The Antrix-Devas self goal

The Antrix-Devas case should be a teachable moment for India's trigger-happy government auditors. 

In brief, Antrix, the commercial arm of Indian Space Research Organization (ISRO), signed a contract in 2005 with Devas Multimedia, a firm promoted by two retired ISRO scientists, whereby Devas acquired a 12 year lease of two ISRO satellites to be operated in the S-band spectrum (which was reserved for defence sector, though India does not possess the technology to use it) to broadcast high speed internet on mobile devices. Devas was to pay $300 million over the contract duration. A CAG report in 2010 found the deal vitiated. In response to the public outcry and media trial, in 2011, an embattled government cancelled the deal saying that the spectrum was necessary for defence purposes. Devas initiated two international arbitration proceedings against the contract cancellation. The International Chamber of Commerce tribunal in Paris imposed a penalty of $855 million, and the UN Commission on International Trade Law at Hague imposed another penalty. The latter ruled that the cancellation constituted "expropriation" and India breached its Bilateral Investment Treaty (BIT) commitments with Mauritius to accord "fair and equitable treatment" to foreign investors. 

A Bloomberg article says,

The CAG in its report says it is a ‘classic case of public investment at private profit.’ It finds conflicts of interest, disregard for rules and procedures and Cabinet apparently being misled into approving the agreement... When CAG said the Devas-Antrix deal was vitiated, the beleaguered Manmohan Singh government gave in to pressure from the Opposition and baying TV channels to abruptly cancel the contract citing strategic interests... The CAG has been wrong earlier too. In 2005, it faulted the sale of two hotels of Hotel Corporation of India ─ Juhu Centaur and Airport Centaur – to single bidders. It had pointed fingers at Arun Shourie, then minister for disinvestment in the Vajpayee government. The CAG alleged the government had suffered losses because the company that won the bid for Airport Centaur for Rs 83 crore had sold it a few months later to the Sahara Group at a profit of Rs 32 crore. The bidder of Juhu Centaur could not pay the full fee of Rs 153 crore and the hotel was shuttered in 2005. An investigation by the Central Bureau of Investigation was ordered, but in 2008, the investigative agency told the government it could not find any irregularities.

The CAG had also said the treasury had been put to a loss of Rs 10.8 lakh crore by the allocation of coal blocks between 2004 and 2009. In 2015, the Modi government claimed it earned more than that amount by auctioning 20 of the 204 coal blocks whose allocation the Supreme Court had cancelled. The claim is misleading because the money will flow in over 30 years if the mines are worked to rated capacity. These cash flows have to be discounted at an interest rate to arrive at their ‘present value’ (because today’s money will not buy the same amount 30 years later).

In all these cases, the CAG has sought to expand its jurisdiction on performance audit and passed judgement on the merits of public policy actions. This is surprising since the National Audit Office (NAO) of UK, which is the model for India's CAG, has this to say about its remit, 

We do not comment on the merits of policy but aim to conclude on whether value for money has been secured

Consider the Devas case where the CAG definitively describes it as a "classic case of public investment at private profit". Consider the leap. It has found procedural lapses, may be even conflicts of interest. But, how does it establish malafide? Or more specifically, how does the auditor establish that these lapses are not genuine omissions or those dictated by exigencies of decision making? In any case, isn't this the jurisdiction of vigilance officials and investigators? If the CAG is competent to pronounce guilty, what is left for the departmental proceedings and criminal investigators? Finally, it is surely an extremely sweeping conclusion to describe it as a "classic case" of crony capitalism. 

The CAG is plagued by the same disease that afflicts the Chief Information Commission, the Central Bureau of Investigations, the Chief Vigilance Commission, and most disturbingly the Judiciary. All these regulatory institutions, none of which have to take any decisions on managing a public agency, have been swept into populist grand-standing. In the process, they have compromised professional integrity, eroded their own long-term institutional credibility, and paralyzed public policy decision making. The lack of leadership in these institutions has never been so missing. 

The coming EM "debt default bulge"?

Bloomberg points to the pace of debt accumulation among emerging economies,

Overall, the external debt of developing economies has tripled in the last 10 years, with the volume growing faster than both gross domestic product and foreign exchange reserves in the last five years

Another article highlights the spectre of non-financial corporate defaults in Asia,

A bulge in Asian defaults is a certainty between now and the end of the decade.

A third article highlights the relative attractiveness of EM, in this case Indian, debt despite their much higher risks,

Glenmark Pharmaceuticals, which sold its first straight dollar bond on Monday. The coupon was 4.5 percent, which translates to a spread of about 325 basis points over Libor, well inside the regulatory limit. The low yield for a company rated two notches below investment grade happened even as the borrower failed to detail its other debts in the prospectus -- "description of material indebtedness," a standard (albeit not mandatory) feature of junk bonds was missing. No worries, the $200 million of notes still received bids equivalent to more than $1.6 billion. With so much cash around, who cares for disclosure, risks or ratings? If it's from India and it pays more than zero, it's good.

All said and done, despite all its risks, given the very low exposure of high-yield Indian corporates to foreign debt, is is tempting to argue that this may be an opportunity to mobilize low-cost capital. But then, in a country with weak general corporate governance standards, high yield corporate offerings are most likely to signal lemons. For a corporate sector already reeling from high levels of leverage, such increased external exposure may tick more negatives than positives.

An FAR sales model

In an earlier post, I had blogged about adopting higher Floor Area Ratio (FAR) and establishing a trading platform and enabling regulatory framework in trading it. 

Since 2004, the Brazilian city of Sao Paulo has been selling Certificate of Additional Construction Potential Bonds (CEPACs) through periodic electronic auctions in the Sao Paulo Stock Exchange (Bovespa). It gives the buyer additional building rights to be used within the notified area. Taking a cue from Sao Paulo, but with several variations, here are the broad contours of a plan for Indian cities. 

To start with, the revised Master Plan with higher and graded FAR should be notified. But property rights should be restricted to the existing FAR. And, construction to realize the higher FAR should be permitted only on purchase of FAR. The FAR would be sold as Transferable Development Right (TDR) through calibrated auctions done on a digital platform.  

Given the vast variation in land prices across a city, it may not be advisable to have a single TDR market for the whole city. Instead, the Master Plan itself should divide the city into TDR zones. This could be done based on a combination of prevailing property prices (guidance value register), economic growth and development synergies, and other parameters that are used in demarcating Business Improvement District (BID) or Tax Increment Financing (TIF) areas. A notified slum or a residential colony could be notified as a zone. The TDR would initially be transferable only within the zone. 

It may also not be prudent to initiate TDR sales across the entire city from the beginning. Instead, it can be operationalized in a few zones identified (and approved by the Council) based on immediate development imperatives (say, a new metro or impending large road widening) or to promote urban renewal (in old town or blighted areas) or to encourage affordable housing (in certain areas close to industrial locations) or to facilitate transit-oriented development (the highest density transit corridors and around major transit stations). 

In the notified area, a small proportion, say 5%, of the total original FAR of the zone can be released into the market once every three years. The extent of releases can also be determined based on assessments of population growth or in pursuit of the realization of some pre-defined targeted average per capita floor space over a period of time. The sale can be done through well-publicized auctions conducted on an easily accessible electronic platform following the prevailing capital market regulations. The entire auction process should be outsourced and the bonds traded on the National Stock Exchange.   

In order to curb hoarding and speculation, the validity of a TDR should be restricted to 5 years. The owner would have to utilize the TDR and get the property tax assessment completed within this period. In exceptional cases, where the buyer was unable to develop the property due to delays in municipal and other government building approvals, the City can buy back the TDR at the same price with interest calculated at prevailing rates. In other words, no buyer, under any circumstance would be able to retain an un-utilized right beyond five years.

Further, since all transactions are done on an electronic trading platform, buyers should register with their Aadhaar numbers or corporate PANs (including the Aadhaar numbers of its Directors). Purchases by any individual or entity should be capped at 10% of the total TDR being sold so as to prevent hoarding. The trading platform should incorporate analytics that filter deviations. 

The implementation of this initiative should necessarily follow a strictly iterative approach. The implementation should be closely monitored and assessed, and its elements should be reviewed after a period of three or five years. The City government should enlist a reputed evaluation agency as a partner to study and offer insights about the interventions' successes and failings. 

The expansion of notified zones should be done only after the first round of review. If the system stabilizes, after a few rounds of reviews, it should be possible to merge zones, have auctions with increased periodicity, and so on.

The legal framework necessary for this would not involve any legislative amendments. The City's building regulations should be amended to reflect the distinction between FAR that comes with property rights and that which have to be purchased. The City would also have to register the TDR issuance in each zone with the Securities Exchange Board of India to use their platform to transact the auctions. However, it will have to be examined as to whether the TDR is a "security" under the SEBI Act 1992 or any other relevant legislation.

Such TDRs can be powerful instruments to achieve urban development priorities. For example, TDRs can be sold at a discount to encourage the construction of smaller affordable housing units. It can be sold through a reverse auction on the condition that the developer should sell 25% as affordable housing units. As the affordable housing stock so added increases, it would put downward pressure on property prices.

Further, the phased, market-driven, and potentially self-financing approach to densification and infrastructure augmentation is more likely to address the practical challenges associated with such efforts.

A vertical development action agenda

Zoning regulations, especially limits on vertical development, impose prohibitive costs on urban development. It can be safely said that housing has become priced out of range for all but the richest 0.5% in the metropolitan cities. A striking manifestation of the problem comes from a nice article by Shanu Athiparambath,

In 1984, the average floor space consumption in Shanghai was 3.6 square meters. By allowing tall buildings, Shanghai raised average floor consumption to 34 square meters by 2010. Cities across the world have raised floor space consumption by allowing tall buildings. In 1910, 16 people lived on a typical floor of 920 square feet in Manhattan. In 2010, four people lived on a typical floor, because floor space consumption had risen four times...

In Mumbai... the average person consumes less floor space than an American prisoner... in 2009, the average floor space consumption in Mumbai was merely 48 square feet... Over half the households have only one room. As early as 1978, a draft of the Department of Justice had accepted that prisons in United States should offer single rooms of at least 80 square feet per man.

It is increasingly evident that affordable housing could be the biggest hurdle to India's urban development aspirations. There are only two approaches to alleviating the constraints - vertical development and unlock vacant public lands. While both would be necessary to address the problem in the long-run, it may be prudent to significantly liberalize vertical development before unlocking vacant government lands so as to realize full value from these last remaining vacant spaces in the largest cities. 

Two fundamental reforms to zoning regulations in Indian cities are essential. One, cities should move away from the present system of single Floor Area Ratios (FAR) across the city to a system of graded FAR. Second, there should be a two-tier FAR arrangement, with certain basic FAR which comes with the property right and the rest to be purchased from the local authority and freely tradeable. In many respects, the still-born Mumbai DP 2034 is a very good example that embraces these principles, though the FAR should have been even higher. These reforms should be complemented with at least four critical policy support initiatives.

1. Cities should then revise their Master Plans based on these principles. Certain areas like the central business district, transit corridors, important transit stations, and newer developments should have much higher FARs. In fact, while the basic FAR can be constant, the sellable FAR can gradually increase with time, based on certain objective considerations.

2. FAR should become an instrument to achieve important urban development objectives. For example, the older and blighted areas of cities, as well as any other strategically valuable areas, should be targeted with very high FAR so as to encourage urban renewal and redevelopment. Similarly, affordable housing developments can even be allowed to purchase the additional FAR at concessional rates. 

3. The local authority should simultaneously invest heavily in upgrading infrastructure so as to increase the carrying capacity of the areas undergoing vertical development. It may be useful to consider ring-fencing such areas and use the proceeds from the sales of FAR in infrastructure improvements there. It can be supplemented with various value-capture techniques to mobilize local area resources to finance such investments.

4. Finally, there should be a trading platform with an enabling regulatory framework to support the trade in FARs. This should capture both the mechanisms for transparent and efficient price discovery and trading of FARs. The Government of India could support the States in the establishment of a platform by preparing model legal and other documents as well as the development of requisite IT applications.

Two China graphics for the day

First, from Goldman Sachs, via MR, on the total fiscal deficit, including off-balance sheet items, which touched 15% of GDP!

Second, Ananth points to the spurt in public spending stimulus in the first half of 2016, which rose by 23.5%, even as growth in private fixed investment fell to a record low. 

It is clear that the Chinese government is still reluctant to face the reality and take on the challenge of squeezing out the excesses from credit-fueled growth that has become entrenched over the years. But, like with everything China, however, there are sub-plots. The recent debate on "systemic financial risks" and the increasingly direct role of President Xi Jinping in the country's economic affairs, over the head of the State Council headed by the Prime Minister Li Keqiang, may portend some course corrections. But it is unlikely to be anything like what is necessary. 

The challenge with development - the curse of standards

There are very few development challenges that do not come with trade-offs. And on most first-order determinants of development, the trade-offs raise disturbing and difficult questions. This is so even when the change is morally, socially, and economically desirable. But trade-offs invariably mean acceptance of second-best standards. 

Accordingly, the imposition of a rigorous patent regime in a least developed country runs the risk of curtailing local enterprise. In countries without any alternatives, outright bans on market intermediaries like money lenders and agriculture middle-men, howsoever fleecing they are, adversely affects the vast majority. In all these cases of regulatory reforms, the costs of formality often outweigh its benefits, leaving the system as a whole worse off than without the reform. I had blogged earlier about how the high cost of regulation and standards that accompany manufacturing for export markets prices such manufacturers out from India's domestic markets. 

Consider four examples of such trade-offs that India is currently grappling with. The first two involve the pursuit of formulating standards, while the last two involves the problems associated with enforcing laid down standards. 

The Employees Provident Fund Organization (EPFO), a public sector entity that manages the gratuity and pension of India's central government employees, is apparently considering the enrollment of unorganized sector workers into EPFO. For a start, this is a contradiction in terms since the unorganized sector workers are not in EPFO precisely because they are not part of any formal network. And they prefer to stay informal because the costs of formality are prohibitive. For example, the total salary deductions for an employee with monthly income below Rs 15,000, ones who form the overwhelming share of the informal sector, is about 32%, with EPFO alone claiming 25%. Such massive deductions alone are enough to deter employees. For employees, apart from the costs, there are the compliance requirements and inspections, all of which would leave them commercially unviable. 

In fact, the growing demand for globally harmonized labor standards may have far-reaching effects on the economic growth trajectories of developing countries. Consider the example of domestic and construction workers, two categories who suffer badly from extremely poor working conditions. It is therefore the natural response of well-intentioned people to demand regulation of working conditions and higher standards. Most often, if not always, they advocate state-of-art labor protections for these workers. But in an extremely price-sensitive markets where the margins are very small (the layers of sub-contracting in construction dissipates margins are all levels), the cumulative cost of these protections almost always make them non-starters. In such circumstances, the result of higher standards is almost always regressive - workers forced out of the market, more informality, more harassment, and more corruption. 

The second example is the recently promulgated real estate regulation legislation. It introduces many consumer protection standards, including complete transparency in transactions and escrowing of the amounts collected from buyers. While undoubtedly laudable, they are likely to increase the cost of development for developers, who are most certain to pass on the costs to the buyers, thereby forcing up an already prohibitive real estate market. Its impact on the government's objective of making housing affordable may be less than benign.  

The third example comes from the field of medical education regulation. The Medical Council of India (MCI), responsible for the accreditation of medical colleges across the country, has just denied permissions for the establishment of 83 new medical colleges, expansion of MBBS seats in 47 existing medical colleges, and starting super-specialty courses in 39 medical colleges. The MCI's argument is that these colleges do not have the requisite qualified personnel and physical infrastructure to run such courses or offer more degrees. Who can fault the MCI for adhering to minimum standards? After all who in their right mind would want less than qualified medical doctors roaming around and killing people?

But what if the standards are too high given the context. We need to keep in mind that India is a country with 0.7 doctors per 1000 of population, one-fourth of that in UK. It surely needs a few times more than the 381 existing medical colleges and 63,800 MBBS seats each year, enough to meet just 1% of the demand among aspiring medical students. 

Staying on in the field of medical care, India proudly declaring that it adheres to the World Health Organization (WHO) standards on primary care. It has sanctioned a Primary Health Center (PHC) for each 25000 population and have an Auxiliary Nurse Midwife (ANM) for each 5000 population. But current standards need the heavily over-burdened (just for illustration, in rural areas, just imagine visualizing the distances that need to be covered in field visits to scattered households) ANMs to keep elaborate and state-of-art documentation of each ante-natal case, irrespective of the nature of the case. This forces her to maintain more or less the same standards of monitoring for normal and high-risk ante-natal cases, though the latter with just 10% of all cases contribute 80-85% of all maternal and child morbidity and mortality.  

At some level, there is also a need to question the prevailing standards on even more mundane things like blood pressure and diabetes in a culture where people are used to taking far higher quantities of salt, spice, and oil even in their staple diets when compared to those for whom the standards were originally formulated.  

The final example is that of primary education where it is now well acknowledged that learning outcomes are extremely poor. Here too, the obsession with standards may have done more harm than good. The National Council for Education Research and Training (NCERT), which lays down the grade and subject specific competency standards, in its politically correct wisdom has laid down minimum national learning standards which are comparable to global benchmarks. But for a country with massive antecedent learning gaps and numerous other capacity constraints, such standardize-and-pretend approach does enormous harm.  

I can already hear people mumbling their discontent at this. I understand their concerns. But they need to appreciate that development rarely ever happens in a straight and neat path. These are real world trade-offs that need to be acknowledged and policy design should accommodate them. Most often, this would necessitate decidedly second-best choices and unsatisfactory compromises. Development is always a process of gradual transition where multiple states of being necessarily co-exist, rarely one of abrupt shift from one condition to another. 

So here is my simple smell test. If we stand a far higher chance of saving the lives of a significant number among the 90% of those at risk, but at the cost of, maybe, increasing the risks for 10% of the cases, by revising ante-natal care standards, then so be it. I am willing to accept that trade-off any day. 

Why does Estonia and Poland score so well in PISA?

From the Economist, the correlation between teacher salary and teaching hours, and learning outcomes (as measured by PISA score).

The variation is very interesting. The surprises are Estonia (526) and Poland (521), both of whom achieve close to the scores of PISA leaders (outside the Greater China), South Korea (542) and Japan (540). So the question should be, how do Estonian teachers achieve better PISA outcomes than their counterparts in Holland who are paid five times more, or in Canada, who also work a third more? Is there a cultural dimension to teaching and education in Estonia and Poland, like with Finland, that contributes to their disproportionately superior performance? Or, is it more institutional design and governance improvements that are behind this success?

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