Sunday, June 28, 2015

Financing smart cities

Smart cities need smart financing. The investments planned under the Government of India program on smart cities would presumably be concentrated on small areas within a city on focused interventions to improve the quality of life. The resultant impact on property prices can be substantial. Given the public nature of these investments, it is only appropriate that a share of the incremental value (by way of higher property prices) be captured by the Government, if only to finance the expansion of the smart city to other parts of the city. In other words, the public investment made under the Smart City program would be the seed capital to catalyze smart city interventions across the city.

One way to do this is to define each smart city area as a tax-increment financing (TIF) district. The tax-increment can be escrowed and used to initiate the project in another part of the city and so on. The practical implementation challenge would be in discovering property prices and overcoming the political economy of an additional tax. The former can be somewhat mitigated, especially in larger cities, by accessing property transaction databases of banks and real-estate developers. If nothing at all, the guidance value increase can be taken as the measure of value increment. 

The political economy can potentially be addressed through the same City Challenge competition being proposed for the selection of the Smart City itself. How about a Challenge competition among localities or wards or Residents Welfare Associations to select the preferred location for the smart city investments on the condition that it would have to be a TIF district? This would take the sting out of the political argument that taxes were being forcibly imposed on the locality. Further, this would also ensure program ownership and make it a real people's competition. 

Friday, June 26, 2015

The IoT potential

Impressive new report from the MGI on the potential of Internet of Things (IoT), defined as "sensors and actuators connected by networks to computing systems". It analysed more than 150 use cases in nine 'settings' and estimates its total potential economic impact at $3.9 trillion to $11.1 trillion annually by 2025, with the upper estimate contributing to a value addition of 11% of the global economy.

As always with MGI reports, the findings from its summary are summarized with nifty graphics, some of which have been extracted below. The summary of findings from the study,
The report identifies nine 'settings' where IoT offers impressive value creation opportunities.
The value creation opportunities are far higher in the developed economies.
An illustrative list of important applications is as follows.
The opportunities in improving efficiency of existing systems is evidently enormous. The report also draws attention to a few important considerations necessary for the realization of full value from IoT applications like the realization of interoperability between IoT systems, using information from IoT not just to detect and control anomalies but mainly for optimization and prediction etc.

While the IoT offers interesting opportunities and undoubted efficiency improvements, its impact on the work-force may not be benign. The knowledge-workers will naturally find new opportunities and their base will expand. For less skilled workforce involved in terminal health care, shop-floor retail, maintenance and repair facilities, large factory floors, logistics management etc, the potential for shrinkage is considerable. It is also not surprising that the two 'settings' with the highest potential and likely impact in developing countries from IoT, factories and worksites, are also the two largest employers of the middle and lower skilled workers. 

Wednesday, June 24, 2015

Implementing smart cities

Smart city is the latest buzz-word in urban development. Conferences and seminars on smart cities abound. The Government of India (GoI) have committed to the development of 100 smart cities across the country as satellite towns of large cities and by modernizing the existing mid-size cities. The government have also allocated over Rs 7000 Cr in the last Union Budget for kick-starting smart cities.

Stripped off all jargon, a smart city is one which uses the latest technologies, progressive urban planning, and proactive civic engagement to create a highly liveable urban environment. It deploys citizen-centric and sustainable policies and the latest information and communication technologies to improve the quality of life of its citizens and public service delivery. Its immediate attraction comes from certain technology interventions that have the potential to dramatically improve urban governance capabilities. 

Intelligent traffic management systems, which integrate the feeds from all existing hardware - cameras, signal lights, GPS devices in various vehicles, wireless and other police communication systems etc - can be a powerful force multiplier in traffic and law and order management. Real-time monitoring of electricity feeders and reservoir fillings can help improve the reliability of electricity and water supply besides lowering leakages. Geo-tagged dumper bins and location tracking devices on vehicles can improve solid waste management. Ambient light sensors can help optimize on energy consumption in streetlights. Street parking slots can be sold using parking meters and status of parking locations made available on smart phone applications.

Lidar and biometric technologies can help improve the monitoring of engineering works and attendance respectively. Finally, smart data analytics coupled with cognitively striking visualization, like that in many developed country cities, can help city governments use the vast amounts of information accumulated by its departments as decision-support to more effectively manage civic services, reduce wastage and increase revenues, and limit accidents and crime.

All these have the potential to both improve operational efficiency and enhance consumer satisfaction. In fact, the biggest contribution of such applications would be to improve the capability of municipal governments to deliver public services.

But implementing these technology applications raises three challenges – identifying interventions, standardizing protocols, and scaling up interventions. The first requires demand-side engagement. Cities need to elicit this information through focused engagement with its citizens and utility managers. Given scarce available resources, we need applications that are likely to yield the greatest bang for the buck in a particular city or its part.  

Even after the intervention is identified, there is nothing available in the market to be purchased and deployed with minimal customization to meet some or all of the aforementioned applications. Further, where available, those applications are made for developed country environments, with vastly different challenges, and most unlikely to succeed in India even with significant modifications. 

In the circumstances, we have a classic co-ordination failure. The market needs the platform of a city to develop and refine a smart city applications suite. Businesses, especially the larger ones, rarely have the appetite to risk huge money upfront to develop a new product with several risks and uncertain commercial prospects, and that too in a market where governments are the biggest customers. On the other side, governments are naturally unwilling to embrace a completely new and untested product and have limited patience to wait out the time required to realize its benefits.

Such co-ordination failures are most likely to be mitigated through concerted public policies. Traditional procurement strategies are off the table. A few pilot projects in certain geographically distinct pockets within cities, involving close collaboration of governments with technology providers and system integrators, preferably smaller and emerging entrepreneurial firms, looks the best bet forward.  

As a first step, a Detailed Project Report (DPR) of the aforementioned applications will have to be prepared, outlining the specifications of the devices, connectivity, and software solution. The DPR will emerge after pilot field-testing of various alternative hardware and network technologies for each application. It will study existing process and outline how these smart city devices and applications can be seamlessly plugged into the municipal government systems. It will also undertake a cost-benefits analysis, duly arriving at the financial and economic rate of returns for the project. The specifications should help define inter-operability standards and mandate open-standards based software solutions. This would help create an eco-system where app developers can plug their software and enrich the smart city project.

This pilot project would require atleast 6-9 months to develop a robust, versatile, and user-friendly solutions suite. It will have to emerge through a process of continuous iteration, involving tight feedback loops managed by the selected implementing agency, working in close collaboration with the municipal government and citizens. Once the solutions suite and DPR is developed, it can be scaled up elsewhere.

As a note of caution, we need to avoid the temptation to implement glamorous first-best solutions involving latest sensor technologies and devices designed for vastly different environments. Atleast in the first phase, solutions have to be decidedly second-best, designed with the objective of realizing the low-hanging fruits from improvements in administrative efficiency and citizen satisfaction. We should also learn from the experience of some of these applications which have been implemented, with varying success, in cities across the country.

More important than the devices themselves, the software suite that integrates all these devices have to be robust, versatile, and extremely user-friendly. A software suite that integrates all these different applications into a single platform and renders information in a cognitively striking visualization dashboard can be a force multiplier for public officials. If made available on different devices including smart phones, this can be powerful decision-support for municipal field functionaries and help dramatically improve their execution and supervision bandwidths.

Such technology interventions have to be complemented with more fundamental policy initiatives. Policies that permit higher Floor Area Ratios (FAR) along important transit corridors and near transit stations promote transit-oriented growth which reduces traffic congestion. Densified mixed-use developments with adequate public spaces, especially in larger plots and green-field locations, promote walkable work-life environments. Higher FAR and property tax concessions, complemented with affordable housing mandates, encourage urban renewal through re-development of blighted areas. 

As with all buzz-words, there is the danger of hype overtaking substance. Amidst all the hype, we would do well to bear in mind that India’s urban development imperative is not so much smart cities as decently governed cities. Numerous studies have highlighted that the governance systems that drive the engines of India’s economic growth are woeful, even dysfunctional. 

Monday, June 22, 2015

The transactional challenge with increasing pulse production

India has an agriculture crop misallocation problem. There is surplus production of water-intensive paddy and deficit of pulses, which is largely a rain-fed crop. Prevailing policy encourages more paddy production - free farm power, high import tariffs, ever increasing Minimum Support Price (MSP). So last week the Government of India announced a policy to partially re-align the incentives - lower MSP increase for paddy and much higher for pulses.

But if history is any evidence (pulses production has remained stagnant despite a 50% increase in price of pulses over the past five years), this is unlikely to make any dent on the crop mis-allocation problem. Experts like Ashok Gulati claim that solving the problem requires crop-neutral incentive structure. In other words, reverse the entire incentive structure from paddy to pulses - do every thing currently being done to encourage paddy for pulses. I am not sure whether even this is likely to have much impact.

This is a well-trodden path. Apart from being the primary source of family income, people also grow paddy because it gives them their food staple, fodder for cattle, maybe dung for fuel, and also because they have always grown paddy. It is not easy to design incentives that can encourage such changes, they may need deeper behavioural shifts. Incentives, while essential in the long-run for mitigating the mis-allocation problem and enabling the transition, can only get you so far in the short to medium-term. Incentives will plant the seeds for gradual change, which however will happen only when the process gathers enough momentum and tips-over through, most often, changes in life-style or livelihood patterns or something causes a critical mass of people to shift their cropping habits.

Most economy or society-wide changes are always hard. Incentives help, and are even necessary, though not sufficient. They are necessary to get to the starting line, but not the finish line. They can only get you so far. Most often the reform required to get you to the starting line is decisional - change rules, deregulate, re-align incentives etc. But those required to get to the finish line are transactional - involving long-drawn engagement with stakeholders or dynamics generated by the initial decisional reforms which culminate in tipping-points or seamless transitions.  

Thursday, June 18, 2015

Peak free-trade and the undesirable quest for policy harmonization

In the context of the debate surrounding the TPP, Larry Summers has a brilliant oped where he makes this candid observation (all the four points raised are deeply insightful),
The era of agreements that achieve freer trade in the classical sense is over. The world’s remaining tariff and quota barriers are small, and often result from deeply held cultural values, such as Japan’s attachment to rice farming. What we call trade agreements are in fact deals on the protection of investment and on achieving regulatory harmonisation and establishment of standards in areas such as intellectual property. There may be substantial potential gains from such agreements, but their merits must be considered case by case. No reflexive presumption in favour of free trade should be used to justify further agreements.
Market endorsement of the diminished importance of such trade deals today comes from the fact that the equity markets reacted indifferently to the failure of President Obama to get fast-track trade promotion authority from the Congress last week.

Both the TPP and Trans-Atlantic Trade and Investment Partnership (TTIP) have important non-trade concerns. The TPP is expected to impose tighter intellectual property rules on members, while the TTIP would reduce non-tariff barriers and both have a provision for "an Investor-State Dispute Settlement mechanism which would establish a separate judicial track, outside a country's own legal system, that would allow firms to sue governments for apparent violations under trade treaties". Dani Rodrik has rightly described both TPP and TTIP as more about corporate capture than liberalism. 

All this goes back to the rising momentum in favor of policy harmonization on issues as varied as labor markets, taxation, investment protection, intellectual property rights, environmental standards etc. Add to this calls for provisions in trade agreements to prevent alleged currency manipulation, and the slippery slope becomes evident. In all these cases, there are very compelling political economy and economic efficiency arguments that would militate against such harmonization.

Such harmonization, by limiting the legitimate sphere of action of national governments not only circumscribes genuine national interest but also undermines democracy itself. By the same yardstick, in light of the risks generated by the massive flood of cross-border capital flows engendered by it, emerging economies should have had a veto on the US quantitative easing policy on grounds of global monetary policy harmonization. In areas like exchange rate valuations, there are not even reliable measures of alleged manipulation.

There is no single standard on any of these issues which can be universally applied to all the countries of the world, independent of their stage of development. In fact, most often, such policy stances are likely to conflict with each other. Instead of selectively pursuing harmonization where is suits you, nation states must adapt, as they have always done, to such situations. Democratic pluralism should underpin international institutional architecture as much as it does domestic ones. 

Tuesday, June 16, 2015

The successes and failings of India's bureaucracy

The Indian states’ struggles with getting stuff done are well documented. Even when programs are apparently well designed, they generally stumble at implementation. This implementation deficit has become a reflection of weak state capability.

This malaise afflicts government agencies at all levels and across states in varying degrees. It is as much applicable to service delivery with welfare programs as it is to the large-scale regulatory failures and resultant corruption scandals that dominate headline news.   

So how it is that Indian bureaucracy delivers spectacularly with programs like Pulse Polio, elections, and Kumbh Mela? What explains the handful of outstanding examples of successes with improving maternal and child health outcomes, or women’s empowerment, or increasing access to sanitation that occasionally come from various corners of India? There are two possible answers.  

One, and relevant to the first question, is that our state is exceptional at doing things that have short duration and clearly defined destination. A common thread that goes through all these activities is meticulous planning which maps functionaries to task and time, simple and clearly defined monitoring goals, rigorous supervision, and insulation from political influence. This is generally achieved through a massive mobilization of the entire local administration, often augmented with external manpower. It helps that the short duration of these activities allows for such cross-departmental mobilization. All this is underpinned by a strong political and bureaucratic commitment at the highest levels to achieve the objective. 

The success with these activities stand in stark contrast to the egregious failure with implementation of regular government programs in the same area by the same personnel. It shines light on the sources of their implementation failure. An apolitical, adequately staffed and appropriately trained bureaucracy, when monitored rigorously gets things done. It is no surprise that all these ingredients are deficient in regular administration of government programs.  

The other examples of success are, most often, a result of individual initiative. A few fiercely committed officers bring great passion and effort into planning and implementing programs. Their energy and leadership masks the chronic deficiencies in state capability and results in the positive deviance.

There are a few features that inform the actions of all such successful officials. They make detailed plans, with clearly defined intermediate milestones and final outcomes with timelines, all of which can be monitored.  
They rely on some improvised information reporting system to rigorously monitor compliance. Some of the more tech-savvy among them use computer applications for internet-based reporting. Others rely on brute force reviews, done with unfailing regularity. These reviews are generally done personally at a painstaking level of granularity, to identify weaknesses and poor performers, which are then followed-up and addressed. It is no accident that their reporting systems are generally at variance from the ineffectual routine state or nation-wide reporting systems for the same program or activity.  

Another prong of their monitoring is intensive field inspections, most often done randomly and without intimation so as to validate the information from the aforementioned reports. Such personal inspections, which are often followed up with strong and certain disciplinary action on errant officials, are a strong deterrent against slacking. But given the large geographical jurisdictions, such personal inspections take up a disproportionately large amount of time and effort, and involve unfavorable work trade-offs.

A handful of motivated and sincere sub-ordinates are co-opted as internal champions in these efforts. In a few cases, committed local non-profits become important partners. The smarter among them keep open active feedback channels - through inspections and interactions with field functionaries, citizens, and political representatives - that reliably convey information on the actual implementation.
Though all these are the physical ingredients of routine bureaucratic implementation, its actual realization in a typical bureaucratic environment is unfortunately very infrequent. It is commonplace that officials are severely handicapped by an enfeebled administrative machinery, whose weaknesses are exacerbated by inadequate, poorly trained, and dis-illusioned staff. Most often, they are left to fend for themselves, in completely unknown terrain, with just a handful of people for support.

The positive deviance is due to the extraordinary level of direct personal involvement of the official. It requires huge mental bandwidth for information processing and monitoring, the ability and commitment for which is understandably possessed by only a handful of very sincere and energetic officials. Their success is despite grave deficiencies in state capability and a triumph over extreme adversity. But this triumph is, most often, a pyrrhic victory. Reflecting the deeply personal nature of such interventions, all such successes are most likely to be short-lived, failing to outlive the officials themselves.

It is therefore no surprise that mundane activities like running mid-day meal kitchens or distributing old age pensions to beneficiaries or delivering ante-natal services to pregnant women appear insurmountable systemic challenges. All these activities fail the test of routinized impersonal administration, and require the dominant presence of an exceptional bureaucrat.

Though the main focus here is on the role of All India Service (AIS) officers, much the same applies to other non-AIS officials of the state government. The successful among them overcome much greater adversity than a similar AIS officer. The point of this post is as much to highlight why things sometimes appear to work in certain places as to why its systemic replication may be difficult given our current state capability.

A bureaucracy is an impersonal rules-based organization of a group of people who work together to achieve certain defined outcomes. Bureaucracies therefore have to work on their systemic strengths rather than the personal initiative of individual bureaucrats. A capable bureaucracy is one which delivers outcomes when administered by the average bureaucrat, rather than being reliant on the serendipitous presence of an exceptional bureaucrat. The typical Indian bureaucracy, at all levels, is most likely to end up short on this test.   

Monday, June 15, 2015

Generating bang for the buck from housing subsidies

A recent FT article had these facts about affordable housing subsidies in UK,
The UK paid £24bn in rent subsidies in 2013-14, double the amount a decade ago and the equivalent of £1bn in every £4bn in Britain's budget deficit. the average UK home now costs a first-time buyer five times their income, up from 2.8 times in the early 1980s. That has in turn fuelled demand for rented accommodation, pushing up the costs and eating up increasing amounts of state subsidy... According to the Office for Budget Responsibility, last year the UK spent more than £25bn on rent and home ownership subsidies but ended up with just 141,000 new houses being built — at least 40 per cent below the level some economists argue it needs... Social landlords build about a fifth of 
The article points to the dilemma between public spending to boost supply (through public housing projects and fiscal incentives to developers) and support demand (through home ownership and rental subsidies), and the overwhelming preference towards the latter in UK,
Despite spending £1.4bn a year on home ownership subsidies, funding for social housebuilding was cut in the last parliament from £2.3bn to £1.1bn a year... But campaigners argue that the money currently being spent on subsidising demand for housing through rents and ownership schemes — £115bn between 2010 and 2014 — should instead be spent on new housebuilding. The money would be enough to build 6.8m new state-backed homes at current average rates of subsidy: enough to house the country’s growing population for 31 years... Around a third of households in any developed economy need some form of financial help with their housing costs, experts say. In 1975 more than 80 per cent of UK government involvement in housing was focused on increasing supply — building new homes. But by 2000 the vast majority of Britain’s housing market subsidies went towards supporting demand, rather than supply.
In contrast, in India, affordable housing subsidy is almost completely spent on supply-side interventions - public housing projects, construction grants to developers, and affordable housing mandates. Rental housing subsidy is virtually absent and interest subvention subsidy initiatives remain still-born as the target group can rarely ever access mortgages. Even on the supply-side, the magnitude of support remains abysmally limited. While some amount of spending on public housing projects is essential, given its high percapita funding requirement, it can make only a marginal dent on the housing market. In contrast, demand-side measures like interest and rental subsidies, which require small percapita annual spending, can have a far larger impact.

The Union Budget 2015-16 allocated just Rs 14000 Cr (£1.43bn) for urban and rural housing. Assuming the state governments would add another Rs 6000 Cr, the total public spending on housing across the country would be about £2 bnTo put this in perspective, India would be trying to meet atleast twenty times UK's housing demand with a twelfth of its public spending. Worse still, the nature of the country's public spending on housing - the major share of resources go into public housing projects instead of demand side support measures - severely limits the bang for the buck from this meager public spending. 

The article also points to this financing route for affordable housing programs,
In the UK a plot of land becomes available to build on when planning authorities give permission for a change of use — from farmland, industrial or commercial use. In places with high house prices, such approval can significantly increase the value of the land. It is possible for the state to acquire land for homes and then sell it on to developers, pocketing the difference in value. That money can then be used to subsidise more housebuilding. South Korea, Singapore, Hong Kong and Taiwan all use national development corporations in this way.
Unfortunately, given the poor enforcement of zoning regulations, the premium associated with land conversion is far lower in countries like India, thereby limiting their ability to capture value from this option. 

Wednesday, June 10, 2015

Steel sector, stressed assets, and asset sales

Livemint writes about the struggles of steel sector in India,
The country’s consumption in April-March 2015 was at 76.3 mt, 3.1% higher from a year ago... in fiscal 2015, India imported 9.3 million tonnes (mt) of finished steel, 71.1% higher from a year ago, while it exported a mere 5.5 mt.... As of 16 April, Indian hot-rolled steel prices stood at Rs.39,681 per tonne or $627 per tonne. Prices of HRCs from China and Russia were significantly lower. According to Bloomberg, HRCs from China were priced at $387 per tonne. Even after adding shipping and transportation costs and export duty, the price added up to around $520 a tonne...Prices of Chinese flat steel products, which now meet the quality standards of established Indian companies, are usually 15% lower than Indian steel prices, thereby making imports very attractive... Russian prices were similar to those of Chinese imports for the past few months. 
And this about the domestic steel industry's finances,
According to data from the Corporate Debt Restructuring (CDR) Cell, as on 31 March 2015, of the Rs.2.86 trillion in loans being restructured, 19.7% or Rs.56,443 crore worth of loans came from the iron and steel sector.
Apart from this, 41 steel sector projects worth Rs 4.6 lakh Cr formed 10% of all stalled projects being monitored by the Project Monitoring Group (PMG). In light of the above and the strong likelihood of the trends persisting, it is highly unlikely that too many promoters will be interested in taking forward these projects. These stalled projects may therefore be as good as cancelled. 

In the quest for deleveraging, Indian corporates, including steel companies, are taking desperate measures. Livemint has another story about firms selling their core assets (mainly to infrastructure funds and infrastructure-focused leasing companies) and leasing it back through a 'sale-with-a-right-to-use' model. Firms sell the asset and enter into long-term contracts to use the equipments for their production. The deals mentioned in the story involve heavily over-leveraged firms, clearly revealing the motivating factor for such deals. However, while such sales help firms monetize non-liquid assets and reduce debt, especially important for debt-laden firms, they also raise operating expenses and thereby production cost. When deleveraging is completed, these firms are likely to face up to the reality of higher production cost and look for buying back the assets. But why should their new owners relent?

It makes very attractive commercial sense for investing in such assets. Given the assured incomes that come from the contracts, with minimal downside risks (albeit limited upside too), investors with patient capital like pension funds should be queing up. It is therefore no surprise that infrastructure funds and leasing companies and jumping into the market. But do these firms have the expertise to manage the operational risks? Or is is just another one of the fads that suddenly strike because of a market opening trigger (deleveraging by firms, here) for capital to rush in head-long and burn their fingers? Further, is the contracting likely to be clean, which minimizes the possibility of contracting disputes? Is it possible to effectively ring-fence asset-ownership and operational sides? 

Fundamentally, this raises the issue of whether the Coasean bargain is attractive enough to pursue such a business model in manufacturing sector, one which has not gained traction even among the largest and most reputed manufacturing firms across the world. Does the profits from the production outweigh the transaction costs associated with manufacturing with leased assets? I am not sure. 

Consider this. The leasing firm has locked-in production supply commitments made to long-term clients, from which they would be loath to renege. In contrast, the asset owner's incentives are far less strongly aligned towards ensuring such rigorous reliability. He does pay a penalty for reneging on contractual terms, but it is unlikely to be anywhere commensurate with the loss suffered by the manufacturer. Further, in order to limit disputes, a tighter ring-fencing of ownership and operation may, perversely enough, by making the owner a lazy rent-seeker, increase the cost for the operator and make his production commercially less viable. Or, is this another Indian jugaad business innovation model?

Update 1 (04.07.2015)

The global steel industry capacity-demand gap is frightening.
Update 2 (22/07/2015)

Neelakanth Mishra points to dismal times ahead for India's steel sector,
At the end of the last financial year, the total debt outstanding to Indian steel companies was nearly $50 billion. This was nearly ten times the industry’s ebitda (profits before interest, taxes and depreciation are deducted), a good proxy for cash profits. Ebitda per tonne was just $63. Since then, Chinese steel prices have fallen, and are already almost $160 per tonne lower than the last financial year’s average. Costs for Indian companies are unlikely to fall meaningfully. Even without including interest costs, no Indian steel mill would be profitable without duty protection. This suggests pressure on debt-servicing. Even last year, when some interest costs on capacities under construction were not included, the average interest cost per tonne of production was nearly $50. This year it should be higher as those capacities get commissioned, and ebitda should be lower: The industry, as a whole, may not be able to pay interest on their debt.

Monday, June 8, 2015

Increasing the utilization of JDY accounts

The biggest concern with India's Jan Dhan Yojana (JDY), in which no-frills accounts with zero-balance are opened to achieve financial inclusion, is with its actual utilization. A large majority of accounts have not been transacted on and very few have had meaningful enough transactions.

In fact, acknowledging this possibility, the government had designed the JDY with multiple incentives. In fact, the scheme has atleast five incentives as top-ups - a zero-balance facility (against the Rs 1000 minimum deposit requirement in regular accounts), a RuPay debit card, a Rs 1 lakh accident insurance, and Rs 30,000 medical insurance for the poor, and an over-draft facility of upto Rs 5000 per household. It was premised that these incentives would promote the bank account utilization. Now that incentives have not proved sufficient, the next dimension is being pursued is to enable access - through increased banking correspondents and even mobile telephones. 

Both incentives and access are doubtless essential to improving account utilization. But if experience from across the world is any indicator, this is unlikely to bridge the last mile gap and get households to use the accounts. Such persistent last mile gaps are more amenable to nuanced behavioral interventions or nudges. Here are atleast three nudges that have the potential to complement incentives and access and bridge the last mile gaps, thereby increasing the actual utilization of JDY accounts.

1. Multi-tier accounts - Behavioral psychologists highlight the importance of mental accounting, whereby people mentally categorize their incomes into different use-directed buckets. Accordingly, people are more likely to save when they desperately want to save for something and have a mechanism to save for it - eg. people use piggy-banks or lock-boxes to save for buying a bicycle or mixer-grinder. In fact, at any time, most poor people use some version of this to save for certain highly valued purposes. Therefore, a multi-tier savings bank account, where people can customize tiers based on their needs, has the potential to be a powerful nudge to get people to start using bank accounts.
2. Lotteries - People, poor and rich, are instinctively attracted to gambling. Lotteries find great attraction among poor people, in particular. In fact, the vast majority of lottery customers come from the lower half of the income ladder. Lottery schemes, like chit funds, which offer investors in recurring payment savings schemes with defined tenures the possibility of windfall payouts are wildly popular among poor people. A periodic lottery offered to active users, through prize-linked savings bank account, can be a powerful nudge to get them to start using the JDY accounts. There is growing evidence of lottery schemes being successful in increasing savings.

3. Commitment contracts - People have a time inconsistency problem whereby they have different preferences on current and future choices on the same issue. Accordingly, while the current-self attaches a high-value to exercising tomorrow morning, the future-self discounts it heavily when tomorrow morning arrives. Consider this example. When they receive their lumpy harvest income, farmers are committed to saving enough to buy fertilizers for the next crop and not fritter it away on festivals or temptation goods. But come the festival or another temptation need, this resolve breaks down, leaving the farmer with too little to buy the fertilizers or make ends meet till the next harvest arrives. So how about a harvest annuity scheme or fertilizer savings account, with attractive enough savings returns, attached to the JDY account, that helps farmers amortize atleast a part of their incomes till the next harvest thereby optimizing their income management or pay for fertilizers for the next harvest. These are examples of commitment contracts that help tide over the time inconsistency problem. Successful outcomes from some such commitment contracts are summarized in a recent report in Science journal highlighted by this WSJ report.   

These are not to be seen as stand-alone strategies, but part of a menu of choices linked to the JDY account and readily available for the account holder to choose from based on their preferences and needs. Their enrollment/subscription processes should be extremely simple and user-friendly, so as to lower the access barriers and costs. Finally, they have to be aggressively marketed through information and education campaigns that reach these customers. Though the potential for their abuse is considerable, the predominantly public nature of banking sector, especially those servicing the poor, should mitigate those risks. 

None of this is to argue that this can be a guarantee to increasing the utilization of JDY accounts. It is just that this approach, coupled with incentives and access that is being promoted by the government, stands a greater likelihood of success with promoting real financial inclusion.

Sunday, June 7, 2015

Investment-demand constrained economy

The latest macroeconomic data releases for India show that the gross fixed capital formation continues on its downward trend, non-food credit growth has dipped to single-digit, and corporate bottom-lines are at their weakest in a long time. Pointing to concerns that the turnaround may not be around the corner, Livemint highlights the capacity under-utilization problem,  
Key industries have huge capacity underutilization. In steel, from a maximum of 88% in 2012-13, utilization level is expected to be 84% in 2015-16. In cement, from a peak of 74% in 2011-12, utilization is down to an estimate 71% in 2015-16. In automobiles, this number is down from a peak of 80% in 2011-12 to an estimated 63% in 2015-16.
Apart from this, real estate market inventories have been piling up. The RBI's own survey shows manufacturing capacity utilization at 71.7% for Oct-Dec 2014, with no signs of a reversal. These trends do not point to any resumption of the investment cycle.
Signatures of consumer demand, for capital goods and consumer durables, too are not promising. As the RBI survey shows, order books of capital goods manufacturers has been declining. And in any case, businesses and banks are hobbled with bruised balance sheets. Business sentiment, as captured in the Business Expectations Survey of March 2015 conducted by the think-tank National Council for Applied Economic Research which tracks over 500 firms of varying sizes, had fallen 6.9% from previous quarter.

All this appears to point towards currently India being an investment-demand constrained economy. If this is true, monetary loosening, for all the hype surrounding it, would be pushing on a string! In any case, all this makes these numbers even more puzzling

India GDP growth graph of the day

India's revised GDP numbers have been variously called as puzzling and confusing. Now, a good friend draws attention to Andy Mukherjee who describes it as a statistical illusion. He constructs a proxy indicator for growth by combining three parameters - corporate earnings (reflects private investment), auto sales (proxy for consumer demand), and software imports (captures productivity gains) - and compares it with the actual GDP growth rate. 
The divergence in the two trajectories, especially since Q4 2012, is striking. In fact, by this indicator, atleast one-third of the GDP growth appears a statistical illusion. 

Saturday, June 6, 2015

India and Bangladesh - the decoupling of economic and social development

WSJ has a nice graphic on Bangladesh's superior social sector achievements over its larger neighbor.
The limited literature available examining Bangladesh's relative success in improving social indicators point to the role of non-profits. But, as I blogged earlier, this may be a case of representativeness bias arising from the high-profile successes of non-profits like Grameen Bank and BRAC, and the consequent under-estimation of the role of government. Given the central role of public systems in the success of social sector policies, the performances of Bangladesh and India also points to the relative success of state in the former and its failure in the latter.

As India struggles with its Clean India initiative, Bangladesh's achievement in reducing open-defecation rate from 42% in 2003 to just 3% in 2014 looks mighty impressive. A less highlighted ongoing ADB funded project is soon set to make Dhaka the first South Asian city to have a functioning 24X7 water supply system. What is it about Bangladesh's public administration and political economy that enhances its state capability?

Friday, June 5, 2015

More on India's power sector woes

Indian Express has this to say about the actual power generation,
Of the country's total installed generation capacity of 2,68,603 MW, the peak demand met on May 23 was less than half at just 1,34,892 MW... at last count, 57 base-load thermal units across India's northern and western heartland were faced with 'reserve shut-down', a technical term for a unit shut down due to lack of demand. Grid managers point to this being indicative of tepid industrial load compensating for a surge in mid-summer domestic demand. 
And Economic Times has this,
2014-15 recorded the lowest plant load factor in over 15 years with the country's power capacities operating at a mere 65%... There are no takers for all the generation capacity that is in place. There is demand but they don't have the money to pay for the power due to the health of the discoms (state distribution companies)... discoms across all states had incurred accumulated losses of Rs 2.51 lakh crore in 2012-13... The average gap between power generation costs and tariffs charged by state discoms is now 82 paise and makes generation unviable... no new power generation project has been announced in the past two years and the low PLFs as well as lack of clarity on bidding parameters for new ultra mega power projects has made investments unattractive for now.
Reflecting, the low actual off-take, the CERC data on traded power price shows a continuously declining trend since 2009. 
All these point to chronic distribution side weaknesses. Hobbled with massive debts and unable to even recover the full cost of service, distribution companies prefer the easy way out - load shedding or power cuts. The low capacity utilization is a reflection of this suppressed demand. Its impact on industries is debilitating. 

Distribution sector reforms bounce against two very formidable challenges - political economy and state capability. Tariff increases, to capture atleast cost-recovery, will require political commitment across states, which may not be forthcoming. After a small blip the cost-revenue gap has been rising. Distribution loss reduction efforts appears to have plateaued off in recent years, with discoms finding it difficult to bring losses down below 20%. Only a handful of discoms have the administrative capability to carry out effective distribution feeder-wise energy audits over a long-enough period with sustained intensity that is required to bring down losses to single-digit levels. 

There is more pain likely from the recent coal auctions for power projects. Promoters who have low-balled their bids, even quoting royalties to the government, in their eagerness to access fuel, have no option but to smuggle the fuel-charges into the fixed capacity charges. With the government firm on not allowing this, a face-off looks inevitable. Atleast some of the contracts are certain to unravel and others renegotiated. And this will all take up more time. 

Unless the distribution side issues get addressed, it is only a matter of time before the vast majority of the stalled generation side investments that have gotten off the ground due to auctions and other recent measures get stalled again. In any case, given these demand trends, new investments will not be forthcoming as lenders and investors would be wary of putting their money in a sector where the demand side constraints appear insurmountable. The lack of new investments in the past two years will start to bite four years hence, severely constraining economic growth. 

This is also a reflection of the difficult reform choices facing governments. Generation-side reforms, which are mostly decisional, are not where the constraints bind. The transactional challenges at the distribution side, involving managing the political economy and improving state capability, are where the real action is.

Solutions like selective feeder franchising skirts around the state capability problem but not the political economy one. However, it is possible that for certain categories of consumers, the political economy problem too can get addressed with a private provider. For example, industrial consumers, who currently suffer the brunt of erratic supply, are most likely to be willing to pay a higher tariff in exchange for reliability. Similarly, it may also be possible to get affluent consumers localized in certain pockets to agree for higher tariffs in return for reliability. The political economy as well as the credibility deficit with public distribution companies will come in the way of such a bargain by public entities.

The risk with this strategy is that it is likely to tip the system into another socially inefficient (albeit economically efficient) dual-market equilibrium, with reliable supply for certain (affluent) consumers serviced by private providers and erratic for other (poorer) consumers supplied by public discoms. But it is likely that the dynamics of competition set afoot by this would in turn force the discoms to become more efficient and also create the political environment for raising tariffs. But the transition can be disruptive and long-drawn. In the circumstances, the million-dollar question is whether the political establishment, across any Indian state, is willing to bite the bullet, and pursue this strategy, even if by stealth?

Wednesday, June 3, 2015

The changing density of Manhattan visualized

Awesome time-lapse animation of 210 years of Manhattan's neighborhood population density, which peaked in 1910 declined for 70 years and started rising since 1980.
(HT: City Lab)

China over-capacity fact of the day

From an excellent article in the WSJ, on how the massive excess capacity in China is exacerbating global disinflation and economic weakness,
Milk producers in New Zealand, coal miners in Australia and sugar growers in Brazil have been forced to cut their prices after finding they had overestimated commodity demand from China. At the same time, Chinese manufacturers, stung by their country's economic slowdown and excess capacity, are flooding export markets with finished goods such as tires, steel and solar panels.
Steel is the stand-out example of this over-capacity,
With China’s slumping construction industry requiring less steel than had been expected, the country has become a massive global exporter of the metal, weighing on global prices. Last year, China exported 94 million metric tons of steel, more than the total output of the U.S., India and South Korea, the world’s third, fourth and fifth largest producers. UBS analysts estimate the world has excess steel-production capacity of 553 million metric tons a year, much of it in China. That is enough to build more than 10,000 modern aircraft carriers a year, or the Eiffel Tower 75,000 times annually. The price of a common steel product called hot-rolled coil has dropped by 44% since March 2012... 
The pace and scale of expansion in all these sectors was staggering and carried seeds of their own demise. Consider the example of tire industry with its linkages,
Between 2000 and 2013, China’s tire production soared threefold to about 800 million tires a year as the country grew into the world’s biggest auto market... Producers exported many of those tires, occasionally drawing complaints from tire industries in the U.S., Brazil, Turkey, India, Colombia and Egypt that China was dumping its excess supplies on their markets. All six nations imposed tariffs on Chinese tires... the more than 300 tire makers in China operate at 70% of capacity, far below the 85% that economists say is needed to generate profits. Chinese tire exports increased tenfold between 2000 and 2013.
Guangrao, a county in eastern China, is home to about 200 tire factories in an area dubbed Rubber Valley... Rubber Valley’s problems have rippled out to other countries, including ones where planters produce the raw material for tires. Rubber trees take about seven years to mature. Planters had to decide in 2007—when China’s gross domestic product expanded by 14.2%—how many trees to plant to meet demand in 2014. When it was time to harvest, the Chinese economic growth rate had fallen by about half... the price of the milky white sap, called latex, that is processed into rubber is down 60% from its high four years ago.

Tuesday, June 2, 2015

Lateral entry and reforming public sector units

Some time back, in an article on lateral entry, I had advocated open competition to recruit for leadership positions in certain public sector entities where private sector expertise could be invaluable. So here is a choice.

In 2013, the combined turnover of India's top 15 public sector units was $330 bn, or nearly 18% of the country's GDP. Further, they sit on massive cash surpluses and have huge investment plans - SAIL plans to invest $25 bn over the next 15 years and NTPC $10 bn over next five years just on green energy projects. These companies include banks, insurers, energy exploration and marketing, mining, steel, and heavy equipment makers. They are large enough to be critical factors in influencing their respective industry itself. It is also arguably true that all of them suffer from inefficiencies arising from poor management, political interference, and, in many cases, weak and compromised leadership. 

In this context, two sets of reforms have the potential to be transformational. One, lateral entry to the top leadership position in these firms through a very rigorous, open competitive process involving company insiders, public sector executives, civil servants, and private sector executives. Second, accord complete operational autonomy consistent with good corporate and public governance standards. This should include flexibility in procurements and investment decisions that are not shackled by excessive regulatory and judicial oversight.

Open competitive recruitment to leadership positions coupled with complete operational autonomy, far more than the piecemeal disinvestments, can be the loudest and most credible signal of the government's commitment to reforming these entities. Further, it can dramatically improve the performance and therefore valuations of these entities, thereby increasing the value capture from their subsequent divestment.

Monday, June 1, 2015

The Great Decoupling

I have blogged earlier about skill-biased technical change and widening inequality. In an HBR interview, Erik Brynjolfsson and Andrew McAfee point to the 'Great Decoupling' since the 1980s between economic abundance (as captured in rising percapita GDP growth and productivity) and worsening income and job prospects for typical workers. 
This trend has paralleled the divergence between wages, which have been declining, and corporate profits, which have been rising.

Brynjolfsson and McAfee blame it on technology - as advances in information and communications technology made plant, machinery, and equipment prices to drop, companies shifted investments away from labor and towards capital. Even as low-skill workers have been replaced by machines or off-shored away, big data, analytics and high-speed communications have enhanced the productivity and value of skilled workers. The consequences of such skill-biased technical change include widening inequality, with all attendant social and political distortions. 

As regards preparing the society for this changing world, they point to the need for fostering an environment that is conducive to innovation, new business formation, and economic growth. In this endeavor, they highlight five focus areas for governments - school education that treaches kids relevant skills, including creativity, inter-personal skills, and problem-solving; world-class infrastructure; more entrepreneurship; more liberal immigration; and investment in basic research (as businesses focus on applied research). Unfortunately, countries like India slip badly on all the aforementioned.