Wednesday, April 25, 2012

Regulated cost of capital for airports

Many elements of infrastructure have natural monopoly characteristics. Under these conditions, if the owner of the infrastructure is profit-maximising, he is likely to impose high user charges and extract a monopoly rent. As a consequence, in many infrastructure services in most countries, independent regulators are established which control the user charge.

The critical building block that goes into this is assessing the `fair' rate of return on equity capital. By and large, infrastructure projects have low betas; whether business cycle conditions are good or bad, they tend to generate stable cashflows. By this logic, the rate of return obtained by the developer should be relatively low.

India requires a trillion dollars of infrastructure investment in coming years. For this to come about properly, sound thinking on the appropriate rate of return is required. If this rate of return is set too low, then the required investments will not be forthcoming. If the rate of return is set too high, then developers will earn monopoly rents, and the economy will be hobbled with expensive infrastructure.

The regulated industry has strong incentive to lobby with the regulatory agency. Almost nobody else in the country has detailed technical knowledge about the activities within the regulated industry. This field is thus fraught with problems of governance, the capabilities of regulatory agencies, etc. High quality public discussion, and criticism of the activities of regulatory agencies, is thus critical to ensuring that the outcomes are sensible. Our puzzle in India is that of getting to an ecosystem comprised of well drafted laws that create independent regulators, high quality staff in regulators, high quality independent experts outside government, well educated journalists, freedom of press, etc.

In this setting, an important order has been released by the Airports Economic Regulatory Agency (AERA): tariff setting for the Delhi airport. This will be of great interest to people interested in the fields of infrastructure financing and corporate finance in India. In my knowledge, this is the first episode in the field of Indian infrastructure where high quality corporate finance knowledge has gone into tariff setting. The arguments and methods here will be relevant for other airports, and for other areas of infrastructure.

Monday, April 23, 2012

The genesis of India's 'basic structure' doctrine

by Pratik Datta.

India and Pakistan are slowly reintegrating their economies, through trade and investment. Will we stop at sterile commercial transactions, or can there be more to the engagement of the two countries? Most of us in India think of Pakistan as a country with serious governance problems; we think that India has little to learn from Pakistan. A careful reading of history will surprise most of us.

One of the most important developments in the history of the Indian Constitution was the rise of the `basic structure' doctrine, which limits the extent to which a powerful political configuration can amend the Constitution. What is not widely known is the intellectual links that led up to this. A judge of the Supreme Court of India created what was possibly the first constructive jurisprudential connection between India and Pakistan: he imported the concept of basic structure into Indian jurisprudence from a decision of the Supreme Court of Pakistan. This is not to say that the basic structure doctrine was not discussed before by myriad scholars and applied in other countries, but merely to celebrate an old acquaintance that not too many of us recall today.

The authors of the Constitution of India saw the necessity of having a mechanism for amending the Constitution: Art. 368 of the Indian Constitution. However, one question that has time and again caught the attention of the Indian Supreme Court is the extent of this amending power. For example, can Parliament amend the Constitution and make India an autocracy? If not, then is there any implied restrictions to the power of amendment? And if such restictions do exist, what is the scope of judicial review of an amendment passed by a super majority of the elected representatives of the country?

There appear to be three critical milestones in India's path to the basic structure doctrine.

Justice Mudholkar in the case of Sajjan Singh (AIR 1965 SC 845), for the first time (para 63) used the phrase `basic feature' of the Constitution to argue that there are certain features of the Constitution that cannot be amended by the Parliament through its amending powers under Art. 368 of the Constitution. This judgment was a seperate concurrent opinion and not the majority view of the Court. Justice Mudholkar drew upon the Pakistan Supreme Court's decision in Fazlul Quader Chowdhry v. Mohd Abdul Haque, 1963 PLC 486, which had used the basic structure doctrine already.

The phrase `basic structure' or `basic feature' of the Indian Constitution has arisen in some decisions before Mudholkar, J. pointed it out in 1964. For example, in re: Beruberi Union case (AIR 1960 SC 845) and State of West Bengal v. Union Of India (AIR 1963 SC 1241) used the phrase but in a much looser sense and not squarely in the context of implied limitations to the amending power under Art. 368. It is, then, fair to say that Justice Mudholkar was the first important introduction of this concept into Indian jurisprudence.

The decision of Sajjan Singh came up for reconsideration by the Supreme Court in IC Golak Nath's case (AIR 1967 SC 1643). Justice Wanchoo after opining in para 113 that `the power to amend includes the power to add any provision to the Constitution, to alter any provision and substitute any other provision in its place and to delete any provision', went on to discuss in para 115 if there are any implied limitations on the power of amendment under Art. 368. In this context he referred to the doctrine of basic structure as was highlighted for the first time in India in the separate opinion of Justice Mudholkar. However, Justice Wanchoo ultimately opined that no limitations can be and should be implied upon the power of amendment under Art. 368 but did not go into the question as to whether Art. 368 can be used to repeal the present constitution and come up with a completely new one. Justice Wanchoo was however speaking only for himself and two other judges amongst the 11 who were on the bench. Finally, 6 judges held that Fundamental Rights cannot be taken away by an amendment while 5 judges held that Fundamental Rights can be taken away by an amendment. However, the line of argument taken up by Mudholkar and Wanchoo, that there are implied restrictions to the power to amendment under Art. 368, was still a fringe argument.

This implied restriction or basic structure argument gained prominence for the first time in Kesavananda's judgment (AIR 1973 SC 1461) where a 13 judge bench of the Supreme Court deliberated on this issue. In spite of the length and complexity of the judgment, the one ratio that emerges out of it is that the amending power under the constitution cannot be used in a manner so as to interfere with the basic structure of the Indian constitution. Reference to Mudholkar's views in Sajjan Singh (which in turn was the view of the Supreme Court of Pakistan) was made in para 681.

It is in this context, we should recognise the immense contribution of the Supreme Court of Pakistan to the constitutional jurisprudence of India. And Justice Mudholkar needs to be credited for at least trying to make possibly the first jurisprudential connection between the two neighbours back in 1964.

Developments on implementation of the GST

by Viral Shah and Ajay Shah.

As with many other problems in Indian economic reform, getting to the right destination on the GST requires winning on policy, politics and administration. On the policy side, the basic design of the GST needs to be done right. Pulling this off will require great political skill - a coalition of beneficiaries from the GST will need to champion it in the Indian federal setting. Finally, assuming that the policy and the politics has been done well, it will require the right plumbing. In this blog post, we review progress on this third element.

Done right, the GST ought to replace all existing indirect taxes. This would remove barriers to inter-state commerce, and create an Indian common market. It should treat all goods and all services identically. It should be a single administrative system covering tax payments to both Centre and States thus eliminating the compliance cost that is associated with dealing with multiple tax authorities. It should be globalisation-compatible: goods and services sold to non-residents would be fully refunded the entire burden of indirect taxation that has been incurred at all stages of production. India would then follow the principle of not taxing non-residents. This would be fair for domestic producers who face foreign competition, and ensure competitiveness of domestic producers selling abroad.

These are powerful and important economic concepts. However, their translation into reality is critically about execution. In the case of the GST, as with the New Pension System, the problem of execution is substantially (though not entirely) a question about building large IT systems.

While much of the legal and policy framework around GST is still being worked on by the Central Government in consultation with States, some progress has been made on setting up the infrastructure for processing registration, returns, and payments in a standardised manner. A detailed note on the IT infrastructure for GST has been put up by the Ministry of Finance.

In terms of organisation structure, existing success stories include the Tax Information Network (TIN) and the New Pension System, both of which are being managed by NSDL. A more general concept of `National Information Utilities' (NIU) was proposed by the TAGUP Report. This report drew on the success of establishing market infrastructure institutions such as NSE and NSDL, and recommended that NIUs be such non-Government companies, with Central and State Governments as joint shareholders, dispersed shareholding among other institutions, avoiding shareholders that may have a conflict of interest, and avoiding listing on exchanges. In spirit, NIUs must have the efficiency of a private corporations, but be animated by a public purpose.

In the Budget Speech of 2012-13, the Finance Minister announced that a NIU for implementing the GST would be constructed. It would be called GSTN and would be fully operational by August 2012. The first steps towards constructing GSTN have now been taken, with a Cabinet approval for GSTN. The official press release on this says:

The Cabinet has approved a proposal to set up a Special Purpose Vehicle (SPV) namely Goods and Services Tax Network SPV (GSTN SPV) to create enabling environment for smooth introduction of Goods and Services Tax (GST). GSTN SPV will provide IT infrastructure and services to various stakeholders including the Centre and the States. 
The GSTN SPV would be incorporated as a Section 25 (not-for-profit), non-Government, private limited company in which the Government will retain strategic control. It would have an equity capital of Rs. 10 crore, with the Centre and States having equal stakes of 24.5% each. Non Government institutions would hold 51% equity. No single institution would hold more that 10% equity, with the possibility of one private institution holding a maximum of 21% equity. 
GTSN SPV would have a self-sustaining revenue model, based on levy of user charges on tax payers and tax authorities availing its services. While the SPV's services would be critical to actual rollout of GST at a future date, it is also expected to render valuable services to the Centre / State tax administrations prior to the GST implementation.

Saturday, April 21, 2012

Welfare programs change behaviour

Many people like to envision worlds where the State will tax the rich and help "the needy" - this ranges from free health care to unemployment insurance to disability insurance, etc.

There are many problems with these schemes. One of them is the fact that people respond to incentives. We are not bricks, we are not stones, but men, and being men, we will optimise. When unemployment insurance is offered, people will try less hard to find a job, to acquire skills that will get them a job, to migrate to a place where jobs are more easily found, etc. When health care is free, people are more inclined to be fat or smoke or otherwise take less care of themselves. And so on.

Among economists, it's considered obvious that people drive in a more rash manner when wearing a seat belt, but in the wider discourse, this raises hackles. When researchers found that drivers pass closer when overtaking cyclists wearing helmets as compared with overtaking bare-headed cyclists, economists were among the few who were not surprised. Laypersons generally recoil from the idea that the presence of a government giving out free open heart surgery increases obesity.

The first element of the behavioural change is lying and misrepresentation by citizens. When a government says it will give out disability insurance, people have an incentive to go to a civil servant and claim that they are disabled. I remember hearing a story from Holland, when a certain set of rules were constructed to give an early pension to the disabled, and policy makers had estimated that 1% of workers would be eligible for those benefits. In a few years, 10% of workers tried to claim these benefits, and front-line civil servants were placed in the difficult situation of having to identify the few genuinely disabled within the large pool that was claiming to be disabled.

The second layer is genuine changes in behaviour. Ljungqvist/Sargent have emphasised the damage caused by European-style welfare programs, which encourage or support withdrawal from the labour market. Some of these problems are now coming about with NREG. Migration out of villages is central to India's future, but NREG is reducing the incentives of people to engage with the urban labour market and ultimately to leave.

I just came across an example of behaviour distorted by incentives that veers on the fantastical: An unemployed Austrian man sawed his foot off, to avoid being found fit enough to go back to work. We find it incredible that Aron Lee Ralson cut off his right arm (to avoid certain death). But sawing your foot off to avoid going back to work?

This is a colourful story and only an anecdote. The man is most likely a nutcase. It is nobody's case that such extreme responses will come about on a large scale. The claim of the microeconomics literature is more limited: that on average, fairly significant behavioural changes come about in response to changes in the rules of the game. Through this, welfare programs have unintentional consequences that go far beyond those visible at the surface.

Politicians and bureaucrats in India like to roll out out more welfare progarms. It would be useful to bring alternative perspectives on these questions, which are mainstream worldwide but are considered cutting edge in India: about the limited governance capacity of the State, about the fiscal crisis that the State faces, and about the behavioural changes induced by welfare programs. In this field, you may like to see a paper by Vijay Kelkar and me.

Thursday, April 19, 2012

Thursday, April 12, 2012

The inflation crisis has not ended



The most important measure of inflation in India is the year-on-year change of the CPI-IW index. This time series, for 120 months, is shown above. From 2006 onwards, India slipped into a new phase of macroeconomic instability, where inflation has strayed far outside the informal target zone of inflation at four-to-five per cent.

Has inflation subsided?


In recent months, there has been a surge of optimism that the inflation crisis is coming to an end. However, a careful look at the seasonally adjusted data reveals that there is cause for concern.



MonthP-o-p SAY-o-y
Sep 2011 17.49 10.06
Oct 2011 2.01 9.39
Nov 2011 3.11 9.34
Dec 2011 -2.14 6.49
Jan 2012 8.22 5.32
Feb 2012 12.01 7.57


In September 2011, point-on-point seasonally adjusted (annualised) inflation was at 17.49 per cent. The year-on-year inflation was running at 10.06%.

We then had three good months: October, November and December, where the point-on-point seasonally adjusted (annualised) inflation dropped to 2.01, 3.11 and -2.14 per cent. This yielded a sharp decline in the year-on-year inflation to 6.49 per cent in December 2011 and further to 5.32 per cent in January 2012.

But after that, things haven't gone well. Point-on-point seasonally adjusted inflation, which is the thing to watch for in understanding what is happening every month, is back up to 8.22 per cent in January 2012 and 12.01 per cent in February 2012. Year-on-year inflation is back up to 7.57 per cent in February 2012.

A casual examination of the key graph (shown above) shows that the worst of double digit inflation seems to have ended. But we are not inside the target zone of 4 to 5 per cent, and neither are we likely to achieve this in the rest of this year. It would be unwise to declare victory over the inflation crisis, with this information set in hand.

Looking forward


Looking forward, there are two main problems worth worrying about. The first is the expectations of households. At the heart of India's inflation spiral is the problem that the man in the street has lost confidence that inflation will stay in the four-to-five per cent target zone. Survey evidence about household expectations has shown double digit values. This generates persistence of inflation; idiosyncratic shocks tend to not quickly die away. The mistrust of households is rooted in the lack of commitment to low and stable inflation at RBI, and this problem is not going to go away quickly. Despite all the problems faced in fighting inflation, RBI continues to communicate, through speeches and official documents, its lack of focus upon inflation.

The second problem is that of the exchange rate. Exchange rate depreciation feeds into tradeables inflation. With a large current account deficit, with policy impediments putting a cloud on capital inflows, rupee depreciation has taken place and may continue to take place. This would be inflationary. Indeed, if RBI chooses to cut rates on the 17th, there will be further weakening of the rupee (since the interest rate differential will go down thus deterring debt flows), which will further exacerbate tradeables inflation.

The media and financial commentators treat it as a given that on 17th, RBI will cut rates. However, the outlook on inflation is worrisome. India's inflation crisis, which began in 2006, has not ended. Year-on-year CPI-IW inflation has not yet got into the target zone of four-to-five per cent, nor is this likely to happen anytime soon.

Our thinking on this needs to factor in the general elections, which are looming at the horizon in May 2014. Given the salience of inflation in India for the poor, the ruling UPA coalition is likely to be quite concerned about getting inflation back to the informal target zone of four-to-five per cent, well ahead of elections. This also suggests that the time for hawkish monetary policy is now, so as to get inflation under control by mid-2013, well in time for elections in mid-2014.

A historical perspective


Inflation went out of control in 2006/2007 because RBI's pursuit of the exchange rate peg required very low interest rates at a time when the domestic economy was booming. (The capital controls that were then prevalent failed to deliver monetary policy autonomy; the only way to get towards exchange rate goals was through distortions of monetary policy). Given the lack of anchoring of household expectations, that inflation crisis has not yet gone away. Today, RBI is substantially finished with exchange rate pegging; we are mostly a floating exchange rate. In the future, inflationary expectations will not get unhinged owing to a pursuit of exchange rate policy by RBI. But while a pegged exchange rate pins down monetary policy, a floating exchange rate does not define monetary policy. RBI has yet to articulate what it wants to do with the lever of monetary policy. The first task for the lever of monetary policy should be the conquest of the inflation that is in our midst, owing to the monetary policy stance of 2006/2007.

In the early 1990s, unsterilised intervention in the pursuit of Rs.31.37 a dollar gave an inappropriate stance of monetary policy, which kicked off an inflation. Dr. Rangarajan wrestled it to the ground, even though the monetary policy transmission was weak then. In 2006, we ignited another inflation, once again owing to exceedingly low policy rates in the pursuit of exchange rate policy. Dr. Subbarao's challenge lies in wrestling this to the ground. His job is easier when compared with what Dr. Rangarajan faced, thanks to the progress which has taken place on financial reforms and capital account decontrol.

Wednesday, April 11, 2012

New insights into the events on the Indian stock market in the mid-1990s

by Ajay Shah. 

Liquidity matters


One of the most important features of a financial market is liquidity. In a well functioning market, a trader faces low costs of transacting and can confidently expect that at future dates, across many states of nature, the cost of transacting will prove to be low.

The immediate impact of a low cost of transacting is that it imposes a lower `tax' upon the speculator, who brings new information into prices, and the arbitrageur, who removes obvious mistakes in prices. The long-term impacts that are obtained when the trader can confidently expect that transactions will be inexpensive are in two parts. When investors expect to waste money in buying and then selling a certain security, they demand higher rates of return from it: i.e., the cost of capital for the issuer goes up. And, when traders are confident that high liquidity will persist into the future into a diverse array of states of nature, they will more confidently embark upon dynamic trading strategies which are required for producing useful securities such as options.

Measurement of liquidity


In an electronic limit order book market, a static concept of liquidity is eminently visible: you look at the order book and work out what is the impact cost faced when doing transactions of a desired size. E.g. it is easy to take order book data from NSE and work out the impact cost seen for doing a transaction of Rs.10,000 for all companies.

Impact cost accurately measures the instantaneous cost faced when placing an order of the stated size. It is a observed precisely in a modern exchange setting. There are two weaknesses. No large order is going to be placed as one single market order into the order book. Hence, the analysis of the NSE order books does not guide us in understanding liquidity when doing large sized transactions, e.g. Rs.1,000,000. The moment we think of orders that are spaced over a short time (e.g. I break up an order for Rs.1 million into 100 orders of Rs.10,000 each) or over a long time (e.g. dynamic hedging of an option book) I have to worry about the fluctuations of impact cost, or my liquidity risk.

The biggest problem lies in the fact that in numerous market situations, order book information is not observed. Two key areas are: the deep past, before order book data existed, and the OTC market, where there is no order book. E.g. the CMIE daily returns data for BSE starts from 1/1/1990. NSE equity trading began in 11/1994. But NSE's order book snapshots (thrice a day) only exist from 4/1996 onwards. For the period prior to 1996, there is no data on liquidity.

The power of range


The first flush of the financial economics focused on returns. It was amazing, the amount of interesting work that could be done once you had assembled a dataset with daily returns. This was first done at the Centre for Research on Security Prices (CRSP) at the University of Chicago, and it made possible an entire generation of financial economics.

As an example, the ARCH model is a very clever way to utilise pure returns information and construct a time-varying notion of volatility. Models of the ARCH family assumes that volatility is deterministic, and that it responds to realisations of returns.

A remarkably important fact looks beyond returns to the range between the day's high and the day's low price. When volatility is high, the range is higher. Range is a volatility proxy. This has been known for a while -- e.g. On the estimation of security price volatilities from historical data, M. B. Garman and M. J. Klass, page 67--78, Journal of Business, 1980.

In the late 1990s, people got back to looking at this in a new way. We understood that range is an enormously informative volatility proxy. There is much more information in the range of the day than is found in the squared returns of the day.

Another new volatility proxy is `realised volatility', where you difference intra-day returns to construct a time-series of returns within the day. As an example, in an 8-hour trading day, there are 480 minutes. So you could difference returns into 5-minute intervals, and you have 96 readings of returns on each day. The standard deviation of this is a good measure of the volatility of the day. As an example, the recent paper by Grover and Thomas, Journal of Futures Markets, August 2012, does performance evaluation for a VIX estimator by asking for better predictions of future realised volatility.

In the ARCH world, volatility of the day was not observed, and squared daily returns was a poor proxy for this. Realised volatility is a highly precise estimator of the volatility of the day, and range is also remarkably good.

Constructing a deep history of stock volatility


Using intra-day data, it is possible to construct a realised volatility for every security for every day. This is obviously infeasible for the period when intra-day data is not observed - e.g. in India before electronic trading came along, i.e. before November 1994.

But as long as the day's high and the day's low are observed, one can construct a range-based measure, and thus push deeper into history.

Constructing a deep history of stock liquidity


When trading is electronic, it is possible for the exchange to produce `snapshots' of the limit order book, as has been done by NSE from April 1996 onwards. Using these, it is easy to get precise estimates of the spread for all stocks. But what about the period before that?

I just read a fascinating paper: A Simple Way to Estimate Bid-Ask Spreads from Daily High and Low Prices by Shane A. Corwin and Paul Schultz, Journal of Finance, April 2012. Their key insight is that the day's high is almost always at the ask and the day's low is almost always at the bid. When the high/low is computed over two days, the variance is doubled but the spread component is intact. This generates a mechanism for extracting a spread estimator using only high-low data.

I liked the paper a lot. At its best, finance is close to data, the data has low measurement error, the work is careful and grounded in a detailed institutional understanding of reality, and the results open up new lines of inquiry.

Using these new ideas, it becomes possible to dig into history, using the CMIE data for BSE which goes back to 1/1/1990, and construct liquidity measures for that deep period.

The authors do precisely this:


They show a big and dramatic drop in the spread at the time when electronic trading came in. There are three key dates here: NSE started electronic trading on 3 November 1994, BSE started electronic trading on 14 March 1995 and in November 1995, NSE became the dominant exchange [link]. This is a valuable addition to our understanding of these events. I do worry about mistakes in measurement of the day's high and day's low, however, prior to the onset of electronic trading at NSE in November 1994.

I found it fascinating, how a 2012 paper has produced a better understanding of our history of the mid-1990s.

Understanding the badla episode


What is equally interesting, and what is not mentioned by the authors, is the dog that did not bark prior to the launch of NSE. This is the event where SEBI forced BSE to stop badla trading.

I had worked on this question at the time (in 1996). I had rigged up a matching scheme where each A group company (where badla trading used to take place) was matched against a partner from the B group (where there had never been badla trading). This allowed you to construct a hedged portfolio: long the A group companies and short the B group companies. The performance of this portfolio is:



This hedged portfolio has a most satisfying zero return in the days before SEBI's decision. This gives us confidence that the matching is done well. The two big dates of SEBI decisions -- 12 December 1993 and 12 March 1994 -- show big negative returns for A group companies. And from 4 November 1994, when trading at NSE began, we start seeing a recovery.

At the time, this was interpreted at the time as a liquidity premium. See Short-term traders and liquidity: A test using Bombay Stock Exchange data by Berkman and Eleswarapu, Journal of Financial Economics, 1998, who worked this out nicely.

But the new evidence for the deep history of spreads on the BSE, by Corwin and Schultz, suggests that there was no big change in liquidity in 1993 or 1994. This raises new questions about why such large price reactions were observed. I used to think this was a great liquidity premium story; now I'm not so sure. I'm pretty certain that A group companies had sharp negative returns in early 1994, but I am now less sure that we know why.

Tuesday, April 10, 2012

Path-breaking rules under the Right to Education Act, in Gujarat

by Parth Shah.

One major initiative of the Indian government, in the field of education, was the Right to Education Act of 2009. This act has major problems, as has been argued by numerous observers and experts in the field. This Act focuses on the interests of incumbent public sector education providers, instead of focusing on the interests of children and parents. It is focused on inputs into the educational process, regardless of the outcomes which are coming out. It penalises private schools that have weaknesses on inputs, regardless of the fact that these schools often induce better learning outcomes when compared with public schools.

At the same time, the translation of the Act into benign or malign outcomes critically hinges on the Rules under the Act, which are notified by State governments. Thus, now that Parliament has chosen to enact the RTE Act, the critical frontier that matters is how state governments choose.

In recent weeks, Gujarat notified its Rules for the implementation of the Right to Education Act (RTE) 2009. It has introduced some of the most innovative ideas for recognition of existing private unaided schools. The Committee in charge of drafting the Rules in Gujarat, that was headed by the former Chief Secretary Mr.Sudhir Mankad, has broken new ground in understanding the policy issues faced in education in India today.

Instead of focusing only on input requirements specified in the Act like classroom size, playground, and teacher-student ratio, the Gujarat RTE Rules put greater emphasis on learning outcomes of students in the recognition norms. Appendix 1 of the Gujarat Rules is the one which has a path breaking formulation for recognition of a school: this will be a weighted average of four measures:

Student learning outcomes (absolute levels): weight 30%
Using standardised tests, student learning levels focussing on learning (not just rote) will be measured through an independent assessment.
Student learning outcomes (improvement compared to the school's past performance): weight 40%
This component is introduced to ensure that schools do not show a better result in (1) simply by not admitting weak students. The effect of school performance looking good simply because of students coming from well-to-do backgrounds is also automatically addressed by this measure. Only in the first year, this measure will not be available and the weightage should be distributed among the other parameters.
Inputs (including facilities, teacher qualifications): weight 15%
Student non-academic outcomes (co-curricular and sports, personality and values) and parent feedback: weight 15%
Student outcomes in non-academic areas as well as feedback from a random sample of parents should be used to determine this parameter. Standardised survey tools giving weightage to cultural activities, sports, art should be developed. The parent feedback should cover a random sample of at least 20 parents across classes and be compiled.

This is one of the first times in India's history that public policy has focused on children and parents, instead of focusing on the public sector producers of education services.

Furthermore, the Gujarat RTE Rules have taken a more nuanced and flexible approach in other areas too. For instance, both class size and teacher-student ratio have not been defined in absolute terms, but in relative terms. The required classroom size is 300 sq feet but in case classrooms are smaller, then instead of re-building them, the Rules allow for a way to accommodate that with a different teacher-student ratio. The formula is: Teacher Student ratio = (Area of the classroom in sq feet-60)/8. This approach not only allows smaller classrooms to exist but also gives schools a more efficient way to manage physical infrastructure.

If a private school is unable to meet recognition norms, then the RTE Act de-recognises the school and forces it to close down. This sudden forced closure would create serious problems for the students and parents who would have to find a new school in the neighbourhood. The Gujarat Rules allow for the State to takeover the school, or transfer management to a third party, and create a genuine possibility for the school to continue and meet the norms. This, once again, shows the focus of the Gujarat Rules upon the interests of students and parents.

This approach is significantly better to that of the other states where recognition norms are based solely on input requirements and that are also rigid (like playground, classroom size and teacher-student ratio). The Gujarat approach recognises the substantial contribution made by budget private schools in urban and semi-urban areas where land and buildings are very expensive. Actually many government schools themselves would not be able to meet the rigid input norms that RTE has mandated.