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.