Post COVID 19 Global Strategic Relations

            The Government of India has recently announced new order amending the country’s Foreign Direct Investment policy to protect Indian companies from opportunistic takeover exploiting COVID19 pandemic induced economic downturn. Although the order relates to investments from countries having land borders with India the target of the new move is anybody’s guess given the fact that investments from Bangladesh and Pakistan already require scrutiny on national security ground. The US and some European countries are already concerned over China’s aggressive overseas foreign investment strategy. These countries are actively considering to deflecting investment from China to other destinations. Japan government has already announced earmarking of $2.2billion to help its manufacturers shift production line out of China. Meanwhile, South Korean companies have evinced interest to move some of their factories from China to India. These developments accompanied by growing anti-China sentiments emanating from China’s suspicious role in devastating worldwide spread of coronavirus suggest emerging of a conglomeration of anti-China forces to downgrade China. China’s increasing use of its clout in world organizations is also a matter of concern. In this backdrop, prediction of perceptible change in global strategic relations in the aftermath of COVID19 crisis holds merit. In order to get an insight of likely geopolitical and economic scenario after the ongoing world war like battle against Covid19 revisiting history of post Second World War has relevance.

Post World War II developments

Post World War II witnessed rise of two superpowers – the Soviet Union (USSR) and the United States of America (USA), engaged in cold war competing to expanding areas of influence. West European countries were rebuilt with the US aid under Marshall Plan. Japan and many other countries were also provided aid by the US. Soviet Union, which had taken control of Central and East Europe formed a group of communist nations and were outside the US aid program. Implementation of Marshall Plan is seen as the beginning of Cold War. Many developing countries including India distanced themselves from the cold war by the formation of a forum named Non Aligned Movement (NAM) in 1961. Birth of People’s Republic of China in 1949 following the victory of Chinese Communist Party in civil war under the leadership of Mao Tse Tung marked watershed in the history of post-World War II. China’s economy started impressive growth following introduction of economic reforms in December 1978 under the leadership of Deng Xiao Ping. Meanwhile, the disintegration of Soviet Union in December 1991 pushed Russia towards economic hardship and loosened its grip on East European countries. The end of cold war in 1991 was followed by splintering of bipolar world. Meanwhile, China’s emergence as economic and military power helped spreading Chinese influence in different parts of the world. China’s humongous OBOR (One Belt One Road) project which had attracted a large number of both developed and developing countries is virtually Chinese ploy to strengthen its clout in large number of countries and thereby emerge as a superpower supplanting the US.

Recent World- wide increasing anti-China sentiments

      

China’s alleged contribution (either inadvertent or deliberate) towards spreading coronavirus causing devastating losses of human lives and pushing the global economy towards rock bottom; supply of defective or low quality medical equipment including PPE, testing kits, etc. have caused anti-China sentiment throughout the world. USA, UK, France, Germany and many other countries have raised their voice against China. While the entire world is struggling against COVID19, China’s bid to acquire strategic industries in many countries taking advantage of pandemic inflicted economic slowdown added fuels to the fire. There may be global unrest against China in the event of China’s involvement in pandemic is established but China disowns responsibility and refuse to pay compensation. China has recently refused to accede to the US request to allowing visit of US experts to probe in China the origin of Covid19 virus. US attacks on China on this issue will continue at least till the country’s presidential election if not beyond. A new cold war may start against China and all the developed countries may expedite formulating strategic policy of reducing dependence on China.

Outlook

China’s dream of becoming economic super power is likely to be jolted by the adverse impact of the pandemic on the economy as well as the apparent hostile attitudes of the developed countries. China’s status as economic power in the post pandemic world order would largely depend on the intensity of coronavirus inflicted damages to Chinese economy and its capability to resist developed countries’ economic onslaught. Whether China could be marginalized in the aftermath of COVID19 pandemic will be subject to various factors such as: resilience of world’s major economies, USA in particular, to bear the brunt of economic fallout from crisis in China; the time taken by the developed countries’ pandemic stricken economies to bounce back, their capability to provide substantial economic assistance to pandemic affected developing countries; intensity of any adverse impact of EU’s any further splintering and China taking advantage of that; China’s capability to withstand stringent economic sanctions if imposed jointly by all the developed countries as earlier China had withstood economic sanctions imposed in 1989 following Tiananmen massacre; extent of success in reducing dependence on China’s supply chain by all the countries; getting Russia’s cooperation in taking actions against China in the backdrop of Sino-Russian relations serving mutual interests akin to marriage of convenience. China and Russia have come closer despite China making inroads into Russia’s backyard through increased scale of cooperation with South Caucasus – Armenia, Azerbaijan and Georgia. China became an important partner of Russia following sanction on Russia by the US in 2014 over Russia’s takeover of Ukraine’s Crimea region.

Taking different aspects into consideration the developed countries’ long term strategy could be to contain China. All the countries may emphasize not only on reducing dependence on China but also on self-reliance to the best of ability. Economic nationalism with protectionist measures may in general take precedence over economic globalization. India has an opportunity to emerge as an economic power provided the country makes spectacular victory in the battle against COVID19. India has an edge over other countries on generic medicines and low cost medical treatment. Medical equipment like PPE, testing kits etc. made in India by eminent institutions like DRDO and others are cheaper despite having quality of international standard. India, which itself is a big market, together with Bangladesh, Sri Lanka and others provide a very big potential market for IT and telecommunication as well as digital technology sectors in view of expected spike in demand in the aftermath of Covid19. Although ASEAN countries particularly Vietnam and Thailand with their cheap labour cost are favourable destinations for manufacturing sector, the bottlenecks in India are not insurmountable. Foreign investment-friendly reforms measures may be undertaken to attract FDIs in various sectors in India. So far, India’s handling of Covid19 crisis with its limited resources is impressive while comparing with most of the developed countries. India’s prompt positive responses to the requests from many countries for providing the drug hydroxychloroquine and its proactive role in taking other countries together in fight against the pandemic has already been appreciated worldwide while Chinese activities have been condemned either openly or in subdued tone. However, surpassing China by India as an economic power seems unlikely in the near future unless the former confronts any internal large scale uprising leading to fragmentation of the country or radical change in China’s political system.  There seems to be an undercurrent of resentment in China. In order to deflect attention China may resort to muscle flexing. Efforts may also be made by China to undermine India’s so far impressive handling of corona crisis by injecting and propagating communal colour and clandestinely work on destabilizing law and order situations in different parts of India to ensure India’s defeat in the fight against Covid19 and thereby cause disinterest among prospective foreign investors in India. An important aspect of post pandemic strategic relations could be to addressing need for global cooperation in order to closely monitor any effort by the terrorists to add coronavirus as low cost highly effective weapon in the arsenal. Need for global platform to have stringent control over research institutes could be highlighted for a viable mechanism.   The functioning of world bodies like UN, WHO etc. could come under scrutiny and the possibility of their restructuring cannot be ruled out.

RBI’s macroeconomic policy trilemma

The monetary policy committee in the recently held meeting decided to keep the interest rates unchanged. Many economists have expressed apprehension that the RBI is facing the classical macroeconomic trilemma. This article attempts to simplify this economic jargon.

The macroeconomic trilemma is the result of Mundell Fleming model which states that an independent monetary policy, a flexible capital account, and a fixed exchange rate is not possible simultaneously.

The commercial banks are entangled with excess liquidity as a result of demonetization. The RBI attempted to mop out the excess liquidity through its open market operations.  However, it decided to suspend its open market sale on November even when the Moody’s revised its ratings. This attributes to the macroeconomic trilemma being faced.

The government yields had crossed 7 %. Had the RBI continued with its open market sales it would have increased the yields further. (Note that yield and price of bonds are inversely related to each other. The higher is the yield, riskier is the security.)

The increased yield would have invited capital flows and appreciated the rupee.

The economy is already mired with rupee appreciation. To avoid further appreciation, RBI might then have to undertake open market purchases of security, thus reversing the initial independent monetary policy of open market sales.

Though India has a partially convertible capital account and managed exchange rate, the application of Mundell Fleming model is still phenomenal.

How much Good and Simple is the present the GST?

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When the clock struck 12 on 30 June 2017, India stepped into long awaited One Nation One Market through implementation of Goods and Services Tax (GST). GST came into effect by 101^st Constitutional Amendment Act following the passage of 122^nd Constitutional Amendment Bill. It is hailed as a Good and Simple Tax because of emphasis on minimising the cascading effects of tax, rationalising tax structures, improving tax compliance and thus aiming at improving the ease of doing business.

Having said that the 101^st amendment has undoubtedly opened a new chapter in India’s economic history, the present GST has certain drawbacks too. The shortcomings of GST can be broadly classified into complexity of tax structures, problem of tax compliances and technical glitches.

1)      Complexity of Tax Structures

GST was envisaged as a Good and Simple Tax but the present tax structure with five different rates and cesses is far away from being simple. There have been reports about how milk has been subjected to different rates. However, it merits attention that this problem is ought to occur in a country which is hostage to huge income inequality. Thus the trade-off is actually between having a good tax (which in my view is a tax which takes into consideration the impact of tax burden on different segments of the society) and a simple tax (which is to approach towards a unified tax rate as close as possible).

Given the fact that only about half of the Indian economy comes under the ambit of GST, the items subjected to GST have mostly been taxed stiffly. India has one of the highest tax rates in GST in the world. Further imposition of cesses goes against the principle of Value Added Taxation. Interestingly, the state finance ministers don’t have much objection to distorted tax structures and its repercussions on growth because of the Compensation Scheme. However, there is optimism that when the tax buoyancy improves the tax rates will be slashed.

2) Compliance Problem

The tax compliance has become major hurdle particularly for MSMEs. In the earlier tax regime, entities with a turnover of Rs1.5 crore per annum were exempted from payment of excise duty. That threshold has been lowered to Rs20 lakh for most of the states under GST. As these sectors are handicapped of the essential infrastructure required for tax compliance so they have to depend on intermediaries which add to their compliance cost.  Against this backdrop , the release of GST app after a week of its implementation can be called as a faulted start.

The delayed input tax credits have also affected working capital requirements of MSMEs  badly. The government had announced composition scheme for the tax payers (threshold limit 1.5 crore) but there are not much takers of this scheme because it is only for intra state supplies and input tax credits can’t be claimed by a dealer opting for this scheme.

3)      Technical glitches

IT is the backbone of GST. Industry has voiced concerns over the issues faced during matching invoices and other tax filing procedures.

The above limitations merit discussions but also taking into account that the government is constantly making efforts to take measures for improving the GST. Slashing of rates on 200 items in November 10 is a much appreciated move. The average shortfall of revenue has also narrowed. The improved ratings in the Ease of doing business and Moody’s ratings allude to the fact that in the long run India’s economy will benefit from this reform. However, going by Keynes statement that in the long run we are all dead, a good policy requires both short term and long term consideration. The government could have introduced GST in phases, by initially targeting companies and then taxing MSMEs. This would have given breathing time to MSMEs to equip themselves with the necessary infrastructure before this major overhaul. The government is mulling direct tax reforms. The government has already set up a task force to draft a new direct tax legislation. Hope more wisdom will be reflected while implementing Direct Tax Reforms.

What is happening with India's telcos?

Presently the telcos are neck deep in debt. The telecom industry’s debt to banks is estimated at  4 lakh crores. The telcos are demanding for a stimulus in this sector as in their view the present situation is a result of unfavorable government policies and due to a new entrant in this sector. The ministry of telecommunications has said that the solution for aiding this sector would have to be done at the policy level to keep sector alive.

Telcos argue that the sector is too critical to be allowed to fail. In 1998-99 the NDA government bailed out telecom operators. At that time the mad bidding for voice prices was the reason for the crisis in the sector. However, the bailout was followed by a boom. But the question arises what is government bailing out -  A wrong business decision or its wrong decision?

According to telcos the high astronomical prices during the rebidding of spectrum in 2014 was a result of faulty government policies. The revenue share model, present GST rates, and the high spectrum fees are some of the major problems cited by telcos.

However, it should also be noted that the telecom companies in India were not investing in the network. They were investing in infrastructure and thus increasing their capital expenditure leading to more debts. Globally the infrastructure expenditure is incurred by the real estate providers. As the companies were not investing in technology it got a big jolt when the new entrant came with unmatched data services.

The telcos are now considering mergers as a solution to alleviate their present woes. In India, there are many telecom operators. There is no country around the world having so many operators, so possibly the merger can be a good step. But it should also be noted that two bad telecom operator can’t give a good telecom operator. The merger between Reliance and Aircel didn’t work because banks did not agree to the merger. This is because the merged entity would result in a larger write-off which will wipe out Rs. 25000 crore from the banks’ balance sheet.

The solution lies in both government and telcos agreeing to take steps to sustain this sector. The telcos need to divest from the business which ain’t considered productive. The government can act as a facilitator by easing the procedures for mergers. Also, the telcos should start investing in new technologies and upgrading networks constantly.

Banking Regulation (Amendment) Bill

The Rajya Sabha has passed the Banking Regulation (Amendment ), Bill. The Bill seeks to replace the Banking Regulation (Amendment) Ordinance , 2017 and amend Banking Regulation Act, 1949. It amends the provisions related to stressed assets.

The Bill empowers the RBI to direct banks to initiate proceedings under the Insolvency and Bankruptcy Code, 2016. RBI’s internal advisory committee has identified 12 large stressed cases for proceedings.

While the humongous problem of NPAs call for a strong institutional framework, there have been questions related to the recent powers vested to RBI on two grounds –

1)      Whether the RBI required such special powers or such powers were already conferred to it under Banking Regulation Act 1949?

2)      Is it advisable to confer RBI with additional powers?

Section 35A of the 1949 Act allowed the RBI to issue binding directions to banks in ‘public interest’ or where the functioning of a bank is detrimental to its interests, among others. The question is whether a high level of NPAs qualifies as ‘public interest’ or ‘detrimental to the interests of the banking company' and therefore allows the RBI to use the powers under Section 35 A to direct banks to initiate recovery of proceedings under Insolvency and Bankruptcy Code.

The opponents of the Bill expressed concerns that focussing on such microeconomic issues might interfere with RBI’s role of framing policies on macroeconomic issues. RBI, as a regulatory institution, is expected to frame broad guidelines, ensure the stability of the banking system and prevent risks to the financial system. As the resolution of stressed assets is a commercial decision so it should be left to the banks. The RBI data shows that about 88 % of the NPAs are in the Public Sector. As the government is the majority shareholder in these banks so it had the authority of initiating proceedings.

The proponents argue that resolving of NPAs is an important task as it has serious repercussions on the economy. It is also argued that RBI’s mandate to initiate proceedings will allay fears of future investigations. The Economic Survey 2016 – 17 mentions that inherent threat of punishments is one of the major reasons due to which bankers delay the decisions of writing off the loans. The new powers will also boost the investor’s confidence.

Though the menace of NPA is because of many factors (giving infrastructure loans, court proceedings on 2G scam and coal allocations, land acquisition etc), it cannot be denied that misgovernance was the major factor. The present bill has enlarged the functions of RBI and it is hoped that more steps are taken in the direction of freeing public sector banks from political interference.

Source : PRS Legislative Research

Transparency in Judicial appointments

The Supreme Court has recently taken a historic decision to disclose the reasons in favour of recommendations by the collegium system with regard to judges. The recent transfer of Justice Jayant M Patel might have triggered this recent move.

 After the Second Judges Case (1993) the Supreme Court reserved the autonomy in the selection of judges as the judgement held that “consultation” of the President with the Chief Justice of India in matters of appointment meant “concurrence”. Though in the Third Judge case (1987) SC opined that consultation meant consultation of the plurality of judges, the appointments had always remained debatable due to the secrecy maintained by the collegium. It was also a bone of contention between the judiciary and legislature.

The collegium note uploaded online gives a brief summary of the professional performances of the candidates, including a rating on their judgements. Suhrith Parthasarthy , an advocate in Madras High Court , in his article “Collegium and Transparency”, which appeared in The Hindu dated 1 November 2017, observed how the present system still falls short of achieving the goal of transparency.

Though a certain degree of discreetness is required as in many cases the reasons might pertain to sitting judges, it is important to strike the right balance between disclosure and discreetness.

Nevertheless, this step albeit small is a step in the right direction and it is hoped that Supreme Court will introduce all other reforms gradually, disclosure under RTI being the foremost.

Return of Fiscal Activism

Japan’s fiscal stimulus, increasing of fiscal deficit targets in Eurozone economies, UK chancellor Hammond’s mulling reviewing his predecessor’s plan on budget, apparently indicate that fiscal activism is gaining currency in developed economies these days. The developed economies are mired with low or zero interest rates (negative interest rates in Japan) and monetary policy has reached its limit. These low interest rates had set up perfect ground for the fiscal policy to emerge as a powerful tool for these economies. In the liquidity trap scenario the fiscal multipliers are large and hence it is conducive to resort to fiscal activism (Strike when the iron is hot)

The genesis of fiscal activism can be traced back into Keynesian economics. The idea of welfare state was embraced during great depression of 1930s .

But Greece’s sorry tale of fiscal expansion following its adoption of the euro in 2001 is the epitome of fiscal activism gone wrong. The adverse consequences in fiscal activism have led to crises in Latin American countries, mainly in Venezuela.

A country’s fiscal space is judged not only by interest rates but also whether country’s public finances are on sustainable path . The basic equation of debt sustainability which includes factors such as country’s primary deficit , nominal GDP growth rate , nominal effective rate of interest and Debt/GDP ratio should be given prime importance. One of the criticisms against fiscal activism lies in  government’s inefficiency in understanding consumption patterns of the society. The ghost towns in China is a reminder of government’s failure to understand the demands of the people in the economy. Thus ill framed fiscal stimulus worsens the problem by increasing the number of non performing assets .

The fiscal activism should be used as a countercyclical policy i.e. an expansionary fiscal policy should be undertaken during economic slowdown and contractionary fiscal policy should be undertaken during boom. If the nature of polity acts as a straitjacket in resorting to contractionary fiscal policy then fiscal activism should be avoided because it will lead to huge fiscal deficits. The economic survey 2016-2017 highlights that the two episodes of Indian macroeconomic vulnerability in 1991 and 2013 were caused due to application of both procyclical and countercyclical policy. 

During 1980s the government increased fiscal deficits as a response to accelerating growth . The 1991 Balance of payment crisis again forced government to resort to expansionary fiscal policy. Similarly, during the 2000 growth boom government increased its spending program. But again in 2008, government had to increase its fiscal deficits due to Global Financial Crises. The combination of procyclical and countercyclical policy worsened the inflation in 2013.

The experiences of fiscal activism underscore that one-size fits all approach shouldn’t be followed. The authorities should take into account a plethora of factors and not just the interest rates while considering fiscal activism as a tool to solve economic problems.

- Tanushree Dutta