active pharmaceutical ingredients or APIs) and capital goods.
    • Instead of boosting investment and domestic technological capabilities, the ‘Make in India’ campaign frittered away time and resources to raise India’s rank in the World Bank’s Ease of Doing Business Index.
    • Decline in foreign capital in GFC: The contribution of foreign capital to financing GCF fell to 2.5% in 2019-20 from 3.8% in 2014-15 (or 11.1% in 2011-12).
    • With declining investment share, industrial output growth rate fell from 13.1% in 2015-16 to a negative 2.4% in 2019-20, as per the National Accounts Statistics.

    Way forward

    • Need for balance: As roads and communications are classic public goods, investment in them is welcome.
    • However, for healthy domestic output growth, there is a need for balance between “directly productive investments” (in farms and factories) and infrastructure investments.
    • And this balance was missed.
    • The recent upturn in the aggregate fixed capital formation to GDP ratio is positive, though the rate is still lower than its mark in the early 2010s.

    Conclusion

    The claim that the investment revival is public sector driven is not borne out by facts. The budgetary figures refer to financial investment, not estimates of capital formation, indicating expansion of the economy’s productive capacity.

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    Back2Basics: Gross fixes capital formation

    • Gross fixed capital formation (GFCF), also called “investment”, is defined as the acquisition of produced assets (including purchases of second-hand assets), including the production of such assets by producers for their own use, minus disposals.
    • The relevant assets relate to assets that are intended for use in the production of other goods and services for a period of more than a year.
    • The term “produced assets” means that only those assets that come into existence as a result of a production process are included.
    • It therefore does not include, for example, the purchase of land and natural resources.
    • This indicator is available in different measures: GFCF at current prices and current PPPs in US dollars, and annual growth rates of GFCF at constant prices, as well as quarterly data for percentage change over previous period and percentage change over same period last year.
    • The indicator at current prices and current PPPs is less suited for comparisons over time, as developments are not only caused by real growth, but also by changes in prices and PPPs.

  • 53 years of Bank Nationalization

    Last week, on July 19 was the 53rd anniversary of then Prime Minister Indira Gandhi nationalizing 14 banks.

    Bank Nationalization: A Backgrounder

    • In 1955 Imperial Bank of India was nationalized as RBI with State Bank of India to act as the principal agent  for extensive banking facilities on a large scale, especially in rural and semi-urban areas.
    • The other banks of the princely states were acquired by SBI much earlier.
    • However, the nationalization of banks in 1969 and later in 1980 was of a completely different scale.
    • In 1969, the move covered 14 (followed by six in 1980) of the largest private sector banks—putting 85% of the deposit base into the hands of the government.
    • This brought 80% of the banking segment in India under Government ownership.

    Why Nationalization of Banks?

    • After independence, the Government of India (GOI) adopted planned economic development for the country.
    • Nationalization was in accordance with the national policy of adopting the socialistic pattern of society.
    • The actual course came at the end of a troubled decade when India had suffered many economic as well as political shocks.

    Other reasons

    • Social welfare
    • Controlling private monopolies
    • Expansion of banking to rural areas
    • Reducing regional imbalance to curb the urban-rural divide
    • Priority Sector Lending
    • Mobilization of savings

    Immediate causes

    • There were two wars with China in 1962 and Pakistan in 1965 that put immense pressure on public finances.
    • Banks were failing largely due to speculative financial activities when Indira Gandhi became the prime minister in 1967.
    • Two successive years of drought had not only led to food shortages but also compromised national security because of the dependence on American food shipments.
    • Subsequently, a three-year plan holiday affected aggregate demand as public investment was reduced.
    • Agriculture needed a capital infusion, with the initiation of the Green Revolution in India which aimed to make the country self-sufficient in food security.
    • The collapse of banks was causing distress among people, who were losing their hard-earned money in the absence of a strong government support and legislative protection to their money.

    Post-nationalization challenges

    • Having ownership and operational control of the banks was a challenging task for the government.
    • The banks were constantly challenged on their profitability parameters—particularly RRBs which had both geographical and portfolio concentration risks.

    Establishing regional balance

    • The objective of social control was about making banking sector accessible in areas where these services were not accessible.
    • The state established 196 Regional Rural Banks (RRBs) between two nationalizations.
    • While nationalization, branch licensing policy and priority sector lending targets helped the banks to go to rural areas and certain sectors, it did not achieve regional balance.
    • Of the 20 banks that were nationalized, seven were concentrated in south India, six in west India, four in north India and three in east India.
    • The expanded rural branch network followed the extant regional concentration, bringing more intensive banking in southern and western regions.

    How was regional balance achieved then?

    • This skew was partially set right by two initiatives. The first was an institutional intervention of opening 196 RRBs which had focused area of operation.
    • The RRBs contributed significantly to reduce the regional imbalance with their expanding branch network in the 1980s.
    • RRBs also had a greater proportion of their loans flowing to priority sector in general and agriculture in particular.
    • The second was the policy on lead bank scheme where one bank was assigned as a lead for each district.
    • The lead bank was responsible for the growth and penetration of banking in districts and had to achieve it in coordination with other banks and the state machinery.
    • A “district credit” plan (euphemism for a banking plan), dovetailed with the government schemes, was to be prepared and monitored by the lead bank.
    1. Regional Rural Banks
    • RRBs are a shade better when it comes to rural lending.
    • While they have deployed 72% of the rural and semi-urban deposits as credit in those areas, the figure for urban understandably is very low, and most of these funds have gone into investments.
    1. Small Finance Banks
    • The new small finance banks (SFBs) give an entirely different picture—a large number of them are MFIs that converted into banks.
    • These institutions are trying to collect deposits from the middle and upper middle class and deploy those resources towards the poor.
    • From a paradigm point of view, possibly SFBs are the most interesting institutions that have turned the tables and are trying to achieve from the private sector the objectives set out in the bank nationalization.

    Public versus Private Banks

    • A look at the broad performance ratios for 2017-18 shows that private sector banks score better on efficiency and profitability parameters.
    • They have better return on assets, return on equity, net interest margin and a higher proportion of low-cost deposits.
    • On the other hand, public sector banks (PSBs) have a better impact on priority sector lending achievement, and paid higher wages.
    • Of the new Pradhan Mantri Jan Dhan Yojana accounts 77% were opened by state-owned banks, 20% by RRBs, and a mere 3.4% accounts were opened by private banks.
    • From this perspective bank nationalization was indeed a good move at that time.

    What benefits do we reap today?

    • Banking under government ownership gave the public implicit faith and immense confidence about the sustainability of the banks.
    • Banks were no longer confined to only metropolitan or cosmopolitan in India. In fact, the Indian banking system has reached even to the remote corners of the country.
    • The present government has reached out to people through banks.
    • Assistance for constructing toilets under Swachh Bharat programme, DBT, Crop insurance schemes etc was given through banks.
    • The dispensing of Mudra loans to about 20 crore individuals, benefits under PM Kisan scheme for providing cash assistance to close to 15 crore farmers annually are only possible through this banks.
    • Thus banks became the government’s dispenser of goodies due to the decision which was taken 50 years ago.

    What about Financial Inclusion?

    • The All India Debt and Investment Survey reports indicate that the formal sector has been losing ground to the informal sector in the rural indebtedness pie since 2001 onwards.
    • This is worrying and indicates that the inclusion agenda is far from achieved.
    • Some examples in the public sector banking system—particularly SBI—have shown that it is possible to achieve the double bottom line of being in the commercial market while continuing to achieve significant targets in inclusion, sectoral, spatial and geographical.

    Way Forward

    • From the larger perspective of efficiency and better utilization of capital, it may be a good idea to move state-owned banks towards more market-based framework.
    • However, that call should be taken to achieve the residual task of inclusion.
    • Making state-owned banks more autonomous and accountable to the market may be the first significant step that can be taken for now.

    Also read:

    [Burning Issue] Privatization of PSBs

     

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  • What is the Controversy over GST levies on Food?

    From July 18, a 5% Goods and Services Tax (GST) has been levied on several food items and grains that are sold in a pre-packed, labelled form even if they are not branded.

    What is the news?

    • So far, these items, which include curd, lassi, buttermilk, puffed rice, wheat, pulses, oats, maize and flour, were exempted from the GST net.
    • The fresh tax levies have attracted an outcry from traders as well as consumers.

    What is GST?

    • GST launched in India on 1 July 2017 is a comprehensive indirect tax for the entire country.
    • It is charged at the time of supply and depends on the destination of consumption.
    • For instance, if a good is manufactured in state A but consumed in state B, then the revenue generated through GST collection is credited to the state of consumption (state B) and not to the state of production (state A).
    • GST, being a consumption-based tax, resulted in loss of revenue for manufacturing-heavy states.

    What are GST Slabs?

    • In India, almost 500+ services and over 1300 products fall under the 4 major GST slabs.
    • There are five broad tax rates of zero, 5%, 12%, 18% and 28%, plus a cess levied over and above the 28% on some ‘sin’ goods.
    • The GST Council periodically revises the items under each slab rate to adjust them according to industry demands and market trends.
    • The updated structure ensures that the essential items fall under lower tax brackets, while luxury products and services entail higher GST rates.
    • The 28% rate is levied on demerit goods such as tobacco products, automobiles, and aerated drinks, along with an additional GST compensation cess.

    How did the rate hikes come about?

    • The 5% tax on unbranded packed food items was approved by the GST Council.
    • Some of the other items to have lost their tax-exempt status include bank cheques, maps and atlases, hotel rooms that cost up to â‚č1,000 a night, and hospital room rents of over â‚č5,000 a day.
    • The pre-packed items weighing over 25 kg would not attract GST.

    Why such move?

    • This move was part of a broader set of changes in the GST structure to do away with tax exemptions as well as concessional tax rates.
    • The Centre and States had discussed the need to raise revenues from the GST, which at the time of its launch five years ago, was premised on levying a ‘revenue-neutral’ rate of 15.5%.
    • All affected food items, including wheat, pulses, rice, curd and lassi, will be exempt from GST when sold loose.

    What has the government said on the issue?

    • FM has hit out at misconceptions about the GST levies on food items and dismissed suggestions that they were imposed unilaterally by the Centre.
    • The 5% levy, she said, was critical to curb tax leakages and was not taken by ‘one member’ of the GST Council alone as all States had agreed to the move.
    • When GST was rolled out, a GST rate of 5% was made applicable on branded cereals, pulses, flour.
    • This was later amended to tax only such items which were sold under a registered brand or brands on which enforceable right was not foregone by the suppliers.
    • This tax exemption triggered ‘rampant misuse’ by reputed manufacturers and brand owners leading to a gradual drop in revenues.

     

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  • Despite pressures, the Indian rupee’s remarkable resilience

    Context

    The Indian rupee has depreciated by around 7% against the U.S. dollar, since the start of the year, in response to various domestic and global factors.

    What are the factors responsible for decline?

    • A widening current account deficit, persistent risk-off sentiment as a result of geopolitical tensions, ‘a strengthening dollar index, and continuous sell-off by foreign portfolio investors have all put pressure on the rupee’.
    • Reversal of monetary policy in the US: The runaway inflation levels since last year, which have seen consumer price index (CPI) inflation in the United States reaching a multi-decade high of 9.1% in June 2022, have prompted the reversal in the monetary policy stance of the US Federal Reserve.
    • With inflation rising unabated, the Fed is widely expected to continue raising interest rates.
    • Higher risk-free return in the US: As a result of higher risk-free returns being available in the U.S., there have been persistent outflows of foreign portfolio capital since October 2021, which, on a cumulative basis, stands at $30 billion this year.

    Comparison with the depreciation in the past

    • Even as the rupee has fallen sharply against the dollar, the depreciation has been relatively lower compared with past crises.
    • During the global financial crisis of 2008, the rupee had weakened by over 20% between December 2007-June 2009 and during the Taper Tantrum of 2013 for seven months from the start of the crisis in May 2013, the rupee had depreciated by over 11%.
    • Reduced external vulnerability: The relative lower depreciation this time is attributed to the lowering of India’s external vulnerability measured in terms of a relatively high import cover and low short-term external debt.
    • During the Taper Tantrum, India’s import cover stood at over seven months as compared to around 12 months in the current period.

    Decline in foreign exchange reserves

    • The Reserve Bank of India (RBI) has stepped in to arrest a large depreciation in the currency, with interventions in the spot and forward foreign exchange markets.
    • Consequently, India’s foreign exchange reserves have moderated by almost $55 billion from a high of $635 billion seen this year.
    • Elevated global crude oil prices have impinged on India’s oil import bill, in turn widening the trade deficit, thus increasing the demand for U.S. dollars, and affecting forex reserves further.

    Effects of weak rupee

    • Export to become competitive: Among the benefits is the premise that the rupee’s weakening should aid exporters in becoming more competitive.
    • However, the concomitant depreciation of currencies of some of India’s competitors such as South Korea, Malaysia and Bangladesh against the dollar, alongwith a high import intensity of some of its key export segments (petroleum, gems and jewellery and electronics), is likely to have blunted the ameliorative impact on India’s exports.
    • Increase in the price of imported commodities: a weaker rupee is driving up prices of key import commodities such as coal, oil, edible oil, gold, thus impacting the imported component of inflation.
    • Impact on the borrowers: The unhedged component of corporate debt denominated in dollars is also likely to bear the brunt of a weaker rupee.
    • Impact on investment: Most importantly, a continuously sliding exchange rate discourages foreign investors from making fresh investments, which keep losing value in dollar terms.
    • For this reason, it is ideal to provide confidence to investors by arresting a continuous slide in the exchange rate.

    Measure by the RBI to arrest the weakening of rupee

    • Apart from intervening in the forex market to arrest the fall in the rupee’s value, the RBI announced a slew of measures recently to liberalise foreign inflows into the country and make them more attractive.
    • Measures such include:
    • Promoting trade settlements between India and other countries in rupee terms.
    • Offering higher interest rates on fresh Foreign Currency Non-Resident (Bank) and Non-Resident External deposits.
    • A widening of investible universe of government and corporate debt, a relaxation of the interest rate.
    • Amount ceiling for External Commercial Borrowing loans, among others, have contributed to arresting the rupee’s slide against the greenback.

    Way forward

    • Inclusion of companies in glabal indices: The Government could encourage some of the large market cap companies (private and public sectors) to be included in the major global indices such as MSCI and FTSE.
    • This will help increase the weight of Indian equities in these indices, compensating for foreign portfolio outflows to some extent as investors are unlikely to be underweight on India.
    • India’s entry into bond indices: The Government could also expedite India’s entry into bond indices such as J.P. Morgan’s Emerging-Market Bond Index and Barclays Global Bond Index.
    • This will not only lead to forex inflows but also have a benign impact on interest rates.
    • Such measures will keep the forex war chest of the RBI at a comfortable level, providing the central bank the requisite ammunition in case there is further weakness.
    • The maintenance of the U.S.-India interest rate differential along with timely forex market interventions by the central bank to manage volatility will prove to be salutary in preserving the rupee value against the greenback.

    Conclusion

    Even as the rupee is expected to remain under pressure in the near term because of global uncertainty, high commodity prices and rising U.S. interest rates, mitigating measures have to be taken to partly arrest the slide.

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    Back2Basics: What is taper tantrum?

    • Taper tantrum refers to the 2013 collective reactionary panic that triggered a spike in U.S. Treasury yields, after investors learned that the Federal Reserve was slowly putting the breaks on its quantitative easing (QE) program.
    • The Fed announced that it would be reducing the pace of its purchases of Treasury bonds, to reduce the amount of money it was feeding into the economy.
    • The ensuing rise in bond yields in reaction to the announcement was referred to as a taper tantrum in financial media.

  • What is Transition Tax Credit?

    Taxpayers who had missed out on getting the benefit of transitional tax credits during India’s switchover to the Goods and Services Tax (GST) regime five years ago, will now get a fresh window to avail them.

    What is Transitional Tax Credit?

    • A tax credit is a component of a company’s tax payment that can be applied to offset a subsequent tax obligation.
    • When India moved to the GST regime in 2017, companies had to transition the credit sitting on their books.
    • So, the closing balance in the old tax regime would become the opening credit balance under GST.
    • When India moved from the old indirect tax regime to GST, a one-time transition of credit was allowed.
    • That is, companies could set off part of the taxes paid during the old tax regime against future GST liabilities.
    • Many companies claimed that they had simply forgotten to claim the transitional credit.

    Why in news?

    • The Supreme Court has directed the revenue authorities to facilitate such credits.
    • The move is likely to benefit hundreds of GST assessees who had hitherto not been able to avail such credits.
    • They will be given two-month window to claim during September and October.

     

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  • The cost of misrepresenting inflation

    Context

    Globally, inflation is now the prime concern of governments, even as there is a speculation that a recession may not be far behind.

    Is inflation in India driven by the global factors?

    • The Governor of the Reserve Bank of India (RBI) has been reported as saying that there was a “need to recognise global factors in inflation”.
    • However, the current inflation in India is, even largely, due to global factors is wrong, and harmful.
    • While the price of edible oils and the world price of crude may have risen following the Ukraine war, the impact of this development on overall inflation in India, measured by the rise in the consumer price index, would depend upon their share in the consumption basket of households, which is relatively low.
    • For the commodity groups ‘fuel and light’ and ‘fats and oils’, chosen as proxies for the price of imported fuel and edible oils, respectively, inflation has actually been lower in the first five months of 2022 than in the last five months of 2021.
    • On the other hand, for the commodity group ‘food and beverages’, it was exactly the reverse, i.e., inflation has been much higher in the more recent period.
    • Contribution of domestic factors: The estimated direct contribution of this group to the current inflation dwarfs that of all other groups, establishing conclusively that the inflation is driven by domestic factors.

    Inadequacy of monetary policy to address the food-price driven inflation

    • Issues with the monetary policy: Starting in May, the repo rate has been raised.
    • Raising the interest rate in an attempt to control inflation, implicitly assumes that it reflects economy-wide excess demand.
    • Such a diagnosis of the current inflation is belied by the fact that the price of food is rising faster than that of other goods i.e., its relative price has risen.
    • So, the excess demand is in the market for foodstuff, and it is this that needs to be eliminated.
    • The inadequacy of monetary policy to address food-price-driven inflation has been flagged by economists internationally.
    • at the World Economic Forum’s annual meet held at Davos, Switzerland in June, Nobel Laureate Joseph Stiglitz observed that raising interest rates is not going to solve the problem of inflation. It is not going to create more food.
    • Jerome Powell is reported stating that even though the Fed’s resolve to fight inflation is unconditional, “a big part of inflation won’t be affected by our tools”.
    • This is an acknowledgement that there is only so much a central bank can do when battling inflation driven by the rise in energy and food prices.

    Way forward

    • Need for supply side interventions:  To hold on to the view that inflation in India is due to excess aggregate demand curable by raising interest rates ensures that attention is not paid to the necessary supply-side interventions.

    Conclusion

    India is suffering from undercurrent of a food price inflation, which, by exacerbating poverty, stands in the way of a more rapid expansion of the economy.

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  • India’s Tenfold Path to manage Exchange Rate Volatility

    The RBI is prepared to sell a sixth of its foreign exchange reserves to defend the rupee against a rapid depreciation after it plumbed record lows in recent weeks.

    Must read:

    [Burning Issue] Global Trade in Rupees

    Is there a forex crisis underway?

    • And the way in which India has tackled foreign exchange crises over the years has been quite profound.
    • A forex crisis can be loosely defined as one where the rupee starts depreciating rapidly or when forex reserves slide precipitously.
    • Ever since India’s reforms of 1991-92, the external sector has been liberalized, with even full capital account convertibility being considered at one point.

    In the rupee’s context, let’s look at options that have been used in the last three decades or so:

    (1) Selling dollars

    • The first course of action has been selling dollars in the spot forex market.
    • This is fairly straightforward, but has limits as all crises are associated with declining reserves.
    • While this money is meant for a rainy day, they may just be less than adequate.
    • The idea of RBI selling dollars works well in the currency market, which is kept guessing how much the central bank is willing to sell at any point of time.

    (2) NRI deposits

    • The second tool used is aimed at garnering non-resident Indian (NRI) deposits.
    • It was done in 1998 and 2000 through Resurgent India bonds and India Millennium Deposits, when banks reached out asking NRIs to put in money with attractive interest rates.
    • The forex risk was borne by Indian banks.
    • This is always a useful way for the country to mobilize a good sum of forex, though the challenge is when the debt has to be redeemed.
    • At the time of deposits, the rates tend to be attractive, but once the crisis ends, the same rate cannot be offered on deposit renewals.
    • Therefore, the idea has limitations.

    (3) Let oil importers buy dollars themselves

    • The third option exercised often involves getting oil importing companies to buy dollars directly through a facility extended by a public sector bank.
    • Its advantage is that these deals are not in the open and so the market does not witness a large demand for dollars on this account.
    • It is more of a sentiment cooling exercise.

    (4) Let exporters trade in dollars

    • Another tool involves a directive issued for all exporters to mandatorily bring in their dollars on receipt that are needed for future imports.
    • This acts against an artificial dollar supply reduction due to exporter hold-backs for profit.

    (5) Liberalized Exchange Rate

    • The other weapon, once used earlier, is to curb the amount of dollars one can take under the Liberalized Exchange Rate Management System.
    • This can be for current account purposes like travel, education, healthcare, etc.
    • The amounts are not large, but it sends out a strong signal.

    (6) Forward-trade marketing

    • Another route used by RBI is to deal in the forward-trade market.
    • Its advantage is that a strong signal is sent while controlling volatility, as RBI conducts transactions where only the net amount gets transacted finally.
    • It has the same power as spot transactions, but without any significant withdrawal of forex from the system.

    (7) Currency swaps

    • The other tool in India’s armoury is the concept of swaps.
    • This became popular post 2013, when banks collected foreign currency non-resident deposits with a simultaneous swap with RBI, which in effect took on the foreign exchange risk.
    • Hence, it was different from earlier bond and deposit schemes.

    Most preferred options by the RBI

    • Above discussed instruments have been largely direct in nature, with the underlying factors behind demand-supply being managed by the central bank.
    • Of late, RBI has gone in for more policy-oriented approaches and the last three measures announced are in this realm.

    (8) Allowing banks to work in the NDF market

    • First was allowing banks to work in the non-deliverable forwards (NDF) market.
    • This is a largely overseas speculative market that has a high potential to influence domestic sentiment on our currency.
    • Here, forward transactions take place without real inflows or outflows, with only price differences settled in dollars.
    • This was a major pain point in the past, as banks did not have access to this segment.
    • By permitting Indian banks to operate here, the rates in this market and in domestic markets have gotten equalized.

    (9) Capital account for NRI deposits

    • More recently, RBI opened up the capital account on NRI deposits (interest rates than can be offered), external commercial borrowings (amounts that can be raised) and foreign portfolio investments (allowed in lower tenure securities), which has the potential to draw in forex over time.
    • Interest in these expanded contours may be limited, but the idea is compelling.

    (10) Settlement in Rupees

    • RBI’s permission for foreign trade deals to be settled in rupees is quite novel; as India is a net importer, gains can be made if we pay in rupees for imports.
    • The conditions placed on the use of surpluses could be a dampener for potential transactions.
    • But the idea is innovative and could also be a step towards taking the rupee international in such a delicate situation.
    • Clearly, RBI has constantly been exploring ways to address our forex troubles and even newer measures shouldn’t surprise us.

     

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  • Why there is no reason to panic over the rupee

    Context

    Rupee hits the all-time low of 80 against US dollar recently. The enormity of the challenges can be gauged by these numbers: Since the beginning of war, foreign exchange reserves have declined by $51-billion, total portfolio outflows have been $23 billion, and the current account deficit is now certain to breach $100 billion.

    Is depreciation of rupee sign of weak domestic fundamentals?

    • In case of strong domestic fundamentals: In an ideal world, if domestic economic fundamentals are strong, the depreciation of the rupee should be accompanied by an appreciation of the Dollar Index (DXY) along similar lines.
    • In case of weak fundamentals: Between January 2008 and February 2012 and October 2012 and May 2014, on a cumulative basis, the rupee had lost a whopping 48.7 per cent against the USD, even as the DXY had appreciated by a modest 5.2 per cent.
    • This indicates that much of the decline in rupee value then was purely because of weak domestic macro fundamentals.
    • Current scenario:  The rupee has depreciated by a modest 5.6 per cent since the Russian invasion of Ukraine, though the DXY has appreciated by 11.3 per cent.
    •  Thus, the recent decline in the rupee has been more because of the strengthening of the dollar and not because of weak fundamentals at home.

    Reasons for the dominance of dollar

    • In principle, Bretton Woods ensured that the dollar would be a “trust” currency.
    • The US sits at the centre of an international financial system where its assets have been in high demand.
    • For instance, frantically growing Asian economies whose penchant for US government securities have also made them susceptible to sudden changes in expectations and economic sentiments sweeping the globe.
    • The recent disturbances in the global supply chain and volatile commodity prices have only made the job more difficult.

    What explains the recent strengthening of dollar

    • High interest rates in the US: The recent gains in the dollar have come along expectations of aggressive monetary policy by the US Fed compared to other major jurisdictions, particularly, the Eurozone and Japan.
    • Markets expect the Fed to continue on its path of interest rate normalisation with multiple rate hikes.
    • Low interest rates in the Eurozone: The European Central Bank (ECB) appears behind the curve, its communication with markets is as uncertain as the political and climatic hot winds criss-crossing the Eurozone.
    • Low interest rates in Japan: The Bank of Japan has taken a completely divergent path, continuing its accommodative monetary policy despite the hammering of the yen.
    • This has augured well for the dollar, obscuring the question of how the Fed failed to anticipate the surge in inflation.

    Measures by the RBI and the government

    • As currencies reel under the weight of an unrelenting dollar, questions on the rupee’s performance and future are a natural corollary, more so in the wake of hitting the psychological mark of Rs 80/dollar.
    • In 2013, when the rupee was in a free fall, stability was finally restored but it came at a cost — a debt buildup of $34.5 FCNR(B).
    • This time, the RBI and government have taken a long-term view of bolstering dollar inflows, which is perfectly justified.
    • The RBI, in close tandem with the government, has been supportive of the rupee, and is also now embarking on an unprecedented journey to internationalise the currency. 

    Conclusion

    A direct casualty of the Ukraine war is that the Indian rupee has now depreciated by 5.6 per cent against the dollar. In terms of relative performance, however, the rupee has done quite well compared to most of its counterparts.

    Back2Basics: US Dollar Index

    • The U.S. dollar index (USDX) is a measure of the value of the U.S. dollar relative to a basket of foreign currencies.
    • The USDX was established by the U.S. Federal Reserve in 1973 after the dissolution of the Bretton Woods Agreement.
    • It is now maintained by ICE Data Indices, a subsidiary of the Intercontinental Exchange (ICE).
    • The six currencies included in the USDX are often referred to as America’s most significant trading partners, but the index has only been updated once: in 1999 when the euro replaced the German mark, French franc, Italian lira, Dutch guilder, and Belgian franc.
    • Consequently, the index does not accurately reflect present-day U.S. trade.

    Bretton Woods Agreement and Systems

    • The Bretton Woods Agreement was negotiated in July 1944 by delegates from 44 countries at the United Nations Monetary and Financial Conference held in Bretton Woods, New Hampshire.
    • Thus, the name “Bretton Woods Agreement.
    • Under the Bretton Woods System, gold was the basis for the U.S. dollar and other currencies were pegged to the U.S. dollar’s value.
    • The Bretton Woods System effectively came to an end in the early 1970s when President Richard M. Nixon announced that the U.S. would no longer exchange gold for U.S. currency.

    FCNR(B)

    • An FCNR ( Foreign Currency Non-resident) account is a type of term deposit that NRIs can hold in India in a foreign currency.
    • FCNR (A) was introduced in 1975 to encourage NRI deposits.
    • The Reserve Bank of India (RBI) guaranteed the exchange rate prevalent at the time of a deposit to eliminate risk to depositors.
    • In 1993, the apex bank introduced FCNR (B), without exchange rate guarantee, to replace FCNR (A).

  • A five-point plan to boost renewable energy

    Context

    As the fallout of Russia’s invasion of Ukraine ripples across the globe, the response of some nations to the growing energy crisis has been to double down on fossil fuels, pouring billions more dollars into the coal, oil and gas that are deepening the climate emergency.

    Need for transition to renewable energy

    • Fossil fuels are the cause of the climate crisis.
    • Renewable energy can limit climate disruption and boost energy security. Renewables are the peace plan of the 21st century.
    • But the battle for a rapid and just energy transition is not being fought on a level field.
    • Investors are still backing fossil fuels, and governments still hand out billions in subsidies for coal, oil and gas — about $11 million every minute.
    • The only true path to energy security, stable power prices, prosperity and a livable planet lies in abandoning polluting fossil fuels and accelerating the renewables-based energy transition.
    • We must reduce emissions by 45 per cent by 2030 and reach net-zero emissions by mid-century.
    • But current national commitments will lead to an increase of almost 14 per cent this decade.
    • Reducing cost:  The cost of solar energy and batteries has plummeted 85 per cent over the past decade.
    • The cost of wind power fell by 55 per cent. And investment in renewables creates three times more jobs than fossil fuels.
    • Nature-based solutions: Of course, renewables are not the only answer to the climate crisis.
    • Nature-based solutions, such as reversing deforestation and land degradation, are essential.
    • So too are efforts to promote energy efficiency.
    • But a rapid renewable energy transition must be our ambition.

    Five point plan to boost renewable

    • 1] Renewable energy technology as global good: We must make renewable energy technology a global public good, including removing intellectual property barriers to technology transfer.
    • 2] Improve global access: We must improve global access to supply chains for renewable energy technologies, components and raw materials.
    • In 2020, the world installed five gigawatts of battery storage.
    • We need 600 gigawatts of storage capacity by 2030.
    • Shipping bottlenecks and supply-chain constraints, as well as higher costs for lithium and other battery metals, are hurting the deployment of such technologies and materials.
    • 3] Fast-tracking : We must cut the red tape that holds up solar and wind projects.
    • We need fast-track approvals and more effort to modernise electricity grids.
    • 4] Shifting energy subsidies: The world must shift energy subsidies from fossil fuels to protect vulnerable people from energy shocks and invest in a just transition to a sustainable future.
    • Increase investment in renewables: We need to triple investments in renewables.
    • This includes multilateral development banks and development finance institutions, as well as commercial banks.

    Conclusion

    When energy prices rise, so do the costs of food and all the goods we rely on. So, let us all agree that a rapid renewables revolution is necessary and stop fiddling while our future burns.

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  • What Rs 80 to a dollar means

    The Indian rupee breached the psychologically significant exchange rate level of 80 to a US dollar in early trade.

    Free fall of Indian Rupee

    • Since the war in Ukraine began, and crude oil prices started going up, the rupee has steadily lost value against the dollar.
    • There are growing concerns about how a weaker rupee affects the broader economy.
    • Certainly it presents challenges to policymakers, especially since India is already grappling with high inflation and weak growth.

    What is the rupee exchange rate?

    • The rupee’s exchange rate vis-Ă -vis the dollar is essentially the number of rupees one needs to buy $1.
    • This is an important metric to buy not just US goods but also other goods and services (say crude oil) trade in which happens in US dollars.

    Benefits of Rupees fall

    • Broadly speaking, when the rupee depreciates, importing goods and service becomes costlier.
    • But if one is trying to export goods and services to other countries, especially to the US, India’s products become more competitive.
    • Depreciation makes these products cheaper for foreign buyers.

    How bad is it for the rupee?

    • If the rupee depreciates at a rate faster than the long-term average, it goes above the dotted line, and vice versa.
    • In the last couple of years, the rupee has been more resilient than the long-term trend.
    • The current fall has brought about a correction.

    Rupee’s exchange rate against the dollar

    • Another thing to note is that, at least as of now, the rupee is still more resilient (against the dollar) than it was in some of the previous crises such as the Global Financial Crisis of 2008 and the Taper Tantrum of 2013.
    • Moreover, the US dollar is just one of the currencies Indians need to trade.
    • If one looks at a whole basket of currencies, then data suggests the rupee has become stronger (or appreciated against that basket).
    • In other words, while the US dollar has become stronger against all other major currencies including the rupee, the rupee, in turn, has become stronger than many other currencies such as the euro.

    Is it a cause of worry?

    • It is important to remember that it is more of a story of the dollar strengthening than the rupee weakening.
    • This suggests that as things stand, India is still not facing an external crisis.
    • Take for instance the issue of external debt.
    • Long-term data shows that India is in a relatively comfortable position.

    Can we be comfortable with this free-fall?

    • While India is fine as of now, trends suggest things are getting worse.
    • For instance, forex reserves have fallen by over $50 billion between September 2021 and now.
    • In these 10 months, the rupee’s exchange rate with the dollar has fallen 8.7%, from 73.6 to 80. For context, historically the rupee depreciates by about 3% to 3.5% in a year.
    • What’s worse, many experts expect the rupee to weaken further in the coming 3-4 months and fall to as low as 82 to a dollar.

    Why are the rupee-dollar exchange rate and forex reserves falling?

    • To understand movements on these variables, one must understand India’s Balance of Payment (BoP)
    • The BoP is essentially a ledger of all monetary transactions between Indians and foreigners. Here it is shown in US dollar terms.
    • If a transaction leads to dollars coming into India, it is shown with a positive sign; if a transaction means dollars leaving India, it is shown with a minus sign.

    How did BoP come to the picture?

    • The BoP has two broad subheads (also called “accounts”) — current and capital — to slot different types of transactions.
    • The current account is further divided into the trade account (for export and import of goods) and the invisibles account (for export and import of services).
    • So if an Indian buys an American car, dollars will flow out of BoP, and it will be accounted for in the trade account within the current account.
    • If an American invests in Indian stock markets, dollars will come into the BoP table and it will be accounted for under FPI within the capital account.
    • The important thing about the BoP is that it always “balances”.

    India’s vulnerability on the external debt front

    • In 2021-22, India had a trade deficit of $189.5 billion.
    • That is, the country imported more goods (such as crude oil) than it exported, and the net effect was negative.
    • At the end of the year, the BoP was at a surplus of $47.5 billion — that is, the net effect of all transactions on current and capital accounts was that $47.5 billion came into India.

    What may happen ahead?

    Now, two things can happen from here:

    (1) Huge BoP surplus would lead to the rupee appreciating

    • This will bring about a change in people’s buying and investing preferences.
    • For instance, India’s exports will become costlier and import cheaper. Over time, the trade deficit will alter (will reduce or turn into a surplus) to “balance” the BoP.

    (2) RBI swoops in and removes all the surplus dollars

    • RBI purchases dollars to increase its forex reserves.
    • In 2021-22, for instance, India’s forex reserves went up by $47.5 billion.
    • The RBI keeps monitoring the BoP every week and keeps intervening in such a manner which ensures that the rupee’s exchange rate does not fluctuate too much.

    What will be the effect on the economy?

    • Since a large proportion of India’s imports are dollar-denominated, these imports will get costlier.
    • A good example is the crude oil import bill.
    • Costlier imports, in turn, will widen the trade deficit as well as the current account deficit, which, in turn, will put pressure on the exchange rate.
    • On the exports front, however, it is less straightforward.
    • For one, in bilateral trade, the rupee has become stronger than many currencies.

    Should policymakers prevent the fall?

    • It is neither wise nor possible for the RBI to prevent the rupee from falling indefinitely.
    • Defending the rupee will simply result in India exhausting its forex reserves over time because global investors have much bigger financial clout.
    • Most analysts believe that the better strategy is to let the rupee depreciate and act as a natural shock absorber to the adverse terms of trade.

    What should policymakers do?

    • The RBI (which is in charge of monetary policy) should focus on containing inflation, as it is legally mandated to do.
    • The government (which is in charge of the fiscal policy) should contain its borrowings.
    • Higher borrowings (fiscal deficit) by the government eat up domestic savings and force the rest of the economic agents to borrow from abroad.
    • Policymakers (both in the government and the RBI) have to choose what their priority is: containing inflation or being hung up on exchange rate and forex levels.
    • If they choose to contain inflation (that is, by raising interest rates) then it will require sacrificing economic growth. So be prepared for that.

    Conclusion

    • We can conclude that the rupee’s exchange rate and forex reserves levels are two sides of the same coin.

    Back2Basics: Taper Tantrum

    • After the 2007-2009 global financial crisis and recession, the US Federal Reserve started a bond-buying program (known as quantitative easing) to infuse liquidity.
    • With these funds, the investors started investing in global bonds and stocks. 
    • In 2013, the US Federal Reserve decided to reduce (taper) its quantum of a bond-buying program which led to a sudden sell-off in global bonds and stocks. 
    • As a result, many emerging market economies, that received large capital inflows, suffered currency depreciation and outflows of capital.
    • This was called globally a ‘taper tantrum‘.

     

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