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Subject: Economics

  • Why India must cancel its nuclear expansion plans

    Context

    A fire broke out near the Zaporizhzhia nuclear plant in Ukraine (Europe’s largest) during the course of a military battle. Had the fire affected the cooling system, the plant’s power supply, or its spent fuel pool, a major disaster could have occurred.

    Issues with India’s nuclear expansion plans

    • On December 15, 2021, the Indian government informed Parliament that it plans to build “10 indigenous reactors… in fleet mode” and had granted “in principle approval” for 28 additional reactors, including 24 to be imported from France, the U.S. and Russia.
    • Capital intensive: Nuclear power plants are capital intensive and recent nuclear builds have suffered major cost overruns.
    • Decreasing cost of renewable: In contrast, renewable energy technologies have become cheaper.
    • The Wall Street company, Lazard, estimated that the cost of electricity from solar photovoltaics and wind turbines in the U.S. declined by 90% and 72%, respectively, between 2009-21.
    • Recent low bids are of ₹2.14 per unit for solar power, and ₹2.34 for solar-wind hybrid projects; even in projects coupled with storage, bids are around ₹4.30 per unit.
    • Global trend suggests declining use of nuclear energy: In 1996, 17.5% of the world’s electricity came from nuclear power plants; by 2020, this figure had declined to just around 10%.
    • Safety concerns: In a densely populated country such as India, land is at a premium and emergency health care is far from uniformly available.
    • Local citizens understand that a nuclear disaster might leave large swathes of land uninhabitable — as in Chernobyl — or require a prohibitively expensive clean-up — as in Fukushima, where the final costs may eventually exceed $600 billion.
    • Indemnity clause: Concerns about safety have been accentuated by the insistence of multinational nuclear suppliers that they be indemnified of liability for the consequence of any accident in India.
    • India’s liability law already largely protects them.
    • But the industry objects to the small window of opportunity available for the Indian government to hold them to account.
    • Climate concerns: Climate change will increase the risk of nuclear reactor accidents.
    • Recently, a wildfire approached the Hanul nuclear power plant in South Korea and President Moon Jae-in ordered “all-out efforts” to avoid an accident at the reactors there.
    • In 2020, a windstorm caused the Duane Arnold nuclear plant in the U.S. to cease operations.
    • The frequency of such extreme weather events is likely to increase in the future.

    Consider the question “What are the concerns with the nuclear energy expansion plans of India? Suggest the way forward.”

    Conclusion

    Given the inherent vulnerabilities of nuclear reactors and their high costs, it would be best for the Government to unambiguously cancel its plans for a nuclear expansion.

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    Back2Basics: What is EPR (nuclear reactor)

    • The EPR is a third generation pressurised water reactor design.
    • It has been designed and developed mainly by Framatome (part of Areva between 2001 and 2017) and Électricité de France (EDF) in France, and Siemens in Germany.
    • In Europe this reactor design was called European Pressurised Reactor, and the internationalised name was Evolutionary Power Reactor, but it is now simply named EPR.

  • Taking stock of the Indian economy

    Context

    This article takes the stock of the Indian economy using the EFGHIJ framework.

    Export

    • The $400-billion target of goods exports in FY22 appears achievable:
    • This is a structural break from ~$300-330 billion per year over the last decade.
    • Note that in calendar year 2021, India exported almost $400 billion worth of goods.
    • This export growth comes at a time when global shipping and freight markets have been in a tizzy over the last few months as Covid-related supply chain disruptions across commodities and final products reverberated across the globe.

    Fiscal growth

    • India has significant fiscal headroom in FY23 with a 6.4% fiscal deficit pencilled in.
    • The revenue buoyancy, assumed at less than 1, is conservative as is the overall assumption on nominal growth at 11%.
    • In as volatile a world as this, the conservatism in forecasting should come to India’s advantage.
    • India saw healthy direct and indirect tax receipts in FY22: the GST collections have consistently remained above the `1 trillion-a-month mark for many months now.
    • Two aspects need a close watch:
    • (a) as the prices of various commodities rise, there can be calls for softening the blow on the final consumer via tax cuts or direct support, and
    • (b) the disinvestment programme of the government which could face a market where investor appetite is uncertain.

    Growth challenges and opportunities for India

    • India’s GDP growth in FY23 is projected to be 7.6-8.5%, making it one of the fastest-growing economies.
    • With the newly changed circumstances, it is possible that this tight range and the absolute number may require revision.
    • It is, however, too early to say in which direction and by what amounts.
    • Opportunities for India: Global dislocations of supply chain or the creation of new supply sources could create divergent challenges and opportunities for India.
    • The post Covid rebound in high frequency indicators (air and rail passengers, toll collections, UPI payments, etc.) suggests that the internal consumption economy is currently back on track.
    • It is important to note that India continues to be the fastest-growing nation of its size in the world.

    Health

    • India has now completed almost 1.8 billion doses.
    • The Omicron wave, thankfully both due to the inherent nature of the virus and the large vaccination drive, did not cause significant economic upheaval.
    •  It may be time to think of Covid as endemic and plan accordingly.

    Inflation

    • The inflation in 2021 was based on a sudden bout of fiscal-support-driven spending meeting with tight supply chain bottlenecks.
    • It was expected that as spending normalises and supply chains open, prices will stabilise.
    • However, the sharp uptick in the prices of crude, coal, commodities, and chips has created a more sustained scare for inflation.
    • Many measures may be taken across the world to curb the impact for the common man: from opening of oil reserves, to cutting of taxes, to direct support, etc—all of which could impact the fiscal.

    Capital

    • Denoted by K by economists, expect to see a lot of ebb-and-flow here as investors react to evolving, volatile trends.
    • Higher public investment in the last two years has supported economic recovery: India has planned for a record `10 lakh crore plus public capex.
    • Net FDI has been strong at $25.3 billion up to December in FY2022.
    • While FPIs have withdrawn $9.5 billion in FY22, DIIs and retail investors have supported the markets.

    Conclusion

    With two waves of COVID-19 largely behind us, many macroeconomic factors have changed dramatically, especially in the last fortnight.

    Source:

    https://www.financialexpress.com/opinion/efghijk-taking-stock-of-the-indian-economy/2457255/

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  • Why society gains when start-ups fail

    Context

    As per the Economic Survey 2021-22, India has become the third-largest startup ecosystem in the world after the US and China.

    Start-up ecosystem in India

    • India attracted huge investment in startups in 2021: Private equity investment was $77 billion, of which $42 billion went to early-stage ventures.
    • Every startup where salaries are paid by investors rather than customers is breathlessly rethinking business plans.

    How do startups benefit society?

    1] Innovation, productivity and job creation:

    • The high failure rate of startups is not a problem per se — society only needs a few successes to harness the gains of innovation, productivity and job creation.
    • A new book, The Power Law makes the case that startup investing is unlike public market investing.
    • He suggests public markets follow a “normal” distribution like human height — most people cluster around the average with a few exceptionally low or high.
    • But venture investments follow a “power law” of distribution, that is, most go to zero but the tiny number that succeeds more than compensate for the losses or mediocrity of the many.

    2] Losses caused by startups are not passed on to society

    • Startups don’t socialise their losses, Corporate bank loans expanded from Rs 18 lakh crore in 2008 to Rs 54 lakh crore in 2014.
    • Such high corporate bank loans created bad loans that needed many lakh crores of government money to recapitalise nationalised banks.
    • This money was diverted from government spending on healthcare, education and defence.
    • The current venture capital binge will also create many write-offs but this cost will fall on consenting adults with broad shoulders — foreign institutions, angel investors and entrepreneurs with successful previous exits.

    3] Startups will solve real problems for Indians:

    • Ending our poverty needs higher productivity regions, cities, sectors, firms and individuals.
    • A modern state is a welfare state that does less commercially so it can do more socially.
    • It needs allies in reimagining financial inclusion, supply chains, distribution logistics, employability, retail, transport, media, healthcare, agriculture and much else.
    • Many of our startups shall redeem their pledge to solve these problems “not wholly or in full measure, but very substantially”.

    Three issues related to startups

    • 1] Fiscal and monetary policy normalisation: The global capital supply fuelling startup funding faces challenges from fiscal and monetary policy normalisation: The rate-sensitive two-year US government bond recently touched a 1.6 per cent yield after being at 0.4 per cent as recently as November — because the risk-free return cannot be return-free-risk forever.
    • Investors are returning to weighing financial sustainability and capital efficiency along with addressable markets.
    • 2] Excesses: This explosive startup funding has created excesses.
    • 3] A different approach of public markets: Private markets are not only delaying IPOs — Amazon went public within three years of starting with less than half the value of a unicorn — but unicorn IPOs’ underperformance suggests that public markets have a different calibration.

    Conclusion

    The few startups that survive will raise India’s soft power and prosperity by using improbable ideas to solve impossible problems. What we need is to ensure the policy environment for the startups to boom.

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  • Inland water transport system in India: Potential and challenges

    • Month after setting sail on the Ganga from Patna, a vessel carrying 200 metric tonnes of food grains for the Food Corporation of India (FCI), docked at Guwahati’s Pandu port on the southern bank of the Brahmaputra.
    • The occasion is believed to have taken inland water transport, on two of India’s largest river systems, to the future.

    Why is a Ganga-Brahmaputra cargo vessel in focus?

    • There is nothing unusual about a cargo vessel setting sail from or docking at any river port.
    • This has rekindled hope for the inland water transport system which the landlocked northeast depended on heavily before India’s independence in 1947.

    Inland water service: A necessity for the NE

    • Seamless cargo transportation has been a necessity for the northeast.
    • Around Independence, Assam’s per capita income was the highest in the country.
    • This was primarily because of access for its tea, timber, coal and oil industries to seaports on the Bay of Bengal via the Brahmaputra and the Barak River (southern Assam) systems.
    • Ferry services continued sporadically after 1947 but stopped after the 1965 war with Pakistan, as Bangladesh used to be East Pakistan then.
    • The scenario changed after the river routes were cut off and rail and road through the “Chicken’s Neck”, a narrow strip in West Bengal, became costlier alternatives.
    • The start of cargo movement through the Indo-Bangladesh Protocol (IBP) route is going to provide the business community a viable, economic and ecological alternative.

    How did the water cargo service through Bangladesh come about?

    • The resumption of cargo transport service through the waterways in Bangladesh has come at a cost since the Protocol on Inland Water Transit and Trade was signed between the two countries.
    • India has invested 80% of ₹305.84 crore to improve the navigability of the two stretches of the IBP (Indo-Bangladesh Protocol) routes — Sirajganj-Daikhowa and Ashuganj-Zakiganj in Bangladesh.
    • The seven-year dredging project on these two stretches till 2026 is expected to yield seamless navigation to the north-eastern region.
    • With this, the distance between NW1 and NW2 will reduce by almost 1,000 km once the IBP routes are cleared for navigation.

    Policy boosts to IWs

    • The Government has undertaken the Jal Marg Vikas project with an investment of ₹4,600-crore to augment the capacity of NW1 for sustainable movement of vessels weighing up to 2,000 tonnes.
    • Sailors who made the cargo trips possible have had difficulties steering clear of fishing nets and angry fishermen in Bangladesh.
    • These hiccups will get sorted out with time.

    Why go for IWT?

    • Inland Water Transport (IWT) is a fuel-efficient, environment friendly and cost effective mode of transport having potential to supplement the over-burdened rail and congested roads.
    • It is a boon where road transport is least feasible.

    Back2Basics: Inland Waterways

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  • UPI123Pay: Payment solution for feature phone users

    The Reserve Bank of India has launched a new Unified Payments Interface (UPI) payments solution for feature phone users dubbed ‘UPI123Pay’.

    What is UPI?

    • UPI is an instant real-time payment system developed by NPCI facilitating inter-bank transactions.
    • The interface is regulated by the Reserve Bank of India and works by instantly transferring funds between two bank accounts on a mobile platform.

    What is UPI123Pay?

    • UPI ‘123PAY’ is a three-step method to initiate and execute services for users which will work on simple phones.
    • It will allow customers to use feature phones for almost all transactions except scan and pay.
    • It doesn’t need an internet connection for transactions. Customers have to link their bank account with feature phones to use this facility.
    • Feature phone users will now be able to undertake a host of transactions based on four technology alternatives.
    • They include calling an IVR (interactive voice response) number, app functionality in feature phones, missed call-based approach and also proximity sound-based payments, the RBI said.
    • Such users can initiate payments to friends and family, pay utility bills, recharge the FAST Tags of their vehicles, pay mobile bills and also allow users to check account balances.
    • Customers will also be able to link bank accounts, set or change UPI PINs.

    Others: ‘Digisaathi’

    • A 24×7 helpline for digital payments has also been set up by the National Payments Corporation of India (NPCI).
    • The helpline christened ‘Digisaathi’ will assist the callers/users with all their queries on digital payments via website and chatbot.
    • Users can visit www.digisaathi.info or call on 14431 and 1800 891 3333 from their phones for their queries on digital payments and grievances.

    Why UPI123Pay was created?

    • UPI, which was introduced in 2016, has become one of the most used digital payments platforms in the country.
    • The volume of UPI transactions has already reached ₹76 lakh crore in the current year, compared to ₹41 lakh crore in FY21.
    • However, at present, efficient access to UPI is available largely via smartphones.

    How will users make payments without internet?

    The new UPI payments system offers users four options to make payments without internet connectivity:

    1. Interactive Voice Response (IVR): Users would be required to initiate a secured call from their feature phones to a predetermined IVR number and complete UPI on-boarding formalities to be able to start making financial transactions like money transfer, mobile recharge, EMI repayment, balance check, among others.
    2. App-based functionality: One could also install an app on feature phone through which several UPI functions, available on smartphones, will be available on their feature phone, except scan and pay feature which is currently not available.
    3. Missed call facility: The missed call facility will allow users to access their bank account and perform routine transactions such as receiving, transferring funds, regular purchases, bill payments, etc., by giving a missed call on the number displayed at the merchant outlet. The customer will receive an incoming call to authenticate the transaction by entering UPI PIN.
    4. Proximity sound-based payments: One could utilise the proximity sound-based payments option, which uses sound waves to enable contactless, offline, and proximity data communication on any device.

    How do UPI payments through sound work?

    • UPI payments using sound isn’t new. When Google Pay was first launched in 2017 as Tez, the app had a sound-based system of payments built in.
    • Google called this ‘Cash Mode’ in which phones would emit ultrasonic sounds that could be used by other Tez users to accept and receive money.
    • It’s somewhat like Bluetooth but instead of using radio waves, it uses sound waves to transfer data from one device to the next.
    • A company called ToneTag also produces audio-based point-of-sale machines.

    Is payment through sound secure?

    • Sound wave-based payments are meant to be contactless, but occur within a certain proximity only.
    • Ultrasonic waves are outside the usual human hearing range, but such payment systems can also use audible sounds, something that US-based startup Chirp showcased back in 2011.
    • Devices using such systems are encrypted, and only the devices involved can recognize the emitted waves.
    • The sound waves being emitted are encrypted, meaning the receiving device will need to have decryption codes to complete the transaction.

     

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  • [pib] National Land Monetisation Corporation (NLMC)

    The Union Cabinet has approved the setting up of a new government-owned firm National Land Monetisation Corporation (NLMC) for pooling and monetizing sovereign and public sector land assets.

    What is NLMC?

    • The National Land Monetisation Corporation (NLMC) is being formed with an initial authorised share capital of ₹5,000 crore and paid-up capital of ₹150 crore.
    • The government will appoint a chairman to head the NLMC through a “merit-based selection process” and hire private sector professionals with expertise.
    • The NLMC will undertake monetization of surplus land and building assets of Central public sector enterprises (CPSEs) as well as government agencies.

    How will it function?

    • NLMC will own, hold, manage and monetise surplus land and building assets of CPSEs under closure and surplus non-core land assets of Government-owned CPSEs under strategic disinvestment.
    • This will speed up the closure process of CPSEs and smoothen the strategic disinvestment process of Government-owned CPSEs, the statement said.
    • NLMC will undertake surplus land asset monetisation as an agency function, and assist and provide technical advice to the Centre in this regard.
    • The NLMC board will comprise senior Government officers and eminent experts, while its chairman and non-Government directors will be appointed through a merit-based selection process, the statement said.
    • The Corporation will have minimal full-time staff, hired directly from the market on a contract basis.

    Stipulated tasks

    • CPSEs have referred around 3,400 acres of land and other non-core assets to the Department of Investment and Public Asset Management (DIPAM) for monetisation.
    • Monetisation of non-core assets of MTNL, BSNL, BPCL, BEML, HMT, is currently at various stages of the transaction, as per latest data in the Economic Survey 2021-22.

    Significance of NLMC

    • The government would be able to generate substantial revenues by monetizing unused and under-used assets.
    • The new corporation will also help carry out monetization of assets belonging to public sector firms that have closed or are lined up for a strategic sale.

     

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  • Centre and RBI must rely on unconventional policies to manage finances better

    Context

    Amid Ukraine crisis and high oil prices, the larger concern is how the government and the RBI will navigate this period at a time of record government borrowings, and prevent domestic interest rates from hardening.

    The Triffin paradox in current context

    • It is ironic that even as emerging economies running current account deficits are getting punished by a depreciating currency and a hardening of interest rates, we are witnessing the US dollar appreciating and US treasuries strengthening.
    • The most common argument for such a macroeconomic paradox is named after the economist Robert Triffin (the Triffin Paradox).
    •  It postulates that the US current account deficit is purely a reflection of the US supplying large amounts of dollars to fulfil the world’s demand.
    • In other words, central banks across the world must build up claims on the US to back their domestic money growth.

    Dollar’s dominance

    • Former US Federal Reserve Chairman Bernanke even extended this argument in 2005 to the “saving glut” proposition by espousing that emerging economies were accumulating foreign exchange reserves in dollars, and diverting domestic savings to buy US treasuries.
    • There are several counter arguments to this view that effectively state that the dominance of the US dollar is inevitable in the global financial architecture, and it is purely a fault of emerging market economies.

    Need for the unconventional tools to avoid the disruption by government borrowing

    This can be done in the following ways

    1] Spread the borrowing over four quarters after taking real-time view of disruption

    • Every year, the government front-loads its large borrowing programme by completing 60 per cent of the borrowings in the first half of the year.
    • This time, the RBI and the government may take a real-time view of disruptions and spread the borrowings over four quarters, keeping the initial two quarters light.
    • The borrowing programme can also be announced as per a quarterly schedule and there could be even two auctions during the week.
    • These steps could smoothen out the non-disruptive elements in government borrowings.

    2] Reconfigure the borrowing program

    • For example, as rates move up, banks tend to prefer short-term investments while insurance companies, provident funds and others prefer longer-term investments.
    • Given this, the borrowing schedule can be reconfigured with a higher proportion of short-and medium-tenor securities being offered in the initial months, while pushing back the longer tenor securities to the second half of the year.

    3] Push Small Savings Schemes

    • Third, small savings collections have significantly exceeded budget estimates.
    • The government could think of giving a push to small savings schemes such as the Sukanya Samriddhi Yojana (SSY).
    • The SSY has witnessed the registration of 2.82 crore girl children in the seven years since its inception in 2015, leaving enough room for further mop-up.
    • The newly opened accounts may even be given an enhanced savings limit in the first year to catch up for the years lost for these new additions.

    4] Listing of LIC

    • LIC currently holds around Rs 23.5 trillion worth of government bonds, higher than even than the RBI.
    • LIC’s G-sec holding is around 19 per cent, while in comparison the banking system’s ownership stands at around 38 per cent.
    • Thus LIC’s listing should augur well for the bond market as the insurance behemoth may have to deploy a greater share of inflows in safer avenues domestically.
    • This is a plausible option as banks may have to readjust their deposits into credit as the economic recovery gains momentum.

    Conclusion

    Rising oil prices have placed policymakers in an unenviable position. If higher oil prices are fully passed through, it will result in higher inflation and hence higher rates as a consequence.  In such a scenario it is best to follow the first option by using unconventional policy measures.

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  • Stagflation’ in India

    Reports suggest that crude oil prices soared and touched almost $140 per barrel mark amid Russian invasion of Ukraine. This has posed a risk of causing Stagflation in India.

    What is Stagflation?

    • Stagflation is a stagnant growth and persistently high inflation. It, thus, describes a rather rare and curious condition of an economy.
    • Iain Macleod, a Conservative Party MP in the United Kingdom, is known to have coined the phrase during his speech on the UK economy in November 1965.
    • Typically, rising inflation happens when an economy is booming — people are earning lots of money, demanding lots of goods and services and as a result, prices keep going up.
    • When the demand is down and the economy is in the doldrums, by the reverse logic, prices tend to stagnate (or even fall).
    • But stagflation is a condition where an economy experiences the worst of both worlds — the growth rate is largely stagnant (along with rising unemployment) and inflation is not only high but persistently so.

    How does one get into Stagflation?

    • The best-known case of stagflation is what happened in the early and mid-1970s.
    • The OPEC (Organisation of Petroleum Exporting Countries), which works like a cartel, decided to cut crude oil supply.
    • This sent oil prices soaring across the world; they were up by almost 70%.
    • This sudden oil price shock not only raised inflation everywhere, especially in the western economies but also constrained their ability to produce, thus hampering their economic growth.
    • High inflation and stalled growth (and the resulting unemployment) created stagflation.

    Is India facing stagflation?

    • In the recent past, this question has gained prominence since late 2019, when retail inflation spiked due to unseasonal rains causing a spike in food inflation.
    • In December 2019, it was also becoming difficult for the government to deny that India’s growth rate was witnessing a secular deceleration.
    • As revised estimates, released in January end, now show, India’s GDP growth rate decelerated from over 8% in 2016-17 to just 3.7% in 2019-20.
    • However, the answer to this question in December 2019 was a clear no.
    • For one, in absolute terms, India’s GDP was still growing, albeit at a progressively slower rate.

    Why this is a cause of concern?

    • Russia is the world’s second-largest oil producer and, as such, if its oil is kept out of the market because of sanctions, it will not only lead to prices spiking, but also mean they will stay that way for long.
    • While India is not directly involved in the conflict, it will be badly affected if oil prices move higher and stay that way.
    • India imports more than 84% of its total oil demand. At one level, that puts into perspective all the talk of being Atmanirbhar (or self-reliant).
    • Without these imports, India’s economy would come to a sudden halt — both metaphorically as well as actually.

    Expected impact on Indian Economy

    • Higher inflation would rob Indians of their purchasing power, thus bringing down their overall demand.
    • In other words, people are not demanding enough for the economy to grow fast.
    • Private consumer demand is the biggest driver of growth in India.
    • Such aggregate demand — the monetary sum of all the soaps, phones, cars, refrigerators, holidays etc. that we all spend on in our personal capacity — accounts for more than 55% of India’s total GDP.
    • Higher prices will reduce this demand, which is already struggling to come back up to the pre-Covid level.
    • Fewer goods and services being demanded will then disincentivise businesses from investing in new capacities, which, in turn, will exacerbate the unemployment crisis and lead to even lower incomes.

    Back2Basics: Inflation and its impact

    • Depression: It is Economic depression is a sustained, long-term downturn in economic
    • Deflation: It is the general fall in the price level over a period of time.
    • Disinflation: It is the fall in the rate of inflation or a slower rate of inflation. Example: a fall in the inflation rate from 8% to 6%.
    • Reflation: It is the act of stimulating the economy by increasing the money supply or by reducing taxes, seeking to bring the economy back up to the long-term trend, following a dip in the business cycle. It is the opposite of disinflation.
    • Skewflation: It is the skewed rise in the price of some items while remaining item prices remain the same. E.g. Seasonal rise in the price of onions.
    • Stagflation: The situation of rising prices along with falling growth and employment, is called stagflation. Inflation accompanied by an economic recession.

     

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  • How to handle impact of Ukrainian crisis on India’s energy sector

    Context

    The Ukraine crisis will affect India’s energy landscape in many ways. This article analyses the impact and suggest the policy measures.

    The trajectory of oil prices

    • The inflation-adjusted price of Brent crude is $83/bbl (as of writing, the nominal price is $116 / bbl), which is lower than the peak of $145/ bbl in 2008 and the average price that year of $100/bbl.
    •  In other words, prices could rise much further and we would still not be in uncharted waters.
    • Factors affecting prices: The price trajectory will depend on the duration of the conflict, its impact on global energy demand, countervailing supply measures (for example, drawdown of strategic reserves, diversion of US LNG supplies to Europe, the Iranian nuclear deal which, if signed, could release up to 1 mbd of Iranian crude into the market) and whether in all this mayhem, the pipeline infrastructure currently feeding Russian gas into Europe remains operational.
    • Impact on India’s earnings: Our earnings from petroleum products (diesel, petrol, naphtha) will be adversely impacted.
    • In 2021, these products generated $39 billion in revenue and at 14 per cent, they accounted for the highest share of export earnings.

    Impact on India’s energy assets in Russia

    • ONGC has a 26 per cent stake in the Vankor oil field, a 20 per cent stake in the Sakhalin-1 LNG/oil export complex.
    • All these holdings have eroded substantially in value.
    • In India, Rosneft (the Russian national oil company) operates the 20 mtpa refinery in Vadinar through Nayara Energy.
    • Nayara is not sanctioned but the traders of crude/products might worry about transacting with an Indian company owned by a sanctioned Russian entity.

    Four emergent energy trends that would affect India

    • 1] Energy ties of Russia and China: Only last week, for instance, Gazprom signed off on an agreement to build a second gas pipeline to China christened “Power of Siberia 2”.
    • The “Power of Siberia 1” pipeline has been pumping gas into China since 2019.
    • 2] Emergence of US as second largest producer: The emergence of the US as the largest producer of oil in the world and potentially the largest exporter of LNG.
    • It has the capacity to blunt the impact of a supply shortfall but as it is controlled by profit-maximising private corporates.
    • 3] The ability of Saudi Arabia to swing the crude oil market: It is the one member of OPEC plus with significant spares, low cost, producible capacity (approx 3 mbd) of crude oil.
    • The US has pressured Saudi to bring this volume into the market but they have, as yet, not buckled.
    • 4] China’s dominance over rare earth metals: The chokehold of China over the rare earths, minerals and components that are required to effect the transition to a clean energy system.

    Suggestions for India

    • 1] Take into account uncertainty: Frame the polic around the expectation of continuing volatility.
    • 2] Strategic reserves: Build up strategic reserves to safeguard against the unexpected.
    • 3] Transnational pipelines: Revive conversations with Turkmenistan and Iran about a transnational gas pipeline.
    • 4] Reduce dependence on China for minerals and components required for the transition to clean energy: Fast forward efforts to decouple the supply chain dependence on China for the minerals and components required for the clean energy transition.
    •  And, finally bring in psychologists to get a better fix on the logic that drives the decisions of the energy autocrats in Russia, Saudi Arabia and China.

    Conclusion

    The Ukraine crisis throws up many learnings. But one needs particular emphasis. It is not enough to read the tea leaves of supply, demand and geopolitical trends to understand the trajectory of the energy market.

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  • Hike in crude oil prices and its impact on India

    Context

    The Russia-Ukraine conflict will impact India’s economy through several channels. The first order impact, emanates from the negative terms of trade shock from higher commodity prices, particularly oil.

    • Crude prices have surged well past a $110/barrel and there is a growing expectation that, as the conflict gets more entrenched, crude could remain elevated for much longer and average close to $100/barrel in 2022, vis-a-vis $70/barrel in 2021.

    Why crude oil price is increasing?

    Limited Supply:

    • Major oil-producing countries had cut oil production last year amid a sharp fall in demand due to the Covid-19 pandemic.
    • Saudi Arabia pledged extra supply cuts in February and March 2020 following reductions by other members of the Organization of the Petroleum Exporting Countries (OPEC) and its allies.
    • In early January 2021, the OPEC and Russia (as OPEC+) agreed to cut back on oil production to increase prices.

    Rising Demand:

    • The production and rollout of vaccines for Covid-19 and the rising consumption post the Covid lockdowns last year have both led to a revival in international crude oil prices.

    Geopolitical reasons

    • Geopolitical tension has risen between Russia, which is the second largest oil producer in the world, and neighbouring Ukraine.
    • In January, there were drone attacks on oil facilities in UAE, another major oil producer.
    • An outage on a major oil pipeline linking Saudi Arabia and Turkey further added to the pressures.

    How it will impact India?

    • Current Account Deficit: The increase in oil prices will increase the country’s import bill, and further disturb its current account deficit (excess of imports of goods and services over exports).
      • According to estimates, a one-dollar increase in crude oil price increases the oil bill by around USD 1.6 billion per year.
    • Inflation: The increase in crude prices could also also further increase inflationary pressures that have been building up over the past few months.
      • This will decrease the space for the monetary policy committee to ease policy rates further.
      • The government had hiked central taxes on petrol and diesel by Rs. 13 per litre and Rs. 11 per litre in 2020 to boost revenues amid lower economic activity.
    • Fiscal Health: If oil prices continue to increase, the government shall be forced to cut taxes on petroleum and diesel which may cause loss of revenue and deteriorate its fiscal balance.
      • The growth slowdown in the last two years has already resulted in a precarious fiscal situation because of tax revenue shortfalls.
      • The revenue lost will erode the government’s ability to spend or meet its fiscal commitments in the form of budgetary transfers to states, payment of dues and compensation for revenue shortfalls to state governments under the goods and services tax (GST) framework.

    Why high growth impact on fiscal space leads to a greater hit to demand and growth?

    • The growth impact will manifest through constraints on fiscal space, household purchasing power being impinged and firm margins coming under pressure.
    • Why does marginal propensity to consume matter? The quantum of the growth impact will depend on how the shock is distributed across the fiscal, households and firms because of the different marginal propensities to consume.
    • For example, the excise duty cuts last November have already absorbed about one-third of the shock from oil (0.4 per cent of GDP).
    • The cost of this, however, is commensurate pressures on fiscal expenditures and growth, agnostically assuming a fiscal multiplier of 1.
    • In contrast, the marginal propensity to consume/invest out of income/earnings is typically lower than 1 for households/firms.
    • So, the greater the fraction of the shock absorbed on the fiscal, the greater the hit to demand and growth. 

    Way forward

    1] Let the rupee reach the new equilibrium

    • The widening of the CAD and associated BoP pressures will create some depreciation pressures on the rupee.
    • More fundamentally, a persistent negative terms of trade shock will argue for a weaker equilibrium real effective exchange rate.
    • Policymakers should let the rupee reach this new equilibrium – albeit in a gradual and non-disruptive manner – and not prevent this adjustment because it will facilitate the necessary “expenditure switching” to reduce imports, boost exports and help narrow an elevated CAD.

    2] Pragmatic fiscal policies

    • Cutting excise duties would buffer the impact on households and protect consumption, but potentially result in a larger hit to demand by shrinking fiscal space to spend.
    • If the government doesn’t cut duties, it has resources that can potentially be used to more directly target affected households at the bottom of the pyramid.
    • But this will mean higher retail prices that can harden inflationary expectations, increasing the challenges for monetary policy.
    • Finally, policymakers could always cut duties, not cut spending and let the deficit widen commensurately — effectively pushing out some of the terms of trade costs to the future — but negative surprises on the fiscal during periods of heightened macro uncertainty can generate significantly risk premia in markets.
    • All told, the fiscal will confront several trade-offs, and should try avoiding corner solutions.
    • What should be clear is that as soon as markets begin to stabilise, authorities must plough ahead with planned asset sales/disinvestment to create more fiscal headroom, without trying to perfectly time the market.

    3) Reduce the dependence

    • India has proposed Oil Buyer’s club. This would be a grouping of India, China, Japan and South Korea. The objective is to reduce the dependence on OPEC, have better bargains, increase the imports of crude oil imports from USA etc
    • It was put forward by Mani Shankar Ayyar in 2005
    • Create a stabilization fund or reserve account – Thailand, UK etc

    Conclusion

    A persistent adverse supply shock is complicated and challenging to respond to, and the new equilibrium will inevitably need some combination of a weaker rupee, higher rates, and judicious fiscal management.

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    Back2Basics: What is a fiscal multiplier?

    • The fiscal multiplier measures the effect that increases in fiscal spending will have on a nation’s economic output, or gross domestic product (GDP).
    • Fiscal multipliers are important because they can help guide a government’s policies during an economic crisis and help set the stage for economic recovery.

    What is Marginal Propensity to Consume?

    • In economics, the marginal propensity to consume (MPC) is defined as the proportion of an aggregate raise in pay that a consumer spends on the consumption of goods and services, as opposed to saving it.
    • Marginal propensity to consume is a component of Keynesian macroeconomic theory and is calculated as the change in consumption divided by the change in income.
    • MPC varies by income level. MPC is typically lower at higher incomes.