Showing posts with label Fiscal deficit. Show all posts
Showing posts with label Fiscal deficit. Show all posts

Tuesday, March 1, 2016

Budget 2016-17; Macro highlights



Introduction

   India's real economic growth  is projected by CSO at 7.6% for 2015-16.  This is a respectable growth rate, despite two specific sectors that do not appear to share this prosperity. The agriculture sector is clearly distressed given two contiguous drought years. The other sector that hasn't seen the increase in growth anticipated two years ago. The excess capacity and deflationary conditions in the global metals and commodity is a major reason for this low growth.  The global growth slowdown and heightened risks in the global environment form a critical background for the budget

Fiscal Consolidation

   The most important and critical part of the budget is the fiscal balance. Despite suggestions  by many economists,  business men and corporates to let the fiscal targets slip for another year to finance higher  government infrastructure investment in 2016-17, the FM has rightly decided to stick to the 3.5% of GDP, fiscal deficit targets for 2016-17, outlined in the 2015-16 budget.  This will also bring the Primary deficit down to 0.3% of GDP in 2016-17. This is the best insurance against heightened global uncertainty.  The pleasant surprise is that the Revised estimate(RE) for Revenue deficit is 0.3% point lower than projected in the BE for 2015-16. The revenue deficit is an approximate measure of the dis-saving of the Government.  A reduction in this deficit adds to National savings and thus provides the most effective way of raising the National saving rate and reducing dependence on foreign savings.

Subsidy

   The most important subsidy reform in the budget is the decision to introduce a bill to give statutory backing to the use of Aadhar for providing benefits, transfers and subsidies to the targeted population of the poor and needy. This disconnects the general problems of secrecy & confidentiality and connects it to the governments duty to ensure that government's social expenditures reach the intended beneficiaries without being lost in administrative waste or corruption. A few small administrative steps are also being taken to reform the subsidy system. One is the program to provide LPG to BPL women so as to eliminate the health hazards of wood fueled open Chulahs. The second is a proposed test in a few districts  of a shift in provision of fertilizer subsidy from the current wasteful approach to a Direct Benefit Transfer (DBT) system successfully tried in LPG. Reform of the food procurement continues to make very slow progress through greater use of online & digital technologies. Disappointingly there was no mention of reform of the kerosene subsidy based on the previously started  DBT experiment.

Infrastructure Investment

    The budget also remains firmly on track with the infrastructure investment programs announced in the last two budgets and in the interim periods. This includes roads, electricity, ports, waterways,  airstrips and digital connectivity. To this has been added a greater emphasis on irrigation and on infrastructure connecting rural areas to State highways. The attempt to provide an integrated program for development of agriculture and rural areas has attracted more focused attention to irrigation & other inputs and processing of agri products. There also three proposals related to PPPs: A Public Utility Resolution of Disputes Bill, Guidelines for PP renegotiations and Credit rating system for Infra projects, which will help in resolving legacy issues while imparting greater regulatory clarity to bidding for new projects.

Tax Reform

        The picture on the tax reform front also remains mixed as in the last budget. Budget takes the first steps to reform the Corporate Income tax, by giving notice of phasing out of some exemptions and lowering the tax rate for new manufacturing firms that opt out of use of remaining exemptions to 25%. There is also a commendable effort to expand the presumptive tax effort including to professionals. However there are also a number of small tax changes that are an irritant to tax payers and slow progress on simplifying tax administration, even though the intent is reflected in adoption/acceptance of Administrative Reform Committee & Justice Eswar committee recommendations.  Numerous changes in excise and customs duty also suggest a move back from simplification to industry specific (dis)incentives.

Policy Reform

    Policy reforms are essential for sustained fast growth. There are three or four  policy reforms that are noteworthy. One is a reform of the Motor Vehicles Act to open the passenger bus transport service sector to private competition. So far this sector has been a monopoly of the State Govts. The proposed reforms will allow private sectors and even State companies from other States to provide bus transport service. This will be a model law which can be adopted by the States.  The second reform is the permission of 100% FDI in the Food Processing sector, for processing and storage of Indian agricultural produce and manufactures based on these products. This is a very important opening, that one has recommended for many years, after trying many other schemes without achieving the desired result of reducing the wastage of Indian grown agricultural produce. The third important reform is the Financial Firms resolution Bill, and related reforms of ARCs plus the amendment of the RBI Act to formally set up a Monetary Policy Committee (MPC). Even though this has been expected, the formalization of monetry policy system in the RBI Act will enhance the global credibility of the monetary system.
Over all it was a good budget, because of the fiscal consolidation and the policy reforms discussed above.
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An version of this note appeared in the Economic Times, under the Banner, "Fiscal Balance best Insurance against global knocks," on  March 1, 2016 at,
http://economictimes.indiatimes.com/news/economy/finance/budget-2016-fiscal-balance-best-insurance-against-global-knocks-says-ficci-mentor-arvind-virmani/articleshow/51201750.cms

Saturday, June 6, 2015

World Excess Capacity Slows Corporate Recovery



Introduction

   The Economic Survey 2014-15 said that, India has reached a sweet spot – rare in the history of nations - is in which it could finally be launched on a double digit medium-term growth trajectory.” It also stated that,”in the short run, growth will receive a boost from lower oil prices,..”  Every Investment analysts of repute and every analyst who has written a newspaper article or commented on TV, agrees that India has benefited greatly from recent changes in global economic environment.  Further an over whelming majority of India analysts also agree that this is the major reason for a transformation of India’s external position (CAD) and the dramatic decline in inflation. This article shows that this is only one side of the external coin.  The other negative side effect of the same external environment is the prolonged U shaped bottom that we observe in the Index of industrial production for manufacturing and the fluctuating fortunes of the corporate sector. 

   It is true that global oil and other commodity prices, collapsed in 2014. It is also true that the collapse of oil prices and related refined products and manufactures based on them have had very positive effect on the current account deficit and the Fiscal deficit. Contrary to popular analysis, the CPI inflation for Fuel in lighting actually accelerated during 2014-15 from 1.6% in October-December 2013 to 2.3% in Jan-March 2015. Worse, the same global fundamentals that led to the collapse of global commodity prices have had a deleterious effect on the World  economy and the Indian corporate sector since the global crisis of 2008.

External Dynamics

   The story starts with world trade and GDP growth boom in the 2000s. This boom, almost a bubble in some respects, was exploded by the Global Financial crisis of 2008, leaving in its wake large excess capacities in the tradeable sectors of the World economy.  World GDP growth, which averaged 3.1% to 3.2% during the 10-15 years ending 2008, collapsed to 2.0% in the following seven years to 2015. The nature of the bubble is better captured by the growth in world trade imports of goods and services. Rate of growth of World imports accelerated from an average of 5.8% per year in 1999-2003 to 7.8% per year in 2004-2008 and then collapsed to 3% per year during 2009-2013.  World gross fixed investment grew at an average rate of 5.4% during 2003-2007, more than double the average growth of 2.5% during the previous five years, before collapsing. As in most recessions in the west, the globalized corporate sector tightened its belt and  improved efficiency in the next few years, preserving its profitability, and  even increasing it in some countries for a couple of years. The globalized parts of the Indian corporates sector did the same.

     The corrective World-wide fiscal stimulus and monetary easing that followed the seizing of Global financial system at the end of 2008, led to a quick recovery in the developing and emerging market economies.  But it had some effects that weren’t necessarily beneficial for all countries. This was partly due to short term focus and mistiming of policies. Many developed countries switched from a relaxed fiscal policy to a tightening one from 2010, instead of correcting the weak demand excess capacity problem in tradeable goods and services.  This put an extra burden on Developed country Central banks at a time when monetary policy was already constrained by near zero interest rates. The commodity boom/bubble revived quickly after a temporary collapse at the end of 2008, and  continued for several years beyond the World GDP & trade growth slowdown. It was finally pricked in 2014, as a credible announcement of an end to the US Feds Quantitative Easing (QE) laid the grounds for its collapse.

     Some large emerging economies compounded the global excess capacity problem by continued investments through large risky injections of policy directed credit or expansionary fiscal policy or a fusion of both.  For instance the rate of growth of China’s gross fixed investment declined only marginally from 13.4% per year during 2002 to 2007 to 12% per year during 2008 to 2013, while overall world GFCF collapsed from 4.6% to 1.8%. Consequently, the excess capacity in tradeable goods and services did not reduce and worsened for some products. This low demand and excess capacity meant low or non-existent opportunities for private capital in developed countries, driving it into commodity markets and keeping commodity prices booming.

Global Excess Capacity

  The negative effects of the global demand deficit and excess capacity have affected different countries to different degree. The export oriented economies of China, East and South East Asia have been most severely affected.  India, which has an export neutral economy, has been less affected overall. But India is a dual economy with a substantial part of its corporate sector globalized. A sub-index for this globalized sector, derived from the Index of Industrial production (IIP) for manufacturing, was in the last quarter of 2014, still below its level in the first quarter of 2011. Its average growth rate during the last four years was -0.3%, compared to an average growth rate of 3.1% for the non-globalized IIP sub index and 6.7% for the IIP for electricity.  Part of the corporate sector and most of the non-corporate economy remains relatively isolated from the global cross-currents as suggested by the robust growth of electricity supply. The Motor vehicles sector, which is somewhat shielded from the global pressures, has also bottomed out and shows signs of recovery despite the negative effect of rising real rates of interest during 2014-15. The recovery of growth of private consumption (5.2%, 6.2%, 7.1%), gross fixed investment (-0.3%, 3.0%, 4.1%) and GDP (5.1%, 6.9%, 7.1%) in 2012-3, 2013-4 and 2014-5, shown by the new GDP series, is therefore consistent with the dual nature of the Indian economy.

    One implication of the negative effect of the external environment on the corporate sector is the slower recovery in tax revenues. The corporate sector contributes tax revenues, not just directly as corporate income tax, but also through the income taxes paid by its employees and excise taxes collected by it (organized sector is important source of both). This negative revenue effect of the external recession has offset some of the positive effect of reduction in oil related subsidies on the fiscal deficit.

Net Effect

    The external environment has therefore had both a positive and negative effect on the Indian economy.  The negative effects of the global recession were felt immediately from the start of the global crises, but were masked by the temporary bubble created in India in 2010-11, through directed credit to PPP infrastructure contractors. These re-emerged with the pricking of the local Indian bubble.  The positive effects of global recession on global commodity prices were delayed by global monetary expansion, but emerged in 2013-14 with the prospective end of US QE. Further the negative effects on the globalized sector have been magnified whenever the rupee appreciated in real effective exchange rate (REER 36 country) terms: Thus between September 2013 to April 2015 the REER appreciated by 11.4%, with the inevitable consequence on recovery 

    On balance therefore, the net effect of external factors on the Indian economy during 2014-15, has been clearly positive on the Current Account, mildly positive on the Fiscal Account and negative on corporate growth.  The net overall effect is therefore positive, but much smaller than analysts have assumed so far.

Conclusion

  Projections of Global growth by multilateral institutions like the IMF and the World Bank have proved since 2010 to be overoptimistic. They have been repeatedly revised downwards, as they have been most recently for 2015 and 2016. Interestingly, the IMF projections were always a little pessimistic for India and therefore turned out closer to actuals(old GDP series) than Government’s more optimistic forecasts for 2011 to 2013. Looking forward the slow recovery projected for the USA and EU will also mean slower recovery for India’s globalized corporate sector.[i] This does not mean, Indian macro-managers can do nothing about it.
     A combination of looser monetary policy, a tighter fiscal policy with greater shift of fiscal expenditure from subsidies & consumption to infrastructure investment and a quick solution of the bankruptcy-bad loan problem can accelerate recovery of corporate investment, and accelerate overall growth.


Post Script (15/8/15)

    A series of recent developments in China have exposed the extent of growth slowdown in China, previously hidden by the careful control that the CCP exercises over information.  This means that in the short term the external environment will become more negative for India.  
    A number of reports have appeared over the past few years about empty apartment complexes and even empty cities in China. This and other indicators such as growth in electricity consumption, led several analysts (including us) to conclude that China’s actual growth was likely a per cent point below the officials numbers released by the Government i.e. around 6%. Recent developments suggest that the growth numbers, going forward, could be much lower, by about 1 to 2% below even this estimate of 6%, i.e. 4-5%.  More seriously the panic reaction revealed by the use of draconian control methods to prop up the stock market in June and the shock devaluation in August suggest that the Communist Party (CCP) may have lost its ability to manage the economy and maintain a growth rate of around 6% (a much wanted soft landing). Consequently the probability of a decline in Chinese growth rate to 4-5% (feared hard landing) has now increased to 30%, from less than 10% in May this year.
    Indian policy can minimize the adverse short term development s of Chinese hard landing by ensuring that the “Real effective exchange rate(36 country)” of the rupee does not appreciate (repeat not).  Temporary measures to control any potential dumping by Chinese firms during the next year or so would also be justified, but these must be withdrawn once the immediate threat has passed.
    In the medium-long term the reduction in profitability of investment, beginning to be revealed in the worsening profitability of foreign (FDI) firms operating in China, will also become visible in State and party controlled enterprises. With lower investible surpluses these State & party controlled firms will be forced to cut down their investment, and stop creating capacity that adds to global excess capacity in traded goods, particularly manufacturing.  Over time this will help reduce excess capacity globally and benefit India and other countries suffering from an imbalance between effective global demand and subsidized capacity creation by China.  In particular the globalized Indian corporate sector, producing standardize products such as metals and basic chemicals will benefit in the medium term.
 
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A version of this article appeared on the Editorial page of the Indian Express, under the banner, “Inside, Outside, “ on June 6th ,  2015,  http://indianexpress.com/article/opinion/columns/inside-outside-4/ .


[i] Japanese growth has much less impact on Indian growth and Chinese growth has almost no impact on Indian growth. Chinese over investment in tradeable manufacturing will however, continue to have a negative impact on Indian manufacturing, whether China grows fast or slow.

Tuesday, February 10, 2015

Budget 2015-16: Some Suggestions



Introduction

    This note makes suggestions on issues that either come directly under the purview of the Ministry of Finance or are closely related to it.  These include Fiscal Deficits, Taxation, Expenditures and Subsidies and Financial Sector.  Though “Big Bang budgets”  have sometimes had policy announcements outside these areas, this is only successful if there is a great deal of confidence that the policy announcements will reach fruition & implementation. Otherwise they can do more harm than good.

Fiscal Deficit & Revenue Deficit

    The budget needs to stick to the Fiscal deficit targets (glide path for reducing FD) outlined by FM Arun Jaitly in his maiden budget, or risk losing credibility. It is equally, if not more, important however to achieve the original FRBM target of zero Revenue Deficit by 2016-7. These two together imply an improvement in the quality of central government expenditures with a shift from subsidies and current expenditures to investment-capital expenditures: In other words the reduction in revenue expenditures can provide room to increase investment in infrastructure while meeting the old fiscal deficit targets.[1]
    This will also create the confidence in the RBI to move aggressively on Repo rate reductions an easing of monetary policy to complete the “Macro Pivot” that the Indian economy desperately needs to stimulate demand for consumer durables (like automobiles, housing & home goods).[2]
   As a reduction in the revenue deficit represents an increase in public savings, this will help increase national savings and thus help slow down the rapid accumulation of foreign liabilities [increasingly negative Net international Asset (NIA) position of India] that has occurred since 2010 and minimize the probability of sudden stops in capital inflows.

New FRBM & Credit Rating

  India’s high fiscal deficit has been the major reason for its marginal credit rating (lowest investment grade: Moodys Baa3/S&P’s BBB-). Government may consider targeting a further reduction in the Fiscal deficit to zero by 2019-20 with the objective of raising India’s global credit rating. FM could announce his objective of raising India’s global rating by three notches to upper medium investment grade [Moodys A3 or S&P’s A-] over the next five years or so.  This would also need to be supported by a new FRBM with new FRBM targets to establish credibility and ensure a credit rating upgrade of this magnitude.

Tax reform

Administration, Appeal & Settlement

       What has been called “Tax Terrorism” by some and “harassment” by others, has been one of the contributors to the collapse of economic growth from 2011 to 2014. There is an urgent necessity for a dramatic overhaul of the entire system of tax administration, tax procedures and tax rules and of the review, appeal and rectification mechanisms. Based on the recommendations of previous committees on tax administration reform and the Government’s  E-Governance ideas, the FM’s budget speech could outline a credible road map for reform of the revenue administration and speeding up of the appeallate system. For instance recording of every decision of each tax officer, including those relating to tax demands, success of legal cases and years spent, would help analysis of outcomes of these decisions with a view to continuous improvement.  It is important to demonstrate quick, fair & effective tax justice for all actual & potential tax payers.

Goods & Services Tax

  The FM can spell out a road map for GST and set in motion any changes in administrative structures/systems that will be required for the GST. He could also start modifying Central Excise/ VAT/ Service tax rates to close the gap with rates that will be required under GST.

Customs Tariffs & Duties

     Inverted duty structures arise whenever selected products are allowed below the average/median rate which is currently close to the general peak tariff rate of 10%. The IT zero agreement reduced tariffs on many electronics final goods to 0% and therefore created an inverted structure in electronics. To the extent it is legally possible an effort must be made in the budget to move to a uniform 10% tariff rate by raising import tariffs that are below this rate and lowering those which are higher than this rate. This is the best structure for the “Make in India objective”
    Textiles and Agriculture are two major sectors of the economy, for which customs duty reforms lagged far behind the others. Textiles still has a complex mix of Specific and Ad valorem import tariffs that is a source of enormous corruption. This undermines/defeats any objectives that such a complex structure was designed to achieve. It would be far better to drastically simplify these rates. The ideal solution would be to eliminate specific duties and unify Ad velorem rates at 10% (which is the general peak rate). The second best solution would be a uniform rate of 15% to be reduced to 10% in a few years. The third best would be to reduce the specific rates to 2-3 at most and eliminate them in next few years.
Agriculture is the only sector subject to Ad hoc bans on import and exports. I know from experience that these bans and their removal always come too late to benefit the farmer. These Ad Hoc changes usually benefit some favored intermediary. The consumer is usually saved from the worst excesses. The farmer can only benefit if there is a stable regime of import tariffs and export duties on the basis of which he can plan future crop patterns and investments for productivity improvement. The FM could announce his intention to eschew import-export bans (in future) and announce a committee to work out a structure of import tariffs & export duties that would balance the interests of farmers and consumers. If some reports/studies exist in the Ministry he could even announce some rationalization of tariffs & duties, for instance a move to reduce tariffs on all agricultural inputs (cotton, wool, silk etc) into manufacturing to 10%.

Income Taxes

   The Income tax law and rules are a ramshackle structure built over decades with new extensions added every year.  The original version of the new Direct Taxes Code, which I saw in 2009 as CEA, came fairly close to a simplified structure based on sound economic principles. There were a few minor items which could have easily been corrected. I understand it has lost some of its economic soundness and simplicity as it went through Parliament. However, the need for a new Income Tax law and simplified rules remains.  Some effort needs to be made to simplify the income tax on the basis of the principle of reducing ‘exemptions and deductions” and reducing marginal rates to produce revenue neutral change. 
The complexity and harassment is even greater with respect to business and corporate taxation, and a good budget must show some effort at simplification, particularly with respect to cross border entities and transactions.
One uniquely Indian anti-entrepreneur tax rule introduced in the last 3 years needs to be eliminated: That is to treat issue of shares of Start-ups to funders at a price above the face value (at which they are held by the start up entrepreneur) as short term capital gains on which a tax must be paid at time of issue.

Non-Tax Revenues

  Finance Ministry must continue to pursue the change in system for leasing national assets like spectrum, minerals, and land is done through transparent, competitive auctions. In the case of spectrum, this requires removal of artificial stipulations of minimum price (price of rural spectrum in many states is zero), freedom to trade or sub-let the spectrum to other qualified bidders and to ensure open access in areas where spectrum is surplus (e.g. many rural areas)

Expenditures

    With the abolition of National Planning and the Finance Commission recommended transfer of higher share of gross taxes, the Central Government should increasingly focus on subjects in the Central list and on public goods(& service) aspects of those in the Concurrent list. The division of expenditure into Plan & non-Plan should be re-classified into the economic categories of “consumption” and “investment”. These overlap broadly with the budgetary categories of “current” & “capital” with the major exception of expenditure on maintenance and repair of capital assets(which is a form of capital formation).  A serious effort must be made in this budget to change the expenditure mix from current to capital and thus reduce the revenue deficit.

Investment Expenditures

    The Central Government must focus its limited resources on classic “Public goods infrastructure”. These are parts of infrastructure in which social benefits far exceed private benefits or from which it is difficult or impossible to collect user or service charges on a sustained basis. Highways and roads, carefully selected rail lines & related signaling equipment and critical bottlenecks in Ports and waterways are already identified focus areas on which greater budgetary emphasis is needed. However, to successfully bring in complementary or supplementary private investment in “private goods infrastructure” the policy & regulatory environment must simultaneously be made more transparent and free of policy and regulatory risks.

Consumption Expenditures

        On the consumption side the focus has to be on the subsidy and other reforms already identified by the government should be pushed along by this budget: Drastic reform of Food Corporation of India and the entire procurement-PDS system can reduce wastage & corruption and make more funds available for investment. Initial steps could also be taken for shifting all metros/urban areas (given competitive supply of food grains) from physical supply to cash subsidies for food grain purchase.  Similarly, NREGA reforms to increase capital component and pay wages directly through Aadhar linked accounts could also change the mix.
        In Education and Health, Central Government should focus on preparing and propagating E-education and E-health systems and platforms that can be used in any/every State, it should focus on educating the educators, teaching the teachers, training the trainers and managers of (public & private) education and health systems across the country. It should focus much more on “Public health” & eradication of Communicable diseases and on “Public Education,” than on personal health & education. The “Swach Bharat” and “Beti Padhao, Beti Bacha” campaigns are good examples of this approach. The Skill Development Mission, including the need for Standardization and Certification of the thousands of certifiable skills, is another initiative that requires a much greater urgency and thrust to be imparted to it.

Subsidies

   The decision of the Govt. to increasingly transfer subsidies directly to intended recipients (without distorting prices of products and services) by linking them to the UID/Aadhar number is a very good one. Government has also accepted the advice to make the (cash) transfer payments through bank accounts.  If all subsidies including kerosene to the poor & fertilizer/Urea subsidies to farmers can be given directly, it will be a signal achievement of the government. The funds saved through reduced administrative costs and elimination of corruption can be used for job creating, productivity enhancing, infrastructure development.
The Aadhar authority needs to start analyzing all its records to eliminate duplicates and identify incomplete coverage. For the latter, one way is to compare with the digitized electoral roles with Election Commission. Second way is to aggregate UID Nos issued, by blocks and compare with population records from the last census, to identify areas that need special effort.
There are two non-conventional ideas that are worth considering & adopting. First is the use of cell phone based subsidy/transfer payment systems for reaching the poorest of the poor, given that 80-90% of the population has cell phones. In fact it would probably be cheaper to give all the ultra-poor a free cell phone than to ensure that they have usable bank accounts.[3]
Second, adopt a UID linked multi-application smart card (MASC) as a single unified platform for all subsidies, welfare and social schemes. Such a card can easily have slots for the poor’s entitlement to public education and government healthcare facilities or Govt. funded credit/debit limits for use in private facilities.[4]

Financial Sector

          The rise of NPAs in Public sector Banks (due to forced lending for infrastructure projects subject to Govt policy & regulatory risk) and the imminent necessity of introducing Basel III capital adequacy norms, makes capitalization of PSBs an urgent problem. The funding required has to be raised from the market. One possible solution is to set a dual limit: 51% for SBI and a few of the strongest & most profitable PSBs and 26% for the rest. Then sell shares in the latter to capatilise all PSBs to required levels (Many years ago a committee headed by Dr. Bimal Jalan had recommended lowering the limit for Govt. shareholding in PSBs to 26%).

Conclusion

    In his speech to the ET Global summit, the PM has laid out the elements of a New Development Paradigm, of Employment Generation and Empowerment of the Poor and Middle Classes.  The forthcoming budget should flesh this out and give it a more concrete shape.[5]

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[1] During 2005-2008  an argument was made that subsidies for health & education should be classified as “capital expenditures” (as “human capital”) contrary to the accepted budgetary practice all over the World. The result of this exercise was not better health & education but a large increase in consumption expenditures that helped create the 2010-11 bubble and subsequent bust in economic growth.
[5] A New Development Paradigm: Employment, Entitlement and Empowerment, Economic and Political Weekly, Vol. XXXVII No. 22, June 1-7, 2002, pp. 2145-2154. https://docs.google.com/viewer?a=v&pid=sites&srcid=ZGVmYXVsdGRvbWFpbnxkcmFydmluZHZpcm1hbml8Z3g6MjQ4ODc3YWI2ZDcxZmE5NQ