A Small Note on Fiscal Balance

What is fiscal Balance?  

           

The balance of a government's tax revenues (plus any proceeds from asset sales) minus government spending is called fiscal balance. This is also called as Government Budget Balance, Public budget balance, or Public fiscal balance (for convenient purpose let us keep as fiscal balance). When the balance is positive then the government has a fiscal surplus, if negative then fiscal deficit.

The fiscal balance is further classified into Primary balance and Structural Balance (also known as cyclically-adjusted balance).

What is Primary Balance?

The primary balance is government budget balance before interest payments. In simple terms fiscal balance minus interest payments gives us primary balance.

What is Structural Balance?

Structural balances are an extension of cyclically adjusted balances, correcting for a broader range of factors such as asset and commodity prices and output composition effects.

The need for calculation of structural balance: 

In order to assess the fiscal sustainability the adjustment of fiscal balances for the output cycle is really crucial and needed. There is no single method is considered as the appropriate adjustment method for adjusting fiscal balance. The appropriate adjustment method depends on country specific factors, data availability, fiscal regime and the economic structure of the country.

Source: IMF Fiscal Monitor, 2013.

Note: Interest rate as a percentage is difference between primary balance (which is not given in the above table) from overall balance. The Bolded numbers are Percent of GDP for Advanced Economies as a whole and EME’s as a whole             

If one read the table carefully, then one can see that emerging markets are doing better compared to developed economy (all data are for the year 2012).          

                              

Note:  In many European countries, they have set an independent body to carry out the study of fiscal balance and they are called Fiscal councils. In India it is not easy to calculate the structural balance due to multiple factors mentioned above.

ANOTHER CURRENCY UNION or CHAOS?

       We all know that Europe have a common currency called Euro. It is still trembling to find stability. The euro crisis has put most people off currency unions. But, it seems that, Africa is not shaken up or put off due to this crisis. An African Monetary Union is proposed (like European Union) creation of economic and monetary union for the countries of the African Union. This union will be administered by the African Central Bank. By forming such union the Africa will go for the creation of new unified currency (same like EURO)

        An International Agreement was signed on June 3, 1991 in Abuja, Nigeria (called as The Abuja Treaty) and created the African Economic Community. They called for African Central Bank to follow by 2028 and the current plan is to establish an African Economic Community with a single currency by 2023. (Source: Wikipedia)

        An article in “The Economist” (in 7^th December, 2013 print edition) said that “In November the leaders of five countries of the East African Community (EAC) agreed to form a monetary union within ten years. A month before West African politicians agreed on a plan to introduce a new shared currency, the Eco, over the next few years. It should eventually subsume West Africa’s existing currency bloc—but not its central African cousin.”

        “Under the proposal an initial group of six countries will adopt the eco by 2015 (see map). Five years later the members of the West African Economic and Monetary Union (known as UEMOA, its French acronym), which currently share a currency called the West African CFA franc, are to adopt the Eco too, creating a currency union of over 300 million people.”(for full article click here)

        The Economist concluded that “If a region as rich as the euro zone has struggled to cope with such pressures, the likelihood that the poorer and less well-governed places hoping to adopt the Eco could is tiny.”

My Perception

        When the entire global economy is debating whether EURO as a currency will survive or not? This new currency union is really an eyebrow raiser. Despite of having many developed economies EURO is facing so many crises then how can Eco or Afro (hypothetically it may be name of African common currency) survive. Some may think that there is a scope that Eco or Afro may survive, because, there are many developing economies (even though tiny) in Africa. But, to have a common currency means to have common policy measures and common (more) effective administration. Can Africa do it?

John Maynard Keynes – A misunderstood economist!!

     John Maynard Keynes (J.M. Keynes) an economist who had given solution during the great depression. Later he was criticized for his theories and proved to be wrong. There is age old debates which are still going for and against J.M. Keynes. Recently, in economist an article titled “A Keynes for all seasons” – by C.R. | CAMBRIDGE, says why Keynes was one of the misunderstood economist.(for full post click here)    

   The author quotes that “Economics is a science of thinking in terms of models joined to the art of choosing models which are relevant to the contemporary world. It is compelled to be this, because, unlike the typical natural science, the material to which it is applied is, in too many respects, not homogeneous through time…Good economists are scarce because the gift for using "vigilant observation" to choose good models, although it does not require a highly specialised intellectual technique, appears to be a very rare one.” (for full post click here)

     John Wasik, a contributer in Forbes has once said “One of the most misunderstood economists haunting the global economy is John Maynard Keynes, a truly friendly ghost who many have transformed into a poltergeist.” (for full post click here)

     Another writer Andrew Murphy had stated in Harry’s Place that “Hayek in the 1970s, in an interview with a Chilean newspaper, gave a backhanded endorsement to the Pinochet regime, saying, “My personal preference leans toward a liberal dictatorship rather than toward a democratic government devoid of liberalism.”  

          It is safe to say, Keynes is a very misunderstood man. It is time for the centre-right to embrace their inner Keynes. He is a man of the middle.” (for full post click here)

  Keynes “The General Theory of Employment, Interest, and Money” came at a specific time during the 1930s, it was not a blueprint for good times or forever. Whenever he was criticized for his latest ideas he retorted by saying: “When the facts change, I change my mind. What do you do, sir?”

    Any economic theory evolves based on the particular condition or situation of that period of time. So, it is not appropriate to criticize any economist or his works without considering their timeline, situation of the economy at that particular period of time, etc… (views are personal)

Second Quarter Review of Monetary Policy 2013-14 and Decoding Rajanomics

Reserve Bank of India (RBI) had announced its Second Quarter Review of Monetary Policy 2013-14 recently (i.e. on 29^th Oct 2013).  In its Policy RBI had said the following major stance

1. Reduction of marginal standing facility (MSF) rate by 25 basis points from 9.0 per cent to 8.75 per cent with immediate effect;
2. Increase  in policy repo rate under the liquidity adjustment facility (LAF) by 25 basis points from 7.5 per cent to 7.75 per cent with immediate effect; and
3. The liquidity provided through term repos of 7-day and 14-day tenor has been increased from 0.25 per cent of net demand and time liabilities (NDTL) of the banking system to 0.5 per cent with immediate effect.

In its policy RBI had said that it is more concerned on Inflation along with the growth rate – “Curbing mounting inflationary pressures and managing inflation expectations will help strengthen the environment for growth by fostering macroeconomic and financial stability. The Reserve Bank will closely monitor inflation risk while being mindful of the evolving growth dynamics.”  (for full policy click here)

Two days after policy announcement RBI Governor Mr. Raghuram Rajan has said that tough measures like raising rates are needed to tackle inflation in India (In an exclusive interview to NDTV’s Mr. Prannoy Roy). Dr Rajan's said to India Inc is: Bear with us. If we don't fix inflation now, the problem will get worse. (For Highlights and full Interview video click here)

My Perspective

I am little surprised on reading the Second Quarter Review of Monetary Policy 2013-14 (to read second quarter review click here). The second quarter review says that "Strengthening export growth and signs of revival in some services, along with the expected pick-up in agriculture, could support an increase in growth in the second half of 2013-14 relative to the first half, raising real GDP growth from 4.4 per cent in Q1 to a central estimate of 5.0 per cent for the year as a whole (Chart 1). The revival of large stalled projects and the pipeline cleared by the Cabinet Committee on Investment may buoy investment and overall activity towards the close of the year." Not for the reason that RBI had estimated GDP growth of 5.0 per cent for whole year but for the statement - revival of large stalled projects!!! These large projects are stalled for past 2 to 3 years; they got to be revived because election is on card now. 

I saw the full interview of RBI governor to NDTV (click here for Transcript), Where Dr. Rajan said that ".........Oh, these guys don't have manufacturing", that's really why they are in the dumps. No. No. That's not why we are in dumps. We are slowing down because we expanded too fast and we have these..." "Dr Prannoy Roy: Old Systems."  and "Dr Raghuram Rajan said Yes"

When Dr Prannoy Roy asked that: So what you are saying is with these old systems, if these remain in place, our growth rate is going to be capped at 4 to 5 percent. If we change the system we can go back to our 9-10% on a long-term basis.

Dr Raghuram Rajan: See 7-8 is what is feasible. These are all numbers, guess work.

This surprised me because our manufacturing sector is widely affected and it is a fact that we have weak manufacturing sector. Even the IIP data replicates only 0.6 percent growth over last year. If we are not worried about our manufacturing sector now, then when!!! In his Monetary Policy statement as well as in his interview, RBI Governor, talked about changing financial systems. This is another alarming thing (at least from my perspective) because this statement means two things either we have a weak financial system (this includes inefficient structure, where financial system fails to absorb shocks) or outdated financial system (which also means the flow of money in the economy is not that smooth)!!! 

Financial system is a engine for any economy; if that fails then economy will be in trouble. It is still too early to say where Indian Economy is heading to!!! We need to wait and watch!    

World Bank sees end of poverty in 2030 - End of Poverty?

           Poverty is one of the biggest issues for any economy. It is believed that nearly half of the world’s population (i.e. more than 3 billion people) lives on less than $2.50 a day. More than 1.3 billion live in extreme poverty (less than $1.25 a day). The share of population living in extreme poverty was believed to be in developing world. It is believed that between 1990 and 2010, this share has cut to half. This fulfills the first and foremost Millennium Development Goal (MDG1a) five years ahead of schedule. This shows or appears to bring the end of extreme poverty within reach. It is believed that, if this rate of global progress is sustained then, we can eliminate poverty by 2030. (from -The Final Countdown: Prospects for Ending Extreme Poverty by 2030 – The Brookings Institution Report – April 2013)

            The Report also stated that “If consumption growth consistently exceeds baseline projections, the global poverty rate could fall to 3.1 percent by 2030. If instead consumption growth in each country persistently falls short of projections, 9.7 percent of the developing world could remain under the poverty line at the end of the period.”

As a general theory and belief that Growth decreases the poverty was the main theme of the report. Economist recently published (Jun 1st,2013 – Print Edition) that “In 1990-2010 the driving force behind the reduction of worldwide poverty was growth. Over the past decade, developing countries have boosted their GDP about 6% a year—1.5 points more than in 1960-90. This happened despite the worst worldwide economic crisis since the 1930s. The three regions with the largest numbers of poor people all registered strong gains in GDP after the recession: at 8% a year in East Asia; 7% in South Asia; 5% in Africa. As a rough guide, every 1% increase in GDP per head reduces poverty by around 1.7%.”

In recently published UN report it is believed that India’s Poverty will be reduced to half. The Hindu Business line today (i.e. 05.07.2013) quoted that “However, while South Asia has done well in reducing poverty, it hasn't done so well in reducing hunger. While in 1990, 27 per cent of the population in the region was undernourished, by 2010-12, the figure came down to 18 per cent. At about the 13.5 per cent, the target of halving the number of people suffering from hunger is still some distance away.”

Perception:  

All these numbers and data are looking fine and attractive. In fact, its thrilling! whether the reality shows the same picture. The recent UN report said that its not done well in reducing hunger which is the base thing for reducing the poverty. When it will happen? A famous Tamil Poet Subramani Bharatiyaar said "தனி ஒரு மனிதனுக்கு உணவு இல்லையெனில் ஜகத்தினை அழித்திடுவோம்" (Translation: If a individual has not got food we will destroy the world). When we will eradicate poverty?   

Is Subsidies are Bad?

We all come across the term subsidies more often. I would like to pen down here about the basic things about subsidies.

1.  What is Subsidy? What are the main Objectives of Subsidies?

Answer: The most general definition – It is an assistance to an economic sector or any business for producers. Subsidies lead to changes in demand/ supply decisions by means of creating a wedge between consumer prices and producer costs.

Many of these subsides are set in place by the Government for producers or distributed as subventions in an industry in order to prevent decline of that particular industry or for an increase in prices of its products or simply to encourage it to hire more labour (as in the case of wage subsidy)

These are often aimed at:

1. Inducing higher consumption/ production
2. Offsetting market imperfections including internalisation of externalities;
3. Achievement of social policy objectives including redistribution of income, population control, etc.

2.  What are the Economics effects of Subsidies?

Answer:  Economic effects of subsidies can be broadly grouped into

1. Allocative effects: these relate to the sectoral allocation of resources. Subsidies help draw more resources towards the subsidised sector
2. Redistributive effects: these generally depend upon the elasticities of demands of the relevant groups for the subsidised good as well as the elasticity of supply of the same good and the mode of administering the subsidy.
3. Fiscal effects: subsidies have obvious fiscal effects since a large part of subsidies emanate from the budget. They directly increase fiscal deficits. Subsidies may also indirectly affect the budget adversely by drawing resources away from tax-yielding sectors towards sectors that may have a low tax-revenue potential.
4. Trade effects: a regulated price, which is substantially lower than the market clearing price, may reduce domestic supply and lead to an increase in imports. On the other hand, subsidies to domestic producers may enable them to offer internationally competitive prices, reducing imports or raising exports.

            Source: Wikipedia

Now comes one of the important question

3. Whether Subsidies are really bad? 

Answer: If you ask an economist then he would answer Yes Subsidies are bad. I would like to quote here from an article by Kenneth P. Green on energy policy. It explains why subsidy in any form is bad policy.

First, subsidies breed corruption. They don’t create incentives for honest people that already have a market-worthy product — such people can already sell their goods into the market easily.

Rather, subsidies create a fertile garden for rent seekers who are unable to sell their goods competitively in a free-market, and prefer to tap the coercive and redistributionist force of government to lever their uncompetitive good into the market at the public’s expense.

Rather than contribute to overall social welfare by giving consumers the best goods at the least cost, or even maximizing the efficient use of people’s taxes, rent-seekers undermine social welfare by foisting inferior or over-priced goods onto the market while taking money from people that could be used for other important purposes.

This is a particular problem in countries with relatively weak property rights regimes, and countries with legal institutions insufficient to prevent it.

He further states that,

Subsidies subvert the efficient functioning of the market, which is our only effective mechanism for matching supply with demand. Free trade of a given good is, as economics tells us, the only way to determine efficiently how much of that good is desirable at a given price.

                    Source: http://www.american.com/archive/2012/august/subsidy-powered-vehicles

In 2011, Delivering the P N Haksar Memorial lecture here, Subbarao, Governor of RBI, said, "In charting a roadmap for fiscal consolidation, we need to be mindful of the quality of fiscal adjustment-- which is to weed out unproductive expenditure and protect growth promoting expenditure," he said.

Sharing his thoughts on subsidies in his address on 'rejigging the Elephant Dance: Challenges to Sustaining the India Growth Story, Subbarao said, "There are bad subsidies and there are good subsidies".

"Bad subsidies like fuel subsidy, subsidy on LPG may be Rs 300 but every time you buy LPG you are getting subsidy to the extent of Rs 300. Not only you, Mr Birla, Mr Ambani, every time they buy a cylinder, they will also get subsidy," he said.

"Then there is fertiliser subsidy...soil degradation happens because of fertiliser subsidy and thereafter irrigation subsidy," he said.

Subbarao said there were good subsidies as well, like giving cycles to girls to come to school and constructing toilets for girls in schools located in villages. "These are good subsidies," he asserted.

Source: http://ww.inwdianexpress.com/news/subsidies-are-bad-d-subbarao/880519

So there are few subsidies which are good, but, most of the subsidies are bad may be due to ineffective management and political reasons.

Currency War – A Small Note

If any one who is following the Exchange Market news closely then those people would have come across this term “Currency War”.  Many news targets on China while US, Japan, UK themselves are also involved in the war silently.  I would like to put few links here which talks about the present currency wars:

1. Why China fears currency wars

2. Central Banks Pause, but 'Currency War' Not Over

3. Currency Wars 2013: China Takes Aggressive Stance On Currency Tension With Japan, As Yen Sinks To New Low Against The US Dollar

4. Currency Wars Have Begun: Central Banks in Denial or Worse

5. China warns over fresh currency tensions

Now back to the topic. Here I am going to start with the basics and then going to give some historical facts

What is currency War?

The Currency war is nothing but Competitive Devaluation.   The Competitive devaluation is a situation in International Affairs where countries compete with each other in order to achieve relatively low exchange rate for their currency.

Who Coined the Term Currency War?

The term “Currency Wars” was coined by Brazils Finance Minister Guido Mantega in 2010 in order to describe how Federal Reserve’s Quantitative easing was pushing up other countries currencies. He also pointed out the effort made by the United States and China to keep their currencies at the lowest value.

What is devaluation? What is the difference between devaluation and Depreciation?

When a government or its central bank deliberately make downward adjustments to its currency in foreign exchange market then it is known as devaluation. This largely happens in fixed exchange rate regime. Depreciation occurs when a currency loses its value due to market forces.

Why one should care or worry about devaluation (or Currency War)

The Currency War will lead to instability. Nations who succeed in devaluation often experience inflation, especially, when they are dependent on imports. While those nations which do not involve in currency war will experience higher unemployment since their export sectors will lose competitiveness (read above article no. 5 for more info). 

Some Historical facts

When one look at the history then the popular method of devaluation was reducing the intrinsic value of precious metals content in minted coinage; example the Roman Empire faced constant threats from barbarians, but they lacked finance to defend themselves, so successive emperors reduced the silver and copper contents in coins.

When Fiat Money came into existence (where the value is purely based on laws rather than intrinsic value of the content) government started simply print bank notes in large quantities. After the First World War Wiemar Germany went to print huge volumes of German Mark in order to cover its expenses which resulted to hyperinflation on a massive scale.

This is a small note on Currency Wars which may lead to serious economic crisis across the globe. 

KAUTILYA's Principles of Taxation and ADAM SMITH's Canon of Taxation

Kautilya alias Vishnu Gupta (who is famously known as Chanakya) was an Indian politician, strategist and writer. He is well known for his text "ARTHASHASTRA". He lived during 350 BC-275 BC. 

Adam Smith, Father of Economics, is well known for his famous book "The Wealth of Nations". He  lived during 1723 AD–1790 AD. 

What's common between the Both or Why I am mentioning about both of them here now? Kindly read both Kautilya's Principle of Taxation and Adam Smith's Cannons of Taxation that are as follows:

KAUTILYA'S Principles of Taxation:

1. Taxation should be Such that it may not be felt by the Poor.

2. In raising taxes higher, it should be done little by little when the realms prosperity is increasing. It should be Mild.

3. Taxes should be levied on Proper Places at proper time in a proper form.

4. It should be reasonable and equitable.

ADAM SMITHS Cannons of Taxation:

1.Cannon of Equality :- Ability to pay principle.

2.Cannon of Certainity:- The amount of tax should be Paid.

3.Cannon of Convenience:- Less burdensome to tax payer.

4.Cannon of Economy:- tax should be collected to minimum Possible Level.

This is just a small comparison between Kautilya's Principles of taxation and Adam Smiths cannon of taxation.  I am leaving this post open  to you.