Indian Economy, 5th edition (119 page)

In the meanwhile, following on the path of ongoing
‘factor market reforms’
the GoI decontrolled the sugar industry in
April 2013
– effective for the ‘sugar year’ September 2012 - August 2013. It abolished the decades-old practice of regulating ‘how much sugar a mill can sell in the open market’ and the ‘levy’ system in which a company is forced to sell 10 per cent of the output at a loss to the FCI for supplies through the PDS (Public Distribution System) – they will be no more under the levy obligation. The
next move
of reform may be ‘linking sugar and sugarcane prices’.

To continue subsidised supply to the poor, states will now have to buy sugar at market rates and maintain the existing PDS sale price of Rs 13.50 per kg, which has not been revised for a decade and is substantially lower than the average market price of Rs. 35 per kg.

Q. 52 Describe the role of ‘energy pricing’ and the recent steps taken by the government in reforming the sector.

Ans.
The economic role of rational energy pricing can hardly be under-estimated. Rational energy prices provide the right signals to both the producers and consumers and lead to a demand-supply match, providing incentives for reducing consumption on the one hand, and stimulating production on the other. Aligning domestic energy prices with the global prices, especially when large imports are involved, may be ideal option as misalignment could pose both micro- and macroeconomic problems. At microeconomic level, underpricing of energy to the consumer not only reduces the incentive for being energyefficient, it also creates fiscal imbalances. Leakages and inappropriate use may be the other implications. Underpricing to the producer reduces both his incentive and ability to invest in the sector and increases reliance on imports. Over the years, India’s energy prices have become misaligned and are now much lower than global prices for many products. The extent of misalignment is substantial, leading to
large untargeted subsidies
. Several initiatives have been taken by the GoI for rationalising the energy prices in different sectors –

•
The Integrated Energy Policy has outlined the broad contours of the pricing system for coal. The
pricing of coal
is done now on gross calorific value (GCV) basis with effect from January 31, 2012, replacing the earlier system of pricing on the basis of useful heat value (UHV) which takes into account the heat trapped in ash content also, besides the heat value of carbon content. The revision in the GCV is likely to increase the prices of domestic coal to some extent, but this is a desirable adjustment because domestic thermal coal, adjusted for quality differences, continues to be underpriced.

•
In case of petroleum products pricing, the government dismantled the Administered Pricing Mechanism in 2002. This decision, however, was not fully implemented and domestic pass through of global price increases remained low for petrol, diesel, kerosene, and LPG – in June 2010, the government announced that the
price of petrol was fully deregulated
and the oil companies were free to fix it periodically.

•
In
January 2013
, the government announced the new roadmap providing for a gradual price increase for reducing
diesel under-recoveries
.

•
Admissibility of subsidized number of liquefied petroleum gas (LPG) cylinders and prices of LPG have also recently been revised. Pricing of gas is presently done under the New Exploration Licensing Policy (NELP). The government provides the operator freedom to sell the gas produced from the NELP blocks at a market-determined price , subject to the approval of pricing formula. The government is reviewing pricing under the PSC (price sharing contract) to clarify the extent to which producers will have the freedom to market the gas.

Q. 53 What is Marginal Standing Facility and what are its objectives? Describe in brief.

Ans.
The MSF (Marginal Standing Facility) is a new scheme announced by the RBI in its
Monetary Policy, 2011-12
. Under this scheme, banks can borrow overnight upto 1 per cent of their net demand and time liabilities (NDTL) from the RBI, at the interest rate 1 per cent (100 basis points) higher than the current repo rate.

The MSF would be the last resort for banks
once they exhaust
all borrowing options, including the liquidity adjustment facility by pledging through government securities, which has lower rate (i.e., repo rate) of interest in comparison with the MSF. The MSF would be a
penal rate
for banks and the banks can borrow funds by pledging government securities within the limits of the statutory liquidity ratio. The scheme has been introduced by RBI with the main aim of reducing volatility in the overnight lending rates in the inter-bank market and to enable smooth monetary transmission in the financial system.

Banks can borrow through MSF on all working days except Saturdays, between 3.30 and 4.30 p.m. in Mumbai where RBI has its headquarters. The minimum amount which can be accessed through MSF is Rs.1 crore and in multiples of Rs.1 crore.

MSF represents the upper band of the interest corridor and reverse repo (7.25 per cent) as the lower band and the repo rate in the middle. To balance the liquidity, RBI would use the sole independent policy rate which is the repo rate and the MSF rate automatically adjusts to 1 per cent above the repo rate.

Similar to India’s MSF the ECB (European Central Bank) also offers standing facilities called
marginal lending facilities
(MLF) and the Federal Reserve (the US Central Bank) has
discount window systems
(DWS). Like the MSF, the secondary credit facility made available by the Federal Reserve to the depository institutions in USA is typically overnight credit on a very short term basis at rates above the primary credit rate.

The effectiveness of standing facilities in reducing volatility have been examined by many scholars and certain studies have pointed out that in the Federal Reserve System in the United States, the design of the facility decreases a bank’s incentive to participate actively in
interbank market
(i.e., India’s Call Money Market) due to the perceived stigma from using such facility. This in turn reduces the effectiveness of standing facility in reducing interest rate volatility.
6

Q. 54 What are Nidhis and how are they regulated in India?

Ans.
Nidhi in the Indian context means ‘treasure’. However, in the Indian financial sector, it refers to any
mutual benefit society
notified by the Central / Union government as a Nidhi Company. They are created mainly for cultivating the habit of
thrift
and
savings
amongst its members. The companies doing Nidhi business, viz. borrowing from members and lending to members only, are known under different names such as
Nidhi, Permanent Fund, Benefit Funds, Mutual Benefit Funds
and
Mutual Benefit Company.

Nidhis are more popular in
South India
and are highly localised single office institutions. They are mutual benefit societies, because their dealings are restricted only to the members; and membership is limited to individuals. The principal source of funds is the contribution from the members. The loans are given to the members at relatively reasonable rates for purposes such as house construction or repairs and are generally secured. The deposits mobilised by Nidhis are not much when compared to the organised banking sector.

Nidhis are companies registered under the Companies Act, 1956 and are regulated by Ministry of Corporate Affairs (MCA). Even though Nidhis are regulated by the provisions of the Companies Act, 1956, they are exempted from certain provisions of the Act, as applicable to other companies, due to limiting their operations within members.

Nidhis are also included in the definition of Non- Banking Financial companies or
(NBFCs)
which operate mainly in the
unorganised money market
. However, since 1997, NBFCs have been brought increasingly under the regulatory ambit of the RBI. Non-banking financial entities partially or wholly regulated by the RBI include:

(i)
NBFCs comprising equipment leasing (EL), hire purchase finance (HP), loan (LC), investment (IC) [including primary dealers (PDs) and residuary non-banking (RNBC) companies;

(ii)
Mutual benefit financial company (MBFC), i.e.
nidhi company
;

(iii)
Mutual benefit company (MBC), i.e. potential nidhi company; i.e., a company which is working on the lines of a Nidhi company but has not yet been so declared by the Central Government; has minimum net owned fund (NOF) of Rs. 10 lakh, has applied to the RBI for certificate of registration and also to Department of Company Affairs (DCA) for being notified as Nidhi company and has not contravened directions / regulations of RBI/DCA.

(iv)
Miscellaneous non-banking company (MNBC), i.e.,
chit fund company
.

Since Nidhis come under one class of NBFCs, RBI is
empowered
to issue directions to them in matters relating to their deposit acceptance activities. However, in recognition of the fact that these Nidhis deal with their shareholder-members only, RBI has exempted the notified Nidhis from the core provisions of the RBI Act and other directions applicable to NBFCs. As on date (
February 2013
), RBI does not have any specified regulatory framework for Nidhis.

Q. 55 What are Chit Funds and how are they regulated in India?

Ans.
Recently, chit funds was in news after the Kolkata-based
Saradha Chit Fund
scam came to light. Chit funds (also known by their other names such as –
Chitty, Kuri, Miscellaneous Non-Banking Company
) are essentially ‘saving institutions’. They are of various forms and lack any standardised form. Chit funds have regular members who make periodical subscriptions to the fund. The periodic collection is given to some member of the chit funds selected on the basis of previously agreed criterion. The beneficiary is selected usually on the basis of bids or by draw of lots or in some cases by auction or by tender. In any case, each member of the chit fund is assured of his turn before the second round starts and any member becomes entitled to get periodic collection again. Chit funds are the Indian versions of ‘Rotating Savings and Credit Associations’ found across the globe.

Chit fund business is regulated under the Central Act of
Chit Funds Act, 1982
and the Rules framed under this Act by the various State Governments for this purpose. Central Government has not framed any Rules of operation for them. Thus, Registration and Regulation of Chit funds are carried out by
State Governments
under the Rules framed by them. Functionally, Chit funds are included in the definition of Non- Banking Financial Companies by RBI under the sub-head
miscellaneous non-banking company
(MNBC). But RBI has not laid out any separate regulatory framework for them.

Official Definition:
As per the Chit Funds Act 1982, chit means ‘a transaction whether called
chit, chit fund, chitty, kuri
or by
any other name
by or under which a person enters into an agreement with a specified number of persons that every one of them shall subscribe a certain sum of money (or a certain quantity of
grain
instead) by way of periodical installments over a definite period and that each such subscriber shall, in his turn, as determined by lot or by auction or by tender or in such other manner as may be specified in the chit agreement, be entitled to the prize amount’. A transaction is not a chit, if in such transaction –

(i)
Some alone, but not all, of the subscribers get the prize amount without any liability to pay future subscriptions; or

(ii)
All the subscribers get the chit amount by turns, with a liability to pay future subscriptions.