Archives: Publication

Overhauls to multilateral development banks could be a lasting legacy of India’s G20 presidency.

Reforming the multilateral development banks (MDBs) is an important aspect of the global reforms agenda under India’s G20 presidency. The World Bank Group (WBG), as the largest MDB, is the most prominent candidate for such reforms. By taking a lead in reforming itself, it can set an example for other MDBs.

The WBG performs three main roles: That of a financier; a knowledge bank; and a trusted advisor. As a financier, it needs to derisk as well as scale up the quantum of lending to its member low-income countries (LICs) and middle-income countries (MICs).

The LICs lack market access. Their economies are smaller and more fragile. They face numerous challenges emanating from natural events, global risk aversion, volatility in global demand, an uncertain trading environment, terms-of-trade shocks, and exchange-rate fluctuations. All these constrain their debt-absorption capacity. The WBG ought to focus on building more resilience and enhancing state capacity of the LICs.

Despite owing half their external debt to the MDBs, the LICs are deemed to be in debt distress. This raises questions about the accuracy of their debt sustainability assessments conducted by the MDBs. The MDBs, including the WBG, reward its staff for clinching new lending business. Fresh lending can be approved only if the country’s debt is deemed as sustainable. This likely incentivises more favourable debt sustainability assessments. To address this, the WBG should conduct more credible debt sustainability assessments of the LICs, considering scenarios entailing exchange rate depreciations, climate risks, and trade wars.

A holistic review of the debt landscape of the LICs, enhanced debt transparency, and diluting their currency risks are essential. Their access to private or dubious sources of bilateral financing should be curtailed, and the share of multilateral funding on concessional rates increased. Coupled with enhanced resilience and state capacity, this can put the LICs on a virtuous path of stability and prosperity.

Conversely, MICs enjoy market access and attract private capital flows. But such flows are fickle. Any change in global sentiment causes speedy reversal of private capital flows. The WBG can stretch the financing envelope of MICs by derisking inflows of private capital. This may be done by offering guarantees, temporary swap lines, or contingency credit lines.

The International Monetary Fund (IMF) currently offers contingency credit lines, but their uptake has been limited due to the perceived stigma attached to being in an IMF programme. A facility offered by WBG is unlikely to carry such stigma simply because, while the IMF lends during an economic crisis, the WBG lends for developmental needs. Operationally, this would entail innovations at its risk insurance and guarantee arm, the Multilateral Investment Guarantee Agency (MIGA).

In addition, it should augment the available funding to MICs for priorities such as climate transition. The Independent Expert Group, set up by the Indian G20 Presidency, has made important recommendations to this effect.

An equally large scope exists for improving the WBG’s delivery as a “Knowledge Bank”. Despite a significant fraction of its operational budget allocated to producing and disseminating knowledge, it has had limited relevance or impact. This calls for commissioning a separate independent group with the mandate to look into the internal organisation and incentives, external engagement, collaborations, and impact evaluation of its knowledge work.

The WBG’s knowledge work is often associated with the publication of cross-country indices. Some of these indices, for example the “Doing Business” index, have repeatedly come under fire for their subjectivity and unreliability. The WBG needs to take a hard look at their rationale, mechanics, and relevance, and revamp and sustain only the most objective and relevant ones. It must also assess the accessibility and country relevance of its scholarly and flagship reports. An example from its engagement in India is telling. India faces many crucial developmental challenges: A persistently low female labour force participation; manufacturing sector in low gear; and the imperative to make its workforce future-ready to serve not just Indian, but also global markets.

The WBG is missing from the discourse on these important issues.

On the other hand, it publishes nearly six growth forecasts on India every year, each one with a large forecast error and no superior accuracy vis-a-vis the others. Since the IMF already publishes similar forecasts, the WBG’s resources could more usefully be deployed elsewhere. Similar shortcomings prevail in its role as a trusted advisor, wherein it is supposed to share relevant cross-country experiences as inputs into complex policy choices that developing countries confront. In the current decentralised model, country staff are not well-versed in global best practices themselves. With little churning in the country offices, even the country-specific knowledge is not refreshed, let alone building an international one.

The WBG needs to deploy more international expertise to advise countries on policy issues on one hand and engage more intensively with local partners on the other. Local institutions work at a fraction of the costs incurred by the WBG; leveraging them would be a sure-fire way to utilise its resources wisely while also attaining relevance and legitimacy.

The WBG is a unique institution and has a lot to offer, but it does not behoove it to act like a monopoly. It should subject itself to greater scrutiny, introspection, and engagement.

The aforementioned reforms are achievable only if the WBG returns to fully work in person, as its client countries have. While the entire developing world has resumed physical work leaving the practices of the pandemic behind, the WBG has mostly remained in remote mode for the last three and a half years. This has been the case at both its headquarters in Washington DC, as well as in its country offices, including in New Delhi.

Reforms of the MDBs, and of the WBG, along the lines proposed in the report of the Independent Expert Group and as delineated here, can be a lasting legacy of India’s presidency of the G20.

Though it will have little impact on exports to EU, India must oppose this trade-discriminatory move.

While the world is grappling with finding finance for energy transition towards low carbon pathway, European Commission has announced a Carbon Border Adjustment Mechanism (CBAM) as a part of its Green Deal (or Fit for package 55).

EU’s CBAM, is an internationally binding unilateral environmental measure with two-fold objectives — one, to achieve 55 per cent net reduction in greenhouse gas emission by 2030; two, to ensure equalization of carbon price between imported goods vis-à-vis domestic goods thereby limiting global carbon leakage and encouraging partner nations to adopt ‘green’ technology.

Despite several internationally coordinated efforts to build resilience against climate change (the Paris Agreement, Glasgow Climate Pact), the EU seems to portray itself as a global ‘boss’ by holding a ‘stick’ (CBAM certificate prices) to achieve the ‘carrot’ — the desirable outcome of other nations to reduce their carbon footprints.

Fact-Check

CBAM has been designed initially to cover five industries — iron and steel, aluminum, cement, fertiliser, electricity, and hydrogen generation.

However, EU’s policy document seems to suggest that the mechanism will be expanded to cover 50 per cent of the sectors under the Emission Trading Scheme (ETS). The initial transition phase begins on October 1, 2023, wherein the importers need to declare the emission embedded in their goods, which will be verified by third-party auditing. Accordingly, importers need to purchase CBAM certificates and the price of these certificates will be based on the EU’s existing carbon prices. The exporting countries with stringent emission regulations will be subject to a rebate, equivalent to the difference between their domestic carbon price and the EU’s carbon price under the ETS.

This discriminatory provision across partner countries (discrimination among foreign goods) challenges the Most-Favored- Nations (MFN) principle of WTO, the basic tenet on which the world trade is now governed. The implementation phase of CBAM begins from 2026, accompanied by gradual phasing out of free ETS allowances across the EU’s domestic producers.

Per the press release of European Commission’s dated June 20, 2023, 75 per cent of the estimated CBAM revenue will be allocated to EU budget. Thus, the lofty idea behind CBAM boils down to another tax to fill-up the gap in EU’s budget!

Should India worry?

Per the Ministry of Commerce and Industry data, India’s total export value to the EU stands at $98 billion in FY2022-23. India’s total export of CBAM goods — iron and steel ($5,083.7 million), aluminium ($2,679.7 million), fertiliser ($0.64 million), and cement ($0.04million) account for 8 per cent of India’s total export to the EU in FY2022-23.

Over the last five years, India’s export of CBAM goods to the EU has increased by 84 per cent — from $4.2 billion in 2018-19 to $7.8 billion in 2022-23.

Will the imposition of CBAM impact India’s export significantly? This would of course depend on carbon intensities of India’s CBAM products vis-à-vis her competitors. If India’s carbon footprints on these products are lower than her competitors, it would have no effect on her exports at this point of time.

However, as all nations are attempting to reduce their carbon footprint on all products including CBAM products, in future, the CBAM tax will benefit nations that move faster towards lowering their carbon footprints.

Clearly, to understand the impact of CBAM on India, we need to use a global trade model like GTAP (Global Trade Analysis Project) model with relevant products and competing countries/region built into it.

However, as the standard GTAP database clubs CBAM sectors with others, we created a GTAP database with separate CBAM sectors and our competing nations using supplementary information to understand the impact of CBAM on India’s exports.

According to our modelling results India’s export of fertiliser, cement, and aluminium and iron and steel will decline by 0.07 per cent, 0.62 per cent, 0.004 per cent and 0.06 per cent respectively. The numbers are also small in absolute terms.

Currently, India has vehemently opposed EU’s CBAM. India sees the proposed levy as discriminatory and a trade barrier, and questions its legality. The government has every right to file a complaint to the WTO against the EU’s unilateral decision.

 Negligible impact

As our findings indicates, the impact on India’s export on these four products will be negligible. However, the danger is that if the EU’s move goes unchallenged, there is every possibility that they will expand the product list in the coming years.

At least, their official position seems to suggest so. While trying to achieve the ‘carrot’, the CBAM can actually induce a distortionary effect in the global trade pattern by altering the global competitiveness of the least developed and developing countries vis-à-vis the developed countries.

Following the commitment of the industrialised countries to reduce GHG emissions under the Kyoto Protocol of 1997, most of the developed countries already have well-defined mechanisms (carbon pricing, emission cap, etc.) to control GHG emissions within their economies. This can give them elbow room to claim a rebate on the price of the CBAM certificates as opposed to the developing or least developed countries without the domestic carbon pricing mechanism.

Moreover, the industrialised nations also enjoy first-mover advantage in the use of less-carbon intensive technologies in their production process. Also export value of CBAM products has declined for developed countries vis-a-vis developing countries.

Apart from the trade-distortion effect, another major concern of the CBAM mechanism relates to financing of the transition towards the adaptation of less carbon-intensive production techniques, especially in the least developed and emerging economies.

Since EU is spearheading the ambitious global climate objectives, it is time to remind EU of its commitment of contributing $100 billion per year to support developing economies to finance their climate action.

Will it not be fair to inject the CBAM revenues back to developing countries? Or, is it a camouflaged trade-barrier, to widen the North-South inequality? As of now, EU has apparently no plan to recycle the CBAM revenue to developing countries.

The writers are with NCAER, New Delhi. Views expressed are personal

Debt is projected to increase by the largest amount in the same states that are currently the most heavily indebted.

At 28 per cent of gross domestic product (GDP), states account for nearly a third of the total debt of Indian governments. (The central government accounts for the rest.) In coming years, the share of the states will almost certainly increase still further. The question is, by how much and — if the answer is “too much”, what can be done about it.

In fact, one can imagine different scenarios for the future evolution of the public debt of the central and state governments. As our baseline scenario, we assume that for the next five years, the GDP growth, real interest rate, and the primary budget deficit of each state will remain the same as their respective averages during the last decade. Other scenarios assume faster GDP growth, a lower primary deficit, and larger contingent liabilities.

The Centre’s debt is projected to stabilise in the baseline as well as other scenarios alike. In contrast, the debt-to GDP ratio of the states is projected to increase on average. By implication, the projected increase in the general government debt in the coming years will be primarily attributable to the increase in debts of states.

There is considerable heterogeneity across states, with some of them contributing disproportionately to the level and rise in debt. States such as Gujarat and Maharashtra have managed their public finances well. Their debts have increased the least since 2014-15, remaining below 25 per cent of their respective state GDP. At the other end of the spectrum are Punjab, Rajasthan, and Kerala, whose debts as a proportion of their state GDP have increased on average by 12 percentage points since 2014-15 and exceeded 40 per cent at the end of 2020-21.

Debt is projected to increase by the largest amount in the same states that are currently the most heavily indebted. Punjab and Gujarat, for example, exhibit starkly diverging debt trajectories. Debt is likely to increase strongly in Punjab from its current level of nearly 48 per cent of state GDP to almost 55 per cent in 2027-28. In Gujarat, on the other hand, it is projected to decline from 20 per cent of state GDP to 18 per cent in 2027-28.

There are other notable differences across states with high versus low burdens of public debt. More indebted states have primary budget deficits and contingent liabilities more than twice those of less indebted states. They exhibit slower GDP growth.

One thing that doesn’t vary across high- and low-debt states, however, is borrowing costs. There is a notable absence of interest rate differentials across the two categories of states. Interest rates do not vary with the level of indebtedness, the primary deficit, or the rate of economic growth. Gujarat and Punjab, our two extreme examples, issue debt at the same interest rate.

This absence of interest rate variation translates into an absence of market discipline. Profligate states are not deterred from borrowing by the need to pay higher interest rates when placing additional debt with investors.

The absence of market discipline reflects an implicit guarantee from the central government, and the fact that the largest investors in government bonds (public-sector banks, insurance companies and provident funds) are themselves owned by the central government, and as such are passive investors. In addition, these institutional investors are required to hold government bonds to meet statutory regulatory requirements.

The Reserve Bank of India (RBI) carefully schedules the calendar of borrowing and coaxing government-owned investors to hold the bonds of the states, ensuring that interest rates on state debt remain in a tight range. Evidently, the RBI does not want perceptions of debt distress or unsustainability of the debts of some states to infect the others. De facto, this results in states in better fiscal health subsidising those whose health is worse. It thus ends up relaxing market discipline on the errant states.

The horizontal devolution of taxes among states, awarded by the Finance Commission every five years, also does not provide incentives for fiscal rectitude. To the contrary, Fiscal Commissions mandated to allocate more resources to states with larger revenue deficits, which is an obvious source of moral hazard, and yet another mechanism through which errant states are subsidised.

The 15th Finance Commission was asked to recommend performance incentives for states in areas like the power sector and solid waste management. However, Finance Commissions have not been asked to consider overall fiscal prudence when recommending allocations. Neither the Finance Commission nor another agency of the government has the data, mechanisms, and a clear mandate needed to estimate the contingent liabilities of states.

So what can be done to strengthen state finances?

First, states should improve revenue mobilisation through additional digitisation and administrative streamlining, broadening the tax base, raising property tax, adopting new taxes, and increasing privatisation receipts.

Second, states should re-orient spending towards capacity- and infrastructure-enhancing investment that promises to further boost state GDP and revenue.

Third, contingent liabilities pose risks to the public finances of states and should be minimised by the adoption of fiscal-management reforms.

Fourth, the RBI, as debt manager, should require states to pay market interest rates that vary with current and projected debt levels.

Fifth, Fiscal Commissions should be strengthened so as to provide incentives for prudence. Fiscal Commissions are dissolved after they submit their report to the President. There is no parallel institution or body to monitor states’ finances subsequently; to assess whether states have departed from the course laid down by the Fiscal Commission. It would be desirable to establish a permanent fiscal or expenditure council to monitor state finances, assess the quality of data and forecasts, measure and track their contingent liabilities, and inform the public of the fiscal stance and debt sustainability of the different states.

Finally, fiscal experts and the media, which subject central government Budgets to a disproportionately high level of scrutiny, need to devote at least a fraction of this scrutiny to the budgetary processes of the states.

Together, these steps would strengthen the finances of state governments and put their debts on a sustainable footing. In turn, this would do much to enhance the fiscal stability of the Indian public sector overall.

Eichengreen and Gupta are, respectively, with University of California, Berkeley, and National Council of Applied Economic Research