Prof Dholakia: the policy rebel within the MPC

Prof Dholakia: the policy rebel within the MPC

V Kumaraswamy

The term of the first Monetary Policy Committee (MPC) has ended with the government nominees retiring at the end of their non-renewable and non-shrinkable 4 year term coming to end in September 2020. The Government has nominated Dr Shashanka Bhide, Dr Ashima Goyal and Prof Jayanth Varma as replacements for Dr Ravindra Dholakia, Dr Pami Dua and Dr Chetan Ghate.

Given its current orientation – banking on the lending side at least is largely industry and service focused – it would have been desirable to have an industrial economist or more appropriately an industrialist on the panel. If customer centricity is the prevailing buzzword, it would have been most welcome to have someone who could share with the committee the situation and consequences of policy actions.

Hopefully, Dr Bhide with his unique smell of the soil will bring in the necessary native knowledge to the proceedings. May be there is a case for broad basing the skills without increasing the number.

While the functioning may have been cohesive, whether the content and policy prescriptions were appropriate and optimal has been in doubt. How much the monetary policy framework is a contributor to the current run of economic sluggishness is yet not widely understood but that the date of birth of both coincide should give rise to doubts to the discerning. For on many occasions it seemed largely prescriptive in nature based on some borrowed ideals.

Prof Dholakia mostly appeared like the rebel within. And truth be told his dissensions captured the ground realities better than the official statements often.

Probably he was never comfortable with the concept of monolithic or prescriptive nature of the Dr Urjit Patel Committee’s (UPC) recommendations that has guided our monetary policy making since early 2014. As early as in 2014 he had countered the rationale articulated by the then Governor for setting up UPC. In an article published in Economic and Political Weekly in July 2014 he had concluded as follows:

 “It is clear from the discussion that the RBI Governor’s assertion of there being not serious trade off between inflation and growth in the country does not get any support from recent empirical evidence. On the contrary, deliberate disinflation would impose a sizeable immediate cost of loss of output on the system. His second assertion on the direction of causality also does not have any clear supporting evidence…” (Page 168, EPW July 12, 2014. But given the time for publication this must have been written much before the committee finalised its report).

That he found a place in the MPC speaks of the Governor’s and the Government’s encouragement of dissensions for enriching the debate.  

For him it is not the ideal but the optimal – one which weighs the costs and benefits of policy actions that counted. As briefly mentioned in 2014, he went to calculate the sacrifices made for every 1% variation from the optimal or natural rate of inflation and the prescriptions of Monetary policy. In an article published (with Mr Kadiyala Sri Vrinchi) by the reputed Journal of Quantitative Economics (April 2016), he proceeded to calculate the sacrifice ratio (the % of output sacrificed in order to obtain one percentage reduction in the inflation rate) based on a fairly long period of 18 years of Indian data. The sacrifice ratio is summarised in the table below:

 Estimates of Sacrifice Ratio (SR)
Inflation measureShort run SRLong Run SR
GDP deflator3.62022.2396
CPI3.29671.7329
WPI2.98242.2404

The numbers are not insignificant for an economy stuck with low employment growth and more onerous task of pulling people out of poverty. Especially for anyone aware of the deficiencies involved in calculating any statistics in India, the validity, narrow base, considerable lag and poor quality to enforce an ideal rate of inflation against an actual sacrifice of the above magnitude must seem wasteful.  His dissensions should be seen in this light and not intent of adding more heat than light to the debate.

He proceeded to arrive at the optimal rate of inflation for India as 5.4 to 6% while presenting his annual Presidential address to The Indian Econometric Society in January 2020. (it was later published in JQE in September 2020).

Based on the regressions on data between 1996 to 2018/19 he observed, “current targets are fixed for combined (states and centre) fiscal deficit at 6%, for CAD at 2%, and inflation at 4%, for a growth at 8%. These are not internally consistent targets, because with the given targets of FD, CAD and inflation rate, consistent estimate for the long run growth as seen (in the table) is only 5.6%—a shortfall of whopping 2.4% points!!”

His equations conclude that to reach 8% growth India would need 2.5% CAD, and fiscal deficit target of 6.5-7% and inflation of 5.4% to 6%.

Probably it explains his preference often for accommodative stance. One only hopes there is a serious review of the inflation targeting levels as well as the approach in the near future. While the targets appear too low, the approach cannot be divorced from our state and stage of growth, degree of integration, and monetary policy reach.

The current state of sluggishness cannot be validly analysed without removing the huge impact that the specific levels of inflation targets as well as the fiscal glide path given by the FRBM review committee whose recommendations again have been prescribed without calculating the optimal or sustainable levels with the result both have started operating as constraints on our growth.

The Governments Formalisation drive may be unwittingly shrinking the economy

The current government has stayed focused on both formalization of the economy and digitization. The first focusses on bringing more of the unorganized economic activity into the formal fold by means of GST, making it uneconomical for others to deal with them, ensuring registrations under various laws governing manufacturing activity and income tax laws. While informal need not necessarily mean evasion, in practice a large proportion of them were. Informal estimates which put 45-50% within formal folds are putting formal economy in the 70-75 % now within a span of 5 years.

It has sought to push digitization by linking most of its subsidies to bank accounts, opening Jan Dhan accounts, and pushing for more digitized payments across all sections.

Both have laudable objectives. They reduce incentives for evasion, provide a level playing field for tax complaint entities besides spreading the tax base so that the burden falls more equitably on all the players rather than a select few, and increase the tax-GDP ratio.

While the salutary effects are already visible, what may have missed our attention is that such formalization may have inadvertently shrunk the economy leading to poorer growth. This article examines how indirect taxes like GST may have caused this.

Effect of Taxes

Our economy was a mixture of formal and informal sector with their various levels of evasion of taxes and dodging of other laws. With the benefits of tax evasion many of the informal and unorganized units in many industries were cost-competitive and enjoyed a fair share of the markets. But with the ‘imposition’ of indirect taxes many of them have become uncompetitive (the dotted bars representing them have moved to the right and hence unable to supply the market, in the middle graph).

It is not that all informal units will fall by the wayside. Several units in Sivakasi, Vapi, Manesar-Dharuhera, Baruch-Ankleswar, Meerut-Moradabad industrial estates – all with a fair proportion of such informal units are very competitive. They have a far better mix of India’s cheap or competitive resource (Labour) and efficient capital utilization. They will survive even after paying taxes.

The net effect of this is that tax collections of the government goes up which is a transfer from the pockets of surviving informal sector units to the government. Market prices go up and volumes adjust downwards due to price increase.

Profitability of previously tax compliant units will go up due to price increase, but of those in informal sector who are still competitive will turn worse.

In the top graph 5 of the 7 units in informal sector were competitive supplying 850 units in the market of 1350 units. After formalization and recovery of taxes from all, only 3 of the previously non-tax compliant units supplying 500 stay competitive and the balance 4 with a capacity of 850 units become unviable.

The shrinking of economic activity

How much economic activity in private sector will shrink will depend on the elasticity of demand of various newly taxed industries. Where demand is inelastic (like food and essential items) people will reallocate from other expenditure lines and maintain purchase volumes in which case volumes may not shrink much. But in discretionary items like purchase of cars or houses, people may not substitute but postpone the decision or downgrade their quality. People might settle for a smaller car or move farther out of city or reduce the size of purchase. In the above case, prices have gone up from say Rs 47 to about Rs 56 and volumes have shrunk from 1350 units to about 1250 units – a fall of 8.5%. If the demand is very elastic and people didn’t want to spend more than Rs 47, volumes would have shrunk to about 900, a fall of 33%.

While nominal incomes may shrink or expand depending upon whether the price effect overwhelms volume reduction, in real terms there will be a shrinkage due both to price increase and volume reduction.

Effect on overall Economy

Taxes need not always result in economic shrinkage. In many cases it is just a transfer from one pocket to another – Government in this case. World over Governments are more compulsive spenders and it may end up boosting the economy also.

An increase in direct taxes may not have any effect on the current volumes or price – it is just a reallocation of profits between the government and the enterprise. But since such taxes will reduce post tax returns on capital employed (ROCEs) and if the Cost of Capital also don’t reduce in tendum, they will impact investment demand directly – a phenomenon being observed now. We have seen a phenomenal increase in entity registrations under income tax, while the cost of capital have been stubborn, which is most likely to have affected the investments in informal sector.

In the case of indirect taxes, it does transfer resources and if the government spends such taxes collected there should be no effect on economy. Shrinkage in one sector will be made up by expansion in areas where government spends its the taxes so collected.

But the current formalization drive is an overall effort and would have most likely shrunk most private sectors as explained above leading to shrinkage of overall private sector economy. The government is not compensating this shrinkage by spending whatever it garners from this drive. It has instead been shrinking its own level of spends (as % of revenue and GDP). Fiscal deficit which were 6.46 % in 2009 and 5.91% in 2011 have shrunk to 3.42% of GDP by 2018 indicating in a sense that a lot of collection is going into reduction from previous levels. Thus when both private sector and Government expenditure is shrinking, the overall economy is bound to shrink.

It is to be recognized that units in informal sector employ more people per output and less capital than formal or organized sector, since employees can be downsized far more easily than capital assets. This also probably explains the job losses or joblessness of our growth story, more so after the formalization drive has gathered momentum.    

 

Formalisation

Selective Rationalization of Subsidies might solve the Agrarian Crisis

 

Link to Businessline: https://www.thehindubusinessline.com/opinion/how-the-agrarian-crisis-can-be-eased/article28128069.ece

The current agrarian crisis in India is a product of two factors (i) failure to recognize when Green Revolution started giving diminishing returns and taking steps to come up with alternatives and (ii) economic impact of subsidies, which this article examines – both man made and policy failures.

The current crisis can be summed up as diminishing soil fertility, sinking water table, increasing costs (all effects of green revolution) and poor returns to farmers, periodic unaffordable spikes in key commodities, periodic excess production which are dumped on the roads ruining several farmers and a huge burden on the government.

The policy failures have arisen due to not recognizing the nature of demand and supply curves for agricultural commodities. The demand is highly inelastic – in a market which consumes 100 kg tomato if one supplies 125 kgs the prices collapse, since not much demand is there for the excess. Contrarily, where it is supplied 75kgs only, the prices skyrocket since everyone wants to garner their daily supplies.

The Graph plots the demand and supply of a typical agri crop. The cost buildup of various suppliers is arranged from lowest to highest and its ridge on top becomes the supply curve. In agriculture the demand curve is steep and supply curve is relatively flat. Where this is the case the market price is closer to supply curve. This leaves a huge consumer surplus (excess of what the people are willing to pay and what they actually end up paying) and thin profits. Where the demand curve is flat but supply curve the price line stays closer to demand and hence smaller consumer surplus and higher profits for producers.

Many people have argued for breakup of cartelization of middlemen and dismantling or reforming APMCs as the panacea for better farm gate prices.  This is as naïve as it can get. The middlemen are performing important functions like taking immediate delivery of perishables, financing farmers, storage, connecting with customers and markets, inventory holding etc. which we forget. If left to government agencies they would mess it up.

Sure most farmers are small (crops from 2-3 acres to sell) and their reach is at best the village boundaries or at best 4-5 kms. How do they perform all the functions the middlemen do? At the Mandies of course it is a case of ‘many sellers’ versus a ‘fewer buyers’. But it is foolish to think that fewer numbers by itself creates usury pricing power.  Most markets should have at least 40-50 buyers (or middlemen) versus may be 500-1000 sellers. But this is statistically enough to create conditions of undistorted trade. Imbalance might creep in if there are only 3-4 on one side and can collude overtly or covertly. Most suggestions on ‘reigning in’ middlemen for tackling agrarian crisis is bound to be ineffectual.

But the real problem is the supply curve‘s flatness. This is largely the result of governments ill-advised subsidy policy which makes no discrimination whatsoever on the various input subsidies to agriculture. When everything from electricity, water, seeds, fertilizer, interest, MSPs, are given free or subsidized without any limits of land holding or size, it leads to similar cost structures for most suppliers and hence the supply curve becomes flat as shown in Graph (Before segment). Even if all mandies are handed over to the farmers, with such a curve, their profitability is unlikely to improve much.

The solution should revolve around exploiting the inelasticity of demand. The sure fire solution is to make the supply curve more elastic and harvest a huge ‘consumer surplus’ (which is what the middlemen do – they don’t take away farmers’ profits; they take away consumers’ willingness to pay).

This can be achieved by rationalizing subsidies. This can be done by restricting subsidies to only those holding 2-3 acres or to the first 2-3 acres only for even for larger farmers. With precise targeting through DBT, it is possible in the current scenario. Or it can be graded like 100% of current levels for 2-3 acres, 50% for 4-8 acres and nil thereafter, like in the graph. This will increase the cost for larger farmers (all units with ‘L’ label on x axis) and induce a steepness (as shown in the After situation in the graph).

Rationalization of Subsidies

Effect of rationalizing subsidies

The prices as is seen in the graph will raise (in the illustration from Rs 69 to 84). This shifts a portion of consumer surplus to producer profits. This will mostly benefit the small and marginal farmers. This transfer is perhaps much needed. We cannot have a society where 55-60% of people get a share of 15% of GDP.

The quantities bought and sold will fall. But given the inelasticity of demand, it will be relatively much less.

The larger units which lose a part of their subsidies will become uncompetitive in their traditional crops. They will diversify into other commercial crops or crops for which there are no subsidies now so that they won’t suffer in relative terms versus subsidy supported small farmer.  This is an important necessity. Our food grains production is in surplus and for increasing its income, diversification is a pre-requisite.

This will also partially address the rural income inequality problems.

Governments finances

The Government will save a lot by curbing subsidies going to larger farmers. It can reduce the crops procured under MSP since the market prices would have substantially moved to enhance their incomes. This would have come from consumers who were willing to pay, hence may be without much pains (other than a onetime price adjustment as inflation). The Government may have to spend a part of its savings on covering some poorer marginal sections (who are net buyers of food) through higher PDS subsidies.

A portion of PDS procurement can be reserved for organic farming by larger farmers. With the promising growth for organic products the world over, it could give an early mover advantage.

The Government need not do this rationalization for all products. It can start with those where there are surplus buffer stocks. If prices of those products move up, consumers will diversify their consumption basket to other products and their prices of unsubsidized products will also start moving up. Larger farmers would gravitate towards such products.

Macro Imbalance and the need for a new framework agreement

My article in Businessline today.

The chorus for reduction of Real interest rates as the panacea for the current economic stall is getting louder. From commentators to administrators to economists that seems the only item in the menu these days.

Interest rates (nominal and real), Inflation, Forex rates and Reserves, Investments, Capital Account convertibility and Foreign Investment Flows (all from the input or causative side) and Growth, Output and Employment on the resultant side are all intricately interconnected. There seems a need to look at things comprehensively and evolve a framework agreement between RBI and the Government reflecting this reality.

Illustration of Inter connectedness and imbalance

People buy things in advance if either it is likely to be costlier in the future when they need it or for de-risking (like Gold and Real estate). But what if the realized prices later consistently prove to be less? Would people still buy upfront or would it indicate some discrepancy? Lets see it in the context of forex rates.

The actual rates post facto have consistently been lower (far lower) than the Forward rates (rates quoted today for $ that will be delivered say 3, 6 months later).

The first one is determined based on the difference in inflation rates and the second one based on difference in nominal interest rates. If the Real Interest Rates are deducted from nominal, then the movement in both should be determined by difference in inflation. This should hold but for changes in outlook and situational factors and the policy induced difference in Real interest rates.

The persistence of actual rate being way less than Forward rate represents a serious imbalance and causes plenty of problems in domestic competitiveness, flow of foreign currency, investment absorptive capacity, etc. For example, if apples (representative of a basket of goods) are selling at Rs 50 in India and $1 overseas, then exchange rate should be ideally 1$ = Rs 50. Say, next year Indian apples have suffered an inflation of 10 per cent and have gone up to Rs 55. But apples overseas have suffered an inflation of 2 per cent and gone up to $1.02. Then the exchange rate should be Rs 55/1.02 = 53.93. But if the exchange rate is kept at say Rs 51, then the Indian exporter will get 1.02$ X 51 = 52.02 Rs /apple while he is able to get Rs 55 selling it domestically. Why would he export? To overcome this, we should allow the Re to correct. This will happen if we match the $ supplies into India with its net imports

Contours of a new framework agreement 

The framework agreement between the Government and RBI should cover all the essential variables not just one or two in isolation. Such an agreement should cover the following.

Limits on Forex Inflows: The inflows should be calibrated to match the absorptive capacity of the economy and its investment needs.  While Capital account convertibility can remain, RBI has to limit the quantum either at total levels or under each major sources of inflow. Reserves are a costly loss making insurance asset (much like Gold in individuals’ hands) whose cost are far more than the difference between interest earned and paid. It has effect on the real economy. The limits can be +/- 1-2% of what is required to plug the CAD or 6 months imports +/- 2 weeks.

Maintenance of Competitiveness: Competitiveness comprises two elements – the physical and the currency. Physical competitiveness comes from technology, scale, skills, IPRs, and natural resource endowments over which neither RBI nor Government may have control. Currency needs to stay competitive which can be achieved only if it floats freely to reflect the inflation differential.

Forex rates: RBI should be mandated to maintain the REER values within 2/3% of Re’s REER value after correcting the massive divergence now on a one-time basis.

Recalibrating REER Values: Again instead of using the general inflation numbers of the countries it should be the inflation of major input costs (including interest costs) of goods and services traded between India and its major trading partners. This basket may keep changing but there are real dangers of monolithic baskets or even currencies as a whole which are governed by many factors other than what determines competitiveness.

Real interest rates – Real interest rates should be mandated to be within 5-10 bps spread over interest rates in competing countries and those investing into India. High real interest rates and overvalued currency may encourage debt flows more than investments in real assets and FDIs.

Inflation: Divergence between estimated actuals and realized actuals after the end of period is difficult to control even for items like Forex rates where almost all participants are educated, trained and hence rational. It becomes even more hazardous in inflationary expectation. It’s time we move on to inflation targets for 3-4 major groups. Food inflation is far more politically sensitive and socially damaging than perhaps white goods or real estate.

Stability of Laws:  The last 4-5 years have seen sudden sharp changes in rules governing provisioning, NPAs, default status, etc. and levels of support to distressed assets even those which are clean but facing stretched cash flows. Changes should factor in reasonable adjustment period.

Quid Pro Quo

If these are corrected, governments should undertake to do the following:

  • To stay within the 3-4% fiscal deficit targets,
  • To smoothen MSP increases based on fundamentals rather than subject to political whims and fancies,
  • To curtail interest declared on mandated savings like PF, PPF etc.,and
  • Not to announce arbitrary minimum wages.

The current economic impasse is arising out of highly overvalued currency, uncompetitive real interest rates, inflows far in excess of absorptive capacity and inflation which looks more western and 1st world’s. The entire burden of causing growth and employment hence falls on the elected Government which has to substitute for the private sector which has been rendered uncompetitive due to these imbalances.

A comprehensive agreement on the above lines would go very far in kick starting growth and employment once again.

Flexibility and Agility are Virtues

Ironically almost a century ago, as the noted economist Irving Fisher in his The Money Illusion quotes Reginald McKenna, Chancellor of Ex-chequer UK as follows: “Since the War, central bank reforms have been instituted in Albania, Austria, Chile, Colombia, Germany, Hungary, …India, Russia, South Africa. In all these countries, except India, not one central bank has copied the Bank Act of England; but with that exception, all have adopted some system which is similar to the Federal Reserve Act” which provides for an ‘elastic currency’… the greater elasticity of the Federal Reserve System (is) the main reason for the higher prosperity of America”.

What was true then of America is true today of China which has proved far more nimble footed and what was true of Bank of England is true of RBI, which treats cast in stone monolithic approach as a virtue.

(The writer is the author of Making Growth Happen in India, Sage Publications).

 

Time to shed excessive fixation over inflationary expectation in Monetary Policy Making

The Last 3-4 years inflation control has become the dominant theme of our monetary policy making with just a lip service to growth and even lesser concern for what is needed most by the democracy – employment. Inflationary expectations have become the mascot of inflation and taming it has become a near exclusive fixation. the current approach fails to incorprate lessons from the recent advances in behavioural economics
Inflationary expectations have stayed stubborn and unrelenting at 8-10% even while CPI inflation has been has been drifting downwards to around 3-4% for several months.
There are some fundamental issues with expectations of individuals.
Firstly, do retail consumers (unlike equity investors) from whom data is gathered for consumer inflationary expectations have sufficient information and expertise to predict inflation even if they are the ones who are affected? People dislike risks and as Daniel Kahneman theorises people dislike losses twice as much as they like profits. There is hence a tendency to overestimate risks and the losses especially the non insurable ones. Even RBI itself has been consistently overestimating inflation.
Secondly, mind comprehends or estimates prices more based on purchase cycle. For example, a vegetable or fruit purchaser might think or worry about what will it be in the next two weeks. But it will be futile to ask him for an estimate of prices 26 or 48 weeks hence. RBI data gathering does not reckon the purchase cycle.
Thirdly, the nature of human mathematical comprehension itself and translation thereof into annual numbers. Even if they knew rightly that the weekly inflation of two different items are 0.2% and 0.5%, they will most likely come up with annual numbers in the region of 6-10% (instead of 11-30%). RBI’s data on various class wise inflation expectation figures reveal how the expectations are in a significantly narrower band than the experience of the preceding few weeks or months which should have had a significant influence on their expectations. Vegetables prices vary by as much as 40% between March and September (RBI’s Mint Street memo 19), yet this is never captured in the expectations reported which stays flat at 8-10% for most of the times.
How much do expectations drive actual behaviour.
This is the most crucial question that would govern the success or failure of the current approach. Unless it can be demonstrated that people’s behaviour (in direction as well as quantum) is consistent with their inflationary expectation using it will be as perilous as a trap shooter shooting before the bell and hoping that somehow the clay pigeon will show up where the shotshell goes.
How much inflationary expectations will affect consumers buying behaviour depends on several factors like the life cycle of the product itself, per transaction costs, costs of advancing or postponing buying decision and the alternative (even if short term) investment avenues and cost of funds (borrowing costs).
A 15% annual inflationary expectation in real estate might make many to advance their purchase of house sooner than later more so if the financing costs are lower and perhaps even reallocate from other items to beat the market. But the same inflation expectations for petrol and diesel prices (roughly 1.12% on monthly cycle basis) may not make a car or 2 wheeler owner to tank up on empty cans to cover his next purchase. The same rate (0.264% on weekly cumulation basis) would not make anyone to stock up on vegetables especially given the cost of preservation and possible deterioration.
The House owner will most definitely compare his cost of borrowing with his expected price increase in house prices to make his purchase decision. But for articles of daily consumption or even white goods the household consumers are unlikely to be swayed by inflations of the range one is talking of in India. This can be gauged by the discount quantum announced during festive seasons or season end sales in India – upwards of 15-20% of sale and in some items 40% or one free for every one purchased and so on. One does not hear of 1-2% off on discount sales open only for 1-2 days (a 2% discount ending in 2 days translates to a cumulative 3500% p.a.) even for ‘definite to be purchased’ articles of consumption like clothing, household supplies etc. It does not have any impact. Even the pensioners may not be influenced to stock up even when their savings may be earning just 6-8% annual interest rates.
Unless inflationary expectations translate to rational choices by consumers, the current approach will on most occasions result on excessive action. And as RBI’s data clearly proves that as far as India is concerned, inflationary expectations are not necessarily rational expectations.
Only when inflation becomes high (say 20-25% for India) and the interest rates are way lower in comparison or in a hyper inflation (like in Venezuela now), would people be driven to rush their purchases fuelling the price increase further. The current approach at inflation levels of 4-6% seems like having a foot firmly on the brake pedal as a precautionary measure while driving at 1 kmph. Actually many end products in agri and manufacturing sector are crying for a better inflation to neutralise their cost increases.
A case for differentiated approach
There is good case for junking our inflation control focus of monetary policy making. If our economists have faith in their own icon, Philips (after whom the curve linking inflation and unemployment is named), even in short run they would be forced to conceed that a low inflation is a leading likely cause of the current unemployment crisis. We can just use the last 2 months or quarters inflation to decide what to do and should it be necessary convene the review meetings at closer intervals whenever necessary.
Rather than a single objective whatever the inflation, we should move a into differentiated approach depending on levels of inflation. Upto 4-6% inflation we should focus on job creation, between 5-8% may be on growth and employment and thereafter inflation control can take primacy.
Our industrial capacity utilisation is stuck at about 75% for a long time now. The lowest hanging fruit to be harvested for employment and growth is to put the unutilised 25% to use. It would take a bold approach to identify the more viable ones amongst these and provide them with 4-6% working capital, which could make them chugging again. A growth of an additional 2% will deliver more goods and services to the consumers and tame inflation and create employment far better. But such a sensible approach would be blasphemous to our orthodox theorists.

Contrarian Ways to tackle Agrarian Crisis

https://www.thehindubusinessline.com/opinion/tackling-the-agrarian-crisis-differently/article26501142.ece

Article link in Businessline 11 March 2019

Agrarian crisis is staring on our face and as usual a flood of familiar suggestions have resurfaced. The political responses have been on expected lines.

Fixing MSPs at 50% over costs is as disastrous as it can get. There is no inherent incentive for cutting down the bill on Government or the rest of society. It may be possible in Western societies where 2-10% farmers depend upon the rest 90% but not in India where 50% are in agriculture. The sinking water table without a care, due to free electricity even in the land of five rivers (Punjab) is an example of such a sink hole. On the contrary, when West Bengal used to charge farm electricity same as residential, it held its water table since the farmers used the expensive resource judiciously.

The basic problem is that our agri sector is producing more than the demand, even when its productivity is way below world standards. The Kcal value of just the top 8 food items produced is approx. 2250 just about what an average Indian requires. And we have compromised the soil health massively in the last 4 decades, so the costs are increasing way beyond productivity gains.

The main impediment in tackling the crisis is the wrong formulation of the problem. Instead of seeking to double the farmers ‘gross’ income, we should seek to raise his “net, net income” – net of costs but more importantly net of soil health loss and depreciation. Let’s see how this cab ne achieved.

First the wastes in our cultivation. Our flood irrigation system which has evolved to cut off oxygen to weeds and thus control their sprouting, has had adverse consequences on plant health also. The excess water washes nutrients, costly chemicals and fertilizers along with it, more than half of these never coming in contact with the plant or root aura. These unutilized chemicals have long term consequences on soil quality.

SRI (System of Rice Intensification) farmers who have consistently reported higher yields, have direct- planted or planted single seedlings with gaps of 20-25 cm (instead of clumps) and shunned flood irrigation for just retaining enough moisture and reported 80% savings in seeds besides saving 50% water.

Next the soil health. Excessive chemical application has killed the earthworms so necessary for aeration and microbes and fungus which break down vegetable matter and carbon into essential inputs for plant growth. These chemicals solidify soil causing easy run-offs. Stronger osmotic pressure of the chemical solution outside the root systems promote reverse osmosis causing the water to flow from roots to soil rather than the other way around causing withering and dryness in some crops.

We need to get a lot more humus into our soil to boost its water retention (without run offs) to achieve the above and enable stronger roots that can to go deeper and wider and sponge more nutrients besides being naturally more disease resistant.

We need to rotate the crops judiciously with nitrogen fixing legumes/plants, so that the artificial life support of chemicals get replaced with natural manures and supplements in a far more balanced way.

Sir Howard the author of the Indore experiment, had demonstrated that with just the organic material available within the village – the foliage, crop residues, and animal residues,  it is possible to generate all the humus and compost and within it all the chemical required in a more balanced manner at much lesser costs. It might require some reinventing the natural and traditional methods and some re-training.

Trapping more incomes within village ecosystem: The Indore experiment cited above reported that a pair of oxen can help generate 1350 cft of compost i.e approximately 27 tons of manure containing a balanced mixture of essential chemical ingredients. The market price of equivalent weight of Urea is about Rs 1.45 lac. Even if one were to offset the cost of animal keep and downscale the value, it would still leave a net Rs 30-40,000 of commercial value in the hands of the farmer and village community. Instead, villagers are driving away these to graze unyoked and spending a fortune in ‘importing’ costly fertilizers. A better balance should be attempted.

Rice production is reported to be contributing nearly 15% of world’s methane emission annually. Long term research should focus on harvesting this thinly spread greenhouse gas like we have done with Sunlight. It is also possible to sequester carbon by traditional methods as modern agriculture is one of the biggest contributory to carbon emission.

If these incomes are trapped within the village ecosystem it could lead to better secondary cycle of incomes and enable our villages to make more investments in housing, electricity, healthcare and education, the other social necessities.

Employment potential: Adoption of natural or semi traditional methods of farming like manual composting and weed control, controlled water charge, focused pest control, recharge of crop residues are reported by Joel Bourne in his book The End of Plenty to absorb 27% higher labour. That may be a huge boon by itself for India which desperately needs to create employment.

‘Open sourcing’ research: The current system of research excessively serves only certain sections or links to the compromise of overall health. It is focused on maximizing chemical or insecticide sales far beyond optimal levels. So much so that insecticide companies do not even train the applicators on optimal volumes or safe methods of application. Today, more people may be dying out of their harmful effects besides those who consume it as poison, than out of farm loan distress.

There is a compelling case for ‘open sourcing’ all agricultural and allied research even if necessary by Government setting up more facilities under its control as well as opening up trade at least in commodities where we have surplus.

In conclusion, it is possible to more than double the net farm incomes just with better seeds and package of farm practices, cutting down heavily on the artificial ‘boosters’ even while preserving or promoting soil health.

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.

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.