What explains the Indian government borrowing at a higher interest rate than the interest rates for a home loan? The answer lies in the structural shortage in demand for government bonds. 

How the government’s cost of borrowing matter

• Interest on government debt is a transfer from taxpayers to savers who own government bonds.
• As the government bondholders are primarily domestic, interest paid by the government is just a transfer from one hand to the other within the economy.
• However, the government’s cost of borrowing does matter.
• The large increase in interest costs limits the government’s ability to spend elsewhere.
• But more importantly, this rate also affects the cost of borrowing for large parts of the economy.

Understanding the term premium and credit spread

• The RBI sets the repo rate, which is the short-term risk-free rate.
• That is, the loan must be repaid in a few days and there is almost no risk of default.
• The rate at which the government borrows is the long-term risk-free rate.
• But the lender wants higher returns given the longer duration of the loan.
• The difference between the repo rate and government’s borrowing cost, say on a 10-year loan, is called the term premium.
• When a private firm takes a 10-year loan, it would have some credit risk too, which means a credit spread is added to the 10-year risk-free rate.

Challenge posed by term premium

• From an average rate of 73 basis points since 2011 (one basis point is one-hundredth of a per cent), and 120 basis points in 2018 and 2019, the 10-year term premium is currently 215 basis points.
• In other words, the interest rate for a 10-year period borrowing is 2.15 per cent higher than the current repo rate.

How this is related to dysfunction in bond market in India

• Financial markets are forward-looking, and as the collective expression of the views of thousands of participants, efficient ones can occasionally “predict” what comes next.
• But the Indian bond market is not one such: The view some hold, that the rise in term premium reflects future rate hikes by the monetary policy committee (MPC), is mistaken.
• The Indian bond market is still too illiquid and not diverse enough to predict future trends.
• Even though some pandemic-driven measures are being withdrawn, the MPC continues to be accommodative, and for several months at least, headline inflation is unlikely to force an abrupt change.
• In any case, the spurt in yields after the budget points to the causality being fiscal instead of inflation-related.
• But even the fiscal rationale seems weak.
• The Centre’s tax collection for FY2020-21 has been substantially ahead of target, and state governments have also borrowed Rs 60,000 crore less than expected.
•  Also, the14 states, accounting for three-fourths of all state deficits, have budgeted FY2021-22 deficits at 3.3 per cent, far lower than the 4 per cent average expected earlier.
• Just these factors suggest that total bonds issued by the central and state governments should be lower than what the market had feared before the union budget was presented.
• And yet, government borrowing costs have not returned to pre-budget levels.
• This reflects dysfunction in the market.
• Why else would a government be borrowing at a higher cost than a mortgage on a house?

What is the reason for dysfunction in bond market

• Dysfunction can be traced to residential mortgages being among the most competitive of loan categories.
• On the other hand, there is a structural shortage in demand for government bonds.
• In such a market where there is a structural shortage in demand the marginal buyer holds all the cards, and as any buyer would, demands higher returns.
• Over 15 years,  the share of banks in the ownership of outstanding central government bonds has fallen from 53 per cent to 40 per cent now.
• But no alternative buyer of size has emerged to fill the space vacated.
• The RBI sometimes buys bonds to inject money into the economy, but of late this space has been used to buy dollars to save the rupee from appreciation.

Solutions

• The solution to the problem of bond market may lie in getting new types of buyers.
• The RBI opening up direct purchases by retail investors is a step in this direction, though it may not become meaningful for a few years.
• That leaves us with tapping foreign savings.
• The limit on share of government bonds that foreign portfolio investors (FPIs) can buy has been raised steadily.
• But without Indian bonds being included in global bond indices, these flows may not be meaningful, and would be volatile, as they have been over the past year.
• To enable inclusion in bond indices, the RBI and the government have earmarked special-category bonds which are fully accessible (FAR) by foreign investors.
• The FTSE putting India on a watch-list for “potential future inclusion” in the Emerging Markets Government Bonds Index is a step forward, and, one hopes, triggers similar actions by other index providers.

Consider the question “How the lack of retailness in the bond market affects the cost of borrowing of the government as well as the private borrowers? Suggest the measures to deal with the issues.”

Conclusion

The issues with bond markets in India highlights the urgency to find new buyers for government bond as it has implications not just for the government’s own fiscal space, but also for the cost of borrowing in the economy.

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The article highlights the untapped potential of the e-commerce sector in the transformation of the Indian economy and suggests factors to take into account in the new e-commerce policy.

How pandemic contributed to the growth of e-commerce

• A celebrated McKinsey study has revealed that we have covered a ‘decade in days’ in the adoption of digital during the pandemic.
• Behavioural changes have been witnessed in most areas like work, learning, health, travel, entertainment, etc.
• But the biggest surge has been in e-commerce, both in goods and services.

Significance of the sector for India

• E-commerce is one of India’s fastest-growing sectors, for attracting FDI and creating jobs, and providing a pan-India market for lakhs of SMEs, and facilitating exports.
• India has a vibrant retail sector, bubbling with energy and a bright future.
• E-commerce can rope in lakhs of MSMEs in cross-border trade and multiply turnover and revenues enormously.
• Its role in facilitation of exports with linkages and access to overseas markets can also help inject competitiveness in our products and creating a lot of jobs and market opportunities, adding to inclusive growth.

Issues faced by the sector

• The digital interface during e-commerce processes with multiple agencies has resulted in a plethora of compliances.
• These compliances include Income Tax Act 1961, Information Technology Act 2000, Consumer Protection Act 2019, FEMA Act 2000, Competition Act 2002, Companies Act 2013, Anti-Piracy Law, GSTN, DGFT, etc.
• In addition, handling, generation and protection of humongous data is a major issue under data protection laws.
• At times, there are requirements of compliances with various local and state laws, and during exports, adherence to foreign laws, many of which could be quite complex and rigorous.

E-commerce policy to aid Inclusive growth

• Inclusive growth being an important objective of the proposed e-commerce/FDI policy, it should recognise and support new business models in both product and service segments.
• The policy should be aimed at improving consumer experience and providing gainful employment to regular and gig workers with improved earnings.
• India, in fact, is the first country to extend protections to workers including the new-age gig and platform workers, which is being viewed with interest globally.
• With the passage of the Code on Social Security 2020, policymakers have focused on financial and social security associated with employment to contemporary socio-economic realities.
• The role of platform workers amidst the pandemic has presented a strong case to attribute a more robust responsibility to platform aggregator companies and the State.
• This has cemented their role as public infrastructures who also sustain demand-driven aggregators and e-commerce platforms.
• This role of the platform workers may help in higher productivity and more sustainable employment, when many of them could potentially become mini-entrepreneurs.
• This, however, would need to be facilitated by concerned public and private institutions as also the multiple regulators in the e-commerce ecosystem.
• In an online services market place and to provide full support to regular and gig professionals rendering services on the platform, it must be imperative on the service platform to build their capacity through training, technology and access to high-quality consumables and tools.

Consider the question “Examine the role e-commerce can play in India’s pursuit of inclusive growth? What are the issues faced by the sector in India?” 

Conclusion

We are in for exciting times, as we enter this decade, rightly called the ‘Techade’; 2020 has accelerated technology infusion in all segments of life and activity. The world is looking at India with expectations and we owe it to our nation.

Source: https://www.financialexpress.com/opinion/e-commerce-policy-needed-for-speedy-inclusive-growth/2226729/

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The article deals with the issues of demand for the inclusion of fuel oils in the GST regime and its implications for the revenue of the states and the Centre.

How much tax we pay on petrol and diesel

• The Union and state levies put together account for roughly 55 per cent and 52 per cent of the retail price of petrol and diesel respectively.
• These work out to around 135 per cent and 116 per cent of the base prices of the two products respectively.
• The central levy on petrol and diesel works out to around 36 per cent of the retail price while the state component is around 20 per cent (diesel) to 28 per cent (petrol).
• Of the total central levies on petrol and diesel, Rs 1.40 per litre and Rs 1.80 per litre is the basic excise duty for the two fuels, and Rs 11 per litre and Rs 18 per litre is the special additional excise duty.
• Both these components form part of the divisible pool of taxes i.e. 42 per cent of which (approximately Rs 52,000 crore) goes to the states.
• The remaining portion of Rs 18 per litre in both cases is the Road and Infrastructure Cess and Rs 2.50 per litre and Rs 4 per litre is the Agriculture Infrastructure and Development Cess which are retained by the Centre.

How other countries tax fuel oils

• Being demerit goods, fuel oils and liquor are almost universally subject to a dual levy by countries that implement any kind of VAT or GST.
• The levy is a mix of GST at a fixed percentage of the price which qualifies for credit in the value chain and a fixed amount or percentage of the price which is not creditable and is thus outside GST.
• Punitive taxes of this order are levied primarily to discourage consumption of environmentally degrading fossil fuels and to garner revenues to fund infrastructure, while the creditable component enables offsetting of taxes on basically capital inputs.
• These products are subjected to a plethora of levies like VAT, excise duty, storage levies, security levies and environmental taxes in the EU and the total incidence of such taxes ranges from around 45 per cent to 60 per cent.
• The US is an exception in these matters since it imposes taxes at rates as low as around 15 per cent.

Including fuel oils in the GST regime

• the 122nd Constitution Amendment Bill in 2014 for GST adopted the delayed choice approach.
• Under the delayed-choice approach, petroleum products would be subjected to GST with effect from such date as the council may recommend.
• Accordingly, sections 9(2) and 5(2) of the CGST/SGST Act and the IGST Act respectively, explicitly provide for levy of GST on these products with effect from such date as the Council may recommend.
• Thus, bringing the aforesaid petro-products under GST is not within the reach of the central government alone.

How much will be the loss of revenue

• A 28 per cent levy of GST on the base price would fetch around Rs 5.40 per litre on petrol and around Rs 5.45 on diesel to the central and each of the state governments.
• Contrast the above with the current yield of Rs 32.90 per litre on petrol and Rs 31.80 per litre on diesel to the Centre alone and an average of around Rs 20 per litre and Rs 15 per litre on petrol and diesel, respectively, to each of the states.
• This, however, would bring down the prices of petrol and diesel to around Rs 55 per litre.
• This would translate into a revenue loss of around Rs 3 lakh crore on account of petrol and around Rs 1.1 lakh crore on account of diesel to the Centre and the states, at current volumes.

Consider the question “What are the various levies contributing to the prices of petrol and diesel in India? Examine the rationale for the heavy taxing of these products in India.”

Conclusion

Clearly, bringing petro-products under GST would not lower fuel oil prices by itself, unless the Union and the state governments are willing to take deep cuts in their revenues.

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The article highlights how the faster recovery of the U.S. economy aided by the faster vaccination and stimulus packages may pose a policy challenge to the emerging economies.

About the fiscal stimulus in the U.S.

• With the recent passage of Biden’s $1.9 trillion coronavirus relief package, the cumulative fiscal stimulus amounts to 25 per cent of GDP. 
• This reliance on fiscal stimulus is in sharp contrast to the policy response in the aftermath of the 2008 global financial crisis (GFC) when monetary policy was the main tool.
• The over reliance on fiscal measures is because of the “liquidity trap” — interest rates are already treading close to zero.

So, what does this mean for the US and emerging economies?

• From the US perspective, this is good news.
• The U.S. economy is expected to converge to the pre-pandemic GDP projection after the third quarter of 2021, exceeding it by 1 per cent in the fourth quarter.
• The impact on emerging economies is less certain.
• A booming US economy generally bodes well for global growth as higher demand “spills over” to the rest of the world.
• However, the sectoral contribution to US growth presents a different picture this time.
• Private consumption of goods (tradable) is already back to pre-pandemic levels, while consumption of services remains significantly below pre-pandemic levels.
• As the vaccination drive gathers pace in the US and the economy slowly opens up, it should be fair to assume that the non-tradable sector would be driving growth.
• But given the expected nature of the underlying growth, the positive impact on emerging economies will perhaps be softer.
• With smaller fiscal stimulus in emerging economies and the slower vaccine roll, the US recovery largely being led by the non-tradable sector will result in a divergence in growth between the US and emerging countries.

Policy challenge for emerging economies which is different from GFC

• Post-GFC, a combination of zero interest rates and quantitative easing in advanced economies led to a significant surge in capital inflows to emerging countries in search of higher yield leading to an appreciation of their currencies.
• Now, the situation is exactly the opposite.
• The differential rate of recoveries has already led to capital outflow from emerging economies.
• The rise in yield in the U.S. may further fuel capital outflows in coming days leading to tighter monetary conditions in emerging markets.

What should be India’s policy response

• As far as India is concerned, the macro-economic fundamentals are much stronger than during the taper-tantrum days.
• The foreign exchange reserves remain at historically high levels, the current account situation is comfortable and the inflation rate remains within the target band of the RBI.
• In the event of capital outflows, the RBI should let the currency depreciate as the first line of defence to preserve India’s external competitiveness and intervene only to smoothen out extreme volatility.
• It should avoid the temptation to increase interest rates at the risk of hurting the pace of economic recovery.

Consider the question “Uneven economic recovery on the global level poses a policy challenge to India. In this context, discuss the possible impact of uneven recovery and suggest the policy measures to deal with it.”

Conclusion

Uneven recovery at the global level demands an unconventional policy approach. The policy approach of India should be based on this premise.

Back2Basics: Taper Tantrum

• The phrase, taper tantrum, describes the 2013 surge in U.S. Treasury yields, resulting from the Federal Reserve’s (Fed) announcement of future tapering of its policy of quantitative easing.
• The Fed announced that it would be reducing the pace of its purchases of Treasury bonds, to reduce the amount of money it was feeding into the economy.
• The ensuing rise in bond yields in reaction to the announcement was referred to as a taper tantrum in financial media.

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The article highlights the issues with government expenditure driven by the selling of public sector assets.

How public asset selling could affects private investment decisions

• Public sector assets are not bought by reducing consumption or investment.
• Current investment expenditure depends on decisions taken in the past and is more or less pre-determined.
• Investment decisions that are taken today for fructification tomorrow that may be scaled down by such a purchase.
• However, if investment decisions taken today are scaled-down, then it results in crowding out and such a strategy should be avoided anyway.
• This implies that selling public sector assets therefore does not release any resources from private use for government spending.

How selling public asset has same macroeconomic effect as fiscal deficit

• In case of fiscal deficit, the government puts its bonds in private hands; in sale of a public asset, the government puts its equity held in public sector assets in private hands.
• The macroeconomic consequences of a fiscal deficit on the economy are no different from those of selling public assets.
• However, finance capital, and institutions like the IMF treat the sale of public assets on a different footing from a fiscal deficit, for ideological — not economic — reasons, because they ideologically favour a dismantling of the public sector.

How fiscal deficit leads to wealth inequality

• In a situation of demand-constraints, where unutilised capacity and unemployed workers exist aplenty, if an appropriate monetary policy is pursued, it can have no adverse effects whatsoever, except one: It increases wealth inequality.
• The government expenditure financed by the fiscal deficit creates additional aggregate demand that increases output and incomes until the additional savings generated out of such incomes exactly match the fiscal deficit.
• These additional savings accrue to the savers without their having to reduce their consumption, compared to the initial situation (that is, prior to government expenditure increase).
• Since savings represent additions to wealth, this amounts to putting extra wealth into the hands of the rich.
• Selling public assets puts into private hands public assets, and that too at prices well below the capitalised value of earnings.
• This increases wealth inequality for two reasons:
• First, it does so exactly as a fiscal deficit does.
• Second, the public asset it puts in private hands is under-priced.

Why tax financed government spending should be preferred

• If the same government expenditure is financed by taxation, no matter who was taxed, then there would be no addition to private wealth and hence no increase in wealth inequality.
• Which is why tax-financed government expenditure should always be preferred to fiscal-deficit-financed government expenditure.

What alternative government have

• The obvious one is wealth taxation.
• Taxing away the private wealth created by a fiscal deficit leaves private wealth inequality unchanged at its initial level; it does not exacerbate it.
• If the government is unwilling to impose higher wealth or profit taxes, it can raise GST rates on several luxury goods.

Consider the question “How fiscal deficit financed government spending differs in its impact on weath inequality from the tax-financed government spending?”

Conclusion

Thus, selling public assets to finance government spending is both undesirable and unnecessary.

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The article highlights how Atmanirbhar Bharat policies can play important role in India’s post-pandemic recovery.

Decline of trade-led catch-up growth

• The Asian Development Bank identifies India as an outlier, with the country’s GDP growth likely to range between eight and 10 per cent — as against 7.7 per cent for China and seven per cent for the Asian region.
• The convergence between the rich and poor countries in the 1990s and 2000s was founded on high relative growth rates driven by globalisation and export-led growth.
• The World Bank and many international think tanks are now projecting a process of de-globalisation, reduction in exports, and reduced service exports from the tourism, travel and hospitality sector in response to COVID.
• So, the phenomenon of trade-led catch-up growth is declining.

How Atmanirbhar Bharat is different from past strategies

• India’s import substituting growth strategy of the 1960s did not succeed because the high protective customs barriers led to the growth of non-competitive industries.
• The current Atmanirbhar Bharat project is different because tariffs are low and public investment is focused on non-tradable infrastructure rather than commodity production.

1) Atmanirbhar in heath: Atmirbhar Swasth Bharat

• Atmanirbhar Swasth Bharat is a domestic non-trade dependent initiative which will invest over Rs 64,000 crore in setting up 17,800 rural and 11,000 urban health and wellness centres and 602 critical care hospitals in the country’s districts.
• Today India has 29 health workers per 10,000 population, while we need 60 such professionals per 10,000 people, as per WHO norms.
• Creating such a cadre will mean nearly four million new jobs, which can be self-paying.

2) Infrastructure

• China and emerging markets like Russia and Brazil have a fairly advanced transport and energy infrastructure.
• India has a huge potential to renew its railways and highways and shift to solar energy from its current dependence on coal.
• In fact, the country’s long-neglected fourth largest rail network in the world is undergoing rapid transformation.
• While rail track coverage expanded by 5,000 km during 2010 to 2014-15, nearly 7,000 km of tracks were added between 2015 and 2020.
• The Railways now aim to lay 9.5 km of track daily and have raised adequate capital for the same by leveraging domestic insurance funds.
• Railways are also aiming for 100 per cent electrification and zero carbon footprint by 2024.
• Electrified track has doubled from 20,000 km in 2012/13 to nearly 40,000 km in 2020.
• The Centre’s decision to invest heavily in urban mass transit systems since 2014 has led to the rapid expansion of such services.
• The resolution of financial problems of blocked PPP projects and smooth land acquisition process has increased the pace of construction of national highways.
• Pace of construction of the national highway increased from 3,330 km per year during 2009-20014 to nearly 9,450 km in 2020-21.

3) Renewable energy

• Today over 55 per cent of India’s energy comes from coal but the share of renewable has been steadly increasing.
• Starting with only 10 MW of solar power in 2010, India has installed nearly 35 GW of solar power by 2020.
• This has been propelled by economic reforms which drove solar power prices down from Rs 17 per unit in 2010 to Rs 2.44 per unit in 2020.
• The target of reaching 100 GW by 2022 can drive growth further.
• Currently nearly 25 per cent of India’s electricity is used for pumping underground water for irrigation.
• Providing irrigation energy from decentralised solar grids — solar power can be generated at the points on consumption.
• This will reduce huge transmission losses and the associated carbon footprint of non-renewable energy sources.

4) Privatising public sector outfits

• The Centre’s shift towards privatising public sector outfits including banks, insurance companies and other PSUs can fund the growth of rail, road and energy infrastructure.
• This will also foster efficiency in India’s credit system.
• China achieved supernormal growth in infrastructure without access to international financing in the initial decades.
• Recent studies have revealed that China’s financial decentralisation and commercial exploitation of state-owned lands was critical for the success.
• In India, too, regional development authorities like the Mumbai Metropolitan Regional Development Authority and Maharashtra Industries Development Corporation have financed the metro, trans-harbour links and industrial infrastructure through a similar commercial land allocation model.
• This model can be extended throughout the country to finance infrastructure expansion.

Consider the question “How Atmanirbhar Bharat policies differ from the past import-substituting growth strategy? Examine the role Atmanirbhar Bharat can play in the post-pandemic recovery?” 

Conclusion

In such a way, Atmanirbharta with its various facets will pave the road of post-pandemic recovery.

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