## Monday, February 17, 2014

### Food inflation: macro and micro perspectives

On 25 February, we have a one-day meeting on this subject. All are welcome.

## Wednesday, February 12, 2014

### The Bombay police: A failure story

A few days ago, I woke up at 4 AM under an onslaught of the shouting of large beefy men instructing a crew, using megaphones, in a movie shoot in Film City. I thought to myself "this must violate some law".

For a while, I tried to be a free rider, thinking "Someone else will complain". But it was 4 AM and clearly nobody had complained. So I thought I should call the police and complain.

1. I used my (Airtel) cell phone and dialled "100". The cell phone said this was an imaginary number. I rotated the phone by 90 degrees but this also did not work.
2. I tried to dial "022-100" but this gave the same error.
3. Some websites said that 112 is an omnibus emergency number. I tried 112 and 022-112. Neither worked.
4. I broke into cold sweat thinking that in Bombay, I actually have no means to call the police in an emergency using my cell phone.
5. I hunted for other ways to reach the police. There is no rapid access mechanism using new technology: You cannot send in a complaint by email or IM. You can chat with an Amazon customer support person by IM or on email, but you can't do this with the Bombay police.
6. I started hunting for a phone number for the police on the web. There were large numbers of websites. It was not clear which to use.
7. If you google for "Mumbai police" and click on the first link -- http://www.mumbaipolice.org -- it takes you to a fashion store.
8. I hunted more on the web and got hold of a few numbers and started trying. The first two shooed me away.
9. The third one was willing to listen to me, but not in English. The only languages that he would speak were Hindi and Marathi. I happen to know some Hindi and some Marathi, but a large number of migrants to Bombay speak neither. It is not good to have government interface that does not grok the lingua franca of India.
10. He heard me and said "okay". He did not say "This is illegal and we will shut it down".
11. He did not give me a ticket number. He made no attempt to take my phone number or email address. Nobody contacted me in the end to tell me what was the disposition of my complaint. I had no idea what happened. The noise blared on.
And I understood why free riding did not work. Nobody had complained because there is no mechanism through which anyone can complain.

There is no public good as fundamental as the criminal justice system, and we in India are simply not trying hard enough.

## Tuesday, February 11, 2014

### Difficulties with Special Guidance and General Guidance in the IFC

by Anirudh Burman, Pratik Datta, Suyash Rai, Arjun Rajagopal, Shubho Roy.

Administrative and regulatory agencies in India currently use multiple legal instruments to regulate. This creates multiple problems for those regulated:

1. Identifying all applicable subordinate legislation;
2. Reconciling sometimes overlapping and inconsistent subordinate legislation; and
3. Distinguishing between binding and non-binding statements/regulations.

For example, a person investing through the FDI route has to reconcile the applicable FEMA regulations, FDI Press Notes and the Consolidated FDI Policy. All of these have been communicated via legal instruments, but there is uncertainty over which instrument is operative in any given situation. This increases compliance costs and legal uncertainty.

The draft Indian Financial Code (IFC) proposed by the Financial Sector Legislative Reforms Commission introduces a completely new way of thinking about regulatory governance in India. Perhaps the most critical component of this framework of regulatory governance is the proposal that regulators will regulate only through regulations''. The use of a single instrument to regulate (instead of the present plethora of circulars, orders, letters, instructions etc.) will ensure legal clarity for regulated entities and therefore facilitate a rule-of-law framework in financial regulation.

However, two provisions in the IFC have the potential to upset this carefully constructed framework. Section 56 (General Guidance) allows regulators to issue general guidances'' with respect to the operation of the IFC and regulations made under it, the operation and objectives of the regulator, and other matters on which the regulator wants to provide information or advice. Section 57 (Special Guidance) allows any person to ask for a special guidance'' with regard to transactions or activities governed by the IFC. The provision on special guidances is similar to the existing system of advance rulings under the Income Tax Act. It should be noted that a need for a system of advance rulings under the Income Tax Act exists because of the lack of clarity of our taxation regime. If the U.S. experience with such guidances is any indication, both these provisions have huge potential to dilute regulatory certainty.

### U.S. experience with guidances

The US Administrative Procedures Act contains uniform administrative procedures to be followed by all federal administrative agencies. Section 553 of the APA requires a public notice and comment procedure to be followed whenever an agency makes a rule''. However, this requirement does not apply when an agency issues interpretative rules, general statements of policy, or rules of agency organization, procedure, or practice''. This exception has been used by agencies to regulate through interpretative rules and policy statements. (For more reading on the subject, see: Anthony (1992); Recommendations of the Administrative Conference Regarding Administrative Practice and Procedure (1992); and Rakoff (2000)). As interpretative rules and statements of policy do not require a public notice and comment procedure to be followed, an agency finds it less costly to regulate through these instruments than to frame rules. As an example, the number of US Food and Drug Administration regulations adopted in accordance with the APA reduced 50 percent in mid-90s compared to early 1980's (Rakoff (2000)). Anthony (1992) and Rakoff (2000) point out that interpretative rules and statements of policy become de facto binding for the following reasons:

1. The staff of the agency starts relying on the interpretative rule or statement of policy in its work. This happens even though some agencies explicitly state that interpretative rules are not binding statements.
2. The language of the interpretative rule or statement of policy indicates that the agency will follow it.
3. The language of the interpretative rule or statement of policy indicates that it is of a binding nature, or will be regularly applied against regulated entities.

U.S. Courts have tried to counter this development by stating that: ...as a general rule, an agency can declare its understanding of what a statute requires without providing notice and comment, but an agency cannot go beyond the text of a statute and exercise its delegated powers without first providing adequate notice and comment. (Fertilizer Institute v. EPA F.2d 1303), Courts however, do not provide a good solution to this problem for two reasons:

1. Judgements are case-specific, and it is difficult to enunciate a broad principle that substantially whittles away agency discretion, and
2. In many instances, it is difficult to determine which exact parts of an interpretative statement or statement of policy are in effect, a disguised regulation, and those that are not.

One alternate method of ensuring some restraint on regulation through interpretative rules (and that also functions as a feedback loop) is that of petitions''. Section 551 of the APA defines a rule'' to include interpretative statements and statements of policy. Section 553 allows any person to petition for the issuance, amendment or repeal of a rule. This provision has been used to petition for changes to the interpretative rules. The US Supreme Court has held that agencies can deny a request made in a petition only on reasons grounded in statutory law.

### What should we change in the IFC?

The U.S. experience clearly shows the pitfalls of giving agencies powers to explain'' their objectives and operations. Granting agencies the power to issue communications without following a defined legal process opens the door to chaos in regulatory governance. It incentivizes over-regulation (as regulation without notice and comment is cheap) and leads to a breakdown of the rule of law. The power to request and grant special guidances only exacerbates this problem. It is therefore important that a regulator's power to issue guidances be restricted.

To achieve this, certain changes need to be made to the IFC.

### Remove Section 57 on special guidances

The U.S. experience with respect to general'' interpretative rules highlights how giving agencies an option to avoid regulation making in fact leads to regulatory chaos. This problem is only going to be exacerbated with a system of special guidances.

Every time a regulator issues a special guidance it interprets the law and applies it to the facts present in the application for guidance. This interpretation will, in many if not most cases, be taken as evidence of how a regulator applies the laws to specific facts. In a good rule of law system, any such interpretation should then be applicable generally to all regulated entities. The lack of general applicability creates legal inconsistency and reduces clarity. This is bad for any system of regulatory governance.

### Restrict the use and content of general guidances

The purpose of guidances is to aid regulators in explaining regulations to regulated entities and consumers. They should not become substitutes for regulation-making. In an ideal world, there would be no need for a guide to regulations as they would be self-explanatory. Guidances should therefore function as regulatory guides''.

At present, Section 56 of the IFC provides that general guidances can be used for the following purposes:

1. The operation of this Act and any regulations made under it;
2. Any matters relating to functions of the Financial Agency;
3. Meeting the objectives of the Financial Agency; or
4. Any other matter about which the Financial Agency finds it appropriate to provide

All of the above provisions leave scope for a regulator to legislate'' regulations through general guidances, in the same way as agencies in the U.S. have done. Unlike the practice mandated under the U.S. APA, financial regulators under the IFC will have to go through a notice-comment procedure even for general guidances. However, they do not have to prepare a cost-benefit analysis of the same. Therefore, regulation'' through guidances is still a less costly proposition than framing regulations. Moreover, guidances in India are likely to become binding in India in the same ways as interpretative rules and statements of policy in the U.S:

1. The staff of the regulator starts relying on the guidance and treats it as binding;
2. The language may indicate to regulated entities that the regulator will implement the guidance; and
3. The language indicates that it is of a binding nature, or will be regularly applied against regulated entities.

Guidances should therefore be used only as regulatory guides i.e. they should only aggregate and present existing regulations and publicly available orders of regulators for the benefit of regulated entities. For example, regulators may prepare a regulatory guide aggregating and summarizing all applicable regulations and approval/decision orders for say, a person who wishes to get an approval for starting a mutual fund business. For doing this, the following legal framework is proposed:

1. Guidances/regulatory guides should be published by regulators for the sole purpose of enhancing the readability of regulations to regulated entities or specific classes of regulated entities.
2. Guidances/regulatory guides may contain clearly distinguishable additional text only for the following purposes:
1. For introducing the subject of the guidance and the relevant regulations/orders; and
2. For connecting portions or extracts of orders to enhance the document's readability.
3. The guidance/regulatory guide should contain a clear disclaimer stating the following:
1. Any additional text contained in the guidance/regulatory guide does not constitute legal advice and is not binding on regulated entities.
2. The regulator will not rely on the additional text in the guidance/regulatory guide in dealing with regulated entities.

This will:

1. Prevent regulators from accidentally or deliberately adding binding'' content in guidances, and
2. Consequently create greater incentives for regulators to write high quality regulations that are clear and comprehensive.

It will also force regulators to think of how to develop world-class websites where different regulations, orders, and even relevant FSAT judgements can be presented to a user seamlessly. A good example of a financial regulator's website performing this function is the page on Regulations guidance and licensing'' of the Monetary Authority of Singapore (link).

### Create a system of review for disguised regulation'

There should be a review mechanism to prevent against regulators accidentally or deliberately adding binding content to guidances. In the U.S., courts have declared invalid interpretative rules that are legislative'' in nature and bind regulated entities. A similar power to review guidances should be given to the FSAT. The FSAT should be able to direct the regulator or directly redact portions of guidances if:

1. The communication is couched in mandatory language;
2. The communication indicates that the regulator will treat the communication as binding in its interaction with regulated persons;
3. The language of the communication strongly evidences a binding intent; or,
4. Regulated persons are led to believe that adverse consequences will follow in case the communication is not complied with.

### Create a framework for petitioning regulators for changes in regulations and guidances

In the U.S. petitions have served as an instrument to force agencies to review their rules, interpretative rules and policy statements. We envision a similar role for petitions under the IFC. Additionally, a framework for petitioning regulators can create a legitimate and transparent feedback mechanism through which regulated entities and consumers can talk to regulators. While in the U.S., courts review the denial of petitions, we envision a system of petitions that is softer in nature and focuses on ensuring a functioning communication mechanism between regulators, consumers and regulated entities.

Any person should be allowed to petition for the issuance, modification or repeal of a regulation or guidance. Regulators should allow for petitions to be submitted through their website and on paper. All petitions should be made available on the regulator's website, and the regulator should respond to every petition on its website in a time-bound manner. The regulator may agree to the request made in the petition, or deny it. However, the denial should be on limited, legally defined grounds:

1. The petition requires the regulator to do something it has no legal power to do;
2. The petition does not require the issuance, amendment or repeal of a regulation;
3. There is no way, in spite of reasonable efforts being made, to verify factual claims made in the petition that form the basis of the request to issue, amend or repeal a regulation;
4. The regulation to be amended or repealed, or the subject matter of a new regulation is under review before the FSAT or any other court; or
5. The regulator agrees with the substance of the petition, but does not have the resources to implement the petition. In case the regulator denies the petition on this ground, the regulator must state when it proposes to act on the petition.

### Quantity and quality of research on the Indian economy

I have watched the work of Jishnu Das and his co-authors on the geography of economics research with great interest. What is going on here? I have four conjectures.

#### The number of economists

A supply argument based on researchers: If there are more American researchers in the world, then they are likely to write more papers about US data as they take interest in the US. By this argument, we will get more research on India when the number of economists in India per million matches that of the US.

#### The raw material of data

Economics is an observational science where the vital raw material is data. A supply argument concerns datasets: In the India of old, there were no good quality datasets. NSSO and ASI have problems of low quality survey administration. The NFHS is well measured, but it's not panel data.

Only in the last 20 years have well administered panel datasets come along. These are the consequence of the maturation of the economy, through which firms and government agencies are capturing more information, mandating disclosure, etc. This includes CMIE data about firms (now widely used) and households (example), the NSE data (example), the NSDL data (used by Tarun Ramadorai), the home loans data (used by Tarun Ramadorai), the KGFS data (used by Renuka Sane and Susan Thomas), etc.

I may conjecture that until a country hits middle income, it is stuck with datasets like NSSO or ASI, which hold back the emergence of good quality economics. From this point of view, the outlook for research on India is very good. Vast amounts of high quality data is now being produced by the private and public sectors, and this is increasingly getting to researchers.

#### What the American journals find interesting

The third aspect is the selection process operated by editors. The papers which are addressing an interesting question in the eyes of an editor in the US are very different from the papers that are interesting questions as seen here. For research on India to get published in the US, it has to be interesting in the context of the conversation that is taking place among editors and their colleagues in the US.

For an analogy, we who live in India know that many NRIs lack common sense on India. Their sense of what looms large and what is trivial is often out of place. When the journals are based on editors and referees who have a low connection to India, their notions of what's an interesting question are frequently odd.

Jishnu and Quy-Toan say that in 20 years, the top five economics journals published 39 papers on India. I am always on the lookout for knowledge and insight into India, and I don't think these 39 papers have contributed much to my understanding. Editors and referees also don't catch many blunders on datasets and data handling when it comes to India, which further reduces the value of these papers.

#### First order versus second order work

The fourth aspect is the distinction between first order and second order work. Datasets in the US like the NLSY (say) are well established and very well studied. Barring outstanding breakthroughs of creative work, most of the first order work using this dataset has been done. The average researcher is doing incremental stuff, and the average editor and referee is used to plodding along with incremental stuff. Diminishing returns have set in, and they're polishing the apple.

In contrast, all the datasets about India, mentioned above, are only now coming into the hands of researchers. There are opportunities for doing the first order stuff where the space is being mapped out for the first time. We are Johannes Kepler with Tycho Brahe's dataset, and we should think like that. At the same time, projects that are imbued with ambition and curiosity generally run afoul of the selection process operated by editors in the US, who are more comfortable with with Kepler fitting epicycles. All too often, I see researchers defining their projects through the question what do I have to do to get past the editors and referees'. Very often, these filters are burned so deep inside the skull that the victims have stopped noticing them. When the editors and referees are not interested in India and lack intuition in it, this strategy is going to yield papers that don't illuminate.

#### Conclusion

There are two ways of doing research connected with India. The first is to look at our backyard, understand what are the interesting questions, and go after them. The second is to look at the top journals, and think of what one could give the editors that happens to exploit an identification opportunity found in the Indian data. Many papers that do the latter have a superficial engagement with the data and suffer from blunders in implementation that aren't visible to the top journal editors and referees. Even when well executed, I find myself unexcited about many such papers.

The incentives of the profession are strongly wired towards publishing in the top journals. Very few people have the ambition and curiosity to care more about the phenomena of interest and less about the editors and referees. This generates systematic under-performance by the economics profession, even though a major constraint (datasets) is now being eased.

## Wednesday, February 05, 2014

### The strategy for systemic risk regulation in India

In recent years, there has been a debate about systemic risk regulation in India. One point of view on this subject was that of Dr. Subbarao, the previous governor of the RBI.

As responses to this, see: a point-wise response by Sowmya Rao and a newspaper column by K. P. Krishnan.

A fully articulated strategy on systemic risk is embedded in the draft Indian Financial Code, which was done by the Financial Sector Legislative Reforms Commission. I have written a guide to the elements of this law. It is also useful to look at Chapter 9 of volume 1 of the report.

We now have two developments on these questions:

1. The objective of RBI is gradually getting clarified in favour of price stability. This reduces the fog that surrounded RBI. RBI's hope of pursuing financial stability as an objective was partly about avoiding accountability; when you have many objectives, you're accountable for none. Clarity of objectives will improve clarity of thought.
2. The strategy for systemic risk regulation is articulated nicely in a recent speech by P. Chidambaram at a conference in Delhi organised by CAFRAL, the new think tank setup by RBI.

This blog post, then, adds up to everything you might want to read on the subject of policy analysis of systemic risk regulation in India, as of date.