Vijay Joshi

India’s Rs 1,66,276 Crore Problem

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One of the major points that we talk about in India’s Big Government is the fact that the Indian state is overambitious. The government wants to do too many things at the same time, and ends up making a mishmash of everything.

One of the areas where the governments (both central as well as state governments) devote a lot of their time and attention are public sector enterprises. In the past columns, we have discussed many cases of central public-sector enterprises continuing to bleed and the government continuing to bail them out, year on year. This includes loss makers like Air India and Hindustan Photo Films Manufacturing Corporation, which have been losing money for many years.

In fact, very recently, the government revealed the losses of the perennially loss-making Air India, in the Lok Sabha. For 2016-2017, the government owned airline made losses of Rs 5,765 crore. Despite all the government spin around the airline working in a much better way, than it was in the past, the losses increased by 50%. In 2015-2016, the losses of the airline were at Rs 3,837 crore. With these numbers, it is surprising that a few media houses chose to report the fact that the operating profit of Air India, had improved year on year. But how does that matter, when the losses have gone up by 50%?

The airline has lost a total of Rs 41,657 crore, between 2010-2011 and 2016-2017. It continues to function on back of the government investing money in it, every year. Between 2011-2012 and 2017-2018, the government has invested a total of Rs 26,545 crore, into the airline. Of course, as we keep saying, every extra rupee invested in this airline, is a rupee taken away from more important areas like defence, education, health, agriculture etc.

Over and above this, the banks give the airline working capital loans. These loans as of March 31, 2017, amounted to Rs 31,088 crore. The question is why do banks give an airline which has accumulated losses of greater than Rs 41,000 crore, more loans? The answer lies in the fact that Air India is ultimately owned by the Indian government. No private sector airline in a similar situation, will get bank loans.

And lending to Air India is essentially lending to the government. Any default on loan repayment by Air India will be seen as a default by the Indian government. Hence, the assumption is that such a default is never going to happen. Given this, banks are happy to keep giving loans.

The point in throwing all these numbers at you, dear reader, is to show you, that it takes a lot of money to keep a “dead elephant” like Air India, alive. It is beyond the government babus who run this airline, to breathe life into it. With every new appointment at the top, we are told this gentleman will now revive the airline. But that hasn’t happened in years.

Meanwhile, the government continues to invest money in the airline. At the same time, the accumulated debt of the airline stands at Rs 48,447 crore (this includes aircraft loans over and above, the working capital loans). The good part is that the total debt is down from Rs 52,817 crore as of March 31, 2016. This is ultimately, the liability of the government of India, which actually does not show on its books.

In the recent past, there has been some talk about selling the airline, lock, stock and barrel. But then, until things really happen, talk is just talk. In fact, the government has been talking about selling the airline since June 2017. The proof of the pudding, as they say, is in the eating.

Air India, over the years, has become a poster boy of the government owning and continuing to run, loss making enterprises. This problem is well known at the central level. In 2015-2016 (the latest set of agglomerated numbers which are currently available) 78 out of the 244 central public sector enterprises, were loss making. Of these nearly half of the companies had made losses three years in a row. Further, between 2006-2007 and 2015-2016, a period of a decade, the net profit to capital employed ratio, of the central public sector enterprises has fallen from 12.27% to 5.97%. This tells us how well the government’s capital (or in other words the taxpayer’s capital) is being put to use.

The story of central public sector enterprises not doing well has been well highlighted over the years. But the same cannot be said for public sector enterprises owned by the state governments. Economist Vijay Joshi in a recent lecture pointed out: “In addition to Central PSEs, there are around 1000-odd State PSEs, of which two-thirds make losses, including notably the zombie electricity distribution companies. The aggregate losses of all PSEs, central and state, amount to about one per cent of GDP annually.”

One percent of  the GDP is not a small amount. The GDP (gross domestic product) at current prices for 2017-2018 is projected to be at Rs 16,627,585 crore. One percent of this works out to around Rs 1,66,276 crore. This is a large amount of money.

Of course, a lot of this amount, the government is not currently paying for directly. Many public sector enterprises borrow from banks, in order to make up for their losses. The banks lend them money simply because these companies are ultimately owned by the central and the state governments.

Hence, the total liabilities of the government keep increasing day by day and will have to be paid for one day, simply because a government cannot default.
Rs 1,66,276 crore are just the projected losses of India’s public sector companies, for this year. Imagine, the kind of losses that have been accumulated over the years. Now imagine the kind of money that has been borrowed by these companies to keep running.

And now imagine, the kind of money that the government of India will have to provide in the years to come, to keep repaying these loans.

It’s a very scary proposition. And since, in the end, we are always asked, but what is the solution, let’s provide a solution, at least this time around. As Joshi said in his speech: “So far, successive Indian governments have been stuck with the fetish of 51 per cent ownership and have only flirted with the idea of privatization…It is high time the government grasped the nettle of mounting a substantial programme of privatization, at least of those PSEs that make losses or meagre profits… This gain could be used by the government to invest in socially beneficial activities that the private sector would normally avoid, such as rural roads and irrigation.”

But this is what we call an impossible solution. Joshi is not the first economist to have recommended the sale of public sector enterprises and the investment of the money thus generated into public goods. The government(s) have been in the know of this solution for a very long time, and have chosen to do nothing about it, up until now. And there is no reason for them to change that.

The column originally appeared in Equitymaster as on February 15, 2018.

Can India Afford a Universal Basic Income?

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In the recent past, there has been a lot of talk around the government providing a universal basic income(UBI) to every Indian.  If UBI becomes the order of the day, then the central government will carry out an unconditional income transfer to every Indian, rich or poor, on a periodic basis (perhaps monthly).

The question is can we afford it? The answer seems to be no. This becomes clear from a remark made by the NITI Aayog Vice Chairman Arvind Panagariya, in a recent interview to The Indian Express: “The Tendulkar urban poverty line at 2011-12 prices is Rs 1,000 per person per month. Due to inflation between 2011-12 and now, at today’s prices, this sum would be significantly larger. But transferring even Rs 1,000 per month to all Indians would cost Rs 15.6 lakh crore (Rs 1,000 x 12 months x 130 crore people) a year. We simply do not have this magnitude of fiscal resources.”

The total expenditure of the Indian government during 2016-2017 has been projected to be at Rs 19.78 lakh crore. Rs 15.6 lakh crore amounts to around 79 per cent of the total expenditure of the Indian government. This makes it unviable. Or so it seems.

The question that crops up here is that why are economists who are recommending UBI, actually recommending it? It doesn’t take much Maths to understand that India cannot afford a universal basic income at this point of time.

The economist Pranab Bardhan in a 2011 article in the Economic & Political Weekly, said: “The main question is: if we want it to be universal, can we afford it? Of course the answer depends on the amount to be given out, if it will be a replacement for the existing transfer programmes which have a lot of wastage and misappropriation.”

The point being that many of the current subsidy programmes run by the government are excessively leaky. Given this, the subsidies don’t reach those that they are meant for. This includes subsidies on rice, wheat, kerosene, sugar, fertilizer etc. In this scenario, it perhaps makes more sense to shutdown these subsidies and handout cash directly to every citizen, who can then spend it the way he or she deems it to be fit.

The economist Vijay Joshi gets into the actual nitty-gritty of UBI in his book India’s Long Road—The Search for Prosperity. He talks about multiple things that will help government raise revenue as well as cut down on expenditure, and in the process, make way for UBI. Let’s look at his suggestions.

Joshi talks about a courageous government taxing agricultural incomes and in the process managing to raise 0.5 per cent of the GDP as annual revenue. He also talks about privatising public sector enterprises leading to efficiency grains and helping raise resources of 1 per cent of GDP annually, for the next decade. Over and above this, there are many counterproductive tax exemptions that have been given over the years. Joshi hopes that doing away with these exemptions would help raise revenues by around 1.5 per cent of the GDP per year.

Joshi then recommends the winding up of non-merit subsidies and food subsidies. In total, this would free up resources of at least 10 of the GDP and perhaps up to 12 per cent of the GDP. All this would make UBI viable, feels Joshi.

As he writes: “The most serious non-fiscal problem with transfer schemes is the identification of beneficiaries… Therefore, in my judgement, a universal cash transfer would be the best route to follow. I would therefore recommend the adoption of the scheme… which involves disbursing a ‘basic income’ of Rs 17,500 per household per year, into the bank accounts of all households.”

Transferring money to every household of this country would essentially ensure that the government does not have to figure out who is eligible for the transfer and who is not, a major problem with paying out almost all subsidies.

Assuming five people per household and a population of 130 crore we come up with 26 crore households. Hence, the total bill for universal basic income would work out to around Rs 4.55 lakh crore, at Rs 17,500 per household per year. If the government is able to eliminate other subsidies and at the same time raise revenues through measures like taxing agriculture, then the UBI is very workable.

And given that many existing subsidies are terribly leaky, transferring money directly to citizens and letting them decide what to do with, makes more sense. There is enough research evidence to show that when people(especially women) are given money they tend to use it wisely and don’t blow it away on alcohol and tobacco. Also, over a period of time, the overall UBI bill can be brought down by allowing people who do not want a basic income to opt out of it.

The trouble is all this is dependent on the fact whether the government is able to eliminate many subsidies that it currently offers including food subsidies. And that is easier said than done. For an economist, making a calculation, it is easy to assume, remove this subsidy, increase that revenue, and everything falls into place. For a politician, it isn’t. And that is where the whole thing starts to unravel.

Let’s take consider some of Joshi’s recommendations. Take the case of taxing agricultural income. On the face of it, this makes tremendous sense. Nevertheless, which politician would have the balls, to venture into this territory.

Or take the case of selling off public sector enterprises, lock, stock and barrel. No government till date has shown even a remote inclination to do something like that. Or doing away with tax exemptions that favours corporates. While politicians talk about it all the time, nothing seems to happen.

The joker in the pack is doing away with food subsidies. Currently, the government sells rice and wheat at subsidised prices through the fair price shops that make up for the public distribution system all over the country. The government acquires rice and wheat from farmers and then distributes it through the public distribution system. If food subsidies are done away with, this procurement would not be required.

Hence, in an ideal world, a successful universal basic income programme would mean the end of the procurement, transportation and distribution of subsidised rice and wheat. This would mean that the government would have to stop acquiring the massive amount of rice and wheat that it does from farmers directly through the Food Corporation of India and other state procurement agencies.

This is something that hasn’t been discussed at all by the economists recommending the universal basic income. Would politicians be ready for something like this? What would be the impact on food inflation? Does the open market for rice and wheat work well enough? What would happen to the five lakh fair price shops across the length and the breadth of the country? Would the government shut down the Food Corporation of India, or would it scale down its operations?

These are questions which no one would like to get into. In this scenario, my guess is that if universal basic income is introduced in the near future, it will be over and above the government subsidies already in place. And that can’t possibly be a good thing. It is something that the country cannot afford.

The column originally appeared in Equitymaster on January 27,2017

India’s Economic Growth and the Power of Compounding

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On August 2, 2016, I had talked about a bungalow on the posh Nepean Sea Road in Mumbai, being up for sale.

The bungalow was last sold in 1917, at a price of over Rs 1 lakh.  Further, similar properties in the vicinity in the recent past had been sold for Rs 400 crore, or so, The Times of India reported.

Essentially, something that was bought for around Rs 1 lakh, 99 years back, is now expected to be sold for around Rs 400 crore.

This works out to a return of 11.3 per cent per year.

How how much would have the bungalow been worth now in 2016, if the rate of return had been just 30 basis points lower, at 11 per cent per year? One basis point is one hundredth of a percentage.

Would like to take a guess, dear reader?

Rs 395 crore? Or Rs 375 crore? Or even lower than that?

In fact, the answer will surprise you.

At a return of 11 per cent per year, the bungalow would have been worth around Rs 306.9 crore, or almost Rs 93.1 crore lower.

This would mean that the bungalow would be worth 23.3 per cent lower in comparison to Rs 400 crore.

And how much would the bungalow be worth at a return of 10.5 per cent per year? Would you like to take a guess?

Actually let me not prolong the agony. At 10.5 per cent per year, the bungalow would have been worth around Rs 196.3 crore. This is less than half of Rs 400 crore. Hence, a fall in return of 80 basis points per year, wipes off the value by more than half, over a 99-year period.

And how much would the bungalow be worth at 10 per cent per year? Rs 125.3 crore. This is around 68.7 per cent lower than Rs 400 crore.

So what is the point I am trying to make here? This is what the power of compounding can do. Even a small difference in return over a long period of time can make a huge difference to the amount of corpus you end up accumulating.

Of course, a normal person who is trying to accumulate wealth does not invest over a 100-year time frame. And further, even if he or she did, there is no way of knowing in advance what strategy would work best, over such a longish period of time.

Nevertheless, this piece is not about which is the best investment strategy in the long run. It is about the fact that what applies to investment returns also applies to the economic growth rate. Even a small difference in the annual economic growth rate over a longish period of time, can have a huge impact on how a country eventually turns out to be.

As Vijay Joshi writes in India’s Long Road—The Search for Prosperity: “The ‘power of compound interest’ over long periods is such that even a small change in the growth rate of per capita income makes a big difference to eventual income per head.”

And how do things look for India? Where would it end by 2040 at different rates of economic growth? As Joshi writes: “At a growth rate of 3 per cent a year, income per head would double, and reach about the same level as China’s per capita income today. At a growth rate of 6 per cent a year, income per head would quadruple to a level around that enjoyed by Chile, Malaysia and Poland today. If income per head grew at 9 per cent a year, it would increase nearly eight-fold, and India would have a per capita income comparable to an average high-income country of today.”

The question is what will make India a prosperous country. How do we define prosperity? As Joshi writes: “At a first pass, it could be defined as the level of per capita income enjoyed by the lower rung of high-income countries today, with the rider that national income should be widely shared and even the poorest people should have decent standards of living. To reach the said goal, India would require high-quality per-capita growth of income of around 7 per cent a year for a period of twenty-four years, from 2016.”

 The trouble is that there is almost no track record of any country (except China) growing at a rapid rate of 7 per cent per year, for a very long period of time, which is what India needs to achieve if it has to be prosperous.

When it comes to superfast growth China grew by 8.1 per cent per year between 1977 and 2010. Only two other countries came anywhere near. As Lant Pritchett and Lawrence H. Summers write in a research paper titled Asiaphoria Meets Regression to the Mean: “There are essentially only two countries with episodes even close to China’s current duration. Taiwan had a growth episode from 1962 to 1994 of 6.8 per cent (decelerating to growth of 3.5 percent from 1994 to 2010). Korea had an episode from 1962 to 1982 followed by another acceleration in 1982 until 1991 when growth decelerated to 4.48 percent—a total of 29 years of super-rapid growth (>6 per cent)—followed by still rapid (>4 per cent) growth. So, China’s experience from 1977 to 2010 already holds the distinction of being the only instance, quite possibly in the history of mankind, but certainly in the data, with a sustained episode of super-rapid (> 6 per cent per annum) growth for more than 32 years.”

Hence, the odds are stacked against India. And it will mean the governments doing many things right in the years to come, if the country has to get anywhere near a sustained growth rate of 7 per cent or more, for a longish period of time.

The trouble though is that most policymakers seem to take a growth rate of 7 to 8 per cent as a given, in their calculations, even though history shows otherwise.

The column originally appeared in Vivek Kaul’s Diary on August 18, 2016

Why Governments Love Inflation

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The Reserve Bank of India(RBI) governor Raghuram Rajan has often been accused of not cutting the repo rate fast enough and in the process hurting economic growth.

Repo rate is the interest rate at which RBI lends to banks. The hope is that once the RBI cuts the repo rate, banks will cut their lending rates as well. In the process people will borrow and spend and economic growth will return.

The Rajan led RBI started cutting the repo rate from January 2015 onwards. Between then and now it has cut the repo rate by 150 basis points, from 8 per cent to 6.5 per cent. One basis point is one hundredth of a percentage.

In June 2016, the rate of inflation as measured by consumer price index was at 5.77 per cent. The repo rate at 6.5 per cent is hardly high enough.  The gap between the repo rate and the rate of inflation is not even 100 basis points. As Rajan said recently: “This discussion keeps going on without any economic basis. You saw the CPI numbers just last week. 5.8 per cent is the CPI inflation, our policy rate is 6.5 per cent. So I am not sure where people say we
are behind the curve. You have to tell me that somehow inflation is very low for us to be seen as behind the curve. So, I don’t really pay attention to this kind of dialogue.”

Also, the rate of inflation in January 2015 was at 5.19%. Since then it has risen by 58 basis points to 5.77% in June 2016. During the same period, the repo rate has been cut by 150 basis points. So the RBI has cut the repo rate despite, the rate of inflation going up. Hence, the question is, how has it been slow in cutting the repo rate? People who make such arguments, typically do not look at numbers and say things for the sake of saying them.

The fact of the matter is that all governments love lower interest rates and inflation. One reason for this is that low interest rates and inflation can create some growth in the short-term. As I had explained in yesterday’s column quoting a February 2014 speech of Raghuram Rajan: “if lower rates generate higher demand and higher inflation, people may produce more believing that they are getting more revenues, not realizing that high inflation reduces what they can buy out of the revenues. Following the saying, “You can fool all the people some of the time”, bursts of inflation can generate growth for some time. Thus in the short run, the argument goes, higher inflation leads to higher growth.”

The trouble is that this inflation eventually catches up with growth. As Rajan said: “As the public gets used to the higher level of inflation, the only way to fool the public again is to generate yet higher inflation. The result is an inflationary spiral which creates tremendous costs for the public.”

Take a look at the following table.

YearInflation (in %)Economic Growth (in %)Fiscal Deficit as a % of GDP
2007-20086.29.322.54
2008-20099.16.725.99
2009-201012.378.596.46
2010-201110.458.914.8
2011-20128.396.695.73
2012-201310.444.474.85
2013-20149.684.744.43
    
  

In 2007-2008, things were going well for India. The gross domestic product(GDP) grew by 9.2 per cent. The fiscal deficit was at 2.54 per cent of GDP. The inflation was at 6.2 per cent. Then the financial crisis struck in 2008-2009. The government decided to tackle the slowdown in growth by increasing its expenditure. In the process the fiscal deficit went up as well. Fiscal deficit is the difference between what a government earns and what it spends.

The fiscal deficit reached 5.99 per cent of the GDP. Next two financial years the economic growth crossed 8.5 per cent. The rate of inflation also entered double digits. The extra expenditure did manage to create growth, but it also created inflation.

This ultimately caught up with economic growth. The economic growth fell to below 5% levels in 2012-2013 and 2013-2014.

Hence, high inflation ultimately caught up with growth. But it did create growth for two years and during that period the Manmohan Singh government looked good. In fact, if the Lok Sabha elections were around that period, the Congress led United Progressive Alliance would have done much better than it eventually did.

The larger point is that any government has only got a period of five years to show its performance and in that period it has to do whatever it takes. If that means turning on inflation to create growth, then so be it. The trouble is that once you get inflation going, it is very difficult to control, as we clearly saw between 2007-2008 and 2013-2014. But the lessons of that are still not appreciated.

In fact, there is another lesson to learn here. As Vijay Joshi writes in India’s Long Road—The Search for Prosperity: “The Indian state has systematically underestimated the prevalence and the cost of ‘government failure’. It often intervenes, arbitrarily or to correct supposed market failures, without any clear evidence that the market is failing, and so ends up damaging resource allocation and stifling business drive.”

While, inflation ultimately catches up with economic growth, it ends up helping the government in another way. The government finances its fiscal deficit by borrowing. When it borrows the absolute level of government debt goes up. Despite this, government debt expressed as a proportion of the gross domestic product, might come down, because the GDP in nominal terms is growing at a faster pace than the debt, due to high inflation.

As Joshi writes: “From 2008 onwards, fiscal consolidation [in fact, the government was spending more] was meagre but this did not stop the debt ratio falling from 80 per cent of GDP in 2008-2009 to 68 per cent in 2014-2015. This is because high inflation eroded the value of debt.”

Due to inflation, the nominal GDP (which is not adjusted for inflation like real GDP, and against which total debt is expressed) went up at a much faster pace than the total debt of the government. This led to government debt expressed as a proportion of GDP falling.

Given this, there is more than one reason for the government to love inflation.

The column originally appeared on July 20, 2016, in Vivek Kaul’s Diary on Equitymaster

How Business Funds Politics

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In the year 1969, Indira Gandhi split from the Congress party, to form her own Congress party. At that point of time, Gandhi was worried that the corporates would back the parties which opposed her.

Hence, she banned corporate donations to political parties. As Vijay Joshi writes in India’s Long Road—The Search for Prosperity: “One of the watershed moments in the history of corruption was the ban on corporate donations to political parties imposed by Mrs Indira Gandhi in 1969 because she was concerned about the money that would flow into the coffers of the right wing parties that opposed her.”

Of course, this did not stop corporates from donating money to political parties; it only drove them underground, into black money. This ban was lifted in 1985, after the assassination of Gandhi in October 1984. But the black money-non transparent nexus of businesses and politicians has continued since then.

There is very little direct evidence for this other than a few sting operations over the years where politicians have been caught on tape, asking for money. These sting operations have impacted the credibility of politicians across party lines.

Nevertheless, there is some very good research evidence to suggest that businesses do pay politicians before elections. In a paper titled Quid Pro Quo: Builders, Politicians, and Election Finance in India Devesh Kapur and Milan Vaishnav look at cement consumption of builders to show that builders make payments to politicians.

All construction requires cement. When it comes to cement demand, the real estate sector accounts for a major part of the demand in India. When the construction activity carried out by the real estate sector goes up, the demand for cement increases. If the real estate companies are key financiers of politicians, as they are assumed to be, then just before the elections, they will need money to finance the electoral campaign of politicians.

If the real estate companies pay the politicians, it would mean that they will lesser money to carry out their own activities. This would mean a slowdown in construction activity. And a slowdown in construction activity should lead to a fall in cement consumption.

Hence, cement consumption can be tracked to figure out whether real estate companies are actually financing politicians.  Kapur and Vaishnav looked at elections in seventeen Indian states between 1995 and 2010. They found a “contraction in cement consumption (representing a 12 to 15 percent decline) during the month of state assembly elections”. What this clearly tells us is that real estate companies do finance state level politicians, as is commonly inferred.

In fact, there is more evidence of businesses financing the electoral ambitions of politicians through black money. Sandip Sukhtankar looks at this phenomenon in a research paper titled Sweetening the Deal? Political Connections and Sugar Mills in India.

As he writes: “The cane price falls by approximately Rs 20 in politically controlled mills during election years. These drops translate to an economically significant drop in revenues of Rs 60 lakh (US$ 135,000) per election year per mill. Evidence suggests that the profit decline is not due to effects on mill operations, but rather due to appropriation of funds for electoral purposes… From the perspective of farmers, this fall in prices could represent either pure theft by mill chairmen, or indirect campaign contributions.”

Hence, sugar mill owners pay low prices to sugar cane farmers in an election year to be able to funnel more money into electoral campaigns of politicians.

So what is the way out of this? Companies are allowed to take tax credits for corporate donations i.e. they can make a deduction of the amount of political donation while calculating their taxable income. But this hasn’t’ helped. As Joshi writes: “Tax credits do not work because corporates prefer secrecy: they are risk-averse and fear reprisals from parties that win election for donations given to their opponents.”

And so the story continues!

The column originally appeared in the Bangalore Mirror on July 20, 2016