What constitutes bold reforms?

I have a column in the Indian Express today with this title.

Policy framework for Finance SEZs

There is a lot of interest in India today, on setting up an international financial services centre (IFSC) in an enclave, i.e. a Special Economic Zone. Possibilities include GIFT City near Ahmedabad and a MIFC in Bombay.

A concept note of ours on this subject has been released for public comment by the Ministry of Finance.

Many decades ago, free trade zones like Kandla or SEEPZ, played a role in improving India's engagement with globalisation at a time when there were many restrictions on the current account. There is a possibility that Finance SEZs could play a similar role in improving India's engagement with globalisation.

In 2007, the Percy Mistry Committee on Mumbai as an International Financial Centre (MIFC) had rejected the strategy of building an enclave, and had emphasised the importance of solving the problems of the mainland. From 2007 till 2015, the main work process of financial sector policy has been to fix the mainland. It is only in the context of that larger strategy that it makes sense, today, to additionally explore an enclave strategy. The raw materials available at hand today, owing to that larger strategy, are what make now the enclave strategy feasible. The enclave strategy is now only a small detour and is now advisable.

The Percy Mistry Committee used the acronym `IFC' for `International Financial Centre'. This has become confusing as the acronym also stands for `Indian Financial Code'. The folks at GIFT shifted to the phrase `International Financial Services Centre' (IFSC) which is unambiguous and we should all just switch.

Conversation on financial sector reforms

A conversation with Sudipto Dey and Jayshree P. Upadhyay is in today's Business Standard.

For GDP growth to revive, we must win back households into financial savings

The decline in private corporate investment in India, in recent years, has been widely noticed. What deserves equal attention is the dismal state of household financial savings. If corporate investment is to revive, firms will require external capital, and the problem of household financial savings will become an important bottleneck. I have a column in the Economic Times today on this.

What's required in the budget speech of February 2015 in fiscal, financial and monetary institution building

There are high expectations for the February 2015 budget. The budget speech is a statement of the workplan of the government for the coming year. The BJP aspires to lay the foundations for India as a mature market economy. A key component of this is setting up fiscal, financial and monetary institutions.

At the Public finance conference in December 2014, I did a talk titled `Fiscal, financial and monetary institution building'. The video is on the NIPFPMF youtube channel:

Expert committee reports in Indian finance

Expert committees play an important role in the evolution of financial economic policy in India. Committees can be a way to merely delay action. But as Isher Ahluwalia says: "Nothing ever got done by writing it in a committee report, but nothing ever got done without writing it in committee reports". In the hands of sensible people in the world of policy, the committee process is an important tool.

Committees sift through debates, analyse rival viewpoints, draft consensus statements, bring heretical ideas into the mainstream, work out nuts and bolts of implementation particularly when there is a need for inter-agency cooperation, and sometimes draft legal instruments such as regulations or laws. I generally find that the highest quality drafting of reglations and laws is done in India through the committee process.

What follows here is a collation of what seem to be, with the benefit of hindsight, some of the more interesting and important reports in Indian finance. I was quite excited about many others at various points in time, but in the end, they turned out to be dead ends.


Full name: Report of the committee to suggest steps for fulfilling the objectives of price discovery and risk management of commodity derivatives markets, Department of Economic Affairs, Ministry of Finance, April 2014. Chairman: D. S. Kolamkar.
Short name: Kolamkar committee report.
Claim to fame: First clean thinking on the role of commodity futures.
Downstream: This will shape the evolution of commodity futures regulation.
Factoid: This was the first fruit of shifting commodity futures to DEA, which took place on 6 September 2013.


Full name: Report of the Committee to Review the FCCBs and Ordinary Shares (Through Depository Receipt Mechanism) Scheme, 1993. Ministry of Finance, November 2013. Chairman: M. S. Sahoo. Blog post.
Short name: Sahoo Committee report, or to the cognoscenti, the Sahoo 1 report.
Claim to fame: Drafted the new capital control regulation for Indian firms issuing ADR/GDRs. The cleanest and best drafted financial regulation as of November 2013.
Downstream: The regulation was issued.
Factoid:  The first report which was accompanied by a video.
Lag:  0.94 years. The shortest gap in Indian history between the committee report and its complete implementation.


Full name: Report of the Financial Sector Legislative Reforms Commission. Ministry of Finance, 22 March 2013. Chairman: B. N. Srikrishna. Blog post.
Short name: FSLRC or Srikrishna Commission report.
Claim to fame: Drafted the Indian Financial Code (IFC).
Downstream: Handbook, MIS on Handbook implementation, and task forces.
Factoid: The biggest ever team in Indian public policy for the purpose of drafting one bill. While the Commission is termed FSLRC or the Srikrishna Commission, the main output of the Commission was the IFC.


Full name: Report of the Working Group on Foreign Investment, Department of Economic Affairs, Ministry of Finance, 30 July 2010. Chairman: U. K. Sinha.
Short name: U. K. Sinha Report, or WGFI report.
Claim to fame: First talked about the rule of law as applied to capital controls, invented the single window QFI system (ht: C. B. Bhave).
Downstream: The thinking on rule of law which began here ultimately laid the foundation for FSLRC. Hopefully this report may yield a single QFI framework one day. The QFI idea is in the IFC.
Factoid:  Embarassing fumbles in the alphabet soup of FPI, QFI, etc., where the implementers seem to have not understood the report. An element of that journey.


Full Name: Financial Well-Being: Report of the Committee on Investor Awareness and Protection, Ministry of Finance. Order Issued 17 March 2009. Report submitted December 2009. Report made public 22 May 2014. Chairman: D. Swarup.
Short name: Swarup Committee Report on Consumer Protection.
Claim to fame: Built an argument for moving to a full trail model instead of the high up-front commission retail model followed by the financial sector. Triggered a public turf conflict between regulators. Also triggered the ordinance issued by the Government of India to decide the turf war in favour of the insurance regulator [blog post].
Downstream: Mutual funds went no load in 1 August 2009, even before the committee submitted its report. Ulip cost structures were reduced to be compatible with mutual funds. The traditional insurance policies continue with a 40% front commission. The knowledge and perspective produced in this committee fed into the idea that consumer protection must be at the heart of the IFC.
Amusing: For many years, the report was buried; it was probably inconsistent with the MoF decision to do the ordinance. Insurance agents burnt effigies of committee chair protesting the recommendation that the industry move to a no-load incentive structure. Links. Images.


Full name: A hundred small steps: Report of the Committee on Financial Sector Reforms, 2009. Chairman: Raghuram Rajan. Video: Part 1. Part 2.
Short name: CFSR report, Raghuram Rajan Report.
Claim to fame: Raghuram Rajan's views when he was an independent economist. Chapter 7, titled "Creating a robust infrastructure for credit".
Downstream: Fed into FSLRC.
Factoid: The chairman signed the report, but recanted in 2014. Response #1, Response #2, Response #3, Response #4.


Full name: Report of the Internal Working Group on Debt Management, Department of Economic Affairs, Ministry of Finance, 31 October 2008, Chairman: Jahangir Aziz. Blog post.
Short name: Jahangir Aziz Report, or WG DMO report.
Claim to fame: This drafted a DMO Bill.
Downstream: This got subsumed into the draft Indian Financial Code that was drafted by FSLRC. The IFC extended this to place cash management for the government also at the DMO.
Factoid: The agency was named `National Treasury Management Agency' in this report. This turns out to be the name of the Irish DMO. FSLRC shifted to the name `Public Debt Management Agency'.


Full name: Report of the High Powered Expert Committee on Making Mumbai an International Financial Centre, Department of Economic Affairs, Ministry of Finance, 10 February 2007. Chairman: Percy S. Mistry. Buy. Blog post.
Short name: MIFC report, Percy Mistry committee report.
Claim to fame: The first committee report in India's history which thought on the scale of the entire financial system. In 2008, Jayanth Varma described this as the only honest committee report in Indian finance. A lot of the things that are considered obvious today first appeared here. E.g. this is the first official document which talks inflation targeting. These were heretical ideas then.
Downstream: Fed into FSLRC.
Factoid: The chairman did not sign the report, but stands by it.


Full name: Report of High Level Expert Committee on Corporate Bonds and Securitisation, Department of Economic Affairs, Ministry of Finance, 23 December 2005. Chairman: R. H. Patil.
Short name: R. H. Patil committee report.
Claim to fame: First focus on the corporate bond market.
Downstream: Corporate bonds went demat. All trades are now reported at NSE, BSE or FIMMDA.
Factoid: In early 2004, Rakesh Mohan as Secretary (DEA) chaired a meeting which simultaneously setup the Percy Mistry Committee and the R. H. Patil Committee; the two reports were (put together) to show the light for the next phase of Indian financial sector reforms.


Full name: Report of the inter-ministerial task force on convergence of securities and commodity derivative markets, 2003. Chairman: Wajahat Habibullah.
Short name: Habibullah committee report, Convergence committee report.
Claim to fame: The first step towards unification of all organised financial trading.
Downstream: On 6 September 2013, the allocation of business rules were modified to place commodity futures into DEA.
Factoid:  A remarkable high minded report, where the Secretary of a department (Habibullah was then Secretary of the Department of Consumer Affairs) supported doing the right thing even when it reduced the turf of his department.
Lag: 10.3 years from report date to the change in allocation of business rules.


Full name: The Project OASIS report. Ministry of Social Justice and Empowerment, 11 January 2000. Chairman: Surendra A. Dave.
Short name: OASIS report or Dave Committee report.
Claim to fame: Designed the New Pension System. Anticipated the consumer protection crises of later years. Anticipated the computer and telcommunications technology that was going to become ubiquitous, but was considered space-age then.
Downstream: In December 2002, the Union Cabinet decided to create the NPS and make it mandatory for all new recruits from 1/1/2004 onwards, and to create PFRDA.
Factoid: Within the committee, it was Dave's insight that the only way to make a pension system work for poor people was to ratchet up to the frontiers of technology.
Lag:  2.93 years from the report date to the decision, and 10.75 years from the decision to the PFRDA Act.


Full name: Report of the committee on derivatives, SEBI, March 1998. Chairman: L. C. Gupta.
Short name: L. C. Gupta committee report.
Claim to fame: Laid the foundations for the start of exchange-traded derivatives in India, along with a pair of Jayanth Varma committee reports which worked out the risk management.
Downstream: Equity derivatives trading started in June 2000.
Factoid: Was the slowest committee process for a report of this complexity. It took 1.3 years from committee creation (November 1996) to the report.
Lag: 3.57 years from the creation of the committee to the start of trading.

Understanding one-rank-one-pension

This is a post that should have been written a long time ago. It seems impossible to reverse one-rank-one-pension in India now, and it seems hopeless to fix the military pension. However, it's worth understanding what the issues are, and the mess that we've landed in.

Nominal annuities in a zero growth environment

Let's start with a country with no GDP growth. So a worker earns some income all his life. We want him to tuck some money away every year into a pension account that will buy an annuity at the age of retirement. He builds up this pension wealth, and at age 60, he buys an annuity. It's common to target a "50% benefit rate", i.e. the magnitude of the annuity should be half his last wage.

To fix intuition, let's assume the number A is the price of an annuity which yields a flow of income of Rs.1 per month. In this case, the pension wealth to get to half the last wage is Aw/2.

This is the challenge of the ordinary pensions discussion. If you want an unfunded, i.e. a `defined benefit' pension, then you want the taxpayer to pay Aw/2 for each person. There is no other difference; the basic story is the same.

In India today, A is roughly Rs.133. That is, if you buy an annuity at age 60 which pays Rs.1 per month until death, the price is Rs.133.

So far, we have asked the annuity provider a simple question: We have said: I want a fixed cash flow of Rs.1 per month until I die. What would you charge for this? The annuity market says: I will charge A for this contract. This is the lowest price of an annuity; this is a simple unindexed nominal annuity.

Now we can modify the terms of this annuity in many ways.

Real annuities in a zero growth environment

You could say: Instead of giving me a nominal Rs.1 per month, give me an inflation indexed Rs.1 per month. This is an inflation indexed annuity. This will of course cost a lot more than A. To produce a nominal annuity, the annuity provider invests in nominal bonds which produce a stream of cash. But to produce a real annuity, the annuity provider has to invest in inflation-indexed bonds, which yield a lower stream of cash. Hence, it needs much more than A to produce an inflation indexed stream of Rs.1 per month. Suppose the price is B, and we know B >> A.

A government that promises an unfunded inflation-indexed annuity is placing an expense on the tax payer of Bw/2.

The problem of GDP growth

Into this environment, let's inject high GDP growth. Let's go to the higher side by assuming per capita GDP growth of 7%, which means that per capita GDP doubles every decade.

When a person is 60, he was at half the wage of persons who are 59. But when he reaches 70, his pension has stood still, but the persons who are at age 59 have (roughly) got a doubling of their wage. The pensioner has lost ground compared with the worker.

That pensioners lose ground when compared with workers is a fact of life of all pension systems. In the West, where pensions were invented, this was not a big deal, as they have had a slow growth environment. But when there is high GDP growth, this can yield glaring gaps. A pensioner who is at the 90th percentile of the Indian income distribution at age 60 will endup at perhaps the 70th percentile of the Indian income distribution at age 70.

This is just a fact of life and you can't do anything about it. Anyone who builds up wealth in India over the working years 1980 to 2020 will seem prosperous in relative terms in 2021 but will seem less prosperous in relative terms in 2031 and in 2041. That's the inexorable logic of high GDP growth.

Suppose we go to the annuity provider and say: Sell me an annuity which is not just inflation indexed, but wage indexed. The payment per month will go up to reflect the average wage growth of the economy. This is a pension which will keep up with the Joneses.

In my knowledge, there is no private insurance company which will produce such an annuity. It's a very expensive annuity to produce. Let's use the symbol C for the price of this annuity. C >> B >> A.

A government that promises someone a wage indexed pension is asking the taxpayer to put up Cw/2 which is much bigger than Bw/2 or Aw/2.

That's one-rank-one-pension

This is the costliest pension imaginable. The Indian government seems to be on the trajectory of offering this for all military personnel. It is a dramatic escalation of the implicit pension debt for the government on account of military personnel.

Once this entitlement is in place, it will be hard for the government to go through with the NPS reform, where the second stage was supposed to be integrating uniformed personnel into the NPS.

It is a disappointment that we did not have adequate thinking on these issues in time. The delays and sloppiness of implementing the NPS have been extremely costly for India.