Addressing the low baseline of property tax revenues of Indian cities

The RBI has just published a report on municipal government finances. It lays bare one of the biggest concerns in India’s urban development agenda, one that I feel does not get its due attention. 

The total revenue receipts (RRs) of 232 municipal corporations studied was Rs 1.7 trillion (~$20 billion) in 2023-24 BE (compared to Rs 1.42 trillion in 2022-23). This amounts to 0.6% of GDP, the same as in 2019-20 and consistently the same throughout the period. Property tax revenues of these corporations was just Rs 32,450 Cr (~$3.9 billion)! In other words, property tax revenues formed just 0.12% of GDP (add the remaining municipalities, and it’ll come to no more than 0.15%)! Tax revenues made up 30% of total RRs, followed by revenue grants and transfers at 24.9%, and fees and user charges at 20.2%. 

The top 10 municipal corporations account for 58% of all RRs at Rs 98,508 Cr (less than $12 billion). Their property tax revenues were just Rs 20,595 Cr (~$2.5 bn). In other words, the 222 other corporations are estimated to raise just $1.4 billion as property tax in 2023-24. 

The RRs of MCs look really miniscule when compared to their state government RRs. It’s estimated to be 4% in 2023-24, up from 3.6% in 2022-23 but down from 4.2% in 2019-20. This conceals a wide variation, from the 30-35% range of Delhi to 14-16% range of Maharashtra to 6-8% range of Gujarat to the 1-3% range for most other states. While own tax revenues (OTR) made up 30% of total RRs, property taxes are the major source of OTR of the MCs, making more than 16% of revenue receipts and more than 60% of their OTR. It’s disturbing that these ratios have hardly changed over the years.

The grants from state and central governments amounted to just Rs 41,872 Cr (~$ 5 bn) and Rs 14,731 Cr (~$ 1.8 bn) respectively in 2022-23.

MCs in India have generally had low borrowings, rising from just Rs 2886 Cr in 2019-20 to an estimated Rs 13,364 Cr in 2023-24 BE, accounting for just 5.2% of total RRs. Municipal borrowings formed a negligible 0.05% of GDP for all MCs. Interest payments made up just Rs 5675 Cr in 2023-24BE. Municipal bonds have not taken off, with a few hundred crores issued each year and just Rs 4204 Cr outstanding on 31.03.2024. 

On the expenditure side, the revenue and capital spending combined of MCs rose from 1.2% of GDP in 2019-20 to 1.3% in 2023-24BE. The revenue expenditure as a share of GDP has hovered around 0.5% and that of capital expenditure has been 0.7-0.8%. 

In absolute terms, the total expenditure estimates of the 232 MCs for 2023-24BE is Rs 3.9 trillion (~$47 bn), of which revenue expenditure if Rs 1.5 trillion and capital is Rs 2.4 trillion (~$29 bn). The same figures for the top 10 MCs being Rs 1.9, Rs 0.8 and Rs 1.1 trillion respectively. The ratios have remained stable in recent years. 

In fact, the total fixed assets created and under creation during the year 2022-23 RE was just Rs 1.8 trillion (~$21.7 bn). 

One positive feature is that the ratio of revenue to capital expenditures was 0.63 for the MCs in 2023-24 (BE) as against 3.7 for the Centre and 3.0 for the States, reflecting better quality of expenditures. However, it must be noted that these expenditure data must account for the salaries of municipal employees which in atleast some states is borned by the state governments. 

Underlining the low level of expenditures, the per capita capital expenditure across states is very low. 

The report has a good summary of all the revenue sources of municipalities. 

A few observations based on these findings. 

1. India’s property tax revenues are shockingly low at a mere 0.12% of GDP. Increasing it significantly should become the biggest priority for urban local governments and for central and state governments in their urban agenda. There should be a policy focus to increase it from its current low baseline to about 1% of GDP over the next five years and 1.5% over the next ten years. Some times such targets can be useful. 

Stuck at such low levels, and being just 1-2% of the state government revenue receipts, municipal revenues have become a rounding error. The vast majority of municipalities have become extended parts of the state government. Therefore, apart from the big cities, there’s no system-wide incentive to focus on expansion of the tax base and collection. 

The 16th Finance Commission should consider devoting significant space in its recommendations on the issue of property tax and other own source revenues of municipalities and propose measures to expand their base. 

Increasing property tax revenues should become as much a priority as increasing tax to GDP revenues of the central government. 

2. In the pursuit to raise property tax revenues from its current abysmal baseline, the following could be done by governments at all three levels.

(a) Given the low baseline, urban local governments should prioritise basic good governance in their tax administration over applications of innovations and technologies. The administrative bandwidth of the MCs should be focused on the plumbing issues of constant updation of their assessment value registers, detection of un-assessed and more importantly under-assessed properties, and expansion of the base of vacant land tax, apart from improvements to collection efficiencies. 

In general, Municipal Commissioners should single-mindedly focus on expanding the tax base and ensuring collections. This should become the predominant review parameter of Commissioners by the state government Municipal Administration Departments. 

(b) State governments should focus on shifting towards capital value method of property tax assessments, removing exemptions given to various categories of properties, and significantly raising the property tax rates for the higher slabs. There should be clear 5-year glide paths for these revisions to achieve some benchmark tax revenue targets. 

(c) A major source of revenue loss and exemption for local governments arises from the state and central government properties. State government properties routinely default and state government provides exemptions to educational institutions, industries etc. The 16th Finance Commission could consider advising that all exemptions on property taxes given by state governments should be compensated from the Budget and all property tax dues on state government properties should be reimbursed promptly to local governments. 

In fact, central government could consider emulating the power sector where all central government support to state’s power utilities have been made contingent on prompt releases of subsidy and current charge dues of public facilities by state governments. Similarly, all central government scheme releases should be made contingent on reimbursement of all property tax dues to the local bodies. 

(d) While there are no reliable assessments on the property tax foregone by municipalities across the country on defence, railways, central government offices, and central Public Sector Units (PSUs), it’s certain to be a very large amount. Central government properties claim exemption under Article 285(1) which prohibits all taxation on them. However, as laid down by the Supreme Court (and acknowledged by central government here), this exemption does not cover fees or service charges or other charges levied by local governments. This provides a window to address the festering problem.

In any case, the provision of Article 285(1) is an anachronism and should be revisited by the central government. This is especially important since the local government bears considerable actual costs in providing connectivity and trunk utility access to these central government properties, besides the costs of the externalities arising from their presence. These costs are currently a subsidy from the local government to the central government. It’s therefore only appropriate that the central government either consider amending Article 285(1) or allow local governments to monetise and collect the costs incurred by them in some uniform manner as service charge, and provide for these amounts in the budget allocations of the respective central government departments. 

The 16th Finance Commission too should consider advising the central government in this regard in its recommendations. For a start, it could do great by just documenting and monetising the property tax revenues foregone by local governments due to the exemptions granted to central government entities. But a strong recommendation to consider an amendment to Article 285(1) might just be the impetus needed to stir up a vigorous and honest debate on this issue.

3. The focus on property tax revenues should be complemented with augmenting non-tax revenues. Instead of fixed rates, building permissions and other layout development and construction fees should be indexed to capital value, at least for buildings and properties beyond a certain value. 

In this regard, as I blogged here municipalities should consider the extensive use of land value capture to finance large investments. They should also consider amending the building regulations and manadating purchase of building rights as discussed here and here. 

Municipal revenue augmentation should focus on lower-hanging plumbing issues instead of being stuck on fancy ideas like municipal bonds. 

4. On the debt side, the low level of leverage of municipalities offers a great opportunity to raise revenues to supplement the limited own revenues. But in the prevailing conditions of poor municipal finance accounting and governance, such debt mobilisation should be done very carefully and under very tight end-use monitoring and utilisation by the state and central governments and banking regulator.

Instead of focussing all efforts on fancy ideas like Municipal Bonds (and municipal bonds are indeed fancy for all but a tiny few Corporations), central and state governments should instead prioritise greater access for municipal governments to bank loans. Like with infrastructure sector generally, contrary to the opinion makers fetish with capital mobilisation through the bond market, bank loans will remain the major source debt finance to cities for the foreseeable future. 

Accordingly, the policy focus should be on bank financing structures like project loans without recourse to municipal general funds, credit guarantees, loan syndication, pooled financing etc. The infrastructure DFIs like NIIF, IIFCL, and NaBFID have important roles to play in the promotion of bank financing through these channels. I have blogged multiple times on bank financing of infrastructure, see for instance this, this and this. 

Finally, I want to point to a few major methodological flaws with the report. For a report published by an institution like the RBI, its accounting of revenue and capital receipts is riddled with inaccuracies and inconsistencies. All transfers from state and central governments as grants are part of revenue receipts. This would include statutory transfers (Finance Commission and state government transfers), central government schemes, and all other grants. The RRs are different places in the report are inconsistent. It also does not contain information on the capital receipts of MCs. As a result, there’s the accounting gap between, for example, the total RR of Rs 1.7 trillion and total expenditure of Rs 3.9 trillion for 2023-24BE. This accounting gap would consist of loans and proceeds from sales of assets. The report does not explain this large gap.

Weekend reading links

1. The Economist on whether India can outcompete Bangladesh in textile exports 

Since building its first export-orientated apparel factory in 1978, a joint venture with a South Korean firm, Bangladesh has turned its economy into a clothes-exporting powerhouse. The sector employs some 4m people, mostly women, and contributes 10% of the country’s GDP. Last year Bangladesh shipped $54bn-worth of garments, second only to China... India does not have the capacity to compete with Bangladesh at this stage, according to one industry insider. Too much policy attention is directed towards boosting capital-intensive sectors, such as electronics, instead of labour-intensive textiles, he says. Between 2016 and 2023 the value of Indian apparel exports fell by 15%, whereas Bangladesh’s increased by 63%. A recent World Bank report points to India’s protectionist policies as the culprit. Average import tariffs on textiles and apparel, including on intermediate inputs used by local manufacturers, have increased by 13 percentage points since 2017, raising prices for producers.

2. Some data on India's services-led growth

Over the last decade, India has added close to $1.7 trillion to its nominal GDP, 52% of which came from the services sector, compared to 11% from manufacturing. Services are far less capital intensive, as they do not require heavy machinery and large factories . Thus, the capital intensity of Indian growth has fallen in tandem... A booming services sector also leads to a concentration of the economic surplus. The backward linkages of this sector happen to be relatively weak. For each additional dollar worth of output by it, only 30 cents reflects the inputs it absorbs from other sectors in the economy. For the manufacturing sector, in contrast, this proportion is much higher at 73 cents... Industrial production data shows sectors (mostly low-tech) that account for 15% of manufacturing output have still not reclaimed their pre-pandemic output. In some of these, such as leather and apparel, production is still down by more a fifth from their pre-pandemic levels.

3. Some important findings from the Annual Survey of Unincorporated Sector Enterprises (ASUSE) of 2021-22 and 2022-23.

Presently, there are 14.6 million active taxpayers, of which nearly 10.4 million have come in the post-GST regime and are therefore new registrations. They represent a formalization of the economy... Over the two surveys, from 2021 till 2023, the number of enterprises rose from 59.7 to 65.4 million, and the corresponding employment from 97.9 million to 109.6 million. The employment numbers include single person-owned enterprises and are lower than in the 2016 survey... Of the 65.4 million enterprises, 82.6% have an annual turnover of less than ₹5 lakh. Almost 99% of the unincorporated enterprises have turnover of less than ₹50 lakhs, and merely 0.3% have more than ₹1 crore. More tellingly, only 2% are registered for GST. Two-thirds of all unincorporated enterprises are not registered under any act or authority. Note, a lot of the benefits to small businesses are linked to their registration on UDYAM. These include collateral free loans under schemes like the Credit Guarantee Fund Trust for Micro and Small Enterprises... A large section of informal small businesses involves sales of products and services directly to the end customer at wafer thin margins. These could be, for instance, selling vegetables or carrying out shoe repair, and often are single-person enterprises. For them, entering the GST net has a disincentive, even if they grow above the exemption threshold, since they do not derive any input tax credit, nor can they pass on the burden to their customer due to a competitive market.

4. Official data has shown that the net financial assets of Indian households declined precipitously from 11.5% of GDP in 2020-21 to 5.1% of GDP in 2022-23, a five-decade low and a fall of over Rs 9 trillion. 

The article says that the decline cannot be explained by the rise in physical assets. 

This trend has been accompanied by a trend of growing non-housing loan share.

The report informs that while the share of vehicle loans has remained stable at aroubg 9-10% since 2018-19, the other loans to finance consumption (medical loans, credit card loans, consumer durable loans etc.) has risen sharply from 14% to 19%. India's non-housing debt is around 30% of GDP, easily higher than peers and in fact higher than those even in advanced countries. The housing debt stands at a low 10-11% of GDP. 

5. The declining venture capital in India.

A longer series is below.

6. China's National People's Congress, the rubberstamp Parliament, has finally announced its long-awaited fiscal stimulus plan. But in a disappointment to investors, the plan avoided targeting the flagging household consumption and was aimed at bailing out local governments. 

As part of the bailout, Beijing would authorise local governments to issue bonds over three to five years to restructure most of an estimated Rmb14tn in “hidden” or “implicit” debts, finance minister Lan Fo’an said in a rare press briefing at the Great Hall of the People in Beijing. These debts are mostly held by thousands of off-balance sheet finance vehicles that local governments used to invest in infrastructure and property-related sectors. Many of these bets went sour when China’s real estate market entered a deep slowdown three years ago, sinking local government finances and undermining the broader economy... Lan said Beijing would authorise local governments to issue Rmb6tn in new bonds over three years for the debt restructuring and would reallocate a further Rmb4tn in previously planned bonds over five years for the same purpose... Local governments would be able to swap these bonds for those of their finance vehicles, bringing the debts on to their own balance sheets. This would lead to lower financing costs, saving Rmb600bn in total, Lan said. Lan estimated that “hidden debts” would be reduced to Rmb2.3tn once the swaps and another debt programme related to slum redevelopment were in place. This would free up resources previously “constrained” by the debt problems and allow local governments to refocus spending on “development and public welfare improvement”, he said. On additional stimulus measures, Lan said officials were “studying” extra steps to recapitalise big banks, buy unfinished properties and strengthen consumption.

This massive fiscal stimulus essentially allows local governments to issue bonds to take on their balance sheets a large proportion of the off-balance sheet debts. It's hard to say this is fiscal stimulus. It's more like monetary stimulus.

This is a longer article. Fundamentally, the debt restructuring of Rmb 10 trillion will allow local governments to convert off-balance sheet loans of LGFVs to longer-maturity, lower-interest liabilities, thereby saving Rmb 600 bn in interest payments over five years and reduce such debt to about Rmb 2 trillion by 2028. However, independent estimates put the LGFV hidden debt at Rmb 60 trillion and not Rmb 14 trillion as claimed by the government. 

7. Veterinary care has become the latest in the sectors dominated by independent businesses to fall to private equity investments. 

Private equity groups Silver Lake and Shore Capital Partners have struck a deal to create one of the biggest US veterinary care groups valued at $8.6bn, with ambitions to further consolidate a sector historically dominated by independently-owned businesses, said people briefed on the matter. The merger between Southern Veterinary Partners and Mission Veterinary Partners, both of which were part-owned by Shore, will create a network of vet hospitals and clinics spanning more than 750 locations and generating $580mn in yearly earnings before interest, taxes, depreciation and amortisation. The veterinary sector is benefiting from a surge in demand as people seek care for their animals following a pandemic boom in ownership... As part of the deal, Silver Lake and Shore Capital will make a $4bn fresh equity investment split evenly between them. The newly combined company has raised roughly $3bn of debt, said people briefed on the matter. Southern and Mission’s founders and employees will have shareholdings worth almost $1.5bn rolled over, and a syndicate of large co-investors will fund a few hundred million dollars of extra equity. The new company will carry less leverage than prior to the recapitalisation... People briefed on it said the combined company is likely to pursue more deals to roll up vet clinics and hospitals, as private equity groups play an increasingly dominant role in consolidation sweeping the petcare industry... Bloomberg previously reported that the two private equity groups were in talks over a deal to combine Southern and Mission. Rival company IVC Evidensia is owned by Sweden-based buyout group EQT, while PetVet is owned by KKR. Among the other biggest petcare clinic networks are AEA-backed AmeriVet Veterinary Partners and the veterinary health division of family-owned consumer group Mars, which operates more than 3,000 clinics worldwide. Southern, in which Shore has been an investor since 2014, operates more than 420 locations across the US, while Mission, which Shore helped to found in 2017, operates more than 330 vet hospitals nationwide.

8. Livemint writes on single or super-specialty hospitals becoming an attractive takeover option for PE firms.

Many private investors have been increasingly showing a preference for single-speciality hospitals, especially since 2022, with deals and fundraising taking place at a brisk pace... This year, in one of the bigger deals so far, Quadria Capital acquired a minority stake in dialysis chain NephroPlus in May for $102 million. In 2022, the healthcare-focused private equity (PE) firm had invested $159 million in eye-care hospital Maxvision... Last year, funding deals worth $5.5 billion were inked by hospitals in India, of which 20% went to single-speciality facilities, according to consulting firm Bain. Among the most prominent deals were Asia Healthcare Holding (AHH)s’ acquisition of Asian Institute of Nephrology and Urology for ₹600 crore ($75 million) and PE firm EQT buying a majority stake in Indira IVF, India’s largest fertility chain, reportedly at a ₹9,000 crore valuation...

Nothing matters more to a PE firm or a similarly aggressive buyer than scaling up a business quickly. Compared to elephantine multispeciality hospitals, single-speciality chains offer a more attractive turnaround time. A multispeciality hospital opening with more than 300 beds in a location can take up to five years to break even... With relatively fewer beds (or none in some cases), these individual hospitals tend to be smaller, making it easier to open many of them in dense urban centres in a short period of time. Smaller spaces also mean a hospital has plenty of existing hospitals and clinics to choose from for a brownfield acquisition... Investors find the single-speciality model attractive because it needs less investment, less space, can be expanded into a chain faster, and tends to have higher prices... That helps the single-speciality-chain model, whose strength is in offering higher-priced, higher-margin procedures at lower fixed costs than those in a multispeciality model... Globally, single speciality hospitals trade at a premium to multispeciality hospitals for several reasons, including higher ROEs... This is because single-speciality chains don’t need to store expensive machinery for multiple diseases, and can use their machinery more than a multispeciality hospital can, leading to a higher asset utilisation and higher margins.

9.  Telecommunications sector comes full-cycle.

The details of how telecom was liberalised in India are much more complicated, and frankly, some of it has repercussions to this day. In 2001, one of the things that the Indian telecommunication did to ease things was that it allowed players who had a “basic service licence” to offer limited mobility services. I don’t want to get too deep into this, but essentially, this allowed players who offered something called WLL (wireless local loop technology) to expand and offer mobile services to Indians... Existing telecom players complained that this was tantamount to a “backdoor entry”, because it let WLL players become mobile telecom players without having to pay the higher fees that they were paying for spectrum, entry, or revenue share. This made existing Indian telecom companies—Bharti, Hutch, Idea, BPL, and a few others—quite upset... In January, 2001 when the government approved the use of CDMA (Code Division Multiple Access) based Wireless in Local Loop (will) platforms by basic telephony companies to provide ‘limited mobile’ services (within a single Short Distance Charging Area, approximately 250 square km), Reliance made its move. It bid for, and won 17 new licences, to go with the one for Gujarat that it had acquired in 1997...

This specific ruling was the basis on which Reliance stormed into telecom, and changed India forever. Mukesh Ambani, who had just taken over as the head of Reliance Infocomm, countered all claims by saying, “If anyone thinks this is a backdoor entry (into cellular telephony), well, it is a backdoor that was open to all”. In just a couple of years, Reliance launched the now famous ‘Monsoon Hungama’ offer, giving away handsets for free to consumers, offering rock-bottom prices, and driving up adoption of mobile services across the length and breadth of the country. Competitors were forced to respond in kind, and well, the rest is history. And it all began with India’s telecom regulator letting the wireless loop players use their technology to disrupt existing telecom players.

Starlink now threatens to reprise the scenario!

10. On America's envious economy, The Economist writes.

In 1990 America accounted for about two-fifths of the overall gdp of the G7 group of advanced countries; today it is up to about half (see chart). On a per-person basis, American economic output is now about 40% higher than in western Europe and Canada, and 60% higher than in Japan—roughly twice as large as the gaps between them in 1990. Average wages in America’s poorest state, Mississippi, are higher than the averages in Britain, Canada and Germany... Since the start of 2020, just before the covid-19 pandemic, America’s real growth has been 10%, three times the average for the rest of the g7 countries. Among the g20 group, which includes large emerging markets, America is the only one whose output and employment are above pre-pandemic expectations, according to the International Monetary Fund... A decade ago many analysts thought that China would, by now, have overtaken America as the world’s biggest economy at current exchange rates. Instead its gdp has been slipping of late, from about 75% of America’s in 2021 to 65% now.

On productivity

This year the average American worker will generate about $171,000 in economic output, compared with (on purchasing-parity terms) $120,000 in the euro area, $118,000 in Britain and $96,000 in Japan. That represents a 70% increase in labour productivity in America since 1990, well ahead of the increases elsewhere: 29% in Europe, 46% in Britain and 25% in Japan... when assessed on a per-hour basis the gap remains sizeable: 73% productivity growth for American workers since 1990 versus 39% in the euro area, 55% in Britain and 55% in Japan.

The churn rate among US companies is 20% (half being new businesses created and other half being those that stop operating), compared to 15% in Europe. Similarly, over any three-month period, about 5% of American workers change jobs, whereas in Italy it takes a year to get the same level of labour turnover.

11. India derivative markets fact of the day.

Four-fifths of equity futures and options trades in the world now take place in India.

On the positive side, India’s capital markets should be counted as perhaps the most impressive economic policy successes of the country. 

India generates only 3% of the world’s GDP, but has been home to nearly a third of all public listings so far this year, which accounts for a tenth of the capital raised in ipos globally. Unusually among emerging economies, India has successfully translated economic growth into shareholder returns, letting ordinary investors benefit. Stocks there have roared since 2019, even as those in China have fallen by 15%. Analysts at Franklin Templeton, an asset manager, reckon that the correlation between Indian company earnings and gdp growth is closer than in any other emerging market. 

The Economist has another article that hails the introduction of the new Rs 250 monthly contribution Mutual Fund.

One in five households today holds shares, up from one in 14 just five years ago. The number is set to rise further... In dollar terms, Indian stocks have risen in price by 80% over the past five years, compared with a 6% rise across emerging markets as a whole... As investment habits have shifted, the share of household assets held in bank deposits has fallen below half...

In August the number of mutual-fund accounts reached 205m, up from 73m in 2021. Most are small: the average holding is under $4,000. The growth is facilitated by a wave of new electronic brokers... Much of the growth has been driven by products available to humbler investors. The number of Systematic Investment Plans (SIPs), a way to invest in mutual funds, has risen from 10m to 99m in the past eight years, with contributions increasing to $24bn in 2023. The funds take monthly instalments from investors. In August they received $2.8bn, continuing a run of record monthly inflows that has, with only rare interruptions, extended back to 2016.

There has also been an explosion in “demat” accounts, short for the dematerialised form in which shares are held. In August their number reached 171m, up by 54% from January last year. But the most extreme aspect of the investment boom is in derivatives trading: India now accounts for 80% of global turnover, and retail investors count for 40% of Indian trading, up from 2% in 2018... In the first three quarters of this year, India’s 258 IPOs accounted for 30% of the global total by number and 12% by the amount of money raised, in an economy that makes up just over 3% of global GDP.  

12. Robert Lighthizer makes a very important point

Economists’ free trade prescriptions fail because they do not reflect modern reality... what we have seen in recent decades is countries adopting industrial policies that are designed not to raise their standard of living but to increase exports — in order both to accumulate assets abroad and to establish their advantage in leading edge industries. These are not the market forces of Smith and Ricardo. These are the beggar-thy-neighbour policies that were condemned early in the last century. Countries that run consistently large surpluses are the protectionists in the global economy. Others, like the US, that run perennial huge trade deficits are the victims. They end up trading their assets and the future income from those assets for current consumption. Many economists will say this is all the fault of the victim, and that the US has too low a savings rate. Of course the trade deficit is equal to the difference between a country’s investment and its savings, but the causation runs the other way. Foreign industrial policy creates the deficits and with investment being set by demand for domestic investment, savings must go down. The problem is not the concomitant savings rate. It is the predatory industrial policies.

13. Rana Faroohar writes on the Trump victory

... the market reaction that greeted Trump’s victory, when stocks and risky assets rose while bond prices fell. This is a man who has promised across-the-board import tariffs and support for the US manufacturing sector. That would argue for lower US share prices and a weaker dollar, to make exports more competitive; investors are betting on just the opposite... America Inc under our brand new CEO Trump feels less like a blue-chip and more like a private equity firm: it’s a highly leveraged, short-term play with an average hold time of around four years. Like Trump, private equity is able to strip assets for immediate profit — no matter how important... If Trump is our CEO, is America now a distressed asset? One has to wonder.

14. Is Mumbai's economic growth choking?

Despite being the country’s financial and entertainment hub, Mumbai, accounting for about 20 per cent of the state’s economy, failed to lead the growth charge. Maximum City real GDP grew at 5.9 per cent between 1994 and 2020, significantly slower than the state, with financial services growing at a paltry 3.6 per cent (2005-20). Mumbai suffers mainly from two main challenges — expensive housing and weak transport. The price-to-income ratio (the median price of a 90 square metre apartment relative to median familial disposable income) in Mumbai is around 40, making it one of the most expensive real estate centres in the world. Likewise, road density in the poshest part of Mumbai, the Island City, is around 7 km per square km as against 10 km for Delhi. Furthermore, Mumbai started developing its metro network relatively late. While Delhi has around 400 km of metro network operational, it is close to 50 km in Mumbai, with about 150 km under construction.

15. In one stroke President elect Trump may have neturalised Elon Musk and Vivek Ramaswamy! Both have been tied-up together (it's very unlikely that they will be able to work together and come up with something coherent). It'll "provide advice and guidance from outside the government", thereby ensuring that its role will be purely advisory with little or no teeth in actual implementation. Finally, by giving it time only till July 4, 2026, there's a sunset for this experiment.  

16. KP Krishnan has a very good oped on how the structure of Statutory Regulatory Authorities in India, with their delegated power to make and amend laws, detract from federalism.

Urban local bodies (ULBs) require the approval of their respective state governments for borrowing money. With the growth of bond markets, increasingly municipal bonds are replacing institutional borrowings as the mechanism for providing debt to ULBs. Sebi’s regulation of municipal bonds implies that the regulatory arm of the Union Ministry of Finance is exercising control over a subject in the state list. So, the deficit is also material in its impact.

The importance of broad-basing economic growth and climate change transiti

Two fundamental issues on economic growth are often glossed over in public debates in India. One, sustained high economic growth rates require a broad consumption base that the country currently lacks. Two, adding layers of costs, whether in the name of formalisation or climate change or emulation of global standards, will further narrow the consumption base and slow down economic growth. 

In a recent interview, Mr RC Bhargava, Chairman of Maruti Suzuki, captured both these aspects nicely.

This year, we are seeing negative growth in the sub-Rs 10 lakh car segment, which represents two-thirds of the market. Only the over-Rs 10 lakh segment is growing, so overall growth is muted. Clearly, a 7 per cent growth rate cannot be sustained when one-third of the market is growing while two-thirds is shrinking… The country decided to upgrade its safety and environmental standards to be on a par with Europe. However, implementing these standards costs money, and it has led to a 60 per cent increase in production costs for lower-priced cars since 2019. The burden of this increase is proportionately much higher on small cars than on cars priced over Rs 10 lakh. So, a car priced at Rs 6 lakh now costs Rs 10 lakh, while salaries have not risen in similar proportions… I think growth will not exceed 3-4 per cent for a few years until economic growth helps bridge the affordability gap in the lower end of the market… It’s clear that the passenger car market in India won’t grow very fast, so we need to focus on exports.

Three things stand out. One, car sales are shrinking or stagnating in the larger lower-priced segment, pointing to a narrow base of the mass market. Two, the Indian car market is expected to grow slowly, only at 3-4%. Three, the costs of environmental and safety standards has fallen disproportionately on the lower-priced vehicles, thereby raising their prices and consequently lowering demand. 

While I don’t hold any brief for Mr Bhargava or Maruti, the points raised are critically important for India’s economic growth. Let’s discuss each point in turn, starting with the narrow consumption base. 

Consider a few data points on indicators that are proximate to consumption. India’s finished steel consumption rose from 66.4 mt in 2010-11 to 136.29 mt in 2023-24, an annual growth rate of 5.69%. Cement consumption rose from 230 mt in 2011-12 to 375.2 mt in 2022-23, an annual growth rate of 4.55%. Electricity consumption rose from 0.785 million GWh in 2012 to 1.403 million GWh in 2024, an annual growth rate of 5.42%. Two-wheeler sales rose from 11.79 million units in 2010-11 to 17.97 million units in 2023-24, an annual increase of just 3.3%, whereas over the same period, passenger car sales rose slightly faster at 4.11% from 2.5 million to 4.22 million units. 

In other words, the annual growth rates of the five most proximate indicators of consumption over more than a decade have trailed in the 3% to 5.7% range. All these growth rates were lower than the annual real growth rate of 5.73% in the 2011-23 period. These are not the indicators of broad-based economic growth for a country starting from a low baseline like that of India. Bhargava may just about be right in his assessment of the potential growth rate of the automobile market in India. 

For a massive economy like India, the binding constraint for the country sustaining high economic growth rates is the base of its consumption class. It needs a base of consumers whose assured and growing supply can support the kind of investments required to sustain those high growth rates. This base should span the spectrum from basic consumption to high-value consumption, with decreasing price sensitivity (and therefore higher margins). 

This broadening of the base must manifest across both consumers and geographies. The number of consumers in each segment must increase (intensive margin), and the geographical footprints of consumption must expand (extensive margin). 

On the spatial side, a market test for whether the economy is becoming more broad-based is to monitor the expansion of the popular markers of middle-class (as opposed to subsistence) consumption. The most definitive markers of such consumption are the popular (locally or nationally) brand retail chains of hotels, restaurants, clothing, consumer durables, grocery, and services (like hairdressing, hospitals, schools etc.). 

In this context, two questions are important for understanding the consumption base of the Indian economy and how it’s evolving. What’s the current distribution of these shops? How’s the distribution changing spatially?

The Ken has a graphic from a Sanford Bernstein report that mapped about 20,000 outlets run by India’s top 30 retail and restaurant chains to the country’s 19,300 plus PIN codes. It finds that just over a fifth of these pin codes are home to all these stores and only 5% have more than five stores. 

It’s a reflection of the narrow middle-class consumption base that the definitive markers of such consumption are confined to just a fifth of the population and in even smaller share of geographies. This must expand significantly if economic growth is to reach a sustained higher level. 

It’s in this backdrop that we are now introducing environmental standards and pursuing climate change mitigation policies. 

Before examining the costs of these standards, it’s worth pausing and taking a status check on what’s happening globally with climate change mitigation policies. 

As the Chief Economic Advisor, Ananthanageswaran has written, the current basket of policies considered globally will place a disproportionate burden on developing countries and are a major headwind on their primary objective of poverty elimination. Any meaningful and fair proposal should take into account both the stock and flows of carbon emissions and apportion commitments accordingly, with primacy for the former. This will necessarily entail atleast some modest de-growth in developed economies. If such policies are unacceptable to electorates in developed countries, it’s hypocritical to assume that the electorates in poorer countries will accept self-restraints and forego their opportunities to improve their lives from their current impoverished baseline. 

Like with any regulation, there are costs associated with such standards. The higher production costs translate to higher costs and lower affordability and reduced demand. 

This reality is unavoidable. And it’s true for any kind of exogenous intervention or economic transition, including the efforts to formalise the economy. We know this from free trade, where happy theory of labour market adjustment has consistently differed from the stark reality of labour market dislocation and pain. 

However, this does not mean that we should refrain from environmental standards or formalisation. Notwithstanding their costs, these reforms are not only essential for their own reasons but also in the long run increase productivity and usher economic progress. 

The critical point to consider for public policy is the balance and speed with which these reforms should be pursued. If pushed too quickly without any balance, they will hinder the economic adjustment process and hurt demand and economic growth. For sure policy can and must facilitate and expedite the adjustment process. But there’s only so much resource and capacity-constrained governments in countries like India can do to address complex challenges like these. 

It’s for these reasons, that economists’ argument that markets will adjust to accommodate those who lose jobs from trade liberalisation has not materialised in reality. Theory has consistently diverged from reality across countries. In fact, it can be stated with reasonable confidence that the economic and social costs associated with trade and immigration liberalisation policies pursued till date have been the two biggest contributors to electoral reverses in advanced countries in the last decade. 

In conclusion, as we have written here, if developing countries like India pursue their climate mitigation policies too aggressively to win brownie points among a hypocritical global audience, poverty and impoverishment will consume their populations before climate change will. The final word on this to the CEA, “It is always desirable and necessary to have the freedom and autonomy to determine the pace of such a transition ourselves. Countries must own the energy transition”. 

India's private sector and R&D investments

I have written several times on the Indian private sector. This post will try to summarise a few things. 

Naushad Forbes has several educative op-eds in Business Standard on the topic, including one where he helpfully outlines a benchmarking exercise for Indian firms.

I’ll draw on two sets of data from his opeds. 

One, the comparison of the R&D expenditures of the top ten profitable non-financial firms of the world’s five largest economies in 2021 shows that despite having the second highest profits as a percentage of sales, nearly double those of China, Japan, and Germany, the Indian companies spend an abysmally low share of profits and sales on R&D. 

Indian firms invest 0.3% of GDP in in-house R&D, compared to a world average of 1.5%.

This is the R&D spending in 2021 of India’s top 10 non-financial firms. It’s abysmally low, even for the IT firms. Despite a total sales of $276.9 bn and profits of $43.3 bn, their total R&D spending was not even a billion dollars (just $0.95 bn).

What does it tell about the country’s private sector when its top corporates don’t feel the need to invest in R&D despite enjoying very high profitability, much higher than counterparts in countries like even Japan or Germany?

Sample this from 2021 data

The most telling comparison is that each of the top seven (global) firms invests more than all of India (every firm, university and government laboratory put together).  And even firms #24 (Honda), #25 (Qualcomm) and #26 (Bosch) each invest more in R&D than all Indian industry combined at over $7 billion each.

Take the second exhibit, which compares the R&D spending of the top 2500 global firms. India has just 23 firms in the full list, with 10 in the pharmaceuticals and biotechnology sectors. 

We have no presence in six of the top 10 industries that invest in R&D: Technology hardware, electronics, construction, health care, general industrials, and industrial engineering. Where Indian firms are present, they invest less in R&D than the world average. In auto, the four Indian firms (Tata Motors, M&M, Bajaj, TVS) that figure in the top 2,500 R&D investors spend 3.8 per cent of their global turnover on R&D, which drops to just over 1 per cent without Tata Motors’ JLR subsidiary in the UK.  The world average for auto is 4.8 per cent.  In software, the top Indian firms (TCS, Infosys, HCL) invest 1 per cent of turnover in R&D, compared to a top 2,500 average of 14 per cent. In pharmaceuticals, the top five Indian firms invest 6 per cent of sales in R&D.  This is less than the world average of 17 per cent, but higher than any other industrial sector in India.  The problem is that our pharmaceutical firms are relatively small.  The average turnover of our five largest pharmaceutical companies (Sun, DRL, Aurobindo, Lupin, Cipla), at $3 billion, is a fraction of the $45 billion average of the top 20 pharmaceutical firms worldwide. Our top five firms invest an average of $200 million in R&D, compared to an international top 20 average of $7 billion.

There are several reasons offered for Indian companies’ failure to invest in R&D. They include cultural factors, smaller sizes, low margins (due to the price-sensitive market), lack of export focus, and so on. There’s perhaps a part of all in the explanation, and more. 

It’s surprising that even sectors like pharmaceuticals and software, where Indian firms enjoyed a head start, have struggled to invest in R&D. The pharma companies have failed to capitalise on their early start and expand to become at least global-scale contract manufacturers of APIs (or bulk drugs), besides having had limited success in moving up the value chain to formulations and nothing to show on drugs discovery. 

The case of India’s software firms is intriguing. As I blogged here, despite achieving global scale, Indian software firms have been unable to transition from being manpower services outsourcing firms to becoming software product companies. Besides, they have not been able to make breakthroughs in cutting-edge technology segments like cloud computing, robotics, data analytics, AI, IoT etc. The R&D spending as a share of sales of even the top Indian IT firms lags by orders of magnitude. 

They appear to have become captives to their own successes in the lower-value manpower services segment and have not exhibited the courage and vision to breakout and aspire to move up the value chain. They have been unable to capitalise on their scale and invest in R&D. Their very low R&D spending (less than 1%, compared to the global average of around 10%) is a reflection of their lack of ambition and an important cause for their failure to innovate. 

I had written sometime back on India’s entrepreneurship deficit. While data is not available, it’s most likely that even the new-age technology sector firms like those in e-commerce and digital platforms’ spending on R&D is only a small proportion of their global peers. 

In this context, it’s also useful to look at the requirements for firm innovation. Mr Forbes also points to some microeconomic research on firm behaviour and when they innovate. In one paper, Philippe Aghion, Antonin Bergeaud, and John Van Reenen examined the impact of labour regulation on innovation and found:

We exploit the threshold in labor market regulations in France which means that when a firm reaches 50 employees, costs increase substantially. We show theoretically and empirically that the prospect of these regulatory costs discourages firms just below the threshold from innovating (as measured by patent counts). This relationship emerges when looking nonparametrically at patent density around the regulatory threshold and also in a parametric exercise where we examine the heterogeneous response of firms to exogenous market size shocks (from export market growth). On average, firms innovate more when they experience a positive market size shock, but this relationship significantly weakens when a firm is just below the regulatory threshold. Using information on citations we also show suggestive evidence (consistent with our model) that regulation deters radical innovation much less than incremental innovation. This suggests that with size-dependent regulation, companies innovate less, but if they do try to innovate, they “swing for the fence”.

Aghion and co-authors (also this) analysed the data of French firms’ exports for the 1995-2012 period and found that exports are associated with an increase in patent filings, but only from those firms with higher average quality patents and in the case of destination countries at intermediate stages of development. 

Another paper uses data from French manufactured goods exporters on their innovation responses (in terms of patent applications) to demand shocks in their destination markets.

Our first finding is that on average firms respond to a positive export demand shock by innovating more. In other words, we find a significant market size effect of export demand shocks on French firms’ innovation… Our second finding is that the innovation response to a positive export demand shock takes 2 to 5 years to materialize, highlighting the time required to innovate. In contrast, the demand shock raises contemporaneous sales and employment for all firms, without any notable differences between high and low-productivity firms... Our third finding is that the impact of a positive export demand shock on innovation is entirely driven by French firms with above-median productivity levels (in an initial period prior to the demand shocks). This heterogeneous response could simply reflect the fact that the demand shock only affects the most productive firms… We find that in contrast to what we observe for innovation, there is no heterogeneous response of sales or employment to a demand shock for low versus high-productivity firms. Thus, similar demand shocks only lead to future innovation responses by relatively more productive firms.

Some takeaways from all this microeconomic research are that only firms above a certain productivity level and size threshold might have the incentive to innovate to reach the technology frontier; only firms above a certain productivity level can benefit from exports; and export benefits accrue only when exporting to countries at intermediate stages of development. 

This assumes importance for the design of Make in India and the production-linked incentive (PLI) scheme. It highlights the importance of exports and that too to more advanced countries as an essential requirement for domestic firms to reap the productivity benefits. 

One of the things that public policy could promote in this regard is to incentivise Indian firms to operate at the technology frontier. One way to achieve this is to encourage making in India for the global markets. As Joe Studwell writes, the North East Asian economies and their companies became globally competitive market leaders by pursuing the policies of export competition coupled with the elimination of the uncompetitive. 

In conclusion, it may not be incorrect to argue that corporate India suffers from a culture where innovation and R&D investments are not valued appropriately. It appears to have become entrapped in a culture that prioritises cost-cutting over all else, including minimising innovation and R&D spending, to boost the bottom line. In this culture, companies do just enough to sell more and investments with long-term benefits like R&D get marginalised. Given this, whatever little R&D happens is in the form of jugaad, and not the industrial-scale research and development undertaken by globally competitive firms. 

It might be the case that the massive and deeply price-sensitive Indian market is a major factor in the emergence of this culture. The massive market means that by and large Indian corporates have realised that they can sustain themselves by merely serving the large domestic market. The low margins in the mass market segments discourage foreign firms, thereby shutting off foreign competition and the one big compulsion for domestic firms to innovate. This is perhaps a curse of the large and price-sensitive market. 

Unless it can break out of this culture, all other efforts will remain futile. Any effort by the government will only be tinkering at the margins. It’s time for India’s corporate leaders to seize the initiative and resolve to create 5-10 world-beating innovating companies over the next five years. As a start, they could begin to benchmark as proposed by Mr Forbes and own up the agenda.