Type: Prelims Only

This article provides a quick summary of what has been happening in the global economy. These are few key terms that one is likely to hear repeatedly in the coming days and weeks:

1. Yield Inversion
2. Soft-landing and
3. Reverse Currency War

Here’s a quick look at what they mean and why they are significant at present.

(1) Bond Yield Inversion

What is Bond Yeild?

• Bonds are essentially an instrument through which governments (and also corporations) raise money from people.
• Typically government bond yields are a good way to understand the risk-free interest rate in that economy.
• This 2019 piece provides an introduction to government bonds and explains how yields are calculated.

What is Yield Curve?

• The yield curve is the graphical representation of yields from bonds (with an equal credit rating) over different time horizons.
• In other words, if one was to take the US government bonds of different tenures and plot them according to the yields they provide, one would get the yield curve.

The chart below provides a sense of the different types of yield curves one could have.

How to see this?

• Under normal circumstances, any economy would have an upward sloping yield curve.
• That is to say, as one lends for a longer duration — or as one buys bonds of longer tenure — one gets higher yields. This makes sense.
• If one is parting with money for a longer duration, the return should be higher.
• Moreover, a longer tenure also implies that there is a greater risk of failure.
• An inversion of the yield curve essentially suggests that investors expect future growth to be weak.

Inversion of bond yield

• However, there are times when this bond yield curve becomes inverted.
• For instance, bonds with a tenure of 2 years end up paying out higher yields (returns/ interest rate) than bonds with a 10 year tenure.
• Such an inversion of the yield curve essentially suggests that investors expect future growth to be weak.

Here’s how to make sense of this?

• When investors feel buoyant about the economy they pull the money out from long-term bonds and put it in short-term riskier assets such as stock markets.
• In the bond market, the prices of long-term bonds fall, and their yield (effective interest rate) rises.
• This happens because bond prices and bond yields are inversely related.
• However, when investors suspect that the economy is heading for trouble, they pull out money from short-term risky assets (such as stock markets) and put them in long-term bonds.
• This causes the prices of the long-term bonds to rise and their yields to fall.

Why use inversion curve?

• Over the years, inversion of the bond yield curve has become a strong predictor of recessions. Of course, for it to be taken seriously, such an inversion has to last for several months.
• Over the past few weeks, such inversion is happening repeatedly in the US, suggesting to many that a recession is in the offing.
• In the current instance, the US Fed (their central bank) has been raising short-term interest rates, which further bumps up the short-end of the yield curve while dampening economic activity.

(2)  Soft-Landing

• The process of monetary tightening that the US is currently unveiling involves not just reducing the money supply but also increasing the cost of money (that is, the interest rate).
• US is doing this to contain soaring inflation.
• Ideally, the US Fed or any central bank doing this would like to bring about monetary tightening in such a manner that slows down the economy but doesn’t lead to a recession.
• When a central bank is successful in slowing down the economy without bringing about a recession, it is called a soft-landing — that is, no one gets hurt.
• But when the actions of the central bank bring about a recession, it is called hard-landing.

(3) Reverse Currency War

• A flip side of the US Fed’s action of aggressively raising interest rates is that more and more investors are rushing to invest money in the US.
• This, in turn, has made the dollar become stronger than all the other currencies. That’s because the dollar is more in demand than yen, euro, yuan etc.
• On the face of it, this should make all other countries happier because a relative weakness of their local currency against the dollar makes their exports more competitive.
• For instance, a Chinese or an Indian exporter gets a massive boost.
• In fact, in the past the US has often accused other countries of manipulating their currency (and keeping its weaker against the dollar) just to enjoy a trade surplus against the US.
• This used to be called the currency war.

What explains this reverse currency war unfolding at the moment?

• The important thing to understand is that a stronger dollar has had a key benefit — importing cheaper crude oil.
• A currency which is losing value to the dollar, on the other hand, finds that it is getting costlier to import crude oil and other commodities that are often traded in dollars.
• But raising the interest rate is not without its own risks.
• Just like in the US, higher interest rates will decrease the chances of a soft-landing for any other economy.

UPSC 2023 countdown has begun! Get your personal guidance plan now! (Click here)

Customers will have to pay a 5% Goods and Services Tax (GST) on pre-packed, labelled food items such as atta, paneer and curd, besides hospital rooms with rents above ₹5,000.

What is GST?

• GST launched in India on 1 July 2017 is a comprehensive indirect tax for the entire country.
• It is charged at the time of supply and depends on the destination of consumption.
• For instance, if a good is manufactured in state A but consumed in state B, then the revenue generated through GST collection is credited to the state of consumption (state B) and not to the state of production (state A).
• GST, being a consumption-based tax, resulted in loss of revenue for manufacturing-heavy states.

What are GST Slabs?

• In India, almost 500+ services and over 1300 products fall under the 4 major GST slabs.
• There are five broad tax rates of zero, 5%, 12%, 18% and 28%, plus a cess levied over and above the 28% on some ‘sin’ goods.
• The GST Council periodically revises the items under each slab rate to adjust them according to industry demands and market trends.
• The updated structure ensures that the essential items fall under lower tax brackets, while luxury products and services entail higher GST rates.
• The 28% rate is levied on demerit goods such as tobacco products, automobiles, and aerated drinks, along with an additional GST compensation cess.

Why rationalize GST slabs?

• From businesses’ viewpoint, there are just too many tax rate slabs, compounded by aberrations in the duty structure through their supply chains with some inputs taxed more than the final product.
• These are far too many rates and do not necessarily constitute a Good and Simple Tax.
• Multiple rate changes since the introduction of the GST regime in July 2017 have brought the effective GST rate to 11.6% from the original revenue-neutral rate of 15.5%.
• Merging the 12% and 18% GST rates into any tax rate lower than 18% may result in revenue loss.

UPSC 2023 countdown has begun! Get your personal guidance plan now! (Click here)