Subject: Finance and Banking

Why in the News?

Sovereign gold bonds provide a safer and more cost-effective alternative to holding physical gold, as they reduce risks and storage expenses. However, the central government is considering discontinuing the SGB scheme.

What is the Sovereign Gold Bond scheme?

What are the concerns regarding sovereign gold bonds?

• High Cost of Financing: The government perceives the cost of financing its fiscal deficit through SGBs as disproportionately high compared to the benefits provided to investors. This perception has led to a significant reduction in the issuance of SGBs, dropping from ten tranches annually to just two.
• Limited Issuance in Current Financial Year: In the financial year 2024-25, no new sovereign gold bonds have been issued so far, and net borrowing through these bonds has been significantly reduced from previous estimates.
• Market Competition from Physical Gold: The recent reduction in customs duty on gold from 15% to 6% has led to a surge in demand for physical gold. Investors may prefer holding physical gold over waiting for returns from debt securities like SGBs, which require maturity periods before realizing gains.

Way forward: 

• Increase Liquidity and Accessibility: Similar to gold-backed ETFs in the U.S. and Gold Bullion Securities in Australia, India can enhance the liquidity of SGBs by allowing them to be traded on stock exchanges, providing easy access and better market engagement for investors.
• Encourage Regular Investments: Drawing inspiration from Germany’s gold savings plans, India can introduce flexible investment options such as monthly or quarterly contributions, enabling dollar-cost averaging and attracting retail investors over time.

Mains PYQ:

Q Craze for gold in Indian has led to surge in import of gold in recent years and put pressure on balance of payments and external value of rupee. In view of this, examine the merits of Gold Monetization scheme. (UPSC IAS/2015)

Why in the News?

The Lok Sabha passed the Banking Laws (Amendment) Bill, 2024, marking the first piece of legislation to be approved during the Winter Session after the resolution of a week-long impasse.

What are the key features of the Banking Laws (Amendment) Bill, 2024?

• Nomination Provisions: The Bill allows bank account holders to nominate up to four individuals for their accounts, with options for either successive or simultaneous nominations. However, locker holders will only have the option for successive nominations.
• Redefinition of “Substantial Interest”: The threshold for defining “substantial interest” for directorships is proposed to increase from ₹5 lakh to ₹2 crore, reflecting current economic conditions.
• Tenure of Directors: The tenure of directors (excluding chairpersons and whole-time directors) in cooperative banks will be extended from eight years to ten years, aligning with provisions in the Constitution (Ninety-Seventh Amendment) Act, 2011.
• Common Directorships: The Bill permits directors of Central Cooperative Banks to serve on the boards of State Cooperative Banks under certain conditions.
• Auditor Remuneration: It grants banks greater flexibility in determining the remuneration for statutory auditors, which was previously regulated by the Reserve Bank of India (RBI) and the central government.
• Reporting Dates: The reporting dates for regulatory compliance will shift from the second and fourth Fridays to the 15th and last day of every month, streamlining oversight processes.

What are the reasons for this amendment?

• Enhancing Governance: The amendments aim to strengthen governance standards within banks, ensuring better protection for depositors and investors while improving audit quality in public sector banks.
• Customer Convenience: By allowing multiple nominations, the Bill intends to simplify inheritance processes related to bank deposits and reduce instances of unclaimed deposits after an account holder’s demise.
• Alignment with Constitutional Provisions: Increasing director tenures in cooperative banks aligns banking regulations with constitutional amendments that govern cooperative societies.

What would be the significant impact of this amendment?

• Improved Customer Experience: The ability to nominate multiple individuals enhances customer convenience and ensures smoother transitions in account management after an account holder’s death.
• Strengthened Governance Framework: By redefining substantial interest and increasing director tenures, the Bill aims to foster a more robust governance framework within cooperative banks, potentially leading to better decision-making and accountability.
• Regulatory Compliance Efficiency: Changing reporting dates is expected to improve compliance efficiency, allowing banks to better align their reporting practices with regulatory requirements.

What is the criticism faced by the Banking Laws (Amendment) Bill, 2024?

• Concerns Over Financial Practices: Opposition leaders raised concerns regarding rising imports from China amid strained relations and questioned broader financial practices like demonetization and electoral bonds.
• Banking Fees and Cybersecurity Risks: Critics highlighted issues related to fees for basic banking services such as ATM withdrawals and SMS alerts, particularly emphasizing vulnerabilities faced by senior citizens concerning cyber fraud.
• Economic Context: Some opposition members criticized the timing of the Bill against a backdrop of economic challenges such as inflation exceeding growth rates, potentially leading to stagflation. They expressed skepticism about whether these amendments would effectively address underlying economic issues.

Way forward: 

• Addressing Broader Economic Concerns: The government should focus on macroeconomic reforms to manage inflation and foster sustainable growth. The Banking Laws Amendment should be complemented by policies that address the root causes of economic challenges, ensuring the banking sector thrives amidst broader financial stability.
• Strengthening Cybersecurity and Customer Protection: Banks should enhance security measures, especially for senior citizens, to safeguard against rising cyber fraud.

Why in the News?

On September 30, the Securities and Exchange Board of India (SEBI) launched the liberalized Mutual Funds Lite (MF Lite) framework specifically for passively managed schemes.

Key highlights of the liberalized Mutual Funds Lite (MF Lite) framework:

• Separate Framework for Passive Funds: It is tailored for passively managed schemes, which are less risky and require minimal active management.
• Relaxed Entry Requirements: Lowered net worth requirement (₹35 crore), simplified criteria for sponsor eligibility (profitability, track record).
• Encouraging New Players: It provides easier entry for new AMCs (Asset management companies) and market players in the passive fund segment.
• Governance Flexibility: It has reduced oversight for trustees; operational responsibilities shifted to AMC boards, focusing on fees, expenses, and tracking error.
• Cost Efficiency Focus: It emphasizes on lowering Total Expense Ratio (TER) and minimizing tracking error for better returns.
• Simplified Disclosures: The Scheme Information Documents (SID) are simplified to focus on key metrics like benchmark index, TER, and tracking error.
• Risk Management: Audit committees of AMCs can handle risk management duties due to the lower risk profile of passive funds.

Why a Separate Framework for MF Lite is Needed?

• Lower Risk Profile: Passively managed funds are generally less risky because they track established benchmarks like BSE Sensex or Nifty50, reducing the need for active decision-making.
• Minimal Asset Manager Discretion: Unlike actively managed funds, asset managers of passive funds have limited discretion in asset allocation and investment objectives. They simply mirror the performance of the benchmark index.
• Inapplicability of Existing Regulations: The current framework is designed primarily for actively managed funds, which involve more risks and require more oversight. It is less suitable for passive funds, which operate with predefined, transparent rules.
• Cost-Effective Market Entry: To encourage new players and make the passive fund industry more competitive, SEBI introduced relaxed regulations regarding eligibility, net worth, and profitability.

What about risks and disclosures? 

• Success depends on Total Expense Ratio (TER) and tracking error. Lower costs and minimal deviation from the benchmark are crucial for performance.
• Scheme Information Documents (SID) focus on key metrics like the benchmark name, TER, and tracking error, leaving out complex strategies.
• Risk management responsibilities are streamlined, allowing the audit committee of the AMC to handle oversight, reflecting the lower risks of passive funds.

Way forward: 

• Enhance Investor Education: Develop targeted educational initiatives to inform retail investors about the benefits, risks, and operational aspects of passive mutual funds, fostering informed investment decisions.
• Ongoing Regulatory Evaluation: Establish a framework for periodic assessment and adaptation of the MF Lite regulations to ensure they remain effective and relevant, promoting competition while safeguarding investor interests.

Why in the News?

The rise in jobless growth, driven by automation and AI, has led to growing inequality, prompting discussions on implementing Universal Basic Income (UBI) in many countries.

What does the ILO say on Inflation and unemployment in India? 

• The ILO reports that 83% of the unemployed population in India are youth, due to the rapidly changing economy influenced by automation and AI.
  • This trend has exacerbated income inequality, with a 1.6% drop in global labour income share between 2004 and 2024, significantly affecting developing nations like India.
• The report indicates that persistent inflation and geopolitical tensions have led to aggressive monetary policies, which could further strain the labor market.
  • The ILO anticipates a slight increase in global unemployment in 2024, reflecting ongoing structural issues in labor markets.

What will be its implications on Indian growth and development? 

• Social Implications: Falling living standards and weak productivity due to automation could lead to greater inequality, undermining social justice efforts in India.
  • The ILO suggests that increasing unemployment and inflation could result in social unrest and political instability without effective social safety nets.
• Political Implications: It makes it difficult for the decision making and governance due to the drop in global labour income, prompting India to increase budget allocations for welfare programs.
• Economic Implications: The emphasis on generating employment in labor-intensive sectors is crucial. The government policies should prioritize job creation to counteract the effects of automation and ensure that growth benefits a broader segment of the population.

What are the safety nets for India? 

• Cash Transfer Schemes: Programs targeting farmers and women, as well as cash transfers for unemployed youth, represent existing safety nets that provide some level of income support.
• Employment Guarantee Schemes: Initiatives like the Mahatma Gandhi National Rural Employment Guarantee Act (MGNREGA) aim to provide employment and income security to rural households, although funding and implementation have faced challenges.
• Universal Basic Social Safety Nets: Experts suggest that rather than a full UBI, India should focus on enhancing existing social safety nets to ensure they are more universal and effective in addressing the needs of the unemployed and underemployed populations.

Why in the News?

The financial relationship between the Union and State governments in India is imbalanced, similar to other nations with a federal constitutional structure.

What is Vertical Fiscal Imbalance (VFI)?

Vertical fiscal imbalance (VFI) refers to the mismatch between the revenue-raising powers and expenditure responsibilities of different levels of government (between the Center and state) within a country.

Why should Vertical Fiscal Imbalance (VFI) be reduced?

• Decentralization of Expenditure: States are responsible for 61% of the revenue expenditure, focusing on crucial sectors like health, education, and infrastructure, but they generate only 38% of the revenue.
  • This imbalance creates a dependency on central transfers, limiting the States’ fiscal autonomy.
• Need Efficiency in Spending: Reducing VFI would provide states with more resources, allowing them to respond better to local needs and improve governance efficiency.
• Need to strengthen Fiscal Federalism: A reduction in VFI promotes a healthier system of cooperative federalism, ensuring that states have adequate resources to carry out their constitutional responsibilities and meet the demands of their populations.
• Need Preparedness for crises: VFI becomes more pronounced during crises (e.g., COVID-19), leading to fiscal stress for States. A more balanced fiscal arrangement ensures better crisis management at the sub-national level.

Present Scenario of VFI and Tax Devolution in India

• VFI Extent: The 15th Finance Commission noted that despite States‘ heavy spending responsibilities, their revenue-raising powers are limited.
• Tax Devolution Rates: The 14th and 15th FC recommended devolving 42% and 41%, however, estimates suggest that an average share of 48.94% was necessary between 2015-2023 to eliminate the VFI.
• Exclusion of Cesses and Surcharges: The exclusion of cesses and surcharges from the divisible pool of taxes shortens the net proceeds. States argue this limits the resources available to them to meet their expenditure responsibilities.
• Fiscal Responsibility: Despite the constraints, states have largely adhered to borrowing limits under fiscal responsibility legislation. However, states still struggle to meet their expenditure responsibilities, highlighting the need for greater financial support from the Centre.

What should be the role objective of the 16th FC?

• Increase Tax Devolution: Many States demand that tax devolution from the Union’s net proceeds should be raised to 50%. The 16th Finance Commission must consider raising the devolution rate to around 49% to address the VFI and ensure sufficient untied funds for States.
• Address Cesses and Surcharges: The 16th Finance Commission should evaluate the exclusion of cesses and surcharges from the divisible pool.
• Empower States with Fiscal Autonomy: The Commission’s objective should be to empower States with greater fiscal autonomy by ensuring adequate resources for them to perform their constitutional duties without undue dependence on the Centre.
• Support Local Priorities: The Commission should aim to provide States with untied resources, enabling them to cater to jurisdictional needs and set priorities that align with their specific developmental challenges, ensuring a more responsive governance system.

Why in the news?

The 2024-25 Budget is a progressive proposal featuring several commendable initiatives aimed at boosting India’s economic growth and advancing social progress.

Prioritized areas in the recent Budget 2024-25

• Job Creation and Skilling: The budget allocates ₹1.48 lakh crore towards job creation, employment, and skilling, emphasizing the importance of developing a skilled workforce to support India’s service sector. This shift from a focus on manufacturing to skilling reflects a strategic move towards building a service-oriented economy.
• Energy Transformation: There is significant investments are directed towards energy transformation initiatives, including solar panel manufacturing and nuclear energy development. The budget allocates ₹89,287 crore to crucial sectors, indicating a commitment to sustainable energy solutions.
• Healthcare Initiatives: The budget includes measures to enhance healthcare access, such as customs duty exemptions on life-saving cancer medications and components for advanced medical equipment.
• Technology and Innovation: A framework with nine priorities is introduced to leverage advanced technology and foster collaboration between the government and private sector, promoting growth and innovation across various sectors.
  • For example: The budget allocates ₹1 lakh crore specifically for research and innovation, accompanied by a 50-year interest-free loan.

What does the budget say on Accessibility and Affordability?    

• Customs Duty Exemptions on drugs: The budget exempts customs duties on three essential cancer medications, making them more affordable and accessible to patients. This move addresses the high costs associated with cancer treatments, which often pose significant barriers to access.
• Support for Medical Equipment: Customs duties are also waived for components of X-ray tubes and digital detectors, which are crucial for advanced medical technologies.
• Alignment with Domestic Capacity: The budget emphasizes aligning customs duties with domestic capacity under the phased manufacturing program, fostering a conducive environment for startups and encouraging local manufacturing.

On Prioritizing Inclusivity and Fiscal Prudence

• Women’s Workforce Participation: The budget focuses on boosting women’s participation in the economy through targeted initiatives such as hostels, creches, and skilling programs.
  • According to a report by McKinsey, India can increase its 2025 GDP, estimated at $4.83 trillion, by 16%-60% simply by enabling women to participate in the economy on par with men
• Research and Development: With India spending only 0.7% of its GDP on research, the budget encourages private sector collaboration with the government to increase investments in R&D. This collaboration is vital for fostering innovation and ensuring sustainable economic growth.
• Public-Private Partnerships: The budget promotes public-private partnerships to enhance healthcare delivery and infrastructure, reflecting a commitment to inclusivity and collaboration in achieving economic and social goals.

Conclusion: The government should expand the scope of skilling programs to cover a wider range of sectors and skill levels while ensuring the workforce is equipped to meet the evolving demands of the service-oriented economy.