Book Review: Repo And Its Masters

A RBI governor remembers his doughty fights, but cuts down on the math

WHO MOVED MY INTEREST RATE?
BY DUVVURI SUBBARAO
VIKING | PAGES: 323 | RS. 699

Central banks have been labelled exotic beasts: rarely seen in public, much less understood. Realisation of what central bankers do has been seeping in slowly. Over the past few decades, as bond and currency trading acquired gargantuan propor­ti­­ons, the arcane world of dealers kept a close watch on every statement coming out of central banks, parsing each phrase and analysing each nuance. Any action, or the faintest hint of a future one, had the potential to affect currency prices, bond rates and indi­vidual fortunes. This need for analysis and interpretation also produced a large tribe of writers called ‘central bank watchers’.

Over time, as societies overwhelmingly bec­a­me dependent on debt— for housing, education or buying their next television—larger sections of the population got interested in the central bank’s actions. Any increase or dec­­rease in interest rates, or liquidity conditions, had a direct impact on household incomes and lifestyles. And yet, despite this growing interface, cen­­tral banking remains shrouded in a mysterious and inscrutable cloak.

Former Reserve Bank of India governor Duv­vuri Subbarao makes a valiant attempt to lift this veil and demystify a central bank’s workings. This is a first and we hope this will enthuse others to share their views. But there are two ways of viewing the book’s purpose. One, in trying to explain a central bank’s operations, Subbarao creates an opportunity to justify his actions dur­ing 2008-13, a period of stubbornly high inf­l­ation, extraordinary exchange rate volat­ility and an unprecedented (and unbroken) spree of interest rate increases. A converse view is also possible: its primary function is to rationalise his actions and he uses it to dec­ode the RBI’s actions and working styles. Which set of lenses have been used? The narrative str­u­cture and the tenor seems to suggest it’s the latter.

This becomes clear as one ploughs thr­ough an otherwise eminently readable account. The book’s pre-launch publicity focused on the governor’s well-publicised conflicts with former Union finance ministers P. Chidambaram and Pranab Mukherjee. Central bankers have traditionally shared antagonistic relationships with fiscal authorities. The book dwells at length on Subbarao’s differences of opinion with Chida­m­baram and Pranab, and how rising prices and a slowing economy widened the rift between Mumbai’s Mint Street and Delhi’s Raisina Hill.

But, with due apologies to Shakespeare, met­hinks the governor doth complain a bit. This is not to imply he was wrong in his stand on interest rates. Subbarao stood up against the collective might of the government, Parliament, a misinfor­med finance sector and uninformed commentariat by defending his right to raise interest 13 times in quick succession. He explains quite expansively why the situation warranted such drastic action. The fiscal and monetary expansion post the 2008 trans-Atlantic financial crisis, without adequate investment in production and supply capacities, embedded inflationary tendencies in the economy. Given political leaders’ reluctance to tighten fiscal reins, it was left to the monetary authority to attempt demand compression through interest rate increases.

Face-offs between monetary and fiscal auth­orities are built into the design; Subbarao mentions as much in the book. In times of crisis, both work in lockstep, as was evident after the 2008 meltdown. But, the impact of an expansionary fiscal policy on inflation and economic growth was ignored by the political class and India’s cossetted business interests. Much of the book describes this clash of ideals.

But there are gaps in Subbarao’s acc­ounts—both when describing clashes with North Block or when recounting challenges faced during vital post-crisis moments. Here are two examples.

First, there’s no mention of his immediate predecessor’s track record. Subba­rao mentions Y.V. Reddy only in passing while mentioning how crisis forced him to rev­erse his predecessor’s string of interest rate increases. We are not asking for public display of dirty laundry. Reddy too had to contend with a frequently (and publicly) remonstrating finance ministry. Reddy’s interest rate increases, to burst speculative asset market bubbles, earned him unstinted praise from economists and observers worldwide.

But, here’s the thing. Subbarao was fin­ance secretary when Reddy was busy inc­reasing interest rates to stave off risks. Interestingly, even Chidambaram was fin­ance minister during that period and he made public his displeasures with Reddy’s insistence on rate hikes. It would have been interesting, and more honest, if the book also disclosed Subbarao’s role as Chidambaram’s finance secretary in his engagements with Reddy, and the lessons learnt from those interactions before moving to RBI. Subbarao limits his interface with Reddy to discussions on RBI’s balance-sheet; I am sure there must be more. If the governor is going to reveal all about his skirmishes with political authorities, his interaction with RBI as finance secretary should also be fair game.

Two, there’s not enough explanation about how the RBI managed its balance-sheet in the aftermath of the crisis. Or, enough inside dope about the crisis days following the closure of Lehman Brothers. Subbarao describes how the monetary tap was kept open at full tilt to give the financial sector confidence that funds were always available. This was largely a signalling and confidence-building measure to avoid payment imbroglios or defaults which get amplified into panic during crisis times. As part of the strategy, RBI kept repo rates (the interest rate at which RBI lends to banks against government securities) low; but the reverse repo rate (interest rate at which RBI accepts money from banks against securities) was always kept 1.5 per cent higher. This was particularly true of December 2008.

Interestingly, this rate difference converted RBI—usually known as a lender of last resort—into a borrower of last resort. Banks would occasionally use the repo window to smoothen temporary mismatches, but would dump far excess cash with RBI’s reverse repo window. Clearly, credit aversion in the immediate aftermath of the crisis forced banks to seek safe havens for their surplus cash. Given money’s fungible character, we also do not know if banks borrowed from the repo window, turned around and tipped over the same money at the reverse repo window, thereby earning a neat 1.5 per cent without breaking into a sweat. The central bank’s annual report for 2008-09 (June 30 year-ending) highlights this anomaly: outstanding repos shrunk to Rs 895 crore (previous year Rs 22,805 crore) and rev­erse repos swelled to Rs 88,335 crore (previous year Rs 300 crore). This surely had some consequences and it would have been interesting to know Subbarao’s views.

But, beyond this, Subbarao has done a superb task of shedding some light on a central bank’s specialised role, especially by making it accessible to a wider spectrum of readers. He uses simple language and infuses some humour when necessary. It stops short of being a complete masterclass because encounters with the political class keep intruding. But somebody needed to talk about these incidents because the public rarely gets to know how both institutions interact. Yet, it also doesn’t do full justice to the political economy of Indian central banking. So, what is it, a book on central banking or an expose? I see it as setting the record straight.

This book review first appeared in Outlook magazine and can also be read here

Book Review: The Wrong Idea of America

A former White House aide and economist makes a surprisingly sloppy appraisal of US’ problems

The Price of Prosperity: Why Rich Nations Fail And How To Renew Them
Todd G Buchholz
Harper, an imprint of HarperCollins Publishers
367pp; $29.99

Brexit has eloquently demonstrated what a terrible bummer nostalgia can be. Wallowing in a sense of persecution and aching for long-lost days of glory, British leaders ceaselessly campaigned to leave European Union; and, nostalgia made for a good tool to rouse, exhort and even to delude. But with “leave” leaders and campaigners increasingly abandoning ship, it is quite evident that nostalgia has limited currency in good governance.

Author Milan Kundera was rather cutting about it: “In the sunset of dissolution, everything is illuminated by the aura of nostalgia, even the guillotine.” When former empires and superpowers refuse to go gently into the fading light or remain steadfast in denial about reality biting their heels, nostalgia is a helpful analgesic that numbs the pain.

Todd G Buchholz uses this anaesthesia to quite remarkable effect. His latest adds to the growing list of works harking back to an imagined ideal period, keen to revive an illusory greatness. This sense of “greatness” is also quite unidimensional, with some of modernity’s post-War distortions embedded deep.Greatness of another kind

The author’s mission is simple: he sets out to diagnose what’s gone wrong with his great country — and here greatness is primarily a shorthand for prosperity — and how it can be revived. But do not be misled by the words “Rich Nations” in the title; this book is mostly about the US. His prescriptive analysis also betrays his politics, which often dips into partisan territory; ironically, he remains blissfully unaware of just how much this limited political worldview has eroded his “great’ nation.

For example, he laments how the Barack Obama administration has not taken advantage of current low interest rates by issuing long-tenor bonds of, say, 50 or 100 years’ maturity. Locking into long-maturity bonds at rock-bottom rates does indeed make sense. Instead, he sees White House opting for the shorter end of the yield curve because interest rates are usually lower at that end. And, here comes the conspiracy theory: lower interest rates help deflate debt-to-GDP ratios and provides an illusion of a lower budget deficit, “flattering the president’s fiscal profile”.

Strangely, the author ignores how a partisan Congress has dogged President Obama’s executive actions. Is there a possibility that the Obama administration issued short term bonds to avoid a combative and obstructionist Congress, which needed any excuse — including bonds longer in maturity and higher in interest rates — to trip up the president?

It’s also funny that Buchholz should complain about short term holdings: as former managing director of Tiger hedge fund, he should know a thing or two about them.The immigrant’s case

Buchholz’s starting hypothesis posits that as nation-states get prosperous, their birth rate drops. Consequently, there are more elderly than young working people. Who does all the work then? The immigrant, of course. And, then he remits his earnings home. Ergo: the immigrant should be integrated better into the American society, so that he can look up to George Washington as a forefather, even if he surrounds his Thanksgiving turkey with some ethnic dishes.

So there it is, Solution No. 1: a strange nationalistic formula that can cure numerous economic ills. His nationalism is also time-stamped: it must pay obeisance to only cultural icons adopted in the past 240 years; whatever existed before July 4, 1776, is not worth knowing. Nationalism also means regaining GMC — grit, mobility and confidence — which defined American exceptionalism in the past.

This is a strange salmagundi of suggestions, which flirts with patriotism without trying to sound too reactionary, strains to accept immigrants without sounding xenophobic. Anecdotal evidence makes up for actual facts, poor research leads to hypotheses, history is used to suit pre-determined conclusions.

Let’s look at poor research: “Traditional Hindu culture honours boys above girls, since the religion requires that parents be buried by a son.” Will somebody please educate Mr Buchholz on Hindu funeral rites, especially since Hindu Americans make up almost 1 per cent of the country’s population.Missing in action

And that’s exactly the nub of everything that’s wrong with this book. While dwelling upon patriotism and nationalism in good motherhood, apple-pie American style, Buchholz misses the US’ main fault-lines — growing inequality — or the myriad reasons behind stagnating real incomes.

It is glib to point fingers at outsourcing but how do you sort out Corporate America, with its flawed governance structures and undue focus on three-monthly profits (which rewards large-scale retrenchment if it helps nudge up stock prices)? Buchholz is silent. Not a single word about how strong, public institutions made the US a true liberal democracy and how their decay is perhaps an important cause behind the slip from “greatness”.

There is also no mention about the US’ hegemonic role in global negotiations, which has systematically eroded multilateralism. The US was one of the principal founders of the post-WWII global multilateral architecture which was then successfully subverted to suit narrow, partisan, private corporate interests. And, of course, Buchholz refers to the 2008 meltdown as a “global” financial crisis, which in itself is symbolic of how blinkers have narrowed the fabled American vision.

In trying to attempt a broad-brush future manifesto for the US, Buchholz may have bitten off a bit too much. There is a lot of research, but some of it fails to meet strict academic rigour and some of it is pointless. The book is readable, written in fast-paced prose and that is it’s only saving grace.

This book review was originally published in The Hindu BusinessLine. It can also be read here.  

Key GST Lessons From The World

The long march to implement the long-awaited Good and Services Tax in India has just begun. It is instructive to understand how other countries introduced this tax and cherry-pick lessons from their experiences

As India gets ready to celebrate the 70th anniversary of its independence, it is also preparing for another important milestone. Great hopes have been pinned on the Goods and Services Tax (GST), which will liberate Indian citizens from the tyranny of multiple levies and tax rates. This tax will unite almost all state and central indirect taxes into one single category, thereby creating a true single market in the country.

The passage of the Constitution (122nd amendment) Bill on 3rd August in the Rajya Sabha marks the crossing of the first hurdle in implementing the transformational GST regime. However, there is still substantial legislative work to be done – apart from the amendment (which will now travel to the Lok Sabha, the President’s office and state assemblies for ratification), Parliament will have to vote in two further bills to make GST a reality.

Beyond the legislative workload, Indian administrators and businesses will need to do their homework before this reality sets in. There are approximately 140 countries in the world that have introduced GST (also called VAT, or Value Added Tax), and there are manifold lessons to be drawn from their respective implementations.

Malaysia was the most recent country to implement GST in 2015, having announced its intention to do so in 2009. Malaysia’s experience highlights how inadequate preparation can hamstring the tax’s speedy implementation from the outset.[i]Malaysian businesses and tax authorities had a harrowing time adjusting to the new system, which was riddled with uncertainties and teething problems. The Malaysian government had to contend with street protests by small businesses and traders who were confused by the new system—whether in calculating the correct value-added rates, or in seeking tax credit refunds. Unsurprisingly, opposition political parties found it opportune to fish in these troubled waters, adding to the government’s mounting operational woes.[ii]

There was another layer of complexity. Malaysia had a multiple GST rate structure, much like the one proposed in India. A 6% GST (among the lowest in the world) was introduced, with some essential goods exempted and some goods attracting a zero rate i.e they were not exempt and could be taxed later. India too has proposed a multi-tiered structure, which will be finalised by the GST Council whenever it is set up.

Two clear lessons emerge from the Malaysian experience. Under pressure to launch GST as soon as possible, the Indian government must resist temptations to truncate the implementation process, which will include the training of tax officers and business executives. A presentation by revenue secretary Hasmukh Adhia estimates that 60,000 tax officials in both central and state governments will need to be trained.[iii] GST is a tectonic shift in the indirect tax architecture: the point of taxation shifts from producers to consumers, requiring a significant reorientation in philosophy and perspective. This overhaul cannot be completed unless the technology backbone is in place and all the relevant economic agents are registered. That alone is a mammoth task. There should, therefore, be no compulsion to implement GST by April 2017 if either the system is not fully tested or all the pieces are not firmly in place.

A related issue almost tripped up Malaysia’s GST experiment: the timely payment of input tax credit refunds.[iv] Unless the necessary technology infrastructure is installed, it can take months to refund tax credits, thereby creating cash flow problems for all links in a supply chain. This can easily convert GST supporters into detractors. Delaying tax credit refunds leads to protracted litigation and provides perverse incentives for the supply chain to stay outside of the organised system.

A second set of lessons can be drawn from Singapore. The city-state introduced GST in 1994 but witnessed a sharp rise in inflation soon after its introduction, mirroring the experience of many other countries.[v] Although inflation rates tend to moderate after a couple of years, the Indian government must be prepared for an initial surge because of India’s unique supply-side pressures, which tend to firmly embed inflationary expectations in households and businesses. India can consider what many countries did: initiate anti-profiteering measures at the retail level to protect consumers from price gouging.

Subsequently, the Singapore government faced other predicaments, like t the need to increase GST rates without stoking inflationary pressures. Eventually Singapore did increase GST rates (from 3% in 1994 to 7% currently), but simultaneously cut income tax rates (both at the individual and corporate levels) and accelerated the delivery of welfare benefits to lower income sections.[vi] While GST is efficient, it can also be regressive, especially for low income workers or pensioners. The Indian government therefore needs to be cognisant of this, and act cautiously.

The final set of lessons come from Canada, which introduced GST in 1991 amidst great internal conflict and disagreement. In fact, at the tax’s introduction, three provinces–Alberta, Ontario and British Columbia–even sued the federal government for violating constitutional agreements and limits. But over the years, Canada has pioneered a unique system that allows for three different models to co-exist.[vii] [viii]For example, Quebec is permitted to administer its own value-added tax alongside a federal GST. Quebec is responsible for all tax administration in the state, independently determining its tax base, independently fixing the state VAT rate, and even remitting federal GST collected in the state to the central government for a fee.

Compared to Canada, India has been able to forge a broad consensus among most states through a process of negotiation and compromises. The only point of disagreement remains the GST rate, which has been entrusted to the GST Council. This may lead to intense political manoeuvring with demands for special status or special rates. Tamil Nadu has already expressed its dissatisfaction with GST.

These examples clearly illustrate that the GST battle has barely begun: there are many mountains to climb, and multiple fires to extinguish along the way. The process of bipartisan consultation and consensus-building with states and various stakeholders must continue to make GST a cornerstone of successful and sustainable fiscal federalism.

This feature was exclusively written for Gateway House: Indian Council on Global Relations. You can also read it here.

References

[i] Pachisia, Vivek; Lessons from countries that have implemented goods and services tax; Financial Express; July 28, 2016;http://www.financialexpress.com/economy/gst-lessons-from-countries-that-have-implemented-the-goods-and-services-tax/331289/

[ii] Dey, Sudipto; Some Lessons From Malaysia That India Can Use; Business Standard; New Delhi; June 13, 2015; http://www.business-standard.com/article/economy-policy/gst-some-lessons-from-malaysia-that-india-can-use-115061300748_1.html

[iii] Adhia, Hasmukh; Goods and Services Tax: Next Steps; Department of Revenue, Ministry of Finance, Government of India; New Delhi; August 4, 2016;http://finmin.nic.in/press_room/2016/GST_nextstep_04082016.pdf

[iv] Beh, Yvonne & Tan Yi Lin; GST In Malaysia: One Year On; Wong and Partners; April 2016;http://www.wongpartners.com/files/Uploads/Documents/Type%202/WP/al_kulalumpur_gstmalaysia_apr16.pdf

[v] Ilias, Suhaimi with Zamros Dzulkafli, Ramesh Lankanathan and William Poh; Malaysia: GST- Early Impact Assessment; Maybank KimEng; April 2015;http://info.maybank2u.com.sg/pdf/investment-insurance/misc/misc-15-04-15-3.pdf

[vi] Singapore Government; How Is the Government Helping to Mitigate Inflation in Singapore; December 14, 2012; https://www.gov.sg/factually/content/how-is-the-government-helping-to-mitigate-inflation-in-singapore

[vii] Kumar, Sanjay with ML Sukhpal, Sandeep Rawal, Ashok Kr Pandey, Samar Nanda; Policy Paper on Role of Central Board of Excise and Customs in GST; National Academy of Customs, Excise and Narcotics;http://nacen.gov.in/inspire/uploads/downloads/569887ea212d1.pdf

[viii] Sharma, Radheshyam with JK Simte, MK Sarangi, KGVN Surya Teja, Sydney D’Silva and Manish Thapliyal; How to achieve administrative harmony between centre and states in the GST regime; National Academy of Customs, Excise and Narcotics; January 6, 2016;http://nacen.gov.in/inspire/uploads/downloads/56989a961d524.pdf

GST: Adding Edge to Exports

The GST will not only advance domestic market efficiencies but also add teeth to India’s economic diplomacy by improving the ease of doing business and enhancing competitiveness for exports.

The passage of the Constitution (122nd amendment) Bill, 2014, on Wednesday allows for the launch of the Goods and Services Tax (GST), a unified and pan-national tax structure. GST will create a common domestic market, remove distortions arising out of a multiplicity of levies and rates, and foster efficiency by minimizing the cascading effect of taxes in the manufacturing chain. GST will also have a beneficial impact on India’s economic diplomacy, including foreign trade.

The GST fits nicely into the Modi government’s drive to improve ease-of-doing business in the ‘Make In India’ campaign. Manifold taxes, with differential rates in different states, created hurdles for the smooth conduct of business and added costs at every stage, frustrating foreign investors. Foreign Investment decisions and the expected rate of return from projects often suffered due to these distortions, occasionally even deterring fresh investment plans. Most global value chains, with the exception of Foxconn, have avoided investing in India because of regulatory and bureaucratic tangles, especially those related to the multi-layered tax regime.

The successful implementation of GST will reverse this, helping to attract new investments especially from global value chains which often aggregate inputs from different constituencies.

The other immediate beneficiary will be Indian exports which have long suffered from lack of international competitiveness due to differential taxes and the energies expended on complying with the complex tax labyrinth. A 2010 report from National Council of Applied Economic Research had found that eliminating cascading taxes on exports could increase GDP growth by 0.9-1.7 per cent.[1]

For instance, a garments manufacturer and exporter has to depend on multiple suppliers of inputs – finished cloth (processed and dyed), threads, buttons, zips, sewing machines, ironing products, packaging, labels – for producing his finished good. These suppliers in turn, source raw materials from multiple sources, located in multiple locations, each party paying multiple taxes in different tax jurisdictions. At each stage, goods get delayed in transit for assessment and payment of varied levies – sales tax, octroi, excise, service tax. This fosters inefficiency and adds costs to each additional layer for the exporter. In addition, with each state legislating separate laws, meant that exporters couldn’t claim full set-off on the free-on-board price, rendering exports uncompetitive.

GST will alleviate this. The Foreign Trade Policy (FTP) for 2015-20 says: “The simplification and harmonization of the indirect tax regime of the country will reduce the cost of production and lead to a seamless, integrated Indian market, thereby making Indian trade and industry more competitive.”[2]

The benefit to services exports will become clearer in the next few weeks, but right away, the travel, tourism and hospitality sector is a clear winner because of its dependence on a wide spectrum of vendors and suppliers.

As the implications and impact of this simplifiying legislation starts to make itself apparent and the GST’s advantages for incoming foreign investment and out-going exports gain momentum, it will add veracity to Prime Minister Modi’s on-going economic diplomacy efforts.

This feature was exclusively written for Gateway House: Indian Council on Global Relations. It can also be read here.

References
[1] National Council for Applied Economic Research, Moving to Goods and services Tax in India: Impact on India’s Growth and International Trade, December 2009,<http://fincomindia.nic.in/writereaddata/html_en_files/oldcommission_html/fincom13/discussion/report28.pdf>

[2] Department of Commerce, Ministry of Commerce & Industry, Government of India, Foreign Trade Policy Statement, <http://dgft.gov.in/exim/2000/FTPstatement2015.pdf>