Why indian govt doing privatization of public sector banks

Intoduction

1. Due to the pandemic, India cannot afford to fund its banks. The dimension of credit growth and management of loans — the assets side of the banks’ balance sheet is considerably worrying. Therefore, the prescriptions is the often repeated agenda of Big Capital, which is the privatisation of Indian banks and handing over the banking system to investors.
2. Many countries have privatised their nationalised banks, including some from the erstwhile Eastern bloc countries. Argentina, Australia, Brazil, Bulgaria, Chile, Denmark, Egypt etc.
3. Before bank nationalisation, a few corporate houses controlled all funds, credit flowed into speculation and the agriculture sector had virtually no access to credit. Nationalisation ensured that a large chunk of India’s population could access banking facilities, farmers got loans and the state could direct the flow of credit to priority sectors.
4. Public sector banks are created out of public money. These entities are therefore duty-bound to extend all types of services to customers across categories. Privatisation will impact this very root purpose.
5. Private sector banks don’t share the government’s social responsibilities. Even in matters of recruitment, they don’t follow the government’s reservation policy or don’t show any enthusiasm in giving education loans to needy students. Thus, we can see that privatisation is not the solution for problems facing PSBs. 

The solution lies in making the public sector more robust, not pawning it in the hands of a few powerful individuals.

What are challanges

• Privatisation of PSBs is not going to be easy, as it would involve building consensus amongst various stake holders, including unions and parliamentarians.
• The decision to privatise inefficient PSBs, consistently delivering negative returns, would require wide debate.
• As the Planning Commission was a vestige of the socialist era, so is social banking. It is time to reconsider whether PSBs, are really required to serve the purpose of social banking in our country and at what cost.
• Therefore, it would be useful to have a high-powered, government-appointed committee, to devise exact criteria, modus operandi, the type of privatisation model to be adopted, and engage with the social ramifications before privatisation is actually undertaken.

Read More

What is role of RBI in indian Economy

Introduction

1.  Reserve Bank of India (RBI) is India’s Central bank. It plays multi-facet role by executing multiple functions such as overseeing monetary policy, issuing currency, managing foreign exchange, working as a bank of government.
2. Before inflation targeting was formally introduced in 2016, RBI was doing multiple roles. They were responsible for growth by managing liquidity as well as interest rates.
3. They also took care of the financial system’s stability by supervising banks and NBFCs.
4. Nobel laureate Joseph Stiglitz made a statement that if RBI Governor was the governor of the US Fed then the sub-prime crisis would not have occurred.
5. The RBI plays a vital role in economic growth of the country and maintaining price stability.
6. A six-member Monetary Policy Committee, headed by RBI Governor, decides the benchmark repo rate.
7. RBI acts as a banker for both the central as well as state governments.

Multiple roles:

1. That extraordinary performance made RBI the go-to-organisation for the government for multiple requirements which were inherently conflicting in nature.
2. Somewhere the adage “don’t repair what ain’t broken” was missed and we shifted to specialisation for RBI. It was like asking Kapil Dev to only bowl rather than contribute with all his talent since Malcom Marshal was a successful bowler.
3. Post 2016, RBI has been mandated to manage inflation and growth in that order of priority. We copied this idea from the developed economies where this idea has been put into cold storage when required.
4. ECB inherited inflation hawkishness from German Central Bank. During the PIGS (Portugal, Italy, Greece and Spain) crisis, caution was thrown to the wind and trillions of dollars worth of liquidity was pumped in at near zero to negative interest rates to support the euro.
5. During the subprime crisis of 2008, the US Fed pumped trillions of dollars worth of liquidity at near zero interest rates to support the crashing US financial system.
6. Bank of Japan has been doing the job of supporting the economy with more than ample liquidity and near-zero interest rates since the ’90s.
7.  What was told to Asian nations in the 1997 Asian crisis was conveniently forgotten by the western world in 2008 as well as in 2013

Inflation Control

1. RBI was constitutionally mandated in 2016 to bring inflation around 4% with a leeway of 2 % on both sides.
2. They have successfully brought down the menace of inflation.
3. It is important to not only bring down inflation but also inflationary expectations.
4. Indians, who are used to double-digit inflation for years, need to see inflation in lower single digit for sufficient period of time to get convinced.
5. RBI has maintained tighter liquidity and higher real interest rates to control inflation as well as inflationary expectations and started convincing Indians at large

What is way forward

1.  RBI has been mandated to manage inflation and growth in that order of priority.
2. They have won the war on inflation and are in the process of winning the war on inflationary expectations.
3. However, there is a price to be paid for the same in terms of below-potential growth.
4. What we require at this point of time is the old RBI that is an all-rounder rather than a specialist.
5. They have to manage multiple roles.
6. They have to manage inherently conflicting issues like inflation, growth, rupee and financial system stability.

Read More

Balance of payment, current account, capital account, rupee recovery, forex reserves - sschub

sschub - Many times you when reading newspaper, you will face keywords like BoP, Current account, capital account, rupee weakens, India's foreign reserves etc. but only few of us have basic knowledge about these terms. So this article will help you to understands all these what and how.ok so lets move.

What is Balance of Payment?

• Suppose you are going to get a company’s incoming and outgoing cash details, you’ve to check its account book.
• Similarly Balance of Payment (BoP) is the account sheet (summary)  that tells the cash flow between India and rest of the world.
• BoP =  Current account + capital account. (As per IMF definition, three parts: Current Account + Capital account + financial account).
• so just know a brief overview:

What is Current account

1. Import, Export (always negative, because we export less and import more oil n gold, hence we’ve trade deficit.)
2. Income from abroad (interest, dividends paid on Indian investor’s FDI, FII in USA etc.)
3. Transfer (gift, remittances from NRI to their families etc. always positive for India because of large Diaspora abroad.)

What is Capital account (+ financial account)

1. Foreign investment in India (FDI, FII, ADR, direct purchase of land, assets).
2. External commercial borrowing, external assistance etc.

• Since we want to track the flow of cash, so, whenever American invest in India (via FDI, FII, ADR etc) we add it as (plus), and
• when Indians invest in USA (via FDI, FII, IDR etc.) we add it as (minus) and then get the final figure for Foreign investment.
• Same goes for everything in balance of payment (remittances, External commercial borrowing whatever.)
• In short, BoP= we are tracking the incoming and outgoing money.
• For India, current account has been in deficit (negative number) and capital account has been in surplus (positive number).
• The BoP accounting system is similar to double entry book-keeping.
• Therefore theoretically, balance in current account and balance in capital account should be same (ignoring the +/- signs).
• In other words, if there is deficit in current account, there has to be equal surplus in capital account. Why?

How Rupee-dollar convertibility works

• Suppose you want to import a dell computer from USA. And American exporter accepts only payments dollars.
• If you can easily convert your rupee into dollars, that means Rupee is fully convertible. And rupee is fully convertible as far as Current account transactions are concerned (e.g. import, export, interest, dividends).
• But rupee is partially convertible for capital account transection. (In crude terms it means, if an Indian wants to buy assets abroad or invest via FDI/FII OR borrow via External commericial borrowing (ECB) he cannot do it beyond the limits prescribed by RBI. (And vice versa e.g. American wants to convert his dollars to rupees to invest in India, then also RBI’s limits have to be followed).
• RBI gets power to do ^this, via FERA and FEMA Acts.
• 1973: Foreign Exchange Regulations Act, 1973 (FERA).
• 1997: Tarapore Committee (of RBI), had recommended that India should have full capital account convertibility. (Meaning anyone should be allowed to freely move from local currency into foreign currency and back, without any restrictions by Government or RBI.)
• 2002: Government replaced FERA with Foreign Exchange Management Act (FEMA). Although full capital account convertibility is yet not given.
• Full capital account convertibility has both pros and cons. But that’d require another article. Let’s get back to the topic, we are seeing the 6^th chapter of Economic Survey: Balance of Payment, exchange rates etc.

Rupee-Dollar Exchange rate

• Let’s create a bogus technically incorrect model to understand the market based exchange rate system, once again:
• Assume following things
  • There are only two countries in the world India and America.
  • India has rupee currency. Indian farmers don’t grow Onions.
  • America doesn’t have any currency, they trade using onions. The rate being 1kg onion=Rs.50
• First situation: American investor thinks that Indian economy is rising. If we invest in India (FDI/FII), we’ll make good profit. So they’re more eager to convert their onions to Indian rupee currency. So they’d even agree to sell 1kg onions =Rs.45. (and then buy Indian shares/bonds worth Rs.45)
• Result =Rupee strengthened against onion (dollar).
• During this time, RBI governor also buys 300 billion kilo onions from the forex and stores these onions in his refrigerator. (Why? Because onions are selling cheap! And why onions are selling cheap? Because there is “surge” in capital investment in India by American investors.)
• Ok everything is going nice and smooth. Now add third country to our bogus model: UAE.
• Second situation: UAE has increased crude oil prices, and they don’t accept rupee currency. They also want payment in onions.
• 1 barrel of crude oil costs 132kg of Onions.
• India is eager/desperate for oil, because if we don’t have crude oil, we can’t get petrol, diesel= whole economy will collapse.
• So India would agree to buy 1kg onion even for Rs.55 (from American or forex agent or whoever is willing to sell his onions). Then India can give that onions to some Sheikh of UAE and import crude oil.
• Third situation: The Sheikh of UAE gets even greedier, he demands 200kg onions for 1 barrel of crude oil. Now 1kg onion sells for Rs.59, Because those with onion surplus (vendors) know that India likes it or not, it’ll have to buy onions to pay for the crude oil!
• Thus, Rupee has weakened against onion (Dollar.)
• If such situation continues, then there will be huge inflation in India (because crude oil expensive=petrol/diesel expensive = transport expensive= milk/vegetables and everything else transported using petrol/diesel becomes expensive.)
• Now RBI governor decides to become the hero and save the fall of rupee against onion.  So, He loads a few tonnes of onions in his truck and drive it to the forex market.
• Result: onion supply has increased, price should go down.
• Now onions get little cheaper: 1kg onion =53 Rs.
• Thus RBI’s “intervention” in the forex market has led to “recovery” of rupee.

Ok so what is conclusion of above?

1. RBI’s intervention to buy Foreign exchange during surge in capital investment= leads to build-up of (foreign exchange) reserves, which provides self-insurance against external vulnerability of rupee.
2. When RBI sells its foreign exchange reserves, it stems (halts) the fall of rupee.
3. Higher foreign exchange reserve levels restore investor confidence and may lead to an increase in foreign direct and indirect investment flows= boost in growth and helps bridge the current account deficit.

How Foreign Exchange Reserves build up

• Prior to 1991, India followed License-quota-inspector (and suitcase) raj and import substitution strategy. (Beautifully explained class 11 NCERT textbook.)
• During that era, foreign companies couldn’t invest in India.
• Imported products such as radio / camera/ wristwatches attracted heavy custom duty. (And that led to rise of smugglers and mafias, and the Bollywood movies that romanticized their criminal lives.)
• On the other hand, thanks to the license-quota-inspector (and suitcase) raj, the private Indian companies weren’t big or efficient enough to compete in international market so export was also low.
• Result: during that time incoming money (via export, investment) was very low. Hence RBI couldn’t build up huge forex reserve. (when onion supply is low, its prices will be high)
• Ultimately in 1991, the Forex reverses of India were about to exhaust.
• Finally India had to pledge its gold to IMF and get loans.
• Then India had to open up its economy for private and foreign sector investment. Remove the license-quota-inspector raj etc. to boost the incoming flow of dollars and other foreign currencies…..all those LPG reforms. (Although suitcase raj still continues, because the Mohans in the system are blinded by totally awesome people like A.Raja.)
• fast-forward: now we’ve a trillion dollar economy, our software and automobile companies are globally recognized… blah blah blah.
• But the lesson learnt: RBI should have good foreign exchange reserve.
• Hence post LPG reforms, RBI has been buying dollars, pound yen etc. from the currency market, whenever FII/FDI inflow is high. Because during such situation, the foreign investors are more eager to get their dollars converted to rupee currency hence rupee is trading at higher rate e.g. 1$=Rs.49
• But after global financial crisis, RBI has stopped building forex reserves actively.
• Nowadays RBI intervenes in the forex market, only to stop the excess volatility (fluctuation) in rupee exchange rate.
• However, there was a sharp decline in rupee in 2011-12. Then RBI had to sell foreign exchange worth 20 billion dollars. (so demand of foreign currency would decrease and rupee would stop).
• Similarly in 2012 also RBI had to sell its foreign exchange reserve worth 3 billion dollars to prevent the fall of rupee. (in June 2012, Rupee had became very weak: 1$=around 57 Rupees. Thanks to RBI and Government’s interventions, it came back to the normal 53-54 level at the end of 2012.)

Foreign Exchange Reserves

India’s foreign exchange reserves is made up of

1. Foreign currency assets (FCA) (US dollar, euro, pound sterling, Canadian dollar, Australian dollar and Japanese yen etc.)
2. gold,
3. special drawing rights (SDRs) of IMF
4. Reserve tranche position (RTP) in the International Monetary Fund (IMF)

The level of forex reserve is expressed in US dollars. Hence India’s forex reserve declines when US dollar appreciates against major international currencies and vice versa.

RBI gains Foreign exchange reserves by

• buying foreign currency (via intervention in the foreign exchange market
• Funding from the International Bank for Reconstruction and Development (IBRD), Asian Development Bank (ADB), International Development Association (IDA) etc.
• aid receipts,
• interest receipts

Why our rupee is volatile ?

• Volatility = Variation in something over the given time.
• if today SENSEX is 12000 points, tomorrow it goes up by 200 points and day after it goes down by 300 points etc…..they we say “market is volatile”.
• If morning shift’s SSC paper is too easy but evening shift’s SSC paper is too damn difficult then we can say “SSC paper is volatile”.
• Similarly, if there is too much fluctuation in Dollar to rupee exchange rate, we say “rupee is volatile”.

• In 2012, the rupee has experienced unusually high volatility. Why?

Cause#1: import-export

• Demand for Indian goods and services has declined due to Euro-zone crisis + America hasn’t fully recovered.
• On the other hand, cost of import= very high due to oil and heavy gold import (due to high inflation).
• Similarly high inflation = raw material / services become costly for the export. If he raises the prices, then his export product becomes less competitive than Cheap China made stuff.

Cause#2: FII

• In the total foreign investment in India, majority comes from FII (and not from FDI).
• FII money is “hot”, it leaves quickly whenever FII investors feels that India’s market is not giving good returns and or some other xyz country’s market is giving better returns.
• There are week-to-week variation in such FII inflows and outflows. Hence it leads to changes in rupee-dollar exchange rate.

Cause#3: Dollar is strengthened

• US treasury bonds are consider the safest investment. During the peak of Eurozone, Greece crisis, the big investors started pulling out money from Europe and investing it in US treasury bonds. = demand of dollar increased. So other currencies would automatically weaken against dollar.

Cause#4: policy paralysis

• For past few years, Indian Government was lazy regarding environmental project clearances, land acquisition, FDI in retail, pension, insurance etc. that has led to foreign investors losing faith in Indian economy= slowdown in FII inflows. (besides Government did not allow more FDI in pension / insurance / retail etc. so FDI inflow did not increase either).

Cause#5: Risk On / Risk off

• From the earlier article on debt vs equity, Government bonds = safer than equities (shares). But when an investment is safe= it doesn’t offer good returns.
• When foreign investors feel confident, they display “risk on” behavior =they invest more in equities, particularly in developing countries. (which are risky but offer more profit).
• But when foreign investors are not feeling confident, they display “risk off” behavior, = they usually fall back to investing in US treasury bonds or gold.
• In India, majority of foreign investment comes from FII (and not FDI)
• and FII investors are more prone to displaying this risk-on/risk-off behavior.
• They plug in their money quickly, they pull out their money quickly. Thus, Indian rupee’s exchange rate becomes volatile against Dollar.
• Therefore, Indian Government needs to inspire and sustain the confidence of foreign investors, to prevent the fall of rupee. RBI intervention in forex market, cannot help beyond a level.

How to recover rupee ?

Rupee is weakening against dollar, it means demand of rupee is less than the demand for dollars. So how did  RBI  and Government fix it?
RBI =>

• During 2012, RBI sold around 3 billion dollars from its forex reserves.
• Oct-12, Rupee recovers, 1$=around 51 rupees.
• RBI allowed Indian banks to give more interest on Foreign Currency  Non-Resident (FCNR) bank accounts. (thus attracting more NRIs to save their dollars in Indian banks).

Govt =>

• Govt. allowed FIIs to invest more money in govt.and corporate bonds.
• Govt. eased the FDI policy for pension, insurance, aviation, multi-brand retail etc.
• Govt. offered subsidies and tax benefits to exporters.

In this way we have an idea how RBI and Govt recovers rupee against foreign currency.

Not only Our rupee weakens

• In 2012, Rupee wasnot the only currency that weakened against dollar.
• The currencies of other emerging economies, such as Brazilian real, Argentina peso, Russian rouble, and South Africa’s rand also depreciated against the US dollar.
• It means dollars’ demand has increased. In the wake of sovereign debt crisis in the euro zone and due to uncertain global economic environment, more and more investors are preferring to buy US treasury bonds and other securities in USA.

For more Economy articles click here Economy

Read More

what is ADR and GDR - sschub

sschub - This article explains basic of ADR and GDR. These are the methods of raising money (by issuing shares) from foreign stock exchanges.

What is ADR

• ADR => American Depository Reciept
• ADR is method of trading non-U.S. stocks on U.S. exchanges
• For example, Indian Company wants to raise(fetch) money from America, by issuing shares in American stock exchange.
• But then Indian co. need to maintain accounts according to American standards.
• so to prevent this problem, Indian company gives its shares to American bank.
• and in return of those shares, American bank gives receipts (called ADR) to that Indian company. 
• so now Indian Co. can trade those ADR receipts (instead of shares receipts) in American share market, to raise money.
• Hence shares are changed into ADR.

What is GDR

• GDR = Global Depository Receipt
• Now think in case, if Indian company wants to raise money from some other 3 or more  countries then it will have to maintain 3 or more receipts = very difficult as number of countries increase.
• to resolve this problem, several international banks (such as JPMorgan, Citigroup, Deutsche Bank, Bank of New York) came into play and issued depository receipts globally = these receipts can be traded globally.
• it helps the countries to raise money from the stock exchanges of developed countries.

For more basics of economy click here

Read More

Highlights of Economic Survey 2013 for Prelims

sschub -

Highlights of Economic Survey 2013 for Prelims

Economic Survey published before the general budget each year by the Finance Ministry is the authentic source of economic data and review of the current economic scenario. No wonder, UPSC gives it so much importance not just in Prelims but Mains as well. In this post I have listed the important points in the 2013 Economic Survey that you will hopefully find of value for this year’s Prelims paper. Also it is suggested that you go through the economic tables in the second part of Economic Survey.

• India’s economy expected to grow between 6.1 percent to 6.7 percent in 2013-14. GDP Growth rate was just 5.0 percent in 2012-13.
• Slowdown in the rate of growth of services to 6.6 percent in 2012-13 contributed to a slow in overall growth. Growth in Manufacturing and Agriculture also declined.
• FDI in retail may pave the way for investment in new technology and marketing of agricultural produce in India.
• Non-performing assets (NPA) of the banking sector increased from 2.36 percent of the total credit advanced in March 2011 to 3.57 percent of total credit advanced in September 2012.
• The survey calls for a widening of the tax base, and prioritization of expenditureas key ingredients of a credible medium term fiscal consolidation plan. Some measures taken in Union Budget 2013-14 include levy of Service Tax on all air-conditioned eating places, 10% surcharge on income of individuals earning more than 1 crore rupees in a financial year.
• Expenditure on social services also increased considerably in the 12th Plan, with the education sector accounting for the largest share followed by health.
•  India is on track to meet its fiscal deficit target of 5.3% of GDP this fiscal year, and to narrow it down to 4.8% of GDP next year.
• The Economic Survey 2012-13 recommended curbing imports, mainly of gold, in a bid to reduce India’s current account deficit, which stood at 4.2% of GDP last year and is projected to be at similar levels this year.
• The study said a priority should be to reduce waste in social spending through projects like direct-cash transfers to the poor. India’s spending on social welfare increased from 5.9% of GDP in the year that ended March 31, 2008 to an estimated 7.1% of GDP in the current year.

Download all chapters and data of Union Budget 2013-14 and Economic Survey 2012-13 here.

Enroll for my Current Affairs and GK Course and get regular current affairs updates.

Read More

Basics of Inflation, WPI, CPI, Current Account Deficit

WPI, CPI and GDp Deflator are 3 ways to measure Inflation. Don't mug-up dates. These are only for clear understanding.

WPI = Wholesale price index

• Compiled by Office of Economic Adviser ->Ministry of Commerce and Industry.
• Base year 2004
• Doesn’t cover services.
• Items are classified into three categories

1. Primary articles
2. Fuel, power, light, lubricants
3. 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 2012, the CPI system was reformed

	Before 2012	After
Subtypes	There were four subtypes of CPI Agricultural Labourer (AL) Rural Labourer (RL) Industrial Workers (IW) Urban Non-Manual Employees (UNME)	Now only three subtypes of CPI Entire urban population Entire rural population Urban + Rural (consolidate from above two)
Prepared by	First three subtypes of CPI were prepared by Labour Bureau -> Ministry of Labour and Employment Last subtype was prepared by Central Statistical Organisation (CSO) -> Ministry of Statistics and Programme Implementation.	All prepared by Central Statistical Organisation (CSO) -> Ministry of Statistics and Programme Implementation
Baseyear	Different years for different subtypes. Agri labour=1986 rural labour=1986 Industrial workers=2001 Urban non-manual=1984	Common base year ( 2010) for all three subtypes.

WPI vs CPI difference?

	WPI	CPI (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
Importance	When RBI and Government make policies, they mainly pay attention to this number.	Not much

GDP deflator 

• It 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).

How to contain inflation

By	How?
Government	Taxation, Expenditure, export bans etc.
RBI	Repo, SLR, CRR

What Government did to control inflation

Via 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 inflation out of Control ?

• 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.

What RBI did to control inflation

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

CRR	I’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%.

Why RBI failed to 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.

What is 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.

Also for better understanding of Economy click Very important basics of CRR, SLR, Rates

Read More

Basics of CRR SLR Repo Rate Reverse Rate Bank Rate NEFT RTGS System for UPSC SSC CGL IBPS

What is Liquidity?

• Liquidity is a relative term.
• For assets: Rs.1 crore worth gold is more liquid than Rs.1 crore worth farmhouse. Because you can quickly sell the gold in a few days, but for selling farmhouse you’ll have to deal with so many prospective customers, real-estate agents, paper work, stamp duty etc., this would take more than 15 days= not so liquid.
• For banking: if yesterday SBI had Rs.100 to give as loan
• today SBI has Rs.200 to give as loan, then we say liquidity has increased. (And vice versa).
• In winter, supply of green vegetables increases (compared to summer) so selling price of green vegetables decreases in winter (compared to summer).
• Similarly when liquidity (money supply) increases, the cost of borrowing (=interest rates) goes down.
• Very high liquidity can create demand pull inflation=bad.
• Very less liquidity=cost of borrowing is extremely high for businessman = bad because he cannot easily start or expand his business=less people get employment.
• So one of the job of RBI= control this “liquidity” in banking system.
• RBI mainly uses following tools to control this liquidity / money supply in the banking system.

1. Cash reserve Ratio (CRR)
2. Statutory Liquidity Ratio (SLR)
3. Liquidity Adjustment Facilities (LAF) (Repo and reverse repo)
4. Open market operations (OMO)

What is Cash reserve ratio (CRR)?

• For the sake of simplicity, let’s assume there are only four people in India: 1) common men and 2) businessmen 3) Commercial banks (like SBI) 4) Central Bank (RBI.)
• Now the Question: How do commercial banks make money?
• Common men save their money in bank. Bank gives them say 7% interest rate on savings.
• Then Bank gives that money as loan to businessmen and charges 12% interest rate. So 12-7=5% is the profit of Bank. Although that’s technically incorrect, because we’ve not counted bank’s input cost=staff salary, telephone-internet-electricity bill, office rent, xerox machine etc. So actual profit will be less than 5%.
• But anyways, first let’s construct a technically incorrect model.

1. SBI has only one branch in a small town. It was opened on Monday.
2. On the very same day, Total 100 common men deposited 1 lakh each in their savings accounts here (=total deposit is 1 crore)
3. and SBI offered them 7% interest rate per year on their savings

WHY CRR: Cash reserve ratio?

• On Tuesday, SBI Branch manager gives away entire 1 crore to a businessman as loan for 12% interest rate for 5 years.
• From SBI’s point of view, sounds very good right? 12-7=5% profit!
• But we’ve not considered the fact that on Wednesday, some of those common men (account holders) will need to take out some money from their banks savings account- to pay for gas, electricity, mobile bills, college fees, writing cheques and demand drafts etc.
• But SBI’s office doesn’t have a single paisa left! = problem, protest, rioting, suicides.
• So condition #1: Banks must not give away all of the deposit money to businessmen for loans. Banks must keep some money with aside.
• Ok but who’ll decide how much minimum cash should a bank keep aside? Ans. RBI via CRR.(Cash reserve ratio).
• But banks donot like high CRR.

WHY SLR: Statutory liquidity ratio?

• Continuing the same example. SBI got 1 crore on Monday.
• But suppose, RBI gave him order, “you must keep Rs.10 lakhs aside. (CRR)”
• Thus, SBI is left with only 1 crore – 10 lakhs = 90 lakh rupees.
• So SBI manager decides to get maximum profit out of remaining money. Suppose ongoing rate for business loans is 12%.
• But there is one businessman Mr.Parajay.
• No bank is offering him loan, because his past track record is not good: his earlier business adventures were epic fail.
• This Mr.Parajay comes to SBI

Mr.Parajay, the businessman	I desperately need loan for my business. but no other bank is giving me loan. Tell you what, give me all of those 90 lakh rupees as loans, I’m ready to pay 36% interest rate on it! And trust me, I’m going to make lot of money in my new business project. And I’m ready to mortgage all of my factories, cars, farmhouses. So if I can’t repay loan, you can auction them and recover your money.
SBI manager	Good! I’ll give you all of my 90 lakhs as loan!

• After six months, Mr. Parajay’s new business project = also #EPICFAIL.
• He cannot pay back the EMIs.
• Although SBI can attach his assets and auction them to recover the money. But it’ll take lot of time.
• In the mean time, common-men also read this story in local newspapers and they panic that SBI will collapse and bank manager will shut down the office and run away.
• So all the common men line up in front of bank and demand back their money. Recall that SBI still has 10 lakh left in CRR. But people want total 1 crore back!
• Again money of account holders (common men) is stuck =problem, protest, rioting, suicides.
• So, Condition #2:  Bank must not give away all its loans to risky loan takers. Banks must invest part of its money in “safe and liquid” investment. So during emergency, bank can sell those “liquid” investments and take out the money.
• For example, Government securities, gold, corporate bonds of reputed companies like Infosys, reliance, TCS. These are “safe” investments.
• These are also “liquid”, because you can sell them quickly whenever you want. (recall that SBI could also auction Mr.Parajay’s properties, but it’ll take lot of time in paperwork, legal issues etc.)
• Ok so, bank should invest part of common-men’s money in “safe” investments like Government securities, gold and corporate bonds of highly reputed companies.
• BUT who will decide how much money should be invested in this sector?Ans. RBI via SLR (Statutory liquidity ratio).
• Let’s assume RBI ordered SBI to keep Rs.25 lakhs under SLR.
• Thus, out of original Rs.1 crore that SBI had, 10 lakhs (CRR) + 25 lakhs (SLR) are gone.

Bank Runs: SLR+CRR

• Suppose a rival bank of SBI, hires some people to spread rumors against SBI.
• The rumor is something like this= “SBI invested lot of money in sharemarket but sharemarket is crashed so now SBI doesn’t have any money left. They’re going to shut down the office and run away.”
• ^this is totally ridiculous rumor because according to RBI rules, banks cannot invest depositor’s money in the sharemarket in the first place!
• Anyways, out of the 100 SBI  account holders (common men), 30 common men believe in this rumor and run to the SBI office.
• They demand SBI to return their entire savings deposit. Such panic movement of bank customers is known as “bank run”.
• Thankfully, SBI has total 10 lakh (CRR), so they can directly give it back. SBI also has set aside Rs.25 lakhs under (SLR), so SBI can sell away those Government securities, gold worth 25 lakhs and give that money back to account holders.
• Thus, SLR+CRR protects a bank against Bank runs.
• However in case of a “totally awesome” bankrun, nothing can protect a bank. (i.e. when all of the account holders simultaneously demand all of their money on the same day!) anyways back to the topic:

WHY Priority Sector lending?

So far, You know what is CRR and SLR.
Now SBI manager start making calculation, how much money is left with him?

Money received from common men	1 crore=100 lakh
Money set aside in CRR	MINUS 10 lakh
Money invested in SLR	MINUS 25 lakh
Money left	100-10-25=Rs.65 lakh.

• Out of that 65 lakhs, let’s assume SBI manager has to keep aside 15 lakh for Administrative costs, salaries of employees, electricity bill, internet bill, Xerox machine etc. So he has only 50 lakh left for providing “loan” to needy people.
• Now loan-takers line up in front of SBI office

50 farmers	Give us loans of 1 lakhs each for buying seeds and fertilizers. However, given the vagaries of monsoon and low profit margin in agriculture, we cannot pay more than 5% interest rate.
25 Small businessman	Give us loans of 2 lakhs each to setup small retail shops / car mechanic / hair saloon etc. We offer 11% interest rate. we cannot offer a penny more because our profit margin isnot good.
2 Students	Sir please give us loan of Rs.25 lakhs each, for paying self-financed medical college. We can pay atmost 9% interest rate.
1 Big businessman	Give me those 50 lakhs. In a few months, Diwali is coming and I want to setup a new firecracker factory. I offer you 15% interest rate.

• if SBI is run from purely profit point of view, then farmers, small businessmen, students and weaker sections of the society will never get any loan.
• Because SBI manager would want to give loan to a person that offers him highest interest rate.
• Then who is going to protect those weak people? Who is going to help them get loans at reasonable rates? Ans. RBI.
• Suppose RBI tells the SBI manager, “40% of the money you lend, must go to priorities sectors viz. agriculture, small scale business, housing and education.” (=40% of 50 lakh=20lakh).
• ^This is the basic funda of priority sector lending. More details are given on page 15.12 of Ramesh Singh.

What is NDTL?

• So far, We know that Banks have to comply with the CRR, SLR and priority sector lending rules of RBI.
• CRR, SLR is counted on amount of money a bank receives. But bank receives lot of money,

1. from depositors,
2. from loan takers who’re re-paying EMI,
3. (fraudulent) hidden charges imposed on credit cards
4. Commission charged on giving demand draft
5. Commission charged on online money transfer
6. Commission charged on foreign currency conversion etc.etc.etc.

• So how does bank exactly count CRR, SLR requirements? = Net Demand and Time Liabilities (NDTL)

	Main example (list not exhaustive)
Time liabilities	Money deposited in Fixed deposits (FD) Cash certificates gold deposits. Staff security deposit. E.g. in some banks when you join as Probationary officer, you’ve to sign bond worth RS.1-2 lakh rupees.
Demand liabilities	Money deposited in savings account Money deposited in current account Demand drafts unclaimed deposits;

• I’m not going into minute nitty-gritty involved in computing NDTL because that’s irrelevant from exam point of view. So long story cut short, CRR and SLR are calculated on this NDTL number with some caveats.
• And banks have to send reports to RBI on fortnight basis that “our NDTL is xyz and we are maintaining xyz SLR and CRR on it as per your direction.”
• Now here comes the problem: In our example, SBI followed SLR, CRR and 50 lakh rupees left for loaning.
• However in the given period, priority sector loan takers (farmers, students etc.) and regular loan taker (businessmen, car/bike loans)….all of them together take total loans worth only Rs.30 lakhs.
• so SBI is left with 50-30=surplus of 20 lakh rupees.
• These 20 lakhs are just gathering dust in the office. Nobody is coming to take new loans! What should SBI do? because SBI has to give 7% interest even on these 20 lakh rupees, so SBI cannot afford to let this money gather dust!
• Now comes the Liquidity adjustment facilities, Repo Rate and reverse repo rate.
• Let’s start with reverse repo rate.

Reverse repo rate?

• The book definition of Reverse repo rate = “it is interest rate paid by RBI to itsclients for short term loans.”  Ok but who are the clients of RBI?

1. Central Government
2. State Government
3. Banks (commercial, regional rural banks, cooperative banks)
4. Non-banking financial institutions etc.etc.etc.

• anyways, Reverse repo rate in crude words= when SBI parks its surplus money in RBI for short term, SBI makes ^this much profit.
• But actually reverse repo rate works in a bit complicated manner= via selling and repurchase of Government securities.
• You’re aware of Government securities: when Government wants to borrow money from market, Government  security / Government  bond is issued.
• Basically it’s a piece of paper. It has agreement something like: “whoever gives me Rs.100 will get 8% interest rate for 10 years and then principle will be repaid”.
• For the purpose of understanding Reverse repo, let’s construct a simplified technically incorrect model:

1. RBI has Government securities worth Rs.100 lakhs.
2. SBI has surplus Rs.100 lakhs and nobody is taking them as loans. But SBI is sure more people will come to take loans before Diwali. So SBI just wants to park this surplus 100 lakhs somewhere for the short-term.
3. SBI enters into Reverse Repo agreement with RBI.
4. The agreement reads “I (SBI) will give buy Government securities worth Rs.100 lakhs from the RBI, and RBI promises to buy back those securities from me after 6 months @Rs.106 lakhs.

Read it carefully:

• Time: after 6 months,
• SBI’s investment: Rs.100 lakhs
• After 6 months, SBI gets: Rs.106 lakhs.
• So profit of SBI (or interest earned by SBI or interest paid by RBI)=(106-100)/100 = 6%. This is reverse repo rate.

Tied to repo rate

In 2011, under RBI made following rule:

1. reverse repo rate would not be announced separately but will be linked to repo rate.
2. The reverse repo rate will be 100 basis points below repo rate.(=minus 1%)

So if RBI declares “Repo rate=8%” then reverse repo-rate is automatically 8-1=7%.But now comes the question:

What is repo rate?

Common sense says, it has to be reverse of “reverse repo rate” right? Yes that is right.
Textbook definition says

• Repo rate is the rate RBI charges on its clients for short term loans.
• To put this crudely, when SBI wants to borrow money from RBI for short term, SBI will have to pay ^this much interest rate.
• (again) For the purpose of understanding repo rate, let’s construct a simplified technically incorrect model:

1. RBI has cash of Rs.100 lakhs.
2. SBI has Government securities worth Rs.100 lakhs.
3. SBI enters into Repo agreement with RBI.
4. The agreement reads “I (SBI) am selling my Government  securities worth Rs.100 lakh to RBI and I (SBI) promise to buy back(repurchase) those securities from RBI after 6 months @Rs.107 lakhs.

Read it carefully:

1. Time: after 6 months.
2. RBI’s investment: Rs.100 lakhs
3. After 6 months, RBI gets: Rs.107 lakhs from SBI.
4. So profit of RBI (or interest earned by RBI or interest paid by SBI)=(107-100)/100 = 7%. This is Repo rate.

Repo rate vs Bank rate?

Repo rate	RBI lends money to banks for short term loans @this interest rate.
Bank rate	RBI lends money to its clients for long term loans @this interest rate.

What is LAF?

• liquidity adjustment facilities (LAF).
• Recall that one of the main task of RBI is to control money supply in the economy.
• RBI controls money supply via monetary policy. For this RBI uses various “tools” e.g. SLR and CRR.
• Liquidity adjustment facilities (LAF) is also a tool used by RBI to control short-term money supply.

LAF timeline

1998	Narsminam Committee on banking rector reforms, recommends LAF
1999	RBI introduces interim LAF
2000	RBI introduces full-fledged LAF.

• In the old Bollywood movies, international smugglers often come to main villain’s hideout with suitcases loaded with cash. Then main villain will auction some ancient Indian statues to them. Something similar happens under LAF.
• LAF helps banks to quickly borrow money incase of any emergency or for adjusting in their SLR/CRR requirements.
• Under LAF, RBI auctions Government securities, starting at the repo and reverse repo rate. Minimum bidding amount is Rs.5 crore.
• So LAF is a tool used by RBI to control short-term liquidity / money supply in the market.
• In LAF, money transaction is done via RTGS. (RTGS is an online money transfer method). So in this auction, players don’t need to bring suitcases loaded with cash.

What is RGTS?

• RTGS, NEFT=These are online facilities for transferring money within the country.

Real Time Gross Settlement (RTGS)	National Electronic Fund Transfer (NEFT)
Fast (immediate money transfer)	Slow (done on hourly basis)
Can be used only if money transfer amount is minimum 2 lakh rupees or more.	Can be used for any amount. There is no minimum or maximum limit.

What is Marginal Standing facility (MSF)?

• RBI started this thing in 2011.
• Under MSF, Scheduled Commercial Banks can borrow money from RBI @1% higher than the ongoing Repo rate under liquidity adjustment facility (LAF.)
• Although, the system of lending remains same just like under repo. = SBI sells Government security to RBI, and promises to buy it back after sometime, at a higher rate. Difference in selling and purchase = interest rate earned by RBI.
• we can memorize it like

1. Repo rate = reverse repo + 1%
2. MSF rate= repo rate + 1%

Difference between LAF and MSF

LAF	MSF
Liquidity adjustment facility	Marginal standing facility
Minimum bidding amount is 5 cr.	1 cr.
All clients of RBI are eligible to bid.	Only scheduled commercial banks can bid.
Bank cannot sell Government  security to RBI that is part of bank’s SLR quota.	bank can sell the Government security from its SLR quota to RBI.
Bank can borrow any amount of money as long as it has the securities to sell.	Bank can maximum borrow upto 2% of its NDTL.
Suppose repo rate is “r%”	MSF lending rate is always (r+1)%

Open market operations?

• Open market operation= when RBI buys/sells securities in open market.
• How is it different from LAF or MSF?
• Well in LAF or MSF, one party buys Government security from second party. But second party has agreed to buy back (repurchase) the same security from first party after some time. So Government security is not “permanently” sold, it is only used as a collateral= that’s like pawning your jewelry in Muthoot finance company.
• But in case of OMO, first party permanently sells the Government security to second party. Second party is free to do whatever it wants with that security.
• When RBI purchases Government securities =liquidity increased (because RBI is paying that party some money to buy that security, right? so RBI is pouring additional money into the system.)
• On reverse, when RBI sells Government securities= liquidity is decreased. (because those players are giving their cash to RBI to purchase the securities= money is sucked out of the system by RBI).

Also you can take a look at Very important basics of WPI, CPI, Inflation

Summary

From SBI manager’s point of view

CRR	I must keep this much money aside. I cannot give it as loan to anyone. I will not earn any interest rate on it.
SLR	I’ve to invest this much money in gold, Government securities (G-sec) and RBI approved corporate bonds.
Repo rate	If I borrow money from RBI for short term, I’ll have to pay them this much interest rate.
Reverse repo rate	If I park my money in RBI, they’ll pay me this much interest rate.
Bank rate	If I borrow money from RBI for long term, I’ll have to pay this much interest rate.

Read More