Current Affairs: Economy - Major Issues 10 to 18 August 2010

CAG Weekly
(Current Affairs & GK)
By Om Prakash (Goldy sir)

Reasons for the country's economic sweet spot

• The economy is growing much faster than the interest rate charged on government debt, ensuring a moderation in the debt-to-GDP ratio due to positive debt dynamics. India also has the advantage that more than 95% of its debt is financed internally. The country’s fiscal consolidation in 2010-11 has progressed much faster than anticipated. The factors that are responsible for this turnaround:
• First, the deterioration in central government’s fiscal deficit was as much a result of the cyclical slowdown as it was the large one-off payments made by the government. With one-off factors set to fade, the burden on fiscal finances will ease.
• Second, the government is benefiting from the return of cyclical buoyancy and an inflation tax. Nominal GDP growth has rebounded from a low of 5.6% year-on-year in Q2 of 2009 to a staggering 21% in Q1 of 2010. On an average, both real GDP growth and inflation are likely to exceed 8% in 2010-11, ensuring that the trend of inflationary recovery continues. In this backdrop, the government’s Budget estimate of 12.5% nominal GDP growth in 2010-11 is clearly an underestimate and we are likely to end up with nominal growth of 16% or higher.

• Tax buoyancy — defined as the percentage change in tax revenues divided by the percentage change in GDP — should rise too. Last year, the slowdown and tax cuts by the government had decelerated tax buoyancy from an average of 1.5 during 2004-08 to 0.3 in 2009-10. This is likely to rebound to above 1.

• Third, the government has enjoyed a bonanza on telecom spectrum and will benefit from higher disinvestment proceeds in 2010-11. Even in the coming years, disinvestment should continue to provide a cushion as new norms announced by the government on June 4 make it mandatory for listed companies to have a minimum 25% public holding, although public sector companies have been given a waiver and need only have a minimum of 10% public holding.
• Fourth, other incremental fiscal reforms are also ongoing. Petrol prices have been deregulated and the government has expressed its intent to deregulate diesel prices too. The government aims to implement structural tax reforms — such as the direct taxes code and the goods and services tax — on April 1, 2011, which should also add to revenue buoyancy.

Reserve Bank of India's discussion paper on entry of new banks

• Tighter guidelines
• The discussion paper, open for public debate, is a major step at framing new guidelines for entry. The Reserve Bank of India's discussion paper on entry of new banks in the private sector collates various, often conflicting, views on what is turning out to be a key aspect of banking policy and financial sector reform.
• It also brings up to date the central bank's thinking and international experiences with private sector banks.
• The Finance Minister in his budget speech, while calling upon banks to extend geographical coverage and improve access to banking services, had said that the RBI would be giving a few licences to select private sector players, including non-banking finance companies.
• The recent financial sector crisis showed the private sector banks in the United States and other advanced countries in a poor light. Almost all major banks in the U.S. and a sizable number in Europe had to be baled out by governments. Prudent regulation might have saved the Indian banks from the worst consequences of the crisis, but the RBI's experience with the private sector banks since the beginning of financial reforms has not been wholly satisfactory. Out of the 10 new banks licensed under the 1993 guidelines, only the four promoted by leading institutions have flourished.
• An important lesson from the experience of the 1990s is that neither a high capital adequacy requirement — of Rs.200 crore to begin with — nor advanced technology has been of particular help to many of the new entrants.
• The RBI has rightly chosen to address some of the key issues of bank licensing by listing out the pros and cons. On the hotly debated issue of letting leading industrial houses there are in, , to be sure, significant advantages in allowing them to run banks — among them are deep pockets and managerial ability. On the negative side, the banks might easily find ways to circumvent regulatory guidelines relating, for example, to group exposures and patronisation of promoters. Also, framing capital adequacy requirements for the new banks is not going to be easy.
• A higher entry level capital of Rs.1,000 crore might put off some genuine and otherwise worthy applicants but it is highly desirable in the context of the growing financing needs of the country. Non-banking finance companies seem to be the obvious candidates. They already deal with most of the banking products and are also regulated, though compared to banks they are subject to much lighter controls. It is just as well that an independent expert group is envisaged to vet and recommend eligible applications to the RBI.
• The six key areas of concern that the RBI raised in its discussion paper on allowing new banks-These relate to the minimum capital required to set up a new bank as well as promoter contribution, minimum and maximum limits on shareholding (both promoters’ and others’), the extent of foreign shareholding, the desirability of giving a licence to business and industrial houses or non-banking finance companies and, finally, the business model for new banks.

Shale gas -- the next big variable in energy consumption

• Shale gas was first produced in the US in 1989. As a natural resource, it is reportedly more democratic and is found in several countries.
• The size of global shale-gas reserves is not known. Potentially, every rock formation, above and under the ground, can have shale gas, but only the US has really tapped this resource. China is said to have the second largest deposits of shale, after the US. Geologists have also identified deposits in Poland and Australia. Elsewhere, including India, the work has barely begun.
• In 2009, shale gas accounted for 13% of US energy consumption; this is projected to increase to 25-30% in three years. It can change their energy production-patterns: how much tapped at home and how much imported? It can trim the clout of oligarchic oil producers by being a natural counter to rising oil prices.
• The share of gas in India’s energy consumption is 10-12%; this is expected to increase to 25% by 2020. A lot of the incremental gas will come from Reliance’s fields in the Krishna-Godavari basin. It will reduce India’s oil import bill by 10%, or $9 billion a year, during peak production, at current prices.
• Given its higher cost of production — $2.5-3 per mmbtu, against $1-1.5 per mmbtu for conventional gas found on land — the price of shale gas will be attractive to consumers only if it is not transported long distances or, worse, liquefied. That calls for a sweeping pipeline infrastructure, which India presently does not have.

India vows to fight liberal import of used goods

• India has opposed suggestion by some developed countries for more liberal trade in remanufactured goods or refurbished old products fearing it could harm the country’s domestic industry and also have environmental ramifications.
• In a submission to the World Trade Organisation, or WTO, India has said that it was not ready to take on commitments to lower trade barriers in second-hand goods though it will participate in the discussions on understanding and defining of remanufactured goods, a stand endorsed by Argentina, Brazil, Equador and Venezuela.
• Discussions on remanufactured goods are taking place as part of the global trade negotiations at the WTO.
• The Doha round for opening up trade in goods and services is expected to result in gains worth an estimated $282 billion. Global trade in remanufactured products has already crossed $100 billion, according to some estimates, with a large number of companies like GE, Xerox and Caterpillar engaged in it.
• India does not have clear-cut guidelines on remanufactured goods. It allows imports against licences for select items such as capital goods but others like second hand automobiles are strictly prohibited.
• Countries promoting trade in remanufactured goods argue that it helps both developed and developing countries by increasing access to lowcost, superior quality products while helping solid waste management and encouraging transfer of technology and skills.
• But India is apprehensive that it could lead to a deluge of import of lowquality cheap goods and actually amount to transfer of waste from developed to developing countries.
• Moreover, it could serve a serious blow to the domestic industry such as the automobiles and the IT sectors as refurbished goods could be several times cheaper than the original products.

India at the FATF high table

• On June 25, India became the 34th country to join the Financial Action Task Force (FATF). This puts India into one of the most critical standards-setting bodies in international finance, and will have far-reaching ramifications both for global capital operating in India, and the ability of Indian firms to undertake exports of financial services.
• In 1989, recognising the emerging complexities of money laundering in a world of technological and financial innovation, the G-7 and the European Commission established the FATF. This is an inter-governmental body aimed at creating a global policy environment that would combat money laundering and terrorist financing, by writing standards and monitoring the worldwide implementation of these standards.
• FATF is important to India from three points of view.

1. First, India faces terrorist attacks, and needs the comprehensive toolkit for law enforcement agencies to be able to track the money behind terrorist attacks, both within India and from other countries.
2. Second, India needs to combine an open approach to global capital alongside tough enforcement against terrorism and money laundering.
3. The third dimension lies in the country emerging as an exporter of financial services. FATF non-compliance is shaping up as a significant barrier in the export of financial services.