Saturday, October 25, 2014

The logjam in infrastructure investment

Quarter-on-quarter growth
of the non-seasonally adjusted value of
infrastructure projects that are classified as being `Under Implementation'
in the CMIE Capex database.

In the standard narrative, the first wave of infrastructure investment in India (2003-2010) choked owing to the ground-level difficulties of investment, including land acquisition, corruption scandals, contract disputes, etc. By this logic, if we solve these problems, we will have set the stage for the second wave of infrastructure investment. This is the sort of idea that motivated the `Cabinet Committee on Investment' in the late days of the UPA.

There is, however, another logjam which needs to be solved, that of infrastructure financing. In today's Indian Express, I worry about the short-term measures which were taken during the first wave. Each of them felt expedient at the time, but with the benefit of hindsight, they were mistakes. Instead of looking for more short-term expedient solutions, we need to solve the deeper problems of the financial system in order to break this logjam.

The second wave of infrastructure financing, that we now require, needs work on both tracks: fixing the foundations of the financial system so that well-incentivised developers try to invest, and fixing the ground level difficulties so that this investment actually turns into smoothly working operating assets.

Acknowledgements : My thinking on these questions has been greatly aided by Josh Felman (IMF), Gopal Sarma (Bain Consulting) and Suyash Rai (NIPFP). The phrase `the long run has caught up with us' is by K. P. Krishnan.

Monday, October 20, 2014

Ebola and India

The biggest-ever Ebola epidemic is taking place is West Africa. Through travellers, this could spread elsewhere. Carriers are asymptomatic for 2-21 days, and hence border screening does not block transmission.

Ebola is very virulent. That is, the Pr(death|infection) is high. However, it is not a complicated pathogen for a public health system to deal with. It has no method of jumping to new victims other than direct contact with body fluids. This is unlike (say) a virulent airborne influenza where there is no easy strategy for blocking transmission. The simple strategy of tracing, diagnosing and isolating cases suffices to block Ebola in its tracks.

Ebola is easy if and only if there is a capable public health system through which tracing, diagnosing and isolating cases is easy. It's a disaster for the countries that don't have such a capability.

Do the public health authorities in India have this organisational capability? We in India will be sorely tested, for we do not have a focus on public goods in our health system.

Our health system is a socialist mish-mash of a government that produces and gifts out private goods. We try to run primary health centres, we try to run hospitals, and such like. We don't do the things that a public health system does -- such as the analysis and control of epidemics. We lack the intellectual clarity that the public health system is not about the health of the public; it is about public goods in the problem of health. This could prove to be a costly mistake in coming weeks and months, if Ebola spreads well beyond West Africa.

The fact that most people in India cremate the dead, and that we don't have rituals which involve touching the victim, will help. Cremation procedures will need to be modified to address the biohazard.

Saturday, October 18, 2014

Elections in Maharashtra: Have the fires of nativism subsided?

by Naman Pugalia, Renuka Sane, Viral Shah.

The results of the Assembly polls in Maharashtra are anxiously awaited. The four main contenders, the Congress, the NCP, the Shiv Sena, and the BJP have all been part of one of the two principal coalitions, the Democratic Front (Congress and the NCP) which ruled the state for the last 15 years, and the Mahayuti (Shiv Sena and the BJP) that has been the principal opposition alliance.

The battle against the `other'


After these two principal alliances in Maharashtra broke up, ahead of the assembly elections, political parties have been quick to rouse nativist sentiments to secure the Marathi vote. Each political party contesting in Maharashtra, and especially in Bombay, has been vying for the "marathi manoos": the BJP by bringing together Narendra Modi and Chattrapati Shivaji, and the Shiv Sena and the upcoming Maharashtra Navanirman Sena reacting strongly against such a comparison, comparing the BJP leaders as foot soldiers of Afzal Khan, the commander of the Adil Shahi, who was killed by Shivaji. At heart seems to be the idea that the son-of-the-soil will never prefer an outsider as the ruler of the state.

The roots of this angst date back to the Samyukta Maharashtra Movement launched in 1955 in Pune. As Kumar Ketar in the Asian Age says:

the business lobbies, mostly consisting of the Gujarati's and Marwaris wanted Mumbai to be an independent city state or a bi-lingual or autonomous city state. But the mass movement led by Samyukta Maharashtra Samiti foiled that plan. The Marathi angst of the time was one of the reasons for the Shiv Sena's rise, and continues to the reason for the undeclared hostility between the Gujarati-Marwari business community and the Marathi working class.

The Gujarati-Marathi antagonism was mostly restricted to Bombay. In other parts of Maharashtra, it has always been a "Maratha" vote, something that the Congress and the NCP had capitalised on over the last few decades. In the 54 years since Maharashtra was formed, the Congress has ruled the State for 49 years. Of its 17 Chief Ministers, 10 have been Marathas. The outgoing cabinet did not have a single non-Maratha!

By this logic, you would have expected that a national party, with a low support base in Maharashtra in the past, with a Gujarati leader and a Gujarati campaign manager, would not fare that well in the coming elections.

Several commentators, have, however argued that the new Marathi middle class has moved on in its economic and cultural ambitions. It no longer shares the sense of injustice that was the cornerstone of the Samyukta movement, and is in fact, brimming with enthusiasm to participate in the new India. In addition, over the years, migration on a large scale has taken place into Bombay and it's environs, and into Poona, which has created a new set of immigrant voters.

How relevant is the issue of the "marathi-manoos"?


FourthLion Technologies has been conducting message testing polls in the run up to the elections in Maharashtra to tease out voter preferences using its Instavaani. The methodology involves using a control and multiple treatments, and comparing the treatments to the control to get a relative understanding of the persuasion power of different messages.

In a message testing poll, the control is a simple horse-race poll, that asks voters to pick the party or candidate of their choice. The poll on October 1, 2014, showed that 41% of voters preferred the BJP, 11% Congress, 14% Shiv Sena and 11% the NCP. BJP was comfortably in the lead. This is the control.

In each treatment, a particular message is read out to the listener, and then the horse-race question is asked again. Differences from the control give us a sense of the immediate short-term impact of this message on the minds of the populace. These polls are conducted by randomly sampling phone numbers across the entire state. The poll typically strives for 200-400 observations. With assumptions of perfect random sampling of a small sample from a representative population, the margin of error is 0.98/sqrt(n). At 200 samples, the margin of error is 7%, and at 400 samples, it is 5%. These polls are typically carried out as soon as news breaks out, and situations develop in real-time, allowing the observation of the mood of the people within hours after an event.

Here are some results which illuminate attitudes to nativism:

  1. `Prithviraj Chavan is a true son of Maharashtra. He went to school in Karad, which is in south Maharashtra. His mother and father, Premalakaki and Dajisaheb Chavan, went to jail because they fought for an independent state of Maharashtra. No other candidate for Chief Minister has the same legacy of fighting for Maharashtra as Prithviraj Chavan'.
    Would you vote for% of respondents
    BJP31%
    Congress26%
    Shiv Sena15%
    NCP11%
    Others17%
    This shows that the CM's background matters quite a bit, and led 10 percentage points of voters to switch from the BJP to the Congress. This also explains why Prithviraj Chavan led the Congress' campaign in the state - his popularity is higher than the party's.
  2. `In 1960, Gujarati minister Morarji Desai ordered police to fire on activists of the Samyukta Maharashtra Samiti, killing 105 Marathis. The Samyukta Maharashtra Samiti activists won their fight to create an independent state of Maharashtra. Today, the BJP is bringing Gujaratis such as Amit Shah to again place Maharashtra under Gujarati dominance'.
    Would you vote for% of respondents
    BJP33%
    Congress14%
    Shiv Sena25%
    NCP11%
    Others17%
    If there was indeed strong antagonism about Gujaratis, this question should have caused a lot of people to switch votes out of the BJP. However, only 8% of the voters seems to have moved away from the BJP, mostly to the Shiv Sena.
  3. `The BJP has no leaders in Maharashtra who are clean, honest and capable of running the state government. That is why the BJP has to parachute in outsiders like the Prime Minister and Amit Shah to campaign for them. The BJP is afraid to announce who their CM candidate will be because their local leaders, including Devendra Fadnavis and Eknath Khadse, are inexperienced and unqualified to run the second-largest state in India, and also have dozens of criminal charges against them'.
    Would you vote for% of respondents
    BJP39%
    Congress15%
    Shiv Sena19%
    NCP10%
    Others17%
    This yielded the least movement away from the BJP: only two percentage points, which is not statistically significant. 39% of voters continue to root for the BJP. It shows there is far greater confidence in the BJP leadership than in that of any other parties.

This post is about nativism, so we don't talk about other measurement of how voters feel. But one point must be made. None of these treatments work as well as other treatment messages that talk about construction of roads, public works, anti-corruption, etc. These results suggest that the passions of caste and creed are now less important; that the history of the Gujarati-Marathi antagonism has faded from memory. By this logic, the BJP was perhaps on the right track in breaking away from the Shiv Sena, and focusing on its core messages of development and good governance. This is what voters in Maharashtra seem to care about.

Implications


We may conjecture that three things are going on:

  1. Part of the reason for this move away from nativist sentiment is the personal appeal of the Prime Minister. His approval ratings, measured in a survey FourthLion did for Mint on August 16, 2014, were highest in Maharashtra and West Bengal. In the bye-polls, there was very little involvement of the Prime Minister, and the BJP did not do well. It is no surprise then that the BJP is seeking votes under the Modi banner, with messages like "Chalo chale Modi ke saath" ("let's walk with Modi") and "Ab ki bar Modi sarkar" ("this time let's make it the Modi administration").
  2. Anti-incumbency against the state government, and the 2 parties (INC + NCP) that jointly governed the state for 15 years, has voters looking for an alternative. Given the BJP's own brand, their assessment of being able to achieve a majority on their own, and the country beginning to taste the benefits of a clear mandate, the BJP has an edge in asking voters in Maharashtra and Haryana to give it a clear mandate in the states too, so that they can work well with the Centre.
  3. But most important is the fact that the Indian electorate has moved on. The desire of the voter to look beyond tribal considerations is the reason why Maharashtra might be the first state to throw up a verdict that challenges preconceived notions about the eternal power of old hatreds.

Does this have implications for regional parties elsewhere in India? Many regional parties may have to go in for radical reconstruction if nativist fires are subsiding. Some, like the BSP, have begun doing this. The entire eastern and southern belt, which sees strong regional parties - West Bengal, Orissa, Telangana, Andhra Pradesh, and Tamil Nadu - could see change. While Jammu and Kashmir and Jharkhand will give us some more intuition in the coming few months, Bihar is going to be the next big test in 2015.

One possible argument is that Maharashtra is a better state, with greater exposure to new ideas, low levels of violence, and a successful economy. In contrast, the backward parts of East India may still be trapped in the old nativist ways. But what about the South? The developments in Maharashtra could be particularly portentious for the better states of the South.

The politics of Bombay has long been benighted by the problem of nativism. What was once a great metropolis has been bogged down by decades of nativist politics. These results show a possibility for becoming a normal city, where the political questions that matter are about efficiently producing local public goods.

Friday, October 10, 2014

Scientific management for election campaigns in India

by Viral Shah.

From 2010, I worked in the Aadhaar project for three years. This helped me learn how Government works and how it does not. The one big takeaway from my experience of working with the Executive arm of the Government was that to bring about true and lasting change, to restructure our defunct institutions and build new ones, one needs to engage with the Legislative arm, with politicians.

Politics in India is a cottage industry. Everybody loves to talk about it; most are cynical; very little is known about how things actually work. The professional ways of working -- which are found in business, science and slowly in government -- are least visible in politics. In particular, the crucible of politics -- the election campaign -- is just black art. In the last 20 years, we have seen family businesses get shaken up, professionalise, and embrace technology and process engineering. We have seen some parts of government do the same. We have seen a transformation of some parts of academiaa. The one place which has seen the least change is politics in general and election campaigns in particular.

This suggests opportunities for achieving important change. Shankar Maruwada, Naman Pugalia and I started a company -- FourthLion Technologies -- to provide professional services to political campaigns. Over a couple of campaigns, we have slowly learned how elections in India work. We have looked at an array of data from various public and private sources, and developed tools and technologies to aid election campaigns in multiple phases.

Elsewhere in the world, election campaigns are run through scientific management. In the US, both the Democratic and Republican parties have voter databases, where one can search for any voter by name. Through a variety of analytical methods, campaigns know fairly well which voters are likely to vote for them, and which ones are marginal, and on which groups of voters, no resources should be expended. Starting with such databases, every voter contact is recorded (a volunteer knock, a telephone call, a letter sent, an email, or a tweet) in the same way companies manage customer services through a CRM system. It took a decade of work for the machinery of election campaigns in the US to get to this stage, to transplant ideas which were well developed in the world of business.

When thinking about election campaigns in India in a professional way, there are many challenges. There are multiple parties, many races are multi-cornered, and with first-past-the-post elections, a candidate can win with as few as 20-30% of the votes. The voter lists are very poor in quality, with every possible error of inclusion and exclusion. They do not capture the large scale of urban migration and are often tampered with. Although the Election Commission of India has made great strides in conducting free and fair elections over the last several decades, much more remains to be done, and the quality of the voter list is perhaps the weakest link in Indian democracy today.

Every election has three natural phases: Registration, Persuasion, and Turnout. A campaign should start 6-12 months before voting date, by registering voters. Three months before the election, voters need to know the candidate and be persuaded, and finally the last week is focussed on "Get The Vote Out", or Turnout. At each stage of the campaign, one has to focus on the message and mobilisation. The message is all about what the candidate says and does, and mobilisation is about execution on the ground, in the digital sphere and in the media. Each stage as a distinct methodology for scientific management, and the problems faced can be quite surprising. As an example, it is not uncommon for 2 to 3% of the population of a constituency to be working for all the candidates, put together, in the last 2-3 weeks. This calls for the processes of large-scale management.

We provide tools and technologies for different parts of the campaign, starting with coalition dynamics, seat selection, analysis of past elections, formulation and testing of messages, calculating the reach of every channel (hoardings, TV, radio, print, etc.), managing call centres, and a control room for the turnout operation and voting day. We use data, analytics, and technology at every stage of a campaign to aid decision making and efficient deployment of resources. Traditional politics often deploys resources in a "Spray and Pray" manner, while we try to combine all available information and intuition so as to use resources more effectively.

In our experience, an incumbent who has a good chance of getting the ticket has a head start as he is able to do preparatory work for the campaign well ahead of time. As emphasised above, the campaign should really start 6-12 months before the voting. All too often, in India, candidate selection is left to the last minute. This makes it impossible to mount a serious campaign, and generally plays in favour of the incumbent. Once we start thinking of an election campaign as a systematic project, this induces the discipline of a minimum time period that is required to execute all the steps, just as is the case with all well planned projects.

On one hand, our thinking about process improvement for election campaigns consciously draws from successful techniques of scientific business management which have been perfected in the worlds of business, science and government in India. Along the way, we have seen that the speed, agility, and scale required in political campaigns in India is something unique when compared with the worlds of business, science and government in India. To some extent, we are seeing innovations in the field of election campaigns that can usefully inform, and sometimes get directly transplanted, into the other three worlds.

We are learning how our democracy works. The accountability is jarring, as any politician will tell you: voters make every possible demand, and speak their mind to the candidate, in as direct a way as can be. Millions of micro-deals are struck with candidates by individuals and groups of people. These are genuine deals about actions of the State and not bribery or corruption. These micro-deals bubble up into the processes of government and ultimately shape policy. It is a rough and tumble world which clashes against our dreams of representative democracy, but it is also astonishing how much this is about representative democracy.

Should a government subsidise the purchase of energy-efficient equipment?

Today the Financial Express has a story, where LED bulbs costing Rs.400 will be sold at Rs.10 with the government paying for the difference. Does this make sense? I think it does not, and that this situation calls for a lot more sophistication in thinking about public policy.

What's the market failure?


The first and obvious place where this spending program fails to make the grade is on the question of public goods. I get a gift of Rs.390 to have a LED bulb, I benefit. The bulb is a private good. A gift to people who buy LED bulbs is as wrong as government spending on other private goods. Just as we criticise a government which runs health clinics for perambulatory care, we should criticise the government when it gifts money to people for the folks who buy LED bulbs. This is just the faddish thinking of one bunch of hausfraus running policy versus another.

The guiding question, in all design of government, should be: What's the market failure? I am not able to see a market failure in the working of the market for LED bulbs.

Get the prices right


Some people in the field of energy have an almost moralistic perspective on energy efficiency. Higher energy efficiency is seen as a good thing, regardless of cost. This is the wrong way to think about it. Energy efficiency is just one part of economic efficiency. An LED lamp is a big up front payment and then a stream of gains in the future. Whether the LED lamp is worth putting in depends on (a) The magnitude of each gain (i.e. how much you use that lamp) and (b) The discount rate. If the interest rate is high, it will make sense to buy a Tungsten bulb instead.

To obtain efficiency in the field of energy we should think about three things:

  1. The first is the question of pricing of energy. When energy is cheap, it will be squandered by consumers, and vice versa. Externalities should be priced in. The biggest externality that is not being priced in is carbon emissions. When we fix these mistakes, the price of energy will go up, which will encourage people to buy energy efficient equipment.
  2. When a household chooses to get capital goods of more or less energy efficient equipment, the flip side of these decisions are the capital goods that will be invested upstream, in the large factories of the energy industry such as generation utilities or natural gas infrastructure. Optimality requires that society should solve that overall problem correctly, and the overall problem is the combination of energy production, energy transportation and the end-devices which use energy. It is not obvious that the greatest bang for the buck is always obtained at the device end.
  3. For that overall problem to be solved correctly, consumers and energy companies should be hanging off a sensible financial system which shows interest rates to both which are internally consistent. The failures of the Bond-Currency-Derivatives Nexus in India hamper that. The interest rates seen by households (which determine their purchase of LED bulbs) are strange, and the interest rates seen by the energy industry are quite different and also strange.

The engineer in me marvels at LED lamps. I was thrilled when the 2014 Nobel Prize went to the geniuses who made blue LEDs; this is simply one of the great sagas of the 20th century. I have watched Shuji Nakamura ever since he moved to UCSB in 1999. But this `gee whiz' should not blind us on questions of public policy; we should be hard headed in how we thinking about what government does. Most of what government in India does is not the job of government; most of what government ought to do in India is not being done. The rocket science that we require in India is the great organising principle of the market economy -- the Bond-Currency-Derivatives Nexus.

Thursday, October 09, 2014

Author: Susan Thomas

How to strengthen the National Pension System

by Renuka Sane and Susan Thomas.

When the Old Age Social and Income Security (OASIS) committee was created in 1998, it was asked to design a pension system that: (a) increased pension coverage on the large area, population and diversity of India; (b) was low cost; (c) was accessible to unsophisticated participants; (d) provided choice of investment; (e) was backed by sound regulation; and (f) had long-run sustainability. The report of the OASIS committee recommended the creation of the National Pension System (NPS), a pension system that was innovative even by the standards of pension systems in developed economies. The design included the following features:
  • Individual accounts with defined contributions.
  • Central record keeping agency which will provide a single account balance statement for each individual, and will move net funds to the fund managers.
  • Investments managed by multiple pension fund managers, each offering standardised asset products. Auction based selection of fund managers where the selection is based on the sum of fees and expenses.
  • Collection of contributions done through a network of banks, post offices and other "points of presence" across the country.
  • Withdrawals permitted only after age 60, with a minimum mandatory annuitisation of 40 percent of the terminal pension funds.
  • EET tax treatment, where benefits and withdrawals are taxed as ordinary income.

The NPS became operational in 2004 for new recruits to the central government. A central recordkeeping agency (CRA) and selection of fund managers through auctions have led to some of the lowest cost structures in the world. The NPS has grown to having 7.1 million accounts, and Rs. 0.6 trillion in assets under management. While it is mandatory for new recruits to the central government, it can be accessed by all. A co-contribution scheme called NPS-Swavalamban encourages participation by poor households in the informal sector.

After a decade of existence, there is need to examine the existing NPS and compare the performance of this system to the goals with which it was created. In a recent paper, we analyse the NPS from this perspective.

Problems with the implementation of the NPS


While several of the key features of the existing system are consistent with the original design features, there are certain critical areas in which the NPS has deviated. There continues to be an attempt to reduce transactions costs in the system, with a central record keeping agency and a limited number of pension fund managers. However, the NPS has several flaws at the ease of accessibility as well as the choice of investments to the pension contributor:

Low transparency: One of the progressive features of the original NPS design was high transparency about cumulations for the NPS member contributors. However, this has not been implemented. Members do not always get communications regarding their pension wealth. There is as yet, no clarity on how long the process of contribution deduction to actual investment takes, and the costs incurred in the form of lost interest owing to delays in the process (if any) on the customer. The PFRDA does not make available aggregate details about assets under management, number of accounts, or cumulated returns. This lack of transparency leads to a lack of awareness and trust in the system, and reduces the quality of policy analysis.

Lack of investment choice: Government employees are not allowed a choice of investment strategy, or pension fund manager. The default investment option of government employees is badly structured - it does not cater to the best interests of participants. International diversification is not permitted.

Inconsistency in tax treatment: Schemes such as the GPF and the CPF continue to be taxed on a EEE basis, while the NPS is taxed on a EET basis. Employee contributions to the NPS above Rs.100,000 are taxed. These tax inconsistencies need to be rationalised.

Confusion: A key element of the original NPS was that it was one single pension system serving the entire country. For a variety of tactical reasons, before the PFRDA Act was passed by Parliament, a series of variants of NPS were created. These create complexity, hamper portability, and increase cost. It is time to go back to one single NPS.

Broader policy problems


Beyond the scope of the original NPS design, there are other policy issues that need to be addressed in order to achieve the end objective with which the NPS was commissioned: the goal of providing old age income security with coverage across the breadth and length of India.

One such issue deals with the question of the annuity the NPS contributor member can expect to access as a pensioner. The price of an annuity will influence the monthly pension available to a pensioner. If annuity prices are very high, it will have a detrimental impact on the pension payout. As of yet, there has been no active effort on the part of the PFRDA to enable the pensioner to obtain the lowest cost annuity product. Similarly, there has been no effort to design a common draw-down policy that works in the interest of both government employees and lower-income, informal sector workers, both of whom contribute to the NPS.

Another area of broad policy concern has centered around the sales of NPS so far. This has been perceived as very low, and has led to suggestions to incentivise sales intermediaries to push the sales of NPS, by improving their commissions. However, experience from the mutual fund and insurance industries in India shows that a combination of high-powered sales incentives without any liability for mis-selling does not lead to an increase in retail participation. Instead, it can lead to defrauding of customers. This suggests that it would be imprudent for the PFRDA to incentivise the sale of the NPS in an environment that is characterised by a lack of strong consumer protection. The PFRDA needs to first re-orient its strategy towards an explicit goal of consumer protection, with a clear enumeration of the rights of consumers and obligations of sellers. A relevant benchmark that provides explicitly for protections against misleading conduct by sales agents is the Indian Financial Code.

The light at the end of the tunnel


One of the key bottlenecks for the NPS since it was implemented in 2003, was the lack of a sound regulatory framework that was implemented by an empowered and independent regulator. While the PFRDA has been in place at the same time that the NPS was implemented, it has awaited the passage of the PFRDA Bill for a regulatory mandate and empowerment. This Bill has since been passed in 2013, enabling the formal institutionalisation of the PFRDA as the regulator of the NPS.

The PFRDA can now take on the task of both the relatively short term agenda of closing the gap between the current implementation and what was visualised in the original design. This includes building trust in the system by improving the transparency and visibility of fund accumulations for contributor members and the overall system; enabling a richer choice of investments available to individual members; and resolving inconsistencies in tax treatment.

Another area which the PFRDA can take forward is to initiate the policy thinking and research analysis for the medium and long-term objectives of sound policy and regulation for annuities, and to design the regulatory framework to improve the NPS customer rights.

With these actions, India can get back on the track to achieve a pension system with universal coverage that was visualised in the OASIS reforms of 1998.

Author: Renuka Sane

Saturday, October 04, 2014

Repeal 100 laws

An earlier version of this appeared on qz.com two days ago.

Fixing the laws is fixing the Republic


Badly drafted laws are at the heart of the failures of government in India. All too often, in India, laws feature sloppy drafting (inducing legal risk), have vague objectives (hampering accountability), and give sweeping powers (inviting abuse). Of particular importance is the role of sloppy drafting coupled with absence of accountability in generating arbitrary power in the hands of the executive. You have to `respect' the executive because it has arbitrary power.

Today there is a thicket of nearly 2,000 central laws, alongside hundreds of state laws, processes, rules and regulations, The Gazette of India fares badly on publishing central legislations, making it impossible for citizens to know all the laws through which government has powers over them. Everyday life has become a minefield: a person never quite knows what laws he is violating.

Remedying this situation requires large scale rewriting and cleaning of the statute books. The first step is outright repeal of obsolete and anachronistic laws. The second is creating a new wave of well-drafted laws which clean up one sector at a time. A well-drafted law is precise, principles-based and will make sense for a long horizon. One example of this is the Indian Financial Code, which aims to replace all existing financial law. Drafting high quality law is a complex and time-consuming process.

Both strategies -- outright repeal and new drafting -- are required to clear the thicket, reduce complexity, uncertainty, mis-governance and opportunities for rent seeking, and ultimately to put the Republic on a sound foundation.

Three groups of laws that require fixing


Three groups of laws are of prime importance in cleaning up the undergrowth:

  1. There are laws from the colonial era which are irrelevant or misplaced today, as the world has changed. Some of these were specifically enacted to curb the independence movement.
  2. In particular, during the Second World War, many laws were passed which reflected the exigencies of the war. In numerous areas, freedoms of Indians were taken away to make it convenient for the British war effort.
  3. The laws from the socialist period, roughly 1950 to 1980, where the government sought to achieve a dominant role in the economy. Many times, the dirigisme which was initiated as a wartime measure ossified into a system of control under socialism. The years around the Emergency in particular had laws which gave a tremendous increase of State power, the after effects of which are still plaguing the country.

The zone of careful rewrite


While all the laws under these three categories merit review, in many cases, outright repeal is neither feasible nor desirable. Three examples are instructive:
  1. The Forward Contracts Regulation Act of 1952 has as its objective the prohibition of options trading. This is not an objective that we wish to pursue today. However, the solution does not lie in a simple repeal of this Act; what is required is a complex drafting of a new law (i.e. the Indian Financial Code).
  2. The RBI Act, 1934, was proposed by the British as a `temporary measure'. It is a badly drafted legislation, and has given us an under-performing central bank, but the solution is not a simple repeal but the complex drafting of a new law (the Indian Financial Code).
  3. There are huge problems with the Indian Penal Code in areas such as freedom of speech. In a sense, the IPC of 1860 (written three years after the mutiny) is incompatible with the Constitution of India when it proposes to imprison a man for committing the crime of speaking. But this is not a simple repeal. What is required is a deeper rewrite of criminal law - e.g. by setting up a Criminal Justice Legislative Reforms Commission a la FSLRC.

The zone of outright repeal


In 2014, a collaborative project was initiated between three organisations -- Centre for Civil SocietyVidhi Centre for Legal Policy and the Macro/Finance Group at the National Institute of Public Finance and Policy -- that aimed to identify 100 laws that can be simply repealed. This initiative came at the back of the new government's undertaking to clean the statute books. The initiative identified laws that are completely out of touch with today's India, where almost everyone would agree that they do not belong, and where there are no complexities other than a simple repeal.

The report of this project has a compact presentation of each of these laws, based on thorough research. This document is a hall of shame of the 100 laws that have no reason to exist. Once there is consensus about this work, a simple `Repeal of 100 Laws Act' can be drafted which eliminates these 100 laws.

In the past few weeks, the government has built momentum towards fulfilling its promise of repealing dated enactments -- however, these have focussed largely on low-impact house keeping repeals. This is no doubt crucial. The 100 Laws Project however, goes a step beyond -- it has assembled a package of both low impact repeal recommendations (40 of which have been included by the 20th Law Commission as part of its Legal Enactments Simplification and Streamlining project/248th Report), as well as gathered evidence to recommend repeal of high-impact laws that materially affect business climate and government effectiveness.

Achieving a modern and capable State in India undoubtedly requires more work. There are surely more than 100 laws which merit simple repeal. There are thousands of laws, which can be removed through more complex drafting projects. Most important of all is the constructive agenda, of drafting high-quality laws which create an accountable government with clarity of objectives. However, in that larger journey, this project is a useful and immediate building block.

A team of experts sifted through the landscape and chose 100 laws that are ripe for repeal. Let's look at the distribution of the date of these laws:

Distribution of the date of the 100 laws

We see a bimodal distribution with one hump at old British laws and another reflecting the period of India's socialism. The vertical lines focus us on the socialist period, 1955-1980, and the red line is the year of the Emergency, 1976. This gives us insights into the time periods which produced laws that obviously merit repeal, and may help increase the productivity of future projects which sift through laws.

World War 2 does not show up as a bump in this graph. Perhaps what is going on here is that the restrictions which were introduced here, such as capital controls, ossified into complex systems of socialist control, and resist simple repeals.

Reinvigorating the legislative process


In the past, the drafting of laws was dominated by the executive. As an example, the Ministry of Rural Development drafted the National Rural Employment Guarantee Act, 2005. The founding team of SEBI drafted the SEBI Act, and RBI staff have repeatedly had a role in drafting amendments to the RBI Act. This method of drafting generates a bias in favour of sweeping powers and low accountability.

For the health of the Republic, it is important to have independent voices involved in drafting and critiquing laws, and to create public debate on the substance and impact of new and old laws. In recent years, we are starting to see the evolution of think tanks away from traditional economic policy analysis towards a greater understanding of, and an involvement in, the legislative process. Examples of these organisations include Centre for Policy Research, Parliamentary Research Service, Centre for Civil Society, Vidhi Centre for Legal Research, Indira Gandhi Institute for Development Research and NIPFP. An array of independent writing now dissects laws and regulations, and creates resistance against badly drafted laws. This is an important and welcome new phase in the policy process in India -- in the maturation of the Republic -- one we think should be received with enthusiasm by the new government.

Tuesday, September 30, 2014

4 task forces setup by MOF to build institutional capabilities for FSLRC

FSLRC's institutional architecture


The draft Indian Financial Code (IFC) envisages seven financial agencies outside the Ministry of Finance:

  1. Financial Sector Appellate Tribunal (FSAT): An improved version of the existing Securities Appellate Tribunal which will hear appeals all across the financial system.
  2. Public Debt Management Agency (PDMA): The investment banker for the government.
  3. Financial Redress Agency (FRA): The one-stop shop where any individual goes to raise a complaint about a financial service provider, where the difficulty was first raised with the financial service provider but not satisfactorily resolved according to the consumer.
  4. Resolution Corporation (RC): A specialised organisation that will handle distress in certain kinds of financial firms.
  5. Financial Stability and Development Council (FSDC): Systemic risk, coordination, development. This contains a database named Financial Database Management Centre (FDMC), which is the one-stop shop where all financial service providers electronically submit all the data that they have to give to financial agencies.
  6. Unified Financial Authority (UFA): Consumer protection and micro-prudential regulation for all finance other than banking and payments.
  7. Reserve Bank of India (RBI): Monetary policy, and consumer protection and micro-prudential regulation for banking and payments.

Shifting to this financial regulatory architecture will (a) Close the gaps, of the things that are at present not being done; (b) Improve economies of scale and economies of scope for the economy and for these agencies, and (c) Sharpen accountability by clarifying objectives. This reorganisation addresses the problems that derive from the arbitrary choices embedded in the system that we have inherited.

It is one thing to design a clean financial regulatory architecture. The next challenge lies in implementing it. Let's think through what's required for all the 7+1 agencies.

  1. FSAT builds on the best tribunal in India today, SAT, and will become a high quality court.  It has to plan for the much higher case load that will come to FSAT under the IFC when compared with the present arrangements with SAT.
  2. PDMA is a capability which is absent today. Subsets of the work that PDMA has to do are to be found within RBI and MOF but the full task is not being performed in India today.
  3. FRA: at present, there are multiple ombudsman systems running in RBI, SEBI, IRDA, etc. FRA brings these together under one roof, with a high quality IT system.
  4. RC: Is a new capability which does not exist in India today.
  5. FSDC: Is an enlargement of the existing FSDC, which gets shifted out of the Ministry of Finance. FDMC has to be built.
  6. UFA: In terms of the areas covered, it is a merger of SEBI, PFRDA, IRDA, FMC and some things which are presently in RBI. In terms of the work being done, it is different from what these agencies do today.
  7. RBI: In terms of the areas covered, banking and payments and monetary policy are in RBI, but these things are done in different ways under the IFC.
  8. MoF: The IFC has important implications for MoF which has to think and work in new ways. Many people have not noticed the big changes that flow from the IFC for MoF.

The key bottleneck in India: State capacity


Once Parliament enacts a law, this has to be enforced, either by an agency (e.g. RC) or by the main line structures of government qua government (e.g. MoF).  We in India have a long history of under-performance in the enforcement of laws.

This is partly grounded in badly drafted laws, which lack accountability mechanisms, lack clarity of purpose (which reduces accountability) and embed extreme executive power and discretion (which reduces accountability). The underperformance of RBI or SEBI is partly the consequence of drafting problems of the RBI Act and the SEBI Act.

But the underperformance is also grounded in bad public administration. A lot of new work is required in public administration, so as to obtain good quality execution. Alongside bad laws, bad execution is an equally important source of underperformance. This takes us to questions like organisation diagrams, HR policy, process manuals, reporting, internal IT systems, etc.

In developed countries, there is rapid execution in the implementation of new laws. E.g. the UK was extremely impressive in their translation of their new law for resolution of financial firms into State capacity for enforcement. In India, the experience has been that it takes a long time to implement, and particularly to implement well.

It will take some time for the IFC to get enacted. Recognising the bottlenecks of State capacity, we should worry about the delays, and about the quality of the execution, in living by the IFC once it is enacted.

Building institutional machinery ahead of time


Reflecting these concerns, there is a long tradition in India, of building institutional capacity before a law is enacted. Here are a few examples:

  • SEBI was created by executive order in 1988, and the law came in 1992.
  • PFRDA and NPS were constructed 2003-2005, while the PFRDA Act was enacted in 2013. 
  • NSE started building Nifty and the real-time risk management system for derivatives trading at NSCC in 1995, while cash settled derivatives only became enforceable in 1999.
  • Work on building the depository began inside NSE in 1995, before the legal foundations for dematerialised settlement fell into place in 1996.
  • Work on the IT systems for the Goods and Services Tax (GST) began at NSDL in 2011, and the GST has not yet been enacted.

These are just a few examples that I have been around; there are many other episodes of this nature. The general principle is: Once the direction of future legislation is clear, project planning for enforcement of the law commences. Hence, once the budget speech of 2014 has established the legislative direction on the IFC, we should now build the institutional machinery through which the IFC would be enforced.

The MOF announcement today


Today, the Ministry of Finance has announced `Task forces' to build four components of the institutional machinery of the IFC. They are:

  1. Financial Sector Appellate Tribunal (FSAT). Chairman: N. K. Sodhi.
  2. Public Debt Management Authority (PDMA). Chairman: Dhirendra Swarup.
  3. Resolution Corporation (RC). Chairman: M. Damodaran.
  4. Financial Data Management Centre (FDMC). Chairman: Subir Gokarn.

The press releases are : overall, FSAT, PDMA, RC, FDMC.

The task forces are implementation teams which start from the design which is in the text of the IFC, and build the institutions that will implement the IFC. The output of the task forces will be working institutions. Other than the RC, the remaining projects are primarily about building complex IT systems.

With these four in motion, there is only one completely new component of the FSLRC institutional architecture where there is no progress, the Financial Redress Agency (FRA).

Twiddle your thumbs?


SEBI had to twiddle its thumbs from 1988 to 1992 as they had no powers in the absence of the law. NSE built the institutional capability to trade equity derivatives by 1998 and had to twiddle its thumbs till the politics worked out. All situations where institutional infrastructure comes up ahead of time have that tension within, of a race between the legislative process and the State capacity building project. The work of the four task forces that have begun has an array of possibilities, ranging from immediate impact to twiddle-your-thumbs:

  1. FSAT: If SAT voluntarily chose to use the new institutional capabilities built for the FSAT, then those could be valuable right away.
  2. PDMA: The new muscles of the PDMA could be of limited use to the Ministry of Finance in some ways that are compatible with the existing law.
  3. RC: The Resolution Corporation must twiddle its thumbs until the IFC is enacted.
  4. FDMC: Some or all of existing financial agencies could choose to voluntarily utilise the services of the FDMC, which will be a better IT-driven mechanism for submission of data from financial service providers to financial agencies.

The new work on building State capacity could thus start giving gains for the economy even before the IFC is enacted.

How we got here, and where we go next


The first phase of Indian financial reform ran from the reform of the equity market (1992-2001) and till the setting up of the NPS (2003-2005). Important new institutional infrastructure was created in this period: SEBI, NSE, NSDL, CCIL, IRDA, PFRDA, the NPS. The key features of this first phase were: (a) Responding to immediate difficulties and (b) Thinking one sub-sector at a time. Some parts of Indian finance made enormous progress in this period, such as the equity market and the pension system.

A long period of stagnation followed. This thought process shifted up from one sector at a time to thinking on a financial system scale, looking at the requirements of the economy even without the immediate impetus of a scandal. This started with the Percy Mistry report of 2007, and led up to the IFC in 2013. The IFC is now the centre of Indian financial reform, and is coming about on three tracks: the legislation, the Handbook, and these four task forces.

In many ways, these four projects are more complex than the new institutions of 1992-2005. The institution-building experiences of that period have many lessons, which have been incorporated into the construction and work procedure of the four task forces. E.g. the non-statutory SEBI drafted the SEBI Act, but now we understand that the Agent should not have a say in the contract between Principal and Agent. Similarly, the clarity of the four TORs of the task forces is not to be found in comparable documents from the 1992-2005 period. Institution building that period relied a lot on Level 3 thinking ("the great man theory"), whereas now there is an accent on formal processes that yield predictable outcomes.

All this connects with the core question of bandwidth and State capacity. In the past, one crack team at a time would setup one new institution.  There are concerns about whether there is State capacity to implement the IFC, and there is reason to believe that State capacity in financial economic policy has improved substantially when compared with what was available 1992-2005. At the same time, the four task forces are a daunting challenge: doing four new institutions at the same time has never been done before.