governance, political economy, institutional development and economic regulation

Posts tagged ‘Realty’

Navigating India’s “perfect storm”

BeltTight

(photo credit:www.webmd.com)

It’s final now. The run of good luck PM Modi enjoyed has tapered off.

The monsoon is likely to be deficient by 12%. This would be the second year in a row. True, agriculture only accounts for around 15% of the economy and didn’t grow much last year either. But when you target 7.8% growth every basis point, added or lost, counts.

Manufacturing and services growth is already slow. Companies are at best cautiously optimistic but the caution makes new investment sticky. The money and jobs spinning realty sector, driven earlier by negative interest rates, is in a slump.

To complete the “perfect storm” scenario there are two important state level elections around the corner-Bihar later this year and UP in 2017. Neither state has BJP governments currently, so doing well in these will inevitably be a metric of how strong the Modi magic remains.

The good news of course is that every threat is also an opportunity. This is PM Modi’s opportunity to show that he is the Lion we think him to be.

Fiscal stability disaster prone

First, more will need to be spent on drought relief; restructuring of bank loans for farmers and income support schemes for farm workers. Delhi, admittedly with a miniscule rural area, has already distributed Rs 50,000 per hectare as relief for the farmers hit by the April 2015 unseasonal rain. FM Jaitley is possibly right that the drought will be localized in North and Central India. But these regions account for around 45% of the farmers. Retaining the targeted revenue deficit at 2.8 % and public investment at 14% of the budget will consequently be tough.

Postponed subsidy reform

Second, it is unlikely that subsidy corrections will now be possible this fiscal. Cheap electricity, water and fertilizer are here to stay with a possible relaxation of the tight minimum support price policy of the last few years.

Higher wage cost

Third, a significant expansion in the wage bill looms. For the armed forces it is the One Rank One Pension promise of the PM.  For the Civil Service the recommendations of the 7th Pay Commission are to kick-in from 2016. Luckily the wage bill is low by international standards- 1.6% of GDP and 14% of the budget. But even small incremental increases, unless accompanied by efficiency enhancing restructuring, are not affordable this year.

This perfect storm of shocks cannot be wished away. Better to deal with it upfront. Here are five suggestions:

Winning the market perception battle

First, don’t be cowed down by stock market fluctuations or seek to pander to them. These are short term adjustments by speculators and not reflective of annual economic prospects. Consequently, rather than play down the “perfect storm” scenario it makes sense for the government to highlight the extreme shocks they are battling with to keep economic growth growing. Even in this David versus Goliath scenario, what is key is to share a plan of action on disaster management; income support; and realigning revenue expenditure to retain the revenue deficit and investment target.

Nothing much was heard about the recommendations of the Bimal Jalan, Expenditure Management Committee (August 2014). But it could provide some useful strategic, short term revenue expenditure rationalization measures.

Cut the Red Tape

Second, stressful times also create an environment conducive for administrative reform. PM Modi’s can quickly lick babudom into shape through positive strokes. He should consider setting up a lean but empowered “Decision Support Team” in his office, manned by ten senior Joint/Additional Secretary level officers selected for their expertise in key sectors; their ability to persuade and their flair for collaborative performance.

They would be mandated to speak for the PMO and be tasked to work with the key ministries and state governments to cut through red tape holding up investment decisions. Working against weekly targets with real time feedback to the PM, the mantra for this team should be “ANA- Achievement Not just Activity”.

Those taking up such high tension assignments should expect to be on the fast track to become Secretaries to the GOI.  The PM is known to be cagey about trusting officers beyond a tiny circle familiar to him. This is not surprising given that he has never worked closely with the babudom in Delhi. But he should experiment by subjecting a larger group to the “agnipariksha” of performance. He will not be disappointed with the results.

Forget the optics of who gets the credit

Third, the knotty problem, particularly in Bihar and Uttar Pradesh, is how to be proactive in the face of state governments, which have the incentive to rebuff such support as being politically motivated.

The farmer does not distinguish between the state and the Union government (Lokniti Survey 2013) – 58% held both the state and the Union government responsible for the sorry plight of agriculture. If farmers fall through the gaps of political finger pointing, they will punish both the BJP and the SP-in Uttar Pradesh and the JD (U)-in Bihar. The beneficiaries of apathy will be Bhenji (Mayawati- the BSP supremo) in UP and Lalu Yadav in Bihar. Doing little is not an option for the Union government despite some of the shine rubbing off on the SP and the JD (U).

Don’t rattle the private sector

Fourth, it would be a big mistake to take too seriously the campaign to paint the BJP as a consort of the corporate sector. When stern action is warranted, it must be taken transparently and without rancor or bluster. But a “Preet Bharara type” of regulatory action is not what we need. Jobs are what the average citizen wants, which only the private sector can generate them.

Strong arm regulatory actions against foreign investors are bad optics- both for investment and for citizen sentiment. If our regulatory agencies are seen to be handmaidens of the government, they lose credibility. But the government also loses by devaluing an efficient instrument for regulating the private sector in a hands-off, technical manner.

Sticky revenues

Fifth, boost revenue. The tax receipt scenario is grim. First, projections for the year were over optimistic at Rs 14.5 lakh crores (US$ 230 billion) around 16% higher than the previous year. Tax receipts are bound to slide with slow external and domestic demand and lower corporate profits, despite the 15% increase in the rate of service tax. A tax receipt equal to last year’s estimate of Rs 13.7 lakh crores (US$217 billion) or 9% more than the actuals of last year is the best we can hope for- 5% points due to inflation and 4% points due to growth of the taxable base.

Getting more tax payers into the net is a worthwhile but effort intensive option with limited upsides. In 2013-14 there were 47 million direct tax assesses. New assesses have varied between 1 to 3 million per year since 2011. Even doubling the number of new assesses helps only marginally in additional revenue.

Transferring the crown jewels to citizens

There is more upside in fast tracking disinvestment. Listed Public Sector Undertakings (PSU) account for 13% of the valuation of the Bombay Stock Exchange or around Rs 13.6 lakh crores (US$ 215 billion). Of this, some equity is already held privately by minority investors. But an additional 10% can be sold without diluting government’s majority control. The problem is that, in the past, Institutional Investors have been the primary takers for such shares. Retail investor appetite has been largely absent from the tumultuous stock market for some years now and market momentum has been primarily provided by Foreign Institutional Investors.

Selling PSU shares in large volumes, without transferring majority control to the private sector, dampens the market price. Even the private IPO market is slow. Government is wary of inviting the charge of crony capitalism by selling shares to large institutional investors at cheap rates.

On the other hand, selling directly to retail investors is more defensible even if the price is low. After all the “Crown Jewels” really belong to citizens. Dispersing the ownership of PSUs widely also meets multiple objectives. Why not borrow a leaf from Dhirubhai Ambani’s 1982 market making strategy and incentivize the retail investor back into the market?

Link disinvestment, as a sweetener, to the issue of government debt for retail investors only – special convertible bonds – with a fixed return for three years at the prevailing Government Bond rate. 50% of the face value could be optionally convertible on termination in 2018-19, into a balanced bouquet of public sector equity at a 15% discount to the then prevailing market price.

A sequenced, mega issue of Rs 1 lakh crores (US$ 16 billion) of an asset backed government security can reduce the short term risk profile of PSU equity investments and pull in finance from an alternative source.

Government must come out with an evidenced strategy to deal with the “perfect storm” India faces. Of course, the PM is a “lucky General”. The drought may not materialize; the world economy may sort itself out and the opposition in Bihar and UP may self-destruct. But waiting for this to happen may be pushing the Gods too far.

Budget 2015: Swap higher outlays for efficient spending

jaitley dnaindia.com3  

(photo credit: http://www.dnaindia.com)

A cold Republic Day had FM Jaitley looking dapper under his stylish cap as he snuggled into his overcoat on a rain lashed Rajpath munched nuts and broodingly watched the parade go past.

PM MODI’s OFF-SWING

Was he fleshing out what he would say in his budget speech to the Indian Parliament just one month away?  Should he bowl a leg-spin veering sharply left towards equity or an off-swing veering right and towards growth? Around him, on its 66 Republic Day, Modi India was visibly exhilarated celebrating its “off-swing” to the right.

China, possibly stung by this sudden change of events, after the cozy, bon homie of the recent jhula swing on the banks of the Sabarmati, retorted by clasping Pakistan even tighter as an eternal friend. Meanwhile the Greek “loony left”, united with the “loony right” to aspire to become a sovereign debt defaulter with the rest of Southern Europe waiting to follow, should their anarchic tactic succeed.

SOVEREIGN DEBT STRATEGY

Avoiding payment by default is not a new strategy. Latin America similarly exploited the short memories of lenders with serial debt defaults.  In contrast Asia, in general and India, in particular, has been very puritanical about its debt obligations, never having defaulted even once in the last forty years, though we came close to it in 1991.

Whilst morally correct, it is unclear if this is a good fiscal strategy. Standard and Poors rates India sovereign debt BBB-, the same as Brazil (which defaulted thrice-1983, 1986 and 1990 in the last 40 years) and lower than Peru-BBB+ (which defaulted twice in 1980 and 1984). From this perspective, debt default is not about “prestige”, “national honour” or about financial rewards. It is merely a game of brinksmanship to be played with the market, if it serves us well.

Was FM Jaitley pondering the merits of doing a Latin America; borrowing recklessly to finance a populist, public investment binge, which “growth-wallahs” are crying themselves hoarse demanding?

Borrowing more is the “soft” option to reforming expenditure since tax collections have dipped. Our borrowing capacity for FY 2015-is limited by a Fiscal Deficit (FD) envelop of 3.8% of GDP, down from the target of 4.1% in the current year. Even the higher FD level severely constrained resources though this constraint remained hidden. The previous UPA-II government put so many non-fiscal barriers on investment-lengthy environmental approvals; land acquisition constraints and contractual inconsistencies which ensured that the project stream froze thereby avoiding additional cash outflows.

The present government is working overtime to unclog the pipes and clear payment arrears. These have built up over time but they do not show up in the budget. Unlike Indian companies, the government follows the “cash” and not the “accrual” accounting system. Both unpaid current liabilities and uncollected current assets are not accounted for in the annual budget. This loop hole enabled the previous government to “sell our future” by collecting arrears whilst falsely showing a robust budget allocation.

GROWTH AND INFLATION

Indian “growth-wallahs” are prepared to risk inflation if it means pushing growth to 7% from the 5.5% it is likely to record in the current year. But the trade off, at the margin, between growth, inflation and jobs is unclear. This is dangerous ground for those living on the edge.

Growth is just a meaningless number for the average citizen. Jobs are welcome of course. But we do not have a “jobs filter” that can assess competing investment.  We do not even measure changes in employment through the year. In comparison inflation is an everyday reality which the poor and the urban lower middle class have to battle with daily.

If there is a choice between growth and more inflation, the FM would be well advised to choose containing inflation to below 5% even at the cost of chugging along at a 6% growth level.

PUBLIC INVESTMENT IS HIGHLY INEFFICIENT

The real question is if the domestic and international private sector is unwilling to invest, as for example in Nuclear energy, how can it be desirable for public investment? Clearly, an unhelpful institutional context makes these investments into “lemons”. Unless the root causes of their unviability are addressed, such projects are neither good for the private nor the public sector.

Public investment stoked growth is strongly dependent on the efficiency of public expenditure and the avoidance of “pork”- gold plated projects which fail to provide social returns and jobs. Excessive investment in new renewable energy (a rapidly evolving technology) has precisely this risk.

NO BUBBLES PLEASE

Of course the stock markets will not be enthused by such fiscal caution. But who really gains from the irrational financial exuberance (or despair) of stock markets except a few savvy speculators with deep pockets- not all of them Indian either.

Real Estate is another sector which should be left to lag not lead growth. It is a safe haven for “black money” fed speculation. Five years of cheap money since 2009, high inflation and massive corruption are the drivers of the Indian realty bubble. We have to guard against such bubbles, which consume the savings of the middle class, as in Japan (1980 to 1990) and more recently in the US (2004 to 2012).

LOOKING BACK TO THE FUTURE

One stratagem to inject conservatism into the budget would be to project the FY 2015-16 budget on the growth and revenue numbers which were achieved in 2014-15.

Looking backwards to define the fiscal envelop will further constrict spending estimates. But this would be a useful, albeit unorthodox mechanism, to drive better collection of tax and non-tax revenues and contain “pork” in the spending estimates.

If there are “happy” surprises – revenue exceeding estimates or growth exceeding forecast levels, the surplus generated could be allocated to pre-defined schemes in a supplementary budget later in the fiscal year. Leaving something on the table is good strategy anyway to keep stakeholders engaged and responsive.

Our biggest worry is that populism will trump reason. Subsidies are the elephant in the room of fiscal responsibility. Rationalizing them has become a political hot potato with potentially high political costs. This is why reform needs to be both well timed and appropriately sequenced.

LIMITED REFORM WINDOW

FY 2015-16 is the only reform window available to India for the next four years. If we can’t do it now we never shall. The 2016-17 budget shall be populist since Bihar (2016), UP (2017) and then Rajasthan, Karnataka, Madhya Pradesh and Chhattisgarh go to the polls (2018) followed by National Elections in 2019.

Can we, for starters at least, legislate a cap on subsidies just as there is a medium term trend and cap on FD? We don’t know enough about the extent, substance, nature and social impact of subsidies. Why not make these aspects more explicit by changing the way in which we present the budget documents?

Two subsidy reform steps are immediately doable.

First, making petroleum prices market determined is a no-brainer in the present scenario of cheap energy. This will plug one gap in the subsidy envelop.

Second, rationalize agricultural subsidies which are provided through multiple mechanisms; assured purchase prices for cereals; cheap fertilizer; cheap power; cheap irrigation water; no tax on income and minimal tax on land. Despite these subsidies, rural wages remain low and migration to urban areas is the only options for landless workers and marginal land owners.

These subsidies have only served to create a class of elite “millionaire” farmers; a tiny fragment at the very tip of the 600 odd million strong farming community. Why not use it to better target the poor, rural folk instead? An additional advantage would be that the rural poor have a significant overlap with Dalits and Muslims, neither of which are part of the BJPs traditional support base.

Will FM Jaitley grasp the moment and push through reform or do we have to wait till 2020 for substantive change?

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