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Tuesday, May 16, 2017

Understanding judicial delays in debt tribunals

by Prasanth Regy and Shubho Roy.

The problem

The present system of measuring judicial statistics in India may highlight the magnitude of the problem of judicial delays; it lacks information which may inform court management on the ways to deal with it. In India, we only measure pendency: The total number of unfinished cases left at the end of the year. It is arrived at by adding the total number of new cases (in a year) to last year's pendency and subtracting the cases which have been closed. For example, the annual report of the Supreme Court notes that total pending cases rose from 59,272 to 60,938 between 2015 and 2016. While this gives some idea about the magnitude of the problem, it does not tell us how to solve it. When we see pendency go up, we can only conclude that the courts have been unable to keep up with their workload. This system has three shortcomings:

  1. There is no definition of what constitutes delay in a case as opposed to total number of pending cases. Therefore, there is no actual measure of delay in the Indian court system.
  2. There is no identification of the cause of the delay. We do not know what delay was caused due to the litigants asking for adjournments, the lawyers being absent, the court administration being slow, etc.
  3. There is no attribution of delay to a party. It ignores the fact that there are multiple parties to every judicial proceeding: the plaintiff, the defendant and the judge. Any of the three parties may cause delays.

An ideal system to measure judicial delays would provide extremely granular data about the court. We would have all information about judicial processes and capture video of proceedings in a court. Such information would allow us to carry out time-motion studies of court functioning. Detailed statistics like that require a dedicated management system for courts which records every step in a judicial proceeding. Dedicated court management entities like the Her Majesty's Courts and Tribunal Service or the Administrative Office of the United States Courts produce detailed statistics of court functioning in their countries. We do not have such systems in India. This creates the problem of: How to measure judicial delays in a manner which helps policy analysis on judicial reforms?

A new approach to measurement

What we have in India, are case files. These are the official records of a judicial proceeding, kept in the court and with the litigants. Case files include all documents filed before the court/tribunal by all parties to the litigation, and all documents generated by the court/tribunal. One important class of documents in a case file are the interim orders. Interim orders are generated every time a case comes before a judicial officer. This gives us a glimpse into what happened in the judicial proceeding (called hearings) on the days it was presented before a judicial officer. Even if the hearing did not result in any judicial work being done, an interim order is generated.

In a recent working paper (Regy and Roy, 2017) we study individual case files, with attention to each interim order, to reconstruct what happened in each hearing of a case. We use the interim orders to determine if the hearings were failure or not. We define a hearing to be a failure if no judicial work was done at that hearing and no penalty was imposed on any party. If a hearing is determined to be a failure we try to determine two additional facts from the interim order for the hearing:

  1. The party was responsible for the hearing failure.
  2. A standardised reason for failure.

This system of measurement has advantages over the present system of measuring pendency. It determines the delay in individual cases without any need to imagine what time a case ought to take. Delays are calculated by the number of failed hearings and the time each such hearing added to the total time of the case. The system also provides the reason for delay and the party causing delays. This information can inform court managers and policy makers on strategies to reduce judicial delays.

One dataset

We deploy this measurement system to orders of the Debt Recovery Tribunal - III, New Delhi (DRT). A research team went through the case file of 22 decided cases of the DRT. For each case the following information was recorded:

  1. The case name, type, and the party who had filed the case (lender or borrower)
  2. Date of filing and final order (finishing the case)
  3. Decision of the tribunal, which was standardised into: dismissed (withdrawn or otherwise), disposed, closed (as fully satisfied or with liberty to revive later)
  4. Date for each hearing of the case;
  5. Brief subject for the hearing and the next date of the hearing
  6. If the hearing was a failure, then: which party was responsible for it, and a standardised reason for failure
This gave us granular data about a total of 474 hearings.

Preliminary findings

Of the 474 hearings, 274 hearings (about 58%) were hearing failures. These failures accounted for more than half the time taken by the cases. We could reduce the duration of the average case by half if we were able to avoid hearing failures. The majority of delays are due to requests from the parties for more time to submit documents. Other common reasons include the absence of lawyers or of tribunal officers. Figure 1 highlights the standardised reasons for delays.

Figure 1: Reasons for hearing failure in Debt Recovery Tribunal.

The other interesting finding is the person causing the delay. One would expect that borrowers would be interested in delaying cases to delay eventual recovery of dues through coercive means like auctioning off collateral. On the other hand, lenders would be interested in quickly finishing cases to recover dues. However, the data does not bear this out. Figures 2 and 3 identify the party causing hearing failure in the cases. Figure 2 identifies parties when the borrower has filed the case (borrower is plaintiff). Figure 3 identifies parties when the lender has filed the case (lender is plaintiff).

Figure 2: Party responsible for hearing failure in cases filed by the borrower (borrower = plaintiff, lender = defendant).
Figure 3: Party responsible for hearing failure in cases filed by the lender (lender = plaintiff, borrower = defendant).
Surprisingly even when the plaintiff is the lender, the plaintiff is the party responsible for most number of hearing failures. Lenders here are financial institutions who are expected to have processes and systems to pursue defaulting borrowers in court, yet they seem to ask for adjournments at rates similar to borrowers who may not have experience in litigation.

Conclusion

Computerisation is seen as a panacea for judicial delays. The Supreme Court plans to move to a paperless system soon. The government had started a process of computerising DRTs in 1997. The National Institute of Smart Governance has been running a project on this since 2011. Yet, there is little information about the functioning of DRTs in the public domain or what are the reasons for delays in them. Computerisation, by itself, will not lead to better management of courts. We need a complete loop, which: Collects granular data of court functioning; analyses the information to identify causes of delays; changes court processes and legal rules (process re-engineering) to reduce delays; and goes back to collecting granular data to check for effects. In this, computerisation will play an important role in gathering information. But computers have no idea about which information is relevant and how to use it. This still requires human intervention and scientific enquiry.

Interesting readings

Does the ordinance solve the banking crisis? by Ajay Shah in Business Standard, May 15, 2017.

Don't expect the next generation to save liberalism by Mihir Sharma in Mint, May 15, 2017.

How Google Took Over the Classroom by Natasha Singer in The New York Times, May 13, 2017.

A Run for Their Money: The Struggle to Exchange Demonetised Notes Did Not End in December at the RBI's Branch in Delhi by Ashish Malhotra in The Caravan, May 13, 2017.

The Nepal-Sikh Alliance That Could Have Changed History by Amish Raj Mulmi in The Wire, May 12, 2017.

The satellite imagery in Google maps and Google earth has gone from 5m to 1m resolution! 'Lost' forests found covering an area two-thirds the size of Australia by Andrew Lowe And Ben Sparrow in Phys, May 12, 2017.

The woman who saved old New York by Jonathan Glancey in BBC, May 12, 2017. She is celebrated in Seeing like a State.

Bankers, proxy firms question sudden orders for transferring CEOs of PNB, BOI by Gopika Gopakumar in Mint, May 12, 2017.

Demonetisation and the Delusion of GDP Growth by Ritika Mankar and Sumit Shekhar in Economic and Political Weekly, May 6, 2017.

Comey's Firing Is a Crisis of American Rule of Law by Noah Feldman in Bloomberg, May 10, 2017.

Scaling the World's Most Lethal Mountain, in the Dead of Winter by Michael Powell in The New York Times, May 9, 2017.

Only 36% of Indian engineers can write compilable code: study by Sam Varghese in Itwire, May 9, 2017.

What Happens When Authors Are Afraid to Stand Alone by Jason Guriel in The Walrus, May 9, 2017.

This data set took six years to create - Worth every moment by Hudson Hollister in Data Coalition , May 9, 2017.

Indian Parliament does not make laws, and MPs have little scope to keep govt accountable by Athreya Mukunthan in The News Minute, May 8, 2017.

China faces resistance to a cherished theme of its foreign policy in The Economist, May 4, 2017.

Why You Need More Dirt in Your Life by Simon Worrall in National Geographic, April 30, 2017.

Irreplaceable Pioneer - Obituary: Ravi Dayal (1937-2006) by Rukun Advani in The Telegraph, June 11, 2006.

Monday, May 15, 2017

Author: Pramod Sinha

Measurement of exports in India

by Radhika Pandey, Ajay Shah and Pramod Sinha.

The Indian statistical system has many difficulties. In general, a certain mistrust of official statistics is well placed. Every user of data must skeptically examine all data that is sought to be used. In this article, we kick the tyres of exports data, juxtaposing two different sources. We are pleased to report that there is no large discrepancy. We conjecture a third possibility for constructing a quarterly measure of exports, based on firm data, and find that this does not work out. In the future, it may work, thus giving a 3rd measure of quarterly exports.

There are two independent sources of exports data:

  1. RBI produces the Balance of Payments data. This obtains information about the exports of goods and services by watching flows of money through banks. This is released quarterly.
  2. The Department of Commerce (DGCI&S) releases monthly data for exports of goods (only). This is based on the daily trade data that it receives from Customs authorities, SEZs and Ports. The phrase 'exports' is used when describing this data, but it is important to always refer to it as 'merchandise exports' or 'exports of goods'.

In order to assess the sanity of these two series, we compare the year-on-year change for them against each other.

The above graph compares the year-on-year change for the BoP exports and the merchandise exports series. Although varying in magnitude, the figure shows broad similarity in the ups and downs in the two series. The rank correlation between the two is 0.93. This seems sound.

The above graph plots the seasonally adjusted point-on-point growth (annualised) for the two exports series. This uses our work on seasonal adjustment. We observe similar trends in the two series. The rank correlation here is 0.83, which is mildly worrisome.

Can firm data yield a third measure of exports?

Large firms are important in India's exports, across both goods and services. As an example, in 2014-15, of the total exports of goods and services of USD 474.24 billion, the annual report data for 4666 exporting companies in the CMIE database reveals exports of USD 248.60 billion. Hence, we wonder: Could we use firm data to construct on exports time series?

The legal framework on reporting of annual financial statements requires that companies report their export income. Section 134 (3)(m) of Companies Act, 2013 states:

There shall be attached to statements laid before a company in general meeting, a report by its Board of Directors, which shall include: ---(m) the conservation of energy. technology absorption, foreign exchange earnings and outgo , in such manner as may be prescribed.

Rule 8(3)(C) of the Companies (Accounts) Rules, 2014 states:

The report of the Board shall contain the following information and details, namely-- ---(C) Foreign exchange earnings and outgo The Foreign Exchange earned in terms of actual inflows during the year and the Foreign Exchange outgo during the year in terms of actual outflows.

This clarity in legal drafting shapes the disclosure of export income of firms in their annual reports. A large chunk of firms disclose their export income in their annual reports. As an example as on 31st March, 2015, out of 4038 listed firms, 1795 firms are identified as exporters using this annual filing of financial statements. We could use quarterly data for these firms, which is required to be disclosed by all listed companies, to construct an exports measure. In terms of methods, we could do for exports what we have done previously for net sales using firm quarterly data.

When we turn to quarterly data, however, the legal instruments that define disclosure requirements do not clearly require information about exports. Under Regulation 33 of the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015, SEBI requires companies to diclose their quarterly results, following the accounting standards prescribed by the Central Government under Section 133 of the Companies Act, 2013. The field on "Income from Operations" includes: (a) Net sales/income from Operations, and (b) Other operating income. (See Annexure I of this circular.) As a result, most firms do not report their 'export income' in their quarterly disclosures. Some firms voluntarily disclose information on exports, but this is part of the "Notes" to financial statements. As an example see Point 4 under Notes of this report.

In the table below, we present a comparison of firms that report exports in their annual reports versus those that report export income as part of their quarterly disclosures. The table shows the proportion of listed exporting firms that report 'export income' in their quarterly disclosures. It shows that a miniscule proportion of firms that are `exporters' as disclosed in their annual reports publish export income as part of their quarterly disclosures.

Year Total Listed Firms Exporters (As per AR) Exporters (As per QR) Share of firms
2000-03-31 3976 1891 54 2.9
2001-03-31 4373 2046 76 3.7
2002-03-31 4800 2013 97 4.8
2003-03-31 4876 1986 106 5.3
2004-03-31 4820 1986 108 5.4
2005-03-31 4990 1982 118 6.0
2006-03-31 4998 2037 131 6.4
2007-03-31 4884 2067 135 6.5
2008-03-31 4882 2084 101 4.8
2009-03-31 4893 2086 109 5.2
2010-03-31 4897 2046 88 4.3
2011-03-31 4867 2032 78 3.8
2012-03-31 4755 1996 49 2.5
2013-03-31 4612 1958 42 2.1
2014-03-31 4436 1911 43 2.3
2015-03-31 4038 1795 34 1.9
 

Recent improvements in the quarterly disclosures of firms

On 5 July 2016, SEBI has modified the format for publishing financial results under the SEBI (Listing Obligations and Disclosure Requirements) Regulations. This new circular mandates that the quarterly financial statements should follow the format prescribed in Schedule III to the Companies Act, 2013. Schedule III to the Companies Act, 2013 lays down general instructions for preparation of balance-sheet and statement of profit and loss of a company. Through requirements of 'additional information', companies are required to disclose income from exports. The relevant text from the legal instrument is as follows:

5. Additional Information The profit and loss account shall also contain by way of a note the following information, namely-- (e)Earnings in foreign exchange classified under the following heads, namely-- I. Export of goods calculated on F.O.B. basis;...

The revised reporting format becomes applicable for the period ending on or after March 31, 2017. From March, 2017 onwards we hope to see improved reporting by firms of quarterly exports data, which would make possible the construction of a third quarterly exports time series.

Conclusion

The Indian statistical system is riddled with problems of measurement. Critical pillars of the statistical system -- NAS, NSSO, ASI, IIP -- are not trusted. Every user of data must bring critical thinking into the choice of data that will be used. Our analysis above is reassuring in finding agreement between exports data released by RBI and the Ministry of Commerce, and rejects the possibility of constructing an exports measure using the present framework of quarterly disclosures by listed companies. Going forward, with improved reporting by firms we could get a third measure of quarterly exports.

 

The authors are researchers at the National Institute for Public Finance and Policy.

Tuesday, May 09, 2017

Interesting readings

So how did that demonetisation thing work out for you? by Tony Joseph in Scroll, May 8, 2017.

When will the jobs come back? by Mahesh Vyas in Business Standard, May 8, 2017.

The journey of a 400 kg buffalo by Harish Damodaran in Indian Express, May 7, 2017.

1965 Nanda Devi spy mission, the movie by Shail Desai in Mint, May 7, 2017.

The great British Brexit robbery: how our democracy was hijacked by Carole Cadwalladr inThe guardian , May 7 2017.

How Machiavelli Trolled Europe's Princes by Erica Benner in The Daily Beast, May 6, 2017.

How Censorship Works by Ai Weiwei in The New York Times, May 6, 2017.

Data is giving rise to a new economy in The Economist, May 6, 2017.

Dhabas and Japanese food: Visit mini Japans in rural Haryana and Rajasthan by Manavi Kapur in Business Standard, May 6, 2017.

Supreme Test by Pratap Bhanu Mehta in Indian Express, May 6, 2017.

Antecedent Transactions: An Anomaly in the Insolvency and Bankruptcy Code, 2016 by Rahul Sibal and Deep Shah in Indiacorplaw, May 5, 2017.

A tighrope walk for Sebi by Somasekhar Sundaresan in Business Standard, May 4, 2017.

What eastern bloc dissidents can teach us about 'living in truth' by Philip Boobbyer in The Conversation , May 4 2017.

Money & Medicine: the odd couple - Complexities of health system financing by Margaret Faux on the NIPFP YouTube Channel, May 3, 2017.

For first time, Naxal heartland begins to be mapped plot by plot by Dipankar Ghose in Indian Express, May 2, 2017.

Is China the World's New Colonial Power? by Brook Larmer in The New York Times, May 2, 2017.

Moving towards a principles-based drug retail policy in India by Amey Sapre and Smriti Sharma in Ideas for India, May 2, 2017.

Highway network designs and regional economic development by Simon Alder in Ideas for India, April 3, 2017.

Land in India: Market price vs. fundamental value by Gurbachan Singh in Ideas for India, February 29, 2016.

The Nanda Devi mystery by Shamik Bag in Mint, April 18, 2015.

Wolf Reintroduction Changes Ecosystem by Brodie Farquhar.

Policy implications of the Tata-Docomo order

by Radhika Pandey and Bhargavi Zaveri.

On 28th April 2017, in a widely reported judgement, the Delhi High Court allowed the enforcement of an international arbitration award requiring the Tatas to pay damages to the tune of USD 1.17 billion to Docomo, in connection with the investment agreement under which Docomo had invested in Tata Teleservices in 2009.

In this article, we argue that the Delhi High Court judgement presents an opportunity to reform the complex regulatory framework governing foreign investment in India. The Tata-Docomo legal battle for the enforcement of undisputed contractual rights, though unfortunate, can have positive spill-overs if the regulator uses the outcome of the litigation as a feedback loop, and rationalises the regulatory framework governing exits from Indian investment, including price controls applicable to the entry and exit of foreign investment.

Background

The much-talked about Tata-Docomo transaction dates back to 2009 when NTT Docomo of Japan bought a 26.5% stake in Tata Teleservices for for about Rs 12,740 crore at Rs 117 per share. The agreement was that if certain revenue targets were not met, the Japanese company could "put" its shares on the Tatas at a pre-determined price equivalent to roughly 50 per cent of Docomo's acquisition cost. When the Tata-Docomo agreement was signed, the law did not expressly restrict such exit mechanisms for foreign investors. However, the RBI had been implicitly objecting to the creation of put options in investment agreement without clarifying the position by a statutory instrument.

On 30th September, 2011, the Department of Industrial Policy and Promotion allowed investments in instruments with in-built options to be regulated as External Commercial Borrowings (see here). This effectively meant that the agreeements with optionality clauses would be governed by the restrictions covered under the ECB policy, including the end-use requirements and a cap on return. After a month of heavy lobbying, the DIPP withdrew the circular, and there was again a vaccum on whether such options were allowed. In 2014, after more than a year of uncertainty, the RBI issued a circular legitimising put options with a host of conditionalities. The key restriction was that the foreign investor should exit without an assured or pre-agreed return.

Timeline from the date of triggering exit mechanism

When Docomo sought to exit its investment from Tata Teleservices by exercising its put option in 2015, the Tata-Docomo agreement came under the scanner, as it sought to offer a pre-agreed fixed return to Docomo. The pre-agreed return was higher than the market value of Docomo's investment at the time of its exit. Hence, the parties applied to the RBI for a waiver from the restriction on pre-agreed returns imposed in 2014. The waiver application was rejected, and Docomo instituted international arbitration proceedings to recover its contractual dues.

In June 2016, the arbitration tribunal ruled in favour of Docomo awarding damages of USD 1.17 billion dollars. The Tatas challenged the enforcement of the award in the Delhi High Court. The RBI sought to intervene in the enforcement proceedings, objecting to the enforcement of the award, on the ground that the award and the Tata-Docomo agreement were violative of FEMA and its directive against fixed returns.

In April 2017, the Delhi High Court dismissed the RBI's intervention application on the ground that, "...there s no provision in law which permits RBI to intervene in a petition seeking enforcement of an arbitral Award to which RBI is not a party." It also held that the Tata-Docomo shareholders' agreement was not violative of the Foreign Exchange Management Act, 1999 (FEMA), as it required the Tatas to (a) procure a buyer for Docomo's shares; and (b) indemnify Docomo for the difference between the pre-determined price and the price at which Docomo's shares are actually sold. Since FEMA did not prohibit the creation of contractual obligations, the creation of the obligation could not be said to be violative of FEMA. The court concluded by upholding the validity of the arbitration award.

The timeline of events leading up to the Delhi High Court order is important as it shows the time taken to effectively exit an Indian investment. The timeline is summarised in the Table below.

Timeline of events leading up to the Delhi High Court order
Date Event
2009 Docomo picks up 26.5% stake in Tata Teleservices Ltd
September 2011 DIPP issues allowing put options to be regulated as External Commercial Borrowings.
October 2011 DIPP withdraws circular issued in September 2011.
January 2014 RBI issues a circular permitting put options in favour of non-residents, subject to the several conditions, including that the put option must not be exercisable at a pre-determined price.
July 2014 Docomo tells Tata of its decision to exercise its put option, as per its contractual arrangement.
January 2015 RBI is reportedly keen to exempt the Tata-Docomo transaction from its rule against pre-determined returns.
January 2015 Docomo begins arbitration proceedings for recovery of its contractually agreed put option price.
June 2016 Arbitration tribunal decides in favour of Docomo
September 2016 Tatas challenge the enforcement of the award before the Delhi High Court.
April 2017 Delhi High Court rules in favour of Docomo.

Controls on rupee-denominated put options

This blog has been commenting on the regulatory tangle surrounding the Tata-Docomo dispute. In January 2015, RBI was reportedly keen to exempt the Tata-Docomo transaction from its rule against put options, and allow the remittance. On this blog, we had argued that allowing ad-hoc individual exemptions, would weaken the rule of law in the administration of the regulatory framework governing capital flows into India. We made a case for rationalising the foreign investment regulatory framework, which imposes restrictions on put options that offer 'fixed returns' to foreign investors. In another article on this blog, we had argued that controls on exit mechanisms through the exercise of put options, were not supported by any economic rationale. Put options, which act as a stop-loss for any investor (foreign or Indian), must not be regulated for two reasons. First, there is no market failure involved when an Indian resident is obligated to buy and pay for Rupee-denominated instruments. A sound regulatory framework governing capital controls must address the systemic risk concerns associated with unhedged foreign currency exposure. In case of put options on Rupee-denominated instruments, no such risk arises as the liability of an Indian resident, on whom the put is exercised, to pay for the shares is in local currency. Second, put options are not akin to debt as they do not entitle the non-residents to the same remedies as a debt-default would. In most cases, put options are not secured.

Three options from a policy perspective

How should RBI, as the regulator of foreign exchange, react to the judgement of the Delhi High Court that enforced the award? There are three options:

  1. RBI may retain the status-quo and not amend the regulatory framework governing the remittance of fixed returns on Rupee-denominated instruments to foreign investors. In such cases, where foreign investors have a stop-loss provision in their contracts, the recoupment of capital by them, will continue to be shrouded in doubt. They may be encouraged by the Delhi High Court judgement to apply to the RBI seeking approval for the remittance. Like many other cases under FEMA, such applications for approval will be dealt with on a case-by-case basis. This is a sub-optimal outcome as there is no regulatory certainty on the conditions in which foreign investors may exit their Indian investment.
  2. RBI may amend the regulatory framework in response to the Delhi High Court judgement. It may dispense with the control on fixed returns on Rupee-denominated instruments, as such fixed returns are in local currency and do not give rise to any systemic risk concerns.

    Besides the two reasons explained above, the current framework needs to be re-visited for two reasons. First, as discussed above, fundamentally, put options are not akin to debt. Even if this position is accepted, the closest proxy instrument would be the onshore Rupee-denominated bonds. The regulatory framework governing foreign investment in onshore bonds does not cap the interest rate. There should similarly be no restriction on the return from the exercise of a put option. If this happens, then we will have uniform rules for investments of a similar nature.

    Second, in its current form, the regulation mandating that put options should not result in pre-determined or fixed returns to foreign investors, renders itself to multiple interpretations on intent. For instance, the judgement of the Delhi High Court records that the RBI had considered exempting cases of 'fixed return' to foreign investors, where the 'fixed return' was lesser than the original amount invested in the Indian entity. The Delhi High Court order shows that the Tatas had filed an application under the Right to Information Act, 2005 (RTI) seeking information regarding the Tata-Docomo transaction. An abstract of an internal file noting, provided by the RBI in response to the RTI application, reads thus:

    "I would take a different view. The assured return applies where the overseas investor gets his entire principal PLUS a certain return. Here both the parties agreed to protect the downside loss at 50% of the invested value. This is according to me a fair agreement/contract and we should facilitate honouring this commitment. ... Although strictly as far as wordings of the regulation this may not be allowed."

    Thus, it seems that even within the RBI, there is little consensus on whether the rule against fixed return should be applied in all cases of exit or not. It appears that the RBI intends to exempt the cases from the prohibition on fixed return where the fixed return provides downside protection to an investment.

    Apart from price controls on the exercise of put options, even ordinary entry and exits of foreign investors are subjected to controls. For instance, the current regulatory framework does not allow a foreign investor to buy shares from an Indian resident at a price that is less than the 'fair market value' (minimum price). Similarly, it does not allow foreign investors to sell their securities to an Indian resident for a price which is more than the 'fair market value' (cap on price). Protectionist price controls were originally intended to protect Indian residents from over-paying non-residents for purchasing shares of Indian companies, and to prevent mis-invoicing of capital outflows. While they may have been relevant when Indian businesses were not exposed to FDI, there seems to be no reason to continue these restrictions. India has been fully current account convertible now, open to FDI for more than 15 years now and there are multiple foreign investors actively looking for investments in Indian companies. Indian entrepreneurs/ shareholders must be free to negotiate appropriate terms of sale or purchase of their securities. The removal of restrictions will allow flexibility in structuring investments and exits. It will allow the terms of contracts to be determined by the risk appetite and commercial understanding between the parties.

  3. RBI may react aggressively and appeal against the dismissal of the intervention application by the Delhi High Court. For the reasons explained above, we believe that this will be a loss of an opportunity to rationalise our foreign exchange regulatory regime governing price controls on entry
    and exit.

Conclusion

The international arbitration award awarding damages to Docomo and the time and costs associated with the exit from Indian investments, shows a crying need to rationalise the Indian regulatory framework governing capital flows. The Tata-Docomo dispute made it to the news. There are numerous other instances where Indian residents have used the complex foreign investment regulatory framework to deny contractual rights to their counterparties (see here). While the Delhi High Court order may have put an end to the protracted Tata-Docomo dispute, a permanent solution to the problem calls for a simplified law governing foreign investments. The principles underlying a coherent and simplified design of capital controls framework are discussed here and here.

While transitioning towards a simplified law governing capital controls is a medium term goal, the immediate solution lies in re-thinking the restrictions on fixed returns on Rupee-denominated instruments, applying the tenets of market failure. This is necessary to ensure that the Delhi High Court judgement does not end up incentivising economic actors to either seek recourse through forced international arbitrations (as is reportedly done in China to evade the recent spate of controls on capital outflows) or resorting to a system of individual exemptions from the RBI.

 

Radhika Pandey is a researcher at the National Institute of Public Finance and Policy. Bhargavi Zaveri is a researcher at the Indira Gandhi Institute of Development Research. The authors would like to thank Ajay Shah and three anonymous referees for their comments and suggestions.

Monday, May 08, 2017

Understanding the recent Banking Regulation (Amendment) Ordinance, 2017

by Pratik Datta and Rajeswari Sengupta.

On 4 May, the President promulgated the Banking Regulation (Amendment) Ordinance, 2017. This adds sections 35AA and 35AB to the Banking Regulation Act, 1949 ("BRA").

The first applications of this modified law are visible. Under these new provisions, the Government has issued an order authorising RBI to give directions to the banks. RBI in turn has issued a notification imposing additional conditions on banks with regard to the JLF and corrective action plan processes.

It may be worthwhile to note at the start that the BRA already gives RBI expansive powers to issue directions to banks (see here). This begs the question as to why was it necessary to amend the BRA to give powers to the RBI that it already has.

Many commentators think that this specific amendment will help resolve the banking crisis. As examples, see here and here. In this article, we ask three questions:

  1. Will the Ordinance help solve the decision paralysis in banks?
  2. Will it help solve the ongoing NPA crisis?
  3. Will it help prevent a future NPA crisis?

The Ordinance

The Ordinance adds two new sections to BRA:

Section 35AA: The Central Government may by order authorise the Reserve Bank to issue directions to any banking company or banking companies to initiate insolvency resolution process in respect of a default, under the provisions of the Insolvency and Bankruptcy Code, 2016.
Explanation - For the purposes of this section, "default" has the same meaning assigned to it in clause (12) of section 3 of the Insolvency and Bankruptcy Code, 2016.

Section 35AB: (1) Without prejudice to the provisions of section 35A, the Reserve Bank may, from time to time, issue directions to the banking companies for resolution of stressed assets.
(2) The Reserve Bank may specify one or more authorities or committees with such members as the Reserve Bank may appoint or approve for appointment to advise banking companies on resolution of stressed assets.

Ideally a new law should be released along with its rationale and background so that there is no ambiguity about its objective. This Ordinance does not have a clear rationale. It starts with a short preamble which is vague, and does not clarify the purpose of the amendment. Ideally, the full strategy for resolving the banking crisis should be visible as a single document. At present, no such document exists, and it is possible that the full picture can change in coming months. Lacking these critical documents, we are hampered in our analysis.

We conjecture that the Ordinance is aimed at solving two problems:

  1. The Insolvency and Bankruptcy Code, 2016 (IBC) has already been implemented as a law and any banker is free to trigger it if there has been a corporate default. We speculate that bankers on their own may come under pressure if they try to initiate an insolvency resolution process under the IBC against politically connected corporate defaulters. Perhaps the amendment aims to address this problem.
  2. Even as part of the resolution process, bankers may not want to take decisions for fear of investigation by investigating agencies such as as the CVC, CBI, CAG, or CIC and subsequent prosecution by the Courts. While there is anecdotal evidence of such fear of investigation and prosecution in individual restructuring deals, this could be applicable to resolution plans under the IBC also.

In the early years, recovery rates under IBC will be rather low

Before we get to the analysis of the amendment, we need to envision what is coming in the evolution of the bankruptcy process in India. We conjecture that in the early years, recovery rates will be poor, for four reasons:

  1. We must remember that the IBC is itself new. The institutional infrastructure for the IBC works poorly, as of yet. It will take time for IBC to work well (see Datta and Regy, 2017; Shah and Thomas, 2016).
  2. India is short of professional participants in the Insolvency Resolution Process of the IBC. E.g. as yet foreign capital has been largely blocked. There will be fewer participants and the highest bid will be a bargain.
  3. The IBC is best applied at an early stage in the difficulties of a company, but most existing NPAs have been ripening for many years. For those cases, there is really nothing to be done but to pick at the bones of the corpse.
  4. Inexperienced creditors' committees are likely to turn down offers that look bad, and later discover that the recoveries in liquidation are worse. It takes capability in a creditors' committee to vote correctly. Even when human skills are present, decisions may often be adversely affected by policy and regulatory constraints. It will take time for those policy and regulatory constraints to be addressed.

For these reasons, we believe that in the early years, the recovery rates will be poor. This is an important building block of the analysis ahead.

Question 1: Will this Ordinance help solve the problem of decision paralysis in banks?

When the banker has to trigger the IBC resolution process against a politically connected corporate defaulter, he is likely to face political pressure to not trigger the IBC. Even in the resolution process, the banker has to take decisions related to the restructuring of the company. The banker will sit in the creditors' committee and vote on critical issues such as how much haircut to accept and which proposed resolution plan to vote for. There could be allegations that the banker colluded with the promoter of the defaulting company for mala fide purposes such as helping the promoter buy off the company's assets at a cheaper price or approving large loan write-offs etc. More generally, there could be allegations of a corrupt nexus between banks, insolvency professionals, and bidders. Investigating agencies could get into the problem. The recent arrest of the ex-IDBI Bank CMD in connection with loans to Kingfisher Airlines has heightened the fear among bankers. Bankers have allegedly responded by refusing to take any decision on triggering the IBC or resolving the stressed assets problem.

Section 35AA of the amended BRA aspires to address the first problem. If an honest banker wants to initiate a resolution process against a corporate defaulter under IBC, but is under political pressure not to, he can turn to RBI. RBI can issue a direction to the relevant bank to trigger IBC. If RBI comes under political pressure, it can turn to the government which will authorise RBI to issue such directions. Will this work? It depends on the extent to which politically connected borrowers are able to influence RBI and the government.

Section 35AB of the amended BRA aspires to address the second element of the problem. If a banker wants to take tough decisions during the resolution process or choose a specific restructuring plan, but is afraid of the investigative agencies, then RBI can give regulatory cover to the banker by issuing specific directions under this section, requiring the banker to take the restructuring decision. The government does not have any role here. RBI on its own can issue directions to banks for resolution of stressed assets. Effectively, RBI's direction will give plausible deniability to the banker, using which he can subsequently justify his conduct and be free of the fear of investigation and prosecution.

Section 35AB is like a guarantee by one arm of the State to a firm that its commercial decisions will be protected from being questioned by another investigative arm of the State. Given the shortcomings on the rule of law in the working of the investigative agencies, it maybe relatively easier for them to go after the bankers but arguably much harder to do the same when RBI, a quasi-government body, is involved and hardest when it comes to government employees.

The protective guarantees by the State implicit in sections 35AA and 35AB should certainly provide some comfort to the bankers and help resolve the decision paralysis. However, this does not solve the underlying problems and raises some new questions: Should investigative agencies of the State be questioning the commercial decisions of banks? If investigative agencies can question commercial decisions of banks, why should they not be able to question the banking regulator if it is taking commercial decisions on behalf of the banks?

For good policy analysis, we should not just think through the optimisation of an honest banker. We should also think about what a corrupt banker will do. What will RBI do when confronted with a request from a banker? How will RBI staff determine that a request should be accepted or denied? What are the accountability mechanisms, and checks and balances, within RBI?

As argued above, in the early years of IBC, recovery rates are likely to be low. Newspaper stories will come out about sensational events where a Rs.1000 crore loan led to a recovery of Rs.100 crore. At that point, investigating agencies could come in, and the finger pointing could start.

We are reminded of the Lok Pal proposal. Advocates of the Lok Pal believe that all Indian government officials are to be mistrusted, but the Lok Pal is to be trusted. That is faith-based policy analysis. Successful policy reforms involve checks and balances, and not faith.

In short, we think more decisions about bad assets will be taken owing to the amendment, but there will be a new array of troublesome questions which will rapidly limit the extent to which it is effective.

Question 2: Will this Ordinance help solve the current NPA crisis?

Let us consider two possibilities:

  1. What happens if RBI directs banks under section 35AA to trigger IBC against the corporate defaulter?
  2. What happens if RBI not only directs the banks to trigger IBC but also passes directions under section 35AB to the banks on what specific resolution plan to approve as part of IBC or directs the banks to initiate any non-IBC restructuring mechanism?

In the first case, while triggering IBC may provide a resolution outcome faster than other restructuring mechanisms, the recoveries from such resolution are likely to result in large losses, particuliarly in the early years. Banks will then have to recognise large losses on their balance sheets, losses that have been hidden until then (see Sharma and Sengupta, 2016). The implicit equity capital crisis will morph into an explicit capital crisis. As yet, there is no sign of additional equity capital even if banks were to trigger IBC under directions from RBI.

In the second case, this Ordinance gives powers to RBI to issue directions, and even to overrule the commercial judgement of the bankers during any resolution process. Will this help? This seems unlikely. Maximising the recoveries from an NPA requires commercial decision making. Bureaucracies in banks have done this badly; it is unlikely that the bureaucracy in RBI will do better. Commercial decision making is best done in for-profit private sector environments.

What about non-IBC resolution mechanisms: Could RBI direct their use to do better than the IBC-based processes? An entire alphabet-soup of restructuring mechanisms initiated by the RBI over the last few years (CDR, 5/25, SDR, S4A) have failed (see here, here, and here). Why would we believe that RBI's directions to banks under the new section 35AB will now succeed? Over the last few years banks were able to hide the actual extent of the bad news using the cover of these mechanisms. Further use of these restructuring packages may prolong the crisis instead of solving it.

Question 3: Will this Ordinance help prevent NPAs in future?

Banking is a business and giving a loan to a borrower is a commercial decision. The corporate borrower maybe unable to repay the loan for any number of reasons. Lending decisions taken by an honest banker can also give rise to NPAs. The problem turns into a crisis when the NPAs are allowed to linger on for years and their volume become so large that banks' balance sheets become severely impaired. This eventually leads to a credit crunch in the economy and starts to affect investment and growth, as has been the case over the last few years in the Indian economy.

The job of a sound banking regulator is to prevent such possibilities through prevention (micro-prudential regulation) backed by cure (resolution). For years, RBI adopted a lax approach which helped banks hide bad news. Had RBI been more vigilant and taken appropriate actions early on, the ongoing NPA crisis could have been prevented from metastasizing. The amendment to BRA through this Ordinance further increases RBI's involvement in the commercial decisions taken by banks. However, the roots of the banking crisis lay in RBI's own internal functioning. This calls for improving the regulatory architecture, accountability mechanisms, and processes for executive/legislative/judicial functions. These are not seen in the Ordinance.

Conclusion

A financial regulator should be like a referee in a football match.

In a football match, typically a higher organisation (for example, IFAB) writes the rules of the game and the referee enforces the rules on the players while supervising their actions. The players are free to play the game on their own within the framework of the rules.

In the case of banking, Parliament writes the Banking Regulation Act, and RBI writes the subordinate legislation under this. After this, banks should be commercially motivated, and RBI should blow the whistle when the rules are being violated. In reality, however, the way RBI does banking regulation is akin to the referee telling the players how to give passes and when to strike the ball. This is an extraordinary power given to a banking regulator which is unique to India. Resolution of stressed assets is fundamentally a commercial decision, not a regulatory one. Is it really the RBI's job to direct the banks on how to restructure stressed assets? RBI's job is to insist that bad assets are recognised, provided for, and that banks have adequate equity capital.

Given that RBI is already empowered by the BRA to direct the banks, the Ordinance seems much ado about nothing. As we have argued, it gives rise to new troublesome questions and will do little to solve the crisis at hand.

The Indian banking crisis is a major challenge to our economic policy establishment. A full strategy for addressing the banking crisis is required. As yet, this is not visible.

References

Datta, Pratik and Regy, Prasanth, "Judicial Procedures will make or break the Insolvency and Bankruptcy Code", Ajay Shah's Blog, January 24, 2017.

Shah, Ajay and Thomas, Susan, "Indian bankruptcy reforms: Where we are and where we go next", Ajay Shah's Blog, May 18, 2016.

Sharma, Anjali and Sengupta, Rajeswari, "How will IBC 2016 deal with existing bank NPAs?" Ajay Shah's Blog, December 5, 2016.


Rajeswari Sengupta is a researcher at the Indira Gandhi Institute of Development Research and Pratik Datta is a researcher at the National Institute of Public Finance and Policy, New Delhi. The authors would like to thank Harsh Vardhan, Nelson Chaudhuri, Sumant Prashant and Shubho Roy for useful discussions

Friday, May 05, 2017

Grievance redress and enforcement problems in the Aadhaar legal framework

by Vrinda Bhandari and Renuka Sane.

Over the last few weeks, there has been a furore over the divulging of Aadhaar details, with the information of the pensioners in Jharkhand to that of a famous cricket player (M. S. Dhoni), being made available publicly. The UIDAI has responded swiftly by filing FIRs against 8 websites, and also shutting down several others to prevent the misuse of data. Other complaints about the Aadhaar have included instances of failure of biometric authentication, server and connectivity problems, cryptic error messages, and identity theft.

A recent paper by CIS reported that around 130-135 million Aadhaar numbers and 100 million bank account numbers were estimated to have leaked from four government portals. It is unclear whether these Aadhaar numbers had been inadvertently published by the government portals (without realising the consequences of their actions) or had been displayed as a measure of transparency. Either way, while Dhoni may be famous enough to reach out to the UIDAI, other ordinary citizens have not been so fortunate.

A key component of a system, especially one that interfaces with individuals, is its ability to provide protection to its intended users from being harassed, misled, or deceived. One way of ensuring this is to provide access to a reasonable mechanism of grievance redress, where citizens can complain and seek remedies. In this post, we focus on the lacunae in the grievance redress mechanisms and the enforcement concerns that arise in the context of Aadhaar. This is especially important, since, in the absence of an over-arching privacy or data protection law, an effective grievance redress mechanism, through the Aadhaar legal framework, remains the only remedy to Aadhaar holders.

Inadequate details about the procedure for grievance redress

When things go wrong, customers need to have access to a proper complaints mechanism. This can be a call center, a web portal, or physical offices. In the case of Aadhaar, such access is to be provided through the establishment of "contact centers" (Regulation 32 of the Aadhaar Enrolment and Update) Regulations).

The Regulations envisage that a contact centre shall provide a mechanism to log queries, ensure safety of the information received, and comply with the procedures and processes as may be specified by the Authority for this purpose. Residents are also permitted to raise grievances by visiting the UIDAI's regional offices, or through any other officers or channels as may be specified by the Authority for this purpose.

To the best of our knowledge, not much beyond Regulation 32 has yet been specified by the UIDAI. In a previous article, Is Aadhaar grounded in adequate law and regulations?, we criticised such delegation of power by the UIDAI to its future self. The same criticism applies equally in the case of grievance redress. If the process of grievance redress has not been specified in the Regulations, there remains an unjustifiable ambiguity on the remedial measures available to an Aadhaar number holder. This is worsened by the ambiguity on how the UIDAI will ensure safety of the information received.

The handling of grievance redress in the Aadhaar Regulations suffers from the following problems:

  1. The regulations leave the actual processes of redress, including the procedure for raising a grievance, the composition of the grievance redress/contact centre, and the timelines envisaged for resolving a query unspecified. They are silent on the identity/qualifications of the final decision maker, on whether the inquiry process will be administrative or quasi-judicial in nature, and whether an appellate remedy is provided for. The regulations are also silent on the binding nature of the resolution mechanism, and their relationship with the penalties and liabilities prescribed under the Act. In fact, even after reading the regulations, one is confused about whether the grievance redress mechanism is a simple contact centre or an actual authority, with some powers.

  2. Regulation 32(3) of the Enrolment and Update Regulations states that residents may raise grievances by visiting the regional offices of the UIDAI or through any other offices or channels as may be specified by the Authority. Notably, there are only 8 regional offices, namely Bangalore, Chandigarh, Delhi, Guwahati, Hyderabad, Lucknow, Mumbai, and Ranchi, which are primarily all Tier I cities. Further, these regional offices are not spread out throughout India - for instance, Western India only has one regional office in Mumbai, whereas North India has three offices in Delhi, Chandigarh, and Lucknow. The other channels remain unspecified.

  3. The efficacy and performance of these contact/call centres is hard to assess, since the regulations do not prescribe any minimum standards, or even a Code of Conduct (as in the case of Registrars, Enrolling Agencies, and other service providers) that would govern the behaviour of these centres. The Regulations are also silent on the performance standards of the grievance redress system as a whole, so that the UIDAI can be held accountable.

  4. In the case of the Aadhaar (Authentication) Regulations and the Aadhaar (Data Security) Regulations, no grievance redress mechanism has been specified, and no reference has been made to the grievance redress mechanism provided for in the Aadhaar (Enrolment and Update) and (Sharing of Information) Regulations. This suggests that there is in effect, no mechanism for redress in these two regulations at all.

These issues become particularly important when we consider that Regulation 30(2) of the Enrolment Regulations envisages the use of this grievance redress mechanism to resolve complaints relating to the omission or deactivation of an Aadhaar number. Between September 2010 and August 2016, the UIDAI had deactivated over 85.6 lakh Aadhaar numbers. The consequences of such deactivation can be huge, including the exclusion from receiving various government subsidies, and now potentially, for filing income tax returns. In this context, the silence on substantive matters of grievance redress in the regulations is disconcerting.

No power to file criminal complaints

While the Regulations provide for a contact center, Section 47 of the Aadhaar Act stipulates that only the UIDAI or its authorised officer can file a criminal complaint for violations of the Aadhaar Act. The Aadhaar Act, criminalises, among other things, the disclosure and dissemination of the identity information of an Aadhaar number holder (Section 37), unauthorised access to the Central Identities Data Repository (Section 38), and the unauthorised use of the identity information of an Aadhaar number holder by a requesting entity (Section 40). Consequently, the UIDAI has been given complete discretion in determining if, and when, to file a criminal complaint for violations of the Act, and an individual aggrieved by actions of a third person, is left to rely upon the bonafide actions of the UIDAI.

In the Dhoni case for example, the UIDAI seems to have decided to not file a criminal complaint against the enrollment agency, even though they reportedly tweeted a photo of his application form. In fact, RTI replies of the UIDAI reveal that in the six years from September 2010 to 31st October 2016, it received 1390 complaints about enrollment. However, only three FIRs were filed against the enrolling agencies, and that too, only by UIDAI's regional Bangalore office. The remaining complaints, were either 'resolved', 'dropped', or 'closed' without initiation of any criminal action. Conversely, the UIDAI's Delhi office was quick to register its first FIR in over six years, when a CNN-18 journalist ran a sting operation on security lapses in the Aadhaar enrollment centers.

Indian law, rarely, if ever, permits a third party to file a criminal complaint on behalf of an aggrieved individual, to the exclusion of that individual. Given that we have no access to any explanatory memorandum or notes on clauses, it is difficult to ascertain the reason for introducing such a provision in the Act. Not only does the Aadhaar Act introduce a new framework, it does so without specifying any accountability mechanism between the UIDAI and the aggrieved Aadhaar number holder. The scheme of the Aadhaar Act does not envisage any remedy for an aggrieved Aadhaar number holder if the UIDAI decides that her complaint is not worth pursuing. The UIDAI, thus, has unchecked discretion. It is worth noting that even the CrPC provides judicial recourse to an individual if the police fails to register an FIR.

Low clarity and emphasis on enforcement

Regulations have force, only when enforcement mechanisms leave no ambiguity about the costs of violation. The Aadhaar Regulations are largely silent on enforcement. In fact, as stated above, even the enforceability of any decision of a "contact centre", as part of the Grievance Redress Mechanism, is suspect. This is a result of the lack of power to enforce penalties in the Aadhaar Act itself.

The Regulations suggest, for example, that enrollment activities are to be monitored by the UIDAI, and any violations may result in immediate suspension and eventual cancellation of the service providers' or the concerned persons' credentials and permissions under the Act. However, apart from this penalty, there is no other prescribed liability - in terms of a monetary fine or imprisonment - as the case may warrant, for failure to comply with the code of conduct or any of the other Regulations. Even the application of this penalty is unclear, and left to the complete discretion of the UIDAI, inasmuch as Regulation 26(3) of the Enrolment Regulations only states that such cancellation will take place after 'holding due inquiry as deemed fit by the Authority'.

Similarly, Regulation 25 of the Authentication Regulation only provides that a requesting entity or authentication service agency may be burdened with 'disincentives' by the UIDAI, including suspension of their activities, in case of any contravention of the Act or the regulations. The regulations do not provide for gradation of offences and consequent punishments in terms of monetary penalties to imprisonment depending on the offence. It is also unclear whether, and which, provisions of the Act will apply.

There exists a Code of Conduct (specified in Schedule V of the Enrolment Regulations) which requires service providers to make 'best efforts' to protect the interests of the residents (Rule 1); to not divulge any confidential information about the residents, except when required by law (Rule 5); to ensure 'timely' redress of grievances (Rule 7); to abide by the Act and the regulations there-under (Rule 9); to inform the Aadhaar number holder in case of any breach or non-compliance (Rule 11); and to follow confidentiality, privacy, and security protocols 'as may be specified by the authority' (Rule 23). However, it is completely silent on the consequences of non-compliance. Thus, without proportionate penalties and clear procedures for imposing liabilities, the incentives to comply with the provisions of the Act and the regulations fall.

Inadequate power to conduct grievance redress

Finally, there is even some doubt on the UIDAI's power to regulate issues of grievance redress itself. Section 23(2)(s) of the Aadhaar Act empowers the UIDAI to set up "facilitation centers and grievance redress mechanism for redressal of grievances of individuals, Registrars, enrolling agencies and other service providers". However, Section 54 of the Act, which enumerates the UIDAI's power to make regulations does not refer to this sub-section, despite referring to other sub-sections of Section 23. This assumes importance because all the Aadhaar Regulations derive their power from Section 54. The source of the UIDAI's power to write regulations on grievance redress is thus, unclear.

Way forward

In this new world, where Aadhaar is the centerpiece of the government's agenda and is becoming a necessity to avail multiple government services and benefits, an effective accountability and enforcement mechanism is paramount. Unfortunately, the Aadhaar Act and the Regulations are inadequate and vague.

Enrollment and use is not accompanied by any adequate redress mechanism, leaving us with the problem of a legal vacuum. Seven years, and a law later, there is still no clarity on the accountability and redress frameworks in the Aadhaar Act. A large part of the problem comes from the structure and governance mechanisms of the UIDAI itself, with no separation between the regulatory functions at UIDAI and its operational functions.

These issues are ultimately derived from the poor intellectual capacity in the drafting of law in India. There is an urgent need to introduce amendments in the Aadhaar Act to address these problems. A new data protection framework is reportedly being drafted. Many elements of our research program on Aadhaar have important implications for both these strands of work.

 

Vrinda Bhandari is a practicing advocate in Delhi. Renuka Sane is a researcher at the National Institute of Public Finance and Policy, New Delhi.

Wednesday, May 03, 2017

Interesting readings

Two subprime shocks betray India's micro-lenders by Andy Mukherjee in Mint, May 3, 2017.

Meet the co-creator of Julia programming language, Viral Shah by Alok Soni in Your Story, May 2, 2017.

Why FRBM failed by Ajay Shah in Business Standard, May 1, 2017.

Frank and Steven's Excellent Corporate-Raiding Adventure by Frank Partnoy and Steven Davidoff Solomon in The Atlantic, May, 2017.

Regulatory framework for IFSC in India: The experience of GIFT IFSC by Dipesh Shah on the NIPFP YouTube Channel, April 28, 2017.

The AI Cargo Cult - The Myth of a Superhuman AI by Kevin Kelly in Backchannel, April 25, 2017.

"Mindless Eating", or how to send an entire life of research into question by Cathleen O' Grady in Arstechnica, April 24, 2017.

Mind Your Language, Judge Sahab, a Badly Written Judgment Can Now Be Overturned in The Wire, April 21, 2017.

Why the Menace of Mosquitoes Will Only Get Worse by Maryn Mckenna in The New York Times , April 20, 2017.

The Benefits of Solitude by Michael Harris in The Walrus, April 19, 2017.

The assault on dairy: Why an effective ban on cow slaughter may soon banish the cow itself by Kirit S Parikh in The Times of India, April 10, 2017.

Crimintern: How the Kremlin Uses Russia's Criminal Networks in Europe by Mark Galeotti in European Council on Foreign Relations, April 2017.

Almost all the world's fastest supercomputers run Linux by Steven J. Vaughan-Nichols in Zdnet, November 14, 2016.

Why are so many houses vacant?

by Sahil Gandhi and Meenaz Munshi.

Urban India has a severe shortage of housing, yet Indian cities have many vacant houses. According to the census of India 2011, out of the 90 million residential census units, 11 million units are vacant; that is about 12% of the total urban housing stock consists of vacant houses. To put these numbers in perspective, consider the houses constructed by the central government under its three largest programmes related to urban housing: Jawahar Lal Nehru National Urban Renewal Mission (JNNURM) (2005-Extended till March 2017), Rajiv Awas Yojana (2011-2015) and Pradhan Mantri Awas Yojana (urban), altogether only provided 1.1 million units. The total vacant housing stock may not exactly match - in terms of quantity and type - the requirements of the households crowded out of the housing market. But this paradox of vacant houses and a shortage of housing, is a symptom of the distortions in the functioning of land and housing markets.

To put the gravity of the vacant housing situation in perspective, let us compare the situation in Indian cities with a few international cases. Gurgaon and Pune have more than 20% and Mumbai has around 15% of their residential stock vacant (see IDFC Institute forthcoming). Internationally, such levels of vacant housing would trigger aggressive public policy interventions. For example, when vacant stock in Paris reached around 7.5% of the residential stock (see Better Dwelling 2017, Planetizen 2017 , Telegraph 2017), the city council proposed to increase council tax rates from 20% to 60% on rentable values on vacant properties. In Vancouver when vacancy rates reached 6.5% of the total housing stock it introduced a vacant house tax (The Globe and Mail 2017).

The housing shortage would be much less severe if the existing housing stock could be used more efficiently. Robert Buckley, former managing director of Rockefeller foundation, asks a similar question in his co-authored piece, "How can the existing urban capital stock help address housing affordability?" (Buckley et al 2016, p. 127). Bringing say 15% of the total (both private and central government funded units) vacant housing stock into the market, could in effect do much more for affordable housing than what PMAY(urban) will be able to provide in the future. Any policy proposals for enabling efficient use of vacant housing stock must be preceded by an understanding of the causes of vacant housing. We look into a few possible causes in a forthcoming IDFC Institute report on making housing affordable by addressing supply side constraints in housing markets. This piece draws from our work for the report.

Vacant housing in Indian states

The census of India 2011 provides numbers on vacant houses in urban India. In the instruction manual for the Census House listing, the instructions for categorising vacant housing are, If a Census house is found vacant at the time of House listing i.e. no person is living in it and it is not being used for any other non-residential purpose(s) write 'Vacant'. Since it is very unlikely that slums will have vacant houses, we can assume that all vacant houses are in the formal sector.

Figure 1 shows the number and share of vacant census houses in urban parts of major states. These 18 states (shown in the figure) together constitute around 95% of the total 11 million vacant houses in urban India. Maharashtra has the highest number of vacant houses (slightly greater than 2 million) followed by Gujarat (around 1.2 million) while Gujarat has the highest share of vacant houses to the total residental stock (around 19%).

Figure 1. Vacant Houses in major States (Urban)

These vacant houses are both government provided and privately owned and have different reasons for being unutilised.

Centrally sponsored housing

Since the launch of JNNURM in 2005, the central government has endeavoured to address the issues of urban housing in India. Under the Basic Services for Urban Poor and Integrated Housing and Slum Development Programme components of the mission and later, with the introduction of Rajiv Awas Yojana (RAY), the government attempted to create housing stock for the urban poor. The UPA government by launching the Pradhan Mantri Awas Yojana (Urban) showed continued commitment to housing for poor in urban areas. However, the success of these schemes can be deemed to be limited if we consider the quantity of houses constructed and the number of those that remain vacant.

In response to questions raised in Parliament in May 2016 and March 2017, the Ministry of Housing and Urban Poverty Alleviation furnished information about the number of houses constructed under the various Centrally Sponsored Schemes that were lying vacant. In 2016, around 23% of total houses constructed were vacant while in 2017, the share of total constructed houses that were vacant was around 17%. It is important to note here that out of the 11 million units vacant in 2011 we do not know the exact number of units built under centrally sponsored schemes. JNNURM was the only urban housing related scheme functioning in 2011. In 2016, 2,24,000 JNNURM sponsored dwelling units were vacant. Assuming the same number of vacant units in 2011 - and this assumption likely overestimates the number - the central sponsored housing formed only around 2% of total vacant housing stock.

Table 1. Status of centrally sponsored housing under JNNURM, RAY and PMAY(U) in urban India
As of May 2016 As of March 2017

Occupied 793,995 964,577
Vacant 238,448 200,677
Total constructed 1,032,443 1,165,254
% vacant 23.1 17.22
Source: Lok Sabha Starred Question No. 256 Answered On May 11, 2016; Rajya Sabha Unstarred Question No. 991 Answered On March 09, 2017

The May 2016 response by the Ministry also provides information on the state-wise break down of vacant houses constructed under the three schemes.

Table 2. State-wise status of Centrally Sponsored Housing
Name Constructed Vacant % Vacant of constructed in state % Vacant in state of India

Maharashtra 128,386 54,282 42.3 22.8
Delhi UT 27,344 26,228 95.9 11.0
Andhra Pradesh 64,942 24,611 37.9 10.3
Gujarat 123,232 23,124 18.8 9.7
Telangana 73,795 17,982 24.4 7.5
Uttar Pradesh 66,169 15,972 24.1 6.7
Madhya Pradesh 34,540 15,737 45.6 6.6
Tamil Nadu 115,713 12,745 11 5.3
Rajasthan 39,924 11,084 27.8 4.6
Chhattisgarh 21,788 10,373 47.6 4.4
Karnataka 48,877 9,431 19.3 4.0
Other States 287,733 16,879 5.9 7.1
Total 1,032,443 238,448 23 100

As one can see in table 2, 10 states and Delhi contribute around 93% of total vacant houses. Maharashtra has the largest number of vacant houses, which forms around 42% of total houses constructed under the three central schemes in the state.

Some rationale for this vacant housing that is meant for the urban poor has been put forth in the policy discourse. Rohini Pande (2017) argues that one of the reasons for high vacancy rates of government built housing is that the poor reject the new housing because of absence of social networks in this type of housing.

On at least two separate occasions (11 May 2016 and 6 April 2017) in the Lok Sabha the Minister and Minister of State of Housing and Urban Poverty Alleviation (Venkaiah Naidu in 2016 and Rao Inderjit Singh in 2017) when asked on the reason behind the vacancy of units have said the exact same thing:

Construction and allotment of houses under these schemes is the responsibility of the State/UT Governments concerned. Due to reluctance of slum dwellers / beneficiaries to shift in cases of relocation projects, lack of / incomplete basic infrastructure and livelihood sources etc., these vacant houses are yet to be allotted by the concerned States/UTs

One crucial takeaway is the importance of location in informing housing decisions. Unless government schemes target creation of houses in sites close to labour markets or areas with access to public transport, public housing schemes will fail in their objective.

Vacant Private Housing: Returns and Risks of Renting

Rental housing can be a significant proportion of housing supply. Rental yields (rent as a share of property price) are the returns a property owner can get on her investment and hence play an important part in deciding the economic viability of investing in rental housing. Rental yields in India are typically very low. For comparing rental yields in Indian cities we make use of user contributed self-reported data available on Numbeo. Figure 2. shows that rental yields, defined as “the total yearly gross rent divided by the house price (expressed in percentages)” for representative Indian cities do not exceed 5% and mostly range between 2 to 4%. Much of the investments in housing stock are done not to earn rental incomes but to gain from capital appreciation or to hide unaccounted money.

Figure 2. Rental yields in Indian cities 2017

Source: Numbeo (as seen on 27 Feb 2017).

For comparing yields in Indian cities with other cities around the world, Figure 2 shows the relationship between rental yields and price to income ratio for cities. The figure allows us to compare rental yields for cities with similar levels of affordability defined as the ratio of income to price. Note that Indian cities have lower rental yields when compared to other cities with similar price to income ratios (See figure 3). Interestingly, all Indian cities (marked in red) in the graph can be seen forming the lower bound.

Figure 3. Relationship of rental yields and price to income ratio (2017)

Note: Indian cities (#16) shown in red, other cities in the world are in blue, a few other international cities are identified in yellow. Data source: Numbeo

The returns from renting out an apartment are low in Indian cities when compared to other cities and other prevailing market investments and they certainly do not reflect the risks involved. Renting out a property is a risky affair in India due to perceived (often, correctly) difficulties of evicting tenants, particularly under the onerous regulatory framework of the various rent control laws that are still applicable across states in India.

Since housing is a subject on the state list, different states have different rent control laws. These laws fix rent for properties at much below the prevailing market rates and make eviction of tenants difficult. As a result, they increase perception of risk and distort incentives for renting. To get around this, leave and licence agreements are being used as an alternate legal mechanism to rent properties. Despite this, the legacy of rent control and policy uncertainty creates reluctance to rent. To provide an example of policy uncertainty, in 1973 the Maharashtra government brought the then existing leave and licensees contracts under rent control (Gandhi et al 2014). Instances like this have had an adverse impact on the confidence of investors and landlords. Further, rent control laws have proved to be very tenacious and difficult to rollback. In 2016, the Maharashtra government tried to amend the Rent Control Act such that residential properties above 847 square feet would no longer be protected under rent control (Tandel 2016). This would have allowed landlords of these properties to increase rents to market rates. However, coming under pressure from the tenants’ associations the government did not amend the law.

The problem is further exacerbated by the slow pace with which disputes are redressed by the judicial system. An account of a High Court case between a tenant and a landlord in Mumbai in Tabarrok (2017) attests to this. The pendency of cases and increase in litigation, even prompted the Supreme court to frame guidelines regarding tenancy agreements (Mohammad Ahmad & Anr v. Atma Ram Chauhan S.L.P. (C) No.6319 of 2007), so as to reduce the number of cases filed by landlords for recovery of rent. It is important to note here that these guidelines are non-binding, and may not lead to any significant change in the situation of the vacant housing stock.

Conclusion

Over the years, rental housing as proportion of total housing has fallen from 54% in 1961 to 28% in 2011 in Urban India (Gandhi et al. 2014). Without a vibrant rental housing market labour markets cannot function efficiently (see Shah 2013). Bringing the private vacant housing stock into the rental market and understanding and resolving the reasons for vacancy in the government provided stock could significantly improve efficiency in utilising available stock of housing. We have the following recommendations and scope for research:

  • Central schemes or missions have provided flexibility to states in order to meet the objective of providing housing for all. However, there is a need to monitor their quality in terms of services provided, accessibility, and links of the dwelling units to the broader labour markets in the urban region. Without these aspects, the units will be rejected by low-income households. There is a need to study state-wise reasons for government sponsored vacant housing. The reasons may differ across states and may require a state specific interventions.

  • More research is required on the reasons behind low rental yields in Indian cities and the possible role of rent control laws.

  • Special fast track courts in states could be set up to handle eviction disputes and guarantee efficient, time bound and predictable settlement of rental disputes.

References

Better Dwelling (2017). Vacant homes are a global epidemic, and Paris is fighting it with a 60% tax. 2nd March.

Buckley, R. M., Kallergis, A., & Wainer, L. (2016). Addressing the housing challenge: avoiding the Ozymandias syndrome. Environment and Urbanization, 28(1), 119-138.

Gandhi, S., Tandel, V., Patel, S., Pethe, A., Agarwal, K., & Libeiro, S. J. (2014). . Marron Institute of Urban Managient Working Paper, 10, New York University.

IDFC Institute (forthcoming). Losing the plot: the supply-side roadblocks for achieving housing for all in urban India.

Pande, R. (2017). Constructing housing for the poor without destroying their communities, Ideas for India, 24th March.

Planetizen (2017). Paris Targets Vacant Second Homes With 60% Tax, 31st March.

Shah, A. (2013). Should policy makers favour home ownership?. Ajay Shah's blog, 3rd June.

Tabarrok, A (2017). A twisted tale of rent control in the maximum city. Marginal Revolution blog, April 2017.

Tandel, V (2016). Why repealing the Maharashtra Rent Control Act is good politics, Firstpost, 13th June.

Telegraph (2017). Britons with property in Paris to be hit with new tax hike. 27th January.

The Globe and Mail (2017). Ontario’s rent and housing reform: 16 big changes, explained in charts. 22nd April.


Sahil Gandhi, is assistant professor, School of Habitat Studies, Tata Institute of Social Sciences, Mumbai and Meenaz Munshi is Senior Associate, IDFC Institute, Mumbai. The authors would like to thank Ajay Shah, Alex Tabarrok, Vaidehi Tandel, and four anonymous referees for their comments and suggestions.