The Economic Times ET In The Classroom – Archives – 1 (Economics Concepts Explained)


The Economic Times newspaper now and then publishes articles on current economic issues in a question and answer format under the heading ‘ET In The Classroom’. They are simple to understand and remember.

Many tough concepts are beautifully explained by the ET team in these articles. All these articles are freely available on the net. They are the property of the Economic Times. I have just consolidated all of them here for the benefit of the readers.

Complete credit is for The Economic Times newspaper for these wonderful articles.

For an IAS aspirant preparing for the UPSC civil service examination, ET in the Classroom is a one-stop solution for getting acquainted with many economic jargon and concepts.

ET in the classroom: What is Islamic finance?

What is Islamic finance?

Islamic finance refers to a financial system that is consistent with the principles of Sharia, the sacred law of Islam. It is different from regular banking in that it prohibits earning of interest (or riba) through the business of lending. It also prohibits direct or indirect association with businesses involving alcohol, pork products, firearms and tobacco. It also does not allow speculation, betting and gambling.

How does it work?

Islamic finance takes the form of Islamic banking and Islamic insurance, also known as Takaful.

Islamic banking is done in five ways:

1. Mudarabah, a profit-sharing agreement

2. Wadiah, a safe keeping arrangement

3. Musharakah, or a joint venture for a specific business

4. Murabahah, cost plus arrangement where goods are sold with a pre-determined margin of profit

5. Ijirah, a leasing arrangement

Takaful is a form of mutual insurance based on partnership and collective sharing of risk by a group of individuals.

How has Islamic banking progressed in recent years?

Islamic banking is most prevalent in Malaysia. It is spreading rapidly in West Asia, where the population is predominantly Muslim. New global financial centres such as Singapore, Hong Kong, Geneva, Zurich and London have made changes in regulations to accommodate the Islamic finance industry, which is nearly a trillon dollar in size now.

Indian regulations do not allow Islamic banking but the government is considering allowing it.

What restricts the growth of Islamic finance?

Most banks conducting Islamic operations have a panel of Muslim scholars called Sharia committee or Sharia board, which determines whether a product or practice complies with Islamic provisions. Also, the accounting is done differently for which there is an official standard-setting body known as the accounting and auditing organization for Islamic financial institutions. The strict code makes Islamic banking a very niche product.


ET in the classroom: Infrastructure debt fund


What is the Infrastructure debt fund or IDF?

Infrastructure debt fund is a debt instrument being set up by the finance ministry in order to channelise long-term funds into infrastructure projects which require long-term stable capital investment. According to the structure laid out by the finance ministry, after consultations with stakeholders, infrastructure NBFCs, market regulators and banks, an IDF could either be set up as a trust or as a company.

What happens in either of the scenario?

If the IDF is set up as a trust, it would be a mutual fund, regulated by Sebi or the Securities and Exchange Board of India. The mutual fund would issue rupee-denominated units of five years’ maturity to raise funds for the PPP, or public private partnership projects . In case the IDF is set up as funds, the credit risk would be borne by investors and not the IDF.

As a company, it could be set up by one or more sponsors, including NBFCs, IFCs or banks. It would be allowed lower risk-weightage of 50%, net-owned funds (minimum tier-I equity of 150 crore). It would raise resources through issue of either rupee or dollar-denominated bonds of minimum five-year maturity. It would invest in debt securities of only PPP projects, which have a buy out guarantee and have completed at least one year of commercial operation.

Refinance by IDF would be up to 85% of the total debt covered by the concession agreement. Senior lenders would retain the remaining 15% for which they could charge a premium from the infrastructure company. The credit risks associated with the underlying projects will be borne by IDF. As an NBFC, the fund would be regulated by the Reserve Bank of India.

Who would be the major investors?

Domestic and offshore investors, mainly pension funds and insurance companies, who have long-term resources, would be allowed to invest in these funds, while banks and financial institutions would act as sponsors.


ET in the Classroom: Marginal standing facility

What is the marginal standing facility?

The Reserve Bank of India in its monetary policy for 2011-12, introduced the marginal standing facility (MSF), under which banks could borrow funds from RBI at 8.25%, which is 1% above the liquidity adjustment facility-repo rate against pledging government securities.

The MSF rate is pegged 100 basis points or a percentage point above the repo rate. Banks can borrow funds through MSF when there is a considerable shortfall of liquidity. This measure has been introduced by RBI to regulate short-term asset liability mismatches more effectively.

In the annual policy statement, RBI says: “The stance of monetary policy is, among other things, to manage liquidity to ensure that it remains broadly in balance, with neither a large surplus diluting monetary transmission nor a large deficit choking off fund flows.”

What is the difference between liquidity adjustment facility-repo rate and marginal standing facility rate?

Banks can borrow from the Reserve Bank of India under LAF-repo rate, which stands at 7.25%, by pledging government securities over and above the statutory liquidity requirement of 24%. Though in case of borrowing from the marginal standing facility, banks can borrow funds up to one percentage of their net demand and time liabilities, at 8.25%. However, it can be within the statutory liquidity ratio of 24%.


ET in the classroom: Priority-sector lending

What is priority-sector lending?

Banks were assigned a special role in the economic development of the country, besides ensuring the growth of the financial sector. The banking regulator, the Reserve Bank of India, has hence prescribed that a portion of bank lending should be for developmental activities, which it calls the priority sector.

Are there minimum limits?

The limits are prescribed according to the ownership pattern of banks. While for local banks, both the public and private sectors have to lend 40 % of their net bank credit, or NBC, to the priority sector as defined by RBI, foreign banks have to lend 32% of their NBC to the priority sector.

What is net bank credit?

The net bank credit should tally with the figure reported in the fortnightly return submitted under Section 42 (2) of the Reserve Bank of India Act, 1934. However , outstanding deposits under the FCNR (B) and NRNR schemes are excluded from net bank credit for computation of priority sector lending target/subtargets.

Are there specific targets within the priority sector?

Domestic banks have to lend 18 % of NBC to agriculture and 10 % of the NBC has to be to the weaker section. However, foreign banks have to lend 10 % of NBC to the small-scale industries and 12 % of their NBC as export credit. However, for the balance, there are a vast number of sectors that banks can lend as priority sector. The Reserve Bank has a detailed note of what constitutes a priority sector, which also includes housing loans, education loans and loans to MFIs, among others.

What has been the experience so far?

It has been observed that while banks often tend to meet the overall priority sector targets, they sometimes tend to miss the sub-targets. This is particularly true in case of domestic banks failing to meet their sub-targets for agricultural advances. One of the reasons banks often site for not lending to this sector is that recovery is often difficult.

Is there any penal action in case of non-achievement of priority sector lending target by a bank?

Domestic banks having a shortfall in lending to priority sector/ agriculture are allocated amounts for contribution to the Rural Infrastructure Development Fund ( RIDF ) established in Nabard. In case of foreign banks operating in India, which fail to achieve the priority sector lending target or sub-targets, an amount equivalent to the shortfall is required to be deposited with Sidbi for one year.


ET in the Classroom: What the Greek crisis means to the world


Why Does the World Want to Save Greece?

No one can quantify the damage to the world if Greece is allowed to sink. But few are willing to risk it either. Such a fear owes its origin to the 2008 crisis. Many economists, policymakers and some within central banks believe that the financial meltdown of 2008 could have been ringfenced, or at least cushioned, if Lehman was bailed out. But since Lehman was an investment bank, and not a commercial bank holding savings of millions, Fed and the US government had thought that the collateral damage from its bankruptcy would be contained within a few blocks of Wall Street, and no one really would lose jobs and take pay cuts. Within months we all found out how wrong they were. Today, no one wants to take a chance with Greece. Leaders across Europe fear that a Greece collapse can start a fire that will engulf continents.

How does fear spread when markets are in such a state?

Banks impacted by a default may find themselves cut out from the dollar market — the engine of global liquidity. As a result, these banks will find it very difficult to roll over their dollar assets as the other banks which are more solvent would be unwilling to lend them. That’s when the world outside financial markets would feel the pinch. Suppose, a French bank that had given a dollar line to the European subsidiary of an Asian company, or to bank in Asia which, in turn, had extended a dollar credit to a local company, would not roll over the credit line

Will a default cause a dollar scarcity?

Banks and companies are already holding on to the dollar. A default will only deepen it. Consider the Asian company whose dollar line has been pulled bank. It will somehow try to organise the money by paying a premium. Having sensed a dollar scarcity and fearing that things may turn worse, it will raise more than it needs. When all companies start doing it, there is artificial scarcity. Not just banks, corporates in Greece would also default

How will panic boil over to other Euro nations

Speculators will target Portugal, and then Italy. The logic is simple: if Germany & ECB do not help Greece, they will also let Portugal and Italy sink. Soon these will be perceived as basket cases and their bonds, stocks and currencies will face a brutal attack from short-sellers. That would be a problem as Italy’s debt is more than the combined debt of Portugal, Spain and Ireland

So, time’s running out for Greece?

Close to $8 billion worth Greek bonds will mature in December. It needs the money before that, failing which a default is inevitable. IMF is willing to lend a little over $8 billion, but only if Greece takes a string of austerity measures. IMF is not spelling out exactly when it will sanction the loan. Some economists fear the IMF pressure can make things difficult for Greece: how will lower consumption help a country which is already doldrums

Isn’t Germany in a bit of a Catch-22 situation

It is. German politicians know that if there was no euro, its currency would have gained so much that their exporters would have been wiped out. It needs the euro. But convincing Germans isn’t easy. They don’t want to bail out all Europeans, particularly those who don’t work hard. Some think Greece should be exiled from EU for a few years to should put their house in order


ET in the Classroom: Interest rate futures


What is the interest rate futures on 91-day treasury bill?

Interest rate futures on 91-day treasury bill are interest rate-driven derivative products that help banks, mutual funds and primary dealers to hedge their interest rate exposure on treasury bills. Financial institutions can lock in the interest rate or the yield on the 91-day treasury at a given date when counter parties enter into the interest rate futures contract.

How are they settled?

The 91-day T-bill interest rate futures are cash settled. In case of the 91-day treasury bill, the final settlement price of the futures contract is based on the weighted average price/ yield obtained in the weekly auction of the 91-day treasury bills on the date of expiry of the contract. But in case of interest rate futures on the 10-year benchmark government security, the contract is physically settled.

How is the product structured?

The minimum size of the contract is Rs 2 lakh and the tenor of the contract cannot be more than 12 months, according to market regulator Sebi, which has designed the product and will supervise its trading. The maximum maturity of the contract can be for 12 months. The initial margin is subjected to a minimum of 0.1% of the notional value of the contract on the first day of trading and 0.05 % of the notional value of the contract thereafter.

What kind of volumes has the product generated so far?

Last week, the average daily trading volume for the 91-day T-Bill IRF was Rs 360 crore. So far, among the exchanges, only NSE has introduced the product for trading. The interest rate futures (IRF) on 91-day TBills clocked a volume of around Rs 730 crore on the National Stock Exchange (NSE) on the first day of trading last Monday.

What are the advantages of the interest rate futures?

It is a good hedging tool for banks, primary dealers and mutual funds who have huge exposure to these money market instruments such as 91-day treasury bills. There is no securities transaction tax (STT). The initial margins are also lower, which could attract volumes for the product. Interest rate futures can be used by investors to take a directional call on the interest rates or for hedging their existing position.


ET in the classroom: Central plan and role of plan panel and finance ministry


The government’s budget exercise usually begins with fixing the contribution of the exchequer to the central plan. Though distributed over many schemes, taken together this is the single biggest item of expenditure in the annual budget. ET takes a look at the concept of Central Plan and the budget support to the plan.

What is central plan in the context of the budget?

Central or annual plans are essentially the five year plans broken down into five annual installments. Through these annual plans, the government achieves the objectives of the Five-Year Plans. The details of the plan are spelled out in the annual budget presented by the finance minister. But the actual responsibility of allocation funds judiciously amongst ministries, departments and state governments rests with the Planning Commission.

What is gross budgetary support, or GBS?

The funding of the central plan is split almost evenly between government support (from the Budget) and internal and extra budgetary resources of public enterprises. The government’s support to the central plan is called the Gross Budgetary Support, or the GBS. In the recent years the GBS has been slightly more than 50% of the total central plan.

How is the GBS figure arrived at?

The administrative ministries responsible for various development schemes present their demands before the planning commission. The planning commission aggregates and vets these demand. It then puts forward a consolidated demand before the finance ministry for the budgetary support it needs from the cental excequer. The amount approved by the finance ministry is usually less than that demanded by the planning commission because of the multiple objectives the North Block has to keep in mind will making allocations. The planning commission in turn adjusts the allocated amount among various demands.

How do GBS, central plan and plan expenditure differ?

Central plan includes the GBS and the spending of the public enterprises that do not figure in the budget. In that sense the government’s spending on the central plan is limited to GBS. But the centre also provides funds to states and union territories for their respective plans. This contribution, together with the GBS, makes up the total plan spending of the government for a year. This is about 30% of the total government expenditure.


ET in the Classroom: Self-help group


What is a self-help group (SHG)?

SHG primarily comprises members with homogenous social and economic backgrounds. It is a voluntarily formed group consisting of women, rural labourers, small farmers and micro-enterprises . The concept is akin to the concept of democracy. SHGs are formed by the members, for the members and of the members. The number of members could be as less as five and could even go up to 20. They save and contribute to a common fund which is used to lend to the members. Since they know each other, members do not seek collateral from each other.

What are the goals of an SHG?

An SHG is seen as an instrument for achieving a variety of goals, including empowering women. Data from Nabard, which pioneered the concept, shows that 90% of members in the SHG are women and most of them do not have any assets. It also helps in developing leadership abilities among the poor, increasing school enrolments, improving nutrition and in birth control. An SHG is generally started by non-profit organisations, such as an NGO with broad anti-poverty agendas. It is also a popular channel of micro-lending by commercial banks, particularly government-run banks.

What are the advantages of financing through an SHG?

A poor individual benefits enormously being part of an SHG . Raising finance through SHGs reduces transaction costs for both lenders and borrowers. Lenders have to handle only a single SHG account instead of a large number of small-sized individual accounts, borrowers as part of an SHG cut down expenses on travel to the branch to get the loan sanctioned.

What are the different ways in which banks fund SHGs?

Banks deal directly with individual SHGs . They provide financial assistance to each SHG for lending to individual members. Alternatively, banks provide loans to SHGs with recommendation from NGOs. Here the SHGs are formed by NGOs or government agencies, which raise funds from banks. In this, NGOs would organise the poor into SHGs , undertake training, help in arranging inputs and marketing and assist in maintenance of accounts.


ET in the Classroom: Draft Red Herring Prospectus


A company making a public issue of securities has to file a Draft Red Herring Prospectus with Sebi through an eligible merchant banker prior to filing a prospectus with the Registrar of Companies.

What is Draft Red Herring Prospectus?

A company making a public issue of securities has to file a Draft Red Herring Prospectus (DRHP) with capital market regulator Securities and Exchange Board of India, or Sebi, through an eligible merchant banker prior to the filing of prospectus with the Registrar of Companies (RoCs).

The issuer company engages a Sebiregistered merchant banker to prepare the offer document. Besides due diligence in preparing the offer document, the merchant banker is also responsible for ensuring legal compliance. The merchant banker facilitates the issue in reaching the prospective investors by marketing the same.

Where is DRHP available?

The offer documents of public issues are available on the websites of merchant bankers and stock exchanges. It is also available on the Sebi website under ‘Offer Documents’ section along with its status of processing. The company is also required to make a public announcement about the filing in English, Hindi and in regional language newspapers. In case, investors notice any inaccurate or incomplete information in the offer document, they may send their complaint to the merchant banker and / or to Sebi.

What does Sebi do with the DRHP?

The Indian regulatory framework is based on a disclosure regime. Sebi reviews the draft offer document and may issue observations with a view to ensure that adequate disclosures are made by the issuer company/merchant bankers in the offer document to enable investors to make an informed investment decision in the issue. It must be clearly understood that Sebi does not ‘vet’ and ‘approve’ the offer document.

Also, Sebi does not recommend the shares or guarantee the accuracy or adequacy of DRHP. Sebi’s observations on the draft offer document are forwarded to the merchant banker, who incorporates the necessary changes and files the final offer document with Sebi, Registrar of Companies (ROC) and stock exchanges. After reviewing the DRHP, the market regulator gives its observations which need to be implemented by the company. Once the observations are implemented, it gets final approval & the document then becomes RHP (Red Herring Prospectus).

How is DRHP useful to investors?

DRHP provides all the necessary information an investor ought to know about the company in order to make an informed decision. It contains details about the company, its promoters, the project, financial details, objects of raising the money, terms of the issue, risks involved with investing, use of proceeds from the offering, among others. However, the document does not provide information about the price or size of the offering.


ET in the Classroom: Reserve Bank ‘oversight’ functioning


What is the ‘oversight’ function of RBI?

The Bank for International Settlements defines oversight as ” central bank function , whereby the objectives of safety and efficiency are promoted by monitoring existing and planned systems, assessing them against these objectives and, where necessary, inducing change” .

The three key ways in which oversight activity is carried out are through (i) monitoring existing and planned systems; (ii) assessment and (iii) inducing change. In India, the Payment and Settlement Systems Act, 2007, and the Payment and Settlement Systems Regulations, 2008, provide the necessary statutory backing to the Reserve Bank of India for undertaking the oversight function. The central bank manages the various settlements system, including cash, through currency chest and clears cheques, besides various electronic clearing services.

What is Electronic Clearing Service?

It was among the early steps initiated towards moving to a paperless settlement system by the Reserve Bank of India. The Bank introduced the ECS (Credit) scheme during the 1990s to handle payment requirements like salary, interest, dividend payments of corporates and other institutions .

The ECS (Debit) Scheme was introduced by RBI to provide a faster method of effecting periodic and repetitive collections of utility companies. ECS (Debit) facilitates consumers/subscribers of utility companies to make routine and repetitive payments by ‘mandating’ bank branches to debit their accounts and pass on the money to the companies.

What are the various settlement systems & agencies?

National Electronic Funds Transfer (NEFT) System: In November 2005, a more secure system was introduced for facilitating one-to-one funds transfer requirements of individuals/corporates . Available across a longer time window, the NEFT system provides for batch settlements at hourly intervals, thus enabling a near real-time transfer of funds.

Real-Time Gross Settlement (RTGS): It is a funds transfer system where transfer of money takes place from one bank to another on a “real time” and on a “gross” basis . Settlement in “real time” means payment transaction is not subjected to any waiting period.

“Gross settlement” means the transaction is settled on one-to-one basis without bunching or netting with any other transaction. Once processed, payments are final and irrevocable. This was introduced in 2004 and settles all inter-bank payments and customer transactions above Rs 2 lakh.

Clearing Corporation of India (CCIL): The Corporation, set up in April 2001, plays the Central Counter Party (CCP) in government securities, the US dollar and the rupee forex exchange (both spot and forward segments) and Collaterised Borrowing and Lending Obligation (CBLO) markets.

CCIL plays the role of a central counterparty whereby, the contract between a buyer and a seller gets replaced by two new contracts — between CCIL and each of the two parties. This process is known as ‘Novation’ . Through novation, the counterparty credit risk between the buyer and seller is eliminated with CCIL subsuming all counterparty and credit risks.

What does the National Payments Corporation of India do?

The Reserve Bank set up the National Payments Corporation of India (NPCI), which became functional in 2009, to act as an umbrella organisation for operating various Retail Payment Systems (RPS) in India. NPCI has taken over National Financial Switch (NFS) from the Institute for Development and Research in Banking Technology (IDRBT). The National Financial Switch (NFS) is an inter-bank network managed by Euronet India.


What is an EEFC Account?

Exchange Earners’ Foreign Currency (EEFC) account is foreign currency-denominated account maintained with banks dealing with foreign exchanges. The Reserve Bank of India introduced this scheme in 1992 to enable exporters and professionals to retain their foreign exchange receipts in banks without converting it into the local currency. Any person residing in India who receives inward remittances in foreign currency or a company with foreign currency earnings can open EEFC account but they don’t earn any interest from the deposits and it is a non-interest bearing scheme.

What is the minimum balance for EEFC?

This is typically a zero-balance account like normal current accounts. In other words, this means no account holder needs to maintain an average or minimum balance in the EEFC account.

How does EEFC help exporters or individuals earn foreign currency receipts?

As the account is maintained in foreign currency, no depositors are protected from exchange rate fluctuations.

Is there any prescribed limit of deposits in EEFC?

There is no such limit. One can credit his or her entire foreign exchange earnings into this account, subject to some permissible credits.

Can one take a foreign currency loan and put it in EEFC?

Remittances received on account of foreign currency loan or investment received from abroad can’t be deposited in EEFC.

What are the permissible credits in this account?

a) Inward remittances received by an individual

b) payments received by a 100% export-oriented unit, export processing zone, software technology park and electronic hardware technology park

c) payments received in foreign exchange by a unit in domestic tariff area for supply of goods to a unit in SEZ

d) payment received by an exporter for an account maintained with an authorised dealer for the purpose of counter trade, which is an adjustment of value of goods imported against value of goods exported

e) advance remittance received by an exporter towards export of goods or services

Can one withdraw in rupees from EEFC account?

There is no such restriction on withdrawal in rupees of funds held in an EEFC account. However, the amount withdrawn in rupees can’t be converted into foreign currency again and re-credited to the account.

Can one make a payment directly from EEFC account?

One can make a direct payment from EEFC outside India as per the provisions laid down in FEMA regulations. Fully export-oriented units can also pay in foreign exchange for purchasing goods as per the country’s foreign trade policy. A person residing in India can use the account for paying airfare or hotel expenditure.


ET In the Classroom: Making a Case of Financial Inclusion


What is a ‘business correspondent’ model?

In 2006, the Reserve Bank of India allowed banks to use non-bank intermediaries as business correspondents, or business facilitators, to extend banking and other financial services to areas where the banks did not have a brick and mortar branch present. The objective behind it was to aid the process of financial inclusion and consequently take banking to the remotest areas of the country and make them bankable.

What do these correspondents do?

The business correspondent is nothing but a bank-in-person, who is authorised to collect deposits and extend credit on behalf of the bank of small-ticket sizes. He also recovers principal interest of small value deposits, sale of micro insurance, mutual fund products, pension products, receipt and delivery of small value remittances/other payment instruments.

Who is eligible to be a banking correspondent?

RBI has allowed a host of entities to act as business correspondents (BCs) of banks. These include NGOs/MFIs set up under Societies/Trust Acts; societies registered under Mutually-Aided Co-operative Societies Acts, or the Co-operative Societies Acts of States; Section 25 companies, which are not-for-profit companies; companies in which NBFCs, banks, telecom companies and other corporate entities or their holding companies do not have equity holdings in excess of 10%; post offices and retired bank employees, ex-servicemen and retired government employees.

How is a business facilitator different from a business correspondent?

Very often the term ‘business correspondents’ is used interchangeably with the term ‘business facilitators’ (BFs). But RBI makes a clear distinction between the two. BFs are allowed to undertake only facilitation services like identification of borrowers, collection and preliminary processing of loan applications, including verification of primary information, creating awareness about savings and other products, processing and submission of applications to banks and promoting and nurturing SHGs and follow-up of recovery and debt counselling. However, facilitation of these services does not include conduct of banking business by BFs, which is the exclusive function of business correspondents.


ET in the Classroom: Take-out financing


What is take-out financing?

Take-out financing is a method of providing finance for longer duration projects of about 15 years by banks sanctioning medium-term loans for 5-7 years. It is given that the loan will be taken out of books of the financing bank within pre-fixed period by another institution, thus preventing any possible asset-liability mismatch. After taking out the loan from banks, the institution could offload them to another bank or keep it.

Though internationally this kind of lending has been in existence for many years, it came to India only in the late 90s. These long-tenure loans were primarily introduced to incentivise banks to lend to the infrastructure sector as banks back then had very little exposure to long-term loans, and also because they did not have adequate resources of similar tenure to create such long-term assets.

What does the Reserve Bank rule say?

Banks/FIs are free to finance technically feasible, financially-viable and bankable projects undertaken by both public sector and private sector undertakings, provided the amount sanctioned is within the overall ceiling of the prudential exposure norms prescribed by RBI for infrastructure financing. They should also have the requisite expertise for appraising technical feasibility, financial viability and bankability of projects.

Which institutions, besides banks, are engaged in this practice?

The government promoted Infrastructure Development Finance Corporation, by setting aside a corpus from the union budget, with a primary mandate to promote infrastructure funding. Later, India Infrastructure Finance Company also came up essentially to refinance infrastructure loans of commercial banks.

What are the problems with take-out financing?

Though take-out financing is a permissible practice in India, the concept has not taken off in a big way. Though the concept in a way addresses the asset-liability issue, regulators still want banks to set aside higher capital for their exposure. Besides, banks are also wary of taking risks such as construction risks, which may delay the project as well as increase its cost.


Did you know coal can be liquid fuel too?

Coal liquification is seen one of the options to cope up with high crude oil prices. While availability of coal in plenty goes in favour of this process in the energy-scarce scenario, environmental concerns and high cost has so far limited the use of coal-to-liquid (CTL) fuel to an insignificant position except in the case of South Africa.

Use of coal for power generation is considered a better option in India as there is no consensus among policy-makers. Let’s look at the basic issues related to conversion of coal into liquid fuel.

Can coal be converted into liquid fuel?

Yes. Coal can be converted into a synthetic liquid fuel and the process is known as coal-to-liquid (CTL) worldwide. Broadly, there are two different methods to convert coal into liquid fuels—direct and indirect liquefaction. Under the direct method, hydrogen is added to crushed coal and liquid is created with the presence of catalysts.

However, further refining of this liquid is needed to achieve liquid fuel with high-grade fuel characteristics. The indirect liquefaction process first gasifies coal using oxygen, steam—heating them to very high temperatures. The resultant gas is purified and mixed with water.

The liquid fuel that is created can be refined to produce diesel, naphtha, jet fuel, cooking gas and lubricants. Creating this fuel is a very intensive process that requires large amounts of coal, water and energy.

Is CTL commercially viable?

Skyrocketing price of oil and concern over depleting crude reserves are triggers generating interest in CTL. Ambitious CTL projects are in operation in South Africa—run by Sasol, the company that pioneered CTL.

Liquid fuel generated from coal caters to 30% of the needs of South Africa. Sasol has patented “Fischer Tropsch” technology of indirect liquefaction, which converts synthetic gas, extracted from coal, into oil.

More than 30 CTL projects across the world are being studied for feasibility, depending on the quality of coal, availability of water and other local conditions. The initial investment in CTL projects is quite high.

Is India game for CTL?

The government has studied CTL. The Tata Group, in collaboration with Sasol, made a presentation on a $8-billion indirect liquefaction project using Sasol’s technology to convert high-ash Indian coal into liquid fuel with a capacity of 80,000 barrels per day of liquid fuel.

An inter-ministerial group (IMG) examined the proposal. The Planning Commission rejected the idea, saying that coal be better used for electricity generation rather than making liquid fuels. The IMD discussion also led to a view that those wishing to set up CTL projects should bid for coal blocks, competing with other users.

Finally, the government offered three blocks of coal in Orissa with cumulative reserves of about six billion tonnes for the project to private players. There were 22 applicants including Reliance Group and the Tatas. The eligibility criteria says the applicant company should have a minimum net worth of $1 billion, besides having a tie-up with the proven technology providers.

The IMG has to decide which companies would be allowed to implement CTL projects. What is CTL’s impact on the environment?

Green lobbies are fighting against CTL tooth and nail, alleging that Sasol has a questionable environmental and social record in South Africa. They advocate higher investment in renewable resources like wind energy and solar energy, rather than opting for CTL.

Liquefying large coal reserves will release huge amounts of carbon dioxide, a greenhouse gas. Proponents of this technology say the gas can be captured and stored underground.

The cost of carbon capture and storage will impact the economics of CTL. Coal liquification requires vast amounts of water too and this has led to concerns in water-deficient areas.


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  • abhishek

    bhai saab, aapne kitni zyaada mehnat ki hai !

  • Vicky..

    Sir, Business Standards should be read completely ? Coz i find many non relevant things.

    • No. You don’t have to read any business newspaper completely. Read its editorials and opinion pages. And international news too.

  • Vicky..

    Sir, I have build almost all my basic concepts in economics. Now, only relying on newspapers is sufficient or anything more needs to be done ? I will cover the new india yearbook and economic survey when it’ll come next year, as i am aspiring for 2014 exam.

  • Dr. Ashish Saini

    eco is one thing that sends jitters down my spine… but i guess these would really help …. kudos to u
    work appreciated sir 🙂

  • Vaibhaw Singh

    Thanks for Sharing this EXAM ORIENTED ARTICLES. It is really amazing and of a great use for the upcoming ASPIRANTS…
    Please, continue with your Great task of COLLECTING and PUBLISHING THE ARTICLES.

  • Sir,
    How to get new ET in the classroom feed/post directly as when published so that it can simplify preparation and to avoid stock pile.

    Ignited Minds

  • must readable

  • vingy stryker

    could you kindly provide the ET in classroom for this year till date too..

  • sir. I have subscribed news feeds by email. But i dont get any notification about this site and new posts and feeds. Please help.

  • Amit Saxena

    Sir, I have applied for subscription a number of times but still I haven’t received any mail from you. Please help!