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

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

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

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

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

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

The aged

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

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

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

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

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

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

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

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

The women

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

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

The farmers

Finally, the farm sector deserves many structural reforms.

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

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

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

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

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

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

Budget 2018: What Equities And Bond Markets Tell Us

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Are Promises Meant To Be Kept?

What you expect is not what you always get. But Budget ’18 seems to have lived up to its promise: effusive praise for its own policies, some grandstanding and lots of signalling. In short, Finance Minister Arun Jaitley’s Union Budget for 2018-19 is custom built to prepare his party for hectic political action over the next 12-18 months. Jaitley’s avowed focus is on improving ease of living in modern India; if the economy benefits, that will be a bonus.

This may sound a bit cynical but Jaitley joins a long list of illustrious finance ministers who grapple with this problem every Budget: How to ensure that the policy design satisfies all economic interests? This gets aggravated during pre-election years when neglected constituencies need handouts and aggrieved voters require hand-holding. Most FMs have settled upon a common formula: showboating, grandiloquence, throwing in a few quotes, data smokes-and-mirrors, and a string of policy announcements that sound good and feel good but might forever remain on the drawing board. The earlier government mastered this art and this government is showing no signs of giving up on it.

This Budget focuses on select voter segments: agriculture and rural voters, women, infrastructure and health, salaried employees and MSMEs (micro, small and medium enterprises). Many schemes have been announced, money allocated and pious intentions announced; time will tell whether these translate into tangible benefits on the ground.

For example, Jaitley has announced a 50 per cent increase in minimum support prices (MSP) for the kharif crop. So far, so good. However, it is common knowledge that MSP does not cover all crops and that most farmers are unable to take advantage of MSP due to a variety of reasons—corruption at procurement sites; paucity of information about MSP; lack of linkages between farms and markets; coercive tactics used by local moneylenders and politicians to buy crop from farmers at sub-MSP.

The government also recognises that most farmers do not have access to MSP levels when market prices often slide below MSP. To remedy this, Jaitley’s Budget speech promises: “Niti Aayog, in consultation with central and state governments, will put in place a foolproof mechanism so that farmers will get adequate price for their produce.” Going by the statement, it seems that it will be a while before Niti Aayog can construct a policy paradigm, launch it and then correct it for bugs. This raises concerns: Can Jaitley honour some of these promises?

Predictably, agriculture and the rural economy occupy the centre stage this Budget, given the imminent political compulsions. Outlays have been announced for agri-market infrastructure, rural roads, food processing, dedicated funds for developing infrastructure in aquaculture and fisheries as well as for animal husbandry, among others.

But here’s the problem: these announcements fall short of ensuring that funds reach the farmers. The Budget paradigm remains stuck in legacy mode, unable to shift from theatrics to improved, on-the-ground delivery mechanisms. For example, the much-vaunted crop insurance scheme has failed to settle claims in a year of severe farm sector distress.

While many commitments have been made to improve the lot of the poor, some existing schemes are being tapered down; the Mahatma Gandhi National Rural Employment Guarantee programme is a good example. Against an originally budgeted Rs 48,000 crore expenditure for the scheme during 2017-18, the government actually spent Rs 55,000 crore during the year. But the expenditure budgeted under this head for 2018-19 remains fixed at Rs 55,000 crore.

This Budget contains another path-breaking announcement: a move towards universal healthcare. As a first step, Jaitley has promised that 10 crore poor families (comprising roughly 50 crore beneficiaries) will be provided coverage (up to Rs 5 lakh per family per year) for secondary and tertiary care hospitalisation. This is a major step forward. But as earlier, there is little information on the details of the scheme or how it will be rolled out, giving rise to scepticism.

The Budget was also expected to provide some stimulus to manufacturing and employment generation. Jaitley has, thus, increased customs duty on imported mobile phone components to encourage indigenous manufacturing. However, even though the announcements are in line with the phased manufacturing programme (launched by Ministry of Electronics and Information Technology), there is no clarity how it will stimulate a move from assembling to manufacturing, which is what currently plagues mobile phone manufacturing in India.

The cynicism gets heightened because of the Budget arithmetic. Jaitley promises to exercise fiscal rectitude by accepting key recommendations of the Fiscal Reform and Budget Management Committee (which was chaired by bureaucrat-turned-politician N K Singh) and to bring down government’s debt-to-GDP ratio to 40 per cent. Consequently, after breaching the fiscal deficit target for the current year (3.5 per cent of GDP against 3.2 per cent promised), Jaitley has now committed to restrict fiscal deficit for 2018-19 to 3.3 per cent of GDP.

This is where the math starts getting tricky. Are the revenue projections in step with spending promises? For example, the Budget assumes a nominal GDP growth of 11.3 per cent during 2018-19 but projects income tax collections growing by 20 per cent, corporate tax growing by 15 per cent and GST collections rising by a whopping 67.3 per cent. As the proverb goes, this is where rubber will hit the road.

The above article was written at the invitation of New Indian Express. It can also be read here

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

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

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

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

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

“Invest, and savings shall follow”

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

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

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

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

All eyes on private sector

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

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

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

No escaping savings

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

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

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

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

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

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

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

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

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

Will Jaitley Sow The Right Seeds?

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Budget 2018: A Trinity of Challenges Confronts Arun Jaitley

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Fintech Moves In The New Year

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Time To Go To FRDI Bill’s Roots

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Sports And The Ease of Doing Business

There is no arguing that sports and sporting events should be made more inclusive

A recent statement by Rajyavardhan Singh Rathore, Union minister of state for youth affairs and sports, has rattled many private television broadcasters operating in India. Delivering the keynote address at the Confederation of Indian Industry’s (CII’s) Big Picture Summit, he said that media has an important role in taking sports to each and every home in India.

The minister’s intentions are honourable and desirable. But when combined with recent reports in this newspaper and elsewhere that the sports ministry is working with the ministry of information and broadcasting to declare cricket’s Indian Premier League (IPL) a tournament of “national importance”, it has multiple implications. This column usually eschews discussions on policy issues which are works-in-progress, but the multiple consequences of such a policy move are compelling enough to merit a moment of pause.

At the moment, the minister is only thinking aloud. But if the decision does come through, it will require a private sector network that won exclusive media rights to this tournament in an open auction conducted by the Board for Control of Cricket in India (BCCI) to share its live feed of the event with national broadcaster Doordarshan under the Sports Broadcasting Signals (Mandatory Sharing with Prasar Bharati) Act, 2007.

Section 3(1) of the Act states: “No content rights owner or holder and no television or radio broadcasting service provider shall carry a live television broadcast on any cable or Direct-to-Home network or radio commentary broadcast in India of sporting events of national importance, unless it simultaneously shares the live broadcasting signal, without its advertisements, with Prasar Bharati to enable them to re-transmit the same on its terrestrial networks and Direct-to-Home networks in such manner and on such terms and conditions as may be specified.” Section 3(2)(1) of the Act also requires the “contents rights owner” (private broadcaster) to share 25% of advertising revenue with Prasar Bharati.

Apart from the relevance and applicability of the Act to IPL, whether the IPL can be termed an event of national importance or whether the statements were meant to influence the Gujarat state election, two critical issues stand out.

One, any possible ex-post intervention by the two ministries will go against the grain of Prime Minister Narendra Modi’s strenuous efforts to improve the ease of doing business in India. The private broadcaster won the rights to broadcast IPL matches via television, digital media, Indian and overseas media for five years on payment of Rs16,347.5 crore. This winning bid was probably calculated on the basis of certain metrics and revenue projections. But, if the two ministries follow through on their plans, it is likely to send all calculations awry. The issue once again raises the spectre of retrospective action, something that makes it vulnerable to international arbitration and investor anathema.

There is no arguing that sports and sporting events should be made more inclusive. Unlike many other developed countries where access to sports—including tennis or golf—is getting increasingly democratized, sports access in India remains largely sequestered behind elite walls. Even popular sports like football and hockey remain out of reach for a vast section of India’s population. Therefore, the ministry’s attempts to foster a deeper sporting culture and expand sports infrastructure is quite commendable.

However, as a policy imperative, this should have been included as part of the auction’s terms and conditions and not articulated as an afterthought. Bidders would have then structured offers differently, factoring in the changed dynamics and sharing of advertising revenue. Inclusion of the national network would definitely bring more eyes to the event, which would justify the sharing of advertising revenue. The contra argument is that with additional access points now available, it would reduce traffic to the original broadcaster, thereby having an impact on the overall revenue.

That brings us to the second point.

According the IPL the proposed special status raises multiple questions: What trigger points are necessary to declare a tournament of national importance? Can any minister, ministry or government department declare anything nationally important?

What adds to the confusion is whether the ministry of sports and youth affairs has any category listed as “nationally important”. The ministry currently has four categories created to determine eligibility for Central assistance: high priority, priority, general and other. The ministry documents: “In the ‘High Priority’ category, the sports played in the Olympic Games and in which India has won medals in last conducted Asian Games as well as Commonwealth Games or in which India has good chance of winning medals in Olympics have been included.” There are nine high priority sports and cricket is not one of them—athletics, archery, badminton, boxing, hockey, shooting, tennis, weightlifting and wrestling.

The Constitution’s seventh schedule puts sports in List II, or areas where states have jurisdiction. The ministry has been trying to include it in the Concurrent List; till that happens, it is questionable whether any declarations can be made. To be fair, the ministers have not yet got around to acting on their thoughts. But thinking aloud or even vocalizing arbitrary government intervention can send mixed signals to potential investors.

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