2. Economics Notes Extra 02

Elaborate Notes

Current Account Deficit

The Balance of Payments (BoP) is a systematic statistical statement that records all economic transactions between the residents of a country and the rest of the world over a specific period, typically a year. As conceptualized by the International Monetary Fund (IMF) in its Balance of Payments Manual, it is divided into two primary accounts: the Current Account and the Capital Account (which now includes the Financial Account as its main component).

• Current Account: This account tracks the flow of goods, services, and unilateral transfers.

  • Trade in Goods (Visible Trade): It records the net balance of exports and imports of physical merchandise. A deficit here (imports > exports) is known as a Trade Deficit.
  • Trade in Services (Invisible Trade): This includes net earnings from services like banking, insurance, tourism, and software services. India has historically maintained a surplus in this component, driven by its robust IT and business process outsourcing (BPO) sectors.
  • Transfer Payments: These are one-way transactions where residents receive money without providing any goods or services in return. As mentioned, they are receipts ‘for free’. This component is dominated by private remittances sent by non-resident Indians (NRIs), and also includes official grants and gifts. For India, remittances from its diaspora are a major source of foreign exchange and help cushion the Current Account Deficit (CAD).

• Capital Account: This account records all international transactions involving the purchase or sale of assets. These assets can be financial (stocks, bonds) or real (land, factories).

  • It comprises Foreign Direct Investment (FDI), Foreign Portfolio Investment (FPI), External Commercial Borrowings (ECBs), and changes in foreign exchange reserves. A surplus in the capital account indicates a net inflow of capital, which can be used to finance the deficit in the current account.

Reason for High CAD in India

India’s Current Account Deficit is a structural feature of its economy, but its magnitude fluctuates based on domestic and global factors.

• Higher Trade Deficit: This is the primary driver. India is a net importer of commodities, especially crude oil and gold. When global commodity prices, particularly oil, rise, India’s import bill swells, widening the trade deficit. For instance, the post-pandemic global recovery and the Russia-Ukraine conflict led to a sharp spike in oil prices, significantly impacting India’s CAD. Conversely, a slowdown in global demand, as seen recently, hurts India’s exports of goods.
• Services Receipts Decline: While India’s service exports are a strength, they are not immune to global economic trends. A slowdown in major economies like the US and Europe can reduce demand for India’s IT, business, and travel services, thereby decreasing net service receipts.
• Impact of Global Factors: Global economic headwinds, such as tightening monetary policies by central banks like the US Federal Reserve, can lead to capital outflows and slow down global growth. This impacts India’s exports and remittance inflows, as economic distress in host countries may reduce the disposable income of the Indian diaspora.
• Foreign Direct Investment (FDI) Decline: While FDI is a part of the capital account, its flow is indicative of investor confidence. A decline in net FDI inflows puts greater pressure on financing the CAD through more volatile sources like FPI or external borrowings, making the external sector more vulnerable.

Potential Threats of Increasing CAD

Sustaining a high CAD is challenging and poses significant macroeconomic risks. The Economic Survey 2021-22 suggested a sustainable limit of 2.5-3.0% of GDP for India, beyond which risks escalate.

• Foreign Investment: A persistently high CAD can be perceived by foreign investors as a sign of macroeconomic instability. This can trigger a sudden outflow of Foreign Portfolio Investment (FPI), often termed a ‘sudden stop’, leading to a sharp fall in stock markets and pressure on the currency.
• Exchange Rate: To finance a CAD, a country needs a surplus of foreign currency. A high CAD increases the demand for foreign currency (e.g., US dollars) relative to the domestic currency (e.g., Indian Rupee). This excess demand causes the domestic currency to depreciate. If unchecked, this can lead to a ‘free fall’ or a self-perpetuating cycle of depreciation and capital flight.
• Inflation: Currency depreciation makes imports more expensive. For an import-dependent country like India (especially for energy), this leads to imported inflation. Higher fuel and commodity prices feed into the general price level, stoking domestic inflation. This erodes domestic savings and can necessitate contractionary monetary policy (raising interest rates), which can slow down economic growth.
• Payment Imbalances and Crisis: If a country is unable to finance its CAD through capital inflows, it faces a Balance of Payments crisis. It may exhaust its foreign exchange reserves, making it unable to pay for essential imports. This was the situation India faced in 1991, which precipitated major economic reforms. More recent examples include the Asian Financial Crisis of 1997, where countries like Thailand and South Korea faced severe crises due to large, unfinanced current account deficits, and the recent economic collapse in Sri Lanka.

Dated Securities

Dated securities, or Government Securities (G-Secs), are debt instruments issued by the government to finance its fiscal deficit. They are considered risk-free as they are backed by a sovereign guarantee.

• Retail Direct Scheme: Launched by the Reserve Bank of India in November 2021, this scheme is a significant step towards the financial inclusion and democratization of the G-Sec market.
  • Objective: Historically, the G-Sec market was dominated by institutional investors like banks, insurance companies, and mutual funds. The scheme allows individual retail investors to directly invest in central and state government securities.
  • Mechanism: An investor can open a ‘Retail Direct Gilt’ (RDG) account with the RBI through a dedicated online portal. This account is linked to the investor’s savings bank account.
  • Investment Process:
    1. Primary Market: Investors can participate in the primary auctions of Treasury Bills (T-Bills), Dated G-Secs, and State Development Loans (SDLs). They participate in the non-competitive segment, meaning they do not quote a price or yield but simply state the amount they wish to invest. They are allotted securities at the weighted average price/yield discovered in the auction. They can also subscribe to Sovereign Gold Bonds (SGBs).
    2. Secondary Market: The scheme also provides access to the NDS-OM (Negotiated Dealing System - Order Matching), RBI’s secondary market trading platform, allowing investors to buy and sell existing G-Secs.
  • Investment Limits: The minimum investment is ₹10,000, and subsequent investments can be made in multiples of ₹10,000.

Goods and Services Tax

The Goods and Services Tax (GST) is an indirect, multi-stage, destination-based tax that has replaced many indirect taxes in India. It was implemented through the 101st Constitutional Amendment Act, 2016.

• Recent Controversy (Online Gaming): The GST Council decided to levy a 28% tax on the full face value of bets placed on online gaming, horse racing, and casinos.

  • The Debate: Previously, a distinction was made between a ‘game of skill’ (like fantasy sports), which attracted 18% GST on the platform fee (Gross Gaming Revenue), and a ‘game of chance’ (like betting), which attracted 28%. The new ruling eliminates this distinction for taxation purposes.
  • Industry’s Concern: Online gaming companies argue that taxing the entire contest entry amount (pot money) instead of just their revenue (platform fee) will make the activity prohibitively expensive, driving users to illegal offshore betting platforms and hurting the industry’s profitability and viability. They also argue that this amounts to a retrospective policy change that undermines investor confidence.

• The Idea behind GST:

  • Pre-GST Regime: The earlier tax system was fragmented. The Centre levied taxes like Central Excise Duty and Service Tax, while states levied taxes like Value Added Tax (VAT), Octroi, and Entry Tax. This led to a cascading effect, or ‘tax on tax’, where a tax was levied on a price that already included previous taxes.
  • VAT and its Limitations: While both Centre (CENVAT) and states (State VAT) had a Value Added Tax system, the input tax credit (ITC) mechanism was not seamless across them. For example, a manufacturer could not claim credit for the State VAT paid on inputs against their Central Excise duty liability. Furthermore, the Central Sales Tax (CST) levied on inter-state sales was a cascading tax as its credit was not available to the buyer.
  • GST’s Solution: GST subsumed most of these taxes into a single tax with a seamless flow of Input Tax Credit across the entire supply chain, thus eliminating the cascading effect. It is a destination-based tax, meaning the tax revenue accrues to the state where the goods or services are finally consumed.
  • Exclusions: Customs Duty, which is levied on the import of goods into India, is not part of the GST regime. It continues to be levied by the Central Government.

Widening Tax Base

• Angel Tax:
  • Introduction: This tax was introduced in the Income-tax Act, 1961, through Section 56(2)(viib) by the Finance Act, 2012.
  • Objective: Its primary aim was to curb money laundering. It targeted the practice of routing unaccounted money into legitimate businesses by subscribing to shares of unlisted, closely-held companies at an exorbitantly high premium, a value much higher than their Fair Market Value (FMV).
  • Mechanism: The tax is levied on the capital raised by an unlisted company from an individual investor (‘angel investor’) if the share price is seen as being in excess of the FMV of the shares. The excess amount is considered as ‘income from other sources’ for the startup and is taxed accordingly.
  • Recent Changes (2023): Initially, this provision applied only to investments made by resident investors. The Finance Act, 2023 extended its scope to include investments from non-resident and foreign entities. This was done to create a level playing field. However, to facilitate genuine foreign investment, the government has notified certain classes of foreign entities (e.g., from certain countries, sovereign wealth funds, pension funds) that will be exempted from this tax.

Periodic Labour Force Survey (PLFS)

• Genesis and Objective: The PLFS was launched by the National Sample Survey Office (NSSO), now part of the National Statistical Office (NSO), in 2017. It was established based on the recommendations of a committee chaired by economist Amitabh Kundu. Its primary objective is to provide more frequent and timely data on employment and unemployment in the country.
• Methodology:
  • It generates quarterly estimates for urban areas using the Current Weekly Status (CWS). In CWS, a person’s activity status is determined based on a reference period of the last 7 days.
  • It generates annual estimates for both rural and urban areas using both Usual Status (reference period of the last 365 days) and CWS.

PLFS Findings on the Gender Pay Gap

Recent PLFS data highlight persistent gender disparities in the Indian labour market.

• Gap in Work Hours: In 2023, the data shows that men consistently work more hours than women. The disparity is most pronounced among the self-employed, where men work 50% more hours. This reflects the “double burden” of paid work and unpaid domestic/care work that falls disproportionately on women. The gap is lower (19%) for regular wage workers, likely due to more structured work hours.
• Gap in Earnings: Men earn significantly more than women across all employment categories.
  • Self-employed: The earnings gap is starkest here, with male self-employed workers earning 2.8 times more than their female counterparts in 2023. This is influenced by factors like women being concentrated in lower-paying agricultural activities and home-based work.
  • Regular-wage workers: Even in formal employment, a significant gap persists, with male workers earning 24% more than female workers.
• Female LFPR Trends: While the overall Female Labour Force Participation Rate (FLFPR) has shown an increase, particularly in rural areas, the nature of this employment is a concern. A large part of this increase is in the category of self-employment, often as unpaid helpers in family enterprises.
• Decline in Work Hours for Rural Women: A worrying trend is the fall in average weekly work hours for self-employed rural women, from 37.1 hours in 2019 to 30.1 hours in 2023. This suggests an increase in underemployment and possibly reflects distress-driven participation in low-productivity work.

Nobel Prize in Economics: Women in Labour Force

The 2023 Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel was awarded to Claudia Goldin for her comprehensive research on women’s earnings and labour market participation over centuries.

• Goldin’s U-Curve Hypothesis: Goldin challenged the conventional wisdom that women’s participation in the labour force simply rises with economic growth. Through meticulous archival research, she demonstrated a U-shaped relationship.

  • Phase 1 (Pre-industrial/Agrarian): Female labour force participation was high as women worked on farms and in family businesses alongside men.
  • Phase 2 (Industrialization): Participation declined as work shifted from home to factories. Social stigma and the ‘marriage bar’—a common practice where companies fired women upon marriage—prevented many married women from working.
  • Phase 3 (Post-industrial/Service Economy): Participation rose again with the growth of the service sector, increased female education, and changing social norms.

• Factors Affecting Female Labour Force Participation Rate:

  • Social Norms: Goldin highlighted the power of social norms and expectations. “Marriage bars,” prevalent in the US until the mid-20th century, were a formal institutionalization of the norm that a married woman’s place was in the home.
  • Parenthood Effect: Goldin’s work showed that the arrival of the first child often marks the beginning of a significant gender gap in earnings, as women typically take on a larger share of childcare responsibilities, leading to career interruptions or shifts to more flexible, lower-paying jobs.
  • Technological Innovations: She famously identified the contraceptive pill as a revolutionary technology. By giving women greater control over timing and number of children, it allowed them to invest more in their education and careers, delaying marriage and childbirth. This led to a “quiet revolution” in women’s life choices and economic outcomes.

Gig Economy

A gig economy is characterized by a prevalence of short-term contracts or freelance work as opposed to permanent jobs.

• Classification of Gig Workers:

  • Platform Gig Workers: These workers use online platforms or apps to connect with customers and provide services. Examples include ride-hailing drivers for Uber and Ola, food delivery personnel for Zomato and Swiggy, and freelancers on platforms like Upwork.
  • Non-Platform Gig Workers: This is a broader and more traditional category, including casual wage labourers in construction, own-account workers (e.g., street vendors), and part-time workers in conventional sectors who are not part of a formal employer-employee relationship.

• Recent Developments: There is growing recognition of the need to provide social security and welfare for this expanding workforce.

  • Parliamentary Standing Committee: The committee’s recommendation to the Labour Ministry to create specific welfare schemes underscores the need for a national policy framework.
  • G20 Meeting (2023): The adoption of an outcome document on social protection for gig workers at the G20 meeting held in Indore, India, signifies international consensus on this issue.
  • Rajasthan’s Legislation: The Platform Based Gig Workers (Registration and Welfare) Bill, 2023, passed by the Rajasthan government, is a landmark legislative initiative. It proposes the creation of a welfare board, a social security fund financed by a cess on aggregator transactions, and a mandatory registration system for all platform-based gig workers and aggregators in the state.

Incremental Cash Reserve Ratio (ICRR)

ICRR is a temporary monetary policy tool used by the RBI to absorb excess liquidity from the banking system.

• Mechanism and Difference from CRR:

  • CRR: The Cash Reserve Ratio is the percentage of a bank’s Net Demand and Time Liabilities (NDTL) that it must hold as a cash balance with the RBI. This is a standard reserve requirement.
  • ICRR: The ICRR is an additional requirement imposed over and above the CRR. It requires banks to hold a certain percentage of the increase in their NDTL between two specific dates with the RBI. For instance, in August 2023, the RBI mandated a 10% ICRR on the increase in NDTL between May 19 and July 28, 2023. It is temporary and is typically rolled back in phases as liquidity conditions normalize. Banks do not earn any interest on funds parked under CRR or ICRR.

• Effect of ICRR:

  • Manage Liquidity: The RBI used ICRR in 2023 to absorb the surplus liquidity created by factors like the return of ₹2000 banknotes to the banking system, sustained foreign capital inflows, and increased government spending.
  • Inflation Control: Excess liquidity can fuel demand and lead to inflation. By impounding this excess cash, the RBI aims to curb inflationary pressures without resorting to a permanent hike in the policy repo rate, which could hurt economic growth. In July 2023, retail inflation had spiked to 7.44%, necessitating this liquidity tightening measure.
  • Banking Resilience: Mopping up excess liquidity can also be a prudential measure. While not its primary purpose, it indirectly enhances banking system resilience by reducing the amount of idle cash that could potentially fuel asset price bubbles. A Bank Run, a situation where a large number of depositors withdraw their money simultaneously due to fears of the bank’s insolvency, becomes less likely in a stable liquidity environment.
  • Decreased Lending: The immediate effect is a reduction in the loanable funds available with banks. This can lead to a temporary increase in short-term interest rates and a slowdown in credit growth, which in turn helps in moderating aggregate demand in the economy.

Surplus Transfer by RBI

The Reserve Bank of India, being the central bank, generates income from its operations and transfers the surplus (profit) to its owner, the Government of India.

• Legal Basis: Section 47 (Allocation of surplus profits) of the RBI Act, 1934, mandates that after making provisions for bad debts and other contingencies, the remaining profit (surplus) is to be paid to the Central Government.
• Sources of Income and Expenditure: RBI’s primary income sources are interest earned on its holdings of government bonds (G-Secs), foreign currency assets (like US Treasury bonds), and interest on loans given to banks (e