#131 Learn From Others. It's Free 🎧

While excellent newsletters on specific themes within public policy already exist, this thought letter is about frameworks, mental models, and key ideas that will hopefully help you think about any public policy problem in imaginative ways.

Audio narration by Ad-Auris.  

India Policy Watch: Road Ahead  

Insights on burning policy issues in India

- RSJ

What’s next for the Indian economy? Here’s a quick 8-point view on where things are at today.

* Clearly, the speed of vaccination will be the single biggest driver of how quickly the economy recovers this year. The daily vaccine rate has inched up to over 3 million a day after a poor May. While this isn’t adequate, there’s greater intent in procuring and debottlenecking the vaccine delivery process that’s evident. India has only vaccinated about 50 million with both the doses as we write this. It will need tremendous effort to get this number to over 600 million before December but it looks in the realm of possibility. That number will get us close to herd immunity. There’s a skew in vaccinations rates with the top 20 cities getting disproportionate supply of them. Considering these are economic hubs and drivers of consumption, this is acceptable for some time. But this skew has to reduce and the vaccines must reach the rest of India soon to reduce the probability of a third wave. There’s a danger of lapsing into complacency on speed of vaccination seeing the reduction in cases and resumption of economic activities in the big cities. We cannot afford it.

* The rural economy has taken a hit in the second wave going by the case count and deaths. The rural demand had held up during Wave 1 last year but it was already tapering before the start of Wave 2. The high auto-debit bounce rate data emerging from NPCI suggest greater stress in the SME sector in this wave than the previous one. The consumer sentiment surveys show the perception about current state of the economy and about the future are worse today than during the first wave. Considering the sentiment will remain muted till September when most of urban consumers would be vaccinated, this suggests we will need a magical H2 for the overall consumption to be better than FY 21. That’s unlikely to happen. IMD has predicted a normal monsoon in 2021 which is a positive though the correlation between monsoon, agriculture production and inflation has grown weaker over the years.

* On the balance, the real GDP for FY 22 will struggle to be at the pre-pandemic levels of FY 20. I think we will come below it. That’s two years lost because of the virus. The human impact of this loss is not widely understood or appreciated yet. On the other hand, the headline inflation might grow (CAGR) at about 6 per cent during the same two year period. This is stagflation territory. The usual problems that have plagued the economy over the last “lost decade” will continue if there isn’t serious problem solving skills brought to the table by the economic team of this government. The banking (esp PSU banks) and the financial services ecosystem will remain in stress following the pandemic. The unwillingness to lend despite huge liquidity in the system will persist. And the sectors that have been under chronic stress like infrastructure, power, telecom and SMEs will continue the same way. Barring few announcements and repackaging of old ideas, there’s no real plan that’s emerged for these issues. Instead there’s hope and optimism of some kind of magical robust recovery of the economy that’s served as a solution. Hope cannot be the strategy.

* The big difference in FY 22 will be the robust recovery and growth that will be seen in OECD economies. This bodes well for Indian exports. The Wuhan Lab virus origination theory and the more direct approach of Biden administration in competing with China on technology and science (US Innovation and Competition Act that was brought in this week) will make the ‘China plus 1’ model more mainstream for many companies who use it as their manufacturing base. India will have to double down on PLI schemes, ease of doing investment initiatives and woo these companies with intent. This will require bringing policy reforms, reducing state control, deft diplomacy and avoiding dysfunctional political moves that seems to have become the calling card of this government in its second term.

* The biggest issue that should worry the government on both economic and political fronts is jobs. Youth (15-24 age group) unemployment has gone from about 17 per cent in FY17 to over 40 per cent in FY 21 according to CMIE. The trolls can shoot the messenger (CMIE) calling it a private company. But CMIE has a track record for providing unbiased data over the years. It is easy to call it names now when the data looks inconvenient. But it won’t help India. It is important to look at the trends and think of policy actions rather than burying our collective heads in sand and listening only to the vacuous paeans of friendly trolls. The real picture isn’t pretty. The service sector jobs have been impacted because of the multiple lockdowns. About 80 per cent of service sector jobs that were lost in Wave 1 were regained by Feb 2021. That meant a 20 per cent permanent loss of jobs in the sector. But, more importantly, the corresponding percentage of jobs regained in manufacturing (excluding construction) was only 45 per cent. The cost cutting initiatives the industry did during Wave 1 have become permanent. This was evident in the FY 21 earnings growth of the listed companies that came in around 25 per cent (y-o-y). So, while the service sector has struggled to create jobs, the manufacturing has shed flab and is in no mood to bring it back. This has meant a reverse migration of labour to agriculture from industry. This is upending the gains made over the last two decades in moving labour out of farming.

* The K-shaped recovery was clear after Wave 1. It will turn more pronounced after this wave. This is clear from multiple data points - earnings growth of BSE 100 or NSE 50 companies that’s driving the stock markets to record highs, the GST monthly collections data that suggests more formalisation of the economy but, possibly, hides the decimation of the informal sector. The wage bill for large companies grew by over 5 per cent in FY 21 in contrast to the almost 10 per cent contraction seen among MSMEs. The high liquidity in the system has allowed the large companies to deleverage over the past five years without any growth in capital investment despite the hollow public commitments made by industry captains. The economy has taken a sharp oligopolistic turn over the last two years across the sectors. Considering the higher health and economic impact in rural areas in this Wave, there will only be exacerbation of the K-shaped recovery this time. This will have political and social repercussions too in future.

* The current account balance is at a surplus of over USD 25 bn driven by weak domestic consumption last year and FDI and FPI inflows into Indian equity markets and a select set of companies. Contrary to the celebratory tweets of the partisans, a surplus current account isn’t necessarily good news for this stage of Indian economy. The Indian forex reserves are also at their record high at over USD 600 bn (add another USD 75-80 bn of outstanding forward dollar purchases). FY 22 will not see any significant change in these. The current account balance will see net inflows given the outlook on domestic consumption. This gives RBI significant opportunity to keep interest rates low (real interest rates are in negative zone already), take measures to spur growth and monetise deficit without the risk of currency instability. This window must be used by the government.

* In summary, there are three policy moves to make - a) address the old, chronic twin balance sheet issue (multiple recommendations already in the policy sphere). Else it will get worse after Wave 2 and continue to be a drag; b) continued focus on exports and Make in India measures to take advantage of the recovery in OECD and possible isolation of China; c) Start the capex cycle, spend on healthcare and spur consumption through direct transfers in H2 FY 22 when sentiments will be better. The current account surplus and record forex reserves give us a window to do targeted spending to revive demand. This isn’t the time for austerity and tightening of the belts. Spend. Then spend some more. Else, stagflation will be a reality.

Matsyanyaaya: Aussie Rules Diplomacy

Big fish eating small fish = Foreign Policy in action

— Pranay Kotasthane

Discussions on India’s diplomacy often hit a wall called ‘lack of capacity’. The conversation-ender is often the small size of India’s diplomatic corps. To take this conversation over the wall, I’ve been on the lookout for diplomatic institutions that can serve as reference points for India in terms of getting more done with less resources.

And Australia fits the bill. Despite a small corps — just 833 Australian staff serving overseas — Australia’s diplomatic outreach has several innovations to its name. I will discuss three recent ones here.

* Paradiplomacy. Australia gets around its low diplomatic corps strength (to some extent) by allowing its states to have their own trade and investment offices in other countries. In Bengaluru alone for example, at least two states — Victoria and Queensland — have trade offices while the Australian consulate for southern India is located in Chennai. Victoria has a total of 23 such offices in important cities across the globe, New South Wales has 11, and Queensland has 16.

I couldn’t locate any recent papers that evaluate the successes and failures of the Australian Paradiplomacy model but this is one area where Australian experiences can be of help to India. Instead of waiting for the Union government’s diplomatic intake to rise, let states take a lead on the trade and investment fronts.

* An India Economic Strategy to 2035. It’s somewhat amusing that the Australian government has an India Economic Strategy to 2035 document even though India itself doesn’t have an official economic strategy that looks 15 years ahead.

Be that as it may, this document is far-sighted. It begins by saying that ‘There's no single major market out to 2035 with more growth opportunities for Australian business than India.’ Apart from identifying key sectors, it also identifies ten priority states in India where Australia should focus leading up to 2035. Under resource constraints, prioritise. This is another lesson worth emulating.

* Focusing on forward-looking global themes. I found out only a couple of weeks ago that Australia has ambassadorships and strategies for Cyber Affairs and Critical Technology, and Gender Equality. Its International Cyber and Critical Technology Engagement Strategy is an interesting document listing out Australia’s vision, goals, and values in the realm of high tech geopolitics. Having ambassadors focusing on horizontal global themes along with the traditional geographic verticals is another innovation that’s worth thinking about.

In short, a small diplomatic corps cannot be used as an evergreen excuse for India’s underdeveloped global outreach. As Australia’s example shows, there is scope to do more with less.

PolicyWTF (revisited): China’s demographic flip-flops

This section looks at egregious public policies. Policies that make you go: WTF, Did that really happen?

— Pranay Kotasthane

On May 31st, the Politburo of the Communist Party of China decreed that parents can now have three kids. Too little, too late.

In edition #4, I had discussed how China’s one-child policy had accelerated the decline in fertility rates. Changing the upper limit to two in 2016 and to three in 2021 is the closest that an authoritarian regime can come to accepting failure.

This is of course quite relevant for India since population, for many, is the root cause of all that’s wrong here. Even if it were a problem, the society has solved it on its own. From a fertility rate of 5.9 in 1960, it has come down to near replacement level — 2.2 in 2018. In any case, India’s problem is undergovernance and not overpopulation, as my colleague Nitin Pai has written before. We have written about this in our edition #49 here. To all those who still curse India’s population, learn from China’s policyWTF.

To know more about China’s one-child policy, tune in to our Dec 2019 All Things Policy episode.

India Policy Watch: The Fable of the Monkey and the two Cats 

Insights on burning policy issues in India

- Pranay Kotasthane

Last week saw an ugly spat between the finance ministers of Tamil Nadu and Goa on the sidelines of a GST meeting. Partisans from both sides predictably quarrelled and moved on. Nevertheless, this kerfuffle is useful for making an important point that often gets missed.

The central issue is that the states’ focus on horizontal devolution is misplaced. Horizontal devolution refers to the formula used for sharing resources between states. All federalism debates almost exclusively focus on just this one issue. It also gets inaccurately framed as a ‘north vs south’ debate — how the taxes collected from the south are frittered away in the northern wastelands.

But the problem really lies in vertical devolution i.e. how the tax resources are split between the Union government and all states as a whole. If the Union government keeps less money to itself, all states stand to gain together. People do not raise this issue because they falsely believe that the Union government increased the devolution substantially from 32 percent to 42 percent following the 14th Finance Commission recommendations. As the 14th FC covered the requirements of both plan and non-plan expenditure, in reality, the increase was from 39 per cent to 42 per cent. Even this modest 3 per cent increase was sabotaged by the Union government by increasing cess and surcharges, which are not shared with states.

That’s why I say that India’s fiscal federalism resembles the monkey and the two cats fable. While states fight amongst each other, the Union government is happy appropriating 59 percent of the divisible pool resources, raising new cesses, and using a part of these funds to run centrally sponsored schemes that fall squarely in the states’ constitutional domain.

I will raise a toast to federalism when I see at least a few states cooperating to addressing this imbalance in the vertical devolution. Until then, Union governments will be happy to play one state against the other.

HomeWork

Reading and listening recommendations on public policy matters

* [Article] Sajjid Chinoy’s two-part series in Business Standard on the economic impact of the second wave

* [Video] Prof Ananth Narayan in conversation with Mitali Mukherjee for The Wire on the way ahead for the economy.

* [Article] A cruel reminder of Goodhart’s law. To meet the 50,000 per day COVID-19 testing target for the Kumbh Mela, private labs forged the results.

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