Sunday, December 13, 2015



Understanding the finance minister

On 13 May, 2004, the Bharatiya Janata Party conceded defeat in the general elections. It had not done too badly; it had won 138 seats. But its principal partner, Telugu Desam Party, had been virtually wiped out in Andhra Pradesh. A new party, Telengana Rashtra Samithi, had channeled the feelings of neglect in a small and backward region, and garnered 6.8 per cent of the votes – almost equal to the fall in TDP’s share of votes from 39.8 to 33.1 per cent. The first-past-the-post system of elections tends to magnify the impact of changes in vote shares; TDP’s seats in Parliament fell from 29 to 5.
That defeat of this ally destroyed the BJP’s chance of returning to power. It also served as an object lesson of what the electorate thought of capitalist development which Chandrababu Naidu, a liberal reformer, had energetically worked for. It does not matter what the personal beliefs of Manmohan Singh or P Chidambaram about correct economic policies are. As long as they want to stay in power, they have to give the people policies they want, not policies that work.
Vajpayee’s unexpected step-down caused consternation in the Congress, which had neither expectations of coming to power nor seats for doing so. But no other contender emerged. The parties that wanted to keep the BJP out huddled together, and a bargain was struck: the communists would not enter government, but would ensure through their crucial support that a Congress-led government would follow illiberal policies.
Sonia Gandhi’s renunciation of the crown led to another convulsion. But finally on 24 May, Manmohan Singh called a meeting of his new cabinet as Prime Minister. Chidambaram, who shared his colleagues’ sense of wonder at being catapulted to power, said on that day, “As I stepped out on to the balcony of my first floor house today, I thought that a beautiful day had dawned.  I hope that every day will be a beautiful dawn and together we will work hard to redeem the promises made to the people during the election campaign.  These promises will be reflected in an important document called the Common Minimum Programme (CMP).  When the CMP is revealed to the people, I am confident it will enthuse all sections of the people to work harder in order to make India a stronger country, to make the Indian economy a stronger economy, and to ensure better lives for all the people of our country.” He took his cue from what the Prime Minister had said to his cabinet colleagues – that his government must maintain the momentum of growth with stress on three issues – agriculture, employment and manufacturing. This has been the mission of the UPA government. This is what Chidambaram pledged to pursue as finance minister. And this is what he has pursued in his latest budget, come hell or high water.
There is a certain tradition of ministerial autonomy in Britain; but in all other countries, finance ministers are in a straitjacket of Prime Ministers’ or Presidents’ wishes, their parties’ programmes and electoral compulsions. Chidambaram is no exception. There is a strong belief in the Congress Party that there is massive unemployment in villages and that its removal is the key to rural prosperity and to winning the rural vote. I think it is a mistaken belief. A visitor to a village may get the impression of virtually everyone being unemployed because farmers and farm workers have to work only during the crop season. But the National Sample Survey has seldom shown rural unemployment to exceed 5 per cent. Working too little is not a sin; if anyone makes a comfortable living by working an hour every year, that is he should be envied. The villager’s bane is his low productivity, not his lack of work. But the orthodox Congressman finds such a view repulsive; he would rather have the villager breaking stones in the open on a summer day than sleep in shade.
Indians do not have the monopoly of cussedness; they have strong support from the international do-gooder community. And that community has its own shibboleths. It has blind faith in education. No one asks what this education should be. It is well known that children in India’s village schools are imprisoned in poorly built shacks, have to sit on the ground, and are taught to memorize and intone when they are taught anything; most of the time, teachers are away and children are left to their own devices. But these juvenile prisons are regarded as temples of learning; one of Chidambaram’s imperatives is to find billions for this largely pointless activity. It is not for him to question the wisdom of political holy cows, not for him to ask whether children could not be taught much more in much less time of what might be useful to them in later lives, or whether they do not have a right to be better accommodated and more effectively taught. His job is only to fund more of the same mindless activity.
It is an article of faith that India lives in its villages, and that for it to grow, agricultural growth must be raised. People do not want to eat more wheat or rice; despite the enormous growth in incomes, per capita foodgrain consumption has been falling. Villagers remain poor because they are only farming, and no one wants any more or the agricultural goods they produce. For them to get richer, they would have to take up some non-agricultural activities – make industrial components, or maybe set up spas for townsmen to relax in. But agriculture is so holy in our country that politicians will waste billions to increase agricultural output that no one wants and which would have to be subsidized if it were to find a market. Agriculture is our bottomless pit, and it was Chidambaram’s duty to throw money at it. He has done it well.
This is just an illustration of the proposition that Chidambaram’s expenditure proposals were born out of the political religion that he belongs to; his belonging to the Congress sect required that he should indulge in these expensive, symbolic actions. He had more freedom on the revenue side; and here there are signs of a cavalier approach. The changes in customs and excise duties bear signs of lobbying. I wonder which lucky dog led Chidambaram to reduce import duty on pet foods. The differential excise on cement is mbodies an incentive to keep prices below a certain arbitrary figure. It is a shamefaced substitute for price control. I wonder how someone with a reputation as a reformer could even think of it.
India is the home of gem cutting, but the industry is now in danger of migrating to China and Thailand. Once the finance minister decided to reduce taxes on it, it was silly of him to limit the “benign assessment procedure” to those who declare profit margins over 8 per cent of sales. And the application of enterprise and innovation is perfectly industry-neutral; one never knows where a clever entrepreneur will strike gold. The finance minister should not even try to second-guess innovators. His proposal to confine venture funds’ pass-through status to his own favourite industries is quite ill conceived.
I have no idea what Chidambaram means when he says that he has brought horizontal equity, or that taxing dividends brings vertical equity. I suppose the idea is that it is generally the rich who earn dividends, and hence that taxing dividends is vertically equitable. Actually, he has an instrument of vertical equity in progressive income tax. This is the only one he needs, and any further complications are unnecessary. He seems to think that he does shareholders a favour by taxing dividends at a lower rate than the maximum income tax rate, which a rich shareholder would normally pay. Actually, those dividends bore the full corporation tax to begin with; any further taxation of them is double taxation. It encourages people to set up companies and siphon off profits without calling them dividends, or even profits. That is why we have so many millions of companies in this country.

These are just a few examples of what I consider mistakes made by the finance minister. I have always been struck by Chidambaram’s high IQ; every budget day I have been baffled how he could introduce so many measures that look poorly conceived to me. It is in the interests of a finance minister to let his bureaucrats do what they like; they then give him an easy time and oblige him when necessary.  It is my guess that Chidambaram decided at the outset to let his bureaucrats make budgets; the mayhem he has wrought is just the havoc finance ministry officials are capable when not controlled by a strong finance minister.

Saturday, December 12, 2015



Looking ahead, realistically

A fortnight ago, I wrote about inflation, which is beginning to engage the government. The official view is that the inflation is microeconomic and can be tackled by commodity-specific policies such as exports and ban on forward trading. Such a view can almost always be confirmed, because rates of inflation invariably vary across commodities; it is always possible to pick commodities whose prices are going up faster. However, differences in the rates of commodity-specific inflation do not prove it to be commodity-specific; for that, the trends have to vary across commodities. If I look at the figures in that fashion, I find that industrial inflation has been going up since March 2006. There was some doubt about inflation in primary commodities, which came down year-on-year last July and August. But the subsequent figures confirm that agricultural prices too have been going up since March. So I am pretty clear that the primary causes of inflation are macro.
The Prime Minister’s Economic Advisory Council claimed that the current boom was consumption-led; the evidence it relied on was the rising share of personal loans in bank credit. This is a partial view. If one looks at all sources and uses of finance, enterprises were highly liquid at the beginning of the boom in 2002 and were not borrowing from banks; so, much against their past prejudices and traditions, banks started giving housing loans to individuals. If one looks at GDP growth, investment has been growing at over 15 per cent a year since 2002, whilst the growth of private consumption has been of the order of 5-7 per cent. This is also borne out by the fact that the share of investment in GDP has gone up. The EAC may argue that investment includes housing; but it cannot argue that housing is investment for estimation of GDP and consumption when one looks at bank credit. Houses are durable assets, and spending on them is investment. This confirms my belief that the boom is investment-driven – and that the recent rise in inflation is a macro phenomenon, and signifies that the economy is overheating.

One reason, as last week’s Economist pointed out, why the boom did not run into supply bottlenecks earlier, is imports: foreign trade is far more open today than in earlier times, so excess demand spilled out into imports. That in earlier times would have ended up in a balance of payments crisis. That has not happened because of increasing capital inflows. But the inflows are more of portfolio than of direct investment; they are therefore less embedded in the economy, and can run out easily.



Waking up to inflation

I have argued for long that the conventional interpretation of India Shining – that India had entered a golden period in which high investment would lead to continuing increases in productivity and high growth would continue for decades – was based on inadequate evidence and that the current boom was triggered off by high liquidity and low interest rates fuelling both investment and consumption. Fortuitously, the Economic Advisory Council to the Prime Minister addressed the consumption part of this view in a report on the economic outlook that it put out in August, and confirmed it. It found that personal loans had accounted for half of the increase in bank credit in the three years up to 2005-06, and had risen from 15 to 25 per cent of total credit. Seeing that bank credit had grown by 32 per cent in 2005-06, it shared Reserve Bank’s preference for slower credit growth; but it wanted more of the credit to go to investment and less to consumption. Looking at prices the way officials do, it was of the view that what inflationary pressure was there was confined to a handful of agricultural commodities – mainly wheat and pulses – and could be dealt with by more liberal imports immediately and higher productivity in the longer run. It noted the sharp fall in share prices in May, but traced it to accentuated international risk perceptions, and concluded that “the market appears to have adjusted, stabilized, and come to a more-or-less neutral position” – in other words, there was nothing to worry about.
Inflation gathered pace, and others in the government got worried about it. So the EAC made another report on inflation in December. It estimated that inflation then was 5.7 per cent and would cross 6 per cent by March. It did not quite put it that way, but it seemed to think that speculators were driving prices up and that better information about crop prospects, more loudly disseminated, would combat their disinformation. To its recommendation of duty-free imports of wheat and pulses, it added reduction of import duties on nonferrous metals.
The EAC’s views have been the basis of the anti-inflationary policies undertaken by the government. Reserve Bank has raised interest rates modestly, slightly increased the cash reserve ratio, and placed restrictions on loans against real estate. The agricultural ministry has imported wheat duty-free. The finance ministry has reduced duties on nonferrous metals. The Forward Markets Commission has banned futures trading in principal pulses. So someone at the helm of economic affairs in the government would carry the impression that it is following an active, well-thought-out, well coordinated, comprehensive policy to keep inflation under control.
Economic policy is made in three steps. First, figures are read and projected. Second, policy options are considered and chosen. Third, as the consequences unfold, policy measures are adjusted. On facts, there are better and worse ways of reading price statistics. My estimates of inflation, together with the likelihood limits, are: food 6.5 (5-8), primary articles 6 (5-7), manufactures 4.2 (3.5-5), overall 5 (4-6). Food price inflation went up sharply in the second half of 2005 when the poor kharif prospects became evident, and has tended upwards throughout 2006. Manufactures price inflation actually came down in the second half of 2005 and fell below 2 per cent by March 2006; it has been going up since.
I think that one reason why agricultural inflation is so high is the stop-go, discretionary agricultural import policy. If the extremely high agricultural tariffs had been brought down or eliminated and imports had been freely allowed, more would have been imported and larger inventories been built up; that would have been far more stabilizing than the syncopated imports by government. Manufacturing inflation has been low because there are no import restrictions and tariffs are generally low.

Reserve Bank can never be relied on to take sufficient and timely deflationary action, both because it would be too afraid of precipitating a crisis, and because with the coming of credit cards and electronic payments, it is losing control on money supply. The onus for anti-inflationary policy is entirely on the finance minister. He should aim at a far greater fiscal correction than is planned under long-term fiscal policy. My preference would be for restraining expenditure; but his party men will, I am sure, have some bright ideas for wasting money. So they would prefer a rise in taxes. Either way, policies against inflation need to be more systemic, more macro and more fiscal.  



Plea for a new type of town

Governments have traditionally given themselves the right of eminent domain – the right compulsorily to acquire private property. The justification given is public interest – for instance, in building roads, ports and airports. Our socialist governments prior to 1991 exercised the right with abandon. They extended it to running businesses as well, many of which they nationalized. And when it suited them, they not only sequestered property, but also expropriated it. For instance, it took away closed textile mills without paying anything for them. Tempted by the central government’s self-appropriated largesse, state governments also helped themselves. In this way, a regime of proprietorial lawlessness came to reign.
This culture of the government helping itself to whatever took its fancy underwent a change after 1991. The government wanted foreigners to invest in India. It did not care what its own investors thought of it, but if foreigners thought that it could just take away their investments, as it did with refineries in the 1970s, they would give India a wide berth. They had done so and gone instead to Southeast Asia; by the 1990s, Southeast Asian economies had a commanding lead over India. The government did not change any laws or give any guarantee against nationalization. But it let it be known that it had changed its stripes. On the basis of this informal assurance, the country has received significant though not copious foreign investment inflows.
Meanwhile, the current boom has led to growing demand for land. As urban property has filled up and its prices have skyrocketed, new enterprises have sought to set themselves up on virgin land. As they spill out of cities, so do the people they employ, who want new residential complexes and multiplexes. And lured by the promise of shining temples of business and burgeoning jobs, state governments have willingly put their powers of compulsory acquisitions at the disposal of companies.
From time to time, these campaigns to remove original residents from sequestered land have erupted into violence. Generally, governments have shot a few, beaten up a few more, and suppressed resistance. But as industrial growth has accelerated, instances of such violent repression have multiplied. They have been particularly endemic in West Bengal, and have brought it unwelcome publicity. But they are not absent elsewhere. As Special Economic Zones proliferate, violent confrontations between landowners and governments threaten to spread escalate.
The central government has been indifferent to the disturbances. But recently it struck the politicians in Delhi that their electoral prospects may be adversely affected by the anger of farmers at forcible acquisition of land. So for acquisition of agricultural land by SEZs, the government proposes to bring legislation that would set minimum standards for compensation to farmers. There is also the idea that ‘fertile’ agricultural land should be exempted from acquisition.
In principle, there should be no difficulty in compensating farmers because the value of land is much greater when it is used for industry, services or urban development than if it is farmed. In fact, it is so much greater that legislation should be unnecessary. It is not because of inadequate compensation for land that West Bengal, Orissa and earlier, Madhya Pradesh, have seen repeated disturbances over compulsory acquisition. The causes are local. In Singur, it was a large section of the population that was employed on the farms but did not own them; it feared loss of jobs, not of land. In Orissa and Madhya Pradesh, it was indigenous people who had no alternative to its traditional subsistence agriculture and that faced the loss of the only livelihood they knew. Gujarat offered the displaced tribals of Narmada valley generous compensation; but inexperience of modern ways – fertilizers, pesticides, markets – made it difficult for them to adjust to a new lifestyle, and many ended up as destitutes and poor landless workers.
Continuous, unencumbered tracts of land often cannot be made available to industry without compulsory acquisition; and it often causes great suffering. Laws on compensation for land, however generous they might be, are quite inadequate and often inappropriate for dealing with the disruption of lives. Such disruption is unavoidable to some extent, but it must be minimized.
There is another reason why the current proliferation of SEZs, industrial zones and residential complexes is undesirable. The more dispersed they are, the greater the traffic they will generate, the greater the fuel consumption and waste of time.

Hence we need to work out how to have maximum development with minimum use of land and multiplication of locations. We should develop a smaller number of larger townships closer to ports and airports. Development should be as vertical as possible, road capacity should be large enough to accommodate long-term requirements, and space should be provided for the pedestrians and peddlers that India inevitably generates. Indian cities of the 21st centuries cannot be like European cities of the 19th century; they must designed around today’s technology.



The money-spinner nation                            

Lakshmi Mittal’s acquisition of Arcelor put Luxembourg on Indians’ mental map. I had never been to Luxembourg before; from photographs I had imagined the Arcelor headquarters to be a chateau – a country house to which you drove up along a long shaded avenue. So I was surprised to find it situated in the center of Luxembourg, close to the railway station.. I had expected ‘Mittal-Arcelor’ to be emblazoned in bold on it; instead, I found that the building still bears the name ‘Arbed’ in big stucco lettering at the top (Arbed was Luxembourg’s steel company which was merged with Usinor of France and Aceralia of Spain to form Arcelor in 2001). The new name of the company is found at the entrance in small letters. I had imagined Lakshmi Mittal looking out of its windows on his green, wooded domain; actually, he looks out on busy noontime traffic. That is, when he visits the four-story office mansion built almost a century ago. He does it often; Arcelor-Mittal no doubt engages much of his attention these days. But he has not converted the office into his residence; he stays in a hotel.
Why the Mittal-Arcelor affair made such big news in India is clear – Lakshmi Mittal is of Indian descent, and all true Indians wanted to take up cudgels for him – verbally. But why did it stir people so in Luxembourg? Luc Frieden, minister of justice, the budget and the treasury, said it was because the father or uncle of almost everyone had once worked in Arbed. Jeannot Kreck√©, minister of the economy, commerce and sports, attached importance to the survival of manufacturing industry. (They do have thick portfolios, these Luxembourg ministers; after all, there are only 15 of them.) Arbed is to Luxembourgers what the Tata Steel is to India. It is an icon; whatever happens to it will reverberate in the local polity – even though Arbed today employs just 6,000 people out of the country’s work force of 311,000, and produces just 4 million tons of steel.
There is also a local way of doing things into which the hostile bid for Arcelor did not fit. Luxembourg has a small share of Arcelor’s equity, and prefers to have a voice in the board. Its government likes to resolve issues by consultation. It also favours shared decision taking, for which it has tripartite bodies in which it brings together workers and employers. Mittal’s reputation as a capitalist buccaneer caused some trepidation at the outset. But both the government and the Mittals (Lakshmi and his son Aditya) have been talking and learning each other’s ways. Luxembourg has a small and approachable government; it acts quickly, and looks for solutions friendly to business. When Luc Frieden drafts a law, he talks to businesses and institutions to learn what they would like to see in it.
I am sure that if Mittal thinks about it, Luxembourg’s ways must contrast to its favour with those of Indian governments. Their slow, opaque, ponderous ways may not so much affect services which require little of land, logistics or investment. But in manufacturing industry, costs depend a great deal on the infrastructure provided by the government. And timing is important in a competitive industry; it makes all the difference how quickly one can go into production. In quality of government, Luxembourg with its small, agile government would score higher than India.
All of manufacturing employs only 11 per cent of Luxembourg’s labour force. Despite – or perhaps because – of the fading of industry, Luxembourg has the highest national income per head in Europe, more than twice that of France, Britain or Japan. Admittedly, the figure involves a bit of sleight of hand, for many people come every day and work in Luxembourg, which is only 82 km long and 57 km wide. Germans call their Turkish workers guest workers, although they have been guests for over 40 years; German guests in Luxembourg, however, commute to work in the morning and go back to their homes across the border every evening, as do workers from France and Belgium, the other countries encircling Luxembourg. A third of Luxembourg working population is non-resident. Foreign workers speed along six-lane highways. As they enter the city, street signs tell them how many parking spaces are available in which underground car park.
Underground activity goes quite far back in Luxembourg’s history. For it is settled on a sandstone cliff overlooking the confluence of the Alzette and Petrusse rivers. Luxembourgers built a castle; but the Austrians, who were visiting Luxembourg in the 18th century, had an even better idea. They tunneled through the cliffs and opened bastions overlooking the valley; this underground fortress was indestructible and made Luxembourg a formidable obstacle to the imperial armies of France as they fought for the mastery of Europe over centuries. Wars between roughly balanced empires are impossible to win decisively. When people despair of winning, their thoughts turn to God. So religion was its major industry in the Middle Ages; buildings of ancient monasteries in the centre are a conspicuous reminder of it. Luxembourg is close to the heart of Europe.
Whereas at one time this made it the tramping ground of armies, today it is bringing to Luxembourg the august institutions of the European Union. Brussels is the home of the European Commission and the fount of its unceasing Directives. But EU is a federation built from the bottom up; so its members have multiplied its institutions, and strewn them across member countries. Luxembourg, being central and beautiful, has got more than its fair share. It could not accommodate the new European armies of bureaucrats in its old palaces, so it has given over the next hill to them. There they have built imposing glasshouses; European Investment Bank, European Court of Justice, Eurostat are amongst the institutions on this hill.
But while European bureaucracy may provide the cream, it is finance that is Luxembourg’s dominant industry. It has an extraordinary concentration of financial service providers. It is host to 155 banks – only 15 of them local. It has 95 insurance companies, and 271 reinsurance companies. It has 946 investment companies, 1046 unit trusts and 15 other undertakings for collective investment as they are locally called. At the beginning of 2006, the combined assets of Luxembourg’s UCIs were over E1.5 trillion – twice India’s national income. The main business of its financial sector is to attract the savings of people in neighbouring countries, principally Germany and Belgium, and to offer them an enormous variety of avenues for financial investment through companies whose solvency is assured. Switzerland has been in this business for much longer; it specializes in investment services for the world’s super-rich. Luxembourg caters more to the middle classes. To this end, it is home to a large number of mutual funds which offer standardized combinations of investments to cater to savers who cannot afford to go to the private bankers of Zurich. It also has branches of all major Swiss banks, which found it to be a good point of entry into EU territory. Initially, investors were attracted by lower taxes; but the difference is now dwindling. Similar funds are available in the home countries of investors, but Luxembourg has kept its lead. Serge Kolb, Deputy Governor of the Central Bank of Luxembourg, attributes it to low costs, greater choice of funds and better knowledge. But as Fernand Grulms of ABBL, the Bankers’ Association of Luxembourg put it, Luxembourg’s command of languages is also important. A large proportion of the work force speaks German, French and English; and the financial institutions combine expertise on the regulations of neighbouring countries. The government is small, approachable, and friendly to business. So it is really the quality of administration and client service that gives Luxembourg an edge. This is why Indian companies have for long found Luxembourg a good place to raise capital. Immediately after they were allowed to do so, 31 Indian companies issued GDRs in Luxembourg in 1994; since then, Luxembourg has been a favourite destination of Indian companies floating GDRs or raising bonds.
But Luxembourg may become attractive to Indian business for another reason. The European Union is a market of 500 million people with high incomes, as Jean Asselborn, Luxembourg’s minister of foreign affairs and immigration, points out. Indian companies are buying and setting up subsidiaries in EU. If they wanted to establish their presence, Luxembourg would be a strong candidate. It is a small city, consisting largely of offices; only 75,000 people live in the city. But it offers all the conveniences of a city, including a concert hall, an opera house and museums of classical and modern art. It is easy to get into and out of; one can enjoy country life in one of the villages in the neighbourhood and drive into Luxembourg for work. One’s children would grow up speaking French, German and Luxembourgish. Paris, London and Amsterdam would be within driving distance. And for those who get homesick, there are at least five Indian restaurants – Star of Asia, Swagat, Himalaya, Everest and Khana Khazana. No wonder Lakshmi Mittal chose a Luxembourg company to buy into.