Monday, February 22, 2021

Blame it on B schools!

McKinsey, the iconic consulting firm, has got embroiled in several controversies in recent years. The latest is the opioid scandal in which it advised a pharma company to offer "rebates' to pharmacies based on the number of people who died or became addicted to its opioid. The firm has had to pay nearly $600 million to settle charges brought against it by law enforcement agencies in the US.

Tom Peters, an ex McKinsey consultant and management guru, tells us who is to blame: B-schools. They focus too much on the hard issues-  finance, marketing, quant- and too little on culture and people. Businesses, he says, need to focus on the "moral responsibility of enterprise", not just on maximising shareholder profit, as Milton Friedman had urged businesses to do.

So the fault is that of B- schools or of businesses? Is there a market for the  idea of the "moral responsibility of enterprise"? Can B- schools change businesses by drilling moral responsibility into their wards? 

They certainly can't be faulted for not trying. Most top schools offer at least one course in Ethics. There are plenty of courses on leadership, including those that expatiate on the "lessons" in leadership to be learnt from Mahatma Gandhi, the classics of literature, the Gita and  the rest. I recall asking a student about the course in Ethics at IIMA. She gave me a memorably reply, "We haven't come here to take lessons in moral science".

Now 78, Tom Peters can afford the luxury of selling the 'moral responsibility to enterprise' to the credulous. Not so those trying to make it up the corporate ladder. Try preaching the 'moral responsibility of enterprise' to your boss who is looking to meet his quarterly sales or profit target. You may find you have to switch from being a manager to being a preacher. Ensuring compliance with law and regulation itself is a huge challenge in the world in which live. A manager has to be very brave to attempt anything beyond that. 

Peters talks of the good old days at McKinsey but is honest enough to mention two friends of his from those days, Jeff Skiing of Enron fame and  Rajat Gupta, ex MD of McKinsey, both of whom ended up in jail. Peters also mentions how he nearly lost his job. And it wasn’t for preaching high-minded stuff. Peters’ crime was that he had written a best-selling book that focused on organisational culture and people rather than on strategy, which was McKinsey's staple. This infuriated one of his bosses. 

Peters is right on one point. McKinsey's problem today could be its sheer size: $10 bn in revenue and 30,000 staff worldwide. Having to grow revenues on such a base would be a challenge for its bosses- and cutting corners becomes inevitable. Not much room for the ‘moral responsibility of enterprise’.

Saturday, February 13, 2021

Privatisation myths and realities

There is no economic topic, perhaps, on which misconceptions are as pervasive as privatisation.

Let me address a few:

i. Private firms are always more efficient that state-owned enterprises (SOEs): Not really. Comparative performance depends on a number of things- regulated versus competitive industries, developed countries versus less developed countries, 100 per cent SOEs versus listed SOEs. In regulated industries, many studies show no difference in performance. In advanced countries with developed capital markets and good governance structures, private firms do better but not  so much in less developed countries. Again, many of the comparisons where SOEs fare poorly relate to 100 per cent government-owned entities. Where the government exposes SOEs to competition and subjects them to market discipline through listing on exchanges, SOEs fare much better. In India, many SOEs showed an improvement in performance consequent to listing.

ii. Under-performing SOEs should be sold off to private parties, then performance will improve: Not true. A change in ownership by itself may not translate into improvement in performance. The valuation of the SOE has a bearing on the outcome. Let us say a listed SOE is sold below its correct value at a time when stock market prices are generally depressed. The new owner has merely to wait for the market to recover to meet his return threshold. He does not have to exert in order to improve firm efficiency. The method of sale or the design of privatisation is thus critical to the outcomes that follow.

iii. Improved performance of SOEs post privatisation shows private ownership is superior: Wrong. SOE  performance often suffers for want of capital- governments facing fiscal constraints are unable to provide the capital needed for modernisation and growth. When the firm is transferred to a private owner, capital comes in and performance improves. Managerial competence is not the factor. Then, privatisation of SOEs is often a long drawn-out process. During the period, managers have little incentive to perform. Once sold, managerial focus returns and performance improves. It is not the change of ownership per se that has contributed. Many SOEs shed flab and streamline operations in order to make themselves attractive to private owners. The results show up over time - and are incorrectly ascribed to a change in ownership.

iv. Auctions automatically result in the sale to the highest bidder and hence ensure improvement in performance post privatisation: Well, no. Much depends on whether the auction is efficient. This requires numerous conditions to be satisfied: multiple bidders, the absence of collusion, opening up to domestic as well as international bidders, etc. In practice, these conditions are rarely satisfied. The auction is not efficient and the firm does not necessarily past into the hands of the most deserving private party. As a result, improvement in firm efficiency may not happen nor will the government have succeeded in maximising revenues through privatisation.

v. What applies to non-financial firms applies to banks as well: Wrong. One of the important considerations in selling off SOEs is that they will then cease to make demands on government capital. In banking, however, the government remains responsible for rescuing all but the smallest of banks. The considerations that apply to privatisation of non-financial firms do not, therefore, apply to banks. Bank privatisation requires to be handled with a great deal more caution.

More in an essay on privatisation I have penned for The India Forum. 

Friday, February 12, 2021

Financing the deficit through privatisation is a high-risk approach

'We are a fiscally prudent government'. That's the line one heard from the government during the pandemic. This was in response to the clamour for a larger discretionary fiscal stimulus. The budget for FY 22 discards this line. What might have prompted the government to do so? Three considerations have been cited by officials and commentators:

i. The higher deficit is okay because it's for a good cause, more capital expenditure

ii. Larger deficits will mean higher growth so we don't have to worry about the deterioration in public debt in the near future

iii. Asset sales will finance a higher proportion of the deficit than before. Sale of PSUs is a major reform that will again deliver higher growth.

I argue that none of these arguments is entirely convincing. Nevertheless, it's good if the fetish about the 3 per cent fiscal deficit to gdp ratio is discarded. We can live with higher deficits. If the government as well as market analysts recognise that, it's a welcome change.

More  in my BS column, What explains the Budget's fiscal stance?




Headline: What explains the Budget's fiscal stance?


Athough the budgetary exercise has made a virtue out of necessity, the policy change could end up having a happy outcome


The deficit numbers in the Budget for 2021-22 are way above what analysts had expected. Hardly anybody had expected the fiscal deficit to end up at 9.5 per cent of gross domestic product (GDP) in 2020-21 and 6.8 per cent in 2021-22.


Through the pandemic, few would have thought that the government would discard the Fiscal Responsibility and Budget Management (FRBM) Act for the foreseeable future. The decision to limit the discretionary fiscal stimulus to around 2 per cent of GDP had indicated that the government was limiting the stimulus in order to return quickly to the path of fiscal consolidation once the pandemic had subsided.  It turns out now that, instead of limiting the stimulus, the government has merely chosen to spread it over two or more years. 


Clearly, the government decided on a change in fiscal stance somewhere along the line. What might have prompted it to do so? The shortfall in revenues in FY21 seems to have been the decisive factor. The shortfall was a staggering Rs 4.65 trillion. On the base of revenues for FY21, containing the deficit for FY22 at lower than 6.8 per cent would have required an increase in taxes and a cut in expenditure that would have derailed the ongoing economic recovery.


Far better to forget about the FRBM Act and live with a higher fiscal deficit up to 2025-26.  Fair enough. The challenge for the government was to make a virtue of necessity. From the finance minister’s Budget speech and the statements made by various officials, it appears that the government is making three arguments in favour of the change in fiscal stance.


First, there is a shift in expenditure in favour of capital expenditure —it’s not the old story of borrowing to finance revenue deficits. Capital expenditure rises by 31 per cent in FY21 revised estimates relative to actuals in FY20 and 26 per cent in the budget estimates of FY22 relative to revised estimates for FY21.


There is reason to be sceptical about both estimates. Former economic affairs secretary Subhash Garg calls the increase in capex in FY21 an “optical illusion”.  One item that contributes Rs 79, 398 crore is a special loan intended to provide liquidity support to the railways. This qualifies as revenue expenditure. Another item of Rs 12,000 crore is a loan to states. Take these two items away and capital expenditure in FY20-21 rises by a mere 3.6 per cent.


As for FY22, the increase in capital expenditure is on account of several infrastructure projects. Infrastructure projects in government take time to materialise, so spending the budgeted amount in a given year is difficult. On past showing, the increase in capex will likely be considerably less than 26 per cent.  


A second argument for the shift in fiscal stance is that growth fuelled by higher capital expenditure will take care of the fiscal deficit. The latest Economic Survey devotes a chapter to this argument. It argues that, in high growth economies such as India, the usual arguments about sustainability of public debt do not apply. Especially during an economic downturn, it makes sense for the government to borrow and spend because growth will ensure that public debt does not spiral out of control. We also need not worry about the crowding out of private investment, especially if public investment is directed at high multiplier areas such as infrastructure.


None of this was unknown to successive Finance Commissions. Nevertheless, Finance Commissions have insisted on adherence to conservative targets of fiscal deficit and public debt. They had reasons for doing so.  The central and state governments have large contingent liabilities. Large external shocks — oil shocks, a global financial crisis and, now, the pandemic — can derail growth for long periods, so having a fiscal buffer is prudent. The rating agencies do treat advanced and emerging markets differently in respect of public debt. The Economic Survey thinks, as an earlier Survey did, that this is unfair. Well, it is an unfair world that we live in.   


It has been recognised that, if GDP growth in India is above 7 per cent, debt sustainability ceases to be an issue. The Economic Survey contends that India does not face a debt sustainability issue even if real growth is a mere 4 per cent in the next 10 years. If that is indeed so, one wonders if we need an FRBM Act at all.   


A third argument is that the old fiscal limits are not valid in the brave new world of reforms. A rising tax/ GDP ratio has long been thought the key to fiscal sustainability. Earlier budgets used to project a rise in the ratio, whatever the setbacks from time to time. There are no such projections in the latest Budget. In FY19, the centre’s tax/GDP ratio was 11.9 per cent. It fell to 10.6 per cent in FY20 and is estimated at 9.8 and 9.9 per cent in FY21 and FY22, respectively.


With the tax/GDP ratio falling, the government has to look to non-tax revenues to finance expenditure. The government will privatise and not disinvest. In all but four strategic sectors, public sector units (PSUs) will be up for sale. The government will also privatise two public sector banks and one insurance company in the coming year. It will use resources raised from privatisation to create infrastructure assets. These assets, in turn, will be monetised through sale to private parties.


Privatisation is intended to earn revenues for the government and to improve efficiency of assets. The distress sale of assets to finance budgetary deficits is bound to affect government finances adversely in the long term. It also has implications for efficiency. We know from the literature that privatisation that is not designed properly — as will happen if assets are sold in a rush — may not result  in more efficient utilisation of assets.


That apart, one wonders whether large-scale privatisation is feasible at all in our fractious democracy. If disinvestment targets cannot be met year after year, how does large-scale privatisation become feasible? The strategic sales of PSUs of many years ago drew adverse comments from the Comptroller and Auditor General of India. One sale of 2002 has resulted in a Central Bureau of Investigation court asking for charges to be filed against the then minister for disinvestment, Arun Shourie, and four others. Political parties and unions will oppose the moves vigorously and, indeed, a federation of bank unions has already called for a two-day strike in March.


The strategy of financing higher government capital expenditure through asset sales is thus likely to have only limited success. We will have to find ways soon to raise the tax/GDP ratio. There could, nevertheless, be a happy outcome from this year’s budgetary exercise. Both the government and market analysts may have come to realise that India can relax somewhat the deficit targets set out in the FRBM Act without derailing debt sustainability or attracting a rating downgrade.


Thursday, February 11, 2021

Government advertising poses threat to newspaper independence in Britain

The biggest advertiser in Britain is not Amazon, Apple or Nike - it's the government, writes Chris Sweeney in RT. How independent can newspapers be if they are so dependent on the government?

On the day of writing (February 10), across six national titles – Daily Express, Daily Mail, Daily Mirror, Daily Star, the Daily Telegraph and the Guardian – there were a staggering 15 pages of government advertising, not counting any supplements. Compare that to the next biggest advertiser on that day in the same titles.

It was the nation’s biggest supermarket chain, Tesco, who reported a 29 percent rise in profits, with four pages. The next biggest was supermarket Asda, bought recently for £6.8 billion, with one and half pages. Budget supermarket chain Aldi and telecommunications firm TalkTalk followed with a single page.

Sweeney argues that this has taken a toll on the reporting on the pandemic:

The newspaper industry has been asleep at the wheel during the pandemic. No hard questions or investigative reporting was done....

But there was a real cost to the newspaper industry's soft soaping: the UK has the highest number of deaths in Europe, with over 113,500. There were embarrassing gaffes, due to an initial lack of scrutiny. 50 million face masks were ordered that couldn't be used, part of a £156 million contract. That was topped by a Royal Air Force plane flying to Turkey to collect gowns. After a ridiculous standoff, the plane finally flew home, but all of the 400,000 didn’t meet standards and were useless.

The British public have been let down by their news-gatherers. There are routine calls for reporters to hold Boris and his ministers to account, along with the leaders of the devolved parliaments – Nicola Sturgeon (Scotland), Mark Drakeford (Wales), and Arlene Foster (Northern Ireland). But the bad news is that when the hard questions needed to be asked, the government’s advertising honeypot kicked in. Now the newspapers are hooked and need the money, so are they really digging as deep as they can?

Wednesday, February 10, 2021

The FRBM Act is dead

The budget for 2021-22 formally buries the FRBM Act. It has been buried informally over the past decade and a half through the 'pause' button on consolidation, invoking of the 'escape 'clause', etc. If something can't be achieved over 18 long years, it is unlikely to be achieved in the next five. The budget finally recognises this reality.

Good. But why the belated realisation after years of pretence? And how is that commentators and the markets seem to applaud the change after years of chastising the government for not practising fiscal prudence? The about-turn is mystifying. 

Commentators who had made a living out of preaching fiscal prudence now see virtue in spending to finance growth. The markets are supposed to be able to peer into the distant future. But the stock market's euphoric reaction suggests it can only look at the immediate year or so. The fiscal deficit will stay well above the FRBM target of 3 per cent until 2025-26 at the very least. The markets couldn't care less. Am I the only one who is baffled?

There's  a buzz in the air about reforms. The government has finally announced big bang privatisation. The markets sees this as a decisive break from our socialist past and a shift in favour of the market. I am at a loss to comprehend how large-scale privatisation can be accomplished in a country that has found it difficult even to pursue disinvestment. 

It is more likely that asset sales will fall below expectations. So will capital expenditure that is premised on non-tax revenues. Fiscal consolidation will become inevitable but we can think of higher fiscal deficit targets than the ones enshrined in the FRBM Act. Post the pandemic, the markets and rating agencies seem to be willing to live with higher deficits and public debt.

My article in the Hindu, A goodbye to fiscal orthodoxy..  


A goodbye to fiscal orthodoxy

Budget 2021 is a departure from a key tenet of the Washington Consensus — macroeconomic stability

T.T. Ram Mohan

Enough of fiscal orthodoxy. Spend like there is no tomorrow. That is what the Narendra Modi government’s Budget for 2021-22 seems to signal with its fiscal deficit at 9.5% of GDP for FY21 and 6.8% in FY22.

A mix

The change in fiscal stance is part of a selective departure from market orthodoxy that has marked the government’s economic policy in the last few years. The government has increased duties on some imports in order to protect and foster domestic industry. It has introduced performance-linked incentives for designated sectors, something that goes counter to market economics. The government is, however, happy to adhere to other elements of market orthodoxy, such as privatisation and a greater role for foreign direct investment (FDI).

To comprehend the shift in fiscal thinking, you only need to compare one document in the Budget with that of previous years. This is the document titled Medium Term Fiscal Policy cum Fiscal Strategy Statement ( The document begins with a table on various fiscal indicators.

In previous years, the document would give the indicators for the past two years as well as the projections for the next two years. The idea was to show that the economy was moving along a fiscal consolidation path, with a fiscal deficit of 3% of GDP as the eventual target. In this year’s Budget, the yearly projections are missing. All we have is a commitment in the Finance Minister’s speech to lower the fiscal deficit to 4.5% of GDP by 2025-26.

For well over a decade-and-a-half, we have kept up the pretence of attaining the deficit targets set out in the Fiscal Responsibility and Budget Management (FRBM) Act (2003). In this Budget, the pretence goes out of the window. The Finance Minister has promised to introduce an amendment to the FRBM Act to formalise the new targets.

Moving away from framework

The Budget thus marks an important departure from one of the key tenets of the Washington Consensus, the framework for market-oriented economics which has dominated policy making in most parts of the world. ‘Macroeconomic stability’ is central to the Consensus. ‘Macroeconomic stability’ means that government budgets need to be broadly in balance so that borrowings to finance the deficit are kept to the minimum. ‘Austerity’ became something of a mantra. It has been bitterly contested in recent years, especially in Europe, but austerity won the day until the COVID-19 crisis struck.

The Economic Survey that preceded the Budget laid the groundwork for a departure from a rigid adherence to fiscal consolidation. It has a quote from economist Olivier Blanchard, “If the interest rate paid by the government is less than the growth rate, then the intertemporal budget constraint facing the government no longer binds.”

The “intertemporal budget constraint” means that any debt outstanding today must be offset by future primary surpluses. Blanchard was saying that this is not true if the Interest Rate-Growth Differential (IRGD), the difference between the interest rate and growth rate, becomes negative. In the advanced economies, as interest rates have turned negative, Blanchard’s condition has been met. So governments there do not have to worry that deficits will render public debt unsustainable.

‘Spend more’

The International Monetary Fund (IMF) and the World Bank, both flag-bearers of the Washington Consensus, have been urging a departure from fiscal orthodoxy in the wake of the pandemic. Both these institutions used to be wary of any increase in the public debt to GDP ratio beyond 100%. Today, they are urging the advanced economies to spend more by running up deficits even when the debt to GDP ratio is poised to rise to 125% by the end of 2021.

The Survey argues that in India, the growth rate is higher than the interest rate most of the time. So the conventional restraints on fiscal policy need to be questioned, especially when there is a serious contraction of the sort the Indian economy faced in 2020-21. It says that, in the current situation, expansionary fiscal policy will boost growth and cause debt to GDP ratios to be lower, not higher. Given India’s growth potential, we do not have to worry about debt sustainability until 2030.

These points are by no means novel; the conditions for debt sustainability are well known. However, the Survey’s line was not accepted in the past. Indian fiscal policy has adhered to orthodoxy even during a downturn, such as the one we faced in the years preceding the pandemic. An important consideration was the fear that the rating agencies would downgrade India if total public debt crossed, say, 10%-11% of GDP. That is a risk that cannot be wished away unless the rating agencies have decided to toe the IMF-World Bank line on fiscal deficits.

Key concerns

Another concern is that a large fiscal deficit can fuel a rise in inflation. It is more than likely that a change in the fiscal consolidation targets will require a change in the inflation target of 4% set for the Reserve Bank of India. The Budget makes no mention of such a possibility. Perhaps the Finance Minister did not want to administer too many surprises at one go.

A third concern is that, with the tax to GDP ratio not rising as expected, the sale of public assets has become crucial to reduction in fiscal deficits in the years ahead. This is a high-risk strategy. For years now, revenues from disinvestment have fallen short of targets. The sale of Air India, which was begun in 2018, is still dragging on.

We need to face up to an important reality: large-scale privatisation is not easily accomplished in India. Selling public assets cheap is politically contentious. There will be allegations of favouring certain industrial houses. Public sector unions are a vital political constituency. Privatisation of banks raises concerns about financial stability. Job losses from privatisation are bound to evoke a backlash.

Privatisation means FDI

Moreover, large-scale privatisation almost always involves substantial FDI. In South East Asia and Eastern Europe, privatisation of banks meant a large rise in foreign presence in the domestic economies. Atmanirbhar Bharat connotes greater self-reliance and stronger Indian companies. How does the government reconcile a rise in FDI with Atmanirbhar Bharat?

If the nation’s political economy came in the way of our meeting the FRBM targets, it is also likely to pose an obstacle to large-scale privatisation. A departure from fiscal orthodoxy is welcome. But the government needs to think of ways to make it more sustainable.