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UPSC Newspaper Article Analysis

A lending hand The RBI has signalled it is aware of the burden on health -care
providers during this period

(Relevance in – prelims; GS III - Indian Economy and issues relating to planning, mobilization of
resources, growth, development and employment)

Source: The Hindu; Page no – 6

Context

The Reserve Bank of India’s move to step in and join the fight against the second wave of the pandemic
through the announcement of measures aimed at alleviating any financing constraint for those
impacted, including the healthcare sector, State governments and the public, is a welcome and timely
intervention.

Mounting fatalities

• The furious pace at which new COVID-19 infections and fatalities have been mounting in recent
weeks has not only overwhelmed the nation’s health infrastructure but has begun to
significantly impair economic activity, just as the economy appeared to have turned the corner
from last year’s debilitating contraction.
• “The fresh crisis is still unfolding,” Governor Shaktikanta Das said in his unscheduled address,
acknowledging the challenge ahead.
• Stressing that it is imperative to both save lives and restore livelihoods, Mr. Das proposed a
calibrated response, mooting a •50,000 crore term liquidity facility to boost credit availability
for ramping up COVID-related health-care infrastructure and services.
• Lenders have been urged to expedite lending under this ‘priority sector’ classified scheme to
entities including vaccine manufacturers, hospitals, pathology labs, suppliers of oxygen and
ventilators, importers of COVID-related drugs and logistics firms.
• And although Mr. Das said the scheme would also cover patients requiring treatment, he failed
to spell out how those most in need of financial assistance to cover their surging medical bills
could borrow the funds.
• In directing the flow of credit to the sector most in focus at the moment, the RBI has signalled it
is cognisant of the burden on health-care and allied providers.
• However, how much lending capital-stressed banks would be willing to write into their ‘COVID
loan books’ remains to be seen.

Focusing on small borrowers

• The central bank’s focus on small borrowers including unorganised businesses and MSM
enterprises, both through enhanced provision of credit via small finance banks and a fresh

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resolution framework for existing borrowings, is also heartening as these economic participants
were already among the worst-hit during last year’s contraction.
• However, the norms laid down for resolution including the proviso that only those borrowers
who had not already availed of restructuring assistance and whose loans were ‘standard’ as on
March 31, 2021, would be eligible for fresh resolution lays an onerous burden on those that the
RBI itself admits are the ‘most vulnerable’.
• Mr. Das was also unreasonably sanguine about the economic impact of the second wave, even
as he granted that “high frequency indicators are emitting mixed signals”.
• The RBI’s position that the dent to aggregate demand is likely to be only moderate is based on
the fact that so far this year, the restrictions to contain the spread of the virus have been largely
localised.
• With more and more voices from the Opposition to top industry groups urging a nationwide
lockdown to break the chain of transmission, Mr. Das may need to very quickly revisit his
assumptions.

Questions

Q1. The Reserve Bank of India’s move to step in and join the fight against the second wave of the
pandemic through the announcement of various measures. How these measures will help India to fights
against pandemic?

Q2. Consider the following statements:

1. Lenders have been urged to expedite lending under this ‘priority sector’.
2. It classified scheme to entities including vaccine manufacturers, hospitals, pathology labs,
suppliers of oxygen and ventilators.

Which of the statements given above is/are correct?

(a) 1 only
(b) 2 only
(c) Both 1 and 2
(d) Neither 1 nor 2

Ans: c

Reform India's fiscal management law for counter-

cyclical impact
(Relevance in – prelims; GS III - Indian Economy and issues relating to planning, mobilization of
resources, growth, development and employment)

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Source: Mint; https://www.livemint.com/opinion/online-views/reform-india-s-fiscal-management-

law-for-counter-cyclical-impact-11620363849497.html

Context

A study of the fiscal impulse imparted by fiscal policy ever since the FRBM Act came into force shows
that it has had a predominant pro-cyclical bias. Our economy needs a new formula.

Efficacy of FRBM Act

• Reams have been devoted to dispensing with India's current Fiscal Responsibility and Budget
Management (FRBM) Act.
• Some critics question the Act’s efficacy in binding our fiscal policy to achieve debt sustainability.
• This laudable consideration apart, there is the first-principles approach to looking at fiscal-
discipline legislation.
• Discussion of public finance usually begins with listing various functions of fiscal policy, one of
the principal ones being the ‘stability objective’.
• The motivation for this often flows from Keynes’ oft-repeated quote, “In the long run we are all
dead. Economists set themselves too easy, too useless a task, if, in tempestuous seasons they
can only tell us that when the storm is long past, the ocean is flat again."

Keynes advice

• What Keynes essentially advocated was this: When output falls below the economy’s potential,
the government must add to aggregate demand and stimulate economic activity.
• This is called a counter-cyclical fiscal policy, in that the size of government stimulus to the
economy runs in the opposite direction to the movement of aggregate economic output.
• Vide this philosophy, which enjoys near-unanimous approval, more government spending in
periods of inadequate demand and higher taxes in periods of faster demand growth are usually
prescribed.
• A scenario of inadequate economic activity is called a negative output gap, since actual output
has dipped below the level of output that the economy would be able to produce given its stock
of resources. For this discussion, the output gap is estimated with respect to a potential level of
output, calculated vide the Hodrick-Prescott Filter approach.

Fiscal impulse

• The FRBM legislation was enacted to rein in fiscal profligacy, which was, more often than not,
driven by political expediency rather than any economic imperative, seeking to place our
sovereign debt on a path more salubrious to macroeconomic stability.
• To achieve this, bounds were imposed on deficit measures (fiscal or revenue deficits and debt
were capped at certain proportions of gross domestic product).

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• While there has been much discussion on the impact of these bounds on debt figures of the
government, it is worth inquiring whether the objective of counter-cyclicality in fiscal policy has
been achieved.
• Look at fiscal policy by means of a parameter often used by the International Monetary Fund
(IMF) called the fiscal impulse.
• The fiscal impulse measures the change in fiscal stance, which, in turn, is a measure of the fiscal
balance adjusted for business cycles, and shows whether fiscal policy is expansionary (positive
fiscal stance) or contractionary (negative fiscal stance).
• Note that the fiscal balance is the global equivalent of what we call the fiscal deficit – the gap
between expenditure and revenues of the government. The IMF, unlike India, leaves out
disinvestment proceeds and recovery of loans from its reckoning of revenues.

What fiscal impulse indicates?

• So, the fiscal impulse indicates the change in government’s fiscal stance: a positive impulse
means a more expansionary fiscal stance vis-à-vis the previous fiscal, and vice-versa.
• Reading the fiscal impulse along with the output gap is a commentary on the conduct of the
fiscal policy pursued.
• In any year when output gap is positive, the economy is in a boom and a positive fiscal impulse
reflects pro-cyclicality in fiscal policy – more expansionary when the economy is already doing
well. But if the fiscal impulse is negative in a period of boom, then there is a counter-cyclical
trend in the fiscal policy, as it ought to be.
• Fiscal policy generally responds a year after an economic slowdown, when the new annual
budget has an opportunity to make a course correction in the light of the previous year's growth
experience.
• Thus, we look at the output gap of the previous fiscal coupled with current fiscal impulse (both
as a percentage of potential GDP), in the post-FRBM period.
• We have data for 15 complete fiscal years since the FRBM Act came in. A negative fiscal impulse
implies a contractionary fiscal policy, which when co-existing with a negative output gap implies
pro-cyclical fiscal conduct.
• Only on four occasions has the fiscal policy been counter-cyclical since 2004-05. Fiscal policy
could not be counter-cyclical in more than 70% of the time that the FRBM Act has been in
operation.
• Since 2016-17, expenditure financed through extra-budgetary resources also contributed to
fiscal stimulus; accounting for this does not alter our findings much; it just adds one more
episode of counter-cyclical fiscal policy.
• It is notable that placing a limit on fiscal deficit-as-a-share-of-GDP ipso facto biases the fiscal
policy towards pro-cyclicality: it allows a larger absolute fiscal deficit in case of a higher GDP.
This is a ripe area of reform if and when we legislate a new debt-deficit law.

Counter-cyclic policy

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• There are ways to anneal counter-cyclicality into a debt law. While retaining the numerical
bounds on our fiscal deficit, leeway can be granted to achieve the target averaged over a couple
of years, instead of each year individually.
• Alternatively, some provision can be made to modulate growth of expenditure such that the
constituent components coupled with their multiplier values cumulatively close the economy's
output gap.
• Admittedly, there are constraints in being able to implement a counter-cyclical fiscal policy
when one doesn’t have a grip on the GDP figure of the fiscal year ahead.
• Even if we had estimates, techniques to calculate the output gap are very sensitive to the
precision of these estimates.
• Also, counter-cyclical fiscal intervention must be pursued in consonance with ensuring debt-
sustainability.
• These issues aside, there is no countervailing thought to the imperative of baking the counter-
cyclicity of fiscal policy into our debt-deficit law.

Questions

Q1. India's fiscal management law needs to be reformed for counter-cyclical impact. Discuss.

Q2. Consider the following statements:

1. The fiscal impulse measures the change in fiscal stance.

2. It measures the fiscal balance adjusted for business cycles, and shows whether fiscal policy is
expansionary (positive fiscal stance) or contractionary (negative fiscal stance).
3. In any year when output gap is positive, the economy is in a boom and a positive fiscal impulse
reflects pro-cyclicality in fiscal policy.

Which of the statements given above is/are correct?

(a) 1 only
(b) 2 and 3 only
(c) 1 and 3 only
(d) 1, 2 and 3

Ans: d

Why RBI wants moderate bond yields, and what it

means for investors
(Relevance in – prelims; GS III - Indian Economy and issues relating to planning, mobilization of
resources, growth, development and employment)

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Source: Indian Express; https://indianexpress.com/article/explained/explained-why-rbi-wants-

moderate-bond-yields-and-what-it-means-for-investors-7304997/

Context

Recently, the Reserve Bank of India’s decision to step up purchase of government securities under the
government securities acquisition programme (G-SAP) led to the yield on the benchmark 10-year bond
falling below 6%.

How have bond yields moved recently?

• The yield on the 10-year benchmark 5.85%, 2030 bond fell by 0.62% and closed at 5.978% on
Wednesday, from 6.01% the previous day.
• It closed under 6% for the first time since February 12. In April, the RBI launched G-SAP under
which it said it would buy Rs 1 lakh crore worth of bonds in the April-June quarter.
• It has so far bought Rs 25,000 crore worth of government securities (G-secs). The 10-year bond
has declined 15 basis points from 6.15% in the last one month.
• Movements in yields, which depend on trends in interest rates, can result in capital gains or
losses for investors.
• If an individual holds a bond carrying a yield of 6%, a rise in bond yields in the market will bring
the price of the bond down.
• On the other hand, a drop in bond yield below 6% would benefit the investor as the price of the
bond will rise, generating capital gains.
• “G-SAP has engendered a softening bias in G-sec yields which has continued since then,” RBI
Governor Shaktikanta Das said while announcing a fresh set of measures to tackle the impact of
the pandemic on Wednesday.

Why are bond yields softening?

• The fall in bond yields in India could also be due to a sharp decline in US Treasury yields or the
economic uncertainty caused by Covid-19.
• “But the most important driver of the bond market was RBI interventions. The announcement of
a bond-buying programme – G-SAP — at the start of the month played a crucial role in turning
the market sentiment,” said Pankaj Pathak, Fund Manager-Fixed Income, Quantum Mutual
Fund.
• He said the RBI continued to send strong yield signals by cancelling and devolving government
debt auctions. In the last month alone, the RBI cancelled more than Rs 30,000 worth of debt
auctions.
• Although part of this amount was offset by availing the green-shoe option (option to accept bids
for more than the notified amount of debt auction) in other securities, the decision to buy Rs
35,000 crore worth of bonds in May would help the market absorb a portion of the Rs 1.16 lakh
crore market borrowings by the government during the month.

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What’s the impact on markets and investors?

• Experts say the structured purchase programme has calmed investors’ nerves and reduced the
spread between the repo rate and the 10-year government bond yield.
• A decline in yield is also better for the equity markets because money starts flowing out of debt
investments to equity investments.
• “That means as bond yields go down, the equity markets tend to outperform by a bigger margin
and as bond yields go up equity markets tend to falter. If you look at the past 5 years since late
2012, the benchmark 10-year yields are down by almost (- 17%) and have been moving
consistently downward, despite occasional hiccups. At the same time, the Nifty is up by nearly
82%,” according to a Motilal Oswal report.
• It says the yield on bonds is normally used as the risk-free rate when calculating the cost of
capital. When bond yields go up, the cost of capital goes up.
• “That means that future cash flows get discounted at a higher rate. This compresses the
valuations of these stocks.
• That is one of the reasons that whenever the interest rates are cut by the RBI, it is positive for
stocks,” it says.
• When bond yields go up, it is a signal that corporates will have to pay a higher interest cost on
debt. As debt servicing costs go higher, the risk of bankruptcy and default also increases and this
typically makes mid-cap and highly leveraged companies vulnerable.
• “The markets have also viewed these measures (Wednesday’s RBI measures) positively with the
BSE Sensex rising, while the bond markets have seen additional buying reflected by decline in G-
Sec yields,” said Madan Sabnavis, Chief Economist, Care Ratings.

Why is the RBI keen on keeping yields in check?

• The RBI has been aiming to keep yields lower as that reduces borrowing costs for the
government while preventing any upward movement in lending rates in the market.
• A rise in bond yields will put pressure on interest rates in the banking system which will lead to a
hike in lending rates. The RBI wants to keep interest rates steady to kick-start investments.
• The yield had fallen to a low of 5.74% on July 10 last year as a result of a series of interest rate
cuts.
• However, yields subsequently rose and touched a high of 6.15%.
• If yields come down, the RBI will be able to bring down the cost of government borrowing for
2021-22, which is set at Rs 12.05 lakh crore.

Where are yields headed?

• Analysts say potential changes in the US monetary policy direction and Fed bond yields are the
biggest risk factors for the Indian bond market in 2021.
• “Notwithstanding this risk, bond yields may remain in a tight range in near future supported by
RBI’s bond purchases.

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• Over the medium term, inflation and potential monetary policy normalisation will play a more
important role in shaping the interest rate trajectory. We expect market interest rates to move
higher gradually over the next 1-2 years,” said Pathak of Quantum Mutual Fund.
• During the “taper tantrum” episode of 2013, when then US Fed chairman Ben Bernanke hinted
at reducing the amount of bond purchases, Indian bond yields spiked and the value of the rupee
collapsed within a few months, he said.
• India’s macro position and external accounts are in much better shape than in 2013.
Nevertheless, Indian markets will not be immune to any such shocks in the global sphere.

Questions

Q1. Recently, the Reserve Bank of India’s decision to step up purchase of government securities under
the government securities acquisition programme (G-SAP) led to the yield on the benchmark 10-year
bond falling below 6%. What is G-SAP scheme and how it will impact our economy?

Q2. Consider the following statements:

1. The RBI launched G-SAP under which it said it would buy Rs 1 lakh crore worth of bonds in the
April-June quarter.
2. Changes in yields, which depend on trends in interest rates, can result in capital gains or losses
for investors.
3. A decline in yield is not good for the equity markets because money starts flowing out of debt
investments to equity investments.

Which of the statements given above is/are correct?

(a) 3 only
(b) 1 and 2 only
(c) 2 and 3 only
(d) 1, 2 and 3

Ans: b

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