Mobilization of Resources and the Role of Monetary policy

INTRODUCTION #

Mobilizing is the process of assembling and organizing things for ready use or for a achieving a collective goal. The term mobilization of resources should be seen in the same context. Mobilization of resources means the freeing up of locked resources.

Every country has economic resources within its territory known as domestic resources. But often they might not be available for collective use. The percentage of resources used when compared to the potential is often very low. For a country to grow, identification and mobilization of its resources is necessary. It should be available for easy use and for central and state level planning.

IDENTIFICATION OF RESOURCES #

Types of Resources of India #

• Natural Resources – Coal, Petroleum, Nat- ural Gas, Water, Spectrum etc.
• Human Resources – The labour force and intellectual capacity of a nation.

The proper utilization of these resources leads to generation of economic resources – savings, investment capital, tax etc. While mobilization of resources is considered, the mobilization of eco- nomic resources (financial resources) should also be studied.

Mobilisation of Resources #

Mobilization of Natural Resources #

India, though a country with sufficient reserves, due to policy bottlenecks, is importing coal and iron. This is increasing our Current Account Deficit.

Mobilization of Human Resources #

Organizing human potential for ready use is nec- essary for growth of India. In-fact, as country of 125 crore people, India now is eyeing more on its human resource potential. The demographic dividend is also in favour of India.

Adding in points, the glimpse of the topic for easy understanding

• Mobilization of human resources highlights the need to empower human resources.
• Weaker sections like women, children, SC, ST, OBCetc should be brought into main- stream.
• There should be right employment opportuni- ties for human resources, and when there is lack of skill the job demands, there should be skill development programs.
• Utilize the demographic dividend.
• India is currently levering on its technologists – engineers, doctors and scientists.

Mobilization of Financial Resources #

If a country needs to grow, more goods and services should be produced. The production can be done by government sector, private sector or in PPP mode. But for that, the economic resources of a country should be mobilized.

In India, despite having good savings rate, domestic investment is less. Indians are investing in less productive assets like gold and consumer durable. If India needs to grow, there should be more investments in agriculture, manufacturing or services.

• In India, tax collected is very less. The tax base has to be widened.
• Four factors of production – land, labour, capital and organization – should come to together. There should be an atmosphere for growth and investment.
• Organizations do not “spontaneously emerge” but require the mobilization of resources.
• In modern capitalistic society, these resources are more “free flowing” and are easier to mobilize than in more traditional societies. Many factors impact the development of the organization.
• Initial Resource Mix: There are various resource needs in a starting organization (technology, labor, capital, organizational structure, societal support, legitimacy, etc.). But the right mix of resources are not always available.
• The most important resource of an organiza- tion is it’s people.
• More savings and more productive investment.

How does public sector mobilize domestic resources? #

1. Taxation.
2. Public revenue generation for investment in social services and infrastructure.

How does private sector mobilize domestic resources? #

The private sector mobilizes the savings of households and firms through financial intermedi-

aries, which allocate these resources to investment in productive activities.

Issues with mobilization of resources #

Issues with mobilization of resources include all those issues and problems highlighted in – mobi- lization of natural resources, human resources and financial resources.

Why is Domestic Resource Mobilization (DRM) particularly important? #

In low-income countries confronting widespread poverty, mobilizing domestic resources is particularly challenging, which has led developing countries to rely on foreign aid, foreign direct investment, export earnings and other external resources. Nevertheless, there are compelling reasons to give much more emphasis to DRM.

• Greater reliance on DRM is vital to elevating economic growth, accelerating poverty reduc- tion and underpinning sustained development.
• High-growth economies typically save 20-30 per cent or more of their income in order to finance public and private investment.
• DRM is potentially more congruent with domestic ownership than external resources.
• Foreign aid invariably carries restrictions and conditionality.
• FDI is primarily oriented to the commercial objectives of the investor, not the principal development priorities of the host country.

DRM is more predictable and less volatile than aid, export earnings, or FDI.

FINANCIAL RESOURCE MOBILIZA- TION #

The saving and investment process in an econ- omy is organized around a financial framework that facilitates economic growth. A well designed financial system promotes growth through effec- tive mobilization of savings and their allocation to the most productive uses by either following a centralized approach or a decentralized approach or a combination of both. Typically, economies with underdeveloped capital markets adopt a centralized approach, whereby financial intermediaries mobilize

resources from savers and allocate them to borrow- ers.

Traditionally, banks has played a critical role in the financial intermediation process as they are able to deal more appropriately with transaction costs and information asymmetries in a financial system. As financial markets develop, transaction costs and information asymmetries reduce, the decentralized approach for guiding the saving-investment process also gains significance, and households with sur- plus resources increasingly invest in capital market instruments. The historical experience shows that virtually in all the economies, including the market- intermediated ones, banks have played a central role in resource mobilization and supporting the growth process, and that the development of banks and other intermediaries has itself facilitated the development of financial markets.

The genesis of banks’ role in the resource mobilization process lies in firms relying critically on external sources of finance, especially in their formative stages. In particular, banks has played a key role in coordinating investment efforts in many economies such as Belgium, Germany, Italy and Japan in engineering ‘take-offs’ during their critical phases of development. Resource mobilization by banks became a critical factor in their ability to act as ‘catalysts’ of economic development.

During the ‘take-off stages’ of these economies, large and powerful banks initially relied on capital contributions from a small number of founders and thereafter as their industrial lending portfolio grew, they took recourse to deposits as a major source of funds. With the development of markets, borrowings also became an important source of funds for the banks.

Historically, financial intermediation by banks has played a central role in India in supporting the growth process by mobilizing savings, particularly after the nationalization of the 14 major private banks in the late 1960s. Banks has been particularly instrumental in mobilizing deposits from the house- hold sector, the major surplus sector of the economy, which, in turn, has helped raise the financial savings of the household sector and hence the overall saving rate. Notwithstanding the liberalization of the finan- cial sector and increased competition from various

other saving instruments, banks continue to play a dominant role in the financial intermediation of the Indian economy.

The deregulation of interest rates has opened up new avenues for banks to mobilize funds at com- petitive rates. Moreover, banks, by virtue of being the ultimate platform for clearing and settlement for all financial transactions, provides accounts and resources to other sectors as also other financial intermediaries.

The Indian economy has witnessed robust growth performance in recent years and banks has played a major role in providing the required amount of resources. In order to sustain the growth process, banks would have to continue to provide funding on a large scale. In India, there exists an enormous potential of savings in rural and semi-urban areas. Also, in India quite a large part of domestic savings is locked up in unproductive physical assets.

The mobilization of savings from hitherto untapped areas and conversion of physical savings into financial savings would necessitate introduction of appropriate products to suit the demand of sav- ers. Banks are indeed in an ideal position to do so because of certain inherent characteristics of deposits such as safety and liquidity.

Apart from mobilization of deposits, banks, for meeting their resource needs, also depends on non-deposit resources both at home and abroad. A part of non-deposit resources comes from bor- rowings, which help augment the funding needs of the banks instantly. However, they also pose a challenge in terms of their availability and manage- ment of borrowing costs, amidst potential interest rate and exchange rate risks. Thus, an effective use of borrowings requires a system of appropriate risk management by banks.

Emerging Issues and the Way Forward #

As the Indian experience shows, the acceleration of economic growth has been largely enabled by the sustained increase in the level of domestic sav- ings, expressed as proportion of GDP. Historically, household savings has been the mainstay of the gross domestic savings of the Indian economy. In recent years, however, there has been sharp increase in the private corporate savings and public sector

savings rates, reflecting strong growth in corporate profitability and fiscal prudence due to the imple- mentation of the Fiscal Responsibility and Budget Management (FRBM) Act, 2003.

It may, however, be noted that the improvement in corporate sector savings on account of higher profitability was largely an outcome of the reforms pursued over the years, whereby forces of global competition and conducive policy environment led to an improvement in productivity and efficiency. In the years ahead, acceleration in the saving rate of the private corporate sector may not continue at the same scale in view of the fact that the early benefits of reforms reaped by the corporate sector, especially by deleveraging of balance sheets, may not be available at the same scale in future.

Similarly, with the Central Government budget- ing a revenue deficit of 1 per cent of GDP instead of 0 per cent of GDP as stipulated under the FRBM Act for 2008-09 and further risks to fiscal consoli- dation from various factors, including the expected pressures from the implementation of the Sixth Pay Commission award, there would be limits to further increases in public sector saving rates in the short run. Therefore, improving the household sector saving rate should constitute the main plank for sustaining the overall domestic savings in the Indian economy.

In this regard, it may be noted that the share of financial savings (net of financial liabilities) in total household savings has declined by almost 10 per- centage points to around 47 per cent in the current decade, reflecting higher savings in physical assets. Accordingly, a major challenge would be to raise financial saving rate which would depend on further deepening of the financial sector through introduc- tion of new instruments with features catering to the household sector’s requirement consistent with their risk-return and maturity profiles as well as through the continuation of insurance and pension reforms.

Furthermore, another challenge would be to release resources of the household sector held in physical assets over and above the genuine requirement for savings in various financial assets. Although households continue to hold their finan- cial savings mainly in the form of bank deposits, there was a significant decline in its share in total

financial savings from an average of around 45 per cent during 1970-1984 to around 37 per cent during 1995-2005, before increasing to 51 per cent in the last two years.

The recovery partly reflects the aggressive efforts at mobilization of time deposits by banks from 2005-06 onwards to meet high credit demand and was partly facilitated by the Government measure of extending tax incentives on special bank deposit schemes. The interest rate differential between small savings/post office deposits and bank deposits, which narrowed down initially, turned subsequently in favour of bank deposits in view of unchanged interest rates on small savings/post office deposits, which also made the bank deposits more attractive.

Accordingly, the sharp jump in time deposit growth reflected to an extent some switch away from small savings, signifying only a portfolio shift and it is a moot question as to whether the current trend would be sustained. Therefore, to sustain the recent trend in deposits, banks needs to tap hith- erto untapped savings, especially in rural areas, by introducing appropriate deposit schemes suitable to savers with various risk and return profiles.

The current phase of high growth has been supported by a step up in the household gross financial saving rate, which, in turn, has been led by aggressive mobilization of deposits by the banks. It is observed that the increase in the growth rates of real GDP from 5.8 per cent during 1992-93 to 2002-03 to 8.8 per cent during 2003-04 to 2006- 07 was supported by the household gross financial saving rate increasing from 12.1 per cent of GDP to 15.6 per cent. Over the same period, the ratio of bank deposits to household gross financial savings increased from 36.7 per cent to 44.0 per cent.

A sensitivity analysis based on these trends shows that raising real GDP growth by one per- centage point would require 1.2 percentage point increase in the household gross financial saving rate (gross financial savings/nominal GDP) in the current phase of economic growth. This, in turn, would require the ratio of bank deposits to gross financial savings to grow by 2.5 percentage point. In the light of the growing resource requirements for sustaining the high growth momentum of the Indian economy, banks would have to reassess their tradi-

tional strategies of resource mobilization, including from the rural sector.

Implications of Changing Pattern of Bank Deposits #

Following the financial liberalization since the early 1990s, some shifts have taken place in the ownership pattern of bank deposits. The household sector’s share in aggregate deposits has steadily declined, while the shares of the Government and corporate sectors have increased. The decline in household sector’s share reflects mainly the sharp fall in their shares in term deposits. The increased interests from the corporate and Government sectors reflects the favourable impact of successive short- ening of the stipulated minimum maturity of time deposits as well as the policy of allowing banks to offer differential interest rates on wholesale term deposits. Another notable feature in respect of time deposits has been the decline in the share of deposits of over five years maturity across all the sectors, reflecting availability of alternative saving instru- ments with attractive returns. This phenomenon is not confined to India alone and was observed in several other countries, as was alluded to earlier.

As the financial sector develops, the share of non-deposit saving instruments tend to increase at the expense of bank deposits. This trend is expected to accentuate in the coming years. The challenge, therefore, for the banks is to mobilize hitherto untapped savings and to improve their services to not only retain their existing depositors but also attract new depositors.

They would also have to widen their deposit base through exploring new opportunities thrown up by the recent emphasis on inclusive growth and financial inclusion. As the growth process strength- ens and becomes more inclusive, it is expected that demand for financial products would accelerate rap- idly, necessitating a greater penetration of banking services.

Changing Demographics and Financial Services #

Banks also have to recognize the changing saving patterns associated with the changing demo- graphic profiles. The proportion of population in the working age group of 15-64 years is expected

to increase steadily from 62.9 per cent in 2006 to

68.4 per cent in 2026. Accordingly, the dependency ratio (ratio of dependent to working age population), which declined from 0.80 in 1991 to 0.73 in 2001, is expected to decline further to 0.59 by 2011 (GoI, 2008).

The changing demographics appear to have played a role in the shift in composition of household savings towards physical assets, especially reflecting housing demand. Accordingly, banks would also need to devise innovative strategies of mobilizing surplus resources from a progressively younger age profile of savers. Another noticeable feature emerg- ing in India is that public sector employment, which grew by an average of 1.53 per cent per annum during 1983- 1994, declined by 0.70 per cent during

1994-2005.

On the other hand, growth in private sector employment in the organized sector accelerated from 0.44 per cent to 0.58 per cent over the same period. With the private sector leading the growth in organized employment, there would be an increased demand for varied financial products such as insurance and other contractual saving instruments consistent with the changing risk-return profiles of the working age population.

The changing demographics and employment patterns would generate demand for a wide range of financial services such as insurance, housing and other financial products with innovative features. In order to reap the benefits of the changing demo- graphics and employment patterns, banks would have to re-orient their role as financial intermediar- ies beyond the traditional confines of passive deposit mobilization and lending by providing a package of financial services as demanded by the customers. Ipso facto, the customers would be keeping their deposits with the banks.

Rural Deposit Mobilization – Need for Innovations #

Against the backdrop of a decline in the share of rural deposits in total deposits of SCBs since the 1990s, there is a need to step up efforts to access rural savings to raise the overall deposit mobilization of banks. Although there are many challenges, the rural sector throws up vast opportunities for banks

to reap the benefits of low cost large deposit base, which may not be available to other financial inter- mediaries. The international experience provides some useful lessons in this regard.

The rural sector harnesses the power of providing small amounts of household savings which can be mobilized by the banks that can be made available for productive uses to rural and agricultural enter- prises. A major challenge faced by banks in rural areas is that deposit transactions often involve small amounts and display irregular patterns reflecting seasonality and erratic nature of small scale income generating activities.

In order to cater to this demand, many banks in the Philippines have adopted ‘piggy banking’ concept, whereby small locked boxes were provided to the savers to be maintained at their homes after opening of the savings account with a minimum deposit. The keys were kept with the banks. This allowed the clients to save small amounts on a daily basis in their boxes and bring them to the banks when they intended to deposit their savings. This enabled reduction in banks’ time on collections (USAID, 2005).

Another major challenge lies in identifying appropriate technologies to reduce significantly the costs of doing rural business that results from low population density and poor physical infrastructure. While technological and management information system (MIS) solutions are necessary to overcome this challenge, their impact on the efficiency, quality of services, bottom lines and outreach potential of the banks need to be carefully assessed.

For instance, local technology firms in the Phil- ippines helped develop open source software to meet the specific needs with multiple branches and units and the central bank’s data processing and reporting requirements. This software allowed customization of the technology by the rural banks and its flexible adjustment in tandem with additions or changes in products. It proved to be high quality and cost effective system that improved the banks’ ability to quickly and efficiently handle multiple transactions and more clients.

Thus, although there are challenges in tapping rural savings, the international experience shows

that these challenges could be met effectively by adopting some innovative methods. The experience of other countries with suitable adaptations can be a guide to the banks attempting to expand their outreach in the rural sector and boost rural savings.

Competition from Other Intermediaries/ Markets #

With greater avenues for the deployment of funds and the prospects for higher returns enabled by the development of markets, investors progressively diversify their portfolios across instruments and institutions, thereby demanding financial services for management of cross-sectional risks. This leads to a change in the nature of the demand for intermedia- tion services, whereby investors look beyond stable returns offered by bank deposits while parking their surplus funds. This, in turn, leads to the emergence of a number of specialized intermediaries/markets that are able to cater to the evolving investor require- ments.

Against the backdrop of the ongoing financial innovations following the adoption of financial liberalization in India in the early 1990s, equity market related instruments such as equity shares and units of mutual funds have been gaining importance in view of their higher returns, albeit with higher embedded risks. To an extent, this trend has resulted from the natural process of financial market devel- opment, whereby new instruments gain popularity with a decline in transactions cost and asymmetric information. By enabling investors in better assess- ment of risk- return perceptions, this has widened the choices of investments.

With traditional deposit base of banks shrinking with these developments, there is a need for them to extend their outreach to prospective depositors/ investors by expanding the ambit of the specialized financial services offered by them by repackaging and redesigning of products to suit individual needs. Banks, however, face various constraints compared to non-banks while diversifying their activities.

First, non-banks are able to manage their resources more effectively by having a leaner cost structure and quickly adopting new technologies, thereby offering higher returns. Furthermore, non-bank intermediaries such as brokerages, asset

management firms and mutual funds are able to offer specialized services like cash management and wealth management for various investors, including high net worth individuals.

Second, unlike non-banks, banks are often subjected to various regulatory requirements such as statutory stipulations of reserve requirements, directed lending, prudential regulations driven pro- visioning requirements and limits on capital market exposures. While these measures promote financial stability, they constrain the diversification opportu- nities thrown by a developing financial system.

Third, special deposit schemes announced by the Government from time to time which offer not only higher returns but also provide tax incentives, boost effective returns vis-à-vis the traditional bank deposits, thereby constraining banks’ effort at deposit mobilization.

While various restrictions on banks and pruden- tial requirements may be justifiable from the special role banks play in the system, the policy anomaly arising out of tax benefits needs to be removed to provide banks a level playing field.

Need for Continued Focus on Deposits #

Banks have the benefit of low cost deposit base which, to an extent, make them immune from the day-to-day market volatilities. Thus, the core deposit base serves as a source of ‘stored liquidity’ which is durable as compared with ‘borrowed liquidity’ originating from the market. Another distinguishing feature is that while deposits rates are relatively more rigid, interest rates on borrowing vary more flexibly in tune with the market conditions.

During periods of favourable macroeconomic conditions characterized by abundant liquidity and low nominal rates, the low perception of financial risks often induces financial market participants to undertake progressively higher risks. On the other hand, during periods of turbulence caused by any unforeseen event, the resultant reassessment and repricing of risks by investors trigger heightened uncertainties in the market and thereby expose the excessively leveraged entities to the risk of default.

Therefore, while accessing the market for bor- rowed liquidity have the benefits, the probability of excessive leveraging associated with borrowings

calls for adequate safeguards to protect the fund base from unforeseen events. This was borne out by the Northern Rock crisis, a UK-based bank, which had a higher share of borrowed liquidity vis-à-vis stored liquidity. Faced with problems in mobilizing funds from the market due to the tightening of credit con- ditions, the performance of the bank was adversely affected prompting depositors to withdraw their money in large numbers, which ultimately resulted in a bank run.

Banks in India have traditionally relied on deposits for their funding requirements. Their reliance on borrowings has been insignificant. As the economy expands and the demand for funds increases, banks at times may find their deposit resources to be insufficient for meeting the growing demand, thereby encouraging them to raise funds by way of borrowings.

Going by the Northern Rock experience, heavy borrowing by banks has serious implications, espe- cially during financial distress, and, therefore, too much reliance on borrowings needs to be avoided. In case banks resort to such borrowings, they also need to adopt appropriate internal risk management strat- egies. In particular, while the increased flexibility given to banks in India in recent years opens up new opportunities for raising resources, the enhancement of associated risks would demand appropriate man- agement of their liabilities through minimizing costs along with mitigation of risks arising from adverse movement in interest rates and exchange rates. They need to regularly review their business strategies so that they are in a position to combine longer term viable financing with profitability in operations.

Need for Skill Development in Banks #

Banks while gearing to face competition from non-banks and capital market instruments both at home and abroad, which is likely to increase in future, would have to appropriately price and pack- age their products to remain competitive, which would demand appropriate skill development at bank levels.

While banks have the potential, they need to invest significantly in skill enhancement at all levels, for developing innovative products and delivering new service modes in the face of increased com- petition. Public sector banks face added challenges

while attracting and retaining new personnel in the face of rigid compensation structures in comparison with private and foreign sector banks.

Implications for Monetary Policy #

Moving forward, resource mobilization that dovetails into the transition to the higher growth trajectory is likely to lead to more product innova- tions on the part of both banks and non-banks. With the blurring of distinctions between banks and non- banks from the functional perspective and increased substitutability of bank deposits with other saving instruments, the assessment of monetary aggregates for drawing policy perspectives would have to be carefully undertaken.

Furthermore, addition of new features into the financial instruments would have implications for the conventional mode of accounting based on iden- tifiable characteristics of money. With the growth process strengthening and becoming more inclusive, the demand for housing, urban services, retail and utilities is expected to be scaled up as disposable incomes grow.

In such a scenario, it is likely that growth in bank credit and monetary aggregates might deviate, and persistently so, from what might be expected from historical relationships and elasticities in view of the ongoing structural changes. This raises the critical issues of clarity in reading signs of inflation, asset prices and systemic liquidity from money/ credit expansion.

Basel III norms #

Basel-III is a comprehensive set of reform measures to strengthen the regulation, supervision and risk management of the banking sector. These measures aim to:

1. Improve the banking sector’s ability to ab- sorb shocks arising from financial and eco- nomic stress, whatever the source
2. Improve risk management and governance
3. Strengthen banks’ transparency and disclosures

Main requirements under Basel-III #

1. Banks to maintain a minimum 5.5% in common equity (as against 3.6% now) by March 31, 2015.

• Banks must create a capital conservation buf- fer (consisting of common equity) of 2.5% by March 31, 2018.
  • Banks should maintain a minimum overall capital adequacy ratio of 11.5% (against the current 9%) by March 31, 2018.

Difficulties with implementing Basel-III norms #

1. There are worries among certain bankers that the implementation of Basel-III proposals will have an adverse impact on the return on equity and financial ratios.
2. There are concerns that public sector banks may not be able to grow their loans since gov- ernment-dependent lenders would not have adequate capital.
3. Critics of Basel-III norms feel that just because banks would have more capital, it does not mean that a bank will not get into trouble. The crises may at best be post- poned.

Basel III rules were too focused on problems that occurred in Europe and the US. They argued the standards unfairly penalize trade finance and project finance, two forms of credit that are particu- larly important in developing nations. This school of thought believes that the Indian banking system has proved robust due to constant monitoring by the RBI. As per past instance, Indian Banks had carried a huge negative net-worth for three years without any problem. As per this argument, Public Sector banks do not need more capital.

Since Basel-III is an international norm, there- fore, Indian banks, including PSB’ (Public Sector Banks) with international presence, would find it an obstacle if they are non-compliant. One of the solution proposed by policymakers is to go slow on imposing new capital adequacy norms for PSB’s as all of them do not have a foreign presence. However, the difficulty in increasing the capital of PSB’s is not because of their inability to attract investors. If investors are given confidence, banks would be able to raise sufficient capital. But the government would have to dilute its holding in the PSB’s. It seems difficult because the government may be unwilling to let go its majority stake in these banks.

If fresh equity is to be raised without diluting the government’s share, huge budget allocations are required. As per estimates, about Rs.60000-75000 crore demands for capital from banks could be there in the next six years. Again, it may not be easy for the government, considering its fiscal deficit.

The government may have to work on two options. One is to ask PSB’s to keep their loan portfolios at current levels or even shrink them. But it would be a retrograde step and will affect the funds available to industry adversely. The other is to accept a dilution of its stake, may be up to 26%.

Resolving The NPA Problem #

Scheme for Sustainable Structuring of Stressed Assets (S4A) #

It is restructuring large ticket loans where the project is up and running.

Here the lenders are required to separate a sus- tainable loan from an unsustainable loan. The bank would convert the unsustainable debt into equity or equity related instruments. As a result, on one hand, the debt burden of the borrower is substantially reduced and on the other hand promoter’s equity stake is also reduced.

The idea behind the scheme is that banks would get the upside if the company regains its old glory and it also gives promoters a second chance to revive the company.

Highlights #

• Banks can split the overall loans of struggling companies into sustainable and unsustainable based on the cash flows of the projects.
• The unsustainable debt could be converted into equity or a convertible security. However at least 50% of the debt should be serviced in the same period as that of the existing loan.
• Once the unsustainable debt is converted to equity, banks can sell this stake to a new owner who will have the advantage of getting to run the business with a more manageable debt.
• An advisory body called Overseeing Com- mittee (OC) will be constituted, which will review the resolution plans submitted by the Banks. It will check the reasonableness

and adherence to the guidelines and give an opinion.

• Projects with a loan of at least Rs 500 crores and have commenced commercial operations are eligible to be restructured under S4A.
• An external consultant should endorse it as a viable project through a techno-economic viability (TEV) study and the forensic audit should give a clean chit to the promoter
• Bankers cannot tinker with the terms of the sustainable loan.

Asset Reconstruction Company #

To tackle rising NPAs, the Union Finance Min- istry and NITI Aayog has recommended to set up an Asset Reconstruction Company (ARC) with equity funding from the government and the RBI. PSBs condition is particularly bad as compared to private banks because they have to lend under various government objectives and under the compulsion of social banking.100% FDI under automatic approval for ARCs.

Other Steps Taken By RBI #

• 5:25 Scheme: It allows banks to extend long-term loans of 20-25 years to match the cash flow of projects, while refinancing them every 5 or 7 years.
• Compromise settlement schemes.
• Strategic Debt Restructuring (SDR) – consor- tium of lenders converts a part of their loan in an ailing company into equity, with the consortium owning at least 51 per cent stake.
• Corporate Debt Restructuring (CDR) mecha- nism and Joint Lenders’ Forum.

Indemnity for Bankers to Tackle NPA’S #

It refers to the security or exemption granted to a person from legal responsibility arising from his/ her action.

Proposal by the Government #

• Finance ministry is considering the possibility of providing indemnity to bankers dealing with one time settlement of non-performing assets.

• This is expected to provide a safety net to bankers to take up loan settlements and gen- uine commercial decisions.
• An external panel consisting of finance minis- ter, RBI officials, external experts and Judges would screen the loan settlement proposals.

Conclusion #

Some assets are best classified as loss assets and should be written off in the books, even as efforts are made to recover whatever value can be recovered through liquidation.

New bankruptcy code is a potential game changer, but may take time to operationalize.

Banks ought to take a large enough haircut on existing debt to make the restructured project attrac- tive for ideas of SDR, S4A, ARCs, NIIF to work.

The proposed National Infrastructure and Invest- ment Fund (NIIF), operating with private partners, will provide both equity and new credit to stressed infra projects going through the SDR mechanism.

Reforms #

Indradhanush #

It is a seven pronged plan launched by Govern- ment to revamp functioning of public sector banks.

Bank Board Bureau #

The bureau was announced last August as part of the seven-point Indradhanush plan.

The bureau will have three ex-officio members and three expert members, in addition to the Chairman.

Function and impacts #

• To recommend appointments to leadership positions and boards in public sector banks.
• To advise on ways for raising funds and mergers and acquisitions to the lenders.
• It will play a critical role in reforming the troubled public sector banks by improving governance.
• With professionalization of appointment in leadership position, the BBB is first step towards Bank Investment Company as rec- ommended by P J Nayak committee.

Challenges #

The framework talks about the government putting in Rs 70,000 crore into these banks over the next four years but the PJ Nayak committee report released in May 2014 estimated that between January 2014 and March 2018 public sector banks would need Rs. 5.87 lakh crores of tiers-I capital. So, the government is not investing as much as the public sector banks really need to get out of the current situation that they are in.

Nayak Committee had proposed a BBB compris- ing entirely of senior bankers. Under Indradhanush, the government will be represented on the BBB. Further, no reference to disinvestment has been made.

Experts also believe that the real reform is for the government to vest the ownership of all the banks in a single holding company, whose board comprises professionals of integrity. It can select PSB boards and oversee their working.

PSB Consolidation And Merger #

Background #

Since 1991, with Narasimham committee report, creation of large size banks is demanded. Second edition of Gyan Sangam (the annual banker’s con- clave) also discussed the need for consolidation of banks.

High NPAs, which are eroding the profitability of many public sector banks and the government is under pressure to capitalize them through consoli- dation.

Advantages    and   disadvantages    (SBI example) #

State Bank of India (SBI) has started the process of merging five of its subsidiaries and Bharatiya Mahila Bank (BMB) with itself.

Advantages #

• Increased domestic and global presence, increased networking of SBI all over India.
• Assets will swell – massive increase in cred- iting capacity: SBI can become one of the anchor banks to finance large infrastructure projects like dedicated freight corridor, solar energy, Sagarmala etc.

• It will reduce duplication as SBI and its associates target the same clients with similar products.
• It will consolidate resources and infrastruc- ture, reducing the cost on operations, human resource and technological solutions like reducing managerial positions, overlapping bank branches, reduce inter-banking transac- tion cost etc.

Issues #

• Presently these banks have huge NPAs thus merger should be planned after sufficient capital is injected.
• Banking competition may be affected, as SBI is likely to be five times larger than its nearest competitor.
• It would affect regional flavour which could lead to losing regional focus.
• Large banks lead to consolidation of risks as well e.g. Global financial crisis of 2007.
• India needs more Banking competition than consolidation- to improve banking efficiency.
• Concerns of the employees- effect on promo- tion prospects due to curtailment of seniority, relocation due to rationalisation of branches.
• Poor government record on mergers e.g. Air India and Indian Airlines.

Suggestions #

• The govt. should not rush through the pro- cess – all stakeholders must be involved in the process.
• In the event of further divestment, the govt. share shall not fall below 51% in any case.
• Acquiring bank shall not dominate the smaller ones- good practices of both should be combined; conscious and organized efforts to synthesize the differences must be made.

Conclusion #

Bank consolidation is a tricky issue. While it is said that the long-term benefits of consolidation outweigh the short-term concerns, it must not be made a general policy. It is only to be done with right banks for right purpose with proper safeguards.

Summing Up #

Historically, banks in India have played a cen- tral role in mobilizing and allocating resources for supporting the growth process. The nationalization of private sector banks in 1969 marked a turning point in the history of the banking sector in India. Large branch expansion that followed enlarged the deposit base of banks in rural and semi-urban areas. Although another wave of nationalization in 1980 carried forward this process, the aggressive strategies of fund mobilization by mutual funds and NBFCs in the backdrop of buoyant capital market in the second half of the 1980s set in process of some disinter- mediation of household savings. Some deceleration in bank deposit growth was again observed during 1995-2005 in tune with the maturing of saving pref- erences under a deregulated market environment.

However, bank deposits growth accelerated sig- nificantly during 2005-2008 due to vigorous deposit mobilization efforts by banks in the wake of strong credit off take. This was despite the sharp growth in other instruments such as shares and units of mutual funds.

Bank deposits have all along been the mainstay of the savings process in the Indian economy. Although banks have played an increasingly impor- tant role in stepping up the financial savings rate, physical savings, nevertheless, have tended to grow in tandem with the financial savings. A major challenge, thus, is to convert unproductive physical savings into financial savings. This is also neces- sary for banks as they face several challenges in realizing the full potential of deposit mobilization in a growing economy. Bank deposits have become relatively less attractive to the households in view of the availability of a wide menu of alternative saving instruments offering scope of higher returns to savers.

Furthermore, savers have also become more informed in managing risks of their portfolios through the use of specialized services offered by other financial intermediaries. This behavior is expected to accentuate in future. In view of the shrinking share of the household sector deposits in total deposits, banks need to explore ways of broad- ening the depositor base as also provide improved services for retaining their clientele. It is, therefore,

necessary for banks to seek for new sources of deposits.

There is an enormous potential in rural and semi-urban areas and banks need to tap these sources. This, however, would require banks to offer customized products with features suitable to indi- vidual risk-return requirements as well as economize on their operational costs through diversification of activities. In this context, the recent policy emphasis on financial inclusion offers greater scope for banks to widen their deposit base.

Furthermore, the changing demographics and employment patterns have also thrown opportuni- ties for banks to expand their role by bringing the depositors with younger age profile within their fold. The substitution of funds from banks to non-bank instruments and vice-versa has been observed in the recent past and such trends may also occur in future. This would call for greater care in the assessment and interpretation of monetary aggregates.

RECENT DEVELOPMENT #

Monetary Policy #

To reform how monetary policy is decided, the Reserve Bank of India Act was amended. This is going to reset the responsibility of deciding India’s monetary policy from the hands of Governor of RBI alone.

Various Committees – Tarapore, Reddy, FSLRC and more recently Urjit Patel Committee have either directly or indirectly recommended that

• Monetary policy should be decided by a Committee rather than a single person.
• Decision should be based on majority voting.
• Minutes of such meetings should be put in public domain.

Background #

Until recently, RBI used to take its monetary policy decisions based on the multiple indicator approach. Its rate decisions were expected to take into account inflation, growth, employment, banking stability and the need for a stable exchange rate. Thus, RBI would be subject to hectic lobbying ahead of each policy review and trenchant criticism after it.

The Government/industries would clamour for lower rates while consumers bemoaned high infla- tion. Bank chiefs would want rate cuts, but pension- ers would want high rates. RBI ended up juggling all these objectives and focusing on different indicators at different points in time.

To resolve this, RBI set up an Expert Commit- tee under Urijit Patel to revise the monetary policy framework, and it came up with its report in January 2014.

It suggested that RBI abandon the ‘multiple indicators’ approach and make inflation targeting the primary objective of its monetary policy.

It also mooted having an MPC so that these decisions could be made through majority vote. Having both Government and RBI members on the MPC was suggested for accountability.

The Government would have to keep its deficit under check and RBI would owe an explanation for runaway inflation.

Thus, it was long felt need to shift to a Com- mittee System for deciding monetary policy that is expected to bring “value and transparency” to rate-setting decisions.

Monetary Policy Committee Composition agreed by Finance Ministry and RBI #

The Government will nominate three members and the RBI- three members (RBI Governor, Deputy Governor-Monetary Policy & One Executive Director).

A search committee will recommend three external members, experts in the field of economics, banking or finance, for the Government appointees.

The RBI Governor, Chairman of the committee, will have a casting vote.

Inflation target for the RBI in each financial year will be determined by the Government in consulta- tion with the RBI itself.

For inflation targeting and for Setting Policy Rates CPI is going to be Sole Parameter.

For this the Central Statistics Office (CSO) has updated the base year and weights for the various goods and services in the consumer price index (CPI). Difference vis a vis TAC (Technical Advisory Committee).

While RBI has a history of working with the technical advisory committee (TAC), the terms of engagement with the new monetary policy commit- tee (MPC) will be different.

Unlike TAC, where the voting was anonymous, the MPC framework requires the central bank to share the minutes of the MPC meeting.

One complaint among TAC members was their limited access to information. The amended RBI Act says MPC members can now request at any time, “additional information, including any data, models or analysis”.

The role of the central bank governor and her/ his deputies will also change under the new regime. In the past, the governor just had to listen and act independently.

Before CPI, Wholesale Price Index (WPI) was main index for measurement of inflation in India till April 2014. It gives more weightage to Manufac- turing articles and is useful for industry. It doesn’t measure retail articles.

Advantages of CPI as sole Parameter #

CPI better reflects demand side of the economy and market dynamism. It is more close to what the general population is effected by, and therefore a better parameter.

The revisions in the CPI are way forward. For ex: weightage for food is down from 47.5% to 45.8%, and fuel from 6.5% to 9.8%. The weightage for housing and clothing have increased. These changes reflects the changing consumption pattern.

CPI includes services sector. It is better than WPI for setting policy rates because, CPI indirectly takes into account the services sector as reflected in the spending of health, education, transport and communication etc.

The central bank has to maintain the real interest rate and therefore has to target CPI because retail consumers, their ability to consume and buy goods (especially poor), their investment and savings deci- sions etc., are impacted by it.

But there are certain Disadvantages of this updation:

• Distorting: The high weightage for a rela-

tively small consumption basket of food and fuel items if used to determine the overall cost of funds can be distorting.

• Volatile sectors like fuel in CPI basket, supply chain bottle-necks and disruptions are beyond control of rates set by the RBI
• Changing demand patterns not appropriately reflected in CPI: there is rising demand for the so-called superior foods, because of growing incomes and transfer payments.

Inflation Targeting: Using Policy Rates Anchored To CPI #

Pros #

• Credibility: Primary goal is ‘price stability’. Stability induces confidence in future and helps in decision making.
• Reduced costs of Inflation: Higher inflation leads to uncertainty, leading to lower invest- ment, loss of international competitiveness and reduced value of savings.
• Avoids Boom and Bust cycles: As high inflationary growth may end up in recession like conditions and provides stable and sus- tainable economic growth.

Cons #

• Pursuit of one objective may lead to compro- mise on others.
• Restricted ability of the central bank to respond to financial crises or unforeseen events.
• Potentially poor outcomes in employment.
• Potential instability in the event of large sup- ply-side shocks (for ex: during droughts etc.,)

Conclusion #

Since the objective of monetary policy is ‘to achieve price stability while striking a balance with the objective of the Central Government to achieve growth, the present revision is a good step in the right direction.

Apart from ensuring price stability, monetary policy also tries to contribute to economic growth and stability, to lower unemployment, and to main- tain predictable exchange rates with other currencies.

Marginal Cost of Funds Based Lending Rate (MCLR) #

Reserve Bank of India has directed banks to adopt Marginal Cost of Funds based Lending Rate (MCLR) for determining their respective Base Rates.

What is MCLR? #

The marginal cost of funds based lending rate (MCLR) refers to the minimum interest rate of a bank below which it cannot lend, except in some cases allowed by the RBI. Thus, it is an internal benchmark or reference rate for the bank.

Objective of MCLR #

• To improve the transmission of policy rates into the lending rates of banks.
• To bring transparency in the methodology followed by banks for determining interest rates on advances.
• To ensure availability of bank credit at inter- est rates which are fair to borrowers as well as banks.
• To enable banks to become more competitive and enhance their long run value and contri- bution to economic growth.

Base Rate vs MCLR #

Base rate calculation is based on cost of funds, minimum rate of return, i.e margin or profit, oper- ating expenses and cost of maintaining cash reserve ratio while the MCLR is based on marginal cost of funds, tenor premium, operating expenses and cost of maintaining cash reserve ratio.

Calculation of marginal cost under MCLR: Marginal cost is charged on the basis of following factors- interest rate for various types of deposits, borrowings and return on net worth.

Therefore MCLR is largely determined by mar- ginal cost of funds and especially by deposit rates and repo rates.

Reasons for introducing MCLR #

RBI decided to shift from base rate to MCLR because the rates based on marginal cost of funds are more sensitive to changes in the policy rates.

This is very essential for the effective imple- mentation of monetary policy.

Prior to MCLR system, different banks were following different methodology for calculation of base rate /minimum rate – that is either on the basis of average cost of funds or marginal cost of funds or blended cost of funds.

Goods and Services Tax (GST) #

Indirect Tax System before G.S.T. #

Centre: Excise Duty, Customs Duty, Service Tax and Central Sales Tax. State: VAT (sales tax), Entertainment tax, Luxury Tax, Octroi etc.

Before G.S.T. the central govt. imposed its own indirect taxes like Service Tax, Excise Duty etc. and the State govts imposed their own indirect taxes like VAT, Entertainment Tax etc. So, when a producer produces a product then he had to pay Excise Duty to Centre as well as VAT to state which used to create cascading effect and makes the product more costly in the market (example above). Further, different states had different VAT rates (1%, 4%, 12.5%, 20%) and gave exemptions on different category of products. Due to the above issues, tax came out different in different states on the various goods and services and ultimately results in different prices of goods and services in different states. This fragments the whole of India into a heterogeneous market affecting business and investment.

Goods and Services Tax (GST): The introduc- tion of GST across the nation is the most important indirect tax reform since independence. It has taken almost 16 years from the date of inception of the idea, formation of a task force, to passage in Par- liament. It represents a Herculean, nationwide, mul- ti-party consensus-building exercise and is the best example of the so called “cooperative federalism”. It is an outcome of a grand bargain struck together by 29 States and seven UTs with the Central gov- ernment. The States agreed to give up their right to impose sales tax on goods (VAT), and the Centre gave up its right to impose excise and services tax. In exchange they will each get a share of the unified GST collected nationally. The anticipated additional gains in efficiency, competitiveness, ease of doing business and overall tax collections are what drove this bargain.

GST plans to merge all the indirect taxes of Centre (except customs duty) and States into just

one tax, GST. So now, when a product or service will be sold to the consumer across India, only one indirect tax will be imposed i.e. GST.

GST will have two components: #

• Central GST (CGST) – share of GST going to the centre.
• State GST (SGST) – share of GST going to the states.

So if the GST rate is decided as 18% then, 8% may go to centre (CGST = 8%) and 10% may go to states (SGST = 10%).

The following are the salient features/benefits of GST:

1. GST is a radical transformation from a com- plex, multi layered and cascading tax system to a single and unified tax system that allows for tax set-off across the value chain, both for goods and services. This would help lower product costs and thereby make Indian goods competitive in comparison to imports, in- creasing profitability of companies.
2. GST will create an un-fragmented unified na- tional market for goods and services, and will result in friendly tax structure over a common base of goods and services. There will be common rules and administration procedure across the nation. It will widen the tax base and simplify tax procedures bringing in clari- ty and transparency.
3. GST will reduce the compliance scrutiny for inter-state movement of goods, which is currently a major source of concern and re- sults in losses owing to transportation time. Statistics suggest, truckers in India currently on an average lose about six hours daily in tax compliance related matters at various en- try points, adding to inefficiencies in logistics and transportation.
4. Presently in case of inter-state sale govt. lev- ies CST. To avoid paying CST businessmen maintain stock depots (warehouse in another state) and they first transfer the stock in these depots and then they show sales from the depot. This does not attract CST. Currently every company spends time & resources in

finding loopholes in the tax system to avoid payment of taxes due to its inherent compli- cated and ambiguous tax structure. With the advent of GST, the industry will focus on business rather than tax planning.

• The structure of claiming input tax credit is linked to having proof of taxes paid at an ear- lier stage in the value chain, this creates in- terlocking incentives for compliance between the vendor and the customer. (Now vendors will not ask a question “Would u like that with receipt or without receipt?). Because of this inherent incentive, the total taxes paid, and hence collected, may go up significantly, giving buoyancy to the GST. In fact, a signif- icant part of the black economy will enter the tax-paid economy.
• Presently, all decisions with respect to sup- ply and distribution are guided by the need to minimize the impact of indirect taxes. With the advent of GST, the supply chain decisions are likely to be a function of economic factors such as costs, proximity to market rather than non-economic factors such as VAT rate dif- ferential between states.

But, various states have started asking for exemp- tions for petroleum, liquor products etc. in GST itself and they are also demanding a very high rate of GST of more than 20%. Various exemptions will again make the things complex and a higher GST rate (which is basically a regressive tax affecting poor more than the rich) will increase the prices of goods & services reducing demand and investment.

The GST is obviously not a panacea for all ills of India’s economy. However, it is a revolutionary and long pending reform. It promises economic growth and jobs, better efficiency and ease of doing business and higher tax collection. Over the next 2-3 years, GST will have a cascading effect on the Indian economy and with structural enhancements, this can translate to a potential growth in GDP of 1-1.5% on a sustained basis.

GST rates decided #

The Goods and Services Tax Council has released details of the rates at which over 1,200 goods will be taxed when the GST regime takes effect.

The process of deciding rates has been a subject matter of speculation for months now, with fears that the new tax rates and slabs would be influenced by special interest lobbies. So it is welcome that the government has offered better clarity.

Various tax rates #

• Under the new structure, rates have been decided for an initial list of 1,211 items.
• The predominant share (43%) of goods will be taxed at 18%. For example, financial ser- vices and mobile services
• About 17% of the notified items will fall under the 12% (like non-AC restaurants) and 14% of the items will fall in 5% tax rate slabs (most of the transport services), respectively.
• A significant share (19%) of goods, including luxury goods and cinemas, has been tucked under the highest tax slab of 28%.
• Around 7% of the items, which include essen- tial goods such as milk, fruits, cereals and poultry, have been exempted from all taxes.

Additional cesses #

Apart from the four regular tax slabs, additional cess taxes of varying rates have also been imposed on sin and luxury goods such as pan masala, cig- arettes and sport utility vehicles to compensate the States for loss of revenue during the initial years.

Revenue-neutral rate #

Winners and losers are sure to emerge as tax rates undergo a major revision. But overall, the government has said the new tax regime will be revenue-neutral. If so, the GST’s influence on pri- vate spending will possibly remain muted.

Simplicity compromised by multiplicity of tax rates #

The four-slab structure of the GST regime gives it the look of a progressive tax code. This is in contrast to similar consumption-based taxes prevalent in other countries, which are essentially simple, flat taxes. The progressive taxes may be justified given the wide disparities in income levels in India. However, the principle of simplicity is being compromised.

No capping of tax rate #

The new tax regime disappoints on earlier expectations that the top tax rate would be capped below 20% too. The middle class will now have to bear the brunt of higher prices.

Challenges forward #

The challenge going forward will be to prevent backdoor manipulation of rates through additional levies that are completely discretionary. States that have added significantly to their debt burden in recent years must be kept in check. Otherwise, addi- tional discretionary taxes would add to the overall tax burden and, more importantly, compromise on tax predictability.

Need to maintain balance between revenue and tax rates: #

Lastly, the Centre and States must keep their pressing fiscal demands from influencing tax rates upwards in the future. Otherwise, the decision to do away with tax competition among States, in favour of a simple centralised tax system, will be done no justice.

GST Explained #

1.  What is Goods and Service Tax (GST)? #

Ans.: It is a destination based tax on consump- tion of goods and services. It is proposed to be lev- ied at all stages right from manufacture up to final consumption with credit of taxes paid at previous stages available as setoff. In a nutshell, only value addition will be taxed and burden of tax is to be borne by the final consumer.

2.      What   exactly    is    the   concept   of destination based tax on consumption? #

Ans: The tax would accrue to the taxing authority which has jurisdiction over the place of consumption which is also termed as place of supply.

3.      Which   of   the   existing   taxes   are proposed to be subsumed under GST? #

Ans: The GST would replace the following taxes:

• Taxes currently levied and collected by the Centre:

• Central Excise duty.
  • Duties of Excise (Medicinal and Toilet Preparations).
  • Additional Duties of Excise (Goods of Special Importance).
  • Additional Duties of Excise (Textiles and Textile Products).
  • Additional Duties of Customs (common- ly known as CVD).
  • Special Additional Duty of Customs (SAD).
  • Service Tax.
  • Central Surcharges and Cesses so far as they relate to supply of goods and services
  • State taxes that subsumed under the GST are:
    • State VAT.
    • Central Sales Tax.
    • Luxury Tax.
    • Entry Tax (all forms).
    • Entertainment and Amusement Tax (ex- cept when levied by the local bodies).
    • Taxes on advertisements.
    • Purchase Tax
    • Taxes on lotteries, betting and gambling
    • State Surcharges and Cesses so far as they relate to supply of goods and services

The GST Council shall make recommendations to the Union and States on the taxes, cesses and surcharges levied by the Centre, the States and the local bodies which may be subsumed in the GST.

4.   Which are the commodities proposed to be kept outside the purview of GST? #

Ans.: Alcohol for human consumption, Petro- leum Products viz. petroleum crude, motor spirit (petrol), high speed diesel, natural gas and aviation turbine fuel& Electricity.

5.    What will be the status in respect of taxation of above commodities after introduction of GST? #

Ans.: The existing taxation system (VAT & Central Excise) will continue in respect of the above commodities.

6.    What will be status of Tobacco and Tobacco products under the GST regime? #

Ans.: Tobacco and tobacco products would be subject to GST. In addition, the Centre would have the power to levy Central Excise duty on these products.

7.   What type of GST is proposed to be implemented? #

Ans.: It would be a dual GST with the Centre and States simultaneously levying it on a common tax base. The GST to be levied by the Centre on intra-State supply of goods and / or services would be called the Central GST (CGST) and that to be levied by the States would be called the State GST (SGST). Similarly Integrated GST (IGST) will be levied and administered by Centre on every inter- state supply of goods and services.

8.   Why is Dual GST required? #

Ans.: India is a federal country where both the Centre and the States have been assigned the powers to levy and collect taxes through appropriate legislation. Both the levels of Government have distinct responsibilities to perform according to the division of powers prescribed in the Constitution for which they need to raise resources. A dual GST will, therefore, be in keeping with the Constitutional requirement of fiscal federalism.

9. Which authority will levy and administer GST? #

Ans.: Centre will levy and administer CGST & IGST while respective states will levy and admin- ister SGST.

10.    Why was the Constitution of India amended recently in the context of GST? #

Ans.: Currently, the fiscal powers between the Centre and the States are clearly demarcated in the Constitution with almost no overlap between the respective domains. The Centre has the powers to levy tax on the manufacture of goods (except alcoholic liquor for human consumption, opium, narcotics etc.) while the States have the powers to levy tax on the sale of goods. In the case of inter- State sales, the Centre has the power to levy a tax (the Central Sales Tax) but, the tax is collected and

retained entirely by the States. As for services, it is the Centre alone that is empowered to levy service tax. Introduction of the GST required amendments in the Constitution so as to simultaneously empower the Centre and the States to levy and collect this tax.

The Constitution of India has been amended by the Constitution (one hundred and first amendment) Act, 2016 recently for this purpose. Article 246A of the Constitution empowers the Centre and the States to levy and collect the GST.

11.    What are the benefits which the Country will accrue from GST? #

Ans.: Introduction of GST would be a very significant step in the field of indirect tax reforms in India. By amalgamating a large number of Cen- tral and State taxes into a single tax and allowing set-off of prior-stage taxes, it would mitigate the ill effects of cascading and pave the way for a common national market. For the consumers, the biggest gain would be in terms of a reduction in the overall tax burden on goods, which is currently estimated at 25%-30%. Introduction of GST would also make our products competitive in the domestic and international markets. Studies show that this would instantly spur economic growth. There may also be revenue gain for the Centre and the States due to widening of the tax base, increase in trade volumes and improved tax compliance. Last but not the least, this tax, because of its transparent character, would be easier to administer.

12.   What is IGST? #

Ans.: Under the GST regime, an Integrated GST (IGST) would be levied and collected by the Centre on inter-State supply of goods and services. Under Article 269A of the Constitution, the GST on sup- plies in the course of interState trade or commerce shall be levied and collected by the Government of India and such tax shall be apportioned between the Union and the States in the manner as may be pro- vided by Parliament by law on the recommendations of the Goods and Services Tax Council.

13.    Who will decide rates for levy of GST? #

Ans.: The CGST and SGST would be levied at rates to be jointly decided by the Centre and States.

The rates would be notified on the recommendations of the GST Council.

14.     What would be the role of GST Council? #

Ans.: A GST Council would be constituted comprising the Union Finance Minister (who will be the Chairman of the Council), the Minister of State (Revenue) and the State Finance/Taxation Ministers to make recommendations to the Union and the States on:

• the taxes, cesses and surcharges levied by the Centre, the States and the local bodies which may be subsumed under GST;
  • the goods and services that may be subject- ed to or exempted from the GST;
  • the date on which the GST shall be levied on petroleum crude, high speed diesel, mo- tor sprit (commonly known as petrol), natu- ral gas and aviation turbine fuel;
  • model GST laws, principles of levy, appor- tionment of IGST and the principles that govern the place of supply;
  • the threshold limit of turnover below which the goods and services may be exempted from GST;
  • the rates including floor rates with bands of

GST;

• any special rate or rates for a specified peri- od to raise additional resources during any natural calamity or disaster;
  • special provision with respect to the North- East States, J&K, Himachal Pradesh and Uttarakhand; and (ix) any other matter re- lating to the GST, as the Council may de- cide.

15.  What is the guiding principle of GST Council? #

Ans.: The mechanism of GST Council would ensure harmonization on different aspects of GST between the Centre and the States as well as among States. It has been provided in the Constitution (one hundred and first amendment) Act, 2016 that the GST Council, in its discharge of various functions, shall be guided by the need for a harmonized structure

of GST and for the development of a harmonized national market for goods and services.

16.   How will decisions be taken by GST Council? #

Ans.: The Constitution (one hundred and first amendment) Act, 2016 provides that every decision of the GST Council shall be taken at a meeting by a majority of not less than 3/4th of the weighted votes of the Members present and voting. The vote of the Central Government shall have a weightage of 1/3rd of the votes cast and the votes of all the State Governments taken together shall have a weightage of 2/3rd of the total votes cast in that meeting. One half of the total number of members of the GST Council shall constitute the quorum at its meetings.

17.  How will imports of Goods & services be taxed under GST? #

Ans.: Imports of Goods and Services will be treated as inter-state supplies and IGST will be lev- ied on import of goods and services into the country. The incidence of tax will follow the destination principle and the tax revenue in case of SGST will accrue to the State where the imported goods and services are consumed. Full and complete set-off will be available on the GST paid on import on goods and services.

18.  How will Exports of goods & services be treated under GST? #

Ans.: Exports will be treated as zero rated sup- plies. No tax will be payable on exports of goods or services, however credit of input tax credit will be available and same will be available as refund to the exporters.

19.  What is GSTN and its role in the GST regime? #

Ans.: GSTN stands for Goods and Service Tax Network (GSTN). A Special Purpose Vehicle called the GSTN has been set up to cater to the needs of GST. The GSTN shall provide a shared IT infrastructure and services to Central and State Governments, tax payers and other stakeholders for implementation of GST. The functions of the GSTN would, inter alia, include:

• facilitating registration;
  • forwarding the returns to Central and State authorities;
  • computation and settlement of IGST;
  • matching of tax payment details with bank- ing network;
  • providing various MIS reports to the Central and the State Governments based on the tax payer return information;
  • providing analysis of tax payers’ profile;

and

• running the matching engine for matching, reversal and reclaim of input tax credit.

20.    How are the disputes going to be resolved under the GST regime? #

Ans. The Constitution (one hundred and first amendment) Act, 2016 provides that the Goods and Services Tax Council shall establish a mechanism to adjudicate any dispute-

• between the Government of India and one or more States; or
• between the Government of India and any State or States on one side and one or more other Sates on the other side; or
• between two or more States, arising out of the recommendations of the Council or im- plementation thereof.