The Economic Survey is optimistic....Mint 1st February 2022

 https://www.livemint.com/opinion/online-views/this-year-s-economic-survey-has-cautious-optimism-written-large-11643649785632.html

Economic Survey provides a lot of cheer on the state of the economy: Business Standard 31st January 2022

 The much-awaited Economic Survey provides a lot of cheer on the state of the economy and the way forward. It cautions on areas of concern, which if known beforehand, are easier to tackle as they do not come as shocks. It is hence a good precursor to the Union Budget, which can consider these thoughts.

Two things ring the positive bells. The first is the take on growth. We are already aware of what the CSO has projected growth at 9.2 per cent for FY22, which has been moderated to an extent by the third Covid wave. If this is kept behind us, the Survey assumes maintenance of economic growth momentum at 8-8.5 per cent in fiscal 2022-23 (FY23), and hence is more conservative than the IMF, which has pitched for nine per cent growth. By pointing to the assumptions made like commodity prices and inflation and restoration of supply chains, it rightly takes a more nuanced view on growth.

Growth is expected to more or less even across both consumption and investment, though the bet is that the latter will be the driver. This sounds good because if the private sector sees an uptick in investment, it will carve the route to sustained growth. The government may just opt for a higher allocation next year. This is the second bit of the good news.

The government’s revenue has been better-than-expected in FY22 notwithstanding the second wave. Therefore, there is reason to believe that the deficit will come in lower-than-expected. This provides room for more expenditure on the development side. But the crux for the government will be to ensure that the money is spent from April onwards and not held back keeping the budgetary numbers in mind. In FY22, the progress has been gradual as the second and third waves have come in the way of speedier implementation. Hopefully, this will not be an issue next year.

Higher growth also means that the government will have the luxury of tax collections increasing (as consumption is expected to revive), which will help to narrow the difference between income and expenditure, thus providing scope for higher expenditure without the need to borrow more. The call on fiscal deficit taken during the Budget will, however, provide a clue to the market on what the quantum of gross borrowing will be.

Some interesting thoughts have been expressed on other areas. The first is on crop diversification. This is something which agri experts have been arguing for long, and there is evidently a need to get into the act of producing more pulses and oilseeds. This will help to reduce the dependence on imports and hence protect against inflation. It may be pointed out that inflation today is high as global prices of edible oils have increased sharply with revival in demand. India, being the largest importer with over 60 per cent of consumption coming from global markets, has been buffeted by high inflation. If we can change this matrix, it will be very useful.

Second, the Survey has lauded the PLI scheme, which is indicative of probably higher allocations to be made for this scheme to cover new sectors in FY23. PLI is probably one of the most progressive schemes to be announced as it gives credit when there is performance. As the government has moved away from freebies to merit based allocations, the PLI fits the bill very well. In fact, the response so far as pointed out by the Survey has been very good and this will lead to higher investment in the next couple of years and hence employment and consumption in subsequent phases.

Third is the approach with respect to PSUs. The sale of Air India has been a major success for the government, and if combined with the National Asset Monetisation plan, one can see better value being derived from the PSUs. These plans were mentioned in the Atma Nirbhar agenda in 2020 and have now moved several steps ahead in terms of implementation. One can see positive fallouts for the capital markets, too, as more SPVs come in and the quantum of InviTs and ReITs increase.

Clearly, direction has been provided by the Survey while also cautioning on inflation where a large part, which is imported is the challenge. It needs to be seen how the Budget is able to address this and how the Reserve Bank of India (RBI) views the same when it brings out its policy on the February 9.

Banking on the budget with no surprises: Business Standard: 31st January 2022

 https://www.business-standard.com/article/opinion/banking-on-the-budget-with-no-surprises-122013100001_1.html

Finance minister should strike fine balance in budget: Indian Express 25th January 2022

 Drawing up a budget is interesting as well as challenging work. There is a plethora of demands from all sections, especially industry. The call for lower corporate tax rates is always amongst the requests made to the finance minister. Sectors want benefits through lower indirect taxes. As GST has blocked one avenue of demand, the focus has turned to customs. The inverted duty argument has got some traction, but the issue is that output for one industry can be input for another. Then there are economists who clamour for higher government spending on capex, even though it is admitted that pushing the economy along will require the private sector’s leadership — Rs 5.5 lakh crore of central government spending cannot drive an economy of the size of Rs 232 lakh crore. Then there are voices of households who need tax concessions as they are affected the most by inflation.

The finance minister has to work with these pressures as well as the uncertainty of how the economy will behave. Government revenue is based on how the economy grows and if there are lockdowns and people cannot consume goods and services, GST collections are likely to be affected. The assumption, therefore, has to be realistic. On the expenditure side, there are several committed expenditures like interest on debt, salaries to employees and pensions to ex-employees. Add to this the subsidy that has to be given for food and fertilisers, and the government’s hands are tied to a large extent. This fine balancing act has to be performed keeping in mind that the ultimate number that analysts and rating agencies look at is th

Given this background, what can one realistically expect from the budget? The starting point is the fiscal deficit ratio because this will be the crux of the calculations as it also indicates the quantum of borrowing in the market. The deficit was targeted at 6.8 per cent. But it could come anywhere between 6.5 and 7.3 per cent depending on how disinvestment fares and how the additional Rs 3 lakh crore of expenditure materialises. The government has maintained the borrowing programme at Rs 12 lakh crore and will strive to bring it down to avoid overcrowding in 2022-23 when the private sector demand for credit will take off. Therefore, a deficit closer to 6 per cent is what may be expected.

On the taxation side, there are few options for the government as GST has fixed the perimeters of what can be tinkered with. The corporate tax rate was lowered in 2019 and it is unlikely to be touched again. But it would be timely to provide sops to individuals, which though marginal, could be useful. The standard deduction for individuals can be enhanced to Rs 1 lakh which will help the working class. Further, as housing is a thrust area of the government, it may be expected that the government will enhance the deductions on principal and interest payments on house loans. An additional Rs 50,000 may be permitted on each of them. To provide support to savings, which are receiving low returns on deposits and other fixed income assets, the limit under 80C should ideally be increased by another Rs 1 lakh to Rs 2.5 lakh.

The challenge will, of course, be on the excise side where the government has received good returns from the duties on petrol and diesel. With the tax rate being cut by Rs 10/litre during the year, there may not be more scope for further reduction. This means that the assumption on crude oil price has to be realistic. Some forecasters are already talking of a level of $100 a barrel during the year. If this does happen, inflation will heighten which, in turn, will again put pressure on both the Centre and state to take a call on taxes.

Since there has been an animated debate on cryptocurrency recently, an announcement of a policy on cryptos cannot be ruled out. The gains from trading could be made taxable, probably at a higher rate than other financial transactions. Further, as cryptos are in the nature of gambling and do not add value, all gains would be of a speculative nature. Given that a stock of at least Rs 7.5 lakh crore is partly traded, there is a scope for picking up considerable revenue. This would be the right time to tax these gains.

For the corporate sector, the announcements are more likely are to be in the area of the credit guarantee programme, which can be extended for another six months and more sectors brought under its ambit, including the services segment — hotels, restaurants, malls, entertainment, travel agencies — that is amongst the worst sufferers of the pandemic’s third wave.

The expenditure side may not have any surprises and it will be just a case of focusing on existing headings of expenditure and then taking a call on where the thrust should be. With the fiscal deficit being pegged at 6 per cent, the absolute level, assuming 13 per cent growth in the GDP would be higher than that projected for 2021-22 at Rs 15.06 lakh crore by around Rs 50,000 crore. Therefore, the scope for manoeuvring the expenditure will be restricted to a large extent and the choice may really come down to looking at relief expenditure and capex.

The former is important when times are adverse like they were in 2020-21 and to an extent in 2021-22. The PM Kisan scheme, free food, MGNREGA are examples of programmes that have been scaled up in these two years. Depending on how the government sees this wave of Covid playing out, a decision could be taken on whether or not it has to persist with aggressive relief and health policies. This will, in turn, support the higher allocation for capex which is the main block for driving growth directly from the side of the government.

This budget will be exciting for economists and analysts as several numbers have to be put on the table. The government has already put forth some effective policies to push growth like the PLI scheme. The budget, therefore, might have a limited reforms content. The task should be trying to get more bang for the buck so that the multiplier effects are higher while giving concessions on taxation where required.

The only constant | Book Review – How to Change: The Science of Getting .....Financial Express 23rd January 2022

 Change is something that we are always afraid of and hence prefer status quo. This can be from rudimentary things like being regular with exercise or saving for the future. While these goals sound logical and fairly straightforward, they are hard to follow. This is the crux of Katy Milkman’s book, How to Change, where she tells us how to get over the obstacles that come in our way in accomplishing these rather simple goals.

The book is based on simple principles of psychology, which the author combines with her experience with companies as well as experiments. Companies, for instance, offer several facilities as well as health schedules to keep employees in good form. This could be not just gyms but also provisions for vaccine shots. Yet the response is never encouraging. So what are the issues here? She gives seven obstacles that must be overcome for us to achieve our goals. To begin with, getting started is important. How do we break out from the routine and start a new life of dieting or saving? Often, we make New Year resolutions, which is a ‘date’ from when we decide to turn over a new leaf. It can also be one’s birthday or crossing a threshold age. It can happen when something affects you or your family and the latest can be Covid where one may suddenly get health conscious and start doing the right thing. A strike in London of the metro brought about a sea change in several lives as people walked more and this became a habit.

One hurdle that all of us can identify with is procrastination, as we prefer the present to the future. By postponing the present to the future we buy time, but at some point, it becomes too late to change when our monetary situation is weak or health fails irrevocably. She gives an example of a locked savings account which forces one to save. This is more like the provident fund which we have, which is forced savings whether or not we want it.

Another obstacle that we all encounter is forgetfulness which afflicts us at various points of time. The author recommends making a written plan preferably and following it so we do not ‘flake out’ notwithstanding our intentions. This is something that is observed during elections where people give their commitment to a party but ‘flake out’ at crunch time, which often upsets calculations. Therefore, she recommends breaking up plans into small bits sequentially so that one follows them in pieces, which is easier to adhere to.

The tendency to follow the path of least resistance is an obstacle to change. Doctors normally follow a standard procedure and never really think of closer scrutiny before giving medicines. Therefore, often during the epidemic, doctors suspect Covid and put the patient on a medicine regimen which may not be required. The so-called standard operating practice that is now a habit makes it an easy decision but has costs.

Milkman gives the example of a public hospital in USA where doctors blindly prescribed medicines that were not even required. When questioned, they accepted that they could have reduced the dosage or given cheaper alternatives that would have saved the health system a lot of money.

This way the author goes through all the hurdles that come in the way of us becoming resistant to change and exhorts the readers to make a genuine attempt. A simple experiment was carried out in a hotel where half the staff had their blood pressure and other health parameters monitored every day after being told the purpose. The other half were not. Those who were told that their health was being monitored tended to become more conscious in their attempt to remain healthy through diet and walks compared to those who were not told. Hence small signals like these can make a difference.

Peer pressure, for instance, is another technique that can be used to bring about change. Seeing others exercising in your housing complex or colleagues eating healthy meals can make one change too. One of her experiments was informing people in a locality every month about the power consumption of all homes. As long as people saw these numbers they tended to economise. Once this was stopped, people went back to their old ways.

The author warns that due to deeply ingrained mindsets, effecting change is not easy. Transformation according to the author is a slow process and it is like treating a chronic disease, which requires patience, endurance and resolve. It is not just starting the new regimen that is important. Sustaining it will make a difference and hence one must be regularly reminded of the same.

This is a useful book as it helps to bring about change in the way we live our lives. What is necessary is to identify our goals and show resolution in implementing the plan.

Madan Sabnavis is chief economist of Bank of Baroda

How to Change: The Science of Getting from Where You Are to Where You Want to Be
Katy Milkman
Penguin Random House
Pp 249, Rs 599

A Budget for consolidation? Businessline 22nd January 2022

 

There is little room for any kind of largesse, and sector-specific demands are unlikely to be part of the Budget as there would be severe constraints in increasing expenditure

It may sound clichéd to say that the Union Budget to be announced will be more important this year, because this is so every time it is presented. FY23 will be different because it will be the start of a new era for the economy where even a possible fourth wave will have less of a negative impact in the form of lockdowns as the earlier ones. The country is better prepared to face these waves as a large part of the population is vaccinated and the governments know how not to debilitate economic activity.

The Budget is actually an income and expenditure statement of the government but has evolved to become a comprehensive policy document where every constituency has something to demand. Therefore the pressures on the Finance Minister are several and balancing these demands with the inherent constraints of any income-expenditure statement is the challenge.

The government has acted responsibly even during the pandemic and while the fiscal deficit ratio did overshoot in FY 21 by 6 per cent to reach 9.5 per cent of GDP, it was caused by a combination of sharp fall in revenue receipts and higher outlay on necessary relief expenses. There were otherwise few freebies given through tax cuts to the public.

Glide path

The new FRBM norms talk of the glide path to 4.5 per cent fiscal deficit ratio by FY26. This means that beginning from 6.8 per cent targeted for FY22, there has to be a reduction gradually by at least 0.5 per cent of GDP every year so that this target can be achieved. Therefore this would be the starting point of the exercise and even if pegged to 6 per cent would mean a deficit of ₹15.5-15.75-lakh crore, which will be slightly higher than that budgeted for FY22 at ₹15.06-lakh crore.

This indicates the intensity of the borrowing programme of the government which will remain high for sure. This is the first number to look out for which will also set the boundary within which the government has to operate.

The assumption of GDP growth is important because this becomes the basis for conjectures on tax revenue. GDP growth of 13 per cent looks likely to be assumed which takes in both real GDP growth as well as inflation. The crux will be on consumption increasing in tandem as GST has a share of 28-30 per cent in total tax revenue.

The wild card will once again be disinvestment on the revenue side. In FY22, ₹1.75-lakh crore was targeted and it is still not sure if the big ticket of LIC goes through. This is where it will be a puzzle. If LIC goes through this year, then this amount will not be available for FY23 as there are no other big tickets that can garner such an amount.

The two public sector banks (PSBs) which the government spoke of will not materialise this year which means that it can be pushed to FY23. Therefore, successful LIC disinvestment will mean a lower amount for FY23 which has to be in the region of ₹75,000-8000 crore assuming the two PSBs and BPCL materialise. With this amount coming down the scope for expenditure will also reduce correspondingly by ₹1 lakh crore.

Expenditure targets and programmes have to hence be planned once the fiscal deficit number is fixed which will be based on a GDP growth number and the disinvestment target. On the expenditure side, too, there are issues. If one looks at the total expenditure of ₹34.8 lakh crore in FY22, the big tickets included were interest payments (₹8.1-lakh crore), defence (₹3.5-lakh crore), subsidy (₹3.4-lakh crore), and pension (₹ 1.9 lakh crore).

These four heads account for 48 per cent of the total budget and are in a way permanent expenses. There is further a committed expense of ₹2.6-lakh crore for salaries which get allocated across various ministries and ₹2.9-lakh crore of transfers to States to carry out certain centrally sponsored schemes. Therefore, around 64 per cent of the budget cannot really be cut in a significant manner.

With 35 per cent of funds available now for allocation, it is a case of balancing out priorities and this is where the government has to take a realistic call. Rural and health are two inescapable expenses and there were around 7-8 per cent of the budget last year. Given that the health priority will continue to dominate during this year with the talks of a booster vaccine being administered to all the people, higher allocations would be required for this purpose.

Ever since the government launched the PM Kisan scheme which provides cash transfer to a large section of farmers with a ticket size of ₹65,000 crore, intuitively cannot be reversed or terminated. Therefore another 1.8 per cent gets caught up in the committed sphere. The call to be taken will be on relief expenditure and whether the free food plan would be extended into FY23.

Therefore practically speaking there would be severe constraints in terms of increasing expenditure in any specific area. The usual argument put forward by economists is to increase capex as this has multiplier effects on the economy in terms of creating jobs and income and hence consumption with a lag. Here, too, the pattern so far is quite interesting. In FY22, the government has targeted ₹5.54-lakh crore of capex.

Within this segment, defence has a claim of ₹1.35-lakh crore which is almost 24 per cent of total. Another 44 per cent goes to roads and railways (₹1.08-lakh each) and urban development (₹0.25-lakh crore). Around 14 per cent goes as capital assistance to lending institutions and transfer for the National Infrastructure Pipeline. Given this structure of capex, at a practical level an increase of not more than 10 per cent can really be expected.

All this means that we must be moderate in our expectations. Sector-specific demands are unlikely to be part of the Budget. The vulnerable sectors could be included under the ECLGS of the government and SMEs and start-ups would continue to be focus points in terms of clearances, payments and credit. There could be some minor benefits to individuals on the tax front as there is little room for any kind of largesse. This will be more of a consolidation budget which, ultimately, makes the task easier.

Should the budget give middle class relief: Times of India 20th January 2022

 https://m.timesofindia.com/india/should-the-budget-give-the-middle-class-tax-relief/amp_articleshow/89020230.cms

Look out for the FY22 revised estimates: Financial Express, 14th January 2021

 Budget FY23 will, of course, be important for the content and its take on the economy, given the Union government has to necessarily take a call on how it thinks the third wave has affected the economy and accordingly make provisions in the Budget.

But, also important will be the revised numbers for the different estimates for FY22. What exactly should we watch out for in these numbers?
The most important number that most watchers will be waiting for is the fiscal deficit ratio that was targeted at 6.8% for FY22. The assumptions on growth were well-placed, but given the course of the pandemic situation and the economy over the year, there have been several announcements made on expenditure that are outside the FY22 Budget.

Revenues, on the other hand, have been meaningfully buoyant, leading to the interesting situation of higher revenue and expenditure with no additional borrowing from the market. To the advantage of the Budget, the denominator has expanded at a higher rate than expected and would be Rs 232 lakh crore against a budgeted number of Rs 223 lakh crore.

There is a benefit of 0.3% of GDP that would accrue to the government under ceteris paribus conditions.

The second point of note would be the disinvestment course. There is considerable debate on whether this will be completed by the end of the financial year, and while the FM has assured that the big disinvestment of LIC will take place in March, this will be confirmed in the FY23 Budget.
Besides, the government has to mobilise 1.75 lakh crore, of which1 lakh crore is for LIC.

What about the rest of the amount? The progress so far has been quite sluggish, with the first eight months yielding just under Rs 10,000 crore.
The Air India deal, to be consummated in December, will not give more than Rs 2,700 crore to the government.

The third number of note would be the over-achievement on the tax-revenue front. There has been a significant bump-up in GST collections in particular, and the performance of corporate India has been very good, yielding a larger-than-estimated kitty of tax revenue. The government has given up a bit, of course, in excise on fuel products as the duty was reduced by Rs 10 per litre. The exact hit on the government compared with the targeted amount would be of interest. As there will be lockdowns of different magnitude over the next three months, overall consumption of petrol would also come down thus affecting revenue.

The fourth is the commentary on the sale of two public sector banks. This will probably not happen in FY22 as there have been no announcements as yet. Therefore, the stance taken on these sales will be of interest. These sales could potentially be big-ticket ones for the government as and when they materialise.

The fifth point of note would be the capex of the Centre. It was targeted at `5.54 lakh crore for the year, and, so far, it looks like that the government may be on the right path.

This will also form the base for future expenditure on investment projects. Given the low level of private investment in the economy, the Union government has been taking the lead when it comes to capex, as even the states have been conservative due to the FRBM constraints.

The point of interest would be whether it would be higher this year, as the case was in FY21 when the government spent an additional Rs 27,000 crore.

Sixth, the government has spoken of additional spending on fertiliser subsidy, of Rs 58,430 crore. So far (up to November), the spending on this count has been only Rs 65,004 crore against a budgeted Rs 79,566 crore. With the sowing of the rabi crop over, the demand for fertilisers would be low until the next seaso, when most companies are expected to commence replenishing their stocks.

Seventh, the PM Kisan scheme: The budget had pencilled in a number of Rs 65,000 crore as cash transfers for the farmers this year. Last year, there was a slippage of Rs 10,000 crore.

Further there were announcements of Rs 94,000 crore as relief in the form of free food. The exact amount would be of interest.

The eighth point of note would be the MGNREGA programme. Here, there was a lower allocation of Rs 73,000 crore compared with FY21, when it was Rs 111,500 crore. The supplementary demand was made for Rs 23,000 crore. Around Rs 86,000 crore has already been spent with another three months to go.

The government has been borrowing separately to compensate states for the GST shortfalls which is not a part of the regular government borrowing programme. However, this amount would have to be accounted for and the market would be keen to know.

Therefore, the revised numbers for FY22 would be as important as the new proposals since this year has been challenging, where the government had to intervene in several areas to provide corrective action.

on Mirror Now 12th January 2022

https://www.youtube.com/watch?v=8Kc-l1s-UPY

 

Watch out for an official central bank digital rupee soon: Mint 13th January 2022

 

Just think of this situation. It is eight o’clock in the evening, and there is an announcement made that from here on, all rupee notes are being withdrawn and replaced with a digital currency called CBDR, short for Central Bank Digital Rupee. People need not panic and have a week’s time to visit a branch of the Reserve Bank of India (RBI) or any public sector bank and exchange all their currency for digital rupees. No questions will be asked. An account will be opened with RBI, and based on one’s Aadhaar card and PAN card details, the amount will be automatically transferred to it for access through a registered mobile phone. The transaction will take just a few minutes and one can step out of the branch with money loaded on one’s handset. Does this sound fantastic? It may sound as much, but this is a credible possibility.

The likelihood of such a scenario has been raised by active talk in various countries, including India, of launching a central bank digital currency (CBDC) that will make it easy for us to carry and use money. Some left-wing economists would likely object, calling it Orwellian or Kafkaesque and clearly dystopian. India has at least 500 million people with no access to a smartphone (Statistica reports the use of 845 million phones in 2021). Large numbers have neither an Aadhaar nor PAN card, or even if they do, are not in the habit of using phones except for making calls. Many of our senior citizens have already been swindled by online scamsters and would be in a spin with a CBDR.

Right-wing progressive economists, however, would likely say that this is the way to go and it is happening everywhere, and that we should adapt and not shy away from technology. The elderly and poor must adapt to this new system and it would be bad for them if they don’t.

We heard similar views during demonetization in 2016 and hence can expect CBDR discussions dominated by the two arguments outlined above.

What exactly is a CBDC? When central banks convert paper currency into a digital version, it would be called a CBDC. This will happen officially and would not be driven by crypto maniacs or the more orderly e-wallets around, though the concept is the same. Today, we swipe our phones to make payments through various wallets, which can be private or UPI-based. Money is drawn from our bank account or kept in these exogenous wallets. So, what really is the difference?

The distinguishing factor is that the ₹30 trillion of currency that currently exists would be consigned to the burner and will be transferred to our digital accounts. It has to be managed by the central bank or else it would be the same as e-wallet money, which have a cost attached by way of either a direct charge or loss of interest on the balance kept with the facility. Clearly, RBI cannot insist that a digital rupee has to be kept with banks or in e-wallets. In fact, RBI could incentivize people to adopt it by paying about 1-2% interest.

The advantage of paper elimination for the government would be that every rupee in the country could then be traced, in contrast with the currency presently held by our population. This means that if we spend heavily and pay by cash for a wedding party, say, then it can be tracked by tax authorities. Even the cash gifts would have to be digital. The same would hold for cash paid for property; real estate developers often still take cash as they have paid cash to get clearances or for land. The system will hence get cleansed.

It would also be an intrusion of privacy, as every monetary action of ours could be tracked by the taxman, be it frequent visits to a high-end restaurant or beauty parlour. Problems will arise if the counter-party has no account of a payment (like, say, a beggar). The judiciary would have to be consulted on this, as it involves privacy issues.

If tracking transactions is not an aim, then what could be the larger purpose? One disingenuous argument often given is that it will save on the cost of printing currency. The annual cost of printing notes for RBI is around ₹4,400 crore, while its total income is around ₹1.5 trillion. Therefore, cost is not a factor. Another argument put across is that it helps in government transfers to the needy, as in the PM Kisan scheme, rural employment guarantee, etc. But the government has already gotten around 440 million Jan Dhan accounts opened for India’s needy, so a system already exists for such transfers. Do we need another vehicle?

All outcomes have to be considered, even if one discounts the disruption at the individual level. The first is that the entire financial system could go into a spin. Payments banks will need to close down, as savers will have to maintain accounts with RBI anyway. The UPI system would be redundant. Even commercial banks will see people move money out of savings deposits and probably opt for term deposits at higher rates. Regular accounts served as cash anyway, though they often also have restrictions on withdrawals. It would make sense to dispense with these accounts. ATMs will have to shut down, for sure, and this industry will vanish along with its retinue of security guards and companies that ferry cash.

The other major challenge for our central bank will be technology disruptions. Hackers would be a threat. We still hear of technical failures at banks, which close for maintenance on holidays.

Paper cash has always been the last resort for transactions. But what if there is no paper cash?

Discussion on Budget expectations with Business Today

 https://www.businesstoday.in/news-reel/video/budget-2022-expectations-with-top-economists-boostershotbudget-318783-2022-01-12

Economic laws don’t always hold: Business Line 10th January 2022

 

Bond yields, food inflation, credit growth and rupee value don’t seem to be guided now by the forces of demand and supply

The rudimentary law of supply and demand mentioned in textbooks has suddenly run into ambiguity in the Indian context. Therefore, the reasoning of higher demand leading to higher price or higher supply bringing down price is passé. Also, lower price does not necessarily lead to higher demand which should normally be the case. Let’s see how these violations of economic laws have taken place this year.

First look at the G-Sec rate. The 10-year paper has now crossed the 6.50 per cent mark and the history in the current financial year has been that it has crept upwards, never relenting, notwithstanding the efforts of the RBI to keep liquidity in a surplus position all the time. The surplus is to the extent of ₹6-8 lakh crore on a daily basis. This has been done by inducing funds through G-Sec Acquisition Programme (which has been stopped now), besides the surpluses generated within the system. The bond yields should ideally have come down. In fact, some auctions have either devolved on PDs (primary dealers) or been withdrawn by the RBI when the market did not accept a lower rate. Therefore, the law of supply did not work.

The reason is that the market expected a higher return on two counts. The first is that inflation has been rising and there are expectations that it will continue to be in the 5-6 per cent range this year till March. Therefore, the market has started looking at real interest rates. The other is the size of the government borrowing programme or rather the expectation of it exceeding the budgeted ₹12-lakh crore.

While the government has announced new expenditures, the indication given is that there will be no excess borrowing which is hard to accept even though tax revenue has been buoyant. Disinvestment is still in a state of flux and to think that around ₹1.6-lakh crore can be mobilised in the next three months sounds difficult. Therefore, the market is demanding higher yields from the auctions.

Lending rates

Second, as the RBI has maintained the repo rate at 4 per cent notwithstanding the rising inflation syndrome on grounds of growth being the driving factor, banks have lowered their lending rates in general. On a point-to-point basis the weighted average lending rate on fresh loans for all banks came down from 8.07 per cent in April to 7.98 per cent in November, though there have been variations in both the directions during the year. But the weighted average rate on outstanding loans came down continuously from 9.10 per cent to 8.91 per cent during this period.

Therefore, loans were cheaper. Yet increase in credit was just 3.3 per cent over March (1.7 per cent last year) and 7.3 per cent on a year-on-year basis. Quite clearly there is less demand for credit and hence price is not a decisive factor. In fact, today there is a rather absurd situation of some banks giving home loans at 6.40 per cent which is even lower than the rate at which the government borrows.

As of November, growth in credit to manufacturing was negative, being driven by large industry, while that in services was just 0.8 per cent. Agriculture and retail lending had enabled this minimal growth. Here the surplus capacity in industry has come in the way of demand for credit.

Third, while we have had the advantage of having a good kharif harvest this time, food inflation remains the Achilles heel. Prices of edible oils and as well as horticulture products have moved up quite menacingly, upsetting the calculations of the RBI. Further, even core inflation has moved up amid stagnant demand. This too calls for an explanation.

While overall kharif crop has been good, India imports 60 per cent of its edible oil requirements which in turn means that inflation gets imported when global prices increase. The monsoon withdrawal was later than usual — this has become a worrisome pattern in the last few years — which in turn has increased the prices of vegetables in particular. Therefore, steady growth in agriculture has led to spikes in inflation due to a couple of categories of products.

In the case of the so-called core products, which is non-food and non-fuel, the picture is different. Higher raw material costs due to an increase in global commodity prices have pushed up retail inflation of consumer, personal care and pharma products. Also, services like healthcare, education and entertainment have become more expensive.

Companies have adjusted their prices to retain solvency at a time when restrictions have been put on their operational capacity for entertainment or tourism. In the case of healthcare, it is a case of the hospitals leveraging a situation where there has been a sharp rise in demand which has led to prices being pushed up even though costs may not have changed to the same extent. Therefore, commodity and service price inflation has been more due to supply side factors than demand.

Last, the currency too has been quite whimsical. Normally textbooks say that the exchange rate is the result of demand and supply of dollars. During the year so far, the forex reserves of the country increased by around $58 billion. This should normally have led to rupee appreciation. But the dollar rate has fallen from ₹72.5-73 in April to ₹74-75 by December. This may be explained by the global factor where a stronger dollar versus the euro caused all currencies to slide which included the rupee.

Deposit rates

On the other side, if one looks at the balance sheets of banks, the picture on deposits is interesting. The weighted average deposit rate on outstanding deposits has come down from 5.26 per cent to 5.04 per cent. Here it is a situation of banks lowering the deposit rate to ensure that deposits do not increase as they have a negative carry of 165 basis points when invested in the reverse repo window.

Deposit growth has slowed down to 5 per cent from 6.7 per cent last year (as of December 17). Here the banks may be better off because the flow of deposits has slowed down. Households have gravitated to alternative avenues like mutual funds, stock coins and cryptocurrency. This can be a worry going forward for the system as higher risk is taken by individuals.

Therefore, the markets seem to be no longer guided by the forces of demand and supply; extraneous factors have guided the prices. This will be the way going forward too. Hence, we cannot assume that the demand-supply forces will drive prices. Welcome to the new market economics.