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Subject: Economics

  • What is Helicopter Money?

    With the coronavirus-hit economy falling deeper and deeper into a chasm with each passing day, Telangana chief minister KC Rao earlier this month has said helicopter money can help states come out of this crisis.

    Various monetary policy tools are being considered to boost consumer demand in the economy which is stricken by the coronavirus pandemic. Helicopter Money is one such tool.

    What is Helicopter Money?

    • This is an unconventional monetary policy tool aimed at bringing a flagging economy back on track.
    • It involves printing large sums of money and distributing it to the public. American economist Milton Friedman coined this term.
    • It basically denotes a helicopter dropping money from the sky.
    • Friedman used the term to signify “unexpectedly dumping money onto a struggling economy with the intention to shock it out of a deep slump.”
    • Under such a policy, a central bank “directly increases the money supply and, via the government, distributes the new cash to the population with the aim of boosting demand and inflation.”

    Is helicopter money the same as quantitative easing (QE)?

    • Quantitative easing involves the use of printed money by central banks to buy government bonds.
    • But not everyone views the money used in QE as helicopter money.
    • It sure means printing money to monetize government deficits, but the govt has to pay back for the assets that the central bank buys.
    • It’s not the same as bond-buying by central banks “in which bank-owned assets are swapped for new central bank reserves.
    • Helicopter money is also different from a central bank directly financing the debt of a government.

    Pros and cons of helicopter money

    Pros

    • Helicopter money does not rely on increased borrowing to fuel the economy, which means that it doesn’t create more debt and interest rates can remain unchanged.
    • Generally, helicopter money boosts spending and economic growth more effectively than quantitative easing because it increases aggregate demand – the demand for goods and services – immediately.
    • While government money drops that come from debt might not boost consumer spending, due to the debt needing to be repaid, it is often thought that ‘money finance’ will stimulate the economy.

    Cons

    • Unlike quantitative easing, using helicopter money as a tactic is not reversible, and many argue that it’s not a feasible solution to revive the economy.
    • A country’s central bank sets its interest rates to reach economic growth targets.
    • However, a helicopter drop means that a central bank cannot use interest rates to recover any costs, because the money is not linked to a borrowed asset (loan).
    • Instead, the money is given directly to the public. This may lead to over-inflation and cause damage to the central bank’s financials.
    • One of the main risks associated with helicopter money is that it could lead to a significant devaluation of the currency on the foreign exchange market.
    • As more money is printed and supply increases, the value of the domestic currency could significantly decrease.
    • It could also discourage speculators from buying the currency as it is less likely to perform well.

  • Economy in lockdown: On India’s worst-case scenario

    This op-ed discusses the latest projections by the IMF. The latest projection and suggestions by IMF are the bleak reminder of economic disruption we have been experiencing.

    IMF discards its previous projections

    • Less than two months ago, IMF had asserted that “global growth appears to be bottoming out” (i.e. announcing the worst is over).
    • But the pandemic induced ‘Great Lockdown’ has forced the IMF to junk all its previous projections for economic output in 2020.
    • Faced with the stark reality of sweeping shutdowns of almost entire economies worldwide, the fund last week acknowledged that the current “crisis is like no other”.
    • The IMF slashed its projection by 6.3 percentage points from its January forecast for 3.3% growth to a 3% decline.
    • This is the sharpest contraction in world output since the Great Depression of the 1930s.
    • Comparison with 2009 slowdown: In contrast, the recession of 2009 saw world output contract by a mere 0.1%.
    • The IMF was blindsided by the comments from Chinese authorities and WHO.
    • Which is clear from the fact that as recently as February 22, the fund’s chief, Kristalina Georgieva, told G20 Finance Ministers that “global growth would be about 0.1 percentage points lower” than forecast in January.
    • China’s GDP, she projected, would expand by 5.6% this year, 0.4 percentage points slower than assumed in January.

    Latest projections for China by the IMF

    • Last week, the IMF slashed China’s forecast to a growth of 1.2%, citing data on industrial production, retail sales, and fixed asset investment that, it said, suggested a contraction of about 8% in the first quarter.
    • China reported a 6.8% first-quarter contraction.
    • Still, in projecting an annual expansion in Asia’s largest economy, the fund is rather optimistically foreseeing a sharp rebound in activity over the rest of the year.

    The following data of the revised projections gives us an idea about the extent to which the crisis has been damaging the economy. There are also suggestions about the strategy to deal with the crisis and that includes a stimulus package.

    Projections and suggestions for India

    • On India, the IMF has cut its projection for growth in the fiscal year that started on April 1, from January’s 5.8%, to 1.9%.
    • This projection is base on two assumptions given below.
    • 1. This again appears predicated on the fund’s baseline scenario that assumes that the pandemic would ‘fade in the second half of 2020’, allowing containment efforts to be unwound and economic activity to normalise.
    • 2. Another key assumption by the IMF’s economists is the availability of policy support to nurture the revival once activity restarts.
    • Suggestion for India: Jettisoning its storied fiscal conservatism, the IMF’s chief economist, Gita Gopinath, has advocated ramping up a broad-based and coordinated stimulus once the disease has been contained.
    • Such measures would help avoid the errors of the Great Depression years when premature efforts to prune budget deficits prolonged the downturn.
    • Inadequate fiscal measures in India: In this context, India’s fiscal measures pale in terms of scale when compared with what several other nations have undertaken.

    Conclusion

    Given the size of the informal sector in India as well as the anticipated prolonged disruption in labour supply even in more formal parts of the economy, the Centre needs to proactively commit to a substantial stimulus package in order to ensure that once the economy reopens, it has the legs to run.

  •  Indian’s decision on FDI to stop predatory Chinese hunt for Indian companies

    This editorial discusses the implications of growing Chinese investment in India. After People’s Bank of China bought 1 per cent stake in HDFC bank, Indian government made prior government approval mandatory for investment from countries sharing border with India. Various aspects of the move are discussed here.

    No separating commerce and security in dealing with China

    • India’s move to prevent a predatory Chinese hunt for Indian companies comes at a time when the stock market has been badly bruised by the coronavirus.
    • It underlines the emerging perception in India that there is no separating commerce and security in dealing with China.
    • India’s concerns are similar to those being expressed elsewhere in the world.
    • A number of European countries have already moved in that direction.
    • In recent years, apprehensions have grown, in both the developing and developed world, that China is targeting their infrastructural, industrial and technological assets for control.
    • But many governments were willing to give the benefit of doubt to Beijing.
    • That willingness has rapidly eroded in the wake of the corona crisis that has devastated the Western world.

    Taking economic advantage of other nation’s misery

    • Although few world leaders want to join the US President in publicly attacking China.
    • Many of them know that Beijing bears some responsibility for letting a health emergency in one of its cities become a global pandemic.
    • That Chinese companies, with access to easy money and strong political support in Beijing, are now taking economic advantage of other nations’ misery has added insult to injury.
    • While most leaders are preoccupied with the corona crisis, they are not likely to let Beijing have its way.
    • Even in Britain, where the Boris Johnson government is now taking a second look.
    • Last week, the British Foreign Secretary, said there will be no going back to “business as usual” with China.

    China’s growing influence has been posing challenges for India on various fronts. Its growing footprint on India’s economy is one of such challenges. The UPSC frames question in relation to China from various angles. So, the penetration of China in India economy is also an important aspect from the Mains perspective.

    Rethinking the commercial engagement with China

    • Beyond the question of accountability for the spread of the coronavirus, many countries are rethinking the very nature of their commercial engagement with China.
    • Gaming the system by China: On a host of issues ranging from trade and investment to intellectual property protection, there is an inescapable sense that China has gamed the global system for unilateral gains.
    • India late in learning: India certainly has had a longer learning curve than the West in recognising the relationship between commerce and national security.
    • Since the early 1990s, Delhi bet that expanding economic cooperation with China will help mitigate political disputes.
    • But the differences have only become intractable even as China became stronger economically.
    • India gave China an easy pass into the WTO.
    • India’s trade deficit: It let cheap imports from China undermine India’s manufacturing sector and run up a massive trade surplus.
    • India allowed massive Chinese penetration of its telecom, digital and other advanced sectors only to discover the multiple negative consequences.
    • India’s new approach: The last few years have seen a new approach that has seen India oppose China’s Belt and Road Initiative and walk out of the RCEP negotiations citing the trade imbalance with China.

    Conclusion

    The decision on Chinese FDI can be seen as one of the piece of the puzzle India has to face on the various front. But the puzzle of dealing with a rising China’s strategic economic onslaught will test India for a long time.

  • How reverse repo rate became benchmark interest rate in the Indian economy?

    Context

    • The Indian economy’s slowdown during 2018 and 2019 is becoming much worse in 2020 with the spread of COVID-19 and the stalling of almost all economic activity.
    • Like most other central banks in the world, the RBI, too, has tried to cut interest rates to boost the economy.
    • However, unlike in the past, when the RBI used its repo rate as the main instrument to tweak the interest rates, today, it is the reverse repo rate that is effectively setting the benchmark.

    We can expect a straight forward question based on this newscard.  For example:  “Critically examine the efficacy of reverse repo rate as benchmark interest rate in the Indian economy. “

    What are repo and reverse repo rates?

    • The repo rate is the rate at which the RBI lends money to the banking system (or banks) for short durations.
    • The reverse repo rate is the rate at which banks can park their money with the RBI.
    • With both kinds of the repo, which is short for repurchase agreement, transactions happen via bonds — one party sells bonds to the other with the promise to buy them back (or repurchase them) at a later specified date.
    • In a growing economy, commercial banks need funds to lend to businesses.
    • One source of funds for such lending is the money they receive from common people who maintain savings deposits with the banks. Repo is another option.

    Repo as benchmark

    • Under normal circumstances, that is when the economy is growing; the repo rate is the benchmark interest rate in the economy.
    • This is because it is the lowest rate of interest at which funds can be borrowed and, as such, it forms the floor rate for all other interest rates in the economy.
    • For instance, the interest rate consumers would have to pay on a car loan or the interest rate they will earn from a fixed deposit etc.

    What has changed now?

    • Over the last couple of years, India’s economic growth has decelerated sharply.
    • This has happened for a variety of reasons and has essentially manifested in lower consumer demand.
    • In response, businesses held back from making fresh investments and, as such, do not ask for as many new loans.
    • Add to this, the pre-existing incidence of high non-performing assets (NPAs) within the banking system.
    • Thus, the banks’ demand for fresh funds from the RBI has also diminished. This whole cycle has acutely intensified with the ongoing lockdown.

    Consequences: Rise in Liquidity

    • As such, the banking system is now flush with liquidity for two broad reasons.
    • On the one hand, the RBI is cutting repo rates and other policy variables like the Cash Reserve Ratio to release additional and cheaper funds into the banking system so that banks could lend.
    • On the other, banks are not lending to businesses, partly because banks are too risk-averse to lend and partly because the overall demand from the businesses has also come down.

    So, how has reverse repo become the benchmark rate?

    • The excess liquidity in the banking system has meant that banks have been using only the reverse repo (to park funds with the RBI) instead of the repo (to borrow funds).
    • As of April 15, RBI had close to Rs 7 lakh crore of banks’ money parked with it.
    • In other words, the reverse repo rate has become the most influential rate in the economy.

    What has the RBI done?

    • Recognising this, the RBI has cut the reverse repo rate more than the repo (see graph) twice in the spate of the last three weeks.
    • The idea is to make it less attractive for banks to do nothing with their funds because their doing so hurts the economy and starves the businesses that genuinely need funds.

    Will the move to cut reverse repo, work?

    • It all depends on the revival of consumer demand in India.
    • If the disruptions induced by the outbreak of novel coronavirus continue for a long time, consumer demand, which was already quite weak, is likely to stay muted.
    • Businesses, in turn, would feel no need to borrow heavily to make fresh investments.
    • If consumer demand revives quickly, the demand for credit will build up as well.

    Concerns of lower reverse repo

    • From the banks’ perspective, it is also important for them to be confident about new loans not turning into NPAs, and adding to their already high levels of bad loans.
    • Until banks feel confident about the prospects of an economic turnaround, cuts in reverse repo rates may have little impact.

    Back2Basics: Long Term Repo Operations (LTRO)

    • The LTRO is a tool under which the RBI provides 1-3 year money to banks at the prevailing repo rate, accepting government securities with matching or higher tenure as the collateral.
    • Funds through LTRO are provided at the repo rate.
    • But usually, loans with higher maturity period (here like 1 year and 3 years) will have a higher interest rate compared to short term (repo) loans.
    • According to the RBI, the LTRO scheme will be in addition to the existing Liquidity Adjustment Facility (LAF) and the Marginal Standing Facility (MSF) operations.
    • The LAF and MSF are the two sets of liquidity operations by the RBI with the LAF having a number of tools like repo, reverse repo, term repo etc.

  • SDR general allocation by IMF

    • Finance Minister has said that India could not support a general allocation of new Special Drawing Rights (SDR) by the IMF because it might not be effective in easing coronavirus-driven financial pressures.
    • FM Nirmala Sitharaman has stated that such a global liquidity boost by the IMF could produce potentially costly side-effects if countries used the funds for “extraneous” purposes.

    Details of SDR mechanism:

    What is SDR?

    • The SDR is an interest-bearing international reserve asset created by the IMF in 1969 to supplement other reserve assets of member countries.
    • To participate in this system, a country was required to have official reserves.
    • This consisted of a central bank or government reserves of gold and globally accepted foreign currencies that could be used to buy the local currency.
    • It is based on a basket of international currencies comprising the U.S. dollar, Japanese yen, euro, pound sterling and Chinese Renminbi.
    • It is not a currency, nor a claim on the IMF, but is potentially a claim on freely usable currencies of IMF members.
    • The value of the SDR is not directly determined by supply and demand in the market but is set daily by the IMF on the basis of market exchange rates between the currencies included in the SDR basket.

    Who can hold SDRs?

    • SDRs can be held and used by member countries, the IMF, and certain designated official entities called “prescribed holders”.
    • It cannot be held, for example, by private entities or individuals.
    • Its status as a reserve asset derives from the commitments of members to hold, accept, and honour obligations denominated in SDR.
    • The SDR also serves as the unit of account of the IMF and some other international organizations.

    General allocation of SDRs

    • An SDR allocation is a low-cost way of adding to members’ international reserves, allowing members to reduce their reliance on more expensive domestic or external debt for building reserves.
    • The IMF has the authority under its Articles of Agreement to create unconditional liquidity through “general allocations” of SDRs to participants in its SDR Department (currently, all members of the IMF) in proportion to their quotas in the IMF.

    The SDR Interest Rate

    • The interest rate on SDRs, or the SDRi, provides the basis for calculating the interest rate that is charged to member countries when they borrow from the IMF and paid to members for their remunerated creditor positions in the IMF.
    • It is also the interest paid to member countries on their own SDR holdings and charged on their SDR allocation.
    • The SDRi is determined weekly based on a weighted average of representative interest rates on short-term government debt instruments in the money markets of the SDR basket currencies, with a floor of five basis points.

    How many SDRs have been allocated so far?

    The general SDR allocation of August 28, 2009 is by far the biggest allocation to date:

    • SDR 9.3 billion was allocated in yearly installments in 1970–72.
    • SDR 12.1 billion was allocated in yearly installments in 1979–81.
    • SDR 161.2 billion was allocated on August 28, 2009.

    What happens to the SDRs once they are allocated?

    • The IMF’s SDR Department keeps records of members’ SDR allocations and holdings; the SDR Department is also the channel through which all transactions and operations involving SDRs are conducted.
    • Once allocated, members can hold their SDRs as part of their international reserves or sell part or all of their SDR allocations.
    • Members can exchange SDRs for freely usable currencies among themselves and with prescribed holders; such exchange can take place under a voluntary arrangement or under designation by the Fund.
    • IMF members can also use SDRs in operations and transactions involving the IMF, such as the payment of interest on and repayment of loans, or payment for future quota increases.

    Issues with new allocations

    • New reserves are allocated according to members’ quotas — or shares in the IMF.
    • A great deal of the benefit in 2009 went to advanced economies that didn’t need help in accessing markets or financing fiscal deficits.
    • If the same system is being used now, only 40 per cent of the total would be given to the emerging economies. That is not good enough.

    Other reasons

    • The possible extraneous purposes FM could be referring to maybe misuse of resources for terror funding or some such purpose by neighbours.
    • This may seem far-fetched to some, but is par for the course for the government.
    • The other possibility is that India is merely trying to prove its loyalty to the Trump administration.
    • India has already requested to access the US Fed’s currency swaps.

  • How the RBI is handling ‘The Great Lockdown’?

    To deal with the crippling effects of the pandemic on the economy the government has unveiled certain fiscal measures. After announcing the first round of monetary measures the RBI has unveiled the second round of policy announcements to align itself with the government in its efforts to review the economy. Following are the measures announced by the RBI in its second such announcement.

    • The IMF has called the ongoing economic crisis due to Covid-19 as “The Great Lockdown” and termed it to be the worst recession since the Great Depression.
    • The total estimated loss to global economic growth is pegged at $9 trillion — more than three times India’s GDP.
    • However, while the rest of the world is certain to contract, India is hoping to be one of the few countries that expand their overall GDP, regardless of how small that increase may be.
    • In this regard, both the Centre and state governments, as well as the RBI, have been coming out with policy announcements that mitigate economic distress.

    UPSC can frame the question based on the measures announced by the RBI like “What measures were announced by the RBI to deal with Covid-19 impact on the economy?”. Also, pay attention to various terms and their effect on the economy from the macroeconomic point of view. That understanding helps us to answer the question based on basic concepts.

    What are the announcements made by RBI?

    A) Cutting Reverse-Repo Rate

    • To begin with, the RBI has cut the reverse repo rate further by 25 basis points (100 basis points make up one full percentage point).
    • The reverse repo rate now stands at 3.75 per cent while the repo rate is 4.40 per cent.
    • The idea behind repeatedly cutting reverse repo more than the repo is to incentivise banks to borrow from it at low rates and lend it forward to customers.

    B) Targeted Long Term Repo Operations

    • RBI has announced another TLTRO of Rs 50,000 crore but this time it has mandated that 50 per cent of this amount borrowed by the banks must go to small and mid-sized NBFCs and Micro Finance Institutions (MFIs).
    • Again, the benefits of this move are two-fold. One, it provides more liquidity.
    • More importantly, it also provides it targeted to those institutions that are most hit by the economic slowdown and, as such, most in need of funds to survive themselves.

    C) Credit to NBFCs and MFIs

    • All India financial institutions (AIFIs) such as the NABARD, etc. will be provided special refinance facilities for a total amount of Rs 50,000 crore by the RBI.
    • This credit will help the end consumer, especially in the rural sector, small industries, and housing finance companies.

    D) Expanding Ways and Means Advances (WMAs)

    • On the issue of providing liquidity and fulfilling its role as “the lender of last resort”, the RBI also announced that it will provide more funding to state governments — under the WMA facility.
    • The WMA is essentially is a facility by which state governments borrow from the RBI to meet the shortfall between their revenues and their expenditure.
    • But the WMA is a short-term measure, only meant for exigencies.

    E) Easing NPA norms

    • Apart from easing liquidity in the system like in the past, the other focus has been to provide an easier regulatory regime.
    • The global lockdown has almost completely halted economic activity.
    • Under the circumstances, it is natural that business will struggle to pay back their loans and there will be a steady accretion of non-performing assets (NPAs) across the board.
    • Similarly, to ensure that loans given to real estate projects, that are getting delayed due to the crisis, do not turn into NPAs, the RBI provided an extension of another year before they are recognised as NPAs.

    F) Easing LCR norms

    • Lastly, given the stress on the system and the demand for cash, the RBI has allowed Scheduled Commercial Banks to reduce their Liquidity Coverage Ratio from 100 per cent to 80 per cent with immediate effect.
    • The LCR essentially mandates the amount of cash that a bank is required to keep with itself.
    • At 100 per cent LCR, a bank would have been required to keep 100 per cent of the net cash it expects to flow out of the bank over the next 30 days.
    • With this being reduced to 80 per cent, banks would have more cash to deal with.

    Though no direct question on monetary policy was asked in the recent past,  understanding the basic concepts stands us in good stead while writing the related answer in the exam. So, the terms mentioned above like-TLTRO, WMAs etc. are important from exam point of view.

  • OBICUS Survey by RBI

    The Reserve Bank of India has launched the latest round of quarterly order books, inventories and capacity utilization survey (OBICUS) of the manufacturing sector.

    OBICUS is something new than we often get to hear from RBI
. Most recent was Ways and Means Advances. We can expect prelims question like- “Order books, inventories and capacity utilization survey (OBICUS) of the manufacturing sector is held by” – with options like NSSO, Labour Bureau etc.

    OBICUS

    • OBICUS survey on the manufacturing sector is published quarterly by the RBI since March 2008.
    • It provides an insight into the demand conditions faced by the Indian manufacturing sector.
    • It covers over 2500 public and private limited companies in the manufacturing sector.
    • The company-level data collected during the survey are treated as confidential and never disclosed.

    Items included in OBICUS

    • The information collected in the survey includes quantitative data on new orders received during the reference quarter, backlog of orders, pending orders, total inventories with a breakup between work-in-progress (WiP) and finished goods (FG) inventories and item-wise production.

    Significance of OBICUS

    • The survey provides valuable input for monetary policy formulation.
    • It represents the movements in actual data on order books, inventory levels of raw materials and finished goods and capacity utilization.
    • These are considered as important indicators to measure economic activity, inflationary pressures and the overall business cycle.
    • The survey also gives out the ratio of total inventories to sales and ratio of raw material (RM) and finished goods (FG) inventories to sales in percentages.

  • [pib] Software Technology Parks of India (STPI)

    Government of India has given 4 months’ Rental Waiver to the IT Companies Operating from Software Technology Parks of India (STPI) Centers.

    STPI which witness multi-million transactions every day are the most promising workplaces for startups in India. They have gained popularity not among Indians, but also on an international platform for its state of the art infrastructure, world-class working conditions and amenities. We can expect a mains question like “Discuss the role of STPIs in making India a hub of ITeS exports”.

    Why this waiver?

    • The rental waiver will provide relief to the industry in this crisis situation emerged due to COVID19 pandemic.
    • Most of these units are either Tech MSMEs or startups.
    • This effort is also in the larger interest of around 3,000 IT/ ITeS employees who are directly supported by these units.

    What are STPI?

    • An STPI is a society established in 1991 by the Ministry of Electronics and Information Technology.
    • The objective of an STPI is to encourage, promote and boost the export of software from India.
    • STPI maintains internal engineering resources to provide consulting, training and implementation of IT-enabled services.

    STPI Scheme

    • The STP Scheme is a 100 per cent Export Oriented Scheme for the development and export of computer software, including export of professional services using communication links or physical media.
    • This scheme is unique in its nature as it focuses on one product/sector, i.e. computer software.
    • The scheme integrates the government concept of 100 per cent Export Oriented Units (EOU) and Export Processing Zones (EPZ) and the concept of Science Parks / Technology Parks, as operating elsewhere in the world.

    Who can get a floor on STPI?

    • An Indian company
    • A subsidiary of a foreign company
    • A branch office of a foreign company

    Features of the STPI

    • The STP Scheme provides various benefits to the registered units, including 100% foreign equity, tax incentives, duty-free import, duty-free indigenous procurement, CST reimbursement, DTA entitlement, and deemed exports.
    • STPI centres also provide a variety of services including high-speed data communication, incubation facilities, consultancy, network monitoring, data centres and data hosting.

  • [pib] “Kisan Rath” mobile app to facilitate transportation of farm produce

    The Union Ministry of Agriculture & Farmers’ Welfare has launched a mobile application to facilitate farmers & traders in searching for transport vehicles for movement of Agriculture & Horticulture produce.

    Initiatives as such are less likely to be asked in the prelims as the name and purpose create no different analogy. But for the sake of information and mains perspective, it is vital to remember ‘Kisan Rath’ while emphasizing on Agricultural marketing reforms.

    “Kisan Rath” mobile app

    • The app aims to facilitate Farmers and Traders in identifying the right mode of transportation for movement of farm produce ranging from foodgrains, fruits & vegetables, oilseeds, spices, fibre crops etc.
    • Primary transportation would include movement from Farm to Mandis, FPO Collection Centre and Warehouses etc.
    • Secondary Transportation would include movement from Mandis to Intra-state & Inter-state mandis, Processing units, Railway station, Warehouses and Wholesalers etc.
    • It also facilitates traders in transportation of perishable commodities by Reefer (Refrigerated) vehicles.

    Utility of the app

    • Transportation of Agri produce is a critical and indispensable component of the supply chain.
    • Kisan Rath will ensure smooth and seamless supply linkages between farmers and the market.

  • Insolvency code should be suspended for six months to help companies recover

    This article argues the suspension of IBC for six months. The issues arising out of suspension like damage to the creditors are also dealt with here. Reading of this article will help us understand the finer details of IBC that are relevant from the UPSC point of view. We have also covered one article from livemint dealing with the same issue, but that article covered the issue in a broader sense.

    Who are operational and financial creditors?

    • After the lockdown is over, several companies are likely to default on their dues to both operational and financial creditors.
    • Who is a financial creditor? The financial creditors include banks and others who have given financial assistance to a company in the form of loans and debentures.
    • According to a 2018 amendment to the Insolvency and Bankruptcy Code (IBC) 2017, flat purchasers are also deemed as financial creditors.
    • An operational creditor is just about anyone who has to receive money from a company.
    • The IBC provides a fast-track mechanism to deal with companies which are unable to repay their creditors and have become financially unviable.
    • Section 22 of the Code mandates the appointment of a Resolution Professional (RP) who is expected to miraculously turn around the company in 330 days.
    • If this attempt fails, the company goes into liquidation.

    The two types of creditors were in the news, so pay attention to these terms.

    Increase in threshold limit to file an insolvency petition

    • The IBC’s provisions have been extensively used by various creditors whose dues were not paid.
    • What was the threshold limit? Initially, the threshold limit was just Rs 1 lakh and the IBC became an effective recovery mechanism for all operational creditors.
    • What is the limit now? Just before the lockdown, the finance minister raised the threshold for invoking the insolvency provisions to Rs 1 crore.
    • This limit was raised to prevent proceedings being initiated against small and medium enterprises.

    Possibility of the domino effect after the lockdown is over

    • After the lockdown, several enterprises, large, medium and small, might not be able to pay their dues, at least in the short-term.
    • The easiest way for a creditor to recover money is to initiate insolvency proceedings against the debtor company and threaten it with liquidation.
    • The shutdown of business after the lockdown could have a domino effect.
    • How would the domino effect come into play? If an auto-manufacturer has shut down its operations, the ancillary units will not get their dues.
    • This would then lead to non-payment to downstream vendors and service providers as well.
    • It might take at least three to four months for the situation to stabilise.

    Steps that should be taken to avoid the domino effect

    • Moratorium on the IBC: The most important, and immediate, step that needs to be taken is to have a six-month moratorium on the IBC.
    • It may be necessary to promulgate an ordinance suspending the prospective operation of Sections 7 and 9 of the IBC so that no fresh petition is filed against a company.
    • Impact on creditors: While this could hurt some of the creditors, the damage that could be done to the corporate sector by invoking the IBC is likely to be far greater.
    • A distressed creditor is not without a remedy as he can always approach the civil courts for relief, which will not be so severe on a defaulting company.
    • If an insolvency petition is filed and the RP appointed, it is difficult to stop the insolvency process.
    • The IBC requires a financially-stressed company to be taken over by a financially-sound
    • For example, Essar Steel was taken over by ArcelorMittal and Bhushan Steel was taken over by Tata Steel.
    • In the current scenario, it will be difficult, if not impossible, for an RP to find a suitable buyer and the only option would be to liquidate the company.
    • Using the insolvency process to recover dues is contrary to the IBC’s objectives.

    The objective of the IBC is not just insolvency but the reorganisation of companies, maximisation of value of assets and the need to balance the interests of all stakeholders. Pay attention to this point.

    How the suspension of the IBC will be beneficial?

    • Suspending the IBC for a short period would enable several companies to return to normalcy.
    • It will help them function without the constant threat of an insolvency application and its Board of Directors and management being taken over by the RP.
    • Moreover, the National Company Law Tribunal benches will simply be unable to take any additional workload.

    Conclusion

    Suspending the IBC for six months would be a much-needed step to prevent further damage to the economy. It would be in the larger public interest. Indeed, at this critical stage, permitting the legal remedy of insolvency could be the last nail in the coffin of many companies.

    Back2Basics: What is the Insolvency and Bankruptcy Code?

    • IBC provides for a time-bound process to resolve insolvency.
    • When a default in repayment occurs, creditors gain control over debtor’s assets and must take decisions to resolve insolvency.
    • Under IBC debtor and creditor both can start ‘recovery’ proceedings against each other.
    • Insolvency and Bankruptcy Code 2016 was implemented through an act of Parliament.
    • It got Presidential assent in May 2016.
    • The law was necessitated due to huge pile-up of non-performing loans of banks and delay in debt resolution.
    • Insolvency resolution in India took 4.3 years on an average against other countries such as United Kingdom (1 year) and United States of America (1.5 years), which is sought to be reduced besides facilitating the resolution of big-ticket loan accounts.