Daily Answer Writing

Model Answer

Internationalization of the Rupee: Benefits and Risks

The internationalization of the rupee refers to increasing its use in cross-border transactions, thereby enhancing its global stature. Currently, the rupee is fully convertible in the current account, but only partially in the capital account. It represents only 1.7% of the global foreign exchange turnover, compared to the dollar’s 88.3%, indicating significant room for growth.

Benefits of Internationalization of the Rupee

1. Mitigates Currency Risk: By using the rupee in international trade, Indian businesses can reduce their exposure to foreign currency fluctuations. This lowers operational costs and promotes business expansion globally.
2. Less Vulnerable to External Shocks: Decreasing dependence on foreign currencies protects India from external shocks. For example, during the 2013 “Taper Tantrum,” India faced adverse impacts due to the strengthening of the US dollar, which led to capital outflows and currency volatility.
3. Reduces Foreign Exchange Reserves Requirement: A more prominent role for the rupee in global trade could reduce India’s reliance on foreign exchange reserves, which are costly to maintain, and alleviate income transfers to advanced economies.
4. Improved Bargaining Power: As the rupee becomes more widely used internationally, India’s global influence and economic power would increase, improving the country’s standing in global trade negotiations.

Risks Associated with Internationalization

1. Impact on Monetary Policy: Greater international use of the rupee could limit the Reserve Bank of India’s ability to control domestic money supply and interest rates. India’s monetary policy would need to adapt to this challenge.
2. Dependence on Foreign Capital: If a large portion of India’s trade is conducted in rupees, non-residents may hold substantial rupee balances in India. This could increase vulnerability to global economic fluctuations.
3. Reduced Reserve Accretion: With less reliance on foreign currencies, India may experience a reduction in its foreign exchange reserves, which help manage exchange rate volatility.
4. Hot Money Outflows: Complete internationalization of the rupee could lead to an increase in speculative investments (hot money), making India more vulnerable to sudden capital outflows during global financial crises.

In conclusion, while internationalizing the rupee presents a potential boost to India’s global influence, it also introduces significant risks, particularly concerning monetary policy and financial stability. As India seeks to become an economic superpower, these challenges must be carefully managed to avoid compromising long-term growth.

Model Answer

Introduction

Central Bank Digital Currency (CBDC) is a digital form of central bank-issued currency, distinct from physical cash. It serves as both a medium of exchange and a store of value, and it is denominated in an existing unit of account. CBDC can be issued through three models: direct, indirect, and hybrid.

Policy Implications of CBDC in India

1. Monetary Policy Transmission
   CBDC does not fundamentally change the mechanics of monetary policy but could enhance its effectiveness by enabling more timely transmission. The impact will depend on whether the CBDC is interest-bearing or non-interest-bearing, remunerative or non-remunerative, and whether it is anonymous or identity-oriented. These factors will influence its role in monetary policy.
2. Liquidity Management
   A rise in CBDC demand could lead to a shift from bank deposits to digital currency, potentially reducing available bank liquidity. This shift may change the behavior of the public in terms of money holdings—whether in physical or digital form—and may affect the overall banking system.
3. Financial Stability
   In the event of a financial crisis, CBDC could trigger a rapid shift of funds from banks, causing a “bank run.” This could destabilize financial institutions and force banks to depend on more expensive and unstable funding sources. Therefore, managing CBDC’s impact on bank deposits and ensuring financial stability will be crucial.
4. Legal Implications
   The existing legal frameworks, such as the Banking Regulation Act, need updates to accommodate CBDCs. Depending on the type of CBDC issued (account-based or token-based), different legal considerations will come into play.

Current Developments

The Reserve Bank of India (RBI) is actively working on implementing CBDCs in phases, conducting pilot programs to evaluate their implications and minimize disruption.

Model Answer

Introduction

The MSME (Micro, Small, and Medium Enterprises) sector is vital for India’s inclusive growth, contributing around 45% to manufacturing output, 40% to exports, and forming one-third of India’s GDP (RBI). It provides employment to approximately 11.1 crore people and plays a key role in reducing unemployment and boosting the rural economy. Despite its importance, the MSME sector faces several challenges.

Challenges

1. Infrastructure Bottlenecks:
   MSME clusters often lack adequate infrastructure and support systems, limiting their ability to scale operations and hinder business growth. This shortage of infrastructure impacts both daily operations and long-term development prospects.
2. Access to Credit and Formalization Issues:
   MSMEs primarily operate informally, making it difficult to assess their creditworthiness and provide financial support. Moreover, the small scale of their operations limits their ability to raise risk capital, making growth even more challenging.
3. Delayed Payments:
   Many MSMEs function as ancillary units for larger industries and face chronic delayed payments, which affect their cash flow and working capital. Although the MSME Development Act, 2006 penalizes delayed payments, the sector’s weak bargaining power and fear of losing business prevent the provision from being invoked effectively.
4. Competition and Technological Lag:
   The MSME sector often relies on traditional methods and outdated technologies, resulting in low levels of innovation and competitiveness. This makes it difficult for MSMEs to compete with larger, more advanced businesses, hindering their ability to thrive.

Government Initiatives

To support MSMEs, the government has launched several schemes, including the Scheme of Fund for Regeneration of Traditional Industries (SFURTI), Credit Guarantee Fund Scheme for Micro and Small Enterprises, and the Credit Linked Capital Subsidy Scheme (CLCSS). However, further reforms, like those recommended by the U. K. Sinha Committee, are needed to strengthen the MSME Development Act and ensure long-term growth.

Conclusion

Addressing these challenges is crucial for unlocking the full potential of MSMEs, driving inclusive growth, and ensuring economic prosperity for all sections of society.

Model Answer

Introduction to PLI Scheme

The Production Linked Incentive (PLI) Scheme, launched by the Union Government in 2020, aims to boost India’s manufacturing sector and promote an Atmanirbhar Bharat. Initially introduced in three key sectors — mobile manufacturing and electronic components, pharmaceuticals, and medical device manufacturing — it has since expanded to 11 sectors, with a budget outlay of Rs 1970 billion. The scheme is expected to generate over US$ 500 billion in production in the next five years, while fostering national manufacturing champions and creating job opportunities for India’s youth.

Significance of the PLI Scheme

1. Boosting Large-Scale Manufacturing: The scheme incentivizes production capacity and incremental turnover, which will help establish large-scale manufacturing facilities and improve industrial infrastructure, benefiting the overall supply chain ecosystem.
2. Import Substitution and Export Promotion: A key goal of the PLI scheme is to reduce India’s dependency on imports, particularly of finished goods. It aims to encourage domestic production and foster exports, thereby reducing the trade imbalance.
3. Technology Transfer and Skill Development: The scheme aims to attract foreign investment, bringing advanced technology and expertise into the country. This will help in the development of skilled manpower, enhancing India’s workforce.
4. Focus on Emerging Sectors: The PLI scheme targets sunrise sectors such as drones, advanced chemistry cell batteries, electronics, IT, and pharma, helping India stay future-ready.

Challenges in Achieving PLI Objectives

1. Dependency on Imported Parts: There is concern that the PLI scheme might turn India into an assembly unit for imported parts. For example, in the production of air conditioners, critical components like compressors, valves, and coils are still being imported.
2. Lack of Research and Development (R&D): While the scheme offers incentives based on incremental sales, India’s private industry still faces challenges in R&D. Most patents and value additions are held abroad, limiting India’s technological advancements.
3. WTO Compliance Issues: The Merchandise Exports from India Scheme (MEIS) was challenged in the WTO for violating the Subsidies and Countervailing Measures (SCM) Agreement. Similarly, products manufactured under PLI could face challenges if they disrupt global market prices.
4. Short-Term Focus: The PLI incentives are primarily short-term, and critics argue that these may not address India’s long-term competitiveness issues in global markets.

Conclusion

Despite its significance, the PLI scheme faces several challenges that could hinder its long-term success. For the scheme to truly empower India’s manufacturing sector, a focus on R&D, domestic part manufacturing, and a sustainable approach to global trade will be crucial.

Introduction

Despite various government initiatives aimed at boosting investment in India, domestic private sector investment remains subdued due to several structural and fiscal challenges faced by states and the broader economy. Here are some key reasons:

1. High State Debt Burden

According to a recent RBI report, states like Punjab, Rajasthan, Kerala, and others have high debt burdens, with the cumulative debt rising from 19.1% of GDP in 2018-19 to 25.1% in 2021-22. This fiscal strain limits the capacity of state governments to invest in infrastructure and development, which in turn hampers private sector confidence (RBI report, 2022).

2. Declining Revenues

State revenues have been on the decline, falling from 69% in 1955-56 to below 38% in 2019-20. The slow growth in tax revenue and the loss of autonomy under the GST regime have made it harder for states to fund projects that could stimulate private sector investment. The COVID-19 pandemic further exacerbated this situation, reducing states’ tax revenues significantly (RBI report, 2022).

3. High Expenditure Commitments:

States face high expenditure commitments due to populist measures like farm loan waivers, subsidies, and pensions. This leaves less room for discretionary spending on development initiatives that could attract private investment. Additionally, interest payments on state debt are growing, further reducing fiscal flexibility (RBI report, 2022).

4. Implementation Issues with Centrally Sponsored Schemes:

The allocation of state resources for centrally sponsored schemes adds another financial strain on states. This not only diverts resources from other essential investments but also reduces the scope for supporting private sector-led growth (RBI report, 2022).

5. Contingent Liabilities and DISCOM Losses:

The growing trend of off-budget borrowings through state PSUs and SPVs, along with the high losses of DISCOMs (power distribution companies), contributes to the rising liabilities of states. These liabilities further constrain fiscal space and discourage private sector investment.

6. Legal and Fiscal Loopholes:

States resort to off-budget borrowings to finance populist measures, which remain hidden to circumvent FRBM (Fiscal Responsibility and Budget Management) targets. This lack of transparency in fiscal management weakens investor confidence.

Conclusion

For private sector investment to rise, states must improve fiscal discipline, cap excessive spending, rationalize centrally sponsored schemes, and focus on raising resources to improve the tax-to-GDP ratio. Addressing these challenges is essential for creating a conducive environment for sustained investment in India.