[Economic Survey Ch1] Introduction, GDP FC MC relation (part 1 of 3)

1. Introduction2. Why Economic Survey = Boring?3. Timeframe4. Link between GDP FC/MC?5. Why India can’t bounce back easily?6. Crude oil prices7. Forex Reserve8. Mock questions

Introduction

Finally economic survey is released. (free download English click me for Hindi click me)

For UPSC, economic survey is important, because just like yearbook, this one also provides you with truckload of facts for MCQs, and fodder for descriptive/essay/interview.

Even for SBI PO, this is important, because lot of MCQs come from current based economy + fodder necessary for GDPI stage.

Why Economic Survey = Boring?

On HBO, Star movies,  they show movie for 15-20 minutes and advertisement for 5 minutes.

But on Zee Cinema, 9x etc. channels, they show advertisements for 20 minutes and movie for 5 minutes.= movie is shown in between advertizements. (advertisements are not shown in between movies.)

That’s the first reason why economic survey is boring, because it gives facts/fodder in between useless numbers and data.

Second reason why economic survey is boring, because the authors assume that you’re already aware of the basic economic terms, concepts and the connections in between.

Therefore, to enjoy the first chapter, make sure you already know following terms and concepts, if not click on the given links

Current Account Deficit

http://mrunal.org/2012/05/economy-current-account-deficit-how-to.html

Fiscal consolidation http://mrunal.org/2012/09/economy-fiscal-deficit-fiscal-consolidation-kelkar.html

Fiscal stimulus http://mrunal.org/2011/04/economy-q-fiscal-stimulus-package.html

Fiscal cliff, Sub prime crisis

http://mrunal.org/2012/11/economy-fiscal-cliff-meaning-reasons-implications-on-us-and-indian-economy-explained.html

GDP calculation http://mrunal.org/2012/02/economy-iip-index-of-industrial.html

GDP @market price and Factor cost

http://mrunal.org/2011/04/economy-q-gdp-at-factor-cost-and-market.html

Inflation http://mrunal.org/2012/08/economy-inflation-demand-pull.html

Now let’s start with the gist of first chapter from Economic Survey. (I’ve further subdivided it into three articles, else it’ll lead to information overload= boredom + frustration.)

Timeframe

2007 Sub prime crisis in USA. Impact felt across the globe.

2008-10

Government of India injects fiscal stimulus. Leads to boost in consumption.

2010-11

Government of India partially withdraws the fiscal stimulus. Because Government wanted to start “fiscal consolidation”.

+ rise in global crude prices etc. leads to inflation.

2011-12

RBI increases rates = Interest on EMI / Loans increased = demand for consumer goods decreased. Businessmen find it hard to get loans.

+ global prices of crude high as usual. Thanks to inflation, People start investing in gold. = less money for business

investment + crude price high = CAD = rupee’s value declines.

Feb 2013 Economic survey is released.

When there was global financial crisis, Government of India and RBI gave monetary and fiscal stimulus (e.g. giving tax-soaps to industries, higher depreciation on commercial vehicles, lowered interest on loans etc.)

This lead to increase in consumption. => later inflation. Now to curb the inflation, RBI sharply raised the borrowing rates = again

problem, it slowed down the demand.

Link between GDP FC/MC?

GDP at factor cost (FC)= GDP at market prices MINUS indirect taxes PLUS subsidies.

GDP (FC)=GDP(MP) – indirect taxes + subsidies.

in years of sharply higher growth, GDP growth @MP >> GDP at FC.

In the years of slowdown, GDP @MP << GDP @FC.

Why? Because when there is slowdown, indirect taxes falldown and subsidy burden on Government increases.

Why India can’t bounce back easily?

Few years back, America faced the sub-prime crisis and recession. But now it seems to be slowly getting back on track.

But if we look @India, it seems as if inflation and slowdown is going to continue forever!

Why can’t India bounce back quickly? Reasons are following First, International investors and their risk taking. Compared to American

Economy, the Indian economy is more exposed this “shifts” of foreign investors. (the whole GAAR, Vodafone controversy, retrospective taxation, policy paralysis, environmental clearances ruined the mood of foreign investors.)

If they pump in money, Indian economy quickly improves, when they pull out money suddenly, our rupee weakens against dollar = crude oil becomes costly.

Second, India’s import bill is strongly tied to the price of oil.

Third, because of ongoing inflation, people prefer to invest in gold. Gold import= CAD = rupee weakens = crude oil import becomes expensive =even more problems.

Rupee weakening?

Suppose on Jan 2012: $1= Rs.50 And on Feb 2012: $1=Rs.60

That means rupee has weakened and dollar has strengthened. But is it good or bad? Theoretically, for Importers = bad. Because now they’ve to pay more money to import same quantity  of goods. And for Exporters, call centers= good. Because they get more rupee.(even if they’re paid same amount of dollars.)

Ok so Rupee weakens = good for exporters. But here is the problem: US, EU still not fully recovered from slowdown, so the demand of Indian goods and services, is not as high as it was few years back.So export sector isn’t really doing great. On the other hand, imports are getting more and more expensive, especially crude oil => petrol diesel become expensive= inflation.

Crude oil prices

In the global market, the price of crude oil have increased last year.

It could be because of two things

1. The demand of petroleum has increased globally. In a way this is good, because it shows the economy of USA/EU etc slowly getting better.

(otherwise they wouldnot be importing so much). So in a few months, the demand of indian exports should increase. = this is a good Development.

2. The crude oil price has increased due to geopolitical reasons (Iran blockade, Libya crisis etc.) If this is the main reason for rise in crude oil price= this is a bad Development.

Bottomline is that India cannot take the external environment (recovery of US/EU economies, crude oil politics of middle east) for granted.

Forex Reserve

India’s foreign exchange reserve, is made up of following components

1. Foreign currency assets2. Gold3. SDR and RTP in IMF.

As per Economic Survey, Forex reserve is:

March 2012 $294.4

January 2013 $295.5

As you can see, there is hardly any increase in Forex reserve during this time. Why?

One reason is current account deficit (esp. gold+petroleum) second is that foreign investors are not pumping enough money due to ‘policy

bottlenecks’.

Mock questions

Q1. Which of the following is correct formula?

a. GDP (Market Price)=GDP(Factor Cost) + indirect taxes + subsidies.b. GDP (Market Price)=GDP(Factor Cost) – indirect taxes – subsidies.c. GDP (Factor Cost)=GDP(Market Price) + indirect taxes – subsidies.d. GDP (Factor Cost)=GDP(Market Price) – indirect taxes + subsidies.

Q2. Which of the following is correct statement?

1. In the period of high growth, GDP (Market Price) is greater than GDP (Factor Cost)

2. During economic slowdown, GDP (Market Price) is less than GDP (Factor Cost)

Choice

a. Only 1

b. Only 2c. Bothd. None

Q3. Which of the following is/are not a component of Foreign Exchange reserve of India?

1. Gold2. Foreign currency assets3. Special drawing rights in IMF4. Diamonds

Choice

a. Only 1 and 3b. Only 2 and 2c. Only 3 and 4d. Only 4

[Economic Survey Ch1] Investment, Savings, Gold Rush, Inflation Indexed Bonds (Part 2 of 3)

1. INVESTMENT o #1: Tight monetary policy o #2: Exports declined o #3: Policy bottlenecks o #4: investment in Valuables

2. DOMESTIC SAVINGS 3. Decline in share-debentures 4. GOLD RUSH

o Why do people invest in gold? o Gold -Current Account Deficit (CAD) o How to stop gold rush? o Inflation indexed bonds

5. Mock Questions

INVESTMENT

The private sector is the major source of investment in the country. Within the private sector there are two categories of investors

1. Private corporate sector2. Households (aam aadmi)

From both type of investors, less investment is coming. (according to Economic Survey). Why? There are four reasons:

#1: Tight monetary policy

Monetary policy = steps taken by RBI to control money supply.

Repo rate = RBI gives short-term loans to its clients (mostly banks) @this rate. So when repo rate =increased= cost of borrowing increased for the banks. And they

transfer this cost by increases the final interest rate on car / home / business loans. Between 2010 and 2011 period, the RBI raised the repo rate by 375 basis points

(bps). cost of borrowing increased = less people borrowing money to invest in business. Due to this tight monetary policy (+inflation), the Production of consumer durables

declined significantly. Because inflation is high. So a family’s most income goes in buying milk, petrol, gas,

schooling, house rent, electricity etc. Given RBI’s tight monetary policy (=increasing repo rate), so home/car loan EMI and

interest rates also increased.= bike/car purchases decreased.

#2: Exports declined

In the first world countries (US, UK etc.) the impact of recession is still present. So their consumers have less money to spend (compared to previous years.) therefore, demand of indian products in internation market = decreased.

This is second reason for lower private investment. (if businessman is not getting export-demand, then he has no rason to invest more money in expanding his operation, buying new warehouse, factories, machinaries etc.)

The World Economic Outlook (WEO) Update released by the IMF, says India’s trading partners (US/EU etc.) are growing at low rate, hence Indian exports also declined

#3: Policy bottlenecks

Business projects worth thousands of crores are delayed because Environmental clearance Land acquisition, farmers agitations. municipal permission supply of raw materials Because of ^these, large number of projects are stalled / pending file approvals

especially in the projects related to electricity, roads, telecommunication services, steel, real estate, and mining.

This reduces IIP. This also discourages new investment. = less incoming dollars = rupee weakens

indirectly. This also increases non-performing assets (NPAs). Particularly in textiles, chemicals,

iron and steel, food processing, construction, and telecommunications.

#4: investment in Valuables

Due to inflation, sharemarket volatility = nowadays, people invest in “valuables”. Valuables = Paintings, precious metals, gold, diamond, silver and jewellery carved

out of such metals and stones. These are called non-productive investment. (because it just stays in your bank

locker / home locker. Money should remain in circulation : from aam-aadmi to bank to businessmen/loans.)

So, Overall investment is slowed down because nowadays people are investing in such non-productive investment: mostly in gold.

DOMESTIC SAVINGS

Domestic savings, come from three sources

1. Households2. private corporate sector3. public sector.

Savings Rate

Savings rate = Gross domestic savings divided by GDP @Market price. If we look at the savings rate,

Era Domestic Savings rate %

80 and 90s 18-23%

Since 2004 onwards >30%

Household (aam-aadmi)’s savings can be subdivided into

1.Financial savings 2.Physical assets

1. bank deposits (most of the money saved here)2. life insurance funds3. pension and provident funds4. shares and debentures

Building, Farmhouse etc.

Usually, most of the household savings go into bank deposits. And Pension –provides funds don’t get much. However, there has been some upward movement in the share of pension and provident funds during 2008-9 and 2009-10. Why?

Because 6th Pay Commission implementation = disposable income of government servants increased. And they’re the significant contributors to these pension / provident funds

Decline in share-debentures

If you look at the data, you can see a trend: Household savings going into sharemarket

Era (approx.)

80s 8%

90s 13%

2000s 5%

So why did it increase in 90s and then suddenly declined? Because in 90s, the sharemarket was less volatile (=it did not go up and down very

frequently). And if you invested money, you could get around 20% return on it, per year.

Fastforward to 2000s: now share market is very volatile and you get barely 10% return on investment= not good.

Thus a combination of lower returns + higher volatility= less savings going into sharemarket.

Implication?

When you combine above phenomenon with inflation = it is not very attractive to invest in share market.

+ bank deposits not giving enough returns. So people fall back to the “safe” investment = gold.

Gold Rush

Demand for gold has been rising worldwide gold prices in international market are calculated in US$. And these gold prices have

doubled since 2008. India has traditionally been a major absorber of world gold. Gold has been a combination of investment tool and status symbol in India Gold imports are positively correlated with inflation. (meaning, if inflation increases

then gold imports will definitely increase.)

Why do people invest in gold?

1. Share market is volatile (fluctuates a lot). And it doesn’t offer attractive return at the moment.

2. To invest in share market / mutual funds, you need PAN CARD + DEMAT Account. Many people still don’t have it. = With limited access to financial instruments, financial markets, especially in the rural areas.

3. Rural people don’t have awareness about Mutual funds, pension-provident funds etc.4. Inflation is high. So the profit (return) offered on back savings, fixed deposits,

pension-insurance funds = not attractive.5. When you combine these factors: most people prefer to invest in gold / silver.

Thus, rising demand for gold is only a “symptom” of more fundamental problems in the economy (inflation, lack of financial awareness etc.)

Anyways, what’s the big deal? let the people invest in gold, after all its their money! The big deal is, if people had invested money in banking / finance sector, then that

money could be given to some needy businessmen, he’ll open / expand his factory = more employment + more production =good for economy.

But if people just purchase gold/ silver = that money stops moving. It just sits in their locker = bad for economy.

Another problem => gold rush = high CAD.

Gold -Current Account Deficit (CAD)

High CAD = bad, because it weakens the rupee. There are two main villains responsible for India’s current account deficit: 1) gold

import 2) crude oil import. Given the energy requirements, we cannot stop / reduce the crude oil import, else it’ll

badly affect economy. Then solution is obviously: reduce gold import. But how?

How to stop gold rush?

One solution = increase duty on gold import. But problem= people will start smuggling. Then Government will not get any import duty at all.

Therefore, Economy survey suggests following things

1. Underlying motive for gold rush = high inflation. So first, Government should curb the inflation.

2. Second problem is lack of financial instruments available to the average citizen, especially in the rural areas. (they don’t have PAN card, DEMAT account or knowledge  of how to invest in sharemarket/ mutual funds etc.). So Government should take initiatives to increase the financial awareness, financial inclusion.

3. Government should introduce inflation indexed bonds. (then it is more attractive to invest in bonds, otherwise 9% return is not good, if there is 11% inflation!)

Inflation indexed bonds

Normal “bonds” work in this fashion: 10%, 2017 Meaning you give me Rs.100 right now. I’ll pay you Rs.10 as interest every year until

2017 and then I’ll return the principle (Rs.100). Ok but what if there get so high inflation in 2017 that even cheapest ballpoint pen

costs Rs.500! Then getting back the Rs.100 principle hardly benefits you. Because of this reason, nowadays people prefer to invest in gold rather than in shares/ bonds/ mutual funds etc.

But in “inflation indexed bonds”, the principle is linked with Inflation index. So, if from 2013 to 2017, inflation increased by 30% then you get 30% more principle (=100 original + 30) =Rs.130. this is good because your investment is protected from inflation.

Mock Questions

Q1. Correct statement about Indian economy?

a. Gold imports are negatively correlated with inflationb. Gold imports are inversely correlated with inflationc. Gold imports are positively correlated with inflationd. Gold imports are not correlated with inflation.

Q2. Which of the following is/are responsible for excessive gold consumption in India?

1. Inflation.2. Lack of access or awareness about financial markets.3. High Volatility in share market.4. High rate of returns on investment in share market.

Choice

a. Only 1 and 2b. Only 1, 2 and 3c. Only 1, 2 and 4d. All of above.

Q3. The Economic Survey suggested that Inflation indexed bonds should be introduced in India. What will be the primary benefit of such bonds?

a. It’ll help curbing the fiscal deficit.b. It’ll help reducing the NPAs of public sector banks.c. It’ll help decreasing the excessive gold consumption.d. None of above.

Q4. Incorrect statements about savings in India?

a. It comes from three sources: households, private corporate sector and public sector.b. Savings rate has been above 30% in recent years.c. bank deposits, life insurance funds, pension and provident funds, shares and

debentures are examples of physical savings.d. None of above.

Economic Survey Ch1] Agriculture challanges, tax to GDP, steps by Government (part 3 of 3)

1. AGRO and Food Management 2. Agriculture: Problem areas? 3. #1: Land holding 4. #2: Nutritional security 5. #3: Supply Chain   Management 6. Kelkar 7. Tax to GDP ratio? 8. Steps Taken by Government

AGRO and Food Management

Agro + allied industries Approx. number

Share in India’s GDP 14% (2011-12)

Share in total employment 58% (2001)

The declining share of the agriculture and allied sector in the country’s GDP= this is characteristic of any fast growing economy

but that doesn’t mean we should ignore agro and pay more attention to manufacturing / service sector.

Because fast agricultural growth = vital for jobs, incomes, food security, + curbing food inflation.

11th Five year plan has led to improvement in agricultural performance. Even states that were traditionally not procuring sufficient foodgrains, e.g. Bihar, Madhya Pradesh, Bihar, Chhattisgarh, and West Bengal have showed significant increase.

Agriculture: Problem areas?#1: Land holding

Indian agricultural sector is the domination of small farmers with small sized landholdings. = they cannot afford sophisticated tractors, thrashers, irrigation system etc. Therefore, per hectare Agricultural yields or productivity= very low

Government  should carry out land reforms, land consolidation, promote cooperative farming etc. to reduced these “small sized farms”.

#2: Nutritional security

Food security =everybody should get food. But doesn’t mean nutritional security. For example, you can feed a poor-child with cheap quality wheat / rice. But for

healthy growth of body and mind, you also need various vitamins, fruits, vegetables, milk, protein, oil, etc. nutritional items. Malnutrition is a big problem in India.

So we don’t just need “food security”, we also need “nutritional security”. For ensuring nutritional security, Government has to arrange the right amounts of

food items in the food basket of the common man. So, Government must give a thrust on horticulture products and protein-rich items,

apart from the regular wheat, maize, rice and foodgrains. + invest more money in agricultural research.

#3: Supply Chain  Management

Another critical issue is supply-chain management in agricultural marketing in India. Lot of agro-produce gets wasted due to infra problem (bad roads, no cold storage,

electricity etc.) Government needs to link wholesale processing, logistics, and retailing with farm-

production activitie. Recently the government allowed FDI in multi-retail, = It’ll bring for investment in new

technology, storage, processing and marketing of agro produce.= less spoilage, better prices for farmers.

Other problems:

soil erosion, soil salinity, waterlogging, excessive use of fertilizers and pesticides overexploitation of groundwater for irrigation. Still dependent on the vagaries of monsoon.

Kelkar

The government appointed a committee headed by Dr Vijay Kelkar to chalk out a roadmap for fiscal consolidation. We already discussed his recommendations in detail. click me

Target: Reduce fiscal deficit to 3.0 per cent of GDP in 2016-17. But how? Government will have to control the Expenditure on subsidies. Government will need to increase the domestic prices of petrol, diesel, LPG as per

the prevailing in international markets. Government has capped the number of subsidized gas cylinders to nine.

^this will decrease the “outgoing” money for Government.

But that alone, cannot solve the fiscal deficit problem. Government also needs to increase the “incoming” money.

Tax to GDP ratio?

As the name suggest: It is the Ratio of tax collection against the national gross domestic product.

From Government’s point of view, higher tax to GDP ratio= “incoming” money is more.

Time Tax to GDP ratio%

2007-08 11.9

2011-12 9.9

Therefore, if Government wants to achieve fiscal consolidation, it must raise the tax-GDP ratio to above the 11 per cent level. But how?

Of course, one way is increase the tax rate like 75% income tax for rich people, 25% income tax for middle class. But then people will feel more compelled to evade tax and / or relocate to some other country where tax rates are low.

So, instead of raising the taxes very much, better try to broaden the base and improve the tax collection mechanism. There are two ways to do it 1)GST (for indirect taxes) 2) Direct tax code (direct tax)

Steps Taken by Government

(list not exhaustive)

1. Government has setup CCI: Cabinet Committee on Investments. This Committee is headed by Mohan. It’ll fast-track projects more than Rs.1,000 crore.

2. Cabinet has cleared the Land Acquisition and Rehabilitation and Resettlement (LARR) Bill. already discussed click me

3. Government has increased FDI in a number of areas including multibrand retail, power exchanges, and civil aviation.

4. Government is increasing investment in irrigation, storage and cold storage networks = less farm produce wasted during transport.

5. Government has passed The Banking Laws (Amendment) Act 2012. This will strengthen RBI and make way for entry of new banks. (we already saw this in detail. click me).

6. Financial Sector Legislative Reforms Commission is formed. This Commission is examining the laws governing the financial sector and suggest ways of modernizing those laws.

7. Government introduced new External Commercial Borrowing (ECB)scheme for companies in the manufacturing and infrastructure sector. So they can get cheap loans from abroad.

HUMAN DEVELOPMENT

In 12th FYP>> social sector Expenditure, Government aims to spend lot of money on education + health.

Nevertheless, India’s expenditure on health as a per cent of GDP is lower than in many other emerging and developed countries.

Poverty removal

As per Tendulkar Committee, the percentage of people living below the poverty line in the country has declined

Year Approx. population living BPL

2004 37%

2009-10 29%

In the last few years public expenditure on social programmes increased dramatically.

In the Eleventh Plan period nearly 7 lakh crore has been spent on the 15 major flagship programmes.

To secure the rights of people, Government made many laws in recent years

Act Beneficiary?

Right to information Act Everybody.

Mahatma Gandhi National Rural Employment Guarantee Act (MGNREGA) Rural households.

Forest rights act Tribals

Right to education act Children (mostly poor).

But the main problem is: Government money isnot reaching the targeted beneficiaries. There is lot of corruption.

Government has come up with solution: Direct benefit transfer (DBT) with the help of the Unique Identification (UID).

This concludes the gist of Chapter 1 of Economic Survey. Next chapter, next time.

For more articles on economy, visit the Archive @ Mruna

[Economic Survey Ch2] Demographic Dividend, Employment, Labour reforms, gist of

1. Demographic Dividend? 2. Why jobs are not created? 3. Problem#1: MSME

o Problem: Bureaucratic procedures o Problem: Infra bottlenecks o Problem: Getting finance o Problems in Debt (borrow) method o Problem in Equity (partnership, IPO, shares) finance

4. Labour laws 5. Case#1: downsizing 6. Case #2: Shifting business 7. Rigid Labour laws: Implications? 8. Pro-Worker or Pro-employer? 9. Apprentices 10. Apprentice: Indian scenario 11. Education 12. School Governance 13. Education: recommendations 14. CONSEQUENCES AND CONCLUSION

o Approach #1: Business as usual o Approach #2: Pro-active, Reformist o Approach #3: Populist, Anti-risk

15. Mock questions

Demographic Dividend?

In next 35 years, around 70 percent of India’s population will be between the working age of 15 and 59.

By 2050 Employable people (crores)

India 100

Europe 45

USA 27

It means, India will have more number of people in the productive age groups= more incomes=more demand of products= more growth=high GDP.

Seems plausible in theory. But hard to do in practice. A larger workforce translates into more GDP only if there are productive jobs for it. If people are given work of digging up wells and ponds (MNREGA), they’re employed

but that doesn’t lead to significant rise in GDP (compared to if same number of people were given some skill training and job in manufacturing or service sector).

So If you really want to tap the demographic dividend, then labour force must go through following “transitions”:

1. From agriculture to non-agriculture (manufacturing / service sector).2. from rural to urban3. from the unorganized sector to the organized.4. from subsistence self-employment to wage employment.

Why jobs are not created?Problem#1: MSME

MSME= micro, small, and medium enterprises. MSME is defined as per investment in plant and machinery.

Sector-> Goods Services

Micro Upto 25 lakh 10 lakh

Small 25 lakh to 5 crore. 10lakh-2cr

Medimum 5-10 crore. 2cr-5cr

MSME sector employ 80+ million people in 30+ million units across the country. But in the MSME group, most of the firms are “small”, there are hardly any “medium”

enterprises. Why? Because The regulatory environment plays an important role in the lifecycle–birth,

growth, and death of MSMEs Small scale firms more receive tax benefits from various Government schemes. For

example If your firm has less than annual 10 lakh Revenue= you don’t need to pay service tax. Similarly, less than 1.5 crore annual turnover= you don’t have to pay Central excise

duty. While medium scale firms have to pay more taxes, have to obey more regulations on

pollution, social security of employees etc. For more, check this Table:

That means, if your firm grows from ‘small’ to ‘medium’ size = Government benefits reduced but Government regulation increased.

So most of the small scale firms don’t buy expensive machinery for production. In the short run: owner makes decent profit because there is less investment (in

machines) + contract laborers are cheap. In the long run: their productivity remains very low (compared to Chinese or

American firms of same size.) Low productivity gives them little incentive to grow, completing the vicious circle.

Problem: Bureaucratic procedures

According to the World Bank’s Doing Business 2013 data, India ranks 132 out of 185 countries in ease of doing business.

Entrepreneurs have to obtain a number of clearances when applying for building/occupancy permits and utility connections (gas, electricity, water, pollution control).

They’ve to separately visits to various Government offices and applications are not approved without bribes.

Problem: Infra bottlenecks

Lack of quality infrastructure (roads, railways, telecom-internet-electricity connectivity etc.)

Big firms are less impacted by such bottlenecks, because they have the cash to create alternatives. For example, if electricity is gone, a big company can install huge diesel generator/ its own thermal plant.

So, absence of quality infrastructure increases transaction costs disproportionately for small and medium sized firm.

Ok so solution = Government should create quality infrastructure. But there is a problem there too:= land acquisition.

However it doesn’t mean, Government is not doing anything to improve infrastructure. One of the prominent project is  Delhi-Mumbai Industrial Corridor (DMIC).

DMIC project worth 90 billion dollars, covering about 17 percent population and 14 percent land in India

It extends over Delhi, Uttar Pradesh, Haryana, Rajasthan, Madhya Pradesh, Gujarat, Maharashtra, Daman and Diu, and Dadra and Nagar Haveli

The project goals are to double employment potential in 7 years, triple industrial output in 9 years, quadruple exports from the region in 8-9 years

skill-building strategy in DMIC is based on a hub-and-spoke model. There will be one Skill Development Centre in every state with subsidiary institutions linked to it. Curricula will be based on the types of industries located in the region and identified regional strengths.

Other infrastructure plans include logistic hubs, feeder roads, power generation facilities, up-gradation of existing ports and airports, developing greenfield ports, environment protection mechanisms, and social infrastructure.

Problem: Getting finance

Suppose you finished cooking/catering course and you wish to start a restaurant/cafeteria. For that, you need initial investment of let’s say 30 lakh rupees.

But you don’t have a single penny in your pocket. So you decide, “I’ll not borrow even a single rupee from anyone. first I’ll work in some other person’s hotel/restaurant. Save money and once I’ve 30 lakh, I’ll open my own restaurant.”

Problem?= well, depending on your salary (+family expenses), It’ll 5-6-15 years to save that much money and by then inflation would have increased (property rents, electricity, milk, vegetables, tea, coffee etc.) so at that time, 30 lakh won’t be sufficient to start a restaurant, you’ll need 50 or 70 lakhs!

Thus, most of the time you can’t start business by ^above approach. You’ve arrange finance from someone else. And we already know there are two ways arrange cash/finance to start a business: first is debt and second is equity. Click me

For small scale firms, arranging finance by either way (debt or equity) = headache. Because

Problems in Debt (borrow) method

1. Many small firms have defaulted on loans in the past. Therefore bank officers are often reluctant to approve their loan applications.

2. To prevent ^risk of loan-default, bank might ask for collateral (e.g. property/valuables that bank can attach if you don’t pay EMIs) but most small scale entrepreneurs don’t have such collateral.

Loan application procedures are “bureaucratic” in nature: they’d ask you lot of documentary proofs (like income tax returns, account books, property papers and so on). But most small scale firms run business informally without maintain lot of paper records.

Problem in Equity (partnership, IPO, shares)

1. Launching IPO = requires lot of paper work, team of CAs, finance experts, lawyers etc. = small scale firms don’t have it.

2. In India, Angel investors, venture  funds are at a nascent stage and small compared to America. (Their meaning / functions already explained in Debt-Equity article.)

3. The Indian angle investors and Venture funds prefer to invest in technology and e-commerce related business. So small scale firms (mostly concentrated in manufacturing sector) don’t get finance from them either.

Solutions?

A vibrant corporate bond market could help. Even though the MSMEs will typically not be able to issue bonds But large firms and infrastructure projects will be able to access (typically cheaper)

bond financing for their long-term projects. So banks will get that much less loan takers from “upper end of the pyramid”= banks

will have more spare cash lying around. Then they’ll be tempted to loan that money to small and medium sized firm to earn some profit (interest).

Labour laws

India’s labour regulations have been criticized on many grounds including sheer size and scope.

There are 45 different national- and state-level labour legislation in India. Labor laws in India = very rigid.

As the size of a factory grows, it increasingly becomes subject to more and more outdated laws.

This has hindered the growth of large-scale manufacturing industry. Let’s understand this with an example:

Suppose you’re running a firm with 500 employees, exporting diamond jewelry to USA. But due to recession in USA, the demand of your diamond jewelry has decreased.

Case#1: downsizing

Demand of your company’s products is decreased, and there is no way you can increase demand because Americans don’t have money, so no matter how much you spend on advertisement, they won’t buy more diamond jewelry.

On the other hand, Indian consumers prefer gold jewelry instead of diamond. So you cannot increase the demand, then you have to reduce your input costs, else

you’ll start making losses. One way to reduce input cost is “downsizing”=lay off a few workers, so you’ve to

spent less money on wages. But according to Industrial Disputes Act (IDA), if a firm with more than 100 workers,

wants lay off workers, it must get permission of state governments (via Labour Commissioner).

While the Industrial dispute act does not prohibit laying off workers but State Governments are often unwilling to grant permission because opposition parties will make an issue out of it saying “This Government is anti-worker, anti-poor.”

Case #2: Shifting business

Since you cannot lay off workers easily (case#1), you decide to shift the business and use those workers.

Instead of diamond jewelry, you decide to make gold jewelry, stop the export oriented business, and concentrate on domestic Indian consumers.

But according to the same Industrial disputes Act, if the employer (boss) wants to change the terms and conditions /salary/ job description of workers or if he wants to move workers from one plant to another, then he must get (written) consent of workers.

This again increases rigidity. The trade union type leaders will blackmail the employer, “Give xyz amount of money else we will not sign the consent papers.”

Rigid Labour laws: Implications?

Because of the rigid labor laws, It is very difficult for the sick industry to either shut down, downsize or shift business arena. So Indian businessmen try to bypass such laws by

buying some expensive machinery to do to the production. =Industries turn capital intensive rather than labour intensive= less jobs created.

hiring contractual labour without doing paper work (so industrial disputes act doesn’t apply in the first place!) and if there is any raid, they’ll simply bribe the officials.

+ outsourcing non-core activities to even smaller firm and those smaller firms also hire contractual labour without doing paper work. Ultimately these things lead to

Roughly 85 per cent of the workforce is engaged in the informal sector. = They don’t receive social security benefits, pension, insurance, provident fund disability /maternity benefits, paid leave etc.

informal workers are also more vulnerable to violations of basic human rights such as reasonable working conditions and safety at work.

With little job security and limited access to safety nets, most of the informally employed remain extremely vulnerable to shocks such as illnesses and loss of income.

Workers in informal sector are usually poor and hence they have neither the time, money or knowledge to approach courts to seek justice.

Thus informality and poverty are directly linked with each other.

Pro-Worker or Pro-employer?

From above examples, it is clear the Government needs to make labour laws flexible. But when Government tries to reform labour laws, opposition parties and trade unions create lot of hue and cry.

Besides, there is always some state Government election after every few months so the ruling party in union Government doesn’t want to lose any vote bank.  That’s why labour reforms are always put on backburner.

Anyways, if and when Government decides to reform labour laws, what should be its “form”? should it be pro-worker or should it be pro-employer?

In most countries, there is a “middle path” in labour laws= not too “pro-worker” and not too “pro-employer” either. Such laws provide for

1. Employer can terminate a worker in case of business distress or for poor worker performance.

2. At the same workers are provided a redressal mechanisms if they’re fired without cause

3. Compensation for severance and unemployment benefits.

Apprentices

Apprentice = Someone who works for an expert in order to learn a trade. For example hawala operator, cricket bookie, running your own liquor and gambling

dens etc. Such trades cannot be learned by reading theory from books. You’ve to work under

a master for many months and years to learn the actual skills. That is called Apprenticeship.

The syllabus taught in Indian schools, colleges and polytechnics =outdated. The present Indian education system doesn’t produce “Work-ready” labour force.

That gap is filled by the system of Apprenticeship. Apprenticeships are an effective way of ensuring that entry-level workers have the

skills required to join the formal workforce by ‘learning on the job’ and even ‘earning while learning’.

Several countries have benefited greatly from focused programmes Apprenticeship.  For example Japan, US, UK, and Germany.

Germany, in particular, has a well-known dual education system that combines classroom/online courses at a vocational school with workplace experience at a company.

More than 75 per cent of Germans below the age of 22 have attended an apprenticeship programme.

Apprentice: Indian scenario

Years ago, Government had enacted Apprenticeship Act. But it is outdated and rigid from both  employer’s and worker’s point of view.

Problem#1: Apprentice ratio

The statutory limit on (regular) worker : apprentice ratio is very strict. Implication: suppose the rules say for a drug company, worker : apprentice ratio

cannot be more than 20:1. You recently finished final year exam and now you need an apprenticeship certificate

otherwise university won’t give you degree for B.Pharm. But the factory nearest to your home already got another apprentice and factory

owner cannot take you because his quota is over according to that ratio. Ratios are strict because Government  feared that businessmen will show their

regular workers as  “apprentice” on paper, in order to pay them very low salary. Even for small violations of Apprentice rules, the penalty provisions for companies,

are very severe. So no matter how much you beg or request, the factory owner won’t take you as apprentice once his quota is over.

Thus the whole purpose of apprenticeship system is defeated because of that outdated law.

Problem#2: coverage

Apprentices are only allowed in specified trades: for example Pharmacist, Engineers etc.

But majority of graduates are not currently covered under formal Apprenticeships.

Some recommendations

Simpler regulation: A single window mechanism is needed to clear company applications for pan-India apprenticeship programmes.

Wider reach: Add more graduation fields in Apprentice Act. company-led apprenticeship programmes, that place employers at the heart of

education, can play a powerful role in imparting job-relevant skills and also repairing, preparing, and upgrading the labour force.

For example, the duration of apprenticeship training can be allowed to vary across trades and companies.

Short-duration programmes (less than 12 months) can be freed from much of the oversight provided they pay minimum wages.

Relaxing the rigid requirements on the ratio of apprentices to workers could also accelerate capacity creation

Dual system of training: Partnerships between companies and educational institutions should be encouraged

Active exchanges: There should be active exchanges and portals, matching prospective apprentices to employers.

Education

Government  measures its success in education sector mainly by two numbers:

1. School enrollment.

2. Money spent in mid-day meal scheme

If we just look at those two numbers, then everything looks hunky-dory. But does it mean all Indian children are getting quality education? But does it mean all Indian children are getting quality education?

According to ASER Survey-2012 (by NGO Pratham)

1. Among all children enrolled in Std. 8, only 47% could read English sentences. And Of those who could read English words or sentences, barely 60% could convey its meaning in their own language.

2. In class 5, more than 50% students cannot read a class 2 level textbook.3. In class 5, almost 50% students cannot solve two-digit substraction (e.g. 49-23)4. In class 5, almost 75% students cannot do division. In rural India as a whole, 75% of

kids cannot do simple division.  (e.g. 25/5)

Interestingly, Mohan has declared the year 2012 as the ‘National Year Of Mathematics’  to mark the birth anniversary of Indian mathematical geniusSrinivasa Ramanujan.

Anyways, point is Indian children are bad at maths, English and comprehension (especially in Government school).

But “There are no bad students, only bad teachers”. (says Jackie Chan in Karate Kid) There is no positive relationship between teachers possessing formal teacher training

credentials (B.Ed, M.Ed) vs. their teaching caliber. Besides, State Governments treat teachers as contract laborers, paying extremely

low salaries to those “teaching assistants / vidhya sahayak”. Hence there is no incentive for teachers to pour their hearts and minds into child-

education. On the other hand, since money is low, it doesn’t attract brilliant minds into teaching

profession in Government schools.

Pedagogy

The default Indian pedagogy (method of teaching) = complete the syllabus of textbook.

But it does not reflect the learning levels of children in the classroom, who are considerably further behind where the textbook expects them to be.

School Governance

In Government  run schools, there is high rate of teacher absence . The fiscal cost of teacher absence was estimated at around Rs 7,500 crore per year. There is evidence that even modest improvements in governance can yield

significant returns.

Education: recommendations

1. If Government improves the monitoring and supervision of its schools, then teacher absence will reduce significantly.

2. Government should make learning outcomes an explicit goal of primary education policy (rather than “finishing textbook syllabus).

3. Government  should invest in regular and independent high-quality measurement of learning outcomes.

4. Government  should motivate teachers by rewarding good performance.5. Government  should Launch a national campaign of supplemental instruction

targeted to the current level of learning of children (as opposed to teaching to the textbook) delivered by locally hired teacher assistants, with a goal of reaching minimum absolute standards of learning for all children: There is urgent need for a mission-like focus on delivering universal functional literacy and numeracy that allow children to ‘read to learn’.

6. Government  should pay urgent attention to issues of teacher attendance, teacher performance measurement, better monitoring and supervision.

CONSEQUENCES AND CONCLUSION

Recent economic history is replete with examples of economies that were supposed to have great potential but ultimately did not achieve rapid economic growth and improvements in standards of living. India could become the next example of it.

In India reforms are typically implemented only after there is really big crisis (for example 26/11, or Delhi rape). And that too after long debate and after some sort of political consensus is reached on them.

Let’s check the possible scenarios:

Approach #1: Business as usual

If Government continues on the current path then effects on Indian society and economy will be as following

1. Some improvement in infrastructure but only slow improvement in education, and no change in institutional structure such as business regulation and labour laws.

2. Some movement from agriculture to low skill services such as construction and household work, but very few quality jobs.

3.  GDP growth settles into a comfortable 6-7 per cent, the new “normal”. Achieving 9-10% will be impossible.

Approach #2: Pro-active, Reformist

If Government seriously implements the necessary reforms then effects on Indian society and economy will be as following

1. The manufacturing sector becomes a training ground for workers, absorbing more students with a middle or high school education.

2. India moves into niches vacated by China such as semi-skilled manufacturing, even while enhancing its advantage in skilled manufacturing and services

3. India experiences faster and more equitable growth.4. Social frictions are minimized as both agriculture and manufacturing create better

livelihoods.

Approach #3: Populist, Anti-risk

In order to win election, if Government spends all money on populist schemes. It doesn’t implement reforms for the fear of opposition (like FDI, labour laws, land acquisition etc.) then effects on Indian society and economy will be as following

1. There will be no improvement in infrastructure, education, or institutions2. Very few jobs are created outside of agriculture.3. ^because of that, more people stay in agriculture= Pressure on land  will increase +

Per capita income will decrease.4. Small agricultural plots do not provide enough income, nor can they be leased out.5. When things go really worse (a point is reached where monsoon is bad, farmplots

are become extremely small, heavy inflation)…villagers will start large-scale migration to overburdened cities. (=problems of slums=unhygienic living conditions=outbreak of some contagious disease, increase in crime etc.)

6. Then Government will come up with some scheme to prevent this large scale migration e.g. “Rajiv Gandhi Village mein raho yojana” under this scheme, whoever goes back to live in village, will be given monthly Rs.500 and 5 kilos of wheat. Thus strain on government finances increases. (=fiscal deficit=even more problems.)

7. The Income inequality between good service jobs in cities and marginal agricultural jobs in rural areas increases tremendously= rich and poor divide grows even further=social unrest, breeding ground for Naxal elements.

Mock questions

Q1. Which of the following are correct about ASER Survey-2012?

1. It is related to status of University education in India.2. It is an official survey conducted by Ministry of Human resources and Development.

a. Only 1b. Only 2c. Bothd. None

Q2. Government’s classification for Micro, Small or medium enterprise (MSME) is based on:

a. Number of workers employed in a firm.b. Annual profit earned by a firm.c. Annual taxes paid to Government.d. Investment in plant and machinery.

Mains

GS1 Discuss the contribution of workers and trade unions in freedom struggle.

GS21. Write a note on National Child Labour Policy.2. Write a note on National Policy on Skill Development

GS3 Examine the need for labour reforms in India.

Essay Tapping the demographic dividend

Interview

1. ASER survey has highlighted the pathetic status of Indian primary school education. As a district collector, what will you do to improve the situation?

2. Suppose you’re the PM of a country whose demographic dividend phase has passed (number of people in working age are very low compared to aged). So what new policies, laws will you launch to keep your economy booming?

3. What do you understand by the term Industrial unrest. Can you cite any recent examples of Industrial unrest?

4. Last year a Maruti General manager died following a labour unrest at the factory. Some company decided to leave operations due to labour unrest in Kolkata Port Trust. should trade unions be banned to prevent recurrence of such episodes?

Economic Survey Ch3] Fiscal Marksmanship, Tax Buoyancy, 14th Finance Commission

1. Overview 2. What Is Fiscal Marksmanship? 3. Why Poor Fiscal Marksmanship? 4. Steps taken in Budget 2012-13 5. #3: GAAR (but delayed) 6. #4: SERVICE TAX: negative approach 7. Issues: Tax Buoyancy 8. Issue: COLLECTION RATES 9. Issue: Non-Tax Revenue 10. Issue: SUBSIDIES 11. Public debt 12. 14 th   finance commission 13. Background: why finance Commission? 14. Finance Commission: structure 15. Terms of reference 16. Way ahead? 17. Mock questions

Overview

We know that when Government spends more money than it earns= leads to fiscal deficit and high level of fiscal deficit = bad for economy. For more details, read the earlier Vijay Kelkar article click me

Chapter 3 of economic survey, deals with these issues of public finances and deficits.

What Is Fiscal Marksmanship?

This is a new term introduced by Economic survey. Marksman= an expert shooter. Suppose Government decided that for the given year,

1. our direct tax collection target is xyz cr.,2. our indirect tax collection target is xyz cr.,

3. our subsidy bill will be xyz cr.,4. our fiscal deficit will be xyz cr….these are all “targets” set by Government.

For the moment, let’s concentrate on the fiscal deficit target. From the earlier articles, you know that high level of fiscal deficit is bad for economy.

So in 2003, Government had enacted an act called “fiscal responsibility and budget  Management (FRBM) Act”

This FRBM act stipulated that Government will reduce its fiscal deficit. The original “target” was that fiscal deficit should be only 3% of the GDP for the year

2008-09. And similarly Revenue deficit should be 0% of the GDP for the year 2008-09.

But actually for 2008-09 the fiscal deficit around 6% of the GDP! (instead of the target of 3%)

That means, Government’s gunman (finance minister) fired a bullet but instead of hitting 3%, it hit 6%. That means Government’s fiscal marksmanship was poor (because they can’t hit the target precisely).

Now the question comes in mind.

Why Poor Fiscal Marksmanship?

How can Government overshoot the (fiscal deficit) target? Well, fiscal deficit will happen when Government’s outgoing money is more than its incoming money.

Recall that in 2007, subprime crisis happened in USA  and its shocks were felt on every country, including India: export declined, business activity declined….So, Government had to take some initiative to protect Indian economy from further damage.

Therefore Government decreased excise duty, decreased the service tax + offered many tax incentives to businessmen, to boost demand of Indian products and services within India and abroad.  (=incoming money of Government reduced).

Thus, Government missed the “Revenue collection target” (first proof of poor fiscal marksmanship.)

On the other hand outgoing money was high because

1. MNREGA and other welfare schemes. (+ the lot of that money didnot go to actual poor people. so such schemes didnot show the desired positive result on the economy.)

2. Subsidies on petrol, diesel, LPG, Urea etc.3. Since 2009’s general election was coming, so Government wanted to woo the

farmers. So it gave debt waiver to farmers = again outgoing money increased. Government increased minimum support prices (MSP) to farmers for sugar, wheat etc. In other words, Government overshot (missed) the “expenditure target” (second proof of poor fiscal marksmanship.)

And since Government already missed the first two targets (Revenue collection and Expenditure) so obviously third target (fiscal deficit) was going to be missed.

Thus in 2008-09 Government could not show its sharp / precise / accurate “fiscal marksmanship”.

To put this concept in refined words= Government overshot the deficit targets in 2008-09 to obviate the adverse impact of the global financial crisis and to give largesse on the eve of the 2009 general elections.

Anyways ^that was the story of 2008-09, but even in 2011-12, Government was showing signs of poor fiscal marksmanship because

1. Policy paralysis in last two years. Combine this with slowdown in Europe=our (export) sector is not performing good, GDP is going down, low IIP=> low tax collection.

2. Disinvestment targets could not be met because market’s response was lukewarm. (Meaning Government wanted to sell its shares of some PSU but private players were not interested in buying them @high price).

3. Inflation continued to be above 7 per cent=again higher subsidy payments, lower tax collection.

4. high inflation = people opting for gold-purchase as “safe-investment” + high crude oil price= CAD increased = rupee weakened against dollar= even more inflation= profit of businessmen declined = less tax collection.

5. In earlier years, Government could make truckload of money through proper auctioning of spectrum and coal mine licenses, but both were ridden with scams and corruption. So when Government tried to auction 2G again in the late 2012 (after supreme court’s order), private players weren’t much interested.

6. Controversies surrounding Vodafone case and GAAR implementation = foreign players felt less confident investing in India.

Lately Government has woken up and started firefighting: the increasing of petrol-diesel prices, decreasing number of subsidized LPG cylinders, increasing FDI limits in multibrand retail, insurance, aviation, increasing the railway ticket prices, direct cash transfer……these are all measures to decrease the fiscal deficit (=achieving

fiscal consolidation).anyways back to the story:

Steps taken in Budget 2012-13

1. In Budget 2012-13, FM announced that Government  will restrict expenditure on central subsidies to under 2 per cent of GDP. (meaning if India’s GDP was 100 billion rupees, then Government will only spend 2 billion or less on various central  subsidies on petrol, diesel, urea, PDS).

2. FM introduced the concept of “effective Revenue deficit.” = Revenue deficit MINUS grants given to states for creation of capital assets. (this means technically, “on paper”, Government’s Revenue deficit will look smaller!)

#3: GAAR (but delayed)

GAAR was already discussed in earlier article, click me This was #EPICFAIL, because led to huge protests from business lobby.

Government setup Shome Panel to look into GAAR. Shome says, “delay GAAR implementation till 2016″. Chindu agrees.

#4: SERVICE TAX: negative approach

Usual approach is: Government would say the service tax on xyz item is xyz%. But in 2012-13: Government introduced a new approach “negative list”. Here,

Government would say “xyz items are exempted from service tax payment”(e.g. doctor, lawyer)= It means service tax applies on all the remaining services that are mentioned in the “Negative list”.

Service tax=12%* on all services that are not included in the negative list. (rate is same for both 2012 and 2013’s budget)

Government also implemented service tax on railways (first class or an air conditioned coach) from 1st October 2012.

*By the way service tax is 12% but some books/material/websites might say service tax is 12.36%. WHY?Because they include cess on the service tax.

Service tax 12.00%

2% educational cess. Meaning tax on tax = 2% of 12% +0.24

1% Senior & Higher Education Cess= 1% of 12% +0.12

Effective service tax =12.36%

#5: IT in IT

To increase the tax collection, Government is making extensive use of information technology is continuing, viz. along with e-filing of income tax returns, various forms, audit reports, and statements of tax deduction at source have been made compatible

with electronic filing and computerized centralized processing. This helps checking tax evasion and black money.

Issues: Tax Buoyancy

A tax is buoyant when revenues increase by more than 1 per cent for a 1 per cent increase in GDP.

After the FRBM act, both direct and indirect taxes remained buoyant except in the crisis years (2008-9 and 2009-10).

But in 2011-12, the tax buoyancy declined sharply in corporate tax sector. Because high level of inflation decreased the actual profits of corporate sector.

Issue: COLLECTION RATES

It is the ratio of revenue collected from imported items vs the value of imports in a year. Collection rates have decreased last year because

1. petroleum, oil, and lubricants (POL) are expensive in terms of value but Government is levying lower levels of duties on them.

2. Tax exemptions are given on various imported items.

Issue: Non-Tax Revenue

Last year, Government  couldn’t get sufficient “incoming” money from non-tax Revenue sources because

Market gave lukewarm response to disinvestment. Government was expecting to auctions of telecom spectrum and phase III FM Radio

for around 15,000 cr. But it did not work out. As the 2G telecom spectrum auction elicited lukewarm response on account of the

high reserve price.

Issue: SUBSIDIES

The Budget for 2011-12 had estimated total expenditure to be contained at 14.0 per cent of GDP but Government  also overshot this target due to high global oil prices and subsequent increase of subsidy bill (for oil and fertilizers) = another example of poor fiscal marksmanship.

Government should give priority to food subsidy due to extent of malnutrition in the country.

The government aims to do this via National Food Security Act. But there is also need to reduce leakages involved in subsidy delivery= Government

aims to do this via Direct benefit transfer (DBT) / direct cash transfer.

Public debt

It is further classified into internal (domestic) and external debt Internal debt makes up around 91 per cent of public debt. State governments are not allowed to directly borrow externally hence their entire

debt is domestic.

14th finance commission

Background: why finance Commission?

India is a quasi-federal country. We’ve union Government, we’ve state Government. Both have their “De Jure heads” (President vs Governor), Both have their “De Facto (Real) heads” (PM vs CM) Both have their separate administrative machinery (central service employees vs

state service employees) Both have their taxation powers and so on… Point is: Taxation power of state Governments is limited. Majority of taxes paid by the

public goes to the Union Government via income tax, corporate tax, service tax, excise duty.

So if the Union did not give even single paisa from its pocket to the states, then state Governments cannot survive. (because state Government also need to pay salary to staff, public amnesties and interest on previous borrowings.)

Therefore, Constitution of India mandates that Union has to share some of its taxes with the states.

But who will decide how much tax money must be shared between union and the states? Ans. Finance Commission. (for more, read financial relations on pg 13.8 to 13.13 in Laxmikanth).

Under art. 280, President sets up this Commission every 5 year.

Finance Commission

Chairman Year

13th Vijay Kelkar 2010-15

14th Y.V.Reddy, Former RBI Governor 2015-20

Finance Commission: structure

1 chairman + 4 members. 1 Chairman = experience of public affairs 4 members need to have following qualifications

1. Serving or retired judges of High Court, or someone who is qualified to become one2. knowledge of Government finances or accounts, or3. experience in administration and finance.4. Special knowledge of economics.

Terms of reference

The 14th finance Commission will look into following matters

1. Distribution of certain taxes between union and state.2. What principles should Union follow while paying grants-in-aid to states? (from the

consolidated fund of India)3. What measures should be taken to augment the Consolidated Fund of a states so

they can help the panchayats and municipalities.

4. Review the state of finances, deficit, and debt levels of the union and states5. Give suggestion to maintain a good fiscal environment and equitable growth.6. Give suggestions to amend the FRBM Act.7. How much money should be spent for the maintenance of capital assets8. How to monitoring ^such expenditure?9. Should Government insulate the pricing of public utility services like drinking water,

irrigation, power ,and public transport via through laws?10. How to make public-sector enterprises competitive and market oriented;11. Matters related to Disinvestment12. Should Government giveup non-priority enterprises?13. Climate change, sustainable economic development14. What will be the impact of the proposed goods and services tax (GST) on Centre and

State?15. Will GST implementation lead to Revenue loss to States? If yes, then how to

compensate that loss?16. How to arrange money for disaster Management related activities?

Way ahead?

Prolonged fiscal deficit leads to

1. higher real and nominal interest rates,2. slower growth in capital formation3. potentially lower the rate of output growth.

Therefore Government must stick to the fiscal targets. Although, Government cannot rapidly reduce its outgoing money (expenditure) because

1. Government has to pay interest on earlier borrowings2. Continued payments on defense, civil service pay and pensions, etc.

Thus the annual budget has to maintain a delicate balance between

1. Non-developmental Expenditure that is necessary.2. development expenditure for inclusive growth.

Mock questions

Q1. What is the correct equation of effective revenue deficit?

a. Revenue deficit MINUS grants for creation of capital assets.b. Revenue deficit PLUS grants for creation of capital assets.c. Primary deficit plus fiscal deficit.d. Fiscal deficit MINUS Revenue deficit.

Q2. Find Incorrect statement(s) about service tax?

a. The service tax rate was 12% for 2012-13 and increased to 12.36% for 2013-14.b. Railways is exempted from service tax.c. Service tax is levied on the items listed in the negative list.d. All of above.

Q3. Find Incorrect statement(s) about Finance Commission

a. The time frame for 14th finance Commission is from 2010-15b. It has 1 chairman and 3 members.c. One of the member must be a serving or retired judge of Supreme Court.d. All of above.

Q4. Find Correct statements

1. Major portion of India’s public debt is financed from external sources.2. The debt of all state Governments is internal.

Choice

a. Only 1b. Only 2c. Bothd. None

[Economic Survey Ch4] Inflation, WPI, CPI, monetary policy, RESIDEX gist of

1. Prerequisite 2. How to measure inflation?

o WPI o CPI o WPI vs CPI difference? o GDP deflator

3. Steps taken by Government to curb inflation o Via import o Via bans / coercive measures o Via schemes o Via Policy/Act

4. Why Govt could not control inflation? o Export bans = uncertainty o Export bans = CAD o Black money and gold purchase o FDI and infra= No quick results o Environmental clearances

5. Steps taken by RBI to curb inflation o CRR rates o SLR rates o Why RBI couldn’t control inflation?

6. Way ahead 7. RESIDEX 8. Mock questions

Prerequisite

To understand this article better, first go through earlier articles on following topics (click on the topic name)

1. WPI calculation 2. GDP deflator 3. CRR, SLR, Repo, reverse repo, LAF and MSF

How to measure inflation?

There are three ways

1. WPI2. CPI3. GDP deflator

WPI

Wholesale price index Compiled by Office of Economic Adviser ->Ministry of Commerce and Industry. Base year 2004 Doesn’t cover services. it’s calculated using Laspeyres formula. Items are classified into three categories

1. Primary articles2. Fuel, power, light, lubricants3. Manufactured products.

Earlier Government  used to give weekly primary and food inflation data based on the Wholesale Price Index. But this practice has been discontinued since 2012.

CPI

Consumer price index In 2011, the CPI system was reformed

Before 2011 After

Subtypes

There were four subtypes of CPI

1. Agricultural Labourer (AL)2. Rural Labourer (RL)3. Industrial Workers (IW)4. Urban Non-Manual Employees (UNME)

Now only three subtypes of CPI

1. Entire urban population2. Entire rural population3. Urban + Rural (consolidate

from above two)

Prepared by

First three subtypes of CPI were prepared by Labour Bureau -> Ministry of Labour and Employment

All prepared by Central Statistical Organisation (CSO) -> Ministry of Statistics and Programme

Last subtype was prepared by Central Statistical Organisation (CSO) -> Ministry of Statistics and Programme Implementation.

Implementation

Baseyear

Different years for different subtypes.

1. Agri labour=19862. rural labour=19863. Industrial workers=20014. Urban non-manual=1984

Common base year ( 2010) for all three subtypes.

WPI vs CPI difference?

WPICPI (reformed in 2012)

Compiled by Economic advisor CSO

Ministry Commerce ministry Statistics ministry

Includes services? No Yes

Baseyear 2004 2010

Items included 676 200

Known as Headline inflation?

Yes no

ImportanceWhen RBI and Government make policies, they mainly pay attention to this number.

Not much

GDP deflator

How and why GDP deflator is calculated? Already explained in earlier article,click me So not going into details in the current article.

GDP deflator is calculated by Central Statistical Organisation (CSO)-> Ministry of Statistics and program implementation.

GDP deflator =GDP @current price divided by GDP @constant price GDP deflator is the most comprehensive number to measure inflation, but RBI

/Government  doesn’t use it much for policy making because GDP deflator data comes quarterly (and not weekly/monthly basis).

Measures to contain inflation

By How?

Government

Taxation, Expenditure, export bans etc.

RBI Repo, SLR, CRR

Steps taken by Government to curb inflationVia import

1. Govt reduced import duties for wheat, onions, pulses, and crude palmolein were reduced to zero

2. Govt. allowed duty-free import of white/raw sugar.3. Govt. imported pulses and edible oils and distributed them at subsidized rate.

Via bans / coercive measures

4. Govt. put ban on onion export for short periods of time whenever required

5. Govt. suspended futures trading in rice, urad, tur, guar gum and guar seed.

6. Govt. banned exports of edible oils (except coconut oil and forest-based oil) and edible oils.

7. Govt. imposed stock limits on certain essential commodities such as pulses, edible oil, and edible oilseeds and rice.

8. Increased excise duty on gold.

Via schemes

9. Govt. has been giving rice and wheat to poor  families at very cheap rate under the Antodyaya Anna Yojana.

10. Govt. allocated huge amount of foodgrain under the targeted PDS (TPDS).

11. government has allocated rice and wheat under the Open Market Sales Scheme (OMSS)

12. direct cash transfer.

13. Introduced Rajiv Gandhi Equity  Saving scheme (with tax benefits) to make people invest money in it, rather than in gold.

Via Policy/Act

14.Recently the government permitted FDI in multi-brand retail trading. This will improve logistical facilities connecting farmers with the final consumers and cut down the middlemen.

15. The States of Madhya Pradesh and West Bengal have recently waived the market fee on fruits and vegetables. Such waivers are expected to promote investment private sector in the infrastructure necessary for transports and processing of fruits and vegetables.

16. Budgetary provisions for improving storage and warehousing facilities, creating infrastructure for aquaculture etc.

Why Govt could not control inflation?

From above points, it seems Government did lot of things to reduce inflation. Then why are we not seeing any good results?

Export bans = uncertainty

Because, to fight food inflation, govt. started imposing ban on exporting some food commodities, increased and decreased the duties on import/export as necessary.

While this may look a good solution for the short term but in long term, this creates uncertainty for businessmen, farmers.

It reduces their incentive to produce more, because they’re not certain whether govt. will allow them to export or not? (for example Sugarcane->sugar, onion etc.)

So indirectly, this affects employment and income of people => leads to more inflation.

Export bans = CAD

When Government  puts ban on export of xyz item, that means India receives that much less foreign exchange (dollars). So this increases the Current Account deficit (CAD).

When CAD increases = rupee weakens against dollar = crude oil become expensive for us = inflation in everything.

Therefore, export bans are like firefighting / short term quickfix solutions. They donot solve the fundamental problems of Indian economy, infact they worsen it in long run.

Black money and gold purchase

All Government schemes = leakage, corruption. And corruption =black money. And black money is mostly invested in gold and real estate.

So demand of gold forever high= high current account deficit = rupee weakens against dollar= crude oil price increases = petrol/diesel price increases = even more inflation.

Government did try to hike excise duty, make PAN cards mandatory for high value gold purchase and even thought of putting bans on gold import. But these moves have been heavily opposed by the jeweler lobby, hence Government has shied away from doing anything “radical” to stop the gold consumption.

Besides a small hike of 2-3% in gold excise duty doesn’t prevent those bad guys with black money from  buying gold! And  Government hasn’t done much to stop the Black money / corruption either.

FDI and infra= No quick results

You have read and heard this ten thousand times that FDI in multibrand retail = no middlemen = less inflation in food. And similarly cold storage, and food processing infrastructure= less wastage.

But, suppose Government allows wallmart on Monday, that doesn’t mean from Tuesday Wallmart will start running and from Wednesday inflation will be gone. All these things take months and years to get file permission, construction, hiring and training employees, setting up supply lines etc.

Environmental clearances

Many coal and mining projects are not cleared due to environmental issues. This has affected the electricity and raw material supply = input cost increased in

manufacturing sector=inflation.

Fiscal consolidation

Government is on the path of “fiscal consolidation” so it increased the prices of petrol, diesel and reduced the number of subsidized LPG cylinders. These moves have increased the inflation.

Steps taken by RBI to curb inflation

Let’s do a recap: from SBI mananger’s point of view

CRRI’ve to keep this much cash aside. I cannot loan it to people. I donot earn any interest on this.

SLR I’ve to invest this much cash in govt. securities, gold and reliable corporate bonds.

Repo I’ve to pay this much interest rate, IF I take short term loans from RBI.

Reverse Repo

I earn this much interest rate, IF I deposit my money in RBI for short term.

So what will be the impact on liquidity when RBI changes these rates?

Rate When rate is increased When rate is decreased

CRR Liquidity decreases Liquidity increases

SLR Liquidity decreases Liquidity increases

Repo Rate Liquidity decreases Liquidity increases

Note: RBI doesn’t need to change reverse repo rate, because they automatically keep it 1% less than repo rate. (1%= 100 basis points).

In winter, the supply of green vegetables is high so their price goes down. But in summer, their supply is low, so price goes high. Same is the link between liquidity and interest rates.

When liquidity increases = loan interest rate decreases. When liquidity decreases = loan interest rate increases = harder to get loans for

home, car, bike, business.

RBI focused its monetary policy on two objectives

1. Control inflation.2. Facilitate growth.

But It has been very difficult to do both these things at the same time. Because if RBI wants to control inflation, then it needed to reduce the liquidity= RBI had to increase repo rate, CRR. But this type of tight” monetary policy badly affects both producers (businessmen) and consumers. Why?

But when repo rate is increased= liquidity decreased= difficult to get loans for home, car, bike etc.= demand down + difficult for businessmen to get loans = this hurts the businessman and whatever hurts the businessmen – also hurt the GDP and employment.

To put this in refined words: the tight monetary policy of RBI decreased the flow of

credit (loan) to productive sectors of Economy and hence negatively affected the growth.

But due to inflationary pressures, RBI followed tight monetary policy during 2010-11. During this period, RBI raised policy rate (repo rate) by 3.75%= repo rate was

increased from 4.75 per cent to 8.5 per cent. Check the following chart.

But this move has backfired: global economy was progressing slow  (due to problems in EU, and USA not yet fully recovered) => so, this tight monetary policy actually contributed to a sharper slowdown of Indian economy than anticipated.

GDP growth rate fell down from good 9+% to around 5-6%.

CRR rates

Check the chart

As you can see, between 2010-11, here too, RBI kept increasing CRR rates to curb inflation. But from 2012 onwards, RBI has started decreasing the CRR.

SLR rates

As you can see, RBI hasn’t changed SLR much in last three years.

Why RBI couldn’t control inflation?

We’re facing inflation because there is mismatch between supply and demand. Supply (of food, gold, houses, everything) is low While demand of those items (particularly food) is high (because population is high,

the income levels of public has increased). Now think about this: What can RBI do? It can only increase the interest rates.

While increased interest rates may decrease the demand of houses, cars, bikes but it cannot directly decrease the demand of food, milk and other essential commodities.

In other words, Interest rates cannot change the dietary habits of people, not at least in the short term.

Besides, high interest rates make it difficult for businessmen to borrow = less new projects = less new employment, less GDP.

Therefore primary solution to fight India’s inflation =Increase the supply of food items. But this will requie thorough revision of the way govt. treats agriculture, allied

activities, food processing and infrastructure. Small farms, disguised unemployment, heavy reliance on monsoon : all these issues must be addressed in comprehensive manner.

Way aheadFor RBI

World Bank’s report (January 2013) says prices of most of the global commodity prices are expected decrease in 2013 and 14 (except for metals.)

However, as per the assessment of RBI, global economic and financial conditions are still fragile. So they’re not providing any growth stimulus to the economy. (for example, if situation in Europe and America was good, they’d have been importing a lot more goods and services from India= India’s GDP could increase.)

So in that context, even if RBI drastically reduces repo or CRR, that won’t do much good to economy.

For Government

tackling the “supply side bottlenecks” take months and years. So in the mean time poor people must be protected from the inflation. That’s why govt. needs to continue giving welfare schemes and subsidies. But such support must be “targeted” to the right beneficiaries: that’s where

UID/Aadhar, Direct cash transfer comes into picture. Other than that, Government  needs to continue pushing for fiscal

consolidation, deregulation of sugar pricing (as per Rangarajan’s recommendations), and other policy initiatives.

On a side note:

RESIDEX

Rural to urban migration is an inevitable part of economic growth. But when people migrate from rural areas to urban areas, it creates pressure on civic

amenities and housing (slums).

Year % of Indian population living in Urban areas

1951 17

2011 30

2040 50 (expected)

Until recently, we did not have an index to capture the prices of residential buildings in urban areas.

Hence “Residex” index was launched in 2007. This index records the changes in the prices of residential buildings. According to the RESIDEX, the housing prices have declined in Hyderabad,

Banglore and Jaipur (from 2007 to 2012) but they have increased by more than 100% in Pune, Bhopal and Chennai.

Mock questions

1. Correct statements about WPI?a. It is released by finance ministryb. It classifies items into three categories 1) primary 2) fuel and fodder 3)

Manufactured products and services.c. It is calculated using Laspeyres’ formula.d. None of above

2. Incorrect statements about CPIa. The base year is 2004-05b. It is calculated by Labour Bureau with the help of NSSOc. Both A and Bd. Neither A or B.

3. Correct statementsa. CPI measures price change in both goods and services.b. WPI measures price change in only in goods but not in services.c. Both A and Bd. Neither A or B.

4. What is the formula for GDP deflator?a. GDP at constant price divided by current priceb. GDP at current price divided by annual WPIc. WPI divided by CPId. GDP at current price divided by constant price

5. What is RESIDEX?a. It is a drug to combat swine flu.b. It is a new vaccine for rabies.c. It is an index to capture the prices of residential buildings in urban areas.d. It is an index to capture the prices of residential buildings in both rural and

urban areas.6. Between March 2011 to March 2013, what was the highest Repo rate?

a. 9.00b. 7.25c. 8.50d. None of Above

7. Which of the following can be used to measure inflation directly?a. Current Account deficitb. GDP deflatorc. Fiscal deficitd. Purchasing power parity

for more articles on economy: visit Mrunal.org/economy

[Economic Survey Ch5] Financial Intermediaries: Insurance Sector: issues, reforms, Bancassurance, FDI (part 1 of 3)

1. Introduction 2. Insurance: intro 3. Insurance Penetration 4. Insurance density 5. FDI in insurance 6. Insurance amendment bill 2008 7. What is Bancassurance?

o Example of Bankcassurance o Bancassurance: pros and cons

8. Chindu’s revival package for insurance sector 9. Chindu’s Budget speech: Insurance 10. Reforms

o New branches o Banks as insurance brokers o Claims o New schemes o Integrated social security package

11. Government Schemes: Insurance o Aam Admi Bima Yojana(AABY) o Janshree Bima Yojana (JBY) o Universal Health Insurance Scheme (UHIS) o Rashtriya Swasthya Bima Yojana (RSBY) o Pravasi Bharatiya Bima Yojana o Agro Insurance o Rajiv Gandhi Shilpi Swasthya

12. Mock Questions

Introduction

Fifth chapter of Economic Survey is about Financial intermediaries. You already know that financial intermediaries = banks, NBFC, pension-insurance-

mutual funds etc. they acts middlemen between lenders (people) and borrowers (govt. and businessmen). for details given in earlier article, click me

The fifth chapter, discusses various issues, reforms related to financial intermediaries in four sectors: 1) Banking, 2) Capital market, 3) Pension and 4) Insurance.

Pension sector Already discussed in NPS article click me

Insurance sector Discussed in the present article. (part 1 of 3)

Capital market: QFI, FII, SEBI reforms, ECB etc. Will be published soon. (in part 2 of 3)

Banking sector: NPA, NBFC, RRB Will be published soon (in part 3 of 3)

let’s start with Economic Survey >> Chapter 5> Financial intermediaries> insurance sector. The chapter itself, barely contains 4-5 paragraphs on Insurance, but this article also covers budget-speech and various insurance schemes given in India Yearbook.

Insurance: intro

Insurance funds = important financial intermediaries for India. They help move peoples savings into Government and corporate securities.

Insurance industry in India, can be classified into following

Insurer Example

Life LIC, ICICI prudential,

Non-life/General insurance (e.g. health, travel, business, marine, fire)

ICICI Lombard, Oriental, New India, United India. Among them, three are standalone Health insurance companies

1. Star health2. Apollo Munich3. Max BUPA

Re-insurer GIC

Specialized1. Export credit guarantee corp.2. Agriculture insurance Company of India ltd. (AICIL)

The basics of IRDA, Insurance ombudsman functions, various types of policies etc. already explained in earlier article click me

Insurance Penetration

It is the ratio of premium underwritten in a given year vs. gross domestic product (GDP).

It helps  measuring growth in the insurance sector in a country.

Insurance density

ratio of premium underwritten in a given year to total population (measured in US dollars for convenience of comparison).

Issue?

In past, (before LPG reforms of 90s), India’s Insurance penetration and density were very low because insurance sector was monopolized by public sector companies.

But Post liberalization, and with the entry of private sector companies, both insurance penetration and density have increased.

However, India’s insurance penetration and density are still low as compared to other developing countries of the world.

FDI in insurance

Before 1999, Insurance sector in India was monopolized by public sector companies: LIC + GIC (and GIC’s subsidiaries).

1999 was the reform year insurance sectoro Insurance Regulatory and Development Authority (IRDA) Bill passedo Private sector companies can enter insurance business (they started doing so

from 2000)o 26% FDI allowed in Insurance sector.

2012:o As of 2012, there are 52 insurers in India.o Chindu gave 12 point revival package for insurance sectoro Cabinet approved 49% FDI in insurance sector.o But insurance amendment bill is not yet passed in the parliament yet.

FDI in insurance = will increase competition, = more efficiency, innovation, cheaper premiums for policy holders; Thus FDI ultimately benefit the customers, and help improving India’s insurance penetration and density.

But some political parties oppose it saying, FDI in insurance = bad idea. Those unscrupulous private insurance companies will invest policy holders’ money into bad corporates and it will lead to something bad like sub-prime crisis.

What they don’t see is: Even China allows 50% FDI in Insurance, Malaysia 70%, and Mexico has 100% FDI in insurance sector.

And all these countries are doing fine. Hence, the fears regarding foreign investment in insurance= misplaced.

Insurance amendment bill 2008

Salient features are

(list is definitely not exhaustive)

Increases FDI from 26% to 49% health insurance policies would cover sickness benefits on account of domestic as

well as international travel. Reduced capital requirement for new company wanting to enter health insurance. Policy can be repudiated on any ground, including misstatement of facts etc.within

first three years of purchase. Public Sector General Insurance Companies and GIC will be permitted to raise

capital from the market, as long as Government’s shareholding doesn’t fall down below 51%.

Appointment of agents is to be done by insurance companies subject to the agents meeting the qualifications, passing of examinations etc. as per IRDA’s guidelines.

IRDA is empowered to take action against agents to protect the insurance customers.

What is Bancassurance?

Bancassurance = Arrangement through which banks sells insurance products. (and earns Commission)

“Bancassurance” system appeared in France in the 80s. According to Insurance law: one bank can work as Bankassurance agent for only one

insurance company. (one for life insurance and one for non-life insurance) Meaning one bank cannot sell policies of multiple insurance companies (unlike a

stationary shop owner- who can sell pens from multiple brands such as Raynolds, Parker, Luxor, Cello etc.)

But this “one bank one insurance co.” system was changed after Chindu’s revival package.

Example of Bankcassurance

Type of insurance

Insurance co +bank

Life ICICI prudential ICICI Bank

SBI-life SBI

Non-life ICICI Lombard ICICI bank

TATA-AIG HSBC, IDBI etc.

Bancassurance: pros and cons

Pros Cons/Anti arguments

LIC has a big network of agents and offices but private Insurance companies don’t. Hence Bancassurance system helps the private insurance companies to utilize the big network and manpower of a bank without much investment.

It helps the reach of insurance products to the masses.

Bancassurance increases Insurance density and insurance penetration.

Increases the competition between public and private sector insurance companies = better prices, products and services for customers.

Account holder doesn’t need to visit multiple offices – one for banking and one for insurance. Now bank is a “big mall” where he can do “shopping” for both.

Banks have huge database of customer telephone numbers. They annoy customers with stupid telemarketing calls for selling insurance policies.

Bank employees donot have in-depth knowledge of insurance products.

They only care about meeting the “sales-targets”. They sometimes misinform the customers about future benefits / returns to sell a particular insurance policy.

(^although same criticism applies for insurance agents also, they push for products that give more Commission.) so ultimately you’ve to do bit of a research and comparison of various insurance policies before investing into one.

Chindu’s revival package for insurance sector

He released this in late 2012. Total 12 points, important ones are

New products

An insurance company has to seek approval from IRDA, before launching a new product. According to this plan, IRDA must give that clearance within 30 days.

Life insurance companies can introduce a product even without getting formal approval from the IRDA. (in some specific conditions).

Bank brokers

Banks can work as brokers of Insurance products. (earlier they could work only as “agents”: meaning as an “agent”, one bank could tie up with only one insurance co.)

But now as a “broker” One Bank can sell insurance products of multiple insurance companies.

Banking Correspondence agents can sell micro-insurance products.

KYC

IRDA will accept Know Your Customer (KYC) check done by banks.

Taxation

Service tax to be cut on single premium policies and 1st year premium Government is thinking about offering some more income tax exemption, for

investing in insurance products.

Investment

Investment norms for Insurance companies=relaxed. Life insurers can invest in infrastructure SPV (special purpose vehicles) of any firm

(earlier they could only invest in public sector undertaking’s SPV only).

Chindu’s Budget speech: InsuranceReforms

We need to increase insurance penetration in India. I’ve a number of proposals that have been finalized in consultation with the regulator, IRDA.

New branches

Insurance companies will be empowered to open branches in Tier II cities and below without prior approval of IRDA.

All towns of India with a population of 10,000 or more will have an office of LIC and an office of at least one public sector general insurance company. I propose to achieve this goal by 31.3.2014.

Banks as insurance brokers

KYC of banks will be sufficient to acquire insurance policies. Banks will be permitted to act as insurance brokers so that the entire network of bank

branches will be utilized to increase penetration. Banking correspondents will be allowed to sell micro-insurance products. Group insurance products will now be offered to homogenous groups such as SHGs,

domestic workers associations, anganwadi workers, teachers in schools, nurses in hospitals etc.

Claims

There are about 10,00,000 motor third party claims that are pending before Tribunals/Courts.

Public sector general insurance companies will organise adalats to settle the claims and give relief to the affected persons/families.

RSBY extended

The Rashtriya Swasthiya Bima Yojana already covers BPL families. Now, It’ll cover rickshaw, auto-rickshaw and taxi drivers, sanitation workers, rag

pickers and mine workers as well.

Integrated social security package

We need a comprehensive and integrated social security package for the unorganised sector

The package should include life-cum-disability cover, health cover, maternity assistance and pension benefits.

At present schemes like AABY, JSBY, RSBY, JSY and IGMSY are run by different ministries and departments.

I propose a convergence among these schemes so we can evolve a comprehensive social security package. It’ll benefit the poorest and most vulnerable sections of society.

Government Schemes: Insurance

From, INDIA Yearboook

Aam Admi Bima Yojana(AABY)

Rural landless households For the death / disability of Head of family / one earning

member of the family. +scholarship for kids implemented via LIC

Janshree Bima Yojana (JBY)

Started in 2000 and merged with Aam Admi Bima Yojana in 2012, for better convergence.

Provided Life insurance protection to the rural and urban poor persons below poverty line and marginally above the poverty line.

Insurance cover 30k (natural death) Rs.75k (accidental death/disability) implemented via LIC

Universal Health Insurance Scheme

(UHIS)

Started in 2003 Healthcare for BPL Medical expenses upto Rs.25k Maternity benefit given Pre-existing diseases also covered.

Rashtriya Swasthya Bima Yojana

(RSBY)

Started in 2007 Smart card based cashless health insurance. BPL family (upto 5 members) in unorganized sector. In Budget 2013, Chindu extended this scheme to rickshaw,

auto-rickshaw and taxi drivers, sanitation workers, rag pickers and mine workers.

For medical expenses upto Rs.30k per year. Premium sharing: centre vs State=75:25, incase of North east,

90:10

Pravasi Bharatiya Bima Yojana

For emigrant workers Minimum Rs.10 lakh insurance cover Applicable during employment contract period abroad. For sickness, accidental death, disability while being abroad. Also cover expenses for transporting dead Also for legal expenses related to employment contract dispute

abroad. body/sick/disabled person back home.

Agro Insurance

Two schemes: 1) NAIS (National agriculture insurance scheme): available to

all farmers, irrespective of their farm size. Protects them against crop losses due to natural calamity.

2) Weather based crop insurance scheme Both are run by Agricultural insurance company (AIC)

Rajiv Gandhi Shilpi Swasthya

Provides health insurance to handicraft artisan’s family. (man, wife and two children only).

Mock Questions

1. For the given year, Insurance penetration is measured as:a. Ratio of Premium underwritten to No. of People in the 18-60 age groupb. Ratio of Premium underwritten to GDPc. Ratio of Premium underwritten to Total populationd. None of above

2. For the given year, Insurance Density is measured asa. Ratio of Premium underwritten to No. of People in the 18-60 age groupb. Ratio of Premium underwritten to GDPc. Ratio of Premium underwritten to Total populationd. None of above

3. Bancassurance meansa. Arrangement in which Insurance company provides banking servicesb. A bank giving security for Indian corporate to raise capital from abroad.c. A Non banking Finance company providing assured returns on its deposits.d. Arrangement in which Bank sells insurance products.

4. Bancassurance leads toa. Increase in Bank’s NPAb. Decrease in Bank’s NPAc. Increase in insurance penetrationd. Decrease in insurance penetration

5. Bancassurance involves ________ and ________.a. Bank, NBFCb. Bank, MNCc. Bank, insurance companyd. None of above

6. The Insurance amendment bill aims to increase FDI limit in Insurance sector toa. 26%b. 49%c. 51%d. None of above

7. Correct Chronology (older to newer)a. IRDA, SEBI, PFRDAb. PFRDA, IRDA, SEBIc. SEBI, IRDA, PFRDAd. None of Above

8. An urban BPL family is not eligible fora. Janshree Bima Yojanab. Rashtriya Swasthya Bima Yojanac. Aam Admi Bima Yojanad. None of Above

9. Incorrect Statement about Rashtriya Swasthya Bima Yojanaa. It is a smart card based cashless health insurance scheme for rural

households.b. Premium sharing between Centre :State is 50:50.c. Both A and Bd. Neither A or B

10. Incorrect matcha. Aam Admi Bima Yojana: urban and rural BPL

b. Janshree Bima Yojana: Rural landlessc. Both A and Bd. Neither A or B

11. What are the similarities between Aam Admi Bima Yojana and Janashree Bima Yojana?

a. Both provide life insuranceb. Both are implemented via LICc. Both A and Bd. Neither A or B

12. Who among the following, is/are eligible for Rashtriya Swasthya Bima Yojana (RSBY)?

a. Rickshaw and taxi driversb. Rag pickersc. Mine workersd. All of Above

Mains

1. Pravasi Bharatiya Bima Yojana (5m)2. Rashtriya Swasthya Bima Yojana (RSBY) (5m)3. Janashree Bima Yojana? (5m)4. Meaning and advantages of Bancassurance (5m)5. Write a note on the salient features of Insurance (Amendment) bill. (10m)6. Examine the need for a comprehensive social security scheme in India. (12m)7. Write a note on Finance Minister’s 12-point plan for revival of Insurance sector. (12m)

Interview

1. Are you in favor of increasing the FDI in insurance sector?2. Suggests the measures required to increase insurance penetration in India.

[Economic Survey Ch5] Financial Intermediaries: Capital Market: External Commercial Borrowing (ECB), AIF, QFI, FII, FDI, FSDC (part

2 of 3)

1. Financial market 2. Primary market: importance? 3. Reform: ECB

o What is ECB? o Who can borrow? o Reforms in ECB?

4. Reform: IDR fungibility o What is ADR? o What is IDR? o IDR: Two way fungibility?

5. Reform: FDI vs FII definition o FII inflow increased o FII reform? o FDI reform? o QFI

6. What is Alternative Investment fund (AIF)?

o 3 types of AIF 7. Why Fin literacy and RGESS? 8. Rajiv Gandhi Equity Savings Scheme (RGESS) 9. FSDC 10. Misc. Reforms

o MCX-SX o CDS o IRDA-repo o Electronic voting o SCOREs o Mock Questions

How does an Indian company arrange for money to start new business / expand existing business? Ans. Via debt or equity.From Where can Indian company arrange for money? Ans.

Within India Outside India

1. Short term funds= Money market

2. Long term funds= Capital market

ADR, GDR, External commercial borrowing (ECB), foreign currency convertible bonds (FCCB) etc.

For the moment, let’s concentrate within India.

Financial market

Two subtypes

Money market Capital market

For arranging Short term funds Long term fund

Apart from that, financial market also includes: forex market, commodity market, derivative market, insurance market. But let’s pay attention to only capital market for the moment.

Within, Capital market: again two subtypes.

Capital market (long term)

Primary Market Secondary Market

New securities are issued here.

In common parlance this is known as Share-market.

The securities issued in primary market, are sold and repurchased here.

This is like a showroom for brand new cars.

This is like a “Mela (fair)” for used cars.

Both are controlled by SEBI.

Primary market: importance?

Primary market helps businessmen (and Government) arrange money for their projects.

It also helps investors earn profit on it via interest / dividend. Financial intermediaries come into picture here: they act as middlemen and help

investor lend money to borrower (and earn Commission in between). If lot of money in invested in primary market (especially for corporate sector), that

means economy is booming. But as per the Economic Survey, Compared to 2011, companies raised less money

from primary market via debt and equity in 2012. It means companies are not doing as many new projects / business expansion like

they did in 2011. Why? 1) policy paralyses, 2) inflation =less demand of products within India 3) Slowdown in US, EU = less demand of products abroad

Now let’s take a look at the reforms taken.

From abroad Within India

External commercial borrowing (ECB) IDR fungibility FII, FDI, QFI

Financial literacy, REGSS Misc.

Reform: ECBWhat is ECB?

External commercial borrowing As the name suggest: ECB= when Indian company borrows money from external

(non-Indian / foreign) sources. Money is borrowed from non-resident lenders. Via bank loans, fixed rate bonds, non-convertible shares, optionally convertible or

partially convertible preference shares etc. For minimum average 3 years.

Who can borrow?

Hotel, infra, IT, hospital sector. (But company must have registered itself under Companies Act 1956, in India).

Micro Finance Institutions (MFI) can borrow via ECB NGOs, NBFCs, Companies can borrow via ECB, if they’re involved in Microfinance

activity. SEZ units

ECB money cannot be used for?

share market or real-estate speculation. Acquiring another company

ECB: Pros and Cons

Pro Anti

Today, American and European economy is not performing well, their banks and lenders are not finding local borrowers even at dirt cheap interest rate.

So in this scenario, If an Indian company can borrow money from abroad, at a lower interest rate than in India, then what’s the harm? Let them do it.

In ECB, the borrower has to repay in foreign currency (usually dollar).

So If Rupee sharply weakens dollar (e.g. from 1$=Rs.50 to 1$=Rs.60), then Indian borrower will have to more amount of rupees to repay the same amount of loan he previously took. (because first he’ll need to convert his Indian rupee income/profit into dollar then repay the loan).

Reforms in ECB?

Government has liberalization in External Commercial Borrowings Policy during 2012-13

Main Beneficiaries of this liberalization = infra companies, SIDBI and NHB.

Infrastructure companies

Infrastructure companies can borrow in Chinese currency (Renminbi/RMB)

Infrastructure companies can use 25% of the money borrowed via ECB for repaying their previous rupee debts IF they invest 75% of the ECB borrowed money to start new infrastructure projects.

SIDBI

Banks as such, are not allowed to borrow via ECB route. But Small Industries Development Bank (SIDBI) can borrow via ECB

route and lend that money to micro, small, and medium enterprises (MSME) sector subject to certain conditions.

National housing bank

National Housing Bank (NHB)/ Housing Finance Companies can also borrow via ECB and use that money on low cost / affordable housing units.

This list of ECB reform is not exhaustive but for exam oriented preparation- you’ve to draw a line somewhere hahaha.

Reform: IDR fungibility

Before going into that, let’s look at:

What is ADR?

American Depository receipt. Already explained, just copy pasting from my old article Suppose, Indian Co. wants to raise money from America, by issuing shares in

American stock exchange. But then Indian co. will have to maintain accounts according to American standards. To prevent this problem, Indian company gives its shares to American bank. American bank gives that Indian company receipts (called ADR) in return of those

shares. Then Indian Co. can trade those ADR receipts in American share market, to raise money.

Sound good? Yes, but then Indian company will have to pay dividends to those investors in Dollar currency.

Similarly GDR= Global depository receipt

What is IDR?

ADR= American depository receipt = from America’s point of view, it allows a foreign company (e.g. Indian) to raise money from American financial market.

Similarly, IDR= Indian depository receipt= from India’s point of view, it allows a foreign company (e.g. American, British) to raise money from Indian financial market.

IDR: Two way fungibility?

First what is fungibility?= ability for mutual substitution. For example, if you borrow Rs.1000 rupee note from someone, you can repay it

using two Rs.500 notes or 10 notes of Rs.100. because currency notes are fungible.

Similarly, One gold bar weighing 100 gms. Vs. 10 gold bars weighing 10 gms. = easily fungible IF all of them are 24-carat gold, because weight and price wise both sides are same.

But gold bars of 22 carat vs 24 carat = not easily fungible because they’ll have different price.

ADR is two way fungible. Meaning, (from American investor’s point of view) if you’ve ADR, you can convert it into the underlying shares of that (foreign/Indian) company.

As part of financial reforms, Now IDR (Indian depository receipts) are also made Two way fungible.

Reform: FDI vs FII definition

Chindu proposed in Budget speech that

We need to remove the ambiguity on what is FDI and what is FII, I propose to follow the international practice:

o if an investor has a stake of 10 per cent or less in a company, it will be treated as FII and,

o if more than 10%= FDI. Later Chindu formed a panel under Arvind Mayaram for giving clear definitions to FDI

and FII.

FII inflow increased

FIIs invest in Indian securities markets based on their perception “how much money will I mae?

Their perception is influenced byo prevailing macroeconomic environment of Indiao The growth potential of the Indian economyo Performance of corporate sector in competing countries (such as Brazil,

South Africa.) In 2012, FII inflows were around 30 billion dollar. Much of these FII inflows went into

equity segment. The increase in  FII inflow indicates their confidence in the performance of the Indian

economy and Indian market. Compared to previous years, the turnover in share market has increased and

volatility has decreased. The economic and political developments in the Euro zone area and United States

had their impact on markets around the world including India. ‘fiscal cliff’ in the US had been resolved, and had a positive impact on the market

worldwide including in India. Further, the reform measures recently initiated by the government have been well

received by the markets.

FII reform?

In 2012, FII limit for investment in G-Secs (government securities) and corporate bonds =was increased.

FII limit (US Billion dollars)

G-Sec 25

Corporate bonds

51

FDI reform?

Cabinet has approved increase in FDI for Multibrand retail, pension, insurance, aviation, power and broadcasting.

QFI

To put this in crude terms:

QFI is a guy who Doesn’t live in India Is not an FII Doesn’t have a sub-account under FII Is not a Foreign Venture Capital Investor.

Year Reforms taken

2011 Initially this QFI guy was allowed to invest in Indian mutual funds, IF he met the

Know your customers norm (KYC).

2012

QFI was allowed to directly invest in Indian equity market. (provided they’re from member countries of Financial Action Task Force (FATF).)

QFIs from Gulf Cooperation Council (GCC) and European Commission were also allowed to Invest.

QFIs have been permitted to invest in debt market, with a total overall ceiling of US$ 1 billion.

PAN card is mandatory for QFIs.

What is Alternative Investment fund (AIF)?

An entity that collects money from people, and invests it. But unlike the regular mutual funds, they donot usually involve in the conventional

debt-equity share market type investment. And They’re not covered under SEBI’s regulations for mutual funds and collective

investment schemes. Such funds / entities are called Alternative Investment fund.

3 types of AIF

SEBI has notified new regulations covering alternate investment funds (AIFs)under three broad categories

Category

Note

1

These funds have positive spillover effects on the economy. E.g. venture capital funds, small and medium enterprises (SME) funds, social venture funds, and infrastructure funds

SEBI and Government might give them incentives or concessions.

2

Funds that don’t fall under category 1 or 3. They can invest anywhere in any combination but are prohibited from raising

debt, except for meeting their day-to-day SEBI/Government will not give any specific incentive or concession to them.

3 Funds that have negative externality. They only work to get short-term benefits/speculation. E.g Hedge funds.

All the alternative investment funds have to register with SEBI.

Why Fin literacy and RGESS?

Government wants to make people buy less gold. Because when Indians buy a lot of gold, it increases our current account deficit–> our rupee weakens against dollar –>we’ve to pay more for importing crude oil =petro-diesel price increase= inflation (+bad election publicity for Government).

Therefore, Government wants to increase financial literacy among (particularly) middle class and lower middle class folks, make them invest in share market, mutual funds etc. and move away from gold-purchase.

So Government needs to generate awareness that investment in capital market is safe and gives you good returns. => Financial literacy / awareness needed. For this, CBSE already included financial literacy related courses in the syllabus.

Financial Stability and Development Council (FSDC) also working on forming national policy for financial literacy.

But just by making people “aware”, won’t make them invest in capital market. Government needs to offer some “carrot” to lure them.

That’s why Government introduced Rajiv Gandhi Equity Savings scheme- it provides tax benefits and assured returns to FIRST TIME INVESTORS in the equities.

Rajiv Gandhi Equity Savings Scheme (RGESS)

It is a new tax saving scheme. This was announced in Budget 2012. Main purpose of this scheme: attract more (middle class and lower middle class)

people to invest in securities market. (and divert them from investing money in gold, which increases current account deficit and creates more problems for Indian economy).

Conditions

Your annual income must be below 12 lakh. (original figure was Rs.10 lakh, but Chindu raised it in budget 2013).

This must be your first investment in securities market. E.g. if you’ve been already investing purchased some IPOs, shares or invested in mutual funds, then you don’t get tax benefit in this scheme.

Lock in period of three years. (meaning you cannot take out your money before that).

You must purchase approved shares/mutual funds only.

Benefit? For investment upto Rs.50000, you get 50% deduction in income tax. You can invest money in installments. No need to invest Rs.50000 in on go. You don’t have to pay tax on dividends paid by the company.

issue/problem in RGESS?

To invest in any type of securities (debt or equity), you first need two things 1) PAN card and 2) DEMAT account. Most of the Indians don’t

have either PAN card or DEMAT account.

FSDC

Government has set up Financial Stability and Development Council (FSDC) in 2010.

Org of FSCD

FM  = chairman Heads of financial-sector regulatory authorities (RBI, SEBI etc), Finance Secretary and a few other departments Chief Economic Adviser

What does FSCD Do?

Promote financial literacy (their sub Committee has made draft National Strategy on Financial Education).

Promote financial inclusion (get people in banking, pension, insurance net) Increase financial stability Increase inter-regulatory coordination (between RBI, SEBI, IRDA etc) Promoting financial-sector development

Misc. ReformsMCX-SX

SEBI permitted MCX-SX to operate as a full-fledged stock exchange (just like BSE/NSE).

Now MCX-SX will directly compete with BSE and NSE, and it’ll lead to better services, lesser costs for the investors.

CDS

Credit default swap (more explained earlier click me) Mutual funds and Insurance companies can now participate in CDS as users. This will increase liquidity in the corporate bond markets.

IRDA-repo

Insurance Regulatory and Development Authority (IRDA) has permitted insurance companies to participate in the repo market.

Electronic voting

A public limited company has shareholders. And the company needs to take votes of the shareholders before merger-acquisition, election of new board of directors etc.

Earlier this was done through postal ballot. But in 2012, SEBI made rule: voting must be done through electronic means. (this

reduces any mischief or foul play and brings more transparency). At the moment, SEBI has made electronic voting is made Compulsory for the top 500

listed companies and more companies will be included soon.

SCOREs

SEBI complaints redress system It is a web portal, where you can file online-complaints to SEBI.

Mock Questions

1. Capital market is madeup ofa. Primary and Money marketb. Primary and secondary marketc. Money, primary and secondary marketd. None of above.

2. New securities are first issued ina. Primary marketb. secondary marketc. Either A or B depending on SEBI’s approval.d. None of above

3. Correct Statements about ECB?a. Infrastructure companies can borrow money only in dollar currency.b. SIDBI and NHB are allowed to borrow money via ECB route.c. Both A and Bd. Neither A or B

4. What is the purpose of ADR?a. Help an American company raise money from within USAb. Help an American company raise money from outside of USAc. Help foreign company raise money from American financial market.d. None of Above

5. What is the function of IDR?a. Help an Indian company raise money from within Indian financial marketb. Help a Foreign company raise money from within Indian financial marketc. Help an Indian company raise money from abroad.d. None of Above

6. Which of the following Depository receipt has two-way fungibility

a. ADRb. IDRc. Neither A or Bd. Both A and B

7. Arvind Mayaram panel is associated witha. Current Account Deficitb. Double taxation avoidancec. FDI, FII definitionsd. PPP project finance

8. Correct statement about QFIa. It is a sub-account under FIIb. They’re not required to have PANc. An Investors from Gulf cooperation council cannot register themselves as QFId. None of above

9. Correct statement about Alternative Investment Fund (AIF)a. It is regulated under SEBI’s mutual fund regulations.b. SEBI classifies AIF into four categories.c. Every AIF is required to get itself registered with RBId. None of Above

10. Correct Statement about Rajiv Gandhi Equity savings scheme?a. It offers tax deduction to any investor whose income is below Rs.12 lakhb. Dividend income under RGESS is taxable.c. For investment upto Rs.50,000, it provides 100% income tax deduction.d. None of Above

11. Which of the following is a function of Financial Stability and Development Council (FSDC)?

a. Controls FDI approvals.b. An organization that aims to increase inter-regulatory coordination and

financial literacy.c. Controls external commercial borrowing and current account deficit.d. None of above.

12. SCORES an online portal to register complaints witha. IRDAb. PFRDAc. SEBId. None of Above

Mains

1. 2 markersa. SCORESb. AIFc. ECBd. IDR

2. 5 markersa. RGESSb. FSDC

3. 12 markersa. Write a note on the recent reforms in the Indian capital marketb. What do you understand by External Commercial Borrowing? Briefly discuss

the recent liberalization in India’s in External Commercial Borrowings Policy.

[Economic Survey Ch5] Financial Intermediaries: Banks, RRBs, NBFCs (Part 3 of 3)

1. Prologue 2. Banks and interest rates 3. Rural Banking: Background

o Government’s action o Timeline: Banking in rural areas o After independence o Why RRB? o How is RRB different from commercial banks? o Rural Infrastructure Development Fund (RIFD) o Financial Inclusion o Swabhimaan scheme o Ultra Small Branches o SHG Bank linkage program

4. Development Banks/AIFI o 1.ICICI o 2.SIDBI o 3.IDBI o 4.IFCI o 5.IIBI o 6.NABARD o 7.NHB o Reverse Mortgage product

5. FINANCIAL PERFORMANCE OF BANKS o Capital Adequacy Ratio o NPA: steps taken to reduce it

6. Chindu’s Budget speech o More cash to NABARD o Multilateral Development banks: Roads in NE o Bank for Women? o Urban housing fund

7. Core Banking Solution (CBS)? o Why is CBS in news? o Why UCBs haven’t implemented CBS?

8. Conclusion (Chapter 5) 9. Mock Questions

Prologue

In the earlier articles, we saw What is financial intermediaries? Why are they important for Economy? Then in part 1 of 3, we saw insurance sector In part 2 of 3, capital market In this third and final part, we’ll see the banks and NBFCs.

Banks

What do banks do? They collect deposits from savers and lend it as loan to the borrowers, and earn Commission in between. Hence they’re one type of financial intermediaries.

We already know that banks have to invest some of their deposit money in govt. securities (and high rated corporate bonds) under the statutory liquidity ratio (SLR).

For past few years, this SLR rate has remained steady 23-24%. Yet banks have invested more than 30% of their deposits in Government securities.

Recall that Government securities are “safe investments” and if an investment is “safe” then it won’t give much profit.

So why are the bank investing more money in Government securities, even above the SLR requirement?

1. because they think it is safer investment (compared to lending it to the likes of Kingfisher) and or

2. because businessmen are not coming forward to take loans and or3. Consumers are also not coming forward for getting loans for bike, car, or home loans

(due to inflation).

Interest rate

There are mainly three type of bank account:

Current Account

Savings account

Term deposits/Fixed Deposit

Interest paid by bank

0% 4-6*%Depends on how long you keep the money. 6-8*%

These rates change from bank to bank, ^these are just approximate numbers for illustration.

For banks Current account and savings account (CASA) are most important. Why? Because on these deposits, bank has to pay very low interest. So if bank gets lot money from CASA source, and lends it as car/bike/home/business/personal loans @12-18% =there  is big profit margin.

Interest rate change

Deposit rates (bank pays to accounts holders) Lending rate (bank charging to loan takers)

RBI controls the interest rates on foreign currency non-resident account (FCNR).

In 2011, RBI deregulated the interest rates on savings deposits.

Still no public sector bank has increased its savings deposit rate. (they just offer 4%). Although private sector banks offer higher.

2012: RBI deregulated the interest rate on loans given to exporters (in foreign currency). This was done to improve the exports.

In 2012-13 period, RBI started reducing the repo rate and consequently banks too lowered their loan interest rates a bit.

Rural Banking: Background

During the British raj and the initial years after independence, the banks (and insurance companies) only operated in the urban areas. Why?

1. Staff/Manpower: easy availability of educated youth in cities.2. Urban areas had better availability of electricity, telephone, telegram, railways, office

supplies etc.3. Customers: Main Target audience of banks and insurance companies= educated

middle class, rich people and businessmen. They live in cities.4. At that time, Banks and insurance companies were controlled by private players: they

had only one motive=Profit. And city folks have more surplus income compared to villagers.

Result:

Villagers did not get facility of banking / insurance, and they had to rely on the (evil) money lender who charged whatever interest rate he wanted to.

Sometimes they paid more money in interest, than the actual principle they had borrowed.

And thus villagers remained in debt and poverty forever.

Government’s action

Over the years, Government certain things to achieve following objectives:

1. To help the villagers get easy loans for buying cows, buffalos, diesel pump sets, seeds, fertilizers, digging wells and bores in their farms etc.

2. increase the penetration of banking services in rural areas3. To achieve financial inclusion in rural areas

Timeline: Banking in rural areas

50s Cooperative banks / societies

55 Birth of SBI and ICICI (although not related with rural banking directly)

60s Bank nationalization (first round)

75 Regional rural banks were setup

80s NABAD was setup.+ Bank nationalization (second round)

Early 90s Self Help groups (SHG) and bank linking

Late 90s Kisan Credit Card

Mid-2000s

1. No-frills account2. Banking Business correspondence Agents (BCA)3. Interest subvention scheme on crop loans

2011 Swabhiman scheme

Now let’s fill in the details

After independence

The structure looked like this (for rural banking)

1. RBI2. State cooperative banks3. Central cooperative banks (@District level.) || Urban cooperative banks (in cities and

small towns)4. Primary Agriculture Credit societies (PCAS) (@village level)

Then came RRB and NABARD.

Why RRB?

1975: Government appointed MM Narsimhan Committee to look into rural banking. Narsimhan observed that Commercial banks (such as SBI, BoB) have high cost

structure (building, staff etc.) so they prefer to open branches in cities rather than villages- Because city branches make more profit.

The staff of commercial banks= expert in banking and financial matters but not aware of the problems of rural people.

On the other hand, the Primary agriculture Cooperative societies have members from the villagers themselves, so they are more aware of the needs and problems of the villagers.

Therefore, we need to create a hybrid institution that has positive characters of both

1. Financial strength and expertise of commercial banks) +2. Grassroot problem awareness of cooperative society).

Thus, Regional rural banks were born.

RRB provides loan and savings facilities to villagers. These villagers include

1. farmers (small and marginal)2. agri laborers3. rural artisans4. rural entrepreneurs5. cooperative societies6. primary agriculture credit societies

RRBs are sponsored by Commercial banks. The Sponsor bank provides training to the staff of Regional rural bank. The sponsor bank also provides initial capital to setup the regional rural bank.

According to the RRB Act, the paid up capital is Central Government : State Government : Sponsor bank = 50 : 15 : 35

How is RRB different from commercial banks?

Commercial Bank RRB

Area of operation

Huge. Small.

Whole India (although mainly concentrated in urban areas and small towns)

One or a few districts. (rural)

Source of finance

Savings accounts, fixed deposit etc.

Borrowing from RBI and other sources

Borrowing from NABARD, SIDBI. They also have savings account of

villagers, but it is not sufficient to cover the loan demands.

Apart from RRBs, villagers also get services from cooperative credit societies, Microfinance institutions;

Even commercial banks such as SBI also serve the villagers via BCA (Banking correspondence agents).

And the urban-rural geographical breakup has changed a lot since the birth of RRBs. (Many places that were villages in 70s have now become small towns).

In this context, it was necessary to consolidate/merge various RRBs- to reduce their overhead expenses and make them more competitive

Therefore in 2005: Government of India started amalgamation of RRB. So now the number of RRBs have decreased.

Till 1 January 2013, 22 RRBs had already been amalgamated into 9 RRBs.

Rural Infrastructure Development Fund (RIFD)

Started in mid 90s. NABARD operates the Rural Infrastructure Development Fund (RIDF). This fund provides cheap loans to states and state-owned corporations So they can quickly complete projects related to

1. medium and minor irrigation,2. soil conservation,3. watershed management4. Flood Protection;5. Forest Development;6. Cold storage7. Community Irrigation wells for the village as a whole;8. Village Knowledge Centres;9. Desalination plants in coastal areas;10. Building schools, Anganwadi Centres etc.11. Building toilet blocks in existing schools, specially for girls12. Rural Roads, Bridges13. and other forms of rural infrastructure.

Banks who do not meet their Priority sector lending requirements, provide money to this rural infrastructure development fund.

Financial Inclusion

Financial inclusion = getting all poor people in the banking, insurance, pension net. So they don’t become victims of evil money lenders who charge 36% compound interest rates (or even more).

Swabhimaan scheme

We’ve already discussed this scheme and Banking business correspondents (BCs) in earlier article. Click me

Budget 2012, Chindu Pranab had announced that Swabhimaan would be extended to habitations with population more than 1,000 in the north-eastern and hilly states and population more than 1,600 in the plains areas as per Census 2001.

Ultra Small Branches

Ultra small branches (USBs) are being set up in all villages covered through Banking Correspondence Agents. (We’ve already discussed Banking business correspondents in earlier article. Click me)

These Ultra small branches (USBs) will have a small area of 100-200 sq. feet. A bank officer will be available here with a laptop on pre-determined days. The Banking Correspondence agents will offer cash service to villagers (e.g.

depositing or taking out money), This bank officer (in Ultra small branch) will offer other services, undertake field

verification (for loan applications), and follow up banking transactions. A total of over 40,000 Ultra small branches (USBs) have so far been set up in the

country.

SHG Bank linkage program

Self-Help Group (SHG)-Bank Linkage Programme started in early 90s.

Under this programs, self-help group open savings account in the bank. They get loans for their projects, deposit money from members (and NGOs earn commission in between).

It is being implemented by

1. commercial banks,2. regional rural banks (RRBs)3. Cooperative banks.

Development Banks/AIFI

They can be further classified based on their target audience

Agro Housing Industry Import-export

NABARD

National Housing Bank

1. SIDBI2. IDBI3. ICICI4. IFCI5. IIBI

EXIM bank

Out of ^them, names highlighted in bold (NABARD, NHB, SIDBI, EXIM) = All Indian financial institutions (AIFI). Rest are development banks.

Industrial Development Bank?

First question: How is industrial development bank different from regular (commercial) banks such as  SBI, PNB etc.?

Industrial development bank

Commercial Bank

Examples

1. ICICI*2. IDBI3. SIDBI (AIFI)4. IFCI5. IIBI

Public Sector

1. SBI2. PNB3. BoB

Pvt.Sector

1. ICICI*2. HDFC

Accept deposit

from public?

No Yes

Job?Provide medium/long term finance to ONLY industries.

Provide short/medium/long term finance to both common men (car/bike/home/education/personal loans) + to industries.

*The ICICI started in 1955 to provide finance to industries. In 1994 they also started ICICI Bank. And in 2002, the original parent (ICICI) was merged with ICICI Bank Ltd.

how do Industrial development banks provide finance to industries?

1. By directly giving loans to a company.2. By buying shares and bonds of a company.3. By underwriting new IPOs.

In the beginning, these organizations started as “All India financial institutions”, their job was to provide medium / long term finance to companies.

But after the LPG reforms in the 90s, capital market become popular. Now businessmen had more options to arrange for finance (via IPOs, bonds). So these All India financial institutions (AIFI) lost their original glamour and government converted them into Development banks (as per Narsimhan Committee’s recommendation).

Now only four AIFI left: NABARD, SIDBI, EXIM and NHB. They areregulated by RBI.

In the (part 2 of 3), we had seen that now SIDBI and NHB are allowed to borrow via external commercial borrowing (ECB) route.

1.ICICI

Full name: Industrial Credit and Investment Corporation of India. Private sector development bank Setup in ‘55. (same year SBI was also born). 2002: Merged it with ICICI Bank ltd.

2.SIDBI

Small industries development bank of India Started in 1990. SIDBI helps the micro, small and medium enterprises (MSME). It provides finance to State Industrial Development Corporation (SIDC),

State finance corporations, Commercial banks, cooperative banks and regional rural banks. And then those organizations deliver loans/finance to the ultimate target group (MSME industries).

3.IDBI

Industrial development bank of India UTI is a subsidiary of IDBI It borrows money by issuing bonds (and then lends that money to

industries at a higher interest rate.)

4.IFCI Industrial finance corp. of India Setup in 1948: that makes it the first industrial financial institution in India.

5.IIBI Industrial investment Bank of India.

6.NABARD

NABARD = National bank for Agriculture and rural development It was setup in early 80s. (Regional rural banks (RRB) were started in ‘75,

that means first RRB came and then NABARD came). It acts as the regulatory authority for cooperative banks and regional rural

banks NABARD lends it downwards to State cooperative banks (SCB), Regional

Rural banks (RRBs), Microfinance institutions, cooperative credit societies etc.

That’s how farmers, villagers, cottage/handicraft, self help group (SHG) get loans at reasonable interest rate.

NABARD operates the Rural Infrastructure Development Fund (RIFD)

7.NHB

National Housing Bank (NHB) Started in late 80s As the subsidiary of RBI It is the apex institution for housing finance in India (just like how NABARD

is for rural / agri).

Reverse Mortgage product

Launched by National Housing bank. For senior citizen The senior citizen can mortgage his house and he’ll be given monthly income. He doesn’t need to repay loan or pay any EMIs, but when he dies, bank will take over

his house and auction it to recover the loan money. (and if house fetches more than loan dues,  then bank will give that extra money to heirs of the dead person.)

Punjab National bank also has a scheme like that, called “PNB Baghban”.

FINANCIAL PERFORMANCE OF BANKS

NPA = Non performing asset, in crude term, bank gave loan to someone but he is not repaying it back on time.

Reasons for rising NPAs

1. current macroeconomic situation in the country;2. increased interest rates in the recent past;3. lower economic growth;4. aggressive lending by banks in  earlier good economic times (i.e. prior to 2007). And

now some of those businessmen / salaried individuals are not earning enough due to slow down, hence unable to repay the loans.

5. Our banks had also loaned to some State electricity boards and airline companies (but they are not paying back on time) so the banks’ NPA increased.

6. switchover to system-based identification of NPAs by Public Sector Banks

Capital Adequacy Ratio

A measure of a bank’s ability to absorb losses. Formula: value of its capital divided by the value of risk-weighted assets. To put this crudely : CAR= bank’s capital / bank’s risky assets. A low capital adequacy ratio (CAR) = bank has a limited ability to absorb losses

(meaning bank is more likely to collapse if people start defaulting on their loans.) High CAR= bank has good ability to absorb losses.

In public sector banks, government of India (GoI) has regularly infused capital to keep the CAR high. But over the years, GoI too is running low on cash (thanks to fiscal deficit), so government had formed a committee, and committee recommended that

Government should create a new financial holding company. This company will raise money from domestic and international sources and then infuse it as equity in public sector banks.

NPA: steps taken to reduce it

1. SARFAESI act and asset reconstruction companies (ARCs) (already discussed,click me)

2. nodal officers in banks for each Debts Recovery Tribunal (DRT);3. close watch on NPAs

RBI has also announced the following remedial measures:

1. sanction of fresh loans/ad-hoc loans from 1st Jan 2013 will be made on the basis of sharing of information among banks;

2. banks will conduct sector- /activity-wise analysis of NPAs;3. banks will put in place a robust mechanism for early detection of sign of distress,

amendments in recovery laws, and strengthening of loan appraisal and post credit monitoring.

Chindu’s Budget speech

Interest subvention scheme

It was started in 2006 Govt. will continue this scheme for 2013-14 also. Given for short term crop loans For loan Upto Rs.3 lakh Time period: 1 year. Under this scheme, farmer can get loan @7% interest rate. But if he repays the loan on time, then he will get additional 4% interest subvention.

(meaning  loan would cost him 7-4=3% interest rate only.) So far, the scheme has been applied to loans taken from public sector banks, RRBs

and cooperative banks. Chindu proposed to extend this scheme to crop loans borrowed from private sector

scheduled commercial banks as well.

In case you wonder “WHY”? Why is govt. giving 3% interest subversion to farmer who repay the loans on time? Earlier the interest  subvention was 1% (2009), It was increased to 2% (2010) and 3%(2011).

Because, in 2009, govt. had launched debt waiver scheme.  (Meaning farmers didn’t have to repay the loans they had taken earlier.) Govt. say they are doing it to prevent ‘farmers’ suicides’, but experts believe it was more of an election gimmick.

It hurt the economy in two ways

1. It increased fiscal deficit of the government.2. The farmers who had been regularly repaying loan, felt cheated. Now they also don’t

repay the loans on time, thinking sooner or later govt. would announce another debt-waiver.

Thus, banks, particularly regional rural banks (RRBs) are facing really hard time recovering the loan money. That’s why Chindu is doing two things

1. On one hand, he offers additional interest subersion to farmers who repay loans on time.

2. On the other hand, he is also working for amalgation of RRBs.

More cash to NABARD

Govt. will provide Rs. 5000 crore to NABARD NABARD will give it as loan for construction of warehouses, godowns, silos and cold

storage units both in the public and the private sectors. Panchayats can also use this money for construction of godowns to help farmers to

store their produce.

Multilateral Development banks: Roads in NE

These banks operate at international level. They are formed by group of countries. Examples of MDB= Word Bank, Asian Development Bank (ADB), African

development bank. Chindu wants to get loan from both World Bank and the Asian Development Bank to

build roads connecting North East India with Myanmar. This will help in our “look east” policy and improve the economic prosperity of north eastern States of India.

Bank for Women?

At present, there is no bank that exclusively serves women. Chindu porposed that we should have have a bank that

1. lends mostly to women and women-run businesses,2. supports women SHGs and women’s livelihood,3. employs predominantly women,4. addresses gender related aspects of empowerment and financial inclusion

for this,

MBN Rao committee = they’ll prepare the blueprint for the country’s first women’s bank.

Govt. shall provide Rs 1,000 crore as initial capital to start this bank. Chindu hopes RBI will give banking license to this by October, 2013.

Urban housing fund

There is already Rural Housing Fund set up through the National Housing Bank. In this system, govt. gives cash to NHB. And NHB lends it to other banks operating in

rural areas >> finally those bank lend it to villagers to construct houses. Chindu has proposed to start similar fund for Urban housing under National housing

bank.

Banking

1. Govt. will provide capital infusion to public sector banks and make sure they meet BASEL III norms.

2. All scheduled commercial banks and all RRBs are on core banking solution (CBS) and on the electronic payment systems (NEFT and RTGS).

3. Public sector banks have assured Chindu that we’ll set up ATM in all our branches by the end of March 2014

4. We are working with RBI and NABARD to bring all other banks, including some cooperative banks, on CBS and e-payment systems by the end of December 2013.

What is Core Banking Solution (CBS)?

Core banking solution= Bank integrates all of its branches in a single IT network. Whenever you take out money or deposit money from your account, the database is

updated in the central server directly. Any branch of the bank, can access this date from the central server. Thus Core banking solution helps customers to operate their accounts, and avail

banking services from any branch of the Bank on CBS network, regardless of which branch he had opened the account.

The customer is no more the customer of a Branch. He becomes the Bank’s Customer.

Thus CBS = Anywhere and Anytime Banking. You can deposit money in any branch-office, you can give cheque, you can take out

money, you can get your account statement, etc.…..as long as that branch is part of the core banking solution.

CBS branch is like a Sales & Service Delivery Center. Internet banking, mobile banking, ATM are all interconnected in Core banking solution.

Why is CBS in news?

Because of two reasons

#1: Chindu’s budget speech

All scheduled commercial banks and all RRBs are on core banking solution (CBS) and on the electronic payment systems (NEFT and RTGS).

We are working with RBI and NABARD to bring all other banks, including some cooperative banks, on CBS and e-payment systems by the end of December 2013.

#2: RBI’s notice to UCB

in March 2013, RBI issued a notice that Many Urban Co-operative Banks (UCBs) haven’t implemented the core banking

solutions (CBS) yet. We’re giving them deadline: Dec 2013. If they do not implement core-banking solutions by that time, then we (RBI) could

deny them various approvals (e.g. permission to open new branch etc.)

Why UCBs haven’t implemented CBS?

All the state-owned commercial banks have implemented CBS system already. But other Urban cooperative banks at district level are unable do it due Lack of funds

(takes lot of money to setup server, buy licensed softwares, intenet bill etc). Although RBI maintains that in long term, use of Information technology and CBS 

will reduce the cost of operation so it’s a win-win situation if UCBs implemented the CBS.

Finally, conclusion, summary, what do we get from fifth chapter?

Conclusion

Indian Government started reforming the financial markets under LPG reforms in 90s.

The results of these reforms have been encouraging. Today, India has one of the most vibrant and transparent capital markets in the

world. But still there are certain challenges before Indian capital market becomes an

important avenue for investors – both foreign and domestic. 1) Our corporate sector requires long term funds (@low cost), and 2) we need lot of money for infrastructure project.

To help ^these two, we need three things

1. Well developed Banking system…already present2. Well developed equity market….already present.3. Well developed corporate bond market…yet to develop.

So, Government needs to take policy initiatives for developing a robust corporate bond market. These policy initiatives include:

1. Need to strengthen the legal, regulatory framework for corporate debt market.2. Legal regulatory framework for financial products which is new or still in nascent

stage e.g. municipal bonds, credit default swaps.3. At present our public sector organizations related to pension-insurance sector (LIC,

EPFO) cannot invest lot money in corporate debts. Government needs to relax their investment guidelines.

Infrastructure development funds (IDF)

IDF are already discussed in earlier article click me Infrastructure Development funds will financing the long term infrastructure projects

@cheaper cost. However, for the IDF to become effective, Government needs to take policy

initiatives. (allowing public sector insurance and pension funds to invest in them).

Financial literacy

Investment will not come just by relaxing the legal/regulatory framework. You need to encourage people to invest in capital market.  (and to prevent them from

investing all their money in gold- because gold purchase increases current account deficit and creates more problems for Indian economy).

Govt also tried to give the “carrot” of RGESS. But challenge : much of the target audience doesn’t have PAN card and DEMAT account.

Banks

Banking Laws (Amendment) Act 2012 already discussed click meo This will  give more regulatory and supervisory to RBI ando help banks in raising funds from the capital market for expanding their

banking business. SARFAESI act amendment help banks reduce their NPAs. Other issues related to RRBs, NABARD etc given in this article itself.

Pension

Pension reforms in India

1. Will facilitate the flow of long-term savings for development2. Will help establish a credible and sustainable social security system in the country

But challenge: NPS is not popular due to low commission, bill pending in parliament. More explained earlier, click me

Insurance

Chindu gave revival package. Challenge: Less insurance penetration, FDI Bill pending in parliament

Mock Questions

1. Correct Chronological order (older to newer)a. NABARD, RRB, SHG-Bank linking programb. SHG-Bank linking program, RRB, NABARDc. RRB, NABARD, SHG-Bank linking programd. None of Above

2. RRBs are sponsored bya. NABARDb. RBIc. Commercial banksd. None of Above

3. Correct statement about Priority sector lending (PSL)a. RBI has mandated that banks should lend maximum 40% of their advances to

PSL.

b. As per RBI rules, the Priority sector lending target for foreign banks is higher than Indian banks.

c. Both A and Bd. None

4. Who benefits from Priority Sector Lending?a. Small scale industrialistb. exporterc. education loan seekerd. All of above

5. Priority sector lending targets _____a. Are Uniform for all foreign banks in Indiab. Depend on number of branches a foreign bank has.c. Donot apply to any foreign banks.d. None of above.

6. Priority sector lending (PSL) target for foreign banks, is decided bya. Department of Economic affairsb. NABARDc. RBId. None of above

7. Ultra Small (bank) branches are meant fora. Army cantonmentsb. Near SEZ unitsc. Village covered through Banking Correspondence Agentsd. Major and Minor sea Ports

8. The main purpose of Ultra Small (Bank) branches isa. Provide easy loans to exportersb. Provide easy loans to importersc. Achieve financial inclusiond. None of above

9. Swabhiman scheme is associated with _____ sector.a. Healthcareb. Pensionc. Educationd. Banking

10. Swavalamban scheme is associated with _____ sector.a. Healthcareb. Pensionc. Educationd. Banking

11. Rural Infrastructure Development Fund is operated bya. Ministry of Rural affairsb. Planning commissionc. NABARDd. None of above

12. Who among the following implements SHG-Bank linkage program?a. Commercial banksb. Regional rural banks (RRBs)c. Cooperative banks.d. All of above

13. RBI regulates the interest rates ona. Interest rates on loans given to exportersb. FCNRc. Savings depositsd. None of above

14. Arrange these bank accounts in the ascending order of interest offered to customer (smaller to bigger)

a. Current, Savings, Term depositb. Term deposit, savings, currentc. current, term deposit, savingsd. none of above.

15. What is the similarity between industrial development bank and a commercial bank?a. Both accept deposits from publicb. both provide short term finance to industries.c. Both A and Bd. None

16. Which of the following is All India Financial institutiona. SIDBIb. NABARDc. NHBd. All of above

17. first industrial financial institution in India wasa. IFCIb. ICICIc. SIDBId. UTI

18. National housing bank has launched Reverse mortgage product for benefitsa. Senior citizensb. studentsc. industrialists setting up new coloniesd. None of above

19. Which of the following has not fully implemented core banking solution yet?a. Scheduled commercial banksb. Regional rural banksc. Urban cooperative banksd. None of above

20. Core banking solution meansa. Bank doesn’t sell mutual funds, insurance policies but concentrates on its

core banking operation.b. Information related to a customer’s account is stored in a centralized server.c. Indian bank offering outsourcing services to foreign banks.d. None of above.

21. For a bank customer, Core banking solutiona. Prevents him from getting services from branches other than his local branch.b. helps him avail banking services from any branch of his bank.c. Helps him buy mutual fund and insurance policies via local branch.d. None of above.

22. Which of the following is an example of NBFC?a. Infrastructure Finance Companies,b. Infrastructure Debt Fundc. Both A and Bd. None

23. correct statement about NBFC-factoring companiesa. They’re infrastructure companies that help entrepreneur in setting up new

factory.b. They’ve to register themselves with RBI.c. Both A and Bd. None

24. A gold loan companya. is an example of NBFC

b. Has to follow the Loan to Value ratio stipulated by SEBIc. Both A and Bd. None

25. for a bank, low Capital adequacy ratio (CAR) meansa. It has low capacity to absorb losses.b. It has high capacity to absorb losses.c. Bank will be exempted from SLR requirementd. None of above

26. If you have to deposit your savings, which of the following bank is most reliable?a. Bank with low CAR and low NPAb. Bank with low CAR and high NPAc. Bank with high CAR and high NPAd. Bank with high CAR and low NPA

27. If you have to deposit your savings, which of the following bank is least reliable?a. Bank with low CAR and low NPAb. Bank with low CAR and high NPAc. Bank with high CAR and high NPAd. Bank with high CAR and low NPA

28. Correct statementa. A Bank customer doesn’t earn interest on current accountb. A Bank doesn’t earn interest on CRRc. Both A and Bd. None

29. Who among the following, will help a bank reduce its NPA?a. Asset reconstruction companyb. NBFC-factor companyc. Both A and Bd. None

30. Interest subvention schemea. was started in 2006 and stopped in 2012b. is applicable to long term agriculture loansc. bothd. None

31. Example of Multilateral development bank?a. SIDBIb. IDBIc. ADBd. None of above

32. Who among the following, is outside the regulatory control of RBI?a. Urban cooperative banksb. SIDBI, NHB and EXIM bankc. Multilateral development banksd. None of above

33. MBN Rao is to prepare the blueprint for _____a. GAARb. Food securityc. India’s first women’s bankd. India’s first multilateral bank

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