The Indian Rupee Crunch....(6) - Task Force Report

The summary of the recommendations of the Task Force on Balance of Payments with India and the Rupee Shortage (and my comments) are presented below:

MONETARY

Immediate measures:

i.                   Review the reserve requirements for banks: Royal Monetary Authority (RMA) to review cash reserve ratio (CRR) and statutory liquidity ratio (SLR) and introduce other demand management measures to control credit.

(Routine job of RMA. RMA should be more accountable to fulfil its responsibilities.)

ii.             Enhancement of Government of India (GoI) line of credit:  Government to enhance GoI line of credit from INR 3 billion to INR10 billion at 5% interest.

(Interest rate is more attractive than SBI overdraft rates.  The credit utilization should be justified with proper rates of return.)

iii.             Rupee currency SWAP arrangement with India:  Government to seek additional support through bilateral local currency SWAP with India for balance of payment (BoP) deficits, as an interim measure.

(An interim measure, so we should not rely heavily on it.)

iv.           Institution of annual Rupee management plan:  RMA to submit convertible currency (CC) and Rupee reserve management plan to the Government, in collaboration with the Ministry of Finance and related stakeholders.

(Isn’t it routine job of RMA? RMA should be more accountable to fulfil its responsibilities.)

v.            Surveillance over the financial sector and its credit expansion: RMA to exercise its authority and take measures to discourage excessive lending to non-productive and highly-exposed sectors through appropriate policy interventions and imposition of more stringent provisions.

(Should have been routine job of RMA. RMA should be more accountable to fulfil its responsibilities.)

vi.           Streamlining access to and use of Indian Rupees: RMA to establish Rupee exchange counters along border towns and main commercial hubs to monitor the outflow of Rupee and for converting local currency to Rupee subject to certain limits.

(This should follow steps of item vii below)

vii.          Exchange restriction: Indian Rupee to be treated as an essential reserve currency and managed (both on the demand and supply fronts) in line with regulations and exchange restrictions framed and enforced by RMA.

(INR exchange rate restriction should be more strategic and step-by-step approach, not to carry out on an adhoc end-to-end basis.)

viii.         Base rate and policy rate: RMA to introduce a system of base rate and policy rate for the financial sector as part of its monetary tool to manage and influence domestic credit growth.

(Aren’t  all central banks suppose to do this? It should be the responsibility of RMA.)

ix.           Enforcement of Bhutan’s foreign exchange regulations to close bank accounts of non-residents at border towns:

 (Recommendation is based on intuition that bank accounts of non-resident Indian businessmen in Bhutanese banks contributed to large Rupee outflows.  It lacks in-depth analysis and correlation with practices of business fronting, tax evasion, illegal authentication, taking advantage of other loopholes at all levels of economy, and black/grey money deposits.)

x.             Promote the use of electronic means of payment:  Use  electronic payments  to allow efficient monitoring and save costs.

(All efficiency enhancing measures should be implemented.)

xi.            Ring-fence adequate Rupee reserve for Rupee debt service.

(Recommendation vague. Efficiency enhancing measures should be implemented )

xii.          RMA to review the annual Government budget size and provide opinion to the Ministry of Finance.

(Very close overall coordination between the Government and RMA is imperative, including for review of annual budget.)

xiii.         Improving surveillance of Rupee flows: promote transparency and informed decision making:. Carry out  in coordination with Department of Trade and Department of Revenue & Customs (DRC) the monitoring of export proceeds and import payments in BoP with India to track the actual flow of Rupees.

(RMA should keep close track of export proceeds and import payments with India.)

FISCAL

Immediate measures - Taxation:

i.              Impose a green tax on vehicle imports: recommended  40% green tax on all vehicle imports.

(The blanket tax increase recommendation looks purely for discouraging indiscriminate vehicle import. Heavy tax on import of vehicles has mostly negative impact on economy because of  high vehicle operation cost through the use of old vehicles, e.g., Singapore discourages using old vehicles by imposing heavy tax on old vehicles. Rather than taxing, positive approach of streamlining import policies and procedures is better option.)

ii.             Levy Customs Duty and Sales Tax on the import of heavy earth moving equipment: recommended to be brought under the tax bracket. 

(This will act as disincentive to construction industry and not in line with developing domestic contractors. The system may be strengthened rather than levying tax.)

iii.            Impose a green tax on fuel imports: recommended that a green tax of 5%, equivalent to the current sales tax on fuel imports be levied.

(The strategy should be saving fuel through vehicle operation cost reduction, rather than raising tax on fuel. The fuel cost is already very high. Further fuel cost raise will increase the transport costs of goods and services.)

iv.           DRC to identify and propose new taxes (including capital gains tax) and rationalize existing rates including the zero rated items; and

(Careful identification without heavy impact on longer term strategic goals may be beneficial to the country.)

v.            Ministry of Finance to consider shifting the levy of sales tax on vehicles from Point of Entry to Point of Sale.

(This will further increase the cost of vehicles in addition to the taxes proposed above. This will be counter-productive to the economy for the reason mentioned above.)

GOVERNMENT EXPENDITURE

Immediate measures:

i.              Review implementation of FY 2011/12 budget. Government agencies not to initiate new works that are yet to be initiated in this FY;

(Adjustments on  FY 2011-12 budget not possible at this stage, if not already done. )

ii.             To minimize the Rupee pressure, non-priority activities including those that have no socio-economic benefits to be eliminated in the FY 2012-13 budget.

(Budget preparation and review procedures to be strengthen. Why should non-priority items that do not contribute to strategic goals be included in the budget?)

iii.            Revise debt service schedule for GoI loans for hydropower development as most of the loan repayments (maximum 2.8 billion) falls due in every January and to include such debt servicing schedules in all future loan agreements.

(Pros & cons of rescheduling debt may be analyzed first.)

iv.            External borrowings should be strictly for investment purposes.

(This should be strictly followed.)

v.             No agency should propose and no consideration should be given for enhancement of allowances and service benefits.

(Indefinitely? Time period for such freeze needs to be indicated.)

vi.            Ministry of Finance (MoF)  to issue directives to government corporations not to hold board/management meetings outside Bhutan and not sponsor sporting events out of corporate funds.

(Indefinitely? Time period for such freeze needs to be indicated.)

Medium term measures:

i.              Deficit if any to be met through domestic borrowings in the form of ways and means account or issuance of T-Bills and to maintain fiscal deficit at not more than an average of 3% of GDP during each FYP period.

(Domestic borrowing to meet fiscal deficit can ease INR pressure. More innovative the means better it is.)

ii.             Currently, debt policy and strategy is to ensure that loans are availed at the lowest cost with maximum social and economic returns and to maintain debt at internationally accepted thresholds. This is important to be continued and constantly monitored.

(Debt policy and strategy need to be diversified and strengthened. International Monetary Fund (IMF) pointed out that indicative debt thresholds are often breached. Specific attention has to be given not to breach the debt indicators.)

iii.             Strengthen debt management capacity

(Debt management capacity seems weak. Mobilize strong staff team and acquire debt management tools to give better and timely analysis on debt and debt issues.)

iv.           Time schedule for GoI fund (grant) releases: Timely release of GoI project-tied grants and SDP funds will help financial planning and project scheduling.

(MoF and GNHC should work on a time schedule and agree with GoI.)

v.            Explore the possibility of issuing Indian Rupee bonds for mega projects.

(Issuance of bonds for selected projects to attract private investment from India is a good idea. It may be difficult to attract private funds without improving corporate governance.)

TRADE

Immediate measures:

i.              Third country imports:  MoF, Ministry of Economic Affairs (MoEA) and RMA should coordinate and put in place an effective import license system, to take care of proper hard currency transactions.)

(We should take more liberal approach to  third country imports as long as the imports are within affordable limits.)

ii.              Software exports

(Department of Trade has stopped issuing certificate of origin. So it is non-issue.)

iii.            Balance of trade projections

(Preparation and projection of balance of trade with India should be given priority and regular job of the Department of Trade.)

Medium-term measures:

i.              Enforce value addition criteria: All industries must meet the national value addition criteria of 40%.

(Review value addition percentage properly and once established, enforce it stringently.)

ii.             Streamlining distribution of goods and services:  The distribution of goods and services to be streamlined and organized so that Bhutanese traders deal directly with principle companies in India and other countries or deal with the main national or regional dealers.

(Streamline government regulations, policies and procedures; and strengthen supply-chain, inventory management and control systems for import of goods and services from India and abroad.)

iii.             Attracting Indian tourists: develop strategies to attract high-end and middle income Indian tourists to the country.

(Attract Indian tourists by competing with other hill stations, Darjeeling, Simla, Ooty, Kathmandu and others.)

Long-term measures:

Encourage industries that can substitute imports as well as has the potential to promote growth in exports as follows:

(Isn’t it asking for too much? If we have strong exports, we should not be too concern about import substitution.)

i.              Promote the use of local building materials:  substitution by local materials. 

(Easier said than done. We should not depend too much on it.)

ii.             Promote sustainable and efficient use of forest resources:

(Isn’t this being done already?)

iii.            Import substitution must be encouraged through the liberalization of policies for manufacturing industries.

(An in-ward looking approach! More emphasis should be given on export earning industries than import substitution enterprises.)

iv.            Ministry of Agriculture and Forests and related stakeholders should consider building simple cold storage based on air-cooling systems on high passes to store agricultural goods for sale during the off-season.

(Is it feasible and cost effective solution? I have my doubt.)

OTHER RECOMMENDATIONS

Corporations to maintain separate CC and Rupee accounts.

(Corporations may keep separate accounts but monitoring of INR and other foreign exchange transactions should be the responsibility of RMA.)

Debt swap for Dungsum Cement (DCCL) : MoF and Druk Holding and Investments (DHI) should study the prospect of converting  INR 2 billion loan from State Bank of India Capital into Rupee bonds, given the huge cost of borrowing under the present arrangement.

(Isn’t this the responsibility of DHI to mobilize most cost-effective financial resources for DCCL? DHI should be made more accountable. )

Consider abolishing tax-free vehicle quota system.

(Quota system has been counter-productive. Introduce more effective incentive  to government staff.)

Government Vehicles:

(The proper management of government pool vehicles is always an issue in most countries. An efficient system can be devised if sincere efforts are made.)

Private education:

There is an urgent need for the Ministry of Education (MoE) to facilitate the development of private tertiary colleges in Bhutan.  Work on starting at least 2-3 such colleges should be started immediately.

(The establishment of private colleges are governed by the demand for such colleges. People should have the options for quality education both within and outside the country. )

Statistics:

On BoP and related matters, there is a need for National Statistics Bureau (NSB) to have data updated and published on a regular basis.

(A recommendation for an agency not doing its job? NSB should be made more accountable.)

Medium-term fiscal framework:

The MoF had established a high level macro-economic framework coordination committee (MFCC) and later this requirement was also prescribed in the Public Finance Act 2007. It has members from the key agencies like RMA, MoEA, GNHC, MoF, NSB and a few others. In view of the recent developments, the need for representation at the highest levels from these agencies in the MFCC through a reconstitution of the Committee is important. MoF should also seek the support of the International Monetary Fund (IMF) in getting a resident expert to assist in further improvement of the framework.

(The recommendation is dubious.  MoF should seek IMF support in preparing medium-term fiscal framework.)

First, we should learn from the experience that import-driven internal consumption-based growth model is not very conducive to a small land-locked country like Bhutan. Economists should be able to analyze better! The sound strategy for us should be to strongly support production base for export of goods and services, and improve balance of payment. Since the economic growth model determine the investment/expenditure pattern, a slow shift towards export-led growth model (from current import driven economy, characterized by high credit growth and internal and external imbalances) is highly desirable. So the medium/longer-term measures should take full cognisance of such strategy. No such depth is reflected in above recommendations.

We are too used to taking unidirectional solution to the economic problems without even looking into diversified options. So, how do you know what the trend is? For instance, while China is starting to lose its attractiveness  in ready-made garments (RMG) markets (also because of their focus on internal consumption to boost economic growth), Bangladesh  is expected to be the next hot spot for RMG. With about $15 billion in exports in 2010, RMG is the Bangladesh’s  most important industrial sector (representing  13 percent of GDP and more than 75 percent of total exports). The forecast is to export-value growth of 7 to 9 percent annually within the next ten years, so the market will double by 2015 and nearly triple by 2020. Bangladesh does not even produce RMG raw materials. They outsource from India and China. That’s called creating your own niche! (see http://sangpatamang4.blogspot.com/2012/03/bangladesh-next-hot-spot-in-apparel.html)     To compete with outside world, the country has to have ‘levelled playing field’. Has our thought process for last 30 years gone beyond hydropower projects and traditional in-ward attitude bogged down with display of superficial skills with no/little substance? The outcomes speak for itself !

Second, in trying to find solution to INR crunch, the Task Force has essentially focused on immediate measures in financial sectors, and included no substantive recommendations on longer-term scale that reflect future development perspective and foresight. For instance, investment in road infrastructure is one of the best approaches to saving costs. Both China and India have been investing heavily on road infrastructure to cut down their vehicle operation costs. Most of road infrastructure in Bhutan is breaking to the levels which are beyond routine/periodic maintenance norms. Should the road infrastructure be improved to appropriate level of road roughness index and other technical standards, the annual saving in vehicle operation costs (fuel, repair and maintenance costs) will amount to billions of rupees, without accounting time savings and other efficiency gain. This requires obviously sector foresight and strong organizational capacity. Similar sector-specific cost savings approaches will have significant contribution to the economy.

Third, the above recommendations have highlighted the fact that the department/Authority/Agency concerned  are not fulfilling their direct responsibilities effectively and there are gross imbalances in terms POWER,  AUTHORITY, RESPONSIBILITY and ACCOUNTABILITY in these organizations. Looking at the above recommendations, I wonder if the RMA is fulfilling its primary and secondary objectives as stipulated in Royal Monetary Authority Act of Bhutan 2010 [see The Indian Rupee Crunch..........(2) for RMA’s objectives.]

Fourth, in early April 2012 it was reported that the Government borrowed INR 9.7 billion [GoI standby credit of  INR 3 billion at 5% per annum interest and from State Bank of India (SBI) overdraft (OD) facility INR 6.7 billion (against the limit of INR 10 billion) at 10% per annum].  In addition on 13 April 2011, Bhutan received INR 1.62 billion Indian grant for development projects under 10th plan. 

Now it is reported that RMA has borrowed INR 2 billion from Punjab National Bank (PNB) at 10.5% interest because overdraft facility extended by SBI reached its limit of INR 10 billion last week (18 May 2012). The credit from PNB will replenish domestic banks with INR. It only means that in about slightly more than a month, an amount of INR 14.62 (3+10+1.62) billion has been used. The INR 14.62 billion is more than 20% of GDP and may not have been used for any plausible purpose except to clear old liabilities. Is this an effort to support BTN in the face of a financial overextension that is driven by past (in)actions including investment in real estate? Time will tell us.

The RMA borrowing INR 2 billion from PNB is an issue, but more than this, the biggest issue that is of concern is INR inflow into the system and debt sustainability. As I said earlier debt can make a country effectively bankrupt. The Task Force seems to have not done detailed review of the country’s debt situation, an issue I consider the most critical in the current situation.

And finally, will implementation of above measures strengthen both public and private sectors and lead the country to the path of easing INR balance of payments in mid/longer-term?  How comfortable are you as regards these? Be your own judge!

continuation under June.....................The Indian Rupee Crunch..........(7) 

The full report of the Task Force is available online since 11 May 2012 at
http://www.cabinet.gov.bt/rp/Task%20Force%20Report%20%20-%2011%20May%202012.pdf