Reorienting India’s Trade Policy

It is vital that India’s trade policy, while taking cognizance of GST’s nitty-gritties, also realigns domestic trade infrastructure with the altering global trade landscape

India’s commerce ministry is conducting a mid-year review of its trade policy to closely align it with the roll-out of the goods and services tax (GST) on 1 July. Truth be told, GST is important but probably too narrow a peg to hang India’s trade policy from; it might make more sense to re-anchor the policy in the shifting framework for global trade and the rapidly evolving nature of globalization.

Deep resentment against globalization’s misaligned distribution effects, a widening wage gap and increasing inequality have given birth to an aggressive brand of nationalism. Strands of these have now found utterance in the economic and political policies of many countries. Brexit in the UK was sold as regaining economic independence from the European Union. US President Donald Trump’s executive decisions on trade (withdrawing from the Trans-Pacific Partnership, restricting H1B visas, threatening the North America Free Trade Agreement) or geopolitical moves (hectoring European leaders or abandoning the Paris climate change agreement) were custom-built to address localized grievances. The sharp pivot by both countries—main actors in constructing the post World War II global trade, financial and security architecture—has made globalization a guessing game, bereft of its earlier certainties and confidence. Both countries are now seen as flag-bearers of a neo-isolationist doctrine.

Australia, New Zealand and Singapore are also following in the US’ footsteps, complicating India’s traditional trade matrix. The picture is further muddied by two momentous shifts occurring in the subcontinent’s neighbourhood. One is the ambitious Belt-Road initiative, a vehicle designed to rejuvenate China’s surplus domestic capacity and to give expression to its expansionist aspirations. The second is the recent schism in the Gulf with Saudi Arabia, Egypt, Bahrain, the United Arab Emirates, Libya, Yemen and the Maldives collectively imposing informal sanctions against Qatar by shutting down transport links and choking essential supplies.

All these developments are bound to reorder the global trade system. Therefore, it is imperative that India’s trade policy, while taking due cognizance of GST’s nitty-gritties, also realigns domestic trade infrastructure with the altering global trade landscape. It is also perhaps the perfect opportunity for the policy to be more of a strategy document rather than a manual. The statement accompanying the 2015 Trade Policy states: “Change has been a constant in the global economy, not least in the international trading landscape.” Never was a truer word spoken, and never has there been a better time to factor this truism into the national trade policy.

Three areas demand trade policy’s attention.

One is to prepare for less reliance on traditional trade partners in the West while increasing India’s trade and investment footprint in alternative markets, such as the African continent. India started looking at Africa seriously after the launch of economic reforms in 1991 and then with renewed vigour after the 2008 crisis. However, promises to increase two-way trade between India and Africa to $90 billion by 2015 have remained largely unfulfilled. India’s trade with Africa touched $56.7 billion during 2015-16, down from $72 billion in 2014-15. The drop is largely due to the fall in oil prices, which contracted India’s import bill with Nigeria. Meanwhile, China-Africa two-way trade touched $215 billion during calendar 2014.

India has intensified its relationship with Africa, which includes initiating several high-level visits since 2015. Prime Minister Narendra Modi, President Pranab Mukherjee and vice-president Hamid Ansari have between them visited 16 countries, with senior cabinet ministers visiting the remaining countries on the continent. During May, the African Development Bank held its 52nd annual meeting in Ahmedabad.

More needs to be done, of course. Trade policy can examine how coordinated action between commerce, finance and external affairs ministries might help in expanding India’s trade efforts; for example, a larger presence of Indian banks outside the conventional East African theatre can help reduce export credit costs. This includes reducing delays in implementing projects under Lines of Credit, India’s flagship instrument for development diplomacy.

Second, there is a need for a clear link between India’s trade policy and Make In India, including strategic linkages through global value chains. Policy clarity will be required whether India desires domestic manufacturing platforms that double as supply hubs for a global market, or assembly units that can be folded up and relocated elsewhere when cost arbitrage dries up (Chinese mobile units are perhaps a good example). Trade policy may be able to play a role here.

Finally, there is trade in services. There seems to be a concerted move within the rich countries—through the Organisation for Economic Cooperation and Development—to open up trade in services, including movement of professionals. This has been India’s longstanding demand because trade in services has been asymmetric so far—high in capital flows, information and communication technology, but low in free movement of professionals. Rising unemployment, particularly in Europe, could be driving Western agencies to prise open employment markets elsewhere. India’s demand (and strategy) for trade facilitation in services should find some articulation in the revised trade policy.

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

The Reserve Bank of India Is Changing Again

While RBI’s central board has certain powers, these have been rarely used to oppose finance ministry action

Time was when the Reserve Bank of India (RBI) resembled more a Soviet rationing officer than a conventional central bank. Mercifully, 1991 and economic reforms ended all that; the RBI got down to conventional central banking, which included moving the economy slowly out of administered interest rates, ending automatic monetization of government debt and shrinking its autarchic footprint. After a 26-year hiatus, there are misgivings that RBI could be lapsing into some of its old habits.

In the now defunct central banking format practised by RBI, all credit over Rs1 crore was rationed. Under a scheme called Credit Authorization Scheme, the RBI vetted all large loan proposals. Even though the floor was raised gradually over time, RBI continued to have a say in how much banks could lend to whom, and at what rate. The RBI was also the implementer (and custodian) of the government’s illiberal measures: banks had to compulsorily invest 40% of deposits in low-priced government securities and keep 20% with RBI as a cash reserve. Of the balance 40% left for lending, 40% had to be mandatorily lent at concessional rates, leaving “commercial” banks with only 24% of deposits to play around with. No wonder average lending rates ranged between 16-18% and non-performing assets were rarely recognized, leave alone provisioned.

These are now part of the nation’s sepia-tinted economic history. The RBI has been easing controls for the past 26 years, even though it has retained numerous other controls as part of its mandate to ensure monetary and financial stability. The overall process has not always been smooth or linear. Economic disruptions, both exogenous and endogenous, have occasionally forced the RBI to slow down or undertake course correction.

In recent months, there are suspicions that RBI’s reform mandate may have changed. The central bank’s role in the demonetization exercise sowed the first seeds of doubt. While the RBI’s central board has certain powers, these have been rarely used to oppose government action. Then, as well as now, the RBI would have gone along with the decision. But, here’s the crucial difference: governor and deputy governors could have used different platforms to speak their mind about the extreme decision. They would have made attempts to explain the economic shock to citizens. Instead, RBI’s March report on the macro-economic impact of demonetisation is an exercise in politesse.

Perhaps RBI doesn’t want to speak out because collateral damage from demonetisation has kept it incredibly busy.

Demonetization led to a liquidity surge, forcing the RBI to step in. Banks had no alternative route to deploy this liquidity, given the uncertainty created by demonetisation and industry’s non performing assets (NPA) induced aversion to bank credit. The RBI implemented a four-stage liquidity management programme, using different instruments at different times. Surplus liquidity also depressed debt yields. Around the same time, on 14 December, the US central bank Federal Reserve raised interest rates leading to outflow of foreign portfolio investment (FPI) from Indian debt markets—Rs46,087 crore went out during the last three months of 2016. This continued in January too. Consequently, the rupee-dollar exchange rate also mirrored these trends, depreciating initially and then staying range-bound for a month.

Then, suddenly around end-January, yields on the 10-year government bond started perking up. Foreign portfolio investment inflows also rushed in—Rs51,679 crore during February-April. By end-April, the rupee had also appreciated by almost 6.5% from the lows of 24 November.

The rupee’s appreciation has hurt exporters. But, more importantly, a 6.5% movement in such a short time is a sign of untreated volatility and should have been countered by the RBI. But, tackling the demonetization-led liquidity surge has probably left the RBI with little or no fire-power. Ordinarily, faced with such a predicament, the RBI would have used another weapon: talking the market down. But, neither the RBI governor nor his deputies has spoken a word over the past few months.

Two conclusions arise: either the RBI agrees with the current rupee value (which most economists think is over-valued) or it is scared to speak out. The government’s distaste for former RBI governor Raghuram Rajan’s public speeches was well publicized. RBI’s top brass has delivered only nine public speeches between January and May this year, compared with 23 last year.

Management of stressed assets is another example where the RBI seems to have abandoned characteristic central bank detachment. The RBI is stepping into the mud-pit of stressed assets to help banks recover sticky loans; this includes even taking commercial decisions regarding selection of credit rating agencies. This could expose RBI to serious risk, including reputational risk.

It might be instructive here to recall how Rajan spent his last days in office staving off pressure from the finance ministry, which insisted that the RBI use its balance-sheet to recapitalize public sector banks. At that time, deputy governor Viral Acharya (then professor with Stern School of Business) had criticized it in a Bloomberg story, saying, “At a minimum, it looks opaque and devious…could be perceived as an attack on central banking independence.”

At a time when globalization is in peril, the RBI seems to be voting for a dubious global trend: ceding autonomy to the political executive without a fight.

The above article was first published in Mont newspaper on May 31, 2017, and can also be read here

No Quick-Fix Solutions for Accumulated NPAs

The amendment to the Banking Regulation Act has failed to provide relief from the government’s latest scheme for cleaning up accumulated NPAs

Those expecting immediate relief from the government’s latest scheme for cleaning up accumulated non-performing assets (NPAs) might have to wait some more. Going by some statements and interviews to media, it may have seemed that a quick-fix was at hand. Nothing could be further from the truth: what has accrued over so many years is unlikely to vanish with the mere snapping of fingers.

The government’s latest weapon against NPAs is an amendment to the Banking Regulation Act, 1949, which is expected to invest banks with some freedom in resolving bad loans without inviting the prosecutorial gaze of central investigative agencies.

NPAs have become a stumbling block in all attempts to re-ignite the economy. Bank credit growth has slowed, affecting capacity creation and expansion—bank credit grew only 5.1% during year to March 2017, against 10.3% in the previous year. The Reserve Bank of India’s (RBI’s) latest Financial Stability Report shows stressed assets (sum of gross NPAs and restructured assets) at 12.3% of assets by September-end 2016. After factoring in demonetisation’s adverse impact and the prolonged economic stasis, this ratio would have further deteriorated by March 2017. This has forced banks to turn risk-averse.

The amendment to the Banking Regulation Act is therefore expected to provide some relief. Unfortunately, the measure has failed to generate unstinted optimism as expected. The reason is that some bugs exist that could slow down progress in the short run.

At one level, the entire exercise is designed as a signalling system, indicating the government’s and the central bank’s resolve to straighten out what seemed like an intractable problem. It also signals that both parties are prepared to support banks’ attempts to resolve this crisis.

But the government itself nullified this confidence-building exercise with another adverse signal—two senior bankers heading two large public sector banks (PSBs) were transferred to smaller entities, signalling a demotion. This was done overnight, without informing either the individual bank boards or the autonomous Banks Board Bureau. Trust plays a large role in any signalling exercise and the latest order just chipped away at the first step to building trust with bankers.

The second crimp is PSBs’ lack of balance-sheet muscle to tackle the volume of NPAs. The International Monetary Fund’s (IMF) 2017 Article IV report on India shows that while aggressive NPA recognition by PSBs turned their return on assets negative in 2015-16, aggregate provisioning coverage ratio still remained low, indicating weak capital bases. The IMF report also shows that PSBs are content writing off loans rather than recovering them—a commentary on the numerous, though deficient, stressed asset resolution mechanisms. The short point is this: banks are unlikely to get aggressive with NPA resolution unless there is capital within sight.

The government, on its part, has drawn up a three-pronged plan to meet its capital infusion responsibility: limited capital infusion depending on performance criteria, merging some of the larger banks, and asking banks to source balance capital from capital markets. All these measures are time-consuming and the pace of capital flow is likely to determine the speed of resolution.

The third problem lies in the wording of the amendment. The government has inserted Section 35AA in the Act, which states: “The Central Government may by order authorise the Reserve Bank to issue directions to any banking company or companies to initiate insolvency resolution in respect of a default, under the provisions of the Insolvency and Bankruptcy Code, 2016.” This is followed by a paragraph stating, “Without prejudice to the provisions of section 35A, the Reserve Bank may, from time to time, issue directions to the banking companies for resolution of stressed assets.” The RBI will also create committees of experts to advise banks.

Two issues spring to mind immediately.

First, the amendment does not explicitly insulate bankers from future persecution, nor is there any implicit signal. The Prevention of Corruption (Amendment) Bill, 2013, which includes provisions for such a shield, is stuck in Rajya Sabha. Therefore, till there is clarity on where the buck stops—the Centre, the RBI, the committee of experts appointed by RBI or the bankers—progress is likely to be slow.

Second, the amendment is unclear about how the Centre proposes to take the resolution forward: will the government monitor each individual asset resolution or provide an umbrella order enabling the RBI to calibrate its action depending on the merits of each case?

Both possibilities have consequences. In the first instance, there are risks of government being accused of cronyism. In the second, the central bank (or its appointed committee) will be exposed to scrutiny from investigative agencies, which may be detrimental for any central bank.

Finally, if all the above do fall into place, there is still one snag: capacity constraint at the National Company Law Tribunals. Of the 700 cases filed with the tribunals, only 70 have been admitted. Moreover, the National Company Law Appellate Tribunal has ruled (as reported by this newspaper) that the 14-day deadline for admitting or rejecting a proposal is not binding, though once admitted, the case has to be resolved in the mandatory 270-day period.

Make no mistake: there is definite movement towards resolution. But, as mentioned earlier, do not expect miracles.

This article was originally published in Mint newspaper on May 17, 2017, and can be read here

Rising Trade Walls and Shrinking Standards

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

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

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

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

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

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

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

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

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

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

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

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

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

Road To Growth Is Paved With Low ICOR

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

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

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

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

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

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

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

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

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

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

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

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

NPAs: The New Wedge in Centre-State Relations

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

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

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

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

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

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

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

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

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

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

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

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

Caught Between The Dragon And The Elephant

India’s trade diplomats will need some deft footwork to manage two trade partners—China and the US

Two large beasts cramp our geostrategic mindspace. One, China’s dragon refuses to vacate our imagination. The second one stirring about in the same space is expected to further cramp room for manoeuvrability. The current US administration, much like the Republican Party’s elephant symbol, is steamrollering global multilateral negotiations. Both these heavyweights present India with a difficult balancing act.

The first inkling of India’s expected high-wire act came from Chile last week when 11 members of the floundering Trans-Pacific Partnership (TPP), all founding nations barring the US, met to revive the plurilateral agreement. An added twist was China’s presence at the meeting.

It is expected that China will step into the US’ large shoes. America’s withdrawal from the TPP was seen as a parting kiss of death since its stewardship had kept negotiations alive. Having invested time, resources and political capital—especially on beyond-the-border issues like labour standards, environment rules and intellectual property laws—many developing countries are loath to let all that work go to waste.

These developments point to the likelihood of an alternative Asia-Pacific trade agreement, perhaps without the trademark TPP markers. Importantly, China was not part of the TPP, which was seen as an instrument and extension of the US’ strategic power. While it is still early to predict how it will all shape up, hopes are the new pact will be built on the back of Latin America’s four-country Pacific Alliance and South-East Asia’s Regional Comprehensive Economic Partnership (RCEP).

India is part of the RCEP trade and investment initiative being negotiated between 16 countries—10 countries from the Association of South-East Asian Nations (Singapore, Malaysia, Thailand, Indonesia, Cambodia, Vietnam, Laos, Myanmar, Brunei and the Philippines) and six others with which the regional grouping has a free trade agreement (India, China, Japan, South Korea, Australia and New Zealand). Many of these nations are also TPP members. The RCEP provides India an opportunity to stamp its strategic and economic presence across the Asia-Pacific. It also provides India an opportunity to bring multilateralism back to centre stage.

But here’s the thing. With China assuming leadership of the RCEP and the putative Asia-Pacific alliance, the world will be keenly watching the shape of the new trade and investment agreement, especially who gets to set standards and the nature of standards finalized. The TPP’s insistence on standardized labour, environment and intellectual property right (IPR) regulations (apart from a host of other issues) conflicted with notions of sovereignty.

The question now is: Will China impose similar standards?

While China has publicly endorsed World Trade Organization (WTO)-compatible trade agreements, will it cherrypick rules? India and China share an uneasy geostrategic relationship, especially in trade. India’s three-tiered tariff proposal for the RCEP has already met with disapproval and India’s push for inclusion of trade in services faces multiple headwinds.

In the other corner, the US’ browbeating at the recently concluded G20 meeting in Germany provides a glimpse of forthcoming challenges to the existing world trade order and globalization. During the drafting of the final communiqué, the US bullied all members to drop pro forma references to free trade and protectionism. Not surprisingly, all members complied, though they did grumble in private.

US President Donald Trump’s administration has repeatedly emphasized that it prefers bilateral agreements over multilateral compacts. The 2017 Trade Policy Agenda makes it official: “The overarching purpose of our trade policy…will be to expand trade in a way that is freer and fairer for all Americans…these goals can be best accomplished by focusing on bilateral negotiations rather than multilateral negotiations—and by renegotiating and revising trade agreements when our goals are not being met.”

India does not have a free trade agreement with the US and negotiations over a bilateral investment treaty between the two countries is stuck over, among other things, the investor-state dispute system. IPR laws are the other thorn in the relationship: India claims its IPR regime is compliant with the WTO’s Agreement on Trade-Related Aspects of Intellectual Property Rights while the US insists on a WTO-plus framework. This has prompted the US to unilaterally include India in its “Priority Watch List” under Special 301.

The trade agenda outlines the future course of the bilateral: “Although existing Indian trade and regulatory policies have inhibited an even more robust trade and investment relationship, India’s economic growth and development could support significantly more US exports…In 2017, the United States will press India to make meaningful progress…on intellectual property rights, promoting investment in manufacturing, agriculture, and trade in goods and services.”

This, in short, is the dilemma. India’s geostrategic ambitions include RCEP membership but it will have to contend with China’s growing heft and increasing pressures to further reduce tariffs. India’s trade deficit with China is growing every year and shows no signs of reversing. On the other hand, India’s support for multilateralism will have to contend with the US’ insistence on bilateral treaties and a re-examination of all existing trade relations. Ironically, India enjoys a trade surplus with the US—in 2015, it touched $30 billion. India’s trade diplomats will need some deft footwork to manage these two trade partners and contradictions.

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

Arun Jaitley’s Shades-of-Green Budget

All said, a fog currently surrounds finance minister Arun Jaitley’s tax play on carbon credits

The West’s climate-change politics vilifies India for its pointed refusal to abandon coal as an energy source. This criticism continues unabated despite praise from multiple quarters for India’s Intended Nationally Determined Contributions (INDCs), submitted before the Paris climate summit in 2015. The INDCs commit to reduce the emissions intensity of India’s gross domestic product (GDP) by 33-35% from 2005 levels by 2030. Interestingly, the INDCs are voluntary, unlike past top-down climate governance mechanisms, such as the Kyoto Protocol.

India’s INDC moves are coming to life in myriad forms. Union finance minister Arun Jaitley has used the 2017-18 annual budget to incorporate some basic elements of a “Green Budget” as well as initiate India’s economic response to the West’s climate change politics. These policy initiatives include lighting up 7,000 railway stations across the country with solar power and halving basic customs duty (BCD) on liquefied natural gas—a relatively cleaner fuel compared to coal or oil—from 5% to 2.5%.
Green budgets deploy fiscal carrots and sticks to influence economic behaviour and improve the environment. Jaitley made a tentative start with his 2016-17 budget but without taking any of the long strides necessary to strengthen India’s commitment to sustainable development or place India firmly on the path to lower emissions. The measures in this year’s budget perhaps quicken the pace, but two decisions stand out for their curious configuration.

The first is a direct tax measure: a new section (115BBG) in the Income Tax Act makes income from the transfer of carbon credits taxable at a concessional 10% rate (plus applicable surcharge and cess). This income was earlier taxed at the normal rate. The directive would have been welcome had the timing not been mystifying. Critics have called the decision a delayed reaction, especially because carbon-credit markets are all but dead. The European Union’s emissions trading system (ETS) shut its doors in 2012; in addition, carbon credit prices have plummeted sharply, rendering the whole process of creation of carbon credits and subsequent trade unviable. But such criticism could also be hasty.

India is trying to create two domestic trading initiatives: Perform Achieve and Trade (or PAT) under the Bureau of Energy Efficiency and a Renewable Energy Certificate (REC) trading system. A third initiative has been launched in three states—Maharashtra, Tamil Nadu and Gujarat—for developing a pilot ETS programme to reduce particulate matter (such as sulphur dioxide) emissions. Only the PAT design, currently in pilot phase, comes anywhere close to an ETS.

The PAT mechanism has identified 11 industrial sectors accounting for 25% of GDP and 40% of India’s energy consumption: thermal power plants, cement, chlor-alkali, pulp and paper, petroleum refinery, power discoms, fertilizers, iron and steel, textile, aluminium and railways. PAT seeks to lower energy intensity in each of these industries through trade in energy savings certificates on designated power exchanges.

In the first phase, 478 companies from eight sectors were included in the programme and achieved an energy savings of 8.67 million tonnes of emissions (mtoe) against a target of 6.886 mtoe. In the second phase, 621 companies from all 11 sectors are being included in the scheme. Is Jaitley’s tax measure designed to provide greater acceptance of, or impart greater depth to, PAT? Did he use the term “carbon credit” interchangeably? This is a distinct possibility: Over the past few years, the number of ETS programmes has been rising across the world, trebling from 5 in 2012 to 17 now.

Throw into this mix China’s planned ETS going live in 2017—slated to become the world’s largest, and bound to change the nature of the game. China, South Korea and Japan are already exploring regional cooperation in carbon markets. Interestingly, India and China signed a bilateral agreement on climate change (goo.gl/BF3hke) in 2015. Both developments point to the possibility of enhanced regional cooperation, especially on a larger, plurilateral platform. But China needs to iron out some wrinkles: harmonizing cross-border compliance and enforcement regimes, improving liquidity, expanding the number of eligible sectors, fungible trading units, among others.

All said, a fog currently surrounds Jaitley’s tax play on carbon credits.

The second curious decision is ending the 5% BCD on the import of solar-tempered glass for the manufacture of solar cells/panels/modules. Simultaneously, and inexplicably, a 6% excise duty has been introduced, where none existed earlier, on domestic production of the same product, solar-tempered glass; it’s like expressing a preference for imports over domestic manufacture and thumbing one’s nose at the Make In India campaign. What adds to the mystery is that 5% BCD was imposed only last year, and in just one year the ministry has decided to backtrack.

There are only two plausible explanations. One, a domestic manufacturer favoured by the current political dispensation probably needs to import for a local photovoltaic fab facility, having already tied up with large importers. Alternatively, two-three large global tempered glass manufacturers have been able to impress upon the government the need to keep imports cheaper than domestic products.

Whatever the reasons, Jaitley needs to provide more clarity on these measures and what they intend to achieve.

The above article appeared in Mint newspaper on March 8, 2017, and can also be read here

Questioning the Infosys Shareholders

Shareholder activism is emerging from Infosys founders as well as a couple of past executive directors of the IT firm

Companies across the world issue shares with differential rights. The garden variety shares are known as “ordinary shares”, investing all shareholders with equal rights to ownership and profits. Then come shares with varied rights, including non-voting shares. In India, Tata Motors and Gujarat NRE Coke, among others, have issued non-voting shares; these shares allow companies to raise capital without diluting promoter shareholding. If events follow a certain trajectory, India could soon witness differential rights even within ordinary shares.

The epicentre of this development is software company Infosys Ltd, where a section of shareholders is publicly airing grievances against the current management led by Vishal Sikka and board of directors chaired by R. Seshasayee. The protesting shareholders have an urgent petition: a public review of severance packages offered to two departing senior executives, and returning part of the company’s cash reserves to shareholders. They’ve also flagged concerns over the chief executive officer’s compensation and the appointment of one independent director. One shareholder has even demanded the replacement of the current chairman.

There are multiple facets to this dispute. First, this shareholder activism is emerging from the company’s original promoters as well as a couple of past Infosys executive directors. The former remain part-owners with substantial shareholding, though as a category they are dwarfed by larger shareholder groups, such as foreign portfolio investors (FPIs). The extent of shares held by former executives is not known. While it might be apposite to question whether their legal position should be viewed as ordinary shareholders or promoter-shareholders (because the media seems to have bundled all of them as promoter-shareholders), one thing is clear: They seem to enjoy support from only a section of the promoter-shareholders.

Second, asking the Infosys board and the management for better communication, however justified, begs a counter-demand: The protesting shareholders need to segregate their respective positions and all the promoter-shareholders should unequivocally communicate whether they are in this collectively or whether only a section of former promoters is siding with the ex-officials. For instance, we have not heard a peep from either Nandan Nilekani or S.D. Shibulal or Kris Gopalakrishnan. This is important to ascertain whether every original promoter is on board with the objections or not.

Third, with so much emphasis on communication, it seems Sikka was not properly briefed about “company culture” when he was hired and welcomed by former chairman N.R. Narayana Murthy. He should have been briefed about what he can change and what he can’t (chartering private jets, for instance).

Fourth, it would seem from all the statements that some shareholders seek to occupy a separate moral perch compared with all other shareholders or shareholder groups. Media chatter seems to be also throwing up mixed signals: Implicit in the carping shareholders’ narrative seems to be an articulation of a superior position in the shareholder hierarchy, based on their legacy executive positions in the company. Murthy’s messages also indicate a desire for cryopreservation of the corporate culture prevalent in the Infosys of the 1990s, regardless of where the company may want to move under a new management.

Does it indicate that some former promoters and former executives want differential rights within the same category of shares? If yes, this is a fresh twist for corporate democracy and perhaps the only instance (with the exception of some past promoter-owned or state-owned enterprises) where a set of shareholders has sought to exercise greater moral suasive powers despite a lower numerical presence.

This is not to outrightly dismiss their claims or demands for improved corporate governance in the company. As ordinary shareholders, they have every right to seek an improved, and constantly improving, corporate governance framework which ably discharges its fiduciary responsibilities and is based on proper disclosure norms. And if the board did indeed indulge in suboptimal disclosure while finalizing severance packages, then it is certainly distressing and requires immediate remedial measures.

But, beyond that, what’s emerging is that some former executives (including some select promoters) are loath to give up their involvement in the company, somewhat evocative of the recent Tata group upheaval. What also stands out is that other shareholder groups, such as FPIs, do not seem to care about the immediate concerns. One FPI has clearly communicated that the existing management should not be distracted but be given a free hand in running the company, improving margins and enhancing shareholder value.

At this point, a sidebar becomes necessary. Two of the vocal critics were chief financial officers in Infosys at different points in time and they are raising questions about severance paid to a CFO who succeeded them, somebody who must have been a junior officer during their respective tenures. This may not have any material bearing on their protestations but it’s a point that needs to be kept in mind.

Finally, an all-important question: Did the original promoters and former senior executives adequately future-proof the company, in terms of products, processes and delivery platforms?

The above article originally appeared in Mint newspaper on February 20, 2017, and can also be read here. 

The Budget Sidesteps Geostrategic Risks

Arun Jaitley’s budget seems to contain very little—by way of either allocations or strategic intent—to mitigate risks that endanger the Indian economy

Both the budget document and the Economic Survey have painstakingly detailed risks that endanger the Indian economy and can disrupt growth and employment impulses. Yet, the budget seems to contain very little—by way of either allocations or strategic intent—to mitigate these risks. The focus seems to be on surmounting immediate electoral challenges and neutralizing near-term policy distortions like demonetization.

Both Union finance minister Arun Jaitley and his chief economic adviser Arvind Subramanian see major risks emanating from the external sector. Jaitley’s budget lists multiple Fed rate hikes likely in 2017, commodity price uncertainty (especially crude prices) and “…signs of increasing retreat from globalization of goods, services and people, as pressures for protectionism are building up”. The Economic Survey also underlines the last two risks.

Given these clear and visible risks, it would be fair to expect defensive action, especially in areas of India’s strengths. The budget small print belies that belief.

Start with this year’s Economic Survey, which identifies clothes and shoes as ideal candidates for low-skill, high-employment manufacturing potential and for occupying crucial trade space being vacated by China. The survey also finds India has competitive advantage in these two items despite myriad challenges—such as domestic labour laws and tax structure, or the duty preferences enjoyed by competing countries in key buyer markets.

Given the Survey’s clear strategic direction, check out allocations for the commerce and industry ministry under the expenditure budget. Jaitley and his team have allocated only Rs0.01 crore to the Footwear Design and Development Institute, compared with Rs109.99 crore in 2015-16 and Rs25 crore in 2016-17. The institute provides skilled human resources and technology development to the leather and footwear industry. The Indian leather development programme (ILDP) gets a higher allotment of Rs500 crore, compared with Rs235 crore in 2015-16 and Rs400 crore in 2016-17. But then the ILDP focuses on improving the raw material base for leather units and the Survey actually shows non-leather footwear has achieved higher exports than leather footwear.

This is not the only mismatched allocation in the commerce ministry. There’s a token entry of Rs0.50 crore against the project development fund, which the ministry created with the Exim Bank to promote Indian private sector investments in Cambodia, Laos, Myanmar and Vietnam (commonly referred as CLMV nations) as part of Prime Minister Narendra Modi’s “Act East” policy. The creation of the fund was announced by Jaitley in his second budget in February 2015. There are, of course, no follow-up remarks in subsequent budgets.

The budget documents are littered with such examples. The geo-economic strategy, drawing from Modi’s repurposed foreign policy, betrays an excessive strategic reliance on select developed countries which could be a risk. The readout from the White House after US President Donald Trump’s brief telephone conversation with Modi reiterates that the US “…considers India a true friend and partner in addressing challenges around the world.” While these “challenges” remain undefined, Trump’s recent trade policy announcements now renders this alliance vulnerable. While it might be too early to declare doomsday, India needs a hedging strategy which includes exploring alternative markets.

And, yet, the budget sidesteps this obvious alternative. Take the example of Chabahar port in Iran, to which India has attached great geostrategic significance. The port offers India a land bridge to Afghanistan and Central Asian markets that bypasses Pakistan, and can become an alternative route to north Europe via Russia. Unfortunately, India continues to drag its feet on Chabahar, even though India and Iran started discussing it in 1997 and signed the first agreement in 2003 as part of the Delhi Declaration. This was further consolidated through a Trilateral Transit and Transport Corridor agreement signed during Modi’s visit to Iran in 2016.

Chabahar port has been allotted only Rs150 crore under the ministry of external affairs, compared with Rs100 crore in 2016-17. One could argue that since the project is being executed by special purpose vehicle Indian Ports Global Pvt. Ltd, a joint venture between Jawaharlal Nehru Port Trust (JNPT) and Kandla Trust, it might make sense to identify capital allocation to these two ports. The two ports have been allotted Rs1,850.30 crore and Rs393.90 crore for 2017-18, against Rs562.38 crore and Rs130.18 crore, respectively, during 2016-17. But there’s a catch: Both amounts have been listed under the head “IEBR”, or internal and extra budgetary resources, which means the government will not contribute any money and the two ports will have to generate these amounts from profits, loans and equity. Importantly, both ports are also implementing significant expansion plans (the JNPT’s plans include two new container terminals, two dry ports in Wardha and Jalna, and a special economic zone, among other things) and it is moot how much funds they can spare for Chabahar.

Is India going deliberately slow on Chabahar, given the Trump administration’s recent statements and executive order against Iran? India’s on-now, off-now engagement with Iran may have pushed the country closer to China through a joint military cooperation agreement and possible One Belt, One Road connectivity. The budget lost an opportunity to make some critical course corrections.

The article originally appeared in Mint newspaper on February 8, 2017, and can also be read here