PPPs or not, building roads requires fiscal support

Newspapers point to a directive to the Roads Ministry to shift away from the current approach of building national highways. In particular the directive from the office of the Prime Minister apparently talks about three things - discontinue direct construction of roads, encourage private sector to take up construction, and monetise completed road projects.

The most worrisome thing for government apparently has been the rise in the volume of debt accumulated by the National Highways Authority of India (NHAI) over the last five years.

The NHAI has pursued a Hybrid Annuity Model (HAM) whereby the developers are paid out 40% in five instalments during the construction period and the rest as annuity over the concession period. It lowers the construction and traffic risks for the developer, and makes the government put upfront a significant share of the construction cost. 

Some observations

1. There is no point trying to assess the relative merits of Hybrid Annuity Model (HAM) and Viability Gap Funding (VGF) models. They are all variants of de-risking the model for commercial investors. We should be doing both (and BOT Toll), each depending on the commercial viability of the specific project. HAM is after all a form of annuitised hybrid VGF. 

2. Whatever the private participation model envisaged, global experience shows that any ambitious nationwide road building program required significant upfront fiscal support. In the absence of adequate fiscal support, the NHAI had to leverage up.  

In fact, the belief that BOT Toll approach (or any other market-based PPPs) will help crowd-in private capital is a stretch. It did not happen when it was tried out by the last government and it is unlikely to happen this time too. And whatever happened spawned renegotiations and bad loans for the banks. 

3. In fact, I imagine that all the road stretches which would have some reasonable commercial viability have already been developed or contracted, and we are now left with the vast majority of the stretches where commercial viability is questionable and large VGF/subsidy (of any kind) is inevitable.

4. The idea of "aggressive monetisation of existing assets" (using whatever approach, InvIT or other) is naive. The NHAI could not even get any bids for the second round of monetisation tender - nobody turned up for the second round. As I have written with V Ananthanageswaran in Can India Grow? (see pages 39-43), the pool of domestic and global non-banking money chasing infrastructure financing is very limited. The belief that there are vast pools of domestic and foreign capital willing to invest in roads in India is completely wrong - see this, this, this, and this. 

And it is most likely that Macquarie overbid for the first round where NHAI got nearly 50% above the off-set price. And we will reap its consequences in the form of skimping and asset-stripping in the years ahead. It has been the standard operating procedure for Macquarie from other parts of the world.

It again highlights the value of a development finance institution which focuses on long-term financing of infrastructure. Anyways, what is the NIIF doing? But it too pull this off without being sufficiently capitalised, and the projects themselves getting significant subsidy support. There are no free private sector lunches!

Palliatives will not address capitalism's problems

I had blogged earlier about Bridgewater's Ray Dalio's explanation of capitalism's problem as one of excesses that have built-up over the years,

Dalio's diagnosis is that capitalism's dynamics, especially since it has been taken to its extremes (say, in seeking profits, efficiency, productivity, market share etc) is now "producing self-reinforcing spirals up for the haves and dow for the not-haves, which are leading to harmful excesses at the top and harmful deprivations at the bottom". In effect, Dalio blames the dysfunctional nature of modern capitalism to an impersonal contributor, some inexorable dynamic of capitalism, say peak capitalism.

So there have been efforts from within in recent times to respond to these excesses. Innovations like the Universal Basic Income (UBI), impact investing, philanthro-capitalism, B-corporations, gender-lens investing, corporate social responsibility, responsible-sourcing, circular economy, carbon footprint tagging etc are examples. 

The use of environment, social, and governance (ESG) criteria in investing by financial institutions is another example. 

Businesspeople, being people, like to feel they are doing good. Until the financial crisis, though, for a generation or so most had been happy to think that they did good simply by doing well. They subscribed to the view that treating their shareholders’ need for profit as paramount represented their highest purpose... It is a view of the world... which has faced increasing pressure over the past decade. Environmental, social and governance (ESG) criteria have come to play a role in more and more decisions about how to allocate financial investment. The assets managed under such criteria in Europe, America, Canada, Japan, Australia and New Zealand rose from $22.9trn in 2016 to $30.7trn at the start of 2018, according to the Global Sustainable Investment Alliance... The discontent does not end with investors. Bright young workers of the sort businesses most desire expect to work in a place that reflects their values much more than their parents’ generation did...

On August 19th the great and good of ceo-land announced a change of heart about what public companies are for. They now believe that firms should indeed serve stakeholders as well as shareholders. They should offer good value to customers; support their workers with training; be inclusive in matters of gender and race; deal fairly and ethically with all their suppliers; support the communities in which they work; and protect the environment... Last year, employees at Google forced the firm to stop providing the Pentagon with ai technology for drone strikes and to drop out of the procurement process for JEDI, a cloud-computing facility for the armed forces. Google depends, perhaps more than any of its peers, on a smallish number of cutting-edge data scientists and software engineers; their views carry weight. Microsoft, despite similar misgivings from its employees, is still in the running for the JEDI contract. Amazon, for its part, is facing employee pressure over contracts with oil and gas companies.

For a start, it may be useful to scratch the surface and examine the ESG consideration details behind the trillions mentioned. Chances are that they would be so superfluous as to be meaningless.

This Harvard Business School case study and this discussion involving the professors concerned is a great example of how top-notch academic ideologues feel comforted by what are at best ultra-marginal tinkering on fund allocation processes of large investors. Such long-route to change can be interminably long. Most likely much ado about nothing!

In general, corporates have sought to deploy "virtue signalling" and initiated "feel-good" measures. These are not even token measures. In fact, they are perhaps downright disingenuous obfuscations. They are worse than band-aid on gangrene. Such song and dance at non-issues are on many occasions conscious efforts by the corporate elites and their ideological cheerleaders to distract attention from the core issue.

The Economist falls back on more of the capitalist medicine - accountability and competition. It proposes taking decision-making away from managers and vesting with shareholders even as shareholder base is broadened, on the grounds that this would bring in accountability and therefore demand for real change. And competition would help keep corporates honest in pursuing the interests of workers, consumers, and regulators. This is a great example of suggesting remedies, knowing fully well that they are both impractical and have little evidence of being effective.

Instead, a meaningful enough attempt will have to involve at least some corporate leaders showing the way with actions on issues like abjuring from tax avoidance, efficiency focused lay-offs and off-shoring, monopoly seeking or oligopolistic actions, providing decent wages and proportionate wage increases for workers, investing in and promoting the rights of lower level workers, ensuring adequate financing of pensions and other worker liabilities and so on. Now these would constitute real progress in addressing capitalism's excesses.

But then the argument would go that these are collective action or free-rider problems. No one corporate or group of corporates would want to pursue them since that would be shooting themselves in the feet. Never mind the reality of today's oligopolistic markets where just the 2-3 leaders could take the lead and show meaningful impact without compromising significantly on their commercial interests. 

Anyways, the collective action problem presents a convenient fig-leaf for liberal opinion makers blame the favourite whipping boy, government, for not putting in place appropriate policies. But if some government tries to engage with the problem, the same liberals accuse governments of meddling with markets or favouring one group over other. The lack of any broad-based ideological support and hair-splitting among opinion leaders (including The Economist) for the actions on European Union in the direction of anti-trust (whatever their real intentions) is a case in point. 

I think we need paradigm shifts. And these shifts are unlikely to emerge from within. The house has to burn down. 

Reforming the global monetary and financial system

It is gratifying when no less a person than the Governor of Bank of England Mark Carney breaks ranks from orthodoxy and summarises our book, The Rise of Finance. The core of the speech goes to the heart of what we have argued in our book. The global financial and monetary system is broken and the role of dollar is central to the problem.

In his speech at the annual Jackson Hole gathering of central bankers, Carney highlighted the problems associated with the world's reliance on the US dollar and spillovers especially on emerging economies from US monetary policy actions. He questioned the macroeconomy stabilisation orthodoxy on flexible inflation targeting and floating exchange rates. He advocated the creation of a new international monetary and financial system (IMFS) based on many more global currencies, where IMF could play a role to avoid having countries self-insure themselves against sudden-stops and capital flight by the inefficient and wasteful hoarding of US dollar assets, and greater global monetary policy co-ordination.

On the problems with the prevailing system,

Globalisation has steadily increased the impact of international developments on all our economies. This in turn has made any deviations from the core assumptions of the canonical view even more critical. In particular, growing dominant currency pricing (DCP) is reducing the shock absorbing properties of flexible exchange rates and altering the inflation-output volatility trade-off facing monetary policy makers. And most fundamentally, a destabilising asymmetry at the heart of the IMFS is growing. While the world economy is being reordered, the US dollar remains as important as when Bretton Woods collapsed. The combination of these factors means that US developments have significant spillovers onto both the trade performance and the financial conditions of countries even with relatively limited direct exposure to the US economy.

He argues that these developments have lowered the global equilibrium interest rates, which in turn influences domestic monetary policy actions, which in turn become a bigger problem when the US economic conditions warrant tightening by the UD Federal Reserve even as economic condition elsewhere are weakening. The result is a structural disinflationary bias in the world economy.

Greater cross-border trade, growth of global value chains, and globalisation in general have synchronised producer prices globally and also introduced a disinflationary bias on the world economy. This increase in global trade has been accompanied by the DCP or trade invoicing in dollars even when the trade does not involve the US, thereby weakening the automatic (external side) stabilisation effects of a floating exchange rate.

The resulting stickiness of import prices in dollar terms means exchange rate pass-through for changes in the dollar is high regardless of the country of export and import, while pass-through of non-dominant currencies is negligible. As a result, import prices do not adjust efficiently to reflect changes in relative demand between trading partners, in part because expenditure switching effects are curtailed, and global trade volumes are heavily influenced by the strength of the US dollar.

It has been shown that, controlling for the global business cycle, a 1% appreciation of the dollar against all other currencies leads to a 0.6% contraction in trade volumes in the rest of the world within one year.

In addition to trade invoicing, dollar is also the dominant currency in the financial markets, and all this creates a self-reinforcing spiral that predominates dollar ever more,

As well as being the dominant currency for the invoicing and settling of international trade, the US dollar is the currency of choice for securities issuance and holdings, and reserves of the official sector. Two-thirds of both global securities issuance and official foreign-exchange reserves are denominated in dollars. The same proportion of EME foreign currency external debt is denominated in dollars and the dollar serves as the monetary anchor in countries accounting for two thirds of global GDP. The US dollar’s widespread use in trade invoicing and its increasing prominence in global banking and finance are mutually reinforcing. With large volumes of trade being invoiced and paid for in dollars, it makes sense to hold dollar-denominated assets. Increased demand for dollar assets lowers their return, creating an incentive for firms to borrow in dollars. The liquidity and safety properties encourage this further. In turn, companies with dollar-denominated liabilities have an incentive to invoice in dollars, to reduce the currency mismatch between their revenues and liabilities. More dollar issuance by non-financial companies and more dollar funding for local banks makes it wise for central banks to accumulate some dollar reserves. 

And the net result is that actions of US government and the Federal Reserve have enormous spill-overs on the world economy, even in countries which have limited US exposure. Helene Rey has described the global financial cycle as a dollar cycle. Carney points to evidence on the harmful effects of spillovers,

For EMEs, this manifests in volatile capital flows that amplify domestic imbalances and leave them more vulnerable to foreign shocks. One fifth of all surges in capital flows to EMEs have ended in financial crises, and EMEs are at least three times more likely to experience a financial crisis after capital flow surges than in normal times. While the typical EME receiving higher capital inflows will grow 0.3 percentage points faster, all else equal, the typical EME with higher capital flow volatility will grow 0.7 percentage points slower... Bank research suggests that the spillover from tightening in US monetary policy to foreign GDP is now twice its 1990-2004 average, despite the US’s rapidly declining share of global GDP. Financial instability in advanced economies also causes capital to retrench from EMEs to ‘safe havens’, as it did during the 2008 financial crisis and the 2011 euro-area crisis. Connally’s dictum “our dollar, your problem” has broadened to “any of our problems is your problem”... Bank of England work finds that redemptions by EME bond funds (with large structural mismatches) in response to price falls are five times those for EME equity funds (with lower structural mismatch). In turn, EME equity funds are twice as responsive as advanced economy equity funds.

So what does he suggest? In the short-run he suggests transparent pursuit of flexible inflation targeting, with focus on trading off domestically generated inflation and output volatility, as well as co-ordination with fiscal and regulatory policies, at both national and international levels.

In the medium term, policymakers need to reshuffle the deck. That is, we need to improve the structure of the current IMFS. That requires ensuring that the institutions at the heart of market-based finance, particularly open-ended funds, are resilient throughout the global financial cycle. It requires better surveillance of cross border spillovers to guide macroprudential and, in extremis, capital flow management measures. And it underscores the premium on re-building an adequate global financial safety net... EMEs can increase sustainable capital flows by addressing “pull” factors including... expanding the scope and application of their macroprudential toolkits to guard against excessive credit growth during booms. Bank of England research finds that tightening prudential policy in EMEs dampens the spillover from US monetary policy by around a quarter... At the same time, it is in the interests of advanced economies to moderate push factors, including risks in their markets and institutions... Pooling resources at the IMF, and thereby distributing the costs across all 189 member countries, is much more efficient than individual countries self-insuring. To maintain reserve adequacy in the face of future larger and more risky external balance sheets, EMEs would need to double their current level of reserves over the next 10 years – an increase of $9 trillion. A better alternative would be to hold $3 trillion in pooled resources, achieving the same level of insurance for a much lower cost.

In the longer term, we need to change the game. There should be no illusions that the IMFS can be reformed overnight or that market forces are likely to force a rapid switch of reserve assets... Any unipolar system is unsuited to a multi-polar world. We would do well to think through every opportunity, including those presented by new technologies, to create a more balanced and effective system... Multiple reserve currencies would increase the supply of safe assets, alleviating the downward pressures on the global equilibrium interest rate that an asymmetric system can exert. And with many countries issuing global safe assets in competition with each other, the safety premium they receive should fall. A more diversified IMFS would also reduce spillovers from the core and by so doing lower the synchronisation of trade and financial cycles. That would in turn reduce the fragilities in the system, and increase the sustainability of capital flows, pushing up the equilibrium interest rate.

Weekend reading links

1. Very good article on India's dairying sector by Chandramogan, the founder of Hatsun Agro Products. This about the importance of milk production to India's agriculture,

The CSO’s national accounts statistics shows that 26.15% of the GVA from India’s agricultural sector in 2016-17 was constituted by livestock. Further, 66.93% of the value of livestock output was from milk. It implies that roughly every fifth rupee in Indian agriculture comes from dairying. This is because practically every farmer produces milk, irrespective of what his/her “main” crop is. Unlike the main/principal crop that is marketed once or twice a year, milk brings in income on a daily basis. Also, its prices are less prone to volatility and there is no other crop where the Indian farmer realises roughly two-thirds of the rate paid by consumers (that ratio is one-third in the US). Organised dairies in India have evolved a unique procurement-cum-marketing system, wherein Indian farmers get 60 to 65% of the value of retail price paid by the consumer. Milk is a source of liquidity, predictability and stability in rural incomes. Moreover, for every eighth or ninth farmer producing milk, there is a mom-and-pop store retailing the same. Again, there is no product that is as fast-moving as milk, allowing the small retailer to rotate capital 365 times a year. In short, in India, in spite of paying approximately 25% higher a price to the farmers compared to US, consumers get it at two-third of the price consumers in the US pay.

And its growth has been impressive,

Our milk output more than doubled from 79.66 mt in 2000 to 176.27 mt in 2017, when the same for the world increased by just 42%, from 579.31 mt to 824.80 mt. In 2000, India produced 79.66 mt of milk versus the rest of the world’s 499.65 mt. 17 years later in 2017, India produced 176.27 mt versus the rest of the world’s 648.53 mt. India’s milk grew by 109% against 30% in rest of the world in the last two decades. India’s contribution to the entire world growth is 35% versus 65% of all countries put together... India, in the last 10 years or more, has been a net exporter rather than importer of dairy products.

If only we had more opeds by people who actually are doing what they are writing about!

2. Livemint points to a CAG report that highlights concerns about India's revenue collection system. For the quarter ending June, gross tax revenue collection grew at the slowest pace in 10 years. The shortfall in central GST collection for 2018-19 was 22%. The report also draws attention to tax compliance not having improved significantly post-GST. The complexity of GST structure has made automated invoice matching difficult to implement, thereby creating opportunities for tax leakages and calculation errors.

A summary of the CAG report findings

3. Nice article on the perils of commercialisation of higher education. The UK's higher education market has been transformed over the past decade by market-based reforms which allowed for-profit colleges. In 2018, the Office for Students (OFS) was set up as the higher education regulator. Higher education institutions have come to rely increasingly on student fees than government grants.

Some of the providers are owned by private equity investors. The OFS requires all universities and colleges to register in order for their students to be eligible for government loans. The OFS has recently allowed private institutions to fail, which in turn raises the concerns about what will happen to the students admitted.

More signatures of distortions and problems,

Universities lower down the pecking order have fared less well... Universities are keenly aware that they are mostly competing with a handful of rivals for students, and that geography plays a big role in determining who those rivals are. Exeter, in south-west England, has commissioned research which shows it attracts students who live near the m5 motorway that runs into town, and struggles to recruit from anywhere north of Birmingham, in the Midlands... Universities not attracting enough students have to adapt. Since the new system was introduced, almost all have charged the maximum allowed—now £9,250 ($11,250) a year. Since students are entitled to government loans, which they don’t have to repay until they earn more than £25,725 a year, they are relatively unfussed by upfront costs. But price competition has begun to emerge in the form of hefty scholarships. A more common way to appeal to students is to lower the grades for entry. At its most devious, this takes the form of offers which do not require the applicant to achieve any grades at all, provided they make the university their first choice.

4. A very good description of today's start-up and technovation world,

WeWork tries to “elevate the world’s consciousness”. Or the company’s claim that it has a market opportunity of $3tn. This is precisely the sort of overconfidence that led Lyft to claim it was part of one of the biggest societal shifts since the invention of the car, and Uber to say flying taxis will soon be in the air, while suggesting it was targeting a $12tn market, including the money consumers spend in restaurants. Hype is one of the tech sector’s most magical qualities. Why under-promise when the financial success of the best bets has been so extraordinary? Tesla’s prediction of robo-taxis has the added bonus of making its forecast for driverless cars seem achievable. Uber’s gargantuan addressable market makes its own valuation look more sane. Much is made of the fact that Lyft and Uber shares trade below the price at which they listed. Less about the fact that two lossmaking companies with no clear path to breaking even are still valued at $16bn and $59bn, respectively. True believers are not limited to start-ups. At an Amazon conference earlier this year, I sat beside a man whose business card told me that he was chief evangelist of Amazon Web Services. Grandiosity makes sense in an industry that often has to generate excitement and funding before products even exist.

5. Interesting inferences here and here on Reliance Industries decision to pare down all its debts. In its latest AGM, the company announced the end of its 7 year $100 bn investment cycle in refining, petrochemicals, telecoms, and retail and a commitment to become a zero-debt company in 18 months.  Andy Mukherjee asks very relevant questions,

While a breather after such frenzied activity may be understandable, why does he want Reliance to be a zero-net-debt company in 18 months? What will it mean for the more than 100 banks and financial institutions around the world that provide India’s largest company and its subsidiaries with billions of dollars – and yen, and rupees – in financing and refinancing? Above all, what will Reliance’s deleveraging mean for India?... in October 2016 Reliance was shouldering 13% to 14% of the entire investment by India’s top 1,250 listed companies as well as Indian Railways and state-owned electricity boards... The rest of India Inc. is paralyzed by debt and self-doubt; consumers are overstretched; and so is the government. A holiday for Reliance would remove from play the only domestic balance sheet with unspent firepower.

Whatever the motivations and reasons, it will clearly take out one of the biggest sources of investment demand away from the market exactly at a time when the economy needs it the most.

6. This blog has long held the view that technology firms benefit from regulatory arbitrage that allows them to socialise a significant share of their costs, which normal brick-and-mortar firms are expected to internalise. 

Sample this from a WSJ investigation,

Many of the millions of people who shop on Amazon.com see it as if it were an American big-box store, a retailer with goods deemed safe enough for customers. In practice, Amazon has increasingly evolved like a flea market. It exercises limited oversight over items listed by millions of third-party sellers, many of them anonymous, many in China, some offering scant information. A Wall Street Journal investigation found 4,152 items for sale on Amazon.com Inc.’s site that have been declared unsafe by federal agencies, are deceptively labeled or are banned by federal regulators—items that big-box retailers’ policies would bar from their shelves. Among those items, at least 2,000 listings for toys and medications lacked warnings about health risks to children. The Journal identified at least 157 items for sale that Amazon had said it banned, including sleeping mats the Food and Drug Administration warns can suffocate infants. The Journal commissioned tests of 10 children’s products it bought on Amazon, many promoted as “Amazon’s Choice.” Four failed tests based on federal safety standards, according to the testing company, including one with lead levels that exceeded federal limits. Of the 4,152 products the Journal identified, 46% were listed as shipping from Amazon warehouses...

Amazon’s struggle to police its site adds to the mounting evidence that America’s tech giants have lost control of their massive platforms—or decline to control them. This is emerging as among the companies’ biggest challenges. Amazon, Facebook Inc., Twitter Inc., Alphabet Inc. ’s YouTube and others are under scrutiny over how they wield their dominance in booming internet markets while their forums are used for fraudulent listings, offensive content and misinformation—including some spread during America’s 2016 elections... Amazon’s common legal defense in safety disputes over third-party sales is that it is not the seller and so can’t be responsible under state statutes that let consumers sue retailers. Amazon also says that, as a provider of an online forum, it is protected by the law—Section 230 of the Communications Decency Act of 1996—that shields internet platforms from liability for what others post there. This is similar to a common defense by internet companies faced with complaints about content or services offered on their platforms. Courts and regulators have largely agreed—until recently...

Third-party sellers are crucial to Amazon because their sales have exploded—to nearly 60% of physical merchandise sales in 2018 from 30% a decade ago, Amazon says. The site had 2.5 million merchants with items for sale at the end of 2018, estimates e-commerce-intelligence firm Marketplace Pulse. Amazon doesn’t make it easy for customers to see that many products aren’t sold by the company. Many third-party items the Journal examined were listed as Amazon Prime eligible and sold through the Fulfillment by Amazon program, which generally ships items from Amazon warehouses in Amazon-branded boxes. The actual seller’s name appeared only in small print on the listing page...

In contrast, Walmart Inc. requires all products on store shelves be tested at approved labs, company documents show. Target says it requires suppliers of store-branded products to undergo additional inspections and testing beyond government standards. Target and Walmart have created online marketplaces for third parties to sell directly to consumers. Target’s site, launched earlier this year with several sellers, is invitation-only. Walmart had around 22,000 sellers at the end of 2018, according to Marketplace Pulse. It requires an application that can take days for approval, and only a fraction of merchants applying make it through the vetting, says a person familiar with Walmart’s policy.

We're all Japan now!

As the bond market rally continues unabated, yields are touching historic lows. The yields of Bloomberg Barclays Multiverse Index, the broadest bond market gauge that tracks more than $58 trillion of debt is nearing the all-time low of 1.4% touched in 2016.

The FT also has this nice graphic that points to a bond market "yield drought"!

Underlining the trend, Germany just sold 30 year bonds at slightly negative yield - it sold €824 million ($914 million) worth bonds that pay no interest, at slightly above face value, so when they mature in 2050, Germany will pay back €795 million. The logic as an FT editorial writes is pretty compelling,

Buying longer-dated, negative-yielding debt makes sense for pension and insurance funds matching assets to future liabilities. Paying to lend money to governments is also profitable — if a year later investors pay even more for the privilege. Thirty-year Bunds bought 12 months ago have generated returns totalling more than 30 per cent. Returns on Amazon shares were flat in euro terms over the same period. The German Dax share index lost 5 per cent. Repeating that performance would require a further percentage point fall in 30-year yields, says Bank of America. Scarily, that is not ridiculous. US president Donald Trump wants the US Federal Reserve to slash its benchmark interest rates. Other central banks would have to follow. Global trade wars and Brexit could give them cover. Supplies of German Bunds are limited, pushing prices up and yields down.

In many ways, the global bond market mirrors what Japan has been going through for the past two decades - howsoever low it gets, it never ends. We're all Japan now!

Update 1 (24.08.2019)

The upshot of this is also the massive risks it poses to the financial system from a future rise in bond yields, the duration risk. Sample this FT assessment,

Diversified investment portfolios have benefited from the tailwinds of the bond rally. A global index of government bonds, for example, has returned some 8 per cent over the past 12 months, compared with a drop of 2 per cent for the FTSE All World stock index. An index of US Treasury bonds with a maturity of more than 20 years has appreciated by more than one-fifth this year alone, with price performance enhanced by the August grab for long-dated paper... "At ultra-low bond yields, the risk of owning bonds converges with the risk of owning equities. The short-term potential for capital appreciation — nominal or real — diminishes, while the potential for vicious losses increases dramatically.’’ The financial system is thus left exposed to any abrupt rise in bond yields while having little scope for strong price appreciation, given the extreme moves that already reflect plenty of bleak growth and inflation data down the road. What should really worry people is how a prolonged episode of negative and lower-yielding government bonds intensifies the challenges facing bank profitability. There are also red flags fluttering over valuations for pension funds and the viability of insurers, as bond coupons shrink. Herein resides ammunition for the next episode of financial market distress, which played a major role in torpedoing the global economy in 2001 and 2008.

NEXT and outcomes-based policy making

The recently passed National Medical Commission (NMC) Act in India has an interesting provision for a common National Exit Test (NEXT) to certify medical students for successful completion of their basic graduation course and license them to practice medicine as well as admission to post-graduate courses. The government also claims that the Act will dispense with the elaborate system of regulations and inspections that the Medical Council of India (MCI) undertakes that had become a source of rampant corruption.

The underlying presumption is that instead of validating  adherence to procedural requirements by medical colleges, focus on certifying the quality of graduates being trained. In other words, focus on capturing the outcomes. Why fuss on regulations and inspections with their messy administration and governance challenges when we can just monitor the quality of exiting students?

This resonates strongly with the logically appealing narrative of outcomes-based policy making, one of the prevailing fads in international development. There is something neat about this - just define outcomes, and leap-frog the messy procedural and governance challenges that have bogged us down for decades.

My own thinking on it has evolved considerably over the past decade or so, and today I am less convinced about neat outcomes-based policies. Accordingly, I have blogged earlier about why outcomes-based policies, especially on complex issues, while deceptively alluring, but are most likely to disappoint. See this, this, this and this.

The stakes are too high, the political economy too complex, and the eco-system constraints too onerous for a NEXT to achieve its desired objective in such a simple manner. For a start, the nature of NEXT itself poses massive implementation challenges. For NEXT to be meaningful, it will have to go beyond the easily administrable Multiple Choice Questions (MCQs) and involve qualitative assessment, including for clinical judgement skills. Unlike MCQs, such testing has too many moving parts, thereby, increasing the likelihood of subversion, even with use of the best technologies. 

If the fidelity of the exam processes itself is not illegally subverted, then the nature of questions or the manner of its administration (the rules of the game) will be legally compromised. And if neither happens and NEXT forces the closure of many medical colleges, or results in failures of large numbers of students (especially those who have paid massive sums under the management quota), or abruptly denies the several influential people who want their children as doctors, then vulnerabilities will only accumulate inexorably. 

In any case, it is naive to expect a simple outcomes-tweak, howsoever rigorously monitored, to force the managements and systems of the 536 medical colleges to start adhering to all requirements in a manner that enables high-level graduate instruction. For there is also the issue of supply-side requirements. We under-estimate the physical infrastructure and personnel quality requirements as well as pedagogy approaches that are critical to ensuring quality in medical graduate instruction.  

Then there is the student feedstock quality itself - we have seen how NEET or JEE have been distorted by the entrance coaching institutions, thereby seriously undermining the quality of entrants into professional courses. NEXT coaching centres will inevitably spring up. Finally, there are the likely serious emergent anomalies and problems (say, those related to reservation etc) which are not easily addressed. Resolving all these take time and persistent effort.

This is not to reject NEXT, but only to qualify the requirements to achieve the objective. For the NEXT to stand any chance of success in ensuring good quality of medical graduates, the exit test has to be complemented with all the governance requisites - basic and easily verifiable eligibility requirements for the institutions (entrance examination, its physical and personnel infrastructure, and course modules), transparent and arms-length accreditation and periodic certification/ranking mechanism, and a light-touch regulator. There is no substitute for these latter requirements. And more than NEXT, it is this that would still remain the biggest challenge.

Admittedly, the details of the regulations on the NMC Act and its operationalisation, and how the NMC itself would acquit itself as a regulator are what would matter. The battle has only started. In many ways, even with NEXT, the main challenges to be overcome are pretty much the same that the erstwhile Indian Medical Council (IMC) failed to administer - governance and regulation.

The worst outcome would be to gloss over the more persistent governance and regulation battles and prematurely declare victory in the belief that the mere introduction of NEXT (even if implemented with high fidelity) would help achieve the objective of quality in medical graduation in India.

The Great Saudi Arabian fiction?

No, this is not from any fiction book. It is about Neom, the brand new city of the future being constructed at a cost of $500bn and covering 10,000 square miles of unknown and neglected rocky desert and empty coastline in north-west Saudi Arabia. It is the vanity project of the de facto ruler of the country, Mohammed Bin Salman (MBS). 

As the article writes, Neom involves several "leaps of faith", 

“This should be an automated city where we can watch everything,” Neom’s MBS-led founding board said, according to the documents—a city “where a computer can notify crimes without having to report them or where all citizens can be tracked.”... Neom aims to have “zero work/stress-related diseases,” with residents working at startups or companies like Amazon.com Inc., which Saudi officials are trying to lure with incentives like free energy and subsidized labor, according to the planning documents... Residents’ children would be schooled in the “leading education system on the planet,” with innovations like "hologram faculty"... Though Neom is surrounded by desert, it will have many farmers markets. Temperatures will be cooler than Dubai, the documents say, and moderated by “cloud seeding” to make it rain. Because they live in the city with the “highest GDP per capita,” the documents say, a resident could indulge in a fancy dinner; Neom aims to have the “highest rate of Michelin-starred restaurants per inhabitant.” To keep Neom safe, cameras, drones and facial-recognition technology will let Saudi intelligence services track everyone... Neom in a statement said the project is about “technology in all sectors such as mobility, livability, health and medical, all of which will ensure we are providing the most attractive living environment on the planet. Earlier this year, MBS issued a decree about an area called Silver Beach. “I want the sand to glow,” he said, according to two people familiar with the project. Engineers haven’t figured out a safe way to do it. Each night, he told underlings, a fleet of drones should create the illusion of a rising moon—crescent, half, full. “That’s what he wants this future to be,” a former executive said.

It is understandable to promote grandiose projects with some hyperbole. But this, even by any standards of grandeur, looks just plain ridiculous. The only beneficiaries from this would be western financiers, consultants, and construction contractors.

Is it the modern reprise of the historical tales of foolish king and conman/thief who try to trick him?