💥Mains Ready By December. Smash Mains & Smash PYQ Admissions Open
Talk to Mentor

Civilsdaily

Login

Subject: Economics

  • Time to rationalise fuel taxes

    Context

    The disconnect between retail and wholesale inflation suggests that the two measures are driven by distinct and unrelated shocks.

    The disconnect between retain inflation and wholesale inflation

    •  In the months between April 2020 and November 2020, retail inflation remained above 6%, while average wholesale inflation was -0.20%.
    • During the financial crisis (2008-2009) wholesale inflation came down significantly as commodity prices crashed after a boom, but retail inflation kept rising.
    • Correlation: This disconnect is reflected in the contemporaneous correlation between these two measures of inflation, which we find to be very low (0.04), and not significant.

    Understanding the reasons for the disconnect

    •  We cannot rule out feedback from wholesale inflation to retail inflation.
    • To better explore this, it helps to understand the driving forces behind retail and wholesale inflation. 
    • Driving factors for CPI: Retail inflation is closely linked to food and beverage prices, partly because of their higher weightage in the consumer price index (CPI).
    • The dominance of supply shocks: High retail inflation in 2020 was primarily due to the rising prices of food and beverages.
    • The surge was likely led by the usual supply shocks—rainfall, agricultural productivity, or Covid-19-induced supply shocks.
    • This suggests two important features of Indian retail inflation: it is predominantly led by supply shocks (food inflation shock) and it is transitory in nature.
    • Driving factor for WPI: High wholesale inflation in recent months was mainly due to rising prices in fuel and power and manufacturing, which together comprise around 77% of the wholesale price index (WPI).
    • Rising fuel and energy prices in India were a result of the recent increase in global oil prices.

    Takeaways

    • High wholesale inflation should not warrant any immediate policy responses as the two inflation measures seem to reflect different things.
    • Overall, the high correlation between world energy inflation and India’s wholesale inflation (0.88) indicates that India’s wholesale inflation is predominantly driven by world commodity prices.
    • On the other hand, the low correlation between India’s retail inflation and world energy inflation (-0.13, and not significant), suggests that India’s retail inflation is primarily driven by domestic food prices.
    • Higher wholesale inflation implies a higher profit margin for producers, which acts as an incentive for investment
    •  There are, in fact, some early signs of a revival in investment in recent quarters, and policy must be careful not to derail this.

    Policy options

    • Given the pass-through of wholesale inflation into retail inflation, if the ongoing commodity boom persists, then the fuel and power component of the WPI is likely to raise retail inflation directly.
    • At that point, there would be some urgency to increase the interest rate, which may be premature and could dampen the revival of growth prospects.
    • To avoid the interest rate response, the best option going forward would be to rationalise fuel taxes, to reduce the pass-through of global commodity prices into wholesale prices and ultimately into retail inflation.

    Conclusion

    The correct fiscal-monetary coordination requires fiscal policy not to be inflationary, so that the RBI can support growth by keeping interest rates low.

    UPSC 2022 countdown has begun! Get your personal guidance plan now! (Click here)

    Source:

    https://www.financialexpress.com/opinion/time-to-rationalise-fuel-taxes-oil-is-a-major-input-in-production-hence-a-tax-on-it-is-highly-inflationary/2430635/

  • Prevention of Money Laundering Act (PMLA)

    The Supreme Court is looking into allegations of the metamorphosis of the Prevention of Money Laundering Act (PMLA), brought to sniff out drug money, into a potent weapon to raid rivals and deny rights.

    What is meant by money laundering?

    • Money laundering is the process of making significant amounts of money obtained through criminal activities, such as drug trafficking or terrorist funding, appear to have come from a legitimate source.
    • Large profits are made by illegal arms sales, drug trafficking, smuggling and prostitution rings, insider trading, bribery, and computer fraud schemes.
    • As a result, it provides an incentive for money launderers to “legitimize” their ill-gotten gains through money laundering.
    • The money generated is referred to as ‘dirty money,’ and money laundering is the act of converting ‘dirty money’ into ‘legitimate’ money.

    Money Laundering Procedure:

    It is a 3-stage process. They are:

    • Placement: The first stage involves the injection of crime money into the formal financial system.
    • Layering is the second stage, money injected into the system is layered and spread over various transactions in order to conceal the money’s tainted origin.
    • Integration: In the third and final stage, money enters the financial system in such a way that the initial association with the crime is sought to be erased, and the money can then be utilized as clean money by the offender.

    Some of the most Common Money Laundering Methods:

    • Bulk cash smuggling, cash-intensive businesses, round-tripping,trade-based laundering, shell companies and trusts, bank capture, gambling, real estate, black salaries, fictional loans, hawala, and false invoicing

    Prevention of Money Laundering Act (PMLA)

    • PMLA, 2002 is an Act of the Parliament of India enacted by the NDA government to prevent money laundering and to provide for confiscation of property derived from money laundering.
    • It was enacted in response to India’s global commitment (including the Vienna Convention) to combat the menace of money laundering.
    • PMLA and the Rules notified there under came into force with effect from July 1, 2005.
    • The act was amended in the year 2005, 2009 and 2012.

    Objectives of PMLA

    The PMLA seeks to combat money laundering in India and has three main objectives:

    1. To prevent and control money laundering.
    2. To confiscate and seize the property obtained from the laundered money; and
    3. To deal with any other issue connected with money laundering in India.

    Key definitions

    • Payment System: A system that enables payment to be effected between a payer and a beneficiary, involving clearing, payment or settlement service or all of them. It includes the systems enabling credit card, debit card, smart card, money transfer or similar operations.
    • Money-laundering: Whosoever directly or indirectly attempts to indulge or assist other person or actually involved in any activity connected with the proceeds of crime and projecting it as untainted property.
    • Attachment: Prohibition of transfer, conversion, disposition or movement of property by an appropriate legal order.
    • Proceeds of crime: Any property derived or obtained, directly or indirectly, by any person as a result of criminal activity relating to a scheduled offence.

    Salient features

    • Punishment and Jail term: The Act prescribes that any person found guilty of money laundering shall be punishable with rigorous imprisonment from three years to seven years. The maximum punishment may extend to 10 years instead of 7 years.
    • Powers of attachment of tainted property: The Director or officer above the rank of Deputy Director with the authority of the Director, can provisionally attach property believed to be “proceeds of crime”.
    • Adjudicating Authority: It is the authority appointed by the central government which decides whether any of the property attached or seized is involved in money laundering.
    • Presumption in inter-connected transactions: Where money laundering involves two or more inter-connected transactions. It is presumed that the remaining transactions form part of such inter-connected transactions.
    • Burden of proof: A person, who is accused of having committed the offense of money laundering, has to prove that alleged proceeds of crime are in fact lawful property.
    • Appellate Tribunal: It is given the power to hear appeals against the orders of the Adjudicating Authority and any other authority under the Act. Its orders are not final and can be challenged.
    • Establishment of Special Court: To ensure speedy trial.

    Issues with PMLA

    • Misuse of central agencies: PMLA is being pulled into the investigation of even ordinary crimes by the Enforcement Directorate.
    • Seizing of assets: Assets of genuine victims have been attached. The ED could just walk into anybody’s house.
    • Politically motivated raids: In all this, the fundamental purpose of PMLA to investigate the conversion of “illegitimate money into legitimate money” was lost.
    • Opacity of charges: Petitioners pointed out that even the Enforcement Case Information Report (ECIR) – an equivalent of the FIR – is considered an “internal document” and not given to the accused.
    • Vagueness over evidences: The accused is called upon to make statements that are treated as admissible in evidence.
    • Harassment: The ED begins to summon accused persons and seeks details of all their financial transactions and of their family members.
    • Against individual liberty: The initiation of an investigation by the ED has consequences that have the potential of curtailing the liberty of an individual.

    Way ahead

    • It is unlikely that corruption can be substantially reduced without modifying the way government agencies operate.
    • The fight against corruption is intimately linked with the reform of the investigations.
    • Therefore the adjudicating authorities must work in cooperation and ensure the highest standards of transparency and fairness.

     

     

  • Back in news: LIC Disinvestment

    The Union government has filed a draft document with the stock market regulator for selling 5% of its shares in the Life Insurance Corporation (LIC) of India.

    Details of the IPO

    • The IPO is a 100% OFS [offer for sale] by the Government of India and entails no fresh issue of shares by LIC.
    • 6 Crore shares are on offer representing 5% of the government’s equity in the firm.
    • As much as 10% of the offer could be reserved for LIC policyholders, as per the regulatory filing, and another 5% of the shares may be reserved for employees.

    About Life Insurance Corporation of India (LIC)

    • LIC is an Indian state-owned insurance group and investment corporation owned by the Government of India.
    • It was founded in 1956 when the Parliament of India passed the Life Insurance of India Act that nationalized the insurance industry in India.
    • Over 245 insurance companies and provident societies were merged to create the state-owned LIC.

    Why LIC?

    • LIC is India’s largest financial institution.
    • When listed on stock exchanges, it could easily emerge as the country’s top listed company in terms of market valuation, overtaking current leaders Reliance and TCS.
    • It is also the largest investor in government securities and stock markets every year.
    • On average, LIC invests Rs 55,000 crore to Rs 65,000 crore in stock markets every year and emerges as the largest investor in Indian stocks.
    • LIC also has huge investments in debentures and bonds besides providing funding for many infrastructure projects.

    Impacts of listing of LICs

    • Profit-making for govt: The government is trying to make the most of the brand value of LIC, given that it is one of the few remaining profit-making entities owned by the state.
    • Better returns: Listing will boost LIC’s efficiency and thereby policy returns.
    • Reforming the insurance sector: LIC will also become more competitive. This will put pressure on its peers to innovate, benefitting policyholders in terms of pricing, product features, and services.
    • Better financial position: Less govt interference will be a positive for LIC’s financial health.
    • Risk-free: As long as a sovereign guarantee over the maturity proceeds and the sum assured to continue, policyholders won’t perceive any risk.

    Various challenges

    • Structural challenges: LIC can even evolve into a bank like many of its global peers like Axa, Berkshire, and Munich Re.
    • Market hurdles: LIC’s own issues are not the only challenge the company would face in going public. It also remains to be seen if the Indian share market is ready to absorb such a large public issue.
    • Impact on growth: The size of the IPO will determine the extent of liquidity it will suck out, but Indian markets do not have the depth to take the issue of a very size.
    • Fears of disclosure: The Company’s books and operations have been opaque for far too long but it is trusted by 250 million policyholders.
    • Investors trust at risk: Being one of the biggest financial institutions of the country, the move to privatize LIC will shake the confidence of the common man and will be an affront to our financial sovereignty.

    Way Forward

    • Over the years, LIC has become the lender of last resort to the Government of India.
    • Confronted with an unprecedented fiscal deficit and worried by an economy in crisis, the government has to find resources.
    • This disinvestment is also a preferred option for ideological and practical reasons.
    • The government could utilize the money gained by selling off its stakes to improve services in public goods like infrastructure, health, and education.

     

    UPSC 2022 countdown has begun! Get your personal guidance plan now! (Click here)

  • Import Ban on Drones

    The Government has banned the import of drones barring for R&D, defense, and security purposes.

    Why in news?

    • To promote Make-in-India drones.
    • Before this order, the import of drones was “restricted” and needed prior clearance of the Directorate General of Civil Aviation (DGCA) and an import license from DGFT.

    India’s sources of Imports

    • For its defense needs, India imports from Israel and the US.
    • Consumer drones such as those used for wedding photography come from China and drones for light shows also come from China apart from Russia.

    Why need drones?

    • Indian drone manufacturers and service providers arrange drones for a variety of use cases such as survey and mapping, security and surveillance, inspection, construction progress monitoring, and drone delivery.

    What does the order say?

    • The Directorate General of Foreign Trade (DGFT) issued an order prohibiting with immediate effect the import of drones in Completely-Built-Up (CBU), Semi-knocked-down (SKD), or Completely-Knocked-down (CKD) forms.
    • Import of drones by government entities, educational institutions recognized by the Central or State governments, government-recognized R&D entities, and drone manufacturers for R&D purposes as well as for defense and security purposes will be allowed.
    • For this, there has to be an import authorization obtained from the DGFT.
    • The import of drone components is “free”, implying that no permission is needed from the DGFT allowing local manufacturers to import parts like diodes, chips, motors, lithium-ion batteries, etc.

    Steps taken to promote indigenous drone manufacturing

    • In August last year, the Government brought out liberalized Drone Rules, 2021 which reduced the number of forms to be filled to seek authorization from 25 to five.
    • They also dispensed with the need for security clearance before any registration or issuance of the license.
    • R&D entities too have been provided blanket exemption from all kinds of permissions, and restrictions on foreign-owned companies registered in India have also been removed.
    • The Government has also announced a production-linked incentive scheme for drones and drone components with the aim to make India a “global drone hub by 2030”.
    • Foreign manufacturers will be encouraged to set up assembly lines in India.

    Why such a blanket ban?

    • Most drone manufacturers in India assemble imported components in India, and there is less manufacturing.
    • The import ban will ensure that an Indian manufacturer has control of the IP, design, and software which gives him or her a total understanding and control of the product.
    • Over a period of time, this can enable further indigenization.

    Possible repercussions of the ban

    • The ban is likely to hurt those who use drones for photography and videography for weddings and events.
    • These drones primarily come from China because they are cheaper and easy to use and India still has a lot of catching up to do in manufacturing them.

    Also read

    [Sansad TV] Perspective: Keeping Drones in Check

     

    UPSC 2022 countdown has begun! Get your personal guidance plan now! (Click here)

  • Capital Gains Tax

    The capital gains tax structure in India is complicated, and it is time for a relook since the union budget has provisions for 30% tax on cryptocurrency.

    What is Capital Gains Tax?

    • Capital gains tax is levied on the profits made on investments.
    • It covers real estate, gold, stocks, mutual funds, and various other financial and non-financial assets.

    Types

    • It is divided into long-term capital gains tax (LTCG) and short-term capital gains tax (STCG) depending on how long you have held the investment in question.
    • Unlike income tax, the percentage of tax does not change on the basis of your overall tax slab.
    • The LTCG tax, excluding surcharge, on equity is the same for gains of ₹10 lakh or ₹10 crore.
    • There is also a separate set of deductions that apply to LTCG, which do not apply to ordinary income.

    Why is it so complicated?

    Capital gains tax is complicated for a few primary reasons.

    • First, the rate changes from asset to asset. LTCG tax on stocks and equity mutual funds is 10% but on debt mutual funds is 20% with indexation.
    • Second, holding period changes from asset to asset. The holding period for LTCG tax is two years in real estate, one year for stocks, and three years for debt mutual funds and gold.
    • Third, exemptions available against it come with their own complex conditions. For instance, buying a house after selling one can get you an exemption, but the new house must be bought in two years or built in three years of the sale.

    Is cryptocurrency taxed as capital gains?

    • The 2022 budget has proposed a 30% tax on cryptocurrency, which is higher than capital gains tax in many cases.
    • Besides, under capital gains tax, investors can adjust profits and losses on different investments against each other or against profits/losses in the future.
    • However, this cannot be done with cryptocurrency.

    What distortions does it create?

    • As capital gains tax is the same regardless of your overall income it can compound inequality.
    • For instance, a person with a salary of ₹40 lakh will pay 30% tax on it but just 10% LTCG tax on gains from stock trading.
    • A person with a salary of ₹5 lakh will pay a 5% tax on it but the same 10% LTCG tax on stock trading.
    • Second, the smaller one-year qualifying period for LTCG in stocks compared to three years in debt mutual funds may encourage short-term trading in equity.

    What can be done to fix these anomalies?

    • The government can bring about uniformity in rates and holding periods for various assets to ensure that the tax for one asset is not more attractive than another.
    • A uniform and long holding period to qualify for LTCG can also discourage short-term trading and speculative  behavior  in assets  such as  stocks.
    • The exemptions for LTCG such as reinvestment in another house property or capital gains bonds can also be made simpler, with fewer conditions.
    • Small investors can also be given relief by reducing rates of capital gains.

     

    UPSC 2022 countdown has begun! Get your personal guidance plan now! (Click here)

  • An MSP scheme to transform Indian agriculture

    Context

    The MSP must look especially into the requirements of farmers and the landless.

    Background of price stabilisation for food grain

    • The Essential Commodities Act in 1955 sought to counter price rise due to speculative private trading and then MSP in the 1960s.
    • A buffer stock policy was developed over time to involve different kinds of mechanisms such as:
      a) setting cost-based minimum procurement price, paying the difference between procurement price and market price.
      b) storing the procured surplus for sale through the Public Distribution System (PDS) at issue price, and market intervention to stabilise price when deemed necessary.
    • This task required interlinking procurement, storage and distribution with more centralised investment and control of each of these tasks.

    3 Purposes MSP could serve

    MSP could serve, in principle, three purposes:

    • Price stabilisation in the food grains market.
    • Income support to farmers, and
    • As a mechanism for coping with the indebtedness of farmers.

    Advantages of wide coverage

    • Fulfilling three objectives: In this way, the objectives of income support to farmers, price stabilization, food security, and inducing more climate-friendly cropping patterns can be combined to an extent.
    • Solution to debt problem: A real breakthrough in the recurring problem of agricultural debt can be made by the linking of selling of grains under MSP to the provision of bank credit particularly for small farmers.
    • The farmer can get a certificate selling grains at MSP which would be credit points proportional to the amount sold; this will entitle them to a bank loan as their right, and calibrate the fluctuations between good and bad harvest years by storing the certificates for later use.

    Issues with MSP in current form

    • Low accessibility and awareness of the MSP regime: A survey highlighted that 81% of the cultivators were aware of MSP fixed by the Government for different crops and out of them only 10% knew about MSP before the sowing season.
    • Arrears in payments: More than 50% of the farmers receive their payments of MSP after one week.
    • Poor marketing arrangements: Almost 67% of the farmers sell their produce at MSP rate through their own arrangement and 21% through brokers.
    • Partial coverage resulting in skewed cropping pattern: This partial MSP coverage skewed the cropping pattern against several coarse grains and millets particularly in rain-fed areas.

    Way forward

    • Flexible arrangement of MSP: Each crop within a band of maximum and a minimum price depending on harvest conditions i.e. higher price in a bad and lower price in a good harvest year in general will have its price set in the band.
    • High MSP for coarse grains: The price of some selected coarse grains can be fixed at the upper end of its band to encourage their production in rain-fed areas.

    Conclusion

    Greater coverage of all 23 crops under MSP is a way of improving both food security and income support to the poorest farmers in rain-fed regions.

    UPSC 2022 countdown has begun! Get your personal guidance plan now! (Click here)

  • What is a Ratings Agency and why do they matter?

    Finance Secretary has accused rating agencies of “double standards” when assessing emerging markets and developing economies.

    What is the news?

    • Fitch, a rating agency, has termed India as the most indebted emerging market.
    • It claimed that the latest budget did not provide clarity on fiscal consolidation plans.

    What is a Rating Agency?

    • Rating agencies assess the creditworthiness or potential of an equity, debt or country.
    • Their reports are read by investors to make an informed decision on whether or not to invest in a particular country or companies in that geography.
    • They assess if a country, equity or debt is financially stable and whether it at a low/high default risk.
    • In simpler terms, these reports help investors gauge if they would get a return on their investment.

    What do they do?

    • The agencies periodically re-evaluate previously assigned ratings after new developments geopolitical events or a significant economic announcement by the concerned entity.
    • Their reports are sold and published in financial and daily newspapers.

    What grading pattern do they follow?

    • The three prominent ratings agencies, viz., Standard & Poor’s, Moody’s and Fitch subscribe to largely similar grading patterns.
    • Standard & Poor’s accord their highest grade, that is, AAA, to countries, equity or debt with the exceedingly high capacity to meet their financial commitments.
    • Its grading slab includes letters A, B and C with an addition a single or double letter denoting a higher grade.
    • Moody’s separates ratings into short and long-term definitions. Its longer-term grading ranges from Aaa to C, with Aaa being the highest.
    • Fitch, too, rates from AAA to D, with D being the lowest. It follows the same succession scheme as Moody’s and Fitch.

    Criticism of rating agencies

    • Popular ratings agencies publicly reveal their methodology, which is based on macroeconomic data publicly made available by a country, to lend credibility to their inferences.
    • However, credit rating agencies were subjected to severe criticism for allegedly spurring the financial crisis in the United States, which began in 2017.
    • The agencies underestimated the credit risk associated with structured credit products and failed to adjust their ratings quickly enough to deteriorating market conditions.
    • They were charged for methodological errors and conflict of interest on multiple counts.

    Do countries pay attention to ratings agencies?

    • Lowered rating of a country can potentially cause panic selling or offloading of investment by a foreign investor.
    • In 2013, the European Union opted for regulating the agencies.
    • Over reliance on credit ratings may reduce incentives for investor to develop their own capacity for credit risk assessment.
    • Ratings Agencies in the EU are now permitted to issue ratings for a country only thrice a year, and after close of trade in the entire Union.

     

    UPSC 2022 countdown has begun! Get your personal guidance plan now! (Click here)

  • What is SWIFT?

    As tensions peaks over Ukraine the United States could exclude Russia from the Society for Worldwide Interbank Financial Telecommunication (SWIFT).

    What is SWIFT?

    • SWIFT is an international network for banks worldwide to facilitate smooth money transactions globally.
    • It is basically a messaging network used by banks and financial institutions globally for quick and faultless exchange of information pertaining to financial transactions.
    • The Belgium-headquartered SWIFT connects more than 11,000 banking and securities organization in over 200 countries and territories.
    • First used in 1973, it went live in 1977 with 518 institutions from 22 countries, its website states.

    What exactly is it?

    • SWIFT is merely a platform that sends messages and does not hold any securities or money.
    • It facilitates standardized and reliable communication to facilitate the transaction.

    How does it facilitate banking?

    • Each participant on the platform is assigned a unique eight-digit SWIFT code or a bank identification code (BIC).
    • If a person, say, in New York with a Citibank account, wants to send money to someone with an HSBC account in London, the payee would have to submit to his bank the London-based beneficiary’s account number along with the eight-digit SWIFT code of the latter’s bank.
    • Citibank would then send a SWIFT message to HSBC. Once that is received and approved, the money would be credited to the required account.

    How is the organization governed?

    • SWIFT claims to be neutral. Its shareholders, consisting of 3,500 firms across the globe, elect the 25-member board, which is responsible for oversight and management of the company.
    • It is regulated by G-10 central banks from Belgium, Canada, France, Germany, Italy, Japan, The Netherlands, the UK, the US, Switzerland, and Sweden, alongside the European Central Bank.
    • Its lead overseer is the National Bank of Belgium.
    • The SWIFT oversight forum was established in 2012.
    • The G-10 participants were joined by the central banks of India, Australia, Russia, South Korea, Saudi Arabia, Singapore, South Africa, the Republic of Turkey, and the People’s Republic of China.
    • Europe, Middle East, and Africa are highest contributors to SWIFT.

    What happens if one is excluded from SWIFT?

    • US excluding Russia from SWIFT could have serious repercussions on how Russian banks carry out international financial transactions.
    • If a country is excluded from the most participatory financial facilitating platform, its foreign funding would take a hit, making it entirely reliant on domestic investors.
    • This is particularly troublesome when institutional investors are constantly seeking new markets in newer territories.
    • An alternative system would be cumbersome to build and even more difficult to integrate with an already expansive system.

    Are any countries excluded from SWIFT?

    • Iranian banks were ousted from the system in 2018 despite resistance from several countries in Europe.
    • This step, while regrettable, was taken in the interest of the stability and integrity of the wider global financial system, and based on an assessment of the economic situation.

     

    UPSC 2022 countdown has begun! Get your personal guidance plan now! (Click here)

  • Privatisation and Related issues

    Context

    There is a consensus that privatization is the panacea. Policymakers often cite the private sector’s ability to grow faster. This may not always be true.

    Meaning of Privatisation

    It means the transfer of ownership, management, and control of the public sector enterprises to the private sector. India adopted a mixed economy model, where the Public Sector Enterprises (PSEs) were established on a socialistic pattern of development. However, due to the poor performance of several PSEs and the consequent huge fiscal deficits, privatization was pursued. 

    Privatization can suggest several things-

    • Migration of something from the public sector to the private sector.
    • It is also used as a metonym for deregulation when a massively regulated private firm or industry becomes less organized.
    • Government services and operations may also be (denationalised) privatised. In these circumstances, private entities are tasked with the application of government plans or the execution of government assistance that had earlier been the vision of state-run companies. Some instances involve law enforcement, revenue collection, and prison management.
    • Privatization of the public sector companies by selling off parts of the equity of PSEs to the public is known as disinvestment.

    Objectives of Privatisation

    1. Providing strong momentum for the inflow of FDI

    2. Improving the efficiency of public sector undertakings (PSUs)

    • The efficiency of PSUs is improved by giving them the autonomy to make decisions.
    • Some companies were given special categories of Navratna and Miniratna.

    3. Reduce the fiscal burden on the government in maintaining PSEs.

    Ways of Privatisation

    Government companies are transformed into private companies in two ways.

    Transfer of ownership

    Government companies can be converted into private companies in the following two ways:

    • By the withdrawal of the government from the ownership and management of public sector companies
    • By the outright sale of public sector companies.

    Disinvestment

    • Disinvestment, or divestment, refers to the act of a business or government selling or liquidating an asset or subsidiary or the process of dilution of a government’s stake in a PSU.
    • The rationale for disinvestment is that the government has no business to be in a business. Thus, the government continues to disinvest in sectors where private companies are already the dominant player.

    However, there are six methods of privatization.

    • Public sale of shares
    • Public auction
    • Public tender
    • Direct negotiations
    • Transfer of control of enterprises that were controlled by the state or by municipalities
    • Lease with a right to purchase

    Benefit of Disinvestment

    • Improves corporate governance: It would result in the introduction of corporate governance in the privatized companies by freeing the PSEs from Government control and giving more scope to innovation. Enhanced corporate and with the introduction of independent Directors.
    • Develops and deepens the capital market through the spread of equity culture: The disinvestment would benefit the small investors and employees as it would lead to a wider distribution of wealth in the form of public offerings of privatized companies.
    • Disinvestment funds can be utilized for long-term goals such as:
      • Financing large-scale infrastructure development.
      • Investing in the economy to encourage spending
      • Expansion and Diversification of the firm
      • Repayment of Government Debts: Almost 40-45% of the Centre’s revenue receipts go towards repaying public debt/interest
      • Investing in social programs like health and education
    • Fiscal space for the relocation of resources locked with CPSEs: Disinvestment also assumes significance due to the prevalence of an increasingly competitive environment, which makes it difficult for many PSUs to operate profitably. This leads to a rapid erosion of the value of the public assets making it critical to disinvest early to realize a high value.
    • Resources locked in sectors developed enough to raise money from the market are channelized into areas of the economy that are less likely to access resources for the market because of their stage of economic development. Letting go of these assets is best in the long-term interest of the taxpayers as the current yield on these investments is abysmally low.
    • Unlocking of shareholder value: It is done with the help of issuing IPO. IPO means Initial Public Offering. It is a process by which a privately held company becomes a publicly-traded company by offering its shares to the public for the first time. Offering an IPO is a money-making exercise. Every company needs money for expansion, to improve their business, to better the infrastructure, to repay loans, etc.
    • Employees: Employees of a firm are benefitted by disinvestment through:
      • Pay rises, which has been done in past disinvestments.
      • Greater opportunities and avenues for career growth and further employment generation through capacity expansion.

    Is privatization a solution?

    • No significant difference in performance: Studies indicate that the gap in growth (and service) between public sector undertakings (PSUs) with autonomy and private firms is not significant.
    • Experience of the privatization in the UK: One study highlighted that the famed British privatization initiative of British Airways, British Gas, and the Railways led to no systemic difference in performance.
    • Evidence on performance after privatization is even more mixed in developing countries.
    • Multiple factors: Growth post-privatization is often due to multiple factors, for example, better funding under a private promoter versus a starved government budget, a better business cycle.

    Failure of Privatisation

    • Privatization as a revenue source:  As a state, we have sought to hock our generational wealth in PSUs for the past two decades, with limited success.
    • Failure to raise funds: Actual receipts from disinvestment have always fallen significantly short of targets.
    • In total, between FY11 and FY21, about ₹5 lakh crore was raised (that is, about 33% of just FY22’s projected fiscal deficit (PRS India, 2021) – some of this, notably through stake sale to other PSUs.
    • Considering social and institutional constraints, it is a slow process. For instance, BPCL’s long-awaited journey.

    Challenges

    • Challenge of valuation: For instance, about 65% of about 300 national highway projects have been recording significant toll collection growth; any valuations of such assets will need to ensure they capture potential growth in toll revenue, as NHAI’s highway expansion bears fruit and the economy recovers.
    • Social consequences: There were about 348 CPSUs in existence in 2018, with a total investment of ₹16.4 trillion and about 10.3 lakh employees in Central Public Sector Enterprises (in 2019). Push for massive privatization resulting in mass layoffs in a period of low job creation.
    • Concentration of wealth: A greater concentration of public assets in select private hands is also a medium-term concern. About 70% of all profits generated in the corporate sector in FY20 were with just 20 firms.
    • Across sectors, a whiff of oligopoly is emerging – cigarettes continue to be dominated by a single player, paints have one entity with ~40% in FY21, airports now have a new operator with about six airports plus a 74% stake in Mumbai’s international airport, while telecom has just three players left.
    • Such concentration, mixed with the privatization of public assets, is likely to lead to higher usage fees (already being seen in telecom) and inflation, coupled with a loss of strategic control.

    Way forward

    • Outright privatization is not a solution: Selective PSU Reform must be considered.
    • The Maruti model is instructive – the government had a joint venture with the Suzuki Corporation, but ceded control, despite Suzuki having only 26% shareholding, in return for a push by Suzuki for greater exports from India and manufacture of global models in India
    • Stake sale route: Empirical evidence highlights that stake sales are considered a preferred route (about 67% of all PSUs sales in about 108 countries between 1977 and 2000 were conducted via this route), as it gives time to ensure price discovery, allowing improved performance to raise valuations over time.
    • Global Experience: In China, for the past few decades, growth has been led by corporatized PSUs, all of them held under a holding company (SASAC), which promotes better governance, appoints leadership, and executes mergers and acquisitions.
    • In Singapore, the Ministry of Finance focuses on policymaking, while the holding firm is focused on corporatizing and expanding its PSUs on a global scale.
    • PSUs with greater autonomy, with the government retaining control via a holding firm, can also be subject to the right incentives.

    Conclusion

    The time has come to take a relook at privatization. Simply pursuing this path, while utilizing such proceeds for loan write-offs or populist giveaways in the election cycle will not do.

    UPSC 2022 countdown has begun! Get your personal guidance plan now! (Click here)

  • Agriculture finance in India

    Context

    While the overall budgetary allocation towards the agricultural sector has marginally increased by 4.4% in the Union Budget 2022-23, the rate of increase is lower than the current inflation rate of 5.5%-6%.

    Agricultural Finance in India – A brief history

    Phase 1 (1951-69):

    • Thrust on developing primary sector since 1st FYP in 1951.
    • National Credit Council in 1968 emphasized that commercial banks must increase financing to small scale industries and agriculture
    • Nationalization of banks in 1969 put thrust on the opening of rural/semi-urban bank branches

    Phase 2 (1970-1990)

    • The decade of 1970s marked the entry of commercial banks into agricultural credit with the Lead Bank Scheme and regulatory prescription of Priority Sector Lending (PSL).
    • Regional Rural Bank Act, 1976 enacted to specifically provide banking and credit facilities for agriculture and
      other rural sectors.
    • National Bank for Agriculture and Rural Development (NABARD) was established in 1982 to promote agricultural and rural development, particularly by financing SHGs and MFIs.
    • RBI introduced in 1989 service area approach (SAA) & Annual Credit Plan (ACP) system to increase outreach
      to rural areas.

    Phase 3 (1991-onwards)

    • Implementation of Narasimham Committee Report of 1991 to increase the operational efficiency of banks.
    • 1st major nationwide farm loan waiver in 1990.
    • Establishment of the Rural Infrastructure Development Fund (RIDF) with NABARD mainly meant for funding rural infrastructure projects.
    • NABARD started a pilot project SHG-Bank Linkage Programme in 1992.

    Mechanisms of Agriculture Credit in India

    • Priority Sector Lending: PSL was introduced to ensure that vulnerable sections of the society get access to credit and that there is an adequate flow of credit to employment-intensive sectors like agriculture and MSME.
    • Interest Subvention Scheme (ISS) was launched for short-term crop loans in 2006-07. 2% interest subvention is given to farmers, which is reimbursed to banks (through RBI and NABARD). Additionally, a 3% prompt repayment incentive (PRI) is provided for good credit discipline.
    • Kisan Credit Card (KCC) Scheme, introduced in 1998, aimed at providing adequate and timely credit with flexible and simplified procedures for agriculture-related and also consumption requirements of farmer households.
    • Self Help Group- Bank Linkage Programme (SHG-BLP) aimed at harnessing the flexibility of an informal system with the strength and affordability of a formal system. The SHG-BLP model accepted informal groups as clients of banks – both deposit and credit linkage & allowed collateral-free lending to groups.
    • Joint Liability Groups (JLG) Scheme was initiated by NABARD in 2006 to enhance credit flow to share croppers/tenant farmers who do not have land rights.

    Issues with India’s low spending in agriculture

    • The UN Food and Agriculture Organization (FAO) report for 2001 to 2019 shows that, globally, India is among the top 10 countries in terms of government spending in agriculture, constituting a share of around 7.3% of its total government expenditure.
    • However, India lags behind several low-income countries such as Malawi (18%), Mali (12.4%), Bhutan (12%), Nepal (8%), as well as upper-middle-income countries such as Guyana (10.3%) and China (9.6%).

    Low budgetary allocation

    a) Low allocation for important schemes

    • Drastic slashing of funds towards the allocation towards important schemes like Market Intervention Scheme and Price Support Scheme (MIS-PSS)- ₹1,500 crores (62% less than the previous allocation of ₹3,959.61 crores in the revised estimates (RE) of FY 2021-22).
    • Similarly, the Pradhan Mantri Annadata Aay SanraksHan Abhiyan (PM-AASHA) was allocated just ₹1 crore for the year as against an expenditure of ₹400 crores in 2021-22.

    b) Low Capital Investment

    • Allocation for the promotion of rural development was 5.59% in the previous budget which has been further reduced to 5.23% for the present financial year

    Other issues

    a) Institutional vis-à-vis Non-Institutional Agricultural Credit: Traditionally, rural agrarian credit needs were met primarily through money-lenders, which led to large-scale indebtedness.

    • According to National All India Rural Financial Inclusion Survey (NAFIS 2015), the share of non-institutional credit still persists at around 28%.
    • Unavailability of credit for consumption purposes and to tenant farmers, sharecroppers, and landless labourers, who are not able to offer collateral security, further pushes them towards non-institutional sources.

    b) Skewed agency share in institutional credit: Dependency on scheduled commercial banks in agricultural & allied credit is still large (~78-80% of the credit). Though co-operative institutions (~15%) and Regional Rural Banks (~5%) play a significant role in extending agricultural credit, their share is highly skewed geographically.
    c) Regional Disparity in Agricultural Credit: States falling under central, eastern, and northeastern regions are getting very low agri-credit as % of their agri-GDP.
    d) Poor deployment of agricultural credit to allied sectors (~6-7%) despite a share of 38-42% in the agricultural output indicates neglect of allied sectors by the banks.
    e) Issues with Priority Sector Lending (PSL): Though at the aggregate level banks have been able to achieve the overall PSL target of 40%, so far they have failed to achieve the agriculture target of 18% at the system-wide level. Moreover, ~60% of Small & Marginal Farmers (SMFs) have not been covered by SCBs.
    f) Interest Subvention Scheme (ISS) on short-term loans have skewed the distribution of agricultural credit in favor of production credit against crop-related investment credit, which is important for the long-term sustainability of the agriculture sector.
    g) Kisan Credit Card: As per Agricultural Census 2015-16, only 45% of the farmers possess operative KCCs. Agricultural households are unable to get credit for their consumption requirements and hence, they are compelled to go-to money lenders.
    h) Diversion of agriculture loans for non-agriculture purposes:     In many states like Tamil Nadu, Andhra Pradesh, Kerala, etc, agri-credit is far higher than their agri-GDP, indicating the possibility of diversion of
    credit for non-agricultural purposes. Diversion accentuates the problem of debt overhang, fuels a high level of indebtedness, and deteriorates credit culture in long run.

    Way forward

    a) Improve the Reach of Institutional Credit:

    • Complete the digitization process and update land records in a time-bound manner.
    • Reforming of land leasing framework by adopting policies like the Model Land Leasing Act proposed by NITI Aayog, which intends to make all lease agreements formal and enhance access to formal credit.
    • Establish a federal institution in agriculture on the lines of GST Council to enable consultation with states during formulation & implementation of reforms.

    b) Addressing regional disparity: PSL guidelines should be revisited for improving the credit off-take in central, eastern, and northeastern states.
    c) Increasing Credit Flow to Allied Activities: Set separate targets for loans towards allied activities under Ground Level Credit (GLC) & Priority Sector Lending (PSL) guidelines.
    d) Enhancing the sub-target of SMFs under PSL- Considering that the total operated area held by SMFs would amount to 51.85% by the year 2020-21, increase the share of agricultural credit under PSL to SMFs to 10% from the current 8%.
    e) Agricultural Loans against Gold as Collateral: Banks should develop an MIS to flag agricultural loans sanctioned against gold as collateral in CBS in order to segregate such loans for effective monitoring of end-use of funds.
    f) Utilizing Farmer Producer Organisations (FPOs): NABARD should promote women-oriented FPOs by identifying successful women SHGs. Government should expand the scope of its credit guarantee program through Small Farmers’ Agribusiness Consortium (SFAC).
    g) Database for Indian Agriculture sector: Develop a centralized database capturing details related to crops cultivated, cropping pattern, output, sown/irrigated area, the health of the soil, natural calamity, etc. Besides, farmer-wise details like identity, land records, loan availed, subsidy given, insurance and details of crop cultivated, etc. should also be captured.
    h) Convergence of National Highways development, Rural infrastructure, rural facilities, and increase the number of markets as recommended by the National Commission on Farmers. 

     

    Consider the question “What explains India’s low score on Agriculture Orientation Index which is the ratio between government spending towards the agricultural sector and the sector’s contribution to GDP? Suggest the way forward.”

    Conclusion

    The intensification in government spending towards the agricultural sector is the key to attaining the sustainable development goals of higher agricultural growth and farm income.