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Saturday, March 28, 2015

Opportunities in analytical and policy-oriented economics

Analytical research

At the Macro/Finance Group in NIPFP, we have an active research program with a flow of papers, conferences, etc. There are exciting opportunities here for people with a Ph.D. (economics, finance, statistics) or Masters (economics, finance or statistics). The key skills are macroeconomics and finance, modern quasi-experimental and time-series econometrics, working with large datasets and complex empirical research. We are at the frontiers of computation, and write and release R packages. The persons who fit these roles are those who want to get absorbed in doing research about how the world works, or learn how to do such research.

Public policy `think tank'

In our `think tank' role, we analyse the problems of existing policy frameworks and propose alternatives. This is multi-disciplinary work with a mix of economics, law, finance and public administration. As an example, we were the technical team which supported FSLRC. If this kind of work excites you, and you possess some of these skills, please get in touch. We welcome economists and lawyers, and also welcome persons from the field of public administration, including mid-career civil servants.

Public policy `do tank'

Our `do tank' role is about building high performance agencies in government. As an example, we are the technical team which supports the four task forces which have been setup by the Ministry of Finance. This is about setting up organisation structure, process manuals, IT systems, and checks and balances, through which world class organisations are built. This is a rare set of opportunities to grapple with the challenges of creating excellence in government. Here, we welcome economists, lawyers, and persons from the field of public administration, including mid-career civil servants. We also welcome persons with a private sector background in constructing high performance organisations, including skills in process engineering, consulting, and private equity.

The workplace

The Macro/Finance Group at NIPFP is a exciting workplace. You will be surrounded by high IQ people, and little politics, bureaucracy, hierarchy or paperwork. The team is driven by intellectualism and a public service culture.

How to apply

Please get in touch with Anurodh Sharma,   , by 15 April 2015 with a resume and a covering letter explaining how you fit into the Macro/Finance Group at NIPFP.

Thursday, March 26, 2015

The issue of authenticity in Indian economics

Aatish Taseer wrote in the New York Times:

In my own world — the world of English writing and publishing in India — the language has wrought neuroses of its own. India, over the past three decades, has produced many excellent writers in English, such as Salman Rushdie, Vikram Seth, Amitav Ghosh and Arundhati Roy. The problem is that none of these writers can credit India alone for their success; they all came to India via the West, via its publishing deals and prizes.


This meant that it was not really possible for writers like myself to pursue a serious career in an Indian language. We were forced instead to make a roundabout journey back to India. We could write about our country, but we always had to keep an eye out for what worked in the West. It is a shameful experience; it produces feelings of irrelevance and inauthenticity. V. S. Naipaul called it “the riddle of the two civilizations.” He felt it stood in the way of “identity and strength and intellectual growth.”

I feel similarly about Economics in India.

Economics in India ought to be about looking at our backyard, understanding what is going on, and getting involved in fixing things. But, to paraphrase Taseer: We can write about our country, but we always have to keep an eye out for what worked in the West. It is a shameful experience; it produces feelings of irrelevance and inauthenticity.

There is no problem of authenticity in (say) physics. A physics paper is a physics paper and it does not matter who you are and where you are. But as Werner Heisenberg said, every electron is the same but every love is different. There was a time, in Economics, when the datasets were few and far between. Economists then analysed imaginary worlds through theoretical models. At that time, the questions that academic economists talked about, the world over, were similar. Now, things have changed. There are thousands of datasets all over the world. Economics today is about diving into these datasets, and the reality that surrounds them, and figuring out what's going on. And each of these datasets is a world of its own. The intellectual imperialism of Economics, where a person in one corner of the world could pretend to know about all parts of the world, has subsided.

In the peer review process, research is judged on two counts: "Is the question interesting?" and "Is the answer persuasive?". On both questions, authenticity is a key problem.

What is an interesting and important question in the Western discourse is very different from what is an interesting and important question here in India. Economists in India, who work on India, have to struggle to distort their work, to package it in a way that it fits the interests of editors and referees outside India.

On the issue of persuasiveness, all too often, editors and referees outside India do not know enough (about institutional arrangements and data) to judge the quality of a research design. This creates incentives to do shabby work and get by.

In this world, a paper on India in the American Economic Review is generally not useful for those of us who want to understand India.

The use of international journal publications in the academic HR process creates severe incentives for economists in India to ignore India and figure out how to succeed when judged in the eyes of editors and referees who do not know India. We should organise ourselves to do research in physics very differently from the way in which we do other fields. 

On this theme, see a previous blog post. There is an interesting discussion on Quora about blogs vs. academic journals which is a bit related.

Wednesday, March 25, 2015

Improving warehousing in India through a grading mechanism

by Smriti Sharma.

A key sub-industry in modern agriculture is warehousing. Storage reduces price fluctuations. Trusted storage permits `dematerialisation', where warehouse receipts are traded or delivered, and is the key link between physical goods and finance. At present, the quantity and quality of warehouses in India are inadequate. This is a key bridge that has to be crossed for the modernisation of agriculture. Trusted mechanisms for warehousing of non-agricultural goods are also an important enabler of the market economy.

Warehouses claim to take in goods and keep them safe. The customer of a warehouse does not know the probability with which the promise will be violated. There are a diverse array of warehouses in India, but customers do not know the failure rate of alternative warehouses. Currently, consumers do not have information to differentiate between one warehouse and the other. Most people make a choice with regard to a warehouse on the basis of word of mouth and local reputation. Sellers of warehousing service withhold privileged information about their warehousing service from the buyers. This leads to a situation of information asymmetry.

Information asymmetry is one of the classic market failures. Market economies seek to establish State capacity that efficiently addresses market failures. As an example, customers of a restaurant do not know whether the kitchen is clean, and this calls for the State to undertake certain interventions which address this problem.

Absent government involvement, users of warehousing services have devised their own solutions to address this problem. National Commodities Derivatives Exchange (NCDEX) operates a remarkable closed-user-group (CUG) that attempts to solve the problem of information asymmetry by creating its own inspection, audit and monitoring mechanism to ensure sanctity of the physical settlement of commodities traded on its exchange. Alongside this, many collateral management companies have come up which offer turn-key services of protection to users.

As is well known in public economics, when faced with market failures, such private solutions are not as nice as having a well structured and efficiently implemented government-based solution.

Grading of warehouses

Warehousing Development Regulatory Authority (WDRA) is mandated by the Warehousing (Development and Regulation) Act, 2007 to regulate warehouses that issue negotiable warehousing receipts (NWRs). Currently, WDRA registered warehouses go through a process of accreditation. This process verifies whether entities who apply to register with WDRA comply with certain registration requirements. This intervention is inadequate in that it does not create a mechanism for watching the performance of a warehouse on an ongoing basis. In and of itself, the WDRA registration has generated limited trust on the part of market participants.

A better intervention, which can be introduced by WDRA, is a mechanism for grading of warehouses, WDRA can provide more granular and complex information pertaining to warehouses and WSPs. This would require establishment of processes through which grades are awarded.

Experiences with grading in related fields

Is grading the right intervention for this market failure? Some analogies may be instructive:

  • Credit rating agencies assign grades to bonds.
  • In the real estate sector, grading helps by providing the real estate developers with the incentives to conform to fair trade practices and legal requirements.
  • The New York Health Department made it mandatory for the restaurants in its five boroughs to get themselves graded for their sanitary scores. The grades summarising the sanitary scores are then made public. Within 18 months of starting the grading programme, the share of restaurants without a trained food protection supervisor decreased from 13% to 7%. Prior to grading, 11% of the restaurants had inadequate hand washing facilities, which reduced to 5%. Also, a 10% drop was registered in restaurants that had signs of mice infestation.
These areas -- bonds, real estate, restaurants -- have the same market failure as that found in warehouses, i.e. information asymmetry.

Grading warehouses and warehouse service providers

Warehousing is an amalgam of warehousing infrastructure including warehousing premises, equipment and manpower which is used to deliver a service. For purposes of grading warehouses, warehouses need to be compared to each other, and against some benchmarks that the market may find useful.

A variety of public and private agencies internationally have formulated broad parameters, on the basis of which warehouses are classified and graded. For example, in Tanzania, warehouses are scored on parameters specified by Warehouse Receipts Regulations, 2006 and then graded accordingly. In UK, United Kingdom Warehousing Association issues an advisory for its members that lists broad headings like these, against which standards are set for warehouses.
Real estate consultants like Knight Frank also have their own list of parameters for warehouses. The parameters devised by each of these agencies are customised for the needs of their clientele. There is no single check-list against which WDRA can require warehouses to be graded.

A grade can capture information on the physical attributes of the warehouse (e.g. warehouse building and warehouse site), management of the warehouse (e.g. ownership, technical and managerial staff) and the warehousing processes and activities (e.g. storage and handling of goods, fire security, pest control, use of technology and book-keeping).

There is no fixed recipe for grading. WDRA must allow expertise present in the market to innovate in designing better grading mechanisms, and for grading agencies to discover what information is relevant for the warehousing market. For an analogy, financial regulators have pushed the bond market towards the use of credit rating agencies, while not micro-managing how credit rating agencies analyse a bond.

Re-imagining the role of accreditation agencies of WDRA

Provisions in the WDR Act allow WDRA to facilitate grading of warehouses by specialised agencies. It would be useful for WDRA to develop such an environment for the warehousing industry.
Rolling this out also presents complexities, which will need to be addressed:

  1. Financial regulation in India has encouraged a mindless notion on the part of investors, where the credit rating agency is the only determining factor about whether a bond can be the target for investment or not. A more subtle environment needs to be created, without black-and-white notions. As an example, a steady stream of information emanating from a warehouse, about failures in settlement, is valuable for users without being a black-and-white grade.
  2. The business of grading is frought with conflicts of interest. The "issuer-pays" model disincentivises grading agencies to be critical of their clients and award unfavourable ratings. The global experience with rating of bonds has exhibited such problems.
  3. The tools of coercion by the State can be applied at various levels, such as forcing warehouses to get graded, or forcing warehouses to always disclose what grade they got, etc. Careful analysis is required to use the minimal coercive power while maximally addressing the market failure.


There is a market failure -- asymmetric information -- in the field of warehousing, which justifies government intervention. The intervention presently used at WDRA -- requirements applied at registration -- are not addressing the problem. The WDRA Act contains provisions which could be used to bring about a mechanism for grading warehouses. Done right, this could reduce the information asymmetry.

Sunday, March 22, 2015

What is interesting in Budget 2015: the package of fiscal, financial and monetary institution building

After the dust has settled, the interesting feature of Budget 2015 is the package of fiscal, financial and monetary institution building:

  1. The signing of the Monetary Policy Framework Agreement, through which RBI now has an objective: That of delivering year-on-year CPI inflation of between two and six per cent.
  2. The establishment of a statutory Public Debt Management Agency.
  3. Shifting of the government bond market regulation from RBI to SEBI.

There are other elements of institution building which are relatively disconnected from this triad. E.g. the merger of FMC into SEBI is also a step towards shifting all organised financial trading into SEBI
regulation, but it is not interconnected with the above three.

The three big reforms are interconnected; they require each other; they strengthen each other. This is why all three elements figure in all the expert committee reports.

The interconnections

Inter-relationships between the three elements of Budget 2015

When RBI is given the responsibility of achieving low and stable inflation, this is a difficult problem for two reasons.

At present, RBI has a conflict of interest: of doing investment banking for the government. This conflict of interest is removed by setting up PDMA. This is also a good thing for bond buyers as it's safer buying bonds from a person who does not know what the next interest rate decision will be.

In addition, when RBI changes the policy rate, there is a low bang for the buck as the monetary policy transmission is weak. Low competition in banking implies that rate cuts by RBI do not propagate out into the economy. The weaknesses of the bond market mean that rate cuts by RBI do not propagate out into the economy. This makes RBI ineffective: very big rate hikes or rate hikes are required (e.g. as was done by Rangarajan in the 1990s) to stabilise inflation. Bond market reforms are required for RBI to get the tools for the task at hand.

When the PDMA tries to sell government bonds, it requires a liquid bond market. Bond market reforms are required for PDMA to get the tools for the task at hand.

Bond market reforms feed into the PDMA reform (by giving PDMA the tools for the job) and the Monetary Policy Framework Agreement (by giving RBI the tools for the job). In addition, bond market reforms improves the working of the corporate and infrastructure bond market, thus improving the investment climate for infrastructure investment and private corporate investment.

For many years, each of these components was recommended by expert committees, got discussed in the run up to each budget, and not undertaken. This is partly because each of these components, if viewed in isolation, is more difficult. Budget 2015 was able to break the gridlock by doing all three in unison. The whole is greater than the sum of the parts.

There are two more respects in which this package of reforms yields gains to the economy. When RBI was doing the investment banking for government, and also controlled banking regulation, they had an incentive to get their work done without undertaking much effort, by forcing banks to buy government bonds. Once the investment banking work shifts to PDMA, we may hope that RBI will reduce the Statutory Liquidity Ratio, and thus free up greater space for banks to lend to private enterprise. This will largely benefit small and medium enterprises as this is the segment which is most dependent upon bank borrowing.

The second dimension concerns the corporate and infrastructure bond market. This market critically relies on the yield curve, that is discovered on the government bond market, and on hedging using interest rate derivatives which trade on the interest rates on the government bond market. The development of the government bond market will increase the viability of corporate and infrastructure bond markets. These gains will largely accrue to large firms, as this is the segment which dominates the corporate and infrastructure bond markets.

All this will play out slowly. Inflation targeting, the setting up of the PDMA, the improvements for the bond market, and the playing out of the downstream consequences: all these will take place over years. This is slow, important work. Once begun, it will take many years to play out.

The reform is incomplete in two respects. When, in the future, the full Bond-Currency-Derivatives Nexus is moved from RBI to SEBI, the effectiveness of monetary policy will be further enhanced, and RBI will become a full fledged central bank by world standards. When, in the future, the policy rate at RBI is set using a Monetary Policy Committee, this will improve upon the decisions of one person.

Addressing the confusion

MoF has done a poor job of explaining what has been done and why, which has given a lot of media misinformation. Here are some questions which have swirled in the discourse.

q: Does this mean that SEBI will set the repo and reverse repo rate?
a: No, RBI will set the repo and reverse repo rate.

q: Does this mean that SEBI will control or regulate the market infrastructure through which RBI undertakes repo or reverse repo transactions, which are essential to the conduct of monetary policy?
a: SC(R)A does not apply for RBI. RBI will design, build and operate the infrastructure through which RBI will do repo or reverse repo transactions in the conduct of monetary policy. SEBI will not have any say or power over these arrangements.

q: Does this mean that SEBI is now the regulator of the money market?
a: This means that SEBI is now the regulator of all government securities. This is true regardless of their maturity. Government securities with less than one year maturity would, previously, have been termed ``money market instruments''. RBI will continue to run its own repo / reverse repo operations in the course of doing monetary policy. RBI will continue to regulate the call money market.

q: What will happen when two private parties enter into a repo transaction?
a: That transaction will be regulated by SEBI as it is a securities lending transaction. SEBI will be the regulator of all aspects of the government securities market, which includes the activity of lending government securities.

q: Why is SEBI the right regulator for government bonds?
  • All securities are alike. Whether a piece of paper is a share or a bond, it is a security.
  • Hence, there are economies of scope and economies of scale for both the private sector and the government in bringing together all work connected with securities.
  • There are three parallel systems for organised financial trading in India: one led by SEBI (the equity market), one led by RBI (the Bond-Currency-Derivatives Nexus) and one led by FMC (the commodity futures market). Of the three, the equity market has worked out the best. Hence, all expert committees have advised that the entire activity of organised financial trading be placed under SEBI regulation. The merger of FMC into SEBI is part of this progression.

q: There are complex interlinkages between RBI's payment system (RTGS), the settlement system for government bonds and the working of RBI repo.
a: At present, IT systems within RBI talk to the depository for government bonds (SGL) which is within RBI. In the future, these systems will have to talk to depositories for government bonds outside RBI. This will require IT system modifications.

q: All these changes will be disruptive.
a: The Finance Bill is written in a way that the changes do not get triggered immediately. They unfold in a phased manner, alongside the implementation work, which will take a few years.

q: Has all this been thought through and analysed with a cool head?
a: Yes, numerous expert committees have recommended precisely these actions. Every single expert committee which wrote on this subject has recommended these changes: Setup a debt management office, merge regulation of organised financial trading, give RBI clarity of purpose to stabilise inflation. Setting up the PDMA is in (1) RBI annual reports, (2) the Jahangir Aziz Working Group, (3) the M. Govinda Rao Working Group that was setup under FSLRC, (4) the Justice Srikrishna Commission, (5) the Percy Mistry Committee, (6) the Raghuram Rajan Committee and (7) the Vijay Kelkar Committee on MOF restructuring. Inflation targeting and the merger of organised financial trading at SEBI (or UFA) is in the Percy Mistry Committee, the Raghuram Rajan Committee and the Justice Srikrishna Commission.

Not one expert committee has disagreed with any one of the three elements. The only critics are those motivated by self-interest.

Saturday, March 21, 2015

Clear thinking on today's RBI question

Sugata Ghosh has an article in the Economic Times titled RBI wants to control both prices and debt market, but government refuses to oblige. Some of this needs to be seen differently. He says:

For the market, there cannot be an I-banker that's more honest and effective than RBI. It's the perfect insider with all powers — it can cancel an auction, buy or sell bonds in the secondary market to generate or absorb excess liquidity, and it regulates many of the investors subscribing to government bonds. Also, there is no debate that RBI acts in the best interest of the fisc.
Do you really want to buy bonds from someone who has insider information on how interest rates will go in the future? It's like trading against a corporate insider in the secondary market for equity. The text above violates the basic logic about why central banks, all over the world, have got out of debt management.

MOF insiders will tell you numerous stories where RBI violated the best interests of the exchequer in the pursuit of other objectives. The trouble is, when you have multiple objectives, you are accountable for none. "Why did you fail on inflation?" "Because we were chasing debt management." "Why did you fail on debt management?" "Because we were chasing inflation." Placing multiple objectives on one Agent, which internally conflict with each other, is bad management by the Principal.

The world over, we separate these things out. The central bank is accountable for delivering CPI inflation within the target zone -- and nothing else. The debt management office is accountable for delivering low cost of borrowing for the government in the long run -- and nothing else. There are no conflicts of interest. The buyer of bonds from the DMO is not worried that he's trading against an insider. The Principal is able to hold both Agents accountable; the Agents don't have plausible deniability in explaining away failure.

If RBI was such a great debt manager, why is it that every single expert committee, and the RBI board, all agreed that it made sense to unburden RBI of the conflict of interest of debt management? A little googling would dig out the logic as articulated in (1) RBI annual reports, (2) the Jahangir Aziz Working Group, (3) the M. Govinda Rao Working Group, (4) the Justice Srikrishna Commission, (5) the Percy Mistry Committee, (6) the Raghuram Rajan Committee and (7) the Vijay Kelkar Committee on MOF restructuring. Not one of these disagreed with the reforms which are now being implemented.

What RBI faces in the old arrangement is a mugs game; RBI lurches from one problem to another. It is easy to criticise RBI, but what's going on is a deeper problem, of a badly structured set of contracts where Ministry of Finance has not allocated the work properly. That deeper problem must be addressed. This is a three-pronged story: (1) Give clarity to RBI that it's job is to deliver CPI inflation; (2) Undertake bond market reforms so that RBI gets a monetary policy transmission; and (3) Unburden RBI of the investment banking function.

Sugata Ghosh also says:

Will the bond market deepen if it moves out of RBI? Ask anyone in the cosy world of bonds, and she would say 'no'.

Insiders in a closed club always love the status quo. Nobody wants to open up a closed club.

Lawyers in India do not want new players to come in.

The old BSE members did not want to admit new members, and they did not want NSE. I could easily paraphrase the above sentence and it tells you the newspaper story of 1992: "Will the stock market deepen if MOF creates NSE and opens up entry? Ask anyone in the cosy world of the BSE and she would say 'no'."

The bond market in South Bombay is a nice closed club -- only banks and PDs welcome. Thousands of sophisticated securities firms are forcibly excluded from this market. Their participation will increase liquidity and market efficiency. This is good for the exchequer, as they will get better pricing when selling into a more liquid and more efficient market.

The incumbents in a closed club market are never going to be enthusiastic about change. BSE members today make more money than they did in the old system -- but they ferociously lobbied against the change.

The fundamental law of securities market development is that we get a deep and liquid market by opening up entry barriers. By the act of opening up a closed club, the market will be made to work better.

Again, the author should consider why every single expert committee has advocated merging all organised financial trading into one regulator: SEBI (or its successor, the UFA). This includes spot or derivatives. This includes equities, bonds, commodity futures, currencies, etc.

There used to be ferocious protests from one player in commodities against this plan of unifying commodity futures into organised financial trading. We saw how that worked out, and that should give caution to journalists listening to vociferous practitioners. Now FMC is merging into SEBI. One by one, the remaining pieces should follow.

Friday, March 20, 2015

Reinventing the criminal justice system (Part 2 of 2)

by Nandkumar Saravade.


In Part 1 of this article, we looked at the problems of investigative capacity. This yields a picture of a case load that has overwhelmed the criminal justice system, poor performance, and an overall lack of effectiveness in criminal investigation and prosecution. We now turn to the ways to remedy the situation.

The key issues which must be understood are capacity and resource constraints, clarity and measurement of the output of the Indian Police, the required structural changes in Police organisations the required accountability framework for that resourcing.

Guiding Principles

Record all crime: The purpose of criminal investigation is to generate deterrence by ensuring that the perpetrator is identified and brought before the court to face trial, while adhering to due process. All citizens have recourse to the law. The first step towards ensuring the rule of law is to record all complaints, irrespective of what further action taken.

There is a bias in public systems to turn away complainants. In addition, not all victims may want to report. These two problems generate bias in the official statistics. This calls for a three-pronged approach with (a) Cultural change that removes the stigma associated with being the victim of a crime; (b) Improved technology and process design through which all crime is reported and (c) Parallel measurement of crime incidence using Crime Victimisation Surveys (CVS).

Investigate selectively: Since resources are limited, not all instances of violation of laws can be investigated. The purpose of the criminal justice system is deterrence, not retribution. If perpetrators feel there is a sufficiently high probability of getting caught, and if the punishments are sufficiently severe, this will generate deterrence. For offences involving loss of property, insurance and other compensation mechanisms may be operated to substantially comfort the victim. However, all instances of offences involving bodily hurt must be investigated. Indian law separates offences into cognisable (where police register a First Information Report (FIR) and investigate) and non-cognisable (where permission of a court is required). There is no merit in this distinction.

Analyse for prevention: Data collected through direct reporting and CVS can be used to improve the allocation of scarce police presence, channeling this to locations and timepoints which maximise deterrence for the same expenditure.

Speed up prosecution: As we saw earlier, delayed trials are not only ineffective, but also counterproductive for subsequent cases. The judges:population ratio needs to be substantially higher. The Law Commission (120th Report) recommended in 1987 that this ratio needs to go up from 12.5 judges per million to 50, which is a four-fold increase (2009 data). This would still be half of that found in the US in 1999. At the same time, dramatic increases in the productivity of judges are feasible through better process engineering of courts. There may be a case for large-scale withdrawal of unviable and old cases, as a one time measure, to debottleneck courts.

Agenda for State Governments

The most important change that is required is to improve the working of the police. The police machinery is currently controlled by the party in power and manipulated for their short term objectives of 'managing the crime numbers.' The National Police Commission (NPC), set up in 1977, went into all aspects of policing in the country and gave detailed recommendations through several reports, which have not been implemented. Most of the findings and the recommendations of the NPC remain valid even today. The issue of police reforms got revived after the Supreme Court judgement on a case filed by Prakash Singh, former DGP, UP and others. It is making slow progress, though not always in the right direction.

The recommended governance model for the police involves setting up of State Security Commission (headed by the Chief Minister, the Leader of the Opposition, the Chief Secretary, members of the civil society and subject matter experts) to act as the highest policy-making and oversight body. Further, an empowered Police Establishment Board is required, to insulate police officers from political interference. A Police Complaints Authority is required, to look into allegations of unprofessional/illegal behavior of police officials.

As the police is a subject in the state list under the Constitution, all the issues of police reform -- structural change, and better resourcing -- have to be carried out by the state governments. There is a remarkable opportunity to re-ignite this agenda, owing to the recent decision of the Central Government to increase the states' share of tax revenues to 42%, which is going to dramatically enhance budgets at the level of states. As part of the devolution of greater resources to the state level, the Central Government is also exiting its interventions in state subjects, which has led to discontinuation of the Police Modernisation Scheme. The facts need to be taken together by the leadership of states, and a sharp increase in the resourcing of police is required, alongside improvements in the organisational effectiveness and accountability mechanisms. These three elements -- increased resourcing, institutional reform, and enhanced accountability -- should be seen as a package.

Vision for the Police

For police organisations themselves, the mission to improve investigation effectiveness starts at creating an effective reporting mechanism, in addition to the local police station. Currently, there is a common telephone number (Dial 100) in most states, which does not always work. However, this is meant only for emergency responses. For filing a complaint, the complainant has to travel to the police station. With appropriate amendment in the Code of Criminal Procedure (CrPC), modified processes to mandate registration of crime must be brought about, including: (a) Reporting on the spot with the police official visiting the place of occurrence and (b) offering multiple channels (telephone/email/web/paper) of interaction. Will these changes reporting will improve, fulfilling the first requirement of police being a responsive organisation.

With a business triage approach enabled through a suitable CrPC amendment, high priority investigations can be taken up and the rest, especially those relating to minor property offences, only acknowledged.

From the organisational side, it would be important to devote a sufficient number of skilled police officers, give them standard operating procedures and measure their performance more accurately, with commensurate incentives for better achievement. To improve the supply of investigators without excessive cost escalation, the current heavy bias towards low-output constabulary should shift to officer-oriented composition. At present, 15% of the staff are officers; this needs to go up to 25%. This will also improve promotions and, consequently, motivation and morale of the force, through aspiration based efforts and more meaningful job content.

Separating the investigation function from public order maintenance to promote specialisation has been a long-standing recommendation. This was (recently done in Punjab). This involves earmarking a fixed number of officers for investigative work at the police station level. These detectives cannot be deployed for public order management or security without the orders of the district police chief and unless there is a dire emergency. This protects the prioritisation of investigations.

A national Police Standards Board needs to be created, to improve police investigative processes with clear Key Performance Indicators (KPIs) and an external audititing mechanism, which can directly report to the State Security Commission (SSC), as is done by Internal Audit to the Audit Committee in a listed company.

To enable the SSC to gauge the level of crime afflicting the society, independent surveys are required to be carried out, as a standard practice. Called Crime Victimisation Surveys, these are invaluable for measuring trends on crime reporting and comparative performance of different police units. They constitute reporting of the performance of the police that is completely independent of the police, and serve as an accountability mechanism in the eyes of society, which would see performance in these surveys as the outcome of resources put into the police.

For keeping the knowledge, skill and ability of the investigators at the desirable level, modern training infrastructure is essential. The current training mechanism emphasises a long initial training period over several months, but little subsequent training. However, there is a need for continuous training all through the working years, through which experience and knowledge interventions come together to induce a spiral of capability. This can be addressed through higher budgets for training and developments of a comprehensive Learning Management System (LMS) and community building through professional certifications, Continuing Professional Education (CPE) and a Code of Ethics to promote independence and integrity.

The technology infrastructure of the police department needs to be transformed. An enterprise-scale Information Technology backbone is required, with seamless flow of communication across the police, judiciary, prisons, forensic department and prosecution. Currently, investigation generates a lot of manual and tedious paperwork. With modern devices and well-designed software, the investigator can be freed to concentrate on the actual work. Digital tools for data visualisation and case management, as well as forensic databases for fingerprints, DNA, ballistic markings, paint/glass, shoe prints and tyre marks will improve the success rate of investigations.

It would simultaneously be important to build in accountability mechanisms for the improved resourcing so that the changes in the system stay put, or become feedback loops for the next stage of improvements.

The Supreme Court has passed an order asking for mandatory registration of criminal cases without any discretion to the police officer, as well avoiding indiscriminate arrests. Adherence to this on the ground is inconsistent and low.

Summing up

In summary, it is important to treat the Criminal Justice System holistically. It is possible to get some early wins, by fast tracking trials of cases involving elected representatives and creating specialised units and courts dealing with economic crimes and violent crimes against women. However, for long-term success in establishing the rule of law, there is no alternative to improving governance and making adequate investments in quantity and quality of investigative resources and trial courts.

Monday, March 16, 2015

Bureaucrats in business: The tension between rule of law and commercial considerations

by Anirudh Burman, Shubho Roy, Ajay Shah.

How to achieve high performance in government

In government, the route to performance lies in clarity of objectives and accountability mechanisms, grounded in the rule of law. Every transaction undertaken by a government must be grounded in a written down process, must treat all legal persons equally (Article 14 of the Constitution), must go through due process, must be open to questioning later on. All persons must have full documentation about how the government will behave under various circumstances, must be given documentation about how their transaction was processed, and explained why. Coercive actions of the State must be subject to judicial review. Purchases must be made through General Financial Rules (GFR).

How to achieve high performance in business

These bureaucratic processes have no place in the world of business.

For a firm, counterparties have no Article 14 rights. A manager must choose to give a contract to vendor A or vendor B based on an overall sense of how this will work out. The manager is not obliged to give a reasoned order or even to treat vendors equally.

In finance, private persons choose to buy equity or debt by exercising their own judgment. There is no obligation to have due process or to face audits that question commercial decisions.

This gun-slinging exercise of discretion works because the competitive market sorts it all out. Firms are kept on their toes by the accountability mechanism of the market. Firms get high speed feedback from the market about how they are faring. Good decisions yield improved profits and improved stock prices, and vice versa.

Phase I of India's journey

When Indian socialism was being constructed, the government wanted to be in business. There is a fundamental contradiction between the decision processes that are required in business when compared with the rule of law.

The solution adopted was to sacrifice the rule of law. All across the Indian state, we got politicians and bureaucrats wielding arbitrary power. The construction of Indian socialism damaged India's institutional capital.

Phase II of India's journey

In recent years, the tide has turned decisively. The Constitution of India is asserting itself. We are building the rule of law, we are restoring the institutional capital. You can no longer fudge the process for allocation of spectrum or coal mines. The old clubby ways are being stripped away, all across government.

Some people continue to yearn for the bad old days when a bureaucrat wielded unchecked power, but those days are safely behind us. As an example, see: CAG asks why Air India sold five Boeing 777s at loss to Etihad in 2013 by Mihir Mishra in today's Economic Times.

This great push towards the rule of law has one important implication: the push for the rule of law makes it  harder for the government to do business.

In the olden days, a public sector company could exercise discretion, and participate in the world of business, because the rule of law in India was in tatters. Now that India is pushing back into rebuilding the rule of law, this makes life difficult for the parts of government that are engaged in commercial activities.

On an international scale, we generally see that in countries with strong rule of law, we don't see public sector companies. The intuition that has been offered, in the past, is that there is a deeper thing called `good institutions'; in countries with good institutions, we see the rule of law and we see the absence of public sector companies. Conversely, when there is low institutional quality, we see failures on the rule of law and we see the phenomenon of public sector companies.

The main argument of this article is that there is another causal connection in the picture. A country that sets out to have public sector companies will damage the rule of law, and a country that sets out to strengthen the rule of law will damage public sector companies. Perhaps countries with strong rule of law lack public sector companies as those rule of law strictures have interfered with their functioning.

Implications for public sector companies e.g. public sector banks

In the best of times, it is difficult for bureaucrats to be in business. All over the world, there is ample evidence that government ownership of business hampers productivity. Layered on top of this is this new twist. Earlier, a bank in India could exercise more arbitrary power in trading securities, giving loans, restructuring bad loans, etc. But once public sector banks come under the full strictures of the rule of law, this becomes harder. India's drive towards the rule of law is detrimental to the concept of a public sector company that is owned by the government but engages in commercial activities.

We repeatedly hear public sector bankers complain that it's impossible to do the business of banking when placed under the myriad accountability mechanisms of the government. Their solution is that the rule of law is optional, that banks should be exempted from these requirements even when banks are owned by the government. We suggest that the solution lies in government getting out of banking.

Where is the line drawn, where a public sector company is the State?

Article 12 of the Constitution says: In this part, unless the context otherwise requires, the State includes the Government and Parliament of India and the Government and the Legislature of each of
the States and all local or other authorities within the territory of India or under the control of the Government of India.

This is important because Part III (fundamental rights) can be claimed against the State, such as equal treatment, non-discrimination, etc.

Here the word `includes' implies that this is not an exhaustive definition. The courts have developed tests to determine what `other authorities' means. The key case is Ajay Hasia. These questions turn on the issues of control and financing: (a) the degree of government control over the administration of the authority, (b) the degree of funding/ grants made to the authority, (c) power to appoint/ remove officials, etc. Based on these criteria, various kinds of entities such as public sector companies, educational institutions that receive government money, etc., have been termed state.

When the government owns less than 50% of a commercial enterprise, that organisation is generally not classified as State. However, evidence of pervasive control in such cases may lead to a judicial
determination that the entity is "state" under Article 12. For statutory monopolies or organisations with pervasive State control, even going below 50% ownership does not elude classification as State. In the case of R.D.Shetty v. International Airport Authority of India the Supreme Court stated that an entity such as the International Airports Authority could not act arbitrarily, but was subject to constitutional requirements.

It stated that, ...power or discretion of the government in the matter of grant or largesse including award of jobs, contracts, quotas, licences etc. must be confined and structured by rational, relevant and non-discriminatory standard or norm.... It then went on to say that corporations established by statute, or incorporated under law (including any company under the Companies Act) are "state"
if they satisfy certain tests based on:

  1. The source of share capital.
  2. Extent of state control over the corporation, and whether it is deep and pervasive.
  3. Whether the corporation has monopoly status.
  4. Whether the functions of the corporation are of public importance and closely related to governmental functions; and
  5. Whether, what belonged to a government department formerly was transferred to the corporation.

For a more detailed answer, see this report of the Law Commission (page 4, paras 2.3 to 2.6).

Three important issues arise related to the 1979 ruling of the Supreme Court:

  1. A business entity making a commercial decision does not hand out contracts as a "grant or largesse", but as a competitive player in the market interested in purchasing goods or services that satisfy its own requirements. To constrain it by the rule of law is to fetter its commercial decision making process.
  2. The transition of the Indian state is different from the transition of many western democracies such as the USA and UK. These democracies transitioned from laissez faire states to
    regulatory states. The Indian state on the other hand, is transitioning from a pervasive state to a regulatory state. Until not too long ago, the state ran hotels and manufactured bread. As such, most functions sought to be deregulated and/or performed by companies/ corporations are or were of public importance, and closely related to governmental functions.
  3. In India, many government functions are being privatised or handed over to government companies. A good example is telecom. Telecommunication services were first transferred to public sector companies owned by the central government, and eventually privatised.

On a related note, GFR has a rule to prevent escaping from GFR through subsidiarisation: Once government provides majority funding to a body, it must accept GFR and CAG.

This results in a situation where though de jure transfers of control, ownership and management have taken place, for government owned/ controlled corporations, there is never a complete de facto escape from the constitutional constraints on the Indian state. Such entities are unable, from the point of inception to act purely on commercial motives. It is therefore questionable whether any government
strategy that aims at greater market discipline and efficiency in a sector can be successful through the route of establishing government owned/ managed entities. Alternatively, the precedent on what constitutes "state" needs to be reviewed. The judgements on what constitutes "state" were made in the era of a pervasive state. A regulatory state must be defined differently.

Sunday, March 15, 2015

Concerns about Finance SEZs

by Anjali Sharma.

For more than a decade, Indian policy makers have aspired for a globally competitive financial sector in India. In 2007, a High Powered Expert Committee headed by Percy Mistry (MIFC) proposed that Mumbai be developed as a full fledged International Financial Center (IFC). At the time, this was `an offensive strategy', in the sense that India was aspiring to export into the world market. In 2013, a Standing Council of Experts on the International Competitiveness of the Indian Financial Sector, was setup to evaluate the cost of doing business in the Indian market, and find ways to improve international competitiveness. This was a `defensive strategy', as there had been a sea change in Indian finance between 2007 and 2013: the collapse of market share in Nifty and the rupee.

A third initiative is now visible: a white paper Policy framework for Finance SEZs (referred to as FSEZs going forward). This was followed by a budget announcement regarding issuance of regulations for GIFT city, a FSEZ, by March, 2015. Finance SEZs are viewed as a tool to expedite the globalisation of Indian finance.

Competing in international finance requires four things: (a) No capital controls; (b) Residence-based taxation; (c) Sound financial law and regulations; (d) Good urban infrastructure. At present, India fails on all four counts. There has been some progress on implementing "c", with the draft Indian Financial Code proposed by the Financial Sector Legislative Reforms Commission (FSLRC) in March 2013. There is little sign of progress on the other three fronts. India's capital controls deter foreign customers of Indian finance, and are not onerous enough to prevent the flight of domestic customers.

The white paper points out to loss of market share in INR and Nifty futures trading. The decline of Indian finance goes beyond just Nifty and the rupee, though these can be visible symbols of the decline of the ecosystem akin to the tiger in the Indian jungle. Indian non-financial firms borrowed Rs.4.5 trillion from foreign shores in 2012-13, almost double their foreign borrowings in 2009-10. Indian firms, and even the Indian government, use offshore rather than domestic commodity derivatives markets to hedge commodity risk. Indian firms are increasingly interested in offshore listings. In India-related CDS, 100% of the market share is overseas.

London, Dubai and Singapore are obtaining a strong share of the increased financial services revenues associated with Indian GDP growth. These cities score over India with stable legal and regulatory frameworks, competitive tax regime and efforts to improve market liquidity and depth. The policy establishment of these countries is free of the reflexive socialism which bedevils economic policy thinking in India.

Are FSEZs the right solution to these problems?

An SEZ follows an enclave approach. Manufacturing units located within the SEZ, are given fiscal, regulatory and trade exemptions so as to enhance exports. The white paper proposes three objectives for an Indian FSEZ: create high value financial sector jobs on Indian soil; create an avenue into financial globalisation (like Hong Kong is to China); and be a laboratory of new ideas for financial policy making for the development of the overall Indian financial system. This is small thinking compared with MIFC, where the aspiration was: to capture a share of the global finance business by delivering a wide variety of services to a wide variety of global participants with minimum friction.
The areas of concern are:

  • Financial reform in India has fared poorly. The implementation of MIFC from 2007 onwards, or the implementation of the Indian Financial Code, from 2013 onwards, has been an uphill struggle. These same difficulties will hamper the enclave approach.
  • There is a chicken-and-egg problem in market liquidity. Bombay has a certain market. It has a full ecosystem of financial firms and their customers. That market can suck in additional orders, if the mistakes of financial regulation, capital controls and taxation are fixed. A Finance SEZ would start from scratch, with no ecosystem. It is hard to build from scratch. The natural jumping off point for obtaining foreign customers is Bombay, not an SEZ.
  • The white paper proposes that a subset of the draft Indian Financial Code will be enacted as the Finance SEZ Act. It will be more complicated than this. The regulatory machinery required in a Finance SEZ differs from that required for India. E.g. there will be no fiat money in a Finance SEZ, hence there will be no requirement for monetary policy. It may make sense to have a single unified regulator in a Finance SEZ. The work required, in going from the Indian Financial Code to the Finance SEZ Act, may be significant.
  • After the Finance SEZ Act is passed, new regulatory institutions will need to be created. It will be important to avoid importing the institutional culture, and pessimism, of existing regulatory agencies. Getting away from the `inspector raj' (as described in the MIFC report) will be quite a challenge. Exporting from an Indian platform can only come about when world class regulatory agencies are found there. This may take many years. If enough new age project management is not put into this, the institutional culture of existing financial agencies might recur, in which case the Finance SEZ will fail.
  • The removal of capital controls in the FSEZ will have an immediate benefit for foreign clients who might shift order flow away from the mainland. This may adversely impact upon liquidity and market efficiency in the mainland. While the FSEZ is intended to compete with London, Dubai and Singapore, the first victim of its success could be Bombay.
  • While the white paper envisages that FSEZs should be India's Hong Kong, this requires today's regulatory agencies to respect and value a Hong Kong. At present, this may not be the case; today's regulatory agencies may work systematically to ensure that FSEZs do not become India's Hong Kong. RBI has regulation-making power under FEMA. This could easily yield draconian restrictions that hamper onshore participants, cutting off the FSEZ from the mainland. If FSEZs on Indian soil are cutoff from India, they cannot succeed.
  • FSEZs require improved working from the Indian tax bureaucracy as much as they require improved working from the Indian financial regulatory bureaucracy.
  • FSEZs will need not just good laws but sound enforcement agencies and sound courts. While important new work is underway in building courts, there is little certainty as yet that this will work out well. Three things are required: a Tribunal to hear appeals against the regulator, a court where disputes between private parties are heard, and an arbitration mechanism. All these are extremely important for the mainland, and have not been done for decades; why will they now be done for FSEZs?

These are onerous challenges. It will take remarkable project management to overcome them, of a kind that we have not seen in Indian finance in the past. Given enormous political capital and implementation capabilities, Finance SEZs in India can work. But would that effort not be better used in combating the low quality of financial law and financial agencies of the mainland?

There is a very scarce resource in Indian economic policy: the time and energy of the persons who actually do reform. Man-hours allocated to Finance SEZs come at the cost of man-hours which could be spent on fixing the mainland. It could get worse. A dangerous scenario that can be envisioned is as follows. Suppose domestic financial reform is stranded in bureaucratic politics. Suppose FSEZs make progress and cannibalise activity away from the mainland. Suppose this creates feedback loops where the intelligent end of the economic policy establishment gets increasingly focused on successful work on FSEZs and despairs of the difficulties of the mainland. It would be very costly for India if, in this fashion, FSEZs damage the future of Indian finance.

How to approach Finance SEZs

As the white paper says, a useful role for Finance SEZs is:

" be a laboratory where controlled experiments with new ideas in policy take place, and feedback can then be used by the Ministry of Finance to alter course for the future."

If this vision is emphasised, FSEZ development would complement domestic reform and globalisation, rather than become a substitute. New ideas should be tried out in an FSEZ, and once proven, be immediately implemented in the mainland. Finance in the mainland should not stagnate in the present mode.

If this is done, FSEZs can facilitate the process of achieving the scale of ambition of the MIFC report. There may be useful lessons from China, in the development of the China (Shanghai) Pilot Free, Trade Zone (SPFTZ). The main objective of the SPFTZ is to develop institutional capacity while opening up the Chinese financial system and liberalising capital controls and currency convertibility. For example, the Shanghai-HongKong Stock Connect is an experimental system through which Chinese investors can trade their share holdings with foreign participants in the Hong Kong market.

This initiative involves setting new capital controls for the traded shares, regulations on the trade and settlement of shares, operations of connecting trading, common clearing and settlement across the Hong Kong Stock Exchange and The Shanghai Stock Exchange. The intention is to develop the equity market liquidity for both domestic and global participants. The intention is backed by consistency of implementation: the experiment was tried once before, failed and tried again.

Many markets and products that are not permitted today in the Indian market, due to legal or regulatory constraints, reinforced by low knowledge in financial agencies. Such missing markets and products can be tested and understood in a controlled environment by policy makers and regulators in the FSEZ, before they are introduced into the Indian financial system. Some examples where there is global interest include Indian OTC commodity derivatives, Credit Default Swaps on Indian credit, Rupee denominated foreign currency settled government bonds, and a Eurodollar market for Masala bonds. This will require changing the easy life of existing Indian financial regulators.

While the effort to take back market share on the INR and Nifty futures may yield some results in an FSEZ, these new markets and products have the potential to yield large benefits for India. The FSEZ could also be a testing ground for introducing global standards into market processes such as marginning for financial portfolios spanning equity, commodity, currency and interest assets rather than each one individually as is done in the Indian market today.

In this approach, the stagnation of financial law and agencies on the mainland must be tackled. Policy makers should not make the choice of permitting the mainland to stagnate, while building high quality structures in Finance SEZs.

The way forward

In conclusion, the FSEZ white paper is the latest policy proposal to improve the international competitiveness of India's financial system. It proposes an enclave approach to overcome the failures of implementation which have held India back ever since the MIFC report and the drafting of the Indian Financial Code. However, the enclave approach appears to face as many challenges. Remarkable inputs of State capacity are required to make it work. That human capital, project management and political capital would surely have better uses in fixing Indian finance.

The key insight in salvaging the situation is to not lose sight of the main objective: the mainland. We should build an enclave because it will help us solve the problems of the mainland. Every decision about building the enclave should be made keeping this larger objective in mind.

The economics of cloud computing: an Indian perspective

by Ajay Shah.
When you buy computer hardware, and build a glass house in India, the costs incurred are those of:

  1. Skilled and specialised labour
  2. Electricity for computers
  3. Electricity for cooling
  4. Real estate
  5. Depreciation of hardware
  6. Cost of capital on all the equipment
  7. The problems of achieving high availability on the above.

Firms all over the world are finding that the make vs. rent choice shifts in favour of cloud computing: You shut down your glass house and rent the services of computation in the cloud, run by the likes of Amazon or Google.

Some of this flows from the universal logic of specialisation and economies of scale. Google hires Ph.D.s in aerodynamics to optimise airflow in data centres. Almost all end-user firms are unable to justify this scale of outlay. Google is able to put a data centre right next to a hydel plant and enter into a long-term contract for 100 years of electricity. Almost all end-user firms are unable to justify this kind of thinking for their data centres.

In addition to this, I think there are some interesting and uniquely Indian perspectives.


If the ambient temperature is 5 C instead of 30 C, this reduces the cost of cooling.


Electricity is very costly in India as the commercial sector is paying for subsidies and inefficiency. This is particularly after you take into account the complexities of ensuring high availability.

Real estate

Land is very costly in India.


Most important, the cost of capital is very high in India.

For Amazon or Google, the cost of debt capital is 4% and the cost of equity capital is 7 to 8% (in USD).

For a big listed company in India, the cost of equity capital is 15% and the cost of debt capital is 11% (in INR). For smaller companies it's much worse.

It makes a lot of sense to reduce the balance sheet size to the extent of the cost of the data centre, and replace it by a stream of rental payments to cloud computing providers outside the country.

This idea has many interesting implications. The propensity for Indian firms to rent from overseas cloud computing providers goes up when capital controls are introduced, goes down when inflation targeting works, etc.

Cloud vendors in India?

I don't see how cloud computing vendors in India can be competitive, as they face these same uphill problems of operating in India: expensive real estate, expensive electricity particularly after taking into account the HA issues, and expensive capital.

They might argue: The labour cost is lower; it's cheaper to get a Ph.D. in aerodynamics in India. My fear is that the labour cost component in the operations of a big data centre is quite small.

So far I have assumed that the core hardware (electronics + cooling) is at high seas prices. There are many mistakes in the Indian tax system, and this could easily not be the case.

Gains for end-users

Before cloud computing, if you were an end-user organisation in India, you had no choice but to deal with the problems: expensive hardware, low economies of scale in systems administration, the high cost of HA electricity and cooling, real estate and capital. Cloud computing is a big gain for India in terms of the reduction of costs that are given to end-users. Other countries will do what's their comparative advantage (producing cloud computing services); firms in India will import these services.

Wednesday, March 11, 2015

Reinventing the criminal justice system (Part 1 of 2)

by Nandkumar Saravade.

Police and court inefficiency is the dominant feature of the Indian criminal justice system. The latest verdict on the L. N. Mishra murder case, which took 40 years to resolve even when the victim was a central minister, has once again brought home the point that things just don't work. Our system has repeatedly fallen short of its objective of being able to investigate and prosecute to ascertain the culpability of the accused and award deterrent punishments. Failure in this area is a significant inhibitor for achieving society's true potential, including economic progress.

After many decades of stagnation, there are now signs of important change in this field:

  1. There was a time when the dominant idea of the Indian State was a "mai baap" who would wipe every tear. The Indian State is now re-engineering itself towards a much narrower vision, of achieving State capacity in delivering core public goods, and leaving the pursuit of happiness to the private choices of each individual. Law and order looms large in the field of public goods. Law and order is the ultimate public good: it is non-rival (my consumption of safety does not diminish the safety available to you) and non-excludable (there is no way to exclude a new born child from the blanket of safety).
  2. Important new work has begun on building high quality courts in India. If these innovations work out well, and are then transplanted more widely into the working of courts all over India, this could have a major impact upon the criminal justice system.
  3. The 14th Finance Commission has given a great surge of budgets at State governments. This is an important time for State governments to rethink their expenditure priorities, and a key element of this should be a greatly increased focus on law and order.

Prioritisation of the criminal justice system is going beyond the intellectual elite to every citizen. One highly visible episode of rape in Delhi [link] appears to have had an impact on elections at the level of the state government and possibly in the general elections also. Politicians are now much more oriented towards succeeding on law and order. As an example, the manifesto of the newly elected AAP government in Delhi speaks of reducing judicial delays.

We may thus be at an important moment, at the early stages of reinventing the Indian criminal justice system. It is, then, particularly important to obtain a clear diagnosis of what is wrong, and of effective strategies for reform. This is what motivates this two-part article. The first part is on the state of affairs of crime, and of the police machinery. The second part will be on the strategy for police reform.

What is the extent of crime?

Crime must be measured as as the crime experience of the citizenry. E.g. the number of murders per 100,000 of population, per year, is a measure of crime. For our present purposes, it is useful to think of the work of the police which takes in a complaint that is filed at one end, and results in convictions at the other end. The workload that comes into the entry point is the number of FIRs filed.

During the 2003-2013 period, India's population grew by 15%, but was outpaced by the growth of crimes defined in the Indian Penal Code (IPC) by 54.3%. The number of IPC crimes registered as First Information Reports (FIRs) during the year 2013 was about 2.65 million.

While the IPC is the main law on crime, there are other laws called Special and Local Laws (SLL), which also keep police investigators busy. These include offences under, among others, the Motor Vehicles Act, Arms Act, Gambling Act and Narcotics Act. SLL figures reached 4 million in 2013. SLL grew less rapidly (5.7%) during the same period, probably due to the fact that most of cases booked under SLL result from a proactive and preventive approach, depending on the time and resources available to police leadership at the local level. For the sake of simplicity, we will focus only on IPC crimes.

With respect to IPC FIRs, investigators processed 3.5 million cases (including cases carried forward from the previous years) during 2013. They completed investigation in 2.5 million cases, of which 1.9 million (75%) cases were sent for trial, leaving 0.95 million cases under investigation to carry over to the next year.

Large as these numbers seem, it is well known that only a fraction of the criminal incidents get registered as FIRs. Indeed, non-registration of crimes is a major factor in citizens' dissatisfaction with the Indian Police. In a landmark experiment conducted in Jalpaiguri, West Bengal in 2007, it was revealed that the actual incidence of IPC crimes across different categories was 4 to 6 times of the recorded numbers. More recently, the Delhi Police leadership stepped up registration, with revealing results. Delhi Police had recorded 64,882 IPC cases in 1998, which fell to 54,287 in 2012. However, the numbers rose rapidly to 80,184 in 2013 and 147,230 in 2014, close to a three-fold jump over two years.

How do the police fare on investigative capacity?

The Bureau of Police Research and Development (BPRD) publishes data on police resources on a regular basis. It shows that the police-population ratio has improved from 139 (per 100,000 population) in 2002 to 181 in 2012. The state police comprises of civil police (police station and support unit staff) and armed police (reserve units). According to NCRB, the total sanctioned strength of the state civil police at the end of 2013 was 1.79 million, while the actual was 1.3 million, leaving about 25% of the positions vacant.

For the purpose of investigation, it is more important to look at the number of investigators who primarily come from the ranks of Assistant Sub Inspector (ASI), Sub Inspector (SI) and Inspectors. These are mere 11% of the civil police strength. However, these officers cannot consider investigation as their primary job, having to give priority to maintenance of public order, VIP security and court appearances.

There have been a few studies in recent years estimating the actual workload at police stations. Though not specifically aimed at the investigation function, these provide some clue about the existing gap. A recently released BPRD report on 8-hour shifts in police stations looked at the existing supply side situation and found that majority of police stations had its staff putting in 11- hour to 14-hour workdays. Further, most police station staff members could get only one or two days as weekly off during a month. The report estimates that to enable a 48-hour work week, with an assured weekly holiday, it will take 68% enhancement in the police station strength. Another highlight was that, of the total police strength, only a third was posted in police stations, though, admittedly, it was the most important part of the police organization.

A smaller workforce is directly linked to low crime registrations described earlier. They are seen as a necessary evil by police supervisors to ensure that work load remains manageable. Even when the top leadership is interested in more realistic registration, the police stations thwart the efforts by turning away complainants. In a territory-based approach, the local police station has a monopoly on registrations and uses it to the detriment of the poor victims, who are unable to get their grievances addressed. In other countries, this monopoly is taken away to a certain extent by a centralised emergency response system, such as the 911 mechanism in the US. No equivalent system has been created in India yet. Madhya Pradesh Police is attempting this currently, with the project cost of Rs.6.33 billion over a five year period.

Court delays and policing

Another factor impacting investigative capacity of the police is the pendency in courts. As described earlier, 1.9 million cases got added to the pool of cases under trial in different courts, swelling the number to 9.8 million. During 2013, only 1.3 million cases were disposed of, increasing the pendency by 0.6 million. Of the 1.3 million disposals, about 0.2 million were due to cases being compounded or withdrawn, 0.77 million discharged or compounded and only 0.52 million convictions. The success rate in offences like rape and murder was around 27% and 36% respectively. The prosecution was even less successful in economic crimes like criminal breach of trust (23%) and cheating (24%). The slow pace of the proceedings was apparent from the vintage of concluded cases, with 13% cases aged between 5-10 years and 3.2% older than 10 years.

Court pendency keeps the investigators unproductively occupied in attending courts where more time is spent on procedural matters, rather than deposing. It reduces the viability of success of prosecution, finally impacting the outcome of investigations and motivation of investigators. It adds to the burden of preserving evidence and tracking witnesses - jobs mostly done by the police - over a longer period of time. Delayed trials are also responsible for the lower rate of success, as a study of corruption cases under the Karnataka Lokayukta showed.

What is the level of funding?

Though manpower is an important factor, it is also relevant to look at the financial expenditure on police department, as an indicator of the relative importance given by the state governments towards bolstering the rule of law. State governments seem to be spending between 3-5% of their budgets on the police.

It would be interesting to put this low expenditure in context by looking at Maharashtra budget figures for FY 2015. The total number of employees under the state government was 0.64 million, of which police personnel were 0.2 million. Thus, despite being one third of the state government workforce, the budget allocation for police was less than 5%, of which sustenance spends (such as salary, fuel and office expenses) took away 98%. The low allocation of resources for training results in lack of upgradation of investigators' knowledge about forensic techniques and new modus operandi.

What is the level of data collection and analysis?

Poor funding has meant that police departments lack IT systems for managing workflow better and data analytical tools to crunch large data sets available in cases of terrorism and financial crimes. The funding for creating new data-sets on understanding crime victimisation, demographic and spatial mapping of criminals, statistical analysis of the investigative processes are non-existent.

One significant factor in doing meaningful analysis is the antiquated method of compiling and analysing crime statistics. The whole process is manual and prone to errors and manipulations. An enterprise level case management system, called Crime and Criminal Tracking Network and Systems (CCTNS) has been delayed by more than four years due to inadequate funding and poor project management. Till the crime data is digitally captured at source and is amenable to modern techniques and tools of business intelligence, mapping the problem of poor-quality investigation in adequate detail remains only an aspiration.

What incentives exist for better performance?

It is not impossible to conceive of an efficient police force within the limitations imposed by the manpower and resource constraints. For this to happen, performance appraisals need to be aligned to elicit appropriate behaviour. Little is known about what constitutes good performance, and how police fare on such metrics.

What metrics of performance exist, are not linked to effectiveness in investigating crime, since it figures low in the list of priorities. Also, trials take a long time to reach conclusion and a negative outcome is attributable to various factors, such as poor investigation, insufficient evidence, long delays and witnesses turning hostile. Existing internal processes to fix accountability for bad investigation seldom seem to work.


Even at current levels of registration of crime, the criminal justice system is overwhelmed and in a state of logjam. There is gross under-registration of crimes; a fact well known to the police leadership. There continue to be considerable delays in police investigation. The police continue to be under-staffed and under-funded. At the same time, performance measurement of the police is weak.

Simply adding more manpower, or increasing resource allocation without appropriate performance metrics and accountability frameworks will not get us the desired results. A reform strategy has to take into account the failures on each of these fronts and devise an approach that will bring in more accountability, structural modifications, adequate resourcing, training and process improvements. This will be the subject of Part II of this article.

Monday, March 02, 2015

Monetary Policy Framework Agreement: The first clarification of what RBI is to do

Our flawed inheritance

The Chamberlain Commission (1914) and the Hilton-Young Commission (1926) led to the drafting of the RBI Act. This was introduced in January 1927 and enacted in March 1934. The RBI Act does not state what the objective of RBI is. The authors of this Act were quite honest about what they were doing:

An Act to constitute a Reserve Bank of India. Whereas it is expedient to constitute a Reserve Bank for India to regulate the issue of Bank notes and the keeping of reserves with a view to securing monetary stability in [India] and generally to operate the currency any credit system of the country to its advantage;

And whereas in the present disorganisation of the monetary systems of the world it is not possible to determine what will be suitable as a permanent basis for the Indian monetary system;

But whereas it is expedient to make temporary provision on the basis of the existing monetary system, and to leave the question of the monetary standard best suited to India to be considered when the international monetary position has be come sufficiently clear and stable to make it possible to frame permanent measures.
From 1934 onwards, this `temporary provision' has been India's central bank. In the years of Indian socialism, this flawed beginning ossified into a full central planning system governing finance. Every detail of products and processes in finance is micro-managed. Alongside this, India got high and volatile inflation:

Fiat money made by RBI failed on the prime test: low and stable inflation.

It is easy to criticise RBI. It's like going into a time machine and making fun of what folks did not know in 1934. This is not a criticism of the individuals at RBI today. The problem lies right in the institutional DNA. What we have is not a central bank; it is a central planning agency for finance, with an improbable and conflicted set of objectives. Accountability mechanisms are absent. Good governance principles, and the rule of law, are missing. Even in the hands of good individuals, RBI has lurched from one mistake to another.

Figuring out the solution

I first saw the beginnings of clarifying what RBI was about at RBI. C. Rangarajan and S. S. Tarapore essentially understood that what made sense was a focused inflation targeting RBI + an open capital account. In the 1990s, open economy macroeconomics was not as well understood, and they did not quite get the fact that this inevitably meant a floating exchange rate. But they had intellectual leadership on the idea that low and stable inflation is the dharma of a central bank.

Similarly, in the late 1990s, intellectual leadership on reforming debt management arrangements came from RBI. By the early 2000s, RBI was saying that there is a conflict of interest between the objective of debt management (i.e. to borrow for the government at low rates of interest) and the objective of monetary policy (i.e. to deliver low and stable prices). To do a good job as debt manager would generate interest rates that are too low, and give an inflationary bias. The solution was for the government to find its own debt management arrangements, and unburden RBI of this conflict of interest.

While RBI fought inflation in the 1990s, this ethos did not turn into legal instruments, organisational reform, and lasting institutional change. By the early 2000s, RBI was back into hankering for exchange rate pegging and more capital account restrictions. On debt management, RBI's position shifted to defending turf. Intellectual leadership on RBI reform shifted outside RBI.

By the early 2000s, as the difficulties of exchange rate pegging became visible. RBI's pursuit of exchange rate objectives repeatedly led to the wrong decisions on monetary policy, and gave RBI a bias in favour of preventing the emergence of a capable financial system. When the Agent is given multiple objectives, he is accountable for none. The heart of the problem lay in putting an end to the temporary arrangement: in establishing a clear objective, removing conflicts of interest, and setting up accountability mechanisms.

The earliest sources that I am able to find on the Internet are a newspaper column by Ila Patnaik on 21 August 2006, Inflation targeting: Much ado about something by Deena Khatkhate in the EPW, December 9-15, 2006, and the Percy Mistry report (2007). By 2007, serious people in Indian macro/finance knew where India needed to go: Inflation target + Open capital account + Floating exchange rate. All the other expert committee reports supported this.

The long run answer

The Indian Financial Code, drafted by Justice Srikrishna's commission, is the full, coherent, internally consistent replacement for the menagerie of Indian financial laws. Once this is enacted, the RBI will have clarity of purpose, and will have sound governance. That is for some unstated date in the future. Does this mean that nothing can be done in the short run?

Some progress in the short run

In 1997, the Finance Secretary, Montek Ahluwalia, and the RBI Governor, C. Rangarajan, signed a `Ways and Means Agreement', which put an end to money creation for deficit financing. This was not in the law, but it was a step forward. The agreement, by and large, delivered.

In July 2014, the Budget speech announced that a monetary policy framework would be put into place. Ordinarily, one would think this is a combination of an inflation target and the machinery of an MPC.

Today, MOF has released a Monetary Policy Framework Agreement signed by RBI & MOF.

It establishes an inflation target. That is a good thing.

Oddly enough, there is no Monetary Policy Committee (MPC). The interest rate is decided by one person: the RBI Governor. This will lead to many infirmities. But this is progress, for the period until the IFC is enacted.

Like many of the other things in this year's budget speech, this is halfway there. Ideally, it should have been an inflation target + a properly constructed MPC. There is an odd loss of nerve.

Sunday, March 01, 2015

Interpreting the BJP's 2015 budget

The BJP, armed with a clear majority in the Lok Sabha, with the desire to break with Nehruvian socialism, was expected to unveil a game plan for structural changes from here till 2019. In large part, Budget 2015 does not rise to the challenge. It has some good elements, and with good execution, they will make an important difference. But an array of important and pressing problems have been left unsolved.

The challenges faced in this 2015-16 budget

This was an unusual budget making exercise for three reasons:

  1. This was the first full year budget of the new BJP government, and they were expected to show a strategy for the coming 4.3 years.
  2. This is the first majority in the Lok Sabha in 30 years, and the campaign was fought on the platform of jobs and not dole.
  3. There is an unusual opportunity for fundamental change in expenditure because of shuttering of the Planning Commission, and 14th Finance Commission's recommendations on enhanced resource flow to state governments.

Fiscal consolidation

Mr. Modi was a fiscally prudent finance minister in Gujarat, and that kind of approach was expected in New Delhi also. Three factors have shaped the fiscal situation:

  1. The goverment got a windfall on account of reduced crude oil prices, which reduce the magnitude of oil-related subsidies. To their credit, they have also done a bit on reducing subsidies on some petroleum products.
  2. The 14th Finance Commission recommendation to increase the resource share of the states from 32% to 42% need not have any adverse impact for central finances, as it should merely send expenditures down to the state government level (where they belong). The combination of closing down the planning commission + the 14th finance commission adds up to the perfect opportunity to make substantial changes in the (broken) machinery of central expenditure.
  3. India's fiscal dynamics in recent years was greatly assisted by the inflation crisis. Inflation breached 5% in February 2006. From that point onwards, buyers of government bonds repeatedly experienced inflation that was greater than expected. This problem is now hitting India in reverse. The global deflation has given a collapse in inflation in India. Now bond holders are experiencing lower inflation when compared with what was expected at the time of bond issue. Debt dynamics in India is now worse.

The calculations of the budget are predicated on 8% GDP growth and 5% inflation. The new GDP data are indeed very exciting for they show better strength in the economy as compared with the old data. We wish the new data is right. However, if the new GDP data has problems, this could generate less tax buoyancy than expected.

When the Indian credit rating was teetering on the brink of sub-investment grade, the then finance minister, P. Chidambaram, made a fairly credible commitment to a certain fiscal adjustment trajectory. Financial markets decided this adjustment was good enough.

The budget speech has unfortunately decided to break with this fiscal adjustment trajectory by asking for one more year to reach the 3% target in 2017-18. In my opinion, this is unwise. The economy will be healthier if we had more fiscal prudence. If the public investments had to be increased, the resources should have come either from disinvestments from sectors where government is not required or from pruning the subsidy bill. Abandoning the fiscal consolidation is not a good way of achieving greater public investment. Para 24 says that the Finance Bill will amend the FRBM Act, thus showing that flouting the FRBM Act is all too easy for the administration.

A sound and elementary test of the correct fiscal stance is the following rule: "Barring a year with a bad business cycle downturn, we should have a primary surplus; Primary deficits should happen no more than (say) in two years out of 10". Last year's primary surplus was -0.8% and the next year's is budgeted at -0.7%. This suggests that the Indian fiscal situation is wrong by roughly 1% of GDP.

Non-interest expenditure is budgeted to grow by only 4.06%. The problem lies in interest payments, which are budgeted to grow at 10.89%. India's debt dynamics are now problematic; even though non-interest expenditure growth is modest at 4.06%, this is giving a gain in the primary deficit of only 0.1 percentage points.

A big area for cutting expenses is subsidy reform, but this has not been done.

It would have been better to run a tight ship, and get to a primary surplus of -0.2% this year and +0.5% next year. Debt/GDP only goes down when we combine small primary surpluses with high GDP growth.

In summary, the fiscal stance, with a reduction of the primary deficit of only 0.1 percentage points, and a break with P. Chidambaram's proposed adjustment trajectory by one year, is disappointing.

Dismantling the Planning Commission

The Planning Commission was not in the Constitution of India. The failures of the Planning Commission, and the concepts of plan vs. non-plan expenditure, are central to the failures of the Indian State. Mr. Modi took a big step forward by announcing the abolition of the Planning Commission on 15 August 2014.

This requires a corresponding re-engineering of government around the theme of accountability. The Ministry of HRD must be given a block of money, and in return must commit to the numbers for learning outcomes, measured by a non-government agency like Pratham, that they must deliver. Failure to deliver should have consequences. Once this is done, they should be free to design their own strategies for how to use this money. This is how fiscal systems in mature countries work, without a Planning Commission running a parallel fiscal system.

Some re-engineering that flows from closing down the Planning Commission has been done. But the bulk of it has not been done. Most `plan schemes' have not been dismantled. There is no articulation of what the post-Planning-Commission world will look like. The budget process appears to have trundled along as usual, without noticing that the Planning Commission has been shut down. There is no talk of even planning how to redesign the Indian fiscal system in this new world. This is disappointing.

Niti Aayog was supposed to be a think tank. It is a source of great concern that thousands of crore of resources are being allocated to it. A good think tank requires Rs.100 crore a year of expenditure. Anything more, and it becomes a fiscal mechanism. The "Planning Commission" was renamed to "Niti Commission", all the old staff were retained, and now we're slipping back into the spending ways of the old Planning Commission. Nehruvian socialism was an intellectual construct, and it is going to require intellectualism to dismantle it.

Tax policy and tax administration

India has an extreme crisis on low quality thinking and execution in tax policy and tax administration. The term `tax terrorism' has entered the lexicon. Badly structured tax policy and tax administration are hampering GDP growth. For many years now, the tax/GDP ratio has been declining. In 2014-15, gross tax revenues (net to centre) had a shortfall of Rs.113,133 crore or 8.3%. To do the (weak) fiscal adjustment of the coming year, MOF has has had to raise tax rates.

India has a tax rate of 44% on corporate income, combining corporation tax and the dividend distribution tax. This is one of the highest tax rates among comparable countries. In the budget speech, there are paragraphs which talk about a cleaner tax system being built in 5 years (para 60 and 97). But at the same time, the budget speech promises us (para 129) that the Direct Tax Code (version 1 of which was the best alternative for direct tax reform) is now buried. There is no display of an implementation mechanism through which the promises of Para 60 and Para 97 will be fulfilled. If the intent is to cut the rate of taxation of firms, why not start now?

Para 96 restates that a good GST will be built. The bottleneck is in implementation. As an example, MOF could have announced that in 2015-16 they will implement a `Central GST' covering only the Centre, which will be put into effect in 2016-17, and then in 2017-18 there will be a mechanism for states to connect into it.

An integral feature of the Modi campaign was the objective of reducing the complexity of doing business. One major element of the difficulties which firms have faced is the tax system. The lack of strategy on reforming tax policy and tax administration is disappointing.

Financial sector reforms

The announcements are:

Financial markets
Para 56 and 57: Merge commodity futures and the government bond market into SEBI, and setup the Public Debt Management Agency (PDMA). A nice gold-linked bond scheme will be an added instrument through which the PDMA will borrow.
International finance
Para 58: Regulation-making power on equity related capital flows to shift to Government. Para 87: Build out GIFT as an International Financial Services Centre (IFSC).
Monetary policy:
Para 13: A `Monetary Policy Framework Agreement' has been signed with RBI, which gives RBI an inflation target of "below 6%". The RBI Act will be amended to provide for a Monetary Policy Committee.
Deeper institution building
Para 88: Setup commercial divisions in courts of India. Para 59: Setup Task force for creating Financial Redress Agency. Para 59: Introduce Indian Financial Code "sooner rather than later"
Pension reforms
Para 40, 41, 42: There are a slew of social security proposals. Para 62: Employees will be given the choice of opting out of EPF and going into NPS instead.
Bankruptcy process
Para 36: Bring a comprehensive Bankruptcy Code in fiscal 2015-16, which will meet global standards, and provide necessary judicial capacity.
Taxation of finance
Para 106: Tax 'pass through' proposed to be allowed to both Category-I and Category-II Alternative Investment Funds, so that tax is levied on the investors in these Funds and not on the Funds. Para 108: Solve the problem of `permanent establishment' faced by global fund managers who locate in India.
Bad ideas
A `MUDRA Bank' which will be a PSU which will refinance micro finance institutions.

This is fascinating and impressive in parts, but disappointing in many respects.

Financial markets: The vision for organised financial trading by all the expert committees has been : to harness economies of scale and economies of scope by unifying all organised financial trading. Government bonds and commodity futures will now be with SEBI. That leaves an odd collection of elements at RBI: corporate bonds with maturity below one year, credit derivatives, and currencies and their derivatives. It would have been much cleaner to do the full thing, instead of settling for such an awkward compromise.

The Bond-Currency-Derivatives Nexus is a deeply interconnected set of markets combining spot and derivatives markets on government bonds, corporate bonds, and currencies. All these markets are tightly interlinked through arbitrage. Achieving a liquid and efficient market on any of these sub-components requires achieving a liquid and efficient market on all these sub-components.

The old arrangement had problems: RBI was keen to prevent the Bond-Currency-Derivatives Nexus from emerging, and SEBI only had jurisdiction on corporate bonds with maturity over 1 year. The new arrangement consists of government bonds and corporate bonds of maturity over 1 year with SEBI, with everything else in the BCD Nexus with RBI. This is a better than the previous arrangement but unsatisfactory.

International finance: In similar fashion, it makes sense to shift regulation-making power on capital controls out of RBI. Capital controls are ultimately political, and the task of defining capital controls cannot be delegated to an independent organisation. In addition, RBI has a long history of writing capital controls regulations which drive up the cost of doing business. However, the formulation adopted -- that regulation-making for only equity flows will shift to the government -- yields small gains. Largely speaking, it replaces the de facto by the de jure.

There is room for improving capital controls regulations on equity flows, but the potential gains are small, as the Indian capital controls on equity flows are not grossly wrong. The big mistakes in the Indian capital controls are with debt flows -- whether ECB or the foreign investment into rupee denominated bonds. Thus, the reform announced in the budget speech is progress, but still unsatisfactory.

International Financial Services Centres (IFSCs) like GIFT City are a good idea. At a high level, the budget speech has made progress. The challenge is in management, execution and details. We will know GIFT City will actually work only when a concrete management mechanism is put into place and starts smoothly delivering results.

Monetary policy:: From 1934 onwards, RBI has had the power to create money, but there has been no monetary policy framework which created a `nominal anchor' for the Indian rupee, and delivers low and stable inflation. The July 2014 budget speech had promised that for the first time, a monetary policy framework would be put into place. The 80-year organisation would, for the first time, find a purpose. Now, we are told that a `Monetary Policy Framework Agreement' has been signed between MOF and RBI, which gives RBI an inflation target of "below 6%". This sounds like a good thing. However, the text of the agreement has not been released, so it is not possible to analyse this agreement and understand whether this has been done properly.

It is also stated that the RBI Act will be amended to provide for a Monetary Policy Committee. There are subtle design issues associated with setting up a Monetary Policy Committee. We have to wait and see the extent to which sound thinking has gone into the Monetary Policy Framework Agreement, and in the proposed amendment of the RBI Act.

Deeper institution building: Four `task forces' are in motion on establishing the institutional architecture of the draft Indian Financial Code. The speech says they are progressing well and will continue to work. One of the four institutions being created -- the Public Debt Management Agency -- will come into existence. The other three new organisations are : the Resolution Corporation (which will be ineffective until the Indian Financial Code is enacted), the Financial Sector Appellate Tribunal (which can yield gains in terms of a better functioning SAT, even before the draft Indian Financial Code is enacted) and the Financial Data Management Centre (which can yield gains by voluntary adoption by regulators, even before the draft Indian Financial Code is enacted).

A fifth task force will be created: To construct the `Financial Redress Agency'. This is a one-stop-shop which will hear aggrieved customers of financial services, across the entire Indian financial system. This task force will presumably utilise the management techniques which have proved successful in the other four task forces. It constitutes one more building block towards enacting and enforcing the Indian Financial Code.

Commercial divisions in courts have been debated for a long time. Now they will come into existence. We will have to wait to find out the implementation mechanisms that are adopted for this laudable venture, given the spotty performance of court automation initiatives in the past in India. The developmental work done by the Task Force on Establishing the Financial Sector Appellate Tribunal could potentially be useful here.

Finally, the budget speech promised to introduce the Indian Financial Code in Parliament. This is the centrepiece of the Indian financial reforms: a single, coherent, modern, well thought out law that replaces the haphazard 61 laws which govern finance in India today.

Pension reforms: EPFO is mandatory for most employees of non-trivial private firms. The National Pension System (NPS) works much better than the EPFO, both on client servicing, and on returns obtained by the worker. Now that the institutional machinery of the NPS is working, it will be given as a choice to workers in the EPF. This is a big step forward in terms of developing pension planning for millions of households, and long-term institutional investment in the country.

However, alongside this, paras 40, 41 and 42 offer announcements of `social security' proposals. If there is any element of `defined benefits' or assured returns in these, it can be quite dangerous. Extreme care is required on understanding the fiscal consequences of these kinds of statements, with number crunching going out into the next 75 years. It would be tragedy if, alongside expanding the well structured pension system (the NPS), the government also grows old-style socialist programs.

Bankruptcy process: The Vishwanathan Committee is working on improving the bankruptcy process. A first report has been released, which proposes incremental modifications. The Budget speech has promised a much more ambitious objective in Para 36: to Bring a comprehensive Bankruptcy Code in fiscal 2015-16, which will meet global standards, and provide necessary judicial capacity. The work process that was used for the Indian Financial Code should inform the construction of the Indian Bankruptcy Code. There may be a connection between this problem and the establishment of commercial divisions in courts.

Taxation of finance: There is an array of mistakes in tax policy when it comes to the financial system. The budget speech promises to solve two of them : the problem of `permanent establishment' of foreign fund managers, and the problem of tax pass-through for two categories of Alternative Investment Funds. Both these have been attempted before, without success. Careful analysis of the Finance Bill is required to understand whether this time, the drafting by DOR/CBDT is done correctly.

Bad ideas: `Mudra bank' is an old style socialist initiative, which is inconsistent with all the other modern elements of financial sector reforms.

Overall, there are many good ideas in the work on financial sector reforms. There is, however, a disconcerting incompleteness of the initiatives. Many of them are half hearted; a line of thought is begun but not completed. Much more is required in terms of thorough follow through in conception and execution.


Before the budget speech, there was a lot of talk of a great wave of public investment in infrastructure which was going to revitalise the economy. The numbers are now visible and do not pass muster. Para 46 says that spending on roads will go up by Rs.14,000 crore and spending on railways will go up by Rs.10,000 crore. Para 47 proposes off-balance-sheet borrowing of Rs.20,000 crore a year. Even if all these are summed up, this comes to less than 0.4% of GDP. In addition, there are the usual problems of low quality investment process with public investment, which have not been addressed. This is not going to make a significant difference to the demand side of the economy, even if we are optimistic and think that all this spending hits the economy in 2015-16 itself. So, if this is the excuse for breaching fiscal discipline, it is not a good one.

The FM has proposed revisiting and revitalising the PPP model of infrastructure development. The proposal is to rebalance the risk in infrastructure projects, by making the government bear a major part of the risk. This just a sentence but it will have major consequences for the infrastructure sector. This risk shift could very easily turn into a `heads I win, tails you lose' proposition for the private sector, or it may translate into the government running the entire infrastructure development process with the private sector stepping in for construction only.

This proposed risk shift may be solving the wrong problem. Is it clear that the problems lies in private parties holding risks they cannot manage? For example, the airport sector has similar risk sharing as other sectors but it has been fairly successful in getting investments and ensuring availability of infrastructure. Moreover, the government's own record of choosing projects for investments has been so poor that shifting the responsibility to the government may be worse that the performance of the PPP model. We have to choose the model that is most likely to work, and then make it work. In all cases, risk and return must move together.

However, there is a group of initatives which are not mere old Indian socialism, which could actually constitute genuine progress on the field of infrastructure. Para 53 promises legislation on replacing multiple prior permissions by a pre-existing regulatory mechanism. Para 72 promises a new law on procurement. Para 73 promises a new law on disputes. Para 74 promises a new law on infrastructure regulation.

There is, of course, the challenge of execution. Many laws are drafted in India, but all too often, the quality of work is poor and the new laws do not solve problems. But given high quality execution, these could be transformative initiatives. A lot of the work on establishing financial regulators, that was done for the Indian Financial Code, could potentially easily carry over to the problem of drafting law for infrastructure regulators.

Other reforms

Para 33 promises that NITI will work on creation of a Unified National Agriculture Market. This is a very important area. We have to cautiously see the extent to which modern thinking, and high quality execution, is brought into the work of NITI on this question.

Para 103 proposes a draconian policing environment on overseas assets. This is a throwback to Indira Gandhi's world, and is highly regrettable.


Narendra Modi showed a willingness to solve problems at the root cause in some sectors in Gujarat. The first budget shows glimmers of the Modi way in a few areas, but all too often, it settles for the conventional approach of compromise and defence of the status quo. Transformative initiatives, like the abolition of the Planning Commission, have not been followed through to their logical conclusion. This yields low gains.

The budget is weak on strategy, on coherent thinking. A variety of dilettantish two-page policy notes have been cobbled together in most areas. To make progress, one needs to start from full picture of where we want to go (i.e. a "grand scheme"), think it through in all its ramificiations, and undertake a series of chess moves which take us to that ultimate goal. Instead, we have got defeatist statements that in democracies, fundamental progress is not feasible. On taxation, expenditure, infrastructure, etc., there is no evidence of this kind of big thinking.

It is one thing to get through the political conflicts and agree on a line in the budget speech. It is a very different matter to get execution. The Government of India is riddled with weak teams, a lack of clarity on the direction for reform, low execution capabilities, etc. In many places, hard political battles have been fought to get a line or a paragraph into the budget speech, but this will come to naught owing to inadequate execution. The subset of the budget speech where results will be obtained will be the subset where sound teams are put into motion. The sound teams will, in turn, feed good ideas back into the next budget process. The management challenge, of establishing high quality teams on the policy priorities, is the defining question about the Indian government. Arun Jaitley and his team at the Ministry of Finance will need to carefully strategise how the good stuff out of the speech is turned into project management, that can deliver valuable change over the year.

The BJP, armed with a clear majority in the Lok Sabha, with the desire to break with Nehruvian socialism, was expected to unveil a game plan for structural changes from here till 2019. In large part, Budget 2015 does not meet the bill. It has some good elements, and with good execution, they will make an important difference. But on an array of important and pressing problems, we do not have solutions.

It is interesting to contrast this against what a UPA budget might have been. A UPA budget might have had elements like:

  • More public expenditure on infrastructure.
  • Weak fiscal consolidation, apologies for lack of deficit reduction.
  • Lack of subsidy reform.
  • Not abolish the planning commission or plan schemes, inability to re-imagine the fiscal system without central planning.
  • Increased the peak income tax rate by 2 percentage points for the rich.
  • Continue to have a 44% tax rate on firms (combining corporation tax and DDT).
  • Continue to have `bad taxes' like the STT.
  • Not remove the 2% corporate social responsibility expense in the Companies Act.
  • Indira Gandhi vintage measures on foreign assets.

It is disappointing to see how little has changed.