governance, political economy, institutional development and economic regulation

Archive for February, 2016

Indian Economic Survey 2016: Bewinderingly optimistic

Arvind S

Arvind Subramanian Chief Economic Advisor- GOI: Rising star and Rajan clone?

The Indian Economic Survey is an annual document that is wrongly titled. The data it reveals is overpowered by large dollops of economic wisdom, literature and policy analysis. Arvind Subramanian, India’s Chief Economic Advisor and the key author of this year’s Survey, has clearly burnt the midnight oil liberally in making the Survey a reader’s delight, even for one who has only a nodding acquaintance with economics, gleaned primarily by pursuing the pink papers.

Running hard to stand still

The key guidance the general public has been looking forward to, is the credibility of the near miraculous GDP growth rate of 7.6 % recorded this year and in that context, prospects for the next year. Unfortunately, clarity still eludes the average reader. Whilst generally optimistic about the government’s ability to improve on the performance this year, the survey is curiously negative on growth prospects for next year (7 to 7.75%), which it says would be strongly dependent on world growth reviving rather than domestic reform being implemented. Running hard to stand still is not a very good incentive for public sector reform. Consequently, India should brace for lower growth next year.

Better fiscal administration but significant legacy problems

The Survey makes the point that over the last year India has done more than most of its peer countries- those with an investment grade of BBB, including China, to retain macroeconomic stability per the index of macro-economic vulnerability developed in the Survey last year. But it simultaneously notes that the quality of assets in government-owned banks has been deteriorating since 2010. This is complemented by the overleveraged position of large business houses who are finding it difficult to service these loans because market conditions are adverse and both the top-line and their bottom-line have taken a hit. Exports have reduced by 18% last year and the competitiveness of domestic suppliers even to meet domestic demand is dodgy. The domestic steel industry being the most recent example.

The popular explanation for the logjam in corporate funds has been that the financial stress of big corporates has less to do with inefficiency or injudicious resource allocations by them. The blame is pinned on government projects not progressing smoothly over the last few years of the previous government resulting in corporate funds getting blocked unproductively.

gadkari

Minister Nitin Gadkari doing the impossible- shaking the dust off moribund highway projects

But over the current year Minister Nitin Gadkari has revitalized the implementation of a large number of projects in the highways sector. Railways Minister Suresh Prabhu has similarly awarded more than double the level of contracts in railways than was the trend earlier.

prabhu Minister

Minister Suresh Prabhu -improving the plumbing of  Indian Rail – a colonial legacy and democracy’s neglected child 

State governments have also enhanced public investment per the Survey which states that the combined public investment increased by 0.8% of GDP over the first three quarters of the current year versus the previous year with state government contributing 46% of the investment.

Why then does corporate loan servicing remain a problem? Is it just a time lag issue before public expenditure decisions kick in and funds flow resumes to corporates? If this is the case  the salutary effects should be visible next year. Or is it that the loan defaults have less to do with poor implementation of government contracts than with the “smart” arbitrage strategy of big corporates to borrow domestically in an unreasonably strong rupee, post 2013 and salt investments away safely overseas? Is it not necessary then to keep the rupee at aggressively competitive levels to avoid the incentive for “carry trade”, boost export competitiveness and price the fiscal impact of imports- particularly oil, realistically?

Does a high risk fiscal strategy make sense?

If the economy could chalk up a relatively high growth rate of 7.6% this year, despite the adverse conditions, why then is there a clamour for more liquidity and lower interest rates to kick start private investment and to fund higher levels of public investment in the coming year?

Would it not be sensible to stick to fiscal rectitude and keep the fiscal deficit target at 3.5% of GDP and hope for the same growth rates next year particularly if domestic actions will count less than world growth and demand?

Does it not make sense to guard against the risk of inflation- particularly drought induced food inflation? Our poorly integrated agricultural markets and inadequately prepared public management structures for managing food inflation by using market mechanisms are unlikely to be effective to deal with the risk of such inflation should the next year also be dry.

Oil prices remain volatile even though the survey is sanguine on the potential for an oil price increase. Whilst there is still no agreement amongst the top oil producers for limiting production, India is badly placed, being heavily (85%) import dependent, to bank on low oil prices continuing. Adequate fiscal space must be reserved for dealing with an oil price shock. These could be occasions when drawing down capital from a highly capitalized Reserve Bank of India (the survey labels it second only to Norway in being highly capitalized) can help without increasing the debt burden.

At least Mint Street is like Norway – we like that

Drawing down RBI reserves to fund dodgy capital investments in the public sector is a bad idea. It would be ok in Norway but not if accountability levels are low.Oddly, to an average India, the fact that we are close to being like Norway, as least with respect to the RBI is comforting and gives hopes. Indians are notoriously miserly and magnificent savers.

rajan RBI

RBI Governor Raghram Rajan – firm as a Norwegian rock: photo credit: businessindia.com

Tax revenue complacency

The survey skirts around the advisability of increasing the ratio of tax to GDP above the 10% achieved last year. It appears  complacent that tax buoyancy in the first three quarters of current year exceeds the average of the last three years- particularly for indirect taxes. The full year’s data would only be available with a lag but the budget documents would show if this happy trend has persisted in the last quarter also and whether the revenue deficit is indeed on track as a consequence.

Ignoring the impact of committed and contingent revenue expenditure

The significant burden (Rs 100,000 crore) imposed by the 7th Pay Commission has been dealt with lightly. Enhanced government salary and pension can increase expenditure by 0.6% of GDP for the Union government alone and threaten the revenue deficit target. The jury is still out on its possible beneficial impact on stimulating demand.

More importantly, the survey deals unduly summarily with the issue of enhancing rural income support and social protection as necessary adjuncts of macro- economic stability. Marco-economic stability can be the first victim if India’s political stability is compromised by concentrated high growth, which is not reflected in shared prosperity. The survey notes that 42% of Indian households are dependent on the rural economy. What it does not mention is the low ability of 60% of households to adapt to income shocks emanating from loss of insecure jobs, medical emergencies or other social obligations. Food for this segment accounts for approximately 40% of their expenditure. Rural wages are down 2.5% this year. Around 40,000 jobs have been lost per the Labour Bureau’s September 2015 report. Even the IT industry has reduced jobs and IT majors like INFOSYS -under a new leadership- are automating processes and putting employees out to pasture. These ground signals fit the survey’s assessment of India being in a hard place. But the survey is short on the best options for dealing with this economic shock.

The historical inadequacy in dealing with out-of-control and poorly targeted power, fertilizer, food, water, public transport subsidies hinges around the inability of elected governments to be seen to be heavy handed with income strapped households. These resultant fiscal pressures amounting to around 5% of GDP (all of government) can only escalate in the highly charged political environment during the next two years on account of state level elections.

A soft Railway Budget- harbinger of the main budget?

The Rail Budget 2016-17 could be a harbinger of such populism. Despite a large number of facilities and passenger amenities being announced there was no increase in the passenger fares which recover on average only around one half of the cost of services. Air India continues to be heavily subsidized. Loss making PSUs continue to sap public resources. How credible the fiscal consolidation plan can be in the face of these risks remains unclear.

Hopefully the Finance Minister will show the way on Monday in the Union Budget 2016-17. We await with bated breath.

Adapted from the authors article in The Wire February 26, 2015 http://thewire.in/2016/02/26/the-bewildering-optimism-of-the-economic-survey-22864/

Finance Minister or supermom

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Will Finance Minister Arun Jaitley protect wailing babies; photo credit: mubasshir.blogspot.com

High expectations in the near mystical ability of any finance minister to find a balm for all economic ills is common across all Budgets. Like all of us, finance ministers are egoists. They respond to expectations, like a supermom does to wailing babies.

The chorus of expectations from finance minister Arun Jaitley in Budget 2016-17, is no different. Growth fundamentalists expect a growth-oriented Budget — presumably heavy on infrastructure and investment. One may well ask then, why the accompanying demand for lower interest rates or for more investment than last year? Last year’s investment-lite Budget — just 1.7 per cent of the gross domestic product — pulled off GDP growth of 7.6 per cent, if government data is to be believed, despite the depressing economic environment.

Low social sector allocations

Social sector fundamentalists fret about low allocations for education and health — the building blocks of tomorrow. In the last Budget, the proportion of devolution to state governments was increased by 10 percentage points as per the recommendations of the 14th Finance Commission. Basic and secondary education, and primary health are state government mandates as per the Constitution. It is, thus, up to the states to get on with the job of prioritising social sectors in their spending.

Inadequate spend on defence

Security groupies worry about our poor defence preparedness. But they simultaneously support large pay and pension increases for the men in uniform who significantly outnumber the amount of modern equipment available to equip them with. No one seems to be thinking about reducing boots on the ground and using the money saved to upgrade much-needed equipment in this age of drones, airborne rapid action deployment and missile warfare.

air force

India’s aging fleet of fighter jets; Photo credit: indianexpress.com

Creaky infrastructure

Business, meanwhile, slouches about in the shadows, cribbing privately about the slow pace of the over-hyped initiative for rapid infrastructure development like the Delhi-Mumbai Industrial Corridor which is a confusing mishmash of railway lines, transportation hubs for improving freight movement and murky land deals for providing the usual real estate sweetener of houses, offices and malls. The fact that the Japanese are funding the railway freight component was probably its strongest point since both, the availability and cost of domestic funding, are at a premium for long gestation ventures. Ditto for the Ahmedabad-Mumbai bullet train.

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More plans than progress; Photo credit: dnaindia.com

As if all this was not enough to put any human into the ICU, public sector banks, egged on by the Reserve Bank of India, have chosen to make the December 15, 2015, quarter their “show and tell” moment.

Domestic shock: high levels of stressed bank assets

Whilst the financial cognoscenti may have known for years, the average depositor is just about finding out about the rot in government banks. Loans worth Rs 6 lakh crore have been extended over the years to borrowers who had no intention of paying them back. Instead of writing-off these loans when they soured or providing reserves against a potential loss, government banks have been dressing up their accounts to look good on paper by restructuring the unpaid loans. In essence, kicking the bad loans football down the road into the lap of the Bharatiya Janata Party government and Raghuram Rajan, governor of the RBI.

The result is that unless the government steps in and coughs up possibly Rs 4 lakh crore to recapitalise government banks over the next two years, bank finance will remain difficult to get and, even if available, it will be expensive. Despite the high margin these banks charge between the rate at which they get finance from the RBI and the rate at which they lend to borrowers, dodgy sets have reduced their profitability and affected growth. As a consequence, the market has sharply marked down the value of the equity of listed government banks.

Three trade-offs before the Finance Minister

Should Mr Jaitley bite the bullet and provide for reviving the government banks or should he keep this on hold and push public money directly into new infrastructure projects? The first option compromises short-term growth, the latter medium-term growth.

Mr Jaitley has to also choose between living with the unwise commitment to increase government pay and pension by 23.5 per cent or enhancing social protection and rural income support. The former helps the middle class, the latter the poor.

Another choice is between theory and practice. Should he stick to a fiscal deficit target of 3.5 per cent of GDP for 2016-17; increase tax revenue by hiking the rate of service tax; levy capital gains tax on equity and income-tax on dividends or should he play to the God of all things — the lack-lustre stock market — and keep tax rates low but blow out the fiscal deficit target?

Unfortunately, much as he may want, the finance minister cannot play supermom and please all. One hopes that he will bite the bullet and set about capitalising government banks — the engines of growth. Hopefully he will also set in motion fundamental reform in government banks. One extreme but useful step could be to explore support funding from the International Monetary Fund in the event of domestic or external shocks — like another drought or a sharp increase in oil prices — disrupt his plans.

The government of Gujarat has shown the way and the President’s address hit the right notes on safeguarding the allocation for social protection, rural income support and human development. The middle class may have to wait for their salary bonanza till growth-driven revenue buoyancy enhances the fiscal space available for such largesse.

To be cannily pragmatic or rigidly correct

The supermom character of the finance minister should kick-in whilst managing the trade-off between retention of the fiscal deficit target, tax revenue enhancement and managing stock market expectations. This is where the finance minister’s judgment will be key in doing something for everyone without disappointing all.

Our friendly Jats in Haryana have made their point with characteristic aplomb. By summarily cutting off the supply of water to Delhi they established a clear quid pro quo between water for Delhi in return for reserved government jobs for themselves. They seem to have won. Mr Jaitley could learn from their earthy pragmatism.

Who said that supermoms have an easy life?

Jaitley in parliament

Finance Minister Arun Jaitley in  Parliament: Adept at keeping hopes alive. Photo credit: oneindia.com

Adapted from the authors article in Asian Age February 26, 2015 http://www.asianage.com/columnists/finance-minister-or-supermom-261

Rail budget 2016: long on potential, short on reform

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Suresh Prabhu: An accountant in politics. India’s most affable politician: Photo credit: samacharplus.com

Even as Railway Minister Suresh Prabhu was presenting the Railway Budget 2016-17, the overriding impression was of a person pressed for time- not just the speech – more than double the length of last year’s- but also to fit his vision into the period available to this government till 2019 and in the prevailing environment of political grandstanding.

Indian Railways is deeply researched. Starting with the Wanchoo Committee report 1968, seventeen separate committees submitted reports of which the most recent is the Bibek Debroy Committee report 2015. It is not surprising therefore that the way ahead is clear but the problem is in getting started.

The neglected child of populism

Indian Railway is the neglected child of populism. It is wrongly branded as a mover of people rather than a mover of freight. The recovery of costs in the lower class comprising 91% of the passenger kilometers is so low that the above cost tariffs of the upper class, comprising 9% of passenger kilometers, is insufficient to subsidize the former. This story should be familiar to Prabhu, who was the Minister of Power earlier. The average recovery of cost is just 50% in passenger fares. The contribution of passenger revenue to total revenue shrunk from 62% in 1980 to just 30% in 2013-14.

The loss from passenger traffic is cross subsidized by charging freight 150% of the actual cost. It is no surprise then that only bulk materials like coal, cement, iron ore and pig iron, food grains, fertilizer and petroleum products- which have no other options- comprise over 85% of the revenue from freight. Other goods traffic has shifted to road transportation which is faster and cheaper.

Loss making passenger fares are the main reason why internal resource generation for investment has remained marginal and constrained track and rolling stock modernization.

indian rail

Indian rail subsidized fares mean high passenger traffic: Photo credit: Indiarailonline.com

Minister Prabhu announced a spate of passenger amenities to make rail travel more convenient, safer and pleasurable. Who will pay for them remains unclear. Passenger fares were left untouched which means the yawning revenue gap will continue to bedevil investment.

Freight tariff is crying out for rationalization and reduction to become competitive with road transport. No definitive plan for achieving this has been spelt out either. The burden of unfinished investments to make freight movement timely and to expand the basket of goods beyond the core bulk goods is steadily growing.

New financing

Prabhu’s financing strategy resembles that of a startups- which is to rely on Angel Investors to fund the revenue gap in the hope that profitability is around the corner. But in the absence of specifics this lacks credibility.

The prime thrust seems to be on bilateral (Japan) and multilateral (World Bank) funding. This is sensible in the absence of a robust revenue model. Forming Joint Ventures with state governments is good optics. But state governments are likely to be even more fiscally stressed than the Union government over the next two years as an outcome of the 7th Pay Commission award and the UDAY scheme for restructuring the debt of DISCOMs which requires the state government to take on their debt.

But it is a bad idea to continue to use the balance sheets of the railway Public Sector Undertakings (PSU) and other Government of India PSUs, as proposed, to borrow commercially for investment. Partnerships with private investors are welcome since the business risk is offloaded. But PSUs have low autonomy from the government and can be railroaded into mortgaging the future. Government owned banks are a prime example of the down side of this strategy.

If this Chinese model of off-budget financing development is used, Government must account for the consolidated assets and liabilities of all government entities, including government PSUs, in the annual budget. Taking expenses off-budget and hiding them in the balance sheets of government owned PSUs is like sticking our neck in the sand to avoid acknowledging the fiscal storm.

Vision 2020 how credible?

The minister assured the Parliament that IR would start using the zero based budgeting approach to provide the maximum bang for the buck. Indeed, hard budget constraints in 2015-16 have resulted in cost reduction over and above the reduction in oil prices- most notably in the cost of power purchased.

But if the value for money logic is applied to its vision it seems to be a losing strategy. Why spend scarce resources on speeding up passenger trains so that travelers spend twelve hours -rather than seventeen – from Delhi to Mumbai when you can cover the same distance in just two hours by air? Does it not make more sense, from a national perspective, to reduce the horrendous tax burden on air travel so that such long distance air-travel becomes affordable at the price of a Rajdhani ticket? Traffic volumes can drive down aviation costs significantly and simultaneously focus the efforts of IR better.

freight train

Indian freight train giving way to passenger traffic. photo credit Wikipedia.com

The comparative advantage of Indian Rail is to haul freight long distance; develop track to connect airports, ports, logistics hubs to markets; broaden the freight profile to include high value non- bulk goods – as proposed by Prabhu; improve metros, suburban trains and connect locations up to six hours of travel time. Even this is a handful, given the degraded status of track and rolling stock and the soft expertise required to run a business of this magnitude. Road, rail and air should mesh and compete- each with their own resources without differential tax distorting markets unless tax is used to price externalities.

Pressing buttons is good, but not enough

Minister Prabhu is sincerely passionate about making a difference. This year he compensated for the lack of real reforms by pushing all the required buttons- new jobs (0.5 million in 2017-18), make in India (two new loco factories), start up India (innovation fund), Swaach Bharat (bio toilets on trains, cleaner stations and trains), Green India (electrification, greening tracks, energy audits), Gender sensitivity (safety measures for women, reserving 33% of seats for women, digital help numbers) Sagar Mala (connecting ports), Cooperative federalism (JVs with state governments) and Digital India (SMART coaches, wi-fi at stations, monetizing captive, eye balls).

Each of these are great but small ideas which do not correct the awry fundamentals. But they are a smart way to go. They also show that Indian Rail and Minister Prabhu are committed to the Cabinet form of collective responsibility towards national programmes.

But a business needs to generate enough revenue to invest in the future to be sustainable. Prabhu listed four Cs comprising the third pillar of his strategy – Co-operation, Collaboration, Creativity and Communication but he missed the most vital one – Corporatisation. Indian Rail must be corporatized and listed on the stock exchange, with minority equity made available to private institutional and individual investors just like the Navratnas ONGC, Indian Oil and NTPC. IR’s colonial structure must bow to the power of Mumbai’s Dalal Street, if it is to grow and serve the people of India.

dalal

Dalal street the wall street of India. Photo credit: Wikipedia.com

Adapted from the authors article in swarajyamag February 26, 2015 : http://swarajyamag.com/economy/rail-budget-2016-long-on-potential-but-short-on-reform

Indian budget in the eye of a fiscal storm

Finance minister Arun Jaitley’s third Budget signals the mid-point of this government’s tenure till 2019. At the best of times, the honeymoon period would have ended by now.

jaitley jostled

Photo credit: in.news.yahoo.com

But it is unfortunate that the FM has to face a perfect storm of snowballing, fiscal liabilities in public sector banks; drought induced low agricultural productivity; international economic head winds; the additional cost of securing India in an increasingly insecure world and the consequences of populism- primarily the wholly unnecessary increase of 23 percent in government pay and pensions and the outcome of delayed reforms in subsidy.

Running out of fiscal resources

In comparison, the government’s budget kitty is woefully inadequate even without meeting the long standing demand for spending more on health and education; developing infrastructure; boosting rural incomes; extending the patchy system of social protection and enhancing long neglected defence preparedness.

cash box

Photo credit: Dreamstime.com

Consider that the total annual capital budget of the Union government last year was just Rs 2.4 lakh crore (just 1.7 percent of GDP). State Governments spend a similar amount. But public investment at just 3.4 percent of GDP does not compare well with the thumb rule for developing countries of at least 8 percent of GDP especially when you are also running a fiscal deficit of 4 percent also in the Union budget alone.

The mess in government banks

More worryingly, even this meagre public investment may not actually be possible if the fiscal mess emanating from public sector banks is to managed. Loans worth Rs 3.5 lakh crore in government owned banks are acknowledged as non performing (the borrowers have defaulted on repayments). Some provisioning for writing off these loans has been done but not enough.

The real risk is that a whopping Rs 2.7 lakh crore of loans have been dressed up by “restructuring” them. In essence rolling over non-performing loans (NPA) so that they exit the NPA classification. But whether the favoured borrowers can support future repayments is unclear. The RBI has come down heavily on such practices and directed banks to start provisioning against all stressed assets. Hence the spate of losses recorded in the quarter ending December 2015 by government owned banks.

Another worry is that government banks will need an additional Rs 1.8 lakh crore of equity infusion to comply with the Basel III capital adequacy norms. This takes the total capital requirement of government banks to Rs 6 lakh crores- just under 4.5 percent of GDP.

Even if the entire capital budget of the government is diverted for re-capitalizing government banks — it will still take two to three years before they get a healthy balance sheet. And what is there to stop the cycle of irresponsible lending from being repeated? After all, these non-performing assets were built up over the past several years. But none of the top honchos of these banks — present or past — have been called to account for this colossal deception.

Poor credibility of corporate governance in government banks

ATM

Jugaad trumps systems; Photo credit: Alamy.com

Today, government bank equity is deeply discounted. The credibility of corporate governance in government banks has been dented. Worse still, there is no clear path for restoring stability. The direction preferred by the government is to retain the governance architecture of government owned banks with notional changes to enhance bank autonomy. Privatization of select government banks – a sure mood lifter for domestic and international investor community- has never been a preferred policy option.

Government ownership has benefits. For one, it notionally reassures depositors that their money is safe. Possibly this is why there is no run on deposits in government banks, unlike what was seen in Greece recently. Depositors and bond holders view government banks through the filter of sovereign credit. It helps that India has an impeccable record on meeting all its financial commitments.

But one trigger, which could escalate the financial risk sharply could be if oil prices start firming up subsequent to the production freezing agreements between Saudi Arabia, Russia and other top oil producers. This will stoke inflation in India; keep domestic interest rates high, thereby impacting investment and worsen the current account deficit. Add to this that sharply reduced public investment- a consequence of possible diversion of capital to clean the balance sheets of government banks, will also impact growth, jobs and incomes.

The poisoned chalice of trade offs

Government has a poisoned chalice it needs to sip from. If it brushes deep, bank restructuring under the carpet, it can postpone the day of reckoning- but only at significant medium term economic cost. A broken government banking system, which caters to 70 percent of banking needs, cannot sustain rapid private sector growth.

One option for maintaining fiscal stability, is for the government to access multilateral support from the International Monetary Fund (IMF) for restructuring government banks. IMF support reassures investors because it comes with a programme of structural and governance reform, including broad basing the share-holding of banks to non-government investors; professionalizing their boards and embedding oversight mechanisms to insulate them from succumbing to politically motivated loan melas or dodgy, private projects.

Government should shed the muscular stance

The down side is that going cap-in-hand to the IMF does not fit the muscular India story, which is the leitmotif of the BJP government. The BJP will worry that it will have negative political consequences in the forthcoming state elections in West Bengal, Assam, Tamil Nadu and next year in Uttar Pradesh (UP). This is true. But none of these states offer credible political gains for the BJP in any case, except UP. The muscular approach can be abandoned without much grief. Its marginal utility is diminishing and reduced dividends are already visible.

One hopes that the government’s brand managers are reading the tea leaves correctly. This is not the time for soaring rhetoric or proclaiming achievements loudly. Far better to adopt a humble posture, point to the depressing state of the world and outline an agenda for dealing with adverse circumstances.

humble jaitley

The FM can be charming if he tries. Photo credit: freepressjournal.in

Three big steps out of the fiscal mess

First Mr. Jaitley must guard against 2016 becoming India’s 2008 “Lehman Brothers” moment. Lehman Brothers was a global financial services firm that filed for bankruptcy protection. This sparked off a domino effect which exposed deep financial irregularities across the banking sector. It also triggered the Occupy Wall Street movement. Ordinary citizens, disgusted by the extent of malfeasance in the financial world, took New York by storm and shut down the financial district. At the best of times, Indians are suspicious of big business and are quick to come out on the streets in protest. This is not the time to risk an “Occupy Dalal Street movement”.

Government must regain credibility by coming out strongly against all those who have connived to build up this huge quantum of non- performing loans — bank managers who were in decision-making roles, large corporate borrowers and those within the political establishment who may have turned a blind eye to such maladministration. Mr. Jaitley must also share publicly how deep is the rot and what steps the government proposes to manage the fall out.

Second, government should take this opportunity and opt for only a “holding budget” for 2016-17 — an accounting exercise to rationalize and consolidate past initiatives. The bottom line is to insulate income support for the poor and allocations for agricultural production from the fiscal mayhem. Health, drinking water and sanitation and education allocations should be held at 2014-15 levels relative to projected GDP.

Finally, the government must increase gross tax collection over the next two years from the low of 10 percent in 2014-15 to 12 percent of GDP- last achieved in 2007-08. The GDP growth projections of 7.5 percent lack credibility when triangulated with the ground realities. Lower growth will impact tax revenues negatively. Services tax is a progressive tax, which primarily affects the well off. Raising the rate by 2 percentage points could generate an additional Rs 30,000 crore. Taxing capital gains from the sale of equity and the receipt of dividend beyond a threshold level, is another option for reducing income inequality and plugging a big hole in the tax net.

Government already spends more than it earns on revenue expenditure. We still run a revenue deficit of nearly 3 percent of GDP, which we fund by taking loans. Hence, the increasing burden of interest payment. Trade-offs will have to be made if the unwise commitment – amounting to Rs 100,000 crore – on the 7th Pay Commission recommendation is implemented.

So are we in the eye of the storm? And could we be on the cusp of a potential financial emergency? We should act before a flash point triggers this eventuality. A modest budget for 2016-17, enhancing tax collection by selectively increasing the effective tax rates and sharply focused allocations for value enhancing public expenditure, is the only way out of this mess.

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A storm brews around Rajpath, New Delhi. Photo credit: gizmodo.com

Adapted from the authors article in Swarjyamag February 24, 2015 http://swarajyamag.com/economy/indian-budget-in-the-eye-of-a-fiscal-storm

NitiAyog’s China style CEZs a big, bad idea

Bad ideas are as resilient as cockroaches — the only living being guaranteed to survive even a nuclear holocaust. Both have a tendency to resurface even after being squashed.

One such bad idea, originating from the Niti Aayog, is to revive the plan of special economic zones (SEZ) on a much larger scale as a carbon copy of SEZs in China. It’s called coastal economic zone (CEZ).

Shenzen

Shikao area, Shenzen at dusk. Photo credit: Xinhua

The ostensible drivers are the need to create more decent jobs- NitiAyog says these are generated only by large industries- and the desperation to revive exports. Both objectives are above reproach. It is the strategy to get there which is perverse.

India is not new to the concept of enclave development for export manufacture. Export processing zones (EPZ) have existed since 1965 when the first one was established in Kandla-Gujarat, followed by Santacruz electronics export processing zone in Maharashtra. These gave way in the 1980s to the stand-alone 100 per cent export oriented units. Next were SEZs with a legislation to support them in 2005.

Niti Aayog’s CEZ proposal focuses on coastal development. Nothing new here — 68 per cent of the 329 notified SEZs existing in 2015 were in eight coastal states. The only problem is that coastal states are far richer than the hinterland so CEZs will make them even richer enhancing spatial inequality.

The big change is that only two CEZs are envisaged, each of 2,000 to 3,000 sq km, to simulate the network benefits of regional development. Compare this with the 626 sq km notified for 390 SEZs, of which just 6 per cent or 25 SEZs exceed two sq km in size. But do we have excess land of this magnitude?

Consider, if Goa wants a CEZ. It must cede 50 per cent of its area of 4,000 square kilometers. With regulatory powers in the CEZ transferred from the chief minister to Union government appointed development commissioner, Goa would effectively revert to the status of a Union Territory.

goa beach

Goa. Photo: Wikipedia.

Should Kerala want a CEZ, it needs to convert 10 per cent of its land area into a “deemed foreign territory” managed from Delhi. How well this will go down with the fiercely combative citizens of Kerala is anybody’s guess. Contiguous states can join hands to reduce the area surrendered by each. But this could invite administrative complexity and delays in harmonising norms and work practices across states.

The NitiAyog paper says Shenzen in China before it became the first SEZ had just 300,000 people. Today 11 million people live there. Only problem, in coastal India the average density of population is around 940. In a 3000 square kilometer area there would already be 3 million living there.

So is the CEZ proposal just old wine in a new bottle? And is it pragmatic?

Tax havens are yesterdays means of boosting exports

The United Nations Conference on Trade and Development (UNCTAD) surveyed 100 developing country export zones in 2015. They concluded that islands of excellence, with special set of laws, rules and practices — as proposed in a CEZ — can create enormous political risk by excluding others from development. Political risk is not an issue in single-party, authoritarian China. But India cannot afford to segment development and exclude large swathes of the “cow belt” where a large number of the poor exist. Unlike China, we have an open domestic migration policy. This makes segmented development politically impractical, especially on the scale envisaged in the CEZs. In any case, in the emerging plurilateral international trade environment, it is questionable if tax breaks and investment incentives are the route to trade competitiveness or whether strategic membership of free trade agreements will be key.

Enclave development for exports are “walled gardens” of the real world

Indian SEZs were primarily tax arbitrage havens with the added sweetener of access to land. The relative export competitiveness of SEZ units versus exports from the domestic trade area, declined significantly in 2013, as soon as the exemption from Minimum Alternative Tax was withdrawn in 2012. This shows that state-driven market distortions do not boost exports in a sustained manner. Another reason why the SEZ scheme floundered was that import taxes and licenses got rationalized across the board and it became easier to import for export across the country. Coupled with the advatngaes of free access to the Indian market locating outside the SEZs became more attractive. SEZs remain a favourite for IT industries, which are mainly export driven and have a culture of enclaved bubbles.

Freedom_Park

Freedom – Bangalore style Photo; wikipedia

There is no alternative to maintaining a competitive exchange rate; managing inflation and broad based, deep administrative reform to enhance exports.

Between 2006 and 2014, 1.4 million jobs were created in SEZs — an impressive 50 per cent of the total increase of 3 million in private employment. But it is unclear if these were all new jobs or the result of existing domestic area export units simply shifting into a SEZ to avail tax advantages.

Land scams accompany if Union government usurps what should be done locally

Consider the 2014 report of the Comptroller and Auditor General (CAG): “Land appeared to be the most crucial and attractive component of the scheme (SEZ)”. In a replay of the coal mining scam, the regulatory gaps emanating from the constitutionally mandated division of oversight between the Union and the state government were exploited. The Union government notifies and de-notifies SEZ land. But it turns a blind eye to the responsibility of the state governments to ensure against scams in the acquisition and subsequent use of such land. Instances of inclusion of ineligible land for notification; allotment of land far in excess of need and protracted non-use of notified land by SEZs, all resulted in the diversion of SEZ land for more lucrative commercial exploitation.

The suspicion of mala-fide intentions is strengthened because state governments sold land, acquired for public purpose prior to 2007, to developers rather than giving it on lease, which would have retained their oversight over its use. Estimating the resultant undue benefits is tough without a forensic audit. It is telling that documents relating to 47 SEZs, including most of the biggest ones, were not provided to the CAG for audit by the Ministry of Commerce.  But even with what was handed over to CAG the results are shocking.

73 per cent of the land notified for nine SEZs in three states was for “restricted” use only – forest, defence and irrigated land, which was not eligible to be notified. Operations started only on 62 per cent of the 456 square kilometers of land notified till March 31, 2013. In eighteen SEZs, operating across eight states, only 17 percent of the 42 square miles notified was actually used for “processing” against the norm of using at least 50 per cent. With large amounts of unused land available, private developers successfully approached the government to de-notify SEZ land which could be used for more lucrative commercial purposes. Assuming that just 25 per cent of the 456 sq km, notified till 2013, was misused, the potential extra-legal earnings would have been to the tune of Rs 4,500 crore — minor pickings by the standards of contemporary scams.

Good policy is never backward looking and can benefit from past errors. If CEZs are to be headline-grabbers in the 2016 Budget, they must have caveats: No new land should be acquired for them. If land is needed the private developer should follow the negotiation route popularized in Punjab and now by Chief Minister Chandrababu Naidu in Andhra Pradesh; No fresh public finance should be available for CEZs; All additional infrastructure needs must be funded by the private developer; Instead of the Union government, the state governments should be in the driver’s seat; and, states should enact their own CEZ legislations (as was done by Rajasthan in labour laws) which could be approved by the President, if constitutionally required.

Adherence to the fiscal deficit targets requires conserving public finance. Developing the richer coastal areas runs contrary to the Prime Ministers vision of development for all. Most importantly, getting directly involved in land and urban development — both of which have been fertile ground for scams — is unwise for a reformist Union government. This high risk strategy is not the best option for sustainable gains in private investment, employment and exports.

port

The duality of Indian ports: Photo credit : alamy.com

Adapted from the authors  article in Asian Age March 17, 2015 http://www.asianage.com/columnists/z-coastal-economic-zones-590

 

TRAI’s ersatz socialism kills innovation

TRAI

R.S. Sharma the new TRAI chairperson and  architect of “ersatz socialism” in the www. Photo credit: economic times.com

By ruling against Facebook’s Free Basics type of innovation, which offers, hitherto undreamed of, free but limited access to data services, Telecom Regulatory Authority of India (TRAI) has regressed to a version of “ersatz Nehruvian socialism”, which persist long after Panditji. It would have astounded him that his thoughts are still evoked to preserve the privileges of a thin crust of 250 million elite Indians whilst doing little for the 700 million poor Indians. Consumer benefit has been sacrificed yet again for ideology.

Nehruvian Socialism and Net Neutrality

Remember the car you used to drive in the 1970s? Most don’t, because it was an expensive, exclusive asset owned only by the rich. Even today Indian cars remain a rich person’s trophy because of the high cost of owning and using one relative to average income. Only 10 per cent of the 230 million Indian households own a car. Ironically, the TRAI order of February 8, 2016, is driven by a similar vision — preserving notional equity and freedom within a small bubble of 250 million well-off, “Internet connected” Indians owning smartphones.

poor buy

India’s poor- ersatz socialism permanently excluded them from the bubble of shiny cars. Net neutrality similarly excludes them from the virtual world. Photo credit: bbc.co.uk

Shunning innovation in the pricing of access to the Net under the garb of Net Neutrality has precisely this bubble effect. TRAI has decided to protect the existing ecosystem which privileges platform managers, content and app developers who today have unpaid access to 250 million netizens. But it ignores the need to grow this market to include 700 million Indians who are too poor to access data services other than phone calls and SMS.

TRAI’s vision of the www is like that of an owner of an expensive mall- keep the poor out.

The net is like a Mall except that you have to pay to get in and guards are actively instructed to keep shabbily dressed people out so that rich customers can float through an air-conditioned heaven- just like in Dubai. The good news is that in the real world business serves the needs of the poor through street markets because the municipality facilitates it. in a TRAI ruled internet the poor are to shunned, exactly as in expensive Malls and no street market is to be made available for the poor. The poor are to be kept invisible – as in China or Rwanda where the strong arm of the State keeps the poor severely controlled.

It is unsurprising that the Congress which has made ersatz socialism into a family business should support “Net Neutrality”. But that this should happen under a government led by Prime Minister Narendra Modi which has vowed to “free” India from the social and economic chains of the past, shows that this government needs to put on its “thinking” cap.

TRAI order equates porn with socially relevant content

TRAI’s decision is perverse and here’s why. It throws out the baby with the bath water. Whilst banning price “discrimination” for content, it also effectively disallows “positive discrimination” or “affirmative action” for access to socially responsible content. In essence it says a consumer must pay to access content whether it is porn or wikipedia.

Consider a large Indian company which may want to subsidise a telecom service provider (TSP) for providing free access to educational sites targeted at helping poor or dalit kids crack the JIIT exam. The TRAI order disallows this effort.

Similarly, it bars a poor, pregnant woman, say on the outskirts of Patna, from availing free access to check the cost of having her baby in a decent hospital in Mumbai, where her husband works. Sorry, says the TRAI order. You must pay the TSP to access the Net.

It is hypocritical to simultaneously support free content-unhindered by state control whilst arguing against “affirmative action” for providing free access to the poor to socially relevant content, developed just for them.

It is not just about Facebook

It’s not only about Free Basics. It is the principle of killing innovation that’s the real concern. The Trai order kills innovation in developing socially relevant content for the poor because there is no way now of getting the content to them.

Free Basics is driven by commerce. Free access has to be paid for by someone. Today it is Facebook subsidising access, tomorrow it could be a Tata CSR project. In Africa, Net subscriptions of the poor are subsidised by foreign donors.

Net neutrality is bad economics

More practically, there is money at the bottom of the income pyramid. Activists, platform managers, content and app developers are being short sighted in ignoring the role of “free access” in getting them there. They lack the business vision of Hindustan Lever which innovated shampoo sachets two decades ago to give every woman an affordable taste of luxury. Or do they fear that international players with deep pockets may get there first before they get their act together? Are they using the garb of “Net Neutrality” as a fig leaf for self-preservation? Do existing Indian players, TSPs want to keep Facebook out so they can do the same once they become big enough?

Predatory pricing based on enormous private equity funding is the essence of the IT start up.

All IT start-ups attract customers by subsidising prices. Take Uber, Flipkart or any other. The fear that they will start increasing prices once they get bigger is misplaced because unlike the bricks and mortar world entry barriers are low in the digital economy which ensures sufficient competition to keep each big player on their toes. Guarding against predatory pricing is a slippery slope for TRAI. It can result in taking the fizz out of e-commerce which is growing by out-pricing the corner mom and pop store and traditional taxis by relying on serial funding from investors, not profits to fund unheard of price discounts. In any case India has laws and the Competition Commission of India to regulate dominance and monopoly. TRAI is hardly equipped to rule on anti-trust issues.

Today’s startup is tomorrow’s business biggie

flipkart

The Bansals of Flipkart- value $ 15 billion and counting- give Amazon a run for its money. Photo credit: livemint.com

Ironically, whilst making it easy to do business for “start-ups,” we are killing commercial innovation by business biggies. Can an “innovation” friendly eco-system really be sliced and diced, such that it is a “free market” for start-ups but a stiflingly regulated environment once they become a business biggie, like Facebook? In the virtual economy startups grow on the strength of innovation not government protection. In any case, the record of ersatz socialism in growing small industry via protection is miserable. The Indian Telecom industry, the only success story of privatisation and reform, has grown from being yesterday’s “start-up” to today’s business biggie. Why discriminate against it because it has been successful?

The digital eco-system must be fair to all stakeholders, not just the software and content developers

There is a symbiotic relationship between TSPs, content providers and app developers. TSPs, represented by Cellular Operators Association of India (COAI), buy expensive spectrum from the government, install and maintain the telecom network to link-in netizens and ensure that the number of eyeballs grows. If the content available is attractive, netizens spend more time surfing, thereby boosting TSP revenues. They enrich app developers by buying an app off the Net.

To access content on Flipkart, Snapdeal, Amazon, Uber or Myntra there is no additional charge other than the Internet access cost. So are these companies just plain generous? No. Like Facebook or Google, they make their money by selling the data they gather from the netizens — demographics and preferences — to market analysts and sometimes to governments; they leverage their eyeball score to increase advertising revenue and get additional private or public equity funding. This is the money they burn to offer fantastic discounts and out-compete brick and mortar pop and mom stores.

So why does National Association of Software and Services Companies, an Indian IT lobbyist, support the Trai order? Because it is in the interest of the software developers and content providers they represent to try and hang-on to the freebie they have — the roving eyeballs of netizens for which they pay nothing.

Why do the parents of the www (US & the Brit Sir Tim Berner) support net neutrality?

Berner

Sir Tim Berner-Lee inventor of the www. Photo credit Wikipedia.com

Indian activists are fond of using the United States as an exemplar of non-discriminatory pricing access and the trenchant advocacy of Tim Berners-Lee – the inventor of the www-for net neutrality. This is their Brahmastra to clinch the argument for “Net Neutrality”.

This is unsurprising. For most netizens, the US is the mother lode of innovation, which it certainly has been. But cut-paste is bad tactics for good governance. The context in which things work is key. Activists and governments routinely overlook the difference in context in a slavish tendency to adopt best practice international templates.

Why the US is different

US poor

The poor people of the US: photo credit: rediff.com

In the US, the poverty level income is $2,000 per capita per month. Data access costs just 5 per cent of income or $100. In India, the poverty level income is $30 per capita per month. Data access costs $10 or one-third of a poor woman’s income. The cost of Internet access is not an economic barrier in the United States. The US is under no compulsion to abandon “Net Neutrality”, an ideology which sounds noble. For India, TTAI’s ideology of “Net Neutrality” means the economic exclusion of 700 million poor people.

TRAI’s technical incompetence drives the ban on differential pricing

The bottom line  is that despite its rhetoric on “net neutrality” TRAI is technically incapable to monitor data services to detect instances of blocking or preferential access for content favoured by TSPs. This why it has opted for the blunt instrument of a complete ban on commercial innovation in pricing and financing. This is the worst option driven by regulatory incompetence not by high minded adherence to principles. A sad comment on the state of regulation and of consumer protection in India.

Adapted from the authors article in Asian Age February 10, 2015 http://www.asianage.com/columnists/trai-s-socialism-kills-innovation-136

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