governance, political economy, institutional development and economic regulation

Archive for February, 2018

Junk policy for action

parliament

Policies mean very little, unless there is a national consensus behind them, because governments change in a  Formulating a policy is a clunky, time- and effort-intensive, process. It should be attempted only if massive structural change is necessary. India has rarely been in the game of big bang reform. Our forte is incremental change. For this, key actions with outsize results are more significant than policies.

Industral licensing became ideological & lasted well past its expiry date

Also, policies can haunt a country for longer that necessary.The Industrial Policy Resolution of 1956 was one such. It was inspired by the seductive early achievements of the Soviet Union. The Bombay Plan 1944 formulated by leading industrialists, including the redoubtable JRD Tata, implicitly supported massive state intervention and regulation to protect domestic industry from foreign capital and competition. This became the trap, chaining private enterprise in regulations and excluding it from capital intensive “core” sectors.

Never mind that Jamsetji Nusserwanji Tata had invested in Asia’s largest integrated steel plant as early as 1907, helped by a buy-back arrangement from the British Indian government, which also laid a railway link to the site. It was India’s first public–private partnership (PPP).

tatasteel

It took us over eight decades, till 1992, to come around to the idea that leveraging public resources with private management and investment was cleverer than autarkic public investment. It took another 25 years for us to come to terms with foreign investment. In the meantime, India missed the bus of industrialisation and manufacturing, even as China marched ahead, from the 1980s, to become the factory of the world.The short point is that making a policy is no panacea for achieving results.

Were the existing low-level of health outcomes unachievable without a policy?

Health is a state government subject under the Constitution in India. But a National was formulated in 1983. Despite three decades of central planning since then, health outcomes vary significantly across states and aggregate achievements are unimpressive.

Gradual privatisation of SOEs is ongoing because there is no policy to stop it

Balco 2

Conversely, structural change is often implemented without articulating a policy.Consider the privatisation of state-owned enterprises. The National Democratic Alliance government under Prime Minister Atal Bihari Vajpayee found it impossible to build a consensus around privatisation. A comprehensive privatisation policy was therefore, never attempted. The Industrial Policy Resolution of July 1991 — which sought to weaken the stranglehold of the government over industry — had shrunk the industries reserved for the public sector to atomic power, defence, mineral oil, mining of coal, iron and other metals and the railways. This enabled the sale of minority shares in the other public sector undertakings (PSU). Then finance minister Yashwant Sinha used the 1999-2000 Budget to reduce the reserved sector to “strategic” PSUs in atomic energy, defence and railways only. All others could be privatised.

Gradual disinvestment has been ongoing, primarily with the intention of raising revenue. This year the government anticipates an all-time high of Rs. 1 trillion from disinvestment, being 30 per cent of non-tax receipts, other than debt.Seasoned bureaucrats will advise never write something down, unless you need to.

Electricity remains a “vexed” business despite reform legislation and policy

Merely articulating aspirational objectives in a policy will not achieve results. This has become particularly true in an uncertain world, made even more unstable by technology development. Clunky state action tends to come late and gets clogged into stranded assets.

This is the fate of our Mega Power Policy with 30 GW of power generation stranded because of low demand or disrupted fuel supply. Policies create huge inertia. Consider that as late as 2015-16 the Budget Speech sought to create 4 GW of additional power capacity, even as stranded power assets were building up.

Foreign policy is different 

ASEAN

Some policies are intended to signal political alignment and intent rather than become an entry point for concrete action. falls clearly in this genre. The “Look East” policy of the Manmohan Singh government was followed by the “Act East” policy of the present government — both signaling our interest in South East Asia. But substantively little has changed in the years since, even as China has gone, from being a dominant economic power to a power-hungry bully in the region.

Paris 2016 – the world laid to rest, climate policy & switched to voluntary actionable metrics 

India does not have a comprehensive  We tend to put development before the environment — in exactly the manner other developed countries have grown. This is pragmatic. The 2016 recognises the futility of having a single for the world. Instead, it defines a global target — reversing aggregate carbon emissions to keep global temperature rise within 1.5 degree Celsius of pre-industrial levels. Countries now evolve their own action plan, keeping in view their development needs. Collective action works better than global posturing.

Imagine the impact on Google’s share value if it bound itself to follow a medium term policy

Consider that multinational companies do not formulate business policies in an autarkic manner. They define strategies which, nimbly align with global trends to  eke out the maximum value for themselves. This is a sensible approach. We should get away from announcing sector policies. Instead, we could define incremental and jointed action plans, which result in achieving national objectives.

Google folllows the money. We could follow the Directive Principles in our Constitution

happy girl

National objectives do not need to be defined afresh. A close look at Part IV of our Constitution will suffice. The Directive Principles of State Policy were formulated more than 75 years ago. Our task is to put in place the action points to achieve them, via the annual and medium-term budgets. Politicians love announcing policies and programmes because these can be narrowly targeted at specific beneficiaries for votes. This is the downside of the dharma of  We should junk sector policies as an instrument of development. Intellectuals will disagree. But pragmatism must trump ideals.

Adapted from the author’s opinion piece in Business Standard, February 26, 2018 http://www.business-standard.com/article/opinion/junk-sector-as-an-instrument-of-development-118022500673_1.html

Delhi babus – between a rock & a hard place

delhi strike

The breakdown of a working relationship between the Aam Aadmi Party (AAP) government of the National Capital Region and its officers is a seminal moment. On February 19, AAP legislators heckled, abused and allegedly assaulted Chief Secretary Anshu Prakash, the Delhi government’s topmost bureaucrat, at the residence of the Chief Minister (CM). Both CM Arvind Kejriwal and deputy chief minister Manish Sisodia were present.

The legislators allege that the chief secretary (CS) used intemperate language in the shouting match between them. Cross-first information reports have been lodged by the two rival parties with the police. Further investigations would reveal the facts.

Chief Secretary’s complaint is, primae facie, more credible

But the circumstantial evidence favours the chief secretary’s case. He was summoned to the CM’s house for discussions at around midnight. He found a group of 11 legislators and/or partymen — notably all male — assembled. He was made to sit on a sofa, sandwiched between two legislators, who subsequently assaulted him. The bone of contention, according to the CS, was that the legislators were outraged that TV advertisements on the completion of three years of the AAP government in Delhi were not approved in time. The CS avers the advertisements violate the Supreme Court guidelines for government advertisements. The AAP contends that holding up the advertisement, churlishly, is yet another instance of how the Central government uses the office of the lieutenant-governor (L-G) to shackle the state government.

The state government-level staff and officer unions have demonstrated and resorted to work-to-rule tactics against the criminal assault on a government servant while on duty — which attracts severe punishment under the Indian Penal Code. Two legislators — the alleged assailants — have been arrested. The Delhi government is in turmoil.

Partial devolution creates potential for conflict in operations 

Beyond the inter-personal behaviour issues, which may have sparked the conflict, a larger problem looms. Are institutional arrangements for governance in Delhi so fraught that they breed conflict between politicians and the hapless bureaucrats, who have to play to the tune of two masters?

Long-term observers would say that no, that is not true. After all, for over two and half decades since 1993 — when elections were first held for the Government of the National Capital Region — this is the first instance of violent conflict.

Delhi is just a “half-state government” — to twist Chetan Bhagat’s evocative phrase. The management of land, the police and the civil service remains with the Union government, represented by the L-G. If the same party is in power at the Centre and in the state government, any conflict can be resolved internally. This safety valve is taken away when different parties are in power.

In the past – guile, maturity and sagacity avoided a breakdown of governance

However, this is hardly the first time that different parties have been in power. In 1993-98 the BJP under Madan Lal Khurana ruled the state, while the Congress under Prime Minister P.V. Narasimha Rao ruled the Union government till 1996. In 1999-2004 the tables were reversed with Prime Minister Atal Behari Vajpayee of the BJP heading the National Democratic Alliance government at the Centre and chief minister Sheila Dikshit, of the Congress, at the state level. So why the open conflict this time?

One difference is, that on the previous occasions, when power was split in Delhi between two parties, both were national parties with mature leaders, well versed and socialised in working within the constitutional constraints of the separation of powers. Put simply, ever since Independence in 1947, a “Lutyens’ political set” has evolved, which often seems to have more in common with each other than their own party brethren from out of town. This is not unlike the Washington “Beltway” syndrome in the United States.

Its different now – the Lutyens consensus is shattered

Since 2014, this “Lutyens’ consensus” lies shattered. Prime Minister Narendra Modi shuns the airy, closeted politics of the Lutyens kind. He draws power directly from the masses. Arvind Kejriwal, chief minister of Delhi, is cast in a similar mould. He exults in being “common” — preferring sweaters to jackets even in Delhi’s winter, with a trademark muffler around his head to keep the wind at bay and is usually clad in sandals rather than shoes. His partymen emulate his casual dress style.

PM Modi and CM Kejriwal are zero-sum people

Mr Modi and Mr Kejriwal are both visceral men. Every election is a zero-sum game which must be won. Compromise is akin to defeat. This strategy has worked for both of them. Neither is likely to change.

Delhi has become the battleground for Goliath Modi to slug it out with David Kejriwal. When elephants fight, the bureaucratic grass is bound to get trampled. Anshu Prakash, the incumbent chief secretary, finds himself between a rock and a hard place. A mild-mannered old-school bureaucrat, he has none of the Machiavellian skills needed to become a trusted adviser, simultaneously, to two implacable political adversaries.

Poor devolution impacts all municipalities in India

Is this sorry state of governance an outlier? Unfortunately, no. Till 1993, Delhi was a Metropolitan Council working under the Union government. In the states, municipalities work under state governments. There is inevitably a potential for conflict, or at the very least neglect (as in Calcutta through the long years of communist rule in West Bengal), if different political parties are in power in the state government and the municipality. Delhi municipalities are currently ruled by the BJP. Their staff have demonstrated in favour of the Chief Secretary. They face symmetric harassment too.  Fuzzy separation of powers and functions and inadequate devolution of finance make local bodies dependent on state governments. This stops cities from becoming the fulcrum of participative democracy and keeps them from becoming vibrant growth centers.

Delhi is a tinder box for igniting urban class-conflict – restraint is advised

Delhi violence

More immediately, in Delhi, we need a truce. The AAP would relish being dismissed by the President of India on the charge of a breakdown in the constitutional machinery. Even as traditional Communist parties remain immersed in obscure, internal ideological battles, it is the AAP which has succeeded in igniting a genuine class war in Delhi, between the “haves” and the “have-nots”. Alas, there are too many of the latter. In this classic struggle, it is the establishment — the bureaucracy and the police — which bear the brunt of public frustration. A dangerous trend, which could be a tipping point, in urban governance.

Adapted from the author’s opinion piece in The Asian Age, February 24, 2018 http://www.asianage.com/opinion/columnists/240218/trouble-in-lutyens-land-babus-as-political-fodder.html

BJP self goals dim the shine

Gadkari 3

It is not often than an innocuous government statement becomes the fulcrum of a storm. The sudden announcement that Minister Nitin Gadkari’s plan to announce a policy for 100% electrification of transportation by 2030 was off the cards, sent shock waves through the industry and political analysts.

Subsuming Gadkari’s proposed electric vehicle policy in a broader Alt Fuel Policy makes sense 

To be fair, not having a narrow policy just for electric vehicles makes sense. Nesting actions, needed to achieve cost-effective electrification in transportation, within a broader “alternative fuels policy”, ostensibly, being prepared by the NITI Aayog, as disclosed by Amitabh Kant – the NITI CEO, who works directly with the NITI Chair – Prime Minister Modi, makes perfect sense.

It is good practice not to choose specific technical options via a policy. Instead, good policy formulation should specify a generic pathway to achieve the final outcomes- in this case lower carbon emissions, clean air and reduced congestion. In the best-case, simplistic scenario, tax incentives for the transportation industry, should be linked to the carbon emissions and road area saved per unit of travel, irrespective of the technology option adopted by them.

Leaving the technology option to industry – electric, hybrid or hydrogen-fuel powered, ensures that the market for innovation is not artificially distorted in favour of any technology.

Why put all our eggs in a China basket?

But, life is rarely that simple. Consider that China has emerged as the leading low-cost manufacturer of electric vehicles. They have also firmed-up supply chains of lithium for the manufacture of associated high efficiency batteries. Natural resource constrained Japan, is in contrast likely to push for a clean, hydrogen powered vehicle.

chinese-electric-cars

Strategically, our relationship with China is cool if not chilled. We lean towards a “Triad” of the US, Japan, India – for collaboration in security and transnational infrastructure development. The choice of Japan, as the partner for the Industrial corridors project to link Indian metros by fast passenger and freight trains and for the proposed Asian Africa Growth Corridor, are illustrations of such cooperation. Closer logistics integration with the US and Indian military forces, is another. Joint patrolling of the sea lanes in the South China Sea is yet another.

Clearly, relying solely on electrification of transportation, has strategic implications with respect to tying our future to China, which begs a more nuanced approach. Ministers Nitin Gadkari and Piyush Goyal might have thought up the electrification push, early in 2017 when Minister Goyal was in charge of Power, Coal and Renewable Energy, to absorb the stranded capacity of 30,000 MW in the power sector.

Boosting efficient electricity consumption by creating demand makes sense

The capacity of distribution utilities to absorb electric power is constrained by the low, regulated retail tariffs versus the higher grid cost of delivering power using coal or gas generation. This makes it sensible to explore alternative options for using power for customers who are willing to pay cost based retail prices for electricity. If additional solar capacity comes up to meet the target of 175 GW of renewable power by 2020 at grid supply prices of 4 cents per unit (kWh), capacity utilization in coal and gas-based generators will fall even lower than 60%.

white goods

Are cabinet ministers being shown who is boss?

Modi Jaitley

At the best of times there is more politics than economics in public policy formulation. But with elections around the corner, every action of government, acquires heightened importance. So, for example, could the trashing of Mr. Gadkari’s policy initiative be an indication that Prime Minister Modi is showing him who is the boss? Ministers Gadkari and Goyal are perceived to be the most effective members of the cabinet. With reverses in recent bye elections in Rajasthan and a perceived tough fight ahead in Karnataka and Madhya Pradesh, has it become necessary for PM Modi to flex his muscles to keep the cabinet orderly?

The PNB scam adds to the slight of losing three bye elections in Rajasthan

Political leaders are notoriously sensitive to perceived loss of power. Given PM Modi’s larger than life persona, this is surely, his personal Achilles heel. The BJPs lucky run over the first four years seems to be petering out. They could avoid responsibility for the Rs 10 trillion of non-performing banking assets they inherited from the UPA. But the most recent case of a fraud of Rs 110 billion in the Punjab National Bank due to poor controls and oversight by a clutch of banks shows that things have not changed.

The “no cash transactions” rule has hit the profitability of the diamond and gems industry 

More worryingly, the market capitalization of listed jewelry companies has become less than one half of their debts. Their profitability is plunging. Their interest cover ratio is barely above the red line of 1.5X with sundry debts increasing to 43% of sales.

Difficult to value jewels have always been a favoured route for hawala (over invoicing imports and under invoicing exports), which is one way to safely transfer black money abroad. Much of this is often brought back as FDI or more likely foreign portfolio investment in the stock market where returns have been generous, inflation has been subdued and the Rs artificially stable such that even exchange risk was minimized, at the cost of exports and at the cost of making domestic production uncompetitive versus imported goods.

Finance Minister Jaitley faces the heat for poor oversight over publicly owned banks

More importantly it is the timing of the expose which is like rubbing salt into the wounds of bye-election losses for the BJP, which campaigns based on “zero tolerance for corruption”. Unfortunately, Finance Minister Jaitley will be in the line of fire too, much as Minister Suresh Prabhu, was hounded out for recurring railway accidents.

Silence breeds discontent and distrust. Communicate please.

With barely a year to go for elections, the number of moving parts is increasing by leaps and bounds. The French Rafale fighter jet deal was also poorly managed. Even worse, communications outreach has failed to dispel the fiction, that it is another “Bofors scam”. Champions get moving when the going gets tough. The BJP had a fabled communications team leading up to the 2014 elections. Today, ensconced in power, the last thing on its mind seems to be, sharing carefully thought through public policy positions with citizens, in a credible manner. Not having an opposition has its own downsides. Or is it the BJP’s unerring instinct to dim the light, just when it is shining.

Also available in the TOI blogs February 17, 2018 https://blogs.timesofindia.indiatimes.com/opinion-india/bjp-self-goals-rub-off-the-shine/

Union taxes are scraping the bottom

old men

The introduction of a 10 per cent tax on capital gains (with effect from April 1, 2018), accruing from the sale of equity, after holding it for at least one year, has generated a great deal of angst. But it is unconscionable that stock market investors who have earned windfall gains of 30 per cent over the past year should mind paying three percentage points out of that windfall as tax.

The government has gone further and “grandfathered” from the tax all equity-related capital gains accruing till January 31 — the day prior to the Budget 2018-19 proposals being made public. The stock market slid by about six per cent thereafter. Future gains will depend upon better profitability in Indian corporates; the options for alternative risk-free returns in developed markets (US treasuries, for example, which are likely to have higher spreads) and growth in India.

Even wealthy Indians dislike taxes

The new long term capital gains tax is not onerous in the present context. But at the heart of the discontent with it, is a corrosive aversion to pay tax, even by the very wealthy. There are good reasons why we are habitual benders of the rule of law.

To find the reason for this national shame, look no further than our political leaders. The Election Commission turns a Nelson’s eye to the yawning gap between actual election expenditures and the income of parties on the books. The recently introduced Election Bonds are unlikely to bring about a transformative reform.

No crony capitalist wants to be identified while buying these bonds from designated banks. Privacy of information arrangements are easily breached, to ferret out who contributed how much to which party.

Demonetisation did throw up big data on the ownership of cash. But following up on suspected tax evaders is quite another matter. The options of bribing their way out or legally delaying a final decision reduces the incentive to respect the rule of law. We are then back to square one. During the demonetisation of November 2016, 99% of the cash came back into the banking system, because tax evaders innovated, on the fly, to escape the tax net.

No wonder then, that the tax revenue at the Central level is stuck at just below 12 per cent of GDP with an additional 10 per cent in the states and local governments.

scraping bottom

Growth need higher public spends

The conundrum is that higher growth needs higher public spends of around 6-8 per cent of GDP on infrastructure, health and education. India has underinvested in these for decades. The real problem is that tax revenues are difficult to increase with 40 per cent of the population being either poor or vulnerable to fall into poverty.

China innovated best-fit solutions to boost public revenues

China had the same problem. Their solution was to decentralise development decision-making within a broad party line of priorities. Local government and local party offices worked together to monetise government assets — principally land — for private development projects. The proceeds from such monetisation generated the resources to finance infrastructure and increase spending on health and education. Without a doubt, the dynamics of working with the private sector also lined the pockets of party and government officials. But both were held to account if there were failures in achieving development targets.

India too is turning away from template solutions

The good news is that India is changing. Prime Minister Narendra Modi has made chai vendors respectable. Our next Prime Minister may do the same for pakora sellers — much derided today by some, who look down their noses, at anything but formal sector jobs. But Shekhar Shah, director-general of NCAER, a New Delhi economics think tank, cautions that formalisation, China style, can be a double-edged sword.

Formalisation of work and rising inequality

Yes, formalisation does improve work conditions and facilitates production at scale. But formalisation is often linked to capital intensive production, which results in disproportionate benefits to those, with access to capital. Unless managed with great care formalisation takes away from rewarding livelihoods for people in the bottom 40 per cent with traditional or low-level skills. President Kagame of Rwanda — till recently a darling of donors, because of his rapid adoption and implementation of the “doing business” type of performance metrics — runs a spotlessly clean capital, Kigali, with neat markets. But this is at the expense of street vendors who were priced out by the prohibitive cost of a licence.

Innovations in public finance lacking

We need to innovate, to increase government revenue, without trying to copy China. The 15th Finance Commission could be crucial in tweaking the transfer of resources to states and local government in a way which incentivises them to generate more local revenues. That is where a significant contribution to aggregate government taxes can be made, as suggested by the Economic Survey 2018-19.

Every Rs 100 spent from the budget can leverage an equal amount from the private sector.

The mantra for government spending is simple. Big ticket public development spending (both revenue and capital) must generate at least a similar level of private investment as extra-budgetary resources. Funding the premia for providing health insurance to 100 million poor families is one such scheme which can change mindsets and provide the forums for productive collaborations between the Central and state governments and the private sector. There is enough fat hidden away in the 2018-19 Budget to fund the scheme.

The National Health Insurance scheme can lead by using insurance permia to establish private or not-for-profit hospitals  

A ready market already exists — in urban and peri-urban areas, covering around 40 million poor families, as private hospitals are accessible. With an annual premia amount of Rs 20,000 crores, a similar sum as private investment can be leveraged in new healthcare facilities. Insurance companies, which will enjoy the bonanza of publicly-funded premia, will need to work with the healthcare industry to enlarge access to hospital facilities in under-covered areas. Similar state-level health insurance schemes should be allowed to lapse. States should divert their funds instead, to primary care, nutrition and public health.

Government should pull out of being the interface with citizens for service provisioning 

The government must, in a sequenced manner, pull out of the business of direct provisioning of services, except in disaster situations. Central,  state and local governments must learn to use the power of public finance to leverage private capital and management. A big push for outsourcing public services might be the only way to fill the financing gap between aspirations and today’s sordid reality.

Adapted from the author’s opinion piece in Asian Age February 13, 2018 http://www.asianage.com/opinion/columnists/130218/innovate-outsource-to-fund-deliver-services.html

Post-budget stocks – Storm-in-a teacup

bear

Those who live by the stock market must pay for their indiscretions. The stock market slid by 2.7 percent on February 2, 2018 – the day after Budget Day; by an additional 0.88 per cent on Monday, February 5, followed up by a further slide of 1.6% on February 6. in tandem with the global sell-off sparked by crashing US markets.

Its the Bond Market stupid?

Lazy analysis would pin the roil, in India, at the usual open-economy problem of capital flight to safety from small markets making them catch cold when the US sneezes. But a closer look tells a more granular story. Of course hot money will move about in search of higher risk adjusted return. So if the fed fund rate rises in the US to a 3% real return some foreign portfolio investors will move out. But consider that on a 6.5% growth and 4% inflation, the Indian stock market grew at 28% over the last year. There is plenty of room for the let the hot air out and still end up reaping a 8% real return in US$.

Media hysteria around the stock roil is over the top, as usual. Consider, if the stock market slid by 5.3% over three trading days post budget since Feb 2, the value which was lost was value added on since as recent as January 5, 2018 when the SENSEX was at 34154. On Feb 7 the stock market is roughly at the same level. India is high growth story with working markets. There are not many such markets available in the world where 8% returns in US$ are reasonable expectations.

Retail investors will rue their panicked selling

To be sure, panicked retail investors, who have sold their shares are the losers and heavy weight “bears” who drive markets by selling today and buying forward in the hope of buying back the same shares at a lower price, have gained. Note that even their capital gains till March 31, 2018 is free of long term capital gains tax. So bears have scored a double victory – taxless capital gains and re-purchase at a lower price. Brokers are also smiling because they make money of both sales and buys.

For small investors, the lesson is that despite the hype, what happens in the US stock market must not dictate their actions in India. Our markets rise and fall due to a variety of reasons- not just what is happening in the US. There is enough financial fire-power with domestic institutional investors to substitute, a temporary flight of foreign hot money to the US.

Domestic drivers of stock markets 

Stepping back here is an alternative story of why Indian stocks fell post budget.

Will inflation rear its ugly head again?

inflation 2

First, inflation fears arising out of the Budget proposals. The fiscal deficit this year has overshot to 3.50 per cent of the GDP, with no respite likely even next year. Mix this with the possibility of oil prices increasing further and the picture turns toxic.

Oil prices (Brent) started increasing from US$ 46 a barrel in end July 2017. They reached US $60, three months later, in end-October 2017. The high of US $70 came in mid-January 2018 with a subsequent cooling off to US $68 per barrel this week.

Consumer price inflation in India, was at 4.5% in 2016-17. Thereafter, it declined through the first half of 2017-18 but increased to 4.9 per cent in November 2017. But food prices tapered off, so 2017-18 is likely to end, with a similar inflation level as 2016-17.

Note that crude oil price increase during the second half of 2017-18, of around 50 per cent, has not directly fed into Indian inflation because government passes only a marginal proportion of crude price changes to final consumers.
2017-18 was a perfect storm. Growth reduced by at least 1 per cent due to the shocks of demonetization and introduction of the GST. These negatives have abated. Direct tax collection this year is 2.5 per cent higher than budgeted. Next year they are budgeted at 14.4 per cent higher than receipts this year. Receipts from GST next year are budgeted at 54 per cent higher than this year. These positives illustrate that broad fiscal stability around 3.5 per cent of GDP is possible, even if crude oil continues to trade at $70 in 2018-19.

Fiscal policy in 2017-18 has prioritized putting income in the hands of consumers – government pay and pension hikes; pro-poor income support (MGNREGA) and farmer income support at the expense of publicly financed investment in infrastructure. More income with consumers creates aggregate demand for better utilization of the surplus manufacturing capacity. Reviving exports – driven by an uptick in world trade – will also absorb some surplus capacity and create value. Inflation fears are consequently overblown.

Global ques only deepen domestic bearish trends.  

Second, the big bear of multiple increases in the US Fed funds rate, to cool an over-heating domestic US economy, has been looming over developing markets. Last week Bond prices fell, pushing up yields in US and Europe, in anticipation of increases in the fed rate. However, yesterday, bond yields pulled back up.  The signals are unclear. More likely it is domestic drivers which are punishing markets.

India has uncovered financial fire power post the crack down on cash and carry

Third, we have a large community of around 40 million domestic investors in our stock markets. Around Rs 1 trillion flooded stock markets, post demonetization, as the earlier mouth-watering returns in realty and cash and carry trade dried up in January 2017. Savvy intermediation by mutual funds and portfolio management companies facilitated the switch into financial assets by investors.

Churning your portfolio helps your broker more than you

But most investors buy and sell based on trust, led by their share brokers. These market participants are likely to have advised investors to sell and book their capital gains in anticipation of the long-term capital gains tax (10 per cent of capital increase) being imposed on all equity sell trades from April 1, 2018.

This advice is flawed since it ignores provisions, sensibly introduced by the Budget, of “grandfathering” capital gains till February 1, 2018. It makes little sense to sell in a turbulent market, unless you desperately need the money. But who can shake an investor’s faith in their trusted share broker -who incidentally, earns a fee on both the sale and the re-investment in – what else but shares!

Government needs to steer the ship of state steadily- no surprises please

The recent experience with demonetization has not helped. Uncertainty in financial arrangements is crippling and its trauma lingers. Under such circumstances, rumors acquire an undeserved potency, over reason.

Fall out of imposition of dividend distribution tax in FY 2018-19

Fourth, treasury management requirement of mutual funds, particularly for their “dividend based” schemes, could also have prompted a sell off. The budget has proposed a 10% dividend distribution tax on equity mutual fund schemes, to level the tax imposition on capital gains (the basis for investor earnings in growth-oriented schemes) and dividend distribution (the basis for investor income in dividend-oriented schemes). Mutual funds will try and distribute the maximum dividends to their investors, in this fiscal itself, to save them the tax imposition next fiscal. This requires mutual fund to sell equity holdings to generate the cash required.

At the risk of gross simplification, 60 per cent of the sell-off, of around 3.5% of market capitalization till close of February 5, 2018 was due to investor uncertainty about future taxation and the treasury needs of mutual funds. Inflation fears possibly drove 25 per cent of the sell off, whilst global cues were responsible for the residual 15 per cent. The good news is that this sell off is temporary. Stock markets are now back to, where they were just a month ago on January 5, 2017. A mere storm in a tea cup, created by investor exuberance in anticipation of a “please all” budget.

Buying into India’s growth story will recover the tax you pay though growth

lioness

So, hang onto your shares and count your blessings over time. If you hold an equity portfolio of Rs 20 lakhs, an 8 per cent dividend payout of Rs 160,000 will attract a tax of just Rs 16,000 – easily absorbed by postponing purchase of a microwave oven. In the case of additional capital gains, over and above the higher of the purchase price or the market price of the share on February 1, 2018 –-assuming a gain of 15 per cent or Rs 300,000, is just Rs 30,000. Making do with the existing car tyres would do the trick. Anyway, eating out and taking the metro or a taxi are rational and possibly pleasurable substitutes.

Adapted from the authors opinion piece in Indian Express on February 6, 2019 http://indianexpress.com/article/opinion/post-budget-uncertainty-global-cues-drives-market-selloff-5053028/

Jaitley’s Budgetary Trident

Jaitley trident

In these cynical times, slim is the market for big ideas, unsupported by facts and figures. The Finance Minister’s 2018-19 budget proposals have met the same fate.

The three big picture proposals –a price assurance scheme covering all Kharif crops at a minimum 50% above their cost of production; boosting agri-product exports from US$30 billion to US$ 100 billion and NamoCare – providing free health insurance for 500 million poor Indians – are being referred to, snidely, as preparation for the state elections this year, closely followed by general elections by in April 2019.

There is some justification for the criticism. The means for supporting these transformative activities are not transparently embedded in the budget. Where is the money to do all this, demand the naysayers?

Imagining the future

hospitals

Piyush Goyal, Minister for railways, remarked, in response to a similar question asked of him on ITV, that those who lack the imagination to think big, are forever dissuaded from “parting the seas” (not his phrase) by the accounting problems. There is some truth in what the Minister says.

NamoCare the game changing first fork of the trident

Let’s take NamoCare first. The budget provides a mere place holder of Rs 20 billion as premia. No estimate of the likely premia were shared. In subsequent press meets numbers ranged from Rs 100 billion (@Rs 1000 per family) to Rs 400 billion were shared by different official spokespersons. Such waffling does not inspire confidence.

Lazy pre-budget preparations are typical outcome of a party having overwhelming majority in parliament. Over time parliament is viewed as a mere inconvenience. It stops being, the key forum to get genuine buy-in for proposals in public interest.

There is little doubt that NamoCare is in the public interest. Heath coverage in India is abysmal. Well-off citizens, government officials and politicians are publicly funded to seek medical treatment in private hospitals rather than risk the vicissitudes of government hospitals. Citizens spend two thirds of the total spend on private health care.

It is in this context that NamoCare could be a breathtaking transition. This writer has a Rs 5 lakh health cover from a government insurance entity. Extending a similar health care cover, for free, to 100 million – the bottom 40% – Indian households, is a huge step towards universal wellness. It also shreds the status quo today, where “class” determines the quality of public service available to citizens. NamoCare is the great leveler.

Is NamoCare unviable and likely to bust the budget? The minimum likely premia is around Rs 5000 per family. This is the existing cost for a Rs 2 lakh family health coverage. Scaling up the turnover can l distribute the risk reducing costs. Scaling up the coverage will enable the government to negotiate down the cost of medical treatment with the health care industry.

Think of NamoCare as a viability gap public funding program to improve the quality of diagnosis and healthcare, rather than the cosmetics surrounding the industry today. Many private hospitals look better than fancy hotels. But the quality of health care may not match up. It is not as if, “best fit” healthcare models are not available in India.  Sankara Nethralya, in Hyderabad, is one such which combines “cut rate” prices with international quality health care.

Despite multiple private insurance companies, only around 210 million Indians (17% of the population) has in-hospital medical care cover of the generic type proposed under NamoCare. The market would be enlarged by 2X when NamoCare comes through. This means a massive incentive for expansion of the private health industry to serve the poor. It is the equivalent of Unilever’s shampoo in a sachet to level product use between the rich and the poor.

But most interestingly, once the bottom 40% are covered along with the top 20%, it is inconceivable that the middle 40% would remain outside the market. Full coverage of the Indian population within five years would create a private health care market at globally unprecedented scale. This is what the Finance Minister meant when he called NamoCare an aspirational proposal.

NamoCare emulates the success of the government financed scaling up of the market for LED bulbs, accompanied by a steep 75% reduction in the price of bulbs, without subsidization, using purely scale economy effects on production.

Critics of the proposal should think of the outlay on NamoCare as a demand boost for kick starting investment in private health care which incidentally is an employment intensive services.

The rural fork

The second fork of the trident are a revised scheme for assuring cost plus purchase of all Kharif crops or direct payment of the difference between the administered price and the market price (if it is higher) to farmers. This aligns with the pilot being implemented by Madhya Pradesh.

Clearly the direct payment option is superior although “big data” based oversight system would be necessary to ensure that “viability gap” payments are not made for the same produce, repeatedly, as was the case with the famous Integrated Rural Development Program financed cattle, in the early 1980s.

The real issue here is whether this is an equity enhancement support scheme or a productivity enhancement scheme. There is much truth to the criticism that the practice of assuring administered prices is inefficient. It promotes the status quo in which big farmers gain at the expense of small farmers who anyway do not have much surplus to market.

Also, it plays to the fanciful view that small farms are more productive than large scale mechanized farming, by making the existing farming practices seem viable. This can only prolong the pain in the context of doubling the productivity of farming. However, one half of rural income comes from farming. Changing the status quo must be done sensitively, aligned to employment opportunities in nonfarm activities, generated by growth.

Agri-exports to be liberalised

Another aspect of the rural fork of the trident is the most potent albeit the most innocuous. Mr. Jaitley has promised that agricultural exports would be liberalized. Their export can increase from $ 30 billion to their full estimated potential of $100 million. Total exports are around $ 270 million, so the target is substantive.

The minimum export price for onions has been slashed to zero – as if in response to the Finance Ministers budget assurance. But the truth is that we have a bumper harvest of onions this year and prices have crashed by around 20% over last year’s kharif crop arrival in Maharashtra – the key producer of onions.

We need to do away completely with the practice of putting regulatory controls on the domestic marketing, exports and imports of agriproducts if we are to develop a robust and productive farm sector. Farmers will be watching out for follow on measures to walk the talk of liberalizing exports.

The fiscal fork

The third fork of the trident was on the revenue side. After a gap of two decades, long term capital gains tax was reintroduced on equity. The stock market expectedly slid by around 2%. Should we worried? Dr. Manmohan Singh once famously brushed aside the stock market as a metric for the mood of investors. Stock market short term movements are created by punters who try and make a killing by anticipating or even creating the public mood.

So, hang onto your stocks. The downturn is temporary. By holding on you spoil the game for professional “Bears”, who short-sell stocks in the hope that they can buy them back cheap, after you have disposed off your stocks.

Others are worried Foreign Portfolio Investors (FPI) will exit triggering a long-term downturn. FPIs are driven by relative profit. Even after a 10% tax on capital gains, the Indian market remains vastly more profitable that what they make back home. Even if they exit following a “risk” derived algorithm, they will be back, once the bottom line starts hurting and if growth in India holds up.

Exit by FPIs could be a blessing. The INR exchange rate could drift down to more realistic levels, diluting the disincentive for exports and pricing imports at competitive levels.

Competitive exchange rates, is a preferred option for Make in India than the selective enhancements in customs duty on imports of electronics proposed in the budget. Beyond the WEF rhetoric, there are good reasons for using trade to enhance domestic competitiveness.

Without competitive pricing, medium term capital allocation signals get distorted; generate anomalies and stranded cost like our stranded capacity of 30,000 MW in power. Poor capital allocation is the consequence of cheap bank capital, industrial slow down magnified by an export slow down; the 2016 demonetization shock and the crippling, but healthy, impact in 2017-18, of GST, on manufacturers, who profited primarily, by operating in the black economy.

Mr. Jaitley’s trident is a powerful instrument to enhance equity, generate growth with “good” work and bring about transformational social changes in India. Not supporting is being short-sigh.

Also available at TOI Blogs Feb 4, 2018 https://blogs.timesofindia.indiatimes.com/opinion-india/jaitleys-budget-trident/

FM walks the budget plank gingerly

happy kisan

The Union Budget 2018-19 appears an honest and judicious construct when first viewed on video. Reading the fine print takes some of the shine off, going by precedent. The biggest relief is that there has been no substantive deviation from the path of fiscal discipline. The fiscal deficit for 2017-18 is pegged at 3.5 percent of GDP. This is 0.30 per cent higher than the budgeted estimate for this year.

But it is well within the 0.50 leeway recommended by the N.K. Singh Committee report on Fiscal Responsibility and Budgetary Management. Disruptions caused by GST still linger. Banks need to be recapitalised to expand new credit and public investment pushed because the private sector is still sitting on its funds. The stage seems set for walking through the door opened by the FRBM committee, in the interest of growth and jobs.

More reassurance comes from the fiscal deficit target for 2018-19 set at 3.3 percent of GDP. This re-establishes the declining trend for fiscal deficit towards the magic number of three per cent of GDP, which has eluded us so far.

Marginalised agriculture gets a break 

On the expenditure side, agriculture and rural development take centrestage. This is welcome against the backdrop of agrarian distress and farmer suicides. Ajay Jakhar of the Bharat Krishak Samaj points out that an Indian farmer commits suicide every 40 minutes. No wonder then that Mr Jaitley outlined, in great detail, many of the specific measures proposed to reverse this trend.

One popular, but possibly ineffective step is an assurance that all the crops notified for the kharif cycle will be covered under the minimum support price (MSP) scheme. This means that if market prices fall below the cost of production plus 50 percent as margin for the farmer, the government will stand committed to make good the difference (as is being done in Madhya Pradesh now) or to physically procure the produce.

Ajay Jakhar

But representatives of farmers’ interests are not satisfied. They want the methodology for setting costs should be spelt out in a participative manner to ensure that a meaningful MSP is assured. The downside of an MSP type of production incentive is that it kills innovation and discourages crop diversification away from those covered under MSP. This way of assuring farmer incomes also privileges the traditional “Green Revolution” areas in the North, which unfortunately are not well endowed with the natural resources — water, for example — to sustain intensive modern farming. On the other hand Eastern India, has all of nature’s bounties, but it is too far away from the national capital-oriented policy making we follow. Consider how different things would have been if Lord Hardinge had not decided in 1911 to shift the capital of the British Raj from Calcutta to Delhi.

Agro-products exports to be liberalised – $100 billion potential

Other big-ticket items in agriculture are a more than doubling of the outlay for agro-processing industries to Rs 14 billion and assurances that the export of agri products would be liberalised to boost their exports threefold to their potential of around $100 billion. Corporate tax on income was also reduced from 30 percent to 25 percent for firms with a turnover upto Rs 2.5 billion (US $35 million) benefiting 99 percent of the registered firms in India.

Bamboo the new “green gold”

bamboo2

For the Northeast, a Mission for Bamboo – now recognised as a grass and not a tree to facilitate its commercial cultivation – with an outlay of Rs 13 billion. Two new infrastructure funds — one for fisheries and aquaculture and another for animal husbandry — at a total outlay of Rs 100 billion. Crop credit would increase by 10 per cent to Rs 11 trillion in 2018-19 and lessee farmers would be facilitated to access crop credit from banks — something which they cannot do today and have, instead, to rely on rapacious moneylenders.

The budgetary outlay for rural roads, affordable houses, toilets and electricity extension of Rs 2.4 trillion will leverage five time more funds from other sources and generate work for 10 million people, per the Budget documents.

NamoCare is bigger than ObamaCare – health-equity in motion

Big changes were also announced in healthcare. A new flagship scheme will provide in-hospital medical insurance to 100 million poor families with an insurance cover of Rs 5 lakhs. Compare this with the measly cover now available of Rs 30,000 only under the Rashtriya Swastha Bima Yojana. The outlay on health, education and social protection increases by around 13 per cent over the 2017-18 spend to Rs 1.4 trillion. Simultaneously, the three publicly owned general insurance companies – National Insurance Company United India Insurance Company and Oriental Insurance Company are to merged to create a behemoth conservatively valued at Rs 4 trillion and listed on the stock exchange. Listing would enable the government to progressively hive off equity in them to the public and generate the estimated Rs 1 trillion per year premium to fund this mammoth programme, nick-named NamoCare after ObamaCare of the US. The scale of the ambition embedded in the program is breathtaking. A Rs 5 lakh cover is what even the well-off deem sufficient as health insurance. More importantly it signals that for the government the life of the poor is as valuable, as that of a well off person.

Incentives for generating employment rather than buying machines

The government proposes to extend the existing scheme under which it meets the cost of a contribution of 12 percent per year towards the Employees’ Provident Fund contribution in the medium, small and micro enterprises to all the manufacturing sectors. The idea is to increase the attractiveness of employing young job seekers by reducing their cost to the employer for three years, by which time it is expected the skills they acquire will make their value addition viable on its own.

Infrastructure development – falling short

The highlights for new projects in infrastructure are that 99 smart cities have been selected with an outlay of Rs 2.4 trillion,  against which projects worth around 10 per cent of the outlay are ongoing and projects worth one per cent of the outlay have been completed. The government expects to complete 9,000 km of highways in this year. Bharat Net, the fiber connectivity programme, is also proceeding apace. The Railways will spend Rs 1.48 trillion on capital investments, mostly in new works in 2018-19. Six hundred railway stations are to be upgraded.

The nominal GDP in 2018-19 is estimated to be 11.5 per cent  higher than in the current year. The total expenditure next year is around 10 per cent higher than the estimate for 2017-18 of Rs 22.2 trillion. On the revenue side, the big increase is an estimated increase of 53 per cent (after accounting for the fact that GST was collected only for 11 months in 2017-18) in GST revenues next year by around Rs 2.6 trillion to a level of Rs 7.4 trillion, and a conservatively assessed Rs 20,000 crores from the new capital gains tax of 10 per cent on equity sold after holding it for one year. The huge increase assumed in GST and the undefined budgetary support for “NamoCare” make sticking to the 3.3 fiscal deficit target a bit dodgy in 2018-19.

FM keeps his gun-powder dry and in-reserve

Jaitley budget 2018

But who knows, maybe the finance minister has some artillery hidden up his sleeve.. Disinvestment has been assessed conservatively in 2018-19 at Rs 80,000 crores, against the achievement this year of Rs 1 trillion. The bank recapitalisation support of Rs 80,000 crores is expected to leverage new lending capacity of Rs 5 trillion. One cannot but  feel that some of the expenditure estimates are a bit conservative relative to the ambition embedded in the programmes.

The good news is ending 2018-19 with a higher fiscal deficit but equal to this year’s at 3.5 per cent is no big deal from the view point of fiscal stability, if all of it is pumped into infrastructure and other investments. But for the Narendra Modi government, which takes targets seriously, it would be an unhappy ending.

The blog and the article mistakenly mention the estimated value of a merged insurance behemoth as Rs 400 trillion. The error has now been corrected in the text. I am deeply embarrassed by this snafu. A more reasonable number is Rs 4 trillion. Regrets.

Adapted from the authors article in The Asian Age February 1, 2018 http://www.asianage.com/opinion/oped/020218/fm-walks-the-talk-honestly-and-judiciously-but-very-diffidently.html

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