governance, political economy, institutional development and economic regulation

Budget to Build Institutions

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We are, for the most part, what institutions make us. Some of us, who are exceptional, disrupt the status quo and change the universe. But generally, such special talents are best in small doses. India has too little of compliance with formal institutional norms and a little too much, of the libertine spirit. Of course, when it comes to informal institutions like caste, religion or class the reverse is as forcefully true.

How can we rework our formal institutions?

What ails most institutions in India is that they lack charismatic leaders and citizens do not see the “value” attached to them. Parliament, for instance, is commonly regarded as a troublesome, distant cousin, who has to be invited to weddings, but from whom most decent folk would run a mile. The Judiciary, even though it has acted repeatedly for the poor and marginalised, is viewed with trepidation, because of the serpentine coils of due process it has wrapped itself in. The Police has traditionally been just plain bad news but now, even the civil bureaucracy, commands scant respect.

One reason for the decline of institutions is that most are closely associated with the legacy of the colonial government. Indeed many are still housed in the same buildings. Most still follow the same rules, which protect the State’s, rather than the citizens’, interests.

But more fundamentally, the conundrum is that India’s Independence struggle was not against the institutions embodying the “Raj”. It was against the foreigners in power at the time. We have retained all the vestiges of the colonial government; a centralized government; symbols of distant, almost princely privilege, for the elected representatives and an under-regulated (albeit also increasingly poorly protected) bureaucracy, trained and organized, to subsume the difference between public and self-interest.

The demise of institutions is a familiar lament. Can it be reversed and what can Budget 2015 do about it? Clearly, the decline is not related to a lack of finances, so change in resource allocation norms provides no solutions. Since 1991, the Budget Speech has become an instrument for announcing big ticket policy changes and this is where it could help. There are three major policy changes for building institutions, which merit inclusion in the Budget Speech of the FM.

First, build the autonomy of Municipal Government. ModiGov is focused on urban areas for economic growth. This is sensible. 700 million (50%) Indians, many of them not yet born, are expected to live in urban areas by 2034. Projectised resource allocations for roads, bullet trains, electricity, water, housing and “smart” cities are being made.

But allocating resources is just the first step. Unless the institution of Municipal Government is restructured, it is unlikely, that the good governance environment required to use these additional resources effectively, can be created.

Local problems need local solutions. But state (provincial) governments are loath to devolve powers downwards. India is a federal democracy. The Union can only persuade and incentivize. It cannot direct state governments to devolve powers.

The FM should use Budget FY 2015 to provide incentives for State Governments to devolve fiscal and administrative powers and functions to municipalities. One option could be a Challenge Fund, with a replenishing, annual corpus of Rs. 10,000 crores (USD 1.5 billion), open to competition amongst the Fifty Four cities, each with a population exceeding one million. Every year, the best five to ten devolution proposals, received from state governments, could be selected. Each selected city would get a direct, long term soft loan, against achievement of milestones, from the Union government via a Special Purpose Vehicle equal to 50% of the average state government grants provided over the previous three years.

This is a “win win” because it enables fund-strapped State Governments to redeploy their funds to other areas, whilst also ensuring more autonomy to dynamic and growth oriented States and cities.

Why is municipal autonomy important? Pan-national schemes are too clunky to be effective. Remote management undermines local participation, ownership and decision making. Meddling in city governance, by state governments, is usually motivated to extract “rent” or some other form of private benefit.

Politically, such devolution makes sense for the BJP, which is a party dear to urban hearts. In fact, rather than go for elections to Delhi State immediately, the Union government should first merge the three municipalities of Delhi into Delhi State, making it the first City State of India. The Union government could retain direct control of the Lutyens Delhi area, where the rich and the powerful live.

Second, is to build the autonomy of regulatory institutions and signal that where a regulator exists the government shall defer to the collective wisdom of that institution. Unless this is done, autonomous regulation cannot be effective. Making regulators effective is key to building investor confidence.

The prime example is the Reserve Bank of India (RBI) which is one of the oldest autonomous regulators.

The positive regulatory experience with the RBI (1934) and then with the Securities Exchange Board of India (SEBI) (1992), encouraged India to expand the area of autonomous regulation for governing Telecommunications (1997); Electricity (1998); Insurance (1999); Anti –Trust/Competition (2002) and Pension Funds (2013).

Our institutional record on managing macro-economic stability is poor. High inflation not only hits the poor the most but also erodes the confidence that the government is in control of the economy. Line managers in government have a hands-off approach to using funds effectively. The government seems complicit in being less than adequately focused on inflation. Public wages are 100% inflation proofed, whilst the poor and employees in the private sector have no such safeguards. Large scale public failures to produce domestic natural resources (oil, gas and coal) in sufficient volume, result in the import of inflation when international commodity prices are high. Poor infrastructure increases the cost of transit. Draconian regulations stifle competition and markets and increase transaction cost.

FM Jaitley needs to clear the air on the institutional arrangements for managing inflation and interest rates. The FM said in his maiden Budget Speech in July 2014 “We look forward to lower levels of inflation…” and asserted the need for “….macro-economic stabilization that includes lower levels of inflation”.

Both objectives have been substantively achieved. The trend is heartening and the FM is entitled to take credit for it. But in the aftermath of this success, there have been discordant voices on interest rates. The RBI Governor has consistently said that windfall benefits from lower international petro and food prices alone should not be the basis for reducing interest rates. The FM has publicly advocated a divergent policy of reducing interest rates to stoke growth.

This public discord is avoidable noise. It perturbs perceptions and muddies expectations. It makes a “dear money” policy less effective. It postpones investments, as entrepreneurs wait for the expected lowering of interest rates. Public unanimity on monetary/interest rate policy issues, with the RBI Governor taking the lead, seems the best way forward.

The Budget Speech provides a good occasion to underline the autonomy of RBI and to give it credit for monetary policy management. The FMs support for an autonomous RBI is bound to be reflected in the relations between other line ministers and their autonomous regulators.

A big gap in the regulatory architecture is the absence of an autonomous regulator for fossil fuels (coal, gas and oil). Coal, gas and oil have consequently suffered from regulatory uncertainty and mismanagement. This is in sharp contrast to the manner in which Central Electricity Regulatory Commission and Telecom Regulatory Authority of India have rationalized the bulk electricity and telecom markets, respectively.

Announcing a time bound plan to legislate an integrated fossil fuel regulator (Federal Energy Regulatory Commission of the US provides a good model), builds on the existing trend to club energy related departments-Coal, Electricity and Renewable Energy have been clubbed under the amiable and eminently qualified Minister, Piyush Goyal. This step would also signal the intention of the government to reverse the politicization of natural resource allocations, whilst also inflation proofing the economy from supply side disruptions.

Third, make the transport sector competitive. Indian Railways (IR) is the life-blood of integrated India. Its declining share in transportation is a result of previous governments bleeding it for political gains. As early as 2001 the Indian Railway Report, chaired by Dr. Rakesh Mohan, laid out a road map for its commercialization. Corporatization is a first step in giving IR the autonomy to compete. Corporatisation will also encourage IR to leverage its considerable assets; use the PPP model aggressively and improve its services. Minister Suresh Prabhu is quick off the block by devolving financial powers to Regional heads to enhance efficiency and transparency in the tendering system, within the existing architecture. But formal restructuring, which requires a bargain to be struck with the unions, would make his job easier.

National Thermal Power Corporation and Bharat Heavy Electricals Limited, both companies listed on the stock exchange, are shining examples of the advantages of corporatization and listing of State Owned Enterprises and their ability to grow, even in a competitive environment. Corporatisation of IR could be followed by restructuring, including possible vertical and horizontal unbundling and a public listing to enlarge its shareholding and expose it to the discipline of the markets.

Bullet trains are a visible symbol that India has arrived. But without the enabling governance structures to sustain such hi-tech assets, today’s advances could easily become tomorrow’s “stranded assets”. It would be a pity if the “smart” cities; the industrial corridors and the bullet trains go the way of toll roads and become pot-holed, one-night wonders. Projects only feed fish. It is institutions which teach a person how to fish.


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