George Lucas and Christopher Nolan: Building the Galaxy

 

OECD Economic Outlook June 2026: Under Pressure

 The conflict in the Middle East has emerged as the dominant force shaping the global economic outlook in mid-2026. While the world economy initially showed resilience through strong investment in artificial intelligence and easing trade tensions, it is now "under pressure" from severe disruptions to regional shipments and infrastructure.

Core Economic Disruptions

The impacts are primarily driven by damage to energy infrastructure and the near-halt of shipments through the Strait of Hormuz.

• Energy Supply: Global oil supply fell by 13.5% between February and April 2026, with Gulf production alone dropping by 45%. LNG exports from the region, notably from Qatar, have also halted due to production facility damage.
• Commodity Prices: Prices for crude oil, natural gas, sulphur, and fertilisers (like urea) have ratcheted upward.
• Trade and Logistics: Strait of Hormuz transits remain a fraction of pre-conflict levels, leading to severe port congestion in areas like Oman and the Red Sea. Global ocean freight rates have risen approximately 45% above pre-conflict levels.
• Industrial Inputs: The region is a critical source for methanol, ammonia, and helium. Helium is particularly vital for semiconductor manufacturing, meaning disruptions could eventually hinder AI infrastructure development.

Scenario-Based Outlook

Recognizing high uncertainty, the sources present two possible trajectories for the global economy:

1. Time-Limited Disruption Scenario: This assumes energy production and trade return to pre-conflict levels from the third quarter of 2026. Under this path, global GDP growth is projected to slow from 3.4% in 2025 to 2.8% in 2026 before recovering to 3.1% in 2027. Inflation in G20 countries would rise to 4.0% in 2026.
2. Prolonged Disruption Scenario: If disruptions persist into late 2027, global growth could plummet to 2.1% in 2026 and 1.8% in 2027, pushing some economies toward recession. In this case, global inflation would see significant upside pressure, rising by an additional 1.3 percentage points in 2027.

Impact on Specific Regions and Sectors

The burden of the conflict is not distributed evenly:

• Asian Economies: These are among the most exposed due to their heavy reliance on Persian Gulf energy imports. Countries like Thailand, Korea, and India have particularly high direct and indirect exposure.
• Developing Economies: Commodity-importing developing nations face severe risks, as they often lack the fiscal capacity to cushion households against price shocks and have weaker social safety nets.
• Agriculture: Higher fertiliser prices and supply disruptions threaten global crop yields and food security, with grain prices expected to remain higher for longer than the duration of the conflict itself.
• AI and Technology: Prolonged energy shortages would increase data center operating costs—energy accounts for 60% of these costs—and potentially delay large-scale AI infrastructure projects.

Policy Recommendations

The OECD emphasizes that flexible and agile policies are required to ensure stability.

• Fiscal Policy: Governments should provide relief to households and firms, but measures should be temporary and well-targeted to avoid excessive fiscal costs and preserve incentives to reduce energy use.
• Energy Resilience: The crisis underscores the urgent need to diversify energy supplies and improve energy efficiency to "wean" economies off dependency on fossil fuel imports from single chokepoints.
• Monetary Policy: Central banks must remain vigilant; while they may "look through" temporary supply-driven price rises, they must act if inflation expectations become de-anchored or growth weakens substantially.

Recognizing the exceptional uncertainty surrounding the conflict in the Middle East, the June 2026 OECD Economic Outlook frames global projections through two distinct trajectories for the next eighteen months. These scenarios are primarily conditioned on the duration of disruptions to energy production and trade routes in the Persian Gulf.

1. Time-Limited Disruption Scenario (Projections-Based)

This scenario assumes that the disruptions caused by the conflict are significant but relatively short-lived.

• Conflict Resolution: It assumes progress toward a negotiated peace agreement, with energy production and regular shipping routes returning to pre-conflict levels starting in the third quarter of 2026.
• Growth Path: Global GDP growth is projected to moderate from 3.4% in 2025 to 2.8% in 2026, before recovering to 3.1% in 2027.
• Inflation: Consumer price inflation in the G20 is expected to rise to 4.0% in 2026 (up from 3.4% in 2025) before easing to 3.1% in 2027 as energy and food price pressures fade.
• Policy Stance: Central banks are generally expected to keep policy interest rates broadly stable through 2026 before easing slightly in 2027. The fiscal stance remains broadly neutral in most countries during 2026.
• Mitigating Factors: Strong underlying momentum from AI-related investment, resilient household balance sheets, and a reduction in effective US tariff rates are expected to support near-term growth.

2. Prolonged Disruption Scenario (Model-Based)

This scenario highlights the severe costs if a peace agreement is not secured until late in 2027.

• Market Shocks: Energy production remains subdued, and oil, gas, and fertiliser prices are assumed to rise by 50% relative to the time-limited scenario from Q3 2026 to Q3 2027.
• Global Recession Risks: Global growth would plummet to 2.1% in 2026 and 1.8% in 2027, potentially pushing several major economies into or close to recession.
• Higher Inflation: Global inflation would see significant upside pressure, rising by an additional 1.3 percentage points in 2027.
• Scarring Effects: The sustained period of lower energy supply and higher costs would lead to lower potential output starting in 2028 due to foregone investment and reduced efficiency.
• Financial Impact: This path involves a renewed tightening of financial conditions, a 15% decline in global equity prices, and an increase in risk premia.

Comparative Impacts and Specific Risks

The difference between these scenarios underscores the global economy's vulnerability to regional chokepoints.

• Regional Exposure: Many Asian economies face the heaviest impact in the prolonged scenario due to their high direct and indirect reliance on Persian Gulf energy.
• Industry Vulnerability: A prolonged conflict could specifically hinder the AI sector by increasing data center operating costs and disrupting the supply of critical hardware and specialized inputs like helium.
• Food Security: Persistent disruptions to fertiliser exports (like urea and ammonia) could lead to lower crop yields and substantial food price inflation well into 2027, particularly hurting developing nations.

Policy Implications

The Outlook emphasizes that "Under Pressure," policymakers must remain flexible and agile. Under the time-limited scenario, central banks can "look through" temporary price rises. However, in the prolonged scenario, many central banks would likely have to raise policy rates (by 50-75 basis points) to anchor inflation expectations, even as growth weakens. Fiscal policy would then face the primary burden of cushioning the downturn, despite already elevated public debt levels in many nations.

The global economy entered 2026 with more resilience than anticipated, driven by strong investment in artificial intelligence (AI), supportive financial conditions, and a temporary easing of trade tensions. However, the onset of the conflict in the Middle East has placed the global system "under pressure," primarily through severe disruptions to energy production and trade routes.

Growth and Inflation Projections

The OECD frames the outlook through two primary macroeconomic trajectories based on the duration of Middle East disruptions:

• Time-Limited Disruption: Under the assumption that energy production and shipping normalise by the third quarter of 2026, global GDP growth is projected to slow from 3.4% in 2025 to 2.8% in 2026, before a modest recovery to 3.1% in 2027. Inflation in G20 countries is expected to rise to 4.0% in 2026 due to the energy shock before easing to 3.1% in 2027.
• Prolonged Disruption: Should disruptions persist into late 2027, global growth could plummet to 2.1% in 2026 and 1.8% in 2027, potentially pushing several major economies into or near recession. In this scenario, global inflation would see significant upside pressure, rising by an additional 1.3 percentage points in 2027.

Key Drivers of Economic Pressure

Macroeconomic developments are currently dominated by several supply-side shocks and shifting fiscal priorities:

• Energy and Commodity Spikes: Global oil supply fell by 13.5% between February and April 2026, with Gulf production alone dropping by 45%. This has led to sharp increases in the prices of crude oil, natural gas, and fertilisers (like urea and ammonia).
• Trade and Logistics: Transits through the Strait of Hormuz remain severely restricted, leading to significant port congestion in the Red Sea and Oman. Global ocean freight rates have risen approximately 45% above pre-conflict levels.
• AI-Related Resilience: Despite these pressures, underlying momentum has been sustained by AI-related investment, particularly in the United States and advanced Asian economies. However, prolonged energy shortages could eventually raise data centre operating costs and disrupt the supply of critical hardware.
• Labour Markets: Employment conditions remain generally stable with low unemployment by historical standards, but real wages have been hit hard by the renewed spike in inflation, with one-third of OECD economies projected to have negative real wage growth in 2026.

Financial Conditions and Debt

Financial conditions have tightened since the onset of the conflict amid higher market volatility.

• Asset Pricing: Sovereign bond yields and corporate spreads have increased, reflecting expectations of higher inflation and risk premia.
• Corporate Debt: Total corporate debt in G20 economies remains high at roughly 90% of GDP. Significant refinancing needs are emerging just as borrowing costs rise, posing risks to firms with weaker balance sheets.
• NBFI Vulnerabilities: There are growing concerns regarding non-bank financial institutions (NBFIs), specifically private credit and equity funds, which have high exposure to the technology sector and face potential liquidity mismatches.

The Rising Impact of Defence Spending

A significant macroeconomic shift is the rapid, synchronised rise in defence spending across OECD nations.

• Fiscal Pressure: NATO members are moving toward a target of 3.5% of GDP for core defence spending by 2035.
• Economic Impact: While providing a modest near-term boost to activity in countries with domestic military production capacity, higher defence outlays add to public debt pressures and may crowd out private investment or other public spending (such as on climate or education) over the long term.

Policy Recommendations

The Outlook emphasizes that "flexible and agile" policies are required. Central banks must remain vigilant; while they may "look through" temporary supply-driven price rises, they must act if inflation expectations become de-anchored. Fiscal policy should provide targeted relief to vulnerable households but must also establish a credible path to long-term debt sustainability in the face of ageing populations and rising defence needs.

The financial landscape in mid-2026 is characterized by significant vulnerabilities that have been exacerbated by the conflict in the Middle East, placing global stability "under pressure." While financial conditions initially remained accommodative, the escalation of the conflict has triggered tighter conditions, higher market volatility, and a substantial repricing of assets.

Corporate Debt and Refinancing Strains

Total corporate debt in G20 economies remains historically high at approximately USD 90 trillion, or 90% of GDP. Firms now face a "maturity wall," with one-quarter of this debt set to mature within the next three years.

• Rising Costs: Much of this debt was issued during the low-rate period of 2018-21; firms must now refinance at significantly higher costs, with nearly half of outstanding investment-grade bonds carrying rates above 4%.
• Refinancing Risks: For financially weak issuers, prolonged energy disruptions and weaker growth could constrain access to credit, potentially lifting global speculative-grade default rates.

Vulnerabilities in Non-Bank Financial Institutions (NBFIs)

The rapid growth of the private capital market—now estimated at USD 22 trillion—has introduced new systemic risks.

• Private Credit and Equity: These funds have grown to USD 15 trillion in assets but face increasing concerns regarding liquidity mismatches and asset quality. Some large US private credit funds have already faced increased write-downs in 2026, leading to investor redemption requests and subsequent actions to limit those redemptions.
• Tech Exposure: Private equity and credit funds are heavily concentrated in the technology sector; software alone accounts for 42% of new US private equity investments in 2025.
• Interconnectedness: Banks have increasingly ceded lending activity to these alternative lenders and have simultaneously expanded their own lending to NBFIs. This creates a "leverage on leverage" effect that could amplify shocks through simultaneous deleveraging and fire sales.

Risks in the AI Sector

The rapid expansion of the artificial intelligence sector is creating specific financial fragilities.

• Valuation Risks: High valuations for AI stocks leave them vulnerable to correlated valuation shocks if expected returns fail to materialize.
• Opaque Financing: AI firms increasingly rely on less transparent private capital and "circular financing" arrangements, where AI firms act as both borrowers and creditors to one another.
• Energy Sensitivity: Because AI infrastructure (like data centers) is highly energy-intensive, the sector is uniquely sensitive to the energy price spikes caused by the Middle East conflict.

Sovereign Debt and Financing Shocks

Sovereign bond yields have risen across most markets due to higher inflation expectations and risk premia.

• Investor Base Shift: There has been a marked shift in who holds government debt, moving from central banks to more price-sensitive private investors, such as hedge funds. This transition increases the risk of financing shocks if investor sentiment shifts abruptly.
• Debt Sustainability: In many countries, current fiscal balances fall short of what is needed to stabilize debt ratios, especially as spending pressures rise for defence, ageing populations, and the green transition.

Scenario-Specific Financial Impacts

In the prolonged disruption scenario, where the conflict lasts well into 2027, the sources project a severe tightening of financial conditions:

• Equity Markets: A projected 15% decline in global equity prices.
• Risk Premia: Investment risk premia could rise by 75 basis points in advanced economies and 100 basis points in emerging markets.
• Default Risks: Sustained high energy costs and weak demand would likely lead to a sharp increase in corporate defaults and a significant scaling back of business investment.

To manage the global economy while it is "under pressure" from the Middle East conflict, the OECD recommends a suite of "flexible and agile" policies. These recommendations balance immediate crisis management with the need for long-term fiscal sustainability and structural resilience.

Monetary Policy: Vigilance and Anchoring Expectations

Central banks are advised to remain vigilant and attentive to shifting risks.

• "Looking Through" Shocks: Central banks can generally "look through" temporary supply-driven price rises if inflation expectations remain well-anchored.
• Rate Adjustments: Policy adjustments will be necessary if price pressures broaden (as in the prolonged disruption scenario) or if growth weakens significantly.
• Liquidity Support: If global financial conditions tighten severely, central banks should consider enhancing currency swap lines and reconsidering plans to reduce sovereign bond holdings.

Fiscal Policy: Targeted Relief and Sustainability

Fiscal space is constrained by elevated public debt and rising spending pressures from ageing, defence, and the green transition.

• Energy Relief: Support for households and firms should be well-targeted toward those most in need to contain fiscal costs and preserve incentives for energy conservation.
• Sunset Clauses: Measures should include automatic sunset mechanisms to ensure they are phased out once energy prices decline.
• Sustainability Path: Governments must establish a credible fiscal path to debt sustainability, requiring efforts to improve public sector efficiency and reallocate spending toward growth-enhancing investments.

Energy Security: Diversification and Efficiency

The vulnerability of global economies to a single chokepoint (the Strait of Hormuz) necessitates urgent shifts in energy policy.

• Diversification: Governments must intensify efforts to diversify energy supplies and reduce reliance on fossil fuel imports from single chokepoints.
• Efficiency and Electrification: Improving energy efficiency through regulatory standards and accelerating the electrification of end-uses are key to structural resilience.
• International Coordination: In the near term, international coordination of strategic energy stocks and emergency demand-restraint measures can help mitigate supply crunches.

Financial Stability: Addressing New Vulnerabilities

The OECD highlights the need for robust supervision to safeguard the financial system.

• NBFI Oversight: Progress is needed on regulatory policies for non-bank financial institutions (NBFIs) and crypto-assets.
• Enhanced Stress-Testing: Stress-tests should explore the potential effects of long-lasting Middle East disruptions and marked changes in AI valuations given the increasing interconnectedness between banks and NBFIs.

Structural Reforms and Trade

To improve medium-term growth prospects, the OECD suggests several reform priorities:

• Reducing Barriers: Actions to reduce regulatory burdens, simplify insolvency procedures, and promote product market competition.
• Labour and Skills: Policies to strengthen skill development, expand lifelong learning, and reduce tax wedges to promote labour mobility and participation.
• Trade Policy: Countries should avoid new export restrictions, which exacerbate global shortages, and instead engage in constructive dialogue to resolve trade tensions.

Defence Spending: Efficiency and Coordination

With defence spending rising toward a NATO target of 3.5% of GDP, the OECD emphasizes efficient resource management.

• Procurement Reform: Governments should improve procurement practices to reduce waste and harness competition.
• International Cooperation: Coordination in military purchases, particularly in Europe, could enlarge markets for productive firms and support interoperability.

Intertemporal Substitution and Household Consumption: Evidence from Structural Shocks

 The central thesis of the provided research is that households do not substitute consumption intertemporally in response to changes in real interest rates. While standard macroeconomic models assume that households adjust their spending paths to take advantage of higher interest rates (saving now to consume more later), the source finds no empirical evidence for this behavior across ten different structural shocks. Instead, the data suggests that aggregate consumption responses are almost entirely driven by changes in the expected path of labor income.

The Context of Intertemporal Substitution

In traditional macroeconomic theory, households are expected to "smooth" their consumption over time. This behavior is governed by the elasticity of intertemporal substitution (EIS), which measures how sensitive consumption growth is to changes in the real interest rate. If the EIS is positive, a rise in interest rates should theoretically induce households to reduce current consumption to increase future consumption.

However, the source highlights a long-standing "lack of evidence" for this sensitivity:

• Historical Precedent: Seminal research by Hall (1988) previously found no strong relationship between interest rates and consumption growth, suggesting the EIS may be zero.
• Near Rationality: The source notes that for many households, the utility gain from perfectly optimizing consumption based on interest rate fluctuations is extremely small—potentially as little as $0.08 to $1.45 per quarter. Consequently, it may be "rational" for consumers to ignore interest rates entirely.
• Popular Advice: Interestingly, popular financial advice books rarely, if ever, advise households to change their spending patterns based on interest rate movements, focusing instead on saving fixed fractions of income.

The Author’s Identification Strategy

To isolate the role of intertemporal substitution, the author uses a "consumption block" approach, which allows for estimation without needing to specify the entire structure of the economy. The methodology relies on:

• Structural Shocks: The author examines 10 different types of shocks—including monetary policy, government spending, and technology shocks—some of which produce large, persistent changes in real interest rates.
• Consumption Jacobians: These are "sufficient statistics" used to map how consumption responds to four specific inputs: labor income, the real fed funds rate, stock returns, and real estate returns.
• Sticky Expectations: By incorporating a parameter for "sticky expectations," the author ensures that the observed lack of response isn't simply an artifact of households being slow to process new information.

Findings and Evidence

The core result is that the estimated parameter for intertemporal substitution is statistically indistinguishable from zero for all ten shocks examined.

• Income as the Primary Driver: In every shock series, the "income component" of the consumption response is the dominant factor. For example, in the Romer and Romer (2004) monetary policy shocks, the rise in consumption is explained by the gradual rise in labor income, not the drop in interest rates.
• The Failure of Substitution Models: When the author applies a standard model with "rational expectations" (assuming an EIS of 1), the predicted consumption response moves far outside the confidence intervals of actual empirical data.
• Robustness: These findings remain consistent even when the author tests different values for the elasticity of substitution or uses alternative models like "finite horizon planning".

Implications for Economic Theory

This evidence challenges the "pivotal factor" role that intertemporal substitution plays in many macroeconomic models. If consumption does not respond to interest rates, it suggests that monetary policy may transmit through the economy differently than previously thought—perhaps primarily through its impact on investment or by directly altering household income through labor market channels rather than through the traditional "substitution" incentive.

The methodology employed in the provided research focuses on isolating the "consumption block" of macroeconomic models to determine if households actually shift their spending in response to real interest rate changes. By narrowing the scope to this specific block, the author can remain agnostic about the rest of the model (such as firm-side frictions or price-setting mechanisms), allowing for the use of a wider range of structural shocks than traditional general equilibrium models.

The following sections detail the specific components of this methodological approach:

1. The Input-Output Framework (Consumption Jacobians)

The author treats the consumption decision as an input-output structure where the dynamics are fully described by consumption Jacobians. These Jacobians are "sufficient statistics" that map how aggregate consumption at time $t$ responds to a marginal change in an input at time $s$.

• Inputs: The expected paths for aggregate labor income, the real federal funds rate, and real returns on stocks and real estate.
• Outputs: Aggregate consumption and savings.

2. Use of Structural Shocks for Identification

To overcome the challenge of interest rates co-moving with other economic factors, the author utilizes 10 different structural shocks identified in existing literature (Ramey, 2016). These include monetary policy surprises, defense spending news, tax shocks, and technology shocks.

• The strategy relies on finding shocks that affect consumption only through their impact on income and asset returns, rather than through changes in household preferences (discount factors).
• By using ten distinct shocks, the researcher aims to provide "overwhelming" aggregate evidence that is not sensitive to a single identification method.

3. Two-Step Estimation Process

The methodology follows a precise two-step process to calculate the role of intertemporal substitution:

• Step 1: Local Projections. The author uses local projections to calculate empirical impulse response functions (IRFs) for every input (income, interest rates, asset prices) and for consumption itself across all ten shocks.
• Step 2: Minimum-Distance Estimation. The author then calculates a "Jacobian-implied" consumption IRF by summing the four Jacobians multiplied by the empirical inputs. A distance metric is used to find the parameters that minimize the difference between this theoretical response and the actual empirical consumption response observed in the data.

4. Incorporating Sticky Expectations

A critical feature of the methodology is the inclusion of a parameter for sticky expectations. This ensures that if households appear unresponsive to interest rates, it is not simply because they are slow to process new information or sluggish in belief updating. By explicitly modeling this friction, the author can more rigorously test if the near-zero response is a "genuine lack of intertemporal substitution" rather than a delay in reaction.

5. Key Assumptions and Limitations

• Separability of Labor and Consumption: The methodology assumes that the consumption-saving decision can be separated from the labor decision through aggregate labor income. This assumption might not hold if leisure and consumption are not separable in the household's utility function.
• Linearization: The model is limited to analyzing small deviations around a steady state and does not account for time-varying risk premiums or state-dependent responses.
• Asset Income Effects: Because households' primary assets (stocks/real estate) are not well-approximated by short-term bonds, the author discards the model-based interest rate income effect and replaces it with empirical estimates of consumption responses to asset price changes.

In the research provided, the consumption block is modeled as a specific input-output structure within the larger macroeconomy. The central thesis is that the dynamics of aggregate consumption can be fully described by how it responds to four specific inputs, mediated through "consumption Jacobians" which act as sufficient statistics for these responses.

The Four Primary Inputs

The sources identify the following as the essential inputs that determine the household consumption decision:

• Aggregate Labor Income: This is the most significant input for determining actual consumption behavior. The author specifically defines this as the sum of employee compensation, proprietors' income, and transfers, minus specific taxes and social security contributions.
• Real Federal Funds Rate: This input is the theoretical centerpiece of intertemporal substitution. It is measured as the nominal federal funds rate minus one-year-ahead expected inflation. Standard theory suggests that changes in this input should incentivize households to shift consumption across time.
• Real Returns on the Stock Market: This input helps capture the "income effect" of wealth. It uses inflation-adjusted prices from Fama French.
• Real Returns on Real Estate: Similarly used for the income effect, this input is based on the Case-Shiller house price index adjusted for inflation.

Inputs in the Context of Intertemporal Substitution

The methodology uses these inputs to isolate why households change their spending. Theoretically, if the elasticity of intertemporal substitution (EIS) is positive, the "Real Federal Funds Rate" input should be a major driver of consumption fluctuations.

However, the sources reveal a disconnect between theory and empirical data regarding these inputs:

• Dominance of the Income Input: Across ten different types of structural shocks (such as monetary policy or technology shocks), the labor income path explains almost the entire aggregate consumption response. Even when interest rate inputs move significantly and persistently, they fail to induce a corresponding shift in consumption.
• The Residual Role of Interest Rates: The author calculates the effect of interest rates as a residual—the change in consumption that remains after accounting for the responses to income and asset prices. In practice, this residual is found to be close to zero, suggesting that the interest rate input has a negligible effect on household timing.
• Asset Inputs as Refinements: The sources explicitly replace the "income effect" of interest rates found in simple models with the stock and real estate inputs. This is because most household wealth is held in these assets rather than the short-term bonds typically used in Euler equation models. Despite this more realistic calibration, these asset inputs are found to play a negligible role in consumption responses compared to labor income.

Key Methodological Assumption

The validity of using these inputs relies on a "Key Assumption": that the aggregate consumption response is a function only of these four inputs (income, interest rates, and asset returns) and other factors independent of the shocks being analyzed. This allows the researcher to be agnostic about the rest of the economy—such as how firms set prices or how the government balances its budget—so long as those factors only affect households through these four specific channels.

In the source material, the author utilizes 10 distinct structural shocks to investigate whether households adjust their consumption timing in response to changes in real interest rates. These shocks, selected from the comprehensive review by Ramey (2016), serve as the primary tool for identifying the role of intertemporal substitution because they induce varied and often persistent fluctuations in real interest rates.

The analyzed structural shocks are categorized into three main areas:

1. Monetary Policy Shocks

The author examines two prominent methods for identifying monetary policy surprises:

• Romer and Romer (2004): Shocks are identified by the residual of the federal funds target rate after accounting for the Federal Reserve’s internal "Greenbook" forecasts.
• Gertler and Karadi (2015): This method uses high-frequency identification, looking at surprise changes in fed funds futures around Federal Open Market Committee (FOMC) announcements.

While these shocks lead to immediate drops in the real federal funds rate, the source finds that the resulting rise in consumption is almost entirely explained by a gradual rise in labor income rather than the interest rate change itself.

2. Fiscal Shocks

These shocks involve changes in government spending and anticipated tax policies:

• Military and Defense News: This includes military news shocks from Ramey and Zubairy (2018) and defense spending news from Ben Zeev and Pappa (2017). The latter is particularly informative because it produces a persistent negative real interest rate for four years.
• Government Spending: Blanchard and Perotti (2002) identify shocks through a recursive structure in a Vector Autoregression (VAR).
• Tax Shocks: These include "tax news" shocks from Mertens and Ravn (2011) and "expected taxes" from Leeper et al. (2012), the latter of which is derived from the spread between federal and municipal bonds.

3. Technology Shocks

The final category focuses on shifts in productivity and investment:

• Investment-Specific Technology (IST) News: Ben Zeev and Khan (2015) identify these through changes in the real price of investment.
• Total Factor Productivity (TFP): This includes utilization-adjusted TFP shocks from Fernald (2014) and unanticipated TFP shocks from Francis et al. (2014).

Findings in the Context of Intertemporal Substitution

The central finding across all ten shocks is that the estimated parameter for intertemporal substitution is statistically indistinguishable from zero. The source provides several insights into why these shocks support this conclusion:

• Failure of Traditional Models: If households behaved according to standard rational expectations models (with an elasticity of 1), the predicted consumption response to these shocks would fall far outside the empirical confidence intervals.
• Income as the Dominant Factor: In every shock series, the "income component" forms the bulk of the consumption response. For instance, despite the long period of lowered interest rates following a defense spending shock, households do not show the increased spending that intertemporal substitution theory would predict.
• Robustness of Evidence: By using a broad range of shocks—covering different identification methods and economic sectors—the author argues that the aggregate evidence against intertemporal substitution is "overwhelming" and not dependent on any single, potentially flawed identification strategy.

The theoretical framework of the source centers on isolating the "consumption block" of the economy to test the standard macroeconomic assumption that households smooth consumption by adjusting their spending in response to real interest rates. The author moves away from fully-specified general equilibrium models, instead using a framework that treats aggregate consumption as an input-output structure defined in sequence space.

1. The Consumption Block and Input-Output Structure

The framework assumes that the household decision-making process can be viewed as a sub-block of a larger model. The key theoretical assumption is that the impulse response of aggregate consumption is a function of specific expected paths: aggregate labor income, asset returns (stocks and real estate), and the real federal funds rate.

• Separability: This requires that the labor supply decision be separable from the consumption-saving decision, meaning leisure and consumption are not interconnected in the household's utility function.
• Agnosticism: Because the focus is strictly on this "block," the framework remains valid regardless of how other parts of the economy are modeled—such as price stickiness, international trade, or investment frictions—so long as they do not violate the block's internal logic.

2. Sequence Space and Consumption Jacobians

To describe the dynamics of this block, the framework utilizes "consumption Jacobians" as sufficient statistics.

• A Jacobian is a matrix that maps how aggregate consumption at time $t$ responds to a marginal change in an input (like income or interest rates) at time $s$.
• By linearizing the model around a steady state, the entire behavior of the consumption block is captured by four Jacobians—one for each primary input.

3. Decomposing the Interest Rate Effect

A critical component of the theoretical framework is the decomposition of the real interest rate Jacobian into two distinct effects:

• Intertemporal Substitution Effect: This measures how households shift the timing of consumption solely due to changes in the incentive to save (the Euler equation effect) while keeping the budget constraint fixed.
• Income Effect: This measures how changes in interest rates affect the household's feasible set of consumption plans (their wealth). The author discards the model-based income effect for interest rates—which often assumes households only hold short-term bonds—and instead uses empirical data for stock and real estate returns to capture the "true" wealth effects.

4. Micro-foundations and Behavioral Parameters

The framework is disciplined by a one-asset heterogeneous agent model (often called a buffer-stock model) where infinitely lived households face idiosyncratic income uncertainty and borrowing constraints.

• Sticky Expectations: The author incorporates a parameter for "sticky expectations" ($\theta$) to allow the model to span a range of behaviors, from full rational expectations to complete inattention. This ensures that a zero response to interest rates is interpreted as a genuine lack of substitution rather than a mere delay in processing information.
• Near Rationality: The framework draws on the theory of "near rationality," which suggests that the utility cost of failing to perfectly optimize consumption based on interest rate fluctuations is extremely low (cents per quarter). Theoretically, this makes it rational for households to ignore interest rate signals entirely and follow simpler rules of thumb, such as saving a fixed fraction of income.

5. Identification Strategy

The theoretical framework uses structural shocks as the identification tool. By selecting shocks orthogonal to household preferences (like technology or defense spending shocks), the author ensures that any observed change in consumption is a reaction to the inputs (income, rates, assets) rather than a shift in the households' internal discount factors. This allows for the estimation of the intertemporal substitution parameter as a residual after accounting for the well-documented effects of income and asset price changes.

The primary finding of the research is that households do not substitute consumption intertemporally in response to changes in real interest rates,,. Despite standard macroeconomic theories suggesting that households should shift their spending paths to take advantage of higher interest rates, the source find no evidence of this behavior across ten different types of structural shocks,,.

The key findings and their implications for the study of intertemporal substitution include:

1. Dominance of the Income Component

Aggregate consumption responses to economic shocks are driven almost entirely by changes in the expected path of labor income,,.

• In every shock examined—including monetary policy, defense spending, and technology shocks—the "income component" accounts for the bulk of the consumption response,.
• Movement in asset prices, such as stocks and real estate, plays a negligible role in determining aggregate consumption compared to labor income,.

2. Failure of Standard Macroeconomic Models

The source demonstrates a significant disconnect between empirical data and traditional "rational expectations" models:

• When a standard model with an elasticity of intertemporal substitution (EIS) of 1 is applied, it predicts consumption responses that fall far outside the 90 percent confidence intervals of actual empirical data,,.
• Even for shocks that produce large and persistent changes in real interest rates (such as defense spending news), households do not adjust their spending timing as the theory of intertemporal substitution predicts,,.

3. Robustness of the Near-Zero Estimate

The estimate that households do not intertemporally substitute remains consistent across various testing environments:

• Statistical Significance: For all ten structural shocks analyzed, the parameter for intertemporal substitution is statistically indistinguishable from zero,,.
• Model Variations: The findings are robust to different initial assumptions for the EIS, alternative behavioral frameworks like "finite horizon planning," and different calibrations of household wealth,,,.

4. Theoretical Justification: Near Rationality

The source provides a "near rationality" explanation for why households might ignore interest rate signals:

• The utility gain for a household that perfectly optimizes its consumption based on interest rate fluctuations is extremely small—estimated to be as little as $0.08 to $1.45 per quarter,.
• Because the cost of making a "mistake" by ignoring interest rates is so low, it is rational for consumers to focus on simpler rules, such as saving a fixed fraction of their income,.

5. Implications for Policy Transmission

The findings suggest that the traditional view of monetary policy transmission—where interest rates directly incentivize households to change their spending timing—may be incorrect. Instead, the source suggests that the effects of policy are likely transmitted through its impact on investment behavior or by indirectly altering household labor income.

Newspaper Summary 070626

 

The day all hedges fell in the US markets

TURBULENCE AHEAD. Markets grapple with the aftershocks of the AI sell-off, rising yields and mounting tensions in West Asia as fear grips investors

By Kumar Shankar Roy and Hari Viswanath (bl. research bureau)

Last Friday was a day when the logic of investing in uncorrelated assets broke down in the US markets. Most stocks fell, while semiconductor stocks crashed. Bonds declined as yields spiked. Gold and silver retreated. Crypto cracked. Crude oil slipped. The iShares MSCI South Korea ETF, traded in the US, tumbled 14.1 per cent. The only thing that went up — and no, that is not a bullish sign — was the VIX or CBOE Volatility Index which shot up nearly 40 per cent, implying fear was the only winner.

FEAR AND FRESH ISSUE

The trigger was not one shock but a pile-up. Results from Broadcom after market close on Wednesday triggered a rout in semiconductor stocks on Thursday and Friday. A solid 48 per cent year-on-year increase in its May quarter revenue was overshadowed by its July quarter outlook for AI chips, which fell short of investors’ lofty expectations.

Further, on Friday, the release of US jobs data for May which solidly beat forecasts added fuel to expectations that the US Fed is now likely to get hawkish amid high inflation and good job market (negates need for rate cuts). This pushed bond yields higher, with the 10-year Treasury yield moving above 4.5 per cent. These factors hurt the two trades that had dominated 2026: Long AI and rate-cut bets. When expensive growth stocks meet rising yields, even good stories need fresh oxygen.

Furthermore, market sentiment has soured over concerns that Big Tech firms may pivot from being buyers of their own equity to net sellers, as they divert capital to fuel their relentless AI infrastructure build-out. Alphabet, Google’s parent, last week moved to raise nearly $85 billion through an upsized equity plan to fund AI ambitions. On Friday, Facebook parent Meta’s stock fell after reports said it could raise tens of billions of dollars for its own AI push, though the company called the report speculation.

That shift matters. For years, cash-rich technology giants were machines of buybacks. Now, the AI build-out is so large that even the richest companies are testing the limits of internal cash flow and debt markets. As bond yields rise, expensive or overvalued equity can become the cheaper currency to fund the build-outs as compared to debt where interest rates are rising.

While Alphabet’s offering found strong bids, including from Berkshire Hathaway, concerns could build over a flood of supply hitting markets. Rumours of additional offerings from Big Tech come just as SpaceX is expected to launch a roughly $75-billion IPO next week. Add to this potential mega listings from Anthropic and OpenAI, and markets may have to brace for an unprecedented wave of equity issuance.

For example, the largest cash equity issuance before Alphabet’s offering was during the US government bailout of AIG, when Treasury bought $40 billion of newly issued preferred stock and took a 79.9 per cent stake in the company. The transaction size was unprecedented and massive but was warranted in a crisis situation. Alphabet’s capital raise is more than twice as large — and more could follow. Gold’s decline made its returns flat for the year against the dollar, while silver has slipped into negative territory.

Crypto did not offer an escape either. Bitcoin fell about 16 per cent for the week amid a record streak of spot bitcoin ETF outflows and a break from its dominant scarcity and institutional-demand narratives. Friday even saw bitcoin drop below $60,000, sinking to the lowest level since October 2024 taking its brutal drawdown to well over 50 per cent from all-time highs in 2024. Nor was the decline in oil a comforting signal. Prices fell on Friday, but global inventories are being rapidly drawn down as the Hormuz crisis escalates and the risk of a price spike remains.

MIND YOUR SURROUNDINGS

Among other concerns, the Japanese yen, which had been hovering near 40-year lows, is now weakening against the dollar at a time when inflationary shocks are spreading. While there is ongoing debate over whether yen carry trades have fully unwound, the risk remains that a major intervention by Japan to support its currency— similar to that seen in August 2024 — could create fresh pressure on global markets.

Going by the signals, it appears fear can spike further as tensions escalated over the weekend in the Middle East conflict. Unless there is any progress on the US-Iran stalemate, investors need to brace for more turbulence in the week ahead. The clearest signal comes from how Nikkei 225 Futures which closed on Friday down by a massive 5.6 per cent. All eyes will be on how Japan and Korea open on Monday, setting the tone for Indian markets. Investors need to heed what Henri Ducard tells Bruce Wayne in Batman Begins — ‘always mind your surroundings’.

Performance and portfolio composition of fund options

Under the NPS All Citizen Model, subscribers can invest in three asset classes through both Tier-I and Tier-II accounts: E (Equity), C (Corporate Debt) and G (Government Securities). NPS earlier offered a fourth asset class, ‘A’ (Alternate Assets), which invested in instruments such as Real Estate Investment Trusts (REITs) and Infrastructure Investment Trusts (InvITs), but it was discontinued in December 2025 due to its limited investment universe. These exposures were integrated into E and C, which can now invest up to 5 per cent of their corpus in such instruments.

Equity (E)

Fund E allows managers to invest in stocks within the Nifty 250 and BSE 250 universes. Managers can also allocate up to 5 per cent of assets to REITs, InvITs, Category I and II Alternative Investment Funds (AIFs), and gold and silver ETFs. Based on 10-year rolling returns, Fund E has delivered an annualised return of 13.5 per cent, which is marginally below the Nifty 100 TRI’s 13.8 per cent.

Corporate Bonds (C)

This fund primarily invests in listed corporate debt issued by public sector enterprises and private companies. The permissible universe includes:

• PSU debt ETFs
• AT1 bonds
• Debt-oriented Category I and II AIFs

While Fund C primarily invests in securities rated AA and above, up to 10 per cent of assets may be allocated to bonds rated between A and AA-. Ten-year rolling return analysis shows Tier-I Fund C generated an average annualised return of 8.6 per cent, outperforming the 7.6 per cent delivered by direct corporate bond mutual funds.

Government Securities (G)

Fund G invests primarily in Central and State government securities with maturities ranging from one to 50 years. The portfolio's modified duration generally ranges between eight and 12 years. Over the long term, Fund G has posted an average return of 8.8 per cent, exceeding the 8.1 per cent return from direct gilt mutual funds.

Asset Allocation Decisions

Asset allocation is considered one of the most critical decisions for NPS subscribers.

• Younger investors: Can benefit from higher exposure to Fund E (capped at 75 per cent under active choice) to maximize long-term growth.
• Investors nearing retirement: May prefer a greater allocation to Fund C and Fund G to reduce portfolio volatility and protect their accumulated savings.
• Passive management: For those who do not wish to manage allocations actively, NPS offers Auto Choice, which automatically adjusts the asset mix based on the subscriber's age.

Poles apart

INDEX OUTLOOK. Nifty Bank indicates potential to rise while Nifty and Sensex have room to fall

By Gurumurthy K (bl. research bureau)

Nifty 50, Sensex and Nifty Bank index fell in the first half last week. Nifty and Sensex remained stable in the second half and closed about 0.7 per cent down each. Nifty Bank index, on the other hand, bounced back well, recovering all the loss. It closed the week higher by 0.47 per cent.

There is a divergence visible on the chart. Nifty has more room to fall. Sensex is very close to a key support. Nifty Bank index is already holding well above its support and has a good chance to rise from current levels itself. Broadly based on the recent price action, it looks like the Nifty Bank index can outperform in the coming weeks.

FPIS SELL

The foreign portfolio investors’ (FPIs’) selling spree continues. The equity segment saw a net outflow of about $4.5 billion last week. We reiterate that the FPIs have to come back strongly into the domestic market in order to boost the Nifty and Sensex.

NIFTY 50 (23,366.70)

Short-term view: Nifty is struggling to rise past 23,500 decisively. That keeps the bias weak. Nifty can fall to 23,000-22,900. If the index manages to bounce from this region, it can rise again towards 23,400-23,500.

But a failure to bounce back and a break below 22,900 can trigger an extended fall to 22,400. However, a fall beyond 22,400 is less likely now in the absence of any new negative trigger.

Key resistance is at 23,850. Nifty has to surpass this hurdle in order to ease the downside pressure. Only then a rise to 24,300-24,700 will come into the picture.

Medium-term view: As mentioned last week, Nifty is now coming down within its broad 22,000-26,500 range. We expect this range to remain intact. As such, the downside can be limited to 22,000 if the index declines below 22,400.

We retain our bullish bias of getting a breakout above 26,500 in the coming months. That can take the Nifty higher to 28,000 and 30,000 in the long term. The bullish view will go wrong only if the Nifty declines below 22,000.

NIFTY BANK (54,496.25)

Short-term view: The recent price action indicates that the Nifty Bank index is getting good buyers in the 53,000-52,800 region.

Supports are at 53,750 and 52,500. As long as the index stays above 52,500, the bias will remain positive. Nifty Bank index can rise to 56,500-56,700 first and then to 58,500-59,000 eventually in the short term. The index will come under pressure for a fall to 50,500 only if it breaks below 52,500. But that looks less likely.

Medium-term view: The broader picture remains positive. Nifty Bank index can rise to 64,000-65,000 on a break above 60,500 – the intermediate resistance. From a long-term perspective, the index has potential to target 68,000-69,000. The bullish view will remain intact as long as the index stays above 50,000. The index has to decline below this support to indicate a trend reversal.

SENSEX (74,243.34)

Short-term view: The near-term picture is still weak. However, there is limited room to fall from here compared to the Nifty. Support is in the 73,000-72,700 region which can limit the downside.

Sensex can bounce from this support zone and rise back to 74,500 initially. An eventual break above 74,500 will then clear the way for a further rise to 76,000-76,500.

Medium-term view: Crucial support is around 71,500-71,000. We expect the Sensex to sustain above this support and keep the 71,000-86,000 range intact. Sensex can make a bullish breakout of this range eventually. Such a break will clear the way for a rally to 90,000 initially and 94,000 eventually over the long term. Sensex has to decline below 71,000 to turn the outlook bearish and fall to 69,000.

NIFTY MIDCAP 150 (22,251.80)

The index is stuck inside the 21,700-23,000 range over the last seven weeks. A breakout on either side of this range will determine the next move. A break below 21,700 can drag the index down to 21,500-21,400 or even 21,000. A fall beyond 21,000 is less likely.

On the other hand, a break above 23,000 can take the index higher to 23,100, a crucial resistance. The broader picture remains positive. As such, we retain our view of seeing a bullish breakout above 23,100 eventually. Such a break will take the Nifty Midcap 150 higher to 26,000-26,500 and 28,000-28,500 in the long term. This bullish view will go wrong only if the index declines below 20,800.

NIFTY SMALLCAP 250 (17,054.50)

The support at 16,600 held very well as expected. The index has risen back recovering all the loss from the low of 16,683.35. That keeps the overall bullish bias intact.

Short-term support is in the 16,400-16,200 region. The index can rise to 17,500 and even 18,000-18,300 in the coming weeks. We reiterate that 18,300 is a crucial resistance. The bias is positive to breach this hurdle eventually. That in turn will clear the way for the Nifty Smallcap 250 index to rally to 22,500-23,000 and even 24,000 in the long term. From a big picture perspective, the index has to decline below 14,000 to turn bearish, which looks unlikely.

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KEY SUPPORTS

• Nifty 50: 22,900, 22,400
• Sensex: 72,700, 71,500
• Nifty Bank: 53,750, 52,500

Dollar gets a boost

US MARKET OUTLOOK. Equities knocked down on rate hike prospects

By Gurumurthy K (bl. research bureau)

The Dow Jones Industrial Average, S&P 500 and the NASDAQ Composite index witnessed a strong sell-off on Friday. The NASDAQ Composite tumbled over 4 per cent, while the S&P 500 and Dow Jones fell 2.5 per cent and 1.3 per cent respectively on Friday. On the forex front, the dollar index and the Treasury yields got a boost on Friday from the jobs data release. The US added 172,000 jobs to its non-farm payroll in May, which was significantly higher than the market expectation of 80,000. Meanwhile, the unemployment rate remained stable at 4.3 per cent.

These strong job numbers are strengthening the case for a rate hike from the US Federal Reserve this year, which pushed the greenback and yields higher on Friday.

DOW JONES (50,872.08)

The rise to 51,500 happened as expected, but the index has declined sharply from its high of 51,665. Key supports are identified at 50,600 and 50,250. A bounce from either of these supports could take the Dow Jones back toward 51,500 and keep the door open for 52,500. However, 52,500 remains a crucial resistance that could halt the rally and trigger a reversal toward 51,000 or lower. If the index breaks below 50,250 immediately, there is a danger of a further fall to the 49,500-49,200 range, negating the chances of reaching 52,500.

S&P 500 (7,383.73)

Contrary to expectations, the index declined and broke below the support at 7,500. Crucial support is now in the 7,330-7,300 region. The index must sustain above this support and bounce back to reach 7,450-7,500 again. A failure to hold and a break below 7,300 would be bearish, potentially leading to a fall toward 7,150-7,100, which would indicate that a top is in place. Ideally, the index needs to rise past 7,500 to restore its earlier bullishness and make the target of 7,700-7,800 possible.

NASDAQ COMPOSITE (25,709.43)

As cautioned last week, a strong reversal has occurred. While a reversal was expected around 27,500, the index turned down after reaching a high of 27,190. The overall bias is now bearish, with a potential fall to 24,500-24,000. This decline could happen immediately or after a short-lived corrective bounce.

DOLLAR INDEX

The dollar index (100.10) has risen sharply, breaking above the resistance at 99.55, and the outlook remains bullish. The region between 99.55 and 99.45 will now serve as support. A fall below 99.45 would be required to put the index under pressure, but this appears unlikely. In the short term, the dollar index could rise to 100.70-101. From a long-term perspective, 101-101.30 is a very crucial resistance zone; a sustained rise above 101.30 could see the index rallying to 105 this year.

TREASURY YIELD

The 10Yr Treasury Yield (4.53 per cent) has recovered well from last week's low of 4.42 per cent. The important resistance to watch is 4.6 per cent. A decisive break above this level could take the 10Yr Yield higher to 4.8 per cent in the coming weeks.

SpaceX inks three-year $30-billion computing power deal with Google

Alphabet Inc’s Google has agreed to pay Elon Musk’s SpaceX $920 million a month for computing power as part of a cloud services deal that runs through mid-2029, its second such agreement with an AI competitor in a matter of weeks.

Google will pay SpaceX the monthly fee from October this year through June 2029, SpaceX said in the filing Friday. That amounts to about $30 billion through the time of the agreement.

If SpaceX fails to deliver access to Nvidia Corp chips as part of the deal by September 30, Google has the right to terminate the contract, with a one-month grace period, the filing shows. A Google Cloud spokesperson said the deal would help the company meet demand for its AI services. In its most recent earnings report, Alphabet said Google Cloud’s backlog — the measure of contracted work that hasn’t been recorded as revenue yet — nearly doubled from the prior quarter to more than $460 billion.

‘BRIDGE CAPACITY’

“This is a short-term, timely agreement to ensure we have bridge capacity to meet surging customer demand for our agent platform, Gemini Enterprise, which has been even higher than we expected,” the Google Cloud spokesperson said. The agreement involves AI chips, memory chips and other related components. Based on the capacity of Nvidia’s H200 chips, that may represent well over 100 megawatts of computing power — or enough power to energise 75,000 homes at any given moment.

The cloud deal isn’t the only pact that Google and SpaceX have been engaged in talks over. The two companies had been discussing launching the search company’s test products for orbital data centres, a person familiar with the matter said in May.

Under the pact disclosed on Friday, either party also has the right to terminate the arrangement with 90 days’ notice — the same feature as in Anthropic’s deal.

Bloomberg

AI will reshape jobs, but India’s big challenge is preparing workers, boards and classrooms

The Hindu Huddle. Redesigning education, skilling and research for an AI-led future is more critical than the debate over potential job losses, say industry veterans

By Jyoti Banthia and Siddhi Patil

The debate around Artificial Intelligence has largely been framed around a single question: Will it take away jobs? But at The Hindu Huddle’s session on “I, Robot: How AI is reshaping the future of work”, industry veterans argued that India risks missing a far more important conversation — how to redesign education, skilling, research and businesses for an AI-led future.

The panel, moderated by businessline editor Raghuvir Srinivasan, brought together former Cognizant CEO Lakshmi Narayanan, former Nasscom president and NITI Aayog distinguished fellow Debjani Ghosh, and B Santhanam, former CEO - Asia Pacific and India Region & Chairman, Saint-Gobain India.

ONLY A CORRECTION

Ghosh argued that the narrative around AI-driven job losses is often misplaced. “A lot of the displacements till now were due to over-hiring during the pandemic. So it was correction that was happening,” she said, pushing back against the view that AI is already eliminating large numbers of jobs.

That does not mean the risks are insignificant. As AI systems become capable of performing routine and repetitive tasks, entry-level jobs are likely to come under the greatest pressure. “The entry-level will definitely get disrupted. And that is important because that’s millions of people in India and millions of youngsters in India,” Ghosh said.

The challenge, she argued, is to figure out which parts of a job can be automated and which continue to require human judgement. That future, she said, will be defined by what she called the “human sandwich model”. “You need the humans to frame the questions and inputs, AI does the work, and then you need humans again at the end to verify the outcome,” she said, adding that the model will become even more critical as autonomous AI agents become commonplace.

THE GLOBAL AI ECONOMY

The conversation soon moved beyond jobs to India’s place in the global AI economy. While India has emerged as one of the world’s largest digital markets, Ghosh warned that being a consumer of technology is not the same as being a creator of it. “The AI economy is being dominated by two countries, the US and China. For India, we should at least aspire to get 10 per cent of that,” she said.

B Santhanam argued that India can create disproportionate impact through the diffusion of AI across sectors such as agriculture and education. However, he pointed to a critical gap: the lack of technological literacy in corporate India. “In the Nifty 45, there are 230 independent directors. Less than 10 per cent of them have any understanding or knowledge of technology. That’s the state of our boards,” he said.

This lack of engagement at the board level is particularly concerning as technology transforms industries. “Not one company in the managing director’s report had AI mentioned. Not one. That’s shocking,” Santhanam noted.

WEAK LINKS

Lakshmi Narayanan echoed concerns about India’s preparedness, particularly in education and research. Asked whether Indian colleges are producing graduates ready for the AI era, his answer was a cautious "no." He emphasized that India needs to move beyond being comfortable with diffusion to building stronger capabilities in innovation and research that drive technological leadership.

“We are not investing enough in research. The blame goes to the private sector,” Narayanan said. He argued that India needs these stronger capabilities if it hopes to play a meaningful role in shaping the next wave of AI.

Taken together, the panellists painted a picture that was neither utopian nor alarmist. AI will disrupt jobs, particularly at the bottom of the pyramid, but it will also create new opportunities. Whether India emerges as a creator of value or merely a consumer of it will depend on how quickly it can overhaul its classrooms, boardrooms, and research labs.

Monsoon advances up west coast even as signs of El Nino strengthen

WET SPELL. Met Department says conditions favourable for the rains to cover much of the country in 2-3 days

By Vinson Kurian, Thiruvananthapuram

The monsoon advanced further along the west coast and into the interior peninsula on Saturday, covering the whole of Goa and extending across parts of Karnataka, Maharashtra and Andhra Pradesh, while spreading over most of Tamil Nadu and into Mizoram and Manipur in the North-East.

The India Meteorological Department (IMD) said the monsoon’s northern limit passed through Devgad in Maharashtra; Koppal in Karnataka; Anantapuramu in Andhra Pradesh; Chennai; and Aizawl on Saturday afternoon. Conditions remain favourable for the monsoon to advance further into Maharashtra, Karnataka, Andhra Pradesh, and Telangana, the remaining areas of Tamil Nadu, and the rest of the north-eastern States over the next two-three days.

Satellite imagery on Saturday evening showed extensive rain-bearing cloud bands over parts of Karnataka including Hubballi, Belagavi, and Kalaburagi; Kolhapur and Ratnagiri in Maharashtra; Hyderabad, Kakinada, Visakhapatnam and Komarada in Andhra Pradesh; Kalimela and large parts of Odisha; Jagdalpur in Chhattisgarh as well as large parts of West Bengal and the southern parts of north-eastern States.

The IMD indicated that a fresh western disturbance expected around June 11 could dip south into the north-east Arabian Sea off the Konkan-Mumbai coast and emerge with a cyclonic circulation. The system may trigger thunderstorms over Mumbai and adjoining south Gujarat for several days.

EL NINO LOOMS

At the same time, global climate indicators point to a strengthening likelihood of El Nino conditions in the tropical Pacific. Sea-surface temperatures have crossed the critical 0.5°C threshold commonly associated with the onset of El Nino. International agencies estimate an 80-90 per cent chance of the phenomenon developing through June and July and potentially peaking between November and January.

OCEANIC PATTERNS

The equatorial Pacific has transitioned rapidly from neutral conditions towards a clear El Nino pattern. While oceanic signals have strengthened, atmospheric responses typically lag and may take more time to fully develop. Even so, evolving El Nino conditions can begin influencing global weather patterns, including the monsoon.

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RAIN IMMINENT. Intense clouds cover Maharashtra, Telangana, Andhra Pradesh, Odisha and West Bengal as the monsoon extended across these States on Saturday.

ICAI Journal Jun 2026

 

The MSME Growth Engine: Navigating Opportunities, Challenges, and the Role of CA in the Era of AI and Viksit Bharat 2047

CA. Mukul Lamba Member of the Institute

The Strategic Paradigm of India’s MSME Sector in 2026

Consider a manufacturer of hosiery based out of Ludhiana, Punjab, a skilled fabric knitter from Coimbatore, and a small-batch tea estate in Upper Assam. During the times of the old economy, these businesses were home-grown players striving to survive against exorbitant costs and intermediaries.

In the era of Viksit Bharat 2047, the concept of “small” businesses no longer exists; they are now referred to as Micro-Multinationals. Any business with a revenue of ₹100 crore in a Tier-2 city now boasts of international reach and data insights, driven by Artificial Intelligence (AI) and steered by strategic CA advisory.

The path traversed by the Indian economy in 2026 is principally defined by the strength of the MSME sector. As India advances toward its 100th year of independence, the sector has transformed into the buttress of industrial propulsion. In FY 2025-26, the sector contributes approximately 31.1% of national GDP and 35.4% of manufacturing yield. With over 7.47 crore enterprises employing nearly 38.82 crore individuals, it is the second-largest employer after agriculture. India’s real GDP is projected to grow at 7.4% in FY26, with manufacturing GVA surging 9.13% in recent quarters.

Viksit Bharat 2047: Ideological Pillars and the MSME Mandate

The mission to transform India into a developed, self-reliant nation is built on four fundamental pillars:

1. Youth (Yuva): MSMEs serve as laboratories for entrepreneurship, absorbing the demographic dividend into high-tech manufacturing.
2. Poor (Garib): The sector offers social mobility through localized employment at low capital cost.
3. Women (Mahilayen): The 2025-26 budget targets 70% participation of women in economic activities, with credit guarantee covers for women-led units enhanced to 90%.
4. Farmers (Annadata): Food processing MSMEs (supported by a ₹10,900 crore PLI outlay) facilitate value addition to make India the “food basket of the world”.

With India aiming to become a $30 trillion to $35 trillion economy by 2047, MSME contribution is expected to surge to 50% of GDP and 60% of exports.

Understanding the Economic Magnitude

• Current GDP Contribution (2026): MSMEs contribute roughly ₹100 lakh crore to a ₹320 lakh crore ($4 trillion) economy.
• The Funding Gap: Despite formalization, a credit gap of approximately ₹30 lakh crore remains.
• Government Allocation: The Union Budget 2026-27 earmarked over ₹22,000 crore for the Ministry of MSME, including a ₹10,000 crore SME Growth Fund.
• The 2047 Vision: By 2047, MSMEs are expected to manage an economic value exceeding ₹1,200 lakh crore.

The Roadmap to Viksit Bharat 2047

Pillar	Objective	Financial Target (Estimated)
Formalization	Move more micro-units to the Udyam portal.	Unlock higher opportunities in formal credit.
Technology Hubs	Establish AI-Common Facility Centers.	Reduce tech-adoption costs by 60%.
Export Scaling	Link MSMEs to global e-commerce.	Boost opportunities for MSME exports.
Skill Transformation	Reskill 10 million workers in AI-collaboration.	Increase labor productivity by 3x.

The Regional Powerhouses in INR Terms

The roadmap to $30 trillion is paved by regional clusters:

• Punjab’s Manufacturing: In Ludhiana, AI-driven predictive maintenance is saving units over ₹50 lakh annually in repair costs.
• Coimbatore’s Textile Tech: Modern looms using AI reduce fabric wastage by 12%, adding ₹1.5 crore to the annual bottom line of exporters.
• Assam’s Tea Renaissance: AI-powered soil analysis and forecasting are increasing yields by 20%, keeping the ₹20,000 crore industry competitive.

The Role of CA in the Era of AI and Viksit Bharat 2047

The CA has shifted from a conventional auditor to an “engineers of progress,” acting as the “General Surgeon” of an MSME's financial health.

A. From Compliance to Strategic Advisory: CAs now perform Data-Driven Business Modeling. Using AI, they provide “What-If” analyses regarding production increases and debt-service coverage. B. The ESG Sentinel: CAs are now authorized to certify carbon footprints and labor practices, ensuring MSMEs access the ₹80 lakh crore global green market. C. AI Governance and Ethical Audit: The mandate includes auditing AI models to ensure financial data security and compliance with the Digital Personal Data Protection (DPDP) Act.

Additional roles include:

• The Valuation Expert: Furnishing real-time valuations via AI.
• The ESG Auditor: Auditing emissions to allow "Carbon Neutral" branding at a 40% premium.
• Financial Shield: Conducting digital audits to safeguard against online frauds costing ~₹25 lakh per incident.

Audit Automation and Initiatives

CAs are encouraged to use agentic workflows to automate auditing labor, moving toward reporting automation and tracking ROI.

• ICAI MSME Clinic: Launched across 183 branches, these clinics provide weekly pro-bono advisory on finance, GST, and technology, acting as credit matchmakers.
• Addressing Liquidity: Approximately ₹10.7 lakh crore is locked in delayed payments annually. Section 43B(h) of the Income Tax Act (effective April 1, 2024) enforces payment discipline.
• Transition to MSME ODR: Since October 15, 2025, all delayed payment applications are filed on the Online Dispute Resolution (ODR) Portal for resolution within 90 to 180 days.

AI: The Catalyst for “Non-Linear” Growth

AI is now a fundamental factor of production.

• Hyper-Efficiency: IoT sensors and predictive maintenance avoid breakdowns costing ₹5–10 lakh annually.
• Democratized Marketing: AI enables rural MSMEs to sell directly to global markets via ONDC, handling localization and logistics.
• Intelligent Credit: AI-enabled Cash Flow Lending uses GST returns and digital data to grant collateral-free loans within minutes. By 2035, AI is estimated to contribute $135.6 billion to $149.9 billion to MSME value creation.

The IMPACT AI Framework for Adoption

This World Economic Forum framework organizes actions into three pillars:

1. Awareness: Utilizing AI Experience Centres and Sandboxes.
2. Action: Using the AI Maturity Index and AI Solutions Marketplace.
3. Recognition: Celebrating AI Pioneers to create blueprints for others.

Challenges: Navigating the Storm

• Digital Divide: 40% of rural units still struggle with high-speed internet and basic digital bookkeeping.
• Cost of Transition: Infrastructure upgrades are daunting for micro-enterprises.
• Cybersecurity: A single breach can cost a small unit ₹50 lakh, often leading to permanent closure.
• Reskilling: The need to train 10 million workers to work alongside AI.

Conclusion: The Lion Awakens

By 2047, the contrast between “small” and “large” business will be blurred by technology. A minor unit in a Tier-3 city, powered by AI and a technologically adept CA, will have the competencies of a multinational. The MSME Growth Engine is no longer just about survival; it is about dominance, transforming the Indian spirit of “Jugaad” into a global standard of “Innovation and Excellence”.

Author may be reached at mukullamba62@gmail.com and eboard@icai.in.

MSMEs in India: Engines of Innovation and Economic Transformation

Contributed by MSME and Start-up Committee of ICAI

Introduction

The adage perfectly describes Indian businesses: A skilled sailor doesn’t wait for the wind; he creates his own course. Small dreams that turn into businesses have navigated global uncertainties and difficult situations to strengthen the nation’s economy over decades. The businesses have also received measured governmental support. Entrepreneurial resilience and these things have further propelled businesses and contributed to the country’s economic stability.

MSMEs stands as the acronym for Micro, Small and Medium Enterprises which form the backbone of the Indian economy, a term which evolved from the early industrial regulatory framework under the Industries (Development and Regulation) Act and was later crystallised through the MSME Development Act, 2006. Recently, the government redefined MSMEs by updating investment and turnover thresholds, reflecting the sector’s transformation and its growing integration with digital markets.

Today, the numbers speak compellingly for Indian enterprise. MSMEs contribute roughly 30% of India’s GDP, account for nearly 45% of manufacturing output, contribute close to 46–48% of India’s total exports, and employ over 37.50 crore people, making them the largest employment generator in the country after agriculture. As of 27th May 2026, 8.47 Cr enterprises have registered on the Udyam Registration Portal (URP) and the initiative of Udyam Assist Platform (UAP) launched by the government is a testament to the ease of doing business and the formalisation of India’s informal economy. Parallel to this, India’s startup ecosystem has surged to approximately 230,000 DPIIT-recognised startups with 23.36 lacs approx. job creation as of May 2026, with over 130 unicorns, third globally, demonstrating world-class innovation and attracting substantial foreign investment.

Indian businesses are increasingly adopting best trading practices, accounting standards compliance, e-invoicing, GST-driven transparency, and supply-chain digitisation, making the ecosystem investor-ready. Indeed, investors are choosing India for its macro-stability, large domestic market, policy predictability, and a startup culture that blends frugality with ambition. Moreover, the sector is pivoting toward green practices: solar-powered units, energy-efficient production, and circular-economy models are becoming the norm.

Digitalisation under initiatives like Digital India, TReDS, the Udyam Assist Platform, and the Open Network for Digital Commerce (ONDC) has democratised market access, enabling even the smallest enterprises to trade nationally and globally. Through the Make in India initiative launched in 2014 and the “Vocal for Local” movement, India is manufacturing everything from smartphones and electronics to defence equipment and renewable-energy components, reducing import dependence while boosting exports. Complementing this, the Production Linked Incentive Scheme (PLI) provides performance-based incentives to boost large-scale manufacturing, enhance exports, and strengthen India’s competitiveness in global supply chains. The renaissance of modernity, rooted in civilisational commerce and propelled by technology and sustainability, affirms India’s position as a global manufacturing and trading powerhouse.

With its vast demographic dividend, India is harnessing its population, particularly its youth and skilled professionals, at peak efficiency. The nation has emerged as a premier outsourcing hub, driven by IT and IT-enabled services, business process management, accounting services, engineering R&D, knowledge process outsourcing, and increasingly, cloud services, digital marketing, and back-office operations. What sets India apart are the practices it has adopted: globally standardised service delivery models, ISO-certified quality processes, strong data security frameworks, seamless digital infrastructure, and a talent pool fluent in multiple languages and global business norms. These practices, combined with cost competitiveness, 24/7 service delivery, and a strong IP protection regime, have made India the preferred destination for foreign multinationals seeking reliable, high-quality services.

Fortune favours the bold, but it would not be wrong to admit that the sweet fruit which is favouring India’s economic ecosystem is the relentless effort by both the government and entrepreneurs who are burning the midnight oil in making it achievable. These schemes are proof that the challenges in India shall be faced with a more power-backed approach. Recognising MSMEs as the backbone of India’s economic fabric, the government has rolled out a comprehensive ecosystem of schemes designed to fuel entrepreneurship. The Credit Guarantee Scheme for Micro and Small Enterprises (CGS) now offers guarantee coverage up to 90% for loans up to ₹10 crore, enabling an additional credit of ₹2 lakh crore at reduced cost. This would not only provide financial help to budding entrepreneurs but would also give them the confidence to boost their businesses.

Schemes Favouring the Entrepreneur Ecosystem in India

Key government initiatives to support MSMEs and startups include:

• Startup India Initiative
• Raising and Accelerating MSME Performance (RAMP): Launched in June 2022 with a total outlay of ₹6,062.45 crore (2022–27), targeting approximately 5.55 lakh beneficiaries by expanding access to finance, markets, technology, and green practices.
• Digital Interventions: Including the SAMADHAAN Portal and the newly launched Online Dispute Resolution (ODR) Portal to ensure timely payment settlements.
• MSME Champions Scheme: Drives technology upgradation and common facility centres.
• Self-Reliant India (SRI) Fund: Infuses ₹50,000 crore equity into MSMEs.
• PM Vishwakarma: Offers holistic support to 18 traditional artisanal trades, including formal recognition, skill upgradation with stipends, ₹15,000 toolkit e-vouchers, and collateral-free loans up to ₹3 lakh at 5%.
• Prime Minister's Employment Generation Programme (PMEGP): Provides credit-linked subsidies (up to 35%) for setting up new micro-enterprises in the non-farm sector.
• Trade Receivables Discounting System (TReDS): Facilitates electronic financing of trade receivables.
• Startup-specific funds: Including the Fund of Funds for Startups (FFS) (₹10,000 crore) and the Startup India Seed Fund Scheme (SISFS).

This confluence of policy support, financial access, and institutional guidance is nurturing a pool of skilled professionals and ambitiously positioning India to generate its own "Big 4," making the dream of globally competitive Indian multinationals not so distant.

Legal and Policy Framework Strengthening Indian Business

The government's strategy is backed by laws and regulations that make it firmer and investor-ready.

• MSME Development Act, 2006: Provides priority sector lending mandates and delayed payment protection.
• Goods and Services Tax (GST) regime: Simplified compliance via composition schemes and threshold exemptions.
• Startup India Recognition Framework: Grants legal identity through DPIIT recognition, enabling tax exemptions and holidays.
• SME Listing Platforms: NSE EMERGE and BSE SME have seen over 1,400 SMEs listed, raising thousands of crores.
• Regulatory Reforms: The Companies (Amendment) Act, 2020, and SEBI (ICDR) Regulations, 2021, have eased exit norms and enabled easier listing.
• ESG and Data Governance: SEBI’s Business Responsibility and Sustainability Reporting (BRSR) framework (2021) and the Digital Personal Data Protection Act, 2023, establish transparency and data protection norms.

Role of Chartered Accountants in Nurturing MSMEs and Startups

Chartered Accountants act as the bridge between policies, laws, and people, serving as the best advisors for business growth. Their role has evolved from being primarily financial-focused to acting as strategic partners who:

• Drive AI adoption in business processes.
• Guide ESG integration and advise on BRSR frameworks.
• Facilitate SME IPO listings and promote green practices.
• Prepare investor-ready financials and conduct due diligence for structured deals.
• Ensure international accounting standards compliance for global scaling.

ICAI: Partner in Nation-Building

Through its dedicated MSME & Startup Committee, ICAI has strengthened the landscape via progressive initiatives.

A. MSME and Startup Yatras The ICAI MSME Yatra 2022 and the 2024 edition (covering 20,000 km across 100 cities in 100 days) facilitated thousands of Udyam and DPIIT registrations and provided expert guidance on business setup, compliance, and finance.

B. Pan-India MSME Empowerment Drive (2025)

• ICAI MSME Mahotsav: Held on 27 June 2025 across nearly 140 branches, providing grassroots support to 20,000 MSMEs through 400 helpdesks.
• ICAI MSME Startup Conclave: Mumbai event bringing together 3,000 delegates and resulting in funding for several startups.
• ICAI MSME Connect: Strategic meet in New Delhi focusing on digital transformation and policy.
• ICAI MSME Clinic: Launched in December 2025, providing weekly pro-bono advisory on finance, technology, and compliance across ICAI branches.
• Strategic Partnerships: MoUs with NPCI Bharat BillPay, IIT Delhi (FITT), and various state governments to promote digitisation and mentorship.

C. ICAI’s 2026 Roadmap

• All India MSME Associations Meet (April 2026): Focused on financial inclusion and access to credit.
• SME Fund Raising Conclave (Indore): Explored funding alternatives like SME IPOs and venture capital.
• MSME Manthan Meet 2026 (Shimla): A residential meet with Ministry officials to address grassroots hurdles and utilize government incentives.

Conclusion

As Dr. A.P.J. Abdul Kalam stated, “Dream is not that which you see while sleeping, it is something that does not let you sleep.” Today, India epitomises this vision. The nation is progressively surfacing as a global champion shaping the future economy. The profession remains steadfast in reinforcing businesses through professional acumen and prudent guidance, as India moves toward emerging as a Vishwaguru.

The Importance of the Foreign Exchange Management Act [FEMA], 1999 in India

CA. Shweta Choraria Member of the Institute

Introduction

In today’s era of rapid globalization, digital payments, and high-volume cross-border transactions, FEMA plays a very important role in facilitating international trade, managing foreign exchange reserves and maintaining the stability of the Indian currency. From the perspective of Chartered Accountants (CAs) in Practice in India, developing expertise in this field and providing consultancy services to clients engaged in multinational businesses is a welcoming and rewarding opportunity. Recognizing the growing importance of this domain, ICAI has been continuously encouraging its members by organizing Certificate Courses on FEMA and regularly updating them on recent changes and their impact on the Indian economy.

What is FEMA, 1999?

FEMA, 1999, is an Indian law enacted to regulate the flow of foreign currency, manage foreign exchange, and ensure monetary stability in the Indian economy. It covers all transactions, including capital account and current account transactions, as well as the scope of Foreign Direct Investments (FDI) and External Commercial Borrowings (ECB). The Act empowers the Central Government to frame rules and the Reserve Bank of India (RBI) to issue regulations for managing foreign exchange to facilitate external trade and maintain a stable forex market. Essentially, the Central Government sets the policy framework, while the RBI regulates authorized dealers and oversees foreign exchange transactions.

Top 10 Positive Impacts of FEMA, 1999, on the Indian Economy

1. Focus on Economic Stability & Forex Management: FEMA focuses on maintaining economic stability by regulating capital flows and ensuring that cross-border transactions do not negatively impact the balance of payments. It promotes the orderly development and maintenance of the forex market.
2. Welcoming Foreign Investment: FEMA is designed to facilitate external trade and actively encourage foreign direct investment (FDI) to boost growth. By providing clear, transparent guidelines for FDI and Foreign Portfolio Investment (FPI), it attracts foreign investors, boosting India’s GDP and capital reserves.
3. Positive Response to Businesses and Start-Ups: By reducing constraints on foreign exchange, it makes it easier to do business internationally. FEMA Valuation guidelines prevent startups from giving away equity below fair value, protecting stakeholders. Adherence also helps businesses maintain a positive legal reputation essential for attracting investors.
4. Liberalization in Trade Practices: FEMA generally allows transactions unless they are expressly prohibited, reversing the restrictive principle of its predecessor, FERA. It classifies most violations as civil offenses rather than criminal acts, significantly liberalizing trade.
5. Shifting from Regulation to Management: The shift from the Foreign Exchange Regulation Act (FERA), 1973, to FEMA represents a foundational transformation from a regime of strict control and conservation to one of management and facilitation. Under FEMA, foreign exchange is treated as an economic asset to be managed for development rather than a scarce resource to be controlled.
6. More than Law, it works like an Eco-System: FEMA forms the foundation of India’s foreign exchange ecosystem, balancing national interests with the need to attract investment and comply with global standards. It continues to evolve to meet changing economic needs and global trends.
7. Boost Foreign Investment: By liberalizing transactions and creating a conducive regulatory environment, FEMA encourages trade and investment that directly or indirectly contributes to economic growth.
8. Enhancing Investor Confidence: A transparent and predictable regulatory framework enhances investor confidence, attracting more foreign capital into India.
9. Sector-Specific Regulations: FEMA prescribes FDI caps and approval routes (automatic or government) based on industry type to regulate inflows and maintain stability. It also specializes in regulations for E-commerce regarding cybersecurity to protect digital assets.
10. Shifting from Criminal to Civil Penalties: Markedly different from the restrictive criminal-based regime of FERA, FEMA's civil-based facilitative framework promotes trade and investment by managing foreign exchange as an economic asset.

Compliances and Documentations under FEMA, 1999

Main compliances include mandatory reporting of foreign investments and transactions to the RBI through AD Category-I banks. Key requirements include:

• Filing the Annual Return on Foreign Liabilities and Assets (FLA).
• Reporting FDI via Form FC-GPR/FC-TRS.
• Filling the Entity Master Form.
• Monthly ECB-2 filings.
• Adhering to LRS limits for outward remittances.
• Complying with downstream investment rules for subsidiaries.
• Filing the Annual Performance Report (APR) for Overseas Direct Investment (ODI).
• Reporting investments in Foreign Joint Ventures (JV) or Wholly Owned Subsidiaries (WOS).
• Reporting individual foreign exchange withdrawals daily via CIMS for AD banks.
• Ensuring export proceeds are realized and returned within specific timeframes.
• Maintaining records like the Foreign Inward Remittance Certificate (FIRC) and ensuring KYC compliance.
• Filing Form 15CA/15CB with authorized banks.
• Registering for an Import Export Code (IEC).

Basic Points to be Considered under FEMA, 1999

• Retaining Resident Accounts: NRI status (staying outside India for >182 days) requires immediate conversion of Resident Savings Accounts to Non-Resident Ordinary (NRO) accounts. Maintaining a resident account as an NRI is a common violation.
• Using NRE Account after Returning: Continuing to operate a Non-Resident External (NRE) account for Indian income after returning to India permanently is a violation.
• Crypto/Prohibited Investments: Using Liberalised Remittance Scheme (LRS) funds for crypto-assets or prohibited items is treated as an LRS breach.
• Splitting Remittances: Exceeding the annual $250,000 limit by using multiple banks to hide the cumulative total is a violation.
• Filing Errors: Non-filing or incorrect filing constitutes a violation.

Important Monetary Limits under FEMA, 1999

• Liberalised Remittance Scheme (LRS): Residents can remit up to USD 250,000 per financial year for authorized purposes.
• Repatriation for NRIs/PIOs: Can repatriate up to USD 1 million per financial year from NRO accounts (income/sale proceeds).
• Educational Expenses: Allowed up to the institution's estimate or USD 100,000 per academic year, whichever is higher.
• Medical Treatment: Permitted up to the doctor/hospital estimate or within the LRS limit.
• Gifts and Donations: Remittances are covered under the USD 250,000 LRS limit.

FEMA and RBI Compliances: Core Reporting Requirements

Requirement	Applicable Forms	Timeline	Regulating Authority
FDI Reporting	FC-GPR, FC-TRS	30-60 days	RBI
Overseas Investment	Form FC	On or before ODI remittance	RBI
APR for ODI	Form APR	Annual	RBI
Import Payments	A2 Form, KYC	Before sending payment	AD Bank
Export of Goods/Services	SOFTEX Form, GR Form	Periodic (project/invoice based)	RBI/SEZ Authority

Some Recent Actions of the Government Related to FEMA, 1999

1. Export/Import Regulation: In November 2025, the RBI extended the export proceed realization and repatriation time limit from 9 months to 15 months. Travelers to Nepal and Bhutan can now carry Indian currency notes up to ₹25,000 (excluding denominations above ₹100).
2. FDI & Non-Debt Instruments (2025): Companies in FDI-prohibited sectors were permitted to issue bonus shares to existing non-residents if the shareholding pattern remains unchanged. Prior government approval for FDI from border-sharing nations was strictly enforced in 2025.
3. LRS & Tax (2025-2026): Budget 2025 increased the TCS threshold for LRS remittances to ₹10 lakh per year. Remittances below this generally avoid TCS, and those for education via financial institution loans also do not attract TCS.
4. Compounding and Compliance Procedures (2025): Applications must now be submitted via the RBI’s PRAVAAH portal. April 2025 amendments introduced a ₹2,00,000 cap for compounding minor or technical contraventions to ease compliance.
5. Enforcement Actions (2025-2026): The Enforcement Directorate (ED) has intensified investigations into “front companies” and foreign NGOs. Notable cases include provisional attachment of assets worth ₹100.44 Crore in an illegal coal mining case, searches in Goa involving recovery of ₹2.25 Crore in cash and cryptocurrencies worth over ₹90 Lakh, and the seizure of 13 bank accounts of M/s Reliance Infrastructure Ltd. related to the siphoning of NHAI funds.
6. Enhanced Reporting Monitoring: RBI upgraded the Single Master Form (SMF) system for auto-reconciliation and alerts, while reducing work duplication on the iFirm portal.

Role and Initiative taken by ICAI on FEMA, 1999

ICAI plays a vital role in administration, compliance, and education. It conducts specialized Certificate Courses, publishes handbooks like the “CAs’ Handbook on Inbound & Outbound Investments under FEMA,” and organizes webinars to help members navigate documentation and RBI guidelines.

FEMA: An Open Opportunity for Chartered Accountants (CAs)

Increasing cross-border transactions and investments offer significant career opportunities. Scope exists in:

• Certifications required by AD Banks for remittances and capital transactions.
• Client representations before the RBI for compounding and approvals.
• Regulatory management roles in leading firms, particularly in Tax Advisory and Litigation.

Challenges under FEMA, 1999

• The dynamic nature and frequent RBI circulars make compliance difficult, especially for smaller firms.
• Significant delays can occur due to approval requirements and extensive documentation.
• Unintentional non-compliance (e.g., clerical errors) can lead to severe penalties or unwinding of transactions.
• Misuse of NRI bank accounts (NRE/NRO) and illegal property purchases remain common.
• Penalties under the 1999 Act are very heavy.

Conclusion

FEMA’s flexible, transparent approach has been vital in inviting foreign investment and promoting the ease of doing business in India. However, it demands strict compliance with reporting and sector-specific restrictions. Under FEMA, what you cannot do directly, you cannot do indirectly either.

Important Government Websites

• RBI FEMA Scripts
• Enforcement Directorate FEMA
• RBI Common Man FAQs
• RBI FIRMS Portal

Based on the "Gist of Opinions" section (pages 1595–1600) of the source, here are the summaries of the Expert Advisory Committee (EAC) opinions provided in the June 2026 edition:

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1. Capitalisation of Dry Dock Expenditure (Major Inspection Costs)

Subject: Capitalisation as a separate component of dredgers and depreciation after completion of their estimated useful lives.

Company’s Response to CAG Comments:

• The Company argued that under Ind AS 16, subsequent costs can be capitalised and depreciated until the next scheduled dry-docking.
• For dredgers with expired useful lives, the Company reviewed and extended those lives based on dry dock surveys, aligning with paragraph 51 of Ind AS 16.

Committee’s Points and Opinion:

• The Committee noted that Ind AS 16 allows capitalization if it is probable that future economic benefits will flow to the entity and costs can be measured reliably.
• Routine repairs, maintenance, and day-to-day servicing must be charged to profit or loss as incurred.
• Not all dry-docking expenses meet the criteria; each item must be analyzed. However, if expenditure increases the expected utility/useful life, it meets recognition criteria.
• Ind AS 16 does not prohibit subsequent expenditure capitalization even after the original useful life has expired, but the Company should review its manner of determining useful life.
• If a component has a different useful life than the remainder of the asset, it must be depreciated separately.

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2. Structured Package of Assistance for a Hardwood Pulp Plant

Subject: Whether a capital subsidy in lieu of SGST reimbursement is a ‘grant related to asset’ or a ‘grant related to income’ under Ind AS 20.

Committee’s Points and Opinion:

• Ind AS 20 defines grants related to assets as those where the primary condition is the purchase, construction, or acquisition of a long-term asset.
• Secondary conditions regarding the location or type of asset do not change this classification.
• The Committee clarified that the frequency of the grant (one-time vs. regular) is irrelevant to determining its nature.
• While the subsidy might be calculated as a percentage of investment, this is merely the basis for the amount and does not dictate the nature of the grant.

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3. Payment to NHAI for Road Connectivity to Exhibition-cum-Convention Centre (ECC)

Subject: Accounting treatment of ₹354.89 crore paid to NHAI for external road connectivity to the ECC project.

Management’s Position:

• Management argued the road infrastructure is critical to the operational readiness of the ECC; without it, the main asset is unusable. Therefore, they capitalised it under Ind AS 16.

Committee’s Points and Opinion:

• The expenditure was for "connectivity" to a road, not a dedicated road for the project itself.
• Under Ind AS 16, only costs directly attributable to bringing an asset to the location and condition necessary for operation can be capitalised.
• The Committee noted the road and project development happened simultaneously, meaning the road was not strictly necessary for the construction of the ECC.
• The objective was to create additional access to increase attractiveness and visitor ease, which may increase future benefits but is not necessary for the ECC to be "capable of operating".
• Conclusion: The expenditure should not be capitalised as part of the PPE cost; instead, it should be recognized as an expense in the Statement of Profit and Loss when incurred.

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Important General Notes:

1. These gists are summarised versions for informational purposes and may not capture every nuance. Users should refer to the complete authoritative text at icai.org.
2. The opinions represent the view of the EAC, not necessarily the Council of the Institute.
3. Each opinion is based on specific facts provided by the querist and current laws at the time of finalisation.
4. A Compendium of Opinions in forty-four volumes is available for purchase via the ICAI CDS Portal.

Accountant’s Browser

PROFESSIONAL NEWS & VIEWS PUBLISHED ELSEWHERE Index of some useful articles taken from Periodicals received during April – May 2026 for the reference of Faculty/Students & Members of the Institute.

1. Audit

• Auditor-Client Relationship and Abnormal Tone: A Simultaneous Equations Approach by Milad Darvishi, Mahmoud Lari Dashtbayaz, Roghayeh Mahmoudi Yekebaghi and Taqi Abdul Redha AI Abdwani. Asian Review of Accounting, V. 34, No. 2, PP. 273-297.

2. Computer

• Employees Are Relying on AI for Personal Support. That’s Risky by Constance Noonan Hadley and Sarah L. Wright. Harvard Business Review, May-June 2026, PP. 67-75.
• How Gen AI Robots are Reshaping Services by Jochen Wirtz. Harvard Business Review, May-June 2026, PP. 117-125.
• Strategic Impact of AI on Bank CRM: Applications, Benefits and Future Governance by S. Jeyakumar. Banking Finance, April 2026, PP. 37-43.

3. Economics

• Horticulture Sector in India: Trends, Performance, and Impact by Sant Kumar, Anjani Kumar, Nalini Ranjan Kumar, Kriti Sharma and Immanuelraj Kingsly. Economic & Political Weekly, April 25, 2026, PP. 42-49.
• Innovation as the Driver of Economic Growth: India’s Roadmap to 2047 by Bimlesh Kumar Singh and Saifullah Khan. University News, April 20-26, 2026, PP. 26-36.
• Mind over money: How Psychology Shapes your Financial Fate by Soumya Ranjan Sahoo and Sunil Kumar Gaud. Banking Finance, April 2026, PP. 29-32.
• West Asia War: What it Means for Exporters, Importers and Marine Insurance by Balasundaram R. Insurance Times, April 2026, PP. 35-37.

4. Taxation and Finance

• Performance Commitment, Earnings Quality and Tax Avoidance: Evidence from Chinese Listed Companies by Xiaoqing Li, Haiyu Yan and Zixing Wang. Asian Review of Accounting, V. 34, No. 2, 2026, PP. 483-509.

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Note: Full texts of the above articles are available with the Central Council library, ICAI, which can be referred on all working days. For further inquiries, please contact 011-30110419 and 011-30110420 or by e-mail at library@icai.in.

Mergers and Acquisitions: Transforming the Global Business Landscape 2026-2030

CA. Neha Sedhara Member of the Institute

Overview and Strategic Necessity

Mergers and Acquisitions (M&A) have evolved from simple tools for expansion into strategic necessities in the globalized market of 2026. The period between 2026 and 2030 is set to witness transformative shifts driven by technological innovation, regulatory reforms, and sustainability. While M&A serves as a primary tool for consolidation, it is increasingly used to drive innovation and navigate the complexities of the future global business environment.

Historical Context and India’s Rise

India has recorded a massive trajectory in the M&A space, with over 28,500 deals since 1996, totaling a cumulative value exceeding $1.06 trillion. The year 2025 marked a significant rebound, with deal values reaching approximately $60.2 billion across 960+ transactions. This surge was primarily driven by high-value, billion-dollar deals and increased inbound interest in sectors like infrastructure, technology, and BFSI.

Technological Transformation

Technology, specifically Artificial Intelligence (AI), blockchain, and digital tools, has become a central driver of the M&A process. AI is used to streamline operations, automate repetitive tasks, and accelerate due diligence through advanced data analysis. Notably, Generative AI is projected to be utilized in 80% of M&A processes within the next three years, a massive jump from 16% in early 2024.

Landmark M&A Deals (2020-2025)

Several high-profile deals have reshaped the global landscape:

• Microsoft – Activision Blizzard (2022): At $68.7B, this historic deal gave Microsoft massive scale in gaming and essential access to the metaverse ecosystem.
• Reliance – Disney Merger (2024): A $8.5B consolidation creating "JioHotstar," commanding 120 TV channels and 280 million subscribers, capturing over 85% of the OTT market in India.
• AMD – Xilinx (2022): A $35B deal that elevated AMD into a full-stack semiconductor player.
• Tata Motors – Iveco (2025): A $4.4–4.5B acquisition that provides Tata Motors with strong access to Europe and Latin America while accelerating its entry into EV and hydrogen technologies.

Sectoral Spotlights: Pharma and Cement

1. Pharmaceuticals: Indian trends are converging with global benchmarks. Mankind Pharma’s acquisition of Bharat Serums & Vaccines (2024) for ₹13,768 Cr mirrors the strategic rationale of global giants like Pfizer (Arena Pharma acquisition), moving from pipeline-driven bets to portfolio-driven dominance in specialty areas like women's health and fertility.
2. Cement: The Adani Group is aggressively challenging market leader UltraTech Cement. By acquiring Penna Cement for ₹10,422 Crore, Adani Cement is on track to hit its target of 140 MTPA by FY2028, aiming for a 20% market share. UltraTech, however, remains the leader with a 23% share and plans to expand beyond 160 MTPA.

Hurdles, Legal Challenges, and the Role of Chartered Accountants

M&A transactions are fraught with regulatory and operational complexities where CAs play a pivotal role:

• Regulatory Compliance: CAs navigate domestic laws (Companies Act, 2013) and cross-border requirements like FEMA and multi-jurisdictional antitrust reviews.
• Taxation: Structuring deals to optimize Capital Gains Tax, managing Stamp Duty variations, and leveraging Double Taxation Avoidance Agreements (DTAAs) are essential functions.
• Emerging Risks: Integrating ESG compliance, managing GDPR and data localization laws, and ensuring robust cybersecurity during IT integration have become modern priorities.

Emerging Trends and 2030 Projections

• Sustainability: M&A in clean energy will accelerate to meet the global goal of 500 GW clean capacity by 2030.
• India as a Global Hub: Supported by regulatory stability and policy continuity, India is projected to maintain M&A transaction values in the range of $65–75 billion in 2026, becoming a hub for strategic global investments.
• Future Outlook: Key trends include a rise in cross-border collaborations, a heavy focus on ESG integration, and the expansion of private equity in early-stage firms.

Sector-wise Share of M&A (2025-26 Estimate)

Sector	Volume Share
IT / Technology	24%
Industrials / Manufacturing	15%
Utilities / Power / Renewable	13%
Healthcare / Pharma	10%
Financial Services	9%
Consumer Goods / FMCG	8%
Telecom / Infrastructure	7%
Others	14%

(Source: Author's estimate)

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Conclusion: M&A will remain central to corporate growth and innovation through 2030. India’s dynamic market, bolstered by proactive policies and professional expertise, will play a pivotal role in this global transformation.