Tuesday, March 31, 2015

Behind the lines of credit: Koan Partner, Vivan Sharan's coauthored article in Business Standard


Last year Indian PM announced a $1 billion concessional line of credit (LoC) on his maiden visit to Nepal. More recently he announced a concessional in his March visit to of $500 million for civil infrastructure projects, and a similar line to of $318 million for development of railway infrastructure. Clearly, LoCs are becoming a key arrow in India's economic diplomacy quiver.

The Indian government subsidises the interest rate on concessional LoCs under its Development Cooperation Programme. Since LoC projects are demand-driven, recipient countries first have to make a request for a LoC to the ministry of external affairs, which considers political and economic aspects before handing over the structural and disbursement process to the ministry of finance and the Export Import Bank, respectively. The sheer size of the LoCs committed to and Mauritius in particular is indicative of the shift in India's foreign policy priorities towards its neighbours.

The importance given to LoCs comes at a critical juncture in the global development discourse. There is little agreement on a 'universally applicable' global development agenda. The heydays of structural macroeconomists arguing for deficit reduction as a precondition to 'development assistance' are perhaps behind us. In the aftermath of the global financial crisis, countries are racking up large debts in an attempt to spend their way out of deflation. As world leaders prepare to negotiate Sustainable Development Goals to succeed the Millennium Development Goals, key development questions will be up for debate.

The negotiations will be rough and tough. A number of politically sensitive questions must be addressed if a truly inclusive and sustainable development agenda is to be crafted: What should be the measure of effectiveness of financial flows, such as LoCs? Who or which body should have the mandate to measure this effectiveness? How critical a role will financial markets play in the maximisation of development impact? What should be the criterion for assistance? How can economic incentives between development partners be aligned?
A study by the Observer Research Foundation on India's concessional LoCs to East Africa has helped shed light on some of these issues. One of India's largest LoC tranches, of $640 million, has been given to the Ethiopian government for expanding sugar refining operations. According to the Ethiopian Sugar Corporation, production from three assisted plants, which would total close to 1.6 million tonnes of sugar annually, would help Ethiopia become a net sugar exporter. The effectiveness of LoCs, therefore, is closely tied to the shift away from structural import dependence. The Ethiopian exchequer could earn $376 million annually through sugar exports from 2015, but the qualitative impact is perhaps wider. The credit extended will help generate livelihoods both directly and indirectly through infrastructure and supply chain creation; it will generate additional revenues for development objectives and create a new industrial ecosystem. Given that this entire process was demand-led, local stakeholders are perhaps best-equipped to measure the developmental and economic impact of the LoC.

From the Indian perspective, two aspects must be revisited to exponentially increase the impact of such LoCs. First, the role of the local agency is central. Often, countries from where LoC demands originate require handholding and technical support. The commercial sections of Indian missions in countries to which large development flows have been committed require support of experts and technocrats. Since the Indian Foreign Service is smaller than New Zealand's, it is vital that the government breaks down silos reserved for diplomats, and supplements its missions with professionals possessing the requisite expertise in handling and supporting commercial projects. Prime Minister Modi would know that economic outcomes are not going to wait for the Indian bureaucracy to reform or for officials to reconcile themselves to the fact that horizontal hires need to be paid market wages. Billions of dollars are at stake, important relationships need nurturing and none of this should be jeopardised by a handful of egos.

The second key issue is the involvement of Indian vendors in funded projects. Under the concessional LoC framework, recipient countries have to procure a variable proportion of goods and services (between 65 and 75 per cent) from Indian firms towards project implementation. Anecdotal evidence gathered for the ORF study suggested that the pre-tendering and tendering processes have much scope for improvement. Given this government's emphasis on expanding the Indian industrial base, there is an opportunity to make the LoC-linked tendering process more competitive and inclusive. Many stakeholders privately confessed that the process is not transparent and is geared to cater to a select few. The government must, therefore, use the new commitments to Nepal and Mauritius as an opportunity to revise the tendering process and to offer a level playing field. The bureaucracy must be kept at arm's length from market operations in order not to replicate the very system of state patronage that the Indian PM hopes to dismantle.

In 2012, the total amount of open LoCs crossed $10 billion and this instrument is only likely to gain further prominence. Yet India is itself a developing country with urgent development needs of its own, and a limited budget. Thus the Modi administration must extract maximum 'bang for the buck' from LoCs, while making sure that the concessional lending programme can stand the strictest tests of public scrutiny. For this, the first step is to institute a stakeholder feedback process that would include the private sector, civil society and perhaps even unbiased voices from recipient countries. Recipient governments rarely critique the Indian government, as it would be considered 'undiplomatic'. What would distinguish the new administration from its predecessors would be the willingness to actively solicit criticism and refine existing processes for the larger public good and efficacy of its primary instrument for economic diplomacy.

In the early post-independence years, the thrust of India's external engagements and economic diplomacy (not necessarily described as such) was with countries with similar colonial experiences and economic realities in the neighbourhood and Africa. More recently, its engagements in groupings such as have resulted in new development financing instruments like the recently announced New Development Bank. The country's involvement in the G20 following the financial crisis compelled India to commit to an IMF-led euro zone-focused stabilisation fund. The new government must now attempt to transition India's towards a more deliberate, durable and definitional framework. Well-administered LoCs offer a great avenue to do this - and therefore must be given commensurate strategic priority and attention.

Former Governer of California, Arnold Schwarzenegger, releasing a report (Future of Global Energy), co-authored by Koan Partner, Vivan Sharan

Koan Partner Vivan Sharan in discussion with JP Morgan (India) Chief Economist and Director, National Institute for Public Finance and Policy

Tuesday, March 3, 2015

Union Budget 15-16: Hopes for a market driven rebalance

Finance Minister Arun Jaitley read out his Budget speech on Saturday (February 28) amidst great expectations from his government to signal a progressive, non-populist agenda. With 800 million living at less than two dollars a day and one million entering the job market every month, India's myriad socio-economic challenges seem to have converged - and can prove to be overwhelming for a state which is not able to achieve targets. 

In the final few years of the erstwhile UPA Government, it had become fairly apparent that a complete revision in the government's approach to the Indian economy would be required -- to build the requisite capacities to address the scale of incumbent challenges. This revision of approach is precisely what has been attempted in the 2015-16 Budget. One of the key challenges of policymaking in India is no doubt the requirement to cater two vastly different constituencies. The first is the burgeoning numbers of rural and urban poor, who also form a large part of the political base. And the second is the business elite and rating agencies that are ever watchful of the balancing act of successive Finance Ministers between populist spending and prudent management. 

As a result of the shriller and louder voice of the latter constituency in the political and financial capitals of the country, much is often made of India's fiscal deficit targets in contemporary intellectual discourse. This overlooks the fact that India's public debt is largely manageable, particularly since only a small proportion is in the form of external debt. Of course less emphasis on prudent fiscal policy requires growth to be on track - which seems to be the case if the revised GDP numbers are to be believed. In fact the Economic Survey has been bold enough to proclaim that double digit GDP growth is now achievable, despite the fact that industrial production is near stagnant. 

Mr. Jaitely has promised to stick to a fiscal deficit target of 3.9 per cent of GDP. This seems to be a distinct feature of his government - its actions in recent days seem to suggest that it is heavily influenced by the need to maintain positive perceptions. 

What Mr. Jaitley seems to have overlooked, is the fact that the fiscal health of India's states is in fact very good - which means the government could have looked to dilute the rhetoric on prudent fiscal management and looked to jump start growth through aggressive capital expenditure in key sectors such as infrastructure. In 2013-14 the states' gross fiscal deficit was only 2.2 per cent of GDP. The average debt to GDP ratio over 2010-2014 was 22.2 per cent, a full eight percentage points lower than in the period 2000-2005 when India first began to experience rapid economic growth. 

This is not to say that Mr. Jaitley has not emphasised the right issues in his speech. One of the key developments in the thinking of the government seems to be on the area of Public Private Partnerships (PPPs). The government seems to have correctly realised that the PPP model of infrastructure investments has not worked, largely because the private sector has thus far been taking the risk of such investments, which are almost never properly assessed. Mr. Jaitley has admitted, in what is a positive sign for things to come, that the sovereign will have to take on a larger share of the risk in PPP investments. After all, private sector cannot simply gloss over the investment risks that are tied to the relative unease of doing business in this country. Furthermore, low global oil prices have given the government fiscal room to manoeuvre and therefore convert excise duty on petrol and diesel to a cess of four rupees per litre towards road projects. 

Another promising development is the recalibration of tax policy in the country. The government earns the largest proportion of its tax revenue from direct tax on corporates, accounting for 3.56 per cent of GDP as per 2014-15 Budget Estimates (as compared to 2.25 per cent of GDP in the case of income tax). Mr. Jaitley has rightly stated that this has made "domestic industry uncompetitive". A sustainable and resilient Indian economy would have to rest on the pillar of strong corporate performance. Given that the effective collection of corporate tax is around a lowly 23 per cent, the proposal to reduce the rate of corporate tax to 25 per cent over the next four years has been a long time coming. Likewise, so has the abolition of the Wealth Tax and the substitution of this with the surcharge of two per cent on the tax liabilities of the super-rich (who earn over one crore per annum). 

While other positives include the reemphasis of the adverse impacts of retrospective taxation, liberalisation of some of the framework rules for foreign funding including "tax pass through" on 'Alternative Investment Funds', and recognition of the "transformative" role that the Goods and Services Tax can play in tax administration, a lot rests on implementation capacity of the government, which has not yet been proven.

Although Mr. Jaitley has promised a "non-adversarial tax administration", it is not quite clear how the government will deliver on this front. Indeed if the experience of Nokia or e-commerce companies is anything to go by, the day when the central government will have better policy oversight over state tax administration is still very far. Moreover, the Rail Budget, which has put additional stress on coal freight, is indicative of the fact that the government has not been able to think through some structural challenges of the Indian economy. Thermal power generation is already stressed because of the lack of coal evacuation capacity. More taxes on the coal supply chain means that the burden will eventually have to be passed on downstream. 

Indeed it is unfair to expect the government to have a fool-proof budget framework - there will always be losers. However, significant implementation challenges can be reduced in the social sector in particular, if the government's vision of the "JAM trinity" -- of Jan Dhan, Aadhar and Mobile is realised in the context of Direct Benefits Transfer (DBT). Subsidies account for around two per cent of GDP,which is larger than the share of capital expenditure. If the efficiency of social spending can be improved upon in a substantive way through DBT, it may prove to be a real game-changer. 

The premise of this Budget seems to have been a market oriented growth strategy - wholly fair given that the government will struggle to fund the growth needs of the country otherwise. This has already been evidenced in the slow delivery on the Smart Cities agenda - compromised because of a lack of both funding availability and more importantly,viable ideas. A lot therefore rests upon the leadership and institutional capacity of the government to deliver. One should hope that this budget has set the controls for a larger shift in the government's approach towards administration and efficacy.