Government officials talk up country’s economic prospects

Source: Economictimes

Private banks start lowering lending rates

Source:Business-Standard

Dose of the day: Tax cuts...but with a difference

Everytime an economic crisis arisis the debate between those who advocate free market play and those who advocate state intervention becomes hot. A similar kind of debate started when this economic crisis started last year. Thankfully, now people unanimously agree that in order to come out of this crisis the state will have to play a pivotal role.

In the past few months the RBI has lowered its policy rates drastically and has urged the banks to lower their lending rates. I am completely in agreement over this. However, today I see excessive reliance by the govts on monetary policies. There is a need for fiscal policies too. It is essential to understand that in a country like India there is no liquidity crunch. We have a demand crisis.
Cheap loans will be taken up by only those who can see demand for their goods. For example: As a CEO of a manufacturing company, I wouldn’t take cheap loans to expand unless I see some demand for my goods. Why are people not buying? Is it because they are short on cash or don’t have access to cheap money? Both to some extent

Today there is a need to boost demand and increase confidence. This recession will worsen if we don’t boost demand.
How to boost demand? This is where fiscal policy comes into play. Indian govt has already announced several stimulus packages. Actually, some people have been asking the govt to stop this spending as it is leading to higher debt levels. Coming back to the point- We can boost demand if we give money to the people. We need tax cuts. But there are two problems with simply reducing taxes-
1. Tax revenue will fall –something that the govt may not want at this time
2. People will definitely welcome this step, but may not start buying. In a country where there is no proper social security, people may be more tempted to save that extra bit of money. (Makes sense- In uncertain times, I would definitely start saving more)

Can we have a plan that not only gives people more money but also gives them an incentive to buy more? I can think of one
The Income tax department gives a Rs 1 lac deduction under section 80c to income earners. This Rs 1 lac deduction is allowed for those who invest this amount in mutual funds/PF/govt securities or other money market instruments that come under section 80c. This provision allows people to subtract that amount from their taxable income and save tax. What happens with all these savings? Basically these savings are loaned out to others. Savings become investments. This is a way through which the govt incentivizes people to save and invest. This is govts way of making people save. Can there be a similar way through which the govt can make people buy and consume?

Yes, here is the plan-
Similar to giving a tax deduction for purposes of saving, the government should give a tax deduction to give people an incentive to buy more. Let’s say that govt gives an additional 50,000 tax deduction under the law to people who consume durable goods. People who buy such goods and shows receipts of such purchases to the govt will get a tax deduction for that amt (less than or equal to 1 lac). How to keep track of this consumption? Well, the govt can start manufacturing special machines that can generate a unique receipt number. Ex- For consumers in New Delhi- receipt nos may start from NDLXX___. These machines can be sold to all companies in the relevant industry.
Now this is a simple plan, but its implementation can have huge benefits-
1. Tax revenue- Yes, the income tax revenue will fall in general. However, the govt will be able to generate more sales tax revenue by expanding the tax base. Sales tax revenue leakage has been a problem for a long time. But now companies will have to buy such govt manufactured machines which will generate receipts and consequently track the sales
2. Demand- Consumer demand will increase. As I mentioned earlier, India is not in a liquidity crunch. Now people will have more money and more incentive to buy goods. Just as the govt used to make people save money by giving tax deductions, now it can make people consume more by doing the same
3. Employment in the govt sector- This new machine will have to be manufactured somewhere...and you will obviously need people to do the manufacturing, distribution, governance, etc

This plan is very ambitious and has its own shortcomings- Given that it is a fiscal policy, its approval by the parliament may take sometime and may also face resistance. Also, manufacturing & distribution of such machines will take sometime.
But I think that this is a long term solution. It is not just to tackle this recession.

Any thoughts?

India’s growth may drop to 4.3% in 2009: OECD

India’s economic growth may slow to an 18-year low of 4.3% in 2009, with falling exports offsetting expansion in domestic demand, the Organization for Economic Co-operation and Development (OECD) said on Tuesday.
Though the country’s gross domestic product (GDP) grew at a meagre 1.3% in 1991-92, the only growth rate comparable with the current projection was in 2000-01 at 4.4%.
OECD economist Sean M. Dougherty told Mint that “this is due to a fairly broad-based slowdown in global economy and less to do with the Indian economy,” adding that India’s external sector will bear the brunt of the slowdown.
Source: LiveMint

4.3% looks very pessimistic.

Here are some of the other predictions for the growth of the Indian economy in 2009-10:

World Bank-4%
CLSA- 4.6%
IMF-5.1%
UN- 6%
ADB-6.5%
Indian govt-7.1%

Free rider problem

Unfortunately, yesterday somebody stole my car stereo while the car was parked in the parking. It was not just me but there were 5 more people who were complaining about the same. Let me describe the parking in my area- We have residential colonies and the parking slots are not permanent, so people park their cars near their houses-not necessarily in front of them.
I went up to the residential welfare association president to complain about what happened. He told me that he was helpless. He described the problem to me-
Problem: There are not many guards in the area. The existing guards are also very weak and are not that efficient
Cause of the problem: There were very few guards because there were no funds with the treasury to hire more. Why were there no funds? Well, the monthly service fee for security was not being paid by a significant number of residents.
So basically, only a few residents were paying money to the association to hire security guards for the residential colonies. This sounds like a typical free rider problem. A free rider is a person who receives the benefit of a so-called public good without paying for it. Few residents were not paying because they wanted others to pay for security.
Clearly, this is a problem
Solution:
Mr president suggested one solution- Make every individual pay a fee for every car they own. This will generate enough revenue to hire more guards. I like this solution. But the problem is that this fee is not a tax on the residents. Even if they don’t pay this fee, the association cannot do anything. This will also give the residents an incentive to lie about the number of cars they own.
Typically, solution to such problems lies with taxation. But, because the residential association is not a government unit, taxation is not an option.
Here is what I would suggest- Make every household pay a fixed fee. Assign an agent for every building (the agent should be a resident from the same building) in the residential area for collecting the amount. Have an incentivized structure for these individuals so they also get some share (1%-2%) from the total collection. I believe that a significant number of individuals who were not paying earlier would start paying. This fee is still not a tax. But collection from those individuals who were not paying anything earlier will increase as now the fee collection will be more organized & incentivized; agents will chase the residents and make them pay the fee. Seeing “friendly” neighbours collect money, residents will definitely start paying the fee.
Can you suggest any other solution?

Forex reserves swells to $ 253.83 bn

Forex reserves went up to $ 253.83 billion for the week ended March 20, up $ 5.1 billion, compared to $ 248.72 billion in the previous week...
Source: EconomicTimes

Good news: Lending rate coming down

4 banks cut PLR by 25-50 bps
Source:Business Standard