The Risk of Trade Wars Becomes A Reality

Trump’s trade actions and its contagion effects could theoretically lead to a slow erosion of the global rules-based trading system

Names can reveal a lot. The recurring cold waves buffeting Europe are called “beast from the east” because of their origin in Siberia. It is unlikely that the trade chill arising in the US and threatening to freeze global commerce will be given a similar sobriquet. US’ controversial decision to levy import duties—25% on steel and 10% on aluminium imports—has given rise to martial terms like trade war, with many countries threatening to retaliate. But truth be told, this is one winter that is unlikely to thaw any time soon.

But all credit to US President Donald Trump for not deviating from script. Multiple risk forecasts for 2018 had predicted a ratcheting up of trade protectionism. The tariff order—purportedly for national security purposes and to save jobs in the US steel industry—fulfils these prophesies. It now becomes necessary to see how the ripples left behind have an impact on India. Below the currents lies another trade development which is taking shape slowly but with potential to affect India.

As numerous reports show, US’ steel and aluminium import levies do not harm India grievously. India’s exports of steel (raw and finished) and aluminium into the US do not exceed $2 billion: it’s less than 5% of the $42 billion exported to the US in 2016-17. The effects will be felt elsewhere: Intermediate goods that originate in the US and form part of the global supply chain will become more expensive and could slow down wheels of trade. A study by Christine McDaniel, former senior economist with the White House council of economic advisers, has shown this is the US’ trade war with itself, given that industries consuming steel to manufacture other products (such as automobiles or washing machines) employ more workers than steel mills.

There will be some indirect consequences for India as well, with many countries threatening to erect their own protectionist walls. According to a Standard and Poor’s publication Global Trade At Crossroads, the strong undertow will be felt globally: “The retaliatory spiral could lead to a breakdown in the global rules-based trading system and raise the risk of an all-out trade war, eventually hurting exporters both in the US and globally.” At risk is India’s incipient export growth momentum: exports during April-February 2017-18 were $273.73 billion, 11% higher than the corresponding period of previous year.

Many commentators were critical of India’s higher import duty rates, presented during budget 2018-19, especially since they were introduced soon after Prime Minister Narendra Modi’s speech at Davos cautioned against growing protectionism. While the new tariffs do seem to contradict India’s stand on free trade, they are broadly consistent with its World Trade Organization (WTO) commitments and are within the bound rates fixed for India.

Trump’s trade actions and its contagion effects also do not violate WTO norms but, by bringing in a national security angle, could theoretically lead to a slow erosion of the global rules-based trading system. The WTO mini ministerial scheduled in Delhi from 19 March might provide a window into the future of the multilateral trading system.

As things stand, US has often been accused of subverting the WTO system when the going gets tough. It has been holding up the appointment of judges to WTO’s appellate body, actively preventing a satisfactory closure to the food security discussions and openly supporting bilateral deals over a multilateral solution. Its unilateral approach to trade—naming and shaming countries through Special 301 or its WTO-plus intellectual property laws—are regarded as openly contemptuous of multilateral systems.

On the sidelines, another global trade development is quietly challenging its predominance. On 8 March, 11 Asia-Pacific countries signed the Comprehensive and Progressive Agreement for Trans Pacific Partnership (CPTPP), an improved version of the earlier Trans Pacific Partnership (TPP) from which the US walked out. What makes the new agreement interesting, apart from 11 nations opting to go ahead without the US, is the relaxation of certain clauses specifically introduced by the US.

The new agreement puts on hold 20 provisions from the old draft, 11 of which relate to intellectual property rights (IPR) included at the US’ insistence. Among the changes introduced are a truncated patent protection phase for innovative medicines, or narrower data protection rules for new pharmaceutical products or biologics. Gone also are some of the onerous investor-state dispute settlement clauses.

India should be concerned about what remains on the books because some clauses could indirectly put pressure for an overhaul of its domestic policies: the chapter on state-owned enterprises is one example. By adopting these rules for trading within themselves, the 11 CPTPP members—Canada, Australia, New Zealand, Mexico, Japan, Singapore, Brunei, Malaysia, Peru, Chile and Vietnam—might demand other trade partners to follow some of these rules. They are unlikely to have one set of rules for TPP members and another set for other trade partners.

It is also quite likely, though not definite, that CPTPP will have a benign influence on other trade pacts involving India, such as the Regional Comprehensive Economic Partnership, which has many common members with CPTPP and is currently being negotiated. India will have to be prepared for this eventuality.

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

Feels Like Scam Season Once Again

The belated discovery of a moon-size crater inside Punjab National Bank (PNB) opens up many fronts and leaves multiple questions unanswered. What’s more, the extent of damages is still evolving and could multiply as individual strands of the multi-layered transactions are extricated.

The overall outlook is also not that encouraging: the spaghetti bowl of interconnected transactions could result in a number of tangled legal disputes that could take some time to unravel. India’s largest commercial bank, the public sector State Bank of India, has just disclosed it has a $212 million exposure. In all, it feels like scam season once again!

The PNB episode seems to replicate all the steps observed in previous bank scams and carries echoes of similar collusions and cover-ups; what remains to be seen now is whether there is a flurry of post-scam reports from Reserve Bank of India (RBI) or Joint Parliament Committees, reminiscent of the Harshad Mehta scam.

To be sure, there will be much hand-wringing and chest-beating, new rounds of regulatory measures, additional layers of risk management processes and documentation followed through with an endless stream of circulars, guidelines and rules. And yet, all this will be secondary to human ingenuity which will always find a way through this thicket of paperwork and red tape.

The PNB incident highlights the problems of over-reliance on systems, processes and paperwork, indicating that if somehow some boxes are ticked, the problems will go away. While it might be too early to conclude that senior management was involved in the scam, it is clear that there were multiple failures at various levels. It might be informative to try and disentangle this skein of multiple threads.

First, and most baffling, how did the senior management members, the board directors and the auditors (external and internal) miss something of this size? Agreed that the liability was contingent but the liability was over `11,340 crore; that is over 25 per cent of the bank’s total capital. Any contingent liability of this size to one client or single entity should have set alarm bells ringing. At the least, it should have merited an examination of the account.

It also transpires from documents filed by PNB officials with CBI and with stock exchanges that Nirav Modi’s diamond firms—Diamonds R Us, Solar Exports, Stellar Diamonds—were caught out on 16 January 2018, when they went to seek buyer’s credit to make payments to overseas suppliers. Their calculations did not include the possibility of having to deal with a new set of bank managers.

The company management apparently bristled when the new manager asked them to provide 100 per cent cash margin for availing the facility because they did not have a sanctioned limit with the bank. In simple language, the new manager wanted Nirav Modi & Co to keep cash equivalent to the loan amount since they had not gone through the usual process of submitting to due diligence from the bank’s credit appraisal team.

This raises two questions. One: How did they manage for so long without obtaining a formal sanctioned facility with the bank? But more importantly, how did they manage to raise so many loans in foreign currency for so long without providing any security? Many institutions are known to provide a one-off facility based on business judgement and yield calculations. But Nirav Modi’s companies seemingly had unfettered access to the bank’s facilities. This does indicate some level of senior acquiescence.

Second, the ignorance is all the more appalling because Nirav Modi used PNB’s instruments to construct a web of multi-layered liabilities. This again could not have been possible without somebody up and down the chain noticing it. The notion that the PNB officers colluding with Nirav Modi kept the deals off the books also seems difficult to swallow since the counter-party banks on which the Letters of Undertaking (LoUs) were raised (Allahabad Bank or Axis Bank in Hong Kong) would have sent multiple deal stubs back to various parts of PNB’s risk management matrix—front, middle or back offices—for settlement and reconciliation. Even if we discount the possibility of complicity, it is a colossal systemic failure, one that has ripple effects across the industry.

In its letter to the stock exchanges, PNB claims: “The bank liability is contingent only. The liability shall be decided based on the law of land.” In other words, the liability is not known till there is legal clarity on who owes how much to whom. This seems to indicate that PNB senses a long-drawn legal battle ahead. But a cursory look at PNB’s website seems to indicate it’s business as usual—it is difficult to find PNB’s own press releases, the MD’s message to assuage investors and customers, or even the reports filed with stock exchanges. It is perhaps this lack of communication within the institution that kept the scam going undetected for so long.

But when all is done and dusted, two crucial questions remain unanswered. One, how all those accused of money laundering—Vijay Mallya, Nirav Modi, arms dealer Sanjay Bhandari—are able to leave the country just before a first information report is filed, or the enforcement directorate carries out raids on their homes and offices? Second, and this has national security implications: if Nirav Modi was not accompanying PM Narendra Modi to Davos as part of his official delegation as the government said, how did he photobomb a group portrait? He is standing an arm’s length away from Modi; is the PM’s security so lax that anybody hanging around in the vicinity can be allowed to stand in an official group photograph with him?

This article was originally published in New Indian Express newspaper. You can also read it here

India-Africa Ties: Economics and Multilateralism

If India is serious about its Africa initiative, a lot will depend on how it marshals its banking and financial sector there

The Leaders’ Declaration from G20 this year comes with an added annexure. It is called the G20 Africa Partnership, included at the insistence of Germany, which has the G20 presidency for 2017 and is at liberty to set the multilateral grouping’s agenda for the year. The annexure states its purpose: “The Partnership intends to support related initiatives of the G20 and facilitate investment compacts between interested African countries, international organisations and interested partners to support private investment, sustainable infrastructure and employment in African countries.”

Germany, as well as the European Union, have an abiding interest in Africa. The unrelenting waves of migration from North African shores (often leading to loss of lives while crossing the tempestuous Mediterranean Sea) and Europe’s volatile immigration politics are likely to have prompted Germany to rally the international community around Africa’s plight. Hence the partnership document focuses, among other things, on creating sustainable employment opportunities so that African youth do not risk lives in search of livelihood elsewhere.

Ironically, the G20 club includes only one African nation, South Africa. The Partnership document has its fair share of detractors, especially within African nations, and suspicions about its overwhelming reliance on private sector investment.

It also holds out three lessons for India.

The first relates to deeply embedded historical attitudes towards Africa. These rose to the surface again, perhaps unwittingly, while French President Emmanuel Macron was addressing a G20 press conference in Hamburg. Answering a question on why there was no Marshall Plan for Africa, Macron is believed to have said Africa had a different set of problems, which included “civilizational” problems. Some of the unique problems cited by Macron included failed states, complex democratic transitions and African women giving birth to seven-eight children. This predictably triggered a maelstrom of protests and diverted attention to Africa’s colonial past and France’s role in it. Macron’s statement was also viewed as reflecting Europe’s smug (and enduring) belief of civilizational superiority. Macron almost buried the partnership even before it had an opportunity to take off.

India must take note of this public relations disaster. The impact of government’s intensive outreach programmes has often been blunted by violent displays of racism against African students and citizens living in Indian cities. It is indeed an odd occurrence for India, which boasts of a long and shared history with Africa—especially cultural, social and trade ties. If at all, there is a felt need to accelerate the Indian Technical and Economic Cooperation (Itec) programme which provides capacity building for officials from low- income countries.

The second lesson arises from the G20’s internal contradictions and the possible impact on India. The document has a section on strengthening the framework for investments and private finance in Africa, in which the G20 welcomes other partners and “…complementary measures by the forthcoming EU External Investment Plan, the Forum of China Africa Cooperation, the Tokyo International Conference on African Development as well as others”.

Herein lie the conflicts within the G20: China, Japan, Turkey and the US are all independently competing for a foothold in Africa, with each country aggressively courting nations and their heads of state. Germany and the European Union are joining the fray now. India also has its own India Africa Forum Summit, which has been re-energized and supplemented with state visits by Prime Minister Narendra Modi, then president Pranab Mukherjee, vice-president Hamid Ansari and other senior ministers.

Given the multiplicity of competing interests, it has to be seen whether different countries will be willing to subsume their Africa ambitions under an over-arching multilateral approach. India will need to watch this effort closely. If required, India could consider activating the Asia-Africa Growth Corridor (AAGC), its joint initiative with Japan, through the G20 compact. The AAGC, which places significant emphasis on both infrastructure investment and capacity building, aligns well with the G20’s Africa approach.

The third point relates to the implicit assumptions behind private sector investments—that they will automatically generate more trade. Unfortunately, intra-Africa trade accounts for only 14% of Africa’s total trade. It is true that poor infrastructure slows down intra-Africa trade traffic, and therefore higher investments in road and rail infrastructure will surely help. The problem lies elsewhere—the lack of a trade facilitation culture and customs capacity which hinders cargo movement. India and Itec can definitely help here.

More importantly, there are other opportunities for India. Data from the African Development Bank shows only 31% of Africa’s trade is backed by bank-intermediated trade finance. This is clearly an opportunity for Indian banks. India’s banking presence in Africa seems to have lost its relevance over time: The geographical footprint is built around traditional Indian diaspora habitats in east and south Africa, and operations are tailored around ethnic banking services. Late in entering Africa, Chinese banks have already acquired stakes in leading banks. If India is serious about its Africa initiative, a lot will depend on how it marshals its banking and financial sector there.

The above article was published in Mint newspaper on July 26, 2017, and can also be accessed here 

The Chinese Encirclement: Within and Without

The recent geopolitical dispute highlights the fraught and schizophrenic nature of the India-China relationship

The recent border dispute has again raised the spectre of Chinese encirclement. It comes close on the heels of India’s boycott of the ambitious Belt and Road Initiative (BRI) summit in China. What is unfortunate, though, is that the dreaded encirclement may have already occurred and, if anything, the recent dispute highlights the fraught and schizophrenic nature of the India-China relationship.

The fresh skirmish at the tri-junction of India, Bhutan and China is part of on-going border tensions. The stand-off continues with both sides raising the temperature gradually, much like the dial on a thermostat; apart from incendiary statements, China recently increased its fleet presence in the Indian Ocean Region. In the past, many similar border misunderstandings were resolved quietly. The latest one burst into the headlines with impeccable timing during Prime Minister Narendra Modi’s visit to the US.

India ignored the BRI summit because it objects to the China Pakistan Economic Corridor (CPEC) which passes through Pakistan-occupied disputed territory. India’s contention is that CPEC is a unilateral validation of Pakistan’s claim on disputed territory. There are other reasons for India’s nervousness. China’s BRI is viewed as a strategic encirclement of India: Hambantota port in Sri Lanka, CPEC traversing west China via Gilgit-Baltistan all the way to Gwadar port in Balochistan, a road from Yunan province cutting through Myanmar to end at a deep-sea port in Kyaukpyu.

But, apart from the geopolitical squeeze, developments seem to indicate that a Chinese geo-economic encirclement may have already happened. While there is popular concern over the overwhelming presence of China-made idols of Indian gods or cheap toys, these are the proverbial iceberg’s tip. What seems to have gone unnoticed is an insidious China creep within the Indian trade, business and financial landscape.

News from the cricket world provides a glimpse: Chinese handset manufacturer Vivo won rights to cricket tournament Indian Premier League (IPL). Vivo will pay Rs2,199 crore for the next five years, which works out to 267% premium over base price of Rs120 crore a year. The next closest bidder was Oppo, which bid Rs1,430 crore for five years. Vivo’s bid is impressive, when compared to Oppo’s bid or the base price, or even amounts paid by previous sponsors (such as, DLF or Pepsi).

But it’s hard to miss the irony. Brands Vivo and Oppo are actually siblings and manufactured by the same Chinese company, BBK Electronics (which also owns brand One Plus). The IPL bidding process should have treated them as parties acting in concert, though that seems to have been overlooked in the general brouhaha over the money on the table. Chinese handset brands now command over 50% of the Indian smartphone market share.

Here’s another example. Chinese capital goods manufacturers have made deep inroads into India, with some critical sectors now highly dependent on Chinese spares and after-sales servicing. For instance, in the boiler-turbine-generator (BTG) segment, many Indian power producers have installed Chinese BTGs. In the 12th Plan alone, close to 30% of generating capacity was sourced from China, with the trend continuing in the 13th Plan as well. What tipped the scales, apart from shorter delivery windows, was cheap buyers’ credit (through Exim Bank of China), with installation crews and maintenance staff thrown in.

Chinese portfolio investors are the other angle in geo-economic encirclement. Among the list of banks managing the recent Central Depository Services Ltd initial public offering was a curious name: Haitong Securities India Pvt Ltd. Haitong, as per its website, is China’s second largest securities firm. Many of the firm’s senior management members hold, or have held in the past, organizational positions in the Communist Party of China. Haitong gained a toe-hold in the Indian market through its global acquisition of Espirito Santo. But, what is really interesting is that Haitong Securities was the book running lead manager in an IPO in which government-owned banks—State Bank of India and Bank of Baroda—were divesting their shareholding.

The Chinese footprint in the digital economy is also expanding rapidly. Numerous Chinese companies—Alibaba, Tencent, CTrip, Beijing Miteno Communication Technology, Bytedance—have made large investments in the Indian digital ecosystem, a mission-critical segment for Modi and his ministers.

India suffers a trade deficit with China which has increased over the years: from $38.7 billion in 2012-13 to $51 billion during 2016-17. One of the reasons for the large deficit are Chinese tariff and non-tariff barriers which constrain Indian exports; for example, Indian pharmaceutical exports have found it difficult to penetrate the Chinese market. Increased Chinese foreign direct investment was suggested to counter the rising trade deficit. But, there were no discussions on the nature of that investment: whether for manufacturing or for assembly jobs.

It would be hasty, and perhaps imprudent, to advocate slamming the doors or erecting barriers. But it is difficult to ignore the duality in rhetoric from both sides. The high decibel in security and strategic issues seems to be disengaged from trade and investment realities. One key question, therefore, needs to be answered: What kind of cost-benefit is involved in keeping engaged or in disengaging?

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

Rising Trade Walls and Shrinking Standards

Country after country, especially free trade evangelists, are erecting walls to stop the flow of professionals and human capital

Indian professionals are finding doors across the world shutting, shrinking opportunities to ply their trade. Weaned on a diet of free markets and globalization, they are finding that promise now ringing hollow. Country after country, especially free trade evangelists, are erecting walls to stop the flow of professionals and human capital.

US President Donald Trump carried out his campaign promise on 18 April by signing an executive order overhauling the H-1B visa regime, a programme allowing foreign professionals to work in the US for six years. Indian infotech companies such as Infosys, Wipro and Tata Consultancy Services (TCS) are among the biggest beneficiaries of this programme.

In less than 24 hours, Australia followed suit by revamping the immigration law which allows entry of professionals, titled “Subclass 457 visa”. Australian Prime Minister Malcolm Turnbull’s abrupt about-turn was unexpected. He was in India less than a week earlier, waxing eloquent about India-Australia ties and dispensing homilies about trade between the nations. He even signed off on a joint declaration with Prime Minister Narendra Modi which, among other things, welcomed “…progress in the flourishing knowledge partnership…building on the strong links in higher education, skills development and science, technology and innovation”. The icing was a memorandum of understanding signed with TCS for opening a new innovation lab in Australia, the fate of which could now be uncertain.

What could have happened in less than a week to force such a transformation? Could it be a follow-up to the now-infamous Trump-Turnbull telephone call? Turnbull’s measure, ostensibly designed to undermine rising nationalist right-wing forces at home, has now jeopardized progress on the Comprehensive Economic Cooperation Agreement (Ceca) being negotiated between India and Australia. A Ceca is wider in scope than a free-trade agreement—apart from trade in goods and services, a comprehensive treaty also includes issues like investment, government procurement and competition policy.

Three other prosperous nations have erected barriers of varying degrees—New Zealand, Singapore and the UK. New Zealand’s new work visa rules came a day after neighbour Australia’s. The UK has been tightening its visa rules for some time now. UK Prime Minister Theresa May recently further tightened visa rules for professionals by mandating minimum salary thresholds and language requirements.

India has a Ceca with Singapore which provides for trade in services between the two nations; to avoid breaching the agreement, Singapore has not denied work permits outright but has kept them in extended limbo.

This pandemic of border and behind-the-border barriers to services trade has compelled even World Trade Organization (WTO) director general Roberto Azevêdo to undergird his 2017 cheery trade prognosis with a caveat: “At the domestic level, policies are needed to help support the workers of today and train the workers of tomorrow. Closing the borders to trade would only worsen the situation—it would not bring the jobs back, it would make more jobs disappear.” WTO estimates world trade in 2017 will grow between 1.8-3.6%, but might settle at around 2.4% if world gross domestic product (GDP) growth sticks to projections. WTO also recognizes existence of multiple downside risks, including the sort of knee-jerk protectionist measures implemented by the US and Australia.

There could be a charitable explanation for why these countries are banding together against professional Indian talent. Australia, New Zealand and Singapore may have responded reflexively to the US and UK’s restrictive immigration laws; apprehensive of a spillover from these countries, the three countries might have responded impulsively and hastily.

The more plausible justification is that these moves—particularly by Australia and the US—are perhaps designed to blunt India’s attempts to introduce trade facilitation in services (TFS) agreement, somewhat identical to the trade facilitation agreement (TFA) in goods which came into force in February. According to India’s concept note—introduced in the WTO on 27 September 2016—like the TFA is intended to “…expedite the movement, release and clearance of goods as well as cooperation on customs compliance issues…”, the TFS can result in “…reduction of transaction costs associated with unnecessary regulatory and administrative burden on trade in services”.

India followed up the concept note with an “element paper” in November 2016 and a draft legal text in February 2017. The TFS is also now pitted directly against TiSA, or Trade in Services Agreement, currently being negotiated outside the WTO by 23 members comprising mostly developed countries. It is aiming for an ambitious overhaul of the General Agreement on Trade in Services (GATS), which it hopes will attract more members and eventually be ratified in the WTO. Both India and China (as well as many other emerging nations) are not members. It is, therefore, safe to expect that trade politics and diplomacy will probably focus a lot on services trade in the immediate future, especially at the WTO’s December ministerial in Buenos Aires.

Coincidentally, TiSA was initiated by the US and Australia. Which brings the discussion full circle: Is Australia’s long-term destiny to remain cat’s paw of the US? Its desire to also be identified as an Asia-Pacific community member will call for some tough balancing act then.

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

Road To Growth Is Paved With Low ICOR

India’s slowing investment rate and rising incremental capital output ratio, or ICOR, have led to low economic growth.

Two recent, and epochal, events deserve our unstinted attention because they mark the end of an era and the beginning of another one. These are critical because of a common thread linking both: the investment rate of the economy.

The 12th Five-year Plan has just ended, bringing down the curtain on decades of India’s planned economic growth and development. This was the last Five-year Plan; as an alternative, the Planning Commission’s successor NITI Aayog has announced the release of a three-year “action plan”, a seven-year “strategy paper” and a 15-year “vision document”. There is one key difference between these documents and Five-year Plans: The government is free to disregard the Aayog’s recommendations.

The end of a centrally planned economic system also coincides with the formal interring of the Planning Commission, an organization central to not only India’s economic strategy but also to its federal temper through the added responsibility of allocating grants, Plan and non-Plan funds to states. The commission’s federal remit was not granted through constitutional mandate and this generated sufficient heartburn, especially among non-Congress states. However, the commission’s shuttering is also due to questions raised about the relevance of centralized planning in a globalized, market-led economy. And then there is politics. The commission was created through a government resolution which makes it easy for the Narendra Modi government to bury it.

But before the institution is shut down, it might be worthwhile to examine the 12th Plan performance, especially some of its macroeconomic targets. The 12th Plan ran between April 2012 and March 2017, with a Congress-led administration in charge till April 2014 and the Bharatiya Janata Party-led government steering the Plan thereafter. Prime Minister Modi announced his intentions of abolishing the commission and ending Five-year Plans during his first Independence Day speech in 2014 but allowed the 12th Plan to formally run till its original expiry date.

The plan had set an average gross domestic product (GDP) growth target of 8% for the 2012-17 period. This growth target was not achieved in any single year by either of the two political dispensations, despite a step jump resulting from a new series introduced by the Modi government. The closest India came was in 2015-16, with 7.9% annual growth. Otherwise, the average growth for the period works out to below 7%, way lower than the average annual growth rate of 8% achieved during the 11th Plan.

A low investment rate is among the many reasons for the under-average performance. The 12th Plan envisaged an average investment rate of 34%. However, the investment rate has been declining every year, starting with 33.4% during the first year of the Plan; the Central Statistical Office’s second advance estimates for 2016-17 show gross fixed capital formation at 26.9% of GDP, the lowest in more than a decade. What’s worse, investments have not been forthcoming from either the private sector (which has historically contributed the bulk of investment as a percentage of GDP) or the government sector which should ideally be investing when private investment dries up.

In a recent newspaper article, former Reserve Bank of India governor C. Rangarajan has also pointed to low productivity of capital, captured through incremental capital output ratio, or Icor, which measures how many additional units of capital are necessary to produce one additional unit of output. India’s slowing investment rate and rising Icor have led to low economic growth.

Discussing Icor might sound anachronistic, especially since the service sector accounts for 55% of India’s GDP where the relation between capital invested and output is still unclear. In addition, supply-side thrusts (such as increased government consumption expenditure) can lead to higher GDP growth despite a depressed investment climate, which can then send garbled messages about improved capital productivity. Ordinarily, a falling ICOR should be accompanied by palpable technological improvements and skill enhancements, leading to an all-round increase in productivity and efficiency.

Discussions on capital productivity seem to be back in fashion because high ICOR in recent times (higher than six during 2013-16) have been complemented by sluggish economic growth, over-leveraged corporate balance sheets and burgeoning bad debts in the financial sector. These factors have dragged down the economy’s growth impulses. In all discussions on efficiency and factor productivity, it is usually Indian labour that has to bear the cross. But this time the focus is squarely on capital productivity.

Obsessing with high ICOR becomes necessary when resolution of non-performing assets (NPAs) tops the public policy agenda. Most of the reasons behind high Icor in India are similar to those found elsewhere in the world, but one unique Indian feature stands out: gold-plating, or padded-up project costs. This not only suppresses capital productivity but also distorts the viability of many projects. With institutions and regulators orchestrating Operation NPA Clean-Up in mission mode—for example, the newly-instituted Insolvency and Bankruptcy Board of India is already grappling with 35 transactions—it is imperative that all resolution mechanisms incorporate enough measures to deter future projects from gold-plating costs and getting away with it.

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

Optics All The Way: Budget 2017 has brought to fore the astute lawyer-politician in Arun Jaitley

India’s finance minister Arun Jaitley has lived up to his credentials as a lawyer-politician adroitly: he has presented a budget for 2017-18 that pleases everybody but satisfies very few.

The capital markets investor class, including the foreign portfolio investor (FPI), is certainly happy. The movement of the stock market index reflected joy at being left alone: at closing time, the 30-share benchmark sensitive index was up 485 points in a relief rally. Investors were pleased that a rumoured restructuring of long-term capital gains tax was avoided. FPIs, who bring liquidity to India’s shallow markets, were spared additional tax blushes under something called the “indirect transfer provision,” which required tax to be paid on transfer of shares overseas if the underlying assets are located in India.

In the end, budget 2017 seems to be more about being seen to be doing the right thing rather than doing it. Jaitley’s thrust can be summed up in his own words: “My overall approach…has been to spend more in rural areas, infrastructure and poverty alleviation and yet maintain the best standards of fiscal prudence. I have also kept in mind the need to continue with economic reforms, promote higher investments and accelerate growth.”

This requires walking a fine line and Jaitley has husbanded all the political smarts he could muster.

Delicately balanced

On one side, the impending state assembly elections (in Uttar Pradesh, Punjab, Goa, Manipur and Uttarakhand) which begin on Saturday (Feb. 04) was bound to cast a long shadow on his plans. On the other side, Jaitley had to present a political budget without breaching the election commission’s restrictions.

Jaitley also needed lots of political nous since the budget had to be drafted in the backdrop of some momentous changes: demonetisation (which has dealt a severe demand and supply shock to the economy), the planned move to goods and services tax (GST), political developments in leading developed countries which could lead to severe economic consequences for India and other emerging economies. In addition, the fiscal responsibility and budget management committee’s report tied his hands by advocating fiscal prudence, barring exceptional situations.

On sum, though, there are a lot of announcements and political grand-standing but little by way of on-the-ground impact. For example, total expenditure planned for 2017-18 is up only 6.57% over the Rs 20,14,407 crore actually spent during 2016-17. That barely covers the rate of inflation. What’s even more disappointing, capital expenditure is budgeted to go up by only 10.7%. The country needs public expenditure to kickstart economic growth, especially in the absence of any private sector investment. Strangely, even though Jaitley has acknowledged this in his budget speech, he has failed to walk the talk.

Revenue could be a legitimate constraint. Tax revenues are expected to grow by only 12.7%, while non-tax revenues are actually budgeted to drop. Total revenue, including capital receipts, is expected to rise only 9.7%. One reason for the conservative estimates could be the expected shift to GST from July. The demand compression arising out of demonetisation could be another reason.

Political imperatives

Despite these limitations, the electoral imperative seems to have forced Jaitley to make numerous announcements for farmers, rural areas and allied sectors. In this, Jaitley has chosen to follow the footsteps of his predecessors by announcing grand schemes and allocating large sums. For example, he announced a Rs10 lakh crore agricultural credit target, against Rs9 lakh crore in 2016-17.

It’s curious that successive finance ministers chose to make this proud proclamation in the budget document when the money will actually be lent by various agri-lending agencies, such as the National Bank for Agriculture and Rural Development. There’s another strange twist: while the government promises to bear the interest subsidy on these concessional loans, the money kept aside for meeting the interest subsidy bill remains unchanged from last year. If the loan volume is likely to go up by Rs1 lakh crore, surely the subsidy element should also rise correspondingly?

Jaitley’s made another strange claim: he maintained that the pace of construction of rural roads under the Pradhan Mantri Gram Sadak Yojana had reached 133 km per day during 2016-17. This fact sits uneasily with roads minister Nitin Gadkari’s admission a couple of months ago that his ministry was unable to meet the highway construction target of 40km every day.

The political framework also probably stayed the finance minister’s hand from slashing corporate tax rates further, as had been promised in last year’s budget. In a year when demonetisation has affected millions of livelihoods and the ruling Bharatiya Janata Party wants to win Uttar Pradesh elections, the optics of helping large corporates could be a recipe for electoral hara-kiri.

He has instead cut tax rates for micro, small, and medium-scale enterprises with annual turnover up to Rs50 crore. His contention: their effective tax rate is higher than large companies and it is these units which actually create employment at the grass-roots level.

Arun Jaitley’s budget for 2017-18 pushes the political messaging of demonetisation further. He has painted a multi-hued picture that appeals to the stock market investor, because a rising stock index is often mistaken for economic health. His brushstrokes also strive to attract voters in various states by not only promising employment and income opportunities but also by painting the government as pro-disenfranchised and anti-privileged.

The above article was published in www.qz.com on February 2, 2017, and can also be read here

Budget And Moral Imperatives

Increasing public investment and employment remains a moral imperative for finance minister Arun Jaitley

Union finance minister Arun Jaitley is probably caught in a cleft stick. With demonetisation throwing a spanner in the works, his fourth budget will understandably try to achieve a balance between reviving economic growth and maintaining fiscal stability. These are two seemingly conflicting goals, with economists sharply split on both sides of the divide. The fiscal responsibility and budget management committee is also believed to have drawn some red lines. But Jaitley may not have much of a choice.

There are two ways to revive growth: either through consumption or through investment. Export-led growth could have been another possibility but India’s persisting trade deficit and the world economy’s delayed recovery makes it a non-starter. With demonetisation squeezing out demand, there could be attempts to stimulate consumption through some restructuring in direct taxes and some realignment of indirect tax rates (especially excise) on goods, in line with the proposed goods and services tax slabs. The clamour for fiscal rectitude, especially the threat perception posed by credit rating agencies, might stay Jaitley’s hand from over-stretching.

The other alternative is government’s capital expenditure, because demand compression is also likely to suck out the private sector’s desire to invest. However, there are valid concerns over the government’s ability to execute projects efficiently and within budgeted costs. Road minister Nitin Gadkari’s recent admission of highway construction falling short of desired targets reflects both private sector lassitude in taking up infrastructure projects and the government’s less-than-stellar record in project execution.

File photo of finance minister Arun Jaitley; photo courtesy: Reuters

At a pre-budget seminar in Mumbai, former Reserve Bank of India governor C. Rangarajan said public investment amounts to roughly 7% of gross domestic product (GDP), with the Centre and the states (collectively) accounting for 1.6% of GDP each and public sector units contributing the balance 3.8%. If quality of execution is a concern, there’s a proposal to re-route part of the Centre’s public investment to public-sector units (PSUs) as equity which, leveraged with bank loans, can be used for greater impact. It’s not the best, or ideal, solution, but it sounds workable.

A section of economists and demonetisation supporters claim that penal taxes collected through the two-tranche income-disclosure scheme are likely to provide Jaitley with elbow room to stretch his capex budget without upsetting fiscal targets. And though that is serendipitous (Rs15,000 crore is expected from just the first tranche), the question arises whether Jaitley would allocate a higher capex outlay even in its absence.

Interestingly, increased capital expenditure meets three objectives simultaneously: reviving economic growth, visible progress towards meeting the UN’s Sustainable Development Goals (SDGs) and implementing some of the campaign promises made by Prime Minister Narendra Modi during the 2014 general election.

India is a signatory to the UN’s SDGs, which succeeded the Millennium Development Goals. The SDGs cover 17 broad goals (incorporating 169 related targets) to be achieved by 2030. The SDGs have been framed with the singular purpose of achieving three overarching objectives: ending poverty, protecting the planet, and ensuring prosperity for all. The Planning Commission’s successor, NITI Aayog, has been entrusted with mapping the targets with different ministries, coordinating with them and helping the government meet the targets.

Goal 9 of the SDGs says: “Build resilient infrastructure, promote sustainable industrialization and foster innovation.” More importantly, this is directly related to Goal 8: “Promote inclusive and sustainable economic growth, employment and decent work for all.” This goes directly to the heart of the debate between fiscal hawks and those wanting the government to expand public investment for kick-starting growth; it also provides a compelling reason for the government to increase outlays for public expenditure.

Employment growth remains stagnant across the world. A joint study (goo.gl/ZvLcsf) by the International Labour Organization, the World Bank, the International Monetary Fund and the Organisation for Economic Cooperation and Development found employment elasticity (the direct relationship between employment growth and economic growth) in most G20 countries is low, giving credence to claims of “jobless growth”. India’s employment elasticity is said to be close to zero. A 2014 working paper by RBI staffers (goo.gl/U09o8b) has also pointed out how employment elasticity has declined in the post-reforms era, especially in the manufacturing sector.

The Bharatiya Janata Party’s (BJP’s) 2014 campaign manifesto promised to create new employment opportunities: “A strong manufacturing sector will not only bridge the demand-supply gap leading to price stabilization, but also create millions of jobs and increase incomes for the working class.” There were also commitments to create jobs in the small-scale sector, agriculture and agri-related industries. Unfortunately, the narrative in many states with high unemployment rates has changed thereafter.

So far, official data and anecdotes both indicate demonetisation-induced livelihood stress in urban and rural areas. People have lost jobs across manufacturing, service and agricultural occupations. Whether BJP wins or loses the approaching state assembly elections, increasing public investment and employment remains a moral imperative.

The above article was published in Mint newspaper on January 25, 2017. It can also be read here

Demonetisation And Budgets: All In The Mind

Arun Jaitley will soon be presenting the 2017-18 budget and his well-laid plans may have to incorporate demonetisation-induced changes

It’s 690 seats this year; another 964 seats are up for grabs next year, with the general election to follow in 2019. This inescapable political imperative will weigh on finance minister Arun Jaitley’s mind when he drafts India’s economic policy. The battle for occupying popular mindspace over the past two months is now telescoping into a two-year battle. And if the vast majority of Indians feel confounded after Prime Minister Narendra Modi’s surgical excision of 86% of currency, they shouldn’t despair: They are in the distinguished company of Jaitley who, presumably, is equally disconcerted.

Jaitley will soon be presenting the 2017-18 budget and his well-laid plans may have to incorporate demonetisation-induced changes, over and above those included for introducing the goods and services tax (GST) system. What’s worse, with the GST start likely to be postponed, revenue projections may now have to be recast along traditional lines. Two huge changes in three months is more than just a rude disruption.

Two other elements add to the confusion. One, the railway budget will be merged with the Union budget this year in a meaningful break from a meaningless tradition. Also, the traditional expenditure reporting format under the broad heads of Plan and non-Plan expenditure will be jettisoned.

File photo of Finance Minister Arun Jaitley; Photo courtesy: Mint  

Standing for a moment in Jaitley’s shoes, what’s likely to be more worrying is how the economic slowdown affects revenue growth and how that shapes spending plans—especially committed social sector or infrastructure expenditure—that cannot be trimmed, leave alone eliminated. Jaitley has already promised higher government pump-priming to boost economic growth. Many new variables have cropped up in the meantime, further skewing the math. Modi contributed gamely during his 31 December speech with promises to increase social spending under both new and old schemes.

For example, new interest subventions on small housing loans and farm loans or increases in the number of rural houses built for the poor under the Pradhan Mantri Awas Yojana are some of the schemes which might expand both capital and revenue expenditure bills for 2017-18. It is clear that Jaitley has little option in slashing the outlay for social sector schemes, especially when demonetisation has eroded rural incomes and the ruling Bharatiya Janata Party is unable to dismount the election treadmill. Apart from state assembly elections for Uttar Pradesh, Punjab, Goa, Uttarakhand and Manipur in less than a month, next year will see elections in Tripura, Rajasthan, Madhya Pradesh, Karnataka, Chhattisgarh, Nagaland, Mizoram and Meghalaya.

With the political economy constraining deep spending cuts—at the most, outlays might be shuffled around under different schemes—revenue generation becomes imperative for meeting many of the grand spending plans. This is where rubber hits tarmac.

The demonetisation narrative focused on cornering tax evaders and, through legislative amendments, forcing assessees depositing unreported incomes to pay higher penal rates. This would require enhanced tax scrutiny and inevitably involve some element of persecution. But by stating that demonetisation was launched to punish currency hoarders, it subjected the majority to widespread suffering for the misdemeanours of a few. The messaging was subsequently imbued with nationalist overtones and repurposed to focus on moving India to a less cash economy.

Enter the good cop: News reports claimed that Jaitley had hinted at lower tax rates in a meeting with tax officers, citing how similar attempts earlier had met with success. News leaks from unidentified finance ministry sources also made similar claims.

Jaitley later seemed to deny his statement without actually denying it. There’s no text of Jaitley’s speech; only a summary is available, which has him stating there was an urgent need for a change of mindset: “India has to move towards a mindset of voluntary compliance…payment of legitimate taxes should be considered as part of the process and nobody should think that tax evasion is acceptable.”

This is where things get muddied up. By using the term “mindset”, Jaitley pivots seamlessly into the arcane world of behavioural economics. It is reassuring to note that Jaitley recognizes the importance of mindset in correcting tax compliance behaviour. But his public musings betray a contradiction. Initiating mindset change is a long-term project which involves altering social norms using a combination of psychological and social forces. The post-demonetisation regime instead uses a carrot-and-stick approach: simultaneously offering incentives (aka the Laffer curve) and disincentives (penalties).

The World Bank’s World Development Report 2015—titled “Mind, Society And Behavior”—states clearly that penalties or incentives have failed to improve tax compliance across the world. The UK government’s behavioural insights team, also known as the “nudge unit”, claims to have used behavioural sciences successfully to improve tax compliance in the UK and other countries. Jaitley will do well to remember that like liquor prohibition failed to stem alcoholism and related social problems, a one-time demonetization (or a subsequent penal regime) might not be enough to raise tax revenue on a sustainable basis. While the impact of behavioural sciences in influencing policy outcomes is still imprecise, one thing is clear: lasting changes in social norms require long-term investments.

The above article was first published in Mint newspaper on January 11 and can also be read here

Unintended Consequences of Demonetisation

The demonetisation scheme was launched without the govt thinking through consequences, hardships or logistical complexities of such an undertaking

Indian businesses have spawned some unique management practices. In his book When The Penny Drops: Learning What's Not Taught former Tata Sons executive director R. Gopalakrishnan credits former ICICI chairman N. Vaghul with coining the term "Mafa". Among the many variants of the acronym, the one that works best for India is "Mistaking Action for Achievement".

Mafa seems to be a unique Indian trait, found frequently in Indian organizations. Executives, keen to show initiative, are often found launching ill-conceived projects with little or negligible homework. Managements, it seems, are content to see senior executives bustling around launching one abortive project after another, rather than thinking through strategy, returns and risks. Introspection is considered a luxury, a sign of indolence; shoot first, ask questions later.

The demonetisation scheme is an appropriate example. The government launched the exercise without thinking through the consequences, the hardships or the logistical complexities of such a mammoth undertaking.

The daily, arbitrary changes in rules puts demonetisation squarely within the theatre of the absurd. 

But, more importantly, the project also has numerous unintended consequences. In 1936 American sociologist Robert K. Merton wrote a popular paper titled "The Unanticipated Consequences of Purposive Social Action". The central idea of the theory is that policy action by government can often lead to undesirable outcomes, or unintended consequences, that were not part of the original plan.

The policy landscape is littered with numerous examples. Many commentators link the US government’s determined push to make affordable housing universally available with the 2008 mortgage-fuelled, trans-Atlantic financial crisis. Research shows tightening anti-money laundering rules could end up increasing costs for official remittance channels, forcing remitters to lapse back to unofficial channels. Government incentives in Brazil’s auto sector are said to have caused over-investment, lowered capacity utilization and eventually affected productivity, employment and incomes.

The Indian government’s “surgical strike” on currency notes also has unintended consequences. Here’s how.

Unintended consequence-I: One of the avowed motives behind the 8 November edict was to flush out bank notes hoarded by tax evaders. And while this might succeed somewhat, faulty implementation has given birth to another unintended consequence: re-incentivizing hoarding. A delay in re-monetizing the system, after having sucked out 86% of currency by value, has created an unplanned scarcity. Banks do not have adequate supply—in branches or in alternative channels—of either old Rs 50/100 notes or the new Rs 500. It has forced many economic agents to squirrel away notes. The shortage has acted like a massive shock to the economy. Consequently, instead of draining the swamp, the demonetisation process now threatens to turn it into a crocodile pit.

In a statement read out during the fifth bi-monthly monetary policy press conference on 7 December, Reserve Bank of India deputy governor R. Gandhi said: “The Reserve Bank and the Central Government note presses are working to their full capacities and all efforts are being made to reach the notes to every part of the country… We reiterate that there is adequate supply of notes and hoarding of notes helps nobody’s cause.” The statement clearly shows that the central bank is cognizant of hoarding, and daily news breaks of various raids and recovered currency notes also prove that demonetisation has actually re-ignited the basic hoarding instinct.

Unintended consequence-II: It is now patently clear that the government did not adequately plan for the aftershocks. The exercise has deprived people from retrieving their own money from what were considered fail-safe bank deposits. 

This has a severe unintended consequence: It can erode people’s trust in banks, which has taken years of hard work and perseverance to build. A democratically elected government’s unilateral diktat, increasing the distance between a depositor and her legitimate deposits, can act as a perverse incentive: people may henceforth shove a few banknotes under the mattress before surrendering the rest to banks. This behavioural pattern is hardwired in the Indian psyche, having survived decades of a command-and-control regime which were marked by severe scarcities. 

It is also natural risk mitigation to build buffers against future autarchic government decrees that might once again restrict access to legitimate savings. Nobody likes queueing up for hours to reclaim their own money. While there won’t be a stampede to exit the banking system (and in fact there may be more Jan-Dhan bank accounts opened over the next few years), the demonetisation move has definitely corroded, if only marginally, confidence in the banking network.

There is an apocryphal story about a government rule boomeranging during the Raj. Seeking to clean up snake-infested Delhi, the British rulers announced a bounty for every dead cobra. While genuine snake-catchers got busy, some ingenious Indian entrepreneurs got even busier: they started breeding cobras, killing them and collecting prize money. When the government got wind of this, they shut down the programme abruptly, forcing snake breeders to release their wards back into various parts of Delhi. Hopefully, demonetisation won’t leave behind too many creepy-crawlies.

The above article was first published in Mint newspaper on December 14, 2016. It can also be read here.

The Two-Step Trump Dance

It seems India-US ties will primarily be a two-track exercise: with one track chugging along smoothly and the other full of bumps and speed breakers

India has witnessed 16 years of progressively intensifying partnership with the US under the George W. Bush and Barack Obama presidencies. With Donald Trump moving into the White House soon, predictions about future India-US ties swing between hope and trepidation. Indeed, both sides may have to reset many existing markers in ongoing negotiations.

Everybody is trying to figure out Donald Trump the president versus Donald Trump the candidate. On the campaign trail he confused observers with his wildly oscillating undertakings. The scope for speculation is greater in his ramblings about India; he waxed effusive about India’s business opportunities but issued grim warnings about Indian software engineers in the next breath.

The question uppermost then is: Where does India figure in his plans? For one, Trump’s campaign arc has seen many flip-flops and this may well continue till he finds his feet in the Oval Office in January 2017; the post-victory phase has seen policy reversals, such as second thoughts on completely discarding Obamacare and scrapping the nuclear deal with Iran.

The clue to Trump’s India policy may lie in the document ‘Republican Platform 2016’: “India is our geopolitical ally and a strategic trading partner… We encourage the Indian government to permit expanded foreign investment and trade, the key to rising living standards for those left out of their country’s energetic economy. For all of India’s religious communities, we urge protection against violence and discrimination.”

Parsing the paragraph, it seems the India-US relationship will primarily be a two-track exercise, with one track chugging along smoothly and the other full of bumps and speed breakers. For instance, as the first sentence suggests, security and strategic ties will remain cordial. The second sentence points to the craters: unfulfilled trade and investment demands. In short, it’s business as usual.

The first reset button, though, will have to be pressed by Prime Minister Narendra Modi. He assiduously built a close working relationship with Obama: They had three bilateral meetings and numerous one-on-one engagements in the past 30 months. Modi will now have to figure out the unknown quantity called Trump and see if they can share a working relationship.

So, while there are no safe bets, hopefully the institutional architecture of the current bilateral framework—especially ministerial negotiations under the Strategic and Commercial Dialogue (S&CD)—will hold under the new leadership.

For instance, the civil nuclear partnership and defence acquisitions will be pursued as aggressively by the incoming administration as the outgoing one. Security, strategic affairs, defence cooperation are likely to be smooth sailing because both countries have some convergence of interest here.

To be sure, there’s still uncertainty about Trump’s outlook towards Pakistan, Russia and China and their knock-on effects on India, but it is clear that the India-US geo-strategic alliance will persevere in some form.

The problem area, as in the past, will be trade and investment. Both sides have painted themselves into intractable corners with numerous trade barriers. While Trump’s trade-related campaign tirade was largely restricted to the Trans-Pacific Partnership (TPP) and US-China trade relations, the new administration might train the arc lights on India’s $30 billion trade surplus with the US. India-US trade in goods and services touched $108 billion during the 2015 calendar year.

Interestingly, during Modi’s first state visit to the US, the joint statement set a $500 billion trade target without mentioning any end date. And while under the S&CD and its predecessor, the India-US Trade Policy Forum has held 10 ministerials so far, progress has been at a glacial pace.

Large parts of each year’s communiqué read like the one from the previous year. There are many pain points developing. For instance, in agriculture market access, India wants to export grapes, rice and honey while the US wants market access for cherries, alfalfa hay and pork.

The US has issues with subsidies in the Indian textile sector. India and the US have dithered over signing a bilateral investment deal, the main trip-wire being the contentious investor-state dispute settlement mechanism.

The other sensitive area is intellectual property rights; both sides have been gingerly circling each other with communiqué politesse masking the underlying stress. There are serious differences of opinion in services trade.

There is one redeeming feature though. Under the Obama regime, India was left out of the three large trade arrangements being shepherded by the US: the TPP, the Transatlantic Trade and Investment Partnership (TTIP) and Trade in Services Agreement (Tisa). While Trump has publicly expressed his distaste for TPP (with TTIP presumably falling in the same category), Tisa remains the odd one out.

This is one area where India will have to be vigilant, given India’s strategic advantage in services. India should also use this opportunity and leverage its relationship with the US to prise open the Asia-Pacific Economic Cooperation for a membership. This is a grouping that works well for India, given its flexibility, advantages and non-binding commitments.

It is unlikely that the Trump administration will roll over on trade any time soon; neither should India, because strategic autonomy will continue to be an asset. While the love-hate relationship can continue, both sides must endeavour to find some middle ground in the meantime.

This article originally appeared as part of my column, General Disequilibrium, in Mint on November 16, 2016. It can also be read here.

Poll Bound: Narendra Modi’s Currency Play Has More Political Value Than Economic Benefit

The Narendra Modi government’s decision to demonetise the Rs 500 and Rs 1,000 notes in circulation will have three distinct political outcomes, two of which will be advantageous for the ruling Bharatiya Janata Party (BJP).

The first, and instantly visible, impact of the late evening announcement on Nov. 08 by prime minister Modi himself is a reversal of the news cycle. Dire discussions on the polluted Delhi air and its impact on foreign investment? Gone. The unfortunate ripple effects from the army veteran’s suicide? Buried. Doubts over the BJP’s chances in the forthcoming state elections? Dismissed.

Elections to state assemblies in the first half of 2017 are crucial for the ruling party, especially since they have been smarting from the defeats in Delhi and Bihar in 2015 and West Bengal this year. The battleground states this time include Uttar Pradesh (UP) and Punjab. UP, as things stand, will see a four-cornered battle.

Demonetisation immediately changes the narrative. The BJP has been trying to stitch together a patchwork support base among the Dalits, Muslims and other disenfranchised segments of UP; their votes are crucial to winning the state. Demonetisation will, in some limited fashion, help in providing a new talking point, one that takes potshots at the privileged and mendacious classes.

Given the fact that the government and the Reserve Bank of India now plan to re-introduce the Rs 500 and Rs 1,000 notes, albeit with a new design and enhanced security features, along with the creation of a new Rs 2,000 note, the entire objective of the exercise seems to be targeted at blindsiding counterfeiters, not so much hoarders of cash. Whichever way you look at it—“surgical strikes” on either counterfeiters who aid terrorism or black-money merchants—it is a narrative ripe with opportunity for rhetoric and election sloganeering.

State elections also point to advantage no. 2. The element of surprise will probably inconvenience the other three parties. The use of cash in Indian elections is an accepted fact and some of the parties are rumoured to be large users of cash. This surprise element would have surely nixed their ground-level strategies. In short, it will be back to the drawing board for most of these parties.

It can be argued that this is a problem for even the BJP. Modi emphasised in his speech: “Secrecy was essential for this action. It is only now, as I speak to you, that various agencies like banks, our offices, railways, hospitals, and others are being informed.” But, the question remains: would he have taken such a momentous decision without consulting the BJP’s command-and-control centre, the Rashtriya Swayamsevak Sangh (RSS)? In many ways, strands of such a policy action have been appearing in the media for a while, as editorial advice or even harking back to the example of the USA which discontinued high-denomination currency notes in 1945.

The question over the consultative process gains further momentum when viewed from a political survival standpoint. The demonetisation exercise will adversely affect small traders and shopkeepers, a segment of society which has traditionally remained a strong BJP vote bank. Most businessmen in this segment depend on cash transactions and PM Modi’s move is bound to discomfit their operations. Given this bloc’s importance, there must have been some serious back-room calculations about going ahead with such a measure.

And a calculated move it is. One probable clue lies in the fresh issuance of Rs 500, 1,000 and 2,000 denominations after a brief hiatus. So, if you ignore the short term spike in chaos, inconvenience and rhetoric, the cash economy is bound to make a comeback in a couple of months, albeit in the form of newly-designed currency. That should give the traders and small shopkeepers some succour.

But, it will require the party apparatus to reach out to various trade associations and federations to communicate with them, assuage them, and address their concerns in the short term.

This will be doubly necessary given the other three-alphabet headache that’s hurtling towards small businesses at breakneck speed: GST. The new tax system envisages a complete overhaul of tax assessment, calculation and reporting. That chaos is in the not-too-distant future, it will create huge turmoil with the trading class having to register with the tax authorities, re-skilling themselves in figuring out the new tax structure, as well as chasing tax credits from authorities. As an example, shopkeepers and small businesses in Malaysia took to the streets early this year, frustrated at the complexity involved in complying with GST.

This is political issue No. 3 for the BJP and its spiritual bosses at RSS.

In the final analysis, the whole exercise seems designed to replace, rather than demonetise (which is to suck out completely and abolish), high-value notes. Counterfeiters will be hurt, middle-class families will be discommoded, and some currency hoarders will be disrupted, but the cash economy will return to a new normal in a few months. But, only after the UP elections.

This article originally appeared in Quartz on November 10, 2016, and can also be read here

India’s Disenchantment with Multilateralism

India’s initial enthusiasm for multilateralism stemmed from the belief that the global economic governance system would take on board emerging economies’ concerns

India’s decision to pull out of the South Asian Association for Regional Cooperation (Saarc) summit in Islamabad marks a new milestone in the country’s growing disaffection with regional and multilateral groupings. This discontent was most visible at the G20 summit, which it used for some unsubtle political messaging. Its near-perfunctory chairmanship of the eighth Brics (Brazil, Russia, India, China, South Africa) summit raises further questions about its interest in multilateralism.

Is there an impending shift in India’s multilateral policy framework, in much the same way that the recent “surgical strikes” pushed the strategic restraint doctrine? Will the current administration give politics greater weightage in its external policies, which till now had an economic focus? Welcome to the post-Uri policy configuration.

The future of Saarc, perennially hostage to the hyphen dividing India and Pakistan, is now further jeopardized, with Bhutan, Bangladesh, Afghanistan and Sri Lanka joining India in boycotting the Islamabad summit in November.

The low-key run-up to the eighth Brics leadership summit, scheduled on 15-16 October in Goa under India’s chairmanship, further reveals the political leadership’s fatigue with such associations. Hopefully, this will be reversed when the Brics leaders get together.

India’s stand at the latest G20 summit in Hangzhou also betrayed frustration, with Prime Minister Narendra Modi highlighting Pakistan’s export of terror. This would have seemed logical at any other global gathering, but the G20’s purpose is fostering global financial stability and economic cooperation, not airing political differences. But then, isn’t economics also about politics?

Modi’s outburst against Pakistan at a China-curated G20 summit was strategic. China has repeatedly blocked India’s attempts to enforce a UN-sponsored ban on Jaish-e-Mohammad chief Masood Azhar. In addition, Beijing is going ahead with the China-Pakistan Economic Corridor, a vital component of the One Belt, One Road initiative, which plans to pass through contested territory in Pakistan-occupied Kashmir despite India’s reservations. The last straw perhaps was China’s public opposition to India’s entry into the Nuclear Suppliers Group. India also denied China some moments of glory in Hangzhou: It refused to ratify the Paris climate accord there.

There’s also growing global disenchantment with the G20, with the weak structural engineering of this alignment now becoming slowly visible. The Hangzhou summit communique reads much like its predecessors’. It included all the well-intentioned, oft-repeated noises about policy coordination, economic growth, governance, development, inequality. Here’s the problem: The communique lacks a credible path to policy action, or any quantifiable targets. Similar communiques in the past have also helped create an atmosphere of scepticism. For example, the 2014 Brisbane summit had announced a policy framework for increasing global gross domestic product by an additional 2% by 2018, predicated on large-scale infrastructure investments. The International Monetary Fund’s staff note for the 2016 summit says the target looks unattainable because of low investment rates in most advanced economies. Consequently, analysts are rushing to publish the G20’s untimely obituary (goo.gl/57hQsn).

The G20’s shaky foundations can be traced to the circumstances of its birth. It was created in 1999—primarily as a reaction to the 1997 Asian financial crisis—as a platform for finance ministers and central bankers to discuss international financial and monetary policies, global economic trends and reform of multilateral financial institutions. In November 2008, then US president George W. Bush invited global leaders to Washington, DC to discuss a coordinated global response to the financial crisis. This became the G20’s first leadership summit, and provided the defining character of its birth: a fire-fighting unit masquerading as a global policy coordination body.

Logically, therefore, once the immediate hump of the crisis was crossed, the G20’s utility seemed diminished. Some good examples are the US’ disregard for policy coordination preceding the taper tantrum, resulting in tough times for emerging economies—and the slow progress in reforming the shareholding of Bretton Woods institutions.

The director of Globality Inc., Rebecca Liao, writes in Foreign Affairs: “Instead of coordinating economic policy among the world’s wealthiest countries, it (G20) broadened its scope to include climate change, investment initiatives, and human rights. Since its members are largely unable to come to a meaningful consensus on this expanded range of issues, the G20 then became a think tank of sorts.”

India’s enthusiasm for multilateralism stemmed from the belief that the global economic governance system would take on board the concerns of emerging economies. That hope now looks dashed, with slow progress on most issues. Add to that India’s concerns on terrorism going unheeded on global multilateral platforms. Consequently, it is quite likely that India’s policy architecture might acquire a slight bias towards bilateralism, given Modi’s predilection for one-on-one engagement with world leaders. There are also some indications of the foreign policy needle shifting slightly towards politics.

This column was originally written as an Op-Ed for Mint newspaper and can be read here 

Lost History: An encounter with the 'king' of Turtuk, a border village near Gilgit-Baltistan

The village is just 10 km away from Pakistan-occupied Kashmir and became a part of India as recently as 1971.

Entrance to the Royal Palace, Turtuk village

A guided tour of the Ladakh's Turtuk village, in the mountainous region of Baltistan that is on the border of Pakistan and India, ended at what is known in these parts as the Royal Palace. After a long walk down narrow and undulating lanes in the crisp afternoon sun, shepherded by a nimble 16-year-old, we had arrived at what was supposed to be the highlight of our excursion. At first glance, it was slightly underwhelming – the house is larger than its neighbours, but little else set it apart.

The palace doors opened into a colonnaded courtyard that supported a verandah with no visible access. A short flight of stone steps, which rose steeply through a hidden corner, brought us to a figure supine on a floor mat. Our guide gently nudged the figure – a man stumbled out of his afternoon siesta, disoriented by the sight of so many strangers. He was feeble and slightly bent.

Smoothing the creases on his shirt and patting his disheveled hair into place, he led us into a room, apologising for not according us a better welcome. He explained, somewhat diffidently, that working the fields in the morning sun had induced the mid-day torpor.

He then sat on a couch, but not before picking up a wooden sceptre, crested with a distinctive metal serpent head, and placing it pointedly on his lap. He then becomes Yabgo Mohammad Khan Kacho, the king of Turtuk and descendant of the Yabgo Dynasty of Chorbat-Khaplu, a region that now falls beyond the Line of Control and in the contested territory of Pakistan occupied Kashmir. Though he no longer enjoys the powers nor the official recognition as a past royalty, he is known in these parts as the king.

Yabgo Mohammad Khan Kacho, King of Baltistan.

Across the border

Turtuk is a quaint village perched barely 10 km from the Pakistan border, under the benign gaze of the K2 peak across the border. The village, located in the Sheyok river valley about 200 km from Leh, is a verdant relief amidst the spare and stark beauty of Ladakh’s landscape.

Turtuk, in Ladakh district, is in the Indian-administered part of the Baltistan region and borders Pakistan’s Gilgit-Baltistan area.

The Gilgit-Baltistan are has for years existed largely away from the glare of Indian and international media, but the spotlight has been on it for the past month, after Prime Minister Narendra Modi publicly promised – twice in quick succession, in his Independence Day speech and before that, in his concluding remarks at the all-party meet on Jammu and Kashmir in Delhi on August 12 – to highlight the plight of residents of Balochistan and Pakistan-occupied Kashmir to the world. While Balochistan is a province in Pakistan, which has been fighting for autonomy, Gilgit-Baltistan is a part of PoK.

The Gilgit-Baltistan territory is special – it is a crucible in which trade, culture, religion, languages and cuisines from Europe, Central Asia, Afghanistan and China have come together for centuries. India has made many claims over the province and many analysts have recounted its recent political history. Interestingly, a thin strip of this province juts into India.

The prime minister’s reference to the three disputed areas has got foreign policy and strategic experts parsing his words, as well as setting off a maelstrom of articles and Op-eds (examples are here, here and here).

Overnight, a new country

This prompted me to wonder: what would the people of Turtuk, just a stone’s throw away form Gilgit-Baltistan, make of Modi’s statement? Would they also be deconstructing his speech?

One thing is certain. Nationality or sovereignty are elusive, if not transient concepts for the king and villagers here. And there's a good reasons for this.

One night in December 1971, village residents went to sleep as Pakistan citizens. They awoke next morning as Indians. Turtuk, along with three other villages in the vicinity – Tyakshi, Chalunka and Thang – were occupied by advancing Indian armed forces during the 1971 war of liberation of Bangladesh.

Turtuk residents have only one grouse – the Indian army should have gone a little further and occupied the rest of Baltistan. The overnight change of sovereignty split many families along the Line of Control – parents on this side with children and grandparents on the other. Political conspiracies abound on why the Indian army did not move further afield when it was there for the taking.

Kacho, Turtuk’s king, also has some family on the other side. He traces his lineage to the Ghaz tribe from West Turkestan, a region today known as Central Asia. His ancestor, Beg Manthal, came to Baltistan in 800 AD from Yarkhand (which is part of modern-day China’s Xinjiang region) via the Saltoro ridge (which is to the west of the Siachen glacier) and conquered Khaplu, in modern-day Gilgit-Baltistan.

The Yabgo dynasty, Manthal onwards, ruled the Chorbat-Khaplu region of Baltistan for a millennium, expanding it over time to Ladakh’s frontiers on one side and to Ghizer district on the western edge of Gilgit-Baltistan. The dynasty ended in the first half of the 19th century when the Dogra empire, which had, in 1846 taken control of Kashmir, forming the princely state of Jammu and Kashmir, expanded its kingdom North and East.

A wall at one end of the room has the family tree painted on it, going back centuries.The king said the Indian army helped him document this. In the face of an elusive administration, the Indian army means many things to most Baltistan residents – employer; buyer of locally-produced vegetables, milk, fruits and meat; provider of healthcare and education as well as occasional source of telecom network and other basic infrastructure.

The king describes himself as a writer and said his father didn’t want him to work but just spread the word about their family. He was not trained in anything but made to read a lot. He read books written by local historians and decided that the best thing to do would be to tell his people what they were all about.

But, the Indian government banned his book based on complaints from a sect that saw blasphemy in his account of how their religious order was established, he said. He contested the ban in Indian courts and eventually won after years of litigation. But he rues the fact that he didn’t retain a single copy of the book – he doesn’t even remember the name of the Delhi-based publisher.

Connected, yet isolated

Turtuk is a microcosm of Baltistan’s inclusive culture: a multi-ethnic village, with around 4,000 residents speaking different languages and praying to different gods. Different denominations – Nurbakshi Shias, Sufis, Sunnis, Buddhists (and perhaps even Ahmadiyas and Ismaili Shias) – live peacefully, farming and trying to make sense of the burgeoning tourism business. Turtuk was opened up to tourists only in 2010. The chairman of the local school and healthcare committee remarked that many old Turtuk residents would long to see cities, but now, the cities were coming to see them.

Turtuk was an important junction on the Silk Route with ancient linkages to Tibet, Afghanistan and the steppes of Central Asia. A part of China’s One Belt, One Road initiative, an attempt to resurrect the Silk Route that connected parts of Asia, Europe and Africa, will now come close to Turtuk as it proposes to pass through Gilgit-Baltistan.

Turtuk residents fervently wish that the LOC opens up so they can meet family on the other side, re-establish social connections and perhaps even resume commerce.

The king is still recounting the region’s old linkages when his narrative is cut short with new arrivals, guests of a senior army officer posted in the vicinity. Yabgo Mohammad Khan Kacho apologises and rushes off to attend to the new rulers of Turtuk.

This article was originally published in www.scroll.in and can also be accessed here