CAFRAL RESEARCH ECONOMIC INSIGHTS: WORKING PAPERS 2024

March 31, 2024

Foreword
About Publication
Papers in the series

Foreword

It is a privilege to introduce the inaugural series of research working papers by the Centre for Advanced Financial Research and Learning (CAFRAL), an institution promoted by the Reserve Bank of India as a house of intellectual excellence. This collection signifies a milestone in our commitment to advancing knowledge in banking, finance, macroeconomics, trade, and public policy. It aims to addres......

Michael Debabrata Patra

Deputy Governor, Reserve Bank of India

About Publication

The working paper series is envisioned as a platform for continual dissemination of applied academic knowledge that deepens understanding of India’s economic systems. The richness and diversity of these papers lay the foundation for future research endeavour aimed at fostering collaborations and inspiring scholars to delve deeper into the complexities of India’s economy.

The contributions in this series reflect research undertaken by CAFRAL scholars and cover a rich set of topics such as the transmission of global price shocks to India, firm financing, sovereign defaults and their implications, trade policies, and firm productivity. This volume commences a journey that shines light on CAFRAL’s endeavour to establish itself as a hub for interdisciplinary research, bridging critical gaps in policy-oriented research and facilitating evidence-based policymaking.

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Papers in the series

Paper 1

Food, Fuel, and Facts:Distributional Effects of Global Price Shocks

We show that exogenous global commodity price shocks lead to a significant decline over time in Indian household consumption. These negative effects are heterogeneous along the income distribution: households in lower income groups experience more adverse consumption effects following an exogenous rise in food prices, whereas households in the lowest and the two highest income groups are affected similarly following an exogenous rise in oil prices. We investigate how income and relative price changes contribute to generating these heterogeneous consumption effects. Global food price shocks lead to significant negative wage income effects that mirror the pattern of negative consumption effects along the income distribution. Both global oil and food price shocks pass-through to local consumer prices in India and increase the relative prices of fuel and food respectively. Expenditure share of food increases with such a rise in relative prices, which provides unambiguous evidence for non-homothetic preferences. Specifically, we show that food, compared to fuel, is an essential consumption good for all income groups in India.

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Paper 2

Protectionism in a Green Suit? Market Power in Carbon-based Trade Policy

Carbon tariffs have received widespread support as a second-best policy tool to regulate foreign emissions indirectly. In this paper, I document novel evidence suggesting that carbon-intensive sectors have higher market power and thus charge higher markups. Thus, carbon tariffs lead to sizable profit-shifting across countries. I build a multi-industry structural model of international trade with input-output linkages to analyze the welfare implications of a carbon-based trade policy reform. I study the nature of profit shifting in response to the carbon-embodied tariffs and quantify the aggregate and distributional effects on welfare and emissions. The findings suggest that accounting for market power increases the effectiveness of trade policy in reducing global emissions. However, it generates heterogeneous effects across countries where countries may lose as high as four percentage points or gain more after accounting for profits with the counterfactual trade policy reform. India, for example, experiences a welfare gain of 0.34 percentage points.

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Paper 3

BRANCHING OUT IN BANKING DESERTS: DO CREDIT I CONSTRAINED FIRMS GAIN?

Does financial deepening increase capital investment by credit-constrained firms? We exploit India’s nationwide bank expansion policy in 2005 that incentivized banks to open branches in “underbanked” districts. Using establishment-level data in a regression discontinuity design, we find substantial increases in capital expenditures and credit growth of manufacturing establishments in underbanked districts post intervention. Establishments likely to face credit constraints — small and young establishments, and establishments not owned by publicly listed corporations — drive the effects. The mechanism is increased physical proximity of lenders to small, informationally opaque borrowers. Financial deepening by bringing lenders closer to borrowers can relax credit constraints in economies with imperfect credit markets.

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Paper 4

Sovereign Default and Tax-smoothing in the Shadow of Corruption and Institution

Emerging countries exhibit volatile fiscal policies and frequent sovereign debt crises, that significantly diminish the well-being of their citizens. International advisors typically suggest developed-world solutions as a remedy. We argue that the root of the problem lies in the institutional environment, which does not incentivize responsible policymaking, particularly tax-smoothing practices. Focusing on democratic representation and control of corruption, our dynamic political-economy bargaining model shows that nations with weaker institutions experience frequent default episodes and greater economic volatility. Our results are in line with stylized facts from a panel of 58 countries between 1990 and 2022. Through counterfactual experiments, we find that while emerging economy policymakers might favor moderate reforms to improve democratic representation, achieving the institutional depth seen in developed countries is politically unfeasible, despite its clear advantages for citizens.

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