3A Flashcards
What is BOP?
- It is a systematic record of all economic transactions made between the residents and non-residents of a country for a specific time period, usually a year.
- Central Banks of each country prepare BoP records as per the format given in IMF’s BPM-6 manual, all the figures are expressed in Dollar$.
- Since any country’s debit (outgoing money) is a credit (incoming money) for another country → World’s NET Balance of Payment is ZERO.
Bop classification
- BoP is further sub classified into two parts → Current Account and Capital Account, based on the nature of transactions.
RBI’s methods of BOP classification
Current Account -
Goods and services
Primary Income: wages, dividend, interest
Secondary income: remittance, gift, donation
Capital & Financial Account
- Direct Investment (FDI)
- Portfolio Investment (FPI)
- Loans / ECB
- Non-resident’s investment in Bank, Insurance, Pension schemes.
- RBI’s foreign exchange reserve
Current Account Deficit in the last 3 years 2016-2019 increased or decreased and reason?
- The Current Account Deficit ⏫ in last 3 years (2016-19) because
- crude oil price ⏫
- US/EU protectionism= our exports ⏬.
What is Balance of Trade (BoT)
It’s the difference between the value of import and export (of goods and services)
Export MINUS Import = MINUS (-)
- If -ve = Trade Deficit (i.e. Import > Export)
- If +ve = Trade Surplus (i.e. Export > Import)
What is Net Terms of Trade (NTT) or Commodity terms of trade?
𝑁𝑇𝑇 = 𝑉𝑎𝑙𝑢𝑒 𝑜𝑓 𝑒𝑥𝑝𝑜𝑟𝑡/𝑉𝑎𝑙𝑢𝑒 𝑜𝑓 𝑖𝑚𝑝𝑜𝑟𝑡 ∗ 100 = 𝑓𝑜𝑟 𝐼𝑛𝑑𝑖𝑎 𝑖𝑡′𝑠 < 100.
Meaning ($ or value) we are importing more and exporting less.
What is Gross Terms of Trade (GTT)?
𝐺𝑇𝑇 = 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦 𝑜𝑓 𝑖𝑚𝑝𝑜𝑟𝑡/𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦 𝑜𝑓 𝑒𝑥𝑝𝑜𝑟𝑡 ∗ 100 = 𝑓𝑜𝑟 𝐼𝑛𝑑𝑖𝑎 𝑖𝑡′𝑠 < 100.
So, in physical quantity (kg, litres) we are exporting more than importing. This is possible because exported Indian rice’s quantity (kg) could be large even though its value ($) will not be very large.
India has trade deficit and trade surplus with which countries?
India’s top 5 trading partners?
We’ve large Trade Deficit: with China (cheap electronics, toys etc.) Switzerland (Gold, Luxury items), Middle Eastern nations (Oil).
We’ve Trade Surplus: with USA (Chemicals, textile, services etc.), UAE (Tea, Spices, textile etc.).
- India’s top five trading partners are USA, China, UAE, Saudi Arabia and Hong Kong
Largest importer and exporter in world for goods and services - 2018
(IYB20 Ch7): Largest importer and exporter in world
Goods (Merchandise)
Largest Importer #1:USA…..#10: India
Largest Exporter #1: China…. #19: India
Services
Largest Importer #1:USA…..#10: India
Largest Exporter #1: USA……#8: India
❓MCQ. The balance of payments of a country is a systematic record of (Asked in UPSC-Pre-2013)
(a) All import & export transactions of a country during a given period of time, normally a year.
(b) Goods exported from a country during a year.
(c) Economic transaction between the government of one country to another.
(d) Capital movements from one country to another.
a
❓MCQ. Which of the following does not form part of current account of Balance of Payments? [UPSC-CDS-2014-II]
(a) Export and import of goods (b) Export and import of services
(c) Income receipts and payments (d) Capital receipts and payments
d
❓MCQ. With reference to Balance of Payments, which of the following constitutes/ constitute the Current Account? (Asked in UPSC-Pre-2014)
1. Balance of trade. 2. Foreign assets. 3. Balance of invisibles. 4. Special Drawing Rights.
Answer codes: (a) 1 only (b) 2 and 3 (c) 1 and 3 (d) 1, 2 and 4
c
❓MCQ (Pre19-SetA Q37). Among the following, which one of the following is the largest exporter of rice in the world in the last five years?
(a) China (b) India (c) Myanmar (d) Vietnam
b
MCQ (Pre19-SetA Q84). Among the agricultural commodities imported by India, which one of the following accounts for the highest imports in terms of value in the last five years?
(a) Spices (b) Fresh fruits (c) Pulses (d) Vegetable oils
d
What does the World Bank’s Remittance Report say about remittance of India?
- In quantitative figures too India received more amount compared to previous years. Because higher oil prices → Arabian Sheikhs are earning more and spending more → Indian workers in middle east are earning more overtime → more remittance to India.
- World Bank also noted: remittances have a direct impact in poverty removal for many households
- but Post Offices charge very high fees in remitting the money to household.
- so Financial inclusion, UPI/BHIM/IMPS blockchain Technology led money transfer mechanism are important in that context as well.
Global migration report 2020 released by?
Top amount of remittance received?
Top number of international migrants are from?
Top destination country of migrants?
- The International Organization for Migration (IOM, HQ: Geneva, Switzerland) is a related organization of UN. As per its latest Global migration report 2020.
- Top amount of remittance received to 1) India 2) China 3) Mexico.
- Top number of international migrants are from 1) India 2) Mexico 3) China
- Top destination country of migrants is USA.
Under Remittance - what is Pravasi Bharatiya Diwas (PBD)?
1915 9th January: Gandhi-ji returned from S.Africa to Bombay (India).
2003 govt decides to celebrate Pravasi Bharatiya divas (PBD) annually every 9th January. First summit @New Delhi.
2015 govt converts PBD into “biennial” event i.e. grand festival every second year
- every other year, only a small event in India, and regional PBD event in a foreign country
2017 @Bengaluru, Karnataka.
2018 Singapore
2019 @Varanasi, Uttar Pradesh
- THEME: “Role of Indian Diaspora in building a New India.”
- 15th Pravasi Bharatiya Divas Convention was organized from 21 to 23 January 2019 instead of 9th January, so that NRIs could visit Prayagraj for Kumbh Mela and witness the Republic Day Parade at New Delhi on 26th January 2019
2020 @New Delhi. But just a small scale video conference type of event.
2021 - The theme of 16th Pravasi Bharatiya Divas Convention 2021, held virtually on 9th January 2021 is “Contributing to Aatmanirbhar Bharat”
at New Delhi
What is the Govt doing about its target of reducing the oil import by 10% by 2022 (compared to 2015)?
➢ Govt’s target of reducing the oil import by 10% by 2022 (compared to 2015).
➢ Therefore, boosting domestic oil exploration & production is necessary. So,
Domestic Oil Exploration Policies
- Nodal? Directorate General of Hydrocarbons (DGH) Ministry of Petroleum & Natural Gas.
- Before the 1991’s LPG reforms, only ONGC and other Public sector companies were allowed to explore the oil, gas and hydrocarbon reserves in India. But under 1991’s Liberalization norms, this sector was opened for the private sector players as well.
- 1997: New Exploration Licensing Policy (NELP: to award contract to public and private sector companies using bidding / auction system.
NELP’s limitations and replacement?
NELP’s primary limitations were →
- Separate license required for each type of hydrocarbon.
- NELP worked on production sharing contract (PSC: , wherein the Oil Explorer will pay a share to Govt from the profits from production.
However, - whenever the oil prices ⏬in the global market, Indian producers will also ⏬their production.
- Indian producers exaggerate their production costs to show less profit. → Govt earned less and lead to inspector raj and no ease of doing Biz.
Hence in 2016, NELP was replaced with Hydrocarbon Exploration and Licensing Policy (HELP).
✓ Single uniform license sufficient to explore and produce all type of hydrocarbons from the given area. (oil, gas, coal bed methane, shale gas, tight gas and gas hydrates etc)
✓ Govt to receive a share from gross revenue from sale of oil / gas etc, irrespective of company’s profit.
✓ Government not to interfere in the marketing and pricing of the oil and gas.
✓ Relaxed norms for exploration in offshore areas, because they have higher risk and higher cost of production.
✓ Open Acreage Licensing Policy (OALP) → company can pick and choose the blocks from the designated area, even if no specific bids are invited by Govt before. Then Government will invite other companies for auction.
✓ 2019-July: Govt finished auctioning process of HELP-OALP round 2 and 3.
What are the objectives of India’s Strategic Oil Reserves ?
Objective? (When crude prices are low) India should buy and store crude oil for strategic- cum-buffer stock → to be used during war & other emergency.
- Ministry of Petroleum & Natural Gas should set up Govt petroleum companies in the east and west coast of India
- It should be stored in underground rock cavern facilities = more secure / safe during airstrikes, more economical and environmental friendly than conventional ‘Above Ground Storage Tanks’ (which may require additional cooling / AC).
OPEC year, members and HQ?
1961: Organization of the Petroleum Exporting Countries (OPEC) is a group of oil producing countries Saudi, UAE, Venezuela, Iran, Iraq etc.
total 14 members. HQ: Vienna city of Austria.
Qatar withdrew from 1/1/19. Russia is NOT a member.
What is a Cartel?
Cartel is an association of manufacturers who collude to keep prices high, and keep the competitors away.
What is Sweet and sour crude oil?
Sweet crude oil = Low Sulphur content. Sour crude = High Sulphur content.
What is BRENT Index?
RENT Index is an index to measures crude oil price, mainly in North West Europe.
What is the fall of crude oil prices in negative figures?
- USA’s crude oil prices are monitored through West Texas Intermediate (WTI) contracts.
- Oil demand decreased due to Corona lockdown on vehicle/aviation traffic. But, American oil drilling companies can’t stop production because it’s more
expensive to ‘restart’ the production after shutting it. - And merchants/intermediaries can’t hold stock because their storage capacity is limited.
- 2020-April: sellers are (temporarily) paying $$ to buyer to take the stock of oil barrels. Hence negative minus $40 per barrel price.
- India may not benefit, since we mostly import from the middle-east and not the USA.
BoP: Current → Petrol & Diesel Prices in India?
- 1970s to 2002: Administered Price Mechanism (APM) - Wherein the government fixed the prices of petroleum fuels and paid subsidy to the oil marketing companies (OMC) for their losses.
- 2002-2014: Government gradually began decontrolling the fuel prices, to reduce its own subsidy burden.
- Present system Dynamic Fuel pricing system wherein OMCs decide the prices of petrol and diesel on DAILY basis, based on the movement in international prices.
- “Trade parity price (TPP)” is related to this
- Benefit of dynamic pricing? In theory, If the oil prices lowered in the international market, petrol diesel should become cheaper in India. But,
- Corona crisis = ⏬ transport → ⏬ demand of crude oil → prices have fallen or remained moderate.
- But, Corona crisis → direct tax and GST collection ⏬. Government required more ₹₹ to run the schemes. So, continuously ⏫ excise & VAT.
- Consequently, by 2020-Jul: Petrol and diesel costing around ₹80/litre in Delhi
impact of Negative Real Interest Rate?
From 2010 onwards, Indian economy was suffering from high level of inflation (8-12%) due drought → Food & Pulses shortage. MNREGA scheme → higher wages in the hands of villagers without proportional growth in supply of commodities etc.
- So households earned ‘Negative Real Interest Rate on
their bank deposits → started investing in gold. - But, high level of gold consumption → more trade deficit, current account deficit → Indian rupee gets weaker. Gold transactions also help in the storage of black money and tax evasion. India is the second largest consumer of Gold after China.
Schemes introduced to reduce the gold consumption due to Negative real interest rate?
RBI and Indian government launched following schemes to reduce gold consumption:
RBI’s 80:20 Scheme (2013-14)
Sovereign Gold Bond Scheme (2015)
Gold Monetization Scheme (2015)
Indian (Sovereign) Gold Coins (2015)
What is RBI’s 80:20 Scheme (2013-14)?
- It is one of the schemes introduced to reduce gold consumption/import due to Negative real interest rate.
- RBI mandated that minimum 20% of the imported gold must be exported back. Until then the Jeweller/ bullion dealers will not get permission to import next consignment of gold.
- RBI gets this power under Foreign Exchange Management Act (FEMA).
- Although, 2014: Scheme was stopped as the gold craze had declined.
What is Sovereign Gold Bond Scheme (2015)?
- It is one of the schemes introduced to reduce gold consumption/import due to Negative real interest rate.
RBI (on behalf of Union Government) issued Gold bonds in the denominations of one gram and its multiples. One person can buy upto 4 kgs.
- They can be purchased from commercial banks, post offices and authorised agents. RBI continued to release them in 2018 and 2019 as well.
- Tenure? 8 years. (But investor can exit from 5th year).
- Fixed ~2% interest every year. On the redemption date you get the principal equivalent of the latest price of gold in grams. So, if gold price increased then you get more
profit. - Bonds can be tradable in stock exchange. Can be used as collateral for loans.
- They are exempted from the TDS and Capital Gains Tax.
- Benefit? People were investing in gold with speculation that when gold prices increase they’ll profit. Gold Bonds offer them similar without actually giving them gold. So it helps reducing gold import.
What is Gold Monetization Scheme (2015)?
- It is one of the schemes introduced to reduce gold consumption/import due to Negative real interest rate.
- Under this scheme, RBI allows commercial banks accept customers’ idle gold / jewellery for 1 year to 15 years tenure.
(2019- RBI also allowed Charitable Institutions
and Central Govt to deposit their gold in the commercial banks)
- Commercial Banks pay the depositor ~2% interest.
- Min. 30gm to maximum any amount of gold can be deposited.
- Gold goes to → Metals and Minerals Trading Corporation of India →
- Gold sold to jewellers, electronic circuits companies and
- Some of the gold used for Minting “Indian Gold Coin.”
- Upon maturity you can redeem deposit in the form of gold coin/bars or cash equivalent.
- The profit exempted from Capital Gains Tax.
❓MCQ. Which of the following are the main objectives of Gold Monetization Scheme launched in the country ? (IEnggS-2018)
1. To monetize gold holdings in the country 2. To increase export of gold from the country 3. To reduce India’s import bill 4. To meet the targets of reduction in fiscal deficit Answer Codes: (a) 1 and 4 only (b) 2 and 4 only (c) 2 and 3 only (d) 1 and 3 only
d
❓MCQ. What is/are the purpose/purposes of Government’s ‘Sovereign Gold Bond Scheme’ and ‘Gold Monetization Scheme’? (Asked in UPSC-Pre-2016)
1.To bring the idle gold lying with Indian households into the economy.
2. To promote FDI in the gold and jewellery sector.
3. To reduce India’s dependence on gold imports.
Answer codes:(a) 1 only (b) 2 and 3 (c) 1 and 3 (d) 1, 2 and 3
c
What are Indian (Sovereign) Gold Coins (2015)?
- It is one of the schemes introduced to reduce gold consumption/import due to Negative real interest rate.
- Issued by a Govt company “Metals and Minerals Trading Corporation of India”.
- Available in denominations of 5, 10, 20 grams.
- These gold coins are not fiat money because not issued under the powers of Coinage act, they don’t bear any markings indicating rupee denominations. Their markings only indicate gold grams.
- And since they’re not ‘fiat money’ → so, not ‘legal tenders’.
- Benefit? Trusted Purity → Easily resold → Easy liquidity, and Profit (if) gold price⏫.
What is GI Tag?
BoP → Current → Export → GI Tag
- A Geographical Indication (GI) is a sign used on products with specific geographical origin and unique qualities due to that origin.
E.g. Darjeeling tea from W.Bengal- It was the first to obtain GI tag from India.
- Benefit? GI tag adds premium quality to a product, helps fetching higher prices in the international market → better income for farmers and artisans.
GIs are governed under?
GIs are governed under:
- WTO’s Trade Related Intellectual Property Rights Agreement (TRIPS) and
- India’s Geographical Indication of Goods Act, 1999.
Once a product gets GI tag, it’s valid for 10 years (and can be renewed further.)
GI name cannot be used for products that are manufactured outside of the designated region, else party can be punished under the law
- International Nodal? UN’s specialized agency World Intellectual Property Organization (WIPO), HQ @Geneva,Switzerland
- Indian Nodal? Commerce ministry → Controller General of Patents, Designs and Trademarks → Geographical Indications Registry in Chennai.
GI-Controversies?
- 2010: GI status given to the Basmati rice grown only in Punjab, Haryana, Delhi, Himachal Pradesh, Uttarakhand and parts of western Uttar Pradesh and Jammu & Kashmir. Madhya Pradesh state government had been fighting to get GI-status for its Basmati rice as well, but 2018 rejected by GI Registry @Chennai.
- 2017-19: W.Bengal and Odisha were fighting to get GI for Rasagola, ultimately they are given separate GIs: ‘Banglar Rasogolla (2017)’ and ‘Odisha Rasagola (2019-July)’.
Guidelines for usage of GI logo?
‘Invaluable Treasures of Incredible India’ → Commerce Ministry’s logo for GI products to make them more attractive to foreign buyers.
2019-June: Commerce Ministry’s Department for Promotion of Industry and Internal Trade (DPIIT) issued guidelines for its usage:
- DPIIT’s prior permission required before using this logo.
- DPIIT will not charge any fees.
- Permission duration will be decided on case-to-case basis.
- DPIIT would not be responsible for the authenticity or quality of the products with these logos.
- Foreign GI products are not allowed to use India’s GI logo.
What are SEZs?
BoP → Current → Exports → SEZ
- Special Economic Zones (SEZ) is a specifically demarcated area of India which is deemed as foreign territory for the purpose of Tax laws and Trade laws.
- Thus, exempted from Excise / GST (Mfg), Customs Duty (import/export), Corporation Tax/ Income Tax (on profit) (OR)/ subjected to lower rate of taxes of Union and State Govts.
- This relief is for a specific time-period only, which is called “Tax holiday”
What is SEZ Sunset clause in Income Tax Act?
Income Tax Act (Section 10AA) provides for a tax-holiday for SEZ firms for a period of “X” years only.
Corona = Economists suggest this deadline should be extended to attract more foreign companies in India.
Benefits given to SEZ?
Its benefits and challenges?
- They get single window clearance for various import / export licenses / permissions
- Government will bear the cost of developing the roads, sewage, affluent treatment, weighing-packaging-labelling etc infrastructure within the SEZ.
- They are regulated under SEZ policy (2000) and Special Economic Zone Act, 2005. State Govt forwards the proposal to create SEZ → Union’s Commerce Ministry
approves. - 1965: Asia’s first SEZ was set up in Kandla, Gujarat (At that time it was called Export Processing Zone/EPZ). Currently we’ve 220+ SEZ in India.
- Benefit? More exports, employment, economic growth.
- Challenges? SEZ entrepreneurs use legal loopholes → Tax avoidance, Workers deprived of EPFO/ESIC/Maternity benefit. When entrepreneurs’ Tax holiday is over in one SEZ, they shutdown operation and move to another SEZ with new name/registration.
Agricultural and forest lands diverted to build SEZs → future challenges in food security, pollution control and climate change.
Solution for the challenges of SEZs?
Solution? 2018: Commerce Ministry had setup Baba Kalyani committee to look into SEZ issues.
Baba Kalyani report on SEZ
1. While the number of SEZ & SEZ-led employment has increased, but their export growth rates were not encouraging in the last decade.
- Instead of giving blanket-general-tax-holiday, SEZ-units should be given tax benefits linked to how many job created, how much FDI investment attracted, how much goods/services exported etc.
- SEZs should be converted into Employment and Economic Enclaves (3Es) with efficient transport infrastructure, uninterrupted water and power supply. (So, both domestic-consumer-centric entrepreneurs and export-centric entrepreneurs can operate from same locality, supply each other with intermediate goods/services. While export-centric entrepreneurs get further tax benefits in Customs Duty & Direct Taxes.)
- Encourage MSMEs in 3Es, so we can create more jobs. Simpler entry and exit processes using time-bound online approval and dispute resolution for entrepreneurs.
- Develop infrastructure: High Speed Rail, Express roadways, Passenger/Cargo airports, shipping ports, warehouses etc. near SEZ/3Es zones.
- Focus on electronics for domestic production for domestic consumers, and make a plan for import substitution.
❓Which one of the following countries in Asia established the first Export Processing Zone (EPZ) in 1965? (UPSC-Geologist-2020)
a. China b. India c. South Korea d. Japan
b
What is Foreign Trade Policy (2015-2020) and the schemes introduced under it?
- India’s export in goods and services in 2013-14 was ~$465 billions. This FTP Policy aims to almost double it to $900 billion by 2020.
- Nodal? Director General of Foreign Trade (DGFT) under Ministry of Commerce.
- Introduced new schemes / streamlined previous schemes such as: MEIS/SEIS.
= Interest Equalization Scheme (MSME exporters given interest subsidy on loans.
= Duty free import of capital goods
= Advance Authorization Scheme allows duty free import of inputs, along with fuel, oil, catalyst, etc., required for manufacturing export product.
= Niryat Bandhu Scheme: Govt mentors the new and potential exporters through training, counselling, orientation programmes
= Towns of Export Excellence (TEE) and Trade Infrastructure for Export Scheme (TIES): where Union gives ₹ for infra development for export (warehouses, transportation, packaging facilities etc.)
✓ E-governance initiatives →
○ CBIC → Single Window Interface for Facilitating Trade (SWIFT) for importers and exporters through icegate.gov.in. Within that, e-governance modules like
E-Sanchit, Turant etc for document approval etc.
○ Commerce Ministry & FIEO (Federation of Indian Export Organisations) launched India Trade webportal and Niryat Mitra App.
Foreign Trade Policy: Challenge / Updates?
- While policy has lofty goal of doubling Indian exports to $900 billion by 2020. But US/EU protectionism = target difficult to achieve.
- 2019-Oct: Government planning to launch new foreign trade policy as existing policy will expire on 31/3/2020.
- 2018: Commerce Ministry launched a separate policy for Agriculture Exports
What is Tax Credit for Exporters: MEIS/SEIS? and their boss?
- Boss? Commerce Ministry WAS running two tax-incentive schemes to boost exports
- Services Exports from India Scheme (SEIS)
- Merchandise Exports from India Scheme (MEIS)
- These schemes provide tax credit to exporters, which they can use for paying Union’s Customs Duty.
- AFTER RODTEP is notified fully, the MEIS scheme will be STOPPED.
Rodtep vs MEIS?
2020-March: govt announced Remission of Duties and Taxes on Exported Products (RoDTEP)
Boss? Commerce Ministry
GOODS Exporter gets Input tax credit for
MEIS - Customs Duty
RoDTEP - Following taxes paid in previous stage:
1. Customs Duty
2. Excise and VAT on Transport fuel
3. State Mandi tax on Agriculture raw material
4. Electricity duty on electricity
WTO-compliant?
MEIS - No, so WTO ordered to stop it
RoDTEP - Yes, RoDTEP will replace MEIS scheme.
What is Authorised Economic Operator (AEO)? Benefits?
Port Logistics: Authorised Economic Operator (AEO)
- An importer/exporter/cargo company can apply to the Central Board of Indirect Taxes and Customs (CBIC) to get this ‘status’.
- Subject to conditions like 1) minimum 3 years experience 2) never filed bankruptcy 3) never caught in fraud / smuggling etc.
- Benefits? Faster clearance times, fewer physical examinations on cargo etc.
- At International level, World Customs Organization (WCO, HQ: Brussels, Belgium)’s “SAFE Framework” guides this program.
ES20 on exports
ES20: “Assemble in India”
ES20 Vol1ch5 Talks about doing “assemble in India for network products” to encourage our exports.
What is FPI and its objectives?
Foreign Portfolio Investors (FPI)
It is a foreign entity registered @SEBI, and who buys upto 10% in equity / shares of an Indian Company. [For Corporate Bonds and G-Sec these % are different.]
- Before Budget-2019: The aggregate limit of all FPIs in an Indian company was 24%. Otherwise if 10 different FPIs invest 9% each in a company then 90% of company’s shareholding will be owned by foreigners, even though a given industrial sector may not be open for 90% foreign direct investment.
- From Budget-2019: 24% cap is removed. Now, aggregate limit of all FPIs in an Indian Company = total foreign investment sectoral cap for that industry
e. g Broadcasting of News TV-channels =49% Foreign investment allowed. So, FPI cap will be 49%. So, NDTV India ltd could be FPI-I (upto 10%) + FPI-II (upto 10%)+…. As long as 51% shareholding is with Indians. - Originally, these were called Foreign Institutional Investor (FII) and Qualified Foreign Investors (QFIs), but in 2013 SEBI merged them all into a single category- FPI, based on the recommendations of K.M. Chandrasekhar committee.
- FPI’s primary objective is make money from buying and selling of shares through the capital market / share market. They even help the SEBI-non-registered foreign
investors by issuing them Participatory notes (P-Notes) - FPIs are not involved in the actual operations / production / management / business
policy making of a company. - If FPI investor is hopeful to get better returns in the other countries’ share/bond market, he may quickly sell his Indian securities and move away. The flight of such money is called hot money. It results into weakening of Indian Rupee and falling of sensex
What is FDI? Sectors it is prohibited in and types for permit?
- FDI is the investment made by a foreign entity into an Indian company, with the objective to get involved in the management / production of that Indian company.
(e. g. 2018: Walmart-USA bought 77% stakes in Flipkart @$16 billion.) - Foreign Investment is prohibited in atomic energy, railway operations (except Metro & infra dev.); Tobacco Products, Real Estate Business, Farm Houses, Chit Funds, Nidhi Companies, Betting Gambling Casino & Lottery.
- For the remaining sectors, Foreign Investment is permitted either through:
A. Automatic Route: i.e. Foreign entity doesn’t require Indian Govt’s approval.
B. Government Route: i.e. prior to investment, they’ve to get approval from the Govt of India’s respective Administrative Ministry/ Department (+ Commerce Ministry).
What is e-commerce?
Definition? E-commerce means buying and selling of goods and services over digital & electronic network. Two subtypes
1. Inventory based model of e-commerce: Company sells the inventory of goods and services, which is owned by them to consumers directly. E.g. primeabgb.com (A computer hardware site). FDI is not permitted here.
- Marketplace based model of e-commerce: Company merely provides a webportal/app to act as a facilitator between buyer and sellers. E.g. Amazon, Flipkart. 100% FDI allowed here.
Marketplace E-Commerce companies were engaging in Anti-Competitive behaviour e.g.
- Flipkart / Amazon would enter in exclusive partnerships with top smartphone brands
such as Xiaomi and Oppo- Prohibiting them from selling their mobile phones through
other online or offline channels → offline mobile shops suffer.
- Flipkart / Amazon run “Marketplace E-Commerce model” i.e. they allow any
merchant to list their products on their website. However they will also have their own merchant company (e.g. Amazon’s cloudtail pvt ltd) who would offer deep discounts / cashbacks to the customers. → Other online merchants on the same web platform will suffer. Offline brick and mortar shop merchants will also suffer.
E-Commerce Rules 2019-Feb- What are they? Who makes them? how do they get that power?
Who? Consumer Affairs ministry.
How? using the powers under Consumer Protection Act 2019.
1. Such E-commerce companies can’t have exclusive agreements with sellers. E.g. Flipkart can’t compel Xiaomi ‘not to’ sell Mi phones on other
online/offline platforms.
2. Tightened the technical norms related to cashback and discounts.
3. Tightened norms on E-commerce company who were using their own subsidiary companies/shell companies as “Online Merchants” to sell products at deep discount
E-Commerce Rules 2020-Jul
✓ These rules applicable to all types of electronic retailers (e-tailers) registered in India or abroad - whenever they’re offering goods and services to Indian consumers.
✓ E-tailers must mention the ‘expiry date’, ‘country of origin’ of goods, its policies on return, refund, exchange, warranty and guarantee, delivery, shipment, cancellation policy.
✓ E-tailer must display sellers’ geographic address, customer care number, rating etc.
Penalties? Consumer Protection Act, 2019.
❓MCQ. Both Foreign Direct Investment (FDI) and Foreign Institutional Investor (FII) are related to investment in a country. Which one of the following statements best represents an important difference between the two?(Asked in UPSC-Pre-2011)
A. FII helps bring better management skills and technology, while FDI only brings in
capital.
B. FII helps in increasing capital availability in general, while FDI only targets specific
sectors.
C. FDI flows only into the secondary market, while FII targets primary market.
D. FII is considered to be more stable than FDI
b
Ministry of Commerce and Industry- looks after and is boss of?
Yearbook: Ministry of Commerce and Industry
looks after Internal and External Trade, WTO, Dumping, SEZ, FDI related issues. It’s the
boss of
Attached offices:
-Directorate General of Foreign Trade (DGFT) for
promotion of foreign trade.
-Directorate General of Trade Remedies (DGTR) to impose anti-dumping duty on foreign products.
-Directorate General of Commercial Intelligence and Statistics
PSUs
- Export Credit Guarantee Corporation of India (ECGC: NIRVIC scheme-walle)
- MMTCltd.(Gold-coin-walle)
- National Investment Promotion and Facilitation Agency of India. Commonly known as “Invest India”: A ‘not for profit’ company by commerce ministry + FICCI + NASSCOM + other in 2009. Sidenote: FICCI and NASSCOM are not-for- profit associations made by businessmen, mainly to lobby/highlight their demands to Government.
Autonomous bodies:
- Agricultural and Processed Food Products Export Development Authority (APEDA), under its statutory act.
- Indian Institute of Foreign Trade (IIFT)- a “Deemed University” that offers MBA, PHD & other programs.
- Statutory Commodity Boards → Coffee, Rubber, Tea, Tobacco, Spices Board.
What does Indus script “Takara Kolimi” , Sreni, Sethi, Poddar mean?
Budget-2020: Indus script “Takara Kolimi=Tin smithery”, “ Sreni “= Guild , ” Sethi”= wholesale merchant, “Poddar”= Assayer of metal into treasury.
What was DPIIT previously? its ministry and functions?
Interim-Budget- 2019: Govt renamed Commerce Ministry’s Department of Industrial Policy and Promotion (DIPP) → Department for Promotion of
Industry and Internal Trade (DPIIT)
It’ll function under Ministry of Commerce and Industry
DPIIT’s Objectives? Promotion of internal trade, including retail trade; welfare of traders and their employees; matters relating to ease of doing business; and startups.
What is FIPB? Its functions and abolishment
(2017) FIPB Abolished
- Foreign Investment Promotion Board (FIPB) was an inter-ministerial body in the Department of Economic Affairs in the finance ministry.
- FIPB processed the FDI applications where government approval was required. If investment amount exceeded ₹ 5,000 crore → application forwarded to Cabinet
Committee on Economic Affairs (CCEA) - FIPB was chaired by the economic affairs secretary, & members from other depts.
- 2017: Govt announced FIPB’s abolition. Now, individual ministries/departments are empowered to clear FDI proposals in consultation with Commerce Ministry. e.g. FDI in Pendrive factory → MEITY + Commerce Ministry. (if proposal above ₹5kcr →CCEA)
- FIPB’s webportal was renamed into “Foreign Investment Facilitation Portal” and transferred to Commerce ministry.
- However, Only Home Ministry will clear FDI proposals coming from Pakistan and Bangladesh; and FDI proposals related to private security agencies, small arms manufacturing.
BoP: Capital →Does Chinese FDI need Govt approval?
Before
If any FDI proposal coming from Pakistan and Bangladesh, it required approval from Government of India.
From 2020-April
- If any FDI proposal from any country that shares border with India → Indian Govt approval required
- Means, Pakistan, Afghanistan, China, Nepal, Bhutan, Bangladesh and Myanmar
✓ Govt decided this because: Corona-led slowdown = Indian companies suffering from losses. China may mis-use this opportunity to takeover such Indian companies @very low share price → will harm our strategic & economic interests.
✓ Criticism? China says this is violation of WTO norms related to foreign investment. Although Australia and Germany also announced similar restrictions with similar reasons.
boss for the following cabinet committees: Cabinet committee on 1) Appointments 2) Accommodation 3) Economic Affairs 4) Parliamentary Affairs 5) Political Affairs, 6) Security 7) Investment and Growth 8) Employment and Skill Development
Boss
1-PM - finalizes the name for top level appointments like Cabinet Secretary, Indian ambassadors for each nation etc.
2-HM - Giving house allocation to politicians, top officials
3-PM - FDI approval, Agri-MSP approval, Bank merger, disinvestment etc grand things
4-Defense Minister - Defense Minister Rajnath Singh made boss for his acumen in parliamentary matters
5, 6-PM -
7, 8- PM - These two are new committee formed after 2019’s General Election.
What is International Financial Services Centre (IFSC)?
✓ A nation will not apply its local taxation and investment norms in its IFSCs E.g. UAE → Dubai’s IFSC centre: 100% FDI allowed in any sector. 100% Capital Account Convertibility (i.e.Invest & pullout money as & when you please in any currency of your choice!), 0% income tax for 50 years. DTAA with most countries. Independent judiciary not bound with local laws. Quick Visa etc.
✓ Result? Such place becomes a hub / base of operation for international financial companies and investment bankers. It also creates trickle down benefits for local people e.g. Chartered Accountants, Hoteliers, Golf club owners, Taxi operators etc.
✓ London, New York, Hong Kong and Singapore to have also grown by setting up such centres. Taking their example, India too has set up Gujarat International Finance Tec (GIFT) city international financial services centre (IFSC) near Ahmedabad. (2015)
✓ Although it not yet attracted good number of international financial companies because the tax benefits are not as great as Singapore, Hong Kong etc.
✓ This ‘greenfield’ GIFT city was developed by 50:50 Joint venture of IL&FS + Gujarat Urban Development Company Limited (GUDCL). Together they were responsible for the construction, electricity, water, sanitation and other responsibilities of running this city.
- But post IL&FS crisis, Government of Gujarat has decided to buy IL&FS’s 50% shareholding.
- Full-Budget-2019: Companies operating in operating IFSC were given additional benefits / tax holidays in the direct taxes (with the hopes that it’ll attract more companies here).
What is IFSC Act?
✓ IFSC (such as GIFT city) are setup under the SEZ Act.
✓ IFSC get relief / exemption in the Indian tax laws. Further, RBI, SEBI, IRDAI and other regulators’ norms also apply in relaxed manner.
E.g. Bank branches in GIFT-city-IFSC are exempted from RBI’s CRR-SLR-PSL etc. norms.
✓ 2019’s Act aim to setup a statutory International Financial Services Centres Authority with
- One Chairperson
- One member each nominated from RBI,SEBI, IRDAI, PFRDA
- few other members from Finance ministry etc
- Tenure? 3 years. Re-appointment? Yes, possible.
✓ The IFSC Authority will regulate all financial services, products, institutions in International Financial Services Centres of India.
- 2020-April: Government announced its headquarter will be at Gandhinagar, Gujarat. (Since Gandhinagar is the only place with an IFSC at present, i.e. GIFT City)
- Controversy? Maharashtra demanding HQ should be in Mumbai.
What is NIIP?
BoP → Capital Account → NIIP
✓ Net International Investment Position (NIIP)= value of overseas assets owned by a nation minus the value of domestic assets owned by foreigners.
Positive NIIP value = creditor nation
Negative value = debtor nation.
USA highest, India at 8th place (in 2018)
❓MCQ. Find correct statement(s): (Pre19-SetA Q63)
1. Most of India’s external debt is owed by government entities.
2.All of India’s external debt is denominated in US dollars.
Codes: (a) 1 only (b) 2 only (c) Both 1 and 2 (d) Neither 1 nor 2
d
❓MCQ. Which of the following constitute Capital Account? (Asked in UPSC-Pre-2013)
1. Foreign Loans. 2. Foreign Direct Investment
3. Private Remittances. 4. Portfolio Investment.
Answer codes: (a) 1, 2 and 3
(b) 1, 2 and 4 (c) 2, 3 and 4 (d) 1, 3 and 4
b
BOP summing up
2018-19 (Bn. USD)
Current Account Deficit = - 57k (previous year -48k, meaning deficit ⏫)
Capital Account Surplus = + 54k (previous year +91k Meaning surplus ⏬)
Errors & Omissions = -0.486
Overall Balance = (-) 3 billion (approx.)
Official Reserve Transactions or Monetary Movements in RBI’s Foreign Exchange Reserves** = (+) 3 bn.
Net Balance Payment off India = 0 (ZERO)
**(+) sign indicates RBI supplied/sold that many $$ from its forex reserve, else $ becomes stronger= ₹becomes weaker, bad for importers.
(+) Sign indicates decrease in RBI’s forex reserve.
What is Accommodating transaction and Autonomous transactions in BOP?
Official Reserve Transactions or Monetary Movements in RBI’s Foreign Exchange Reserves under the BOP is called Accommodating transaction, because RBI will do it based on whether we are having surplus or deficit due to previous four items (so that RBI can accommodate NET BoP to ZERO).
Current Account Deficit, Capital Account Surplus , Errors & Omissions, Overall Balance are called Autonomous transactions because they occur independently on their own without RBI’s involvement.
What is Sterilization under BoP?
If there is a BoP situation, wherein RBI has to sell ₹ to buy $ to get the NET answer ZERO
(e. g in 2017-18: Current -48k Capital +91k = overall balance was +43k billion$. So, RBI had to sell ₹ to buy those +43k billion$), but then,
- Such RBI action would result in increased supply of rupee currency in the Indian market → it can cause inflation if there is not sufficient supply of goods for purchase.
- So, RBI must ‘absorb’ that excess rupee currency back.
- It does so through Open Market Operation (OMO) → sell government securities to buyback Indian rupees. This entire process is called Sterilization.
What was India’s Balance of Payment crisis (1991)?
- Nowadays India usually has “DEFICIT” in current account (due to crude oil imports), but there is usually sufficient “SURPLUS” in capital account (thanks to FDI & FPI) to counter/offset that Current Account DEFICIT.
- But in the pre-1991’s Socialist Economy, many sectors were nationalised (banking insurance) and / or reserved for the public sector companies only which lead to mismanagement & inefficiency.
- Private sector industrialists were allowed only in selected sectors, and were subjected to Licence-Quota-Inspector Raj → low level of competition, low innovation = low exports.
- And our policy makers restricted foreign investments (FDI /FPI) fearing that:
- It’ll bring USA-CIA’s invisible hand in Indian Affairs
- Our Swadeshi industries & our ‘Non-Alignment Movement (NAM)’ will be harmed.
- End result? High level of “DEFICIT” in Current Account and not enough surplus in Capital account to counter/offset that DEFICIT.
- In such a situation, plus (+) in the Monetary Movements in RBI’s Foreign Exchange Reserves indicates RBI must sell dollars from its forex reserve to keep India’s BoP at ZERO level.
- If they can’t do it then shortage of dollars in Indian market to pay for our import bills → results in heavy weakening of Indian rupee (e.g. $1 =₹ 60 → $1= ₹ 6000) then it becomes even more expensive to import oil.
- In 1991, RBI didn’t have enough forex reserves to get India’s BoP zero → RBI had to pledge gold to IMF to borrow dollars.
- IMF also imposed certain conditions which required India to open up its economy through LPG reforms (Liberalisation, Privatisation, Globalisation)
RBI’s Forex Reserve in decreasing order of size?
The Forex Reserve component(s) in decreasing order of size =
1) Foreign Currency Assets (includes foreign currencies & G-Sec/bonds of foreign Govts
2) Gold
3) Reserve Tranche Position (RTP) in the IMF.
4) SDRs
➢ Total ~480 million USD (2020-April).
➢ As of 2019. We’re 8th largest after China ($3 Trillion)> Japan > Switzerland > Saudi Arabia > Russia > …
➢ USA is not in the top-10 list, it barely keeps ~$125 billion in reserve.
❓MCQ. Which one of the following groups of items is included in India’s foreign- exchange reserves? (Asked in UPSC-Pre-2013)
A. Foreign-currency assets, Special Drawing Rights (SDRs) and loans from foreign
countries.
B. Foreign-currency assets, gold holdings of the RBI and SDRs.
C. Foreign-currency assets, loans from the World Bank and SDRs.
D. Foreign-currency assets, gold holdings of the RBI and loans from the World Bank.
b
Factors responsible for Disequilibrium in BoP?
When Credit (Receipt, income money) = Debit (Payment, outgoing money) then BoP will be ZERO. If, not then BoP is in disequilibrium. This can happen because of:
- Development disequilibrium ( poor nations have to import more grains, medicines etc. = adverse BoP.
- Secular or Long-term Disequilibrium ( newborn nation is usually poor & backward so imports»_space; Export. E.g. India in 1980s
- Consumerism and Demonstration Effect: Rich Indians try to copy westernized lifestyles. So, ⬆import of Switzerland wristwatches+Sports Cars = adverse BoP.
- Structural Disequilibrium =if transport, electricity infrastructure is poor or Technological Backwardness = exports can’t improve.
- Cyclical Disequilibrium ( When two countries may be passing through different phases of business cycle (Boom, slowdown), so there will be mismatch in imports, exports, FDI etc.
What is currency exchange rate?
(Definition) The price of one currency in terms of the other currency is called exchange rate. E.g. $1 = ₹ 70. Meaning, it costs ₹ 70 to buy one dollar (or $0.014 to buy ₹ 1).
- This is also called Nominal Exchange Rate because it does not take into consideration inflation or purchasing power in the respective countries.
Place where currencies are exchanged? and this is regulated by?
- The place where currencies are exchanged is called Foreign Exchange Market.
- Their dealers are called Authorized (Forex) Dealers (AD). They can be banks or non-banks. They have to get registered with RBI under the Foreign Exchange Management Act (FEMA).
- These dealers keep separate prices for buying and selling, to make profit in between e.g. ICICI: $1 Dollar buying price ₹ 67.95 and $1 selling price is ₹ 72.76.
- Such currency transaction service is also subjected to GST, however the rate depends on the quantum of currency exchanged. (e.g. upto ₹ 10 lakh exchanged in foreign currency then only ~₹ 3000 of that 10 lakh will be taxable in GST → 18% of 3000 → ₹ 540 GST Tax.)
What is Tobin Tax?
- American Economist James Tobin had suggested 0.1% to 0.5% Tobin Tax on currency exchange transactions to discourage the speculative trading and volatility in the International Financial Market,
- but on that logic if ₹ 10 lakhs exchanged then 0.1-0.5% = ₹1,000 to 5,000 should be levied as ‘tax’, but since GST amount is much lower, so in reality it can’t be labelled as ‘Tobin Tax’
Explain Currency rate regime theory and its challenges
It is the set of rules governing the exchange of domestic currency with foreign currencies.
Floating or Flexible:
- Here the exchange rate is determined by the market forces of demand and supply.
- So if there are more number of Indian people wanting to import crude oil, gold, iPhones/going to USA for higher - studies compared to the number of Americans interested to buy Indian goods, services/ coming to India for vacation
- Then, demand for dollars will be more than that of rupees. So, $1 = 50 → $1=70 - In this system, if rupees weakens, it’s called
‘Depreciation. Makes the export look cheaper to the foreign buyer. if ₹ strengthens it’s called ‘Appreciation’
Challenge?
- Currency Speculation: When a person buys $ and other foreign currency with the hopes they become more expensive in future so he can sell @ profit to others. Such elements distort the exchange rate by hording foreign currencies.
- Interest Rates: If US repo rate / Treasury Bonds are going @ 2% whereas in Greece’s bonds going@4% Then American investors will convert Dollars to invest in Greece. Later, when US increases their repo rate from 2% to 4% American investors might pull back from Greece. (Because America commercial bank loans will become more expensive ~5%, then there will be American companies willing to borrow by issuing Bond/debentures at 4.5%.)
Fixed or Pegged:
- When the central bank of a country itself decides the exchange rate of local currency to foreign currency e.g. People’s Bank of China (PBC) $1 = 6 Yuan.
- If excess dollars are entering in their market, the central bank will print more Yuan to buy and absorb the excess dollars, to ensure Yuan doesn’t weaken against Dollar ($1=6 → 5 Yuan). As a result, their forex reserve will get large build up of dollars, due to central bank’s purchase.
- In future, if less dollars are entering in their market, the central bank will sell the (previously acquired) dollars from its forex reserve to ensure Yuan doesn’t weaken (₹ 1= 6 → 7 Yuan) - In this system, if Yuan is weakened by Central Bank’s official notification, it’s called ‘devaluation’ - usually done when it doesn’t have enough dollars in reserve and / or when it wants to deliberately weaken Yuan to encourage exports.
if Yuan is strengthened by Central Bank’s official notification, it’s called ‘Revaluation’
Challenge?
- If trade deficit widens / speculators are hoarding dollars / FPIs are pulling their money back to USA due to higher interest rates → shortage of $ in local forex market→ PBC will have to sell $ from its forex reserve to keep the exchange rate stable.
- but since PBC will not have infinite amount of dollars in its reserve ultimately it will be forced to be devalue the local currency → imports will become more expensive.
- Therefore, most of the countries have abandoned this system after 70s. China too abandoned it in eventually, and shifted to Managed Floating Exchange Rate.
❓MCQ. Under flexible exchange rate system, the exchange rate is determined by [UPSC-CDS-2015-II]
(a) predominantly by market mechanism (b) by the Central Bank (c) as a weighted index of a group of currencies (d) by the World Trade Organization
a
What is Managed Float / Dirty Float?
- It is the middle path between the two extremes (floating and fixed).
- RBI will not decide the exchange rate (unlike the fixed system). In the ordinary days, RBI will let the market forces of supply and demand decide the exchange rate.
- But if there is too much volatility, then RBI will intervene to buy / sell $ to keep the volatility controlled.
- Similarly, People Bank of China will not intervene in ordinary circumstances. They’ll intervene during volatility i.e. if $ to Yuan value changes more than “x%” up or down compared to previous day’s exchange rate.
Challenges in Managed Float System?
- Currency speculation and interest rates
- Currency Manipulation: usually occurs when a central bank keeps buying dollars to create artificial scarcity of $ in the forex markets → dollar becomes expensive → local currency becomes weak → boost to exports.
US Department of the Treasury publishes a semi-annual report to track such nations. 2018: China, Germany, Japan, Switzerland, S.Korea and India have been kept in (‘Watch list’) citing the (alleged) lack of transparency and consistency in their respective Central banks operations. USA has not officially labelled anyone as “Currency Manipulator”, since 1994.
❓MCQ. The price of any currency in international market is decided by: (Pre-2012) 1. The World Bank.
2. Demand for goods/services provided by the country concerned.
3. Stability of the government of the concerned country.
4. Economic potential of the country in question.
Answer codes:(a) 1, 2, 3 and 4 (b) 2 and 3 (c) 3 and 4 (d) 1 and 4
b
What Fixed exchange rate system → Gold Standard under the Currency rate exchange regime history?
Fixed exchange rate system → Gold Standard (1870-1914)
- USA would issue $1 note, if only it has 14 grams of gold in reserve, whereas England would issue one pound note if only it has 73 grams of gold in its reserve. Accordingly, their exchange rate will be 1 Pound =73/14 = ~5 USD.
- And, each Central Bank Governor has promised to convert their currency into gold at a fixed amount. So, a person could walk with paper currency and demand the gold coins or gold bars in return.
- When the gold mining production declined, nations gradually shifted to ‘bimetallism’ e.g. $1 promised with 14 gm gold or 210 gm of silver whichever available with their Central Bank.
- This system collapsed during the First World War (WW1) because the nation’s currency printing capacity was limited by their gold reserve, but their governments were more eager to print more money to finance the war (soldiers’ salaries, rifles’ ammunition etc.)
Fixed exchange rate system → Bretton Woods System (1946-1971) under the Currency rate exchange regime history?
Here, USA agreed to fix price of its $1 = (1/35) ounces of gold. [1 ounce = 28 grams]. USA allowed free convertibility of Dollar to Gold. So if a person walked into the US Federal Reserve with $35, their chairman (Governor) will give him one ounce of gold.
- Then IMF fixed the exchange rate of every country’s currency against USA. e.g.₹ 1= $0.30 = ~0.24 grams of Gold. So, that implied India can’t issue more currency If Indian RBI does not have proportionately sufficient gold reserve of its own. Still if RBI issues more ₹ currency, International Monetary Fund (IMF) will order India to devalue its rupee exchange rate against dollar.
- American Economist Robert Triffin claimed this system will collapse eventually because gold is a finite commodity and its price will continue to rise. So there is always danger of people converting the local currency into dollars and then converting dollars into gold @$35, then selling it in open market @profit, then US Feds Chairman can’t continue honouring his promise. It was called “Triffin Dilemma. He therefore suggested an alternative SDR (Paper gold) system for IMF.
- 1971: USA President Robert Nixon pulled out of Bretton Woods gold convertibility system, mainly because he wanted freedom to print more dollars to finance the Cold
War and arms race against the USSR. - Thus, USA shifted to “Floating Exchange System”. Eventually most of the nations also shifted in that either floating / managed-floating system.
- 2000: Ecuador adopted Dollarization i.e. it abandoned the domestic currency and adopted the US dollar as their official currency.
Currency Exchange in India after 1995
Towards Managed Floating Exchange Rate →
✓ 1995 onwards: “Minimum Reserve System is continued but RBI is required to only keep ₹ ’x’ crores of gold. No compulsion for RBI to keep additional 400 crore worth foreign currency or foreign securities. RBI can print as much currency it wants as long as its balanced by the Assets of Issue Dept. (such as Indian G-sec, Foreign Securities, Gold etc.)
What is IMF’s Special Drawing Rights?
After the collapse of Bretton Woods Exchange Rate System, IMF was converted into a type of ‘deposit bank’, where the members would deposit currencies in the proportion of quotas allotted to them (depending on size of their economy, openness etc).
- IMF will pay them a small interest rate for their deposits. And IMF would lend this money to a member facing balance of payment crisis. To operationalize this mechanism, IMF would allot an artificial currency / accounting unit called SDR to the members based on their deposits.
- Initially the price of SDR was fixed against the amount of gold but present mechanism
Currency Basket - Weight - Exchange rate against $?
U.S. Dollar - 41.73 - $1=$1
Euro - 30.93 - 1.13
Chinese Yuan (Renminbi *added in 2015) - 10.92 - 6.7 - By applying a formula involving (weight * exchange rate), IMF will obtain value of 1 SDR = how many dollars? Presently, 1 SDR = $1.40 = ₹ 98 (assuming $1 is trading @₹ 70).
Why is SDR called ‘Paper Gold’?
- SDR is called ‘Paper Gold’ because it’s merely an accounting entry or artificial currency, without any gold involved.
- SDR can be traded among the members, it can be converted into members’ currencies & be used to settle their Balance of Payment Transactions / Crisis.
- If the BoP crisis is so big, that a country’s entire SDR quota exhausts, then member country may borrow more SDR from IMF, but eventually member will have to repay this loan to IMF with interest.
- 2016-Reforms: The total quantity of SDR was increased, and India’s quota was increased from 2.44% to ~2.75%, accordingly, we are allotted ~13 billion SDR (25% of it is kept as reserve tranche position RTP)
- India is 8th largest quota holder after USA (~18%), Japan (~7%), China (~6%)
- In IMF, a member’s voting power depends on his SDR quota contribution.
- For India, this voting power is exercised by India’s Finance Minister as the ex-officio Governor in IMF’s Board of Governors.
- If FM absent, then RBI Governor can vote as the Alternate Governor during the IMF’s meetings.
❓MCQ. Recently, which one of the following currencies has been proposed to be added to the basket of IMF’s SDR? (Asked in UPSC-Pre-2016)
Answer codes:(a) Rouble (b) Rand (c) Indian Rupee (d) Renminbi
d
RBI’s restrictions no convertibility of rupee?
Indian rupee is not fully convertible on capital account transactions. - due to limits on ECB and FPI limits on govt securities and corporate bonds.
Indian rupee is considered fully convertible on current account transactions (i.e. Import and export, remittance, income transfer gift and donations) since 1994.
S.S. Tarapore Committee (1997) recommendations for convertibility?
He suggested India to allow full Capital Account Convertibility (CAC) only when the fundamentals of our economy become strong enough, such as:
- RBI must have enough forex to sustain 6 months’ import
- Fiscal deficit must not be more than 3.5% of GDP
- Inflation must not be more than 3-5%
- Banks’ NPA must not be more than 5% of their total assets. And so forth.
So, time is
not yet ripe for allowing full CAC.
RBI reforms (2004-2019) for convertibility?
While RBI has not permitted full convertibility of Indian rupee (on Capital Account), but over the years it has liberalised the norms, such as
2004 → Liberalised Remittance Scheme (LRS) for each financial year, An Indian resident (incl. minor) is allowed to take out upto $2,50,000 (or its equivalents in other currencies) from India. He may use it for either current account or capital account transaction as per his wish. (e.g. paying for college fees abroad, buying shares, bonds, properties, bank accounts abroad.)
Controversy? Panama papers allege certain Bollywood celebrities used LRS window to shift money from India in their shell companies in tax havens → later used those shell companies for tax avoidance.
2016 onwards: RBI began relaxing the norms for External Commercial Borrowing (ECB), mainly to soften the NPA problem e.g. Software cos. can bring up to $200 million in ECB, Microfinance $500 mill, Infra.cos $750 mill etc.
- 2018-19: When ₹ started to depreciate heavily against dollars ($1 → ₹ 63 → ₹ 74), RBI had to encourage the flow of dollars into Indian economy. So, aforementioned sector- specific limits streamlined → all eligible companies automatically allowed to borrow upto $750 million via ECB route. (Although prohibited in certain categories e.g. purchase of farm house, tobacco, betting, gambling, lottery etc.)
- 2019: RBI allowed ECB even for working capital & repayment of rupee loans.
What are VRR and FAR under Currency Exchange Rate → Attracting Dollars? benefits?
To prevent weakening of ₹, we’ve to attract more $ (and other foreign currencies) in India. So, RBI taken following notable measures:
Voluntary Retention Route (VRR)
- Launched in 2019: If an FPI buys Indian Union/State Governments’ G-Sec and Indian Corporates’ Bonds through this route → FPI will be given more freedom in certain technical regulations of RBI & SEBI.
- But, with condition= FPI must remain invested in India for minimum 3 years. ( to curb Hot Money)
- RBI decides quantitative limits to how much money can FPI invest through this route.
Fully Accessible Route (FAR)
Budget-2020 had announced allowing non-resident investors to invest in G-Sec, without any restrictions.
2020-March: RBI announced this window, non-resident individual investors (who’re not FPI) can buy G-Sec.
No limits on amount of investment.
Benefit? Investors will convert $ & other foreign currency into ₹ currency to buy G-Sec= more $$ coming towards India = helps keeping BoP and currency exchange rate stable during crisis.
❓MCQ. Convertibility of rupee implies:(Asked in UPSC-Pre-2015)
(a) being able to convert rupee notes into gold.
(b) allowing the value of rupee to be fixed by market forces.
(c) freely permitting the conversion of rupee to other currencies and vice versa. (d) developing an international market for currencies in India.
c
What are FCRA violations for convertibility?
- if NGO / Universities were allowed to accept foreign donations in an unrestricted manner, they may become puppets of ISI / Pakistan / China / CIA.
- So, Ministry of Home Affairs (MHA) requires them to ‘register’ and furnish annual reports under Foreign Contribution Regulation Act 2010 (FCRA)
- Those who fail to comply with it, are prohibited from accepting foreign donations.
What was the Currency War of 2018?
- 2015: Chinese authorities announced they don’t manipulate/control Yuan exchange rate. They only intervene if Yuan’s exchange rate varies more than +/- 4% from previous day.
- During 2018, People’s Bank of China pursued ‘Easy/Cheap/Dovish Money Policy’ → injected more Yuan (renminbi) in the system to makes loans cheaper in domestic market and boost the consumption, demand, growth.
- But, on the other side,US Federal Reserve pursued Tight/Dear/Hawkish Money Policy, so dollar supply is shrinking, so dollar is becoming more expensive against other currencies.
- So, increased supply of Yuan vs. reduced supply of $: resulted in $1=6.20 Yuan weakening to almost $1= 7 Yuan.
- USA govt alleges Yuan was deliberately weakened (due to PCB increasing Yuan supply) to make Chinese product more cheaper in global trade and even accused Russia and Japan of playing similar ‘Currency War’ against them.
Currency War → Fall of Indian ₹ in 2018
2018: Turkey was suffering from high Inflation, current account deficit and political turmoil.
- US Feds was pursuing Hawkish monetary policy → so dollar supply shrinking → dollar is becoming more expensive against other currencies. In this atmosphere, foreign investors feared Turkish companies (who had previously borrowed lot of money from American financial market) will not be able to repay their loans in dollar currency.
- So foreign investors began selling their shares and bonds from Turkey’s market → got Lira currency → exchanged it to dollars and ran away from Turkey.
- Because of this mad rush, demand of dollars strengthened even further → other currencies became even weaker. Including India: $1=₹ 63 in January → $1= ₹ 74 in Oct’18.
- In 2019-20 also, India rupee continued to weaken towards $1=75₹ because Corona Force Majure → SENSEX⏬ → foreign investors pulling out money from India.
- While such depreciation is good for our exporters but bad for our importers.
Steps taken by Govt and RBI to combat Currency War → Fall of Indian ₹ in 2018?
To combat this fall, Govt and RBI initiated following steps:
- FPI’s investment limits in Bond market was relaxed. (So they feel encouraged to convert their Dollars into Rupees and invest in Indian bond market)
- External commercial borrowing (ECB) norms were also relaxed.
- RBI sold ~25 billion dollars from its forex reserve to calm down the demand of dollars.
- Further, to attract NRI’s dollar savings into India:
a. RBI could announce more interest rates on Foreign Currency (Non-Resident) Account (Banks) [FCNR (B) Account] & then pay interest subsidy to Indian Banks, like they had done in 2013.
b. Govt could also tell RBI to issue NRI bonds to attract their $ savings to India. - But, Urjit Patel avoided doing #4A and #4B because eventually such borrowed dollars have to be returned back to NRI with interest, which could result in exchange rate crisis in future.
- RBI could also pursue Hawkish Monetary Policy to reduce rupee supply in market - but because RBI act mandates inflation control within 2-6% CPI, and by December 2018 the CPI has been falling towards 2% so RBI’s MPC had to actually reduce the policy rate (2019 Feb to August) to combat deflation.
- 2018-Oct: The central banks of India and Japan signed Currency Swap Agreement of $75 billions i.e. either party can use that much dollar currency from other party’s forex reserve during the crisis. Even in 2008 and 2013 too they had signed similar agreement but lower amount was involved.
- 2019- March: RBI’s $5 bn Currency Swap with Indian banks →RBI gains dollar reserve to fight future volatility in currency exchange rate, whereas Indian banks got extra
rupee liquidity → cheaper interest rates to combat deflation. - 2018-Dec: India signed pact with Iran to pay crude oil bill in rupee currency. National Iranian Oil Co (NIOC) will open a bank account in India’s UCO Bank (a PSB). Indian oil companies will make payments there in ₹ currency. This will help curbing the demand of dollars in India.
- 2019-Full Budget: FM announced various measures to attract more FPI and FDI investment in India.
- 2020-Feb: CoronaVirus Force Majeure = SENSEX⬇ so FPIs Selling shares from Indian companies= they got ₹₹ → converting them into $ → running back to USA to invest in (AAA rated) US treasury bonds which is safest investment. So there is a great shortage of dollars in the Indian market. If RBI does not supply dollars → further weakening of rupee ($1=₹75 → ₹80). Therefore…
- 2020-March: RBI starts Dollars Swap with Indian banks. i.e. A bank shall buy US Dollars from the Reserve Bank and simultaneously agree to sell the same amount of US Dollars at the end of the swap period (6 months). It is done through auctioning, so, RBI to earn some % of profit.
- Corona: Dollar updown movements, RBI signing more swap agreements, Indian Government borrowing more $$ from ADB, BRICS Bank etc
❓MCQ. (Pre19-SetA) Q65. In the context of India, which of the following factors is/are contributor/contributors to reducing the risk of a currency crisis?
1. The foreign currency earnings of India’s IT sector.
2. Increasing the government expenditure.
3. Remittances from Indians abroad.
Answer Codes: (a) 1 only (b) 1 and 3 only (c) 2 only (d) 1,2 and 3 only
b
❓MCQ. (Pre19-SetA) Q86. Which one of the following is not the most likely measure the Government/RBI takes to stop the slide of Indian rupee?
(a) Curbing imports of non-essential goods and promoting exports
(b) Encouraging Indian borrowers to issue rupee denominated Masala bonds (c) Easing conditions relating to external commercial borrowing
(d) Following an expansionary monetary policy
d
What is Quantitative Easing and Federal Tapering? results in?
- 2007-08: Subprime crisis in USA → Borrowers unable to repay the home loans → American Banks and NBFCs’ bad loans / NPA / toxic assets increased → to help them, US Federal Reserve printed new dollars & used it to buy those toxic assets → increased dollar supply in the system. Known as “Quantitative Easing”
- 2013: US Federal Reserve gradually cut down its toxic asset purchasing program → less new dollars issued → called “Federal Tapering”
- Result? = shortage of dollars in USA → Loans% become more expensive in USA→ American investors began selling shares/bonds in other countries, and took their dollars back to USA (to lend to local businessmen). This phenomenon was called “Taper Tantrum”. It resulted into weakening of other currencies against USD.
What is Helicopter Money & Zero interest rate regimes?
- Economist Milton Friedman (1969) introduced concept of ‘HELICOPTER MONEY’= To combat recession, a central bank should supply large amounts of money to the public
at near zero interest rate, as if the money was being showered on them from a helicopter. It will encourage consumption, demand → more factories, jobs and economic growth. - In the aftermath of sub-prime crisis and global financial crisis → fall in consumption, demand → deflation & recession scenario. So, the Central Banks of Sweden, EU and Japan cut their deposit interest rates into negative figures (-0.1%) so if a commercial bank parked/deposited its surplus money into the central bank (through a reverse repo like mechanism), its money will be deducted in penalty instead of earning deposit interest.
Result? Commercial banks will proactively try to give away more loans to customers to boost demand in economy.
Yuan as global currency?
- 2015: Yuan added in an SDR basket of currency. → It increases the acceptance of Yuan in global economy.
- China is also loaning Yuan to other nations for infra. development in One Belt One Road Initiative (OBOR), via AIIB and BRICS bank, and even via Panda Bonds.
- In future, China may have to be less dependent on dollar$ while importing oil, missiles, metal and food commodities- as other nations begin to happily accept Yuan.
- Such Yuan dominance may pose strategic challenges to USA and India.
What is NEER and REER?
- In real life we are not just trading with USA but other countries, using foreign currencies other than US dollars (Euro, Pound, Yen, Yuan etc).
- Therefore, only tracking $1=60, $1=70 will not give a full picture. So, RBI also calculates geometric average of rupee’s exchange rate against upto 36 types of foreign currencies. The formula will give weightage to each of those 36 foreign currencies depending on their trade-volume with India.
- The result is called “ Nominal effective exchange rate (NEER)”.
- When NEER is mathematically adjusted as per the CPI-inflation levels in India and those foreign countries, it’s called “Real effective exchange rate (REER)”.
- REER interpreted as the quantity of domestic goods required to purchase one unit of a given basket of foreign goods
- NEER vs REER values help analyzing whether a currency is really weakening (depreciating) against the foreign currencies or not, thus helps to know our international competitiveness in exports.
- For example: REER⏬ = foreigners will find our export prices attractive. REER⏫ = foreigners will find our export prices less attractive. Says ES20
- 2018’s analysis reveals that though Indian rupee weakened against dollar $1=₹ 63 → ₹ 74, but rupee has not so greatly weakened against other foreign currencies.
What is Twin Deficit, Purchasing Power Parity (PPP), Big Mac Index?
It’s the term used when both Current Account Deficit and Fiscal Deficit are high
- Hypothetical concept that tries to compare two currencies’ exchange rate through their purchasing power in respective countries.
- So, If 1 cup of coffee in India = ₹ 20 whereas 1 cup of coffee costs $2 in USA then Dollar to Rupee exchange rate (PPP) should be $1 = ₹ 10. (According to OECD, exact figure is $1=₹ 17@PPP).
- This (hypothetical) exchange rate can happen in real life, if both the countries have Floating Exchange Rate without any intervention of the respective Central banks; and if the bilateral trade is free of protectionism (= without tariff or non-tariff barriers).
- GDP is the total market value of all goods and services produced in a country within a year. When we convert these GDP values from local currencies into PPP $ exchange rates, the largest economies of the world (GDP, PPP wise) are 1) USA 2) China 3) India 4) Japan 5) Germany
- The Economist magazine’s informal index to measure PPP exchange rate using the price of one McDonald burger in USA vs the respective country.
❓MCQ. Find correct statement(s) (Pre19-SetA Q82)
1. Purchasing Power Parity (PPP) exchange rates are calculated by the prices of the same basket of goods and services in different countries.
2. In terms of PPP dollars, India is the sixth largest economy in the world.
Codes: (a) 1 only (b) 2 only (c) Both 1 and 2 (d) Neither 1 nor 2
a
