Political Funding

On November 8, 2016, when Prime Minister Narendra Modi declared 86% of the currency in circulation as illegal tender to curb illicit wealth, he promised to take more steps to curb the generation of black money. On December 31, he put the issue of political funding to the fore. To his credit, political funding, which is discussed in hushed tones in civil society and was persona non grata for the longest time, can now be discussed and the means to reform party funding debated in the open.

In keeping with the discussion, the Union Budget 2017 announced certain experimental political party funding methods, which sought to protect the need for privacy and secrecy, while changing the method of payment from cash to electronic money—this, as we now believe, is the panacea for all ailments.

The Budget announced two measures for political funding: (1) capping the cash donation limit at R2,000, and (2) issuance of electoral bonds. Currently, parties are entitled to receive donations below R20,000 in cash. Post April 1, 2017, this amount will stand at R2,000. The announcement is being envisaged as a reform that will crack the whip on the cesspool of black cash that finds its way into funding of political parties.

It was encouraging to see all the political parties unanimously support this announcement. Admittedly, any party that would had not supported this announcement would have invited unwanted attention and further investigation.

On second thoughts, while the spirit of the announcement is reformative, it is worth assessing the impact of this announcement on status quo. How will this change the existing rules of the game?

First, donations are just one of the many sources of funds for a party. For all national parties, donations contribute less than 50% to the total party funds, with the Communist Party of India (CPI) being the only exception. The new rules do nothing to bring about more transparency in the functioning of political parties. Now, all political parties—except the Aam Aadmi Party (AAP)—are united in their opposition to bringing them under the RTI. Neither do they have any desire to have their books audited like any transparent organisation should.

Second, the accompanying chart represents disclosed donations as percentage of the total income of a party. The brilliance of this chart is that the Bahujan Samaj Party (BSP) has not disclosed any donations, as the party claims that all donation received by it is under R20,000—most of it being as low as R1. In light of this, the new R2,000 limit will have no effect on donation declarations of the BSP. One can also assume all other political parties would take the lead of the BSP and claim that all their cash donations are less than R2,000.

It must be noted that the total income of the Indian National Congress (INC) was R765 crore in 2014-15, of which R141.5 crore was received through 280 donors—the average donation being R51 lakh. Similarly, the total income of the Bharatiya Janata Party (BJP) was R970.4 crore in 2014-15, of which R437.4 crore was received through 1,234 donors—the average donation being R35 lakh.

The finance minister does not mention anything about mapping donations to unique donors. As a result, one is likely to see the number of donors (including fictitious ones) multiply and the average donation get adjusted accordingly. The inability of the announcement to address cases such as the BSP weakens its merit. The way to bring transparency in donations would have been to ban cash donations completely.

Third, the proposal of floating electoral bonds is fraught with transparency and income-tax issues that would make a hawala operator froth. The bonds would make donations to political parties completely anonymous. In an age when people in the US are worried about how Russia helped Donald Trump get elected, electoral bonds would make it easy not only for corporations but also the proverbial ‘foreign hand’ to lean on elections in India. An amendment to Section 13A of the Income-tax Act proposed in the Budget would exempt political parties from keeping records of donations made via electoral bonds, thereby taking away any semblance or pretence of transparency.

The finance minister has not announced any provisions that would bring political parties under the tax scanner. Currently, political parties enjoy tax exemption on income from property, voluntary contributions, capital gains and others. This has resulted in parties being set up for the purpose of siphoning money and evading taxation. A quick glance through the donor list reveals the high number of trusts and charitable institutions that donate large sums to each party, year on year. According to the Election Commission (EC), there are more than 1,500 registered political parties that have not contested elections between 2005 and 2015. In this reference, the EC delisted 255 parties that had never participated in any election since their inception. The remaining parties continue to avail tax exemption.

Political funding reforms must take into cognisance the nature of permissible income and expenses of parties. In addition, political parties receive support in kind, such as helicopters, sponsored rallies, election merchandise, campaign support, etc. Also, disclosure requirements of political parties must be linked to the income received by a party in a financial year, with special disclosures in case the party participated in elections during the year in question.

In the past few months, the government has talked about its passion for a swachh Bharat by attempting to attack black cash through demonetisation, followed by announcements related to funding of political parties in the Union Budget. It is praiseworthy that we can finally discuss political funding. However, it is also clear that policy-makers did not go all the way to ensure transparency whether by design or oversight.

This article first appeared in Financial Express.

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Grads with Grades that go nowhere

Since 1991, India has been among the fastest growing economies in the world. World Bank estimated that in the 1960s, approximately 45 percent of the population lived below the poverty line. This figure is now down to around 23%. Per capita income has risen from $250 in 1992 to $1627 in 2014. This has made Indians more ambitious. Traditionally, the government distributed the increased income from development on providing free food and education. Now, with the rise of a more urban India, aspirations have changed. Instead of worrying about the next meal, most Indians now think about public services, inflation and infrastructure. They ask for better education, jobs and faster development as a path to prosperity.

India has been a vastly unequal society for centuries, with the majority of the population denied access to education via the caste system. But in modern India, social mobility has finally become possible and education is seen as a mode of social upliftment.

Education is seen to provide access to stable jobs. India has expanded education in the past two decades, with millions of peoples graduating from colleges. India now has about 700 degree granting institutions which have over 40 thousand affiliated colleges churning out graduates every year.    

Type of Institution Number
Central University (Public) 47
State University (Public) 356
Deemed Universities 122
Private Universities 252
Total Degree Granting Institutions 777
Affiliated Colleges (Public or Private) 40,760

Source: UGC

Education Level Enrolments in lakhs
Graduate 26.67
Post Graduate 8.5
Doctoral 1.3
Diploma/Certificate 2.27
Total 39.7

Source: UGC

With a large number of students graduating every year, India faces the challenge of putting them into productive employment. As I have discussed in the previous article (Looking for a Good Job in December 16-31, 2016 issue of Governance Now), if these people aren’t put to work, a sense of disillusionment may creep into the youth.

Unfortunately, the quality of education in majority of the institutions is such that most graduates are unemployable. The blame lies principally on the poor quality of education in India. Millions of job seekers have impressive sounding diplomas but many don’t have the skills promised by those certificates from substandard colleges and technical institutes. Apart from a few elite universities, Indian universities impart subpar education and do not find a place in world rankings for higher education institutions.

Most universities conduct no research to speak of and most of the faculty do not have any papers published in journals of high repute. Bemoaning the lack of quality would miss the point that they are not expected or incentivised to conduct research and alas have fallen behind their peers globally. Reflecting the sad state, India granted 6,153 patents in 2014 compared to over 2,00,000 filed by China (WIPO 2015). The pedagogy in universities has not changed in decades and they are ill-equipped to impart education that would be useful in the current century.

The vocational training sector in India is similarly lacking. China has nearly 5,00,000 senior higher secondary vocational schools, whereas we have about 5,100 ITI’s and 6,000 VET schools in all. Germany, Indonesia, Japan, Korea, Israel and China have supported vocational education at school level on a large scale since the 1970s. Strategy to achieve full employment must include an important component: to ensure that all new entrants to the workforce are equipped with the knowledge and skill needed for high productivity and high quality of work.

To match the skills of the labour force to the requirements of the industry, the national skill development corporation (NSDC) was launched as a public-private partnership to upgrade the skills of the growing Indian workforce. According to NSDC, about 2 percent of the existing workforce has undergone formal skill training and only 20 percent of the existing workforce has marketable skills. Whereas, 90% of the formal jobs in India are skill based and require vocational training. As a result, there is a significant ‘skill-gap’ between the supply of skilled labour and the market demand for applicants with job-ready skills; leaving 68 percent of India’s businesses struggling to find qualified applicants. But unlike in the US and Europe, where many highly skilled applicants are fighting over few jobs, only a minority of working-age Indians are qualified for skilled occupations. With millions of young people entering the job market each year, the sheer number dwarf any government sponsored programme to impart skill training to first time job seekers.


It would be overly optimistic to expect the industry to generate enough employment to engage all of India’s graduates every year. There are certainly some impressive Indian manufacturers, but their likes prefer to employ sophisticated machinery rather than abundant labour. This is partly down to archaic socialist regulations which dis-incentivise hiring more labour and shift it towards capital. This is at a complete tangent to India’s cheapest resource i.e., labour. The development of China was largely on the back of its cheap labour force which not only found productive work but allowed China to move over half a billion people out of poverty. We on the other hand have innumerable tin-pot workshops, employing handfuls of people and outdated methods. What India lacks is a ‘Mittelstand’ of midsized, labour-hungry firms. During 2000-2008, India’s boom years, India created more jobs in construction than in manufacturing reflecting the sad state.

Over 84 percent of India’s employment is in the informal sector i.e. small and unincorporated enterprises. (Erstwhile) planning commission’s report ‘Creating a Vibrant Entrepreneurial Ecosystem in India’ said that “India needs to create 1- 1.5 crore (10-15 million) jobs per year for the next decade to provide gainful employment to its young population. Accelerating entrepreneurship and business creation is crucial for such large-scale employment generation.” The 2012 report goes on to state that, “India has the potential to build 2,500 highly scalable businesses within the next 10 years… that means 10,000 start-ups will need to be spawned to get to 2,500 large-scale businesses”.

World Bank’s report ‘Doing Business 2016’ ranked India at 130 out of 189 global economies in terms of ease of starting a business. Starting a business and securing permits are especially difficult. India is placed at almost the last position in enforcement of contracts. First-generation entrepreneurs are significantly affected by such an environment where the cost and time involved in establishing a business become deterrents especially to business ideas that need a first-mover advantage. Exiting a business takes even longer.

The ecosystem for starting and running new ventures has many gaps. Regulations and procedures are restrictive and time-consuming and add significant cost for an emerging venture. Banks and financial institutions are wary of lending to first-generation entrepreneurs and to micro, small and medium enterprises (MSMEs) in general, due to various norms like tangible asset coverage, debt to equity ratio etc., even though such enterprises make a major contribution to the economy, employment, and exports. This imposes constraints on their credit absorption capacity and consequently, growth.

Development and aspirations

The aim of development lies in the aspirations of the people. Once people have basic requirements like food, shelter and security, people require education and social growth. Education is an enabler, a pre-requisite. When poor people desire to educate their children, they see it as a step towards social and upward economic mobility, respect and access to better services. Education determines the socioeconomic status; moving from lower working class up to middle class, for education leads to economic opportunity. It is through education that young people secure higher status jobs than their parents.  Thus, education provides the channel not only to better socioeconomic status, but also to social mobility.

Social infrastructure has enormous externalities. Education and health are social goods in which social marginal productivity exceeds private marginal productivity. Therefore, private investment capital in such social infrastructure is likely to fall far short of what is needed. Therefore, the state must provide adequate resources, financial and others and social infrastructural projects. At the same time, the quality of implementation must improve to maximise the return from investments. This has been lacking so far.

No doubt enrolment has improved a lot and reached 100% at the primary. e. However, quality of education remains a big issue. This is borne out by the ASER surveys conducted by Pratham every year. The PISA tests that rank countries according the status of their school going population, found that a majority of students in Class VIII cannot either read Class II material and could not complete basic (Grade II or III) mathematics.

In many education outcomes, we are marginally better than sub-Saharan countries and worse than Bangladesh. This dichotomy has occurred in India because after independence, the state saw itself as the provider of services rather than a supplier of services. The state does not necessarily have to operate or manage social infrastructure, but it is necessary for the state to provide guidelines and monitor its operation.

Demographic predictions warn that the promise of demographic dividend will not last long, in any case not beyond 2050, when India’s population stabilises, and starts ageing. India needs to take advantage of its demography in the next couple of decades. The challenge for the country is in planning and acting towards converting its demographic ‘burden’ into enhanced opportunities for growth by skilling the increased youth population according to the requirements of employers. From Tahrir Square to Wall Street, growing economic inequalities and a persistent lack of jobs have caused demonstrators in many countries to demand real change from their governments. Research reveals that damages of long-term unemployment to the economic, political, and cultural life in the country are the major cause of eroding social integration in the long run (Beleva, UNESCO). Taking cue from international episodes, the good and the bad, India has to start planning now to ensure that social integration is preserved and not broken by lack of political will or strain of political competition.

This article first appeared in GovernanceNow.

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And the city softly sings the blues

India is a largely rural country with 68% of its population living in villages. As per the 2011 census, approximately 32% of the population or 38cr people stay in Indian cities. This figure is expected to grow rapidly to 59cr by 2030 [Mckinsey] with rural to urban migration being the main driver of urbanization. Rural to urban migration is key to the demographic perspective of urbanization. Urbanization has been the result of multiple factors like industrialization, employment opportunities and social factors.

Fifty years ago, agriculture accounted for half of India’s GDP and was responsible for more than three-fourths of the jobs in the country.  Today, it accounts for 13.7% of GDP but still employs 51% of Indian’s unorganized workforce while agricultural productivity has remained more or less stagnant in the last 50 years. As India has developed into a more services based economy, agriculture has become more crowded and less profitable. It has forced hundreds of millions of rural inhabitants into choosing between two options; remain in the villages, surviving through low-return and subsistence farming, and, struggle to find non-farm related opportunities due to limited market access or marketable skills or migrate as part of the 100mn plus urban migration to urban centers where the lack of marketable skills and inability to connect to gainful employment leads many to be exploited.

The growth of urban population as well as the pace of urbanization has been generally slow in India compared to other Asian countries. For India’s demographic dividend that to pay out, India needs thriving cities not just the metros but cities like Madurai, Gwalior and Amritsar with population more than 10lacs to start supporting a modern sustainable economy. It is estimated [Mckinsey] that by 2030, Indian cities can produce 70% of the net new jobs in the economy and sustain ~59cr people. We have not really come to terms with the reality of an urban future. Politicians still debate whether the prosperity of the future lies in villages or cities and many people believe that urbanization is anti-rural. This is clearly a myth as cities shift the workforce away from the least productive sector of the economy (agriculture) towards more productive jobs that will be important for the eventual rise of per capita income in the country.

Cities deliver a higher quality of life for its citizens. Urban scale benefits mean the cost of delivering basic services is 30 to 40 percent cheaper in concentrated population centers than in sparsely populated areas. Cities provide better access to sources of income, health facilities, education and other social amenities.

While cities may be melting pots that have helped mitigate traditional caste-based discrimination, urban spaces are generating newer forms of inequalities and exclusions that go beyond caste. Urban development in India is a story of sharp contrasts. On one had we have glitzy buildings, shopping arcades, corporate offices, and neatly laid out residential complexes that provide a clean, safe, and healthy existence, there also exist shanty towns, slums, and the informal economy where people live in sub-human conditions and earn a living by doing odd jobs, including casual labor at construction sites, domestic work, rickshaw pulling, security guard duty, street vending, and hawking. While their contributions are indispensable to the smooth working of urban spaces, these people, their needs are overlooked in the planning and vision of urban development. In fact, urban planning is completely ignored in India.

In British times, cities were segmented into blocks, wards and colonies, whereby people belonging to similar socio economic brackets lived together. This spatial segregation of the rich and the poor made it easier for the government as well as private agencies to determine the level and quality of basic amenities to match the affordability of the local community or the power structure and almost effectively institutionalizing the disparity. When newly migrated people came into urban centers, the poor were pushed out to urban peripheries or marginal lands within the cities, resulting in the growth of slums. The growth of slums or squatter settlements has resulted in serious social, economic and environmental problems. About 25% of India’s urban families live in slums, squatter settlements or refugee colonies due to the non-availability of affordable habitat in modern urban settlements.

India places no restriction on internal migration like China. People are free to move across States in search of opportunities. However, local governments and the middle class view economically poor migrants as outsiders making illegitimate claims to life in cities. In urban India, economic class has become the new caste. The caste anonymity is not enough to allow access to all urban spaces. Gated communities and private spaces restrict entry to most poor people. In Bombay, housing is often restricted on the basis of religion, food habits and even marital status. While such exclusionary practices are not legalized, little is being done towards the active enforcement of rights that allow for an integrated society.

Much depends on a city’s ability to create an enabling environment for new entrants. This involves planning for services such as access to safe housing, water, electricity, schools, and healthcare. However, institutional and state policy efforts to this end seem to have been sparse. In urban India, government services can only be accessed through a host of official documents such as property lease or ownership papers, PAN cards, bank statements, bills, and voter IDs, essentially leaving poor migrants to accesses basic services at a premium in the black market economy.

Urban Saturation

India’s urbanization has its own quirks. So far, we have not been able to create multitudes of cities with their own eco-system. We have instead relied upon the major cities to drive urbanization and it is to these cities that most of the countries migrant labor flocks in search for better opportunities. India’s urban centers are hence fast becoming congested. Local governments have not been able to ramp up public goods to match the inflow of people to cities.


Housing in Indian metros is notoriously expensive. China’s mega-cities have seen a five-fold increase in property prices over the past decade. Yet despite these astounding increases, property prices in Beijing and Shanghai are still only half those of their Indian counterparts of New Delhi and Mumbai; without comparable infrastructure. India’s excessively high property prices reflect a combination of two archaic practices: reserving large parcels of valuable urban land for government use and outdated and overly rigid building codes that discourage concentrated development of commercial activity and housing in the core of cities. This pushes development to the outer suburbs, making it difficult to realize the agglomeration benefits that drive productivity gains. Correspondingly, people have to either commute huge distances for work or live in expensive and sup-par housing. In every city, almost 50% of the population lives in slums. As these are illegal colonies, they do not have any civic amenities like drinking water, sewage, electricity etc.

Urban Transport

As cities are growing, distances to be travelled are increasing. With more than half the population being poor or belonging to low income groups, public transport is a necessity. Unfortunately, we are just waking up to this challenge. While poor migrants do not have access to adequate and affordable transport facility, richer people are able to buy cars for their travel. The main reason for this condition is that the low income forces people to live in areas with cheap accommodation which necessitates extensive travel. Further, since they cannot afford to pay high fares for using public transport, fares have to be kept low resulting in bus services sustaining such annual losses as hamper their expansion or maintenance of a fleet adequate to meet city needs. As the number of motor vehicles is rising, traffic jams and pollution is increasing. Only recently local and state governments have woken up to this problem and metro rail systems are being setup. Calcutta and Delhi have well managed metro rail systems but they are inadequate. Mumbai and Chennai have had a long history of local trains but even these are proving inadequate with populations in these cities growing rapidly. People have to rely mostly on bus transport but their number is not enough nor is the roads able to accommodate all the vehicles now in use.


All cities are under-policed. Rich citizens are able to pay for their own security with gated communities and private security arrangements. This is a sad reflection on the capacity of the authorities to provide security to inhabitants. Similarly, healthcare, waste disposal, almost every public service is overburdened in cities.

Rural Infrastructure

The sad truth is that even with all these problems, Indian cities manage to provide better conditions for inhabitants than villages. The state of rural infrastructure is pathetic. Currently, 45% of rural India does not have access to a stable power supply, 10% have no access to drinking water, and 70% have no access to toilet facilities. The average distance to all weather roads is 2km.

Rural health outcomes are alarming to say the least. 20% of rural households have none of the three basic services viz. safe drinking water, sanitation and electricity and only 18 per cent have access to all three. Access to basic facilities is glaringly unequal among income and social groups. Only 5% of the lowest expenditure quintile and about 10% of the SC/ST group have all three facilities. But deprivation is so high in rural areas that only 39% of even the highest expenditure quintile and only 33% of advanced social groups have access to all three basic facilities.

The major work in Indian villages is agriculture and allied activities apart from some small businesses. Agricultural productivity has not increased much in the past decade and to improve rural incomes, people will have to be moved to more productive work like trade or industry. The value added in agriculture in 2012 was INR 63,000 per agricultural worker, less than a fourth of the average figure for non-agricultural workers. At INR 170/day, this is barely higher than the minimum daily wage of unskilled agricultural labor. For the millions working in agriculture, the possibilities of escaping poverty depend on the availability of jobs in more productive sectors.

As long as rural infrastructure languishes, migration will continue to happen putting immense pressure on cities. Along with infrastructure, the government also needs to focus on rural employment. NREGA by providing a baseline support to rural workers has increased rural welfare immensely. But to take Indian villages into the next century, aside from improved infrastructure, employment has to be generated in the villages.

India is undoubtedly becoming urban. As our cities become more congested, the quality of life in the cities is also taking a beating. If the quality of life in cities keeps deteriorating, we may have to face a reality where people prefer to live subsistence lives in villages than move to cities in search of opportunities and social mobility. A job is essentially looked upon as a tool for social mobility. It provides income and via income access to services that improve the quality of one’s life. In a more interconnected world, the poor can observe how the rich live and people in developing countries are aware of what social infrastructures are available in developed countries. If India is not able to meet the rising aspirations of the upcoming generation, if youth are idle and are denied basic service, a sense of disillusionment and exclusion will grow. The 100 smart cities project looks good on paper but a city cannot be smart as long as basic amenities are not provided for. If urban services are not provided for in all these 100 cities, hi-tech gadgetry will be of no consequence. It behooves the government to focus on basic infrastructure rather than make castles in the sky or in this case in air-waves.

This article was first published in Governance Now.

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RBI’s Demonetisation Cross

CThe sequence of events leading to the demonetisation move are becoming more convoluted as more information is revealed. At this point, it is starting to resemble a comedy of errors at best and an insidious plot at worst. We attempt to delineate the sequence of events that led to November 8, 2016, and understand the role of one of India’s most credible institution, Reserve Bank of India (RBI) in the larger scheme of things.

The central bank has informed the Parliamentary Committee that it acted on the government’s advice on demonetisation. This is at odds with the minister of state of power, coal, new and renewable energy, Piyush Goyal’s remarks in the Rajya Sabha. He said that the government merely approved the RBI Board’s decision.

The RBI note to the Parliamentary Committee says that “the introduction of new series of notes could provide a very rare and profound opportunity to tackle all the three problems of counterfeiting, terrorist financing and black money by demonetizing the banknotes in high denominations… Though no firm decision was taken initially, whether to demonetize or not, preparations still went on for introduction of new series notes, as that was needed in any case.” RBI cannot make these claims with a straight face. First, it is evident that RBI was grossly unprepared for the move. Second, all three above-stated reasons for demonetisation have been proven false. RBI has itself stated that there are no additional security features in the new notes; so, the problem of counterfeiting will persist. Finally, several people, including terrorists, have already been caught possessing crores of new currency notes.

In a separate RTI response, RBI had stated that the decision to introduce new notes of R2,000 denomination was taken in a meeting on May 19, 2016. However, the minutes of the RBI Board meeting only mention the design of the new notes. As per the RBI Act, it is mandated to reveal the decision to introduce the new notes which it did not. Similarly, the government waited till November 8 to notify the new notes.

On November 8, the prime minister announced the demonetisation of the 500- and 1,000-rupee bills. He also made certain announcements related to dates for exchange of currency notes at banks (December 30, 2016), at RBI counters (March 31, 2016) and withdrawal limits at ATMs/through cheques. Alongside, he mentioned the objectives of demonetisation and the secrecy of the move. He also introduced the 2,000-rupee bill. Indians lauded as this a step towards penalising the growing breed of corrupt and extinguishing the existing stock of black cash in the economy. Consequences of sucking out 86% of the currency included long queues at banks, malpractices at bank branches, and attenuated consumption, but the nation has stood by the decision believing in the intent of the act.

Reserve Bank of India, as the issuer of currency, was responsible for replenishing currency in the system. As days passed, RBI issued multiple notifications on how, why and who could withdraw how much currency. At last count, in a 50-day period the RBI issued 74 such notifications. This is astounding agility for any central bank and raises questions if RBI was at all prepared for such an act? Or does it indicate that the RBI Board succumbed to external pressures to approve demonetisation? If RBI is an independent regulator, insulated from all political influence and could not see itself implementing the move, there is little reason why it did not refuse to be an accomplice. And finally, if RBI’s economic talent pool was on ground with this, cognizant of leaving a nation with 15% of the currency in circulation, the citizens have a right to know the reasoning.

The institution denied a RTI query on disclosure of minutes of the board meeting on the demonetisation decision, citing exemption clause Section 8(1)(g), i.e., endanger(ing) the life or physical safety of any person or identify(ing) the source of information or assistance given in confidence for law enforcement or security purposes. While the intent of demonetisation has been fluid beginning from targeting black money, and counterfeiting to digitising the economy.

Post the demonetisation announcement, RBI disclosed data related to the receipt of old currency on a daily basis. Regular reporting of data, in line with the ethos of the institution was appreciated by the public. According to the last disclosure made on December 12, 2016, RBI had received R12.44 lakh crore. However, it abruptly stopped sharing the data when it seemed imminent that most of the approximately R15 lakh crore of demonetised notes will be returned.

 The increasing opacity of RBI’s role in demonetisation goes against the global trend of increasing monetary policy transparency. We should ask RBI to disclose detailed notes of the minutes of its Board meeting. As of now, there is no clarity on the nature of background work undertaken by RBI to assess the move and the institution’s conviction to go ahead and implement the same. It is unfortunate that the very custodian of demonetisation is unable to exonerate itself by coming out with reliable facts, that would convince the common man and investors alike, of its intentions and independence. If policymakers have decided to operate in secret, then we should consider amending our Constitution to reflect that the government is not responsible to the people.
This article first appeared in Financial Express.
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Calling for a Head

We will state our baseline assumption first; the “implementation” of the demonetization exercise, though admittedly an historically unprecedented exercise in its scale and timelines, could still have been far better. We will not get into whether the exercise was justified or not or the reasons for its failure, but focus on the institutional failure in the exercise.

On December 30 2016, the President signed the Specified Bank Notes (Cessation of Liabilities) Ordinance, 2016 which extinguished liabilities of the Reserve Bank for the currency withdrawn. From January 2 2017, the next working day post the signing of the ordinance, the RBI was not liable to exchange old notes for new. Only NRIs who can prove that they were not in the country during the 50-day period are now allowed to exchange their old currency at the RBI. On November 8 2016, the RBI had clearly said that those who are unable to exchange old notes during November 8 to December 30 2016 in banks shall be able to do the same at RBI offices till March 30, 2017. It is unclear why RBI and the incumbent Government waited till the last day to rescind the March 30, 2017 deadline. Considering that RBI released 74 notifications in the 50-day period, there is little rationale to justify this last-minute rescindment.  To add to the woes of common man, the announcement came over the new year weekend, and was absorbed only when business opened on January 2 2017. Prior to this, on November, 24 RBI had advanced the date of exchanging old currency at branches from December 30 to November 24 itself. Preponement of critical deadlines, without any reasonable explanation from the central bank, not only questions the foresight of policymakers; it also creates a trust deficit among the citizens. The Reserve Bank of India is known for exemplary policy making and execution. However, when it issued bizarre notifications such as those which mandated depositors to provide explanations for depositing old currency towards the fag end of the 50-day period, its institutional repute appeared to be on a free fall.

The demonetization drive led to an acute cash crunch. People had to wait for hours to withdraw cash. The country’s 2.2 lakh ATMs needed to be recalibrated for the new currency notes. This took more than six weeks and reportedly is still going on in rural areas. So, while people were eligible to withdraw INR 2,500 per day from the ATMs, more than 90% of the machines did not work in the first few weeks. In response to an RTI query, RBI stated that it had printed bills of INR 2,000 amounting to INR 4.95 lakh crore of currency before November 8. In light of the mayhem caused by sucking out 86% of the currency in circulation, it is worth understanding what had prevented RBI from circulating these bills into the system or was it mindful of the “top secret”.

Post the demonetization announcement, RBI disclosed data related to receipt of old currency on a daily basis. According to the last disclosure made on December 12, 2016, RBI had received INR 12.44 lakh crore. However, it abruptly stopped sharing the data when it seemed imminent that most of the approximately INR 15 lakh crore of SBNs will be returned. It followed up this decision with curbs on deposit of currency notes asking for clarification of why the notes were not deposited much before the deadline. It seemed that the RBI does not want to honor the signed commitment on each currency note. This, and many such instances have caused the many to believe, that RBI’s decisions are based on factors undisclosed or unknown. The double counting of currency argument does not hold any water because any banker can tell you that cash is accounted for every night in every bank branch. There is never any double counting if there were we have a bigger problem with the efficacy of the banking system than we imagined. Banks simply do not make mistakes while executing credit or debit entries.

That a demonetization was being contemplated was kept a secret for good reason. But, little was achieved by not keeping even a single RBI official in the loop who could have been consulted on the availability of new currency, printing capacity, readiness of the banking system and other operational procedures. If an RBI official was consulted, then he clearly is not up to the job.

Concerns have been previously raised about the presence of only 8 out of 10 members on the RBI board meeting which approved the demonetization. The RBI Act prescribes 21 board members of which 11 have not been appointed at the moment. Only the number of government appointees is compliant with the RBI Act (at 2). This seriously compromises the independence of the RBI Board. Refusal by the RBI to furnish the minutes of the RBI Board meeting and other information under the RTI has further led to the belief that the RBI has become the opposite of the transparent organization that was hoped with setting up of the MPC, MPC minutes disclosures and an inflation targeting framework. The RTI act mandates that any written record that comes under the RTI and needs to be disclosed if asked for.

The idea of an independent monetary authority is not a very old one. It is a 20th century creation to act as a counterbalance to the populist tendencies of governments. The idea is that if a government is fiscally profligate, an independent central bank will raise interest rates to control inflation thereby maintaining monetary stability in the country. This idea gained worldwide acceptance after inflation wreaked havoc with economies from Germany to Latin America. The RBI governor on behalf of the Government of India is the guarantor who signs on currency notes promising to pay holder. He is the most well informed person on the banking sector in the country. If he had an iota of doubt about the capacity of the banking system to handle the exercise he should have shut the idea down. The prerogative was on him and the RBI board. On the other hand, if they succumbed to pressure from the government, then investors should reconsider India as an investment destination. I would like to direct Dr. Patel to his own brilliant report on monetary policy which argued for an independent MPC and why central banks should have an independent and targeted focus.

The Government announced demonetization in less than two months of Dr. Patel’s appointment as the RBI head. The nation expected him to speak on the announcement, and address the concerns caused by a act of such humongous scale. Dr. Urijit Patel’s silence on a decision, that comes under the realms of the RBI Act, led to wide spread speculation, on both, his stance and consent. Even a single press address by Dr. Patel would have gone a long way in reposing the faith of common man, in the institution that was responsible for implementing the exercise as the banking regulator.

The RBI as the issuer of currency in India and the banking regulator has done an extremely shoddy job of handling the exercise and as it stands, the current leadership has substantially harmed the institutional credibility of a venerated institution. It goes without saying that Dr. Urjit Patel had big shoes to fill. He was well regarded and considered a good fit for the job. Since that veneer has been removed, it is best that the task of restoration of the credibility of the RBI falls to someone else; perhaps Professor Viral Acharya.

This article first appeared in thedialogue.

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Unemployment as a Societal Problem

East Asia went through an economic miracle between 1960 and 1990, with income per capita nearly tripling. The four Asian Tigers, including Hong Kong, Singapore, Taiwan and South Korea, achieved impressive growth rates of more than 7% for more than three decades. Japan went through a similar phase till the 1980s. This prolonged period of economic growth is attributed to export-oriented policies, investment in health and education, high savings rate and capital accumulation. Studies have examined the influence of demographic transition on economic growth [Bloom and Williamson: 1998]. If most of a nation’s population falls within the working ages (15-60), the productivity of this group can produce a ‘demographic dividend’ of economic growth, assuming that policies to take advantage of this are in place. The combined effect of a large working-age population and health, family, labor, financial, and human capital policies can create virtuous cycles of wealth creation.

India faced a similar scenario with fertility rate declining in the 1980s leading us to today; where we are one of the youngest populations in the world and the largest workforce on the planet at the exact time China’s labor force begins to decline. India currently has 120cr people with a median age of 26 years. By 2030, India is projected to have 1.4bn people, of which over 100cr will be in the age group 15-64 (productive workforce).

This is a boon as well as a challenge. To consider the scale of the challenge, the working-age population, aged between 15 and 64, will rise by 12.5cr in the current decade, and by a further 10cr in the following decade. A third of this growth will come from poorer and less literate states, particularly Bihar and Uttar Pradesh [Literacy: 69.8% and 69.7%; GDP per capita: 31k and 37k respectively in 2014]. To employ this population, India needs to create 10cr net new jobs in the next 10 years. From 2002 to 2012, China created 13cr net new jobs in services, however in India, no net new jobs were created from 2005-2010.

India’s youth unemployment rate currently stands at 12.9% compared to an overall 4.9% unemployment rate in the country. Compared to advanced economies, overall rates of unemployment in developing countries are generally lower than observed in developed economies because most individuals cannot support themselves and their families through social protection schemes.

According to a survey [National Employability Report: 2013], almost half the graduates are unemployable in the market, while according to labor ministry statistics, almost one in three graduate up to the age of 29 is unemployed. The Economist estimates that India produces twice as many new graduates each year as it can absorb. The problem lies not just in the quantity of jobs. India’s incomplete economic liberalization since 1991 has left the country with few good employment opportunities for unskilled workers who do not have much education. Statistics verify what is plain to see; all cities have an army of liftmen, guards, peons and delivery boys. About 85% of the jobs are in the informal sector, another 11% are casual jobs with formal companies. IT firms account for only a few tens of lakhs of jobs out of a total of about fifty crore. 23% of Indian workers are categorized as working in “industry”, compared to nearly 30% in China and 22% in Indonesia. However, half of India’s industrial workers are in construction. India’s manufacturing jobs also do not involve exposure to modern machinery, techniques or training. More than half of Indians in the manufacturing sector work in facilities without electricity.

The skills mismatch in the youth labor markets has become a persistent and growing trend. Over-education and over-skilling coexist with under-education and under-skilling and increasingly with skills erosion brought about by long-term unemployment. There hasn’t been much growth in manufacturing to create lower-skilled jobs. Young men often have no choice but to stay in low-paying idle jobs. This is a result of supply driven education and a lack of interface between the various stakeholders’ viz. industry, education institutions, and education and labor ministries.

Our leaders have long said they are committed to generating employment, but have shown little stomach for the economic upheaval that rapid job creation entails. China’s policymakers accepted that the process of adding jobs overall often destroyed jobs in particular industries and places. Politicians have preferred economic palliatives such as NREGA and subsidies for the needy. The lack of political resolve means India is unlikely to summon up the single-minded dedication with which South Korea, Taiwan and China created industrial jobs. India’s demographic dividend will yield only a fraction of what it could, and the problem of low-quality employment will continue.

In the rural areas, majority of the population is engaged in the primary sector resulting in low productivity and persistent poverty. There is also a need to increase formal employment which currently constitutes only 8% of the labor force.

Impact of Unemployment: Brain-strain (stressed to be employed)

How is this going to affect India? Hundreds of millions of young people are or soon will be looking for jobs and spouses. If those hopes aren’t fulfilled, aspiration will turn into frustration. And, frustration can manifest itself in rising crime. Long-term youth unemployment drains the motivation and ambition of those it afflicts and makes them more cynical. This is evident all around the world, including developed economies such as the US. Prolonged high levels of youth unemployment may lead to a risk of social instability. Unable to become part of the rising middle class in India, this rising army of unemployed could fuel violence and destructive politics thereby destabilizing the country. It can result in a vicious circle of inter-generational poverty, social exclusion and trigger violence.

Does the frustration of India’s youth help explain the prevalence of sexual harassment and violence against women? India already fares badly in terms of the demographic divide between males and females with 933 women for every 1000 men. This number looks dire with the youth sex ratio standing at 908 and adolescent (10-19) sex ratio at (898). Certainly, the patriarchal society and other reasons play a part, but it is worth exploring the role of economic and social frustration. Women in India describe daily incidents of harassment: taunts, stalking and groping. Most of the time, the culprits are relatively young men with lots of time on their hands and nothing productive to do.

The Justice Verma Committee Report, speaks of the “mass of young, prospect-less men whose sexual harassment of women may tip over into more aggravated assault. These men are fighting for space in an economy that offers mainly casual work.” And concluded that “large-scale disempowerment of urban men is lending intensity to a pre-existing culture of sexual violence”.

Prof. Craig Jeffrey, Professor of Development Geography at Oxford University, an expert on India’s unemployed youth, has a sociological term for the act of loafing around with nothing to do: “timepass.” “Rapid social change in provincial India has created a vast army of educated and semi-educated ‘loafers’ among young men. Young men find themselves with little or no opportunities or resources and find it difficult to get married. They hang about near college campuses or even by the roadside, taking out their frustration on women. ‘Time-passers’ aren’t just unemployed or underemployed; they’re often also unattached. After decades of skewed sex ratios at birth, India now has approximately 37 million more men than women. This excess supply of men, combined with falling fertility rates has led to a ‘marriage squeeze’.” [Craig Jeffery: 2010]

The combination of young men with few prospects and the frustration of being single is especially pronounced in North India, where sex ratios are the most skewed. Sexual harassment is just one of the social pathologies that can arise from these economic and demographic trends.

Insurgency has been in the limelight, which too is related to the challenges of youth unemployment and underemployment [Magioncalda: 2010]. Regions with inadequate employment opportunities have witnessed serious problems. Similarly, the Arab spring, London riots of 2011 and Occupy Wall Street movements were to an extent an expression of the disenchantment with the lack of opportunity in the respective countries. It does not take much for such small-scale movements to become a destabilizing force.

India may discover that demographic dividend has its perils.

This article first appeared in Governance Now

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Fintech Opportunities for Financial Inclusion

There has been so much noise around fintech recently that it is very easy to do both either get caught up in the hype or believe that it is another tulip mania. Matt Levine in a brilliant piece in Bloomberg wrote about the three ways fintech companies are trying to disrupt banking; 1. with the same business model, 2. with more computers or 3. by wearing a hoodie because being cool is a technology. He goes on to elaborate how most fintech companies are not replacing banking but just disaggregating services or making it customer friendly, something that banks can easily co-opt.

While technology companies are gung-ho about their ability to develop a great front end product while banks lag in customer experience, very few have any experience in dealing with the myriad regulations and licenses that come with handing public money. Because of this inherent weakness, fintech companies have been happy to outsource the back-end operations to banks. This essentially amounts to outsourcing the banking to banks. The net effect being that banks remain entrenched in the system without much disruption. A beneficiary of this has been Cross River Bank which is pitches itself as the bank of choice for fintech companies and has in the process become the darling of Silicon Valley venture capitalists, a strategy being replicated in India by RBL Bank. Quite a few people have expressed similar apprehensions with payment banks and online wallets not being a panacea of financial inclusion problems as they are not disruptive enough or have viability issues (Payment Banks).

For all the calls to sobriety, there are many things fintech companies can do to address failures of the banking system in providing access to the financial system at the bottom of the pyramid. At the annual conference of the Bank of International Settlements, a paper discussed that the cost of financial intermediation has remained constant at 2 per cent across many developed countries for the past 100 years, implying that the gains from technology have not been passed to consumers. Eliminating the cost of opening a savings account can increase the uptake, savings levels and reduce informal savings according to studies in Sub-Saharan Africa. Similarly, in Nepal ease of access to basic bank accounts via tellers visiting houses led to significant uptake and increase in welfare (GONESA). These costs of financial intermediation can easily be eliminated by the use of technology.

Accounts which apply behavioral insights can further increase the benefits for the poorest. A study by RAND revealed that less educated people are more likely to choose the default options in any financial product. This should allow companies to make products that further the objective of increasing savings for the poor by introducing commitment or lock-in features to bank accounts.

The poor live risky lives. The limited research into insurance shows significant benefits for the poor from insurance products. Crop insurance and micro-insurance products though proven to be effective from a welfare perspective, do not scale without government subsidy. ICICI Bank has had a crop insurance product for over a decade but it cannot be considered successful by any stretch. Finally, lack of information about credit-worthiness and lack of screening ability among lenders hinders the efficacy of any rural lending programs. Traditional banks are not profitable in these areas without high transaction costs.

Access to digital payment services is a potential platform for providing insurance to the poor because firstly, they reduce financial institutions costs while enabling informal P2P risk sharing by enabling easy payment services. Like in other industries, fintech companies propose disruptive innovations for specific services. Their key advantage is that they aren’t held back by legacy systems like most banks and are more focused on data. Are there viable models to insure poor households? How does a company scale digital credit on a small scale? How to support the delivery of advanced savings products and not the no-fills account that are pervasive in policymaking circles? Finally, finance is just a means to an end. We need to achieve tighter linkages between finance interventions and other sectors to magnify impact. These are some of the key questions that fintech companies can answer to be as transformative as Grameen Bank was.

This article first appeared in thedialogue.

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Game Theory and Traffic

The below rant got published in GovernanceNow.

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Game Theory of Traffic

For those of you who have ever argued with me, you would know how I ascribe the traffic conditions on Indian roads to low IQ. That obviously is hyperbole but, this is my attempt to coherently put down my thoughts on it. Arguing that it essentially is a failure to solve a repeated prisoners dilemma game.

Driving on a road can be modeled as a game. I can choose to cooperate and be stuck behind the car in front of me, or I can choose to not cooperate and not cooperate and overtake the car. Now, let us break this down.

Round 1: If I am new to a city/country/planet and am only going to be there for a day. I see that I am stuck behind a car whereas the opposite lane is completely empty. I have every incentive to not cooperate and switch to the opposite lane. Thus saving time and I win.

Round 2: Other people see this and see that it is in their interest to not follow lane rules and decide to not-cooperate. Which brings us to a situation where it is a loosing strategy to cooperate and everyone loses out due to the sub-optimal Nash equilibrium.

Hence, it can be argued that the chaos that is driving in India is essentially a sub-optimal Nash equilibrium.

Now, things get interesting. the way around this dilemma is to repeat the action of the opposing player i.e. if he cooperates, you cooperate in the next round, if he does not cooperate, you punish him by not cooperating in the next round. This is helpful if one of the players is illogical and there is some amount of randomness in the choices he makes. If on the other hand, everyone is logical (as economist are wont to argue) one bad move or initial condition, and the system again gets stuck in a sub-optimal equilibrium. The solution to this problem is “altruism” i.e. you need to forgive the other player after a certain number of moves. If everyone is logical then at some point, an optimal equilibrium will be achieved.

In 70 years, Indian drivers have failed to solve this basic problem hence my argument that the sub-optimal driving conditions result from either a low-IQ or a lack of social capital. The development of social capital is beyond the scope of this post so let us leave it here and assume that it has been achieved.

At some point in the future, let is imagine that India becomes like Germany and everyone chooses to cooperate every time. Now let us play the game again. Do I cooperate or not? If I choose to not cooperate, I have an empty lane to take advantage of whereas all the lemmings follow the rules! Oops!

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Regulation in the 21st Century

In 2012, the state of Minnesota in the US briefly banned free online education. That’s right, a government thought it was a bad thing for people to educate themselves for free. The government essentially banned universities from offering classes online without taking permission from the regulatory body which included a registration fee. We in India are no strangers to stranger regulations; the banning of surge pricing by taxi platforms in Delhi in April 2016, during the odd-even experiment, is one of many examples. However, the Uber/Ola debate does not seem to go away. Recently, taxi unions in Delhi were on strike (again!) protesting against aggregators taking away their jobs. This is nothing new and strikes have been happening in Delhi and Mumbai since Uber and Ola set up shop. For that matter, textile workers in the 18th century broke spinning jennies to protest the imminent loss of jobs. In fact, Uber has faced challenges in almost every jurisdiction from strikes by Paris taxi drivers to falling foul of New York city’s transport authority.

The “gig economy” or the “sharing economy” refers to online platforms that let workers sell their services or products directly to consumers on their own time. The 20th century was characterized by people staying in one company for their lives. The corporation was the mode via which the workforce was organized. The current workforce changes jobs several times in their lives. The gig economy is an evolution of that trend where people work when it suits them or when they need money. There are many benefits of a gig economy. It enables better utilization of resources, increasing supply. By lowering prices, it adds to real disposable income, stimulating demand. It creates new markets which generate employment opportunities in other sectors. Online platforms also enable more efficient pricing and better supply-demand matching. Its impact in developed markets has been powerful, increasing supply, reducing prices and compressing profit margins and surely raising consumer welfare.

The advantage of the digital economy is the reduction of transaction costs which make customized transactions viable and thereby reduce under-utilization of assets. Data is at the heart of this revolution and manifests in the way that people consume goods and services. This results in a challenge to an existing player that is subject to existing government taxes and regulations. Their favoured response, that is, to strike informs even more people about the existence of alternatives and is akin to shooting oneself in the foot. The challenge for regulators is to avoid stifling innovation but at the same time ensure equitable application of rules that have been set up to regulate businesses and protect consumers. Platforms are able to provide solutions to some governance failures too. There is a security concern in using shared services. But, by verifying identity and reputations, platforms can mitigate such scenarios. They can also enforce requirements for criminal checks or insurance.

The government must remember that the ultimate purpose of regulation is to tackle market failures so that commercial exchange is not stifled by information asymmetries or blocked by firms with too much market power. Profit is a more powerful driver for quality than regulatory compliance (in the presence of competition). In the gig economy, reputation serves as the institution that protects buyers and prevents the market failure that policymakers worry about. Regulation to maintain quality is an option but if a hotel room is dirty, a bad rating and review on TripAdvisor would hinder future business and act as an incentive to maintain quality.

Reputation is definitely important in the gig economy, but biases may affect ratings. In a society cleaved by differences for millennia, we cannot afford to let these propagate as they would further the economic and social exclusion of individuals. Algorithms need to correct for biases so that these reputation systems don’t create a barrier to access. Biases exist in the traditional workplace too but as we look forward we should aim higher. With big data and artificial intelligence (AI) developing fast, it should be possible to correct these. Reputation is going to be the gateway to access and the government can mandate supervision of algorithms to recognize bias and remove it. This works the same way as anti-discrimination laws. As an example, credit card approvals were fraught with biases in the 1980s in the US against black applicants and applicants from certain locales. But, banks recognized this and have designed credit scores that calculate the probability of fraud more objectively and minimize bias.

Arguments can be made against some aggregators on the basis of predatory pricing. It would be interesting to see how they fare without subsidizing consumers and service providers. There are also arguments to be made that sharing platforms have economies of scale that encourage a monopoly and should be regulated like utilities. But, these platforms are not silent intermediaries. The seek to actively shape markets they create. Because the potential of these platforms is huge, they will be highly disruptive in the short term. The government has a very important role to play in establishing contracts but should be careful to not try to guide development with too little information. For even with a lot of information, the platforms themselves are not sure yet and are experimenting with various business models.

The internet has rapidly evolved from information sharing to e-commerce and now into a method of accessing real world services. This takes us back to the basic tenets of capitalism where everyone is capable of being a business owner and set prices for their services. The growth of sharing economy companies like Taskrabbit or Elance has enormous implications for how we look at work in the 21st century. Social security, labour laws and retirement plans will need to take into account the greater prevalence of freelance workers. We will soon be facing a world with driverless cars and the government should be aware of the changes it would need in terms of regulation to allow them. AI bots are now being employed by law firms, call centre workers will soon be replaced by Siri. Do we know how to respond?

This article first appeared in Livemint

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