Monday, March 02, 2015

Monetary Policy Framework Agreement: The first clarification of what RBI is to do

Our flawed inheritance

The Chamberlain Commission (1914) and the Hilton-Young Commission (1926) led to the drafting of the RBI Act. This was introduced in January 1927 and enacted in March 1934. The RBI Act does not state what the objective of RBI is. The authors of this Act were quite honest about what they were doing:

An Act to constitute a Reserve Bank of India. Whereas it is expedient to constitute a Reserve Bank for India to regulate the issue of Bank notes and the keeping of reserves with a view to securing monetary stability in [India] and generally to operate the currency any credit system of the country to its advantage;

And whereas in the present disorganisation of the monetary systems of the world it is not possible to determine what will be suitable as a permanent basis for the Indian monetary system;

But whereas it is expedient to make temporary provision on the basis of the existing monetary system, and to leave the question of the monetary standard best suited to India to be considered when the international monetary position has be come sufficiently clear and stable to make it possible to frame permanent measures.
From 1934 onwards, this `temporary provision' has been India's central bank. In the years of Indian socialism, this flawed beginning ossified into a full central planning system governing finance. Every detail of products and processes in finance is micro-managed. Alongside this, India got high and volatile inflation:

Fiat money made by RBI failed on the prime test: low and stable inflation.

It is easy to criticise RBI. It's like going into a time machine and making fun of what folks did not know in 1934. This is not a criticism of the individuals at RBI today. The problem lies right in the institutional DNA. What we have is not a central bank; it is a central planning agency for finance, with an improbable and conflicted set of objectives. Accountability mechanisms are absent. Good governance principles, and the rule of law, are missing. Even in the hands of good individuals, RBI has lurched from one mistake to another.

Figuring out the solution

I first saw the beginnings of clarifying what RBI was about at RBI. C. Rangarajan and S. S. Tarapore essentially understood that what made sense was a focused inflation targeting RBI + an open capital account. In the 1990s, open economy macroeconomics was not as well understood, and they did not quite get the fact that this inevitably meant a floating exchange rate. But they had intellectual leadership on the idea that low and stable inflation is the dharma of a central bank.

Similarly, in the late 1990s, intellectual leadership on reforming debt management arrangements came from RBI. By the early 2000s, RBI was saying that there is a conflict of interest between the objective of debt management (i.e. to borrow for the government at low rates of interest) and the objective of monetary policy (i.e. to deliver low and stable prices). To do a good job as debt manager would generate interest rates that are too low, and give an inflationary bias. The solution was for the government to find its own debt management arrangements, and unburden RBI of this conflict of interest.

While RBI fought inflation in the 1990s, this ethos did not turn into legal instruments, organisational reform, and lasting institutional change. By the early 2000s, RBI was back into hankering for exchange rate pegging and more capital account restrictions. On debt management, RBI's position shifted to defending turf. Intellectual leadership on RBI reform shifted outside RBI.

By the early 2000s, as the difficulties of exchange rate pegging became visible. RBI's pursuit of exchange rate objectives repeatedly led to the wrong decisions on monetary policy, and gave RBI a bias in favour of preventing the emergence of a capable financial system. When the Agent is given multiple objectives, he is accountable for none. The heart of the problem lay in putting an end to the temporary arrangement: in establishing a clear objective, removing conflicts of interest, and setting up accountability mechanisms.

The earliest sources that I am able to find on the Internet are a newspaper column by Ila Patnaik on 21 August 2006, and the Percy Mistry report (2007). (Please do point me to other such early writings advocating inflation targeting for India). By this time, serious people in Indian macro/finance knew where India needed to go: Inflation target + Open capital account + Floating exchange rate. All the other expert committee reports supported this.

The long run answer

The Indian Financial Code, drafted by Justice Srikrishna's commission, is the full, coherent, internally consistent replacement for the menagerie of Indian financial laws. Once this is enacted, the RBI will have clarity of purpose, and will have sound governance. That is for some unstated date in the future. Does this mean that nothing can be done in the short run?

Some progress in the short run

In 1997, the Finance Secretary, Montek Ahluwalia, and the RBI Governor, C. Rangarajan, signed a `Ways and Means Agreement', which put an end to money creation for deficit financing. This was not in the law, but it was a step forward. The agreement, by and large, delivered.

In July 2014, the Budget speech announced that a monetary policy framework would be put into place. Ordinarily, one would think this is a combination of an inflation target and the machinery of an MPC.

Today, MOF has released a Monetary Policy Framework Agreement signed by RBI & MOF.

It establishes an inflation target. That is a good thing.

Oddly enough, there is no Monetary Policy Committee (MPC). The interest rate is decided by one person: the RBI Governor. This will lead to many infirmities. But this is progress, for the period until the IFC is enacted.

Like many of the other things in this year's budget speech, this is halfway there. Ideally, it should have been an inflation target + a properly constructed MPC. There is an odd loss of nerve.

Sunday, March 01, 2015

Interpreting the BJP's 2015 budget

The BJP, armed with a clear majority in the Lok Sabha, with the desire to break with Nehruvian socialism, was expected to unveil a game plan for structural changes from here till 2019. In large part, Budget 2015 does not rise to the challenge. It has some good elements, and with good execution, they will make an important difference. But an array of important and pressing problems have been left unsolved.

The challenges faced in this 2015-16 budget

This was an unusual budget making exercise for three reasons:

  1. This was the first full year budget of the new BJP government, and they were expected to show a strategy for the coming 4.3 years.
  2. This is the first majority in the Lok Sabha in 30 years, and the campaign was fought on the platform of jobs and not dole.
  3. There is an unusual opportunity for fundamental change in expenditure because of shuttering of the Planning Commission, and 14th Finance Commission's recommendations on enhanced resource flow to state governments.

Fiscal consolidation

Mr. Modi was a fiscally prudent finance minister in Gujarat, and that kind of approach was expected in New Delhi also. Three factors have shaped the fiscal situation:

  1. The goverment got a windfall on account of reduced crude oil prices, which reduce the magnitude of oil-related subsidies. To their credit, they have also done a bit on reducing subsidies on some petroleum products.
  2. The 14th Finance Commission recommendation to increase the resource share of the states from 32% to 42% need not have any adverse impact for central finances, as it should merely send expenditures down to the state government level (where they belong). The combination of closing down the planning commission + the 14th finance commission adds up to the perfect opportunity to make substantial changes in the (broken) machinery of central expenditure.
  3. India's fiscal dynamics in recent years was greatly assisted by the inflation crisis. Inflation breached 5% in February 2006. From that point onwards, buyers of government bonds repeatedly experienced inflation that was greater than expected. This problem is now hitting India in reverse. The global deflation has given a collapse in inflation in India. Now bond holders are experiencing lower inflation when compared with what was expected at the time of bond issue. Debt dynamics in India is now worse.

The calculations of the budget are predicated on 8% GDP growth and 5% inflation. The new GDP data are indeed very exciting for they show better strength in the economy as compared with the old data. We wish the new data is right. However, if the new GDP data has problems, this could generate less tax buoyancy than expected.

When the Indian credit rating was teetering on the brink of sub-investment grade, the then finance minister, P. Chidambaram, made a fairly credible commitment to a certain fiscal adjustment trajectory. Financial markets decided this adjustment was good enough.

The budget speech has unfortunately decided to break with this fiscal adjustment trajectory by asking for one more year to reach the 3% target in 2017-18. In my opinion, this is unwise. The economy will be healthier if we had more fiscal prudence. If the public investments had to be increased, the resources should have come either from disinvestments from sectors where government is not required or from pruning the subsidy bill. Abandoning the fiscal consolidation is not a good way of achieving greater public investment. Para 24 says that the Finance Bill will amend the FRBM Act, thus showing that flouting the FRBM Act is all too easy for the administration.

A sound and elementary test of the correct fiscal stance is the following rule: "Barring a year with a bad business cycle downturn, we should have a primary surplus; Primary deficits should happen no more than (say) in two years out of 10". Last year's primary surplus was -0.8% and the next year's is budgeted at -0.7%. This suggests that the Indian fiscal situation is wrong by roughly 1% of GDP.

Non-interest expenditure is budgeted to grow by only 4.06%. The problem lies in interest payments, which are budgeted to grow at 10.89%. India's debt dynamics are now problematic; even though non-interest expenditure growth is modest at 4.06%, this is giving a gain in the primary deficit of only 0.1 percentage points.

A big area for cutting expenses is subsidy reform, but this has not been done.

It would have been better to run a tight ship, and get to a primary surplus of -0.2% this year and +0.5% next year. Debt/GDP only goes down when we combine small primary surpluses with high GDP growth.

In summary, the fiscal stance, with a reduction of the primary deficit of only 0.1 percentage points, and a break with P. Chidambaram's proposed adjustment trajectory by one year, is disappointing.

Dismantling the Planning Commission

The Planning Commission was not in the Constitution of India. The failures of the Planning Commission, and the concepts of plan vs. non-plan expenditure, are central to the failures of the Indian State. Mr. Modi took a big step forward by announcing the abolition of the Planning Commission on 15 August 2014.

This requires a corresponding re-engineering of government around the theme of accountability. The Ministry of HRD must be given a block of money, and in return must commit to the numbers for learning outcomes, measured by a non-government agency like Pratham, that they must deliver. Failure to deliver should have consequences. Once this is done, they should be free to design their own strategies for how to use this money. This is how fiscal systems in mature countries work, without a Planning Commission running a parallel fiscal system.

Some re-engineering that flows from closing down the Planning Commission has been done. But the bulk of it has not been done. Most `plan schemes' have not been dismantled. There is no articulation of what the post-Planning-Commission world will look like. The budget process appears to have trundled along as usual, without noticing that the Planning Commission has been shut down. There is no talk of even planning how to redesign the Indian fiscal system in this new world. This is disappointing.

Niti Aayog was supposed to be a think tank. It is a source of great concern that thousands of crore of resources are being allocated to it. A good think tank requires Rs.100 crore a year of expenditure. Anything more, and it becomes a fiscal mechanism. The "Planning Commission" was renamed to "Niti Commission", all the old staff were retained, and now we're slipping back into the spending ways of the old Planning Commission. Nehruvian socialism was an intellectual construct, and it is going to require intellectualism to dismantle it.

Tax policy and tax administration

India has an extreme crisis on low quality thinking and execution in tax policy and tax administration. The term `tax terrorism' has entered the lexicon. Badly structured tax policy and tax administration are hampering GDP growth. For many years now, the tax/GDP ratio has been declining. In 2014-15, gross tax revenues (net to centre) had a shortfall of Rs.113,133 crore or 8.3%. To do the (weak) fiscal adjustment of the coming year, MOF has has had to raise tax rates.

India has a tax rate of 44% on corporate income, combining corporation tax and the dividend distribution tax. This is one of the highest tax rates among comparable countries. In the budget speech, there are paragraphs which talk about a cleaner tax system being built in 5 years (para 60 and 97). But at the same time, the budget speech promises us (para 129) that the Direct Tax Code (version 1 of which was the best alternative for direct tax reform) is now buried. There is no display of an implementation mechanism through which the promises of Para 60 and Para 97 will be fulfilled. If the intent is to cut the rate of taxation of firms, why not start now?

Para 96 restates that a good GST will be built. The bottleneck is in implementation. As an example, MOF could have announced that in 2015-16 they will implement a `Central GST' covering only the Centre, which will be put into effect in 2016-17, and then in 2017-18 there will be a mechanism for states to connect into it.

An integral feature of the Modi campaign was the objective of reducing the complexity of doing business. One major element of the difficulties which firms have faced is the tax system. The lack of strategy on reforming tax policy and tax administration is disappointing.

Financial sector reforms

The announcements are:

Financial markets
Para 56 and 57: Merge commodity futures and the government bond market into SEBI, and setup the Public Debt Management Agency (PDMA). A nice gold-linked bond scheme will be an added instrument through which the PDMA will borrow.
International finance
Para 58: Regulation-making power on equity related capital flows to shift to Government. Para 87: Build out GIFT as an International Financial Services Centre (IFSC).
Monetary policy:
Para 13: A `Monetary Policy Framework Agreement' has been signed with RBI, which gives RBI an inflation target of "below 6%". The RBI Act will be amended to provide for a Monetary Policy Committee.
Deeper institution building
Para 88: Setup commercial divisions in courts of India. Para 59: Setup Task force for creating Financial Redress Agency. Para 59: Introduce Indian Financial Code "sooner rather than later"
Pension reforms
Para 40, 41, 42: There are a slew of social security proposals. Para 62: Employees will be given the choice of opting out of EPF and going into NPS instead.
Bankruptcy process
Para 36: Bring a comprehensive Bankruptcy Code in fiscal 2015-16, which will meet global standards, and provide necessary judicial capacity.
Taxation of finance
Para 106: Tax 'pass through' proposed to be allowed to both Category-I and Category-II Alternative Investment Funds, so that tax is levied on the investors in these Funds and not on the Funds. Para 108: Solve the problem of `permanent establishment' faced by global fund managers who locate in India.
Bad ideas
A `MUDRA Bank' which will be a PSU which will refinance micro finance institutions.

This is fascinating and impressive in parts, but disappointing in many respects.

Financial markets: The vision for organised financial trading by all the expert committees has been : to harness economies of scale and economies of scope by unifying all organised financial trading. Government bonds and commodity futures will now be with SEBI. That leaves an odd collection of elements at RBI: corporate bonds with maturity below one year, credit derivatives, and currencies and their derivatives. It would have been much cleaner to do the full thing, instead of settling for such an awkward compromise.

The Bond-Currency-Derivatives Nexus is a deeply interconnected set of markets combining spot and derivatives markets on government bonds, corporate bonds, and currencies. All these markets are tightly interlinked through arbitrage. Achieving a liquid and efficient market on any of these sub-components requires achieving a liquid and efficient market on all these sub-components.

The old arrangement had problems: RBI was keen to prevent the Bond-Currency-Derivatives Nexus from emerging, and SEBI only had jurisdiction on corporate bonds with maturity over 1 year. The new arrangement consists of government bonds and corporate bonds of maturity over 1 year with SEBI, with everything else in the BCD Nexus with RBI. This is a better than the previous arrangement but unsatisfactory.

International finance: In similar fashion, it makes sense to shift regulation-making power on capital controls out of RBI. Capital controls are ultimately political, and the task of defining capital controls cannot be delegated to an independent organisation. In addition, RBI has a long history of writing capital controls regulations which drive up the cost of doing business. However, the formulation adopted -- that regulation-making for only equity flows will shift to the government -- yields small gains. Largely speaking, it replaces the de facto by the de jure.

There is room for improving capital controls regulations on equity flows, but the potential gains are small, as the Indian capital controls on equity flows are not grossly wrong. The big mistakes in the Indian capital controls are with debt flows -- whether ECB or the foreign investment into rupee denominated bonds. Thus, the reform announced in the budget speech is progress, but still unsatisfactory.

International Financial Services Centres (IFSCs) like GIFT City are a good idea. At a high level, the budget speech has made progress. The challenge is in management, execution and details. We will know GIFT City will actually work only when a concrete management mechanism is put into place and starts smoothly delivering results.

Monetary policy:: From 1934 onwards, RBI has had the power to create money, but there has been no monetary policy framework which created a `nominal anchor' for the Indian rupee, and delivers low and stable inflation. The July 2014 budget speech had promised that for the first time, a monetary policy framework would be put into place. The 80-year organisation would, for the first time, find a purpose. Now, we are told that a `Monetary Policy Framework Agreement' has been signed between MOF and RBI, which gives RBI an inflation target of "below 6%". This sounds like a good thing. However, the text of the agreement has not been released, so it is not possible to analyse this agreement and understand whether this has been done properly.

It is also stated that the RBI Act will be amended to provide for a Monetary Policy Committee. There are subtle design issues associated with setting up a Monetary Policy Committee. We have to wait and see the extent to which sound thinking has gone into the Monetary Policy Framework Agreement, and in the proposed amendment of the RBI Act.

Deeper institution building: Four `task forces' are in motion on establishing the institutional architecture of the draft Indian Financial Code. The speech says they are progressing well and will continue to work. One of the four institutions being created -- the Public Debt Management Agency -- will come into existence. The other three new organisations are : the Resolution Corporation (which will be ineffective until the Indian Financial Code is enacted), the Financial Sector Appellate Tribunal (which can yield gains in terms of a better functioning SAT, even before the draft Indian Financial Code is enacted) and the Financial Data Management Centre (which can yield gains by voluntary adoption by regulators, even before the draft Indian Financial Code is enacted).

A fifth task force will be created: To construct the `Financial Redress Agency'. This is a one-stop-shop which will hear aggrieved customers of financial services, across the entire Indian financial system. This task force will presumably utilise the management techniques which have proved successful in the other four task forces. It constitutes one more building block towards enacting and enforcing the Indian Financial Code.

Commercial divisions in courts have been debated for a long time. Now they will come into existence. We will have to wait to find out the implementation mechanisms that are adopted for this laudable venture, given the spotty performance of court automation initiatives in the past in India. The developmental work done by the Task Force on Establishing the Financial Sector Appellate Tribunal could potentially be useful here.

Finally, the budget speech promised to introduce the Indian Financial Code in Parliament. This is the centrepiece of the Indian financial reforms: a single, coherent, modern, well thought out law that replaces the haphazard 61 laws which govern finance in India today.

Pension reforms: EPFO is mandatory for most employees of non-trivial private firms. The National Pension System (NPS) works much better than the EPFO, both on client servicing, and on returns obtained by the worker. Now that the institutional machinery of the NPS is working, it will be given as a choice to workers in the EPF. This is a big step forward in terms of developing pension planning for millions of households, and long-term institutional investment in the country.

However, alongside this, paras 40, 41 and 42 offer announcements of `social security' proposals. If there is any element of `defined benefits' or assured returns in these, it can be quite dangerous. Extreme care is required on understanding the fiscal consequences of these kinds of statements, with number crunching going out into the next 75 years. It would be tragedy if, alongside expanding the well structured pension system (the NPS), the government also grows old-style socialist programs.

Bankruptcy process: The Vishwanathan Committee is working on improving the bankruptcy process. A first report has been released, which proposes incremental modifications. The Budget speech has promised a much more ambitious objective in Para 36: to Bring a comprehensive Bankruptcy Code in fiscal 2015-16, which will meet global standards, and provide necessary judicial capacity. The work process that was used for the Indian Financial Code should inform the construction of the Indian Bankruptcy Code. There may be a connection between this problem and the establishment of commercial divisions in courts.

Taxation of finance: There is an array of mistakes in tax policy when it comes to the financial system. The budget speech promises to solve two of them : the problem of `permanent establishment' of foreign fund managers, and the problem of tax pass-through for two categories of Alternative Investment Funds. Both these have been attempted before, without success. Careful analysis of the Finance Bill is required to understand whether this time, the drafting by DOR/CBDT is done correctly.

Bad ideas: `Mudra bank' is an old style socialist initiative, which is inconsistent with all the other modern elements of financial sector reforms.

Overall, there are many good ideas in the work on financial sector reforms. There is, however, a disconcerting incompleteness of the initiatives. Many of them are half hearted; a line of thought is begun but not completed. Much more is required in terms of thorough follow through in conception and execution.


Before the budget speech, there was a lot of talk of a great wave of public investment in infrastructure which was going to revitalise the economy. The numbers are now visible and do not pass muster. Para 46 says that spending on roads will go up by Rs.14,000 crore and spending on railways will go up by Rs.10,000 crore. Para 47 proposes off-balance-sheet borrowing of Rs.20,000 crore a year. Even if all these are summed up, this comes to less than 0.4% of GDP. In addition, there are the usual problems of low quality investment process with public investment, which have not been addressed. This is not going to make a significant difference to the demand side of the economy, even if we are optimistic and think that all this spending hits the economy in 2015-16 itself. So, if this is the excuse for breaching fiscal discipline, it is not a good one.

The FM has proposed revisiting and revitalising the PPP model of infrastructure development. The proposal is to rebalance the risk in infrastructure projects, by making the government bear a major part of the risk. This just a sentence but it will have major consequences for the infrastructure sector. This risk shift could very easily turn into a `heads I win, tails you lose' proposition for the private sector, or it may translate into the government running the entire infrastructure development process with the private sector stepping in for construction only.

This proposed risk shift may be solving the wrong problem. Is it clear that the problems lies in private parties holding risks they cannot manage? For example, the airport sector has similar risk sharing as other sectors but it has been fairly successful in getting investments and ensuring availability of infrastructure. Moreover, the government's own record of choosing projects for investments has been so poor that shifting the responsibility to the government may be worse that the performance of the PPP model. We have to choose the model that is most likely to work, and then make it work. In all cases, risk and return must move together.

However, there is a group of initatives which are not mere old Indian socialism, which could actually constitute genuine progress on the field of infrastructure. Para 53 promises legislation on replacing multiple prior permissions by a pre-existing regulatory mechanism. Para 72 promises a new law on procurement. Para 73 promises a new law on disputes. Para 74 promises a new law on infrastructure regulation.

There is, of course, the challenge of execution. Many laws are drafted in India, but all too often, the quality of work is poor and the new laws do not solve problems. But given high quality execution, these could be transformative initiatives. A lot of the work on establishing financial regulators, that was done for the Indian Financial Code, could potentially easily carry over to the problem of drafting law for infrastructure regulators.

Other reforms

Para 33 promises that NITI will work on creation of a Unified National Agriculture Market. This is a very important area. We have to cautiously see the extent to which modern thinking, and high quality execution, is brought into the work of NITI on this question.

Para 103 proposes a draconian policing environment on overseas assets. This is a throwback to Indira Gandhi's world, and is highly regrettable.


Narendra Modi showed a willingness to solve problems at the root cause in some sectors in Gujarat. The first budget shows glimmers of the Modi way in a few areas, but all too often, it settles for the conventional approach of compromise and defence of the status quo. Transformative initiatives, like the abolition of the Planning Commission, have not been followed through to their logical conclusion. This yields low gains.

The budget is weak on strategy, on coherent thinking. A variety of dilettantish two-page policy notes have been cobbled together in most areas. To make progress, one needs to start from full picture of where we want to go (i.e. a "grand scheme"), think it through in all its ramificiations, and undertake a series of chess moves which take us to that ultimate goal. Instead, we have got defeatist statements that in democracies, fundamental progress is not feasible. On taxation, expenditure, infrastructure, etc., there is no evidence of this kind of big thinking.

It is one thing to get through the political conflicts and agree on a line in the budget speech. It is a very different matter to get execution. The Government of India is riddled with weak teams, a lack of clarity on the direction for reform, low execution capabilities, etc. In many places, hard political battles have been fought to get a line or a paragraph into the budget speech, but this will come to naught owing to inadequate execution. The subset of the budget speech where results will be obtained will be the subset where sound teams are put into motion. The sound teams will, in turn, feed good ideas back into the next budget process. The management challenge, of establishing high quality teams on the policy priorities, is the defining question about the Indian government. Arun Jaitley and his team at the Ministry of Finance will need to carefully strategise how the good stuff out of the speech is turned into project management, that can deliver valuable change over the year.

The BJP, armed with a clear majority in the Lok Sabha, with the desire to break with Nehruvian socialism, was expected to unveil a game plan for structural changes from here till 2019. In large part, Budget 2015 does not meet the bill. It has some good elements, and with good execution, they will make an important difference. But on an array of important and pressing problems, we do not have solutions.

It is interesting to contrast this against what a UPA budget might have been. A UPA budget might have had elements like:

  • More public expenditure on infrastructure.
  • Weak fiscal consolidation, apologies for lack of deficit reduction.
  • Lack of subsidy reform.
  • Not abolish the planning commission or plan schemes, inability to re-imagine the fiscal system without central planning.
  • Increased the peak income tax rate by 2 percentage points for the rich.
  • Continue to have a 44% tax rate on firms (combining corporation tax and DDT).
  • Continue to have `bad taxes' like the STT.
  • Not remove the 2% corporate social responsibility expense in the Companies Act.
  • Indira Gandhi vintage measures on foreign assets.

It is disappointing to see how little has changed.

Wednesday, February 25, 2015

Become a public policy thinker in three easy steps

Step 1: What's the market failure?

Each of us tends to get unhappy at some feature of the world or the other. As an example, I don't like rap music. But value judgements of this nature do not justify the use of State power - either to ban rap music or to encourage classical music. Such coercion by the State is just abuse of power.

When should the State intervene? The technically sound answer is: When you are certain there is a market failure, and when you are confident you know how to setup the correct State capacity for the intervention.

Market failures come in four kinds: 1. Asymmetric information,   2. Externalities,   3. Market power and 4. Public goods. These are technical terms in microeconomics and each needs to be carefully understood.

The first hurdle that must be crossed in policy thinking is the question: "Is there a market failure?"  Every proposal to do something in public policy faces this test.

A good way to smell market failures is the prices being wrong. In a well functioning economy, the price should be close to marginal cost or to the Ramsey price. When the observed price diverges from these normative ideals, a market failure may be afoot. But while the price being wrong is the diagnostic that alerts you to a problem, direct intervention in the price is seldom the right answer

At present, most of what the government does in India is not about market failures. Using the coercive power of the State to meddle in the voluntary decisions of consenting adults is mostly a bad idea. The Indian State suffers from rampant central planning, license-permit raj, and shameless value judgments.

Step 2: What's the proposed intervention?

Once we agree there is a market failure, we have to figure out what we'd like to do about it. Here, it's important to understand the anatomy of the market failure, and solve it at its root cause.

If there is a causal chain x -> y -> z, leading up to a bad outcome z, don't use the power of the State to change y or z. Understand the root cause, and solve it there.

Example: Investors are not buying infrastructure bonds. Don't propose tax exemption as the solution.

Example: Micro-finance companies in Andhra Pradesh are mistreating their consumers. Don't propose micro-prudential regulation of micro-finance companies as an answer.

Example: OTC derivatives are not enforceable. Don't propose changing the financial regulatory architecture as the answer.

Government agencies in India are known to do a bait-and-switch. A problem is shown, outrage is created, and then a completely unrelated solution is pushed forward which will increase power and reduce accountability. We need to be skeptical and verify: Does your claimed intervention address your claimed market failure?

Complicated microeconomic interventions which require volumes of law are generally abuses of power, and will not deliver on the original objective. At a heuristic level, the Indian capital controls don't work because the FEMA handbook weighs 3.5 kilos.

Occam's Razor in Public Policy: Many different interventions could possibly change the world in the direction that you like. The least intrusive intervention that gets the job done is the right one. In order to find this least-intrusive intervention, you have to understand the market failure deeply. Sound thinking in public policy requires understanding the anatomy of the market failure, and coming up with the minimum use of the coercive power of the State in addressing that market failure and in minimally disturbing the rest of the landscape.

Corollary: Macroeconomic problems require macroeconomic policy tools. It's almost always wrong to use microeconomic interventions to pursue macroeconomic goals.

Step 3: The hurdle of public administration

Okay, you are all dressed up and ready to go, with a demonstrated market failure, and a minimal intervention which solves it. Now the question arises: Can you design a feasible solution with real world political economy and public administration?

Pressure groups will hijack well meaning policy frameworks to favour small groups at the expense of the diffused populace. Government agencies like to be lazy and corrupt. Politicians and officials work for themselves and not for the citizenry. Can we envision the accountability mechanisms through which the Principal (the citizen) is able to coerce the Agent (the government) to deliver results? A complex machinery of checks and balances has to be designed, including transparency, reporting, rule of law, due process, etc.

As a thumb rule, government should almost never be in the position of determining a price [example]. Prices must fluctuate every day, based on changes out there in the world. It is impossible for government agencies to figure out what the right price should be. Similarly, a government should not be in the business of determining business plans or business models. That's a tell tale sign of central planning.

We have to be careful about mission creep. Market power is the job of the Competition Commission and not the IRDA. Enforcing IPC is the job of the police and not of FMC. SEBI should not be forcing listed companies to have women directors; RBI should not be subsidising ATM placement in Assam, and so on.

Libertarianism of necessity vs. libertarianism of choice

Many times, even after we know there is a market failure and we're able to envision a surgically limited intervention, we have to fall back on doing nothing, as the market failure is not very large or significant, and it's not easy to design the public administration machinery through which we can make a government deliver the desired outcomes. When there is low State capacity, this happens more often. We do more subtle interventions in Sweden, we do more laissez faire in India.


Decades of Indian socialism have starved us of capabilities in economics. Everyone interested in the field of public policy should limber up with these three steps: (a) What's the market failure? (b) What's the minimal intervention that precisely addresses the root cause of the market failure? (c) How do we construct mechanisms through which government agencies in the real world will deliver the desired outcome, even though their first instinct is to favour laziness and corruption?

This is hard work. The outcomes of this process of thinking resist classification into prefabricated belief systems. I sometimes meet people who say "As I'm a Keynesian, I propose policy X". That's a great economy of thought; by reading a few books by Keynes, you have figured out the world. It's  better to start from first principles, and analyse each problem on its merits, and engage with the gritty reality out there in figuring things out.

Going from strong as in scary to strong as in capable

by Suyash Rai and Ajay Shah.

The central question in India's journey, today, is that of constructing State capacity. How should laws, agencies, processes and accountability be designed, to engender high performance? In a recent speech titled Democracy, inclusion and prosperity, Raghuram Rajan talks about the joint process of evolution of economics, politics and the State. Rajan provides a brief summary of the framework articulated in the first of Francis Fukuyama's two volumes on political development. Fukuyama uses three pillars to trace political development globally: State-building, rule of law, and accountable government.

Late in the speech, he asserts that India is unique in having built democratic accountability and rule of law before building a strong government. He argues that there is a conflict between government accountability and government capacity, and since checks and balances make it difficult for the government to do its job, we should focus more on State-building and less on accountability. In other words, we have plenty of accountability but little capacity, and should therefore focus on the latter. The key text is:
An important difference from the historical experience of other countries is that elsewhere typically strong government has emerged there first, and it is then restrained by rule of law and democratic accountability. In India, we have the opposite situation today, with strong institutions like the judiciary, opposition parties, the free press, and NGOs, whose aim is to check government excess. However, necessary government function is sometimes hard to distinguish from excess. We will have to strengthen government (and regulatory) capability resisting the temptation to implant layers and layers of checks and balances even before capacity has taken root. We must choose a happy medium between giving the administration unchecked power and creating complete paralysis, recognizing that our task is different from the one that confronted the West when it developed, or even the task faced by other Asian economies.

For instance, a business approval process that mandates numerous government surveys in remote areas should also consider our administrative capacity to do those surveys well and on time. If it does not provide for that capacity, it ensures there will be no movement forward. Similarly, if we create a multiple appellate process against government or regulatory action that is slow and undiscriminating, we contain government excess but also risk halting necessary government actions. If the government or regulator is less effective in preparing its case than private parties, we ensure that the appellate process largely biases justice towards those who have the resources to use it, rather than rectifying a miscarriage of justice. So in thinking through reforms, we may want to move from the theoretical ideal of how a system might work in a country with enormous administrative capacity, to how it would work in the actual Indian situation. Let me emphasize, we need "checks and balance", but we should ensure a balance of checks. We cannot have escaped from the License Permit Raj only to end up in the Appellate Raj!
In this article, we disagree with this argument. We analyse RBI in some detail as an example of what is going wrong in the Indian State. We see the argument above as a restatement of the present mores of the Indian State. This way of thinking is integral to the poor outcomes that we see in India today, and yields low State capacity and abuses of power. The essence of making progress on the construction of liberal democracy in India, and of building State capacity, is to break with this position.

The three big phrases in this debate

State-building. Fukuyama uses the term `State' in the sense that Max Weber used it: An organisation deploying a legitimate monopoly of violence over a defined territory. He also borrows the definition of a modern state: A state that is subject to a rational division of labor, based on technical specialisation and expertise, and impersonal both with regard to recruitment and their authority over citizens. State-building essentially amounts to successfully extending the state's legitimate monopoly on force over the territory it governs, and modernising the use of this force by division of labor, technical expertise, and impersonal recruitment and authority. The state may use its force for benign ends, but it has the power to do the opposite. This monopoly is necessary but it is also dangerous, and therefore it must be constrained. That is why democratic accountability and rule of law become important.

Rule of law. For many people in India, the phrase rule of law means `obeying all laws'. However, it means much more than this; it is about a deeper constitutionalism that pervades the working of the State. The essence of this complex and multi-faceted concept is the restriction of arbitrary use of power. When the power of the State is given to an individual, that individual is expected to use it in good faith for the precise purpose for which it was given, without undue intrusion into the people's lives. However, trust in good faith is not enough. If men were angels, no government would be necessary. Hence, the rule of law must be enshrined in procedures and policies. All use of power must be subordinated to established laws, and not based only on volition. The rule of law is strengthened when laws limit the use of power, and prescribe due process for use of power. Under the rule of law, the law is known, State behaviour is predictable and aggrieved persons have efficacious mechanisms for appeal.

Accountable government: In Fukuyama's words, accountable government means that the rulers believe that they are responsible to the people they govern and put the people's interests above their own. This moral concept of accountable government has formal manifestations. One major way in which this manifests itself in democratic societies is through the Constitution and parliamentary laws. The government is mandated to put the public interest above its own interest. If the government fails to meet the objectives satisfactorily or if it uses its powers for some other ends, the electorate would hold it accountable at the elections. Alongside this, well drafted laws create an array of additional accountability mechanism, which constantly keep government agencies and their employees under check.

Ordering or interdependence?

While many countries developed strong governments before they strengthened government accountability and rule of law, there are important examples of countries where this was not the case. The US and UK saw the emergence of democratic accountability and rule of law alongside the rise of strong governments. Democratic accountability and rule of law helped decide what kind of strong and capable government the country needed. That is what protected the populace from a rapacious state. Even James Madison who wrote about enabling the government to control the governed, and then obliging it to control itself, helped build accountability and rule of law in the US Constitution from day 1, which helped shape the nature and extent of strengths of the US government (see Federalist 47-51 by James Madison).

There is a deep dialectical relationship between government capacity and government accountability, and not some simple ordering. Accountability may shape State capacity, and the opposite could also happen. As Tocqueville demonstrated in his book on the French Revolution, The Old Regime and the Revolution, the French monarchy unintentionally paved way for a democratic revolution by creating a rational, centralised state that weakened the feudal order and placed most citizens on equal footing, thus laying the foundations of democratic society.

Education in India shows us an opposite story: if so many people in the country had not exercised the "exit" option by taking their kids to private schools, and instead "voiced" their dissatisfaction with government schools, we would have seen much better performance from the government schools.

It is more risky to have the State build capacity in a vacuum as it is all too easy to misuse coercive power. State capacity must be built within the contestations and pressures of democratic accountability and it must operate within the bounds of rule of law.

Strong as in scary vs. strong as in capable

At first blush, it seems that India has a `weak State' and has rushed ahead on greater democratic accountability and rule of law. However, the precise sense of `strong' or `weak' needs to be carefully understood. There are two aspects of the 'strength' of a State.

  1. One feature of a `strong' State is having coercive power over citizens, the ability to force them to do certain things, and the ability to hurt them. By this definition, large parts of the Indian State qualify. Many regulators in the financial and infrastructure sectors are fairly strong in terms of their ability to make their regulated sectors follow their commands. The tax bureaucracy in India is very powerful, to the point where the phrase `tax terrorism' has entered the lexicon. If we think of the word `strong' as `scary', then a lot of the Indian State meets the test.
  2. Another feature of a `strong' State is one that delivers the desired results. A `strong' criminal justice system is one that delivers law and order. If we think of `strong' as `capable', most of the Indian State apparatus is faulty.
Rajan says that asking for more accountability and the rule of law will hold back the emergence of a strong State. At present, all too often, the Indian State is strong as in scary but not strong as in capable. A great deal of coercive power has been given to the government and its agents, but they do not build sufficient capacity to do their jobs. At the same time, they use the power as they wish.

How to map power into the desired outcomes? This is substantially about accountability and the rule of law. If results are not delivered, it is very likely because there is not enough accountability and the rule of law. The journey from a scary State (which has the coercive power over citizens) to a capable State (one that delivers on governance outcomes) runs through the bridge of accountability mechanisms and the rule of law.

'Leave it to the experts' or 'give them power and hold them accountable'?

Rajan says that since it is difficult to distinguish necessary government function from excess, the government should get a long rope. But it is precisely because government function is hard to distinguish from excess, that government and regulators can amass illegitimate power and use it excessively. Only when we build adequate checks and balances will the temptation for excess be curtailed.

To place Rajan's comments in context, in a recent debate [link, response, response, response, response], he opposed judicial review of regulations. Is such review an example of "excessive checks and balances"? In the working of liberal democracy, nobody has the ability to write law without checks and balances. As an example, a committee report led by Professor Rajan in 2009 strongly and repeatedly recommends the idea of an appellate system for all financial regulators. Now, Governor Rajan opposes the idea.

Looking at the RBI through this framework

It is well and good to talk about high principles, the big picture and the long march of history. However, specific actions, real institutions and the current context also matter. When talking of the entire system, one is vulnerable to commit a fallacy of division, i.e. assuming that what is true of the whole must also be true of the parts. What is true of the overall Indian government may not actually be true of all its parts. Rajan is on a three-year term as the Governor of RBI. He has completed about half of the term. This is hence a good time to look at how issues of State capacity, accountability and rule of law are working at RBI.

Regulators such as RBI subsume within them legislative, executive and judicial powers. They make regulations, implement them and adjudicate over those they claim have breached the regulations. This devolution of authority from the Parliament is justified because of technical expertise required, and because there is a need for independence from day-to-day political intervention. However, if such power is not checked, it is a recipe for tyranny.

Is the grand narrative of the Indian state - high on accountability and rule of law, and low on capacity and strength - true of the RBI? RBI is strong as in scary. It lords over banking, payments, capital flows, etc with such strength that it is almost unimaginable that a regulated entity would do anything against RBI's wishes. Most employees of financial firms privately excoriate the RBI but are scared enough to praise it in public. There is a level of fear, and self-censorship, that is seldom found in argumentative India.

While India has high democratic accountability overall, this is not true of RBI. RBI is a set of unelected bureaucrats who are, in effect, largely unaccountable. Although it is supposed to be held accountable by the Parliament, one cannot see how such accountability can be enforced. At present, RBI pursues multiple, conflicting objectives, which give endless opportunities of offering alibis for non-performance. It is a central bank, manager of government debt, redistributor (e.g. priority sector requirements), regulator of banks, non-banking financial companies, payments and capital flows. It runs exchange and payments infrastructure. When failing on beating inflation, it can say it was keeping interest rates low on government debt. When failing on safety and soundness regulation, it can argue that it was busy ensuring banks lend to priority sectors where they incurred losses. Multiple objectives, and conflicts of interest, has given a loss of accountability.

What about the rule of law at RBI? RBI has taken undue advantage of what Rajan calls "the difficulty of distinguishing between necessary government function and excess".

Example: RBI has arbitrarily arrogated to itself the power to restrict competition in banking by giving only 2 licenses a decade, and there is no effective mechanism to question this power. This is partly because the RBI Act and the Banking Regulation Act do not impose sufficient procedural restrictions on such misuse of powers. If, for example, the RBI was mandated to conduct a cost-benefit analysis of its regulations, we would learn about the economic consequences of the restrictions it imposes, but no such mandate exists.

Example: RBI's actions on exchange-trade currency derivatives, which damaged the liquidity in the market, and increased currency volatility. These mistakes would have been less likely if there were better checks and balances.

Example: Under Rajan, RBI's intervention of the Rupee has grown manifold compared to that in the previous Governor's tenure:

This major shift in the actions of monetary policy has not been announced or explained to the public. This change in course is an exercise of arbitrary power conducted under opacity.

Example: In a recent case involving Docomo, RBI arbitrarily announced that one particular transaction was allowed to violate its own regulations. This violates the rule of law. See: Good sense on Docomo vs. the rule of law by Bhargavi Zaveri and Pratik Datta.

Example: RBI's notion of `wilful default' is inconsistent with the rule of law.

Example: RBI repeatedly puts out orders which are arbitrary exercises of power.

RBI has almost completely unchecked powers. Judicial review would be a valuable check. The judiciary will not rewrite regulations or order, but it may strike down regulations and orders that are found violating the Constitution, some laws or regulations. This helps improve the quality of regulations and orders.

Rajan seems to be arguing that because RBI is low on capacity, the accountability mechanisms should be reduced. We have one interesting counter-example in the Indian experience. SEBI was weak, and issuing a stream of low quality orders. The application of constitutional principles led to the introduction of appeals against SEBI orders, in 1997, at the Securities Appellate Tribunal. In the years since the SAT was set up, to hear appeals from SEBI orders, the quality of SEBI orders has improved, and indeed, the quality of investigations and enforcement at SEBI has been pushed up.

In similar fashion, the highway to a superior RBI runs through subjecting RBI actions to judicial review. State capacity at RBI is 18 years behind the capacity which has come up at SEBI as a consequence of the pressure that SEBI faced in the form of appeals at SAT. We have `Governor Raj'. If we add some `Appellate Raj', we might get a good mix.

Accountability and rule of law are not just about judicial review. The rule of law is violated when RBI makes a regulation without proper cost-benefit analysis, without a two-way public consultation, without detailed reasoning for the regulation. This is arbitrary use of power. This happens, among other things, because the idea of rule of law is not properly embedded in the institutional framework of the RBI.

Take the example of payment regulation. At present, the RBI does not allow customers to waive the two-factor authentication requirement even for small value transactions [link, link]. So, if I want to be able to transact upto Rs. 1000 transactions every day without a second factor of authentication, I am not allowed to do that, even though it is my own money. We have the same level of security for Rs. 10 lakh transaction as for Rs. 100 transaction. This imposes undue transaction costs on small value transactions and makes many businesses difficult to do. If the RBI followed due process in making regulations (cost-benefit analysis, consultations, etc), it may have, in the process, modernised its regulatory approach and liberalised the sector.

Greater accountability and rule of law would help RBI build the right kind of capacity and to use it to regulate free markets optimally, and not to constrain the markets unnecessarily. Will more due process and judicial review slow down RBI? In fact, RBI will have to speed up its game. It will not be able to centrally plan the sectors it regulates, and therefore it will have to build systems to actually regulate the fast-moving innovations of the financial system, rather than slowing down innovations to make its own life easy. It is only in a police state that a policeman's job is easy. Our thinking on public policy should not cater to the convenience of an RBI official.

The RBI has recently allowed two more types of banks - payment banks and small banks. However, the basic framework of central planning by RBI, and the License-Permit Raj, is intact. RBI continues to decide what innovation the market will do, and market participants bend over backwards to modify their business models to accommodate RBI's notions of innovation. Once in a decade or so, a committee is set up to tell the market what kinds of business models it can pursue. Now that RBI has released two new types of business models that it was preventing from getting out, we are happy and thankful. Institutional reform would be to change this system of "innovation by committees". More pressures of accountability mechanisms is required, to break the edifice of central planning. We have not escaped from License-Permit Raj; more Appellate Raj will help break down License-Permit Raj.

Four strands of thinking

There are four strands of thinking in India on the project of building the Republic:
  1. At one end is the Left, which just wants an intensification of the socialist republic of India.
  2. A second group wants to do direct democracy - get citizens to devote a large amount of their time to participate in governance in pursuit of the common good, just like ancient Athens. This group also wants to hand over arbitrary power to a watchdog agency - Lok Pal.
  3. A third group wistfully looks back at the power concentrated in Nehru and Indira Gandhi and thinks "Gee, what would I do with that power!" This is not about the rule of law, it is not about the rule of men, it is the craving for the "rule of me".
  4. A fourth group wants to construct a liberal democracy, where performance is obtained out of potent accountability mechanisms and checks-and-balances.
In India, some in the elite pay lip service to words like liberal democracy, rule of law, and free markets. At the same time, there is limited commitment to enlightenment values, and limited understanding of how a complex State works. For some in the elite, arbitrary power for the State means increasing their own power. We need to do more in terms of improving knowledge and the quality of the debate.

As Fareed Zakaria has emphasised, holding elections is not the essence of liberal democracy. The real story of liberal democracy lies in the internal machinery of checks and balances, of the intricate systems of rule of law, judicial review, separation of powers, freedom of speech and myriad accountability mechanisms. The main story of India should be about making these institutions work [example].

Sunday, February 22, 2015

How to make courts work?

by Pratik Datta, Ajay Shah.

We in India are proud of the way elections are conducted. We are ashamed of the way our courts work. The problem of judicial delays in Indian courts is well-known. Delays are a significant contributor to India ranking 186th in "Enforcing Contracts" in the Doing Business Report. Studies have shown that court efficiency has a bearing on economic activity, making our record on delays a serious cause for concern.

There are many initiatives presently underway, which seek to do `court modernisation' using computer technology. We argue that most present initiatives are poorly designed. Simply computerising the existing processes of courts will not give us better functioning courts.

A recent example: Computerisation of court records

One example of superficial application of technology to courts is the Supreme Court's e-filing process. This has a few problems.

The Advocate-on-Record (AoR) doing the e-filing is notified online of the defects. He is supposed to rectify the defects and ultimately submit a hard copy. The requirement of a physical document defeats the very purpose of e-filing.

Physical filings cost less than electronic filings. This should be reversed.

Most important, the e-filing system merely injected some computers into existing court processes without fundamentally rethinking the design of the existing processes. This yields low, zero or negative gains.

Business process engineering

A court is an organisation made up of various components: judges, advocates, registry, IT team, accounts department and so on. Each component interacts with the other in a consistent pattern: each gets an input from another, processes it and delivers an output. Failure of one component to deliver the right output results in delay. For example, when a matter is filed, the advocate provides an input in the form of a petition. The registry processes the petition, reviews it and fills a checklist and delivers an output - often a checklist of filing defects. From this perspective, a court is just like any other firm. The experiences of firms in business process re-engineering from the world of firms are relevant to the objective of building better courts.

There is enormous global experience with business process re-engineering in firms. Three main lessons can be identified:

  1. The superficial sprinkling of technology on top of legacy processes yields low, zero or negative gains.
  2. What is required is comprehensive redesign of processes, utilising the possibilities of contemporary technology.
  3. Rolling out such comprehensive transformation is difficult. It will be resisted by erstwhile staff who are set in their ways. These initiatives have to be owned and championed by the top leadership.

Business process re-engineering of Indian courts should start with time and motion studies, to look at how air time of courts is used, and abused. This should then lead to a brand-new design of how the court room functions. There are many global initiatives which can give ideas in this regard. Indian IT and consulting teams have done a lot of overseas work, and have global state of the art expertise in process engineering. We should tap into this talent pool for building world class courts in India.

In the mind of a BPR person, the foundations of the thinking are the work load (how many customers show up per month) and the capacity which is required to serve them. This is simple division: How many man-hours of a court room does it take to serve one customer, and hence how many court rooms do we need? This also leads to the question: How can the man-hours used by one customer be reduced? These elementary sizing calculations do not take place in the judiciary today. Courts are built with no regard for the anticipated case load, nobody knows how many cases will show up, and all that happens when queues build up is hand-wringing. No Indian IT/consulting professional would accept such lassitude, but the legal fraternity has become used to treating delays like death and taxes.

Integral to the new system should be an instrumentation mechanism, through which fine grained data is made available about the working of the new processes. This can then be used to kick off a continuous spiral of process improvement. In other words, a brand new process should not be seen as a one time reform. Integral to the one time reform should be a process of continual measurement and refinement.

This kind of thinking has been used with courts before, elsewhere in the world. Here are some examples. The National Center for State Courts in the US has done extensive research on this. Software have been developed to manage court business processes across jurisdictions (some examples are here and here).

Why do our courts work badly?

Expert committees have played an important role in policy making in India. However, in the past, court automation committees have usually comprise of judges, lawyers and registrars. All these persons (a) Lack knowledge on business process engineering (example: the composition of the Supreme Court e-committee) and (b) Are invested in the present ways. They have succeeded and risen to the top of the profession under the present arrangements, and tend to treat the present system as broadly sound.

Contrast this with an example of a successful re-engineering of business processes in another wing of the government - the Income Tax department. In his 2006 Budget Speech, the then Finance Minister declared that the IT department will undergo process re-engineering. Accordingly, a global tender was floated and a management consultant firm was appointed as external consultant for the project. It is because of this extensive project that today income tax returns can be easily filed online.

Projects must start with the mandate of building a world class court, not a mandate of computerising the court. Computerisation committees are typically not given the mandate of redrafting the procedural rules of the courts. For example, the terms of reference of the Supreme Court's e-committee does not clearly specify that it should produce new draft procedural rules. However, the Supreme Court e-committee itself in its Policy and Action Plan Document (2014) instructed all High Courts to take up process re-engineering. Accordingly, some High Courts set up their own process re-engineering committees (see here, here). Reportedly, the High Courts have submitted these reports to the Supreme Court and these have been forwarded to the Law Commission for identifying the best practices. It is unclear whether the result of this exercise will be a fresh set of procedural rules. Moreover, this approach is inefficient as it requires every High Court to reinvent the wheel and leads to the possibility of a differential response from High Courts.

The way forward

We think three ingredients are essential:

  1. The dominant flavour of new projects should be to do fundamental, ground-up process re-engineering, drawing on the tremendous talent pool found in India in the consulting and IT industries. The flavour of the teams should be consulting and IT, and not legal practitioners.
  2. Since we have started out at the bottom of the world, too often, our aspirations are too low. International experiences should be used much more than is presently the case. E.g. consider the example of Dubai. The attitude should be to jump to the top 10 in the world, not go up from rank 186 to rank 166.
  3. We should build scalable systems and institutional arrangements which, once proven in one or two courts, can be rapidly re-applied all across the country.

Some important developments are now taking place in building better courts:

  1. Justice Srikrishna's Financial Sector Legislative Reforms Commission has drafted primary law governing the `Financial Sector Appellate Tribunal' with strong provisions forcing world class functioning.
  2. The Ministry of Finance has setup a `Task Force' to build this Financial Sector Appellate Tribunal.
  3. We may be at the early stages of important new developments in finance with the rise of `Finance SEZs'. The NIPFP concept note on this subject recommends that the agency design for FSAT be applied to commercial courts which would do dispute resolution between firms.


As Fareed Zakaria says:

...when we think about democracy, we should really think about not simply the electoral process but the inner stuffing of democracy, which is the institutions that produce liberty, separation of powers, the rule of law, courts and constitutions and that that inner stuffing is in many ways more important than elections.

The Constitution requires elections. We would be outraged if elections were marred by delays, corrupt staff, etc. The Constitution also requires courts. We should bring that same level of outrage to the failures of courts in India. The organisational capabilities which are used to run elections properly need to be brought into the field of running courts properly. As with free and fair elections, there is no contradiction between efficient management and fairness. All that is required is obtaining a quantum jump in processes. India has made this jump with the working of elections; now we need to do this with the working of courts.

Wednesday, February 18, 2015

Policy framework for Finance SEZs

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

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

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

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

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

Thursday, February 12, 2015

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

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

Saturday, February 07, 2015

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

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

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