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Wednesday, May 27, 2015

Understanding the Indian financial environment

by Ajay Shah. 

The big facts about the US financial environment

Using very long time series in the US, three important facts are : (a) An inflation target of 2%, which is successfully delivered by the US Fed; (b) Bond return of 2.7% and (c) Equity premium of 3 percentage points.

In the US, there is a fair understanding about these three numbers and confidence that these values will hold in the coming decades.

The fact that these three things are known in the US with fair precision generates an environment of confidence. In the US, we know the probability distribution; the only thing not known is how future draws from the distribution will work out. All economic agents -- households and firms -- are able to look into the future and make plans knowing these foundations. This ability to make plans at long time horizons generates good outcomes for all economic agents and for society at large.

How might we think about the Indian economic environment?

In India, we don't know the probability distribution governing these three things (inflation, bond returns, equity returns). This generates a qualitatively higher level of uncertainty. Every financial or real sector investor faces bigger difficulties owing to this lack of knowledge. Many investments don't get made, many financial strategies (e.g. retirement planning) are not undertaken owing to the inability to peer into the future and figure out what will happen. The phrases `ambiguity' or `Knightian uncertainty' are used when describing an environment where we don't know the probability distribution of the shocks that we face.

It is interesting and important for us to understand the fundamental facts about the Indian economic environment. When institutional reforms generate enhanced clarity, and take us into the world of shocks from a known distribution, this will give a qualitative reduction in uncertainty and a better climate for all economic agents.

This is partly about better understanding the past, and partly about envisioning the new institutional machinery which is coming together. Let's start at the past.

Long-run equity returns and returns to equity investment in India

India is an equity market dominated financial system. The failures of public policy have hampered the working of the bond market and the banking system. On 20 May 2015 the market capitalisation of the CMIE Cospi index was Rs.101 trillion, and it had 2318 firms. On 17 April 2015, the stock of `non food credit' of banks, to all firms and individuals in India (and not just 2318 big firms) was Rs.65 trillion. The equity market is the dominant and market-based foundation of the financial system.

An array of interesting questions swirl around equity investment in India:
  1. Do equities in India deliver a strong equity premium, in the long run?
  2. How well does `dumb' investment in index funds perform? Is the market so inefficient that active management beats the index funds?
  3. There are over 4000 listed firms with a very great heterogeneity within them. Should one just focus on the top 50, or are there interesting investment strategies by delving into smaller and/or less liquid firms? If so, what's the appropriate investment technology to use when going there?

The long run performance of the stock market indexes with the biggest stocks

The graph above starts with the oldest time-series of equity index returns -- the 
BSE Sensex. My data here starts from 3 April 1979. This is a 30-stock index which had idiosyncratic rules about modification of the index set. From 3 July 1990 onwards, we switch over to Nifty, where the rules about changes in the index set are systematic and sensible. The black line above is the long time series obtained by pasting the two.

Over a span of 36.17 years, the black line has compound nominal INR returns of 15.91%. On average, this is a doubling every 4 years. Of course, a part of this is inflation. We don't have sound inflation data for 36.17 years so it's not possible to compute the average real INR returns on the Indian stock market index.

Nifty is the 50 biggest firms in India who have adequate stock market liquidity. Nifty Junior delves one notch below them to the next 50 big firms who have high stock market liquidity. You may think it's only a small step away from Nifty firms in terms of the large-cap high-liquidity character. Data for Nifty Junior starts from 1 January 1997. This is superposed in the graph above as the red line.

Over this span of the most recent 18.41 years, Nifty gave compound returns of 12.62%. In this period, Nifty Junior gave compound returns of 17.17%. This was a premium of 455 basis points per year.

The graph above can be interpreted as follows. Suppose you invested Rs.100 in the BSE Sensex index fund on 17 July 1979, then switched to a Nifty index fund on 3 July 1990, and 100% switched to a Nifty Junior index fund on 1 January 1997. In this case, over the 36.17 years in the graph, you'd have got a 400x return, from 100 to 40,000.

These are eye-popping numbers, but they are all in nominal INR. When expressed as USD or when expressed in real terms, the picture becomes good, but not eye-popping.

While these sample means are computed over long time horizons, it's important to keep the uncertainty of these estimates in mind. As an example, consider the estimate for BSE Sensex + Nifty above: a mean return of 15.91% over a time horizon of 36.17 years. The annualised standard deviation of this market index works out to 24.9%. This gives a distribution of the mean that has a standard deviation of $\sigma/\sqrt{N}$ of 4.14. A 95% confidence interval would be 8.11 percentage points on each side of the point estimate of 15.91 per cent. Hence, even though 36.17 years seems like a lot of data, it isn't enough to be really confident about the numerical estimate for the average equity returns in the historical data.

All this information does not take us all the way to an estimate of the equity premium, as we don't know much about the riskless rate of return in this period. See this article by Suyash Rai on alternative methods for estimating the equity risk premium. 

Interpretation and speculation


  1. These are strong rates of return over long time periods. The BSE Sensex / Nifty index had long run average returns of 15.91% and the Nifty Junior fared significantly better.
  2. These returns were achievable by index funds. There is no slip between cup and lip when going from this evidence to realised investment performance.
  3. The sharp difference between returns on Nifty and returns on Nifty Junior (455 basis points of a difference in returns per year, over 18.41 years) suggests that there may be many interesting subsets within the 4000+ listed firms in India with heterogeneity in returns. We shouldn't paint the entire Indian equity market with the Nifty brush.
  4. Can active management do better? Three factors are at work. Is the market inefficient? Does the fund manager know how to beat the market? Do you trust the fund manager to work for you? There is ground for concern about all three checkpoints.
  5. We have evidence, in mid cap stocks, that foreign institutional investors do much worse in security selection when compared with domestic institutional investors. This evidence suggests that foreign investors should sub-contract to domestic money managers or buy index funds. From the viewpoint of foreign investors, there are three issues. First, there is high home bias against India; global portfolios are systematically underweighted against Indian equities and fixed income. Second, one chunk of that investment problem (the Nifty / Nifty Junior asset class) can be done well using index funds. Third, they need to explore smaller firms and figure out answers to the three factors of market inefficiency, fund manager capability and the principal-agent problem of the manager.
  6. I am not aware of sound studies of mutual fund performance. I am not aware of sound databases about mutual fund returns. It would be interesting to look at how mutual funds are faring, to subject them to benchmark risk based on mixing Nifty and Nifty Junior, and see the extent to which there is outperformance.
  7. The case for private investment in public equities (PIPE) or hedge fund structures, which charge 2+20, would lie in three claims: (a) The market is inefficient (b) The manager understands these inefficiencies and is able to exploit them (c) The 2+20 structure aligns the incentives of the manager. At the same time, 2+20 is a very large tax; you'd need very large market inefficiencies to make it work.
  8. It's time to look behind Nifty Junior in the construction of index funds. 


A speculative view about the big facts about the future Indian investment environment

If we peer into the future, we can get an outline of the big numbers in macro/finance in India:
  1. There is some slow progress in Indian financial policy. RBI now has an objective -- CPI inflation of 4%. In time, the conflicts of interest at RBI will be removed. In time, the Bond-Currency-Derivatives Nexus will get built, which will give RBI the ability to deliver on the inflation target. In time, RBI will become a sound institution. Once all this happens, CPI inflation in India would become stable with a tight distribution around the mean of 4%.
  2. Sound practices in monetary policy and sound practices in public debt management will give a government bond yield curve with perhaps 6% on average at the short end and 9% at the long end. Perhaps the average nominal return for government bonds will be 7%, as most EMs tend to finance a lot at short maturities.
  3. Equity returns in the past came from (a) India's one-time abandonment of socialism and (b) High returns for extremely high risk given the bad macro/finance institutional environment. I think the equity premium in the future will be lower; it will be 5 to 6 percentage points. This will be higher than what's seen in the US (where risk is very low) but lower than what we've enjoyed in India in the past. This will give nominal INR returns on the Indian equity index of 11 to 12 per cent.
  4. I think that when the US inflation target is 2% and the Indian inflation target is 4%, we will get a long-run average USD/INR exchange rate depreciation of 0% to 1% per year with a volatility of 13% per year. The latter number is typical of floating exchange rates from inflation targeting EMs. It will make sense for most global investors to invest in Indian fixed income and equity without needing to fully hedge USD/INR fluctuations.
In summary, I think that in a few years, the Indian financial reforms will be completed. After that, when we peer into coming decades, there may be an internally consistent picture around five numbers:
  1. An inflation target of 4%;
  2. A short rate of 6% on average;
  3. Average nominal return for government bonds of 7%;
  4. An equity premium of 5 to 6 percentage points and
  5. Mean USD-INR returns of depreciation of 0 to 1 percent per year with a volatility of 13%. 
Clarity on these foundations, supported and made possible by the financial reforms, will make a difference to the lives of all economic agents in the country.

This is, of course, all speculative. I am surely off track on many elements of this story. For everyone working with Indian macro and finance, however, it is an interesting exercise to arrive at an opinion on the five numbers above, which are the skeleton frame of Indian finance. It would be interesting to think about the internal consistency of this picture, and chip away in finding flaws and fixing them.

Saturday, May 16, 2015

Voluntary participation in the National Pension System: What does the evidence show?

by Renuka Sane.

Long-term saving is challenging in most parts of the world. Individuals are impatient, and old age is too far away. Rising life expectancy and potential poverty in old age have led countries to set up state funded pension programs or mandate contributions through the employer. Both these are difficult to implement in India. For example, the EPFO covers only about 8-10 percent of the workforce. This makes the voluntary build-up of savings important. Informal sector workers often do not have access to formal finance, and are unable to save large sums of money in one transaction. Poor people may also find it difficult to forgo current consumption and get invested in illiquid pension assets. There is a case for the State to facilitate a formal savings mechanism, and encourage pension accumulation through co-contribution.

These ideas started gaining ground after the `National Pension System (NPS)' (which used to be called the New Pension System) had been in operation for a few years. The NPS is grounded in the philosophy of self-help and thrift. It is mandatory for central government employees since 2004, and accessible to all citizens of India. The NPS-Lite model was introduced for the informal sector, followed by the launch of the NPS-Swavalamban (NPS-S) scheme in 2010. Under the Swavalamban scheme, if a subscriber in the informal sector contributes a minimum of Rs.1000 in a financial year into her NPS account, she receives a co-contribution of Rs.1000 from the government. The scheme has been operational for four years now, and the co-contribution was promised to last until March 2017.

In the recent Budget, the Finance Minister announced another informal sector pension scheme, the Atal Pension Yojana (APY) which promises a fixed pension of at least Rs.1,000 at age 60 if subscribers contribute pre-defined amounts over their working life. While the APY has several design flaws, it seems likely that it will replace the Swavalamban scheme before 2017, at least for those between 18-40 years of age. NPS-Lite, i.e. the NPS without the co-contribution, is likely to remain in place.

It is important to take stock of what has been the response of the informal sector to NPS-Lite/Swavalamban before taking policy measures on the same. Are people enrolling in the scheme? What kinds of contributions are they able to make? Do we have the policy and processes in place for when customers retire?

How are enrollments and accumulations faring?

There is often skepticism about the ability of poor people to save. However, research has demonstrated that when provided with formal channels, poor people do save, sometimes at high cost. For example, Mukherjee (2014) finds that the willingness of people to save in a co-contribution pension scheme is high.

Aggregate official data also show that subscriptions to the scheme have been rising. According to the 2013-14 Annual Report (Table 1.6, page 22) of the PFRDA, there were a total of 2.8 million customers of NPS-Lite/Swavalamban. They made up 43 percent of the total NPS subscribers, and were the largest category of subscribers - more than government employees who make up a total of 30 percent of the subscriber base. The AUM under NPS-Lite/Swavalamban was Rs.8.4 billion, about 2 percent of the total NPS AUM. The percentage growth of AUM at almost 94 percent, between 2012-13 and 2013-14 was the highest for NPS-Lite/Swavalamban.

Sane and Thomas (2015) analyse participation and contributions of customers over the first three years of the scheme in more detail, using data from one financial services provider, the Kshetriya Grameen Financial Services (KGFS). They find that voluntary participation in an individual account DC pension system is feasible. In fact, it is the relatively poor in the sample that are more likely to open Swavalamban accounts. The evidence on persistence, is however, not as optimistic: only about 50 percent of the participants had managed to contribute more than Rs.1000 at least in one financial year in their NPS-S account. However, non-contribution in one year did not mean dormant accounts - several customers came back the next year. In terms of total contributions, members stop short of contributing more than Rs.1000 in a financial year. Part of this seems to be driven by the scheme becoming centered around the threshold for the Rs.1000 co-contribution. Members could actually contribute larger amounts, but often do not, because the scheme is sold as a Rs.1000 per year contribution scheme.

The problems in the draw-down phase

A pension scheme is ultimately judged by its ability to provide for an adequate consumption in retirement. Accumulations are only one part of the story. Since the accumulated wealth has to provide for a meaningful consumption over the lifetime of the individual, how this wealth is drawn-down becomes important. All the NPS models, including NPS-Lite/Swavalamban require that 40 percent of the account balances be used to purchase an annuity, while the remainder may be drawn-down as a lumpsum. There is currently no option of a programmed withdrawal, where part of the retirement fund is used for a draw-down (as income withdrawal) while leaving the rest of it invested.

Annuities can be expensive for the poor as they have a lower life expectancy than the rich. If they die early, they effectively end up subsidising the rich. We, therefore, need to think more carefully about the choice between annuitisation and programmed withdrawal. Different countries have approached the question of annuitisation differently, and are largely influenced by existence of a state funded pension which offers protection from poverty in retirement. The Chilean approach, for example, has been to restrict lump-sum distributions, and mandate the use of fixed inflation-indexed annuities or lifetime phased withdrawals. The Australians, are more flexible in allowing lump sums. Most recently, the UK has done away with its rule of mandating the purchase of an annuity by the age of 75, and allows for programmed withdrawals. The US has very little mandatory annuitisation.

Life insurance companies are often reluctant to enter into annuity markets because of the lack of availability of good mortality tables as well as instruments for hedging longevity and inflation risk. Lack of good mortality data is especially true in the case of low-income customers. The nominal annuity may also not be able to buy a minimum consumption basket if inflation rises over the lifetime of the retiree. If the administrative costs charged by insurance companies are high, then the value of the annuity will fall further.

Benefit policies of NPS-Lite/Swavalamban thus require a re-think. Enabling the development of mortality tables, market for inflation indexed bonds, changing the procurement of annuity service providers so as to minimise the costs of the annuity, designing default options for those who cannot choose the optimal combination of annuity and lumpsum are some of the policy initiatives that the PFRDA needs to undertake.
Similar questions are pertinent for the NPS as well. However, government employees who were enrolled in the NPS starting 2004 still have some time before they retire. The NPS-Lite/Swavalamban members who enrolled in their late 40s will get to the retirement threshold sooner, and bad design of the draw-down policy or delays in providing benefits can potentially destroy the foundation that has been built for improving informal sector participation.


There are several take-aways from the experience of the NPS-Lite/Swavalamban schemes:

  1. The number of people contributing Rs.1000 is gradually increasing.
  2. Non-contribution in one year does not mean subsequent non-contribution.
  3. There seems to be a hump in contributions at Rs.1000, most likely driven by the threshold design of the co-contribution.
  4. Benefit design policies and processes require a re-think.

The NPS-Lite/Swavalamban is gradually taking root, people are beginning to understand the scheme, and intermediaries are learning how to distribute it. Familiarity with the scheme and intermediaries is likely to build the trust that is important in fostering long-term illiquid pension contributions. The infrastructure required for channeling contributions to the fund managers seems to be largely in place.

Analysis shows that the APY by itself is not enough to meet consumption needs in retirement. Thus, even if the APY replaces Swavalamban, intermediaries should consider continuing to distribute the NPS-Lite, as a combination of APY and NPS-Lite may allow customers to enjoy higher returns than the APY alone. A minimum amount of contribution could be made to the APY towards the guaranteed pension, while the remaining can be invested in the NPS-Lite for potentially higher returns. The PFRDA needs to incentivise the sale of both the APY and the NPS-Lite, dislodge the mental threshold of Rs.1000 to encourage contributions of larger amounts, and do a rethink of the draw-down phase.


Mukherjee (2014), Micropensions: Helping the Poor Save for Old Age, Paper presented at the 5th Emerging Markets Finance Conference.

Sane, R. and S. Thomas (2015), In search of inclusion: informal sector participation in a voluntary, defined contribution pension systemJournal of Development Studies (forthcoming).

The problems of financing and the elusive recovery in the Indian business cycle

The pre-crisis credit boom and its consequences in the post-crisis period is a key feature of understanding what ails the economy today.

The pre-crisis credit boom

In Y. V. Reddy's period as governor (6/Sep/2003 to 5/Sep/2008), there was vigorous pursuit of exchange rate policy. In an attempt to defend the dollar, RBI purchased a lot of foreign assets and paid for this using rupees. These rupees distorted domestic monetary policy. At a time of the biggest ever business cycle expansion in India's history, RBI engaged in loose monetary policy. This gave the biggest ever bank credit boom:

Year-on-year growth of bank credit ("non food credit")

Central banks are supposed to take away the punch bowl when the party gets going. Instead, RBI laced the punch bowl when the party got going. Exchange rate policy converts the pro-cyclicality of capital flows into pro-cyclicality of monetary policy.

If we encountered the same combination of events today, would things work out better? One part of the problem has been partly addressed but the second has not. At the time, RBI had no clarity of objective, so each governor could make up his own objective, and the objectives could keep changing from day to day, without transparency. Y. V. Reddy had decided that his objective was the exchange rate. We are now on better ground: RBI now has only one objective -- CPI inflation -- and is held accountable for it and this choice of objective is no longer under the control of the governor. By taking away the discretion of the Governor, we have made RBI a more effective institution. However, we have yet to see the extent to which RBI works within the Monetary Policy Framework Agreement.

A second line of defence is systemic risk regulation. If there had been a systemic risk regulator in the country at this time, they would have seen this credit boom. The first trick in the mind of a person in the field of systemic risk is to watch out for big credit booms led by bank lending. This would have generated pressure to take countervailing actions. On this front, as yet, we do not have progress: there is no institutional capability in India which engages in systemic risk regulation. The draft Indian Financial Code envisages that FSDC will be the systemic risk regulator, but this institution has not yet been constructed. See this previous blog post on the strategy for systemic risk regulation.

The problems of banks

Finance is the brain of the economy, but in India, banking works badly. Weaknesses of regulation and supervision have given difficulties in the thinking of banks. With the low knowledge about banking at RBI, in India, a credit boom generally implies that credit goes into the wrong places.

A lot of the increased credit of the pre-crisis credit boom went into the wrong places. While most firms in India today are reasonably healthy, perhaps a quarter of the balance sheet size of Indian firms is in significant distress. These firms have low earnings, and are finding it difficult to handle their debt. The banks that have lent to them are also, consequently, finding that the going difficult. Some people look at overall statistics about Indian firms and draw comfort. But what's important here is not a measure of location but the left tail. If 25% of corporations are in trouble and that hampers investment by 25% of the firms, that still generates a financial channel for business cycle fluctuations.

As with past business cycle downturns, RBI's strategy has been to support banks in hiding the bad news. This postpones the bad news but does not solve the problem. As is well known in the international experience with banking distress, the countries that confront problems are better able to bounce back into safe and sound banking. When a banking regulator works to hide bad news, and supports zombie banks, this gives a Japanisation of banking, with a slow lingering crisis that hurts for years and years.

We are seeing two kinds of unwillingness to give out loans in Indian banks today. Some banks are able to discriminate good borrowers from bad borrowers and shun the weak ones. Most banks see trouble on the horizon and are holding back on all lending. They are just putting their money into government bonds. Let's zoom into the latest 3 years of the graph above, of the growth in non-food credit of banks:

Year-on-year growth of bank credit ("non food credit") for the latest 3 years

The graph above shows the substantial drop in year-on-year growth of bank credit that's afoot. To some extent, this is about the decline in inflation. But this is also about the combination of difficulties in the economy (that hamper demand for credit) and difficulties in banks (that hamper supply of credit).

Implications for macro and finance policy

This perspective has a major impact upon our thinking on macro and finance policy. When the BJP government came to power, this should have played a big role in thinking about how to play things. As an example, see this column in the Economic Times on 12 February 2015. It suggests:

  1. Formal inflation targeting at RBI.
  2. Setting up PDMA and phasing out financial repression.
  3. Enacting the Indian Financial Code to do consumer protection and properly regulate long-term contractual savings.
  4. Setting up the Bond-Currency-Derivatives Nexus, drawing on the success of the equity market.
  5. Fixing the capital controls for rupee bond inflows and
  6. Reforms of NPS, EPFO, and other long-term savings mechanisms.

How did we fare in the period after 12 February? There is some progress but not enough to solve the problems.

  • We got an inflation target but RBI managed to stave off the sound institutional machinery of a properly constructed monetary policy committee.
  • The PDMA and the bond market reforms were rolled back so we have nothing there. See P. Chidambaram in the Indian ExpressVivek Dehejia in the Mint, and Tarun Ramadorai in the Mint.
  • Capital control reform took place with an important amendment to Section 6 of FEMA. But regulation-making power for debt remains with RBI so there will be no progress on that part.
  • Portability between EPFO and NPS is a good step forward (though a lot rests on how frictionless the arrangement is). But a spectre is now haunting the NPS, the spectre of defined benefits. This could damage the core principles of NPS, of thrift and self-help.
  • The Finance Minister has made commitments about bond market reform (shifting the BCD Nexus from RBI to SEBI), setting up the PDMA, and tabling the Indian Financial Code in Parliament. But these remain actions at unstated future dates.

A great wave of entry of private and foreign banks would have helped bring new energy into banks, thus augmenting the flow of bank credit. But we remain stuck with the silliness of giving out only 2 new bank licenses per decade and blocking the expansion of foreign banks. Short term improvements can be made in the working of Asset Reconstruction Companies, and thus give a bit of improvements on de facto bankruptcy process. Instead, RBI is going in the opposite direction, favouring restructuring and deferring early resolution.

Yesterday, Neelasri Barman and N. Saraswathy, writing in the Business Standard, talk about bond issues by firms which failed. While this is partly about unexpected developments in the global bond market, this is also about the deeper problems of macro and finance policy that are holding back the macro economy.


Arun Shourie has emphasised the problem of too much tactics and not enough strategy, that afflicts the Modi administration.

For many years now, Josh Felman has emphasised the importance of the pre-crisis credit boom, and its downstream implications for busienss cycle conditions. The rich interplay of finance and macro is a key element for thinking about what ails the economy today. This perspective should have a major impact upon the strategy for macro and finance policy.

Perhaps 25% of the required work has been done through the Finance Act, 2015. The bulk of it has not been done. The lack of strategy in macro and finance policy is hampering the economic recovery. There is a need to put MOF, RBI and SEBI on the right track to go after these problems.

Friday, May 15, 2015

RBI solves the two-factor authentication problem. NOT.

22 August 2014: RBI blocked the neat payment mechanism invented by Uber. In two days, we figured this was a mistake.

15 September 2014: After thinking about this for 24 days, Raghuram Rajan said: If there is a rule on the book, we don't allow it to be violated simply because the innovation is cool. We pointed out that this was wrong.

14 May 2015: RBI showed that 18000 people in 265 days could have as much CPU power as two people in two days. However this policy change is not adequate! You can do these transactions upto Rs.2000 for a very specialised kind of card: an NFC card and NFC acceptance. Almost nobody in India at present has this. Hence, in effect, the problem has not yet been solved.

Internationally, Uber is synonymous with the cashless experience. Perhaps they gave up on the policy bottlenecks of payments in India: last week they started testing the use of cash in India. Compare and contrast with the way things are going elsewhere: E.g. in Denmark, shops are now permitted to refuse to take cash.

Stanley Pignal has written a special report in the Economist on financial technology. It makes for compelling reading. The field is pregnant with possibility for India. There are so many inefficiencies in the Indian financial system which could be attacked by such thinking. India has the requisite talent pool. Indeed, scrappy innovators in India, who are focused on solving inefficiencies in Indian finance, can build solutions that will matter on a global scale.

It's an exhilarating vision, but if you're in India, it will make you weep. None of this will come about under the present regulatory arrangements. We will silently slumber on in the dark ages. Far from launching Indian firms into the global economy bearing innovations of this nature, our regulators will domesticate the Ubers of the world and bring them down into mediocrity. It's broke and we should fix it. Cool innovation in financial technology is all about disrupting the cosy world of the incumbents, but financial regulation in India today is all about protecting the incumbents.

Sunday, May 10, 2015

MenAfriVac: A novel strategy for building a vaccine

by Swapnika Ramu.

A meningitis vaccine manufactured in India has been approved for routine immunisation in Africa: a development that is being hailed as a breakthrough in global health. Equally important is the fact that the vaccine - dubbed MenAfriVac - was developed using a new approach specifically targeted towards solving public health issues in developing countries, issues that many big pharmaceutical firms choose not to get involved in for a perceived lack of market potential.

The success of the MenAfriVac vaccine

For over a century, recurring epidemics of meningococcal A meningitis have become a significant public health problem in sub-Saharan Africa; in fact, a swathe of the continent stretching west from Senegal all the way to Ethiopia has been dubbed the meningitis belt. Meningococcal A meningitis is caused largely by the bacterium Neisseria meningitidis and can cause brain damage, hearing loss and death. Despite early detection and treatment, an estimated 5-10% of all patients die within the first 2 days after symptoms emerge. The meningitis epidemic of 1996-97 proved to be the largest in history, with 250,000 diagnosed cases and over 25,000 deaths, underscoring the urgent need for newer and more effective treatment options.

In response, representatives from some of the affected African countries partnered with the World Health Organisation (WHO) to prioritize the development of a new meningococcal vaccine. The precursor to the creation of the MenAfriVac vaccine was the Meningitis Vaccine Project (MVP), a joint effort of the WHO and the Program for Appropriate Technology in Health (PATH, a nonprofit). The MVP was funded through the Bill and Melinda Gates Foundation, and its mandate was to oversee the development and production of a safe, cost-effective meningococcal vaccine. A major player in these efforts was Pune-based Serum Institute of India Limited (SIIL), which joined
the consortium in 2004 and went on to actually produce the vaccine. While SSIL is not a listed company, it's in the CMIE database and in 2014-15 it had revenues of Rs. 36 billion.

MenAfriVac turned out to be a great success on multiple fronts. First, its production took only six years, a record time, according to the WHO. It was the first vaccine developed specifically for use in Africa, cost less than 50 cents per injection (less than 1/10th the cost of a typical new vaccine), and proved to be remarkably effective: a trial conducted in Chad showed that districts in which people had been vaccinated had 94% fewer cases of meningitis in 2012 as compared to unvaccinated districts. The vaccine also outperformed other, more expensive options from big pharma companies; in a 2011 trial, 96% of infants and toddlers immunised with MenAfriVac had antibodies in their blood, compared to only 64% of a group given a vaccine developed by GlaxoSmithKline.

By 2013, over 100 million people in the meningitis belt had been vaccinated, and the number of cases was the lowest recorded during the epidemic season over the last ten years. At present, more than 210 million people have been vaccinated, and the vaccine has now been approved for routine vaccination of infants under one year of age. Simply protecting adults against a specific disease is not enough
to eliminate epidemics, since unprotected infants are still vulnerable; a vaccine like MenAfriVac that is effective both in infants and adults will create long-term, wide-spread protection against meningitis.

Another remarkable feature of the vaccine is that it remains effective even when stored outside the cold chain, retaining its potency for up to four days when stored at temperatures up to 40 degrees Celsius. Most other widely-used vaccines, those against polio and smallpox for example, need constant refrigeration. By eliminating this requirement, the immunisation campaign can cut costs to the tune of over 12 million dollars and can target those remote areas where electricity supplies are unreliable or absent. As a result, MenAfriVac is now the first vaccine to receive WHO approval for use at ambient temperatures in developing countries.

New models in the healthcare sector

The MVP, an alliance that started between a public health organisation (the WHO) and a non-profit (PATH) and grew to include several other international partners, states that its approach was based on a "novel strategy of facilitating and coordinating numerous partnerships across the world", which could facilitate the introduction of other orphan vaccines, whose primary markets are low-income countries in the developing world. SIIL and the Dutch company Synco BioPartners supplied the raw materials necessary for making the vaccine. The conjugation technology required to put the raw materials together to generate a functional vaccine was developed through a collaboration with the US FDA's Center for Biologics Evaluation and Research. SIIL was tasked with identifying a low-cost process for vaccine production. In effect, the MVP broke the entire vaccine development process into several pieces, each of which was the responsibility of a different partner. According to Dr. Suresh Jadhav, SIIL's executive director, this modular approach was seen as controversial, with many people "sceptical...That technologies (could come from different) places and manufacturing happen at another place; this was something unheard of."

How did the MVP achieve success with its unconventional operational model?

I spoke with Dr. Marc LaForce, founding director at the MVP, and he listed some key factors. The first was that much of the basic science around developing an effective vaccine was already in place. As he said, "You need to have pretty good science in place already for the product you want to develop. This model will not work for an AIDS vaccine, for example, where an enormous amount of basic research still needs to be done." Second, the MVP was able to exploit the gap generated by big pharma's lack of interest; they focused on a problem that was restricted to developing countries, where the economics had not driven solutions at scale. Under these conditions, the MenAfriVac model worked quite well, and in fact, a similar approach was used to generate the first conjugate typhoid vaccine.

Third, the MVP focussed on developing low-cost solutions and partnered with SIIL to leverage their considerable experience in this field. SIIL also has a long history of working with global manufacturing standards, such as those laid down by the FDA, an especially important attribute in a project with multiple players. Each partner was picked based on a global analysis and very high levels of due diligence, anticipating the level of public scrutiny that grew over time as the project marched ahead.

Dr. LaForce pointed out that the biggest challenge faced by the MVP was solving intellectual property issues around the conjugation process in vaccine development. He said, "Africans really wanted this particular product, so convincing them to introduce the vaccine wasn’t really a problem. Solving the IP issues was probably the hardest part. A lot of the conjugation and structural chemistry was already known. What we had to do was to identify chemical methods to tie two compounds together that were not already covered by patents. This was a big deal and took us quite some time to solve."

The operational model that birthed MenAfriVac holds valuable lessons for building clever, low-cost healthcare solutions in resource-poor countries while bypassing the limitations of the traditional big pharma business model. One limitation is that much of the basic science needed to develop a specific vaccine must already be available. However, given that vaccine-related research and development in India holds a good deal of potential, it is reasonable to hope that lessons from MenAfriVac can be applied towards solving some of India's most pressing healthcare problems, such as malaria and tuberculosis - diseases where the traditional big pharma approach has not yielded notable results, and that are ripe for intervention through unconventional R&D models.

Thursday, May 07, 2015

Reforms of prosecution in the Indian criminal justice system

by Smriti Parsheera

The criminal justice system consists of four main components - police, prosecution, prisons and courts. These agencies are collectively responsible for apprehending, prosecuting and sentencing offenders, keeping in view the interests of the accused, the victims and the society at large.

The little data that is available about the workings of the system in India, at present, paints a grim picture. At the end of 2012 there were 18.82 million criminal cases pending before subordinate courts. Disposals and institution of new cases during the year led to a marginal decline in the figure to 18.56 million in 2013. Data from the Crime Records Bureau shows that there were 9.7 million serious criminal cases pending under the Indian Penal Code in that year out of which the trial was concluded in 1.2 million cases with a conviction rate of 40.2 per cent. Only a small fraction of the pending criminal cases are geting decided each year. Of the ones that do get decided, a majority of the verdicts in serious criminal cases do not support a conviction. A combination of factors contribute to this situation - defects in investigation techniques, inefficiency of court processes, poor quality of prosecution, delay tactics used by the parties, insufficient coordination between the agencies and absence of a framework to protect victims and witnesses, which often results in them turning hostile.

The performance of the prosecutorial wing has a direct bearing on the pace as well as quality of justice being rendered by courts. Often referred to 'ministers of justice' and 'gatekeepers of the criminal justice process' (197th report), public prosecutors (PPs) represent the interests of the state before the courts. Under Indian law, the prosecutor's role comes into play after completion of the investigation and once the matter has been admitted before the court. A lot has been legitimately said about the responsibilities of PPs and their duty to act in an impartial, truthful and fair manner. But these expectations need to be weighed against the ground realities in which the prosecution system operates. Problems in the selection and training of PPs, their poor service conditions and lack of independence and supervision have all led to prosecution being branded as the "weakest link of the criminal justice system".

The subject of prosecution falls under the concurrent list of the Constitution. This has induced difficulties in consistent nationwide reforms. States have used their authority to formulate rules for the appointment, conduct and remuneration of PPs. Recent developments include the introduction of an e-Prosecution system in Madhya Pradesh to streamline and manage the workflow of PPs in the state, and a slew of changes announced by Maharashtra to boost their conviction rates. These include a number of positive steps such as measures for securing greater independence for the Directorate of Prosecution (DoP) and evolving a court monitoring system for better coordination between the prosecutor, the investigator and witnesses. There is also a suggestion of allowing the police to have a direct say in the appointment of PPs, which goes against the well established principle of independence of the prosecution from police control.

This is, hence, a good time to think about and debate fundamental questions about the independence and accountability of prosecutors and their relationship with the other state agencies. Better knowledge can help shape and strengthen the reforms of Madhya Pradesh and Maharashtra, and help other states better navigate their own reforms of prosecution.

Structure and independence of prosecutors

The Code of Criminal Procedure (CrPC) speaks of four categories of prosecutors - PPs and additional PPs; assistant PPs for magisterial courts and special PPs who may be appointed under exceptional circumstances. Appointment of PPs and additional PPs at the district level can be done in two ways - 1) on tenure basis from a panel prepared by the district magistrate in consultation with the sessions judge; or 2) from a regular cadre of prosecutors maintained by the state.

Both methods have their pros and cons. The former makes it possible to attract the best talent from the bar while allowing judicial officers who have direct insights on the competence of those lawyers to have a prominent say in the matter. However, the extent to which this happens in practice is suspect, given the vast difference between the earnings of a successful defence counsel and a PP. Panel appointments are also criticised for lack of accountability as appointments are for a fixed tenure, generally three years, and tend to be more susceptible to political interference. The CrPC was amended in 1978 to address these issues by introducing the concept of cadre appointments. States that maintained a "regular cadre of prosecuting officers" were required by the law to treat that as the only source for appointment of PPs. The idea was that a new breed of salaried PPs would replace all empanelled prosecutors. This would improve accountability and create promotion opportunities for prosecutors in the permanent staff.

The proposal for exclusive cadre appointments, however, turned out to be a non starter. First, the Supreme Court interpreted the term "regular cadre of prosecuting officers" to mean a permanent prosecution cadre encompassing all levels, starting from assistant PPs and going up to the PP at the top. This is not the case in most states - cadre appointments are generally restricted to the level of assistant PPs. Second, a number of states passed local amendments to dilute the requirement of mandatory cadre appointments. Some of them have also done away with the need for consultation with the sessions judge for panel appointments thus giving full control to the executive. In 2006, the Prime Minister's office raised concerns about these developments and their consequent scope for arbitrariness. The Law Commission responded by indicating its preference for a combined appointment process - 50:50 split between Bar members and assistant PPs selected from the regular cadre. The Malimath Committee had also expressed the same view. A decade has passed since these recommendations, and implementation has not taken place.

The appointment process of assistant PPs for magisterial courts is more straightforward. It is generally done through a direct recruitment exercise conducted by the state public service commission. Before the enactment of the CrPC in 1973, prosecutors working at this level used to function under the control of the police.

In many cases, police officers themselves used to act as prosecutors. This blurring of lines between the prosecution and police was problematic on may counts. It was observed by the Law Commission that the police had a tendency to focus on securing convictions, which made it difficult for them to exhibit the degree of detachment found necessary for the role of a prosecutor. In the words of the Law Commission: “In undertaking the prosecution the State is not actuated by any motives of revenge but seeks only to protect the community. There should therefore be an unseemly eagerness for, or grasping at a conviction. A public prosecutor should be personally indifferent to the result of the case. His duty should consist only of placing all available evidence irrespective of the fact whether it goes against the accused or helps him, in order to aid the court in discovering the truth.

Section 25 of the CrPC fixed this by explicitly stating that police officers would not be not eligible for appointment as assistant PPs. In doing this, the legislature recognised the importance of independence of the prosecution from the investigative arm of the state, a demarcation that has also been emphasized by the courts.

Sometimes the complexity or gravity of a case may justify a more experienced lawyer to handle the prosecution. Section 24(8) of the CrPC recognizes this possibility by empowering the government to appoint a special public prosecutor (SPP) for a specific case or a class of cases. The appointment of a SPP amounts to a deviation from the general norm (of using PPs) and is therefore resorted to only under special circumstances and only and only when public interest so demands. Many times, the request for appointment of a SPP may come from the victim of the crime, but the law as laid down by the Supreme Court makes it clear that such requests cannot be granted on a routine basis. The application for appointment of a SPP has to be properly examined by the government - in most cases through the Remembrancer of Legal Affairs in the state - and should be granted only after being satisfied that the material on record justifies the need for a SPP. It has also been clarified that even though the request may have been initiated by the complainant the costs of the SPP are to be borne by the government.

Relationship with the government

PPs are appointed by the government, but the duty cast upon them is to represent the interests of the State and not the government of the day. Prosecutors who are wholly dependent on the executive for their tenure and appointments may find it hard to maintain this distinction. This is illustrated by the reshuffling of posts which seems to happen with every change in government. The problem becomes all the more stark in cases involving corruption, violence by state agencies or other instances where people close to the government find themselves on the wrong side of the law. For instance, while ordering a retrial in the Best Bakery case the Supreme Court noted that no credibility could be attached to an acquittal that is based on tainted evidence, tailored investigation, unprincipled prosecution and perfunctory trial. The court found that through selective examination of witnesses and mishandling of evidence, the PP had "acted more as a defence counsel than one whose duty was to present the truth before the Court".

Section 321 of the CrPC gives the PP the power to withdraw any case from prosecution with the consent of the court. This leads to the discharge/acquittal of the accused. The wording of the law and its interpretation by the Supreme Court makes it clear that the discretion to withdraw from prosecution is that of the PP and none else. The Government may suggest a withdrawal to the PP but cannot compel her to do so. It is the duty of the court to consider if the PP has applied her mind "as a free agent, uninfluenced by irrelevant and extraneous considerations". Yet it is often reported that prosecutors act on the directions of the government. This again raises concerns about the lack of independence from the executive.

One way of addressing this is to entrust the appointment and monitoring of PPs at all levels to an independent DoP. Most states have already set up their own DoPs but these bodies are not really independent. For instance, the head of the DoP does not have a statutorily prescribed term of appointment that would allow her to function freely from the government. DoPs are also not entrusted with control over the appointment process of PPs. The vision and organisation design of DoPs varies across states. To take an example, the DoP manual for Delhi speaks of the duty of the prosecution to secure justice for victims of crimes, and to extend support to the state in maintaining law and order. The guiding policy in Maharashtra is "To secure maximum conviction in criminal cases in all courts", which explains the nature of changes being adopted by the state. Practices also differ on where the DoP is placed - under the home department or the law department; who heads it - judicial officer, bureaucrat (Haryana), prosecutor (Delhi) or police officer (Tamil Nadu) and the scope of the DoP's powers. In a feeble effort to streamline these systems, the CrPC was amended in 2005 to say that the state governments may establish a DoP to be headed by an experienced advocate who should function under the administrative control of the state's home department. The benign wording of the provision, and the concurrent nature of the subject, have ensured that states continue to exercise their discretion on whether or not to have a DoP and what form it should take.

International practice

Unlike the Indian system where the prosecutor has little or no say till a case has been filed before the court, most other jurisdictions regard the decision on whether or not to prosecute as one of the core responsibilities of a prosecutor. In addition, prosecutors also tend to have some role to play in the investigation stage although the scope of their intervention varies across jurisdictions. The United States is an example of a country where the prosecution plays a dominant role in the working of the criminal justice system. At the federal level, a set of US Attorneys working under the US Attorney General are responsible for trial in criminal and civil cases before federal courts. They initiate prosecutions in cases and also have the authority to request investigative agencies to conduct investigations in suspected violations. In fact the attorneys can also use the grand jury process to conduct an investigation on their own.

In addition, each US state has its own State Attorney General who is in most cases an elected representative. All the State Attorneys are members of the National Association of Attorney Generals, a coordinating agency that facilitates inter-state cooperation and conducts policy research and training programs for attorneys and their staff.

This presents a useful model that can be emulated in India. The heads of the DoP or whichever body is in-charge of prosecutors in each state can be members of a body created as a forum for regular exchange of ideas among prosecutors. This will help in articulating the issues faced by them which are often common across states and finding appropriate solutions. It can also be used to create a mechanism for specialised training of PPs from across the country.

In England the Crown Prosecution Service (CPS) serves as the principal prosecuting agency. The CPS is a statutory body headed by a Director of Public Prosecutions, who works under the overall superintendence of the Attorney General. Their role is to advise the investigation authorities, decide on which cases are to be prosecuted, and to frame the charges in more serious cases. To facilitate better cooperation with other government agencies, the CPS has entered into comprehensive agreements with the police association and the prison authorities that set out their respective responsibilities for appropriate handling of crimes. Accountability and transparency in the functioning of the office is maintained through the publication of detailed annual reports, business plans and evaluation reports.

The way forward

Independence, both from the police and the government, is essential for the efficient discharge of the prosecutor's functions. This calls for the creation of a strong DoP in every state that is both operationally and financially independent. Some of the ways to do this are by statutorily providing for a transparent appointment process for the head of the DoP, a fixed term of service and clear process of removal for cause. The functions of the DoP should also be clearly articulated in the law to cover the appointment, evaluation and training of PPs and allocation of work to them. In addition, improvements of remuneration and working conditions are required so as to improve the talent pool.

The legislature should act on the recommendation of having 50:50 tenure and cadre appointments for PPs and additional PPs. The DoPs can then be tasked with the duty of evolving the evaluation criteria for the empanelment and selection of PPs from the bar and the regular cadre. In doing so, the DoPs must look at performance measures that go beyond mere conviction rates. Some of indicators that may be considered include time taken in the completion of trials; role in causing any delays in the process; conduct in plea bargaining cases; feedback of victims and witnesses; and participation in professional training programmes. In order to achieve all of this, states need to give the DoP the capacity to operate independently and the budgetary capacity to deliver on these promises. Corresponding accountability measures are required, to assess the performance of the DoP and ensure proper utilisation of resources.

There is a pressing need for better coordination between the investigation and prosecution wings. The DOPs can manage this interface with the police through a formal coordination mechanism that will enable the police to seek legal advice from the prosecution prior to the framing of charges even though they are not statutorily bound to do so. The prosecution will also benefit from police assistance in the production of witnesses and evidence before the court. The goal should be to strike a fine balance between the independence and interdependence of the two agencies.


I thank Nandkumar Saravade, Pradnya Saravade and Raja Thakare for valuable discussions.

Tuesday, May 05, 2015

Concerns about Atal Pension Yojana

by Renuka Sane.

In the recent budget, the Finance Minister announced the Atal Pension Yojana, which promises a fixed pension of at least Rs.1,000 at age 60 if subscribers contribute pre-defined amounts over their working life. The APY suffers from five problems.

1. Clarity of objective. The NPS-Swavalamban (NPS-S) has been the flagship pension scheme for the informal sector since 2010. While it has taken root over the last few years, problems in the design and process of the scheme persist. The APY seems to be motivated by these concerns. The scheme document says: `... coverage under Swavalamban Scheme is inadequate mainly due to lack of clarity of pension benefits at the age after 60. The Finance Minister has, therefore, announced a new initiative called Atal Pension Yojana (APY) in his Budget Speech for 2015-16'. Clarity of pension benefits could be interpreted as clarity of process for receipt of benefits, or certainty about the amount of benefit. The exact interpretation has not been made clear. It seems that the intent of the government is to migrate the entire existing NPS-S to the APY [See Page 7 of the APY FAQs]. It is not clear that this is the right approach. A careful examination of the lessons obtained from NPS-S over the last four years (e.g. Sane and Thomas, 2015) would have helped design a better response. Perhaps there was a role for co-contribution separately from the pension guarantee.

2. Design of the procedure. There is considerable confusion on how the APY is actually going to work. Initially, the APY was to be sold through the same aggregators that distribute the (NPS-S). New documentation indicates that it is actually only open to bank account holders. All the existing NPS-S customers are to be migrated to the APY with an option to opt-out. Does this place the responsibility of opening bank accounts for NPS-S customers on the aggregators? What happens to those who wish to continue with the NPS-Lite i.e. use the NPS without the co-contributions? In that case, the PFRDA ought to define well-defined standards of skill and care that aggregators will be expected to exercise towards a customer as invariably the aggregator will end up playing the role of an advisor when making a decision on whether to opt-out of the APY, or continue only the APY or continue the APY along with NPS-Lite.

The scheme levies penalties on those who are not able to maintain the required balance in the savings bank account for contribution on the specified date and close bank accounts if contributions are not paid for 24 months. However, we know from the NPS-S experience that informal sector workers often do not have liquidity, are not able to contribute on time, but do come back over subsequent periods. This design of the APY will invariably exclude those who cannot maintain a balance in their savings bank accounts or make regular contributions, defeating the purpose of providing a formal sector savings mechanism.

3. Price of the guarantee. Apparently innocent guarantees can prove to be disastrously costly when viewed in their entirety (e.g. Shah, 2003). The APY seems to be motivated by the desire of the government to ensure that on contributing continuously, a member gets at least a pension of Rs.1,000. While not explicitly specified, the APY seems like a minimum return guarantee which will ensure that accumulated savings at retirement do not fall below a certain value. There are different kinds of guarantees, and several ways to design minimum return guarantees. For example, an absolute rate of return guarantee promises a pre-specified rate of return, while a relative rate of return guarantee promises a return close to the average of all funds. The motivation for the choice of this particular design, and the calculations that influenced the choice have not been articulated. Under the APY the subscriber may actually be getting a sub optimal return. This is not surprising, as all guarantees come at a cost (Pennacchi, 1999). However, policy makers need to show the application of mind: the class of guarantees which was evaluated, and the logic that led up to this choice. The contributions under APY are to be invested as per the investment guidelines prescribed by Ministry of Finance, Government of India. The investment guidelines, and how they would finance the guarantee of the APY are not yet clear.

4. Safeguards against arbitrary increases. Almost all pension guarantees in the world have turned into fiscal problems. Even if a guarantee is fiscally sound at the outset, modifications to the program design later on render it bankrupt. Governments are tempted to increase benefits prior to an election. Apparently innocuous changes are announced, which add up to many percentage points of GDP. Any guarantee program requires an elaborate array of safeguards to protect against reckless actions in the future. The APY features no safeguards. It does not require governments to show actuarial calculations before any changes to the design are introduced. An example of a defined benefit guaranteed return plan running into funding difficulties is the Employees Pension Scheme (EPS). Estimates suggest that the EPS is facing a shortfall of Rs.54,000 crore, and several changes in scheme design have now been put in place owing to these funding difficulties.

5. Improper process. Indian finance has taken a big step forward by committing to the Handbook on adoption of governance enhancing and non-legislative elements of the draft Indian Financial Code. The procedural requirements in the Handbook, for framing regulations include a statement of objectives and a cost benefit analysis of each of the provisions. Many of the mistakes of the APY could have been avoided by the use of this process. It is not too late to apply this process to APY, even now.


Pennacchi, G. (1999), The value of guarantees on pension fund returns, The Journal of Risk and Insurance , 66(2), pp: 219-237.

Sane, R. and S. Thomas (2015), In search of inclusion: informal sector participation in a voluntary, defined contribution pension system, Journal of Development Studies (forthcoming).

Shah, A (2003), Investment risk in the Indian pension sector and role for pension guarantees, Economic and Political Weekly, 38(8).