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

Why India’s GDP numbers may be right; but so are its doubters.

Why Arvind Subramaniam is right; but Government is not wrong.

Link to the article in Businessline: https://www.thehindubusinessline.com/opinion/gdp-both-subramanian-govt-may-be-right/article28657586.ece

The ex-CEA has argued that the figures of GDP growth are exaggerated. He may be right but equally right may be the government. The tension will ease if one recognizes that it is possible to grow for some period of time without the total amount of goods and services consumed by community not increasing at all. The reverse is also equally feasible. This can happen with increase and decrease in % terms in the domestic content in value addition, or better productivity (or fall) of natural resources, etc. The crucial bridge between the two sides may be the efficiency gains and shifts in the structure of economy in the last few years.

Let’s examine the impact from efficiency gains. Business line published a few weeks ago (GST on the Highway dtd June 4, 2019) the story of a reporter’s journey with a truck driver from Chennai to Bhiwadi. He reported reaching the destination in 42.35 hrs instead of the 4 days it used to take not so long ago. The driver saved 2 days for his owner and as a bonus pocketed the petrol he managed to save from the 400 litres allowance he was allowed for the trip.

This was confirmed to the writer by an official of a leading transport company who claimed it takes 44 hours to reach Madurai from Dharuhera (Haryana) these days instead of the 4 days previously carrying cars. Only 15% of potential savings have come from GST so far; balance has come from better roads and better driver crews who operate as a team. Let’s construct (with some lenience in calculations) the effect of such savings on GDP in different scenarios.

 

Impact on GDP from Logistics savings (of the reported case)
 

 

 

Scenario —>

Before After
1 2 3 4
Customers final bill remains same; Transport company’s profits go up. Customer takes the savings (other than Drivers bonus) Customer takes away all the savings
Petrol (assumed for illustration) Ltr 400 300 300 300
Lorry Hire (day) Days 4 2 2 2
Driver gets paid for (Days) Days 4 2 2 2
Drivers Bonus NIL Petrol savings of 100 litres (assumed) NIL
Petrol price Rs/Ltr 70 70 70 70
Driver’s wage rate Rs/day 1200 1200 1200 1200
Lorry Hire rate Rs/Day 5000 5000 5000 5000
Composition of GDP
Petrol Rs 28000 21000 21000 21000
Wages to Drivers Rs 4800 2400 2400 2400
Bonus to driver from Savings Rs 7000 7000
Lorry Hire Rs 20000 10000 10000 10000
Profits to Transport Company (say) Rs 20000 32400 20000 20000
GDP (Price Paid by Customer) Rs 72800 72800 60400 53400
Fall in GDP 0 (12400) (19400)
Fall in GDP in % 0% -17% -27%

 

The volume of final services (real GDP) has not gone down but the nominal GDP has fallen sharply. If the final price remains due to market demand and supply, both real and nominal GDP will remain same. If the consumer pays less, GDP will fall due to the efficiency gains, unless there is 50% increase in other economic activities to absorb the truck and driver’s time (unlikely) or we start measuring value of driver’s leisure as equivalent to value of wages.  Here the quantum of services enjoyed has not gone down and so the real GDP should not go down. But the real GDP this is usually measured by using deflators, even real GDP will show a decline.

Paradoxical but that’s the exact reason (but contrarian effect) why big earthquakes and natural disasters are big boosters for GDP growth.

How Arvind Subramaniam and Government may both be right

India’s new normal growth looks 7%. But there have been drop in the exports in the last 5 years of some commodities like rice, raw cotton, meat and oil cakes;  construction activities have been hit, GST and demonetization have hit some cash dependent or tax evading activities, China dumping has clipped the growth in steel and tyre industry. But these may have been made good by growth in insurance services in rural areas, banking services through Jan Dhan, massive spread of LED bulbs, construction of toilets on a massive scale, etc. These may well have compensated for the decline in other areas and the Government’s stance of 7% growth may well be true.

Revisions in the GDP calculation approach takes years and they lag changes in the structure of the economy by a considerable time. Hence it is quite likely that many new sources of growth are not captured properly. Without these services in the estimate samples, the ex-CEA’s estimates may well be true.

But the real joker in the pack may be the efficiency gains in the economy. The last few years have seen significant gains in several areas. LED bulbs have grown rapidly saving huge amounts of electricity. Industries have also invested significantly in energy and utility savings. Banking has gone largely digital  cutting down long queues and wasted time; so are airline and railway tickets. Solar energy has replaced capex with opex and led to vastly reduced levels of consumption of fossil fuel. Digital books vastly reduce the consumption of paper; Netflix reduces trips to the theatre.

As illustrated in the table, such efficiency gains have a dampening effect on the GDP. The greater the gains accrue to the final consumer lower will be the GDP and growth.

And the impact from reduction in corruption. DBT reach the beneficiaries without leakage alright. But they have also taken away the jobs of several intermediaries and fixers. This has contributed to loss of several layers of jobs, even as it resulted in convenience, reduced costs, and saved loads of time for beneficiaries.

With the impact from the above factors, the GDP may have fallen as contended by of ex-CEA.

But GDP calculation is not a perfect maths.  The entire GDP calculation of Zambia is done by a single individual. A minister in Robert Mugabe’s cabinet likened measuring GDP to “trying to use a tape measure to figure out how much Coke is in this glass.” GDP is not measured by double entry book keeping; it is based on sampling with all the deficiencies that come with it. The Ex CEA’s approach is even more remote. The rapid changes that have been observed in the last few years especially since 2008, the urbanization and formalization since GST cannot be captured or compared with static sampling approach, size or methodology.

One wishes that the ex-CEA had not adopted an alarmist approach and present India’s GDP as some kind of methodological fudge. Without an examination of reasons, chains of causation, Working Paper no 354 looks more like the statistical appendix in the Economic Survey. If he had examined the reason behind fall in electricity consumption ratio (for example) from pre 2011 period, he could perhaps have come up with appropriate suggestions for perfecting the system.

Nevertheless, assuming his figures are correct, if the 4.5% has come about due to efficiency gains, better ICORs, reduced project implementation times, cost savings, and lesser inconvenience to consumers why should we be ashamed of it. These would only improve the competitiveness of Indian industry and services.

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.

RCEP can spell RIP for domestic manufacturing jobs

https://www.financialexpress.com/opinion/opening-up-manufacturing-without-proper-employment-impact-assessment-might-prove-disastrous/1486932/

No one can deny that overall there are net gains from free trade (FT). If the most efficient producers are provided access without artificial restrictions (political or geographical boundaries) obviously it would optimize the costs for a given level of consumption.

But how those gains are distributed is an unsettled question. We can have examples of countries losing out due to FT and others gaining at their expense. It is not even difficult to construct examples of just one country garnering all the gains and all the others losing.

Its also possible that the gainer(s) gain far more than the gains from free trade efficiencies at the expense of others (kind of loss imposition on losers). Unless one is careful about what to negotiate/avoid and does homework properly, one may be a heavy loser. Lets see an illustration.

Illustration

The illustration seeks to break up the supply curve in the standard demand supply analysis of micro economics. The supplying units are arranged from the most efficient to least efficient from left to right. Efficiency is measured by how low the total variable cost is. The thick ridge line running over the top of various bars representing individual units comprises the supply curve. Those to the left of where the Demand curve meets the Supply curve gets to supply the market.  Those to the right will incur a cash loss since the market price is less than their variable cost.

The illustration studies the impact of removal of import duties after FTAs. After removal of import duties, the supply curve accommodates more overseas players to the left and push out some domestic suppliers to the right of equilibrium pricing and hence face closure.

The net impact (difference between before and after scenarios) in the illustration is as follows:

  • The Government has lost whatever Import duties it was getting from the Korean (for example) suppliers who were already competitive suppliers in the market. The entire amount would have accrued to the Korean suppliers,
  • The domestic consumers have benefitted from a price reduction of less than 1%. This is most likely from better efficiencies of the overseas suppliers.
  • There is a net loss in domestic employment (loss of 9% down from 139 to 127 in the illustration).This would have either resulted in better employment overseas or better capacity utilization for them.

This kind of relatively flat demand or supply curves prevail in commodity industries where consumers don’t pay much premiums for brand and supply efficiencies come from factor cost differences, scale economies, cheap labour, patents, etc.

Net loss in employment.

Larger and concentration of capacities enabled by FT does facilitate mechanization and result in net loss of employment as empirically observed. These net losses in employment have also to be distributed and one can end up with a disproportionate share of this unemployment as in the above case where the host country ends up with all the employment loss.

Ineffectiveness of Revealed Comparative Advantage

One of the methods oft-used by trade economists to identify industries with export or import competitiveness is the Revealed Comparative Advantage (RCA) and its variants. Essentially this method calculates the ratio of (i) % of a particular commodity in a country’s exports to (ii) the % of global exports of the commodity in world exports. If the ratio is more than 1, then the country is supposedly export competitive. Instead of global %, one may use specific country %s, regional %s, or host country’s %s, to identify export competitiveness or import vulnerabilities.

But it is terribly reliant on the past like using KL Rahul’s yesteryears averages to play him in todays matches. What is important is the current competitiveness in an ever dynamic world, where the steep price fluctuations in some key inputs like oil, metals, interest rates, etc. can vastly change the fates of several industry players’ competitiveness.

As can be seen from the illustration the units around the equilibrium price – may be 20-30% on either side would largely decide the gains or losses from trade. Units which are highly competitive (leftmost) or least competitive (rightmost ones) will hardly matter. For example, ASEAN units despite a duty reduction do not enter domestic market. There may not be much point in negotiating access in such a commodity if we are in a similar situation.

Likely effects of Regional Comprehensive Economic Partnership (RCEP)     

This kind of analysis should be done for both commodities where we have some basic strengths and where we would like to invite competition. Using elasticities alone may not suffice as so much depends on capacities of individual players around the equilibrium price. ASEAN FTA has not resulted in much gain or loss over the last 5 years it has been in full operation. But China is a different player altogether.

Many Chinese commodity players have huge capacities – in select cases a single unit or player have enough capacities to supply the entire Indian market. If an import facilitating measure or cut in duties make them competitive in domestic industry, then the whole domestic manufacturing can get wiped out resulting in loss of domestic employment.

India’s strength in its low cost labour, but largely untrained and low skilled. In most manufacturing units the wages account for 8-12% and dwindling by the day. Even a 30-40% cheaper labour translates to only a 3-5% overall advantage which is not even sufficient to counter our unreasonably high real interest rates. But where wages constitutes 40-50% like in many services, IT, research, design, etc. a 30-40% cheaper labour can give 10-20% overall advantage. These are also less capital and machine intensive and interest rates are less impactful.

India’s homework so far in negotiating trade agreements has not been stellar. Opening up our manufacturing without proper employment impact assessment might prove disastrous with RCEP. Even if services are negotiated well, it will open up opportunities for higher skilled but the low skilled and labour which are newly transferred from agriculture and rural areas may be left in the lurch.

Illustration:  Before and After FTA – impact of duty reduction

RCEP jpeg

In case the picture is not clear, you may kindly open XL file from the link below

RCEP

The Art and Need for Creating Employment

Link to FE 29/5/2018:  https://www.financialexpress.com/opinion/the-art-of-and-need-for-creating-jobs/1184633/

If there is one thing that is common to every government since reforms they all had a growth consciousness but equally they all lacked an employment creation strategy. Employment it needs to be realised is like the insulin that delivers the sweet benefits of growth to the individual citizens. Otherwise growth accumulates like sugar in the blood as inequalities in society with their own adverse consequences.

The chart shows the employment in formal sector versus the economic growth over the last 40 years. Unfortunately, reforms have preferred cost cuts over ensuring adequate levels of government services and preferred efficiencies over employment in private sector. If only post reforms had created employment at half the rate as before, it would have taken care of the army of currently unemployed, a ticking time bomb. An employed and hence an engaged mind would tackle several of our social ills far better than investments in tightening surveillance or even infrastructure. Even the 1.3% uptick in the last few years may be more due to informal employment turning formal.

Presentation1

Unsatisfied needs – the basis of all markets and economic activity

Demand or an unsatisfied need is the basis on which any business is created. Meeting an existing demand with an established market and pricing mechanism is a safer approach to success. But, ingenious minds come up with IPL which fulfilled a latent demand (which perhaps even the customer didn’t know existed) for after day entertainment. Our telecom sector saw explosive growth by satisfying India’s motor mouth urges, never previously anticipated. But this requires foresight, some daring, financiers willing to take the bet, besides creative minds to come up with the relevant package of practices.

Demand for Government services arises out of public goods, constitutional rights like justice, safety, protection of property, ensuring equality of opportunity besides some commercial activities. It sometimes is required to serve needs where users may not be willing or able to pay commensurate prices.

Art of creating jobs – an example

Huge negative value is being imposed on the citizens by our unclean surroundings, waste and litter, sewage drains masquerading as rivers, un-cleared urban wastes spilling over to drive ways etc. There is sure a demand for neatness, cleanliness and hygiene, even if all those desirous of the service may not have the ability to pay for it.

India’s employment from rag picking and waste collection is abysmally low at 0.1% of population whereas similar activities employ 0.7% in South Africa, 0.5% in Brazil, 0.6% in Lima (Peru) as per ILO. The GDP from these activities in advanced countries vary from 2.5% to 3.8%. Employing the people required (say 50 lacs at even 0.4% of population) won’t affect other sectors since these skill sets are low and there is an excess supply in the labour market in any case.

The main missing link is who will pay for the services. At the macro level given the direct and indirect benefits it may be worthwhile re-distributing 1-2% of GDP through taxes and expending it in tackling wastes. But there are other ways. Elsewhere, nearly 30% of value of wastes generated are recovered and reused. There are people in various income classes whose desire for ‘cleaner surrounds, safe drinking water, litter free zones’ are more intense and more can be recovered from them for cross subsidizing the lower income strata. Hopefully the net unrecovered portion can be contained to 0.6-0.7% in the initial periods. People taking employment under these schemes could be made to give up all other subsidies.

The direct and indirect benefits of cleaner surroundings should also be taught to the citizens creating over a period of time greater ‘demand’ for them and higher willingness to pay for them. Or higher willingness to move into areas where such services are recovered at higher charges. The capital required for creation of each job in this sector is way lower than industrial or service sector jobs, private or public sector. The skill sets can be developed a lot easier with minimal training.

The open sewages in our cities, unclean rivers, garbage, etc.  are all a huge source of opportunity for employment creation. Of the various links in the supply chain the only missing link in this case is the poor ability or unwillingness to pay arising out of poor sensitisation of benefits and income. In the case of IPL virtually all the links were missing or invisible and it required some genius still to spot the opportunity and put all the links in place to create the ‘market’.  Similar opportunities exist where just one or two links may be missing and some creative thinking can add substantially to GDP, welfare and employment.

The disproportionate fatal accidents per vehicle is an opportunity to set right the systems by employing people (may be a lac or two) and adding positive welfare value. Our ill-disciplined roads, haphazard parking in crowded areas, rampant littering, usage of killer plastics are all potential opportunities of employment at low incremental capital investments. Our collapsed criminal policing and investigation (in deficit by at least 5 lacs); delayed judiciary can easily create new jobs for twice the existing number. Our deficient healthcare as Dr Shetty points out has a 50 lac employment potential at ‘fit for purpose’ doctors, nurses and service levels.

Government at both central and state level should identify ‘demand’ and need for its various services and ways to fulfil them rather than just run after roads, ports or infrastructure: our governance infrastructure for policing, justice, safety, protection of property, education and primary healthcare are in far greater levels of deficit.

Hiding behind our awful deficit of government services and under-development, chaos and disorder is a latent demand which could create 3 crore new jobs at comparatively low capital investment. This level of additional employment would have most certainly returned the incumbent government in 2014 despite all other troubles and could make a difference in 2019 as well.

This level of employment can be created at 1.8% of our GDP at Rs 100,000 p.a. wage levels. It requires some ingenious minds in the government to identify and fit the missing links in each case. The government should perhaps leave the return based (ICOR, IRRs and Paybacks) growth to private sector and chase newer indices like Incremental Employment per Capital Invested (IECI) for itself –a compromise of efficiency for employment.

Tribal protection or Poverty Preservation

The article with the above title has appeared in Financial Express of May 16, 2018.

Link: https://www.financialexpress.com/opinion/tribal-protection-or-poverty-preservation/1169401/

 

Conversations with an Ex-Naxalite

Warning: I have generally decided that Grammar and spelling are useless appendages. If you are not in that genre, pl pardon. Naxalism, for the uninitiated is domestic militancy or localised terrorism.

This was about 8-9 months back. My driving licence had been suspended and i had to rely on Ola and Uber on holidays.
It was twilight and i had hailed an Uber to get back home from Noida. When the cab arrived, I tried to put 3-4 bags with me beside the front seat before taking the front சleft seat as I always do.
‘How is the day treating you Sir’ Came a confident voice – more of a CEOs than a cab driver. I must have murmured some response since i was still at tucking in the bags between my foot/legs and seat.
Once he started driving, i said everything was fine; the day had treated me all fine. I was looking into his face which had the rediance and lustre of say a Kabir Bedi with a 4-5 day cultivated bread which always stays that way.
Me: Are you from Bihar? (I have generally found that people from Bihar and Jharkhand are loquacious and keep yapping and many times excessively to my discomfort dishing out advice on advice even if unsolicited.
No Sir. I am from south- western orissa -Korapur district.  We have a factory in the adjoining district and so know something about the district and naxalite movement in adjoining areas within Orissa, northern Andhra and Chattisgarh.
Somethings I learnt from him about naxalites during the ensuing conversation:
1      It is not like you people think – that naxalites live a life of complete seclusion from the rest of society – in a demarcated land island with boundaries. they move in and out of society. Most of them do farm work during sowing, transplanting or harvest times in the adjoining villages. during slack or non season (or people permanently unemployed work) their activities peak. Most people know them and their families and activities. people in the vicinity dont have the same level of animosity towards them as people distant from the scene.
2      It is only the top 2-3 who dont mix with or expose themselves to the rest of society. They are nearly completely cut off – and some more people who are not known to move around. But mostly they move in and out of the society.
3      The recruits are drafted based on 3 criteria: Physical strength, ability to execute gruesome pain or crime and thirdly loyalty.
4       There are pay scales and cadre depending on the skill levels and experience and years with the movement and of course ‘performance’. They are all trained in their assigned activities.and there is specialisation.
5       the area under their influence has shrunk slowly. It is more or less finished in Andhra Pradesh. (as someone else confirmed in the late 1990s prominent guys in AP from the affected areas felt unsafe or scared even in Hydrabad; now you can drive thru the areas even at night). In Orissa and southern tip of Cgarh their is a marked downscaling of activities.
6      Many of them have moved into Government contracts – road construction, etc. The Govt knows it and has been helping it along. The local politicians and MLAs (who help them with some moneys sometimes) and sometimes even the police help them along.
7       Govts also dont make too much of their past crimes or issues or hound them or their families. there has been a practical approach in the last 10-15 years which helps in normalising their relationship and rehabilitating.

My mind started weighing the new insights with my pre-existing ones item by item saying yes, no , possibly, unlikely and likely as so on. And i muct have fallen silent for a while.
Driver: ‘Kya hua Ji suddenly completely silent’
‘No No just getting frustrated with the jam. I must have reached home by now. We are not even half way through. By the way can i ask you a personal question?’
Yes

Me: Haven’t you thought of joining the naxalite movement yourself. By what you say, it is not as dishonourable as i once thought it was.
He turned and sized me up for may be 20-30 seconds. I was unnerved for those few moments. Not knowing what was in store.
‘Yes I was’.
Hmmmm… i was a bit relieved now.
‘I was a good student normally topping my class and school right thru. suddenly at the 10th std board exam much to the surprise of my teachers, family and self i plugged in 2 subjects. I gave the papers again 12 months later but failed again. I realised my heart was not in it any more. I was loitering around, no work and leaning on poor parents during the time. almost for a year and more. It singed me that i should earn something and thats when i decided i will take it.

But then i was short on physical parameters. But then since i was good with my science, they agreed to train me as a ‘doctor’ (their brand). The training lasted for 3-4 months. I used to stay with my family and they used to pick me up whenever required.
But then it was mostly during night times at whatever time … 10 pm one day and nothing for a few days and then 3 am – very erratic. It took a toll on my health, outlook and general wellbeing. I was getting disillusioned even while the money was OK.
I must have been on duty for 9-10 months – say about 15 months with them.

I was looking around and a sardar offered migration to Canada and i went to Toronto. There it was … I was hold up for 45-50 days. I didnt have money … so was hardly moving out … mostly confined to the garage level shelter. It was not that the sardar wasnt trying but then it was not easy. I lost hope and decided to forget the Rs 2 lacs i had spent from my familys and self savings and loans and came back to India.
As luck would have it, i found employment as a travel desk operator with a French MNC office in Delhi. I looked decent and spoke good English so i guess i was lucky with that one.
Me: So do you know Mr Nathan?
Him: How can i not know him. He was a top boss. He used to live here only in Mayur Vihar somewhere. (actually the Gman was our beighbour for 4-5 years and moved to deep south on voluntary retirement).
Him: I was with them for about 3-years or so.

So why did you quit such a cushy job?
I thought i knew travel management well and so thought of starting a cab service and after some trials and errors started driving for Uber and Ola. For the last 3 years.

Me: So whats the status of Naxalism now?
Him: Havent really been following. Hardly visit my home town these days. Next time i go there i will find out. Meet them. may be some of my friends will be there.

And then there was a long pause.
I looked at him and now asked him ‘So its your turn to go silent now?’.
Him: After some long pause. In a completely different tone now. The gleam and glitter in his eyes gone and voice not exhuberant or decidedly hopeful like in the beginning.
Dont know sir. I manage to make Rs 15-20,000 a month doing this driving and my wife makes some 10-12 doing some office work. (some catering or some such thing). We have a daughter in 3 std and one 3 years old.

But dont know where i am going in life or what next. feeling lost not knowing what to do. I am just 34 and have so many years ahead. Not a great feeling. And saddled with responsibilities.
Me: Oh nothing new. Sounding bouyant  and pontificating (dont know if thats the proper way to respond). Welcome to the world of people trying to figure out their place under the Sun. It happens to everyone … between 32 and may be continue for you for the next 4-5 years.
even Vivekananda could not escape it. (he didnt seem all that convinced and i wasnt sure if he was taking in what i was saying).
even if you thought you had figured out, many other thoughts and doubts will wash that clarity in no time and you will feel desolate again. You will try to figure out the meaning of life, your purpose and so on. (That was the Philosopher myself for his benefit. Lucky he didnt say Enough. Shut up now and wait till we reach the destination).
I dont think much conversation took place for the last 7-8 minutes. he must have gone deep into introspection.
We reached home may be in 45-50 minutes where it should have taken 20-25 minutes normally. I paid him.
Him:“Hope we meet again soon. Hope fursat milega apko. Please store my number.
Yes I will. You too.
‘Sir you are brilliant conversationist. I enjoyed it with you”. (what a lie. he must have spoken for 90% of the time. and i became a brilliant conversationist!). In any case i rarely am at at the receiving end of such compliments and hence gracefully took it saying ‘No it was all because of you”.
And forgot to store his number.

Make in India spoilt by persistent low manufacturing inflation

A Copy of this appeared in Financial Express on 12-03-2018. Link: http://www.financialexpress.com/opinion/make-in-india-delivery-patchy-heres-why-rethinking-is-needed/1094828/

V Kumaraswamy

Make in India is one of the key cornerstones of the current government to raise growth rates and create employment. It has been almost 4 years since the Make in India was launched with much hope and fanfare. The Government has initiated several useful steps and reforms to actualise it. The most recent upgrade in credit rating and 30-odd points jump in Ease of Doing Business will get us some mileage.

But it is clear that the delivery of Make in India is rather patchy. Several reasons have been advanced for its lacklustre show – highly overvalued currency, unfavourable ASEAN FTA, tight and unyielding monetary policies, very high real interest rates, high logistics costs etc. All of them have a degree of truth.

But it has to be recognised that beyond all these, an entrepreneur or corporate will invest only if they get remunerative prices returns are competitive to what the other sectors yield. This last aspect has not been addressed at all by the Government or inflation conscience keepers. Had this single factor been corrected, Make in India would have had a far better report card to show.

Nature of Indian Manufacture

Indian manufacturing is not high tech where heavy engineering, high end electronics, aircraft and space crafts, ship building etc. dominate. It is relatively low to medium grade in its maturity. It has a heavy dominance by industries which prepare or convert produce from agriculture for domestic consumption.

To give a few examples: Textile sector (the biggest industry by employment) is dependent on agriculture for cotton supplies and silk which can account for about 60% of final product costs, Sugar industry on sugarcane, Cigarette on tobacco, Beedi industry on Tendu leaves and tobacco, Vegetable/ cooking oil industry on sunflowers, groundnut, sesame, Food processing industry on wheat, maize, fruits, fish, poultry and Dairy industry on milk. Roughly 40-45% of Indian manufacturing sector depend on agricultural for their inputs. And a few more for inputs from Mining.

It is important to maintain a balance between input and output prices in these sectors and they should ideally move in tandem, if the manufacturing sector has to stay attractive for investments.  In India since agriculture feeds industry and industrial final goods are sold to those in rural and agriculture areas, any persistent imbalance could hurt both.

Our Manufacturing Prices are down 41% since 2004-05 in relative terms.

Terms of trade in international trade means the prices a country gets for its basket of export goods versus what it pays for its imports and how the relative price moves over a period of time. In domestic trade it means how the prices which a sector gets for its output moves in relation to the prices it pays for its inputs from other sectors.

From 2004-5, the terms of trade have been relentlessly moving against Manufacturing. If the manufacturing sector has had to pay 165% more for its key inputs from agricultural sector, it has been able to recover just about 57% from its customers. If Agricultural input prices are taken as the base, the manufacturing sector is getting nearly 41% less today for what it sells to other sectors compared to what it pays for agri inputs. (see Chart)

WIN_20180312_21_17_06_Pro

At one level it helps transfer of income from non agriculture sectors to rural and agriculture sector and thus corrects income skewedness. But a consistent increase of this magnitude has continuously eroded the margins of the manufacturing sector to unattractive and unsustainable levels leading to lack of enthusiasm in investing.

Reasons

Year on year for almost a decade and half, Agri inflation has been more than parity. This has come about by steep and arbitrary increases in Minimum Support Prices (MSP) announced by the Centre for many crops, especially in 2009-10, 10-11, 12-13 and 13-14 possibly due to electoral compulsions (see Table). Although MSPs are restricted to certain crops, farmers tend to gravitate towards higher MSP yielding crops till the yield per hectare for other crops equalises with those under MSP. Thus MSPs impact transmits with a lag on other crops as well. One has witnessed a similar phenomenon in rural wages consequent upon implementation of NREGA.

On the other hand,  ASEAN FTA agreement has more or less put an effective ceiling on the prices that manufacturing can recover for its end products. Free trade has more or less made recovering cost inflation through domestic price increases an impossibility over the years. India’s over-valued currency has played a spoil sport on top of these.

Need for Correction

India’s growth story to continue requires Indian manufacturing to expand and diversify and create employment for those released from rural and agri sector. As the sector saddled with the responsibility of creating jobs for those entering the market, it should be the one which is relatively more attractive. Unfortunately, things are exactly the opposite for the last decade and a half relentlessly.

Ease of doing business can contribute to encourage entrepreneur by making the state machinery less intimidating but it cannot alter the base investment arithmetic of Return on Investments (ROIs).

Year Wise Inflation for Mfg and Agri Products                     (2004-05 = 100)
Year Mfg Inflation Agri Inflation Agri Inflation / Mfg Inflation
2005-06 2.4% 3.4% 140.3%
2006-07 5.7% 8.8% 155.4%
2007-08 4.8% 8.0% 167.0%
2008-09 6.2% 9.9% 160.9%
2009-10 2.2% 13.1% 589.6%
2010-11 5.7% 17.0% 297.9%
2011-12 7.3% 7.8% 107.6%
2012-13 5.4% 10.0% 185.5%
2013-14 3.0% 11.2% 370.7%
2014-15 2.4% 4.7% 195.8%
2015-16 -1.1% 3.4% NA
2016-17 2.6% 5.0% 195.0%

 

The approach announced in the recent Budget for MSP fixation might lend stability and certainty. If the MSPs are linked to the input prices which should include manufactured items like fertilisers, pesticides, seeds, etc. the inflation of manufactured products would have a decisive say in the agri inflation and hence MSPs. They would get inter locked.

Details are awaited on the exact scheme. Even if a margin of 50% is built in (which should take care of imputed interest, rent and profit besides inflation of inputs), it would build some parity and hence rein in persistent deterioration of adverse terms of trade against manufacturing.

Even so the heavy backlog built up since 2004-05 would need to be corrected if manufacturing is to see green shoots again. The States also should have a say in the future FTAs; they should have a choice of what industries and products to offer for free imports and what products to seek exemption from our overseas importers. States should also have a say in the fixation of MSPs.

With Due Apologies to Pensioners

This appeared in Financial Express on 13th December, 2017 http://www.financialexpress.com/opinion/myths-on-pensioners-busted-check-out-the-real-and-false-arguments/971509/

Inflation Proofing Pensioners – the real and the false arguments

V Kumaraswamy

Our tight inflation targeting in the last 6-7 years are sought to be justified on (i) stable prices being a pre-requite for sustained growth and (ii) that pensioners who largely on interest income should be protected. Such targeting is being achieved by RBI through higher interest rates regime. Similar argument is advanced against correcting our over valued currency.

That the pensioners have suffered in the last few years and will suffer heavily if we loosen controls on interest is a big myth at this point in time when coming out of low growth inertia and near nil new employment creation seems so vital.

Have they suffered in recent times?

The main argument is that the pensioners with fixed income will suffer capital erosion through inflation and will have less and less real capital base to earn their future incomes. If interest income remains constant but expenditure keeps going up year on year due to inflation, progressively they will be left with smaller amounts to consume.

Table 1 clearly shows that this argument is clearly overdone in the last 4-5 years. Ever since the 4% CPI inflation target has been articulated and rather doggedly pursued by maintaining higher interest rates, inflation has fallen steeply whereas the interest rates have not traced the same trajectory.

From 2005-06 till 2011-12, the interest on Bank Term deposits were 1.5% more than the WPI inflation and 0.7% less than Consumer Price inflation. Since then, interest earners have had it good and the interest rates have been more than both – by a whopping 5.6% over WPI and 1.5% over Consumer Inflation.

 

Table 1: Interest Rates and Inflation – Pre & Post 2012
Period WPI Inflation @ Inflation Consumer Prices # Interest on Term deposits @
Ave 2005-06 to  2011-12 6.6 8.8 8.1
Ave since 2011-12 2.3 6.4 7.9

Source: @ from RBI; # from World Development Indicators.

But why the all-round feeling of being left out by the Pensioners now as the social media would have us believe when in real terms their income is 3 times compared to the period before 2012. In the years since 1991 except for a brief period between 1998 to 2002 asset prices have always been going up, in many years faster than inflation. When there is asset price inflation there is the wealth effect which makes us feel wealthier and prone to spending more, as articulated by economists. But once again in the last 3 years, real estate prices have hardly gone up. Without this illusory wealth effect backing, pensioners may be feeling poorer off.

Class of Interest Earners and Pensioners

People in agriculture tilling the land are unlikely to be living on interest income. They till as long as they can and then reply on family as the social security net on reverse mortgage of sorts – family supports them on the understanding that on death, his property will pass onto them. This is 50-60% of rural population. Landless labour are unlikely to be hit due to interest rate variations; they would need a safety net of a different kind. Non- farm rural labour is unlikely to be living off bank deposits.

People who are largely living on interest income are most likely urban or middle class. Most of them hedge their bets and have houses, gold etc. as safety nets and only a portion of their savings is in interest bearing instruments.

Amongst these are retired Government employees, whose pension is adjusted for inflation from time to time if they have been in service before 2004. They are a substantial proportion among pensioners. Those who joined after 2004 are unlikely to have retired by now.  Those who are most likely sufferers are those who retired from private service. Let’s see what proportion these are.

The total term and savings deposits of the banking system as of Sept 2017 is about Rs 114 lac crores and with the MF, Small savings and Public deposits it would be about Rs 130-135 lac crores, which is about 80% of our GDP. The comparative figures for US is more than 150%.  At an average rate of 6.6% this would give an income of Rs 8.91 lac crores or 5.5% of GDP.

From the above, we have to deduct the interest accruing to people still in service and Government pensioners. The income accruing to those who are surviving on interest alone is likely to be less than 2% of population.

Effect of Currency Devaluation

One of the strident and stubborn arguments against correction of our overvalued currency is that it will lead to inflation and hurt the interest of pensioners. The Urjit Patel Committee has summarised the several studies (see Table 2) on India estimating the inflation over the short term and the long term from a 10% movement in Rupee versus USD. With the singular exception of Ghosh and Rajan, the resultant incremental inflation (from currency alone) is likely to be 0.6% in the short term to about 1.5% over the long term. This is hardly worth the scare given the real income of pensioners have risen 3 times since 2012.

 

Table 2: Impact from 10% Depreciation of Re vs US $
Author Period Covered Short Term Inflation Long Term inflation
Khundrakpam (2007) 1991 – 2005 0.5% in WPI 0.90%
Kapur and Behera (2012) 1996 – 2011 0.6% in WPI 1.20%
Patra and Kapur (2010) 1996 – 2009 0.5% in one qtr WPI 1.5% in 7 qtrs
Patra et al (2013) 1999 – 2013 1.5% before 2008 crisis 1% after Crisis – WPI
Ghosh and Rajan (2007) 1980 – 2006 4.5%  to 5% in CPI  
Bhattacharya et al (2008) 1997 – 2007 1% – 1.1% in CPI 0.4% to 1.7% in CPI
Source: RBI – Urjit Patel Committee Report

 

Pensioners Vs Job Seekers 

Should our monetary system be so sensitive to such a small proportion of GDP and the group of people behind that (less than 2%). A 2-3% drop in interest rate in line with inflation would help the investment climate substantially especially in utilising capacities lying idle. The number of new job seekers is about 0.75 – 1% of total population each year.  For years on end the job creation has suffered and they will far outnumber Pensioners and its time their aspirations are also met.

Deposits till death.

If term deposit interest rates spread inflation had been same post 2012 (as between 2005/6 to 2012), Banks would be now saving Rs 164,000 crores on the incremental deposits of Rs 40-odd lac crores. If similar reduction had accrued on Central Government’s net additional borrowings, it would be an additional Rs 74,000 crores. These amounts saved would be sufficient to take care of those who purely depend on interest for survival.

The real sufferers can be taken care of by special deposits which can yield 2 % over CPI inflation s.t minimum of 5%. The deposits can be on joint names of spouses and on death of the latter to die, the deposits can be given over to the designated nominees after deducting tax. If prematurely withdrawn by depositors, the interest can be recalculated as per past prevailing interest rates and the balance of deposit paid to the depositor. Those who are entirely dependent on interest alone could be easily taken care through this mechanism from the potential savings as earlier estimated.

The writer if CFO of JK Paper and Author of Making Growth Happen in India (Sage).