economy

14 lkh households to be provided skill development training

About 14 lakh households, which have completed 100 days of work under the rural job flagship scheme MGNREGA in the last financial year and have workers under 35 years of age will be imparted skill development training to help them find urban employment opportunities

The project, named Livelihoods in Full Employment (LIFE), has identified 14 lakh households which have completed 100 days work in 2014-15 and have workers under 35 years of age, the ministry said in a communique.

Government has proposed that workers from such households may be skilled in line with the National Rural Livelihood Mission (NRLM) and Deen Dayal Upadhyaya Skill Development Yojana programmes of the Rural Development Ministry.

The project aims at strengthening the livelihoods of the poorest households dependent on MGNREGA work for their sustenance, the communique said.

This would be done by imparting skills required for migrating to urban areas using the apprenticeship or the DDU-SKY skill training and later placing them in jobs in urban areas.

The programme will also strive to group workers into labour cooperatives, training and equipping them so that they seek contract work with construction/road laying firms, it said.

It will also organise workers into groups, skill and equip them with essential machinery to take up agricultural operations efficiently and at competitive market rates.

According to government officials, this will not only help in giving sustainable incomes to the workers but would resolve the

problem of labour shortage in agriculture.

The ‘LIFE-MGNREGA’ is likely to be implemented in July and states have been asked to prepare their plans

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M Ramachandran: Smart accountability

The Centre and states will not be able to find the resources required for making our cities smart. Each city will have to plan its own agenda. So, empowering the elected systems of city bodies has to be a priority

Now that enough discussions have taken place as to what is meant by a “smart city” in the Indian context, how the agenda is to be taken forward, and the contours of the scheme that are likely to be announced by the central government soon, it is worthwhile looking at two key elements of the concept. As the Union urban development minister has been repeatedly emphasising, smart cities would essentially mean smart people on the one hand and smart governance on the other. The question is whether our city governance system is ready for the big challenge.

The 74th Constitutional Amendment was enacted in 1993. It did two things: first, it gave urban and rural local bodies the recognition required; and second, it left it to the states to decide about empowering the third level of governance. This second item remains an unfinished agenda even today, because states have not redrafted their municipal legislations to make governance effective. All the functions listed in Schedule 12 of the Constitution have not been meaningfully transferred to urban local bodies. How then are they to assume leadership roles in providing basic facilities to city-dwellers?

We have mayors and chairpersons who are mostly indirectly elected, in many places for a one-year period. Even if mayors and chairpersons are directly elected, as is the case in a select number of states, they have no powers – their constant complaint being that either all the powers are with the commissioner, or many matters have to be referred to the state government. In such a scenario, how is the city-level leadership to emerge and take new initiatives to bring about improvements in service delivery or make the city more liveable?

Worldwide, those cities have marched ahead which had visionary leadership and where mayors led the process of city improvement from the front. It has been said about mayors of New York that their administrations use business methods to improve everything from city services to long-term planning. In the wake of stiff competition to find resources, and the need to excel in improving civic facilities, mayors the world over focus on issuing urban prospectuses and attending conferences of businesspeople. Seoul’s mayor made his policy intentions clear and initiated the transformation of urban space from accommodating cars to space for people, representing a new paradigm for urban management in the new century. The mayor of Greater London has the authority to hire talent and expertise from outside – city-level agencies have leaders appointed by the mayor which remain cutting-edge as far as performance is concerned. Transport for London is a typical example of a corporatised agency with an independent board appointed by the mayor which very effectively manages the city’s huge transport issues.

The minister has referred to a city challenge process to identify cities that will be eligible to be in the smart cities list. The prime minister is reported to have said that there should be competition among city authorities to assess their preparedness and capability to undertake this ambitious task. It looks as though initiatives taken by cities to ensure good governance, progress in implementing the Swachh Bharat Abhiyan, status of urban reforms and preparedness for reforms as well as revenue generation initiatives will figure in this list of eligibility criteria.

The Jawaharlal Nehru National Urban Renewal Mission had given cities the opportunity to implement reforms and make a difference. States have repeatedly been advised to focus on municipal cadre restructuring and capacity development. Finance Commissions have gently guided the states on to the path of making local bodies account for performance and decide on devolution of resources. Naturally, those states and cities which paid attention to these much-needed requirements are likely to be ahead in the race.

But what is critical and important now is whether our cities will and can move in the direction of smart governance through smart governments. This would mean steadily moving in the direction of improving the credit rating of cities, and strengthening and bringing about visible improvements to service levels of basics like water supply and waste management. All these become highly relevant because the Centre – alone or even with the states – is not going to be in a position to find the type of resources required for making our cities smart. So, it will be a question of how each city wants to plan its agenda; what proportion of the needed resources it will be able to raise itself, working with private or institutional partners; and what proportion will be found from within the city.

That is why strengthening and empowering the elected systems of city bodies has to be a priority. This will be a challenging and at the same time a difficult decision for state leaderships – because there will have to be a very delicate balancing of power equations between the state and the cities – and the faster the decision, the better. Citizens will gain, as they can hope to participate more effectively in the smart city planning process and also demand more accountability.

Criticisms of proposed GST are mostly wrong

All GSTs in federal countries all over the world are imperfect

When the 122nd amendment Bill for amendment of the Constitution is due for discussion in Parliament, it is but natural that there will be criticism and appraisal of the proposed model. I am writing here to say that the criticism should not be unfair. I shall discuss which are the unfair criticisms and which have some validity.

One of the most unfair criticisms is that the proposed model is not ideal and is fractured due to compromises made mostly under the pressure of the states. What is not remembered is that all kinds of goods and services tax (GSTs) in federal countries all over the world are imperfect. Brazil’s GST is so complicated that economists have called it a patchwork quilt. In European Union also the structure is defective such that in poorer countries like Italy and Spain, etc, there is a lot of cash sale. Even in Canada, each state collects it own sales tax apart from the central levy of seven per cent. In India, we have been able to subsume the sales tax, which is a better model than in Canada.

The exclusion of petroleum, liquor and tobacco, which accounts for nearly 40 per cent of total revenue, has been a point of criticism. However, it is to be understood that the share of revenue on petroleum may be high, but to judge the impact on the GST on the basis of just share of revenue is to miss the macroeconomic picture. Petroleum is a bulk commodity and is also traded in bulk. So the impact of non-inclusion of petroleum does not adversely affect the creation of a common market for the general merchandise, like raw materials and machines. Moreover, there can be a proper system of value-added tax (VAT) at state level and CENVAT at the central level for petroleum and tobacco, which will solve the problem of input credit. No great harm is done if parallel VAT runs with GST. For alcohol, tobacco and mineral oil, even in the European Union, there is excise in addition to VAT with different rates in different countries. Saying that GST without petroleum is not GST at all, is just over reaction.

Another criticism is that the present model does not include real estate. This point is entirely without merit. Real estate does not fall in the definition of goods and services. There will have to be many amendments of Constitutional provisions if it is to be included, namely Entries 63, 54,18 and 19 of State List and Entry 84 of Union List. This will bring about tremendous strife between Centre and the states . It is now prevalent only in Canada, Australia, New Zealand and Singapore.

The real defects in the model are the following.

(a) There is a retrograde move to extend GST to stock transfer by first charging on it and then giving credit. The states have forced their way in this decision which will cause a lot of impairment in work against the wishes of the Centre. It will involve tremendous work with no revenue gain. Even if certain amounts are given credit after initial payment of duty, the money has to be brought out from other circulations and to that extent the economy will become slower.

(b) On import, a countervailing (CV) duty of 27 per cent, which is said to be revenue neutral rate for IGST, is to be paid which is substantially higher than before. Earlier, service tax was not to be included in CV duty, but now that also is included in the IGST (integrated GST). Charging such higher duty is economically regressive. Government may have to lower the whole rate for countervailing duty which has not been indicated.

Conclusion is that most of the criticisms do not take into account the reality of federalism. They do not count the blessings which are the following:

One rate of tax, no distinction between goods and services, common market, no entry tax, common exemptions, comprehensive nature of tax, demise of the concept of manufacture, no more of that fat book called excise tariff, no classification controversy, no central sales tax which will increase inter-state trade, simpler invoicing, etc. We should now try to remove the defects rather than trying to include what has not been included.

So What is GST, and What Are Its Benefits?

The Goods & Services Tax (GST) has been debated in India for nearly a decade. But now, finally, it looks like it will be a reality soon. So what is GST, and what are its benefits? Swarajya offers a primer

Finance Minister Arun Jaitley held discussions with state finance ministers over the last two days in a determined bid to seal a deal on goods & services tax (GST) that his ministry officials said is as close as it has ever been. The Modi government wants to ensure that this key element of its economic reforms agenda can be put in place by April 1, 2016, as part of efforts to speed up growth.

Finance Minister Arun Jaitley, committing to push the GDP growth rate to 6-6.5 per cent in the 2015-16 financial year, on Friday said the government was working overtime to push reforms, especially in sectors like insurance, coal and the Goods and Services Tax (GST).

“We are working overtime on reforms… Insurance Bill will be taken up next week,” Jaitley said while speaking at a programme organised by the India Today Group-owned television channel Aaj Tak.

The Finance Minister further said that he sat late on Thursday evening with state FMs to sort out the issues hampering the rollout of the long-pending GST. “I will try to introduce the Constitution Amendment Bill for GST in the current session of Parliament so that it could be discussed and considered in the next session,” Jaitley said.

So what is this all-important GST?

It is a single, comprehensive value-added tax on goods and services that is levied at every stage of a transaction. The person paying the tax can offset it as an input cost. Thus, tax is levied only on the value added during a particular stage of transaction.

It really shifts the burden of tax to the point of final consumption. But the tax burden on the final consumer will be less than it is now because taxes paid earlier have been set off.

Understanding GST

How GST WorksSource: website of the empowered committee of finance ministers 

Why a GST

It will do away with cascading of taxes or the tax-on-tax phenomenon where the tax paid at one stage gets added on to the price of a good on which tax is levied at the next stage. So it will reduce the tax burden on goods and services for the final consumer.

GST will also end the multiplicity of taxes that make compliance with, and administration of, indirect taxes a nightmare. It will improve indirect tax collections by broadening the tax base, making evasion less attractive (you can get tax credit only if you have paid tax earlier).

Above all, it will create a common market in India, since the rate will be uniform across the country and taxes paid in one state can be offset for transactions done in another.

But wasn’t VAT supposed to do all this?

Yes, and it did, to an extent. Sales tax, which preceded VAT, was a cascading type of tax. Besides, states levied several other taxes, all of which not only made things difficult for manufacturers and traders but also increased prices. With VAT being introduced in 2005, people at various points of a transaction chain could set off the taxes they paid on previous transactions. Most of the other taxes were also subsumed into VAT.

However, VAT has some shortcomings. It does not include all taxes/levies at the central and state level, which it should have. What’s more, some of these taxes cannot be set off as input tax credit. Also, VAT applied only to goods.

There was a separate service tax, which got added on since the production of goods involves some services as well. VAT also did not cover inter-state transactions. So, though cascading was reduced significantly, it was not eliminated altogether.

The National Council for Applied Economic Research (NCAER) has estimated that the implementation of GST will boost GDP by between 0.9 per cent and 1.7 per cent.

The history of GST in India

The initiative for GST started soon after the implementation of VAT in 2005. Then Finance Minister P. Chidambaram announced, in his Budget speech in February 2007, that GST would be implemented from April 2010.

The Empowered Committee of State Finance Ministers started work on drawing up a roadmap. A broad agreement was arrived at on GST being a dual tax—a central and state GST; barring a few agreed exemptions, all goods and services will be brought under GST through a common legislation; there would be no distinction between goods and services.

A Constitution amendment bill was tabled in 2011 to enable GST. This was required because the Constitution does not allow states to tax services and the Centre to tax sales of goods. The Parliamentary Standing Committee on Finance submitted its report on the bill in 2013. A revised bill is to be tabled by the present government.

Who stands to lose

Not all states are keen on GST. With one single tax and rate, they will have to give up their freedom to levy taxes, an important element of fiscal autonomy. States’ own taxes form a significant chunk of their revenues.

Right now, they levy a number of taxes (entry tax/octroi, luxury tax, entertainment tax, taxes on lottery/gambling, purchase tax) and these would get incorporated into GST. This, they fear, will be detrimental to state finances.

State governments want to be compensated for losses they suffer due to GST and an independent compensation system to be institutionalised so that the Centre will not be able to shortchange them. Many also want certain items like petroleum products, items containing alcohol and tobacco products to be kept out of GST.

However, economists have said that GST would be meaningless if this was done. Everything will now depend on the revenue-neutral rate (the rate at which there will be no revenue loss to states) that will be fixed as well as the compensation amount and mechanism for it.

If there is agreement on these issues, GST will be a shoo-in. However, it is unlikely to happen from April 2015. The revised bill has to be cleared by the cabinet and then go through the parliamentary process.

International experience

India is coming to the game pretty late. Nearly 140 countries have a GST system in place, though the models may vary. These include Canada, China, New Zealand, Singapore, Japan and the Scandinavian countries. The European Union has a single rate VAT system that applies to all its members.

Each country gets to keep the VAT levied on purchases within its area. Countries with GST have seen a rise in revenues after its adoption.

Ground realities about renewable power

India is undoubtedly doing well in increasing the share of renewable sources in power generation. Almost 5 per cent of the country’s energy requirements now come from renewable power. This is a fairly respectable number, given the pressure on keeping electricity prices affordable.

The renewed thrust on renewables is also welcome and the interest shown by all stakeholders in the value chain has been overwhelming. But how do we make renewable power truly mainstream and meaningful in fulfilling our energy needs?

The big ‘elephant in the room’ that still remains is the infirm nature of renewable power and the consequent challenges in keeping the grid stable. The grid becomes increasingly unstable if the share of infirm power increases beyond 20 per cent to 25 per cent of the total generation capacity.

There is no doubt that the basic cost of renewable power has been dropping sharply (around ₹4.5 to ₹7 per unit) and almost approaching grid parity, that cost however is notional. If this renewable power has to be made useful and more meaningful, then the cost of storage or some form of ‘back-up generation’ has to be added.

Inter-connect grids

The present back-up costs range from ₹13 per unit for diesel generation to over ₹20 per unit for battery storage. The total cost of ‘useful’ renewable power, therefore, is currently anywhere between ₹17 per unit to ₹27 per unit.

In fact, the more we add renewable power to the grid, the more we will increase the financial losses of the utilities, because we still lack the political will to increase power tariffs, commensurate with increase in costs.

We would be doing immense disservice to the renewable sector if we do not address this elephant in the room and take up this challenge squarely. The good news is that we do have solutions available and we need to focus on implementing them alongside adding generation capacity.

Renewable power by definition will be concentrated in those areas where the natural resource is available. These natural resources are usually concentrated in certain geographies. For example, the speed of wind is good in Tamil Nadu, Maharashtra and Gujarat. Solar intensity is good in States such as Rajasthan and Gujarat.

Renewable power generation therefore tends to get concentrated in these areas. If the local grid has to absorb all the renewable power then it certainly gets to be a major challenge.

For example, the Tamil Nadu grid faces serious grid balancing issues when the wind suddenly dies, and almost 20 per cent of the State’s total generation comes down. In the absence of any back-up form of generation, the only way to balance the grid is to then shed load which can cause major disruption.

One way to address this is to interconnect grids so that the share of infirm power as a proportion of the total power generated in the country is smaller and grid management becomes easier. Given the concurrent nature of the power sector it would be necessary for various States and their power regulators to come together to make this happen.

Obsession with capacity

From a policy perspective, we need to shift focus on energy (units or kWh) generation and not just on capacity (kW) addition. For some strange reason, India is obsessed with the name plate capacity (KW) of the renewable generation facility without really focusing on how much of electricity (kWh) the facility actually produces.

Further, the incentivisation regime for renewable power is focused on a capital subsidy (depreciation benefit) rather than incentivising actual generation (GBI).

The more electricity any power generation facility generates, the lower will be the cost of generation and ultimately, the cost of electricity in terms of ₹/kWh is more relevant than just capital cost in terms of ₹/KW.

Globally, technology development in renewables is focused on increasing generation and making it more predictable rather than just the nameplate capacity rating. In India, the entire emphasis is on increasing the nameplate capacity of the equipment even at the cost of inferior utilisation.

As a global leader in renewable power, India too needs to encourage the right behaviour in both technology development and power generation. This can be achieved encouraging efficient generation over the long term rather than only giving initial capital subsidies.

Back-up power

Given the scale at which India wants to develop renewable power, there is no substitute for a spinning reserve or some form of energy storage. Energy storage is clearly an area where India can take the global lead in encouraging innovation. The country uses diesel generation as the “spinning reserve” in the form back up generation.

Any form of electricity storage, that is cheaper than diesel generation at ₹13 per kWh, can replace polluting diesel. Globally, Gas is the preferred fuel for “back up / peaking / spinning reserve”, given its lower cost and far cleaner composition. Gas based peaking power would cost around ₹7 to ₹9 per unit.

There is no clear policy in India to address peaking power demand and it’s high time the country formulated one rather than resort to load shedding or diesel generation.

Peaking power solutions will also be able to address the back up requirement for renewable generation. Gas based generation is the cleanest and most affordable of all peaking power solutions.

Lack of distribution reforms can stall the renewable sector. A lot of focus is being put on clearing the bottlenecks in increasing generation. But for every additional unit that is generated, it adds ₹1 per unit of loss on to the distribution company.

This is because the average realisation of revenue from consumers is lower than the cost of electricity production. Over the last few years, additions to coal-based generation capacity have been negligible.

Renewable capacity however did get added which, in turn, has further increased the average cost of power generated. We see renewable power being regularly backed down and developers not being paid for power generated. This situation will only worsen, unless distribution reforms are undertaken on an immediate basis.

We must not wait for a China- like smog situation to arise in our cities and then we sit up and take notice. We must bite the bullet to address the issue of appropriate tariffs.

NGOs fall short as agents of change

Profit motive often takes the place of the original spirit to bring about social change

Ruling authoritarian regimes are being increasingly challenged by civil society organisations since the 1980s.

Grassroots-level participation is being seen as a major social and political agent of change and an important instrument in the democratisation process, particularly in the developing world.

The role of government may be justified to ensure that, at the very least, those with meagre resources do not get excluded from the process, and the benefits, of growth.

The role of NGOs can also be envisaged as a major force which can improve the wellbeing of low-income households.

The active role of NGOs can result in the enhanced wellbeing of the bottom deciles only when there is transparency.

Some studies show that NGO assistance accounts for only a marginal proportion of the reasons cited for poverty alleviation.

This does not mean NGOs were not present — rather their impact is likely to have been on an insignificant number of people.

Hence, the issue is not the existence of such forces; it all depends on how actively civil society involves itself in the development process.

There are several cases of poor performance, for which there are primarily two reasons: members of an organisation are often guided by the profit motive, either individually or collectively, and secondly the constraints under which NGOs function are so severe that performance is impacted negatively.

The 1990s brought about renewed interest in NGOs. There has been a need to cover the growing gaps in social services created by structural adjustment and other reforms in developing countries.

The risk-takers

Studies suggest that individuals who are politically active with extreme positions, those with a sense of commitment to social issues and those prepared to engage themselves in costly and risky activities, are those who initiate social movements and collective action. However, as institutions change over time, the relationship between civic engagement and citizens’ democratic values, generalised trust, and cooperative norms also tend to change.

Using the World Values Survey, it has been verified by studies that engagement-trust relationship is not stable.

Hence, the possibility of the profit motive becoming predominant at a later stage cannot be ruled out even if initially one was motivated by a philanthropic attitude.

Based on our survey data, the findings on the effectiveness of civil society groups suggest that the beneficiaries are not necessarily better-off in terms of the number of days of employment in a month. NGOs are not able to provide substantial employment opportunities over a long period of time in a sustained manner, due to the lack of work consignments that they are able to access.

Wage factor

As some of the respondents opined, the organisations they were attached with secure work orders mainly from export houses, and that too in a limited field, which in turn tends to reduce work opportunities. The results are indicative of the fact that women from large households with greater domestic burden tend to join NGOs as beneficiaries.

Also, with age, the probability of seeking employment through NGOs increases at least till a threshold limit, as they are not able to participate in the job market explicitly given their household responsibilities.

Once they are associated with such NGOs their earnings are certain to increase.

However, though the NGOs included in our case study are able to provide higher earnings, the lack of employment assignments forces many of the workers to drop out.

Based on our field survey we noted that the respondents were happy to work for contractors even for lower earnings as they could provide them with work opportunities on a regular basis.

Lower pay is preferable if it involves regularity in terms of livelihood.

For NGOs to be effective, active operation and large-scale coverage are important. The government and NGOs may have to operate in close cooperation in order to reap better outcomes.

Otherwise, NGO failures will be as widespread as government failures.

Microfinance is no economic miracle

It meets consumption needs of the poor. But it is incapable of creating the requisite assets for poverty alleviation

The innovation called microfinance is actually an innovation in banking systems and processes to enable lenders to lend to the poor in a sustainable way. Here, the sustainability of the lender and not the borrower is the objective.

Bangladesh’s Muhammad Yunus filled the gaps in existing banking system in innovative ways such as replacing physical capital with social capital, doorstep banking, and weekly repayments to make the poor bankable without compromising on prudent banking rules.

The result was a business model that ensured repayment and approved of reasonable profit. This motivated many lenders to explore the market at the bottom of pyramid — a term that Yunus does not want to be associated with microcredit.

What’s the effect?

Various studies on the impact of microfinance have found that there is no transformative change in income and poverty levels despite the availability of credit.

Expecting a change as huge as pulling the poor out of poverty is turning a blind eye to the limitations of market-based solutions – such as microfinance .

Just as the availability of a ₹1 sachet cannot ensure hygiene for the poor in the absence of structural support such as water and sanitation facilities.

Similarly, providing the poor with small sums of credit cannot ensure reduction in poverty in the absence of holistic interventions. FMCG outlets selling these sachets and microfinance institutions (MFIs) are doing business at the bottom of the pyramid. An FMCG cannot and will not focus on substantially changing the hygienic condition of the poor, because that is beyond the scope of its business. Likewise, MFIs cannot necessarily create enabling conditions for growth, because that is none of their business.

MFIs are just commercial lenders (above 75 per cent of micro finance business is done by for profit NBFC MFIs). Financial institutions are not expected to bring about complete development and should not be judged on those criteria.

MFIs can be fairly assessed in their performance as lenders. A closer look at the policies, however, discloses that even as lenders, MFI policies are not designed to create an impact, and commercial considerations prevail over the needs of borrowers.

Assessing performance

First of all, the selection criteria for clients are permanent residence in the area, ownership of a pakka (brick and cement) house, and the existence of an enterprise for at least a year. Those who have already invested and survived for a year get credit.

Though it makes good business sense to lend to a running unit, the claim of giving loans to the poor for asset creation and income enhancement is not validated.

Most often, clients use the credit as working capital. Not that working capital is not required but since investment is not enhanced, productive capacity is not enhanced; hence there cannot be transformative change.

In addition, this policy leaves out the very poor. Further, this approach limits the number of eligible borrowers. All MFIs target these comparatively fewer numbers of eligible borrowers. This, in turn, leads to client poaching and multiple borrowings.

Moreover, unlike a good lender, the MFI appraisal process does not have a provision for assessing enterprise need.

The present repayment capacity and not the projected income generation of the activity being financed are assessed.

There is no assessment of project cost, raw material or stock cost, gestation period, projected cash flow, prospective buyers, feasibility of project, and capital gap.

Instead, current assets, earnings and working members are recorded to ensure that the client is able to repay from household income.

Simply not enough

Since enterprise need is not the focus, MFIs offer only one type of product. This product ranges between ₹10,000 and ₹20,000. The catalogue of MFIs may have a few more products but all clients are given a similar amount with similar repayment period and similar instalment amount.

This could be cost effective for the MFI, but clearly, the financial needs of the micro enterprise are ignored.

Different enterprises may have different needs: for example, the investment needs of a photocopier, a mechanic and a home-based tailor differ substantially, but the MFI will offer the same: ₹12,000 or ₹15,000. This leads the borrower to borrow more from outside sources at high cost or to utilise the money for non-productive purposes thus creating an extra interest burden.

Similarly units at the take-off stage that can grow with proper financial support and generate more employment remain outside the purview of this policy.

Further, the loan amount is too small to create an enduring asset. Barring a few low income-generating activities such as like home-based tailoring, no other investment can be done. Even a buffalo of average quality costs between ₹30,000 and ₹40,000.

Incidentally, this amount is not sufficient even as working capital to cater to a running and growing enterprise. Entrepreneurs have to depend on private sources for peak season work.

MFIs fill the void of formal lenders for a population with a constant cash crunch and as such are welcome.

But their lending policies are aimed at consumption smoothening, and nothing more. This is what all studies have found.

Inflation targeting is not a good idea

It has not worked elsewhere. And it could lead to instability in exchange rates, interest rates and GDP growth

The Centre and the Reserve Bank of India signed an agreement on February 20, 2015, which intends to put in place the inflation targeting framework (ITF) as the preferred monetary policy approach to be operated by the RBI. The objective for monetary policy that it has set is “to maintain price stability, while keeping in mind the objective of growth”.

The target lies in a flexible band of 2 per cent to 6 per cent of CPI-based inflation. Deviation in inflation from this band in either direction for a consecutive period of three quarters (nine months’ average) would mean a failure to meet the target. The RBI governor would have to offer explanations for the deviation and the timeline to bring the inflation within the desired band. This effectively means that the RBI has to follow the ITF, overriding other objectives of monetary policy. Moreover, the agreement does not include any commitment on the part of the government to maintain fiscal prudence.

Clarifying the position

Essentially, the ITF approach consists of setting an inflation target, aligning monetary policy to ensure its attainment, and doing so in a manner that is both transparent and accountable. It requires a robust and predictable relationship between output gap, inflation and policy rate in the economy to exploit a trade-off. It also requires the ability to forecast potential output and demand which together determine output gap, the expected inflation and the corresponding time path for policy rate that would keep inflation within the stipulated limit.

However, the monetary policy statements do not go beyond fan charts for inflation and growth in gross value added. Specifically, there is no answer to several pertinent questions, for example the contribution of policy rates in bringing down recent WPI inflation or the effect of prolonged high interest rate on potential output. In the absence of such transparency, the decisions on policy rates seem to remain as ad hoc as before.

Therefore, the RBI has the responsibility to make public the source of its confidence in shifting to ITF despite the uncertainties regarding supply shocks and productivity growth across sectors. The 2014 report of the expert committee to revise and strengthen the monetary policy framework also did not show any such preparedness.

Moreover, the Reserve Bank of India Act 1939 (amended up to February 2013) has no provision to allow the RBI and the Union government to enter into such an agreement. In such a situation the legal status of the agreement is not clear.

Coping with instability

At the same time, the pure inflation targeting regime is already under strain as it has not been able to cope with financial instability and supply side shocks. Since the 2008 crisis, central banks have found themselves faced with new challenges which have raised questions about the future of inflation targeting as a framework for the conduct of monetary policy; modifications are being suggested to incorporate additional goals. In fact, for the past five years, several inflation targeting countries have missed their target bands and suffered from excessive instability in interest rate, exchange rates and GDP growth.

In contrast, China and the US, which together produce more than one-third of the global income, do not have an explicit inflation target. Yet both these countries have consistently maintained a low inflation, low interest rate regime for almost two decades. During the last five years, from 2008 to 2013, these two countries have not only posted a better inflation and growth record but also outperformed several inflation targeting countries in terms of level of achievement and variations. The variations in exchange rates, GDP growth and interest rates are remarkably high in prominent inflation targeting countries.

Stabilisation of inflation is always an implicit target of any central bank, but along with that, managing financial stability and exchange variations is equally important. After the 2008-09 financial crisis, these aspects of central banking have taken centre-stage.

Structural issues

The monetary framework for India needs to factor in its structural problems. The frictional cost between point of production and consumption, which is generally reflected in wide gaps between WPI (proxy of producer price) and CPI, is aggravated by increasing interest rates. A high interest rate inhibits growth in potential output by constraining investments in infrastructure, storage and modernisation.

Poor and inadequate infrastructure creates supply-side constraints, limits growth in productivity and potential output, and raises the prices of goods and services. This is likely to be mistaken as the result of excess demand prompting central banks to adopt monetary tightening. For example, take the case of construction of roads, railways, ports and other infrastructure, including digital cables, electrification, hospitals and schools. During the construction phase, such investment tends to increase output gap for the current year, and may be mistaken as a source of overheating.

Thus, in a growing economy which is trying to make up for the infrastructure deficit, an inflation targeting central bank will put all the breaks on money supply, leading to high costs and deceleration. Such deceleration will create a vicious cycle of supply constraints, raising prices further. This may be how India got itself into a high inflation, high interest rate regime for some time now.

In fact, countries such as China followed policies that motivated huge investment in futuristic infrastructure. They brought down the cost of inputs, including the cost of energy, and stabilised the economy at low inflation and low interest rate. This has paid huge dividends in terms of sustained growth without overheating. India needs to come out of the inflation targeting syndrome, reduce interest rates and take measures to fix supply-side issues.

Farm Distress – Is Anyone Interested In A Solution?

Adoption of technology and improving on existing land legislation is the solution for the prevalent agrarian distress. The death of a quasi-farmer in a rally – ostensibly to challenge the Land Acquisition Bill, has brought to the fore the issue of farm distress in a rather ironical manner. The party holding the rally has little to do with farmers, being an urban party rooted in Delhi where every farmer doubles up as a land dealer and doesn’t have even a nodding acquaintance with poverty. The man who died was just a quasi-farmer in the sense that he derived his main income from peddling saffas and rendering a service in tying them on festive and celebratory occasions.

Not just that, there was no imminent threat of any land acquisition in Baswa Tehsil of Dausa district where the only land that may be required in the next 20 years could be for doubling of the Delhi-Jaipur railway line, or the Alwar-Sikandara Highway which joins the main Agra-Jaipur Highway. Both these possibilities are far removed from the village of Nangal-Jhamarwada to which the deceased Gajendra Singh Kalyanvat belonged.

The issue is that of farm distress. Land was always a national resource, and rightly so. Even today, most states call the farmers’ land a tenancy. This tenancy has become a holy cow over the years for two reasons- one, the proliferation of a rent-seeking middleman class in areas where a land market exists, or an acquisition is afoot; and second because it suits the local politician to appropriate both goodwill and the land in the name of saving the farmer. Except Gujarat and to some extent, Andhra Pradesh and parts of Maharashtra, little thought has gone into making the land remunerative.

We know now that the population solely dependent on agriculture is down to 22%, and the contribution of Agriculture to GDP is down to 13%, yet the figure of 60% poor farmers is bandied about like an incantation. After the 1950s land reforms and 1960s Green Revolution, nothing has happened to remove the asymmetry between agriculture and national economy.

Sharad Pawar had the right ideas in agriculture sector but was not able to deliver for reasons that can only be speculated. He did bring about great changes in western Maharashtra and parts of Marathwada by encouraging diversification into horticulture based on micro-irrigation, and was instrumental in initiating the National Horticulture Mission, but the software part required to make it a national movement remained absent.

It is widely recognised that 3 kind of agricultural reforms are absolutely vital to make agriculture a viable option for a majority of people engaged in agriculture:

Integrated Farming

Crop Husbandry by itself is not a viable option in rain-fed areas. It has to be supplemented by horticulture and animal husbandry and augmented by micro-irrigation. Even in irrigated areas, rise in income depends upon these innovations. The Gujarat Green Revolution Corporation is an example of how micro-irrigation can spread in a State in an exponential manner. I was heading Horticulture in Rajasthan for 30 months. The protective cultivation module developed by us to supplement the crop husbandry in Bassi area of Dausa district is bringing an additional annual income of 20-30 lakhs to farmers on land which used to yield barely 25-30000. Introduction of tissue-cultured date palm in the desert areas is bringing significant additional incomes. If anyone wants to see a model of integrated farming in the world, he needs to go only as far as Kutch where progressive farmers are earning as much as 40-50 lakhs per hectare, annually. I tried to adapt that module in Western Rajasthan. Why can’t more states take the same route?

Modern seeds, credit and insurance reform

Populism has thwarted any movement on these aspects. After the success of BT cotton, India should have imparted momentum to modern seed industry, but the entire scientific discussion got hijacked by environmental fundamentalists. Credit institutions have been killed by frequent loan waivers, so farmer has to depend on usurious loans. Regressive ideas have prevented a full roll-out of crop insurance policies. All these aspects have to be tackled. With PM Modi at the helm and path-breaking work by him in Gujarat, I have hope as well as doubts, whether the more regressive elements would allow him to tackle this headlong. Allowing BT Brinjal trials is a welcome move.

Market reform in produce and land

With all their pro-farmer pretensions, how the parties can oppose FDI in retail boggles the mind completely. All progressive farmer organisations support it. Sharad Joshi of Shetakari Sanghatana was its foremost proponent. The argument about small businesses getting ruined is a completely disingenuous one. When the same amount of production brings 40% extra produce from the farm to the fork, everyone wins. “It’s the middleman, stupid”, seems to be the only explanation.

Coming to land, 60 years of antiquated policies have distorted the land market completely. Those who want to cultivate don’t have land. Those who have land mostly seek rent by becoming absentee land-lords and big entities have no hope of getting into farming business at all. The Gujarat land policy is a universally admired one. What is preventing the present government from extending it pan-India is not known. The amended Land Acquisition Bill is a step in the right direction notwithstanding all the noise, but stops short of actively encouraging land pooling and consolidation for infrastructure projects. This has been the norm in Gujarat. Are you aware that the 3rd Ahmedabad Ring Road has been built without acquiring a single acre of land and purely through land pooling and consolidation. That methodology may require a separate blog. Long term leasing is not permitted when the ground reality is that 70% land is being tilled by share-croppers or contractors. Licensing is not even contemplated.

Antediluvian Land Revenue and Tenancy Acts dot the landscape. Selling of agriculture land faces severe restrictions, producing absurd asymmetries. Land conversion is a huge scandal across the country. Once again I have to advert to Gujarat, where these issues were successfully addressed. Unless we modernise our agriculture market and land policies, farm distress will occur and recur with nauseating regularity.

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