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Why States Need to be Involved in India’s Foreign Policy


Image credit: The Aspirant Forum

By Ratish Srivastava (@socilia13)

The involvement of states in India’s foreign policy making could be vital in launching India onto the next phase of development. The centre holds executive power in all matters related to foreign policy as stipulated in Article 246a, 7th schedule. Indian states already have many responsibilities like improving infrastructure for public health services, agriculture, transportation, etc. However, there is a heightened need to improve their economic performance and generate enough revenue so as to not depend on the centre for funding and help improve foreign relations with other nation-states.

States can and have proven themselves to be important players in improving India’s ties with other countries and at the same time improve their economic performance. States like Gujarat and Maharashtra have shown great promise with exports, contributing as much as 46% of India’s exports. Combining the exports of Tamil Nadu, Andhra Pradesh and Karnataka with the exports of Gujrat and Maharashtra increases the figure to about 70% of the total exports of India.

These states have accessed global economic opportunities, and have witnessed tremendous growth. These states have struck deals with major players in the international market, like Maharashtra’s deal with Enron in 1996, although the deal ended with the Enron scandal, which rendered the Texas-based company bankrupt. It is still worth noting the role a state can play in striking deals with international companies. Another example would be Andhra Pradesh’s ability to negotiate a state-level World Bank development loan in 2002 under the leadership of Chandrababu Naidu, proving that states can meet their development goals without help from the central government.

States in India who lag behind in these areas need to come up with a stronger structure for engaging in exports. A major concern for states with no ports, or states who depend on other states for container facilities and ports is that their export figures are being undervalued. This is because the point of origin code is filled by clearing agents rather than the exporters themselves, as the agents see no significant importance of the point of origin.

States need to understand the importance of having a state export policy, like Gujarat, which has a five-year export policy. This policy will not only address the supply side of the problems but will also address the need for adequate infrastructure and appropriate labour laws to make the state a more attractive destination for trade.

Chief Ministers of state should travel abroad to negotiate with industrial houses (Maharashtra-Enron), international organisations (Andhra Pradesh-World Bank) and commercial wings of foreign governments with the aim of achieving investment deals for their own states and to be part of intergovernmental negotiations within the World Trade Organisation (WTO). To improve the infrastructure the state needs more FDI inflows and they need to increase taxes to generate the revenue necessary for making such changes.

Apart from the economic benefits a state could reap, there is motivation for states to be involved in neighbourhood policies. Matters such as illegal trade and immigration (border security) and improving relations with the Indian diaspora in the neighbouring countries with which they have socio-cultural ties also contribute to a state’s involvement in foreign policy. Improving trans-border regional links and trans-border neighbourly contacts through the involvement of states can have positive effects on India’s foreign policy.

State interference can also have adverse impact on foreign policy, for instance, the fiasco regarding the Teesta water treaty with Bangladesh in 2011 and pressure from DMK on the central government to vote against Sri Lanka in the United Nations Human Rights Council. in 2013.

On the other hand, the role that a state can play in improving relations with India’s neighbours is huge. Border states, with historical, cultural, linguistic, religious, and ethnic links can help provide a platform for the central government to build stronger ties and improve border security. They can help improve socio-cultural ties as well, case in point, the Chief Minister of Bihar Nitish Kumar and the Deputy Chief Minister of Punjab Sukhbir Singh travelling to Pakistan in 2012 to leverage socio-cultural ties.

India can also improve border security if it allows the states who have borders with other countries to be involved in the process. It can help the centre make policies accordingly as states understand the ground realities better at the border which will help strangle illegal drug trade and immigration.

The benefits for state involvement in foreign policy has been underplayed, with much of the focus being put on the negative impact it can have. However, the positive impact could outweigh the negative as it allows states to have the power to improve its situation.

Ratish Srivastava (@socilia13) is a research intern at Takshashila Institution.

This post is the part of a series of blogposts on ‘States in Foreign Policy’.

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Structural Reforms: What are they and how do you go about it?

BY Anupam Manur (@anupammanur)

No democratically elected government with a limited term of office would want to risk negative popularity in the short term for potential benefit in the future, for which they might not be able to take credit.

The microeconomist’s universal answer to all questions is demand and supply and the macroeconomist’s version is structural reforms. So goes the joke. Kaushik Basu, Chief Economist of the World Bank, in fact tweeted something similar: “Structural reform is safe advice. No one knows what it means. If economy grows: I told you. If it stalls: You didn’t do structural reform.”

So, what exactly constitutes structural reforms? From the political angle, The Economist looks at structural reforms as changes to the way the government works. From an economic viewpoint: it is about making markets work efficiently in the various sectors of the economy. An IMF paper[i] describes structural reforms as: “They typically concern policies geared towards raising productivity by improving the technical efficiency of markets and institutional structures, and by reducing or removing impediments to the efficient allocation of resources”. In fact, changes in the Ease of Doing Business rankings, published anually by the World Bank, signifies the various structural reforms undertaken in any country.

Structural reforms gained popularity from the IMF and World Bank. The two global institutions would attach preconditions to the loans that they provided to countries. These conditions were known as Structural Adjustment Programmes (SAP). Only upon initiating these reforms would a country be eligible to get loans from the IMF or World Bank. These reforms included:

  1. Trade liberalisation: Removing barriers to trade, decreasing tariffs and quotas, exchange rate liberalisation, and minismising the government’s involvement in trade.
  2. Balancing budgets: Governments had to impose strict austerity measures to reduce the fiscal deficit and create a roadmap for repayment of the loan, which involved raising taxes and cutting down expenditure.
  3. Reigning in inflation by imposing tighter monetary policy conditions and removing government’s influence in the central bank’s functioning.
  4. Removing many state controls on production, subsidies, price controls, etc.
  5. Encouraging investment by removing regulatory hurdles. This applied to both domestic and international (FDI) investment. This also involved market deregulation in most sectors of the economy.
  6. Improving overall governance structures, reducing corruption, etc
  7. Privatization and divestment of large public sector units.

Much of the Fund’s current work still revolves around the same issues. In the latest Article IV IMF staff consultation with member countries, their recommendations for most of the countries bordered around the same issues: initiate structural reforms: the United States has to reform its primary education, while France has to balance its budget and urgently carry out labour market reforms; Japan needs structural reforms to inspire more migration to mitigate the demographic crisis, and Brazil need to reduce the fiscal deficit, inflation, corruption in the government, undertake financial market reforms, and so on.

Most empirical analysis does bear out the fact that structural reforms matter to increasing productivity and GDP growth. However, there are a lot of conditions under which structural reforms work. Most countries try to undertake structural reforms when they are in crisis – either out of their own volition in order to fix the broken systems or by command from the IMF and World Bank. The success of the reforms depend upon a number of factors, such as the initial conditions, strength of existing institutions, speed of reforms and the sequencing of the reforms. After the disintegration of the USSR, for example, many countries undertook structural reforms in order to move to a market based economy. Each country followed a different approach and the ensuing results very varied. The Central and Eastern European countries fared far better than the former Soviet Union countries.

There are two important political economy factors at play that determine the success of structural reforms. The first is the time lag between the implementation of the reforms and the eventual positive effects of the same. Most empirical research shows that there is a considerable lag before the positive effects are played out in the economy, be it in terms of increased growth, reduced inflation, increased employment or higher trade. In between, however, it is not uncommon to see short term pain and a dip in growth. This explains why most countries are still reluctant about implementing big reforms. No democratically elected government with a limited term of office would want to risk negative popularity in the short term for potential benefit in the future, which they might not be able to take credit for.

Closely related is the second political economy factor of managing the winners and the losers. Every big reform will create multiple winners and losers. Economists such as Roland suggests that a gradual approach to reforms would allow an opportunity to giving compensating tranfers to losers from reforms to buy their acceptance.

The former Swedish Finance Minister, Anders Borg, has written an insightful article on the ways to tackle this particular problem. One of his biggest advice: front loading. “When structural reforms are implemented close to an election, the short-term impact will dominate the debate, and the more nebulous long-term gains will be written off as uncertain forecasts.” Thus, this should be done early enough after a government is formed to allow for some of the positive effects to come through before the next election.

Anupam Manur is a Policy Analyst at the Takshashila Institution.

[i] “Structural Reforms And Macroeconomic Performance: Initial Considerations For The Fund”, IMF Staff Reports, November 2015.

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Reforms in global financial system — Finally

The reforms at International Monetary Fund(IMF) has meant better voting share for India and a voice in global financial system

The IMF’s reform package of quotas and governance became effective on January 26, 2016. As a result of this, India, Russia, China, and Brazil gain entry into the club of 10 largest economies of the world. This review was long pending since December 2010. The delay was attributed to approval by the US Congress which finally gave its nod in December 2015. What do these reforms exactly mean?

First, it is essential to know the origin of IMF. It is an international organisation of 188 countries working to foster global monetary cooperation, secure financial stability, facilitate international trade, promote high employment and sustainable economic growth and reduce poverty around the world. To summarise — it is the lender of last resort for the all the countries in the world. It was formed at the end of World War II as part of international financial system led by the US.

Second, what exactly is ‘quota’? Each member country is assigned a quota — which is a value of its share in the IMF financing system. This is proportional to that country’s impact on the world economy. A country’s quota in the IMF determines its voting power, the amount of financial resources it must provide to the IMF, and its access to IMF financing. It then goes without saying that larger a country’s quota, greater will be its say in the governance of IMF. Quotas are based on a weighted average of GDP, openness, economic variability and international reserves. They are expressed in Special Drawing Rights (SDR), an international reserve asset determined by the value of the US dollar, euro, Japanese Yen and pound sterling. The increase in quota has meant enhanced resources for IMF.

The IMF’s capital has nearly doubled from $ 329 billion to $ 659 billion. Much of this has come because of funding from member countries, especially of G-20, contributed after the financial crisis of 2008. As a result, more than 6 percentage points of quota have been transferred from developed to the the emerging market countries. India and China have increased their voting shares by 0.292 and 2.265 percentage points respectively. India’s increase, though marginal has been enough to place it in the top 10 countries. The developed countries have had a decrease in their voting share from 0.2 to 0.5 percentage points. This redistribution has catapulted China from sixth to third position behind US & Japan. Saudi Arabia’s decrease by nearly a percentage point has placed it below India, Russia and Brazil. This reform will also affect the selection process of Executive Directors,i.e., the governance.

Once the reforms are in place, all positions on the board will be determined by election. In the earlier system, member countries with five largest quotas each appointed an Executive Director. This invariably meant a European as the head of IMF. It had been a common refrain among the developing countries that IMF would always be headed by an European and World Bank by an American. The reforms are reflective of the emerging economic order in the world and reinforce IMF’s legitimacy as a global financial institution.

Guru Aiyar is a Research Scholar at Takshashila Institution and tweets @guruaiyar

Featured Image: IMF by Javier Ignacio, licensed by creativecommons.org


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Why is the Ease of Doing Business report not enough?

The ease of doing business ranking is a useful tool to compare regulatory framework in countries. However, a single index is not enough to capture the complexities and practical difficulties at the ground level. 

By  Devika Kher (@DevikaKher) and Surya Prakash B. S. (@SuryaPrakashBS)

In the first post in this series, we have explained how there has been little focus in India on everyday hurdles to doing business which has lead to the generation of ‘unaccounted income’. However, there have been welcome deviations from this norm. One such example is the focus of the Union Government on India’s ranking in the World Bank’s Doing Business Report, one of the most comprehensive indices that compares regulatory frameworks across countries.

As per the World Bank’s Doing Business 2015 Report, India ranked 142 out of 189 countries. The ranking was based on factors such as dealing with construction permits, registering property, protecting minority shareholder interests, enforcing contracts, resolving insolvency, getting electricity, getting credit and trading across borders. Amongst these factors, India scored highest in protecting minority investors (7th position) and the lowest rank in enforcing contracts (185th position).

The factors considered by the report appropriately capture the regulatory hurdles faced by businesses. However, the report falls short on two grounds. First, it does not capture the administrative practices followed in a country. Second, it looks at all the sectors with the same frame of reference.

Reports on doing business

The Ease of Doing Business (EDB) ranking captures the conduciveness of the regulatory environment to business operation. The countries are ranked from 1 to 189 with 1 being the best. The EDB ranking is useful tool to compare business environments across borders. It highlights the cost incurred by businesses in a country in the form of innumerable regulations that precede setting up of a business. These additional barriers increase the cost of setting up business and indirectly provide a conducive atmosphere for illegal modes of transactions.

The rankings also act as a comprehensive guide for any business trying to set up shop in a new location. It has thereby helped in raising competition amongst countries trying to attract higher investment. The index provides an international scale to compare business environments across the globe. In order to attract foreign businesses, the 189 members have undertaken various reforms to improve the business environment within their countries. For instance, the Indian government recently increased the validity period of industrial licenses as a step to ease the burden of cumbersome registration processes in the country.

The EDB ranking plays a vital role in indicating the significance of business environment in attracting investment. However, it is overly dependant on factors which are one- time or infrequent, and does not factor in issues unique to the individual countries. As can be seen in Table 1, most of the factors consider by the EDB report are one-time or infrequent occurrences and does not capture the everyday hurdles faced by the businesses. In addition to that various countries have norms and general practices which are followed but are not in the regulations by the government.

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Table 1:  Factors taken into account by World Bank’s Doing Business Report and the frequency of their occurrence

Improving over the Ease of Doing Business Report, The World Bank along with KPMG came up with an India specific report titled “Assessment of state implementation of business reforms” covering a wide range of factors – see Table 2 below.

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Table 2: Factors considered by the Assessment of state implementation of business reforms

The assessment studied the implementation status of reforms in areas such as setting up a business, complying with the regulations, carrying out inspections and enforcing contacts. The Department of Industrial Policy and Promotion, a part of the Ministry of Commerce and Industry has listed out a set of recommendations based on these assessments for the States and Union Territories to begin implementing. The recommendations ranged from suggesting increase in access to information and transparency enablers to creating a special bench or division under the high court to hear commercial cases.

Shortcomings of the reports on doing business

To begin with, the EDB report although an important step towards recognising the need for a better business environment, fails to capture the administrative practices applied on the ground. For instance for a factor like obtaining construction permits, applying for the permits is only part of the process. The rest of the process involves paying a fee to obtain permit at almost each step of the construction. In addition to this, as per the Anti-Corruption Bureau Chief there exists rampant corruption while issuing building permits in major cities like Mumbai.

One of the plausible ways to indicate the high cost of conducting business transaction in a country can be based on the legal restrictions imposed on them. The high cost of transactions creates the incentive to opt for illegal activities which reduce the economic cost of the business. Hence, the builder in the previous example would prefer bribing the government official at the higher levels enough to reduce the fine paid at each step and the time spent in getting clearances.

The second shortcoming of both these reports is that they measure the same factors as if they were equally important to all sectors. For instance factors like complying with environment regulations will be of higher significance for the heavy industrial than for the software industry. Hence, the factors considered should vary as per the characteristics of a given sector.

In all, EDB report indicates the pace at which the global markets are opening up to business development. However, as the report specifies, “it is unable to capture  factors like security, market size, macroeconomic stability and the prevalence of bribery and corruption.” Thereby, it lacks the ability to capture the intrinsic problems with doing business and, thereby curb the generation of unaccounted income.

This is the third blog in our series on unaccounted income. The previous post explains the nuances of the common phrases used in the context of ‘black money’. 

Surya Prakash B. S. is a research scholar at The Takshashila Institution. His twitter handle is @SuryaPrakashBS

Devika Kher is a Research Associate at Takshashila Institution. Her twitter handle is @DevikaKher.

Source for feature image: Wikipedia

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