Don’t Shackle the New Economy with the Restrictions of the Old: Vivan Sharan in The Wire, 11 July 2016

http://thewire.in/50544/old-vs-new-challenges-of-a-changing-economy/

There is a perpetual tussle between the old and the new. Perhaps nothing exemplifies this better than the tensions between the old economy and the new economy. A large share of the billions of dollars of foreign investments into India are now linked to the new economy. The new economy in turn is one that benefits from the freer movement of capital that has been enabled through a gradual opening up of our domestic market. And this capital is ruthless. It is attracted by productivity and efficiency, and not the populist impulses of our political class. Conversely, the old economy does seem to care about social equity – insofar as at least giving back through entrenched political patronage. A number of fallacies persist in the manner in which the old is pitted against the new –  and recent debates on Uber versus traditional taxi operators illustrate this.

Perhaps the biggest fallacy is that there are no common traits between old and new economy businesses. Of course, both aim to maximise profit, albeit through different means. Old economy businesses rely on high barriers to entry, which in the case of traditional taxi services are achieved through manipulation of the political economy. Anyone attempting to use community parking spots in Delhi for instance, would quickly realise that taxi stand operators have managed to appropriate space in a number of them, by paying ‘rent’ to the local officials. No doubt the cost of this rent is lower than that which would have to be paid if this were a formal levy.

On the other hand, new economy businesses such as Uber, rely on the sheer efficiency of technology to minimise costs. A nifty mobile application matches demand and supply in the taxi market, through an interactive experience that both the driver and the rider can use. There should be no mistaking the fact that the objective of any technology that is applied commercially is to create a monopoly of some form. And this is enabled through intellectual property laws that are widely recognised as essential for innovation, with some governments also complicit in perpetuating this virtuous cycle. Indeed, old and new economy businesses have different ways to achieve the same objective of achieving some form of monopoly in a product or a service value chain. And it remains incumbent on the government to regulate monopoly formation through appropriate regulatory mechanisms – whether for the old or for the new.

Another fallacy worth pointing out is that foreign capital is very different from domestic capital in its ruthlessness. The first quarter of the 2016-17 fiscal year has already witnessed the highest capital raise through initial public offerings (IPOs) in India in nine years. While the sum is a relatively paltry Rs. 5,855 crores (less than a billion dollars), capital allocation patterns are illustrative of this fallacy. Three out the six of the companies that participated in these IPOs were previously funded through private equity or venture capital investments, which are in turn intrinsically linked to capital availability in the global markets. Distinguishing between foreign and domestic capital, at some level or the other, is a fool’s game.  If India has chosen not to remain isolated from global markets, it is incumbent upon policymakers to make capital available for domestic enterprise to flourish.

So how can policymakers resolve this regulatory debate? One would imagine that a first step would be to reduce entry barriers, including licenses wherever possible, in order to foster competition. This should include doing what it takes to increase access to capital as well as removal of arbitrary pre-conditions at every step. Instead, state governments are busy figuring out how entry barriers to technologically-enabled businesses can be made higher. Karnataka for instance, has issued “On-demand Transportation Technology Aggregators Rules, 2016”; wherein one of pre-conditions is that licensees should have a minimum of 100 taxis in their fleet. This is perhaps not the best way to ‘Start-Up India’.

An alternative could be to first revisit and reconcile existing regulations and to focus on institutional capacity building within government while finding ways to enforce transparency. It is neither the moral responsibility of the private sector to think beyond its stakeholders, nor is it the task of governments to save the old economy from disruptions. It is however necessary for technology-driven businesses to be transparent given their inherent complexities; and in turn for governments to manage inevitable transitions from old to new by through some useful form of ‘co-regulation’ that empowers consumers.  

The ability of government or for that matter, the judiciary, to regulate dynamic sectors is limited – most recently evidenced in the call-drop case wherein the judgement states that telecom operators should not be penalised for bad quality of service since the faults cannot be “traceable exclusively” to them. Consumer experiences can easily prove otherwise and therefore should be used as a metric within the regulatory paradigm.

The author is a partner at Koan Advisory Group.

Submission to the Telecom Regulatory Authority of India (TRAI) on the consultation on Free Data

Please click on the link below to be taken to the TRAI website where the file is accessible:

http://trai.gov.in/Comments_FreeData/Companies_n_Organizations/KOAN.pdf

Please write to us in case you cannot access the file. 

The Tricky Challenges of Regulating Service-in-India: Op-ed in The Wire by Vivan Sharan, 27 May

http://thewire.in/39061/the-tricky-challenges-of-regulating-service-in-india

It has been two years since the last general elections and currently a range of assessments of the Modi government’s performance are dominating headlines. Despite the recent debate between the finance minister and the central bank governor on whether or not India is a “one-eyed king in the land of the blind’’, it is clear that for foreign investors, the country’s growth is exceptional. Evidence for this is in the equity inflows over 2015-16, which touched around $41 billion, up from around $32 billion in 2014-15.  

While the final data is awaited, a large share of equity inflows were targeted at service industries. Therefore, FDI growth is not yet a cause for ‘Make-in-India’ triumphalism. Rather, trends indicate that ‘Service-in-India’ is where investor interest really lies. And within the services sector, e-commerce and other over-the-top (OTT) services have attracted among the largest shares of inbound capital. This poses challenges for Mr. Modi’s policy makers at multiple levels particularly since technologies are not static, unlike the policies that circumscribe them. Moreover, disruptive innovation is a concept that is still far from understood by government.

The Department of Industrial Policy and Promotion’s (DIPP) recent guidelines for FDI in e-commerce are a case in point. The policy finally recognises multi-crore investments by e-commerce companies in the “marketplace” model as legitimate; by allowing FDI in “business to business e-commerce”. Buyers and sellers transact on e-commerce marketplaces directly, facilitated by technology platforms that underpin them. Such clarity on whether FDI is allowed should ordinarily be cause for celebration. However, problems remain.

The DIPP’s policy pronouncement came with strings attached – marketplace companies cannot “directly” or “indirectly” affect the price of products sold through their proprietary platforms. The net result will be that only companies that are backed by investors with deep pockets will be able to survive. Litigation will inevitably ensure, on subjective interpretations of “directly” and “indirectly” and courts will be relied upon to define economic policy.  This is something that the finance minister has spoken out against in his recent comments on taxation policies and the active role of the judiciary, and yet there is dissonance within government.

One of the main reasons why brick and mortar retail purportedly cannot compete with e-commerce is the heavy product discounting on internet marketplaces. This is linked to economic logic – if a seller does not need to keep a large inventory as is the case in a dynamic marketplace, lower business costs allow the margins for discounting. These discounts also derive from large marketing budgets of e-commerce incumbents with foreign investors. Consequently, sellers do not have to spend a dime on the most critical function of frontend retail. So what happens to the small retailer?

Whatever happens should in no case be decided through courts or committees of government. It should be decided through fair competition and transparency in the business ecosystem. Both the small and large players in retail should do their part to allow for this. Large businesses must utilise their technological prowess to create channels of reporting and feedback, that can lead to a clearer understanding of transactions, taxation and all other grey areas as government sees them. The reluctance on part of big businesses to share data is an untenable 20th century legacy.  And small businesses should simply evolve by adopting technology wherever possible. Nothing stops small retailers from selling on internet platforms; either their own or those offered by incumbent e-commerce companies that have managed to integrate thousands of small sellers already.    

A favourite quote of many “India watchers” is that whatever you can think of the country, the opposite also holds true. This also seems to be the case in India’s business ecosystem, technology centric services included. For instance, large telecom service providers (TSPs) have been lobbying for differential pricing of “Over the Top” (OTT) services on the internet. That is, they have been demanding government intervention in pricing of internet services, based on usage of different consumer applications. To be clear, this is a case of the private sector asking policymakers to regulate the best level playing field for businesses that exists today; the internet.

Conversely of course, technology entrepreneurs contend that differential pricing should not be allowed as it will kill competition and a free internet. As a result of this debate, the Telecom Regulatory Authority of India (TRAI) has been busy taking wildly differing positions over the issue. A year ago, TRAI was accused of favouring TSPs, whereas today, it seems to have taken a more considered stance in favour of keeping the internet unfettered.  At the core of the TSPs’ demands are an inherent inability to provide OTT services that can compete with rapid innovation. For instance, TSPs fear revenue losses owing to voice over internet protocol based international calling.

The question to ponder over is: whether a sustainable solution to competitiveness concerns such as those raised by small retailers or large TSPs, is more regulation? What are the origins of some of the largest internet based service companies in the world? The answer to the latter is that many of them were not necessarily Internet-focussed from the start, but adapted to changing realities.  

Disruptive innovations enhance competitiveness in a way that protectionism in any form cannot.  In India, a predominantly young country reliant on the service sector, the inexorable role of technology in business and job creation, should not be undermined by myopic regulation. Technology in turn can help leapfrog some of the seemingly intractable challenges the country faces today including in education and healthcare delivery. India’s growth may be unique, but the Modi government should recognise that so are its stark socio-economic circumstances that must be overcome.

In the case of the internet, the role of government should be limited to provision of secure and resilient digital infrastructure for universal access (whatever happened to ‘BharatNet’?); as well as to demand from businesses, as much transparency as technology allows.

*Vivan Sharan is a Partner at Koan Advisory Group.

Koan Advisory supported FICCI and UNEP report released on 29 April by RBI Deputy Governor

Koan Advisory has supported the United Nations Environment Programme led "inquiry on the design of a sustainable financial system" in India.

The RBI deputy governor Mr. R. Gandhi released the final report in Mumbai on 29 April 2016 in the presence of the financial community.

The final report can be accessed here: http://unepinquiry.org/wp-content/uploads/2016/04/Delivering_a_Sustainable_Financial_System_in_India.pdf

Inauguration of Nepal's Public Diplomacy Programme in New Delhi, organised by Koan Advisory, 13 April

Koan Advisory organised the inaugural session of the Government of Nepal's new "Public Diplomacy Programme" with support from IDSA and the BP Koirala Foundation on 13 April. The conversations were candid and substantive. 

There Has Never Been a Better Time to Reach Out to China, Article by Vivan Sharan in The Wire, 3 April

http://thewire.in/2016/04/03/there-has-never-been-a-better-time-to-reach-out-to-china-27238/

The Indian economy is facing some serious challenges on the external front. It relies heavily on ‘external demand’, evidenced by the fact that slowing global economic growth has resulted in fifteen consecutive months of export contraction in the country. This is despite the fact that India’s trade with emerging and developing countries has been growing faster than its trade with developed economies. The IMF estimates that the aggregate growth in emerging and developing economies would work out to around four per cent in 2015, the lowest since the financial crisis.

There is growing suspicion among analysts that this subdued growth, along with the slowdown in the commodities cycle, represents a ‘new normal’. In such circumstances, it can be argued that there has never been a better time for India to reach out to China. There are at least three arguments to support this premise.

First, Chinese growth is expected to slow to around 6.3% in 2016 and 6.0% in 2017 (IMF). This in turn has two critical implications: the slowdown in China’s trade and investments will continue to be a significant drag on the global economy and commodity prices, and Chinese businesses and policymakers will be forced to look for unconventional solutions to their economic woes. A few years ago, when Chinese policymakers first realized that this slowdown was on the cards, their economic strategy began to evolve rapidly. From a strong focus on the external economy, Chinese policymakers began to focus on the ‘domestic demand’ narrative. However, this has not quite managed to pull the country out of the docks. Excess production capacity remains a challenge for almost all manufacturing industries in the country.

Meanwhile, the Indian consumption demand is perhaps the only story worth telling in the context of its faltering economy. Industrial growth is nothing to write home about, and the pace of real GDP growth is a source of worry to many who observe the economy closely. Of course the fact that consumption is growing from a low base helps. It is no surprise then that India remains a hotspot for venture capital and private equity deals in consumer driven businesses ranging from ecommerce to transport solutions. And this growing consumer demands presents a ready market for China. This is a bargaining chip for India with no parallel. It is time for Indian policymakers and businesses to also think out of the box and strike lucrative deals with China.

Second, the corruption crackdown led by Xi Jinping is unprecedented in its scale and impact. With hundreds of thousands of officials under investigation, the businesses running through their patronage are also under the scanner. Consequently, many Chinese elite are busy liquidating assets, from private jets to factories and buildings. The corruption crackdown will not last forever. Xi Jinping has used this as an opportunity to control opposition within the Communist Party, and not necessarily to revisit structural flaws in the functioning of the state. However, while it lasts, there are opportunities aplenty for Indian businesses to acquire Chinese assets across the world. The key would be to assess the value proposition correctly.

Third, the downward spiral of the commodity cycle has led to a sharp reduction in investments in the extractives sector in China. The spillover effect of this is being felt by many of the state owned enterprises (SOEs) that are focused on resource extraction. A key incentive for large investments by Chinese SOEs in geographies such as Africa has been the large natural resources that can be secured for the State. Now that the value of natural resources is being rebalanced through a ‘new’ cycle of demand and supply, many SOEs will have to look to diversify their business interests abroad. Moreover, many such SOEs are saddled with large cash reserves that will depreciate over time.

This need to diversify can be leveraged by Indian industry, particularly the infrastructure sector. Infrastructure companies in India are over-leveraged and have been the primary contributors to the non-performing assets (NPAs) in the banking sector. Stressed assets on banks’ books are estimated at Rs. 4,00,000 crore. Which in turn has resulted in a liquidity crisis in the infrastructure sector. The large NPAs owe their origins to pervasive crony capitalism and poorly managed companies that grew rapidly in the years following the liberalization of the Indian economy. Given this liquidity constraint in the Indian banking industry, the timing is optimal for select well-managed Indian firms to raise funds from Chinese SOEs, and solicit their participation in building critical infrastructure assets.

It goes without saying that some of what has been suggested here comes with its own set of challenges, philosophical and real. The philosophical challenges relate to how the Indian state views its relationship with China. This is bound to change over time. Those who have grown up and earned their stripes in the post-liberalization era would not tend to think of China as the ‘enemy’, or the national border issues as something that should impact business ties. However the point is that India has often missed the bus in terms of timing its economic moves in the past. It cannot afford to overlook an enhanced commercial engagement with China, even as it courts the United States, Japan, South Korea and other partners from beyond its neighbourhood.  

The real challenges relate to the trust deficit that businesses from both countries need to work on. Chinese businesses do not trust Indian conditions – while they are happy to pay fixed sums of money  ‘to get things done’, the fact that nothing seems to be time bound in India is deeply concerning to the Chinese businessman. Conversely, Chinese service standards are infamous in India. Anecdotes of Chinese equipment failure, operational opacity and the lack of a service ethic are fairly commonplace. The way around these issues is to ‘partner’ in every sense of the word. The two countries must begin to do business on equal terms, with equal stakes and with a clear sense of their shared future. And there are enough mid-sized, professionally-run companies that can benefit from this relationship on both sides, as long as their governments let them.

Vivan Sharan is Partner at Koan Advisory Group

Three Structural Challenges that the Budget Hopes to Overcome: Article by Vivan Sharan in The Wire, 29 March

http://thewire.in/2016/02/29/the-three-structural-challenges-that-the-budget-hopes-to-overcome-23137/

It is a strange time for the observers of the Indian economy. Some commentators seem to place a great deal of hope in the future while others are worried that the headwinds of the global economy will inevitably overwhelm us. This is a rather stark conceptual binary. Clear answers are further obfuscated by three structural challenges that are highlighted here along with the salient features of the Union Budget announced today.

It worth pointing out that the finance minister (FM) himself did not succumb to the aforementioned binary. He began his speech by lauding India’s resilience to a weak global economy and simultaneously cautioned against a continuing unfavourable external environment. This was a good hedge as the FM would be acutely aware that the even though India’s growth rate at constant prices is projected to increase to 7.6 per cent in 2015-16, real GDP growth is beginning to converge with nominal GDP growth. This is largely owing to the fact that wholesale price inflation (WPI), the index for producer’s prices, has collapsed to negative territory. Banks are still lending at over 10 per cent despite this. Moreover the convergence of the two GDPs means that the government’s balance sheet liabilities cannot be financed by assumptions of an expanding base.

In the face of new liabilities accruing from one rank one pension (OROP) and the seventh pay commission recommendations, sticking to the deficit target of 3.5 per cent in 2016-17 will prove difficult, especially given that public spending seems to be a primary driver of growth today. This is the first structural challenge. The FM was candid about the fact that some experts wanted him to expand spending to resuscitate the investment cycle and others wanted him to continue to be fiscally prudent. He decided in favour of the latter, which is perhaps the wiser option given that governments are bad resource allocators in general, and concomitantly the quality of spending should be the primary focus rather than quantity.

Second, another vexing challenge relates to the pace and pattern of manufacturing sector growth in the country. The ‘Make in India’ initiative is expected to generate growth and jobs. And the industrial production (IIP) shows that production in the sector grew by a healthy 3.1 per cent during April-December 2015, as compared to 1.8 per cent in the corresponding period in 2014. However, growth in credit to the sector was a subdued 2.5 per cent in in the same period as compared 13.2 per cent in the corresponding period in 2014. This does not bode well for the investment cycle.

Holes in the strategy

And, despite the ‘fiery’ Make in India thrust, the service sector contribution to growth continues to prove that there is something amiss in this strategy. The service sector’s share in the economy has increased by four percentage points from 49 to 53 per cent in 2015-16 and it contributed to about 69 per cent of the total economic growth between 2011-12 and 2015-16. Moreover nearly half of the tax revenues of the country come from corporate tax and service tax receipts. Yet, the FM has decided to add another cess (Krishi Kalyan Cess of 0.5 per cent) to the service tax starting June 2016, and to reduce the corporate tax by only one per cent only for small companies with turnover less than INR five crores and 25 per cent for new manufacturing companies. The embedded logic seems to be that service sector competitiveness cannot be undermined by any of the burdens imposed by the state.

A third challenge is that of the exports sector which has been witnessing a sustained contraction owing to weak global demand. The new Economic Survey has pointed out that every percentage point decrease in the global growth rate is now associated with a 0.42 percentage point decrease in India’s growth, compared with 0.2 percentage point decrease between 1991-2002T. The Budget has not made any attempt to address the export slowdown, despite the fact that the Economic Survey has highlighted that the contraction in India’s export, in services industries in particular, is cause for “alarm”.

Ignored areas

Despite the potential for focused interventions in service industries such as tourism, manufacturing sector exports command all of government attention. Yet, even in terms of manufacturing, one of India’s strangest structural binaries lies exposed. On the one hand, a large share of the manufacturing exports contraction is due to lower value of petroleum exports. On the other, the Government has more than capitalised on the opportunity to tax domestic sales. The central excise duty collection from petroleum products has resulted in revenues to the tune of Rs. 1.3 lakh crores this fiscal (up till December 2015) as against Rs. 0.7 lakh crores in the same period the previous year. The question therefore arises: what happens if oil prices begin to recover? While this would be good for exports, does the government have a backup plan for fiscal consolidation?

Thankfully, this year’s speech was not littered with tall promises based on a gamut of Rs. 100 crore schemes which seem to have gone nowhere. The FM’s call to put a sunset clause on all new schemes, along with a review of outcomes, is a leading contender for timely governance reform that could put an end to budgets such as last year’s.  Other good moves include the much needed relook at the Fiscal Responsibility and Budget Management (FRBM) Act, as well as the promised statutory backing to the Aadhar platform for targeting beneficiaries of subsidies. The unwavering focus on roads and ports, as well as electrification too may yield some benefits in the medium term. In fact Nitin Gadkari and Piyush Goyal were the only two ministers chosen for praise by the FM in his speech. Conversely, some would say this indicates limited bench strength.

There are also some contenders for initiatives that are most likely to fail. There has been a severe contraction in lending by scheduled commercial banks to the ‘food sector’, with -4.1 per cent year on year decrease in 2014-15. Despite this, the FM promises to deliver Rs. 9 lakh crore by way of farm credit in the next fiscal. Similarly, the FM proposes to set up 1500 ‘Muti Skill Training Institutes’ with just Rs. 1700 crores. That’s just over Rs. 1.13 crores per institute – seemingly unviable from the outset, but it would be great to be proved wrong. In the end, what stood out was that the government has now pivoted to being more circumspect and social sector oriented. In the run up to this Budget, the finance ministry had asked Indian Twitter users’ opinions to determine the focus of the Budget. Perhaps better perspectives can be garnered from the ground next time, partly by enhancing the feedback loop with Panchayati Raj Institutions. One can hope that the massive grant in aid promised to Gram Panchayats (Rs. 80 lakhs on average) can help with this instead of being squandered in return for well-timed political mileage.  

Vivan Sharan is a Partner at the Koan Advisory Group