BUDGET – 2011

The important positive point of the current year Budget was claimed to be the control achieved over the fiscal deficit as a percentage of GDP. THIS WAS CLAIMED TO BE A MAJOR ACHIEVEMENT BY ALL ECONOMIC NEWS PAPERS AND NEWS CHANNELS. As an economics student, out of curiosity, I studied the budget in detail to find out the magic wand of the Hon. Finance Minister which made it possible for him to reduce the Fiscal Deficit in spite of increase in budgeted expenses. I am shocked to say that the reduction in the percentage of fiscal deficit to GDP was on account of very high inflation in the last few years. It is all because of how we estimate the GDP.

As an economics student I have studied that ‘GDP of a country is always estimated in current price as well as at constant price’. When it is computed in current price it is named as nominal GDP and when calculated under constant price it is known as real GDP. In the nominal GDP computation of the value of goods and services produced during the year are aggregated at current prices which always include the current inflationary effect also. Since during last year our country is facing run away inflationary situation, the nominal value of GDP is also expressed at high value. This fact has been admitted by the government document itself namely “The Medium Term Fiscal Policy Statement” annexed to the budget. This statement states that “higher nominal growth in GDP – which is just due to inflation- has helped in reducing the fiscal deficit.” Let me go on to explain this from the figures in budget itself.

In his budget speech itself Hon. Finance Minister has claimed that he has increased his spending but reduced the fiscal deficit. This is possible if revenue has increased as compared to the estimate more than his increased spending. But unfortunately the truth lies elsewhere. As per Budget Estimate of 2010-2011 [last year budget] the fiscal deficit was estimated at Rs.3.81 Lakh Crores which is 5.5% of GDP of Rs.69.35 Lakhs Crores estimated by CSP at 2010-11 prices at that time. Thanks to inflation, the GDP at current prices has gone up to Rs.78.78Lakhs Crores, showing an increase of Rs.9.57 Lakhs Crores. This has resulted in reduction in percentage of fiscal deficit to GDP as the denominator in this fraction has increased substantially. Thus, an absolute increase in actual fiscal deficit from estimated level of Rs.3.80 Lakhs Crores to Rs.4.01Lakhs Crores was shown as reduction in percentage of fiscal deficit to GDP from 5.5 % to 5.1%. In reality the Revised Estimate of fiscal deficit for 2010-11 is increased from 5.5% to 5.8% and not reduced to 5.1%, if we take out the effect of inflation and value the GDP at the same price level of estimate made at the time of 2010-2011 budget. Since inflation escalates prices and consequently the nominal GDP, in a year of high inflation the ratio of Fiscal Deficit to GDP will always be lower. It is not a “fiscal consolidation” as claimed by many.

If we look in to the figures of real and nominal GDP for the last five years we can see the widening gap between the two due to inflation over the years. While this gap in 2005-06 was 9.1%, in 2010-11 it has reached an all time high of 38% resulting in an increase in GDP figure by Rs.30 Lakh Crores. If we recalculate the nominal GDP of 2010-2011 at 2005-2006 prices [Real GDP at 2005-06 prices] the ratio of fiscal deficit to real GDP would be 21% .[extract from the article in “The Hindu dated 02-03-2011 by Sri.S.Gurumurthy]

Normally by growth in GDP we expect increase in production and services which must increase the collection of Excise and Customs duties. But curiously, as per Economic Survey 2010-11 presented, the share of these duties to the nominal GDP has come down to 1.7% in 2010-11 from 3% in 2005-2006. Most of the duty cuts announced to stimulate our economy and to save it from the global meltdown has only helped the corporate to make super profit in this period as they have not passed on the benefit or concession of these duties to the consumers. This is also established from the budget it self from the statement of revenue foregone. As per this statement the corporate sector has improved their profit from Rs.4.08 Lakh Crores in 2005-06 to Rs.8.24 Lakh in 2009-10. Not only the corporate have benefited by not passing on the duty cuts to the ultimate consumers but the Government has also come to their rescue by writing off huge tax revenue as not collectable. As per the “Statement of Revenue Foregone” given in the Budget speech this year, Rs.88,263cr has been written off as not collectable or foregone under Corporate Income Tax, Rs.1,98,291cr was foregone under the head Excise Duty and Rs.1,74,418cr has been foregone or written off under the head of Customs Duty totaling to Rs.4,60,972cr for the year 20010-11only.

Please hold your breath. The total tax revenue foregone by the Government since the last five years from 2005-06 to 2010-11 is a staggering amount of Rs.21,25,023cr, an amount equivalent to twice the total budgeted revenue of the year 2010-11. It is important to note that the revenue foregone under customs duty on import of Gold and Diamond alone in the past three years is Rs.95,675cr. which includes Rs.48,798cr in the current year. May be the best scheme for enshrining the social consciousness of the Government and their concern for “aam aadmi”. This amount will be sufficient to fund our PDS system for the whole country. The nexus between the rich and the rulers is ruining the country and the educated intelligentsia of this country is remaining deaf and dumb. We proclaim that the budget is “well balanced.” We rush to evaluate the budget even before the Hon.Finance Minister completes his budget speech but conveniently ignore and forget the important fine prints of his budget speech. We are more concerned with the rise and fall in the stock index rather than what is good for the country. Our Government is ready to write off or forego Rs.4,60,972cr tax amount due from the Corporate sector in the year 2010-11 only, but not willing to compensate the middle income group for inflation by increasing the basic exemption limit to Rs.2 lakhs.

Another important aspect to this fiscal deficit. The budget speech make a mention that the Government will introduce the Food Security Bill this year but no additional provision has been made in the budget for the food subsidy. Actually the food subsidy has been reduced by Rs.5000cr in the current year budget as compared to last year provision. Even without the food security bill the provision for food subsidy was Rs.60.599.53cr as per the revised budget estimate for 2010-11. So what will be the fiscal deficit if subsidy based on food security bill to be included is left to the imagination of the readers? The actual effect of food subsidy bill will be known only from fiscal 2012.

Considering the actual performance of the Government in relation to the expenses side, it is difficult to believe that it will be able to achieve the projected FD/GDP ratio of 4.6% in the next fiscal. If we consider the past budgeted expenses and the actual expenses since 2005-06 to 2010-11, the actual expenses were always higher by 15% to 26.42%. While the actual expenditure of 2010-11 has exceeded the corresponding budget estimate by 18.75%, FM has estimated that coming year expenses will grow only by 3.4% taking into account even the present inflation levels. Similarly the budget provision for fuel or oil subsidy for current year is reduced to Rs.23,640cr from last year levels of Rs.38,686cr [a reduction of Rs.15,040cr] seems to be highly improbable figure considering the fact that oil prices or on the rise. Lastly during the year 2010-11, Government had a windfall revenue of more than Rs.40,000cr from 3G Spectrum Auction which improved the revenue of last year dramatically but will not be available every year. Due to inflation interest rates will go up and that will further fuel the inflation as the input costs will increase. Due to inflated prices nominal GDP may go up but not the real GDP. All these facts make one to feel that FD/GDP ratio will shoot up and not decline as claimed in the budget.

While most of the emerging markets have imposed stringent conditions against short term inflow of capital in to their country, our budget has opened the floodgate to foreign short term capital through increased FII inflow. It will only contribute to the flow of hot money perhaps including the black money transferred abroad. While FDI inflow into our country in the first half of current year has declined by 36% it has increased by nearly 50% in other emerging economic countries. Thus already our country is facing a volatile forex situation and this year’s budget proposal will only aggravate the situation.

The high growth that India has been witnessing in the last decade has increasingly benefited a minority of its citizens who are rich and has more adverse impacts on the majority of citizens consisting of poor and lower middle income group. Unless the situation is corrected at the earliest, it may explode one day when all the growth will vanish into thin air.

I will be much obliged for your views.



Misery Tax

Misery Tax

(Click on the image to adjust it to your screen)

Unjust, inequitable, morally wrong

Business Line, 2/3/2011

by S Gurumurthy

A fraction of the giveaways to corporates could save Indian agriculture from stress. No seer is needed to say that the Budget, branded as favouring the aam aadmi, could not have been more inequitable.

‘I have spent more, yet, I have brought down the fiscal deficit for 2010-11 from 5.5 per cent to 5.1 per cent’, claims the Finance Minister, Mr Pranab Mukherjee. The amount of fiscal deficit has actually gone up by Rs 20,000 crore. How, then, could the percentage of fiscal deficit come down? It defies the logic of numbers. Yet, none of the commentators in awe of his miracle asked Mr Mukherjee how he achieved it. It is not his feat. It was runaway inflation that did the trick, not the Finance Minister. Surprised? Read on.

In his Budget speech for 2010-11, the FM had fixed the fiscal deficit of Rs 3.81 lakh crore at 5.5 per cent of the GDP of Rs 69.35 lakh crore estimated by the CSP at current prices for 2010-11. But, thanks to the hyperinflation that hit the people of India, the GDP at current prices — also called nominal GDP — rose from the estimated Rs 69.35 lakh crore to Rs 78.78 lakh crore in 2010-11. The rise of Rs 9.57 lakh crore is pure inflation.

As a percentage of the new, inflated nominal GDP figure of Rs 78.78 lakh crore, the fiscal deficit of Rs 4 lakh crore came down to 5.1 per cent. Had inflation not escalated the estimated GDP of Rs 69.35 lakh crore, the fiscal deficit would risen to 5.8 per cent, not fallen from 5.5 per cent.

The Medium Term Fiscal Policy Statement annexed to the Budget obliquely admits this fact. It says that “higher nominal growth in GDP” — which is just inflation — has helped in reducing the fiscal deficit

The gap between real and nominal GDP is inflation. Year after year, from 2005-06, this inflationary gap between real and nominal GDP has been incrementally enlarging.

In 2005-06 the gap was 9.4 per cent; in 2006-07, it rose to 16.9 per cent; in 2007-08, it expanded to 21.8 per cent; in 2008-09 it topped 31.3 per cent; and in 2010-11, the gap touched an all-time high of 38 per cent, equal to Rs 30 lakh crore.

Meaningless ratio

Imagine, had the gap between the real and nominal GDP for 2010-11 not risen over the percentage of the gap in 2005-06, the fiscal deficit for 2010-11 would have been as high as 21 per cent! And had it been the same as in 2009-10, the fiscal deficit for 2010-11 would have been 7.5 per cent.

When inflation is high the GDP-fiscal deficit ratio becomes almost meaningless. So much for the reduction in fiscal deficit, acclaimed as “fiscal consolidation” “safe play” or “cutting spend”.

Curiously, inflation escalated the nominal GDP year after year from 2005-06, but surprisingly, not particularly the indirect tax revenues proportionately. This makes the comparison of nominal GDP with fiscal deficit misleading. It also takes us to the confession of the FM that he has not mobilised revenue in this Budget.


The media has eulogised the FM for sparing the corporates from a higher dose of tax, and still managing the deficit. The truth is that the UPA has altogether stopped taxing the corporates and other tax-worthy entities.

Excise revenue, as a percentage of the real GDP, is now almost half of what it was in 2005-06; in terms of nominal GDP, even less.

According to the Economic Survey 2010-11, the ratio of excise revenue to GDP has come down from 3 per cent in 2005-06 to 1.7 per cent in 2010-11 and Customs from 1.8 per cent to 1.5 per cent.

On the basis of the excise-Customs to GDP ratio of 2005-06, the government has under-levied excise by Rs 1,00,000 crore and Customs duty by Rs 43,000 crore in 2010-11, totalling Rs 1,43,000 crore.

The under levy of excise, which started in 2006-07 at Rs 13,000 crore, rose to Rs 63,000 crore in 2008-09, when the stimulus was introduced, and to Rs 81,000 crore in 2009-10.

Even if the fiscal stimulus — calculated with 2007-08 as the base — of Rs 59,000 crore in excise and Rs 41,000 crore in Customs are deducted, the under levy is still Rs 43,000 crore. It means that the UPA government has simply refused to levy the legitimate tax.

But, despite huge tax cuts, inflation is hitting the roof. Yet, on the fear and threat that withdrawal of stimulus would intensify inflation, the stimulus continues.

Is it justified? Read more.

It is not that corporates are in distress; in fact, they never were. An analysis of the profits of corporates given in the statements of revenue foregone attached to annual Budgets shows that corporates have been making huge profits. The companies surveyed posted a profit before tax of Rs 4.08 lakh crore in 2005-06; Rs 7.11 lakh crore in 2007-08; Rs 6.68 lakh crore in 2008-09 (global meltdown year) and Rs 8.24 lakh crore in 2009-10.

Most of the super profits in 2009-10 — rise of 23.35 per cent in just one year — were clearly the stimulus cuts not passed on to the public. The super profits clearly make the continuation of stimulus unjust. The story doesn’t end here. Thanks to exemptions, corporates have paid far less than the statutory rates of excise, Customs and income-taxes. Taxes thus foregone by the government have been rising from year to year from 2005-06 — from 50 per cent of the tax collected that year to 72 per cent of the tax collected in 2010-11.

For 2010-11, the tax giveaways, including excise-Customs waivers of Rs 3.62 lakh crore, totalled Rs 5.12 lakh crore.

The stimulus cut of Rs 1 lakh crore, and under-levy of Rs 43,000 crore are on top of the tax foregone. More, the big corporates manage to pay less than the small ones. If they pay as much, the extra tax realised for 2010-11 could have been Rs 14,470 crore.

Stagnant agriculture

Contrast the giveaways of several lakh crores with the admission in the Economic Survey that capital formation in agricultural sector, which employs 58 per cent of the Indian people, has, from 2005-06, stagnated around 7.5 per cent of the total capital formed in the economy. The Survey says that huge investment is needed to make agriculture viable and sustainable.

A fraction of the giveaways to the corporates could save Indian agriculture from stress.

No seer is needed to say that the Budget could not be more unjust, inequitable, and morally wrong. And yet this budget is branded as an aam admi budget.

The Finance Minister could not have trivialised more the issue of black money stashed away abroad.

He has just repeated in his Budget speech what he told the media on January 25. He has pontificated on corruption. His written brief on the implementation of programmes he had announced in the previous Budget shows that, of 66 programmes, only 25 have been completed, many of them still paper-work. Yet the media discourse has hardly noticed these critical issues.

There are positives, but the hidden vices in the Budget make them cosmetic.

Anyway, the positives have been highlighted so disproportionately that it is waste of media space to repeat them here.

Something lighter to end: the entry of onion in the Budget speech has raised its importance to that of infrastructure!

What Are We Becoming?

What Are We Becoming-A Nation Of Traders And StockBrokers?

Source: Fwd Email, Author Unknown

Life In A Metro-Suffocating smell of an Economy In Self-Destruction

Try travelling by the Delhi Metro between 8-10.00 AM and 3.30-6-30 PM and you would find a youthful army either on-way or the way-back from a enthralling day at the bourses. 20 something youngsters find employment either as day-traders or as arbitrageours at a multi-tude of brokerages. Another horde following them is the army of real estate agents pandering homes stretching all the way from Manesar to Greater Noida and all the way down to Rohtak in some sort of a virtuous real estate triangle. If speculating in land and stocks is the career option for millions of graduates then we are sowing the seeds of destruction for the society at large.

Government is not like science or technology – where we build, intentionally, on past experience to create something that becomes better and better over time. Instead, it is rather like an evolutionary development…that often ends with extinction.

Since America’s modern social welfare democracy is not the product of enlightened rational, accumulated decision-making, America’s leaders will be unable to re-design it for the new conditions it faces. Instead, this social welfare democracy will face extinction – like dinosaurs and Neanderthal man…and all previous forms of government…all previous forms of paper money…and all previous monetary systems.

In other words, don’t expect the US government to reduce its deficits and bring its finances under control voluntarily. It will take a crisis…and maybe even a revolution.

Let’s look at the financial situation more closely. As near as I can tell, the Great Correction continues, much as we thought it would. This is “Year 5” of the Great Correction. There is much more to go.

A Great Correction is very different from a recession. It is not a pause in an otherwise healthy economy. Instead, it is a change of direction…an adjustment to new circumstances (similar and related to the adjustment needed in government itself). After 60 years of near continuous credit expansion, the economy is finally deleveraging…reducing credit in the private sector.
To give you one small indication of the kind of adjustment that is taking place, let’s look at some good news. US manufacturing is finally picking up. For the first time in 10 years, more people are now joining the manufacturing labor force than leaving it. Of course, this is just what you’d expect. Labor costs are going down. At the margin, America’s competitive position is improving.

But this is not, as the media has advertised, “proof” the economy is recovering. Far from it. It is proof that the economy is not recovering at all. It is going in a different direction…and responding to a different set of circumstances. Much of the last 10 years was spent in bubble territory. During that time the economy was losing manufacturing jobs, not gaining them. The economy is not now “recovering” to the bubble conditions of 2005-2006. It is moving on.

And it’s a good thing. Who would want to go back to an economy that destroyed real jobs in manufacturing while creating phony, unsustainable jobs in finance and housing? Now the economy is simply doing what it should do: it’s adjusting to new conditions. Unfortunately, it will take time. You don’t shift the world’s largest economy overnight. So, the rate of joblessness is likely to remain high for many years as the transition takes place.

The other major feature of the Great Correction is the weakness of the housing industry. This too is perfectly predictable. The nation has too many houses – and they’re still too expensive. The figures show that about one in four homeowners is underwater. And there is no reason to think he’ll come to the surface any time soon.

The latest S&P/Case-Shiller numbers show the housing market seems to be entering a second dip. Once homeowners realize this, they are likely to also come face to face with their grim choices. They can default. Or they can wait it out – paying more for housing than the going rate. Many will choose to default, bringing housing prices down further. Some won’t have a choice: they won’t be able to meet mortgage payments.

Housing and jobs are the twin pillars of household wealth in America. The papers are full of stories about what happens to people when these pillars give way. High unemployment rates have lowered household income and forced people to take jobs at salaries far below their peaks. A record number, 43 million, of Americans now depend on food stamps. Children are moving back in with their parents – even adult children. And tax receipts are falling. At the local and state level this is causing havoc. The feds can print money. But California, Illinois and New Jersey can’t. And between the 50 states there is something like $2 trillion worth of unfunded pension obligations.

So far, all of those things were expected. It is a Great Correction, after all. Also expected – but still not fully appreciated – was the reaction of the US government and the Fed. When the crisis began, we calculated that it would take about seven years to bring debt levels in the private sector down to where a new period of genuine growth could begin.
We just looked at the debt levels and guessed about how long it would take to default, restructure and pay them down. There were plenty of other calculations based on different assumptions. But they all came up with about the same answer: between 5 and 10 years.

But we all underestimated the ability of the feds to muck things up. Thanks to federal intervention, it now looks as though this period of transition may take much longer. Obviously, the feds are adding debt while the private sector is getting rid of it. But it goes beyond that. The feds are also propping up the industries that need to be cut down to size – finance and housing – at a cost of over a trillion dollars.

The feds are also trying to engineer a recovery…and promising one. As I mentioned above, a recovery is just what we don’t need. But promising that the economy will return to its previous condition leads people to think that they don’t really have to make major changes. All they have to do is wait. This further delays the transition to a new economy.

Pretending the economy will return to its old pre-2007 self also makes people think that they will be safe in pre-2007 investments. So they stick with stocks and bonds…and eschew the one asset they most need. With all the talk of a “slow recovery” investors don’t suspect that there is anything really wrong…or at least nothing that a few trillion in stimulus spending can’t fix! So, they don’t make the sort of changes that they need to make – in their personal finances and in their investments.

The feds are not only stalling the transition, they are also destroying the currency and the credit of the world’s largest economy. This further confuses the situation and creates huge uncertainties. Investors are nervous. They don’t know what to expect.

They become reluctant to commit to large long-term projects – just the kind the country needs, in other words.

If you can’t trust the value of the money, how can you make a capital investment that will only pay off five years from now? How can you even make a budget or a business plan? Serious investors hold off…or put their money into the growth economies overseas, where the risk/reward ratio is more favorable and the financial authorities are not actively trying to undermine the local currency.

What is in some ways most remarkable is that even five years into the correction, the US authorities still seem to have no idea of what is going on. Ben Bernanke recently told us that we could expect 3% to 4% growth this year. Since he completely missed the biggest financial crisis in 80 years, you have to question his forecasting abilities. But even if he is right about the GDP growth rate, he doesn’t seem to understand what it means.

He admits that 3% to 4% growth is not enough. He’s thinking about employment. At that growth level, you can barely keep up with new people coming into the workforce, let alone reabsorb the 15-30 million who are currently out of work. It is also too slow to keep up with the debt load. The deficit is expected to be about 10% – two to three times more than the anticipated additional GDP. This will mean, grosso modo, an increase in the national debt equal to 6% or 7% of GDP.

You can’t expect to do that for very long. But here is the remarkable thing: so far, there is little official recognition of the dark, dangerous road that the feds are driving down. In the fedsʼ minds, the problem is that the economy is growing too slowly. Three percent isn’t enough. They believe they need more growth…and they believe they can get it by “stimulating” the economy.

It is as though they were driving down a wet country road at breakneck speed. The radio is not working very well, so they step on the accelerator, trying to catch the radio waves before they get away. When this doesn’t work, they go even faster.

This is not the way to make the radio work. It is the way to get in a serious wreck.

*We are not aware about the author of the article,but the article is interesting and debatable. Vivek Karwa

End to sordid saga of hidden hoards?

Business Line, 19/1/2011

B.S. Raghavan

One can only hope that the promised disclosure by Wikileaks founder, Mr Julian Assange, of the names of 2,000 high-net-worth entities and individuals from Britain, the US and Asian countries who have hidden their unaccounted-for wealth in Swiss banks, and whose names were ceremoniously handed to him in two compact discs (CDs) in London on January 17 by the former Chief Operating Officer of Julius Baer, Mr Rudolf Elmer, will write finis to a sordid saga that had defied all efforts at unravelling the mystery for more than half-a-century.

I am reacting to the news guardedly because of my uneasiness about the infinite ingenuity and formidable influence of the account-holders, but for which they could not have made their piles and kept guard over their hoards all this time.

One can be sure that within the government of every country to which they belong, they have extensive political and official networks with a vested interest in perpetuating anti-social and anti-national activities such as corruption, tax-evasion and money-laundering.

In India, too, we have been witness to the same kind of pretence and prevarication at work — outwardly professing keenness to unearth the long buried booty but in reality, doing precious little, by citing a variety of inventive excuses (privilege, embargo in tax agreements, need to renegotiate tax treaties, denial of permission by authorities, deficiencies in enactments).

For instance, according to the Reuters report of the media conference at London, “Some, if not most, of the material has already been handed over to government authorities in countries where the account holders are believed to reside.” This can only mean that Delhi is already in possession of much of the details contained in Mr Elmer’s CDs. Is it, or is it not? We, the people, have a right to know, but we also know we will get no answer, just as the Government has so far succeeded in holding back from us the names of 50 tax evaders handed to it by the German Government.

The usual trick is to erase the case from public memory so that it is no longer a live issue. Does anyone know what happened to the cases of Hassan Ali Khan and Chandrika Tarpuriah, on whom the Income-Tax Department served notices in January 2009, raising a demand of Rs 40,000 crore and Rs20,000 crore respectively for stashing undisclosed amounts of $8 billion and $1.6 billion in foreign banks?


It is quite on the cards that the hoarders abroad of illicit wealth have by now had enough time to sanitise their holdings, and even make them evaporate. They are capable of fighting a protracted rear-guard action, with the help of their cohorts in the political and official networks.

They can make the governments, the public, tax departments and courts of law ineffective and helpless by every conceivable means: Dubbing the information and documents as false and fabricated, resorting to their standard description of the whole operation as “politically motivated”, stalling proceedings at every stage and every level and, finally, by obliterating all record of their malfeasance!

Meanwhile, they have received the ‘godsend’ of an offer from the Swiss Banks Association, of which it is doubtful whether even the Government is aware. It has come forward to regularise the assets of foreign clients hidden from their governments by levying a flat rate tax and passing on the proceeds to those governments, freeing the account-holders from any further obligation to disclose their assets or their investment income to the tax authorities of their countries. I can see them getting into a stampede to grasp the offer.

Hence, Mr Assange will be well-advised to put the list on his Website quickly, for the longer he tarries, the greater the opportunity for the miscreants to do a Harry Houdini and make sure that the follow-up action comes to naught. My fear is that it is already too late.

Black Money of Indians in Swiss Bank Accounts

So much they don’t know

by Ila Patnaik, Indian Express 4/1/11

The Indian economy is showing signs of overheating. But the RBI lacks a clear monetary policy framework that can address the problem. In the coming years, the RBI should focus on research that will build the foundations of such a framework.

The performance of the Indian economy in 2010 was beyond expectations. The GDP growth was higher than expected. But at the same time, inflation was also above acceptable levels. The current account deficit was higher than historical levels. Property prices rose at an average of 30 per cent during the year. Liquidity became tight and credit demand rose. By the end of the year the Indian economy witnessed most signs of overheating.

However, concerns about output and employment growth weighed upon policy-makers. There was no serious attempt at fiscal consolidation. Monetary tightening neither pulled output growth down nor contained inflation. Did India err on the side of too much caution? Should macroeconomic policy have been tightened much more to prevent overheating?

Macroeconomic policy-making is hard, as it involves judgment and is done under conditions of uncertainty. Raising rates is also almost always harder than cutting them. Few people criticised Greenspan’s low interest rates or clamoured for hikes in the Greenspan years. The “great moderation”, with low inflation and stable growth, was appreciated by most at the time.

India is one of the fastest growing economies in the world today. It is an engine of growth for the world economy. High growth rates in India are above expectations and almost unbelievable. A rate hike that would upset growth would be unpopular.

Further, to have a significant impact on growth and inflation, the RBI would have to raise rates significantly. Monetary policy transmission is weak in most emerging economies. Financial markets are not well developed, and changes in policy rates do not translate into changes in lending and borrowing rates across the financial sector. In addition, a large part of the economy only has access to informal finance. This makes the transmission mechanism of monetary policy in India very weak. Former RBI governor C. Rangarajan had to raise rates by 500 basis points to bring high inflation under control. Small changes in rates do not have a large enough impact on the economy. Weak transmission of monetary policy makes the central banker’s job even more difficult. That we do not know how weak this effect is, makes the problem harder.

Monetary tightening would perhaps be less unpopular if it was happening in the midst of high export growth. If the RBI raises rates, interest differentials with the world would increase. Fears of carry trade and rupee appreciation would be raised. Concerns about the sustainability of the current account deficit would be raised. What would be forgotten is that the most important determinant of export and import growth is growth in the world and Indian economies respectively. A reduction in Indian GDP growth would reduce the demand for imports. A reduction in domestic prices would shift demand away from foreign goods to domestic goods. Lower import growth would reduce the current account deficit. Any effect of rupee appreciation on trade is likely to be small compared with the effect of a change in output. A large current account deficit, a symptom of high aggregate demand, is normally a reason for raising rates, not keeping them low. Empirical studies of the causal relationships involved are needed to assess the magnitude of the impact.

In addition, food inflation accounts for a significant share of India’s rising inflation. Our understanding of the role of monetary policy in India in stemming inflation when food prices rise is still rudimentary. Little theoretical or empirical work exists to support the view that the RBI can do much to control inflation when it is caused by rises in the price of food. While there is some recent evidence to suggest that food inflation feeds into higher wages and higher inflationary expectations, setting off a wage-price spiral, there seems to be little consensus within the RBI to support this view. Speeches by RBI staff often take a different and conflicting view on the subject. An understanding of inflation caused by rising commodity prices is similar. There is confusion within the RBI about whether it should respond to rising world commodity prices by raising rates or not.

The consequence of the RBI’s lack of research and a clear framework was visible in the most recent credit policy review. When its policy of monetary tightening failed to slow down growth or inflation, and the money market continued to witness tight liquidity, the RBI put brakes on its policy direction, and signalled monetary easing. This happened to be exactly the opposite of what it should have done.

Looking forward, the RBI may raise rates, but its lack of conviction may mean this might be done in baby steps and may have little impact. High inflation may consequently become a problem that remains with us for many years.

This lack of both clarity and framework, on the part of the RBI, has resulted in one of India’s biggest problems: high inflation. Empirical and theoretical research to understand price behaviour and the functioning of monetary policy in India; how policy should respond to food inflation and commodity prices; inflationary expectations; what would be the impact of changes in policy rate on output, on prices, on the rupee, and on the current account deficit should be on top of the RBI’s agenda.

Instead of engaging in debates about whether inflation should be one of its many targets, or its only target, the RBI should focus on building a monetary policy framework that helps India obtain a low and stable inflation rate. A country with high inflation can neither guarantee financial stability, not high growth or employment. Only when RBI has a clear, coherent and effective strategy, backed by high quality empirical and theoretical research, on how to tackle inflation, can it fulfil its primary role and function. Research to develop such a framework should be the RBI’s top priority in 2011.

The writer is a professor at the National Institute of Public Finance and Policy, Delhi

Jalan Panel Disrespects Parliament

Economic TImes, 15/12/10

Surprisingly, no one has commented yet on how insulting it would be for the Indian Parliament if the recommendations of the Jalan committee report are accepted by Sebi and enacted as Sebi regulations, in effect overruling statutory law.
The recommendations contradict several provisions and the entire philosophy of a previous committee headed by a former Chief Justice of India M H Kania (the Kania report) which counted stalwarts such as a former chief justice of a high court, Y H Malegam and importantly, no Sebi official.

The Kania report was accepted by Sebi and by Parliament, which extensively amended not only the securities laws to enable corporatisation and demutualisation, but also gave a special tax exempt dispensation to various entities. Sebi has publicly supported the Jalan report prematurely, even though it is still under a period when Sebi is seeking public comments on the recommendations.

Profits are evil: The Kania report accepted by Parliament mandated 22 not-forprofit exchanges to become for-profit by amendment to the Securities Contract (Regulation) Act (SCR Act). Now in a flip-flop , the Jalan report recommends stock exchanges to generate only ‘reasonable’ profits.

Reasonable has been defined as something over government securities’ return. The recommendation raises the false bogey of profitmaking entities being somehow inferior. The NSE as a profitmaking entity has consistently evaded scams but the BSE prior to corporatisation (as a charitable organisation) was involved in several scams.

Restriction on profitability will mean that no further investment will result in the sector and investors who invested Rs 10,000 crore based on the statutory amendment will not only lose a bulk of their investments but will have a share with the returns of debt (capped) and the risk of equity (possibility of losing all).

Listing: The Kania report recommends that a demutualised stock exchange may list its shares on itself or on any other stock exchange, though listing should not be made mandatory. The Jalan report recommends that listing should be prohibited because, “An MII (market infrastructure institution) should not become a vehicle for attracting speculative investments. Further, MIIs being public institutions, any downward movement in its share prices may lead to a loss of credibility and this may be detrimental to the market as a whole.”

This is an amazing conclusion. On the one hand, listing is so important for the economy that its market is called a public utility; at the same time, it is so horrible that exchanges can lose their credibility by being listed. The Jalan report thus results in the official implementation of hypocrisy that listing is good for all companies but is bad for exchanges. It is loss of credibility which causes fall in share price and not the other way round — the mirror doesn’t cause us to be ugly.

Further, the recommendation would result in poor governance, lack of accountability to shareholders and lack of transparency. Ceiling on ownership: The Jalan report suggests a ceiling of 5% on the equity shareholding (including warrants and other ‘value’ instruments) and allows only public financial institutions and banking companies with a net worth of at least Rs 1,000 crore to invest up to 24%. Interestingly, the report contradicts its own annexure (by misquoting it) by saying an ownership cap is the international standard.

In fact, the report’s own annexure shows that India is the only country in the world with an ownership cap. In fact, none of the countries listed in the annexure even has a voting cap. Other countries in the world only have disclosure standards or permission for crossing a limit to ensure fitness of such shareholders.

THE Jalan report seeks to give special status to banks and public financial institutions as anchor investors with around five times the shareholding permitted to others despite the fact that both JPC reports on stock market scams have implicated banks and public institutions for actively participating in the biggest financial scams in independent India.
One chapter of the 2003 JPC report is devoted to the role of banks and seven chapters of the report is devoted to UTI. In any case, banks and FIs are passive investors and invest for returns rather than for charity — given the cap on profit, it would take a very charitable institution to invest in an exchange.

The cap on ownership for others means there is no interest in setting up a new exchange as the promoter cannot own over 5% equity in an exchange. I have written an open letter to the Jalan Committee in this paper (ET, 12 May 2010) explaining why this cap is perverse.

Competition: While the Kania report recognised the need for stock exchanges to cope with competition and hence recommended demutualisation, the Jalan report actively recommends that Sebi should discourage competition, and that it should choose how many players should be allowed in the exchange space. “Sebi should have the discretion to limit the number of MIIs operating in the market, in the interest of the market and in public interest.”

Besides reminding one of an A Raja kind of allotment of 2G spectrum, this is an anti-competitive recommendation contrary to the Competition Act, 2002.

Executive compensation: The Jalan report introduces a recommendation on the remuneration of top management of stock exchanges to be a fixed sum without any variable component linked to the commercial performance of the stock exchange. This recommendation lays the foundation for destroying performance in exchanges which cannot incentivise their management (specially in a growing or struggling exchange).

What the market needs is more competition and better regulation rather than less competition and outsourced regulation. The Jalan committee takes us back not just in time but to the Soviet philosophy of 1970s. I hope that the readers of this column, unlike the committee, do not welcome the world of 1980s phone lines which also carried the public utility tag and an eight-year wait in public interest, or the choice of Ambassador and Fiat cars with a 10-year queue — in the national interest. Viva public ‘service’ death to profits.

(The author is of Finsec LawAdvisors. The firm has advised exchanges and its investors on the impact of the report.)