1.Formalization of Indian Economy (Down to Earth)

2.Recapitalising PSB (The Hindu)

 

1.Formalization of Indian Economy (Down to Earth)

Synoptic line: It throws light on the claims made in Economic Survey 2018 as how the process of formalization can be accelerated and figure out what are the deeper effects of this overdue change. (GS paper II)

Overview

  • The new Economic Survey provides compelling evidence of how the Indian economy is becoming more formalized. The reason this shift is important is not just because of the possibility of higher tax revenues for the government to spend; it is also about a profoundly different social contract between citizens and the state.

Reasons for shift

  • There are four key shifts that are mentioned in different parts of the Economic Survey.
  • First, the introduction of the goods and services tax (GST) has brought more firms into the tax net. The number of enterprises paying indirect taxes has gone up by 3.4 million, an increase of 50%. The bulk of the new entrants are enterprises that are in the business-to-business or export sectors, or what economists would call the production of intermediates.
  • Second, only around a quarter of the 240 million Indian working outside farms file their income tax returns. The controversial demonetization decision taken in November 2016 seems to have led to a statistically significant increase in the number of new income tax filers, after controlling for obvious problems such as the previous trend as well as seasonal patterns of change.
  • Third, the Indian workforce is more formalized than most people believed till recently. Nearly a third of the non-farm Indian workforce of 240 million has some social security coverage. And more than half of the non-farm workforce is employed in firms that now pay taxes.
  • Fourth, the demonetization shock is one reason and perhaps not the only reason why Indians are putting a greater proportion of their savings in the formal financial sector. Bank deposits swelled after November 2016, though the booming stock market has also made financial savings through mutual funds more attractive compared to gold or real estate.
  • These four shifts more firms paying indirect taxes, more individual filing income tax returns, a big increase in the proportion of formal jobs and the increase in savings in the formal financial sector can have profound effects on the Indian economy if they are sustained. It is quite likely that these claims will be the source of heated debate in the coming weeks.
  • It is useful to point out that much of the data offered by the finance ministry comes from the GST system, rather than from surveys. The mining of GST data is part of the welcome introduction of Big Data into Indian policy discourse. The Economic Survey released a year ago had similarly used Big Data and satellite images to estimate issues as diverse as interstate migration to the extent of Indian urbanization. The finance ministry economists deserve kudos for their methodological innovations.

Potentials for formal economy

  • The Indian nation state sits on a very weak fiscal base. It is neither able to invest in national security or provide public goods or create a social security system without running up destabilizing fiscal deficits. A careful data analysis shows that India has a tax-to-GDP ratio that is broadly similar to what other countries had at a similar stage of development. The question is whether that ratio can be increased as India gets richer, which is difficult unless more economic activity moves into the formal sectors. The new data offers hope.
  • However, the issue is not just about fiscal capacity. Modern social contracts are built on a wide base of tax payers. Almost all Indians pay regressive indirect taxes but too few of us pay progressive direct taxes. This newspaper hopes that more direct tax payments by individuals as well as enterprises will not only create fiscal space for lower GST rates but also provide incentives for citizens to demand better governance.

Way ahead

  • It is quite possible these four changes will lead to partisan debate about whether the formalization of the Indian economy can be explained by the two big policy risks taken by the government demonetization as well as the decision to push for a compromised GST. These debates will generate more heat than light. What is far more important at this juncture is to look at the claims made in the new Economic Survey more closely, ask how the process of formalization can be accelerated and figure out what the deeper effects of this overdue change is.

Question: How formalization of Indian manufacturing will help in economic development?

 

2.Recapitalising PSB (The Hindu) 

Synoptic line: It throws light on the issue of how recapitalising the banking sector may be helpful for economy. (GS paper II)

Overview

  • The Union government on Tuesday unveiled an ambitious plan to infuse ₹2.11 lakh crore capital over the next two years into public sector banks (PSBs) that are saddled with high, non-performing assets (NPAs) and facing the prospect of having to take haircuts on loans stuck in insolvency proceedings.
  • The move is vital for the slowing economy, as private investments remain elusive in the face of the “twin-balance sheet problem” afflicting corporate India and public sector banks reflected in slow bank credit growth.

Capital Infusion in banks

  • This would be funded through budgetary provisions of ₹18,139 crore and the sale of recapitalisation bonds worth ₹1.35 lakh crore. The balance would be raised by the banks themselves by diluting the government’s equity share.
  • Indiscriminate lending earlier by banks led to a high level of NPA and these NPAs were kept under the carpet. Now they have come to light because of the Asset Quality Review conducted by the Reserve Bank of India. The capital infusion would also be accompanied by a series of banking sector reforms.
  • About ₹1 lakh crore is expected to be pumped into India’s 21 public sector banks by March, which the Centre hopes will enable them to extend fresh credit lines worth over ₹5 lakh crore to spur economic activity.
  • Leaving aside the market-raising efforts by banks, over half the fresh capital of over ₹52,000 crore is being directed to the 11 public sector banks that the Reserve Bank of India has placed under the prompt corrective action, or PCA, framework.

PCA monitor

  • The RBI deploys the PCAto monitor the operation of weaker banks more closely to encourage them to conserve capital and avoid risks. For these entities, this capital offers a fresh lease of life as it will help meet regulatory requirements under the Basel-III regime as well as cushion them to an extent from possible haircuts on stressed loans that are going through the insolvency resolution process.
  • State Bank of India, the country’s largest, and the nine others that are out of the RBI’s PCA net will receive nearly ₹36,000 crore in order to strengthen their lending capacity.

Way ahead

  • Rating agencies have given the move the thumbs up, but remain unimpressed about governance reforms packaged with it. These include tweaks to existing systems for closer monitoring of big-ticket loans, identifying niche areas where a bank has strengths, restricting corporate exposure to 25%, and a new performance management system. Actual capital inflows will depend on their performance on these fronts and their ability to meet the government’s service priorities, including smoother credit flows to small businesses.
  • More structural reforms may well be on the anvil in the second half of this recap plan, which RBI Governor Urjit Patel had described as providing a real chance to meet the banking sector’s challenges for the first time in a decade. Yet, the absence of any reference to consolidation through mergers is glaring. Moreover, while the government has repeatedly ruled out privatisation of these banks, the only one where it intended to offload its majority stake

Question: What is recapitalization of banks? How the present initiatives of fund infusion will be helpful for the banking sector?