Six economic policy mistakes – an expanded version

This is an expanded version of my MINT column today. Newspaper columns have to conform to character limit (5500 characters with spaces is the limit that MINT prescribes). Here is the first version of my article:

The slowdown in economic growth (5.7% y/y in the first quarter of fiscal 2017-18), the near-total absence of bank credit growth to industry – small or medium or big, and the lacklustre growth in industrial production, to name a few, have brought many experts out of the woods. There is near-total unanimity on the need for a fiscal stimulus in India. That alone should make the government wary of the recommendation. Second, if the government was the problem, can it also be the solution? Humans’ belief in their ability to find answers to the problems they create vastly overstates their actual record in doing so. It is far easier to spoil than to spruce up. Sometimes, problems do not have solutions. It is not possible to press the UNDO arrow that easily in real life. Discussions of solutions must take into account costs and alternatives considered and discarded. Otherwise, solutions could end up becoming the case of committing a second wrong to right the first wrong.

Until the note-ban happened last November happened, even its worst critics could not really point to egregious economic policy mistakes that this government had committed. But, it had committed a few. We will examine them to see which of them are really reversible.

First, it had not prepared for being in power at all, in terms of using it as an instrument for economic advancement. Manifestos do not count. It inherited the budget projections of the previous government without question. It even copied and pasted text from the interim budget document in the first budget presentation made in July 2014! The mid-term economic appraisal of 2014-15 pointed out that the true fiscal deficit inherited could have been of the order of 1.1% to 1.8% more than the official number of 4.5%. The NDA government thus engaged in a massive fiscal consolidation even as the economy was limping back to normalcy. Had it done its homework and put out a white paper on the economic mess it had inherited in various areas, it would have prepared the ground for a gradual fiscal consolidation. Thus, it could have used the windfall from the oil price crash to recapitalise banks rather than working overtime to legitimise the previous government’s fiscal recklessness and partly-sham fiscal consolidation. In this one aspect, its errors were lack of homework and hence no white paper and mindless pro-cyclical fiscal consolidation. That brings us to the second mistake.

It did not take the emerging banking sector woes seriously enough. It thought that the matter would sort itself out, because of higher growth. If crony capitalism was rampant under the previous regime, it stood to reason that bad financing decisions would have made both for bona and mala fide reasons. The government was again guilty of not confronting the problem but ducking it. Today, the problem has grown bigger and is even yet to peak. Short of drastic reforms to the banking ownership and governance models, the problem of Non-Performing Assets (NPA) is likely to persist and remain a big drag on growth. Nor is it any more a question of recapitalising the banks alone. Governance is a serious issue. Without collusion by bank staff, not all banned notes would have made it into bank accounts. Drastic reforms are made infeasible partly because of resistance from ideologues aligned to the BJP and because of the government’s unwillingness to commit political capital to see it through. Above all, the reluctance to confront the problem stems from the facile assumption that economic growth would wash away the sins that lenders and borrowers committed. That brings us to the third mistake.

It was to believe in the economic growth numbers that the Central Statistical Organisation put out. The CSO put out growth numbers based on its new methodology and new base year that bore no resemblance to reality. That was too apparent because the growth numbers even for the ‘disastrous’ UPA years of 2011 to 2014 were revised higher to appear almost respectable. So, the government felt rather proud that it was able to achieve fiscal consolidation and felt confident that economic growth would turn NPA to PA. Its mistake lies in not being sceptical enough of CSO calculations and asking them to be thorough, transparent and fix the economic growth calculations methodology especially since many competent economists inside the system had expressed reservations on the numbers. The role of bad economic statistics in India’s current economic plight is a story that has to be told. That would put data collection, methodology, accurate and timely reporting an urgent priority for future governments.

The fourth mistake is its implicit and explicit anti-big bias. That was not expected from this government. India’s production structure is fragmented. The sizes of its farms and factories makes them inefficient and primitive. Technology upgradation is infeasible and not viable in their present sizes. The numbers are shocking and beyond belief. I can stick my neck out and state that India cannot ‘make it’ with such extremely nano and micro sized farms and factories. There is no scale in the country in any sector. The solution is not to favour the current big firms (that is cronyism) but to favour potential enterprises becoming big or to encourage firms starting big. There are an estimated 6.34 crore non-agricultural unincorporated enterprises (excl. construction) contributing Gross Value Added (GVA) of Rupees 11.5 trillion only. In contrast, only 189, 468 registered (with the Annual Survey of Industries) factories generate Rupees 11.6 trillion of GVA. More startlingly, just 4.1% of them have 500 or more workers and they contribute 60% of the GVA of the registered factories. The government has to burn the midnight oil on policy reforms that encourage starting big and/or scaling up and growing big. But, the anti-big bias is evident in the fact that the government had stopped (or, been stopped) in its tracks to reform the corporate tax system. Mudra loans without any strings attached will not result in any economic transformation of India but would be a big opportunity cost in a resource-constrained economy.

The fifth big mistake is in continuing with and even strengthening tax terrorism and the obsession with tax revenues. In the process, it has reduced all economic policymaking to one of and only of morality. That is a slippery slope because it is impossible for the politicians to set a personal example and demand reciprocity given how elections are funded. Revenue neutrality is easily achieved in spreadsheets but it happens in reality only when economic activity happens. Note-ban has been seen almost only as an exercise in broadening the tax base and not as a transformative exercise from its pigmy sized farms and factories.

The sixth and final mistake lies in surrounding itself with the kind of advisors who would speak truth to the power. I do not have to add more than what the Tamil poet Thiruvalluvar had said in the 45th chapter of ‘Thirukkural’ which deals with the necessity for a King to surround himself with fearless advisors who are not only loyal but also more intelligent than him. Now, we can decide how many of these mistakes could be possibly reversed by a fiscal stimulus.

Demonetisation update 32 – sales of small companies

A friend of mine referred to a tweet by Mr. M.K. Venu that linked to a news-report in ‘Indian Express’ and asked if any of us had seen the RBI study that the tweet referred to (i.e., referred to, in that article). Last night, on returning home, I decided to investigate since the magnitudes mentioned were substantial: 57.6% (as per the IE article) drop in sales by small companies (with sale of 25 crores or less) in the fiscal fourth quarter of 2016-17 (January  – March 2017). Since that quarter followed the announcement of demonetisation on Nov. 8, it was rather too easy to attribute it to demonetisation.

On investigation, this is what I found:

Again, the news-story that MKV had tweeted is this.

This is the header of the article:

Small firms flounder post demonetisation, on GST: RBI study

The first para of the article gives the lie away:

Small companies are finding the going tough with sales and profits taking a big beating in the wake of demonetisation and implementation of Goods and Services Tax (GST). Small companies with a turnover of less than Rs 25 crore reported a 57.6 per cent fall in sales for the quarter ended March 2017, the Reserve Bank of India said in a study.

The RBI data covers the period only up to March 2017. How can it include the impact of GST already?

Subsequent paragraphs state that the GST impact is mentioned in a study by Care Ratings:

The GST implementation from July has further exacerbated the woes of small companies in the June quarter. Small companies bore the brunt of the GST regime with profits plunging as much as 78 per cent in the quarter ended June. This is largely owing to destocking of goods by companies before execution of GST regime from July 1, rating agency Care Ratings said.

What the article does not tell you – rather cleverly (or, so they thought) – is that firms with sale of 25 crores or less had sales growth of -46.9% in the third quarter of 2016-17 (the quarter that included demonetisation) and – 48.6% in the final quarter of 2015-16 when there was no demonetisation (nor GST, of course).

It has been a problem well before demonetisation happened. It reflects weak export demand, weak economy, etc., but not demonetisation.

Further, the article conveniently inflates the drop in 4Q2016-17 sales to -57.6% when the RBI table reports a figure of -51.6% which is not drasticall different from the contraction in the previous quarter and in the same quarter of the previous year.

The RBI spreadsheets can be accessed through this link.

The assumption that people will not do their homework and will simply quote each other in a self-reinforcing cycle drives much of the press coverage of the government policies and actions.

What is amusing is that most commentators still discuss and tweet them as though they were truths because either they have no time to verify or that they believe naively that the journalists would have done their homework or that they too want to believe that that is the truth.

Amusing, troubling and, may be, disgusting too?

This is instructive (and yet another) reminder on how not to tweet or blog or form judgements based on stories in the Indian media on this government just as one is sceptical of government claims on some of their achievements.

Where possible, we should go to the source data ourselves or make our comments with caveats about the reliability of the report being unverified yet.

Why small may be sad (and) Why Big is not bad?

In late June, the Ministry of Statistics and Programme Implementation in India (MoSPI) had uploaded this document. It went, as far as I know, unnoticed. But, I cannot be sure. I had begun to travel heavily then. It might have been covered in the media.

It is the press note on the key findings of the survey of unincorporated non-agricultural enterprises excluding construction, conducted during the period 2015-16.

I had tried to distil some key findings and compare them to the factories registered with the Annual Survey of Industries. The latest ASI that is available is for 2014-15.

Uninc. and ASI enterprises- a comparison

Most of the unincorporated non-agricultural enterprises are ‘Own Account’ enterprises. Yes, some of them render a useful social function. No doubt. They contribute social capital. But, they tie up valuable resources like land, power, water, etc., and unlikely that they pay for them. Those who employ outside workers do not pay them well as you can see above. They cannot. These are subsistence enterprises.

No, the answer is not that India does a ‘Turkman gate’ on them. Political and social dynamite, such an approach would be.

But, policy options are clear:

If they become formal (only 31% of these enterprises are registered) and if they have to be given access to finance (not all of them should be given), then there should be some criteria on their improvement – workers, emoluments, protection of workers and also productivity. That is what MUDRA loans should aim at. But, only a small fraction of them will go on to make it somewhat big, if not BIG.

This is where demonetisation comes into play. It might have made life difficult for many of the enterprises that operate on cash. So, the social capital they generate is disrupted. That is a negative. Some of them will become poorer as a result. That is an economic consequence. That is worse.

But, how many of them will also be enabled to grow out of their humble origins to which they are condemned for life, now? How many of them can make it? For those who cannot continue now with their humble enterprises, do we know how to train them and absorb them in bigger and formal enterprises? How many of them do we have, actually? What are we doing to them? That is what we turn to, next. We examine the Annual Survey of Industries (ASI), 2014-15. That is the latest available ASI.

ASI registered firms add more gross value (GVA), pay better and the bigger ones among them (500 or more workers) are even better on these two parameters.

But, the killer punch comes in the last five lines of the table above. The proportion of factories that employ more than 500 workers is barely above 4%. But, their GVA per worker is 150 times more than the factories that employ 499 or less workers. Their GVA per worker is 14 times more than the overall GVA per worker (which includes factories with more than 500 workers)!

While the Government of India can pursue all the taxes that these big enterprise (factory) owners have to pay, it should also spare a thought as to the economic value added of these bigger units.

Per policy minute or policy hour spent, their economic value added is far more than unincorporated enterprises. There is much to do and should be done to ease their business conditions even as they are held accountable to obey the laws of the land in all aspects and pay their workers better.

But, India needs to have more of them. How much more is optimal is surely worth debating because, at some tipping point, scale can be wasteful. But, surely not 4.1%. That is why policy response to ‘big’ cannot be that ‘Big is bad’ and that the only policy response to them is tax raids, notices, searches and seizures and revolutionary rhetoric.

Indeed, the Indian economy needs more competition for the existing few big players in different sectors such that at least some of them become internationally competitive too. So, let us be clear. Government policy does not have to favour incumbent big players but it cannot be against ‘bigness’ itself.

To summarise:

(1) Make small, micro and nano firms formal – the Government is pursuing
(2) Some or many will go out of business – what is the social safety net, what are re-training and re-deployment opportunities in the formal sector? That is where and why growing the formal sector becomes important
(3) Few should be encouraged and facilitated to grow big with financing but with performance caveats
(4) No need to favour existing big firms but do not have an ‘anti-big’ policy bias
(5) In fact, we need more big firms than what we have now

This is where policy attention has to be on, in the next two years, if not longer.

(p.s: I might have made calculation errors. But, all the source data are available in the press release on unincorporated enterprises linked above and in the ASI report (page 59) linked above. You can point out errors, if any. Will be grateful.)

The clamour for fiscal stimulus

A very detailed article in ‘Economic Times’ on the various Japanese assisted infrastructure schemes. It is welcome, in more ways than one.

Once again, the same old hackneyed arguments about whether India needs Bullet trains had cropped up. There is a deliberate conflation of arguments that the money could be used elsewhere. That is patently false and a lie. That money – on very concessional terms – is available from Japan only for this project. I had blogged on some of these patently misleading and mischievous arguments in December 2015. There are likely strong and sizeable multiplier effects. I am glad Ajit Ranade agrees with me. He makes the right arguments on India’s space missions and on India’s public transportation projects.

A friend shared this piece by Gordon Chang on how India and Japan are encircling China.

A Deloitte report that paints India in brighter light than China is briefly reported here in Bloomberg.

If the previous link set you up for listening to or reading only ‘Feel Good’ stuff on India, this could make you ecstatic. It is a speech by Nilesh Shah of Kotak Mutual Fund.

Merryn Somerset Webb ‘Editor in Chief’ of Moneyweek provides a stiff competition to Nilesh Shah, in print. I hope it is not behind a paywall.

Swaminathan Anklesaria Aiyar relishes the prospect of promoters leaving and workes staying as bankruptcies become de rigueur in India. Debashis Basu has a more detailed article on how the Bankruptcy resolution of Synergies-Dooray was handled. It is more lucid than some of the other press articles on the ‘sham’ resolution. I had covered this case in my blog post here.

If the sceptic in you rears its head, then here are the links for you on the failure of National Skill Development Mission to hit its targets. One is based on a research report by (which, in turn, is based on the Sharada Prasad Committee report,  I think) and the other is a news-story. The first link is more about Skill Development Franchisees that failed to deliver in terms of placement. Both appeared in ‘Business Standard’:

Data shows that the NSDC, through its partners, only managed to skill around 600,000 youth till September 1, 2017, and could place only 72,858 trained youth, exhibiting a placement rate of around 12 per cent. Under PMKYV 1, the placement rate stood at 18 per cent.

We should probably look for the Sharada Prasad Committee report and read it ourselves since newspapers can choose to highlight some aspects and not others, etc.  The report was submitted in December 2016 and made public in April 2017.

Business Standard reports on a research report by the State Bank of India research team. It calls for a boost to public spending, disregarding the potential concerns that credit rating agencies would express on fiscal slippage.

Ajit Ranade writes a brief and clear article calling for fiscal boost to the economy. Spells out three areas where they can go – affordable housing, pensions and labour costs to be borne by government to boost hiring and enhanced support for manufacturing and export service support schemes. I am not sure of the third. I am fully behind the second and on the first, I am neutral. Enough policy boost has been given for the first.

If I were recommending, I would boost public sector banks’ capitals in return for some stringent accountability and wholesale changes to their governance and accountability.

India missed the boat on fiscal boost to economic growth in 2014-15 when the new government, thoughtlessly, engaged in pro-cyclical fiscal consolidation to the extent of 1.1% to 1.8% of GDP in 2014-15 by inheriting implausible assumptions and accepting expenditure postponement of the outgoing government. The target of 4.1% for fiscal deficit/GDP ratio in 2014-15 was an impossible one. The previous achievement of 4.5% in 2013-14 was not a real achievement. UPA II’s economic misdeeds of omission and commisison would take years to show through.

Given all that, the government should have come out with a White Paper on the economc situation and proceeded to tighten fiscal policy more gradually. It should have used the oil price crash windfall to reform banks, recapitalise and clean up balance sheets and get private sector credit growth going. Instead, it was used to achive fiscal deficit targets in the hope that a credit rating upgrade would be coming. It has not. India missed an opportunity to provide the needed boost to growth when private sector balance sheets were (and are still) being mended.

On 8th September 2015, I was one of the few people invited for a conversation with the Prime Minister at 7, Race Course Road. I had said that a specific 0.5% fiscal stimulus earmarked for banking recapitalisation would be desirable, at that stage. Evidently, it was not heeded.

I am not viscreally or intellectually opposed to a fiscal stimulus now. But, I am guarded. I can react better when I see the details. That would make all the difference between another wasted effort with negative consequences and a smart growth multiplier. I am concerned that one could commit the mistake of thinking that two wrongs make a right.

I am als concerned that the calls for fiscal stimulus do not take into account the fiscal stimulus already in motion. The State governments have managed to spend even more than their much improved revenues under the generous Fourteenth Finance Commission. They have, as usual, promised fiscal prudence from 2017-18 onwards. But, fiscal years 2015-16 and 2016-17 have seen slippages. No major asset creation has happened.

In 2016-17, state governments spent less than budgeted by about 7% as per Credit Suisse estimates. Capital expenditure is a small portion of the overall expenditure and there too, they spent less than budgeted. But, note that it does not mean that their deficits would be lower. They spent less than what they budgeted. We have to wait for deficit numbers to see if there was any meaningful reduction in overall State fiscal deficits in 2016-17 compared to 2015-16 or a further slippage.

Farm loan waivers announced by eight states would amount to 1.3% of GDP spread over 2-4 years, as per Neelkanth Mishra of Credit Suisse. That too is a fiscal stimulus. But, he noted,

loan growth could be affected: the slowdown by banks in April may last several quarters. (Credit Suisse Asian Daily 13 June 2017)

This is what happened from 2009 onwards. When loans are waived and even prudent borrowers take the wrong hints, loan growth actually takes a hit. It is not good for borrowers and lenders. So, it is bad fiscal stimulus and unsound economic policy. But, the train has left the station.

That is why when one comes down on the side of  fiscal stimulus, the questions of what for, how, how much and for how long and economic quid pro quo (accountability, outcomes and productivity, to name just three) matter.

Then, there is the Seventh Pay Commission recommendations that are not yet fully impelmented by the Centre and then States would folow suit. So, I am not sure if the calls for fiscal stimulus (SBI, Ajit Ranade) take into account these expenditure already in motion.

One of the most useful set of policy recommendations with as much specifics as is possible in a newspaper column is to be found in this article by Shankkar Aiyar, published on 10th September 2017. This is not high altitude platonic stuff but specific action areas are pinpointed.

Sometimes, the more effective stimulus is leadership that understand, accepts and acknowledges the problems and is focused on resolving them. The problem may not be money but all the uncertainty that unco-ordinated and thoughtless sequencing of policy actions and reforms with no heed for the short and medium term side effects. Listening to the so-called intellectuals who are willing to speak truth to the power, at least once in a while, will do more good than harm. Throwing money at problems may not solve and may, on occasions, worsen the situation.

Think of UPA I and II. They were not afraid to throw money at the problems. What did they leave behind for India? A big mess. What were they missing? Credible, sincere, competent and focused leadership.

[Postscript: Those who clamour for fiscal and monetary stimulus and yet claim that the economy is in fine fettle must stop and accept that they canot have it all!]

‘Stay on hold’, says FT!

The Financial Times has an editorial advising the Bank of England to stay on hold at 0.5% and not shrink its balance sheet because Brexit uncertanties loom large, they argue. It is wrong on many counts.

Ten years after the crisis started, the FT is still advocating that the BoE stayed with 0.5%. Do the writers even sit back for a second in their chairs and reflect on what they wrote, before hitting the ‘Gut zum druck’ button?  Quite how the monetary policy connects to the travails or woes that the British economy might experience with Brexit is never explained because, in the opinion of the FT writers, it is axiomatic.

The UK economy would need different set of policy responses to deal with the economic shocks, if any, arising out of Brexit. In the meantime, the costs of ‘too loose for too long’ would keep piling up. In July 2012, the BoE published a paper on the distributional effects of asset purchases. Five years later, the consequences have gotten worse and not better.  If policymakers appear incompetent and make wrong decisions, we do not have to look too far to identify their source of inspiration.

City-States over Nation-States?

My friend Ram forwarded me the first of the four-part lecture by Lim Siong Guan for the Institute of Policy Studies – Nathan annual lecture series. The first lecture was titled, ‘Accidental Nation’. It is worth going through. The full lecture is available here. Mr. Lim mentions a paper by Sir John Glubb: ‘Fate of empires and search for survival’. The extracts he cited were interesting. The paper is available here. I am yet to read it. I hope this is the paper he referred to.

My wife found an interesting article in the ‘Comments’ section below the newspaper report that carried his speech highlights. That article suggests that the future belongs to City-States rather than nation-States. I don’t buy that. Not that I have done much research into it. Nor do I claim myself to be an expert in such matters. I am grateful to be educated.

From the article, I learnt about the unclaimed land between Croatia and Serbia and also about Patri Friedman, the grandson of Milton Friedman.

But, I do believe that modern nation-States would last longer than the ancient Roman Empire, perhaps.

Humans need anchor these days. They have come a long way from their nomadic hunter-gatherer days. Back then, there were no identity markers such as religions and groups. Now that we have them, it is difficult to go back to that ultimate ‘libertarian’ world.

Even those who enjoy the freedoms that cities afford but nation-States don’t – the highly educated foot-loose global citizens who feel at home in all global cities rather quickly – would ache for the protection and security that nation-States afford when technology and other threats make their livelihoods and lives that much less secure.

So, it is good to have competition for today’s Nation-States. But, I am not prepared to wager on their demise. Not soon.

TCA on leaders and leadership

TCA Srinivasa Raghavan has a well-written and hard-hitting article on leaders, ideology and leadership. Could be behind a paywall, though.

I have one minor question:

TCA writes that Vajpayee turned inwards in 2002:

This happened to Indira Gandhi in 1974; Rajiv Gandhi in 1987; Rao in 1993; and Mr Vajpayee in 2002.

I thought Vajpayee’s best years in office were between 2002 and 2004.

Also, I  am not inclined to agree that Manmohan Singh provided ‘good leadership in governance’, as he writes here:

The same thing was true of P V Narasimha Rao, Atal Bihari Vajpayee, and Manmohan Singh.None of them was a great leader in that they could not ensure political success on their own. But each provided good leadership in governance, which is where it counted most.

That contradicts what he wrote earlier about UPA 2 leaving the economy in shambles. In fact, the foundations of that were laid in UPA 1. The boom that India enjoyed between 2003 and 2008 had nothing to do with UPA 1. It was in spite of UPA. They just happened to be in power when the Indian economy happened to enjoy a boom, which was due to a combination of the lagged effects of the policy decisions of the previous NDA government, lean and hungry corporate sector with cleaner balance sheet in 2002 and the global economic boom.

On voter wisdom,

Yet, they were voted out, which speaks volumes for voter wisdom. You can see this phenomenon in many states as well.

This sentence coming after the sentence that included Manmohan Singh in the category of those who provided good leadership and governance is problematic. Voters were right to vote him out in 2014 and were wrong to re-elect him in 2009 because the boom the country enjoyed had nothing to with him, his governance or with his government.

On voter wisdom, in general, quite apart from India-specifc arguments, it is a bit like form and class. Form is fickle and class is permanent in cricket or in any other sport.

Similarly, voter patterns in the short-run, election by election, may appear arbitrary. But, given two or three generations,  the patterns make sense.

Second, this is not a lacuna of democracy. It is ingrained in Sapiens. We had not come out of our hunter-gatherer days in many respects. Survival was uncertain. We had to live for short-term. Who knew if we would be alive tomorrow, let alone long-term?

Hence, we binge on sugary diets, etc., Our preferences for someone who promises short-term goodies is traced to that.

That is why we do poorly, on average, in investing too. We are not simply wired for long-term decision making.

As for the general thrust of the article,  TCA gets it right.