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Subject: Economics

  • No green shoots of a revival in sight as yet

    Context

    As the third-quarter GDP was marginally higher than the second-quarter figure of 4.5% many concluded that the economic slowdown witnessed during the last six quarters has “bottomed out”. Has it?

    What closer examination of data reveal?

    • Estimates revised upwards: A closer reading reveals that the latest data release has revised the estimates of the first two quarters of the current year (2019-2020) upwards to 5.6% and 5.1%, from the earlier figures of 5% and 4.5%, respectively.
    • What the revision mean? The upward revisions have, perhaps unwittingly, changed the interpretation of the current year’s Q3 estimate: the slowdown has continued, not bottomed out; hence, there is no economic revival in sight as of now.

    Competing views of the performance

    • The question therefore is why did the current year’s Q1 and Q2 GDP estimates get revised upwards?
      • The answer is this was simply because the corresponding figures for the previous year (2018-2019) got revised downwards.
    • The question over the revision process: Many viewed the revision of last year’s estimates as evidence of lack of credibility of the NSO’s revision process.
    • Questions over the veracity of data: Such doubts are well taken, given the long-standing debate and unresolved disputes on the veracity of GDP figures put out since 2015, when the statistical office released the new series of National Accounts with 2011-2012 as base year.

    Why the GDP estimates undergo revisions?

    • Lags in data: As there are lags and unanticipated delays in obtaining the primary data, the GDP estimates undergo several revisions everywhere (except in China).
      • GDP is a statistical construct, prepared using many bits of quantitative information on an economy’s production, consumption and incomes.
    • How frequently is data revised? GDP estimates are revised five times in India over nearly three years.
      • The initial two rounds, the advanced estimates, are prepared mainly using high-frequency proxy indicators followed by three rounds based on data obtained from various sectors.

    Quarterly GDP estimates and issues with it

    • Since 1999, quarterly GDP estimates are being prepared, as per the International Monetary Fund (IMF)’s data dissemination standards.
    • Subpar quality: Their quality is subpar as the primary data needed quarterly are mostly lacking.
      • Why quality is subpar? Nearly one-half of India’s GDP originates in the unorganised sector (including agriculture), whose output is not easily amenable to direct estimation every quarter, given the informal nature of production and employment.
      • Hence, the estimates are obtained as ratios, proportions and projections of the annual GDP estimates.
    • Quarterly estimates are extrapolations: In general terms, quarterly estimates of GDP are extrapolations of annual series of GDP. The estimates of GVA by industry are compiled by extrapolating value of output or value-added with relevant indicators.

    Way forward

    • Little ground to question the present revisions: There were considerable variations at the sectoral estimates after the revision, which probably contained more noise than information. For now, there is little ground to question the revised estimates based on the publicly available information.
    • Slowdown not bottomed out: If we accept the latest data, it is clear, though in an alarming way, that there has been an undeniable decline in the GDP growth rate over seven consecutive quarters, from 7.1% in Q1 of 2018-2019 to 4.7% in Q3 of 2019-2020.
      • Considering that physical indicators of production, such as the official index of infrastructure output, or monthly automotive sales, continue to show an unambiguous deceleration, the economic slowdown has apparently not bottomed-out.
      • More seriously, the quarterly GDP deceleration comes over and above the annual GDP growth slowdown for four years now: from 8.3% in 2016-17 to 5% in 2019-20 (as per the second advance estimate).
    • Limited primary information: India’s quarterly GDP estimates have limited primary information in them. Their revisions are largely extrapolations and projections of the annual figures. Hence, one should be cautious in reading too much into the specific numbers.

  • Don’t blame it on NSO

    Context

    The latest GDP data witnessed significant revisions that have gone largely unnoticed.

    The GDP data revision and its criticism

    • Revisions an act of due diligence: In the last few years there has been a lot of noise regarding the data revisions.
      • The need for closer examination: While part of revision requires closer examination, we must be fair to our statistical system as such revisions are, in large part, due diligence and happen globally.
    • Schedule of NSO estimates
      • First estimate: The NSO releases the first estimates of any fiscal year in January.
      • Revises the January’s first estimates in February.
      • And then again in May.
      • Simultaneous revision in February: Simultaneously, it revises the previous year estimates in February, alongside the February data release.
    • Suspicion of statistically protecting the 5% growth: The primary criticism, with the current year’s fiscal data, is that the revisions in February for 2019-20 and the 4th revision in 2018-19 are almost identical, implying that the sanctity of 5 per cent growth was statistically protected.

    Examining the criticism purely on the data

    • Precedence of 1st and 2nd quarter revision: There is precedence to the first and second quarter revisions for the current financial year that happen in February.
      • For example, while in the current fiscal, the cumulative downward revision was close to Rs 30,000 crore.
      • In FY19, there was even a greater upward revision of roughly Rs 86,000 crore in February.
    • Is there precedence of such large first-time revisions? Yes, there has been since 2014-15. In 2018-19, the first-time data was revised by a sharp Rs 1.43 lakh crore, while in 2017-18, it was revised by an even larger Rs 1.69 lakh crore.
    • Revision in the same direction: The simultaneous revisions are mostly in the same direction, though different in magnitude, and hence it is unfair to say that the 2018-19 data was revised downwards to protect the 2019-20 numbers.

    What was the problem?

    • Uncertainty: The problem has been that the global and domestic uncertainties in 2017-18 and 2018-19 have been so swift that it has been virtually impossible to predict the outcome initially.
      • While in 2017-18, the final estimates were progressively higher.
      • In 2018-19, while the interim estimates were higher, they were drastically scaled-down later as the impact of the NBFC crisis began to unfold.
    • The US example: The US Fed had also missed the possibility of the US economy bouncing back in 2018 on the back of tax cuts when in 2015 it had projected the economy to expand by only 2 per cent, only to change it to 3 per cent in 2018 (almost at par with scale of revisions in India).

    Why such unconditional biases arise?

    • Asymmetric loss function: It is common for such unconditional bias to arise due to the fact that the statistical reporting agency produces releases according to an asymmetric loss function.
      • For example, there may be a preference for an optimistic/pessimistic release in the first stage, followed by a more pessimistic/optimistic one in the later stage.
    • Cost factor: Intuitively, one might argue that the cost of a downward readjustment of the preliminary data is higher than the cost of an upward adjustment.
    • This asymmetric loss function is not so relevant at the reporting stage but at the forecasting stage.
    • Interpreting the data revision: A statistical reporting agency like the NSO simply does not have all the data at hand and has to forecast the values of the yet to be collecting data.
      • It is at that moment that the asymmetric loss function comes into play.
      • So, we must be careful about interpreting data revisions by the NSO by attributing ulterior motives as we more often tend to do.

    India lagging in the use of data analysis

    • Unlike countries across the world, India is still significantly lagging in its use of data analysis.
      • Methodologies based on thin surveys: Some of the current methodologies of data collection is based mostly on thin surveys.
      • Not supported by the data in public domain: It is also not supported by data available in the public domain that are more comprehensive, less biased and real-time in nature, based on digital footprints.
      • The end result is that we end up publishing survey results that are misleading.

    Way forward

    • Development of big data and AI bases ecosystem: We must develop an ecosystem that is high quality, timely and accessible.
      • Big data and artificial intelligence are key elements in such a process.
      • Big data helps acquire real-time information at a granular level and makes data more accessible, scalable and fine-tuned.
    • Use of payment data: The use of payments data can also help track economic activity, as is being done in Italy.
      • Different aggregates of the payment system in Italy, jointly with other indicators, are usually adopted in GDP forecasting and can provide additional information content.

    Conclusion

    To be fair to both the RBI and the NSO, the volatility of oil prices and structural changes in the economy make the forecasting of inflation and GDP a difficult job indeed. However, we should supplement our existing measurement practices with “big data” to make our statistical system more comprehensive and robust.

  • What is ‘Yes Bank Crisis’?

    On the advice of the Reserve Bank of India (RBI), the government imposed a moratorium on Yes Bank with effect from 6 p.m. on March 5 up to April 3. This has created a furore among the account holders of the bank.

    What restrictions did RBI put?

    • The RBI superseded the private sector lender’s board and appointed as an administrator.
    • Under the moratorium, deposit withdrawals have been capped at ₹50,000.
    • Within 24 hours, the RBI proposed a reconstruction scheme under which SBI could take a maximum 49% stake in the restructured capital of the bank.

    Why was it imposed?

    • The RBI cited a steady decline in Yes Bank’s financial position mainly due to the lender’s inability to raise adequate capital to make provisions for potential non-performing assets.
    • This failing resulted in downgrades by credit rating agencies, which in turn made capital raising even more difficult — a vicious cycle that further worsened its financials.
    • This apart there were serious lapses in corporate governance.
    • The bank has also experienced serious governance issues and practices in the recent years which have led to steady decline of the bank.

    When did it all start?

    • As on March 31, 2014, the bank’s loan book was ₹55,633 crore and deposits were ₹74,192 crore.
    • Since then the loan book expanded fourfold to ₹2,24,505 crore while deposit growth failed to keep pace and increased less than three times to ₹2,09,497 crore.
    • Asset quality also worsened during the period with gross non-performing assets sharply rising from 0.31% as on March 31, 2014, to 7.39% at the end of September 2019.
    • The exponential growth at Yes Bank during that period also came under the regulator’s scanner.
    • The lender has substantial exposure to several troubled borrowers including the IL&FS.

    What will be the likely impact on depositors?

    • While deposit withdrawals have been capped at ₹50,000, there are exceptions under which a higher amount can be withdrawn, with the permission of the RBI.
    • The RBI can allow a customer to withdraw more than ₹50,000 under the following conditions:
    1. in connection with the medical treatment of the depositor or any person actually dependent on the depositor;
    2. towards the cost of higher education of the depositor or any person actually dependent on him for education in India or outside India;
    3. to pay obligatory expenses in connection with marriage or other ceremonies of the depositor or his/her children or of any other person actually dependent upon depositor;
    4. or any other unavoidable emergency.
    • The total withdrawal should, however, not exceed ₹5 lakh or the actual balance in the account, whichever is lower.

    What about deposit insurance?

    • In case Yes Bank goes belly up for any reason, depositors will not lose all their money since deposits up to ₹5 lakh are covered under deposit insurance.
    • While the deposit insurance cover was ₹1 lakh till recently, this was increased to ₹5 lakh in the aftermath of the crisis at the Punjab and Maharashtra Cooperative (PMC) Bank Limited.
    • Finance Minister has announced the increase in deposit insurance in this year’s Budget.

    What do such bank failures imply?

    • While the government and the regulator have asserted that the problem is solely related to this particular bank, the latest developments spotlight the governance risks in India’s banking sector.
    • There is a risk that the already poor operating environment for the banking sector could suffer further impairment if the government’s efforts to tackle problems in the bank fail to provide reassurance to depositors and investors.

  • Monetary policy can’t combat the COVID-19 impact

    Context

    Central banks the world over are devising the strategies to deal with the impact of COVID-19 on their economies.

    How the Central banks are responding?

    • US Fed’s response: The huge 50 basis points cut in rates by the U.S. Federal Reserve to lift economic sentiment hit by COVID-19 has disrupted central banking worldwide.
    • Pressure on other Central banks to follow suits: Even as analysts debate whether a monetary policy response is a right strategy, central banks across the world are feeling the pressure to follow suit to the largest rate cut by the Fed since 2008.
    • How banks are responding? Central banks of Australia and Malaysia have cut rates already while others such as the Bank of Japan, Bank of England and the European Central Bank are contemplating joining the caravan.

    How the RBI is responding?

    • First line of economic defence: With monetary policy turning out to be thede facto first line of economic defence against the ill-effects of the virus, the focus in India has turned to the Reserve Bank of India’s response.
    • Hope of rate cut: Yields on 10-year government securities fell by as much as 0.12% in the hope of a rate cut by the RBI and they stayed soft.
    • But what are the central bank’s options?
      • No unilateral rate adjustment: Unlike other countries, the legal framework in India after the setting up of the Monetary Policy Committee (MPC) is such that the RBI cannot unilaterally adjust rates.
      • The MPC will have to meet and deliberate on the situation before the call to cut rates is taken and such a call will have to be based on an assessment of inflation in the economy.

    Is a rate cut the right response?

    • Impact of the virus on the supply side: The first-order impact on the global economy of the spreading virus is a disruption to trade and to global supply chains.
      • With China being the factory of the world, the clampdown in that country has already disrupted supplies of products ranging from cell phone components to bulk drugs and auto components.
      • Factory lines across the world could freeze as supply chains get disrupted.
    • Limits of Monetary policy to deal with the supply-side problem: Monetary policy is excellent to address demand shocks but is a blunt tool when it comes to addressing supply-side issues.
      • Where to spend? People may be encouraged to spend more due to a rate cut but what will they spend on if products go scarce, travel convulses and public spaces such as movie theatres and malls become no-go areas?
    • The rate cut will boost the sentiments only: A rate cut can, at best, help to boost sentiment but that again will be transient as the market’s reaction after the Fed rate cut proves.
      • Expansionary monetary policy cannot improve the situation: The Swedish central bank’s deputy governor Anna Breman has rightly questioned the logic of a rate cut as a response to the coronavirus impact pointing out that an expansionary monetary policy cannot improve the situation.
    • How the RBI might respond? The sentiment being what it is, the RBI may find itself under increasing pressure to act. Given the MPC constraint, it may well choose to do what it did in the February monetary policy– unleash other weapons in its armoury to give the same effect as a rate cut.
      • Thus, we may well see the central bank announcing another tranche of long-term repo operation, akin to the ₹1 lakh crore that it announced in February.
      • That will mean that banks will gain access to three-year funds at the repo rate of 5.15%, much lower than the market rate.
      • And then, there’s Operation Twist which the RBI employed to good effect in December, softening rates at the long end of the yield curve.

    Would any of these measures yield any response?

    • Doubtful results: It’s doubtful if any of these measures can address the hit to economic growth. The virus has undoubtedly surfaced at a very wrong time for the Indian economy which is showing hesitant signs of a return to growth.
    • Which sectors will be impacted the most? The impact will be felt on more than one front. Industries such as pharmaceuticals, electronics and automobiles could be headed for trouble given their high dependence on Chinese inputs.
    • Government’s response: While the government is said to be formulating a response, including the possibility of airlifting supplies, the practicality of this solution needs to be watched as also its impact on costs for the industries concerned.

    Impact on exports and offsetting factor of oil import

    • The biggest problem: The bigger problem could be from a fall in exports, which accounts for 20% of the GDP.
    • Which exporters would feel the heat? If the developed world tips into recession due to the virus, exporters of products ranging from petroleum and textiles to leather and gems and jewellery will feel the heat.
    • Oil offset due to fall in oil prices: The offsetting factor, of course, will be a lower oil import bill due to the sharp fall in oil prices. This may also have a benevolent effect on inflation.
    • But there will be other headaches for the central bank if the developed world embarks on monetary expansion. The RBI will be faced with the challenge of staunching inflows of hot money coming in search of the higher returns available in India.

    Conclusion

    • Hot money concern for RBI: There will be other headaches for the central bank if the developed world embarks on monetary expansion. The RBI will be faced with the challenge of staunching inflows of hot money coming in search of the higher returns available in India.
    • Opportunity in the crisis: As with every crisis, there’s also an opportunity here. Economic growth is bound to suffer in the short-term but there could be long-term spin-offs if domestic industry and government get their acts right.
      • Supply chains can be localised through fresh investments and India can bid to be an alternative to China in the global value chain.
    • India can be an option to China for global supply chain: The COVID-19 crisis has only underlined in red the lesson that global corporations learnt when trade war broke out between the U.S. and China- the global supply chain needs alternative options to China. India is eminently qualified to assume that role. If only our policymakers and industrialists rise up to the challenge.

     

     

  • An unrest, a slowdown and a health epidemic

    Context

    India faces imminent danger from the trinity of social disharmony, economic slowdown and a global health epidemic.

    Social disharmony

    • Violence in Capital: Delhi has been subjected to extreme violence over the past few weeks. We have lost nearly 50 of our fellow Indians for no reason. Several hundred people have suffered injuries.
      • Communal tensions have been stoked and flames of religious intolerance fanned by unruly sections of our society, including the political class.
    • University campuses, public places and private homes are bearing the brunt of communal outbursts of violence.
    • Institutions of law and order have abandoned their dharma to protect citizens. Institutions of justice and the fourth pillar of democracy, the media, have also failed us.

    Impact of social disharmony on the economy

    • Exacerbating the economy: At a time when our economy is floundering, the impact of such social unrest will only exacerbate the economic slowdown.
    • Lack of investment by the private sector: It is now well accepted that the scourge of India’s economy currently is the lack of new investment by the private sector.
      • Investors, industrialists and entrepreneurs are unwilling to undertake new projects and have lost their risk appetite.
      • Increase in fears and risk aversion: Social disruptions and communal tensions only compound investors’ fears and risk aversion.
      • Social harmony, the bedrock of economic development, is now under peril.
    • When policy tweaks stop to matter: No amount of tweaking of tax rates, showering of corporate incentives or goading will propel Indian or foreign businesses to invest, when the risk of eruption of sudden violence in one’s neighbourhood looms large.
    • How the vicious cycle works: Lack of investment means a lack of jobs and incomes, which, in turn, means a lack of consumption and demand in the economy.
      • A lack of demand will only further suppress private investments. This is the vicious cycle that our economy is stuck in.

    Impact of COVID-19 on the economy

    • Global reactions: Nations across the world have sprung into action to contain the impact of this epidemic. China is walling off major cities and public places. Italy is shutting down schools. America has embarked aggressively both to quarantine people as well as hasten research efforts to find a cure.
      • Many other nations have announced various measures to address this issue.
    • What India can learn? India too must act swiftly and announce a mission-critical team that will be tasked with addressing the issue. There could be some best practices we can adopt from other nations.

    Bringing in reforms to address the problems

    • The government must quickly embark on a three-point plan.
      • First, it should focus all energies and efforts on containing the COVID-19 threat and prepare adequately.
      • Two, it should withdraw or amend the Citizenship Act, end the toxic social climate and foster national unity.
      • Three, it should put together a detailed and meticulous fiscal stimulus plan to boost consumption demand and revive the economy.

    Turning a moment of deep crisis into a moment of great opportunity

    • The past instance of turning crisis into an opportunity: In 1991, India and the world faced a similar grave economic crisis, with a balance of payments crisis in India and a global recession caused by rising oil prices due to the Gulf War.
      • But India was able to successfully turn this into an opportunity to reinvigorate the economy through drastic reforms.
    • Turning the present crisis into an opportunity: Similarly, the virus contagion and the slowing down of China can potentially open up an opportunity for India to unleash second-generation reforms to become a larger player in the global economy and vastly improve prosperity levels for hundreds of millions of Indians.
      • To achieve that, we must first rise above divisive ideology, petty politics and respect institutional salience.

    Conclusion

    The India that we know and cherish is slipping away fast. Wilfully stoked communal tensions, gross economic mismanagement and an external health shock are threatening to derail India’s progress and standing. It is time to confront the harsh reality of the grave risks we face as a nation and address them squarely and sufficiently.

     

     

     

     

     

  • Online versus offline

    Context

    Any intervention to “correct” pricing essentially involves placing a higher weightage on the assumed losses of competitors/producers than on the consumer’s apparent gains. This is not a straightforward exercise.

    Duopolies and scrutiny by the CCI

    • Duopolies in the most segment: The online marketplace or the platform/intermediation service market is now largely characterised by duopolies in most segments:
      • Amazon and Flipkart in e-commerce, Uber and Ola in transport, Zomato and Swiggy in food service, MakeMyTrip and Yatra in travel bookings.
      • Some niche players do exist in these segments, but by and large, the market has been carved up by large players.
    • Why CCI is scrutinising these companies? Several of these companies have come under the scrutiny of the Competition Commission of India (CCI).
      • What are the issues involved? The issues involved here have far-reaching ramifications for both online and offline market places. Some of the more contentious issues are:
      • Do such market structures restrict online competition?
      • Are the players engaging in predatory pricing?
      • If so, is it driving out both online and offline competition and does this adversely impact consumer welfare?
      • Is there a need for policy intervention, and, if so, what should be the underlying framework?

    Lower barrier to entry not translating into greater competition

    • Market not working as per theory: In theory, the online market structure should facilitate greater competition given the lower barriers to entry. But this may not be the case.
      • Take-over: Most other firms in the segments mentioned above have either been taken over or have folded up.
    • What is the reason for the emergence of such marker structures
    • Positive feedback loop: One explanation for the emergence of these market structures is that as companies grow, with more users coming on board these platforms, they benefit from what CCI calls positive feedback loop.
      • This leads to market concentration.
      • Difficulties for new players: Given the network effects, which are common in digital spaces, it becomes difficult for new players to enter these spaces, and gain market share as there isn’t much space for many such networks.
    • Capital intensive market: Another possible explanation is that, contrary to perception, the online space is highly capital intensive.
      • Deep pockets are required to fund the discounts to get customers on board initially.
      • Such market structures are more likely in capital deficit countries like India.
    • Incumbents restricting new entrant: Incumbents, as in other sectors, may also engage in various strategies to restrict entry and thus competition.
      • Even small actions by these platforms coupled with the network effects can adversely impact competition.

    Predatory pricing-issues involved in it

    • Allegations of predatory pricing driving out the competition: Many allege that these two-sided online platforms engage in predatory pricing or below-cost pricing either by funding it themselves (deep pockets) or by squeezing producers.
      • This drives out the competition — both online as well as offline.
      • Predatory pricing is anti-competition, to begin with.
      • How it is harmful to the customers? While consumers do benefit in the short run, once the competition is driven out, the platform starts raising prices to recoup previous losses.
      • But is it that straightforward?
    • What are the issues involved in predatory pricing?
    • First- Assessing whether a platform is engaged in predatory pricing.
      • In India, it is defined as price falling below average variable cost — may not be a straightforward exercise.
      • Why it is not a straight forward exercise? The dynamics of online pricing (prices change over time), their unique cost structures — in such two-sided platforms, prices/costs on both sides should be seen in conjunction — as well as the impact of economies of scale and organisational efficiency in lowering costs, all need to be factored in.
      • Discount for clearing inventories: Besides, one would also have to take into account that even offline firms engage in deep discounting to clear inventories.
      • As do both online and offline firms to acquire customers in the early stages of their business.
    • Second-The impact of such pricing strategies on competition and on consumer welfare must be carefully assessed.
      • Driving out competitors is not equal to driving out the competition: It is quite likely that once the competition is eliminated and the platform starts to raise prices, new players will enter the market, attracted by higher prices.
      • Driving out competitors may not be the same as driving out the competition — though the extent to which new firms are able to enter the market will depend on the degree to which barriers to entry exist.
      • Concerns of recovering the losses: Platforms will be mindful that losses will be hard to recover, and may not engage in below-cost pricing to drive out competitors for extended periods.
      • Consumers are unlikely to lose out as prices are likely to remain low.
    • Third- Possibility of collusion
      • There is also an argument for closer examination of such market structures because of the possibility of collusion.
      • Customers moving towards cheaper options: In most such markets, as the consumer has little to differentiate between the two platforms, it is the price that sets them apart.
      • Consumers tend to gravitate towards the cheaper option. This ensures continuous competition between the major players to offer low prices.
      • Possibility of customer left with no option: It is possible that at some point, the players will find it in their interest to venture into some sort of agreement that allows both of them to survive, rather than be engaged in a race to the bottom — as has seemingly happened in the telecom sector.
    • Fourth- Linking predatory pricing with abuse of dominant market position must be reexamined.
      • The dominant position is not always linked with predatory pricing: As the experience of the telecom sector shows, a dominant position may not be a prerequisite for predatory pricing.
      • Accepting this argument would imply that if regulatory intervention is required to check predatory pricing, it could kick in before market power or dominance is established.
      • Taking into account deep pockets: Alternatively, the definition of market dominance could be expanded to take into account deep pockets.

    Conclusion

    • Set of guidelines instead of the fixed framework: Any intervention to “correct” pricing essentially involves placing a higher weightage on the assumed losses of competitors/producers than on the consumer’s apparent gains. This is not a straightforward exercise. Having a fixed predetermined framework is unlikely to be helpful. Instead, it would be more useful to have a set of guiding principles based on which regulatory intervention, if required, can be undertaken.
    • Safeguarding competition not competitors: Competition policy should be driven by safeguarding competition, not competitors. It should seek to bring about greater transparency in pricing and reduce information asymmetry.

     

  • [pib] Mega Consolidation in Public Sector Banks 

    The Union Cabinet, chaired by the Prime Minister has approved the mega consolidation of ten PSBs into four which include the –

    • Amalgamation of Oriental Bank of Commerce and United Bank of India into Punjab National Bank
    • Amalgamation of Syndicate Bank into Canara Bank
    • Amalgamation of Andhra Bank and Corporation Bank into Union Bank of India
    • Amalgamation of Allahabad Bank into Indian Bank

    About the merger

    • The amalgamation would be effective from 1.4.2020 and would result in creation of seven large PSBs with scale and national reach with each amalgamated entity having a business of over Rupees Eight lakh crore.
    • The Mega consolidation would help create banks with scale comparable to global banks and capable of competing effectively in India and globally.
    • Greater scale and synergy through consolidation would lead to cost benefits which should enable the PSBs enhance their competitiveness and positively impact the Indian banking system.

    Must read

    Bank Mergers

    [Burning Issue] Merger of Public Sector Bank

  • Supreme Court ruling on Virtual Currency

    The Supreme Court in a significant move has set aside a ban by the Reserve Bank of India (RBI) on banks and financial institutions from dealing with virtual currency holders and exchanges.

    Why did the Supreme Court ban virtual currencies?

    • In a circular in 2018, the RBI had banned banks from dealing with virtual currency exchanges and individual holders on the grounds that these currencies had no underlying fiat.
    • RBI held that it was necessary for the larger public interest to stop banks from providing any services related to these.

    Why was the ban unjustified?

    • The court held that the ban did not pass the “proportionality” test.
    • The test of proportionality of any action by the government, the court held, must pass the test of Article 19(1) (g) which states that all citizens of the country will have the right to practise any profession, or carry on any occupation or trade and business.

    What are virtual currencies?

    • There is no globally accepted definition of what exactly is virtual currency.
    • Some agencies have called it a method of exchange of value; others have labelled it a goods item, product or commodity.
    • In its judgment the apex Court observed- Every court which attempted to fix the identity of virtual currencies, merely acted as the 4 blind men in the Anekantavada philosophy of Jainism, who attempt to describe an elephant but end up describing only one physical feature of the elephant.

    Similarities with Bitcoin

    • Satoshi Nakamoto widely regarded as the founder of the modern virtual currency bitcoin and the underlying technology called blockchain defined bitcoins as “a new electronic cash system that’s fully peer-to-peer, with no trusted third party”.
    • This essentially meant there would be no central regulator for virtual currencies as they would be placed in a globally visible ledger, accessible to all the users of the technology.
    • All users of such virtual currencies would be able to see and keep track of the transactions taking place.

    Are they different from cryptocurrencies?

    • Virtual currency is the larger umbrella term for all forms of non-fiat currency being traded online. Virtual currencies are mostly created, distributed and accepted in local virtual networks.
    • Cryptocurrencies, on the other hand, have an extra layer of security, in the form of encryption algorithms.
    • Cryptographic methods are used to make the currency as well as the network on which they are being traded, secure.
    • Most cryptocurrencies now operate on the blockchain or distributed ledger technology, which allows everyone on the network to keep track of the transactions occurring globally.

    Are cryptocurrencies dangerous?

    • The jury is out on that. Organisations across the globe have called for caution while dealing with virtual currencies.
    • A blanket ban of any sort could push the entire system underground, which in turn would mean no regulation.
    • In June 2013, the RBI had for the first time warned users, holders and traders of virtual currencies about the potential financial, operational, legal and customer protection and security-related risks that they were exposing themselves to.
    • The following year, the FATF came out with a report that highlighted both legitimate uses and potential risks associated with virtual currencies.
    • In a different report, it again said the use of such virtual currencies was growing among terror financing groups.

    Why did the RBI ban virtual currencies?

    • Owing to the lack of any underlying fiat, episodes of excessive volatility in their value, and their anonymous nature which goes against global money-laundering rules, the RBI initially flagged its concerns on trade and use of the currency.
    • Risks and concerns about data security and consumer protection on the one hand, and far-reaching potential impact on the effectiveness of monetary policy itself on the other hand, also had the RBI worried about virtual currencies.
    • In its arguments, RBI said it did not want these virtual currencies spreading like a contagion, and had, therefore, in the larger public interest, asked banks not to deal with people or exchanges dealing in these non-fiat currencies.
    • The RBI perceived significant spurt in the valuation of many virtual currencies and rapid growth in initial coin offerings as a risk.

    Proponent’s stance

    • They said the RBI action was outside its purview as the non-fiat currency was not a currency as such.
    • They also argued that the action was too harsh and there had been no studies conducted either by the RBI or by the central government.
    • Arguing that the ban was solely on “moral grounds”, the petitioners said the RBI should have adopted a wait-and-watch approach, as taken by other regulators such as SEBI.

    Faring the Proportionality test

    • In its judgment, the Supreme Court held that the RBI directive came up short on the five-prong test to check proportionality.

    It includes:

    • the direct and immediate impact upon fundamental rights
    • the larger public interest sought to be ensured; a necessity to restrict citizens’ freedom
    • inherent pernicious nature of the act prohibited or its capacity or tendency to be harmful to the general public
    • the possibility of achieving the same object by imposing a less drastic restraint

    Way Forward

    • The Supreme Court’s judgment could lead to the RBI rethinking its policies surrounding virtual currencies.
    • It is expected that the RBI will reconsider its approach to cryptocurrency and come up with a new, calibrated framework or regulation that deals with the reality of these technological advancements.
    • The decision will help those investors who had used legitimate money through banking channels.

  • Way out lies within

    Context

    Domestic demand must play a greater role in India’s growth story.

    Recovery in the Indian economy

    • Sub-5 per cent growth rate: India’s fourth-quarter GDP growth (the calendar year 2019) printed another sub-5 per cent growth rate.
    • Favourable base effect: It would have been lower had it not been for the large downward revisions to previous years’ GDP that statistically boosted the last quarter’s growth rate because of favourable base effects.
    • The decline in GDP stabilised: Policymakers and the market heaved a sigh of relief that the relentless decline over the last three years at least seems to have stabilised around 4-5 per cent.
    • Why some countries prefer sequential growth rate: Because year-over growth rates are so strongly affected by what happened a year ago, most economies (including China) instead publish and conduct policy discussions based on sequential quarterly growth.
      • Better sense of momentum: Sequential growth rates provide a much better sense of the momentum and turning points in activity, which are critical to deciding whether, how much, and when the economy needs policy support.
    • The magnitude of recovery: The growth momentum rose, albeit modestly, from 3.8 per cent in the third quarter of 2019 to 4.1 per cent.
      • Non-farm and non-governmental GDP recovery: More importantly, non-farm and non-government GDP (the closest approximation to non-farm private-sector GDP) bounced much more sharply from 1.6 per cent (and no this is not a misprint) to 4.4 per cent in the fourth quarter.

    What is the dominant narrative of the slide in growth?

    • The deceleration in sequential terms: With the revised data, we now know that annual growth over the last four years has slowed from 8.3 per cent to 7 per cent to 6.1 per cent to 4-5 per cent.
      • The decline in non-farm private GDP: In sequential terms, the deceleration was far more dramatic, especially in non-farm private GDP, which after hitting a run rate of 13 per cent in the first quarter of 2016 fell to 1.6 per cent by the third quarter of 2019.
      • The dominant narrative of the cause of slide: The dominant narrative is that India’s woes are just an unfortunate and unintended consequence of demonetisation, the shift to a national GST, and the credit squeeze caused by the bad debt in banks and non-banks.
      • The dominant narrative on recovery: With a bit more fiscal support, some monetary easing, and extended regulatory forbearance to help banks work out their bad debts, these headwinds will fade and India will likely be back to its winning ways.

    Why real cause of the slowdown lays somewhere else?

    Following factors suggest that answer lies somewhere else.

    • Disruptive but not the drivers of the slowdown: While it is undeniable that facts stated in the dominant narrative had been disruptive, they couldn’t be the drivers of the decline.
      • Slide in growth started even before demonetisation: India’s growth had been sliding since the second quarter of 2016; nearly 6 months before demonetisation and a year before the GST was introduced.
      • By the third quarter of 2016, non-farm private sector growth had already slid to 3.5 per cent.
      • Bad debt problem predates slowdown: Although bad debt hit the headlines in 2016, the overleverage had already begun to tighten bank lending since 2014.
    • Fall in corporate investment- inexplicable cause: More inexplicable is the argument that falling corporate investment is the main culprit for the slowdown.
      • It is true that corporate investment is no longer running at the heady 17 per cent of GDP of the pre-global financial crisis (GFC) days but at a much more sombre 11-12 per cent.
      • However, this outsized adjustment had already taken place by 2010 and since then, corporate investment has flatlined at current levels.

    The answer lies in globalisation

    It is obvious once one eschews India’s exceptionalism and accepts that it is just another emerging market economy that grew on the coattails of globalisation with the minimal reforms. Globalisation has largely determined India’s fate.

    • Growth in corporate investment and exports: Contrary to a widely held misperception, India is and has been for a long time far more open to the global economy than believed.
      • Rise in corporate investment from 5 to 17%: The limited liberalisation of 1991-92, coupled with the corporate restructuring in the late 1990s, spurred corporate investment to rise from 5-6 per cent of GDP in the early 2000s to 17 per cent of GDP by 2008.
      • Increase in exports: Almost all of this expansion in investment was geared to produce for exports, which grew at an astonishing pace of 18 per cent per year-over-year in this period as global trade expanded at breakneck speed with the entry of China into the WTO in 2001.
      • 12% of GDP to 26% of GDP: Exports as a share of GDP more than doubled from 12 per cent in the early 2000s to over 26 per cent by 2008.
      • Slow growth in private consumption: In contrast, private domestic consumption, which is considered to be India’s great strength, grew only at 6 per cent annually, less than the growth rate of the economy, such that its share in GDP fell from 63 per cent to 56 per cent.
      • The engine of the Indian economy- Export: Since 2012, global trade has floundered and with that so has India’s economy.
      • Indeed, the entire rise and fall of investment, including the quarter-to-quarter twists and turns in it, can be almost fully explained by changes in exports.
      • The Indian economy has long been flying on one engine – exports — and that is now spluttering.

    What are the prospects of taking the economy back to its high growth path

    • Unlikely: So will the nascent recovery strengthen and take the economy back to its high growth path? Unlikely on current policies.
    • COVID-19 factor: In the near term, as in now widely feared, the COVID-19 outbreak could turn into a pandemic, sharply reducing global demand and trade.
      • With that, even expectations of a modest 2019-20 recovery to 5.25 per cent growth are under threat.
    • Backlash against globalisation: Over the longer term, it is unlikely that global trade will return to its pre-Global financial crisis growth rates not only because supply chains have stopped expanding in the absence of any material technology breakthrough, but there is also a growing political backlash against globalisation in the developed market that has led to increased trade barriers.

    Way forward

    • Search for new sources of growth: India too, like other emerging market economies, needs to face up to the reality that it can no longer depend on global trade to be the only growth driver. Instead, it needs to search and find new sources of growth and that starts with recognising and accepting reality.
    • Let domestic demand play a greater role in the economy: Policymakers need to stop thinking about India as a perennially supply-constrained economy focusing almost all policies and reforms to easing these constraints. Instead, it is time to let domestic demand play a greater role in India’s growth story.
    • Policy changes: The above factors mean that India Inc. needs to shift from producing what foreigners want to produce what residents can afford, it also means that policymakers have to reverse policies that have so far forced households to keep increasing savings (for retirement income, children’s education, healthcare, and housing) through a web of financial repression, regulatory distortions, and public spending choices.
      • It means redesigning India’s infrastructure to look more inward and less outward.
      • Reduce out of pocket expenses: Increasing public provisioning of healthcare and education, reforming insurance regulations to reduce out-of-pocket expenses and eliminating financial repression to raise returns on retirement savings.
      • Merely tinkering with macroeconomic policies will not be enough.

     

     

  • The growth challenge

    Context

    The focus in the near future should to increase investments and facilitate credit for funding these productive assets so that India’s potential output growth can steadily rise.

    Growth prospects of India

    • The NSO forecast at 5%: The latest data from the National Statistical Office (NSO) retained India’s economic growth forecast at 5 per cent for the current financial year.
      • Growth has dropped from 6.1 per cent in the previous year.
    • Fall in nominal GDP: More strikingly, nominal GDP growth has decelerated from an average of 11 per cent during 2016-17 to 2018-19 to 7.5 per cent this year.
      • Lower inflation added to the volume slowdown.
      • The value of India’s GDP for FY20 is estimated at around $2.9 trillion.

    Input and output side growth prospects

    • GDP is estimated from both output and demand lenses, using specific economic indicators as proxies for activity in specific sectors.
    • Output side: From the output side, sector-wise estimates were as following-
      • Agriculture sector growth was revised up to 3.7 per cent (up from the 2.8 per cent previously).
      • Agricultural production is expected to improve based on the third advance estimates of the rabi season crops, as well as higher horticulture and allied sector output (livestock, forestry and fishing), which now is significantly larger than conventional food crops.
      • Industrial activity was lowered to 1.5 per cent (from 2.3 per cent earlier).
      • The key concern regarding the continuing slowdown is the increasing weakness in the industrial sector (particularly of manufacturing, whose growth has progressively fallen from 13.1 per cent in FY16 to 5.7 per cent in FY19, and plummeting to 0.9 per cent in FY20).
      • Services output remained largely unchanged at 6.5 per cent.
    • Demand-side: From a demand perspective, the obverse side to the manufacturing slowdown is the even sharper drop in fixed asset investment growth — down sharply from an average 8.5 per cent during FY17 and FY19 to -0.6 per cent in FY20.
      • The causes for this contraction needs to be understood in detail, and we will return to this.

    Private consumption- a significant driver of growth

    • Private consumption at 60% of GDP: The other significant driver of growth in India has been private consumption. For perspective, the share of private consumption had averaged 59-60 per cent during FY16-FY20.
    • Government consumption 10% of GDP: Reflecting the higher spending over the last couple of years, the share of government consumption in GDP has risen from an average of 10.5 per cent of GDP over FY12-17 to almost 12 per cent in FY20, resulting in the share of total consumption above 70 per cent.

    Drop in the share of nominal investment

    • Drop from 39 % to 30 % of GDP: The really remarkable trend, though, as noted above, is the share of nominal investment in GDP progressively dropping from 39 per cent in FY12 to 30 per cent in FY20.
    • Is it a good sign? Part of this is actually good, reflecting higher Capex efficiency.
      • Slowing household consumption: One narrative underlying the contraction in fresh Capex in FY20 was slowing household consumption growth, which, in nominal terms, fell from an average 11.6 per cent during FY16-19 to an estimated 9.1 per cent in FY20.
      • Disproportionate contribution to lower growth: Though the deceleration prima facie does not seem significant enough to result in a broader economic slowdown of the current magnitude, the high share of household consumption has contributed disproportionately to lower growth.
      • Fall in capacity utilisation: A direct fallout of this is that seasonally adjusted capacity utilisation (based on RBI surveys) had shrunk from 73.4 per cent in the first quarter of FY20 to 70.3 per cent in the second quarter, and this is unlikely to have improved materially in the second half of the year.
      • This is one of the reasons for the low levels of fresh investment.

    Reduced flow of credit to the commercial sector

    • Impediment to growth revival: The other cause of the low Capex, more from the supply side, is a much-reduced flow of credit to the commercial sector, and this remains the proximate impediment for growth revival, with signs of risk aversion in lending still strong despite the recent measures by RBI to incentivise credit to productive sectors.
      • Funds from selected sources, over April-January FY20, was only about Rs 9 lakh crore as against Rs 15 lakh crore in the corresponding 10 months of FY19.
    • Bank credit lowest in three months: Growth in bank credit (which is still the largest source of financing) till mid-February 2020 was down to 6.3 per cent — the lowest in three years.
      • Even this is almost wholly driven by retail credit; incremental credit to industry and services over this period was negative.

    Investor confidence and coronavirus factor

    • A bright feature of the economic environment: One bright feature in this economic environment is strong foreign investor confidence in India, reflected in both FPI equity and FDI flows.
      • Many borrowers have used offshore sources to refinance or pay down domestic bank loans and debt.
      • A global risk-off environment might restrict even this channel in the near future.
    • Robust corporate bond issuances: Domestic corporate bond issuances have also remained robust, although the dominant set of borrowers still remain public sector agencies and financial institutions.
    • Coronavirus factor likely to moderate the gains: Monthly economic indicators suggest that the growth deceleration has likely bottomed out in the third quarter.
      • The bet has been on reducing inventories and the consequent production ramp-up to replenish stocks. However, the evidence on this is mixed.
      • The coronavirus effects, both concurrent and lagged, will also moderate some of the emerging positive effects of counter-cyclical policy measures of the past six months.
      • If the outbreak does not abate over the next month or so, the complex supply chains of intermediates sourced from China will run dry and add to the already weak system demand.
    • Growth prospects in the next few weeks: Surveys indicate that both business and consumer confidence, which while improving, remain muted. A growth revival, hence, is likely to be only very modest over the next few quarters.

    Conclusion

    A $5 trillion economy by 2025 is still a worthwhile target and aspirational; coordinated strategies, policies, execution and institutional mechanisms will be needed to move up to a sustained 8 per cent plus growth consistent with achieving the target. The focus in the near future should to increase investments and facilitate credit for funding these productive assets so that India’s potential output growth can steadily rise.