governance, political economy, institutional development and economic regulation

Posts tagged ‘Interest rates’

Saintliness versus efficiency

BJP winner

The BJP can put India on auto-pilot over the next eighteen months and probably still win the next general election, principally because, things are going well and the combined opposition has still to acquire the characteristics – leadership, resolve and broad agreements – of credibility. This high probability of winning in 2019 should push the BJP to evolve strategies, rather than tactics, particularly for the economy.

The key decision – morality or results

The key decision is to choose between prioritising morality or efficiency. The former entails more public delivery, the latter more private enterprise. Going down the moral route, say “zero tolerance” for corruption, has severe consequences – continued economic dislocation over the next two years; losing out on economic growth and inhibiting the availability of jobs. In a largely informal, cash based economy, like India, putting anti-corruption first, requires the private sector to reorganise, become more efficient and profitable, other than, by just avoiding tax. Whilst this adjustment plays out, the state – despite it being more inefficient than private enterprise – would need to step in with an enhanced role. The moral choice puts us on the long route to efficiency, which could last, well into the second term of the government starting 2019.

Corruption has its uses

The “amoral” choice is to junk the fundamentalist approach to anti-corruption, fix one’s eyes on the objective of high growth and navigate the waters by feeling the stones underfoot, to avoid deep pools, where corruption and inefficiency, overlap the most. Some examples of such action are – sticking to a reasonable “real” interest rate rather than go for an artificially “low” interest rate. The latter may enhance investment. But it comes at the cost of possible future stressed assets via “gold plated” bank-financed projects. Similarly, choosing Direct Benefit Transfers rather than the physical provision of subsidised public goods of indifferent quality is another example, which reduces corruption and enhances efficiency. But, in many other cases, the choice is not so obvious.

Corruption can be functionally efficient. Consider the case of information asymmetries – shorn of jargon, this simply means that it is not easy to know how or why government acts in a certain manner – whilst awarding contracts; appointing employees or allowing its assets – like land, to be misused.

Democratising access to information

If I bribe an official to understand the politics around a pending economic decision, corruption ends up “democratising information”, which is what a perfectly “transparent” system would achieve in Norway or Sweden. Consider, that prisoners in Indian jails bribe guards, merely to get minimum sanitary and nutrition conditions. Turning a blind eye to such “corruption” is “amorally pragmatic” till prisons become more acceptably habitable. After all, prison is meant to reform not penalise prisoners through health hazards. Petty corruption is the common persons way of dealing with administrative inefficiency.

Morality tends to exclude private enterprise

So, why does morality and a “big” state go together? Consider a government, which is stuck with a poorly motivated; inadequately qualified and shoddily managed workforce. Suppose it chooses to bypass public inefficiency by outsourcing public service delivery to the private sector. How will they oversee the private provider? Poor drafting of agreements and enforcement of contractual obligations generates corruption or delays execution. This is what took the fizz out of the juggernaut of Public Private Partnerships. Why for instance, did Mr. Piyush Goyal, the minister of railways decide to call in the Army to repair the collapsed pedestrian over-bridge at Elphinstone Station, Mumbai? Could it be that, contracting private parties, on an emergency basis, inevitably has lags and creates opportunities for corruption? We saw a lot of this in the run-up to the Commonwealth Games, New Delhi in 2010.

Preferring to work in-house is the obvious safe, default option for an executive which is capable and willing to work 24X7. The downside is that extensive use of state enterprises crowds out the private sector, which is hard put to better the riskless cost of finance available to the public sector. If publicly managed service delivery is sustainable, there is no harm in that. But not every public leader is an efficient “saint” and public systems, set-up by them, revert quickly to the mean, once the leadership changes.

How many Saints do we have?

Saintliness, humility and frugality make great copy and attract votes. The problem lies in scaling up a system based on virtue and otherworldliness. It is not for nothing that the competitive spirit -so important for sustainable efficiency- springs from the basic “killer” instinct to be numero uno. Saintliness is also rigid in adapting to the world. Effectiveness – getting results on the ground,  requires flexibility in implementation.

“Jhooming” can’t generate shared growth

closed market

A tax system with high nominal tax rates, which is efficiently oppressive can reduce supply because producers and service providers will shut shop, rather than risk getting their personal assets forclosed. This is worse than a tax system, which is not completely evasion proof but encourages growth in value addition. Black money, in progressively, smaller doses over time is better than a clean but scorched economy. Unlike in nature, “jhooming” may not generate shared growth.

Also available at TOI Blogs November 15, 2017

Albert Pinto’s Gussa Redux


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The defining feature of India today is bottled up, seething anger. It erupts unexpectedly anywhere — in the plush drawing rooms of the rich, on our choked roads, in crowded, middle-class colonies over parking rights or in the ramshackle dwellings of the poor, over imagined insults and petty money disputes.

Saeed Akhtar Mirza’s 1981 celebrated film — Albert Pinto Ko Gussa Kyoon Aata Hai (What makes Albert Pinto angry?) starring the blessedly talented Naseerudin Shah, explores the roots of societal anger. It concludes that, contrary to modern liberal belief, it is difficult for individuals to go from zero to hero overnight. Society functions best when individual expectations align with the pace of social change.

Political pundits have forever advised politicians not to raise expectations too far beyond what can be realised or delivered, precisely to avoid such a backlash of sullen resentment or angry outrage. Yet, this has never stopped politicians from continuing to make rash promises.

Contrast this with the behaviour of bureaucrats, who are usually conservative with promises and targets. This could be because they have little to gain from aiming high. With no upside, why take a risk? Is risk aversion holding governor Raghuram Rajan of the Reserve Bank of India from lowering interest rates and thereby risking inflation? This could be one, albeit implausible, explanation.

Alternatively, maybe, the RBI governor and his team have watched Albert Pinto… carefully and remember that nothing can be worse than creating expectations and not meeting them. This government was voted in on the plank of restoring fiscal stability and providing jobs. Inflation can totally disrupt both objectives.

The political problem, of course, is the 10 million young people, who join the workforce every year. They voted the government into power and are now looking for the jobs they were promised. Telling them now that they lack a job because they lack skills, is a Kafkaesque googly that could result in a Pinto-type outburst on a massive scale. Hence the political pressure to kick start growth.

But what is the surety that lowering interest rates alone will result in more jobs. The world is finally flat — at least in terms of prospects for economic growth. In this dull market, with large inventories and surplus manufacturing capacity, new manufacturing jobs can only be created by ramping up protection for domestic industries. This option, as anyone who has driven an Ambassador car will know, has disastrous long-term consequences for productivity and competitiveness.

A better option to increase the competitiveness of Indian exports and provide protection to domestic manufacturing, would be to depreciate the INR as China and other competitors have done. But here again the ghost of potential inflation lurks via higher landed cost for petroleum and edible oil. The possible flight of foreign capital threatens the stock market and the external account. The higher cost of servicing the foreign debt of businesses is also a downer.

In any event whilst the macro-economic variables are tweaked, direct, rapidly deployed interventions for growth and employment are needed to meet expectations. Three “win-win” options stand out which are reasonably non-inflationary; targeted at jobs and quickly implementable.

First, get a grip on administrative reform and focus on tangible outputs and outcomes. The determination to get the Goods and Services Tax (GST) implemented by April 1, 2016 shows the way, as does the focus on ramping up highways construction and making Indian Railways more efficient.

Second, the steps being taken to increase domestic coal production via the transparent allocation of mines and gas production via price incentives for exploration in difficult fields, are necessary foundational work, albeit with medium term benefits.

More immediately, the Union government needs to restructure the accumulated loss of Rs 2 lakh crores of the electricity distribution utilities, as was done previously-albeit at a much smaller scale- in 2001. This is the only way to reactivate the demand side and realise the downstream benefits of enjoying, for the first time, an idling surplus generation capacity. But the 24×7 “electricity for all” mission can only be sustainable if it is linked to reasonable cost recovery for the utility and the complete stoppage of theft. This is one subsidy hole which is completely avoidable.

Third, an interim option to whip up “employment”, in these troubled times, is to offer a two-year National Service Mission for all young citizens of ages 19 to 25. One million young adults, each paid a stipend of Rs 6,000 per month by the government, could be offered this opportunity with a relatively nominal annual outlay of Rs 14,000 crore. For the young, this interim employment could be a “holding plan” while they look for a job. For the government, it buys time to create the environment for incremental private employment.

To weed out the rich, the poorly motivated and the faint-hearted, these young men and women would need to work in the 6,000 rural development blocks which dot the country and acquire skills on-the-job, in forestry, agriculture, irrigation, civil engineering, policing, security, public health, sanitation and education. They would function as management trainees and be placed according to their aptitude, education and skills. Trainee doctors are already required to do such service.

If the scheme were to be presented as just an opportunity for the unemployed and the poor to earn some money, it would end up being a less useful replica of its cousin, the Mahatma Gandhi National Rural Employment Guarantee Act. To brand the mission appropriately, it must attract the educated young across the social and economic spectrum.

To profile it as an option for high achievers it should be made compulsory for all aspirants to public office — budding politicians, potential judges and future civil servants — to start by experiencing life at the bottom of the public service ladder even before they fight an election or take the entrance exams.

Considerable social benefits are possible by bringing together the young from disparate groups in a competitive environment over extended periods. The resulting cohort networks of “desh sevaks” would be unique. Unlike educational or social networks these would cut across class, regional and religious rigidities and narrow the gap between “people like us” and “others”.

The first step in anger management is to feel equally responsible for the situation one is caught in. Albert Pinto and his ilk might have been less disillusioned and less angry had they had the chance to be a “desh sevak”.

Adapted from the authors article in the Asian Age August 13, 2015:

Budget to Build Institutions

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

How can we rework our formal institutions?

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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