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Subject: Economics

  • The HDFC Ltd.-HDFC Bank Merger

    Mortgage lender HDFC Ltd. and India’s largest private sector bank HDFC Bank on Monday announced a mega-merger.

    Impact of the move

    • Under the terms of the deal, which is one of the biggest in the Indian financial sector, HDFC Bank will be 100% owned by public shareholders.
    • Existing shareholders of HDFC Ltd. will own 41% stake in HDFC Bank.
    • Post-merger HDFC Ltd. will no longer be a separate mortgage lender, it will get folded into the bank.

    What are the terms of the merger?

    • The merger has to go through a series of regulatory approvals.
    • It has to get approval from the shareholders of both companies.
    • At this moment what has been announced by the two entities is that its an all-share deal, so there’s no cash transaction involved.
    • The terms of the share swap are such that shareholders of HDFC Ltd. will receive 42 shares of HDFC Bank for every 25 shares they hold in HDFC Ltd.

    What happens to existing customers and employees?

    • As far as customers are concerned, HDFC Ltd.’s customers will become the bank’s customers as well.
    • As for employees, HDFC Bank is planning to absorb and retain all the employees.
    • Neither of the entities are very heavy on employee numbers and have been fairly conservative in their employee sizes.

    What is the rationale behind this merger?

    • HDFC have largely had a fairly conservative lending culture, both reasonably customer-friendly, customer-centric, culturally, there wouldn’t be a big challenge.
    • The evolution of the regulatory framework for the NBFC (non-banking financial company) industry has been gradually moving closer, to harmonise with the banking sector’s regulatory framework.
    • Earlier, NBFCs had a fairly different and a far more loose sort of framework for lending and deposits.
    • This led to issues in the industry with some NBFCs struggling and going under or being taken over by others.
    • As Basel III norms for capital adequacy are in place, the NPA (non-performing asset) book is very closely monitored.

    What is in it for HDFC Ltd. and HDFC Bank?

    • Post-merger, the mortgage lender, HDFC Ltd., gets access to HDFC Bank’s CASA (current and savings accounts) deposits, which are lower cost funds.
    • For the mortgage lending business, the capital cost will come down. As the capital cost comes down, automatically it will have the ability to lend at a finer rate.
    • For HDFC Bank, every home loan customer can be tapped to become a bank customer.

    Impacts of the deal

    • It’s possible that we might see more NBFCs seeking to merge with banks.
    • There is already talk of the number of banks coming down.
    • So in some ways, this merger may be a precursor to what is going to happen in the state-run banking space, where the government has said it is going to reduce the number of public sector banks.

    Back2Basics: Basel Accords

    • They refer to the banking supervision Accords (recommendations on banking regulations)—Basel I, Basel II and Basel III—issued by the Basel Committee on Banking Supervision (BCBS).
    • They are called the Basel Accords as the BCBS maintains its secretariat at the Bank for International Settlements in Basel, Switzerland and the committee normally meets there.
    • These are a set of recommendations for regulations in the banking industry.
    • India has accepted Basel accords for the banking system.

    Let’s revise them:

    [1] Basel I

    • In 1988, BCBS introduced capital measurement system called Basel capital accord, also called as Basel 1.
    • It focused almost entirely on credit risk. It defined capital and structure of risk weights for banks.
    • The minimum capital requirement was fixed at 8% of risk-weighted assets (RWA).
    • RWA means assets with different risk profiles.
    • For example, an asset backed by collateral would carry lesser risks as compared to personal loans, which have no collateral. India adopted Basel 1 guidelines in 1999.

    [2] Basel II

    • In June ’04, Basel II guidelines were published by BCBS, which were considered to be the refined and reformed versions of Basel I accord.
    • The guidelines were based on three parameters, which the committee calls it as pillars:
    • Capital Adequacy Requirements: Banks should maintain a minimum capital adequacy requirement of 8% of risk assets.
    • Supervisory Review: According to this, banks were needed to develop and use better risk management techniques in monitoring and managing all the three types of risks that a bank faces, viz. credit, market and operational risks.
    • Market Discipline: This need increased disclosure requirements. Banks need to mandatorily disclose their CAR, risk exposure, etc to the central bank. Basel II norms in India and overseas are yet to be fully implemented.

    [3] Basel III

    • In 2010, Basel III guidelines were released. These guidelines were introduced in response to the financial crisis of 2008.
    • A need was felt to further strengthen the system as banks in the developed economies were under-capitalized, over-leveraged and had a greater reliance on short-term funding.
    • Also the quantity and quality of capital under Basel II were deemed insufficient to contain any further risk.
    • Basel III norms aim at making most banking activities such as their trading book activities more capital-intensive.
    • The guidelines aim to promote a more resilient banking system by focusing on four vital banking parameters viz. capital, leverage, funding and liquidity.

     

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  • Asian Development Outlook Report

    The Asian Development Bank (ADB) forecasts has provided some useful insights about India’s GDP growth.

    About Asian Development Bank (ADB)

    • The ADB is a regional development bank established on 19 December 1966 which is headquartered in Philippines.
    • ADB is committed to achieving a prosperous, inclusive, resilient, and sustainable Asia and the Pacific, while sustaining its efforts to eradicate extreme poverty.
    • The bank admits the members of the United Nations Economic and Social Commission for Asia and the Pacific (UNESCAP).
    • The ADB was modelled closely on the World Bank, and has a similar weighted voting system where votes are distributed in proportion with members’ capital subscriptions.
    • The president has a term of office lasting five years, and may be re-elected.
    • Traditionally, and because Japan is one of the largest shareholders of the bank, the president has always been Japanese.
    • ADB is an official United Nations Observer.

    Highlights of the ADB Outlook Report 2020

    • India’s GDP growth will moderate to 7.5% in 2022-23, from an estimated 8.9% in 2021-22.
    • It has factored in the Russia-Ukraine conflict’s implications for India, which would be largely indirect through higher oil prices
    • The severity of the COVID-19 pandemic would subside with a rise in vaccination rates.
    • Higher public capital spending is expected to improve the efficiency of India’s logistics infrastructure, crowd-in private investment, generate jobs in construction and sustain growth.

     

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  • Unlocking the potential of green hydrogen

    Context

    The ongoing tensions between Russia and Ukraine have led to the prices of crude oil shooting to $130/barrel. Green hydrogen is an emerging option that will help reduce India’s vulnerability to such price shocks.

    Four deficiencies in Renewable Energy Technologies

    • 1] Intermittent nature of RE: RE can only be generated intermittently.
    • Battery technology cannot store electricity at a grid scale.
    • 2] Financial viability: There are question marks on the financial viability of green power.
    • In India, renewable electricity is a replacement for coal-based power, the cheapest form of energy.
    • That’s a big constraint on its viability.
    • Moreover, the customers of this power – the state distribution companies – are collectively insolvent.
    • A business cannot prosper if its primary customers are not financially viable.
    • 3] Batteries are not suitable for heavy trucks: While electric cars and two-wheelers get a lot of visibility, much of India’s oil is burnt in heavy trucks.
    • Lithium batteries are not viable for trucks.
    • 4] Critical minerals: Electric vehicles require large quantities of lithium and cobalt that India lacks.
    • These minerals also have very concentrated supply chains that are vulnerable to disruptions.
    • Large-scale investments in electric vehicles may create unsustainable dependencies for the country.

    Is green hydrogen a solution?

    • Intermittent hydrogen in the energy mix can help circumvent some of these problems.
    • Hydrogen is an important industrial gas and is used on a large scale in petroleum refining, steel, and fertiliser production.
    • As of now, the hydrogen used in these industries is grey hydrogen, produced from natural gas.
    • Green hydrogen produced using renewable energy can be blended with grey hydrogen.
    • This will allow the creation of a substantial green hydrogen production capacity, without the risk that it may become a stranded asset.
    • Creating this hydrogen capacity will provide experience in handling the gas at a large scale and the challenges involved.
    • Blending with CNG: To widen the use of green hydrogen, it can be blended with compressed natural gas (CNG), widely used as a fuel for vehicles in Delhi, Mumbai and some other cities.
    • This will partly offset the need for imported natural gas and also help flag off the challenges of creating and distributing hydrogen at a national level.
    • By bringing down the price of green hydrogen sufficiently, India can help unlock some stranded assets.
    • The country has close to 25,000 megawatts of gas-fired power generation capacity that operates at a very low-capacity utilisation level. The high price of natural gas reduces the viability of such electricity.
    • These plants could use hydrogen blended with natural gas. Hydrogen should, however, be used to generate electricity after it has served its utility in other avenue.

    Way forward

    • To catalyse a hydrogen economy, India needs some specialist players to execute projects as well as finance them.
    • Participation of private players: Apart from government-backed players, the hydrogen economy will need private sector participation.
    • India’s start-up sector, with over 75 unicorns, is perhaps the most vibrant part of the country’s economy currently.
    • This ecosystem has been enabled by a mix of factors, including the presence of entrepreneurs with ideas and investors who are willing to back up these ideas
    • Creation of refueling network: One challenge of using new transport fuels, whether CNG or electric vehicles, is the creation of large-scale refuelling networks.
    • Bringing hydrogen vehicles on the road too soon will require the creation of yet another set of infrastructure.
    • Building fleets of hydrogen-fueled vehicles for gated infrastructure can be a good starting point.
    • Airports, ports and warehouses, for instance, use a large number of vehicles such as forklifts, cranes, trucks, tractors and passenger vehicles.

    Conclusion

    The government’s Green Hydrogen Policy sends the right signals about its intent. It now needs to ensure that investment can freely come into this space.

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  • Tariff problem of renewable energy

    Context

    We need to shift to a two-part tariff for solar and wind to incentivise private investments.

    Background of power generation tariff in India

    • The two-part tariff has been in vogue since 1992.
    • It applies to thermal and hydro generation.
    • 1] Fixed component: The first part is a fixed component – the cost that a generator incurs.
    • This is not linked to the amount of power generated.
    • 2] Variable component: The second part varies with the quantum of generation.
    • It does not apply to renewable generation — solar, wind, and also nuclear.
    • Under the two-part formula, the variable cost is calculated on the basis prescribed by the regulatory commissions.
    • This is based on the cost of fuel — coal or gas or lignite — as the case may be.
    • The fixed cost is also determined by regulatory commissions and it has a graded payment system depending on the extent to which the plant would be in a position to generate.
    • The point here is that when a generator is in a position to generate, it gets to recover the fixed cost (or some part of it), irrespective of whether it actually generates power.

    Single-part tariff for nuclear, wind and solar

    • In contrast, solar and wind generation and also nuclear are still governed by a single-part tariff.
    • The single-part tariff applies to nuclear power stations for various reasons including the fact that given the technology, a nuclear generator does not usually increase/decrease the generation at a quick tempo, but maintains a steady stream.
    • In any case, nuclear power accounts for only about two per cent of the entire generation, so let’s leave it aside.
    • On the other hand, solar and wind generation account for about 10 per cent of the generation today and going by the statement delivered during COP26 in Glasgow, we want to ramp it up to 50 per cent by 2030.

    Issues with single-part tariff for wind

    • Must run status: The renewable sector has been given a “must run” status.
    • This means that any generation from renewables needs to be dispatched first.
    • The problem is that “must run” runs counter to the basic economic theory that in order to minimise total cost, dispatch should commence from the source offering the cheapest variable cost and then move upwards.
    • With a single-part tariff, whenever the renewable generator is asked to back down for maintaining grid balance, it is paid nothing.
    • With a single part tariff for renewable generation, the entire cost is variable and at Rs 2.5 per unit for solar generation, it is not the cheapest source.
    • There are several NTPC coal-fired pit head plants whose variable costs are far lower, for example, Simhadri (Rs 1.36), Korba (Rs 1.36), Sipat (Rs 1.43).
    • For the older solar plants, the tariff could be well above Rs 3 per unit and for wind-based generation, it is even higher, averaging around Rs 4.5 per unit.
    • Therefore, the SLDCs often flout the principle of “must run”, since the distribution companies would save money by asking the renewable generator to back down while keeping the tap on for a coal-based generation.

    Solution

    • Two-part tariff for solar: The solution to this problem is to apply a two-part tariff for solar and wind generators as we do for hydro plants today.
    • Lowest variable cost: The overriding principle is that the percentage allocated as variable cost should ensure that renewable generation has the lowest variable cost so that there is no violation of the “must-run” principle.
    • At the same time, the fixed cost component should not be kept so high that it hurts the consumers. 
    • A fine balance between the proportion of the fixed and variable costs will have to be maintained.
    • It would also ensure a certain minimum return to developers even if they are not generating during certain hours, as in the case of coal and hydro plants.
    • Proper environment: If we are serious about having a renewable generating capacity of 450-500 GW by 2030, we need to create a proper environment and ensure adequate returns to invite fresh investments into renewable generation.

    Conclusion

    The switch from a single to a two-part tariff structure for renewables has to be made right now as we are at the cusp of ramping up our renewable generation and it takes time for matters to get streamlined as we have seen in the past.

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  • India to export Wheat

    Russia and Ukraine account for about 25% of the world’s wheat exports. However, Russia’s invasion of Ukraine and the subsequent Western sanctions against Moscow have curtailed wheat supplies drastically.

    India eyeing the global wheat basket

    • As a result of War, many countries which were sourcing wheat mainly from these two nations are now in a dire need of alternatives.
    • India, the largest wheat producer after China, is reported to be eyeing the void.
    • The government plans to allow increased exports to cash in on the higher price of wheat in the international market.
    • With harvesting season (March to May) coinciding with the supply crunch, a bumper crop is also expected again this year.

    Global wheat scenario

    • While Russia and Ukraine exported 183 million tonnes (MT) and 91 MT of wheat, respectively, between 2017 and 2021, India exported just a fraction of its output, or just 12.6 MT, in the period.
    • Five other countries accounted for the bulk of wheat exports in this period, including the European Union (157 MT), the U.S. (125 MT), Canada (112 MT) and Australia (83 MT).
    • India, which had the second-highest wheat supply (including production, existing stocks and imports) in this period at 613 million tonnes, exported only 2% of this, with about 80% used for domestic consumption, and the rest stored.

    Impact of the war

    • Many countries in Africa, West Asia and Southeast Asia rely heavily on Russian and Ukrainian wheat.
    • Egypt, the biggest importer of wheat, sources 93% of its needs from the East European neighbors. Indonesia, the second-largest importer, has a 30% dependence on these two nations.
    • African nations such as Sudan (60% reliance), Tanzania (64%), Libya (53%), Tunisia (52%), and West Asian countries including Lebanon (77% dependency), Yemen (50%) and the UAE (42%) are also highly dependent on supplies from the two neighbors now at war.

    India’s focus markets

    • India is now focussing on exporting wheat to many nations such as Egypt, Turkey, Nigeria, Algeria, West Asia, Indonesia, Vietnam, Sri Lanka, Bangladesh, Thailand, the Philippines, Morocco and Tanzania.
    • To give impetus to the export promotion of wheat as well as to bring focus on the challenges and bottlenecks faced in production and export, APEDA has created a task group.

    Legal hurdles over Wheat Exports

    • If India decides to export wheat from its stocks, some developed nations may raise objections at the World Trade Organisation.
    • Already, in March, India was accused of exporting rice from its stocks.
    • India had replied that its rice exports were not from stocks set aside under the public stockholding programs.

    India’s consideration

    • The Supreme Court in the Right to Food case, observed that the peace clause adopted in WTO’s Bali Ministerial in 2014 does not prevent India from exporting foodgrains.
    • With the buffer stocks at hand, India should increase its wheat exports in order to stabilise global prices to the extent that it can.
    • It is also important because the countries that were dependent on Russia and Ukraine for their wheat are looking for an alternative source.

    Way ahead

    • There is a need to prioritise local prices and ensure adequate supplies for domestic consumption before deciding on the quantum of exports.
    • Ensuring the stability of prices in India and availability of grain for internal consumption should be of utmost priority to the Indian government
    • The government should plan this move in such a way that it does not impact local consumption.
    • A bumper crop of wheat is expected, so the government can procure enough for its distribution and buffer needs.
    • Further, as of now, there are no export restrictions, so farmers can also get the advantage of higher prices by selling the surplus to private traders for exports.

     

    Try this PYQ from CSP 2019:

    Q. Among the agricultural commodities imported by India, which one of the following accounts for the highest imports in terms of value in the last five years?

    (a) Spices

    (b) Fresh fruits

    (c) Pulses

    (d) Vegetable oils

     

    [wpdiscuz-feedback id=”ff150g1lak” question=”Please leave a feedback on this” opened=”1″]Answer is subjective to the year. But still you can give it a try.[/wpdiscuz-feedback]

     

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  • The Chartered Accountants, the Cost and Works Accountants and the Company Secretaries (Amendment) Bill, 2021

    Context

    The Lok Sabha has approved a Bill to amend the Chartered Accountants Act, 1949, the law that governs the Institute of Chartered Accountants of India (ICAI).

    What are the changes proposed in the Bill?

    • Introduced in the Lok Sabha on December 17, 2021, and titled the Chartered Accountants, the Cost and Works Accountants and the Company Secretaries (Amendment) Bill, 2021.
    • The key changes it proposes are in the area of discipline and governance and administration.
    • 1] Discipline: The ICAI’s disciplinary committee and board of discipline will be chaired by non-chartered accountants (CA),
    • Its elected council members will no longer be in a majority in them.
    • 2] Governance and administration: The term of the ICAI’s Council will be raised from three to four years, the maximum number of consecutive terms for its elected members will be reduced to two from the current three;
    • The ICAI’s Secretary will replace the ICAI’s president as its chief executive and perform the functions to be specified;
    • The ICAI will appoint its auditor from the Comptroller and Auditor-General of India’s panel of CA firms;
    • The Government will form a coordination committee for the ICAI and the Institutes of Cost Accountants and Company Secretaries of India.
    • The Parliamentary Standing Committee on Finance has endorsed these changes and has further recommended an end to the ICAI’s monopoly in certification.

    Challenges facing Chartered Accountancy and ICAI

    1] Lacking critical thinking and analytical ability

    • Senior industry managers say that many CAs do not have what it takes to succeed in the corporate world, i.e., analytical ability, critical thinking, appreciation of the business context, grasp of technology, and communication and presentation skills.
    • CA students do not have in-class interaction.
    • Also, the coaching is focused on cracking examinations rather than facilitating understanding and application.

    2] Poor record in disciplining members

    • The ICAI’s record in disciplining its members is even more problematic.
    • There have been persistent complaints that the ICAI is lax in acting against errant members.
    •  In 2018, the Government had set up the National Financial Reporting Authority as India’s first independent regulator of accounting and audit.
    • The proposed changes in the composition of the ICAI’s disciplinary arms will further limit its role.
    • As a result, the ICAI will be effectively reduced to an examination board.

    3] ICAI failed to keep pace with changes

    • The ICAI was set up in 1949, largely as the Indian version of the U.K. institute
    •  Much of the work that CAs do and clamour for is a remnant of the licence raj.
    • Many businesses and professions have changed beyond recognition as a result of the economic reforms initiated in 1991.
    •  The demutualised and technology-driven National Stock Exchange of India has transformed stock-broking.
    • Indian IT and pharma companies now compete successfully with the best in the world.
    • In contrast, CA has not kept pace with the changes in India’s dynamic economy and changing society.
    • Overseas accountancy qualifications such as the Association of Chartered Certified Accountants (ACCA) and Chartered Institute of Management Accountants (CIMA) are gaining popularity in India, perhaps because they are recognised worldwide, are more relevant to current and future needs, and are accepted even in India by global companies and global accounting firms.

    4] Challenges posed by technology such as AI/ML

    • Accounting and auditing are more amenable to the replacement of humans by technology.
    • AI, robotics, and other technological advances are likely to reduce the need for human intervention in accounting.
    • Also, recent administrative reforms aimed at enabling ease of doing business and ease of living, such as faceless tax assessment, easy filing of tax returns, prompt refunds, rising threshold for tax audit, and abolition of Goods and Services Tax audit have greatly reduced the availability of captive, government-mandated, make-work business for CAs.

    Way forward

    • Setting IIAs: The Parliamentary Committee’s suggestion to set up a string of Indian Institutes of Accounting (IIAs) on the lines of the Indian Institutes of Technology (IIT) and the Indian Institutes of Management (IIM) is innovative.
    • At one level, they will end the ICAI’s statutory monopoly over certification.
    • More competition should result in better quality and higher standards of conduct.

    Conclusion

    The Bill and the Parliamentary Committee’s report can be seen as efforts to drag the ICAI to the contemporary world. It would be wise to read the proposed changes as a warning and respond maturely.

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  • Startup India Initiative and its Success

    A research, reviewing India’s entrepreneurial policy Startup India, affirmed its positive impact in reducing regional entrepreneurial disparities.

    Startup India Initiative

    • The Startup India campaign was first announced by PM Modi during his speech on 15 August 2015 address from the Red Fort.
    • The action plan for this initiative is focusing on three areas:
    1. Simplification and Handholding.
    2. Funding Support and Incentives.
    3. Industry-Academia Partnership and Incubation.
    • An additional area relating to this initiative is to discard restrictive States Government policies within this domain, such as License Raj, Land Permissions, Foreign Investment Proposals, and Environmental Clearances.
    • It was organized by the Department for promotion of industry and internal trade (DPI&IT).

    The success of the scheme

    • Minister for Commerce and Industry has informed the Lok Sabha that the entrepreneurial portal had more than 65,000 startups registered.
    • Of which, 40 attained the ‘unicorn’ status in the last twelve months, bringing the total as of date to 90.
    • India now ranks third among global startup eco-systems.
    • The networking, training and mentoring facilities provided by Startup India alongside entrepreneurship outreach campaigns in tier-2 and tier-3 cities, helped address regional entrepreneurial disparities in India.

    Limitations to its success

    (1) Heavy concentration in megacities

    • Entrepreneurship continues to be “highly concentrated” in three megacities, namely, Mumbai, Bengaluru and Delhi NCR.
    • India’s venture capital industry is also clustered in and around these three cities.
    • Such concentration can lead to increased economic inequality and hinder emergence of entrepreneurs from industries other than those belonging to the clusters.

    (2) Narrow Representation

    • The Startup India Action Plan document has no mention of the words ‘caste’, ‘tribe’, ‘marginalised’, ‘indigenous’ or ‘social group’.
    • Additionally, the policy’s reliance on technology does not take into consideration India’s digital divide, especially with respect to urban and rural areas.

    (3) Few Women in the industry

    • There is an under-representation of women and marginalized caste groups in the national startup ecosystem.

    Dedicated measures to support Women

    • 10% of the fund in the Fund of Funds operated by Small Industries Development Bank of India (SIDBI) has been reserved for women-led startups.
    • Further, all the alternate investment funds where the SIDBI takes equity have been mandated to contribute 20% in business which are women led.
    • There is a capacity-building program and a dedicated webpage for women on the portal.

    Way ahead

    • There is a need for policies and progressive strategies from governments to encourage startups and provide access and assistance in key areas including tax clarity, incubation, affordability and licensing.
    • In any case, governments should be well prepared and dedicated to creating a culture of startups to impact the entrepreneurial ecosystem in their cities, countries and citizens.

     

    Also read:

    [Burning Issue] Five Years of Startup India Scheme

     

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  • RBI cannot ignore inflation

    Context

    Despite being legally mandated to keep inflation in check, RBI has persisted with easy monetary policy, even as inflationary pressures have increased. We need to understand why, and what could be the repercussions.

    Inflation problem in India

    • For most of the past two years, CPI (consumer price index) inflation has been hovering close to the 6 per cent upper threshold of the RBI’s target band.
    • Inflation averaged 6.1 per cent during the pandemic period (April 2020 to June 2021), despite a massive collapse in aggregate demand.
    • Then in January 2022, as food prices recovered, headline inflation once again crossed the upper threshold of the inflation targeting band.
    • Inflationary pressures do not seem to be diminishing either. Instead, they continue to build up.
    • The standard measure of inflation “in the pipeline” is WPI (wholesale price index) inflation, since price increases at the wholesale level tend to translate into retail inflation in due course.
    •  Russia’s invasion of Ukraine has resulted in a sharp increase in global commodity prices, including prices of crude oil, edible oils, and fertilisers.
    • Indian firms are already adapting to this situation, passing on commodity price increase to retail prices.

    Issues with RBI’s stance

    • Standard economics gives us a guide for how central banks should react in a situation like this.
    • Two conditions: It says that monetary policy should accommodate the first round of commodity price increase, but only under certain conditions, notably that inflation is initially on target, and expectations are firmly anchored.
    • But neither condition holds at present. Inflation is already too high, and so are expectations.
    • An argument is nonetheless being made that monetary policy should not be tightened when inflation is driven by supply-side factors, as it can adversely impact growth.
    • This is fallacious. When there are supply constraints, using easy monetary policy to boost demand is not going to boost output.
    • And if firms are expecting high inflation, this will send things into a vicious spiral, as they will increase their prices even more in advance of any input price pressures.
    • Surely the RBI is aware of all of this. So why is it still not acting on it?

    Why RBI is ignoring inflationary pressure?

    • Growth concerns: The problem seems to be that governments all over the world are worried about growth.
    • The US Federal Reserve has been slow to raise rates even as inflation has reached a four-decade high. The European Central Bank has been even slower to react.
    • Fiscal dominance in India: In India, monetary policy also suffers from a strong fiscal dominance.
    • As a result, not only is the RBI expected to support growth, it is also expected to keep the government’s borrowing costs in check, which is in direct conflict with its inflation targeting objective.

    Implications of RBI ignoring inflationary pressure

    • Aggressive reduction in interest rates: A decade ago, we were in a similar situation when RBI delayed its response because it was focusing on growth.
    • When inflation subsequently took off, it reached double digits and the RBI had to raise interest rates aggressively to bring it down.
    • That was a very painful adjustment.
    • Impact on credibility of the RBI: In addition, if the RBI does allow inflation to take off, there will be long-lasting repercussions for its credibility.
    • Unachrored expectation:  if the public sees the RBI consistently ignoring inflation, expectations can rapidly get unanchored, and then it becomes very costly to bring it down.

    Conclusion

    To conclude, inflation is best addressed by the central bank using monetary policy, not by the government adjusting taxes. The RBI needs to urgently revisit its inflation forecast and its monetary policy stance in order to avoid potentially painful adjustments down the road.

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  • Self reliance in Agriculture

    Context

    For the Amrit Kaal (next 25 years) that the government has announced, we need to be self-reliant not just in missiles (defence equipment) but also in meals (food).

    What does self-reliance in food mean?

    • Its true meaning lies in specialising in commodities in which we have a comparative advantage, export them, and import those in which we don’t have a significant comparative advantage.
    • Self-reliance in food does not mean that we have to produce everything ourselves at home, irrespective of the cost.
    • If some protection is needed for new areas to develop (infant industry argument), that may be okay.
    • But one should not aspire to be self-sufficient behind high tariff walls.

    Importance of agri-R&D

    • What is it that gives a country an edge over others in attaining comparative advantage?
    • There is ample literature to show that agri-R&D raises total factor productivity and makes agriculture more competitive globally.
    • If India wants to be fully self-reliant in food, it is generally agreed that it must invest at least 1 per cent of its agri-GDP in agri-R&D.
    • The Economic Survey (2021-22) explicitly highlighted the correlation between spending on agri-R&D and agricultural growth.
    • Low expenditure on agri-R&D: But the budgets of both the Union government and the states put together reveal that this expenditure on agri-R&D and education hovers around 0.6 per cent of agri-GDP.
    • This is way below the minimum cut off point of 1 per cent and government policy must urgently work towards raising this substantially.
    • There are some global and local companies like Bayer, Syngenta, MAHYCO, Jain Irrigation, and Mahindra and Mahindra that spend a considerable amount of their turnover on R&D programmes and developing high-tech inputs.
    • The USP of these companies is that they develop technology that increases productivity while addressing the current challenges of limited net sown area, depleting water resources, vulnerability to climate change, and the need to produce nutrient-rich food.

    Way forward

    • Role of private sector: The private sector need to come forward and help India attain supremacy in agri-R&D and innovation systems and a hub for exports and agri-technology.
    • Increase expenditure on Agri-R&D and education: The need of the hour is to focus on increasing expenditure on ARE and other development projects, which can aid in the sustainable growth of the agriculture sector.
    • India’s budget allocations in the agri-food space should thrive on creating “more from less”.
    • There is a need to work on building long-term sustainable solutions that have an aggressive approach to implementing relevant policies and developing new ones.
    • India’s current budgetary allocation strategy and trends need to be reoriented to ensure that there is more room for R&D expenditure by the government.
    • Incentivise private companies for R&D: In addition to this, the government should come out with policies that incentivise private companies to expand their R&D programmes and invest more financial resources on development projects, which have the potential to overcome the challenges of the current agrarian setup of India.

    Conclusion

    If India wants to be fully self-reliant in food, it must focus on agri-R&D and increase allocation in the Budget.

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  • Sovereign green bond (SGB)

    Context

    The other two major budget announcements pertain to the issuance of sovereign green bonds and a central bank digital currency. While geopolitical turbulence might make the current moment inopportune for experimentation, the government seems firm on both the proposals and they will most probably be rolled out.

    Sovereign green bond (SGB):  how it is different from a traditional bond

    • The sovereign green bond is a novel idea.
    •  It will be a part of the government’s borrowing programme.
    • The gross borrowing programme of the government is pegged at Rs 14.95 lakh crore.
    • The SGB (sovereign green bond) raised will be part of the aggregate borrowing programme and has to be used for projects which are ESG (environment, social and governance) compliant.
    • Hence, if the bond is being used to finance a power project or road, or in case it is used to finance revenue expenditure, it has to be ESG compliant.
    • If they succeed at the central level, green bonds can be replicated by states.

    Challenges for SGB

    • Pricing challenge: As these bonds are different from G-secs (government securities), they may have to provide a better return as all ESG compliant companies have to make special investments that will push up costs.
    • Low-interest rate: Further, given the low-interest rates prevailing today — real returns on deposits are negative — the SGBs can be issued as tax-free bonds, open to the public.
    • This will evince a lot of interest given that these are government-issued bonds.
    • The RBI and the government have been trying to get retail investors to participate in the government’s borrowing programme, and this move will expedite the process.

    Central bank digital currency (CBDC) and challenges

    •  For launching such a currency, the RBI has to address certain fundamental questions.
    • 1] Will it replace currency: Is a CBDC going to replace currency at some point in the future?
    • One must remember that there are several sections in India that are not conversant with technology.
    • 2] How will it be different from digital payments: If it is going to coexist with currency, how different will it be for the public from the digital payments that are being made today?
    • Will people need to choose between a mobile wallet and a CBDC wallet?
    • 3] Security of owner’s information: any issuance of CBDC on a voluntary basis also raises a question on the security of the owner’s information.
    • CBDC has to be clear on the issue of confidentiality as it is bound to be a matter of concern.
    • 4] The future of the banking system: If people have to be incentivised to move voluntarily to the CBDC, the cash exchanged must earn interest or else all money will go to bank accounts where a minimal interest rate can be earned.
    • Will we require savings bank accounts with commercial banks in case all cash goes to the RBI?
    • Will we then require ATMs for cash withdrawal? Will bank tellers become redundant? Will we need logistics companies that handle cash?
    • These finer issues need to be addressed by the RBI as the widespread use of CBDC will progressively lead to lesser need for banks.
    • 5] Issue of security: Any financial system that runs on technology can be hacked.
    • It has to be foolproof and power failure resistant.
    • There is a real danger of cyber fraud increasing as the majority of the population is not tech-savvy.
    • Similarly, there is always downtime for bank servers when banking transactions cannot be carried on.
    • This cannot be allowed to be the case with CBDC as it has to be available on a 24 x 7 basis.

    Consider the question “What are green bonds? How the green bonds can act as a tool to achieve the targets of sustainable development as a means of finance?”

    Conclusion

    The arguments for CBDC are compelling on the grounds of keeping up with the central banks of other countries, and the possibilities of taking advantage of new technologies like blockchain. But before embarking on these measures, it might be useful to keep in mind the issues flagged above.

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