ReportNo. 18089-IN India 1998 Macro Economic Update Reforming for Growth and Poverty Reduction June 30, 1998 Poverty Reduction and Economic Management Division South Asia Region Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized
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Report No. 18089-IN
India1998 Macro Economic UpdateReforming for Growth and Poverty Reduction
June 30, 1998
Poverty Reduction and Economic Management DivisionSouth Asia Region
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CURRENCY
Rs/ US$Currency Official Unified Market '
Prior to June 1966 4.76June 6, 1966 to mid-December 1971 7.50Mid-December 1971 to end-June 1972 7.28
Note: The Indian fiscal year runs from April 1 through March 31.
Source: IMF, International Finance Statistics (IFS), line "rf"; Reserve Bank of India.
a A dual exchange rate system was created in March 1992, with a free market for about 60percent of foreign exchange transactions. The exchange rate was reunified at the beginning ofMarch 1993 at the free market rate.
Vice President Mieko NishimizuCountry Director Edwin LimSector Manager Roberto ZaghaTask Leader Sanjay Kathuria, Sr. Economist
Abbreviations and Acronyms
ABBREVIATIONS AND ACRONYMS
AP Andhra Pradesh QR Quantitative RestrictionsAPL Adaptable Programs Loan RB Resouce basedASEAN Association of South-East Asian Nations RBI Reserve Bank of IndiaASI Annual Survey of Industries RE Revised EstimatesATM Automatic Teller Machine REER Real Effective Exchange RateBE Budget Estimates SDR Special Drawing RightsBOP Balance of Payments SIL Special Import LicenseBOT Build-Operate-Transfer SLR Statutory Liquidity RequirementsCAD Current Account Deficit SSI Small Scale IndustryCIDA Canadian International Development TAMP Tariff Authority for Major Ports
Agency TOR Terms of ReferenceCMIE Center for Monitoring Indian Economy TPDS Targeted Public Distribution SystemCONCOR Container Corporation of India TRAI Telecom Regulatory Authority of IndiaCRR Cash Reserve Requirement UK-DFID UK-Department for InternationalCSO Central Statistical Organization DevelopmentDECPG Development Economic Policy Group UNCTAD United Nationa Conference on Trade andDGCIS Directorate General of Commercial Development
Intelligence and Statistics USAID US Agency for International DevelopmentDOT Department of Telecommunications UTI Unit Trust of IndiaDRS Debt Reporting System V.A. Value AddedERP Effective Rate of Protection VAT Value Added TaxFDI Foreign Direct Investment VDIS Voluntary Disclosure Income SchemeFII Foreign Institutional Investor VSNL Videsh Sanchar Nigam Ltd.FSU Former Soviet Union WB World BankGAIL Gas Authority of Indiia Limited WDI World Development IndicatorsGCF Gross Capital Formation WPI Wholesale Price IndexGDP Gross Domestic Product WTO World Trade OrganizationGDR Global Depository ReceiptsGNFS Goods and Non-factor ServicesGNP Gross National ProductGOI Government of IndiaHSEB Haryana State Electricity BoardIBRD International Bank for Reconstruction and
DevelopmentICICI Industrial Credit and Investment
Corporation of IndiaIDA International Development AssociationIFS International Financial StatisticsLDBI Industrial Development Bank of IndiaIMF International Monetary FundIPP Independent Power ProducersKfW Kredit Anstalt Frier WiederaufrauKwh Kilowatt-hourLNG Liquified Natural GasLPG Liquified Petroleum GasMFIL Mahindra Ford India LimitedMODVAT Modified Value Added TaxMOU Memorandum of UnderstandingMTNL Mahangir Telephone Nigam LimitedMW MegawattNAS National Accounts StatisticsNBFCs Non Bank Financial CompaniesNCAER National Council of Applied Economic
ResearchNIPFP National Institute of Public Finance and
PolicyNFS Non-FactoT ServicesNRI Non-Resident IndianNPA Non-Performing AssetsNTB Non-Tariff BarriersO&M Overheads and MaintenanceOCC Oil Coordination CommitteeOECF Overseas Economic Cooperation Fund of
JapanOGL Open General LicensePDS Public Distribution SystemPSU Public Sector Unit
CONTENTS
CurrencyAbbreviations and AcronymsAcknowledgmentsEconomic Development DataExecutive Summary
GDP Growth ............................................................. IInflation ............................................................. 2The Balance of Payments ............................................................. 2
Chapter 2 Policy Developments and Issues .............................................................. 5
Overview ............................................................. 5Large Public Sector Deficits Remain an Issue ........................ ..................................... 5The Growing Unsustainability of State Finances .............................................................. 9Public Finance Issues ............................................................. 10Recent Monetary Policy ............................................................. 12Financial Sector Liberalization and Strengthening ............................................................ 13Slowing Trade Reform, Slowing Exports .................... ......................................... 14
Chapter 3 Policies to Reduce Poverty, Raise Growth ............................................................. 17
Introduction ............................................................ 17Reducing the Deficit, Realigning Government ............................ ................................ 17Developments in Private Participation in Infrastructure ............................................................ 19Increasing Growth, Reducing Poverty through External and Internal Deregulation .................... 20Reforming the Financial Sector ............................................................ 25
Chapter 4 Development and Financing Prospects ............................................................ 32
Table.1: GDP Growth 1981-98 .ITable 2: Balance of Payments, 1991-2000 .3Table 3: Changes in State Spending on Economic & Social
Infrastructure, 1990-96 (%GSDP) .10Table 4: Trends in Commercial Bank Asset to Deposit Ratios .13
List of Text Boxes
Box 1: India's Progress in Privatization 1991-92 to 1997-98 ................................................... 12Box 2: Haryana Power Sector Reforms - Pioneering the Bank's Adaptable
Program Lending Haryana ................................................. 22Box 3 Legal and Procedural Reform is Lagging ................................................. 23Box 4 Getting Agriculture Going ................................................. 26Box 5 Impact of Small Industry Reservation ................................................. 27Box 6 The Narasimham II, Khan and Gupta Reports on the Financial Sector .......................... 29Box 7 Lessons from the S.E. Asian Crisis ................................................. 30
List of Text Figures
Figure 1 Public Sector Deficits .................................................. 6Figure 2 Central Government Surpluses/Deficits .................................................. 8Figure 3 Gross Capital Formation by Pvt. Corp. Sector & Consolidated Deficit
of Gen. Govt .................................................... 9Figure 4 India's Share in World Trade Rose when Tariffs Fell ................................................... 15Figure 5 Exports Grew Rapidly in Countries Where Imports Also Grew Rapidly ........................ 16Figure 6 Percentage of products covered by non-tariff barriers ...................................... 16
List of Annex Tables
Table 1 Domestic Demand, 1981-96. ............................................. iTable 2 Evolution of the Public Deficit, 1990-98 ................................................. iiTable 3 Central Government Finances, 1990-98 ................................................ iiiTable 4 State Government Finances (%GDP) ................................................ ivTable 5 Year-wise details of shares disinvested since 1991-92 ................................................. vTable 6 Key Interest Rates, 1994-98 ................................................ viTable 7 India's Share in World Trade rose when Tariffs fell ................................................ viiTable 8 Coverage Ratio for Non-Tariff Barriers on Indian Imports ........................................... viiiTable 9 Coverage Ratio for Non-Tariff Barriers on Indian Imports 1981-97 ................................ ixTable 10C India/Tariff Structure, 1990-98 ................................................. xTable 11 Current Trends in Direction of Trade ................................................ xiTable 12 Composition of Gross Product (Manufacturing): Average Shares .................... ............ xiiTable 13 External environment for India ................................................ xiiiTable 14 Foreign Direct and portfolio Investment ................................................ xivTable 15 Details of mobilisation in the primary market .................... ............................ xvTable 16 Selected Monetary Indicators 1990-97 ................................................ xvi
ACKNOWLEDGMENTS
This report was prepared by a team led by Sanjay Kathuria. It draws on contributionsfrom Alok Bansal (surface transport), Benoit Blarel (agriculture), William McCarten (recentfiscal developments and tax reform), Jamies Hanson (fiscal issues and financial sector), CliveHarris (infrastructure and disinvestment), VJ Ravishankar (fiscal issues), and Djamal Mostefaiand Sameer Shukla (Haryana power refornis).
Background papers for the report were prepared by CRISIL Information Services(Banking, Performance of Indian Industry), NCAER (effective protection), Bibek Debroy (legalreform), Sanjaya Lall (export strategy), Garry Pursell (lessons from local sourcing programs inautomobiles), Uday Sekhar (recent export performance), and Nisha Taneja (small-scale industry).
The report benefited from comments by its peer reviewers (Suresh Tendulkar, DelhiSchool of Economics; Rakesh Mohan, NCAER; and Martin Muhleisen, IMF), and from detailedcomments by John Williamson (Chief Economist, South Asia region), Roberto Zagha (SectorManager, PREM) and Garry Pursell. Useful comments were also provided by Vivek Bharati,Peter Wogart, Bhaskar Naidu and Miria Pigato.
Data analysis and management were done by Anjali Bhardwaj, Bhaskar Naidu, FarahZahir and Harpinder Oberoi. It was desktopped by Shabnaz Rana and Rita Soni. Lata Ganeshand Lin Chin provided logistical support.
The report was discussed with Indian Government officials in June 1998. The helprendered by various Government agencies including RBI, SEBI and the Ministry of Finance isgratefully acknowledged.
The report was prepared under the guidance of James Hanson (Economics Advisor).
(Percentage or index numhers)Money and Quasi Money as % of GDP 49.6 51.4 52.0 53.6 55.2 54.0 54.8Wholesale Price Index (1981-82 = 100) 182.7 207.8 228.7 247.8 274.7 294.8 314.6
a. The per capita GNP estimate is at market prices, using World Bank Atlas methodology. Otherconversions to dollars in this table are at the prevailing avera2ge exchange rate for the period covered.
b. Total Labor Force from 1991 Census. Excludes data for Assam and Jammu & Kashmir.c. Transfers between Centre and States have been netted out.d. All loans and advances to third narties have been netted out.e. As recorded in the Rovernment budget.
Balance of Payments (USS Millions) Merchandise Exports (Average 1990-91-1996-97)
1944_4i 194S_9.6 19064I7 !TT9Mil /A of Tot
Exports of Goods & NFS 32,990 39,668 42,379 Tea 386 1.6Merchandise, fob 26,855 32,311 33,764 Iron Ore 486 2.1
Private Non-Guaranteed 7,382Foreign Investment 4,922 4,794 5,834 Total (Including IMF and Short Term) 89,827Official Grants and Aid 416 345 410Net Medium & Long Tenn Capital 2,357 562 -758 Debt Service Ratio for 1996-97
Public & Publicly Guaranteed 20.6Other Caniital Flows' 2.410 -2.113 1.582 Private Non-Guaranteed 1.3Non-Resident Deposits 818 944 3,536 Total (Including IMF and Short Term) 24.5Net Transactions with IMF -1,174 -1,719 -972
IBRD/ IDA Lending, March 31, 1997 (USS Mil)Overall Balance 6,858 -2,004 6,199
IBRD IDAChange in Net Reserves -5,684 3,723 -5,227 Outstanding and Disbursed 8,768 17,616
a. Figures ,given cover all investmnent income (net). Major paymnents are interest on foreign loans and charges paid to IMF,and major receipts is interest earned on foreign assets.
b. Figures given include workers' renittances but exclude official grant assistance which is included within official loansand grants, and non-resident deposits which are shown separately.
c. Includes short-tern net capital inflow, changes in reserve valuation and other items.d. Excluding gold.e. The exchange rate was reunified at the market rate in March 1993.f. Total exnorts (commerce): net of crude ettroleum exwrts.
India Social IndicatorsLatest sinale year Same realonhlncome group
Would Development Indicators 1998 CD-ROM, World Bank
Executive Summary
1. The Indian economy exhibited considerable in red tape for foreign investors, did little to reduceunderlying strength in 1997-98, but the environment the deficit or subsidies, and raised average importis weakening in response to external and inl:ernal tariffs by about 5 percentage points, on top of the 3developments, intensifying the need for fiurther percentage point rise effected by the previousreforms. Sustaining a high growth rate that will government in September 1997. In light of thesereduce poverty rapidly will depend on three factors: developments, foreign institutional investors(i) substantial reduction of the government deficit, withdrew more than $400 million from the stockthrough subsidy reduction and tax base broadening, markets in May and June 1998 and Moody'sin order to reduce the risk of macroeconomic downgraded India's sovereign rating to speculative.instability, increase resources for rapid, privatesector-led growth and improve equity; (ii) 4. A key concern remains the still-high publicrealignment of government toward basic human sector deficit. Fiscal imbalances remain a majordevelopment and truly public infrastructure, with risk to macroeconomic stability and absorbgreater reliance on the private sector in other areas; resources that would otherwise go to the privateand (iii) broader, deeper, faster deregulation of sector. Since the major adjustment in 1991-93,external and internal markets to encourage further adjustmnents have been limited, leaving theefficiency improvements and higher private Central Government's deficit at about 6 percent ofinvestment. GDP, one of the world's largest. The States' lack
of deficit reduction has put them in an2. India has underlying strengths. In 1997-98, increasingly unsustainable position. Moreover,GDP grew at 5 percent, notwithstanding a 2 percent they have cut back on education, health,decline in agricultural production and the East Asian infrastructure and operations and maintenanceturmoil. Inflation declined to the 5 percent range. expenditures that are critical to development.The external position remained comfortable: the Although the States received a one-time windfallcurrent account deficit remained a low 1.6 percent of from last year's VDIS revenues, they will face evenGDP, foreign direct investment remained strong, the greater fiscal pressures as last year's excessivedebt service ratio fell below 20 percent, and reserves Central wage settlement filters down. Some statesincreased by $3.6 billion to over $26 billion, raising such as Andhra Pradesh, Haryana, and Orissa havereserve cover to over 6 months of imports cr 1.2 begun to address these problems. Major reasons fortimes potential short-term obligations. On the the continued large Central and State deficits are thepolicy front, petroleum and gas prices were still narrow tax base and the large explicit andincreased and linked more closely to world prices, implicit subsidies, which often encouragecontributing to a 0.5 percentage point of GDP inefficiencies (such as groundwater depletion), havereduction in the consolidated public sector deficit (to adverse effects on agricultural growth because of9.1 percent of GDP) and improved efficiency and low service quality and have adverse equityequity. The central government tax net was implications. Also, public sector production remainsexpanded. However, an excessive wage settlement large in areas where private production would beput upward pressure on the deficit. more efficient, reflecting limited progress on
privatization and the infrastructure regulatory3. More recent developments point to a framework (related to the subsidy issue).deterioration. In the first quarter of 1998-99, theexchange rate came under pressure, falling about 7.5 5. India's producers remain among the world'spercent from March 31, with a reserve loss of over most protected, and protection has increased over$1.6 billion. The pressure reflected both the turmoil the last year, raising concerns about efficiency,in international markets, which affected the yen and technological progress, product upgrading anddeveloping country markets, and developments export competitiveness. With the recentspecific to India. Following the nuclear tests in appreciation of the real exchange rate and slowdownMay, the G8 imposed sanctions on India and in cuts in protection, India's export growth in 1997-Pakistan. The Budget, while proposing a pickup in 98 fell below world export growth for the first timeprivatization (including a willingness to cut in 6 years. International evidence suggests that anGovernment equity to 26 percent in most cases), important factor in sustained rapid growth in GDPderegulation measures for insurance, urban land, and labor demand is sustained rapid growth inagricultural exports, and foreign exchange, and cuts exports and imports. This generates benefits from
ii
improved resource allocation, cuts in costs and temporary effect. Sustainable higher growth willimprovements in products in response to depend on fiscal consolidation rather thaninternational competition. stinulation, on public sector realignment, and a
broadening and deepening of reforms that increases6. Although domestic liberalization has taken incentives to invest efficiently and take advantage ofplace., the domestic economy remains subject to a the world market.complex web of regulations, taxation, and explicitand implicit subsidies that limit competition and 9. The centrality of fiscal adjustment andinternal trade and restrain deployment of resources Government realignment. High fiscal deficitsinto productive areas. In particular, although absorb funding from the private sector, threatenagricultural deregulation has started, the main crops macro-stability and hinder financial sector reform.(rice, wheat, sugar, oilseeds) remain subject to many Reductions in the large existing subsidies (implicitbarriers to internal and external trade, procurement and explicit) on power, water, higher education,policies and imnplicit and explicit subsidies. fertilizer, etc. would help, as well as benefit equity
and efficiency and crowd-in private investment.7. The financial sector has improved Further efforts to broaden the tax base would helpsubstantially but its ability to finance private both revenues and equity. Deficit reduction will besector-led growth remains an issue. Post-1991 most productive in the context of public sectorreforms in the financial sector have seen interest realignment, to focus on basic human development;rates being liberalized, the CRR and SLR reduced, truly public infrastructure where private interest isdomestic and foreign competition increased and low; civil service reform and improved governance.regulation and supervision improved. However, the Elsewhere, greater reliance on the private sector,still-large fiscal deficit absorbs funds that otherwise both new investment and privatization, would add towould go to the private sector. Although non- efficiency and growth and reduce public borrowingperforrning assets (net of provisions) are less than 4 and deficits. The private sector's contribution inpercent of total assets, this is largely because infrastructure could be increased by an improvedcommnercial lending is only about 40 percent of regulatory framework and independent andbank assets. The dominance of the public sector in empowered regulatory authorities, as well asthe financial sector, such as in ownership of banks increased user charges (in the absence of which theand financial institutions, as well as in new bond service provider will have to be subsidized, which isissues, limits the financial sector's ability to allocate unrealistic given State Governments' finances).resources to the most productive sectors. Stabilization and reform are particularly needed in
the States, where fiscal adjustrnent is lacking and8. Ganerating Sustained Higher Growth and much of the responsibility lies for humanPoverty Reduction. The rapid, private sector-led development and infrastructure.growth of 1994 to 1996 reflected a reduced publicsector role, and an increasingly deregulated 10. External and internal reform will enhanceeconomy. This increased resources for the private efficiency and improve resource allocation.sector and led to higher investmnent and saving, Liberalization of external markets would meanincreased efficiency in resource use, and, seemingly, eliminating the coverage of non-tariff barriers bymore rapid technological progress and product 2003, as already announced. Increased benefitsupgrading. However, as stabilization and would flow from. an easing of these barriers throughliberalization have slowed, these growth factors greater use of special import licenses in the interim.seem to have slowed too. In particular, the slowing A pre-announced program of further tariff cuts withof private investment partly reflects the current the goal of low and uniform tariffs would generateunprofitability of expansion into the world market, increased efficiency, provide investors with greaterthe consequent increased probability that capacity security, and increase the benefits from foreignwill need to satisfy a slower growth in demand, direct investment. Internal market reform needs touncertainty regarding future policy changes and the be deepened and broadened. Substantial easing ofrisks fiom the still-large public sector deficit. In this the constraints on resource deployment andcontext, an expansionary fiscal policy would risk corporate restructuring, such as those embodied incrowding-out private investment, raise risks of the current labor, land and company laws, wouldmacroeconomic instability and at best have a improve efficiency and growth. Implementation of
iii
proposals to ease land use restrictions would help 12. Prudent policies are necessary to limitreduce urban sprawl and cut the high prices of urban external risks, especially in the light of theland. Eliminating restrictions on internal trade current environment. Although the challenges towould create a truly large national market that would poverty reduction in India are largely internal, as theimprove efficiency of resource use. Easing of small- foregoing makes clear, the external sector also isscale reservation would contribute to the dynamism important. However, the recent East Asian crisis,of the small scale sector and help efficient Indian the likelihood that exports may face increasingfirms compete more equally with imports and competition from East Asian economies and theincrease exports. Finally, increasing agricultural sanctions mean that the short-run situation is riskiergrowth would require a comprehensive program that than in the recent past. Since many controls oncombines elimination of interstate and export/import capital account transactions remain, externalrestrictions and public expenditure reform, including pressures are likely to be felt mainly through thethe phasing out of power and irrigation subsidies current account. Limiting the risk of externalwhile simultaneously improving quality of supply, disturbances will involve maintaining a low currentand the phasing out the fertilizer subsidy as account deficit through prudent fiscal and monetaryrecommended by the Hanumantha Rao committee. policy, strengthening the financial system, limitingEffectiveness of growth-enhancing agricultural short term external obligations to prudent levels, andexpenditures needs improvement, which will entail maintaining a high level of resenres for emergencies.participation by the users, local governments and the In terms of the capital account liberalization,private sector in the planning and operation of rural experience suggests that a substantial reduction ininfrastructure, and focusing the public sector role on the fiscal deficit and strengthening of the domesticessential public good activities. financial system are preconditions, as recommended
by the Committee on Capital Account11. Financial sector reform is necessary for Convertibility. In addition, reserve requirementsimproved allocation of scarce financial resources. and taxation on domestic and foreign funding shouldThe financial sector's capacity to lend more to be equalized, and capital requirements on short termactivities with high returns will depend on funding increased, to avoid excessive incentives toreductions in the public sector deficit and changes in foreign funding. The Government should continueincentives and institutions, including improvements to monitor external borrowing closely and, as ownerin regulation and supervision, to limit growth of of the public banks, limit their external borrowing tonon-performing assets and enhance service. Public prudent levels, especially short-term borrowing.sector banking has generally done poorly in lendingto the private sector worldwide and in India. Hence, 13. External concessional capital flows willimproving performance means an increasing role for continue to be important for India, althoughthe private sector in banking, under much slronger foreign direct investment will play an increasingincentives for prudent behavior and better regulation role. Despite its progress, India still has more poorand supervision, along the lines recomnmenled by people than in all of Sub-Saharan Africa. Externalthe Narasimham Committee. Regarding assistance will help to reduce poverty by meetinginfrastructure funding, public guarantees should be critical needs in areas outside the private ambit, suchcarefully monitored to limit the large potential off- as primary health and education, urbanbudget liabilities and to ensure that incentives to infrastructure, rural and state roads, etc., in manyprivate project assessment and performance are cases "crowding-in" private investment. Externalmaintained. To improve long-term funding for assistance also will help in institution building.infriastructure, the country could liberalize insurance, Finally, concessional external assistance willbeginning with the Government's proposals to provide stable inflows, long maturities and lowincrease competition, and moving toward a fully- interest charges that support a continued low debtfunded pension system, beginning with the public service ratio and a stable capital account. For thesesector where again deficit reduction is a reasons, continued high levels of support by theprecondition. donor community are needed by India.
1. RECENT MACR'OECONOMIC DEVELOPMENTS
1.1 GDP growth slowed to 5% in 1997-98, after suggests informal construction remained strong.averaging 7% in the previous three years. Agrizulture Finally, GDP growth rose in services, mining andgrowth fell sharply from a 1990s' record of 7.9% in electricity, water, & gas, in 1997-98.1996-97 to -2.0% (advance estimate) in 1997-98. Thisfall seems to be a return, after a good monsoon in 1.4 On the aggregate demand side, export growth1996-97, to agriculture's underlying growth palh. The slowed sharply in 1997-98. Imports grew at about thefall accounts, numerically, for all of the slowdown in same rate as GDP; oil imports actually declined butGDP. If agricultural growth had been spread evenly non-oil imports rose much faster than GDP. In someover the past two years (which would have implied areas, such as electrical machinery and steel, importsgrowth in each year was roughly equal to the recent have increased between 10-12% while domestictrend of agricultural growth), then overall GDP growth production is stagnant. Private investment fellin both 1996-97 and 1997-98 would have been about slightly in 1996-97 as a percentage of GDP, because of6.2 % p.a. a fall in inventories, and appears to have slowed further
in 1997-98, as evidenced in the decline in capital goods1.2 Non-agricultural GDP growth began l:o slow production and imports. The General Governmentin 1996-97, but the impact of this slowdown on overall deficit (including OCC) declined only slightly as aGDP data was masked by the high agricultural growth. percentage of GDP (Annex Table 2), suggestingManufacturing growth fell by nearly half in 1996-97 Government was not a major factor in any decline inand slowed an additional 1.3 percentage points in aggregate demand.1997-98 (Table 1). However, while other sectors, suchas steel, commercial vehicles, scooters and capital 1.5 Various explanations have been given for thegoods did poorly. slowdown in GDP growth. Moving beyond sector-
specific slowdowns, like agriculture and construction,1.3 Some sectors did well, such as l:extiles, to more general concerns, various explanations havechemicals and products, fertilizers and consumer been advanced. Some analysts have suggested that adurables other than autos. Formal construction slowdown in government contracts is to blame, but thisremained a low percentage of GDP by international is belied by the constancy of the deficit andstandards and it slowed again in 1997-98. The silver government direct investment for some time. A secondlining in the slowdown in formal construction, lo some possible explanation is the saturation of the upper-endextent related to the problems in Non Bank Financial of the consumer goods market, but this seems belied byCorporations (NBFCs, see para. 2.43), was that it continued strong foreign direct investment. Otherreversed the potential inflation of property prices at an analysts have pointed to the slowdown in investment asearly stage (para. 1.8). Rapid growth in cemeni: output a lagged impact of the tight money in 1995-96. In
a. Quick estimates, b. Advance estimatesSource: CSO, NationalAccounts Statstics 1997-93 Advance Estimates.
2 Chapter 1: Recent Macroeconomic Developments
addition, in 1997-98, construction finance became of the wholesale index, continue to decline. Thisdifficull. And real interest rates were kept higher than decline may reflect some previous over-building, but,they might otherwise have been in the first quarter by also a slowdown in demand related to high real interestthe concentrated financing of the still-large fiscal rates and the reduction in lending by the NBFCs, whichdeficit and, in the last quarter, by tightening of money were an important source of housing finance.(although for the year as a whole monetary policyseems to have loosened somewhat, see paras. 2.35- 1.9 The Balance of Payments was comfortable2.38). Fourth, the export slowdown has also reduced in 1997-98 but pressures have developed since then. Indemand growth. Analysts point to a slowdown in 1997-98, reserves rose 16% and the Currentworld markets. Perhaps more worrying is that India's Account Deficit increased to 1.6% of GDP (fromshare of trade also declined (Annex Table 7). If India 1.2% in 1996-97). India largely escaped the firsthad maintained its share of world trade, export growth round of contagion from the East Asian crisis, as didin 1997-98 (in dollars) would have been nearly 5%, other South Asian and Latin American countries.about the same as imports, rather than 2.7%.
1.10 Merchandise Export growth of 2.7% in1.6 This leads to perhaps the most plausible dollars was somewhat below 1996-97's 4.6%. Thisexplanation of the slowdown, the slowdown in India's decline reflected the decline in Indian exports' share ofadjustment. Because the fiscal deficit remains high, world trade, as well as the slower growth of worldthe Government still absorbs a substantial part of trade (growth of world trade (in dollars) slowedloanable funds and the risks of macroeconomic sharply because of dollar appreciation, even as tradeinstability remain. At the same time, the profitability volumes continued to grow rapidly). Maintenance ofof both exports and import-substitution have stagnated, India's share of world trade would have nearly doubledif not fallen. In this context, and given the the growth rate of exports. India's loss of marketuncertainlties about the speed, if not direction, of policy share was the first in 6 years.change, investors may be playing it safe by cuttingback investment growth. Associated with this 1.11 Thus far the impact of the East Asian crisis onexplanation is the possibility that the improvements in India's trade has been small. East Asia (includingresource allocation and reductions in costs from Japan) accounts for less than 20% of Indian exports.liberalization that contributed to the recent rapid Competition in third country markets has also beengrowth, are becoming exhausted (see Chapter 2 for limited so far. Although the East Asian countries havefurther discussion). devalued massively in real terms, their export supply
has been limited by lack of trade credits. However,1.7 Inflation fell to 5.0% in 1997-98, compared once trade credits resume, or if China attempts toto 6.9% in 1996-97 (Economic Survey). Inflation increase its exports substantially, India may fnd exportbegan to slow in April and fell as low as 3.7% (year- competition much more difficult.on-year) in September 1997. Since then, inflation hasrisen, reaching the 6-6.5% range after May 1998. 1.12 Import growth in 1997-98 was a low 4.6%.
Oil imports, which represent about 15% of imports1.8 'The variations in inflation largely reflect the (21% in 1996-97), declined 24.3%, reflecting lowvariations in agricultural supply (food articles' prices. Non-oil import growth, 12.3%, was muchinflation was only 3.5% in 1997-98 versus 9.6% in higher than the 4.3% growth in 1996-97.1996-97), although monetary growth also increasedslightly in 1997-98 (see Chapter 2). Regarding the 1.13 Thus, the merchandise trade deficit was heldother main commodity groups, the inflation in fuel and to 4% of GDP largely by declining oil prices. In thepower prices in 1997-98 was less than in 1996-97, current account, the merchandise trade deficit waseven taking into account the September 1997 increase largely offset by the continued large surplus onin petroleum product prices. Inflation in manufactured invisibles, mainly continued high worker remittances.goods' prices, which might be considered a rough The current account deficit for 1997-98, an estimatedmeasure of core inflation, also was down somewhat in US$6.2 billion (1.6% of GDP), was about $1.8 billion1997-98. Finally, property prices, which are not part larger than in 1996-97.
Chapter 1: Recent Macroeconomic Developments 3
Table 2: Balance of Payments, 1991-2000(US$ billion)
a. World Bank Debt Reporting System (DRS), these numbers differ from RBI.b. Retuums on foreign investments.c. Current account balance differs from GOI, on account of mterest paynents (DRS) and official capital grants (treated as a fnancing item).d. Servicng of the Russia rupee debt.e. Residual item including reserve valuation changes, rupee tade imbalamce, etc.f (-) = indicates increase in assets.g. Frorn IfF Intemational Financial Statistics, includes Foreign exchangp assets, SDRs and Reserve position in the Fund.h. Net flows in NRI deposit schemes, plus India Resurgent Bonds in 1998-99, except the non-repatiable NR(NR)D Scheme
Soerce: Govement of India, RBI; Ministry of Comnerce; IMF; World Bank Debt Reporting System; World Bank Staff estimates.
4 Chapter 1: Recent Macroeconomic Developments
1.14 The Capital Account ran a substantial far higher than the East Asian economies had at end-surplus. Direct investment accounted for the largest 1996, particularly since much more of the potentialshare of net capital inflows, rising to an estimated $3.1 short term withdrawals3 in India would be subject tobillion, a healthy increase of more than 24% over penalties for withdrawal than they were in East Asia.1996-97 (Table 2). Inflows from Foreign Institutional Nonetheless, the ratio is somewhat less thanInvestors (FII) and Global Depository Rights (GDRs), recommended by the Committee on Capital Accounton the other hand, were down by half. Net monthly FII Convertibility. It will continue to be prudent toinvestments turned negative in November 1997, for the monitor volatility cover and respond promptly tofirst tinme, and fluctuated through March 1998. Part of exchange market pressures with reserves sales,these developments may have reflected a spillover exchange rate adjustments, and tighter money tofrom Elast Asia. Gross external commercial achieve balance of payments and reserve targets.borrowings were down slightly, to $5.7 billion in1997-98. Towards the end of the year, spreads 1.16 In the first quarter of 1998-99, the rupee cameincreased internationally and the costs of forward cover under pressure. The rupee was allowed to slide 7.5%rose as short-term interest rates increased. The net rise between March 31 and June 26. The RBI's foreignin NRI deposits slowed sharply, from $ 3.5 billion in currency assets declined by $670 million in May and1996-97 to $1.1 billion in 1997-98. The debt service $1.2 billion in the first two weeks of June, reducingratio continues to fall, to about 19% in 1997-98, as a total reserves including gold to about $27.6 billion onresult of a decline in amortization payments after the June 12. A large part of the pressure probably came"bunching" of 1996-97, falling interest payments, the from increased liquidations of foreign institutionalreduced importance of debt inflows in the capital investors, who reduced holdings of equity and debt inaccount, and a low current account. Indian markets by $218 million in May and over $200
o million in the first three weeks of June. More broadly,1.15 Gross Foreign Exchange Reserves rose $3.6 the pressures probably reflect investors concerns aboutbillion, reaching a comfortable $26.3 billion (IME, the nuclear tests of May 1998, the G8 sanctions on aidInternational Financial Statistics; reserves including and lending that followed the tests, investors' concernsgold and SDRs reached $ 29.4 billion) at the end of following the budget, and the general turmoil inMarch 1998. This was equivalent to over six months international markets that affected the yen andof goods imports (including gold, over 7 months of developing country borrowers. On June 20, Moody'sgoods imnports). In terms of the standard measure of announced that it was downgrading India's sovereign"volatility" cover, gross foreign exchange reserves rating by two notches, to Ba2 (speculative), from Baa3were more than twice the total of trade credit and short (lowest investment grade); Standard & Poor's has ratedterm debt (including short term non-resident deposits). India speculative (BB+) since May 1991. However,They were about 120% of short term debt, trade credit the stock and foreign exchange markets stabilized atand (the stock of) foreign portfolio investment. This is the end of June.
2. POLICY DEVELOPMENTS AND ISSUES
2.1 Overview: After a period of strong, private resources, and complicated subsidies, tax and financialsector-led growth, India experienced a slowdown, sector regulations hinder efficiency of resource use,particularly in some industrial sectors, and, in 1997-98, while having at best unclear distributional implicationsin agriculture. Nonetheless, in 1997-98, GDP growth and at worst contributing to inequity. Reflecting thewas 5%, inflation down, the external position reduced profitability of increased sales in worldcomfortable, and contagion from East Asia minimal. markets, the lower capacity growth that would beHowever, India now faces a more difficult needed in an economy that is not increasingly outward-environment and a possible further slowdown in looking, the uncertainty of trade policy and the generalinvestment. The Government's concern focuses on regulatory regime, and the overhang of a still-largereturning to sustainable 7-8% p.a. growth within a public sector deficit, private investment slowed instable macro economy, which will reduce poverty 1997-98.rapidly.
2.5 In this context, looser fiscal policy is likely to2.2 The recent, rapid growth reflected an have little sustained impact on growth, because of itsadjustment that reduced the public sector's role in the potential crowding out effect and the increased risk ofeconomy and increased the economy's outward- macroeconomic instability it raises in investors' minds.orientation. This approach led to more resources for Sustained rapid growth will depend on fiscalthe private sector, higher private investment and consolidation, coupled with a broadening, deepeningsavings, increased efficiency in resource use and and acceleration of internal and external deregulationquicker technology adoption and product upgrading. to encourage cost cutting and output growth. TheHowever, the adjustment process seems to have slowed 1998-99 Budget projects a slight reduction in theover the last few years, negatively affecting these deficit, did not reduce subsidies, and raised externalgrowth factors. duties by almost 5 percentage points while
complicating their administration. However, the2.3 In particular, the public sector deficit has not Budget Speech proposes a speed up of privatization,declined much since 1992-93 and remains among the greater competition in insurance, an easing of thelargest in the world. This limits substantially the restrictions that hobble urban land use, and reductionfinancing for the private sector and the efficiency of of regulations and red tape that limit agriculturalresource use, while creating a risk of macroeconomic exports and foreign investmnent.instability in investors' minds. In addition to theCentral Government's deficit, the States' lack of fiscal 2.6 Large Public Sector Deficits Remain an Issue.adjustment, largely linked to large subsidies thaLt often The Central Government Deficit in 1997-98encourage inefficiency and have uncertain impacts on [including net revenues from the Oil Pool Accountequity, increasingly threatens the provision of the (OCC), excluding disinvestment (capital) revenues]social and physical infrastructure that is needed for was about 6% of GDP, the same as 1996-97.4 Fiscaldevelopment. The States' problems are likely to be performance improved in some important areas. Thecompounded by the filtering down of last year's Government cut subsidies on petroleum products,excessive Central Government wage settlement. The saving 0.9% of GDP compared to 1996-97, by linkingdisinvestment process slowed after 1995-96, ,nd no average domestic prices more closely to internationaltransfer of majority ownership has occurred yet. prices and raising gas prices in September 1997. This
policy will eliminate the Oil Pool's annual deficit and2.4 Some deregulation occurred in 1997-98, improve efficiency, equity, and prospects for privatenotably the closer linking of oil prices to world markets investment in oil and gas.5 Corporate taxes almostand the changes in and proposals for the financial attained the 15% budgeted increase, despite a rate cutsector. However, broadly speaking, external and (from 43% to 35%) and slower growth. The Voluntaryinternal deregulation also seems to have slowed and Disclosure of Income Scheme (VDIS) raised aboutprotection of domestic inefficiency from external 0.7% of GDP on a one-time basis, through taxcompetition remains among the highest in the world. payments on income that had previously escaped theOn the external side, one indicator of the slowing tax net (the States received 77.5% of these revenues inadjustmnent is that India's share in world markets fell in 1997-98). Finally, current spending was held to1997, after rising in the previous 5 years. Intemnal tax budgeted levels, while direct capital spending rose byand trade barriers, regulations on deploymrLent of 0.3% of GDP.
6 Chapter 2: Policy Developments and Issues
Figure 1: Public Sector Deficits (% GDP)
%GP %GDP 14;2.3
12 - " Consolidated Nonfinancial Riblic Sector 12
10 - 6-' ' . 4 , , 9.1 .10
8 Central Government (incl. OCC, excl. Disinvestment)-- 8
6 6
4 3.3i 3.0 3. 3.1 4
2 State Government 2Source: Annex Table 2
0- l l lo0 C1) n 0 ( (D C- 0X
0) 0) 0) 0) 0) 0) 0) 0) a)0) 0) 0) 0) 0) a) a) CD 0)
2.7 These gains were offset by four factors (Annex 2.9 The Fiscal deficit for 1998-99 is projected to beTable 3) : (i) Customs revenues were down by about about 5.8% of GDP (excluding disinvestment revenues0.5% of GDP and about 22% less than budgeted. This and including the oil pool revenues), down slightlyshortfall reflected the drop in oil imports that account from last year's 6%. On the Government basisfor about 25% of tariff revenues and, perhaps, the (including disinvestment, excluding the oil pool), thebeginning of the impact of lower average tariff deficit also is about 5.8%. The budget was originallyrates.(ii) Income taxes (excluding VDIS) and excise projected to yield a 5.6% deficit, but following thetaxes also were down (a total of 0.2% of GDP), budget speech, the government made adjustments thatreflecting the econonic slowdown and the lower will reduce projected revenues by about 0.2 % of theincome tax rates.6 (iii) Central Government pay was GDP (lowering of special import duty, withdrawal ofraised much more than the Pay Commission urea price hike and transfer of the additional exciserecommended (0.6% of GDP more than budgeted, duty on petrol from consumers to the oil pool). Inincluding arrears; moreover, the award was not addition to the spending and revenue programs, theaccompanied by any measures to increase efficiency Finance Minister's Budget speech laid out a number ofand the Pay Commission's proposals to reduce staff by economic reform proposals (para.2.32, Box 4).30% over 10 years and eliminate unfilled positionswere rejected as part of the final wage settlement). (iv) 2.10 Three classes of measures account for most of theNet lending to the States (a Central Government projected increase in revenues:expenditure) also rose, reflecting a large rise in smallsavings deposits that were attracted by high interest * an increase in excise taxes notably on motor fuel,rates. multi-use vehicles, and some food products, and some
adjustments of other excises. Regarding the motor fuel2.8 The Consolidated Public Sector Deficit was down excise, the 12 percentage point rise will be paid from0.5 % of GDP in 1997-98, reflecting the improvement the oil pool surplus; in addition a specific 1 Rupee peron the Oil Pool and the VDIS. Although estimates liter tax, paid by consumers, will be earmarked to thesuggest that the States' higher interest payments and National Highways Authority.(net) lending and transfers to state public enterprisestended to push up their deficit, this was more than * an across-the-board rise in India's already highoffset by their share of the VDIS. The Central Public tariffs of 4 percentage (major exemptions include crudeEnterprises' position improved slightly. oil, newsprint, trading companies and project capital
goods). Some individual tariffs also were adjusted,notably a 5 percentage point cut on crude oil.
Chapter 2: Policy Developments and Issues 7
an increase in oil pool revenues, net of the price rises as envisaged in the 1997 oil decontrolpayment of the motor fuel excise. measures, d) discipline on expenditures, with a
reduction in spending if revenues grow less than2.11 Also on the revenue side, the tax net for high projected, and e) privatizations despite what looks likeincome taxpayers will be widened further by using a weak equity market. Major risks are the potentialadditional presumptive indicators to increase the increase in interest costs, as a result of the morenumber of filers. At the same time, the level of tax difficult environment for Indian debt, and the pressureexemption is increased from Rs. 40000 to Rs. 50000. to increase Central loans and transfers to the StatesThese changes are projected to leave (non-VDIS) because of worsening state fiscal problems, inincome taxes slightly lower as a percentage cf GDP. particular the rising wage bill (para. 2.7).Better administration of corporate taxes is projected togenerate an offsetting increase. The changed 2.14 A Longer Term Perspective suggests that sincecomposition of the increased revenues means that the the major fiscal adjustment of 1991-92 and 1992-93,states' share of revenue rises only about 0.1% of GDP, the Consolidated Public Sector deficit has remainedrelative to (non-VDIS) revenues in 1997-98. Finally, roughly constant, at 9-9.5 % of GDP (Annex Table 2).disinvestment revenues are projected to increase The Central Government's deficit reduction of 2.2 %substantially, largely from sales of shares in GAIL, of GDP between 1990-91 and 1997-98 accounts forIOC, VSNL, and CONCOR that were programmed for most of the fiscal adjustment that has occurred, againlast year but then postponed because of a wealk equity with most of that cut coming in 1991-92 and 1992-93.market. The Government also proposes to allow Despite the reduction, India's Central Governmentreductions to 26% of Government equity in non- deficit remains one of the biggest of the largestrategic industries. developing countries.'8
2.12 Total expenditures are projected to rise about 2.15 Over the same period, the Oil Pool deficit first0.1% of GDP, with some shift toward spending on Plan rose, but then was curtailed in September 1997 by theinvestments and the social sectors, including an adoption of the new pricing policy. The Central Publicincrease to cover increased wage costs of university Enterprises cut their deficit by about 1 % of GDP overteachers. Capital expenditures are projected to rise by the last seven years, again with most of the cutabout 0.1% of GDP. For the states, grants are flat at occurring in 1991-92. They could face increased wage1.7% of GDP, but net lending is down by 0.3%, costs in 1998-99, as a result of the excessive Centralreflecting a lower mobilization in small savings as a Government wage settlement. The States have doneresult of closer linkage of the rates on small saving to little adjustment, as discussed below.market rates. Other expenditures, overall, areprojected to rise slightly as a percentage of GDP. 2.16 Generally speaking, large public sector deficitsSubsidies are up about 0.1% of GDP (after factDring in seem to reduce growth within individual countriesthe backtracking on the urea price hike), with food (Easterly et al, and IMF 1996, 1997) and are associatedsubsidies up about 20%, because of the higher support with slower growth among the larger countriesprices for wheat, and higher fertilizer subsidies. during the period 1985-95. "Crowding-out" of privateMinistry of Defense spending, at 2.5% of GDP, is investment by public sector borrowing is a majordown slightly, while the allocation to the Department explanation of this negative relationship (Easterly etof Atomic Research was increased from 0.1% ito 0.2% al). Larger public sector borrowing raises interest ratesof GDP. above what they otherwise would be, particularly if
loose fiscal policy is being offset by tight money.2.13 Holding the deficit to projected levels depends Crowding-out shows up in India, where roughly a one-upon a number of factors: a) a higher nominal GDP to-one negative relation exists between the deficit ofgrowth than last year, despite the weakening world the General Government and Oil Pool and privateeconomy and the higher domestic taxes and tariffs, to corporate investment over the last 10 years (Figure 3,support the projected revenue growth; b) continued see also RBI Annual Report 1996-97, pp.76, 85).improvements in administration to mobilize corporateand individual tax revenues and collect the higherexcises and tariffs; c) continued low world oil prices sothe oil pool surplus remains high, and, if world oilprices rise or the exchange rate depreciates, domestic
8 Chapter 2: Policy Development and Issues
Figure 2: Central Government Surpluses I Deficits% of GOP Developing Countries Over 20 mnillion, (1995 unless otherwise stated)
3
a
0 E
.2~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~A
.3
.4
.5
Source: IFS, IMF
.7
2.17 In addition, public sector deficits tend to slow 2.18 Large public sectoT deficits also raise the risk ofgrowth because they often finance either public macroeconomic instability. One such risk is the so-consumption by the private, or public activities that called "domestic debt trap"9, a steadily rising ratio ofcould be done by the private sector more effectively public debt to GDP about which RBI has warned(Easterly et al). Again these observations are relevant (Annual Report '93-94, p. 41; '95-96, pp. 45-46, 49;to India (RBI, Annual Report 1996-97, p. 76). Indian '96-97, pp. 76, 85). In the past, financial repressionGovermnents' current (revenue) deficit remains about prevented such a possibility, by administratively3.1 % of GDP. This means Indian Govermnents' crowding out private borrowers and imposing aborrow to finance interest and other consumption distortionary implicit tax on them through higherexpenditures, apart from investment. And, India's spreads between lending and deposit interest rates.large public sector engages in many activities that Financial liberalization reduced this distortionarycould be done effectively by the private sector within a implicit tax and made the true cost of the deficitcompetitive market framework implying public sector clearer. However, correspondingly, the interest costscrowding-out through public sector supply in goods of the State and Central Government have risen over 1markets as well as through borrowing in financial percent of GDP since 1990-91, even though the deficitmarkets. has fallen by about 25%. 10 While the ratio of domestic
Chapter 2: Policy Development and Issues 9
Figure 3: Gross Capital Fonnation by Pvt Corp. Sector &Consolidated Deficit of Gen. Govt. (incl. OCC, excl. disinvt.)
8
95/96
7
1- 92/93*o *94/95
(I * 93/94
i 91/92CL
o 86/87GCF=15.2-1.lDEF R2 =C0.52
t 2.93
U-0
0 49 88/89 8/90
* 87/88
Consolidated Deficit
3
7 8 9 10 11
public debt to GDP has declined slightly since: 1991, 2.21 The States' weak fiscal position reflects theirand India is not in a debt trap, an increased deficit continued large subsidies to users of power, water,could lead to one. transport and secondary and tertiary education, directly
or through support for State public enterprises which2.19 Macroeconomic instability could also occur in the also suffer from overstaffmg. State electricity boards'unlikely event that the Government suddenly resorted average revenue has fallen from 82% to 80% of coststo inflationary finance or increased offshore borrowing since 1992-93, reflecting subsidies, particularly ofto fund its deficit. Such a policy would avoid a agriculture, and large losses in transmission anddomestic debt trap but would create its own, well- distribution (Ahluwalia, pp. 96, 97). Irrigation chargesknown distortions and risks. Since the 1980s debt have declined dramatically relative to state income"1
crises, investors and rating agencies have worried (however, some states are initiating reforms in bothabout such possibilities in countries with high fiscal these areas (Box 3)). The States also have not wideneddeficits. In turn, such concerns tend to increase the their tax net, for example by imposing taxes onrisk premia that India faces, and translate into higher agricultural income and land that are reserved to themfnancing costs for private investors. under the constitution. At the same time, the interest
costs of the States' borrowing has risen.2.20 The Growing Unsustainabilitv of StateFinances. The States' lack of fiscal adjustment not 2.22 Given the States' relatively hard budgetonly worsens the consolidated deficit; it also worsens constraint 2, with no fiscal reforms, and with risingthe States' ability to provide economic infrastructure interest bills, the States have been forced to reduce(irrigation, power, roads) and social infrastructure their spending in important areas: investment in(education, health) that will be critical to growth irrigation, power, and transport and recurrent spending(Annex Table 4). Although the States' deficit of 3.1% in education and health. Few states have been able toof GDP in 1997-98 is less than in 1990-91, this reflects maintain their spending levels in both these areas.their windfall from VDIS (0.5 % of GDP). Without Indeed, many have suffered on both counts, as shownVDIS, their deficit would actually be worse than in in Table 3.1990-91.
10 Chapter 2: Policy Developments and Issues
2.23 In addition, maintenance allocations have been Finance, Discussion Paper, NIPFP). Although theinadequate, a problem repeatedly cited by Finance Central Government reduced explicit subsidies as partCommissions. This problem has been exacerbated by of its fiscal adjustment in the early 1990s, and again inthe division between plan and non-plan expenditures. 1997 with the removal of the average subsidy onRecurrenit maintenance, which may have a high return, petroleum products, subsidies remain a major elementcan only be financed by the states' own revenue, while of Indian public finance, especially in the States. Therepairs necessitated by deferred maintenance can be major remaining subsidies are in fertilizer, irrigation,financed as part of the Plan. The Finance Minister power, and secondary and higher education, andproposed a re-examination of this issue in his 1998-99 represent more than 4% of GDP. The last three mostlyBudget Speech. reflect policy in individual states.
Table3: Change in Social & Economic Infrastructure 2.26 Subsidies not only tend to increase the deficit,and Interest Spending (1990191 & 1996197) they often have hindered the Governments' ability to
Change in percentage points of GSDP; Bold indicates deterioration provide infrastructure and social services to the poor,States Social 1 Economic2 Interest often have had negative effects on efficiency and
Payment growth, and often have had unclear distributionalPayments 08 .. effects. For example, subsidized agricultural electricity
*daaeh070 prices encourage overpumping of aquifers; reduce theBihar 0.1 -2.2 1.3 possibility of using aquifers for drinking water, andGujarat -0.3 -1.2 0.5 require deepening of wells and investment in largerHaryana -0.3 -0.6 0.4 pumps to bring water from the lower water table. LowKamataka 0.0 -1.4 0.3 electricity and irrigation charges encourage water-Kerala -0.1 -0.2 1.0 intensive crops in a country where water is scarce.Maharashtra -0.2 -0.5 0.1 Failure to differentiate peak and non-peak tariffsMadhya Pradesh -0.1 -0.1 0.6 increases pressures to over-build capacity that will beO)ssa 0.1 -1.7 0.8 underutilized. Since part of the subsidy typically
Punjab -0.4 -0.9 2.0 ~~comes from not charging fully for operations,Punjab -0.4 -0.9 2.0 maintenance and capital costs, service quality hasRajasthan 0.7 0.0 1.0 deteriorated in areas like power and irrigation and,Tamilnadu -0.7 0.1 0.6 perhaps, education. To limit losses, supply has beenUttar Pradesh -0.4 -0.5 1.2 rationed by limiting sales, rather than raising price,West Bengal 0.6 0.8 1.1 with negative impacts on efficiency. To mitigate such14 States Average *0.2 -0.6 0.8 problems, individuals and firms may make investmentsAU States 3 -0.4 -0.4 0.5 in power generators, water pumps, tanks, etc.,Note: 1996-97 is Revised Estimate investments which would be unnecessary if service1. Reters to total expenditure on health and education provision were better.2. Refers to power,inigation,& transport -capital ouftay and loans3. All States as a proportion of GDP at factor cost 2.27 Distributional implications of the subsidies areSource: RBI Bulletin various issues unclear, not only because the beneficiaries may or may
not have lower average incomes than the taxpayers, but2.24 These problems will be exacerbated over the next also because the "subsidy" partly reflects large "non-few years, The States' potential deficit will increase, technical" losses for example, in power and water, andas the excessive Central wage settlement filters down partly the ability of finms and individuals to defineto the States in a possible 2-4% of GDP increase in themselves as part of the subsidized group. Intheir own salary costs,'3 and higher salaries in State addition, the subsidy to one group of users is oftenpublic enterprises. Dealing with this large potential partly covered by a cross subsidy by other users in theincrease, while reversing the deterioration in economic same sector, such as power, water, airlines,and social investment, will depend on major fiscal telecommunications, which is a politically easy way toadjustments by State governments. fund a subsidy. In some areas where market power
exists, such as telephones, this approach has allowed2.25 Pubic Finance Issues. Government subsidies, public enterprises to allow them to increase spendingexplicit and implicit, are a major factor in the Central without improving efficiency much. However, suchand State deficits as well as resource allocation in the use of cross subsidies and market power has littleeconomy and the public budgets. Subsidies, explicit support on efficiency or equity grounds in tax theory.and implicit, were estimated at 14.4% of GDP in 1994-95, with 10.7% on non-merit goods.14 (Ministry of
Chapter 2: Policy Development and Issues 11
2.28 Finally, because of low tariffs, large non-tecemical and land not only contributes to the fiscal crisis, aslosses, uncertainty about future tariff policies, and the noted, it also foregoes the equity gains that wouldpoor financial condition of the public compamies, result from taxing large agricultural incomes and largeprivate provision of services has been limited in areas landholdings, and generates inefficiency to the extentlike power generation, water and roads. In these other types of taxes are used. The States' reliance oncircumstances, Government guarantees have often Central taxes and transfers also sets up a potential gapbeen required to attract private investors. However, between tax payment and delivery of public servicessuch guarantees use up public borrowing capacily on that can reduce the quality of public sector spendingcontingent liabilities that is often not fully recognized (Bagchi). State sales taxes cascade to deter interstatein public accounts. Guarantees also reduce the benefit and intemational trade, and sometimes even taxof private sector project assessment and risk taking, interstate trade directly, with corresponding reductionsunless carefully specified. in national efficiency and export potential. Finally, the
complexity of the current, parallel indirect tax systems2.29 A second major public finance issue is the of the Center and the States imposes substantialDecline in Governments' Direct Capital Spending. administrative and compliance burdens.As part of the fiscal adjustment, direct capital spendingby the Central Government (excluding defense capital) 2.31 A fourth major issue is the Still-large Role offell from about 1.4% of GDP in 1990-91 to 0.7% of Public Enterprises. Long protected from marketGDP in 1997-98, representing nearly 40% of the cut in competition, but subject to various objectives andits deficit. In the States, direct capital spending also political demands, many ended up as a major burdenfell. These cuts occurred while explicit and implicit on public finances and on the economy because ofsubsidies, as a percentage of GDP, seem to be their low productivity, and, in some cases, exercise ofincreasing. Private infrastructure provision may market power. The removal of reservations thateventually offset some of these investment cutbacks, limited competition and some increase in autonomyand raise efficiency. However, in many other areas, have improved performance in some sectors.such as roads, power transmission, urban However, another factor in the improvement may beinfrastructure, primary school buildings, health the regulations that still protect or give advantages toinfrastructure, a strong case exists for more public the public enterprises (e.g. telecoms, and petroleum).investment. For example, it is widely estimated that The Disinvestment Commission's establishment (1996)only about 20% of the national and less than 5%1o of implicitly recognized the 'need to reduce the burden ofstate highway capacity expansion needs could be met the public enterprises and the possibility of capitalby private toll-roads; not to speak of needs for rural revenues from sales. Once disinvestment occurs, theroads to provide better market access for the poor. Of government deficit will fall as firms require lesscourse, Government investment need not mean that it transfers, debt relief and capital injections and increasecarries out the investment. For example, substantial their tax payments. Experience world-wide alsosavings and efficiency gains would probably result suggests that a shift from public to private ownershipfrom private construction and maintenance of roads raises efficiency (see for example, Galal et al,under competitively let contracts. Megginson et al, World Bank 1995b). This is
particularly true where competitive market conditions2.30 A third issue is the Unfinished Tax Reform protect consumers and stimulate innovation, such asAgenda. Tax cuts have brought rates to mrrore tradable goods. It is also true in many sectors oncereasonable levels over the last few years. The number thought to be natural monopolies, such as powerof individual assessees have been increased from about generation.8 million in 1993-94 to about 12 million currently,through expansion of withholding and greater reliance 2.32 However, privatization has lagged in the reformon presumptive indicators, but this is still only about process so far, and slowed in the last two years (Box1.2% of the population. Despite the reforms, Central 1). Only partial disinvestments have occurred. As theGovernment tax revenues are still excessively Disinvestmnent Commission has noted, these have beendependent on customs receipts which have low aimed mainly at raising revenues and have reaped fewbuoyancy and generate a large bias against exports, benefits from efficiency gains.competitiveness, and efficiency. Even in 1997-98customs revenues represented 32% of (non-VDIS) 2.33 The 1998-99 Budget Speech announced a numbertaxes, despite their slow growth. This compares to 10- of proposals to speed up privatization, including15 % in most large developing countries, and much moving forward on the disinvestment postponed lastless in the East Asian, export-oriented economies. At year, divestment of 51% of Indian Airlines over 3the state level, the failure to tax agricultural incornes years, an improvement in the voluntary retirement
12 Chapter 2: Policy Developments and Issues
schemes to reduce surplus labor and a willingness to Box 1: India's Progress in Privatization 1991 to 1997reduce the Government's shareholding to 26% ofcapital in the "generality of cases". The Government Through 1997-98, equity in 40 enterprises of the 240 non-has also decided to move ahead on strategic sales of departmental Central public enterprises had been divestedfive companies. Implementation of these proposals (Annex Table 5). However, in 16 cases, the divestment waswill providle a strong impetus to privatization. less than 1 0%. In no case did disinvestment exceed 5 1%,
although it is almost 49% in two cases. The process of saleseems to have slowed since 1995-96, with only 7 sales
2.34 Recent Monetary Policy. Reserve money grew exceeding 2% occurring. Last year, the Government hadat 13.1% in 1997-98 (Annex Table 16), versus 2.9% in planned to increase its divestment of the Gas Authority of1996-97. RBI credit to the banks, the commercial India, Videsh Sanchar Nigam Ltd., Container Corporation ofsector and Government rose in 1997-98, while in 1996- India, and Mahanagar Telephone Nigam Ltd (MTNL), but,97 these credits declined, or rose only slightly. after scaling back the MTNL GDR offering because of a
weak market, it decided to defer the other sales. Some state2.35 Broad money (M3) grew at 17.0% in 1997-98, goverments such as A.P. and Gujarat have also madefaster than the 16.0% of 1996-97, the same as the long- progress in privatization.run average growth rate of 17.2% p.a. since 1980-81. India's Disinvestment Commission was set up in 1996. ItThe long-run growth rate has been remarkably stable. has so far considered 41 companies (overlapping slightlyThe asset counterparts of M3 growth in 1997-98 were: with the 40 in which shares have been sold), and(i) a pick-up in bank lending to the commercial sector recommended strategic sale in 18 cases, and trade sales/(14.3% increase versus 9.1% in 1996-97), particularly partial equity sales in 11. Action has been taken on 7 ofafter December 1997; (ii) a 13.8% increase in bank these recommendations. The Commission recommendedcredit to the Government (reflecting both RBI also setting up a disinvestment fund out of the proceeds fromaccommodation and increased investments by the share sales, to restructure public enterprises and fundcommercial banks); (iii) an increase in net foreign voluntary retirements, in order to make divestment easier.exchange assets of the RBI of 22.2% in rupees (which The Commission has also made a number ofreflects some revaluations, gross international reserves recommendations on corporate governance, notably gradedrose about 11% in dollars). increases in autonomy for the remaining pubic enterprises,
depending on their performance. MTNL has been given2.36 Thus, several indicators point to an easing of substantially more autonomy (navratna status). Themonetary policy in 1997-98 compared with 1996-97. Government has also begun to follow up on theM3 growth was slightly higher, even as real GDP Commission's recommendations to include non-official partgrowth has slowed down. Bank lending has also gone time directors, to alter MOUs to allow easier evaluation ofup substantially (para 2.38). Nominal interest rates performance, and grant more autonomy in investments.(except call money rates, see below) declined by to However, the Government has not acted on the
cm ytsa one t Commission's recommnendations to improve stability andfour percentage points compared with corresponding quality of management, introduce perforrnance-basedmonths in 1996-97 (Annex Table 6). Real interest incentives for management, and provide for election ofrates, wiith average annual inflation down 1.9 directors to represent minority shareholders. And, as long aspercentage points, declined somewhat less. The Bank the Government retains over 50% of the capital, the publicRate, which was reactivated in April 1997 as a enterprise and its employees remain subject to the scrutinypolicy instrument, was reduced from 11% in April and legal frarnework as Governnent employees. Thus, in1997 to 9% in October. However, the easing was some sectors, there is increased competition for the publicuneven during the year. In the first half of 1997-98, enterprises, but not much reduction in the constraints theyhigh Government market borrowing kept interest rates face.higher than they otherwise would have been.
2.37 Between November 1997 and January 1998 measures left banks, particularly the new private banksRBI's measures to defend the rupee tightened the and foreign banks, short of resources to meet theirmonetary stance temporarily. The rupee depreciated commitments, and led to a sharp hike in short-term6% vis-a vis the dollar between October 24 and interest rates as well as call money rates (Annex TableNovember 28, 1997 (from 36.2 to 38.5 to the dollar), 6) and a one percentage point increase in lending ratesand again to Rs. 40.4 in January 1998. On January 16, of many banks. The measures had the desired effect,the RBI :Lncreased the Bank rate from 9 to 11%; appreciating the rupee back to Rs. 39.5 to the dollar asincreased ithe cash reserve ratio from 10 to 10.5%, and on April 7, 1998, a depreciation of less than 10% sinceincreased the costs of trade finance (thereby creating July 1997. With the pressures receding, the RBIdisincentives for leads in import payments and lags in partially rolled back its measures on March 18, 1998.repatriating of export proceeds). These unanticipated State Bank of India inmmediately reduced its lending
Chapter 2: Policy Development and Issues 13
rate by half a point. In the busy season credit policy 17.6%. However, about one-third of this increase wasannouncement on April 29, 1998, the Bank Rate was in commercial paper, bonds, debentures, etc. issued byrolled back to 9%. the public and private corporate sectors (which have
grown at 70%). These instruments do not carry any2.38 Commercial banks continue to hold more than priority sector obligations since they are not classifiedrequired in Government securities, reflecting, at least as lending. Also, these instruments are relativelyin part, their risk aversion. In March 1997 (see table highly rated, and thus are another avenue for banks tobelow), the ratio of commercial banks' investment in reduce the overall risk in their portfolios. This meansGovernment and approved securities to deposits :ratio lending/investing moved towards the most highly ratedwas 38% as opposed to the statutory requirement of corporates, and away from the medium and small-scale26.5% (reduced to 25% in October 1997). The firms. Regarding non-bank sources of finance,Government carried out much of its borrowing financial institutions' disbursements are uprequirements for 1997-98 in the first half of the fiscal substantially, over 28%. Mutual funds, capital marketsyear, pushing this ratio up to over 40%. Then, with and foreign investment also increased. However,commercial lending picking up, this ratio fell to 36.2% lending by NBFCs declined, and disbursements ofby the end of March 1998. extemal commercial borrowings were roughly the
same,, although precise data are not available. Thus,2.39 Despite the easier money picture in 1997-98, the the aggregate picture is increased funding to primepattem of the flow of funds to the commercial sector corporate borrowers, a slower increase, if any, for otherwas mixed. The stock of bank credit to the borrowers, and an increasing concentration of fundingcommercial sector grew about 14.3%. Elank of prime corporate/public sector paper, except from theaccommodation to the commercial sector grew by extemal sector.
Table 4: Trends in Commercial Bank Asset to Deposit Ratios (°/e)Mar. '90 Mar. '91 Sept '96 Mar. 96 Mar. 97 Sept '97 Mar '98
Investment ' - deposit ratio 37.2 37.7 38.3 38.0 37.7 40.4 36.2Cash -deposit ratio 16.3 17.6 12.1 12.4 10.5 11.1 10.2Credit -deposit ratio 60.8 60.6 54.3 58.6 55.1 51.4 53.5Effective SLR 28.0 26.5 25.0Note: Data pertains to last reporting Frday of the month1 Investment is in government and approved securibes.Source: Trends & Progress of Banking in India (RBI); RBI Weekly Bulletin
2.40 Prior to 1997-98, mismatches between receipts deposits (Annex Table 6), loans greater than about Rs.and expenditure of the Central Government were met 200,000 (US$5000), and debentures and public sectormainly by issue of ad hoc treasury bills. This was bonds. Rates remain controlled on savings deposits,replaced by the system of agreed upon Ways and small savings, NRI deposits, and loans under Rs.Means Advances that began on April 1, 1997, and has 200,000. Directed credit to the public sector has beencontinued into 1998-99. As the RBI notes, this system reduced: the cash reserve requirement has beenhelps prevent unplanned creation of money and gives a reduced from 15% in 1990-91 to the 10% rangetruer picture of the Government's credit requirement currently and the statutory liquidity requirement, whichfrom the market. It therefore gives more autonomy to requires banks to invest in public sector paper, hasthe RBI. However, if fiscal policy is loose, and the been reduced from 38.5% of deposits in 1990-91 toagreed-upon ceilings for Ways and Means advarLces 25% in 1997-98. The April 1998 credit policyare adhered to, then the upward pressure on interest continued these reforms by permitting banks to freelyrates will increase. set rates on loans under Rs. 200,000 up to a maximum
equal to the prime lending rate, by reducing the2.41 Financial Sector Liberalization :nd minimum maturity of term deposits to 15 days, and byStrengthening. India has a large deposit base and allowing banks to set different rates for the same typelarge equity and bond markets for a country of its per of deposit and appropriate penalty rates on prematurecapita income (WB 1995a, IFC). Since the early 1990s withdrawal of term deposits. The announcement alsoIndia has gradually liberalized its fnancial system to raised the maximum rate on NRI foreign currencysupport more rapid, private sector-led development. deposits over one year by 0.5 percentage points andBank interest rates have been gradually freed on term
14 Chapter 2: Policy Developments and Issues
lowered the rate on shorter deposits by 0.25 percentage banks had reached the 8% capital adequacy standard,points. up from 19 in 1995-96. However, this reflects
substantial injections of government funds, Rs. 272.42 New entrants (quasi-private, private, and foreign), billion in 1997-98 (0.2% of GDP), following Rs. 23.6have been allowed into the banking system and capital billion in 1995-96 and 1996-97 and Rs. 110 billionmarket. This entry, along with eased restrictions on between 1993-94 and 1994-95.17borrowers' switching banks, has increased competitionin lending and tended to reduce spreads (mostly in the 2.45 Since the early 1990s, the capital market has alsoprivate banks, public banks spreads remained roughly been strengthened. A regulatory agency, SEBI, hasconstant, see RBI, Report on Trend and Progress of been set up and has been taking an increasingly activeBanking in India, 1996-97). Private banks account for role. A share depository system has been set up toabout 17% of bank assets, up from 11.5% in 1991-92. improve the efficiency and security of transactions.Finally capital account restrictions have been eased, Transactions costs are now about the same as inallowing Indian public and private firms to raise funds developed country markets. However, new issues haveoffshore and foreigners to invest in the capital market, languished after an initial burst of activity, reflectingincluding government debt since October 1997. weak information on them and inefficient approaches
to their initial pricing (Shah and Thomas). Much of the2.43 The growth of NBFCs in the mid 1990s provided post-1993-94 activity in the stock market reflectedtypes of lending outside the normal purview of banks, foreign investors.although their expansion also reflected easier reserveand prudential requirements than applied to the banks. 2.46 Slowine Trade Reform. Slowing Exports. InIn 1997-98, the NBFCs' over-expansion was slowed 1997-98, India's export growth continued to slow, asby a few well-publicized failures. As a result, the RBI noted above. Moreover, for the first time since 1991,appropriately tightened prudential and capital adequacy India's dollar export growth in 1997 was lower thanregulations for NBFCs, enhanced its regulatory powers world trade. The 1997 decline in market share was inover NBFCs and, appropriately, refused to provide ex- contrast to 1992-1996 when India's exports grew fasterpost deposit insurance for the bankrupt NBFCs' than world trade every year and slightly faster thandepositors. The slowdown in NBFCs reduced growth Southeast Asia's-averaging 13.5% p.a. compared toof finance for consumer durables and construction, two 12.5% p.a. for Southeast Asia. Despite the slowof their main areas of lending. growth of world markets for the products that India
exports and the intense competition in these markets,2.44 The financial system has also been strengthened. India was able to increase its share of world trade fromIn 1992 banking regulations were tightened on income 1992-96 (Annex Table 7).18recognition, definition of non-performing assets,provisioning and capital, to more closely conform with 2.47 Important factors in this export performance wereinternational norms.15 Initially this led to a large the reductions in protection and the real exchange rate.percentage of many public banks' loans being recorded Figure 4 shows that rapid growth of exports wasas non-performing assets. By 1995-96, public banks accompanied by a sharp fall in average tariffs fromhad reduced gross non-performing assets to about 7% 128% in 1990-91 to about 34% in 1997-98 (Annexof total assets, where it remained in 1996-97. Net of Table 10).19 Also, there has been a significant declineprovisions, non-performing assets are about 4% of total in non-tariff barriers to imports, whose coverage ofassets.'6 However, these low figures reflect the banks' imports declined by 30-35 percentage points since thestill-large holdings of public debt; gross non- economic reforms began (Annex Table 8).20 As isperforming assets are 17.8% of total advances, a figure well known, high protection of imports in effect taxesthat has remained roughly constant over the last two exports, by raising the cost of scarce resources and theyears. As in all countries, these figures do not reflect price of imported inputs to exporters (relative to thebanks' reschedulings, which often reduce the cash flow prices they receive). Reduction of protection raisesas well as the present value of the debt. Moreover, the exports and imports, given prudent management ofnon-transparent accounting of many Indian companies demand and the exchange rate. To put it another way,make it difficult for the banks and the public to get an rapid export growth requires low protection and rapidaccurate pictures of their status. In March 1998, the import growth as well, so that more of the scarceRBI relaxed the classification norms for agricultureloans made by banks for the fiscal year 1997-98, whichwill impart an artificial improvement to the figures fornon-performing assets. In 1996-97, 25 of 27 public
Chapter 2: Policy Development and Issues 15
Figure 4: India's Share in World Trade Rose when Tariffs Fefl0.65
tariff cuts on exports until 1995, the REERappreciation meant that it worked against exports
factors of production will shift out of import competing thereafter.industries and into exporting (since these factors canproduce more output, valued at world prices, inexporting industries than in import-competingindustries, such a shift raises national output). 2.49 However, the pace of tariff reduction slowed afterThisclose relation between export and import growth 1995-96 and reversed beginning in September 1997shows up across countries (Figure 5), as well as in (Annex Table 10). In September 1997, tariffs on allIndia recently. products but oil were increased 3 percentage points.
Then the 1998 budget imposed a special additional2.48 The real effective exchange rate (REER) duty of 4 percentage points on most imports exceptdepreciated between in 1991 and again in 1995 (41% crude oil, newsprint, trading goods, etc (the averagedepreciation between 1990 and 1995, IMF data, Amnex increase is about 5 percentage points since duty isTable 9). However, it has appreciated thereafter. The levied on c.i.f. cost plus existing duties, (see para.appreciation would be even higher if competing 3.19). Even before the recent reversal, Indian tariffscountry weights, rather then trade weights, were used were among the highest in the world. Similarly,in the calculation of the REER, as implied by the despite the reforns, about 63% of import lines werebilateral exchange rates with India's competitors. covered by non-tariff barriers of one kind or another,Thus, while exchange rate movements (including according to UNCTAD, higher than almost allpossible lagged effects) reinforced the effects of the comparable countries.
16 Chapter 2: Policy Developments and Issues
Figure 5: Exports Grew Rapidly In Countries Where Imports Also Grew Rapidly(1965-94) (Countries over 20 million)
3.1 Introduction. Poverty reduction depends on reducing demands for funds and creating room andrapid growth and basic human development, incentives for faster private sector growth. Deficitaccording to a wide range of international and reduction also would reduce the risks of inflation,national studies (see for example WB 1993, 19971)). and increased external borrowing, with theirIn turn, rapid growth and poverty reduction seem to associated risk of macroeconomic instability, anddepend on macroeconomic stability, investment in reduce pressures for reversing financial reforms.infrastructure, and an incentive framework thatsupports rapid, efficient and internationally 3.3 A simultaneous realignment of India's publiccompetitive growth, especially in agriculture. sector would increase the benefits of deficitReducing the Government deficit is a key reduction. Such a realignmelnt would entailmacroeconomic element in improving India's growth concentrating scarce public financial andand reducing poverty. But, more than deficit administrative resources on core public sectorreduction is needed. Another important factor will be activities, such as mass primary education and health,Government realignment--leaving more to thle rural roads, urban infrastructure, and regulation. Itprivate sector, especially where external and internal would require improving service delivery in thosecompetition in effect provide a sound regulatory areas by acting more as a business, responsive toframework, and focusing on areas where private users and charging user fees that reflect costs. Such ainterest is low and the public sector has a clear role, realignment would correspondingly entail devolutionfor example basic human developmenit. to the private sector of many of the public sector'sInfrastructure improvement is another major current activities that the private sector can do moreelement in growth, and will also help reduce poverty effectively--in particular, areas where competition(WB 1997b). Here, realignment of government and ensures that the private sector will performreduction of (non-merit) subsidy will play a major effectively, such as most directly productiverole. In addition, regulatory reforms are needed to activities where internal or external competitionencourage more private sector investment. Mo:re exists, and infrastructure activities such as powergenerally, a more deregulated, competitive, generation. Some of the policies that would improveincentive framework will be needed to encourage both the deficit and the efficiency and equity ofmore efficient use of resources (notably greater government activity, as well as make better use of thedemand for unskilled labor), more investment, and private sector for development are highlighted inappropriate technology improvements. External and paras. 3.4-3.9.internal deregulation hold the key here. One way ofjudging the success of deregulation is whether 3.4 A reduction in non-merit subsidies, explicitexports again begin to grow faster than world trade. and implicit, would cut the deficit of the Central andFinally, financial sector improvement will support State Governments (including state publicgrowth and poverty reduction by encouraging the enterprises), encourage efficiency, and, in manyallocation of funds to activities with the highest cases, benefit equity. It would also stimulate greaternational productivity, developing domestic sources of private investment, particularly in infrastructure, bylong term funds, and avoiding financial instability improving the regulatory framework. For example:that will hurt the real sector. Specific elements ofthese policies are discussed below. * Raising the currently subsidized power tariffs at
the state level (and adjusting tariff schedules to price3.2 Reducing the Deficit. Realigning by the kilowatt hour rather than a flat rate, and toGovernment. Deficit reduction would accelerale vary by peak load), along with establishment ofgrowth by crowding-in private sector investment-- independent regulatory commissions (see para 3.12)
18 Chapter 3: Policies to Reduce Poverty, Raise Growth
and pnrvatizing distribution, would improve underwriting services through competitive bidding.collections as well as power delivery, raise capital However, widespread dispersion of equity sharesutilization and reduce over-pumping from aquifers. may provide management improvement only slowly.Solvent power distributors and more politically Divestiture to a strategic partner may yield greaterindependent tariff setting will stimulate private benefits over the long run. But such divestiture stillinvestmeint in power generation. Improved needs to be done under well-specified, competitivedistribution and availability of power supplies in conditions in order to ensure tranparency andrural areas would have significant positive effects on maximum benefits to the country. In addition, aagricultwual growth and rural employment sound sectoral regulatory framework, which at leastopportunities, to the benefit of farmers and the rural "mimics competition", is needed to ensure low pricespoor. and technological upgradation by private producers.
In this context, implementation of the June 1998* Turning canal irrigation over to water user Budget Speech announcement that "in the generalityassociations of farmers, industrial and urban users, to of cases, the government shareholding will becollect fees for O&M and water use. This would brought down to 26 percent", and its proposal forreduce tle drain on state governments, improve more generous severance packages would have aquality of water delivery and improve equity, since positive impact on privatization (see also Box 1 andsubsidized irrigation benefits mainly the better-off paras. 2.31-2.33).farmers. Water use would eventually need to bemanaged and priced by water basin authorities. 3.7 Further tax reforms would help cut the
deficit, while adding to the efficiency and equity of* Raising fees on secondary and higher education, the revenue system. Income tax collections could beand providing a system of scholarships for low raised by as much as 0.5 percentage points of GDP,income students, would cut the deficit and improve while improving the equity of the system, throughthe equity of education spending. continuation of the efforts to double the number of
contributors based on outward signs of wealth,* Increasing road taxes on gasoline and diesel to tougher treatment of perquisites and fringe benefits,fund maintenance and new construction of public better collection of taxes on interest (either throughroads, as has been widely recommended, would flmd use of banks' computer records or a minimumthe road construction that India needs without a drain withholding rate), continued improvement inon the budget. administration based on better use of penalties,
further computerization, and strengthening of the* Phasing out the fertilizer subsidy and eliminating contributor identification numbering system.the Retention Price Scheme and moving toward Corporate tax collections could also be increased bymarket- based gas pricing would cut the deficit and limiting business expense deductions, freezing newreduce the distortions in fertilizer consumption while tax concessions and, where possible, removing thehelping thLe environment (see Box 4). numerous existing incentives that have complicated
tax compliance and administration and created an
3.5 A speed-up in privatization would impenetrable maze of effective tax rates. Sinceincrease efficiency and raise revenues, reduce the previous concessions may not disappear for manypublic sector deficits and help realign Government years, the use of the minimum altemative tax willto contribute to faster growth. But these benefits are remain important. One option, used in Mexico wherenot automatic. They will depend on Government's it raised substantial revenues, would be to switch thecareful atention to divestiture procedures, the market base of such a tax from book profits to assets (atstructure facing the privatized entities and replacement cost values). MODVAT could becompetition andcregulatoryipolicies. further strengthened by extending the tax base to
services. In addiltion to raising revenue, these tax3 '6 The benefits from the divestiture are measures would improve equity, help level themaxi*ized by a competitive, transparent sale. .Tis playing field across tax payers, and perhaps evenmaximizes the price for the asset. Lengthy permit cuts in rates.negotiations and changes in the terms of the deal,unsolicited bids, and non-competitive sales should beeschewed., since these create non-transparency andreduce the benefits to the country. These problemsare avoided in competitive sales of shares throughequity mnaurkets--the main issue is securing effective
Chapter 3: Policies to Reduce Poverty, Raise Growth 19
3.8 Customs revenues could well increase telecommunications, electricity, transport and waterfrom their current level as quantitative restrictions are supply, would make a major contribution to growthremoved. India already depends heavily on customs and has been a major focus of Indian economicrevenues, and attempts to raise still more customs policy since 1991. However, although manyrevenue by raising tariffs would have negative contracts have been awarded, relatively few dealsefficiency and equity consequences (see below). have reached financial closure. As a result the privateIndeed, it would be desirable to move from tariffs to sector has not thus far made a substantial contributionexcise taxes on many luxury items to improve to expanding service coverage and quality. Improvedproductive efficiency. This switch would be sectoral regulatory frameworks and independent andfacilitated from the Central Budgetary standpoint by empowered regulatory authorities would stimulatethe agreement (not yet approved in Parliament) to efficient private sector participation.devolve to the states a constant percentage of allcentrally collected taxes. 3.11 Telecommunications has seen the most private
sector participation. Private cellular operators in the3.9 At the state and municipal level, fiscal four major urban centers now have around 500,000sustainability, efficiency and equity suggest a need to consumers. In addition, one basic service operatortax agricultural income and property. Taxation of has commenced operations in Madhya Pradesh, inagricultural income consistently with non-agricultural competition with the Department ofincome might be facilitated by states ceding taxation Telecommunications (DoT). Financial closure hasrights back to the Central Government. A national been harder to achieve for the other basic serviceproperty tax system, again for reasons of consistency, licence holders, partly because of slow progress onis an option (Chile uses such a national wealth lax issues such as the assignability of licenses so thatwith redistributive features favoring poor areas). lenders have more security in the event of a defaultHowever, keeping property taxes with sub-national by borrowers, and in some cases, can shift back andgovernment also has some advantages, notably forth, before and after boxes, the high level of licencelinking them more closely to services provided payments that these operators bid to win the licence(Bagchi). The other sub-national tax issues are to auction. A more fundamental problem is the delay inremove the disincentives to international and transforming DoT into a policy maker rather than ainterstate trade and to reduce the administrative and service provider and a regulator. DoT and the sectorcompliance burden associated with operating state regulator, TRAI, are embroiled in court disputessales taxes and MODVAT separately. Over the relating to who decides what. The service provisionmedium term, the reform agenda would involve function of DoT itself needs to be corporatized toconvergence to a system of dual VATs w:ith remove DoT's conflict of interest. A by-product ofharmonization of commodity classification and this conflict is that private operators complain thatuniform rules for tax treatment of interstate trade. the rules of the game--entry of the public operatorsExperience in Canada suggest such a system is MTNL and VSNL into their markets, less onerousfeasible. Many Indian states have experimented w]ith license conditions for these two companies and theVAT-like additions to the manufacturer's sales tax. lack of an efficient interconnection regime--areBut only in Maharashtra have the reforms been hampering their progress.comprehensive enough to approach a full-fledgedVAT and to capture the potential benefits of VAT. 3.12 In the power sector, progress in reachingDespite a drop in revenue growth in the VAT fnancial closure for IPPs has been very slow.implementation year (1995-96), Maharashra has Although the Central Electricity Authority haspersevered and plans to bring its VAT into provided in-principle clearance to 38000 MW, onlyconformity with a full-fledged VAT through the 5000 MW have reached financial closure. Resolutionretail stage within a few years. The chief lesson of of some issues, such as the establishment of escrowthe Maharashtra experience is that VAT can take root accounts may bring some more projects to financialon Indian soil and achieve a high degree of closure. However, independent estimates suggest thatacceptance from taxpayers despite many obstacles. the country as a whole only has about 8000 MW ofA second lesson is that state level VAT is more likely escrowable capacity. More fundamentally, it is hardto be successful with a simplified rate structure of no to see how the sector could financially support manymore than 2 to 3 non-zero rates. more IPPs, costing upwards of US 5-6 cents per
kWh, until higher tariffs and collection rates and a3.10 Developments in Private Participation reduction in system losses are imnplemented in thein Infrastructure. Improving basic infrastructure distribution sector. This will depend on fundamentalservices through private sector participation in sector reform, which will include establishing an
20 Chapter 3: Policies to Reduce Poverty, Raise Growth
independent regulator and privatizing distribution. payment, financed by National Highway Authority ofOrissa is on schedule to achieve privatization of its India (NHAI) funds. State governments aredistribution sector by March 1999, and other states developing road investments on a BOT basis,such as Haryana are following the same path. Only including two projects for widening to 4-lane intwo of tlhe larger states (Haryana and Orissa) have set Gujarat and an expressway and several flyovers inagricultural tariffs close to or at the levels prescribed Maharashtra.in the Common Minimum Action Plan for Power(which is itself far less than the cost of generation). 3.15 Even so, limited traffic volumes mean that theThe incoming Government has announced plans to bulk of the road network will require public funding.streamline the concession approvals procedure, This could be financed partly by an ad valorem levydelegating more authority to the States to clear on petrol and diesel dedicated to an independentprojects. However, decisions on fuel and Road Fund along with other user charges. Thetransmission linkages, which are also serious Government in June 1998 announced a rupee 1/literobstacles, will clearly still be made at the central levy on petrol, with the estimated revenue of Rs. 8level. A 1998 Bill provides some impetus to the billion per year to be deposited directly with NHAIreform efforts by (i) providing for the formation of a for the development of national highways.quasi-judicial Central Electricity RegulationCommission; (ii) encouraging states to establish State 3.16 In ports, the Government has also announcedElectricity Regulation Commissions, which would be policy initiatives to attract private finance (in Octoberthe nodal agencies for all tariff-related matters; and 1996) and airports (in December 1997). Several(iii) requiring states to explicitly provide for the sections of Indian Port Act of 1908 and Major Portlosses incurred by SEBs as a result of subsidized Trust Act of 1963 already permit private sectortariffs, but not limniting subsidies as originally intervention in port operations. However, theproposed. Government is revising these acts to increase private
interest. A tariff authority for major ports has been3.13 Similar problems affect the water sector. established to regulate port tariffs independentlyAverage tariff levels are low and losses (both from the port trust. Because of its limited area ofphysical and commercial) are high, meaning that authority, however, it cannot be regarded as a totallyutilities will have trouble paying for privately- independent regulator. One US$200 million projectfinanced schemes. Some bulk supply and treatment at a major port (container berth at JNPT) wasprojects may reach financial closure, driven by awarded to an Australian-Malaysian consortium inrevenues from large industrial consumers. However, 1997, and two at minor ports in Gujarat (Pipavav,this sector will need to embark on the sort of reforms commissioned in 1997, and Mundra) were contractedthat are now being undertaken in the power sector to to the private sector (Ahluwalia, p. 114). In addition,attract more private funds. several ports and jetties are under construction or
operation by major users for their own use.3.14 In the roads sector, private finance is beingsought for the development of bridges, bypasses, and 3.17 In civil aviation, despite the announcement of awidening of state and national highways. The policy to attract investment in airport operation, onlyGovernment has announced a package of financial one airport project at Cochin (Cochin Internationalincentives and taken some major policy decisions to Airport Ltd.) has come up and the proposed Tata-encourage private sector participation. These are i) Raytheon project is still struggling. The Governmentmodification of National Highway Act of 1956 to is allowing foreign investments, except those withcharge public and private entities to allow tolls on foreign airline equity, in domestic air services, as partnational highways; ii) amendment of the procedures of a policy introduced 5 years back. Private airlinesfor land acquisition for national highways; and, iii) now account for 40% of domestic traffic. In Junedeveloping a Model Concession agreement for 1998, the Government announced plans to reduce itshighway projects. So far, the Government has equity in Indian Airlines to 49% over three years.awarded contracts for the development of private Reforms are still needed which split up the policy,investment worth Rs. 6 billion, mainly for bypasses regulatory and service provision functions.and bridges on a BOT basis. The Government hasrecently introduced tolls on a section of NH 8 after 3.18 Increasine Growth. Reducing Povertywidening it to 4-lanes. It is considering through External and Internal Deregulation.concessioning four-laning to the private sector, with Increasing growth and reducing poverty will dependcost recovery either from tolls or on a design-build- on more efficiency in the use of India's resources,finance-operate (DBFO) option with annuity more and better allocation of investment in both
Chapter 3: Policies to Reduce Poverty, Raise Growth 21
human and physical capital, and appropriate of produced inputs that exporters need. For example,improvements in technology. Reduction of the the competitiveness of Indian software might havedeficit and realigmnent of goverrnent will help. A been enhanced, had computer hardware beenlower deficit, lower subsidies, tax reform, a better available at international prices. In addition,infrastructure framework, and greater reliance on the impediments to imports allow producers of importprivate sector will encourage private investmtent, substitutes to avoid competition and thereby reduceraise efficiency at the firm level, reduce thte the incentives to adopt new technology and upgrademisallocation of resources that is now encouraged by product quality. This is particularly true for NTBs,subsidies, and permit the Government to increase ard which place no limit on the inefficiency of theimprove public investment in physical and social producer or product quality, relative to the worldinfrastructure where private interest is low. But market. Also, since neighboring countries such asadditional gains could be realized by improving the Bangladesh, Sri Lanka and Nepal allow imports ofefficiency of the private sector. most goods subject to NTBs in India, Indian NTBs
encourage smuggling and impede more effective3.19 Reduction of the still-high barriers to trade, economic integration with South Asian neighborsinternal and external, would encourage more efficient (Acharya). Finally, impediments to importsuse of the nation's resources and appropriate encourage management to spend time lobbying fortechnology improvements--cuts in costs and prices protection, rather than cutting costs, and reward goodand improvements in products. The current lobbyists, not good cost cutters and good productimpediments to trade, international and domesti-, innovators.reduce output. They divert scarce capital, labor, landand management away from efficient uses, such asexports. For example, because of tariffs, on average,land, labor and capital (value-added) in secondaiyindustry can be about 43% less efficient than inexport production (on exports, effective protection iszero because "border" prices of exports are the sarneas world prices, or even negative, if inputs cost morethan world prices.21 While there is considerable tariffredundancy for a whole range of products, thepervasive presence of non-tariff barriers (NTBs, seeAnnex Table 8) means there is potentially unlimitedprotection against imports for the products covered.The impediments to imports and exports divertexcessive resources to import substitutes, by raisin.goutput prices and hence demand for resources inimport substitutes and by reducing output prices anddemand for resources in exporting industries, relativeto free trade.22 At the same time they reduce demandfor resources that are used heavily in India's potentialexports, notably unskilled labor. For these reasons,as long as the NTBs and tariffs that protect import-substituting manufacturing continue at high levels(para 2.47), a significant part of econornic growthwill be be inefficient, occurning in high-costmanufacturing industries at the expense of exportsand other more efficient sectors of the economy, thatare labor-using. For example, resources are divertedaway from agriculture by the combination of barriersto agricultural exports and protection of non-agricultural irnport substitutes, which produces a highdegree of anti-export bias and lower terns of tradefor agriculture than would otherwise be the case.
3.20 Moreover, impediments to imports also hurtexports by raising the cost, and reducing the quality,
22 Chapter 3: Policies to Reduce Poverty, Raise Growth
Box 2: Haryana Power Sector Reforms - Pioneering the Bank's Adaptable Program Lending
Haryana was plagued by increasing system losses, power shortages and operational inefficiencies, and represented a hugedrain on the state treasury (World Bank 1996). To resolve these problems, Haryana decided to reform its power sectorcomprehensively (World Bank 1997a). The state assembly, in July 1997, approved the Haryana Electricity Reform Billwhich lays down the legal basis to establish an independent regulatory commission and to unbundle HSEB to agenerating company, a transmission company and a number of distribution companies before end-1998. Distribution isexpect:ed to be fully privatized by 2002. These measures will also be accompanied by tariff adjustments, comprehensivefinancial restructuring, and the implementation of a large investment program (about US$ 1.8 billion spread over tenyears) that includes transmission and distribution rehabilitation and expansion, generation plant modernization, demandside mianagement and end-use energy efficiency improvement.
The VWorld Bank has agreed to support Haryana's efforts to the extent of US$ 600 million over a period of 8 to 10 years,through a series of Adaptable Program Loans (APL), a new lending instrument approved by September 1997. The newinstrument involves a series of loans through which the Bank provides phased and sustained support for a borrower'slong-term reform program. On January 15, 1998, an initial APL of US$ 60 million was approved to finance criticallyneeded investments, enhance the credibility of Haryana's reform agenda and demonstrate that "something is happening inthe power sector". Subsequent APLs will be processed as Haryana meets the milestones in its reform agenda, based onprogress in implementing the investment program and the financing requirements. The APL approach has allowed theBank to start its support to Haryana at an early stage of the reform process and to express a long-term commitment tosupport reforms. The Haryana Program approach will provide much more flexibility to adapt the Bank's assistance toevolving conditions. UK-DFID and USAID have decided to provide technical assistance for the reform program, andseveral other aid agencies such as OECF, KfW and CIDA (Canada) also have expressed interest. A financially sounddistribution system is expected to attract more private generation.
Impact of the Power Sector on State FlnancesFow of Funds from Power Sector to State Govemment (Rs. nmillion)
The fiscal gains will be large. Haryana has provided more than Rs. 40 billion (US$ I billion) through direct and indirectsubsidlies to the power sector over the past eight years. In the absence of reforms, the power sector would continue to bea drain on the state, and subsidies, which in the past represented about 2.4% of GSDP and about 70% of the state's fiscaldeficit, which would increase to much higher levels. Upon successful implementation of the first phases of the reformprogram, by FY 2002-03, the sector will no longer need any subsidies from the state government and instead willcontrilbute, on average, US$ 50-60 million annually to the state treasury.
Chapter 3: Policies to Reduce Poverty, Raise Growth 23
Box 3: Legal and Procedural Reform is Lagging
The legal system must ensure property rights and provide an adequate structure of incentives and deterrents for amarket-based economy to function (WB 1997c). India has a vast and highly sophisticated legal system, unique in thedeveloping world, that addresses many of these issues. However, some important constraints remain that need to beaddressed to complement deregulation and encourage private investment.
Perhaps the most important issue remains the delays in resolution of cases. There are an estimated 25 millioncases pending in various courts. On average it can take up to twenty years for a case to be resolved. This does notmake the redressal mechanism credible and creates uncertainty about economic rights. The net addition of suits isabout 8 percent per annum. Owing to pervasive Govemment intervention and micro-level regulation, but within anAnglo-Saxon legal framework of protecting individual choices, the Government became a party to as much as 65percent of civil cases (from a sample survey in Karnataka). While economic deregulation should, over time, reducesome of the origins of the litigation, it needs to accompanied by several conscious steps: a) Much of Govemmentlitigation is in the form of appeals against lower court judgments (95 percent of which failed in the Kamataka survey).The decision to appeal is taken at the lowest level of Govemment decision making, but a decision not to appeal has tobe taken at the top. Reversal of this procedure would reduce the number of appeals. b) Disputes between different armsof the Govermment including public sector units could be settled outside the courts. c) Improvement in other disputeresolution mechanisms such as conciliation, mediation and arbitration that would reduce the demand for adjudication.d) Wide-ranging amendments in the Code of Civil fProcedure to speed up the disposal of cases (a Bill to amend whichwas pending before the now dissolved Parliament). e) Better training of personnel and computerization of courts,which has already contributed to reducing considerably the backlog in the Supreme Court.
The other looming issue is the very slow pace of reform in laws which have a major impact on economicdecision making. Some consequences are: One, slowing down of industrial and corporate restructuring, owing todelays, and inefficiencies in relevant company law. Liquidation of corporations can take upto 20 years. Resolution oflabor disputes can also take up to 20 years. Ambiguities and uncertainties exist about rights of both employer andemployee. In this situation, ex-ante incentives are biased towards less job creation than would otherwise be the case.Two, contrary to Govemment intentions as demonstrated in SSI reservation and other policies, small businessdevelopment is constrained by excessive regulatory burdens and disclosure requirements. About 80 percent thereforeoperate without incorporating. Three, regulations and procedures often leave room for subjective interpretations anddiscretion at a low level, and sometimes result in harassment and corruption, such as in the exercise of laws relating tolabor, land and real estate, environmental clearances, and taxes. Most of these laws apply at the State rather than at theCentral level.
Some of the above concems were reflected in the legislation pending in Parliament. At the time of dissolution ofthe Lok Sabha, 15 bills were pending before the L.ok Sabha (including those relating to sick companies, electricitylaws and electricity regulatory commissions, essential commodities), 12 before the Rajya Sabha (including lawsrelating to the code of civil procedure, and the Companies Bill), and 23 new bills (such as Insurance RegulatoryAuthority, Biodiversity, Plant Variety Protection, Foreign Exchange Management) were waiting to be introduced.None of this includes the subject of law reform at the state level, which is a vast area in its own right and is currentlylagging behind the Center's reform initiatives, will ithus need to be stepped up. The new Govemment has indicated itsinterest in a new Companies Act and a new Foreign Exchange Management Act, as well as reducing "red tape".
Source: Gopal (1996) and Debroy (1998).
3.21 Clearly India's first phase of reduction in most-favored nation basis) with a few countries suchprotection has yielded substantial benefits, as as the EU, Canada, Australia, Japan mean that Indiadiscussed in chapter 2. Ways to reap further benefits has begun to phase out all QRs as per a six yearfrom the world economy would involve: program, by March 2003. This is a welcome
development, and a clearer (domestic) public* Reducing the still-high coverage of NTBs toy announcement of this policy as soon as possiblemoving products to Special Import License (SU.) would give better signals for investment. In order tocategory. Recent bilateral agreements (applied on a speed up the benefits of this liberalization, India
24 Chapter 3: Policies to Reduce Poverty, Raise Growth
could phase in all or most products into SIL much these barriers affect agriculture, and have keptearlier thtan 2003 (imports would not explode because agricultural prices below world prices, an effect thatof tariffs as well as the cost of SIL licenses). has been only partially offset by subsidies to inputs.Switchin.g to tariff-based protection would limit the Moreover the canalization of exports (and imports)degree of inefficiency and force producers to has contributed to an inefficient distribution network.innovate and improve product quality, which could Well-known problems with bureaucratic proceduresfeed back into an export stimulus. This would also and red tape continue to be a serious deterrent toallow the Government to capture some of the benefits exporters.30
of protection that now go to producers, in terms ofincreased revenue. * Reduced limitations on foreign direct
investment. Limitations such as case-by-case* Reducing the still-high level of tariff by approvals and preference for "core" FDI havetopping down the maximum tariff. This would reduced the access of India's exports to globalreduce both the average tariff and the dispersion of production networks. Examples are electronics andtariffs, including India's current "cascading" tariffs auto parts, which were a major factor in Asia'sthat supports "downstream" industries at the cost of growth (except Korea). FDI brings not only capitalmore efficient producers.25 The eventual aim should and know-how, but also links to global markets.be a low, uniform tariff such as Chile's 11%. A low, Even FDI in so-called low priority areas, such asuniform tariff would not only reduce the consumer goods brings benefits to the economy.discrimination against exporters, it would level the Even "potato chips" create employment, stimulateplaying field among producers of import demand for upgraded agriculture, and benefit the
26substitutes. Inefficient producers would not be processing and packaging industry (in its infancy inprotected, and their inefficiencies (higher-than-world India). An environment of low and uniform tariffsprices) would not be passed on to other producers or and no QRs would maximize the benefit from FDI,consumers. Even small differences in tariffs can and avoid incentives for setting up inefficientprovide substantial benefits to inefficient producers. operations. Moreover, easing of infrastructureOther benefits of a uniform tariff are ease of constraints is particularly important for export-administration, ease of interpreting the protective oriented FDI that is concemed with costcontent of the tariff structure (resource use in all competitiveness (Srinivasan).industries would enjoy the same protectionagainst imports),2 7 and reduction of lobbying for 3.22 Although the June 1998 budget speech didprotection. promise action to reduce red tape its tariff proposals,
alongwith the previous Government's increase of* Preannouncing a schedule of topping down three percentage points in tariffs in September 1997,tariffs. ]Preannouncement of tariff cuts, as was done reversed some of the progress that had been madein Chile and Indonesia, gives producers more along lines suggested in para 3.21. The budgetcertainty in their investment decisions. In India's announced an increase of 8 percent in specialcase, the Chelliah Committee's recommendations additional duties for all imports except crude oil,signalled the general direction and target tariff rates goods intended for trading, inputs for exports,for the first phase of tariff reform (not the exact tariff fertilizer, coal and power projects, etc., in order toschedules as for Chile and Indonesia). But there has "level the playing field" for domestic industry (whichbeen no similar articulation of a strategy for the next on average is a:lready protected by amongst thephase. Uncertainty about the direction of policy, or highest tariff and non-tariff barriers in the world).3 'even the period over which a policy will be This rate was later reduced to 4 percent in response toimplemented, can lead producers to delay investment widespread protests, including by industries whichand to lobby for delays in tariff cuts on particular used imported inputs. This special additional dutyitems (see para 3.20). In contrast, a preannounced will be levied on a base that includes existing dutiesschedule puts the burden on an individual producer to including the existing special duty, implying anshow reasons for preferential treatment. Also, by actual increase of 5-7 percentage points on the valuedoing this, India will be making a statement that its of imports. As a result of the budget, the averagepost-Uruguay Round tariff bindings, which have tariff has increased from 34.4 in October 1997 tobeen bound at an average of 42.2 percent, are just an 40.2 percent in June 1998, and the import-weighted
32upper bound.29 tariff from 25.4 to 29.7 percent. This tariff increasereverses the direction of tariff reform and reinforces
Removing non-tariff and procedural barriers the anti-export bias, will create uncertainty and delayto exports would also improve efficiency. Many of in investments (para 3.19), and confer extra
Chapter 3: Policies to Reduce Poverty, Raise Growth 25
rents on existing producers. Its partial reversal also . Increasing flexibility in resource deploymentmakes the Government more susceptible to pressure and corporate restructuring. Amendments to theby interest groups. labor and company law (Box 3), and the Sick
Industrial Companies (Special Provisions) Act;3.23 There are several other problems with the elimninating reservation for small-scale industry (Boxspecial additional duty. One, the computation of the 5); and easing land-use regulations (the repeal of theduty itself is not straight forward. Two, by Urban Land Ceiling Regulation Act, as proposed inintroducing many classes of new exemptions, it also the 1998 budget speech would help reduce urbangoes against the avowed objective of reducing sprawl and cut the high prices of urban land) wouldexemptions. Three, it creates artifical incentives for reduce delays, corruption, lobbying, rent-seeking andmanufacturers and others to set up trading compani~es inefficiency.to avoid the levy. Four, it creates more room forcorruption by introducing fresh classification issues. 3.25 Reforming the Financial Sector. TheTransaction costs for importers and exporters will financial sector's effectiveness in supporting rapidincrease. On the whole, its complexity goes against growth, providing resources to the private sector andthe spirit of simplification and reduction in limiting the risk of macroeconomic instability willdiscretionary decision-making, which militates depend on reforms in six key areas: reducing theagainst exports as much as the increase in duties. public sector deficit, managing links to the externalMoreover, owing to exemptions and the incentives to capital markets, strengthening the financial systemavoid the levy, even the objective of providing a through incentives and institutions that will improvelevel playing field will be diluted.3 3 credit management, dealing with priority sector
lending, developing the long-term capital market3.24 Increasing the efficiency of resource use also further through prudent introduction of a fully-involves broadening and deepening domestic funded pensions system, and improving quality ofreforms. Among the most important are: financial services.
* Increase agricultural growth, which is a key 3.26 Reducing the consolidated public sectorto combating poverty. The agricultural econoray deficit will be critical to reducing the crowding outfaces a complex maze of (explicit and implicit) taxes of private sector funding and continued financialand subsidies. The net result is that there is still an reforms (paras. 2.16-2.17). Indeed, the publicanti-agriculture bias inspite of a decline in this over sector's rising interest costs could lead to reversal ofthe years. Increasing agricultural growth would financial reforms, as the Government seeks to makerequire a comprehensive program as outlined in Box more room for non-interest spending. Or it could4. lead to increased public offshore borrowing or, very
unlikely, inflationary finance. The risks of such* Reductions in restrictions on interstate developments occurring, though small, add to the riskmovements of goods, notably limits on movements premia on savings and investment, which in turn addsof agricultural goods, differential sales taxes, and the to the cost of private sector funds in India.octroi (which could be replaced by taxes on propeityand agricultural income). Such limits, like limits oninternational trade, reduce efficiency of resource use.
* Switch to state VAT taxes, from sales taxes, asrecommended above, which would reduce thecascading of taxes that currently deters trade betweenstates (and internationally).
26 Chapter 3: Policies to Reduce Poverty, Raise Growth
Box 4: Getting Agriculture Going
Agricultural growth could be increased through gradual implementation of a comprehensive reform program.The program addresses the web of trade distortions and subsidies that have grown up over time so as to increaseincentives for efficient and sustainable production, while avoiding a deterioration in the real incomes of the poor.Implementing only part of the program is likely to yield less benefits and create new distortions and new lobbies tomaintain them. In broad terms, the program is based on the idea that better infrastructure and support services,together with well-functioning markets, are needed to encourage growth and quickly reduce poverty. This is incontrast to past approaches that kept agricultural prices low while attempting to prornote production growth throughpervasive subsidies, public provision of low-cost inputs and support services. The previous approach did not generaterapid nrral growth and poverty reduction, however, and it proved unsustainable since the steady rise in subsidies andpublic provision of most inputs and support services is increasingly beyond the the fiscal and administrative capacityof the Govemment. The main elements of the proposed program are:
* Eliminate power subsidies to agricultural users, and improve power supply and quality (in many cases farmerspay a flat rate but power is not delivered, so actual payments per Kwh are high; the poor finances of the powercompanies have limited capacity growth and maintenance, leading to growing and acute power shortages that curtailgrowth and employment in rural areas). To make the program more politically palatable and economically viable,some key investments to improve supply and quality should be made first. The gains in productivity will more thancompensate for the increase in power tariffs. Regulatory and pricing measures to avoid depletion of the aquifer andimprove water delivery should be initiated.
* Raise canal water charges to cover for operation and maintenance, and improve water service delivery by tumingcanal irrigation over to users. Water basin management to price and regulate water usage will need to be phased in.Increase canal irrigation where justified economically, taking full account of resettlement and rehabilitation and landcosts.
* Improve technology dissemination services by making them responsive to farmers.
* Improve the access and quality of infrastructure (roads, markets, water supply and sanitation) in rural areas toimprove access to output and input markets.
* Allow agricultural as well as farmgate prices to increase by linking them more closely with world prices byeliminating controls on intemational trade including canalization (import restrictions will be phased out by 2003, seepara 3. 19), and phasing out controls on domestic trade, such as movement and storage controls, and pan-territorial andpan-seasonal pricing for rice and wheat distributed through the TPDS.
* Allow markets to perform better--de-reserve agro-industries (oilseed crushing, garment manufacture) from thesmall-scale industry reservation list eliminate the dual sugar market system and liberalize the sugar industry.
* Improve the targeting of income support measures to the poor through greater decentralization (TPDS,JRY/EAS). Facilitate development of the non-farm economy by gradually devolving untied resources and functionalpowers to the lower tier of the Panchayati Raj Institutions.
* Reduce public procurement to what is needed for the TPDS, and pay market prices. Let those remaining in thePDS buy at market prices and make the TPDS subsidy a fixed, decreasing portion of the price.
* Eliminate the fertilizer retention price scheme (RPS) and phase out the fertilizer subsidy. With rupee depreciation,Indian fertilizer plants have become more competitive and require much less protection; the retention price schemedoes nct provide fertilizer plants with the necessary incentives and flexibiity to adjust to the oil policy changes; thedrop in world fertilizer prices is an opportune time to eliminate the RPS and link ex-factory prices to intemationalprices. The relative pricing of different fertilizers should reflect the desirable NPK ratio (Economic Survey, p. 122,summarizing the recommendations of the Hanumantha Rao Committee).
* Improve roads and ports so that farmers benefit from higher prices and price disparities across regions be reducedby competition.
* Develop futures market for crops to provide a way of hedging risk. (the June 1998 Budget announced thegovemrnent's intention to introduce futures trading in edible oilseeds, oils and cakes).
Chapter 3: Policies to Reduce Poverty, Raise Growth 27
Box 5: Impact of Small Industry Reservation
The Hussain Committee (1997) report states that "...case for reservations is fundamentally flawed and self-contradictory....The policy for reservations has crippled the growth of several industrial sectors, restricted exports andhas done little for the promotion of small-scale industries" (p.1 30).
One impact of reduction in import restrictions would be increased imports in areas reserved for exclusiveproduction by the small-scale sector. While large domestic firms would be barred, large foreign firms would enter andcompete only with small Indian firms, which is both inefficient and inequitable, and would create political pressureagainst reforms. This is already a major issue. The Hussain Committee report showed that of the 836 items reserved forexclusive SSI production in 1996, which mapped on as 1045 tariff lines, as many as 563 or 54 percent were under afree trade regime, which means free competition with all foreign firms.
Other arguments for dereservation include: One, many of the reserved products are star export items. In 1996-97, SSI accounted for over one-third of total Indien exports. Of the 1045 reserved tariff lines above, over 25 percentwere in the category of 'extreme focus' products for exports.34 With no constraints to growth, industries such asgarments, which have been star performers for India, would have done much better. SSI reservation (alongwith laborrigidities) in garments has been found to be a constraint to exports, since small firms cannot deliver large volumes ofconsistent quality.35 Industries such as toys, hand tools, and food processing have also suffered. Two, there issubstantial reservation redundancy: in 1987-88 (tdie date of the last census of SSIs), 22 percent of the items reservedfor SSIs were not being produced at all. Moreover, of the items reserved in 1987-88, only 4 percent accounted for72 percent of total reserved sector output, implying that dereservation of the remaining 96 percent would do littleharm to total reserved sector output. Three, reservation has led to capacity fragmentation, and forced the choice of thescale of production in many cases to suboptimal levels. Four, there may be some 'reservation-jumping' prevalent inIndian joint ventures abroad, which means distorted investment decisions and to the extent that it would not havehappened in the absence of the distortion, negates the purpose of reservation i.e. of increasing employment. A surveyof 61 joint ventures in Nepal showed that 27 percent were producing items reserved in India for SSI.36 Five, in caseswhere a pre-existing large firm produces a reserved item, the policy is to freeze that firm's capacity at the pre-reservation level. This gives the large firm protection from other large firms, and can lead to premium pricing by thelarge firm. 37 Six, there is no strong evidence tco believe that reservation has indeed helped to increase aggregateemployment or output.
While the steps taken so far are in the right direction (increasing the limit on small-scale investment to Rs. 30million in December 1997, and generalizing the exemption from SSI reservation if 50 percent of output is exported), itwould be a good idea to implement the Hussaini Committee's recommendations for complete dereservation whileproviding transitional support arrangements to tbie affected units.38 On the other hand, if the approach of phaseddereservation is favored, then the simplest and most compelling approach would be to invoke the level playing fieldargument. This means first dereserving the 563 items (in the 1997 listing) which are subject to import competition, aswell as the redundant items, followed by a matching of the QR phase-out schedule with dereservation of correspondingSSI items. In this context, the 1998 budget announced a dereservation of about 10 items in the farm implements andtools category with a view to helping farmers. However, the reported intention of the Government to rejectcomprehensive dereservation and reduce the invesiment limit from Rs 30 million to Rs 10 million would go against thespirit of liberalization and hamper Indian firms from competing efficiently with foreign firms.
28 Chapter 3: Policies to Reduce Poverty, Raise Growth
3.27 Mlanaging links to external capital markets. bank owners, managers, staff, as well as lenders andA much lower public sector deficit and a depositors (except the smallest) suffer losses fromstrengtlening of the domestic financial system (as bank failures. Regulation is also needed to limitdiscussed below) are preconditions to capital account exposure to related firns. Good supervision isliberalization, as recommended by the Committee on needed to enforce the regulations, protect capital andCapital Account Convertibility. In addition, reserve evaluate banks' risk management capacity, alongrequirerments and taxation on domestic and foreign with good auditing. Improvements in the legal andfunding should be equalized, and capital judicial system., to speed up collection fromrequirements on short term funding increased to defaulters and liquidation of capital, and betteravoid excessive incentives to foreign funding. The disclosure of information, would also reduce non-Government should continue to monitor external performing assets (although such improvements haveborrow:ng closely and, as owner of the public banks, proved difficult in the Indian context).39 Failures inlimit their external borrowing to prudent levels (as these areas, in some cases long standing, aredone in the past), especially short-term borrowing. If generally regarded as contributing to the current Eastthe current account deficit begins to widen, the Asian crisis (Box 6) Of course, the numerous bankGovernment will need to tighten monetary and fiscal failures around Ihe world suggest that even the mostpolicy. Finally, even the current degree of capital up-to-date bank supervision and regulation cannotaccount convertibility implies that monetary policy substitute for incentives to good credit managementwill need to take into account international and cannot prevent individual bank failures.developments. Difficulties in these areas were thefoundations of the Latin American debt crises of the 3.30 Difficulties in creating incentives for stronger1980s and the East Asian crisis of the 1990s. performance by public banks are apparent from the
above discussion. The owner, the Government, has3.28 Third, the banking system, which is by far the no good way of maintaining the capital. Indeed,biggest intermediary in the financial system, will more capital for public banks may simply give themneed to improve its credit management in loans to more low cost resources to lend, not increasethe private sector, which will probably mean incentives for prudence. Performance could improvechanges in institutions and incentives. Many of the by not equating public bank staff with Centralnecessary changes have been recommended by the Government employees as is the case now (whichNarasirnham II Committee (see Box 6). Although means guaranteed employment but being subject tonon-performing assets are currently less than 4% of government vigilance)40 and offer higher pay, linkedtotal assets, this figure reflects the "narrowness" of to performance. Another involves judgingIndian banks, i.e. the large percentage of their assets managerial performance on the basis of recoveriesin cash reserves, statutory liquidity requirements and and collections. Systemic incentives for good creditexcess holdings of public sector debt. Currently only management might be improved while reducing longabout 40% of total assets are lent out--"advances" in term losses, by turning weak banks that requireIndian nomenclature. Of the public banks' advances, multiple capital injections, into "narrow" banks17.8% were non-performing at end-March 1997 investing only in Government debt, with a(9.2% net of provisions), a figure that has declined corresponding reduction in staff. In this respect, theonly slightly over the last two years. Worldwide creation of a bad debt institution, to clean the balanceexperience, including these Indian figures, suggest sheets may send the wrong signals--it would reducethat public banks have found it difficult to lend to the managers' incentives to make good loans and toprivate sector without incurring large non-performing collect, and lenders' incentives to pay--while notassets. Incentives are lacking for good risk increasing the system's collection capacity.management because the managers and staff havelittle at stake. Political pressures always abound.Hence the banking system will need to move towardsprivatization with regulation providing much strongerincentives to prudent behavior.
3.29 Best practice suggests that incentives for betterperformance include high levels of capital, so that theprivate owners have something at stake; additionalcapital linked to risky activities, and ensuring that
Chapter 3: Policies to Reduce Poverty, Raise Growth 29
Box 6: The Narasimham II, Khan and Gupta Reports on the Financial Sector
The Narasimham I Committee report, in 1991, along with other reports issued at that time, provided an outlinefor reform of India's financial system. This year, the Narasimham II Committee report on banking, the KhanCommittee on harmonizing banks and development finance institutions, and the Gupta Report on rural credit, alongwith last year's Tarapore Committee on capital account convertibility, suggest approaches for broadening anddeepening reforms in the financial system.
Narasimham l's recommendations followed best practices of the period, focusing on reduced controls on interestrate and credit allocation; tougher capital, supervision, and classification of non-performing assets and increased entry,including for foreign banks. The implementation of many of these recommendations and the worldwide problems withpublic sector banking and bank crises mean there is a new set of challenges. Narasimham II brings to bear the bestcurrent practices to these issues. Appropriately, :it focuses even more than the last report on improved incentives forprudent behavior rather than relying solely on regulation and on upgrading banks' performance.
Among Narasimham II's major recommendations along these lines are:
* Reduction of Government's and RBI's share of equity in banks to 33%, by dilution.
* Separate RBI from its role in bank boards.
* Raise bank capital to 9% of risk weighted assets by 2000 and 10% by 2002; mark to market and give governmentsecurities a 5% "risk weight" to begin to deal with their interest rate risk. Give foreign open positions a 100% riskweight (i.e. 8% of the open position would have to matched by capital, up from the current, separate 5% requirement).
* Reduce NPAs sharply; tighten definitions, avoid further recapitalization by the Government; any "hiving off'should involve major operational restructuring to prevent the problem's recurrence; closure of weak banks that cannotbe revived, with safeguarding depositors' and employees' interests.
* Give banks more autonomy in bank management and pay setting (for banks that have gone to the market),lengthen terms for top managers, restructure and develop voluntary retirement schemes as appropriate, upgrade staffand computerize faster; improve risk management; improve disclosure.
* Leave deposit insurance coverage as is, but move to risk based premia.
The Khan Committee's principal recommendation, was a move toward universal banking, with a progressiveelimination of the boundary between banks and the development finance instructions. The Narasimham Committeealso supported this convergence. Both committees noted the need for harmonization of the cash reserve and statutoryliquidity requirements over time. The Khan conmmittee also recommended lowering the CRR (as did the Taraporecommittee) and abolishing the SLR. Both the Khan Committee and the Narasimham Committee called forimprovement in the legal framework for loan recovery.
The Gupta Report, and the Khan and Narasimham Committees, have recommended further deregulation ofpriority sector lending. The Gupta Report has recommended allowing banks to set interest rates on agricultural loansand speeding up the process of credit by allowing branches to approve most loans. It also recommended replacing thepriority lending target with a system of annual targets.
30 Chapter 3:Policies to Reduce Poverty, Raise Growth
Box 7: Lessons from the SE Asian Crisis
The SE Asia crisis reflects 4 main factors:
* Excessive dependence on foreign debt, particularly short term debt, to finance excessive current account deficits(3.5-8% of GDP) and large amortizations. Thailand, the most overextended with two consecutive current accountdeficits of 8% of GDP, lost its reserves through failure to adjust (see below) and was unable to defend its fixedexchange rate, in July 1997. Investors in the region, foreign and domestic, lost confidence and reduced their exposure.This triggered crises in Indonesia, Malaysia and the Philippines, which had lower current account deficits, but highdebt (except Malaysia). In Korea, the crisis began in 1996 with an industrial slowdown masked by unsustainable shortterm external borrowing to support over-extended firms.
* Channeling of large volumes of external funds through weak financial systems. Local financialintermediaries were often undercapitalized, invested heavily on the basis of minimal credit analysis and expectations ofa continuing boom. Often they were closely linked to borrowers.
* Lack of incentives to prudent behavior in the financial system, including lheavy government involvement andtraditions of ensuring that owners and investors, as well as depositors, would not suffer losses. In Thailand, bailouts offinancial institutions and investors in the stock market cost the Central Bank $25 billion between June 1996 and June1997, a monetary policy totally inconsistent with.the fixed exchange rate policy.
* Excessive incentives to use foreign funds (less restrictions/costs than domestic funds) including inadequateexchange rate and interest rate variations to limit inflows. In Korea it is likely that the large buildup of short term debtwas tacitly, if not actively, encouraged by the Government, given the close relations between the Government andfinancial system. In the other countries, Governments did not take adequate measures to offset/slow the inflows.Foreigners were attracted by high interest rates and expectations they would be able to exit without much loss, whichin fact seems to be occurring.
The SE Asian crisis has many similarities with the 1980s Latin American debt crises, the main difference being thatexternal loans were at least nominally private-to-private, rather than financing public sector deficits. However, Chilein the 1980s is similar to SE Asia in the 1990s in its low fiscal deficit, the private-to-private flows, the channeling ofoffshore funds through weak, poorly regulated banks to related borrowers, and the Government's eventual bail-out.All the Latin American countries channeled foreign loans through their banking systems, which collapsed wheninflows were cut-off. Other similarities are the unwillingness to take fiscal, monetary, or exchange rate action to slowunsustainable current account deficits/booms and the underestimate of short term debt.
The lessons of the SE Asian crisis and Latin American crises seem to be:
* Fiscal prudence is a necessary, but not a sufficient condition to avoid an external debt crisis.
* Dependence on foreign inflows needs to be limited to sustainable levels, at the macro level by fiscal, monetaryand exchange rate policy, at the micro level by at least ensuring that the potential costs of foreign borrowing to thecountry are fully reflected in private costs, and the Government tightly limits public banks' exposure.
* Financial sector strengthening, in terms of higher capital requirements, linked to risky behavior; limits onexposure; and better supervision to enforce these rules and evaluate risk management capabilities.
* Quick action to force over-exposed financial firms to increase capital or suffer takeovers or closure, with closureleading to financial losses for owners, depositors, and lenders, foreign and domestic.
Not surprisingly, these lessons are not easy to follow. They require not only fiscal prudence, but action to cut-offpolitically popular booms and close weak financial institutions that often are politically connected. A tendency alwaysexisits to delay such actions, in hopes that the situation will improve of its own accord. However, the examples LatinAmerica and East Asia, not to mention industrial countries like the US, Sweden, and Spain, suggest that earlierintervention reduces the eventual cost.
3.31 AL fourth issue is priority sector lending. The of such lending to banks. However, performance ofeasing of interest rate restrictions has eased the cost priority sector loans is worse than non-priority loans
Chapter 3: Policcies to Reduce Poverty, Raise Growth 31
(priority sector accounts for 40% of net bank credit pension system, starting with the public sector, wouldbut about 47% of NPAs), reflecting both banks' generate a large volume of long term funds, whiledifficulty in managing such credit and, in some cases, providing good incomes for retirees. Such apolitical interference. The critical political issuo in movement will depend on reducing the fiscal deficit,reducing priority sector lending is to improve the in order to cover both the existing obligations underrural credit system, which again will depend on the current, pay-as-you-go system, and makingimproved incentives for sound banking, including a payments to a fully funded system without raising thegreat private sector presence and legal remedies for deficit. In the area of insurance, the requirements onexecuting collateral. Subsidies to small scale and investments by the two state insurance firms need torural lending should be made directly from the be eased prudently, and their monopoly powerGovernment, not be implicit through priority sector reduced by allowing private sector entry into thelending. Crop insurance, rather than loans, woull be system, as the government proposed in its 1998more appropriate for disaster relief than bank loans. budget speech. The resulting competition will
improve service provision, reduce costs, and increase3.32 Infrastructure lending should not be accorded benefits to the insured.priority sector status. It would mean a return to theuse of directed credit, as a substitute for Governrment 3.35 A sixth issue is improvement in bank servicespending, an approach that has proved unsuccessful to increase the welfare of Indian firms andworldwide. In general ternns, such an approach households and prepare for liberalization of financialwould reduce the availability of loanable funds for services. India's 65,000 bank branches have spreadother activities and implicitly tax them. In this banking across the country. But inter-branch andparticular case, it would cause a severe term inter-bank linkage is weak, reflecting thetransformation problem for the banks and force them telecommunications system and the lack of a goodto lend in an area where they have little expertise in payments system, which RBI is now working tocredit management. Most importantly, at the upgrade. While public banks' costs, as a percentagemoment the problem in infrastructure is not fundling, of assets, are reasonable by intemational standards,but lack of bankable projects. Projects are not reflecting India's low labor costs (spreads remainbankable because they lack a sound regulatory high, owing to the still-high cash, liquidity, andframework, as discussed above, and suffer from poor priority lending requirements), their service quality iscost recovery in the sector, which makes the required poor. Strong unions have imposed stringent workrisk-adjusted rate of return very high. Forced lending rules and limited computerization, ATMs, etc.to such projects would simply transfer the cost of Again, a major upgrade will depend upon substantialproject failure to the banks and, ultimately, the change, such as removal of bank staff fromGovernment. Government employee status and privatization (as
recommended by the Narasimham II Committee).3.33 The fifth major issue is the development of However, without a major upgrade to improvethe long term equity and debt markets. India's service and payments, a reduction in politicalstock and bond markets are relatively large for a low control, and a reduction in the costs ofincome country, as noted. They perform well by unprofitable branches and priority lending, it isdeveloping country standards (Shah and Thomas). hard to see how Indian public banks couldImprovements in technical areas, such as a depository compete internationally without subsidies orfor shares, movement toward shorter, rolling protection. So far, deregulation has improvedsettlement periods, and better new issues pricing, are lending services and cut spreads somewhat andon-going and need to be continued. Information widened choices for borrowers. In this context,provision is still weak and could be improved by policies should ensure, as far as possible, a levelallowing rating by the large international audiiting playing field between banks and NBFCs (the recentfirms as well as local fuims. Improved bond market moves to strengthening control over NBFCs are inefficiency will depend on resolving similar technical the right direction), while at the same time ensuringissues. that competition is not reduced except for prudential
reasons.3.34 Although these improvements are importantto preparing the capital market to receive more funds,the key to mobilizing large sums of long-term fimdsis improving the pension system and liberalizinginsurance firms' investments. In particular, a prudentmovement toward a fully-funded, transferable
4. DEVELOPMENT AND FINANCING PROSPECTS
4.1 In order to reduce poverty significantly, India reserves. However, the debt service ratio wouldwill need sustained rapid growth supported by continue to decline, reflecting increased reliance onvigorous human development. This will depend on: foreign direct investment in the capital account.
. maintaining macroeconomic stability, to 4.5 Regarding exports, the East Asian crisis isencourage saving and investment and avoid an likely to have mainly an indirect effect. As noted,inflation tax on the poor; India's exports to East Asia (including Japan,
excluding China) are less than 20 percent of its total* an open and competitive economy, to encourage exports. However, there is likely to be substantially
efficient allocation of resources and continuous increased competition in third country markets onceupgrading of technology and product quality; credit to East Asian exporters, including credit to
* higher infrastructure investment; and finance their imports, recovers, or if China attemptsto increase its exports substantially. Another
* a sound financial system that avoids fnancial important issue for Indian exports is the potential ofinstability and allocates resources to high return increased protectionism in the industrial countries.activities. The growth of anti-dumping actions in industrial
countries may begin to place impediments to4.2 Prospects for such development will depend mutually beneficial trade.on further stabilization, government realignment andreform that reduces the consolidated fiscal deficit, 4.6 Despite these external developments, the mainespecially the high level of subsidies; accelerates the challenges to increasing growth, the pace of povertyreduction of tariff and non-tariff barriers; reduction, and exports are internal. Policies thatconsolidates financial sector reform, especially in increase the profitability of exports enough tobanking; increases public spending on physical and increase India's share of world exports will yield asocial infrastructure (mainly at the state level); substantial rise in export growth, GDP growth andimproves the framework for private participation in labor demand. The scenario assumes sufficientinfrastructure; begins civil service and pension domestic reforms will occur to yield a rise in exportreforms; and improves the quality of governance. growth beginning in 1999-2000 that will exceed the
projected growth of world exports. While oil4.3 The actual pace of such concerted policy (import) prices are likely to remain low, prices of keyreform is difficult to predict. Moreover, in the short export commodities such as tea (after 1999), rice andrun, the environment for India has become more wheat are also forecast to decline, so that the overalldifficult. International exchange and capital markets terms of trade would remain constant over theare volatile and the cost and availability of funds for medium-term. The current account deficit woulddeveloping country borrowers is likely to be higher stabilize at about 2.5% of GDP for 1999-2001, beforethan in the last few years. India also faces G8 falling. Reserves would resume their increase andsanctions, a lower credit rating, the likelihood of the debt service ratio would continue to fall.increased competition in export markets from EastAsia, arid the slowdown of domestic investment. 4.7 In the short run, the external vulnerabilities in
this scenario are in the current account, and in the4.4 The scenario for the next few years assumes possible repatriation of foreign portfolio investmnentsufficient reforms to at least maintain export growth and slowdown in capital inflows. In the short run,over the next year (see Table I on page 3). However, some pressures on the exchange rate and reservesthe current account deficit is likely to worsen could develop through leads and lags of currentsomewhat (to 2.3% of GDP), since, despite the fall in account payments--increased leads in importoil prices in 1998-99, import growth is likely to payments and increased lags in export receipts ofremain above export growth. With the increased export--and slowdowns in the remittances on whichdifficulties in offshore finance, the widening trade the current account is heavily dependent. Over thedeficit is likely to lead to some loss of international longer term, carrying out enough reforms to achieve
.'Development and Financing Prospects 33
the higher projected export growth will be critical, 4.10 Official development assistance is needed toboth to increase efficiency but also to avoid a help reduce the number of India's poor, which isdeterioration in the balance of payments, because of greater than all the poor in sub-Saharan Africa. Thethe current excess of imports over exports. vast needs of India's poor cannot be met solely by
higher inflows of private capital. Official4.8 The capital account is still fairly closed, and development assistance will also play a major role inreserves are fairly high ($29.4 billion including gold reducing poverty. It can support improvements inat end-March), compared to the (controlled) low critical social and physical infrastructure, such aslevel of short term debt and trade credit. However, primary education and health, roads, water supply,foreign portfolio investment, currently about $9 etc., areas where the private sector traditionally hasbillion, can be repatriated, although sharp outflows not played a role. There is also a need to build upare likely to be deterred by the potential losses that institutional capacity in these areas, particularly at thewould occur from declines in the stock and foreign sub-national level, which official assistance can helpexchange markets. Net private capital inflows riight provide. Official development assistance also willslow somewhat in the short run, but official flows are help to "crowd-in" both foreign and domestic privatelikely to remain fairly constant, as they reflect investment. Finally, external assistance alsodisbursements from already-committed loans. improves the structure of debt and debt service
profile because of its long-term and concessional4.9 India is classified as a moderately indebted nature. It thus provides a stable source of externalcountry, in spite of an external debt of about U';$92 fnance, which will be important even as the capitalbillion, one of the highest in the developing world, account is gradually liberalized. This report thereforeand a high debt stock to export ratio. Its moderately urges a continued high level of official developmentindebted rating reflects the large concessional assistance, with a substantial concessionalcomponent of its debt (almost 50%), which lowers its component.debt service to export ratio through reduction ofaverage interest rates and increasing averagematurity.
Endnotes
Net outstanding forward sales against this total were $1.8 billion at end March 1988.
2The figures for short term NRIs reflect the original maturities of the deposits. Maturing long term NRIs also represent apotential claim on reserves, which would be increased at a point in time to the extent the maturities are "bunched".
3Penalties include fall in stock market prices, which are likely to be large in a market where foreign investors have providedmuch of the impetus for price movements, and penalties on early liquidation of NRI deposits and term deposits in Rupees. In theApril 29, 1998 monetary policy statement, banks were allowed to set their own penalties for early withdrawals, previously, thepenalty set by RBI had been low and had led to some problems for foreign banks (see para 2.28).
4As in previous years, the deficit does not include the capital cost of recapitalization of public banks, which was 0.2% of GDPin 1997-98, see endnote 14.
5Petroleum prices were gradually deregulated, begiining with 6 products on April 1. The original program also entailed areduction, over four years, of the cross subsidies on Icerosene and LPG from surcharges on petrol, aviation fuel, etc., with thefnal, negligible subsidy eventually to become part of the budget. However, the Government has since decided to maintain thesubsidies, which would either lead to a large budget cost or continuation of the cross-subsidy.
6 Tax revenues are recorded on a cash basis, and hDnce may be overstated or understated to the extent that tax refunds andrebates are varied from year-to-year.
7Allocating India's Consolidated Public Deficit between the Central Government and the States is complex. Under the FederalConstitution, a large share of taxes collected at the Center is returned to the States--77.5% of income taxes and 47.5% of Centralexcise taxes, which amounted to 6.1% of GDP in 1997-98. The Tenth Finance Commission proposed an alternative, 29% of alltaxes, which would avoid any possible emphasis on one tax or another. The proposal, which requires a constitutionalamendment for enactment, would increase the State's share of revenues by over I percentage point of GDP, compared to pastresults. The Center also makes substantial transfers to the States (1.6% of GDP) and net borrowing on behalf of the States,which in total represent almost 40% of central expenditure. In part they fund Central schemes that are implemented by theStates, which in many other countries are the full respDnsibility of the States.
8 Cross country differences in the Central Government deficit may partly reflect differences in Federal transfers to states.Comparable international data on consolidated public sector deficits is limited. Differences in consolidated deficits acrosscountries would partly reflect differences in the role of public enterprises.
9A public sector debt trap arises when the average interest rate paid exceeds the nominal GDP growth rate, at which point anysustained new public borrowing causes an explosive growth in the ratio of public interest payments to GDP.
10 The rise in interest costs reflects both the higher interest cost of financing a given deficit, and the higher cost of rolling overoutstanding debts. As the average interest cost of the debt stock thus rises, the sustainable deficit, i.e. the deficit consistent withavoiding a debt trap, declines as a percentage of GDP. The rise in interest costs, as the Government shifted from implicit taxesin the financial sector to market borrowing, partly explains the limited reduction in the revenue deficit.
A recent exception is Andhra Pradesh, which has set water and land revenue charges to cover 70% of O&M.
12 The hard budget constraint for States is judicious; in some Latin American countries, large state deficits financed throughaccess to the central bank were a major factor in hyperinflation. The ability of Indian states to run larger deficits is limited bylimits on their borrowing capacity, which is determined by loans from the Center, access to borrowing from RBI, and theallocated share of statutory holding of state paper by the banking system. Many states have tried to get around their hard budgetconstraints with the use of guarantees on borrowing by state-owned enterprises, thereby increasing their contingent liabilitieswhich were not as closely monitored as their borrowings. Some states also had used borrowings from their public enterprises toease the limits on their direct borrowings. However, the removal of the State public enterprises from qualifying for the StatutoryLiquidity Requirement in 1994-95 and the deterioration in the State public enterprises' finances has now limited the enterprises'access to borrowing without state guarantees. Relying on the market to limit States' and State Public Enterprises' borrowing toprudent levels is complicated by whether there is an implicit guarantee by the Central Government.
13 States employ about 7.5 million workers directly (about twice as many as the Central Government) and 8.8 million moreindividuals work in quasi-public positions at state-funded private schools and hospitals. Hence the cost of the wage settlementcould be 2-4 times as much as in the Center.
I The Government defined non-merit goods as goods and services that neither involved significant externalities nor obviouslyaimed at improving equity. The split between explicit and implicit subsidies is difficult to make. Explicit subsidies in theCentral B3udget were 1.3% of GDP in 1994-95. The Central Statistical Office estimates that the States provided subsidies of1.2% of GDP through their budgets. However, these figures exclude debt relief, recapitalizations, and net payments foreducation. Moreover, as explained in end note 1, the recapitalization of public banks is not included, this averaged about 0.2%of GDP in the last 4 years.
15 In 1992-93, banks were instructed to classify as NPAs loans on which principal and interest was past due for four quarters,tightened to three in end 1994 and two quarters in end 1995 and thereafter. For financial institutions, the classification is morelenient on principal repayments i.e. one year past due. While many countries still follow the norm of 180 days, some countrieshave moved to a tougher standard of 90 days.
16 Write-offs, even of fully provisioned assets, are difficult in the Indian legal and regulatory framework, so provisions are arelatively large percentage of non-performing assets in a strong bank.
17 The 1997-98 transaction of Rs.27 billion was an injection of equity, in the form of non-negotiable, 12 year, 10% bonds, andthus did not show up as part of government expenditures, although the interest will later. The previous injections also took thisform. Such injections increase the share of public debt in total assets of the recipient bank.
Is India's manufactured exports (which constitute over 75% of total exports) are biased towards activities based on naturalresources and simple technologies, and this pattern has remained relatively static over the past decade. For India, RB (resource-based) and LT (low-tech) exports accounted for over 86% of total manufactured exports in 1985, and for 84% in 1996; worldaverages are 43% and 35% respectively. India's HT (high-tech) exports rose only from 3 to 4.4% over 1985-96. India's exportstructure is far more 'backward' than those of South East Asian economies, China and Mexico. Malaysia and Thailand, by nomeans technologically more sophisticated than India, have HT exports of over 60 and 36%. India's export 'positioning' is alsonot favorable. The percentage of its manufactured exports that are increasing their market share in products that are 'dynamic'(increasing their share in world trade) were 19.3% over 1990-95. Figures for Asian countries were much higher, such as 47.4 forChina, 72.7 for Malaysia, 47.4 for Indonesia, 41.6 for Korea etc. On the other hand, India has 65.6% of its manufactured exportswith increasing market share in those products whose share in world trade is declining. This is a direct consequence of itsproducts being largely in RB and LT sectors. See Lall (1998) for more details.
19 Of course, the Effective Rate of Protection is a better measure of protection (i.e. the degree of inefficiency in productionrelative to the world that a country is prepared to live with) than tariffs. This has also moved down consistently over the years(NCAER, 1998). However, since cross-country data for ERPs is not available, the text reports average tariffs.
20 India's import regime has several categories, such as free (OGL), prohibited, canalized through state trading agencies,importable subject to clearances, and a special import license (SIL). The UNCTAD methodology to calculate NTBs, used byNCAER, gives a zero weight to any OGL import, and a weight of one to all other categories. The SIL allows exporters to import5-10% oi their exports from an increasingly large list of products and is transferable. Thus, it provides an additional channel offairly free imports (with an overall monetary ceiling), albeit at a premium.
21 The effective rate of protection on secondary industry is about 43%. In other words, the average margin available to pay forland, labor and capital in the secondary sector is about 43% more than that available to produce a unit of exports. Thiscalculation ignores the impact of subsidies on both exports and secondary industry production. Generally speaking, subsidies,even to agricultural products, do not offset the impact of high domestic costs of imported inputs and the restrictions on exportsthat lower their domestic prices below world prices.
22 Restnctions on both exports as well as imports also violate multilateral trade rules.
23 Manufacturing employment was higher after trade liberalization in 11 of 12 countries studied by Papageorgiou et al (1990). InIndia, it iis interesting to note that the average labor intensity in unregistered manufacturing increased from an average of 59.3percent over 1988-89 to 1990-91 (just before reforms) to 62.4 percent over 1993-94 to 1995-96 (Annex Table A.13, based onASI and NAS data). However, over the same period, there was little change in the labor-intensity of registered manufacturing,which perhaps reflects the lack of flexibility in the labor market (Box 3 on legal reforms).
24 However, the USA has challenged the continued maintenance of QRs by India (implying that it would like to see a quickerphase-out), and at its request, a dispute settlement panel was established in November 1997. Hearings were continuing at thetime of writing.
25 For example, the average tariff (weighted by value -added weights) on primary goods was 20.6% and on secondary productswas 37.7 percent in 1997-98 (NCAER 1998). Also, many agricultural products report negative ERPs for 1988-89 through 1997-98. In terms of the use-based classification, consumer durables consistently have the highest ERPs of all products, even withoutthe fact that most consumer durables actually have virtually infinite protection on account of QRs.
26 Ltl,aSee Joshi and Little, pp.70-77, for an excellent articalation of this issue.
27 A common uniform tariff of say 10 percent allows each import-competing industry to charge upto 10 percent more than worldprices. At the same time, importable inputs cost 10 percent more than world prices. For every import-competing industry, thereis now a 10 percent increase in the difference between price of its output and the price of its tariff-inclusive intermediate inputsi.e. there is a 10 percent 'effective protection' of value-added. See also Harberger, p. 160.
28 Such as in the infant industry argument justifying the case for protection. See Subramanian.
29 India's post-Uruguay Round bound tariff rates of 42.2 percent (simple average) are higher than all but three of 26 developingcountries (average bound rate 28.5 percent) (Pursell). Bound rates serve an important function of establishing credibility that thereform program will not be reversed. Of course, high bound rates leave open the possibility of reversing tariff cuts, which couldcreate uncertainty and lead to deferred investment.
30 For example, exporters can wait 6-8 months for dtty drawback or export promotion for capital goods licenses (Nair and Kaul1996). Special export promotion zones, set up to avoid many of these problems, so far seem to provide little relief .
31 Manufacturer-Importers do not pay sales tax on imported inputs while they pay sales tax on domestic inputs. This argumentignores the fact that domestic producers are in any case protected by very high tariffs on imports.
32 The figures for 1997 include the 3 percent special duty imposed in September 1997.
33 The one case where the domestic producer is most at a disadvantage is where imports are duty free, since the importer wouldnot pay any tax on imports whereas he would pay a sales tax on domestic purchase. However, the budget has exempted the zeroduty import category from the special additional duty,
4 In one of various exercises by the Ministry of Commerce, done in 1996-97, for selecting key export product categories.
35 See Kathuria and Bhardwaj, and ICICI-Harvard study. Bhavani and Tendulkar, using 1987-88 census data for 395 garmentsand apparel units in Delhi, found that scale of operations was directly correlated with export performance; and that given theform of business organization, larger firms made a proportionately greater contribution to employment and paid higher wages.
36 See Taneja, quoting from a FNCCI study.
37 The Godrej steel almirah, for example, is priced 200-300 percent higher than the corresponding item in the small scale sector.See Guhathakurta. Of course, this kind of product differentiation happens even in the absence of reservation, but the differencethere is that the large firm is not in a quasi-monopoly position.
3S While there are firms which would export more thzn 50 percent of output, the compulsion to export more than 50 percent year
after year would still be a deterrent to entry by large firms.
39 The Recovery of Debts due to Banks and Financial Institutions Act 1993 established special tribunals for adjudicating debtand speeding recovery, but the tribunals' activities have been tied up in the courts. One way that Mexico used to extend thetribunals' mandate was to require borrowers to agree to adjudication by the tribunals, rather than the courts.
40 According to a recent Supreme Court ruling, an employee of any institution with greater than 50 percent holding by theGovernment will have guaranteed employment but also be subject to vigilance, as is the case with Government servants. Thismeans that privatization may be the only solution to this issue, as recommended by the Narasimham lI Committee.
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PQ
E-o
i Annex Tables
Annex Table 11: Domestc Demand, 1981496(percent of GDP at market prices)
Fiscal Deficit 12.3 9.5 10.7 9.0 8.9 9.6 9.1a Govemment of India definitione Estimatei Fiscal deficit minus interest payments.2 Includes central and state govts. and excludes net lending from center to states.3 Consolidated non-financial public sector comprises central govt. (incl. the balance of OCC),
central public enterprises and state governments. Excludes intra-govemmental transfers.Source: Budget documents, RBI, IMF, and staff estmates.
iii Annex Tables
Annex Table 3: Central Government Finances, 1990-98(percent of GDP)
90-91 91-92 92-93 93-94 94-95 95-96 96-97 97-98 98-99RE BE
Note: BE= budget estimates; RE=revied estimates.a. Revenue expenditure is the budget terminology for current expenditure.b. Revsed Estmates unless otherwise mentioned.c. Fisal deficitwould rise to 5.8% of GDP owing to a loss of revenue (urea, excise on petrol and import duty) following the post budget announcementd. Staff estimatSource: Government of India, Budget documents, IMF
* These companies had floated public issues. Percentage of Govt. holding after proposed public issue is not known.# figures are provisional, as the shares sold in Oct. 1995 are yet lo be transferred in favour of successful Bidders.Source: Economic Survey, 1997
Annex Tables vi
Annex Table 6: Key Interest Rates, 1994-98
Call Money Treasury Bills 2 Prime 3 Maximum 4 IDBI 6 Bank7 Exchange 8 6-month Inflation 9Rate 364-day 91-day Lending Term Deposit Rate Rate Rate Forward
p ., t T re n d In C a 11 M o n e y R a te s: D e . '9 7 M a rc h '9 8
52
42
M o n th .
1 Call money rate of major commercial banks, average for the month.2 Implicit yield at cut-off price (forthe last auction in the month). 364-day Treasury Bills were introduced in April 1992, and are sold through periodic auctions. Since
January 1993, 91-day Treasury Bills are being periodically auctioned. Earlier they were sold on tap at 4.6% 182 day treasury bills were reintroduced in the credit policy of 29 April '9832 Since Octoer 18, 1994, lending rates of scheduled commercial bankswerefreed for creditlimits of over Rs 200,000; at 13.5 percent per annum for credit limits over Rs 25,000
and upto Rs 200,000; and at 12 percent credit limits upto Rs 25,000.4 Interest rates on domestc term deposits with a maturity of 30 days and upto one year are prescribed at'not exceeding Bank Rate minus 2 perecentage points per annum'.
Effective October 22,1997, banks are free to fix their own interest rates on domestic term deposits of 30 days and over. Minimum period of maturity for term depositswas reduced from 30 days to 15 days in the credit policy of Aprl 29, 1998.
6 The deposit rate for March 1996 is the ceiling rate for maturity of 46 days and up to 2 years. Effective July 2, 1996 banks were free to determine term deposit rates for maturityperiod above one year. The rate for March 1997 is the ceiling rate for maturity of 30 days and up to one year.
6 Medium term lending rate.7 The bank rate was reduced to 11 percent in April, 1997 and 10 percent in June'97. The rate was furtherbrought down to 9 percent in the busy season credit policy of Oct.1997.
On 16 Jan. 1998, the bank rate was increased by a sharp 200 basis points to 11 percent. The bank rate was reduced to 10.5 percent on 18 March, and to 9 percent on Apnil 29,1998.3 Period average rate as given in the Intemational Financial Stastics.' Wholesale price index, annual increase, point-to-point.
Source: RBI Monthly Bulletin, various issues; RBI Weekly Bullefin; CMIE
vii Annex Tables
Annex Table 7: India's Sharn in World Trade Rose when Tariffs fellYears World Merchandise India's Merchandise Share Tariff
Source: NCAER8Special Import Ucense (SILs) have been given a weight of 50 percent, and all other non-tariff barriers a weight of 100 percentAll non-tanff barriers assigned equal weight of 100 peroent
ax Annex Tables
AnnexTsbl 9: R Exchag Rbofinda MaInTrading Prtners d Compets 1981 -98
Export 1997Share 1981 1990 1991 1992 1993 1994 1995 1996 1997 1998 Jul Oct Dec Mar
Nobs 1. Inaease = deprecationZ Data pertains lo avees of Mauch.
a. Index of counys noninal exphangte vinaiis bie US$ dMded by eounbys CPI isa4s US CPI.b. Real effectve exchange ra, based on the IMPs Infonmatn Notice Sysbrm (INS) rethodobgy. Trade meights are based on tade
flow awaged over 1990-92.Sowce:blemationetnanF itStisfkisti IMF; Wodd Bank Staff Estnaes.
Annex Tables x
Annex Table 10: India - Tariff Structure, 1990-98
(in percent)Mean -- - -- -ImportWeightedAverage --
(32) (26) (24) (20) (12.4) (12.2) (9.4) (10.2)Note: Standard deviations are in parentheses. In 1990-91 and 1992-93, mining is induded in intermediates.
Total customs duty is calculated as a sum of the basic customs duty, the special duty of customs, and the special additional duty.
Special additional duty is levied on the value of imports as well as the basic duty value, the special duty value, and the additional countervailing duty value.Figures for 1997-98 include the 3%special duty imposed in September 1997.
Source: World Bank Staff Estmates, the rates are based on the 1997-98 and 1998-99 editions of the Easy Reference Customs Tariff, Academy of Business Studies.
160 Mean Tariff Rates 160
140 140
120 I 120
100 I 100
80 * l o>l 80 _iiiiiiiAgricultural Productsr-lConsumer goods
60 60 _.-Whole Economy
40 40
20 20
0
o 4 t. C o00 0
The Impact of the Four Percent Special Additonal Duty, 1998-99 (%)Sector Customs Duty Total Customs Duty Difference
1:3 ProvisionalNote: The flow as a percentage of the change in base money or the change in broad money stock is in parentheses.
Increases in foreign assets following a devaluabon are offset by declines in other assets.Source: RBI
x
0 PkV: bW
Statistical Appendix
CONTENTS
I. National Accounts
Al.1(a) National Accounts Summary, (Rs. billion at current prices)A1.1(b) National Accounts Summary, (Rs. billion at 1980-81 prices)A1.2(a) Gross Domestic Product at Factor Cost - By Industry of Origin, (Rs. billion at current
prices)A1.2(b) Gross Domestic Product at Factor Cost - By Industry of Origin, (Rs. billion at 1980-81
prices)A1.2(c) Implicit Price Deflators for GDP at Factor Cost, (1980-81 = 100)A1.3 Gross Savings and Investment, (Rs. billion)A1.4 Disposable Income and Its Uses, (Rs. billion at current prices)AL.5(a) Gross Domestic Investment by Industry of Origin, (Rs. billion at current prices)Al .5(b) Gross Domestic Investment by Industry of Origin, (Rs. billion at 1980-81 prices)AL.5(c) Investment Deflators by Industry of Use, (1980-81 = 100)A1.6(a) Gross Domestic Investment in Public Sector, (Rs. billion at current prices)A1.6(b) Gross Domestic Investment in Public Sector, (Rs. billion at 1980-81 prices)
II. Balance of Payments - Current Accounts
A2. 1 Balance of Payments, (US$ million at current prices)A2.2(a) Merchandise Exports, (US$ million at current prices)A2.2(b) Merchandise Exports, (US$ nnillion at 1980-81 prices)A2.2(c) Export Unit Value Indices, (US$ terms, 1980-81 = 100)A2.3(a) Merchandise Imports, (US$ million at current prices)A2.3(b) Merchandise Imports, (US$ million at 1980-81 prices)A2.3(c) Import Unit Value Indices, (US$ terms, 1980-81 = 100)A2.4 Invisibles on Current Account, (US$ million)A2.5 Decomposition of Recent Export Growth, (US$ million at current prices - annual
averages)
m. Balance of Payments - Capital Accounts
A3.1(a) External Debt Summary: Debt Outstanding and Disbursed, (US$ million at currentprices)
A3.1(b) External Debt Summary: Disbursements, (US$ million at current prices)A3 .1(c) External Debt Summary: Principal Repayments, (US$ million at current prices)A3. 1(d) External Debt Summary: Net Flows, (US$ million at current prices)A3 .1(e) External Debt Summary: Interest Payments, (US$ million at current prices)A3.2 External Reserves (US$ million at current prices)
2 Statistical Appendix
IV. Public Finance
A4.1 Central Government Finances Summary, (Rs. billion at current prices)A4.2 Budgetary Classification of Central Government Finances, (Rs. billion at current prices)A4.3 Budgetary Classification of State Government Finances, (Rs. billion at current prices)A4.4 Budgetary Classification of General Government Finances, (Rs. billion at current prices)A4.5 Tax Revenue - Center and States, (Rs. billion at current prices)A4.6 Non-Tax Revenue - Center and States, (Rs. billion at current prices)A4.7 Revenue Expenditure of the Central Government, (Rs. billion at current prices)A4.8 Revenue Expenditure of State Governments, (Rs. billion at current prices)A4.9 Capital Expenditure - Center and States, (Rs. billion at current prices)A4.10 Transfers between Center and States, (Rs. billion at current prices)A4. 11 Explicit Subsidies in the Central Government Budget, (Rs. billion at current prices)A4.12 Outstanding Debt of Central Government, (Rs. billion at current prices)A4.13 Outstanding Debt of State Governments, (Rs. billion at current prices)A4.14 Outstanding Debt of Central and State Governments, (Rs. billion at current prices)A4.15(a) Projected and Actual Plan Outlays by Sectors, (Rs. billion at current prices)A4.15(b) Projected and Actual Plan Outlays by Sectors, (Rs. billion, annual averages at 1980-81
prices)A4.15(c) Projected and Actual Plan Outlays by Sectors, (percent distribution and achievement
rates)
V. Money and Credit
A5.1 Money Supply and Sources of Change, (Rs. billion)A5.2 Base Money Supply and Sources of Change, (Rs. billion)A5.3 Selected Monetary Policy InstrumentsA5.4 Structure of Short-term and Long-term Interest Rates, (percent per annum)A5.5 Sectoral Deployment of Gross Bank Credit, (Rs. billion - change during year)
VI. Agriculture, Industry, Transport, Energy and Prices
A6.1 Production of Major CropsA6.2 Irrigated Area Under Different Crops, (million hectares)A6.3 Yield Per Hectare of Major Crops, (kgs. per hectare)A6.4 Net Availability, Procurement and Public Distribution of Foodgrains, (million tons)A6.5a New Index of Industrial Production, (1993-94 = 100)A6.5b Index of Industrial Production, (1980-81 = 100, Old series)A6.6 Production, Imports and Consumption of Fertilizers, (000' nutrient tons)A6.7 Indian Railways: Freight and Passenger TrafficA6.8 Petroleum Summary: Commodity Balance of Petroleum and Petroleum Products,
(million tons)A6.9 Generation, Consumption and Capacity of Electricity, (000' GWH)A6.10 New Index Numbers of Wholesale Prices - by Years, (Base 1981-82 = 100)A6.11 Consumer Price Index Numbers for Industrial Workers, Urban Non-Manual Employees
and Agricultural LaborersA6.12 Evolution of the Wholesale Price Index, 1991-97 (index and twelve months point-to-
point increase)
Statistical Appendix 3
Table Al.1 (a)National Accounts Summary(Rs. billion at current prices)
Note: Exports, Imports, Foreign Savings, Net Factor Income and Capital Tninsfers numbers are used from the BOP.Source: CSO, National Accounts Statistics 1997 and CSO Ouick Estimates 1998
10 Statistical Appendix
Table Al.5 (a)Gross Domestic Investment by Industry of Origin
a. Refers to CSO's savings-based estimate of investment.b. Refers to Gross Capital Formation unadjusted for errors and omissions, which is CSO's direct estimate of investment based on physical flows.
Source: CSO, National Accounts Statistics 1997 and CSO Quick Estimates 1998.
Statistical Appendix 1
Table AI.5 (b)Gross Domestic Investment by Industry of Origin
a. Refers to CSO's savings-based estimate of investment.b. Refers to Gross Capital Formation unadjusted for errors and omissions, which is CSO's direct estimate of investment based on physical flows.
Source: CSO, National Accounts Statistics 1997 and CSO Quick Estimates 1998
12 Statistical Appendix
Table Al.5 (c)Investment Deflators by Industry of Use
a. Refers to CSO's savings-based estimate of investment.b. Refers to Gross Capital Formation unadjusted for errors and omissions, which is CSO's direct estimate of investment based on physical flows.
Source: CSO, National Accounts Statistics 1997 and CSO Quick Estimates 1998.
Statistical Appendix 13
Table A1.6 (a)Gross Domestic Investment in Public Sector
Note: Debt related information is taken from the World Bank Debt Repordng System.
a. Includes interest on military debt to FSU and retuns on foreign investments.b. Corresponds to bilateral balance or servicing of the Russia debt from 1990-91 onwards.c. Residual item including reserve valuation changes, rupee trade iunbalance, etc.d. As proporton of gross current receipts (GNFS exports + factor receipts + curent transfer receipts).
Source: Government of India; Reserve Bank of India; Ministry of Commere; Ministry of Finance, Economic Survey, various issues;World Bank Staff estimates.
TOTAL EXPORTS (Customs) C 13003 24449 11446 100.0Discrepancy 635 412 -223TOTAL EXPORTS (BOP)' 12252 22910 10659
Memo:Gems(Net)d 317 1449 1132
a. Refers to engineering goods.b. Including unclassified exports.c. Total exports, fo.b., net of crude oil.d. Exports less imports of gems and jewellery.
Source: Ministry of Commerce, (D.G.C.I.S.); lteserve Bank of India.
24 Statistical Appendix
Table A3.l (a)Extemal Debt Summary: Debt Outstanding and Disbursed
Note: BE = Budget estimates; RE = Revised estimates.
a. Including sale of public assets (disinvestment).b. Net of states' share.c. Net of loan recoveries.d. Monetized deficit (equal to net RBI credit to Central Government).e. T-Bills and dated securities, excluding those issued to RBI.f Includes RBI (net) figure.
Source: Ministry of Finance, Union budget documents.
Statistical Appendix 31
Table A4.2Budgetary Classification of Central Govemment Finances
Note: BE = Budget estimates; RE = Revised estimates.
a. Actuals for centre and revised estimates for states.b. Other expenditure include compensation and assigmnents to local bodies and panchayat raj institutions and reserve with the
finance department.
Source: Union Budget Documents; RBI bulletin on state finances; World Bank Staff Estimates.
Note: BE = Budget estimates; RE = Revised estimates.
a. Actuals for the center and revised estimates for the states.Source: Ministry of Finance, Union budget documents; Reserve Bank of India, RBI bulletins on state finances; World Bank Staff Estimates.
Note: End of year stocks are used to calculated outstanding debt and External Debt as shown in the central budget.a. Provisional.
Source: RBI, Report on Currency and Finance, various issues; Ministry of Finance, Union Budget & Indian Economic Statistics(Public Finance); Ministry of Finance, Econotnic Survy, various issues; World Bank Staff estimates.
Note: End of year stocks are used to calcualte outstanding debt.a. Provisional.
Source: RBI, Rewort on Currency and Finance, various issues; Ministry of Finance, Union Budget & Indian Economic Statistics(Public Finance); Ministry of Finance, Economic Survev, various issues; World Bank Staff estimates.
Statistical Appendix 43
Table A4.14Outstanding Debt of Central and State Governments
Loansto States from Center 170.71 495.34 562.22 641.39 741.17 834.90 924.12 1019.45 1167.05 1315.06
Note: End of year stocks are used to calculated outstanding debt and External Debt as shown in the central budget.a. Provisional.
Source: RBI, Report on Currency and Finance, various issues; Ministry of Finance, Union Budget & Indian Economic Statistics(Public Finance); Ministry of Finance, Economic Surv ny, various issues; World Bank Staff estimates.
44 Statistical Appendix
Table A4.15(a)Projected and Actual Plan Outlays by Sectors
Note: Derived from Table 4.15(b).a. Percentage share in total plan outlay.b. Actual outlay as a percentage of target outlay for the Plan.c. Covers Major and Minor ports, Shipping, Lighthouses and Inland Water.
Source: Planning Commission.
Statistical Appendix 47
Table A5.1Money Supply and Sources of Change, 1985-86 - 1996-97
Note: Dates given are those on which the announced measures take effect.
a. Minimum cash reserves to be deposited with thb, RBI as % of net demand and time liabilities (NDTL).b. The ratio of liquid assets, exclusive of those under (a), to aggregate demand and time liabilities
upto March 28, 1985 and net demand and time liabilities with cffect from March 29, 1985.
Sources: Reserve Bank of India, Report of the Committee to Review the Working of the MonetarySystem, 1985; Reserve Bank of India, AnnMuaL E2 various issues.
50 StatisticalAppendix
Table AS.4Structure of Short-term and Long-term Interest Rates
a Effective 8 January, I93, a new auction system for 91-day Treasury Bills was introduced.b. Effective 22 April, 1992, a singl 'maximum deposit rate has been for deposits of various maturities.
Earlier different rates were precned for different deposit maturities.c. Deposits accepted from the public.d. Well-established private sector companies.
Swrce: Reserve Bank of India, Ro on Curmnev and Einnc various issues.
Statistical Appendix 51
Table A5.5Sectoral Deployment of Gross Bank Credit
Notes: Units of measurement of all commodities is million tonnes, except in the case of coton, jute and mesta where production is in terms ofmillions of bales. Figures for 1995-96 are provisional.
a. Includes groundnuts, rapeseeds and mustard, sesame, linseed, castorseed, nigerseed, safflower, sunflower and soybean.
Source: Minisiry of Finance, Economic Surve, various issues.
a. Excludes nitrogen meant for non-agricultural purposes.b. Excludes data in respect of bonemeal and rockphosphate.c. Anticipated.d. Incorporates import of Urea in nutrient terms, the only controlled fertiliser imported on Government account.
Source: The Fertilizer Association of India, Fertilizer Statistics various issues; Ministry of Finance, Ecognmic Survey various issues.
Statistical Appendix 59
Table A6.7Indian Railways: Freight and Passenger Traffic
Passenger Traffic
Revenue Earning Freight Traffic Non-Suburban Suburban a
Originating Net tons- Average Passenger Passenger- Average Passenger Passenger- Averagetonnage kilometers lead originating kilometers lead originating kilometers lead
Year (mln.tons) (million) (kilometers) (million) (million) (kilometers) (million) (million) (kilometers)
a. Passengers booked between stations within the suburban areas of Bombay; from 1988/89 onwards suburban passenger traffic includeMetro Railway, Calcutta.
Source: Ministry of Railways, Railway Budget.
60 Statistical Appendix
Table A6.8Petroleum Summary
Commodity Balance of Petroleum and Petroleum Products(million tons)
Note: The last column indicates each item contribution to the WPI increase, that is the index item percentage change in Dec 1996times the weight of the item in the WPI.
Source. Ministry of Finance, Economic Survev, various issues; CMIE, Monthly Review of the Indian Economy, various issues.