Economy

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Why have Private Investments dropped?

Context: Discussions regarding the upcoming Union Budget 2025 highlights the perceived underperformance of the private sector and slowdown of private investments in India.

Relevance of the Topic: Prelims: Private Sector Investments: Key Trends;  Gross Fixed Capital Formation. 

Historical Context: Public and Private Sector Investments

  • Period of Public Sector Dominance:
    • During Second and Third Five-Year Plans (1956-1966), India had massive public sector investments.
    • Tax increases under TT Krishnamachari’s Budget (1958) financed these investments successfully.
  • Shift in the 1980s: 
    • From independence to economic liberalisation, private investment largely remained either slightly below or above 10% of the GDP.
    • By the mid-1980s, public sector investments stagnated, and the government turned to the private sector.
    • Pro-growth reforms like tax cuts in 1985 and the LPG reforms of 1991, spurred private investments, despite challenges like low consumption and high interest rates.
  • Post-liberalisation Era:
    • Post-liberalisation, private investment took the leading role in fixed capital formation.
    • Growth in private investment lasted until the global financial crisis of 2007-08. It rose from around 10% of GDP in the 1980s to around 27% in 2007-08. 
    • From 2011-12 onwards, private investment began to drop and hit a low of 19.6% of the GDP in 2020-21.
  • Recent Trends:
    • Corporate tax rate reduction in 2019 (to 22%) was aimed at attracting private investment, but failed to yield desired results.
    • Even with a 15-year high profit-to-GDP ratio of 5% in 2024, private sector investments in India remain sluggish.

Why have private investments dropped?

  • Structural issues (like policy uncertainty, issues in ease of doing business, delays in land acquisition, lengthy dispute resolution) have led to significant fall in private investment as a percentage of GDP. 
  • High levels of NPAs in the banking sector have constrained credit availability for the private sector. 
  • Crowding out of private investment due to expansionary fiscal policies and increased borrowings of the government. 
  • Narrow corporate bond market due to illiquid secondary market, narrow investor base, lack of diversity of instruments and crowding out by large public issuance impacted corporate investment.
  • Low private consumption expenditure can also be a reason for reducing demand-driven investment opportunities. 

Associated Challenges

  • Low Private Investment: Declining private investment has been impacting the Gross Fixed Capital Formation (GFCF) in India. Private investment in India declined from 27% of GDP in 2007-08 to 19.6% of the GDP in 2020-21. As per NSO, GFCF in India declined from 34% in 2009-10 to 26% in 2021-22.
    • GFCF refers to the growth in the size of fixed capital in an economy.
      • Fixed capital refers to things such as land improvements, buildings, plants, machinery etc. which require investment to be created. 
      • GFCF excludes financial assets such as bonds, stocks, and other financial instruments. 
    • Private GFCF can serve as a rough indicator of how much the private sector in an economy is willing to invest.
  • Preference to overseas investments:
    • Despite benefiting from government initiatives like Make in India (shielding domestic industries), private entities prefer international investments or overseas expansion. 
  • Labour Exploitation Concerns:
    • Suggestions by industry leaders for employees to work 72-90 hours per week raise ethical and practical questions about workforce sustainability.

Policy Recommendations

  • Rebalancing Tax Rates:
    • Government could consider revising the tax rates:
      • Increasing corporate tax 
      • Reducing personal income tax 
    • This could increase disposable income and stimulate demand and consumption.
  • Focus on structural reforms like policy consistency, labour reforms, improving the ease of doing business, ease of land acquisition, early dispute resolution, etc. 
  • Encouraging domestic investment: Introduce incentives for businesses investing in India, such as sector-specific subsidies or reduced compliance burdens for targeted industries.
  • Strengthen corporate bond markets and diversify financial instruments to ensure adequate capital for private investments.  
  • Strengthening Public-Private Partnerships (PPPs): Foster collaboration in long term projects (like infrastructure) and manufacturing to share risks and benefits equitably.

The biggest cost of low private investment would be slower economic growth as a larger fixed capital base is crucial to boost economic output.

QS World Future Skills Index 2025

Context: Recently released QS World Future Skills Index 2025 highlights India’s strong position as a forward-thinking nation with significant potential. However, challenges in its current economic and academic systems could slow progress.

Relevance of the Topic: Prelims: QS World Future Skills Index 2025

QS World Future Skills Index

  • QS World Future Skills Index evaluates how well countries are equipped to meet the evolving demands of the international job market. 
  • Aim: To empower governments to align education and skills with future demand, fostering innovation, sustainable global competition and talent development.
  • Released by: London-based Quacquarelli Symonds (QS).

Key criteria in the QS Future Skills Index:

image 156

India Spotlight on QS World Future Skills Index

  • India’s overall rank: 25th 
    • India’s overall ranking puts it as a future skills contender.
    • Comparison: Countries like US, UK, Germany, Australia, Canada and others in top 10 have been categorised as ‘future skills pioneers’.
  • Skills Fit:
    • India’s rank: 37th 
    • In this indicator, India scored 59.1, which is the worst among the top 30 countries overall.
  • Academic Readiness:
    • India’s rank: 26th
  • Future of Work:
    • India’s rank: 2nd only behind the US.
    • This indicator measures how well the job market is prepared to meet the growing demand for digital, AI, and green skills.
    • The assessment of this indicator has been largely done from the demand side. i.e., job postings. On supply side indicators, India’s ranking leaves much to be desired. 
  • Economic Transformation:
    • India’s rank: 40th 
    • India scored a full score of 100 on account of economic capacity.  
    • India fared the worst when it came to ‘future-oriented innovation in sustainability’. 
      • India’s score: 15.6/100
      • Comparison: G7 countries- 68.3, EU countries- 59, APAC countries- 44.7, African countries: 25.4.
image 157

Challenges for future skills in India

  • Poor performance in Green Readiness:
    • Green readiness is an area of relative underperformance for the Indian economy versus G20 peers.
    • Whilst rising demand for green occupations and green skilled workers is clear through India's strong Future of Work score, India places 176 in the Environmental Performance Index.
  • Inadequate investment and innovation: 
    • Gaps in investment and innovation capacity pose challenges that could slow long-term growth.
  • Lack of relevant skills: 
    • India’s graduates are struggling to keep up with the pace of change in relevant skills required. 
    • India has a particularly large skills gap in ‘entrepreneurial and innovative mindset’.
  • Need for higher education reforms: 
    • Employers across India highlighted a critical gap in the workforce’s ability to meet the demands of a rapidly changing economic landscape. 
    • This highlights a broader challenge for India’s higher education system which is struggling to keep pace with evolving employer needs.

Way Forward: Tapping the potential of Future Skills in India

  • Invest in green skills development: Address green skill gaps by aligning curricula and learning modes to nurture the green skills necessary.
  • Higher education reforms: Universities must prioritise embedding creativity, problem solving and entrepreneurial thinking into their curricula.
  • Collaboration and Coordination:  Industries must foster stronger collaborations with universities to better align education with workforce demands. 
  • Government policy intervention:  Focused strategies are required to re-engage workers in continuous and lifelong reskilling programs. This ensures that skilled workers remain relevant and productivity contributors.  

To fully realise its potential, India must align economic momentum with robust higher education reforms and skills development, ensuring a dynamic and competitive position in the global economy. 

ILO Report: Global Estimates on International Migrants

Context: The 4th edition of the International Labour Organisation’s (ILO) Global Estimates on International Migrant Workers was released in December 2024. International Migrants not only address the labour market shortages in host nations but also send remittances to their home countries, thus making significant contributions to the world economic growth. 

Relevance of the Topic Prelims: Organisation based questions on UN and ILO; Basic idea of trends of international migration and their contribution. 

Major Highlights of Report: 

  • Global migrant estimates: The report estimates approximately 169 million international migrant workers recorded in 2022.
    • This accounts for 4.7% of the global workforce.
    • Note: Global workforce stands for the number of people employed or unemployed, but are willing to work.
  • Incremental trend: The estimate of migrant workers has increased from previous years, i.e., 164 million in 2017 and 150 million in 2013.
  • Regional distribution: Over 68.4% of all migrants are in high-income nations like Europe, North America and Arab states.
  • Gender disparity: The report has highlighted the evident gender disparity in the migrant labour force
    • Only 38.7% of female migrants are employed as compared to the 61.3% of male migrants. 
    • Females are predominantly employed in the service sector, that too in the sectors associated with the care economy. 
  • Sectoral distribution of migrants: Migrant population dominates the service sector i.e., 68.4% migrants are employed in the service sector.
    • Female migrants dominate the service sector 80.1% females as compared to 60.8% male counterparts.
  • Comparison with the non-migrants: 
    • The service sector is out-numbered by migrants.
    • The manufacturing sector is marginally dominated by migrants.
    • The agriculture sector is predominantly handled by non-migrants.  
image 154

Challenges highlighted by the Report

  • Gender-bias: The data of the report highlights the gender based biases, as most female migrants are part of the care economy. Also, the unemployment rate is higher in females as compared to males.
  • Economic vulnerability: The report also highlights the low wages and exploitative conditions of laborers. Also, the lack of social security leaves the labour in distress during any negative event.
  • Barriers in employment: Qualification and skill deficit along with the language barriers hinders the labour to adjust in the country of migration.
  • Social isolation: Migrants often face Xenophobia, racism and social exclusion that further marginalises them in the host societies.
  • High cost of migration: Migrants often pay exorbitant fees to recruiters leading to debt and financial burdens due to which workers fall victim to trafficking and forced labour. E.g., the Kafala System of Arab nations.

About International Labour Organisation

  • International labour organisation (ILO) is a specialised United Nations agency that focuses on promoting social justice and internationally recognised human and labour rights. 
  • Objectives of ILO: 
    • Promote decent work for all
    • Advance social and economic justice
    • Establish international labor standards
    • Advocate for workers’ rights, social protection and inclusive employment opportunities.
  • Major publications: World employment and social outlook; Global Wage Report; Global estimates on International Migrant Workers; Unemployment Rate Index.
  • India and ILO: 
    • ILO was established in 1919, where India was one of the original members. Narayan Malahar Joshi, founding member of All India Trade Union Congress, joined it. (Social Service League of 1911 is also associated with NM Joshi)
    • ILO has eight core conventions, of which India has not-ratified two conventions: 
      • No. 87: Freedom of Association and Protection of Rights to Organise Convention
      • No. 98: Right to Organise and Collective Bargaining.
    • In 2017, India ratified ILO Conventions No. 138 and 182, signaling its legal commitment to the elimination of child labour.

Bharatiya Vayuyam Adhiniyam 2024

Context: India is one of the world's fastest growing civil aviation markets. The Bharatiya Vayuyan Adhiniyam 2024, a legislative reform aimed at modernising India’s aviation sector, came into effect from January 1, 2025.

Relevance of the topic:

Prelims: Key facts about Bharatiya Vayuyam Adhiniyam 2024; Cape Town Convention Bill.

Mains: Detailed question on issues in aviation question. 

About Bharatiya Vayuyam Adhiniyam 2024

  • Objective: The Act is aimed at modernising India’s aviation sector by replacing the Outdated Aircraft Act of 1934.
  • Major Features of the Act:
    • Empowered Director General of Civil Aviation (DGCA): DGCA has been provided with expanded jurisdiction over aircraft design, manufacturing, maintenance and operations, ensuring a centralised regulatory framework. 
    • Establishment of Bureau of Civil Aviation Security (BCAS): It focuses on establishment of a dedicated body exclusively for security matters in the aviation sector, enhancing safety of air travel. 
    • Aircraft Accidents Investigation Bureau: Creating an independent body for the investigation of aviation accidents and incidents, promoting transparency and accountability.
    • Streamlining leasing of Aircraft: will guarantee lessors rights to repossess their leased equipment.
    • Emergency powers to Central government: It empowers central government to take immediate actions to address crisis like;
      • Health pandemic affecting aviation
      • Cybersecurity threats
      • Situations requiring temporary suspension of air operations.
    • Compensation and Appeal Framework: It allows individuals and organisations to seek compensation for damages caused by government actions in the aviation sector.
    • Penalties for Non-Compliance: It includes monetary fines and other penalties on violation of aviation laws deterring companies and establishing a culture of accountability.
    • Alignment with International practices: It harmonises India’s aviation laws with international conventions like ‘International Telecommunication Convention’, for the aviation sector.
    • Encouragement for Domestic Manufacturing: By regulating the entire lifecycle of aircraft, the bill supports domestic production and maintenance, contributing to economic growth and self-reliance.

Cape Town Convention Bill

  • Recently, the Union Cabinet has approved the Protection and Enforcement of Interests in Aircraft Objects Bill, 2024 (Cape Town Convention Bill). The bill will be tabled in the next parliamentary session for consideration.
  • The proposed Bill will give primacy to the Cape Town Convention in case of conflict with any other domestic law, mainly the Insolvency and Bankruptcy Code (IBC), 2016.
  • Aim: To make the process easier for aircraft leasing companies to seize the planes of airlines that miss rental payments.
  • Significance:
    • Allow the aircraft leasing companies to reclaim their planes from Indian airlines in case of default on rental payments. 
      • Presently, the expensive assets like aircraft and engines of lessors, get stuck in India when Indian carriers default on paying rentals.
      • The lessors have to wage lengthy legal battles (in National Company Law Tribunal) to get their planes and engines back. E.g., the case of Wadia Group's erstwhile GoAir.
    • Expected to boost lessors' confidence in the Indian civil aviation space.
    • Expected to lower the lease rentals in India and help finance high-value mobile equipment, like airframes, helicopters and engines.

Cape Town Convention:

  • CTC is a global treaty that guarantees the rights of lessors to repossess leased high-value equipment such as aircraft, engines, and helicopters in case of payment defaults.
  • It was adopted at a conference in Cape Town in November 2001, under the International Civil Aviation Organisation (ICAO) and the International Institute for the Unification of Private Law (UNIDROIT).
  • India is a signatory to the convention (since 2008), but the Indian Parliament has not ratified the same. Hence, Indian laws presently prohibit such recovery once a company initiates bankruptcy proceedings
challenges in Indian Aviation

Major issues in Aviation Sector of India

  • Taxation challenge: The rejection of the proposal to include Aviation Turbine Fuel under the Goods and Services Tax regime means continued high tax on the fuel for the aviation sector.
  • Pilot fatigue: The industry faces challenges related to shortage of pilots that leads to extended hours of service by pilots. Such practices compromise passenger safety and the wellbeing of pilots.
  • Unsecure practices: Airlines violate safety protocols for landing by promoting Flap 3 landing instead of full flap landing, compromising with the safety of passengers.
  • Import dependency: The airlines sector is overdependent on imports of equipment for airlines including critical spare parts. 
  • High operational cost: Airlines are burdened with high user development fees, landing charges and parking fees adding more to their operational cost.
  • Infrastructure constraints: Major airports like Delhi, Mumbai, and Bengaluru operate at or near capacity causing delays and operational inefficiencies.

What more can be done?

  • Include Aviation Turbine Fuel (ATF) under GST to reduce costs.
  • Invest in airport capacity, especially in tier-2 and tier-3 cities.
  • Develop India as a hub for aircraft leasing with tax incentives.
  • Encourage adoption of AI, big data, and automation for efficiency.
  • Enhance training facilities to address pilot and workforce shortages.
  • Focus on improving passenger experience with better services and digital solutions.

Conclusion: The Bharatiya Vayuyan Adhiniyam, 2024 will foster indigenous manufacturing under Make in India, align with international conventions like the Chicago Convention and ICAO, and streamline regulatory processes. Hence, the Act is a major step to revolutionise India’s aviation sector, enhance safety, innovation, growth, and global compliance. 

Scale Based Regulations of NBFCs

Context: The Reserve Bank of India (RBI) has released the list of Non-Banking Finance Companies categorised under the upper layer segment (NBFC-UL) for the year 2024-25.

Relevance of the Topic: Prelims: Scale based Regulation of NBFCs.

Need for Effective Regulation of NBFCs?

  • Growth of the Sector: Size of balance sheet of NBFCs (including HFCs) has more than doubled from Rs 20.72 lakh crore (2015) to Rs 49.22 lakh crore (2020).
  • Increased lending by NBFCs: The share of credit given by NBFCs increased from 8.5 % (2012-13) to 11.5 % (2019-20). However, bank credit as a proportion of GDP declined from 52% to 50% during the same period.
  • Interconnectedness: NBFCs mobilise more than 50% of funds by borrowing from Banks. This interconnectedness between Banks and NBFCs has systemic implications. Failure of large NBFCs such as IL&FS could have adverse implications on the financial health of the Banks.
  • Recent failure of large NBFCs such as IL&FS, Dewan Housing Finance etc. has also highlighted the need for strengthening supervisory tools for NBFCs.

What is Scale Based Regulation of NBFCs?

  • The scale-based regulation is based on the principle of proportionality and narrows the regulatory arbitrage between banks and large NBFCs while allowing for operational flexibility. 
  • Under this regulation, NBFCs are segregated into four layers based on their size, activity, and perceived level of riskiness: (i) Base Layer (NBFC-BL), (ii) Middle Layer (NBFC-ML), (iii) Upper Layer (NBFC-UL), and (iv) Top Layer (NBFC-TL).
scale-based regulation is based on the principle of proportionality and narrows the regulatory arbitrage between banks and large NBFCs

Regulatory Changes under the SBR Framework

  • Applicability: Any regulatory stipulation applicable to a lower layer under the new NBFC categorisation will automatically apply to a higher layer, unless otherwise notified by the RBI.
  • Increase in Net owned Fund (NOF) requirement: The RBI has increased the minimum net owned fund (NOF) requirement for NBFC-ICC from Rs 2 crores to Rs 10 crores. For NBFC-MFI and NBFC-Factor, the NOF requirement has been increased from Rs 5 crores to Rs 10 crores.
  • Changes to NPA classification norms: Presently, all NBFCs other than NBFC-MFIs classify loans as NPA if it is due for more than 180 days. The RBI has prescribed a uniform overdue period of more than 90 days for classification of loans as NPA for all categories of NBFCs. Hence, going forward, the NPA classification requirements for banks and NBFCs would be aligned. 
  • Extension of PCA Framework: The Prompt Corrective Action (PCA) framework, applicable to banks, has been extended to NBFCs in the middle and upper layers. Under the PCA framework, NBFCs need to undertake timely remedial measures if they breach the prescribed risk thresholds. 

Prioritise MSMEs under Interest Equalisation Scheme

Context: Ahead of the Union Budget 2025-26, the Commerce and Industry Ministry has approached the Finance Ministry to extend the revamped Rs 3,000 crore Interest Equalisation Scheme (IES) to prioritise Micro, Small and Medium Enterprises (MSMEs) involved in exports.

Relevance of the Topic: Prelims: Key facts about the Interest Equalisation Scheme.

Interest Equalisation Scheme

  • Launched: April, 2015 
  • Aim: To provide pre- and post-shipment export credit to exporters in Indian rupees at subsidised rates. 
  • Implementing agency: Reserve Bank of India (RBI) through various Public and non-Public Sector banks. 
  • Monitoring: Jointly monitored by Directorate General of Foreign Trade (DGFT) and RBI through a consultative mechanism.

Key Features of the scheme

  • Who can apply for IES?
    • MSME manufacturer exporters
    • Other merchant and manufacturer exporters exporting along 410 HS (Harmonised system) lines.
  • Interest Subvention: Subsidy ranges from 3% to 5% on credit. 
  • Documentation: 
    • An eligible exporter has to submit a certification from the external auditor to the concerned bank to claim this benefit.
    • Banks provide IES benefits to the eligible exporters and claim a reimbursement from the RBI, based on the external auditor certification furnished by the exporter.
  • Digital application process: An active IEC (Import Export Code) is mandatory and digital signature/ Aadhar e-sign token is required.
  • The Scheme has now been made fund-limited, and the benefit to individual exporters has been capped at Rs 10 Crore per annum per IEC (Import Export Code). 

Benefits of Interest Equalisation Scheme

  • Provide credit to the exporters at competitive rates. 
  • Helps the identified export sectors to be internationally competitive.
  • Achieve a high level of export performance.

Need for Revival of the Scheme

  • Boosting Economic Competitiveness: Subsidies offset the high cost of credit in India, addressing structural inefficiencies in the Indian financial system. 
  • MSMEs and Exports:
    • MSMEs contribute 45% of India’s total exports.
    • Challenges faced:
      • High credit costs
      • Inflation
      • Logistics issues (E.g., the Red Sea crisis)
  • Export Credit Trends:
    • Export credit declined from ₹2,27,452 crore (March 2023) to ₹2,17,406 crore (March 2024).
    • Rising demand for longer credit durations: from 30-60 days to 120-150 days.

Challenges

  • Skewed Towards Larger Exporters: Past misuse by non-MSME entities prompted calls for focusing IES solely on MSMEs.
  • Liquidity Concerns: High inflation and logistical delays (E.g., Red Sea crisis) has increased working capital needs.
  • Insufficient Support: The ₹50 lakh cap on credit subsidies for MSMEs is insufficient for many MSMEs.

Suggested Reforms

  • Targeted Focus: Restrict the scheme exclusively to MSMEs to ensure equitable benefits.
  • Long-Term Continuity: A sustained IES can improve predictability and help MSMEs manage orders better.
  • Revamping Through EFC: Modifications will not require budgetary announcements but can be implemented via the Expenditure Finance Committee (EFC) route.

Impacts of Rupee Weakening

Context: The Indian rupee recently registered a sharp devaluation with respect to the dollar, after remaining stable for over two years. Hence, there arises a need to review India’s exchange rate policy and study the structural constraints existing in the Indian economy.

Relevance of the Topic: Prelims: Nominal & Real Exchange Rate, Exchange Rate Regimes, India’s exchange rate policy. 

What is the Exchange Rate?

  • An exchange rate is the rate at which one currency can be exchanged for another currency.
  • Most exchange rates are defined as floating. Their values rise or fall based on supply and demand in the foreign exchange market.
  • Some exchange rates are pegged or fixed to the value of a specific country’s currency.

What is the Nominal Exchange Rate?

  • Nominal exchange rate is the general exchange rate of one country’s currency relative to another.
  • It is the price of buying one unit of foreign currency in terms of domestic currency. 
  • Factors influencing changes in nominal exchange rate:
    • Demand-supply conditions of the foreign exchange market 
    • Exchange rate policy of the central bank.

What is the Real Exchange Rate?

  • The real exchange rate compares the general price level of certain commodities or baskets of commodities of the two countries.
  • It is the relative price of foreign goods in terms of the domestic currency with respect to the prices of the domestic goods. 
  • It describes how cheap or costly domestic goods are concerning the foreign goods.

Factors influencing Foreign Exchange Market

  • Demand and supply conditions of the foreign exchange market depend on the flows ofcurrent account and capital account.
    • Current Account Flows: Related to exports and imports of goods and services.
    • Capital Account Flows: Related to foreign investments and capital inflows/outflows. 
  • Demand for foreign currency would rise if the sum of net current account and capital account flows falls.
  • Supply of foreign currency would rise if the sum of net current account and capital account flows increases. 
  • The lower the net exports and greater the capital outflow, the greater would be demand for foreign currency and vice-versa.
Net ExportsCapital OutflowDemand for Foreign CurrencyNominal Exchange Rate
DecreaseIncreaseINCREASEFALLS
IncreaseDecreaseDECREASERISES

Exchange Rate Policy Frameworks

  • There are three kinds of exchange rate policy frameworks, depending on how the central bank responds to the demand and supply conditions in the foreign exchange market:
    • Fixed exchange rate
    • Floating exchange rate
    • Managed-floating exchange rate

1. Fixed Exchange Rate:

  • The central bank responds to the higher demand for foreign currency entirely by selling (decumulating) foreign exchange reserves (and vice versa).
  • This is done while keeping the nominal exchange rate fixed at a predetermined level.
Fixed Exchange Rate

2. Floating Exchange Rate:

  • Central bank responds to higher demand of foreign currency entirely by devaluing the domestic foreign currency (making foreign currency costlier in terms of domestic currency) and vice versa
  • This is done while keeping the level of foreign exchange reserves unchanged.
Floating Exchange Rate:

3. Managed Floating Exchange Rate:

  • The central bank responds to higher demand for foreign currency both by selling foreign currency as well as devaluing the domestic foreign currency.
Managed Floating Exchange Rate

RBI’s Exchange Rate Policy

  • RBI has largely pursued a managed-float exchange rate regime in the last three decades. 
  • RBI’s response under excess demand conditions in the foreign exchange market has been qualitatively different from excess supply conditions.
    • Excess demand conditions in the foreign exchange market: RBI simultaneously devalued the domestic currency and decumulated its foreign exchange reserves. 
    • Excess supply conditions:
      •  RBI accumulated foreign exchange reserves while largely resisting appreciation of the nominal exchange rate.
      • This was done to avoid appreciation of the real exchange rate or the worsening of export competitiveness. 
  • Thus, while net capital outflow was associated with depreciation of the nominal exchange rate, the net capital inflow did not involve appreciation of the exchange rate to the same extent.  
  • This asymmetry in the behaviour of the nominal exchange rate led to an overall devaluation of the rupee throughout the 2010s decade.
RBI’s Exchange Rate Policy
  • In the post-COVID period: RBI momentarily shifted to a fixed exchange rate regime.
    • This is reflected by the flat segment of the dollar exchange rate in the above graph during the relevant period. 
    • Deterioration of the current account deficit and capital outflow during this period were met by selling foreign exchange reserves while holding the nominal exchange rate more or less at the same level. 
  • Last month: The sharp devaluation of the rupee in the last month hints towards RBIreturning to its earlier regime of the managed-float exchange rate. 
    • Due to greater capital outflow and a rise in imports amid higher crude oil prices, RBI allowed the rupee to depreciate. This was done to put less strain on the foreign exchange reserves.

Implications of Devaluation

  • Depreciation of nominal exchange rate can have both positive & adverse macroeconomic implications.
  • Positive Effect: Boosting Exports
    • A weaker rupee makes Indian goods cheaper for foreign buyers.
      • For example: If 1 dollar = ₹85, a $100 foreign product would cost ₹8,500, while a ₹1,000 Indian product would cost just ₹1,000.
      • This makes Indian goods more competitive in global markets.
    • Certain conditions to be met for exports to benefit:
      • Export levels should increase when Indian goods become cheaper (real exchange rate falls).
      • Domestic prices should stay steady. If domestic prices rise, Indian goods could become expensive again, canceling out the benefit.
  • Negative Effect: Rising Costs and Inflation
    • A weaker rupee increases the cost of imports, especially raw materials like oil or machinery that firms need.
    • Firms pass on these higher costs to consumers by raising prices, leading to inflation (higher prices for goods and services).
    • This reduces people's purchasing power, as their real income (what they can buy) decreases.

India’s Challenge since the 2010s

  • For India, the positive effects of a weaker rupee (boosting exports) have been limited.
  • This is because:
    • Domestic prices have been rising faster, making Indian goods less competitive even with a weaker rupee.
    • This unique problem means depreciation hasn't helped exports as much as it should.

Recent constraint: Diverging NEER & REER

  • The period since the mid-2010s, particularly 2019 has been characterized by the growing divergence between the nominal and the real exchange rate.
    • These indices reflect the weighted average exchange rate of India with respect to its multiple trade partners.
    • Any increase or positive change of these indicators implies appreciation.
    • Any decrease or negative change implies depreciation.
image 144
  • After moving in the same direction till the mid-2010s, they started moving in opposite directions with the real exchange rate registering an appreciation despite a depreciation in the nominal exchange rate.
    • Such a phenomenon distinguishes India from other countries. 
    • Chart 3 shows this by depicting the exchange rate movements of 62 countries using data from the Bank of International Settlements (BIS).
image 145
  • Appreciation of the real exchange rate in India despite a depreciation of the nominal exchange rate indicates that the latter has been associated with counteracting rise in domestic prices. 
  • Rise in domestic prices can be attributed to the recent increase in the markup of non-financial firms.
    • After registering a decline till the mid-2010s, the markup reversed its trend and started rising. 
    • Since prices are formed by a markup over variable costs, any rise in markup would push up domestic prices at any given level of variable costs and nominal exchange rate.
image 146
  • Markup: 
    • Ratio between the output price and the variable cost per unit of output 
    • Ratio between the nominal value of sales and the total variable cost

Key Questions for India’s Exchange Rate Policy

  • Should India go back to the 2010s strategy?
    • In the 2010s, the RBI followed a specific managed-floating approach where it used both reserve sales and currency depreciation to stabilize the exchange rate.
  • Does India need a completely new exchange rate policy?
    • A fresh framework might better address today's economic challenges.

The response of the RBI in the post-COVID period has appeared somewhat arbitrary, as it has frequently shuffled its policy stance without providing adequate explanation. The recent challenges bring forth the need to address these questions in a more systematic way.

RBI to conduct daily VRR auctions to infuse liquidity

Context: To ease liquidity tightness in the banking system, the Reserve Bank of India (RBI) has decided to conduct daily variable rate repo (VRR) auctions until further notice. The first such auction will be conducted on January 16 for ₹50,000 crore.

Relevance of the Topic:Prelims: Key facts about Variable Repo Rate (VRR). 

Why is there a liquidity deficit?

  • RBI’s intervention in the forex market aimed at ensuring gradual depreciation of the rupee against the dollar have caused the current liquidity deficit in the economy.
  • As of January 2025, the RBI’s intervention in the forex market is estimated at about ₹2 lakh crore.

What is Variable Repo Rate?

  • Also called Term Repo Rates, VRR is a liquidity injection tool used by the RBI for managing short-term liquidity in the economy.
  • VRR Auctions: They are conducted by the RBI, when the weighted average call money rate trends above the repo rate in the interbank money market, serving as a signal to the RBI of System Liquidity Deficit. 
  • Tenure: It is a short-term liquidity injection against collaterals, with a tenor of overnight to 13 days.
    • For injection of durable liquidity, the RBI conducts VRR auctions for a tenor beyond 14 days (but very rarely).
  • Rate of Interest: Borrowing through VRR is at a rate decided by market, generally lower than the Repo Rate (though not less than Reverse Repo Rate).
  • Who can participate in VRR: Standalone primary dealers along with all other eligible participants are allowed to participate in these auctions.
  • What VRR will do?
    • The daily liquidity support via VRR auction could neutralise the (rupee) liquidity-draining effect of RBI’s forex market intervention. 
    • Improved liquidity conditions could lead to softening of government securities (G-Sec) yields.

Difference between Repo and Variable Repo

S.No.Aspect Repo Rate Variable Repo Rate
1.DefinitionFixed rate at which RBI lends money to commercial banks Market-determined rate in auctions conducted by RBI 
2.Usage Used in regular monetary policy operations to control liquidity Used in fine-tuning short-term liquidity
3.Determination Set directly by the RBI Determined through market bidding in RBI auctions
4.Purpose To influence borrowing costs for banks and control inflation or liquidityManage short-term liquidity needs
5.Impact on banks Provides liquidity to banks at a predictable cost. Provides liquidity at market-driven rates. 

RBI suggestions for Cross-Border Rupee Transaction

Context: In the backdrop of devaluation of Rupee against US Dollars, the Reserve Bank of India (RBI) has come up with steps to facilitate cross-border rupee transactions.

Relevance of the Topic: Mains: Detailed question on steps to facilitate Internationalisation of Rupee.  

Suggested steps by RBI: 

Steps SuggestedImpact of Steps
Liberalisation of the foreign exchange regulations: Indian exporters are now allowed to open accounts in any foreign currency overseas reducing dependency on the US dollar and Euro.Reducing transaction cost of the business promoting ease of doing business.Encouraging Indian companies to engage in the global supply chain.
Establishment of rupee account for non-residents: Overseas branches of authorized banks can now open INR-denominated accounts for non-residents.Encourages foreign entities to hold and transact in INR, boosting the global presence of the currency.Attract investors in India by simplification of investment procedures
Promoting trade settlement in rupees: RBI's framework permits exporters and importers to invoice and settle their trade transactions in INR.Strengthens the resilience of Indian trade against global currency volatility.

Constraints in Internationalisation of Rupee

  • Limited exports: India has limited export destinations and faces a high trade deficit that weakens the rupee position internationally. 
  • Focus on Consumption led growth instead of investment led growth restrains Indian rupee to strengthen its position in global market by fostering investments. 
  • Global dynamics: Issues like the Russia-Ukraine war placed an additional burden on the rupee due to oil price hike and US sanctions. 
  • Volatile investments: More than 70% investments in India are FPI that makes rupee position volatile as FPI is more susceptible to economical shocks. 
Internationalisation of Rupee

More steps required for Internationalisation of Rupee

  • Promoting bilateral currency swaps: More currency swap agreements with key trading partners like USA and UAE would allow India for direct exchange of INR with other countries.
  • Introducing UPI internationally: Expanding the reach of UPI and Rupay cards to key destinations of trade and tourism will enhance interoperability of rupee with other international currencies.
  • More focus on rupee denominated instruments: Enhancing density and penetration of rupee denominated bonds like Masala bonds will allow India to internationalise INR.
  • Enhancing GIFT capacity: Enhancing IFSC GIFT city capacity in Gujarat, by providing more confessions in trade and investment will attract investment in India strengthening the position of rupee.
  • Alternate currency: India should also focus on reducing dependence on the US dollar, evolving the BRICS currency can become a better alternative in this regard.

Conclusion: The RBI’s measures to promote INR in cross-border transactions mark an important step toward the internationalisation of the currency. However, sustained efforts are required to deepen partnerships, build infrastructure, and create financial instruments that increase the acceptability of INR. A comprehensive approach based on innovation, diplomacy and regulatory support can establish the rupee as a strong global currency.

Startup Sector in India

Context: India’s startup ecosystem has grown exponentially, emerging as the world’s third-largest hub for innovation and entrepreneurship. From just 400 startups in 2015-16 to over 1,30,000 today, the ecosystem is a testament to India’s entrepreneurial potential and supportive policies.

Relevance of the Topic: Mains: Startup sector- Present status, Challenges, Issues, Strategies

Present Status of Startup sector in India

  • Global position: India is the world’s third-largest hub for innovation and entrepreneurship.
  • Remarkable progress: Today, India has over 1,30,000 recognised startups- up from approximately 400 in 2015-16.
  • Successful funding and ecosystem expansion: 
    • Startup funding has grown 15 times.
    • The number of investors has increased nine-fold.
    • The number of incubators has risen seven-fold.

Scope for further growth of Startup Sector

  • Emerging areas: India stands at the threshold of a technological revolution, presenting immense opportunities in areas such as
    • Artificial intelligence (AI)
    • machine learning (ML)
    • big data
    • electric vehicles (EVs)
    • quantum computing
    • genomics
    • 3D printing
    • Robotics
    • Drones
    • space exploration.

Government Initiatives to promote Startups in India

  • Fostering growth in Emerging areas:
    • National Quantum Mission
    • India AI Mission
    • Semiconductor Mission
  • Promoting Research & Development: 
    • Union Budget 2024-25 allocated a substantial Rs. 1 lakh crore to the Anusandhan National Research Fund for research and development (R&D).
  • Progressive policies:
    • Opening up new sectors to the private players like space, geospatial technology, defence, and drones. Encouraging startups to venture into cutting-edge domains.
  • Facilitating Funding:
    • Fund of Funds for Startups (FFS): launched in 2016, it has committed Rs 11,688 crore through 151 Alternative Investment Fundas (AIF).
    • This has catalysed a capital pool of Rs 81,000 crore, creating a multiplier effect.
  • Minimal regulatory interference:
    • Startup India prioritised avoiding excessive regulations that could hinder startups.

Challenges and Concerns in Startup sector

  • Funding Issues:
    • Lack of long-term investments: Indian startups, particularly in deep tech sectors, face challenges in accessing long-term capital. 
    • Inadequate domestic funding: Although Indian startups raised over $12 billion in 2024, about 75% of this funding came from international sources.
  • Corporate mismanagement:
    • Recent incidents of corporate mismanagement and governance issues in startups such as Byju’s, Dunzo, and BharatPe have raised concerns.
  • Inadequate Innovations and IP Development:
    • India produces approximately 24,000 PhD graduates annually, yet lags behind in Intellectual Property (IP) earnings. 
    • India paid $14.3 billion in IPR royalties in 2024, while earning only $1.5 billion. This highlights a significant gap in innovation.

Strategies needed to tap into potential of Startups

  • Collaboration: 
    • Coordinating and collaborating among policymakers, entrepreneurs, and educational institutions.
    • Collaboration between academia and industry to ensure that educational programmes align with market needs.
  • Funding: 
    • Creating a specialised fund of funds for deep tech startups that require long-term investments.
    • Increasing domestic capital sources: Large domestic institutions like insurance companies and pension funds can allocate a portion of their surpluses to support startups. 
  • Management:
    • Startups must adopt self-regulation frameworks that emphasise accountability, transparency, and ethical conduct. This involves strong mentorship, professional boards, and sound financial management. 
  • Skilling, Reskilling and Upskilling:
    • Leverage India’s premier educational institutions (IITs, IIMs, and IIIT) to address skill shortages in product development, data science, and AI-ML. 
    • Programmes for internships, apprenticeships, and recruitment can attract talent to startups and bridge existing skill gaps.
  • Balancing risks with regulation:
    • Regulatory framework must balance innovation with oversight, enabling startups to thrive while mitigating risks associated with unregulated growth. 
  • Boosting innovations:
    • Creating a vibrant ideas ecosystem that rewards and protects intellectual property.
  • Supporting new regional hubs:
    • Nearly 50% of India’s startups originate from Tier II and Tier III cities. Emerging hubs like Indore, Jaipur, and Ahmedabad offer immense potential. 
    • Supporting these regional hubs with infrastructure, educational opportunities, and inclusivity (increasing women’s representation in leadership roles).

As India works towards its vision of Viksit Bharat by 2047, startups will play a pivotal role in driving economic growth, creating jobs, and positioning the country as a leader in innovation. 

Status of External Trade in FY 2025

Context: India’s goods exports dipped in December 2024, while imports showed growth. However, the trade deficit narrowed to a three-month low.

Relevance of the Topic:Prelims: Basic idea of the key trends in External Trade. 

Present Status of External Trade

  • Exports of Goods: Goods exports contracted 1% year-on-year in December 2024, totaling slightly over $38 billion.
  • Import of Goods: Imports grew 4.9% to almost $60 billion.
  • Merchandise Trade Deficit narrowed to a three-month low of $21.9 billion.
    • This reflects significant improvement from November’s record gap of $31.8 billion.
  • Gold Imports: grew by $4.7 billion in December.
    • This is the corrected data by the government after rectifying an error of “double counting”.
  • Petroleum imports rose 2.2% to $15.3 billion in December.
  • Petroleum product exports declined sharply by 28.6%, standing at $4.9 billion.
  • Trade deficit:
    • On a year-on-year basis, December’s trade deficit was 17% higher, compared to December 2023. 
    • Total deficit through the year increased by 11.1%, reaching $210.8 billion.
image 130

Analysis of External Trade Data

  • Reasons for export blip: Volatility of gold and petrol prices shooting up are the main factors behind fall of exports.
  • Consistency of the export sector: Shipment values have grown in every quarter through the 1st nine months of this financial year (FY 2024-25).
    • This highlights the resilience of the export sector during a challenging global economic environment. 

A tariff war by the incoming U.S. administration could throw up new opportunities for India. A focused export strategy for key markets like the U.S., the continuation of measures like the Interest Equalisation Scheme, and a resolution of GST-related export challenges are necessary to ensure sustained growth.

National Turmeric Board

Context: The Ministry of Commerce & Industry has established the National Turmeric Board of India at Nizamabad, Telangana.

Relevance of the Topic Prelims: Key facts about the National Turmeric Board. 

About National Turmeric Board

  • The National Turmeric Board is a dedicated body that will focus on the development and growth of turmeric and turmeric products in the country.
  • Nature: It is not a statutory body.
  • Nodal Ministry: Ministry of Commerce & Industry. 
  • Functions: The board will perform following functions;
    • Trade policy: It will work on policy formulation to increase turmeric yield and boost logistics and supply chain to foster trade into newer markets. The board has been constituted to boost turmeric exports to $1 billion by 2030. 
    • R&D and value addition: It will promote research and development of new turmeric products, and will look into value addition of turmeric related products for marketing abroad. 
    • Ensure quality and safety standards: It will ensure quality and safety standards of turmeric production and exports. It will put efforts to enhance the capacity of farmers and food producer agencies for the same. 
    • Awareness generation: It will work on awareness generation about the medicinal and essential properties of turmeric.

About Turmeric

  • Turmeric (Curcuma longa) is a flowering plant from the Ginger family grown in temperature conditions of 20-30 degrees Celsius and high rainfall conditions.
  • India is the largest producer, consumer and exporter of turmeric with 75% of global production.
  • It has anti-bacterial and anti-inflammatory properties, and finds its mention in Ayurveda as Haridra.
  • More than 30 varieties of Turmeric are grown in India and it is grown in over 20 states in the country. 
  • The largest producing states of Turmeric are Maharashtra, Telangana, Karnataka and Tamil Nadu.
  • The leading export markets for Indian Turmeric are Bangladesh, UAE, USA and Malaysia.