Economic Development and Policies

Monetary and Credit policy: Meaning and Importance

Monetary policy of   pertains to controlling and regulating money supply and cost borrowing with twin objectives of price stability and economic growth.  The monetary authority of all modern economies (countries), typically the central bank, targets an inflation rate or interest rate to ensure price stability and general trust in the currency. The other goals of a monetary policy are usually to contribute to the stability of gross domestic product, to achieve and maintain low unemployment, and to maintain predictable exchange rates with other currencies.

Types of Monetary Policy

There are two types of monetary policy:

  1. Expansionary Monetary Policy and 2. Contractionary Monetary policy

Expansionary Monetary Policy

When an economy is undergoing recession, expansionary monetary policy is used to stimulate the economy.  The monetary authority in an expansionary policy maintains short-term interest rates at a lower than usual rate or increases the total supply of money in the economy more rapidly than usual. It is traditionally used to try to combat unemployment in a recession. A lower interest rate leads to increased borrowing (due to low cost of borrowing ) and investment  by  businesses This increases aggregate demand (the overall demand for all goods and services in an economy), which boosts short-term growth as measured by gross domestic product (GDP) growth. Expansionary monetary policy usually leads to depreciation of currency of the country in question . In other words it diminishes the value of the currency relative to other currencies (the exchange rate).

Contractionary Monetary Policy

In  contractionary monetary policy, the monetary authority increases short run interest rates or in other words maintains short-term interest rates higher than usual in order to reduce borrowing (as it becomes costlier) This in turn slows the rate of growth in the money supply or even shrinks it. This slows short-term economic growth and lessens inflation. The contractionary monetary policy is resorted to curb high level of inflationary expectations or “cool down” an “over- heated economy” due to much higher aggregate demand than aggregate supply.However, it can lead to increased unemployment and depressed borrowing and spending by consumers and businesses, which can eventually result in an economic recession if implemented too vigorously.

Credit Policy

Credit is created on the basis of money supply. In a branch banking system operating with provision of a reserve ratio, every bank has to maintain an amount equal to reserve ratio out of its total time and demand deposits and the remaining part is lent out. This is how “reserve money” or “high powered money” creates “credit”. In economics, credit policy is government policy at a particular time on how easy or difficult it should be for people and businesses to borrow money and how much it will cost.

Money Multiplier or Credit Multiplier

Money multiplier or credit multiplier is a model that illustrates how banks can create money. The rate at which credit is created depends on the reserve ratio and the capital ratio for banks. The money multiplier or credit multiplier tells how the maximum amount the money supply could increase based on an increase in reserves within the banking system. Money multiplier closely related ratios of commercial bank money to central bank money (also called the monetary base) under a fractional-reserve banking system. In a fractional-reserve banking system, the total amount of loans that commercial banks are allowed to extend (the commercial bank money that they can legally create) when there are no leakages is equal to a multiple of the amount of reserves. This multiple is the reciprocal of the reserve ratio, and it is an economic multiplier.

In equations, writing M for commercial bank money (loans), R for reserves (central bank money), and RR for the reserve ratio, the reserve ratio requirement is that {\displaystyle R/M\geq RR;} {\displaystyle R/M\geq RR;}

 R/M{\displaystyle R/M\geq RR;} ≥ RR

the fraction of reserves must be at least the reserve ratio.

Taking the reciprocal,

M/R≤1/RR{\displaystyle M/R\leq 1/RR,}

 Which, yields {\displaystyle M\leq R\times (1/RR),}M≤R X (1/RR)

meaning that commercial bank money is at most reserves times (1/RR) which is the multiplier ignoring leakages into currency If banks lend out close to the maximum allowed by their reserves and there are no leakages into currency holdings, then the inequality becomes an approximate equality, and commercial bank money is central bank money times the multiplier. If banks instead lend less than the maximum, accumulating excess reserves, then commercial bank money will be less than central bank money times the theoretical multiplier.

High Powered Money

It is high powered money that creates overall money and credit supply in an economy. High powered money or powerful money refers to that currency that has been issued by the Government and Reserve Bank of India. Some portion of this currency is kept along with the public while rest is kept as funds in Reserve Bank. Base money or high powered money in a country is the total amount of bank notes and coins circulating in the economy. This includes:

  • the total currency circulating in the public,
  • plus the currency that is physically held in the vaults of commercial banks,
  • plus the commercial banks’ reserves held in the central bank .

The monetary base should not be confused with the money supply, which consists of the total currency circulating in the public plus certain types of non-bank deposits with commercial banks.

If a country’s gross domestic product is declining or growing sluggishly, monetary policy can offset this with open market purchases of bonds, which expand the monetary base. This expansion of the base in turn leads to expansion of the money supply and to downward pressure on interest rates, which makes it less expensive for consumers to buy consumer goods and for companies to purchase new physical capital; the increase in these types of expenditure gives an upward push to gross domestic product. On the other hand, if gross domestic product is growing at an unsustainably high rate, threatening to cause an increase in the inflation rate, contractionary open market operations can be used to slow the economy down.

Objectives of Monetary Policy

  • The primary objective of monetary policy is to maintain price stability while keeping in mind the objective of growth. Price stability is a necessary precondition to sustainable growth.
  • In May 2016, the Reserve Bank of India (RBI) Act, 1934 was amended to provide a statutory basis for the implementation of the flexible inflation targeting framework.
  • The amended RBI Act also provides for the inflation target to be set by the Government of India, in consultation with the Reserve Bank, once in every five years. Accordingly, the Central Government has notified in the Official Gazette 4 per cent Consumer Price Index (CPI) inflation as the target for the period from August 5, 2016 to March 31, 2021 with the upper tolerance limit of 6 per cent and the lower tolerance limit of 2 per cent.
  • The Central Government notified the following as factors that constitute failure to achieve the inflation target:(a) the average inflation is more than the upper tolerance level of the inflation target for any three consecutive quarters; or (b) the average inflation is less than the lower tolerance level for any three consecutive quarters.
  • Prior to the amendment in the RBI Act in May 2016, the flexible inflation targeting framework was governed by an Agreement on Monetary Policy Framework between the Government and the Reserve Bank of India of February 20, 2015.

Monetary Policy Framework

  • The amended RBI Act explicitly provides the legislative mandate to the Reserve Bank to operate the monetary policy framework of the country.
  • The framework aims at setting the policy (repo) rate based on an assessment of the current and evolving macroeconomic situation; and modulation of liquidity conditions to anchor money market rates at or around the repo rate. Repo rate changes transmit through the money market to the entire the financial system, which, in turn, influences aggregate demand – a key determinant of inflation and growth.
  • Once the repo rate is announced, the operating framework designed by the Reserve Bank envisages liquidity management on a day-to-day basis through appropriate actions, which aim at anchoring the operating target – the weighted average call rate (WACR) – around the repo rate.
  • The operating framework is fine-tuned and revised depending on the evolving financial market and monetary conditions, while ensuring consistency with the monetary policy stance. The liquidity management framework was last revised significantly in April 2016.

Instruments of Monetary Policy

There are several direct and indirect instruments that are used for implementing monetary policy.

  • Repo Rate: The (fixed) interest rate at which the Reserve Bank provides overnight liquidity to banks against the collateral of government and other approved securities under the liquidity adjustment facility (LAF).
  • Reverse Repo Rate: The (fixed) interest rate at which the Reserve Bank absorbs liquidity, on an overnight basis, from banks against the collateral of eligible government securities under the LAF.
  • Liquidity Adjustment Facility (LAF): The LAF consists of overnight as well as term repo auctions. Progressively, the Reserve Bank has increased the proportion of liquidity injected under fine-tuning variable rate repo auctions of range of tenors. The aim of term repo is to help develop the inter-bank term money market, which in turn can set market based benchmarks for pricing of loans and deposits, and hence improve transmission of monetary policy. The Reserve Bank also conducts variable interest rate reverse repo auctions, as necessitated under the market conditions.
  • Marginal Standing Facility (MSF): A facility under which scheduled commercial banks can borrow additional amount of overnight money from the Reserve Bank by dipping into their Statutory Liquidity Ratio (SLR) portfolio up to a limit at a penal rate of interest. This provides a safety valve against unanticipated liquidity shocks to the banking system.
  • Corridor: The MSF rate and reverse repo rate determine the corridor for the daily movement in the weighted average call money rate.
  • Bank Rate: It is the rate at which the Reserve Bank is ready to buy or rediscount bills of exchange or other commercial papers. The Bank Rate is published under Section 49 of the Reserve Bank of India Act, 1934. This rate has been aligned to the MSF rate and, therefore, changes automatically as and when the MSF rate changes alongside policy repo rate changes.
  • Cash Reserve Ratio (CRR): The average daily balance that a bank is required to maintain with the Reserve Bank as a share of such per cent of its Net demand and time liabilities (NDTL) that the Reserve Bank may notify from time to time in the Gazette of India.
  • Statutory Liquidity Ratio (SLR): The share of NDTL that a bank is required to maintain in safe and liquid assets, such as, unencumbered government securities, cash and gold. Changes in SLR often influence the availability of resources in the banking system for lending to the private sector.
  • Open Market Operations (OMOs): These include both, outright purchase and sale of government securities, for injection and absorption of durable liquidity, respectively.
  • Market Stabilisation Scheme (MSS): This instrument for monetary management was introduced in 2004. Surplus liquidity of a more enduring nature arising from large capital inflows is absorbed through sale of short-dated government securities and treasury bills. The cash so mobilised is held in a separate government account with the Reserve Bank.

The Monetary Policy Process

  • Section 45ZB of the amended RBI Act, 1934 also provides for an empowered six-member monetary policy committee (MPC) to be constituted by the Central Government by notification in the Official Gazette. Accordingly, the Central Government in September 2016 constituted the MPC as under:
    1. Governor of the Reserve Bank of India – Chairperson, ex officio;
    2. Deputy Governor of the Reserve Bank of India, in charge of Monetary Policy – Member, ex officio;
    3. One officer of the Reserve Bank of India to be nominated by the Central Board – Member, ex officio;
    4. Shri Chetan Ghate, Professor, Indian Statistical Institute (ISI) – Member;
    5. Professor Pami Dua, Director, Delhi School of Economics – Member; and
    6. Dr. Ravindra H. Dholakia, Professor, Indian Institute of Management, Ahmedabad – Member.(Members referred to at 4 to 6 above, will hold office for a period of four years or until further orders, whichever is earlier.)
  • The MPC determines the policy interest rate required to achieve the inflation target. The first meeting of the MPC was held on October 3 and 4, 2016 in the run up to the Fourth Bi-monthly Monetary Policy Statement, 2016-17.
  • The Reserve Bank’s Monetary Policy Department (MPD) assists the MPC in formulating the monetary policy. Views of key stakeholders in the economy, and analytical work of the Reserve Bank contribute to the process for arriving at the decision on the policy repo rate.
  • The Financial Markets Operations Department (FMOD) operationalises the monetary policy, mainly through day-to-day liquidity management operations. The Financial Markets Committee (FMC) meets daily to review the liquidity conditions so as to ensure that the operating target of the weighted average call money rate (WACR).
  • Before the constitution of the MPC, a Technical Advisory Committee (TAC) on monetary policy with experts from monetary economics, central banking, financial markets and public finance advised the Reserve Bank on the stance of monetary policy. However, its role was only advisory in nature. With the formation of MPC, the TAC on Monetary Policy ceased to exist.
Economic Development and Policies

NBFC crisis: CEA for stricter compliance norms

The Chief Economic Adviser in the finance ministry Krishnamurthy Subramanian said (April 09, 2019) that the Non Bank Financial Companies are facing the problem of adverse asset-liability mismatch of firms and there are genuine fears that more non-banking financial companies (NBFCs) may default like IL&FS due to a growing liquidity crunch. According to him the issue is actually one of solvency and very few of them are solvent. He asserted that  the entire shadow-banking space needs to be “very tightly and carefully monitored” to ensure the crisis doesn’t recur or flare up. He added, “Assets of some NBFCs are long-dated while liabilities are short-term. When the going gets tough, those NBFCs that are not solvent enough find it difficult to roll over (payment obligation). So what is typically a solvency issue appears to have been a liquidity issue.”

He said that the role of credit rating agencies is very important perhaps because they help knowing which the firms in which insolvency problems are brewing. The onus of ensuring the quality of ratings lies solely with the rating agencies; they can’t just crib that companies didn’t provide enough information to them to be able to discharge their duty efficiently. Similarly, auditors, being the first line of information intermediaries, can’t complain they couldn’t detect irregularities early because they went by what the company’s management told them. Also, they must not be self-regulated, so the National Financial Reporting Authority (NFRA) has to be strengthened. Even some of the developed countries like the US were forced to shun self-regulation after the Enron scandal in 2001. The CEO prescribed the option of a seven-day default rule for lenders if the one-day default rule is too difficult to be implemented. However, such strict default-reporting mechanisms are essential, he viewed. Commenting on some of the mutual funds delaying full redemption for investors due to a delay in recovery of their funds lent to NBFCs, the CEA said investors need to be made aware of risks.

What is meant by NBFCs?

Non Bank Financial Companies are kind of nonbank financial institutions. The World Bank Group defines Non Bank Financial Institutions as follows:

“A nonbank financial institution (NBFI) is a financial institution that does not have a full banking license and cannot accept deposits from the public. However, NBFIs do facilitate alternative financial services, such as investment (both collective and individual), risk pooling, financial consulting, brokering, money transmission, and check cashing. NBFIs are a source of consumer credit (along with licensed banks). Examples of nonbank financial institutions include insurance firms, venture capitalists, currency exchanges, some microloan organizations, and pawn shops. These non-bank financial institutions provide services that are not necessarily suited to banks, serve as competition to banks, and specialize in sectors or groups.”

A Non-Banking Financial Company (NBFC) is a company registered under the Companies Act, 1956 engaged in the business of loans and advances, acquisition of shares/stocks/bonds/debentures/securities issued by Government or local authority or other marketable securities of a like nature, leasing, hire-purchase, insurance business, chit business but does not include any institution whose principal business is that of agriculture activity, industrial activity, purchase or sale of any goods (other than securities) or providing any services and sale/purchase/construction of immovable property. A non-banking institution which is a company and has principal business of receiving deposits under any scheme or arrangement in one lump sum or in installments by way of contributions or in any other manner, is also a non-banking financial company (Residuary non-banking company).

A NBFC’s financial activity is taken as principal business when a company’s financial assets constitute more than 50 per cent of the total assets and income from financial assets constitute more than 50 per cent of the gross income. A company which fulfils both these criteria will be registered as NBFC by RBI. The term ‘principal business’ is not defined by the Reserve Bank of India Act. The Reserve Bank has defined it so as to ensure that only companies predominantly engaged in financial activity get registered with it and are regulated and supervised by it.

Difference between banks & NBFCs

  • NBFC cannot accept demand deposits;
  • NBFCs do not form part of the payment and settlement system and cannot issue cheques drawn on itself;
  • Deposit insurance facility of Deposit Insurance and Credit Guarantee Corporation is not available to depositors of NBFCs, unlike in case of banks.

Types of NBFCs

By the kind of activity they conduct NBFCs may be Asset Finance Company (AFC) , Investment Company (IC), Loan Company (LC), Infrastructure Finance Company (IFC; Which deploys at least 75 per cent of its total assets in infrastructure loans,and minimum net owned fund Rs. 300 crore; a minimum credit rating of ‘A ‘or equivalent  and a CRAR of 15%.), Non-Banking Financial Company  Infrastructure Debt Fund, Mortgage Guarantee Companies (MGC) etc.

Some Examples of NBFI

 Insurance companies underwrite economic risks associated with death, illness, damage to or loss of property, and other risk of loss. Another example is Contractual savings institutions (also called institutional investors) provide the opportunity for individuals to invest in collective investment vehicles in a fiduciary rather than a principle role. Collective investment vehicles invest the pooled resources of the individuals and firms into numerous equity, debt, and derivatives promises. The two two main types of mutual funds are open-end and closed-end funds. Open-end funds generate new investments by allowing the public buy new shares at any time. Shareholders can liquidate their shares by selling them back to the open-end fund at the net asset value. Closed-end funds issue a fixed number of shares in an IPO. The shareholders capitalize on the value of their assets by selling their shares in a stock exchange.

Market makers are broker-dealer institutions that quote both a buy and sell price for an asset held in inventory. Such assets include equities, government and corporate debt, derivatives, and foreign currencies. Once an order is received, the market maker immediately sells from its inventory or makes a purchase to offset the loss in inventory. The difference in the buying and selling quotes, or the bid-offer spread, is how the market-maker makes profit. Market makers improve the liquidity of any asset in their inventory.

Specialized sectoral financiers provide a limited range of financial services to a targeted sector. For example, leasing companies provide financing for equipment, while real estate financiers channel capital to prospective homeowners. Leasing companies generally have two unique advantages over other specialized sectoral financiers. They are somewhat insulated against the risk of default because they own the leased equipment as part of their collateral agreement. Additionally, leasing companies enjoy the preferential tax treatment on equipment investment.

Other financial service providers include brokers (both securities and mortgage), management consultants, and financial advisors. They operate on a fee-for-service basis. For the most part, financial service providers improve informational efficiency for the investor. However, in the case of brokers, they do offer a transactions service by which an investor can liquidate existing assets.

How the problems arose in NBFCs in India: The IL&FS’ Issue

Since August 2018, several NBFCs in India including debt-ridden Infrastructure Leasing and Financial Services (IL&FS), in which various corporates, as well as mutual funds and insurance firms, had invested through short-term instruments like commercial papers and non-convertible debentures (NCDs), has been defaulting on its several debt-obligations. The ongoing liquidity crisis in the NBFC industry is the result of asset-liability mismatch (ALM). Since the NBFCs cannot raise retail deposits from the general public, they depend on wholesale lending for their capital requirements. As a result, the cost of funds for NBFCs is higher than that of banks.

The biggest error that the majority of NBFCs and housing finance companies (HFCs) committed with regards to the real estate sector is that they ventured into long-term lending to builders and also into underwriting loans with very long-term repayment tenures. As a result, the NBFCs short-term borrowing was channelised towards financing long-term loans. They were heavily dependent on banks, mutual funds and private placements to meet their capital requirement as well as for refinancing of loans.

Driven largely by global factors – chiefly rising crude oil prices, rising interest rates in the U.S., and trade tensions – Indian interest rates started to rise. The yield on the benchmark 10-year government bond moved up from around 6.8 percent to over 8 percent in a period of about three months. Fresh inflows into mutual funds, especially into debt funds, slowed, and debt fund managers began to adopt a “wait and watch” policy on deploying fresh funds. Liquidity supply to NBFCs began to dry up rapidly. Fresh bond issuances by NBFCs declined and the costs of borrowing rose. All this preceded the spate of defaults by IL&FS.

Infrastructure Leasing and Financial Services (IL&FS) defaulted on short-term debt obligations.  According to the Ministry of Corporate Affairs (MCA), IL&FS’ borrowings from banks and financial institutions added to nearly Rs 63,000 crore as per the balance sheet of 2017-2018. There were concerns that many NBFCs could have their funds stuck in IL&FS debt instruments. Reportedly, approximately Rs 2 trillion ($27.23 billion) of NBFC and HFC debt was due for redemption by the end of December 2018. Also, funding costs of NBFCs were likely to go up and could lead to a sharp decline in their margins. And then the news of IL&FS defaults broke. It had two immediate implications. First, there was a fear of large scale redemptions in debt mutual funds. So some funds resorted to panic selling of debt securities which sent a negative signal to the entire market. Second, the defaults shattered faith in ratings of debt securities. IL&FS debt had the had the highest rating just a couple of weeks before the default. The rating was revised to the lowest default grade (“D”) after the default occurred. This raised doubts about the quality of other issuers assigned similarly high ratings. The reaction in the market was vicious. Yields on corporate bonds went up and the debt market almost stalled. The RBI acted quickly and took steps to inject liquidity via open market operations. Since then calm has returned to the market for securities of less than one year but the market for medium-term securities remains tight.

Steps taken to resolve NBFCs crisis in India

The central bank has been taking several initiatives, including intermittent open market purchase of government securities, ever since the occurrence of a series of payment defaults by IL&FS and its arms which had culminated in the Centre disbanding the entire board of the infrastructure company and appointing a new one in its place under the leadership of Uday Kotak.

On September 27, the RBI permitted  banks to avail higher liquidity with effect from October 1 as it had enhanced the Facility to Avail Liquidity for Liquidity Coverage Ratio (FALLCR) from the existing 11% to 13% of their deposits. Liquidity coverage ratio refers to highly liquid assets that financial institutions need to hold in order to meet short-term obligations. The Reserve Bank has also permitted banks to use government securities, equal to their incremental outstanding credit to NBFCs, over and above their outstanding credit to them as on October 19,to meet the liquidity coverage ratio requirement. This would be in addition to the existing FALLCR of 13% of NDTL and limited to 0.5% of the bank’s NDTL (net demand and time liability), the RBI said. The additional window will be available up to December 31, 2018, the notification said.

On October RBI The Reserve Bank of India (RBI) decided to increase the single- borrower exposure limit of banks for non-banking finance companies (NBFCs) which do not finance infrastructure, to 15% from the existing 10% of their capital funds. This was to remain effective till December 31. While the Reserve Bank of India (RBI) and the Government have taken steps to ring fence the NBFC crisis and support its financing needs by providing additional liquidity to banks and credit enhancement for refinancing needs.

Economic Development and Policies

Urjit Patel resigns as RBI governor

Well known economist and Reserve Bank of India (RBI) Governor Urjit Patel resigned today (December 10, 2018).  He said that he has decided to “step down” from his current position effective immediately “on account of personal reasons”. The governor’s decision to resign came five days after the bi-monthly policy meeting, in which he refused to answer questions on the controversies surrounding the RBI’s autonomy. He also appreciated the support and hard work of RBI staff, officers and management saying that it had been the proximate driver of the Bank’s considerable accomplishments in recent years. He expressed gratitude to his colleagues and Directors of the RBI Central Board, and wished them all the best for the future. All sober officers like Urjit Patel claim personal reasons when they resign, but public and observers do not take such reasoning on its face value. The differences between the RBI and government came loudly in public domain in last few weeks. Resignation of the RBI government is no doubt partly because of irreconcilable difference between the approach of the RBI and government. Media reports were rife with speculation of Urjit Patel’s resignation following the government’s decision to invoke the never-used-before special powers under Section 7 of the RBI Act to initiate consultation on a range of issues such as the Prompt Correct Action (PCA) norms, RBI’s capital reserves, and liquidity problem in NBFCs.

To clear the cloud, few minutes after Urjit Patel announced his resignation, Prime Minister Narendra Modi tweeted praise for him, saying that he is “an economist of a very high calibre with a deep and insightful understanding of macro-economic issues”. The PM added, “He steered the banking system from chaos to order and ensured discipline. Under his leadership, the RBI brought financial stability”.

Former Governor of the RBI, Raghuram Rajan, reacting  on Urjit Patel’s decision to step down, said that the autonomy of the central bank should not be undermined. He said, “Believe resignation of RBI Governor Urjit Patel is a matter of great concern. Resignation by a government servant is a note of protest when faced with circumstances they cannot deal with” .  While refusing to speculate what led to Urjit Patel’s resignation, he advised the government to take “extreme care” in its relationship further with the RBI. “Need to understand what prompted this act by Urjit Patel”.

Urjit Patel was appointed the 24th governor of the RBI on September 2016 for a three-year term. He was heavily criticised for his silence on demonetisation, which was announced just two months after he took the position. Urjit Patel earlier served as a deputy governor of the RBI and was elevated to the governor’s position after Raghuram Rajan’s tenure ended.

Economic Development and Policies Persons in News

Krishnamurthy Subramanian: The New Chief Economic Advisor to Govt. of India

The Appointments Committee of the Cabinet (ACC) has approved for the appointment of Dr Krishnamurthy Subramanian, Associate Prof. and ED (CAF), ISB, Hyderabad, to the post of Chief Economic Adviser,” said a government notification. Subsequently, the government appointed ISB Hyderabad professor Krishnamurthy Subramanian as Chief Economic Adviser for a period of three years on December 7, 2017. The Chief Economic Adviser (CEA) is the economic advisor to the Government of India. The CEA is the ex-officio cadre controlling authority of the Indian Economic Service. The CEA is under the direct charge of the Minister of Finance.

Who is Krishnamurthy Subramanian?

Mr. Subramanian is seen as one of the world’s leading experts in banking, corporate governance and economic policy. Before being appointed to the post, he was an associate professor and executive director (Centre for Analytical Finance) of Indian School of Business (ISB), Hyderabad. He Subramanian is a trained engineer and has a degree in Electrical Engineering from IIT Kanpur. He is also an alumni of IIM Calcutta, where he was named to the famed Honour Roll on account of his stellar academic performance after he had topped his batch. He earned PhD from Chicago-Booth, US  in Financial Economics under the advice of Professor Luigi Zingales and Professor Raghuram Rajan, the former RBI governor. Prior to taking a plunge into the world of academia, Subramanian worked as a consultant with JPMorgan Chase in New York and also served in a management role in the derivatives research group at ICICI Ltd. Besides being on the boards of Bandhan Bank Ltd, the National Institute of Bank Management, and the RBI Academy, Subramanian also serves as a member of SEBI’s standing committees on alternative investment policy, primary markets, secondary markets and research.

Economic Development and Policies

Former CEA Arvind Subramanian speaks on back series GDP data and autonomy of RBI

The former Chief Economic Adviser (CEA) Arvind Subramanian, in an interview with the PTI,  called for an investigation by experts into the back series GDP data of India to clear doubts and build confidence in the country. He opined that the “puzzle” about the data needs to be explained. According to him, the institutions which do not have technical expertise in calculating the GDP data should not be involved in the process, apparently referring to the Niti Aayog. The well known economist also criticised demonetisation in his new book titled ‘Of Counsel: The Challenges of the Modi-Jaitley Economy’. He stressed the need to explain the issues involved in the back series data just to create confidence and eliminate any uncertainty or doubts. He also spoke on the controversy over the Niti Aayog’s presence at the release of the GDP back series data by the Central Statistics Office (CSO) last month. He opined that (only added) experts should have the main job of producing and explaining data.“I think this [calculation of GDP] is a very technical task and technical experts should do the task, institutions that don’t have technical expertise should not be involved in this.” It may be noted that data of past years using 2011-12 as the base year instead of 2004-05, the CSO last month lowered the country’s economic growth rate during the previous Congress-led UPA’s regime.

On the issue of demonitisation and Mr. Subramanian criticism of the policy after he demitted the office of the Chief Economic Adviser to the Government of India, he said that “this is not a Kiss and Tell memoir, that is for gossip columnists.” Referring to criticism that he did not speak on demonetisation when he was working for the government and now he is raising the issue to sell his book, Mr. Subramanian said that whatever people say, it is important to ananlyse why even after 86% reduction in cash [after demonetisation], there little impact on the economy; was it due to current GDP calculation method. It was important according to him to understand is it because “we are not measuring GDP correctly, or is it because our economy is very resilient,” Mr. Subramanian who currently teaches at Harvard Kennedy School remarked.

In the six quarters before demonetisation, growth averaged 8% and in the seven quarters after, it averaged about 6.8% [with a four-quarter window, the relevant numbers are 8.1% before and 6.2% after],” Mr. Subramanian wrote in the chapter “The Two Puzzles of Demonetisation — Political and Economic”.

On the recent spat between the government and the Reserve Bank of India (RBI) over a host of issues, Mr. Subramanian opined that the autonomy of the RBI must be protected because the country will benefit by having strong institutions. He, however added, “But, I think there must also be cooperation, consultation and everything. Both have to happen.”

Economic Development and Policies

Bimonthly RBI Monetary Policy June 2018

Shekhar Sengar

Bimonthly RBI Monetary Policy June 2018

The Monetary Policy is reviewed by Monetary Policy Committee (MPC) of the Reserve Bank of India. This time RBI governor Urjit Patel headed the six member NPC. This was the first three-day bi-monthly policy meeting (June 06)  of MPC headed by Urjit Patel. The next meeting of the MPC is scheduled on July 31 and August 1, 2018.The decision of the MPC is consistent with the ‘neutral’ stance of monetary policy in consonance with the objective of achieving the medium-term target for consumer price index (CPI) inflation of 4% within a band of +/- 2% while supporting growth.

Growth and Inflation according RBI

On the domestic front, the Central Statistics Office (CSO) released on May 31 the quarterly estimates of national income accounts for Q4:2017-18 and provisional estimates for 2017-18. Gross domestic product (GDP) growth for 2017-18 has been estimated at 6.7 per cent, up by 0.1 percentage point from the second advance estimates released on February 28. This increase in growth has been underpinned by a significant upward revision in private final consumption expenditure (PFCE) due especially to improved rural demand on the back of a bumper harvest and the government’s thrust on rural housing and infrastructure. Quarterly data suggest that the economy grew at 7.7 per cent in Q4:2017-18 – the fastest pace in the last seven quarters. Gross fixed capital formation (GFCF) growth accelerated for three consecutive quarters up to Q4.

Retail inflation, measured by the year-on-year change in the CPI, rose sharply to 4.6 per cent in April, driven mainly by a significant increase in inflation excluding food and fuel. Excluding the estimated impact of an increase in house rent allowances (HRAs) for central government employees, headline inflation was at 4.2 per cent in April, up from 3.9 per cent in March. Food inflation moderated for the fourth successive month, pulled down by vegetables due to lower than the usual seasonal increase in their prices, and pulses and sugar which continued to experience deflation. However, within the food group, inflation increased in respect of cereals, fruits, prepared meals, meat and fish.


Highlights of the Bi monthly Monetary Policy

  • Repo rate under the liquidity adjustment facility (LAF) has been raised by 25 basis points to 6.25% in a first rate hike in four-and-half-years.
  • Reverse repo rate under the LAF stands adjusted to 6% and the marginal standing facility (MSF) rate and the Bank Rate has been adjusted to 6.5%.
  • The MPC has decided to retain the projection of GDP growth for the financial year 2018-2019 at 7.4% with risk evenly balanced around this number.
  • All six members of the MPC including RBI Governor Urjit Patel and Dr Chetan Ghate, Dr Pami Dua, Dr Ravindra H. Dholakia, Dr Viral V. Acharya Dr Michael Debabrata Patra voted for 0.25% rate hike.
  • RBI has projected retail inflation at 4.8-4.9% for the period of April-September and 4.7% in H2 FY19.
  • RBI Governor has said that the forecast of normal monsoon for 2018-19 augurs well for the agriculture sector.
  • Emerging market currencies have by and large got depreciated against the US dollar. The geopolitical risks, financial market volatility and trade protectionism will further impact domestic growth.
  • According to RBI, the adherence to budgetary targets by the central government and the respective state government will ease upside risks to the inflation outlook.
  • The major upside risk to the inflation path is due to continuous rise price of crude oil as Brent crude rose to $76 a barrel from a level of $67 per barrel during April meeting of MPC.
  • RBI pointed that the volatility in the crude oil prices has added to uncertainty to the inflation outlook.
  • Investment activity is recovering well in the context of IBC (Insolvency and Bankruptcy Code) and will further get a boost from swift resolution under IBC.
  • The Reserve Bank of India’s next Monetary Policy Committee meeting is scheduled on 31 July and 1 August 2018.


About Monetary Policy Committee

The Monetary Policy Committee of India is a committee of the Reserve Bank of India that is responsible for fixing the benchmark interest rate in India. The meetings of the Monetary Policy Committee are held at least 4 times a year and it publishes its decisions after each such meeting.

The committee comprises six members – three officials of the Reserve Bank of India and three external members nominated by the Government of India. They need to observe a “silent period” seven days before and after the rate decision for “utmost confidentiality”. The Governor of Reserve Bank of India is the chairperson ex officio of the committee. Decisions are taken by majority with the Governor having the casting vote in case of a tie. The current mandate of the committee is to maintain 4% annual inflation until March 31, 2021 with an upper tolerance of 6% and a lower tolerance of 2%.

The committee was created in 2016 to bring transparency and accountability in fixing India’s Monetary Policy. Minutes are published after every meeting with each member explaining his opinions. The committee is answerable to the Government of India if the inflation exceeds the range prescribed for three consecutive months.

Goal of Monetary Policy and inflation targeting

The monetary policy aims at growth with price stability apart from promoting saving, investment and capital formation. But in recent years the primary goal of the monetary policy is “inflation targeting” or “price stability” for which MPC is accountable. Inflation targeting is a monetary policy regime in which a central bank has an explicit target inflation rate for the medium term and announces this inflation target to the public. The assumption is that the best that monetary policy can do to support long-term growth of the economy is to maintain price stability. The central bank uses interest rates, its main short-term monetary instrument.

An inflation-targeting central bank will raise or lower interest rates based on above-target or below-target inflation, respectively. The conventional wisdom is that raising interest rates usually cools the economy to rein in inflation; lowering interest rates usually accelerates the economy, thereby boosting inflation. The first three countries to implement fully-fledged inflation targeting were New Zealand, Canada and the United Kingdom in the early 1990s, although Germany had adopted many elements of inflation targeting earlier.

Understanding Repo Rate and Reverse Repo Rate

The repo rate is the rate at which the central bank lends short-term money to the banks against securities. It is more applicable when there is a liquidity crunch in the market. In contrast, the reverse repo rate is the rate at which banks can park surplus funds with the reserve bank. This is mostly done when there is surplus liquidity in the market.

Repo rate — Repo rate also known as the benchmark interest rate is the rate at which the RBI lends money to the banks on collateral of securities for a short term. When the repo rate increases, borrowing from RBI becomes more expensive. If RBI wants to make it more expensive for the banks to borrow money, it increases the repo rate similarly, if it wants to make it cheaper for banks to borrow money it reduces the repo rate.

Reverse Repo rate — Reverse Repo rate is the short term borrowing rate at which RBI borrows money from banks. The Reserve bank uses this tool when it feels there is too much money floating in the banking system. An increase in the reverse repo rate means that the banks will get a higher rate of interest from RBI. As a result, banks prefer to lend their money to RBI which is always safe instead of lending it others (people, companies etc) which is always risky.

Repo Rate signifies the rate at which liquidity is injected in the banking system by RBI by, whereas Reverse Repo rate signifies the rate at which the central bank absorbs liquidity from the banks. In the event of inflation, central banks increase repo rate as this acts as a disincentive for banks to borrow from the central bank. This ultimately reduces the money supply in the economy and thus helps in arresting inflation.
The central bank takes the contrary position in the event of a fall in inflationary pressures. Repo and reverse repo rates form a part of the liquidity adjustment facility.

Liquidity Adjustment Facility

Reserve Bank of India’s liquidity adjustment facility of LAF helps banks to adjust their daily liquidity mismatches. LAF has two components — repo (repurchase agreement) and reverse repo. When banks need liquidity to meet its daily requirement, they borrow from RBI through repo. The rate at which they borrow fund is called the repo rate. When banks are flush with fund, they park with RBI through the reverse repo mechanism at reverse repo rate.

Marginal Standing Facility

Marginal standing facility is a window for banks to borrow from Reserve Bank of India in emergency situation when inter-bank liquidity dries up completely. Banks borrow from the central bank by pledging government securities at a rate higher than the repo rate under liquidity adjustment facility or LAF in short. Marginal Standing Facility (MSF) as a new policy was announced by the Reserve Bank of India (RBI) in its Monetary Policy (2011-12) and refers to the penal rate at which banks can borrow money from the central bank over and above what is available to them through the LAF window. MSF, being a penal rate, is always fixed above the repo rate. In MSF scheme banks can borrow overnight upto 1 per cent of their net demand and time liabilities (NDTL) i.e. 1 per cent of the aggregate deposits and other liabilities of the banks. However, with effect from 17th April 2012 RBI raised the borrowing limit under the MSF from 1 per cent to 2 per cent of their NDTL outstanding at the end of the second preceding fortnight. The rate of interest for the amount accessed through this facility got fixed at 100 basis points (i.e. 1 per cent) above the repo rate for all scheduled commercial banks. But all MSF limit and interest rate have been subject to change from time to time. The minimum amount which can be accessed through MSF is Rs.1 crore and in multiples of Rs.1 crore. ( Rs 1 crore = Rs 10 million). The application for the facility can be submitted electronically also by the eligible scheduled commercial banks. The banks used the facility for the first time in June 2011 and borrowed Rs.1 billion via the MSF.


The MSF would be the last resort for banks once they exhaust all borrowing options including the liquidity adjustment facility by pledging government securities, where the rates are lower in comparison with the MSF. The MSF would be a penal rate for banks and the banks can borrow funds by pledging government securities within the limits of the statutory liquidity ratio. The scheme has been introduced by RBI with the main aim of reducing volatility in the overnight lending rates in the inter-bank market and to enable smooth monetary transmission in the financial system.MSF represents the upper band of the interest corridor with repo rate at the middle and reverse repo as the lower band.

Bank Rate

Bank rate is the rate charged by the central bank for lending funds to commercial banks. In other words it is the rate of interest which a central bank charges on its loans and advances to a commercial bank. Bank rates influence lending rates of commercial banks. Higher bank rate will translate to higher lending rates by the banks. In order to curb liquidity, the central bank can resort to raising the bank rate and vice versa. Whenever a bank has a shortage of funds, they can typically borrow from the central bank based on the monetary policy of the country.

There is a difference between bank rate and repo rate. Bank rate deals with loans whereas repo or repurchase rate deals with the securities. The bank rate is charged to commercial banks against the loan issued to them by central banks, whereas, the repo rate is charged for repurchasing the securities.

Interest rate corridor

Interest rate corridor has repo rate in the centre and MSF above it and reverse repo below it. This became important to define the interest rate corridor after giving up administered interest rate regime in India. To balance the liquidity, RBI uses the sole independent “policy rate” which is the repo rate (in the LAF window) and the MSF rate automatically gets adjusted to a fixed per cent above the repo rate (MSF was originally intended to be 1% above the repo rate) and reverse rate is adjusted 1% below the repo rate. MSF is at present aligned with the Bank rate. Under Section 49 of the Reserve Bank of India Act, 1934, the Bank Rate has been defined as “the standard rate at which the Reserve Bank is prepared to buy or re-discount bills of exchange or other commercial paper eligible for purchase under the Act. On introduction of Liquidity Adjustment Facility (LAF), discounting/rediscounting of bills of exchange by the Reserve Bank has been discontinued. As a result, the Bank Rate became dormant as an instrument of monetary management. It is now aligned to MSF rate and is used only for calculating penalty on default in the maintenance of cash reserve ratio (CRR) and the statutory liquidity ratio (SLR).

Base Rate

Base rate is the minimum rate set by the Reserve Bank of India below which banks are not allowed to lend to its customers. Base rate is decided in order to enhance transparency in the credit market and ensure that banks pass on the lower cost of fund to their customers. Loan pricing will be done by adding base rate and a suitable spread depending on the credit risk premium.

Economic Development and Policies

Unemployment: Measurement in India

A person who is in the age group of working population (15-60 years), is called unemployed if s/he does not get work, despite offering himself in the labour market for work on existing wage rate. There are various sub categories of unemployed people such as underemployed, seasonally unemployed and disguisedly employed. If a person voluntarily chooses to remain unemployed for education, upgrade of skills and waiting for a better job avenue, he is not considered as unemployed. Only involuntarily unemployed are described as unemployed.

Types of Unemployment

  1. Structural unemployment: unemployment occurring because of structural features of the economy such as lack of economic growth and private enterprise, use of capital intensive technology, higher share of services sector in GDP especially financial sector
  2. Frictional unemployment: Such kind of unemployment is short term unemployment that exists in the developed countries due to recession in some sectors. Labour force remains unemployed while taking some kind of training and skill enhancement and soon they get employment in sectors that are vibrant.
  3. Cyclical unemployment: Such kind of unemployment occurs due to downswing of the business cycle.
  4. Seasonal unemployment: This kind of unemployment occurs when any seasonal activity like agriculture passes through slack season.
  5. Underemployment: Underemployment refers to a situation in which the labour force is employed at lower than his qualification and at lower wages than s/he deserves or for lesser hours than he can work.
  6. Disguised unemployment: This kind of unemployment exists in agriculture. This is about employment of such labour force in agriculture, who contribute nothing or negligible amount in total production, still they seem to be employed while actually they are disguisedly unemployed. Technically the marginal productivity of disguisedly unemployed is zero or near zero. For example 10 labour units produce 100 quintals of wheat in a plot and 15 labour units also produce 102 quintals. Then we can say them disguisedly unemployed.


Measurement of unemployment in India

Unemployment and employment is measured in India on the basis of quinquennial (every five years) and annual surveys on activity status of the work force of India done by the National Sample Survey Organization (NSSO), since its setting up in1950. The quinquennial data is based on bigger samples and so more reliable than annual data, which is based on a smaller sample. Thus we can say that more reliable unemployment and employment figures come with a time lag of four years at least.

The National Sample Survey Organization (NSSO) provides three different estimates of employment and unemployment based on different approaches / reference periods used to classify an individual’s activity status. These are the

  1. Usual status approachwith a reference period of 365 days preceding the date of survey. reference period of 365 days preceding the date of survey. The activity status on which a person spent relatively longer time (major time criterion) during the 365 days preceding the date of survey is considered the principal usual activity status of the person.
  2. Current weekly status approachwith a reference period of seven days preceding the date of survey. A person found ‘working’ for at least one hour for at least one day during the reference week was categorised as ‘working’ according to current weekly status even if he was seeking work or available for work for the rest of the period.
  3. Current daily status approachwith each day of the seven days preceding date of survey as the reference period. CDS does provide day-to-day accounting of the available labour time (in terms of ‘half-day’ units) of persons classified under the categories employed and unemployed (labour force) is done according to the current weekly status concept separately for each of the seven days period of reference. It mean if you get employment for more than half a day on a particular day, your activity status according  to CDS  is equal to one full man day “employed.”



Activity Status

The surveys by NSSO try to find the activity status of the work force from the given samples in order to find out whether an individual is employed or unemployed during the chosen reference period. Activity Status refers to the activity situation in which the individual is found during the reference period with respect to his participation in economic or non-economic activities. The NSSO defines three broad Activity Status—first is activity status classified as employed or working (engaged in an economic activity), second is unemployed that is seeking employment  and still not getting it and third is that segment of working age which is not the part of work force as they are not seeking nor available for work.

Work force = Number of people employed + no of people seeking employment

It is notable that “not seeking work” segment of working age people are classified as “not in labour force.”

Unemployment Rate

Unemployment rate is the percent of the labor force that is without work.

Unemployment Rate = Unemployed Workers/Total Labour Force x 100

Work participation rate

The Work participation rate is also estimated which is defined as the percentage of total workers (main and marginal) to total population.

Work Force Participation Rate = Total Workers (Main + Marginal)/ Total Population x 100

Usual Status measures chronic or open ended unemployment (unemployment in the longer period) whereas Current Weekly Status and Current Daily Status measure underemployment and variations in unemployment in the shorter period. It is notable that Usual Staus Unemployment and Current Weekly Status unemployment are “person rates” of unemployment whereas Current Daily Status Unemployment is the “time rate of unemployment”. Person rates of unemployment how many persons out of total work force are unemployment whereas time rate of unemployment measures how many work days remained unemployed out of total man days available in a country.

Man Day =  one unit of labour’s  work in a day (within legal working hours)

Thus a man day is a day regarded in terms of the amount of work that can be done by one person within this period.

As far as the situation in India was concerned, the longer the reference period, the smaller will be the rate of unemployment and the shorter the reference period, the larger the unemployment rate. Current Daily Staus unemployment is the most comprehensive measure of unemployment in India.

The NSSO collected employment data based on ‘usual status (UPS)’ only upto its eighth round. However from 9th round onwards, it started collecting data based on ‘current weekly status (CWS)’ approach also. Planning Commission set up the Committee of Experts on Employment Estimates (Dantwala Committee) in 1960. The Committee recommended concepts and definitions for conducting such surveys. It recommended collection of data based on CDS in addition to UPS and CWS. Accordingly, beginning with the 27th round (1972-73),quinquennial(5-yearly) surveys were being conducted by NSSO to collect employment-unemployment data based on all the three approaches of UPS,CWS and CDS.

In the annual survey rounds of NSSO, only employment-unemployment data based on ‘usual activity status’ and ‘current weekly status’ were collected up to 59th round. However in 60th round, a separate schedule was canvassed to collect employment and unemployment data on ‘current daily status’ also. In fact, since 60th round, NSSO is collecting data on employment and unemployment on current daily status also in its annual rounds.

NSSO surveys are conducted on quinquennial basis. In order to measure employment-unemployment on an annual basis, Employment-Unemployment Survey is being conducted by Labour Bureau since 2009. This survey also captures the labour estimates in terms of usual principal status, usual principal and subsidiary status, current weekly status and current daily status.

Besides this, a quick quarterly enterprise level surveys (Quick Employment Survey)are also conducted by Labour Bureau to capture the changes in the employment –unemployment scenario at much shorter interval. However the intent of this survey was to mainly assess the impact of global financial crisis on the Indian economy.

The National Sample Survey Office (NSSO) has addressed the problem through a clever technique of measuring a sampled person’s time disposition using multiple concepts: usual status, daily status and weekly status. By collecting data on employment through large sophisticated surveys of inter-penetrating samples and using these multiple employment concepts, the NSSO has been generating fairly reliable estimates of both open unemployment and underemployment for several decades.

However, since the employment-unemployment survey is an elaborate and costly operation, it is undertaken only once every five years. Such quinquennial estimates of unemployment are obviously inadequate for macro-economic policy, which requires up-to-date information at least annually, if not more frequently. In fact, no NSS estimates of employment are available since 2011-12. Unfortunately, the more recent Labour Bureau surveys have been largely ignored, and all sorts of humbug estimates are put out to fill the gap.

This situation is about to change. The NSSO has replaced the old series of quinquennial employment-unemployment estimates with a new survey series, the periodic labour force survey (PLFS), that matches the different production cycles of the agricultural and non-agricultural sectors. Urban employment surveys are now being conducted every quarter to give us quarterly estimates of urban employment covering most of the non-agricultural sector. Rural surveys are being conducted annually to give us annual estimates of rural employment, and underemployment, covering most of the agricultural sector. The urban and rural estimates are being combined to give us annual estimates of total employment.

Pointers from latest NSSO data

According to NSSO 68th round of the Employment and Unemployment Situation among Major Religious Groups in India report, following points come out.

Key findings of the survey 

  • The unemployment rate in urban areas reduced from 4.5% in 2004-05 to 3.4% in 2011-12, the unemployment rate in urban areas reduced from 4.5% in 2004-05 to 3.4% in 2011-12.
  • According to the survey, which was conducted in 2011-12, the unemployment rate across all the religious groups in rural areas was on the lower side than those in urban areas for both males and females.
  • The most peculiar finding of the survey is that Christians which are supposed to be a better off community have the highest rate of unemployment in both rural (4.5%) and urban (5.9%) areas in 2011-12. The rate in urban areas for Christians stood at (8.6%) in 2004-05 while the rural rate stays constant.
  • While the unemployment rate in rural areas has decreased for Sikhs (from 3.5 to 1.3%) – now the lowest across all religious groups – it has slightly increased for Muslims (from 2.3 to 2.6%). At 3.3%, Hindus have the lowest unemployment rate in urban areas.
  • Self-employment is the major source of income for almost half the households, across all religious groups, in rural areas, followed by casual labour.
  • In urban areas, the proportion of households deriving major income from regular wage or salary earnings is the highest. Half the Muslim households in urban areas have self-employment as major source of income, the highest among all religions, while regular wage or salary earnings was the highest for Christians with 45.8 per cent households.

What does the survey indicate?

  • The survey confirms the apprehensions shown by many experts that India is facing rural distress. As survey clearly indicates that all religious groups registering an increase in unemployment in rural areas.
  • The report states that the unemployment rate is 1.7% in rural and 3.4% in urban areas. In its previous report of 2013, unemployment rate was 1.5% in rural and 4.8% in urban areas.
  • The unemployment rate in India is even lower than Many developed countries, however survey of NSSO on number of jobs created reveal that there are very less number of jobs created in formal sector in last 2 decades, Therefore this low unemployment figure indicates that most jobs created in last few years are either in informal sector or in unorganized sector.

Why do Christians have largest unemployment rate?

  • Unemployment level in India is highest among those people who are richer and more educated. The reason is that poor people can’t afford to stay unemployed, and hence, opt for any kind of work, irrespective of the nature of the job. The better off have the capacity to be unemployed as they look for the right job. Christians are the most educated group, hence unemployment rate is higher among them
  • Among the persons of age 15 and above, the proportion of people who are not literates was the lowest for Christians. Also, the proportion of persons with educational level secondary and above is highest for Christians.
Economic Development and Policies

Public Finance, Taxes and Fiscal Policy

Public Finance studies the finances of the government, i.e., government’s receipts (revenue receipts and capital receipts) and government’s expenditure (revenue expenditure and capital expenditure). Government’s revenue is called Public Revenue and government’s expenditure is called Public Expenditure.

The classical theory and practice of economics were based on “Laissez Faire” or free economy, in which there was no outside intervention in the free play of market forces and consumers and producers took their decisions freely. The classical economists considered that government as best which governed the least. But with the advent of democratic welfare states and Keynesian economics based on “pump priming” and “multiplier effect” to bring back the depression hit global economy to normalcy, the significance of public finance increased much.

Public Revenue

The tax sources of public revenue include direct and indirect taxes, which can generally be understood as tax on individuals/groups and commodities respectively. In economic literature we use the concept of “shiftability” or “transferability” to differentiate between the direct and indirect taxes. Direct taxes are not shiftable or transferable from the point of levy to other point while indirect taxes are shiftable or transferable. There are two technical terms to explain shiftability or transferability of taxes- the “impact” of taxes, which is the first point of levy of taxes and the “incidence” of taxes, which is the final resting point of taxes. In case of direct taxes the incidence and impact of tax remain at the same point while in the case of indirect taxes the impact is at one point and incidence is other point. The shifting of taxes takes place through price mechanism.

Income tax, corporate tax, gift tax, capital gains tax are direct taxes while excise duty, customs, service tax, sales tax are indirect taxes.

Trends in tax collection

The gross tax collections are reasonably on track. The growth in direct tax collections of the Centre kept pace with the previous year, with a growth of 13.7 per cent. The budgeted growth for indirect taxes for the full year 2017-18 is 7.6 per cent; the actual growth till November is 18.3 per cent.

The States’ share in taxes grew by about 25 per cent during 2017-18 (Apr-Nov), much higher than the growth in centre’s net tax revenue at 12.6 per cent and of gross tax revenue at 16.5 per cent.

Non- tax sources of revenue

Non- tax sources of revenue of the government include various fees and charges (leasing of FM or broadband spectrum, lease of mining rights, registration of companies), receipts from public enterprises and commercial departments of government (post and telecommunications, railways etc. for example), market borrowing from small savings and Treasury Bills or Government Bonds, receipt of interest etc and issue of new money (seigniorage).

The non-tax revenues have visibly under-performed. However, non-debt capital receipts, mainly proceeds from disinvestment, are doing well. As against last year’s achievement of Rs. 46,247 crore realized from 16 transactions of disinvestment, the budget estimate for 2017-18 was set at Rs. 72,500 crore, split into Rs. 46,500 crore from disinvestment of Central Public Sector Enterprises (CPSEs),Rs. 15,000 crore from strategic disinvestment and Rs. 11,000 crore from listing of insurance companies. An amount of about Rs. 52,378.2 crore has been realized during April-November 2017, that includes Rs.30,867.0 crore through minority stake sale in CPSEs, Rs. 4,153.6 crore through disinvestment of strategic holdings in SUUTI and Rs.17,357.5 crore through listing of insurance companies.

Revenue Account and Capital Account

Budget divides receipts in revenue account receipts and capital account receipts. All recurring receipts like taxes and earnings from the PSUs and commercial undertakings are receipts on revenue account while all long term receipts or receipts in the form of assets are called capital receipt, which include PSU disinvestment proceeds, market borrowing and receipt of principal amount loaned out.

Public Expenditure

Public expenditure of recurring nature which does not create any asset is called “revenue expenditure” such as subsidies, interest payments, wages, salary, pension etc. The asset creating expenditure, which are meant for acquiring land, building, plant, machinery and equipment etc, is called “capital expenditure”.

The total expenditure of the Government increased by 14.9 per cent during 2017-18 (Apr-Nov), as compared to 12.6 per cent in the same period of the previous year. The revenue expenditure grew by 13.1 per cent and capital expenditure by 29.3 per cent during the first eight months of the current year. The advancing of the budget cycle and processes by almost a month gave considerable leeway to the spending agencies to plan in advance and start implementation early in the financial year, leading to progression of Central expenditure at a robust pace.

Fiscal Policy

Fiscal policy collectively refers to the set of policies related to “Public Revenue” and “Public Expenditure”. These policies are manipulated or handled according to the requirements of the economy. An “expansionary fiscal policy” (adopted during recession) reduces taxes while increases expenditures whereas a “contractionary fiscal policy” increases taxes and reduces expenditure (adopted during inflation and boom). The fiscal policy in modern times is also categorized as “cyclic fiscal policy” and “counter-cyclic fiscal policy.” Generally governments in the past adopted “cyclical fiscal policy”, which means that they adopted expansionary fiscal policy when economic was growing reasonable fast because in this case governments have more space for increased public expenditure and tax cuts because with higher growth its tax and non-tax revenues are high. Contrary to this they cut government expenditure to reduce burden on budget and raised taxes during recession to increase government’s revenue. Both these responses refer to cyclic fiscal policy; however, these cyclic fiscal policy measures may be convenient, but are not expedient. For example during the growth phase government should save resources while during recession it should increase public expenditure and cut taxes to buoy the falling economy. Such a fiscal policy is called counter-cyclic fiscal policy.

Fiscal health

Fiscal health of a country is said to be good if the divergence between total receipts and total expenditure is small and manageable, public debt is low and tax collection is sufficient.

Fiscal health is measured with the help of “deficit concepts”, debt-GDP ratio and Tax-GDP ratio.

Fiscal Deficit is the broadest measure of deficit in public finance.

Fiscal Deficit = Total Expenditure on revenue account and capital account —- Total Receipt on revenue account and capital account


Fiscal Deficit = Total expenditure —- Total non-debt creating receipts

Revenue Deficit = Total Expenditure of Revenue account of the budget —- Total Receipt on revenue account of the budget

Primary Deficit = Fiscal Deficit —- Interest Payments

Fiscal Consolidation

Fiscal consolidation refers to measures taken by the government to reduce the divergence between its expenditure and receipts. Kelkar Committee, however, pointed out that fiscal consolidation should be revenue-led (increasing tax proceeds by reforms) and not by a cut in expenditure, which by its very nature is recessionary.

India passed a Fiscal Responsibility and Budget Management Act in 2003 which is being implemented since April 2004 in order to reduce fiscal deficit and revenue deficit within a given strategy and time frame (fiscal roadmap). According to the original FRBM Act fiscal deficit was to be cut to 3% of GDP while revenue deficit to zero. The effectiveness of FRBM Act could be seen by a continuous reduction in fiscal deficit and revenue deficit in central budget. The fiscal deficit for 2013-14 was 4.4% of GDP. The Indian government has always attached utmost priority to prudent fiscal management and controlling fiscal deficit. Fiscal Deficit was brought down to 4.1% in 2014-15 to 3.9% in 2015-16, and to 3.5% in 2016-17. Revised Fiscal Deficit estimates for 2017-18 are Rs5.95 lakh cr at 3.5% of GDP.

Data on 23 States shows that both revenue and fiscal deficits as percentage of the corresponding budget estimates is lower in the current year, compared to the previous year.

The net market borrowings by the State Governments, as reported by the Reserve Bank of India (RBI), during April-December of the current and previous years stood at Rs. 2493.0 billion and Rs. 2351.6 billion respectively.

Coupled with the Central Government’s target for reducing fiscal deficit by 0.3 percentage points of GDP, the State fiscal targets for 2017-18 meant that the General Government targeted to achieve an overall improvement in their fiscal position in the current year, boosted by a compression in revenue expenditure and a modest improvement in capital expenditure.

N.K Singh Committee on review of FRBM Act

The FRBM Review Committee headed by former Revenue Secretary, NK Singh was appointed by the government to review the implementation of FRBM. In its report submitted in January 2017, titled, ‘The Committee in its Responsible Growth: A Debt and Fiscal Framework for 21st Century India’, the Committee suggested that a rule based fiscal policy by limiting government debt, fiscal deficit and revenue deficits to certain targets is good for fiscal consolidation in India.

Main recommendations of the NK Singh Committee:

1. Public debt to GDP ratio should be considered as a medium-term anchor for fiscal policy in India. The combined debt-to-GDP ratio of the centre and states should be brought down to 60 per cent by 2023 (comprising of 40 per cent for the Centre and 20% for states) as against the existing 49.4 per cent, and 21per cent respectively.

2. Fiscal deficit as the operating target: The Committee advocated fiscal deficit as the operating target to bring down public debt. For fiscal consolidation, the centre should reduce its fiscal deficit from the current 3.5% (2017) to 2.5% by 2023.

Justifying the target of 2.5% to be realized in the next six years, the Committee observed that debt sustainability analysis (DSA) conducted for the central government suggests such a target (for fiscal deficit) will help to achieve the public debt target of 40% for the centre by 2023.

3. Revenue deficit target

The Committee also recommends that the central government should reduce its revenue deficit steadily by 0.25 percentage (of GDP) points each year, to reach 0.8% by 2023, from a projected value of 2.3% in 2017.

The Committee advised government to follow the golden rule here ie., not to finance government’s day to day expenditure through borrowings. Revenue deficit implies financing of government’s day today activities from borrowings.

In the 2014-15 budget speech, Finance Minister Arun Jaitley announced the constitution of Expenditure Management Commission (EMC). The Commission had been conceived as a recommendation body with the primary responsibility of suggesting major expenditure reforms that will enable the government to reduce and manage its fiscal deficit at more sustainable levels. The EMC was formed as a five-member body composed of the former Reserve Bank Of India (RBI) Governor Bimal Jalan, who has been appointed to Head the Commission, former Finance Secretary Sumit Bose, former Deputy RBI Governor Subir Gokarn and two other members. The commission was mandated to evaluate proposals for reducing the three major subsidies (i.e. food, fertilizer and oil). The commission was to submit an interim report before the presentation of the Budget for 2015-16. The final report was to be submitted before the 2016-17 budget. But the Commission took a little more time.

Bimal Jalan Commission: Expenditure Management

The expenditure management commission, headed by former Reserve Bank of India (RBI) governor Bimal Jalan, submitted its first interim report in January 2017 to Finance Minister Arun Jaitley. The finer details will take time till Finance Minister and a team of policymakers examine it and make it public. However, the broad proposals suggest ways for the government to reduce administrative costs and disburse funds for various schemes more efficiently. The commission might submit a few more interim reports to the government, before presenting a final report sometime in 2018. The panel is studying various government schemes, programmes, acquisitions and projects for which the Centre is spending substantially.

It is anticipated that the commission might have suggested the Centre not to carry forward pending expenditure from a particular year to subsequent years to show better expenditure or fiscal deficit numbers. The panel, however, for the time being may not be looking on to the allocation of expenditure towards particular schemes. Rather, it may is recommend ways in which the sum allocated can be spent in the most cost-effective manner. The three broad areas the commission has examined are the delivery mechanism of programmes, the technology being used to implement these, and the accounting methods used by the government.

The government follows the cash-based accounting system, through which income is counted when cash (or a check) is actually received, and expenses are counted when actually paid. An alternative method is an accrual-based system, wherein transactions are counted as they happen, regardless of when the money is actually received or paid. The Commission studied the pros and cons of both methods. Their recommendations in this regard, however, are not yet known. The terms of reference of the commission, constituted on September 4, 2016, include reviewing all matters related to central government spending, including suggesting space for increased developmental spending and reviewing the budgeting process and norms under the Fiscal Responsibility and Budget Management Act and suggesting ways to meet a reasonable proportion of spending on services through user charges. It is also to recommend ways to achieve a reduction in financial costs through better cash management, greater use of information technology and improved financial reporting systems.


Economic Development and Policies

ADB forecasts recovery in India’s GDP growth in 2018

The Asian Development Bank in its 2018 Asian Development Outlook released on April 11, 2018 raised its 2018 economic growth estimate for developing Asia from 5.8 percent to 6.0 percent citing solid export demand. However it pointed out that the U.S. protectionist measures and any retaliation against them could undermine trade in Asia. Further the bank said that the growth rate for Asia would moderate a little bit in 2019 to 5.9 per cent. According to ADB Strong external and domestic demand helped economies in the region expand by an average 6.1 percent last year.

According to the ADB forecast China’s economy is expected to grow 6.6 percent this year, faster than the bank’s prior estimate of 6.4 percent made in December and by 6.4 percent in 2019. China has set a growth target of around 6.5 percent this year, the same as last year, but it achieved a higher growth rate at 6.9 percent. But the ADB forecast that China’s growth will further moderate “as economic policy leans further toward financial stability and a more sustainable growth trajectory.”

By region, South Asia will remain the fastest growing in Asia Pacific, with the ADB pegging expansion this year at 7.0 percent and 7.2 percent in 2019. Despite growth easing to 6.6 percent in 2017, India’s economy is projected to bounce back to 7.3 percent in 2018 and to 7.6 percent in 2019 as the country’s new tax regime improves productivity. It said that banking reform and corporate deleveraging are also taking hold, which could reverse a downtrend in investment. Growth in Southeast Asia is forecast at 5.2 percent for this year and next, the same pace as 2017, while Central Asia is projected to slow to 4 percent in 2018 before picking up to 4.2 percent next year.

The ADB expressed apprehension that that although till now the protectionist trade measures by the United States has not made any remarkable dent in trade flows to and from Asia this year, the risks of the same happening cannot be ruled out. If trade war continues followed by action of the US and reaction, this could undermine the business and consumer optimism that underlies the regional outlook. It noted that China has blamed the United States for trade frictions amid escalating threats of tariffs on billions of dollars worth of goods between the world’s two biggest economies, sparked by U.S. frustration with China’s trade and intellectual property policies. Another risk to Asia’s growth, the ADB said, is “diminishing capital inflows if the U.S. Federal Reserve needs to raise interest rates faster than markets expect.” The Fed last raised rates in March and policymakers signaled two or three more hikes this year.

Economic Development and Policies

7.5% growth rate is not enough for employing 12 million people in the country: Raghuram Rajan

In a recent interview with CNBC-TV18, Raghuram Rajan, the former RBI governor who left the office in 2016, has said that 7.5% growth rate is not enough for employing 12 million people in the country. India had slumped to a three year low of 5.7% in the first quarter of FY18, but disruptions caused by demonetisation and the implementation of the GST are phasing out and India is expected to grow to 7.5% in next two years. But Raghuram Rajan has said it is not good enough. The World Bank also noted the same in a half-yearly report on India’s growth.

He said that India has the potential to grow at 10%, but that would require a lot of work. He said that reforms in India are happening but more slowly than one would wish. He added that India may move up to 10%, provided some kind of source of demand exists. He anticipated that reforms would be shelved till next general election. According to him, India is entering into a poll-bound financial year and it is a popular belief that with the impending General Election in 2019, there would be fewer reforms and more populist measures.

Another question which he raised in the interview is about the Chinese model of development which India is trying to replicate. The former RBI governor Rajan said that China’s economic growth boom on the back of its manufacturing industry and cheaper goods cannot be replicated in India. He said that world has become less receptive to exports, and asked that even if India becomes a manufacturing giant overnight, who’s going to buy its stuff?

There is no doubt that India can reap demographic dividend only if it can productively engage its young workforce. The innovative programmes like skill development, make in India and start up India have not been able to buoy the job market in India due to many constraints. Government’s latest quarterly survey on employment in eight key sectors reveals that there’s been a net addition of just 64,000 jobs across these eight sectors between April and June 2017. Even more worryingly, the manufacturing sector lost 87,000 jobs over this period, indicating that Make in India remains a distant dream. The labour bureau’s quarterly survey shows that the education and health sectors between them added 1.3 lakh jobs in April-June 2017, while the other six sectors – manufacturing, construction, trade, transport, accommodation & restaurants, and the IT/BPO industry – put together saw a net loss of 66,000 jobs. Education was by far the biggest job creator, adding 99,000 jobs over this quarter. Health saw an addition of 31,000 jobs. The survey, which in its current format has been running since April 2016, covers both regular and casual employment as well as the selfemployed in these sectors.

Since April 2016, there has been a net addition of 4.8 lakh jobs in these eight sectors with over half from education (1.7 lakh) and health (1 lakh). That translates to a 2.3% growth in employment over 15 months, an annualised growth rate of barely 1.8%. This rate is not enough to even take care of new entrants to the job market each year, leave alone reducing unemployment.

The last decade was described by many as jobless growth because the main driver of growth in India all through these years has been the services sector, particularly financial and software services which do not absorb much labour per unit contribution to GDP by very nature. The Chief Economic Adviser Arvind Subramanian had suggested in the last economic survey to focus more on labour intensive industries like textiles and leather, more so because China is leaving this space to graduate into high technology based industries. One of the major employing sectors that is metals and particularly steel industry is not doing well for quite some time and it has employment implications too. There would be certainly adverse impact of winds of protection blowing in the world, especially in the US and Europe. India needs to respond with all these challenges swiftly and imaginatively because there is still chances of more automation and technological disruptions in the world impinging on employment prospects.