IssuesforIIMPIProcesshttp://www.essaysforIIM.co.

in

FISCAL CLIFF AND ITS IMPACT

What is the fiscal cliff?

The fiscal cliff is the phrase thats become associated with the combination of $500 billion in spending cuts and tax increases that are scheduled to automatically start at the start of 2013 in the United States. Tax Increases: The Bush-era income-tax rates, which have been extended once already under President Barack Obama, will expire at the end of the year for all taxpayers. Also ending is a payroll-tax holiday, which means a tax increase for workers of as much as two percentage points. In addition, some 26 million additional people face the alternative minimum tax, or AMT, which would raise their taxes liability sharply unless Congress acts.

Spending Cuts: Across-the-board cuts in domestic and, particularly, defense spending would be triggered, including a $55 billion, 9% cut in the defense budget next year and another $55 billion in cuts to domestic programs, including a 2% cut to Medicare providers.

Whats the economic impact of going over the cliff?

If the said measures are taken, the Congressional Budget Office has projected the economy would contract 1.3% in the first six months of 2013, with the economy stabilizing in the second half and eventually achieving an annual growth rate of 0.5%. Joblessness would rise to 9.2% at the end of 2013 if Congress didnt act. But alternately, it has been argues that the budget cutting that would automatically take place will eventually boost growth by putting the government on a firmer and more sustainable financial footing. The counter argument is that going over the cliff would cause a) investor panic and b) consumer panic and fundamentally derail whats already a weak economic recovery. "The US fiscal cliff represents the single biggest near-term threat to a global economic recovery," the Fitch ratings agency said recently. The dramatic fiscal tightening implied by the fiscal cliff could tip the US and possibly the global economy into recession. At the very least it would be likely to halve the rate of global growth in 2013. The IMF has warned that even the uncertainty raised by the fiscal cliff has hit global investment and job creation.

What is the likely impact on India?

Reserve Bank of India cited World Bank research that predicted only a modest impact on India: Economic growth in South Asia would fall by 0.2 percentage points while the current account deficit would improve by 0.1 percentage points of gross domestic product. But the central bank seems worried enough to add: a sharp fiscal contraction may have a deleterious impact on global growth. http://www.essaysforIIM.co.in

 IssuesforIIMPIProcesshttp://www.essaysforIIM.co.in
Commodity prices will ease off and oil prices will stay significantly lower than in the recent past. In fact, fear of the fiscal cliff has already drove down commodity prices, starting in October.This will mean that Indias inflation rate may come down fast enough for the central bank to cut interest rates more quickly than anticipated to stimulate growth. Lower crude oil prices could also ease some of the current pressure on the balance of payments (BoP). Trade: However, there could be potentially adverse impact on the Indian economy from reduced trade and investment. Indias merchandise exports now account for nearly 16% of Gross Domestic Product, while total exports account for approximately 24% of GDP. With Indias major trading partners in trouble, exports are expected to take a hit. Capital flows will also be affected as the global recession that may result, even if the fiscal cliff is avoided, will lead investors to safe havens. That means rising demand for gold and dollar-denominated assets and capital will move away from risky assets (both equity and currency) of emerging markets, including India. Equities: If we look at the correlation of returns of EM equities, they are positively correlated to global equities. Hence any fall in global equity markets due to a fiscal cliff could cause a fall in all emerging stock markets including India.. The fundamentals of the Indian economy are far weaker than they were at the end of 2008, which means that the ability of policymakers to intervene effectively is less than before. One indication of this is the level of foreign exchange reserves with the central bank relative to monthly imports. Such import cover has nearly halved in the past four years, from 12 months to six months. At an International Monetary Fund meeting in Nov 2012, FM P. Chidambaram said that the issues of fiscal cliff and the lifting of the debt ceiling in the U.S. also need to be resolved. The need is to put in place a medium-term fiscal plan while avoiding excessive fiscal correction in the short run. Should the economic situation in the U.S. worsen, its impact on emerging market economies will be much more severe than in the case of the situation in the euro area.

LEVESONINQUIRYImportantasroleofmediahasbeeninlimelightinIndiatoo WhatwastheLevesonInquiry? Itwasapublic,judgeledinquirysetupbyPrimeMinisterDavidCamerontoexaminetheculture, practiceandethicsofthepress.Itwasestablishedinthewakeofthephonehackingscandalatthe nowdefunctNewsoftheWorldtabloid.

Whatdiditlookat? It looked at the relationship between the press and the public, including phonehacking and other potentially illegal behaviour, and at the relationships between the press and the police and the press andpoliticians. WhatdidLordJusticeLevesonrecommend? Hemadebroadandcomplexrecommendationsrelatingtohowthepressisregulated:

http://www.essaysforIIM.co.in

 IssuesforIIMPIProcesshttp://www.essaysforIIM.co.in
Newspapersshouldcontinuetobeselfregulatedandthegovernmentshouldhavenopowerover whattheypublish. Therehadtobeanewpressstandardsbodycreatedbytheindustry,withanewcodeofconduct That body should be backed by legislation, which would create a means to ensure the regulation wasindependentandeffective Thearrangementwouldprovidethepublicwithconfidencethattheircomplaintswouldbeseriously dealtwithandensurethepressareprotectedfrominterference.

Whydidherecommendreworkingpressregulation? The current system, where the press is selfregulated voluntarily through the Press Complaints Commission (PCC), is widely agreed to be doomed the PCC itself has agreed to move into a "transitionalphase"untilalongtermreplacementcanbeestablished. The chairman of the PCC, Lord Hunt, wants a new "tough, independent regulator with teeth". He told the Leveson inquiry there was a willingness among publications for a "fresh start and a new body"basedonlegallyenforceablecontractsbetweenpublishersandthenewbody. TheFreeSpeechNetwork,whichrepresentsmanyeditorsandpublishers,isvigorouslyopposedto anystateinvolvementinpressregulation.Itsaysthepressexiststoscrutinisethoseinpositionsof power,anditcouldnotdothatifthoseitwasscrutinisinghadauthorityoverit.

JUDICIAL ACTIVISM
Judicial activism is a philosophy of judicial decision-making whereby judges allow their personal views about public policy, among other factors, to guide their decisions. It can be narrowly defined as one or more of three possible actions: overturning laws as unconstitutional, overturning judicial precedent, and ruling against a preferred interpretation of the constitution. (For instance widening the right to life to include right to free legal aid, right to privacy, right to healthy environment etc) The chief instrument through which judicial activism has flourished in India is Public Interest Litigation (PIL). In normal course of law, an individual can approach the courts only if he/she has been personally aggrieved. But in the case of PIL, the case is filed not by the aggrieved persons but by others on their behalf. Many public spirited citizens and voluntary organisations (eg. Center for PIL - CPIL represented by Prashant Bhushan and Shanti Bhushan) sought judicial intervention for protection of existing rights, betterment of life conditions of the poor, environment etc. Detractors of judicial activism charge that it usurps the power of the elected branches of government or appointed agencies, damaging the rule of law and democracy. They argue that an unelected or elected judicial branch has no legitimate grounds to overrule policy choices of duly elected or appointed representatives, in the absence of a real conflict with the constitution. In some instances, government regulation by appointed officers in government agencies are overturned by elected judges.

http://www.essaysforIIM.co.in

 IssuesforIIMPIProcesshttp://www.essaysforIIM.co.in
Defenders of judicial prerogatives say that many cases of so called "judicial activism" merely exemplify judicial review, and that courts must uphold existing laws and strike down any statute that violates a superseding law. Some recent instances of Judicial Activism can be o Distribution of food under Public Distribution System to poor free-of-charge instead of letting it rot in godowns o The SC ordered the Delhi Government not to demolish night shelters in Delhi for the homeless in the midst of winters as it is against the right to life. The court had taken suo moto cognizance from news paper reports o The brawl on the appointment of CVC PC Thomas In India, even as Prime Minister Manmohan Singh frowned upon judicial overreach, Supreme Court former chief justice K G Balakrishnan had welcomed its outcome as a desirable tension between the judicial and the legislative and executive branches. The source of the tension, however, lies in the vacuum created by the lapses of both the legislative and executive branches. The judiciary is giving the impression of stepping in to fill the vacuum by often forcing the executive to take action (against the privileged sons of politicians, as in the Jessica Lal case) or compelling Parliament to enact laws (for example, to curb sexual harassment at workplaces). This has encouraged the Indian urban middle class to repose its faith in the new-found concept of judicial activism, and to wish that the judiciary replaces the corrupt legislature and bureaucracy as the benevolent authority. But there is a catch in this wishful belief. Barring a few recent cases of judicial intervention, which have had some positive effect on governance, the Indian judiciary on the whole has not displayed any spontaneous will to act on behalf of the common people. Even though this phenomenon has been welcomed by many, it has many negatives o It has overburdened the courts leading to delayed justice for normal cases o It has blurred the line of distinction between the legislature on the one hand and the judiciary on the other. o It has made the balance among the three organs of government very delicate. Democratic government is based on each organ of government respecting the powers and jurisdiction of the others. Judicial activism may be creating strains on this democratic principle. Even though Judicial review is essential to maintain the fundamental rights of citizens, the constitution clearly defines the legislature as the law making body. Any aberration in either of these will be against the spirit of the constitution. The two parts should try to work together without stepping into the jurisdiction of each other for the benefit of the nations common man.

IMPACT OF RUPEE DEPRECIATION

There are three important effects: 1. Some people had borrowed in dollars, and left it unhedged since they were speculating that the INR would appreciate. They get hurt in the process. But this is fine as in a market economy, many people place bets about future fluctuations of financial prices, and half the time the speculator loses money. (If the rupee had not depreciated sharply, these speculators would have been gained). http://www.essaysforIIM.co.in

 IssuesforIIMPIProcesshttp://www.essaysforIIM.co.in
2. When the rupee depreciates, imports become costlier and India's exports become more competitive. So exports (X) gradually start going up and imports (M) gradually start going down. The net gain in X-M is increased demand in the local economy. Hence, INR depreciation is good for aggregate demand (and conversely INR appreciation pulls back demand). However, we have to bear in mind that these effects are small and take place with long lags. 3. Many things in India are tradeable. It is important to focus on the things that are tradeable and not just on the things that are imported. As an example, there are many transactions between a domestic producer of steel and a domestic buyer of steel. The buyer and seller are both in India. But the price at which they transact is the world price of steel (which is quoted in dollars) multiplied by the INR/USD exchange rate. This is called `import parity pricing'. Through this, the domestic prices of tradeables goes up when the rupee depreciates.

OPTIONS BEFORE RBI AGAINST A FALLING RUPEE

Problem: The falling rupee is worrying policymakers, not least because a steady drop in the countrys foreign exchange reserves and a worsening current account deficit make it vulnerable in a tough global environment. Why the problem arose: 1. The Euro zone crisis has triggered risk-aversion among investors and slowed capital inflows 2. pressure on the economy and the currency from a slowing economy, a widening trade deficit amid high contractual repayment obligations. 3. Dollar liquidity crunch globally in the wake of downgrades by ratings agencies of European countries and banks. Measures Taken: The government has already taken measures to boost capital inflows. These include raising the foreign institutional investment limit in government securities and corporate debt, raising borrowing limits for banks and companies and asking companies to quickly bring back home funds raised overseas. Measures which are being considered: 1. 2. 3. 4. 5. 6. Imposing restrictions on overseas investments by local companies Curbing pre-payments of foreign loans Enforcement or revision of prudential limits on currency positions Strong communication to cool markets Steps to curb speculation Ease overseas borrowings for corporates and banks

Long term measures 1. Assess preparedness to deal with any financial crisis 2. Freeze the contours of the proposed Crisis Management Group with more clarity on its role and powers

http://www.essaysforIIM.co.in

 IssuesforIIMPIProcesshttp://www.essaysforIIM.co.in

INFLATIONS IMPACT ON ECONOMY

Inflation has an adverse impact on the real economy. The following points are worth noting 1. High and persistent inflation imposes significant socio-economic costs. Given that the burden of inflation is disproportionately large on the poor, high inflation by itself can lead to distributional inequality. Therefore, for a welfare-oriented public policy, low inflation becomes a critical element for ensuring balanced progress. 2. High inflation distorts economic incentives by diverting resources away from productive investment to speculative activities. 3. Inflation reduces households saving as they try to maintain the real value of their consumption. Consequent fall in overall investment in the economy reduces its potential growth. 4. As inflation rises and turns volatile, it raises the inflation risk premia in financial transactions. Hence, nominal interest rates tend to be higher than they would have been under low and stable inflation. 5. If domestic inflation remains persistently higher than those of the trading partners, it affects external competitiveness through appreciation of the real exchange rate. 6. As inflation rises beyond a threshold, it has an adverse impact on overall growth. 7. RBI's current assessment suggests that the threshold level of inflation for India is in the range of 4-6%. If inflation persists beyond this level, it could lower economic growth over the medium-term. Hence there is a need for a monetary policy response by the Central Bank to control inflation

PIIGS DEMYSTIFYING THE CRISIS

[This is an overview of the genesis of the crisis; What is happening currently in Europe is covered separately]

Portugal, Ireland, Italy, Greece and Spain share a currency and an acronym PIIGS. Each lost cost competitiveness after 1999, seeing prices and wages rise more rapidly than the Euro area average. As members of the Euro zone, they cannot devalue their currencies, making the struggle out of recession harder. Thus they need internal devaluation which means falling wages, and falling GDP (Due to fiscal consolidation). But, as GDP falls, the tax collections will drop too and the deficit will not get reduced as much, thus a further fall in GDP is necessitated. As the trouble brewed, the symptoms varied in each country. Greece and Spain sucked in cheap imports and ran-up huge current account deficits. They at least enjoyed prosperity for a while unlike Portugal and Italy whose economies were held back by high wage costs and poor productivity. Irelands export-led success gave way to a bubble economy built on low interest rates.

http://www.essaysforIIM.co.in

 IssuesforIIMPIProcesshttp://www.essaysforIIM.co.in

Details: Portugal It seemed to have exhausted the benefits of Euro even before it was launched. Its boom in the second half of 1990s was fed by a sharp decline in borrowing costs, based on the mere prospect of Euro membership. Rapid wage inflation eventually made it harder for local firms to compete with foreign rivals. By 2000, Portugals current account deficit had widened to a deficit of 10% of GDP. The emerging economies of Eastern Europe and Asia have further dulled Portugals appeal as a low-cost producer. Its poor education system keeps it trapped in low-skilled work, which can be done more cheaply by others. Ireland Ireland had a more ruinous credit boom that even America or Britain. Bank lending was heavily tilted towards mortgages and construction. One legacy is the bad commercial-property loans that have crippled its banks. Another is the stockpile of household debt, mostly mortgages that exceeded 100% of GDP. The regulation of banks was also an issue. There was huge and wasteful investment in real estate sector, financed by banks by borrowing from non residents and capital markets. At one time, 60% of bank assets = 250% of nominal GDP = loans to real estate sector. (Infact, it had a current account surplus so that was not part of the problem)

http://www.essaysforIIM.co.in

 IssuesforIIMPIProcesshttp://www.essaysforIIM.co.in
The government guaranteed all liabilities of Irish banks including private sector banks against defaults. But, those banks were not facing a liquidity problem but a solvency crisis. Thus, the problem could not be solved. Finally, IMF and EU bailout became necessary. The bailout was of Eur 85 bn. Ireland seeks to return to export-led growth that was once its key to success. To do so, it must lower its wages relative to its trading partners in euro area. For many households, that means wages will fall, making debt looms larger. One salve is that mortgage rates in Ireland are linked to the European Central Banks main interest rate, which is set to remain low. Italy- Italy had a nasty recession but unlike others was not pulled out of shape by a big credit boom or housing boom. Between 2002 and 2007, Italys current account deficit averaged less than 2% of GDP compared with between 7% and 9% of Greece, Spain and Portugal. Yet Italy suffers many of the same problems. Like Spain, its productivity growth is dismal. Like Greece, it has huge public debts and trouble collecting taxes. That is in part due to the countrys vibrant North that the levies raised there help pay for the many failures of the poorer south. Spain- Spains economic trouble is closely tied to its housing bust. The unemployment rate is close to 20% and many of the newly idle had been construction workers. Spains poor productivity growth is partly the result of the housing mania.(construction booms are labour-intensive). Yet much of the fault lies with Spains labour market rules. Wages are set centrally and most jobs are protected, making it hard to shift skilled workers from dying to blooming industries. (Most job losers were low skilled temporary workers, who are hard to reemploy). Recession revealed how dependent public finances had been on housing-related tax revenues. House prices have further to fall. On one measure, the ratio of house prices to rent, Spanish property is more than 50% above its face value. Greece- Public finances are in a mess in most rich European countries, but Greece is in by far the worst shape. There was fiscal and financial irresponsibility resulting in ultra loose fiscal policy and a huge Current account deficit. In 2009, the government ran a budget deficit of 13.6% of GDP. Greeces debt stood at 115% of GDP in 2009. Among OECD countries, only Japan has a higher burden. Public spending was 51% of GDP bloated by the standards of America, but broadly in line with the average for Euro area countries. Greeces main fiscal problem is collecting revenues. Tax evasion is endemic, contributing to Greeces low tax/GDP ratio of 31%. Among Euro area counties, only Irelands figures are lower. All this necessitated a record 110 bn euro ($147 bn) bailout for debt-stricken Greece after Athens committed itself to years of painful austerity. It is a three-year package of emergency loans. In exchange for by far the largest bailout ever assembled for a country, Greece announced further spending cuts and tax increases totaling 30 billion euros over three years on top of tough measures already taken. Telling angry Greeks to choose between the painful rescue or economic collapse, the government now aims to bring its towering budget deficit back to the EU limit by 2014, two years later than originally promised.

http://www.essaysforIIM.co.in