Urbanomics

Price variations in US healthcare market and the power of data visualization

noreply@blogger.com (gulzar) — Sat, 11 May 2013 15:47:00 +0000

Competitive markets deliver cost-effective health care? No, if evidence presented in the graphic from New Jersey on treatment of chronic obstructive pulmonary disease is to be believed.

In the same New York city area, a joint replacement surgery costs anywhere between $15000 and $155000! The variation in prices, over such a small area, is truly stunning. This variation is equally stark when procedure rates in the US are compared with those in other countries. A few weeks back Time carried a well researched story on the high health care costs in the US, which had this graphic.

The data on the variations in prices for the 100 commonest diagnosis related groups (DRGs), spanning 163,065 patients, charged by 3337 hospitals in 306 metropolitan areas in 2011 was recently released by the US Government's Centers for Medicare and Medicaid. The data is available here. Is there any more compelling evidence of a market failure? Health care is clearly not broccoli.

The Times has rendered the database in a superbly informative interactive infographic. Its cognitive appeal and user-friendliness is striking. It is also an excellent example of how appropriate rendition of "big data" can be transformational in bridging the "last mile gap" in awareness creation efforts. Such graphics present critical decision-support information (here, a very good representative metric, fee charged by the hospital for each DRG for both Medicare and non-Medicare patients, both compared with respective national averages) in a manner that resonates cognitively (it is mentally easier to compare hospitals when information is so presented, on a geographical plane) with its audience.

In this context, considerable academic research has been done in recent years on the impact of information dissemination on increasing the responsiveness of elected representatives, quality of learning outcomes in primary schools, girl child literacy, prices of farm products, and so on. In many respects, all these studies are merely regurgitating conventional wisdom. At a conceptual level, even before any such research, people at the cutting edge in each of these areas already knew that bridging information asymmetry can be transformative. But the challenge, and they also knew it all along, is in presenting it in a manner that would facilitate easy use by its targeted audience. The academic research, beyond validating conventional wisdom, does nothing to address that challenge.

Imagine having similar visualization in developing countries to help people shop for school admissions or buy insurance policies and savings instruments, parents know the learning trajectory of their child, farmers know the optimal farm-gate price for their produce, and so on. And also if this information can be made available on a mobile phone interface.

I strongly believe that the search for such solutions require a smart intersection of statistical analysis, data visualization techniques, communication technologies, and behavioral psychology. Given the inherently complex nature of these issues and co-ordination problems, the market is not likely to resolve this challenge. It requires a partnership between governments, large private foundations, non-government organizations, and private service providers. But governments have to take the lead in facilitating this partnership.

PS: In the US, even with the available information, in the absence of some form of regulation, the local market power of hospitals, the presence of an insurance intermediary, and the very nature of demand for health care services, will conspire to maintain the diverse price distribution.

Designing effective development program implementation

noreply@blogger.com (gulzar) — Fri, 03 May 2013 15:56:00 +0000

A collaborative approach to development program implementation that marries the consultant's problem solving skills with the academician's experimental research skills is the subject of my latest Governance Agenda column.

The "inflation dog" is locked up in bank vaults!

noreply@blogger.com (gulzar) — Tue, 30 Apr 2013 23:45:00 +0000

The IMF recently described inflation as the "dog that did not bark". It pointed to structural unemployment (which lowers competition in labor market and thereby attenuates deflation) and anchored inflation expectations (due to the high perceived inflation fighting credibility of central banks) as being responsible for muting both deflation and inflation.

There will obviously be disputes about how accurately this reflects the underlying reality - Alok Sheel has a good analysis of other equally compelling factors. Amidst all this speculation we forget that the extraordinary quantitative easing has left no signatures of inflation. This FRED graphic shows that in the US an exploding monetary base has been accompanied by relatively stagnant stock and velocity of M2 money.

And if we add consumer lending, commercial and industrial loans, and commercial paper to the M2 stock and monetary base, the underlying lack of demand becomes painfully obvious.

Atleast for the time being, the "inflation dog" appears safely locked up in the vaults of banks! But do I see the M2 stock inching up or is it just a squiggle?

Germany fact of the day

noreply@blogger.com (gulzar) — Fri, 19 Apr 2013 19:55:00 +0000

From a very good article by Edward Luce in FT which explores the attractions of German economic model as America grapples with stagnant or declining manufacturing and a crisis in its human skill development channels,

Germany channels roughly half of all high-school students into the vocational education stream from the age of 16. In the US that would be seen as too divisive, even un-American. More than 40 per cent of Germans become apprentices.

As America suffers a big unemployment crisis, with no end in sight, structural issues like skills mismatches have been blamed as being responsible,

Almost half of Americans with a degree are in jobs that do not require one... Fifteen per cent of taxi drivers in the US have a degree, up from 1 per cent in 1970. Likewise, 25 per cent of sales clerks are graduates, against 5 per cent in 1970. An astonishing 5 per cent of janitors now have a bachelor’s degree. They must offer endless nocturnal moments to repent those student loans.

Another PPP in renegotiations - Mysore Water Project

noreply@blogger.com (gulzar) — Mon, 15 Apr 2013 23:42:00 +0000

The Mysore Municipal Corporation's Rs 164 Cr PPP project to provide 24X7 water supply is the latest to fall victim to the curse of contract renegotiations. The Tata owned Jusco won the tender in November 2008 for a three-stage project, financed under the JNNURM, to rehabilitate the existing supply network, reduce non-revenue water, manage operation and maintenance, and deliver 24X7 water to the entire Mysore city over a six year period.

The project had three phases - preparation (1 year), rehabilitation (3 years), and O&M (2 years) - with clearly defined performance clauses. But now with rehabilitation period deadline having passed in January, just 61000 out of the 117000 services have been connected to the rehabilitated network and of them only 13000 have 24X7 supply. Now Jusco is seeking renegotiations. Livemint writes about the reasons,

First, Jusco found problems with the scope of the work defined in the project agreement. When the tripartite agreement was signed, the work was for laying a network of pipelines over 910km with 117,000 connections. During the initial survey done by Jusco, the length of the pipeline network that needs to be rehabilitated was found to be 1,910km with 1.74 lakh connections... With changes in the scope of the work, the estimated cost of the project shot up, and renegotiating became messy. The government does not have money to increase the cost of the project, and even if they did, it would lead to litigation... Jusco is in talks with the government to resolve the discrepancies in the initial surveys... The Planning Commission working group conceded in its report that the risk of data gaps is high and that guaranteeing performance is difficult if a project design is flawed.

I haven't read the Jusco contract document. But it is clear that Jusco is following the same script as the numerous failed or failing utility PPPs across the world. In all such PPPs, conventional wisdom would have it that the public agency should design the tender in a manner as to align incentives. The most favored design in such water supply rehabilitation and O&M contracts is Engineering Procurement Contracts (EPCs) where the bidders study the network and offer their quotes. These quotes are invariably based on an estimate of how much it would take to rehabilitate, operate and maintain the network for a period of time (Jusco may not be an exact form of this). It is reasoned that this project design will align incentives and encourage bidders to adopt the most optimal rehabilitation and O&M plans and leverage the latest technology, thereby lowering costs and raising efficiency.

However in the real world, this approach rarely ever works, especially for utilities where massive legacy systems dominate. Even with the most comprehensive upfront surveys, baseline information collection, and O&M plans, it is impossible to reliably estimate the cost of any such project. In all such projects, the rehabilitation costs generally emerge in unpredictable manner, as the project work starts. Tailoring an incentive compatible contract becomes an imposing challenge.

In the circumstances, and especially when faced with competition, a market failure ensues. The bidders, eager to be the first-mover in an emerging market with great long-term potential, invariably under-estimate the costs and bid aggressively. Renegotiations are a fait-accompli. In fact, the window of renegotiations serve to generate the moral hazard that drives aggressive bidding. I am not aware of even a single such project which has been successful.

There are no easy solutions. The legacy risks inherent in rehabilitation of existing networks cannot be borne by private operators. It has to be dealt separate from O&M. Its entrustment to private operators poses the aforementioned difficulties. However, once the rehabilitation is done, the performance contracts to monitor O&M is a much more tractable and realistic window to bring in private capital, management, and technology.

Is India's power crisis, also a case of foreign policy failure?

noreply@blogger.com (gulzar) — Tue, 09 Apr 2013 23:55:00 +0000

In 2010 the Indonesian government decided to annually benchmark all coal exports to international market price and also announced the levy of higher royalty and income tax on these exports. It has adversely affected the operationalization of 20000 MW of power capacity addition projects in India, including two of the Ultra Mega Power Plants (UMPPs). In 2012, Indonesia accounted for 79% of all thermal coal imports, of which 93% were made by private generators.

One could take the view that these projects were awarded to private generators through global open competitive bidding and it was their responsibility to have hedged for such risks. But, given the strategic nature of these economic transactions, there is a compelling case for the government's close involvement in such transactions. In other words, shouldn't all such transactions, private and public, which impinge on India's energy security be facilitate and underpinned by the umbrella of India's strategic diplomacy?

If one were to step back and analyze this, certain important questions arise. When the private generators were aggressively pursuing coal mines acquisitions in Indonesia in mid-2000 and developing large country-risk exposure, how actively was the government engaged with the process? Did this form an important part of India's diplomatic engagement with Indonesia? Couldn't we have got early warning signals about the impending policy change and advised power regulators and private generators accordingly? Once the Indonesian government announced its policy, what could have been done to mitigate its adverse impact on India's power generation program?

In the years ahead, given India's ambitious infrastructure upgradation targets, our country-risk exposure in strategic minerals, oil, and gas will increase dramatically. The increasingly widespread trend of resource nationalizations means that expropriation risks are very high in these sectors. We cannot afford to leave such risks in the hands of the private sector, who are in no position to hedge against them. It requires active, often aggressive, support from India's foreign policy establishment.

Corporate India's Woes

noreply@blogger.com (gulzar) — Mon, 08 Apr 2013 22:29:00 +0000

I was struck by this graphic of the changes in the distribution of ratings of India's business firms done by CRISIL. In many ways, it is a nice reflection of the fortunes of corporate India during the period. Clearly ratings downgrades continue to outnumber upgrades.

Construction and infrastructure sector firms are the worst affected, with the highest ratings downgrades and corporate debt restructurings. The graphic shows that a very high proportion of firms from these sector have suffered ratings downgrades and their credit ratio (ratio of upgrades to downgrades) is extremely low.

Thanks to declining economic growth, project delays, cost over-runs, high interest rates, and slow revenues growth, total restructured loans crossed Rs. 2.27 trillion, or 4.4% of the total loans given by Indian banks, and is rising. This may be an underestimate given the bilateral restructurings and the true estimate may be around Rs 4 trillion. Iron and Steel (23%), infrastructure (9.65%) and power (8.13%) were top of the pile in the Rs 77,101 Cr worth loans restructured in 2012-13.

Moral hazard from CERC ruling is a reflection of India's corporate culture

noreply@blogger.com (gulzar) — Thu, 04 Apr 2013 22:53:00 +0000

India's Central Electricity Regulatory Commission (CERC) has ruled in favor of a bailout to Adani Power for its 4260 MW UMPP to offset the losses on account of the unexpected increase in the prices of coal imported from Indonesia. It has agreed for a "compensatory tariff" to allow the developer to pass-through the fuel price increase.

In 2007, in a Case I bid, Adani Power had won the global bid to supply power to Gujarat Urja Vikas Nigam Lt (GUVNL), and in 2008 to Haryana's Uttar Haryana Bijli Vitaran Nigam Ltd (UHBVNL) and Dakshin Haryana Bijli Vitaran Nigam Ltd (DHBVNL). The PPAs signed with Gujarat government was to supply 1000 MW each at a levellized tariff of Rs 2.35 per unit and Rs 2.89 per unit respectively, and with Haryana government for 1424 MW at Rs 2.94 per unit. The buyers, Gujarat and Haryana, had refused to bear the fuel supply risk and offered the bidders the option to quote an "escalable" component to hedge fuel risk. But Adani, bidding aggressively, offered a nil tariff on this head.

The present problem arose when in 2010 the Indonesian government suddenly superseded all long-term coal export contracts and started levying higher royalty and taxes, reasoning that all exports should be bench-marked to international market rates. Many power generators in India, including Adani, Reliance Power and Tata for their UMPP, clearly overlooked this risk and bid aggressively offering very low levellized tariffs.

The CERC has now allowed Adani Power to temporarily charge a higher tariff but directed the generator and the buyer state governments to sit down and arrive at a mutually agreeable long-term tariff rate. The dissenting CERC member, Mr Jayaraman has raised several very valid issues in his dissent note. In this context, here are a few more observations

1. The moral hazard concerns arising from this decision are quite obvious. In this case, the developer clearly ignored the option of bidding with an "escalable" fuel price and bid very low with the intention of bagging the contract. It is not a stretch to believe that this aggressive bid was driven by the firm belief that they could re-negotiate their way out if the discounted risks surfaced. Clearly, the central principle of a transparent competitive bidding process was compromised. Whatever spin one gives it, the CERC ruling will only exacerbate the moral hazard. This becomes a matter of great concern given the large number of power and other infrastructure projects proposed to be contracted out to private developers.

2. As the financial market bailouts and the resultant "too-big-to-fail" problems among big banks in US indicates, bailouts can quickly transmit and entrench moral hazard risks that socialize private losses. In the circumstances, it is imperative that the Power Ministry and regulator step in with measures that will atleast partially mitigate the moral hazard risks. Apart from other measures, the only effective way in which such risks can be mitigated is by making the bidder internalize some share of the social cost inflicted by his irresponsible bid. The CERC order is conspicuously silent on this. Is the Rs 1350 Cr of loss apparently accumulated by Adani Power going to be the penalty? Or is there some definite amount of liquidated damages that will be imposed? Or should some share of the profits from the merchant power sales from Mundra now be ploughed back to re-compensate the PPA consumers? Whatever the penalty, it is important to specify it upfront, since it would carry considerable signalling effect on potential bidders and thereby contribute to mitigating the moral hazard unleashed.

3. The CERC directive to re-negotiate a mutually agreeable tariff is filled with several dangers. Discretionary decisions on such matters are very likely to benefit the private developer at the cost of the consumers. Since a number of other generators will now invoke the precedent to seek renegotiation for similar "compensatory tariffs", it is important that the CERC issue clear guidelines that guide any re-negotiation process.

4. Further, if it is a wholesale re-negotiation, then we need to explore a formal bankruptcy of the existing promoters. It may be even worth exploring the possibility that the project entity be taken into a form of temporary receivership and then ownership resolved through a formal process. After all the worst scenario from the moral hazard perspective would be for the project to be renegotiated on commercially attractive terms with the same developer who would escape with a small one-time penalty. That would be a recipe for similar irresponsibility in bidding and seriously undermine India's massive infrastructure investment ambitions.

5. This is a strong reminder on the need for adequately mitigating commercial risks on projects of such long-term nature and the adage that "risk allocation should be to those who can bear it best". In the euphoria surrounding PPPs, in the guise of aligning incentives, mainstream debates have encouraged governments to structure contracts in a manner that bundles such non-diversifiable risks on the private promoter. The private sector has most often played along, in the firm belief that they could escape through re-negotiations. Fuel price pass-through should be mandatory in all power generation contracts. Similarly, foreign exchange risks should be a mandatory pass-through in contracts with import requirements.

6. Another issue that needs to be examined is the contract based on which Adani Power purchases coal from Indonesia. This is because the Indonesian government order only says that exports can be done at international prices and does not expropriate foreign ownership of the mine. In other words, if the Adani Power has a 74% ownership of the mine, there is a strong possibility that, as the dissenting member in the CERC order wrote, "the Adani Group as a whole may be the ultimate beneficiary of the Indonesian regulations". In fact, as this Mint report writes, if we take a holistic view of the ownership of the coal mine and the power plant, the net cash flows would be affected only to the extent of additional royalty and tax payments.

7. Finally, this and others that I have blogged here, here, here, and here about recently are an accurate reflection of the irresponsible and even predatory nature of India's high-corporate culture. When they were formulated, the UMPP tender documents were acclaimed. It provided an elaborate formula, using a diverse basket of domestic and international indices, to allow the bidder to pass-through any increases in fuel prices. And, by allowing for both fuelprice escalation and fixed price bids, it followed the principles of a classic textbook bidding mechanism. In the circumstances, it is easy to blame the government, as is the wont now on anything, without shining the torchlight on corporate India.

Update 1 (5/4/2013)

As if to underline the issue of cross-ownership of mines and power company, Tata Power decided to transfer its 75% share in Indonesian mines to fully owned subsidiary Coastal Gujarat Power Ltd (CGPL), which runs the Mundra Project. This is to ensure that the cash flows of CGPL is not heavily squeezed by the tariff problem. In 2007, Tata Power had bought a 30% stake in Indonesian mining company PT Bumi Resources and inked long-term contracts for supply of coal to Mundra project.

It would have been logical to have the ownership integrated with CGPL from the beginning. But firms resort to such cross-holdings to minimize tax exposures as well as to maximize profitability of their investments. In the event of re-negotiations, it is important that all such cross-holdings be removed and costs internalized to the fullest extent possible.

Monetizing project assets

noreply@blogger.com (gulzar) — Wed, 03 Apr 2013 03:08:00 +0000

The Hindu reports that IVRCL Ltd has signed an agreement with TRIL Roads Private Ltd (TRPL), a TATA enterprise, to divest its stake in three highway projects - Salem Tollways Ltd (STL), Kumarapalayam Tollways Ltd (KTL) and IVRCL Chengapally Tollways Ltd (ICTL) - with a total project cost of Rs 2200 Cr and monetize these BOT assets.

STL had commenced commercial operations on the 53 km stretch of NH-47 from Salem to Kumarapalayam in Tamil Nadu from June 2010, KTL was operating another 47 km stretch on the same highway from Kumarapalayam to Chengapally from August 2009, and ICTL is planning to commence commercial operations on 54.83 km stretch of NH-47 from Chengapalli to Walayar via Coimbatore in the first half of 2013-14.

I have two observations on this practice.

1. As India sets out on its massive $1 trillion infrastructure investment plan for the 12th Plan period, monetization of infrastructure assets is an attractive proposition. It frees up the balance sheet of infrastructure construction firms to take up newer projects. However, it is important that there be a sufficiently developed market in the management of the assets that are being monetized. Apart from outright sale, monetization can be done by securitizing the project asset either in the bond market or in equity market.

2. A more important issue is what happens to the original financial structuring of a PPP project once its financing pattern is changed. For example, in BOT toll roads, the financial structuring is generally done on a 70-30 or 80-20 debt-to-equity model with 16-20% return to equity for a 25-30 year period. But once the construction and commissioning risks are off-loaded and the project asset transacted, it is certain to attract debt at much lower rate and allow for much higher debt-to-equity ratios. In other words, while the project cash flows remain unaffected by the changes in ownership pattern, its cost of financing comes down. This invariably benefits the original developer who, as with IVRCL, would either dilute his equity or even exit, and pocket a handsome rent in the process.

I have blogged about this practice earlier. The British infrastructure regulation expert Dieter Helm has documented this trend in British government's concession agreements. He believes that it is costing the government atleast one billion pounds annually in funds siphoned away by enterprising concessionaires who dilute or divest their equity stakes for more debt.

China Vs India banking fact of the day

noreply@blogger.com (gulzar) — Mon, 01 Apr 2013 01:13:00 +0000

India’s commercial banking system has assets of about $1.5tn, according to the Reserve Bank of India, less than those held by any one of the four largest Chinese banks.

(HT: FT)

Scary Charts - European Edition

noreply@blogger.com (gulzar) — Fri, 29 Mar 2013 20:30:00 +0000

Here are three scary charts about Europe. The scariest comes from three BofA economists, via Wonkblog, which carries the output growth projections. Even the optimistic projections look bleak for Italy and France, and positively catastrophic for Spain.

Zero Hedge points to the rapidly declining bank deposits in the PIIGS and Cyprus (which will soon fall sharply). The crisis is certain to leave deep scars in the banking sector of the peripheral economies.

Youth unemployment in Greece and Spain is at shockingly high level, well above 50% and rising. For the Euro-zone as a whole it was 23.8%.

Competition and market failures

noreply@blogger.com (gulzar) — Thu, 28 Mar 2013 02:06:00 +0000

Econ 101 teaches us that market competition, by enabling efficient price discovery, results in win-win outcomes for both producers and consumers. Alternatively, in the absence of competitive dynamics, markets fail to take off, leaving both consumers and producers worse off.

In this context, this article from FT about the contrasting fates of US and European telecoms market is instructive. It is considered an efficient practice in utility infrastructure to force the network asset owner to share it with competitors for a prescribed fee, most often determined by the sector regulator. This is thought to lower entry costs in such capital intensive sectors and thereby stimulate competition. Accordingly, the India's Electricity Act of 2003 provides for mandatory "open access" of the distribution and transmission network owned by state-owned entities for a fee to private firms for transmitting and distributing their power.

The same logic has been applied to unbundling of telecommunication networks. However, even as the European Union aggressively pushed through unbundling in the late nineties, it failed to pass legal challenges in the US. Accordingly, while European network owners were forced to share with their competitors the local loop part of their networks that connect to customers, the US carriers managed to maintain exclusivity and retain entry barriers. If the logic of Econ 101 held, then lower entry barriers and resultant competitive pressures would have boosted the European telecoms market while the absence of the same would have weakened the US market. But the fortunes have been reversed, as the FT writes,

Unbundling has been the single biggest difference between the regulatory environments in the US and Europe over the past decade. The idea was first taken up in the US in the mid-1990s, though the established American carriers managed to block the idea in the courts a decade ago. Their peers in Europe had no such avenue for appeal, forcing them to give new rivals low-cost access to the local loop part of their networks to reach customers. The result: more competition, lower prices and dwindling cash flow. That has been a boon to consumers but, along with the slumping economy, has left network companies badly positioned to finance the next round of network-building.

The contrast with the US could hardly be starker. Over the past five years, the operating cash flow of AT&T and Verizon has risen by a fifth, even as cash flow of the main European players has dwindled. As a result, shares in the two dominant US carriers have risen by more than half since the financial crisis, while their European counterparts have slumped, denting their ability to finance upgrades.

In other words, competition has resulted in market failure. Instead of the "more competition, lower prices, more consumers, more profits, and network expansion", the real-world outcome has been "more competition, lower prices and dwindling cash flow".

The fate of European telecoms market is not an isolated example. Much the same market failures have been a characteristic features of telecoms and airline deregulation in India. In fact, India's telecoms market has evolved in a manner that would have pleased a Chicago economist, but is now facing serious troubles. Instead of the expected win-win outcomes, lower entry barriers and cut-throat competition in both sectors have ended up devastating operators. While consumers have undoubtedly benefited from the lower prices, operators are left without resources to finance expansion and technology upgradation.

This is yet another real-world example of how perfect competition often fails to yield the expected outcomes. In all these markets, once entry barriers get lowered, the size of the market and its long-term potential makes it irresistible for competitors to indulge in price wars. As with winners curse in auctions, such price wars invariably result in a race to the bottom.

The point here is not to convey that competition or deregulation is not desirable, but to caution against any unqualified support for such measures. The dynamics of the market is far too nuanced to be explained away by simplified "invisible-hand" reasoning.

India's labor productivity problem

noreply@blogger.com (gulzar) — Mon, 25 Mar 2013 21:38:00 +0000

India's share of population employed in agriculture has fallen sharply from 60% in 2000 to 51% in 2010 and the pace of decline is set to quicken in the coming years. In addition to transitioning those leaving agriculture, there is the need to accommodate the nearly 12 million people who are expected to join the workforce each year. In most historical examples of such growth transitions in developing countries, industries sector has provided the major share of new employment opportunities.

However, as the Economic Survey 2012-13 highlights, recent trends in industrial employment creation in India has been cause of concern. Even if industry's share of total employment has been comparable to other large Asian countries at similar stage of their growth, its share of gross value added has remained more or less stagnant over the last decade and is far less than that in other countries.

The main reason for this near stagnant share of industrial sector value addition is the low productivity in the sector. This becomes especially pronounced since construction, where most employment is in the informal sector and involves mostly unskilled and semi-skilled workers, has been the fastest growing segment within industry.

In fact, this low productivity trap extends to informal sector economic activity in general. The value addition by a worker in the informal sector is only a small proportion of that in the formal sector for workers in similarly sized firms.

PPP with public finance?

noreply@blogger.com (gulzar) — Sat, 23 Mar 2013 01:57:00 +0000

The obvious attraction of Public Private Partnerships (PPPs) is that it leverages private capital to provide public goods, thereby relieving public finances of atleast some burden. However, an analysis of India's PPP financing reveals that the "private" capital comes mainly from public sources. A 2008 World Bank note had this assessment of the sources of PPP financing,

In 1995–2007 senior debt accounted for 68 percent of project financing on average. The rest took the form of equity (25 percent), subordinated debt (3 percent), and government grants (4 percent), typically “viability gap” grants provided during construction to PPPs deemed economically desirable but not financially viable. Of the senior debt, about 70 percent was provided by commercial banks, four-fifths of this by public sector banks. The rest of the total debt financing came from institutional lenders (around 23 percent), with 5 percent provided by the International Finance Corporation. Bond markets were used sparingly. The use of subordinated debt also remains limited... In recent years the role of senior debt has grown while the share of equity has declined, leading to rising debt-equity ratios

The biggest concerns are the limited role played by bond markets and foreign capital, the two most desired forms of private capital. Another important concern is that the largest source of funding, forming nearly 50% of the total financing, is public sector banks. To put the problem in its perspective, in 2009 bank credit to infrastructure was Rs 2699 billion while the amount raised by corporate bonds was a mere Rs 5.4 billion. These go against the trend in developed and most other developing countries, where private sources and bond markets are the biggest source of capital. India's PPP financing pattern effectively becomes a case of "backdoor public financing".

These trends persist even today. The share of bank finance extended to infrastructure sector as a share of total bank finance has grown from 2.2% in 2001 to 13.4% in 2011. Most banks have reached or are close to their upper limits on infrastructure lending. Given the long-term nature of these loans, asset-liability mismatches are showing up in the balance sheets of all banks. Further, given the environment of crony capitalism that has enveloped larges swathes of the economy in recent years, especially in rent-thick infrastructure sectors, it may not be a surprise if significant share of the loans from public sectors banks are of questionable nature like this.

While debt-equity ratios have been consistently rising on the back of increased willingness of banks to give commercial loans, there may be some cause for concern with the trend of using the Government of India's viability gap funding as a form of equity,

While the evidence is inconclusive, there are some indications that lenders and developers view grants as substituting for the equity infusion needed during construction. The few projects involving a negative grant—a payment by the PPP to the government—also have a higher ratio of senior debt to equity, suggesting that these payments are being financed by debt borrowed by the PPP project.

Placing the de-worming story in its perspective

noreply@blogger.com (gulzar) — Wed, 20 Mar 2013 13:29:00 +0000

De-worming has been the poster child of the randomized control trial (RCT) movement in development economics. Its obvious simplicity and cost-effectiveness, apparently validated by numerous RCTs across Asia and Africa, has been highlighted as proof of what evidence-based development policy making can achieve. No serious discussion on evidence-based policy making is today complete without some mention of de-worming. So much so that crusaders are now out to "deworm the world".

In this context, the latest issue of Lancet (pdf here) has some unsettling truths. An RCT of 72 blocks in Uttar Pradesh in India over a period of 5 years, covering over 5000 children in 1-6 year group, conducted by medical scientists, finds that "regular deworming had little effect on child mortality". The randomization was done at the block level, with 4158 ICDS's anganwadi centers in 36 blocks receiving Albendezole tablets twice a year.

Though the main objective of the study was to explore the effect of de-worming on child mortality, its findings on other physical health parameters carry relevance in light of claims made by RCTs done by economists. The graphic below shows that on a host of physical - height, weight, BMI, haemoglobin level - and illness prevalence parameters, there is no statistically significant difference between the treatment and control groups of children. Furthermore, this finding comes despite the treatment almost halving the prevalence of worm infection.

Furthermore, the authors compare the physical health parameters between infected and non-infected students within the control group ICDS centers and report similar findings. In fact, for all worm categories, there is no statistically significant difference in health outcomes between the infected and non-infected child populations.

The main case of the supporters of de-worming is that it prevents students from falling sick frequently and thereby increase their school attendance days. But this study questions the presumption that it contributes to significant health improvements or reduce other disease incidence. Even where worm infection has been halved, it appears to not have contributed to any increase in general physical well-being and lowering of other disease incidence. If this true, how does it square up with the claims of the de-wormers that school attendance increased because of improving child health outcomes and resultant lowering of disease incidence?

The authors of the study qualify their findings to "lightly infected" areas, which are more likely in rural areas. But this leads us to what is a "high infection" rate? The "de-worming crusaders" themselves report incidence rates at 16% for Delhi slums and 14% for Andhra Pradesh. But this is just half the incidence rate of the "lightly infected" areas in the present study. Other studies of Kathmandu and Assam, two areas one would suspect of being "high incidence", too point to worm infection rates of 10-25%. If this infection range can be generalized across most of developing Asia, then the findings of the present study becomes immediately relevant.

Now, it is possible for the supporters of de-worming to quibble about the small details of any study and dig their heels in. But what cannot be denied is that contrary to anything they claim, there is no unqualified (or so obviously clear) case for universal and prioritized adoption of de-worming on the highfalutin grounds that it is the most cost-effective intervention to improve student attendance.

Further, as I have already blogged here, the definition of what constitutes "cost-effectiveness" is certainly flawed. A more appropriate frame of reference for judging "cost-effectiveness" would be the "implementation bandwidth" of public systems. Supporters of de-worming overlook the fact that the limited "implementation bandwidth" of any public system would invariably result in this intervention squeezing the implementation space for all other programs.

None of this is to decry or oppose the idea of de-worming. This is only an attempt to temper the claims around de-worming and locate it in its true perspective. It is a note of caution to the prevailing trend of squeezing the last ounce of "academic juice" from a fairly commonplace intervention. In that sense, this post is deliberately written to be similarly provocative, though in the opposite direction, as the "de-worming crusaders".

Promotion of air-connectivity to remote areas

noreply@blogger.com (gulzar) — Tue, 19 Mar 2013 01:25:00 +0000

India's civil aviation ministry is considering two proposals - a direct subsidy and a market-based seat-credit trading mechanism among airlines - to boost air connectivity to less-developed markets and remote areas of the country.

The current Route Dispersal Guidelines of the Civil Aviation Ministry mandates all scheduled operators to deploy atleast 10% of their trunk-route capacity on flights to less well-served areas, or so-called category II routes (like northeast, J&K, Andaman, Lakshadweep), and 50% of trunk-route capacity on Category III routes (smaller towns like Coimbatore).

Under the seat-credit trading mechanism, all airlines would be allotted a minimum number of mandatory remote areas connection requirements. Airlines could meet their connectivity deficit by purchasing seat-credits from other airlines who have already met their requirements. Livemint writes,

Under the ministry’s proposed seat-credit mechanism, small air taxi operators can fly to a particular small city destination and earn seat credit that can be sold to a scheduled airline such as Jet Airways or SpiceJet. The bigger carriers will be able to use such credits to meet their requirement of having to connect such remote areas without having to lose money on such operations.

It is reasoned that the seat-credit trading would incentivize small regional air-taxi operators with smaller airplanes to service the small town airports, leaving the more established operators with their regular sized aircrafts to service the bigger towns. The operators themselves or the government would have to establish an exchange which would facilitate efficient price-discovery and trading of seat-credits.

An alternative to the seat-credit trading mechanism is a proposal to encourage regular airlines service the 80 Category-III towns by offering them a subsidy and a monopoly over the route for 2-3 years. The routes could be auctioned off to the airline that would bid for it at the least subsidy. The subsidy would be paid from an Essential Air Services Fund, mobilized from a combination of budgetary grant and a cess on the major route tickets.

Though both these are interesting proposals, it may not be possible to make definitive judgements in favor of either given the complex nature of airline markets in extremely price-sensitive countries like India. However, I am inclined to the latter for the following reasons

1. A direct subsidy suffers from much less information asymmetry. The reverse auction will help transparently and efficiently (atleast better than anything else) identify the amount of subsidy. Once this is done, it is much more easier to administer than the seat-credit trading mechanism. Further, such a subsidy support is likely to help establish the market and also facilitate the integration of these markets to the mainstream. A seats-credit sharing would merely exacerbate the existing market stratification of these areas.

Typically, some risk insurance or viability gap financing is necessary to break open any such market and only governments can finance this. In other words, given the inevitability of such a subsidy support, a reverse auction based direct subsidy may be the least distortionary and most cost-effective subsidy transfer design.

2. The seat-credits model does little to address consumer welfare. Relative to the larger airlines, the smaller air-taxi operators (unless some large players emerge) will have neither the incentive nor the capability to pass on the benefits of an expanding market by way of lower ticket prices. Given the risks involved, it is difficult to imagine airlines operating exclusively on these routes ever acquiring the balance-sheet cushion to lower prices in any meaningful (read market-creating) manner.

3. Lower prices can contribute to sharply increasing volumes, which in turn enables operators to benefit from economies of scale. In the absence of lower prices, these price-sensitive markets are likely to remain stuck up in a low-volume equilibrium. The fact that the seat-credit trading mechanism physically divides the market into two parts, with different operators and their business models, makes a low-level equilibrium a strong likelihood.

4. Finally, there is the Achilles Heel of all trading mechanisms - the initial allocation of mandatory remote-areas connections requirements to each airline. In the absence of a satisfactory process to discover an efficient initial allocation, airlines are more likely to get away with smaller quotas that would be easily met by purchasing from the existing air taxi operators. An efficient initial allocation would have to based on an estimate of the traffic growth in these nascent markets, a highly unreliable exercise at most times. There is also the danger that the seat-credits would end up subsidizing the air taxi operator's traffic expansion that would have happened anyways in the business as usual conditions. As with all such discretionary decisions, corruption can never be far away.

The African Bond Bubble?

noreply@blogger.com (gulzar) — Sun, 17 Mar 2013 14:00:00 +0000

The FT reports of a number of sub-Saharan African countries rushing to raise foreign currency denominated debt. In September 2012, in a heavily overs-subscribed offering, Zambia raised $750 million as 10 year dollar denominated debt at an yield of 5.625%, lower than Spain sovereign bond yield at that time. Rwanda and Angola have announced plans to raise $350 m and $1 billion respectively, and Nigeria and Ghana too are expected to enter the market.

Unlike Latin America and Asia, Africa has had very few foreign currency denominated bond offerings. Currently, only 13 out of 54 African countries have issued foreign currency denominated debt. Multi-lateral and bilateral financing have formed more than three-quarters of external debts in Africa.

The current interest in emerging market debt has to be seen in light of the global liquidity glut engendered by the ultra-low interest rates in developed economies. With debt market yields hugging the bottom, investors have been looking at exotic markets in search of yields. Even the emerging market bond yields have been falling. Zambia was able to raise debt at such low rates despite its offering being rated "junk" (B+) by S&P.

Predictably, the number of African countries trying to raise foreign currency denominated sovereign debt has led to concerns about its repayment and the "original sin" of a Latin American style potential future debt crisis. The low rates does not tell anything about the risks posed by exchange rate volatility and the country's balance of payments (BoP) position. A depreciating currency would increase the effective repayment rates, while a weak BoP position would strain the repayment capacity.

Zambia, for example, is heavily reliant on Copper, which forms 80% of its export basket. Any volatility in exchange rates will therefore have dramatic effects on its real debt burden. Its currency has depreciated by over 40% against the US dollar since January 2008. Others are similarly exposed, with small variations, to commodity prices and therefore forex market volatility could potentially affect debt sustainability.

Given the widespread governance problems in all these countries, it is important that these debts are for clearly defined objectives. For example, debt raised to finance critical infrastructure investments are more likely to be effectively utilized and compensate the debt cost. In this context, multilateral loans for infrastructure projects can be dovetailed with foreign currency debt. The presence of the multi-lateral lender would not only increase expenditure side discipline, but also serve as a credit enhancement and contribute to lowering of the cost of debt.

The opportunity cost of India's subsidies and the foregone roads

noreply@blogger.com (gulzar) — Fri, 15 Mar 2013 09:00:00 +0000

Niranjan Rajadhyaksha writes in Mint,

The subsidy bill since fiscal year 2004 has grown nearly six times, far more than the growth in the underlying economy in nominal terms. The gross number is even starker: the two Manmohan Singh governments have spent a cumulative Rs.11.82 trillion on various subsidies over the past decade... Subsidies have crowded out spending on public goods. Just ask yourself what could have been built if at least half of those Rs.11 trillion had been redirected to build new infrastructure... building a kilometre of a good rural road costs about Rs.5 crore per km, which means that India has effectively given up around 20,000 km of new rural roads, assuming one-tenth of the subsidy spending since 2004 had been used to build new rural roads. One could come to similar conclusions about new schools or drinking water schemes or public toilets... Look at what China has built in the past five years: 19,700km of new rail lines, 609,000km of new roads or 31 airports.

I am in particular struck by the 20000 km new rural roads. This blog has consistently argued that all-weather roads and three-phase electricity supply are the two most effective anti-poverty and development interventions. Furthermore, the absence of all-weather roads attenuates the effectiveness and sustainability of any other development intervention, whereas its presence amplifies their long-term value.

Cost of monopoly profits - Mexican telecoms edition

noreply@blogger.com (gulzar) — Wed, 13 Mar 2013 23:06:00 +0000

An OECD review (pdf here) of the telecommunications policy and regulation in Mexico finds,

The OECD estimates that the lack of competition in Mexico cost the country USD 129.2 billion between 2005 and 2009., equivalent to USD 25.8 billion or an annual 1.8% of GDP... This estimates represents the opportunity costs of lack of competition in Mexico. It does not represent the profit or sales of any single firm. The figure is based on an analysis of the economic loss that Mexicans have suffered as a result of paying higher prices than they would have paid in a more competitive market. It also takes into account thee loss suffered by potential users who were deterred by high prices from subscribing to telecommunications services in Mexico.

The econometric analysis is here. In a different context, Acemoglu and Robinson makes the point that Mexico has suffered a big net loss since Carlos Slim's latest net worth is only $79 bn.

An assessment of "The Economic Complexity Atlas"

noreply@blogger.com (gulzar) — Tue, 12 Mar 2013 21:36:00 +0000

I've been thinking of writing about this for sometime. Now that I've passed a preliminary muster of Cesar Hidalgo and Ricardo Hausmann's concept of diversified productive knowledge within an economy, and its role in economic growth, I am left with mixed feelings.

Obviously (or so atleast I think) the Atlas has a two-fold agenda. It has brilliantly explored the manifestations of growth, as reflected in the profile of each country's export products and mapped them. It has also quantified the productive knowledge of an economy in terms of the Economic Complexity Index (ECI), and has shown that this is a reliable predictor of economic growth. Its next objective would be to explore what can be done to help countries acquire a diversified base of productive knowledge. I am not sure whether we are covering much new ground here.

1. The Atlas tells us where countries stand on the complexity map and that complexity appears to be a better predictor of economic growth prospects. So what? Standard endogenous growth theories have for long dwelt on the importance of accumulation of knowledge - both product variety/diversification and specialization - as the critical driver of economic growth.

Yes, the Atlas qualifies the character and dynamics of this knowledge. And Hausmann and Hidalgo believe that this "new" information (about drivers of growth), with its close relationship with growth, would help countries, presumably unaware of this, focus on its acquisition.

But I'm not sure whether there is compelling enough evidence - qualified interpretation of existing theories or new evidence - in anything presented by them to convince political leaders and policy makers anywhere to re-visit their prevailing notions about economic growth. However, it does undoubtedly add significant value to the continuous refinement of the endogenous growth models. But that is a matter of interest for academicians and to this small group sitting in Sweden.

2. Even assuming that we have learnt something new, what does it tell about how to get there? What can knowledge about the current level of a country's productive knowledge base and the desired level of complexity tell about the actual path of getting there? In broad terms, this quest is similar to industrial policy regimes followed by many countries that have sought to promote the acquisition of knowledge and technology in specific sectors.

In fact, the decades experimentation on industrial policy, and its mixed results, should itself caution us about the difficulty of any effort at promoting growth with the productive knowledge destination map. Obviously, even when we know our current location and future destination, we still need to know the path and the vehicles to get there. And if the path is itself a dynamic target and we also have to travel in multiple vehicles at the same time, then the quest for destination becomes even more difficult.

3. It finds that diversity of productive knowledge is a more important predictor of growth than even investments in human capital. Maybe. But even controlling for various "observable" factors, we simply cannot quite infer causal relationship between acquisition of diversified productive knowledge and economic growth. The interaction dynamics of the contextual (I am wary of using "institutional"!) factors are too complex to do that with any degree of reliability. It could just be that countries with high ECI scores also had the right environments to acquire that knowledge.

4. Then there is the practical difficulty of its assumptions. Clearly, we cannot expect the numerous small least developed countries like Gabon, Sudan, and Malawi, who are languishing at the bottom of the ECI rankings to do anything much, even in the medium to long-run, to acquire a diversified base of productive knowledge. In an ideal world, the inhabitants of these places should merely migrate to other more habitable locations. In the real world though, their most realistic chance of expedited development lies not in acquiring diversified productive knowledge, but in being able to achieve success with a few sectors.

5. The Atlas points to the relatively low growth potential of the richer natural resource endowed economies, attributing it to their low productive knowledge base. But it can also be argued that given the low economic base from which they started, the natural resources provided them to best and fastest path to economic growth. And atleast some of them grew faster than their other similarly placed colleagues. It is true that many of them have not leveraged that growth to diversify their economies (and expand their productive knowledge), which in turn raises questions about the sustainability of their growth.

While we may claim that once we control for the role of oil, the Middle Eastern economies, with their low productive knowledge base, would have been as backward as any other developing country, it cannot be denied that the people of these countries today enjoy lives which are far better than those in non-resource developing countries, including those with much higher productive knowledge base. If they, like Norway, had used resource windfall to build up a modern economy, we would today have been talking about that as a growth model. There is no reason to lend any more credibility to the productive knowledge base model than one which advocates leveraging natural resources to develop an economic base and then move up the technology frontier.

6. Finally, the Atlas is created using export data. This may be a less reliable proxy for the productive knowledge base of the larger economies, whose domestic economy may contain a diversity of productive knowledge that may not be appropriately reflected in the exports.

Lest we need any more reminders, all "holy grail" explanations of economic growth and development are futile exercises. It all ultimately boils down to exercises in circular logic. Critics will rightly point out that countries lagging behind on diversified productive knowledge base do so because of lack of effective institutions, culture, inadequate investments in human capital, geography, historical factors, weak governance systems, and a series of other factors. Supporters will say that the process of acquisition of productive knowledge will help overcome these other deficiencies. And so on...

India decoupled?

noreply@blogger.com (gulzar) — Fri, 08 Mar 2013 23:37:00 +0000

Amidst all the gloom surrounding India's fading economic growth, we risk glossing over the large variance in economic growth rates and quality of governance across Indian states. The fact that many of these states are comparable to large national economies, should alone be enough for us to be more nuanced in analyzing India's economic prospects.

As the recent Economic Survey points out, states like Bihar, Madhya Pradesh, and Maharashtra, have grown in excess or close to double-digit rates. In fact, even as national GDP growth rate slumped to 6.5% in 2011-12, half the states grew at double-digit rates for the 2010-12 period. One of the surprisingly less discussed stories is the remarkable success of state governments in reining in their fiscal deficits, reducing them from 4.1% for 1998-2004 to an estimated 2.1% for 2012-13, and even running a revenue surplus. This stands out in sharp contrast to the fiscal mess that has characterized the federal government. Some of the traditional laggard states have become trendsetters with progressive reforms. A recent article in Forbes summed up the successes,

Gujarat has emerged as arguably the best destination for investors... Bihar and Orissa have pioneered legislation to stamp out corruption. Karnataka is putting gender equality and women’s empowerment at the heart of planning. Kerala, as mentioned earlier, wants to be on par with Nordic nations. West Bengal now allows free movement of goods, having removed checkposts and trusting businesses to be honest. Punjab has introduced a Right to Services Act. The idea is to reduce citizens’ interaction with government officials and subsequently reduce the opportunity for corruption.

A few observations in this context

1. Many of these successes are not built on any of the structural reforms that have been the staple of debates surrounding what needs to be done to get the Indian economy back on track. In fact, all these states have done well on the back of plain simple good governance.

Sure, there are benefits from some of these macro-level structural reforms. But, given the low level of inefficiency equilibrium, there are substantial low-hanging fruits to be plucked by good governance and effective implementation of the existing programs and schemes. It is a pointer to the federal government itself that simple governance reforms can itself dramatically improve outcomes.

2. It is well past time to reform the one-size-fits-all centrally sponsored schemes. Given the varying growth trajectories and requirements of states, such uniform programs are an extremely inefficient use of scarce resources. But instead of reforming or phasing them out, the federal government has in recent years, in deference to populist political considerations, dramatically increased the spending on such programs.

Consider this. The high-profile centrally designed programs NRHM, SSA, NREGA, NRLM, NSAP, IAY, and JNNURM form overwhelming share of financing in critical sectors like health, education, employment guarantee, livelihoods, social safety, housing, and urban development respectively. In other words, the agenda for addressing almost all the major development problems of a state is being framed in New Delhi, leaving the state as a passive recipient of central dole.

Many state governments have even scaled back their local need-based sectoral initiatives to accommodate these central programs. Apart from regular establishment expenditures, state government's own spending in these sectors is now mostly confined to meeting its share of the central allocation or in the complementarities to the national program. The rigid program guidelines, with norms and components, ostensibly aimed at facilitating the achievement of objectives, end up distorting incentives and distracting from addressing the real local problems.

3. Redesigning these programs require reforming the mandate of the Planning Commission itself. It is widely acknowledged that the current process of plan consultations are merely an exercise to annually re-validate the ongoing central schemes. Instead of planning top-down (sic), the Planning Commission should collaborate with the state governments and help prepare need-based state plans. It should provide state governments with the necessary professional expertise in the preparation of such plans.

This would mean dispensing with many of the central schemes and replacing it with sectoral bulk transfers. Such allocations should be made as part of comprehensive sectoral plan with clearly defined outcomes and accountability measures.

4. We need to be careful with the promulgation of nation-wide regulations on economic issues. As the economy diversifies, private sector expands, the role of government changes, and India integrates more with the world economy, there will be the natural technocratic temptation to harmonize regulations to lower transaction costs. We need to be cautious about rushing with hasty legislations.

The need for harmonization, with its attendant benefits, has to be balanced against both political economy considerations and also economic issues arising from asymmetric economic cycles. In this context, TV Somanathan has forcefully argued in this article that proponents of a national Goods and Services Tax (GST) have overlooked important political economy considerations and its impact on the fiscal space available for state governments.

The Eurozone crisis has show that excessive harmonization carries with it considerable economic risks. Harmonization often leaves regions exposed to asymmetric economic shocks without the traditional cushions against the vagaries of the economic cycle. We need to be aware of the need to leave sufficient fiscal and regulatory flexibility that is necessary to effectively manage a continental size economy.

Where will the funds for infrastructure finance come from?

noreply@blogger.com (gulzar) — Tue, 05 Mar 2013 03:41:00 +0000

Theoretical wisdom on financing infrastructure projects would have it that these long-gestation projects be funded through long-term debt. Such debt is raised primarily from the bond markets since banks are constrained by potential for asset liability mismatch arising from their business model (their deposits are short to medium term, making them borrow short and lend long).

However, India's nascent infrastructure sector growth story goes against this wisdom and relies mainly on bank loans for project funding. The last decade saw a massive increase in private sector investments in infrastructure, especially in power and roads, mostly financed with domestic bank loans. In the wave that swept the sector, many banks lend disproportionately to the sector. This has predictably had the effect of raising concerns about the un-sustainability of bank's exposure to the sector.

Consider these figures from a recent report in Mint,

Infrastructure is the sector to which Indian banks have the greatest exposure... Among the banks that have significant exposure to the power and infrastructure sectors are Central Bank of India (34% of its loans), IDBI Bank Ltd (32.9%), UCO Bank (32.3%), Canara Bank (22.4%) and Andhra Bank (24.5%)... At least 50% of the highway projects in the rated portfolio scheduled for completion in 2013 have already reported three-six months delays due to land/right of way not being handed over by the concession grantor

The outstanding bank loans to infrastructure projects stood at Rs 6.9 trillion as on 31st December 2012. Of this, Rs 3.8 trillion dollars are to the power sector (mostly generation) alone and Rs 1.26 trillion to road sector. A number of these projects, which are due for commissioning now, are delayed and are likely to request for debt restructuring. The close relationship these projects have with the fluctuations in the business cycle makes debt restructuring even more likely.

Interestingly, both these sectors are very long gestation projects, with returns generated over 23-30 years. Evidently, the most efficient way to finance such projects is through long-term debt. Further, these projects, with distinct project assets and operational contours, are ideally suited for project finance.

The RBI norms stipulate that bank lending to a borrower should not cross 15% of its capital and to a borrower group should not exceed 40%. But most banks have either crossed their sectoral exposure limits to infrastructure or are close to that point. This is important in light of the ambitious $1 trillion infrastructure investment estimates for the Twelfth Five Year Plan (2012-17). Since banks are currently the primary source of funding for infrastructure projects and are close to reaching their lending limits, the source of funds to meet the Plan targets becomes a matter of great concern.

In the circumstances, there are only two other alternatives. One, encourage foreign capital investments in infrastructure. Two, sharply increase the depth and breadth of India's long-term corporate debt market. The second assumes great significance and urgency if we are to have any chance of even achieving half the 12th Plan target. It is also critical to enable banks to securitize and off-load the infrastructure loans from their balance sheet and rectify their unsustainable asset-liability mismatches.

The challenge with law enforcement

noreply@blogger.com (gulzar) — Sat, 02 Mar 2013 00:10:00 +0000

My latest Governance Agenda column in Pragati talks about the difficulty with enforcing laws in India. It argues that top-down enforcement works at the margins and fails when deviation or violation is the norm and not the exception.

Which is the least discussed area in development?

noreply@blogger.com (gulzar) — Thu, 28 Feb 2013 02:37:00 +0000

Instinctively, I am inclined to say state capability, though on reflection, I believe that law and order management stands out in splendid isolation.

I am not aware of the statistics. But it is undoubtedly true that law and order failures have been a major cause of people's dislocation (riots), weak and ineffectual governance (local thugs controlling economic activities in slums), inefficient markets (inadequate protection of property rights), perpetuation of deprivation (social and political disenfranchisement in rural areas), violation of civic rights (crimes against women), and so on, all of which contribute in no small measure to constraining the development process. Further, law and order failures affect the functional efficiency of other organs of the government.

Despite such overwhelming evidence, law and order reforms and policing have remained outside the mainstream discourse on development. I can speculate on a few possible reasons for this trend.

1. We tend to see law and order problems as representative of more fundamental underlying causes with roots in social and economic factors. But this overlooks the reality that these problems have an undeniable law and order dimension, whose enforcement is critical to make any progress with addressing the underlying factors themselves. There are many cases where enforcement of basic law and order is enough to create conditions which facilitate addressing the underlying social and economic factors.

We need to look no further than the success of the current government in Bihar. Its initial success was not so much in the traditional development sectors, but in aggressively pursuing law and order management, which in turn played an important role in creating the conditions for promoting investments and economic growth. Bihar is today the fastest growing state in India, a dramatic improvement from the bottom rung it occupied five years back.

2. We also use law and order inter-changeably with civil strife. Since civil wars are complex issues, not readily amenable to simple solutions, we tend to think much the same for law and order. But basic law and order management is just about assuring rule of law and basic civil rights protection. It is a fundamental duty of the state, one not disputed by even the most hardline neo-liberal.

3. Whenever law and order issues are discussed, it is generally as part of the larger issue of state capability. This conflation with state capability misses the point about the critical importance of law and order maintenance in itself. A failure on this front also erodes the credibility of the state in other areas. This assumes great significance in many developing countries where the police is the symbol of the state presence, and its weakness reflects on the credibility of other institutions of the state.

What can be done to bring policing to the door-step of citizens? How do we increase access to a police station? How do we streamline and increase transparency in the process of filing complaints, their registration, and investigation? How do we increase accountability at each of these levels within local police units? What can be done to increase the linkages between the police and the judiciary so that cases registered in a police station can be expeditiously tried and justice awarded?

CAG and the Delhi Metro Rail

noreply@blogger.com (gulzar) — Thu, 21 Feb 2013 03:18:00 +0000

The Times of India reports that the CAG has found fault with the DMRC for causing loss to the public exchequer in the execution of the contract for construction of the Delhi Airport Express Metro Link (DAEML). The project was executed on PPP mode through a consortium of Reliance Infrastructure and Construccionesy Auxiliar de Ferrocarriles, SA (CAF) of Spain. I have mixed views on the CAG's latest exposure.

1. The CAG points out instances of non-contract concessions and dilution of statutory regulations in the contract provisions which benefited the concessionaire over and above that allowed in the original tender. For example, it points to the concessionaire benefiting by about Rs 30 Cr through customs duty concessions on capital equipment worth Rs 990 Cr imported for the project. It also points out that the project was awarded despite the concessionaire arranging only 46.17% of the total cost through its equity and debt and the government financing the rest, whereas the PPP guidelines mandate a 40% cap on government spending.

If, as appears to be the case, these two concessions were given outside the scope of the original tender, then it would constitute a clear financial benefit for the concessionaire. Furthermore, despite the contractual stipulation of 70:30 debt:equity ratio for the concessionaire, the ratio was 4,3218:1, 230,907:1 and 275,205:1 for three financial years between 2009-12. This clearly benefited the concessionaire by boosting its return on equity. More importantly, it leaves the concessionaire with too little skin in the game and sets the conditions for engendering moral hazard, especially when the project runs up against market risks induced commercial viability problems. This moral hazard gets amplified by the fact that most of the lending would have come from public sector banks as project finance loans.

These findings highlight the moral hazard created by the attraction of non-contractual gains and the possibility of contract re-negotiations in large infrastructure projects. Contractors bid aggressively to bag the project in the firm assurance that they can make handsome profits by using their influence to either skirt around contractual obligations or re-negotiate provisions that adversely affect them. I have blogged about this pernicious trend here, here, here, and here.

2. But the CAG's observations about failure to levy penalties (or liquidated damages) for construction delays may be questionable and is certain to contribute towards further policy paralysis. Construction delays, especially those involving short time periods, while theoretically objectionable, most often tends to get condoned due to practical implementation issues. Such delays occur mostly because of site handing over and other problems, which are more likely beyond the control of contractors.

Further, the execution of any large contract is accompanied by several operational decisions, some of which involve financial implications (though only a minuscule proportion of the contract). Requests for time extensions and non-imposition of liquidated damages for failure to meet pre-defined milestones are commonplace in large contracts. Similarly, all projects involve repeated invocation of cost escalation provisions. All such decisions are judgement calls, made on the basis of appreciation of some evidence which cannot be easily quantified, by field engineers. If we examine all such decisions post-facto from the narrow lens of financial costs and benefits, without appreciating the context in which the decision was taken, most of these decisions will end up as audit objections.

If this precedent is established, it will adversely affect the progress of all major projects. Engineers and officials will play safe and simply refuse to take operational decisions. This will in turn affect the contractor's commercial viability and create undesirable incentive distortions.