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)

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.

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.

Some Freaknomics? - For a Change!!

As per our Constitution, Article 47 states that "Government shall endeavour to bring about the prohibition of the consumption (of alcohol) except for medicinal purposes of intoxicating drinks." In reality this completely fails.

Many of us know that, Alcohol consumption is steadily increasing in developing countries like India and decreasing in developed countries from 1980’s.  It was estimated that that are 62.5 Million alcohol users in India. A study shows that per capita consumption of alcohol increased by 105.7% between 1970 and 1996 (over the 15-year period) (Source: Alcohol related harm in India – a fact sheet by INDIAN ALCOHOL POLICY ALLIANCE)

India is generally regarded as a traditional ‘dry’ or ‘abstaining’ culture (Bennet et al, 1993). Yet, it has one of the largest alcohol beverage industries in the world. The UB Group, for example is the third largest spirits producer in the world after Diageo and Pernod Ricard (ICAP, 2006c). India is the dominant producer of alcohol in the South-East Asia region (65 percent) and contributes to about 7% of the total alcohol beverage imports into the region. More than two thirds of the total beverage alcohol consumption within the region is in India.

There has been a steady increase in the production of alcohol in the country, with the production doubling from 887.2 million litres in 1992-93 to 1,654 million litres in 1999-2000 and was expected to almost treble to 2300 million litres (estimated) by 2006-07 (The Planning Commission  of India, 2003).

Though consumption is still low, patterns of alcohol consumption vary widely through the country. Punjab, Andhra Pradesh, Goa and the north-eastern states have a much higher proportion of male alcohol consumers than the rest of the country. Women tend to drink more in the states of Arunachal Pradesh, Assam and Sikkim in north-east; Madhya Pradesh, Chhattisgarh, Orissa and Andhra Pradesh in central and east India; and Goa in the west, compared to other states. 
(Source:F-Current Patterns and Trends – ALCOHOL ATLAS OF INDIA –WHO)

This is the trend shown in the recent study on Alcohol in India. Now, when it comes to revenue part there is large part of revenue come from Liquor. In 2006-07 the combined earnings of States from alcohol were estimated about Rs. 30,000 crore which was over 11.5% of tax revenues. In fact, liquour was the second largest contributor to the State’s aggregate revenue kitty after sales tax  which was Rs 1,20,709.15 crore.

The revenue generation from alcohol is a national phenomenon. Karnataka is leader with the excise collection of Rs. 4060 Crore while Uttar Pradesh is in second followed by Andhra Pradesh in third with Rs. 3650 Crore and Rs. 3250 Crore respectively. 

(Source: Can govt ignore alcohol's revenue earnings? - IBN)

My Reflection:

India is the one of the largest producer of Alcohol. This news may not be surprising to many of us; but, the thing is our constitution says one thing and the reality is totally different. The worried part is consumption of alcohol by youngsters has increased from 2 percent in 1990 to 14 percent in 2006 (below the age of 21) and among adults (between age group of 21-30) it is increased from 29 percent to 35 percent in the same timeline. One side the per capita consumption of alcohol is increasing on the other side Government revenue from alcohol is also increasing; whether the revenue from this is utilised for some development purpose or again it goes only to produce more alcohol that's a big question mark ?

Note: TASMAC (Liquour Company owned by Government of Tamil Nadu) revene for 2011-12 was Rs. 18, 081.16 Crore with increase of 20.82% and This year Kerala saw Rs. 70 Crore worth sale of alcohol during two onam days. The entire week revenue was approximately Rs .720 Crore. As per the recent study  Punjab tops the sale of alcohol followed by kerala.

CRR DEBATE – Whether CRR will survive?

During the past few weeks, in the newspapers and televisions, many would have read, saw, and heard that whether CRR is required or it should be abolished? In fact, the close follower of this news would have noticed that the debate was initiated by SBI chairman, Mr. Pratip Chaudhuri and in response to his comment (on abolishing the CRR) RBI Deputy Governor Mr. K. C. Chakrabarty said that CRR is the only and important tool with RBI and it cannot be abolished.

Before going further let us see what exactly CRR is and its purpose?  Cash Reserve Ratio (CRR) is ratio of reserves at which commercial banks must hold or deposit with the central Bank. In other words it is a central bank regulation that sets the minimum reserves that each commercial bank must hold physically in bank vaults or as deposits made with the central bank. This reserve can be maintained either in cash, gold or unencumbered government securities.

The reserve requirement, on one hand, helps the bankers to have enough cash to meet any crisis and on the other hand, they serve as tools for Central Bank to control the liquidity in the system in order to manage the Inflation. When CRR is altered then the interest rates will be changing as per availability of funds with the commercial banks.

Now coming back to the debate that SBI Chairman said Abolish Cash Reserve Ratio, he said that "CRR does not help anybody. It is locked up in the vault and not ploughed back into the economy. It is unfairly applied on banks. If CRR is a liquidity mop-up tool, why not apply it to insurance companies, NBFCs and debt mutual funds, who as well mobilize deposits from the public?" he asked.

After three days of SBI chairman commented the RBI Deputy governor K C Chakrabarty commented that “the banks must work within the frame work of the regulatory norms”. He also said that “If SBI is not protected, the risk may catch other banks leading to a systemic failure and SBI is too big to fail.” He further went on to say that “If the SBI Chairman is not able to do business as per our regulatory environment, he has to find some other place”

This row has become a big debate now. Recently, Reserve Bank of India Governor D. Subbarao made a prank up his sleeve at a banking summit in Mumbai. In serious tone he announced that central bank has set up a ‘committee’ to review the need to retain the much-debated cash reserve ratio (CRR)” But when the Governor revealed the names of the committee members and its conditions, people realised he was only joking.  He said that “The members of the committee, Subbarao said, would be Pratip Chaudhuri, Chairman, State Bank of India, and K.C. Chakrabarty, Deputy Governor, RBI. Both, with opposite views on CRR (the percentage of deposits that banks need to keep with RBI), have sparred over the issue.” He also went on to say further that “the two conditions for such a committee would be: First, the two members would be locked up in a room till they come to an amicable solution. And, second, the findings of the committee should not be made public until his own term as Governor comes to an end.”

So let us see the main reason why SBI chairman said CRR is not required. The main reason for it is that CRR has come down from its peak level of 15% in 1994 to 4.75% at present. Few years ago RBI had ceased to pay interest rate on CRR, which affects the commercial banks. This is one of the main reasons why SBI chairman wanted CRR to be abolished. SBI chairman had got some support for his view from Former RBI governor and present chairman of the Prime Minister's Economic Advisory Council (EAC) C Rangarajan; he said on that there is a need to bring down the cash reserve ratio as the instrument is no longer used in credit control and liquidity management. In his own words "We need to move towards a situation in which the level of CRR comes down and it is used as an instrument of credit control only in extraordinary circumstances," he also stated that "As OMO (open market operations) becomes increasingly a major instrument of credit control, the role of CRR as an instrument of credit control will come down,".
 
Here are 2 more articles on this debate 1.     CRR harsh on public sector banks
2.  CRR has outlived utility

My perspective with a Thank Note:

When one reads the debate then one may come to a quick conclusion that SBI governor is right and CRR should be abolished. If CRR is abolished then what are the other tools through which RBI can control credit and inflation? (Even though this is not the only tool to the do this, but one of the major tool for RBI). No doubt as EAC chairmen said that OMO becomes increasingly a major instrument of credit control, but at the same time we cannot ignore or doubt the credibility of CRR. The Problem with commercial banks is few years back RBI had stopped paying interest rates on the cash reserves; this affects the business of the commercial banks, because without any incentive when the cash is kept then it is no use for anybody. RBI need to find a amicable solution to stop this debate, either by paying some interest rates or through some other incentives. 

I wanted to end this big post with a THANK note to all the Visitors who had viewed, read, visited and commented on this blog. Today, with the help and support from all of you, this blog had crossed 4000 visitors (which you can see in the left side of the screen). I Thank  all of you again for giving your support and encouraging me to keep posting in this Blog. THANKS ALL
  

 

Next Big Bash Economic Tsunami: Banking Union in Euro!! - Will Euro Survive Again?

     The Next Big Bash of Economic Tsunami is clouding over in the European Area. Yes, if you are following the European Crisis then by this time you would have guessed what I was talking about, the BANKING UNION in Euro. In last week Economist Print Edition (June 30^th – July 6^th, 2012) there was an article titled “Bankers of the Euro Area, Unite!” (Please click on the quote to read full article). It talks about the prospects of Banking Union and the reason behind forming this Bank Union. It gives insight on what are the problematic issues over the banking union. 

       Mr. Herman Van Rompuy, the President of European Council, published proposals of banking union with centralised banking supervision and to avoid banking collapse or run. Mr. Van Rompuy thinks that the banking union ought to cover the whole European Union (EU) to avoid fragmenting  Europe's single Market in Financial Services. There is another article titled "Without Banking Union the Euro is History" by Protesilaos Stavrou. The article talks about the need for recapitalisation of Banks and Banking Union. It went on to conclude that “A banking union, or at least steps towards that direction are of cardinal importance in order to escape from this policy-made morass, otherwise the euro will soon belong to history, with tragic results on the entire global economy.”

       Many Economist and Analyst say that banking union is the only option left for the Euro to survive. After reading these articles few questions raised in my mind

1. Is recapitalisation of banks is tougher than Banking Union ?

2. Will all the European countries accept for Banking Union? - Remember, the banking liabilities in Britain, Switzerland and Denmark are 4 to 5 times larger than their Nation Economies. Since, they have their own Central Banks they can print money if they needed and this cannot happen after Banking Union.

3. If Banking Union had occurred what will happen to those countries that are in verge of bank panic and those countries banks which are earning more profit? - Remember, a bank run is the sudden withdrawal of deposits of just one bank. A banking panic or bank panic is a crisis situation which occurs when many banks suffer runs at the same time, as a cascading failure. This will result in Economic Crisis. 

          

        The Banking Union may be helpful for the Euro to survive at present and it may make them to move further to certain period of time. But, the real question is Whether this Banking Union alone will solve the problem of Euro? If you ask me the same question I would say NO. Banking Union alone will not solve the problem but it may give further scope for Fiscal integration.What's your Call? Kindly let me know.

BRICS Rising!!! - Hit Over IMF and World Bank Policies

The BRICS summit successfully ended (as claimed by all the Members) yesterday (i.e. 29.3.2012). Many Indian newspaper today (i.e.30.03.2012) had different headlines on the BRICS summit, like, “Brics seeks bigger say at IMF, World Bank”, “BRICS stresses cooperation spirit at Delhi Summit” etc…. In New York Times it had the following headline on BRICS summit “BRICS Leaders Fail to Create Rival to World Bank” and the article stated that “The leaders of the five countries, Brazil, Russia, India, China and South Africa — the so-called BRICS nations — emphasized their mutual good will and their growing economic power, but fell short of achieving the tangible goal most discussed before the gathering: the establishment of a new development agency to rival the World Bank.”

In the Article titled “BRICS NATIONS THREATEN IMF FUNDING” in Financial Times, it stated that “Leaders of the world’s most powerful emerging economies have threatened to withhold additional financing requested by the International Monetary Fund to fight the European sovereign debt crisis unless they gain greater voting power at the Fund.” The article further stated that the “Meeting in India on Thursday, the heads of state from Brazil, Russia, India, China and South Africa expressed frustration at the slow pace of reform at the Washington-based multilateral lender, historically dominated by Europe and the US.”

It also stated that “In a joint statement, the so-called BRICS nations said there was an urgent need to “better reflect economic weights” and “enhance the voice and representation of emerging market and developing countries” at the IMF.” “We stress that the ongoing effort to increase the lending capacity of the IMF will only be successful if there is confidence that the entire membership of the institution is truly committed to implement the 2010 reform faithfully.”

It is believed that the IMF’s shareholders had agreed to shift more voting weight towards emerging market nations during 2010, but US has not passed enabling legislation. The BRICS leaders criticized the western countries for their poor handling of the global economy post financial crisis.

The Reuters (famous and leading international news agency) had given the key points of the BRICS summit (click here).

My Perception:

First of all the great news is BRICS summit ended successfully with tight security and many road blockades. Now, the good news is BRICS nations are asking bigger say at IMF and World Bank. It's really appreciable move that BRICS nations had said to IMF that we will withhold the additional finance which was requested to fight the European sovereign debt crisis unless we gain greater voting power. Many people may think this some biased statement and what BRICS had said is something inappropriate at this juncture. But, if one sees the fact and the truth that, Europe and USA had dominated the IMF and World Bank from the time it is established and the outcome from these 2 big institutions is very meagre. In fact, when one looks back what IMF and World Bank had done is nothing but more of a patch work for the economies in trouble not development. If you see the history of financial crisis, one of the major financial crisis (Asian Crisis) was due to the intervention of IMF. The BRICS nations were also rightly criticized the western countries for their poor handling of the global economy post financial crisis.

All these are good things in the BRICS summit. Now, here is the major eyebrow raiser incident that questions the China's role among BRICS. It is believed that when the discussion came up for the United Nations Security Council the BRICS nations agendas were remained divided. While India, Brazil and South Africa are aspiring for the permanent seats on the UN Security Council, as earlier Russia has endorsed it, the same position was repeated on Thursday by President Dmitri A. Medvedev. The China (as usual) has remained noncommittal on the issue, especially regarding India, and Mr. Hu was noticeably silent on that point during his remarks. The silence of China means lots of things, only time will say how much unity BRICS has among themselves!!