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Why are petrol prices not decreasing?

Why are petrol prices not decreasing with the fall in global crude oil prices?

Why are petrol prices not decreasing with the fall in global crude oil prices?

A common refrain from most motorists is that petrol prices should have reduced considerably with the fall in global crude oil prices. Even though global prices have fallen from well above $100 per barrel to less than about $30 per barrel in the past 1-2 years, the price that we pay for a litre of petrol in India has not reduced proportionately. Are the oil PSUs fleecing the consumers and raking in super-normal profits by buying low and selling high? Not quite.

Firstly, it is extremely important to understand that petrol prices in India is highly regulated and controlled by the government. The individual firms (be it private or government) have little say in fixing petrol prices.

Also, it should be noted that global crude oil prices is just one side of the coin. All oil imports are priced in dollars, which makes the exchange rate of the rupee with the dollar extremely important. The rupee has been depreciating continuously against the dollar and this affects the price of petrol as well. Let’s assume that the price of 1 barrel of crude oil is $30. At an exchange rate of Rs.60/$, it would be Rs.1800, where as it would jump to Rs. 2100 per barrel, if the exchange rate jumps to Rs.70/$ (where we are inching towards).

Second, only about 40% of the price you pay is for the actual price of petrol. The rest of it is taxes. The cost of a basic litre of crude oil is around Rs.13.5. Then, of course, the crude oil has to be refined and there are various costs involved in this. At the first level, there is entry tax, refinery processing, margin and landing cost from refinery to the Oil Marketing Companies (OMC). Then, there are costs which the OMCs have to bear such as transportation, freight, landing to the dealers and finally, their own margin. All of this put together adds Rs11 to the price of oil, of which the OMC margins are less than Rs.2 per litre. The petrol pumps takes a commission of about Rs.2.25 per litre.

Then comes the first of the big taxes – the excise tax. The excise tax charged on one litre of petrol by the Union government is close to Rs.20 (which was hiked recently by the government). Thus, the dealer (the petrol pumps) pay about Rs. 45 for one litre of petrol . Then, there are a flurry of state taxes and cesses. Around 33% of what you pay for one litre of petrol goes towards state taxes, of which, state sales tax accounts for 25%, state entry taxes account for about 5%. All of this broadly falls under the state VAT. Additionally, there are other various cess that are levied both at the centre and the state. (Karnataka levied a monorail cess in the 1980s and though the project has been shelved in the early 1990s, the cess continues to this date).

Petrol Prices Breakup

One question that can always be asked is why does the government charge such a high rate of excise duty? The simple reason is to balance its fiscal books. Excise duty on oil is one of the major sources of revenue for the central government. When faced with a scenario of an impending fiscal deficit, the central government tends to raise excise duty. By a recent hike of excise duty by 75 paisa, the government hoped to raise Rs.17000 crores in revenue for the purpose of infrastructure. The government aslo used revenues from these taxes to cross-subsidize other fuel costs (diesel). Further, the PSU oil companies understand that they are in this for the long term. When prices were high, many oil companies witnessed significant losses and petrol prices were subsidised by the government. When oil prices fall, the government does not quickly pass the benefit to the consumer, instead it prefers to allow the oil companies to build a cash reserve for the next hike in prices.

Now, back to the question at hand. With the paying nearly 60% of the price towards taxes and nearly 35% towards operating costs, there is not much room to cut prices. The only way that the price that consumers pay for petrol can come down is when the government reduces the taxes it levies. For that, its budget has to be in a much better shape than what it is now. And for the budget to be in a better shape, it has to decrease its spending on the myriad of welfare schemes and subsidies: it can remove the LPG subsidy and decrease the price of petrol, but not many would favour that either.

Anupam Manur is a Policy Analyst at the Takshashila Institution and tweets @anupammanur

Note: Figures are approximate and keep changing with the change in oil prices, as taxes are a percentage of the price.

Tax rates and calculations derived from: Know how fuel cost is computed to Consumer.


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Growth, Urbanisation, and Poverty Reduction in India

Despite a few issues in inequality, the process of urbanisation has been clearly important in poverty reduction in urban and rural India post 1991 reforms

In light of a new and more comprehensive data-set, spanning 60 years with 20 years of post-liberalisation data, Gaurav Datt, Martin Ravallion, and Rinku Murgai revisit the important linkages between growth, urbanisation, and poverty reduction in India in their NBER working paper.

Broadly, there has been a downward trend in poverty measures since 1970, which has accelerated post-1991, when India undertook liberalising reforms. An interesting finding of the paper is that declines in rural poverty has been greater than the decline in urban poverty, which has led to a convergence in the poverty rates in the two areas. Part of this is explained by a significant decline in rural poverty and increase in real wages and part of it is explained by a sharp urbanisation of poverty in urban areas: from about one in eight of the poor living in urban areas in the early 1950s to about one in three in 2012.

There's a decrease in absolute poverty levels in both urban and rural areas in India.

There’s a decrease in absolute poverty levels in both urban and rural areas in India and a convergence between the two numbers.

The evidence also bears out what is common knowledge today – that much of the growth and consequently, poverty reduction, has come from growth in the tertiary sector and to a much lesser extent, the secondary sector. There has also been significant increase in inequality in the urban areas and a decrease in inequality in the rural areas.

There has been an increase in urban inequality and decrease in rural inequality

There has been an increase in urban inequality and decrease in rural inequality post 1991 reforms. Source: Growth, Urbanisation, and Poverty, NBER working paper. 

While rural growth was the most important contributor to poverty reduction pre-1991, it has been replaced by urban growth after the reforms. A more important finding is that urbanisation has impacted poverty reduction not just in urban areas but also in rural areas. This phenomenon of inter-regional effects of economic growth is applicable to the post-reform period only. Before 1991, urban growth had no effect on rural poverty.

The authors have also shown that the classic Kuznets process has not had significant impact in the poverty reduction in India. As per Kuznets process, the growth in poor countries leads to increase in inequality in the beginning, which eventually declines as rural poverty measures exceed urban measures. However the low impact of Kuznets process in India signifies that the difference between rural and urban poverty rates is small.

It was also found that there are strong inter-sectoral linkages post-1991. Growth in one sector has had a positive impact on the other sectors. It is also quite interesting to note that the secondary sector which had minimal impact pre-1991 has contributed to poverty reduction in the latter period, along with the primary and tertiary sectors. The role of the tertiary sector, however, remains the most important, with its contribution to poverty reduction as high as 60%.

There has also been significant changes in growth elasticity (responsiveness of poverty reduction to economic growth) in the three sector between the two periods. The tertiary sector has the highest (absolute) growth elasticity for both periods, implying that poverty reduction is highest in response to growth in the tertiary sector. The elasticity for the primary sector has been decreasing since 1991, reflecting its lower share of national income. The most important change has been in the secondary sector, which has changed signs from negative to positive since 1991.

Apart from decrease in poverty levels, India’s labour markets are also undergoing structural changes. According to the authors, there has been a tightening of rural casual labor markets, with rising real wage rates, and also a narrowing of the urban-rural wage gap. The three main factors explaining such a change are: reduction in the supply of unskilled labour due to the expansion of schooling, decline in female labor- force participation rates, and the construction boom across India. This mismatch between lower supply of unskilled labor and rising demand for that labor has increased the casual wages and thereby reduced the urban-rural wage gap.

If the urbanisation process in India is seen as both urban economic growth and increase in urban population, its contribution to poverty reduction in post reform India is clearly significant.

Anupam Manur and Devika Kher are Policy Analysts at the Takshashila Institution and they tweet at @anupammanur and @devikakher respectively.


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Price of Dosas

In an event hosted by the Federal Bank in Kerala, RBI Governor Raghuram Rajan was asked an unexpected question. Just when he had proclaimed that the central bank had won the war on inflation, a student asked him “In real life, I have a query on Dosa prices — when inflation rates go up, Dosa prices go up, but when inflation rates are lower, the Dosa prices are not lowered. What is happening to our beloved Dosa, sir?” she asked. His response revolved on technology. There has been no significant improvements in the technology involved in making dosas and thus, the prices have remained constant.

The same question was then posed in our GCPP forum. Here’s my response:

First and most importantly, inflation is the rate of change of prices and thus, when Rajan says inflation has come down, it means that the rate of change in prices have slowed (prices are increasing less rapidly).  It does not mean that prices have decreased and thus, the Dosa prices will not come down. So, the input costs and labour costs are still increasing, but at a slower rate, and thus, dosa prices stay the same.

Also, remember that prices do not react to inflation. Rather, the inflation number is an index of how prices of different commodities are moving.

Second, there is always a considerable lag in the macroeconomy for changes to take place. Even if all the input costs are decreasing, it takes time for it to travel through the economy. The more complex the product, the greater the lag for the transmission. The only things that you see where prices fluctuate often is farm produce (fruits and vegetables). This is so because there are very few people in the chain between the producer and the consumer. Thus, prices go up and down quite quickly reacting to demand and supply.

However, wages for labour are usually very sticky (read the concept of sticky prices by Keynes). No worker would agree to get a reduction in nominal wages even if the economy is in a deflationary (negative inflation). Newer contracts may be signed for lesser wages, but that takes time. Other aspects, such as rent, interest rate, etc will also not change immediately. Thus, our Dosa chap cannot reduce the price of his Dosa following a lowering of inflation.

Finally, prices of common commodities do come down after a sustained period of low inflation. When people expect inflation to stay low for a long period, they might be willing to renegotiate contracts. So, inflation expectations are also extremely important for this.

Raghuram Rajan is also correct in saying that technology plays a huge role. We can see in the field of electronic products that prices are continuously dropping or you are getting better models for the same price, which amounts to the same thing. That is due to the usage of better technology in producing these products.

There are a few restaurants in Bangalore who have optimized the technology, streamlined the production process for quicker turnaround and turned it into an assembly line production. They seem to offer dosas at the cheapest prices (Rs.20 in Jayanagar 4th block).

Anupam Manur is a Policy Analyst at the Takshashila Institution and teaches Economic Reasoning for GCPP students. He tweets @anupammanur

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Aftermath of Venezuelan Socialism

Venezuela is on the brink of a complete economic and political collapse, which has been building up since the early days of Bolivarian Socialism.

How does one know that things are going bad in Venezuela? – By the fact that there are no reliable ways of knowing it. Good economic data about Venezuela is conspicuous by its absence. It seems that President Maduro has made it State policy to not publish data. The last time that the Venezuelan central bank published inflation data was in January 2015 and it was 63% at that time, already the highest in the world. By the end of 2015, it was estimated by the IMF that inflation rates would have reached 275%

The Venezuelan economy and the government is in complete shambles and the only question is, as a Washington Post article points out, is which one will collapse first. A combination of bad policies and global situation has put Venezuela on the edge of the precipice.

The Venezuelan economy is driven by oil. In fact, it has the world’s largest oil reserves and like many oil-exporting countries today, is suffering due to low global crude oil prices. However, this is just the proximate cause. The seeds of destruction were sown with the extreme socialist measures taken by the late populist President Hugo Chavez. When oil prices soared in 2000s, it offered Chavez the funds to pursue a hyper-populist and socialist reforms in the economy. The Chávez government pursued a series of “Bolivarian Missions” aimed at providing public services (such as food, healthcare, and education) to improve economic, cultural, and social conditions. Very soon, fiscal spending ballooned in a view to retain loyal political support. Two cent gasoline, free housing, highly subsidized food from government controlled supermarkets and a whole range of such populist policies were practiced.

The first part of his inequality reduction was to conduct land reforms. Many productive agricultural lands were seized with the belief that land belongs to the state and not private individuals. With this move, a sizeable area of productive land previously owned by individuals were now sitting idle under government control, which led to reduction in food supply.

Further, the Chavez government set price controls on about 400 food items in 2003, in an effort to “protect the poor”. In March 2009, the government set minimum production quotas for 12 basic foods that were subject to price controls, including white rice, cooking oil, coffee, sugar, powdered milk, cheese, and tomato sauce. As it has been throughout history, price controls lead to massive shortages and to the creation of underground economies. In January 2008, Chavez ordered the military to seize 750 tons of food that sellers were illegally trying to smuggle across the border to sell for higher prices than what was legal in Venezuela.

As many socialist countries in the past will bear witness, one set of distortions introduced by the government will lead to many more and an attempt to correct those leads to further distortions. Price controls led to supply shortages. A few of the supermarkets that could manage to get its hand on essential supplies charged a price higher than what was stipulated. The government seized all of these supermarkets and the shelves have been empty ever since. This was a pattern that was found across all industries. A few examples:

  • Price controls caused shortages in the cement industry and led to a downturn in construction activities. The government nationalized the cement industry, including hostile take over of multi-national companies, which completely eroded business confidence in Venezuela, and led to a marked decrease in cement production.
  • The largest electricity producer in Venezuela was a private US firm, which was later nationalized. In 2013, 70% of the country plunged into darkness with 14 of 23 states of Venezuela stating they did not have electricity for most of the day
  • Similar cause and consequences were seen throughout Venezuela. Cable and telephone companies were nationalized – led to government censorship; Steel companies were nationalized – led to drop in production and capacity underutilization; Food plants – shortage of processed food; bank nationalization – a banking crisis in 2009-10, etc.

The biggest development that has led to present crisis is the complete take over off their biggest oil company. Even though the Petroleos de Venezuela was State-owned previously, it was at least run professionally before Chavez took over. People who knew what they were doing were replaced with people who were loyal to the regime, and profits came out but new investment didn’t go in. Accusations of nepotism were ripe. The result was that the company did not receive any new investments, which made the much-required technical upgradation impossible. Consequently, oil production in Venezuela declined by as much as 25% between 1999-2013.

The current economic crisis is a direct result of economic mismanagement in the past decade. Price controls led to reduction in supply and export bans led to shortage of foreign exchange needed for imports. The result is empty shelves on most retail outlets and a severe shortage of food supplies and being on the route to galloping inflation rates. Two to three hour-long lines in front of government owned supermarkets are not an uncommon sight. The government even deployed security personnel to kick out shoppers from the lines and introduced a two day per week limit for buying groceries.

People line up to buy food at a supermarket in San Cristobal, Venezuela. Source: Gateway Pundit

People line up to buy food at a supermarket in San Cristobal, Venezuela. Source: Gateway Pundit


Excessive government spending has led to deep fiscal imbalance and huge external debts. Many analysts are betting on a Venezuelan default by the end of the year, which will cripple the economy’s ability to rebound from the current crisis.

When faced with huge debt with no ability to raise revenues and limited borrowing opportunities, countries inevitably resort to one thing: printing notes and Venezuela has been doing it relentlessly. This has caused the Bolivar to drop 95% in the last two years, from 64/$ to 959/$ in the beginning of 2016. Given this, the IMF estimates inflation rate to touch 720% in 2016, which will no doubt intensify civilian protests in the country.

The Bolivar has dropped 93% in the past two years. Source: Washington Post

The Bolivar has dropped 93% in the past two years. Source: Washington Post

The need of the hour is economic reforms in order to dull the pain of an intensifying crisis. However, even if Maduro is prepared to bring in some much-needed reforms (which he probably is not), the opposition will not allow him. The opposition has just won the Congressional elections, which has given it a veto-proof majority, and they are determined to stall any plans that the ruling government may have.

The possibility of the opposition blocking Maduro’s reforms is a moot point. Maduro has far too much conviction in his socialist ideals and doesn’t look like he is too eager to change his policies. In fact, he passed a law, which has made it impossible to remove the Central Bank Governor that he has chosen and surely, he has chosen a remarkable candidate. He has chosen a central bank governor who doesn’t believe in the concept of inflation. As the Washington Post quotes the governor:

“When a person goes to a shop and finds that prices have gone up, they are not in the presence of ‘inflation,’ but rather parasitic businesses that are trying to push up profits as much as possible. Let me be clear, printing too much money never causes inflation. And so Venezuela will continue to do so”.

Please Mr Maduro, ask any Zimbabwean how this went down. Many economies have been on a similar path in the past and it is not pleasant. Venezuela will keep printing money until it runs out of money to buy printing paper. Hyperinflation (with inflation rates in millions) will ensue, before a complete economic and societal collapse, which will include asset stripping, rent seeking, and resource capture and hoarding by those who have power. In the end, generations in the future will suffer.

Anupam Manur is a Policy Analyst at the Takshashila Institution and tweets @anupammanur

Read about Brazilian economic crisis here and the Chinese debt burden here.

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Changes in FDI Regulation in 2015

An overview of the significant changes in FDI regulations in 2015. 

2016 saw the highest FDI inflows into India. Amount in USD million. Data source: RBI, chart by author

2015 saw the highest FDI inflows into India. Amount in USD million. Data source: RBI, chart by author

The financial year 2015 has been an exemplary one for foreign investments. Both FDI and FII have peaked in 2015. Net FDI inflows into India were a staggering $35billion, a 62 per cent jump from the previous fiscal year, which saw $21.6 billion. A report by the Japanese brokerage firm Nomura calculated that FDI forms 1.7 per cent of GDP, up from 1.1 per cent in the previous year.

  • The report attributes the higher net FDI to two factors: growing investor confidence in the country and lower outbound FDI following weak balance-sheet of domestic companies coupled with a weak global growth outlook. “We expect FDI inflows to pick up further in FY 2016, driven by an improving domestic growth outlook, recent liberalisation of FDI limits and government efforts to improve the ease of doing business,” the report says.
  • A sector wise breakup of the FDI inflows reveals interesting information. FDI into manufacturing, which the government has been trying to promote, has been modest. The auto industry has been an exception. Telecom, pharma and financial and business services were the largest recipients over the first three months of this fiscal year. The report speculated that some of the inflow was due to fund-raising in the e-commerce sector.
  • The government’s ‘Make in India’ campaign and higher FDI in the defence, insurance and other sectors are likely to see a further fillip in the net inflows.
  • The government’s move to put most of the sectors onto the automatic route and out of the RBI purview, as part of the grander plan for FDI liberalisation, has helped immensely. Further, increased caps on many sectors such as defence and insurance have helped.
  • FDI limits have been hiked in teleports (uplinking hubs), DTH (direct-to-home) and cable networks to 100 per cent with government approval required beyond 49 per cent. Further, news and current affairs TV channels and FM radio companies can now bring in up to 49 per cent FDI under the government route compared with 26 per cent earlier. For non-news and down-linking of TV channels, 100 per cent FDI has been permitted under the automatic route.

Apart from increasing the ceiling, the government has undertaken other steps towards FDI liberalisation. Some of them are:

  • Companies need not approach the Foreign Investment Promotion Board (FIPB), which is the nodal agency for attracting foreign investment, for M&As in sectors where FDI is allowed under the automatic route.
  • The circular also said the government permission will not be required for issuing ESOPS (employees’ stock option scheme) in sectors under the automatic route.
  • Allowed the Foreign Investment Promotion Board (FIPB) to clear proposals up to Rs 5,000 crore from Rs 3,000 crore earlier.
  • In construction industry, where India has traditionally fared poorly, area restriction (20,000 sq m) and minimum capitalisation requirement of $5 million to be brought in within six months of commencement of business have been removed. Further, foreign investors can exit and repatriate investments before a project is completed, but with a lock-in of three years.
  • In banking, the government has introduced full fungibility, meaning FIIs/ FPIs/ QFIs can now invest up to the sectoral limit of 74 per cent subject to the condition that there is no change in control and management of the private bank.
  • Manufacturers have been allowed to sell their products through e-commerce without government approval.
  • Another major booster for companies such as IKEA, a single-brand retail company with 100 per cent FDI, has come in the form of dilution in sourcing norms. Earlier, such companies had to ensure sourcing to the extent of 30 per cent of the value of goods from the date of FDI receipt. Now, it has been changed to opening of the first store.
  • In case of “state-of-the-art” and “cutting-edge technology” ventures under the single-brand route, sourcing norms have been relaxed. Further, single-brand retail companies can also undertake e-commerce business, not allowed at present.

Anupam Manur is a Policy Analyst at the Takshashila Institution and tweets @anupammanur

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Time Lags in Price Mechanism

The speed of price adjustment to market conditions of demand and supply is a function of information availability.

It is common textbook knowledge that prices react to demand and supply in the economy. The point where the two meet provides the equilibrium price and quantity. However, the price mechanism does not work uniformly across all markets. There are appreciable variations in the time taken for the prices to adjust to the dynamics of market demand and supply. The time lag in the adjustment of prices are different across different markets and they are based on the nature of the product.

In many markets, the prices adjust to the forthcoming changes in demand and supply well in advance. The holiday season will definitely see a hike in prices much before the actual spike in demand. Many tourist destinations have designated a two pronged pricing strategy: one for the holiday season and one for ‘off-season’ and the difference between the two can be significant. All the hill stations in India have seasonal high prices during the summer months, when the tourists leave their hot city behind and want to experience relatively cooler climates in the hill stations. Similarly, the winter season (especially, during Christmas and New Years) will see a spike in demand for beach holiday destinations. The hotels and lodges operating in these areas form definite expectations about the surge in demand, based on the previous years, and adjust their prices accordingly. Since an increase in the supply of lodging cannot be achieved in a short time period and the fact that it is not immediately desirable (the inventory will not be used during ‘off-season’), the only adjustment is via prices. Transportation sees a mixed response. The market does see an increase in supply (extra busses during holiday season) plus a surcharge.

Note that price increases due to an anticipation of a surge in demand in not the optimal response. Ideally, a profit-maximising firm would like to increase its supply in advance and meet the anticipated surge in demand. Retail outlets in the US dramatically increase their supply in anticipation of the Thanksgiving holiday and will be able to offer reduced prices and discounts. [This is a chicken and egg problem – increased demand due to lower prices and discounts or increase in supply and consequently lower prices in anticipation of higher demand]

Few markets actually witness real-time price adjustment mechanism that economic textbooks model. It is only the advances in technology that has enabled real time price adjustments. App-driven cab  operators, such as Uber and Ola, use real time pricing based on the current demand and supply. Given the technology, it is fairly easy to calculate actual demand and supply in any given area and fix prices accordingly. The price  surges in the apps are an excellent example of real time pricing. Financial markets such as equity and currency markets are also examples of real-time price adjustments. It is fascinating to see this play in low volume stocks. One can witness actual price movement of a stock when buying a relatively large number of shares of a stock that is traded in low volumes. Many other market places that have moved online are gradually trying to emulate real-time dynamic pricing. Air-tickets and e-commerce sites do have an element of such dynamic pricing.

Finally, there are those markets where the price tends to adjust only months or even years after the change in market situation. Labour markets are the classic example of delayed price changes. Wages react to demand and supply of labour with a considerable time-lag. Wages also react to inflation expectations, but renegotiating wage contracts are a prolonged process and can take time.

Ultimately, the reaction of prices to the market conditions boils down to the availability of information. Advance information about forthcoming fluctuations in demand or supply will lead to the forward-looking price changes; real-time information availability with the help of technology leads to real-time price fixing; and in a macro situation with many variable, information about market conditions is slow to seep through the system and thus contains a considerable time lag.

Anupam Manur is a Policy Analyst at the Takshashila Institution and tweets @anupammanur


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Has Modi lost the Narrative Dominance?

Modi’s PR machinery, which achieved such narrative dominance during the elections, has failed to take a hold of public discourse in the recent past.

It’s barely 18 months ago when there was jubilation from all corners when Mr. Modi took the office of Prime Minister of India. In the analytical circles, it was largely commented that the Modi narrative of development won the election much before the results came out in May 2014. Modi campaigned by building on the narrative of development, higher economic growth, rising incomes of the Indian population, etc. He promised better roads and bridges, better educational facilities, healthcare and overall, a better standard of living. He was especially successful in reaching out to the middle class. He tapped into their aspiration and made them believe that he would deliver in realising those aspirations. He also succeeded in getting the support and backing of the business community by his emphasis on governance over government. He made assurances of easier procedures to do business, cutting red-tapism, and improving the investor confidence in the India story. Given all of this and the exhaustive election campaign trail, the result of the elections was decided a long time before the actual votes were cast.

There were other narratives too. Competing, but not compelling – ‘The ‘Harbinger of Death’ and the communal agent. Godhra was thrown about without any hesitation. There were other stories existing as well. A dictator and an autocrat in the making, who would centralise all power. However, these narratives failed to gain traction despite a protracted effort by the opposition and Modi won the election with a comfortable margin. Modi’s PR machine, spin doctors and campaign managers were simply better.

This post is not to deal with whether the promises made by Mr. Modi were kept up; rather, it is to explore how he lost the narrative dominance in India. The issues that have been discussed in the media recently have nothing to do with what Mr.Modi achieved or failed to achieve. There have been a few achievements surely, but that has not gained the kind of national attention that his promises gained. The opposition has been extremely successful in taking charge of the national discourse and has diverted it from economic issues to more political ones. Dadri got more attention that the rural electrification program; ‘intolerance’ over the fact that 2015 saw the largest FDI inflows into India (double than that in 2014), Rohit’s death over Startup India. This is not to say that any of these issues are not important, but it is a cause of wonder as to how the BJP’s PR machine has entirely broken down and allowed their achievements to be sidelined while simultaneously giving way for constant criticism. The very same BJP’s campaign managers who successfully deflected attention away from these very issues and fears of communalism into the development story are failing miserable these days. Where are the spin doctors now?

Modi’s silence has not helped either. An extremely vocal person against his critiques during the election trail, he now barely responds to criticism. When the entire nation is worried, justified or not, over intolerance or minority persecution in the country, it is the duty of the Prime Minister to speak up and placate the citizens. Silence from him is handing over the narrative dominance to the opposition.

There’s also an appreciable lack of ‘chest-beating’ from the BJP about their achievements. People are not barged with full page ads, social media campaigns, etc about their achievements so far. There are a few ‘bhakts’ who religiously try to highlight the economic achievements, but these are not taken seriously as the label itself is designed to remove credibility.

Whether the BJP has actually achieved all that they wanted to or not is an entirely different matter. Achievement, usually, in Indian politics has nothing to do with publicity. And what the Modi government desperately lacks is clear messaging, a publicity strategy, and a hold on public narrative. They have allowed themselves to be sucked into issues from which they would rather stay far away.

Anupam Manur is a Policy Analyst at the Takshashila Institution and tweets @anupammanur

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The Flavoursome Financial Instrument

Masala, or rupee denominated, bonds are an exciting new financial instrument that transfers the currency risks from the issuer to the investors. Its success will depend on the investors’ confidence in the Indian growth story.

Prime Minister Modi, on his visit to the UK, announced that the Indian Railways would issue bonds in the London stock exchange and raise funds. Though an Indian company raising funds in foreign markets is not new, this time it was slightly different. Traditionally overseas issuance of bonds has been in foreign currencies: pounds and dollars. However, this time, the bond issued by the Indian Railways will be denominated in rupees.

Rupee denominated bonds were first issued by the International Finance Corporation, the private corporate lending arm of the World Bank group, in 2013 and were given the innovative name of ‘Masala Bonds’. It was only in 2015 that an Indian entity, the railways, issued a rupee denominated bond in overseas market. Since then, HDFC issued the first corporate masala bond in London to raise about $750 million. Many others have followed suit: IIFCL, a state-backed funder of infrastructure projects, Power Finance Corporation Ltd, which arranges finance for the electrical power sector, power producer NTPC, etc.

The concept of Masala bonds is not entirely new. The Chinese have been issuing bonds denominated in their local currencies in overseas markets called Dim sum bonds. There are also the Japanese Samurai bonds, US Yankee bonds and the British Bulldog bonds.

Masala Bonds are rupee denominated bonds issued in foreign markets.

Masala Bonds are rupee denominated bonds issued in foreign markets.

The advantage with the Masala bonds is that the risk of currency fluctuations is solely with the investors and not the issuer. Usually, in a bond denominated in a foreign currency, the issuer bears the risk of currency fluctuations – if the rupee were to depreciate significantly during the period, the issuer loses out. To counter this, the issuer will have to hedge against this risk, which adds to the borrowing costs. With the Masala bonds, the risk has been transferred to the investor, who is taking a bet on the Indian story.

Further, the issuer gets access to the larger and more liquid overseas markets. The cost of borrowing is also significantly lower in the foreign markets, roughly by about 200 basis points, than in India. An Indian company usually pays about about half a percentage point higher than the government bonds, which translates into roughly 8.25 for a five year bond and 8.2% for the 10 year bond. In the UK, the issuer will be willing to pay upto 7.5 or even 7.8% for the bond. This is a good alternative for companies who struggle to raise funds in India as Indian commercial banks are reluctant to lend to sectors with heavy debt and facing weak demand.

Investors are exempt from many taxes for investing in the Masala bonds. The Finance Ministry has cut the withholding tax (a tax deducted at source on residents outside the country) on interest income of such bonds to 5 per cent from 20 per cent, making it attractive for investors. Also, capital gains from rupee appreciation are exempted from tax. The masala bonds will offer an opportunity to those foreign investors who are not registered in India to take exposure to Indian debt. It will diversify the investor base for Indian corporations and, most importantly, its success will internationalise Indian currency.

Though this is an exciting new venture, it is unlikely to see immediate big results. There are still concerns in the overseas markets about the liquidity for offshore bonds raised by Indian companies. In a report by Standard Chartered, ―analysts cited investor worries over pricing and a lack of liquidity in offshore rupee paper as factors likely to limit the market‘s growth in the short term. The bank said the global Masala market was likely to be worth between $3bn and $5bn over the financial year ending in March 2017.

Anupam Manur is a Policy Analyst at the Takshashila Institution and tweets @anupammanur 

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Potential Areas for Reforms

With most parliamentary sessions in 2015 being washed out due to noncooperation by the opposition, there is a lot left to done by the Modi government. Depending on the success of Modi’s talks with the opposition, here’s a few things that can be achieved in 2016.

The February session promises to be action packed with a few interesting bills lined up:

GST: The goods and services tax, once approved, will simplify India’s tax regime by integrating the central excise tax, service tax, and state value-added tax. India currently has as many as 14 state level taxes, each of which differ from state to state in levels and implementation. The simplification and unification of these taxes is, according to some estimates, poised to add 2% to India’s GDP. The GST, which has been adopted in several other countries with good results, is expected to boost export volumes, create employment opportunities, encourage competition between states, and increase the tax collection for the government.

Pushing the GST through the parliament has not been easy though. Despite a clear majority in the lower house, the BJP has not been able to pass the bill in three consecutive parliamentary sessions, due to opposition from the Congress party. The latest winter session was again washed out without any major reform going through. Since then, however, PM Modi has had several political talks with the opposition leaders with GST as the specific agenda and the Finance Minister Arun Jaitley commented on January 3, 2016 that he was reasonable confident of passing the GST in the February session. Mr. Modi will have to spend a great deal of capital to pass the GST in the upcoming session, and even then, the bill that gets passed might be a slightly diluted form of the ideal bill.

Bankruptcy Reforms: The average time taken for insolvency proceedings in India is a staggering 4.3 years, whereas the comparable figure in the US is 1.5 years and 1 year in the UK. Having a clearly defined bankruptcy law is essential for providing a favourable investment climate in any country. Exit norms are as important as easy of entry. The new bankruptcy law is expected to not only reform domestic bankruptcy law but also set the framework for developing an effective system for addressing cross-border insolvencies in India. The Insolvency and Bankruptcy Code Bill, which was introduced in the 2015 winter parliamentary session, is currently stalled in a joint committee between the two Indian houses of parliament. However, because bankruptcy reform is a priority area for the Modi government, we expect to see movement on this important matter in the next parliamentary session.

Banking Reforms: The Indian banking sector is dominated by the public sector banks, which are starved for capital and have huge Non-Performing Assets. The pace of stressed asset creation has also been high, which had prompted Moody’s to keep a ‘negative’ outlook for Indian banking sector. However, the Modi led government has been talking of reforming the banking sector with the Finance Minister introducing a 7 point programme to revitalize the public sector banks. The revitalization plan includes creation of a Bank Board Bureau, improving governance standards, and additional capital infusions. Though privatization of the banking industry is the need of the hour, which is unlikely to happen any time soon, this is the first step in the right direction. 2016 should see some significant improvements in the banking industry. Moody’s has already changed its outlook to ‘stable’, following the reduced pace of stressed assets addition.

Legal reforms: Opening up the legal sector in India, i.e., allowing foreign firms to practice and set up offices in India will be crucial to improving the ease of doing business. Inflow of FDI is hampered by concerns over legal cover and arbitration. Companies investing in India want the assurance that they can rely on sound legal advice, judges, and courts.  In 2015, the government began discussions surrounding a gradual opening of the legal services sector to foreign attorneys. The Prime Minister strongly supports legal reform in India and though India is adopting a cautious approach, it has taken the first steps by informing the World Trade Organisation in August 2015 that it would open its legal sector to foreign lawyers and law firms, but would do so only after consultations with all stakeholders, including the Bar Council of India (BCI). As the first step, the benefits of an open legal sector would only be provided to those countries that offer similar treatment to Indian lawyers and firms.

The proposal being considered by the CoS recommends that international arbitration and mediation services and only advisory or non-litigious services in home country law of the foreign lawyer, third country law and international law may be allowed. It proposes that foreign lawyers could be permitted to practise in India in conjunction with Indian lawyers, as a joint venture, with a cap on foreign participation.

Increased Ceiling for FDI: The Modi government has increased the ceiling for FDI in India in many sectors since 2014. It has also cleared many sectors to be considered under the automatic route and has allowed up to 100% FDI, without prior approval of the RBI. The long-standing 10 percent limit on single institutional investors still exists and continues to inhibit growth. Furthermore, even in sectors where the investment limit has been increased to 49 percent, barriers still exist. For example, in the insurance sector, even though the government raised the FDI cap to 49 percent, no foreign company has been able to increase its investment due to India’s restrictive interpretation of management control.

There are some exciting times ahead. If the Modi government can push through some of these long pending reforms, India can look forward to the next wave of growth.

Anupam Manur is a Policy Analyst at the Takshashila Institution and blogs @anupammanur


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Taking Advantage of Lower Commodity Prices

By focusing on those industries that rely on oil as a producion import, India can take maximum advantage of falling global commodity and oil prices. 

The biggest headlines in the economic world over the past year has been news of slowdown in the Chinese economy and the resultant fall in commodity prices. The slowdown in China, which has been the engine of growth in the past decade, has had significant impact on most other economies. China has been the biggest consumer of commodities and oil and thus, a slowing Chinese economy will import lesser amounts and this reduced demand leads to a fall in prices. Commodity prices have fallen by over 40% since their peak in the early part of this decade. Apart from oil, copper, iron ore, zinc, and many metal prices have been declining consistently. Price of energy related commodities, such as coal, has also significantly dropped. The reduced prices have hit many commodity and oil exporting countries. Brazil, Russia, South Africa and many other emerging markets have had severe declines in their exports and consequently in their GDP growth.

Commodity prices have fallen by 40% since their peak.

Commodity prices have fallen by 40% since their peak.

How is India poised? Is it going to be hurt by the Chinese slowdown or can it be a tailwind to increase growth?

First, the negatives: Indian apparel and yarn exports have declined considerably. China has been a big importer of Indian textile products and its decreased pace of income generation has meant lesser demand for Indian exports. Further, with China devaluing its currency considerably as a means to improve their trade, Indian competitiveness has been further eroded. India’s exports have fallen in every single month from April to November 2015 in comparison with the same month a year ago.

However, with India being a net importer of oil and commodities, it should really focus on taking advantage of the lower global commodity prices and falling oil prices. Here’s a few things that India can focus on:

1. With oil prices set to decline further in the first half of 2016, this is the time for India to seriously consider building a large enough strategic oil reserve.

2. India should get its current account balance in line. The rupee has also been declining significantly and if India can increase its exports, and with a reduced import bill, the current account deficit can be corrected to an extent.

3. Lower oil prices will imply smaller oil, petroleum and fuel based subsidies. This should be a golden opportunity for the government to get its fiscal accounts in check.

4. A lower import bill will also have positive effects on inflation and inflation expectations. This should give more room for a more accommodative monetary policy.

5. Most importantly, the government should focus on those industries that uses imported material, commodities and oil, as raw materials for production. The Indian auto industry should get a considerable fillip due to lower input prices. If policy can be more accommodative, the auto industry can soar. Other industries that rely on oil, such as, plastic industries including pipes, chemicals and resins selectively, paints, footwear manufacturers etc can really benefit from oil prices and the government should focus on creating a friendly climate for these industries. Apart from oil, reduced price of iron-ore, copper and even coal should help a large number of Indian industries by lowering input costs.

6. Finally, since India’s nearest peers – Brazil, China, South Africa, and many other EMs – not faring well in terms of economic opportunities, it is poised to receive a lot more of global funds, both FII and FDIs. The next round of liberalising reforms cannot come soon enough to attract global capital into India.

After the stagflationary episode in 2010-12, India is finally getting back to the higher growth track and global conditions seem to be favouring India. It should do all that it can to take advantage of these conditions and accentuate the positives.

Anupam Manur is an economics Policy Analyst at the Takshashila Institution. Connect with him on Twitter @anupammanur


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