When Social Goes Federal: Business World: 23rd March 2015

The government did not skimp on funds for the social sector, but in some areas it left it to the states to pitch in, says Madan Sabnavis

here has been a perception, real or exaggerated, that the government was predisposed to focusing only on productive sectors, thus ignoring the social sectors. The speech in the Union Budget does, however, focus a lot on social alleviation and covers areas like agriculture, health, education, rural infrastructure, micro enterprises and employment (NREGA), which belies this perception.

Evaluating the focus in numeric terms is difficult considering the 14th Finance Commission has recommended higher devolutions to states which, in turn, would be in a position to utilise these resources for social development programmes. Therefore, when analysing the expense numbers under various ministry heads, it can be surmised that where allocations have fallen sharply, the onus would be on the states to deliver.

What do the numbers reveal? Sectors such as health, SMEs, rural development, tribal affairs, social justice and skill development show higher allocations, albeit marginal ones. Rural development, which includes the NREGA, housing, roads and bridges and social security, has a relatively higher increase of Rs 3,500 crore. Allocations for Panchayati Raj are down by around Rs 2,500 crore though one is not sure if the states would fill the gap, and the allocation for agriculture has declined too. For all these sectors taken together, there has been a marginal dip from Rs 1.4 lakh crore last year to Rs 1.35 lakh crore in FY16.

At the aggregate level, this may be viewed as a neutral stance on social sectors with states filling in through their higher devolutions (up from Rs 3.37 lakh crore to Rs 5.24 lakh crore). The decision taken by the Finance Commission is quite pragmatic as states get more involved with social schemes as they are implemented at state level.  Even under the earlier dispensation, while the schemes were sponsored by the centre, the funds used to flow to the states from above. Under the new formula, states could fund schemes where they find lacunae. So, if a state is well placed in education, but not health, additional funds could be used for the latter as education schemes may not be pertinent. Hence, getting out of the one-size-fits-all approach does look positive.

But the important takeaway is that the central government is presently positioned to support the existing schemes through funding but would gradually move away leaving it to the states. Also, as long as the fiscal space is limited, there would be a proclivity to conservatism in terms of enhanced allocation. Given that the government has displayed parsimony in all allocations, the social sector on the whole has fared well.

The other area of interest which concerns social spending relates to the subsidy bill — food in particular. There was some speculation on whether the coverage of the Food Security Bill would be reduced from two-thirds to something close to 40 per cent. Here the government has chosen to retain the existing coverage and has in fact, increased the allocation from Rs 1.22 lakh crore to Rs 1.24 lakh crore. The budget has mentioned that it would concentrate on better allocation and targeting of the same by using the direct benefit transfer route through the Jan Dhan account. While the scheme is going to be implemented, it would be useful to work out the feasibility of the same given that rice and wheat distributed under the public distribution system have varying prices across the country and change at different rates every year which can make fixing the benefit level a challenge. Also, the impact on market prices should be gauged in specific pilots where it is implemented before being scaled up.

The Budget also talks of creation of a national market for agriculture, which was mooted by the Economic Survey. The creation of such a  market would be arduous given that today the farmer’s only access to a sale is the mandi and selling anywhere in the nation may not be feasible unless the logistic support is created. Therefore, while the idea is stimulating, getting it to work would require the government along with the states to actually allocate funds to make it happen. Hopefully, this will be taken up in future budgets.

For the self-employed or micro units, the Budget does reach out and will be creating a MUDRA (Micro Units Development Refinance Agency) Bank with a corpus of
Rs 20,000 crore. The idea is ostensibly to provide refinance to microfinance institutions which would be useful considering that this class does require support in the area of finance. This needs to crystallise with funds flowing in through the budgetary allocations over time.

Hence, on the whole the Union Budget has been fairly neutral to the social sectors, and tended to have preserved the status quo at the sectoral level and given discretion to states to prioritise their own expenditures by providing them with additional funding. This is probably the best that could have been done under these circumstances.

Tackling the land reforms labyrinth: March 17th Financial Express

The issue of land reforms is a complex game involving farmers, corporates and the government. There are also land dealers who are at the periphery, just waiting to walk into the fray, while activists, social rights groups, NGOs make the right sounds to highlight the pros and cons of such ‘reforms’. Finally, there are fringe elements who capitalise on the ‘skewed agreements’ with violence, which degenerates to terrorism as they camouflage their own interests with the cloak of being a modern Robin Hood. It is not surprising that reaching an amicable solution is difficult and the imbroglio continues.
Landowners are probably the most important constituency and the clash of ideology emerges when several small landowners are involved.
There are four issues here. One relates to valuation. While there are compensation formulae in the form of multiples of 2 or 4 spoken of depending on the location, the issue is how one values land. In India, unfortunately, most transactions have a cash component that can range from 30-60% of the value of the deal. Therefore, going by sale deeds, we can never get the right number. Getting independent valuation done is fraught with risk as it is normally alleged that the land surveyors can be bribed easily by the buyer to undervalue land.
Two, there is an ethical issue that comes in when the price of land goes up after sale. This is but natural when a transaction of such magnitude takes place, which leads to the seller feeling that he has been cheated.
Three, while we talk of the owner and the sale of land, there are landless labourers who work on this land, who get left out of the deal and will be on their own. Are there any safeguards for them?
Four, anyone selling land will need rehabilitation, which means that the person needs to get employed on a regular basis. While the amendments to the Bill do talk of one member getting such employment, practically speaking can a farmer who gives up land be the right person for the buyer, say a corporate, to run a machine?
Anecdotally speaking, the consent clause is hogwash as there are several cases where people have been forced to sign on the dotted line to enable such sales. Therefore, building safeguards becomes necessary. Similarly, the social impact study, though necessary, will always be doubted by both industry and activists depending on the way the result goes.
At a broader level, giving up agricultural land for industrialisation is controversial as we are facing an issue of migration away from agriculture.
The land under cultivation is not increasing proportionately to demand, and as the profession of farming carries risk, it has become less attractive over the years. This being the case, it is necessary to ensure that the sale of agricultural land should not be the first option.
The corporates buying land require this resource for expansion of production facilities, and an infrastructure project is contingent on land availability. Paying a fair price would be acceptable to all, though arriving at this number is always going to be dicey. However, while the corporates are willing to pay the price, forcing them to rehabilitate sellers by offering jobs cannot be part of the deal, as there are different skillsets required and all the corporates may not be willing to train the sellers as they would ideally prefer to take in qualified people.
The government is in a peculiar situation as there is an absence of trust from all sides. First, the government is unlikely to take up projects on its own. If it were the Railways, for example, undertaking a project, it would be relatively clear. But when it is a road or a bridge, or the famous industrial corridors, there is an element of distrust which comes in as the parties would be in the private sector. Second, such projects are known to get stalled, delayed and, at times, abandoned.
While putting in a time clause is a solution, resolution becomes important in case the project is not completed. One is not sure of the judicial processes involved and the question is what do we do then? Tracing the sellers is as difficult as tracing the unclaimed pensions and provident fund holders. Valuation becomes another issue as the earlier sellers cannot become buyers. Therefore, there are several grey areas. Can we think of solutions?
The issue requires some unconventional thinking. First, for valuation, we can think of going in for an auction with a reserve price for each piece being set by the current multiples. A single rule cannot hold across all geographies, for clearly the compensation that must be provided varies with the quality of land (farms), location (Mumbai and Delhi command higher prices), access to major towns, availability of infrastructure, etc.
The market price is the best indicator (though not perfect) and an auction can be an improvement over the current system. A price discovery model on a commodity futures exchange can be a way out.
Second, for rehabilitation, the government has to take on the onus by creating a fund which provides an equivalent to all landless labourers displaced. The clause of providing employment to the seller should be on the government and a variant of the NREGA can be used and the cost shared between the states and the Centre.
Third, non-completion of projects should have a penalty of confiscation of land and auctioning the same, with the proceeds going into the rehabilitation fund. Therefore, anyone purchasing land should get all clearances before embarking on the project—environment, power, finance, etc.
Fourth, the social impact study should be outsourced to accredited professional organisations such as consultancy firms and rating agencies, so that an independent evaluation is available. An impact on, say, the environment would mean a higher compensation to the seller. In fact, such studies could be the starting point of fixing variable reserve prices for blocks of land on sale.
With these prerequisites in place, we need not distinguish between private and government purchases and the transactions would be transparent. The only grey area would still be the consent clause, where the number has to be fixed. If all these safeguards are adhered to, there could be a case for even lowering this clause from 80% to 60%, which will have less resistance once the system is considered to be fair.

Pitfalls of Collective Speculation: Book Review: Business Today March 15, 2015

Money Mania
By Bob Swarup
PAGES: 310
PRICE: Rs 499
Bloomsbury IndiaThe global financial crisis that erupted in 2007 is perhaps remarkable for generating the largest number of books by authors with the wisdom of hindsight. Bob Swarup in Money Mania takes a different approach as he narrates financial crises down the ages. He traces similar patterns in each occurrence, with human behaviour playing a key role.The commonality is the position of fallacy wherein we wrongly interpret upswings as high and sustainable development, oblivious that there are seeds of crisis already sown. Even when we have our own models to guide our future investments, we prefer to go with the majority, which in turn becomes self-fulfilling when a crisis strikes and affects all.Such crises have been there since Roman times. There has always been an urge to spend in a big way and build empires through borrowing. They crumble when there are wars, which was the case when Sparta attacked ancient Greece. More recently, Japan was obsessed with growth. It took the nation to large-scale speculation in land, which eventually led to a crisis in the 1980s. The Great Depression showed us how an unsustainable model based on higher spending and borrowing after World War I ended up in a stock market crash.Almost all growth stories have strong traces of financial speculation. Swarup clinically analyses this persistent seduction of our senses by new opportunities, leading to a collective belief that this state of bliss will hold forever. In the run up to the latest financial crisis, too, we assumed so. It is the case with real estate, too, where it is assumed that prices will always go up, riding on speculation.Let us look at what conclusions Swarup draws from the past financial crises. Man is not rational, which is opposite of what all theories in economics assume. We are motivated by self-interest and influenced by our cognitive biases. Furthermore, our actions do not add up laterally but cascade exponentially making interpretation of human behaviour complex. Therefore, the whole is not the sum of all parts. Also, economies are not isolated entities in a static equilibrium. They are dynamic and interwoven with political and social dimensions. Above all, efficient markets do not exist as information is contextual and asymmetries exist making free markets an idealistic limiting case.He gives several examples to support his theory of speculative activity fostered by groupthink. One of the more interesting ones is on how the market for tulips developed in the Netherlands gave shape to the futures market, which eventually led to excess speculation and crash.A thought expressed here which should tickle our brains is that we do always find reasons for a crisis and say that it could have been avoided if certain things were done. There is hence a tendency to pontificate especially by the regulator, which is a false belief.The book is a historical work and an interesting read. But it is difficult to read as the narrative is not chronological; chapters do not flow from one to another. The reader has to connect them and in a way it adds charm to the book.(The author is Chief Economist at CARE Ratings)

Don’t shrink RBI’s regulatory ambit: Financial Express: March 13, 2015

Three issues have been flagged in the Budget, probably indicating the prevailing thought process—which is to reshuffle regulatory oversight within the financial markets for certain segments with the possibility of creating new structures. These issues relate to handling of public debt, trading of the same in the secondary market, and oversight of forex inflows through equity.
In India, there are multiple regulators in the financial sector where players come under different regulators or quasi-regulators such as RBI, Sebi, IRDA, PFRDA, Nabard, FMC (till recently), and Sidbi. This is because every market player has to contend with regulation in other markets as they operate across segments. A bank, for instance, is under RBI, but when it gets into investment banking, it has to look at Sebi’s guidelines, and has to adhere to IRDA’s rules while selling insurance products. Pension funds come under PFRDA, but when investing in, say, the debt market, they have to follow Sebi guidelines. Therefore, prima facie, having multiple agencies is not really odd. By changing jurisdiction to other regulator or entities, the function is still carried out by the government-appointed entities and should not really matter.
But the issues flagged in the Budget are significant as RBI has certain functions to perform within the realm of monetary policy, which would become more challenging if segments such as government debt or forex are under other regulators either partly or fully. Having a PDMA (Public Debt Management Agency) could mean ending up with the same department being shifted elsewhere, but doing the same function of issuances and management of government borrowing. However, when RBI has to conduct monetary policy, then it has to perforce have regulatory power over all aspects of government paper.
If they were held with the PDMA, then RBI has to necessarily become a player in the market to gain access to gilts. This is because it needs government paper for conducting its repo/reverse repo auctions under LAF as well as open market operations. If it is not in charge then it has to conduct its own operations in the market to pick up G-Secs and then become a player in the market, which can tilt the scales given the volumes required. An argument often put forward is that there is conflict of interest when RBI is in charge of public debt. This is not true as RBI has little interest in how the prices of gilts move. In fact, the same concern would be more in case of the PDMA, which would be a government outfit, and which can have probably greater interest in keeping the rates under check.
Trading in G-Secs currently comes under the central bank with the CCIL providing the platform. The logic of shifting all such trading to Sebi is sound as securities, forex futures and commodity futures are all under this umbrella. The advantage is that by getting in G-Secs, an individual can also trade in gilts. A question to be asked is that on such a platform, can a broker who is not a financial institution be allowed to trade? This would have been ideal but for the fact that the G-Sec market is critical from the point of view of monetary policy as the market is largely influenced by the RBI action and the efficacy of transmission also gets reflected from the trading that takes place. Getting in more players can lead to unjustified volatility that comes in the way of understanding the true dynamics of the market.
The change in the policy rate, i.e. the repo rate, is seen in the G-Sec market to begin with before banks decide to take action on deposit and lending rates. RBI, by having oversight on the market for gilts as well as trading, is able to realign structures which include reissue of paper, yield curve determination, correcting yield structures, liquidity, etc, as its own OMOs have a bearing on the price movement. Therefore, the strong link with monetary policy justifies having the same entity regulating monetary policy and trading in gilts.
In the new perceived scenario, RBI would be conducting monetary policy with the PDMA overseeing the issuance of government debt. The movement of yields would be determined in the secondary market where the regulator will be Sebi, which will be more concerned with fair play, and the priority would not be related to the effectiveness of monetary policy action of RBI. The issue becomes ticklish with the recent agreement between the ministry of finance and RBI to have in place a monetary policy committee responsible for inflation control. Inflation targeting becomes perplexing as RBI will have no say over conduct of public debt and trading in gilts which affects interest rates and hence bank business parameters in a situation where the government already runs a deficit based on its need, which is not in the purview of monetary policy.
The forex market is quite unique in the sense that RBI has to control the movements in currency, ensure that the reserves are stable and regulate the forwards market, while Sebi oversees the futures market and no one controls the NDF market which influences the spot rates. Now, if RBI is the agency to be in control of the forex rate and reserves, then it has to necessarily have oversight of these inflows under FEMA. The issue stops not just at the exchange rate but also the implications on monetary policy. FIIs inflows can create monetary issues that have to be addressed by RBI. Thus,  the central bank has to have a say here.
The existing structure of RBI oversight has been created with a purpose of ensuring stability and better transmission of monetary policy. Having different regulators should not ideally create a difference of opinion but as each one focuses on development of its own terrain, there could be speed breakers for the central bank. And the latest twist in tale that makes RBI responsible for the inflation rate adds a new dimension. Ideally, the new monetary policy committee and its functioning should be administered first before evaluating the efficacy of the same when these props—PDMA, secondary market operations and forex equity flows—are removed. This may be a pragmatic approach.

Frugal Innovation: A stitch in time: Financial Express: 8th March 2015

FRUGAL INNOVATION is probably the only pragmatic way out today for any successful enterprise that operates in a volatile, uncertain, complex and ambiguous world. This is the message given by authors Navi Radjou and Jaideep Prabhu in their book Frugal Innovation. We live in a world where resources are scarce and time matters for successful implementation. Further, customers insist on quality and demand value from the products they buy. How exactly we marry these demands with the scarcity concept is the crux of the analysis done by the authors, who punctuate their storyline with several examples that the reader can relate to.
Frugal innovation is all about doing more with less, which means extracting higher value by being economical in the use of resources. In the earlier era, there were plenty of resources that could be used to produce goods. But today, with scarcity and concerns about the environment, it has become progressively difficult to do so, and we need to revisit our business models.
The authors give a very illuminating example at the beginning of the book relating to Renault. A senior manager went to Russia and saw that there was a car that cost $6,000 and the challenge was to produce a similar vehicle within this cost range in France, which seemed unthinkable. The ‘more for less’ struggle led to the creation of the ‘Logan’. To get more for less, the production facility was moved to Romania, as Romanians were more cost-sensitive than the French, having grown in a communist regime. The car used 50% fewer parts than a typical Renault car and boasted of a simpler architecture. The rest, as the cliché says, is history.
Frugal economy basically deals with mass customisation, recycling along the value chain, sharing resources and ideas, and producing faster but better-quality and cheaper goods. There are, however, barriers that need to be overcome when pursuing this line, as companies fear that frugal products may dent their brand value and also cannibalise their existing products. These mindsets have to change. Often, there is concern that the shareholders may not like the idea of going to this lower end of the chain, but then this can be overcome if the venture follows a simple six-step path.
The first step is to engage with the customer. This has to happen at the front and back ends for improving the product. It involves continuous interaction with customers and adapting the interaction with cheaper and better solutions. The authors suggest the concept of crowdsourcing and social media to get these ideas, as it is cheap and smart. Starbucks does this through its dedicated site to get ideas from customers.
The second step is what the authors call ‘flexing the assets’ of the company, which is all about saving money and time along with resources. By flexing their production and distribution networks, companies are able to move goods faster by making them locally, hence saving on costs. The old model of huge factories and energy guzzlers is passé and the new model is based on using new materials, tools and new approaches for manufacturing. ‘Reshoring’ is in fashion now, as production facilities have moved back from countries like China to the US. Local sourcing and sharing of resources have helped to bring about the required economies in scale. The whole idea now is not to look back and plan, but to look forward and strategise. Even the business of advertising has been affected by social media, with Internet bringing great reinvention.
The third step is to create sustainable solutions, as everyone talks about the environment. Regulation, too, is being introduced by almost all countries. Companies all over are working to use fewer materials, especially water and energy, and better materials, while simultaneously ensuring that the final products are not harmful. This has involved the new process called ‘cradle to cradle’, or C2C, where all products can be recycled. Sustainability is important because there is scarcity of resources to begin with and consumers are asking for eco-friendly solutions, with the shadow of the regulator falling quite sharply on all. The authors quote McKinsey’s view that such circular economies can save $700 billion annually. Special mention is made of Unilever, Kingfisher and Marks & Spencer in this context.
The fourth step is to shape consumer behaviour and logically follows from the first three principles. The fundamental contradiction today is that while consumers care about the environment, they are still profligate. The authors argue that for saving, say, energy, we can use ‘visualisation’ through signs, leaflets, advertisements, etc, to make consumers aware of the problem. Changing consumer behaviour is difficult, as all kinds of cognitive and psychological biases intervene and scupper the best intentions of consumers. However, this can be done over time.
The strongest ally here, as per the authors, is the creation of ‘prosumers’ among consumers. This is the fifth principle. The idea is to get consumers to design a product, so that it works with them in the store. This is effective, as consumers always look for personalised solutions and, as a corollary, always seem to be dissatisfied with the existing array of products. They want to have a say in the brand and would like their ideas to be used for other products too. This has led to the proliferation of peer-to-peer sharing platforms and crowdfunding approaches for new ventures. Getting in prosumers means co-discovering the need and dreams of the consumer (Harley Davidson’s electric motorbike), co-developing the solution (a low-carb yoghurt by Danone), and co-marketing, co-branding and co-distributing the product (Saatchi & Saatchi use social media and word-of-mouth).
As an extension to the role of prosumers, the authors talk of different roles for the otherwise passive customer. There are dreamers (Volkswagen’s competition for designs), validators (Hasbro gets consumers on Facebook to vote for their new game of Monopoly), ideators (Lego invites new ideas), makers (Kimberly Clark’s grant to DIY mothers) and evangelists—a combination of all these personalities become brand managers. They are complemented by sales agents and fixers (Yatango Mobile offers credit to customers who provide technical support).
The final principle or step is to make innovative friends through collaboration. This will be at the stage of suppliers, partners in design, sharing of assets and resources with other companies, working with the social and public sectors, etc.
As per the authors, almost all industries are witnessing this frugal innovation and leading companies like Renault, GE, Siemens, etc, are shaping and leading new markets for affordable products. Besides the tangible benefits, they also bring in intangible advantages in the form of increased brand recognition, customer loyalty, higher employee engagement and more public goodwill. This turns out to be a win-win solution for everyone.
Frugal Innovation is easy to read, as there are examples given everywhere to explain the point being made. It is also quite amazing to learn that a large number of leading companies have already entered this frame and have made rapid strides on the global business map, which should be an inspiration for others.

Monetary Policy: It takes two to tango: Economic Times 4th March 2015

The agreement on monetary policy framework signed by the government and Reserve Bank of India (RBI) is significant because this is the first time such a thing has been done. Curiously, this was a recommendation of the internal committee set up by RBI earlier, and, hence, is not coming from the top but is an internally agreed-upon move. The RBI has already been targeting CPI inflation; the difference is that it will be responsible for the inflation number. This is the addition to the storyline. It is extremely interesting to watch how this will play out, for four reasons.

First, the RBI will be targeting the CPI inflation number whose composition is such that its own policy may have limited power to influence. The new index, with 2012 as base, assigns weights of 48.3% to food-related items, 10.1% to housing and 6.8% to fuel and light, which are not leveraged. This accounts for around 65% of the index. Clothing, with a weight of 6.5%, may be leveraged through cards and another 3-4% of the miscellaneous category (weight of 28.35) which includes handsets, television, refrigerators, could be on credit. Therefore, not more than 10% of the index, which is being targeted, could be amenable to monetary policy action.

Further, in FY14 for instance, the items outside the RBI’s purview accounted for over 98% of inflation. While interest rate action should be linked to inflation on grounds of prudence to ensure positive real interest rates, expecting the repo rate to control inflation which is largely driven by supplies, government action (crude oil and related products) and extraneous forces is a challenge. Second, there is sound reason for having a target of 4% with a band of 2% at either end. However, an economy which has not invested much in agriculture will always be susceptible to supply shocks from farm products. In the past 10 years, we have had CPI inflation for industrial workers at less than 6% only twice, and, in fact, in the past eight years it has always been higher than 6%. Are we challenging ourselves considering that 4% looks like a tall order? Third, the inflation targeting has to be done while also ‘keeping in mind the objective of economic growth’. This poses a conundrum. Going by, say the old GDP series, when growth had slowed down to 4.5% and 4.7% in FY13 and FY14, respectively, which coincided with CPI inflation numbers of 10.2% and 9.5%, would the monetary authority have been expected to keep increasing rates continuously or just retain rates at high levels? It would never have been possible to explain why monetary policy could not bring down inflation especially since products like tomatoes and onions pushed up inflation, over which monetary policy has no control.

Fourth, the RBI has often commented on the policy transmission mechanism being weak. Therefore, when the RBI lowers or increases rates by 50 bps, the response in bank deposit and lending rates is not proportional. The repo rate affects them to the extent of say 1% of NDTL which is around `80-85,000 crore, which is accessed through the daily LAF and term repo facilities. Would this then mean the RBI has to lower the LAF facility in case it realises banks are not increasing rates when the repo rate is increased? It is because of this sluggish mechanism that there are dualistic images in the market — an increase in repo rate leads to G-sec yields increasing even while banks may not be doing so with their rates. An interesting conjecture to make is on the response time for policy action in future. If inflation goes up to say 6.2% for February, would this mean the trigger will be pulled even before the policy? The market will start guessing more on the 12th of every month when the CPI numbers are released and that will add zing to an otherwise sedentary money market.

The missing links in the Budget: Financial Express: 4th March 2015

The proposals of the Union Budget have resulted in palatable fiscal numbers. This has been done by providing incentives where they were due and cutting expenses or raising tax rates to balance the fiscal sheet, which is always a challenge. In doing so, there are some bold assumptions made or certain stances taken which we may have missed. Also, the proposals have been iced with some new initiatives to be taken.
Do they all fit in?
Some of the optimistic proposals relate to the disinvestment process. It has become a habit to target a high number, which is to be R69,500 crore this year. The issue is that the ability to get close to this number requires the capital market to be buoyant and the procedures to be followed. Unless the attempt is made from April, it is a touch-and-go affair, as delays can coincide with unfavourable market conditions which have come in the way of this programme.
Interestingly, in the last five years, where the initial target has been above R30,000 crore, in only one year—FY13—we have come close to the target when 86.3% of the R30,000 crore target was realised. In all other years, the realisation was lower, at 57.1% in FY11, 45.2% in FY12, 52.6% in FY14 and 49.4% in FY15. With static expectations in FY16, the realisation, in fact, could be in the region of R35-40,000 crore this year.
Second, the Budget talks of the creation of the MUDRA Bank—to be formed with a corpus of R20,000 crore—which will be involved with providing refinance to MFIs lending to small units. There is no provision in the Budget for this venture, which means that the formation of this bank would be from outside the Budget with probably only the initial capital coming from the government. This would not have been an issue but for the fact that the big bang announcement last year on 100 smart cities has not quite taken off. The Budget for FY15 had allocated R7,016 crore for 100 smart cities along with JNNURM, while the actual amount spent was R924 crore. This anchor project, which was to bring in strong linkages with manufacturing and investment, has an allocation of just R143 crore in FY16. Therefore, one may have to wait and watch as to how this project takes off.
Third, there has been some enthusiasm on the lowering of the corporate tax rate from 30% to 25% from FY17 onwards. However, this comes with a rider that the exemptions given would actually come down or be removed completely once this is implemented fully. The net result is always important. The Budget document does give some numbers of the tax rates and tax paid for a set of 5.64 lakh companies in FY14. The calculation is that the effective tax rate is 23.2%, which is much lower than the nominal tax rate of 30%-plus surcharges. However, assuming that the exemptions go and that profits before tax on the P&L account are taxed at 25% now, the overall tax paid would be higher than the R2.58 lakh crore paid currently by R20,000 crore. Therefore, we may have to moderate our cheer on this score.
Fourth, contrary to the perception that the government would be more severe with social spending, the Budget has actually retained the spending levels and increased them at times. The food and fertiliser subsidies have been increased while the flagship NREGA programme has been retained and overall allocations for the rural economy increased for FY16. This is remarkable because it shows that fiscal prudence can still be maintained by not giving up on social spending. The positive part is that the stated approach is to make the money work better by plugging leakages and ensuring better delivery of services. This focus has been highlighted by the higher allocation for interest subvention, which is to increase by R3,500 crore this year.
Fifth, there is once again a strong reminder for public sector banks on the capital front. The allocation is lower at R7,940 crore, which may not be adequate for them. This is an indication that the current financial year may witness either mergers of public sector banks or a sale of equity up to 52%, depending on how the government views it. Given that the commercial ratios of ROA and ROE are to be used to see which banks qualify for capital infusion, there could be something significant in both the areas of disinvestment and M&A in the coming year, which has not been clearly spelt out.
Sixth, the Budget evokes positive sentiment by talking of three gold schemes. But will they work? Providing a return of 2-3% will not be adequate to get one to monetise their gold. Further, a bank recycling gold would run a high price risk as well as cost of conversion charges. If sold to jewellers, the deposit holders have to be given the gold after the tenure, which will involve a price change. Would banks be willing to take on this job? Besides, we would only be deferring the import of gold to another date, hoping all the while that there is a rollover. The Budget also talks of a sovereign gold bond which works on the price of gold. Who will pay the interest on this bond? It has to be the government? Will it be attractive? Today, there is an active futures market for investors and hence such a paper certificate may not be too attractive. If it does work, then there would be a cost borne by the government and it could just end up getting in fresh investors while the traditional buyers of the physical asset remain unchanged. Last, a gold coin from India would also need gold to be brought from somewhere, i.e. imported. Will this mean the same gold being imported by different entities?
Last, the total revenue foregone in FY15 has been put at R5.89 lakh crore on account of all the four taxes—corporate, income, excise and customs—compared with R5.49 lakh crore in FY14. Can we expect that, going by the proposal to eliminate exemptions for corporates, we could soon see the government working towards the same for the other taxes too? The DTC smelt like this.

Good for growth, though households may not be too satisfied: Free Press Journal 1st March 2015

With three successive years of high inflation, a typical household would have been wishing for some adjustment in the tax rates which would help increase the disposable income. The budget does not deliver on this score and has kept the tax rates and limits unchanged. This would have come as a disappointment for individuals. The implication is that if this had been done and households had got more money for spending on non-food items, it would have created a self-fulfilling demand for consumer durable goods, which have been afflicted by low growth for the last 3 years. In the current scenario, this may not materialize immediately.

 Given that there could be some increase in prices of commodities since the excise rate has been increased uniformly through an additional cess, there would also be an upward pressure on the prices. The railway budget has already added to freight costs, which will get reflected in higher prices of food items to a certain extent. The budget says that on account of all the proposals on indirect taxation, the government will be collecting around Rs 23,300 crore, which will finally come from both corporates and households, depending on how much of this enhanced cost is passed on.  Looked at from this point of view, there is reason for households to feel dissatisfied.

However, the budget does give compensation in the form of higher incentives for savings, especially in insurance and pensions. There is reason to migrate households to having greater cover for health through insurance and the higher limits serve this purpose. Further, by encouraging them to save in the pension schemes, there is a move to make individuals more self-sufficient in old age by providing for the rainy day from now itself.

 Therefore, the interests of households have just about been balanced. So, should the common man be happy? On the balance yes, though there will still be some dissatisfaction in terms of not getting tax benefits. Ideally the tax exemption limit should be linked with inflation so that there is an automatic tendency to increase the same when inflation rises.

 The budget does focus on growth through public expenditure and this is what would be of interest for the economy as we are targeting growth of over 8% in FY16. Such expenditure needs to be incurred from the beginning and not kept pending for the end of the year which has been the case in the past. Last year, if the plan and non-plan expenditure was combined, the revised number indicated a cut of around Rs 35,000 cr which was done to ensure that the fiscal deficit target of 4.1% was achieved. Quite clearly we need to get out of this syndrome. If this were done, then government expenditure in infra will provide the backward linkages with the rest of the economy by setting in motion a virtuous chain that will feedback into the cement, steel, capital goods etc. sectors.

 It does appear that the government is keen to kick start the growth process and would begin spending this money on infra projects which will be good for the growth process. Given the limited fiscal space that was available to the FM, an attempt has been made to do the best with focus more on increasing the savings habit and spending money where it can generate growth and hopefully employment, rather than cutting taxes and giving away freebies. This does appear to be the ideology of the government which focuses on making money work better. To this extent it is pragmatic.

Bank on buoyancy to garner higher revenues: Financial Express 25th February 2015

Formulating the Union Budget is a difficult exercise especially on the revenue side as almost every line item is based on the performance of the base on which it is generated. Expenditure is straight forward as there are some that have to be incurred while others are discretionary. The government has the choice to increase or decrease these numbers. The curious fact of the process is that, unlike individuals, who plan expenditure based on income, here, the government fixes expenditure and then judges the income flows and has the buffer of borrowing or using other avenues like disinvestment for balancing the budget.
Tax revenue accounts for around 75% of total receipts of the government. Three taxes—corporate, excise and customs—account for 48-50% of total receipts. The elasticity of each of these taxes has been calculated for the last 5 years, based on Budget data for revenue and growth in imports in rupee terms for customs and GDP from industry in current prices (old series) for excise. For corporate taxes, the profit before tax (PBT) and tax paid has been reckoned for a random set of 2,046 companies.
The elasticity for corporate tax collection has tended downwards, which can be due to both lower profits being earned and concessions being given. Therefore, the elasticity is at 0.6-0.8 in the last 2 years. If the government needs larger revenue from this source, then PBT has to grow at a very robust rate and hence, a prerequisite would be healthy corporate performance. This has to correspond with a high growth in GDP and industry.

The elasticity for customs is very skewed and does not show any trend as such. In FY14, the elasticity looks very buoyant but it is more due to a statistical phenomenon of growth in collections being 5.9% and imports 1.7%. In FY11, both the growth rates were very high at 63% and 23% respectively. But as the accompanying set of tables show, the average customs rate has come down due to the government systematically lowering these rates to enable industry to grow. This would mean that imports have to be even more robust to fetch these revenues as the rates keep moving down.
The picture for excise collections is different with the average rate increasing in the last 2 years. This explains partly the elasticity increasing in FY13 when growth in industry was low. In FY11, both industry and excise collections increased at similar rates.
The conclusion that may be drawn is that the government has to bank on higher growth in corporate profitability, imports and industrial growth to garner higher revenue from these sources. The effective rates of taxation have tended to be stable or low for corporate taxation, marginally lower for customs but increased for excise duties. Therefore, a consideration can be reworking these rates. However, with an informal commitment on retaining corporate taxes at where they are, there is less room for manoeuvrability. But customs and excise would be interesting areas for which their compositions need to be ascertained.
If the total revenue earned has to increase, these major components should contribute to it. Let us look at excise collections first. Crude oil and derivatives are important components and consumption has to increase continuously to keep revenue increasing. This is so as the duty rate is specified in terms of per unit production and not ad valorem. Also, if the price of crude increases, revenue will not go up correspondingly and consumption will be the important factor.  Second, for excise duties, tobacco is a major contributor, and this sin tax is critical for maintaining buoyancy as demand tends to be inelastic here.
Increasing rates across the board will not be feasible given an increase in the pace of growth through the infrastructure route will cause the demand for cement, machinery and steel to increase. Hence, the focus will be on buoyancy more than change in rates.
In case of customs, collections would be affected by both the price as well as exchange rate and a higher crude oil price will generate more revenue for say petroleum products as will a weaker rupee. This will mean some challenges on the balance of payments front as well as inflation.
While the GDP growth number is revealed, the certain performance of the economy in different revenue generating areas remains implicit. Non-realisation of the same would mean that there are likely to be slippages along the way. The alternative is to increase rates where possible, but may not be advisable in a situation where the economy is looking for incentives for a boost.  Also, with the GST planned for the next financial year, there may be some hesitance in increasing rates across the board this time.

Managing Capital Flows book review: Going with the flow: Book Review: Financial Express 22nd Febraury 2015

Managing Capital Flows
Subir Gokarn, Bruno Carrasco
& Hiranya Mukhopadhyay
Oxford
R995
Pp 286
MANAGING CAPITAL Flows is a collection of academic papers that were presented at a conference held jointly by the Asian Development Bank (ADB) and Reserve Bank of India (RBI) in Mumbai in 2012. Therefore, the reader can expect detailed technical papers on the subject, as the authors  deep-dive into the issue of capital flows and their effects on various economies. The authors of the papers analyse capital flows in different countries as case studies to make suggestions on what should be done to tackle them. We get to learn what various countries did when faced with these challenges, and these responses could serve as possible templates in the future for others. But there are different views on this possibility too.
The three important messages, which the authors highlight based on the conclusions of various authors of the papers presented in this volume, are the following: the first is that countries can gain a lot from these inflows if they come more in the form of equity, that is, FDI and are channelled in the right direction, that is, investment. This means that FII investment in the secondary market would not have the same positive impact on economies. Second, price stability does not guarantee financial stability, as large inflows can be inflationary and can lead to misalignment in exchange rates. Therefore, macro prudential regulation has to necessarily be the first line of defence against the building up of asset prices. Third, a proactive policy is needed to avoid a constant exchange rate and interest rate realignments, which put central banks under constant pressure, as they have to tune monetary policy to these twin developments.
A paper by Michael Klein argues that there is little evidence to prove that controls of any nature on capital flows tempered exchange rate appreciation. His take is that while countries like China and India did witness lower appreciation, there is less evidence for other countries, which had capital controls. Therefore, the conclusion is that capital controls could tend to be less potent in controlling exchange rate appreciation in several cases.
Another paper by Jonathan Ostry recommends that there is no ‘certain magic formula’ for dealing with short-term volatile capital flows. The usual policies of stabilisation may not be effective and one will also have to examine the implications on other macro indicators to gauge whether or not these measures work. Capital controls can be impactful if the distortion is temporary. However, persistent inflows would require a different set of policies, and capital controls will not be feasible.
Subir Gokarn’s paper relating to India focuses on policy flexibility rather than adherence to theoretical rules. The recommendation is to pursue a flexible rate policy with selective exchange rate intervention, which is what was done during the period 2007-12 when the economy went through both varieties of flows: large inflows and sudden outflows. The controls on inflows were on both quantity and price, while those on outflows were essentially quantitative in nature. The effectiveness of such policies is more important and tends to be time-specific, which reinforces the belief that there is no size that fits all. But such actions have an impact on expectations, development of the market and various stakeholders.
The experience of Brazil is elaborated in another paper, where inflation and financial stability goals were jointly pursued. Regulations introduced were more to deal with financial stability. Brazil tackled forex inflows by contractionary fiscal and monetary policies, and allowed for substantial currency appreciation, while sterilising the incremental reserves simultaneously. In the case of Indonesia, traditional policies did not quite work in the form of open market operations. Here, the central bank pursued a blend of keeping a flexible rate, conducting capital flow management, as well as invoked macro prudential measures.
This collection of papers is interesting, as it analyses in great detail the stories of tackling capital flows in emerging markets. But ultimately, one would go with Gokarn’s view that it may not be possible to always go by the textbook, as the macroeconomic conditions prevailing within the specific country would determine to a large extent the available policy responses. Though at a generalised level, the solutions offered here would hold. Therefore, internal introspection is called for and countries do need to monitor all these flows and be prepared with responses to ensure that the distortions caused are minimised.

The new GDP series: Questions abound: Financial Express: 3rd February 2015

The revision in data of any economic variable is necessary as the entire product and services baskets keep changing over time for an emerging economy. Therefore, the base years need to be revisited periodically and shifting the same to 2011-12 for GDP appears pragmatic. Aligning the concept to the globally accepted practice of reckoning the variable at market prices makes sense for comparison.
That said, the new series introduced by the ministry of statistics will take time to be absorbed as it has brought out a plethora of data to the table, leaving behind several questions in the minds of the readers. To begin with, the choice of the base year hangs in suspension as usually all base years are considered to be normal years. Here, the choice looked appropriate given that this year was the first one from whence there was a sharp decline in growth based on the old series. But the data put forth now, which starts really from FY13 and FY14, are so different that this premise can be questioned and we will never know whether this was the right choice.
The problem begins with the GDP growth rates under the new concept coming in at 5.1% and 6.9%, respectively, in FY13 and FY14, compared with 4.5% and 4.7% (at factor cost) under the old series. Normally, when base years change, there is always a change in growth rates, but we have never seen a turnaround in judgements due to a change in concept. The first strike is one of embarrassment, as whatever negative was spoken about the earlier political regime with euphemisms of a non-functional government with policy angina are cast aside as the economy was actually very dynamic and there was a V-shaped recovery in FY14 compared with stagnation which was a conclusion drawn from the old series data for FY14.
In fact, given the changes in the concept where we include net product taxes, one could look at just gross value added (GVA). Growth in GVA still comes to 4.9% and 6.6%, respectively, which means that taxes per se are not the reason for this difference and the economy was really growing. Or rather the new coverage has grown sharply. What, then, can account for this big change in GDP?
The sector-wise growth in GVA shows that everything that economist and analysts were saying was incorrect. Mining now has grown by 5.4% against minus 1.4% in the old series, manufacturing by 5.3 perfect as against minus 0.7%, and trade, repair and hotels by 13.3% against 1% earlier. These numbers are radical changes in the structure now presented. If these numbers reflect better coverage and are hence are more exhaustive, then we were wrong in saying that the mining irregularity affected growth and that industry was buffeted by absence of policy movement.
At the theoretical level, there are two questions. First, as the sizes of GDP at current prices under the old and new series are almost identical for 2013-14, it is hard to believe that when converted to real terms (both the concepts are at market prices), growth can increase sharply. The implication is that the real economy suddenly became buoyant with better coverage and reporting. Curiously, in this concept, if GVA grows by a stable number but net taxes rise sharply due to higher taxes or lower subsidies, then the GDP number will increase by a higher level.
This leads to the second question, which is that in this scenario it means that inflation actually came down as with 6.9% growth in real GDP and 13.6% in nominal GDP, inflation was 6.7% against 8% in 2012-13 (13.1% nominal GDP and 5.1% real GDP). Were we then off-track on monetary policy even though arguably these inflation numbers are closer to the GDP deflator rather than the CPI numbers?
At the operational level, the ministry’s paper on GDP revision does not give the same for various sectors and stops at the GVA level only. This will make it hard to forecast GDP as the net product taxes for various sectors have not been provided.
The ministry has loaded the statement with too much of data that it does become challenging to put them together. Much like what RBI has done for balance of payments, where the data is presented in both the new and old formats separately, the same should have been done here. This holds especially as the new series has a very different basket of goods and services, which, prima facie, looks hard to digest. Has our consumption basket changed radically or is it just that better reporting is taking place? If it is the latter which is what it appears to be then to maintain comparability we need to see how the earlier series would move with the old composition but new concept at market prices. Curiously, when the old series is looked at FY05 base year but at market prices, then the two growth numbers for GDP are 4.7 and 5% (as per the May 2014 press release). The new numbers are still way higher at 5.1 and 6.9%.
These numbers do not quite give comfort as they could be revised later and we could get different numbers. It would also be unwise to talk on the state of economy right now as all the analysis and judgements we have passed until January 29 based on the old series could be overturned when we get in the new core sector data, IIP and GDP numbers under the new criteria. It is also hard to reconcile this buoyant 6.9% number with the gloom in industry which includes the entire corporate space and SME segment which is still looking to see the economy recover. Further, it is hard to reconcile high real GDP growth with declining capital formation in both real and current prices. In fact, growth in government expenditure has been higher in both real and current terms which are the brightest spots in FY14. And to think that we said that the government is not spending by sticking to FRBM, now sounds incongruous.

Greek roulette: Financial Express: 31st January 2015

The Latin phrase, Timeo Danaos et dona ferentes (Aeneid, Virgil), translates into “Beware of Greeks bearing gifts”. This old saying should have been heeded when 240 billion euro was provided by the EU, ECB and IMF to resuscitate the Greek economy in 2010. Greece, on its part had agreed to all the conditions that were placed especially on fiscal austerity, and the euro crisis seemed to be probably over. Strict cuts in expenditure, higher tax rates and extended working years with fewer pension payouts were all part of the deal which was accepted. But was there any guarantee that it would continue to comply with these conditions, especially as governments tend to change?
The issue has come to the fore today with the Syriza coming to power and the government is to be headed by Alex Tsipras whose election plank was to do what was best for Greece’s citizens, i.e., go back on its commitments to the euro-world and revert to its liberal policies on fiscal balances in particular.
Greece may have a story that could engender sympathy. GDP growth since 2009 has been negative indicating that a recovery was never on the cards. Between 2009 and 2013, the GDP declined by 28% on a cumulative basis. The unemployment level increased sharply to 27.3% in 2013 and this rate among the youth has been estimated to be over 50% (around 7.5% in Germany). This is not a good sign for any country. The government’s debt-to-GDP ratio rose from 120.4% in 2007 to 133.2% in 2009, before declining for two years and increasing again in 2012 to 163.6%; It is is estimated to be at 175% in 2014. The fiscal deficit is still around 12% of GDP.
The new PM has a five-point programme to keep his promises. First, the minimum wage is to increase from 580 euro to 750 euro per month. Second, the government has promised to provide 300 units of free power and food subsidy to households below the poverty line. Third, Tsipras would work to have some debt written off and also tie the same to economic growth rather than the budget. This argument will find support from economists given several countries have tied themselves to a slowdown by following the path of fiscal austerity. In the same length, it can be said that there would be a better chance of servicing debt if growth had taken place generating revenue which could be used to service debt.
Fourth, there is a move to scrap the tax on property while the last point on the agenda is to forge closer ties with Russia, which can be disturbing for the Western nations. Tsipras had, in fact, opposed the EU sanctions on Russia when the latter invaded Ukraine. Russia is already the largest trading partner and accounts for the large tourist inflow into Greece.
What could be the implications in case Greece was to default and then told to walk out of the alliance? Greece accounts for less than 0.5% of the population of the set of 19 euro countries and just about 2% of its GDP. A default on its loans could mean an exit from the alliance forever. The burden of adjustment has been on countries like Germany, Austria, Belgium, etc. which have followed prudence all along. It is unlikely that they would acquiesce to any further renegotiation with Greece or restructuring of debt and simultaneously allow it go on spending as it did earlier. This could mean Greece going back to the drachma or a new currency which will be severely devalued. What does this mean for the world economy?
First, it will set a precedent for all other recalcitrant nations that there would be no tolerance. Second, a run on the banks is but natural as deposit holders would try and draw out euros to be used elsewhere in future. Third, the banking system would collapse with capital already being scarce at just about 8%. NPAs were at a high of 33.5% in 2014 and have been increasing since 2009. Borrowers too would be unwilling to service their loans under these conditions.
Fourth, the cost of going to a new currency would be high and there would be reluctance for other nations to deal with the drachma to begin with. Fifth, foreign banks, especially other European banks that are holding on to Greek debt, would take a major hit as the government would not be able to repay debt since the total forex reserves are just around $6 billion. This will mean a pile up of bad assets in their home countries and probably some support from their respective governments. The CDS on Greek sovereign debt has gone up by 550 bps in the last fortnight. Sixth, the euro would tend to weaken further against the dollar until equilibrium returns. Last, the Greek economy would collapse sharply and enter another painful recession which can have serious social implications given the unrest that is already there in the country.
While the pain would be more for Greece in case of an exit, given the banking linkages and the debt extended by the troika—ECB, EC and IMF—there would be significant spillover effects across the region.
Greece has repayment deadlines for debt in March, July and August, and it looks unlikely that it would be able to meet these commitments and would have to go in for restructuring. Any decision to permit such a move would be contingent on the new government adhering to the austerity lines. Therefore, there is consternation on whether or not the Tsipras government will stick to the past commitments or break away given the domestic promises made at the time of elections. The next month would be critical for Greece and currency and stock markets across the globe as the absence of a solution would enhance volatility against uncertainty.

Primary colours of the Indian stock market: Business Sandard: Book Review January 30, 2015

The author believes that the government's huge divestment programme is largely responsible for the monopoly-like situation arising in the secondary issues market because it crowds out private players

HANDBOOK OF INDIAN SECURITIES Gautam H Parikh
Bloomsbury India
374 pages; Rs 799

When we think of the capital market we normally look at the stock indices and the price movements of various scrips. This subject is well researched and there are several theories that go into the daily madness we see in the market. Rarely, however, do we think much of how these shares get on to the market. This is where Gautam Parikh adds value not just to the literature on the subject of primary issues but also in providing a detailed analysis of the genesis of the stock market and the various ways in which companies bring these shares up for trading.

In his book Handbook of Indian Securities Gautam Parikh goes into the finer nuances of what an IPO (initial public offering) or an IDR (Indian depository receipt) means and then elucidates why these routes of raising capital are chosen by a company. He then examines the procedures to be followed when bringing this effort to fruition. Through an individual discourse on 10 such issues, he explains the "why" and "when" of these preferences. By giving examples of which companies have used a route like, say, preference shares or a rights issue, he is able to theorise as to why companies do what they do.

Hence, an issue called QIP (qualified institutional placement) has an appeal because it is faster and does not require permission from the market regulator, the Securities and Exchange Board of India (Sebi). Rights issues, too, have the charm of being faster and relatively less expensive than an IPO. While all of us have heard of this terminology, rarely do we stop to ask ourselves what they mean precisely and why they are used by companies. The author fills this knowledge gap.

Mr Parikh also provides a comprehensive view on the evolution of the stock market and correctly points out that the concept of economic reforms was not the idea of an individual or the prime minister or the government but a necessity that was imposed by the International Monetary Fund when India needed a loan to tide over a foreign-exchange crisis. The capital market went through a renaissance with the abolition of the Controller of Capital Issues and the opening of the bourses to foreign institutional investors that, along with changes in infrastructure, let the market grow. This includes the creation of the National Stock Exchange, a regulator (Sebi), and the entire clearing and settlement infrastructure that strengthened the ties between the primary and the secondary markets. The concept of brokers changed and a till-then hereditary business became more open for the market. Technology was, to use a cliche, the major game changer.

Let us look at some insights Mr Parikh provides. He avers that a close and cosy relation exists between the management and the board with each one owing a lot to the other; which is the reason it has been mandated that, at least to begin with, all listed companies should have 25 per cent public holdings. While the author does refer to public sector companies here, his observation would hold for all companies irrespective of ownership. The author also believes that the government's huge divestment programme is largely responsible for the monopoly-like situation arising in the secondary issues market because it crowds out private players.

He also says IDRs have lost their sheen today, with citizens also being able to buy shares of overseas companies in foreign currencies under the liberalised remittance scheme. Therefore, although the idea of having IDRs was to be beneficial for both the foreign company operating in India and potential domestic investors, current account liberalisation has made it less attractive. On foreign currency convertible bonds (FCCBs), the author points to the exchange rate risk that calls for hedging as the principal to be returned often becomes more expensive over the tenure of the loan. He also believes that bonus shares should not be treated as a proxy for dividend, as it often is. More importantly, it cannot be used as a lead or a lag indicator of economic growth.

Along the way, Mr Parikh also provides some insights into the relatively more difficult ground of participatory notes that could be a conduit for black money, though it is debatable whether this is often the case.

Look before you leap: Financial Express: January 26th 2015

Reforming institutions is always necessary, especially so as they tend to stagnate and, at times, outlive their purpose. This was felt about the Planning Commission which has been replaced by the NITI Aayog. It is not surprising that the Food Corporation of India (FCI) has come under the lens in terms of restructuring given that the value-chain of food delivery—which is what the FCI is involved in—has been reviewed and found to be sub-optimal. Alternatives are being discussed as to how to procure foodgrains and distribute the same in a better manner.
To ensure that we do not end up doing the same thing through different names, we need to understand the raison d’etre of FCI. The function of FCI is primarily three-fold (looked at directly and indirectly). The first is to procure foodgrains, store the same and distribute to the households. While FCI has been blamed for all the ills in this chain from wastage, slack and leakages in distribution, the major issue is with the policies that are behind this chain rather than the institution. By changing the institutional framework, and not the approach, we may only be scratching the surface.
Procurement in India is an open-ended scheme where all farmers can sell at a predetermined price to FCI. Quality specifications are specified and farmers are free to sell anywhere they want. The idea was to ensure that farmers are encouraged to grow more rice and wheat and they are fairly compensated through the MSP. Do we want to change this motivation behind the procurement policy?
Further, by making it open-ended, farmers sold a progressively increasing quantity which had to perforce been taken up by FCI making it an expensive affair. The procurement incidentals are 25% of the procurement cost for both rice and wheat. Do we want to retain this kind of procurement or keep it within limits?
But if the idea is to provide an income and encourage output then it has to be kept open-ended, in which case the replacement agency has to bear this cost and be compensated with a commission. Otherwise, it is a high-cost business where the returns are low. FCI borrows today under the food credit system at an average cost of 10.7%. Few private players will be interested in such a model considering that the procurement centres have to be replicated (FCI has 14,000 such centres).
Therefore, as long as the procurement ethos does not change, the basic issues remain. Also, with such procurement and absence of a policy to deal with surplus grains, FCI is the largest hoarder of foodgrains—in 2013, at one point of time, they had stocks of over 70 million tonnes (currently 39 million tonnes). The fault is not really with FCI.
While theoretically a cash transfer can be given to farmers on recorded production (though there will be an incentive to cheat to get this benefit), procurement is needed for the PDS as well as maintaining a security buffer. In the absence of the latter, the cash transfer would be possible theoretically at the first point of sale in pre-specified selling points. How do we tackle the PDS?
The distribution part is also a major cost for the system where incidentals are 30% for wheat and 25% for rice on the pure cost of grains. But while decentralised distribution is spoken of, it is not that easy in reality as production regions and distribution centres are not the same and someone has to move the wheat from Punjab to Kerala. If FCI is not efficient, can anyone do it better as both crops are grown in one season (rice has a small share of rabi crop), and has to be stored for a year until the next crop arrives. Therefore, grains have to move from the production areas to distribution centres and have to be stored for a year. There is no option really in the practical sense.
This brings the issue of cash transfers to the fore. Can we have cash transfers given that we are treating Aadhaar as a panacea for all distribution of benefits? While theoretically it sounds good, pricing is an issue even if we look beyond the practical reality of the money being diverted away from foodgrains. The price of common variety of rice ranged from R24-56 per kg. Wheat ranged from R16-36. How do we transfer the money given that a fixed sum will make some better-off and others worse-off? It is very likely that once the cash transfer sets in, there will be lots of criticism of a replication of a dole system, a la MGNREGA.
In fact, the ethos of the PDS was to ensure that everyone got a standardised product at the same low price. There will be political lobbying for claiming higher cash transfers as we will not know the fair price. Once there is cash given and even assuming that it is spent on rice and wheat, then automatically market prices will start increasing, which will lead to inflation concerns. Also, given that inflation increases every year, we will have to revise these numbers across states and districts. Have we made any calculation of this cost by back-testing the results based on targeted distribution numbers?
Ideologically, if we are antagonistic on providing foodgrains to the people on grounds of systems being inefficient or that the targeting is skewed and leakages abundant, then we just need to do away with the PDS. Let everyone buy their own foodgrains at the market price and the government can save on the incidental procurement and distribution cost, which are around 50%. Even a cash transfer makes little sense if it becomes a dole.
Similarly, can the procurement stop and FCI only buy the strategic buffer and roll over the stock through the market? Let the markets take over. Are we prepared to do this?
We need to be clear of our objectives or else there will be more contradictions

Book review ‘The Innovator’s Method': What an idea: Financial Express, 25th January 2015

The Innovator’s Method
Nathan Furr
& Jeff Dyer
Harvard Business Review Press
Pp 268
R1,095
WHEN GODREJ and Boyce realised that there was too much competition in the market, which affected its sales, the company decided to introspect. Given that 80% of the country did not have refrigeration facilities, there was obviously something missing in the way in which they operated. Rural India was the most likely target, but the typical household lives in a small home with limited space. Further, given their income size, they do not have too much food to store in the fridge anyway. Also, the absence of electricity for several hours meant that the product had to offer some back-up. Therefore, the company had to come up with customised products. The result was the creation of ‘chotuKool’, a small refrigerator, which addressed all these issues and was custom-made for such households. The rest, as the cliche goes, is history for the company.
This entire process of relooking at the business model and then coming up with new solutions is what goes into what Nathan Furr and Jeff Dyer call ‘the innovator’s method’. Furr and Dyer believe that often we are scared to do anything, which might have uncertain results because of the fear of the unknown. Most of these ideas die a natural death, as these plans rarely get implemented. This holds even more for companies, which do not want to experiment, as the possibility of failure hangs in suspension. But for those who have the innovative streak, it is this uncertainty that poses a challenge. They overcome it with solutions and come out as winners.
The authors in their book, The Innovator’s Method, give the example of how a college student found that her sister’s expensive wedding dress would probably never be used again. Her mind started working and she ended up starting a rental agency (Rent the Runway) with a partner, where expensive dresses could be hired for a fee. The clue here was to do things in an unconventional manner without a business plan and go by instinct. They did not hire professionals, but split their responsibilities. They didn’t develop a website, but launched a beta version of its service.
Blow up this situation and several companies, too, have shown how they can do things differently through innovation. The authors give examples of companies like Amazon, Google, Salesforce, IDEO, etc, which continuously innovate to move ahead. It becomes a part of their DNA and the companies start being known for taking chances and coming up with something innovative. Then there are companies like Hindustan Unilever and Procter & Gamble, which reignited innovation to progress once they realised that there was something amiss in their existing models. The authors also draw up the final outcome of ‘innovation performance’ for companies, which is expressed as a ‘premium’. It ranges between 17% and 95% after the companies have opened up to innovation and this helps increase market capitalisation as well for shareholders.
In fact, the authors give the example of Hindustan Unilever, where the CEO actually asked everyone to take time out to go to the customer and find out what was going wrong with their products. With great reluctance, several seniors moved from their comfortable offices, but finally reconnected with customers to bring about changes.
Furr and Dyer reduce the innovator’s method to four stages. The first is developing ‘insights’ into the business, which is the starting point of innovation. For this, we need to have open innovation, which is possible, provided we have creativity and ideation in the organisation. The focus is entirely on thinking. The second stage is the identification of the problem because without this goal, one can never find a solution, which is the third part of the puzzle. One must remember that whenever we think of innovation, it should address some lacuna in the system, which has not been widely explored. Lastly, one needs to have a business model to really get things going. And this should be scalable because, at the end of the day, any innovation has to make commercial sense.
Who do the authors address in this book? They identify three sets of audiences in this context. The first is managers from any discipline who want to innovate and solve problems characterised by uncertainty, but are not aware of the steps that have to be taken. This class holds for any organisation and is hence universal. The second is leaders who face the challenge of declining growth or have a challenge of sustaining growth to retain momentum, as well as talent. The third is groups of entrepreneurs who are self-driven and would like to do something different after doing the same thing several times over.
The book inspires all these classes of people to think and, more importantly, think differently. While the four stages mentioned here are not necessarily textbook steps, intuitively, one can see the wisdom in pursuing this path. The example provided of Banco Davivienda of Columbia is a good one that shows how one can work around this issue. To reach out to the unbanked population, the bank focused on opening accounts with low fees. But it did not find any takers and when they sent their officials to find out why things did not work, the answers were simple. The requirements were quite different. By listing out the elements of a bank account and what people expected, they realised that every requirement could actually be met through this account, provided there were innovative tools used. Realising that almost all customers had cellphones, they integrated the account with the phone to make payments such as bills and allow for banking transactions so that one could move away from branch, cards, application forms, etc. This made the product attractive now.
This example can be used in our own attempts at financial inclusion, where presently the focus has been on opening bank accounts, which have mostly nil balances. By linking these accounts with various activities of account holders, the account can be made active, serving several requirements of customers.
The Innovator’s Method is quite an interesting book that provides several examples of how innovation can be initiated in different areas and while there are several theories and jargon propounded during this discourse, it will surely inspire the reader to think of innovation in whichever domain he/she is in.

Rethinking budget calculations: Financial Express, 21st January 2015

Budget FY16 has been projected as the next big thing to watch out for, with hype being that it will be the clichéd game-changer. Similar hype had been built up around the gubernatorial succession at the central bank in 2013 as well as before the Lok Sabha elections last year. The various bills that were to be passed, like the ones on FDI in insurance, land acquisitions and the GST were other game-changers that passed us by quite silently. With these precedents, are we expecting too much from Budget FY16?
The major, so-called tax reform, i.e. GST, would be possible only from FY17, and hence is out of the purview of the present Budget. Some rates would change then but those would not be the reforms that change the canvas. So, what can we look out for in the upcoming budget that would make it different from the usual statement of accounts presented on February 28?
A feeling of déjà vu creeps in every year when we look at how the budget is balanced. Ever since the economy slowed down, the story has been the same. The fiscal deficit keeps ballooning, with over 70% of the deficit being consumed in the first half of the year, and then the government’s hurry to control the fiscal deficit situation forces the expected action. Expenditures are cut across departments and the capital plans are stalled. Some hasty action is taken on disinvestment and some expenses are rolled over to April, which ensures that the current year’s numbers look good. Can we change this?
There are three things that the budget needs to focus on; these can work towards ensuring that the dismal budgeting story is not repeated. First is the assumed target for GDP growth in nominal terms. This is critical because around 55% of the total budget is accounted for by tax revenue which normally is closely associated with this number. This is one area where the government has little control as taxes are linked to the base which has to increase in a desired manner. Normally, we look at growth of
13-14% in nominal GDP which broadly is a break up of real GDP and inflation (ideally the GDP deflator). However, if we are looking at a pragmatic combination of 6.5% real GDP growth and 5% wholesale price index growth (which is a better proxy compared with CPI), then a number of 11.5% looks reasonable which can be scaled up by not more than 0.5%.
While this number may be academic, it created challenges during the year as expenditures are planned based on this growth number and constrained by the fiscal space accorded by the fiscal deficit number. And the expenditure cycle is such that the committed ones are reckoned on time while the discretionary ones are kept in abeyance till a reconnaissance is done during the year, when, per force, the latter is cut if things do not work out. Therefore, the first rule is that we need to have a conservative growth target and tune the project expenditure to these collections. As a corollary, the money should be spent from the beginning even if the budgeted amount is small—it can be R30,000 crore instead of R60,000-70,000 crore, but invoking them will make a difference.
The second area is how we estimate the oil price as it has the potential to disrupt the subsidy bill. Last year, the budget looked at something in the range of $ 100-110/barrel. What will it be now? If one looks at the Brent futures price on ICE, for all the contracts through FY16, the average would be around $60 a barrel, which is around $15 higher than what it is today. Intuitively, it can be seen that relative to last year, a price lower by 60% can slice the subsidy bill under ceteris paribus conditions (assuming stable exchange rate too) by this amount which can be close to R25,000 crore. Leaving prices as they are at the retail end is one way to allow for cross subsidisation for kerosene and LPG without compromising on the budget numbers. The second rule can be to leverage the gains from lower oil prices by not lowering retail prices but creating a buffer. This will help in case the calculations go awry in case oil prices increase beyond $ 60/barrel.
The third area concerns disinvestment. We always tend to be bullish on this front in February, but turn bearish through the year which causes the programme to be sub-optimal. The number appears to be more of a residual coming after accounting for various components of the budget by fixing the fiscal deficit ratio at a pre-designated level. At an ideological level, the question often asked is whether this should be a part of the budget to begin with. Curiously, if disinvestment proceeds are excluded from such calculations, then the fiscal deficit numbers would look less attractive. The deficit in FY12 will move from 5.73 to 5.93%, FY13 from 4.85 to 5.11%, FY14 from 4.62% to 4.85% and FY15 from 4.10 to 4.59%.
While it is the prerogative of the government to earn income from any source, a suggestion could be to exclude this component from the budgetary calculations so that the fiscal deficit number can be taken as a clean concept. At the next stage, any disinvestment can be used to earmark capex that will proceed irrespective of what happens on the fiscal front. With the disinvestment rate averaging 0.3% of GDP on an annual basis for the last 5 years, this can be the Keynesian stimulus amount that will go a long way in fixing the infra commitment of the state. This can be the third rule that can be pursued.
The government as usual has to tread the path between fiscal prudence and effectiveness within the contours of the economic environment. Being conservative in defining growth paths and pragmatic in expenditure management could add the necessary delta to make the Budget more convincing. And it is also likely to work well as we do not wait before we act.

Are surprise rate cuts the way ahead: Financial express, 16th January 2015

In a double surprise, RBI has added zing to the markets which were trying to guess whether a rate-cut will be announced in the credit policy in February or after the Budget.
The first surprise was announcing a rate-cut between two policies. It is not, however, completely out of the blue as the earlier policy statement did clearly note that RBI would not wait for the policy cycle to end to lower rates if it was convinced that inflation and its future trajectory were both acceptable. One could still argue that waiting for another three weeks would not have mattered as there would be no new view on inflation anyway.
The second surprise was that the announcement of the cut was made in the morning, just before the markets commenced operations rather than Wednesday evening. In the past, we have had such surprise announcements but they were made in after-market hours, after 5:30 p.m.
The concept of a surprise is always novel for monetary policy as there is a school of thought which believes that unless there is a surprise element, the impact of monetary policy is less potent. This is not incorrect as, often, when rates are increased or decreased by RBI in line with market expectations, the market remains unperturbed as it has already factored the move ahead of the policy. Therefore, a surprise policy change is normally more effective. However, making such surprise policy changes a habit will increase volatility in the market as players would always keep guessing when RBI would intervene.
Curiously, the goal behind having a series of monetary policies that ranged from 8 to 6 (as is the case at present) was to remove this ‘noise’ factor. One may recollect that in the days when rate changes were announced in between policies, there would be considerable distortions in the market as everyone would guess when RBI would come up with a rate change. Such conjectures do cause upheaval in the markets which involve considerable sums of money as trading moves in different direction. G-Secs, stocks, money markets, currencies all tend to be affected by such conjectures.
Normally, the central bank reserves the right to intervene at any time, but this is done when there are serious problems in the economy. In 2013, for example, when the rupee went down, there were emergency measures announced concerning the LAF and rates to ensure that there was order. But by making such an announcement when things are going right, a new dimension has been added to the process of conduct of monetary policy.
While it may be interesting to ponder why this move was made, two implications stand out. The first is that RBI is convinced that inflation has come down and will remain within range. Also, the 6%-mark is what one can infer to be the target for RBI, even in the short-run. Further, speculation of how the inflation numbers will behave after November, when the base effect wears off, has been put to rest given the central bank quite clearly expects CPI inflation to stay within this mark. Given the fact that the announcement was made after the WPI inflation numbers were out, the takeaway is that while CPI inflation is being targeted overtly, the WPI also matters. While WPI inflation always tends to be lower than CPI inflation, it still is something to be monitored.
The second implication is that we can see this rate-cut as the beginning of a series of similar rate-cuts during the year. The scale and pace will be largely determined by the actual CPI inflation and expectations of the same. Given the preponderance of the food basket in the retail price index, inflation tends to be driven a lot by the state of monsoons and hence, it may be expected that while the direction of rates is southwards, it would be calibrated with momentum picking up only after a clearer picture emerges on the state of monsoon after June. On the whole, assuming a normal monsoon, one can expect a 100 bps reduction in interest rates during the course of the calendar year 2015.
Two questions that would be asked are whether or not industry would be happy with this announcement and whether banks would follow suit with rate cuts. Industry would take heart mainly since the rate-cut was long overdue and something which has been asked for very often in the last 2-3 months. Therefore, this will prove positive for industry. However, it will not lead to a flush of investment as there will be a wait-and-watch period for investors. Infrastructure projects would wait for further cuts as money borrowed has to be committed for a long fixed tenure. Manufacturing, with 70% capacity utilisation in the face of stagnant demand, would not be in a hurry to invest more at the moment and will prefer to see demand revive first.
On the second issue, RBI will be keenly observing whether or not banks lower their interest rates. Anecdotal experience shows that when RBI cuts rates, banks are quicker to lower deposit rates than lending rates. There is normally a lag between the two, and when the lowering of lending rates does happen, the extent of reduction is lower than that on deposits. Also, there is a tendency to lower interest rates on the retail portfolio and the decision to do so on the corporate loan portfolio will be driven a lot by the credit risk perception of banks.
The lowering of interest rates by RBI is good news as it provides clear direction to the markets. However, it will be interesting to see whether in future such actions will be generated in the normal course of economic activity between two policies. If so, the market will always try to guess such action, and one can expect considerable volatility in the financial markets when such expectations are triggered. The surprise rate-cut impact has been manifested immediately in the form of lower interest rates, stronger currency and rising stock markets.
And at an ideological level, if we are going to pursue the policy of acting on an ‘as and when when required’ basis, then should we revert to the conventional bi-annual policy approach?