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INDIANOMICS


Rural Credit Constraints in India

Bhavyaa Sharma

As a developing economy, India faces several challenges to its growth, and the analysis of all of these is pertinent, particularly in the current scenario where headwinds from the financial crisis in the developed world have lead to a slowdown in the growth rates at home. India being an agrarian country, Rural Finance is of immense importance to the growth story. However, constraints to the provision of the same have led to stagnation in the agricultural growth, especially in the post-reform period.

Issues concerning the availability of credit to the rural poor are limited participation of the poor in the formal sector and considerable inequality in the distribution of formal credit. Credit loans have been predominantly made to wealthier farmers, while the small farmers have been rationed out of the credit market. Historical evidence suggests that repayment of “prior debts” was by far the single most significant motivation for borrowing in the earlier periods. Rates of interest were generally higher for the poorer cultivators, partly because they made greater resort to grain loans and also reflecting their generally more vulnerable position. “Real” rates of interest, historically, have not just been the rate charged but they were also hidden in the lower price paid for the products sold, exploitative wage rates and rents charged for land leased. Although the share of “usurious” sources of rural credit fell steeply in 1951-1991, the post reform period saw the return of the rural moneylender as one of the primary sources of the same. The share of the marginal farmers in disbursement of short and long term loans by the SCBs has witnessed a steep decline, evidencing the fact that left to itself, the formal sector will exclude the rural sector, particularly the rural poor. The main activity with which commercial bank credit was associated with was financing agro-processing firms and purchase bonds floated by land development banks. This could be attributed to the informational advantage about the rural borrowers that moneylenders have over the formal institutions as well as the lack of availability of collateral with the marginal and small farmers. Given that the interest rates are on a rise, the worst affected have been the rural poor. One also notices informal credit transactions occurring among people of a specific social group or the moneylenders charging differential rates of interests from people belonging to different social and economic backgrounds (segmentation). Formal sources of credit are cheaper across all areas as compared to the informal credit sources, with interest rates charged by private lenders being as high as 300% per annum, despite which the formal sector default rates are comparatively much higher. However, studies suggest lack of participation in the formal credit market on the part of the rural borrowers, which can be traced to the differences in reservation costs of obtaining informal credit vis-à-vis formal credit. India’s Co-operative Credit Structure covers directly or indirectly, nearly half of India’s total population. However, the concept of mutuality between savings and credit functions has been missing.

There may be several reasons why people borrow from village lenders, despite the fact that they charge exorbitant interest rates. Due to lack of information about the borrowers as well as the inability to accept collateral in exotic forms, institutional lenders usually discriminate against poor borrowers since their richer counterparts can repay in almost all contingencies, resulting in credit rationing. Poorer borrowers may also be reluctant to borrow from formal sources out of the fear of being cheated or sanctioned in the event of non-repayment. High interest rates may not necessarily be a result of monopoly of the lender over his clientele, instead, the risk of involuntary and strategic default and weak enforcement machinery can drive up the rates to the aforementioned levels.

The figure given below explains credit rationing in the face of possibilities of defaults. L is the loan size and f(L) is the production function describing the value of output for every loan size L. Now, we assume that the farmer can have access to a net profit of A by borrowing elsewhere. Hence, to make the farmer participate at some interest rate i and some loan size L:

f(L) – L(1+ i) 

in which case, the optimal loan amount would be L*. Now, if the farmer’s mental horizon is of N dates, he gets N[f(L) – L(1+i)] over the entire N if he doesn’t default in any period. If he decides to default, he will get all of f(L). But next period onwards, he will be excluded by the moneylender and would be able to earn only A per period. So for default not to occur:





The cost line is now modified for the farmer from to  to. Simple optimization yields the optimal loan size as L** (such that L**.

This fear of default also creates a tendency to ask for collateral, which can take several forms [e.g. Ration cards in Kerala (Kurup, 1976)]. In case the collateral is of a higher value to the lender than the principal itself, the debt contract maybe written in a way so as to induce the borrower to default, which explains extensive landholdings of some landowners in rural India as well as the persistence of bonded labour till date. It is the fear of a default and the unfeasibility of charging a higher interest rate as well as information asymmetries regarding the “good” and the “bad risks” that the equilibrium in the informal market is thrown to ‘Credit Rationing’, leading to inadequacy of credit.

Interlinkages between credit and other markets is also an important characteristic of rural credit markets in India and are reflected in the coincidence of credit relations with other economic relations viz. trader-cultivator, landlord-tenant etc. The rationale for interlinked markets is lowering of transaction as well as monitoring costs. It becomes even stronger where law or custom restricts certain contractual arrangements. Interlinkage may be used in many cases to counteract the distortion in loan amounts and is often achieved by charging a rate of interest that is not too high or even equivalent to the formal rate of interest and paying a wage rate or output price that is lower than the market rates.

In order to tackle these constraints, policies should be implemented in the right direction. SHGs should be induced to enter matured levels of enterprise and factor in livelihood diversification in order to ensure that their members are not dependent on informal sources of credit for their financial and non financial needs. There is a scope of increasing credit disbursals on the part of the public lending institutions through policies, innovations and techniques that enable correct identification of viable borrowers. Effective policy interventions in other markets can increase the size of asset holdings with borrowers, thus increasing their access to formal credit sources. As of now, RBI’s actions have been effective to a very large extent in purveying credit in the rural sector through regulations pertaining to priority sector lending and opening branches in rural areas. However, Co-operative banks and credit societies as well as RRBs need to shift their focus primarily towards the poorest of the poor rather than just looking broadly at the rural sector. Policies should be initiated in order to incentivise lending to the marginal and small farmers to a greater extent by formal institutions. At the same time, policies like concessional credit rates should be reconsidered since they distort socially optimal loan decisions. Microfinance Institutions developed on the lines of Grameen Bank, which promote group lending can be another possible solution. Credit rationing theory implies that under a policy of no restrictions on interest rates and in a competitive environment, credit will be rationed. Thus any intervention in the market other than to alleviate informational constraints will do more harm than good. A new theory of incentives and monitoring embedded within the actual operational framework of India’s lending institutions might be more appropriate for analysing and designing corrective mechanisms.



References:

  1. Dreze, Jean, P. Lanjouw and Naresh Sharma (September 1997), Credit in Rural India: A Case Study, STICERD.

  2. Shah, Mihir, R. Rao and P.S. Vijay Shankar (2007), Rural Credit in 20th Century India: Overview of History and Perspectives, Economic and Political Weekly, April 14, 2007.

  3. Kochar, Anjini (1997), An empirical investigation of rationing constraints in rural credit markets in India, Journal of Development Economics, Vol. 53, pp 339-371.

  4. Braverman, Avishay and J.L. Guasch , Rural Credit Markets and Institutions in Developing Countries: Lessons for policy analysis from practice and modern theory, World Development, Vol.14, No.10/11, pp. 1253-1267, 1986.


A Tale of Two Transfers

Parnika Dar and Upasana Majumdar


A transfer payment (or government transfer) is a redistribution of income in the market system. These payments are considered to be exhaustive because they do not directly absorb resources or create output. Examples of certain transfer payments include those for welfare (financial aid), social security, and subsidies given by the government.

Recent months have witnessed a spurt in discussions on cash transfers as an instrument for delivering social security in India. The dominant view is advocating a transition to cash transfers from existing regimes, be it as a replacement for the public distribution system (PDS) or administered pricing for select fertilisers. This transition to cash transfers is plagued by financial inclusion and availability of information technology infrastructure constraints. Also, it would be imprudent to ignore the success of in-kind transfer scheme like PDS in Tamil Nadu and Chattisgarh.

Transfer programmes in developing countries are constrained by three factors: financial resources, institutional capacity and ideology. Governments in poor countries are highly limited in the amount they can invest in transfers and the money required to ensure that the programmes are effective. The amount invested is influenced by ‘value for money or the commodity in question’ considerations, as well as by political and ideological concerns regarding ‘free handouts’ and ‘creating dependency’.

A central question in anti-poverty policy is whether transfers should be made in kind or cash. The potential benefits of in-kind transfers are weighed against the fact that cash transfers typically have lower administrative costs and give recipients greater freedom over their consumption. Simple economics clearly states cash is better for welfare. Cash raises the budget constraint leading to higher indifference curves (as shown in the figure). With an in-kind transfer, however, you (potentially) impose a constraint on the basket of goods, thus (potentially) reducing the utility compared to the cash case.



Another potentially important but less discussed aspect of this policy trade-off is the effect that In-kind and cash transfers have on local prices. Cash transfers increase the demand for normal goods, and if supply is not perfectly elastic, prices of these goods should rise. In-kind transfers have a corresponding cash value, so they similarly shift demand through an income effect. But, in addition, an in-kind transfer program increases local supply. If the government injects supply into a partially-closed economy (e.g., a village), then relative to cash transfers, local prices should fall when transfers are provided in-kind.

Price effects of transfer programs are likely to be most pronounced when, first, the size of the individual transfer is large; second, there is high program enrolment within a community; and third, the economy is not fully integrated with the outside economy so local supply and demand determine prices.

Price effect of cash transfers should be positive for normal goods since the income effect shifts the demand curve outward. The supply effect of an in-kind transfer is the change in prices caused by the influx of goods into the local economy. This supply effect should cause a decline in prices. Goods that are not part of the transfer program are also subject to pecuniary effects. The supply influx from the in-kind transfer should lower the demand and prices for goods that are substitutes of the in-kind items.

In the empirical application, an economy is an Indian village, and the main goods that are examined are food grains. The local suppliers are shopkeepers in the village, and they procure the items from outside the village. A positively sloped supply curve implies increasing marginal costs.

In effect, we assume that for local suppliers, procuring more supply entails increasing marginal costs, at least in the short- run. A high transportation cost to other markets is one reason that inventory in local stores is unlikely to adjust instantaneously. To meet higher demand, a shopkeeper in a remote village might need to travel to a neighbouring village to buy supply from a shop there. In the long run, one might expect the supply curve to be flatter.

Figure 1 depicts the market for a normal good in a village. The demand curve represents the aggregate demand faced by local suppliers. The figure shows, first, the effect of a cash transfer. The demand curve shifts to the right via an income effect, and the equilibrium price, p, increases. Denoting the amount of money transferred in cash by X cash, our first prediction is that a cash transfer will cause prices to rise. In-kind transfers also generate an income effect, so demand will again shift to the right. Here, the in-kind transfer amount X-In Kind is defined in terms of its equivalent cash value. Thus the demand shift caused by a transfer amount X is by definition the same for either form of transfer.

With an in-kind transfer, however, some of consumers’ demand is now provided to them for free by the government, so the residual demand facing local suppliers shifts to the left by the amount provided in kind. While the net price effect of an in-kind transfer relative to the original market equilibrium is, in general, theoretically ambiguous, one can sign the price effect of in-kind transfers relative to cash transfers. For transferred goods, the price should be lower under in-kind transfers. Government transfer programmes often inject a large quantity of goods or services or cash into a community. Through these shifts in supply and demand, transfer programs could have quantitatively important price effects.



Here, two main predictions are tested; first, that cash transfers should lead to price inflation and second, that prices should fall under in-kind transfers relative to cash transfers. There is no strong evidence for the first hypothesis, though the point estimates generally match the prediction. There is robust evidence in support of the second hypothesis. Prices are significantly lower with in kind transfers than cash transfers. The transfer programme injects a large quantity of food or cash into these villages. This finding suggests that in most settings, price effects will have quite negligible consequences for policy decisions. The hypothesis is that price effects are bigger in more physically remote areas, where the markets are less tied to world prices and there is less product market competition. Moreover, in remote villages, the price effects estimated are economically significant. While these explanations cannot be tested decisively, there is suggestive evidence that imperfect competition is part of the explanation. Even if marginal costs are flat in the long run, with imperfect competition there could be long-run price effects of in-kind transfers since the residual demand facing local suppliers would be permanently lower.

The dearth of supply-side competition in remote markets suggests then when the government acts as a supplier and provides in-kind transfers; it may not only be creating a monetary externality but also reducing the inefficiency associated with imperfect competition.

An In-kind transfer leads to an increase in the demand facing the local suppliers, due to the income effect of the transfer, which is offset by an increase in supply due to an injection on the government’s part. The net effect is that the marginal revenue curve shifts from MR to MR – in kind. A cash transfer has only the income effect, and the marginal revenue curve shifts to MR - cash. Social programs are often targeted, and in the presence of imperfect information for recipient identification, offering in-kind transfers leads to self-selection. For example, only needy people will show up at a soup kitchen or health clinic providing free services. Of course, some needy people may be erroneously screened out. Note, however, that targeting does not necessarily imply overprovision of in-kind goods like paternalism does.

Cash transfers do not encourage poor people to do something about their future, as future cash payment depend on them being poor. Providing in-kind transfers takes care of this problem by forcing them into consuming goods that will help them out (education, health screening, etc.).


Moreover, the voters prefer to bestow on the poor, benefits-in-kind rather than cash transfers. For example, a coronary artery bypass graft (CABG) can easily cost the equivalent of a fully loaded Mercedes Benz E- 350 with GPS and a six-deck CD player. Taxpayers do buy such medical procedures for fellow countrymen in countries like USA with few questions asked. Can we imagine taxpayers voting for handing out the equivalent amount in cash to the stricken poor?

Another important consideration is how efficiently the government can provide supply. Reforms; like taking away the ownership of all the PDS shops from private businessmen and giving it to local community-owned bodies like forest co-operatives employing tribals, gram panchayats (village councils) and women self-help groups, increasing the commission to PDS shop owners, online monitoring of PDS operations as implemented successfully in Chattisgarh; are helpful. Also, cash transfers are obviously less effective in periods of rising prices of essential goods and services. In situations of volatile and rising prices in the deregulated markets, the real value of cash transfers can get quickly eroded, and the systems of price indexation of such transfers are typically slow, insensitive and inadequate to cover the price increases.

The cash transfers cannot be a solution to the problem of persistent poverty, simply because they do not in any way address the basic causes of poverty. The poor are defined not just by low income but more fundamentally by their lack of assets, which in turn is related to the concentration of assets somewhere else in the same society.

The bank account is the most important criterion for the cash transfers to work. But only 40% of India's population has bank accounts. The other pillar that the cash transfer scheme leans heavily on is the UID. The implementation of UID has been cumbersome - getting banks to rural areas and sensitizing administrators working at the grassroots level have been some of the challenges. So far, about 21 crore Aadhaar numbers have been created. This is less than a third of the number of people targeted under the cash transfer scheme. Thus, financial inclusion and availability of information technology infrastructure are preconditions to cash transfer and there are substantial problems in the state on both accounts.

To sum up, we see that in-kind transfers do not raise prices like cash transfers, and are also expected to be compatible with the social security expectations of tax-payers, as illustrated by the heart operation and Mercedes example cited above. Cash transfers cannot and should not replace the public provision of essential goods and services, but rather only supplement them. They cannot be considered as panacea for evils like poverty, low incomes etc. In other words, cash transfers are desirable and can play a positive redistributive role if they are additional to other basic goods and services, provided in-kind to the needy.

References


  1. WORLD BANK (1994): World Development Report 1994: Infrastructure for Development. Oxford University Press for The International Bank for Reconstruction and Development, New York.

  2. WORLD FOOD PROGRAMME (2011): “Cash and Vouchers: An Innovative Way to Fight Hunger,” News release

  3. BEARSE, P. M., G. GLOMM, AND E. JANEBA (2000): “Why Poor Countries Rely Mostly on Redistribution In-Kind,” Journal of Public Economics, 75(3), 463–481.

  4. IFAD (2010): “Rural Poverty Report 2011,” International Fund for Agricultural Development Policy Report.

  5. NICHOLS, A. L., AND R. J. ZECKHAUSER (1982): “Targeting Transfers through Restrictions on Recipients,” American Economic Review, 72(2), 372–77.

  6. PEAR. (2003): “Welfare Spending Shows Huge Shift,” New York Times, October 13.

  7. Jesse M. Cunha, Giacomo De Giorgi, Seema Jayachandran(2011): “The Price Effects of cash versus in -kind transfers”, NBER working paper no 17456.

Indirect taxation in India: GST- a must needed switch

Shivani Jain

There is a saying in Kautilaya's Arthshastra, one of the earliest books on economics in the world, that the best taxation regime is the one which is "liberal in assessment and ruthless in collection". The proposed GST (Goods and Service Tax) seems to be based on this very principle. Although there has been a lot of hype about the much needed change in the Indian indirect taxation system with an introduction of GST, its true relevance and salient features have not yet been highlighted.


In recent years, the Indian government has undertaken significant reforms in the indirect taxation system. This includes the initiation of a region-based and state-level VAT on goods. However, in order to remove barriers to inter-state trading and to attain a secured market for the activities related to services and goods, more reforms are needed. Some of the reforms that can be introduced for a better indirect taxation system in India are:

  • The serialized set of Indirect Taxes so far activated at the central and state levels should be amalgamated and treated as a single tax and should be neutral at all levels.

  • The Central Sales Tax, which obstructs easy trading between different states, should be terminated in order to boost inter-state trade.

The Indian government has planned to activate a Goods and Services tax neutral at all levels in order to fulfill these objectives.


Goods and Services Tax is a broad based and a single comprehensive tax levied on goods and services consumed in an economy. In simple terms, GST may be defined as a tax on goods and services, which can be levied at each point of sale or provision of service, in which at the time of sale of goods or providing the services the seller or service provider may claim the input credit of tax which he has paid while purchasing the goods or procuring the service.
The government plans to introduce dual GST structure in India. Under dual GST, a Central Goods and Services Tax (CGST) and a State Goods and Services Tax (SGST) will be levied on the taxable value of a transaction. This dual structure will ensure a higher involvement from the states, and consequently their buy-in into the GST regime, thus facilitating smoother implementation. Both the tax components will be charged on the manufacturing cost. The government is deliberating on fixing the value of combined GST rate at the moment, which is expected to be between 14-16 per cent. After the combined GST rate is decided, the centre and the states will finalize the CGST and SGST rates. All kinds of goods and services, barring some exceptions, would be under the GST purview.
Salient Features of Proposed GST in India

  1. Consistent with the federal structure of the country, the GST will have two components: one levied by the Centre (hereafter referred to as Central GST), and the other levied by the States (hereafter referred to as State GST). This dual GST model would be implemented through multiple statutes (one for CGST and SGST statute for every State). However, the basic features of law such as chargeability, definition of taxable event and taxable person, measure of levy including valuation provisions, basis of classification etc. would be uniform across these statutes as far as practicable.

  2. The Central GST and the State GST would be applicable to all transactions of goods and services except the exempted goods and services.

  3. Since the Central GST and State GST are to be treated separately, in general, taxes paid against the Central GST shall be allowed to be taken as input tax credit (ITC) for the Central GST and could be utilized only against the payment of Central GST. The same principle will be applicable for the State GST.

  4. Cross utilisation of ITC between the Central GST and the State GST would, in general, not be allowed.

  5. To the extent feasible, uniform procedure for collection of both Central GST and State GST would be prescribed in the respective legislation for Central GST and State GST.

  6. The taxpayer would need to submit periodical returns to both the Central GST authority and to the concerned State GST authorities.


Benefits of Goods and Services Tax:

  • Eliminates cascading effect of taxes across all supply chains by reducing cost of doing business and makes the economy competitive.

  • Eliminates multiplicity of taxes, rates, exemptions and exceptions.

  • Eliminates dual taxation of the same transaction (e.g. VAT & Service tax on EPC (engineering, procurement and construction) contracts.

  • Reduces cost of production.

  • Achieves, uniformity of taxes across the territory, regardless of place of manufacture or distribution.

  • Provides, greater certainty and transparency of taxes.

  • Ensures tax compliance across the economy.


Need For Goods and Services Tax in India:

The introduction of the GST brings about a macroeconomic dividend as it reduces the overall incidence of indirect taxation and therefore the overall tax burden by removing the many distortionary features of the present sales tax system. There are four important macroeconomic channels through which this happens:

a) The failure to tax all goods and services distorts consumption decisions; GST reduces these distortions and enables all economic agents to respond more effectively to price signals.

b) The non-refundable taxation of capital goods discourages savings and investment and retards productivity growth. This is perhaps the most important gain through introduction of GST in an emerging economy like India.

c) For a given constellation of exchange rates and price levels, violation of the destination principle places local producers at a competitive disadvantage, relative to producers in other jurisdictions.

d) Differences in tax bases of different States and the Central government greatly increase costs of doing business. The GST based tax reform provides a real policy opportunity to do something about this problem without waiting for prior and sweeping political economy changes.


There has been a lot of controversy on implementing GST in India, one of the main reasons behind being the pivotal and a major change needed in the constitution written by our forefathers:

The Constitution provides for delineation of power to tax between the Centre and States. While the Centre is empowered to tax services and goods up to the production stage, the States have the power to tax sale of goods. The States do not have the powers to levy a tax on supply of services while the Centre does not have power to levy tax on the sale of goods. Moreover, the Constitution also does not empower the States to impose tax on imports. Therefore, it is essential to have Constitutional Amendments for empowering the Centre to levy tax on sale of goods and States for levy of service tax and tax on imports and other consequential issues. As part of the exercise on Constitutional Amendment, there would be a special attention to the formulation of a mechanism for upholding the need for a harmonious structure for GST along with the concern for the powers of the Centre and the States in a federal structure.


Despite the major hurdle mentioned above, GST is seen as the panacea for removing the ill-effects of the current indirect tax regime prevalent in the country. If adopted and implemented in its true spirit, GST may neutralize the existing problem of taxes being levied on top of taxes and would also help to spur the economic growth.
FDI in Retail: Boon or Bane


Ganganjyot Kaur Narwal
For some time now, India has been witnessing heated debates over allowing Foreign Direct Investment (FDI) in some more sectors. Most recently, allowing 51% foreign direct investment in multi-brand retail saw a huge uproar. It drew attention from almost all sections of the society. On one hand, FDI is believed to be a boost to economic growth, but on the other, apprehensions have surfaced emphasizing the loss of social welfare to small farmers and traders. To find a balanced solution to this issue, a deep understanding of the complex composition of the Indian economy is essential.

In simple terms, FDI is defined as the net cash flow of investments from overseas. United States of America is the highest recipient of these cash flows accounting to almost $194 Billion in 2010. China happens to be the second largest recipient with a total of $85 Billion. UNCTAD in its investment report classifies India as the second most important country in the world for FDI. Further analysis reveals that in a developing country, FDI can boost up an economy’s GDP by 5% to 35%. India is one such country which can benefit tremendously from FDI. At present, India allows 100% FDI in areas like floriculture, horticulture, animal husbandry and services among others. However, the actual investment is a mere 32%. Industries such as mining of gold, silver and precious stone etc too have 100% FDI permissible. Asset reconstruction companies, among others, are some services with full FDI allowed. Atomic energy, real estate and tobacco etc are completely banned from any foreign investments.

The apprehensions over the credibility and functioning of FDI are rising as the government is becoming more and more liberal with its FDI policies. Unfortunately, not much can be concluded from the persistent debate about FDI because the debate itself is not pointed in the right direction.

Indian GDP consists of a 27% contribution from agriculture and rest 73% from services and industries. Demographic statistics suggest that the proportion of the population engaged in the agriculture sector is 60%. It is just the 40% in manufacturing and services which make the largest contribution to the GDP. Disproportionate contribution by agriculture is a proof of poor performance and low income generation in this sector. Indian agriculture is in jeopardy as even with a 100% FDI, there has hardly been any significant investment. Thus, the immediate focus of FDI policies must be agriculture and agriculture based industry.

Food production in India has increased tremendously over the years. The Indian food processing market is an assured source that can attract large scale investments. India has a wide ranging and extensive base for food processing industries. So far, 100% FDI policy has met with negligible success as the impetus for foreign companies has not been enough. The need of the hour is for policies to be framed and implemented in such a way that the potential of the agriculture sector can be put to best possible use.

Rapid urbanization, industrialization and fast changing lifestyles open vast potentialities for an increased demand for processed food. This industry already accounts for 32% of the country’s total food market. Estimated to be almost $121 billion, it is definitely one of the largest industries in the country. FDI policies, if implemented in innovative ways, can help tap the potential of this market.

Certain factors such as a cheap labor force should be one of the greatest incentives given to the foreign companies for investment. Further, this will tremendously help the Indian workforce, which is needlessly engaged in agriculture, to disengage itself and turn to new avenues of employment.

Increased awareness about the need to incentivise India’s food processing sector has led the ministry of Food Processing Industries to come up with policies such as Vision 2015, Mega Food parks and Agri-export zones. Such policies must focus on deriving investment from foreign resources. Kellogg’s, Nestle, Heinz etc are some existing companies in this sector. Entry of many more is needed.

Agriculture, being the largest sector (in terms of employment), is the key to success. Many areas such as irrigation and technological assistance for machinery, implements, and farm management need attention. Credit market hitches, disguised unemployment and risk bearing are some other loopholes that need to be fixed. For example, in the Indian context, underground water has been the major source of irrigation. Large exploitation of this source has led to a great fall in underground water resources. Foreign companies, if allowed to enter the arena of irrigation, can address issues of poor irrigation. Vast areas have inadequate facilities of irrigation and farmers’ dependence on monsoons is a serious problem in the country. Construction of ponds, canals, reservoirs, etc will become easier and more efficient with Foreign Direct Investment. The methods of watering could be changed from flood to drip and sprinkling irrigation. Other services such as storage, procurement, etc will be better-planned and at the same time, will open new opportunities for jobs. Credit flows and risk sharing will be much better than at present.

U.S.A, the largest economy in the world, has approximately 60% of its FDI in food processing/convenience goods sector. This serves as an example for an agrarian economy like India to understand the growth potential bestowed within this sector. The terms and conditions of the FDI policies may be debated over in such a way that small farmers and traders benefit tremendously without jeopardizing the profits earned by overseas companies. A win-win situation can emerge provided the policies are framed in a desirable way.



Foreign Direct Investment has now become an essential domain in the Indian growth issue. In conclusion, Indians must shift away the focus of the current debate from the economic creditability of F.D.I to its orientation so that maximum benefits can be extracted.
Understanding Direct Cash Transfers



Aditi Singh
The newly launched Direct Cash (Benefits) Transfer (DCT) scheme has generated a lot of debate and this article aims to explore the pros and cons of it. Under this scheme, the government will transfer cash benefits directly to the bank accounts of identified beneficiaries. Initially, this scheme covers only scholarships, pensions and Mahatama Gandhi National Rural Employment Guarantee Act (MNREGA) wages. The identity of the person will be verified through the Unique Identification (UID) or Aadhaar cards.
To start with, let us examine the advantages of this scheme. First, direct cash transfers can be targeted unequivocally to the poor, which reduces the corruption caused due to the presence of middlemen. Second, the Aadhaar number will help to eliminate duplicate cards and cards for non-existent persons or ghost beneficiaries in schemes such as MNREGA. Third, DCT can plug leakages of the Public Distribution System (PDS) by reducing hoarding, black marketing and wastage. If the fair price shop dealers get the same price from their legitimate customers as from the black market, then there is no incentive to cheat. These three factors, together, lead to massive savings for the government. Even if these leakages are conservatively estimated at less than 10% of the total subsidy bill, it amounts to a substantial annual sum, given the subsidy bill of about Rs 300,000 crore.
Another benefit is that unlike subsidies, direct cash transfers do not distort market prices. The scheme will also enhance the efficiency of welfare schemes. A big part of the inefficiency in government service delivery is due to the inability to authenticate the identity of individuals. The UID provides a platform amenable to technological innovations to resolve the numerous pinpricks that affect service delivery. The use of micro ATMs, for instance, can enable people (with a UID number) to open a bank account at their preferred kirana shop. Delhi started such a scheme, Saral Money, in December 2012, where merely stating your UID number suffices for know your customer norms. The Unique Identification Authority of India (UIDAI) transfers the relevant data to the bank branch concerned without losing time or depending on the kirana shop owner to use his discretion. This system can be a boon for the poor.
Additionally, such projects have often helped to build the state's legitimacy as programmes are targeted at marginalised groups and support their integration. Another boon is that because DCT will only compensate for a finite amount of resources consumed, it will encourage beneficiaries to reduce their usage of these resources. Furthermore, since cash transfers are regular (typically every month), so the poor can plan on them and include them in the household budget.
In the context of DCT, a recent study was conducted in Delhi by the India Development Foundation (IDF) on behalf of Self-Employed Women’s Association (SEWA). Poor people in similar conditions were randomly divided into three groups. Group 1 got the cash transfer through a bank account that was opened for the woman in the household; their Below Poverty Line (BPL) cards were stamped by the Delhi government stating that they were not eligible to get anything from the PDS shops for one year from the date of the stamp. A bank account was opened for the women in Group 2, but no cash was given to them and they could use the BPL card in the PDS shop. Nothing was done for Group 3. The reason for creating Group 2 was to isolate the impact of the cash transfer from that of having a bank account.
The study does not find any evidence for the argument that with a direct subsidy, households would spend less on food and more on other things that could lead to a loss in nutrition with harmful long-term effects, especially on children. On the contrary, it finds that unconditional cash transfers provide opportunities for households to shift to other nutritious options in the non-cereal segment. What is remarkable, though, is that this increase in non-cereal food items is not compensated by a decrease in calorie intake from cereal food items.
An interesting effect of cash transfer on those who did not receive it was also observed. This is the spillover effect. In particular, it was found that the service quality of PDS shops improved over the period of the experiment, probably because they now faced competition from private shops. At the very least, the study suggests that there could be poor households that would prefer the cash transfer compared to the PDS and the objectives of the PDS would not be compromised.
Nevertheless, there has been a lot of opposition to the DCT scheme, mostly pivoting around its implementation. A vast majority of beneficiaries still do not have the requisite bank accounts mapped with 12-digit Aadhaar numbers. There are also not enough bank branches to open accounts. Only 40% of India's population has bank accounts. Additionally, not all account holders have got passbooks. Banks have also been reluctant to come to rural areas because no-frills accounts in these areas do not fit in with their business model. For greater financial inclusion of the poor, orientation and acquaintance courses must be held to make the masses more familiar with banking terms and formalities. Several other technical and logistical difficulties have come to the fore in the various pilot projects launched. For example, in the case of those few people who have Aadhaar-linked accounts, often their fingerprints do not match when they try to get paid via the new micro ATMs. Banks are also not able to cope with the volume of transactions. They also have to face other problems like poor internet connectivity and power cuts. Concerns about the security and integrity of the cash-carrying banking correspondents have also been raised.
There may still be a serious problem of transition, especially if there is a time lag in opening an account in a bank to receive the cash transferred. If, meanwhile, the subsidised food disappears, the poor who fail to open an account adequately fast will lose doubly through not having the cash yet, and through the fact that others will have the cash to buy food which would keep the prices high. Moreover, under the previous system, in case the head of the household was sick, or disabled or unable to move due to old age or otherwise, he could send someone else to buy rations. Now however, to withdraw the cash subsidy, the account holder is required to be physically present at the bank, which has made it useless for old-age card holders as several bank branches are located 8-15 km from their villages.
Some fear that the scheme is likely to be misused by the government as a political gimmick. In addition, as giving money to the poor becomes easier, politicians might spend much more than necessary which would lead to a rising fiscal deficit. There are also concerns about the confidentiality of private data and the government's ability to misuse it to monitor individuals.
Interestingly, activists support DCT when it pertains to providing social security pensions, scholarships, and maternity entitlements. However, replacing subsidized food grains, kerosene, and fertilizers with direct cash transfers is being fought tooth and nail, especially in light of the express timelines laid out by the government. This is because independent studies reveal that government pilots for DCT scheme have been disasters. A case in point was the Kotkasim district (Rajasthan) pilot, conducted between 2011 and 2012, wherein the government tried to provide DCT to those eligible for subsidised kerosene. In one year, sales of kerosene fell by 80%. But far from being a result of efficient design, this was due to people either not getting their bank accounts in place or not getting the subsidy amount in their existing accounts. As a result, people stopped buying costly kerosene with no assurance of support. Noted economist John Drèze and his fellow activists call it ‘denial by design’. Also, it is still not advisable to replace subsidized food grains by cash because while the market price of food goes up instantaneously, the increased subsidy can happen only with a lag.
I would like to conclude by first recognising the fact that in a country as vast as India, any new programme is bound to face executional difficulties. But rejecting it simply because of the difficulties in implementation is wrong. There is no doubt that the DCT scheme is based on sound ideology. Hence, the need of the hour is to bring in this scheme in a proper manner which includes all the poor.
References
1. www.thehindu.com

2. http://www.business-standard.com/article/opinion/shubhashis-gangopadhyay-who-prefers-cash-transfers-113012600135_1.html

3. http://indiatoday.intoday.in/story/what-is-direct-cash-transfer/1/235028.html

Rural-Urban Migration and Issues in Urbanization

Vatsala Shreeti

The sharp U-turn of the Indian growth story has been the focus of economists, leaders and policy makers from all over the world recently. The country finally seems to be coming out of the much talked about ‘policy paralysis.’ While the focus had been on broad macroeconomic indicators such as interest rates and inflation among others, there is a parallel need to critically examine issues that will determine the long term course of India’s development. Through this article, I attempt to examine one such issue, that of migration of labour from rural areas to urban areas and the urban poverty that is linked with it.
India is urbanizing at a very fast pace and in just over two decades, the urban population of the country is expected to almost double. This means that there will be immense pressure on existing cities in the future and a spurt in the growth of unplanned satellite cities. Without effective management of the entire process of urbanization, it is unrealistic to expect sustainable and inclusive development of the country. In order to analyze these issues in urbanization, it is essential to start by describing the nature of rural-urban migration and its causes.

Rural-Urban Migration
The theory of rural-urban migration is based on the Harris-Todaro model. The basic cause of migration, as identified by this model, is the wage differential between the urban formal sector and the rural agricultural sector of an economy. We divide the economy in two sectors: a traditional rural sector and an urban sector. The total labour force is divided between these two sectors. Wages in the formal sector tend to be higher due to a variety of reasons. This sector is usually unionized, subject to collective bargaining, pension schemes, minimum wage laws, etc which translates into a better bargaining position for workers and hence leads to higher wages. It may also be the case that firms in the formal sector deliberately pay higher wages (efficiency wages) in order to induce greater effort by workers and lower turnover rates. On the other hand, the traditional rural sector has lower wages which fluctuate according to demand and supply conditions. Migration from the rural sector to the urban sector is viewed as a result of this wage gap.
The problem arises when the urban formal sector lacks the capacity to absorb all the workers that migrate from the rural sector. The wage differential between the two sectors leads to a pool of unemployed people in the urban sector. These unemployed workers cannot move back to the agricultural sector because this would reduce the wages in the agricultural sector even further hence increasing the incentive to migrate. This leads to a proportion of the migrated workers to work in the informal sector, where jobs are easy to find but pay very less. This informal economy thrives as it keeps the labour costs in the formal economy relatively low.

Unregulated economic activity in the informal sector is often one of the major challenges of urbanization. The informal sector forms the bulk of the urban poor. This sector is often associated with the congestion, pollution and crime rates that are characteristic of big cities. Additionally, the haphazard growth of this sector due to migration puts pressure on the existing infrastructure and administration. More importantly, wages in the informal sector are depressed and access to a better standard of living (which, paradoxically, is the rationale behind migration) is limited due to supply side constraints. This translates into rising economic inequality and fragmented development. One doesn’t need to go too far to validate this; the co existence of slums in close proximity with plush shopping complexes in Delhi serves as a perfectly accurate example of how severe the challenges of urbanization are.

The growing urban population calls for policy action at two distinct levels. While there is a need to expand the absorption capacity of the urban formal sector, there is also a simultaneous need to manage our cities better.

The paradox of urban job creation

The most obvious way in which the problem of a largely unregulated informal sector can be addressed is by trying to accelerate the absorption of labour in the formal sector. This may be done either by incentivising businesses or by expanding the public sector. While this may lead to a temporary shrinkage of the informal sector, the expansion of the government sector will eventually lead to the rural-urban migration picking up again in response to new formal sector job opportunities. The initial ‘soak-up effect’ may be dominated by fresh migration in response to better job conditions in urban areas and paradoxically, the size of the informal sector may end up increasing once again (This phenomenon is known as the Todaro paradox). Physically restricting migration is unfeasible politically and ethically, however, this paradox can, in theory, be addressed by offering employers in the formal sector a subsidy for every unit of labour they hire. In this case, the employer pays the same wages, however, workers get a higher a wage and with a rise in the subsidy, formal sector demand for labour also rises. The problem with policies of this kind is that employment figures are difficult to verify. It is costly to determine the right amount of subsidy as this would involve verifying the veracity of each employer’s employment data.



Management of the Urbanization Process

Since it is difficult and often unethical to restrict the migration from rural to urban areas, the focus should be on effective management of the process of urbanization. Policies should be targeted at alleviating large sections of the urban population from the abysmal conditions that they live in and ensure that cities can sustain such large numbers. Additionally, the focus should also be on creating more urban centres and relieving the pressure on existing ones like Delhi, Mumbai and Bangalore.



  • The capacity of existing cities continues to be dismal. The High powered expert committee report on urban infrastructure has recommended that a municipal cadre of officers trained in town planning be made. According to this report,

  • As large scale public investment is required for the urbanization process to go on smoothly, revenue generation will have to be from within the cities. Additionally, cities will have to be able to raise debt funds through the market.

  • The attitude of citizens towards migrants, especially from economically weaker sections of the society, is a cause of worry. It is essential to include citizens in the planning process and make them aware of the long term benefits of planning policies.

  • The efficiency and execution of the service delivery process in cities need to be improved. Further, initiatives need to be taken by citizens themselves to ensure better standards of services and service delivery.

Integrated and sustainable urban development is the need of the hour and India has a long way to go in terms of addressing these issues in uneven development across space and inequality of opportunities across different sections of the society.

References
1. Ray, Debraj (1998): Development Economics
2. Themes from workshop on Urban Infrastructure and Service Delivery, IFMR Finance foundation& Centre for Development Finance
3. Mann, Preeti (2012): India in Transition; Urbanization, Migration and Exclusion in India, Centre for Advanced Study of India, University of Pennsylvania


The Relevance of Cooperatives

Swaril Dania

“Cooperatives are a reminder to the international community that it is possible to pursue both economic viability and social responsibility.” –Ban Ki Moon, UN Secretary General

The year 2012 has been recognized by the United Nations as the international year of cooperatives (IYC), highlighting the contribution of cooperatives to socio-economic development. With its slogan “Cooperative enterprises build a better world” the initiative seeks to encourage the growth of cooperative organizations. But what exactly is a cooperative and how have they suddenly become so crucial in the present world?

According to the statement of ICA on cooperative identity, a cooperative may be defined as an autonomous association of people who voluntarily cooperate for their mutual, social, cultural and economic benefit. ICA or the International Cooperative Alliance is an independent nongovernmental organization with 277 member organizations from 98 countries which unites, represents and serves cooperatives worldwide. Founded in 1985, ICA today serves to be the major connecting tool between cooperatives across the globe.

Also, as a part of its statement on cooperative identity, it lays down seven principles that define cooperatives:


  • Voluntary and open membership: Cooperatives are voluntary organizations open to all people able to use their services and willing to accept the responsibilities of membership without gender, social, racial, political or religious discrimination.

  • Democratic member control: Cooperatives are democratic organizations controlled by their members, who actively participate in settling their policies and making decisions. Men and women, as elected representatives, are accountable to membership. In primary cooperatives, members have equal voting rights and cooperatives at other levels are also organized in a democratic manner.

  • Member economic participation: Members contribute equitably to, and democratically control, the capital of their cooperative. At least part of that capital is usually the common property of the cooperative. Members usually receive limited compensation, if any, on capital subscribed as a condition of membership. Members allocate surpluses for any or all of the following purposes: developing their cooperative, possibly by setting up their reserves, part of which would at least be indivisible; benefiting members in proportion to their transactions with the cooperative; and supporting other activities approved by the membership.

  • Autonomy and independence: Cooperatives are autonomous, self help organizations controlled by their members. If they enter into agreements with other organizations, including governments, or raise capital from external sources they do so on terms that ensure democratic control by their members and maintain their cooperative autonomy.

  • Education, training and information: Cooperatives provide education and training for their members, elected representatives, managers and employees so they can contribute effectively to the development of the cooperatives. They inform the general public particularly the young people and opinion leaders about the nature and benefits of co-operation.

  • Cooperation among cooperatives: Cooperatives serve their members most effectively and strengthen the cooperative movement by working together through local, regional, national and international structures.

  • Concern for community: Cooperatives work for the sustainable development of the communities through policies approved by their members.

Indeed, the above stated principles highlight the regard for both economic viability and social responsibility in cooperative structures as has been stated by the UN Secretary General.

Together these principles guarantee the conditions under which members own, control and benefit from the business, ensure that they effectively contribute to the development of cooperative and to the sustainable development of their communities.

And hence, in today’s era, where no one can escape globalization, these have a crucial role to play as they encourage self reliance and empower people by providing employment opportunities and securing the livelihoods of nearly a quarter of the world’s population and thus help in poverty alleviation as well.

With the intensification of liberalization and globalization, cooperatives have become all the more important as tools that bridge the gap between market and human values. What makes these organizations so different from the others is their member driven nature. Because cooperatives are business enterprises owned and controlled by the very people they serve, their decisions are balanced by pursuit of profit and the local interests. As the world becomes increasingly borderless and the advent of multinationals in the developing countries raises fears in the minds of small scale producers and workers, the role of the cooperatives becomes more and more significant. With no protectionist policies and opening up of markets by the government, cooperatives are an efficient way of organizing the small scale sector in the developing countries as these have immense potential to neutralize the adverse effects of globalization. Initially the idea of cooperatives in India emerged from the growing menace of rural indebtedness but over time it has come to occupy a central place in the measures to strengthen our economy.

Cooperatives are considered by some as an ideal model for local economic development because with local ownership and control and proportionate distribution of net profits among the members, it has the potential to foster economic growth at the regional and community level based on the spirit of cooperation that exists predominantly in the rural areas. They give a boost to the rural economy which is largely based on agriculture as they provide real economic benefits to farm families through increasing the stability of farming sector and by improving market access for their products. Often traditional companies find it very costly to provide services in the rural areas and there also the cooperative sector fares quite well as unlike the traditional profit seeking companies which anticipate unacceptable levels of economic return and hence do not venture into the areas, cooperative enterprises respond to the local needs and act as a provider of services such as electricity or management of water resources.

One of the major advantages of the cooperatives, due to the member owned nature, is that they meet community needs and objectives and place greater importance on them and have flexible profit objectives. Investor owned firms on the other hand have considerable pressure to raise profits and grow as fast as possible. Not only do the cooperatives add sustainability to the development, also as people pool their limited resources to achieve a goal they combine people, resources and capital into larger more viable and economically competitive units.

Moreover, they have certain financial advantages as well as they become eligible for loans and grants from various agencies. Cooperatives are stable employers and often they strive to find innovative ways to retain jobs ensuring job security. The democratic nature and values (self help, democracy, self responsibility, equality, equity and ethics) of the cooperative institutions allow the local people a voice in policy matters which gives a sense of empowerment to the people. Of late cooperatives have been associated with women empowerment as well as today one comes across various success stories of women organizing various cooperative ventures in countries like India and Nigeria and across the globe. They respond to both the practical and strategic needs of women and chart their route to economic political and social empowerment. As self help organizations they contribute to the eradication of poverty, stimulate the local economies, and enhance the social fabric of the communities. They generate employment and promise job security and better living standards for their members. By empowering marginalized sections of people, women and other socially disadvantaged groups they encourage social integration and cohesion and perform a very important task of social development and fostering equality and peace building.

Despite challenges like mismanagement and manipulation in the affairs of elections to the governing body of the cooperative, excessive government interference, local politics, lack of awareness among members, inadequate promotion, restricted coverage and several other functional weaknesses like that of inadequacy of training personnel and lack of quality management; the inherent advantages of cooperative ventures have made it increasingly significant to promote the growth of these institutions.

In the words of Kofi Annan – “In an age where community involvement and partnerships with civil society are increasingly being recognized as indispensable, there is clearly a growing potential for cooperative development and renewal worldwide.”


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