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Subject: Economics

  • GST on processed food items

    A recent GST ruling sparked off the debate with the Authority for Advance Rulings (AAR, Karnataka Bench) suggesting parottas would be subject to a higher GST rate of 18 per cent as compared to roti.

    Try this question from CSP 2018:

    Q. Consider the following items:

    1. Cereal grains hulled
    2. Chicken eggs cooked
    3. Fish processed and canned
    4. Newspapers containing advertising material

    Which of the above items is/are exempt under GST (Goods and Services Tax)?

    (a) 1 only

    (b) 2 and 3 only

    (c) 1, 2 and 4 only

    (d) 1, 2, 3 and 4

    What is the Case?

    • Bengaluru-based food products company involved in preparation and supply of ready-to-cook items had approached the AAR regarding whether preparation of whole wheat parotta and Malabar parotta attracting 5 per cent GST.
    • The products khakhra, plain chapatti and roti are completely cooked preparations, do not require any processing for human consumption and hence are ready to eat food preparations.
    • The impugned product (whole wheat Parottas and Malabar Parottas) are not only different from the said khakhras, plain chapatti or roti but also are not like products in common parlance as well as in the respect of essential nature of the product.

    Classification of food items for GST

    • Most food items, especially those of essential and unprocessed nature, are charged nil GST.
    • But processed foods attract higher rates of 5%, 12%, or 18% depending on the food product.
    • For instance, pappad, Bread (branded or otherwise), are charged zero GST, but pizza bread is charged 5% GST.
    • Heading 1905 under the Harmonised Commodity Description and Coding System classifies pizza bread, khakhra, plain chapati or roti, rusks, toasted bread in one category, for which a 5% GST rate is levied.
    • Similarly, in the ready for consumption category, unbranded namkeens, bhujia, mixture and similar edible preparation attract 5% GST, while such branded namkeen, bhujia, mixture attract 12% GST.

  • How fuel price decontrol works — or why consumers always lose out

    India fuel prices are somewhat stagnant these days despite spikes in global crude oil prices. The key beneficiary in this subversion of price decontrol is the government. The consumer is a clear loser, alongside fuel retailing companies as well. Let’s see how.

    Do you know?

    Grade of crude oil processed in Indian refineries:  ‘Sour grade’ (Oman and Dubai average) and ‘Sweet grade’ (Brent)

    Oil and India

    • In theory, retail prices of petrol and diesel in India are linked to global crude prices.
    • There is supposed to be complete decontrol of consumer-end prices of auto fuels and others such as the aviation turbine fuel or ATF.
    • It means that if crude prices fall, as has largely been the trend since February, retails prices should come down too, and vice versa.

    So, why is there a divergence in the trends?

    • Oil price decontrol is a one-way street in India — when global prices go up, this is passed on to the consumer, who has to cough up more for every litre of fuel consumed.
    • But when the reverse happens and prices go down, the government — almost by default — slaps fresh taxes and levies to ensure that it rakes in extra revenues, even as the consumer, who should have ideally benefited by way of lower pump prices.

    How does decontrol work?

    • Price decontrol essentially offers fuel retailers such as Indian Oil, HPCL or BPCL the freedom to fix prices of petrol or diesel based on calculations of their own cost and profits.
    • Fuel price decontrol has been a step-by-step exercise, with the government freeing up prices of ATF in 2002, petrol in the year 2010 and diesel in October 2014.
    • Prior to that, the Government used to intervene in fixing the price at which the fuel retailers used to sell diesel or petrol.
    • While fuels such as domestic LPG and kerosene still are under price control, for other fuels such as petrol, diesel or ATF, the price is supposed to be reflective of the price movements of the so-called Indian basket of crude oil.

    Are India’s taxes on fuels high? Obviously, Yes!

    • On May 5, the Centre announced one of the steepest ever hikes in excise duty by Rs 13 per litre on diesel and Rs 10 per litre on petrol, following up on another round of sharp hikes in the first week of March.
    • All of this effectively cements India’s position as the country with among the highest taxes on fuel.
    • Prior to the increase in excise duty (in February 2020), the government, centre plus states was collecting around 107 per cent taxes, (Excise Duty and VAT) on the base price of petrol and 69 per cent in the case of diesel.
    • With the second revision in excise duty in May, the government is collecting around 260 per cent taxes, (Excise Duty and VAT) on the base price of petrol and 256 per cent in the case of diesel (as on 6th May 2020), according to estimates by CARE Ratings.
    • In comparison, taxes on fuels as a percentage of pump prices was around 65 per cent of the retail price in Germany and Italy, 62 per cent in the UK, 45 per cent in Japan and under 20 per cent in the US.

    Do OMCs also benefit?

    • The only entity that benefits at the consumer’s expense is the government — in fact, both the Central and state governments.
    • OMCs, interestingly, are also among the losers from the sharp downward gyrations in oil prices.
    • The problem for companies such as IOC or BPCL is that a continuous slide in fuel prices leads to the prospect of inventory losses.
    • It is a technical term for the losses incurred when crude oil prices start falling and companies that have sourced the oil at higher prices discover that the prices have tumbled by the time the product reaches the refinery.
    • Including both crude oil and products, companies such as IOC keep an inventory of about 20-50 days.

    Also read:

    [Burning Issue] Oil Prices and OPEC+

  • NITI Aayog bats for Border Adjustment Tax (BAT)

    A notable NITI Aayog member has favoured imposing a Border Adjustment Tax (BAT) on imports to provide a level-playing field to domestic industries.

    Note how BAT is different from the Custom Duties on imports. Refer to our B2B section.

    What is the proposed Border Adjustment Tax?

    • BAT is a duty that is proposed to be imposed on imported goods in addition to the customs levy that gets charged at the port of entry.
    • It is proposed to be a non-creditable levy on imported goods. The idea is to bring similar goods in the imported and domestic baskets at par.

    Why need BAT?

    • Generally, BAT seeks to promote “equal conditions of the competition” for foreign and domestic companies supplying products or services within a taxing jurisdiction.
    • The Indian industry has been complaining to the government about domestic taxes like electricity duty, duties on fuel, clean energy cess, mandi tax, royalties, biodiversity fees that get charged on domestically produced goods as these duties get embedded into the product.
    • But many imported goods do not get loaded with such levies in their respective country of origin and this gives such products price advantage in the Indian market.

    Will it be WTO compatible?

    • Countries that are members of Geneva-based global watchdog WTO have locked the upper limits of customs levies for product lines that they trade-in.
    • Any additional duty that gets imposed by WTO members are scoffed upon and in many instances, extra customs duties led to countries being dragged to international arbitration under WTO.
    • Commerce Ministry believes that the proposed extra customs duty through the Border Adjustment Tax is compatible with global trade norms.
    • Officials maintain that Article II: 2(a) of GATT allows for import charge that is equal to the internal tax of the country with respect to a “Like Product” or an item from which the imported product is made. Legal opinion on the proposed levy has also been taken.

    Back2Basics: Customs Duty

    • It refers to the tax imposed on the goods when they are transported across international borders.
    • The objective behind levying customs duty is to safeguard each nation’s economy, jobs, environment, residents, etc., by regulating the movement of goods, especially prohibited and restrictive goods, in and out of any country.

    Customs duties are charged almost universally on every good which are imported into a country. Some of these are:

    •      Basic Customs Duty (BCD)
    •      Countervailing Duty (CVD)
    •      Protective Duty
    •      Anti-dumping Duty etc.

  • Faults in section inserted for the suspension of IBC amid pandemic

    Following the lockdown, the government announced the suspension of some provision of IBC to soften the blow of economic crisis. Section 10A was inserted to suspend the provision. But it giver rise to other questions. What are these questions? Read the article to know…

    What changes were made?

    • In mid-May, the Finance Minister announced that the government was planning to bring in an ordinance to suspend provisions enabling filing of fresh insolvency cases for a period of one year..
    • Finally, on June 5, the government promulgated an ordinance which inserted Section 10A in the IBC.
    • The government said the ordinance was promulgated because the lockdown has caused business disruptions which may lead to default on debts pushing such companies into insolvency.
    • Therefore, it felt that suspending Sections 7, 9 and 10 of the IBC would be the right course of action.

    What are the issues with section 10A?

    • Section 10A provides that “no application for initiation of corporate insolvency resolution process of a corporate debtor shall be filed, for any default arising on or after 25th March, 2020 for a period of six months or such further period, not exceeding one year from this period, as may be notified in this behalf”.
    • This means that these provisions shall remain suspended from March 25 till September 25, unless extended for another six months, which would extend the suspension up till March 25, 2021.
    • However, the proviso to the section states that no application for insolvency resolution shall ever be filed against a corporate debtor for any default occurring during the suspension period.
    • While the main Section 10A suspends such applications for a limited period, the proviso enlarges the scope to provide complete amnesty under the IBC for any default occurring during such period.
    • The role of a proviso in a statute is to restrict the application of the main provision under exceptional circumstances.
    • However, the proviso here expands the substantive provision in the main section.
    • Further, if the main provision is unclear, a proviso may be given to explain its true meaning.
    • In this case the main provision appears clear, only to be obfuscated by the proviso.
    • The proviso therefore does not appear to be legally tenable.
    • As creditors can still approach courts, and as banks/FIs can still approach Debt Recovery Tribunals, the protection given by this proviso seems illusory.
    • But Section 10A also suspends provisions of Section 10 of the IBC which enables voluntary insolvency resolution.
    • This is difficult to understand as such voluntary insolvency resolution should have been made easier for companies facing distress.

    Painting all defaults with the same brush

    • The ordinance appears to consider every default occurring during the suspension period to be a consequence of the pandemic.
    • There could be cases where defaults were imminent due to other reasons, but which will now still enjoy this protection.
    • The ordinance should have protected only such defaults which may occur as a direct consequence of the pandemic or the lockdown and should have left this determination to the National Company Law Tribunal.
    • Also, a company defaulting on its payment obligations on March 24 (a day before the lockdown started) would not be provided any relief under the IBC as compared to a company defaulting on or immediately after March 25 due to similar reasons.
    • This makes the suspension, in the absence of definition of a COVID-19 default, prima facie arbitrary.

    Issue with increasing the default amount limit

    • Earlier, the government increased the minimum default amount to trigger corporate insolvency resolution from â‚č1 lakh to â‚č1 crore.
    • This was purportedly done to protect MSMEs from insolvency petitions.
    • However, this also operates against such MSMEs because they will now be forced to approach civil courts to recover undisputed debts below â‚č1 crore.
    • The suspension of these provisions would now impact even claims above â‚č1 crore for at least six months to a year.

    Conclusion

    The ordinance has opened itself up to a legal challenge on grounds of arbitrariness and untenability of the proviso due to the flaw in its drafting. It is unfathomable how these flaws arose despite the government having ample time to think this through.

    B2BASICS:

     Insolvency and Bankruptcy Code, 2015

    The code contains a clear speedy mechanism for early identification of financial distress and initiates revival/re-organisation of the company if it is viable.

    Timeline

    • The bill proposes a timeline of 180 days to deal with the applications for insolvency resolution with an option of extending it by 90 days for exceptional cases.

    Insolvency Resolution Plan

    • The insolvency resolution plan has to be approved by 75% of the creditors. If the plan is approved, then the adjudicating authority will give its sanction. In case of rejection of insolvency resolution plan, the adjudicating authority will pass an order for liquidation.

    Insolvency Professionals (IPs) & Insolvency Professional Agencies (IPAs)

    • The resolution processes will be conducted by licensed insolvency professionals (IPs).  These IPs will be members of insolvency professional agencies (IPAs).  IPAs will also furnish performance bonds equal to the assets of a company under insolvency resolution.

    Information Utilities

    • Information utilities (IUs) will be established to collect, collate and disseminate financial information to facilitate insolvency resolution.

    Bankruptcy and Insolvency Adjudicator

    • The National Company Law Tribunal (NCLT) will adjudicate insolvency resolution for companies.  The Debt Recovery Tribunal (DRT) will adjudicate insolvency resolution for individuals.
    • The Debt Recovery Tribunal (DRT), which has jurisdiction over individuals and unlimited liability partnership firms. Appeals from the order of DRT shall lie to the Debt Recovery Appellate Tribunal (DRAT).

    Insolvency regulators

    • The Insolvency and Bankruptcy Board of India will be set up to regulate functioning of IPs, IPAs and IUs.

  • Payments Infrastructure Development Fund (PIDF)

    The RBI has created a Payments Infrastructure Development Fund (PIDF) with an outlay of Rs. 500 Cr.

    Possible prelims question:
    Q. Which of the following is the major aim of Payments Infrastructure Development Fund (PIDF) recently created by the Reserve Bank of India (RBI)?
    a) Promotion of UPI payments

    b) Deploying Points of Sale (PoS) infrastructure

    c) Creation of digital wallets

    d)All of the above

    Payments Infrastructure Development Fund (PIDF)

    • PIDF aims to encourage acquirers to deploy Points of Sale (PoS) infrastructure — both physical and digital modes in tier-3 to tier-6 centres and north eastern states.
    • The setting of PIDF is in line with the measures proposed by the vision document on payment and settlement systems in India 2019-2021.
    • It is also in line with the RBI’s proposal to set up an Acceptance Development Fund which will be used to develop card acceptance infrastructure across small towns and cities.

    Its working

    • The PIDF will be governed through an Advisory Council and managed and administered by RBI.
    • It will also receive recurring contributions to cover operational expenses from card-issuing banks and card networks.
    • RBI will also contribute to its yearly shortfalls, if necessary.

    Why need PIDF?

    • Over the years, the payments ecosystem in the country has evolved with a wide range of options such as bank accounts, mobile phones, cards, etc.
    • To provide further fillip to digitization of payment systems, it is necessary to give impetus to acceptance infrastructure across the country, more so in under-served areas.

  • Who is afraid of monetisation of deficit?

    Rating agencies influence the decisions of investors. So, when any economy is downgraded by them, it’s certainly a cause for concern. But to restart the economic engines, governments need to spend more by borrowing. This article suggests the way to achieve both: avoiding downgrade and increasing spending. How? Read to know…

    To worry or not to worry: Issue of downgrading by rating agencies

    • Some economists urged the government amid covid pandemic to go out and spend without worrying about the increase in public debt.
    • They said the rating agencies would understand that these are unusual times.
    • If they did not and chose to downgrade India, we should not worry too much about it.
    • Well, the decision of the rating agency, Moody’s, to downgrade India from Baa2 to Baa3 should come as a rude awakening.
    • The present rating is just one notch above the ‘junk’ category.
    • Moody’s has also retained its negative outlook on India, which suggests that a further downgrade is more likely than an upgrade.
    •  The downgrade, Moody’s says, has not factored in the economic impact of the pandemic.
    • Any further deterioration in the fundamentals from now on will push India into ‘junk’ status.

    Here is why we should be worried about a downgrade

    •  Whatever the failings of the agencies, in the imperfect world of global finance that we live in, their ratings do carry weight.
    • Institutional investors are largely bound by covenants that require them to exit an economy that falls below investment grade.
    • If India is downgraded to junk status, foreign institutional investors, or FIIs, will flee in droves.
    • The stock and bond markets will take a severe beating.
    • The rupee will depreciate hugely and the central bank will have its hands full trying to stave off a foreign exchange crisis.
    • That is the last thing we need at the moment.

    So, what is the way out? Try for an upgrade!

    • We have to put our best foot forward now to prevent a downgrade and bring about an upgrade instead.
    • To do so, we need to note the key concerns that Moody’s has cited in effecting the present downgrade to our rating: slowing growth, rising debt and financial sector weakness.
    • These concerns are legitimate.

    Bleak prospects

    • Many economists as also the Reserve Bank of India (RBI) expect India’s economy to shrink in FY 2020-21.
    • The combined fiscal deficit of the Centre and the States is expected to be in the region of 12% of GDP.
    • Moody’s expects India’s public debt to GDP ratio to rise from 72% of GDP to 84% of GDP in 2020-21.
    • The banking sector had non-performing assets of over 9% of advances before the onset of the pandemic.
    • Weak growth and rising bankruptcies will increase stress in the banking sector.

    Fiscal deficit and growth: two concerns of rating agencies

    • The government’s focus thus far has been on reassuring the financial markets that the fisc will not spin out of control.
    • It has kept the ‘discretionary fiscal stimulus’ down to 1% of GDP.
    • That 1%  figure is most modest in relation to that of many other economies, especially developed economies.
    • ‘Discretionary fiscal stimulus’ refers to an increase in the fiscal deficit caused by government policy as distinct from an increase caused by slowing growth, the latter being called an ‘automatic stabiliser’.
    • Keeping the fiscal deficit on a leash addresses the concerns of rating agencies about a rise in the public debt to GDP ratio.
    • But it does little to address their concerns about growth.
    • The debt to GDP ratio will worsen and financial stress will accentuate if growth fails to recover quickly enough.
    • The government’s stimulus package relies heavily on the banking system to shore up growth.
    • But there is only so much banks can do.
    • More government spending is required, especially for infrastructure.

    So, government need to increase fiscal stimulus without increasing public debt

    • We need to increase the discretionary fiscal stimulus without increasing public debt.
    • The answer is monetisation of the deficit, that is, the central bank providing funds to the government.
    • These fears are based on misconceptions about monetisation of the deficit and its effects.

    What monetisation of debt mean?

    • A common misconception is that it involves ‘printing notes’.
    • But that is not how central banks fund the government.
    • The central bank typically funds the government by buying Treasury bills.
    • As proponents of what is called Modern Monetary Theory point out, even that is not required.
    • The central bank could simply credit the Treasury’s account with itself through an electronic accounting entry.
    • What is base money? When the government spends the extra funds that have come into its account, there is an increase in ‘Base money’, that is, currency plus banks’ reserves.
    • So, yes, monetisation results in an expansion of money supply.
    • But that is not the same as printing currency notes.

    But expansion of money supply leads to inflation, what about that?

    • It could be that the expansion is inflationary.
    • This objection has little substance in a situation where aggregate demand has fallen sharply and there is an increase in unemployment.
    • In such a situation, monetisation of the deficit is more likely to raise actual output closer to potential output without any great increase in inflation.

    No difference in borrowing from banks or RBI directly:MMT

    • Exponents of the Modern Monetary Theory (MMT) make a more striking point.
    • They say there is nothing particularly virtuous about the government incurring expenditure and issuing bonds to banks instead of issuing these to the central bank.
    • The expansion in base money and hence in money supply is the same in either route.
    • The preference for private debt is voluntary.
    • MMT exponents say it has more to do with an ideological preference for limiting government expenditure.
    • Central banks worldwide have resorted to massive purchases of government bonds in the secondary market in recent years, with the RBI joining the party of late.
    • These are carried out under Open Market Operations (OMO).
    • The impact on money supply is the same whether the central bank acquires government bonds in the secondary market or directly from the Treasury.

    So why the shrill clamour against monetisation of public debt?

    • OMO is said to be a lesser evil than direct monetisation because the former is a ‘temporary’ expansion in the central bank’s balance sheet whereas the latter is ‘permanent’.
    • But we know that even so-called ‘temporary’ expansions can last for long periods with identical effects on inflation.
    • What matters, therefore, is not whether the central bank’s balance sheet expansion is temporary or permanent but how it impacts inflation.
    • As long as inflation is kept under control, it is hard to argue against monetisation of the deficit in a situation such as the one we are now confronted with.

    Way forward

    • We now have a way out of the constraints imposed by sovereign ratings.
    • The government must confine itself to the additional borrowing of â‚č4.2 trillion which it has announced.
    • Further discretionary fiscal stimulus must happen through monetisation of the deficit.
    • That way, the debt to GDP ratio can be kept under control while also addressing concerns about growth.

    Consider the question “Examine the issues involved in the direct monetisation of the debt by the government to fund the spending in  the wake of covid pandemic.”

    Conclusion

    The rating agencies should be worrying not about monetisation per se but about its impact on inflation. As long as inflation is kept under control, they should not have concerns — and we need not lose sleep over a possible downgrade.

    Back2Basics: Automatic stabiliser

    • Automatic stabilisers refer to how fiscal instruments will influence the rate of growth and help counter swings in the economic cycle.
    • Automatic stabilisers will influence the size of government borrowing.

    Discretionary fiscal policy

    • Keynesian Perspective: Keynes noted that in a recession, confidence falls and the private sector cut back on spending and investment.
    • Therefore, we see a rise in private savings and a fall in aggregate demand. This can worsen the recession.
    • This is why Keynes advocated government borrowing – to make use of these surplus savings.
    • Keynes argued that automatic stabilisers may not be enough, and the government should specifically find public sector projects to inject money into the circular flow.
    • This is known as discretionary fiscal policy.

  • India’s rising Forex Reserves

    India’s foreign exchange reserves are rising and are slated to hit the $500 billion mark soon. In the last month, it jumped by $12.4 billion to an all-time high of $493.48 billion.

    Aspirants must make a note here:

    1.Authority managing FOREX in India

    2.Components of FOREX

    3.IMF’s SDRs

    4.Emergency use of FOREX

    Rising above the 1991 crisis

    • Unlike in 1991, when India had to pledge its gold reserves to stave off a major financial crisis, the country can now depend on its soaring Forex reserves to tackle any crisis on the economic front.
    • The level of Forex reserves has steadily increased by 8,400 per cent from $5.8 billion as of March 1991 to the current level.

    What are Forex Reserves?

    • Reserve Bank of India Act and the Foreign Exchange Management Act, 1999 set the legal provisions for governing the foreign exchange reserves.
    • RBI accumulates foreign currency reserves by purchasing from authorized dealers in open market operations.
    • The Forex reserves of India consist of below four categories:
    1. Foreign Currency Assets
    2. Gold
    3. Special Drawing Rights (SDRs)
    4. Reserve Tranche Position
    • The IMF says official Forex reserves are held in support of a range of objectives like supporting and maintaining confidence in the policies for monetary and exchange rate management including the capacity to intervene in support of the national or union currency.
    • It will also limit external vulnerability by maintaining foreign currency liquidity to absorb shocks during times of crisis or when access to borrowing is curtailed.

    Why is Forex rising despite the slowdown in the economy?

    1.Rise in  FPIand  FII

    • The major reason for the rise in forex reserves is the rise in investment in foreign portfolio investors in Indian stocks and foreign direct investments (FDIs).
    • Foreign investors had acquired stakes in several Indian companies in the last two months.
    • Forex inflows are set to rise further and cross the $500 billion as Reliance Industries subsidiary, Jio Platforms, has witnessed a series of foreign investments totalling Rs 97,000 crore.

    2.Crash in oil prices

    • On the other hand, the fall in crude oil prices has brought down the oil import bill, saving the precious foreign exchange.

    3.Fall in overseas remittances and foreign travel

    • Similarly, overseas remittances and foreign travels have fallen steeply – down 61 per cent in April from $12.87 billion.

    What’s the significance of rising forex reserves?

    • The rising forex reserves give a lot of comfort to the government and the RBI in managing India’s external and internal financial issues at a time when the economic growth is set to contract by 1.5 per cent in 2020-21.
    • Provides Cushion: It’s a big cushion in the event of any crisis on the economic front and enough to cover the import bill of the country for a year.
    • Appreciation of Rupees: The rising reserves have also helped the rupee to strengthen against the dollar.
    • The forex reserves to GDP ratio is around 15 per cent.
    • Provides confidence to Market: Reserves will provide a level of confidence to markets that a country can meet its external obligations, demonstrate the backing of domestic currency by external assets, assist the government in meeting its US dollar needs and external debt obligations and maintain a reserve for national disasters or emergencies.

    What does the RBI do with the forex reserves?

    • The RBI functions as the custodian and manager of forex reserves and operates within the overall policy framework agreed upon with the government.
    • The RBI allocates the dollars for specific purposes. For example, under the Liberalized Remittances Scheme, individuals are allowed to remit up to $250,000 every year.
    • The RBI uses its forex kitty for the orderly movement of the rupee. It sells the dollar when the rupee weakens and buys the dollar when the rupee strengthens.

    Where are India’s forex reserves kept?

    • The RBI Act, 1934 provides the overarching legal framework for the deployment of reserves in different foreign currency assets and gold within the broad parameters of currencies, instruments, issuers and counterparties.
    • As much as 64 per cent of the foreign currency reserves is held in the securities like Treasury bills of foreign countries, mainly the US.
    • 28 per cent is deposited in foreign central banks and 7.4 per cent is also deposited in commercial banks abroad.
    • In value terms, the share of gold in the total foreign exchange reserves increased from about 6.14 per cent as at end-September 2019 to about 6.40 per cent as at end-March 2020.

    Is there a cost involved in maintaining forex reserves?

    • The return on India’s forex reserves kept in foreign central banks and commercial banks is negligible.
    • While the RBI has not divulged the return on forex investment, analysts say it could be around one per cent, or even less than that, considering the fall in interest rates in the US and Eurozone.
    • There was a demand from some quarters that forex reserves should be used for infrastructure development in the country. However, the RBI had opposed the plan.
    • Several analysts argue for giving greater weightage to return on forex assets than on liquidity thus reducing net costs if any, of holding reserves.
    • Another issue is the high ratio of volatile flows (portfolio flows and short-term debt) to reserves which are around 80 per cent. This money can exit at a fast pace.

  • Shapes of Economic Recovery

    Predicting recovery graphs, economists have added cool shapes for our information.

    The types of graphs mentioned here are the possible indicators of macro-economic recovery. They are the potential hotspots for a prelim question. UPSC can puzzle you with the type of graphs and associated macroeconomic situation.

    Try to mirror! How would our economy grow?!

    Types of graphs

    The shape of economic recovery is determined by both the speed and direction of GDP prints. This depends on multiple factors including fiscal and monetary measures, consumer incomes and sentiment.

    • The best scenario is a V-shaped recovery in which the economy quickly recoups lost ground and gets back to the normal growth trend-line.
    • A pipe graph is a V graph with a longer tail — the recovery isn’t one that happens quickly over one quarter but over two-three quarters.
    • The pipe is different from the Swoosh because in the latter the economy bears the pain for longer.
    • A Z–shaped recovery is when a post-lockdown spending surge is so fierce that growth is lifted above the trendline and then after a party settles down to trend. The Z-shaped recovery is the most-optimistic scenario in which the economy quickly rises like a phoenix after a crash.
    • A U-shaped recovery — resembling a bathtub — is a scenario in which the economy, after falling, struggles and muddles around a low growth rate for some time, before rising gradually to usual levels.
    • A W-shaped recovery is a dangerous creature — growth falls and rises, but falls again before recovering yet again, thus forming a W-like chart. The double-dip depicted by a W-shaped recovery is what some economists are predicting if the second wave of COVID comes along and the initial rebound flatters to deceive.
    • The L-shaped recovery is the worst-case scenario, in which growth after falling, stagnates at low levels and does not recover for a long, long time.
    • Then, there is the J-shaped recovery, a somewhat unrealistic scenario, in which growth rises sharply from the lows much higher than the trend-line and stays there.
    • There is also the Swoosh shaped recovery, similar to the Nike logo — in between the V-shape and the U-shape. Here, after falling, growth starts recovering quickly but then, slowed down by obstacles, moves gradually back to the trend-line.
    • Finally, say hello to the Inverted square root shaped In this, there could a rebound from the bottom, the growth slows and settles a step-down.

    Why is it important for India?

    • The Indian economy was slowing down even before COVID hit, and the trouble has now been amplified manifold because of the lockdowns.
    • Experts predict a fall of up to 5 per cent in the GDP in FY-21.
    • This is clearly a crisis situation, and our getting out of the hole will depend a great deal on the shape of the economic recovery that will hopefully follow.
    • A Z- or at least V-shaped recovery would be the most preferable. If not, we should at least have a U-shaped recovery or a Swoosh to get back on our feet in a couple of years.
    • A W-shape will bring in much pain before the eventual gain, while an L-shape or the Inverted-square root will make a wreck of the growth train.

  • Tax Avoidance: case study on Flipkart deal

    Through this story, we will explore how investment fund companies exploit the tax agreements between the two countries. This story involves the famous case of investment by Walmart in Flipkart. So, let’s see what was involved in the case and what argument was made by the investment fund involved in the case.

    Tax avoidance

    Tax avoidance is the use of legal methods to minimize the amount of income tax owed by an individual or a business. This is generally accomplished by claiming as many deductions and credits as is allowable. It may also be achieved by prioritizing investments that have tax advantages, such as buying municipal bonds.

    First, let’s understand why Mauritius is favourite among investors?

    • Mauritius and India do have a tax treaty to start with.
    • Suppose an investment company based out of (why not based in?) Mauritius made a lot of money selling shares of an Indian company.
    • Now, Indian authorities won’t tax the gains you made via the transaction.
    • Instead, you’ll be taxed in Mauritius.
    • But since Mauritius does not tax capital gains, you get away without paying capital gain tax.
    • So you got the answer to why Mauritius.
    • Obviously, foreign corporations lapped up this opportunity until 2016 — when the government finally decided to plug the gaps.
    • They made amendments to the treaty.

    The story of Tiger Global’s investment into Flipkart

    • Tiger Global was one of the earliest investors in Flipkart.
    • They held 22% of the company until 2018 when they sold about 17% to Walmart’s Luxembourg entity FIT Holdings.
    • This transaction was valued at over INR 14,500 Cr.
    • But Tiger Global had made its investments through funds based out of Mauritius.
    • Since Tiger Global had made most of its investments during the first half of the decade (obviously before 2016).
    • So the amendment to the treaty wasn’t really applicable to them.
    • So when they made all that money selling their stake in Flipkart, they figured they wouldn’t have to pay any tax.
    • And at first sight, this argument seems legit.

    Let’s dig deeper into the case by going through 3 arguments

    • The funds were operating out of Mauritius.
    • The directors were discharging their duties in Mauritius.
    • All in all, everything was firmly placed in Mauritius.
    • But if you peel back the layers, you’ll see that these funds are ultimately owned by Tiger Global Management LLC, USA — albeit through a maze of holding companies.
    • So, the tax authorities argued that Tiger Global had in fact set up the Mauritius based entity for the sole purpose of avoiding taxes.
    • And therefore contested that they shouldn’t be exempt from paying tax on gains they made through the Flipkart Transaction.
    • Tiger Global, miffed with the taxmen, took the matter to a quasi-judicial body — The Authority for Advance Rulings (AAR).

    And the case begins.

    Let’s look into three arguments.

    1. Focus on transaction, not on the entity that involved in the transaction

    • Tiger Global investment fund counsel had the following argument to make:
    • “It must be proven that the transaction [the final sale of shares] itself was designed to avoid taxes.”
    • And proving that the structure of the entity undertaking the transaction was designed for the avoidance of income-tax should not be necessary here.
    • So, the Revenue (the Income Tax Department) had failed to discharge its burden of proof. But AAR didn’t agree with this argument.

    2. So, what’s AAR’s argument?

    • AAR said that you don’t just compute taxes by looking at the final transaction.
    • Instead, you look at the transaction as a whole —When were the shares bought? What was the purchase price? What happened in between? Who’s the primary executioner? What’s the appreciation in value? You look at everything.
    • More importantly, the “head and brains” executing the transaction resided elsewhere.
    • Tax authorities had shown rather conclusively that a certain Mr. Charles P. Coleman (operating out of a U.S based entity) was the beneficial owner of the fund.
    • And that “he” was primarily responsible for most management decisions.
    • So the AAR hit back with the following observation:

    In our opinion, it is not the holding structure only that would be relevant. The holding structure coupled with prima facie management and control of the holding structure, including the management and control of the applicants, would be relevant factors for determining the design for avoidance of tax. The applicant companies were only a “see-through entity” to avail the benefits of India-Mauritius DTAA [Double Taxation Avoidance Agreements]

    But wait… what about the past judgements?

    • Tiger Global had another weapon in its arsenal — Past judgements on the matter.
    • Specifically, a particular ruling in the case of Moody’s Analytics Inc.
    • AAR in this case conceded that capital gains accruing to a Mauritius based entity from the transfer of shares of an Indian company shouldn’t ideally be taxed.

    3. Flipkart is a Singaporean company. So, pay the taxes!

    • The AAR said that “In this particular case, gains were made by transferring shares of a Singaporean company. Not an Indian company.”
    • That’s right. Flipkart is based out of Singapore.
    • Flipkart Singapore is the strategic shareholder of Flipkart India.
    • Flipkart India is the entity that owns most of the capital assets.
    • The shares that were sold to Walmart — that’s Flipkart Singapore, not Flipkart India.
    • But the India-Mauritius tax treaty agreement is only applicable to the transfer of shares of Indian companies.

    Is Flipkart Indian?

    Consider the question “Examine the basis used by the Authority for Advance Rulings (AAR) that led it to rule in favour of tax authorities.”

    Conclusion

    AAR concluded that there was no doubt that Tiger Global had set up the Mauritius based entity to avoid paying taxes and therefore should be liable to pay what the Income Tax authorities deem fit.

    Back2Basics: Vodafone tax

    Can India tax the gains made by selling the shares of Singaporean company?

    • According to Section 9(1)(i), (popularly known as the Vodafone tax), any income accruing or arising, whether directly or indirectly (through multiple layers), inter-alia, through the transfer of a capital asset situated in India, shall be deemed to accrue or arise in India.”
    • So Indian tax laws are pretty clear about where the gains ought to be taxed.
    • But the India-Mauritius treaty doesn’t say anything about this matter.
    • That’s why the AAR ruled the way it did.

  • Fund for pharmaceutical innovators

    Pricing of the drugs in a contentious issue across the world. In some countries like the U.S. price of the drug at 100000%  of the production cost is not atypical. In India, prices are much lower. This article suggests the novel of Health Impact Fund which could strike the balance between affordability and R&D.

    Medicines: Humanities greatest achievements

    • They have helped attain dramatic improvements in health and longevity as well as huge cost savings through reduced sick days and hospitalizations.
    • The global market for pharmaceuticals is currently worth â‚č110 lakh crore annually, 1.7% of the gross world product (IPFPA 2017, 5).
    • Roughly 55% of this global pharmaceutical spending, â‚č60 lakh crore, is for brand-name products, which are typically under patent.

    Issue of high drug prices

    • Commercial pharmaceutical research and development (R&D) efforts are encouraged and rewarded through the earnings that innovators derive from sales of their branded products.
    • These earnings largely depend on the 20-year product patents they are entitled to obtain in WTO member states.
    • Such patents give them a temporary monopoly, enabling them to sell their new products without competition at a price far above manufacture and distribution costs, while still maintaining a substantial sales volume.
    • In the United States, thousandfold (100000%) markups over production costs are not atypical.
    • In India, the profit-maximising monopoly price of a new medicine is much lower, but similarly unaffordable for most citizens.

    Covering large R&D costs: before we think about a solution

    • To be sure, before such huge markups can yield any profits, commercial pharmaceutical innovators must first cover their large R&D costs.
    • Currently, this cost is  â‚č14 lakh crore a year (Mikulic 2020).
    • This includes the cost of clinical trials needed to demonstrate safety and efficacy, the cost of capital tied up during the long development process, and the cost of any research efforts that failed somewhere along the way.

    Three concerns with R&D

    1. Neglect of the diseases suffered by the poor

    • Innovators motivated by the prospect of large markups tend to neglect diseases suffered mainly by poor people, who cannot afford expensive medicines.
    • The 20 WHO-listed neglected tropical diseases together afflict over one billion people (WHO n.d.) but attract only 0.35% of the pharmaceutical industry’s R&D (IFPMA 2017, 15 and 21).
    • Merely 0.12% of this R&D spending is devoted to tuberculosis and malaria, which kill 1.7 million people each year.

    2. High prices of new medicines

    • Thanks to a large number of affluent or well-insured patients, the profit-maximising price of a new medicine tends to be quite high.
    • Consequently, most people around the world cannot afford advanced medicines that are still under patent.
    • This is especially vexing because manufacturing costs are generally quite low.

    3. Rewards are poorly correlated to the therapeutic value of drugs

    • Firms earn billions by developing duplicative drugs that add little to our pharmaceutical toolbox — and billions more by cleverly marketing their drugs for patients who won’t benefit.
    • These large R&D investments would be much better spent on developing new life-saving treatments for deadly diseases plaguing the world’s poor.

    Health Impact Fund: Solution to the above problems

    • The Health Impact Fund as an alternative track on which pharmaceutical innovators may choose to be rewarded.
    • The basic idea behind it:
    • Any new medicine registered with the Health Impact Fund would have to be sold at or below the variable cost of manufacture and distribution.
    • But would earn ten annual reward payments based on the health gains achieved with it.

    How health impact fund would work?

    • The Health Impact Fund could start with as little as â‚č20000 crore per annum and might then attract some 10-12 medicines, with one entering and one exiting in a typical year.
    • Registered products would then earn some â‚č17000-â‚č20000 crore, on average, during their first ten years.
    • Of course, some would earn more than others – by having greater therapeutic value or by benefiting more people.
    • Long-term funding for the Health Impact Fund might come from willing governments.
    • Those countries would contribute in proportion to their gross national incomes — or from an international tax, perhaps on greenhouse gas emissions or speculative financial transactions.
    • Non-contributing affluent countries would forgo the benefits: the pricing constraint on registered products would not apply to them.
    • This gives innovators more reason to register as they can still sell their product at high prices in some affluent countries and affluent countries reason to join.

    The fund will have the following 5 major benefits

    1. Help the Neglected areas of research

    • The Health Impact Fund would get pharmaceutical firms interested in certain R&D projects that are unprofitable under the current regime – especially ones expected to produce large health gains among mostly poor people.
    • With the Health Impact Fund in place, there can be more research on diseases like Tuberculosis or Malaria, even Covid.
    • We can develop rich arsenal of effective interventions and greater capacities for targeted responses quickly.

    2. Rewarding health outcomes and not sales

    • The Health Impact Fund will focus on performance of drugs and not make it a marketing stunt.
    • Like in its model, firms would earn annual reward payments based on the health gains achieved with by the medicine.
    • Present scenario: firms seek to influence hospitals, insurers, doctors and patients to use their patented drug and to favour it over other more effective medicines.

    3. Sustainable research and marketing system

    • A reward mechanism oriented towards health gains rather than high-markup sales would lead to a sustainable research-and-marketing system.
    • How? Simple for health gains, innovators will have to ensure:
    • They will have to think holistically about how their drug can work in the context of many other factors relevant to treatment outcomes.
    • They will need to think about therapies and diagnostics together, in order to identify and reach the patients who can benefit most.
    • They will need to monitor results in real time to recognize and address possible impediments to therapeutic success.
    • Finally, they will have need to ensure that patients have affordable access to the drug and are properly instructed and motivated to make optimal use of it with the drug still in prime condition.
    • Such a system would obviously make research more streamlined and sustainable.

    4. No fear of compulsory licence clause

    • Participation of commercial pharmaceutical firms is crucial for tackling global pandemics.
    • At present such firms have issues with use of compulsory licences by governments as it divest them of their monopoly rewards.
    • Health Impact Fund registration would remove this risk as states would have no reason to interfere with innovators whose profit lies in giving real and rapid at-cost access to their new product to all who may need it.

    5. Holistic approach

    • Multinational firms can collaborate with national health systems, international agencies and NGOs, to build a strong public-health strategy around its product.
    • The highest goal here would be complete eradication of many communicable diseases(Example: Malaria) which we are fighting right now.

    Can we apply the above to Covid-19?

    • Applying it to a new disease like COVID-19 is complicated by the fact that we lack here a well-established baseline representing the harm the disease would have done in the absence of the new medicine to be assessed.
    • For malaria, such a baseline can be established on the basis of a stable disease trajectory observable over many years.
    • In the case of a new epidemic, one must rely on a modelling exercise that estimates the baseline trajectory on the basis of obtainable data about the spread of the disease and its impact on infected patients.
    • This surely is a challenging undertaking which cannot yield precise or uncontroversial results about what damage the epidemic would truly have done if the vaccine or medication in question had not appeared.

    Consider the question “Drug pricing has always plagued the authorities and policymakers. Cap it and you tend to lose on innovation. Deregulate it, and high prices make it unaffordable. In light of this, examine the issues with the R&D in the pharmaceutical sector and suggest the ways to strike the balance between lives and innovation.”

     Conclusion

    The Health Impact Fund would give innovators the right incentives. It would guide them to ask not: how can we develop an effective product and then achieve high sales at high markups? But rather: how can we develop an effective product and then deploy it so as to help reduce the overall disease burden as effectively as possible?