BANK SYNERGY AND SCENARIO

History:

The amalgamation of all presidency banks started the emergence of modern banking in India (Bank of Calcutta, Bank of Bombay, and Bank of Madras) in 1921 to form the Imperial Bank of India, which was run by European Shareholders. They set reserve Bank of India up in 1935 to address the irregularities in the Joint Stock Company. Post-independence, they nationalized the RBI in 1949 as per the Transfer to Public Ownership Act. In 1955, State Bank was nationalized under the State Bank of India Act in Parliament. In 1959, seven subsidiaries of State Bank were nationalized.

In 1969, Indira Gandhi presented a paper entitled “Stray Thoughts on Bank Nationalization” at the annual conference meeting of the Government of India. The paper emphasized on nationalization of Banks. 

There were factors that led to the nationalization of banks. It was told that banks must play a social role in the economy and maintain social balance. They assumed capitalists to be imperialists. Indian freedom battles were against imperialism. Hence, people and government were conservative and influenced by the alternative to socialism. East India Company was a product of monopoly. There were few business people and rich authorities who used to dominate the banking sector and make a profit. The government of India wanted to stop this practice. Banks were set up in cities and also targeted the urban people who were very few at that time. It did not provide people living in rural areas with banking facilities. The banks before nationalization were focusing to perform transactions in the Corporate and Business sectors. They gave not much emphasis on infrastructure sectors. Despite being a country dependent on agriculture for its income and livelihood, they did not give farmers loans because of their poor economic condition.

In response to these factors, the major nationalization of Indian Banks was implemented within a month of the proposal. After this acquisition, the government-controlled around 91% of banking business in India.  

Post Nationalization Reforms:

Indian Banking System experienced a good turn after nationalization. With nationalization, the government focused on components that led to this event. In 1975, the first regional rural bank was set up. Branches of banks were set up in the rural areas of the country. In 2013, the number of branches reached 109,811. Loans to farmers were granted. People, according to their economic status, were given subsidies. In 1975, the first regional rural bank was set up. 

Nariman Committee:

In 1969, under the chairmanship of Shri F.K.F Nariman, new objectives were put forward to discharge social responsibilities and to implement Lead Bank Scheme (At least one bank should have a lead branch in one district).

Narasimhan Committee:

In 1975 and 1991, the Narshimha Committee (also known as Committee on Financial System) brought reforms in the banking sector by introducing the concept of big banks, three-tier system of banks, mega-banks, and more control.

In 1980, six more banks were nationalized. In 1993, Punjab National Bank was merged with the New Bank of India, which reduced the numbers of nationalized banks from 20 to 19. In 2018, Bank of Baroda was merged with Vijaya Bank and Dena Bank. In 2019, 10 more banks were merged into 4 major banks.

Need and Advantages of Mergers (Implementation of 4Rs: Regulate, Recapitalise, Resolution and Reform)

The number of PSBs is high. 27 Public sector banks in India were targeting the same potential customers. It made little sense for the government to compete to gain the same customers. Recapitalization will reduce if the mergers become successful. The government is facing fiscal constraints. Hence, a reduction in recapitalization is needed. The non-performing assets are very high in some banks. A proper check is required to reduce it. By merging, the regulatory burden on banks will reduce. Except for SBI, there is no big bank in India to compete on International Level. Merging banks will cause the formation of big banks with more total business and deposits.

Issues of Mergers

It is difficult for one bank to sync with a bank with higher NPAs. This might create complexities further and can have side effects. Different banks have their unique mission and visions. Merging the two different banks will need time to settle with the new system. If banks after merging are not assessed and controlled well can result in higher NPAs.

Why back to privatization?

 To solve these issues, a new agenda is required. With Globalization and competencies in the Economy, the Government of India is gradually shifting to the Libertarian side of the economy. The business of government is not to run a business. As per the RBI Financial Stability Report, the Gross NPA ratio is likely to increase. Also, because of financial limits, it is proposing private players come forward and invest in banking. Market capitalization in Public Sector Banks is less than the private sector banks. The money used to recapitalize the banks to recover the stressed assets should be used in development projects and the improvement of infrastructure. The budget presented in 2021 states Rs. 1.75 Lakh Crore worth revenue will be generated by Private Sector. There was much emphasis on disinvestment, too. The budget also says two banks will be privatized in this financial year. The government will have a bare minimum presence in running them. 

Privatisation is expected to decrease the recapitalization burden on government as India is already a capital starved country. Considering the business angle of the banking industry, PSBs are more leveraged than PVBs, making the former one risky. On the business expansion front, they have fallen way behind: their (y-o-y) CASA growth in September 2021 was 11.6 percent compared to 22.8 percent for PVBs and 17.2 percent for FBs.

Conclusion

Although much has been talked about privatization, the proper implementation and regulation is demanded so that banking reforms do not shift back to square one. In a country like where people expect populist reforms, we might not well appreciate this move. Also, bitter memories of private imperialism still haunt people. People can easily lose money in private banks if the employees of banks indulge them in malpractices. There is equal risk in public sector banks and the value of frauds in these banks is much higher than in private banks. The solution to every problem is better asset liability management and efficient use of capital, as well as policies. 

Country post-pandemic is facing issues of rising inequality and inflation. Privatisation at this point in time would be very stricter move as people are unsure about the policy changes. How these banks will try to cater to people from different income group and different sectors, is still a question?

REFERENCES

  1. Banking In India –Wikipedia (https://en.wikipedia.org/wiki/Banking_in_India)
  2. Data and image- Bloomberg Quint(https://www.bloombergquint.com/opinion/the-origins-of-the-great-indian-bank-merger)
  3. Draft Reports- RBI (https://m.rbi.org.in/scripts/PublicationDraftReports.aspx?ID=552)

Should emerging markets worry about the US monetary policy announcements?

INTRODUCTION

Financial markets of both developed, as well as emerging countries, usually have some kind of impact due to the United States Monetary Policy. Any changes made by the United States or even ramblings about potential changes can have both positive as well as negative impacts on the Exchange rates as well as Bond rates of Emerging Market Economies (EMEs). When Foreign Banks lend to firms in EMEs they essentially do them in terms of dollars. This creates a direct relation between the United States Monetary Policy and the credit cycles of the EMEs. The impact of the United States Monetary Policy is varied depending on the nation as well as the industries that are directly affected by them. The local lenders of EMEs do not have an offsetting impact on the foreign bank capital inflows, while the United States Monetary Policy affects the credit conditions both extensively as well as intensively. It has been found by many researchers that the spillover effect of the United States Monetary Policy is stronger for EMEs which have a higher risk.

FEDERAL OPEN MARKET COMMITTEE (FOMC) AND ITS ANNOUNCEMENTS

Monetary policy decisions in the United States have a significant impact on financial markets in both developed and developing countries. This was clear in the summer of 2013 when Federal Reserve Chairman Ben Bernanke first mentioned the prospect of decreasing the Federal Reserve Board’s security purchases on May 22. In the months that followed, this “tapering talk” had a significant negative influence on financial conditions in developing countries, with currency rates depreciating, bond spreads widening, and equities prices falling. A full-fledged balance of payments crisis appeared to be looming for several of the countries.

The US Federal Reserve chose to utilize the Federal Open Market Committee to undertake monetary policy changes in response to the Global Financial Crisis caused by the Sub-Prime Crisis in 2008. (FOMC). The FOMC chose to employ an unconventional monetary policy starting in 2008, as illustrated in the chart below.

Fig: Period of Unconventional Monetary Policy

The next era was highlighted by the Large-Scale Asset Purchase Program (LSAP), a programme of direct asset purchases, as well as prior indications on monetary policy direction. The research relied on high frequency variations in longer-term Treasury rates to detect monetary policy shocks because the federal funds futures rate no longer provided a suitable basis for doing so during the unconventional monetary policy phase. The identifying assumption is the same as for the traditional monetary policy period: Treasury rate fluctuations in a brief window around policy announcements are attributable to unanticipated changes in the US monetary policy stance.

Fig: Treasury Yields on FOMC days

Two-year Treasury rates are seen in the first panel of Chart 2. The period is characterised by medium-term patterns, in which yields declined between 2008 and 2011, stayed low from 2012 to 2013, and then rebounded, as well as shorter-term variations with more regularity. The vertical lines represent FOMC days where the percentage change in yields was 2 standard deviations below or above the period average.

The second panel shows the percentage change in yields on each of the FOMC days. Day-to-day changes in response to FOMC announcements that exceeded the two-standard deviation band around the average changes are indicated in red. The third panel compares the daily percentage change in rates on FOMC days to the daily percentage change in yields on all other days in the sample period. It shows that Treasury yields declined on FOMC days on average compared to non-FOMC days, and that the former had more tail events, such as sudden rises or drops in yields.

Finally, on the days of the FOMC announcements, we compare changes in 2-year Treasury yields to changes in 10-year Treasury yields in the last panel. On FOMC days, the fluctuations in 2-year and 10-year rates were significantly connected, as shown in the graph. There were only a few times when the yields’ near synchronisation was broken.

IMPACT OF US MONETARY POLICY ON INDIAN ECONOMY

There was a lot of research done to identify the effects of the US Monetary Policy on the Emerging Market Economies, various statistical as well as regression models were run to come to various conclusions. The most significant of which were the following.

Bhattarai et al (2018) estimated the spill-over effects of US QE on EMEs and assessed the differences in the responses in the policy of those economies, in which they found that the US quantitative easing (QE) resulted in currency appreciation for EMEs, as well as higher long-term bond rates, stock prices, and capital inflows.

Dahlhaus and Vasishtha (2014) studied the possible impact of the withdrawal of stimulus due to QE on EMEs which resulted them in finding for EMEs, the impact of QE tapering was predicted to be minor as a percentage of GDP. However, they warn that this might still create severe market volatility.

Gupta et al (2017) looked at the effects of QE and EMEs, in which they found In EMEs, QE had a considerable impact on exchange rates, stock prices, and bond yields.

Impact on India

Fig: INDM1 (Indian Money Supply), USMBASE (United States Monetary Base), EFFR (Effective Federal Funds Rate), INDBNCRE (Indian Bank Credit Rate), USD INR (Exchange Rate), and Indian Interest Rate changes

QE increased the money supply in the United States, which in turn increased capital inflows into emerging economies like India, increasing the economy’s money supply. At the same time, as the money supply shifted to growing economies such as India, the money supply in the United States shrank. As a result, there is a bi-directional causality between the money supply in India and the money supply in the United States. Indian Money Supply and Indian Bank credit rate also show a bi-directional causality due to the fact that the increase in bank credit will lead to increase in money supply.

QE increased the money supply in the United States. As a result, inflows into emerging economies like as India increased dramatically. This should have caused the Indian rupee to appreciate against the US dollar during QE and depreciate during tapering. In contrast, the rupee has been progressively losing strength versus the US dollar. This is because the Reserve Bank of India intervenes in the foreign exchange market to prevent the Indian currency from gaining too much, lowering volatility. The influence of QE on the currency rate has been negligible as a consequence of the RBI’s involvement.

CONCLUSION

According to our research, surprise US policy pronouncements have a big and significant influence on asset values in developing countries. Our estimates demonstrate that in developing nations, a surprise monetary easing, as assessed by a decline in the 2-year Treasury yield on the day of the FOMC announcement, leads to exchange rate appreciation, equities price gains, and bond yield reductions. A surprise tightening, as measured by an increase in the 2-year Treasury rate, on the other hand, has the opposite effect.

Evidence suggests that monetary policy shocks have a lesser spill-over in other advanced economies, such as the euro-zone, Japan, and the United Kingdom, owing to their weaker financial connectivity with emerging economies.

The signaling effect or portfolio rebalance effect, of US policy statements may have an impact on emerging economies. The findings highlight the impact of unexpected US monetary policy pronouncements for emerging economies and add credence to emerging market policymakers’ concerns in recent years. They emphasize the necessity for emerging economies to remain cautious in the face of US policy changes.

The Federal Reserve Bank of the United States, and to a lesser extent other advanced countries’ central banks, prepare the markets well in advance by providing unambiguous guidance, particularly when policy tightening is expected. The influence would then dissipate over a longer period until the day of the announcement, and emerging economies would be unlikely to see significant short-term financial upheaval.

REFERENCES:

  1. Jaswal, A., & Ahuja, B. R. (2021). Unconventional US Monetary Policy: Impact on the Indian Economy. The Indian Economic Journal, 0019466221998627.
  2. Bräuning, F., & Ivashina, V. (2020). US monetary policy and emerging market credit cycles. Journal of Monetary Economics, 112, 57-76.
  3. Gupta, P., Masetti, O., & Rosenblatt, D. (2017). Should emerging markets worry about US monetary policy announcements?. World Bank Policy Research Working Paper, (8100).
  4. Arora, V. B., & Cerisola, M. D. (2000). How does US monetary policy influence economic conditions in emerging markets?

Impact of US-China trade war on across the globe

Abstract:

The US-China trade war started in 2018 and it hasn’t ended even though there has been a change in the US administration. These two countries have great importance in the world trade and any changes in policies with respect to it affect the whole world. This report studies the impact US-China trade war on the stock market of various countries during the period 2018-19.

Overview:

The two giant economies of world USA and China have been in constant growth trade relations since 1970s. These trades accelerated after China entered World Trade Organization in 2001. The US has consistently imported from China their onwards and the bilateral trade deficit in of US rose to $375.6 billion in 2017. During Donald Trump administration, US started imposing tariffs and trade barriers on China in hope to reduce the trade deficit and provide market for home grown industries. The imposition of tariffs escalated quickly resulting countries taking some drastic measures which in-turn converted into a trade war.

This imposition of tariffs had ripple effects around the world. Some countries benefitted to some extent from it and some countries paid the similar price via tariff hikes. By 2019, the US had placed tariffs on about $350 billion in Chinese imports, while China had countered with duties on US exports worth more than $100 billion. The tariffs were imposed to reduce the trade deficit, but in 2020, the US-China trade deficit hit a new high of $915.8 billion and the goods and services deficit hit a new high, the most since 2008. The decision to impose tariffs affected consumers, the importing firm also absorbed some cost The US consumers paid the price in the end of all the tariffs imposed onto China. The impact on US producers with significant exposure to Chinese markets was also captured in stock market valuations. The equity price performance of US companies with high sales to China underperformed relative to US businesses exposed to other international markets, after tariffs linked to the $34 billion retaliation list by China were implemented.

                     Impact of US Tariffs on Sales                  

   Tariffs affecting top 10 importing sectors

The above charts show impact of tariffs onto top 10 imports of US from China. The sectors which import the maximum in terms of $ are telecom and electrical industry, computer industry and households’ items.

First, Trade Policy uncertainty about trade policy affects investment decisions of companies. If it were 100% certain that the tariffs stay in place, the producer in the import competing sector could raise investments and if it were sure there would be an agreement about the reduction of tariffs to pre-trade conflict levels, the producer in the exporting sector could raise investments. If it is uncertain what will happen, companies in both sectors will wait with investing. This slows down the whole manufacturing cycle ultimately hurting parties on both sides.

Second, the trade policy uncertainty had a much larger impact on the stock market than on investment itself, the S&P 500 fell by 2.5% on March 22, 2018, the day the US announced higher tariffs on 50 billion dollars of Chinese imports. Many companies listed on the stock market have substantial commercial business outside of the US which were also heavily affected by the new tariffs. This uncertainty has weighed on investor confidence around the world and has contributed to losses. In 2018, Hong Kong’s Hang Seng index fell more than 13% and the Shanghai Composite slumped nearly 25%. Both indices have recovered some ground and were up 12% and 16% respectively 2019 (Fig-1: Shows the performance of US and China stock index)

                                    Impact of Trade war on Stock Market of US & China

 Impact of US-China trade war on other countries:


The trade war between the United States and China had a significant worldwide impact, with some countries benefiting while others suffered the brunt of the consequences, and some economies remaining unchanged.

While trade flows between the US and China dropped, trading prospects for other countries increased. Here, we have picked a few countries to analyze the impact of the trade wars:

Vietnam:

During the US-China trade war, Vietnam was one of the countries that benefitted as US, over the years, has been the biggest market for Vietnam’s exports, and China was the 2nd largest source for Vietnam’s imports.

Vietnam’s exports rose to around $290.4 billion, and the country saw a trade surplus of $34.78 billion with the US. Meanwhile, Vietnam faced a trade deficit of $24.17 billion with China in 2018. However, Vietnam spent US$57.98 billion on imports during the first quarter of 2019. Additionally, there a GDP growth of 7% majorly due to manufacturing, consumption, and tourism. The expansion of manufacturing helped in gaining more investors and thus aided in increased exports including apparels, furniture, shoes, seafood to the US.

While there is an increase of exports to US to a large extent (by 27.3% in 1st half of 2019), the increase to exports to China was only 0.3%. Vietnam’s exports to China mainly consisted of electronics, semiconductors, apparels, furniture.

There is a benefit as the effect of tariffs on the Chinese goods consumed are also produced and consumed in Vietnam. Therefore, such products were exported to the US, and gain market share from Chinese goods subjected to tariffs, while exporting to US. This led to increase in FDIs, expanding the job market.

Another benefit was that the companies based in China shifted production operations to Vietnam. However, investors are finding it strenuous as the quality of manufacturing and sourcing materials are not at par with China.

Despite the jump in exports and investments, Vietnam also saw a negative impact as it faced similar tariffs as China due to the increasing trade surplus with the US. Vietnam is also not immune to US taxes.

China’s rampant exports to the country would lead to an increase of Vietnam’s trade deficit with China, and Vietnam’s domestic firms will face difficulty from rising competition from Chinese goods. Due to the trade wars, if China decides to consume the exports instead of exporting to other countries, Vietnam will find it challenging to export to China.

                                                        Vietnam-US Trade (2017-2019)                               

                                     
                                                        Vietnam-China Trade (2017-2019)                                       

Taiwan:

Taiwan was also one of the countries that benefitted from the US-China trade wars due to the effect of trade diversion, gaining unexpected earnings of $4.2 billion in 2018-2019. The country earned the most out of office machinery equipment by gaining around $2.8 billion dollars.

Due to increasing labor charges, productivity challenges, IP rights violations, Taiwan had already begun shifting its operations from China back to Taiwan. Therefore, now those goods turned from made-in-China to made-in-Taiwan. Additionally, Taiwanese investors invested back NT$610 billion from China back to Taiwan.

Taiwan had initially faced a loss due to steel and aluminum tariffs, but as it is a rich ICT hub, it gained the most in precision engineering products and electronics ($2,941.6 million, and $310.7 million) the effects of trade diversion was made up for. However, Taiwan also faced negative effects in services like Business, transportation, trade, finance ($58.323 million, $36.6 million, $25.3 million, $24.5 million).

In 2018, Mainland China was Vietnam’s largest trading partner (with 23.9% total trade, 18.6% Taiwan imports).

US was Taiwan’s 2nd largest trading partner (with 11.8 % of total trade and 12% of Taiwan imports), the countries had a total transaction in goods and services of $94.5 billion – with $40.3 billion in exports, $54.2 billion imports, where Taiwan faced a trade deficit of $13.9 billion. Taiwan’s GDP grew to 2.96% in 2019 from 2.79% in 2018.

                          

                   
                              Goods exported from Taiwan – overall (Source: Statista.com)

Mexico:

As Mexico is a country of low tariffs, it was viable for companies to move their production from China to Mexico during the trade wars between US and China.

The global economy was facing a slowdown as there was a decrease in investment in manufacturing, but due to the shift of operations to Mexico, the country had opportunity to grow through employment, investment, and market.

Due to the effects of increased tariffs imposed by US on China, Mexico replaced China as a major trade partner in 2019 as the value of Mexico exports to US increased as compared to China

Mexico exported a total goods and services of US$ 361 billion to the US (majorly automobiles with reciprocating piston engine – where Mexico’s US market share rose 15%, and China’s dropped 9%; raw materials), and imported a total goods and services of US$ 235 billion (majorly petroleum) million in 2019.

When it comes to China though, the scale tips considerably to China as Mexico exports to China was only US$ 7.1 billion, whereas China’s exports to Mexico was around US$ 93 billion. However, there is a steady increase from US$ 6.7 billion in 2017

Mexico did benefit from the trade war, as the resulting exports of China to US reduced, opportunities grew for Mexico. Additionally, China started using Mexico as an export platform to reach US as the tariff for exporting from Mexico was lesser than the 25% tariff of exporting directly from China

However, Mexico’s GDP declined by -0.177% and entered recession in early 2019 as the country couldn’t handle the slow industrial output, and decreased business investments

                                       
     
Conclusion:

Bottom line for the US-China trade war is that both the countries being economic superpower share huge stake in fostering open trade and investment. Any geopolitical disputes among these countries will have and had serious repercussions on countries all over the globe. Some countries may have benefited from this, but majority of the countries had to face some difficult time. Both the countries risk losing billions of dollars’ worth of money which could have contributed to their GDP due to this trade war. US’s changes in trade policy could have been based purely on politics and to reduce the China’s economic growth and its growing importance in the world economy. Since it has not benefited any of the two countries. The China’s government in its turn has a goal to achieve leadership in robotics, biotechnology, and artificial intelligence. It will provide financial support to high-tech industries and will do everything possible not to let the US stop or slow down the modernization and digitalization of the China’s economy.                 

References:
https://www.vietnam-briefing.com/news/us-china-trade-war-inspires-vietnam-growth.html/
https://ajot.com/news/why-vietnam-could-be-asias-biggest-trade-war-winner
https://www.bloomberg.com/news/features/2020-02-02/vietnam-s-economy-is-being-squeezed-in-the-u-s-china-trade-war
https://www.emerald.com/insight/content/doi/10.1108/S2514-465020200000008011/full/html
https://direct.mit.edu/asep/article-abstract/19/1/61/93319/Implications-of-the-U-S-China-Trade-War-for-Taiwan?redirectedFrom=fulltext#:~:text=One%20of%20the%20positive%20impacts,domestic%20value%2Dadded%20and%20employment.
https://www.forbes.com/sites/ralphjennings/2019/11/29/why-taiwan-is-benefiting-the-most-from-the-us-china-trade-war/
https://direct.mit.edu/asep/article-abstract/19/1/61/93319/Implications-of-the-U-S-China-Trade-War-for-Taiwan?redirectedFrom=fulltext
https://www.stimson.org/2018/us-china-trade-war-impact-taiwan/
https://www.wilsoncenter.org/publication/the-us-china-trade-war-and-options-for-taiwan
https://www.researchgate.net/publication/340955319_Implications_of_the_US-China_Trade_War_for_Taiwan
https://www.export.gov/article?series=a0pt0000000PAyNAAW&type=Country_Commercial__kav
https://tradingeconomics.com/taiwan/exports
https://research.hktdc.com/en/article/MzU3OTI2Nzg1
https://dialogochino.net/en/trade-investment/32441-is-mexico-really-winning-the-us-china-trade-war/
https://www.cnbc.com/2019/09/12/mexico-may-be-an-unexpected-winner-of-the-us-china-trade-war.html
https://www.tecma.com/mexico-is-a-beneficiary-of-the-us-china-trade-war/
https://www.ft.com/content/e291718a-7c6e-11e9-81d2-f785092ab560
https://wits.worldbank.org/CountryProfile/en/Country/MEX/Year/LTST/Summarytext
https://gbsrc.dpu.edu.in/blogs/impact-of-us-china-trade-war-on-indian-economy
https://home.kpmg/in/en/blogs/home/posts/2020/01/impact-of-us-china-trade-war-on-india-asean-countries.html
https://journals.sagepub.com/doi/abs/10.1177/26316846211038223
https://www.livemint.com/news/india/us-china-trade-war-impact-india-gained-755-million-additional-exports-to-us-11573047787150.html
https://www.hindustantimes.com/analysis/why-the-us-china-trade-war-has-not-helped-india-analysis/story-bQ74UotjHLBpHmRsoZc2xJ.html
Trade war: US-China trade battle in charts – BBC News
US-China trade war: ‘We’re all paying for this’ – BBC News
The U.S.-China Trade War The Global Economic Fallout | S&P Global
The global macroeconomics of a trade war | VOX, CEPR Policy Portal
USCBC Reports | Page 2 | US-China Business Council
The Economic Impacts of the US-China Trade War
U.S. trade deficit hits record high in 2020: The Biden administration must prioritize rebuilding domestic manufacturing | Economic Policy Institute
The Impact of US-China Trade Tensions – IMF Blog
The US-China Trade War and Brazil as Proof of Trade Redirection – Harris Bricken
US-China trade war to cost $455bn in lost output, says IMF | International trade | The Guardian
Trade Balances Mostly Driven by Economic Forces, Not Tariffs – IMF Blog
Full article: US-China trade war and China’s stock market: an event-driven analysis
The failure of Trump’s trade and manufacturing policy | Economic Policy Institute

Coal Crisis in India

India has been battling a severe coal supply shortage for the past few months. The situation was critical when India saw a massive power supply shortage in October’21. It was due to a scarcity of coal, which had reached the point where 135 thermal plants in the country didn’t even have a four-day supply.

So what is fuelling this coal shortage?

Let us first understand the source of India’s coal supply. India is the second-largest consumer of coal after China. Coal accounts for 70% of India’s electricity generation. Though India is the fifth-largest holder of coal reserves which is close to 10% of the world’s share, it still imports 25% of its coal consumption. India imports 80% of its import coal requirement from Indonesia, Australia, and South-Africa. Coal India Ltd. (CIL) and Singareni Collieries Company Ltd. (SCCL), both being government-owned corporations are the major contributors to the production and dispatch of coal in India.

Causes of the Coal crisis

Global factors

Prices of coal are rising globally, seeing a gain of 160% in the last few months. This could be attributed to the reviving economy and increasing demand for electricity. The year 2020 experienced a sharp decline in demand for coal as production was halted in various industries because of the pandemic. But the reviving economy is demanding both, an increase in production as well as consumption of coal. Therefore, the imports had to be substantially curbed due to the rise in global rates building a gap between the demand and supply and leading to the supply crunch. High imports of coal by China is one of the reasons inflating the coal prices.

Source-RBI portal

High imports of coal by China is one of the reasons inflating the coal prices. Along with India, China has also been facing a energy crisis due to flooding in one of its key sources of coal. Also, it has been taking steps to reduce coal consumption to reach its carbon neutrality goals, which is not practical currently as its economy is reviving and the industries are heavily reliant on coal-sourced power.

Indonesia, being one of biggest exporters of coal has currently announced a ban on coal exports for a month due to not meeting domestic production targets. This has led to a disruption in market causing rise in price.

Rising demand for electricity

As the economy revived in 2021, India saw a 13.2% increase in demand for power and reached its all-time peak in the month of July.  As the electricity generation increased rapidly, energy crisis was unfolding as most of the thermal plants were running out of coal stock reaching critical and semi-critical inventory levels. According to Central Electricity authority, power demand in April-August 2021 was 203014 MW which was significantly higher compared to 171510 MW in the same period last year. The mismatch of demand and supply has created a disequilibrium in the market leading to increase in price of coal.

Domestic Coal production

Domestic coal production has been stagnated since 2018. Due to water logging in coal-bearing areas caused by severe rains in September and early October’21, dispatches from coal mines were hampered, resulting in lower-than-normal stock accumulation by thermal power plants in October.

Coal India Ltd. has monopoly over the coal supply as it supplies over 80% of the total supply. As per the data below, CIL has been failing to expand and instead the production is seeing a decline since 2018. Though India has the fifth-largest share of coal reserves, it is yet to ramp up its coal production.

Following data shows the production of coal during the last 10 years. The data points out the decline in production in 2020-21 which is also the first ever decline in production in the span of last 10 years.

Source -Ministry of Coal

Let us now examine the causes for India’s failure to increase coal production.

Delayed payments to coal miners and distributors

One of the major reasons for the slowing down production and supply of coal, is the high amount of dues which are yet to received by the coal mining and producing companies like CIL and SCCL

Source -Praapti portal

De-allocation decision in 2014

In 2014, government after being blamed for illegal allocation of mines, had to re-allocate as per the decision of Supreme court.  The government took this opportunity to bring in new players and actively promoted by introducing stimulus packages to attract new players in this market. It failed to work as it is a tough industry and it is very difficult to compete against an established corporation like CIL. Also CIL’s prices have always been significantly lower than the global prices and majority of thermal plants rely on CIL. Not only competing with prices would be an entry barrier, but the bureaucratic and political hurdles to pass through would be very difficult compared to CIL. Therefore, CIL continued to have the monopoly but has been the backbone of the entire coal industry.

I would like to talk about the criticality of this crisis on our economic recovery. If we think about it, Indian sources 70% of its electricity through coal, therefore it is an extremely critical issue to look into as it hampers the recovery as well as the future growth of the economy.

As we saw, there are multiple reasons why this industry has stagnated in the last few years. But one of the reasons which surprised me the most is the fact that though CIL has been always given the complete monopoly over mining and distribution, it has not improved its production. Majority of its shares is owned by the government, and it also receives tariff support from the government which allows them to keep the prices low. It was predictable that the power demand and consumption is going to rise as government designed many booster packages for the economy for its post-covid revival but government owned CIL did not prepare well for the upcoming demand. Government had also decided to curb imports, but it was practically not possible when the domestic production could not keep up with the rising demand.

The issue of delayed payments by DISCOMS might not be highlighted as much as the other causes, but it is one of the major reasons behind delayed production of coal. Operating inefficiency on part of DISCOMS leading to higher costs have delayed payments, especially state-owned DISCOMs.

As many other government-owned and controlled industries are now permitting private entrants, could coal industry too benefit from this trend? But this could only be possible if government gives them a fair chance by supporting these companies. It needs to provide support if they have to compete against prices of CIL. These new enterprises would also require significant capital, and if they are unable to attract coal consumers owing to price disparities, they will be unable to survive.

Therefore, the coal crisis being a substantial obstacle to our economic prosperity, it must be addressed at all levels.

Author

Shilpa Jain

Editor, TJEF

Biggest Economic Risks of 2022

Economists tried hard to predict and prepare for the risks due to the pandemic in 2021. But their predictions didn’t work out. They are again trying hard to predict what 2022 has in store for economies across the world, amid new variants of COVID-19, inflations, hard Brexit, a fresh euro crisis, rising food prices, energy crunches, and peak oil prices. Let us now look at some of these potential risks that can pose global economic threats in the year of 2022.

Omicron and Lockdowns

Though it is early to predict how deadly the new variant of COVID-19, the Omicron can be, though, more contagious than the earlier variants, it may also prove to be less deadly. This can help the world get back to the pre-covid levels of spending, thus increasing the demand and supply of goods. A rebalancing of these spending levels can help and boost global growth upto 5.1%

On the other hand, all of this can be proven to be our wishful thinking. A more contagious and deadly variant can loom on economies across the world, pushing countries into the toughest 2021 restrictions and making economic growth sluggish in 2022.

In such a scenario, demand and supply will fall, workers will be kept out of labor markets leading to worse supply chain and logistic problems. Such scenarios are already evident in the Chinese city of Ningbo which is home to one of the world’s busiest airports, now seeing fresh lockdowns. A new wave of COVID-19 can push the already hit traveling industry into a reel of losses.

Inflation

With post-COVID-19 recovery and supply chain bottlenecks, the widespread surge in power and energy sectors, the costs have been rising, leading to global inflation. The inflation of the US is currently at around 7% contrary to the forecast of 2% by the end of the year 2021. Such major misses in controlling the inflation rates are very much possible with potential causes like Omicron, wage rates which are already rising at a rapid pace in the US. Tensions between Russia and Ukraine can lead to a surge in gas prices.

Similarly, in India though RBI expects the inflation to ease in 2022, the inflation might rebound to 6% in early 2022 due to unexpected higher prices of food, core commodities and services. RBI has been doing a great work in inflation targeting which is evident from the fact that the inflation stayed within the RBI’s target range of 2%-6% for a fifth straight month. But how well inflation in India can be targeted and curtailed in 2022 remains to be seen.

Disruptive weather conditions due to climate change may continue to rise food prices increasing the Wholesale Price Index, worsening the Global Hunger Index of developing countries. India stands at 101st out of 116 countries with a score of 27.5 which depicts a level of hunger that is serious.

Source: Website of globalhungerindex.org

Source: Website of globalhungerindex.org

Uncertain Federal Reserve Policies

Uncertain Federal Reserve Policies concerning managing inflation rates is one of the biggest risks global economies are facing. While the causes are driven by complex factors beyond disrupted supply chains and increased consumer spending, there is no doubt that the solution lies with the Federal Reserve and its Chairman Jerome Powell. The White House might raise taxes to control inflation since other programs to control inflation have not been showing impressive results.

Adding to the risks are already-elevated asset prices. The S&P 500 Index is near bubble territory, and surging home prices suggests that the housing-market risks are bigger than during the sub-prime crisis back in 2007 which might lead to a recession at the start of 2023.[SJ2] 

Federal Reserve policies also influence the RBI. Increase in Fed interest rates narrows the spread between US and Indian government bonds leading to pulling out of money by foreign investors from Indian Government Securities. This might push RBI to increase interest rates in the country to prevent outflow of Foreign Portfolio Investments (FPI) from Indian Bond Market which will weaken the rupee further leading to inflation.

Once the US dollar strengthens further as interest rates of dollar denominated securities might begin to move higher. This will lead to decline in rupee.

Impact of Fed Lift-off on Emerging Markets

To curtail repercussions of COVID-19, USA has been buying bonds and securities in large scale, a process called as Quantitative Easing, which helps in inducing liquidity in its economy. This increased liquidity in the economy helps lower the interest rates, encourages businesses to invest more and consumers to spend more, thereby increasing the aggregate demand. However, this might lead to the central bank running into the risk of higher inflation and hence in September 2021, US Fed Reserve hinted at starting to reduce its large-scale asset purchases, a process known as ‘tapering’ which may lead to higher interest rates in 2022. The tapering process would affect the supply and demand dynamics which can lead to short-term volatility in certain market segments and raise the interest rates. This would mean a global risk aversion as global investors pulls out their money from emerging markets and invest in ‘safe-haven’ assets like gold and US treasury instruments, bringing back the memories of the “taper tantrum” episode of 2013.

Countries like India, the emerging markets, might take the brunt of such taper tantrums due to reduction in funds infused by Fed and increases fed fund rate which will impact the availability and cost of overseas finance of Indian companies. After signals of hike in interest rates in June, the benchmark Sensex fell 461 points or 0.87% The rupee also lost 0.75 paisa or 1% against the dollar during the time.

China’s Great Wall of Debt

In the third quarter of 2021, China’s economy has slowed down due to the weight of the Evergrande (a real estate company that bears $300 billion in liabilities), repeated COVID lockdowns, and energy shortages. This slowed down the economic growth to 0.8% on contrary to the world accustomed economic growth pace of 6%

While the energy crunch caused by high coal costs and inflexibility in electricity prices might show signs of easing in 2022, the ‘Zero-COVID strategy’ of Beijing might call for more lockdowns. According to some government statements, the plan of Chinese government to curtail the Evergrande real estate slump is to manage a controlled implosion by selling off some of Evergrande assets while limiting the damage to homebuyers, businesses and without bringing down the epic property boom of China. But with the dire situation in real estate, the sector which contributes to a quarter of China’s GDP and worth $52 trillion, China’s economy might have to fall further.

On the flip side of the coin, what can go right in 2022?

Amid lockdowns due to new variants of COVID-19, tapering process of US and other developed countries, higher inflation rates and uncertain monetary policies to curtail it, what can go right in 2022?

Globally, households are sitting on trillions of dollars of excess money saved from cutting down on spending during the pandemic during lockdowns. If the world is back to pre-covid times and that money gets spent, boosting the consumer spending, demand, and supply and hence the growth would accelerate.

In China, investments in green energy and affordable housing which is already stated in the country’s 14th Five Year Plan could increase investments. Asia’s Regional Comprehensive Economic Partnership – which includes 2.3 billion people and 30% of global GDP can boost exports in the region.

Countries have been recovering surprisingly rapidly, proving economists wrong in their predictions of sluggish recoveries. This can be true next year, too like in 2021.

Author

Niharika Jayanthi

Editor, TJEF

Peak Oil – Its Economic Impacts and the Future

There hasn’t been any industry that COVID-19 hasn’t impacted and one of the most impacted sectors in the economy was the Oil and Gas Industry. The Oil Price fell to an all-time low of negative $37.63 on the WTI (West Texas Intermediate) index in April 2020, there was an excess of supply and for that time, there was no need to produce any more oil. All OPEC and OPEC+ countries together decided to reduce their production of Oil and Gas by about 10 million barrels per day. This decrease in production revisited a question in the minds of many in the energy sector… Have we reached Peak Oil?

What is Peak Oil?

Peak Oil is defined as the moment at which the global oil production will reach its maximum rate after which it will gradually decline. This happens as the rate of extracting new reserves becomes more expensive. This puts a strain on the existing resources which are being rapidly exploited and will be depleted if new sources are not found faster than the rate of depletion of current resources. So, the fear of Oil getting completely depleted was genuine, thus sparking a deluge of multiple experts trying to predict. This was a major concern till new technologies were developed and there was a strong need to develop renewable sources of energy due to the rise in the realization of the Global Warming phenomenon in the late 1970s.

Fig 1: Hubbert’s Peak Oil Model

Peak Oil Demand

It was always assumed that the ‘supply’ of oil would eventually come to an end. Due to scarcity, the oil prices would increase, making Oil Expensive. In the past 40 years or so for every 1 barrel of oil consumed, 2 new were discovered and could be recovered at an economic rate. In recent research by Industry experts, it was found that the oil required for the world till the year 2050 was available twice over and due to abundance in technology, this value will increase multifold. This tells us that the world will not fall short on Oil any time soon and there might never be a shortage of oil as earlier predicted. It also means that most of the identified recoverable sources of oil may never be recovered.  Due to the world moving towards renewable sources of energy, the dependence on conventional sources like oil, gas, and coal is reducing as you read this.

The world is still dependent on conventional sources like Oil, Gas, and Coal to achieve its energy requirements, however, there is now a shift towards more renewable sources of energy and now it is evident that the demand for Oil will gradually decrease. The moment in time when the demand for oil reaches its maximum and then starts reducing, it is called Peak Oil Demand.

Fig 2: Projections for Peak Oil Demand

The next question which comes to mind is When will Peak Oil supply occur?

Analysis has been done and potential dates ranging from 2028-2040 have been estimated. The range is very large and there are many factors that are responsible for the determination of Peak Oil Demand. Due to the new Environmental Protocols and with the proper observance of these regulations and promises, this date can take place even earlier. The world is already preparing for peak oil demand in terms of energy, but we are yet to understand the economic impacts of this phenomenon.

Impact on the Oil Market

With this shift in recognition from apparent scarcity to proven abundance, the behavior of oil-producing economies will change. It will cause the Oil market to become even more competitive than it is now. The Oil market hasn’t been behaving normally over the past decade as high-cost producers are able to compete with low-cost producers even if the high-cost oil has a multifold price difference as compared to low-cost oil. By the law of competitive markets, these high-cost producers should have been shut down or should have been driven out of the market.

This has not happened as the low-cost producers have rationed their resources to be able to produce over the next 100 years. This made sense in a scarce market, however, since the market has now shifted to being abundant this method of rationing will not work. In an abundant market, the low-cost producers will now try to force out the high-cost producers from the market. In such a market, the money in the bank is more valuable than the oil in the ground. This means that the low-cost producers would have to utilize the “high-volume, lower price” model to stay relevant in the market, this model heavily benefits the consumers. For the high cost to somehow survive in this highly competitive market they would have to give very lucrative contracts so that they can continue this business.

Both these models have problems, for the low-cost model, there is an operational problem as it becomes difficult for any producer to suddenly up their production even by 50%. Whereas for the high-cost producers there is a risk of their resources being depreciated in exchange for their contracts due to the lower price of oil.

Economic forces and dynamics take a lot of time to take effect, so for this situation to become a market norm it will take some time to become more competitive and will face significant challenges before these forces have their full effect.

Conclusion

Peak Oil Demand is a huge rage in the energy sector. The fact that the demand for oil will eventually reduce is not going to change. Rather than finding the date of the peak, the shift in paradigm needs to be shown more concern. The world will still need large quantities of oil at least for the next few decades.

The shift from an era of perceived scarcity to an age of abundance will result in a highly competitive market environment. This will result in oil-producing countries starting diversifying in order to survive in a world without Oil. The rate of this diversification as well as how much it is diversified will impact the oil prices in the coming few decades. However, it is unlikely that these changes will ever cause the major oil producing economies to have heavy fiscal deficits and the average price of oil will depend more on the social cost rather than the technical cost of production

.Peak Oil Demand is an interesting phenomenon and will result in the change of the energy sector in the coming few years. The decrease in the demand for oil will not only change the way energy is consumed but also be a factor for change for the better.

Author
Abishek Jeremy Lobo
Editor, TJEF