Perils of Overtaking Investments

By V Kumaraswamy

There are severe risks attached to investments that are overtaking in nature, even while temptations to make them are high. This is an area that justifies market intervention by the government in the larger societal interest.

An easy-to-understand example is Jio’s launch, which does not introduce a new service or previously unknown product, but essentially an enhancement or more cost-effective solution to an existing demand. It is mostly a differentiated packaging of what was available through Airtel, Idea, Vodafone, etc.
The current wave of investments in retailing, some banking services, building airports in nearby areas, building parallel roadways or expressways are other examples. Jio’s financial engineering and data plans makes it more attractive for customers to switch. It is most likely commercially feasible: Perhaps by incorporating the lessons and piggybacking on other investments, it will generate better margins than previously seen by others—but these are for Reliance.

The problems with such investments are the wide divergence between private returns and net incremental returns at the societal level. Sure, it will attract new customers who couldn’t afford cellphones earlier and, to that extent, the incremental value-addition from investments will be equal at both private and societal levels.

But for customers who switch from other service providers, the two will vary vastly. Some customers may switch for better quality or range of service and, hopefully, their bills will also increase. In such a case, the net difference between their earlier bills and the current may count for net increase in value-addition at societal level (GDP increase). But for customers switching purely for better prices, even measurement becomes an issue.

In all the above cases, the private player will enjoy the full benefits of sales. However, the net value-addition for the sector as a whole after deducting the decrease in sales of other existing players is what the society gets as incremental value-addition. This will be significantly lower than new private player’s income depending upon the degree of substitution and customer switches. While the net value-addition is so constrained, in investments no such adjustments are possible. The returns on investments at the individual corporate level and at the societal level will differ, with the societal return on investments most likely to be far lower. While the former will be higher than the prevailing interest rates (otherwise the concerned corporate won’t be investing in the venture), it will be difficult to be ensure the same at the country level.

This subpar (at country level) investments will sure create problems for lending banks and equity investors. The key question is: Should the society’s savings be invested in such ventures?

If a different division of Airtel had come up with an exact replica of Reliance (even without Reliance coming out with its own), would its board approve it in the larger interest of customers and risk writing off huge standing assets on the ground? Doubtful.

And even where innovation was distinctly better; GE’s Edison fought tooth and nail for continuation of DC current over AC current supply systems being attempted by its competitors, largely to protect its standing investments rather than due to any conviction that DC was less risky for consumers. Many consumer products and durables also have such examples, but they do not create the same societal inefficiencies like in infrastructure or capital-intensive industries.

Precautions
While consumers should have choice on at least cost, emerging economies can ill-afford such investments. There will be many investments into newer sectors that can deliver far superior returns at national level. We should ideally be pursuing those, rather than ‘overtaking investments’. It is easy for emerging economies to fall into the trap of investing in ventures that individually look attractive, but do not deliver much GDP, growth or employment on a net incremental basis since tested alternatives are readily available elsewhere.

Sure, in a free-market economy, there can’t be any legislations to bar private players from investing in such sectors. But those investments could be mandated to bring in equity to support such investments since the risk is higher due to uncertainties in market share capture, new investments being able to reach planned customer switches, etc. The lending banks could be mandated to insist on a far greater proportion of equity in such ventures. This could be based on net social returns calculations. Banks may also be empowered to require the existing players to bring in more equity on the advent of such investments into the related sector. This may, in some cases, force the existing ones to seek exit by selling out to the potential newcomer. The Insolvency and Bankruptcy Code at least makes exits faster and reduces idling investments.

A certain level of such investments is inevitable or perhaps even necessary for continuous upgrade of services. The sector regulator or banking regulator could perhaps prescribe minimum social return criteria for lending public money in such ventures. Alternatively, the proportion or quantum of funds that can stay invested in such ventures may also be specified.

Turning useless wastes to useful wastes

In Beverly Hills… they don’t throw their garbage away. They make it into television shows.” —Woody Allen.

Indian wastes are ‘useless wastes’. Our consumption habits may have leapfrogged, but our disposal habits are primitive. We mix up useful wastes with useless wastes, destroying the value in the former—you can’t compost paper and vegetable remains mixed with broken glass and plastic pet bottles, nor can you recycle paper mixed with food wastes and electronic remains.
If India has to successfully deal with its wastes, two paradigmatic changes are required in our thinking.
Unfortunately, it is the rag-pickers and the municipal authorities who are made to grapple with the messy problem, without either adequate incentives or resources. The problem has to be back-loaded on consumer product companies who created the non-destructive, non-biodegradable or unconsumed packaging or products and also benefited from it; and instead of trying to segregate mixed wastes, we should prevent it from getting mixed in the first place by appropriate incentives or punishments for compliant or errant behaviour, respectively, at the stage of the mix-up.
If this principle is accepted, (1) all packaging material should also go back to the packager—just like the truck goes back to the truck owner after the delivery of cargo—and they should be made to pay for the costs of such ‘back trace’, (2) what comes into the city and urban centres should go back from where it came, and (3) electronic hardware (which are potential future debris) and packaged food (which comes with non-biodegradable packaging) should be handled at the time of the original sale itself. Outlined below is a system of incentivising segregation at source and the benefits therefrom.

The suggested scheme
1. Every consumer and industrial manufacturer/marketer should be mandated to file their recycling plan or reclamation plan annually, or on a one-time basis. This can be enforced through fines or suspension of licence, till complied with.

2. They should be made to declare on the packaging (where it is multi-layered, on each of them) what value the marketers are prepared to give back to the consumer if he/she hands over the empty containers, cartons, plastics, corrugators, etc, to the point of sale. For example, water bottles may say: “Collect 40 paise against this bottle”. This would help create a ‘waste currency’.

3. Marketing companies should be mandated to collect at least 50% initially, and by the third year if at least 90% are not collected, their manufacturing licence should stand suspended (a similar procedure of disposal to source supplier exists in the Atomic Energy Regulatory Board regulations). The actual collection must be audited by independent entities.

4. To ensure compliance that marketers make efforts to collect back, few things can be done:
–   An upfront deposit with the government can be collected, say, at 3-4% (to be varied based on the biodegradability of leftovers) at the time of manufacture or entry into state or import into India, which can be refunded back based on the percentage collection.
–   Fines on the shortfall at twice the rate will enforce recollection of wastes.
–   Over a period of time, proper price discovery will happen if the enforcement is tight. If competing consumer marketing companies start offering different rates for recollection, it will be a signal to tighten enforcement on manufacturers who offer poorer rates.

5. Marketers may not deal with the wastes themselves. They will locate third-parties to reclaim, recycle, sell to re-users, or incinerators, energy companies, etc. Positive values will be reclaimed by recycling. Reusable material will be sold at commercial values. The rest may be sold to energy or incinerating companies.

6. The end-consumer may not find it worthwhile to go to a shop and exchange the waste currency. Rag-pickers may pick up wastes at the doorstep, and claim the waste currency at a discount and hand it over at sales counters. This will incentivise source-segregation. Rag-pickers should be trained to pick up all wastes and exchange the value of wastes, and dispose of the rest in designated ways.

7. Special shops will emerge that only concentrate on the collection of all wastes for a margin in every shopping mall, street corners, etc.

8. Heavy fines should be levied on selling companies for litters found in the open, which will induce some policing by them directly.
In addition, litter disposal should be made part of the Swachh Bharat Abhiyan.
Forward distribution is highly working capital intensive, requires expensive shelf space, advertising and product promotion, besides hefty retail margins. Wastes being reclaimed do not suffer from any of these. In fact, the total cost (net of recoveries, if any) involved may not be more than 1-2% of the selling price of base material, excluding the manpower involved.

Estimates of employment and benefits
The Indian retail market for FMCG and pharmaceuticals was estimated at $630 billion in 2015. In FMCG, packaging costs typically account for 3-4% of sales value—the costs incurred on packaging on sales of $630 billion (`42 lakh crore) is likely to be about `1.4 lakh crore.
If the fines for non-collection are kept at, say, 4% of the sales value, hopefully companies could be expected to spend at least 2% on recollection (including on wages, transportation, storage and dealing with wastes), i.e. Rs 84,000 crore.
If roughly one-third of this accrues to labour as wages, it is about Rs 28,000 crore. At minimum wage rates of around `300 on 240 working days, it comes out to be 35 lakh man-years, i.e. 0.3% of our population. This is not wayward compared to the reported 0.7% currently employed in South Africa in similar activities, compared to 0.1% in India currently.

Going forward, probably the government’s role would be minimal. It should create the enabling legislation and set-up a ‘waste police’ whose job will be to catch and fine sellers who are not marking waste currency value, people littering, recyclers not completing their jobs, supervisory audit of audits, ensuring manufacturers file their plans, certifying refunds, etc. This ‘waste police’ should be additional trained staff, and not as an adjunct to the existing police duties.
The government can use a portion of ‘funds in custody’ (through upfront deposits) or fines for training and certifying the people involved. It can train people as part of skill development programmes or get originating companies to train them (for automobiles, e-wastes, hazardous chemicals, etc).
Even if compliance starts with multinational corporations and organised sector companies, it could quickly reach 40-50%. It will have a demo effect and lead to others falling in line.

Dhan Foundation – The Republic of Goodness

The Mega Micro Inst – Dhan Foundation
For the last 15 years or so whenever i visit Madurai for Business or pilgrimage, i make it a point to visit the temple of Social action and entrepreneurship – the Dhan Foundation, founded by my classmate Vasimalai (with me in the photograph).

In the initial years i could see his energy, his vision, the founding principles. But the scale and breadth of his initiatives were still not totally manifest. Much like a Sachin Tendulkar after the first 3-4 matches for India. So every once in 3-4 years i was catching up or when he was in Delhi. A slightly late morning flight back to Delhi gave me 35-40 minutes time to catch up with Vasi and
the opportunity to refresh and update. But this time it was truly astounding in the meganess of what has been achieved. A few samplers:
i. Micro finance was their start point. It has spread to several to liberate them from the money lenders usurious nature by pooling resources. By now the SHGs have a corpus of over Rs 600 cr and levered funds from banks of over Rs 1100 cr. Supporting some 11-12 lac beneficiaries.
ii. I used to see some water bodies here and there as samplers but i dont think the numbers were in high 3 digits back then. Now the score is over 4000 water bodies and tanks revived. And work on several cascade of tanks, individual tanks and systems in progress.
iii. Community insurance which leverages some of government schemes together with self resources benefits some 17 lac people – mind boggling. It covers not just what the govt and insurance companies cover but old age life insurances beyond 50 and 60, funeral expenses (a dignified death is as important in our society as in several African communities), medical, crop, cashflow, etc. Members pool their resources and divide the risks and is an out and out community based initiative where the role of Dhan is capacity building and help in scaling up.
iv. They have several initiatives for removal of poverty on sustainable (perhaps irreversible) basis. A unique scheme where the target beneficiary him/herself have to come and declare that they are out of poverty – not based on some criteria determined and remotely declared. It has been running last 10 years and covers some 900,000 families and so far over 248,000 of them have declared themselves to be over the line. Initiatives differ from place to place and person to person and based again on individual capacity building. There is healthcare initiatives, orphanage, and sanitation too.
v. Starting from 2-3 districts, the foundation is working today in several states (14 if i recollect right) and 19 districts within Tamil Nadu and RBI which has assigned them 25 village for some finance related intervention. It has over 800 staff and over 3000 community workers. It has a university, training over 15 people per batch aiming to train them in social intervention initiatives. The effort started with Tata’s substantial contribution but is self sustaining now (guess anything else would have been against the spirit with which Dhan runs) and concentrates not just on skill building thru case studies (a la IIM Ahmd of which he is an alumni) and theories… ‘most of our efforts are aimed at bringing about mind set change and imbibing appropriate and functional attitudes’.
If only the Govt locates a few such foundations India will be very soon done with the business of poverty removal and the cottage, SME and Mega industries that thrive in their name on the oxygen of siphoned off funds which have to perpetuate the very thing they are trying to get rid of so that they stay relevant.
I must confess that what keeps taking me back again and again to Dhan is an incident in my first visit. He (Vasi) had despatched me to one of his SHG groups and me and a colleague had an interview with the leader + some members of local SHG from the dis-advantaged section (if things are not misunderstood, from ST community). It took all of 2 minute to get impressed with her confidence she exuded and the grip and depth on the subject. It was extra ordinary work by Dhan i thought and it has attracted me over and over again and each time something more happens to be impressed with has taken me there the next time.
What has enabled you to reach such extraordinary levels i dared to ask this time. In fact this time the scale was far too striking and hence almost compulsive in my ask. ‘We do not run anything. It is all community based initiatives by the beneficiaries themselves. And we insist they contribute financially also to the schemes. Our role is only capacity building and I believe we have acquired some expertise in scaling up’ was the rather humble reply from Vasi,of whose orgn 5 case studies have been put out incl one in Harvard’s website.
(Numbers are as recollected based on today’s conversation. You may want to check the website). Next time you are in Madurai, please make Dhan Foundation a part of your pilgrimage. I will assist you in whatever way. You will be better off for it.IMG-20181023-WA0008

India is Thrivvving in the Interiors; forget the snooty and skeptical city dwellers

 

As i went thru the streets of this town of 70K population and drove thru the interiors, i could see the festive spirit of the independence day. Each of the 28 wards in this township had a flag hoisting ceremony, most govt establishments, hospitals, schools and some shops had their own. There were others at the street corners. People exchanging greetings, young children coming and pinning flags on your shirt, people greeting each other, loud speakers blaring speeches, national anthem, etc. On the roads one could see school children returning after assemblies, some serious holding small flags high, someone thrusting sweet into his friends mouth, making merry, greeting passersby ‘Vande Mataram’ or ‘Happy I Day’, enjoying the spirit. For the first time since mid-1960s i was seeing this kind of festive spirit about our national independence.

It was almost like the famous Tamil Song ‘ஆடுவோமே பள்ளு பாடுவோமே ஆனந்த சுதந்திரம் அடைந்துவிட்டோம்…’ kind of spirit and fervour (Lets dance; lets sing now that we have attained joyous freedom). This was on my way to the Government funded hostel /school for tribal girls in Kumaran Bheem district Telangana.

when our own ceremony was over the patron of the school asked me if i would be interested in visiting the school. We had less than 3 hours to catch the train and school is about 25 kms away. But these days most parts of India – rural or small towns – seem to promise one KM/Minute speeds and so we dared.

1 Kumaran Bheem district was part of Adilabad district and recently bifurcated and is a reserved constituency. Not so long ago – about 10 years back- the district was Naxal infested. The MLA had been gunned down right in his house inside town. and as we were driving the patron (man right of SI) pointed to other areas where there had been skirmishes and cases of vehicle burning, arson etc. But the Govt of C Naidu seem to have had some 75 encounters and gunned down many. and both his Govt and the succussor govt seem to have done a great lot of developmental work to showcase the benefits of belonging to formal systems over staying alienated. The place still has tigers roaming in the jungles and occasionally seen on the roads in summer.

2 Kumaran Bheem has the status of God in this area. He was a warrior and tribal chieftain. About 600 years ago the area was ruled by Shahs of Ballarshah (who was the maha chief), and there were several smaller kings and chieftains under his protection. These poeple belonged to the Gond tribal sect – a god fearing, hard working, and honest group. In later years the Lombardas (south indians use Lomabardi to denote a certain sense of dressing). Lombarda are Naiks who migrated from nearby Maharashtra and supposedly more intelligent and smarter and said to have climbed the social ladder faster than the original occupants. There are frequent clashes between the two. When the Shah kingdom fell there were wars with the others, then the British, then the Nizam whose army gunned down Kumaran Bheem in 1940s. Thus he attained martyredom and Godly status. (when we were getting out of school we garlanded his bust with all the temple fervour, agarbathi, garlands and camphor and no footwear allowed). (see clipping)

It appears that Naxalism is of 2 kinds – one of people who get disillusioned with the formal systems and take to arms and the other of the descent variety. People in this region who have always had to fight someone or the other right thru history protecting their land and livelihood. they fought other tribal chiefs, then British, then the Nizam and when we attained independence, the Nation took the place of the list of tormentors and they continued their ‘war’.

3 Farmer Suicides: we saw some crazy youth dancing and posing for selfies and group photos on the railway track not aware of the risks. I asked the patron about farmers suicides and the agrarian distress esp given the fact that there was an acrimonious debate on the subject a few days back in the state assembly. ‘What former suicides. Just an attempt to milk the situation. Once something happens like that, the others will make a hue and cry to take maximum advantage and get their loans written off. The fact is the govt is giving Rs 20000 loan to each farmer for each acre per crop thru Grameen Banks. I also write legal opinions and the format is so standard. If you have repaid all your previous loans it hardly takes 10 minutes.

Its those who have over-reached that fall into difficulties. there is widespread absent landlord cultivation. People who can manage 7-10 acres of lease cultivation take 50-100 acres and fail to manage or their crops fail due to want of care and unable to manage some commit suicides.

Each villager/village house unlike you and me has 3 cellphones these days. One for songs playing – usually a chinese phone it will be, one a smart phone for whatspp, social media and facebook etc. and a basic phone for talking whose battery will last for 2-3 days. and most homes have a vehicle to move around – 2 wheeler and cars in some houses. every 50 households may have a tractor and and auto per every 20-30 homes to ferry people.

4 School. The school has over 400 girl children studying upto 10 th std. Has 18 teachers. The school is well funded by the State government and is one of several such schools in the district. The government gives them 4 pair of uniforms, 2 blankets, towels, and books and stationery, sumptuous breakfast (4 different items each day), besides lunch and dinner. They are all hostellers since their parents are too poor to afford any education.

When my turn came to speak, i said something by way of reiterating sacrifices made by our forefathers and elders and asked them to be mindful that freedom comes with responsibility. But when it ended, i asked permission from the chairman and the headmaster to speak to the students (if there is something like Public Listener as opposed to Public Speaker, i would like to be a member of the club) and enquired as to what each ones ambitions are. Many Doctors, some teachers, a solitary Collector, a dancer, and a singer. You can look at the video. Each of them gave a crisp, clear and onthe spot answers – no prevarication, whataboutry or may be … this or that kind. Very clear on their goals. When i asked the ‘singer’ to sing a song, no hesitation .. sang a telugu (i presume) song  and then one more volunteered and sang Honge Kaamyaab, ek din, man me hai vishwas. I asked her to lead the chorus and she did it unhesitatingly. .

I wished i had been as clear and bold and unapologetic about myself in my younger years. I remember an older cousin of mine asking me on my future plans when i was in my final year B Com. I gave such a shameful wishy washy, gooey diffident answer like ‘ if i pass my exams may be i will try for M com in such diffident halting manner that the questioner would have wondered ‘why is this worm even existing on this earth’.

5 Pace of public works. The state has done wonders in linking up water supplies. from being a dry and draught prone area, over the last 10 years thruough a network of irrigation canals and dams water is being provided to almost all areas now. about 5-6 months ago when we were traversing the same route, we saw some planning for an irrigation canal – some markers although the road bridge had more or less been completed. But on 15th August when we went, the canal had been completed and the CM announced water connection to some 26,000 villages virtually covering all the remianing villages.

6 Hemandroff Pattas. An englishman lived and worked amongst the tribal way before Independence. he had determined that each tribal family would require about 30 acres to survive. accordingly many pattas were issued and these are even today called by his name. (not sure of spelling). Even his successor /son worked in this area and are buried here.

The confidence, bounce and the optimism and confidence of the school children was radiating. So was the festive spirit of independence day. India is thriving and will gallop along speedily and see great heights. I was taken there to enthuse and inspire them. On the contrary it was i who got inspired by them and got my faith on our democracy and development renewed on the independence day.

While on the way back i offered a decent sum to start a scholarship for the school. My patron almost instantly refused saying ‘tension math leejiye. The school is well funded by the government. there is no dearth of resource. I called you only to inspire them. all of them will remember today for a life time.’ I only wished you had spent more time and eaten with them. I (the patron) donated a block and all these were arranged in a matter of 30 minutes by the local SI, chairman of school, and headmaster’.

It seems infinitely more enthusing to belong to a colony of hopefuls however lowly (in income stakes) placed than to a colony of cynical cribbers,even if they are reservoirs of wisdom. Many city dwellers behave as if they are superior to the nation and that the nation needs them more than they need the nation. Not so the interior.

Image may contain: 8 people, including Ram Chandran, people standing, people sitting, child and outdoor
Image may contain: 7 people, including Kamal Lakhotia, people smiling, people standing

A Contrarian Monetary Policy

Indian industry has been sluggish for a fairly long time, and all our orthodox monetary policies have not been able to make it come alive, grow and deliver employment of any great proportion. Democracy does not seem to be the villain, as much as unimaginative policies. Opportunity costs for experimenting with an alternative policy are very low now, as never before.
The key cornerstones of such a policy would be as follows:

  •  No FDI/FPI or FII targets: Just maintain the rupee within -4%/+1% of REER values. This will be pre-fixed with a one-time readjustment to correct the current overvaluation.
  • No inflation targeting: Target industry/economic activity-specific interest rates based on supply gaps or potential. Debunk general purpose credit measures.
  • Switch from price-based (repo and bank rate) money volumes to volumes-based price (interest rate) discovery.
  • These monetary measures have to be garnished with two fiscal actions—bringing petroleum under the ambit of GST (28%), and aligning all export incentives with the ‘best of ASEAN’ incentive package.

Let’s see how these contrarian measures are better suited to kick-start industrial revival and help in the creation of employment. First, a recapture of changes in business behaviour especially with respect to the main policy tool, i.e. interest rates.

Interest on working capital should count as variable cash costs (marginal cost to economists). An increase across the board for all players would only push up the supply curve and result in inflated prices—quite contrary to the effect desired. In any case, due to advances in communication, payment systems, ‘as and when needed door delivered’ systems, optimisation algorithms in stock keeping, etc, businesses are working with a lot less working capital and some enterprises even on negative working capital.

The ability of long-term interest rates to influence investment decisions is fast dwindling over time. Most of the new economy is funded by equity capital and sweat equity. In conventional manufacturing, gone are the days of 4 or 3:1 debt equity structures. Credit rating agencies frown at 1.5X debt levels now. Investments in new economy areas like Google, Ola, Paytm, IPL, casinos, Reliance Jio and space travel are more an outcome of guts and vision, rather than RoI and IRR-based like automotive sector, consumer products and street corner restaurants. And the new economy’s share in investments is overshadowing that of the traditional economy’s. These have reduced the potency of some of the monetary tools. More savings are also finding their bypass route to investments than through conventional banks and financial institutions, i.e. through private equity, VC, HNI, PMS systems, etc. Interest can affect consumer demand and have some effect on savers conduct, and this could be used for maximum impact.

The Indian context
The general capacity utilisation in industries is stuck at less than 75%—a level that will hardly inspire any investments. A great proportion of consumption growth has been met through imports from more cost-competitive nations. A few relatively better cost-competitive players have seen their capacity utilisation grow to fuller levels.

There are some industries (such as telecom) that have seen investment, but these are largely in the nature of ‘overtaking’ investments, i.e. fresh investments with superior offerings, driving customers away from existing players, thus rendering already standing investments to lower capacity utilisation levels. Some such industries (such as modern retail and banking) have also destroyed jobs through the use of technology.

A contrarian approach
Working capital interest rates for manufacturers with fuller utilisation should discourage stocking. Credit flow for downstream distribution and trade for such industries may be either curtailed using physical norms or prohibitive interest rates. But long-term interest rates should be kept lower to encourage quick capacity additions. Industries which see low capacity utilisation need lower working capital and export-facilitating interest rates, but long-term loan rates should ideally dissuade fresh capacity additions.

Overtaking investments should be mandated to raise a greater proportion of funds through own or equity funds. Besides being risky themselves, they also create systemic risks for all the existing players and their financing banks, and hence the whole industry should be charged risk premiums and far tighter debt/equity targets (<0.5 maybe), which would slow down such investments.

The above clearly indicates a need to junk the current general purpose credit policies and adoption of a sector-specific approach, with working capital and capacity addition loans being priced differently—risk premiums on one end and incentives on the other.

The 2008 meltdown could, in large measure, have been avoided by controlling just one industry—construction and mortgage-backed securitisation. Industry-focused approach produces results faster, is focused on the causes, and avoids unnecessary spillages and unintended harmful side-effects on other industries.

Sticking to the REER corridor of -4%/+1% on a yearly basis will help in competitive (to the rest of the world) inflation anchoring (of traded/tradable goods and services and thus overall), unless, of course, we import a large portion from the Venezuelas of the world. A 4% undervaluation will somewhat neutralise the loss/lack of competitiveness due to our infrastructural bottlenecks, substandard scales and bureaucratic bottlenecks. Such REER targeting will also determine levels of FPI/FII targets and portfolio investments.

Even if we want to anchor inflation, 6% makes sense, but giving the same width on the underside at 2% does not make sense. Any growing economy needs higher inflation and the corridor for an anchor of 4% may even be 4-6%, instead of 2-6%. Or even just 6% maximum, like highway speed limits.

Inflation, interest rates and volume of credit all have their influence on economic activity with varying degrees, with inflation being the least direct and perhaps most loose, and the volume of credit most direct and perhaps more immediate. Moderating through a more direct tool can be more effective. Interest rates can be the resultant, than being a determinant.
Fuel oil has the largest influence for a single item and should perhaps be under the central control of the GST Council, rather than be a matter of political Centre-state slugfest. Proper control of a few such items could moderate inflation to the desired levels. Indian incentives as well infrastructure are way too uncompetitive, and even as physical infrastructure takes time, one can work with export incentives.

Monetary policies increasingly look like wet blankets to suppress high fever. Without redressing the causes, we will only reap the harmful side-effects. Monetary policies do not seem to have rediscovered themselves in the last several decades with advances in behavioural economics, not even business behaviour.

GST surpluses should be used more purposefully

https://www.financialexpress.com/opinion/gst-put-surplus-to-more-purposeful-use/1248647/

GST collections have been buoyant. The implementation seems to have gone off smoothly after initial fears, making one international indirect tax practitioner to grant that India’s experiment has been a source of positive learning for the rest and ‘no other country has implemented tax changes as fast as India’. As per reports, collections have been gathering pace and June 2019 collections are Rs 6,000 crore more than the average of last year. The GST Council has reduced the rates for 178 items from 28% to 18% in most cases and, in some cases, to 12%.

While the items seem carefully chosen, one does not know what are the alternatives the government considered before coming to the conclusion that such a step would benefit the country most optimally. The unexpected buoyancy should have been used in the best possible way to serve the greatest common good. Instead, the government and/or the GST Council seem to have settled for what looks fashionable. The government/GST Council seem to have erred for the following reasons.
First, almost all tax rates on products and services have come down under GST compared to the earlier regime of excise + CST + VAT and several other local levies cumulated. Yet, the tax collections have gone up. It is only reasonable to conclude that the enhanced tax collections have come from reduced levels of tax evasion, reduced cash transaction levels and more informal sector units getting formalised and thus getting into the tax net, besides some uptick in economic activity. The neo-converts to the formal sector are mostly small and medium enterprises and rural and semi-urban entities.

The government should have kept in mind the sources of ‘excess’ collections and its employment-generating and other distributional effects while deciding how and whom to ‘refund’ it to. There is no need to reward erstwhile tax evaders in the formal sector who have become compliant now. Since a substantial additional GST collections have come from the rural and informal sector, it would have had an impact on the employment levels there or at least reduced their net disposable income. It would be a mistake, if not sheer travesty, to sponge resources from this poorer section and pass it on to items mainly consumed by richer segments.

Second, the lost opportunity to create much-needed employment. Let us assume the government wanted to use the entire excess and it deployed this in employment-intensive and wage-intensive sectors. Let us say wages would account for half, and the other half would be used for non-wage overheads. It would leave Rs 3,000 crore in wages per month. At Rs 5,000 per month per worker, this works out to 60 lakh jobs.

Here are some areas which could have absorbed such a vast army of people. Traffic regulation to bring back discipline on our roads. Against just the belief that CCTVs and cameras would bring about discipline and maintain order on our roads, the presence of uniformed staff at every street corner would have had a far more pronounced impact.

We could have created a plastic/pollution police or litter collectors. The police force alone is short of 5 lakh personnel, compared even with a standard fixed years ago.

Third, it is not that India is a highly taxed country. Its tax-GDP ratio is one of the lowest, considering the number of things it supplies free of cost or at subsidised rates. Most of the government services are in an awful state in terms of delivery delays, due to lack of staff or ill-trained staff. Ensuring safety and security, fast and timely justice, adequate education should all be considered fundamental rights, much more so than six-lane highways and high-speed lanes. For achieving basic standards on these, it is necessary to garner greater resources. It is ironic that we have shrank from collecting resources to ensure basic minimum services.

Distributional efforts may not have the same effect on Keynesian income multipliers as fresh ‘autonomous’ investments and hence indirect job creation may not be much. But, it is likely to be far more advantageous than mere tax-cuts that are being planned now, tax cuts for people with higher than average propensity to save might even shrink employment.

Even from a political angle, it makes more sense to use it for funding low-wage employment. An increase of low-wage employment is more certain to translate into positive votes. One is not sure if the tax reduction—largely in the consumption basket of upper- and middle-class— would induce the beneficiaries to vote positively. This educated class would decide on voting preferences based on a more informed and educated choice than just tax reduction. Several such beneficiaries may not even take the trouble of voting.

Employment generation of the scale talked about here could have alleviated urban poverty in most of our major cities quite fast. Or, if the employment was focussed in rural villages, it would have meant 10 jobs in each of our 6 lakh villages, each with 200-300 households—small yet significant. That would have been the most impactful advertisement for our employment-starved reforms agenda.

For the Poor Interest Rates are more a function of Culture; not arithmatics

https://www.financialexpress.com/opinion/a-poor-understanding-of-monetary-policy/1234554/

For much of poor – rural or urban – in many parts of the world, interest rates are not a monolithic price point balancing demand and supply of credit with variations mainly (if not solely) for credit risks and time duration.

Poor people have been observed to keep currencies for safe custody without any compensation with the same wealthy lender from whom they have borrowed money at  usuary rates of interest. This seems irrational but is compelling to the poor to ensure cashflows for upcoming events like marriage, funeral, school admission, or sowing. This perhaps addresses their ‘fear’ against an irresponsible husband or ‘lack of self control’ over competing short term spending itches.

Nothing can explain so many irrational practices (as formal system sees them) in South Africa surrounding funeral finances. A decent funeral is a matter of prestige and social standing (ranks perhaps number 1 in their Maslows hierarchy) and consumes about half/full years income. Years of zero interest (or even paying safe keeping fees), deposits with funeral societies defeats arithmatic rationality but addresses anxieties on maintaning social prestige.

As the book Portfolios of the Poor reports, moneylenders to the poor almost always collect interest rates in advance and don’t refund proportionate portion for unutilized period on any prepayment. Yet just to feel relieved from the burden/shame of indebtedness the poor pay up most loans ahead of time thus increasing the ex post interest rates by several % points – irrational arithmatic wise but rational mental relief wise. The book also observes practices where people borrow expensive monies leaving savings accounts intact due to a silo (usewise) mentality.

Just no commentator or official have understood the ‘Rs 10.50 in the evening for Rs 10 in the morning’ small trade finances. Simple arithmatic tells us it is more than 1800% per annum even without compounding. But the money lender apart from running counter party risks also knows the purpose and can get into such business himself or set up someone else who can. So why should he not get to share the spoils with the trader. In that sense it is more a share in the joint venture profits not interest. Its just dividends with a Cap in treasury managers parlance.

Surely in the ladder of social shame, borrowing ranks somewhere sub-ordinate to other social compulsions (gifts and donations in marriages, funerals, festivals, religious functions, etc), medical emergencies etc. Otherwise they wont be borrowing. Borrowing for economic purposes like for sowing, cattle buying, houses etc. may be justified on rational grounds. If Governments want the poor to become rational, they may have to invest a lot in social education and training to move up indebtedness and make other non economic needs less shameful than borrowing.

In fact this sense of indebtedness and shame from failures to meet obligations and social policing have induced repayment discipline amongst the poor. This is a great social collateral which the formal systems refuse to recognise or promote.

Most poor cannot count; even if they can, most don’t

Many studies indicate that in their decision on when to borrow, from whom (for some loans from next door neighbour is preferred, for some relatives but some other purposes it is considered shameful to borrow from them), and when to repay or prepay, the arithmatic of interest rates weighs far lower as compared to a rational person. Culture, social customs, peer pressure, shame and fear, family pressures decisively overshadow the arithmatic.

Thus when the RBI’s appointed committee put caps on the interest rates charged by MFIs as the main weapon to deal with some events in the erstwhile combined Andhra Pradesh, it only betrayed its lack of understanding of the financial culture of the poor. The arithmatics of interest rate may work better for formal systems, between banks and financial markets, in cities and amongst the rich and heavily banked but not amongst the poor.

The poor levels of financial integration and inclusion in india is the result of this lack or refusal to understand the culture. RBI (or its equivalent monetary authorities) should stop their colonising mindset: they should not  supplant the financial culture by dictating the price, acceptable instruments and institutions. Formal form over substance KYC’s can never match the KYC of the local moneylender whose self interest is locked in with his customers fortunes.

Establish the role of money first before seeking policy effectiveness

Before trying to establish the suzerinity of its policies over the rural and poor India, RBI should first establish the hold of our currency (Rupee) on the poor. For some of more important functions of money the poor trust its surrogates more. Gold (cows in Swaziland or cattle in many parts of Africa) has much more dominance in store of value function of money and to a limited extent even in liquidity and transaction demand. Policies and schemes about Gold over the years have been rather unimaginative. The high levels of informal economy does not help either.

Some aspects of the financial culture of the poor described above also come out of fear and anxieties, cashflow uncertainties, ill timed arrival of cultural exigencies, etc. These can be overcome to a large degree by appropriate insurance whose penetration is very poor now. Proper insurances on various cashflow risks that the poor face, will release a lot of gold and make the poor adopt a more ‘rational’ and self-optimal practices.

Indian authorities should subsume the existing system into its network by refinancing money lenders and accepting social collaterals, finance Nidhis and Chit funds, etc.; instead they erect barriers against such practices on institutions which seek to use the available conducive social infrastructure.

We should of course continue to educate the poor communities about the arithmatics so that wherever possible the poor could act rationally, including proper search of alternatives in their own ‘irrational’ markets.

A regulator who fails to have a grip of the market culture, market practices or interact with its participants continuously to gather market intelligence and spot any significant trends and shifts, is bound to falter. East Asian societies like Indonesia (as spread out), Malaysia, Vietnam (as dense as India) have not tried to supplant the local systems but have sensibly allowed them to co-exist and serve their societies.