Table of Contents

India’s preparedness, or, more precisely, the lack of it—the poor quality of its human resources and the pervasive weakness in state capability—constrains the country’s ability to overcome the structural headwinds and global trends and take advantage of opportunities. The shackles imposed by restrictive regulations exacerbate India’s weaknesses, further limiting the country’s ability to achieve a high growth rate and sustain it for a prolonged period of time. With business as usual, India’s massive size, even with all of the internal weaknesses and headwinds, means the country may grow rapidly in short bursts (as happened for a few years in the last decade) interspersed with longer periods of moderate growth.

In fact, for a country of India’s size and diversity, there are always likely to be geographic and sectoral pockets of economic dynamism that may be enough to sustain 3 to 4 percent annual growth rates. Some of these knowledge-based services sectors could potentially grow at very high rates for long periods. A young population with 12 million people entering the workforce each year and a very low income base for the vast majority of the population are accounting artifacts that naturally increase growth. All this, coupled with strong public spending and business-as-usual corporate infrastructure investments, should be adequate to sustain a 4 to 5 percent annual growth rate.

Efforts are under way to remove the hurdles that stand in the way of rapid economic growth in the years ahead. The government in New Delhi has initiated several programs over the past fifteen months. They include ones to improve the ease of doing business (Make in India), address skill deficiencies (Skill India), catalyze the use of digital technologies (Digital India), foster entrepreneurship (Start-up India), promote urban development (the Smart City Challenge; AMRUT—the Atal Mission for Rejuvenation and Transformation; and the Housing for All initiative), and so on. Other institutional reform initiatives, such as the goods and services tax, the Financial Code, the four Labor Codes, the Bankruptcy Law, and the Arbitration and Conciliation Act, are in various stages of enactment and implementation and will be significant contributors to the country’s economic growth.

Though these reform initiatives are certainly important steps in the right direction, it may be necessary to undertake more extensive reforms in certain areas to attain a sustainable growth path. A comprehensive set of policies to improve the quality of education and healthcare is a must. Cities, the engines of growth, need fundamental reforms in governance and in land and housing markets. Economic growth and job creation depend critically on easing infrastructure constraints and improving the business environment. The banking sector needs immediate and far-reaching reforms to strengthen it, and the formal economic base must be expanded greatly to support sustained economic growth. Finally, the Indian state at all levels needs to be strengthened through significant reform of its personnel policies and the enactment of measures to improve state capability. A few important interventions in these areas are proposed and discussed below.

Human Resource Development Strategy

The realization of India’s demographic dividend, the economic benefit resulting from a more youthful workforce with fewer dependents, is premised on a high quality of its human resources. Unfortunately, the poor learning outcomes and acute skills deficiency, which reflect the subpar quality of school and college education, threaten to turn the demographic dividend into a demographic disaster.

The abysmal student learning levels in India’s schools, captured by numerous surveys conducted by both the government and nongovernmental organizations for many years, must count among the nation’s biggest failures. The ineffectual educational system has a debilitating effect on the foundations of the country’s economic growth, for it results in unemployable graduates, an inadequate supply of skilled labor, a large and unproductive informal sector, and wasted human resources.

India needs a mission with the focused objective of ensuring that every child leaving primary school has functional reading, writing, and numerical skills, at least commensurate with third grade skills. Achieving this goal would require drawing from existing initiatives, such as the Gunotsav, which has been implemented in Gujarat since 2009, and those that, like Pratham, focus on foundational learning, teacher capacity building, and continuous learning-level assessment.

What gets measured is monitored. In the absence of any ongoing student-level learning outcomes measurement, it is no surprise that the issue has been neglected. India needs a learning trajectory tracking database, linked with the Aadhaar number, for all students, to help assess, address, monitor, and inform their learning progress in all grades. Such a database would help classroom teachers track each child’s learning achievement or deficit, would help parents be aware of their child’s learning progress, and would provide inspectors with information on each school’s aggregate performance on measures of learning outcomes.

This database could be seamlessly integrated with the proposed digital degrees depository of school-leaving certificates, college degrees, academic awards, and report cards that was announced in the Union Budget 2016–17. By validating authenticity and allowing easy retrieval, such a database and its linkages would significantly reduce the transaction costs associated with college admission decisions and jobs recruitment.

The qualitative nature of the intervention means that a top-down, one-size-fits-all program implemented across the country is unlikely to be effective. Instead, a program that allowed self-selected districts to craft their own three- to five-year learning outcomes improvement plan by drawing from a menu of available interventions would have a good likelihood of success. The districts could be incentivized by allocating a gradually increasing share of their Sarva Shikhsha Abhiyan school budget for learning outcomes and would be held accountable for delivering on their commitments.118 This strategy, like that of the Smart City Challenge competition, has the potential to trigger competition among districts and push the learning outcomes agenda to center stage.

The Ministry of Human Resource Development should support the initiative with the development of open-source learning outcomes tracking software, which would form the core of the data management system. The software should have various user-friendly data entry interfaces, be supported on multiple devices and platforms, and be able to produce reports to serve as decision support for teachers, headmasters, school inspectors, and higher-level supervisors. The ministry should also disseminate brief, easy-to-understand multimedia presentations, in vernacular languages, explaining the various possible learning outcomes improvement interventions; case studies from around the country should be part of the presentation. The program could be effectively coordinated through an interactive digital platform that enables participating districts to interact with each other, share their successes and learn from others’ experiences, access technical support, and communicate with and submit reports to the state government and the ministry.

School education reforms alone will not be sufficient, however. They must be complemented by policies that correct the institutional plumbing of the higher education system. The extant regulatory system with its emphasis on micromanagement distorts incentives at all levels and should be radically revamped. The need for sufficient entry barriers to screen out unscrupulous promoters must be balanced against the need for adequate administrative, academic, and financial autonomy. Universities should be accorded sufficient autonomy to structure their curricula, recruit faculty, provide degrees, open campuses, and offer online courses. The regulations should differentiate between research and training institutions, on the one hand, and universities and affiliated colleges on the other.

The mandates of the University Grants Commission and sectoral entities such as the All India Council for Technical Education and the Medical Council of India will need to be revised to reflect these requirements. The National Assessment and Accreditation Council should be replaced by a robust and credible system of periodic independent evaluation of the nearly 50,000 establishments of higher education. Finally, the effective implementation of these reforms will require enlightened and visionary leadership in all these institutions and government agencies.

The Union Budget 2016–17 announced the establishment of ten world-class research and teaching institutions in the public sector and another ten in the private sector. These institutions are to be supported by a light-touch, enabling regulatory architecture. The objective is that over the next fifteen to twenty years, each of these institutions will develop into large, excellent higher learning and research institutions with enrollment of around 15,000 to 20,000 students. This is a step in the right direction and should be the trigger for the gradual easing of the stifling regulatory constraints on all institutions of higher education. These institutions should be given enough academic, administrative, and financial autonomy to design their own curricula, admit students, recruit faculty, expand course offerings, raise resources, and so on.

On the demand side, the increasingly high cost of good-quality professional degrees makes them unaffordable for all but a handful of students. But the returns associated with the acquisition of such qualifications are very high. It is only appropriate, then, that students have hassle-free access to loans to help finance their higher education. Governments, both state and central, should catalyze the development of a broad-based and easily accessible student loan market with various enabling policies, especially policies to facilitate the seamless recovery of loan amounts from future employers. Instead of directly providing scholarships, as some institutions do, state governments should establish credit guarantee funds that can at least partially underwrite the risks associated with the expansion of the student loan program in the initial years. The central government should also provide partial credit guarantees to encourage expanding the issuance of such loans beyond students from elite institutions to students taking professional courses at non-elite institutions.

Finally, as with healthcare, after entry, the private sector is largely unregulated, and information asymmetry is pervasive. But more regulation may not be the appropriate response. Instead, there should be a robust system for the independent assessment of the quality of educational institutions, from schools to colleges and universities, similar to the independent assessment function of credit-rating agencies in the financial markets. The ratings should be credible enough to generate the competitive pressures needed to keep institutions, public and private, focused on quality. Organizations similar to the financial market rating agencies or the Quality Council of India or other industry-driven initiatives should be encouraged to offer such ratings.

While the government should refrain from serving as the rating agency, public policy may be necessary to catalyze the development of a rating ecosystem. Public policy should mandate that, over a period of five to ten years, all institutions should arrange to be rated every two years. It may even be worth considering some form of public support for the rating agencies in the initial years to keep costs down and encourage schools and colleges to get rated. A widely available platform, such as the websites in the United States, the United Kingdom, and elsewhere that consolidate school information and facilitate comparisons, could be a powerful force to bridge information asymmetry, promote competition, and improve school quality. A vibrant rating system would also go a long way toward getting regulatory institutions such as the University Grants Commission and the All India Council for Technical Education to relax their highly prescriptive, rules-based regulatory approach.

These reforms, coupled with existing programs such as the National Skill Development Mission, have the potential to transform the human resource development landscape and lay a strong foundation for India’s long-term growth prospects.

  1. Initiate a learning outcomes improvement mission.
  2. Create an Aadhaar-linked student learning trajectory tracking database.
  3. Reform the regulatory architecture of the higher education sector.
  4. Create a broad-based higher education loan market.
  5. Create a system for the independent assessment of the quality of educational institutions.

Healthcare Reforms

As in education, most of the action in healthcare revolves around state and local governments. The role of the central government lies in enacting the enabling frameworks, setting the agenda, and providing direction and guidance. The central government should provide the institutional and regulatory policy direction, making available different options to address various first-order issues. It should eschew one-size-fits-all approaches that require the health systems in all states to march in lockstep.

In recent years, “universal health coverage” has emerged as the catchall healthcare phrase. Fundamentally, a universal healthcare plan seeks to provide both health improvement and financial protection. But because such plans are often riddled with conflicting politics and economics, any effort at providing universal health coverage must strike a balance between health improvement and financial protection. The former must meet the test of efficiency, in terms of delivering a sizable healthcare bang for the buck; the latter must meet the test of fairness, in terms of offering a financial cushion to protect against catastrophic and financially ruinous health events.

A good place to start is at the bottom. Any debate on healthcare reforms must acknowledge that preventive, promotive, and primary care should be the responsibility of the government and should be publicly provisioned. Therefore, public spending to strengthen the bottom of the healthcare pyramid should be nonnegotiable. But since the existing architecture is dysfunctional, increased spending without fundamental institutional reforms is merely throwing good money after bad.

Any institutional redesign will have to accommodate the vast differences across Indian states. At one end are states like Kerala and Tamil Nadu, with very strong primary health centers (PHCs); at the other end are states like Uttar Pradesh, with virtually nonfunctional facilities. In the former, it may be appropriate to strengthen the existing network of subcenters, PHCs, and community health centers (CHCs), while in the latter it may be prudent to focus on strengthening the subcenters through intensive community mobilization and capacity building and to consolidate care provision in CHCs. In both cases, it may even be necessary to accommodate less than fully qualified providers after sufficient capacity building and with some form of regulation. Certain basic diagnostic services can be offered through the PHCs, wherever possible, or through mobile units in other places.

But fundamentally, across states, there is a compelling case to view the subcenter as the care-providing interface and the PHC as a coordinating and managing entity for preventive, promotive, and primary care. The subcenter should be the point of convergence for the delivery of all national programs, including maternal and child health interventions. The PHC, administered by a public health manager instead of a doctor, should be responsible for coordinating the delivery of all these programs and should function as a gatekeeper for accessing referral services.

Because of the rapidly growing incidence of noncommunicable diseases, primary care facilities should also focus on creating awareness of and screening for diabetes, hypertension, certain types of cardiovascular conditions, and some cancers, and providing palliative care for patients. Auxiliary nurse midwives can be trained to conduct the screening exams. Depending on their respective capacities, certain states, even some districts, should initiate the process of portable electronic documentation through the electronic medical record (EMR).

Instead of ad hoc line-item allocations, with tight norms and components, the central government financing of primary care should be linked to a five- to ten-year outcomes-focused plan addressing a range of desirable objectives. Apart from routine administrative monitoring, the achievements should be evaluated by third-party agencies. In turn, the state government should establish similar performance contracts with the PHCs. This approach could be phased in gradually across the country, with the strongest states and districts receiving the reforms in the first phase.

This approach should be complemented by more infrastructure investments and personnel deployments to strengthen both the CHCs as first referral centers and the tertiary care hospitals as competitors to private hospitals. Above all, these facilities should seek to reattract private citizens through offering more diagnostic facilities, greater cleanliness and responsiveness, and better management. The Swachh Bharat Mission, the cleanliness and sanitation campaign that is being led by the prime minister himself, should prioritize the cleanliness of hospitals as a priority within the program itself, and the secondary and tertiary care hospitals should be ranked according to cleanliness and given financial incentives. Apart from providing affordable and accessible care for the poor, strong public tertiary care facilities are essential to keeping private providers honest. Because of their large multiplier effects, initiatives to strengthen secondary and tertiary care facilities should be taken up at mission level and states incentivized with financial allocations.

No discussion of healthcare today is complete without taking up the politically popular matter of universal coverage health insurance. Because it is fiscally unsustainable, a more realistic compromise may be to offer coverage for a set of catastrophic medical conditions, ones that contribute the largest share to India’s high out-of-pocket spending. Instead of unrestrained consumer choice, there should be a rigorous selection process for empanelment to ensure that insurance coverage does not become a channel to enrich private multispecialty hospitals. For patients covered by publicly financed insurance, public facilities should be the first choice by default. Such patients should not be seen at tertiary care facilities for simple secondary care treatments but instead should be directed to the revamped first referral units. But all this assumes the service standards at these facilities can be improved.

If this strategy is adopted, it may also be useful to consolidate all the public insurance schemes offered to different categories of people under one umbrella, with a basic insurance plan and different options for additional insurance beyond the basic plan, including a premium care option. The basic plan could be offered by different insurers across the country. As in continental Europe, the basic plan should be community-rated, cover a very basic set of high-incidence catastrophic medical conditions and no more, involve strategic purchases (as a monopsony buyer) at an appropriate level, and be offered for the same premium by all insurers within a region. Private insurers should also offer this basic plan on the same terms while being allowed to differentiate on additional coverage according to the quality of the services offered. 

For a country of India’s diversity, it is prudent that several strategies exist to provide universal health insurance. States with strong public healthcare systems should try to adopt some form of capitation-based health services delivery model, at least in a few districts. The services of primary, secondary, and tertiary care centers should be closely integrated into a referral system with an EMR system once these centers’ geographic and demographic mapping is complete. The deficiencies should be plugged with mobile services delivery and by contracting private providers. Performance standards and service outcomes should also be clearly defined. Instead of the usual line-item budgeting, the budget allocation should be made on a per capita population basis, disaggregated to subcenter level, as a capitation payment in return for the delivery of a defined set of healthcare services. The capitation could also be confined to just the primary and secondary care activities.

This model would require careful structuring of incentives to prioritize preventive, promotive, and primary care services and minimize referrals, while not encouraging skimping on diagnostic and therapeutic procedures. The providers could even be incentivized with capitation top-ups—both personnel rewards and money for asset creation—for superior health outcomes. The existing public health insurance schemes could be integrated into the capitation model. A district may be the most appropriate capitation unit. This approach could be tried in a few districts and gradually refined, and the lessons learned used to inform a broader rollout. It is essential that such experiments be given adequate operational flexibility and time to stabilize. Accordingly, state National Rural Health Mission (NHM) societies should enter into at least five-year memorandums of understanding with the district NHM societies. The districts should preferably enlist the services of a technical support partner that can assist with capacity-building support to manage the capitation structure.

The success of all these initiatives is critically dependent on reforms to medical education. Most fundamentally, the Medical Council of India should be unbundled to separate the roles of registration, standards setting, and regulation. It may be useful to examine the possibility of establishing central and state regulators for health to regulate areas such as the quality of care, diagnostic services, medical devices, and so on. However, such regulation must be carefully managed to ensure it does not become another stifling layer of bureaucracy or captured by vested interests. Its touch should be light, and regulation setting should involve the participation of professional bodies of medical service providers themselves.

India’s medical education system presents an inverted structure: the ratio of basic to specialist doctors is about 1:3; elsewhere the reverse is the case. In light of the acute shortage of medical professionals, a large expansion in medical training facilities and more seats for specialist degrees are urgently required. District hospitals could be allowed to start medical colleges, perhaps beginning by offering paramedical and medical board preparatory courses. The Medical Council of India should address the growing concerns about the deteriorating quality of medical care by increasing the rigor of certification of new graduates. The implementation of the much-delayed proposal for a common national eligibility entrance test for admission to Bachelor of Medicine, Bachelor of Surgery (M.B.B.S.), Bachelor of Dental Surgery (B.D.S.), and postgraduate courses, which was recently cleared by the Supreme Court of India, is an important step in this direction. This should be complemented with a similar standardized test for graduating students. A new cadre of public health managers could be created to address primary care needs through a three-year Bachelor of Science degree in public health. This would allow basic doctors to be redeployed from PHCs to strengthen the far fewer CHCs.

Finally, today, apart from a very small sliver of the population, the overwhelming majority of Indians have no record of their medical history. Each medical consultation is a stand-alone exercise, with attendant problems of information asymmetry. As a result, the quality of care suffers. Under the circumstances, the EMR has the potential to increase the effectiveness of care delivery and to lower costs dramatically. The records should be integrated with the patient’s Aadhaar number to enable portability and interoperability across providers. On the conditions coverage side, the EMR could start with maternal and child health interventions, noncommunicable disease screenings, and outpatient and inpatient care. On the institutional side, it could gradually expand from primary care facilities to cover secondary and tertiary institutions, including private providers who chose to access the public network.

Because common standards are essential for interoperability and the development of a large ecosystem of third-party applications, and for security and privacy concerns, the Indian government’s Ministry of Health and Family Welfare should lead the development of standardized open-source EMR software that can be easily customized to meet local requirements. A prudent strategy would entail developing the software application through pilot projects in a few districts through an iterative approach, and then scale up across the country in phases. Such standardization of protocols and platforms would also enable the development of a crowd-sourced ecosystem of mobile phone apps and other software to take advantage of valuable network effects.

The implementation of new initiatives should provide adequate flexibility at the cutting edge. Apart from the EMR, such technology applications as the online management of drug supply chains, maternal and child health tracking, and so forth should be encouraged by making available easily customizable open-source software for the full range of electronic user devices. Integrating the informal providers, the continued capacity building of paramedical staff, making secondary and tertiary care centers attractive for patients, the use of mobile services, and other secondary uses should be left to the discretion of district governments based on a menu of available alternatives. However, each initiative should spell out clearly the expected outcomes, milestones, and timelines, all of which should be incorporated into memorandums of understanding entered into by the district and state NHM societies.

Toward a Healthy India

  1. Initiate an institutional redesign of primary care systems based on state context.
  2. Transition to more outcomes-based budgeting for care providers at all levels.
  3. Strengthen CHCs and tertiary care facilities.
  4. Provide universal, basic health insurance with top-ups.
  5. Experiment with a capitation-based service delivery model.
  6. Reform the health regulatory systems.
  7. Mandate greater regulation and standardization of private providers.
  8. Initiate a national electronic health records program.

Urban Governance Reforms

A 2010 report by the McKinsey Global Institute on urbanization in India estimated that by 2030, cities would create 70 percent of new jobs, produce 70 percent of incremental output, and account for 85 percent of all tax revenue.119 Some of the largest Indian cities are country-sized economies. Despite their size and importance, however, they suffer from weak long-term leadership, are shackled by state governments, are sorely deficient in urban planning, and are acutely constrained by lack of resources and limited capacity.

The current urban administrative disposition aligns the incentives of city leaders and government-appointed municipal commissioners on hygiene factors and projects, such as maximizing tax collections, maintaining cleanliness, promoting road widening and flyovers, and implementing projects. Critical determinants of long-term urban growth—affordable housing, metropolitan transportation systems, education and healthcare, and economic growth and job creation—are far from the priorities of urban administrators.

Indian cities require strong political leadership with long enough tenures, supported by a municipal commissioner and a competent team. The global experience in both developed and developing economies shows that transformational urban development has been powered by the leadership of committed mayors. This demands administrative reforms that allow for empowered and directly elected executive mayors, the devolution of the full extent of eighteen functions under the Seventy-Fourth Amendment to the Constitution, establishment and empowerment of ward committees and area sabhas (composed of local-level representatives), and removal of the mandatory reservation and rotation system for the mayoral post. These changes likely would attract the best and brightest among public-spirited leaders from academia, bureaucracy, corporations, and nonprofits into urban politics. And this experience can be an excellent stage for higher state and national leadership aspirations.

Urban planning, long the Achilles’ heel of the country’s city administration, needs to abandon its current ad hoc, expediency-based approach. A master plan is a blueprint for the city’s future, for its spatial elements and density. Functionally, it guides the city’s transportation and utilities plans, future land-use patterns, and locations of economic activity for twenty to twenty-five years. The transportation and utility networks of an area need to be planned, and often constructed, in anticipation of the area’s future development trajectory. A cascaded system of long-term planning, with reviews at defined times and minimal conversions in between, should be adopted and enforced in a credible manner. To promote vertical development, Indian cities need to replace their current uniform and low floor area ratio (FAR) regime with a more graduated system. The FAR should be highest in the central business areas and along transit corridors and should decrease with distance. Land-use conversions on the city margins should be avoided to minimize the development of suburban sprawl.

Indian cities, even the largest, lack sufficient institutional capabilities. Because of the acute lack of internal professional expertise in the management of modern cities, it may be necessary to outsource this function and procure the services of external talent. Apart from hiring consultants, urban administrative systems should institutionalize a provision for the contracting of individual professionals in such areas as planning, finance, transportation, public health, and IT. An initiative such as an Urban Fellows for India that mobilizes public-spirited professionals to work with cities for a one- to two-year period has the potential to attract talent and thereby to create a pool of urban sector professionals. These efforts should be complemented by the establishment of a network of mutually beneficial partnerships with local universities and think tanks.

The 2010 McKinsey Global Institute report documents that India chronically underinvests in its cities, with per capita spending, at $50, being one-seventh of China’s and one-tenth of South Africa’s.120 The report estimated that to provide a basic level of urban civic services, India would need to increase urban capital expenditure eightfold and operational expenditure at least threefold. The first and most important step in this direction is to broaden the country’s narrow property tax base. This would require capturing both unassessed and underassessed properties as well as increasing tax rates, though both remedies, unfortunately, would run into issues of state capability and the political economy.

The other potentially major source of internal revenue is value capture from public assets and infrastructure improvements. The urban planner Donald Shoup articulated one of the great ironies of development: “Why is it so difficult to finance public infrastructure that increases the value of the serviced land by much more than the cost of the infrastructure itself?”121 Given the near certainty of large increases in property valuation associated with infrastructure improvements, local governments should seek to capture a share of the increment through such instruments as impact fees, development charges, or tax increment financing. Apart from this, local governments own vast extents of prime real estate, which often are suboptimally utilized or just vacant and could be leveraged to maximize value capture. The McKinsey Global Institute study estimated that land monetization could yield about $27 billion annually, a ninefold increase and more than the current total capital and operating expenditure across all of urban India. Even if only a quarter of this amount materialized, it would dramatically increase city finances.

Even if all these sources of revenue were operationalized, however, cities would still need massive budgetary grant support from state and central governments. States should be encouraged to adopt these reforms in at least some urban development regions by incentivizing them with the direct devolution of a share of the direct or indirect taxes. Alternatively, cities that embrace these reforms and increase their internal revenue beyond a predefined benchmark (regional) could be incentivized with additional resources from the government of India.

Since state governments may be unwilling to grant more authority to the mayors of the largest cities and state capitals, it may be prudent to consider such governance experiments in second- and third-tier cities. In the absence of adequate capacity, these reforms are most likely to create a period of instability and chaotic disequilibrium. But postponing devolution on these grounds will not only prolong the current problems but also worsen them.

A combination of institutional reforms that devolves the full extent of the eighteen functions under the Seventy-Fourth Amendment, empowers elected mayors with executive functions, builds capacity by drawing on external expertise and initiating partnerships with local institutions, develops innovative value capture initiatives, and transfers a share of the direct and indirect taxes has the potential to be a game changer in India’s urban development.

Urban Governance Reforms Agenda

  1. Empower mayors as authorities with full executive powers, at least in second-tier cities.
  2. Fully devolve all eighteen functions of the Seventy-Fourth Amendment and establish and empower ward committees and area sabhas.
  3. Focus on urban planning by instituting cascaded master plans and higher floor area ratios.
  4. Broaden the property tax base by capturing unassessed and underassessed properties.
  5. Adopt value capture methods to raise internal resources.
  6. Build institutional capacity through institutionalized lateral hiring, internships (such as Teach for India), and partnerships with local institutions.

Affordable Housing and Unshackling Land Markets

No ingredient is more important to the success of urban growth than the supply of adequate affordable housing for the large numbers of migrants relocating to cities. The Ministry of Housing and Urban Poverty Alleviation has estimated a deficit of 18.78 million housing units in 2011, with 95 percent needed by lower-income groups.122 To put this in perspective, the total number of housing units sanctioned in seven years under the flagship Jawaharlal Nehru National Urban Renewal Mission is 1.44 million, of which fewer than 600,000 units have been completed and occupied. It is now proposed to bridge this deficit by 2022.

Public housing projects cannot make a dent in such a huge demand. Demand on such a scale can be met only through private markets. Public support should come in the form of making renting and ownership affordable. Unfortunately, the private market for affordable housing, especially for those at the lower end of the income ladder, is nonexistent. One of the perverse features of India’s urban housing market is that while 90 percent of the demand comes from those with annual incomes below Rs 500,000, units for them make up just 10 percent of the supply.123 Furthermore, low-income housing forms a negligible proportion of the total mortgage origination and is largely funded by the small housing finance companies. Formal rental markets are virtually absent.

Under the circumstances, the objective should be to increase the stock of affordable housing by creating attractive conditions for developers to build for this market and by lowering the information asymmetry to enable banks and other lenders to offer mortgages to people with little or no formal credit history. Policies to advance the first goal should include ones to lower land cost, simplify and expedite permits (including environmental permits, conversions, and building approvals), and reduce taxes (such as the stamp duty and the service tax). Policies to achieve the second goal include earmarking a share of housing credit for lower-income housing, expanding credit bureaus to consolidate all consumer durables and other hire-purchase transactions, and vastly simplifying processes for accessing mortgages and repossessing defaulting properties. The Real Estate (Regulation and Development) Act of 2016 provides an excellent opportunity for enabling such transparency.

These policies should be complemented by another set of policies to eliminate the distortions in the land market. A plan should be phased in over eight to ten years for a simultaneous increase in official guidance value to equalize with market value and a lowering of the stamp duty. This can be done in a revenue-neutral manner to increase political acceptability by creating a win-win situation for state and local governments. If, in addition, information on the registration values for each area was made publicly available, a database of property transactions and prices from all possible sources (housing lenders, real estate agencies and websites, and registration departments) was set up, and stricter monitoring of housing finance transactions was put in place, these steps would also have the effect of limiting the origination and circulation of black money in real estate transactions.

The poor quality of land title documentation, coupled with the country’s presumptive (as opposed to guaranteed) land registration system, means that purchasing land is fraught with risks. Neither the quality of titles nor the registration process is amenable to short-term solutions. Under these circumstances, title insurance emerges as a prudent compromise. Two important enablers—bridging the information asymmetry on title encumbrances and on mortgage origination—have the potential to catalyze the creation of a title insurance market. This would require the establishment of a depository of this information, captured and made available in a searchable and user-friendly manner.

Limited land availability, a rapidly growing urban population, and the problems of sprawl point to high-density vertical growth as the way forward. The highly restrictive FAR of India’s cities must be relaxed along transit corridors, in areas surrounding transit stations, and in newer developments. Relaxation of FAR requirements could also incentivize urban renewal in blighted or declining areas and lower the cost of affordable housing units.

Governments at all levels—central, state, and local—are the biggest landlords in most cities. An estimated 12–18 percent of the total urban lands are suboptimally utilized or vacant.124 Apart from the central public sector enterprises, the Ministries of Defense, Railways, and Shipping hold vast tracts of land within the country’s largest cities. The Salt Commissioner’s Organization holds 61,000 acres across mainly five states. In Mumbai alone, it owns nearly 5,400 acres (21.6 square kilometers), or 30 percent of the total area available for residential development in all of Greater Mumbai.125 A calibrated release of these vast hoardings and their high-density development, both directly by government and through public-private partnerships, can put sharp downward pressure on property prices.

Finally, in the context of the deadlock in the central land acquisition legislation, apart from considering their own legislation, state governments should examine the possibility of procuring land through partnerships such as land-pooling or town-planning schemes. The former, which is being tried on a massive scale for the new capital city of Andhra Pradesh, and the latter, which have been successfully implemented for decades in Gujarat, are excellent examples of consensual strategies for land procurement that can be used not just by governments but also by private investors.

Affordable Housing and Land Market Reforms

  1. Simplify and expedite the process for acquiring approvals and permits.
  2. Earmark bank housing credit for affordable housing.
  3. Phase out guidance valuation and lower the stamp duty.
  4. Create a national property valuation registry; develop an expanded Residex.
  5. Catalyze a market for title insurance.
  6. Increase the FAR along transit corridors and around stations.
  7. Develop a calibrated use of government-held lands for affordable housing projects
  8. Use land-pooling arrangements to procure land.

Ease of Doing Business Reforms

Many conversations around improving India’s business environment focus either on macroreforms or on easing one-off transactions. Proposed macroreforms include improvements to infrastructure facilities; the relaxation of labor market regulations, such as the Industrial Disputes Act, that set onerous conditions for hiring labor; and improvements to property titling systems, which make land transactions a nightmare. Reforms of onetime transactions include measures to ease incorporating firms, purchasing and registering property, obtaining building and other permits, and getting utility service connections.

But even if these constraints were eased, the business environment likely would not change dramatically. That would require a transformation in how the Indian state interacts with the private sector. Businesses constantly deal with officials from a wide variety of departments—labor, environment, taxation, local governments, police, and customs and immigration—in the course of normal operations. These interfaces often involve repeated game playing that goes beyond the onetime interaction and provides officials, even in the most deregulated environments, with considerable leverage over businesses in their jurisdiction.

The additional cost of preventing whimsical actions and harassment adversely affects business competitiveness, especially of start-ups and smaller firms. Mitigating this problem entails creating an environment in which such harassment and corruption are minimized and strengthening the state’s ability to deliver on its commitments effectively. Transaction costs can be reduced by minimizing and simplifying bureaucratic layers, eschewing rigidly prescriptive regulatory standards, outsourcing public service delivery to eliminate interfacing with officials, and instituting web-enabled workflow automation of departmental processes. Technology also can have a powerful role in simplifying and expediting processes, bridging information asymmetry, and ensuring accountability.

The various types of mandatory labor-related information filings illustrate the problem. According to current labor laws, service enterprises and factories must maintain twenty-five and forty-five registers, respectively. They must file semiannual and annual returns in duplicate and as hard copies. Furthermore, the salary and attendance documents have tens of columns. A recent estimate found that the country’s 50-million-plus enterprises will use 5 billion sheets of paper each year in complying with labor laws.126 Worse still, these papers are unlikely ever to be scrutinized and will merely gather dust and take up space in public offices. The vast majority of these filings should be dispensed with and the essential ones captured online.

Another recommended reform is the adoption of a unique enterprise identity number to replace the maddening array of identification numbers required for the administration of various rules and regulations. These include the Corporate Identity Number (unique twenty-one digits) from the Registrar of Companies, the Tax Identification Number for Commercial Taxes (unique eleven digits), the Service Tax Number (fifteen digits, alphanumeric), the Permanent Account Number (ten digits, alphanumeric), the Central Board of Excise and Customs number (the Permanent Account Number plus two characters), the Employees’ Provident Fund number (eleven digits, alphanumeric), and at least ten other numbers required by taxation, labor, or other central government laws. Apart from these, each enterprise gets a number, either for registration or licensing, issued under at least twenty-odd state or industry or labor legislations. This multiplicity of identification numbers prevents interoperability of applications and causes duplication of data management. The extra effort adds several layers of unproductive administration and works against the ease of doing business.

In this context, a single identification number, such as the Permanent Account Number, for a firm can be a game changer in simplifying processes and enabling process automation and integration. Businesses could sign on to an Ease of Doing Business portal using a single number and complete all their regulatory, tax, labor, and other individual departmental filings. Furthermore, the portal could provide a platform to integrate the workflow of individual processes and departments, thereby helping avoid data duplication as well as enhancing the ease of doing business. If sufficiently simple, it would dramatically lower the regulatory and other compliance costs for businesses and encourage greater business in the formal economy.

Technology has a powerful role to play in simplifying and expediting processes, bridging information asymmetry gaps, and ensuring accountability. For example, large gains are possible in transportation logistics management. It is estimated that trucks spend one-quarter of their journey times at checkpoints, the 650-odd interstate border posts, and city entrances, and 15 percent of their time at toll plazas.127 These vehicles cover just 250–300 kilometers (about 155–186 miles) a day, compared with 800 kilometers (about 500 miles) in the United States, making the cost of the logistics more than the entire wage bill for manufacturers. The World Bank estimates that halving such delays would cut freight times by 20–30 percent and logistical costs by 30–40 percent.128 Electronic tolling, the unique numbering of vehicles, and e-billing, coupled with the imminent goods and services taxation, could achieve this objective. Such a nationwide transportation logistics management system could potentially be the most powerful force for interstate trade since the unification of the princely states and could usher in a truly integrated pan-Indian market for goods and services.

Similar gains are possible in port logistics management. Just the documentation compliance for exporters takes sixty-one hours at Mumbai port, versus the Organization for Economic Cooperation and Development members’ average of just five hours, and at the respective costs of $104 and $36.129 Workflow automation of berthing, customs and immigration services, standards certificates and invoices, manifests and certificates of origin, and logistics management at ports and airports could dramatically reduce the time drain at the country’s entry and exit points. All these processes and the relevant paperwork should be made available online to enable the trading and shipping agencies to upload the requisite documentation for approvals well in advance. Furthermore, the workflow software for all the individual port services, public and private, should be integrated on a common portal to ensure organic data seeding and automatic retrieval across applications.

A prominent area of discussion in respect to improving the business environment concerns easing labor market regulations. The government has already laid out an ambitious labor reform agenda. Apart from consolidating the existing forty-four labor laws into four labor codes, all organized and unorganized sector workers and employers would be assigned unique identification numbers, which would considerably simplify access to employee benefits and ease the current tortuous filings and tax payment obligations of employers. These initiatives are in the initial stages of implementation and need to be pursued to completion. However, the political setting in which these reforms are to be executed and the logjam in the Indian Parliament make them difficult to pull off. In the circumstances, more immediate results could be achieved by pursuing the equally important reforms of labor taxation.

The fundamental problem with India’s manufacturing is that firms start small, in the informal sector, and remain small and informal. This situation engenders an inefficient equilibrium of low productivity, low wages, inadequate social protections, limited investment, and stunted growth. While it is possible that restrictive hiring and firing policies encourage firms to start small and informal and remain so, another possibility is that the high labor taxes, payable by both employers and employees (up to 32 percent of wages are deducted for pensions and insurance from the wages of those with smaller incomes, whereas just over 5 percent are deducted from the wages of those with higher incomes), encourages much the same and may be a more proximate deterrent to starting and hiring in the formal sector.130 It is certain that both restrictive labor regulations and a high rate of labor taxation contribute to keeping firms small and informal. What is not certain is which is the greater constraint facing firms.

A cautionary tale takes shape. A typical entrepreneur starting a textile unit is more likely to start small and not be able to afford higher salaries. However, by offering low salaries, the entrepreneur is also unlikely to be able to attract workers, especially in light of the prohibitively high payroll deductions. So the firm prefers either to start in the informal sector or to use contract labor. Once it starts in the informal sector, it is trapped in a low-level equilibrium. Exiting from that is constrained by several factors, including informality itself, as well as restrictive labor regulations.

Therefore, a more prudent strategy involving labor market reforms would revolve around lowering mandatory payroll deductions and replacing them with publicly funded social protection, currently programmed for a gradual phaseout. As a step in this direction, the Union Budget 2016–17 announced that the government of India would pay the employer’s contribution of 8.33 percent to the Employees’ Pension Scheme in the first three years for all new employees with salaries up to Rs 15,000 who enroll in the Employees’ Provident Fund Organization. Extending this idea further, it may be useful to make the current mandatory employee contributions voluntary.

In light of the growing prominence of the construction sector, policy measures that encourage the transition of the largely informal construction workforce to formality may be another priority area for action. A comprehensive social safety net for construction workers may provide a powerful nudge in this direction. The potential impact on productivity in the fastest-growing sector is immense.

The various labor-side measures discussed in this section would be expected to wean industrial policy away from its traditional focus on physical capital incentives and toward investing in human resources.

Ease of Doing Business Reforms

  1. Lower the transaction costs of repeated transactions.
  2. Simplify mandatory business filings.
  3. Introduce workflow automation of immigration, customs, and logistical services in ports and airports.
  4. Use e-tolling, a unique vehicle number, and the goods and services tax to establish a nationwide transportation logistics management system.
  5. Introduce a single identification number for enterprises and workflow automation.
  6. Lower mandatory payroll deductions for those with lower salaries.
  7. Introduce policies to encourage formality in the construction sector.

Infrastructure Expansion Mission

Infrastructure constraints remain arguably the biggest obstacle to the achievement of a sustained period of high economic growth. Inadequate road and rail transportation capacity, port handling and logistics management bottlenecks, an unreliable power supply, and a deficient urban infrastructure not only erode business competitiveness but also constrain entrepreneurship and business expansion.

A long-term plan for massive investments in infrastructure, with public spending providing the basis and private capital leveraged where private investors are best positioned to bear the risks, has to be formulated. A prioritized shelf of projects in different sectors, supported by a project-centric financing strategy—using public finance, public-private partnerships, and private finance, among other sources—should be prepared and rolled out in a phased manner.

A few such projects stand out. A mission-level project to develop dedicated freight corridors, expand the national highway network, and establish road and rail connectivity for ports should assume top priority among all infrastructure projects. Apart from the Eastern and Western Dedicated Freight Corridors, other corridors with high traffic density should be covered in a phased manner. Similarly, the remaining links of the national highway network should be completed and those with the highest traffic density should be widened to six to eight lanes to accommodate demand forecasts for the next three decades. The potential of these road and rail networks is best realized when they are connected to the existing ports. These projects could reasonably provide the biggest catalysts for the development of industrial corridors and propel the Make in India initiative.

In the energy sector, the ambitious renewables program raises issues of grid management and grid stability. It necessitates investment in new peaking plants and, more important, the retrofitting of existing thermal plants to serve as peak load providers. Transmission capacity is fast becoming a binding constraint on the power sector. Because of the long times needed to plan and place transmission lines, it is necessary to create a shelf of projects to handle at least three times the current capacity and bring them online over the next decade and a half.

The weakest link in the chain is distribution. In recent years, loss reduction efforts have plateaued and are likely to remain flat with business-as-usual measures. Apart from reducing losses, governments should commit themselves to raising tariffs to ensure cost recovery and to reforming free farm power. A first-order requirement is to measure and audit energy distribution, not through fancy advanced technology solutions but through simple real-time metering of feeders and feeder-consumer mapping, followed by rigorous monitoring and enforcement. The Ujwal Discom Assurance Yojana, or UDAY, scheme, the financial revival package for distribution companies, could potentially be the tipping point for fiscal prudence with respect to ensuring that tariffs keep rising to cover the costs of service.

Technology and Aadhaar together are a potentially powerful combination to reform farm power. Instead of having their supply times restricted, farmers could be assured equivalent (or higher) units of a free supply. Farm connections would be metered and agriculture tariffs fixed. Each farmer would pay a monthly electricity bill, whereupon the previous month’s bill would be reimbursed to the extent of the free units, with the funds deposited into the farmer’s Aadhaar-enabled bank account. Furthermore, the farmer could be incentivized to reduce consumption through reimbursement of an amount proportional to unconsumed units (of the free units allotted).

There is arguably no more effective development initiative than extending all-weather roads and assured three-phase electricity to rural and remote areas. The multiplier effects in terms of opening up remote economies, integrating them with urban centers, and dramatically expanding economic opportunities outweigh those of any other initiative. The ongoing programs should be expedited and monitored with great rigor.

The importance of private capital, especially on the scale required, demands a credible, fair, certain, and prudent procurement and contracting process. Certain rules of the game must be followed. First, detailed project reports should be made without compromising on rigor or introducing overly optimistic forecasts. Second, public-private partnerships are most effective when there are also significant efficiency gains to be realized from private equity participation, that is, when they are not just a means to mobilize private finance. Third, project costing should be done to internalize all possible risks, including cost escalation and interest accumulation. This assumes great significance because the Chaturvedi Committee formula for project costing caps cost escalation at 5 percent, instead of using a pass-through for cement, steel, and bitumen, and does not allow an increase in project costs due to the accumulation of interest during construction. Extending the concession tenure by the period of delay without addressing these deficiencies in the formula is merely kicking the can down the road. Finally, governments have to bear all those significant construction and commissioning risks that cannot be mitigated or diversified away through available market mechanisms.

In road construction, because of the significant nondiversifiable construction and traffic realization risks, and with the sector’s long history of attendant cost overruns and traffic shortfalls, private developers may be in no position to bear those risks. Under the circumstances, governments may have to bear the risks and construct the project before outsourcing operation and maintenance to long-term concessionaires. The recent revisions in the National Highways Authority of India contracting structure signaling a shift from the build-operate-transfer model to the engineering, procurement, and construction model are an acknowledgment of this reality. Once the construction risks are off-loaded and the project is commissioned, it becomes possible to attract the large stock of patient foreign capital from pension and insurance funds, private equity, infrastructure funds, and other institutional investors.

Apart from these considerations, in recognition of the near inevitability of renegotiations in long-term concessions, such contracts should be structured with adequate flexibility for nondiscretionary renegotiations when the need arises.131 A few principles could guide the creation of any renegotiations policy framework. First, concessionaires should internalize the cost of renegotiations. The use of alternative contracting approaches, such as the least present value of revenue or minimum income guarantee models, which are based on commercial viability considerations, can help easily internalize the costs and thereby mitigate renegotiation risks. Second, experience from across the world shows that contracts that have investment obligations and those under price-cap regulations, as in transport and water, are most vulnerable to renegotiation. Such contracts would benefit from a built-in provision for periodic review, with clearly defined contingencies that would precipitate such reviews, as well as a clear statement of their scope. In such projects, the British model of price cap regulation—whereby tariff increases are capped according to inflation, efficiency improvements, and capital investments, and the bid value is valid for only the initial few years and is revised after regulatory reviews over five- to seven-year periods—may be more appropriate.

Third, the renegotiation process should be apolitical and institutionalized. The original mandates of the regulators should clearly outline the scope, terms, and protocols for any renegotiation. The legal basis of the entire renegotiation and its appellate processes should be clear and strong and insulated from the government. All these conditions should be stipulated in the contract. Furthermore, regulatory autonomy is critical to curbing both political opportunism and corporate greed, besides creating institutional credibility surrounding such contracts. This credibility can be enhanced by involving a panel of reputable sector specialists in the renegotiations process. The public utility (resolution of disputes) bill announced in the Union Budget 2016–17 should incorporate these principles.

Fourth, where the project valuation is clear, governments should also consider buying out the developer’s investments and then contracting out the project anew. Power projects are potentially amenable to such arrangements. In such cases, to avoid moral hazard, the amount payable for termination should be contingent on the bids received during the rebidding process.

Fifth, cost overruns during the construction phase commonly precipitate renegotiations, especially on price or tariff increases. In this regard, the practice in Australia and the UK of adjusting for a so-called optimism bias, calculated from the history of cost overruns in all projects in the sector, while writing contracts can be useful. Scenario planning that considered various contingencies of risk materialization and the actions that would follow would help mitigate the adverse consequences of risk appearance.

Finally, renegotiations are more likely when competition is intense and on contracts negotiated in good times when plentiful credit is available. Just as investors pour money into asset classes, driving up valuations and inflating bubbles, developers throw caution to the wind and submit lowball bids with excessively optimistic revenue projections that reflect the euphoria of the boom. In such times, financial markets fail to do the due diligence that prevents excessive risk-taking by euphoric developers. Once the business cycle turns down, affecting the project’s commercial viability, the developer is left with no option but to seek renegotiations. Governments should therefore be cautious in evaluating excessively attractive bids made in euphoric times and when competition is high. The real cost of such apparent free lunches follows, but not until much later.

As the portfolio of completed public-private partnership projects expands, developers are likely to exit by securitization or by direct stake sales. Exits of both types are now allowed in all the National Highways Authority of India road projects. And the agency is seeking to monetize its commissioned road assets. Given the difficulties associated with raising toll tariffs and the likelihood that the concessionaire will skimp on maintenance and improvements, monetization by outright sale, as happened with the much-studied examples of the Indiana Toll Road and the Chicago Skyway, may not be the right strategy. A more prudent strategy may be ten- to fifteen-year tolling along with operating and management concessions. Such exits, as the example of Delhi Airport Express Metro link shows, also raise concerns about the concessionaire’s incentive to minimize life-cycle costs.132

Fundamentally, because of the uncertainties involved and the vastly different nature of the implementation environments, it is not possible to graft uniform best-practice models of procurement and contracting onto infrastructure projects. Accordingly, the procurement processes, conditions, and contracting documents should be revised regularly to incorporate lessons learned from the most recent experiences.

Infrastructure Mission

  1. Prioritize a shelf of projects, including for direct freight corridors, national highway segments, and port connectivity.
  2. Improve power grid management by building peak capacities.
  3. Plan a threefold transmission capacity expansion program.
  4. Reform power distribution through energy audits, increased tariffs, and free farm power reforms.
  5. Extend all-weather roads and a three-phase electricity supply to remote and rural areas.
  6. Institute public-private partnership contracting policy reforms.
  7. Develop a contract renegotiations framework.
  8. Develop a policy framework for the monetization of commissioned infrastructure assets.

Banking Sector Reforms

The most urgent requirement to put the economy on a sustainable growth path is for banks to resume normalcy in lending. For the year ending March 2016, the total of the banking system’s net owned funds was a little over $118 billion, the stated gross nonperforming assets were around $90 billion, and the estimated level of nonperforming assets, including restructured assets, was around $190 billion, thereby leaving the banking system as a whole with negative equity.133

The elevated and rising level of stressed assets—17.2 percent of gross advances ($190 billion) as of March 31, 2016—makes lenders wary of assuming any risks. Independent analysts estimate the level should be reduced to be around 30–40 percent in such sectors as steel and power.134 The equity infusion needed to meet the higher capital reserve requirements under the Basel III rules is an additional INR 3,100 billion by 2019, as estimated by the P. J. Nayak Committee.135 Setting aside money to meet capital reserve requirements not only affects new project lending but it also limits the scope for reviving stalled projects.

Because of the dominant role of banks in India’s credit transmission, restoring their health and recapitalizing banks to create the space for further lending should be an immediate priority of the government. The revival of private investment, especially infrastructure spending, depends critically on a healthy banking system.

The overhang of bad loans is not going to go away on its own. Nor can the loans be auctioned off, as was done in the United States in the aftermath of the subprime lending crisis. Unlike in the United States, the vast majority of these assets are owned by public sector banks. More important, a significant share of the bad loans involves large infrastructure projects—some under construction, some completed—and these loans cannot simply be sold in the same fashion as conventional retail and commercial loans.

The completed projects may be auctioned off to private asset reconstruction companies (ARCs), stripping equity holders and imposing haircuts on banks, with a back-end clawback of some part of future revenue to the banks and equity holders. This approach could avoid the political backlash that would likely occur should the asset generate windfall revenue in the future. But with the current model of ARCs, the vast majority of which are incorporated as trusts, such sales may be little more than an exercise in smoke and mirrors because the trusts issue securitization receipts to the same bank and manage the bad assets for a 1–2 percent management fee, a move that results in the reclassification of the bad asset from loan to investment on the bank’s balance sheet.

Rather than engage in this roundabout, banks should make a clean break with the asset, taking losses and auctioning off nonperforming assets completely to the ARCs, which should then have the freedom to resolve the assets as they choose. Owing to the nascent and narrow market for such assets in India, an enabling regulatory environment is essential to the success of the restoration process. To start, the ARCs should be allowed to immediately sell or lease the assets they have taken over. The existing regulations on mandatory open offer for listed companies in the takeover code must be relaxed.136 Furthermore, ARCs should have flexibility on secondary sales to private equity or leveraged buyout groups and infrastructure funds, as well for pooling and securitization of their assets. Another step would be to encourage the development of a market for securitization receipts. The announcement in the Union Budget 2016–17 allowing 100 percent foreign institutional investors in ARCs and in a single asset is a step in the right direction.

Most ongoing projects are likely to be commercially viable once completed. It would therefore be prudent to restructure and complete them at the earliest, if need be with more equity infusion. The construction risks associated with them make them less attractive for long-term investors, such as infrastructure debt and equity funds. In the circumstances, a preferable strategy would be to value them and sell them off to a public entity, such as the India Infrastructure Finance Company Limited (IIFCL). The IIFCL, by itself or through the newly created National Infrastructure and Investment Fund (NIIF), could raise dedicated infrastructure equity and debt funds, leveraging long-term domestic and patient foreign capital, to finance these purchases and infuse the additional capital required. More than individual banks, these funds, with their patient capital stock and professional project management units, are more likely to ensure completion of these projects and make them commercially viable. The financing patterns could even be restructured once construction was completed. A distinction may have to be made between public good assets, such as roads, and private assets, such as power and steel plants, regarding their extent of exposure to public funds. 

The entire resolution process should be conducted quickly and in a credible manner. To mitigate decision paralysis, the process should be concurrently audited and all requisite clearances obtained to preempt ex post facto audit and vigilance objections. Finally, the resolution of nonperforming assets would have to be accompanied by a clear recapitalization schedule and a grant of full operational autonomy. In fact, it might be even worth deviating from the fiscal consolidation path if the additional fiscal spending were transparently dedicated to bank recapitalization. The operational autonomy would have to include refraining from saddling banks with various social obligations without sufficiently compensating them. The government would have to act as an investor rather than as a sovereign.

The entire process of asset resolution, recapitalization, and the devolution of greater autonomy to banks must be complemented by the phased dilution of the government’s stake in banks, including full exit in some cases, and the infusion of top-tier talent into leadership positions. The major part of the disinvestment plan should be back-loaded and oriented toward a not-too-distant future when the reforms have restored market confidence, got credit flowing, and raised valuations. The market’s embrace of the Bank of Baroda, which appointed a new board and expedited the declaration of all its nonperforming assets, suggests a plausible outcome.

Finally, the government must move forward its recent initiatives on payments and small banks and new universal bank licenses to expand the breadth and depth of the country’s banking sector. The RBI governor has himself signaled the need to make the banking system vibrant through the establishment of more differentiated credit intermediaries, such as custodian banks and wholesale banks.137 As Tamal Bandopadhyay recently wrote, “India needs more banks of different shapes, sizes and business models.”138

The new entrants, besides expanding coverage to include remote and rural areas, the poor and unbanked, and mini- and microenterprises, would exert competitive pressures, with the potential to disrupt the prevailing banking system, allocate resources more effectively, and help manage risk more efficiently. Such pressures could also force the politically difficult choices of increased operational autonomy, consolidation, and privatization. Public policy should create the enabling conditions for these dynamics to gradually unfold. Realizing these objectives will take time, but the foundations are likely to be much stronger for the emergence of a vibrant and sustainable banking sector, one capable of meeting the enormous challenges of financial intermediation for a vast and fast-growing economy.

Reinventing the Banking Sector

  1. Introduce reforms to the ARC model, including the choice of placing nonperforming assets in a trust or selling them outright.
  2. Use the IIFCL/NIIF provisions to resolve incomplete public good infrastructure assets.
  3. Develop a policy framework for the resolution process, to include concurrent audits.
  4. Recapitalize the banks.
  5. Complete operational autonomy and phased stake dilution of public sector banks.
  6. Develop a more differentiated banking system.

Shrinking the Informal Economy

The primary reason for India’s very narrow industrial base and low tax-to-GDP ratio is the country’s widespread informal economy. Some estimates put it in the range of 40–50 percent of GDP.139 But its influence is far more than this figure can convey. A more intuitive measure of the size of the informal economy is the scale of informal employment, which accounts for nearly 84 percent of employment in the nonagriculture sector and 93 percent of total employment, a share far higher than in any other economy, large or small.140Pretty much everything that happens in rural India and a large part of trade and small economic activity in urban areas is informal. In fact, it would be fair to say that in the majority of financial transactions, at least one end of the transaction is informal. Apart from the massive revenue loss to the government, the informal economy has a deeply corrosive effect on the transmission of market dynamics and market efficiency, limits the productivity of both capital and labor, and hampers the effectiveness of public service delivery.

Shrinking the informal economy is essential to India’s sustainable high-growth ambitions. Because of its pervasive and broad-based nature, actions would be needed at multiple levels. One way to address this is to harness the power of information technology and data management to capture financial transfers from the bottom up and move them into the formal system.

The combination of Jan-Dhan Yojana, the national financial inclusion program to ensure access to banking services, the Aadhaar number, and the mobile phone—referred to as the JAM trinity in the government’s Economic Survey 2014–15—offers an unprecedented opportunity to dramatically expand financial inclusion. This, coupled with the newer payment systems, more small banks, and the rapid uptake of mobile phone–based payment platforms, is a potentially powerful force to nudge a vast majority of previously unbanked individuals to formalize their financial transactions.

The JAM trinity would enable a workflow-automated targeting of the whole constellation of social welfare programs involving some cash payments made into a beneficiary’s bank account. Apart from curtailing fraud and waste, it would also ensure that all eligible people, especially the poorest among the poor, were able to access their rightful benefits.

In this context, the expenditure information network (EIN) recommended by the TAGUP Report of 2011 assumes great relevance.141 The EIN is proposed as an online workflow automated application to manage and monitor all fund releases from central and state governments, right up to the last mile of the transaction chain. Apart from providing a massive boost to the efficiency of the government’s treasury management and ensuring timely access to program funds, it would help capture the end use of all public funds. The JAM applications could also be plugged into the EIN.

Similarly, the Goods and Services Tax Network (GSTN), designed to manage the massive chain of indirect tax appropriation and reimbursements, could help capture the vast volume of retail commercial transactions. If implemented effectively, these initiatives could make a significant dent in the country’s massive informal sector. In any case, it would do no harm to encourage migration into these formal networks with financial and other incentives.

A combination of all three—the JAM, EIN, and GSTN—would offer unprecedented network effects encompassing all the economic transactions involving the state. Apart from the obvious benefits of reducing evasion and leakages and better targeting of public spending, this system could dramatically increase the efficiency of public service delivery and the utilization of scarce public resources. It would also be a much-needed first step toward expanding the formal economic base and increasing the tax-to-GDP ratio. The integration of these three applications would have to be done very carefully and with an eye to safeguarding the security and privacy of personal and financial information.

This mechanism for moving informal sector participants into the formal economy should be accompanied by a series of other measures to curtail the origination of the largest informal markets. The measures already initiated or proposed to combat black money and money laundering should be expedited and implemented effectively. A revenue-neutral strategy to reduce registration and stamp duties on land transactions while simultaneously lowering and phasing out the differential between the official guidance and the market value of property would be a huge step in the direction of shrinking the informal economy. This should be complemented by measures to limit cash transactions for goods and services, especially for purchases of gold, vacations, and medical services, beyond a progressively declining value. If these measures are implemented in a sustainable manner, their cumulative effect could dramatically reduce the size of the informal economy.

A JAM-GST-EIN Approach to Shrinking the Informal Economy

  1. Use JAM to manage all welfare and program transfers.
  2. Use EIN to capture all other payments by the government.
  3. Use the GSTN to capture marketwide transactions involving economic value added.
  4. Introduce other policies to limit cash transactions.

Public Sector Management Reform and Lateral Entry

India’s bureaucracy and its management of public sector units have been the subject of much scorn and criticism. Lateral entry into senior-level positions has been advocated as a possible solution. Supporters argue that it would instill fresh energy and thinking into an insular and complacent, often archaic, bureaucracy and enable the entry of right-minded professionals and the adoption of best practices to improve governance. Skeptics highlight the risk of lateral entry becoming entrapped in a “spoils” system as a result of the nature of the country’s political system. Because of the associated uncertainties, it may be prudent to adopt a cautious and incremental approach.

There should be a carefully calibrated process of infusing external talent into the public sector. To start, a set of the largest public sector entities—banks and insurers, oil companies, manufacturing units, and power plants—should be allowed to hire talent for board positions through a global competitive and professional sourcing process and at far higher compensation levels than typical public sector compensation packages. The posts should be advertised globally and open to internal candidates, other government employees, and private candidates. In addition, the largest public sector entities should have complete operational autonomy, enshrined in a five-year performance contract between the company and the ministry concerned. Subsidies, including the costs associated with implementing government programs,142 should be monetized and reimbursed out of public funds.

Short of outright privatization, this would be the most effective strategy to improve large public sector firms’ performance while also credibly signaling the government’s strong commitment to improving the governance of public sector units. Because of their size, all these entities, and therefore their leadership positions, directly and substantially affect the economy, arguably even more so than positions within the government. A significant improvement in the performance of each of these entities could also generate considerable positive externalities for the sector itself. Apart from improved leadership and governance, it would boost company valuations, thereby enabling the government to capture greater value in subsequent divestments.

In conjunction, some number of senior-level positions in the government, such as those for mission- or project-mode interventions across sectors, should be filled through similar open competition involving both public and private sector talent. The recruitment rules will have to be tailored to mitigate the risks of a revolving-door strategy and the potential for cronyism, which is never far away with such arrangements. This should be complemented by liberalized norms that allow civil servants to work outside government, for example, in multilateral agencies, with nonprofits, and in the corporate sector, for short periods of time. By enabling exposure to market practices and fresh ideas, this recess as much as lateral entry would likely help achieve the objectives of lateral entry itself.

The government of India’s internal human resources management policies must undergo a radical revision. It is settled wisdom across the world that senior-level appointments entail a process of matchmaking. The employers select those they find most competent from among interested applicants. The prevailing system of postings to various ministries in the government of India satisfies neither requirement.

It may be worth examining the proposal that all such appointments at the director level and above be handled through a process whereby the ministry or department concerned announces the vacancy, interviews and evaluates applicants according to a set of parameters and recruitment guidelines, and recommends a panel of two or three names for the approval of the competent authority. Those candidates not considered are free to apply elsewhere, though an upper limit of three (or five) applications in any two-year period could minimize frivolous applications. Entrusted with the responsibility of recruiting officials, departments would not be able to blame anyone for poor performance because of personnel deficiencies and would therefore face greater accountability. Furthermore, this approach would eliminate the possibility of officers being assigned to positions against their wishes and so would make them more accountable for their performance.

Finally, in keeping with the “minimum government, maximum governance” theme that Prime Minister Modi espouses, state and central governments should reexamine their current administrative structures. It may not be necessary to have more than two or three ministries for each of the following areas: social welfare, public goods provisioning, infrastructure, industrial development, regulatory affairs, and finance. All departments within a ministry should be consolidated into a single unit. This would eliminate duplication, realize organic synergies, and spur greater coordination in program and policy implementation. And because of the acute scarcity of top-quality administrative talent and pervasive personnel vacancies, such consolidation may be an important step toward improving state capability.

Public Sector Human Resource Management Reforms

  1. Open competitive recruitment to executive positions of public sector enterprises.
  2. Encourage lateral entry of candidates to head mission-mode programs.
  3. Introduce reforms to postings to government ministries.
  4. Implement the phased introduction of performance management systems.
  5. Merge and consolidate departments and ministries.

Improving State Capability

Lant Pritchett, the Kennedy School of Government economist and education researcher, famously called India a “flailing” state.143 The signs are everywhere, from poorly run midday meal kitchens to corrupt infrastructure contract management. The business-as-usual state is simply too enfeebled to effectively administer the public system. No amount of technological innovation or process reengineering can cover up the country’s sorely deficient state capability.

The most common causes for degeneration in state capability include politicization of bureaucratic processes, administrative indiscipline, erosion of accountability in the discharge of official responsibilities, weakened supervision and monitoring, lack of accountability, and ubiquitous corruption. Because state capability is deeply engaged in the dynamics of political and civil society, there are no easy answers to these problems.

But the broad contours of a plan can be sketched. Administrative reforms that minimize politicization, enhance professionalism, promote transparency, and improve accountability are critical to any effort in this direction. Some important contributors to state capability failings are the unhealthy practices that corrode personnel deployment and hamstring procurement by government agencies. Fixed tenures for district heads of departments and uniform and transparent, preferably online, transfer and procurement processes can be useful steps toward ameliorating these factors.

Performance management measures, while always difficult to enact in public systems, are essential to enforce accountability among officials and their departments. The government of India’s Results-Framework Document, despite its failings, is a good beginning.144 It needs to be continuously iterated and allowed to permeate down to district and local governments. A more sustainable strategy for achieving this objective, though one fraught with uncertainties, may be through a phased decentralization of functions, funds, and functionaries. Teachers and doctors who are not accountable to the local community cannot be expected to deliver services to any reasonable degree of satisfaction.

Technology, in the form of e-governance applications, has the potential to increase transparency and thereby accountability and also to improve the efficiency of public service delivery. Unfortunately, while there have been numerous stand-alone, individual-driven, and locally designed e-governance applications for a range of public interventions across districts, there has been little effort to refine, standardize, and scale up these applications across the state. State governments need to identify such applications across sectors, refine the workflow, and improve their technical efficiency before making them available for implementation across districts. Of more direct and immediate concern is improving the state’s capacity to monitor and supervise its functionaries and interventions. Reliable data, appropriately analyzed and rendered in a user-friendly and portable manner, can provide a powerful decision support for supervisors in this effort.

Finally, though such an assertion risks charges of political incorrectness in this age of government baiting, in light of India’s minimalist state, none of these efforts can succeed until administrative resources are strengthened by adequate provision of the required personnel, logistics, and finances, especially at the cutting edge. Inadequate personnel and litigation over promotions mean that important departments such as health or education have either no or only ad hoc leadership in several districts across the country. The absence of any form of leadership is true of many departments in a typical district and invariably leaves it directionless.

The challenge of easing decision paralysis is very complex and has no straightforward answers. Executive and legislative actions, however far-reaching, must be accompanied by greater collective appreciation of the nature of the problem and maturity in dealing with such issues.

As a first step, it would help to complete the proposed amendments to section 13(1)(d)(iii) of the Prevention of Corruption Act that is before Parliament. Since the Right to Information Act, 2005, has reached its ten-year anniversary, this may be a good time to review its implementation. In particular, a bipartisan committee could be constituted to examine the possibility of exempting communications related to deliberative processes from the law.

Another committee should examine the methods and processes used by auditors and investigative agencies in light of recent trends and lay down guidelines in this regard. Auditors should preferably confine themselves to examining whether public money has been spent in accordance with prevailing rules and whether due process has been followed in decisionmaking. They should refrain from passing judgment on the merits of departmental decisions or policies that have been arrived at through due process and approved by the competent authority. Not only do auditors not have the competence to make such judgments but they are very likely to be swayed by simplistic and first-order assessments that gloss over the deeper considerations that led to such decisions. In particular, they should exercise great caution and have in place adequate administrative controls before constructing counterfactuals and making presumptive valuations.

Performance and policy audits should be part of ex post facto evaluations of decisions and should be done by independent and professionally competent third-party agencies, not by auditors. The findings of such assessments should subject individuals to disciplinary proceedings only if there is prima facie evidence of mala fide in arriving at the original decision.

Such ex post facto audits should be complemented by ex ante and concurrent financial and process audits. Any new program or policy initiative should be audited and certified before its implementation. Similarly, without adding another layer of bureaucracy, random audits should be conducted during the course of implementation to detect lapses in real time and help make appropriate corrections. Much the same should apply to the activities of vigilance officials.

Such an approach would be similar in spirit to the advance tax rulings that multinational corporations and large taxpayers seek from taxation authorities. This written interpretation of tax laws, applicable to a particular client, binds the tax authorities to their ruling and clears up taxation-related uncertainties. Such concurrent audit mechanisms would integrate audits and vigilance into the decisionmaking process, obviating comprehensive post facto assessments. While it would undoubtedly improve the legality of decisionmaking, the trade-off would be a slower pace.

Any reform of the investigative process has to start with measures to equip investigators with professional expertise in scrutinizing financial and contracting cases. Investigators should be drawn from a broader pool and should include officials with professional expertise in these areas and lateral entrants. It is also essential that officials at both central and state government levels, especially those involved in high-stakes policymaking, be offered adequate legal protection against frivolous investigations and prosecutions. The former demands adherence to a set of permission protocols before the investigative processes can kick in.

Most important, once it is established that the decision has been made by a competent authority following due process, investigations should cease. Finally, both investigators and auditors would do well to bear in mind the fundamental principle that their findings should clearly distinguish between genuine errors and mala fide actions and be able to establish the latter.

At a time when decision paralysis has taken firm hold, it is critical to ensure that officials have certain safeguards against frivolous and malicious complaints and investigations. While section 19 of the Prevention of Corruption Act of 1988 is a safeguard against prosecution, it may be necessary to restore similar protections against flippant investigations, especially for officials involved in high-level policymaking. An official vulnerable to being investigated for any complaint is certain to postpone or escalate upward decisionmaking.

The most difficult challenge will be to initiate reforms to restrain judicial overreach and snowballing litigation. One intervention could be to gradually phase out tribunals and replace them with sectoral benches in the higher courts. The issue of judicial activism may be best addressed if it is examined by a committee of the country’s most credible judges and jurists, preferably appointed by the Supreme Court. The committee should, in consultation with all stakeholders, lay down certain principles and rules that limit the range of a judge’s individual discretion and draw the line between judicial activism and judicial excess, especially on the issue of entertaining public interest litigation. The Supreme Court should then require that all courts across the country follow those guidelines. A similar process could be followed and guidelines issued on the exercise of appellate authority.

Regarding the Finance Ministry’s veto, it is imperative that certain guidelines that govern the exercise of jurisdiction by the Finance Ministry be formulated and strictly implemented. The guidelines should confine the ministry’s jurisdiction to decisions on overall budget allocations, conformity with general costing and other financial principles, and egregious deficiencies. The ministry should strictly refrain from investigating issues such as project structuring or costing formulas that have been decided by competent authorities within the administrative department. At best, the Finance Ministry should be allowed only to make suggestions, which the administrative department should then be free to disregard, for compelling reasons, recorded appropriately.

All these changes will have to overcome strongly held conventional wisdom and political correctness. They will need to be undertaken with great care and tact so that the delicate institutional balance that is critical to India’s vibrant democracy is not upset. There are no quick-fix solutions. No extent of lateral entry is going to resolve this. Not even a change of government and a strong commitment to good governance can easily correct the incentive distortions created by these trends. It requires foresight and leadership of an exceptional nature from all institutional stakeholders. Acknowledging that the problem exists is therefore an essential first step to address this deep-rooted institutional incentives problem.

Mission to Improve State Capability

  1. Reform procurement policies.
  2. Reform personnel deployment policies.
  3. Use technology to automate the workflow in as many processes as possible.
  4. Use data for decision support for public officials.
  5. Increase recruitment at certain levels and in certain sectors.
  6. Amend the Right to Information Act to exclude deliberative processes.
  7. Conduct ex ante and concurrent financial and process audits.
  8. Conduct ex post facto performance and policy audits by independent third-party agencies.
  9. Develop guidelines on functional jurisdiction and processes for auditors and investigators.
  10. Implement safeguards against frivolous investigations.

Notes

118 In 2015–2016, 66 percent of the Sarva Shiksha Abhuyan (SSA) budget went for teachers’ salaries and 12 percent for civil works. There was no designated share for learning outcomes improvement.

119 Sankhe et al., “India’s Urban Awakening.”

12O Ibid.

121 Donald Shoup, “Is Under-Investment in Public Infrastructure an Anomaly?” in Methodology for Land and Housing Market Analysis, eds. Gareth Jones and Peter M. Ward (London: Routledge, 2003).

122 “Housing,” chap. 28, in Statistical Year Book, India 2015, ed. Ministry of Statistics and Program Implementation (New Delhi: Government of India, 2015), http://mospi.nic.in/mospi_new/upload/syb2015/CH-28-HOUSING/HOUSING.pdf.

123 Gulzar Natarajan, “India’s Affordable Housing Challenge – A Graphical Summary,” Urbanomics (blog), December 9, 2014, http://gulzar05.blogspot.in/2014/12/indias-affordable-housing-challenge.html.

124 Shirley Ballaney, et al., “Inventory of Public Land in Ahmedabad, Gujarat, India,” Policy Research Paper no. 6664, Finance Economics and Urban Department, World Bank Sustainable Development Network, October 2013, http://www-wds.worldbank.org/external/default/WDSContentServer/WDSP/IB/2013/10/18/000158349_20131018101926/Rendered/PDF/WPS6664.pdf.

125 Hafeez Contractor and Pankaj Kapoor, “Study on the Assessment of FSI for Mumbai,” Liases Foras, http://www.liasesforas.com/Reports/Final%20-%20FSI%20Mumbai.pdf.

126 Manish Sabharwal and Shihabudin Abdulkhader, “The Cost of Paper Compliance,” Business Standard, March 13, 2016, http://www.business-standard.com/article/opinion/the-cost-of-paper-compliance-116031300651_1.html.

127 Victor Mallet, “Notebook: India Is a Nation in Need of a Trade Deal with Itself,” Financial Times, November 3, 2014, http://www.ft.com/intl/cms/s/0/647d1630-5ec5-11e4-be0b-00144feabdc0.html?siteedition=intl#axzz3IG4LYKEk.

128 Ibid.

129 “Doing Business 2016: Ease of Doing Business in India,” World Bank Group, 2016, http://www.doingbusiness.org/data/exploreeconomies/india/#trading-across-borders.

130 Manish Sabharwal, “Pains of the Pay Cheque,” Indian Express, November 25, 2014, http://indianexpress.com/article/opinion/columns/pains-of-the-pay-cheque/99/.

131 J. Luis Guasch, Granting and Renegotiating Infrastructure Concessions: Doing It Right (Washington, DC: World Bank Institute, 2004), http://pppinharyana.gov.in/ppp/general/report-granting&renegotiatingconcessions.pdf. José Luis Guasch et al., “Renegotiation of PPP Contracts: An Overview of Its Recent Evolution in Latin America,” International Transport Forum Discussion Paper no. 2014-18, Organisation for Economic Co-operation and Development, December 2014, http://www.itf-oecd.org/sites/default/files/docs/dp201418.pdf.

132 T. V. Somanathan and Gulzar Natarajan, “On Restless Pinions,” Indian Express, November 9, 2013, http://archive.indianexpress.com/news/on-restless-pinions/1192676/0.

133 “India Financial Sector Review (4Q16),” Credit Suisse, May 30, 2016.

134 Vishwanath Nair, “Banks Stare at Over Rs 1 Trillion Haircut from Stressed Assets,” LiveMint, August 7, 2015, http://www.livemint.com/Politics/xbWmPWy1afcdh2wByjzkCI/Indian-banks-stare-at-over-Rs1-trillion-haircut-from-stresse.html.

135 Rajiv Lall, “Calling PSUs to Account,” Business Standard, August 4, 2014, http://www.business-standard.com/article/opinion/rajiv-lall-calling-psu-banks-to-account-114080401435_1.html.

136 Security and Exchanges Board of India (SEBI) guidelines mandate that any entity acquiring a 25 percent or more stake or a controlling stake (even if lower than 25 percent) must make a mandatory open offer for purchase of an additional 26 percent of shares from the public shareholders.

137 “There Is a Need to Make Banks More Vibrant, says Raghuram Rajan,” Economic Times, April 7, 2016, http://articles.economictimes.indiatimes.com/2016-04-07/news/72132588_1_existing-banks-raghuram-rajan-new-instruments.

138 Tamal Bandyopadhyay, “Why Banking in India Will Never Be the Same Again,” LiveMint, April 11, 2016, http://www.livemint.com/Opinion/VXJOMNx2O5xbi2nXIr8nPJ/Why-banking-in-India-will-never-be-the-same-again.html.

139 Ramesh Kolli, “Measuring the Informal Economy: A Case Study of India,” working paper, 15th Conference of Commonwealth Statisticians 2011, New Delhi, February 7–10, 2011, http://www.cwsc2011.gov.in/papers/sna/Paper_4.pdf.

140 International Labour Organization (ILO) Department of Statistics, “Statistical Update on Employment in the Informal Economy,” ILO, June 2012, http://laborsta.ilo.org/applv8/data/INFORMAL_ECONOMY/2012-06-Statistical%20update%20-%20v2.pdf.

141 Nandan Nilekani et al., Report of the Technology Advisory Group for Unique Projects (New Delhi: Indian Ministry of Finance, January 31, 2011), http://finmin.nic.in/reports/tagup_report.pdf.

142 It has been argued that many of the government’s financial inclusion programs impose a cost on the bottom line of the public sector banks.

143 Lant Pritchett, “Is India a Flailing State? Detours on the Four Lane Highway to Modernization,” Harvard Kennedy School Faculty Research Working Paper RWP09-013, 2009.

144 Cabinet Secretariat, “Results Framework Document,” Performance Management, http://performance.gov.in.