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

The world’s strongmen are eroding the autonomy of central banks. Exhibit A: India

Whatever the differences over the demonetisation fallout, there is near consensus over one collateral damage: the reputation of the country’s central bank, the Reserve Bank of India (RBI), has taken a severe beating after 86% of the country’s currency (by value) was withdrawn and not replaced on time. But, worse, there is a growing perception that the central bank buckled under government pressure and rubber-stamped demonetisation. Fingers are pointing at governor Urjit Patel for readily agreeing; this may be jumping to conclusions but governor Patel’s non-communicative mien has not helped matters.

Three former RBI governors have publicly lamented the erosion of the central bank’s relative autonomy. Former governor Y V Reddy expressed concern about the knocks the RBI is taking: “For the RBI, for a central bank, reputational risk is the worst risk…And if this is happening in the international opinion, I would say that it is a national problem now and it is not just a political issue.” Even Reddy’s predecessor, Bimal Jalan, chimed in with his concerns over threats to the RBI’s autonomy. The opening line of former deputy governor Usha Thorat’s recent op-ed was anguish-laden: “It is indeed a sad day to see one of the most respected public institutions in India becoming an object of ridicule and scorn.”

India is only playing catch-up

On closer scrutiny, though, this shouldn’t come as a surprise. India is only following a global trend. The world over, in countries with right-wing governments headed by perceived “strongmen,” the executive has locked horns with serving central bank governors, and in some cases even abrogated the relative autonomy of the central bank. India is only playing catch-up: the refusal to extend former governor Raghuram Rajan’s term, and the growing public perception of Patel’s inability to dissent, further reinforces the notion of India tacking on to a global trend.

Two recent examples testify to the global pattern’s prevalence. President-elect Donald Trump denounced US Federal Reserve chief Janet Yellen on his campaign trail, claiming she was playing politics with interest rates (translation: she was keeping interest rates deliberately low to help Hillary Clinton) and should be replaced. Whether he will follow through on that promise will be known only after Jan. 18.

In England, soon after securing the referendum supporting Brexit, Conservative Party grandees—notably Michael Gove and former foreign secretary William Hague—tore into Bank of England (BoE) governor Mark Carney. They were taking their cue from prime minister Theresa May who, at an earlier party conference, had slammed the BoE for the low interest rates and quantitative easing since it short-changed savers. Carney has since dropped dark hints of resigning.

The relationship between elected politicians and central bankers has always been fraught. The 2008 trans-Atlantic financial crisis has deepened the chasm with central banks being increasingly asked to take on quasi-fiscal responsibilities. This has resulted in increasing institutional friction.

In Japan, soon after prime minister Shinzo Abe assumed office in December 2012, he leaned on the Bank of Japan (BoJ) to print more money and to bump up its inflation target from 1% to 2%; both measures would require the BoJ to pursue an expansionary monetary policy. This, the government hoped, would provide the necessary growth stimulus to the economy and finally help Japan escape the pernicious deflationary trap that’s plagued the economy for over 10 years. BoJ governor Masaaki Shirakawa was initially reluctant and when the pressure continued to pile on, he resigned in February 2013, two months before he was due to retire.

The Hungarian president and head of the right-wing party Fidesz, Viktor Orban (who recently built barbed wire fences to keep out immigrants), used his majority powers in parliament to browbeat the central bank into submission. He even went to the extent of replacing the sitting governor with long-time Fidesz politician Gyorgy Matolcsy. Interestingly, Matolcsy currently faces myriad allegations of cronyism and misuse of public funds, including those of the central bank to window-dress the government’s fiscal health.

Closer home, Sri Lanka has been witnessing heightened tensions between central bank governor Indrajit Coomaraswamy and finance minister Ravi Karunanayake.

More than just monetary policy

Bank of Israel governor Stanley Fischer resigned ahead of his retirement date, sparking off rumours of differences with prime minister Benjamin Netanyahu. Fischer subsequently joined the Federal Reserve as vice-chairman. A year ago, he had delivered a speech on central bank independence, in which he made an interesting point, one that resonates with the Indian situation. He said: “…there is a distinction between the terms monetary policy independence and central bank independence. In the literature that developed before the global financial crisis, central bank independence referred to independence from political influences in the setting of monetary policy. But many central banks have roles outside monetary policy—in particular, bank regulation and supervision. These roles are in certain cases granted their own level of independence…”

This point has also been made by former governor Y V Reddy: “There are two types of confusion… my own suspicion is that the institutional identity of the RBI has been damaged… the RBI is the monetary authority, yes. But it is also a full-service central bank. It is in charge of many other things. The recent emphasis appeared as though monetary policy is the main function. The governor is accountable to monetary policy. Then he is not accountable to regulation, he is not accountable to currency coins? There is a confusion about relative importance. That relative importance is being decided more outside than within.”

Successive governments have found ways of corroding each of these different independent roles. For instance, under the previous Congress-led government, former finance minister Pranab Mukherjee (currently the country’s president) set up in 2013 a new financial sector monitoring body, called Financial Stability and Development Council, to be chaired by the finance minister. This was a clear intrusion; the central bank’s mandate includes financial stability. The RBI governor was put on par with other regulators, which betrays a flawed understanding of a central bank’s role and remit.

The Australian example is instructive. The governor of the Reserve Bank of Australia chairs the single integrated prudential regulator, the Australian Prudential Regulation Authority, as well as the Council of Financial Regulators.

Rule by fiat

The process of emasculating the RBI seems to have accelerated now. The surgical changes to RBI’s governance structure are telling: The government’s unwillingness to fill up vacant posts of independent directors is believed to have accelerated the passage of the demonetisation proposal and helped obtain the central bank’s acquiescence overnight. Ordinarily, the central bank would have debated and dissented, after assessing the logistical nightmare of not only distributing fresh cash to the wide network of bank branches across the country but also recalibrating and replenishing over 200,000 ATMs across the country.

Subsequent RBI submissions to parliament’s committee on finance disclosed that the central bank had acted on government advice.

Truth be told, the RBI Act does not empower the central bank with absolute autonomy, but the RBI does have relative autonomy allowing it to pursue certain monetary and regulatory functions with some degree of independence, free from political pressure. Saying “no” in the interest of avoiding short-term volatility and ensuring the economy’s long-term health is part of the job. Tinkering with this fine balance will have massive repercussions, including undermining investor confidence in various asset markets.

The article first appeared in www.qz.com on January 15, 2017, and can also be read 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

Rex-T: Sharp Edge of Donald Trump’s Foreign Policy

Donald Trump’s choice for secretary of state, Rex Tillerson, is an old oil hand; do not be surprised if his statecraft leads to fresh geo-strategic conflagrations

A small spark can light up an entire forest and leave it wreathed in smoke and ashes for days. They say the flapping of a butterfly’s wings translates into weather changes halfway across the world. Nassim Nicholas Taleb pulled out a black swan from his risk bucket to explain hard-to-predict catastrophic events.

Will there be one careless spark, a languid butterfly or a black swan to distinguish 2017? Some events of 2016—Brexit, Donald Trump’s surprise election victory, oil prices creeping up, boardroom brawls at Bombay House and demonetization—will continue to influence developments in 2017. But this being the merry season for compulsive crystal gazing, here’s hazarding a wild guess about one risk element that might set 2017 apart.

It’s called Rex-T: US president-elect Trump’s choice for secretary of state, Rex Tillerson. He’s not to be mistaken for the Jurassic carnivorous dinosaur; but he’s also not quite the cardboard character from a Steven Spielberg movie set. An Exxon lifer and chief executive officer, Rex-T has been described, variously, as a deal-maker, a hard-boiled negotiator, an inveterate networker. In selecting Rex-T for the position, Trump is bringing the oleaginous mix of history and politics back to centre stage after almost a century.

Exxon Mobil CEO Rex Tillerson, Donald's Trump's choice for secretary of state. Photo credit: Reuters

Anthony Sampson’s classic The Seven Sisters: The Great Oil Companies And The World They Shaped describes how oil multinational corporations exercised inordinate heft in shaping early 20th century geopolitics: “The (US) government…preferred to use the oil companies, at a discreet distance, as the instruments of national security and foreign policy.” Texaco, Exxon, Standard Oil, BP, Shell, Gulf Oil and Mobil carved up vast territories in the Middle East, left behind by a retreating Ottoman empire, between themselves for oil concessions; occasionally, they even helped the US state department or British foreign office redraw political boundaries to suit business interests. Rex-T’s appointment rekindles suspicions of close links between oil and US statecraft.

The first risk arises when the US Senate foreign relations committee meets to confirm Rex-T’s appointment, which will then have to be endorsed by the entire Senate. It is speculated that this could be in jeopardy, given Rex-T’s Exxon background, the company’s business interests in Russia and the man’s proximity to Russian President Vladimir Putin. Many Republican senators have voiced their discomfort with Trump’s choice of the US’ future foreign policy architect: too compromised, too close to the enemy. If the confirmation falls through, events can take a different turn. That’s a risk in the unknown-unknown category because Trump’s backup choice is not known.

Assuming Rex-T obtains the confirmation, the state department can be expected to follow a certain policy trajectory. At this point, it might be safe to assume that part of Rex-T’s foreign policy design will be influenced by three chief factors: his oil background (having worked in Exxon all his life), his company’s Russian assets, rendered uneconomic by US-imposed economic sanctions, and his close friendship with Putin.

It might also be realistic to expect that Rex-T will bring two economic sanctions back into play: Russia and Iran. The US will probably relax economic sanctions against Russia, as Trump has hinted several times. The noose regrettably tightens in Iran’s case. A huge question mark looms over how Trump will follow through with the US’ recent extension of the Iran Sanction Act, which was expected to lapse at December-end. The renewal provides Trump with a window to reimpose punitive sanctions if he is convinced that Iran is violating the Joint Comprehensive Plan of Action signed with the US, France, Germany, China, Russia and the UK. Incensed by the renewal, Iran is already threatening to build a nuclear submarine.

Will Rex-T be the spark that ignites this risk? Consider this: The Organization of the Petroleum Exporting Countries’ (Opec’s) members and non-members (primarily Russia) recently agreed to cut oil output. This had an immediate impact: Oil prices moved up sharply. Also consider this: Trump has promised to revive the US’ shale oil and gas industry, asserting during his campaign that this will create two million jobs. This additional output could potentially depress prices again.

The only way to keep prices up is to take out a large producer from the equation. And that could be Iran. The country’s oil exports, which dropped to a low of almost 1.1 million barrels per day (mbd) in 2013, is now back to almost 2.5 mbd on the back of almost 4 mbd of production. However, low oil prices have deterred revenue from reaching pre-2011 levels. Iran, which has so far refused to heed any Opec call for production cuts, seems to have finally agreed during November’s 171st ministerial conference in Vienna to reduce production marginally.

On the stump, Trump repeatedly railed against Iran and carped about the nuclear deal; vice-president-elect Mike Pence even threatened to “rip” it up. Will Rex-T be the sharp edge of this machete, to keep oil prices high and revive his old company’s sunk investments in Russia? Closer home, high oil prices further compromise India’s fiscal fragility. 

There is an even chance that Rex-T will baulk and this risk won’t play out. But, then, Trump has introduced another known-unknown to the equation: Peter Navarro, a well-documented China-baiter, as head of the White House National Trade Council. If Trump’s administration does initiate the promised trade war with China, that’s another future wrinkle for the global economy.

On that note, wish you all a happy 2017!

The above article was first published in Mint newspaper on December 28, 2016. It 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.

Split Personality: Modi is no Mao, Marx or Mahatma. And demonetisation is no Cultural Revolution

You know it’s silly season when people start muddling up identities, comparing two dissimilar events and equating themselves with great historical figures. And you know this whole thing is straying into nutty zone when the ease of comparison trumps traditional ideological divides.

Uma Bharati, India’s water resources minister, recently claimed that prime minister Narendra Modi’s economic policy actions (especially the demonetisation scheme) were consistent with Karl Marx’s ideology. “The truth is the prime minister is executing what Marx always advocated,” Bharati asserted rather breezily in a recent interview with The Economic Times newspaper.

This suggested convergence of Marxist economics and Modi’s policy does not carry even a trace of irony or hint of sarcasm. It also seems to lobotomise the bitter philosophical and political antagonism between the Hindu nationalist Bharatiya Janata Party and the Indian Left parties, currently playing out through the students of New Delhi’s Jawaharlal Nehru University.

Taken at face value, Bharati’s statement seeks to prise out crucial electoral space from the Left parties that has traditionally eluded the BJP; her equivalence stems from the idea that both Marx and Modi seek equality and want to eradicate disparity. This is not the first time Bharati has tiptoed into enemy territory: “I am in the BJP, but ideologically I am a Leftist,” she reportedly said according to India Today.

This blurring of sharp lines between political opposites has been taking many curious twists.

Demonetisation was part of a grand “cultural revolution” being choreographed by Modi, the BJP’s minister for urban development and information and broadcasting, M Venkaiah Naidu, wrote in an Op-Ed on Nov. 29. There are three ways of vivisecting Naidu’s poker-faced assertion.

One is to assume that the minister is using the historical allusion with full knowledge of the barbarity and societal upheaval that accompanied the Cultural Revolution in China. Two, this is his Shilpa Shetty moment: the article has been ghost-written without him or the scribe really caring to check its authoritarian imprint. Three, Naidu is consciously seeking to divorce the term from its Chinese precedents and has used it bereft of its underlying significance.

Crossover in America

The line between the deep Right and the Left has been blurring for a while, especially in the US. Neo-conservatives, who occupied important positions within the Bush administration, were ironically considered as ideological descendants of Leon Trotsky, the communist theorist and prominent leader of the 1917 Russian Revolution. The neocons sought common cause with Trotskyites through their differentiated understanding of permanent revolution, world revolution or the withering away of the state.

The US has a long history of Left-wing firebrands moving to the Right; David Oppenheimer’s book Exit Right: The People Who Left the Left and Reshaped the American Century provides details of people who undertook the ideology-traversing journey and are still influencing political thought in the USA.

It should, therefore, come as no surprise that Steve Bannon, the alleged white supremacist and handpicked member of Donald Trump’s incoming administration, had supposedly declared himself a “Leninist”a few years ago. While Bannon does not remember the conversation, the possibility that such a declaration might exist has inspired many op-eds and articles.

Assuming the conversation did take place, Bannon presumably makes this leap of faith because he sees his desire to demolish the state congruent with Lenin’s vision, though there is a deep divergence over what comes thereafter. Bannon is executive director of brietbart.com, which gained infamy during the recent US presidential campaign for peddling half-truths and unwittingly helping “post-truth” become the word of the year.

Modi and Indira

Apart from Karl Marx, Modi has often been compared to other historical figures. Occasionally fawning acolytes have even rushed into cringe-land blithely: the new chief of Indian Council for Cultural Relations, Lokesh Chandra, called Modi a reincarnation of god and greater than even Mahatma Gandhi for adopting a practical approach to solving India’s social and economic problems.

The fact that 87-year-old Chandra was a lifelong loyalist of late prime minister Indira Gandhi and reportedly enjoyed close links to former Soviet Union leaders in an earlier life can be viewed either as an absurd incongruity or part of the same affliction that’s warping boundaries between the Right and Left.

Historian Ramchandra Guha recently compared Modi with Indira Gandhi herself. Despite the two leaders inhabiting conflicting political terrains, many overlapping points exist: the personality-driven politics, the authoritarian streaks, the high-decibel rhetoric of punishing the rich and eradicating poverty.

The opening pages of Sukumar Ray’s Bengali book of nonsensical stories, HaJaBaRaLa, describes how a man sleeping under the tree one summer afternoon suddenly finds his handkerchief transmogrified into a cat. Ray, father of renowned filmmaker Satyajit Ray, was influenced by Lewis Carroll’s idea of distorted reality. There is a similar shade of fantasy in Indian politics: What you see may not always be a true depiction of absolute reality.

This article originally appeared in quartz (www.qz.com) on December 1, 2016, and can also be read here

After Shock Within, Comes External Shock Wave

Apart from demonetisation worries, Donald Trump’s victory in the US has added new risk variables for equity, bond and currency markets

The government’s demonetization contretemps has focused attention on the short-term havoc it will inflict on the domestic economy. There’s another worrisome front opening up which could exert additional pressure on the stressed economy: the external sector.

Donald Trump’s unanticipated election victory in the US and his scattergun statements on trade, visa control and general economic policymaking have added new risk variables for equity, bond and currency markets.

In addition, markets sense that the Federal Reserve might be on track to increasing interest rates in December. Consequently, investors are headed for dollar-denominated assets which, in turn, has adversely affected emerging market assets.

In India, foreign portfolio investors sold close to Rs32,000 crore of securities in November (till 25 November) alone. Predictably, the Indian rupee also depreciated by over 2% in November.

It also raises questions about the Reserve Bank of India’s (RBI) surgical strike: There’s speculation that the sudden and inexplicable 100% incremental cash reserve ratio announcement is aimed at stopping the deposits deluge from bringing down bond yields further and staunching outflow of foreign exchange.

But, that’s not the main problem; it only adds to the underlying weakness. The problem lies on the current account front.

The mainstay of India’s export basket— services—is slowing down. According to RBI data, services exports between April-September 2016 increased only 2% over the same period in 2015, while services imports are up 7%. And, though India enjoys a positive trade balance in services exports, slowing export growth has shrunk the surplus trade balance by 50%.

There’s more. The performance of software and IT-related services exports, the largest contributor to services exports, is expected to deteriorate progressively. Leading infotech companies are revising their FY2017 estimates downwards.

For example, Infosys has marked down its top-line growth expectation to 8-9% for FY17; the lowered guidance comes a second time this year.

Nasscom, the industry association for the information technology and business process management companies, expects IT industry’s exports to grow at 8-10% for the financial year ending March 2017, against its earlier estimate of 10-12%: from $119-121 billion estimated earlier to $116-118 billion now.

The drop in the IT sector’s revenue generation is a direct fallout from US-based companies holding back, or deferring, their spending till the political drift becomes clearer. Trump is expected to take over in January; meanwhile he has revealed his business agenda which, if followed through, is likely to spell trouble for India’s IT sector.

For example, he has promised to review the US visa programme and reform “abuses of visa programmes that undercut the American worker”. Read that as targeting the H1B visa programme, a non-immigrant visa that allows US companies to hire foreign workers in specialized roles for short periods. In IT-speak, it’s a special window which allows Indian software coders to work on client sites in the US.

Trump seems to be following through on his promise: his pick for advocate general, Alabama senator Jeff Sessions, is a long-time H1B opponent who has tried to legislate a reduction in H1B annual quotas and sought federal investigations into alleged H1B visa frauds.

So, till the picture gets clearer, most US companies have put their IT spends on hold. This hurts because the US accounts for about 60% of India’s software exports. Add to this Brexit and the uncertainty caused earlier in year, and that’s another negative mark against the rupee. Expect further changes over the next few months as the picture becomes clearer.

There’s additional pressure on the horizon. Goods exports have been in steady decline, affected by a mix of cyclical and structural factors. Merchandise exports between April-October 2016, in dollar terms, were stagnant (actually marginally down by 0.17%) over the same period in 2015.

The trade balance might look redeeming, with the negative spread between imports and exports having narrowed but hides another source of worry: goods imports during April-October contracted 10.85% in dollar terms.

Apart from the impact of lower oil prices, this reflects two trends: waning global demand squeezes items imported for re-export (such as precious stones, or other jewellery inputs), and decline in domestic demand affects imports of raw materials or intermediate goods.

The bad news doesn’t end there. One of the pillars of India’s current account— remittances sent by Indian workers overseas—has also been steadily coming down. Net remittances during April-June 2016 amounted to $8.82 billion, down 3% from $9.1 billion in the same period of 2015.

It can be argued that the external economy has been under stress for a while. What’s changed is the effect of demonetization on the economy.

The sudden liquidity withdrawal will have a shock effect on the economy, disrupting supply chains, dampening an imminent consumer-led economic revival, deterring capex impulses and lowering overall GDP growth.

How long that will last is still uncertain. But what is certain is that the added burden of a shrinking external economy—gripped by a decade-long slowdown and buffeted by systemic shocks like Brexit or unexpected sharp turns in US economic policy—will only aggravate the systemic shock.

This article originally appeared in Mint newspaper on November 30, 2016, and can be 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

Anatomy of the unspoken word

Loss is inevitable when opacity obscures both government policy and price-sensitive corporate development

Ratan Tata (left) with Cyrus Mistry. File photo courtesy PTI.

This year’s Nobel for economics—on contract theory—continues the Sveriges Riksbank’s quest to reward investigations into information asymmetry, especially its role in contracts, markets and incentives. Theory suggests that asymmetry of information leads to imperfect markets, including adverse selection and moral hazard. While perfect markets are chimeras, restricted to theoretical constructs, communication and information flows play a definite role in reducing imperfections.

Two recent events highlight how lack of communication, or not saying the right word at the right time, can lead to sub-optimal consequences, especially for minority shareholders.

The first is the corporate putsch playing out on prime time. The sudden, unseemly ouster of Cyrus Mistry as Tata Sons chairman, and the subsequent two-way flow of accusations and assertions between him and his predecessor Ratan Tata, highlight how things can go terribly wrong when leaders do not communicate. In fact, the hazy chain of events suggests that breakdown in communications lines led to this abrupt, indecorous turn of events. As a result, the share prices of most listed Tata companies have suffered.

The first thing that strikes any observer is the perception gap between what Ratan Tata wanted from his successor and what Mistry, in turn, understood and delivered. While conversations between the two during the passing of the baton remain private, it is abundantly clear that either Mistry misunderstood his covenant or Ratan Tata was not explicit in describing the role. Ironically, and rather late in the day, both are indulging in excess communication, mostly through the media.

Consequently, there is soiled laundry on display. Leaving the allegations aside, there is sufficient evidence to suggest that Ratan Tata’s and Mistry’s paths to corporate excellence diverged sharply and there were no attempts to make them meet. Mistry also expresses incredulity at the board “replacing” him for non-performance, especially after directors had lauded his performance. He also claims that while he was promised a “free hand”, some directors would leave in the middle of board meetings to seek Ratan Tata’s guidance.

The other side brushes these contentions aside; but it does maintain that Mistry has been on the Tata Sons board for a decade and was, therefore, party to some of the business decisions that he is now questioning.

All these point to a much larger, and grievous, communication gap. Neither Ratan Tata nor Mistry thought it fit to publicly discuss the controversial issues before they blew out of proportion. As a holding company of numerous listed companies, the Tata Sons board should have ensured adequate discussion and disclosure. For example, instead of lavishing Ratan Tata with public commendations, Mistry should have warned shareholders of the impending write-offs that he so direly predicts now.

The second incident of crossed wires is a direct outcome of the government’s multilateral trade strategy. A recent news story, citing unidentified people, said that the Indian negotiating team at the World Trade Organization’s (WTO) recent Oslo mini-ministerial had decided to oppose attempts by rich countries to introduce the promotion of global value chains (GVCs).

Indian negotiators fear that developed nations will sneak in issues like intellectual property rights, investment safeguards, competition laws under the garb of discussing GVCs. India, and a host of other developing countries, want WTO to first settle the pending Doha agenda before taking up new issues. Unfortunately, the Indian government’s ensuing communiqué about the meeting does not reveal whether GVCs came up for discussion at all. And even if they did, how the Indian side reacted.

Conversely, the whole episode might end up muddying the government’s policy stand on GVCs. India has been a proponent of GVCs, especially increasing the share of small- and medium-sized enterprises in GVCs. The government views GVCs as a device to increase domestic and foreign investment in manufacturing. The commerce ministry’s annual report for 2013-14 spells it out: “The business and trade segments of e-commerce and global value chains provide an opportunity to compete at par with other world economies and expanding our technology base.” But in the absence of proper communication, there is a lingering doubt over the government’s stand: Does it want GVCs or is it opposing their entry? Lack of clarity in economic policy hurts everybody because it affects investment decisions and stifles employment generation.

A similar lack of communication besmirched India’s reputation when WTO members met in July 2014 to vote on the trade facilitation agreement. India was the only country to oppose the deal and was subjected to global condemnation, despite having valid reasons for blocking the agreement. What made it doubly intriguing was the fact that India was principally on board with the idea and had already implemented many of the measures listed under the agreement. The problem: India did not communicate adequately with WTO fellow travellers or explain its stand lucidly. Western media, taking the cue from political leaders, labelled India a game-spoiler. Outcome: Global decision makers still look at India askance.

Both examples lead to one indisputable conclusion: Loss is inevitable when opacity obscures both government policy and price-sensitive corporate development.

This article originally appeared in Mint on November 2, 2016. It can also be read here.