governance, political economy, institutional development and economic regulation

protest 

photo credit: news.nationalpost.com

The ability of a sovereign to levy and collect tax sustainably, on an equitable basis and without overt coercion is a sound measure of the strength of the “social compact” between the State and citizens.

In India, the “social compact” is weak partly due to our colonial past but mostly due to the State evading the obligation thrust on it by a social contract. Citizens do not perceive public funds as belonging collectively to them. State funds are still viewed as belonging to the “ruler”, as they did pre-independence, to either the 250 Indian Princes or the British Raj.

Of course we are poor, which limits the tax potential. Two thirds of Indians (700 million) have a per capita income of less than USD 2 per day. They do not pay any income tax on their earnings but they do pay around 10 to 15% of indirect tax (excise and general sales tax) on the goods and services they consume. But indirect taxes are bundled into the price of goods. They become “invisible” and no individual can wave the tax receipt under the nose of the State and demand to be served.

Of the funds available with State governments (FY 2012 Indian Public Finance Statistics), where interface with the citizen is the most, only 20% is on account of direct taxes (including their share in direct tax collection by the central government). The remaining 80% is all on account of indirect taxes.

Only 34 million Indians (2.8% of the population) pay Income Tax. But it is direct tax, like Income Tax, which creates a clear, direct “contract” between citizens and the State and obliges the latter to do its duty by the former.   Worse still in India 60% of the direct tax collection is from firms, not individuals. Not surprising then that corporates matter more than individual tax payers.

The Income Tax Department recently announced that it had unearthed Rs. 100,000 crore (Rs. 1 trillion) of unaccounted income in FY 2014-no mean achievement on the face of it. But it pales into insignificance against Jawaharlal Nehru University Economist, Arun Kumar’s estimate of “black money” accounting for 50% of India’s GDP, which is around Rs. 90 Lakh crore (Rs.90 Trillion). If Dr. Kumar is right, our Income Tax sleuths got their hands on only 2% of the “black money” circulating in that year.

The impact of tax policy on corruption is ambivalent. Tax people too high, or over regulate the economy and you create an incentive to evade tax and licensing and thereby to operate in the “black economy”- a parallel environment of wealth or income, for which transactions remain unrecorded and on which no tax has been paid. Conversely, not taxing people at all, runs the risk of bankrupting the State and also of losing an opportunity to gauge the “willingness to pay” of citizens for public goods and services provided by the State.

Non-payment of tax is the first manifestation of citizens losing faith in the State. The Mahatma’s Dandi march (1930) was not just a protest against the specific tax imposed on the production of salt, but also highlighted the low levels of satisfaction under British colonial rule.

The “Boston Tea Party” (1773) was a similar event in America, where the flame of nationalism was lit by the spark of protest against unjust colonial taxation of tea by the British, without representation of American interests.

India has neglected the “social compact” building aspect of tax and relied instead on “freebies” like cheap fertilizer, electricity and water; high grain, sugar cane and other cash crop support prices and very low tax on ownership of land, to bribe farmers into a one way social compact, where the government owes them a lot and they owe nothing to the government.

This lack of a “social compact” is most evident between the swelling middle class (500 million strong in rural and urban areas) and the State.  The middle class anger, which Kejriwal’s Aam Admi Party was able to coalesce across the upper middle and the lower middle class, urban voter in the 2014 national elections, most dramatically in Delhi and Punjab, is the anger of inequity. The perceived injury being that they are lumped with the taxes (property tax, income tax, motor spirit tax, entertainment tax, high petrol cost, paying for cross subsidy for free electricity to rural areas) but have little say in government decision making.

Ironically, the consolidation of middle class anger, triggered by Kejriwal against the Congress, helped the BJP and in particular PM Modi, to emerge as a viable leader to further middle class agendas.

Electricity, gas, water supply, road transport utilities; schools, universities, health centers and hospitals are still predominantly owned by the State in India. Most of them suffer for a vicious cycle of low user charges for retail consumers and punitive charges for commercial and industrial users. Despite this price distortion, which creates its own incentives for by-passing formal billing mechanisms or for outright theft, utilities have insufficient revenues to meet costs. Admittedly, some of this is due to inefficiency. But once utilities stop being “profit centers” and become “freebie providers”, they degenerate in operational efficiency over time. Employees lose the motivation to cut costs and maximize efficiency.

Just as the levy of direct tax, even in small amounts, builds “social compact’, paying utilities and State facilities a cost based tariff, is essential for users to feel empowered to demand efficiency from these agencies and for agency employees to view users as valued customers, not petitioners for public services.

Since the mid-1980s this problem of building the social compact has been sought to be addressed internationally by enlarging citizen access to information; creating entry points for citizen participation; making public decision making more transparent and adopting the mechanisms of the direct route for accountability (as opposed to the long route of democratic representation) by bringing government decision making closer to the people (decentralization). These are all useful interventions. (Refer to a paper by Sukhtankar and Vaishnav prepared for the NCAER Policy Forum 2014 for a detailed review of how these tools have been applied in India).

But in the absence of a direct “compact” between the State and the citizen via direct tax and market oriented user charges, citizen empowerment is seriously compromised since citizens do not perceive public funds as money contributed by them.

Rebalancing the presently warped proportion between direct and indirect taxes and rationalizing user charges, is not only necessary for greater tax progressivity; a higher tax to GDP ratio and a higher level obf cost recovery y public utilities, it is critical for “empowering citizens” to ask for more from the State.

If the State fails to make the first move in this direction, the ball will slip into the hands of citizens, as it did in Algeria, Libya and Egypt and nearer home in the Delhi State elections earlier this year.  Large economies, like India, cannot afford the disruption of citizen anger boiling over. The State has better ways of defusing this bomb but it must resolve to apply them.

 

 

                                                                                                                                 

Sahib

PM Modi has gone to great lengths to get the Principal Secretary of his choice. Institutional “purists” may cavil at his amending the TRAI (Telecom Regulatory Authority of India) law to enable the individual to work in government post retirement from the position of Chairman TRAI. But viewed from the perspective of optics this is pure theater.

This is PM Modi, underscoring, yet again, his absolute control over things that matter to him. Pragmatists would shrug their shoulders and assert that far more important than “rules” (the last refuge of the lazy bureaucrat) are outcomes in public interest. If having Nripendra Mishra manage his office, leaves the PM free to manage the affairs of the Nation-more power to his elbow.

It is noteworthy that Mishra has impeccable credentials; has no known links to Modi prior to this appointment; is not his “jaat bhai”, nor is he a Gujarati. His appointment is based on his abilities not his identity or his personal “proximity” to the PM.

PM Modi has displayed a similar strain in his interaction with Secretaries (top babus) of the Union Government. He cut through the formal intermediation of individual ministers (so dominant in the recent past) to encourage top babus to use him as a support resource, assuring them free access to him to resolve constraints to furthering public interest.

Delhi glitterati will draw instant comparisons with Indira Gandhi’s call for a “committed” bureaucracy. They are not far from the truth. Like Indira, Modi is defining a new political reality. He is building a party around himself. This requires perturbing the existing political equilibrium. Consequently, he needs to choose his political friends very, very carefully.  If one is short of friends, the default option is to rely on babus-carefully selected for their merit and ability to deliver. In the process traditional hierarchical concepts of “seniority” and rule based promotions will surely get short shrift.

Those outside the government will instantly recognize that this is how any chief executive chooses her core team. The one place you should not have to guard your back is in your own office.

Many would want PM Modi to go further and bust the system of constrained choice the present system offers to the PM. Why should a PM not be able to choose “professionals” to manage his Departments?

The three All India Services (the Indian Administrative Service-IAS, Indian Police Service-IPS and the Indian Forest Service –IFoS) are primus inter pares in the central bureaucracy. Of these it is the IAS which has the lion’s share of the senior babu positions reserved for it. A government survey (2010) found that the IAS with just a 30% share in officers working in the central government occupied 76% of the top babu positions. It is not clear that this “destined to rule” timeline encourages operational effectiveness. It demotivates the more specialized services by the “glass ceilings” imposed on them. It perversely places a premium on subsuming specialist skills and knowledge in general management skills.

The need of the hour is highly specialized public professionals whose passion is their specialization. Whilst the world is getting increasingly specialized and even MBA students at Harvard are forced to learn code, to vibe with the technology firms they seek to lead, our Babu princelings glory in playing with time warped regulations, systems and processes all aimed at “managing their political masters” like a shop-worn, re-run of Yes Minister.

The new world is flat, because status is not linked to position but to achievement. The IAS gets the brightest minds available for public service at the time of recruitment. But thereafter the frozen-in-time seniority places a premium on longevity not innovation and the taking of risk. Of course many, within the IAS, are self-starters, highly motivated despite the comforts of the ritual status available; committed do-gooders in social development; industrial and infrastructure developers and gifted policy makers, marrying theory with context driven “doability”.  

One hopes that the new government will dig deeper to discover “talent” within the services whilst also contracting in the best minds internationally for specific tasks including for spicing up our moribund Universities and “think tanks”.  

The initial “initiatives ”of the government (including the budget) seem to indicate that the Ministers are under-served by just-in-time advice from specialists and domain experts. An “open economy” cannot keep its “windows” tightly shut.

Top babus who are best as “gate keepers” should be shunned. The top bureaucracy must be judged on the basis of its ability to collaborate with domain experts and build them into a team, not on their ability to work overtime to become an expert herself, unless she already is an acknowledged “thought leader” in her field-of which type, there are some babus but not enough.

For starters, the government would do well to start putting up on the Department of Personnel website the positions which are likely to become vacant over the next one year. Once an officer is offered for deputation by a State Government they should be asked to apply to not more than three available positions simultaneously. Selection should be made from amongst those who apply. This would be welcomed by all aspirants to these positions. Today just getting the information is no mean feat, let alone getting into these positions, given the opaque system for placement.

Second the government could try broad banding IAS cohorts for promotion to Secretary-the senior most babu position. Since we are a soft state and prefer easy transitions, for the present, the mode l used in many state governments could be adopted. Free choice for the PM, from amongst the eligible officers in three successive IAS cohorts for appointment as Secretary and equivalent positions. All those passed over would have the choice of (1) either remaining in their existing jobs to “compete” another day (2) get immediately transferred to the Planning Commission with Secretary rank to do what people do in the PC or (3) revert to their State cadres.

There is nothing like a bit of competition to make employees perform. Some will complain that competition to get positions based on “performance” can result in neglect of public interest to further private interest or the abandonment of “unpopular but inclusive tasks” like a commitment to poverty reduction; managing the environment or safeguarding human rights from encroachment by the State.  

There is amble evidence from State governments that this is a real and ever present danger if babus are made to compete for positions. But even with the existing babu safeguards in the central government, there is plenty of abdication of principles. Tighter oversight and accountability; enhanced access to information for citizens; transparency and breaking up the “omerta” culture, which service “cartels” encourage, by inducting external actors into government, are the only real options to prevent a perversion of public interest.   

For sustainable “ache din” babu reform is overdue.  A fish rots from the top. Time to get the best into top positions.  

 

FM Jaitley presented a soft budget with a hard Fiscal Deficit target. Such miracles can only happen if supported by “tricks”.  One such trick could be to fund the increased expenditure, over 2013-14, of around Rs 100,000 crores (Rs 10,000 billion) through a fast track resolution of the Rs  400,000 crores in tax arbitration. This is possible. But the extent thereof is likely to be low. These cases are locked up in various courts and it would require a gargantuan effort of the judiciary and the executive pulling together, like a set of paired bulls, the likes of which are not seen any mor, even in Bollywood masalas.

The other option is increased collection efficiency. Tricky again given that there is less than nine months of effective time to gear up the tax administration and get the best people in place.

Disinvestment is always an easy one but with the markets already riding high, the likelihood is of tapering-off of the exuberance over the next six months. Babus find it difficult to sell shares in a falling market. First, the market knocks prices down even further with increased supply of PSU stock. Second, CAG and CVC ex-post facto scrutiny of such transactions make babus defensive in their approach. No one wants to go to Tihar for selling the family silver cheap.

There is no talk of privatization at all, which is a pity since that is what could unlock financial value; add to growth through improved efficiencies and generate decent capital gains for government. But then that is an old story. The BJP even in its previous innings (2004) had gone cold to privatsation once powerful vested interests in oil started opposing the sale oil companies.

On the expenditure side, the FM has himself succumbed to the “Mujra” of the “social spending” lot and loosened his purse strings. Possibly, as the effect wears off, he will tighten the availability of cash to all the various “schemes” he has announced.

But the real question is why should the central government be in the business of setting up hospitals or universities in the first place? Is this not an area where individual state governments should take the lead? Why is the FM irrigating farmers’ fields? What will the Chief Ministers do if every subject under the Sun has to be managed from the center? Why is the center keen to impose a cookie cutter template of “smart” cities on 100 existing towns in different states? The urbanization and the rural development lobby should shift base to state capitals. That is where all these subjects should right fully be dealt.

This budget just proves that the time is ripe for decongesting Delhi. Disband all the social sector departments in the central government or squeeze then into a Research Body called the Social Policy Authority (SPA) with the mandate to fund policy research on how states can manage social policy better.

The central government needs to concern itself only with Finance; Defence; Security, including Human Rights and minority inclusion; External Affairs, including External Finance, Investment and Trade; Banking; Infrastructure; River Development; Natural Resource Development and Environment. In these areas it should both make policy and implement it on the ground.

In all other areas the association of the central government should only be facilitating; policy research; access to grant finance-external and domestic, from specialized agencies constituted for the purpose. For example NABARD could be reconstituted and revitalized on a PPP basis. The EXIM should be resuscitated to lead on financing EPZs, Ports, and transport linkages. Similarly in Human Development the government should constitute a Development Financing Institution to fund hospitals and schools in the States.  

Till Delhi is squeezed into becoming efficient, it will continue to be the sponge absorbing the bulk of the tax money and frittering it away on isolated projects in fire-fighting mode.

To his credit Mr. Jaitley is new to the job and more importantly does not have a “team” around him. His FY 2015 budget is just a “holding” tactic; a cause no harm approach. We hope he will spend the next nine months developing a team and putting flesh to the expansive vision on which we all voted for him.

My bet is that he shall do this. Even he looked pained at the shallowness of his endeavor today. His motivation to do better is clear; his sincerity above doubt. But even the previous PM had these qualities in plenty. These are not enough for a government which came to power on the basis of actions not words.

 

The “Jaitley-Modi” team is working out to be invincible. Who, amongst the chattering classes, would have conceded, even as late as May 1, that Modi could transform himself from a hands-on, salt-of-the-earth, provincial, micro manager,  into a suave opinion maker, at perfect ease trading handshakes (though not yet air kissing) with the international jet set? Is he modeling his public profile on Vajpayee; the genial poet? Is Jaitley his Advani- the brusque implementer and dreaming aspirant for succession?

Indians wish Modi a long and stable tenure in Delhi, as the boss. We similarly approve of Modi’s knack of choosing the right person for the job. We admire his sense of timing, his courage and his fortitude.

But there are some things JaMo need to do pronto to walk the talk.

First, they need to tax capital higher. India inc. hates such suggestions and most growth wallahs will agree with them. But the fact is India’s share of taxes in total government revenue is too low. There is a hole of around Rs 3000 billion between what the government earns every year and its’ recurrent expenses. Yes, it is true that collecting money is not as important as using resources well. But who amongst India inc. actually behaves that way. Do they stop looking at their headline to grow their bottom line? Of course not. They make the consumer suffer for their inefficiencies if they can get away with it. In regulated markets with low levels of competition they manage to do just that. So must government.

One way of filling this hole is to tax incomes at a higher rate. This is very inefficient and inequitable. Why should a person be penalized for working harder and earning more money?

It makes more sense to tax consumption, across the board, at low rates, rather than income. After all if an individual earns more and saves her earning shouldn’t she be rewarded and the profligate spender penalized? Well, not quite. High tax rates encourage evasion. If consumption is taxed at penal rates, it will just be driven underground and result in welfare losses all around, except for the profits of the “evasion management mafia” that springs up with every new regulation. Anything above a tax rate of 10% is a sure inducement to even petty evasion.  

But what of the poor? Is it fair for the government to tax a poor man, the same as a seth (rich man) for the bread they consume or the tea they drink?

Yes it is. The correct way of discriminating between the two, is to send money back to the poor person, to neutralise the consumption tax she paid on her purchases. Cash transfers, based on the Aadhar platform, leveraged with a Poverty Card linked to the UID, so no one can fudge their identity or double dip, are an ideal medium particularly if the cash transfer is done by upgrading  the 150,000 Post Offices into “payment banks”, as the insightfully gifted Raghuram Rajan, Governor RBI, wants to do.

It is a myth that the poor, or the farmers, are not taxed. Every individual pays at least 5% to 10% of her cash consumption as tax, through “invisible” indirect taxation like excise and sales tax. The poor should be directly compensated for this fiscal support they provide to the nation.

Second the government should tax consumer durables higher. Taxing them at low rates implicitly discriminates against labour and in favour of capital. If washing machines are cheap and water unmetered, that is the option any householder would prefer rather than employing a “bai” to do the same job, with less water and no electricity, but with more time spent on personnel management. But in an economy where barely 2% of the labour force is skilled to a level of international competitiveness, should double digit tax incentives for capital be driving out low skilled, poorly paid jobs?

Third the government should tax capital gains higher. The tax exemptions on disinvestment income from sale of equity are so liberal today that it is possible for a very rich woman to pay no taxes at all on her “income (capital gains)”, by the simple expedient of having a rolling portfolio of equity investments, a part of which are sold and partially reinvested, after holding the equity for a year.  

We have artificially pegged our destiny to the stock markets. The BJP is most prone to falling into this trap, because of its class base, which is most active and has benefited the most from capital markets. The markets are a good measure of investor sentiment but a fickle barometer of economic fundamentals. This is why they need to be “managed” and wooed, to perform.

Chidambaram had mastered this art. It worked for a while, but eventually the markets tired of even him and looked for new “tricks”. Jaitley, being an imaginative and innovative thinker, is sure to dish out some of these. But it would be a mistake to misread the success of “tricks by the outreach team” with substantive achievements on the ground.

On the ground, what matters for growth, is to reduce the Fiscal Deficit, particularly by increasing the tax to revenue ratio. We cannot afford revenue holes funded through debt. There will be trade-offs to be made in the process, between sequencing expenditure control and enhancing revenue.

The guiding principle, for these operational trade-offs, must be the objective of avoiding market distortions to the extent possible. Reduce tax exemptions. Disinvest public sector equity aggressively, whilst simultaneously freeing these companies from political backroom control, as Piyush Goyal (Power Minister) seems to want to do. Tax at low rates but across the board. Freeze all babu “real” salary enhancements. Pump in catalytic volumes of investment to kick start manufacturing; infrastructure development (particularly Railways and Minor Ports) and reduce the subsidy burden in a phased manner to one third of existing volumes by 2019.   

Even unbeatable political combinations need the force multiplier of forward looking development principles. Hope the JaMo teams’ social media analysts are picking this up.

 

Every hero has a side kick. Sadananda Gowda, the Railway Minister, is to Jaitley, what Mac Mohan “Sambha” was to the lovable “Gabbar” Amjad Khan, sadly however minus Mac’s trademark “skunk” hair dye, in the Sippy blockbuster “Sholay”-

Gowda’s Railway Budget on July 8 is the teaser to Jaitley’s big event two days later. At worst, it is “time pass”. At best, for a reformist government, it can be a trumpet blast of the good things to come.

But the trumpet sounds emerging this year are likely to be muffled. How horribly dated the railway has become, is illustrated by the fact that if you booked your ticket in 2013, a year in advance and left your money, for that period, with the railways, a sharp-eyed, unpleasant looking, Travelling Ticket Examiner may yet turn up at your reserved “berth” (bunk) demanding extra cash, because the Hon’ble Railway Mantri increased the fare on July 8, 2014. This is “retrospective taxation” even the Income tax and Excise boys could learn from.

Why the Railway (IR) has a separate budget presentation beats everyone hollow. The expenditure budget of IR in 2013-14 was Rs 1453 billion around 9% of the expenditure in the main budget. In comparison the expenditure for Defence was 12% of the total and for police an additional 3%.

The government capital invested in IR (albeit dubiously valued) was a mere Rs 2103 billion in 2013-14 on which it earned a net return of a mere 7.4%. Compare this with the government’s borrowing cost of 8%. Even if the capital employed could be fully recovered (which it can’t), it would still only bridge less than half the Fiscal Deficit of the Government of India.

NTPC, India’s premier government majority owned, power generating company, which is listed on the BSE/NSE, has invested Rs 844 billion in its business, on which it earns a net return of 16%.

ONGC, India’s flagship, government majority owned, oil and gas exploration and production company has invested Rs 1017 billion on which it earns a return of 20%.

Both these government “corporates” function perfectly well. They make decent profits under a professional board and without the government’s hot breath breathing down their necks….though even with them, the government could cut back on some of its heavy breathing and let the professionals loose.

Why is the Railways not similarly a corporation, run by a “Sreedharan” clone supported by a board of infrastructure, finance and management professionals? Here is why.

The Railways has spawned a huge “biradri” (community) of railway people since its inception in 1853 in Bombay. Railway officers are divided into four generalist cadres: Railway Traffic, Railway Accounts, Railway Stores and Railway Personnel Management; four engineering cadres: electrical, mechanical, signals and civil; its own Medical Service and its own Police Force. Over 17,000 officers are employed in the higher level Group A and B grades. Indian Rail employs 42% of the Central Government employee workforce or 1.3 million people.

George Fernandez, the erstwhile stormy petrel of the Railway Unions could single handedly block traffic on all its track (115,000 kilometers today) in the 1970s. Luckily, and thanks to the judiciary, those stormy days are behind us now and Unions can no longer hold customers to ransom. But reform is urgently needed.

The single most important citizen budget indicator is the proposed investment in Indian Rail.In 2013-14 the Railway Budget allocated Rs 68 million for depreciation (replacement of capital) and Rs 207 million for pension reserve (the liability on account of workers). IR spent three times more on protecting employee futures as compared to reinforcing its capital assets.

If this continues, disregard dreams of emulating the Chinese; connecting Myanmar to Manipur; Dhaka to Kolkota; Tamil Nadu to SriLanka and building a rail ring in the Himalayas. Talk is cheap. Even just improving the quality of the existing rolling stock; communications and track; reducing travel time and rolling stock utilisation requires a mammoth investment.

Railways is not a people intensive business, at least in terms of direct employment. It is a capital intensive business. Germany invests around USD 7 billion a year to sustain around 700,000 jobs in manufacturing of railway equipment; management and maintenance of urban mass transit rail systems. China invests 1% of its GDP on rail investments.

We budgeted to invest Rs 426 billion in 2013-14 but ended up investing only Rs 384 billion or 0.4% of our GDP. An investment of USD 6 billion was meagre for a developing economy, the size and population of India. But worse, we try and sustain 1.3 million jobs versus our investment needs. Most of these are unproductive “tail not teeth” type of jobs, which need to be replaced with skilled opportunities for our ITI diploma holders, engineers, finance experts and social scientists.

A corporatized IR, freed from crippling politicization, could grow at 15% every year. This would double its scale of operations every five years and create demand for at least 1 million skilled jobs at market rates.

But for now lets’ watch the IR Citizen Budget Indicator of proposed investment for 2014-15

(1) Below Rs 400 billion. Rating: Bad;

(2) Between Rs 400 to 440 billion: Rating good

(3) Above Rs 440 billion: Rating: outstanding.

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“Mujra”, the traditional PakIndia dance of seduction honed in glittering Lahore, immortalized by the ever beautiful, dusky Rekha in Umrao Jan, a classic film by our very own desi, aristocrat, designer Muzaffar Ali. Mujra is a dance of deception. The idea is for the danseuse to so mesmerize the viewers, that their head gets delinked from their heart and money slips through their loose fingers, like a snake escaping from fire.

All Finance Ministers have to be expert Mujra dancers. This will not be difficult for Arun Jaitley. First, he is a lawyer and those of his ilk are masters of deception. They apply the art of “need to know” whilst arguing in court. The need being to win the case of course. Second, Jaitley is a Panjabi. Amritsar, just an hour away from Lahore, rejected him for Patiala Royalty. But all Panjabis, on both sides of the border, know that when Royalty comes calling, others have to step aside.

Finance Ministers stamp their personalities on the speech they make on budget day in Parliament. Only the Mujra of the speech is different. The budget proposals have remained much the same since the Union Jack made way for our Tiranga in “our tryst with destiny”.

Manmohan Singh radiated “good intentions” and technical competence but was as dry as the Gobi desert

Yashwant Sinha, a babu, was all technical arguments and feigned “savoir faire”, as babus are when they stop being babus. Technically correct, but forgettable.

Chidambaram was Tamilian guile and sophistication coupled with brains sharper than a pair of “Shun” knives. But off-putting with his so very deliberate speech, which seemed consciously slowed, to enable the rest of the World to catch up with him.

Jaitley is different. In his latest avatar he is a cuddly as a Panda and larger now than a Sumo wrestler. But his personality radiates from his heart, which is as solidly Panjabi, as Amritsari Fish. His style is argumentative erudition bordering on the pedantic and mildly adversarial. He needs to watch that. Budget session is all about consensus, not contest.

But don’t be fooled by the style, the special smile, the sensuous, sliding look through the sides of the eye or the fluttering hands of the Mujra dancer. Look past the flashing diamonds on display. Look closely at the core service being offered and then and only then, make up your mind to loosen your purse.

Here are seven core indicators to signal whether or not the Finance Minister is serving you well.

First, has be budgeted for a decrease or an increase of the Fiscal Deficit over the FY 2013-14 budget? Forget the 2014-15 interim budget presented by the UPA it was worse than Mujra. It was pure American “smoke and mirrors” designed to set impossible benchmarks for the next government, which UPA was sure would not be them.

The Fiscal Deficit in India is the difference between the total income of the government plus recoveries of loans and what it intends to spend, loan or gift over the next year. It is financed by borrowing at between 8 to 9% per annum. If it is being spent on the salary of an absent policeman or a sleeping babu, there is no way the government can get a matching “economic return” on that amount. So be very wary if the Fiscal Deficit is increasing in nominal terms over 2013-14. If it remains at the same “nominal “level you are winning because inflation has eaten away 8% of last years value. The Fiscal Deficit in 2013-14 was (hold your breath) Rs 5,24,530 crores or Rs 5,254 billion.

Do not be fooled by sops like a reduction in the excise duty for automobiles or enhanced allowance for setting off EMIs against Income Tax on loans taken for buying property. Do not rejoice even if the Income Tax Free limit is raised. Inflation can eat away these “notional” gains faster than water flows through Delhi’s clogged drains.

If you are not a senior or a super-senior citizen and earn Rs 600,000 a year pre-tax, an 8% inflation eats away Rs 48,000/- of your income. Compare this with “Mujra” gains FMs tend to give:

  1. A 5% point reduction on the excise duty for a car worth Rs 600,000 comes to only Rs 6,000 per year over the five year life of the car.
  2. The FM would need to raise the “free of income tax” limit from Rs 200,000 to Rs 300,000 and similarly raise the upper limit of the band in which you pay Income Tax at 10% above the free limit, from Rs 500,000 to Rs 600,000, just to neutralise the likely impact of inflation on your purchasing power. A change in Income Tax rates on this scale is very unlikely to happen.

Of course, if you are one of the 18 million lucky ones, working for the government, or if you are one of the estimated 10 million government pensioners, you need not bother about inflation. The government meekly and automatically adjusts babu salaries (including allowances) and pensions, twice a year, for inflation, which ironically, is caused by the loose fiscal policies; inefficient expenditure decisions and corruption within the government.  

If you are not a babu and still under the age of 28, try and become a babu to get the “life-long” immunity from inflation. It’s a one-shot vaccination. If you have crossed that age limit, your only option is to not spend/save at least 8% of your monthly income because you will need it later in the year to cope with rising prices.

This blog intends to discuss one “citizen budget indicator” a day till July 9, 2014 so watch this “Mujra” space closely. 

The first indicator is the budgeted estimate for Fiscal Deficit: (1) Rs 5000 billion. Rating: Outstanding (2) Rs 5300 billion. Rating: Good (3) Rs 5700 billion or more: Rating: Poor              

 

  

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Babus are looking forward to another bonanza, courtesy the 7th Pay Commission, which the previous government constituted just before demitting office. The armed forces, always better organized, are first off-the-mark with an earmarked Pay Cell already created, headed by a two star General, to lobby for better terms and conditions. Other Unions and Associations will also gather themselves together, once PM Modi signals the go-ahead.

Here are five reasons why he should not do so.

First, the history of Pay Commissions (the first was in 1946 with the rest following almost every ten years) validates that they achieve very little beyond finding the lowest commonly agreeable formula, for farming out pay increases to babus and the armed forces.   Never has the pay increase been linked to higher productivity or even to aggregate measures of productivity, like economic growth. Growth, admittedly an overly-broad measure, is now on the downslide and expected to remain that way for at-least another two years. Aam admis find it difficult to swallow, that babus should get paid more, whilst they themselves are struggling to make ends meet.

Second, babus have been getting 100% inflation neutralization twice a year, since 1996. The dreaded inflation (often itself the outcome of loose fiscal control and inefficient expenditure policies) consequently, flows-off babu backs, like water-off a duck, but swooshes down onto aam admis and makes their life miserable. The biggest sufferers are the 700 million poor.

The urgency for another increase in the “real” pay of babus is difficult to justify, in a strained fiscal environment, where subsidies have to be gradually moderated and administered prices of petroleum products, electricity, fertilizers increased-all of which stoke inflation.

Government also has to increase the tax-GDP ratio in 2014-15 to provide the funds needed for stepping up long forgotten defence equipment; higher outlays for education, health, sanitation, water and infrastructure; all this within a fiscal envelope which does not further aggravate inflation. Increasing existing babu compensation, in real terms, will only stoke the flames of inflation.

Third, if the government feels that the existing pay structure does not promote efficient functioning, it has only to look at the reports of the past two commissions. Both Commissions recommended excellent measures for linking pay enhancement to productivity, which remain unimplemented. The Administrative Reforms Commission did similar stellar work in 2008. Throwing more money at the problem of inefficiency is a highly ineffective way of trying to deal with it, which is bound to fail. Better to brush the dust of previous research and get down to implementation.

Fourth, less than 4% of India’s working age population of 500 million (ILO) is employed by government. The total formal sector employment (including in government) is less than 10%. Unlike government, in the rest of this “labour aristocracy” there is no assured inflation indexing and individuals have to justify every year, why employers should even neutralize inflation let alone give them an additional increase in “real” pay.

The residual 90% of other workers live in a jungle, where they survive by their wits, with no help from law or regulation. The Minimum Wage Act is a non-functional piece of legislative gloss, which is regularly contravened in the unorganized sector. None of us, including babus and politicians, who employ household help or buy products made in the informal sector, where “sweat labour” is the norm, walk-the-talk, by being willing to pay the prescribed minimum wage rates.  Even the lowest level of compensation in government is way above the minimum wages.

Fifth, the process of babu pay determination has acquired a routine automaticity, which needs to be disrupted. Opponents of abandoning the business-as-usual stance, argue that the outcome of stagnating babu pay in real terms will be higher levels of corruption. This is difficult to buy. Despite the consistent increase in babu pay since 1952, corruption has also grown not decreased. Babus, even at the leadership level, including the previous PM, “passively accepted” corruption, even if they have not actively associated themselves with the loot. They have not endeared themselves to aam admis by such behavior.

PM Modi has already started the process of interacting directly with babu-level chains of command and demanding from them, measurable, targeted performance, aligned with the government’s priorities. Pay rewards should follow only in 2018 (one year prior to elections in 2019) if performance improves.

Between now and then, the government should start publishing Annual Service Delivery Report Cards for every urban ward and every rural village, listing the manner in services have improved. Pay rewards beyond 100% inflation indexing (which already exists) should come only if the citizen reports show improvements from 2015 to 2017.

Let’s apply the same “value for money” standards to public finance, which resonate so well with our personal lives, vividly captured in the “kitna daite hai” (how many miles does it go in a liter of fuel?) metric, popularized by MARUTI.      

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(photo credit: post.jagran.com)

PM Modi’s external affairs team has hit the ground running; making friends and influencing people in the region. His visit to Bhutan and Sushma Swaraj, External Affairs Ministers’ forthcoming visit to Dhaka, build on links forged previously. These are relatively “low hanging fruit” to show that we want to be part of a friendly neighborhood. PM Modi said as much in Thimpu when, borrowing from  Acemoglou D. (2012), he stressed the criticality of “good neighbors” for gross happiness

But you can’t choose your neighbor and Pakistan is the biggest. It is a mixed blessing that Pakistan is defined politically by the province of Punjab and its heart beats in Lahore. Our blighted common history is most deeply etched in the minds of Punjabis. The upside is that PM Nawaz Sharief has a natural proclivity to develop his province; Punjab. In our Punjab, the BJP has an ally in the Akali Dal. Defence Minister Jaitley has laid claim to his Punjabi heritage and is likely to grow his links with Amritsar. Most importantly, our Punjab has been in relative decline since the 1990s; an outcome of poor fiscal management (Aiyer.S.2012 CATO) by both the Congress and the Akalis. Too many freebies and too little revenue wrecked Punjab, despite its robust agriculture; medium scale industry and vibrant entrepreneurship.

The immediate problem is jobs for unemployed youth. Economic prosperity allows a decent standard of life for even the unemployed young due to family wealth. But drugs and alcohol addiction are the downsides for directionless young people; too rich to work in the manual and semi-skilled jobs available. Rapid industrial growth is the answer for “quality jobs”.

Trade and investment normalization, between Pakistan and India, can immediately benefit the two Punjabs in volumes which could be significant for the two entities. When we expand the analysis to the national level, the welfare gains reduce and point to an imbalance in favor of India. The full potential for trade  is estimated at around USD 20 billion or ten times what it is today, by ICRIR (2013), FICCI (2012), CUTS (2012) and Hafeez Pasha, a previous Finance and Commerce Minister of Pakistan, now Dean of the School of Social Sciences, Beaconhouse National University, Lahore.

This would still be only 6% of India’s total trade but nearly one half of Pakistan’s total trade. It is unlikely that Pakistan would want to be in the precarious position of being dependent on India’s market to that extent. The realistic bound for trade level is consequently much lower. But this makes it of less interest nationally. Since the business opportunity comes with the considerable risks of insecurity and the adverse impact of an uneven keel in diplomatic ties, businessmen are justified in spending even less time on it.

To complicate matters, the central government in India is no longer in the drivers’ seat. Business opportunities are best defined outside the ambit of government sponsorship and regulation, not within it.  Shrinking fiscal space narrows the opportunities for “directed entrepreneurship” of the Chinese kind. Increasing levels of fiscal federalism and enhanced private investment has strengthened the role of state (provincial) governments in industrial development. Local labour and land regimes have become key to private investment.

Pratap Singh Kairon, Chief Minister of post-partition Punjab (including Haryana and Himachal Pradesh) was famous for micro managing economic development and inviting industrial investment to, what was then, a dusty, rural, unskilled hinterland, a mere adjunct to the urban marvel of Lahore, which still shines as a jewel. But successive governments in Indian Punjab have grown it into the granary of India by utilizing its comparative advantage. It is now time to pool the resources of the two Punjabs to mutual advantage.

Naysayers and conspiracy theorists will point to the downside of closer ties between the two Punjabs providing a basis for the break-away of an amalgamated Punjab from India. Either due to the allegedly “burning” desire of Pakistani elites to undo the shame of the break-away of East Pakistan, by amalgamating our Punjab into Pakistan. Alternatively, but less likely, the theory goes, this could happen due to the efforts of the Khalistani’s to become a separate nation.

Break-aways from India are a romantic’s fantasy, both in Kashmir and in Punjab. Both Kashmiri’s and Punjabis have much more to lose by breaking away from India, than there is to gain, by either carving a separate identity or amalgamating with Pakistan. “Landlocked” developing countries are more prone to fail, as separate nations, for a variety of reasons. Paul Collier (2007).  Punjab and Kashmir qualify on that count.

India’s Punjab, Haryana and Delhi have a combined GDP of around USD 190 billion; broadly similar to the GDP of Pakistan. 85% of Pakistan’s GDP is derived from Punjab and Sindh and 54% of the population is Punjabi.

Punjabiat” is consequently a significant force in forging closer links. But historian Zoya Hassan warns against falling into the trap of assuming that cultural history and identities on both sides of the border alone can drive the future. The political architecture; composition of the elites and aspirations have diverged considerably, since 1947. Notwithstanding the loss of close cultural similarities, economic cooperation provides a firm and sustainable basis for growth and positive welfare benefits on both sides of the border.

It may be wise to be practical rather than romantic or aggressive in identifying what is possible even with the bon-homie current prevailing between the two PMs. Three generic principals can help to make identification of the entry points.

First, trade and investment liberalization can never come at the expense of decreasing levels of security. Any adverse impact must be swiftly containable. This implies that normalization proposals must preclude the proliferation of generalized person-to-person contact.

Second, the proposal must be tightly monitorable. This implies its implementation in a defined and sanitized environment.

Third, it must provide real benefits-jobs and business to local populations along both sides of the border.

All three conditions are met if India proposes a jointly administered industrial hub along the Punjab border with a target of creating 1 million jobs and a turnover of USD 40 billion. This could be an EPZ linked both to Karachi and Mumbai or a combination of an SEZ and production for meeting domestic demand. Naturally 100% FDI would be available with attendant harmonized tax structures.

Since farmers on both sides complain of poor productivity, due to the insecurities of a border area, getting land should not pose difficulties. This would be made easier if displaced farmers are offered commercial incentives in real estate development. The facility could link into the proposed Amritsar to Calcutta and the Delhi to Mumbai industrial corridors on the India side.  

Like Pakistan, which faces growing fiscal pressure from dwindling external aid and has to meet the demands of its demographic dividend, the Akalis are under pressure in Punjab to shape up or ship out. The Defence Minister, Jaitley fell prey to this public disenchantment with the Akalis by failing to get elected from Amritsar. Time for Mr. Badal to act before he and Punjab miss the bus yet again.     

 

 

 

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(Photo credit: outlookindia.com)

The Pak-India affair is almost as tiresome as the Israeli-Palestine impasse.   Neither party can pull apart nor do they live together in peace. Successive governments on both sides start a peace initiative at the beginning of their terms, only to lapse into status-quo near the end-defeated by the inertia of babus and elite interest on both sides.

For most of India, south of the Vindhayas and East of the Yamuna, Pakistan remains a distant and intractable land. For the average Pakistani, India is a bully, growing muscular by the day, bent upon destabilizing Pakistan.

It doesn’t help that for all practical purposes, Pakistanis and North Indians are very alike.  They share the same values and prejudices. The daily “show” of faux aggression at the border post of Attari, near Amritsar, illustrates the brawny culture on both sides. Border guards on both sides face off in a peculiar, mirror image, “Punjabi Tango” of choreographed, muscle and moustache to the accompaniment of lusty words of encouragement of their country people. But the bravado ends tamely, with both sides trotting off to their own quarters, their duty done.

The similarities extend to the mirror, comparative advantages of the two countries; near similar human capital development levels, low income levels and low natural resource endowments. Also similar are the barriers to growth, vast inefficiencies in government and elite capture; by the agro-military-industrial complex in Pakistan and by the agro-industrial elite in India.

Both economies have benefited from adoption of the “open economy” model of growth since the mid 1980s. India more so than Pakistan, which has been constrained over the last two decades by its preoccupation with Afghanistan and its own war on terror-albeit some of it, of its own making. As Bhindrenwale was to Indira Gandhi, the Taliban has become for Pakistan; an out of control Tiger.

The first casualty of insecurity is investment-both public and private-especially in infrastructure. Long payback periods are unsuitably risky if revenue streams become uncertain. More importantly, with the world increasingly in the “open economy’ mode, there are easier business pickings elsewhere. The 21st century belongs to growth in Africa and that is where business is rushing to be, both Indian and Pakistani.

It is not surprising therefore, that trade between Indian and Pakistan is minimal and stagnant, relative to the total trade of both countries. Pakistan exports only 1% of its total goods to India and only 4% of its imported goods are Indian. Of course, the official data underestimates the actual trade through third countries and destinations. Both could benefit by cutting out the intermediaries margin and higher transportation cost of acceptable third party destinations. Non-tariff barriers on both sides; poor trade infrastructure and low financial integration make even the best cross border trade intentions die. Cross border investment is yet to be a reality.

Why then bother at all to disrupt the convoluted stalemate of the past five decades? Here are three good reasons:

First, Pakistan estimates (Economic Survey 2013-14) that it loses up to 3% of its GDP due to insecurity, bleeding it of nearly one half of its potential GDP growth. For India, an insecure Western border is expensive. The geo-politics of Pan-Islamic militancy unsettles its domestic, plural aspirations.

More generally, “including the poor” is a common challenge for both countries. The last thing, either could possibly want, is to add the cost of managing terror to that long list of unproductive, resource draining preoccupations.

Second, India and Pakistan both gain by operationalizing the Turkmenistan-Afghanistan-Pakistan-India gas pipeline. This has been on the agenda for the last two decades and 2018 is the new aggressive target. Both economies are deficient in gas, a clean and versatile fuel for power generation, domestic use and industrial purposes. India loses 0.5% of its GDP every year due to shortage of peaking power capacity. Perversely, domestic coal supply shortages and the high cost of imported coal and LNG keeps installed capacity idle. The TAPI pipeline, would meet around 20% of our gas demand till 2030.

Third, the lack of Pak-India economic integration provides a ready opportunity to China; the “big Panda in the room”, to deepen the economic “silos” with each integrated independently to China, but not to each other. This is already happening. Whilst trade between India and Pakistan stagnates, trade between China and Pakistan is booming, as is trade between China and India.

Of course China is the world’s factory. It aggressively supplies price competitive goods, well suited to the limited pockets of developing countries. Chinese trade comes with generous financial outlays to develop and manage strategic infrastructure; Gwadar Port in Baluchistan (linking the Middle East to China in a trade and energy corridor) and the offer to build high speed railways and highways in India.

Both Pakistan and India will accept much needed foreign capital and investment from anyone who offers it. That is the wise thing to do commercially. But it makes strategic sense to also develop alternative trade and investment opportunities in their “near abroad”. Infrastructure development is a great facilitator for growth. But it also has enduring legacy value. It determines the future spatial spread of growth and jobs along economic corridors. It is sobering to remember that Karachi Port is nearer to Delhi and Amritsar than is Mumbai.

Democracy is great for transparency but is a killer for negotiations, strategic deals and moving on, which are best done in privacy. This is a limitation for PakIndia normalization. The history of distrust and animosity extends far beyond the cricket field. Babu led governments become hostage to the “agency problem”. The narrow self-interest of the managers drowns the real interests of those they represent.

Progress can only come from “disruptive innovation” by leaders. It’s PM Modi’s call. A dash of Gujarati Dandia could spice up the frozen-in-time “Punjabi Tango” to produce results.  

 

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Air Asia,the newest aviation kid on the block, got a taste of the heavy hand of Indian regulators even before it starts service on June 12. The Director General of Civil Aviation directed them not to implement their innovative initiative to charge only those passengers with check-in luggage for the service. The normal practice is to build-in the average cost of a 15 kg free luggage allowance whether one needs it or not.

Why DGCA was compelled to do so remains in the secret annals of the regulator which, being a government agency, hoards information on why decisions are made. There could be three possible reasons why this happened.

First, this unbundling of the checked in luggage charge was a departure from the norm. Babus hate such departures. The absence of the all-important “precedent” complicates life for them. A possible stint at Tihar, looms large in their minds, if their decision is perceived as favouring the licensee. This particular decision predated the assurance from PM Modi that babus need not be scared of retribution, unless it is deserved.

The key to effective governance is innovation. This “can-do” approach is foreign to the average babu DNA, across the world. But it is only innovation, which can reduce transaction cost and improve efficiency- both sorely needed in India.

The international experience in economic regulation indictates that intrusive regulation retards innovation. Nor does it help consumer interest, because the supplier is left with no incentive to increase profits by optimizing costs and maximizing revenue. Secondly, the entrepreneurial energy, which is unleashed by competition in the market, gets blunted if market forces are unduly restrained.

The Indian aviation market has more choice than two decades ago. But competition is still stifled by the “cartel” of five scheduled operators: Air India, Jet, Indigo, Go and Spice jet. To be fair, since their injection into the market, they have led on price discovery. Air India has been unable to compete and is accumulating massive loss, despite the advantage of preferential allotment of prime travel slots and destinations.

Cartels, like babus, hate “disruptive innovation” since it shakes up a stable financial equilibrium they have adjusted to over time. Consumers on the other hand look for such innovations in pricing which adapt to their specific capacity to pay. Think Hindustan Lever’s shampoo sachets.

Air Asia did just that. It slashed its inaugural tickets to negligible amounts. But it proposes to charge if you want to check-in luggage. This is welcome news for those on short trips, who carry nothing more than a briefcase. But it is terrible news for those who travel with a “colonial style” “bistra bund”. Air Asia proposes to allocate cost only to those on whose behalf they are incurred. Today the “bistra bund” lot free rides on the price paid by the “briefcase” lot. This is also bad news for passengers who consume their 15 kg free allowance but hang around, trying to pool their surplus luggage with other obliging passengers. Many obliged becuase their unused free luggage allowance was a sunk cost, till Air Asia came around.

Tariffs drive behavior. Airlines have already unbundled preferential seat allotment and food service with salutary effect on customer and staff behavior. Customers no longer jostle, pull rank or use influence to get the seat of their choice for free. Now its pay and get. Cabin staff, which previously used to throw free food and drinks at customers, like relief workers do at refugees, is now responsive to customer needs. Paisa bolta hai (money talks)

Possibly DGCA had concerns about Air-Asia duping customers into buying cheap tickets and then loading charges on them at the last minute, whilst checking in. This could have been dealt with by requiring the airline to (1) get a declaration signed from the customer that they are aware of the “no free luggage” clause and (2) ensured that in all advertisements of the cheap fares, the “no free luggage” clause is prominently displayed. After all airline customers have already got used to paying for their food and drinks on board and paying for specific seats. How is luggage so different?

A third concern, DGCA may have had, is of predatory pricing. This is what the existing “cartel” charged Air-Asia to be indulging in. At the very least the charge is odd. Predatory pricing is a strategy usually adopted by an existing dominant supplier, with huge sunk costs, to keep competition at bay. The fledgling Air Asia is hardly a likely candidate to invite the charge of predatory pricing.

Civil Aviation is a vital sector of the domestic economy. Viewed holistically, with railways, road and waterways; it is integral to an efficient multi-modal transportation system, each of which has a comparative advantage for a particular profile of passenger and cargo.

Unfortunately aviation continues to be viewed as a service for the rich. Aviation fuel is taxed punitively. The sector is ruled with a heavy hand by the DGCA-the government managed regulator. A report authored by Nathan Consulting in 2008 concludes that aviation needs to transition to more light handed and market oriented regulatory options, in the interests of enhanced competition and protection of customer interest.

The DGCA has erred in knocking down the very worthwhile innovation by Air Asia, which is perfectly in line with sound economics for the determination of fair and efficient user charges. At the very least, this reeks of an unsuitable, heavy handed, danda  wielding style of regulation. At its very worst, this action can be construed as undesirable collaboration with the “cartel” to “discipline” the kid in town- Air-Asia. In either case it has not brought glory to DGCA, which is more familiar with engineering safety concerns rather than the nuances of economic regulation.

One hopes, that the new chief babu in Civil Aviation and the new Minister will show the way and reward rather than retard dynamic and innovative pricing.

 

 

 

    

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