A patently absurd thing called reforms

There have been several ‘game changer’ moves of late. They are more likely to boomerang


Alam Srinivas | March 23, 2013

In the past six months, UPA-II and especially finance minister P Chidambaram have been applauded for a slew of reforms. The government has claimed that it has broken the shackles of policy paralysis and is on its way to usher in a new growth phase, after the downturn in 2011-12 and 2012-13. Each and every decision that was taken in the recent past was categorised as a ‘game changer’. It was projected as a panacea and an immediate solution for all the ills in the economy.

The direct cash transfer will root out corruption in subsidies and welfare schemes. Foreign investment in organised retail will curb prices and inflation forever. The restructuring of state electricity boards (SEBs) will lead to electricity for all consumers. The decision to hike diesel prices incrementally will slash the subsidy bill and lower the looming fiscal deficit. And the postponement of general anti-avoidance (tax) rules (GAAR) by a few years will open the floodgates for foreign investment.

Unfortunately, many of these so-called reforms will achieve the objectives that are unintended by the policy makers. In fact, they cannot solve the existing problems, and will only create new ones. The real outcome of these measures will be that although they will help the government to manage its finances and face, they will increase corruption and, more importantly, make the poor suffer more. Some of them will create a bigger mess than the one that exists now.

Dual pricing, dual corruption
Dual pricing in any product, be it LPG or sugar, has always led to higher corruption. Therefore, the differential prices now imposed for bulk and retail users of diesel will lead to the same situation. In fact, market reports indicate that many bulk diesel users, who have to pay a higher price, have changed their models to show their buying as retail. In addition, since the difference between bulk and retail price is huge, bulk buyers are willing to pay a specific amount under the table to get a lower price.

Whatever means that were tried to stop leakages in the dual pricing mechanism have failed miserably. There was an attempt to colour-code LPG cylinders meant for retail and commercial uses differently. It flopped. Even the idea to cap the number of subsidised cylinders per household cannot succeed because each family will have two registrations (as is the case with most middle-class homes) – each allowing them to buy nine cylinders each per year. And many may even have benami registrations.

Policymakers feel that dual pricing of diesel will ease the burden on retail buyers – urban individuals and farmers – who will pay less. While this may be so, at the same time, it will create chaos, increase leakages, and create a new corrupt system. One will have to watch if suddenly consumption of diesel in the retail market zooms and that of bulk ones shows a lower growth because of dual pricing. This will surely indicate that corruption levels have gone up. 

SEBs – state enticement boards
It was touted as a huge reform for the ailing power sector, especially the state-owned SEBs, which are saddled with huge problems such as high debt, low and unviable power tariffs, and huge distribution losses. But, in effect, it was a huge bailout. Late last year, the cabinet approved a debt restructuring package for the SEBs, which allowed for conversion of their short-term debts into long-term bonds, payment moratorium for a few years and reduced interest rates.

The philosophy was this will free up cash that can be used by the SEBs to modernise their distribution, pay off power suppliers, and get its financial houses in order. But what will it actually do? In the corrupt SEBs’ bureaucracy, this will result in surplus cash that can be further siphoned off. It will create fresh avenues for business-bureaucracy nexus to make more money. Does this government really believe that throwing cash can correct a deep-rooted mindset to earn illegal money?

However, the bailout came with certain ‘reform’ caveats. To qualify for the bailouts, the SEBs were asked to collect outstanding money from customers, reduce distribution losses by a quarter, and progressively raise electricity tariffs to viable levels. All this sounds good in theory as such decisions can improve the financial and operational status of the Boards. But the moot question is: will it happen? Will the SEBs reform? The answer here is a resounding NO.

Past experience has shown that bailouts given to state-owned organisations generally do not work. Within a few years, the companies or institutions are back to their old state. Even if they are asked to reform, such measures are slow or do not take off. Some time ago, the SEBs were given another bailout, and the result is there for everyone to see. They are in a worse situation than before. So, while they will gladly accept the bailouts, the so-called reforms will remain mostly on paper.

Grrrrrr to GAAR
Ever since, it was proposed in Budget 2012 by the former FM, Pranab Mukherji, almost everyone hated GAAR. The foreign investors, who bring in their money to invest in India stocks or buy Indian assets, generally route it through tax havens like Mauritius to save on taxes. GAAR would have shut this door – forever. And the foreign entities would have to either pay taxes or think of other innovations. They opposed it vociferously and Chidambaram gladly obliged them when he postponed it.

So, what will it achieve? It will give a few years to investors to use the Mauritius-like routes to ‘avoid’ taxes. It will incentivise many others to quickly use these channels before they are closed, i.e., if they are closed. Most experts agree that if UPA comes back to power in 2014, it is unlikely to re-impose GAAR. For all practical purposes, GAAR is dead. Therefore, investors may continue this route forever, even when it is established that it is meant for tax evasion and avoidance.

Government committees, regulators and investigators have repeatedly concluded that Mauritius is being used for round-tripping, i.e. allowing Indians to bring back the black money stashed abroad through Mauritius as legitimate money without paying any taxes. In early 2011, SEBI felt that Indians used the venture capital route through Mauritius to bring in their black money to invest in stocks. Many Indian promoters own Indian assets through entities based in Mauritius.

Since most foreigners also use the Mauritius route, a finance ministry sub-committee feared that illegal narcotics, gun-running and terror money may be flowing into the Indian stock markets. In fact, Indian investigators are almost convinced that many Pakistan terror organisations park their money in Indian stocks to earn attractive annual returns; Indian bourses have given the best returns globally in the past few years. Despite these fears, the Mauritius route has been deliberately kept open.

Direct ‘slush-money’ transfer
We have criticised the inadequacies of the direct cash transfer before. It is an idea which cannot work in a large country like India, where the poor who cannot afford two meals has to pay a higher price upfront and then wait for the lethargic, inefficient and bureaucratic government to transfer the subsidy amount into his bank account. Not to forget the ailments of the Indian banking system that takes several days to transfer money from one account to another in different cities.

So, instead of helping the poor it will penalize them further, and subject them to more misery. How can one think that the poor who earns Rs 30-40 a day will buy an LPG cylinder for over Rs 800 and wait for Rs 400 to be put into his bank account before he can access it? As several pilots across the country have shown, the banks take six to 12 months to transfer the cash transfers. The end result: the poor stopped using kerosene and went about cutting trees for their fuel.

More important, as recent research has shown, direct cash transfer will only change the modus operandi of corruption, especially when it comes to subsidies. Instead of a nexus between the ration shops and small businesses to siphon off the produce, now there will be a new illegal relationship between local bankers and administration to take their cuts and commissions. The poor will have no option but to pay this money to access and operate his bank account.

What is important here is that even if direct cash transfer reduces corruption, the public perception will not change; in fact, it may become worse, as is the case in Bihar. According to Sandipan Deb, a columnist writing in the Mint, Bihar decided to opt for direct cash transfer for the Indira Awaas Yojana, where money is given to a specific number of poor families to build new homes. Although the objective was noble, the Nitish Kumar government got a bad name for the change in the payment mode.

Earlier, if 1,000 people had to receive the subsidy, the local administrators would call only 100, give them the full payment, and pocket the remaining 90% of the funds. The corruption rate was thus 90%. Under the new direct cash transfer mode, the bureaucrats would have to pay the full amounts to 1,000 people as it went into bank accounts, but they would ask each for a 10% cut to get their names in the list. The corruption rate dropped dramatically to 10%. But there was a catch.

Earlier the 100 people who got the funds confidently said there was no corruption as they got the full amount. But now 1,000 people said there was corruption because they got only 90% of the amount. This is how the perception changed overnight. And if UPA-II has to come back to power, it may well be aware of this ground reality, and make preparations to combat it.




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