Medium-term power deal between India and Nepal

On 23 May 2023, Nepali and Indian authorities signed a 5-year (medium-term) agreement that will allow Nepal to sell an additional 200 MW of hydroelectricity to India. This is in addition to the 452.6 MW that Nepal already has permission to sell to India. More electricity export to India will mean more export revenues to Nepal. The new agreement applies to wet season only (from June up until November). In June 2023, during PM Dahal's visit to India, Nepali and Indian PMs agreed to a long-term energy deal, which targets 10,000 MW of electricity import by India in 10 years.

Excerpts from The Kathmandu Post:

The state-owned power utility and NTPC Vidyut Vyapar Nigam Limited (NVVN) of India signed an agreement on May 23, paving the way for the Indian company to purchase 200MW of electricity from Nepal for five years. The agreement was reached between the two sides just ahead of Prime Minister Pushpa Kamal Dahal’s state visit to the southern neighbour from May 31 to June 3.

The five-year agreement which the authority describes as a ‘medium-term’ power sale deal, means that the power utility will be securing the market for its 200MW of power. This deal is outside the existing quota of 452.6MW.After the Indian government approves a list of hydropower projects that Nepal has forwarded for exporting electricity under this mechanism, the selling will begin. Based on an agreement reached with NTPC Vidyut Vyapar Nigam Limited (NVVN), the prices the NEA will be receiving will be modest. The NEA will receive a net tariff of INR 5.25 (Rs8.40) per unit after trade margin, transmission losses and transmission charges.

Nepal has been selling its excess power in India’s day-ahead market since November 2021. The prices in the market fluctuates on a daily basis so the NEA’s sales income changes accordingly. The southern neighbour has so far allowed Nepal to sell 452.6MW of power in the Indian market.

Energy deficit in India

According to Reuters, India will likely face risks of nighttime power cuts due to delays in adding new coal-fired and hydropower despite the rapid addition of solar farms, which helped India avert daytime supply gaps. The power availability during nighttime is expected to be 1.7% lower than peak demand. Coal, nuclear and gas capacity are expected to meet about 83% of peak demand at night.

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April nighttime peak demand is expected to hit 217 gigawatts (GW), up 6.4% on the highest nighttime levels recorded in April last year. While Indians looking to beat the heat this summer will want steady power for their air-conditioners, night time outage risks threaten industries that operate around the clock, including auto, electronics, steel bar and fertiliser manufacturing plants.

After the Grid-India report, the government brought forward maintenance at some coal-fired power plants and secured extra gas-fired capacity to run to try to avert outages, another senior government official said. As much as 189.2 GW of coal-fired capacity is expected to be available this April, according to Grid-India's February note. That would be up more than 11% from last year, according to Reuters calculations based on Grid-India data. Together, coal, nuclear and gas capacity are expected to meet about 83% of peak demand at night.

Hydro power will be crucial not only to meet much of the remaining supply but also as a flexible generator, as coal-fired plants cannot be ramped up and down quickly to address variability in demand. However Grid-India has forecast peak hydro availability in April this year will be 18% below what it was a year earlier, when output was boosted by favourable weather conditions.

Around midnight through April last year, jostling for power was intense, with buyers making bids for five times more power than sellers offered, a Reuters analysis of data from the Indian Energy Exchange, the country's most liquid electricity trading platform, showed.

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Digital payments revolution in India

An interesting article in the NYT on how India's homegrown payment system has transformed commerce and helped formalize the economy. Excerpts:

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Billions of mobile app transactions — a volume dwarfing anything in the West — course each month through a homegrown digital network that has made business easier and brought large numbers of Indians into the formal economy. The scan-and-pay system is one pillar of what the country’s prime minister, Narendra Modi, has championed as “digital public infrastructure,” with a foundation laid by the government. It has made daily life more convenient, expanded banking services like credit and savings to millions more Indians, and extended the reach of government programs and tax collection.[...] It is a public-private model that India wants to export as it fashions itself as an incubator of ideas that can lift up the world’s poorer nations.

Indian officials describe the digital infrastructure as a set of “rail tracks,” laid by the government, on top of which innovation can happen at low cost. At its heart has been a robust campaign to deliver every citizen a unique identification number, called the Aadhaar. The initiative, begun in 2009 under Mr. Modi’s predecessor, Manmohan Singh, was pushed forward by Mr. Modi after overcoming years of legal challenges over privacy concerns. The government says about 99 percent of adults now have a biometric identification number, with more than 1.3 billion IDs issued in all.

The IDs ease the creation of bank accounts and are the foundation of the instant payment system, known as the Unified Payments Interface. The platform, an initiative of India’s central bank that is run by a nonprofit organization, offers services from hundreds of banks and dozens of mobile payment apps, with no transaction fees. [...]The system has grown rapidly and is now used by close to 300 million individuals and 50 million merchants. Digital payments are being made for even the smallest of transactions, with nearly 50 percent classified as small or micro payments: 10 cents for a cup of milk chai or $2 for a bag of fresh vegetables. That is a significant behavioral shift in what has long been a cash-driven economy.

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India: Recent developments and economic outlook

In its 2022 Article IV consultation report on India, the IMF noted that the economy rebounded strongly from the pandemic-related downturn, supported by fiscal policy targeted at vulnerable groups and to mitigate the economic impact of commodity price increases. Front-loaded monetary policy tightening is addressing elevated inflation and a robust public digital infrastructure is facilitating innovation, productivity improvements and access to services. 

However, the India economy is facing new headwinds, including the adverse effect of climate change. These include high fiscal deficit that requires consolidation anchored on stronger revenue mobilization and spending efficiency; monetary policy tightening to rein in inflation and financial sector vulnerabilities; and financing and technology transfer to move to a carbon-neutral economy. This blog post includes key highlights from the report.

Recent developments

The economy benefited from broad-based recovery from the deep pandemic-related downturn. Real GDP grew by 8.7% in FY2022. All sectors recovered to pre-pandemic levels by end-FY2021/22 except for contact-intensive services, which remained 11% below FY2019/20 levels.

Due to growing domestic demand, commodity and food price shocks, and supply chain disruptions, inflation has been at or above the RBI’s inflation band of 4±2% since January 2022. The report notes that long-term inflation expectations remain relatively well anchored, but the risk of second-round effects from fuel and commodity price shocks remains high.  

Credit growth increased following relatively subdued growth over the past two years. Non-food bank credit growth was driven by stronger credit growth by private banks, mostly to MSMEs in the industry sector. However, credit gap (credit to GDP gap) remains negative, i.e. credit-to-GDP ratio remains below its long-term trend.

The external position in FY2022 was considered broadly in line with that implied by medium-term fundamentals and desirable policies (level of per capita income, favorable growth prospects, demographic trends, and development needs). Current account surpluses and large capital inflows boosted international reserves during the pandemic. The IMF assessed current account gap at 1% of GDP after accounting for transitory impacts of the COVID-19 shock. Current account deficit in FY2022 was 1.2% of GDP, reflecting recovering domestic demand and rising commodity prices. The widening current account deficit and portfolio investment outflows have depleted foreign exchange reserves in FY2023.  External shocks such as global financial tightening and the Russian invasion of Ukraine, and recovering domestic demand have put pressure on the exchange rate. Reserves are enough to cover around 7 months of prospective imports. 

General government fiscal deficit is estimated to decrease to 9.9% of GDP in FY2023 from 10% of GDP in the previous fiscal. Central government fiscal deficit declined to 6.7% of GDP in FY2022 (in its definition of central government deficit, the IMF also includes NSSF loans to central government PSUs and fully serviced bonds). The phasing out of some pandemic-related expenditures contributed to 1% of GDP reduction in spending. Buoyant GST and income tax revenues, thanks to improvements in tax administration and additional taxes on domestic crude oil production and fuel exports, helped boost revenue. The state government’s deficit is estimated to decline close to the medium-term target of 3% of state-level GDP, but variations in fiscal performance persist.  

The pandemic-related disruptions reduced access to education and trainings, adversely impacting human capital accumulation. Most affected were vulnerable groups, including females, youth, less skilled and educated, and daily wage and migrant workers. 

Economic outlook

Growth is projected to moderate amid higher oil prices, weaker external demand, and tighter financial conditions. The IMF projected GDP growth at 6.8% in FY2023 and 6.1% in FY2024. Growth is projected at around 6% over the medium-term. 

General government fiscal deficit is projected to moderate but will remain high: 9.9% of GDP in FY2023, 9% of GDP in FY2024 and then around 7-8% of GDP over the medium-term.

Inflation is projected to moderate to 6.9% in FY2023 as core inflation remains sticky and near-term uncertainties in food prices and input costs affect prices. Inflation is projected to return to the tolerable band over the medium-term. 

Current account deficit is projected to increase to 3.5% of GDP in FY2023 owing to higher commodity prices and import demand, and will decline to about 2.5% of GDP over the medium-term. 

Foreign exchange reserves are projected to cover about 6.5 months of imports over the medium-term. Net FDI inflows are estimated to be about 1.4% of GDP.

Risks to outlook: Uncertainty about the economic outlook is considered high and risk tilted to the downside. A materialization of these risks would worsen the economic outlook (lower growth and trade). 

External risks include a sharp global growth slowdown (affects India through trade and financial channels), and intensification of spillovers from the Russian invasion of Ukraine combined with supply and demand shocks in the global food and energy markets. These can worsen inflation and de-anchor inflation expectations. Over the medium-term, broadening of conflicts and reduced international cooperation can disrupt trade, increase volatility of commodity price, and fragment technological and payments systems. 

Domestic risks include rising inflation impacting vulnerable groups, emergence of more contagious COVID-19 variants, tighter financial conditions (weaken asset quality and result in financial sector stress), high financing costs due to weakening of fiscal position, climate change. 

However, upside risks include a resolution of the war in Ukraine and de-escalation of geopolitical tensions (will boost international cooperation, moderate commodity price volatility, and promote trade and growth). Also, successful implementation of structural reforms and greater than expected dividends from ongoing digital advances could increase medium-term growth potential. 

Fiscal policy: India’s fiscal space is at risk and debt sustainability risks have increased. The government will need to improve targeting to lower public spending. For instance, the reduction in fuel excise taxes and additional fertilizer subsidies are not well targeted. Revenue have been improving due to buoyant GST and income tax revenues. High debt levels (84% of GDP in FY2022) and substantial gross financing needs (15% of GDP) due to higher effective interest rates together with monetary policy tightening have increased debt sustainability risks. These risks are somewhat mitigated as the bulk of public debt are fixed-rate instruments denominated in domestic currency and predominantly held by residents per regulatory requirements. DSA shows that debt dynamics remain favorable in the medium-term and support a sustainable debt path. 

The government has targeted 4.5% of GDP central government deficit, implying a general government deficit of 7.5% of GDP (down from 9.9% of GDP in FY2023). The IMF recommends a clearly communicated medium-term fiscal consolidation plan to enhance policy space and facilitate private sector-led growth. It will also reduce uncertainty, lower risk premia, and help to maintain price stability. 

Fiscal consolidation should be facilitated by stronger revenue mobilization and improving expenditure efficiency. General government primary consolidation of around 1% of GDP and debt of around 80% of GDP by FY2028 could be targeted. 

Expenditure efficiency is possible through better targeting of subsidies, greater utilization of the existing social support infrastructure (DBT) to reduce leakages, rationalization of central schemes, reforming electricity tariffs and improving the financial viability of electricity distribution companies. 

Revenue measures can include reversing the fuel excise tax cuts, further broadening the corporate and personal income tax bases, simplifying the goods and services tax (GST) rate structure, rationalizing the items subject to preferential GST treatment, and continued improvements in tax administration, in line with international good practice. These measures would help narrow India’s tax gap, estimated at around 5% of GDP. Asset monetization and privatization agenda could generate additional receipts. 

Fiscal transparency will improve PFM. For instance, recognizing previously off-budget expenditure at the center and state level has improved transparency. Digital solutions have helped streamline PFM processes, advancing transparency and governance, including through e-procurement, faceless income tax assessments and the recent rollout of e-bills. Integrated Government Financial Management System along with a dedicated platform for central, state, and local governments to share fiscal information will support timely production of consolidated fiscal reports and identification of fiscal risks at the subnational level.  

Effect of carbon tax on household welfare in Asia and the Pacific

Carbon pricing or taxation is a popular climate change mitigation strategy.  However, the distributional effect seems to be different depending on how heavily households rely on carbon-intensive energy sources. In a latest IMF working paper, Alonso and Kilpatrick (2022) argue for a wide range of country-specific policies that could be implemented to compensate households, reduce inequality, and build support for adoption. 

A carbon tax is a fee imposed on the burning of fossil fuels (e.g., natural gas, coal, oil) based on their carbon content. Carbon tax implementation is politically sensitive because of the general opposition to higher energy prices, displacement of workers, and social disturbances (price increases have led to riots in Haiti, France, Kazakhstan, Ecuador, etc). Studies show that a price of $75 per ton for advanced economies, $50 for high-income emerging market economies, and $25 for low-income emerging market economies set in place by 2030 will be needed to achieve the Paris Agreement’s target of limiting warming below 2°C.

They use household surveys and input-output (IO) tables to examine the effect of a carbon tax on households in Asia and the Pacific. The Asia and the Pacific region accounts for 27% of all emissions so far, equivalent to 452 billion tons of CO2, and the region’s global share in fossil fuel combustion emissions has risen from 30% to 49% between 2000 and 2019. 

Carbon prices in the region are low based on those standards. Of the current carbon prices in place in the region, the average is around $6 per ton and only covers an average of 0.3% of yearly emissions in each country

They use IO tables to compute how higher energy prices induced by a carbon tax would lead to higher consumer prices in non-energy goods (if higher energy costs are fully passed-through). They then combine this result with household surveys to quantify the negative impact on welfare based on household consumption bundle. They also examine the extent of possible labor income loss as the carbon tax tends to lower labor demand. They study the impact of a carbon tax of $50 per ton. They use household surveys for Australia, China, Hong Kong SAR, India, Indonesia, Japan, Kiribati, Korea, Mongolia, Myanmar, New Zealand, the Philippines, Singapore, and Taiwan, Province of China.

Major findings of the paper:

Based on higher prices and lower labor income, a carbon tax of USD 50 per ton would lead to substantial losses of welfare for households amounting to around 10 percent of initial consumption in Mongolia and 7 percent in Indonesia. In China and India, the average loss would be slightly above 3 percent. It would be 2.1 percent for the Philippines and lower than 2 percent in Kiribati and Myanmar. However, the distributional impact would also be quite different. The carbon tax would be regressive in China, Indonesia, and Mongolia, but it would be progressive in India, Kiribati, the Philippines, and Myanmar. Across the region, small groups of households employed by the energy sector would be heavily exposed to labor income losses. 

They argue that the household welfare loss produced by a carbon tax can be reverted and redistributed through relatively simple and cheap compensation schemes. A wide range of country-specific policies could be implemented to compensate households, reduce inequality, and build support for adoption. They find that cash transfer targeted to the poorest 40 percent of the households through realistic proxy-means testing would cost only 16 percent of the resources raised by a carbon tax to ensure that these households are on average not worse off after the reform. It would be as cheap as 8 and 11 percent for India and Kiribati, respectively. The ratio would be around 15 percent for China and Myanmar. It would reach 17 percent for the Philippines and 23 and 24 percent for Indonesia and Mongolia, respectively.

Providing a universal cash transfer or “carbon dividend” to all households to ensure that more than half of the households are better off after the reform would cost only 23 percent of the resources raised by a carbon tax in India and 33 percent in Myanmar.

In India, they find that the burden of a carbon tax due to higher prices would be mildly progressive for households. Consumers in the poorest quintile would experience a loss of around 3.2 percent compared to initial consumption, while the richest households would lose around 3.4 percent. It reflects a strongly progressive direct effect from higher energy prices, partially offset by a regressive indirect effect from higher prices on other goods. The richest households allocate relatively more of their expenditure towards electricity, gasoline, and LPG while the bottom quintile of households consume more kerosene and to a lesser degree coal. Electricity, gasoline, and LPG would see their prices rise by 20.5, 12, and 23.6 percent, respectively in response to the carbon tax. This would add up to a burden of 0.4 percent of initial consumption for the poorest quintile, but 1.5 percent for the richest quintile. This progressivity is mitigated by the effect of higher prices of kerosene and coal, which would lead to a burden of 1 percent of initial consumption for the poorest quintile and only 0.3 for the richest. In sum, the direct effect of higher energy prices would cost 1.4 percent of initial consumption for the poorest households and 1.8 percent for the richest. The implementation of a $50 carbon tax would raise fiscal revenues by about 2.5 percent of GDP.

Agriculture productivity shocks and nonagricultural employment in India

Abstract from Jonathan Colmer's published paper in American Economic Journal: Applied Economics, 13(4):101-24

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To what degree can labor reallocation mitigate the economic consequences of weather-driven agricultural productivity shocks? I estimate that temperature-driven reductions in the demand for agricultural labor in India are associated with increases in nonagricultural employment. This suggests that the ability of nonagricultural sectors to absorb workers may play a key role in attenuating the economic consequences of agricultural productivity shocks. Exploiting firm-level variation in the propensity to absorb workers, I estimate relative expansions in manufacturing output in more flexible labor markets. Estimates suggest that, in the absence of labor reallocation, local economic losses could be up to 69 percent higher. 

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Differences in consumption aggregates and poverty estimates in South Asia

In a paper published in the latest edition of Asian Development Review (Vol.38. No.1), Islam, Newhouse and Yanex-Pagans study how differences in the construction of consumption aggregate in South Asian countries contribute to total error (arising out of nonsampling error and the error in the process of determining the international poverty line) in international extreme poverty measurement. Methodology and questionnaire for household survey differ among the countries, contributing to total error of the subsequent international extreme poverty line obtained for each country. They examine how sampling and survey design; spatial deflation to account for cost-of-living differences and intertemporal deflation; and construction of nominal consumption aggregate contribute to total error. 

Some factors that affect total error are incomplete coverage of the country’s population, errors in measuring consumption data, errors in calculating the poverty line, use of the consumer price index (CPI) to deflate prices in a manner that may not be consistent with the consumption patterns of the poor, and geographic differences in prices.

On sampling and survey design, the paper examines (i) sampling design, (ii) monetary welfare measure, (iii) food consumption questionnaire and data collection methods, (iv) self-production and meals outside home, (v) nonfood durables, (vi) durables, (vii) housing expenditures, and (viii) health and education expenditures. 

Among these, there exists significant differences in the way food consumption data are collected, especially the number of food items in the consumption questionnaire. Inclusion of more food items tend to increase levels of reported consumption, leading to lower reported poverty rate. While Pakistan has the lowest number of food items (69) listed in the survey, Sri Lanka has the highest (227). Bangladesh has 141, Bhutan 130, India 143, Maldives 92, and Nepal 74. For nonfood items, Afghanistan has the lowest number of items (38) and Maldives has the highest number of items (483). India has 338 and Nepal 95. 

Consumption data are collected either using diary method (households record all consumption data over a certain period in a notebook) and/or recall method (households list what they consumed over a specific past reference period). Length of consumption recall is also different. Lowering the recall period have increased reported consumption by households, which resulted in poverty rates falling by half in India. The authors note that “this simple change in the method of collecting data “lifted” 175 million Indians out of poverty”. 

The South Asian countries also have different questionnaires for the value of consumption of self-produced food and meals from outside home. For instance, Bangladesh, Pakistan and Sri Lanka do not account for food expenditures on meals outside the household as a part of their consumption aggregate. Note that consumption of food eaten outside the home is shown to raise extreme poverty rate. Similarly, Maldives and Pakistan do not account for consumer durables, and in Afghanistan and Nepal it is imputed. In the case of housing, all countries except Maldives include actual rent for urban and rural areas. They also include imputed rent except for (India and Maldives). All countries include health and education expenditure (except for Nepal in the case of health expenditure). 

Spatial deflation is used to adjust cost-of-living differences, which lowers the possibility of overestimation of poverty in rural areas and underestimation in urban areas (since an urban household needs to spend more to maintain the same standard of living as that of a rural household). Use of appropriate regional price indexes is important in this regard, but this could be challenging to construct. All South Asian countries do spatial deflation when they calculate their national poverty estimates, but when calculating international extreme poverty rates, the World Bank spatially deflates consumption aggregates in Bhutan and Nepal only. Bhutan uses survey-based price index to deflate prices, but Nepal and Bangladesh use an implicit spatial price index to deflate prices. The authors show that using spatial deflation is important in the case of international extreme poverty estimates, especially given the fact that without spatial deflation urban areas have less poverty and rural areas have more poverty. They recommend collecting regional price data for different durable and nondurable goods, and services. They also suggest collecting rental cost of housing at regional level so that imputation for rental rate of owner-occupied housing could be done suitably. 

A third source of total error is the way standardized consumption aggregates are computed compared to the national consumption aggregates. Here, standardized consumption aggregate refers to the one obtained from the standardized consumption datasets created by the World Bank. It basically reclassifies expenditure items into the various categories used in the International Comparison Program (ICP). However, note that the method of data collection and questionnaire design affect standardization. The authors show slightly different average per capita consumption using the standardized and the national consumption aggregates. Not much difference, but in the case of India there is notable difference because of imputed rents for home owners. Also, standardization decreases housing expenditure in Nepal, Bhutan and Sri Lanka. 

The authors shows that standardization of consumption aggregate also changes share of particular item on total consumption expenditure. In Nepal, while food items account for 57% of national consumption expenditure, the standardized value is a bit less at 53%. Standardization reduces the share of food expenditure in consumption aggregate in all South Asian countries except Sri Lanka. 

The standardization of consumption aggregates increases poverty rate in Bangladesh, Bhutan Pakistan, and Sri Lanka. However, they authors show that it decreases the international extreme poverty rate in India, Maldives and Nepal.  

Fiscal and debt paradigm in India

In its report for 2021-26, the 15th Finance Commission of India states that public debt as a share of GDP should continue to serve as the medium-term anchor for fiscal policy in India despite the spending pressures created by the pandemic and investment needs during the recovery phase. Fiscal deficit should be the operational target as recommended by FRBM Act 2003 (amended in 2018). A rule-based framework is credible and transparent, but it must be flexible as well to avoid fragility, states the FC's report. 

It argues that extraordinary times like these require growth and income support measures that will unavoidably put upward pressure on public finances. The Commission expects positive interest-growth differentials and adverse debt dynamics over the next two to three years. However, it recommends fiscal consolidation and a declining trajectory for total public debt as a share of GDP over the medium-term. 

The FC forecasts fiscal deficit of the union government to be between 3.5% and 4.5% of GDP in FY2026, declining from a range of 6.0% and 6.5% of GDP in FY2022. Given the uncertainties and risks, the Commission outlined fiscal deficit under three scenarios: (i) economy recovery is slower than assessed, (ii) macro-economic assessment holds, and (iii) economic recovery is faster than assessed. In all cases, fiscal deficit is to decrease by 0.5 percentage point of GDP each successive year. It assumes a gradual return to a trend of real GDP growth of around 7% and a less severe than feared effect on workers and businesses due to the pandemic. 

For the States, the Commission recommends three options to allow for greater flexibility: (i) additional unconditional borrowing for the first two years to compensate for the loss of tax revenue; (ii) additional borrowing of 0.5 percentage of GSDP in case they meet the criteria for power sector reforms; and (iii) allowing the States to utilize any unutilized borrowing space in the subsequent years within the award period. If the States use the full borrowing space available, then the fiscal deficit, as a share of GSDP, is forecast at 4.5% for FY2022, 4% for FY2023, 3.5% for FY2024 and FY2025, and 3% for FY2026. If the States limit borrowing, on an average, to FRBM threshold, then it will be 3% of GSDP throughout. 

Overall, the Commission projects general government fiscal deficit to decline to 9.3% of GDP in FY2022 from 11.6% of GDP in FY2021 and then gradually decrease to 6.8% of GDP in FY2026. The Commission states that it is providing higher fiscal room to both the Center and States to be able to deal with the current pandemic and then the expected economic recovery. 

On outstanding general government debt, the Commission expects it to gradually decrease to 85.7% of GDP by FY2026 from a high of 89.8% of GDP in FY2021. The center’s public debt is expected to be 56.6% of GDP by FY2026. Given the prospect of increased borrowing by both the Union and State governments due to large expenditure needs (State government’s expenditure as a share of GDP is greater than that of the Union) in the short-term, there has to be a medium-term debt consolidation effort to ensure a sustainable debt to GDP ratio. Given that the Center’s outstanding public debt will be over 40% of GDP (general government debt 60% of GDP) and fiscal deficit above 3% of GDP for the foreseeable future, the FRBM Act needs to be amended again. 

It recommends additional expenditure be used not only to boost investment, but also to strengthen fundamentals to seize new opportunities such as the likely relocation of global production to India, and remote work setting in a distributed economic geography rather than continued growth of the largest cities. The commission prioritizes investment in human capital (especially health and education) and climate change and environmental risks such as air pollution. 

The Commission recommended vertical devolution of 41% of resources. For horizontal sharing/allocation of resources, it recommends 15% weight to population, 15% for area, 10% for forest & ecology cover, 45% for income distance, 2.5% for tax & fiscal efforts, and 12.5% for demographic performance. 

For revenue deficit grants, a type of grants-in-aid, the Commission recommends an allocation of 1.92% of gross revenue receipts of the Union government. Besides this, there are other performance-based grants-in-aid for sectors such as social sector (health and education sectors focusing on large and particularly vulnerable subset of the population), rural economy (agriculture and maintenance of rural roads), and governance and administrative reforms (judiciary, statistics, and aspirational districts and blocks). 

The Commission also estimated that structural ‘tax gap’ for India is over 5% of GDP. It recommends a series of operational and policy reforms to bridge the tax gap such as correcting the inverted duty structure in GST, addressing IT system deficiencies for GST, facilitating complete invoice matching, and reviewing exemptions, thresholds and concessions in income tax. 

It argues that India’s fiscal architecture needs to have three mutually reinforcing pillars: (i) fiscal rules that set institutional and budgetary framework for fiscal sustainability; (ii) consistent, reliable, and timely reporting of fiscal indicators; and (iii) ability of fiscal institution to conduct independent assessment to facilitate the first two pillars. This calls for restructuring the FRBM architecture, and constitution of a high-powered inter-governmental group to chart out a new fiscal consolidation framework.  

The Finance Commission provides recommendations to the President of India on the distribution of net proceeds of taxes between Center and the States, determination of factors and magnitude governing grants-in-aid to the States, and sound public finance, among others. They operate under a TOR that is different for every Commission and have a tenure of five years. 

Indian economy to grow by 0.4% in Q3 FY2021 but contract by 8% in FY2021

According to the latest estimates released by NSO, the Indian economy grew y-o-y by 0.4% in the third quarter of FY2021 (October to December 2020) after contracting by 24.4% and 7.3% in the first and second quarters, respectively. GVA growth was 1.0%. It indicates a gradual recovery upon unlocking of the economy following severe disruptions to economic activities and livelihoods due to the COVID-19 pandemic. The economy grew by 3.3% in Q3FY2020. 

While agriculture and industry sectors are projected to grow (y-o-y) by 3.9% and 2.7%, services sector is projected to contract by 1%. A bountiful harvest due to favorable monsoon and availability of agricultural inputs including abundant labor force that reverse migrated to the villages after the lockdowns contributed to the strong agricultural sector performance. In fact, rice output grew by 2% in Q3 FY2021 compared to 0.1% in the corresponding quarter in FY2020. 

Industrial activities began to recover after five successive quarters of negative growth starting Q2FY2020. Within industry sector, mining and quarrying contracted by 5.9%, but manufacturing, electricity and other utilities, and construction activities continued recovery. The corresponding IIP data for industry sector show that mining contracted y-o-y by 4.4% and metallic minerals by 15.9%. However, manufacturing and electricity grew by 1.2% and 6.7%, respectively. That said, the cumulative data up to the third quarter show that all IIP broad sectors actually contracted in FY2021 compared to FY2020.  

Within services sector, while financial, real estate and professional services recovered trade, hotels, transport, communication, and public administration and defense activities continued on contractionary trend. Travel and tourism industry still continues to be affected by the pandemic-related restrictions and consumer apprehension.

On the demand side, private consumption growth remains strong but public consumption growth is moderating. Gross fixed investment grew at a solid pace of 33.0% y-o-y compared to 32.3% in Q3FY2020. Exports of goods and services grew by 21.2% but imports decreased by 0.8%. So, it is strong private consumption and investment, partly assisted by the fiscal stimulus and subsidies provided by the government, that is driving growth. This is reflected in the supply-side data as strong agricultural sector growth and recovery of industrial sector activities. 

The NSO also released second advance estimates, which show notable revisions in the benchmark estimates released in the first advance estimates. The extrapolation is based on information available during the first nine months of the fiscal year. It shows that the economy will likely contract by 8.0% in FY2021, steeper than in the first advance estimate. The economy is expected to grow by 4.0% in FY2020.

While agriculture sector is expected to grow by 3.0% in FY2021, industry and services sectors are expected to contract by 8.2% and 8.1%, respectively. Except for electricity and other utilities, other sub-sectors in industry sector are expected to contract sharply (over 8%). The disruption to travel and tourism activities is expected to contract trade, hotels, transport and communications activities by 18.0%.  

INR 2.5 lakh crore (INR 2.5 trillion) from asset monetization target in India

As announced by the finance minister in the FY2022 budget speech, the Indian government is aiming to monetize 100 government-owned assets across sectors to mobilize about INR 2.5 trillion, which will be crucial to meet the overall revenue target. This is part of a National Asset Monetization pipeline. Excerpts from a news report in The Times of India. 

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Reiterating his strong backing for privatisation and asset monetisation, the PM said the reforms, which have been launched, were aimed at ensuring that public money is spent judiciously to benefit the poor, in what was seen as a response to critics of the new policy unveiled in the Budget.

“The money that belongs to the poor is used for such enterprises (PSUs). This puts a huge burden on the economy,” Modi told a webinar to draw up the roadmap for the implementation of Budget proposals on privatisation and asset monetisation.

He said the government does not have to keep running public sector enterprises just because they have been running for decades or they were “pet projects of somebody”.

[…]Since coming to power in 2014, the NDA government has talked about the sale of PSUs, especially loss-making ones, such as Air India, but it has a poor track record. It sought to pass off the sale of state-run entities, such as HPCL to ONGC, another PSU, as strategic sale, drawing criticism even from the CAG.

It is now trying to push it as a key reform initiative and has even added state-run banks and a general insurance company to the list, after specifying that only four strategic sectors — atomic energy, space and defence, transport and telecom, power and petroleum — will have PSUs. Even in the sectors, state-run firms can have a diminished presence.

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The finance minister committed, in her budget speech, that the government will bring down fiscal deficit to 4.5% of GDP by FY2026, largely by increasing buoyancy of tax revenue through improved compliance, and increased receipts from assets monetization (including public sector enterprises and land).

In FY2022 alone, divestment receipts (which are a part of capital receipts) of INR 1.8 trillion is planned. Divestment targets have been missed in the past. For instance, the government could not meet the divestment target in FY2020 (INR 0.5 trillion vs INR 1.05 trillion targeted) and FY2021 (INR 0.32 trillion vs INR 2.1 trillion targeted). Note that for FY2022, planned divestment receipts account for 5% of total revenue receipts and 10.3% of capital receipts.

Quick overview of India's FY2022 budget

Finance Minister Nirmala Sitharaman presented INR 34.8 trillion expenditure plan [USD 476.8 billion, USD 1 = INR 73.05 as on Feb 1) for FY2022 (starts 01 April 2021). It is 1.0% increase over the revised expenditure estimate for FY2021. Revenue growth is expected to be 23.4% (15% if we consider revenue plus recovery of loans & divestment receipts).

FY2022 budget focuses on six pillars: 

1. Health and wellbeing (PM Aatmanirbhar Swastha Bharat Yojana to develop capacities of primary, secondary and tertiary healthcare system, strengthen existing institutions and rollout COVID-19 vaccine, among others)
2. Physical and financial capital, and infrastructure (ANB production linked incentive scheme to promote manufacturing activities, mega investment textiles parks, National Infrastructure Pipeline, recapitalization of PSBs, infrastructure financing through Development Financial Institution, national asset monetization pipeline of potential brownfield infrastructure assets; roads, highways and railway infrastructure with focus on corridors; development of world class Fin-tech hub at GIFT-IFSC; divestment of strategic assets such as BPLC, Air India, SCI, CCI, IDBI Bank, etc)
3. Inclusive development for aspirational India (focus on agriculture and allied sectors, farmers' welfare and rural India, migrant workers and labor, and financial inclusion incl MSME)
4. Reinvigorating human capital (proposed Higher Education Commission of India that will set standard, accredit, regulate and fund higher education; benchmark skill qualifications, assessment, and certification, accompanied by the deployment of certified workforce)
5. Innovation and R&D (national research foundation, language translation mission, a space PSU, etc)
6. Minimum government and maximum governance (bill to regulate healthcare professions, first digital Census, etc)

The thrust is on Aatmnirbhar Bharat (Self-reliant India) initiative, for which it has rolled out sectoral incentives (such a production linked incentives to spur industrial activities), increase in custom duties on certain items, and sectoral reforms. 

Expenditure: Revised total expenditure for FY2021 is estimated to be 113.4% of budgetary estimate for FY2021 as pandemic-related expenditure on providing relief increased. For FY2022, about 84.1% of total expenditure outlay of INR 34.8 trillion consists of revenue expenditure (recurrent expenditure) and the rest 15.9% is capital budget. About 23.2% of the revenue expenditure consists of interest payments, 10% for defense, 9.9% for transfer to states and UTs, and 9.6% for subsidy. Interest payment alone is expected to be 45.3% of total revenue (tax and non-tax revenue).

The budgeted expenditure for FY2022 is equivalent to about 15.6% of GDP (per government’s estimate of nominal GDP for FY2022). Revenue expenditure is estimated to be 13.1% of GDP and capital expenditure 2.5% of GDP. Food, fertilizer and petroleum subsidies (interest subsidy is excluded in expenditure reporting in the budget) together is equivalent to about 1.5% of GDP, of which 72% is food subsidy and 24% fertilizer subsidy. Interest payments is estimated to be 3.6% of GDP. The government is hoping that interest payments will come down in the medium-term with RBI’s accommodative monetary policy and adequate liquidity in the market. 

The expenditure outlay for health sector is down by 9.5% compared to FY2021 revised estimate. It grew by 30% in FY2021 compared to FY2020, reflecting the spike in healthcare expenditure to contain the pandemic. Similarly, allocations for rural development, which includes NREGA, is down 10% compared to 51.9% growth in FY2021.  

In addition to INR 34.8 trillion expenditure outlay, the government is also expecting capital investment of INR 5.8 trillion from various public enterprises, resulting in total expenditure outlay of about INR 40.7 trillion. In FY2021, the union government’s expenditure was INR 34.5 trillion and public enterprises spent INR 6.5 trillion in capex, making total expenditure of INR 41 trillion. So, total capital spending of the central government (incl PSUs capex) could be as high as 5.1% of GDP.

Revenue: As per the revised estimates for FY2021, the government expects to mobilize 77% of the tax and non-tax revenue outlined in the FY2021 budget. While tax revenue is expected to be 82.2% of target, non-tax revenue is expected to be just 54.7% of the target. Capital receipts are expected to be 185.6% of budget target, thanks to a massive borrowing after the lockdowns. 

In FY2022, the government is expecting to mobilize INR 17.9 trillion revenue, of which 86.4% is tax revenue and the rest 13.6% is non-tax revenue— similar to the revised estimate for FY2021. The government wants to mobilize INR 1.9 trillion in the form of non-debt creating capital receipts (recovery of loans and divestment receipts). A substantial part of it consists of divestment receipts (INR 1.8 trillion). Divestment targets have been missed in the past. For instance, the government could not meet the divestment target in FY2020 (INR 0.5 trillion vs INR 1.05 trillion targeted) and FY2021 (INR 0.32 trillion vs INR 2.1 trillion targeted). 

The projected revenue is estimated to be 8.9% of GDP (6.9% tax revenue, 1.1% non-tax revenue and 0.9% non-debt creating capital receipts), which is higher than 8.2% revised revenue estimate in FY2021. Note that non-debt creating receipt is estimated to be about 0.84% of GDP, much higher than 0.24% of GDP last year. This is primarily due to a large divestment target (about 0.79% of GDP, up from 0.16% of GDP in FY2021). 

Of the total gross revenue to be mobilized by the center (including transfer to NCCF/NDRF and state’s share), GST accounts for 21.8%, income tax 19.4% and corporation tax 18.9%.

Fiscal deficit: The projected expenditure and revenue including recovery of loans and divestment receipts leaves a budget gap of about INR15.1 trillion for FY2022 (6.8% of GDP). The government wants to finance this fiscal deficit by borrowing and using other resources (including drawdown of cash balance). Specifically, it is planning to borrow almost all of it from the internal market. Specifically, about 64.3% of it will be in the form of market borrowing (dated government securities and T-bills) and the rest from securities against small savings, state provident funds and other receipts including 364-day treasury bills and net impact of switching-off of securities. External borrowing is estimated to be about INR46.2 billion (0.01% of GDP).

For FY2022, projected revenue deficit is 5.1% of GDP, fiscal deficit 6.8% of GDP, and primary deficit 3.1% of GDP. In FY2021, the estimated revenue deficit is 7.1% of GDP, fiscal deficit 9.5% of GDP and primary deficit 5.9% of GDP. 

The reduction in deficit targets primary hinges on the ability of the government to accomplish its divestment target. Divestment of government-held assets is kind of one-off revenue bonanza. Relying on divestment alone to lower fiscal deficit is not going to be sustainable. The government is planning to divest assets in several PSUs (such as Air India, LIC, etc). It is expected to be around 0.79% of GDP, up from 0.16% of GDP in FY2021. The plan for big ticket divestment has been dragging on for a long time. 

However, if nominal GDP growth accelerates (more infrastructure investment funding by divesting government-owned assets), then revenue mobilization will also pick up and fiscal deficit could be narrowed. Fiscal Responsibility and Budget Management (FRBM) Act 2018 sets fiscal deficit target at 3% of GDP by FY2021 and central government debt at 40% of GDP by FY2025. The government will amend FRBM Act as it will not be able to bring fiscal deficit to the level stipulated in the existing version of FRBM Act. The finance minister committed, in her budget speech, that the government will bring down fiscal deficit to 4.5% of GDP by FY2026, largely by increasing buoyancy of tax revenue through improved compliance, and increased receipts from assets monetization (including public sector enterprises and land). States are allowed to borrow more next year but will have to lower net fiscal deficit to 3% of GSDP by FY2024. 

Starting this budget document, the government will discontinue NSSF Loan to FCI for food subsidy and that it will be provisioned directly in the budget. This applies to FY2021 revised estimate and FY2022 budget estimate. This move improves budget transparency as substantial subsidy related extra budgetary resources were complicating true extent of government borrowing and level of fiscal deficit. In fact, in FY2020 budget, the FM released data on extra budgetary resources, especially borrowings of government agencies that went towards funding GOI schemes and the repayment was the government's burden. In FY2021 budget, the FM extended its scope and coverage to include NSSF loans provided by the government to the FCI. This is now discontinued. 

The stimulus measures (Self-reliant India initiatives such as production-linked incentives for 13 key sectors, increase in customs duty to encourage Make in India, increase net borrowing limit for states by 4.0% of GSDP for FY2022 and it could be conditionally increased by 0.5% of GSDP, capex increase, and RBI accommodative measures) and rapid vaccination program are expected to support economic recovery. Some of the rating agencies are okay with the high fiscal deficit along with a realistic (or even conservative) revenue projection. 

Concerns over fiscal/debt sustainability and sovereign ratings have been sidelined in favor of higher expenditure to support economic activities. The fiscal situation will be okay as long as GDP growth rate is higher than interest rates on government bonds. Already interest payment by central government is about a quarter of total spending and 45% of total revenue. Higher the borrowing by the government, the higher will be interest payments. It is important that higher borrowing goes into creating productive assets so that the return is more than enough to pay off debt.

Hardware and software of economic reforms in India

Subramanian and Felman on the inherited problems, macro-economic stability, and "hardware" and software" of economic reforms (detailed analysis here):

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The infrastructure investment boom of the early 2000s ran into major difficulties, especially after the GFC. But bankrupt firms were not allowed to exit, resulting in overcapacity that dragged down profits for the entire sector and led to burgeoning non-performing assets (NPAs) at the banks. This Twin Balance Sheet (TBS) crisis undermined growth because it meant that many firms weren’t sufficiently strong enough to expand—even if they were, banks were reluctant to lend. Real credit growth—the lubricant of any economy—consequently slid to historically low levels, and turned negative in recent years.

Summing up, the government has still not been able to overcome the problems it inherited. Now covid-19 has dealt another blow. Currently, 2020 growth estimates are being upgraded as economies are normalizing, but even revised IMF forecasts are likely to show India’s growth to be amongst the worst in the world. At the same time, macro-economic stability has been set back, as the fiscal position and inflation have deteriorated significantly. So, the RBI forecast that under the baseline scenario, the NPA ratio will almost double to 13.5% by September 2021.

[…] What then needs to be done? Consider why the government’s measures have so far failed to achieve the desired results. Transformational measures always require tweaking to ensure that they work properly. […] One possibility is that the “hardware" of reform measures has not been accompanied by sufficient “software". What is the software of economic reforms? Traversing the sequence from planning to implementation sound policies require accurate data, fair decisions, statecraft to win support, policy consistency over time, and rule of law in implementation.

[…] In the fiscal accounts, despite improvements, increasing off-budget expenditures have rendered the deficit figure less meaningful.

[…] The current government has made extensive efforts to create a level playing field, including a reliance on auctions and use of technology to automate public procurement and tax filing. But certain decisions—in retail, telecom, airports—have been perceived as demonstrating favouritism, reinforced by the reduction in Parliamentary discussion of policy initiatives. Stigmatized capitalism remains a serious problem.

[…] Once a policy is formulated, statecraft is needed to gain support of the stakeholders, especially the states, because nearly every major issue requires joint action.

[…] Once consensus is achieved and a major policy initiative launched, governments need to ensure that subsequent measures remain in line with the strategic objective. Often this does not occur. […] Widening the tax base was set back when in 2019 the income tax threshold was raised dramatically, removing about three-quarters of taxpayers from the tax net.

[…] this government, like all its predecessors, is embroiled in contract disputes with its contractors, especially on infrastructure projects. Its arrears to suppliers run high and there is anxiety about arbitrary tax enforcement.

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Indian economy to contract by 7.7% in FY2021

The first advance estimate of economic activities in FY2021 (April 2020 to March 2021) released by Ministry of Statistics and Programme Implementation shows that the Indian economy will likely contract by 7.7% in FY2021. GVA (at basic prices) contraction is expected to be 7.2%. This is due to the severe economic disruptions— supplies as well as demand shocks— caused by the pandemic and the ensuing lockdowns that started from March 25 and was relaxed in a phased manner since June. The Indian economy had been slowing down even before the pandemic, especially since FY2017, when the economy grew by 8.3%. 

The only saving grace is agricultural sector, which is expected to grow by 3.4% on the back of favorable monsoon and the output surge as labor reverse migrated to villages after the lockdowns. All other sectors are expected to contract. Industry sector, which accounts for about 30% of the economy, as a whole will likely contract by 9.6%. The pandemic accelerated its slowdown as it was already losing steam, especially since FY2017. For the 2011-12 national accounts data, industrial sector growth peaked at 9.6% in FY2016. Within the industry sector, manufacturing activities have slowed down the most. It barely grew last fiscal (0.03%). In FY2021, it is expected to contract by 9.4%. Mining & quarrying activities are expected to contract by 12.4% and construction by 8.8%. However, electricity, gas, water supply and other utilities are expected to post a 2.7% growth. 

Services sector, which accounts for about 54% of the economy, is expected to contract by 8.8%, with the largest contraction in trade, hotels, transport and communications activities (-21.4%). These were severely affected during the lockdowns and continue to be partially affected even after relaxation of lockdowns. Financial services were not that affected compared to other activities (-0.8% growth). The slowdown in public spending is reflected in 3.7% contraction in public administration, defense and other services. 

On the expenditure side, consumption and investment are expected to contract sharply, but net exports are expected to improve largely because of slower deceleration of exports compared to imports. While public consumption is expected to grow by 5.8%, private consumption is expected to contract by 9.5%. Similarly, gross fixed capital formation is expected to contract by 14.5%, and change in stocks by 4.3%, indicating that the surge in pent-up demand has not been strong enough yet to clear and restock inventories. Exports and imports are expected to contract by 8.3% and 20.5%, respectively.  

The current forecast is based on the expectation of pickup in economic activities in the second half of FY2021. The economy contracted 23.9% and 7.5% in the first and second quarters, respectively. As expected, the most severe contraction was in services sector. 

Overall, the already slowing economy is expected to slowdown even faster due to the lockdowns and the lingering effect of the pandemic. Specifically, the slowdown in industrial sector since FY2017 is concerning. This is even more concerning in the case of manufacturing activities, which account for about 17% of the economy (one percentage point higher than the agriculture sector). This slowdown is actually reflected as a drop in capital formation, which contracted by 2% in FY2020 and is expected to further contract by 15.3% in FY2021. Note that first advanced estimate of GDP is based on data available (and its extrapolation) up to the first six to eight months of the fiscal year. 

Historically, FY2021 is going to be the worst fiscal year in terms of GDP growth (2011-12 constant prices series starting from FY1952). Previously, the economy contracted five times: FY1958 (-0.4%), FY1966 (-2.6%), FY1967 (-0.1%), FY1973 (-0.6%), and FY1980 (-5.2%).

The FY2022 central budget will focus on economic recovery and vaccine rollout. All eyes will be on how the government manages to increase public capital investment as well as secure financing for vaccine and its eventual coordinate, distribution and administration right up to the last mile. Gradual normalization of economic activities, income earnings and government’s fiscal support in terms of social security payments will prop up consumption. 

The expected slow pace of vaccine rollout in the initial phase and myriad challenges in its distribution and eventual administration might drag growth prospects, especially that of travel and tourism sector, in addition to the impending financial and fiscal sector stresses, which are expected to hit private as well as public investment. 

A sharp recovery in FY2022’s GDP growth inherently will have a large base effect component. The pace of the recovery in the following years may not be that fast without a sharp pick up in capital spending/investment (watch out for the additional NIP investment). 

In its January 2020 GEP, the World Bank estimated that the Indian economy will grow at 5.4% in FY2022 as “the rebound from a low base is offset by muted private investment growth given financial sector weaknesses”.

Restructuring stressed loans and higher government borrowing to stimulate economy

Restructuring stressed loans in India

Ramal Bandyopadhaya writes in Business Standard that the RBI's decision to allow restructuring of stressed bank loans will help to lower gross NPAs in the banking system. Some 80% of the loans in the banking system qualify for restructuring. 

None could miss the collective sigh of relief from the bankers’ community on the Reserve Bank of India’s (RBI) decision to open a restructuring window for stressed loans. Those accounts, which had been in default for not more than 30 days as on March 1, 2020, can be restructured if the borrowers are unable to service them because of their businesses being affected by the Covid-19 pandemic. The loans can be restructured, among others, by funding interest, converting part of debt into equity and giving the borrowers more time to pay up.

The banks must disclose such recast and set aside 10 per cent of the exposure to make provision for the restructured loans. In June 2019, the RBI had framed norms for loan restructuring, making it mandatory for banks to treat restructured, stressed loans as sub-standard unless there was a change in ownership of the borrowing company. Now, the banks can treat the restructured loans for Covid-19-affected companies as a standard asset even if there is no change in ownership.

[...]Going by one estimate, at least 80 per cent of the loans in the banking system will be eligible for such restructuring. One way of looking at this is that it will delay the inevitable by two years. Also, the 10 per cent provision requirement seems to be low as the banks’ unrealised but booked interest income from stressed borrowers is far higher. By RBI’s estimate, the gross bad loans of the banking system, which dropped to 8.5 per cent in March 2020, could rise to 14.7 per cent by March 2021. The restructuring window may not allow such a spike. The one-time forbearance was the need of the hour, particularly when all banks are not adequately capitalised. The good news is the presence of enough caveats to prevent misuse by the banking industry. In absence of this, many banks would have resorted to the tried and tested method of ever-greening — giving fresh loans to the stressed borrowers to keep the accounts good.

Current economic contraction is different from previous ones

Harish Damodaran argues in The Indian Express that arresting the current demand slowdown requires government investment and that debt concerns should not be overead. Despite fiscal slippages, yields on 10-year government bonds have dropped to 5.9% for the center and about 6.4% for states. This may fall further if banks are not able to lend the money they have collected as deposits.

That makes the current contraction totally different from the previous ones which were “supply-side” induced. There’s no shortage today of food, forex or even savings: Aggregate deposits with commercial banks as of July 31 were Rs 14.17 lakh crore or 11.1 per cent higher than a year ago. The closest parallel one could draw is with the 2000-01 to 2002-03 period of the Atal Bihari Vajpayee-led government. The Food Corporation of India’s (FCI) grain stocks in July 2002 were 2.6 times the buffer norm and the country ran current account surpluses in 2001-02 and 2002-03. But the economy didn’t contract then; growth merely fell from 8 per cent in 1999-2000 to an average of 4.5 cent during the next three years.

What we now have is a classic “western-style” demand slowdown that post COVID-19 has turned into a full-fledged recession bereft of consumption and investment demand. Households have cut spending as they have suffered income, if not job, losses. Even those with jobs are saving more than spending because they aren’t sure when their luck would run out. The same goes with businesses. Many have shut or are operating at a fraction of their capacity and pre-lockdown staff strength. The ones still making profits are conserving cash. If at all they are investing, it is to buy out struggling competitors and not to create new capacities. Just as households are uncertain about jobs and incomes, firms don’t know when demand for their products will really return.

This demand-side uncertainty and the resulting economic contraction is something new to India. And it stands out in a situation where food stocks and forex reserves are at record highs. Meanwhile, banks are also facing a problem of plenty. While their deposits are up 11.1 per cent, the corresponding credit growth has been just Rs 5.37 lakh crore or 5.5 per cent. With very little credit demand, the bulk of their incremental deposits are being invested in government securities, which have increased year-on-year by Rs 7.21 lakh crore or 20.3 per cent.