The political economy of tsunami

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The killer tsunami has raised two important issues of rehabilitation and creating an early warning system. But both require funds. While the governments and its banks will provide crucial help, special low-rate relief and rehabilitation bonds repayable in three years or special securities issued on perpetuity basis with a guaranteed interest rate can be thought of. Incentives are needed for raising resources even if it means rejecting the view that tax exemptions would generate distortions, says A. Vasudevan.

A. Vasudevan

THE devastating tsunami that hit the east coast of India is a major disaster that requires us to carefully consider ways of tackling it in an expeditious manner. It is no use complaining now about the country not having early warning systems. For, till this tsunami, no one barring an insignificant number of persons had ever openly spoken about the imperative for an early warning system as part of either the economic development priorities or scientific and technological progress.

The task of providing relief to, and rehabilitating, those affected by the tsunami needs to be vigorously pursued simultaneously with efforts to minimise the impact of such disasters. The economic costs in rupee terms are, therefore, likely to be substantial even if they cannot be precisely determined at this point of time.

It is useful to view the costs on account of relief and rehabilitation as ones to be incurred in the short run of, say, one year.

The costs on account of having early warning systems would be in the nature of capital expenditure (including regular maintenance expenditure for monitoring undue changes in the atmosphere and for training of scientific personnel).

The political economy aspect of the recent tsunami attack is a tricky one. As governance and accountability are famously weak in India, leakages could occur and the real benefits of relief and rehabilitation expenditures may not be passed on in full to the victims. Given this reality, local administrations involved with relief and rehabilitation operations would need to sharply minimise the impact of weak governance and take assistance wherever possible of the tested sections of civil society.

Yet another political economy aspect relates to the determination of the ground space where the victims need to be housed.

If this determination is not made and the victims of the tsunami are provided money to have their own shelters, they would most likely prefer to live close to where they had lived in the past mainly because most of them are fisher folk or tourism operators, as the reports suggest.

Such an inclination is led not merely by the famous `invisible hand' reasoning but also by the subtle operation of what economists call the dynamic inconsistency problem.

The invisible hand reasoning suggests that the victims would like to continue having a stream of permanent income as in the past through the use of the skills they already have. The latter the dynamic inconsistency arises because the local administrations, despite their protestation that they cannot be held responsible should any disaster occur at certain pre-specified places, would still come to the rescue of those affected by natural disasters.

This would imply that the local administrations would have to construct shelters for the victims at places where there has been no impact of natural disasters. At the same time, they would need to ensure that the newly sheltered do not incur high transportation costs for commuting to and from work.

The question of meeting the costs of relief and rehabilitation is now addressed mainly by governments, at the Centre and in the States. Contributions from individuals and corporate houses, aided as they are by tax exemptions, are useful but would not be adequate.

Where the governments' relief and calamity funds are insufficient, as they seem to be the case now, it would become necessary to temporarily divert funds from the budgeted expenditures on certain earmarked programmes. If the governments' past behaviour were any indication, such diversions would most likely affect social sector budgets a sensitive political economy spot of the day and not capital projects that could perhaps be funded through some innovative approaches.

It is against this background some ideas had come up to mitigate the costs of disaster management in the overall sense. The Centre has already announced that early warning systems would be set in place though without giving details about their financing. One would presume that the costs would be met from the general revenues.

The most specific proposal to meet the economic costs is the advocacy for levy of a special cess. The Finance Minister is reported to have reacted to the effect that the idea behind the proposal would be comprehensively examined by his team of experts. Levy of a special cess would turn out to be a bad idea if levied for a number of years. The initial enthusiasm to contribute would die quickly and the cess would be treated as nothing but a tax with a different name.

In case the cess has to be a one-time levy, the rate would have to be large enough to yield significant revenues. This would be burdensome and could be iniquitous if the incidence of the cess were to be transferred.

Irrespective of the fate of this proposal, an announcement has already been made that commercial banks have been directed to lend to those affected by the tsunami attack without insisting on collateral. Bank lending for the purpose would presumably be at low, affordable, rates of interest. Perhaps prudential norms in the case of such loans would not be made applicable.

There was also an argument in favour of promoting disaster insurance. But individuals with low incomes would hardly take such a cover even if it were to be heavily subsidised. In any case, this idea would not help to raise resources for meeting the economic costs of the current disaster. Let me briefly give my take on the matter. One could consider the Government of India issuing special relief and rehabilitation bonds at low interest rates of say 0.5 per cent on subscriptions of over Rs. 10,000 repayable at the end of three years along with simple interest amount.

Such investments could be tax-exempt up to a certain minimum of, say, Rs 5,000. This scheme could be in addition to the voluntary contributions.

The Government could also issue special securities for meeting capital costs. The bonds could be issued on perpetuity basis with a guaranteed interest rate of 3 or 4 per cent the presumed long-term inflation target plus an adjusted interest rate equivalent to one-half of the actual annual inflation rate less the guaranteed interest rate.

At least one-half of the interest income on such bonds could be tax-free. Nominations could be allowed. But transferability of the bond within a period of five years need not be allowed. The minimum investment would have to be sizeable at say Rs 50,000.

The reasoning behind this proposal is this. While the financial savings of the household sector have gone up by about 10 per cent a year in the recent past, they grew sharply only in those instruments that provided incentives. Between 1997-98 and 2003-04, households' claims on government grew at an average rate of over 30 per cent whereas their savings in the form of bank deposits, life insurance fund, and provident and pension fund increased by only 20 per cent, 21 per cent and 9.7 per cent respectively.

These data show that incentives are needed for raising resources even if it means rejecting the view that tax exemptions would generate distortions.

The proceeds from sales of such bonds should go into a separate account for disaster management and would have to be used only with appropriate accountability norms in place.

(The author, a former Executive Director of the Reserve Bank of India, can be accessed at

(This article was published in the Business Line print edition dated January 6, 2005)
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