It’s All In The Sequencing

There is silence on how the digital payments universe will foster competition, spur innovation and design a regulatory framework to protect consumers

Public policy discussions globally have often debated the role and sequencing of regulatory reforms in the series of structural changes necessary for introducing market dynamics to state-controlled economies. In India, post 1991 reforms, this critical issue was not adequately deliberated; worse, the government’s piecemeal approach to reforms and policy planners’ disregard for prioritizing regulatory reform inevitably led to regulatory capture and crony capitalism.

The demonetisation exercise is another pertinent example of how non-systemic reforms, without preceding regulatory reform, lead to chaos and economic dislocation. The withdrawal of 86% currency overnight was accompanied by a steady stream of shifting narratives: launched initially to curtail counterfeiting and currency hoarding, the objective soon segued to facilitating a digital payments infrastructure. But the lack of any planning before introducing this coercive shock, or the absence of preparatory infrastructure build-up and roll-out, has nullified all initial benefits.

Digital payments values and volumes went up between 8 November and 31 December 2016 because people had no other options. A recent research report from securities firm Motilal Oswal estimates that digital payments reduced substantially by May. For example, Motilal Oswal’s calculations show cumulative value of transactions across all digital payments channels during May at Rs111.55 trillion, down from the December 2016 peak of Rs131.45 trillion. The report disregards the Rs180.73 trillion spike during March, attributed primarily to seasonal phenomena.

Even a senior executive from the National Payments Corporation of India (NPCI) was quoted in this newspaper as saying the December spike in digital payments had ebbed by April.

So, what has demonetisation achieved? Observers cite two tangible, but divergent, results: a political victory through electoral gains in Uttar Pradesh and deepening agricultural distress leading to widespread farmer unrest. While there is no detailed, granular research linking demonetisation and these two outcomes, there is one noteworthy collateral benefit though: casting a wider net exposes the asymmetrical regulatory landscape in the payments and settlement ecosystem.

Soon after demonetisation, the Ratan Watal committee on digital payments advanced its deadlines and rushed through its report submission. Another committee of chief ministers was set up by Niti Aayog under Andhra Pradesh chief minister N. Chandrababu Naidu. This committee spawned another committee for digital payments security under IT secretary Aruna Sundararajan. Niti Aayog has set up another committee helmed by chief executive officer Amitabh Kant to “enable 100% conversion of government-citizen transactions to the digital platform”. Meanwhile, the ministry of electronics and information technology (Meity) has issued its own guidelines to facilitate adoption of electronic payments and receipts for various government services. Before all this, in June 2016, the Reserve Bank of India (RBI) had set up an inter-regulatory working group on fintech and digital payments, though the fate of this committee is not yet known. Besides, demonetisation also occasioned a host of other private reports.

Predictably, such a surfeit of committees and reports has led to overlaps and repetition. A cursory reading might even give the idea that committees are competing among themselves to say the same things. However, the burst of reports and recommendations in the first flush of demonetisation seems to have petered out: nobody seems to be listening and there doesn’t seem to be any urgency to implement many of the suggestions.

For example, the Watal committee’s recommendation of carving payments regulation out of RBI’s jurisdiction and making it into an independent body met with resistance from the central bank; eventually, finance minister Arun Jaitley announced the setting up of a payments regulatory board in his 2017-18 Budget speech (to replace the existing Board for Regulation and Supervision of Payment and Settlement Systems, or BPSS) on the lines suggested by the committee, but with one critical exception: the board will have three members from RBI and an equal number from the government, thereby diluting its independent status.

Many other skews in the regulatory architecture have been pointed out but remain unresolved. For example, as owner and operator of the retail digital payments network, the NPCI is a provider of critical infrastructure; but, simultaneously, it also competes with users by pushing its own payment products and services. In addition, its entire equity capital is owned by 56 banks, which automatically puts non-bank payment service providers at a distinct disadvantage and raises questions of infrastructure neutrality.

There is also complete silence on how the digital payments universe and its regulators will foster competition, encourage innovation and design a regulatory framework to protect consumers. Currently, allowing only banks to access the payments network—and denying that to non-banks—seems to be the default regulatory design.

The attention of policy planners and administrators might have been temporarily diverted to the other elephant in the room: goods and services tax, which goes live from 1 July. But, GST’s success is also predicated on a robust and secure digital payments network; an ad hoc digital payments network spells only provisional success for GST.

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

NPAs: The New Wedge in Centre-State Relations

NPAs are expected to acquire a two-tier, federal character with enormous implications for Centre-state relations

There was jubilation in stock markets recently after finance minister Arun Jaitley hinted at a scheme to sort out the messy tangle of bad loans in the banking sector. The equity market’s optimism beggars belief because NPAs—or non-performing assets, as bad loans are called technically—have remained impervious to an alphabet soup of previously attempted schemes. And now, NPAs are expected to acquire a two-tier, federal character with enormous implications for Centre-state relations.

In the post-1991 era, multiple schemes have been conceived and launched to tackle the menace of NPAs: DRTs (debt recovery tribunals, as suggested by Narasimham Committee-I and then subsequently amended in 2012), CDR (corporate debt restructuring), SARFAESI Act (Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest), CRILC and JLF (Central Repository of Information on Large Credits and Joint Lenders’ Forum), 5/25 scheme, ARC restructuring (asset reconstruction companies, formed as a consequence of DRTs), SDR (strategic debt restructuring), AQR (asset quality review), S4A (scheme for sustainable structuring of stressed assets) and finally the IBC (Insolvency and Bankruptcy Code).

There are multiple reasons for many of these schemes failing, which includes an inadequate legal framework for pursuing resolution; however, the one reason that remains unchanged from pre-reforms period is final policy design always providing corporate borrowers enough protection so that they can reprise the same act all over again. And while public attention has focused on Vijay Mallya—deservedly of course—there are other larger industrial groups which are habitual offenders but manage the system adroitly. Former Reserve Bank of India (RBI) governor Raghuram Rajan was compelled to state: “…it is extremely important that banks do not use the new flexible schemes for promoters who habitually misuse the system (everyone knows who these are) or for fraudsters.”

This raises issues of “moral hazard”; in the Indian context, moral hazard has taken the form of corporates or public sector banks undertaking increasingly riskier behaviour because they know the government is underwriting that risk or bearing the cost of that risk. Post the 2008 financial crisis, moral hazard has acquired some flexibility globally: it has become acceptable to bail out institutions if government feels such failure can lead to widespread systemic risk.

This may have inspired finance ministry’s chief economic advisor Arvind Subramanian to blithely suggest that government should perhaps bail out large corporate borrowers because that is how “capitalism works”. He feels only write-offs can sort out the “mountain of debt” sitting on bank books, or settle the twin-balance sheet problem (over-leveraged companies and NPA burdened banks). 

Interestingly, Subramanian has also contributed to the NPA soup cauldron: the annual economic survey recommends the creation of PARA, or Public Sector Asset Rehabilitation Agency. Not to be left behind, even RBI’s recently appointed deputy governor Viral Acharya has gamely added his two-bit: PAMC (Private Asset Management Company) and NAMC (National Asset Management Company).

So, while attempts are being made to untangle the knotted skein of corporate bad loans, albeit through an ever-growing thicket of acronyms, Jaitley has at the same time flatly turned down requests for farm loan waivers. He has received wide support. State Bank of India chairman Arundhati Bhattacharya has warned that fulfilling such pre-election promises might lead to dilution of credit discipline: borrowers might tend to defer repayment till the next elections in the hope of loan waivers. This newspaper also recently pointed out that the Indian agricultural sector needs long-term structural investments, not short-term exchequer-funded loan waivers. There is merit in each of these arguments.

But, here’s a catch: the ruling Bharatiya Janata Party also promised farm loan waivers in its Uttar Pradesh assembly election manifesto. Having won the elections and faced with the prospect of fulfilling that promise now, Jaitley has used an escape hatch to wriggle out of the commitments. Answering the debate on Finance Bill in Rajya Sabha, he has asked individual states to foot the bill for farm loan waivers. He has effectively created a two-tier, federal, moral hazard framework: Centre’s responsibility to bail out large corporates and states get to write off farm loans.

This further complicates attempts at creating a long-term, sustainable set of solutions for controlling and resolving the financial system’s NPAs. It also adds new headaches to the already vexed Centre-state relations. Competitive waiver promises have already weakened the fragile balance sheets of Andhra Pradesh and Telangana. 

It also raises issues of discrimination. If the Centre wants to bail out some 30-40 large corporate borrowers on the pretext that their debt misery was the outcome of external shocks, does not the same logic or argument apply to farm loans, especially since many states have been victims of droughts, inadequate monsoons and crop failures? There is no doubt the NPA mess needs to be resolved urgently to kick-start investments and the growth process. But then, that solutions framework cannot be built on the foundation of discrimination and selective relief.

The above article was published in Mint newspaper and 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

Security Cover As Status Symbol

It's admittedly weird. But, for many Indians, the level of security provided by the state is a prestige issue, to be worn like a badge of honour.

The Minister of State for Home Affairs, Haribhai Parathibhai Chaudhary, in a written reply to a question by Om Birla in Lok Sabha on Wednesday, July 22, 2014, gave details of people provided varying levels of security by the Central government. Here are the details provided by the minister:

“Z+” category – 31 

“Z” category – 77 

“Y” category – 136 

“X” category – 31 

Total – 275 

I feel that the number of people provided "Z+" cover at 31 seems to be quite high. I wish the government discloses who these people are and places its "assessment-of-threat" in the public space. I don't want to sound too indelicate, nor question the security cover provided to the President, the Vice-President or the Prime Minister; but it's my gut feeling that many have been provided "Z+" as a mark of honour, to provide them with a higher perch on the slippery social totem pole. 

People's representatives: Former Bihar chief minister Lalu Prasad Yadav (above) and former Uttar Pradesh chief minister Mayawati; (pix courtesy Reuters & Livemint) 

In recent times, Manohar Bhagwat, chief of Rashtriya Swayamsevak Sangh (with the official title of "Sarsanghchalak"), was provided "Z+" cover based on an fresh risk assessment. 

Ordinarily, "law and order" is a state subject, according to the federalism formula provided in the Constitution. But, the Centre also makes its own assessment and also provides security cover, based on "...assessment of threat to some individuals. The security provided is subject to periodic review, based on which security is continued/ withdrawn/ downgraded/upgraded. Thus the number of protected in the Central List varies from time to time."

And, the cost? This what the home minister's statement in Lok Sabha said, "...(it) is difficult to determine precisely as it would include salary and allowances to security personnel, communication, transport vehicles etc. which are acco
unted for under respective budget heads of different security agencies, including State Government agencies, involved in providing security cover. Such details are not compiled centrally and so cannot be provided." 

The details can be accessed here: http://pib.nic.in/newsite/PrintRelease.aspx?relid=123481

Lessons for Maya & Co

Here’s a quiz question.

What’s the difference between a political party and a joint stock company? The logical, and common, answer is: lots. Both are structured differently, have different aims, mission statements, leadership structure, stakeholder involvement. The list can be expanded endlessly. But, that’s what is visible only on the surface. Increasingly, the distance seems to be shrinking, especially with politics becoming so competitive and political parties being forced to focus on core competencies.

Also, Mayawati’s “rainbow coalition” experiment in Uttar Pradesh seems to suggest a further convergence between the two organisational structures. Why her? According to elections observers and political experts, she used a caste combo that not only appealed to voters sick with identity politics but also capitalised on the anti-incumbency wave against the ruling Mulayam Singh government. This coalition itself constitutes a promise that she will now be duty-bound to deliver — an undertaking to put an end to identity politics and the beginning of inclusive development, irrespective of caste.

It’s here that she should look at some similar structures existing in the corporate world. In fact, to belabour the same point, politics may have something to learn from business. This newspaper has carried articles in the past about how political parties have a lot to learn from businesses, especially when it comes to handling succession planning, given that most political parties now resemble family-run enterprises. The only exception to this probably is the CPI(M). But to get back to Mayawati and her political party Bahujan Samaj Party (BSP). Her resounding victory in the UP Assembly polls now puts her squarely in a position that will require her to fulfil the glimmer of hope that she so tantalisingly displayed. Look at the challenges that she faces and the similarities with the corporate world.

First cut: Like a company draws up a strategy — which includes product, production, marketing, sales, distribution, finance — for delivering value to shareholders, Mayawati also has an umbrella agenda in place: A coalition of upper and lower castes. But it’s still not a strategy. There’s no clear, well-defined path that shows how the coalition will be achieved in its entirety. She needs to articulate a strategy that goes way beyond finding ministerial berths for upper caste representatives.

Second Stage: She now needs to put a team in place that will deliver the nuts and bolts of the strategy. She has an able Number Two who has helped bring in the votes. He has to now build a team of lieutenants who will be able to figure out what needs to be done to translate the over-arching agenda into a political reality. Only a dedicated team, with credibility at the grassroots level, will be able to make the connection between the back-rooms at party HQ and UP’s arid fields.

Third Tier: Most brilliant strategies flounder because of poor execution. Mayawati’s entire credibility quotient is currently very high and she must make sure she utilises this honeymoon period to make real, effective and sustainable changes on the ground. UP has become the dump heap in terms of development indices — it is at the bottom of the table in almost every category. If she manages to bring in some improvement, the dividends will be enormous. Therefore, key to her success will be effective execution, which also includes zero victimisation of OBCs or the other intermediate castes.

Fourth Principle: The BSP, like a smart marketing company, has understood the need for realignment of strategy and repositioning of its products. And while a good corporate always uses a combination of intuition and market research, Mayawati used only her innate sense and gut feel for analysis. All the opinion polls (supposedly scientific) — commissioned by TV channels — were wide off the mark. Mayawati has to be able to take the repositioning to its logical conclusion for her “rainbow coalition” to make any tangible sense. It’s not enough to just win this one election.

Finally, like all corporate organisations have to look after all their stakeholders, BSP also has to focus on the well-being and welfare of all its constituents.