The Report of the Thirteenth Finance Commission Conundrum in Conditionalities

NIPFP Working Paper 76
[PDF]

M Govinda Rao
December 2010

Abstract

The 13th Finance Commission has forayed into a number of areas partly warranted by its terms of reference and partly due to the approach it adopted. The Commission, besides tax devolution, has recommended as many as 12 different types of grants with a plethora of conditionalities. A critical appraisal of the recommendations shows that the transfer system recommended by the Commissions suffers from the same limitations of inequity and perverse incentives as in the past.

The inability to offset the fiscal disabilities of the states leads to giving several grants. Even here, the approach is ad hoc. In particular, the grants recommended for individual states for their special needs is a classic example of ad hoc approach which is arbitrary and judgemental. The recommendations relating to the GST are the ones which have been resented most by the states and actually, this has taken the reform agenda backwards. The “all or nothing” types of conditions do not leave much room for a “grand bargain”.

A major concern is with a plethora of conditionalities imposed by the Commission. Besides the conditions on GST compensations discussed above, there are several conditions stipulated for achieving fiscal consolidation and incentivising local bodies. There are questions on design, implementation, and monitoring of these conditions. These questions leave one suspect that the Commission lost an opportunity to reform the transfer system yet again.

Determinants of Trade Misinvoicing

NIPFP Working Paper 75
[Link]

Ila Patnaik, Abhijit Sen Gupta, Ajay Shah
October 2010

Abstract

Traditional explanations for trade misinvoicing -- high custom duties and weak domestic economies - are less persuasive in a world of high growth emerging markets who have low trade barriers. We construct a 35 country data set over a 26 year span, covering both industrialised and developing countries, to study the phenomena of export and import misinvoicing. Capital account openness, differentials in interest rates, political stability, corruption, indebtedness and the exchange rate regime are identified as factors related to misinvoicing. Trade misinvoicing should be seen as one element of de facto capital account openness.

Foreign Shareholding: A Decomposition Analysis

NIPFP Working Paper 74
[PDF]

Ajay Shah and Ila Patnaik
October 2010

Abstract

Stulz (2005) has emphasised that for home bias to decline, insiders have to reduce ownership so as to make purchase of shares by foreigners possible. We offer a decomposition in the ownership of shares by foreigners into three parts: the change in insider shareholding, the change in market capitalisation and the change in the fraction of outside shareholding that is held by foreigners. As an example, this decomposition is applied to help understand the sharp change in foreign ownership of Indian firms after 2001.

Fiscal Consolidation with High Growth: A Policy Simulation Model for India

NIPFP Working Paper 73
[PDF]

Sudipto Mundle, N.R. Bhanumurthy, and Surajit Das
August 2010

Abstract

In this paper a fiscal consolidation program for India has been presented based on a policy simulation model that enables us to examine the macroeconomic implications of alternative fiscal strategies, given certain assumptions about other macro policy choices and relevant exogenous factors. The model is then used to estimate the outcomes resulting from a possible strategy of fiscal consolidation in the base case. The exercise shows that it is possible to have fiscal consolidation while at the same time maintaining high GDP growth of around 8% or so. The strategy is to gradually bring down the revenue deficit to zero by 2014-15, while allowing a combined fiscal deficit for centre plus states of about 6% of GDP. This provides the space for substantial government capital expenditure, which translates to a significant public investment program. This in turn leads to high overall investment directly and indirectly, via the crowding in effect on private investment, which drives the high GDP growth. The exercise has also tested the robustness of this strategy under two alternative scenarios of higher and lower advanced country growth compared to the base case.

Monetary Policy in an Uncertain World: Probability Models and the Design of Robust Monetary Rules

NIPFP Working Paper 72
[PDF]

Paul Levine
July 2010

Abstract

The past forty years or so has seen a remarkable transformation in macro-models used by central banks, policymakers and forecasting bodies. This paper describes this transformation from reduced-form behavioural equations estimated separately, through contemporary micro-founded dynamic stochastic general equilibrium (DSGE) models estimated by systems methods. In particular by treating DSGE models estimated by Bayesian-Maximum-Likelihood methods I argue that they can be considered as probability models in the sense described by Sims (2007) and be used for risk-assessment and policy design. This is true for any one model, but with a range of models on offer it is also possible to design interest rate rules that are simple and robust across the rival models and across the distribution of parameter estimates for each of these rivals as in Levine et al. (2008). After making models better in a number of important dimensions, a possible road ahead is to consider rival models as being distinguished by the model of expectations. This would avoid becoming `a prisoner of a single system' at least with respect to expectations formation where, as I argue, there is relatively less consensus on the appropriate modelling strategy.

Understanding the ADR Premium under Market Segmentation

NIPFP Working Paper 71
[PDF]

Matthieu Stigler, Ajay Shah and Ila Patnaik
July 2010

Abstract

Capital controls can induce large and persistent deviations from the Law of One Price for cross-listed stocks in international capital markets. A considerable literature has explored firm-specific factors which influence ADR pricing when LOP is violated. In this paper, we examine the interlinkages between Indian ADR premiums and macro economic time-series. We construct an ADR premium index, whereby diversification across firms diminishes idiosyncratic fluctuations associated with each security. We find that the S&P 500 index and the domestic Nifty index influence the ADR Premium Index. Positive shocks to the ADR premium index precede higher purchases by foreign investors on the domestic market, and precede positive returns on the domestic index.

A Floating versus Managed Exchange Rate Regime in a DSGE Model of India

NIPFP Working Paper 70
[PDF]

Nicoletta Batini, Vasco Gabriel, Paul Levine and Joseph Pearlman
July 2010

Abstract

We first develop a two-bloc model of an emerging open economy interacting with the rest of the world calibrated using Indian and US data. The model features a financial accelerator and is suitable for examining the effects of financial stress on the real economy. Three variants of the model are highlighted with increasing degrees of financial frictions. The model is used to compare two monetary interest rate regimes: domestic Inflation targeting with a floating exchange rate (FLEX(D)) and a managed exchange rate (MEX). Both rules are characterized as a Taylor-type interest rate rules. MEX involves a nominal exchange rate target in the rule and a constraint on its volatility. We find that the imposition of a low exchange rate volatility is only achieved at a significant welfare loss if the policymaker is restricted to a simple domestic inflation plus exchange rate targeting rule. If on the other hand the policymaker can implement a complex optimal rule then an almost fixed exchange rate can be achieved at a relatively small welfare cost. This finding suggests that future research should examine alternative simple rules that mimic the fully optimal rule more closely.

The Exchange Rate Regime in Asia: From Crisis to Crisis

NIPFP Working Paper 69
[PDF]

Ila Patnaik, Ajay Shah, Anmol Sethy and Vimal Balasubramaniam
May 2010

Abstract

Prior to the Asian financial crisis, most Asian exchange rates were de facto pegged to the US Dollar. In the crisis, many economies experienced a brief period of extreme flexibility. A ‘fear of floating’ gave reduced flexibility when the crisis subsided, but flexibility after the crisis was greater than that seen prior to the crisis. Contrary to the idea of a durable Bretton Woods II arrangement, Asia then went on to slowly raise flexibility and reduce the role for the US Dollar. When the period from April 2008 to December 2009 is compared against periods of high inflexibility, from January 1991 to November 1991 and October 1995 to March 1997, the increase in flexibility is economically and statistically significant. This paper proposes a new measure of dollar pegging, the “Bretton Woods II score”. We find that by this measure Asia has been slowly moving away from a Bretton Woods II arrangement.

Urban Governance and Finance in India

NIPFP Working Paper 68
[PDF]

M. Govinda Rao and Richard M. Bird
April 2010

Abstract

Over 330 million people live in India’s cities; 35 cities have a population of over a million and three (Mumbai, Delhi, and Kolkata) of the 10 largest metropolises in the world are in India. India’s cities are large, economically important, and growing. However, neither urban infrastructure nor the level of urban public services is adequate for current needs, let alone to meet growing demands. Dealing with this problem is a formidable challenge. Not only must adequate finance for the provision of services be found but it is critical to ensure that the money spent results in desired outputs and outcomes. To do so, local governance structures also need to be reformed and strengthened. This paper attempts to point the way towards some possible solutions by analysing urban governance and finance in India in the context of lessons drawn from fiscal federalism theory and experiences of governance institutions and financing systems both in India and around the world.

No one system of urban governance is likely to work equally well for all urban local bodies. However, the paper identifies some key reforms required to realise both the constitutional intent to encourage citizen participation in urban governance and the economic and politically desirable goal of ensuring greater accountability of urban governments. For example, the paper draws attention to existing ambiguities in the assignment system and underlines the need to undertake activity mapping to ensure clarity as well as to make independent agencies significantly accountable to elected governments in urban areas.

The paper also discusses a variety of ways of augmenting the resources of the municipal bodies in the country including essential reforms in the property tax system and adequate exploitation of user charges and fees for various services delivered as well as ways of strengthening and improving Central and State transfers to urban local governments. With respect to financing urban infrastructure, development charges should be used more effectively. More should also be done to utilise public lands more effectively. In addition, to a considerable extent capital expenditure requirements will have to be financed through borrowing so further development of the municipal bond market is important, as is more and more effective use of public private partnerships in some areas.

Stabilising the Indian Business Cycle

NIPFP Working Paper 67
[PDF]

Ajay Shah and Ila Patnaik
February 2010

Interstate Distribution of Central Expenditure and Subsidies

NIPFP Working Paper 66
[PDF]

Pinaki Chakraborty, Anit N. Mukherjee and H.K. Amar Nath
February 2010

Graduating to Globalisation: A Study of Southern Multinationals

NIPFP Working Paper 65
[Link]

Dilek Demirbas, Ila Patnaik and Ajay Shah
February 2010

Abstract

FDI by firms in developing countries is a recent phenomenon and demands a study of relationship between firm productivity and different modes of globalization activities. This paper attempts to understand this relationship through ordered probit models, examining two key hypotheses using firm level panel data from India. First, we test whether there are characteristic differences between domestic firms, exporting firms and firms engaging with FDI. Second, we test if FDI is an integral part of the evolution of firms in developing countries. Our results suggest that there are strong differences between domestic firms, exporting firms, and firms that invest abroad, especially in their knowledge investment, indicating the presence of a ladder of quality in graduating to globalisation.

Asia Confronts the Impossible Trinity

NIPFP Working Paper 64
[PDF]

Ila Patnaik and Ajay Shah
January 2010

Abstract

In this paper, we examine capital account openness and exchange rate flexibility in 11 Asian countries. Asia has made slow progress on de jure capital account openness, but has made much more progress on de facto capital account openness. While there is a slow pace of increase in exchange rate flexibility, most Asian countries continue to have largely inflexible exchange rates. This combination - of moving forward with de facto capital account integration without bringing in exchange rate flexibility - has lead to procyclicality of monetary policy when capital flows are procyclical. The paper emphasizes the case for a consistent monetary policy framework.

Why India Choked When Lehman Broke

NIPFP Working Paper 63
[PDF]

Ila Patnaik and Ajay Shah
January 2010

Abstract

India has an elaborate system of capital controls which impede capital mobility and particularly short-term debt. Yet, when the global money market fell into turmoil after the bankruptcy of Lehman Brothers on 13/14 September 2008, the Indian money market immediately experienced considerable stress, and the operating procedures of monetary policy broke down. We suggest that Indian multinationals were using the global money market and were short of dollars on 15 September. They borrowed in India and took capital out of the country. We make three predictions that follow from this hypothesis, and find that the evidence matches these predictions. This suggests an important role for Indian multinationals in India's evolution towards de facto convertibility.