Poll Khol: Farmers, Women, And The Elderly: Jaitley Readies Modi’s Votebank For 2019

Pre-election budgets are all about understanding the political economy and delivering a sharp message. Finance minister Arun Jaitley seems to have dipped into his party’s successful electoral playbook to design his budget for 2018-19. And his manual of choice seems to be the Uttar Pradesh (UP) elections, compelled by the erosion of margins during the recent Gujarat state polls.

A new paradigm for categorising voters helped the Bharatiya Janata Party (BJP) sweep the UP elections in 2017. Apart from using the conventional tools of mass appeal and deploying a predictable Hindutva message, the BJP changed the rules of the game by slicing voters horizontally along socio-economic backgrounds and gender. This was a marked departure from the opposition’s shop-worn tactic of vertically dividing voters along caste lines or as Hindus and Muslims. As part of the exercise, the BJP converted the autocratic demonetisation decision (which inconvenienced millions of citizens) into a virtue as a battle against the wealthy. And this seems to have worked.

In contrast, Gujarat voters expressed scepticism about the party’s message of successful economic management in the face of visible disruption, stagnant incomes, and growing unemployment. So, seemingly, it’s back to the UP formula for now.

Jaitley’s last full budget, and opportunity to showboat before the next general elections, focuses on three large socio-economic cohorts: those engaged in farming and allied professions, women, and the elderly. There are the customary paeans to the middle-class and salaried individuals as well, but those don’t amount to much.

The aged

So let’s start with the last category first because it’s not only the most interesting but also counter-intuitive. In a country that boasts of a demographic dividend, with 50% of the population below 35 years of age and viewed as an engine of economic growth, a policy bias towards senior citizens seems to go against the grain. Jaitley has announced numerous benefits for the elderly: A 400% rise in the tax-exemption limit on interest income, an over 60% increase in tax set-off limits for health insurance, an increased deduction limit for medical expenditure, and other benefits.

These benefits are more like corrections and have been long overdue; it is the timing that attracts attention.

The choice is all the more interesting because the number of senior citizens in India is not very high—between 100-110 million, less than 10% of the total population. While the population census of 2011 put the number of Indians above 60 years of age at 104 million (8.4% of total population), the registrar general of India’s 2014 sample registration system estimated the number closer to 107 million. Peeling down the group data from the 2011 census further reveals some interesting highlights: Rising literacy rates (44% in 2011 against only 27% in 1991), a gender divide born out of varying life expectancy rates (53 million women against 51 million males), 41.6% still engaged in some occupation and earning (with a higher working population in rural areas), and a predominantly rural bias with only 29% based in urban centres.

The surprise lies in the electoral data. According to the election commission’s annual report for 2016, there were up to 868.6 million voters registered as on Jan. 01, 2017. According to the commission’s Electoral Statistic Pocketbook, 2017, only 11.5% of the total registered voters—or slightly below 100 million—are above 60 years of age. It is not a sizeable chunk but could be a decisive voting bloc if husbanded and harvested strategically.

Jaitley’s budget perhaps takes the first step in that direction.

Apart from its innate significance, the focus on senior citizens also marks a pivot from the BJP’s pronounced courtship with the youth in 2014. In the run-up to general elections, the party promised jobs for the youth by reviving investment in manufacturing and making a decisive break from past style of governance. While the jury’s out on the last issue, promises of more jobs and higher incomes have not materialised.

The Gujarat elections provided a brief glimpse into the youth brigade’s frustration and disillusionment. It is, therefore, logical for the party to search for newer pastures.

It is unlikely that the BJP will give up totally on the youth—though it will be interesting to see the nature of messaging adopted and the varying degrees of chauvinism built into it—but it doesn’t harm to hedge one’s bets.

The women

The second interesting population segment is women, a vote bloc that over the years has proved to be exceedingly influential. During the 2014 general elections, women voters constituted 47% of the turnout. While it was quite high in the UP polls, even outnumbering males in many seats, it was significantly lower in Gujarat (about 10% lower than men). This might have given the BJP reason to believe that women voters required special treatment.

And so Jaitley duly opened the budget tap, with special emphasis on rural women: 30 million free LPG connections to be added to the earlier 50 million, some 40 million more rural households to get free electricity, 20 million toilets, and close to 14 million affordable houses. What rings odd in all this is a mechanical positioning of broad livelihood proposals as women-centric proposals, treating the household and women as synonymous. While free electricity, affordable houses, and toilets benefit all household members, they have been pitched as women-centric.

The farmers

Finally, the farm sector deserves many structural reforms.

With close to 60% of the country’s population dependent on farming and allied occupations—directly or indirectly—continuing distress in the sector has been affecting income levels and livelihoods across a broad swathe of rural India. There is an additional sense of disenchantment, given the widening gap between expectations raised and actual benefits delivered. It was widely expected that Budget 2018 would undertake some course correction, especially after the Gujarat electoral rebuff.

It might be instructive to parse Jaitley’s budget speech: “For decades, the country’s agriculture policy and programme had remained production-centric. We have sought to effect a paradigm shift. Honourable prime minister gave a clarion call to double farmers’ income by 2022 when India celebrates its 75th year of independence. Our emphasis is on generating higher incomes for farmers.” The last two sentences seem to indicate Jaitley is injecting a dose of reality into the PM’s lofty promises: PM Modi may want to double farmers’ incomes, but let’s just generate higher incomes first. Or, perhaps, we’re reading too much into a simple statement.

Jaitley has also provided the BJP with ammunition to wage a faux class war: tax on long-term capital gains.

Even though there is merit in such a progressive tax, the undertone suggests that this tax is likely to be showcased as the government’s attempts to reduce economic inequities, and position itself as a champion of the poor. There is also a passing gesture to the oppressed castes in a somewhat curious turn of phrase: “…the present top leadership of this country has reached this level after seeing poverty at close quarters. Our leadership is familiar with the problems being faced by the SC (scheduled castes), ST (scheduled tribes), backward classes, and economically weaker sections of the society. People belonging to poor and middle class are not case studies for them, on the other hand they themselves are case study.”

Make of it what you will. One thing is clear: The BJP does not seem so sanguine any longer; it’s all hands to battle stations.

The above article was written at the invitation of quartz and can also be read here 

Budget 2018: What Equities And Bond Markets Tell Us

While the equity markets seem to have comprehensively disapproved of Jaitley’s last full budget, the response of bond prices indicate the likelihood of hardening interest rates in the future

Two needles moved decisively after Union finance minister Arun Jaitley announced his budget for 2018-19. Both movements provide some clues on how to read the budget.

The first needle—indicating stock market health—oscillated wildly during Jaitley’s speech and continued to fluctuate thereafter. The BSE Sensex started floating downwards soon after the finance minister began reading his budget speech on Thursday morning, disheartened by the heavy overload of social sector announcements. It then dropped further on news of a new long-term capital gains (LTCG) tax, recovered slightly and ended the day marginally below opening levels. But, on Friday, it capsized as the full weight of the budget sank in. By the time markets closed on Friday, Sensex had lost almost 900 points, or close to 2.5%, over its Wednesday closing.

This sell-off can be read in multiple ways. The charitable justification is that the stock market was over-valued and investors needed an excuse to make a correction. The moderate explanation is that investors are unhappy with the budget maths, the expenditure programme, the lack of visible funding sources, lack of clarity over the generous spending programme and the red light flashing over the fiscal deficit levels. The extreme view is that the sell-off revealed a marked distaste for the new LTCG levy, an inexplicable 42% jump in the securities transaction tax collection next year (raising fears that the tax rate might be increased in the interim) and the inclusion of equity mutual funds in the dividend distribution tax net.

The Sensex started floating downwards soon after Jaitley began reading his budget speech, disheartened by the heavy overload of social sector announcements. Photo courtesy: AFP and Mint.

In short, whatever the reason, it does seem that the equity markets have comprehensively disapproved of Jaitley’s last full budget. It’s perhaps also an expression of the market’s scepticism with the numbers.

For example, there is no accounting for many of the grandiose spending schemes. Analysts are clueless how either the minimum support price programme for farmers, or the ambitious health coverage scheme, will be financed. There are doubts even about some of the capital expenditure schemes. Many of these are likely to be launched in conjunction with states, giving rise to a fresh wave of cynicism about their viability.

In most cases, the policy architecture is yet to be worked out. Making announcements before finalizing the policy contours is a curious practice, somewhat like a nervous sentry shooting first and asking questions later.

Some disingenuous measures on the personal tax front might have also left a bad taste. For example, a standard deduction of Rs 40,000 that was announced as relief for the salaried taxpayers was negated the next moment by an increase in cess from 3% to 4%. In fact, the budget relies heavily on cess collection, a revenue source which the centre does not have to share with states, betraying signs of nervousness not only about revenue collection but also about the impending political battles that lie ahead.

The second needle—bond markets—is providing a far more layered story of what lies ahead. Reacting to budget arithmetic, especially the government’s spending and planned borrowing programme for 2018-19, 10-year government bond prices fell and yields rose, indicating the likelihood of hardening interest rates in the future. The Reserve Bank of India (RBI) announces its sixth bi-monthly monetary policy on 7 February and it will be interesting to see what emerges.

One thing is certain though: the prospect of a rate cut now seems to have receded. On the contrary, RBI is likely to adopt a tightening stance, with oil prices rising globally, bank credit picking up, money supply growth clocking 10.7%, the government’s borrowing programme looking unrealistic and poised to breach the budgeted target (just like the current year) and general uncertainty over how the government’s proposals will impact the price line.

For example, there are questions over whether the 50% increase in kharif minimum support price will impact the consumer price line or whether it has already been priced in.

Pressure on yields will emerge from another front if Jaitley’s plans for the corporate bond markets take off. Jaitley’s speech stated that securities markets regulator Securities and Exchanges Board of India will soon come out with rules that will compel large corporates to source 25% of borrowings from the corporate bond market. In addition, he said many sectoral regulators will be asked to relax investment rules in their respective industries; for example, the insurance regulator might henceforth allow insurance companies to invest in A-rated bonds when the current rules draw the line at AA-rating. To facilitate growth of the corporate bond market, Jaitley also promised to reform the stamp duty regime in consultation with states.

Even if we leave aside the oddity of telling corporates where to borrow, the development has the potential to affect government bond yields and, subsequently, interest rates. While the government has kept its FY19 borrowing programme largely the same as FY18 (Rs6.06 trillion against Rs6.05 trillion), any additional borrowings over the budget target is likely to have consequences for interest rates.

And as the ruling Bharatiya Janata Party gets into election mode—as was evident from the budget speech’s tone and tenor—and spending gets subjected to realpolitik, the likelihood of a bloated borrowing programme and deviation from the fiscal deficit glide path cannot be ruled out. It’s election season after all.

The above article was written for Mint newspaper. It can also be read here

Read Between The Lines: Arun Jaitley Can’t Just Spend His Way Out Of Trouble

The Union budget, to be presented by finance minister Arun Jaitley on Feb. 01, has engaged everybody’s attention for multiple reasons. Primarily, though, it’s because this is his last full budget before the 2019 general elections and everybody anticipates a political-economy imprint. But, mainly, it will be judged for its ability to create conditions leading to asset and job creation. So far, so logical.

Job creation will need large dollops of investment in fresh capacity or augmenting existing capacity—whether it’s manufacturing, services or infrastructure. Investment as a percentage of gross domestic product (GDP) has been falling for a while now, primarily because of private sector withdrawal, and the only way to move the needle is for the government to invest in large projects. This hit a roadblock because resident economic orthodoxies drew a thick red line on fiscal deficits, limiting the government’s capacity for public expenditure.

This hit a roadblock because resident economic orthodoxies drew a thick red line on fiscal deficits, limiting the government’s capacity for public expenditure.

Thankfully, chief economic advisor Arvind Subramanian may have found a way around the ideological obstacles through the economic survey for 2017-18.

“Invest, and savings shall follow”

The ingredients necessary for asset and job creation—investment and its raw material, savings—have been in trouble for some time and need remedial measures. Ideally logic—and received economic wisdom—would have then said that higher savings need to be generated to catalyse investment. This is where Subramanian makes an important deviation: He says, forget savings for now and focus on increasing investment first. That will get you growth which in turn will take care of savings.

What he seems to be saying is that it’s okay for the government to breach the year’s fiscal deficit target, if government investment can crowd in private investment and spur another virtuous cycle of economic growth. The economic survey doesn’t seem to be saying this explicitly but it’s there. With regard to fiscal performance in 2017-18, the document states: “Reflecting largely fiscal developments at the centre, a pause in general government fiscal consolidation relative to 2016-17 cannot be ruled out.” While discussing the prospects for 2018-19, the survey is cautious: “…setting overly ambitious targets for consolidation—especially in a pre-election year—based on optimistic forecasts that carry a high risk of not being realised will not garner credibility…”

So, Subramanian seems to be bestowing investment with some kind of primacy. Investment is important because government and private sector investment into new factories, infrastructure facilities, or services will be necessary to create jobs for the armies of young, able-bodied youth joining the workforce every year.

But the investment rate, measured through gross capital formation (GCF), has been declining: from a peak of 39% of GDP in 2011-12 to 33.2% now. A decline in investment rate means a slowdown in fresh capacity being added to existing manufacturing, infrastructure, or service capacities. That also means a diminished ability to absorb employable youth.

All eyes on private sector

Private investment is a key engine that drives the overall investment rate, contributing between 65% and 75%. The government has already been spending substantial amounts in public expenditure in the hope of “crowding in” private investment. The centre’s capital expenditure has increased from 2.6% of the GDP during 2014-15 to 3% in 2016-17. According to data from the controller general of accounts, till November 2017, the government had already spent 60% of its budgeted allocation on capital expenditure. In some sectors, such as the ministry of road transport and highways, 73% of the budgeted outlay on capital expenditure had been spent till November 2017.

Yet this has failed to catalyse private investment. The private sector’s GCF has dropped from a peak of 29.2% of the GDP during 2011-12 to 23.9% in 2015-16. Going by the first advance estimates of national income for 2017-18, GCF is unlikely to improve. While the government may have to continue focusing on capital expenditure, it has simultaneously taken action on other fronts to spur private investment: resolving the non-performing assets overhang in public sector banks’ balance sheets, recapitalising these banks, and improving the ease of doing business.

Key to accelerating private investment, though, will be stability and certainty in the policy environment. An overnight, unilateral decision to demonetise high-denomination bank notes, without first arranging for adequate replacement and replenishment, resulted in considerable hardship for both firms and households. Before the economy could re-adjust to the new reality, the government introduced the goods and services tax (GST) which, ideally welcome in normal circumstances, added to the confusion and chaos.

No escaping savings

But, much as Subramanian may want to take his foot off the savings pedal, the economy will need increased savings for investment to materialise. Perhaps not immediately but soon.

Data for India’s gross savings rate is available only till March 2016 but provides some general trends for analysis. So, here’s the bad news: India’s gross savings rate has been falling for the past few years. It reached a peak of 36.8% of GDP during 2007-08 but has steadily declined thereafter to 32.2% by 2015-16. It will be interesting to see how it behaves during 2016-17, especially since it will take into account the effects of demonetisation.

On a disaggregated basis, the household sector still accounts for the largest share of savings at 19.1% of the GDP, a sharp drop from its high of 25.2% in 2009-10. Traditionally, the household sector has contributed the bulk of savings, with the private sector and the public sector bringing up the rear. The government, which forms a part of the public sector, has traditionally shown negative savings, thereby bringing down the overall rate by 1-2% of the GDP. The household sector’s savings rate, despite its decline, has one redeeming feature: Over the years, it has been slowly moving away from physical assets (such as land or bullion) towards financial assets, with the ratios decisively flipping in 2015-16.

The household sector’s savings in financial assets have been further bolstered by the after-effects of demonetisation and apprehensions over deposits being used for “bailing-in” wobbly banks. The recent rush of savings into equity markets, via mutual funds, is testimony to that phenomenon.

Disaggregated gross savings data shows that the private sector’s savings, especially in the non-financial segment, has been going up—from 8.3% of the GDP in 2011-12 to 11% in 2015-16. This means many non-financial companies in the private sector, in either manufacturing or services, are sitting on cash and waiting for the right opportunity to invest these surpluses.

Budget 2018, therefore, must incorporate a policy nudge to not only increase the overall savings rate but to also channel private non-financial corporate savings into investments.

There are many expectations from the budget which, oddly, is the most-awaited economic event in the policy calendar. Nowhere else in the world does a budget offer such mass anticipation or allure; its appeal in India, perhaps, springs from its ability to make annual changes in personal tax rates and levies on consumables. With the GST introduced from July 2017, some of the yearly variations in prices of goods will now cease.

Yet, the excitement persists because of the political action expected over the next 12-18 months. Given past tumbles and future challenges, one of budget 2018’s big themes is likely to be job creation. And, for that, it may first need to sort out how to stimulate savings and investment.

The above article was written on invitation from quartz. it can also be read here

Will Jaitley Sow The Right Seeds?

As Finance Minister Arun Jaitley prepares to present the Budget on February 1, one issue will dominate his mindspace: agriculture. With large sections of India’s population depending on the farm sector, continuing distress has reached crisis proportions.

And this predicament manifested itself in the recent Gujarat elections where the BJP retained its majority but lost 16 seats from its 2012 tally. After the polls, Gujarat Chief Secretary J N Singh attributed this loss to farmer distress and unemployment. The distressing after-effects of demonetisation were felt most acutely in the agrarian economy.

This year sees Assembly elections in eight states, of which the predominantly agri-states Madhya Pradesh, Rajasthan and Chhattisgarh are currently ruled by the BJP. And in the 2019 general elections, the BJP will be forced to defend its 2014 majority. Hence, agriculture and allied industries will surely play a significant role in shaping the Budget.

Agriculture has been in deep crisis for some time now: The Central Statistics Office’s advance estimates for 2017-18 GDP growth show agriculture growing at 2.1 per cent in the current fiscal against 4.9 per cent during 2016-17.

Apart from the long-term structural issues ignored by all governments so far—fragmented land-holdings impairing productivity, constraints in the input (water, credit, seeds, fertilisers) supply chain, insufficient forward linkages, lack of market access, wastage—the current year has seen some additional low points. The Budget will focus on three areas in agriculture that will convince farmers to vote the BJP back.

Infrastructure: Weather reports showed that 2017 monsoons were bountiful, with a minor deficit. However, there were spatial disparities in distribution of rainfall. This affected kharif sowing in Uttar Pradesh, Haryana, Punjab and Madhya Pradesh with pockets of stress recorded in Maharashtra and Karnataka.

This affected output and consequently incomes. It also brought home the age-old problem of how the slow pace of irrigation—covering only 40 per cent of cultivable land—has made agriculture overly dependent on monsoons. With frequent droughts, this infrastructure deficit translates into lower crop and incomes.

For example, an October 2017 presentation from rating agency Crisil showed MP felt the highest stress, with deficient rainfall aggravated by poor irrigation infrastructure. It also singled out Rajasthan, MP and Chhattisgarh which showed a dip in profits earned per hectare during 2017. Jaitley may decide to increase the budget allocation for irrigation, having allotted lower amounts in the previous years. There also needs to be a review of the money spent on irrigation projects which are not being used to their potential.

Sliding prices: During 2017, the arbitrary market structures and policies yielded lower profits for farmers, even with losses in some areas. Loss of income due to sliding prices is critical to understanding farmer distress. This even prompted farmer organisations to request Jaitley to ensure some kind of assured income for farmers in the Budget. The story of declining farmer income is illustrative of the policy missteps by the government.

For example, faulty signals to farmers in the previous year, especially through higher minimum support price (MSP) for certain crops (pulses, for example) led to a bumper crop in 2017. But callous trade policy, especially regarding free imports, led to a glut. To top this, the government’s procurement target was inexplicably kept at a low percentage of the total harvest. Prices inevitably crashed well below MSP and farmers had to sell their crop at non-remunerative prices.

There is also the undeniable shadow of the trader community—the BJP’s traditional vote bank—looming over the Centre’s agriculture policy. The government’s MSP policy has been floundering for a while because of insufficient education leading to low levels of awareness among farmers, inaccessible procurement centres forcing farmers to sell to local traders for lesser prices (in many cases to the local moneylender) and graft in the official procurement system.

The Centre’s eNAM (electronic National Agriculture Market) which provides farmers a platform for selling their produce by linking them electronically with traders across the country is still a work in progress.

Policy Politics: In an open letter to Jaitley, Ajay Vir Jakhar, chairman of Punjab State Farmers’ Commission, has argued that the government’s policies must pivot from “Food Policy” to “Farmers’ Policy”. This is a major change in focus and would require complete overhauling of the farm policy. This suggestion also encapsulates within it the dilemma that confronts policymakers: Should they design policy to ensure food for all at all costs or ensure fair income-generation opportunities for farmers that will also lead to food security?

The policy framework should also examine how to deal with farm-related payments which are entangled in red tape. For example, the crop insurance programme—Pradhan Mantri Fasal Bima Yojana, launched in 2016—has drowned farmers in a sea of paperwork and failed to provide either adequate or timely compensation. The failure of this scheme has been cited as one reasons for Gujarat farmers, especially Saurashtra-based farmers, to change their voting preferences.

Jaitley’s earlier Budgets devoted many sections and paragraphs to the farm economy. However, many of these policies, schemes and announcements were seen as course corrections, tinkering with existing schemes or just plain grandstanding. February 1 should give him an opportunity to make some substantive changes in the farm sector.

The above article was written for New Indian Express and can also be read here

Budget 2018: A Trinity of Challenges Confronts Arun Jaitley

Budget 2018 is Arun Jaitley’s last full budget before next year’s general election and he may choose to do nothing but wait it out

There is something magical about the number three. In Shakespeare’s tragic play, it is three witches who provide Macbeth with a prophecy. The Chinese consider three as the perfect number, three represents the holy trinity, and so on. Finance minister Arun Jaitley’s last Union budget turned out to be quite prescient when he presaged three identifiable risks for the Indian economy: the Federal Reserve increasing interest rates, oil prices rising, and a retreat from globalization. Most of these risks are playing out with slight variations.

There are new fault lines developing now and it will be interesting to see whether the upcoming Union budget has a toolkit for these challenges.

One emerging danger is the capital market’s decoupling from the real economy. This was perceptively highlighted in recent interviews by Uday Kotak, executive vice-chairman and managing director of Kotak Mahindra Bank. In one interview he said: “Money is coming to a broad funnel and it’s going into a narrow pipe where massive amount of Indian savers’ money is now going into few hundred stocks…The amount of money that’s going into small and mid-cap stocks is something on which we have to ask tough questions. Is there a risk of a bubble?”

Kotak could be on to something. According to data from the Association of Mutual Funds in India, investment in mutual funds (net of redemptions) during April-December 2017 was up 28% over the previous year’s corresponding period. Much of this is flowing into stocks and influencing key indices: the 30-share S&P BSE Sensex has appreciated over 29% in the one-year period between 18 January 2017, and 18 January 2018. No other asset class can match these returns. State Bank of India’s fixed deposits for one year pay 6.25%, the government’s 364-day T-bills were recently auctioned at a cut-off rate of 6.52%, metals have ranged between 14-18%, gold yielded about 4%, crude oil is roughly 6% up and real estate continues to remain in the dog-house.

Two provisos merit mention: bitcoins are excluded because they are not available widely (like art or horses) and all the above returns are taxable while returns from investment in stocks for more than a year are tax free.

Curiously, and by serendipitous timing, discussions over a long-term capital gains (LTCG) tax on equity holdings are suddenly in play. LTCG—defined as gains realized from equity sales after holding for more than a year—are exempt from taxation. Short-term capital gains are taxed at 15%. The LTCG debate looks and feels like a test balloon floated to gauge the mood for new taxes. The guessing now is that tax-free LTCG may require a longer holding period of, say, two years. Even then, it is unlikely to yield great tax revenues.

Herein lies Jaitley’s dilemma: a larger section of Indians is now affected (directly or indirectly) by market movements and there’s no saying how additional taxes will have an impact on share values. Jaitley may want another Tobin-like tax to slow down runaway markets—investors already pay securities transaction tax, averaging around Rs 7,400 crore annually—but without rocking the boat. The market’s reception to government slashing its additional borrowing programme by Rs 30,000 crore (Rs 300 billion) was euphoric—the BSE Sensex rose over 300 points—ignoring that Rs 20,000 crore (Rs 200 billion) extra will still be borrowed. It is all down to managing the news cycle so that markets do not reverse course.

The LTCG speculation may have been prompted by need for new tax sources, given the slowdown in overall tax revenue accretion—till November 2017, 57% of the full year’s target had been collected while expenditure has raced ahead. Tax revenue growth is slack because the goods and services tax is taking time to settle down. Cheerleaders have made much of the spike in income-tax collections (15% higher than the corresponding period last year) but are silent about the slowdown in indirect taxes which not only provide a larger proportion of tax collections every year but also indicate continuing stagnation in the real economy with direct repercussions on unemployment.

There are red lights flashing elsewhere. Post demonetisation, money supply is in a frisky zone—in the 12 months to 22 December 2017, it has grown by 10.5% against 6.2% in the previous 12-month period. This has forced the Reserve Bank of India to suck out around Rs3.4 trillion liquidity between 26 December and 6 January. So, a rate cut looks remote at the moment.

Add to these the persistence of risks Jaitley mentioned last year—oil prices inching up and the Federal Reserve’s December interest rate increase with more likely to come in 2018. Then there’s the US’s new corporate-friendly tax bill which provides companies incentives to take back home roughly $3 trillion of global profits—Apple, for example, has announced it is repatriating close to $252 billion.

All this complicates Jaitley’s task. This is his last full budget before next year’s general election and he may choose to do nothing but wait it out. But he has to contend with three (that number again) challenges, which will directly have an impact on eight state elections this year and a general election next year—balancing a hysterical stock market with a slow real economy, providing enough policy measures to incentivise private sector investment and spur job creation, ensuring adequate allocations for the rural sector given the continuing farm distress.

Beyond that, it is most likely to be a holding operation which, in itself, is no mean task.

The above article was first published in Mint newspaper and can also be read here

Fintech Moves In The New Year

Government and regulatory agencies expected to provide some policy actions and regulatory direction to fintech

The lingering after-effects of demonetisation were felt through calendar 2017. These were further buffeted by the introduction of the goods and services tax. Both events hastened the adoption of fintech, particularly digital payments. The trend is likely to be consolidated during 2018, with government and regulatory agencies expected to provide some policy actions and regulatory direction.

The government’s resolve was perhaps reinforced by EY Fintech Adoption Index 2017, which surveyed 22,000 respondents across 20 countries. India’s adoption rate is seen as among the highest in the world, second only to China’s. So, what can finance minister Arun Jaitley do in his last full budget that can further improve the adoption rate?

Some pending issues from last year’s budget need his attention first.

One, the 25-billion digital transactions target, spanning multiple platforms (Unified Payments Interface, Unstructured Supplementary Service Data, Aadhaar Pay, Immediate Payment Service and debit card), is likely to be missed. This will require the government to conduct additional research on what needs to be done, especially how best to ground such annual targets in reality.

The other pending issue is completing the formation of a Payments Regulatory Board, which was set up through an amendment to the Payment and Settlement Systems Act. While the new board was a follow-up to the Watal Committee’s recommendations, the composition of the board disregards the committee report’s spirit and intent. The board currently has equal number of representatives only from the Reserve Bank of India (RBI) and the government.

There are a host of other targets and promises that were made in the previous budget that either remain unfulfilled or about which updates are not available in the public domain—such as, using Small Industries Development Bank of India’s refinancing role to allow small and micro units to access formal finance, or accelerating financial inclusion using digital payments platforms. In the forthcoming budget, Jaitley will need to iron out numerous regulatory and infrastructure issues.

The first move should be to re-imagine the role of National Payments Corporation of India (NPCI). The company introduces itself as “an umbrella organization for all retail payments in India.” The NPCI was set up with the “guidance and support” of RBI and the Indian Banks Association for creating a reliable and robust payments infrastructure in India. Its shareholders are commercial and cooperative banks and its products are limited to only the banking industry. This is where the distortions set in.

Currently, NPCI is like the owner and major user of a common infrastructure facility and allows only select customers to use this resource. NPCI’s products should be given the tag of utility infrastructure, to be used as an open application programming interface by the fintech industry. This is likely to foster new products and innovation. In other words, if the government plans to use fintech to achieve financial inclusion, it cannot afford to exclude non-bank payment service providers from common utility infrastructure.

Second, administered merchant discount rates (MDR)—the rate which banks charge merchants for providing payment infrastructure—have been quite contentious, especially since they are seen as an intrusion into a commercial relationship between the card issuer (mostly a bank) and the merchant. The RBI’s latest regulatory guidance caps MDR charges to drive up merchant acceptance of digital payments. Two anomalies emerge which need some course correction.

The guidelines spell out differentiated capped rates, based on the annual turnover of the merchant. This might become cumbersome and subject to various abuses. There is another problem. The RBI’s moves can be viewed as a market development strategy for fostering greater acceptance of digital payments. However, in all such endeavours, it is desirable to spell out the sunset period. For instance, the Union cabinet has decided to subsidize merchants for all digital transactions below Rs2,000 for the next two years. Even if one ignores the policy’s overt political ambitions, there is a visible end-point for the exercise.

Third, the government must take a call on blockchains and crypto-currencies soon. The government and RBI have been repeatedly cautioning investors about risks of investing in cryptocurrency, especially bitcoin. Simultaneously, a committee under the secretary, economic affairs, in the finance ministry is examining all issues related to cryptocurrencies. Policy and regulatory action should try to remain a step ahead of market practices, especially since some Indian banks have already developed blockchain technology to deal with overseas clients. Axis Bank, ICICI Bank and Yes Bank have all separately developed, or tied up with technology companies, to use blockchain technology for faster cross-border remittances. For example, the State Bank of India has joined hands with 29 other banks and finance companies (including ICICI Bank) to fund BankChain, a blockchain based cross-border payments platform.

Finally, RBI’s guidelines on peer-to-peer (P2P) lending need further refinement to bolster the nation’s growing fintech credentials. The rules have confusing eligibility criteria, are ultra-conservative in lender exposure limits and allocate too much discretionary power to the central bank without spelling out specific trigger points for regulatory action.

The above article originally appeared in the Mint newspaper and can also be read here

Time To Go To FRDI Bill’s Roots

Controversy around the bail-in clause aside, FRDI Bill’s clauses 58 and 62(1) regarding governance of a firm declared critical are inherently conflicting

Much has been said and written about the Financial Resolution and Deposit Insurance Bill, 2017. The FRDI Bill was scheduled for discussion in Parliament this winter session but will now have to yield to more immediate concerns such as the Gujarat election results and the Central Bureau of Investigation special court’s verdict on 2G spectrum allocation. In addition, the joint committee of both Houses is yet to submit its report on the bill.

Public discussions on the FRDI Bill have focused on the formation of a resolution corporation and its bail-in powers in the event of a financial company going bust. The said corporation will monitor financial services companies, in coordination with regulators, and resolve them in case of failure. Bail-in implies using the company’s various existing liabilities—different debt categories or deposits not covered by deposit insurance (all deposits over Rs1 lakh)—to resolve impending failure. This is different from bailout, which implies external help, such as government using taxpayer money.

There may be some merit in constructing a resolution regime, given the financial system’s broader linkages. But there are other equally larger issues that also need highlighting, especially because they explain how we got here.

First, there is a need to discuss the relevance of an imported idea, a palliative designed for a different disease in a different body. Soul-searching after the 2008 financial crisis and its broader systemic impact through economic linkages led to the idea of a resolution corporation. It was felt necessary to design shock absorbers to insulate the economy and other financial sector institutions in the event of one single organization going bust, à la Lehman Brothers. The idea was discussed in various global governance institutions and rules were framed.

Some of the global credit rating agencies have been following up assiduously on the progress of implementation. Eyebrows are raised at jurisdictions, especially emerging economies, continuing to defer a resolution regime or designing a custom-built framework suited to their economy. In the meantime, the US, the epicentre of the crisis—which used taxpayer money to bail out all banks, including ensuring hefty bonus payouts to bankers—continues to enjoy the highest credit rating. Irony has, of course, been missing from the global credit rating lexicon.

In India, the idea of a resolution corporation was advocated in 2013 by the Financial Sector Legislative Reforms Commission. This was followed up in 2014 with a Reserve Bank of India (RBI) working group report on crafting a resolution regime for financial institutions. Finally, in 2016, a Union finance ministry committee submitted a draft code on the resolution of financial firms.

Speaking in Parliament on 21 December, Union finance minister Arun Jaitley defended the FRDI Bill, claimed that depositors’ money in public sector banks would be protected and said that the bill was the outcome of a commitment made by the previous government to G20. Jaitley is right. The resolution framework was part of the G20 leadership’s final declaration at the 2011 Cannes summit. Ironically, there’s also a segment in the same communique that’s titled ‘Avoiding Protectionism and Reinforcing the Multilateral Trading System’; see where that’s got us.

This goes to the heart of the issue. The Indian government’s willingness to accept a cut-and-paste formula is curious, coming as it does on the back of similar decisions in the past which seemed alien to the peculiar complexion of India’s financial services—salary cap for financial sector chief executive officers and tightening regulation of “shadow banks”, leading to a squeeze on non-banking financial corporations which provide a unique last-mile solution to the Indian banking system, among others. In a system where banks (with an overwhelming public sector presence) dominate the financial system and are extensively regulated by RBI, there should be some discussion about whether importing regulatory frameworks, in universum, makes sense. More pertinently, whether the bail-in provisions recommended in the Financial Stability Board’s October 2014 guidelines are applicable to India.

By the way, all those fond of citing Singapore’s examples of good governance should look at the city-state’s proposed resolution regime, which excludes all deposits and senior debt from bail-in.

Secondly, there’s the issue of democracy and fundamental rights. In its current form, the FRDI Bill disallows the proposed corporation’s resolution process from being challenged in courts. This might be necessary to avoid undue delays in the resolution process and to avoid failure of wobbly financial companies. But it’s also like a slippery slope: the overwhelming presence of government representatives on the corporation’s board (including regulators’ representatives) can convert the corporation into a blunt tool of vengeful political action. It also disregards the RBI working group’s recommendation that a grievance mechanism be built into the process.

The larger, moral question is: Why does the FRDI Bill have to start off by being ham-fisted and draconian? Add poor drafting to that list; think tank PRS Legislative Research demonstrates how clauses 58 and 62(1) regarding governance of a firm declared critical are inherently conflicting. There are other similarly inconsistent clauses.

Finally, there’s the spectre of new regulators chipping away at the powers of old regulators, such as RBI. It raises the question: Does it really remedy anything?

The above article was originally published in Mint newspaper and can also be read here

The Rich Know How to Sidestep Responsibilities

The Paradise Papers show how the wealthy and powerful use tax havens—some do it legitimately, others for re-routing illegal wealth—to avoid or evade tax liabilities

Three developments over the past few weeks provide pointers to how the rich, whether individuals or nations, behave when it comes to meeting obligations.

The Paradise Papers have revealed how wealthy and powerful individuals use tax havens—some do it legitimately and some for re-routing illegal wealth—to either avoid or evade tax liabilities. The examples also highlight how this corrosive affliction equally infects industrialists and politicians.

The second example relates to the behaviour of rich nations, which have unabashedly deployed evasive tactics at Bonn, host to the 2017 UN Climate Change Conference to implement the Paris Agreement signed in 2015. The rich countries have been trying every trick to avoid meeting commitments on reducing greenhouse gas emissions, arresting climate change and funding developing and poor countries to help counter the effects of climate change. The US, European Union and some other rich countries—including Australia, Canada and Japan—have blocked efforts by developing nations to review the developed world’s performance vis-à-vis commitments.

Developing nations have been blaming the rich for sidestepping commitments made under the Kyoto Protocol, which placed mandatory emission reduction targets to be achieved during 2012-15. Later, through what is known as the Doha Amendments, the target date was extended to 2020. Developing countries have been arguing that to finalize the rule-book for the Paris Agreement, as the successor to the Kyoto Protocol, it is necessary to understand the achievements so far.

For instance, as part of the Copenhagen Accord of 2009, the developed countries pledged to provide developing nations with $30 billion during 2010-12 and $100 billion every year till 2020 to help mitigate climate change effects. The understanding was that since the industrialized nations were historically responsible for greenhouse gas emissions and the consequent global warming, they have a moral obligation to help poor countries, especially island nations, offset the adverse effects of climate change. But, as data shows, the rich are not only in breach but have been dissembling: Apart from reneging on their promise, they have also been padding funding data.

The third example crosses the Atlantic Ocean to Washington, DC, where the annual meetings of the World Bank and International Monetary Fund were held a month ago. Among other things, the agenda included the Bank’s pivot towards a new financing mode, for which it has been laying the ground over the past few months. The new strategy is called the “cascade approach”, under which Bank president Jim Yong Kim proposes to convert “billions into trillions”, essentially by leveraging the Bank’s financing and crowding in private investment.

The Bank released a document in September titled “Maximising Finance For Development: Leveraging The Private Sector For Growth And Sustainable Development”. This builds on a preceding March 2017 document called “Forward Look—A Vision For The World Bank Group In 2030, Progress And Challenges”. This document defines the scope: “... The Cascade first seeks to mobilize commercial finance, enabled by upstream reforms where necessary to address market failures and other constraints to private sector investment at the country and sector level. Where risks remain high, the priority will be to apply guarantees and risk-sharing instruments. Only where market solutions are not possible through sector reform and risk mitigation would official and public resources be applied.” Currently focused on infrastructure, the approach will be later extended to financial services, healthcare, education and agribusiness.

On the surface, it sounds like a logical progression of the Bank’s strategy and, at a theoretical level, the right thing to do. The Bank, in some senses, seems to be heeding conservative economists who have for long contended that the Bank crowds out the private sector and, therefore, must step back and facilitate private sector project funding. But there’s no avoiding the tricky questions: How do you manage the political economy of reforms, who will bear the risks, how will risk be eliminated, what will be the role of user charges, what is the private sector’s exact role, and, what happens in countries with minimal private sector presence? There are also concerns about involving the private sector in healthcare and education, especially because private and public interests are rarely aligned. Many of these concerns have already played out in India.

To be fair, the Bank’s hands are tied because the rich countries, especially the US, have refused to provide additional capital. India’s finance minister Arun Jaitley was forced to comment at the annual meeting: “The possibility of generating sufficient resources through the management levers has had only a marginal impact given the scale of capital requirement, and hence, early capital infusion into WBG (World Bank Group) is an imperative... The excessive emphasis on the ‘Cascade Approach’ to determine suitability of the financing source and mechanism does not have potential to make a big difference. Applying cascade approach to every project posed to the World Bank will lead to considerable delay. We should be careful in applying this approach especially to social sector projects.”

What is worrying is that the lessons of 2007 and earlier crises are being forgotten as soon as the first signs of economic growth are visible in the Western economies.

The above article was originally published in Mint newspaper and can also be read here

Bank Recapitalisation: Slow-Mo Replay

Scepticism over bank recapitalisation plan is fuelled by the government’s predilection for grandiose policy announcements without adequate preparation or execution

Like all things Indian, there are multiple ways of viewing Union finance minister Arun Jaitley’s comprehensive presentation on the Indian economy and the package of measures formulated to provide some momentum to a decelerating economy.

One is to view government as profligate: throwing caution to the winds, raiding the exchequer and reaping subsequent political dividends. With state assembly elections due in Gujarat and Himachal Pradesh, this package seems custom-built to address concerns over slowing growth, rising unemployment and the severe economic dislocation which followed demonetisation and implementation of the goods and services tax.

Some may even view this development as a snub to the reconstituted Prime Minister’s Economic Advisory Council (EAC). Convened to suggest measures to revive the economy, the council rebuffed calls for a fiscal stimulus programme during its maiden 11 October meeting. EAC chairman Bibek Debroy ostensibly acknowledged, during his post-meeting press briefing, that there was indeed an economic slowdown but, puzzlingly, declined to publicly list the reasons. The new package can thus be seen as realpolitik trumping good economic sense.

Viewed through a different lens, the package can be seen as an attempt to generate temporary feel-good with all the right ingredients thrown in—large numbers, a dizzying number of projects, heady growth estimates. This scepticism is fuelled by the government’s predilection for grandiose policy announcements without adequate preparation or execution. What further bolsters the cynicism is the inordinate rush to announce schemes without fleshing out details: for example, the Rs2.1 trillion bank recapitalisation plan lacks all the relevant details. There is another reinforcing factor: the government has front-ended announcements of funds injection, but all mentions of painful restructuring, if any, have been kept for later.

There is another nuanced view. Keeping the political compulsion as a constant, since the impact of the economic distress on impending elections cannot be ruled out, Jaitley’s package tries to walk a fine line by providing an economic stimulus while also heeding fiscal concerns. While this assessment does seem closer to reality, implementing it is unlikely to be easy. For example, it will be difficult for the government to undertake all the listed infrastructure projects without any budgetary support, given the private sector’s current inability to pitch in with capital.

Many observers and analysts have inveighed against the recapitalisation programme even though the final design is yet to be revealed. They see it as rewarding banks with a free get-out-of-jail card without any corrective measures to avoid repeating past mistakes. There’s also the moral hazard question: recapitalisation studies conducted globally have shown that banks receiving fresh government capital tend to exhibit increased risk-taking activity compared with banks deprived of capital infusion. There are other studies which show that recapitalisation stimulates the credit cycle for only larger banks and existing borrowers. This then contradicts the government’s assertion that recapitalisation will lead to increased credit availability for the micro-, small- and medium-enterprise segment.

While these are legitimate concerns, the recapitalisation programme seemed like a fait accompli, especially since banks were caught in a vicious cycle, leading to a credit impasse which exacerbated the economic distress. As the largest shareholder, it was incumbent on the government to recapitalize banks to kick-start the credit cycle and growth process. Banks could have raised fresh capital from the market by diluting the government’s stake, but their contaminated books made that impossible.

Ideally, recapitalisation and restructuring should go together. The government’s current plan incorporates one without the other or, at best, inserts a time lag between the two actions. Many commentators have been clamouring for an accompanying restructuring programme. One suggestion is to reduce the government’s stake in public sector banks, which, then, one naïvely assumes will provide banks with operational autonomy. Will, say, a 30% or 40% stake prevent ministers and government officials from calling up a bank’s chief executive and influencing credit decisions? Government intervenes in a bank’s credit operations in many other ways.

The Banking Regulation Act mandates that a bank’s board, apart from the executive directors and the regular government nominee (usually a conscientious bureaucrat), should also include professionals with knowledge of accountancy, agriculture and rural economy, cooperatives, small-scale industry, among others. Governments often exploit this section to appoint party loyalists and sympathizers under one category or another since the eligibility criteria is not rigid. These nominees then enjoy unofficial government imprimatur to intermediate between the bank and Big Business. This gap must be plugged.

The other demand is for complete privatization but, realistically speaking, the political economy will not allow that. And, even if that goes through, it is not fool-proof because some of the largest private banks are also struggling with mountains of bad loans featuring the usual suspects: large corporations. A sustainable, long-term solution must therefore include punitive measures for all wilful defaulters, especially majority shareholders, and not just politically convenient soft targets.

The above article was originally published in Mint newspaper and can also be read here