## Saturday, May 16, 2015

### Voluntary participation in the National Pension System: What does the evidence show?

by Renuka Sane.

Long-term saving is challenging in most parts of the world. Individuals are impatient, and old age is too far away. Rising life expectancy and potential poverty in old age have led countries to set up state funded pension programs or mandate contributions through the employer. Both these are difficult to implement in India. For example, the EPFO covers only about 8-10 percent of the workforce. This makes the voluntary build-up of savings important. Informal sector workers often do not have access to formal finance, and are unable to save large sums of money in one transaction. Poor people may also find it difficult to forgo current consumption and get invested in illiquid pension assets. There is a case for the State to facilitate a formal savings mechanism, and encourage pension accumulation through co-contribution.

These ideas started gaining ground after the National Pension System (NPS)' (which used to be called the New Pension System) had been in operation for a few years. The NPS is grounded in the philosophy of self-help and thrift. It is mandatory for central government employees since 2004, and accessible to all citizens of India. The NPS-Lite model was introduced for the informal sector, followed by the launch of the NPS-Swavalamban (NPS-S) scheme in 2010. Under the Swavalamban scheme, if a subscriber in the informal sector contributes a minimum of Rs.1000 in a financial year into her NPS account, she receives a co-contribution of Rs.1000 from the government. The scheme has been operational for four years now, and the co-contribution was promised to last until March 2017.

In the recent Budget, the Finance Minister announced another informal sector pension scheme, the Atal Pension Yojana (APY) which promises a fixed pension of at least Rs.1,000 at age 60 if subscribers contribute pre-defined amounts over their working life. While the APY has several design flaws, it seems likely that it will replace the Swavalamban scheme before 2017, at least for those between 18-40 years of age. NPS-Lite, i.e. the NPS without the co-contribution, is likely to remain in place.

It is important to take stock of what has been the response of the informal sector to NPS-Lite/Swavalamban before taking policy measures on the same. Are people enrolling in the scheme? What kinds of contributions are they able to make? Do we have the policy and processes in place for when customers retire?

### How are enrollments and accumulations faring?

There is often skepticism about the ability of poor people to save. However, research has demonstrated that when provided with formal channels, poor people do save, sometimes at high cost. For example, Mukherjee (2014) finds that the willingness of people to save in a co-contribution pension scheme is high.

Aggregate official data also show that subscriptions to the scheme have been rising. According to the 2013-14 Annual Report (Table 1.6, page 22) of the PFRDA, there were a total of 2.8 million customers of NPS-Lite/Swavalamban. They made up 43 percent of the total NPS subscribers, and were the largest category of subscribers - more than government employees who make up a total of 30 percent of the subscriber base. The AUM under NPS-Lite/Swavalamban was Rs.8.4 billion, about 2 percent of the total NPS AUM. The percentage growth of AUM at almost 94 percent, between 2012-13 and 2013-14 was the highest for NPS-Lite/Swavalamban.

Sane and Thomas (2015) analyse participation and contributions of customers over the first three years of the scheme in more detail, using data from one financial services provider, the Kshetriya Grameen Financial Services (KGFS). They find that voluntary participation in an individual account DC pension system is feasible. In fact, it is the relatively poor in the sample that are more likely to open Swavalamban accounts. The evidence on persistence, is however, not as optimistic: only about 50 percent of the participants had managed to contribute more than Rs.1000 at least in one financial year in their NPS-S account. However, non-contribution in one year did not mean dormant accounts - several customers came back the next year. In terms of total contributions, members stop short of contributing more than Rs.1000 in a financial year. Part of this seems to be driven by the scheme becoming centered around the threshold for the Rs.1000 co-contribution. Members could actually contribute larger amounts, but often do not, because the scheme is sold as a Rs.1000 per year contribution scheme.

### The problems in the draw-down phase

A pension scheme is ultimately judged by its ability to provide for an adequate consumption in retirement. Accumulations are only one part of the story. Since the accumulated wealth has to provide for a meaningful consumption over the lifetime of the individual, how this wealth is drawn-down becomes important. All the NPS models, including NPS-Lite/Swavalamban require that 40 percent of the account balances be used to purchase an annuity, while the remainder may be drawn-down as a lumpsum. There is currently no option of a programmed withdrawal, where part of the retirement fund is used for a draw-down (as income withdrawal) while leaving the rest of it invested.

Annuities can be expensive for the poor as they have a lower life expectancy than the rich. If they die early, they effectively end up subsidising the rich. We, therefore, need to think more carefully about the choice between annuitisation and programmed withdrawal. Different countries have approached the question of annuitisation differently, and are largely influenced by existence of a state funded pension which offers protection from poverty in retirement. The Chilean approach, for example, has been to restrict lump-sum distributions, and mandate the use of fixed inflation-indexed annuities or lifetime phased withdrawals. The Australians, are more flexible in allowing lump sums. Most recently, the UK has done away with its rule of mandating the purchase of an annuity by the age of 75, and allows for programmed withdrawals. The US has very little mandatory annuitisation.

Life insurance companies are often reluctant to enter into annuity markets because of the lack of availability of good mortality tables as well as instruments for hedging longevity and inflation risk. Lack of good mortality data is especially true in the case of low-income customers. The nominal annuity may also not be able to buy a minimum consumption basket if inflation rises over the lifetime of the retiree. If the administrative costs charged by insurance companies are high, then the value of the annuity will fall further.

Benefit policies of NPS-Lite/Swavalamban thus require a re-think. Enabling the development of mortality tables, market for inflation indexed bonds, changing the procurement of annuity service providers so as to minimise the costs of the annuity, designing default options for those who cannot choose the optimal combination of annuity and lumpsum are some of the policy initiatives that the PFRDA needs to undertake.
Similar questions are pertinent for the NPS as well. However, government employees who were enrolled in the NPS starting 2004 still have some time before they retire. The NPS-Lite/Swavalamban members who enrolled in their late 40s will get to the retirement threshold sooner, and bad design of the draw-down policy or delays in providing benefits can potentially destroy the foundation that has been built for improving informal sector participation.

### Conclusion

There are several take-aways from the experience of the NPS-Lite/Swavalamban schemes:

1. The number of people contributing Rs.1000 is gradually increasing.
2. Non-contribution in one year does not mean subsequent non-contribution.
3. There seems to be a hump in contributions at Rs.1000, most likely driven by the threshold design of the co-contribution.
4. Benefit design policies and processes require a re-think.

The NPS-Lite/Swavalamban is gradually taking root, people are beginning to understand the scheme, and intermediaries are learning how to distribute it. Familiarity with the scheme and intermediaries is likely to build the trust that is important in fostering long-term illiquid pension contributions. The infrastructure required for channeling contributions to the fund managers seems to be largely in place.

Analysis shows that the APY by itself is not enough to meet consumption needs in retirement. Thus, even if the APY replaces Swavalamban, intermediaries should consider continuing to distribute the NPS-Lite, as a combination of APY and NPS-Lite may allow customers to enjoy higher returns than the APY alone. A minimum amount of contribution could be made to the APY towards the guaranteed pension, while the remaining can be invested in the NPS-Lite for potentially higher returns. The PFRDA needs to incentivise the sale of both the APY and the NPS-Lite, dislodge the mental threshold of Rs.1000 to encourage contributions of larger amounts, and do a rethink of the draw-down phase.

### References

Mukherjee (2014), Micropensions: Helping the Poor Save for Old Age, Paper presented at the 5th Emerging Markets Finance Conference.

Sane, R. and S. Thomas (2015), In search of inclusion: informal sector participation in a voluntary, defined contribution pension systemJournal of Development Studies (forthcoming).

### The problems of financing and the elusive recovery in the Indian business cycle

The pre-crisis credit boom and its consequences in the post-crisis period is a key feature of understanding what ails the economy today.

#### The pre-crisis credit boom

In Y. V. Reddy's period as governor (6/Sep/2003 to 5/Sep/2008), there was vigorous pursuit of exchange rate policy. In an attempt to defend the dollar, RBI purchased a lot of foreign assets and paid for this using rupees. These rupees distorted domestic monetary policy. At a time of the biggest ever business cycle expansion in India's history, RBI engaged in loose monetary policy. This gave the biggest ever bank credit boom:

 Year-on-year growth of bank credit ("non food credit")

Central banks are supposed to take away the punch bowl when the party gets going. Instead, RBI laced the punch bowl when the party got going. Exchange rate policy converts the pro-cyclicality of capital flows into pro-cyclicality of monetary policy.

If we encountered the same combination of events today, would things work out better? One part of the problem has been partly addressed but the second has not. At the time, RBI had no clarity of objective, so each governor could make up his own objective, and the objectives could keep changing from day to day, without transparency. Y. V. Reddy had decided that his objective was the exchange rate. We are now on better ground: RBI now has only one objective -- CPI inflation -- and is held accountable for it and this choice of objective is no longer under the control of the governor. By taking away the discretion of the Governor, we have made RBI a more effective institution. However, we have yet to see the extent to which RBI works within the Monetary Policy Framework Agreement.

A second line of defence is systemic risk regulation. If there had been a systemic risk regulator in the country at this time, they would have seen this credit boom. The first trick in the mind of a person in the field of systemic risk is to watch out for big credit booms led by bank lending. This would have generated pressure to take countervailing actions. On this front, as yet, we do not have progress: there is no institutional capability in India which engages in systemic risk regulation. The draft Indian Financial Code envisages that FSDC will be the systemic risk regulator, but this institution has not yet been constructed. See this previous blog post on the strategy for systemic risk regulation.

#### The problems of banks

Finance is the brain of the economy, but in India, banking works badly. Weaknesses of regulation and supervision have given difficulties in the thinking of banks. With the low knowledge about banking at RBI, in India, a credit boom generally implies that credit goes into the wrong places.

A lot of the increased credit of the pre-crisis credit boom went into the wrong places. While most firms in India today are reasonably healthy, perhaps a quarter of the balance sheet size of Indian firms is in significant distress. These firms have low earnings, and are finding it difficult to handle their debt. The banks that have lent to them are also, consequently, finding that the going difficult. Some people look at overall statistics about Indian firms and draw comfort. But what's important here is not a measure of location but the left tail. If 25% of corporations are in trouble and that hampers investment by 25% of the firms, that still generates a financial channel for business cycle fluctuations.

As with past business cycle downturns, RBI's strategy has been to support banks in hiding the bad news. This postpones the bad news but does not solve the problem. As is well known in the international experience with banking distress, the countries that confront problems are better able to bounce back into safe and sound banking. When a banking regulator works to hide bad news, and supports zombie banks, this gives a Japanisation of banking, with a slow lingering crisis that hurts for years and years.

We are seeing two kinds of unwillingness to give out loans in Indian banks today. Some banks are able to discriminate good borrowers from bad borrowers and shun the weak ones. Most banks see trouble on the horizon and are holding back on all lending. They are just putting their money into government bonds. Let's zoom into the latest 3 years of the graph above, of the growth in non-food credit of banks:

 Year-on-year growth of bank credit ("non food credit") for the latest 3 years

The graph above shows the substantial drop in year-on-year growth of bank credit that's afoot. To some extent, this is about the decline in inflation. But this is also about the combination of difficulties in the economy (that hamper demand for credit) and difficulties in banks (that hamper supply of credit).

#### Implications for macro and finance policy

This perspective has a major impact upon our thinking on macro and finance policy. When the BJP government came to power, this should have played a big role in thinking about how to play things. As an example, see this column in the Economic Times on 12 February 2015. It suggests:

1. Formal inflation targeting at RBI.
2. Setting up PDMA and phasing out financial repression.
3. Enacting the Indian Financial Code to do consumer protection and properly regulate long-term contractual savings.
4. Setting up the Bond-Currency-Derivatives Nexus, drawing on the success of the equity market.
5. Fixing the capital controls for rupee bond inflows and
6. Reforms of NPS, EPFO, and other long-term savings mechanisms.

How did we fare in the period after 12 February? There is some progress but not enough to solve the problems.

• We got an inflation target but RBI managed to stave off the sound institutional machinery of a properly constructed monetary policy committee.
• The PDMA and the bond market reforms were rolled back so we have nothing there. See P. Chidambaram in the Indian ExpressVivek Dehejia in the Mint, and Tarun Ramadorai in the Mint.
• Capital control reform took place with an important amendment to Section 6 of FEMA. But regulation-making power for debt remains with RBI so there will be no progress on that part.
• Portability between EPFO and NPS is a good step forward (though a lot rests on how frictionless the arrangement is). But a spectre is now haunting the NPS, the spectre of defined benefits. This could damage the core principles of NPS, of thrift and self-help.
• The Finance Minister has made commitments about bond market reform (shifting the BCD Nexus from RBI to SEBI), setting up the PDMA, and tabling the Indian Financial Code in Parliament. But these remain actions at unstated future dates.

A great wave of entry of private and foreign banks would have helped bring new energy into banks, thus augmenting the flow of bank credit. But we remain stuck with the silliness of giving out only 2 new bank licenses per decade and blocking the expansion of foreign banks. Short term improvements can be made in the working of Asset Reconstruction Companies, and thus give a bit of improvements on de facto bankruptcy process. Instead, RBI is going in the opposite direction, favouring restructuring and deferring early resolution.

Yesterday, Neelasri Barman and N. Saraswathy, writing in the Business Standard, talk about bond issues by firms which failed. While this is partly about unexpected developments in the global bond market, this is also about the deeper problems of macro and finance policy that are holding back the macro economy.

#### Conclusion

Arun Shourie has emphasised the problem of too much tactics and not enough strategy, that afflicts the Modi administration.

For many years now, Josh Felman has emphasised the importance of the pre-crisis credit boom, and its downstream implications for busienss cycle conditions. The rich interplay of finance and macro is a key element for thinking about what ails the economy today. This perspective should have a major impact upon the strategy for macro and finance policy.

Perhaps 25% of the required work has been done through the Finance Act, 2015. The bulk of it has not been done. The lack of strategy in macro and finance policy is hampering the economic recovery. There is a need to put MOF, RBI and SEBI on the right track to go after these problems.

## Friday, May 15, 2015

### RBI solves the two-factor authentication problem. NOT.

22 August 2014: RBI blocked the neat payment mechanism invented by Uber. In two days, we figured this was a mistake.

15 September 2014: After thinking about this for 24 days, Raghuram Rajan said: If there is a rule on the book, we don't allow it to be violated simply because the innovation is cool. We pointed out that this was wrong.

14 May 2015: RBI showed that 18000 people in 265 days could have as much CPU power as two people in two days. However this policy change is not adequate! You can do these transactions upto Rs.2000 for a very specialised kind of card: an NFC card and NFC acceptance. Almost nobody in India at present has this. Hence, in effect, the problem has not yet been solved.

Internationally, Uber is synonymous with the cashless experience. Perhaps they gave up on the policy bottlenecks of payments in India: last week they started testing the use of cash in India. Compare and contrast with the way things are going elsewhere: E.g. in Denmark, shops are now permitted to refuse to take cash.

Stanley Pignal has written a special report in the Economist on financial technology. It makes for compelling reading. The field is pregnant with possibility for India. There are so many inefficiencies in the Indian financial system which could be attacked by such thinking. India has the requisite talent pool. Indeed, scrappy innovators in India, who are focused on solving inefficiencies in Indian finance, can build solutions that will matter on a global scale.

It's an exhilarating vision, but if you're in India, it will make you weep. None of this will come about under the present regulatory arrangements. We will silently slumber on in the dark ages. Far from launching Indian firms into the global economy bearing innovations of this nature, our regulators will domesticate the Ubers of the world and bring them down into mediocrity. It's broke and we should fix it. Cool innovation in financial technology is all about disrupting the cosy world of the incumbents, but financial regulation in India today is all about protecting the incumbents.

## Sunday, May 10, 2015

### MenAfriVac: A novel strategy for building a vaccine

by Swapnika Ramu.

A meningitis vaccine manufactured in India has been approved for routine immunisation in Africa: a development that is being hailed as a breakthrough in global health. Equally important is the fact that the vaccine - dubbed MenAfriVac - was developed using a new approach specifically targeted towards solving public health issues in developing countries, issues that many big pharmaceutical firms choose not to get involved in for a perceived lack of market potential.

### The success of the MenAfriVac vaccine

For over a century, recurring epidemics of meningococcal A meningitis have become a significant public health problem in sub-Saharan Africa; in fact, a swathe of the continent stretching west from Senegal all the way to Ethiopia has been dubbed the meningitis belt. Meningococcal A meningitis is caused largely by the bacterium Neisseria meningitidis and can cause brain damage, hearing loss and death. Despite early detection and treatment, an estimated 5-10% of all patients die within the first 2 days after symptoms emerge. The meningitis epidemic of 1996-97 proved to be the largest in history, with 250,000 diagnosed cases and over 25,000 deaths, underscoring the urgent need for newer and more effective treatment options.

In response, representatives from some of the affected African countries partnered with the World Health Organisation (WHO) to prioritize the development of a new meningococcal vaccine. The precursor to the creation of the MenAfriVac vaccine was the Meningitis Vaccine Project (MVP), a joint effort of the WHO and the Program for Appropriate Technology in Health (PATH, a nonprofit). The MVP was funded through the Bill and Melinda Gates Foundation, and its mandate was to oversee the development and production of a safe, cost-effective meningococcal vaccine. A major player in these efforts was Pune-based Serum Institute of India Limited (SIIL), which joined
the consortium in 2004 and went on to actually produce the vaccine. While SSIL is not a listed company, it's in the CMIE database and in 2014-15 it had revenues of Rs. 36 billion.

MenAfriVac turned out to be a great success on multiple fronts. First, its production took only six years, a record time, according to the WHO. It was the first vaccine developed specifically for use in Africa, cost less than 50 cents per injection (less than 1/10th the cost of a typical new vaccine), and proved to be remarkably effective: a trial conducted in Chad showed that districts in which people had been vaccinated had 94% fewer cases of meningitis in 2012 as compared to unvaccinated districts. The vaccine also outperformed other, more expensive options from big pharma companies; in a 2011 trial, 96% of infants and toddlers immunised with MenAfriVac had antibodies in their blood, compared to only 64% of a group given a vaccine developed by GlaxoSmithKline.

By 2013, over 100 million people in the meningitis belt had been vaccinated, and the number of cases was the lowest recorded during the epidemic season over the last ten years. At present, more than 210 million people have been vaccinated, and the vaccine has now been approved for routine vaccination of infants under one year of age. Simply protecting adults against a specific disease is not enough
to eliminate epidemics, since unprotected infants are still vulnerable; a vaccine like MenAfriVac that is effective both in infants and adults will create long-term, wide-spread protection against meningitis.

Another remarkable feature of the vaccine is that it remains effective even when stored outside the cold chain, retaining its potency for up to four days when stored at temperatures up to 40 degrees Celsius. Most other widely-used vaccines, those against polio and smallpox for example, need constant refrigeration. By eliminating this requirement, the immunisation campaign can cut costs to the tune of over 12 million dollars and can target those remote areas where electricity supplies are unreliable or absent. As a result, MenAfriVac is now the first vaccine to receive WHO approval for use at ambient temperatures in developing countries.

### New models in the healthcare sector

The MVP, an alliance that started between a public health organisation (the WHO) and a non-profit (PATH) and grew to include several other international partners, states that its approach was based on a "novel strategy of facilitating and coordinating numerous partnerships across the world", which could facilitate the introduction of other orphan vaccines, whose primary markets are low-income countries in the developing world. SIIL and the Dutch company Synco BioPartners supplied the raw materials necessary for making the vaccine. The conjugation technology required to put the raw materials together to generate a functional vaccine was developed through a collaboration with the US FDA's Center for Biologics Evaluation and Research. SIIL was tasked with identifying a low-cost process for vaccine production. In effect, the MVP broke the entire vaccine development process into several pieces, each of which was the responsibility of a different partner. According to Dr. Suresh Jadhav, SIIL's executive director, this modular approach was seen as controversial, with many people "sceptical...That technologies (could come from different) places and manufacturing happen at another place; this was something unheard of."

How did the MVP achieve success with its unconventional operational model?

I spoke with Dr. Marc LaForce, founding director at the MVP, and he listed some key factors. The first was that much of the basic science around developing an effective vaccine was already in place. As he said, "You need to have pretty good science in place already for the product you want to develop. This model will not work for an AIDS vaccine, for example, where an enormous amount of basic research still needs to be done." Second, the MVP was able to exploit the gap generated by big pharma's lack of interest; they focused on a problem that was restricted to developing countries, where the economics had not driven solutions at scale. Under these conditions, the MenAfriVac model worked quite well, and in fact, a similar approach was used to generate the first conjugate typhoid vaccine.

Third, the MVP focussed on developing low-cost solutions and partnered with SIIL to leverage their considerable experience in this field. SIIL also has a long history of working with global manufacturing standards, such as those laid down by the FDA, an especially important attribute in a project with multiple players. Each partner was picked based on a global analysis and very high levels of due diligence, anticipating the level of public scrutiny that grew over time as the project marched ahead.

Dr. LaForce pointed out that the biggest challenge faced by the MVP was solving intellectual property issues around the conjugation process in vaccine development. He said, "Africans really wanted this particular product, so convincing them to introduce the vaccine wasn’t really a problem. Solving the IP issues was probably the hardest part. A lot of the conjugation and structural chemistry was already known. What we had to do was to identify chemical methods to tie two compounds together that were not already covered by patents. This was a big deal and took us quite some time to solve."

The operational model that birthed MenAfriVac holds valuable lessons for building clever, low-cost healthcare solutions in resource-poor countries while bypassing the limitations of the traditional big pharma business model. One limitation is that much of the basic science needed to develop a specific vaccine must already be available. However, given that vaccine-related research and development in India holds a good deal of potential, it is reasonable to hope that lessons from MenAfriVac can be applied towards solving some of India's most pressing healthcare problems, such as malaria and tuberculosis - diseases where the traditional big pharma approach has not yielded notable results, and that are ripe for intervention through unconventional R&D models.

## Thursday, May 07, 2015

### Reforms of prosecution in the Indian criminal justice system

by Smriti Parsheera

The criminal justice system consists of four main components - police, prosecution, prisons and courts. These agencies are collectively responsible for apprehending, prosecuting and sentencing offenders, keeping in view the interests of the accused, the victims and the society at large.

The little data that is available about the workings of the system in India, at present, paints a grim picture. At the end of 2012 there were 18.82 million criminal cases pending before subordinate courts. Disposals and institution of new cases during the year led to a marginal decline in the figure to 18.56 million in 2013. Data from the Crime Records Bureau shows that there were 9.7 million serious criminal cases pending under the Indian Penal Code in that year out of which the trial was concluded in 1.2 million cases with a conviction rate of 40.2 per cent. Only a small fraction of the pending criminal cases are geting decided each year. Of the ones that do get decided, a majority of the verdicts in serious criminal cases do not support a conviction. A combination of factors contribute to this situation - defects in investigation techniques, inefficiency of court processes, poor quality of prosecution, delay tactics used by the parties, insufficient coordination between the agencies and absence of a framework to protect victims and witnesses, which often results in them turning hostile.

The performance of the prosecutorial wing has a direct bearing on the pace as well as quality of justice being rendered by courts. Often referred to 'ministers of justice' and 'gatekeepers of the criminal justice process' (197th report), public prosecutors (PPs) represent the interests of the state before the courts. Under Indian law, the prosecutor's role comes into play after completion of the investigation and once the matter has been admitted before the court. A lot has been legitimately said about the responsibilities of PPs and their duty to act in an impartial, truthful and fair manner. But these expectations need to be weighed against the ground realities in which the prosecution system operates. Problems in the selection and training of PPs, their poor service conditions and lack of independence and supervision have all led to prosecution being branded as the "weakest link of the criminal justice system".

The subject of prosecution falls under the concurrent list of the Constitution. This has induced difficulties in consistent nationwide reforms. States have used their authority to formulate rules for the appointment, conduct and remuneration of PPs. Recent developments include the introduction of an e-Prosecution system in Madhya Pradesh to streamline and manage the workflow of PPs in the state, and a slew of changes announced by Maharashtra to boost their conviction rates. These include a number of positive steps such as measures for securing greater independence for the Directorate of Prosecution (DoP) and evolving a court monitoring system for better coordination between the prosecutor, the investigator and witnesses. There is also a suggestion of allowing the police to have a direct say in the appointment of PPs, which goes against the well established principle of independence of the prosecution from police control.

This is, hence, a good time to think about and debate fundamental questions about the independence and accountability of prosecutors and their relationship with the other state agencies. Better knowledge can help shape and strengthen the reforms of Madhya Pradesh and Maharashtra, and help other states better navigate their own reforms of prosecution.

### Structure and independence of prosecutors

The Code of Criminal Procedure (CrPC) speaks of four categories of prosecutors - PPs and additional PPs; assistant PPs for magisterial courts and special PPs who may be appointed under exceptional circumstances. Appointment of PPs and additional PPs at the district level can be done in two ways - 1) on tenure basis from a panel prepared by the district magistrate in consultation with the sessions judge; or 2) from a regular cadre of prosecutors maintained by the state.

Both methods have their pros and cons. The former makes it possible to attract the best talent from the bar while allowing judicial officers who have direct insights on the competence of those lawyers to have a prominent say in the matter. However, the extent to which this happens in practice is suspect, given the vast difference between the earnings of a successful defence counsel and a PP. Panel appointments are also criticised for lack of accountability as appointments are for a fixed tenure, generally three years, and tend to be more susceptible to political interference. The CrPC was amended in 1978 to address these issues by introducing the concept of cadre appointments. States that maintained a "regular cadre of prosecuting officers" were required by the law to treat that as the only source for appointment of PPs. The idea was that a new breed of salaried PPs would replace all empanelled prosecutors. This would improve accountability and create promotion opportunities for prosecutors in the permanent staff.

The proposal for exclusive cadre appointments, however, turned out to be a non starter. First, the Supreme Court interpreted the term "regular cadre of prosecuting officers" to mean a permanent prosecution cadre encompassing all levels, starting from assistant PPs and going up to the PP at the top. This is not the case in most states - cadre appointments are generally restricted to the level of assistant PPs. Second, a number of states passed local amendments to dilute the requirement of mandatory cadre appointments. Some of them have also done away with the need for consultation with the sessions judge for panel appointments thus giving full control to the executive. In 2006, the Prime Minister's office raised concerns about these developments and their consequent scope for arbitrariness. The Law Commission responded by indicating its preference for a combined appointment process - 50:50 split between Bar members and assistant PPs selected from the regular cadre. The Malimath Committee had also expressed the same view. A decade has passed since these recommendations, and implementation has not taken place.

The appointment process of assistant PPs for magisterial courts is more straightforward. It is generally done through a direct recruitment exercise conducted by the state public service commission. Before the enactment of the CrPC in 1973, prosecutors working at this level used to function under the control of the police.

In many cases, police officers themselves used to act as prosecutors. This blurring of lines between the prosecution and police was problematic on may counts. It was observed by the Law Commission that the police had a tendency to focus on securing convictions, which made it difficult for them to exhibit the degree of detachment found necessary for the role of a prosecutor. In the words of the Law Commission: “In undertaking the prosecution the State is not actuated by any motives of revenge but seeks only to protect the community. There should therefore be an unseemly eagerness for, or grasping at a conviction. A public prosecutor should be personally indifferent to the result of the case. His duty should consist only of placing all available evidence irrespective of the fact whether it goes against the accused or helps him, in order to aid the court in discovering the truth.

Section 25 of the CrPC fixed this by explicitly stating that police officers would not be not eligible for appointment as assistant PPs. In doing this, the legislature recognised the importance of independence of the prosecution from the investigative arm of the state, a demarcation that has also been emphasized by the courts.

Sometimes the complexity or gravity of a case may justify a more experienced lawyer to handle the prosecution. Section 24(8) of the CrPC recognizes this possibility by empowering the government to appoint a special public prosecutor (SPP) for a specific case or a class of cases. The appointment of a SPP amounts to a deviation from the general norm (of using PPs) and is therefore resorted to only under special circumstances and only and only when public interest so demands. Many times, the request for appointment of a SPP may come from the victim of the crime, but the law as laid down by the Supreme Court makes it clear that such requests cannot be granted on a routine basis. The application for appointment of a SPP has to be properly examined by the government - in most cases through the Remembrancer of Legal Affairs in the state - and should be granted only after being satisfied that the material on record justifies the need for a SPP. It has also been clarified that even though the request may have been initiated by the complainant the costs of the SPP are to be borne by the government.

### Relationship with the government

PPs are appointed by the government, but the duty cast upon them is to represent the interests of the State and not the government of the day. Prosecutors who are wholly dependent on the executive for their tenure and appointments may find it hard to maintain this distinction. This is illustrated by the reshuffling of posts which seems to happen with every change in government. The problem becomes all the more stark in cases involving corruption, violence by state agencies or other instances where people close to the government find themselves on the wrong side of the law. For instance, while ordering a retrial in the Best Bakery case the Supreme Court noted that no credibility could be attached to an acquittal that is based on tainted evidence, tailored investigation, unprincipled prosecution and perfunctory trial. The court found that through selective examination of witnesses and mishandling of evidence, the PP had "acted more as a defence counsel than one whose duty was to present the truth before the Court".

Section 321 of the CrPC gives the PP the power to withdraw any case from prosecution with the consent of the court. This leads to the discharge/acquittal of the accused. The wording of the law and its interpretation by the Supreme Court makes it clear that the discretion to withdraw from prosecution is that of the PP and none else. The Government may suggest a withdrawal to the PP but cannot compel her to do so. It is the duty of the court to consider if the PP has applied her mind "as a free agent, uninfluenced by irrelevant and extraneous considerations". Yet it is often reported that prosecutors act on the directions of the government. This again raises concerns about the lack of independence from the executive.

One way of addressing this is to entrust the appointment and monitoring of PPs at all levels to an independent DoP. Most states have already set up their own DoPs but these bodies are not really independent. For instance, the head of the DoP does not have a statutorily prescribed term of appointment that would allow her to function freely from the government. DoPs are also not entrusted with control over the appointment process of PPs. The vision and organisation design of DoPs varies across states. To take an example, the DoP manual for Delhi speaks of the duty of the prosecution to secure justice for victims of crimes, and to extend support to the state in maintaining law and order. The guiding policy in Maharashtra is "To secure maximum conviction in criminal cases in all courts", which explains the nature of changes being adopted by the state. Practices also differ on where the DoP is placed - under the home department or the law department; who heads it - judicial officer, bureaucrat (Haryana), prosecutor (Delhi) or police officer (Tamil Nadu) and the scope of the DoP's powers. In a feeble effort to streamline these systems, the CrPC was amended in 2005 to say that the state governments may establish a DoP to be headed by an experienced advocate who should function under the administrative control of the state's home department. The benign wording of the provision, and the concurrent nature of the subject, have ensured that states continue to exercise their discretion on whether or not to have a DoP and what form it should take.

### International practice

Unlike the Indian system where the prosecutor has little or no say till a case has been filed before the court, most other jurisdictions regard the decision on whether or not to prosecute as one of the core responsibilities of a prosecutor. In addition, prosecutors also tend to have some role to play in the investigation stage although the scope of their intervention varies across jurisdictions. The United States is an example of a country where the prosecution plays a dominant role in the working of the criminal justice system. At the federal level, a set of US Attorneys working under the US Attorney General are responsible for trial in criminal and civil cases before federal courts. They initiate prosecutions in cases and also have the authority to request investigative agencies to conduct investigations in suspected violations. In fact the attorneys can also use the grand jury process to conduct an investigation on their own.

In addition, each US state has its own State Attorney General who is in most cases an elected representative. All the State Attorneys are members of the National Association of Attorney Generals, a coordinating agency that facilitates inter-state cooperation and conducts policy research and training programs for attorneys and their staff.

This presents a useful model that can be emulated in India. The heads of the DoP or whichever body is in-charge of prosecutors in each state can be members of a body created as a forum for regular exchange of ideas among prosecutors. This will help in articulating the issues faced by them which are often common across states and finding appropriate solutions. It can also be used to create a mechanism for specialised training of PPs from across the country.

In England the Crown Prosecution Service (CPS) serves as the principal prosecuting agency. The CPS is a statutory body headed by a Director of Public Prosecutions, who works under the overall superintendence of the Attorney General. Their role is to advise the investigation authorities, decide on which cases are to be prosecuted, and to frame the charges in more serious cases. To facilitate better cooperation with other government agencies, the CPS has entered into comprehensive agreements with the police association and the prison authorities that set out their respective responsibilities for appropriate handling of crimes. Accountability and transparency in the functioning of the office is maintained through the publication of detailed annual reports, business plans and evaluation reports.

### The way forward

Independence, both from the police and the government, is essential for the efficient discharge of the prosecutor's functions. This calls for the creation of a strong DoP in every state that is both operationally and financially independent. Some of the ways to do this are by statutorily providing for a transparent appointment process for the head of the DoP, a fixed term of service and clear process of removal for cause. The functions of the DoP should also be clearly articulated in the law to cover the appointment, evaluation and training of PPs and allocation of work to them. In addition, improvements of remuneration and working conditions are required so as to improve the talent pool.

The legislature should act on the recommendation of having 50:50 tenure and cadre appointments for PPs and additional PPs. The DoPs can then be tasked with the duty of evolving the evaluation criteria for the empanelment and selection of PPs from the bar and the regular cadre. In doing so, the DoPs must look at performance measures that go beyond mere conviction rates. Some of indicators that may be considered include time taken in the completion of trials; role in causing any delays in the process; conduct in plea bargaining cases; feedback of victims and witnesses; and participation in professional training programmes. In order to achieve all of this, states need to give the DoP the capacity to operate independently and the budgetary capacity to deliver on these promises. Corresponding accountability measures are required, to assess the performance of the DoP and ensure proper utilisation of resources.

There is a pressing need for better coordination between the investigation and prosecution wings. The DOPs can manage this interface with the police through a formal coordination mechanism that will enable the police to seek legal advice from the prosecution prior to the framing of charges even though they are not statutorily bound to do so. The prosecution will also benefit from police assistance in the production of witnesses and evidence before the court. The goal should be to strike a fine balance between the independence and interdependence of the two agencies.

## Tuesday, May 05, 2015

### Concerns about Atal Pension Yojana

In the recent budget, the Finance Minister announced the Atal Pension Yojana, which promises a fixed pension of at least Rs.1,000 at age 60 if subscribers contribute pre-defined amounts over their working life. The APY suffers from five problems.

1. Clarity of objective. The NPS-Swavalamban (NPS-S) has been the flagship pension scheme for the informal sector since 2010. While it has taken root over the last few years, problems in the design and process of the scheme persist. The APY seems to be motivated by these concerns. The scheme document says: ... coverage under Swavalamban Scheme is inadequate mainly due to lack of clarity of pension benefits at the age after 60. The Finance Minister has, therefore, announced a new initiative called Atal Pension Yojana (APY) in his Budget Speech for 2015-16'. Clarity of pension benefits could be interpreted as clarity of process for receipt of benefits, or certainty about the amount of benefit. The exact interpretation has not been made clear. It seems that the intent of the government is to migrate the entire existing NPS-S to the APY [See Page 7 of the APY FAQs]. It is not clear that this is the right approach. A careful examination of the lessons obtained from NPS-S over the last four years (e.g. Sane and Thomas, 2015) would have helped design a better response. Perhaps there was a role for co-contribution separately from the pension guarantee.

2. Design of the procedure. There is considerable confusion on how the APY is actually going to work. Initially, the APY was to be sold through the same aggregators that distribute the (NPS-S). New documentation indicates that it is actually only open to bank account holders. All the existing NPS-S customers are to be migrated to the APY with an option to opt-out. Does this place the responsibility of opening bank accounts for NPS-S customers on the aggregators? What happens to those who wish to continue with the NPS-Lite i.e. use the NPS without the co-contributions? In that case, the PFRDA ought to define well-defined standards of skill and care that aggregators will be expected to exercise towards a customer as invariably the aggregator will end up playing the role of an advisor when making a decision on whether to opt-out of the APY, or continue only the APY or continue the APY along with NPS-Lite.

The scheme levies penalties on those who are not able to maintain the required balance in the savings bank account for contribution on the specified date and close bank accounts if contributions are not paid for 24 months. However, we know from the NPS-S experience that informal sector workers often do not have liquidity, are not able to contribute on time, but do come back over subsequent periods. This design of the APY will invariably exclude those who cannot maintain a balance in their savings bank accounts or make regular contributions, defeating the purpose of providing a formal sector savings mechanism.

3. Price of the guarantee. Apparently innocent guarantees can prove to be disastrously costly when viewed in their entirety (e.g. Shah, 2003). The APY seems to be motivated by the desire of the government to ensure that on contributing continuously, a member gets at least a pension of Rs.1,000. While not explicitly specified, the APY seems like a minimum return guarantee which will ensure that accumulated savings at retirement do not fall below a certain value. There are different kinds of guarantees, and several ways to design minimum return guarantees. For example, an absolute rate of return guarantee promises a pre-specified rate of return, while a relative rate of return guarantee promises a return close to the average of all funds. The motivation for the choice of this particular design, and the calculations that influenced the choice have not been articulated. Under the APY the subscriber may actually be getting a sub optimal return. This is not surprising, as all guarantees come at a cost (Pennacchi, 1999). However, policy makers need to show the application of mind: the class of guarantees which was evaluated, and the logic that led up to this choice. The contributions under APY are to be invested as per the investment guidelines prescribed by Ministry of Finance, Government of India. The investment guidelines, and how they would finance the guarantee of the APY are not yet clear.

4. Safeguards against arbitrary increases. Almost all pension guarantees in the world have turned into fiscal problems. Even if a guarantee is fiscally sound at the outset, modifications to the program design later on render it bankrupt. Governments are tempted to increase benefits prior to an election. Apparently innocuous changes are announced, which add up to many percentage points of GDP. Any guarantee program requires an elaborate array of safeguards to protect against reckless actions in the future. The APY features no safeguards. It does not require governments to show actuarial calculations before any changes to the design are introduced. An example of a defined benefit guaranteed return plan running into funding difficulties is the Employees Pension Scheme (EPS). Estimates suggest that the EPS is facing a shortfall of Rs.54,000 crore, and several changes in scheme design have now been put in place owing to these funding difficulties.

5. Improper process. Indian finance has taken a big step forward by committing to the Handbook on adoption of governance enhancing and non-legislative elements of the draft Indian Financial Code. The procedural requirements in the Handbook, for framing regulations include a statement of objectives and a cost benefit analysis of each of the provisions. Many of the mistakes of the APY could have been avoided by the use of this process. It is not too late to apply this process to APY, even now.

### References

Pennacchi, G. (1999), The value of guarantees on pension fund returns, The Journal of Risk and Insurance , 66(2), pp: 219-237.

Sane, R. and S. Thomas (2015), In search of inclusion: informal sector participation in a voluntary, defined contribution pension system, Journal of Development Studies (forthcoming).

Shah, A (2003), Investment risk in the Indian pension sector and role for pension guarantees, Economic and Political Weekly, 38(8).

## Thursday, April 30, 2015

### 5 steps forward, 2 steps back

The Ministry of Finance had begun:

• Monetary policy framework agreement (MPFA)
• Shift government bond market regulation to SEBI
• Shift commodity futures regulation to SEBI
• Establish the Public Debt Management Agency
• Shift regulation-making power for non-debt flows (under Section 6 of FEMA) from RBI to MOF

Two  of these were rolled back today -- bond market regulation and PDMA. Here's a response by Ankur Bhardwaj in the Business Standard.

The lack of a bond market is going to weaken the monetary policy transmission, thus making it harder for the MPFA to work. The presence of debt management at RBI is a conflict of interest, which makes it harder for the MPFA to work. The reforms could have worked because they reinforce each other.

Now RBI will have excuses: lacking a monetary policy transmission, they were not able to do inflation targeting; owing to the problems of selling government bonds, they had to keep interest rates too low and SLR too high. The agent who has multiple objectives is accountable for none.

## Tuesday, April 28, 2015

### Can India leapfrog into decentralised energy?

India woke up to telecommunications through the reforms of the late 1990s: the power of DOT was curtailed, VSNL was privatised, private and foreign companies were permitted, new methods of working were permitted. At the time, wired lines were mainstream and wireless communications was novel. However, setting up wire lines in India is very hard. India leapfrogged, and jumped into the mobile revolution for both voice and data. The concept of not having a land line at home was exotic in the US when it was normal in India. In similar fashion, India was an early adopter of electronic order matching for financial trading, and of second generation pension reforms: these things became mainstream in the world after they were done in India.

Could similar leapfrogging take place in the field of electricity? An important milestone in this story will come about with the announcement by Tesla Motors on Thursday the 30th of April, 2015.

### The problem of electricity, worldwide

Electricity consumption fluctuates quite a bit within the day. More electricity is purchased when establishments are open (i.e. daytime), when it's too hot or too cold, and when humans are awake in the dark. The electricity system has to adjust its production to ensure that instantaneous consumption equals instantaneous generation.

If producers are inflexible and consumers are inflexible then generation will not equal consumption. The puzzle lies in creating mechanisms through which both sides adjust to the problems of the other in a way that minimises costs at a system level.

For producers, it is not easy to continually modify production to cater to changing demand. The two most important technologies -- coal and nuclear -- are most efficient in large scale plants which run round the clock. It may take as much as a day to switch off, or switch on, a plant. These plants are used to produce the base load': the amount of electricity that is required in the deep of the night. Other technologies and modified plant designs are required to achieve flexibility of production within the day. This flexibility comes at a cost. Suppose the lowest demand of the day is $L$ and the highest is $H$. For the electricity system as a whole, a given level of average production is costlier when $H/L$ is higher. The cheapest electricity system is one where $H/L=1$; this runs base load all the time.

Matters have been made more complicated by renewables. Solar energy is only available when it's light, while peak demand of the day is generally in the late evening. Electricity generation from windmills is variable. Further, the planning and despatch management of the grid is made complicated when there is small scale production taking place at thousands of locations, as opposed to the few big generation plants of the old days.

There are thus a large number of decisions: how to produce, how much to produce and when, how much to consume and when. Economic efficiency is achieved by putting a market in between buyers and sellers, where the price of spot electricity continuously fluctuates. The electricity industry, organised around this price, becomes a self-organising system where a large number of players make uncoordinated decisions about how much and when to consume, how to produce, and how much and when to produce. The price in this market is the summary statistic of the problem of electricity, worldwide' as articulated above. Here's an example (source) of the key patterns, from PJM Interconnect, the biggest power market of the world:

 Figure 1: Demand and price of electricity at the PJM Interconnection

The orange line shows consumption. This was lowest on Saturday night at around 70 GW. It peaked in the evening of Thursday at around 160 GW. This was $H/L> 2$! This gave huge fluctuations in the price, which is the blue line in the graph above. Base load production has no flexibility and was probably configured at 70 GW. When demand was 70 GW, the price was near zero, given the inelasticity of base load production. The price went all the way up to 450 \$/MWh at the Thursday peak. From the viewpoint of both consumers and producers, these massive price fluctuations beg the question: How can we do things differently in order to fare better? The question for consumers is: How can purchase of electricity from the grid be moved from peak time to off-peak time? The question for producers is: How can more production be achieved at peak time? ### Unique features in India All this is true of electricity worldwide. Turning to India, there are two key differences. The first issue is that ubiquitous and reliable electricity from the grid has not been achieved. The mains power supply in India is unreliable. The euphemism intermittent supply' is used in describing the electricity supplied by the grid in India. Households and firms are incurring significant expenses in dealing with intermittent supply (example). Intermittent power imposes costs including batteries, inverters, down time, burned out equipment, diesel generators, diesel, etc. Diesel generation seems to come at a cost of \$0.45/kWh. When power can be purchased from the grid, it isn't cheap, as a few buyers are cross-subsidising many others.

In large parts of India, the grid has just not been built out. There are numerous places where it would be very costly to scale out the conventional grid. There are places in India where calculations show that a large diesel generator in a village has strengths over the centralised system. There are small towns in Uttar Pradesh where private persons have illegally installed large generators and are selling electricity through the (non-functioning) grid, in connivance with the local utility staff.

Global discussions of energy systems talk about base load and peak load. In India, the existing generation capacity is not adequate even at base load! The apparent $H/L$ in the data is wrong; demand at the peak is much greater than $H$ -- we just get power cuts. Every little addition to capacity helps. There has been a large scale policy failure on the main energy system. Perhaps more decentralised solutions can help solve problems by being more immune to the mistakes of policy makers.

The second interesting difference is high insolation with high predictability of sunlight.

Compare the insolation in Europe:

 Figure 2: Insolation in Europe

against that in India:

 Figure 3: Insolation in India

(source for these maps). Note that the deep blue for the European map is 800 kWh/m$^2$ while for the Indian map, the same deep blue is 1250 kWh/m$^2$. Arunachal Pradesh and Sikkim get more sunlight than Scotland.

### Innovations in renewables

Substantial technological progress is taking place in wind and in solar photovoltaics (SPV).

Wind energy is enjoying incremental gains through maturation of engineering, and also the gains from real time reconfiguration of systems using cheap CPUs and statistical analysis of historical data from sensors.

The price of crystalline silicon PV cells has dropped from \$77/watt in 1977 to \$0.77/watt in 2013: this is a decline at 13% per year, or a halving each 5 years, for 36 years. This is giving a huge surge in installed capacity (albeit a highly subsidised surge in most places).

For decades, renewables have been a part of science fiction. Now, for the first time, massive scale renewable generation has started happening. The present pace of installation is, indeed, the child of subsidy programs, but the calculations now yield reasonable values even without subsidies. If and when the world gets going with some kind of carbon taxation, that will generate a new government-induced push in favour of renewables, which could replace the existing subsidies in terms of reshaping incentives.

### Innovations in storage

Electricity generation using renewables is variable (wind) or peaks at the wrong times (solar). In addition, wind and solar production is naturally distributed; it is not amenable to a single 100 acre facility that makes 2000 MW. These problems hamper the use of renewables in the traditional centralised grid architecture. These problems would be solved if only we could have distributed storage.

What would a world with low cost storage look like? Imagine a group of houses who put PV on their roofs and run one or two small windmills. Imagine that these sources feed a local storage system. The renewable generation would take place all through the day. When electricity prices on the grid are at their intra-day peak, electricity would be drawn from the storage system.

For the centralised system, the cost of delivering electricity at a certain $(x,y,t)$ can be quite high: perhaps households at certain $(x,y,t)$ can sell electricity back to the grid.

This is the best of all worlds for everyone. The grid would get a reduced $H/L$ ratio and would be able to do what the grid does best -- highly efficient large-scale base load technologies. The grid would be able to deliver electricity to remote customers at lower cost. Consumers would be better off, as payments for expensive peak load electricity would be reduced.

This scenario requires low cost storage. For many years, we were stuck on the problem of storage. In recent years, important breakthroughs have come in scaling up lithium-ion batteries, which were traditionally very expensive and only used in portable electronics. Lithium Ion batteries have 2.3 times the storage per unit volume, and 3.1 times the storage per unit mass, when compared with the lead acid batteries being used with inverters in India today.

Tesla Motors is an American car company. They have established a very large scale contract with Panasonic to buy Lithium Ion batteries. Nobody quite knows, but their internal cost for Lithium Ion batteries is estimated to be between \$200/kWh and \$400/kWh. On Thursday (30 April 2015), they are likely to announce a 10 kWh battery for use in homes. It's cost is likely to between \$2000 and \$4000 for the battery part, yielding a somewhat higher price as there will also be a non-battery part. (It is not yet certain that the part they announce will be 10 kWh. There are many stories which suggest this will cost \$13,000, which are likely to be wrong). A 10 kWh battery can run for 10 hours at a load of 1000 Watts. Note that Tesla is only pushing innovations in manufacturing; they are not improving battery technology. Many others are on the chase for better battery technology. Stupendous progress has happened with batteries in the last 20 years. Only two years ago, this price/performance was quite out of reach. It is a whole new game, to get a Lithium-Ion battery at between \$200 to \$400 per kWh. Suddenly, all sorts of design possibilities open up. Further, this is only the beginning. Experts in this field in the US believe that when Lithium Ion batteries are below \$150/kWh, they will be fully ready for applications in the electricity industry in the US. These experts believe this number will be reached in 5 to 10 years.

The rise of storage links up to the rise of electric cars in two ways. First, electric cars are driving up demand for lithium-ion batteries and giving economies of scale in that industry. Second, a home which has an electric car has that battery! The present technology in electric cars -- Tesla's Model S -- has a 85 kWh battery, which is good capacity when compared with the requirements of a home.

Renewables have generated excitement among science geeks for a long time, but have disappointed in terms of their real world impact. Scientific progress in renewables, and in batteries, are coming together to the point of real world impact.

Storage is one method for coping with the intermittent generation from renewables. The other method is to make demand more flexible. As an example, a smart water heater or a smart air conditioner could do more when electricity is cheap, and vice versa. This would make consumption more price elastic.

### Leapfrogging in India?

The Indian environment with expensive and intermittent electricity from the grid is an ideal environment for renewables + batteries.

Distributed generation and distributed storage are seen as ambitious cutting edge technology in (say) Germany. Perhaps the natural use case for this is in India. In Germany, the grid works -- there is no problem with achieving high availability. In Germany, there isn't that much sun. In India, every customer of electricity suffers increased costs in getting up to high availability, and there is plentiful sunlight.

A weird thing that we do in India is to charge high prices for the biggest customers of electricity. For these customers, roof-top PV systems are already cheaper. Problems in the fuel supply have given a steep rise in base load prices, and have pushed the shift to renewables.

In the US, the cost of power varies between 7 and 20 cents/kWh. In this environment, grid parity requires that Lithium Ion batteries achieve \$150/kWh. In India, the break even point is much higher. The announcement on Thursday may yield a price that is viable for many applications in India. At a campus scale in India, a small electricity system could be constructed with the following elements: • The roofs are covered with PV. • There are a few windmills. Large-scale adoption would require windmill designs which cater to aesthetic sense and not just technical efficiency. • It would make sense to add one diesel generator into the mix, with the advantage that it would run at top efficiency as it would only be used to feed the battery. (This is similar to the efficiencies of running the engine in a hybrid car). • The campus would buy electricity from the grid when it's available and when it's cheap, and use this to charge the battery. • Electricity from the grid, the renewables and the disel generator would feed the battery. • All consumption would happen from the battery. Users inside the campus would experience 100% uptime. • Electric cars and motorcycles could augment the battery capacity at the campus scale. • Cheap CPUs would give the intelligence required to seamlessly orchestrate this system, in real time, all the time. As an example, the picture below is a pretty windmill, 3m diameter and 5m high, which has a nameplate rating of 6500 watts. The output would vary with the wind, but under normal circumstances in India, we might get average production of 1500 watts from this.  Figure 4: A windmill with aesthetic qualities Sprinkling a few of these devices on a campus would be quite elegant. Here is another example, a device that is 1.5m wide, and costs 4000 Euro or Rs.260,000. A large number of installations of this nature would change the elasticity of demand for electricity. When there is peaking load, and the price of electricity is high, these installations would switch to using their batteries. This would reduce the$H/L$ratio and thus bring down the capital cost of the centralised electricity system. A related development is taking place with rural mobile towers in India. These must grapple with the problem of intermittent electricity, and are starting to do distributed electricity generation for surrounding households. They are also pushing into new storage technologies. ### Scenario 1: Hunky dory Scenario 1 is where all this happens. For this, five things have to happen: 1. Higher oil prices, ideally a carbon tax worldwide. 2. In industrial countries: continued government support for R&D and adoption of renewables and electric cars. 3. Continued worldwide scientific progress with batteries. 4. Sustained low interest rates, globally, for a long time. 5. Electricity policy in India which gives time-of-day pricing all the way to each household, and sets up an API through which a CPU at the household can query the price. Ideally, a mechanism for distributed producers to sell back to the grid at a cost which reflects the cost faced by the grid in delivering electricity at that location. If these five things happen, then we're pretty much on our way to a new world of distributed generation and distributed storage, in India and in the world outside. One interesting consequence of this scenario would be a sustained decline in crude oil prices. This would finally yield the outcome envisaged by Sheik Zaki Yamani who said in 1973: The stone age did not end because the world ran out of stones. ### Scenario 2: This shapes up as a mainstream technology for difficult areas only In an alternative scenario, these five things do not quite work out okay, and distributed generation + distributed storage do not shape up as the mainstream technology for every day use in the first world. However, this could still be compatible with the possibility that these are good technologies for a place like India where grid supply is untrusted and there is plenty of sunlight. ### An Indian public policy perspective The malleability of a late starter. In the US, where the grid is well established, these new developments threaten the business model of the existing electricity industry where vast investments are already in place [example]. In India, high availability grid power has not yet come about; the grid is far from meeting the requirements of the people. Hence, there is greater malleability and an opportunity to change course, in a direction that favours decentralisation and reduced carbon. Disrupting a broken system. If a lot of buyers in India defect from the excessive prices charged by the grid (owing to the cross subsidisation and theft), this will generate financial difficulties for the grid. As an example, see this submission in Maharashtra by the Prayas, Energy Group, and their response on the proposed amendments to the Electricity Act. Allocative decisions for the capital that goes into distributed energy. On the scale of the country, capital would shift from centralised production of electricity to distributed production + distributed storage. In the Indian public policy environment, it's always better to have self-interested households and firms making distributed choices about capital expenditures, rather than capital being placed in the hands of regulated firms. Industrial policy is not required. This article is not a call for industrial policy. We don't need to launch subsidy programs, or force car manufacturers to switch to electric, or force mobile phone towers to switch to renewables, etc. The Indian State has poor capacity on thinking and executing industrial policy. As a general principle, in public policy thinking in India, it's best to eschew industrial policy or planning, and just focus on getting the basics right. No industrial policy was required in getting to the ubiquitous water tanks on every roof in India -- it came from private choices responding to the failures of public policy on water. The invisible hand is amply at work. Indian car manufacturers exported 542,000 cars in 2014-15. Hence, these firms have ample incentive to figure out electric cars. Unreliable and expensive electricity is giving ample incentive to customers to find better solutions. Indian software services and IT product companies have ample incentive to tune into this space, and build the software end of this emerging global environment. New technological possibilities will be rapidly taken up. India should fix the grid. There are major economies of scale in making centralised electricity generation work. But we should see that we are coming at this from the opposite direction. In the West, we start from 100% centralised energy and will perhaps head towards 66% centralised energy. We in India may first overshoot to 40% centralised energy and then go up to 66% centralised energy through gradual improvements in public policy on centralised electricity. Compare and contrast this with how we see water tanks on roofs. These water tanks are the physical manifestation of the failure of public policy in the field of water. When sound water utilities come up, they will do centralised production of 24 hour water pressure, and the water tanks will go away. On one hand, the failures of public policy on electricity in India are exactly like the failures of public policy in water in India. Once it becomes possible to opt out of public systems to a greater extent, with generation and storage under the control of a campus, people will take to this. This will overshoot, going beyond what's technically sound. In the long run, when the policy frameworks on electricity become better, the share of centralised energy will go up. But there is good sense in distributed energy and it's not just a coping strategy. Even deep in the future, when policy failures are absent, there's a big role for distributed energy while there is no role for distributed water storage. For an analogy, the wireless revolution came first to Indian telecom. But now that this is established, we know that there laying fibre to the home is required in order to get good bandwidth. We will asymptotically endup converging on what's seen in the West, we'll just come at it from a different direction. India has yet to reap the efficiencies of centralised generation, transmission and distribution. We need to end subsidies and combat theft. This is the slow process of improving policy frameworks in electricity. The main point of this article is that along the difficult journey to this destination, we'll first have an upsurge of Sintex water tanks on roofs. Sound pricing rules are required. From an Indian public policy point of view, the key action point required is that moment to moment, supply and demand should clear, the spot price should fluctuate, buyers of electricity should be fully exposed to these fluctuating prices, and the spot price at all points of time should be made visible to each buyer through an API. This is not insuperably difficult. Even the present bad arrangement -- unpredictable grid outage where the price goes to$\infty\$ -- is actually pushing private persons in the right direction.

The market failure: externalities. Knowledge spillovers benefit society at large, and self-interest favours under-investment in knowledge. In the face of this market failure (i.e. positive externalities), perhaps the government can fund a few research labs [example] so as to grow skills in this emerging landscape. See Rangan Banerjee's article at page 38 of the December 2014 issue of Energy Next which talks about renewables R&D and manufacturing in India. It would help if there was a large number of pilot projects which aim to build towards campus-scale adoption, so as to have a precise sense of how well things work, solve local problems, and diffuse knowledge.

The gap in knowledge in India on batteries is large. But it is feasible for India to get into manufacturing power units, solar cells, etc. We need to study the steps taken by Japan and China to build up their capabilities in this field.

The importance of the cost of capital. Renewables involve high capital cost and near-zero running cost. The use case is critically about the cost of capital. Successful inflation targeting, and capital account openness, will give lower rates of return for equity and debt, which is required for the adoption of these technologies.

There is no market failure in energy conservation. When customers are given high prices of electricity, they have ample incentive to adopt energy-efficient technologies. India is in good shape on pricing in some areas (electricity, petrol) though not in some others (kerosene, LPG). Once the price of energy is correct, the next price that shapes adoption of energy efficient technology is the cost of capital. The failures of monetary policy and finance in India are giving a high cost of capital. Once these are solved, there is no market failure in the adoption of demand side innovations. Low interest rates and low required rates of return on equity will shift the private sector calculation in favour of energy efficient technology.

### Implications for the private sector

If this scenario unfolds as described in India, there will be a loss of momentum in centralised energy, and sharp growth in distributed production and storage of energy.

Perhaps we will get a surge in imports of Lithium Ion batteries and slow growth of lead-acid battery production in India.

### Acknowledgements

Brijesh Vyas helped me in understanding the issues and in getting the calculations right. He recommends that we read Linden's Handbook of batteries. I also thank Sanjay Arte, Ashwini Chitnis, Ashwin Gambhir, Sanjeev Gupta, Gopal Jain, Rajeev Kapoor and Anand Pai for useful discussions. All errors are, of course, mine.

## Tuesday, April 21, 2015

### The big changes in financial reform

Budget 2015 has been an important period for India's financial reforms. Indian Merchants Chamber, BSE and NIPFP had organised a meeting on these issues. From this show, here are two videos.

Yours truly:

and Ashish Chauhan:

## Friday, April 17, 2015

### The standard approach in public economics

The standard approach of conventional public economics is to emphasise that the market economy generally works well, barring a group of market failures. The job of government is to try to address these market failures. The standard checklist of market failures is:

1. Externalities -- e.g. a factory that pollutes.
2. Asymmetric information -- e.g. safety in food or medicines.
3. Market power -- e.g. firms that earn super-normal profit owing to weak competition, and
4. Public goods -- e.g. law and order.

In the standard approach we weigh market failures against the problems of obtaining effective State intervention. The barrier is public choice theory': the State is not benevolent. The citizen is the principal, the State is the agent, and there is a principal-agent problem. It is not easy to obtain performance when setting up real world arrangements that will sally forth, intervene in the working of the economy, and address market failures. This limits the class of situations where intervention may be appropriate. In a world with a perfect and benevolent State, we'd do a lot more in terms of going after market failures. In India, where State capacity is low, we are very selective and only do a few things.

### The end of asymmetric information?

Alex Tabarrok and Tyler Cowen look at the proliferation of methods to create, store and transmit information, and say that there is an increased class of situations where asymmetric information has been conquered, thus reducing the extent of market failures.

Improved access to information also reduces the public choice problem. More information about the activities of politicians and bureaucrats is available to the citizen, which reduces the principal-agent problem.

It's a good article. I felt the case was a bit overstated. E.g. reputation measures on the Internet help people see more about you, and that's good in some settings (e.g. you know something about the Uber driver), but it's a small change in a vast gulf of lack of information. E.g. the authors say : Many public choice problems are really problems of asymmetric information. I don't agree. Yes, more information will help, but the principal-agent problem between citizen and State is vast and complicated. Merely monitoring some of the activities of civil servants better does not solve the public choice problem.

There is vast asymmetric information in the relationship between an employer and an employee in most complex work places, and nothing has changed which will make a dent to this. We can think of numerous other situations where the asymmetric information has not changed.

### More or less government intervention?

The flavour of the article is that with less asymmetric information, you'd need less State. Yes, that is true, but it's also the case that with less of a public choice problem, you could use more State. In thinking about public policy, we are constantly watching the market failure that's worth addressing versus our ability to construct a State apparatus that would actually deliver the goods in trying to address this market failure. The new age of improved information cuts both ways: it reduces the places where we might want a State intervention, and it increases the class of places where we could pull off a successful State intervention.

### A new kind of State intervention

In this new age of easy capture, storage and transmission of information, I have felt that there is a new kind of State intervention: one which rearranges the information set. The State can use its coercive power to force certain kind of information to be captured or released or transmitted. This is a beautiful intervention that directly addresses the root cause of the market failure, the lack of information.

As an example, in the old analysis of insurance, there were some good drivers and some bad drivers, but the insurance company did not know who fell into what category. There was adverse selection (bad drivers were more likely to sign up for insurance) which led to high prices of insurance and many good drivers got insurance which was not actuarially fair.

This is the standard description of the market failure, in the textbooks. We can now think of a new kind of State intervention: The government forces cars to be equipped with devices that measure how the person drives. This is an intervention that directly stabs at the asymmetric information.

Here is another example which nicely illustrates an information intervention. We have been working in the field of regulation of warehouses. There is an asymmetric information problem: I submit my goods for storage at the warehouse, but I don't know how much care will be exercised by the warehouseman. There are old style interventions which reduce this information asymmetry.

In some situations, we can directly attack the information asymmetry. As an example, consider frozen food. When you deposit 1000 kilograms of cheese into a cold storage, you worry that the warehouseman will not maintain the temperature at precisely 4 degrees. But now there are low cost devices that will measure the temperature every minute and thus tell you what your cheese experienced.

Now the customer and the warehouseman can enter into a private contract where the temperature of the cheese is monitored, and a set of payoffs calculated based on the extent to which the temperature of the cheese strays above 4 degrees. Good warehousemen would think: Why don't I release this information, so that prospective customers would trust me? The trouble is: this data could be tampered with, or data could be selectively released.

This suggests the design of a government intervention: The government could establish an inspection mechanism which ensures truthful release of comprehensive data about all transactions by the warehouse. This is a combination of the new age of devices (the data logger) plus a dose of State intervention (to ensure truthful and complete data release). We could also envision a valuable State intervention that standardises the XML files which are put out by all warehousemen, which would reduce the cost of processing this data for customers.

This is an example of what I call an `information intervention', which rearranges the structure of information, and thus combats the market failure that's rooted in asymmetric information.