Saturday, March 28, 2015

Opportunities in analytical and policy-oriented economics

Analytical research

At the Macro/Finance Group in NIPFP, we have an active research program with a flow of papers, conferences, etc. There are exciting opportunities here for people with a Ph.D. (economics, finance, statistics) or Masters (economics, finance or statistics). The key skills are macroeconomics and finance, modern quasi-experimental and time-series econometrics, working with large datasets and complex empirical research. We are at the frontiers of computation, and write and release R packages. The persons who fit these roles are those who want to get absorbed in doing research about how the world works, or learn how to do such research.

Public policy `think tank'

In our `think tank' role, we analyse the problems of existing policy frameworks and propose alternatives. This is multi-disciplinary work with a mix of economics, law, finance and public administration. As an example, we were the technical team which supported FSLRC. If this kind of work excites you, and you possess some of these skills, please get in touch. We welcome economists and lawyers, and also welcome persons from the field of public administration, including mid-career civil servants.

Public policy `do tank'

Our `do tank' role is about building high performance agencies in government. As an example, we are the technical team which supports the four task forces which have been setup by the Ministry of Finance. This is about setting up organisation structure, process manuals, IT systems, and checks and balances, through which world class organisations are built. This is a rare set of opportunities to grapple with the challenges of creating excellence in government. Here, we welcome economists, lawyers, and persons from the field of public administration, including mid-career civil servants. We also welcome persons with a private sector background in constructing high performance organisations, including skills in process engineering, consulting, and private equity.

The workplace

The Macro/Finance Group at NIPFP is a exciting workplace. You will be surrounded by high IQ people, and little politics, bureaucracy, hierarchy or paperwork. The team is driven by intellectualism and a public service culture.

How to apply

Please get in touch with Anurodh Sharma,   , by 15 April 2015 with a resume and a covering letter explaining how you fit into the Macro/Finance Group at NIPFP.

Thursday, March 26, 2015

The issue of authenticity in Indian economics

Aatish Taseer wrote in the New York Times:

In my own world — the world of English writing and publishing in India — the language has wrought neuroses of its own. India, over the past three decades, has produced many excellent writers in English, such as Salman Rushdie, Vikram Seth, Amitav Ghosh and Arundhati Roy. The problem is that none of these writers can credit India alone for their success; they all came to India via the West, via its publishing deals and prizes.


This meant that it was not really possible for writers like myself to pursue a serious career in an Indian language. We were forced instead to make a roundabout journey back to India. We could write about our country, but we always had to keep an eye out for what worked in the West. It is a shameful experience; it produces feelings of irrelevance and inauthenticity. V. S. Naipaul called it “the riddle of the two civilizations.” He felt it stood in the way of “identity and strength and intellectual growth.”

I feel similarly about Economics in India.

Economics in India ought to be about looking at our backyard, understanding what is going on, and getting involved in fixing things. But, to paraphrase Taseer: We can write about our country, but we always have to keep an eye out for what worked in the West. It is a shameful experience; it produces feelings of irrelevance and inauthenticity.

There is no problem of authenticity in (say) physics. A physics paper is a physics paper and it does not matter who you are and where you are. But as Werner Heisenberg said, every electron is the same but every love is different. There was a time, in Economics, when the datasets were few and far between. Economists then analysed imaginary worlds through theoretical models. At that time, the questions that academic economists talked about, the world over, were similar. Now, things have changed. There are thousands of datasets all over the world. Economics today is about diving into these datasets, and the reality that surrounds them, and figuring out what's going on. And each of these datasets is a world of its own. The intellectual imperialism of Economics, where a person in one corner of the world could pretend to know about all parts of the world, has subsided.

In the peer review process, research is judged on two counts: "Is the question interesting?" and "Is the answer persuasive?". On both questions, authenticity is a key problem.

What is an interesting and important question in the Western discourse is very different from what is an interesting and important question here in India. Economists in India, who work on India, have to struggle to distort their work, to package it in a way that it fits the interests of editors and referees outside India.

On the issue of persuasiveness, all too often, editors and referees outside India do not know enough (about institutional arrangements and data) to judge the quality of a research design. This creates incentives to do shabby work and get by.

In this world, a paper on India in the American Economic Review is generally not useful for those of us who want to understand India.

The use of international journal publications in the academic HR process creates severe incentives for economists in India to ignore India and figure out how to succeed when judged in the eyes of editors and referees who do not know India. We should organise ourselves to do research in physics very differently from the way in which we do other fields. 

On this theme, see a previous blog post. There is an interesting discussion on Quora about blogs vs. academic journals which is a bit related.

Wednesday, March 25, 2015

Improving warehousing in India through a grading mechanism

by Smriti Sharma.

A key sub-industry in modern agriculture is warehousing. Storage reduces price fluctuations. Trusted storage permits `dematerialisation', where warehouse receipts are traded or delivered, and is the key link between physical goods and finance. At present, the quantity and quality of warehouses in India are inadequate. This is a key bridge that has to be crossed for the modernisation of agriculture. Trusted mechanisms for warehousing of non-agricultural goods are also an important enabler of the market economy.

Warehouses claim to take in goods and keep them safe. The customer of a warehouse does not know the probability with which the promise will be violated. There are a diverse array of warehouses in India, but customers do not know the failure rate of alternative warehouses. Currently, consumers do not have information to differentiate between one warehouse and the other. Most people make a choice with regard to a warehouse on the basis of word of mouth and local reputation. Sellers of warehousing service withhold privileged information about their warehousing service from the buyers. This leads to a situation of information asymmetry.

Information asymmetry is one of the classic market failures. Market economies seek to establish State capacity that efficiently addresses market failures. As an example, customers of a restaurant do not know whether the kitchen is clean, and this calls for the State to undertake certain interventions which address this problem.

Absent government involvement, users of warehousing services have devised their own solutions to address this problem. National Commodities Derivatives Exchange (NCDEX) operates a remarkable closed-user-group (CUG) that attempts to solve the problem of information asymmetry by creating its own inspection, audit and monitoring mechanism to ensure sanctity of the physical settlement of commodities traded on its exchange. Alongside this, many collateral management companies have come up which offer turn-key services of protection to users.

As is well known in public economics, when faced with market failures, such private solutions are not as nice as having a well structured and efficiently implemented government-based solution.

Grading of warehouses

Warehousing Development Regulatory Authority (WDRA) is mandated by the Warehousing (Development and Regulation) Act, 2007 to regulate warehouses that issue negotiable warehousing receipts (NWRs). Currently, WDRA registered warehouses go through a process of accreditation. This process verifies whether entities who apply to register with WDRA comply with certain registration requirements. This intervention is inadequate in that it does not create a mechanism for watching the performance of a warehouse on an ongoing basis. In and of itself, the WDRA registration has generated limited trust on the part of market participants.

A better intervention, which can be introduced by WDRA, is a mechanism for grading of warehouses, WDRA can provide more granular and complex information pertaining to warehouses and WSPs. This would require establishment of processes through which grades are awarded.

Experiences with grading in related fields

Is grading the right intervention for this market failure? Some analogies may be instructive:

  • Credit rating agencies assign grades to bonds.
  • In the real estate sector, grading helps by providing the real estate developers with the incentives to conform to fair trade practices and legal requirements.
  • The New York Health Department made it mandatory for the restaurants in its five boroughs to get themselves graded for their sanitary scores. The grades summarising the sanitary scores are then made public. Within 18 months of starting the grading programme, the share of restaurants without a trained food protection supervisor decreased from 13% to 7%. Prior to grading, 11% of the restaurants had inadequate hand washing facilities, which reduced to 5%. Also, a 10% drop was registered in restaurants that had signs of mice infestation.

These areas -- bonds, real estate, restaurants -- have the same market failure as that found in warehouses, i.e. information asymmetry.

Grading warehouses and warehouse service providers

Warehousing is an amalgam of warehousing infrastructure including warehousing premises, equipment and manpower which is used to deliver a service. For purposes of grading warehouses, warehouses need to be compared to each other, and against some benchmarks that the market may find useful.

A variety of public and private agencies internationally have formulated broad parameters, on the basis of which warehouses are classified and graded. For example, in Tanzania, warehouses are scored on parameters specified by Warehouse Receipts Regulations, 2006 and then graded accordingly. In UK, United Kingdom Warehousing Association issues an advisory for its members that lists broad headings like these, against which standards are set for warehouses.

Real estate consultants like Knight Frank also have their own list of parameters for warehouses. The parameters devised by each of these agencies are customised for the needs of their clientele. There is no single check-list against which WDRA can require warehouses to be graded.

A grade can capture information on the physical attributes of the warehouse (e.g. warehouse building and warehouse site), management of the warehouse (e.g. ownership, technical and managerial staff) and the warehousing processes and activities (e.g. storage and handling of goods, fire security, pest control, use of technology and book-keeping).

There is no fixed recipe for grading. WDRA must allow expertise present in the market to innovate in designing better grading mechanisms, and for grading agencies to discover what information is relevant for the warehousing market. For an analogy, financial regulators have pushed the bond market towards the use of credit rating agencies, while not micro-managing how credit rating agencies analyse a bond.

Re-imagining the role of accreditation agencies of WDRA

Provisions in the WDR Act allow WDRA to facilitate grading of warehouses by specialised agencies. It would be useful for WDRA to develop such an environment for the warehousing industry.

Rolling this out also presents complexities, which will need to be addressed:

  1. Financial regulation in India has encouraged a mindless notion on the part of investors, where the credit rating agency is the only determining factor about whether a bond can be the target for investment or not. A more subtle environment needs to be created, without black-and-white notions. As an example, a steady stream of information emanating from a warehouse, about failures in settlement, is valuable for users without being a black-and-white grade.
  2. The business of grading is frought with conflicts of interest. The "issuer-pays" model disincentivises grading agencies to be critical of their clients and award unfavourable ratings. The global experience with rating of bonds has exhibited such problems.
  3. The tools of coercion by the State can be applied at various levels, such as forcing warehouses to get graded, or forcing warehouses to always disclose what grade they got, etc. Careful analysis is required to use the minimal coercive power while maximally addressing the market failure.


There is a market failure -- asymmetric information -- in the field of warehousing, which justifies government intervention. The intervention presently used at WDRA -- requirements applied at registration -- are not addressing the problem. The WDRA Act contains provisions which could be used to bring about a mechanism for grading warehouses. Done right, this could reduce the information asymmetry.

Sunday, March 22, 2015

What is interesting in Budget 2015: the package of fiscal, financial and monetary institution building

After the dust has settled, the interesting feature of Budget 2015 is the package of fiscal, financial and monetary institution building:

  1. The signing of the Monetary Policy Framework Agreement, through which RBI now has an objective: That of delivering year-on-year CPI inflation of between two and six per cent.
  2. The establishment of a statutory Public Debt Management Agency.
  3. Shifting of the government bond market regulation from RBI to SEBI.

There are other elements of institution building which are relatively disconnected from this triad. E.g. the merger of FMC into SEBI is also a step towards shifting all organised financial trading into SEBI
regulation, but it is not interconnected with the above three.

The three big reforms are interconnected; they require each other; they strengthen each other. This is why all three elements figure in all the expert committee reports.

The interconnections

Inter-relationships between the three elements of Budget 2015

When RBI is given the responsibility of achieving low and stable inflation, this is a difficult problem for two reasons.

At present, RBI has a conflict of interest: of doing investment banking for the government. This conflict of interest is removed by setting up PDMA. This is also a good thing for bond buyers as it's safer buying bonds from a person who does not know what the next interest rate decision will be.

In addition, when RBI changes the policy rate, there is a low bang for the buck as the monetary policy transmission is weak. Low competition in banking implies that rate cuts by RBI do not propagate out into the economy. The weaknesses of the bond market mean that rate cuts by RBI do not propagate out into the economy. This makes RBI ineffective: very big rate hikes or rate hikes are required (e.g. as was done by Rangarajan in the 1990s) to stabilise inflation. Bond market reforms are required for RBI to get the tools for the task at hand.

When the PDMA tries to sell government bonds, it requires a liquid bond market. Bond market reforms are required for PDMA to get the tools for the task at hand.

Bond market reforms feed into the PDMA reform (by giving PDMA the tools for the job) and the Monetary Policy Framework Agreement (by giving RBI the tools for the job). In addition, bond market reforms improves the working of the corporate and infrastructure bond market, thus improving the investment climate for infrastructure investment and private corporate investment.

For many years, each of these components was recommended by expert committees, got discussed in the run up to each budget, and not undertaken. This is partly because each of these components, if viewed in isolation, is more difficult. Budget 2015 was able to break the gridlock by doing all three in unison. The whole is greater than the sum of the parts.

There are two more respects in which this package of reforms yields gains to the economy. When RBI was doing the investment banking for government, and also controlled banking regulation, they had an incentive to get their work done without undertaking much effort, by forcing banks to buy government bonds. Once the investment banking work shifts to PDMA, we may hope that RBI will reduce the Statutory Liquidity Ratio, and thus free up greater space for banks to lend to private enterprise. This will largely benefit small and medium enterprises as this is the segment which is most dependent upon bank borrowing.

The second dimension concerns the corporate and infrastructure bond market. This market critically relies on the yield curve, that is discovered on the government bond market, and on hedging using interest rate derivatives which trade on the interest rates on the government bond market. The development of the government bond market will increase the viability of corporate and infrastructure bond markets. These gains will largely accrue to large firms, as this is the segment which dominates the corporate and infrastructure bond markets.

All this will play out slowly. Inflation targeting, the setting up of the PDMA, the improvements for the bond market, and the playing out of the downstream consequences: all these will take place over years. This is slow, important work. Once begun, it will take many years to play out.

The reform is incomplete in two respects. When, in the future, the full Bond-Currency-Derivatives Nexus is moved from RBI to SEBI, the effectiveness of monetary policy will be further enhanced, and RBI will become a full fledged central bank by world standards. When, in the future, the policy rate at RBI is set using a Monetary Policy Committee, this will improve upon the decisions of one person.

Addressing the confusion

MoF has done a poor job of explaining what has been done and why, which has given a lot of media misinformation. Here are some questions which have swirled in the discourse.

q: Does this mean that SEBI will set the repo and reverse repo rate?
a: No, RBI will set the repo and reverse repo rate.

q: Does this mean that SEBI will control or regulate the market infrastructure through which RBI undertakes repo or reverse repo transactions, which are essential to the conduct of monetary policy?
a: SC(R)A does not apply for RBI. RBI will design, build and operate the infrastructure through which RBI will do repo or reverse repo transactions in the conduct of monetary policy. SEBI will not have any say or power over these arrangements.

q: Does this mean that SEBI is now the regulator of the money market?
a: This means that SEBI is now the regulator of all government securities. This is true regardless of their maturity. Government securities with less than one year maturity would, previously, have been termed ``money market instruments''. RBI will continue to run its own repo / reverse repo operations in the course of doing monetary policy. RBI will continue to regulate the call money market.

q: What will happen when two private parties enter into a repo transaction?
a: That transaction will be regulated by SEBI as it is a securities lending transaction. SEBI will be the regulator of all aspects of the government securities market, which includes the activity of lending government securities.

q: Why is SEBI the right regulator for government bonds?
  • All securities are alike. Whether a piece of paper is a share or a bond, it is a security.
  • Hence, there are economies of scope and economies of scale for both the private sector and the government in bringing together all work connected with securities.
  • There are three parallel systems for organised financial trading in India: one led by SEBI (the equity market), one led by RBI (the Bond-Currency-Derivatives Nexus) and one led by FMC (the commodity futures market). Of the three, the equity market has worked out the best. Hence, all expert committees have advised that the entire activity of organised financial trading be placed under SEBI regulation. The merger of FMC into SEBI is part of this progression.

q: There are complex interlinkages between RBI's payment system (RTGS), the settlement system for government bonds and the working of RBI repo.
a: At present, IT systems within RBI talk to the depository for government bonds (SGL) which is within RBI. In the future, these systems will have to talk to depositories for government bonds outside RBI. This will require IT system modifications.

q: All these changes will be disruptive.
a: The Finance Bill is written in a way that the changes do not get triggered immediately. They unfold in a phased manner, alongside the implementation work, which will take a few years.

q: Has all this been thought through and analysed with a cool head?
a: Yes, numerous expert committees have recommended precisely these actions. Every single expert committee which wrote on this subject has recommended these changes: Setup a debt management office, merge regulation of organised financial trading, give RBI clarity of purpose to stabilise inflation. Setting up the PDMA is in (1) RBI annual reports, (2) the Jahangir Aziz Working Group, (3) the M. Govinda Rao Working Group that was setup under FSLRC, (4) the Justice Srikrishna Commission, (5) the Percy Mistry Committee, (6) the Raghuram Rajan Committee and (7) the Vijay Kelkar Committee on MOF restructuring. Inflation targeting and the merger of organised financial trading at SEBI (or UFA) is in the Percy Mistry Committee, the Raghuram Rajan Committee and the Justice Srikrishna Commission.

Not one expert committee has disagreed with any one of the three elements. The only critics are those motivated by self-interest.

Saturday, March 21, 2015

Clear thinking on today's RBI question

Sugata Ghosh has an article in the Economic Times titled RBI wants to control both prices and debt market, but government refuses to oblige. Some of this needs to be seen differently. He says:

For the market, there cannot be an I-banker that's more honest and effective than RBI. It's the perfect insider with all powers — it can cancel an auction, buy or sell bonds in the secondary market to generate or absorb excess liquidity, and it regulates many of the investors subscribing to government bonds. Also, there is no debate that RBI acts in the best interest of the fisc.
Do you really want to buy bonds from someone who has insider information on how interest rates will go in the future? It's like trading against a corporate insider in the secondary market for equity. The text above violates the basic logic about why central banks, all over the world, have got out of debt management.

MOF insiders will tell you numerous stories where RBI violated the best interests of the exchequer in the pursuit of other objectives. The trouble is, when you have multiple objectives, you are accountable for none. "Why did you fail on inflation?" "Because we were chasing debt management." "Why did you fail on debt management?" "Because we were chasing inflation." Placing multiple objectives on one Agent, which internally conflict with each other, is bad management by the Principal.

The world over, we separate these things out. The central bank is accountable for delivering CPI inflation within the target zone -- and nothing else. The debt management office is accountable for delivering low cost of borrowing for the government in the long run -- and nothing else. There are no conflicts of interest. The buyer of bonds from the DMO is not worried that he's trading against an insider. The Principal is able to hold both Agents accountable; the Agents don't have plausible deniability in explaining away failure.

If RBI was such a great debt manager, why is it that every single expert committee, and the RBI board, all agreed that it made sense to unburden RBI of the conflict of interest of debt management? A little googling would dig out the logic as articulated in (1) RBI annual reports, (2) the Jahangir Aziz Working Group, (3) the M. Govinda Rao Working Group, (4) the Justice Srikrishna Commission, (5) the Percy Mistry Committee, (6) the Raghuram Rajan Committee and (7) the Vijay Kelkar Committee on MOF restructuring. Not one of these disagreed with the reforms which are now being implemented.

What RBI faces in the old arrangement is a mugs game; RBI lurches from one problem to another. It is easy to criticise RBI, but what's going on is a deeper problem, of a badly structured set of contracts where Ministry of Finance has not allocated the work properly. That deeper problem must be addressed. This is a three-pronged story: (1) Give clarity to RBI that it's job is to deliver CPI inflation; (2) Undertake bond market reforms so that RBI gets a monetary policy transmission; and (3) Unburden RBI of the investment banking function.

Sugata Ghosh also says:

Will the bond market deepen if it moves out of RBI? Ask anyone in the cosy world of bonds, and she would say 'no'.

Insiders in a closed club always love the status quo. Nobody wants to open up a closed club.

Lawyers in India do not want new players to come in.

The old BSE members did not want to admit new members, and they did not want NSE. I could easily paraphrase the above sentence and it tells you the newspaper story of 1992: "Will the stock market deepen if MOF creates NSE and opens up entry? Ask anyone in the cosy world of the BSE and she would say 'no'."

The bond market in South Bombay is a nice closed club -- only banks and PDs welcome. Thousands of sophisticated securities firms are forcibly excluded from this market. Their participation will increase liquidity and market efficiency. This is good for the exchequer, as they will get better pricing when selling into a more liquid and more efficient market.

The incumbents in a closed club market are never going to be enthusiastic about change. BSE members today make more money than they did in the old system -- but they ferociously lobbied against the change.

The fundamental law of securities market development is that we get a deep and liquid market by opening up entry barriers. By the act of opening up a closed club, the market will be made to work better.

Again, the author should consider why every single expert committee has advocated merging all organised financial trading into one regulator: SEBI (or its successor, the UFA). This includes spot or derivatives. This includes equities, bonds, commodity futures, currencies, etc.

There used to be ferocious protests from one player in commodities against this plan of unifying commodity futures into organised financial trading. We saw how that worked out, and that should give caution to journalists listening to vociferous practitioners. Now FMC is merging into SEBI. One by one, the remaining pieces should follow.

Friday, March 20, 2015

Reinventing the criminal justice system (Part 2 of 2)

by Nandkumar Saravade.


In Part 1 of this article, we looked at the problems of investigative capacity. This yields a picture of a case load that has overwhelmed the criminal justice system, poor performance, and an overall lack of effectiveness in criminal investigation and prosecution. We now turn to the ways to remedy the situation.

The key issues which must be understood are capacity and resource constraints, clarity and measurement of the output of the Indian Police, the required structural changes in Police organisations the required accountability framework for that resourcing.

Guiding Principles

Record all crime: The purpose of criminal investigation is to generate deterrence by ensuring that the perpetrator is identified and brought before the court to face trial, while adhering to due process. All citizens have recourse to the law. The first step towards ensuring the rule of law is to record all complaints, irrespective of what further action taken.

There is a bias in public systems to turn away complainants. In addition, not all victims may want to report. These two problems generate bias in the official statistics. This calls for a three-pronged approach with (a) Cultural change that removes the stigma associated with being the victim of a crime; (b) Improved technology and process design through which all crime is reported and (c) Parallel measurement of crime incidence using Crime Victimisation Surveys (CVS).

Investigate selectively: Since resources are limited, not all instances of violation of laws can be investigated. The purpose of the criminal justice system is deterrence, not retribution. If perpetrators feel there is a sufficiently high probability of getting caught, and if the punishments are sufficiently severe, this will generate deterrence. For offences involving loss of property, insurance and other compensation mechanisms may be operated to substantially comfort the victim. However, all instances of offences involving bodily hurt must be investigated. Indian law separates offences into cognisable (where police register a First Information Report (FIR) and investigate) and non-cognisable (where permission of a court is required). There is no merit in this distinction.

Analyse for prevention: Data collected through direct reporting and CVS can be used to improve the allocation of scarce police presence, channeling this to locations and timepoints which maximise deterrence for the same expenditure.

Speed up prosecution: As we saw earlier, delayed trials are not only ineffective, but also counterproductive for subsequent cases. The judges:population ratio needs to be substantially higher. The Law Commission (120th Report) recommended in 1987 that this ratio needs to go up from 12.5 judges per million to 50, which is a four-fold increase (2009 data). This would still be half of that found in the US in 1999. At the same time, dramatic increases in the productivity of judges are feasible through better process engineering of courts. There may be a case for large-scale withdrawal of unviable and old cases, as a one time measure, to debottleneck courts.

Agenda for State Governments

The most important change that is required is to improve the working of the police. The police machinery is currently controlled by the party in power and manipulated for their short term objectives of 'managing the crime numbers.' The National Police Commission (NPC), set up in 1977, went into all aspects of policing in the country and gave detailed recommendations through several reports, which have not been implemented. Most of the findings and the recommendations of the NPC remain valid even today. The issue of police reforms got revived after the Supreme Court judgement on a case filed by Prakash Singh, former DGP, UP and others. It is making slow progress, though not always in the right direction.

The recommended governance model for the police involves setting up of State Security Commission (headed by the Chief Minister, the Leader of the Opposition, the Chief Secretary, members of the civil society and subject matter experts) to act as the highest policy-making and oversight body. Further, an empowered Police Establishment Board is required, to insulate police officers from political interference. A Police Complaints Authority is required, to look into allegations of unprofessional/illegal behavior of police officials.

As the police is a subject in the state list under the Constitution, all the issues of police reform -- structural change, and better resourcing -- have to be carried out by the state governments. There is a remarkable opportunity to re-ignite this agenda, owing to the recent decision of the Central Government to increase the states' share of tax revenues to 42%, which is going to dramatically enhance budgets at the level of states. As part of the devolution of greater resources to the state level, the Central Government is also exiting its interventions in state subjects, which has led to discontinuation of the Police Modernisation Scheme. The facts need to be taken together by the leadership of states, and a sharp increase in the resourcing of police is required, alongside improvements in the organisational effectiveness and accountability mechanisms. These three elements -- increased resourcing, institutional reform, and enhanced accountability -- should be seen as a package.

Vision for the Police

For police organisations themselves, the mission to improve investigation effectiveness starts at creating an effective reporting mechanism, in addition to the local police station. Currently, there is a common telephone number (Dial 100) in most states, which does not always work. However, this is meant only for emergency responses. For filing a complaint, the complainant has to travel to the police station. With appropriate amendment in the Code of Criminal Procedure (CrPC), modified processes to mandate registration of crime must be brought about, including: (a) Reporting on the spot with the police official visiting the place of occurrence and (b) offering multiple channels (telephone/email/web/paper) of interaction. Will these changes reporting will improve, fulfilling the first requirement of police being a responsive organisation.

With a business triage approach enabled through a suitable CrPC amendment, high priority investigations can be taken up and the rest, especially those relating to minor property offences, only acknowledged.

From the organisational side, it would be important to devote a sufficient number of skilled police officers, give them standard operating procedures and measure their performance more accurately, with commensurate incentives for better achievement. To improve the supply of investigators without excessive cost escalation, the current heavy bias towards low-output constabulary should shift to officer-oriented composition. At present, 15% of the staff are officers; this needs to go up to 25%. This will also improve promotions and, consequently, motivation and morale of the force, through aspiration based efforts and more meaningful job content.

Separating the investigation function from public order maintenance to promote specialisation has been a long-standing recommendation. This was (recently done in Punjab). This involves earmarking a fixed number of officers for investigative work at the police station level. These detectives cannot be deployed for public order management or security without the orders of the district police chief and unless there is a dire emergency. This protects the prioritisation of investigations.

A national Police Standards Board needs to be created, to improve police investigative processes with clear Key Performance Indicators (KPIs) and an external audititing mechanism, which can directly report to the State Security Commission (SSC), as is done by Internal Audit to the Audit Committee in a listed company.

To enable the SSC to gauge the level of crime afflicting the society, independent surveys are required to be carried out, as a standard practice. Called Crime Victimisation Surveys, these are invaluable for measuring trends on crime reporting and comparative performance of different police units. They constitute reporting of the performance of the police that is completely independent of the police, and serve as an accountability mechanism in the eyes of society, which would see performance in these surveys as the outcome of resources put into the police.

For keeping the knowledge, skill and ability of the investigators at the desirable level, modern training infrastructure is essential. The current training mechanism emphasises a long initial training period over several months, but little subsequent training. However, there is a need for continuous training all through the working years, through which experience and knowledge interventions come together to induce a spiral of capability. This can be addressed through higher budgets for training and developments of a comprehensive Learning Management System (LMS) and community building through professional certifications, Continuing Professional Education (CPE) and a Code of Ethics to promote independence and integrity.

The technology infrastructure of the police department needs to be transformed. An enterprise-scale Information Technology backbone is required, with seamless flow of communication across the police, judiciary, prisons, forensic department and prosecution. Currently, investigation generates a lot of manual and tedious paperwork. With modern devices and well-designed software, the investigator can be freed to concentrate on the actual work. Digital tools for data visualisation and case management, as well as forensic databases for fingerprints, DNA, ballistic markings, paint/glass, shoe prints and tyre marks will improve the success rate of investigations.

It would simultaneously be important to build in accountability mechanisms for the improved resourcing so that the changes in the system stay put, or become feedback loops for the next stage of improvements.

The Supreme Court has passed an order asking for mandatory registration of criminal cases without any discretion to the police officer, as well avoiding indiscriminate arrests. Adherence to this on the ground is inconsistent and low.

Summing up

In summary, it is important to treat the Criminal Justice System holistically. It is possible to get some early wins, by fast tracking trials of cases involving elected representatives and creating specialised units and courts dealing with economic crimes and violent crimes against women. However, for long-term success in establishing the rule of law, there is no alternative to improving governance and making adequate investments in quantity and quality of investigative resources and trial courts.

Monday, March 16, 2015

Bureaucrats in business: The tension between rule of law and commercial considerations

by Anirudh Burman, Shubho Roy, Ajay Shah.

How to achieve high performance in government

In government, the route to performance lies in clarity of objectives and accountability mechanisms, grounded in the rule of law. Every transaction undertaken by a government must be grounded in a written down process, must treat all legal persons equally (Article 14 of the Constitution), must go through due process, must be open to questioning later on. All persons must have full documentation about how the government will behave under various circumstances, must be given documentation about how their transaction was processed, and explained why. Coercive actions of the State must be subject to judicial review. Purchases must be made through General Financial Rules (GFR).

How to achieve high performance in business

These bureaucratic processes have no place in the world of business.

For a firm, counterparties have no Article 14 rights. A manager must choose to give a contract to vendor A or vendor B based on an overall sense of how this will work out. The manager is not obliged to give a reasoned order or even to treat vendors equally.

In finance, private persons choose to buy equity or debt by exercising their own judgment. There is no obligation to have due process or to face audits that question commercial decisions.

This gun-slinging exercise of discretion works because the competitive market sorts it all out. Firms are kept on their toes by the accountability mechanism of the market. Firms get high speed feedback from the market about how they are faring. Good decisions yield improved profits and improved stock prices, and vice versa.

Phase I of India's journey

When Indian socialism was being constructed, the government wanted to be in business. There is a fundamental contradiction between the decision processes that are required in business when compared with the rule of law.

The solution adopted was to sacrifice the rule of law. All across the Indian state, we got politicians and bureaucrats wielding arbitrary power. The construction of Indian socialism damaged India's institutional capital.

Phase II of India's journey

In recent years, the tide has turned decisively. The Constitution of India is asserting itself. We are building the rule of law, we are restoring the institutional capital. You can no longer fudge the process for allocation of spectrum or coal mines. The old clubby ways are being stripped away, all across government.

Some people continue to yearn for the bad old days when a bureaucrat wielded unchecked power, but those days are safely behind us. As an example, see: CAG asks why Air India sold five Boeing 777s at loss to Etihad in 2013 by Mihir Mishra in today's Economic Times.

This great push towards the rule of law has one important implication: the push for the rule of law makes it  harder for the government to do business.

In the olden days, a public sector company could exercise discretion, and participate in the world of business, because the rule of law in India was in tatters. Now that India is pushing back into rebuilding the rule of law, this makes life difficult for the parts of government that are engaged in commercial activities.

On an international scale, we generally see that in countries with strong rule of law, we don't see public sector companies. The intuition that has been offered, in the past, is that there is a deeper thing called `good institutions'; in countries with good institutions, we see the rule of law and we see the absence of public sector companies. Conversely, when there is low institutional quality, we see failures on the rule of law and we see the phenomenon of public sector companies.

The main argument of this article is that there is another causal connection in the picture. A country that sets out to have public sector companies will damage the rule of law, and a country that sets out to strengthen the rule of law will damage public sector companies. Perhaps countries with strong rule of law lack public sector companies as those rule of law strictures have interfered with their functioning.

Implications for public sector companies e.g. public sector banks

In the best of times, it is difficult for bureaucrats to be in business. All over the world, there is ample evidence that government ownership of business hampers productivity. Layered on top of this is this new twist. Earlier, a bank in India could exercise more arbitrary power in trading securities, giving loans, restructuring bad loans, etc. But once public sector banks come under the full strictures of the rule of law, this becomes harder. India's drive towards the rule of law is detrimental to the concept of a public sector company that is owned by the government but engages in commercial activities.

We repeatedly hear public sector bankers complain that it's impossible to do the business of banking when placed under the myriad accountability mechanisms of the government. Their solution is that the rule of law is optional, that banks should be exempted from these requirements even when banks are owned by the government. We suggest that the solution lies in government getting out of banking.

Where is the line drawn, where a public sector company is the State?

Article 12 of the Constitution says: In this part, unless the context otherwise requires, the State includes the Government and Parliament of India and the Government and the Legislature of each of
the States and all local or other authorities within the territory of India or under the control of the Government of India.

This is important because Part III (fundamental rights) can be claimed against the State, such as equal treatment, non-discrimination, etc.

Here the word `includes' implies that this is not an exhaustive definition. The courts have developed tests to determine what `other authorities' means. The key case is Ajay Hasia. These questions turn on the issues of control and financing: (a) the degree of government control over the administration of the authority, (b) the degree of funding/ grants made to the authority, (c) power to appoint/ remove officials, etc. Based on these criteria, various kinds of entities such as public sector companies, educational institutions that receive government money, etc., have been termed state.

When the government owns less than 50% of a commercial enterprise, that organisation is generally not classified as State. However, evidence of pervasive control in such cases may lead to a judicial
determination that the entity is "state" under Article 12. For statutory monopolies or organisations with pervasive State control, even going below 50% ownership does not elude classification as State. In the case of R.D.Shetty v. International Airport Authority of India the Supreme Court stated that an entity such as the International Airports Authority could not act arbitrarily, but was subject to constitutional requirements.

It stated that, ...power or discretion of the government in the matter of grant or largesse including award of jobs, contracts, quotas, licences etc. must be confined and structured by rational, relevant and non-discriminatory standard or norm.... It then went on to say that corporations established by statute, or incorporated under law (including any company under the Companies Act) are "state"
if they satisfy certain tests based on:

  1. The source of share capital.
  2. Extent of state control over the corporation, and whether it is deep and pervasive.
  3. Whether the corporation has monopoly status.
  4. Whether the functions of the corporation are of public importance and closely related to governmental functions; and
  5. Whether, what belonged to a government department formerly was transferred to the corporation.

For a more detailed answer, see this report of the Law Commission (page 4, paras 2.3 to 2.6).

Three important issues arise related to the 1979 ruling of the Supreme Court:

  1. A business entity making a commercial decision does not hand out contracts as a "grant or largesse", but as a competitive player in the market interested in purchasing goods or services that satisfy its own requirements. To constrain it by the rule of law is to fetter its commercial decision making process.
  2. The transition of the Indian state is different from the transition of many western democracies such as the USA and UK. These democracies transitioned from laissez faire states to
    regulatory states. The Indian state on the other hand, is transitioning from a pervasive state to a regulatory state. Until not too long ago, the state ran hotels and manufactured bread. As such, most functions sought to be deregulated and/or performed by companies/ corporations are or were of public importance, and closely related to governmental functions.
  3. In India, many government functions are being privatised or handed over to government companies. A good example is telecom. Telecommunication services were first transferred to public sector companies owned by the central government, and eventually privatised.

On a related note, GFR has a rule to prevent escaping from GFR through subsidiarisation: Once government provides majority funding to a body, it must accept GFR and CAG.

This results in a situation where though de jure transfers of control, ownership and management have taken place, for government owned/ controlled corporations, there is never a complete de facto escape from the constitutional constraints on the Indian state. Such entities are unable, from the point of inception to act purely on commercial motives. It is therefore questionable whether any government
strategy that aims at greater market discipline and efficiency in a sector can be successful through the route of establishing government owned/ managed entities. Alternatively, the precedent on what constitutes "state" needs to be reviewed. The judgements on what constitutes "state" were made in the era of a pervasive state. A regulatory state must be defined differently.

Sunday, March 15, 2015

Concerns about Finance SEZs

by Anjali Sharma.

For more than a decade, Indian policy makers have aspired for a globally competitive financial sector in India. In 2007, a High Powered Expert Committee headed by Percy Mistry (MIFC) proposed that Mumbai be developed as a full fledged International Financial Center (IFC). At the time, this was `an offensive strategy', in the sense that India was aspiring to export into the world market. In 2013, a Standing Council of Experts on the International Competitiveness of the Indian Financial Sector, was setup to evaluate the cost of doing business in the Indian market, and find ways to improve international competitiveness. This was a `defensive strategy', as there had been a sea change in Indian finance between 2007 and 2013: the collapse of market share in Nifty and the rupee.

A third initiative is now visible: a white paper Policy framework for Finance SEZs (referred to as FSEZs going forward). This was followed by a budget announcement regarding issuance of regulations for GIFT city, a FSEZ, by March, 2015. Finance SEZs are viewed as a tool to expedite the globalisation of Indian finance.

Competing in international finance requires four things: (a) No capital controls; (b) Residence-based taxation; (c) Sound financial law and regulations; (d) Good urban infrastructure. At present, India fails on all four counts. There has been some progress on implementing "c", with the draft Indian Financial Code proposed by the Financial Sector Legislative Reforms Commission (FSLRC) in March 2013. There is little sign of progress on the other three fronts. India's capital controls deter foreign customers of Indian finance, and are not onerous enough to prevent the flight of domestic customers.

The white paper points out to loss of market share in INR and Nifty futures trading. The decline of Indian finance goes beyond just Nifty and the rupee, though these can be visible symbols of the decline of the ecosystem akin to the tiger in the Indian jungle. Indian non-financial firms borrowed Rs.4.5 trillion from foreign shores in 2012-13, almost double their foreign borrowings in 2009-10. Indian firms, and even the Indian government, use offshore rather than domestic commodity derivatives markets to hedge commodity risk. Indian firms are increasingly interested in offshore listings. In India-related CDS, 100% of the market share is overseas.

London, Dubai and Singapore are obtaining a strong share of the increased financial services revenues associated with Indian GDP growth. These cities score over India with stable legal and regulatory frameworks, competitive tax regime and efforts to improve market liquidity and depth. The policy establishment of these countries is free of the reflexive socialism which bedevils economic policy thinking in India.

Are FSEZs the right solution to these problems?

An SEZ follows an enclave approach. Manufacturing units located within the SEZ, are given fiscal, regulatory and trade exemptions so as to enhance exports. The white paper proposes three objectives for an Indian FSEZ: create high value financial sector jobs on Indian soil; create an avenue into financial globalisation (like Hong Kong is to China); and be a laboratory of new ideas for financial policy making for the development of the overall Indian financial system. This is small thinking compared with MIFC, where the aspiration was: to capture a share of the global finance business by delivering a wide variety of services to a wide variety of global participants with minimum friction.

The areas of concern are:

  • Financial reform in India has fared poorly. The implementation of MIFC from 2007 onwards, or the implementation of the Indian Financial Code, from 2013 onwards, has been an uphill struggle. These same difficulties will hamper the enclave approach.
  • There is a chicken-and-egg problem in market liquidity. Bombay has a certain market. It has a full ecosystem of financial firms and their customers. That market can suck in additional orders, if the mistakes of financial regulation, capital controls and taxation are fixed. A Finance SEZ would start from scratch, with no ecosystem. It is hard to build from scratch. The natural jumping off point for obtaining foreign customers is Bombay, not an SEZ.
  • The white paper proposes that a subset of the draft Indian Financial Code will be enacted as the Finance SEZ Act. It will be more complicated than this. The regulatory machinery required in a Finance SEZ differs from that required for India. E.g. there will be no fiat money in a Finance SEZ, hence there will be no requirement for monetary policy. It may make sense to have a single unified regulator in a Finance SEZ. The work required, in going from the Indian Financial Code to the Finance SEZ Act, may be significant.
  • After the Finance SEZ Act is passed, new regulatory institutions will need to be created. It will be important to avoid importing the institutional culture, and pessimism, of existing regulatory agencies. Getting away from the `inspector raj' (as described in the MIFC report) will be quite a challenge. Exporting from an Indian platform can only come about when world class regulatory agencies are found there. This may take many years. If enough new age project management is not put into this, the institutional culture of existing financial agencies might recur, in which case the Finance SEZ will fail.
  • The removal of capital controls in the FSEZ will have an immediate benefit for foreign clients who might shift order flow away from the mainland. This may adversely impact upon liquidity and market efficiency in the mainland. While the FSEZ is intended to compete with London, Dubai and Singapore, the first victim of its success could be Bombay.
  • While the white paper envisages that FSEZs should be India's Hong Kong, this requires today's regulatory agencies to respect and value a Hong Kong. At present, this may not be the case; today's regulatory agencies may work systematically to ensure that FSEZs do not become India's Hong Kong. RBI has regulation-making power under FEMA. This could easily yield draconian restrictions that hamper onshore participants, cutting off the FSEZ from the mainland. If FSEZs on Indian soil are cutoff from India, they cannot succeed.
  • FSEZs require improved working from the Indian tax bureaucracy as much as they require improved working from the Indian financial regulatory bureaucracy.
  • FSEZs will need not just good laws but sound enforcement agencies and sound courts. While important new work is underway in building courts, there is little certainty as yet that this will work out well. Three things are required: a Tribunal to hear appeals against the regulator, a court where disputes between private parties are heard, and an arbitration mechanism. All these are extremely important for the mainland, and have not been done for decades; why will they now be done for FSEZs?

These are onerous challenges. It will take remarkable project management to overcome them, of a kind that we have not seen in Indian finance in the past. Given enormous political capital and implementation capabilities, Finance SEZs in India can work. But would that effort not be better used in combating the low quality of financial law and financial agencies of the mainland?

There is a very scarce resource in Indian economic policy: the time and energy of the persons who actually do reform. Man-hours allocated to Finance SEZs come at the cost of man-hours which could be spent on fixing the mainland. It could get worse. A dangerous scenario that can be envisioned is as follows. Suppose domestic financial reform is stranded in bureaucratic politics. Suppose FSEZs make progress and cannibalise activity away from the mainland. Suppose this creates feedback loops where the intelligent end of the economic policy establishment gets increasingly focused on successful work on FSEZs and despairs of the difficulties of the mainland. It would be very costly for India if, in this fashion, FSEZs damage the future of Indian finance.

How to approach Finance SEZs

As the white paper says, a useful role for Finance SEZs is:

" be a laboratory where controlled experiments with new ideas in policy take place, and feedback can then be used by the Ministry of Finance to alter course for the future."

If this vision is emphasised, FSEZ development would complement domestic reform and globalisation, rather than become a substitute. New ideas should be tried out in an FSEZ, and once proven, be immediately implemented in the mainland. Finance in the mainland should not stagnate in the present mode.

If this is done, FSEZs can facilitate the process of achieving the scale of ambition of the MIFC report. There may be useful lessons from China, in the development of the China (Shanghai) Pilot Free, Trade Zone (SPFTZ). The main objective of the SPFTZ is to develop institutional capacity while opening up the Chinese financial system and liberalising capital controls and currency convertibility. For example, the Shanghai-HongKong Stock Connect is an experimental system through which Chinese investors can trade their share holdings with foreign participants in the Hong Kong market. This initiative involves setting new capital controls for the traded shares, regulations on the trade and settlement of shares, operations of connecting trading, common clearing and settlement across the Hong Kong Stock Exchange and The Shanghai Stock Exchange. The intention is to develop the equity market liquidity for both domestic and global participants. The intention is backed by consistency of implementation: the experiment was tried once before, failed and tried again.

Many markets and products that are not permitted today in the Indian market, due to legal or regulatory constraints, reinforced by low knowledge in financial agencies. Such missing markets and products can be tested and understood in a controlled environment by policy makers and regulators in the FSEZ, before they are introduced into the Indian financial system. Some examples where there is global interest include Indian OTC commodity derivatives, Credit Default Swaps on Indian credit, Rupee denominated foreign currency settled government bonds, and a Eurodollar market for Masala bonds. This will require changing the easy life of existing Indian financial regulators.

While the effort to take back market share on the INR and Nifty futures may yield some results in an FSEZ, these new markets and products have the potential to yield large benefits for India. The FSEZ could also be a testing ground for introducing global standards into market processes such as marginning for financial portfolios spanning equity, commodity, currency and interest assets rather than each one individually as is done in the Indian market today.

In this approach, the stagnation of financial law and agencies on the mainland must be tackled. Policy makers should not make the choice of permitting the mainland to stagnate, while building high quality structures in Finance SEZs.

The way forward

In conclusion, the FSEZ white paper is the latest policy proposal to improve the international competitiveness of India's financial system. It proposes an enclave approach to overcome the failures of implementation which have held India back ever since the MIFC report and the drafting of the Indian Financial Code. However, the enclave approach appears to face as many challenges. Remarkable inputs of State capacity are required to make it work. That human capital, project management and political capital would surely have better uses in fixing Indian finance.

The key insight in salvaging the situation is to not lose sight of the main objective: the mainland. We should build an enclave because it will help us solve the problems of the mainland. Every decision about building the enclave should be made keeping this larger objective in mind.

The economics of cloud computing: an Indian perspective

When you buy computer hardware, and build a glass house in India, the costs incurred are those of:

  1. Skilled and specialised labour
  2. Electricity for computers
  3. Electricity for cooling
  4. Real estate
  5. Depreciation of hardware
  6. Cost of capital on all the equipment
  7. The problems of achieving high availability on the above.

Firms all over the world are finding that the make vs. rent choice shifts in favour of cloud computing: You shut down your glass house and rent the services of computation in the cloud, run by the likes of Amazon or Google.

Some of this flows from the universal logic of specialisation and economies of scale. Google hires Ph.D.s in aerodynamics to optimise airflow in data centres. Almost all end-user firms are unable to justify this scale of outlay. Google is able to put a data centre right next to a hydel plant and enter into a long-term contract for 100 years of electricity. Almost all end-user firms are unable to justify this kind of thinking for their data centres.

In addition to this, I think there are some interesting and uniquely Indian perspectives.


If the ambient temperature is 5 C instead of 30 C, this reduces the cost of cooling.


Electricity is very costly in India as the commercial sector is paying for subsidies and inefficiency. This is particularly after you take into account the complexities of ensuring high availability.

Real estate

Land is very costly in India.


Most important, the cost of capital is very high in India.

For Amazon or Google, the cost of debt capital is 4% and the cost of equity capital is 7 to 8% (in USD).

For a big listed company in India, the cost of equity capital is 15% and the cost of debt capital is 11% (in INR). For smaller companies it's much worse.

It makes a lot of sense to reduce the balance sheet size to the extent of the cost of the data centre, and replace it by a stream of rental payments to cloud computing providers outside the country.

This idea has many interesting implications. The propensity for Indian firms to rent from overseas cloud computing providers goes up when capital controls are introduced, goes down when inflation targeting works, etc.

Cloud vendors in India?

I don't see how cloud computing vendors in India can be competitive, as they face these same uphill problems of operating in India: expensive real estate, expensive electricity particularly after taking into account the HA issues, and expensive capital.

They might argue: The labour cost is lower; it's cheaper to get a Ph.D. in aerodynamics in India. My fear is that the labour cost component in the operations of a big data centre is quite small.

So far I have assumed that the core hardware (electronics + cooling) is at high seas prices. There are many mistakes in the Indian tax system, and this could easily not be the case.

Gains for end-users

Before cloud computing, if you were an end-user organisation in India, you had no choice but to deal with the problems: expensive hardware, low economies of scale in systems administration, the high cost of HA electricity and cooling, real estate and capital. Cloud computing is a big gain for India in terms of the reduction of costs that are given to end-users. Other countries will do what's their comparative advantage (producing cloud computing services); firms in India will import these services.