GS (M) Paper-2: “Effect of policies and politics of developed and developing countries on India’s interests, Indian diaspora.”
US Fed raises key interest rate – Why it is not a good news for India?
The United States Federal Reserve’s decision to raise interest rates by a quarter point around midnight could not have come at a worse time for India, especially because it was accompanied by a statement that there will be more, and faster, increases in 2017.
Current global scenario:
- The United States president-elect, Donald Trump, said he won’t allow H1B visa holders to replace US workers.
- Last year the seven largest Indian IT companies got nearly 15,000 of the 85,000 H1B visas approved by the US, more than any other country.
- Crude oil prices touched $57 a barrel, their highest in a year and a half. And India’s factory output shrank 1.9%.
- The rise of oil prices, as a direct impact, means a rise in motor fuel prices.
- Indirectly, it will cause a rise in prices all-around, because a lot of goods move on trucks.
- And the IIP dip in October is ominous because the predictions for November, thanks to demonetisation, are already dire.
Impact of Fed reserve decision on India:
Impact on economy:
- Dollar outflows could weaken the rupee, and hold the RBI back from cutting interest rates as that could lead to further outflows.
- With crude prices on the rise, a weak rupee will inflate the import bill and put pressure on the government’s finances.
- Already, demonetisation and the resultant currency shortage has dampened household spending.
- This in turn could hurt firms already sitting on vast unused capacities in consumption-linked sectors.
Impact on market:
- An increase in US Fed rate will be negative for emerging markets in general, India included.
- That is because a rate hike will improve the yields on US government bonds.
- In other words, the bonds will offer a better rate of return than before. This could prompt global money managers to shift a part of their money into US government bonds.
- More often than not, fund managers sell a part of their holdings in emerging market equities and deploy that money in US bonds.
Impact on companies:
- For an exporter, a stronger dollar would mean higher earnings in rupee terms.
- But stiff competition and anemic demand in most export markets means that exporters won’t have much to cheer about.
- Imported raw material such a copper, aluminum and machinery can turn expensive, potentially squeezing margins of companies dependent on them to make products.
- This may lead to hike in prices of goods such as cars and televisions.
- The rupee’s slide can also hurt companies with foreign currency loans as repaying in dollars will get costlier.
Impact on startups:
- An increase in US Fed rate will likely lead a shift of part of their capital and even their focus away from markets such as India towards the US.
- The limited liability partners such las large pension funds and insurance companies which used to invest in venture capital and private equity funds may do so now in funds focused at home, than in Asia.
- This may likely to lead to more consolidation, shutdowns, and lowering of valuations of Indian startups in the months to come.
Impact on investments:
- A stronger dollar could negatively impact gold prices.
- Hence, financial planners suggest staying away from the yellow metal for the time being.
- Equities could be volatile in the short term, but investors should stick with their investments in quality companies.
Higher interest rates in the US will make capital more costly, and affect Indian companies that hope to get funds from there.
This comes as yet another setback for the Indian economy which, grappling with the effects of the demonetisation, is facing uncertain times.
Several agencies, including the Reserve Bank of India, have already reduced their projections of growth for the country’s GDP.[Ref: Hindustan Times]
GS (M) Paper-3: “Indian Economy and issues relating to planning, mobilization of resources, growth, development and employment.”
GS (M) Paper-3: “Inclusive growth and issues arising from it.”
Regulating the digital payment industry
The 8 November 2016 event in India (8/11) is closely linked to the 11 September 2001 event in the US (9/11). The terror attacks led to a large exodus of funds and failures of payment systems brought in the federal banks in the US to aid the system.
India’s payment system infrastructure:
- India has seen a rapid disintermediation of the payments system that was once restricted to only banks and their traditional clearing facilities.
- Entrepreneurs abound in the recent digital payment interfaces such as prepaid instruments like mobile wallets.
- These will replace the traditional clearing systems such as RTGS (real time gross settlement) as also online facilities provided by banks and telecom companies.
- Unified Payments Interface is in itself a game changer and only banks have been allowed by the Reserve Bank of India (RBI) to become payment service providers keeping wallets and other prepaid instruments out, thus giving a boost to banks in the race to secure a big slice of the payments pie.
Requirements of digital transaction regulatory framework:
- It needs a comprehensive legal framework assessment that can identify and set out the rights and obligations of each payment system participant in the ordinary course of business and in adverse conditions is a robust one.
- This will require predictability on how the regulator applies its rules and regulations (circulars and guidelines) and oversees its applicability to payment system operators.
- It will have to cover the plethora of instruments and test them for conflict such as with the new insolvency and banking laws.
- Seamless cooperation between the bodies involved in policy and regulatory development must be forged so as to oversee consistent application of rules and regulations governing all participants.
- The playing ground for entrepreneurs must be levelled so as to provide confidence, stability and integrity in the financial system.
This will enable participants in a payment system to move in their own orbits performing functions that when interwoven ensure that the country has an efficient, secure and reliable payment system that reduces the cost of exchanging goods and services. A system that, in contrast, is not efficient, secure and reliable can adversely affect the financial system, and can contribute to systemic crisis.
Role of RBI:
- RBI is the sole regulator for the payments industry space and derives its power to oversee the payments industry from the Payment and Settlement Systems Act (2007) and its accompanying regulations (2008).
- Several circulars and guidelines have been issued for the regulator to govern prepaid instruments, intermediaries and the payment system operator.
- Electronic wallets and mobile banking are exempted from KYC compliance for transactions under Rs20,000 and has relaxed the security measure of requiring two-factor authorization to only when one loads money from other banking instruments.
- RBI has also ensured there is not much float pending with prepaid instruments by requiring certain prepaid instruments to seek its approval and exempting those that facilitate simultaneous settlement and clearance.
- Although the regulator is at present vested with powers to call out a systemic risk posed by a participant in the payments space, it may also do well to identify certain payment systems as critical and afford them systemic important status similar to how it identified certain non-banking financial companies as systemically important.
- Such singling out will ensure that their failure in a nascent payment industry does not trigger further disruptions among system participants and stretch to larger financial markets.
- The regulator must also in the days to come set up an end customer protection/guarantee fund so she is protected when the largest participant/debtor in the payment system fails.
- This allows for the deflection of liquidity crunch, so settlement system clearances are maintained without the participants knocking on the doors of clogged courts.
Further, in tune with the self-regulated entrepreneurship that the government is encouraging, the system participant should be encouraged to submit a self-certification assessing and disclosing the technical risks it faces at an enterprise level that can balloon into systemic risks.
The ability to grasp the intricacies of the payment systems have grown since the International Monetary Fund-World Bank Financial Sector Assessment Program in the 1990s, yet there are many issues beyond our collective immediate expertise.
The when and how of the pace of evolution of the payment systems are not known but the why of it is obvious.
The payments terrain therefore should expand and be enabled by regulations to accommodate new kinds of participants in the system. This will foster further innovation that is bound to occur from the disruption caused in the payment spaces, without the regulator having to play catch-up.
The digital payment revolution is the best disruption demonetisation has unleashed. An aspiring economy like India should welcome this brave new world.[Ref: LiveMint]