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Thursday, October 26, 2006

Estimating the liability of state governments

A new RBI committee report on liabilities of State governments is now on the RBI web site. It has some interesting new material. But they seem to have missed out on some pieces of literature survey. E.g. the committee does not seem to know about Bhardwaj & Dave, 2005, the best work so far on estimating the liabilities on account of pensions.

While I'm on this subject, I'd like to draw your attention to a summary table of the liabilities of the US government done by the GAO. It's a great table - I would be thrilled when we are able to do such a table for India - I wonder what is the agency in India which can become such a GAO? It's interesting to see that they fold their liabilities on account of civil servants health and pensions into the early part of the table. On a related note, there's a great article in The Washington Post by Matt Crenson titled GAO Chief Warns Economic Disaster Looms.

In the Indian case, in estimating the liabilities of the State, we'd have to add in the liabilities on account of the implicit put option that the State has out on all public sector finance companies. Susan Thomas and I did some measurement work on this question in 2000, with a paper titled Systemic fragility in Indian banking: Harnessing information from the equity market. In the following years, the idea of using this option theory approach has become much more mainstream (e.g. papers by Luc Laeven etc). In the years that followed, the moneyness of the put worked out fine, but that does not change our measurement of the contingent liability faced by the Indian State circa 2000. There is a new NBER paper by Gray, Merton and Bodie on a related theme.

Sometimes, it is felt that in the case of US-64, the political process reached a roughly 50-50 allocation of the pain, between citizens and taxpayers. Does this bode well for the future? I don't believe so. In the case of US-64, there was no legal liability on the hands of the government - even if UTI claimed the units were worth Rs.14 while they were really worth Rs.6, there was no legal obligation upon GOI to pay customers anything. In contrast, when it came to the assured return schemes, there was no space for GOI to dodge any of the liability that UTI had written down in black and white. In similar fashion, there is no space for GOI to avoid the liabilities of PSU banks and insurance companies. So in short, the fact that GOI did not go up to Rs.14 for US-64 does not change anything in terms of the contingent liability that GOI faces owing to other public sector finance companies.


  1. "...the political process reached a roughly 50-50 allocation of the pain, between citizens and taxpayers."

    That's a funny statement. But it says a lot about how the politics of Indian economy work.

  2. Ideally CAG would be poised to take on the functons of GAO, but only ideally speaking!

  3. Yes, a CAG on steroids would become the GAO. But from what little I know about the two agencies, there is a big gap between the two right now.

    The 50-50 pain sharing is a fair description of what happened on US-64. I personally think this outcome was quite a bit better than what would have come out of the ordinary pessimistic portrayal of the Indian State.


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