Stemming Rupee fall: RBIs move will increase Indias vulnerability to volatile capital inflows

The Reserve Bank of India (RBI) has hiked the cap on the amount of government and corporate debt that foreign portfolio investors are allowed to buy, in an effort to attract more dollars to India and prop up the rupee. But the merits of this proposal are suspect. One, the easing comes at a time when even existing limits have not been fully exhausted. Two, the pursuit of fickle portfolio inflows, rather than more enduring foreign direct investment (FDI), can become the economy's Achilles' heel. In contrast to China, which opened up to FDI much before it relaxed restrictions on portfolio flows, successive Indian governments favoured portfolio investors over FDI. As a result, not only did we lose out on the positive externalities of FDI ancillary industries and jobs but the Indian economy became much more vulnerable to volatile portfolio capital flows. Today, the logical thing would be to reduce our dependence on FIIs and encourage durable investments by raising the FDI ceiling in sectors such as aviation, insurance and pension, and allowing FDI in sectors where it is presently banned, as in multi-brand retail. The government must also remove hurdles that hold up large projects in infrastructure sectors such as power, roads and ports. Once these projects start, investments both local and foreign will pour in. But, increasingly, policymakers are abandoning logic in favour of knee-jerk responses to economic events. The RBI's current moves result from the government's eagerness to somehow strengthen the rupee. Yet, the precarious state of the world economy and high risk aversion among potential investors make it unlikely that overseas capital will make a dash for India. Having painted itself into a corner by encouraging short-term overseas capital flows, the government now has no choice but to go further down the same path and seek yet more FII inflows. The problem is, foreigners are bound to demand a much higher risk premium, in view of the changed global scenario and our declining macroeconomic fundamentals. To attract foreign investments, speed up shovel-ready projects and remove FDI bottlenecks.

Global finance, democracy at loggerheads

Universal franchise and free market capitalism are considered to be the two sides of Western democracy. Conviction in the infallibility and inevitability of the model has been so strong that the dominant powers used every means to topple and democratise the rouge regimes. But few had anticipated that the two pillars democracy and capitalism could come into such sharp conflict with each other in such a short time. This has been happening throughout the world in the past few years. The protagonists may try to brush aside the spreading phenomenon merely as the incumbent rulers failures to push neo-liberal economic reform with adequate force. The respective ruling parties, on

their part, realise that the standard reform prescriptions, such as cutting government subsidies, public health schemes and other welfare measures, are sure to ensure their electoral rout.
EUROPES VERDICT

Hence, electoral democracy, the very foundation of the modern system, is being despised as a hurdle, if not challenge, to the present kind of globalisation. Global financial capital insists on pushing its way in countries already under squeeze. In many EU countries, it has taken the form of a severe financial siege. Yet, almost in all of Europe, angry voters reeling under the rigours of growing unemployment (23 per cent in some cases), wage cuts, and reductions in health coverage and other safety nets are using their voting power to challenge the outside imposition. Watch the way the voters have made their own regime change. This has happened in Spain, Italy, Ireland, Portugal, Denmark and Finland. In Greece, after initial negative voting, the voters have given a majority to a pro-bailout group. Just last month, local polls in the UK revealed rejection of the Cameron governments austerity programmes. Even Germanys Ms Angela Merkel got a wake-up call from her own strongholds. In France, the newly elected Mr Francois Hollande is obliged to keep his poll promise of subsidised water, power, fuel and 75 per cent tax on those earning over one million euro, the very issues the global financiers have resented. This has brought about another element in the conflict between the peoples will and imperatives of global reform. Which is more crucial the will of the people as expressed in a constitutionally valid general election, or the diktats of the global capital? Already, politicians are being blamed for their failure to convince people about the virtues of austerity. Now, there are suggestions concealed in long commentaries for things such as guided democracy. Some have even suggested transient regulations when voters behave immaturely in a freewheeling manner. Another protagonist is more forthright: insulate the economic policy platform from the purview of elections. In the US, the clash takes the form of what Dr Paul Krugman calls Wall Streets war to impose its self-serving agenda on the electors. The frustrated Wall Street campers described it 99 per cent vs 0.01 per cent.
INDIAS EXPERIENCE

In India, the conflict of the two agendas works at two levels. Within the ruling establishment, the government wing is under constant pressure to curtail Ms Sonia Gandhis welfare programmes, the Congress partys sole helpline during the elections. Denial of fixed pension to the elderly, hike in tariffs and fuel prices and fear of foreign giants ousting millions of local traders and their suppliers are issues of contention. At one stage, it seemed like the pragmatic politicians within the party were able to prevail. But in the past six months, 10, Janpath, seems to have yielded to the reform pushers. At the second level is the clash between those pushing an elitist agenda and the electoral compulsions of the demands of an aspirational aam aadmi. Recent assembly elections have brought

this into sharp focus. Regional parties had vied with each other with a long list of populist schemes to woo different groups of voters while the Congress party went on harping on youth aura, FDI and GDP. When the DMK earlier offered TV sets to voters and the AIADMK saris, we had ridiculed them. But both won. P.V. Narasimha Rao suffered his first shock in the Karnataka and Andhra elections after he scrapped the universal PDS. By way of damage control, he came up with his revamped PDS. By far the biggest voter revolt was against the NDAs elitist India Shining plank. In elections, you cannot sell fiscal discipline and austerity. Look at the kind of promises made by the regional players. Last time, Mr Nitish Kumar and Ms Mayawati had promised bicycles to all girl students. An estimate puts the one-time offer of schemes promised by the Samajwadi Party in UP at as high as Rs 30,000 crore. Loan waiver for farmers alone is put at Rs 11,000 crore. If Ms Sonia Gandhi could do it, why cant we, Mr Akhilesh Yadav asks. Then, there are recurring annual commitments, such as Rs 6,000 crore as support price to farmers, Rs 1,000 crore unemployment allowance, Rs 1,819 crore worth laptop computers and free books for students up to Class VIII, free education for women up to graduate level, fee waiver for poor students, old-age pension for farmers, irrigation and water subsidy and higher education and marriage allowance for Muslim girls. Akalis in Punjab followed a similar pattern free laptop for three lakh students, dole for registered unemployed, doubling of widow and old-age pensions, a five marla plot for landless village families, free gas to BPL families, free power to dalit and economically weaker sections, incentives for three lakh girl students and free healthcare for blue card holders and widows. The winners are now seeking central assistance to finance the electoral bounties. In case the Centre rejects their demands, as is most likely, that itself will be made an issue against the perceived antipoor, reforms establishment. With rupee falling steadily and rating agencies and global finance pushing hard for scrapping the FDI cap, we are possibly walking into a BoP mess. World capitals and visiting dignitaries have tightened the investment siege. Delhis reform establishment is in a state of panic. But the trouble is that the Indian electorate has a tradition of being more alert and brutal than its counterparts elsewhere.

Arbitrage galore
Agricultural credit booms - but misses its target
The amount of agricultural credit has exploded in the recent past. But its impact is not showing up to the extent it should. Going by the Reserve Bank of India estimates, the total disbursement of agricultural credit soared by 755 per cent between 2000 and 2010. But it has resulted neither in commensurate growth in farm productivity, nor in the sale of seeds, fertilisers, pesticides and farm machinery. More importantly, the dependence of farmers on informal sources of credit, notably moneylenders, has not declined. The Planning Commission estimates that about 80 million of Indias 128 million land-holding farmers continue to be out of the institutional system of credit. Clearly, much of this expansion of credit is missing its target, and is not reaching small and marginal farmers who need it the most. Worse, recent reports suggest that relatively well-off large farmers, who enjoy preferential access to bank loans, are misusing the highly subsidised credit for non-agricultural purposes or even for making a fast buck by putting the money in fixed deposits or other lucrative financial instruments, utilising the arbitrage opportunities open to them.

Several factors are responsible for this problem, of which at least three are significant. First, the ill-advised broadening of the definition of agricultural credit means both direct and indirect credit to agriculture to be treated as priority farm-sector lending. This allows banks to advance loans for allied activities or to even put their funds in entities connected only vaguely with agriculture, such as non-banking rural financial institutions, rather than lending directly to farmers, which is higher-risk. Second, populist farm debt waivers like UPA-I announced in 2008 have severely dented Indias loan repayment culture. Wilful default by farmers has become more common, in the expectation that debt will be forgiven come election time. The government has tried to repair the moral hazard problem it created by offering two per cent additional interest subvention for timely loan repayment; but even this boomeranged. It led to the short-listing of non-defaulting farmers and the banks lent more and more to the same group of individuals, further excluding small and marginal farmers. The third major factor is the relatively high cost of servicing loans to farmers. Banks often need to deploy special teams to chase farmers for loan recovery after harvests, which adds to their costs. In any case, bringing more farmers into the banking network essential to increase the direct flow of credit needs the opening of bank branches in unbanked areas, which is inherently a loss-making exercise. What is needed, therefore, is to make a clear distinction between direct and indirect credit and a redefinition of both these categories unambiguously. In addition, annual targets should be fixed not just for banks total disbursement or rural credit, but also for the expansion of their agricultural customer base. Unless banks reach out to small and marginal farmers, the objectives behind increasing the flow of farm credit will remain ill-served.

G20 marks and guides integration of policies in a globalising world

As usual, the G20's summit declaration is a compromise, endorsing the middle ground amidst extremist advocacy, for example of growth or of austerity, but leaving room, through caveats and qualifications, for individual countries to pursue their own adjustment programmes at their own pace. The G20 leaders' statement reflects the sense articulated by India's prime minister, that austerity needs to be calibrated so that coordinated austerity in a number of countries does not undermine the sustainability of fiscal adjustment, which can be underwritten, ultimately, only by growth. Many countries are honouring their commitment in 2010 to halve their fiscal deficit measured as a proportion of GDP by 2013. China has been gently encouraged to make its currency more flexible and to increase domestic consumption. Another Manmohan Singh favourite, infrastructure in developing countries, also finds mention in the summit declaration. But it shuns Dr Singh's call to stay focused on a few key issues of global financial and economic coordination. The G20 process runs the risk of losing its teeth by taking on the entire range of development concerns, the latest being consumer rights. It was to be expected that the crisis in the eurozone would consume much of the summit's attention. It is welcome that the final statement recognises the need for economic expansion in the eurozone unqualified in the surplus countries and as required by national circumstance and stage of structural reform in the deficit ones. It is also welcome that the leaders try to boost the flow of funds to private enterprise through greater market access, innovative funding of smart infrastructure, etc. This has the stamp of the new French President, Francoise Hollande, apart from being a favourite themes of Barack Obama. One thing that stands out in the declaration is the extent of intertwining of national destinies through globalisation's multiple channels. To keep abreast of the humongous task of setting national standards, global coordination frameworks, monitoring of one another's progress on commitments and measuring accountability, governments need to invest in new talent and skill.

Concrete movement
CCI's fine on cement companies is welcome
The Competition Commission of Indias order on Thursday that the 10 largest cement companies and industry body Cement Manufacturers Association should pay a cumulative fine of Rs 6,307 crore, as a penalty for forming a cartel to control prices, is a welcome step forward for market regulation in India. It is the first order of such magnitude since the passage of the Competition Act, 2002, which was supposed to ensure free and fair competition, and has been viewed as an act of assertion by the Competition Commission of India (CCI). Each of the 11 entities will have to pay a penalty equal to 50 per cent of its declared profit in 2009-10 and 2010-11, within 90 days of the orders passage. The order has several points of note. First, it specifies that written evidence of cartelisation is not necessary. Second, it says that proper cartelisation requires the institutionalisation of a system to share prices, capacities and production which the cement industry was doing, it says, through the Cement Manufacturers Association. They colluded, the CCI maintains, to ensure that they did not utilise their full capacity, keeping supply low so that prices would not ease. Earlier this year, the all-India average for the price of a 50-kg bag of cement hit a historic high, of over Rs 300. The cement companies are expected to appeal this order. Puzzlingly, share prices of the companies so censured did not react immediately, in spite of the fact that their cash pile has been severely eroded, and their pricing power cut into. It is possible that the market had already priced in the possibility of the CCI verdict being negative. A less sanguine possibility is that market participants simply do not believe that this regulatory action will be allowed to stand, or suspect that it will be weakened significantly by the politically powerful cement lobby. The cement industry may have many arguments in its defence, but it is important to ensure that the CCIs landmark order is judged by the appellate authority on its merit alone. As markets grow in size and complexity, they will become more open to manipulation, and a robust, empowered regulator will be essential to protect market integrity and consumers interests. It will, thus, be in nobodys interest for this, the first major such regulatory action, to be diluted or evaded. The chairman of the CCI, Ashok Chawla, has said that an investigation of practices in the tyre sector is at an advanced stage and that other probes are on in milk, pharmaceuticals and civil aviation. Anecdotally, several of these sectors have been seen to coordinate price increases and decreases, but a formal investigation of cartelisation, of course, requires more than that; as the order said, the institutionalisation of such coordination is what matters. The government is in the process of examining whether the CCIs regulatory ambit should be expanded to include the scrutiny of mergers and acquisitions. That, taken together with the CCIs recent energy, is a good sign for robust, regulated capitalism in India. Some short-term pain for individual companies is a small price to pay for a more efficient, lower-cost economy in which capacity is properly utilised.