Understanding Fiscal Policy

Even though it received bids six times the offer, RBI recently turned down bids for government securities citing higher yield as unacceptable. Selling and buying of government securities is a part of RBI’s Monetary Policy. Fiscal Policy being its sister policy, it remains in as much talk. In this two part series, we will understand what fiscal and monetary policy are and what is RBI’s current dilemma around Monetary Policy. Let’s understand fiscal policy in this part.

Crux of the Matter

What Is Fiscal Policy?
Fiscal policy is a means through which the government of the nation adjusts its spending levels and tax rates to monitor and influence a nation’s economy.

Fiscal policy is based on the Keynesian theory given by British economist, John Maynard Keynes. It states that the government can influence macroeconomic productivity levels by increasing or decreasing tax levels and the amount that the government spends.

Tools Of Fiscal Policy
The government can boost consumer spending and aggregate demand by reducing taxes on individuals and businesses – called expansionary fiscal policy. Similarly, increasing tax on individuals and businesses can reduce consumer spending and aggregate demand – called contractionary fiscal policy.

The government can also boost consumer demand through influx of money (expansionary) in the economy through various means like spending money on infrastructure projects or reduce it in times of rapidly rising inflation by cutting spending (contractionary).

What Is Fiscal Deficit Then?
Fiscal surplus/deficit = Government’s Revenue – Government’s Expenditure. Fiscal surplus is when revenue is higher than expenditure, and deficit is when expendityure is higher than revenue. Experts say that, a big reason for India’s fiscal deficit has been its struggles with tax collection. Take a look at these numbers.

Tax GDP Ratio
India’s tax collection lags behind most emerging nations. Since the majority of Indians do not pay income taxes, Indian tax revenues remain largely dependent on indirect tax collections (such as GST).

India’s tax collected as % of GDP is behind most emerging nations

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The Keynesian Revolution was a fundamental reworking of economic theory concerning the factors determining employment levels in the overall economy. The revolution was set against the then orthodox economic framework, namely neoclassical economics.
Monetarism is a school of thought in monetary economics that emphasizes the role of governments in controlling the amount of money in circulation. Monetarist theory asserts that variations in the money supply have major influences on national output in the short run and on price levels over longer periods.
Sher Shah Suri was the founder of the Suri Empire in India, with its capital in Sasaram in modern-day Bihar. He is often credited for introducing the currency of rupee or rupiyah.

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Privatization of Payments Space in India?

Recently, RBI allowed private companies to set up an “umbrella entity” like that of National Payments Corporation of India (NPCI) to manage retail payments space and settlement systems in India. Will NPCI, which controls 60% of all retail payments in India, lose monopoly due to the privatization of payments space in India?

Crux of the Matter

What Is NPCI?
National Payments Corporation of India manages retail payments and settlement systems in India. It is a ‘not-for-profit’ entity owned by a consortium of leading public and private sector banks. The following are the core banks of the consortium managing NPCI: SBI, Punjab National Bank, Canara Bank, Bank of Baroda, Union Bank of India, Bank of India, ICICI Bank, HDFC Bank, Citibank, and HSBC.

Moreover, it maintains digital payment channels such as Unified Payment Interface (UPI), National Automated Clearing House (NACH), National Financial Switch (NFS), IMPS, Bharat Bill Payments, FASTag, etc.

RBI’s Announcement
RBI has allowed privatization of the payments management space in India. It will allow private players to set up an NPCI-like umbrella company. They can be ‘for-profit’ entities. Companies are required to apply before February 2021. Approved entities will be given powers similar to that of NPCI.

Moreover, FDI will also be allowed with additional scrutiny. Apart from foreign fintech firms, domestic firms like Reliance, Paytm, NSE, BSE, have expressed their interest.

Private players will be allowed to set up, manage and operate new payment systems in the retail space, and operate clearing and settlement systems. They can also participate in RBI’s payment settlement and clearing systems. “Interaction and interoperability” with systems operated by NPCI will also be allowed.

Criteria To Set Up Such An Entity

The entity cannot have a single promoter with more than 40% investment.
Promoters have to reduce their share to 25% in the first five years of operation.
Entity needs to have a minimum paid-up capital of ₹500 crores.
10% or ₹50 crores of the paid-up capital to be paid at the time of application.
Entity must maintain minimum net worth of ₹300 crores at all times.

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Dilip Asbe is the current managing director and chief executive officer of the NPCI. The NPCI was incorporated in December 2008 and the Certificate of Commencement of Business was issued in April 2009.
NPCI International Payments Limited is a separate subsidiary to take NPCI’s product to the global market. Internationalization of RuPay and Unified Payment Interface (UPI) is the primary focus of the NPCI International Payments Limited.
The NPCI won Policy Change Agent of the Year 2018 by Economics Times. HDFC was awarded the Company of the Year award at the ceremony too.

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RBI’s Positive Pay To Make Cheques Safer

Amidst the ongoing debate on whether the Indian government should decriminalize cheque dishonoring, RBI has introduced a mechanism called Positive Pay to increase the security of cheques, giving banks the burden to verify the details of cheques. Let’s understand what is this mechanism and how does it work.

Crux of the Matter

Positive Pay Mechanism
RBI’s Positive Pay mechanism would be valid for cheques worth above ₹50,000. This mechanism is aimed at adding security and reducing instances of fraud. Approximately 20% cheques issued by volume and 80% cheques issued by value in India will be covered under this system. ICICI bank has been implementing a similar system since 2016.

Let’s Understand It Through An Example
Mr A, having a bank account with SBI issues a cheque of ₹1 lakh to Mr B having a bank account in Yes Bank. Earlier, Mr B could do fraud by changing the amount, duplicating the cheque, etc. But, with Positive Pay Mechanism, Mr A will notify to SBI the cheque number, date, payee name, payee account number, amount, image of the front and back of the cheque before issuing it to Mr B. So whenever Mr B deposits cheque into Yes bank, SBI will verify the details of the cheque sent by Mr A. Cheque is honoured if the details match, and referred back to the issuer if do not.

What Is Reverse Positive Pay?
In the Reverse Positive Pay mechanism, everything remains the same but the burden to verify the details will be on the person who issues the cheques. Here, the bank will send details to the issuers to confirm the details.

Debate On Decriminalizing Cheque Bounce
In the month of June, the Union Finance Ministry had proposed to decriminalize cheque bounce cases and proposed to count it as a civil offense rather than a criminal offense. The government has asked for public comment on the matter. Currently, the punishment for bounced cheques is jail imprisonment of up to two years and/or fine double the amount of cheque.

Experts’ And Government’s Take On Why It Should Be Decriminalized
The government believes that by doing so, ease in doing business will increase. By decriminalizing cheque bounce, it will reduce the burden on courts as currently ~40 lakh cheque bounce cases are pending as per 213th Law Commission Report. Moreover, one has to file different cases for each cheque bounce, and the burden to prove remains on the one who filed the case, making it less feasible with negligible favorable results. The government believes that in the wake of coronavirus, it is necessary to remove such hurdles to boost investments and businesses. The government also thinks that such harsh criminal punishment stops domestic as well as foreign investments.

Criminalising procedural lapses and minor non-compliances increases burden on businesses and it is essential that one should re-look at provisions which are merely procedural in nature and do not impact national security or public interest at large.
Department of Financial Services

Experts’ And Government’s Take On Why It Should Not Be Decriminalized
However, business unions have opposed this proposal saying that it will cause great instability in the trade cycle and worsen the trust in the market. Cheques have value because of the strict laws and business people may stop taking cheques because of fear of being unpaid, leaving them in a financial turmoil.

A bounced cheque is equivalent to paying in fake currency, a much more serious crime. It also amounts to cheating, since the receiver is under the false impression that there are sufficient funds in the issuer’s bank. Hence, cheque bouncing cannot be equated with a minor non-compliance or a procedural lapse. It should remain a criminal offense.
Ajit Ranade, Indian Economist

Some corporate lawyers also believe that it may prove to be counter-productive for foreign investors. Legal remedies of a civil nature are time-consuming making this proposal less feasible.

While a defaulter whose intent is genuine will anyway find ways to adhere to his obligation and reach out to his creditor, for habitual offenders this will be a huge relief and thereby unfortunately encourage them to continue the same which will disrupt the business ecosystem in India.
Anant Merathia, Chennai-based Corporate Lawyer

The criminality factor had made people act responsibly when issuing cheques. While the government has taken steps to speed up the process of settling cheque bounce cases through Lok Adalats, making it into a civil offence goes against the interest of the consumers.
T. Sadagopan, Consumer Activist

Curiopedia

Frank Abagnale is an American security consultant known for his career as a con man, check forger, and impostor. Abagnale’s story inspired the Academy Award-nominated feature film, Catch Me If You Can, starring Leonardo DiCaprio as Abagnale.
Cheque fraud refers to a category of criminal acts that involve making the unlawful use of cheques in order to illegally acquire or borrow funds that do not exist within the account balance or account-holder’s legal ownership. Specific kinds of cheque fraud include cheque kiting, Embezzlement, Bad cheque writing and Forgery.
The Eurocheque was a type of cheque used in Europe that was accepted across national borders and which could be written in a variety of currencies. Eurocheques were originally introduced in 1969 as an alternative to the traveler’s cheque and for international payments for goods and services.

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What Does RBI’s Monetary Policy Committee Do?

RBI’s latest Monetary Policy Committee (MPC) meeting was conducted in the first week of August 2020. It announced a bunch of adaptive measures at a time when world economies are battling with Covid-19. Let’s break down the recent announcements and understand the role of MPC.

Crux of the Matter

About MPC
Monetary Policy Committee aims at maintaining price levels in the country while keeping growth level in mind. It also sets repo and reverses repo rates. The committee consists of 6 members – RBI Governor, Deputy Governor of RBI (also in charge of Monetary Policy), an officer of RBI nominated by the Central Board, and three external members nominated by the Government of India. For utmost confidentiality, these members observe a silent period for seven days before and after the rate decision.

Highlights Of The August MPC Meeting

Real GDP rate to remain negative in FY21.
Repo rate unchanged at 4% amidst Covid-19.
RBI also allowed banks and NBFCs to restructure loans.
MPC expects inflation to remain at elevated levels in Jul-Sep quarter, and ease in the second half of the financial year.
India’s foreign exchange reserves rose by $56.8 billion to $534.6 billion as of July 2020.
Additional Special Liquidity Facility of ₹10,000 crores to be provided at the policy repo rate.

Measures For Liquidity
RBI has raised the limit of loans that can be availed by mortgaging gold. This will be applicable only to banks. RBI has increased the Loan-To-Value (LTV) ratio to 90% from 75%. LTV ratio is the % of loan that can be availed on the value of a mortgage. This means on gold worth ₹100, max of ₹75 could be borrowed, but now with the LTV at 90%, ₹90 can be borrowed against ₹100 worth of gold. Generally, loans with high LTV ratio have high-interest rates as it tends to have a high risk. Indian households now have access to larger credit.

RBI’s Restructuring Norms
Restructuring happens when borrowers are unable to pay the whole loan or part of the loan and/or interest, and they renegotiate loan terms with the lender by reducing interest, cutting some portion of the loan, removing the whole loan in exchange of equity, moratorium, etc. RBI has made it mandatory for banks to classify defaults or bad loans. A bank’s credit rating is downgraded in case of increasing bad loans. Also, RBI considers restructured loans as defaults. However, RBI in the recent MPC meeting decided that banks would be allowed to restructure loans without worrying about a downgrade.

Also Read: Viral Acharya Raises Critical Points For RBI & Govt

Details Of Restructuring
RBI has allowed a one-time restructuring of personal loans and corporate loans before 31st December 2020. Personal loans include student loans, consumer loans, housing loans, etc. Moreover, only those accounts which were classified as ‘Standard’, and were not in default for more than 30 days with the lending institution as of 1st March 2020 will be eligible.

Bank may allow borrower, rescheduling of payments, conversion of any interest accrued, or to be accrued, into another credit facility, or, granting of a moratorium, based on an assessment of income streams of the borrower, subject to a maximum of two years.
RBI

As a part of the restructuring, borrowers can take another loan to repay the interest accrued during the moratorium. Loans to micro and small enterprises can also be restructured up to ₹25 crores per borrower and corporates loans can be restructured in exchange for equity or debt instruments. For instance, company A borrowed a loan of ₹10 crores, however, it is unable to repay ₹5 crores as of now. The company may issue equity to the lender of the equivalent amount, or issue a debt instrument and make regular interest payments.

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Amartya Sen is an Indian economist with contributions to welfare economics, social choice theory, economic and social justice, economic theories of famines, decision theory, development economics, public health, and measures of well-being of countries. He was awarded the Nobel Memorial Prize in Economic Sciences in 1998 and India’s Bharat Ratna in 1999 for his work in welfare economics.
Fault Lines: How Hidden Fractures Still Threaten the World Economy is a 2010 book by Indian economist Raghuram Rajan on the underlying causes of the 2008 financial crisis. It won the Financial Times and McKinsey Business Book of the Year award in 2010.
NABARD was established on the recommendations of the B.Sivaramman Committee on 12 July 1982 to implement the National Bank for Agriculture and Rural Development Act 1981. It is one of the premier agencies providing developmental credit in rural areas.

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Viral Acharya Raises Critical Points For RBI & Govt

Former RBI Deputy Governor Viral Acharya in his latest book “Quest For Restoring Financial Stability In India”, says that fiscal dominance in India has become a mainstream practice that hinders the growth of banks and eventually results in the slow growth of the nation. His critical views on RBI’s functioning and the central bank’s relationship with the government have become the talk of the town. Let us simplify them and understand.

Crux of the Matter

Acharya on Fiscal Dominance
Viral Acharya is a former RBI Deputy Governor and currently a professor at NYU Stern. He has mentioned that Fiscal dominance is hampering the growth of India. Fiscal dominance is a situation in which the government has high debt and deficit. Because of limited funds, the government is unable to recapitalize public banks when they have to recognize bad loans in the books. Instead, the government pressurizes RBI to ease credit norms so that banks can avoid NPA recognition. This is like keeping the house clean by shoving al the dust under the carpet. Acharya said that it is not too late to infuse capital into banks and NBFCs.

On Non-Performing Assets
In an interview with India Today, Acharya said that growing NPAs during Covid-19 would be a concern. NPAs are expected to rise to ~12.5%, i.e. of the ₹100 loans given by a bank, ₹12-13 would be unrecoverable and banks will have to set aside a provision for the bad loan.

2021 figures are estimation by RBI

NPAs are loans that cannot be recovered. Viral Acharya also criticized the practice of evergreening of loans in India. Let us understand it through an example what it means and what are its implications:

Mr. A took a loan of ₹10 lakh but is now unable to pay back the principal amount and/or interest. Now, Mr. A may take an additional loan to pay off the interest, or principal and interest both. Banks allowed this practice because that particular loan would not have to be categorized as an NPA and hence, no provision amount needed to be set aside.

On RBI’s Autonomy
Acharya writes in the book that RBI’s autonomy was being compromised and hinted that he left for the same reason. Acharya left the post before the completion of his tenure. He also pointed out that Former RBI Governor Urjit Patel would have also left for a similar reason.

The government was trespassing on the autonomy of the regulator, rowing back on prudent measures and making unreasonable demands.
Viral Acharya, Former RBI Deputy Governor

Urjit Patel’s Resignation
Urjit Patel possibly resigned amidst the government trying to dilute the clause of Prompt Corrective Action. PCA is a framework under which banks with weak financial metrics are put under watch by the RBI. Besides that, the government wanted RBI to formulate policies to help it borrow more and ease up on defaulters. It also wanted the RBI to transfer surplus funds in the form of an interim dividend a few months before the 2019 Lok Sabha elections. All these factors might have caused Patel’s exit.

Also Read: Changes In RBI Accounting Year To Put Curbs On Contentious Interim Dividends

Curiopedia

“Yaadon Ke Silsile” is a music album by Viral Acharya. The funds raised through the album were funneled into charity – Pratham – which works to educate children.
“The Third Pillar: How Markets and the State Leave the Community Behind” is a book by Raghuram Rajan. The book was shortlisted for the financial times and McKinsey business book of the year award 2019.
As of January 2017, Viral was appointed to serve a three-year term as a Deputy Governor of the Reserve Bank of India. He resigned from the post in July 2019 with 6 months left for his completion of a term.

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