The United States Congress approved an emergency bailout package of $700 billion during that fateful week in September 2008. This was just days after the spectacular crash of Lehman Brothers.
[wptelegram-join-channel link=”https://t.me/s/upsctree” text=”Join @upsctree on Telegram”]
That bailout package was part of what became the Troubled Asset Relief Program, or TARP, which was used to buy off mortgage-backed securities from banks, hedge funds and pension funds to avert further Lehman-type bankruptcies. These mortgages had turned into toxic assets that nobody wanted to buy, and government funds were used for purchases of last resort.
As a result, fresh money was injected into the banking system for it to resume normal credit operations and clean up balance sheets. Some people believe that the then Treasury secretary Henry Paulson practically spooked the Congress into approving a gigantic package at short notice, without adequate debate. Such was the state of panic and fear of domino failures in the financial system that the package was de facto viewed as fiscal support, even though it was a monetary tool.
Subsequent actions of the US government and Federal Reserve blurred the distinction between fiscal and monetary policy. A fancy term was coined to describe unorthodox measures like a central bank buying off mortgages and loans, and thus taking credit risk onto its balance sheet. It was called ‘quantitative easing’ and was merrily pursued by all the major central banks of the developed world, from New York and Washington to London, Frankfurt and Tokyo.
Central banks embarked upon an aggressive money-printing spree. Assets on their books ballooned. The chairman of the European Central Bank (ECB) famously said that he would do whatever it took to revive the economy. This meant buying even junk bonds to push the envelope. Nothing seemed untouchable to a central bank. While the US economy did stabilize and its unemployment rate halved, the monetary effort seemed excessive for the limited success it was achieving.
On the other side of the Atlantic, European growth did not pick up significantly, hampered as it was by sovereign debt crises in addition to the mortgage crisis. But a recession was averted and some tepid growth was achieved.
During the pandemic year more than a decade later, the West’s monetary spigots have been opened even more. A liquidity glut has ensued. The size of the Federal Reserve’s balance sheet has grown by seven times since its pre-Lehman days, which amounts to a compound annual growth rate of about 21% over a 12-year period. While the rate of monetary expansion over this period has been torrid, neither employment nor economic output grew by even a fraction of that rate.
Still, the US economy stayed afloat and stock markets rallied, while wealth inequality worsened. How does a central bank exit this chakravyuh, or maze? Any hint of reducing the rate of money expansion threatens to cause panic and burst the bubble it blew. Just a mention of the word ‘taper’, which means reducing the pace of money expansion, caused a big shock to the world economy in 2013. The shock was such that the T-word has got seared into the collective memory of global financial markets.
The Reserve Bank of India (RBI) too finds itself in a similar predicament, where the way out of its liquidity glut is hazy. By last August, RBI’s balance sheet had ballooned by more than 30% over the previous year, thanks to purchases of foreign exchange externally and of government bonds domestically. That pace has been sustained. RBI has injected liquidity through long-term repo operations, which essentially provide long-term money at low overnight rates.
The Indian central bank has also provided implicit liquidity support to mutual funds, which is like an Indian version of unorthodox monetary policy. It has not quite ventured into taking credit risk onto its books, nor has it signalled a readiness to buy toxic assets, but that day may not be far off when it is asked to defrost frozen credit markets. To enhance market liquidity through money infusion or through open market operations is nothing but money creation.
As a result of India’s liquidity glut, money is flowing in and out of the central bank to the tune of ₹7 trillion on a daily basis. This has resulted in an anomaly: market lending rates have gone below RBI’s reverse repo rate, which is supposed to be the de facto floor. Cheap money is an invitation to do foolish and risky things, which, if done widely and voluminously enough, can spell disaster for financial stability. So RBI has tentatively tried to nudge market rates higher by announcing a reverse repo auction. This is our own mild version of policy normalization (sans the dreaded T-word).
But the market reaction was one of panic all the same, and there was a spike in interest rates, causing the central bank to rethink its strategy. To calm nervous bond traders, the governor has categorically said that liquidity support will continue as long as necessary, but surely we need to plan an exit from the current glut?
Why not simply loan ₹5 trillion to the central government against shares of public sector undertakings, on a bilateral basis at a low rate of 3% for a period of five years to fund its huge deficit? That will bypass markets and not cause any disruption to interest rates. Whatever the way out of this whirlpool of liquidity, it’s not going to be easy.
Receive Daily Updates
Recent Posts
Petrol in India is cheaper than in countries like Hong Kong, Germany and the UK but costlier than in China, Brazil, Japan, the US, Russia, Pakistan and Sri Lanka, a Bank of Baroda Economics Research report showed.
Rising fuel prices in India have led to considerable debate on which government, state or central, should be lowering their taxes to keep prices under control.
The rise in fuel prices is mainly due to the global price of crude oil (raw material for making petrol and diesel) going up. Further, a stronger dollar has added to the cost of crude oil.
Amongst comparable countries (per capita wise), prices in India are higher than those in Vietnam, Kenya, Ukraine, Bangladesh, Nepal, Pakistan, Sri Lanka, and Venezuela. Countries that are major oil producers have much lower prices.
In the report, the Philippines has a comparable petrol price but has a per capita income higher than India by over 50 per cent.
Countries which have a lower per capita income like Kenya, Bangladesh, Nepal, Pakistan, and Venezuela have much lower prices of petrol and hence are impacted less than India.
“Therefore there is still a strong case for the government to consider lowering the taxes on fuel to protect the interest of the people,” the report argued.
India is the world’s third-biggest oil consuming and importing nation. It imports 85 per cent of its oil needs and so prices retail fuel at import parity rates.
With the global surge in energy prices, the cost of producing petrol, diesel and other petroleum products also went up for oil companies in India.
They raised petrol and diesel prices by Rs 10 a litre in just over a fortnight beginning March 22 but hit a pause button soon after as the move faced criticism and the opposition parties asked the government to cut taxes instead.
India imports most of its oil from a group of countries called the ‘OPEC +’ (i.e, Iran, Iraq, Saudi Arabia, Venezuela, Kuwait, United Arab Emirates, Russia, etc), which produces 40% of the world’s crude oil.
As they have the power to dictate fuel supply and prices, their decision of limiting the global supply reduces supply in India, thus raising prices
The government charges about 167% tax (excise) on petrol and 129% on diesel as compared to US (20%), UK (62%), Italy and Germany (65%).
The abominable excise duty is 2/3rd of the cost, and the base price, dealer commission and freight form the rest.
Here is an approximate break-up (in Rs):
a)Base Price | 39 |
b)Freight | 0.34 |
c) Price Charged to Dealers = (a+b) | 39.34 |
d) Excise Duty | 40.17 |
e) Dealer Commission | 4.68 |
f) VAT | 25.35 |
g) Retail Selling Price | 109.54 |
Looked closely, much of the cost of petrol and diesel is due to higher tax rate by govt, specifically excise duty.
So the question is why government is not reducing the prices ?
India, being a developing country, it does require gigantic amount of funding for its infrastructure projects as well as welfare schemes.
However, we as a society is yet to be tax-compliant. Many people evade the direct tax and that’s the reason why govt’s hands are tied. Govt. needs the money to fund various programs and at the same time it is not generating enough revenue from direct taxes.
That’s the reason why, govt is bumping up its revenue through higher indirect taxes such as GST or excise duty as in the case of petrol and diesel.
Direct taxes are progressive as it taxes according to an individuals’ income however indirect tax such as excise duty or GST are regressive in the sense that the poorest of the poor and richest of the rich have to pay the same amount.
Does not matter, if you are an auto-driver or owner of a Mercedes, end of the day both pay the same price for petrol/diesel-that’s why it is regressive in nature.
But unlike direct tax where tax evasion is rampant, indirect tax can not be evaded due to their very nature and as long as huge no of Indians keep evading direct taxes, indirect tax such as excise duty will be difficult for the govt to reduce, because it may reduce the revenue and hamper may programs of the govt.