Given the expectations surrounding the upcoming
budget, one question needs to be addressed headon:
Does India need Big Bang reforms? Much
of the cross-country evidence of the post-war
years suggests that Big Bang reforms occur during
or in the aftermath of major crises. Moreover, Big
Bang reforms in robust democracies with multiple
actors and institutions with the power to do, undo,
and block, are the exception rather than the rule.
India today is not in crisis, and decision-making
authority is vibrantly and frustratingly diffuse.
Not only are many of the levers of power vertically
dispersed, reflected in the power of the states,
policy-making has also become dispersed
horizontally. The Supreme Court and the
Comptroller and Auditor General have all exerted
decisive influence over policy action and inaction.
Moreover, some important reforms such as
improvements to tax administration or easing the
cost of doing business, require persistence and
patience in their implementation, evoked in Max
Weber’s memorable phrase, “slow boring of hard
boards”.
Hence, Big Bang reforms as conventionally
understood are an unreasonable and infeasible
standard for evaluating the government’s reform
actions.
Equally though, the mandate received by the
government affords a unique window of political
opportunity which should not be foregone. India
needs to follow what might be called “a persistent,
encompassing, and creative incrementalism”
but with bold steps in a few areas that signal a
decisive departure from the past and that are aimed
at addressing key problems such as ramping up
investment, rationalizing subsidies, creating a
competitive, predictable, and clean tax policy
environment, and accelerating disinvestment.
Thus, Weber’s wisdom cannot be a licence for
inaction or procrastination. Boldness in areas
where policy levers can be more easily pulled by
the center combined with that incrementalism in
other areas is a combination that can cumulate over
time to Big Bang reforms. That is the appropriate
standard against which future reforms must be
assessed.
What has India done? Given the uncertainty about the nature of the shock, India has appropriately hedged. Figure 1.4 below compares the decline in international crudeoil prices with the corresponding decline in domestic retail prices of petrol and diesel. Since end-June 2014, the international price declined by about 50 percent. Of this, about 17 percent (representing about 34 percent of the overall decline) was passed on to consumers while the government retained the rest. In other words, 66 percent of the terms of trade shock went into the government’s savings with the rest being passed on to consumers. (As detailed in section 1.12, the government’s actions in this regard are also helping in form of a de-facto carbon tax.) Accounting for uncertainty about the future movement of prices, the macro-economic response has appropriately balanced savings and consumption, and by favouring the former, provided a necessary cushion to absorb the effects of higher oil prices in the future
Regardless of which data source is used, it seems clear that employment growth is lagging behind growth in the labour force. For example, according to the Census, between 2001 and 2011, labor force growth was 2.23 percent (male and female combined). This is lower than most estimates of employment growth in this decade of closer to 1.4 percent. Creating more rapid employment opportunities is clearly a major policy challenge.
AGRICULTURE
One response in the short run must be to enhance targeted support for the vulnerable in agriculture, namely the small farmer and agricultural labourer. The MGNREGA program has the virtue of being reasonably well-targeted. The challenge here is to build on this feature and use the program to build assets such as rural roads, micro-irrrigation and water management, while also shoring up rural incomes.
Rationalisation of subsidies and better targeting of beneficiaries through direct transfers would generate part of the resources for the public investment that is essential in research, education, extension, irrigation, water-management, soil testing, warehousing and cold-storage. Distortions emerging from various policies, including, exempting user charges for electricity and water need to be reduced, though better targeting and eliminating leakages. The recommendations of the Shanta Kumar Committee provide useful suggestions for the future road-map of food-policy. The functioning of the Food Corporation of India needs to be revamped substantially
Different subsidies also interact to hurt the poor. For example, fertiliser manufacturers do not have the incentive to sell their product in hard-to-access regions, since price controls mean that prices are similar everywhere, so freight subsidies on railways have been introduced to incentivise manufacturers to supply their produce widely. But those subsidies are sometimes insufficient, since freight rates are among the highest in the world, and intentionally so, to cross-subsidise artificially low passenger fares. This is an example of how a mesh of wellmeaning price controls distort incentives in a way that ultimately hurt poor households.
At first glance, kerosene seems a good candidate for price subsidies as it is popularly conceived to be consumed mostly by the poor, and yet work done in this Survey (Chapter 3) based on NSS data show that only 59 percent of subsidised kerosene allocated via the PDS is actually consumed by households, with the remainder lost to leakage, and only 46 percent of total consumption is by poor households. Even in the case of the food distributed via the PDS, leakages are very high (about 15 percent for rice and 54 percent for wheat, with most of these leakages concentrated in the APL segment).
High minimum support for rice and wheat distort crop choice, leading to water-intensive cultivation in areas where water tables have been dropping like a stone, and ultimately induce greater price volatility in non-MSP supported crops which hurts consumers, especially poor households who have volatile incomes and lack the assets to weather economic shocks. High MSPs also penalise risktaking by farmers who have ventured into nontraditional crops.
GROWTH, PRIVATE AND PUBLIC INVESTMENT
First, hobbled by weak profitability and weighed down by over-indebtedness, the Indian corporate sector is limited in its ability to invest going forward (the flow challenge). One key indicator of profitability—the interest cover ratio, which if less than one implies firms’ cash flows are not sufficient to pay their interest costs—has also worsened in recent years (Figure 1.15). Further, as the Figure 1.16 shows, the debt-equity ratios of the top 500 non-financial firms have been steadily increasing, and their level now is amongst the highest in the emerging market world
Second, weak institutions relating to bankruptcy means that the over-indebtedness problem cannot be easily resolved (the stock and ‘difficulty-ofexit’ challenge). This is reflected in the persistence of stalled projects which have been consistently around 7 to 8 percent of GDP in the last four years. Third, even if some of these problems were solved, the PPP model at least in infrastructure will need to be re-fashioned to become more viable going forward (the institutional challenge). Fourth, since a significant portion of infrastructure was financed by the banking system, especially the public sector banks, their balance sheets have deteriorated.19 For example, the sum of nonperforming and stressed assets has risen sharply, and for the PSBs they account for over 12 percent
THE BANKING CHALLENGE
Banking is hobbled by policy, which creates double financial repression, and by structural factors, which impede competition. The Economic Outlook, Prospects, and Policy Challenges 29 solution lies in the 4 Ds of deregulation (addressing the statutory liquidity ratio (SLR) and priority sector lending (PSL)), differentiation (within the public sector banks in relation to recapitalisation, shrinking balance sheets, and ownership), diversification (of source of funding within and outside banking), and disinterring (by improving exit mechanisms). Discussions of banking in India have recently focused on the problem of stressed and restructured assets, the challenges in acquiring the resources to meet the looming Basel III requirements on capital adequacy, including the respective contributions of the government and markets, and the need for governance reform reflected in the 2013 Nayak Committee Report. Stepping back from these proximate issues allows a deeper analytical diagnosis of the problems of Indian banking which in turn provide the basis for more calibrated solutions. A first question that arises is whether India is creditaddled and overbanked. One way to assess this is to see whether Indian banks were unusually imprudent in the boom phase.21 Figure 1.19 plots the domestic credit to GDP of a number of countries, as defined by the World Bank, during their period of rapid growth (these periods vary across countries) since the year of “takeoff”. It shows that while the boom years of the last decade both spawned and were fed by a credit boom, originating in the public sector banks, irrationally exuberant behaviour was not out of line with similar experiences in other countries. Indian credit grew no more rapidly than elsewhere. For example, the Japanese and Chinese financial systems lent much more during their takeoff years.
Where then does the problem lie? The problems in the Indian banking system lie elsewhere and fall into two categories: policy and structure. The policy challenge relates to financial repression. The Indian banking system is afflicted by what might be called “double financial repression” which reduces returns to savers and banks, and misallocates capital to investors. Financial repression on the asset side of the balance sheet is created by the statutory liquidity ratio (SLR) requirement that forces banks to hold government securities, and priority sector lending (PSL) that forces resource deployment in less-than-fully efficient ways23. Financial repression on the liability side has arisen from high inflation since 2007, leading to negative real interest rates, and a sharp reduction in household savings. As India exits from liabilityside repression with declining inflation, the time may be appropriate for addressing its asset-side counterparts. The structural problems relate to competition and ownership. First, there appears to be a lack of competition, reflected in the private sector banks’ inability to increase their presence. Indeed, one of the paradoxes of recent banking history is that the share of the private sector in overall banking aggregates barely increased at a time when the country witnessed its most rapid growth and one that was fuelled by the private sector. It was an anomalous case of private sector growth without private sector bank financing. Even allowing for the over- exuberance of the PSBs that financed this investment-led growth phase, the reticence of the private
sector was striking (see Figure 1.21).
Second, PSL norms too can be re-assessed. There are two options: one is indirect reform bringing more sectors into the ambit of PSL, until in the limit every sector is a priority sector; and the other is to redefine the norms to slowly make PSL more targeted, smaller, and need-driven. There must be differentiation between the PSBs and the recent approach to recapitalization adopted by the government is a step in the right direction. One size fits all approaches such as governance reform cannot be the most appropriate. Differentiation will allow a full menu of options such as selective recapitalization, diluted government ownership, and exit.
‘Diversify’’ implies that there must be greater competition within the banking system, including liberal licensing of more banks and different types of banks. There must also be greater competition from capital, especially bond, markets. Facilitating that will require exiting from asset side repression, namely the phasing down of the SLRs which would also help develop bond markets. ‘‘Disinter’’ implies that exit procedures must become more efficient. Debt Recovery Tribunals are over-burdened and under-resourced, leading to tardy resolution. The ownership structure and efficacy of Asset Restructuring Companies, in which banks themselves have significant stakes of banks, creates misaligned incentives. The Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI) Act seems to be implemented most vigorously against the smallest borrowers and MSEs. Mechanisms for distributing pain efficiently amongst promoters, creditors, consumers, and taxpayers without creating moral hazard incentives for imprudent lending by banks are necessary. One important lesson is that the clean-up is as important as the run-up.
Box 1.4: ‘‘Make in India’’ Not by Protecting but by Eliminating Negative Protectionism Eliminating all the exemptions for the countervailing duty (CVD) will eliminate the negative protection facing Indian manufacturers, and help the ‘‘Make in India’’ initiative, without violating India’s international obligations. There is one response that would help manufacturing and the “Make in India” initiative without being as difficult as improving the business environment, and as controversial and expensive as the industrial policy or protectionist response: eliminating the exemptions in the countervailing duties (CVD) and special additional duties (SAD) levied on imports. Why will this help?
]
These actions have taken India from a carbon subsidization regime to one of significant carbon taxation regime—from a negative price to an implicit positive price on carbon emissions. And the shift has been large.
In addition India has increased the coal cess from Rs. 50 per ton to Rs.100 per ton, which is equivalent to a carbon tax of about US$ 1 per ton. The health cost of coal for power generation in India is estimated to range from US$ 3.41 per ton to US$ 51.11 per ton depending on the value of statistical life. The average number is US$ 27.26 per ton. The health costs of emissions from coal fired power plants include costs associated with premature cardiopulmonary deaths and illnesses from the chronic effects of long-term exposure and the acute effects of short-term exposure. Higher taxes on coal to offset these purely domestic externalities would need to be balanced against their implications for power pricing and hence access to energy for the 300 million households still without electricity
On January 22nd, 2015, the Prime Minister launched the Beti Bachao, Beti Padhao campaign from Panipat in Haryana. The campaign is aimed at increasing the very low value that Indian society puts on a girl child. But India is somewhat of a paradox on gender issues. On the one hand, India has had prominent and visible women leaders such as a female President, a female Prime Minister, several female heads of large political parties at the national and state levels, several Cabinet rank ministers, and several captains of industry (particularly in the banking sector). And yet, according to the UNDP’s latest Human Development Report (2014), India ranks 135 out of 187 countries on the Human Development Index (HDI) and 127 out of 152 countries on the Gender Inequality Index (GII).
Of the total sterilisation operations performed in 2012-13, tubectomy/laproscopic sterilisations account for 97.4 percent, while male vasectomy operations, considered less complicated risky, account for only 2.5 percent (Figure 1.27). Government expenditures are also skewed toward female sterilization
The negative fallouts of pursuing a population policy that largely focuses on birth control also contributes to declining child sex ratios: if every family is to have fewer children, there is a greater anxiety that at least one of them should be male.
government could:
(i) Review the family planning program in India and reorient it such that it is aligned with reproductive health rights of women, and needs of India’s population.
(ii) Increase budgets for quality services, static family planning clinics and quality monitoring and supervision.
(iii) Address youth needs, induct more counsellors for sexual health, more youth-friendly services, and adequate supply of spacing methods
What has India done? Given the uncertainty about the nature of the shock, India has appropriately hedged. Figure 1.4 below compares the decline in international crudeoil prices with the corresponding decline in domestic retail prices of petrol and diesel. Since end-June 2014, the international price declined by about 50 percent. Of this, about 17 percent (representing about 34 percent of the overall decline) was passed on to consumers while the government retained the rest. In other words, 66 percent of the terms of trade shock went into the government’s savings with the rest being passed on to consumers. (As detailed in section 1.12, the government’s actions in this regard are also helping in form of a de-facto carbon tax.) Accounting for uncertainty about the future movement of prices, the macro-economic response has appropriately balanced savings and consumption, and by favouring the former, provided a necessary cushion to absorb the effects of higher oil prices in the future
Regardless of which data source is used, it seems clear that employment growth is lagging behind growth in the labour force. For example, according to the Census, between 2001 and 2011, labor force growth was 2.23 percent (male and female combined). This is lower than most estimates of employment growth in this decade of closer to 1.4 percent. Creating more rapid employment opportunities is clearly a major policy challenge.
AGRICULTURE
One response in the short run must be to enhance targeted support for the vulnerable in agriculture, namely the small farmer and agricultural labourer. The MGNREGA program has the virtue of being reasonably well-targeted. The challenge here is to build on this feature and use the program to build assets such as rural roads, micro-irrrigation and water management, while also shoring up rural incomes.
Rationalisation of subsidies and better targeting of beneficiaries through direct transfers would generate part of the resources for the public investment that is essential in research, education, extension, irrigation, water-management, soil testing, warehousing and cold-storage. Distortions emerging from various policies, including, exempting user charges for electricity and water need to be reduced, though better targeting and eliminating leakages. The recommendations of the Shanta Kumar Committee provide useful suggestions for the future road-map of food-policy. The functioning of the Food Corporation of India needs to be revamped substantially
To provide efficient advance price-discovery to
farmers and enable them to hedge price risks the
Forward Markets Commission is being
strengthened. The concern that there may be
unnecessary speculation should be addressed
though more effective regulation along the lines of
the recommendations made by the Financial Sector
Legislative Reforms Commission (FSLRC).
Different subsidies also interact to hurt the poor. For example, fertiliser manufacturers do not have the incentive to sell their product in hard-to-access regions, since price controls mean that prices are similar everywhere, so freight subsidies on railways have been introduced to incentivise manufacturers to supply their produce widely. But those subsidies are sometimes insufficient, since freight rates are among the highest in the world, and intentionally so, to cross-subsidise artificially low passenger fares. This is an example of how a mesh of wellmeaning price controls distort incentives in a way that ultimately hurt poor households.
At first glance, kerosene seems a good candidate for price subsidies as it is popularly conceived to be consumed mostly by the poor, and yet work done in this Survey (Chapter 3) based on NSS data show that only 59 percent of subsidised kerosene allocated via the PDS is actually consumed by households, with the remainder lost to leakage, and only 46 percent of total consumption is by poor households. Even in the case of the food distributed via the PDS, leakages are very high (about 15 percent for rice and 54 percent for wheat, with most of these leakages concentrated in the APL segment).
High minimum support for rice and wheat distort crop choice, leading to water-intensive cultivation in areas where water tables have been dropping like a stone, and ultimately induce greater price volatility in non-MSP supported crops which hurts consumers, especially poor households who have volatile incomes and lack the assets to weather economic shocks. High MSPs also penalise risktaking by farmers who have ventured into nontraditional crops.
GROWTH, PRIVATE AND PUBLIC INVESTMENT
First, hobbled by weak profitability and weighed down by over-indebtedness, the Indian corporate sector is limited in its ability to invest going forward (the flow challenge). One key indicator of profitability—the interest cover ratio, which if less than one implies firms’ cash flows are not sufficient to pay their interest costs—has also worsened in recent years (Figure 1.15). Further, as the Figure 1.16 shows, the debt-equity ratios of the top 500 non-financial firms have been steadily increasing, and their level now is amongst the highest in the emerging market world
Second, weak institutions relating to bankruptcy means that the over-indebtedness problem cannot be easily resolved (the stock and ‘difficulty-ofexit’ challenge). This is reflected in the persistence of stalled projects which have been consistently around 7 to 8 percent of GDP in the last four years. Third, even if some of these problems were solved, the PPP model at least in infrastructure will need to be re-fashioned to become more viable going forward (the institutional challenge). Fourth, since a significant portion of infrastructure was financed by the banking system, especially the public sector banks, their balance sheets have deteriorated.19 For example, the sum of nonperforming and stressed assets has risen sharply, and for the PSBs they account for over 12 percent
THE BANKING CHALLENGE
Banking is hobbled by policy, which creates double financial repression, and by structural factors, which impede competition. The Economic Outlook, Prospects, and Policy Challenges 29 solution lies in the 4 Ds of deregulation (addressing the statutory liquidity ratio (SLR) and priority sector lending (PSL)), differentiation (within the public sector banks in relation to recapitalisation, shrinking balance sheets, and ownership), diversification (of source of funding within and outside banking), and disinterring (by improving exit mechanisms). Discussions of banking in India have recently focused on the problem of stressed and restructured assets, the challenges in acquiring the resources to meet the looming Basel III requirements on capital adequacy, including the respective contributions of the government and markets, and the need for governance reform reflected in the 2013 Nayak Committee Report. Stepping back from these proximate issues allows a deeper analytical diagnosis of the problems of Indian banking which in turn provide the basis for more calibrated solutions. A first question that arises is whether India is creditaddled and overbanked. One way to assess this is to see whether Indian banks were unusually imprudent in the boom phase.21 Figure 1.19 plots the domestic credit to GDP of a number of countries, as defined by the World Bank, during their period of rapid growth (these periods vary across countries) since the year of “takeoff”. It shows that while the boom years of the last decade both spawned and were fed by a credit boom, originating in the public sector banks, irrationally exuberant behaviour was not out of line with similar experiences in other countries. Indian credit grew no more rapidly than elsewhere. For example, the Japanese and Chinese financial systems lent much more during their takeoff years.
Where then does the problem lie? The problems in the Indian banking system lie elsewhere and fall into two categories: policy and structure. The policy challenge relates to financial repression. The Indian banking system is afflicted by what might be called “double financial repression” which reduces returns to savers and banks, and misallocates capital to investors. Financial repression on the asset side of the balance sheet is created by the statutory liquidity ratio (SLR) requirement that forces banks to hold government securities, and priority sector lending (PSL) that forces resource deployment in less-than-fully efficient ways23. Financial repression on the liability side has arisen from high inflation since 2007, leading to negative real interest rates, and a sharp reduction in household savings. As India exits from liabilityside repression with declining inflation, the time may be appropriate for addressing its asset-side counterparts. The structural problems relate to competition and ownership. First, there appears to be a lack of competition, reflected in the private sector banks’ inability to increase their presence. Indeed, one of the paradoxes of recent banking history is that the share of the private sector in overall banking aggregates barely increased at a time when the country witnessed its most rapid growth and one that was fuelled by the private sector. It was an anomalous case of private sector growth without private sector bank financing. Even allowing for the over- exuberance of the PSBs that financed this investment-led growth phase, the reticence of the private
sector was striking (see Figure 1.21).
Second, PSL norms too can be re-assessed. There are two options: one is indirect reform bringing more sectors into the ambit of PSL, until in the limit every sector is a priority sector; and the other is to redefine the norms to slowly make PSL more targeted, smaller, and need-driven. There must be differentiation between the PSBs and the recent approach to recapitalization adopted by the government is a step in the right direction. One size fits all approaches such as governance reform cannot be the most appropriate. Differentiation will allow a full menu of options such as selective recapitalization, diluted government ownership, and exit.
‘Diversify’’ implies that there must be greater competition within the banking system, including liberal licensing of more banks and different types of banks. There must also be greater competition from capital, especially bond, markets. Facilitating that will require exiting from asset side repression, namely the phasing down of the SLRs which would also help develop bond markets. ‘‘Disinter’’ implies that exit procedures must become more efficient. Debt Recovery Tribunals are over-burdened and under-resourced, leading to tardy resolution. The ownership structure and efficacy of Asset Restructuring Companies, in which banks themselves have significant stakes of banks, creates misaligned incentives. The Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI) Act seems to be implemented most vigorously against the smallest borrowers and MSEs. Mechanisms for distributing pain efficiently amongst promoters, creditors, consumers, and taxpayers without creating moral hazard incentives for imprudent lending by banks are necessary. One important lesson is that the clean-up is as important as the run-up.
Box 1.4: ‘‘Make in India’’ Not by Protecting but by Eliminating Negative Protectionism Eliminating all the exemptions for the countervailing duty (CVD) will eliminate the negative protection facing Indian manufacturers, and help the ‘‘Make in India’’ initiative, without violating India’s international obligations. There is one response that would help manufacturing and the “Make in India” initiative without being as difficult as improving the business environment, and as controversial and expensive as the industrial policy or protectionist response: eliminating the exemptions in the countervailing duties (CVD) and special additional duties (SAD) levied on imports. Why will this help?
]
These actions have taken India from a carbon subsidization regime to one of significant carbon taxation regime—from a negative price to an implicit positive price on carbon emissions. And the shift has been large.
In addition India has increased the coal cess from Rs. 50 per ton to Rs.100 per ton, which is equivalent to a carbon tax of about US$ 1 per ton. The health cost of coal for power generation in India is estimated to range from US$ 3.41 per ton to US$ 51.11 per ton depending on the value of statistical life. The average number is US$ 27.26 per ton. The health costs of emissions from coal fired power plants include costs associated with premature cardiopulmonary deaths and illnesses from the chronic effects of long-term exposure and the acute effects of short-term exposure. Higher taxes on coal to offset these purely domestic externalities would need to be balanced against their implications for power pricing and hence access to energy for the 300 million households still without electricity
On January 22nd, 2015, the Prime Minister launched the Beti Bachao, Beti Padhao campaign from Panipat in Haryana. The campaign is aimed at increasing the very low value that Indian society puts on a girl child. But India is somewhat of a paradox on gender issues. On the one hand, India has had prominent and visible women leaders such as a female President, a female Prime Minister, several female heads of large political parties at the national and state levels, several Cabinet rank ministers, and several captains of industry (particularly in the banking sector). And yet, according to the UNDP’s latest Human Development Report (2014), India ranks 135 out of 187 countries on the Human Development Index (HDI) and 127 out of 152 countries on the Gender Inequality Index (GII).
Of the total sterilisation operations performed in 2012-13, tubectomy/laproscopic sterilisations account for 97.4 percent, while male vasectomy operations, considered less complicated risky, account for only 2.5 percent (Figure 1.27). Government expenditures are also skewed toward female sterilization
The negative fallouts of pursuing a population policy that largely focuses on birth control also contributes to declining child sex ratios: if every family is to have fewer children, there is a greater anxiety that at least one of them should be male.
government could:
(i) Review the family planning program in India and reorient it such that it is aligned with reproductive health rights of women, and needs of India’s population.
(ii) Increase budgets for quality services, static family planning clinics and quality monitoring and supervision.
(iii) Address youth needs, induct more counsellors for sexual health, more youth-friendly services, and adequate supply of spacing methods
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