governance, political economy, institutional development and economic regulation

Archive for July, 2014

PM Modi’s “Cooperative federalism”; distant vision or national glue?

village

(photo credit:www.voices.halabol.com)

How close is India to achieving the PM’s vision of “cooperative federalism”? Very far I would say on current trends. Federalism itself is a distant goal, cooperative, or otherwise.

There are too many unitary features in our constitution to qualify us as a federation. Just to list a few; (1) the vertically higher judiciary with the President of India appointing all judges of the High Courts and the Supreme Court; (2) the Union Government’s power to supersede the constitutional checks and balances by declaring national or state level emergency; it’s powers to direct a State Government to redress any failure to support the exercise of its executive powers; its controlling powers over the civil and police administrative elite cadres (IAS and IPS) which dominate state government administration also and its power to appoint a Finance Commission to advise on the inter-government distribution of revenue without the concurrence of states (3) the overriding status of Union law even in the concurrent list; (4) the Rajya Sabha can authorize the Union Government to legislate even on matters in the State List

“Federalism” in the Indian context is a tug-of-war between the Union and the States. It does not extend to the devolution of powers and funds to local governments-Panchayats and Municipalities, which are closest to where citizens live. This leg of federalism has been largely ignored, despite explicit constitutional provisions, available since 1992 via the 73rd and 74th amendments, for such downward devolution by States. Whilst lamenting the “unitary slant of the Constitution” versus themselves, the State Governments tend to replicate the very same “unitary” approach whilst dealing with local governments.

The oft cited barriers for devolving powers to local governments include the lack of capacity; the risk of even greater financial irregularities; the increased cost of administration; the inefficiencies arising from even greater need for coordination. The good news is that other developing countries have successfully overcome such barriers; Brazil in Latin America; Indonesia in East Asia; South Africa, Kenya and Tanzania in Africa are some leading examples of large developing economies.

The real barriers to devolving power to local governments are not technical. They relate to the loss of elite power and the associated loss of “rents” (personal profits) and patronage at the state government level. Take land management for example which is currently located at the state government level. If the management of land and other natural resources like lakes; forests and mining for minerals are located at the community level, a major source for “rents” available to state level elites either disappears or gets transferred to local elites. The expectation is that local elites, being interdependent with the aam admi, are likely to be less rapacious than distant elites located in the state capitals.

Is India ripe for deepening our nascent “federalism”? At the very extreme federalism allows a State to secede from the Union. This is unthinkable though it is not self-evident that given this choice, state governments would walk out. But even the devolution of more functions, powers and funds is constrained by the ground realities.

The belief that there is no longer any real and present danger of the splintering of India is naive. At least one fourth of the 680 Districts in India are sensitive to sequential insurgency, communal, caste or access to resources based violence and a significant number are virtually inaccessible to the civilian administration. Many insurgents draw inspiration from the Chinese revolution. It doesn’t help that tumescent China is flexing its muscles in its’ near abroad. We should consequently expect that such local insurgencies will increase rather than decrease. Our Western borders are directly exposed to Islamic terror. We have contentious and unresolved border disputes with Pakistan, China and Bangladesh. These are not trivial security concerns. Consequently, strategic unitary features seem sensible.

There is little sense in devolving the core sovereign functions of external and internal security; diplomacy and immigration; monetary management and the financial sector; external trade and investment; environmental protection; development of network industries; infrastructure including inland waterways (rivers); space, science and technology; and Atomic Energy. All these must remain directly managed by the Union government.

But large swathes of the social sector (education, health, water and sanitation, sports, culture)  and natural resources sector (forests, land, coal, oil and other minerals) can be devolved to states and local governments though the revenues should be shared across the three levels of government. The Union government could restrict itself to setting standards; harmonizing Rules and Regulations; promoting sustainability research and knowledge management.

Strategically, taking federalism to the people level is a national glue. Stronger local governments reduce the potential threat of state level separatism and enhance levels of vertical interdependence. Better network infrastructure; greater private sector led investment with pan-India supply chains and the Goods and Services Tax can bind states horizontally.

Finance must be aligned with the restructured functions. Currently the Union government has an effective share of 40% of all government revenue. It also effectively encroaches on an additional 8%, which it is supposed to transfer to states, by usually withholding this as the contribution of a State as co-financing of central schemes. In effect States get just 52% of aggregate government revenue to discharge their long list of responsibilities. They pass through only around 15% to local governments.

Admittedly, state governments have been delinquent in growing taxes available to them; property tax and agricultural income tax being two examples. But it is unconscionable for the Union Government to retain anything more than 30% for its own purposes (15% for defence, 5% for internal security and 10% for its other functions).

State governments must in turn transfer 40% of their aggregate revenue to local governments. They must start cutting their coats according to the cloth (the residual 60% of available resources) available. The earlier administrative sprawl is contained in the Union and State governments, the better, stranded facilities and human resources are expensive and politically disruptive .

The devices used by the Union to evade sharing of revenue, like increasing the rate of a cess; fee or surcharge (which are not sharable with states) rather than the tax rate itself, should be curtailed by simplifying the sharing formula to take into account all revenues other than the sale of assets and net loans. 

The 14th Finance Commissions report is eagerly awaited.  It should be measured against the broad metric of devolving enhanced shares in finance downwards to states and most importantly to local government. It must starve higher levels of government so that they are forced to change track and implement decentralization. Its five year time frame would be inadequate to achieve this restructuring. Unlike Indonesia, India does not take easily to big bang reform. But the Commission could lay out a transition path to simplify the formula for revenue sharing; move money downwards and suggest accompanying vertical functional shifts. It will be measured against this metric.   

Some symmetry is needed in the constitutional arrangements between state and local governments to balance control with and trust and autonomy. One step could be to change the status of the Governors of states. Today they are mere nominees of the Union Government. Like the President of India, they must be indirectly elected by the people’s representatives at the state and local government level. Their current status is pretty unedifying and they risk ending up as being completely redundant to good governance.

An associated amendment should be to replicate the unitary facets of the Union-States constitutional arrangements, to define the arrangements between a State Government and its local governments; (1) emergency powers of the State Government; (2) vertically integrated police and civil administration; (3) state government control of local courts, ability to override the legislative autonomy of local governments on concurrent subjects and with the approval of the legislative councils (which would be replicas of the Rajya Sabha) to legislate even in the local government list of subjects.

Despite some symmetric arrangements, there is ample room for vertical asymmetry to accommodate the diversity in the endowments; economic potential; population; geographical size and cultural plurality across states so as to strengthen both the Union and the  States.

“Sardar” Patel dedicated his entire post-independence career to creating a unified architecture of India but not as a mere draftsman “moving boxes around”. He did this by negotiating, cajoling, convincing and overcoming local resistance overt and covert, and building on local support.  

We need a second “Sardar” to convert the PM’s vision of cooperative federalism into reality, by loosening the unitary bias versus the state governments and simultaneously pushing federalism to the level of people, using the principle of subsidiarity.

If we delay in sharing power at the “peoples’ level” the relentless force of urbanisation, communication technology, social media and the autonomy endowed on local jurisdictions by private sector investment and growth, is likely to create a maelstrom of political disruptions, which we can ill afford. Time to act and preempt the inevitable.    

 

 

 

 

 

Tax Policy & Corruption in India

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.

 

 

                                                                                                                                 

The Sahib and his Officer

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.  

 

Jaitley’s budget tricks flop

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 JaMo; an unbeatable combination

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.

Railway budget: “Sambha’s” side show

 

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.

Jaitley’s Maiden Budget Mujra

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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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