Sep 12, 2018

NAFTA Rebooted - some points

How do you stop the President from tearing up a trade deal. As per Bob Woodward in his new book Fear:Trump in White House, by simply pulling out the signing paper from the desk. The President simply forgot that he had to unsign the NAFTA deal, or rather sign a NAFTA withdrawal (someone please do that for RCEP in India). While the deal break never happened (or engineered to not happen), the revised onerous negotiations on NAFTA wound their way to give the world a glimpse of what makes the US President happy when it comes to trade deals. Mexico has hammered out a deal that's acceptable to the US President. And going by the look of it, Trump loves trophies. He got his wall sponsored. Well almost. Canadians are still thinking, and bargaining. 

One can understand the Canadian negotiators' dilemma. There's noting on the table for Canadians if they sign. But if they don't, they have things to lose in trade and economic growth. US is their biggest trade partner with more than 3/4th of Canadian exports headed to USA, thanks to NAFTA and friendly border compliance procedures. They also import more than half of all their import needs from US. Of particular interest is automobile trade that makes almost one fifth of the total trade between them. This would change if NAFTA changes. 

Automobiles are interesting in NAFTA. NAFTA changed the way auto majors operated in north American market. Auto components shuttle across NAFTA borders around 7 times on an average before coming out inside a car. Many carmakers shifted assembly bases to across border Mexico where wages were cheap, almost tenth of that in US. I had blogged earlier about the preposterousness of Trump's demand to have the cars assembled by workers who earn atleast 16 USD per hour (Mexican assembly workers earn around 2 USD per hour). I thought that's a deal breaker. I was wrong! Trump has pulled it off in the first round as Mexicans have agreed to the condition of more than 40% of final assembly to be done by workers earning 16 USD per hour, and for the condition that the share of USA in car components to increase from almost 60% currently to 75% after the reboot of NAFTA. If that jacks up the car price by a thousand dollars, so be it. It's an 'America first' world after all. 

It's not that Canada is not warming up. Their dairy sector is thinking of opening up for US imports after years of resistance from Quebec farmers; Canadian dairy sector has protectionist tariffs that would put India's dairy product tariffs to shame. The investments in Canada are already taking a hit due to uncertainty around NAFTA and due to the revised corporate tax rates in US.  At this time, Canadians seem to focusing too much on dispute resolution mechanism, the chapter 19 of the deal, that shouldn't bother so much during normals times; but given Trump's record at WTO dispute body Canadians are right to try and play safe here. Given the overall loss Canadians stand to suffer if the deal falls apart, it won't be a surprise if Canada decides to play ball after all.

There's time till September end to strike out a deal and make the rebooted NAFTA a union of original three. Otherwise, going Trump's way it would be a bilateral US-Mexico deal, on Trump's terms. Well almost. 


Sep 3, 2018

National logistics portal of India - A step in right direction


image of National logistics portal of India
National logistics portal for logistics service providers

India is planning to setup a National Logistics Portal on an e-marketplace model. The initial idea was mooted sometime during February 2018. The idea is to have an amazon for logistics service providers that would help bring down the logistics cost in the country. In principle, this is a great idea. The rest boils down to execution. In that respect, I find the National Trade Portal of Singapore to be a good single window example to emulate. While I am not a fan of Government being in business of making e-marketplaces of anything, I believe that public sector needs to step in to create infra-superstructures if/when the private sector fails. This effort falls in the category of private sector not living up to the expectations. 

The logistics portal aims to bring onboard some 80 odd regulatory functions under one umbrella. I assume most of this boils down to providing links to the respective websites, which while dumb might still work as long as the respective websites work well. For example, the clearance at customs is done through ICEGate portal and I can visualise a link being provided to file bills of entries to ICEGate using the new logistics portal. If ICEGate works fine, all would be fine. However, there are many websites that just don't work the way they should. For example, obtaining RCMCs (one of the myriad necessary certificates that could be done away with) from various export promotion councils is a nightmare. Links to these websites might not help unless the entire request system for RCMCs is redesigned. This brings me to the topic of process redesign in e-governance. 

I believe that most initiatives to computerise government functions/services fail because they fail at process re-engineering. Computerisation is usually super-imposed on the existing manual system of doing things in government service delivery process. That doesn't work. One needs to re-design the work flow before it could be computerised. Let me cite an example related to international trade area. DGFT issues something called a duty credit scrip under various schemes. This is a manual scrip that is printed on a security paper, signed by an officer after affixing something called a security seal. Customs would accept only when the seal, signature and the security paper is intact and whole. When we computerise this process, we need to re-imagine the security paper and seals. Unless we evolve a system of NSDL kind of de-materialzation, or come up with our own blockchain based technology, the computerisation cannot be complete. The paper and the signatures would still make the process slow and inefficient. This would be a challenge for National Logistics Portal too when they think of integrating these 80-ish regulatory functions. Unless they can get many of the departments onboard for process re-engineering, they delivery efficiency would be moot. The problem is that not all these regulatory functions fall under the purview of the commerce department which is making the portal. Therein lies the risk that the integration would end up as links to the respective useless websites.

Second is the aim to bring various logistics services providers on-board. This is where the efficiency and user-friendliness of the portal comes into play. Being a user of various forced Government marketplaces such as GeM, I can vouch for their user-Unfriendliness. But for their mandatory nature, I would stay away from Government e-Marketplace. It fails on all counts of ease of navigation, placing of orders, payment, delivery and support. You just don't know where to look for when things fail. I hear that a special purpose vehicle (SPV) might be launched for logistics portal. The SPV usually is a way of saying that private sector would get involved. The unfortunate thing with the government is that the least cost bidder is picked up for execution. While the rules may be tweaked at the stage of entry to weed out smaller unproven players, yet there is no guarantee that the best developer is picked up. Even if we assume that we get a semi-decent developer, the rest boils down to proper definition of proposal and requirements. And here, I have seen that wish lists are doled out to developers without proper definition of the scope. The end product is loose if the scope is not tightly defined. 

The third challenge would be get the service providers on board. This would happen relatively easily if the portal is good and gains traction. I would hope for the best and wait for the launch of the portal. If done properly, this would indeed be a good step in right direction. The pilot launch is expected during March 2019. 




Jul 17, 2018

Urgently needed - an integrated E commerce policy for India

image of E commerce policy in India
E-commerce policymaking in India is a story of missed chances. As late as couple of months ago, the government was in the process of setting up a think-tank to formulate national E-commerce policy. It would take another six months for the rough contours to be formed, and for the interdepartmental heads to come to some kind of consensus, or not. A reason for not formulating a national policy was that the area of B2C E-commerce is handled by various ministries/departments ranging from India post, RBI, commerce, industries, finance and IT. Coming as late as it would, even if it comes within scheduled time, it would still make a good joke but for the fact that it is true. 

Image of E commerce policy in India

To put things in perspective, we are at a stage where India has been reduced to a marketplace for plunder by multinationals. On one had we have what The Economist calls the FAANGs (Facebook, Amazon, Apple, Netflix and Google/Alphabet) and on the other we have the Chinese BATs (Baidu, Alibaba and Tencent). The FAANGs peddle their own products in India and the BATs enter like trojan horses through investments in our supposedly homegrown PayTMs, Snapdeals, Olas and Flipkarts. Of course, Flipkart is now sold to Walmart, a deal with the loser label hung all over. Within the spectrum, and probably all over it, hangs the Japanese SoftBank with its might of money and investments in all that's tech and glitters. Chinese have now created a tech fund to emulate SoftBank. Among all this, we have very few E-commerce players that can be called truly Indian or India funded. Reliance is making an entry as per their recent announcement but then we have to actually see how it rolls out. 

China has been as clever as ever with its E-commerce policy. They effectively banned FAANGs from China and let their domestic firms build up capacity in the area. Whenever they let someone come through the Chinese wall (e.g. Apple), they ensured that they acquired the required technology to put up a competitor (Xiaomi and others). That's as foresighted as one can get, especially when it comes to policymaking in areas that exist at the cusp of various departments. It's not only their domestic policy that has clicked, but even their exports are an E-commerce success story. That's why when China earmarks ten areas of technology that it wants to dominates through its China 2025 plan, one needs to take notice and prepare. Lest it be misunderstood, it's not that China has got everything right. The BATs are struggling outside China and the overseas markets add less than ten percent to their bottomline unlike FAANGs who get more than half of their revenues from non domestic territories. Most of the Chinese presence abroad in this area is through investments in third parties and not their own brands. This strategy might or might not work in the long run. 

image of E commerce policy in India

And this is where we need to strategise better. The current method of think tanks making reports and joint secretaries from various departments mulling over it till the report twists itself to become what they like won't work. We need an apex body staffed with experts and bureaucrats with sense and direction to sit down and hammer out a policy or strategy. Something like a Technology and E-commerce department within current PMO might not be a bad idea to start with. We have already missed the bus. We are however not yet too late to do some damage control, avoid being a bazaar for the world, and if things go well, get our footing back. If that makes an already rich Ambani richer, it's a small price to pay. 

Jul 12, 2018

Rupee value and exports in short run

(This post was originally published at the Hindu Business line here)


Image for Depreciation of currency and exports

A belief in weak Rupee


A common belief while the Rupee depreciates against USD is that it would help our exports. This ‘weak rupee shall help exports’ is shown as a positive over various negatives arising out of falling Rupee. There is great attractiveness in the argument supported by textbook economics. Undervalued or depreciated currency acts as a direct subsidy for exports while acting as a punitive tax on imports. China used the undervaluation of currency as an effective international trade tool for decades. The undervaluation doesn’t fall foul with the regional or multilateral agreements in the way export subsidies do. However, given India’s situation, it is doubtful if we can have a conscious control on the level of Rupee anymore in light of the central bank’s mandate getting anchored to inflation control. Till some time ago there were calls to depreciate the rupee through direct intervention to help exports. Thankfully the idea is now on the backburner as the rupee has slid on its own, mostly due to the factors originating abroad. In addition, one can never predict a correct level. Rupee at the level of 60 for one USD might be very competitive for services exports, while it may still be dear at 70 for manufacturing sector. However, a mere weakening of Rupee might not be enough to boost exports, at least not in a significant way when it comes to manufacturing sector due to three possible phenomena discussed here.

Twin mechanism of inputs and value chains


First, India is no longer an isolated market exporting local goods alone. Our exports are tightly linked to imports through twin mechanisms of input import dependence and global value chains. The inputs for two of our leading exports, Petroleum & derived products and gems &jewellery, originate abroad. Crude, rough diamonds, and gold are imported to make these export products. A significant part of our non-petroleum, non-jewelry based manufacturing exports are tightly linked to the global value chains. We import various steel products, automobile parts, engineering and electronic components that are processed and assembled before getting exported.  Except raw material, primary forms and agricultural exports, we have few items where the origin is fully Indian. Given this scenario, any depreciation of our currency works both ways. The gain would be only to the extent of value addition that happens in India. 

image for currency of invoicing and exports

The invoice currency curse


Second, there appears to exist a counter-intuitive effect of weak local currency not helping exports that arises due to the choice of invoicing currency (Gopinath, 2015).  Almost all our exports are invoiced in international currencies such as USD, Euro or Pounds. Assume a case where the price of a certain export good is agreed at 100 USD for the coming quarter. The goods are invoiced at this price in USD for all shipments for the quarter. If the Rupee weakens meanwhile, this invoicing method would lead to windfall profits for un-hedged exporter during the period (and commensurate pain if it strengthens), but it does nothing to change the underlying competitiveness. An item, which was invoiced at 100 USD earlier, continues to do so in international markets even after weakening of rupee, unless the terms are renegotiated between the exporter and buyer for the quarter. It is seen from the study that the weak exchange rate effect may take upto two years (http://www.nber.org/papers/w21646.pdf) to trickle down into the local non-invoicing currency. This time zone while prices are renegotiated is the profit zone for Indian exporters. The process of renegotiation and adjustments is a medium to long-term process and therefore we don’t see an immediate advantage in terms of trade despite a fall in value of rupee. There is no change in the level of attractiveness of sourcing from India for an international buyer. Therefore, it doesn’t boost exports in terms of quantity or exports in terms of USD.Only value of exports in terms of Rupee shoots up to the extent of depreciation while the effect lasts. The invoicing of international trade in foreign currency is therefore a disadvantage for us, as it doesn’t let our competitiveness improve automatically and immediately upon depreciation of Rupee. Unless the exporter consciously uses the windfall to mark down the prices, or uses it to boost productivity, there’s not much hope.
However, arising out of the same study, there are further two negativespossible. First, the import costs shoot up almost immediately as the invoicing is done in foreign currency which now needs more Rupees to buy. This leads to inflationary pressurearising out of inelastic imports such as crude for a country like India. Second, it adds to the cost of inputs that go into export products in the value chain, thus eroding margins. There appears to be nothing much we can do about the way the trade invoicing is done in foreign currency.

A weak correlation


Third, there are also doubts about correlation between a weak rupee and manufacturing exports. It was found that a fall in the value of rupee didn’t lead to an expected commensurate gain in manufacturing exports during the period 2004-2012 (http://www.nipfp.org.in/media/medialibrary/2013/04/WP_2013_115.pdf). This weakness in the correlation between a weakening rupee and increase in manufacturing exports may be an outcome of combination of factors, including the integration into global value chains which makes the exports dependent on imports. As the sensitivity to exchange movement is faster on imports, and slower on exports, the weak correlation is not a surprise. At least the Indian experience attests to it. 

In short, one cannot rely on a weak rupee alone to boost exports. We need to look beyond at structural factors and take a sectoral approach to boost competitiveness if the aim is to improve export performance. The central government has taken various steps in this direction, significant among them being the collaboration with the state governments in order to take a micro sectoral approach at the level of clusters and districts. While the steps produce results, we may discount the expectation of a weak Rupee boosting exports. 


Jul 11, 2018

Leveraging export control group memberships

India has recently become member to Wassenaar Arrangement (WA), Australia Group (AG) and Missile Technology Control Regime (MTCR), the three leading export control regimes in the world. The memberships to these bodies reflect acceptance of India as a responsible growing power, and an acknowledgement of impeccable non-proliferation record that India has maintained over decades.  However, a mere membership doesn’t confer the desired benefits unless India walks the extra mile to harness the technological benefits these agreements confer. Lest it be misunderstood, one must state here that India has shown tremendous self resolve to develop technologically despite non-cooperation from leading technology powers over decades, especially in the area of missiles, space and computers. However, with the membership to the technology control groups, we may now look forward to develop as a partner and a leader in future if we strategize and work towards it in mission mode. 

The export control multilateral agreements seek to control the proliferation of dual-use, advanced military, space and sensitive technology from falling into the hands of rogue nations, terrorist groups and non-member states. They have their genesis during cold war era, but have continued in altered forms to the present. India has suffered for want of such technology for decades while being a non-member. The non-availability of advanced technology hampered India’s fast technological advancement in the past as she was forced to develop most of the required technology indigenously. While in few areas we did well, we suffered in various defense related technology development. It is difficult to measure the exact impact of technology denial on development; one may reasonable surmise that we must have lost decades of manpower reinventing the wheel. 

India has now set up a reliable and effective export control system for controlling the export of sensitive technology from India in line with the best practices of the member countries. The outreach with the industries has ensured that partner industries, especially in the private sector, understand the sensitivity of technology transfer to non-member states. Various arms of the government work in tandem to ensure that India adheres to the commitments in letter and spirit. The number of applications for exports under these arrangements has soared up in recent times, indicating the fact that there is a good awareness of export control requirements, and that India is integrating into the technology regime. Many of those who are exporting the technology products are private sector players, which is a positive development. 

Yet this is not enough. India needs to strategize to gain more from the memberships to these groups. The membership opens up a world of opportunities for technology up-gradation that was not available earlier to us. For effective utilization, India should move on two fronts. 

First, we should do a SWOT analysis to identify the fields in which we are lagging when compared to the member states. A team of experts should be constituted in each such area in terms of technology verticals. A collaborative R&D setup including universities, research institutions and industry should be established to get the technology at the working levels in each vertical into the country. At times, some of the technology might not have any takers in the industry. Even then, the technology should be mastered at the research institution levels. For example, in the area of some of the high temperature alloys used in turbines and missiles, we should establish research foundries that can produce these alloys and develop the knowledge base for industry transfer whenever need arises. Similar arguments can be made in the area of advanced manufacturing, 3D printing, armaments and defense equipment, software, drone technology and so on. The list is endless. 

Second, we should develop deeper linkages with friendly member nations for technology collaboration and transfer. India has developed as an important export market for the member states. The membership is an attestation to our growing potential as a market for technology products, in addition to our credentials as a non-proliferator. We need to leverage our position to collaborate and grow. While India would certainly benefit from technology transfer, our technical manpower and expertise would help the member states too. It would be a two way street in the long run. We should use the membership for developing and integrating into the technology value chains in defense and advanced technology areas. 

It is important that India strategizes and moves actively to harness the benefits arising out of these memberships as early as possible. Otherwise the membership would simply end up as a decorative feather in the cap with marginal utility for a handful of public and private sector players who fulfill defense offset requirements and elementary technology exports that fall under export controls. 

May 18, 2018

The wage factor in NAFTA negotiations - a potential deal breaker


This is new and preposterous. It could be the dealbreaker. It might be better to face a non NAFTA trade barrier of 2.5% over complying with this provision. The median wages in USA for auto workers is almost 8 times that in Mexico on an average. In addition, there would be the burden of accounting and bookkeeping to comply with the provision. 

These types of requirements are usually designed for dealing with developing countries who prove too hot to handle for the domestic sector in developed countries. Recall the child labour free certifications, carbon footprint requirements, wood certification for legality and so on. These requirements are cloaked in the guise of humanitarian concerns, eco footprint, food safety etc to give it a semblance of respect while implementing. But the wage requirement is bare knuckle tactic that punches on the face of the idea of free trade. 

A wage requirement like the one proposed would take away the very key advantage that makes trade possible between developing and developed nations. Developing countries typically have wage advantage in terms of competitive labour costs. Take that away and the developing country is handicapped in cross border trade. There is still a possibility that Mexico might negotiate. But then, Mexico might as well walk away and face the tariff if the costs outweighs benefits. At the moment, it looks like it would be the dealbreaker.

It's interesting times to watch as NAFTA renegotiations are falling behind schedule. America is slowly and steadily undermining the very system it helped build in the last fifty and more years. Its amazing how one person's paranoia about free trade can grip an entire country and shake the very foundations on which lasting ideas are built. It's sad to see the very competent US trade officials twisting themselves into knots to propagate ideas that suit the president. 

Sooner or later, these ideas would trickle down to other forums including WTO. India needs to be on guard. 


Apr 25, 2018

The forgotten caveats

The headline in the business standard reads : "India must grow at 18% to ensure jobs to growing workforce: World Bank".  The article is based on the recent world bank report titled "Jobless Growth" under the south Asia economic focus series. 

One would agree that 18% growth for a country of our size is not attainable. That being so, the headline implies that World Bank is saying that India cannot secure jobs to its growing workforce. Gloomy picture indeed. There is an element of certainty about the nice round number 18 which misleads a lay reader. 

It is not so if one reads the actual report. The actual report has pushed in enough caveats to survive any close scrutiny about the number 18. The problem is, the report presents things in a way that make newspapers pick up such headlines. That's a danger that any report writer should be wary about, and should factor in while presenting data to a lay reader. To expand the debate, the assumptions behind the models and the assumed simplifications should be made amply clear to the uninitiated audience lest they take the models on face value and start drawing conclusions for real world. The simplified models work, under set of circumstances and assumptions, to enlighten about some particular causal phenomenon under study. And it stops at that. A brief look at the calculation of the number 18 would throw some light. 

The first assumption the model makes is the roughly U shaped relation between employment rates and economic growth. It runs thus. 

image of U curve GDP per capita versus employment in percentage
GDP per capital Vs Employment rate - The U curve

Data indicates that employment and per capita income appear to exist in a U shaped relationship as shown above. When per capita income is low, the country has high employment as people start working young and remain employed due to sheer pressure of survival. If they drop out, they go hungry. As per capita income grows, children enroll in schools and stay there longer, old  people may get pensions, women may not go to work, and the abject need to work for survival decreases. This leads to decrease in employment till a certain stage is reached where the per capita income increases enough to reverse the trend. This happens as people in countries with high per capita income have higher education, they are less likely to drop out of employment, including women who now have access to better daycare and health facilities and can afford to be in the labour force. Also, better healthcare and life indicators ensure that one remains in labour force longer with less drop outs. The first set of assumptions while deriving the 18% growth is that such a curve exists, and India exists at a point on the curve where it is downward sloping, that is, more prosperity would lead to less employment with people dropping out. 

The second set of assumptions is that the employment data the model relies upon is good enough. That might not be so, even in the own words of the report: 
Economists in South Asia agree that the quality of the available employment data makes it difficult to credibly assess the labor market situation in their countries...PP34
One may recall the recent debate in the newspapers about the EPFO based employment data being used to prove the growth in employment numbers. Everyone took sides, but agreed on the point that we are far from getting reliable data on employment. So the report cleans up some sets of employment data that it has and goes ahead with whatever best it could manage. 

The report outlines the below equation to represent the approximation of the U curve mentioned above

Where Et is the employment rate, Yt is the total output, Nt is the population, Beta is the approximate slope of the U shaped curve around Yt, and negative for countries like India as mentioned above. 
Delta captures the responsiveness of employment to economic growth and is expected to be positive for India. Alpha and Gamma are short and long term constants arising while linearising the equations respectively. 

Then quarterly changes in employment are correlated with quarterly GDP growth, the report mentions that Okun's law (which roughly states that employment increases in direct relation to GDP growth) doesn't hold for India. For each percentage point increase in GDP growth, India's growth seems to drop by 0.11%. Counterintuitive? Yes, but the models say so. And within south asia, the law holds in Pakistan and Sri Lanka and fails for India. Nevertheless, we plough ahead with acceptable p values. 
See images below. 

image of Jobless growth in India

image of jobless growth in India


Then the attention of report turns towards the question in hand. The one I have a problem with. How much growth is needed to create enough jobs? It takes three scenarios: 
a) Unambitious - let the Growth be whatever it is and lets see where employment would head
b) Constant - Growth needed to keep the level of employment constant
c) Catch-up or Ambitious - Growth needed to catch up in terms of employment levels and get pushed to the positive slope area of the U curve in a certain number of years. 

image of Okun's law in india

Based on T number of years to catch up, it models three equations by substituting above into the earlier two equations. Then the linear models look thus: 

image of Modeling employment unemployment GDP growth

Based on this, the model predicts the growth rates, and puts them on a neat bar chart. 

image of Unemployment and job creation problem in India
Now one may see that India needs a growth rate of around 18% to catch up with a time horizon T of 20 years. This chart doesn't contain any disclaimer. If one simply scrolls down the report and stops at it, it misleads. While the methodology is probably the best one could get in given circumstances of shaky data and inapplicable models, yet the chart doesn't mention any of those. It assumes a linear and deep reading of the text. 

If you observe, by the time you reach here in this post, you must have forgotten the first U curve assumptions I started with, unless you are econ types. Most policymakers in India are not Econ types. They are generalists who are more managers than policymakers. And that's why I have problems with data presented in this form. It has a ring of conclusiveness to it while the report embed the doubts about the U curve and Okun's law inside the text. To be fair, the report has been candid about employment data inaccuracies. 

If asked, I would present the following way. I would add up the uncertainties at each level in the modeling process as error terms. And when the final value is presented, and if forced to make a bar graph, I would include this cascaded final error term in the projection. It would be a range to reflect the uncertainties built into the model. 

Probably the headline then would read like this: 
India might need around between 7 to 25% growth rate for twenty years to ensure jobs for a growing workforce, depending on where we lie at the downward sloping U curve, and depending on the assumption that it's an U curve after all, with an inverse relation Okun's law holding tightly enough; which though counterintuitive, we shall somehow ignore, and depending on how much we believe on the employment data being generated, and given that other things remain constant in the time horizon considered. This after ignoring the inherent assumptions in data collection methods, which ignores pakora makers, and uncertainties in calculation of GDP growth. We are in bad shape. 

Probably that'll not be a click-bait headline. But then, who cares about the misleading headline too? 

Apr 17, 2018

Mainstreaming block chain technology in international commerce

This post was originally published at The Hindu Business Line newspaper here

Distributed Ledger Technology (DLT), a concept of recording and sharing data across multiple data stores, or ledgers as they are popularly called, is an idea whose time has come. The concept of DLT was introduced through block chains in the famous paper by the elusive author known only as Satoshi Nakamoto in 2008.
While the initial application was limited to crypto currencies, it didn’t take much time for the world to realise that the underlying technology of using distributed ledgers has multiple applications spanning various spheres. However, it is only lately that we are seeing actual implementation of the often discussed concepts.
To cite an example of block chain application in mainstream commerce in India, we may look at the Trade Receivable Discounting System (TReDS) guidelines of the RBI, which sought to set up a system to ease the liquidity crunch for MSMEs by way of bill/invoice factoring in the financial market for the supplies made to big corporates. The simplified process under TReDS may be explained with an example. Let’s assume Mismi enterprise, which is an MSME, supplies items to Bigcor, a corporate house. Usually Bigcor takes three months to settle the payments after the delivery of goods. This holds up Mismi's working capital for three months leading to a liquidity crunch for Mismi.
Mismi’s efforts to convince Bigcor to make payments earlier doesn’t work as Bigcor has market power to dictate terms to Mismi and other such suppliers. With the advent of TReDS, Mismi uploads the digitally signed invoice on one of the three platforms currently approved by the RBI. The upload is done after the supplies are made to Bigcor.
Bigcor gets a time window (say of two days) to approve the invoice online, thus verifying the authenticity of the supply and the commitment that it would pay the sum against the invoice raised within three months (or the agreed time frame).
The approved invoice can now be factored on the platform, through auction, by the financial intermediaries like banks/NBFCs. For example, BigBank may buy the invoice at a discount and pay the money to Mismi, thus providing it with immediate liquidity. The actual payment would be realised by the BigBank after three months from Bigcor.
In an ideal competitive market place the discount should equal the interest cost for three months plus nominal service charges. Registration on TReDS has been made mandatory for public sector enterprises by the government. As the public sector is a big ticket buyer for a large number of MSMEs, it is expected that a critical mass would be easily obtained by the system to start rolling. Three platforms (RXIL, M1xchange and A.TReDS) approved by the RBI are already active.
There are two clear advantages of using blockchain technology in such a situation. First, maintaining anonymity of invoice raiser is easier. Second, cross trading across multiple platforms is possible without the fear of double invoicing (double-spend problem). It makes the entire chain secure, anonymous, and verifiable at the same time. The credibility issue also gets sorted out.
As TReDS is one of the early examples of implementation of Blockchain in real commerce, we can look at it as torch-bearer of a future era of trade facilitation.
In fact, if the technology and infrastructure are set up correctly there is no reason as to why the entire paper based international trade transactions shouldn’t be moved onto something based on DLT.
However, when it comes to international trade, two further institutional arrangements need to be put in place. They are:
(a) International arrangement to give sanctity to DLT-based transactions through common agreement or laws and
(b) Physical infrastructure for DLT including the system architecture and configurations.
The first point can be integrated with the trade facilitation efforts in the next stage at the WTO. It could be augmented through efforts at making model laws and best practices at UNCITRAL/UNCTAD. The second part is where individual governments and private sector would have a greater role to play.
We have proved with TReDS that we have the ability to push it. India could become a leader if we take the initiative at blockchaining the entire gamut of international trade transactions. It might indeed be a 21st century issue that India might like to discuss at the WTO.

Apr 15, 2018

Strategic manufacturing growth - tariffs and policy nudges

(This post was originally published at Swarajya magazine https://swarajyamag.com/economy/building-a-manufacturing-ecosystem-screwdriver-technology-will-show-the-way) 
image for Strategy for Manufacturing sector growth in india

India has become world’s second largest mobile phone manufacturer in the world after china. While there are reasons to cheer, there is also a feeling that we are at the screwdriver level technology when it comes to electronics hardware manufacturing. We bring in most of the components and assemble them here using screwdrivers. The critiques use the term screwdriver technology to deride such activities. What many of them miss is the fact that usually such screwdriver technologies are the stepping-stones to upper levels of value chain. And while at it, the millions who turn the screwdrivers have a job.
During early 2000s I used to work in the engineering product development at an Indian firm. We designed the components in house, did all validation tests, and launched the products in the market. My skills got me a well paying job with a US multi-national corporation that had newly set up an engineering service centre in India. I was one of the first dozen employees there. Once I joined, I was placed in front of a computer and asked to do something called ‘engineering change note’ (ECN) work the whole day. The drawings arrived from US, through secure online mode, necessary minor changes were carried out at the center, and then the drawings were uploaded for checking and approval by the US parent. I never saw the actual product. It was frustrating and after a couple of months I barged into my manager’s cube to vent. The manager, a US-returned Ford motors veteran, told me coolly, “Son, keep at the ECN for some months, then I will get you 2D to 3D conversion work.” That 2D to 3D conversion work was just a miniscule step above in value chain than what I was doing. It was frustrating.
Recently, I visited the same facility after many years. The centre now employs more than a 1,000 engineers and carries out advanced engineering work including product conceptualisation and development. They have a full-fledged product-testing lab that carries out the product validations. The journey took less than 15 years for the centre. The ECN work was the screwdriver technology. The current work they do is cutting edge. There are thousands of such engineering centres in India today, falling somewhere along the spectrum that spans from ECNs to engineering system modelling. Most of them started with ECNs or 2D to 3D drawing conversions. The same story holds for IT services where we started out as Y2K bug operators, a screwdriver technology. When one spots a screwdriver, one should look at the direction it points to. Usually they point to the next level.
The same holds for manufacturing, but for two differences. First, goods face tariffs at borders and tariffs play a role in determining the technology that is developed in the country, which I shall discuss below. Second, manufacturing of goods, especially consumer goods, electronics hardware and advanced engineering products, has moved to global value chains (GVCs) in recent decades due to discretisation and specialisation of production steps, and containerisation of cargo, which led to ease of transportation.
The goods pass through tariff barriers whenever they cross borders. If the tariffs for parts as well as the finished item were to remain same, screwdriver plants would vanish, as completely assembled items would then be shipped in directly. Therefore, policymakers design tariffs in such a way that progressively higher value added products face steeper tariffs. This works in a tiered manner. The screwdriver assembly lines come up first. Then simple sub assembly lines would form. Then comes the component localisation. And finally we end up with the complete product being manufactured and assembled in the country. It might not always work the same way or in that order, but that’s the overall drift if things go as planned. The auto industry is a good example of how this worked. The sector was opened very gradually during the 90s. It still is one of the guarded industries, making US President rant against the high tariff walls on Harleys sent to India. But the calibrated move helped the sector.
On the other hand, WTO’s Information Technology Agreement (ITA1) ensured that tariffs on electronic hardware items covered through the agreement were brought to zero, and this stunted the growth of electronics hardware manufacturing in India. It made more sense to pick up the electronic hardware from ‘factory Asia’ (China, Japan, ASEAN) and ship them to India. There is a counter point that lower priced electronics helped the information technology (IT) service sector grow. However, this counterpoint does not factor in the loss to hardware manufacturing and associated jobs that never materialised, or the fact that IT services mostly operate out of zones such as software technology parks of India/special economic zones (SEZs), where duties anyway are zero for all imports. Add to it the loss in technology development, and we can easily see why it was a bad idea. The argument here is not that we should have high tariff walls everywhere; but that the policymakers need to pick and choose the way the tariffs are structured for each sector in order to help manufacturing. There is no point in dropping all tariffs to zero in the name of free trade.
It must however be noted that not all sectors are amenable to a mere structured tariff policy alone. For example, chip making or silicon wafer manufacturing technology operates at economies of scale and requires initial sunk research and development (R&D) costs, and this needs a massive initial push and support. Mere tiered tariffs will not convert the solar module makers of India, a simple assembly operation, into silicon ingot makers or wafer dicers even after decades. Further, handholding is required for that to happen. This is being done through efforts such as M-SIPS programme of MeitY, which is trying to boost electronics hardware manufacturing. Such dual effort of tariff structuring and handholding is required in multiple sectors to cajole the manufacturing into growth phase. Critics who lament every tariff hike or state led support as Nehruvian economics miss the point here. There is nothing wrong in thinking in that direction. It might appear to some as a return to licence-permit raj, but given the amount of efforts the government is putting towards automatic approvals and ease of doing business, it is wrong to compare this to the pre 90s era. The interfaces are fast moving online for all kinds of public citizen interfaces, right from customs clearances to industrial approvals. When China talks about ‘Made in China 2025’ and focuses on key sectors, they are actually talking about strategising such state support. It is a common developmental strategy.
The second often talked about matter in recent years is about how global value chains (GVC) has changed the way manufacturing is carried out. This is visible especially in sectors such as automobiles and electronics. The ‘designed in California assembled in China’ iDevices model is an example of GVC in operation. China adds less than 10 per cent of value to a typical iPhone, which is actually a product of multiple countries with each contributing various components and inputs.Being a part of GVC is important in order to bring in jobs in these sectors. If zero custom tariffs implied automatic participation in GVC, India should have become tightly integrated with ‘factory Asia’ long ago. We had cheap labour, zero or low tariffs on most electronic components and SEZ facilities where custom duties are zero for imports.
Therefore we should have automatically got integrated into the GVCs in a meaningful way. That didn’t happen to the extent we wanted. For sure, the trade in value add statistics for India makes us look good as long as we see the value added percentages alone. When we look at the quantum of trade, we are far below the expectations. Low tariffs is just one variable for GVC participation. In addition, we need infrastructure, skills, R&D investment, ease of doing business and supportive policies in order to gain the required competitiveness to be a significant GVC player. The government is moving in that direction.
That brings us to the point that the time in our hands is very limited given the twin factors of advancement of automation in manufacturing and what we call as peak trade phenomenon. The automation would soon disrupt the labour cost advantage. We need to strategise keeping this in mind. Only upskilling and increased productivity would keep us in the run for future. The appetite for old world way of discretisation of manufacturing is on the wane. The stalemate at WTO, threats of tariff wars, and the rise of anti trade sentiments is a testimony that probably the best of opening up days are behind us.
Developing a strong manufacturing sector is not an option but a necessity. We are in a different century, with unique challenges like automation, yet it would help us look at the experience of those who got the manufacturing right. A good example is China. They opened up with screwdriver level technology jobs, forced foreign companies to transfer technology through local partnerships, maintained cheap currency for decades, provided state subsidies and incentives, and used all tricks available in policymaker’s book to become a leader in manufacturing. South Korea followed neo-mercantilist trade policies up to early 80s to grow its exports machine. MITI played an important role in development of Japanese industry and exports. Had all these countries followed a universal low tariff theory during their stages of industrial infancy, they might probably not have ended up with the same results.
Here, one must caution that such state actions at times might generate unintended consequences and hence cannot be a blanket recommendation. However, one cannot deny that these examples demonstrate that a determined state which runs a systematic industrial and trade policy plays an important role in growth of manufacturing and exports. India is waking up to a synchronised industrial and trade policy where the government is looking at playing a facilitator’s role. There is nothing wrong if a tariff is hiked here or there for valid reasons. Or if some rudimentary assembly plants pop up in the interim leading to doubts whether ‘Make in India’ has ended up with just ‘assemble and sell in India’.
When I quit the private sector for a government career, I was working in area of system simulation of flight controls at Airbus, the biggest airplane maker in the world. That was as cutting edge as it got for me. The ECN job was a stepping-stone in my career. I am sure the screwdriver turning jobs of today would vanish sometime in a generation or two. We need to prepare for that future by moving up the value chain and preparing a solid manufacturing sector. The strategising and push must come from the state. I fail to see how it could be achieved otherwise.

Apr 3, 2018

Commercial Blockchain application in mainstream commerce - An India Example

I have been a supporter of Blockchain technology (the keypin of crypto currencies) for long time now. I had blogged about the utility of secure open-ledger transactions here and here. Blockchain applications can be extended to virtually a lot of fields and international trade is one of them. India is at decent level of technology application when it comes to blockchains, as opposed to the shoddy levels we display when it comes to AI and machine learning applications in public policy sphere.

To cite a good example of blockchain application in mainstream commerce, we can look at the Trade Receivable Discounting System (TReDS) guidelines of RBI, which sought to set up a system to ease the liquidity crunch for MSMEs by way of bill/invoice factoring in the financial market for the supplies made to big corporates. 


image of blockchain factoring MSME India M1xchange
Blockchain technology behind MSME liquidity solution

I shall briefly explain the simplified process under TReDS with an example (or see image below). Let's assume Mismi enterprise, which is an MSME, supplies items to Bigcor, a corporate house. Usually Bigcor takes three months to settle the payments after the delivery of goods. This holds up Mismi's working capital for three months leading to liquidity cruch for Mismi. Mismi's efforts to convicne Bigcor to make earlier payments doesn't work as Bigcor has market power to dictate terms to Mismi and other such suppliers. With the advent of TReDS, Mismi uploads the digitally signed invoice on one of the three platforms currently approved by RBI. The upload is done after the supplies are made to Bigcor. Bigcor gets a time window (say of 2 days) to approve the invoice online, thus verifying the authenticity of the supply and the commitment that it would pay the sum against the invoice raised within three month (or agreed time frame). The approved invoice can now be factored on the platform, through auction,  by the financial intermediaries like Banks/NBFCs. For example, BigBank may buy the inovice at a discount and pay the money to Mismi, thus ending the liquidity crunch immediately. The actual payment would be realized by the BigBank after three months from Bigcor. In an ideal competitive marketplace the discount should equal the interest cost for three months + nominal service charges. Registration on TReDS has been made mandatory for the public sector enterprises by the government. As public sector is a big ticket buyer for a large number of MSMEs, it is expected that a critical mass would be easily obtained by the system to start rolling. The three platforms are already active. They are RXIL, M1xchange and A.TReDS

image of TReDS Process - blockchain invoicemart - From A.TReDS website
TReDS Process - Simple process flow - From A.TReDS website


When the system was initially set up, there were apprehensions that the big corporate bodies were uncomfortable with the identities of their suppliers being revealed online. Now the platforms have come up with the solution that includes the blockchain. I see two clear advantages of using blockchain technology in such a situation. First, maintaining anonymity of invoice raiser is possible.  Second, cross trading across multiple platforms is possible without the fear of double invoicing. It makes the entire chain secure, anonymous, and verifiable at the same time, in a way the simple digital key encryption cannot.

As TReDS is one of the early examples of implementation of Blockchain in real commerce, I see this as heralding an era of trade facilitation through e contracts, secure e waybills, secure letters of credit, bills of lading, international factoring and forfaiting services and so on. In fact, I don’t see a reason as to why the entire paper based international trade transactions including title of goods (currently the paper bill of lading) shouldn’t be moved onto something based on blockchains which are maintained through peer to peer open ledger platforms.

This would need two further institutional arrangements to be put in place:

A) International arrangement to give sanctity to these transactions through common agreement or laws
B) Infrastructure support to develop and maintain the basic structure of the transactions or the marketplaces - either through private parties or through a multinational consortium.

While A can be integrated with the trade facilitation efforts in the next stage at WTO, and through  efforts at making model laws and best practices at UNCITRAL/UNCTAD, part B has to be a joint or multilateral effort by the leaders in the field. Both are doable. The technology is there. We need to gather the will to push it. Probably India might be a leader if we take the initiative. It can indeed be a 21st century issue that India might like to discuss. 





Mar 23, 2018

Rethinking Export promotion in the era of trade wars

(This article was first published few days ago on Swarajya Online Magazine with the heading "Export promotion in the era of trade wars" at this link)
The newspapers are awash with analysis of President Donald Trump’s tariff hikes and the subsequent threat by United States Trade Representative (USTR) to pull India to World Trade Organization (WTO) dispute panel for maintaining export subsidies to the tune of $7 billion. The current popular narrative revolves around how the US’s tariff move is bad for the world trade, and why India should stick to the stand of promoting multilateralism in international trade. The arguments are usually sound and include the fact that there is ultimately no winner in a long drawn trade-war. However, it is important to understand and analyse the matter in more depth, as the stand we take now would affect the direction of our industry and trade policies in future. In addition, it is also important that we understand and account for the emerging big picture in order to fine-tune our strategy for future.
The pundits and the papers have been almost unanimous in declaring Trump's tariffs economically harmful to the US. However, what they miss is that Trump is trying to do a Reagan of 80s who extracted so-called ‘voluntary export restraints’ (VER) from the exporters to the US. When Reagan went hard on trade and imposed tariffs on a wide range of goods including textiles, automobiles, electronics etc, people warned and recalled the horrors of Smoot-Hawley Act of 1930s, when tariffs destroyed trade and exacerbated the depression. That didn’t stop Reagan from going ahead. While it is debatable if VERs helped the US economy, it did make for a good PR, especially when the agreement with Japan was reached. It paved the way for low resistance towards further globalisation in the next decade when WTO was founded.
Today when Trump talks about reciprocal tariff measures and imposes duties on items ranging from washing machines to steel, one needs to factor in the need for Trump to do a good PR on this front. Renegotiating ‘bad’ trade deals has been one of the key planks on which Trump got elected. To that extent any discount that Trump extracts through the noise and actions would make for good PR. Only this time the world might not be ready to accommodate the US, and the US economy might indeed suffer more than it gains. Nevertheless, we should expect the noise to last the term at the least.
That brings us to India, as India has started figuring lately in Trump’s trade talks, after China. He has not taken kindly to high tariffs India maintains on some items. A favourite of Trump has been the tariffs India imposes on motorcycles (50 per cent) versus the tariff the US imposes (zero). Despite the recent reduction in duties by India, Trump was not happy. It doesn’t matter that US President’s favourite export product constitutes almost 25 per cent share of India’s motorcycle imports, whereas the US figures at 22nd place in the list of countries to whom India exports the item, with a share of 1 per cent in total (read more for details). Trump quoted the tariffs imposed, called it unfair, and warned about imposing reciprocal tariffs. A few days later USTR came down heavily on India’s alleged exports subsidies and sought consultations. Trump’s rants are less harmful than potential USTR actions.
To start with, one may safely ignore Trump’s threat of reciprocal tariffs on countries such as India as it is not easily implementable unless the US decides to violate the principle of most favoured nation (MFN) at WTO. If done, it would lead to unraveling of WTO and the rule-based trade ecosystem that the US has helped build over decades. While the US has undermined WTO in the recent years through measures such as blocking appointment of judges at dispute panels, it is safe to assume for the time being that the US is not willing to break the system completely. This is attested by the fact that when Trump imposed tariffs on steel and aluminum, he used the pretext of ‘national security’ in order to not fall foul with the WTO rules.
The USTR’s allegation that India provides export subsidies is partially true as acknowledged by Indian counterparts. Therefore, greater danger lies in the potential actions that USTR may propose if the consultations fail. India needs to be wary about it. The timing couldn’t have been worse given that India’s exports are slowly showing an uptick despite recent shocks to the economy. India has defended the move well so far. Under the agreement on subsidies and countervailing measures (ASCM) of WTO, certain exemptions and remissions are allowed. India would easily defend allegations on some of the schemes that she runs for export promotion; especially the ones where the indirect taxes are nullified. Other exemptions such as special economic zones and export-oriented units would take deft to defend by proving that they do not violate the spirit of ASCM. Some schemes such as merchandise export incentive scheme would be difficult to defend in the long run.
India was supposed to stop the subsidies once it reaches the GNP per capital level of $1,000 (ASCM Annex to Para 2(a) of Article 27), after 2015. There, India has taken the correct stand that a time of eight years to phase out the subsidies as mentioned under ASCM should be allowed, as allowed for other members at the time of agreement. In the end, it all boils down to the consultation process, and how well it is handled. There is a good likelihood that the consultations might go well and the countries reach an agreed middle ground. However, the allegations should act as a warning for the policymakers in future.
In a developing economy context, it is difficult to dictate that governments should stay away from all kinds of subsidies and assistance to industrial growth. The non-actionable subsidies allowed as per ASCM under Article 8 include research and development (R&D) support, generic support to disadvantaged geographical areas, and one-time assistance to comply with new environmental regulations. In addition, indirect tax nullification is allowed as per general rules. Apart from these any kind of direct or indirect support can be quantified under subsidies. Annexure I to ASCM maintains an illustrative list of export subsidies that covers almost everything that the government does in the name of export promotion/industry development, and effectively leaves little flexibility to the government to help the industries.
Therefore, the coming years should see industrial and trade policies aligning to these requirements. A good way to move forward would be to let the individual states formulate their export strategies. The individual state level solutions catering to local industries and trade would be more difficult to quantify and countervail. Assistance in the form of alleviating pain areas in industry development through process simplifications, easier documentation, support for integrated logistics infrastructure, R&D support for key sectors and special packages for backward districts would not fall foul with ASCM requirements. Government is already moving in that direction.
In addition, it is time India prepares its own team to counter bodies such as USTR. There is a severe manpower crunch when it comes to countering ASCM allegations from other countries. In addition, offense may be best form of defence in trade matters. The team should also research on potential subsidies provided by other countries and launch investigations aggressively. India may do well to groom and train a dedicated sizeable team of hundreds to man these positions. International trade has evolved from being a pastime for economists to being a part of strategic arsenal for a nation. One needs dedicated teams working full time on these matters.
Finally, India should continue with the principled stand of multilateralism in international trade. It is heartening to see that India is hosting informal talks for trade ministers and officials from WTO on 19-20 March. While bilateral and regional partnerships may have their charm, there is nothing that matches the WTO in terms of reach and potential. Many a times India has been singled out as being the deal breaker, yet the unwavering faith in multilateralism that India has shown at WTO is not easily matched.
WTO’s continued importance is underlined by the fact that despite efforts to dilute the effectiveness of dispute settlement mechanism in the recent years, the US still uses it to settle disputes with other members. WTO has shown the way to accommodate the less endowed members through the special and differential treatment clauses, and more often than not, has helped countries gain through trade. If we keep at it, probably in a decade or so, these years might appear like the Reagan era that ushered in hyper globalisation in the next decades, and today’s discontents.

Mar 20, 2018

GST long term positive for tax collection - More evidence

Image of GST effect on tax compliance
GST effect on tax compliance

Yesterday, Bibek Debroy commented that it might take around 10 years for the GST to settle down. That might be so, but some effects might start showing quite early. One of the effects I am very keen to see is the effect of computerised invoice matching between suppliers and recipients.  This matching should ideally eliminate mis/under invoicing over a period of time as the participants in the value chain realise that compliance is better than the efforts required to maintain informal accounts, and is not commensurate with the risks associated. This effect, I felt all these days, should not take more than two years. Two years should be the rough time period when a new system rolled out at a scale of our country emerges out of the teething troubles. Or so was my hunch. 

Looks like the period indeed is around that much as per this NBER working paper by Fan, Liu et al.  It is a study of effect of computerisation of VAT in China during early 2000s. The study found that most of the good effects of tax increase due to computerised invoice matching are found in first three years before stabilising onwards. In terms of growth, this study of 7 years data post computerisation summarises thus: 
"In terms of magnitudes, the estimates imply that computerization caused the effective tax rate to increase by 4.7% in the short run, 14% in the medium run and 11.7% in the long run, from 4.95 to 5.19-5.65 percentage-points, and explains 14.38% of all VAT revenues during 2001-2007. Thus, the effect on government revenues is sizable."

The formalisation of economy is an important side outcome of invoice matching through computerisation. The paper uses a method similar to difference-in-difference (DnD approach was also used recently in our economic survey to isolate the effect of export incentives on textile sector). It appears to me that the study has done a good job at eliminating confounding factors such as economic growth post WTO and sectoral effects. It is a good read and the results seem directly transferable to Indian context. 

Another insight from the paper is that the compliance in indirect taxation had no spillover effect on other forms of taxation. So those expecting a corporate or income tax windfall might be disappointed: 

"An interesting question is whether strengthening the VAT information chain had positive spillover effects in the enforcement of other types of taxes. We examine corporate tax payments, which are also reported in our survey data. Table 8, column (1) shows that the interaction coefficients are positive but statistically insignificant. Thus, there is no evidence of positive spillovers.
The result on corporate tax is also interesting for another reason – it provides evi- dence against the concern that our main finding that computerization increased VAT is confounded by general improvements in tax enforcement."

Did the firms export more to avoid VAT as exports VAT paid is rebated? The papers says that no such effect was statistically present. So the domestic taxation didn't drive the participants to turn exporters. 

In the end, the simple effect of computerisation (or computerised invoice matching) seems to be that it increased the compliance and tax collection by bringing in more formalisation. That alone would be a significant achievement for GST. Three years are not that long. Mr Debroy should agree.