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Subject: Economics

  • Let clear principles prevail in the bailout of Yes Bank

    Context

    Resolving bank failure is tough but following a set of principles could achieve a fair and efficient outcome.

    Key issues involved in the resolution

    • Challenge in courts: Resolving Yes Bank’s failure is no easy task. Some bondholders are already challenging the restructuring plan of the Reserve Bank of India in court, and seem ready for a long-drawn battle.
    • How much dilution is fair for existing shareholders to take?
    • AT-1 Bonds issue: Should the value of the Additional Tier 1 (AT-1) bonds be written off entirely?
      • As such issues become matters of policy discussion and address, we must not lose sight of some fundamental principles of resolving bank failures.
    • Three of them should be on the top of the list: honour contracts, address market failure and protect systemic stability.

    How honouring contracts matter for economy?

    • For efficient outcomes: Honouring contracts is vital for achieving efficient outcomes between contracting parties such as lenders and borrowers, managers and shareholders, and insiders and outsiders.
    • Shying away from entering a contract: If there is uncertainty over this fundamental principle, contracting parties will shy away from entering contracts in the first place.
      • Lenders will be less willing to lend.
      • Prospective minority shareholders will be less keen to buy shares in a company.
    • Impact on allocative efficiency: This will ultimately compromise the economy’s allocative efficiency, or the market’s ability to deploy capital to its best use.

    AT-1 bond issue

    • Honouring contract in Yes banks resolution: There are several issues in the application of this principle in Yes Bank’s resolution.
      • The most visible one concerns the decision of writing off its perpetual contingent, or AT-1, bonds.
    • Write off: According to the original agreement, these additional tier-1 (AT-1) bonds are indeed supposed to be written off at a time like this.
      • And this write-off need not happen before the common equity value goes down to zero.
      • The entire idea behind these perpetual contingent bonds is to improve a bank’s capitalization if its common equity value falls below a certain threshold, but does not hit zero.
    • Counter argument: These bondholders and some commentators are arguing that writing off those bonds will be a big blow to India’s bond market.
      • Moral hazard problem: This is just the opposite of the truth. Not writing them off in accordance with the original contract will create a severe moral hazard problem.
      • What incentive would any bondholder have to correctly price and monitor these banks in the future?
      • Market discipline would die a quick death, and the bond market will suffer in the long run.
    • What the resolution process should do? Therefore, the resolution process should honour the contract and write off the entire value of Yes Bank’s AT-1 bonds.

    Dealing with critical market failures

    • Second core principle: The second core principle in this resolution should be to tackle some critical market failures that led here.
      • Several observers have pointed out the failure of board oversight, promoter negligence and reckless lending at the bank.
    • Vital market failure in the purchase of AT-1 bonds by retail investors: Indeed, these issues must be addressed. But there seems to be another vital market failure hidden in this crisis: the purchase of AT-1 bonds by retail investors.
    • Why AT-1 bonds are complex? AT-1 bonds are “information-sensitive” instruments, which means that the value of these instruments is extremely sensitive to information on the firm’s fundamentals.
      • Complex financial security: They are very complex financial securities. Understanding the risk and reward associated with these securities and valuing them properly is not an easy task even for the best of market professionals.
      • Retail investors are certainly not suited to buy this product. Still, several of them ended up holding Yes Bank AT-1 bonds in their asset portfolios.
    • Demand deposits and market failure: Banking theory relies on the idea that demand deposits are information-insensitive instruments.
      • Hence, a retail investor can place deposits in a bank without worrying about understanding the real risks borne by it. Government-backed deposit insurance makes deposits even more liquid and riskless.
      • Hence, retail investors should hold regular deposits in a bank, and not complex securities like AT-1 bonds.
      • Where is the market failure involved? If such bonds are sold to them without proper disclosure of the associated risks, then it amounts to a serious market failure.
    • Way forward: This market failure must be corrected.
      • Holding investment advisors to higher standards of fiduciary responsibility is one way of doing so.
      • Prohibiting retail investors from investing in such securities is another critical step to prevent such a market failure.

    Way forward to carry out the resolution process

    • Restitution of value to retail investors: Meanwhile, the resolution process could consider partial or full restitution of value to retail investors in Yes Bank’s AT-1 bonds, if these products were indeed mis-sold to them.
    • Large professional investors should be treated differently: But such a rescue must not extend to large professional investors who willingly bought these bonds for higher returns.
      • One mechanism to do this could be to create a separate fund for retail investors with investments capped at a certain point.
      • Or, their AT-1 investments up to a specific limit could be converted into a simple deposit contract. The legal hurdles may be insurmountable.
      • However, in principle, those who mis-sold these products to retail investors should be required to compensate them.
    • Conflict in two principles: Sometimes, these principles can come into direct conflict with each other.
      • If the resolution allows retail investors in those AT-1 bonds to recover their investments, it would go against the “honour the contract” principle, but it would address the “market failure” issue.
    • Ensuring systemic stability: How should we reconcile this conflict? That’s where the third principle comes in: ensuring systemic stability.
      • After all, the regulator’s main objective is to restore the market’s faith in the country’s financial system.
      • While this is not an easy task, protecting the capital and confidence of small investors can go a long way in restoring their faith in the banking system.

    Conclusion

    Resolving bank distress is never an easy job. But honouring contracts, addressing market failure and ensuring systemic stability can together go a long way in achieving a fair and efficient outcome.

     

     

     

     

     

  • [pib] Flexi Fare System

    During the eight months period from 1st July 2019 to 29th February 2020, approximately 28.93 Lakh berths remained vacant in Rajdhani, Shatabdi and Duronto type trains having Flexi fare.

    What is Flexi Fare System?

    • The flexi-fare scheme was introduced by the IRCTC in 2016 for the 142 “premium trains” such as Shatabdi, Rajdhani, and Duronto (now Vande Bharat Exp. as well).
    • Under this dynamic pricing system, the base fare increases by 10% with every 10% of berths sold, with a limit set at 1.5 times the original price.
    • The scheme was applicable to all classes, except AC first class and executive class. The pricing system is still in force.

    Reasons for flexi fares:

    1. Indian Railways run about 12900 passenger trains per day and the railways is losing around more than 40% of what they spend on passenger trains.
    2. The trains like Rajdhani are the ones in which the elite class prefers to travel. So, some revenue can be garnered from them.
    3. The cost of service is almost double of what is being charged from the passengers.
    4. Freight business is already very expensive in India as compared to other countries in the world. Therefore, a further increase in this area is not feasible.

    Issues with the system

    • After the introduction of Flexi-fares, the railways lost 700,000 passengers in just 11 months while the additional revenue earned as a result of the scheme was ₹ 552 crore.
    • While drawing upon the fundamentals of dynamic pricing, what Indian Railways failed to introduce was a simple principle that Flexi-fares work ways, hikes, and declines.
    • The railways model just focused on increasing fares with no provision for a decrease in price when demand is low.
    • While half of the decision-makers in the Railway Board support it, half of them oppose it stating that what the railways require is an increase in ticket prices across the board.

  • Triggering a Global Financial Crisis

    Context

    Although we could not have predicted it, Covid-19 was not the reason, but just the trigger for the ongoing financial crash as all we needed was the proverbial straw to break the finance sector’s back

    Economic sudden stop

    • Not just any trigger: Covid-19 was not just any trigger as it gave birth to the concept of the economic “sudden stop.” When the global equity markets dropped on 31 January 2020 following the WHO declaration of the Public Health Emergency of International Concern, El-Erian (2020) warned the investors on 2 February 2020 that they should snap out of the “buy the dip” mentality.
      • Pointing out two vulnerabilities, namely structurally weak global growth and less effective central banks, he introduced the concept of “sudden stop” economic dynamics.
    • What is sudden stop? It can be considered as an abrupt onset of a deep recession.
      • Supply and demand shock: In the case of Covid-19, it is a sudden stop of economic activity resulting in supply and demand shocks to the global economy as major cities in infected countries, more than 100 and counting, are put on lockdown.
      • And, add to that the deepening oil price war between Russia and Saudi Arabia.
    • On 8 March 2020 in New York, the futures markets opened and oil futures (both Brent and WTI) are trading about 21% down, gold is above $1,700 per ounce, and all United States (US) equity index futures are trading about 4% down.
    • Long terms treasury yield at historical lows: What is worse is that with the long-term US Treasury yields at their historical lows (10-year yield below 0.5% and 30-year yield below 1%), the capital markets are frozen (not to mention many oil projects that will go bust at these prices).

    Disorderly non-financial private sector debt leading to dire consequences

    • A disorderly global non-financial private sector debt deleveraging, which is likely to lead to deep global debt deflation, followed by a recession (and possibly a depression).
      • Which could result in creating financial and economic instabilities, and further tensions in international relations with dire consequences for emerging and developing countries, not to mention developed countries.
    • Difference in developed and developing countries debts: While in developed and high-income developing countries, the non-financial private sector is more over-indebted, in middle-income and low-income developing countries, the public sector is more over-indebted.
    • Impact on developed economies: Given that the global non-financial private sector debt deleveraging has already started, the public sector debts of the developed and high-income developing countries will also go up and the governments’ ability to rescue their economies will also decline in these countries.
    • Impact on funding for climate change: Furthermore, this will severely constrain the governments’ ability to spend on climate change-related projects to address the potentially catastrophic effects for many years to come, diminishing our hopes to make the necessary investments and innovations to address the now existential climate crisis on time will diminish.
    • The corona factor: The measures we have to take to control the spread of Covid-19 before a cure is found will further challenge the financial system, as people stop earning an income and businesses go bankrupt.

    Way forward

    • Three authorities solution: In the suggested framework, there would be three authorities to maintain a deposit account at the central bank in each country
      • 1. A deleveraging authority for leverage reduction.
      • 2. Lastenausgleich (based on German Currency Reforms) authority for capital levies.
      • 3. Climate authority for financing needs in developing national climate plans.
      • These national authorities should be globally coordinated through the appropriate United Nations agencies.
    • Control the three authorities: The Lastenausgleich authority would be under the finance ministry, whereas the deleveraging and climate authorities would be not-for-profit corporations promoted by the government.
    • Capitalisation issue: The government would capitalise the deleveraging and climate authorities by the Treasury-issued zero-coupon perpetual bonds.
    • The deleveraging authority would then sell its equalisation claims to the central bank in exchange for an increased balance in its deposit account at the bank, while the climate authority would wait until the deleveraging concludes.
      • Further, the climate authority would not be allowed to open deposit accounts to its borrowers to ensure that it would be a pure financial intermediary, not a bank.
    • Framework: Assuming that a globally agreed-upon debt reduction percentage that would bring the global non-financial sector leverage well under 100% is determined and that all countries agree to act simultaneously, the framework is as follows
      • (i) the financial institutions comprising the banks and non-bank financial institutions (NBFIs) write down all the loans and debt securities on both sides of their balance sheets by the required percentage;
      • (ii) the deleveraging authority compensates the banks and NBFIs for the loss if any; and
      • (iii) the deleveraging authority pays each qualified resident their allocated amount less than the debt relief if any.
      • If an NBFI gain after the above debt reduction, it should owe equalisation liabilities to the deleveraging authority of its jurisdiction.
      • Note that as all debts mean all debts, public sector debts will also be written down by the same percentage except the official debts of the sovereigns that fall out of the scope of our proposed framework and should be handled by other means.
    • After deleveraging: After deleveraging the balance of the deleveraging authority account at the central bank goes down whereas the total balance of the bank accounts (reserves) at the central bank goes up by the total payment made by the deleveraging authority.
      • Hence, the base money goes up by the total payment of the deleveraging authority.
      • Since NBFIs and residents cannot maintain deposit accounts at the central bank, they have to be paid through a bank which creates deposits for the NBFIs and residents against reserves.
      • Hence, the broad money goes up by the amount of the payment to the NBFIs and residents.
    • Issue of multi-currency balance sheet: One issue is that in many countries, the bank and NBFI balance sheets are multi-currency balance sheets.
      • However, the deleveraging authority payments are in domestic currency, which may create currency risk for some banks and NBFIs.
      • Backed by the central banks, the globally coordinated national deleveraging authorities should stand ready to intervene to avoid potential crises.
    • Condition to spend on climate bonds: The authorities would require their domestic banks and other financial institutions to spend an internationally agreed-upon percentage of their newly found money, if any, after the deleveraging on the interest-bearing, finite-maturity bonds the national climate authorities would issue.
      • Since the promoter of the climate authority is the government, the bonds of the climate authority would have the same credit with the government bonds, and the central bank would accept the climate authority bonds in its open market operations.
    • Climate authority bonds as reserves: Therefore, the climate authority bonds would be the main tool to manage the reserves and deposits created through the equalisation claims.
      • In addition, the climate authority bonds could be used for the greening of the financial system through the investment of foreign exchange reserves of the central banks proposed by the Bank of International Settlements (BIS 2019).
    • Progressive wealth tax collection: Lastly, equipped with a “globally coordinated wealth registry” (Stiglitz et al 2019), the Lastenausgleich authorities would collect progressive wealth taxes from the owners of real and non-debt financial assets for the equalisation of burdens.
      • While a part of these taxes could be used to retire some of the equalisation claims and the corresponding reserves and deposits created in the deleveraging process, another part could be transferred to the climate authorities, and the rest could be spent in the interests of the society.

  • Essential Commodities

    The Price Monitoring Division (PMD) in the Department of Consumer Affairs is monitoring the retail and wholesale prices of 22 essential food commodities due to increased panic buying by customers.

    Essential Commodities Act

    • The ECA is an act which was established to ensure the delivery of certain commodities or products, the supply of which if obstructed owing to hoarding or black-marketing would affect the normal life of the people.
    • The ECA was enacted in 1955. This includes foodstuff, drugs, fuel (petroleum products) etc.
    • It has since been used by the Government to regulate the production, supply and distribution of a whole host of commodities it declares ‘essential’ in order to make them available to consumers at fair prices.
    • Additionally, the government can also fix the maximum retail price (MRP) of any packaged product that it declares an “essential commodity”.
    • The list of items under the Act includes drugs, fertilizers, pulses and edible oils, and petroleum and petroleum products.
    • The Centre can include new commodities as and when the need arises, and takes them off the list once the situation improves.

    How ECA works?

    • If the Centre finds that a certain commodity is in short supply and its price is spiking, it can notify stock-holding limits on it for a specified period.
    • The States act on this notification to specify limits and take steps to ensure that these are adhered to.
    • Anybody trading or dealing in the commodity, be it wholesalers, retailers or even importers are prevented from stockpiling it beyond a certain quantity.
    • A State can, however, choose not to impose any restrictions. But once it does, traders have to immediately sell into the market any stocks held beyond the mandated quantity.
    • This improves supplies and brings down prices. As not all shopkeepers and traders comply, State agencies conduct raids to get everyone to toe the line and the errant are punished.
    • The excess stocks are auctioned or sold through fair price shops.

    Ex: The Union Government has brought masks and hand-sanitisers under the ECA to make sure that these products, key for preventing the spread of Covid-19 infection, are available to people at the right price and in the right quality.

    What about Food Items?

    • The items covered include rice, wheat, atta, gram dal, arhar dal, moong dal, urad dal, masoor, dal, tea, sugar, salt, Vanaspati, groundnut oil, mustard oil, milk, soya oil, palm oil, sunflower oil, gur, potato, onion and tomato.
    • Based on the deliberations, Government takes various measures from time to time to stabilize prices of essential food items which, inter-alia, include appropriately utilizing trade and fiscal policy instruments like import duty.
    • The govt. can impose stock limits and advise State for effective action against hoarders & black marketers etc. to regulate domestic availability and moderate prices.
    • The government utilizes the buffer of agri-horticultural commodities like pulses, onion, etc. built under Price Stabilization Fund (PSF) to help moderate the volatility in prices.

    Back2Basics

    Price Stabilization Fund (PSF)

    • The PSF was set up in 2014-15 under the Department of Agriculture, Cooperation & Famers Welfare (DAC&FW) to help regulate the price volatility of important agri-horticultural commodities like onion, potatoes and pulses were also added subsequently.
    • Procurement of these commodities will be undertaken directly from farmers or farmers’ organizations at farm gate/mandi and made available at a more reasonable price to the consumers.
    • Losses incurred, if any, in the operations will be shared between the Centre and the States.
    • PSF provides for advancing interest-free loans to State Governments/ UTs and Central agencies to support their working capital and other expenses they might incur on procurement and distribution interventions for such commodities.
    • The scheme provides for maintaining a strategic buffer of the commodities for subsequent calibrated release to moderate price volatility and discourages hoarding and unscrupulous speculation.
    • The PSF is managed centrally by a Price Stabilization Fund Management Committee (PSFMC) which will approve all proposals from State Governments and Central Agencies.
    • The PSF is maintained as a Central Corpus Fund by Small Farmers Agribusiness Consortium (SFAC), a society promoted by the Ministry of Agriculture for linking agriculture to private businesses and investments and technology.

    With inputs from: http://www.arthapedia.in/index.php?title=Price_Stabilisation_Fund_(PSF)

  • Count work, not workers

    Context

    India is one of the few countries in the world where women’s work participation rates have fallen sharply — from 29 per cent in 2004-5 to 22 per cent in 2011-12 and to 17 per cent in 2017-18.

    What could be the possible explanations for the decline?

    • No consensus among economists: Trying to explain whether women are choosing to focus on domestic responsibilities or whether they are pushed out of the workforce has become a minor industry among economists.
    • Can the quality of data be the explanation? Strangely, the one explanation we have not looked at is whether the declining quality of economic statistics may account for this trend.
      • Our pride in the statistical system built by PC Mahalanobis is so great that we find it unimaginable that it could fail to provide us with reliable employment data.
      • However, as challenges to economic statistics have begun to emerge in such diverse areas as GDP data and consumption expenditure, perhaps it is time to consider the unimaginable.
      • Issue of data collection: Is the decline in women’s labour force participation real or is it a function of the way in which employment data are collected?

    Anatomy of the decline in participation rates

    • Driven by rural women: The anatomy of the decline in women’s work participation rates shows that it is driven by rural women.
    • Data of the prime working-age group: In the prime working-age group (25-59)-
      • Urban area data: Urban women’s worker to population ratios (WPR) fell from 28 per cent to 25 per cent between 2004-5 and 2011-12, stagnating at 24 per cent in 2017-18.
      • Rural area data: However, compared to these modest changes, rural women’s WPR declined sharply from 58 per cent to 48 per cent and to 32 per cent over the same period.
    • Among rural women, the largest decline seems to have taken place in women categorised as unpaid family helpers — from 28 per cent in 2004-5 to 12 per cent in 2017-18.
      • This alone accounts for more than half of the decline in women’s WPR. The remaining is largely due to a drop of about 9 percentage points in casual labour.
    • In contrast, women counted as focusing solely on domestic duties increased from 21 per cent to 45 per cent.

    What are the explanations for this massive change?

    • Data collection issue: It is the change in our statistical systems that drives these results.
      • Change of workforce collecting data: The questionnaires through which the National Statistical Office (NSO) collects employment data have not changed, but the statistical workforce has, and the surveys that performed reasonably well in the hands of seasoned interviewers are too complex for poorly trained contract data collectors.
    • How data is collected? The National Sample Surveys (NSS) do not have a script that the interviewer reads out. They have schedules that must be completed. The interviewer is trained in concepts to be investigated and then left to fill the schedules to the best of his or her ability.
      • The NSS increasingly relies on contract investigators hired for short periods, who lack
    • Need for redesigning the surveys: Do we need to return to the days of permanent employees or can we design our surveys to overcome errors committed by relatively inexperienced interviewers?
      • A survey design experiment led by Neerad Deshmukh at the NCAER-National Data Innovation Centre provides an intriguing solution.
      • In this experimental survey, interviewers first asked about the primary and secondary activity status of each household member, mimicking the NSS structure.
      • They then asked a series of simple questions that included ones like, “do you cultivate any land?” If yes, “who in your household works on the farm?”
      • Similar questions were asked about livestock ownership and about people caring for the livestock, ownership of petty business and individuals working in these enterprises.
    • What was the result of survey experiment: The results show that the standard NSS-type questions resulted in a WPR of 28 per cent for rural women in the age group 21-59, whereas the detailed activity listing found a WPR of 42 per cent — for the same women.
      • This is an easily implementable module that does not require specialised knowledge on the part of the interviewer.

    Identifying the sectors from which women are excludes

    • Missing the identification of sector: In our concern with ostensibly declining women’s work participation, we have missed out on identifying sectors from which women are excluded and more importantly, in which women are included.
    • What data for men indicate? For rural men, ages 25-59, between 2004-5 and 2017-18, casual labour declined by about 6 percentage points.
      • However, this decline is counterbalanced by regular salaried work which increased by 4 percentage points.
      • Thus, it seems likely that men are exchanging precarious employment with higher-quality jobs.
    • What data for women indicate? In contrast, women’s casual work has declined by 9 percentage points while their regular salaried work increased by a mere 1 percentage point.
      • Moreover, the usual route to success, gaining formal education, has little impact on women’s ability to obtain paid work.
    • The explanation for the disparity: Rural men with a secondary level of education have options like working as a postman, driver or mechanic — few such opportunities are open to women.
      • It is not surprising that women with secondary education have only half the work participation rate compared to their uneducated sisters.
    • Takeaway: The focus on employment for women needs to be on creating high-quality employment rather than getting preoccupied with declining employment rates.

    Conclusion

    It may be time for us to return to the recommendations of ‘Shramshakti: Report of National Commission on Self Employed Women and Women in the Informal Sector’ and develop our data collection processes from the lived experiences of women and count women’s work rather than women workers. Without this, we run the risks of developing misguided policy responses.

  • Short Selling of Stocks

    The stock exchanges have clarified that the Securities and Exchange Board of India (SEBI) was not considering any proposal regarding a ban on short selling to curb the ongoing volatility and equity sell-off.

    What is Short Selling?

    • Short-selling allows investors to profit from stocks or other securities when they go down in value.
    • In order to do a short sale, an investor has to borrow the stock or security through their brokerage company from someone who owns it.
    • The investor then sells the stock, retaining the cash proceeds.
    • The short-seller hopes that the price will fall over time, providing an opportunity to buy back the stock at a lower price than the original sale price.
    • Any money left over after buying back the stock is profit to the short-seller.

    When does short-selling makes sense?

    • Most investors own stocks, funds, and other investments that they want to see rise in value.
    • Over time, the stock market has generally gone up, albeit with temporary periods of downward movement along the way.
    • For long-term investors, owning stocks has been a much better bet than short-selling the entire stock market.
    • Sometimes, though, you’ll find an investment that you’re convinced will drop in the short term (as in case of COVID 19 outbreak).
    • In those cases, short-selling can be the easiest way to profit from the misfortunes that a company is experiencing.
    • Even though short-selling is more complicated than simply going out and buying a stock, it can allow making money when others are seeing their investment portfolios shrink.

    The risks of short-selling

    • Short-selling can be profitable when one makes the right call, but it carries greater risks than what ordinary stock investors experience.
    • When we buy a stock, the most we can lose is what you pay for it. If the stock goes to zero, we suffer a complete loss, but will never lose more than that.
    • By contrast, if the stock soars, there’s no limit to the profits one can enjoy. With a short sale, however, that dynamic is reversed.

    Example:

    • For instance, say you sell 100 shares short at a price of $10 per share. Your proceeds from the sale will be $1,000.
    • If the stock goes to zero, you’ll get to keep the full $1,000. However, if the stock soars to $100 per share, you’ll have to spend $10,000 to buy the 100 shares back.
    • That will give you a net loss of $9,000 — nine times as much as the initial proceeds from the short sale.

  • [pib] Employees’ Pension Scheme (Amendment) Scheme, 2020

    The Union Ministry of Labour & Employment has informed about the total enrollments under EPS.

    Employees Pension Scheme (EPS)

    • EPS is a social security scheme that was launched in 1995 and is facilitated by EPFO.
    • The scheme makes provisions for pensions for the employees in the organized sector after retirement at the age of 58 years.
    • Employees who are members of EPFO automatically become eligible for EPS.
    • Both employer and employee contribute 12% of employee’s monthly salary (basic wages plus dearness allowance) to the Employees’ Provident Fund (EPF) scheme.
    • EPF scheme is mandatory for employees who draw a basic wage of Rs. 15,000 per month.
    • Of the employer’s share of 12 %, 8.33 % is diverted towards the EPS.

    Features of the 2020 Amendment

    • EPS pensioners will get normal pension even after getting a reduced pension due to commutation.
    • On retirement, if the employee opts for commutation of pension, a portion is paid as a lump sum based on the commutation factor while on the balance the pension begins.
    • In simple terms, commutation means a lump sum payment in lieu of periodic payments of pension.
    • In such a case, the amount of pension will be lower than the amount of pension without any commutation.
    • The amendment seeks to restore the original amount of pension as per the commutation table, after 15 years equal to the same amount as it would have been without commutation.

  • India can use Yes Bank debacle to chase China in Crypto

    Context

    There’s an opportunity to stabilize the financial system and prevent a rival power from widening its lead.

    The backdrop of YES bank failure time for cryptocurrency

    • Perfect time for cryptocurrency: Confidence in the Indian financial system has been breaking down for some time. Instead of trying to restore trust, it may be time to require less of it — with the help of an official rupee cryptocurrency.
    • The last straw: The collapse of corporate lender Yes Bank Ltd. was the last straw, which failed in slow motion in full view of authorities.
      • Depositors have been assured that their $20 billion-plus in stuck funds will be released after a rescue by the government-controlled State Bank of India.
      • What could be the impact on the sentiment of the people? While that may help prevent widespread panic, even temporarily stopping people from accessing their funds would mean that from now on, not all savings and current accounts will be treated by individuals and businesses as a perfect substitute for cash.

    Why it would be costly and difficult to revive the public faith?

    • It will be both difficult and costly to revive the public’s dwindling faith.
    • Nationalisation not an option: A nuclear option is to nationalize the banks and non-bank finance firms that provide $1.75 trillion in annual funding. Doing so would be a doomed throwback to the late 1960s when India lurched toward stultifying socialist-style state controls.
    • Corruption in banking won’t go away: Similarly, it would be unrealistic to assume that the Yes Bank embarrassment would trigger an improvement in the status quo.
      • Deep crony-capital relationship: The crony-capital relationships between financiers and borrowers in India are steeped in its colonial history.
      • Basel III won’t solve the problem: Putting on the gloss of Basel III capital requirements, which are supposed to make lenders less prone to failure, doesn’t make corruption in banking go away.

    Can cryptocurrency be an answer?

    • It offers hope: Blockchain technology, which the Indian establishment is trying to snuff out in finance, offers hope. Government should consider official crypto to obviate the need for trusted intermediaries, which are in short supply, anyway.
    • China expected to launch digital currency: Before the coronavirus outbreak, China was widely expected to start its own central bank digital currency this year.
      • But India’s need is greater, and its motivation very different from Beijing’s desire to shake the hegemony of the dollar.
    • After the Yes Bank debacle and botched rescue, deposits in India will probably gravitate toward four or five large lenders, whose managers may be emboldened to make risky bets with other people’s money. The remaining banks will struggle for liquidity. A perennially unstable credit delivery network will always be one misstep away from the next blowup. While every country has its share of manias, panics and crashes, to be gripped by absolute financial mistrust every few years is not an environment where growth can flourish.
    • Opportunity to think afresh: Earlier this month, India’s highest court set aside the Reserve Bank of India’s directive that asked banks to not offer services to cryptocurrency traders and exchanges.
      • A legal defeat has provided the opportunity to think afresh.
      • But in parallel, the government is considering a blanket ban on private virtual tokens. The crypto activity could get slammed again.
    • Possibility of misuse: To be sure, one popular use of technology is money laundering.
      • But to kill the industry and send practitioners packing would be to lose out on a valuable innovation at a time when India needs to build on the globally recognized successes of its digital payments industry, which has gained users’ trust just as banks and shadow banks have lost it.

    Implications for deposit in the aftermath of Yes bank debacle

    • Deposits may gravitate towards big banks: After the Yes Bank debacle and botched rescue, deposits in India will probably gravitate toward four or five large lenders, whose managers may be emboldened to make risky bets with other people’s money.
      • The remaining banks will struggle for liquidity.
    • Next blowup: A perennially unstable credit delivery network will always be one misstep away from the next blowup.
    • Impact on growth: While every country has its share of manias, panics and crashes, to be gripped by absolute financial mistrust every few years is not an environment where growth can flourish.

    Possible pathways for central banks digital currency

    • Pathways suggested by BIS: After surveying 17 projects around the world — from Norway and Sweden to China, Cambodia and South Africa — the Bank for International Settlements (BIS) has identified four possible pathways for a central bank digital currency.
    • Starting point- Rupee token: Of the pathways suggested by the BIS, a rupee token that doesn’t require the holder to have an account with anyone but has value guaranteed by the Reserve Bank of India could be a starting point.
    • Who should enable the fund transfer? Cryptography (“I know a secret, therefore I own the funds”) rather than an account relationship (“I am who I say I am, therefore I own the funds”) would be used to enable transfers.
      • Later, the RBI can open up the validation of transactions to authorized parties on distributed ledgers.
    • What is the current system and issues with it? Currently, a deposit holder has to rely on everyone from the bank’s management and board to the auditors, the rating firms and the regulator to do their jobs.
      • When they all fail, as in the case of Yes, the bank’s chequebook, ATM card, and online banking password cease to generate liquidity.
      • Deposits stop being the same as cash, even if the state guarantees their safety.
      • It would be far less painful if deposit owners only had to trust the RBI, not as a banking regulator but as a money-printing authority that could never run out of resources to settle its IOUs.

    Conclusion

    • China’s ambition challenge dollars position as a reserve currency: China wants the yuan to take over from the dollar as the world’s reserve currency. A tech-enabled global alternative to the greenback — of the kind that Facebook Inc.’s proposed Libra had threatened to be — would have been an obstacle. Hence, Beijing accelerated its tokenized currency initiative.
    • India should jump the bandwagon: India needs to jump on the bandwagon for self-preservation. If the RBI doesn’t make easy-to-transact digital rupees available and leaves ordinary folks at the mercy of poorly run and supervised banks like Yes, people would rather store their wealth in Silicon Valley-sponsored tokenized money — or Beijing’s digital yuan — whenever they arrive.

  • Growth and the farmer

    Context

    Last month, Montek Singh Ahluwalia’s book, Backstage: The Story Behind India’s High Growth Years, was released. Which tilt in favour of consumer in food policy reduces incentives for farmers, makes it difficult to unlock resources for growth.

    What is covered in the book

    • Besides some very interesting episodes pertaining to author’s personal and professional life, the book is full of useful insights into policy debates and their complexities.
    • At many places, it provides evidence of the impact of these policies.
    • This can be extremely useful as we try to rejuvenate the country’s sluggish economy and abolish poverty.

    Inclusive growth and agriculture

    • Growth in agriculture must for inclusive growth: During the UPA period, from 2004-05 to 2013-14, it was believed that inclusive growth is not feasible unless agriculture grows at about 4 per cent per year while the overall economy grows at about 8 per cent annually.
    • The reason was simple: More than half of the working force at that time was engaged in agriculture and much of their income was derived from agriculture.
      • But many political heavyweights, did not believe that agri-growth could reduce poverty fast enough.
    • Main instrument of agricultural strategy: The main instrument of agricultural strategy was the Rashtriya Krishi Vikas Yojana (RKVY), which gave more leverage to states to allocate resources within agriculture-related schemes.

    What was the impact of strategy?

    • Agri-growth increased: The agricultural strategy, along with other infrastructure investments in rural areas, had a beneficial impact on agri-growth.
      • Agri-growth increased from 2.9 per cent during the Vajpayee period (1998-99 to 2003-04) to 3.1 per cent during the UPA-1 period (2004-05 to 2008-09) and further to 4.3 per cent during UPA-2 (2009-10 to 2013-14).
      • The agri-GDP growth during UPA-2 was driven not as much by RKVY as it was by high agri-prices in the wake of the global economic crisis of 2007-08.
    • Impact on poverty reduction: Agri-GDP growth had a significant impact on poverty reduction, whichever way it was measured — the Lakdawala poverty line or Tendulkar poverty line, which is higher.
      • At what rate poverty reduced? The rate of decline in poverty (headcount ratio), about 0.8 per cent per year during 1993-94 to 2004-05, accelerated to 2.1 per cent per year, and for the first time, the absolute number of the poor declined by a whopping 138 million during 2004-05 to 2013-14.
      • Interestingly, this holds even on the basis of the international poverty line of $1.9 per capita per day (on 2011 purchasing power parity, PPP, also see graphs).

    Right to food and debate around it

    • Scepticism over the success of agriculture support to food subsidy: Instead of celebrating this success of the growth strategy in alleviation of poverty, several NGOs and even Congress stalwarts remained sceptical.
      • They advocated food subsidy under the Right to Food Campaign.
      • National Advisory Council (NAC) came up with a proposal to subsidise 90 per cent of people by giving them rice and wheat at Rs 3/kg and Rs 2/kg.

    What were the arguments put forward by Montek Singh Ahluwalia?

    • Burden on exchequer: He tried to convince them that this was likely to create an unsustainable burden on the exchequer.
    • India could end up importing food: He also argued that India could end up importing grains to the tune of 13-15 million tonnes per year.
    • Cap the population coverage at 40%: He favoured a cap at 40 per cent of the population to be covered under the Food Security Act as the poverty ratio (HCR) in 2011-12 was 22 per cent.
    • Smart card to beneficiaries: He also favoured providing smart cards to the beneficiaries so that they could opt for buying more nutritious food rather than just relying on rice and wheat.
    • Chance for diversification of agriculture: Smart card with beneficiaries would have also allowed diversification of agriculture and augmented farmers’ incomes.
      • But he could not win over the NAC — although the coverage for food subsidy was reduced from the original proposal of 90 per cent to 67 per cent of the population.
    • Against the ban on agri. export: Montek also argued against export bans on agricultural commodities as these impacted farmers’ incomes adversely.
      • Government siding with consumers: But the government of the day often ended up taking the consumer’s side, as that was considered pro-poor.
      • This reduced the incentives for farmers, who then had to be compensated by increasing input subsidies.

    What are the result of this strategy adopted by the government?

    • Negative PSE: No wonder, years later, when we estimated the producer support estimates (PSEs), as per the OECD methodology — used by countries that produce more than 70 per cent of the global agri-output — we found a deeply negative PSE.
      • What negative PSE indicates? This indicates implicit taxation of agriculture through trade and marketing policies, even when one has accounted for large input subsidies going to farmers (see graph on PSE).
    • Consumer bias in the system: Today, the food subsidy is the biggest item in the Union budget’s agri-food space. In the current budget, it is provisioned at Rs 1,15,570 crore.
      • Borrowing by FCI not factored in: But this factor hides more than it reveals. Lately, the government has been asking the Food Corporation of India (FCI) to borrow from myriad sources, and not fully funding the food subsidy, which should logically be a budgetary item.
      • The outstanding dues of the FCI are more than the provisioned subsidy, and if one adds these dues to the budgeted food subsidy, the effective amount of food subsidy comes to Rs 3,57,688 crore.
      • This displays the consumer bias in the system.

    Conclusion

    • Restrict the population coverage of food subsidy: The Economic Survey of 2019-20 makes a case for restricting food subsidy to 20 per cent of the population — the headcount poverty in 2015 as per the World Bank’s $1.9/per capita per day (PPP) definition was only 13.4 per cent.
      • For the others, the issue prices of rice and wheat need to be linked to at least 50 per cent of the procurement price or, even better, 50 per cent of the FCI’s economic cost.
    • Unless we make progress on this front, it is difficult to unlock resources for the growth of agriculture, which slumped from 4.3 per cent during UPA-2 to 3.1 per cent during Modi 1.0.

  • Excise Duty on Petrol and Diesel

    The Central levies on petrol and diesel were hiked amid sliding global crude oil prices. But the price of petrol and diesel registered a decline after oil companies further cut auto fuel prices in light of the substantial fall in global crude oil prices.

    What is Excise Duty?

    • Excise duty is a form of tax imposed on goods for their production, licensing and sale.
    • It is the opposite of Customs duty in sense that it applies to goods manufactured domestically in the country, while Customs is levied on those coming from outside of the country.
    • At the central level, excise duty earlier used to be levied as Central Excise Duty, Additional Excise Duty, etc.
    • Excise duty was levied on manufactured goods and levied at the time of removal of goods, while GST is levied on the supply of goods and services.

    Purview of excise duty

    • The GST introduction in July 2017 subsumed many types of excise duty.
    • Today, excise duty applies only on petroleum and liquor.
    • Alcohol does not come under the purview of GST as exclusion mandated by constitutional provision.
    • States levy taxes on alcohol according to the same practice as was prevalent before the rollout of GST.
    • After GST was introduced, excise duty was replaced by central GST because excise was levied by the central government. The revenue generated from CGST goes to the central government.

    Types of excise duty in India

    Before GST kicked in, there were three kinds of excise duties in India.

    Basic Excise Duty

    • Basic excise duty is also known as the Central Value Added Tax (CENVAT). This category of excise duty was levied on goods that were classified under the first schedule of the Central Excise Tariff Act, 1985.
    • This duty was levied under Section 3 (1) (a) of the Central Excise Act, 1944. This duty applied on all goods except salt.

    Additional Excise Duty

    • Additional excise duty was levied on goods of high importance, under the Additional Excise under Additional Duties of Excise (Goods of Special Importance) Act, 1957.
    • This duty was levied on some special category of goods.

    Special Excise Duty

    • This type of excise duty was levied on special goods classified under the Second Schedule to the Central Excise Tariff Act, 1985.
    • Presently the central excise duty comprises of a Basic Excise Duty, Special Additional Excise Duty and Additional Excise Duty (Road and Infrastructure Cess) on auto fuels.